Friday, February 29, 2008

Price Controls Suck (the Yuan from the People's Pockets)

The United States (allegedly) goes to some extreme lengths for its oil. China is no stranger to these sorts of extremes. But only one of these countries has price controls on its petrol, and the People from that country pay more for petrol out of the pump than the country waging a war in the Middle East. (Sure, I prefer the colonial term "gas," but gas more accurately describes natural gas and that's a whole other story)

The biggest loser of China's price controls is its flagship company, PetroChina, which once had a "surreal market capitalization of just over $1 trillion, a figure roughly equal to the economic out of India," China's greatest weapon in the battle (in the eye's of observers from developed nations) for the king of the BRIC stack. Yesterday, an article at BusinessWeek, The Squeeze on PetroChina, explains the impact of the petrol price controls on PetroChina. Under "orders to subsidize fuel prices for consumers," PetroChina is selling petrol and diesel at a price that "reflect[s] $60 a barrel for oil, not $100 a barrel." The direct impact on PetroChina is obvious: even with robust profits on the global oil trade, 2007 growth in net profit is expected to be over 2% lower than the previous year. This is partially reflected in PetroChina's share values which "have fallen 40%-plus over the last four months."

The United States, without direct price controls, has lower gas prices than China. Are these price controls limiting incentive for innovation in business, systems and exploration, and limiting incentive for investors to invest in PetroChina? Or are the indirect price subsidies in the U.S. keeping our gas prices lower? Tax breaks for oil companies in the U.S. add up to about $18 billion per year which is almost equal to PetroChina's expected 2007 net revenue of $22 billion.

On a related note, China does the exact same thing with their coal.

On an unrelated note, G-7 countries are calling for an end to oil subsidies in China and India.

Thursday, February 28, 2008

Labor Contract Law as Labor Rights Triumph?

We've heard much about how huge of a deal China's new Labor Contract Law is, but a fine piece on NPR today made me realize how important it should be for improving working conditions for Chinese workers. By reducing their labor contracts to writing, Chinese laborers should be more successful in enforcing claims against their employers in court. The theory goes that this should mean employers give their employees written contracts and abide by the terms of those contracts for fear that the employees will sue the employers for either failing to abide by the Labor Contract Law or for breach of contract.

The NPR piece reports on "thugs" hired by "gang members" and local factory owners maiming a labor activist who was educating workers about their rights under the Labor Contract Law. This is problematic, but the radio piece also points out that the largest key to enforcing laws in China is getting the local government on board in enforcing laws. At Danwei, Teng Yun writes that for better or worse media attention is a proven method of exercising legal rights. By allegedly shutting up their workers with violence and drawing international media attention, these factories might be inadvertently speeding the use of the Labor Contract Law by their workers, increasing the chances of success these workers will see in court, and increasing the speed that the workers' labor conditions are improved. I'm not terribly current on the going price for hired thugs in China, but if those factories merely obeyed the Law they could apply the thug fund savings elsewhere, while avoiding the lawsuits that are inevitable and will only become more expensive under the terms of the Law.

Tuesday, February 26, 2008

VC in China from K@W by way of CER and FORBES, plus a Pira… Privateer Story

Back in the days of yesteryear I worked across the street from THE Sand Hill Road. There were a bunch of small, unassuming buildings that were charging more for rent per square foot than Manhattan or London's West End. Nothing memorable about the real estate. But I've always liked this internet thing and those VCs had something to with it financing some 2,500 companies per year in 1998-2000. This number has dropped considerably, but the title "Venture Capitalist" always reminds me of Sir Francis Drake; that guy was a paragon of badassedness. With 164 other guys he set off around the world with secret financing from the Queen and a few others. 3 years and 36,000 miles later he returned with 58 men, commercial contracts with the Far East, charts of the Asian archipelagos, and tons of gold, silver, cloves and cinnamon representing a 4,700 percent return to his investors. This profit in part formed the East India Company, and according to Keynes, "may be fairly considered the fountain and origin of British Foreign Investment." But enough about history; what of venture capital in China, today? (Drake info sourced from Derek Leebaert's, To Dare & To Conquer)

There's an interesting interview at Forbes of Ted Schlein, partner at Kleiner, Perkins, Caufield & Byers (KPCB), and Wharton professor Andrew Metrick on venture capital in China (h/t CER: The Editors' Journal). Mr. Schlein is the principal interviewee and he shares his insights on the major benefit and the major drawback of venture capital in China, how KPCB takes a different approach to investing in China as opposed to other developing markets, and the four strategies of venture capital in China.. Mr. Metrick rounds out the interview with some nice background data and a useful criticism of the "The Franchise," the venture strategy that KPCB is using in China.

Mr. Schlein identifies the Chinese market as the main reason for ventures in China. He does give the common spiel that the market is huge and Chinese customers are getting wealthier, but Mr. Schlein also finds that "in a lot of cases the Chinese companies are in a better position to after the [Chinese] market" than the U.S. based companies. He identifies some significant markets wars that are taking place (Baidu v. Google; Alibaba and DangDang v. Amazon), and he identifies some Chinese companies that are serving a marketplace that doesn't exist in the U.S. (Focus Media). Chinese simply know more about the Chinese marketplace and they are in a better position to exploit it.

The problem that Mr. Schlein identifies is that many of these homegrown companies are succeeding against their U.S. rivals not as innovators but as successful "me too companies." Presumably there is more money to be made on a venture when the company your funding has its own IP. Mr. Schlein attributes this not to a lack of bright students, but to Google and Microsoft's aggressiveness in recruiting the best students from the best universities in China and paying them a lot. He says that in the US the VC firms do the same thing and crawl through university's labs, but that they just haven't started doing that yet in China.

