Why This May Not be China’s Century

Shanghai Skyline

The Shanghai Skyline, by dawvon (Pudong) via Wikimedia Commons.

Over the past few centuries, China has suffered its fair share of embarrassments.  From the Opium Wars to the Great Leap Forward, its hailed position as the middle kingdom has been eroded time and again.  Deeply engrained into the psyche of China’s populous is the belief that China must reclaim its position as a world power.  This stark contrast between China’s idealized status today, and the ruinous state of China a mere half-century ago, resulted in a cognitive dissonance among its populous that has no doubt been a strong catalyst for recent economic reforms.

Gradually implemented reforms such as dual-track pricing, liberalization of socialist policies, and expansion of investment between China and foreign powers has brought about three decades of maintaining nearly 10% growth rates, an extraordinary feat for a nation that was on the verge of collapse fifty years ago.

Its recent ascension as the world’s second largest economy, coupled with potential increases in domestic spending and widespread domestic and foreign investments, have led many to call this century “China’s century.” Yet this optimistic forecast quickly sours when one considers the slew of imminent crises confronting China over the coming decades.

Implemented to curb China’s booming population growth rate, the one-child policy is sowing the seeds of China’s demographic and economic crises.  With the vast majority of families proscribed from having more than one child, China enjoyed an enormous demographic dividend – defined as the economic benefit a country experiences when it has a low ratio of dependent to independent workers – over the past three decades.

This dividend is already starting to expire.  By 2050, 25% of China’s populous will be above the age of 65.  Attempts to solve the demographic crunch by relaxing the one-child policy will prove futile, as any increase in China’s birth rate will only reap modest effects some two decades from now.  Furthermore, as a consequence of this policy, China’s gender distribution has already taken a heavy toll.  A well-established trend in China is the preference of male rather than female children, which has resulted in scores of sex-selective abortions. With an estimated 30-40 million more boys than girls in China, millions of young bachelors will now be unable to find wives.  Add sexual frustration to their already bleak economic prospects, and millions of disgruntled male migrant workers will be even more inclined to take to the streets in the name of political protest.

In addition to economic stagnation and political upheaval is a housing bubble throughout the PRC.  Fueled by greed and overly optimistic homeowners, price to rent ratios across China have skyrocketed past stable levels.  Flawed social expectations have only exacerbated this impending bubble.  Across China owning a home is a prerequisite for finding a wife.  With millions of only children, bachelors are in a position to seek financial assistance from both parents and grandparents, and pay grossly inflated prices for real estate acquisition.  It is unclear how the Politburo plans to address the housing market’s impending crisis.  What is clear is that whether the housing market encounters gradual deflation or a bubble burst, China’s economic prospects will suffer as a result.

Government action to address widespread pollution will bring about similar economic decline.  Two winters ago, China’s AQI (air quality index) broke records when it surpassed 800. Prior to this incident, measures of AQI had never exceeded 500.  Across China, pollution’s wrath has affected the health and economic livelihood of its population.  In Beijing it is now common for parents to select their children’s schools based upon the quality of their air filtration systems.  One particularly noxious chemical, PM 2.5, is found in hazardous doses across Mainland China.  Until China adequately addresses this affront to its citizens’ health and well-being, it will continue to pay increasing social and economic costs.

In spite of China’s woes, there remains a chance at redemption.  This may not be China’s century in terms of economic and geopolitical supremacy, but it may be their century to pave the way for environmental protection, sustainable development, and economic and political reform.  In the words of Churchill, “Failure is never fatal, success is never permanent.  The only thing that really matters is never giving up.”  This of course assumes that China’s population of 150 million migrant workers doesn’t take to the streets, overthrow the Communist Party, and support a military coup.  That could just be the straw that breaks the camels back.

Hooray for Hollywood? – Where Hollywood Meets the PRC

Grauman's Chinese Theater Panorama

Grauman’s Chinese Theater. Samantha Decker (Own work) [CC-BY-SA-3.0 (http://creativecommons.org/licenses/by-sa/3.0)], via Wikimedia Commons

As more people move into the middle class in China, disposable income spent on goods and services will only increase. But disposable income extends far beyond goods and services, and to date some 300 million more people in the world are ready to start spending money on entertainment. In a 2013 study by Ernst & Young, the firm noted “spending on entertainment and recreation [in China] jumped from $350 billion in 2010 to $547 billion last year.” Because American content – whether television, film, or music – is universally revered, huge opportunities await US Media and Entertainment (M&E) companies in a region capable of hauling in more than $10 billion in value by 2017. Hollywood’s most successful films are reliably hitting the $100 million revenue mark at the Chinese box offices.

