China – United States Trade Analysis
Chinese Economic Development
China’s Growing Resource Needs
China and Globalization
Protecting Intellectual Property
Working with Government Bureaucracy
International Management Considerations
Modes of Market Entry into China
Recommendations for International Expansions
China financial integration has significantly developed over the past three decades. The total of U.S.-China trade balances grew from $5 billion in 1980 to $409 billion in 2008. Both economies were significantly affected by the global financial crisis and the 2008 balance was reduced by a little over ten percent in 2009. However, the United States is still the world biggest importer of Chinese goods and the Chinese market as represent the third largest importer of U.S. exports. The total amount of trade between these two financial powerhouses is enormous. Furthermore, the Chinese population is already staggering and it is developing economically in historical rates. Thus China also represents a key strategic partnership for the U.S. indefinitely.
However, these trade routes do not come without a fair share of frustration. Since the U.S. imports far more than they export, there is rather large trade deficit that must be dealt with. Also, China’s authoritarian government has intermittently chosen which World Trade Organization obligations it wishes to follow and seems to stall or ignore the rest. There have been numerous calls from nations across the global for China to let its exchange rate float as opposed to keeping it fixed. China also has a weak record on enforcing intellectual property rights (IPR), and its extensive use of protectionist policies to promote domestic Chinese firms over foreign companies. Many analysts predict that such trade conditions will continue to erode into the future; however given the extent of economic integration this may prove to be a slow and tedious process at worst.
This analysis will look at the potential for a U.S. company to incorporate Chinese manufactures into its supply chain to serve as a production base. The chosen U.S. industry will be that which consists of small handheld electronic devices i.e. cellular phones, personal organizers, global positioning system (GPS) devices, and other related goods. This strategy has worked well for many of the firm’s competitors and the attractiveness of utilizing China’s production capabilities seems to grow exponentially. However, at the same time, there is inherent risk associated with such a strategy and the risks identified will also be presented. The concluding recommendation asserts that, under the present circumstances, that such a strategy move should be deferred until economic conditions stabilize.
Chinese Economic Development
In the year 2001, China joined the World Trade Organization (WTO) and Americans gave way to the new “Asian powerhouse” (Rumbaugh and Blancher 2004). China has developed at roughly nine percent a year for more than a quarter decade and is sometimes referred to as the fastest growth rate for an economy in history. With exports rising from 38.8 billion to 196.7 billion (a 400% increase) from 1994 to 2004 to the U.S. alone, this growth curve represents one of the most remarkable financial developments ever. China is responsible for roughly two-thirds of the world’s copiers, microwave ovens, DVD players and shoes which are manufactured in China.
With this powerful manufacturing advantage that China has, its promising future does not seem to contain any boundaries. Some have estimated that the size of the Chinese economy will overtake the U.S. economy within a decade. With its 4,000 skyscrapers in the financial capital alone, Shanghai, and the ever rapidly growing economy, China might just do more than simply overtake the United States’ economy. They may undoubtedly dictate the direction of world markets. This is the course China seems to be headed for.
The unbeatable Chinese manufacturing industry is due not only to low labor costs but also, by some accounts, to unethical trade practice. According to one article in Newsweek World News a Morgan Stanley report showed that cheap imports from China has saved American consumers more than $600 billion in the past decade (Zakaria 2005). At the same time, this has in turn acted to devastate the domestic production capacities that the U.S. once held. Some view the world’s fastest-growing economy and second largest holder of foreign-exchange reserves as a threat while are oblivious to its potential. Many in the U.S. are also realizing that this adds to the domestic unemployment rate (Mankiw 2003). This also adds to the risk of enhanced levels of tension through the political ramifications of millions of unemployed American manufacturing workers.
China’s Growing Resource Needs
China has experienced economic growth in the last half century that can only be referred to as historical (Gallagher 2005). With its enormous population and track record of double digit growth, some analysts predict that China could emerge as the world’s dominant economy within the next decade; some estimates as early as 2016 (Inocencio 2011). It already accounts for a massive percentage of the world’s total manufacturing capabilities and its manufacturing dominance is unlikely to erode anytime in the foreseeable future. Although it would not be accurate to say that the Chinese population on a whole has benefited from this economic prosperity equally, these developments have brought millions of citizens out of extreme poverty and also have led to the development of a large and growing middle class. Some experts predict that the middle class will grow from twenty three percent of the population to forty eight percent within the next ten years (People’s Daily 2010).