The four venture strategies that Mr. Schlein discusses are "Got No Soul," "Dragon Roll," "Peking Duck," and "The Franchise." The first three of these strategies use an approach that is unique to China & India, in which the venture firm does not exercise as much control over the company as venture firms simply would not do in the U.S.

Usually when a venture capital firm invests in a company, partners in the venture firm take some of that companies' board positions. In Got No Soul, the U.S. board member sends emails back and forth, talks on the phone, and might go to China twice a year to check on the company. Mr. Schlein has experience investing in this way, and he says that the most important part is making sure that you have a Chinese CEO that you can trust.

In Dragon Roll:
"A U.S. venture firm would hire a bunch of inexperienced or less experienced Chinese nationals in the country but not really empower them. There would be this raw American in the middle, making the decisions without really having the on the ground experience to understand what it really means to make investment decisions."
I guess the money wasn't what it was supposed to be?

In Peking Duck, the venture firm invests in a Chinese based fund expecting to learn how to invest in China. Mr. Schlein says, "You might get to see what they invest in, but you really don't learn. You just get a feel for what that group of people is putting its money into."

The Franchise is the type of venture that Mr. Schlein's firm, KPCB, is operating in China. There's even a link to their China franchise on their webpage. Here is Mr. Schlein's description of The Franchise:
"You will find professional managers over there, professional venture capitalists, and buy into them. They will be part of your firm. You will open a fund and they will be part of your fund, and you will integrate together. Maybe you will raise a separate fund, or maybe they are just general partners that are there. But they are Chinese nationals; they are practiced venture capitalists, at least to the extent that it has been practiced over there. Or you vetted them and you believe they can be good practitioners of ventures. They are senior enough, they make the decisions over there, and you don't try to manage them from the United States. I think that's the only way that you're going to have an enduring way to practice venture capital over there."
This is similar to his observations on the China marketplace. Chinese venture capitalists are going to have a better grasp on what needs venture funding in China.

Mr. Metrick worries that The Franchise results in the creation of "too diffuse" of a venture organization which has spelled disaster in the past. Mr. Schlein counters that they're engaged in "brand extension," and unlike the diffusion that has taken place in other firms, the U.S. head office is very hands off with the Chinese office. He says you have to try and pick the best people you can find, "teach them something about an investing process and investing discipline," and hope they succeed.

Mr. Schlein notes that this is very different to their investment process in the rest of the developing world such as Croatia or Russia. KPCB keeps some of its developers and engineers in these countries, but they bring the core business and executive team to America where they can have close watch over the business.

I guess they see something in China?

Saturday, February 23, 2008

Posts of the Week: 2/17 - 2/23

No excuses for my poor post frequency this week... No excuses for this simple list of posts of the week, either...

G2000 v. 2000: Is 20 Million Yuan Enough for Trademark Infringement? at China Business Law Blog
20 million yuan?!

Let's Rag Some More on China Joint Ventures at China Law Blog
China Law Blog was more prolific than usual this week; lots of short and sweet posts.

China Investment: Just Passing Through at This is China! BLOG

Tort damages for wrongful death in China at Conglomerate

Economic Returns to Communist Party Membership at China Economics Blog

Apple in China, Part 1: Apple Takes An Unfair Beating On iPhone at The China Game

Tuesday, February 19, 2008

"China's Infrastructure Splurge": America in the '50s or 19th Century?

A bunch of interesting articles this week in The Economist, and there is a definite theme: Beijing is raking in the dough and beefing up China's infrastructure. In one of the articles, America's splurge the author suggests that, "Perhaps China's leaders have been similarly impressed by America's interstate highways." I'd argue that "China's infrastructure splurge," as described in Rushing on by road, rail and air, seems more similar to America's transportation infrastructure growth in the 19th century.

Poles apart notes that "According to official estimates, China's government ran a budge deficit of around 1% last year." The chief economist at China International Capital Corporation, Jiming Ha, suggests that the government probably actually has "a surplus of around 3% of GDP," which adds up to US$86.37 billion. China also has the lowest proportional public debt of any "big country," with a public debt of 17% of GDP compared to the OECD average of 77%. This gives China plenty of cash and credit to play around with.

"Rushing on by road, rail and air" chronicles the infrastructure projects:
  • Beijing's new airport terminal is bigger than all the terminals at London's Heathrow combined.
  • "The world's longest sea-crossing bridge [at 36km, 4km longer than Donghai bridge] is due to open in June."
  • Bullet trains are being cast [?] all over the mainland.
  • Yangshan port outside of Shanghai is shaping up to be one of the largest deep-water ports in the world.
  • Plans are in the air "to add another 97 airports by 2020 to the 142 China had at the end of 2006."
  • An interstate highway system that has grown to the second largest in the world.
The article explains these projects are eased along by the autonomy that Beijing enjoys and the ease with which central planners can invoke eminent domain. The major problem is that several of the projects, especially in Shanghai, reflect "a tendency to spend big money on projects of questionable value" at the expense of systems that could use major improvements, such as the bus system. On the bright side, the Ministry of Railways is considering let the market drive more of these infrastructure projects which they hope will bring in outside investors.

"America's splurge" describes the return on investment that America has seen on the interstate highway system which cost $425 billion and took 37 years:
  • In 32 of 35 industries studied costs fell 24 cents per $1 invested in the highways.
  • During the 1950s, "interstate-highway spending was responsible for 31% of the annual increase of American productivity."
But, China's infrastructure spending is about more than creating their own "Futurama" (see The Next Slum? at The Atlantic if you don't recall the New York World's Fair of '39). China's spending seems more closely related to the massive growth in infrastructure that America experienced in the 19th century; the infrastructure that united the country and turned America into a manufacturing and trade powerhouse by allowing easier transportation from the interior of the country, say the Great Lakes region. This growth turned America into a country with enough economic power to allow it to replace Old Europe after it was ravaged by the World Wars. If nothing else, Beijing is spending its money well.

