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Six Myths About China

Understanding China is critical to competitive success. Unfortunately, what you understand could be dead wrong

The world’s economic center of gravity is shifting rapidly towards Asia and, in particular, China. Within 15 to 20 years, China’s economy will almost certainly overtake that of the U.S. and become the world’s largest. Given China’s rapidly rising importance, it is critical that policymakers in both government as well as corporate circles have an accurate understanding of where it is coming from, where it is today and where it is headed. Unfortunately, myths about China appear to dominate viewpoints and discussions even in otherwise-well-educated circles. Here are six commonly believed myths about the emerging world power – and the reality behind them. 

Myth No. 1:

Exports have been and remain the primary driver of China’s growth.

It’s easy to be mesmerized by data pertaining to overall export revenues, which totaled more than 30 percent of China’s gross domestic product (GDP) in 2007 and 2008 (see Estimated GDP Figures, this page). GDP, however, refers to value added by the economy and not to revenues generated by its enterprises. By most estimates, value added within China constitutes about one-third of the country’s exports. Even after hefty growth over the last several years, exports presently account for only about 10 to 12 percent of China’s GDP (and about 20 percent of the annual growth in GDP). The remaining 88–90 percent comes from domestic spending and domestic investment. The next time you buy an iPod or an iPhone that says “Assembled in China,” it may be well to remember that, almost certainly, only a fraction of the value in that gadget was added in China. Given the likelihood of slower growth in most developed economies and rising consumption within China, exports will quite likely be less important for China’s economy in the future than they have been so far.

Estimates for 2009 are illustrative. For the year just ended, even as China’s GDP grew by about 8.5 percent, its exports are estimated to have dropped by about 16 percent. (See China’s Exports of Goods and Services below)

While piracy in China is not dead, it is a declining challenge for both commercial as well as consumer products and, in any case, pales in comparison with other challenges.

Myth No. 2:

China is merely an imitator, not an innovator.

Until the mid-1970s, Japan too was regarded as an imitator. China is evolving at a faster rate. From 2004 to 2008, China-origin patents granted by the U.S. Patent & Trademark Office (USPTO) grew at about a 33 percent annual rate relative to virtually zero growth in the number of all patents granted (see Number of Patents Granted by the U.S. Patent & Trademark Office below). If current trends continue, by 2020, the number of China-origin patents granted by the USPTO will exceed those from Germany, the U.K., France, and Italy combined.

As with painting, sculpture or architecture, imitation is a necessary first step towards becoming a successful innovator. Creativity without discipline results in chaos, not innovation. China has demonstrated its ability to be disciplined. The government is now pushing scientific and technological innovation with all its might. China’s R&D-to-GDP ratio was 1.3 percent in 2005 and is being steadily ramped up toward a goal of 2.5 percent by 2020. Also, as we note below, enforcement of IPR laws is now becoming a ground level reality.

According to a recent report by Reuters, China had the world’s largest number of patent filings relating to wind, solar and marine technology, followed by Japan, the U.S. and Germany, in that order. BYD, a China-based global leader in lithium-ion battery technology, has become the world’s first company to start selling a plug-in hybrid car and is emerging as a credible contender in the global electric car race.

Myth No. 3:

Intellectual property risks are the biggest challenge that foreign companies face in China.

China’s historical disregard for intellectual property rights (IPR) is well known and has been extensively documented in legal skirmishes such as those between Cisco and Huawei, General Motors and Chery Auto, and Microsoft and an army of pirates in small shops as well as high-rise offices. However, China is changing rapidly and, even in the IPR arena, today’s China is quite different from that of even five years ago. First, the government has now become extremely serious about developing science, technology and innovation as the new basis for China’s competitiveness. It has concluded that a weak IPR regime is as much a deterrent to domestic innovators as it is to foreign companies. IPR lawsuits by Chinese companies against each other are now a welcome and growing phenomenon.

Second, large publicly listed and increasingly global Chinese companies are not only more professionally run than the purely domestic Chinese companies of yesterday, they are also increasingly wary of the reputational and business risks associated with facing an IPR lawsuit outside China. Third, on the consumer goods front, as China’s retail sector has become increasingly consolidated into large chains, the new intermediaries are far more interested in selling higher-margin genuine products than very low-priced, low-margin fakes.

In short, while piracy in China is not dead, it is a declining challenge for both commercial and consumer products and, in any case, pales in comparison with other challenges, such as widespread corruption, a brutally competitive marketplace, a vast and diverse country, and government regulations that can change rapidly and may vary from one province to another.

