Experience Not Logic - 不经一事，不长一智

Posts of the Week: 9/20/10 - 9/26/10

noreply@blogger.com (Will) — Sun, 26 Sep 2010 15:24:00 +0000

Does Beijing’s clampdown on property still have force? at beyondbrics

Hiring a Chinese Employee Without a Chinese Entity. Good Luck With That at China Law Blog

China has left the west on the sidelines in Africa at beyondbrics

Posts of the Week: 9/13/10 - 9/19/10

noreply@blogger.com (Will) — Sun, 19 Sep 2010 23:27:00 +0000

Tell Me What You Yuan, What You Really, Really Yuan at Free Exchange

Why Getting Tough With China Won't Solve Our Jobs Problem by Robert Reich

China Joint Ventures. Who's Your Partner? at China Law Blog

Singing the China-US WTO Blues at China Hearsay
Summary of recent China v. US WTO cases.

Central Planning v. Market Capitalism at Managing the Dragon
A tale of BYD and A123.

China. A Really Good Place to Do Business at China Law Blog

The Politics of the Anti-China Bill

noreply@blogger.com (Will) — Thu, 16 Sep 2010 17:39:00 +0000

For the sake of convenience and rabble-rousing I'm going to refer to the Currency Reform for Fair Trade Act as the Anti-China Bill. The bill will essentially allow the US to impose trade sanctions against countries that manipulate their currencies. The best thing written about the bill and Geithner's speech today is from the Economist's Free Exchange:

Pundits have been demanding that Mr Geithner pressure China to allow its currency to appreciate against the dollar, and Mr Geithner (reluctantly, one imagines) is rising to heed the call.

. . .

It was American pressure that led the Chinese to de-peg their currency in the first place; recall that they wanted to avoid heated confrontations at the June G20 summit. And American pressure has likely contributed to the recent sharp rise in the yuan (which has appreciated by 1.25% in just the last fortnight), though signs that the Chinese economy is achieving a smoother landing than previously believed have obviously helped.

Persuasion, in other words, is working.

. . .

My view is that China recognises the need to let its currency rise, and when economic conditions permit it is willing to move toward gradual appreciation.

. . .

Actual trade confrontation, on the other hand, would be very messy. Chinese leaders are explicitly warning that sanctions would be counterproductive. Some American leaders and pundits seem to assume that if persuasion is working, an aggressive policy confrontation would work better.

. . .

But there's an election on, and populism is ascendent, and the trade warriors in Congress will have their day. I just hope the legislature holds to its recent pattern of behaviour—all talk and no action.

A qualitative analysis of why it matters that it's an election year goes something like this: While the Democrats have been in power the US unemployment rate is hovering around historic highs for a historically long time. Democratic policies have either failed or appeared to have failed to fix the unemployment situation. In a bid to deflect blame for the poor state of unemployment from themselves, the Democrats have chosen an external target: China. Simplified, they claim that unemployment is due to the trade imbalance which is due to an under-valued renminbi.

Supposing that trade tends to be good for the economy and that data shows that manufacturing jobs in the US have been in steady decline since the '50s, one should only be able to make the above argument if they are intellectually dishonest because they arguing for what they should argue for politically even if it is not a real solution. If this is the case, then one would expect that Democrats who sponsored the Anti-China Bill are disproportionately in congressional districts where they are not considered safe in the mid-term elections in November. So I took a look at the congress people who endorsed the Anti-China Bill, and whether or not they are considered to be safe in the November elections according to Real Clear Politics polling.

Of the 146 sponsors of the bill, 103 are Democrats and 43 are Republicans. Of the 43 Republicans, 40 are considered safe, and 3 are in districts that are likely or leaning Republican. Of the 103 Democrats, 47 are in districts considered safe, 23 are in likely/leaning Democrat, 18 are in tossup districts, and 15 are in likely/leaning Republican. The 18 Democratic congressmen in elections that are considered tossups represent half of the total 36 Democratic congressmen in tossup elections, and the 15 Democrats in elections likely/leaning Republican represent half of the 30 total Democrats in those elections.

I think that's some pretty good evidence that quite a few of our elected representatives are being intellectually dishonest with themselves and their constituency. plus ça change, plus c'est la même chose...

Posts of the Week: 9/6/10 - 9/12/10

noreply@blogger.com (Will) — Sun, 12 Sep 2010 17:30:00 +0000

The New ‘FronTier’ – How These Domestic Companies Have Achieved Success Beyond China’s First Tier at The China Observer

Product Name Makes No Sense? Probably a Trademark Issue at China Hearsay

Foreign Prices Undercutting Domestic Chinese Prices. Yes, You Read That Right at China Law Blog

Cheng Siwei on China's Property Bubble at beyondbrics

Online Business in China: High Stakes, Short Tempers at beyondbrics

New York Times on China’s Clean Tech Subsidies: This Stuff is Complicated at China Hearsay

Operating Illegally in China. Half-Assing it Does Not Help at China Law Blog

Yuan Up, Yuan Down at Free Exchange

A China That Can Say Whatever at China Law Blog

Latest Chinese Statistics Show A Healthy Property Price Slow-Down... But Private Statistics Show A Price Explosion at Money Game

Comment on the NYT China Clean Energy Subsidies

noreply@blogger.com (Will) — Thu, 09 Sep 2010 13:45:00 +0000

Stan Abrams has a great post up today on this morning's New York Times article by Keith Bradsher about China's various solar subsidies, On Clean Energy, China Skirts Rules. In his post, Stan enumerates the various subsidies discussed in the article, and he discusses their strengths if they were filed in a WTO complaint. One response to Mr. Bradsher's article: I thought the juxtaposition of US industry complaints with a Chinese entrepreneur's responses, or at least the selection of quotes from a Chinese entrepreneur, definitely painted the alleged Chinese subsidies in a poor light. One response to Stan's post: I had to investigate why export restrictions are such difficult items.

