Chinese Companies Make Quick Exit from US Markets

Chinese firms leave US stock markets amid complaints about price, accounting scrutiny

By Joe Mcdonald, AP Business Writer | Associated Press 

BEIJING (AP) — Just a few years after Chinese companies lined up to sell shares on Wall Street, a growing number are reversing course and pulling out of U.S. exchanges.

This week, Focus Media Holding Ltd., announced its chairman and private equity firms want to buy back its U.S.-traded shares and take the Shanghai-based advertising company private. The deal would value Focus Media at $3.5 billion, according to financial information firm Dealogic.

Smaller companies also are withdrawing from U.S. exchanges. In a sign of official encouragement, a Chinese business magazine said a state bank has provided $1 billion in loans to help companies with listings abroad move them to domestic exchanges.

The withdrawals follow accusations of improper accounting by some companies and a deadlock between Beijing and Washington over whether U.S. regulators can oversee their China-based auditors.

Some Chinese companies say they are pulling out of U.S. markets because a low share price fails to reflect the strength of their business. Withdrawing also eliminates the cost of complying with American financial reporting rules.

Focus Media “has been seriously undervalued on U.S. stock markets” and being taken private will help to promote its “long-term strategic development,” said a company spokeswoman, Lu Jing.

The company, formed in 2003, operates electronic advertising displays in elevators, grocery stores and other locations.

“We haven’t considered whether to list the company on Chinese markets but that possibility has not been excluded,” Lu said.

U.S.-traded Chinese companies faced scrutiny after auditors for several quit and others were accused of accounting irregularities. Concerns about company finances have caused share prices to tumble, costing investors several billion dollars.

“Probably all these companies have some questionable accounting, so they may prefer to move out of the U.S., not to come under too much scrutiny,” said Marc Faber, managing director of Hong Kong fund management company Marc Faber Ltd.

A financial firm, Muddy Waters Research, accused Focus Media last year of overstating the number of its display panels and questioned acquisitions reported by the company. Focus Media denied the allegations and said independent auditors confirmed the size of its network.

This week, Muddy Waters founder Carson Block said in a statement: “The markets are far better off if a few deep pocketed investors own Focus Media instead of mutual funds and other public shareholders.”

The group proposing to take the company private includes its chairman, Jason Nanchun Jiang, and private equity firms Carlyle Group, CITIC Capital Partners, CDH Investments and China Everbright Ltd.

The status of Chinese companies in the United States could be complicated by a dispute between U.S. and Chinese regulators over whether American inspectors will be allowed to examine the work of their China-based audit firms.

Washington wants auditors to hand over documentation on companies that are under investigation but Chinese authorities have barred the release of some information. If a settlement is not reached, the SEC could reject audits by China-based firms, forcing companies to find new auditors.

In May, Beijing took steps to tighten control of local affiliates of major accounting firms by issuing a requirement for Chinese citizens to head those offices.

Dozens of Chinese companies issued shares on Wall Street over the past decade, raising billions of dollars from investors who wanted a stake in the country’s booming economy.

Many were private companies that could not raise money on Chinese exchanges that were created to finance state industry or wanted the higher public profile.

Chinese regulators encouraged the move as a way for entrepreneurs to raise money and speed the development of China’s economy. But in recent years Beijing has encouraged private companies to issue shares in China to help develop its markets and give Chinese households better investment options.

Regulators have made it easier for private companies to join China’s two exchanges in Shanghai and the southern city of Shenzhen, though most listings still are for state enterprises. The Shenzhen exchange created a second board for small companies, imitating the U.S.-based Nasdaq market.

Major state companies such as oil giant PetroChina Ltd. and China Mobile Ltd., the world’s biggest phone company by subscribers, also have issued shares abroad. None has indicated it plans to withdraw from foreign stock exchanges.

The economics also are shifting in China’s favor.

U.S.-traded companies saw share prices plunge following the 2008 global crisis, while economic growth at home, even after a recent decline, is still forecast at about 8 percent this year. Rising Chinese incomes are creating a bigger pool of money for investment.

“Generally speaking, a company’s shares are sold at a higher premium in initial public offerings on Chinese stock markets than on U.S. markets,” said Mao Sheng, a market strategist for Huaxi Securities in the western city of Chengdu.

Also, he said, “If the company’s business is mainly in China, it will be good for its brand promotion.”

Another U.S.-traded company, Fushi Copperweld Inc., announced plans in June by its chairman, Li Fu, and a Hong Kong firm, Abax Global Capital, to take the maker of metallic conductors private.

Muddy Waters cited Fushi Copperweld in April as one of several companies it said dealt with an investment bank that helped enterprises seeking U.S. stock market listings to conceal problems and misrepresent financial information.

Fushi Copperweld denied Muddy Waters’ “vague and nonspecific” claims.

The company said its privatization will be financed with loans from the China Development Bank.

Created to support construction of highways and other public works in China, CDB plays a growing role in its corporate expansion abroad. The bank provides credit to buyers of Chinese telecoms gear and other big-ticket goods and has financed building projects in Africa, Latin America and Asia.

CDB has lent $1 billion “to help Chinese public companies leave the U.S. stock market to return to domestic markets,” the business magazine Caixin said last month.

Employees who answered the phone at Fushi Copperweld said no one was available to comment.

Also in June, China TransInfo Technology Corp., a provider of traffic management technology, announced privatization plans to be financed by CDB’s Hong Kong branch. A company spokeswoman said she could not comment because the plan is not finalized.

In October, Harbin Pacific Electric Co. withdrew from Nasdaq in a share buyback financed by $400 million in loans from the CDB.

 

Federal Reserve Approves First US Bank Acquisition in the United States by a Chinese Bank

On May 9, 2012, the Board of Governors of the Federal Reserve System (the “FRB”) issued an order (the “Order”) approving the acquisition of 80% of the shares of common stock of The Bank of East Asia (U.S.A.) National Association (“BEAUSA”), by Industrial and Commercial Bank of China Limited (“ICBC”). This Order marks the first occasion on which the FRB approved the acquisition of a U.S. bank by a Chinese bank since the Bank Holding Company Act of 1956 (the “BHC Act”) was amended by the Foreign Bank Supervision Enhancement Act of 1991 (“FBSEA”). The FBSEA, which increased federal supervision of foreign banks operating in the United States, requires the FRB to make a finding that a foreign bank seeking to acquire control of a U.S. bank is subject to comprehensive supervision on a consolidated basis (“CCS”) by its home country supervisor. The Order marks the first time that the FRB has made a full and unqualified CCS determination for a Chinese bank to acquire control of a U.S. bank, although it has previously made a so-called “limited” CCS determination in the context of Chinese banks establishing U.S. branches.

On November 8, 2007, the FRB approved an application by China Merchants Bank Co., Ltd. (“CMB”) to establish a branch in New York, New York, the first such approval for a Chinese bank since the FBSEA. The FRB made a “limited” CCS determination pursuant to a provision that allows the FRB to approve a branch application if the appropriate authorities in the home country of the foreign bank are actively working to establish arrangements for the consolidated supervision of the bank submitting the application, and all other factors are consistent with approval. The FRB’s approval of CMB’s branch application opened the door for other Chinese banks to apply for branches in the United States. Thereafter, branch approvals based on similarly limited findings of CCS were granted by the FRB to ICBC in November of 2008 and to China Construction Bank Corporation in March of 2009. The “limited” CCS determination available for a branch application is not available for an application to acquire a U.S. bank under Section 3 of the BHC Act, which requires the FRB to make a full and unqualified CCS determination.

The FRB’s evaluation of whether ICBC is subject to CCS was foreshadowed in the FRB’s August 31, 2010 determination that CIC, an investment vehicle organized by the Chinese government, qualified under the CCS standard in the context of a Section 3 application for CIC’s non-controlling, but greater than 5%, investment in the shares of common stock of Morgan Stanley. The FRB explicitly noted, however, that that finding was based on both the unique nature and structure of CIC and the noncontrolling nature of the investment under consideration in that application. In addition, the FRB noted that, in evaluating a proposal by a Chinese bank to acquire a U.S. bank, the FRB would evaluate whether that Chinese bank is subject to CCS.

In the Order, the FRB detailed its exhaustive analysis on the CCS of ICBC by the China Banking Regulatory Commission and other regulatory authorities including, among others, the People’s Bank of China, the State Administration of Foreign Exchange, China Securities Regulatory Commission and China Insurance Regulatory Commission. The Order also noted the International Monetary Fund’s most recent determination that China’s overall regulatory and supervisory framework adheres to international standards. In addition, the FRB noted China’s efforts on combating money laundering and terrorism financing and found that the anti-money laundering efforts by ICBC and the Chinese regulators are consistent with approval.

