From the New York Times

The Chinese Century

July 4, 2004

By TED C. FISHMAN

China used to be far away, the country at the bottom of the world. Certainly that must be how it seemed just 20 yearsago in a place like Pekin, Ill., a city of 34,000 residents on the Illinois River that took its name from the Chinese capital in the 1820’s. According to local legend, Pekin is directly opposite Beijing on the globe. The high-school teams there were still called the Chinks until 1981, when they were renamed the Dragons. A smart and forward-looking decision, it turns out: as is happening throughout the United States, the Pekinese have in their own local ways grown inextricably linked to the Chinese of today. They are now connected not by an imaginary hole through the earth but by the world’s shipping lanes, financial markets, telecommunications networks and, above all, the globalization of appetites.

Follow the corn, for example. Trade deals struck between the U.S. and China in April will, farmers around Pekin hope, lead China to lower its import barriers and buy half a million metric tons of American corn this year. Illinois corn farmers get higher-than-usual prices for their exports because they have ready access to river transportation and in turn to big ports. Pekin is also home to the plant of Aventine Renewable Energy, the nation’s second-largest producer of ethanol, a fuel derived from corn. (Ten percent of the American corn crop is converted to fuel.) China recently passed Japan as the world’s second-largest consumer of petroleum, and growing Chinese demand has lately been pushing up oil prices worldwide. That makes ethanol an increasingly attractive alternative. And, indeed, ethanol prices climbed 40 cents a gallon this spring, dragging up U.S. corn prices as a result, a boon to Pekin’s farmers and industry.

Then there’s Excel Foundry and Machine, a local factory that makes parts for machinery used in heavy construction and mining operations. Doug Parsons, the current head of this family-owned business, has already relocated 12 percent of the company’s production to China in order to hold onto business that would otherwise be lost to China’s

huge, cheap foundries; during the next decade he may well have to move much more of his production offshore. Parsons has China on his mind for other reasons too: over the past few months, the prices of copper and iron, like those of oil, have skyrocketed in response to Chinese demand, driving up Excel’s costs as a result. At the same time, however, his international mining customers have been buying more Excel products in order to feed that same Chinese appetite for commodities. And Parsons himself recently started a new company that he says will build and service advanced rock-crushing machines—in part to take advantage of the frenzied construction boom under way in China. (One measure of just how big this boom is: China currently has more than 15,000 highway projects in the works, which will add 162,000 kilometers of road to the country, enough to circle the planet at the equator four times.)

Even something as all-American as Pekin’s new Wal-Mart Supercenter spreads China’s influence around town. Because 12 percent of China’s exports to the U.S. end up on Wal-Mart’s shelves, and because Wal-Mart’s trade with China accounts for 1 percent of that country’s gross domestic product, the company exerts tremendous downward pressure on prices. Its buying power enables it to dictate, in effect, what a Chinese manufacturer will get for producing goods that American consumers want. By selling Chinese-made portable DVD players with seven-inch L.C.D. screens for less than $200, for instance, Wal-Mart helped to cut the price of these trendy devices in half over the last year. Competitors have to match the chain’s prices or go under. Nearly every shopper in Pekin will therefore save money by shopping at Wal-Mart—which is to say he or she will profit from the retailer’s China connection. Of course, this very connection may also contribute to Wal-Mart’s ability to drive other Pekin-area stores out of business.

In short, Pekin, Ill., is not so different from lots of American places. China is everywhere these days, influencing our lives as consumers, providers, citizens. It has by far the world’s most rapidly changing large economy, and our reactions to it shift just as quickly. China is at one moment our greatest threat, the next our friend. It siphons off American jobs; it is essential to our competitive edge. China is the world’s factory floor, and it is the world’s greatest market opportunity. China’s industrial might steals opportunities from the developing world, even as its booming economy pulls poorer countries up (lately it has been getting credit for helping Japan out of its slump too). China exports deflation; it stokes soaring prices. China will boom; it will bust. Or perhaps the country’s economy is feeling its way right now to the soft landing that will prevent another Asian economic crash, and all the recent record numbers on trade, industrial output, consumer spending and debt are simply now in scale with China’s size. The truth about China is that, like all big countries, it is full of real contradictions.

Another truth is that the current feelings about China do not fully reflect today’s reality. The U.S. economy is about eight times the size of China’s. Our manufacturing sector is bigger than the entire Chinese economy.

Americans, per capita, earn 36 times what the Chinese do. And there is no shortage of potential roadblocks in China’s path, either. Its banks may collapse. Its poor and its minorities may rebel. Uppity Taiwan and lunatic North Korea may push China to war. The U.S. could slap taxes on everything China ships to us.

Still, barring Mao’s resurrection or nuclear cataclysm, nothing is likely to keep China down for long. Since 1978, its gross domestic product has risen fourfold; in straight

dollar terms, China’s economy is the world’s sixth-largest, with a G.D.P. of around $1.4 trillion. It has gone from being virtually absent in international trade to the world’s third most-active trading nation, behind the U.S. and Germany and ahead of Japan. Tom Saler, a financial journalist, has pointed out that 21 recessions, a depression, two stock-market crashes and two world wars were not able to stop the U.S. economy’s growth, over the last century, from $18 billion ($367 billion in 2000 dollars) to $10 trillion. In constant dollars, that is a 27-fold increase.

China is poised for similar growth in this century. Even if China’s people do not, on average, have the wealth Americans do, and even if the United States continues to play a strong economic game and to lead in technology, China will still be an ever more formidable competitor. If any country is going to supplant the U.S. in the world marketplace, China is it.

Mao as Proto-Capitalist

Mornings at Wanfeng automotive factory outside Shanghai begin with a neat line of employees doing calisthenics to martial music broadcast over a P.A. system. The blue-uniformed workers, nearly all of them young men, make for a clean-cut, well-pressed company line. The Japanese introduced courtyard exercises and company songs to the world back in the 70’s, when that nation appeared to have the world’s best industrial jobs. Today, Japan is just stumbling out of a long malaise, and its dwindling pool of young laborers seem to lack the compulsion to work like hell.

But the striving Japan of old still sets a good example for would-be worldbeaters, as Wanfeng’s management knows— only the Chinese manufacturer goes one better. Its employees regularly have their spirits revved at company boot camps run by People’s Liberation Army drillmasters who inculcate the twin virtues of patriotism and hard work. The results are impressive. Ten years ago, Wanfeng was hammering out motorcycle wheels by hand in a Chinese garage; a few years later it was the No. l seller of aluminum-alloy motorcycle wheels, first in China and now in Asia. The company soon became a top national and global seller in alloy automobile wheels too.

Wanfeng may have received some breaks on the way up: the company-produced video that describes its rapid ascent does not identify the early contracts that enabled Wanfeng to grow so fast, nor whether Wanfeng had insider connections to state-run companies in the motorcycle and car businesses. There is nothing in the company literature about how the private company secured its financing, either. Nonetheless, Wanfeng today is still scrappy, aggressive and capable. It now turns out about 60,000 vehicles a year that, if you squint just a little, appear to be remarkably like Jeep Grand Cherokees. They look great, come with every modern luxury, including leather seats and DVD video systems, and purr when driven.

Yet Wanfeng’s factory itself is a bare-bones machine. Most tellingly—this goes a long way toward accounting for China’s current status as an economic juggernaut—there is not a single robot in sight. Instead, there are hundreds of young men, newly arrived from China’s expanding technical schools, manning the assembly lines with little more than large electric drills, wrenches and rubber mallets. Engines and body panels that would, in a Western, Korean or Japanese factory, move from station to station on automatic conveyors are hauled by hand and hand truck here. This is why Wanfeng can sell its hand-made luxury versions of the Jeep (to buyers in the Middle East, mostly) for $8,000 to $10,000. The company isn’t spending money on multimillion-dollar machines to build cars; it’s using highly skilled workers who cost at most a few hundred dollars a month—whose yearly pay, in other words, is less than the monthly pay of new hires in Detroit. Factory wages in the country’s booming east coast cities can be $120 to $160 a month and half that inland, according to Merrill Weingrod of China Strategies, an affiliate of Kurt Salmon Associates, a consulting firm.

Wanfeng is hardly the first to mobilize Chinese labor as a stand-in for machinery. Mao Zedong believed that China could leapfrog other developing countries by employing an effectively unlimited supply of human labor. Chinese peasants and urban laborers would take the place of the expensive machines that the Western industrial powers had spent 100 years developing; China’s wealth, Mao reasoned, lay in its abundant population.

He was right, though China failed disastrously to execute his Great Leap Forward in the late 50’s. Most famously, Mao exhorted the Chinese to build backyard furnaces to melt down their iron implements, all in service of his goal to have China outproduce Great Britain in steel and to surpass the British economy in size in 15 years. Instead, the people were left without the few tools, pots and pans they had started with. And they starved: the Great Leap Forward was the direct cause of the famine that killed 30 million people, among the deadliest man-made disasters in history.

But even as the Communists pauperized the nation and continued to exercise complete control over the deployment of labor—determining, for example, who would be moved

out of the countryside and into the cities—they also primed China for the capitalist successes to come. Prasenjit Duara, a professor of Chinese history at the University of Chicago, acknowledges the paradox: “The Communists made the work force docile and organized labor to be a managed entity that could be continuously mobilized,” he says. “A Marxist might see China under Mao as producing the conditions of capitalism.” (Duara adds that the institutions created by the Communists to provide housing, education and medical care later saved capitalists the price of developing the work force.) An obedient labor force keeps management costs down too. Despite the enormous numbers of workers in Chinese factories, the ranks of managers who supervise them are remarkably thin by Western standards. Depending on the work, you might see 15 managers for 5,000 workers, an indication of how incredibly well self-managed they are.