Monday, February 18, 2008

I Want to Take You Higher

Today, Scientific American posted an article by Theresa Hitchens from the March 2008 issue, Space Wars - Coming to the Sky Near You. Not so coincidentally, the article opens with a passage from Sun Tzu's The Art of War:

In war, do not launch an ascending attack head-on against the enemy who holds the high ground. Do not engage the enemy when he makes a descending attack from high ground. Lure him to level ground to do battle.
—Sun Tzu, Chinese military strategist, The Art of War, circa 500 B.C.

I suppose there is no higher ground than space… Hitchens provides several reasons why the weaponization of space has been avoided:
  • "[S]atellites and even orbiting weapons, by their very nature, are relatively easy to spot and easy to track, and they are likely to remain highly vulnerable to attack no matter what defense measures are taken."
  • "[D]eveloping antisatellite systems would almost surely lead to a hugely expensive and potentially runaway arms race, as other countries would conclude that they, too, must compete."
  • "[E]ven tests of the technology needed to conduct space battles—not to mention a real battle—could generate enormous amounts of wreckage that would continue to orbit Earth. Converging on satellites and crewed space vehicles at speeds approaching several miles a second, such space debris would threaten satellite-based telecommunications, weather forecasting, precision navigation, even military command and control, potentially sending the world’s economy back to the 1950s."
This has recently changed with China's test of an antisatellite weapon. Hitchens writes that China's test has given way to "Congressional reaction … along predictable political lines": China Hawks are calling for an space arms race, and moderates are calling for international bans on space weapons.

Hitchens also points out that in addition to the U.S., Russia and China, India is also now working on space weapons and if India gets them, Pakistan is sure to follow. Even Japan is expressing interest in joining the race for the hottest new space weapon.

Currently there are three things holding the world's nations back from developing space weapons:
  • "Political opposition"
    • Space weapons destroy our "eyes in the sky" which reduce our early nuclear missile detection which would produce distrust that "could rapidly lead to catastrophe"
  • "Technological challenges"
    • They're all vulnerable, and the proliferation of space debris hurts all nations
  • "High costs"
    • $2,000 to $10,000 per pound of weapon put in low orbit, and $15,000 to $20,000 per pound in geostationary orbit
Hitchens ends with a paragraph that has meaning far beyond just a new space race:
"Space warfare is not inevitable. But the recent policy shift in the U.S. and China’s provocative actions have highlighted the fact that the world is approaching a crossroads. Countries must come to grips with their strong self-interest in preventing the testing and use of orbital weapons. The nations of Earth must soon decide whether it is possible to sustain the predominantly peaceful human space exploration that has already lasted half a century. The likely alternative would be unacceptable to all."

The full article is free online, and like any SciAm article contains a lot on the details of the weapons including XSS, Rods from God, parasitic satellites, and Space Bombers.

Anti-nuclear proliferation group Federation of American Scientists, has also convened a Weapons in Space Panel under its Military Analysis Network. The FAS are into details, and you can find plenty at their site.

For further reading checkout Travis Hodgkins' blog post at Transnational Law Blog, chronicling the Wired blog posts "How China Loses the Coming War" (Parts I, II & III) on space war. Also, see Disharmony in the spheres at The Economist.

EDITED: Inserted the name of the Wired blog posts. Thanks to a reader for the suggestion.

Sunday, February 17, 2008

Posts of the Week: 2/10 - 2/17

[I'm doing something different this week. No football, not the 足球 sort, on Sunday means too much time on my hands. In the narrative that follows I'm embedding links to the "Posts of the Week," and placing the list of the posts of the week at the end of the post. A "Post of the Week" can be identified by the "*#" following the embedded link, with the # matching the same number at the end of the post where the Posts of the Week will be listed by number.]

"Boogity, boogity, boogity! Let's go racing, boys!" Thusly D.W. waves the green flag on another running of "The Great American Race," the Daytona 500. If you want to succeed in America*1, you must watch the Daytona 500, and learn some of the values we hold dear*2.

The Robin Hood history is well-documented: NASCAR was founded by moonshiners, and the early drivers were products of bootlegging, outrunning the cops in the Appalachia in the fastest vehicles on offer from Detroit (see Tom Wolfe's article on Junior Johnson, "The Last American Hero"). The Horatio Alger story of the rise of the hard working young man flaunting the law for the sake of bucks and booze in high tech machine jives well not only with America's unashamed infatuation with the outlaw, but also with what Henry Adams characterized as our international reputation for hard work, whiskey drinking, and engineering.

This the year the event was kicked off with a concert by an Elvis impersonator, followed by an invocation for the faithful*3 by Pastor Bobby Welch, essentially our ideals wrapper up in a shiny package. Next, country music star Trisha Yearwood sang the Star-Spangled Banner. During this routine rendition at athletic events we usually see the athletes standing on the field with hat or hand over their heart trying to sing along. Not at the Daytona 500! The drivers stand with their wives by their side, and their children in front or in their arms, beaming proudly up at Ms. Yearwood. Yes, all cultures love their families, but politicians and pundits have told us for about twenty years now that "Family Values" are really really important to us, so we're compelled to show each other and the world how important our family values truly are. Mixed with shots of the drivers during the anthem we're treated to the obligatory shots of soldiers and old people because we're supposed to care about them too. And, the routine flyby of F-16s and fireworks symbolizing our military might closes out the singing. Then, the real show begins.

