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by Financial Sense news hour
Friday, Mar. 17, 2006 at 5:52 PM
China's development vs world
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Financial NewsHour - Ask the Expert: George Zhibin Gu, book author, "China's Global Reach: markets, Multinationals, and Globalization"
JIM PUPLAVA: My guest this week is George Gu. George obtained his education at Nanjing University in China and Vanderbilt University and the University of Michigan in the United States, he holds two MS degrees and a PhD from the University of Michigan. Since 1990 he’s been an investment banker and a business consultant. He’s also worked for the last 15 years in the investment world with a focus on China. His work focuses on helping international businesses to invest in China and Chinese companies expand overseas. He’s got experience working with Prudential Securities, Lazard and State Street Bank. He’s also written several books, one Made In China: Players and Challenges in the 21st Century, and his current book is called China’s Global Reach: Markets, Multinationals and Globalization.
George, you grew up in China during a very difficult time, especially during the Cultural Revolution. How has this impacted your thinking today in terms of how you view China?
GEORGE ZHIBIN GU, PHD: Well, while I was growing up in China, China experienced a cultural revolution, as well as people’s communes in the countryside. It was chaotic, it was characterized by abusive government power which was expanding into everybody’s lives. What is more, it was an entirely closed society. In other words, every citizen had to work for the government to make a living. So the government exactly demanded the servitude of citizens, but today everything has changed fundamentally. So, in my mind two things are most crucial for modern society and progress, that is, having an open society is a must; secondly, private initiatives – people must rely upon their own efforts for progress and prosperity. That is exactly what has been happening for the last 25 years. This makes all the difference. The third one is that international participation in any country’s development is a necessity, otherwise development slows down tremendously. So, the situation in China and India shows [this is] the case. [3:05]
JIM: You know that was one of the points that you made in your book, that the grand lesson of China is that no nation can truly develop without making itself open to the rest of the world.
GEORGE: That is very true. 500 years ago, Europe became an open society expanding globally. Especially the US, it depended on talents, capital, and technology from the rest of the world. That’s why the US has become a dominating power globally for the last 100 years. Today, China is doing the same thing, relying upon all the resources from around the globe. [3:46]
JIM: You know, one of the great paradoxes as you look at China today is this vast economic progress, but it does not have a new political-economic system in place. Can you explain that?
GEORGE: Basically, this current reform at an institutional level was initiated by the government. The government wanted to try something different from the previous 30 years. In Mao’s era the government dominated all economic and political spheres – everybody had to work for the government. On the other hand this political structure created a lot of burdens for the government. Therefore the government wanted to shift the burdensome aspects of the business to the society and people. At the same time, government does not like to give up on its traditional power hold on the society, therefore at the institutional level you [will] still see that traditional political framework is still at work. For example, about 70% of China’s business assets are still in government hands. So, this is one fundamental aspect of China’s current reform. However, you see the other trend which is overpowering the government and promoting its political and economic reform, reluctantly or not. [5:24]
JIM: George, in your mind what are the key driving forces behind China’s economic development today?
GEORGE: Number one, opening up. During the Cultural Revolution, China’s economy was shutdown. It had no economic ties to the outside world whatsoever. So, opening up China has brought new ideas – technical and technology – as well as results, for growth. So, this is the most crucial aspect behind the growth.
Number two is the domestic consumption explosion. For example, 25 years ago China did not have any mobile phones, but today China has about 400 million mobile phone subscribers. Also, 20 years ago China had few television sets, but today almost every urban family has at least one television set, and in the countryside about 50% do. So, therefore China has become the biggest home appliances market really.
JIM: Now, in May of 2003 the Chinese government allowed 2 investment banks, Nomura and UBS to trade in the Chinese stock market. George is this a sign of things to come, and initially why only two companies?
GEORGE: Basically, the Chinese government has a law qualifying foreign institutional investors to play in the domestic market. Initially, they gave about a US billion allowance and you have to go through the selection process. So, in order to attract competition from foreign money managers so every month they gave permits to a couple of players, that’s how Nomura and UBS got the first tickets, but we’re seeing during the last year and a half about 27 UBS competitors such as Morgan Stanley, Goldman Sachs and JP Morgan all got [permission]. So far, they have invested about billion, now they’re putting an additional billion (US) into China’s domestic stock market. So, that’s what’s happening. [18:26]
JIM: I wonder if you might explain how the development of China has become the global manufacturing center has been more of, let’s say, a move by demand than by design.
GEORGE: Yes, that is one of the biggest Chinese growth stories, and nobody expected this to happen 25 years ago. It has come to life more by accident than by design. The initial stage was really a shift to meeting consumer demand for home appliances and electronics. At that time China did not have anything to manufacture on its own. It shared a lot of TV sets from Europe, Japan, and South Korea directly. But those TV sets had high price tags on them. You’re talking about the average Chinese family having to spend up to 10 years of their savings to buy a TV set. This huge profit margin prompted tremendous domestic investment. Immediately, we’re talking about several hundred Chinese TV manufacturers emerging by the mid 1980s. The same thing can be said of other areas of consumer products. The demand was tremendous, that’s because for most of the time China had a tremendous goods shortage for about 3 decades. There was nothing on the shelves. If you wanted to buy a pair of shoes you might have to wait or if you bought a bicycle you needed to find a friend to help you get one. So, there was a tremendous shortage meeting this huge consumer demand which therefore gave birth to the initial setting up of new manufacturing. Once this new manufacturing was set up, then they had to buy all sorts of components and chips. At that time, China couldn’t manufacture them itself, therefore it had to buy them from the overseas market, such as from Intel, Texas Instruments, and IBM, and Motorola. Therefore those international multinationals made huge profits sending their components and chips to China. Later they found out that they had better set up manufacturing facilities within China in order to make better profits. That’s initially how they came 25 years ago. So they were brought by the tremendous profit picture, and immediate business transactions.