“There is a reason why the world is so impressed by Chinese workers,” Weingrod says. “Culturally, the Chinese put a very high premium on not losing face. In manufacturing, that translates into not making mistakes on the production line. Their self-discipline and their ability to adapt are key factors driving Chinese competitiveness.” And for every worker disinclined or unable to apply himself with energy and concentration, there is always another poor Chinese worker waiting to escape the farm or adrift in the so-called floating population of the underemployed, willing to take his place.

Still, it’s not only cheap labor that drives China’s economy. “If you look just at low wages, you overlook the talents of Chinese manufacturers to drive their costs down,” Weingrod says. The best operations are as efficient and as responsive as the world’s elite manufacturers.

China’s miracle economy can come at you in a lot of ways. By now most of us know that China is the factory floor of choice for the world’s low-road manufacturing: it assembles

more toys, stitches more shoes and sews more garments than any other nation in the world. But moving up the technological ladder, China has also become the world’s

largest maker of consumer electronics, like TV’s, DVD players and cellphones. And more recently, China is climbing even higher still, moving into biotech and high-tech computer manufacturing. No country has ever made a better run at climbing every step of economic development all at once. Behind China’s rapid economic ascendancy over the last 25 (and especially last 10) years is the basic fact of China’s huge population. China is home to close to 1.5 billion people, probably, which would make the official census count of 1.3 billion too low by an amount equal to roughly the population of Germany, France and the United Kingdom combined. China has 100 cities of more than a million people. Since economic liberalization began in 1978, under Deng Xiaoping, the Chinese have started tens of millions of businesses. The number of Chinese who have left farms and now trawl the cities for work probably exceeds the entire work force of the United States.

China is not home to the cheapest work force in the world. Even at 25 cents an hour, Chinese workers cost more than laborers in the poorer countries of Southeast Asia or Africa. In the world’s miserable corners, children carry rifles and walk mine fields for less than a dollar a day.

China is the world’s workshop because it sits in a relatively stable region and offers manufacturers a reliable, pliant and capable industrial work force, groomed

by generations of government-enforced discipline. The other great contributing factor is the migration of hundreds of millions of peasants from the countryside now that the government makes it easier for them to leave. Indeed, the country’s embrace of market capitalism over the last decade and the government’s insistence that farmers fend for themselves are combining forces to all but evict peasants from the land. The plots allotted to farm families are on average 1.2 acres but can be as small as an eighth of acre; in hundreds of millions of cases these farms fail to generate enough money for a family. Average city incomes, according to the Chinese government, are $1,000 a year, which is three times what they are in the countryside. That disparity has set in motion the largest human migration in history. By 2010, nearly half of all China’s people will live in urban areas.

What these numbers mean is that China’s people must be regarded as the critical mass in a new world order. The productive might of China’s vast low-cost manufacturing machine, along with the swelling appetites of its billion-plus consumers, have turned China’s people into probably the greatest natural resource on the planet. How the Chinese (and the rest of the world) use that resource will shape our economy (and every other economy in the world) as powerfully as American industrialization and expansion has over the last hundred years.

We Have Created a Monster

In the political debate over trade and jobs, China is the place where the world’s companies choose to exploit low-cost manufacturing. The framing of this debate implies that American consumers and businesses have strong choices in the market; in fact, China, supplying ever more goods as it does, in ever more varieties and at ever better prices, is straitjacketing the choices of American businesses. China’s size does not merely enable low-cost manufacturing; it forces it.

Increasingly, it is what Chinese businesses and consumers choose for themselves that determines how the American economy operates. The American political debate on China’s economic threat overlooks this dynamic entirely. The experience of Motorola, the U.S. telecommunications giant, offers a lesson in how China’s size changes the rules of competition and consumption there and everywhere else.

Every month, five million new subscribers sign up for mobile-phone service in China. The country’s 300 million mobile-phone users make China by far the largest such market in the world (and hundreds of millions more accounts are up for grabs). Hence the world’s makers of handsets need to be in China. It gives them a chance to grow at a time when the big European and U.S. markets are saturated.

Not that it’s a seller’s market: for equipment makers, China is also the most competitive and protean environment in the world. New manufacturers appear out of nowhere; new phones materialize daily at big-city stores. There are 800 current handset models to choose from. Young urban consumers change phones on average after only eight months they sell them to someone else or pass them to family members. Mobile phones in the hands of migrant construction workers, whose annual wages might not cover the cost of a phone, are a common sight in Shanghai and Beijing.

And this mobile-phone market in China is one that Motorola invented.

For Robert Galvin, the company’s former and longtime chief executive, China in the early- to mid-80’s promised a market that could more than make up for Motorola’s having been foiled in Japan for years. But first the company had to develop a top-drawer telecommunications infrastructure. In an unscripted bold stroke at a dreary state ceremony during a tour of the country, Galvin turned to the minister of railroads and asked him whether he wanted to do a good job as minister and be done with it or whether he wanted to create a world-class society. In doing so, Galvin tapped a thick vein of economic patriotism.

Motorola’s company archives on its move into China are deep and open. They show that Galvin and his team knew that eventually the transfer of technology to China would sow

formidable Chinese competitors. Nevertheless, Motorola decided its best strategy was to get into China early. Before long, Motorola’s reports to China’s political leaders—infused with the same missionary vocabulary on industrial quality that had made the company a model for American manufacturers—were soon parroted by China’s leadership. Galvin also brought Motorola’s best technology to China. The proof today is in the size and efficacy of the country’s mobile communications network: calls get through to phones in high-rises, subway cars and distant hamlets—connections that would stymie mobile phones in the U.S.

What no one at Motorola saw was that the Chinese market would become the most competitive one of all. Nokia and Motorola now battle for market share in the Chinese handset business. German, Korean and Taiwanese makers figure strongly. And all these foreign brands are now facing intense competition from indigenous Chinese phone makers. “Competition goes through a cycle in China,” says Zirui Tian, a researcher at Insead, the French business school.

“At first the foreigners can make things at much lower cost than the Chinese. But as local companies come along to supply the multinational companies, the supply network expands very fast. Then local Chinese manufacturers can start to source their parts in China and drive the prices of their products far lower than the multinationals.”

One of Motorola’s most important suppliers is the battery maker BYD Company Ltd., based in Shenzhen, near Hong Kong. In only a decade, the private company has gone from virtual invisibility to owning more than 50 percent of the global market in mobile-phone batteries. Before BYD, phone batteries were made in highly automated plants, like those run by Sanyo and Sony in Japan. But BYD, like Wanfeng, stripped robots and other machines out of the manufacturing process and replaced them with an army of workers. By paying for Chinese salaries, and not for million-dollar American, German or Japanese machines, BYD slashed the price of batteries. Initially the company could not meet Motorola’s quality demands, but the American company sent a team of engineers to work with the upstarts, and six months later BYD earned a Six Sigma certification, a universally recognized badge of quality (which Motorola itself invented). The fact that in China machines can be replaced by people for huge cost savings and without sacrifice in quality changes the competitive landscape of the global marketplace. When Motorola and Nokia were pressed to lower their prices by Chinese competitors, they turned to BYD.

One of the biggest challenges facing Motorola and other global manufacturers is that Chinese suppliers are getting too good. Their quality, low-priced parts have helped create new, homegrown and extremely aggressive competitors. More than 40 percent of the Chinese domestic handset market now belongs to local companies like Ningbo Bird, Nanjing Panda Electronics, Haier and TCL Mobile. Ningbo Bird will produce 20 million handsets in 2004 and is likely soon to nudge its way into the ranks of the top 10 mobile phone makers in the world. Yet Motorola can’t exactly exit the Chinese market. If it did, says Jim Gradoville, Motorola’s vice president of Asia Pacific government relations, the Chinese companies that emerged from the crucible of their market would be the leanest and most aggressive in the world, and a company like his would have no idea what hit it. So Motorola stays. Already the largest foreign investor in China’s electronics industry, Motorola plans to triple its stake there to more than $10 billion by 2006.

More Power to the Chinese Consumers Generalizing about

Chinese business always raises exceptions. The country’s crazy quilt of state-owned, village-owned, private and hybrid businesses was stitched together over 25 years of rocky reforms. Peasant entrepreneurs, opportunistic officials, government planners, new urban sophisticates and foreign investors all created operations that best fit the moment they stepped into the evolving market economy. And yet, looking at the marketplace from the broadest perspective, one overwhelming fact stands out. Ninety percent of everything made in China is in oversupply; in other words, nearly every manufacturing industry has surplus capacity. And instead of using cheap labor to push their profit margins higher, Chinese companies use cheap labor to drive down prices to the sweet spots for the great mass of Chinese consumers.

A Chinese family can live a life comfortably close to that of the American middle class for a fraction of the cost. Though China claims urban per-capita income is $1,000, “the government numbers on incomes don’t tell nearly the whole story on the consumer class, especially not in the eastern cities,” says Merrill Weingrod of China Strategies. Weingrod, working with Linsun Cheng of the University of Massachusetts at Dartmouth, surveyed incomes in Shanghai and several other cities in industrial centers.

“People tend to have two and three jobs, with many taking in short-term assignments here and there,” he says. “Real income in Shanghai, for instance, is close to $2,500 per capita, $5,000 per household.” The Chinese can, on average, buy nearly five times in goods and services per dollar what an American can with the same dollar in the U.S. “If you multiply income against China’s purchasing power parity,” Weingrod says, “Chinese urban incomes approach the buying power of Americans making $12,500 a year. For working couples, that’s the equal of $25,000. Do the math, and you can understand why Shanghai looks as prosperous as it does and why it seems like everyone is out shopping all the time.”

According to Weingrod’s and Cheng’s research, China now has 100 million people who are comfortably middle class. They buy (in reduced measure) what the American middle class buys. The allure of China’s market is obvious: the huge volumes of potential sales mean even products with the most modest of margins can earn lots of money.