The Chinese market is one of the most attractive and misunderstood markets in the world from the perspective of developed countries. There have been attempts to break into this market by world class companies that have resulted in disaster because of the staunch cultural divide. One future necessity for the Chinese manufactures to maintain their growth curve will be the importation of key resources; including water (Asia Water Project 2009). China’s land holdings are blessed with many natural resources however at the rate of current consumption and demand for various resources it is reasonable to suspect that vast amounts of importation will be necessary to fill its demand.
Since the growing need for raw materials is increasing exponentially, Chinese supply chain will grow increasingly outside of the domestic market. Consequently, this does carry some risk to the sustainability of supply chains that originate in China. If the Chinese rely solely on international firms as suppliers their supply chains will be under their control and thus subsequent to their demands. In order to exert more control over their raw material sources, Chinese firms will have to expand internationally resulting in the potential for increased tension and conflict (Pleven 2010).
Figure 1 – U.S. Stockpiling Race with China (Pleven 2010)
China and Globalization
With China’s trajectory into the global markets appearing to be exponentially increasing, the country is often considered as the most vital nation today for both developing and developed countries alike. China manufacturing capabilities are ever increasing and not only can the produce high-quality, low-cost manufacturing but increasingly, high-quality, high-cost manufacturing. Organizations’ such as Google and Microsoft have relocated research and development operations close to Tsinghua University in Beijing in hopes of recruiting top students from China’s greatest science and technology institutions (Tsinghua University 2011). Despite considerable losses incurred thus far, Microsoft has remained steadfast in regards to funding operations in China, indirectly suggesting their predictions of the future of the Chinese economy.
China to this end has accepted a proactive position in regards to the flattening of the world by allowing competitors from other nations entry into its markets; although still clinging to many protectionist policies. The Chinese have also embraced many of the various types of products as well as the cultural lifestyles they represent. Examples of this are Wal-Mart, Kentucky Fried Chicken, McDonalds, and Domino’s Pizza, just to name a few. The country finds itself more connect to more people than ever before through the implementation of cheap broadband and mobile services; though many of these services are still censored.
China has also made a significant investment in domestic infrastructure that also helps connect cultures such as roads, airports and other transportation systems. Education spending within China has received record levels of funding and is often internationally focused. For example, China has more English speaking citizens in its country than does many other countries in the Asian Pacific. They have recognized that education is vitally important for the continued growth of the nation and an international focus is only one method which they are pursuing.
Between China, India, Brazil, and Russia (BRIC), roughly 12% of their collective populations have broadband access, linking some 340 million people. These people have access to many of the same, if not better, resources, education and tools as people in developed countries. The repercussions of this trend are exceptional and it is predicted that in the coming years China will grow from simply a manufacturing base to more of an intellectual bases as well. However, in order to facilitate the economic, social and political transition to accommodate globalization, China must overcome some major obstacles which are specific to China; protecting intellectual property, working with government bureaucracy and increasing effective business relationships.
Protecting Intellectual Property
Intellectual Property (IP) is regarded as a major deterrent for foreign companies wishing to establish themselves in the Chinese market. It is projected that as much as 90% of business software sold in China is derived from pirated copies. This problem remains widespread despite recent changes to China’s IP policy. It is uncertain if this problem will lessen in the future. Many of the roots causes for imitation goods arise from the dishonesty of local government officials and a large population living in poverty that use pirated goods as a means to sustenance.
The problem of IP rights serves as a major problem for U.S. investors looking to expand to international markets. It serves as a major deterrent for any organization to form a partnership with a Chinese firm in any market. If such a partnership did manifest, then the outside partner would always hoard any proprietary information. If they shared any proprietary practices then the Chinese firm may very well collect this information and send it back to China for its own personal use. Thus this would serve as a major obstacle for any firm to expand into a new market through the means of a partnership.