The Order should create the opportunity for other leading Chinese banks to acquire U.S. banks of a relatively modest size. Although the CCS determination is nominally bank-specific, in practice a CCS determination for one bank in a country is typically precedential for all similarly situated banks in that country. In addition, because the FRB takes the position that a CCS determination is required before a foreign banking organization can obtain financial holding company (“FHC”) status, the Order should pave the way for Chinese banks and their holding companies that are subject to the BHC Act to become FHCs.

 

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Innovation in China

Dynamic domestic players and focused multinationals are helping China churn out a growing number of innovative products and services. Intensifying competition lies ahead; here’s a road map for navigating it.

MCKINSEY QUARTERLY  FEBRUARY 2012 • Gordon Orr and Erik Roth

China is innovating. Some of its achievements are visible: a doubling of the global percentage of patents granted to Chinese inventors since 2005, for example, and the growing role of Chinese companies in the wind- and solar-power industries. Other developments—such as advances by local companies in domestically oriented consumer electronics, instant messaging, and online gaming—may well be escaping the notice of executives who aren’t on the ground in China.

As innovation gains steam there, the stakes are rising for domestic and multinational companies alike. Prowess in innovation will not only become an increasingly important differentiator inside China but should also yield ideas and products that become serious competitors on the international stage.

Chinese companies and multinationals bring different strengths and weaknesses to this competition. The Chinese have traditionally had a bias toward innovation through commercialization—they are more comfortable than many Western companies are with putting a new product or service into the market quickly and improving its performance through subsequent generations. It is common for products to launch in a fraction of the time that it would take in more developed markets. While the quality of these early versions may be variable, subsequent ones improve rapidly.¹

Chinese companies also benefit from their government’s emphasis on indigenous innovation, underlined in the latest five-year plan. Chinese authorities view innovation as critical both to the domestic economy’s long-term health and to the global competitieness of Chinese companies. China has already created the seeds of 22 Silicon Valley–like innovation hubs within the life sciences and biotech industries. In semiconductors, the government has been consolidating innovation clusters to create centers of manufacturing excellence.

But progress isn’t uniform across industries, and innovation capabilities vary significantly: several basic skills are at best nascent within a typical Chinese enterprise. Pain points include an absence of advanced techniques for understanding—analytically, not just intuitively—what customers really want, corporate cultures that don’t support risk taking, and a scarcity of the sort of internal collaboration that’s essential for developing new ideas.

Multinationals are far stronger in these areas but face other challenges, such as high attrition among talented Chinese nationals that can slow efforts to create local innovation centers. Indeed, the contrasting capabilities of domestic and multinational players, along with the still-unsettled state of intellectual-property protection (see sidebar, “Improving the patent process”), create the potential for topsy-turvy competition, creative partnerships, and rapid change. This article seeks to lay out the current landscape for would-be innovators and to describe some of the priorities for domestic and multinational companies that hope to thrive it.

China’s innovation landscape

Considerable innovation is occurring in China in both the business- to-consumer and business-to-business sectors. Although breakthroughs in either space generally go unrecognized by the broader global public, many multinational B2B competitors are acutely aware of the innovative strides the Chinese are making in sectors such as communications equipment and alternative energy. Interestingly, even as multinationals struggle to cope with Chinese innovation in some areas, they seem to be holding their own in others.

The business-to-consumer visibility gap

When European and US consumers think about what China makes, they reflexively turn to basic items such as textiles and toys, not necessarily the most innovative products and rarely associated with brand names. In fact, though, much product innovation in China stays there. A visit to a shop of the Suning Appliance chain, the large Chinese consumer electronics retailer, is telling. There, you might find an Android-enabled television complete with an integrated Internet-browsing capability and preloaded apps that take users straight to some of the most popular Chinese Web sites and digital movie-streaming services. Even the picture quality and industrial design are comparable to those of high-end televisions from South Korean competitors.

We observe the same home-grown innovation in business models. Look, for example, at the online sector, especially Tencent’s QQ instant-messaging service and the Sina Corporation’s microblog, Weibo. These models, unique to China, are generating revenue and growing in ways that have not been duplicated anywhere in the world. QQ’s low, flat-rate pricing and active marketplace for online games generate tremendous value from hundreds of millions of Chinese users.

What’s keeping innovative products and business models confined to China? In general, its market is so large that domestic companies have little incentive to adapt successful products for sale abroad. In many cases, the skills and capabilities of these companies are oriented toward the domestic market, so even if they want to expand globally, they face high hurdles. Many senior executives, for example, are uncomfortable doing business outside their own geography and language. Furthermore, the success of many Chinese models depends on local resources—for example, lower-cost labor, inexpensive land, and access to capital or intellectual property—that are difficult to replicate elsewhere. Take the case of mobile handsets: most Chinese manufacturers would be subject to significant intellectual property–driven licensing fees if they sold their products outside China.

Successes in business to business

Several Chinese B2B sectors are establishing a track record of innovation domestically and globally. The Chinese communications equipment industry, for instance, is a peer of developed-world companies in quality. Market acceptance has expanded well beyond the historical presence in emerging markets to include Europe’s most demanding customers, such as France Télécom and Vodafone.

Pharmaceuticals are another area where China has made big strides. In the 1980s and 1990s, the country was a bit player in the discovery of new chemical entities. By the next decade, however, China’s sophistication had grown dramatically. More than 20 chemical compounds discovered and developed in China are currently undergoing clinical trials.

China’s solar- and wind-power industries are also taking center stage. The country will become the world’s largest market for renewable-energy technology, and it already has some of the sector’s biggest companies, providing critical components for the industry globally. Chinese companies not only enjoy scale advantages but also, in the case of solar, use new manufacturing techniques to improve the efficiency of solar panels.

Success in B2B innovation has benefited greatly from friendly government policies, such as establishing market access barriers; influencing the nature of cross-border collaborations by setting intellectual-property requirements in electric vehicles, high-speed trains, and other segments; and creating domestic-purchasing policies that favor Chinese-made goods and services. Many view these policies as loading the dice in favor of Chinese companies, but multinationals should be prepared for their continued enforcement.

Despite recent setbacks, an interesting example of how the Chinese government has moved to build an industry comes from high-speed rail. Before 2004, China’s efforts to develop it had limited success. Since then, a mix of two policies—encouraging technology transfer from multinationals (in return for market access) and a coordinated R&D-investment effort—has helped China Railways’ high-speed trains to dominate the local industry. The multinationals’ revenue in this sector has remained largely unchanged since the early 2000s.

But it is too simplistic to claim that government support is the only reason China has had some B2B success. The strength of the country’s scientific and technical talent is growing, and local companies increasingly bring real capabilities to the table. What’s more, a number of government-supported innovation efforts have not been successful. Some notable examples include attempts to develop an indigenous 3G telecommunications protocol called TDS-CDMA and to replace the global Wi-Fi standard with a China-only Internet security protocol, WAPI.

Advantage, multinationals?

Simultaneously, multinationals have been shaping China’s innovation landscape by leveraging global assets. Consider, for example, the joint venture between General Motors and the Shanghai Automotive Industry Corporation, which adapted a US minivan (Buick’s GL8) for use in the Chinese market and more recently introduced a version developed in China, for China. The model has proved hugely popular among executives.

In fact, the market for vehicles powered by internal-combustion engines remains dominated by multinationals, despite significant incentives and encouragement from the Chinese government, which had hoped that some domestic automakers would emerge as leaders by now. The continued strength of multinationals indicates how hard it is to break through in industries with 40 or 50 years of intellectual capital. Transferring the skills needed to design and manufacture complex engineering systems has proved a significant challenge requiring mentorship, the right culture, and time.

We are seeing the emergence of similar challenges in electric vehicles, where early indications suggest that the balance is swinging toward the multinationals because of superior product quality. By relying less on purely indigenous innovation, China is trying to make sure the electric-vehicle story has an ending different from that of its telecommunications protocol efforts. The government’s stated aspiration of having more than five million plug-in hybrid and battery electric vehicles on the road by 2020 is heavily supported by a mix of extensive subsidies and tax incentives for local companies, combined with strict market access rules for foreign companies and the creation of new revenue pools through government and public fleet-purchase programs. But the subsidies and incentives may not be enough to overcome the technical challenges of learning to build these vehicles, particularly if multinationals decline to invest with local companies.