NASCAR racing is different because success depends more on the other drivers and your relationship with them than any other form of racing, something D.W. calls "Co-opetition," a hybrid of "cooperation" and "competition." Presumably, the cars are all equal, and winning depends on drafting ability. Drafting is important in all forms of racing, but the sturdiness of a NASCAR allows a form of drafting that would destroy, for example, a Formula 1 car, "bump drafting." Bump drafting sounds like what it is, while drafting you bump the back of the car in front of you pushing them faster helping you both pass another racer. If two racers are not on the same team, or they're not too fond of each other, then they're not necessarily going to help each other out when they can both benefit. It's no mystery*4, there is no lesson whatsoever for the business world to derive from bump drafting metaphors… Though we could make comparisons to pioneers on the frontier helping each other erecting a barn; that should avoid any subtle socialist comparisons.

In the face of World Rally and F1, NASCAR takes a hit from racing enthusiasts for lacking skill. What NASCAR drivers may or may not lack in skill, they more than make up for in audacity, bravado, courage, daring, enterprise, fearlessness, guts, hubris, intrepidity, mettle, moxie, and nerves. Driving a car near 200 mph for 500 miles is daunting enough, but driving 200 mph inches away from your competitors bumping off each other for 500 miles takes a different breed of person. These guys deserve the recognition they get.

There's a lot on offer as far as choice of driver goes. You can root for the NASCAR poster boy, Jeff Gordon, or the image of wild hard partying son of "The Intimidator," Dale Earnhardt, Jr., or the git 'er doneness of Michael Waltrip. Personally, I'm all about the current champ, a sponsor's dream come true, the generous native San Diegoan, Jimmie Johnson. And, if you can't find a driver to root for, well, you can always root for your favorite Fortune 500 corporate sponsor, for NASCAR attracts more Fortune 500 sponsors than any other sporting event. Makes sense when there are 75 million fans, 17 of the top 20 most attended US sporting events are NASCAR races, and the fans purchase over $3 billion of licensed products per year. Toyota recently got the picture and built some NASCARs, is Chery next?*5

I've checked my sources*6, and I'm pretty sure I haven't forgotten anything this week*7

Posts of the Week
  1. Top Ten Reasons For China Business Failure -- List After List at China Law Blog
  2. Low-Budget, High-Yield Legal Aid in Xi'an at China Business Law Blog
  3. A Reason to Have Faith in China's Legal System at Transnational Law Blog
  4. China's mystery value does NOT enhance its creditworthiness at China financial markets
  5. The 2008 Detroit Auto Show: Chinese Carmakers Eye the US Market at Managing the Dragon
  6. LinkedIn Answers China question at Asia Business Media (h/t CLB)
  7. Donald Clarke's Posts at Conglomerate at, um, Conglomerate
EDIT: Apologies to Mr. Clarke for calling you David. Thank you to Dan Harris of China Law Blog for the correction.

Friday, February 15, 2008

Less Red Ribbon Equals More Ribbon Cutting Events for Clean Energy

There is an interesting article by William Chandler and Holly Gwin at the (somewhat) new Energy and Climate Program of the Carnegie Endowment for International Peace, Financing Energy Efficiency in China. Chandler and Gwin argue that "Removing barriers to clean energy investment in China may contribute more to climate protection than any global climate treaty." We have become more acutely aware that cheap coal is not preventing the development of clean energy projects in China, and the government seems genuinely committed to cutting emissions as evidenced by their high "automobile fuel economy targets" and their plan "cut energy intensity by 20 percent by 2010." Chandler and Gwin argue that red tape in four areas is restricting the growth of clean energy:
  • "Restrictions on debt financing"
  • "Restrictions on foreign equity investments"
  • "Asymmetric policies at the central and local levels"
  • "Confiscatory tax policy"
"Restrictions on Debt Financing"
Among the problems identified by Chandler and Gwin:
  • "Chinese equity markets provide only about 25 percent of the capital provided by comparable markets in other developing economies, and commercial debt provides only 2 percent"
  • Corporate bonds are illegal in China, but they "provide $5 trillion per year in financing in the U.S." and there is no reason China corporations should be missing out on this financing opportunity
  • Financing is being channeled to SOEs rather than private companies which actually account for the majority of GDP
  • "All interest payments are assessed a 10 percent withholding tax"
  • Interest rates are capped at "roughly 8 percent" which discourages "risk-based" lending. Clean energy projects are risky, but "Returns on energy investments in China often exceed 50 percent per year," and allowing higher interest rates might encourage banks to more readily lend to clean energy projects.
  • The roughly 10 percent interest rate cap on foreign shareholder loans has the same discouraging effect on the willingness of shareholders to finance clean energy projects.
"Restrictions on Foreign Equity Investments"
The problems identified by Chandler and Gwin:
  • "Foreign investors' ability to repatriate foreign exchange" is strictly controlled, and "is an anachronism in a nation with a $1.4 trillion foreign exchange surplus."
  • Prohibition on preferred stock in China.
  • China does not allow a priority investment return to foreign investors in a CJV that develops and sells carbon credits under the CDM. The CJV is the only business form allowed for CER/CDM projects, and this restriction on business structure might discourage investment.
"Confiscatory Tax Policy"
China's value added tax (VAT) on clean energy is not a true VAT, but instead requires clean energy projects to "pay 17 percent of revenue as VAT." Meanwhile, coal-burning energy facilities are only assessed a 13 percent VAT. Also, clean energy producers are no longer afforded an income tax break under the new corporate income tax. Chandler and Gwin argue that revisions to both of these tax policies could encourage investment in clean energy projects in China.