Wilf Corrigan, the chairman and C.E.O. of LSI Logic, an American company in the Chinese video player market, says that Chinese manufacturers have short-circuited one of the most predictable trends in consumer electronic manufacturing. “Typically,” he says, “a new technology would be released at $1,000 in Japan, and it would take two years to drop below $1,000 and make it to the U.S. and Europe, and it would take a total of five to seven years for it to make it into the mass market.” As features were added, prices rose. Now China’s low-cost labor and the vastness of its consumer population are combining to bring bargain electronics into homes in record time. Chinese companies build sophisticated goods with components produced locally and rush them by the millions into their huge domestic market. New companies arise. Competition shrinks the time it takes for new products to appear. New features are added while prices are likely to drop. Anything to pump sales.

Corrigan’s company is now supplying Chinese consumer electronics manufacturers with the chip sets they need to make digital video recorders, machines that record DVD’s and that are displacing VCR’s on retail shelves. Currently, the Japanese and Korean brand-name giants have consumers’ attention. Corrigan, however, sees no reason DVR’s won’t go the way of DVD players, plummeting in price as the Chinese enter the competition. Expect the recorders to be on sale for $100 within the next two years.

Collective I.Q.

‘Look, China is the most exciting place in the world right now to be a manufacturer,” says Mark Wall, president of the greater China region for G.E. Plastics. His operation sells the plastic pellets used to make everything from DVD’s to building materials. Within two years G.E. will sell $1 billion in advanced materials, including plastics, in China. Wall, who came to China from G.E. Plastics, Brazil, describes a country in love with manufacturing like no other, where engineers come in excited and readily work long days. Where university students clamor to get into engineering and applied sciences. Like many American manufacturing executives in China, Wall talks about working in China with the delight that young computer whizzes felt when they found cool in Silicon Valley. There’s no going to a cocktail party and then trying to talk around the fact that you make things in factories. Wall says he feels at home. He loves it. G.E. has every plan to capitalize on the local zeal for manufacturing. It recently opened a giant industrial research center in Shanghai, and by next year will it employ 1,200 people in its Chinese labs. The company has also set up scholarship programs at leading Chinese technical universities. It will have no shortage of good candidates.

The government is pouring resources into creating the world’s largest army of industrialists. China has 17 million university and advanced vocational students (up more than threefold in five years), the majority of whom are in science and engineering. China will produce 325,000 engineers this year. That’s five times as many as in the U.S., where the number of engineering graduates has been declining since the early 1980’s. It is hard to imagine Americans’ enthusiasm for engineering sinking lower. Forty percent of all students who enter universities on the engineering track change their minds.

The case for the ability of American industry to stay ahead of its international competition rests on the national gifts and resources that the U.S. devotes to innovation. Certainly, the confidence of big American companies like Motorola, General Motors and Intel, all of which have billion-dollar-plus stakes in China, is based on the brainpower they have at home. The research gap between the U.S. and China remains vast. In December, Washington authorized $3.7 billion to finance nanotechnology research, a sum the Chinese government cannot easily match within a scientific infrastructure that would itself take many more billions (and years) to build. Yet, when it comes to more mainstream, applied industrial development and innovation, the separation among Chinese, American and other multinational firms is beginning to narrow.

Last year, China spent $60 billion on research and development. The only countries that spent more were the U.S and Japan, which spent $282 billion and $104 billion respectively. But again, China forces you to do the math:

China’s engineers and scientists usually make between one-sixth and one-tenth what Americans do, which means that

the wide gaps in financing do not necessarily result in equally wide gaps in manpower or results. The U.S. spent nearly five times what China did, but had less than two times as many researchers (1.3 million to 743,000). For now, the emphasis in Chinese labs is weighted overwhelmingly toward the “D” side—meaning training for technical employees and managers. Nevertheless, foreign companies are quickly moving to integrate their China-based labs into their global research operations. Motorola has 19 research labs in China that develop technology for both the local and global markets. Several of the company’s most innovative recent phones were developed there for the Chinese market.

Motorola’s newest research center is located 40 minutes from Chengdu, the capital of Sichuan, a province in southwestern China. Sichuan is slightly larger than

California, but three times as populous. There are around 90 million people in the province, 43 universities and 1.2 million scientists and engineers. Sichuan’s fragmented transportation system prevents Chengdu from rivaling the eastern powerhouses as a manufacturing center, but the city is promoting the advantage of its plentiful, relatively low-cost brain pool with its new research corridor, the West High-Tech Zone. And Motorola regards its building—subsidized generously by the development zone—as a world center for software engineering. The company now employs more than 150 developers there and has plans to add hundreds more. That will pit it against a growing number of the world’s top research-driven enterprises taking advantage of Chengdu’s largess: Intel, Ericsson, D-Link, Siemens, Alcatel, Mitsui & Company and Fuji Heavy Industries of Japan and more than 200 other firms in one of the area’s special tech districts.

In all, foreign companies have been involved in establishing between 200 and 400 of their own research centers in China since 1990. China’s People’s Daily has reported that 400 of the world’s transnational corporations have set up research and development projects in China. In part, tax incentives attract such financing. But the biggest incentive of all, of course, is access to China’s consumers. The Chinese government knows that foreign tech companies can be coaxed into sharing technology and training in exchange for easier access to the Chinese marketplace. The World Trade Organization forbids formal bargains that demand international tech transfers, but it does not police winks and nudges.

The likely outcome of all this R.&D. investment in China? Even more overcapacity. Just as China’s abundant unskilled workers feed the world more shoes and more gadgets than it needs—or at least more than it can absorb without forcing prices down—China’s abundance of newly skilled industrialists threatens to swamp the world’s most highly prized, high-tech markets. The Wall Street Journal reported earlier this year that in the past three years foreign investors have invested or pledged $15 billion to build 19 new semiconductor factories. China imports 80 percent of the semiconductor chips it needs, $19 billion worth, and the government has made it a point of national pride to end the country’s dependence on foreigners. Industry observers seem to agree that China will be able to compete with the world’s leading semiconductor makers in a decade, but even before that it may exert strong downward pressure on chip prices. Will there be a 2005 recession in the chip market? Morris Chang, the influential founder of Taiwan Semiconductor Manufacturing, the world’s largest dedicated independent semiconductor foundry, asked an industry gathering last September. “Yes, I think there will be,” he said. And who will cause it? China, thanks to all the capacity it’s building.

The China Price

China now offers the world a labor supply with depth unlike anything ever seen. In a recent policy brief for the Carnegie Endowment for International Peace, Sandra Polaski, a former State Department special representative for international labor affairs, writes that to put things in perspective, “if all U.S. jobs were moved to China, there would still be surplus labor in China.” That fact highlights what is most sobering about China’s booming economy: it can force down the value of work in any job that is at all transferable.

In American business this is called the “China price.” It is the price American suppliers to other American businesses have to match to keep their customers. It is the price at which Chinese manufacturers can deliver the same goods and services. Last November, the Chicago Federal Reserve Bank noted the complaints that “automakers have reportedly been asking suppliers for the ‘China price’ on their purchases.” It also observed that U.S. suppliers had been asked by their big customers to relocate production to China, or to find subcontractors there.

The bellwether of American industry may very well be its foundries. Casting is one of those unsexy industries that rarely get top mention in personal ads. But no amount of buzz could overstate its importance. Without metal casting, the United States would boast hardly any industry at all. The U.S. Energy Information Administration of the Department of Energy notes that more than 90 percent of all manufactured goods and capital equipment use metal castings, or are made with equipment that uses them.

The American casting industry is the world’s largest, with more than $25 billion in annual sales. Nearly 3,000 foundries are spread across the country, and are especially concentrated in the Midwest. Most are small businesses, with fewer than 100 employees who, on average, outearn their counterparts everywhere else in the world. The metal-casting industry once had generous trade surpluses with the rest of the world, but imported castings have increased their share of the American market by 50 percent since the mid-1990’s; they now have 15 percent of the market. Imports from China are growing at between 7 and 10 percent a year, and worldwide by volume China is now the top producer of castings. The effect has been severe pressure on American foundries, 140 of which closed their doors in 2002, the last year for which the American Foundry Society has figures.

Bob Schuemann is executive vice president and part owner of Signicast Corporation, a privately held casting business located at the edge of Hartford, Wis. Hartford is one of the state’s many midsize towns whose roads are shared by farm tractors and semitrailer trucks making their way to the loading docks of manufacturers that since the 1970’s have stayed competitive by migrating out of the urban Midwest and into the more economical countryside.

Schuemann, like many, now lives under the sword of the China price. His company owns proprietary technology for producing metal machine parts with extremely high precision. Yet the network effect means that the company’s fate is tied in part to the economic vitality of its business community. Wisconsin lost roughly 90,000 of the 2.8 million U.S. manufacturing jobs that disappeared over the last four years. Signicast survived with automation. Robots fill its factory, moving everything from thumb-size precision parts to the boxes in the warehouse. Workers are scarce. Walking through the plant is a lesson in how the hardware business has become a software business. The whole plant seems to be run by smart ghosts.

Even so, the company feels the gravity of China’s growing influence in manufacturing. Schuemann says some of his corporate customers also want the company to make the move to China and have offered to help cover the costs of doing so. The company won’t move. Schuemann fears the Chinese will usurp Signicast’s processes and thus its strength.

Schuemann knows too that his company’s selling points

evaporate quickly when overseas investment casters drastically undercut the price of its parts. “We don’t need to match the China price dollar for dollar,” he says.