Four priorities for innovators in China

There’s no magic formula for innovation—and that goes doubly for China, where the challenges and opportunities facing domestic and multinational players are so different. Some of the priorities we describe here, such as instilling a culture of risk taking and learning, are more pressing for Chinese companies. Others, such as retaining local talent, may be harder for multinationals. Collectively, these priorities include some of the critical variables that will influence which companies lead China’s innovation revolution and how far it goes.

Deeply understanding Chinese customers

Alibaba’s Web-based trading platform, Taobao, is a great example of a product that emerged from deep insights into how customers were underserved and their inability to connect with suppliers, as well as a sophisticated understanding of the Chinese banking system. This dominant marketplace enables thousands of Chinese manufacturers to find and transact with potential customers directly. What looks like a straightforward eBay-like trading platform actually embeds numerous significant innovations to support these transactions, such as an ability to facilitate electronic fund transfers and to account for idiosyncrasies in the national banking system. Taobao wouldn’t have happened without Alibaba’s deep, analytically driven understanding of customers.

Few Chinese companies have the systematic ability to develop a deep understanding of customers’ problems. Domestic players have traditionally had a manufacturing-led focus on reapplying existing business models to deliver products for fast-growing markets. These “push” models will find it increasingly hard to unlock pockets of profitable growth. Shifting from delivery to creation requires more local research and development, as well as the nurturing of more market-driven organizations that can combine insights into detailed Chinese customer preferences with a clear sense of how the local business environment is evolving. Requirements include both research techniques relevant to China and people with the experience to draw out actionable customer insights.

Many multinationals have these capabilities, but unless they have been operating in China for some years, they may well lack the domestic-market knowledge or relationships needed to apply them effectively. The solution—building a true domestic Chinese presence rather than an outpost—sounds obvious, but it’s difficult to carry out without commitment from the top. Too many companies fail by using “fly over” management. But some multinationals appear to be investing the necessary resources; for example, we recently met (separately) with top executives of two big industrial companies who were being transferred from the West to run global R&D organizations from Shanghai. The idea is to be closer to Chinese customers and the network of institutions and universities from which multinationals source talent.

Retaining local talent

China’s universities graduate more than 10,000 science PhDs each year, and increasing numbers of Chinese scientists working overseas are returning home. Multinationals in particular are struggling to tap this inflow of researchers and managers. A recent survey by the executive-recruiting firm Heidrick & Struggles found that 77 percent of the senior executives from multinational companies responding say they have difficulty attracting managers in China, while 91 percent regard employee turnover as their top talent challenge.

Retention is more of an issue for multinationals than for domestic companies, but as big foreign players raise their game, so must local ones. Chinese companies, for example, excel at creating a community-like environment to build loyalty to the institution. That helps keep some employees in place when competing offers arise, but it may not always be enough.

Talented Chinese employees increasingly recognize the benefits of being associated with a well-known foreign brand and like the mentorship and training that foreign companies can provide. So multinationals that commit themselves to developing meaningful career paths for Chinese employees should have a chance in the growing fight with their Chinese competitors for R&D talent. Initiatives might include in-house training courses or apprenticeship programs, perhaps with local universities. General Motors sponsors projects in which professors and engineering departments at leading universities research issues of interest to the automaker. That helps it to develop closer relations with the institutions from which it recruits and to train students before they graduate.

Some multinationals energize Chinese engineers by shifting their roles from serving as capacity in a support of existing global programs to contributing significantly to new innovation thrusts, often aimed at the local market. This approach, increasingly common in the pharma industry, may hold lessons for other kinds of multinationals that have established R&D or innovation centers in China in recent years. The keys to success include a clear objective— for instance, will activity support global programs or develop China-for-China innovations?—and a clear plan for attracting and retaining the talent needed to staff such centers. Too often, we visit impressive R&D facilities, stocked with the latest equipment, that are almost empty because staffing them has proved difficult.

Instilling a culture of risk taking

Failure is a required element of innovation, but it isn’t the norm in China, where a culture of obedience and adherence to rules prevails in most companies. Breaking or even bending them is not expected and rarely tolerated. To combat these attitudes, companies must find ways to make initiative taking more acceptable and better rewarded.

One approach we found, in a leading solar company, was to transfer risk from individual innovators to teams. Shared accountability and community support made increased risk taking and experimentation safer. The company has used these “innovation work groups” to develop everything from more efficient battery technology to new manufacturing processes. Team-based approaches also have proved effective for some multinationals trying to stimulate initiative taking .

How fast a culture of innovation takes off varies by industry. We see a much more rapid evolution toward the approach of Western companies in the way Chinese high-tech enterprises learn from their customers and how they apply that learning to create new products made for China. That approach is much less common at state-owned enterprises, since they are held back by hierarchical, benchmark-driven cultures.

Promoting collaboration

One area where multinationals currently have an edge is promoting collaboration and the internal collision of ideas, which can yield surprising new insights and business opportunities. In many Chinese companies, traditional organizational and cultural barriers inhibit such exchanges.

Although a lot of these companies have become more professional and adept at delivering products in large volumes, their ability to scale up an organization that can work collaboratively has not kept pace. Their rigorous, linear processes for bringing new products to market ensure rapid commercialization but create too many hand-offs where insights are lost and trade-offs for efficiency are promoted.

One Chinese consumer electronics company has repeatedly tried to improve the way it innovates. Senior management has called for new ideas and sponsored efforts to create new best-in-class processes, while junior engineers have designed high-quality prototypes. Yet the end result continues to be largely undifferentiated, incremental improvements. The biggest reason appears to be a lack of cross-company collaboration and a reliance on processes designed to build and reinforce scale in manufacturing. In effect, the technical and commercial sides of the business don’t cooperate in a way that would allow some potentially winning ideas to reach the market. As Chinese organizations mature, stories like this one may become rarer.

China hasn’t yet experienced a true innovation revolution. It will need time to evolve from a country of incremental innovation based on technology transfers to one where breakthrough innovation is common. The government will play a powerful role in that process, but ultimately it will be the actions of domestic companies and multinationals that dictate the pace of change—and determine who leads it.

Latest US – China Trade Dispute – Rare Earth Minerals

AP source: US to bring trade case against China over materials used for high-tech goods

By Julie Pace, Associated Press | Associated Press 

WASHINGTON (AP) — The Obama administration is bringing a new trade case against China that seeks to pressure the rising economic power to end its export restrictions on key materials used to manufacture hybrid car batteries, flat-screen televisions and other high-tech goods.

The new trade initiative being announced Tuesday is another effort aimed at leveling the playing field for U.S. companies.

Senior Obama administration officials said the U.S. will ask the World Trade Organization to facilitate talks with China over its curtailment of exports of rare earth minerals. The U.S. is bringing the case to the WTO along with the European Union and Japan.

Tuesday morning, the EU announced its participation in the case. In Brussels, EU Trade Commissioner Karel De Gucht said China’s restrictions “hurt our producers and consumers in the EU and across the world.”

Obama was scheduled to speak about the WTO action from the White House later Tuesday, according to the U.S. officials, who requested anonymity in order to speak ahead of the president.

The fresh action is part of President Barack Obama’s broader effort to crack down on what his administration sees as unfair trading practices by China that have put American companies at a competitive disadvantage.

China has a stranglehold on the global supply of 17 rare earth minerals that are essential for making high-tech goods, including hybrid cars, weapons, flat-screen TVs, mobile phones, mercury-vapor lights, smartphones and camera lenses. The materials also are used in the manufacture of tiny motors, such as those used to raise and lower car windows and in consumer electronics.

China has reduced its export quotas of these rare earth minerals over the past several years to cope with growing demand at home, though Chinese officials also cite environmental concerns as the reason for the restrictions. U.S. industry officials suggest it is an unfair trade practice, against rules established by the WTO, a group that includes China as a member.

The senior administration officials said Beijing’s export restrictions give Chinese companies a competitive advantage by providing them access to more of these rare materials at a cheaper price, while forcing U.S. companies to manage with a smaller, more costly supply.

On Tuesday, a Chinese foreign ministry spokesman defended Beijing’s curbs on rare earth production as necessary to limit environmental damage and conserve scarce resources.

“We think the policy is in line with WTO rules,” said the spokesman, Liu Weimin, at a regular briefing.

He rejected complaints that China is limiting exports. “Exports have been stable. China will continue to export, and will manage rare earths based on WTO rules,” Liu said.

