China Airborne (12 page)

An economist and financial-markets expert named Michael Pettis, who was trained in the United States and Europe but has taught since the early 2000s at Peking University, drew out this comparison for me during one of several interviews I had with him in Beijing around the time of the Olympics, this one in 2009. When people say that China is like “what America used to be,” he told me, it’s often meant as a compliment to China and a criticism of the United States. But there was an important opposite side to the story.

Through the early 1900s, he said, the United States played a role in the world economy surprisingly similar to China’s
since about 2000. Until the start of World War I, the United States had long been a “net debtor” country—as premodernized China had also been. Through its first century-plus of development, the young United States had relied on foreign loans and investments to build the factories and lay the railroads that ultimately made it an industrial titan. By the end of World War I, it had become a “net creditor,” as its undamaged industrial base supplied European combatants and the former customers of ruined European companies.

In the 1920s, its farms and industries made America the workshop of the world. It ran trade surpluses with most other economies, which meant that a disproportionate share of the world’s jobs were in America (that is, it was doing work to create products that other people consumed). By the same logic, a disproportionate share of what it made went for other people’s use. Foreigners paid the difference by transferring gold reserves—the economist John Maynard Keynes complained in the 1920s that the United States was amassing “all the bullion in the world”—or taking on loans and investments from Americans. So far, this is like China’s story. And so far, apparently, so good.

But its very role as global exporter made the United States unusually vulnerable when global demand collapsed in the 1930s. Having had more than its “fair” share of the world’s jobs to begin with, it had more of them to lose. This doesn’t mean that Americans suffered more deeply than Europeans, overall. Americans got Franklin Roosevelt; Europeans got Hitler, Stalin, Franco, and Mussolini. But as a matter of plain economics, the layoffs and unemployment of the Depression years were worse in the United States.

That was the prospect for China, as the world economies began their series of shocks and contractions soon after the triumphant
Beijing Olympic Games. China’s several-trillion-dollar war chest of foreign holdings, built up from its long string of trade surpluses, gives it advantages. But China’s reliance on foreign customers is a serious vulnerability.

Pettis wrote in 2009 that China’s worldwide trade surplus, “the cleanest measure of overcapacity”—factories that are running and workers who are employed
only
because of foreign customers—was by one measure about as large as America’s had been in 1929. China today, like America then, has a trade surplus equal to about 0.5 percent of
global
economic output. But as a proportion of its own economic output, China’s trade surplus has been much bigger than America’s ever was. In proportional terms, China has in recent years been five times as reliant on foreign customers to create domestic jobs as America was in 1929. So unless China can find a sustainable way to keep selling when its customers have stopped buying, it will face proportionately greater employment shock.

China’s response to that shock in 2008 and 2009 was to ramp up its public-spending surge even further. That buffered the shock of this recession but didn’t change the reality that China was still too dependent on customers everywhere else to provide markets that would keep its own people at work. As of 2010, net exports still represented more than one quarter of China’s total economic output, an astonishingly high number. (That manufacturing powerhouse Germany, in comparison, had net exports of less than 4 percent of its GDP at the same time.)

“The next decade for China is arguably just as important, if not more so, than the last three combined,” the analyst Damien Ma, of the Eurasia Group, wrote in 2011, about the overall efforts to shift the economy from its infrastructure-and-export frenzy. “The curtains on the era of easy ‘catch-up’ growth are being closed, and a transition to a prosperous and equal society
is the fundamental issue facing Beijing. It’s not that the Chinese leaders don’t get what’s at stake—they know such a reckoning must be had. But recognizing what must be done is quite different from summoning the political chutzpah to achieve it.”
⁴

The word “chutzpah” might seem odd in this context. Mustering the kind of cheek and daring it suggests is only part of the Chinese central government’s challenge. The rest involves incentives to governors, mayors, managers, bureaucrats, to pull in the direction the government wants—plus the means of figuring out whether they are doing what they say. The system has to keep growing fast enough that most people continue to feel that things are overall getting better rather than worse, and that the disadvantages of a one-party system are outweighed by its effectiveness. All the evidence suggests that, despite their complaints, most Chinese people have felt this way through the country’s decades of growth. But it has to change course enough to accommodate all the tensions that growth itself has created: a radically unequal income distribution (some people are buying jets with cash, while others pull oxcarts down the streets) and a perception of life being rigged, chronic trade frictions with the Americans and others, a devastated environment, and a steady demand for the daily liberties increasingly prosperous people would like to enjoy.

How could the Chinese model “change” or “rebalance” to address these concerns? Although reckoning time in units of Five-Year Plans seems strange outside China, the shifting emphasis from the Tenth plan, released in 2001, to the Eleventh, in 2006, to the Twelfth in 2011, does help illustrate a significant shift
in strategy, and sets the context for ambitious projects like the dream of aerospace preeminence.

The Tenth plan, still in effect when Hu Jintao assumed power,
⁵
emphasized economic growth at the highest speed possible. Then, starting in 2006, as Hu and his premier Wen Jiabao solidified their hold on the government, and as much of the country prepared for the Beijing Olympics and the Shanghai World Expo, the Eleventh Five-Year Plan was supposed to reflect the spirit of the “Harmonious Society” (in Chinese
, or
hexie shehui
). In practice, a more harmonious China was supposed to be one that paid more attention to the devastated environment and took better care of the hundreds of millions of farmers and migrant workers left behind by the Chinese miracle. That aspiration was reflected in a variety of social-welfare measures—for instance, relaxing the
hukou
, or residence-permit, system that had made it near-impossible for migrant workers to enroll their children in schools outside the family’s officially “registered” home or to be eligible for medical treatment without trekking hundreds of miles back to their home villages. It also lay behind a number of “Green China” initiatives, from funding wind- and solar-energy projects to judging provincial bureaucrats in part on their environmental record, to allowing and even encouraging journalistic exposés of environmental problems.