“If we stay within 20 percent of their price, our customers will stay with us.” It’s getting harder to keep them anyway, however. The company used to have livelier

business with a big local power tool maker, but the customer moved production to China and found jerry-built substitutes for Signicast’s high-quality parts. “Our part was one sturdy piece, and their new one is two inferior pieces,” Schuemann says. “Theirs will break more easily, but it’s a lot cheaper.” The business cards of executives at Milwaukee Valve Company Ltd., located in Wuxi, a city of more than four million outside Shanghai, list the company’s address at “End of Guangrui Road.” By the outward appearance of the trio of decades-old, corrugated-tin roofed industrial buildings that make up the small factory, “end of the road” might seem an apt description. Along the interior of a wall at the back of the factory yard is a pile of wooden kindling that is used to stoke the factory’s large furnace when the local electric grid is out of power, which lately has been often. Inside one of the barns, the furnace’s orange glow heats and dimly lights a shop that looks little different than that of a foundry early in the last century. Sandboxes with molten brass are assembled manually and set end to end in the black earth floor to cool.

While the method looks primitive—the Chinese have been making castings for 2,500 years—workers in Wuxi manage to produce quality castings comparable to those made in spiffier factories in the U.S., Europe and Japan. Milwaukee Valve is a family-owned company whose manufacturing is still anchored in the United States. Its management entered China 20 years ago, soon after economic liberalization began. The company’s valves are critical components in pipelines used in many industries. A faulty valve produced by one of the company’s Chinese suppliers several years ago nearly ended the relationship with China. But that mistake, according to the company’s management, is what made this Chinese manufacturer a “world-class operation.” Engineers from both countries redesigned the valve and changed the production process. Since then, Milwaukee Valve has stationed five Chinese quality-control engineers as roving inspectors at all of its factories in China. Apply this learning-curve experience at the Wuxi plant to China’s manufacturing economy generally, and you get a sense of how the country is moving up the manufacturing feeding chain so quickly. (Of course, no one would be interested in seeing the Chinese improve if the cost of high quality were not still a bargain.)

Out in front of the valve factory is another telling symbol of China’s competitiveness. It is a small $2,000 truck, a circus car of a truck, and one of many quaint but operable models still turned out by China’s state-owned vehicle factories. In the U.S., cheap trucks prone to failure and always in need of new parts would wreck production and delivery schedules by causing down time and burden bottom lines with $50-an-hour mechanic bills. But in China, mechanics can tend such cheap trucks the way pit crews tend Indy cars—and for less than a dollar an hour. Chinese factories can take advantage of all sorts of machinery that is one, two or three generations past its usefulness in more expensive economies, because the Chinese can afford to run them and fix them. Thus China wrings further cost savings from the manufacturing process, and American companies are forced to go there to get them.

“First there was the wholesale price, then the retail price and now there is the China price, and it is very real,” says Oded Shenkar, a professor at the Fisher College of Business at Ohio State University. Big manufacturers, Shenkar says, come into their American suppliers with the China price in hand and present ultimatums, often veiled, that the price be met.

The China Savings

No politician declares it. There is no

Association of Big Box Store Customers beating the drum. But, as nearly any shopping trip in America will teach you, China saves American consumers enormous amounts of money.

The worry that Chinese producers are hurting American businesses and eliminating American jobs misrepresents the problem—at least geographically. While the U.S. trade deficit with China is growing, most of the goods from China, between 60 and 75 percent of them, simply would have been imported in past years from other countries. Still, because the China price forces manufacturers the world over to drop their own prices, the jobs that have not moved have been shaken up all the same, in the U.S. and in other countries. In Mexico, for example, which has lost nearly half a million manufacturing jobs and 500 maquiladora manufacturers, workers earn four times what their Chinese counterparts do. So for Mexican factories to stay competitive, they must get by with fewer hands or smaller profits.

Americans who would demonize China also have a local problem: the China price is a boon to American consumers. Gary Hufbauer, a senior fellow at the Institute for International Economics, has done some rough math that shows how. “From time immemorial,” Hufbauer says, “most American and Japanese businesses have been reluctant to move their manufacturing to new locales unless they can save at least 10 to 20 percent with the move.” For the $152 billion worth of goods coming in from China last year, those savings have already been realized.

The multiplier effect on the rest of the world’s manufacturers, however, dwarfs the savings that come directly from China. Hufbauer figures some $500 billion in goods come from countries that are China’s low-wage competitors, and another $450 billion in goods come from China’s American and Japanese competitors. That means savings on nearly a trillion dollars of goods. If the savings on that non-Chinese trillion dollars’ worth of trade are just 3 to 5 percent, rather than the 20 percent the Chinese can deliver, Hufbauer calculates further savings starting at $500 for the average American household. And people who spend more, get more back. Have a drawer full of $3 T-shirts, a DVD player in every room, a Christmas tree annually encircled with piles of toys? You probably have tons more stuff—and additional savings—thanks to the China price.

This inexorable downward pressure on prices now shows up even when the prices of raw materials rise, costs that in the past were hurriedly passed on to consumers. The Chinese industrial boom has, for example, pushed up the cost of copper, aluminum, nickel, plastics and nearly every other important industrial commodity. Chinese demand has caused the price of steel to rise 20 percent this past spring.(China is now the world’s top steel producer, by the way, while the U.K. has dropped out of the top 10.)

Nevertheless, the price of cars, which reflect nearly the entire commodity index, has been weak. In April, cotton climbed to its highest price at this time of year in seven seasons, but the price of clothing declined.

American firms can find it hard to compete. “China hits domestic U.S. manufacturers twice,” Oded Shenkar says. “They drive down the price of goods, but they drive up the price of raw materials. It’s a wholly different environment.” And yet it’s a good one for Americans too.

The efficiencies forced on the market by Chinese factories also hold U.S. inflation in check. Lower inflation means the Federal Reserve can keep interest rates low, making money more freely available for investment in new and stronger industries. Chinese competition forces American businesses—Signicast, for example—to use capital as efficiently as possible. And to run their plants full tilt. And to find ways to save on labor costs. The Americans who lost manufacturing jobs over the last three years, and the millions more who are expected to see their white-collar jobs migrate overseas, may have not only China to blame, but also the very economic benefits that China has provided for them.

And that’s to say nothing of what happens once the Chinese countryside, thinned of its oversupply of farmers, turns into efficient farms. Already the Chinese have their eyes on cash crops. Though it has only recently begun exporting apple juice, China already produces seven times as many apples as the U.S., enough to cause a depression in the price of apple juice worldwide. Whole apples for exports are individually wrapped by hand in a foam sock. Given the country’s wealth of manual labor, it can assert dominance in crops that must be tended by hand.

In a stable China, where its great resource, its people, are allowed to work and spend money in a reasonably well functioning market economy, the growing place of China in a global economy cannot be legislated away with tariffs, quotas or tax incentives for struggling industries. China’s strengths cannot be altered by changes in the value of its currency or by restricting the flow of foreign investment into the country. By having changed itself, China is changing the world.

That doesn’t necessarily mean things will be worse for Americans as the century—the Chinese century—unfolds. Following World War II, the nations of Western Europe, Japan and the so-called tiger countries of Asia rose from the ruins, aided, not thwarted, by the strength of the American economy. In turn, those economic booms fed our own.

So perhaps we will be as Europe is to us today, and China will be our America.

Imagine Pekin, Ill., a few decades from now. It may, like innumerable small Chinese cities today, be accustomed to a stream of foreign business managers. Perhaps the regional boss for a Wanfeng Automotive dealership is there to be host of a “dig to China contest”: the team that gets closest in 40 minutes might win one of the company’s hot new red-and-gold Lucky 8 hybrid sports coupes, worth $4,000. As a promotion, Wal-Mart’s new World Store is rolling prices back to 2004 levels for the day—shoppers are grabbing the steaks and fish, whose prices Chinese consumers have driven up fourfold since then. Wal-Mart might have competition, however, perhaps from a new giant outpost of Homeworld, a Chinese retail giant that has learned to exploit its proximity to Chinese suppliers and beat Wal-Mart on price. A big event scheduled for the evening might get knowing smiles from the town’s old-timers. The Foreign Devils, a high-school basketball team from Manhattan, a new suburb of Beijing, is due in for an exhibition game. Provided its flight, on an all new Chinese jumbo jet, arrives on time.

Ted C. Fishman, a contributing editor for Harper’s

Magazine, is writing a book about China’s place in the

world. This is his first cover article for The Times

Magazine.

http://www.nytimes.com/2004/07/04/magazine/04CHINA.html?ex=1089965938&ei=1&en=2c8e52d76f10efb5

From the Economist

“A DISORDERLY HEAVEN”

Mar 18^th 2004

Most foreigners underestimate the eccentric nature of China’s business

environment

“THERE is great disorder under heaven. The situation is excellent.” Chairman Mao’s aphorism encapsulates a lesson all foreign businesspeople should take to heart: the Chinese scent profit in chaos. When it comes to doing business in China, the first rule is to throw away the rulebook, along with the business-school texts and western management theory.

Of far more use would be a new book by a man who spent ten years actually trying to run companies on the ground. In “Mr China”, to be published next month, Tim Clissold tells the thinly disguised story of Asimco, one of the largest foreign investors in the country at the time. Started in the early 1990s by Jack Perkowski, a Wall Street banker, and run by Mr Clissold, a British accountant, Asimco raised $434m, invested it in a series of car-component factories and breweries—and watched almost all of it drain away within a decade.

It made no difference that Asimco screened hundreds of factories before making its first investment; that it always insisted on majority control and put in its own managers and accountants; that Mr Clissold spoke fluent Mandarin and spent much time and effort courting officials at every level. The Chinese, it seems, were always one step ahead.

