China: The Next Big Market Opportunity or the Next Big Bubble?

Is China post WTO a land of great entrepreneurial opportunity, or a house of cards threatening to collapse on foreign investors?
by James Heskett

Summing Up

Those with firsthand experience suggest, in response to this month's column, that few CEOs with a reason to be there can forego investment in China. However, there is a reason why involvement today is most likely to be as a customer of China's global factory. Dramatic market opportunities and substantial returns on investment of the kind suggested by some are years, perhaps even decades, away. It will require not only caution but also a great deal of patience as barriers to economic development are lowered. The risk is not so much that of potential economic meltdown as it is overestimating the speed and magnitude of possible investment returns.

First, what's the amount of risk at the macroeconomic level? Wenbin Guo suggests that it is lower than most people think, primarily because of the vast, diverse nature of the economy. As he puts it, "Whether the [a market opportunity or bubble] will happen at the national level at once is a big question mark." Warren Ching comments, "The Chinese government wants nothing but [to save] face. They will not allow this kind of economic meltdown." Others argue that, given the gradual transition of the Chinese economy, Russia is not a good analogy. The risk of a sudden disruption in China is much lower. Patrik Akerman articulated the argument in this way: "The European Communists opened up their economies because of a collapse (on a multitude of fronts), whereas China gradually opened up on its own terms."

On the other hand, those without patience should beware as well. As Herb Smith, who lives and teaches in China, puts it, "... invaders will do well to be forewarned to bring their lunch and plan to stay awhile." The most-often mentioned barrier to growth was the complete absence or ineffective enforcement of intellectual property laws that may stifle China's transition from a manufacturing to a higher-value-added knowledge-based economy. Greg Durst cites both "Western gullibility" in overestimating the ease with which access can be gained to China's vast markets and "massive issues around the respect of intellectual property rights" in arguing, "It's high time to call into question portions of the Chinese miracle."

Perhaps Jack Zhang captured the sense of many respondents best when he said, "I think both versions [large market opportunity and possible bubble] have their own merits." But, like others who suggest that anyone developing a market in China needs to do it with an open mind and open eyes, he believes that those who do it will find that "The growth is real, the changes are real, and being there is fun, exciting, and rewarding."

Several respondents emphasized that the most essential ingredients for success in developing markets in China are trusted partners with management talent who understand and operate comfortably and effectively in the Chinese market. Indeed, this may be the scarce resource. This view raises questions of whether there will be an adequate supply of such talent. Will impatient Western managers eager to develop Chinese business opportunities delay initiatives until the right people can be found? How high is the cost of delay versus the cost of premature entry? What do you think?

Original Article

It was recently announced in somewhat wondrous tones that new car sales in China this past year exceeded one million. Reports in BusinessWeek and Forbes trumpet the growth of China and the size and promise of Chinese markets. Several economists have suggested that Chinese gross domestic product will once again surpass that of the U.S. by the year 2020, two hundred years after Chinese GDP was nearly one-third of the world's total. Those optimistic about China's economic future have poured the equivalent of billions of dollars in foreign investment into the country.

On the other hand, Joshua Kurlantzick, writing from Shanghai in The New Republic three weeks ago, paints another picture. His is of a China with a failed banking system with 50 percent of non-performing loans made to state-owned enterprises to satisfy political pressure; rampant corruption; false reporting of growth, beginning at the provincial level to conform with announced national goals; an economy that is propped up by foreign investment; and a country that is actually using less and less energy—energy use being a reasonably reliable indicator of real growth. In short, he describes China as a house of cards that is being held up largely by a Communist regime and foreign investors who are for the most part silent about the results of their Chinese investments.

Where does the truth lie—at the extremes or somewhere in between these wildly different views? For those of us who believe in free market economies, what's the best that we can hope for? A Russian-style transformation to more social and economic freedom? A collapse and rebirth of the Chinese economy would dwarf what happened in Russia. For example, it is estimated that more than half a trillion dollars would be required just to put the Chinese banking system on reasonably firm footing. Less optimistic views envision everything from a more violent transition to a pull-back to a more dogmatic form of Communism by a threatened leadership. Is it possible that the very investments flowing into China today could eventually trigger a Chinese economic meltdown?

What kind of risk-reward profile does this represent for foreign investors? What priority would you give to investment in China in you were the CEO of a large multinational? Could you afford to stay out? Could you afford to invest heavily in fixed assets if you went in? Will this be the next great growth market for investors? Or will it implode with a force greater than that of the U.S. high-tech bust of the past few years? What do you think?

