What’s next for business in China (1989)
This story looks at the reactions of U.S. business leaders to the Tiananmen Square crackdown in June 1989. It originally ran in the July 17, 1989, issue of Fortune. We are reproducing it here on the 25th anniversary of the Tiananmen massacre.
“WHEN ARE YOU COMING BACK?” implore the telexes, faxes, and phone calls from China to foreign partners. In raising the question — and in their hurried, nervous efforts to reassure Western investors that their country is still a good place to do business — Chinese managers are taking their cue from Deng Xiaoping. Despite his bloody swerve to the right, the 84-year-old strongman insists China’s door is still open to foreign capital and technology. But business will not go on as usual — not anytime soon. Deng may genuinely want to keep the door open, and he may be able to do so despite the reemergence of more conservative leaders who want less contact with the West. The question is whether Westerners will want to walk through such an uncertain opening. As a semblance of order returns, U.S., European, and Japanese companies with operations in China will likely crank up again. But many executives say they will postpone — or cancel — future investments. Some plan to shift orders for Chinese goods to Asian neighbors — Thailand and the Philippines among them. Tourists, who regard automatic-weapons fire as worse than losing traveler’s checks, will certainly stay away. And many Chinese students and scholars studying and working abroad will not return. China is the biggest loser. “The Chinese economy will slow down significantly,” predicts Kenji Dobashi, managing director of Nomura Research International Co. in Hong Kong. The tortuous, ten-year experiment with capitalist incentives, which produced stunning growth and held such promise for the future, is stalled. Not for a long time will liberal-minded economists press hard for more reform. For Japan and the West the fallout is best summed up as an opportunity deferred. How the rest of the region fares will depend mainly on how Chinese businessmen in Taiwan, Hong Kong, Singapore, Thailand, Malaysia, and elsewhere react. “China has a very strong psychological impact on the Overseas Chinese,” says Dobashi, referring to the millions of ethnic Chinese who are citizens of other Asian countries. There is a political dimension too. China has helped check North Korea’s extremism, and it holds the face cards in negotiations aimed at stabilizing Cambodia after a decade of war. Most important, its efforts to transform a socialist economy into one driven by market forces have encouraged economic reformers from the Kremlin to Hanoi.
Regardless of how the old men at the top feel, China cannot easily cut itself off from the world again. The most populous nation is linked far more with the outside than when it turned inward during the Cultural Revolution of the 1960s. It has some $42 billion in foreign debt, compared with $3 billion in 1978. To get hard currency to service that debt and to pay for essential imports like grain and steel, the country must keep selling Chinese products to foreign buyers. China’s ability to export has been boosted considerably by the technology and capital ($11.5 billion) that foreigners have invested since 1978. Coastal provinces like Guangdong, across the border from Hong Kong, have prospered so much that they have the financial strength and will to resist attempts by the central government to close the open door. If the Chinese withdraw even a little, they risk missing out on the continued growth of the rest of Asia. One powerful force behind reform was the realization among Deng and his allies of how far behind China had fallen during the Cultural Revolution, when many other countries in the region were reporting double-digit growth rates. The next few years might well be a repeat of that era, with China stagnating while neighbors forge ahead. The rest of the world can get along nicely without China. The country accounts for a mere 1.4% of world imports and 1.5% of exports. It produces almost nothing that other countries cannot easily supply, though in a few commodities (tin, tungsten, and silk) China’s share of global exports is substantial. While its surging economy of late has been a boon to trade within Asia, China in no way is the engine behind the region’s growth. According to George Baeder of Pacific Rim Consulting Group in Hong Kong, China contributed just slightly more than 10% of the growth in intra-Asian trade last year. Says Baeder: ”Yes, there would be a significant impact [if China withdrew], but it would not be terminal for intraregional trade.” The immediate foreign reaction to the Tiananmen massacre was dramatic. Western buyers of such Chinese goods as toys and garments canceled orders, unwilling to risk the possibility that future turmoil would disrupt production. Japanese steelmakers, for whom China is a major export market, announced a production cut because of uncertainties about future demand. China’s $230 million purchase of New Zealand Steel fell through, apparently scuttled by edgy foreign lenders. Scores of companies active in China rushed to shift at least some operations to Thailand and other low-cost Asian countries. Investors in one major European investment fund asked it to liquidate all Asian holdings for fear that violence in China would destabilize the whole region. In the longer term, though, there are compelling reasons to expect less precipitate action. However fragile or repressive, a modicum of political stability is returning to Beijing. Western companies will ultimately send many of their managers and technicians back. Those that trade with China may be more cautious in their financial dealings, but they will keep buying and selling as before, though at a lesser rate as the Chinese economy slows.