However, at the same time, many companies choose to do just that. Apple’s supply chains originate in China where entire cities are built around Apple’s supplier’s production facilities consisting of hundreds of thousands of people working on iPhones, iPads, and iPods. However, to maintain control over IP in this instance, Chinese partners use brute force. Suppliers have come under criticism for using child labor, having unsafe working conditions, and being guilty of other human rights abuses (Moore 2010). There have also been many complaints about Apple’s suppliers breeching environmental regulations (Meyer 2011). One case even highlighted the harsh conditions that these employees must endure by telling the story of an employee who worked at Foxconn, one of Apple’s largest suppliers, who committed suicide while undergoing a beating for being accused of stealing an iPad.
Working with Government Bureaucracy
China has been called one of the world’s most corrupt regions of the world in which to do business. Today’s problem stems from a new cultural development which leads many people to pursue personal gain before any other consideration, a significant move away from socialist ideal. Additionally, the government also maintains the control over the access to resources Corruption can take the form of any one of the following forms; demands for payments of unauthorized fees, payment for services that should be provided as part of a bureaucrat’s job, or a payment or kickback for awarding a business contract or preferential treatment.
The Economic Co-operation and Development (OECD) and five other countries have recently signed the OECD Convention on Combating Bribery. All countries struggle to ensure that corruption be eliminated by establishing legislation in all contributing nations. In addition, some research suggests that international agents may improve communications between their stakeholders and the foreign entity thereby increasing cooperation. Communication has been show to significantly increase the sense of group effectiveness, cohesion, mutual obligation and interdependence all of which may act to deter corruption in international business deals.
International Management Considerations
Measuring a potential business endeavor has many facets which the international manager must be conscious of in order to deliver the correct information back to the decision makers. Being unaware to any of the aspects can lead to an incorrect representation of the project, and hence an uninformed decision being permitted. In order for a business to survive it must grow and in China’s case this requires massive amounts of resources. For growth to be ideal, management must first be able to identify the most attractive prospective leads. The country as a whole, specifically geography, government, and financial aspects must be considered in order to produce the most accurate analysis of the market that a company may wish to enter. Awareness of various issues should be based on than gathering reliable facts that are backed up by more than one source.
The success of the multinational corporation lies on the shoulders of its management. International management has three essential duties: direct supervision, development of the organization’s strategy, and management of the organization’s internal boundaries. Top management’s obligation at and beyond the organization’s precincts is largely a communication requirement. Within even some of the largest world class organizations, the process used is disorganized and unpredictable; especially in the light of language and cultural barriers. Furthermore, the Chinese language and culture are vastly different from that of the traditionally recognized developed countries. Thus this translates as a significant barrier for Chinese entrepreneurs.
Modes of Market Entry into China
There are four mechanisms that represent foreign market entry modes. These modes are exporting, licensing, joint venture, and also direct investment. Generally organizations choose a joint venture motive entry to achieve one of five objectives. The first is market entry as in our case with China. However organizations may also choose a joint venture to share risks and rewards or to engage in joint product development. The other two objectives are technology sharing and also a joint venture to be chosen to conform to a foreign government’s rules and regulations.
Many other advantages can be acquired through a joint venture such as access to key product distribution channels or knowledge of the local customs and intricacies within the international marketplace. Although many of the same benefits can be gained through acquisition, a joint venture often has an advantage by ensuring both organizations work towards their common strategic goals. Also sharing resources they provide access to quantities of scale in different arenas that he could not access individually.
There are also many potential problems associated with a joint venture. One potential problem is a constant struggle over proprietary information. This occurs when one company refuses to share where hordes if knowledge management or acquired best practices. Disconnects create mistrust between the two organizations. Cultural clashes can also produce barriers to collaboration. This is definitely a problem Chinese firms will have to work to overcome since the conditions surrounding the state of intellectual property rights is so volatile in domestic China.
Recommendations for International Expansions
It is recommended that U.S. firms explore the joint venture avenue first and foremost. This will help them overcome the cultural divide that they might otherwise struggle with if they tried to enter a market by themselves. It would also serve to help them navigate the governance restrictions and local regulations that would otherwise require a rather sharp learning curve since they are so different than that of the U.S. regulatory environment. This is true especially in light of the IP voids in China and any over exposure to IP risk could be catastrophic for U.S. firms. It is not recommended to be as brutish as Apple is in regards to human rights, however some measure would have to be taken.