    • Anonymous

    I see some real movement—including the willingness (and even encouragement)—by the Chinese government to tolerate foreign trade.

    At the same time, personal freedoms continue to be curtailed, even the right to determine how many children to have.

    I don't see China slipping back to its repressive ways (such as the response to Tiananmen
    Square), but I don't see it surpassing the U.S or Europe in terms of economic strength, either; not until the present generation of leaders dies of old age and a new leadership arises.

    • Stephanie Wolanski

    We've seen repeatedly that most booms are followed by busts. But look at China's population and the ways they are trying to modify their urban growth and integrate capitalism with a communist government, even some of the ways (Three Gorges Dam) they are trying to increase energy production. They've even established a space program. China offers incredible opportunities—and risks. The boom will be long and steady, if the last decade is any indication.

    • Patrik Akerman
    • Student, Stockholm School of Economics

    If I were a CEO my priority for China would be to continue investing in a country that has become the factory of the world. Sure China has problems with corruption, as does the rest of the developing world, and its fair share of environmental disasters looming. But listen well because this is the main difference between China and the Soviet bloc: The Chinese people have had a mental transition period. By that I refer to the fact that China has, since the days of Deng Xiaoping, been changing the way it sees the future. The European Communists opened up their economies because of a collapse (on a multitude of fronts), whereas China gradually opened up on its own terms. There is a "can do" spirit in China that is lacking in the most parts of Eastern Europe.

    Besides, measuring growth against the Chinese market for electricity is a method not fully thought through, considering the miserable state it is in. (See an article entitled "Power Politics" in the Economist, on June 6th 2002.)

    • Warren Ching
    • Center Director, Wall Street Institute

    The Chinese government wants nothing but [to save] face. They will not allow this kind of economic meltdown, especially with the 2008 Olympics and 2010 World's Fair coming. China is the biggest market in the world, how can anyone afford not to be part of it?

    • Carlos Amtmann
    • ABC Cost Manager, BUSINESS TOOLKIT/Mexico

    The size of China's population is more than tenfold that of my country, Mexico.

    Its GDP growth resembles that of the "Mexican Miracle" of the '50s and '60s and it is probably due to the thin GDP per capita raised by huge foreign investment—as it was in our case after World War II.

    The Chinese are enjoying a substantial growth on the surface economy, but stealing copyrights and selling their super-cheap labor threatens [this growth].

    The internal economy does not have the strength to grow on its own. That means you can expect a growing debt and deficit problem, if the capital the West lends them is more money than allowed by a developed country. Can anybody survive a Tequila effect ten times as big?

    The longer it takes to arrive at a growth recession in China, the greater amount of Western funds may be involved. Competition and legal know-how (plus ethics) have to play a major role in smoothing growing pains, for China and for its future creditors.

    Beware; we've got to share (invest) our best values too. An economy is made out of people on the go; it's not just money, or industry.

    • Wenbin Guo
    • Researcher, Victoria University

    I think China is a bit of both—the next big market opportunity balanced by the next big bubble. Whether the above mentioned situations will happen at the national level at once is a big question mark. We can always imagine that part of the economy grows very fast while the other part bubbles. However there are opportunities in bubbles as there are bubbles in boiling water too.

    In fact, the Chinese Confucius system of Guanxi is the real problem for the Chinese economy. As a Chinese, I do see some of the Guanxi bubbles break open. I believe what China needs for its economy is market competition and hope that China's WTO entry will burst the Guanxi bubble.

    • Swameshwar
    • Financial Analysis Manager, Henkel Saudi Arabia Detergents Company Ltd.

    China, like the erstwhile USSR, is a mystery. When someone questions the very accuracy of GDP growth reported, confusion creeps in. But judging from the flooding of cheap Chinese goods (of course only low-end products, like toys, household articles etc.) it looks like China is a great cost competitor. If I were a CEO of a large MNC I would definitely follow the footsteps of other MNCs that have found a new land of opportunity in China.

    • Herb Smith, Ph.D.
    • Professor of Marketing, Yang-En University

    I have been living and teaching in China for two years.

    The Chinese people are on the verge of a popular revolution involving consumer goods. However, Chinese marketing is at an embryonic stage and it will be some time before Chinese consumers will be the sophisticated buyers necessary for Western companies' substantive success.

    I think communication will be quite hot after AT&T and the Bells arrive. There is already a market for quality mobile telephones, but service is not top quality. Thus, the market is volatile.

    TV ads are beginning to emulate Western advertising, but without buyer sophistication, the ads will be simply an interesting diversion. A major information and education process needs to take place.

