‘Protectionism is a fact of life in China’: Interview with Shaun Rein

By Patrick Lozada and James Griffiths

Shaun Rein is the founder and managing director of the China Market Research Group, a strategic market intelligence, and Bloomberg Businessweek columnist. He is the author of The End of Cheap China: Economic and Cultural Trends that Will Disrupt the World. Rein, who is married to the granddaughter of 1980s Politburo chairman Marshal Ye Jianying, has been criticised by some China watchers for being a ‘water carrier’ for the Communist Party, while being lauded by the American business press. Even Dan Harris, one critic of Rein’s, has written that he “greatly respect[s] Mr. Rein’s courage in consistently taking the most extreme positions favoring China”. Shanghaiist’s Patrick Lozada spoke to Shaun about his new book, Apple, prostitutes, protectionism, and the state of the Chinese economy.
Check back on Friday when Shanghaiist will be publishing an exclusive excerpt from The End of Cheap China.
Shanghaiist: What is ‘The End of Cheap China’?
Shaun Rein: Starting in 2007, my colleagues and I found rising labor and real estate costs were starting to pose problems for many companies relying on “cheap China” to generate profits. We started to do research into whether cost increases were a short-term blip or if we were at the start of a dramatic change in the economy that would cause China to become an inflationary rather than deflationary force on the global economy.
It became clear China would no longer be a cheap place to manufacture. The one child policy meant fewer overall people coming into working age. Available workers harbored white collar dreams and were no long willing to work for pennies on the dollar. I first presented our results at a speech at the Asia Society in New York. A fellow speaker literally hissed at me while I was speaking and told me I was flat out wrong – she said China would always be cheap. Well, migrant workers salaries have been rising 20% annually since 2007, and it is only about 30% cheaper to produce in Shanghai than in Alabama in America when factoring in all transportation and other costs. Already companies like Nike source 38% of their product from Vietnam versus only 36% from China. We often tell clients to think twice before relocating operations to China and that it might be better to stay in America.
Despite rising costs, China will not lose its overall dominance in manufacturing. Its infrastructure is far superior. What will happen is China will move up the manufacturing value stream while other markets like Indonesia and Cambodia will continue to take share in light industry. Already China buys from Germany than it exports there mostly because it is buying high-end machinery needed for manufacturing.
To deal with rising costs, companies will either have to relocate manufacturing, accept squeezed margins if they cannot transfer higher prices to end customers or focus more on worker efficiency. For most companies, I recommend focusing on worker productivity and training as it is easier and cheaper to do than relocate.
SHist: What characterizes the kinds of goods and services an increasingly wealthy China wants to buy?
SR: Instead of becoming a place simply to manufacture, China has emerged as the spot to sell into. Chinese are now the 2nd largest luxury consumer in the world, buying about $20 billion USD of luxury products a year. Over the last three years there has been a marked change in what truly wealthy Chinese want however. We recently interviewed three dozen Chinese worth $10 million USD or more. They told us they no longer wanted Louis Vuitton because it was too common and moving more towards brands like Bottega Veneta and Hermes.
The recent crackdown on corruption is also forcing people to move away from bling. Brands like Ferrari that have been linked to scandals are too high profile. Many ultra-wealthy are looking for more lifestyle experiences like safaris in Africa or donating buildings to elite western boarding schools.
For instance, we found ultra-wealthy Chinese wanted to buy James Purdey brand shotguns from the Richemont Group. These are not cheap shotguns – they often cost 6-figures or more and have been used by Britain’s Royal Family for centuries. Chinese did not necessarily want to hunt but they wanted the best guns to live their conception of the Chinese dream of being in nature, far from China’s pollution. Going forward, the luxury market will be less about bling and more about lifestyle experiences in the coming years. The change will pose serious challenges for companies like Louis Vuitton and Omega that have long dominated but will provide opportunities for new sectors and more niche companies. I am particularly bullish on travel. We expect 90 million Chinese to travel abroad in 2013, up from 50 million in 2010.
SHist: You talk about a lot about the growing strength of Chinese brands and entrepreneurs, but are these companies really ready to compete with global heavyweights?
SR: Let me answer in two parts. First, Chinese firms absolutely compete with western brands on their home turf. Companies like Sheng Xiang flooring, Supor kitchen crock ware, and JDB in herbal tea beverages often beat western counterparts because they respond quickly to consumer tastes, launching new products as well as marketing campaigns. We find for instance wealthy Shanghaiese consumers are shifting to local chains like Hao Shui Guo to buy fruit rather than at Wal-Mart or Carrefour because they trust the local chain more for supply chain management for high end fruit.
Ten years ago, being beaten by Chinese firms here was not a big deal because the market was so small. But now the market is too important to lose out. Brands like chip-maker Qualcomm and YUM Brands generate over 40% of their revenue in China but will face challenges if they cannot adjust to rising domestic competition.
