The Great Leap-Frog Forward

1 September 2005

Nigel Ash investigates the entrepreneurial skills of expatriate Chinese and the subtle change of political philosophy. These have allowed China to take huge economic strides.

In the last 25 years, Western companies have learnt a lot about doing business with China, almost invariably the hard way. Initially there were no textbooks and few reliable guides, if for no other reason than that the Chinese themselves were rediscovering the business of business. However, China remains a complex challenge, not least because of the sheer pace of expansion and change.

Nowadays there is more China advice than you could shake a stick at and a significant body of commercial experience that newcomers to the market can scour carefully.

However, few individuals have had the same opportunity as the former US ambassador to China, J Stapleton Roy, to observe and assess strategically the changes that have occurred in China and the way in which the Chinese have handled them.

Now the managing director of Kissinger Associates, Roy, who was born in Nanjing in 1935, was US ambassador to China from 1991 to 1995 and had previously served in the country as deputy chief of mission.

Roy says: "The worst assumption a foreigner can make about China is that there is money hanging on trees, and that you can come in and make quick profits easily. Most of your best-established foreign investors in China have moved in carefully, gained experience in the market and have then upped their investments as their experience has grown."

China is now the largest recipient of foreign direct investment (FDI), last year attracting some $154bn, fully a third up on 2003, in 43,664 individual deals. The 12,900 equity and contractual joint ventures were, however, down by some 13% to $29.5bn, while the number of wholly owned foreign enterprises rose by the same percentage to over $70bn.

Roy says: "One of the traditional problems foreign companies encounter in China, is in selecting a joint venture partner, or being forced to accept a joint venture partner which it turns out is not a good partner." Such relationships have in the past been required because of restrictions on the level of foreign ownership in certain sectors. However, even in the best of circumstances, explains Roy, it has often been extremely difficult to assess such local partners.

Also, risk assessment has been alien to parts of the banking system, which still have the old command economy reflexes from the time when their sole function was to fund state-owned enterprise. Thus more than $400bn non-performing loans are burdening the financial system.

"The Chinese have made considerable progress in trying to address this problem," says Roy. "But they still have poor risk assessment as a basis for making commercial loans. They still have a situation where local, powerful figures can exercise sufficient influence over the allocation of loans, so the risk assessments don't drive the process."


To outsiders, the notion of a communist country embracing full-on capitalism is absurd. More puzzling still is the way in which the government is seeking to control the pace of economic and social transformation, while drawing a clear line in the sand when it comes to political change.

"More than $400bn non-performing loans are burdening the financial system."

Roy offers two key insights for understanding these apparent contradictions. One is China's observation of what happened to its old Communist neighbour and sparring partner in Moscow and how Marxist doctrine has been used to validate the espousal of capitalism.

Roy says: "Always at the back of their minds in the Chinese government is what happened in the former Soviet Union, when it lost control of the reform process. They do not want that to happen in China, where the consequences would be far more immense than they were in the former Soviet Union.

"They believe that Gorbachev made a fundamental error by essentially loosening the political reins faster than he was able to introduce economic reforms sufficient to cushion any changes on the political front. The Chinese view is that you need to emphasise economic growth as your primary objective, and the precondition for economic growth is stability. You cannot have stability if you move ahead too rapidly with political reform. So the Chinese simply do not accept Western advice that they need to speed up political reform because they believe that that will kill the goose that is producing the golden egg."

In Roy's opinion, this view that stability and change must be linked unites the government with people who may not be happy with it in other areas. He notes that even some of the former Tiananmen Square activists now in exile admit that what happened in 1989 was a demand for too much change, too soon. Underpinning this, says Roy, is the experience of chaos in the living memory of many Chinese, who do not want to return to such instability.


It took China three years to recover from the economic downturn that followed the unedifying repression of the Tiananmen protests. But driving the return to strong growth were expatriate Chinese investors, who all along have underpinned FDI. Roy says: "When China decided to engage in market-oriented reforms, there was a vast pool of Chinese in East Asia who had not been living under communism, who had the expertise and experience necessary to help China move in that direction and who were able to bring capital to the table."

"Driving China's return to strong growth were expatriate Chinese investors, who all along have underpinned FDI."

"If Russia had had a vast pool of émigré Russians, some of whom were pooled on the borders of Russia and were prepared to bring in capital, spoke Russian and had experience of how you function as an entrepreneur in the West, then I think that you would have found that economic reform in Russia would have taken a very different course.

"But Russia simply didn't have the equivalent of the Chinese communities in Hong Kong, South-East Asia or Taiwan, all of which poured capital into China, spoke the language and were comfortable operating in a Chinese environment. This was an enormous benefit. The skill of China's reformers was that they tapped into that effectively."