    The middle class is nascent and will be aborning for several years. The urban
    middle class is already shopping until they drop, but the future is not necessarily bright. The lower classes seem to me to be where the potential is, but whether demand is real remains to be seen.

    China is chockablock with mom-and-pop operations and I do not think they will easily surrender their markets, especially since they are known and part of their communities. They provide a type of service almost defunct in America and rapidly dying in England, I think. However, in China, relationships are paramount, and I think invaders will do well to be forewarned to bring their lunch and plan to stay awhile.

    China has very quietly reversed the balance of payments with the U.S. and currently enjoys comparative advantage.

    The key, in my opinion, is to learn and use Chinese culture to your advantage: Think long term and cultivate relationships for the long haul. Skimming strategies may work in the very short term, but the Chinese learn quickly. Consequently, penetration strategies will reap optimum benefits.

    Companies that hire and train Chinese marketing grads will have an edge because they speak English to some degree and have some essential knowledge of marketing. However, Chinese companies are beginning to understand the need for skilled marketers and a bidding war may arise in the very near future.

    In brief, the Chinese situation is in flux and anyone who tries to make a prediction is either very brave or very foolish. I think the latter.

    • Jack Zhang
    • CEO, eYou Corporation

    I think both versions have their own merits. The best way, if not the only way to verify is to experience the country itself.

    After that, most people would find out at least part of the answer: The growth is real, the changes are real, and being there is fun, exciting, and rewarding.

    If one had visited the "older" China (five to fifteen years ago) and Russia, the comparisons are even more striking. So come and see it for yourself before it becomes history again.

    • Anonymous

    I think it is the biggest bubble.

    I went to China for an international residency for the MBA program at UCI, during which I learned that we could sell one of any product for the entire Chinese market. The state-owned entities and its associates would copy and make the rest regardless of your patents.

    An executive from Citibank-China said to our class that even if we make a profit on this one sale, it would be nearly impossible to take it out of China back to our country because of the corrupt banking system.

    • Saeed A. Bawazir
    • General Manager, Atalla Systems Ltd.

    For several reasons, I feel optimistic that China is a promising economy. Many of the negative issues described in the article could very well be true. But what economy in the world today (or before) has not faced some sort of very tough challenges? We have been listening to a lot of bad news about the leading U.S. economy over the past few years and that does not mean it is collapsing.

    On the other hand, the strength of the Chinese economy in manufacturing is very obvious. Their inroads to software technology are being carefully observed by many concerned entities. Above all there is a huge pool of rather disciplined and increasingly educated work force [members] and consumers.

    • Anonymous

    I have been to China and studied its history, language, and contemporary issues. Many sinophiles like myself have at times been captivated by the image of China as a "waking dragon" just on the beginning of its rise to first-world country status and world prominence.

    However, though I believe China has a great civilization, culture, and history, and potential, I have also come to realize that China faces many hurdles along the road. Take any problem that the U.S. faces, and multiply it by five (the ratio of our populations).

    Take, for example, the environment. Although we have environmental problems here, we have the technology and are mostly on the right path to solving them. In contrast, China does not yet have the capital to clean up its factories and the millions of coal-burning stoves in its cities. Respiratory disease is the number one killer in China. If China's economy and wealth continue to grow, the environmental damage will grow as its demands for energy and goods also rises.

    I could cite other major issues, such as corruption, population pressure, unemployment, a growing gap between rich and poor, and others. My point is that China has great potential but also huge roadblocks in its way.

    Whether China can achieve its potential is very much in question. I would wager that China will be unable to "catch up" with the U.S. for at least another fifty to 100 years, if not longer.

    In terms of economics, I believe China will go through a major challenge in the next few decades, as new sources for continued growth will not appear as quickly in the future. It will eventually need to deal with its corruption and bad debt and other problems in order to sustain an acceptable level of economic growth. If the Chinese don't deal satisfactorily with all the issues they face, they will encounter a stagnating economy like Japan's, plus social unrest and environmental disasters.

    I sincerely hope China can solve these problems, and eventually create a prosperous and free nation. However, I am not as optimistic as I once was.

    • Anonymous

    Both extreme positions are accurate. From my long-term experience in China, and with other Asian economies, it is clear that there is great opportunity. There is also great risk, and most outsiders have limited understanding of these risks, and little capability to mitigate them.

    The potential in the economy is definitely there, but CEOs need to choose capable people and partners to manage the risk, investment, and opportunity. That is a difficult task, as many have found. CEOs must find people who are significantly experienced in doing business in China. These individuals must have lived there for a significant period, four years or more. They must have hands-on experience with the opportunities in the market, and the dangers. They must also have solid ethics, sound business practices, and capability to relate to China and U.S. business cultures. There is a very limited set of people to choose from in this area, and they are not easy to find.