Second, many of these firms will be strong in China but will have difficulties becoming truly global players. Look at the problems Li Ning has been facing. Nurturing the mid-level management needed to become global players organically will not be easy and might take decades as it did for Sony and Samsung. I expect more Chinese companies to follow what auto-maker Geeley which bought Volvo and Fosun Group which acquired Folli Foli did. They will become global players through acquisition and get management know-how and brands.
But it would be a mistake for western companies to underestimate the rise of Chinese brands to grow organically. Senior executives need to plan 5 years out at least. In 2007, we did a massive 6-month project for DuPont to analyze and deal with rising domestic Chinese chemical makers. DuPont is ahead of the curve which is why they have been able to maintain their dominance.
Ten years ago, few had heard of SANY in construction equipment or Huawei in the telecom sector but look at their dominance now. If I were on the board of construction equipment maker Terex, I would be nervous about the rise of SANY as companies tell us they are buying SANY not just because they are cheap but because they are as good if not better than western brands. Underestimating the competition is a recipe for disaster.
SHist: What role do you think that IP theft, protectionism, and corrupt business practices have played in the development of China’s economy?
SR: The levels of corruption in China have reached a terrible level and needs to be stopped as they threaten the legitimacy of the Party and could cause an implosion like we saw with the Soviet Union if corruption were to continue unabated. President Xi Jinping is right to make it a major part of his administration and he also needs get rid of the entitlement culture among so many Princelings and their families.
But corruption, especially in the late 1970s and 1980s in many ways probably had a positive effect on China. In those early days of reform, the laws were so backward and officials so anti-capitalist that corruption greased initial business forays and cut through red tape, like opening restaurants or clothing stores which previously were not allowed. Similarly, IP theft in sectors like software has allowed hundreds of millions of poor Chinese use Microsoft products which they could not afford and not be left too far behind better off westerners.
Let me be clear, I am not condoning corruption or IP theft as those issues are serious problems that need to be addressed, but they did play an important role in China’s initial opening up period and growth. But the economy has reached the point where corruption and lack of IP protection is starting to hurt the country’s development. My guess is that domestic Chinese firms will lobby the government to protect IP issues when they start to lose money – right now it is mostly western firms that are hurt and the government does not care enough to help protect them.
SHist: In your book, you argue that capitalism has been good for Chinese women. However, others point out that women are increasingly seen as objects, face sexual violence on the part of powerful employers, and are labelled as ‘leftover women‘ if they prioritize their careers? How do you resolve these two different pictures of women in China today?
SR: In the 1950s Chinese women accounted for only 20% of household income. That number hit 30% in the 1990s when I first arrived in China. Now, women account for 50% of household income. They are the main drivers of retail sales growth in China and half of the country’s billionaires are female. There are more women than men getting university degrees.
In my book, I track the lives of several migrant women who have started to out earn their husbands and become their families’ major bread winners. More of this will happen as the economy shifts to be more service oriented where brute strength is not as important.
Undoubtedly, the opportunities for women in China (and brands that sell to them) is far better than any time in recent history. That said, there is not enough gender equality and there are ways to improve.
But the “leftover” women phenomenon often occurs because women are independent, successful and do not want to settle for a man they do not view as their equal and is actually a sign of more equality rather than less. I interviewed one “leftover” woman who is the daughter of a former provincial Party Secretary. She went to the US for graduate school, went into investment banking and simply did not find a suitable mate and never married. Now that she is nearing her 40s, she is sad that she prioritized her career. But her situation is partly due to gender equality rather than discrimination. Her parents pushed her to follow her dreams and not follow traditional gender roles. The reality is successful Chinese women are facing the same issues former Princeton Professor Anne-Marie Slaughter brought up in the US – can women have it all? The answer for most women is probably not. But that is due more to time constraints than female discrimination.
SHist: Some like Richard Burger have attacked you for being a ‘panda-hugger’ or a patsy for the Chinese government because of assertions like ‘Real poverty is pretty much gone in China‘ and your persistent assertion of the public’s support of the Chinese government. How do you respond to these concerns?
SR: Whenever someone has strong opinions, it is natural and healthy for debate to flow, and I certainly welcome criticism of my views. Without strong debate, there cannot be improvement. In a country like China where there are so many problems, it is critical that open debate be pushed. I have not heard of a compelling reason for across the board censorship and wish the current policies overseeing the internet get a re-think because the regulations are seriously hurting business productivity of Chinese companies. For instance, as Tencent’s WeChat system goes global, what laws dealing with censorship are to be imposed on two users in America? I doubt that Americans would be willing to use a system that is censored which will hurt Tencent. On a more personal note, my book was banned for sale in China, so I not sure how the people who call me a panda-hugger reconcile that fact.
That said, debate needs to be professional for it to be worth anything. Some of the attacks on me by Richard Burger and Dan Harris of China Law Blog* have been overly personal and a little less than professional. Such attacks might make for great theater and get a lot of webhits but serious people with real businesses to run do not have time for that type of behavior.
