The Rise of a New Power
A Communist economic juggernaut emerges to challenge the West
SHANGHAI--Richard Qiang could be an archetypal American. The son of blue-collar workers, Qiang thrived in school and graduated with a law degree from prestigious Fudan University. Then he landed a job here with Paul, Hastings, Janofsky & Walker, a New York law firm with dozens of corporate clients. The 25-year-old attorney owns a car and apartment, and his only complaint involves the long workdays. "I have no time to find a girlfriend," he grins.
Only one thing distinguishes Qiang from a yuppie in Chicago or San Francisco or Manhattan: He belongs to the Communist Party. Like many ambitious young Americans who get involved in politics, Qiang's motives are pragmatic. He hopes to work for the government someday, helping craft China's budding legal system. Party membership is one way to open the right doors.
Angst. But Qiang's path to upward mobility--like that of China itself--is causing angst among Washington policymakers, Midwestern factory workers, and millions of others worried about the emergence of China as an economic and military superpower. It's an article of faith in the West that democracy and free enterprise must exist hand in hand. Yet China is transforming itself from a moribund state-run economy into one of the world's most vibrant marketplaces--and crowning thousands of millionaires in the process--all within the grasp of the Chinese Communist Party.
China is teaching the West something new. Its economy, growing at 9 percent per year, will most likely become the second largest in the world by 2020, behind only the United States. Last year Americans spent $162 billion more on Chinese goods than the Chinese spent on U.S. products. And that gap has been growing by more than 25 percent per year, as China moves from building toys and tchotchkes into more-sophisticated appliances, auto parts, and semiconductors. China's consumer class, meanwhile, is spending like lottery winners on everything from bagels to Bentleys--and will soon outnumber the entire U.S. population. China's explosive growth "could be the dominant event of this century," says Stapleton Roy, former U.S. ambassador to China. "Never before has a country risen as fast as China is doing."
A communist rival--with wealth--is a new worry for Washington. Some fret about another Soviet Union in the making, flush with cash for missiles, satellites, and other advanced weapons--as well as a target to use them on: the island of Taiwan, which China considers a renegade province. Defense Secretary Donald Rumsfeld claimed earlier this month that China's military budget is much higher than it acknowledges--probably the third biggest in the world. "Since no nation threatens China," he mused, "one must wonder: Why this growing investment?"
Yet there may be even more at stake in an economic confrontation with China. Since the expiration of long-standing trade quotas in January, Chinese textile imports to the United States have leapt by 48 percent, prompting the Bush administration to enact new quotas to protect U.S. jobs. Washington and Beijing have also been lobbing verbal missiles over China's fixed exchange rate, which makes Chinese products even cheaper than they'd be with a floating currency.
The booty in this battle is jobs and prosperity. A recent report by the National Intelligence Council warns that by 2020, the rise of China could drive the world's most powerful companies to lean more toward the east than the west, cause more displacement of middle-class workers in the United States and Europe, and make Washington "increasingly irrelevant." Congress has formed a panel to monitor China's economic policies, and one bill, which has bipartisan support, would slap hefty fees on all Chinese imports. "It will not be Communist militarists that most threaten the U.S. standard of living," Ted Fishman writes in the bestseller China Inc., "but a Communist-capitalist rival that is a much more formidable economic competitor."
Open for business. Strange, then, that the planefuls of American business experts flocking to China are discovering a country that greatly resembles . . . their own. Premier American corporations like Microsoft, General Electric, and IBM have arrived in China not so much for the ubiquitous 50-cents-an-hour assembly workers as for the English-speaking engineering talent and, of all things, a pro-business political climate. World-class manufacturers like General Motors and Motorola are more interested in building products to sell to the Chinese than to ship back home. Businesses worry more about missing out on "the Chinese century" than about losing their way in terra incognita. "This is the late-19th-century United States, except that it's happening on a faster and broader scale," says Marshall Meyer, a professor at the Wharton School. "It's Chinese manifest destiny."
To rejuvenate its dormant state-run economy, China in the 1980s began wooing foreign multinationals to form joint ventures with Chinese companies, most of them government owned. That gives China the "last-mover advantage," says Spencer White, Asia Pacific chief equity strategist for Merrill Lynch. Home-grown firms extract business know-how from those who have perfected it, offering access to the Chinese market in return. "The size of their market makes them uniquely assimilated to attract technology," says White. "China knows it can just drop a couple of huge orders, and it blows away the critics."