    Can companies create these individuals from the inside? Yes, but not without mentoring from someone already capable, and not without the people needing to experience things for themselves. Can seminars and courses manage some of this? Yes, many of us use this option.

    How does an organization find a good manager, or solid partner? Most people and potential partners claim to fit the need, but a very small percentage actually does. Like any relationship, it starts with getting to know each other, conducting solid due diligence and relationship checking, and testing the relationship through joint activities before the bulk of investment is made. The most often-made mistake here is weak due diligence, and references validated from unknown parties.

    My best advice: Do not become blinded by untested opportunity. Hire capable and trustworthy people to manage the initiative, continue to utilize sound business practices for investment/risk management, ask more questions since you know less, and maintain a common-sense perspective.

    • Waters Deng
    • Business Development Manager, Insight Corporate Solutions

    There's no doubt that China will be the next big market opportunity. However, it is not as big as some of the China enthusiasts trumpet. There's no way China's GDP can catch up with that of the U.S. by 2020, even assuming all of China's development strategy worked flawlessly in the next twenty years.

    The obstacles to true modernization are much bigger than most people realize. It goes way beyond the lack of a proper banking and legal system. What's being attempted is nothing less than changing a billion people's way of thinking and living. The seemingly simple ideas of equal opportunity, human rights, individual responsibility, etc., will run into unimaginable resistance. The displacement of farmers and workers as a result of economic development will be an acute problem for the government. What's more, the wide spread corruption simply can't be rooted out without true democracy and an independent legal system, both of which requires an upgrade of the quality of the general population, and is absolutely impossible to achieve by 2020.

    Despite all the problems, the Chinese economy is not as bleak as some of the China bashers would like you to believe. True, there is some false reporting in the official numbers, but it goes both ways. There's a huge underground economy in China comprised mainly of private businesses, both legal and illegal, seeking to dodge taxes and the limelight. Over the last twenty years, there's very significant improvement in productivity in China, as evidenced by the increase of both the export and the import. The Chinese companies have steadily become more competitive in the international market and have moved up the food chain in their product offerings. The decline in energy can be explained by both more efficient energy use and the fact that more Chinese companies are moving into technology and capital intensive industries that are consumes less energy.

    The real income for average Chinese has been steadily rising for over twenty years. China now has a significant domestic market. It's already the second largest market for wireless devices and will soon become the second largest market for personal computers. Even if the foreign investment slows down significantly, the Chinese economy should be able to maintain reasonable growth.

    Politically, the country is fairly stable. The government truly understands that the top priority for the people is prosperity. There won't be any Russian style "shock therapy" reform or collapse. In the long run, the country will be modernized in every way.

    If I were a CEO today, China will be one of the top priorities for investment, sourcing and marketing. I will carefully evaluate each case and possibly seek good local partners or partners with plenty of experience and knowledge in China. (For example, companies in Hong Kong, Taiwan, and Singapore may be good partners.) It's not an easy market, but it's certainly a place no multinationals can afford to ignore.

    • Sean Durkin
    • Senior Vice President, MassMobile

    While I believe in requiring large corporations to stay aware and participatory (some on an experimental level) within developing Chinese markets, I would temper any over-enthusiasm with comments on par with those concerns raised in your article.

    In previous roles I had the opportunity to spend much time traveling to accounts throughout Mainland China. Currently, I manage an offshore Chinese development organization. In each of these experiences, I am left with a marked disparity between the bill of sale and the final product.

    When visiting Shanghai for example, foreign visitors fly into a gorgeous new airport and are shuttled along new highways into the Pudong district of the city, whose skyline is marked with futuristic new buildings and two of the tallest structures in the world. However, there is no activity or people along this journey. Unless the visitor is flying out of Shanghai to points within Mainland China, they will be shuttled back to the new (empty) airport, none the wiser to the false sense of growth the movie set city has presented to them.

    Without the insight or corporate governance available within free markets it will be a difficult and dangerous road, yet the reward may be worth the risk.

    • Greg Durst (MBA 1998)
    • Managing Director, Conscripti

    I think it's high time to call into question portions of the Chinese miracle.

    For me, there are two key issues here. The first is Western gullibility, where the number of Chinese simply overwhelm rationality of MNCs looking to invest there. I call this the "Two Billion Armpits Syndrome." That is, any consumer products company (for example) looks at the potential market for deodorant and thinks, "Gosh, if we can get only a fraction of that market, say 20 percent, we'll be bigger than we are anywhere on earth!"

