The US embassy in Beijing has for years sought an explanation of how the Ministry of Foreign Trade and Economic Cooperation calculates foreign direct investment returns, but without success. Even the most inconsequential data tend to be treated as state secrets. Furthermore, academic standards are low in an environment where professorships are earned through tenure rather than excellence and criticism is taboo.
Believing in the dream
None of this, however, explains why, when confronted with a lack of reliable information, most foreign companies jumped into China investments anyway. The gap between the little that was known in the 1990s and the vast amount that was expected of the market cannot be put down to bad mathematics and poor research alone. A real understanding of what happened in the China gold rush is arrived at not only through rational analysis but through a psychological leap into the realm of the China Dream: foreign companies invested in China because they wanted to believe that dreams come true.
The story of automotive investment is instructive. In other developing countries, the experience of multinational automotive companies is that private car ownership takes off when economies reach a level of around US$6,000 per capita. At such a point the pooled resources of families make car ownership an affordable proposition.
In the China of the mid-1990s, even if the economy were able to grow at 10 percent a year indefinitely, and without devaluations, the country's gross national product per capita was not due to reach US$6,000 until some time after 2020. Yet in 1994, when annual sales of domestically made cars were 250,000, international car makers were planning to build 2.7m units of annual manufacturing capacity. General Motors alone wanted the capability to build 900,000 cars across three plants – one and a half times total sales in 2000. As it was, Chinese fears of losing the vast potential market to foreign interests meant that only 1.3m units of capacity was licensed, and at the end of the decade overcapacity stood at a mere 100 percent.
There was, and is, no logical way to derive from the level of car sales in the mid 1990s, or from China's economic growth rate, the projection of a market of 1m-3m vehicles a year that both the government and international automakers forecast for 2000. A report in China Daily in 1996 noted that there were only 50,000 licensed private cars in the country since almost all were bought by government units.
But in their pursuit of the China Dream, the hunger of the carmakers was blind, sometimes to comic effect. When GM concluded at the height of the frenzy that the company must open components joint ventures to curry favour for vehicle manufacturing licences, the first business it entered was one for a product for which no market in China existed. Wan Yuan-GM Automotive Electronic Control Co was a US$30m joint venture with an arm of China Aerospace, the rocket-launching agency, to manufacture electronic fuel injection systems.
When the venture was signed in January 1994, not a single vehicle made in China used such components. Somehow, GM was oblivious to this. Indeed, Thomas Sheehan, Asia president of the investing GM subsidiary Delco Electronics, told journalists that China was already absorbing 1m units of electronic fuel injection systems a year and that there was potential for 4m-7m units by 2000. He added that, although total car sales in China in 1993 were only about 300,000, the number was expected to jump to 1m in 1995.
Even this was less wide of the mark than statements by GM's vice-president for Asia-Pacific operations, Thomas McDaniel, who told reporters several times in 1993 that China would buy 1m cars that year. McDaniel appeared to be confused by Chinese statistics for total 'automotive' output, which include not just cars but trucks and agricultural vehicles such as three-wheeled mini tractors. When GM discovered the truth about electronic fuel injection systems, only tiny numbers of which were in use in China even at the end of the decade, the Wan Yuan joint venture was mothballed.
The sirens of the Chinese market sang to most international automakers for the first time in the 1990s, but in other industries there was a definite element of d?j? vu. Carl Crow had written about the disappointment experienced by foreign pharmaceutical companies in China in the 1930s in his book 400 Million Customers. In the 1990s these companies were back and their market estimations were no more rationally grounded than they had been 60 years before.
Early foreign entrants
By the end of 1995, the State Pharmaceutical Administration registered 1,500 foreign drug joint ventures, with US$1bn invested and another US$1.5bn committed. Three early entrants in the 1980s – Johnson & Johnson, SmithKline Beecham and Bristol-Myers Squibb – had built profitable businesses with factories producing low-cost cold remedies, vitamin supplements and anti-fungal creams for the likes of athlete's foot. The success of these operations was made possible by small investments, an absence of competition and the willingness of the state health system to pay for basic over-the-counter medicines for government employees.
However, in the gold rush of the 1990s, international pharmaceutical companies piled into the market with a different proposition – to manufacture expensive, state-of-the-art prescription drugs for the billion-strong market. Almost without exception, the big investments of the decade became loss-makers. Companies like Pfizer, Novartis and GlaxoWellcome were left with US$30m, US$50m and even US$100m factories that operated at as little as 10-20 percent of capacity.
