Why is Taiwan important to China? It’s a matter of face.

Most of us assume that China’s current fixation on Taiwan is related to the military threat that Taiwan poses to mainland China. After all, Taiwan is 90 miles off the coast of the People’s Republic of China (PRC), the same distance as Cuba is from the United States, and straddles important sea lanes. However, over time, China’s insistence that Taiwan is still a part of China has evolved from a perceived military threat from Taiwan to that of a threat to domestic political stability. Let me explain.

From 1949 through the 1970s Taiwan was regarded by China as an extension of U.S. military power in the region. The United States maintained military forces in Taiwan during a period when China had little relations with the outside world other than with the former Soviet Union and its satellites. In addition, the U.S. constructed alliances with Japan, Korea, Thailand, South Vietnam, and the Philippines, and formed the Southeast Asia Treaty organization (SEATO), establishing military bases and stationing troops in many of these countries. China felt threatened and was suspect of U.S. intentions.

Things began to change in the 1970s when China’s relationship with the former Soviet Union began to worsen and the U.S. was looking to end the war in Vietnam. Therefore, in 1972, President Nixon met with Chinese Premier Zhou Enlai. This meeting resulted in a withdrawal of all U.S. forces and military installations from Taiwan and succeeded in diminishing tensions in the region. A short time later, in 1979, China and the U.S. established full diplomatic relations and the U.S. broke formal diplomatic relations with Taiwan, although the U.S. and Taiwan agreed to maintain informal relations and signed the Taiwan Relations Act which committed the U.S. to help Taiwan militarily.

Also in 1979, Deng Xiaoping instituted China’s Open Door Policy which welcomed trade with the outside world and included Taiwan. With the absence of a foreign military in Taiwan, and the opening of trade, the military threat to mainland China from Taiwan was now considered minimal.

So why is Taiwan still considered by the Chinese government to be their 23rd province? Why is it so important to the Chinese government to have Taiwan a part of China if it doesn’t pose a military threat? After all, China has enough military might to quickly erase Taiwan in any military style conflict. The reason China won’t let go of Taiwan: doing so would create an unacceptable risk to the continued rule of the Chinese Communist Party (CCP), and a loss of face within China.

Originally, Taiwan was not even a part of China, and China’s historic geographic footprint was much smaller than that of present-day China. Taiwan became a part of China in the seventeenth century during the Qing dynasty. It remained a part of China until 1895 when China was defeated in the Sino-Japanese war and lost Taiwan to Japan. It then remained in Japan’s hands until Japan’s defeat in World War II. Since Japan no longer had control of Taiwan, most Chinese believed that Taiwan would revert back to Chinese control. That didn’t happen. Instead, as time went on, the United States, the dominant military power at the time, intervened to keep Taiwan independent and ultimately in the hands of Chiang Kai-shek’s Republic of China (ROC).

In addition, Taiwan was still a military threat to China, especially since the U.S. was tacitly supporting the ROC. Forgetting for a moment how China obtained Taiwan in the first place, the Chinese government wanted Taiwan back to both protect themselves from Chiang Kai-shek , who vowed to return and capture mainland China, and as a matter of honor and face since they didn’t want a foreign power telling them that they couldn’t have back what they felt was rightfully theirs.

Over time, as Taiwan’s military threat faded, Taiwan’s importance to the Chinese government shifted away from military considerations to that of politics. For the last 50 years the CCP has demanded that Taiwan again become part of mainland China. It’s been a non-wavering position. Many within China feel that if the CCP were to change course and let Taiwan have their independence, then they would lose the confidence of those they govern. According to Susan L. Shirk, in her book China: Fragile Superpower, most in China believe that the Chinese Communist Party (CCP) would fall if the government didn’t take a hard line on Taiwan’s return to Chinese control as people may view the government as weak and unable to protect a sovereign China. In that event, they may demand a stronger government, even a democratic one.