Chandler and Gwin's Priority List for the Chinese Government for Promoting "Clean Energy Development"
  • "Exempt clean energy investments from foreign exchange, foreign-invested enterprise, and industrial policy controls;"
  • "provide tax exemptions for clean energy companies and services—particularly in regards to the value added tax (VAT), which sucks up 17 percent of total revenues;"
  • "make risk-based clean energy lending more worthwhile for banks;"
  • "provide loan guarantees for energy-efficiency projects in China;"
  • "reduce required paperwork for clean energy investment; and"
  • "address restrictions created through the emissions trading system that actually increase risk to investors."

Closing Remarks
Chandler and Gwin are literally invested in this research. Chandler is the president of Transition Energy and the co-founder of the Dalian East Energy Development, Ltd. (DEED), and Gwin is the general counsel and co-founder of Transition Energy. Transition Energy develops "financing for clean energy projects around the world," and DEED is a clean energy CJV in China and co-founded by Transition Energy. However, they are probably as aware as one could be of the difficulties in developing clean energy projects in China, and they have raised valid concerns that make it difficult to develop the clean energy that Beijing has verbally committed itself to. Clean energy is heavily dependent on cutting-edge technology, and Beijing would probably be wise to take a close look Chandler and Gwin's paper.

As for the Carnegie Endowment, this is a perfect paper for them. The Carnegie Endowment believes in peace through prosperity, and prosperity through a free and open global market. Slash that red tape and let's all get wealthy together. I wish my French was good enough to come up with a witty pun expressing the ability of laissez-faire capitalism to promote peace between the United States and a communist country. C'est la vie.

Thursday, February 14, 2008

Inside an International Negotiation

Yesterday, Dr. Chen Ke of AllBright Law Offices in Shanghai spoke at USD School of Law on the formation of foreign invested enterprises. The real gem of the presentation was Dr. Chen's description of international negotiations.

Negotiations typically take place in a conference room with a long table. The principal negotiators, typically someone below the CEO because the CEOs are off "drinking and having fun," sit across from each other in the middle of the table. On one side of the negotiator is the numbers guy and on the other side is an attorney. The attorney's job is not to speak, but to quietly consult with their negotiator. Next to the attorney sits "The Troublemaker," the interpreter. The interpreter is likely fluent in both of the languages being spoken, but it is unlikely that an interpreter is fluent in the legalese of each respective language. This interpreter whispers mistranslations of legal terms of art into the ear of the attorney who whispers legal interpretations based upon mistranslations into the ear of the negotiator, and the negotiation begins to go sour in this game of telephone. Dr. Chen pointed out that the next negotiation often goes much smoother because the interpreter has lost all face and remains silent throughout.

Wednesday, February 13, 2008

China Soft Power v. Hollywood Hard Power

I've been expecting this since I saw John Prendergast speak at USD's Joan B. Kroc Institute for Peace & Justice in January of '07. Mr. Prendergast spoke on the current situation in Sudan, and during the Q&A session talk turned to China's ties to Sudan. Mr. Prendergast spoke of grand plans for advertising campaigns and global protests in the lead up to and during the Beijing Olympics. A year later, Mr. Prendergast is the Scholar-in-Resident at the Kroc Institute and Steven Spielberg has raised the first high profile objection to China's Sudan Connection by resigning as artistic adviser to the Beijing Olympics. There is an even-handed account of Mr. Spielberg's resignation at the Financial Times. In celebration of partisan politics, I'm going to avoid that style and inject a little bias.

The strongest argument against Mr. Spielberg's resignation is that the Olympics are supposed to be about sport not politics. The FT article writes that "critics counter that Beijing itself ties the Games to its political agenda of promoting patriotism and "harmonious" development."" That statement is ridiculous, of course the Olympics are about promoting patriotism and development. Any nation rallies around their Olympic success and the IOC virtually demands that the hosts of the Olympics develop sufficient facilities for the Games. This is not so much a political agenda as a reality of the Olympics. As China's envoy to Sudan said last year, "anyone who linked the situation in Darfur with the Olympics was either ignorant of reality or steeped in obsolete cold war ideology."

China will probably not bend on its support of the sovereignty of the regime in Khartoum because China's diplomatic strategy is based on soft power. There is a nice article by David Roberts on China's soft power at Asia Times, China's soft power filling moral void. Mr. Roberts characterizes China's soft power diplomacy as such:
"In return for countries strict adherence to an avowed policy of sovereignty and non-interference in other states' affairs, China offer both unusual levels support even of smaller countries as well as, crucially, a reciprocated and fervent promise not to interfere in their policies."
Mr. Roberts writes that this allows China to deal with the less scrupulous nations of the world

Mr. Roberts characterizes hard power, soft's opposite as follows:
"[C]oercion of one form or another: you don't follow China's lead because you want to, but because there are implicit or explicit military, economic or diplomatic threats."
This is the sort of diplomacy the U.S. is more use to employing with nations of questionable character.

Mr. Spielberg is employing hard power by refusing to offer his services to the Beijing Olympics. This sort of tactic can work in the short term, but in the long run hard power invites "resentment and general antipathy," according to Mr. Roberts. When someone shows that they are unable to work with someone over a disagreement that is unrelated to the event, especially an event that celebrates a global community under the auspices of athletic competition, that person is showing that they are unwilling to work together on more ambitious projects. Mr. Spielberg represents more than just the Hollywood elite, he represents the United States, and this real politick is setting a dangerous precedent. Let alone, Mr. Spielberg's audacity in the statement that he would still like to attend the Games.

Mr. Roberts ends his article at Asia Times by suggesting that if the U.S. employed the same soft power tactics with the less moral regimes around the world, those regimes would have the chance to learn our values:
"One can only hope that through interaction with the West and the exchange of Western soft power, grandiose notions such as democracy and human rights will filter down however slowly and become embedded to help guard against the seductive allure of a mechanical foreign policy of naked self interest."
World peace and global human rights take time and cannot be foisted upon others by force. They take internal movements. Did Mr. Spielberg ever pause and think of the effect that his guidance, wisdom and, even, politics could have had on the Chinese film artists he would have worked with? Did he pause and think that by shunning China and the Olympics, an event that China is taking very seriously as a display of their rise from, essentially, a British colony to a [Fragile] Superpower he might be creating resentment, in not just Beijing but the common Chinese citizen, against the ideals that we Americans hold so dearly?

