Inside the Red Dragon--Part 2

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This is Part 2 of my interview series with Jeremy Hurewitz, Head of Business Intelligence for Nardello & Co., an international corporate investigations firm based in New York.  Mr. Hurewitz is an expert on Chinese affairs, and he offers keen insights into the political and economic developments there and what they mean for the United States and the rest of the world. We ended Part 1 questioning whether China’s one-party state can effectively reform itself to face the challenges ahead. James R. Gorrie, Managing Editor, Absolute Wealth.

Jeremy: Many people feel that to be an honest political official in China means you’re going to struggle because everybody is on the take there. The Chinese government has taken steps to combat corruption, but can they be effective? Can a one-party state effectively reform itself? 

James:  That’s the question, and I’m here to get your view. But from my research, I don’t believe those numbers of 9%, 10%, and 11% annual growth, and here’s why: Everywhere on the economic and financial food chain, there is so much corruption, there is so much cheating. This culture of corruption goes back at least to the Great Leap Forward, when people were producing iron in their back yards--so many ingots of iron per day--and if they didn’t say that they met their quotas, they’d be shot. So there’s no real incentive to tell the truth in China and every incentive to pad the figures.

If you’re a private business enterprise, you’re profit motivated and you survive on profits; but most private Chinese enterprises have been absorbed by state-run enterprises and their profitability drops to zero.  And there’s a political aspect of that, too. They have to pay off people to keep things running -- it's a shakedown.

So when I hear about these numbers, these ghost cities being constructed, and 10 years of concrete consumption being reported when it's not the case, it tells me that those numbers just aren’t real. That culture of corruption and “fake it till you make it” to stay alive has been embedded in the Chinese political culture for decades, because if you didn’t perform, you were gone.

What’s your take on that?”

Jeremy: Well, there’s a lot I agree with in what you’re saying. That being said, I don’t think China is a contemporary Potemkin village, but I do think that there’s a real estate bubble that’s been percolating for years. When you asked me about the regime’s greatest fear, it draws upon some of the things you just mentioned, that the facts and figures are unreliable. There is a pressure to perform there, and if you don’t you’re out.

A couple things that I see in my work are both a crisis of morality and a lack of legal consequences and protection in doing business in China. For instance, recently VW (Volkswagon) came up with a complaint against its Chinese joint venture Chinese partner, First Automobile Works, which goes by FAW. Volkswagon found that some of its auto components, its intellectual property, have appeared in some of FAW’s cars.

VW is complaining about that, but it's a very delicate matter.  They don’t want to complain too stridently because China is now 35% of their global market share. So there’s that aspect to it; they don’t want to upset the Chinese and their political patrons.

Also, there’s a lack of legal recourse. If you have a problem with a counter-party in China, if your intellectual property is stolen, you have very few good options. The idea of litigation risk is something I talk about frequently with my clients. In the US, if you’re an investor and you have a problem with a counter-party you have access to relatively transparent courts.

That’s not the case in China. The lack of consequences for illegal business practices is something that creates a big problem for Western businesses operating there. Yet, you have to be in China if you want to be a global company. So it's a real conundrum and it's difficult to navigate.

This leads us to the crisis of morality. It’s discussed at the very top levels of the Chinese government.  For years, President Hu Jintao has talked about creating a “harmonious society” because rapid economic growth has created ethical problems within Chinese society. If you look around China, it's just kind of capitalism run amok, everyone is trying to get rich and without strong regulation and a transparent legal system it has led to very bad behavior.

But remember, this is a people who have direct memories of, if not starvation, just real deprivation, really going without. I think there’s a sense in China that while they’re optimistic about the future, they don’t know what tomorrow has in store, so people are really trying to get rich as quick as they possibly can, come hell or high water.

The idea of civil society that we have in the West is just not present in China. The Chinese subscribe to a notion of Confucian society, which is about relationship circles, expanding outward from the nuclear family.

Chinese do anything for the nuclear family and the expanded circle of friends and close family.  But the rest of society they tend to not care about. You see that in with the way they drive, the kind (or lack) of pollution standards, and the littering everywhere. I think that outlook permeates the business sector as well.

James: Are you saying that Confucianism begets that or are you saying it's the abandonment of Confucian ideals towards a more materialistic viewpoint?

Jeremy: Well, it's a little tricky, actually. I wouldn’t blame the crisis of morality on Confucianism. I’m just saying the way that we in Western society think about civil society--that we all have a responsibility to our communities, that we vote, that people are part of civic organizations--is not really the mindset of the Chinese.

Those Confucian values helped people survive the chaos of thousands of years of Chinese history when they couldn’t count on the government in any way, so they leaned inward.  That’s still evident today; people who grow old depend on their children in a huge way, which is going to be a big problem soon with the one-child policy. I’m not blaming the crisis of morality on Confucian culture; I’m just trying to give a little context about how the Chinese view the outside world.

James:  You mentioned optimism.  Who or which Chinese are optimistic? Where is that optimism most deeply placed and perhaps where is it not placed (in Chinese society)?

Jeremy:  Well, I think that the middle class that’s been created in China is pretty extraordinary. The hundreds of millions of people being pulled out of poverty are who I’m talking about; the people who are sending their child to university for the first time, who have the opportunity to spend money and go on junkets to Hong Kong and go shopping.

There’s a sense of destiny in China today, and I think that is particularly felt in the middle and upper class. At the same time, China is still a poor country, and there are people who are still going without. That sense of frustration is palpable too, and therefore, social unrest is arguably the biggest concern of the Chinese government.

You’re seeing rising protests against certain environmental issues, which is the result of years of environmental degradation; that’s a really important trend to watch. People lash out at corruption more and more, and in a more public manner, even though the Chinese control the Internet very well. There are people who are taking to their micro blogs to express their frustrations, and some of the same people who are optimistic are also the people who are most frustrated.

Consider those that are the first generation in their family to graduate from university. They are finding that all their hard work on these incredibly difficult tests they’re forced to take, and after all the pressure they’ve been under, that there’s a lack of jobs commensurate to what education level they just achieved.

It's not easy to draw a line in society and say, “these people are happy and these people aren’t.” The east coast is more prosperous than the center and west of the country, but in many of the big cities in central/western China they’re doing very well, too. Like many things in China, it’s a little bit ambiguous.

This ends Part 2 of my interview with Jeremy Hurewitz, Head of Business Intelligence for Nardello & Co., an international corporate investigations firm based in New York. Read Part 3 in next week’s Friday edition of Absolute Wealth.  JRG

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