More important to the average Chinese person is the state of employment, inflation, and other factors which affect their everyday life. In fact, since 1979, when China’s Open Door Policy was written to include Taiwan, economic trade between Taiwan and China has steadily increased to the point that Taiwan’s exports to China exceed its exports to the U.S. Taiwan today is economically important to China since Taiwanese companies operate many manufacturing facilities in China, where labor and infrastructure costs give them a competitive advantage.

There are many in the Chinese government who feel that an independent Taiwan is acceptable and that both countries should continue be united by their cultural links and by trade. However, for a government official to espouse such a view would be political suicide. Given its historical position on China, it would be very hard for the CCP to reverse course without risking their political dominance.

If you have any questions please send them to info@thornhillcapital.net

 

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Review from my up and coming new book…

I have been working diligently on my new book, “Doing the China Tango II”, for sometime now. It gives me great pleasure when I read quotes such as this from my esteemed colleagues to  know that I am helping people in so many ways, take a look.

“Had I met Alan Refkin earlier in the process I might have been better prepared to swim in China’s great white infested waters.

After working with and learning from Alan, I came to recognize it is possible to do business in China, but only with the intrepid guidance of a grizzled veteran of the China business world.

Consider “Doing the China Tango” your personal survival guide for doing business in China. Don’t read it. Study it, and use what you have learned.

Had the aggressive investment bankers of the last 10 years studied “Doing the China Tango”, a great deal of emotional and financial pain might easily have been avoided.”

– Larry Isen, Editor and Publisher, EmergingChinaStocks.com

Stay tuned for more on my new book and it’s release date, it is full of more important information you will definitely want to read!

An alternate Universe: How the Chinese View Time

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When we, as Westerners, view time, we view it as linear – from today, through tomorrow, and into future. It’s sequential. We begin a task and finish it before we begin another. It’s culturally what we’ve been taught, what we understand, and what we believe to be the case in any country. However, in China, time is viewed as polychromic and circular where the present is connected to the past. A person may begin a task and then start several more before completing the first. They may feel that there’s always enough time to finish the task and they’ll eventually get to where they want to be.

Quite often these cultural differences can cause business conflicts and affect relationships. Let me give you an example. You’re at an airline counter in China and speaking with an agent. The agent is patiently answering your questions when another person walks up and begins a dialogue, followed by another also asking that agent a question. Suddenly, instead of answering your question and then moving on to the next, the agent is polychromic and attempting to address all three issues. In the West we most likely find this type of behavior to be frustrating and rude. In China, it’s not uncommon. One is never too busy as it’s about the person and one’s relationship with that person rather than about linear time and schedules.

Other examples:

You have a business plan, which has been agreed to by both sides. It’s a rigid plan on how your joint venture is to move forward. However, your Chinese counterpart may view these plans as circular and view them as continually subject to change. He’s not rigid, he’s flexible. Plans are always subject to change. What’s been agreed to by your Chinese partner is more likely thought of as a general outline of the direction you’re headed.

You have an 8 AM breakfast meeting at your hotel, but its 8:30 before your Chinese guest greets you in the lobby. There’s no traffic, no cataclysmic event. No apology, he’s just late. You feel his conduct is insulting and that he’s being rude and insensitive. However, your guest’s point of view may be quite different. He may feel that being late is not rude, it’s just the way it is. Time isn’t rigid, it’s flexible. Therefore, you’re both meeting for breakfast as you agreed.

Understanding the Chinese view of time will help you avoid misunderstandings due to cultural differences and more readily allow you to establish long term relationships.

If you have any questions please send them to info@thornhillcapital.net

The Formation and Influence of China’s Middle Class

Until a little more than 50 years ago, China was a hierarchically based society where your class or status was determined by your ability to accumulate wealth and influence others. This was reflected in ancient Chinese society, during the time of Confucius, where there existed four levels of Chinese society:

  1. The Shi, or scholars, who achieved bureaucratic rank due to their knowledge or relationship with the emperor. This class of society had fame and fortune and exercised bureaucratic control over social resources;
  2. The Nong, or farmer who, as a landholder, produced food and also was a source of tax revenue for the rulers. They were held in high regard by both the ruler and the citizenry;
  3. The Gong, or craftsman, who produced needed goods, and whose esteem was slightly below the nong;
  4. The Shang, or merchants and traders, and were considered the lowest level of society because they did not produce anything, but made money off the goods of others. They were largely despised during the time of Confucius.