Monday, February 11, 2008

Energy Update: Transmission Deregulation coming

I'm not going to be so presumptuous as to suggest that my post comparing California's 2000-01 energy crisis with China's current energy crisis had anything to do with this, but over the weekend China's NDRC decided to try to start deregulating China's energy transmission by increasing FDI in transmission. Chris Devonshire-Ellis has an in-depth post on this over at China Briefing. You can only transmit as much energy as you have wire. If there's a profit to made in transmission, and there is, then companies will be scrambling over each other to build those transmission lines when they can. End result, more people are getting more energy, and there is more wealth to go around. Or so goes the theory.

Xinhua IP Kookiness

Xinhua released a couple of weird IP articles on February 11. There must be a deficit of reporters in the office this week...

In Pirated software still a poser (presumably using the "question or problem that is puzzling or confusing" definition of poser and not this), the Shanghai Daily seems to be playing a joke on Xinhua with their witty story title. The title implies that pirated software is still a big problem, while the story lauds the 53% increase in companies using software under valid copyrights from 1,500 companies in December 2007 to 2,300 companies by February 7. 53% is a big number and so is two-thousand three-hundred, but the China Business Directory alone lists 173,765 Chinese firms, which would mean that there are still at least 170,000 Chinese companies still using infringing software. The story doesn't carry the same title at Xinhua, and the Shanghai Daily editors must be applauded for this article title.

In China authorizes 30% more patents in 2007, Xinhua comes to the obvious conclusion that the increase in authorized patents means that "China's innovation capability has been upgraded." Perhaps on paper, yes, innovation capability appears to have increased, but is an increase in patents necessarily a measure of innovation? Part of the solution to this question surely lies in how many of those patents were for perpetual motion machines? Other questions one should ask to answer this question are how many of these patents were issued to foreign-invested enterprises? and how many of those patents can be attributed to an increase in patent filings due to an increase in trust in the legal protections afforded by China's patent laws rather than a bona fide increase in innovation? There are concerns about China's innovation, and these concerns are not going to be genuinely solved by juking the stats.

Saturday, February 9, 2008

Posts of the Week: 2/3 - 2/9

Happy Spring Festival to y'all.

This has been one long week. Lots of excitement Stateside with the Super Tuesday. And, I just checked the current returns and it looks like Obama's currently ahead in Washington and Nebraska, and in a statistical tie in Louisiana.

In China even Warren Buffet would be a speculator at China Financial Markets
It's always nice when the government gives you the wink and the nod on buying and selling.

Establishing FICEs in China: Registration procedures explained at China Briefing
Forgive me, but I really really enjoy boring legal topics.

A couple of posts on the metals industry at Managing the Dragon
Jack Perkowski covers the latest for BHP, Rio Tinto, Alcoa, Chinalco, and Baosteel, and the implications for the China and world aluminum, steel and iron ore industries.

China's Five News at China Law Blog
Lots of fun stuff on China's 5 major legal changes.

Graphing China: Shanghai Moves Up the Value Chain at This is China! BLOG
While I think dry legal commentary is pretty neato, I really like graphs, charts and spreadsheets. This chart, by Bill Dodson, conveys a lot of information and it avoids misleading design.

Shanghai's Extreme Makeover at All Roads Lead to China
Interesting piece on constructing Pudong.

Gross imbalances at Free Exchange
I missed this last week, but this is Free Exchange's response to James Fallows's recent article in The Atlantic about China's dollar reserves.

Thursday, February 7, 2008

U.S. State Department on Hong Kong and Macau

A few weeks ago I found myself on the U.S State Department's website and I stumbled across an Email Updates page. The service seemed pretty nifty; they let you choose from a laundry list of different topics that you want to be updated on, and then they send the updates right into your box. Perhaps, I checked too many topics; my inbox is starting to look like the State Department's clearinghouse. But the information that comes in is truly useful, and today, the info was topical. The State Department released their new background notes on Macau and Hong Kong. And I bring especially to you, yes you, my summary of the State Department's Background Notes on Macau and Hong Kong. I wonder if they're more optimistic than the "Unbelievably Scary China Committee."

The State Department just doesn't have much to say about Macau. This might have something to do with a lack of a U.S. government office in Macau. The U.S. Consulate General in Hong Kong handles our interests in Macau.

The U.S. is the destination for almost 45% of Macau's exports, but the State Department speculates that this will dry up at the end of next year with the expiration of the 2005 Multi-Fibre Arrangement quotas. U.S. business just does not have the same presence in Macau that it has in Hong Kong and China. This Special Administrative Region is simply represented as a tourist destination for folks from Hong Kong and the Mainland, with a dying export market, growing gambling market, and a government dominated by a cross between Beijing appointees and "pro-entertainment industry groups."

Hong Kong
Here we have a lesson in contrast. Juxtaposing the State Department's Background Notes on Hong Kong and China, Hong Kong seems to represent everything the State Department wishes China could be. There even seems to be a sense of confusion in their writing over how Hong Kong can possibly be under the control of Beijing.