The spokesman noted that China has about 35 percent of rare earth deposits but accounts for more than 90 percent of global production. “China hopes other countries can shoulder responsibility for supplies and can find alternative resources,” he said.

Rare earth minerals are scattered throughout the Earth’s crust, but only in small quantities, making them hard to mine. However, rich deposits of these rare earth oxides are in China, giving it command of the market.

The U.S. has just one rare earth mining company, the Colorado-based Molycorp Inc. There are also working mines in Australia, and a proposed one in Malaysia.

With the U.S economy slowly inching its way out of recession, Obama has sought to bring a renewed focus to Chinese policies that could hinder U.S. growth.

Obama used an executive order last month to create a new trade enforcement agency — the Interagency Trade Enforcement Center — to move aggressively against China and other nations. In announcing the new agency, Obama said it would bring “the full resources of the federal government to bear” in order to level the playing field for U.S. workers.

Under the terms of the WTO complaint, China has 10 days to respond and must hold talks with the U.S., E.U. and Japan within 60 days. If an agreement cannot be reached within that time frame, the U.S. and its partners could request a formal WTO panel to investigate Chinese practices.

The WTO, the only global international organization dealing with the rules of trade between nations, has sided with the U.S. in previous trade disputes with China.

In 2009 the Obama administration imposed a three-year tariff, starting at 35 percent, on U.S. imports of low-grade Chinese tires. The tariff was approved after imports of those tires rose threefold to about 46 million tires between 2004 and 2008. Last year the WTO rejected an appeal from China and found that the United States acted consistently with its obligations in imposing the duties.

 

Like America, Chinese Politics will Buffer Hard Landing

Analysis: Politics cushion China’s economic hard landing risks

REUTERS  February 27, 2012 By Nick Edwards

BEIJING (Reuters) – The politics of China’s need for a smooth leadership succession this year provide the best protection against a hard economic landing, regardless of stuttering exports, faltering capital flows, local government debts and lingering inflation risks.

By the time President Hu Jintao and Premier Wen Jiabao are handing over power in the late autumn, China should be well on course for its slowest full year of growth since they took office a decade ago — and that’s without any economic shocks.

It’s not an auspicious bequest in a system that relies on stability to justify the one-party rule of the Communist Party and is precisely why any significant threats to the economy will be met with an unmistakable policy response.

“That is the only line of thinking,” Paul Markowski, President of New York-based MES Advisers, a long-time investment adviser to China’s monetary authorities, told Reuters.

“While financial risks abound, the composition of debt ownership means the government can brush off hard hits for now,” he said.

Government debt is 26.9 percent of gross domestic product according to IMF data, well below the 60 percent seen as the international threshold for stable state finances, and 2011 fiscal revenue was a record-breaking 10.37 trillion yuan ($1.64 trillion) that produced a tiny 1.1 percent of GDP deficit.

Even allowing for the bad debts in the $1.7 trillion owed by local governments, the $200 billion or so of non-performing loans analysts believe the big state-backed banks are nursing, and any other miscellaneous restructuring costs, the most gloomy forecasts barely get gross debt up above 60 percent.

That said, there are few signs of willingness to repeat the 4 trillion yuan stimulus unveiled in 2008/09 at the height of the global financial crisis as international trade, on which much of China’s growth and employment depends, froze.

The government’s mantra has been about “fine tuning” economic policies — tweaking taxes, cutting red tape and gently easing the required ratio of reserves (RRR) banks must maintain to keep money supply growth steady against a backdrop of fluctuating international capital flows.

CURRENCY FLOWS MIS-READ

Bank of America/Merrill Lynch China economist, Ting Lu, says flow risks are overstated as analysts mis-read monthly foreign exchange transaction data and fail to take into account the impact on currency purchases of China’s concerted efforts to expand the use of yuan for international trade settlement.

Lu says there is no need for aggressive RRR moves and he forecasts a below-consensus two 50 basis point cuts by year end.

But the political implications of a 50 bps RRR cut to 20.5 percent on February 18, two weeks before China’s annual meeting of parliament when the next budget will be announced, should not be underestimated, said Yao Wei, China economist with Societe Generale in Hong Kong.

“The timing of the move may signal more fiscal easing measures at the annual National People’s Congress in early March, which is also in line with our initial expectations,” Yao wrote in a client note.

Quite what the government might unveil is anybody’s guess.

“The complication surrounding China’s economic policy stems from the fact that the Chinese government still controls many aspects of the economy. You would not find so many policy parameters that can be constantly tuned to influence the trajectory of economic growth in advanced economies,” she wrote.

Already 2 trillion yuan is earmarked to build millions of affordable homes in coming years to offset risks from a policy-induced cooling in the private sector real estate market, where a frenzy of speculation was triggered by the 2008/09 stimulus.

Fraser Howie, chief executive of brokerage CLSA Singapore and author of a new book on China, Red Capitalism, believes the last stimulus plan highlights Beijing’s willingness to act and the risks it breeds.

“There are no miracles in China. They haven’t beaten the laws of economics,” Howie told Reuters. “What they did was take a problem that even today is still insoluble for them — which was 20 million unemployed workers — and they substituted that for a bad debt problem somewhere down the road.”

EXPORT ANXIETY

It also helps explain why hard landing fear lingers, especially given an external sector slowdown.

Exports were a net drag on economic growth in 2011, which hit a 2-1/2 year low of 8.9 percent on the year in Q4, as the European Union — China’s biggest export market — fought debt crisis demons.

But some analysts say export anxiety is misplaced.

“Although nearly half of all Chinese exports are destined for the euro area, fully a quarter of that goes to Germany — the strongest economy in the region,” analysts at Lloyds Bank Corporate Markets in London wrote in a note to clients.

Official trade data shows China’s combined exports to the troubled economies of Portugal, Ireland, Italy, Greece and Spain were $62.3 billion in 2011, less than one percent of GDP. Exports to Germany were $76.4 billion.

Meanwhile, there’s solid demand from developing economies which the World Bank estimates have contributed as much as 70 percent of the growth in global imports in the last five years.

Capital flight arguments don’t make sense to Carl Weinberg, chief economist at New York-based consultancy High Frequency Economics, who can’t understand why foreign investors would flee China given still-steady yuan appreciation and risks elsewhere.

“Even if China’s GDP slows this year — which we doubt — it will still grow faster than any other major economy in the world. Huge real rates of return on capital are all but assured. China remains a safe haven from euro land’s woes. We doubt investors will abandon it,” he wrote in a note to clients.

 

Meeting the Future Chinese Leader, Xi Jinping

David Griffith’s Note: I went to the US-China Economic Forum yesterday in downtown Los Angeles as a guest of the Chinese Consul General to get a glimpse of the future Chinese leader, Xi Jinping, and I was encouraged by what I saw.  Xi appears to be a man who likes America and can in turn put a new face on China that Americans will embrace.  The American leaders there, Vice President Joe Biden, Governor Jerry Brown, and Mayor Antonio Villaraigosa looked very comfortable with the future president and their various counterparts from Chinese government at both the national and provincial levels.  Over 500 Chinese companies were part of a series of major trade announcements.  The event definitely confirms Southern California’s prominence in trade with China.

LOS ANGELES (Reuters) – China’s leader-in-waiting Xi Jinping on Friday swiped away fears that his country’s economic growth could stumble, and turned to courting American companies, film-makers and governors hungry for a slice of that growth on the final day of his U.S. visit.

At the end of Vice President Xi’s five-day trip, his U.S. counterpartJoe Biden announced China had agreed to make it easier for Hollywood to distribute movies to China’s expanding audiences. Xi (pronounced “shee”) told a business forum in Los Angeles that China would promote greater domestic demand and turn more to the United States to buy imports and send investment.

Despite recent economic slowing and persistent price pressures, Xi told the gathered business executives that China’s economic momentum would not falter as some economists warn.

“China’s economy will maintain stable growth,” he said “There will be no so-called hard landing.”

Xi is almost sure to succeed Hu Jintao as Chinese president in just over a year, and the final day of his tour of the United States featured commercial deals and reassuring talk intended to blunt American ire about the trade gap between the countries.

“We will further increase imports from other countries in the light of our economic and social development and consumer demand. We will actively expand imports from the United States,” Xi later told a midday meeting.

Biden, who accompanied Xi to Los Angeles, praised the Chinese Vice President‘s efforts to reach out to often wary Americans, but reminded him that rancor over trade imbalances and barriers had not evaporated in all the sunny goodwill.

“The crux of our discussion is that competition can only benefit everyone if the rules are fair and followed,” Biden told the midday reception for Xi.

