Steel and Beer Highlight the Challenges Ahead for Chinese Industry

Companies, as Westerners define them, have existed in China for less than 20 years. Understand that, and much of the flux in the country’s economy and its commercial regulations begins to make sense. “China eliminated firms in 1950 and didn’t reconstitute them until 1988,” said Wharton management professor Marshall Meyer during a presentation at the recent 2005 Wharton China Business Forum. “Therefore, it only has 17 years of experience with Western-style businesses.”

The U.S. economy operates like a big city symphony, with companies playing their parts with well-schooled precision. China, in contrast, is like a jazz combo, improvising furiously. Just as jazz’s swirl of sound and rhythm can be disorienting, so can the business environment in China’s fast-growing, quasi-capitalist economy. 

Take intellectual property protection, which remains weak in China, according to Gloria Kamph, chief executive of Interliance, a California-based consultancy. Kamph suggested that officials in Beijing are not willfully ignoring the misdeeds of dishonest firms. “China has new laws that protect IP,” she said. “But the government doesn’t have the resources to police the problems.” 

In addition, noted Steve Sammut, a senior fellow at Wharton and a venture partner at Burrill & Co., any new body of law and regulation takes years to develop. “You can’t just turn on a switch and have intellectual property protection in place. There is a scarcity of attorneys, jurists and common procedures.”

The Chinese government knows that many foreign firms are reluctant to bring operations to China out of concern for their intellectual property, Sammut added. It therefore has committed to taking some necessary steps. “The intention is there. The execution is sometimes overlooked.”

Economic regulations in many areas — and the government’s enforcement of them — can seem haphazard, Kamph added. Likewise, the government can seem to hopscotch from favoring one industry to another. When these changes occur, attempts to do business in the former favorite sector falter, while those in the new one thrive. “Sometimes one door opens up, but another closes,” she said. These changes are partly just the gyrations of a fast-growing, but still adolescent economy, Meyer argued. “Chinese firms come and go like fireflies. Most of them only last two to four years.”

Privatization of state-run firms has seemed similarly chaotic. “It is not clear that, in every case, the privatization process represents an improvement,” Meyer noted. Rather, China’s government has a problem — many of its state-run enterprises are inefficient and poorly run — and privatization has become the favored solution.

Fragmented Domestic Market

Ironically, perhaps the best-known and most successful company in China, Shanghai’s Baosteel, is government controlled, Meyer pointed out. Baosteel began in 1978. Since then, the country’s leaders have dispatched its bosses to find the world’s best steel-making technologies and introduce them in China. The company has grown into one of the world’s largest steelmakers and likely will soon be the biggest, Meyer said. It isn’t just huge; it’s also profitable. In 2004, Fortune magazine named its chief executive, Xie Qihua, the second most powerful female executive of a company outside of the United States.

Baosteel also epitomizes a paradox of China’s development: Companies that export to other parts of the world have developed more rapidly than those that serve its home market. “Domestic markets in China remain fragmented, with lots of little companies and few dominant regional or national players,” Meyer said.

The beer industry, for example, would seem to lend itself to a few big players. People in China enjoy beer; according to The Economist magazine, they drink twice as much, on average, as Germans. That gives the industry the sort of scale that favors big firms. Yet little local brewers still prevail in China. “Five years ago, it was anticipated that two brewers would consolidate the market. That hasn’t happened,” Meyer noted.

Fragmentation and the inefficiency that accompanies it are problems that will solve themselves with time, conference participants suggested. As China’s economy continues to grow and the country’s infrastructure develops, domestic companies that rival Baosteel in size will eventually emerge. But two other challenges — the country’s demand for resources, especially energy, and the degradation of its natural environment — will likely worsen as China tries to extend its recent record of torrid growth.

China, for example, sucks in about 6.75 million barrels of oil a day, making it the third biggest consumer in the world, behind the United States and Japan, said Willie Chien, Asia regional manager for Utah-based Huntsman Corp. Its consumption is dwarfed by that of the United States, which uses 20 million barrels a day, but China’s stands to grow much faster. Like the United States, China has limited reserves — about 24 billion barrels — for a country of its size. That’s less than a tenth of Saudi Arabia’s estimated reserves.

China’s lack of oil means the country will probably have to satisfy much of its energy hunger by turning to other sources, such as coal and natural gas, and to more advanced technologies such as coal gasification, said Pat DeLaquil of Maryland-based Clean Energy Commercialization. Yet even domestic coal isn’t a sure thing for China, he said. Though the country appears to have an ample supply, it may not have enough water to mine it all. Mines use significant amounts of water in drilling and dust management and often wash their coal as part of its preparation. Combine these problems, and China should have sufficient incentives in the long run to embrace cleaner, advanced technologies such as wind and solar power, he said.

The trouble will be getting people to put their long-run interest in clean technology ahead of cheaper, short-run fixes to immediate problems. As is often the case, everyone benefits from energy conservation, but in the short run a few people can end up bearing the costs. “The biggest impediment to energy efficiency in China is the lack of incentives for builders to make the correct investments because they don’t own and operate the buildings,” DeLaquil explained. “The problem is building standards, and buildings last for 40 years. The shame is that, as China builds its infrastructure, it is locking in a lot of energy inefficiency.”

China needs to embrace better building standards and energy efficiency soon, said Anthony Tomazinis, a University of Pennsylvania professor of city and regional planning. If the country continues to pollute as much as it does, the consequences could be severe.  

China is, of course, the world’s most populous country with about 1.3 billion people, or a fifth of the world’s population. Many people means increased garbage, sewage and smog. Industrialization will bring even more. As people’s incomes grow, for example, they buy cars. Cars spew out carbon dioxide, contributing to global warming. “About three million people a day enter Beijing by bike to go to work, and Beijing is building roads like mad,” Tomazinis said. Soon enough, many of these cyclists will switch to cars. And the fumes from their vehicles will add to already significant air pollution levels. By his estimates, Beijing has 265 smoggy days a year. The city faces water shortages as well. “It’s the most water deficient of the world’s 120 largest cities.”