Well aware of these opportunities, American film studios have made China a top priority marking a dramatic shift in perceived foreign markets only a few years ago. Notably, Bank of America-Merrill Lynch Global Research released a study this year detailing these opportunities and reaffirmed that “from 2007-12, China’s box office has improved at a compound annual rate of 47% to $2.7 billion […] fueled by a 30% CAGR in screens […] The top 10 Hollywood films in China generated a steady 30% share of the 2012 box office.” Breaking down these statistics, 26% of the China box office goes to local films – roughly 560 Chinese domestic films get made every year – and 150 of those are released theatrically with only 70 becoming notable box office contributors. These statistics not only reflect the expanding local production industry in China, but also their preferential regulatory treatments standing as a major entry barrier for US film studios.

Along with preferential treatments, an import quota on Hollywood films makes for fierce competition among US studios. Before 2012, China capped the number of US films to be released in mainland cinemas at 20; only last year was President Obama able to get China to increase their quota to 34.

Looking to 2030, however, it is unlikely that China’s film quotas will disappear all together. With the Hollywood quota already maxed out for 2013, China’s domestic films have been able to flourish. As of November 25, 2013, Chinese films hit the $3 billion revenue mark with prospects of another late boost as cinemas rush for a photo year end finish marking a remarkable shift from a considerably more lackluster balance sheet just over a decade ago with FY2002 revenues below $164 million.

While still a burgeoning industry in China – America’s $385B industry dwarf’s the PRC’s $73.2b – Ernst & Young predicts Chinese M&E will grow 17% annually for the next five years. En masse injections of private capital have been the major driver, truly enabling the industry to soar. In 2013 alone, China built over 4,500 new movie theaters (over 10 per day) increasing their countrywide total to over 17,600.

A major bankroller in the industry has been Wang Jianlin who is Chairman of property giant Dalian Wanda Group Corp. along with being China’s richest man. Earlier this year he bought America’s second largest movie theater chain, AMC, for $2.4 billion. Following that, in November Wanda announced their plans to build China’s own version of Hollywood with a $4.9 billion to $8.2 billion investment in a mega-entertainment center. The Qingdao Oriental Movie Metropolis, or “Chollywood” as it is being called, will include 20 massive studio lots and is being supported by A-list stars such as John Travolta, Catherine Zeta-Jones, Nicole Kidman and Leonardo DiCaprio. With signing agreements with four top global talent agencies, by 2030 we could see a substantial “brain drain” from Hollywood into China. Because the US is unquestionable global hegemon in the entertainment world, the demand for American expertise in content, storytelling, marketing and distribution is very high in China. Yet, there is a great deal of doubt surrounding Wanda’s project.

China’s politicians have made clear that conceptual films portraying China in a negative light will have no market on the mainland, as highlighted in World War Z’s recent debacle with the PRC. In one of the first cuts of Brad Pitt’s zombie movie, there was a scene where his character concluded the zombie apocalypse originated in China. Fearing governmental backlash, Paramount producers changed the origin to South Korea. In sum, China wants non-controversial films that pay tribute to Chinese life and culture. However, even if Wanda’s “Chollywood” project is completed, and in 2030 China’s film industry becomes large enough that China no longer needs import quotas to achieve their growth objectives, the government’s intense and seemingly unrelenting relationship with censorship will become an impediment to future growth.

As stated above, out of the 560 films made per year in China, only 70 make it to the box office. Much of this is due to strict government examination. All 34 Hollywood films allowed in China also go through close inspections to ensure alignment with government principles. To mitigate potential issues with their films, US studios are increasingly re-editing content, and with some going so far as to shoot entirely different versions for a PRC release.