    Of course what that ignores is the litany of problems, including corrupt officials, daunting paperwork/regulations, problematic manufacturing, inefficient distribution, cultural differences, and a multiplicity of languages. More importantly, it misses that point that millions of Chinese citizens still brush their teeth with a neem stick and would have little interest or use in deodorant! The potential may in fact be large, but the cultural and infrastructural barriers will restrict the adoption of Western practices for the foreseeable future to the biggest cities and coastal areas with the most interaction with the rest of the world.

    Second, and more importantly, there are massive issues around the respect of intellectual property rights in China. Despite the public crushing of software CDs and DVDs with a steamroller, there appears to be a pervasive disregard for copyrights and other standard (Western) tools for protecting the intellectual property of others. I would be curious to see how many manufacturing techniques, processes, and formulas have been introduced into Chinese operations only to resurface at competitor facilities.

    The issues around intellectual property are especially critical, as China would want to move beyond its labor cost advantage-driven manufacturing output to something that represents a knowledge industry. In my experience, those people who are best at creating true intellectual property will eventually gravitate to regions where their creativity is inspired, but more importantly will be protected and ultimately rewarded--witness Silicon Valley and much of the Indian IT industry.

    Should China wish to mirror the latter's desire to move hundreds of millions from a subsistence existence to a proper middle class through real wealth creation, a key ingredient would be the creation and cultural respect for real intellectual property rights. Without this massive shift, China will be stuck in the low cost supplier game (without real IP creation and capture) on the largest scale. We have seen how that story ends, whether demise of textiles in the American South or migration of auto part sub-assembly manufacturing globally. The advantages are often transitory and often dependent on currencies and politics.

    • Don Plunkett
    • Principal, United Lighting Inc; New York

    The house of cards metaphor applies to our entire global economy, which is supported by antiquated nationalistic systems. Nothing short of an international system, complete with a world legislature, judiciary and executive, one world currency, and one auxiliary world language is required for our global world economy. Anything short of this is fit for history and not for continued growth of our global civilization.

    Corruption is found everywhere in the world. Regarding the energy/GDP gauge, China is promoting energy conservation, and when you drive through its urban streets at night, as I did earlier this month, you'll notice almost all lights turned off except those required! Not to say industrial energy use may be down which makes sense given its international trade interdependencies. However, the foundation of economics is agriculture, and on this point one may be concerned about China. Much of its labor force is leaving behind an important agricultural sector to work in urban factories. This too should be addressed.

    • Joel Ryba
    • Vice President of IT, The Grandoe Corp.

    China is a true growth market but it is difficult to make a profit due to the tight control and corruption within the Chinese government. My company has looked at opportunities to sell products inside China, but the problems are bigger than the opportunities. For now we are sticking with just using China as a manufacturing/exporting base. Eventually, American companies will be able to profit from sales in China.

    • Anonymous

    I think that China does offer a large growth opportunity, and the potential is real. However, I also believe that once the migration from agrarian to industrialization/service economy matures, the rate of growth will slow down to more sustainable levels as China's economy becomes more comparable to the Western nations. However, that may take a long time. And until then, the huge differential in skilled labor costs will continue to propel China—which will eventually trickle down into its markets. However, as the Chinese become a consumer-oriented society, there will be an expectation of higher wages, which will eventually bring about wage parity, and moderation of growth.

    As anecdotal evidence, I just look around to see how many of the things on the store shelves are coming from China. If the growth numbers were fabricated, as suggested in the New Republic article, then it would be difficult to keep seeing everything from clothing to stereos coming from China, year after year.

    • Greg Corrin
    • MBA Student, Hitotsubashi University, Tokyo, Japan

    Is it fair to compare China to the former Soviet Union anymore? The fact remains that China is manufacturing the majority of products for sale at Wal-Mart in the United States, and a growing number of products that are sold in Japan.

    What this means is that somewhere in China more energy is being used—maybe not electricity or oil, but certainly personnel. While there is not doubt that many government estimates of growth and prosperity are falsified, are we that certain that U.S. officials could get it right in a country with three times as many people and half the infrastructure at the government level?

    Additionally, while there is rampant unemployment and underemployment in the north of China, and other areas outside the urban centers of Shanghai and Beijing, unlike the USSR, China's one party continues to enforce rules and can stop any demonstration when it needs to. The government is working as hard as possible to modernize and is making great progress in creating laws and programs to govern private enterprise but it still retains absolute power over the people of China—something the USSR lost with glasnost and perestroika.