In the US and Europe, premium prescription drugs sold to ageing but wealthy populations are the big money spinners for pharmaceutical companies. In China, a similar market has never existed. Three-quarters of the Chinese population live in rural areas without medical insurance and on an average cash income of US$260 a year. This does not support expenditure on sophisticated medicines costing hundreds or thousands of dollars per course. Another 150m Chinese live in semi-rural townships and might be able to afford to treat athlete's foot or a vaginal yeast infection, but they are equally out of reach of drugs treating depression, rheumatism or arthritis.
The actual prescription drug market is confined to a small number of unusually rich individuals, mostly in big cities, and those state employees whom the government is willing to reimburse for medical expenses; as the 1990s wore on, and pressure on government budgets increased, this latter category was squeezed to keep costs under control. At the end of the decade, a winning prescription drug in the China market was considered to be one that could generate revenues of US$5m a year; in the US, a drug that produced revenues of less than US$250m a year was considered a dud. Even China's best selling over-the-counter medicine, Smith-Kline Beecham's Contac cold cure, generated sales of less than US$90m in 2000.
Despite the evidence that they should do otherwise, multinational companies kept pushing ahead with investments that were predicated on genuinely large markets. This was only encouraged by the role that chief executives played in shaping business plans. China in the 1990s was the place for grand strategy – Jack Smith aiming to use China to increase General Motors' share of the Asian car market from 2 percent to 10 percent; AT&T's Robert Allen looking to reinvent America's most stodgy conventional telecoms company as an emerging market supremo; and Jack Welch of General Electric, normally reckoned so astute, ready to storm Chinese beaches with every one of his 12 operating divisions.
Corporate strategy in China was almost always made at board and chief executive level, and this contributed to the 'no turning back' approach. Removed from day-to-day reality, chief executives were particularly prone to denial when anything went wrong on the ground, and equally likely to blame independent third parties – often politicians – if forecasts were not met.
Most of the world's developing countries are small and command no more than passing attention at the board meetings of large corporations. Strategy in the Czech Republic, with a population of 10m, is not going to land a chief executive on the cover of Business Week. China can. Its size and population alone hold out eternal promise. The Chinese market is the means for a successful multinational to close out its global dominance, the magic charm with which a fading multinational can avoid eclipse. At least this is the stuff of the China Dream – and it demands a commitment of resources far beyond that suggested by current sales figures.
At GM, chief executive Jack Smith and head of international operations Louis Hughes invested enormous amounts of personal time and credibility in their China adventure. The closure of the company's Shenyang pick-up truck line and the stagnation of car sales after 1994 had almost no effect on the men's vision. When the Guangzhou Peugeot joint venture was close to insolvency in 1995, GM saw it not as evidence of the weakness of the market, but as an opportunity to acquire the elusive third car plant that boardroom strategy said the company must have. GM built up an office of 21 staff in the southern city in an attempt to negotiate a takeover. By 1996, the Peugeot factory was selling fewer than 100 cars, and losing US$1m, a week, but GM wanted it.
Whatever had gone wrong was the fault of Peugeot-Citroen, not the market. In May 1997, Louis Hughes thought he had the deal clinched, only for GM to be trumped by Honda – one of many other international car firms still hungry for a China presence.
In the same vein, AT&T's chief executive Robert Allen and his China chairman William Warwick refused to question China's potential for their company, despite mounting evidence that it was the tiniest fraction of what they had believed. In August 1993, on his first visit to Beijing, Allen met President Jiang Zemin and signed a US$500m memorandum of understanding for a ?comprehensive partnership? in telecoms development. The piece of paper came to nothing – AT&T was invited to sell equipment in China but, as was often the case in China, buyers expected to be provided with loans to pay for the purchases.
By 1997, the year in which Allen predicted the country would account for US$10bn of AT&T's business, his company was running a series of small joint ventures, most of them loss-makers; AT&T's turnover in China was a few million dollars.
But Allen and Warwick would not blame the market; instead, they cursed American politicians for irritating the Chinese government. Robert Allen lobbied furiously in Washington for a more concessionary trade policy toward China. In 1996, when Beijing ordered missile tests off the coast of Taiwan, Warwick insisted that it was in America's interests not to oppose the action. He told colleagues at the American Chamber of Commerce in Beijing that US companies had created their own problems in China by upsetting its political leaders.
China became a highly emotive issue for many businessmen. When markets failed to materialise, critical enquiry by outsiders was met not just with denial, but outright anger. In an interview in his Beijing office in 1998, Stan Clemens, the second general manager of GM's pick-up truck joint venture, could barely conceal his rage when it was suggested the business was a failure. "This is a success story and should be presented as such," he snapped.
It was a curious remark to make about a manufacturing line that had produced only a few hundred pick-up trucks in seven years. Clemens insisted GM's accumulated losses were minimal because the 'physical write-off' had to be judged against the 'intangible benefits' of having learned so much about the Chinese market. It became a common justification for businessmen that one had to pay what the Chinese term 'school fees' in order to understand the operating environment.