Juxtapositions of Complaints and Responses

In response to export subsidies in general, Zhao Feng, a GM at Sunzone, responded that "the world should appreciate the generous assistance of Chinese government agencies to the country’s clean energy industries."

In response to the land use rights, Mr. Zhao responded that "the subsidized land will also help Sunzone afford plans to sell solar panels below cost to poor people in western China."

And in response to official encouragement, Mr. Zhao pointed out that "Our provincial governor has come several times to our plant, just as Gov. Arnold Schwarzenegger has made several visits to solar power companies” in California.

Mr. Zhao is not exactly helping his own case here.

Mr. Bradsher only presents one real defense from the Chinese government: China contends "that it is still a developing country struggling to understand its commitments."

Response to Export Restrictions

Stan's comment on rare earth metal export restrictions:

"Export restrictions on raw materials and currency manipulation are certainly ongoing trade disputes. However, whether either of these practices is a violation on WTO law are hotly debated issues, and if you take a poll of trade lawyers, you would be unlikely to get any sort of consensus opinion. Moreover, proving these allegations in a formal dispute resolution procedure would be quite difficult."

I think he is right that proving the allegations is quite difficult because WTO rules allow for export restrictions in certain circumstances including general revenue and conservation. And, in fact, when Beijing imposed export restrictions on rare earth exports, they claimed it was for conservation after "years of over-exploitation that has damaged the country's environment." Export He is also right that the issue is hotly debated. Let's see what the debate is about.

So what are the WTO legal standards for illegal export restrictions under the General Agreement on Tariffs and Trade (GATT)? Here's a summary of a summary of GATT rules. The main source for what export restrictions are and are not allowed is Article XI:1 of the 1994 GATT. The summary distinguishes between allowed export duties and disallowed quantitative export restrictions:

Export Duties: Export duties, taxes, and other charges are generally permitted.
Quantitative Export Restrictions (QER): Includes quotas, bans, minimum prices, and non-automatic licensing requirements on the "exportation or sale for export of any product." Could potentially include prohibitively high export duties, but that's highly debatable. There are exceptions:

If QERs are applied to relieve temporary shortages;
If QERs are necessary to spread supplies over a longer period of time;
If QERs are for price stabilization;
If QERs reasonably relate to conservation "in conjunction with restrictions on domestic production or consumption." And this exception, which is in Article XX(g), cannot be relied on if they are "designed to protect or promote a domestic processing industry."
And there are also a number of security related exceptions.

If a quantitative export restriction causes the price for domestic production to be lower than in the absence of the restriction, then a subsidy could be found to exist. If a subsidy is found to exist, then a countervailing duty or anti-dumping remedy could be appropriate.

Of particular note by analogy for rare earth metals is that quantitative export restrictions apply to the saleor sale for export. The OPEC countries and their oil quotas have not been tested, but it is argued that OPEC quotas are production quotas and not sale or export quotas. But China's quotas are explicitly export quotas.

So, yeah, this sounds like one difficult situation...

Debt for Equity Swaps by FIEs in China

noreply@blogger.com (Will) — Wed, 08 Sep 2010 14:24:00 +0000

[The meat's a few paragraphs down under "In China" header. I just wanted to do the comparative law thing first.]

Given the prevailing gloomy economic climate in the developed world, and market volatility in the developing world, debt for equity swaps have received a lot of coverage over the past couple of years. Debt for equity swaps can be by contract or under a bankruptcy statute, and if in bankruptcy then they can be voluntary or involuntary. The possibility of debt for equity swaps can encourage creditors to lend to riskier borrowers, and involuntary debt for equity swaps in bankruptcy can theoretically help keep interest rates down by allowing creditors the opportunity to take control of, or at least a significant stake in a company if it is forced into bankruptcy.

The most famous debt for equity swap is GM's reorganization in bankruptcy. GM was nudged into filing for chapter 11 bankruptcy which allows for the restructuring of a company's debt-holder's interests into equity interests. And if the most senior creditor of a debtor corporation has at least a 33% or higher equity interest in that company following the chapter 11 reorganization, then the reorganization is tax free to the company, shareholders, and creditors. In GM's case, secured creditors received the requisite amount of equity to keep the reorganization tax free. Chapter 11 is a useful mechanism for a debt to equity swap because it allows for a corporation to receive a fresh start while giving the creditors a judicial forum to protect their interests.

In China
Cagman Palmer of Shanghai Nan Guang Law Firm recently wrote an interesting paper on debt for equity swaps in China, Debt-for-Equity Swap and Reorganisation Law in the People's Republic of China. As in the US, there are three types of situations where there might be a debt for equity swap: 1) contractual, out-of-court swaps; 2) voluntary reorganizations in bankruptcy; and 3) involuntary reorganizations in bankruptcy. Mr. Palmer explains each in extreme detail. I'd like to briefly summarize his description of contractual, out-of-court debt for equity swaps by foreign invested enterprises in China.

Contractual Debt for Equity Swaps by FIEs in China

The key component of these swaps is that 1) they must comply with any laws, regulations and administrative rules of the PRC, and 2) they must be registered and approved by the SAIC in Beijing, or the SAIC's "local or provincial counterpart at the debtor company's domicile." The swaps must be registered and approved because the swap increases a company's level of registered capital. And since this is Chinese law, you should be asking where is the catch-22? It is in enforcement.

Provisions on restructuring say that contractual debt for equity swaps will be recognized in civil disputes if 1) they are purely consensual, and 2) in compliance with compulsory laws and administrative rules. However, the Supreme Court of the PRC has also ruled that the recognition provisions only apply to domestic enterprises, and not to FIEs. This means that since the laws, regulations and administrative rules do not explicitly allow for debt to equity swaps in FIEs, the approving bodies may not approve them. In effect, an FIE debt to equity swap may not be forced because regulations may not cover them because they may not be able to be enforced. D'oh!

