A Simple Solution

This “Green Dam-Youth Escort” filtering software issues continues to get more interesting in highlighting the complexities of the Chinese political system today.  On the one hand, senior levels of the Chinese government continue to press their support for the new regulation and propaganda officials reportedly have ordered that criticism of the new regulation in the media be stifled.

At the same time, opposition in China continues to grow and is widely aired on the internet (sort of ironic, no?).  One of the most interesting developments is the potential use of China’s new Anti-monopoly Law (AML) to attack the new regulation as an administrative abuse of power.  Here’s a description of the issue from the WSJ (subscription required; full article here:  http://online.wsj.com/article/SB124482083845410171.html):

“Zhou Ze, a political science professor at China Youth University, said he and a professor from Hong Kong have submitted formal complaints to China’s State Council and the National Anti-Monopoly Committee saying the requirement is an “abuse of power.”

They argue that it is anti-competitive because it will flood the market with software produced by two companies selected by the Ministry of Industry and Information Technology in a non-transparent way.”

Ok, so in 1979 China begins its policy of reform and opening.  Years later as a part of that process China enacts the AML, to deal with the issue of monopolies in the economy, an important issue all market-based economies must deal with.  And today it is being cited to attack the non-competitive way this filtering software was chosen for monopoly status by the Chinese government.  And who says that economic reforms don’t bleed over into reform of the political system?

To make matters worse, there now seems to be some evidence that the Green Dam software is based in part on pirated computer code from a US company (full AP article via Physorg.com:  http://www.physorg.com/news164103095.html):

“Solid Oak Software of Santa Barbara said Friday that parts of its filtering software, which is designed for parents, are being used in the “Green Dam-Youth Escort” filtering software that must be packaged with all computers sold in China from July 1.

Solid Oak’s founder, Brian Milburn, said he plans to seek an injunction against the Chinese developer that built the software, but acknowledged that it’s new legal terrain for his company…

A report released Thursday by University of Michigan researchers who examined the Chinese software supports Solid Oak’s claim that the Green Dam software contains pirated code. The report also found serious security vulnerabilities that could allow hackers to hijack PCs running the Chinese software.

The report found that a number of the “blacklist” files that Green Dam employs were taken from Solid Oak’s CyberSitter program.

The report’s authors – researchers in the university’s computer science and engineering division – also said they found another clue that Solid Oak’s code was stolen: a file that contained a 2004 CyberSitter news bulletin that appeared to have been accidentally included in Green Dam’s coding.”

All in all this is turning into a larger and larger embarrassment for the folks who promulgated this regulation and for China’s government more broadly.

And here’s a pop quiz:  what one simple step could Chinese regulators have taken to avoid all this embarrassment?

Answer:  Publication of the draft regulation with an adequate period of time for public comment.

In fact, I believe that prior publication and public comment on this kind of regulation would fall under China’s commitment to this mechanism as a part of its WTO accession.  In any event, I think it would be clearly required under guidelines that have been issued (more than once), though never effectively enforced, by China’s State Council.

Just think about it:  had this regulation been published as a draft with a 60 or 90 period for public comment, all of the concerns of Chinese citizens and foreign companies would have been aired.  Chinese companies with competing products could have made their case for a competitive selection process and software experts inside and outside China could have reviewed the Green Dam software to assess its effectiveness and expose any use of software piracy it contains.  Then regulators could have assessed whether changes were needed in the regulation in an orderly, non-embarrassing way.

Instead, the folks who rammed this sweetheart deal through the Chinese system in secrecy have put senior Chinese leaders in an awkward position, domestically and internationally.

It is true that China has ramped up its public support for the new regulation in response to the increasing criticism it has generated.  But I stand by my predict (see my previous post) that ultimately this regulation will be withdrawn or allowed to wither away unimplemented, though it may take six months to a year for that to happen.

In addition, I have some hope that this debacle will reinforce the voices of those within China who have argued strenuously for more transparency in government rulemaking, including a strict commitment to prior notice and public comment for new regulations.

And when China’s most senior leaders get together and talk about the Green Dam issue, I hope they realize that it was this pro-transparency group, not the unhealthy alliance of Chinese IT companies in bed with their Ministry supporters, who had the interests of China foremost in mind.