The doctrinaire analysis that led China to embrace capitalism is more subtle. There are, says Roy, few if any Marxist functionaries sitting in Beijing bemoaning the present state of affairs.

"One of Deng Xiaoping's most brilliant concepts was to draw on doctrinaire Marxism to justify the current phase of market development. In the Soviet Union, to justify a country such as Mongolia not having to go through the capitalist development process, the Russians came up with the concept of 'leap-frogging' into socialism, because under doctrinaire Marxism you went from feudal systems to capitalism, to socialism and then to communism. So since Mongolia had had a feudal system, according to orthodox Marxism, it should have gone to a capitalist system. The Russians didn't want that to happen, so they came up with the concept of leap-frogging."

"What Deng did was to say that China had moved too rapidly from feudalism into a socialist system and that it needed to go through a market system, before it could move fully into socialism. However, he defined the period that you needed to be capitalist as between 100 and 200 years."

So the revolution may be on hold, but what is happening in China now is very far from being 'contradictory', 'hypocritical' or even 'schizophrenic', all words used by outside commentators to describe Beijing's economic policies.

"It is not possible to have stability if you move ahead too rapidly with political reform."

China's present leader, Jiang Zemin, has taken Deng's analysis further with his 'Three Represents', outlined in 2002 at the Sixteenth Communist Party Congress. These, explains Roy, have redefined the question of who the Communist Party represents: "Under traditional Marxist concepts, the party was the vanguard of the proletariat. It represented the workers, the peasants and the soldiers. However under the new concept of the Three Represents, the Chinese Communist Party represents the advanced productive forces of the country, the advanced cultural forces of the country and the broad masses of the people of the country."

The 'advanced productive forces', says Roy, are, of course, the new entrepreneurs, China's capitalists. "It shows remarkable doctrinal flexibility to justify continuing to move China along the path that it has been on now for 25 years."


The effect of Beijing's observations of Russia's errors and its own harmonisation of capitalism with Marxism has been to give China time to make the necessary big social and economic adjustments.

These should not be underestimated, says Roy. State-owned companies with 200,000 workers on their payroll may be producing only the same output as a new entrepreneurial company with just 7,000 workers. As with aggressive start-up companies in the West, China's new businessmen do not have the legacy of pensions and debt and outdated plant. The Chinese once worked for a single entity all their lives, receiving housing, healthcare, benefits and retirement pensions from that company.

"China cannot expect to become a creator of intellectual property, unless it is able to protect that property."

Roy maintains that the authorities are moving toward the position were unsuccessful companies will be allowed to fail or be bought out, but are deeply concerned about the social impact of bankruptcies.

"China has been forced to develop a social safety net and retirement system, and it has to try to make that system portable, because workers now move around in China in a way that they did not in the past.

"This is an enormous burden on the government, and if they seem cautious at times in moving in this direction, it is not because they think that reform is not necessary; it is that they are trying to contain the potential downside of reform."


For Roy, less caution seems necessary over the issue of intellectual property protection, an unpopular issue in any country where people have become used to free access to other people's intellectual property. Every China briefing contains warnings on the issue for foreign investors. Some companies now refuse to do more than source components from carefully separated Chinese suppliers, preferring to do final assembly in another country.

Since China joined the WTO in 2001, the protection of intellectual property has been an obligation that has not been tackled. Roy, however, believes that, now China is the world's third largest trading country, it can no longer duck the issue. He goes further: "China cannot expect to become a creator of intellectual property, unless it is able to protect that property. It is already clear in a large number of areas, including software development, that China has not been able to move ahead rapidly because of the weakness of its intellectual property protection."

Roy sees that competitors are already resisting Chinese growth by using the government's failings over intellectual property protection as a counter-lever. Equally China's own economic development is being held back by the controversy: "China's potential creators of intellectual property cannot create it because there is no economic incentive to do so when it cannot be protected," he says. "I think the top levels of the Chinese government recognise both aspects of this. It has to undertake the educational effort and the enforcement measures necessary to demonstrate credibly to its principal trading partners that it is serious about this issue and is prepared to incur the political risks necessary to enforce intellectual property protection."

"China is now the largest recipient of Foreign Direct Investment."

He admits, however, that because it will require enforcement on such a massive scale, the government is hesitant to take the actions necessary because of the ripples it will cause.

"But if they don't take them or if they don't show steady progress, I think that China is going to encounter increasing resistance from countries such as the USA that are major trading partners and major creators of intellectual property in the world."

The expectation is, however, that China will tackle the problem to head off confrontation. Roy says: "Investing in China is not without risk. But clearly investors have concluded that the likely returns are better there than in alternative investment targets. So in that sense, China, by maintaining stability and by sustaining rapid economic growth, has created an expectation that there are reasonable returns likely for prudent investment."