confucius2

Later portrait of Confucius,
from the provincial museum of Shandong, China

Confucius taught that a hierarchical society created political and social harmony. This was extremely important during a time when rulers generally governed through succession, and dissatisfaction among the populace could result in a revolution. In addition, the citizenry also supported the teachings of Confucius and regarded his teachings as both an ethical and philosophical system that taught them how they could improve themselves through personal and communal endeavors. The harmony and political stability espoused by the teachings of Confucius was therefore supported by both the citizenry and the Chinese rulers. For the next 2,500 years Confucianism became the official ideology of China, was taught in schools, and was integrated into Chinese culture.

All that changed in 1949 when Mao Zedong came to power. Mao enacted land reform, which seized land from the landowners. Private businesses disappeared as four million non-state-owned entities were systematically dismantled. China overnight became a classless society and the teachings of Confucius were banned from all schools.

With a lack of economic incentives for individuals, the Chinese economy, largely based on the former Soviet Union, fell into disarray. Domestic consumption, except for trade with the former Soviet Union and its satellites, remained economically unresponsive until 1979 when Deng Xiaoping initiated economic reforms throughout China. Deng declared “to get rich is glorious” and, from this time forward, there was an immediate wave of personal entrepreneurship and the gestation of social stratification within China. No longer was the state the sole beneficiary of one’s labor. Individuals could now own businesses and directly benefit themselves.

For the next 21 years China experienced unparalleled economic growth, and social stratification within the population continued. The government, once weary of an emerging multi-class society, could no longer ignore the fact that individuals now had increasingly significant economic and sociopolitical power. They realized that, unless they established policies to address this new social stratification, especially for the fast growing middle class, social and economic instability might occur. The government, fearful that social dissatisfaction could eventually lead to another Tiananmen Square, acted to address major sociopolitical issues. Therefore, in 2000, Jiang Zemin, Secretary General of the Chinese Communist Party (CCP) officially indicated that the CCP would not only represent the interests of the working class, but would also represent entrepreneurs, intellectuals, and technocrats, largely the middle class within China.

But who exactly constitutes the middle class? The answer:  the definition of middle class varies widely, both in the U.S. and internationally. For example, in the U.S., one source has defined middle class as individuals making between $25,000 and $100,000 per year. Max Weber, one of the founding architects of sociology, defines middle class as a class of professionals or business owners who share a culture of domesticity and sub urbanity and a relative level of security against social crisis, in the form of socially desired skill or wealth. In other words, someone is in the middle class if they are a professional and are relatively immune to economic downtowns. However, I believe the best definition of middle class comes from Dennis Gilbert in his book The American Class Structuremiddle class persons commonly have a comfortable standard of living, significant economic security, considerable work autonomy, and rely on their expertise to sustain themselves. The Chinese definition of middle class doesn’t differ markedly from this, and defines middle class as a combination of one’s income, occupation, and education.

The Chinese middle class is generally thought to comprise 214 million people, of which most are entrepreneurs, small business owners, large farmers, government officials, lawyers, academics, and media personalities. Merrill Lynch projects that by 2016 the middle class will grow to 350 million people or 32% of the adult population. McKinsey further projects that, by 2025, China will have a middle class comprising 520 million people. It’s also important to note that most of the Chinese middle class are self-made and not the result of government patronage.

Contact with the West is also responsible for changes within Chinese society, especially within the middle class. One reason is that, as China’s middle class continues to grow economically, they’ve increasingly adopted a more Western point of view wrapped within their cultural heritage. They admire the West, and want to emulate our lifestyle as best they can within the sociopolitical confines of present-day China. In addition, a great many Chinese have been educated in Western countries. Students returning to China from the West, over a period of time, frequently seek lifestyle changes as well as greater economic reforms within China. As a result, the middle class Chinese has increasingly put pressure on the government to act in a manner more responsive to their needs. These efforts have included lobbying against corrupt officials as well as putting pressure on the government to lessen the state’s monopoly of key industries.