A recent example is Relativity Media’s 21 & Over, a story about a Chinese-American medical student besieged by parental-induced anxiety who chooses to alleviate exam stress by partying at a fraternity house. Before production began, Relativity Media told producers there would be two movies made, one for an American audience and one for a Chinese audience. With a vastly different storyline from the original plot, the movie’s director Jon Lucas said in an interview: “21 & Over, in China, is sort of a story about a boy who leaves China, gets corrupted by our wayward, Western partying ways, and goes back to China a better person […]” Hollywood is an industry where the realm of creative possibilities is endless. Studios have always strived to balance creativity with profits; movies like Gravity prove that you can have both, no matter how expensive. However, this question of balance is taken to new heights when looking ahead to 2030 and the inevitable interconnectedness that will define the China-Hollywood relationship.

At what point is the creative process impacted by geopolitical constraints that define China’s film market? The multi-billion dollar question facing Hollywood today is whether film studios can fully tap into the China market without marginalizing the creative process that should, and hopefully will continue to, define the industry.

The Bear and the Dragon

An hour outside of Mandalay in upper Burma (Myanmar), construction of the Sino-Burma pipeline tears through the thick jungle. The pipeline is a joint venture between China National Petroleum Corporation (CNPC) and Myanmar Oil and Gas Enterprises (MOGE) and is designed to ease China’s dependence on oil/gas transfers through the Strait of Malacca. (Photo Credit: Reid Lidow, All Rights Reserved 2012).

An hour outside of Mandalay in upper Burma (Myanmar), construction of the Sino-Burma pipeline tears through the thick jungle. The pipeline is a joint venture between China National Petroleum Corporation (CNPC) and Myanmar Oil and Gas Enterprises (MOGE) and is designed to ease China’s dependence on oil/gas transfers through the Strait of Malacca. (Photo Credit: Reid Lidow, All Rights Reserved 2012).

In recent months, international news has focused intensely on ominous developments in the East and South China Seas, along with the bloody sectarian dramas engulfing the Middle East. Conflicts across Africa, from Somalia to Nigeria to the Central African Republic, have also captured attention, though they remain largely under-reported in the Western press. Major political shifts between Iran, its neighbors, and the West, along with the confusion and unrest in the Ukraine as it seeks to define its relationship with its Eastern (i.e. Russia) and Western neighbors, rightly command the bulk of our attention as of late.

But in the midst of all this, beneath the eyes of a world preoccupied with clashes worthy of box office films, far subtler power plays are at work that will likely matter far more to the course of history than the flashpoints in Syria, Egypt, Somalia, and Ukraine. Consider foreign policy developments in Moscow and Beijing – though both states are plagued by internal unrest and beset by international humanitarian pressure, both states are clearly ascendant in their respective, and overlapping, neighborhoods. Their maneuvers in Asia will increasingly bring them into tension, and perhaps conflict, in the years to come. This is a development Americans should watch closely.

The tense relationship between the Bear and the Dragon in Russia’s Far East and China’s Northeast is legendary, from the days when exhausted Cossacks dealt with (and stole from) the Qing Dynasty. The Soviet Union propped up Communist states in Xinjiang and Mongolia while warlords, Nationalists, and Communists all squabbled over the ruins of China. When a Communist victory became apparent, the Soviets sought to make Red China essentially an arm of their global strategy, a relationship which Mao and his followers deeply resented. As the People’s Republic came into its own, it grew increasingly autonomous vis-à-vis patrons in Moscow, which would precipitate a series of violent border clashes in the late 1960s. Nixon and Kissinger’s skillful manipulation of this rivalry has been recorded in the history books. So fraught has been the relationship between the authoritarian giants that they only resolved their border disputes along the Ussuri River in late 2008.

The start of the 21st Century has seen a cooler, and on the surface more cooperative, Sino-Russian relationship. While the United States was distracted in Iraq and Afghanistan prior to 2011, both Beijing and Moscow began asserting themselves in their historic borderlands and defending each other’s positions. Their mutual condemnation of international interference in internal affairs, as seen with respect to Syria and Iran, seems to have pushed them closer together. Additionally, their alignment in the Shanghai Cooperation Association grants them at least hollow Eurasian authoritarian solidarity. Xi Jinping’s first foreign trip as President of the PRC was to Moscow; the diplomatic import of this visit should not be lost on us.