Enter Shanghai. Last year Shanghai introduced measures allowing for debt to equity swaps by FIEs, which should, as long as Shanghai is the domicile of the FIE debtor, make debt to equity swaps in FIEs enforceable in a civil dispute. The Shanghai Department of Commerce should approve a debt to equity swap if the following elements are satisfied:

The swap is a conversion of a registered foreign shareholder loan into the registered capital of the same FIE;
The registered capital of the FIE has been paid in full and on schedule;
It has been unanimously approved by all shareholders;
It meets the requirements of the State Administration of Foreign Exchange (SAFE);
The swap agreement state the amount of debt to be canceled in exchange for equity;
The proper documents proving that the debt meets SAFE requirements has been attached; and
The change in registered and paid-in capital were processed at the same time.

I think the comparative aspects are interesting. And I'm sure we'll see a national expansion of these rules over time.

Posts of the Week: 8/30/10 - 9/5/10

noreply@blogger.com (Will) — Sun, 05 Sep 2010 21:51:00 +0000

Why Settling Trade in Yuan Matters at China Real Time Report

The Next President of China at The Atlantic

The Basics On China Pharma, Part 3: Mistakes To Be Avoided at China Law Blog
I've really been enjoying this series.

China's Disposable Backhoe at Managing the Dragon

Upfront prices tend to have more impact in purchasing decisions than cost/km.

How To Win Over The Chinese Consumer. What Happens In The Store May Not Stay In The Store at China Law Blog

Identifying, Measuring, and Taking Action on the Risks of China at All Roads Lead to China

Is Low Wage China Disappearing? at Project Syndicate

Not necessarily.

The Go-Go World of Private Equity in China at Deal Journal

More on Construction Equipment at Managing the Dragon

Was Essay a Bank Chief's Plea for Reform? at China Real Time Report

Markets Ignore China Rumor (for a change) at China Real Time Report

You know the rumor...

What It Takes To Get A WFOE/WOFE Registered In China at China Law Blog

China Government Sanctions for Violation of Environmental Laws

noreply@blogger.com (Will) — Wed, 01 Sep 2010 20:06:00 +0000

BNA Daily Report for Executives (subscription only) has an interesting article today that gives 6 examples of ways that various city and provincial governments are discovering and responding to violations of environmental laws.

"Serious Environmental Violations" in Liaoning Province

46 of 74 companies with "serious environmental violations" in Liaoning province will have restricted access to credit at state-owned banks. The province did not identify the companies, the extent of the restriction, or how long the restriction will last.

Penalties for Failing to Meet Energy Intensity Reduction Goals in Guizhou Province

Guizhou province created a monitoring system that will monitor energy consumption, and alert companies when their energy consumption nears their monthly quota. Penalties already instituted this year in Guizhou:

Fines and close monitoring for the rest of the year for 32 companies that did not meet their energy intensity reduction goals.
71 companies have been shut down this year for using outdated production methods.
52 companies have been ordered to suspend operations until they cure their energy consumption issues.
14 cement companies have been ordered to change production patterns to rely on off-peak energy.

Jiangsu Promoting Pollution Liability Insurance

The promotion of pollution liability insurance is part of Jiangsu's campaign to reduce pollution. Presumably pollution liability insurance will make companies presumptively liable for damages caused by certain types of pollution?

Hubei Fines Paper Company Almost $1 million USD

A Hubei paper company, Huahai Zhiye, was fined almost $1 million USD for illegally discharging wastewater through a hidden pipe.

Guangzhou Opens a Pollution Hotline

Guangzhou opened a pollution hotline encouraging people to call in and identify polluters, particularly vehicles that emit black smoke.

After the Fall of Communism, Why Did Russia Become Democratic and China Remain a Communist State?

noreply@blogger.com (Will) — Tue, 31 Aug 2010 15:11:00 +0000

A friend emailed me the other day asking for my thoughts on why Russia democratized after the fall of Communism and China did not. My initial, flippant thought is, Russia democratized? But that's too harsh. Let's give Russia the benefit of the doubt that it is a representative democracy, or a republic. Let's also give China the benefit of the doubt and not say "the fall of communism," but instead the beginning of the adoption of market economies. I think there are three factors for why Russia has democratized since the fall of the Soviet Union, and why China has not democratized since the fall of the Gang of Four and the rise of Deng Xiaoping Theory: 1) different solutions to the trilemma of international finance; 2) historical tradition; and 3) the particular circumstances in each country that led to the adoption of market economies.

Trilemma of International Finance

What is the trilemma? The New York Times had a great article by Gregory Mankiw on the trilemma almost two months ago. The trilemma is that economic policy makers would like to achieve the following three goals, but economic logic only allows regulators to choose two of the three:

International capital mobility;
Ability to use monetary policy to stabilize the economy; and
Maintain currency stability.

Although some argue that the trilemma can be challenged, research tends to show that it does indeed exist.

The US has chosen the first two 1) by allowing Americans to easily invest abroad and by allowing foreigners to easily invest in America, and 2) by using the Federal Reserve to set monetary policy. 3) But at the price of a volatile dollar value which is set by international markets.

Europe has chosen the first and third 1) by allowing Europeans to easily invest abroad and by allowing foreigners to easily invest in Europe, and 3) by maintaining currency stability, at least across the euro zone. 2) But at the cost of nations giving up the ability to use monetary policy to the European Central Bank.

China has chosen the second and third 2) by setting monetary policy, and 3) by maintaining tight control over the exchange rate of the yuan. 1) But at the cost of restricting outbound and inbound international capital mobility to control how much money comes into and goes out of the country.

Russia's policy is closest to the US in practice. 1) There are some restrictions on international capital mobility, but a) they are not as strict as China's, and b) the geographic realities of China and Russia make them more difficult to enforce in Russia's case. 2) and 3) The goal of the Central Bank of Russia is to maintain currency stability, but it has proven ineffective at maintaining currency stability, and is instead focusing on using monetary policy to stabilize the economy (see the link to the "goal of the Central . . .").