The growth of the middle class within China has proven to be a great benefit to both sides. As the middle class within China continues to grow, so has China’s economy. The middle class has, and continues to be, important to the Chinese economy. For example, in 1990 there were 240,000 cars in China.  In 2009 there were 26 million cars. In 2003 there were 3 million credit cards issued within China. In 2008 there were 150 million credit cards issued in China. This domestic consumption and growth was largely fueled by the middle class.

The importance of the middle class is not lost on the Chinese government. Increasingly, the political and economic influence of the middle class is being taken seriously. Since 2000 the Chinese government has viewed the Chinese middle class as a catalyst for the economy. With their ability to invest in domestic products and services, along with their ability to attract foreign investment, the middle class is critical to China’s future and its efforts at converting itself from an export-driven economic model to a domestic consumer driven economy. As this happens, the political and economic influence of the middle class will continue to grow.

If you have any questions please send them to info@thornhillcapital.net

Peer-to-Peer Lending in China

shanghaiIn performing our due diligence of smaller companies, we sometimes run across peer-to-peer lending (P2P lending). It’s a concept that wasn’t prevalent when we started in China in 2003, but it’s since become a significant source of financing for small companies who can’t obtain bank loans as banks tightened their credit policies and focused their lending efforts on larger companies and state-owned enterprises.

Peer-to-peer lending is a fast growing financial segment that first began in China in 2006. In P2P lending an intermediary, or microfinance company, connects lenders and borrowers for a fee, ranging from 1% to 4%. Lenders, seeking to loan small amounts of money, and achieve superior returns on their loans, are connected with people who are looking to borrow small amounts of capital. P2P lending is largely used by those who can’t obtain a bank loan, but don’t want to pay the exorbitant rates charged by shadow bankers.

Microcredit companies are not unique to China, and even exist in the U.S, Germany, and the United Kingdom, for example.  However, China provides a far greater opportunity for such lenders, as their interest rates average about 20%.  According to Simon Rabinovich of the Financial Times, China has 60 million micro-entrepreneurs in cities and 200 million rural poor who can take advantage of P2P lending. There are currently 200 P2P lending websites and 4,144 microfinance companies in China. Microfinance lending in 2012 amounted to 369 billion RMB, up 87% from 2011. Even though this is a huge sum, loans can be quite small, in many cases under $100 USD.

Unlike banks, a micro-lender’s loan is unsecured and the industry is unregulated by China’s Banking Regulatory Commission (CBRC). The reason for this is that the CBRC lacks authority over micro-lending platforms. In addition, the Supreme People’s Court in China has ruled that an intermediary, between a lender and borrower, is not responsible for a defaulted loan.

Borrowers who default can be taken to court by the lender, but a lawsuit is usually too time consuming and expensive given the amount borrowed. So far, defaults don’t seem to be widespread. CreditEase, the largest of the micro-lenders, with over 5,000 employees, estimates that only about 2% of the loans they arrange are overdue.

Part of the reason for this is that, in obtaining a loan, all prospective borrowers are screened and their credibility is checked, sometimes by reviewing utility and tax payment records. According to Li Xiaoxiao of MarketWatch, good credit risks include those who are members of the Communist Party, the well-educated, and blood donors!

But defaults inevitably happen. When they do, the primary weapon of the micro lender is the blacklist, whereby a borrower’s default is made public and their name is posted on the P2P site’s bad credit list. Generally, anyone who is delinquent for more than 30 days will have their name, cell number, China ID card details, and other personal information posted on the P2P website. This turns out to be a significant deterrent to many Chinese who don’t want their financial default to be publicized, which causes them to lose face.

Since most bank-lending in China is directed toward businesses controlled by the state and large to medium sized companies, small entrepreneurs have been forced to look elsewhere for capital. P2P lending fills an important niche between banks and shadow bankers, allowing small businesses and entrepreneurs to obtain un-securitized loans to grow their businesses.

If you have any questions please send them to info@thornhillcapital.net