Global Tremors From An Unruly Giant

China finally awakens--and the world braces for a new economic superpower

Stroll past the white-barked plane trees and worn buildings in the ancient Yangtze River city of Nanjing, and suddenly, through the branches, looms the enormous blue and white sign of Panda Electronics Group, a top-tier member of China's expanding industrial elite.

Here a New China is hard at work. Thousands of white-smocked women crank out boxloads of televisions, videocassette recorders, and digital switches--goods that give new meaning to the words "Made in China." But Panda's ambitious goals are what really make it distinctive. Within the next five years, it also expects to be a player in multimedia personal computers, mobile-phone base stations, and airborne transmitters. "Our emphasis will be on high tech," says Yuan Junwei, an international official who has inked technical cooperation agreements with the likes of Motorola, Ericsson, Rockwell International, and other leading Western companies that are plunging into joint ventures with Panda.

On a scale that the rest of the world is just starting to comprehend, China is extending its industrial revolution. Until now, growth has come mostly from manufacturers that took advantage of the country's immense pool of cheap labor, where wages average around $100 a month. Increasingly, though, these companies are moving to more advanced products. Within four years, China expects to ship out $100 billion worth of electronics and machinery. It may soon become one of the world's biggest exporter of color TVs, auto parts, and cellular phones, and will also start offering engines, power generators, and computer tomography scanners.

By masterfully leveraging access to its market, Beijing is getting multinationals to subsidize large research and development institutes, modernize university curriculums, and promise to use China as an export base. Thanks to investments from Taiwan and Hong Kong, Chinese engineers are helping produce computer motherboards, CD-ROM products, and educational computer toys. The semiconductor industry, virtually nonexistent a decade ago, could have joint ventures producing chips with superfine circuit lines at a 0.3-micron level by 2000--about the same as South Korea today.

Western corporations are rushing aboard this next industrial lift-off. But the price of entry is mainly on Chinese terms, and as they offer up their tech secrets, anxiety is growing. For some, China increasingly represents the dark side of globalization. "You sit back and wonder," says George J. Kourpias, president of the International Association of Machinists & Aerospace Workers. "Is this the new global economy that we're all being urged to embrace?"

The concerns about China extend to think tanks, government offices, and corporate suites in most industrial countries. As China's joint ventures begin to export more, Chinese policy, not just comparative advantage, will be a force in determining winners and losers in industries across the world. For instance, multinationals that have followed Beijing's rules may use their Chinese factories, rather than U.S. plants, to meet the huge demand for goods in the developing world. Southeast Asian and Latin American countries, even with billions for new investment in better facilities and education, are also finding it hard to compete.

Of the world's big traders, China is in a protectionist league of its own. While Beijing is enacting substantial liberalization, prohibitive duties and arbitrary rules still curb imports of everything from cars to computers. Foreign investment in services such as telephone networks, consumer banking, and publishing is sharply limited or banned altogether. And planners are drafting policies that will demand foreign investors increase their transfer of technology and raise their exports of Chinese-made goods. To build a $420 million color-TV plant in Shanghai, for instance, Sony Corp. had to promise to export 70% of production.

MERCANTILIST JUGGERNAUT. Because its application to enter the World Trade Organization has stalled, China may be able to play this game for years. The thought of such a colossal, unregulated, and unruly object hurtling through the global economy makes analysts shudder. "China's sheer size means the rest of the world has to take developments there very seriously," says Marcus Noland of Washington's Institute of International Economics. "It is the single biggest potential threat to the world trade system."

The first casualties are starting to appear. Both Boeing Co. and McDonnell Douglas Corp. have laid off skilled workers after shifting production to China. James Aldridge, a 30-year McDonnell Douglas assembly specialist, worked at a sprawling Torrance (Calif.) plant that made parts for jets. Now, as one of only 244 left after massive layoffs, he has been shunted to a warehouse and expects that the company will soon be moving even that to China, where it assembles midsize MD-90 jets. "The handwriting is on the wall," he says.