Mr Sha, the company’s best manager, who ran a rubber-parts factory in the mountains of Anhui province in central China, secretly set up a rival plant down the valley which he financed by siphoning money from the Asimco joint venture. When he was eventually found out and fired, he told his workers to package defective products from his own production line in Asimco crates and sent them to its customers so they would cancel orders. “There were pitched battles on the street with knives and broken bottles, and the army was called out,” says Mr Clissold. In Zhuhai, near the border with Macau, the director of Asimco’s brake-pads factory absconded to America with $10m-worth of letters of credit, leaving behind his entire family. Asimco sued the bank for validating the certificates, but ended up liable for the lot. A local anti-corruption official promised Mr Clissold he would investigate, but only if he got a car and working capital. In 1998, after eight years of frustration and back-breaking work, Mr Clissold, at the age of 38, suffered a total collapse.

His book is at its most telling in describing the attitude of Asimco’s New York board members and investors, which included some of America’s top mutual funds and banks. They had a stock answer for every problem—fire the manager, cut costs, find new customers—in blissful ignorance of local conditions.

Asimco’s story is unusual only in its detail. Many other companies have similar tales to tell. America’s PepsiCo has spent more than a year trying to undo its tie-up with a joint-venture bottler in Sichuan after its manager secretly sold the venture to a local-government bureau to buy himself expensive holidays and cars. James Bryant, who runs Subway’s Beijing sandwich franchise from a grim office, describes how his Chinese joint-venture partner (now in jail) swindled the company out of $200,000. “People leave their heads at home when they come here,” Mr Bryant says. “They forget all about due diligence. They meet a guy on the street, give him a ton of money to run something and six months later he absconds with it.” After nine years in China, Subway operates just 30 restaurants, rather than the 2,000 it once envisaged.

Many of the problems foreigners encounter reflect the fundamentally non-rational nature of China’s business environment. This can be summed up under three headings. The first is bureaucratic. Donald Lewis, a law professor at the University of Hong Kong, argues that if the great invention of European civilisation was a legal system, China’s was bureaucracy. The communists simply took over the imperial civil service and added a further layer of complexity by superimposing a party organisation on the government one.

McDonnell Douglas for one fell foul of the system. After an early entry into China in the 1970s, the (then independent) aircraft maker thought it had outwitted Boeing when it signed a $6 billion deal in 1991 to build 150 airliners for China locally in partnership with Avic, China’s state aerospace group. With such gold-plated backing, the Americans assumed that China’s government-owned national and regional airlines would buy their planes.

But the airlines, represented by a rival ministry, preferred to buy their aircraft direct from Airbus and Boeing, which were cheaper and offered the bureaucrats “factory tours”, mostly to Disneyland. Only two McDonnell planes were ever built in China, and the company lost a packet on the contract, which was cancelled in 1997. As Mr Studwell writes in “The China Dream”, “Douglas’s returns from more than two decades in China were 40 Sino-US marriages among its staff and untold embarrassment.”

Another bureaucratic complication is the power struggle between the centre and the provinces. “The mightiest dragon cannot crush the local snake,” goes a favourite 16^th-century saying in a country traditionally run on decentralised lines. The central government in Beijing may appear all-powerful to outsiders, but in practice its reach is limited. Local officials and party bosses hold sway not only in individual provinces and cities but even in the smallest villages. “The centre has no control over the provinces,” says Michael Enright, a professor at the University of Hong Kong School of Business. “When it sends people to investigate illegal pirating of CDs, local governors block access to the factories.”

Currently, this problem shows up most clearly in China’s foot-dragging compliance with the requirements of the WTO. Whereas the central government is keen to lower trade barriers and increase competition, local barons, afraid of unemployment and instability in their own backyards, are withholding their co-operation.

Chinese bureaucracy also gets in the way in sensitive industries such as cars and technology, where a centrally directed industrial policy appears to be allocating a share of the market to domestic companies. From this summer, foreign makers of wireless technology must rejig their software to a Chinese standard “in the interests of national security”. This new rule will force companies such as Sony and Intel to work with officially designated Chinese partners, exposing their intellectual property to the risk of piracy.

All too frequently, a short-sighted central government seems to regard foreign companies as cash cows to be milked. For example, plans are afoot to fund a rural postal service by slapping a tax on the (largely foreign) logistics industry, which could cost 800,000 new jobs, according to the US-China Business Council. David Cunningham, Asia Pacific president for Federal Express, fumes: “Why should we fund a Chinese postal service any more than a Chinese steel plant?”

A LAW UNTO ITSELF

The second problem for foreigners is a direct consequence of the bureaucratic system of government: China is subject to the “rule of man” rather than the “rule of law”. Rights derive from political power, generally the power of an individual, which explains the importance of personal connections, or GUANXI. Granted, China has come a long way since 1978, when it had no formal legal system at all. In the past 20 years it has seen one of the greatest floods of legislation in history. But although China may have laws for most things, enforcement is weak. China needs far more than the 100,000 lawyers it currently has, most of them poorly trained and badly paid.

There is no comprehensive bankruptcy law to protect businesses. A long-awaited draft is still in the works, and even that is more about closing down enterprises than about looking after creditors’ interests. Nor is there an effective way to resolve contract disputes. Some foreigners, such as Sumitomo Chemical, have sued their local partner in the Chinese courts, only to destroy their business relationships. Others, such as Newbridge Capital, an American venture-capital firm, have turned to international arbitration.

“Chinese legislation is chock full of ambiguities”, says Lester Ross, a Beijing-based lawyer. He thinks this will take 10-15 years to resolve. Donald Clarke, a law professor and China specialist at the University of Washington, is more pessimistic: “Look at the US legal system in the 1920s. It took over 80 years to modernise.”

The transition from a power-based planned economy to a rule-based market economy has opened the door to endemic corruption. Most foreign companies must deal with constant bribe-taking and the theft of property. They cannot trust the corporate governance or the accounts of Chinese joint-venture partners, and sometimes find it hard even to establish clear title to land and physical equipment. Not surprisingly, many foreign companies (especially struggling ones) lose sight of their own ethical standards: “I have a hard time believing foreigners can succeed in China and keep their hands clean,” says one senior American consular official.

THE NAME OF THE GAME

The third distinct challenge of operating in China is cultural. It is not just that the language is difficult and frustratingly imprecise at times, that the country is huge and the working conditions are often appalling, from freezing offices to constant traffic jams and a permanent pall of pollution. Most foreign businessmen who have been

there for any length of time say they are baffled by the attitude of their local counterparts. “Often it is not about doing the best deal, but about scoring points,” says one. The Chinese often seem to be driven by emotions more than business logic. Some westerners accuse them of racism.

The concept of “face”—gaining it, preserving it—matters above all, and deception to wrong-foot an “opponent” is an accepted form of negotiation. Bill Young, an American who has worked in China since 1985, originally for McDonnell Douglas and now running a boiler business in Shenyang, recalls that in one round of talks with a customer, “the stenographer in the corner turned out to be the CEO.” An almost ritual test of face for foreigners is the official banquet, where the Chinese host will delight in serving up exotically revolting dishes (Mr Clissold has eaten everything from scorpions to deer’s penis) and try to get his guests drunk on BAI JIU, a liquor that tastes rather like diesel oil.

The way Mr Clissold tells it, “I was dealing with a society that had no rules; or more accurately, plenty of rules but they were seldom enforced. China appeared to be run by masterful showmen: appearances mattered more than substance, rules were there to be distorted and success came through outfacing an opponent.” The best way to prosper, therefore, is to play China by Chinese rules, a lesson that too few companies have learned. BAT, a tobacco company that has been in China since before 1949, proved more adaptable than most. One of its more aggressive marketing tactics was to buy up stocks of rival cigarettes, hold them until they were mouldy and then sell them on.

Despite all these problems, foreign investors continue to pour money into China (even Mr Clissold is still there, now working for Goldman Sachs). Whether the country will ever become a more rational and more profitable place in which to do business will depend largely on whether it can reform its state corporations, allow its private companies their head and salvage its financial system—the subjects of the remainder of this survey.

See this article with graphics and related items at http://www.economist.com/displaystory.cfm?story_id=2495184

From the New York Times

China’s Boom Brings Fear of an Electricity Breakdown

July 5, 2004

By HOWARD W. FRENCH

SHANGHAI, July 4 - With the hottest days of summer fast approaching, Shanghai is making preparations to seed clouds over the city to make it rain, in the hope that a couple of degrees of reduced temperatures will help ward off brownouts, or worse, here in China’s commercial capital.

Even now, city inspection teams are visiting factories and ordering the least efficient energy consumers to be closed down, and thermostats are being raised in public offices. City officials say they are even contemplating shutting down the huge flashing advertising signs that made the Bund, or downtown riverfront in Shanghai, China’s largest city, the neon equivalent of Times Square.

With China projecting a 20-million-kilowatt shortfall in electricity supplies this year, actions like these are anything but isolated. With severe power shortages predicted for the country’s southern and eastern regions, Guangzhou, China’s third largest city, an industrial powerhouse, has had rationing since January, six months earlier than the emergency measures put into effect last year. Discussions about China these days are often dominated by economic terms like “overheating,” and “hard versus soft landings.”

What is described as being at issue, typically, is whether the country’s leaders can continue to manage this huge and increasingly complex economy successfully at growth rates that are among the world’s fastest.

The rush to find short-term, sometimes even fanciful-sounding, palliatives for the country’s power shortage, however, reflects creeping doubts of a more profound order. Those concerns have recently been expressed even at the level of China’s normally serene and confident-sounding senior officials. The worry, put bluntly, is that the world simply may not have enough energy and other resources for China to continue developing along present lines, especially at its present rate. Furthermore, sharply increased environmental damage might make the country unlivable, even if such growth could be sustained. China’s predicament is reflected in a simple statistic: this country is already the world’s second-largest consumer of energy, and yet on a per capita basis, the Chinese consume scarcely 10 percent of the energy used by Americans.