A few people retained a greater perspective. Jack Perkowski, who touted China on Wall Street with more Barnum than most in the early 1990s, had the good humour a few years later to describe the country as 'the Vietnam war of American business' – because so many promising young careers had been lost there.
Global investment standards
Those businesses that escaped the jaws of miscalculation did so because they maintained global investment standards. The enthusiasm of General Electric and Daimler-Benz chiefs Jack Welch and Edzard Reuter for China was no less burning than that of their peers. Yet both companies pulled back from the brink.
At GE, Welch was saved from misadventure by the very financial systems he had put in place during his 30 years at the helm of the company. GE had transformed itself in that period from a staid engineering business into a lithe manufacturing-to-financial services opportunist through its relentless concentration on investment returns. It was the potential for high returns that Welch thought he spotted in China. After his 1993 visit – at the height of the China frenzy – corporate executives were set scuttling about the country in search of deals. GE Appliances, which makes fridges and other household goods, was one of the most aggressive divisions, scouring dozens of Chinese factories for a partner for a US$300m, pan-Asian manufacturing unit. But the deal never happened. Any investment had to meet an unbreachable GE requirement for a minimum 20 percent return on investment.
Failure to achieve profitability
No matter how many sets of figures, for however many putative joint ventures, the bean counters at the company's Louisville headquarters tried, they could not achieve the requisite level of profitability. Investment costs were too high, brands too weak, distribution too fraught. The same pattern recurred in other GE divisions, and most units did not invest.
It was just as well. Two of GE Appliances' competitors, Maytag and Whirlpool, leapt into investments and paid a heavy price in the face of cutthroat domestic competition. Whirlpool reported Asian losses of US$142m between 1994 and 1996, most of them in China, and thereafter pulled out of local manufacturing operations.
GE went ahead only with a small number of operations where it could plot the road to returns: a successful plastics factory in Guangdong serving export manufacturers; a small business in Beijing assembling medical equipment; a more troubled, larger venture in Shanghai making lighting. In total, and by the end of the decade, the company invested less than half the US$1bn Jack Welch had talked of as GE's initial commitment.
At Daimler-Benz, Germany's biggest industrial company, China investment policy changed because the chairman did. In 1995, the arch-strategist Edzard Reuter gave way to Jurgen Schrempp. The new incumbent announced a GE-like requirement for a minimum return on investment for every corporate division – only his benchmark was a more modest 12 percent. Any project that could not meet the standard was to be abandoned.
The effect in China was immediate. Reuter had beaten off Ford and Chrysler to secure partnership in a US$1.1bn venture making multi-purpose vehicles (MPVs). He also wanted to invest US$800m in building China's 'family car' and have Daimler-Benz Aerospace be a partner in a European consortium to manufacture a 100-seat passenger jet that he claimed would generate US$40bn in sales. But the only car plant in China that had made any returns was Volkswagen's in Shanghai, and aircraft orders were drying up. It was impossible to show where profits would come from.
Family car plans put on hold
Daimler-Benz's MPV and family car plans were put on hold. The company's representatives in the European consortium to build aircraft were told to do nothing that would encourage the project to move forward. When Schrempp travelled to China in December 1997 for an audience with Li Peng, his main concern was that the then premier would ask why Daimler-Benz had not moved ahead with the MPV project. Schrempp was relieved that the subject did not arise.
The number of companies that held back from China investments, however, was small. The boardroom 'visionaries' almost always triumphed over the sceptics, where they existed at all. Normal standards of assessment were suspended because China was deemed too important.
A combination of rudimentary mathematics and 'what if' thinking has long been China's greatest ally. This remained so in the 1990s. In January 1993, Peter Woo, chairman of Hong Kong conglomerate Wharf, could have been selling the China railway bonds of the 1890s or making the case for Lord Macartney's mission of the 1790s when he reasoned: 'Some say that China's GDP will match Japan's in ten years. That assumption is not so far out, because the population base is so huge. Japan only has about 120m people. China has 1.2bn. So if every person in China earns one-tenth the GDP per capita of Japan, you've got the Japanese GDP. Is that so unthinkable?'
Almost 10 years later, China's GDP is still well under a quarter of Japan's, and it is indeed unthinkable. China's economy will not equal Japan's in the next decade, or even in the decade after that. But if history is any guide, this will not stop men like Woo – smart enough to be a billionaire – from dreaming.
This is an edited extract from The China Dream by Joe Studwell (Profile Books, ?15.00). To order your copy post-free call Profile Direct on +44 (0)20 7404 3001 or email email@example.com