The U.S. movie industry has long complained about China’s restrictions on the number of foreign films allowed into the country each year, a limit that they say boosts demand for the bootleg DVDs that are widely available in China.

The film announcement does not remove China’s quota system, but it might ease some of the ire.

The agreement allows more American exports to China of 3D, IMAX, and enhanced-format movies, and also expands opportunities to distribute films through private enterprises rather than the state film monopoly, the U.S. Trade Representative’s office said.

GETTING READY FOR NEXT DECADE

The two vice presidents both suggested that Xi’s diplomacy, deals and folksy public displays could pave the way for steadier ties between the world’s two biggest economies.

Xi said that he felt from his visit that “mainstream American opinion” supports stronger ties. “I can now say that my visit has been fully successful,” he said.

“We’ve established a personal friendship and a healthy working relationship,” he said of himself and Biden.

Xi is poised to become China’s next leader after a decade in which it has grown to become the world’s second-largest economy. Beijing wants to avoid tension with Washington while the Communist Party leaders focus on the power handover.

Xi’s visit to the United States was also intended to get both sides more familiar with each other for the decade that he could be in power. He will most likely succeed Hu Jintao as party chief in late 2012 and as president in early 2013.

Under Xi, China’s economic size and military capabilities are likely to grow closer to U.S. levels.

Washington and Beijing have often jostled over economic, political and foreign policy disputes from human rights to Taiwan and most recently Syria.

The U.S. trade deficit with China expanded to a record $295.5 billion in 2011, and many U.S. lawmakers complain China’s yuan currency is significantly undervalued, giving its companies an unfair advantage.

The Obama administration has also accused China of distorting trade flows by ignoring intellectual property theft, putting up barriers to foreign investors and creating rules that favor China’s state-owned behemoths.

Xi’s stop in Los Angeles was choreographed to blunt those complaints and make China’s case that its rapid growth presents the U.S. economy with opportunities, not threats.

Scores of executives from major U.S. and Chinese companies, from Intel to Microsoft, lined up to sign deals after Xi’s address at the economic forum on Friday.

They included “Kung Fu Panda” studio Dreamworks Animation’s venture to make films from Shanghai, and Chinese telecom giant Huawei’s pledge to award $6 billion in contracts over three years to Qualcomm Inc, Broadcom Corp and Avago.

“MISSION IMPOSSIBLE” FAN

More than the publicly stern Chinese President Hu, Xi has tried to put a friendlier face on his government during his U.S. visit, including revisiting the small town of Muscatine in Iowa where he visited in 1985 and stayed two nights with a family.

The 58-year-old also visited the International Studies Learning School in South Gate — a Los Angeles enclave of mainly Hispanics — where students learn Chinese.

At the school, Xi recalled his first visit to Muscatine: “They gave me the same impression that, like Chinese people, they are warm-hearted, friendly, honest and hard-working. Twenty-seven years have passed, but that remains my impression, and it has become a deeper one.”

Xi also offered a glimpse of his personal life, telling the students he enjoyed swimming and watching sports, including American basketball, baseball and gridiron football.

Showing his familiarity with Hollywood fare, Xi said it was difficult to find time to relax. “It’s like the name of that American movie — ‘Mission Impossible’.”

After their visit to the school, Biden told reporters the talks with Xi had been very forthright, and was also intensely curious about the workings of the American political system.

“This is a guy who wants to feel it and taste it, and he’s prepared to show another side of Chinese leadership,” said Biden. “He is intensely interested in understanding why we think the way we do, what our positions are, and the need to actually broaden this kind of understanding.”

Xi was due to watch part of an LA Lakers basketball game before he left for the next two countries of his international tour, Ireland and then Turkey.

 

Innovation in China

Dynamic domestic players and focused multinationals are helping China churn out a growing number of innovative products and services. Intensifying competition lies ahead; here’s a road map for navigating it.

MCKINSEY QUARTERLY  FEBRUARY 2012 • Gordon Orr and Erik Roth

China is innovating. Some of its achievements are visible: a doubling of the global percentage of patents granted to Chinese inventors since 2005, for example, and the growing role of Chinese companies in the wind- and solar-power industries. Other developments—such as advances by local companies in domestically oriented consumer electronics, instant messaging, and online gaming—may well be escaping the notice of executives who aren’t on the ground in China.

As innovation gains steam there, the stakes are rising for domestic and multinational companies alike. Prowess in innovation will not only become an increasingly important differentiator inside China but should also yield ideas and products that become serious competitors on the international stage.

Chinese companies and multinationals bring different strengths and weaknesses to this competition. The Chinese have traditionally had a bias toward innovation through commercialization—they are more comfortable than many Western companies are with putting a new product or service into the market quickly and improving its performance through subsequent generations. It is common for products to launch in a fraction of the time that it would take in more developed markets. While the quality of these early versions may be variable, subsequent ones improve rapidly.¹

Chinese companies also benefit from their government’s emphasis on indigenous innovation, underlined in the latest five-year plan. Chinese authorities view innovation as critical both to the domestic economy’s long-term health and to the global competitieness of Chinese companies. China has already created the seeds of 22 Silicon Valley–like innovation hubs within the life sciences and biotech industries. In semiconductors, the government has been consolidating innovation clusters to create centers of manufacturing excellence.

But progress isn’t uniform across industries, and innovation capabilities vary significantly: several basic skills are at best nascent within a typical Chinese enterprise. Pain points include an absence of advanced techniques for understanding—analytically, not just intuitively—what customers really want, corporate cultures that don’t support risk taking, and a scarcity of the sort of internal collaboration that’s essential for developing new ideas.

Multinationals are far stronger in these areas but face other challenges, such as high attrition among talented Chinese nationals that can slow efforts to create local innovation centers. Indeed, the contrasting capabilities of domestic and multinational players, along with the still-unsettled state of intellectual-property protection (see sidebar, “Improving the patent process”), create the potential for topsy-turvy competition, creative partnerships, and rapid change. This article seeks to lay out the current landscape for would-be innovators and to describe some of the priorities for domestic and multinational companies that hope to thrive it.

China’s innovation landscape

Considerable innovation is occurring in China in both the business- to-consumer and business-to-business sectors. Although breakthroughs in either space generally go unrecognized by the broader global public, many multinational B2B competitors are acutely aware of the innovative strides the Chinese are making in sectors such as communications equipment and alternative energy. Interestingly, even as multinationals struggle to cope with Chinese innovation in some areas, they seem to be holding their own in others.

The business-to-consumer visibility gap

When European and US consumers think about what China makes, they reflexively turn to basic items such as textiles and toys, not necessarily the most innovative products and rarely associated with brand names. In fact, though, much product innovation in China stays there. A visit to a shop of the Suning Appliance chain, the large Chinese consumer electronics retailer, is telling. There, you might find an Android-enabled television complete with an integrated Internet-browsing capability and preloaded apps that take users straight to some of the most popular Chinese Web sites and digital movie-streaming services. Even the picture quality and industrial design are comparable to those of high-end televisions from South Korean competitors.

We observe the same home-grown innovation in business models. Look, for example, at the online sector, especially Tencent’s QQ instant-messaging service and the Sina Corporation’s microblog, Weibo. These models, unique to China, are generating revenue and growing in ways that have not been duplicated anywhere in the world. QQ’s low, flat-rate pricing and active marketplace for online games generate tremendous value from hundreds of millions of Chinese users.

What’s keeping innovative products and business models confined to China? In general, its market is so large that domestic companies have little incentive to adapt successful products for sale abroad. In many cases, the skills and capabilities of these companies are oriented toward the domestic market, so even if they want to expand globally, they face high hurdles. Many senior executives, for example, are uncomfortable doing business outside their own geography and language. Furthermore, the success of many Chinese models depends on local resources—for example, lower-cost labor, inexpensive land, and access to capital or intellectual property—that are difficult to replicate elsewhere. Take the case of mobile handsets: most Chinese manufacturers would be subject to significant intellectual property–driven licensing fees if they sold their products outside China.

Successes in business to business

Several Chinese B2B sectors are establishing a track record of innovation domestically and globally. The Chinese communications equipment industry, for instance, is a peer of developed-world companies in quality. Market acceptance has expanded well beyond the historical presence in emerging markets to include Europe’s most demanding customers, such as France Télécom and Vodafone.

Pharmaceuticals are another area where China has made big strides. In the 1980s and 1990s, the country was a bit player in the discovery of new chemical entities. By the next decade, however, China’s sophistication had grown dramatically. More than 20 chemical compounds discovered and developed in China are currently undergoing clinical trials.