Nor is investment likely to shift to other countries as much — or as quickly — as the initial reaction suggests. For one thing, the octogenarians in charge of China are bumping against actuarial odds. Among foreign businessmen, there is a persistent hope that China’s new leaders, whomever they turn out to be, will put the country back on a more positive course in a few years. Also, shifting assets from one country to another is not like moving checkers around a checkerboard. Chess is the better analogy. The consequences of each move are intricate. You have to deal with a new government, learn a new language and culture, hire new workers. And just because China is less inviting at the moment doesn’t mean that problems of other countries — clogged ports in Thailand, corruption in Indonesia — have suddenly been solved. “China could blow up,” says Michael Kwee, an executive with Prudential Asia in Hong Kong, “but unless you are comfortable with the Philippines or Thailand or Indonesia, you are not necessarily going to invest there.” Most big multinationals are not in China primarily to tap cheap labor or natural resources. They are there for one reason: access to the world’s biggest potential market. Though some may take a second look at other large (and no less frustrating) virgin markets like India and Soviet bloc countries, most will find it difficult to dismiss visions of a billion consumers, however fuzzy and far off the dream may be.
Vincent Sarni, chairman of PPG Industries, which has a joint venture in Guangdong province that makes window glass, is one of many who doesn’t expect to divert resources from China. He compares investing in China with investing in R&D. Says he: “We’re getting in on the ground there because we believe that market, in time, in the 21st century, is going to be a very important market for what we do.” But for the upheaval in Beijing, PPG would now be negotiating a second investment in China. Though the project is off for now, Sarni says it will be back on track eventually. Thousands of smaller firms drawn to China because of low wages will be tempted to invest elsewhere. But many are owned and run by Hong Kong entrepreneurs who have developed close and efficient ties with their Cantonese-speaking brethren across the border. The common language and culture, and the proximity (Shenzhen, a magnet for Hong Kong investment, is less than a hour’s train ride away), are powerful incentives to ride out even the stormiest weather. Finally, a sizable number of small firms that might otherwise consider Thailand or the Philippines are manufacturers of garments and other products exported to the U.S. under specific quotas granted to China. The U.S. won’t necessarily increase Thailand’s quota just because a lot of apparel makers want to move there from China. The uncertainty in China may cause companies to hedge their bets. “From now on no one will put all his eggs in one basket,” says William Fung, who runs Li & Fung, a large Hong Kong company that buys clothes, housewares, and other consumer products throughout China. He says his managers recently spent a few days scouting for alternative sources in Thailand. Still, Fung notes that as investment originally budgeted for China shifts to other higher-cost countries, China’s comparative cost advantages will come into focus again. Says he: ”The political risk will be outweighed by the difference in cost. People will go back to China.” Fung’s economic logic notwithstanding, many Hong Kong residents will find the political risk too great. The latest newspaper polls, conducted a few days after residents saw nightmarish television images of PLA tanks and troops crushing unarmed demonstrators, suggest that fully 15% of all Hong Kong residents plan to leave between now and July 1, 1997, when China’s flag will fly over the tiny territory after more than 150 years of British rule.
Hong Kong has been rattled before, but has usually bounced back. It thrived, for instance, during much of the Cultural Revolution. But today Hong Kong’s future is far more intertwined with China’s — and in more ways than 1997. In recent years its manufacturing sector has rapidly expanded into Guangdong province, where Hong Kong firms now employ two million to three million workers. About half the goods flowing through Hong Kong’s container port, among the busiest in the world, are China trade. Hong Kong’s impressive roster of banks, transportation companies, and multinational corporations is oriented significantly toward China. As China has modernized, no place has benefited more than Hong Kong. And no place will suffer more if China’s economy, along with its politics, turns backward. On the surface China looks like a safe place to return to. The streets of Beijing — and other cities where students marched — seem back to normal. Cyclists stream by Tiananmen Square; nearby markets overflow with fruit and vegetables; across from the square a Kentucky Fried Chicken outlet is open for business again. In other parts of the country, roads and bridges that were blocked by demonstrators in early June are clear. Shanghai’s port, paralyzed at the height of the crisis, hums with activity. Factories in Guangdong that never missed a beat despite the trouble up north continue to churn out shoes, picture frames, and toys for the coming Christmas season. But beneath this normalcy is fear and disillusionment. Though it is impossible to know how deeply the Chinese people have been shaken, outsiders who follow China believe that large numbers of urban workers, students, clerks, and even government bureaucrats are dismayed and discontented. An American lawyer with long experience in the country says Chinese now fear being turned in by a neighbor for supporting ”counterrevolutionaries” or perhaps just for enjoying a ”bourgeois” life. The government’s crackdown ensures that many Chinese will fear contact with foreigners. In turn, many foreigners will avoid doing anything that might be taken as a show of sympathy for the student protesters. In its mildest consequences, this climate of disillusionment and fear will impede the flow of commerce and depress the quantity and quality of the economy’s output.