This is ready ammunition for trade warriors who fear that China is becoming a mercantilist juggernaut. This spring, Congress may resurrect the debate over whether to rescind China's most-favored-nation trade status. Along with the usual hot buttons of human-rights abuses and illegal arms sales, such issues as technology transfer, exports of U.S. jobs, piracy of software and music, and the ballooning trade gap are likely to become more prominent.

It's easy to overstate China's economic threat. It has dynamic exporters, but it poses little threat today in heavy and high-tech industries, which are controlled by the inefficient state sector. Beijing enforces protectionist rules, but imports have grown almost as fast as exports over the past 15 years. Through joint ventures, multinationals are getting impressive access in key sectors, with 80% of car sales, 90% of PCs, and almost 100% of telecom equipment. The trade surplus with the U.S. is growing, but the U.S. estimate of $35 billion does not account for services, the high content of imported components in Chinese-made exports, or the billions worth of U.S. goods transshipped or smuggled into China through Hong Kong.

Multinationals contend that transferring technology is largely risk-free. Many pioneers in China have reaped rewards without creating new competitors. Since United Technologies Corp.'s Otis Elevator Co. started a joint venture in the northern Chinese city of Tianjin in 1984, it has moved ahead of Mitsubishi Corp. and Schindler Elevator Corp. to capture 25% of the expanding market. This year it will double its capacity, to 8,000 elevators. "We bring the latest technology," says Richard J. Latham, president of UT's China operations. Yet little of that knowhow has leaked to the 200 local elevator makers, whose products are far from world standards.

Otis' success has opened doors for other units of UT, which has invested some $500 million in ventures ranging from Carrier air conditioners and Transicold refrigerated trucks and railcars to Pratt & Whitney jet-engine parts. An additional 10 joint ventures are under negotiation. By having such a huge presence, Latham believes UT companies also have an edge in landing big orders for U.S.-made power generators and high-end air conditioners.

Still, China's efforts to milk more out of foreigners means few secrets are really safe. The Chemical Industry Ministry has long been suspected of passing proprietary formulas obtained through joint ventures with foreign chemical and pharmaceutical companies to other state-owned factories. Moreover, now that the West has relaxed restrictions on high-tech sales to communist countries, it's also possible that technology will be diverted to China's ambitious military. McDonnell Douglas sold sophisticated machine tools under pressure from Beijing for use at a civilian aircraft plant; it later learned the machinery went to a factory producing defense fighters and missiles.

MENACING MICROSOFT. The demands on multinationals to help make Chinese industry competitive are unrelenting. Microsoft Corp., under threat of having its software banned, co-developed a Chinese version of Windows 95 with a local partner and agreed to aid efforts to develop a Chinese software industry. Chubb Corp., one of more than 40 foreign insurers competing for a new license to operate in China, is promising to build a $1 million "insurance university" in Shanghai. Northern Telecom, AT&T, Alcatel Alsthom, and others have established tie-ups in wireless communications, networks, and microchips. They have also established local labs, sent researchers to the West, and brought Chinese engineers into their product-development networks.

No one has outdone General Motors Corp. in the effort to win over the Chinese. To beat out Ford Motor Co. for the right to become a 50% partner in a $2 billion project to build midsize sedans in Shanghai, GM offered to bring in dozens of parts joint ventures and design much of the car in China. It also will set up five research institutes to teach Chinese engineers--most of whom don't even drive cars themselves--to turn technological theory in fields such as power trains and fuel-injection systems into applications. China will become an important part of GM's global sourcing network. Says GM China President Rudolph A. Schlais Jr.: "We've made the level of what it takes to participate here a hell of a lot higher."

Yet, given its self-image as a 21st century superpower, China may not be satisfied just being part of a foreign company's network, observes Denis Fred Simon, a technology-transfer specialist with Andersen Consulting: "They talk techno-globalism, but deep down, they're techno-nationalists. They don't want to be incorporated into an interdependent world."

If China is destined to be the world's biggest market for everything from cars to electrical appliances to computers, Beijing policymakers ask, what's wrong with wanting strong local industries? "To build a modern telecom network is impossible if you only import," says Xu Shangyan, a Ministry of Posts & Telecommunications director. "We must build a domestic industry."