But the story does not end there. Important fractures continue to underlie the relationship, though they are far less tense in their present iteration. Russia and China remain powerful states with rising ambitions. Chinese-born workers and contractors take up a large share of the labor market within the Russian Far East province, and analysts estimate that the population of China’s border provinces is at least four or five times that of Russia’s border provinces. The immense resources of Russian territory are assuredly a powerful strategic draw for Chinese planners, and wary Russian policymakers strive to develop these resources without surrendering a total monopoly to the Chinese. What happens in this strategically critical region matters to Beijing and Moscow’s relationship.

Looking further afield, the Chinese and Russians are looking to balance their resources in the region to offset the other’s gains, though not explicitly. Russia has been working to improve its relations with South Korea, signing arms deals and free trade agreements far more generous than those it shares with its client states in Eurasia. To the South, Russia extended an invitation Vietnam, an old Soviet ally, to join its Eurasian Customs Union. To sweeten the pot, Russia has sold Vietnam refitted Soviet submarines. Looking West from Vietnam, the Kremlin is increasingly engaging with India, continuing to supply much of its military hardware while simultaneously negotiating bilateral energy deals. It is important to note that each of these three countries fought savage wars with China in the 21st Century and continue to engage in strategic competition with the dragon.

Russia’s grand strategy looks like a classic case of power politics. The ancient Indian strategist Kautilya argued that border states would always be enemies, and therefore states separated by a buffer would be natural allies. A brief glance at the map shows that China separates Vietnam and India from Russia, while South Korea borders China through North Korea, long China’s client state. Russia’s strategy is not necessarily bellicose, however as prudent statesmen have long recognized, when the time comes to exert pressure on another nation, it helps to have friends on that nation’s borders who fear and envy it.

Meanwhile, China continues its economic expansion and integration of the Asian continent. As has been widely reported, it initiated oil drilling in Afghanistan last year, making it the first energy investor in the war-torn state. Its pipelines crisscross Russia’s sphere of influence in Central Asia, traversing Kazakhstan, Uzbekistan, and Turkmenistan. China’s pipeline and highway projects in Myanmar stand poised to modernize that nation, while connecting the Indian Ocean’s trade directly to the Chinese heartland. Beijing also continues to provide security assistance to a Pakistan increasingly distrustful of the United States, and Pakistan hosts a Chinese port at Gwadar.

It is clear that the Chinese are concerned with boosting international economic development; foreign trade, especially in energy sectors, will be essential in sustaining China’s remarkable economic growth story as it seeks to pivot away from unhealthy domestic infrastructure spending sprees that have defined the last decade. But aside from being a mere cash cow, these foreign assets provide China with leverage in the host countries. That’s the power of the purse.

The new great game in Asia is not a particularly violent one, but it is an important one. As Russia and China rise and balance against each other, not unlike two scorpions in a jar, their interests are bound to clash. Policymakers in the US should continue to monitor these developments carefully as such problems will surely present challenges and opportunities. It is not hard to imagine American policymakers working with their Russian counterparts to contain a rising China while simultaneously working against an advancing Russia in contested regions such as Eastern Europe and the Middle East. American policymakers may even find themselves working more closely alongside their Chinese colleagues if the Xi Jinping era presents such an opportunity. The shifting geopolitical fortunes of Russia and China demand our statesmens’ most vigilant attention.

Xiaomi’s Expansion and the Test of Chinese Soft Power

Xiaomi is outselling Apple in the Chinese smartphone market, and recently announced its plans to expand globally. You may be asking: “Xiao-who?” Well, here is an introduction to the hottest tech company in China, their blueprint for expansion, and what this means for China’s growing “soft power” – a construct that emphasizes a state’s economic and cultural influence.