No one knows when — or whether — China will erupt. If people do go back to the streets, economic issues are more likely to send them there than demands for democracy or free speech.
Here’s what to watch for:
INFLATION. Soaring prices probably had as much to do with driving the Kuomintang from power in 1949 as Mao and the Communists. The annual rate is now above 30% in some cities and can only go higher in the short term. With the army keeping order, military spending is bound to rise, deepening the government’s budget deficit. Because the government cannot afford to antagonize urban workers, it will almost certainly have to boost subsidies for food and other items in order to keep purchasing power from slipping too much. Productivity is destined to suffer because of poor morale and the absence of foreign managers.
FOOD SUPPLY. Understanding China begins with grasping the fact that 870 million of its 1.1 billion people live in rural areas. Deng’s economic reforms paid off best for farmers, who initially enjoyed unprecedented prosperity. Last year, however, the government ran short of cash and paid many farmers with IOUs. Angery farmers beat up officials in several rural areas, and there were runs on local banks. In the past few weeks the official press has reported that Beijing will again be seriously short of the cash it needs to pay farmers for the summer wheat harvests, now under way. David Zweig, a specialist in Chinese rural politics at the Fletcher School of Law and Diplomacy, says the government has two familiar options: print money, which would make inflation worse, or hand out more IOUs. Not only could IOUs create unrest at a time when the government doesn’t need any more, Zweig says they would also lead to smaller harvests in the future. Without cash, farmers would buy less fertilizer, seed, and pesticide. The result: higher grain imports or lower production of meat and dairy products — or both. Grain production fell 2.2% last year, while China’s population continued to grow. As a sign of the central government’s nervousness, it recently sent soldiers into fields near Beijing to cut wheat and is now using army trucks to carry grain and other commodities from the countryside to city markets.
FOREIGN DEBT. At the moment, the debt is manageable, but it could become one of China’s biggest problems. China has long been viewed as a conservative borrower, and its $42 billion in foreign debt is easily serviced by export earnings. China’s estimated annual debt service will be under $5 billion next year and around $7 billion in 1991 and 1992. In addition, it has an estimated $19 billion in foreign currency. But China has increasingly counted on foreign borrowing to finance its budget deficit. According to Business International, foreign loans will make up 5.6% of the budget this year, compared with 1.6% in 1984. If any country has economic leverage over China, it is Japan. While U.S. banks and government agencies have lent less than $1 billion, Japan has supplied roughly $31.5 billion, or three-quarters of the country’s external borrowing (including grants through such agencies as the World Bank). Japan has also promised to lend $5.4 billion more over the next five years. Few analysts expect Japan to exert its leverage. Still, in recent years the Japanese have become more willing to use economic power in the region for political purposes. An important signal could come after a mid-July meeting in Paris of top economic officials of Japan, the U.S., and European nations. Says a Citicorp banker: ”If your biggest creditor turns his back on you, you are in big trouble.”
There is yet another factor to consider: What will happen when Deng dies? With no successor clearly established, Deng’s death will set off a fierce leadership struggle that could turn bloody. The best outcome would be the ascension of a group of leaders who would put China back on the road to prosperity — and freedom. Reading these tea leaves is risky business. No one predicted that a million Chinese would parade through the streets of Beijing in early May shouting ”Down with Deng” and other blasphemous antigovernment slogans. Nor that Chinese soldiers would turn their guns on unarmed citizens. In such a fluid situation, the best advice is to make no big decisions about China until you absolutely must. When the time comes to place your bet, it’s wise to remember that even your best assumptions are just that — your assumptions, not necessarily those of the aging cadres in Zhongnanhai, the placid compound near Tiananmen Square where China’s senior leaders live and jockey for power.
Reporter associates: Shelley Neumeier and Karen Nickel.