When economic policy makers choose to restrict international capital mobility, I think that it necessitates a government with stronger or more authoritarian control over its citizens. And I think a democratically elected government would have a much harder time maintaining legitimacy with such tight controls on capital mobility. That isn't to say that China's economic policy isn't working brilliantly, just that democracy suggests greater freedom, and capital mobility restrictions are a more tangible restriction on freedom than currency pegging and a central bank's tinkering with monetary policy.

Historical Tradition

We all know the traditional narrative about government institutions in the West v. those in the East, right?

The historical tradition in the West follows an embrace of an idealized Athens and Rome. Athens became super-rich as the de facto head of the Delian League, and being rich is totally awesome because you have all this cash to make art and pay for plays. People even forget that everybody got pissed at you for being super-rich, and you got your ass handed to you by Spartans in the Peloponnesian War, and twice more by barbarians: one Macedonian, and the other Roman. Rome was super-powerful, and being powerful is awesome because it allows you to dominate others. To be super-rich and super-powerful, the Western tradition dictates that you should be like Rome and/or Athens, and to be like Rome/Athens, we look to their writers. Democracy, or at least a republic, where citizens exercise votes to choose their leaders is considered ideal because Plato wrote about Socrates arguing about topics such as courage, liberty and freedom. But Plato actually believed in philosopher-kings, and when western philosophers started reading all of the awesome Aristotle during the Renaissance that Islamic and Jewish scholars had preserved, they started to totally dig this idea of a real republic which resulted in liberty and freedom, not that fake one that Plato writes about. Then a bunch of well-educated people bought a bunch of printing-presses and had some revolutions. Some were cool, some were creepy, and tradition is preserved.

In the East, Qin Shi Huang unified China through a highly bureaucratic state in which the nobility was replaced by a relatively meritocratic hierarchy of officials who administered the state which begat a major ass-kicking of the other kingdoms during the Warring States period. After Liu Bang successfully exploited Qin and Chu weaknesses, the Han dynasty emulated Qin's bureaucracy. Fast-forward through a couple thousand years of monarchical bureaucracies to the People's Republic China, and what China now has is a single-party, nominal republic with a highly bureaucratic state. Tradition is preserved, but the monarchy has, if you'll allow me some wiggle room, been replaced by the Party.

But what of Russia, that great nation that straddles East and West? As anyone who has ever read Tolstoy's War and Peace can tell you, a) it's long, and b) 19th century Russians really dug French culture. We see Russia's fascination with and eagerness to engage with Europe over the arc of it's history, particularly manifested in 1) the declaration of Moscow as the New Rome under Ivan the Great following the Ottoman conquest of Byzantium in 1453, 2) the military, political and economic reforms of Ivan the Terrible, and 3) a turbulent affair with a pair of Germans. Russia aspired to be a part of the West, and democratic institutions are more in line with the historical traditions of the West, which Russia has engaged with for far longer than the east, than a single-party bureaucracy.

Circumstances at the Inception of the Adoption Market Economies

This, I think, is the big one. Fortunately, I think I can describe it less verbosely than the other two.

The collapse of the Soviet Union began with turmoil in the Warsaw Pact allies. The communist countries of Eastern Europe were economically inefficient as a direct result of the command economy. The governments had lost legitimacy because of the form of government. After the Sinatra Doctrine, the Eastern European countries turned to new forms of government that were modeled on representative democracies. When economic inefficiencies finally brought down the Soviet Union in 1991, it was also because the form of government was blamed for the economic inefficiencies. With the form of a highly centralized and all-powerful federal government rendered illegitimate, a new form of government was needed, and because of tradition and the First World's success with representative democracies, the Second World decided to take the democratic route. Of course, this probably could not have been accomplished without the strong personalities of Gorbachev and Yeltsin.

The adoption of a market economy in China began in 1978 when Deng Xiaoping became head of the CPC and guided the Party toward political and economic pragmatism. But it was never the Party or the autocratic government that had lost legitimacy; it was people in the government that had lost legitimacy. Mao Zedong's policy of perpetual revolution had caused the country to economically stagnate, and atrocities were committed under the Gang of Four, but people still believed in Communism, and Deng Xiaoping brought China a socialism with Chinese characteristics: "Poverty is not socialism. To be rich is glorious."

China had not been a world superpower on the order of the Soviet Union post-WWII and prior to the adoption of market reforms. There was not glorious scientific, athletic, and artistic achievement in China in the post-WWII to Deng period. Communism was not associated with poverty, poverty simply existed, and Deng started to bring China wealth under the auspices of Communism. The CPC has not been without its hiccups since 1978, but it has been remarkably successful at maintaining control and legitimacy.

Posts of the Week: 8/23/10 - 8/29/10

noreply@blogger.com (Will) — Sun, 29 Aug 2010 16:50:00 +0000

Chinese Banks Are Making Easy Profits Off of Artificially Low Interest Rates at Money Game

Reports of China IP’s Demise Are a Bit Premature at China Hearsay

Manufacturing: Maybe It Isn't China at Free Exchange
Since the end of World War 2, US manufacturing output has grow steadily and manufacturing employment has declined steadily. Getting tough on China will not reverse this trend.

Have We Underestimated Chinese Consumption at China Financial Markets

China Needs 10 New Yorks Over the Next 20 Years. How Do We Get in the Real Estate Game?

noreply@blogger.com (Will) — Wed, 25 Aug 2010 21:37:00 +0000

Dan Harris at China Law Blog has been quite bullish on the China healthcare business prospects, particularly pharmaceuticals (see parts one and two). I am not one to disagree, and Chinese pharmaceutical R&D, manufacture, and sales does sound like quite the opportunity. But what if you are not in the enviable position of owning valuable pharma IP? I'd take a wager on construction.

The other day it was revealed that Blackstone was reentering China's real estate market. I was a bit shocked by this news, as I'm sure many others were, because all the signs seem to be pointing towards a real estate bubble in China: 25-30% of commercial and housing space may be sitting vacant, prices seem to be leveling off, and the government has apparently insisted on tightened real estate lending. Intrigued, I delved further and realized that Blackstone was actually investing in a realty developer. Now that makes sense!