Government directives over the past decade have prodded China's closet capitalists to test their entrepreneurial mettle. In the mid-1990s, when it became evident that lawyers were scarce, the government encouraged people with legal training to start practicing law--which few were doing. It worked. Ji Zou had graduated from law school in Beijing in 1990, but law was considered a shabby profession at the time, and only a few of the graduates in her class of 160 went to work as lawyers. So Zou moved to New York to work as an attorney. In 2003, she returned to China, eventually joining Paul, Hastings in Shanghai. Now, she says, nearly 70 percent of her old classmates have rejoined the legal profession, typically earning $35,000 per year or more--plenty, in Shanghai, for a car, nice house, and a few luxuries.
Fleeced. Command capitalism doesn't always work. In 2000, the government instructed China's four state-owned banks to start offering car loans to juice growth in the automotive sector. Car sales exploded--but the banks were massively fleeced by phantom borrowers who disappeared with their new cars. Still, forced enterprise is not a bad second to free enterprise. A 2002 "go global" campaign led by Premier Hu Jintao, which urged Chinese firms to explore other markets and develop new brands, has brought a number of Chinese firms to the world stage. Chinese computer maker Lenovo grabbed the spotlight late last year when it agreed to purchase IBM's personal computer division.
Former party leader Deng Xiaoping, who first put many of China's economic reforms in place in the 1980s, famously told his compatriots, "To get rich is glorious." Now that some are finally figuring out how to do it, a booming professional class is starting to generate an information society tailor-made for western services firms. When AIG, the huge New York-based insurance company, first got a license to operate in Shanghai in 1992, most Chinese didn't even know what insurance was. Now, with more personal property and fewer state pensions, "people here are starting to realize, 'Hey, I have these things I could lose,' " says Chia-Yan Chang, AIG's chief officer in Shanghai. "And it's not going to take China 30 years to catch up."
AIG's sales in China hit $500 million last year, and like other western firms, it's looking to double China revenues every year--a nifty offset to setbacks elsewhere, such as the accounting scandal that has engulfed the company in the United States. In China, many of AIG's 2,400 agents, in eight cities, have master's, medical, or law degrees. Some agents make over $100,000 per year.
Copycats. As always in China, there are growing pains. Local competitors have copied AIG's policies word for word--seemingly anything can be pirated in China--and priced their coverage cheaper. Several high-profile scams have soured consumers on insurance. And AIG still is not allowed to sell lucrative group policies to companies or other organizations. Senior executives, however, are undeterred. "It will become the largest market in the world over a couple of decades," predicts Edmund Tse, AIG's senior vice chairman.
Executives in countless other industries believe the same thing. Citigroup expects China to become one of its biggest markets--and sees a rare opportunity to be present at the creation of a consumer juggernaut. With a savings rate higher than 30 percent--compared with less than 2 percent in the United States--China has a vast fortune in its bank vaults. But most accounts are simple savings plans earning minimal interest. Citigroup and dozens of other financial service providers hope to offer more-sophisticated accounts producing better returns once the Chinese banking sector opens fully to foreign competition by the end of 2006, the deadline set when China joined the World Trade Organization four years ago. Of course, savings may drift down as Chinese consumers learn how to shop--but Citigroup hopes to get a cut of that action, too. Fewer than 5 percent of Chinese have a credit card, compared with 80 percent or more in the West. Citi is already pitching plastic in Shanghai in partnership with a local bank.
The lopsided U.S. trade deficit with China and the "offshoring" of manufacturing work there have focused attention on lost jobs and the fading fortunes of industries such as textiles, decimated by cheap Chinese imports. But America's interdependence with China has benefits, too. Cheap goods keep U.S. inflation and interest rates low. And the growth of China's service sector--likely to be heavily fueled by American companies--will bring a well-heeled new consumer to the global market, with less threat to American jobs. "China will be a second driver of economic growth in the world after the United States," says Richard Stanley, CEO of Citigroup China. Stanley claims the 2001-2002 U.S. recession would have been worse if not for Chinese demand for goods from America and elsewhere.