I would prefer debates gets centered on the ideas and remain professional in order to help improve China. One person who has criticized me a lot whose ideas I respect a bit is Charlie Custer from China Geeks who has done documentary films trying to show the plight of kidnapped children. I do not always agree with Custer’s views, especially on how to exact change in China. He tends to throw tantrums at people who disagree with his methods. He has not spent that much time on the ground in China, so we disagree on how to change things – I tend to be more patient and want to work within a system while he is more confrontational. But he remains fairly professional in his attacks on me, even when they are very harsh. I welcome barbs like that, as they make me question my own views. Criticisms like Custer’s are worthwhile.
SHist: Local government debt has recently caught the attention of policymakers and economists as a major problem. How will this affect future development and infrastructure in China?
SR: Local government debt is problem for China but overall debt in China comes in around 70% of overall GDP which is disconcerting but manageable and at a similar rate to America’s. What I am more concerned about are the challenges inherent in transitioning from an economy based on investment and manufacturing to a more sustainable, service oriented one to overcome the middle income gap that hits when per capita GDP hits $6000 USD and income disparity grows. That is not an easy shift.
Local officials need to stop focusing on GDP growth at all costs and start cracking down on pollution. The last year has been so depressing. Sometimes I wonder if it is worth staying here because of the ill-effects on my family. I actually spend 3 months a year in Thailand or Bali because of the pollution problems and to track Chinese tourist trends in Southeast Asia. It is shameful how bad pollution is here for the world’s second superpower.
But getting local officials to change their mindset to focus on sustainable investment and accept lower GDP growth is difficult. After the Cultural Revolution, the government needed to get officials to realize business and profits were ok again so they tied promotions to GDP growth and other economic metrics. Now the Central government needs to re-orient the bureaucracy to focus not just on the economy but other quality of life issues.
SHist: Apple computer has come under persistent assault by the Chinese government as of late. What’s your take on that? What do you think Apple needs to do to resolve this situation? What lessons does it have for companies working in China?
SR: The attacks by the state media on Apple show it is clear companies cannot rely too much on China for both production and the market to sell into otherwise you are the mercy of the government. Most of Apple’s assembly is done in China via Foxconn and the country is now Apple’s 2nd largest market with $23 billion sold in 2012. Being so reliant on China and thus beholden to the government is never a good position to be in. Protectionism is not rising in China – it unfortunately has always been a fact of life here. The Government is far more likely to make an example out of a western brand than a domestic one to show it is cracking down on food safety or corruption, as it did with Wal-Mart for its mislabeled meat products.
Companies need to take what I like to call a China plus strategy by producing in different markets to help mitigate risk. As for the apology, I don’t think Apple’s CEO Cook should have apologized. Before the apology, most consumers we interviewed said Apple had the best customer service and did not understand why the state-owned media was attacking them. Post-apology, consumers changed and told us they wonder if Apple was indeed a bad player.
Moreover, Apple showed the government they are pliant which will come to haunt them in the future if the government does not like something Apple is doing with iTunes or whatever. Apple should have said that it will work with the government to ensure it follows all government regulations and surpass both government and consumer expectations. But Chinese negotiation 101 is you need to show respect for the other side but not crumble to them.
The government also needs to be careful that it does not create such a toxic environment that western brands start investing elsewhere. Chinese companies are investment more in Europe than America because of anti-China sentiment in the US. China is no longer the only game in town so companies might switch to other markets like Indonesia if they feel the government is emerging as a large risk. Right in the middle of the attacks on Apple, I met with senior executives of a Fortune 500 firm that flew from HQ in the US to China to run through with me crisis scenarios if suddenly the state media turned on them too.
SHist: Finally, why do you begin and end your book with detailed descriptions of prostitutes?
Prostitution is a great metric to see how a country is evolving. Fortunately, job oportunities are getting better so good looking girls do not need to engage in it just to put food on the table. They have other opportunities to make money. But when you go to a country like Vietnam where 50% of the population is under the age of 30 and job opportunities are limited, it is quite easy to find good-looking hookers. Last time I was in Ho Chi Minh City, I was accosted by a dozen goregous hookers as soon as I stepped out of my hotel’s lobby, a similar situation to what happened to me in the 1990s in China but rarely happens now.
I also opened with the sex industry because I wanted potential readers to know that my book is meant to be a fun, easy yet informative read. People can read a chapter a day on their commute to work or on a trans-ocean flight. They do not need to be in the corner of a library with calculators, hunkered down, trying to figure out what I write. I do not like to read jargon-filled, boring books and I certainly was not going to write one.
Click HERE to get a copy of The End of Cheap China: Economic and Cultural Trends that Will Disrupt the World by Shaun Rein.
*Dan Harris has responded to Shaun’s comments, see below.