A recent piece at Foreign Policy heralds the coming of the Megacities through a collection of charts and graphs of urban changes in China and India over the coming 20 years. Of particular note is that China will require 40 billion square meters of new commercial and residential space over the next 20 years. That is equivalent to 10 New Yorks, or the size of Switzerland. A rising tide might not necessarily lift all boats, but it will surely lift those with the capital necessary to keep building. And a company like Blackstone should be able to provide the financing to a housing developer to ensure that it can reap a healthy profit off of the natural growth of China's urban landscape.

So how does one go about getting into the construction game? Well, construction of anything worthy of a significant foreign investment, such as 1) class A hotels, residential buildings or office buildings, 2) international exhibition centers, 3) large scale theme parks, 4) public gas, heat, water facilities, 5) golf courses, 6) cinemas, 7) refineries, and 8) smaller coal fired plants, falls in the Catalogue of Restricted Foreign Investments. This does not mean that it cannot be done, it just means that the formation of a company that wants to engage in one or more of these types of construction will be subject to a more onerous (read: more lengthy and expensive) review and approval process than other types of foreign investment. This, of course, is in addition to the standard examination and approval procedures (see a "simplified" flow chart). But if you have the time, money and patience, plus some synergies in your portfolio, construction sounds like one hell of an opportunity.

The Huawei and Sprint Nextel Deal Seems Innocent Enough

noreply@blogger.com (Will) — Tue, 24 Aug 2010 00:34:00 +0000

On first impression, the eight Republican Senator's opposition to Huawei's bid to supply Sprint Nextel with telecommunications equipment in the US seemed like a typical political exploitation of xenophobia, particularly in a competitive mid-term election season. But Huawei has had some accusations against them over the years that make them seem more suspect than other Chinese companies. However, I think the nature of this particular business deal does not make it a serious security risk.

Huawei was accused of stealing technology from Cisco, Motorola, and some vendors at a Supercomm show. Cisco's suit against Huawei was dismissed because it was determined that rogue developers were at fault, the 'spy' at the Supercomm show was never prosecuted, and we have yet to see whether the Motorola case has legs. So Huawei's history with corporate espionage is so far undetermined.

Transactions with Huawei have previously run into problems in two other countries. In the US, Huawei was attempting a merger of 3Com and the CFIUS committee found that the merger would pose a threat to national security, but the deal was not blocked. Instead, Huawei voluntarily withdrew their offer. The Indian government has also previously canceled two deals between Huawei and Indian telecom companies because of national security concerns, including BSNL and Sistema Shyam Teleservices Ltd., the Indian unit of Russia's AFK Sistema.

The allegations of corporate espionage have not yet proven true, and while corporate espionage is a criminal issue, the government should not block a deal because it is possible that Huawei might steal technology from Sprint. Sprint should be able to make those determinations on their own as part of their willingness to be supplied by Huawei.

Even if there have been security concerns in the US over a merger with Huawei, those same concerns should not be a problem in the supply of equipment in the US market. The great and only fear, of course, is a hardware hack. The successful application of hardware hacks in espionage is limited, and largely just to the US against very specific targets that were already our enemies.

A hardware hack is an unreasonable fear, the risk of technology theft can be dealt with effectively by Sprint's choice to deal or not deal with Huawei, and it's time to realize that the second largest mobile equipment in the world, Huawei, might, might just be after a profit. And if they're the best provider of equipment, then it's a net good if Sprint buys their equipment from Huawei.

Richard Pozen's Solution to Solve the US-China Trade Deficit

noreply@blogger.com (Will) — Sat, 21 Aug 2010 17:27:00 +0000

Robert Pozen wrote an op-ed for the WSJ yesterday arguing that the best way to shrink the trade deficit is for Chinese companies to increase wages, rather than faster yuan appreciation: Bashing Beijing Will Not Help Our Trade Deficit. He argues this because wages are the most expensive input for most of the goods exported from China to the US. And if wages increase, then Chinese will have more money to spend in China resulting in more of China's goods being purchased in China.

He also attacks yuan appreciation as an effective tool for the 3 following reasons:

Exports from China to the US are assembled in China while the component manufacture takes place in other countries. Chinese input costs are typically about 10%, so even a substantial appreciation would not result in a large increase in prices.
Appreciation of the yuan would push low-end manufacturing to other countries, but the overall exports to the US would be the same, just not from China.
The volume of high-end exports to the US is driven by competition with Germany and Japan, which depends more on the value of the euro and yen.

There are some significant problems with Mr. Pozen's argument.

First, if Chinese input costs are not significant, then higher wages will have no different effect on the trade deficit than a more valuable yuan.

Second, wage increases would also result in low-end manufacturing migrating to other countries. Also, many of the products manufactured in China for the US market are never sold in China. If wages increase, then Chinese might have more money to spend on the goods, but the goods would not be sold in the Chinese market anyway. The overall US trade deficit would remain the same, and jobs would likely be lost in China because the goods currently being manufactured for the US market cannot likely be re-purposed for the Chinese market.

Third, if the volume of high-end exports from China is driven by competition with Germany and Japan, and the value of the euro and yen is a strong factor in determining which country customers purchase goods from, then surely the value of the yuan would also be a strong factor if it appreciated to its true value due on freely convertible exchange.

Lastly, and most importantly, either a wage increase or an increase in the value of the yuan would produce the same end, but it is impossible to use a stick to force Beijing to raise the minimum wage in China. It is possible and legal to use sanctions against a country if they are manipulating their currency. That is not to say that China is manipulating their currency under the law, but the yuan is certainly undervalued.

Mr. Pozen's real concern is that American politicians' declarations that China is a currency manipulator only provoke resistance, and that they should instead promote higher wages. I certainly agree that yelling in front of cameras that China is a currency manipulator is not the most effective method to get China to act, and I wish Mr. Pozen had restricted his argument to this point because telling China that their workers don't earn enough certainly can't be any more effective.

