F. Warren McFarlan on U.S.-China relations, xenophobia, and the ambition of Chinese companies - SupChina

F. Warren McFarlan on U.S.-China relations, xenophobia, and the ambition of Chinese companies


F. Warren McFarlan is professor emeritus and former senior associate dean at Harvard Business School. He is the author of 18 books, including, most recently, Can China Lead? Reaching the Limits of Power and Growth, coauthored with professors Regina M. Abrami and William C. Kirby. Can China Lead? explores China’s extraordinary growth in recent decades, but asserts that its lack of transparency, hostility to intellectual property protection, and political favoritism have the potential to derail the country’s growth and its ability to become a world leader.

He recently spoke with SupChina editor-in-chief Jeremy Goldkorn on a range of issues, including Taiwan, displaced industries in the U.S. as a product of globalization, the acquisition of U.S.-based technology companies by Chinese companies, the potential effects of a trade war with China, and the reemergence of xenophobia.

Jeremy Goldkorn: We are at a pivotal time in U.S.-China relations. The news from the Trump administration and the way China is positioning itself with regard to the U.S. has been very difficult to make sense of. Things have been moving pretty fast just in the last few days. Do you have a sense of what we can expect?

Warren McFarlan: The Pacific Trade Treaty was an area where both liberal Democrats and President Trump saw eye to eye. Its demise was a win for China but an anticipated one. Pursuing Taiwan recognition as initially started by the Trump administration would be much more serious. What is not clear is whether President Trump can deal with the reality that “One China” is the platform on which the U.S.-China relationship began in 1971 and still stands. Without subscribing to the idea of “One China” that Kissinger, Nixon, and Mao put together, we will not only not have a trading relationship between our two countries, but many other difficulties as well.

“One China” has been important to China since 1650. Taiwan was part of China from 1650 until China lost the Japanese War in 1895. Taiwan was then taken away by Japan as a war reparation. It was only returned to China at the end of World War II. In the Chinese mind, Taiwan is the lost province and as important to them as California is to us.

Beyond the Taiwan issue, we have the difficult territorial problem in the South China Sea, where China feels it should be the naval power. [China uses] a map from 1,000 years ago with a dotted line, which it claims shows it owns the whole sea. We disagree! China is now building airstrips on these islands in what will clearly be a conflict point. This will not be easy to solve.

A final thing to remember is that President George W. Bush started off his presidency in a similarly belligerent way in regard to China. In the midst of the tension, we shot down a Chinese fighter pilot. In retaliation, one of our planes was forced down on Hainan Island. After extensive apologies by President Bush, the pilot was released. The plane was then cut into four pieces and returned to us. Our relationship subsequently improved during his presidency. These are not new issues. We haven’t yet seen, however, that the new administration understands what the limits and sensitivities are on the Chinese side.

JG: How much support do you think the more aggressive posturing [receives] in the U.S.? For example, John Bolton had an editorial in the Wall Street Journal basically calling for an end to the “One China” policy. Is that becoming a more mainstream view in the United States?

WM: I do not think so. Bolton has always been on the far conservative end. He does not understand just how deep an issue the “One China” policy is in the Chinese mind, and that the Chinese government thinks it might fall if it walked away from “One China.” How would we feel about President Trump getting rid of California? It’s the same emotional thing for Taiwan.

 

“In the process of globalization, we spent no time thinking about how to re-create or preserve big pieces of our economy that we were destroying.”

 

JG: How do we reimagine future trade relations with China?

WM: There are several things to remember. The first is that China is no longer the global low-cost producer. It has changed dramatically over the past 40 years. For example, take a big trading company in Hong Kong, Li & Fung. It facilitates 15,000 Chinese suppliers supplying various pieces of soft goods to U.S. and European customers. On the eastern part of China, thousands of those suppliers have disappeared in recent years. Their successors have moved either into the “low manufacturing cost” western part of China, now accessible because of China’s improved infrastructure, or to Vietnam and Bangladesh with their very low labor costs. China is a very different trading and business partner today than that of two decades ago.