China’s solar- and wind-power industries are also taking center stage. The country will become the world’s largest market for renewable-energy technology, and it already has some of the sector’s biggest companies, providing critical components for the industry globally. Chinese companies not only enjoy scale advantages but also, in the case of solar, use new manufacturing techniques to improve the efficiency of solar panels.

Success in B2B innovation has benefited greatly from friendly government policies, such as establishing market access barriers; influencing the nature of cross-border collaborations by setting intellectual-property requirements in electric vehicles, high-speed trains, and other segments; and creating domestic-purchasing policies that favor Chinese-made goods and services. Many view these policies as loading the dice in favor of Chinese companies, but multinationals should be prepared for their continued enforcement.

Despite recent setbacks, an interesting example of how the Chinese government has moved to build an industry comes from high-speed rail. Before 2004, China’s efforts to develop it had limited success. Since then, a mix of two policies—encouraging technology transfer from multinationals (in return for market access) and a coordinated R&D-investment effort—has helped China Railways’ high-speed trains to dominate the local industry. The multinationals’ revenue in this sector has remained largely unchanged since the early 2000s.

But it is too simplistic to claim that government support is the only reason China has had some B2B success. The strength of the country’s scientific and technical talent is growing, and local companies increasingly bring real capabilities to the table. What’s more, a number of government-supported innovation efforts have not been successful. Some notable examples include attempts to develop an indigenous 3G telecommunications protocol called TDS-CDMA and to replace the global Wi-Fi standard with a China-only Internet security protocol, WAPI.

Advantage, multinationals?

Simultaneously, multinationals have been shaping China’s innovation landscape by leveraging global assets. Consider, for example, the joint venture between General Motors and the Shanghai Automotive Industry Corporation, which adapted a US minivan (Buick’s GL8) for use in the Chinese market and more recently introduced a version developed in China, for China. The model has proved hugely popular among executives.

In fact, the market for vehicles powered by internal-combustion engines remains dominated by multinationals, despite significant incentives and encouragement from the Chinese government, which had hoped that some domestic automakers would emerge as leaders by now. The continued strength of multinationals indicates how hard it is to break through in industries with 40 or 50 years of intellectual capital. Transferring the skills needed to design and manufacture complex engineering systems has proved a significant challenge requiring mentorship, the right culture, and time.

We are seeing the emergence of similar challenges in electric vehicles, where early indications suggest that the balance is swinging toward the multinationals because of superior product quality. By relying less on purely indigenous innovation, China is trying to make sure the electric-vehicle story has an ending different from that of its telecommunications protocol efforts. The government’s stated aspiration of having more than five million plug-in hybrid and battery electric vehicles on the road by 2020 is heavily supported by a mix of extensive subsidies and tax incentives for local companies, combined with strict market access rules for foreign companies and the creation of new revenue pools through government and public fleet-purchase programs. But the subsidies and incentives may not be enough to overcome the technical challenges of learning to build these vehicles, particularly if multinationals decline to invest with local companies.

Four priorities for innovators in China

There’s no magic formula for innovation—and that goes doubly for China, where the challenges and opportunities facing domestic and multinational players are so different. Some of the priorities we describe here, such as instilling a culture of risk taking and learning, are more pressing for Chinese companies. Others, such as retaining local talent, may be harder for multinationals. Collectively, these priorities include some of the critical variables that will influence which companies lead China’s innovation revolution and how far it goes.

Deeply understanding Chinese customers

Alibaba’s Web-based trading platform, Taobao, is a great example of a product that emerged from deep insights into how customers were underserved and their inability to connect with suppliers, as well as a sophisticated understanding of the Chinese banking system. This dominant marketplace enables thousands of Chinese manufacturers to find and transact with potential customers directly. What looks like a straightforward eBay-like trading platform actually embeds numerous significant innovations to support these transactions, such as an ability to facilitate electronic fund transfers and to account for idiosyncrasies in the national banking system. Taobao wouldn’t have happened without Alibaba’s deep, analytically driven understanding of customers.

Few Chinese companies have the systematic ability to develop a deep understanding of customers’ problems. Domestic players have traditionally had a manufacturing-led focus on reapplying existing business models to deliver products for fast-growing markets. These “push” models will find it increasingly hard to unlock pockets of profitable growth. Shifting from delivery to creation requires more local research and development, as well as the nurturing of more market-driven organizations that can combine insights into detailed Chinese customer preferences with a clear sense of how the local business environment is evolving. Requirements include both research techniques relevant to China and people with the experience to draw out actionable customer insights.

Many multinationals have these capabilities, but unless they have been operating in China for some years, they may well lack the domestic-market knowledge or relationships needed to apply them effectively. The solution—building a true domestic Chinese presence rather than an outpost—sounds obvious, but it’s difficult to carry out without commitment from the top. Too many companies fail by using “fly over” management. But some multinationals appear to be investing the necessary resources; for example, we recently met (separately) with top executives of two big industrial companies who were being transferred from the West to run global R&D organizations from Shanghai. The idea is to be closer to Chinese customers and the network of institutions and universities from which multinationals source talent.

Retaining local talent

China’s universities graduate more than 10,000 science PhDs each year, and increasing numbers of Chinese scientists working overseas are returning home. Multinationals in particular are struggling to tap this inflow of researchers and managers. A recent survey by the executive-recruiting firm Heidrick & Struggles found that 77 percent of the senior executives from multinational companies responding say they have difficulty attracting managers in China, while 91 percent regard employee turnover as their top talent challenge.

Retention is more of an issue for multinationals than for domestic companies, but as big foreign players raise their game, so must local ones. Chinese companies, for example, excel at creating a community-like environment to build loyalty to the institution. That helps keep some employees in place when competing offers arise, but it may not always be enough.

Talented Chinese employees increasingly recognize the benefits of being associated with a well-known foreign brand and like the mentorship and training that foreign companies can provide. So multinationals that commit themselves to developing meaningful career paths for Chinese employees should have a chance in the growing fight with their Chinese competitors for R&D talent. Initiatives might include in-house training courses or apprenticeship programs, perhaps with local universities. General Motors sponsors projects in which professors and engineering departments at leading universities research issues of interest to the automaker. That helps it to develop closer relations with the institutions from which it recruits and to train students before they graduate.

Some multinationals energize Chinese engineers by shifting their roles from serving as capacity in a support of existing global programs to contributing significantly to new innovation thrusts, often aimed at the local market. This approach, increasingly common in the pharma industry, may hold lessons for other kinds of multinationals that have established R&D or innovation centers in China in recent years. The keys to success include a clear objective— for instance, will activity support global programs or develop China-for-China innovations?—and a clear plan for attracting and retaining the talent needed to staff such centers. Too often, we visit impressive R&D facilities, stocked with the latest equipment, that are almost empty because staffing them has proved difficult.

Instilling a culture of risk taking

Failure is a required element of innovation, but it isn’t the norm in China, where a culture of obedience and adherence to rules prevails in most companies. Breaking or even bending them is not expected and rarely tolerated. To combat these attitudes, companies must find ways to make initiative taking more acceptable and better rewarded.

One approach we found, in a leading solar company, was to transfer risk from individual innovators to teams. Shared accountability and community support made increased risk taking and experimentation safer. The company has used these “innovation work groups” to develop everything from more efficient battery technology to new manufacturing processes. Team-based approaches also have proved effective for some multinationals trying to stimulate initiative taking .

How fast a culture of innovation takes off varies by industry. We see a much more rapid evolution toward the approach of Western companies in the way Chinese high-tech enterprises learn from their customers and how they apply that learning to create new products made for China. That approach is much less common at state-owned enterprises, since they are held back by hierarchical, benchmark-driven cultures.

Promoting collaboration

One area where multinationals currently have an edge is promoting collaboration and the internal collision of ideas, which can yield surprising new insights and business opportunities. In many Chinese companies, traditional organizational and cultural barriers inhibit such exchanges.

Although a lot of these companies have become more professional and adept at delivering products in large volumes, their ability to scale up an organization that can work collaboratively has not kept pace. Their rigorous, linear processes for bringing new products to market ensure rapid commercialization but create too many hand-offs where insights are lost and trade-offs for efficiency are promoted.