However, hasn't Washington been fairly effective at getting Beijing to loosen up its currency Policy? It reminds me of the classic and instructive South Park episode when Cartman travels back to 1776 and learns Benjamin Franklin's important policy that a republic can have its cake and eat it too by voting to go to war while being anti-war. In this case, Senator Chuck Schumer and legislative branch can play bad cop, while Timothy Geithner and the executive branch play good cop, and concessions are reached.

Posts of the Week: 11/2 - 11/8

noreply@blogger.com (Will) — Tue, 10 Nov 2009 01:28:00 +0000

China Joint Ventures: Understanding the Intangibles at China Briefing

Americans believe relationship with China is most important at China Economic Review

Where To Locate Your China Business at China Law Blog

Multinational Companies Could Face Stricter Transfer Pricing Investigation By Chinese Tax Authorities at China Law Update

China Joint Ventures Again. This Time We Blame The Victims at China Law Blog

Posts of the Week: 10/26 - 11/1

noreply@blogger.com (Will) — Sun, 01 Nov 2009 22:17:00 +0000

China Antimonopoly Law Update at China Realtime Report
Discussing two interesting lawsuits under the AML, one against China Mobile, and the other against Shanda and Xuanting.

Love The One You're With. When China Joint Ventures Make Sense at China Law Blog
Dan covers some instances where he thinks JVs are appropriate.

A Call For More Transparency In China’s Africa Investments at China Realtime Report

China Briefing's Series on Chinese JVs
China Joint Ventures as Strategic Investment
China Joint Ventures: Legal Due Diligence
China Joint Ventures: Financial Due Diligence

Preparing For Domestic Carbon Trading In China at China Law Update
Information on what may be China's first domestic carbon trading market.

Looking Under the Hood of the China Deal Machine at Deal Journal
Deal Journal getting excited about Volvo, Sino-Swedish relationships, and Qatari gas deals.

CIC Gives Rare Tally of Overseas Spending at China Realtime Report
It is what it is. Anybody else totally stoked about WSJ's way expanded China coverage?

China Antimonopoly Law Series at Antitrust & Competition Policy Blog
China’s Antimonopoly Law—One Year Down
China’s Antimonopoly Law—One Year Down: Part 2. China’s new merger review regime
China’s First Court Decision under the Antimonopoly Law: A Misreading of the Law?

Decoding China: Why Its Stock Markets, GDP Aren’t Linked at Deal Journal
"A unique characteristic of China’s equity market is the relatively high percentage of nontradable shares held by the central government, local governments and state-owned enterprises. One feature of this system is the transfer of risks to the country’s individual stock investors, causing price aberrations in the stock market, while keeping outsize returns for the government holders of nontradeable shares."

Head West, China: An Interview with Private Equity Consultant, Song Jin by Aimee Barnes

Private Equity Case Study Offers Some Good Lessons

noreply@blogger.com (Will) — Tue, 27 Oct 2009 20:41:00 +0000

In the October 24th edition of The Economist is a concise case study of Infinity , a private equity company that has been operating successfully in China since 2004. The article identifies the two major problems that PE companies have in China, and the article identifies reasons why Infinity has been able to overcome these problems.

The two problems:

Western private-equity firms trying to enter China run into two problems: getting their money and getting their money out. The Chinese government keeps an asphyxiating foot on currency conversions. It is hostile to investment that involve restructuring (sacking people and selling assets) and financial engineering. And it has not interest in outsiders flipping assets for fast profits.

How Infinity has overcome these problems:

The "Chinese government entities are co-investors in the firm's two funds in the country."
- Spreading the wealth around is sure to make friends.
- Their website is too opaque to fleece out the legal structure of Infinity's firms in China. The company was issued a venture-license, which makes it possible to assume that the company is an FIEVC. What isn't clear is what the underlying structure of that FIEVC is? EJV, CJV, WFOE? Research has shown that CJV's are popular in private equity and venture capital as a means of creating the legal fiction of preferred equity in private equity firms, but there is nothing definitive on Infinity's structure.
Infinity's "investments have helped create viable Chinese companies in areas rich in technology and intellectual property."
- Infinity's deals tend to be structured around the shifting of high tech manufacturing to China while maintaining ownership of the technology abroad. While it seems that the government would usually prefer the technology to be transferred to the Chinese entity, it appears that they are satisfied with the technology merely making its way into the country regardless of who actually owns it.
"Infinity raised $30m for its first fund in China, perhaps just enough to intrigue China's government but not enough to frighten it."
- The just right, Goldilocks' sizing of the fund is certainly part of it. But I'd venture that Infinity's country of residence, Israel, plays a considerable role in it, too. Israel just seems less dangerous of a country of origin than, say, the United States, where the sophistication and capability of the PE firm is more presumed. That's not to say a fund from Israel is not sophisticated, but the optics count. Additionally, Infinity's website plays up the close ties between both Israel and China, and the Chinese and Jews in a way that I have never seen on a private company's website.

So, sounds like a good model for succeeding in PE in China. There are two extra hurdles, though: 1) you must have some technology that you want to manufacture in China, and 2) the "transfers of technology and production across multiple countries and entities is horribly complex."

Posts of the Week: 10/19 - 10/25

noreply@blogger.com (Will) — Mon, 26 Oct 2009 03:09:00 +0000

China's New Patent Law Effective October 1, 2009 at China Law Update

China’s Energy, China’s Power: An Interview with China Energy Specialists, Elizabeth Balkan and Chris Brown by Aimee Barnes

UBS Lays Out Their China’s Big Four Themes. Forgets One at All Roads Lead to China

Yuan May Rise Later Rather Than Sooner at China Journal

Chinese Drywall and the US Personal Income Tax

noreply@blogger.com (Will) — Tue, 20 Oct 2009 21:08:00 +0000

While some blogs seem obsessed with drywall and its litigious matters, we here at this blog don't seek to lay blame, we are just concerned with how the homeowners stuck with toxic walls can get a tax deduction.