Acquisition of intellectual property is very important to both Chinese companies and their government. We haven’t seen any indication about what our reaction will be, for example, when Chinese tell us, “We will only buy your planes if the rudder is designed and built in China.” What the Chinese want is technology transfer. If Boeing won’t build the plane under their demands, then they’ll go to Airbus to do it. That is complicated to negotiate.

How do we think about the acquisition of technology-based companies in the U.S. by Chinese companies? The course I taught eight years ago was called “Doing Business in China.” Now it’s called “Doing Business with China” because the Chinese companies have grown so large and are making many acquisitions of companies with special technologies. The U.S. has only begun to debate how to deal with the changed complexities created by large, acquisitive, technically sophisticated Chinese companies.

JG: Bloomberg had a piece that looked at which companies were most at risk in a U.S.-China trade war. It said the three most exposed companies in the U.S. were semiconductor makers: Ambarella, Texas Instruments, and Marvell. It had a list of Chinese companies looking for acquisitions. The top ones were a company called GoerTek, which is a wireless provider, and a clothing company called Regina Miracle International. Does that make sense to you as to the companies that are most at risk?

WM: The top U.S. companies that are at risk are the ones that are encountering technically sophisticated Chinese competitors that are attacking their markets and want to share their technology. This is where the battle will be waged.

Additionally, we should recognize that we are not going to recapture much of what we lost. It would take forever to build and place a full-fledged textile industry back in the U.S. now. That said, there is, however, some progress. Some of the high-end stuff has come back to South Carolina in the last couple of years.

JG: Do you see any bright spots?

WM: I think the bright spots are that the very process of debate is shaking things up. In the process of globalization, we spent no time thinking about how to re-create or preserve big pieces of our economy that we were destroying. We assumed that somehow it was normal for people to move and for communities to disappear. These issues were not sufficiently thought through as a matter of public policy.

I was brought up in Boston, which had a bad 20th century. It was one of the perennially depressed areas of the country. First, the shoe industry suddenly left, shortly followed by most of the textile industry moving from New England into North Carolina, South Carolina, and Mississippi. We were left with big empty buildings and impoverished mill towns. Some mills were never used again.

Some of the mills were used for new computer companies like Digital Equipment, Data General, and Prime, which, after a decade of success, subsequently died or moved west. After a period, they have been replaced by biotechnical firms. Boston has reinvented itself three times in my lifetime. While the textile and mini-computer industries are gone, we now have the biotech and semiconductor industries. Renovation with refocus can take place. Even today, however, Massachusetts is not out of the woods, being divided between an eastern Massachusetts with a good economy with innovation and new companies, and a western Massachusetts that is struggling with empty mills and high unemployment.  

JG: So, what we are seeing is sort of a global replication of the same process.

WM: Yeah, people are saying, “Nobody is caring for us,” and, “What the hell, things cannot be worse.” The U.S.-China relationship is at the center of this. Interestingly, our economic relationship with China was a complete accident. When the U.S.-China relationship was put together between Mao, Kissinger, and Nixon, there was absolutely nothing in it that had anything to do with trade. There is no whisper of what you and I are talking about.

JG: Right, that came later.

WM: It came later when suddenly it was clear the framework allowed trade; 20-cents-an-hour Chinese labor could go head to head with four-dollars-an-hour U.S. labor. But at the core, the China relationship defined in 1971 was a geopolitical one where we were trying to make it more difficult for the Soviet Union. The Chinese were feeling very uncomfortable about their neighbor in the north. Their new relationship with us helped them.

 

“An issue that I now worry a lot about is awakening the dogs of hate and xenophobia.”

 

JG: Xi Jinping has, at every step along the way, strengthened his control over key departments of the government. Universities must adhere to the Party line more so than before. There are tighter controls on media and dissident opinions, etc. We are dealing with a strong central government that believes it holds the winning strategy. Any further commentary on that?