Myth No. 4:

Through acquisitions, Chinese companies are on the verge of becoming global champions in many industries.

Many Chinese companies, often backed by the government, do have the ambition to become global champions – witness the recently announced agreement by Ford to sell its Volvo brand and operations to China’s Zhejiang Geely Holding Group. However, lofty ambitions are not the same as the organizational capability to acquire and integrate sizable companies in other countries.

On the road to becoming truly global enterprises, Chinese companies suffer from significant capability gaps in several important domains: corporate finance, strategic analysis, the art and science of competing through differentiation, post-merger integration, managing horizontal organizations, managing across cultural diversity and widespread fluency in the English language. This is why, unlike companies from India, there have been very few major acquisitions by Chinese companies. TCL’s acquisitions of French consumer electronics businesses proved to be disasters. Despite a concerted effort at integrating IBM’s PC business, Lenovo continues to face market share challenges in almost every major market and has been forced to devote more of its attention to the domestic market within China. And Shanghai Auto, the big car company, recently witnessed an almost complete wipeout of its $500 million dollar investment in South Korea’s Ssangyong Motor. Not surprisingly, outbound FDI by Chinese companies has either focused on natural resource companies in Africa and Latin America or taken the form of minority investments rather than outright control.

Chinese companies and Chinese people are eager learners. One day, there will be many truly global enterprises with roots or headquarters in China. However, that day is at least 10 years away.

Myth No. 5:

Rising costs in China will spark a return of jobs to the U.S.

In recent years, several developments have led to a significant rise in labor and other costs in China, particularly in the more developed east coast regions. First, the Chinese yuan has appreciated by about 18 percent against the U.S. dollar since 2005. Second, as part of its 11th Five-Year Plan, launched in 2006, the government has enacted and started enforcing tough environmental control regulations. In the short term, these regulations have resulted in an increase in the cost of operations in China. Third, a new labor law designed to protect workers’ interests and remedy widespread abuses went into effect on January 1, 2008. The law is being implemented vigorously, especially by foreign enterprises, and has resulted in at least a 20 percent increase in labor costs. Fourth, a new corporate income tax law designed to harmonize tax rates has increased the tax rate applicable to foreign invested enterprises from15 percent to 25 percent, while reducing it for domestic-invested enterprises from 35 percent to 25 percent.

Put together, all of these developments have significantly increased the cost of doing business in China. However, total labor costs (including benefits) on China’s east coast are still less than $2.50/hour as compared with more than $20/hour in the U.S. – which makes the theory that rising costs in China will lead to a shift of jobs to the U.S. misguided. Instead, what is happening is a shift from eastern China to cheaper inland locations within China or to even lower cost countries such as Vietnam, Indonesia or India.

Myth No. 6:

The best way to prepare American children for the new era is to make them fluent in Mandarin.

Who wins or loses any future competition between the Americans (or Europeans or Indians) and the Chinese will be decided not by who can speak Mandarin better but by who is stronger in math, science and engineering, and who can be more innovative and cost efficient. American children are already behind their Chinese peers in math and science skills. Any diversion of time and energy towards learning Mandarin will only make a bad situation worse. Also, English is the language of the world. And as the native language of only one-fifth of the world’s population, Mandarin will never catch up. The Chinese will acquire English language fluency far faster than non-Chinese will acquire fluency in Mandarin. Finally, given that a Chinese counterpart will always be stronger in Mandarin, the last thing a non-Chinese should do is to negotiate with a Chinese in the latter’s native language. Even if you speak decent Mandarin, it would be wise to rely on excellent translators.

It is far more important to be deeply knowledgeable about China – its history, its culture, its geography, its economy and its politics – than to be able to speak Mandarin. If you know China well but have to communicate through your own highly capable translator, the Chinese will respect you. However, if you can speak Mandarin but are ignorant about China, they will likely run circles around you. Fortunately, for the non-Chinese, learning about China is a far easier and more enjoyable task than learning how to speak, read and write the language.

Anil K. Gupta (anil.gupta@insead.edu) is the INSEAD Chaired Professor of Strategy at INSEAD. Haiyan Wang (hwang@chinaindiainstitute.com) is managing partner of the China India Institute and an adjunct professor of strategy at INSEAD. They are the coauthors of Getting China and India Right and The Quest for Global Dominance.

About anil k. gupta and haiyan wang