Understanding Trade

Just saw a great piece on the ForeignPolicy.com website called “The Myth of Made in China” (http://experts.foreignpolicy.com/posts/2009/06/10/chinese_exports_are_not_exactly_chinese)

The article, in unusually clear language, makes the point that most of what China ships to the US consists of components sourced all over the world and merely assembled in China.  For this reason, it does not make sense to view the trade deficit with China as an indicator that we are big losers in this flow of products across the Pacific.  The piece also notes that much of what we import from China used to be produced in other Asian economies, not in the US anyway.  Here’s a sample from the article:

“…”Made in China” is a bit of a misnomer these days. Over the last 20 years, supply chains have fragmented across the globe — with one part made here, and another made there. Rarely is any one product made in any one country. China often specializes in the final stage of production: putting components together before exporting to the final users. Indeed, much of the value of U.S. imports from China, and similarly from Mexico, includes parts and components made in other countries — the United States among them. According to our recent study, domestic content (the stuff that directly contributes to domestic economic growth) makes up about 45 percent of Chinese exports and 34 percent of Mexican exports to the United States. The rest comes to China from abroad to be assembled and sold. A tag like “Made in China, Vietnam, the United States, Japan, and China again,” might be more apt.”

The article makes points that sophisticated analysts of trade flows have been trying to make for some time.  Unfortunately, it is much more satisfying (and beneficial) for politicians to rail about the US-China trade deficit and assert that it is a substantial cause of the problems facing US manufacturers over the past decade or so.  Too bad it’s just not true.  Read the full article.

It’s the Economics, Stupid

All readers of this blog will have seen the extensive press coverage given to the reported Chinese government requirement that all new PCs in China come with filtering software aimed at blocking pornographic sites.  The stated purpose is to ensure that children surfing the web are protected from viewing these sites.  (Tons of coverage on this; just Google; I like the WSJ reporting, which seems to get at the complexities a bit better than others).

Some coverage has focused on the political aspect, i.e., suggesting this may be a backdoor route to even tighter political censoring of the Internet in China.  But I think this is not really the main point.  It’s more about the economics.

Of course, this new regulations does highlight the differences between the (expansive) Chinese view of the scope of activities appropriately managed by the government vs. the (much more narrow (yes, even today)) view in the US, a subject I have opined on previously in this blog.  The US approach to the issue of objectionable material on the Internet is to, first of all, view it as the responsibility of parents, not the government, to decide what their kids should see on the Internet.  Then, if they want a filter, they can compare commercially available products, choose one, and buy it.

I can imagine the situation in which government and Party officials are discussing the rampant pornography on the Internet and each in turn tries to outdo the other in denouncing it and demanding a solution, sort of what we often hear from the US Congress on similar issues.  The difference of course is that our basic view of the scope of government activity in society usually prevents this kind of rhetoric from developing into concrete government mandates.  It is much easier in China, given the broader view of the role of the government, for the rhetoric to become reality.

But more significant here is how this regulation represents the distortions in the Chinese economy that come from the unhealthy relations between government and enterprises.

Keep in mind that the new regulation mandates inclusion of a specific software product (“Green Dam-Youth Escort”) developed by two government-affiliated Chinese companies with each computer.  Yikes!  Even if the US were to implement some requirement for filtering software it is almost certain that the government would specify a set of standards such software has to meet, make the standards public (following a period of public review and comment) and then certify any product that met those standards.

But equally interesting is the fact that, according to press reports, there is no requirement that the software be used.  It may be possible to meet the requirements of the regulation by having the PC manufacturer include a copy of the Green Dam-Youth Escort on a disc in the box with the computer.  Or, even if pre-installed, it can apparently be turned off.  In this sense, it still gives the Chinese consumer the option to use or not use the software, and to go out on the market and buy a competing product.  But is does ensure enormous monopoly rents will accrue to the “government affiliated” institutions that developed the software.  A bit of money will go to them for each new PC sold in China!  Great franchise.  These guys have used their relationships with the Chinese government to print money.

So, it’s great for the officials who now can feel they are “doing something” about the pornography-on-the-internet problem.  And it is great for the managers of the companies that have been granted this monopoly.  Who loses?  Just the portion of the rest of the 1.3 billion Chinese people who will be buying new computers.  The price of that computer will be higher (at least a bit) due to the mandated inclusion of the new software.  And in fact, the increased cost will be higher than it would be if one firm had not been granted a monopoly.

So, if you ask me, this new requirement represents in a microcosm a huge issue that will continue to be a drag on the Chinese economy for some time to come:  government actions taken to support favored Chinese companies at the expense of the Chinese consumer and broader economy.

Having said all of the above, I do want to note the bright side:  reporting over the past few days has highlighted the backlash in China among web users over this new mandate.  A lot of the backlash has focused on the aspect of increased government control over what people see.

This active public backlash is a sign of an increasingly free, public debate over government policies.  It highlights the fact that in many areas, people are free to express views critical of government policies.