Xiaomi Founder at the Fortune Global Forum 2013. (via flickr: Fortune Live Media/ Creative Commons some rights reserved)

Xiaomi Founder at the Fortune Global Forum 2013. (via flickr: Fortune Live Media/ Creative Commons some rights reserved)

Ascent to Stardom

Xiaomi Inc. is an Internet service and consumer electronics company founded in April 2010 by Steve Job’s Asian twin, Lei Jun (see photo). Selling high-end smartphones at near production costs, Xiaomi has challenged Asia’s top smartphone providers in the Chinese, Taiwanese, and Hong Kong markets. In the second quarter of 2013, Xiaomi became the fifth-largest supplier of handsets in Mainland China. In August, Lei poached top Google executive Hugo Barra to orchestrate Xiaomi’s global expansion. And shortly thereafter, a “flash sale” of 100,000 Hongmi-model smartphones ($135 compared to the $750+ iPhone) sold out in 90 seconds. In October, Xiaomi sold 100,000 of the luxury Mi3-model smartphones ($327 for 16GB or $410 for 32GB) in 83 seconds. Less than four years after incorporation, Xiaomi has gained Apple-like popularity and a market valuation at $10 billion (equal to Lenovo or double that of Blackberry). Xiaomi executives project smartphone sales in the neighborhood of 20 million units by year’s end.

International Expansion

But they aren’t satisfied. At a recent media event in Taiwan, Lei and Barra announced their expansion into the Southeast Asian market, specifically Singapore and Malaysia. Why? Singapore and Malaysia have the necessary technological (network coverage) and regulatory (welcoming governmental and legal institutions) infrastructure for Xiaomi’s entry. Further, the people of Singapore and Malaysia are smartphone fanatics. Smartphone penetration in Singapore and Malaysia is at 87% and 80% respectively. Comparatively, the United States is at 60%.

Xiaomi may succeed in its initial expansion—despite entering a saturated market—for four reasons:

  1. Fandom: “Flash sales,” and the social media blitzkrieg surrounding these events, have generated frenzy among middle-class shoppers eager for the newest smartphone. Further, Xiaomi allows its customers to actively shape its software platform. Miui, a spinoff of Google Android software, is updated nearly every week based on the suggestions of its 5.1 million members. Client-customer collaboration has boosted Xiaomi’s popularity in China and promises to do the same in Southeast Asia.
  2. Increased competition: Samsung has run a near monopoly in the Southeast Asian smartphone market. But three Asian companies, Huawei, Lenovo and LG, are challenging its dominance and eating away at its market share each successive quarter. Xiaomi could benefit from an increasingly diverse market.
  3. Subsidies: Singaporean and Malaysian telecom operators offer smartphone subsidies. Thus, Xiaomi phones could be free with the purchase of a contract—an enticing offer for those who disheartened by the larger sticker price of a Samsung or Apple handset.
  4.  Apps: Singaporeans and Malaysians love apps. In fact, they score highly (Singapore at number one) in the World Mobile Readiness Index, a metric that calculates a population’s willingness to pay for mobile apps. Singaporeans’ and Malaysians’ willingness to pay for apps perfectly accommodates Xiaomi’s business model. Xiaomi has razor-thin profits on smartphones (compared to a company like Apple that has a 55% profit margin on the iPhone) and therefore relies on apps and accessories to generate profit.

Litmus Test

Xiaomi’s success in Singapore and Malaysia will be indicative of its potential success outside the Chinese mainland. Xiaomi has thrived in the Chinese market where Apple holds less than 5% market share and Google Play (Google’s “App Store”) is not officially available. How Xiaomi competes in areas where Apple and Google have a stronger grip will be telling. If unsuccessful, Xiaomi will likely retreat to China. If successful, look for Lei and Barra to deepen expansion in Southeast Asia, particularly in the Philippines—a country with a higher Mobile Readiness score than Malaysia and Hong Kong yet with only 15% smartphone penetration. The Filipino market would be wide open to an injection of Xiaomi products.

China’s difficulty in accumulating soft power has been well documented. However, much to the chagrin of some Americans, China’s soft power, particularly its global economic influence, is on the rise. A burgeoning tech market has begun to stimulate international growth for a number of Chinese companies (think Lenovo, Baidu, and Haier). Xiaomi’s success in Southeast Asia could demonstrate or precipitate greater success of Chinese companies in foreign markets. As a result, Chinese communication technology may attain the “cool factor” of Apple or Samsung products—which are widely regarded as fashionable and reliable. In short, Xiaomi may trigger consumers of Chinese tech products around the world to begin prizing the “Made in China” tag rather than associating it with mediocrity. And such a rise in economic influence is a necessary characteristic of any great power.