By the end of the Eleventh Plan, the major imbalances remained: a huge trade surplus with the United States, an infrastructure and construction boom that was gaining rather than losing momentum, an ever more extreme gulf between rich and poor. Anything the Chinese or others said about “rebalancing” or “harmony” would be a mockery, as long as the economy kept racking up huge trade surpluses and relying on foreign markets, as long as the building and industrial boom kept ravaging
the country’s own environment, as long as Chinese society kept indulging the most extreme Gilded Age excess with little sign of correction or balm on social unease.

The Twelfth Five-Year Plan included very long lists of strategic initiatives and “areas of focus,” but the ideas for “rebalancing” and “harmonizing” the economy fell into a few main categories. Aerospace is affected by each of these, and its progress will be an indication of the Chinese planners’ overall success in realizing their new goals:

1. “Apex industries” and escaping the “smiley curve”

Will it be possible to move from assembly factories, which capture a small share of the value, to the brand names that get most of the profit? And therefore to convert China from a workhouse of the world to one of its sources of innovation? Few politicians or outside observers dwell on such questions. They obsess economists and business leaders within China.

In the mid-2000s, I heard a way of thinking about these questions that has stayed with me ever since. It is the concept of the “smiley curve,” and I heard about it from Liam Casey, an Irish businessman who had lived and worked for nearly ten years in Southern China.
⁶

The smiley curve is a U-shaped graph (named after the smiley-face symbols of the 1970s) that covers the different stages of a product’s development. On one end of the curve, at the highest point on the left side, are corporate brands, with the extra market value they bring—Apple, Mercedes, GE, Samsung, all of which command a premium compared with their generic counterparts. Next comes product concept and industrial design—thinking up the iPad, the S-class car, GE’s new turbine engines. Then, moving down the curve, come high-value components—turbine blades, graphics chips, advanced displays.
Then the commodity components, like simple memory chips. At the bottom of the curve comes assembly—the process of combining the elements into a finished product. Moving up the other side of the curve, as it rises, are transportation—DHL or FedEx—and then retailer’s margin, and then after-sale service.

The height of the curve indicates the relative profitability of each stage of the process. The highest values are at its two extremes—the extra profit that goes to an Apple- or Mercedes-branded product, and the margin from retail sales and service. The lowest value is at the bottom of the curve, where the actual manufacturing takes place. And that lowest niche is the one that China has occupied throughout the first thirty years of its growth. The work was done in China, and the money went everyplace else.

The smiley curve and its implications became so famous that Wen Jiabao began mentioning them in speeches and negotiations with U.S. officials. Of an iPhone costing four hundred dollars or a computer costing a thousand, at most one tenth of the total profits stayed with anyone in China—even though every iPhone and iPad in the world, and most computers of any brand, are produced in Chinese factories. Much larger shares of the profit stayed with Apple, Philips, or the other international brand holders, or with the Japanese, Korean, or German chip-makers who produced the advanced components, or the retailers and deal-makers in North America and Europe, or with others. The curve also accounted for distortion in trade figures: While the entire value of an iPad or iPhone is treated as a Chinese “export” and thus a component of China’s trade surplus, nearly ten times as much of its value comes from Japan or Germany as from China. An Asian Development Bank study released late in 2010
⁷
used the example of an iPhone, with a wholesale cost of $178.96 and a retail cost of as much as twice
that. A total of $6.50 of the value of each phone went to workers in China, according to the report, even though all the phones were physically assembled in China, in plants from the Foxconn company.
⁸
Twenty-five to thirty times that much could go to wholesalers, distributors, and retailers. The biggest surprise of the Asian Development Bank analysis was what it illustrated about the fallibility in normal trade statistics. While every penny of the wholesale cost of an iPhone was listed as a Chinese “export” to the United States—which together made iPhones seem to account for more than 1 percent of China’s total trade surplus with America—in reality, when all the components were traced to their source, each iPhone represented a small but net
export
from the United States to China. The ingredients of each iPhone that came from U.S. suppliers to China were worth considerably more than the small value added from Chinese assembly. Statistical artifacts like this made the American trade situation look more hopeless than it really was, and made the Chinese economic model seem unrealistically triumphant.

This pattern is generally not known outside China (except by the corporations doing the outsourcing) but is very well understood by China’s political and economic leadership. “In the United States and Europe, the manufacturing industry
was created
due to technology innovation,” Helen Wang, author of a book about China’s middle class, wrote in 2010. “In China, the manufacturing industry is
being created in response
to global demand. Chinese manufacturers take orders from Western companies that have designed products for their home markets. They have no involvement with product development, innovation, market research, and even packaging.”
⁹
Yet those factories churning out goods for foreign markets are miracles of high-value productivity, compared with much of the rest
of China’s vast workforce in stores, offices, and government bureaus. Even the slightest exposure to China anywhere outside a high-output factory leaves foreigners (and well-traveled Chinese people) asking, Why does it take so many people to do this job?