In material terms, the contemporary Chinese dream is not so different from the traditional American dream, of spacious homes full of power-consuming appliances and a car or two in the driveway, and therein lies the source of concern for the country’s leaders - and indeed for the world. As urbanization gathers pace here, there is a growing sense that such dreams will collide with intractable limits.

“If we use the patterns of today, China cannot double its economy,” said Chen Jinhai, director of the Shanghai provincial government’s Energy Commission and Environmental Protection Department. “We would need the energy of Mars or other planets. Our consumption may still be less than the U.S. or Japan, but the key for our future will have to be greater efficiency.”

Mr. Chen is far from a lone voice speaking about the severe environmental and resource limitations that will challenge this country’s seemingly irresistible rise of late. Indeed, his perspective echoes that of senior policy makers in Beijing.

“If we continue with the massive consumption of resources, shortages will only get worse, it will become very hard to maintain stable, high-speed growth, and the economy risks declining greatly,” wrote Ma Kai, director of the State Development and Reform Commission, in a sobering recent article in People’s Daily, the Communist Party newspaper. “Now we are at a key point in the industrialization and urbanization process. If we don’t transform our economic model, we could lose the ability to grow.”

For some, statements like those represent the dawning of a new kind of awareness, not unlike what happened in Japan between the outbreak of a huge industrial poisoning disaster at Minamata, in the 1960’s, and the oil shocks of the 1970’s, when that country began to question its blind pursuit of growth in its gross domestic product.

They also represent an acknowledgment that whether measured in use of resources, or increasingly, in use of capital itself, the very economic model that has given China growth rates that are the envy of the world is wasteful in the extreme.

According to Zhang Jun, a prominent Chinese economist who has made a comparative study of China and India, China consumes 3 times the energy and 15 times the amount of steel as its neighbor, even though the Chinese economy is only roughly twice as large, and is growing only about 10 percent faster than India’s.

Part of this picture comes from an intensive focus on manufacturing and exports, which many economists say has led to overindustrialization and empty growth. A lot of the

responsibility for wastefulness can be laid to duplication, with each province - and indeed many city governments - simultaneously pushing for the same kind of growth, based

on industrial parks and manufacturing zones. The municipalities that boast of becoming China’s Silicon Valley, to take one common example of this trend, are almost too numerous to count. “China will definitely be facing a huge, huge challenge in a decade or so if the growth patterns don’t change,” said Dr. Zhang, who is the director of the China Center for Economic Studies at Fudan University in Shanghai. “Ours is an extreme case of the East Asian model, and we are coming quickly toward the limitations in terms of the way we use energy, in terms of the environment, and even in terms of labor.”

Dr. Zhang said the government had invited him and other economists to tour the provinces and lecture local governments on these realities in the hope of readjusting priorities, to little avail.

“What we are facing is decentralization and the birth of developmental government in China,” Dr. Zhang said. “The local officials all say they understand the new

perspectives, but that it has nothing to do with them. They all say, ‘My job is to look after local economic development.’ “ The toll on China’s environment from this growth-at-any-cost strategy has been truly alarming. China’s official development goal is to build what the government calls a well-off society by the year 2020, yet today the very growth that makes such dreams permissible has left China with 16 of the world’s 20 most polluted cities, according to the World Bank.

Using standards that are relatively lax when compared with those of the United Nations, the Chinese government itself reckons that fewer than half of the country’s cities have acceptably breathable air.

The government also says that 90 percent of urban residents face serious water pollution problems. By another estimate, 700 million Chinese must make do with contaminated drinking water. Even the country’s seas are increasingly under siege from industrial pollution and are regularly choked by red tide infestations.

If the country’s galloping energy needs have caught people’s attention throughout China, mobilizing resources to protect the environment has been far more difficult.

“There is nothing about China’s environmental situation that is not critical,” said Jiang Jilian, a member of Friends of Nature, a private Chinese environmental group. “The government may have a sense they should do more about this, but they still have another priority - economic development.”

http://www.nytimes.com/2004/07/05/international/asia/05shan.html?ex=1090079906&ei=1&en=6f3907b7be8fd520

December 20, 2003, Saturday

BUSINESS/FINANCIAL DESK

INTERNATIONAL BUSINESS; Report Faults China’s Policy Since It Joined Trade Group

By ELIZABETH BECKER (NYT) 843 words

WASHINGTON, Dec. 19 -- China has failed to live up to many of the promises it made when it joined the World Trade Organization, and it continues to maintain formidable trade barriers, unfair subsidies for its domestic producers, and uneven enforcement of regulations, according to a report issued late Thursday by the Bush administration.

With the trade deficit with China at a record $13.5 billion, Republican and Democratic lawmakers have been pressing for tough action to ensure that China plays by the global trade rules of the World Trade Organization, which it joined two years ago.

By confirming some of the harsher criticisms by Congressional figures, the report is bound to rekindle the growing demand in Congress to tame what lawmakers say is China’s assault on the American market.

“The shortcomings in China’s W.T.O. implementation are noteworthy,” Robert B. Zoellick, the United States trade representative, wrote in the report.

With trade fast becoming crucial to good relations between the United States and China, several lawmakers said the report was important for fixing responsibility on China.

Representative James A. Leach, Republican of Iowa and a member of the International Relations Committee, said that “it is principally up to China” to improve trade relations.

“We want free trade to work and they, in the abstract, do, too. But there is an equity or fairness issue that is measurable, and right now the measurements for China are coming up short,” Mr. Leach said in a telephone interview.

The report found that despite some improvement, China is undercutting many United States industries by using tax policies to favor its own producers. The report also found trade barriers to United States agriculture and services and a poor record of preventing the sales of counterfeit film, music, software and other products protected as intellectual property.

China has one year to make a series of concessions under terms of its membership in the W.T.O.

“China cheats,” said Senator Lindsay Graham, Republican of South Carolina. “China steals markets, it doesn’t earn them.”

The administration has taken several steps recently to answer these criticisms. The Commerce Department has moved to put import quotas on selected Chinese textiles—knitted fabrics, dressing gowns, robes and bras—and impose tariffs on television sets.

Senator Charles E. Schumer, Democrat of New York, said that in his view the report was especially damning since it came from an administration he said had been “treating China with kid gloves.”

“This shows you how bad the situation is,” he said in a telephone interview. “China wants all the benefits of membership in the world economy, but few of the responsibilities.”

Mr. Schumer is the co-sponsor with Mr. Graham of legislation meant to rectify another problem cited in the China trade debate: China’s refusal to float its currency, a stance that helps keep prices low for its exports to the United States. The lawmakers are asking Congress to pass legislation that would impose an across-the-board tariff of 27.5 percent on all Chinese goods if the Chinese refuse to float their currency.

Lawmakers point out that the problem of unfair trading practices extends beyond manufacturing and agriculture—where China has the advantage of cheap labor—to intellectual property where the United States has the advantage.

But China continues to be a haven for pirated copies of copyrighted material. The report found “rampant piracy of film, music, publishing and software products, infringement of pharmaceutical, chemical, information technology and other patents, and counterfeiting of consumer goods, electrical equipment, automotive parts and industrial products.”

Agriculture was meant to be one of the biggest sources of American exports to China, meeting the demands of the rapidly growing middle class there with huge shipments of grain and meat. And while soybean exports reached a record $1.2 billion and cotton exports to China increased by nearly 500 percent, the report complained of China’s “apparent use of subsidies” to promote its agricultural exports.

(The United States spends an average $19 billion each year on agricultural subsidies, but only a small portion is paid directly for exports. Recent global trade talks collapsed in large part over poor nations demanding that richer nations reduce their agricultural subsidies.)

To quiet concern about trade barriers in the automobile industry, China agreed last month to allow the United States’ Big Three automakers to send it about 15,000 cars and trucks over the next couple of years as well as more than $1 billion in parts from General Motors.

The report noted, however, that “in many instances, China has sought to deflect attention from its inadequate implementation” by making temporary changes to muffle criticism abroad. Copyright 2003 The New York Times Company

From the Economist

MERCANTILISM WITH CHINESE CHARACTERISTICS

Aug 13^th 2003

The Chinese currency is under attack—not from speculators but from finance ministers who think it is unreasonably cheap

FIVE years ago, as one currency peg after another fell victim to the Asian financial crisis, the world’s economic policymakers urged China to hold fast to its fixed rate of 8.28 yuan to the dollar. Today, finance ministers around the world are urging China to turn the yuan loose, or to repeg it at a less competitive rate. Having sold the Chinese on the virtues of rigidity, they are now preaching the merits of flexibility. China’s currency peg is no longer seen as an anchor holding the region’s economy in place, but as a deadweight holding the rest of the world’s economies back.

Ever since it opened up to the world economy, China has been encroaching on the export markets of rich and poor alike. Barry Eichengreen, an economist at the University of California, Berkeley, notes that China now makes more sombreros than Mexico. Foreign investors poured more money (net of outflows) into China than any other country last year; this year investment has fallen, mainly because of the outbreak of SARS. But with the Chinese authorities holding the yuan within a tight band around the dollar, this strong demand for Chinese goods and Chinese assembly lines cannot manifest itself in a strengthening currency. Quite the opposite. Over the past year, as the dollar fell, the yuan rode down with it. Spurred by the cheaper currency, China’s exports charged ahead, showing few signs as yet of the economy’s respiratory problems (see chart).

The Europeans complain that the euro is bearing too much of the strain of the dollar’s long-awaited return to earth. With the yuan fixed, and the yen held down by the Bank of Japan in an effort to reflate Japan’s economy, the euro is the only major currency that is free to rise against the dollar. Japan, for its part, blames China for exporting deflationary pressure abroad. At the ASEAN summit last week and again at the weekend, Masajuro Shiokawa, Japan’s finance minister, demanded that China’s communist authorities leave the value of the yuan to “market principles”. With Alan Greenspan, the Federal Reserve chairman, and John Snow, America’s treasury secretary, also weighing in on the question, the fate of China’s peg is becoming a matter of some speculation—quite literally. Money that used to sneak past China’s capital controls on its way to havens abroad is now sneaking back in: a sure sign that some China-watchers are willing to bet on an appreciation of the yuan.