In fact, I will stick my neck out and make a prediction.  I believe the Chinese ministry that inflicted this new measure on the Chinese people did so without adequate consultation or coordination throughout the Chinese government.  Nor did they allow for public review and comment of the regulation.  It was mostly a sweetheart deal with some well-connected institutions.  Therefore:

I predict the Chinese government within a few months will either withdraw this new regulation or allow it to die a quiet death.  This is not your grandfather’s China.

Update:  just saw the very good NYT article outlining the growing opposition to the new regulation (http://www.nytimes.com/2009/06/11/business/global/11censor.html?_r=1).  That article states that the Chinese government, not the consumer, will pay for the new software, to the tune of RMB 41million.  Nonetheless, this represents government money that could have been spent for the benefit of China’s people in many ways much better than by providing monopoly profits to a couple of government affiliated companies.  That article also has the Ministry of Foreign Affairs spokesman defending the new regulation.  Nonetheless, I stand by my prediction that the regulation will not wind up being implemented in any kind of effective way.

Ten Feet Tall?

When a major Chinese SOE bids for or completes an acquisition involving natural resources outside of China we hear a lot about the unfairness of such deals (the big SOEs have unlimited access to cheap credit from the Chinese government!) and the threat these crafty Chinese pose in buying up resources around the globe.

But then we get something like the recent collapse of the Rio Tinto – Chinalco deal (WSJ article on this here (subscription required, but lots of articles on the web on this): http://online.wsj.com/article/SB124416345648587527.html#mod=rss_asia_whats_news)

What to make of it?  As the WSJ put it:

“The collapse Thursday of Aluminum Corp. of China’s $19.5 billion effort to boost its stake in Anglo-Australian mining-giant Rio Tinto shows that cash-starved producers of everything from oil to metals have more alternatives than they had just a few months ago.

Back then, China looked like one of the few ready sources of funds. But a rally in commodity prices in recent weeks — oil Friday traded as high as $70.32 a barrel for the first time this year — has drawn new investment opportunities, and funding is becoming easier to find as the credit crisis eases.

Both factors doomed the bid by the state-owned Chinese company, known as Chinalco. While deal watchers don’t predict an end to China resource deals, they see a more competitive landscape and expect smaller moves.

“Chinalco saw an opportunity and, unfortunately, the market turned against them before they could execute,” says Antony Dapiran, a partner in the Shanghai office of law firm Freshfields, Bruckhaus Deringer LLP.”

Wait a minute.  If this deal was part of the central government’s plot to buy up the world’s resources (using their huge foreign exchange holdings), why didn’t Chinalco just up its price and pay whatever it took?  And for that matter, if the masterminds in Beijing are so smart, why didn’t they move more quickly to nail down this deal before the market turned?

I have long believed:

1)    The acquisition of natural resources by Chinese SOEs abroad is consistent with the policies of the Chinese government, which is risk averse and believes (mistakenly) that owning the resources gives them greater security of supply

2)    However, the individual deals are not directed by the Chinese government and the Chinese government is not writing unlimited blank checks for the SOEs on these deals

3)    The Chinese SOE managers are smart and sophisticated, but no smarter or more sophisticated than their counterparts at the global companies with which they are dealing; they will win some and lose some

4)    To the extent that Chinese bureaucrats are involved in the process this is a net negative for the Chinese SOEs because these officials, like government officials everywhere, are not as sophisticated or knowledgeable about global markets as their private sector counterparts.

So I say, let’s write about the big successful acquisitions, but keep episodes like this in mind as we think about how quick, smart, tough, relentless, and well funded China’s SOEs are.

Bad Analysis

Some of the reporting on US-China relations in the US media is good and some not so good.  But every now and then something comes along that is really awful.  My most recent example of the latter category is an AP story titled “Geithner Lacks Much Leverage in China Talks” (full text here (via Fox news):  http://www.foxnews.com/politics/2009/05/30/geithner-lacks-leverage-china-talks/).  Time does not permit an exhaustive presentation of all the misunderstandings offered in this piece, but I will point out a few.  I’ve got quotes from the article in bold, followed by my comments:

“…Mired in a brutal recession, the United States needs Beijing to boost its purchases of U.S. goods, let China’s currency rise and take other steps to narrow an enormous trade gap. And it needs China’s help to combat any military threat from North Korea…”  Comment:  This misses the whole point of the interdependent dynamic that exists between the US and China today.  China “needs” the US economy to recover as much (more actually) than the US “needs” China to increase imports from the US.  Even on the political front, the North Korea situation is just as much a problem for China as it is for the US.  On both the economic and political fronts we need to be working together.  Of course when you get down to specific policy approaches the issues we will have different perspectives based on each country’s concrete situation.  The challenge is to work through these differences and come up with coordinated approaches on the common problems we share.