JIM: George, there are other places in the world where the labor pool is much cheaper. For example, India and there are other countries. Is it China’s sense of business or its entrepreneurial shift which distinguishes China from the other places in the world?
GEORGE: Yes, I would say that it’s China’s overall strength that makes China a new business center. If you compare India and China you will see that India’s labor market is cheaper – about 50% cheaper – than China’s. But India’s development is more in the service sector, especially for software consulting and outsourcing. But China’s manufacturing [has advantages over the] Indian one in many aspects. This is because China has built up a complete business chain, for example, India does not have an effective manufacturing base at all. It lacks key component suppliers, it does not have the logistics, it does not have the infrastructure, but China, over the last 26 years has gotten all of them in one place. For example, in consumer electronics you can set up your shop in Guangdong, then you get more than 10,000 component makers. For example, Sony alone has more than [3,000] China based component makers. Here, you need to know that these component makers come from both Chinese companies and multinationals. So, Sony’s 3,000 come from the Chinese, the Japanese, Koreans and Europeans, and American suppliers, always in China – actually, in one province. That’s the kind of effectiveness and efficiency China has, but in India, and even in Europe you don’t have that kind of advantage.
Another advantage is the low price [gap]. These companies rely on cheap labor as well as mass production which can give you the best price, and also delivery at the best time, or any time. Therefore it gives Chinese manufacturing a lot of advantages. This is something India, and many other countries, don’t have. To build up this we are talking maybe about a trillion dollar investment plus all the key players – we’re talking about tens of thousands there from all business sectors. That’s difficult to attract all the elements into one place, within such a short time. Therefore, I call this Chinese manufacturing center an accident rather design. But it is now entering a new phase - with a lot of powerful players and a lot of design coming into play. [27:06]
JIM: George, let’s talk about something that’s very important to China in maintaining its manufacturing base, and growing its economy, and also something that impacts the rest of the world. I want to talk about China’s need for natural resources. We see that China is scouring the globe trying to secure sources of natural resources. Just the other day, CNOOC signed a .4 billion deal for Nigerian oil. How important is that and is there a possible conflict coming globally? In other words, with China’s voracious appetite for energy, the United States with 5% of the world’s population consumes 25% of its energy, if energy gets tight how does the world grow and do we avoid conflict regarding natural resources?
GEORGE: On one hand, China’s biggest economic growth comes from manufacturing. Manufacturing demands more and more resources and raw materials and components, therefore China has the biggest demand growth of oil, energy and raw materials. Therefore it has tremendous global impact, especially in this field. And unfortunately there is no way to avoid China going out into international markets to buy directly the supply or to take your words, the assets. This is needed. At the same time, there is another area of improvement that is badly needed. China’s manufacturing stands at very low level, that is, it is not energy efficient, it has a lot of old facilities which waste a lot of energy. For example, for every 0 product manufactured in Japan, it may cost little energy, but in China we’re talking about 5 times the Japanese. So that’s terribly bad, and needs a lot of effort to improve.
On a global basis China is having problems to find sufficient supplies, therefore we see Chinese companies increasing their efforts to buy natural resources assets or companies. To the established world, this may look like a risky business, that is they have to compete with China for global resources, but on the other hand you will see that this takes cooperation, because the natural resources the Chinese buy most is oil to ship back into Chinese manufacturing which manufacture international products for Sony, for Nokia, for Motorola, and GM. So it’s all interlinked. At the same time, China does have enough [of] most of the raw materials and oil and energy. So, we’re talking about China can take for example coal ,instead of oil for most power needs. At this time the US is the biggest global consumer of energy, oil, and raw materials. China is becoming number two. Even so, China last year only consumed about 7% of global oil supply. This rate may go up to 20% within the next 20 years, but I still see more cooperation and more sharing is needed, especially on the political side.
Americans consumers need to remember that China must get more oil, energy and resources in order to [do] the manufacturing. So this Chinese manufacturing requires more energy and more oil. At the same time, almost 50% of Chinese manufacturing has something to do with international demand. For example, in 2004, in terms of China’s exports, about 57% came directly from international operations within China. Another 15% of exports from China came from all sources demanded by foreign companies, which was done by Chinese manufacturers. So, all together, we’re talking about up to 75% of China’s exports comes from international parties directly, or indirectly, so everything is tied [together]. Therefore we need to get a new understanding about global economic realities, and interdependence – we need each other – especially in oil, natural resources and component supplies, which are these days are on a global basis. Unfortunately, this economic development is happening so fast upward that it has caught everyone by surprise, now it’s time to sit down and talk about cooperation, to talk about responsibilities and sharing with one another urgently. So, that’s what’s needed. [55:14]
JIM: George, what about the issue of Taiwan. And also as China’s economy has expanded, as the country has grown more wealthy, military expenditures are also increasing, and some people are uncomfortable with that. Address that issue, if you would.
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