If Japan, and the rest of the world, wants a more valuable yuan, why don’t the Chinese? Maybe Japan should look inwards for an answer. In the 1960s and 1970s, Japan’s great exporting industries led the country to prosperity, supported, at least in part, by a competitive yen. Indeed, central bankers in Japan show little respect for “market principles” even now, intervening massively in the foreign-exchange markets to keep the yen around 120 to the dollar. Japan’s frustrated policymakers appear to see China as a handy scapegoat. They ought to see it as a protege.

In fact, China’s brand of mercantilism is mild compared to the Japanese variety. China has held firm to its peg through periods of dollar strength, as well as dollar weakness. It runs a large, $103 billion trade surplus with the United States, but its overall trade surplus is smaller than Russia’s, and a quarter the size of Japan’s. Besides, China is not alone in tracking the dollar. Malaysia has a hard peg, and many other East Asian countries peg “softly”, dampening daily and monthly movements against the greenback. The dollar serves as an anchor for the region’s currencies and price levels, and much of the region’s trade—even trade with itself—is invoiced in dollars. Ronald McKinnon, a Stanford economist, sees China as just one member of an informal dollar block that spans much of East and South-East Asia. If China were to revalue the yuan unilaterally, its trade surplus with America might narrow, but its exporters would also lose ground against regional rivals, such as South Korea, Malaysia and Thailand, with whom China currently runs trade deficits, not surpluses.

The prospect of financial crisis is a still greater fear for China’s policymakers. If China were to float the currency and tear down its great wall of capital controls, its banks might not survive. With bad debts of about $500 billion by some estimates, the banking system is ill-placed to withstand the added strains of a currency free to float and capital free to flee.

Mr Eichengreen thinks these fears are overblown. As he points out, China’s banks, unlike the Thai and Korean banks of pre-crisis Asia, have not taken advantage of the longstanding peg to borrow offshore in dollars—China’s capital controls put a stop to that. Mr Eichengreen advises China to keep its capital controls, but to give up its fixed exchange rate. Better, he argues, to make a graceful exit from the peg now, from a position of strength, than to wait until an unforeseen crisis forces a hasty and clumsy departure some time in the future.

Most economists, however, believe that China would do better to repeg the yuan at a less competitive rate, rather than unpeg it completely. That would spare China’s banks and corporations the risks of a floating currency, while taking the immediate pressure off China’s trading partners. The respite would, of course, be temporary. China’s trade surpluses reflect the fundamental fact that its people are thrifty and its exports cheap. A one-off repricing of the yuan might temporarily mask that fact, but it cannot reverse it.

Eventually, no doubt, China will join the world’s leading economies and float its currency alongside the yen, the euro and the dollar. Until then, expect to see the Chinese dragon soaring but not floating.

See this article with graphics and related items at http://www.economist.com/agenda/displaystory.cfm?story_id=1985909

June 12, 2004, Saturday

BUSINESS/FINANCIAL DESK

INTERNATIONAL BUSINESS; Made in India vs. Made in China

By KEITH BRADSHER (NYT) 2127 words

SHENZHEN, China -- When Crystal Chen, a 28-year-old mechanical engineer, started designing microwave oven doors for Whirlpool in 2001 in this gleaming Chinese metropolis, one of her biggest surprises was the size of the ovens.

Built to be installed over ranges in spacious American kitchens, the ovens were twice the size of the countertop microwaves sold for Chinese kitchens. And as she has kept working on them, the Whirlpool models, nearly all of them made to be exported to the United States and Europe, have grown even larger, approaching three times the size of a typical Chinese microwave.

By contrast, at a Whirlpool complex more than 2,500 miles away in Thirubhuvanai, on the southeastern tip of India, the washing machines built in a hot low-tech factory are products the Indian workers easily recognize. Unlike the microwave ovens in Shenzhen, these washing machines are very much designed for local use, not for export.

They have rat guards to keep vermin from nibbling laundry or hoses. They have extra-strong parts to survive being bumped around in trucks on India's potholed roads. And they are built with heavy-duty wiring to cope with the powerful ebbs and surges in India's electrical grid.

The difference is telling. Whirlpool's emphasis on using China to make goods for export while locating in India to enter the local market reflects a broader trend that is becoming apparent for many household appliances, from television sets to refrigerators. And it highlights a division that could spread in the coming years to other industries.

For all the dreams of selling goods into a fast-growing market of 1.3 billion Chinese, the reality is often very different. While China still holds considerable allure, many multinationals have struggled to earn profits selling here.

Companies setting up shop in China face domestic manufacturers that consistently undercut them by building factories at practically no cost, borrowing the money cheaply from state-owned Chinese banks and using various strategies to avoid repayment. To make matters worse, many department stores are still owned by municipal or provincial governments that give floor space to local products and resist selling foreign brands.

A result has been a struggle among manufacturers to see who can discount wares more deeply -- a struggle with little appeal for multinationals that need to make real profits.

''We're not interested in chasing a price-driven strategy,'' said Garrick D'Silva, the regional vice president for Asia at Whirlpool.

India's economy has been growing nearly as quickly as China's in recent years. By dismantling many barriers to foreign investment, the government in New Delhi has also made the country an increasingly attractive market for globalizing companies.

Marketing is easy through thousands of privately owned retailers, from department stores to corner shops. Risk-averse banks in India charge such steep interest rates to local manufacturers, and so strongly insist on repayment, that some economists worry they may even be slowing growth unnecessarily.

India's steep tariffs, although starting to decline, long insulated its markets from international competition and still keep prices somewhat higher for many manufactured goods.

And because India did not follow China's draconian ''one child'' policy, United Nations demographers forecast that India's population will surpass China's as soon as 2040.

With all those factors, Whirlpool -- while still strongly interested in tapping the Chinese market -- has found greater opportunity to lock in profits and expand its market share in India than in China, Mr. D'Silva said.

LG Electronics of Korea, Whirlpool's rival in Asia for many kinds of household appliances, shares that view.

''We couldn't make a profit in China,'' chiefly because of the free loans available to local competitors, said Kim Kwang Ro, the managing director of LG Electronics India. ''The main focus of expansion for LG is India, not China.''

China's effort recently to brake its economy, in response to rising inflation and a growing problem of nonperforming bank loans, is also starting to take the edge off some companies' interest. China's political prospects remain murky.

By contrast, India has just gone through a peaceful change of democratic government that produced a mere two-day drop in the stock market followed by an immediate recovery in share prices and corporate confidence.

''The Chinese economy is looking rather unstable,'' Mr. Kim said. ''Meanwhile, in India, the political, economic situation is becoming more stable.''

Despite rising costs for steel and many other commodities that go into factory goods, prices for manufactured products are still falling in China because companies keep building more and more facilities to take advantage of the nation's extraordinary investment boom. Refrigerator prices, for example, fell 2.2 percent in China in the 12 months through April 2004. In India, they rose 3.5 percent.

India's combination of duties on imports and complex regulations on manufacturing start-ups has tended to benefit companies with factories in the country. ''The harder the obstacles, the bigger the advantage for the inside firm,'' Mr. Kim said.

Many companies, of course, remain bullish on the Chinese market. Automakers are racing each other to build more assembly plants in China, but have moved more cautiously in India, where incomes are still somewhat lower and roads are in much worse repair. Anheuser-Busch just beat out SABMiller in a costly battle to take over a low-margin beer business in China's northeastern corner.

Moreover, for all their differences, India and China share a growing popularity as places for companies from the United States and other countries with high labor costs to set up shop.

Like many of its counterparts, Whirlpool is moving quickly to tap Asia's huge supply of well-trained engineers. Its employment of engineers and technicians in India and China has grown from zero in 1999 to 240 currently, with plans for 700 by 2007, or more than a quarter of the company's engineering work force.

''We're shifting quite a bit of our technology capacity to these countries from the higher-cost parts of the world, part of it from the United States and Europe,'' Mr. D'Silva said.

Like many companies, Whirlpool insists that it has been able to manage this without significant layoffs among its engineers and technicians in the United States. But it acknowledges that it has not been increasing the size of its American staff, either.

As it has expanded abroad, the company has increased the number of different models of everything from big Whirlpool refrigerators to KitchenAid coffee grinders. It has cut the time it takes to develop new models of the larger appliances to 12 to 14 months, from 30 to 36 months a few years ago.

Engineers in the United States now work in the day on new designs, using computer-aided design software, then send the project around the world in the evening so that engineers in India and China, earning less than $1,000 a month, can continue the work during their normal daytime hours.

The high cost of the necessary computer software is an important reason for the 24-hour programming, which allows different technical centers to take turns using a limited number of software licenses, said Herbert Fu, the company's product development director here in Shenzhen.

As the sun sets each evening in the United States and computer-design work is transferred across the Pacific, engineers in India and China operate very differently. The Chinese engineers tend to continue working on the same projects as their American colleagues: designing or improving products for the American market. The Indian engineers, who occupy a warren of cubicles upstairs from the factory in Thirubhuvanai, devote a lot more of their effort to revising designs for sale in the local market.

As with many outsourcing issues, the expansion of Whirlpool's engineering activities in Asia has been much more complicated than a simple transfer of American jobs.

The main job losses, in fact, have been in Sweden rather than the United States. Whirlpool cut employment in half at a microwave oven factory there in 2003, to 305 jobs, while expanding research and development here and increasing its output at a factory up the Pearl River in Shunde.