Big companies come here for the people, too. General Electric opened one of four global research centers in Shanghai in 2002 to serve the Chinese market but also to tap into Chinese talent. Universities in China issue about 160,000 advanced degrees every year--four times as many as in the United States. And they're not knockoff diplomas. "The quality of university graduates is every bit as good as in other countries," says Bijan Dorri, managing director of GE's China Technology Center.
Flying high . At a brand-new glass-and-steel structure in Shanghai's Pudong area--a swamp until it was filled in and started sprouting skyscrapers 10 years ago--600 engineers, most of them Chinese, do groundbreaking research on electronics, solar energy, plastics, and other advanced materials. Typical pay is about $35,000 per year. One major project involves GE-made jet engines that China is buying for the 100-passenger ARJ-21 jet, the first Chinese-built airliner. GE originally designed the engines to be mounted on the wings and engineers here are figuring out how to retrofit them to the fuselage, to satisfy the Chinese design.
GE plans to staff up the Shanghai lab by about 25 percent this year--but not at the expense of U.S. jobs, according to Dorri. "It's not like we have stopped hiring in the U.S. and are hiring people here," he says. "We need more talent wherever we can find it." Some of GE's employees even prefer China to the States. Chang Wei, an electrochemist, worked at a GE lab in upstate New York for several years, then came here two years ago. "It's where the growth is right now," he says. "It gives me more responsibility and helps me grow."
There are still plenty of danger zones for western firms coming to China. Companies like Intel and Microsoft are so worried about theft of key technology that they won't even do certain kinds of research in the country. Motorola's experience is a cautionary tale studied by many newcomers to China. The company led the market for cellular phones in the 1980s and '90s. But as it invested millions of dollars in local suppliers, those companies learned the business and began to offer their own phones--much cheaper than Motorola's. The local firms have since captured many of the smaller markets and are gobbling up business in big cities, too. Meanwhile, stealing of intellectual property is a problem that's getting worse, not better, according to a recent report by the American Chamber of Commerce in Shanghai, which represents U.S. business interests.
Credit check. The peculiarities of the Chinese market also force creative workarounds. Last year, General Motors Acceptance Corp., the automaker's highly profitable lending arm, got the first license issued to a foreign company to grant auto loans in China, where most people still pay cash for cars. Doing credit checks in China, however, is almost as labor intensive as building a car. Since there are no established credit bureaus, field investigators check out every applicant individually. They visit homes, making sure somebody actually lives there, and even check out their employers' offices if something looks fishy. Christian Weidemann, president of GMAC-China, recently turned down one applicant after looking at photos of his workplace taken by the field investigator. "There were no pictures on the walls. It felt like nobody worked there," he says. "We were the first to open, but we don't want to be the first to get burned."
Still, many of the old hallmarks of Marxist planning are quickly being junked. Nearly 2,300 outdated laws have been repealed since China joined the WTO, according to Dion Wiggins of the Gartner Group, the U.S. consulting firm. Just five years ago, companies constantly hit roadblocks the government called "internal documents" --secret laws, often meant to protect some apparatchik's personal empire. "We never run into that anymore," says Mitch Dudek, a partner at Paul, Hastings in Shanghai. The central government even seems to be purging corrupt officials--proving that communism can still be ruthless. Last year the government executed four bankers accused of fraud.
Foreigners are usually treated much better. Shanghai woos western conglomerates with favorable tax treatment and other perks, the same way American cities and states compete to lure businesses. Western firms often discover that when it comes to business, an authoritarian government isn't such a bad thing. "Usually, if the government says a road is going to be built by September, it will," says Jerry Nissen, a former U.S. investment banker who is executive director of SmartLink International Holdings, a Shanghai-based consultancy. "There's no second party to create opposition."
The more warmly China's leaders embrace capitalism, however, the more standing they have to pursue territorial or political goals at odds with Washington. In March, the Chinese government adopted a resolution stating its right to use force if Taiwan were to declare its independence. A war with Taiwan, or even an outbreak of anti-Taiwan fervor, is one scenario that could unnerve western businesses. Recent anti-Japanese protests have also worried China's trading partners.