In 2006 alone, enough drywall for 32,000 homes was imported from China into the US and used to build homes in Florida, Virginia and Louisiana. People spent good money for those homes, or at least took out bad loans to finance the purchases. These homes became worthless when it was discovered that the walls were toxic. If an individual sells their home at a loss, they can not use that loss as a deduction against their income. Deductions can only typically be taken on losses from transactions entered into for profit and for casualties, and although a home is considered to be an American's biggest investment, a home purchase is not considered a "transaction entered into for profit" according the US Tax Code.

But Senators Jim Webb and Bill Nelson are doing all that they can to allow taxpayers to take a casualty loss for the houses they have purchased that used the defective drywall. The IRS is currently awaiting reports by the CPSC and the EPA before making any definitive ruling about whether these homes will be deductible as casualties.

I will hazard the guess that, absent a limited policy exception, these homes will not be deductible as casualty losses because the loss to the taxpayer is not a casualty. A casualty loss must be sudden, unusual, and unexpected. Toxic drywall, even if, as it appears, it only amounts to the emission of sulfur gases and does not rise to the level of radioactivity, is quite unusual. Whether the loss is unexpected would require a factual inquiry into the taxpayer's awareness of the possibility of sulfur-ridden drywall. Even if it is unexpected, the toxic drywall isn't sudden. It was made in a far off land, shipped here, installed, the houses were held on the market for some period of time, sold to home buyers, and then started causing problems. There is nothing sudden about that.

The casualty loss provision is simply not for losses of this nature. The kinds of losses that fall under this provision are the ones where there is some sort of event, such as a fire, a flood, or the first instance of a plague of beetles that eat your trees over the course of 5-10 days. Not the walls of your house emitting sulfur gas.

I guess we might actually need those trial lawyers to start suing away.

Posts of the Week: 10/12 - 10/18

noreply@blogger.com (Will) — Sun, 18 Oct 2009 22:38:00 +0000

Why Did 70% of Caijing's Staff Resign? at Cup of Cha

Dual Language China Contracts Double Your Chance Of Disaster at China Law Blog

Money well spent? at Free Exchange

The Tangled China Immigration Web Some Weave at China Law Blog
I'm a sucker for war stories, and there are some good ones in here.

Everything You Wanted to Know About the Chocolate Business in China

noreply@blogger.com (Will) — Sat, 17 Oct 2009 19:35:00 +0000

What is that makes a good China business book?

A detailed, refined case study comparison of a hand full of major players in a single industry over the course of almost 30 years; or
A rip-roaring romp through booze-fueled negotiations, shady backroom dealings, and outsized personalities.

The king of the latter is undoubtedly Mr. China. Haven't read it? Shame on you. Mr. China also takes on the mantle of greatness by offering several good lessons.

As for the former? Until Chocolate Fortunes by Lawrence Allen landed in my mailbox, I was unaware that such a staid book could make such a fascinating read. Mr. Allen meticulously describes the Big Five chocolate sellers' forays in China with attention to company goals both globally and in China, manufacturing, logistics, the products, marketing, and retailing. Mr. Allen has spent career in chocolate, and he knows his subjects.

The Big Five are Ferrero Rocher, Cadbury, Hershey, Nestle, and Mars. Fascinating absent the China angle are the profiles of these companies. I found myself deeply fascinated in the different approaches these companies took in their global development and in their internal structure. Mars and Nestle were particularly interesting, mostly because I simply was not aware of either how vast an empire each commands nor was I aware of how Mars' status as a private company translates into how privately it indeed conducts itself.

Chocolate is a very special product for several reasons. Chocolate requires a wholly refrigerated logistics chain to maintain flavor and consistency, and this is difficult enough to achieve in 2009. Chocolate consumers are very loyal, and once a company establishes itself as a preferred brand, customers are slow to switch. There was essentially no chocolate in China between the late '30s and the entrance of Ferrero Rocher into the market in 1982. It is estimated that 70% of chocolate purchases are on an impulse basis. The Chinese viewed chocolate as an exotic delicacy. Chocolate enjoyed virtually no regulatory oversight by the government. Mr. Allen writes that this unique combination made it so that the Big Five were given a level playing field, and the game would be decided by the application of the executives' "experience, management skills, and leadership capabilities."

If you know your chocolate brands and you've been to Shanghai, you probably know who the winner is. But I don't want to spoil it for everybody else. I'm not going to give any names, but here's how it all broke down and why:

One company prospered, and continues to prosper, by offering a single unique, decadent product designed to take advantage of the gift-giving tradition in China.
Another had big dreams, but made big mistakes in its agricultural and manufacturing side that led to poor quality. There was a slight rebound, but management shakeups spelled its doom.
A household name, and a reluctant player on the international stage, found that the Chinese instantly took to one if its most iconic chocolates. Management problems found another victim, though.
The biggest of the five found some success, but didn't follow up the success aggressively enough. Probably didn't matter too much because all of their market shares were in line with their global market shares, and they were raking in dough hand over foot, but there were some weird things going on in the boardroom with the confectionery business
The tenacious one seemingly did everything right. But it took them a long time to start realizing a profit, a luxury the others were without.

The opportunity to view management decisions in a relative vacuum is enlightening. Mr. Allen shows and evaluates how management decisions affect the viability of the whole business model. He also shows his readers certain management techniques that are particularly effective and particularly ineffective in China. His analysis of managing in China is that it is different, but he soberly explains the difference.

This book is highly informative, and reads at a good speed. Recommended if you want to know more about managing a global business or if you like chocolate, highly recommended if you want to know more about managing in China. The book is not without its flaws, though.

There are a lot of China cliches. I don't necessarily know if this makes me like the book more or less, but my high school English teacher said cliches are bad, so I'll just follow her advice on this one.

The other glaring problem is that Mr. Allen's story doesn't come through enough in the pages. He was a senior executive at both Hershey and Nestle, but we don't really learn much about him. More personal anecdotes would have made the book that much better.

If you want to learn something about managing in China, do yourself a favor and buy this book. Be forewarned, though: there is not even a slight reference to baijiu in its pages.