The second best route for U.S. firms to gain control over supply chains would be through the form of acquisition. If U.S. investors acquired an existing organization then it could keep most of the existing staff. This would also help them overcome the cultural issues that will serve as obstacles in their business endeavors. This staff would undoubtedly already be familiarized with the regulatory environment and could maintain their operations roughly to the standard in which they have in the past. The only key difference in this scenario is that the ownership of the firm would be from foreign origins as opposed to the domestic ones. Then the U.S. ownership could have some flexibility in the amount of control in which they wish to influence over the arrangement. Ideally, management could operate virtually independent as long as they adhere to the key strategic requirements of the parent company.
If neither of the first two options is feasible, then Chinese firms could always stick to importing raw materials from foreign firms. Although, under this scenario they would have limited control over their supply chains they would also have little risk in regards to market entry and ownership issues. This currently represents the most common form of raw material imports for the Chinese. However, as the market becomes more competitive for sources of raw materials then it is reasonable to suspect that the Chinese will wish to exert more control over their supply chains.
Direct market entry serves as a future option, however at the present time it is not recommended for Chinese firms. The cultural and social differences would carry to much risk. Into the future however, the effects of globalization might make this option more feasible. Also, it seems like Chinese planners might already be training the next generation of business leaders right now. As previously mentioned, there are more English speaking Chinese people in China than English speaking people in the United States. It is doubtful that this is a coincidence.
U.S. firms will be increasingly looking to gain more control over their manufacturing base as China continues to dominate the world in this scene. Current efforts were identified that would lead one to believe that they are training a new generation of business leaders that are capable to bridging cultural divides in China. It is reasonable to suspect this generation would be accommodating to U.S. firms. However, at the present moment it would seem unlikely for U.S. firms to be able to mitigate the risks associated with direct entry into new markets.
This basically leaves two options available for U.S. firms in regards to securing China’s manufacturing capabilities. They should first look to form partnerships in China that already have the production capacities to produce electronic goods. This would benefit the U.S. firms greatly, however it is suggested that the domestic firms would be not deserving of too much trust due to the lack of enforced intellectual property rights in China. Thus any U.S. firm could not trust any of their Chinese partners with trade secretes making the relationships uneasy at best. Thus, acquisition would be the only other remaining alternative available for market entry in China. This would allow U.S. owners to keep the existing foreign staff and give them flexibility over both their level of control as well as the supply chain.
Asia Water Project. “Water supply and demand gap.” The Asia Water Project. December 2009. http://www.asiawaterproject.org/water-crises/why-water/water-gap / (accessed August 29, 2011).
Gallagher, P. “CHINESE TRADE GROWTH IN HISTORICAL, REGIONAL CONTEXT.” Trade & Public Policy . June 14, 2005. http://petergallagher.com.au/index.php/site/article/chinese-trade-growth-in-historical-regional-context (accessed August 30, 2011 ).
Inocencio, R. “The ‘American Age’ to end in 2016?” CNN Business. April 27, 2011. http://business.blogs.cnn.com/2011/04/27/the-american-age-ends-in-2016 / (accessed August 29, 2011).
Mankiw, G. “China’s Trade and U.S. Manufacturing Jobs.” Havard Economics. October 2003, 2003. http://www.economics.harvard.edu/files/faculty/40_testi_hcwm.pdf (accessed August 29, 2011).
Meyer, D. “Can Apple Redeem Itself on Supply Chain Sustainability? Taking a Cue on Accountability from Nike’s Playbook.” Valuestreaming. February 3, 2011. http://valuestream2009.wordpress.com/2011/02/03/can-apple-redeem-itself-on-supply-chain-sustainability-taking-a-cue-on-accountability-from-nike%E2%80%99s-playbook / (accessed August 29, 2011).
Moore, M. “Apple admits using child labour.” The Telegraph. February 27, 2010. http://www.telegraph.co.uk/technology/apple/7330986/Apple-admits-using-child-labour.html (accessed August 29, 2011).
People’s Daily. “China’s middle class to reach 48% in 10 years.” People’s Daily Online. July 19, 2010. http://english.peopledaily.com.cn/90001/90778/90862/7071235.html (accessed August 28, 2011).
Pleven, L. “Pentagon in Race for Raw Materials.” The Wall Street Journal. May 3, 2010. http://online.wsj.com/article/SB10001424052748704608104575220112898707130.html (accessed August 28, 2011).
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