WM: At every step along the way, the Party is more front and center, more visible, pushier. I met with someone yesterday who had just come back from China and was talking about the monitors that were now in the back of classrooms reporting any deviant thought by either faculty or students.

One of the byproducts of this is, of course, a huge desire by the Chinese for education outside the country. Over 300,000 Chinese students are now studying in U.S. colleges and universities. A key new question floating around is, “Is that useful for China, is that useful for us?” They’re clearly learning large amounts of our technology, which they take back home (if they don’t get a green card). From the Chinese point of view, however, the students are also learning new kinds of new ideologies, which do not fit into today’s China. The Chinese are now putting people here to do training programs for their students who are here. This training is to remind students what are the Party values. Further, when they go back home, reorientation programs are being contemplated.

JG: I am relatively new to this topic. I just read John Pomfret’s book on it (The Beautiful Country and the Middle Kingdom), so I have been thinking about it quite a lot recently. The issues have a long history.

WM: The U.S. has a long history of denying Chinese immigration. This policy followed the completion of the transcontinental railroad. The Exclusion Act of 1878 lasted until 1943 and allowed no immigration. In 1943, the laws were changed and we gave China a quota of 103 per year. What we see today with the movement of money and people is absolutely counter to what went on from the late 19th century until recently. Consequently, an issue that I now worry a lot about is awakening the dogs of hate and xenophobia. That could get unleashed again.

JG: Well, this is all quite bleak. So let’s move on to the final question. I asked about Tencent and WeChat, you also mentioned Alibaba and ChemChina. Are you seeing innovation — real innovation — coming from China? For some of the findings of your book Can China Lead?, have you gone back to any of them two years later and decided that there is more hope for Chinese companies, that there is more likelihood of China being able to develop a better kind of business culture?

WM: Innovation is a funny thing because an important part has been China taking ideas that have been important in other places and applying them in their environment behind protective walls that keep foreign companies out. Alibaba, Baidu, and Tencent were enormously advantaged by the fact that they were protected.

Jack Ma, the CEO of Alibaba, was over here last week. The incredible thing is that he came out of Trump Tower in New York with President Trump. They were on national TV for one minute where he was never identified to the audience. The entire TV interview had to do with recent tweets between Meryl Streep and President Trump. For those who knew him, the question was, “What the hell was Jack Ma doing, standing beside Donald Trump?” For sure he wasn’t sitting for the previous two hours with President Trump without Xi Jinping’s approval. The substance of the unreported story was the fact that this CEO of this “Chinese software company” was in the United States, sitting for two hours with the U.S. president, talking about how he could stimulate U.S. job creation. That is a big story. It is an example of the fact that a lot of unreported conversations are going on right now, as was work to develop a China policy.

The Chinese companies are ambitious. I wrote a case on ChemChina a couple of years ago. I remember sitting with the chairman as he described being the 250th-sized company in the world. He stated that his basic objective in 20 years was to be the number two or three chemical company in the world. He was going to do it by systematically acquiring the technologies they needed and hadn’t developed on their own. So it doesn’t matter what their innovation ability is (pretty good, by the way). They are acquiring to fill the gap. If you go back and look at the acquisition of companies by Chinese companies, you’ll see it has absolutely soared over the last four years.

JG: Thank you very much. That is a lot of ground we’ve covered.

WM: This is a topic that you could spend a lifetime with. It’s really hard to understand all the nuances. I’m pretty comfortable with what I wrote in that book a couple of years ago. It was recently translated into Mandarin. It was done in Taiwan because this is not something that the Chinese government really wants the man on the street to read.

Thanks to Carlisle Micallef for transcribing this interview.

Jeremy Goldkorn

Jeremy Goldkorn is co-founder of the Sinica Podcast and currently edits SupChina and its daily newsletter.