And there are limits on how rapidly China can become an economic superpower and employ the geopolitical muscle that comes with such status. Most big Chinese firms, for instance, are a web of entangled interests, both party and private. "The question about Chinese corporations is always, Where does it begin, and where does it end?" says Marshall Meyer of Wharton. "The line between the government and the corporation is very indistinct." That makes it difficult for firms to get listed on respectable stock exchanges and to raise public money through equity offerings or bond issues. Sometimes it's hard to tell whether a state-owned company is even profitable, since published financial results don't always add up. The lack of standardized accounting and a robust, transparent financial system could keep China out of the world's economic big leagues for a long time. "People see China running," says Jeffrey Bernstein, chairman of the American Chamber of Commerce in Shanghai, "but they don't see how many heavy bags they're carrying."
Big brother. There are also limits to how much control the Communist Party is willing to relinquish. More than 30,000 government censors, for example, monitor Internet and E-mail traffic, which is filtered through eight gateways that the government can shut down at will--making China the only country in the world able to effectively monitor its citizens' E-mail. A true test of the party's commitment to free markets will be the growth of China's own companies. "The question is, To what extent can China tolerate the globalization of its firms, since then you lose control?" says Denis Simon, provost of the Levin Institute, the international relations school at the State University of New York. "These companies are going to face major challenges as they go overseas. They're going to have trouble maintaining their Chineseness."
For all its talk about market magic, China's overpopulated state sector is a massive job bank compared with western governments, which leaves some of the Beijing's byzantine ministries woefully inefficient. One Indian software supplier, for instance, tried to sell the Chinese government a program to automate parts of the state-owned railroad industry, which employs 20 million people. The idea flopped. "Greater efficiency creates a social problem," explains an executive for a major American software company. "Yes, 20 million are inefficient, but a more efficient system lops off heads."
If China's leaders truly aim to create the Chinese century, the Communist Party itself will probably have to recede into history. One scenario outlined by the National Intelligence Council: an "Asian way of democracy" with elections at the local level and a looser central government. Some think the party is already irrelevant. "I don't think communism really exists anymore," says a former senior official at the Bank of China. "At a certain point, being a party member is a burden. If you're related to the party, you're not doing business." And if you're not doing business, you're not cutting it in China.
More Online. U.S. News and the Levin Institute have assembled a group of experts to respond to your inquiries about China. Questions can go to china@usnews.com.
China's economy is expected to surpass Japan's by 2020, becoming the second largest in the world.
China has 16 of the world's most polluted cities.
In China, there are an estimated 2 million people whose net worth is at least $40 million.
China had 269 million cellphone users in 2003. There'll be 500 million in '08.
What Drives China
Its 1.3 billion people have launched an unprecedented economic boom. Here's what helps fuel the growth:
Gross domestic product
2000 $1.1 tril.
2005 $1.6 tril.
Milken Institute, World Bank
Foreign direct investment
2000 $38 bil.
2004 $55 bil.
United Nations Conference on Trade and Development
Internet users
2000 22.5 mil.
2005 94 mil.
www.internetworldstats.com
Energy consumption
Coal 66 pct.
Oil 23 pct.
Hydro power 8 pct.
Natural gas 3 pct.
China map
[map labels]
Beijing Population 7 million
Tianjin Population 5 million, Manufacturing
Shanghai Population 10 million, Manufacturing, textiles
Wuhan Population 4 million, Textiles, natural gas reserves
Hong Kong Population 7 million, Manufacturing, textiles
[key]
Manufacturing
Textiles
Coal production (50 million + tons/year)
Oil fields (3.4 million barrels a day)
Natural gas reserves (53.3 trillion cubic feet)
0 MILES 200
[labels]
Lanzhou
Xi'an
Chengdu
Chongqing
Kunming
Taiyuan
Guangzhou
Hangzhou
Nanjing
Shenyang
Harbin
Dalian
Three Gorges Dam
Russia
Mongolia
Nepal
India
Bhutan
Bangladesh
Burma
Laos
Vietnam
Taiwan
Japan
South Korea
North Korea
Yellow Sea
0 MILES 200
Sources: State of China Atlas, International Petroleum Encyclopedia, National Geographic Family, Reference Atlas of the World, United Nations, Thomas Brinkhoff: www.citypopulation.de
Graphic by Stephen Rountree and Danny Dougherty-- USN&WR
Research by Philippe Moulier
This story appears in the June 20, 2005 print edition of U.S. News & World Report.