But in scanning China's industrial landscape, planners see a long way to go. State companies in a host of industries need big infusions of technology and capital to stand on their own when China finally joins the WTO. There are 3000 Chinese pharmaceutical makers, for example, but only 20% are seen as up to world standards. Some 1 million PCs were sold in China last year. But of the top five brands, only one--Beijing's Legend Group--is local. And it's losing share.

To remedy that, the resurgent State Planning Commission in Beijing is focusing on bringing five "pillar industries"--autos, electronics, petrochemicals, machinery, and building materials--into the 21st century. The goal is to guide foreign joint ventures and get local players to merge into big groups like Korea's chaebol. "We want to elevate and develop our industrial products and one day replace the imports," says Lu Zheng, an industrial economist at the Chinese Academy of Social Sciences.

To reach this goal, Beijing is willing to flout free-trade principles. Its auto-industry policy, announced in mid-1994, is particularly harsh. The tariff for an imported passenger car is 100%. Rather than sell directly to consumers, foreign auto makers must deal with government trading companies. The result: In the first six months of 1995, vehicle imports plunged by 60%, to around 20,000, even though domestic car sales surged 7.4%, to 719,000. The plan also said that until 2000, only one new foreign auto maker would be allowed to form an assembly joint venture, resulting in the fierce contest between Ford and GM.

Bureaucrats are pressing ahead in other sectors. Last September, the Electronics Industry Ministry issued guidelines saying that all new foreign projects in computers, electric appliances, mobile phones, and fax machines should involve "new generations" of products and "continuous technology transfer." In addition, they must export over 70% of production. Policies are expected soon in machinery and chemicals.

But as the Sino-U.S. trade gap mounts, critics ask why U.S. companies must jump through these hoops. Besides denying access to companies that can't afford to play Beijing's game, China's policies perpetuate a structural imbalance: The U.S. can't directly export where it has comparative advantage, while America's doors are wide open to China. Says former Deputy Trade Representative Michael B. Smith: "They only are letting in companies which fit their master plan."

LACKING THE TOOLS. The Clinton Administration has had trouble confronting this issue. It now includes compulsory technology transfer and export commitments in its litany of unfair practices. But other than complaining to Beijing, Clintonites argue there's little they can do when U.S. and European rivals are still one-upping each other to woo China's bureaucrats. "We are creating a competitor of extreme proportions," argues a senior U.S. official. "But we don't have the tools to deal with that threat."

With relations strained, talking China out of its restrictive policies is becoming increasingly difficult. In this respect, China-watcher Gerald Segal at London's International Institute of Strategic Studies says China "is even scarier than Japan." At least with Tokyo, he notes, Washington has a solid ally with common security and geopolitical goals. Not so with China. And as party hard-liners turn more stridently nationalistic, they tend to view any setback, including failure to enter the WTO, as part of a grand U.S.-led conspiracy to "contain" China.

Many people worried about China hope it will behave once it wins entry to the world trade club. But Beijing wants to raise its domestic industries to world standards before fully opening up and seems willing to wait--unless it can enter under soft terms reserved for developing nations. The Chinese are also confident that they can exert leverage on Western trade rulemakers. If China isn't admitted, "all contracting parties will suffer," says Sun Zhenyu, vice-minister for foreign trade and economic cooperation. "China needs the WTO, and the WTO needs China." The rest of the world, therefore, faces a dilemma. If China is inside the club without sharing the same obligations, it is big enough to render the rules of world trade meaningless. Having an 800-pound gorilla on the loose, though, is just as destabilizing.

The pressure will only grow. As it continues to enjoy the benefits of multinational largesse, China is turning into a greater threat to countries that once saw it just as a land of cheap labor and huge markets. So far, there's little that officials in Washington, Tokyo, or Brussels are doing about it. Companies anxious to get access to China's riches are willing to pay the piper. While that continues, Beijing may be able to play by its own rules for a long time to come.

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