Looking for a Mildly Pessimistic Take on the Global Economic Situation?

noreply@blogger.com (Will) — Wed, 14 Oct 2009 19:54:00 +0000

Then read Andy Xie's latest opinion piece over at Caijing, Can interest rate adjustments, currency devaluation and zigzag policymaking help unwind economic stimuli? It depends. Something's brewing over at Caijing, but Mr. Xie will always come up with something interesting to write.

The stimulus for the article seems to be Australia's increasing its interest rate by 25 basis points, and Andy Xie carves out what he thinks is the best case global scenario if the central banks manage policy competently. And he thinks that central banks should make his scenario their goal.

The goal for the global economy? 2% growth and 4% inflation. "Mild stagflation."

In the US, he sees interest rates climbing 4.5% through 2012, with an inflation rate of 4-5% by 2012. He sees the current devaluation of the dollar as a down payment for the this future inflation.

Despite the EU's difficult internal economic problems, he doesn't see the European Central Bank allowing the euro to decline in value because the bank "was structured solely to maintain price stability." He thinks that this will result in lower real economic growth rates than in the US.

He sees the same thing happening in Japan because of the "strong yen psychology."

And in China? Well China and the rest of the developing world still have asset bubbles according to Xie and others (according to yet others, including the Economist, there is just a serious potential for asset bubbles in China). This means that China's central bank will pursue a zigzag policy in which the yuan will likely remain pegged to the dollar resulting in similar interest and inflation rates as in the US, and credit controls, through the expansion and curtailing of lending, will be employed by the state to heat up or cool down asset markets as the need arises.

Cheery, isn't it?

What Else Does the Economic Downturn Have to Do with Protectionism in China?

noreply@blogger.com (Will) — Mon, 12 Oct 2009 21:18:00 +0000

In their annual survey, the US-China Business Council's (USCBC) finds that US companies' China outlook since 2008 remains largely unchanged. This is probably because 84% of the companies China operations remain profitable, and 76% have experienced revenue growth. Of the top 10 business issues in China, there is one new problem, the economic downturns impact on China operations, and one problem has deteriorated since 2008, protectionism. The increase in protectionist worries goes in hand with the economic downturn, but the reality of the situation does not (yet) justify the fears of US companies in China.

The obvious problem that the downturn has led to is in a reduction in sales in China, further investment in China, and employment of staff in China. The not so obvious problem, and the one that is raising cries of “Protectionism!” is the perception that FIEs are being excluded under the “buy local” requirements in much of China's $600 billion stimulus package. The worry is that the products of FIEs will not be included as “domestic” under the provisions of these rules. The facts just don't bear this fear out, though.

FIEs are domestic Chinese companies, so their products should be domestic. The report's take on the legal issue:

[T]he Ministry of Commerce and NDRC have publicly stated that products manufactured in China by FIEs should be considered “domestic.” This position was confirmed by Vice Premier Wang Qishan in the outcomes issued jointly by the United States and China following the July 2009 meeting of the Strategic and Economic Dialogue.

Sounds open and shut, but the optics aren't there for the US companies.

The problem seems to be in what US companies aren't perceiving any stimulus benefit, what companies are optimistic about the stimulus, and what companies have received a stimulus benefit. Companies in the consumer goods, IT, payroll, services, logistics industries have not reported any benefit from the stimulus. Pharmaceutical companies are optimistic about “capacity-building projects in the stimulus plan and the healthcare reform plan,” but these have yet to be implemented. Companies in the heavy equipment, infrastructure, high-tech component, and telecom industries have reported benefits from the stimulus package.

Frankly, it sounds like some companies are disappointed by their China performance and are looking for a scapegoat. There have been complaints about this before in regards to the “domestic” policies in the financial incentives given for boosting indigenous innovation, even though companies were unable to point to a single clear instance of discrimination.

Much ado about nothing? Time, I suppose, bears all out, but for now, looks like it.

Posts of the Week: 10/5 - 10/11

noreply@blogger.com (Will) — Mon, 12 Oct 2009 04:54:00 +0000

Just for Fun:
Ferrari Makes One For China at Autopia
"Ge Kiln porcelain is known for its “cracked” glaze pattern and Lu has incorporated this elegantly colored design with clearly defined cracks etched at different depths."

Regular 'Ole Favorites of the week:
Online Gaming Industry Banned From Foreign Investment at China Briefing
WoW Backlash: Weather Control Sets Sights on Blizzard. What are the Zerg going to do about it?

Banks and The China UnStrategy at Silicon Hutong

China’s NPLs: Another financial time-bomb? at Dragonbeat
If the growth rates can erase the NPL damage, no. The estimated RMB 3,300 billion in NPLs resulting from the 2008-10 lending expansion should be taken care of by the estimated growth rates through 2020. But, the author warns, this is China's last chance at an unnatural expansion of commercial lending. Natural? I suppose that word works.

Tax Related
China’s Export Tax Rebates Up 8.6 Percent at China Briefing

Posts of the Week: 9/28 - 10/4

noreply@blogger.com (Will) — Sun, 04 Oct 2009 23:49:00 +0000

Meet the New IPO Sheriff in Town: China at China Journal

The New Chinese Growth Enterprise Market Is Launched -- Stock Transfer Duties On "State-Owned" VC Firms and PE Funds? at China Law Update

China Crystallizes Royalty Clause of Tax Treaty at China Law Update

China Strengthens Supervision of State-Owned Asset Restructuring at China Law Update

Posts of the Week: 9/21 - 9/27

noreply@blogger.com (Will) — Sun, 27 Sep 2009 23:57:00 +0000

US-China Tire Case Part II - US Politics at China Hearsay

EU Afraid To Share Sensitive Proprietary Info With China at IP Dragon

Understanding China FCPA Risks. Who Is A Foreign Official? at China Law Blog

What’s behind China’s skyrocketing residential property market? Subsidies … subsidies … subsidies at dragonbeat