One Chinese consumer electronics company has repeatedly tried to improve the way it innovates. Senior management has called for new ideas and sponsored efforts to create new best-in-class processes, while junior engineers have designed high-quality prototypes. Yet the end result continues to be largely undifferentiated, incremental improvements. The biggest reason appears to be a lack of cross-company collaboration and a reliance on processes designed to build and reinforce scale in manufacturing. In effect, the technical and commercial sides of the business don’t cooperate in a way that would allow some potentially winning ideas to reach the market. As Chinese organizations mature, stories like this one may become rarer.

China hasn’t yet experienced a true innovation revolution. It will need time to evolve from a country of incremental innovation based on technology transfers to one where breakthrough innovation is common. The government will play a powerful role in that process, but ultimately it will be the actions of domestic companies and multinationals that dictate the pace of change—and determine who leads it.

International Patent Applications in China

[tweetmeme]

Courtesy of International Business Law Services

China has joined the growing list of countries allowing electronic filing of patent applications; the first day of the service was May 1, 2007.  Sophisticated software enables electronic filing of international patent applications with cooperation of the World Intellectual Property Organization’s (WIPO), Patent Cooperation Treaty (PCT). The WIPO is the “cornerstone of the international patent system” and its dynamic system, offering quick, flexible and economical approach to establishing patents in nearly 140 countries. In regards to China establishing this Intellectual Property (IP) milestone, and also the great interest in Chinese business, these questions will be answered: What Software is used for the Electronic Patent Process? How Does PCT-SAFE Filing Work? What Benefits are gained by Filing with the Electronic System? How Big Have Chinese Patent Applications Become? What IP Legislation does China Have for Patent Protection?

China newly implemented software for the electronic filing of international patent applications is the foundation of their entire patent filing system, which makes a formerly clunky process smooth and risk-free. The software, called “PCT-SAFE” (“Secure Applications Filed Electronically”), has been in use for awhile and working in patent offices across the globe, such as Australia, Denmark, the European Patent Office (EPO), Finland, France, Germany, Japan, Malaysia, Netherlands, Philippines, Poland, Republic of Korea, Romania, Slovakia, Spain, Sweden, United Kingdom and the United States of America.  Since February 2004, the software has added the superb capability of allowing businesses and inventors the ability to seek multiple-country patents by electronically submitting an international application under the PCT. In this instance, the WIPO acts as the receiving office of the patent filed.

How Does PCT-SAFE Filing Work?

According to the WIPO, the PCT-SAFE system has four major components:1)  PCT-SAFE client for preparing the PCT request form: in case of e-filing, it is also used for securely transmitting the entire application to the receiving office;2)  PCT-SAFE Editor: a word processor-like tool that enables users to prepare the text and drawings of a PCT application in electronic format (the application will be saved in Extensible Markup Language (XML)) for e-filing purposes; 3) Security services and a Public Key Infrastructure (PKI); 4) A receiving server for use in receiving Offices that includes a back-end system to print and securely store the received data.

What Benefits are Gained by Filing with the Electronic Patent System?

Chinese patent applicants who organize and submit PCT applications via electronic format will help the patent office by ensuring a more orderly, timely and efficient process. This cuts down on paper handling and eliminates traditional mail routines. In return, WIPO will allow the following, (i) fee reductions in some instances; (ii) eliminated or reduced costs for printing, copying and mailing the applications; (iii) Near instantaneous notification when the application is received and processed; and (iv) Easy and secure transmission of international applications.

How Big Have Chinese Patent Applications Become?

China is the 8th largest country for filing PCT applications and this grew by 57% from 2005 to 2006. Beyond this, the WIPO World Patent Report 2006 stated that China is now the 4th largest patent office in the world in terms of total patent applications filed.  While Chinese residents had an individual patent filing increase of greater than five-fold from 1995 to 2004, resulting in 65,786 patents placed; worldwide, a mere five patent offices account for three-quarters of all patents filed across the globe. The five top patent filers nations are the United States, Japan, South Korea, China and the European Patent Office (EPO).

What IP Legislation does China Have for Patent Protection?

China has placed a great deal of importance on patent registration (PR) legislation since the implementation of a legislative reform intending to protect fair market competition, safeguard market economic freedom and order, and promote economic and cultural development.Beginning in 1984, China has toiled to create and implement a reformed Patent Law, which was then amended in 1992. Despite starting late with IPR Legislation, China has used international models of successful patent legislation to draw on for IPR legislation, putting a Chinese slant upon the process. To help the effort, China joined the World Intellectual Property Organization, the Paris Convention for the Protection of Industrial Property, the Strasbourg Agreement Concerning the International Patent Classification, the Locarno Agreement Establishing an International Classification for Industrial Designs, and has also signed reciprocal agreements for IPR protection with the U.S. and other countries.The Chinese Supreme Court has formulated and established almost twenty judicial interpretations and explanatory papers in the last several decades, which were based upon apparent need arising from Patent cases. These include: “the circular on Several Issues concerning Trials of Patent Cases(February 1985), the Circular on the Issues of Geographical Jurisdiction over Patent Dispute Cases( June 1987 ), the Circular on Several Issues concerning Trial of Cases Involving Patent Application Disputes (October 1987 ), the Answers to Several Questions on Trial of Patent Dispute Cases ( December 1992 ), the Circular on Further Strengthening Judicial Protection of IPR  (September 1994 ), and the Opinions on the Correct Handling of Several Issues in Cases Involving Science and Technology Disputes ( April 1995 ).

Related articles

• Is the Term “Patent Pending” Worth the Paper It is Printed On? (brighthub.com)
• International Patent System Marks Two Millionth Filing (patentcalls.com)
• The International Patent Filing Process: Utility Patents (iplawforstartups.com)
• Daniel B. Ravicher: Supreme Court Signals Pending Patent Reform Is Unconstitutional (huffingtonpost.com)

The Case for a Chinese ‘Hard Landing’

David Griffith’s Note: I recently published the case for a Chinese ‘soft landing’ in this blog.  There are many ‘China Bears’ that are now advocating that the Chinese economy is becoming the classic bubble; while I don’t necessarily agree with this belief, and hope for the sake of the global economy they’re wrong, here’s one excellent argument for the bearish side.

SEEKING ALPHA by: Williams Equity Analysis December 19, 2011

China’s growth curve has gone parabolic in recent years. For the last couple of decades, China has typically averaged 10% GDP growth, and it has maintained that growth even as a multi-trillion dollar economy. Of course, 10% growth in an economy already worth trillions is an astounding achievement, but it can also lead to severe economic tribulations, such as soaring housing and food prices. China has incurred both of these troubles. As a growing middle class emerges, demand for beef has far outstripped supply growth, and beef is typically making record highs every month. Additionally, the usage of real estate as collateral for local government loans, amongst other factors, has led to soaring housing prices.

China has a significant housing bubble on its hands. Growth in the real estate sector is important in all modern economies. Construction of homes and commercial office space is a huge driver for demand in the steel, cement, and construction sectors, and is an important part of demand in the commodities market. Construction requires the use of iron (in steel), copper, and fuel. Moreover, local governments depend wholly on rising land and real estate prices, since almost all of their collateral is in their properties. The famously investment driven Chinese also depend heavily on rising home prices to attain better rates of return than are possible in other markets.

A slowdown in the real estate market has appeared recently; prices in nine major Chinese cities fell 4.9% in April from a year earlier. Real estate prices in major cities had been on an absolute tear for the past several years, as a growing Chinese middle class desires to migrate from the countryside into major cities. A year ago, prices in these cities rose an astounding 21.5%. Now, as demand has significantly weakened, some analysts believe the supply glut in two of China’s largest markets (Dalian and Tianjin) could be as bad as twenty months of housing inventory. Furthermore, China’s official numbers need to be taken with a grain of salt, since the central government can twist the numbers a bit; the government can pressure developers to withhold or add high-value properties, contingent on the kind of statistics it wants to display. Therefore, China’s housing slowdown is potentially being understated.

Ordinary citizens are finding it nearly impossible to buy a reasonably priced home in Chinese cities, which is a classic sign of a housing bubble. When average, financially sound individuals can no longer buy homes, prices have typically deviated far away from their equilibriums. In 2006, it cost $100,000 to buy a decent apartment in Beijing. The average Chinese citizen would have had to save for 32 years based on the average disposable income. Five years later, in 2011, it cost $250,000. Of course, the actual price of housing is irrelevant if incomes are rising as much, if not more than housing prices are growing. Unfortunately for Chinese citizens, income growth came up short, and it now takes more than 57 years of saving to be able to cover the cost of buying said apartment. 57 years of saving is not a normal figure for average citizens in a healthy, economically balanced real estate market. Even the chairman of China Construction Bank, one of China’s largest banks (and who is heavily dependent on strong real estate growth) said, “In some ways, real-estate prices are really crazy.”