“…The problem is Washington’s leverage has waned just as China’s power over the U.S. has grown…”  Comment:  Ugh.  This whole “leverage” myth really gets to me.  The notion of “leverage” is increasingly outmoded in an interdependent world, especially among the major countries.  And it certainly does not apply in US-China relations.  Per para. above, the goal is for two major countries to seek win-win solutions that advance both countries’ interests and address global challenges.

“…Even so, as Geithner headed Saturday to China to meet Monday and Tuesday with top Chinese officials including President Hu Jintao, he brings an ambitious U.S. goal: persuading Beijing to adopt policies that would transform its nation of savers into spenders…”  Comment:  China’s leaders recognize they need to increase domestic consumption as a main driver of their economy (and they are taking steps in that direction).  They now view this goal with increased urgency because of the global downturn in demand for their exports.  No doubt Geithner will discuss this issue with China’s leaders, but describing this as an “ambitious goal” of “persuading China’s leaders” of the wisdom of the US view sounds dramatic, but it’s just not consistent with the situation.

“…Those comments, plus remarks by the head of China’s central bank about whether the world needs a new top reserve currency to replace the dollar, jolted financial markets…”  Comment: maybe my memory is off here, but I recall those comments created a lot of discussion, but don’t remember they “jolted” financial markets, which have much bigger issues to be jolted about.

“…But the fact that the administration’s chief economic policymaker is going hat-in-hand to the Chinese to explain the soaring deficits shows how much has changed since his predecessor, Henry Paulson, met with the Chinese as the Bush administration’s treasury secretary in 2006…”  Comment:  this is really obnoxious.  No “hat in hand” here.  China and the US have a common set of problems.  China needs the US economy to recover and the US (and the world) needs China’s economy to continue to grow.  Our relations today are not the balance of power politics of 19^th century Europe 

“…Back then, Paulson managed to arm-twist China into agreeing to a new round of economic talks. Those talks were aimed at prodding Beijing to move faster to let its currency, the yuan, rise in value against the dollar. Doing so would make U.S. exports cheaper for the Chinese to buy…”  Comment:  great example of a journalist creating drama from nothing.  Chinese did not need “arm-twisting” to establish the SED with Paulson.  They were happy to do it because they saw it as a useful forum for dialogue.  And the SED was not “aimed at prodding Beijing to move faster to let its currency” rise.  Paulson raised that issue (under political pressure from the Hill) but it was never a major focus of the SED.

“…But this time, Geithner is expected to adopt a softer tone on the issue, even though some U.S. lawmakers want to impose tough sanctions on countries like China that are deemed to manipulate currencies to gain trade advantages…”  Comment:  Geithner’s tone on this will be similar to Paulson’s I’ll wager.  Currency is not now and has not been a significant issue with regard to employment in the US.  The main pressure on the currency issue has come from some manufacturing groups and the Congress.  But it is more of a political than an economic issue and is treated as such in US-China interactions.

“…Though the crisis has given Geithner a weak hand, Treasury officials said he’ll push for something of a grand bargain. The United States would work to reduce its budget deficits once the crisis ends and urge U.S. consumers to save more and shrink the trade deficits that are pumping dollars into the hands of Chinese and other exporters.

But to replace diminished U.S. spending, the administration will push for the Chinese to step up their own spending and stop saving so much. The administration says this can be done if Beijing improves pensions and health insurance so Chinese households don’t feel pressured to save so much…”    Comment:  Again with the “weak hand”!  This is not an arm wrestling match.  “Grand bargain”?  Both the positions stated here (US to reduce deficits after the crisis ends and encourage savings; China increase consumption) are already the stated positions of both governments.  I’m sure each side will want to reassure the other on its goals, but our interests are aligned here already, as are our stated policies.

I think you get the idea.

The story as I see it should read something like:  “The US and China (and the world) are facing the worst economic crisis in two generations.  Both sides have made clear they understand this and are working closely together to contribute to a recovery.  Of course, there are some differences of view on specific policy prescriptions.  Also, each side wants the other to move more quickly than it is to make changes in its economy to ensure sustained global growth going forward.  But the huge changes each side needs to make will inevitably take time.  Geithner on his trip will explore all these issues and work to coordinate even more closely with China on this set of critical issues.  We can expect announcements from the trip reiterating both sides commitment to addressing the current crisis.”

I understand the imperative to make a story exciting and create dramatic tension (Geithner is going hat in hand!  Will he prevail?).  But this is important stuff and deserves more thoughtful treatment.