See if you can spot which of the following are about Hong Kong and which are about China:
  • "[A] free and open society where human rights are respected, courts are independent, and there is well-established respect for the rule of law."
  • "[W]ell-documented and continuing abuses of human rights in violation of internationally recognized norms, stemming both from the authorities' intolerance of dissent and the inadequacy of legal safeguards for basic freedoms."
  • "Although new criminal and civil laws have provided additional safeguards to citizens, previously debated political reforms, ... have been put on hold."
  • "[A]dopted a new state constitution that emphasized the rule of law under which even party leaders are theoretically held accountable" (emphasis added).
  • "[A]chieve full universal suffrage for the ___ in 2017, and full universal suffrage for _____ sometime thereafter."
I guess that was more of a rhetorical question, but if you're wondering, the first and the last come from the State Department's report on Hong Kong. Of particular interest is the part about the possibility for true democracy in Hong Kong for the election of the Chief Executive (CE) and the Legislative Council (Legco). The section on Hong Kong's government is devoted to how well the republican form of government is working, and how swiftly the Special Administrative Region is moving to democracy even while under the watchful eye of Beijing. The similar section in China can be summed up in a single sentence: "The Chinese Government has always been subordinate to the Chinese Communist Party (CCP); its role is to implement party policies."

You know the U.S. is fond of Hong Kong when the State Department writes: "Hong Kong is one of the world's most open and dynamic economies." And here's something I was unaware of: U.S. official policy towards Hong as stated in the U.S.-Hong Kong Policy Act of 1992 is to "promote Hong Kong's prosperity, autonomy, and way of life." Our number one economic goal with China is to "fully integrate China into the global, rules-based economic and trading system." The relations are both paternalistic, but the father is feeding one a carrot and the other a stick.

Despite Hong Kong's robust economy, the State Department avoids the pissing match it gets into with an imaginary Chinese opponent in the following bizarre exchange:
"The result has been the largest reduction of poverty and one of the fastest increases in income levels ever seen. China today is the fourth-largest economy in the world. It has sustained average economic growth of over 9.5% for the past 26 years. In 2006 its $2.68 trillion economy was about one-fifth the size of the U.S. economy."
To paraphrase the State Department: "Yeah, sure, they're doing alright, but they still stand in our shadow."

Fortunately, the State Department stays away from the many silly China conclusions of others, and actually recognizes the importance of China for the U.S. China is one of our largest export markets, and the State Department lists several reasonable factors for our trade deficit including a strong domestic demand for Chinese goods and faulty U.S. trade data attributes.

I'm pretty sure the State Department would prefer that China become more like Hong Kong between now and 2047, but at first blush that seems unlikely. Then you have to wonder, if China is allowing democracy in Hong Kong over the next decade plus, does China plan on being a democracy come 2047?

Tuesday, February 5, 2008

The Internet is Different in China[!?!?!?]

I like The Economist. Wait, wait, let me rephrase that. I REALLY like The Economist. Ok, so I mostly like it because it provides positive reinforcement of my political and economic views (governments should promote free trade because free trade encourages fair[er] competition, and competition encourages innovation and adaptation). And, I also like The Economist because no one else employs writers and editors who are better at writing sarcastic captions and single sentence zingers at the end of each story. Oh, and the writing quality and insight are reasonably good and deep for a weekly periodical. But, and this is a big 'but,' what is with The Economist and its reporting on the internet in China. Back in November they wrote some wacky story about 'emobytes,' and on the cover of this week's magazine is a story about How the internet is different in China.

Did you know that in China internet use is growing? Did you know that in China Wikipedia is restricted, and Google China filters search results? Did you know that in China people buy and sell stuff online, use social networking, look for "virtual friendships," and swap pirated media? You did, huh? Did you just assume all of this because people everywhere do the exact same thing on the internet, or did you actually know this, or both? Did I find anything novel in this article at all? Yes.

Thing I Learned:
  • "Operating margins for leading internet firms are 28% in China, compared with 15% in America."
That is impressive, but really it is just one sentence, and I'd like to hear a story that covers the why. Presumably it is has something to do with cheaper labor?

Internet Tidbits That Could and Should Be Expanded Beyond The Single Paragraph Allotted:
  • Internet use over mobile phones is China's largest internet market.
    • Yes, this is well known, but this is important and worthy of its own article in The Magazine. Maybe even a study into cross-platform and cross-country profit margins in internet delivery methods?
  • "The most dynamic area, and the hardest for outsiders to understand, is that of online communities."
    • The paragraph devoted to this subject is insufficient.
    • The dynamism should not simply be left to my imagination because I probably won't understand it.
    • Profit margin comparisons, please?
The Economist, please keep giving me China internet articles. But give me something other than government issued pork to chew on, please.

Monday, February 4, 2008

Energy: Learning From The Mistakes Of Others

Way back in 2000-01, when I was but a wee lad in my Freshman year at Pomona College in (the eastern border of) Los Angeles (County), my $36k/year school was hit with "rolling blackouts." I grew up in the mountains of Santa Cruz, and the power went down at least once a year. In elementary school, this was sufficient cause for school cancellation. In college, class was cancelled the first day, but alas, thereafter we were required to attend class in the dark. The blackouts had an upside, though, they forced us out of our rooms and into the emergency lighting of the dormitory halls. This probably did more for our camaraderie than any of the school's group spirit building activities. Eventually, the school bought an exemption and we returned to our rooms to hone our bridge skill on the internet for our regular contests of bidding for points above the line to secure our rubbers.

At the time, we were told that there was an energy crisis; there was a lack of energy. With time, it was discovered that a company called Enron had somehow manipulated the markets and the shortage was merely perceived. Supposedly, "deregulation" was at fault. This was my understanding of California's energy crisis until I took a course in Energy Law and Policy.