Housing prices got to this level mainly because the Chinese government wanted its citizens to save, but it has not offered them viable alternatives to the real estate market in which to invest. As previously mentioned, the stock market has been too volatile for most individual investors, capital markets are considered to be overwhelmingly underdeveloped, and the deposit rates that banks are paying their customers are much too low to provide reasonable rates of return after inflation is factored in. Thus, citizens have had no other practical investment vehicles in which to park their savings. China has, in recent years, attempted to cool the real estate market, most notably by requiring that prospective buyers put 40% down in cash on their purchases. Even more recently, that mandate was bumped up to 60% down. There will, at the very least, be an assuredly long-term trend of deflating construction activity and declining housing prices. This development will lead to lower GDP growth.

Fitch, another one of the “big three” rating agencies, also put out a terrifying note: “the process of bundling the debts into securities continues to grow, which is transferring the credit risk to a broad group of investors.” What this process essentially describes is securitization; any hint of the word should spook those familiar with the 2008 financial crisis. These banks are wrapping up bad loans and selling them to outside investors in return for a sum of cash. Investors can typically bet on different tranches of the security; the tranches with the highest probability have the lowest rate of return for the investor, and as you move into riskier tranches, the rate of return improves (providing that the default limit is not reached). Chinese regulators are considering allowing banks to further securitize more of their assets, in order to reduce liquidity and capital strains (by generating more cash flow). This should come as unwelcomed news, and it appears that the central government is becoming worried about the low-quality loans that are maturing in the short term.

Increased leverage in China is a dangerous development. Worldwide, overwhelming debt levels, particularly in developed economies, have been a major economic concern recently; China is typically (and mistakenly) not included in these discussions relating to over-leveraged economies. The ability of the Chinese economy to expand right on through the global recession at a torrid pace was baffling. The Chinese Gross Domestic Product grew at 9.6% in 2008, 9.2% in 2009, and 10.3% in 2010. This expansion, compared with the figures in the European Union and the United States, whose economies saw negligible growth in 2008, contraction in 2009, and about 2% growth in 2010, shows a stark contrast. The obvious question, of course, is how it is possible that China grew an incredible 9.2% in 2009, while two of its biggest customers were plummeting into their worst recessions in decades. The answer lies within massive, hidden government expenditures.

Chinese exports make up 30% of the nation’s GDP, so any decline in total annual exports should result in a subsequent decline in GDP growth, everything else equal. In 2009, China’s global exports fell 16% from 2008, yet its GDP mustered 9.2% growth. This kind of growth in a multi-trillion dollar economy is difficult enough, without the added hurdle of severe demand contraction in overseas markets. In order to pick up the slack, consumer spending (domestic consumption) had to have either surged, or the government must have had to sink hundreds of billions, or even trillions into the Chinese economy to achieve 9.2% growth. Total household consumption is typically used to measure domestic consumption. Chinese household consumption checked in at 35% of GDP in 2008 and 35.1% of GDP in 2009. This negligible growth is clearly not enough to make up for a $230 billion decline in exports; the only driver of growth left is government spending. Not surprisingly, the World Bank calculated that while fixed-asset investments (the definitive measure of social capital investments and government real estate projects) were only responsible for 4.6% of China’s GDP growth in 2008, they were responsible for 8.8% of GDP growth in 2009; this was good for a 91% year-over-year increase. This investment is now equal to 70% of China’s GDP. To put this figure in perspective, Japan’s fixed-asset investment was equivalent to approximately 35% in the 1980s (during its housing boom), and the United States’ measurement has typically hung around 20% for the last couple of decades.

Certainly, China needs to allocate significant capital toward infrastructure; China has a massive population, a furiously growing middle class, and a great deal of migration from rural areas into major cities. The issue, however, is that much of this investment is highly leveraged (little cash is put down as payment, while the rest is financed through bank loans), and a large proportion of these projects exist simply to sustain headline growth over 9%, despite deteriorating fundamentals. Because these projects are so leveraged, merely servicing the debt becomes a huge intermediate-term cost. Beijing’s public finance system is set up so that local governments are responsible for almost all social services, which include social capital and real estate investments, even though the central government collects 60% of all national taxes. Because of this, local governments have almost no equity to finance projects, even while Beijing is mandating increased investment to sustain rapid headline growth, as written in the 2008 national stimulus bill. Worse still, local governments aren’t even allowed to sell bonds to institutional or private investors to help pay for the projects; a typical solution is to create state-run corporations to whom private banks will then lend money to, thereby serving as the intermediary.

To make the system even risker and more confusing, the collateral that the local governments and their subsidiaries often use to attain the bank loans is lofty, and likely overvalued land prices. Finally, in confusing and illogical fashion, private banks aren’t even allowed to collect on bad loans, or any loan for that matter. Essentially, money lent to state enterprises is free. Of course, private banks have trillions in consumer deposit monies, so a growth in asset toxicity, or bad loans, would require huge recapitalizations from the Chinese federal government, or a financial crisis could ensue.

Furthermore, Beijing’s tight controls have resulted in a structure in which bank loans are the only way to finance public projects. Since local governments collect almost no tax revenue (the central government collects 60% of all taxes), they can’t use cash to fund capital ventures. Also, as previously discussed, since local governments can’t issue bonds, they must go to private banks to get the necessary principal; their only collateral for the loans is state-owned real estate. This has inexorably led to unquantifiable risk for banks, local governments, and the central government (since Beijing will have to bail-out involved parties if and when the loans go rotten). Land-grabs have become common in China (government authorities seizing private property in order to generate revenue), a sure sign of deteriorating conditions.

Moreover, Chinese officials have a destructive propensity for attempting to distort underlying demand by pumping up spending, and then hiding it in state-run investment corporations. To see figures that show severe exports contraction and stagnant domestic consumption, in conjunction with 9.2% GDP growth in 2009 screams falsification and distortion to me. I also believe that China’s tendency to re-stimulate its economy every time international demand weakens is a horrible way to try and achieve sustainable long-term growth.

Given these factors, it appears certain that most investors have yet to grasp a firm understanding of both how secretive and manipulative the Chinese Government is, and how much debt is hidden in the system. Additionally, a horrific financial structure will be a major factor in China’s eventual crash landing.

This shouldn’t be surprising to anyone. The idea that a few government officials can decide how an economy should function, and consequently set countless controls on markets is remarkably ignorant. Perhaps the most important thing to note is that the Chinese governemnt is desperate to keep GDP growing at a pace above at least 7% for the next several years, since China requires astonishing expansion to mitigate the effects of a rapid migration into cities. The political pressures alone will almost certainly lead to poor decision making (over-aggressive stimulus), and an eventual uprising from the Chinese people. There is simply no way that a wealthier, more educated China will remain quiet (they’ve already begun protesting) about a suppressive system.

While sheltered from discussions involving the failed Keynesian practices of incredibly over-leveraged developed economies, China is indeed the younger brother of countries like the U.S. and the European Union.

What Should Investors be Doing?

Investors need to understand that China’s days as “the driver of World growth” are numbered. No, that doesn’t mean China will fall off a cliff tomorrow, but it’s coming. All it takes is one serious catalyst; it could be Europe, angry Chinese banks, or a continued decline in real estate prices to the point where local governments become insolvent.

At the very least, investors should know how much prospective investments rely on Chinese growth. Companies like Intel (INTC) derive half of their revenue from the region.  You can also play the short side of companies who are heavily reliant on Chinese growth, but this complicates the process a bit and may not provide the exposure you’re looking for.

Conclusion

As was the case in the years leading up to the 2008 global economic collapse, the so-called “China bears” are often brushed aside as doom and gloomers. General consensus is that China can engineer a soft-landing, so as to avoid to a rapid decline in economic activity.

Well, for those in that camp, let me ask you something. Why would you ever want to turn off good economic growth? Healthy, natural economic advances should never be thwarted by governments or central banks. The only reason growth would ever need to be turned off artificially, i.e. by a central authority, is because it has bubbled so much that further growth would cause a catastrophe.

Granted, as an economy surges, any free market should begin to inch interest rates higher anyway. The issue in Beijing is that the time to decrease speculative activity was before it saw housing prices reach epic levels, or before it saw food prices begin to cause street riots. At this point, any central action is too late. A horrificially constructed financial system, in conjunction with overly agressive central planning, has set China up for anything but a soft-landing.