While the share of Whirlpool's work force overseas will continue to grow in the coming years, the increase will come from expanding the company's total employment; the overall number of jobs in the United States is not expected to decline, according to Stephen J. Duthie, a company spokesman.

In India, Whirlpool has catered to customers like Rupam Shekhar, a New Delhi housewife whose husband has a small export business selling bed linens and curtains. They live with their two children in a walk-up apartment on the outskirts of New Delhi.

The Whirlpool refrigerator they own is quite different from those sold to Americans. Milk in India is seldom pasteurized, for example, so consumers boil it in a very tall steel urn on a stove. Whirlpool made it possible to fold away part of the top shelf in the refrigerator, so that the urn, known as a patila, could rest on the shelf below.

At the same time, Whirlpool also uses a much smaller percentage of the refrigerator's space for the freezer than in other markets. Research showed that two-thirds of India's people are vegetarians who have little use for a freezer -- except for storing a little ice cream and a few ice cubes.

Few Indian kitchens have room for refrigerators, and the appliances are also something of a status symbol: the cost is equal to nearly two months' salary for an engineer. So they are commonly displayed in living rooms or dining rooms. In response, Whirlpool now sells refrigerators in bright colors and curvy doors and sides.

Mrs. Shekhar, more traditional in her tastes, has bought a plain white Whirlpool refrigerator and put it in the bedroom, next to a small shrine to Hindu deities. She used to have to boil milk and chill it a pint at a time for her son and daughter.

''Now, I can boil it all,'' she said, showing off the inside full of steel pots and fresh vegetables.

Whirlpool has been able to overcome the typically fractious factory floor labor disputes and work stoppages in India by locating in the Pondicherry region, a former French colony that has a tradition of social peace described in Yann Martel's novel ''The Life of Pi.''

India also appeals to Whirlpool because it is easier to enforce contracts there than in China. A Whirlpool executive said that the company had a contract in 2002 with a Shenzhen company to supply many of the components for a new toaster oven, only to have the supplier raise the price sharply.

Whirlpool switched production to India. ''We had a contract but we decided it wouldn't be prudent to enforce it,'' the executive said. ''You never try to put a supplier too much in the corner because you get it back in quality.''

But Whirlpool is not giving up on China, despite its difficulties here so far. In a workroom near Ms. Chen's cubicle, Cindy Wu, a 30-year-old engineer, was testing a new design for the fan blade that cools the microwave oven.

''Maybe someday,'' Ms. Wu said, ''Chinese families will have microwaves like these.''

Copyright 2003 The New York Times Company

Note: This article gives some background about the current political environment in China.

July 16, 2004 New York Times

Former Leader Is Still a Power in China's Life

By JOSEPH KAHN

EIJING, July 14 - With bold front-page headlines and top billing on the main television news show, China's state media announced this week that Jiang Zemin, the country's military chief, had visited the northern city of Shenyang and called on troops there "to master revolutionary theory."

At first glance, the item seemed like just another dutiful recounting of the prosaic meetings and utterances of senior leaders, standard fare for the Communist Party-controlled media. But this report was notable for one fact: Mr. Jiang's visit took place in January 1991.

The reports shed no light on why the authorities had trumpeted a seemingly unexceptional event 13 years after it happened. But editors and experts say Mr. Jiang, 77, may consider himself as having entered the pantheon of Communist giants, along with Mao Zedong and Deng Xiaoping, entitling him to re-release what he views as his great political moments.

More significant, it is the latest indication that Mr. Jiang, who handed the titles of Communist Party chief and president to Hu Jintao in 2002, still holds ultimate power in China and has no immediate plans to give up his remaining position as head of the military. Some members of the party elite had expressed a desire that he do so this fall, when the party convenes its fourth plenum, or national planning session.

The consequences of Mr. Jiang's prolonged reign are substantial, party officials, editors and political analysts say. Mr. Jiang has retained final say on the most delicate foreign policy issues, as well as some prickly domestic disputes, even though he no longer holds China's top government and party posts.

Chinese party officials and Western experts say split leadership has contributed to increased political repression at home and heightened chances of military conflict with Taiwan, while raising the specter of a power struggle down the road.

"Divided leadership makes it much harder to pursue compromise positions on sensitive issues, either in domestic or foreign policy," said Kenneth Lieberthal, a former Clinton administration China specialist who is now at the University of Michigan. "Tactically, this makes it more difficult to be either nimble or decisive."

Mr. Jiang has stressed the need to accelerate preparations to attack Taiwan in the event the island pursues independence, a stance that may also make him seem indispensable to the military at a crucial juncture, party officials say.

He recently overruled Mr. Hu's attempts to develop a new framework for China's foreign policy, when he rejected using the phrase "peaceful rise" to describe China's emergence as a global power, two people involved in those discussions said. The term had been carefully vetted - and used repeatedly by Mr. Hu - before Mr. Jiang voiced his objections.

It was also Mr. Jiang who decided to detain Jiang Yanyong, the Chinese doctor who earned wide renown for exposing the cover-up of the SARS epidemic last year and calling for a re-evaluation of the 1989 crackdown on democracy protests, people informed about the doctor's detention said. Dr. Jiang, who is not related to Jiang Zemin, has spent nearly 45 days in military custody, where he has been subjected to extended "study sessions" to change his political thinking, these people said.

Mr. Hu and Mr. Jiang have not feuded publicly. Mr. Hu, in fact, has remained studiously deferential, allowing Mr. Jiang to precede him at official events, despite the fact that Mr. Hu nominally outranks him. When both Mr. Hu and Mr. Jiang meet the same visiting dignitary, Mr. Jiang's comments often get more prominent coverage.

The leadership has tried to persuade people that laws and institutions outweigh any individual. But China's orderly transition to a new leadership in 2002, once promoted by the party as a sign of political maturity, is now viewed as incomplete by many people, including Mr. Jiang.

In a meeting with Condoleezza Rice, the national security adviser, at the Zhongnanhai leadership compound last week, Mr. Jiang volunteered that he was "handing over more and more power" to Mr. Hu, according to an American official who attended the meeting. The statement implied that ultimate authority still rested with Mr. Jiang, who would dictate the pace of change.

The continued prominence of Mr. Jiang may partly account for the relatively tight political environment, including a captive press and reduced scope for debating policy issues, political analysts say. Paradoxically, the atmosphere is more stifling than in the final years of his official rule, perhaps partly because Mr. Hu wants to avoid any liberalization that could lead to social unrest - and expose him to censure - before he consolidates power, these analysts said.

Mr. Jiang steered China through a period of rapid economic growth and stable foreign relations during his long tenure. But party officials say he has now associated himself with the hard-line position of some elements in the army that favors taking decisive steps to stop the drift toward independence in Taiwan.

Chinese hard-liners, both military and civilian, argue that the recent re-election of Chen Shui-bian as president of Taiwan has confirmed fears that Taiwan will sooner or later seek formal independence, which Beijing has promised to oppose militarily. Bush administration officials say China has recently emphasized using force to restrain Taiwan, even though the Americans believe that it is still possible - and highly preferable - to reduce cross-strait tensions through dialogue.

Liu Yazhou, the deputy political commissar of the Chinese Air Force, wrote an essay circulated on Chinese Web sites in May that discussed preparations for conflict with Taiwan and quoted Mr. Jiang as saying, "We must fight a war with Taiwan."

While it remains unknown whether Mr. Hu would steer a more conciliatory course if he had unchallenged authority, Mr. Jiang's stance leaves little space for alternative views, analysts say.

When Mr. Hu has tried to put his own stamp on Chinese foreign policy, Mr. Jiang has prevented him from doing so.

Mr. Hu's circle of advisers at the Central Party School, the Communist Party university that Mr. Hu managed before he was elevated to the top rank, spent months preparing a vision statement for China's emergence as a regional and world power.

They coined the term "peaceful rise," which they said reflected a consensus view that China could break historical precedents and become a great power without using military force to exert influence.

The idea became a staple of academic conferences and scholarly books. Mr. Hu and Wen Jiabao, the prime minister, both used the phrase repeatedly.

But in March, around the time of the Taiwan election, pressure from Mr. Jiang and the military prompted Mr. Hu to stop using the term, two people involved in the discussions said. Some scholars have continued to refer to the peaceful rise theory in their studies.

Chinese foreign policy experts said the debate signaled the delicacy of proscribing military force as a foreign policy tool while Mr. Jiang stressed the threat of Taiwan independence. But they said it also reflected Mr. Jiang's desire to prevent Mr. Hu from formulating a new doctrine, even if the contents were not especially contentious.

The way dissent by Dr. Jiang, the SARS whistle-blower, was handled by the leadership has also tended to underline assertions that Mr. Jiang remains the top decision maker, people directly informed about the doctor's case said.

Dr. Jiang wrote a letter in February that challenged the leadership to apologize for violently suppressing protests around Beijing 15 years ago. As a senior Communist Party official, elite surgeon and a military officer who is thought to have a rank equivalent to lieutenant general or major general in the West, Dr. Jiang's plea was treated as a political crisis.

The ruling Politburo, over which Mr. Hu presides, discussed Dr. Jiang's case shortly after his letter circulated and took steps to make sure that the doctor did not repeat his public appeal. But it was Mr. Jiang, acting in his capacity as chairman of the Central Military Commission, who decided to detain Dr. Jiang on June 1 and subject him to political indoctrination, according to the people informed about the case.

It is unclear when Dr. Jiang will be released or whether he will be charged with a crime, though the latter action seems unlikely. Some party officials say they regard the detention of Dr. Jiang, considered a hero by many Chinese, as a mistake.

"Jiang created this problem," one person connected to the case said, referring to the military chief. "Jiang will have to find a way out." Copyright 2004 The New York Times Company