The U.S. energy industry has been on a steady path of deregulation. The only ones who have fought for regulation are the state-sanctioned monopolies and the, now defunct, monopsonies. Monopolies are safe and are guaranteed a return on investment according to the rates they are allowed to charge, and monopsonies just get to rake in money hand over foot. And, hell, it's always cool to be the only guy in town. Competition is important in all aspects of the energy industry because competition drives innovation in energy efficiency and energy price, competition encourages the construction of new generation facilities, competition encourages the building of energy transportation infrastructure, and competition was driving the growth of green energy by allowing energy retail consumers to choose energy providers and thereby creating a market for green energy. The Energy Policy Act of 1992, and the implementing FERC initiatives, started the U.S. on the road to energy deregulation because prices were too high, there were too few generation facilities, transportation infrastructure was poor, and consumers wanted to choose their retailers.

The problem was that in California, the deregulation did not go far enough. Prices on the wholesale spot market within California were deregulated, but retail prices to consumers were capped. By the authority of the Commerce Clause of the Constitution, the FERC chose to cap wholesale prices on energy sold from California to other states. This mix of regulation and deregulation allowed power marketers, such as Enron, to step in and manipulate the market.

Power marketers are necessary in a deregulated market because they create a futures market which helps to stabilize energy prices. Problems arise when power marketers start manipulating the market to their own gain at the bad faith expense of others.

Enron engaged in five primary market abuse tactics to drive wholesale energy prices up. They even went so far as to give each con scheme a cute name:
  1. Wash Trades: this is the sale of electricity to another company with a simultaneous purchase of the same electricity at the same price. This gives the appearance of both business and market activity, which results in both making the company look more financially healthy than it is, and in making the energy demand look more robust than it actually is pushing up price.
  2. Death Star: Enron would accept payment to relieve electricity line congestion. Due to the physical nature of the electron, it is impossible to relieve line congestion with a paper trade, and this just added to the cost of wholesale electricity.
  3. Fat Boy: Enron would schedule high MWs to its subsidiaries, and then only use a fraction. They paid for energy they did not need, to drive up the price of electricity.
  4. Get Shorty: There were several different markets, and Enron would make electricity deals on the day-ahead market, which it didn't have the ability to do, and then purchase the electricity for those deals on the more volatile hour ahead market.
  5. Ricochet: It is not completely clear that this scheme is illegal, but under the regulatory framework, Enron could purchase wholesale energy at the capped rate from California companies, and then sell that energy in other states with deregulated wholesale energy prices.
Enron wasn't wholly to blame, other power marketers and energy wholesalers were also withholding power from California energy retailers thus driving prices through limited supply. And, though these guys were acting like a bunch of jerks, California was also hotter than usual that year which placed a much higher than usual strain upon the energy grid due to increased AC use.

The effect was that after it was discovered how easily wholesale prices could be manipulated, wholesale prices shot through the roof. While wholesale prices soared, retail prices were capped, and wholesale prices quickly exceeded retail. Energy retailers began operating at a loss. Soon, the retailers' creditors grew unwilling to lend them money to purchase the necessary electricity on the spot markets. Without electricity, the retailers had to impose rolling blackouts upon Southern California because energy was simply too expensive. Eventually, the Department of Water Resources bailed us out with a bond initiative, which is attached to each of our electricity bills. And, the fight is on for proper deregulation sometime in the future.

What the heck does this have to do with China?

Well, China's currently in a remarkably similar situation to California in 2000-01. China is as uncommonly cold as California was uncommonly warm, which places great stress upon the energy grid. But the big similarity jumped out at me from the Financial Times article, Coal price debate at root of power shortage. The price of China's primary energy source, coal, is deregulated, while electricity prices are regulated by the government. The coal shortage is, apparently, not caused by manipulation, but by other external factors, and this shortage of supply drives up prices. If the electricity generation companies must pay higher prices for coal, but are required to charge the same rates for their energy, then they are being forced to operate at a loss, or at least a lower profit. Even in a Communist country, it can be too much to ask a power company to operate at a loss.

With worries over inflation in China, the deregulation of electricity is almost certainly a no go. However, deregulation combined with a robust electricity futures market might help alleviate problems. A futures market in both coal and electricity would help stabilize the price of both. A futures market in electricity would require deregulation that isn't there.

The final sentence of the article makes one wonder if there actually is some market manipulation similar to that conducted by Enron: "But Beijing appears equally furious at the brinkmanship of the power companies. Mr Brock said: “I think the power companies’ tactics have backfired.”"

A key component of vision is having the ability to learn not from your own mistakes, but from the mistakes of others. Those Enron guys were some slippery jerks, but they were named Fortune Magazine's "Most Innovative Company" for 6 straight years, defrauded West Coast utilities out of $1.8 billion, and cost tens of thousands of people around the world their jobs. And, they accomplished this in one of the most tightly regulated securities environments in the world. If China truly has vision, I hope they see the error of our ways, and prevent this abuse in their country. Ex post facto executions do not count.

More Reading on China's Energy and Weather Crisis

China's Power Crisis at All Roads Lead to China
Extreme Weather Affecting Operations in China & China Storm Update at Managing the Dragon
China leadership Winter 2008 tour at Imagethief
China's Weather Report: Because It Really Matters at China Law Blog
The Call of the Home at China Business Law Blog
Winter weather updates at CER

Saturday, February 2, 2008

Posts of the Week: 1/27 - 2/2

China is in a power/weather/travel crisis. We're thinking of you here in the States, and hope that you all stay as warm as possible and can get home to see your families.

China's Power Crisis at All Roads Lead to China
The most comprehensive post on what's happening in China.

Corporate America’s China plus one strategy at China Briefing
As China becomes more expensive, big business is branching out its operations over East Asia.

More on why high share prices don’t mean Chinese banks are in good shape at China Financial Markets
Interesting comparison of Mexican banks and China banks. I am impressed by post after post coming from this blog, and it's jumping onto my blog roll.

Don't Count on the Chinese, You Better Do It Yourself at Transnational Law Blog