As reported in China Daily, the World Trade Organization (WTO) has ruled that China’s tariff on imported auto parts goes against the organization’s rules. This is the first time that China has lost a trade dispute in the WTO since joining the organization in 2001. Under the current regulation, Beijing taxes imported auto parts at the same rate as completed automobiles if more than 60 percent of the parts for finished vehicles are imported. The tariff on an imported car is 28 percent; that on auto parts ranges from 10 to 14 percent.

This trade dispute has been going on for several years, and quite naturally, the ruling raises the question as to what impact, if any, it will have on the development of China’s auto industry. As a China-based supplier of components, many have asked how an adverse ruling for China in this case might affect ASIMCO’s business. Seemingly, the ruling reduces the cost of importing components into China and poses a competitive threat to domestic suppliers.

The answer I have given all along is that an adverse ruling would have no impact on the development of China’s auto industry and ASIMCO’s business. The reason is simple. Any other conclusion misses the point that it is virtually impossible in the auto business, and in most other industries for that matter, to compete in China with imported products or products that utilize a high percentage of imported components. Even with zero tariffs, the cost of a component or product that is manufactured in a high-cost country and then shipped to China will be prohibitively expensive for the vast portion of the China market.

Perhaps a product or component with unique technology that is not otherwise available in China might enjoy premium pricing for some period. But, I would argue that such products or components will be ultimately replaced by products or components that are produced locally at much lower prices. My advice on this is always the same: “If your product is needed in China, but is high priced, you have two choices. Enjoy the premium pricing while you can, or prepare to stay competitive by producing locally.” In China, premium pricing for products in demand will draw competition like bees to honey.

Accordingly, I gave the following answer to China Daily when they called to ask my thoughts on the ruling:

Jack Perkowski, CEO of ASIMCO Technologies Ltd, one of China’s major auto parts makers, said the ruling will not make a big difference to China’s auto parts industry because of the country’s price competitiveness. For foreign carmakers, localization of auto parts in China brings down prices of vehicles and help them make bigger profits, said Perkowski.

In terms of improving competitiveness and profitability through local sourcing, I was referring specifically to the case of PSA, the large French auto assembler that sells cars under the Citroen and Peugeot brands, and its experience in China. In fact, I wrote about how local sourcing had improved both for the company’s China operation in a post last September entitled PSA Gets It Right In China. (PSA’s joint venture in China to manufacture passenger cars is with Dongfeng Motors and is commonly referred to as DPCA.)

DPCA’s fortunes began to improve with the dawn of the new century. China’s entry into the World Trade Organization in late 2001 sparked the growth of China’s passenger car industry, and in the years since then, the China market has more than fulfilled everyone’s dreams of what it might become. DPCA got its product strategy right. And most impressively, it significantly reduced its cost of making cars by sourcing more of its parts locally. At the end of 2004, DPCA only sourced 55 percent of its parts from China-based suppliers. Today, that figure is 82 percent, an increase of almost 30 percentage points. As a result of its shift in sourcing strategy, DPCA’s cost of making a vehicle in China has declined by 32 percent, and with that significant decline has come price competitiveness and profitability.

Despite the favorable WTO ruling, most global automakers will not derive much benefit from it. As PSA has found, the key to success in China is cost competitiveness which cannot be achieved by importing components.

The principal beneficiary of the ruling, in my opinion, is a company like Daimler that makes expensive, high-end luxury cars that, by definition, will never be high volume. Daimler is making approximately 12,000 of its E and C class models annually in its joint venture in Beijing. Given the low volumes and the complexity of the parts used, developing a local supply base for the seven different models that Daimler produces in China is extremely difficult. In this particular case, the ruling will have the effect of reducing Daimler’s costs by 14 to 18 percent, not an insignificant amount.

If you are making luxury cars in China, the recent ruling is cause for celebration. For all other assemblers, though, it seems that a better course is to take PSA’s lead and localize your sourcing of components.

When I returned to Beijing this past Sunday after a short trip to the States, I found a city in Olympic mode. With the Opening Ceremony less than three weeks away, the signs are all there that the much awaited 2008 Olympics are near. As I stepped off the plane, I couldn’t help but notice the people holding “NBC” signs to welcome members of the network that will broadcast the Games, and the special immigration channels that have been established for Olympic participants.

On the day that I landed, Beijing began implementing the odd/even license plate system that will take at least one-half of Beijing’s 3.35 million vehicles off the road. The two-month traffic rule, effective July 20 through September 20, will see vehicles with even and odd plates allowed into the city on alternate days. Beijing authorities believe that this restriction, coupled with an earlier ban on vehicles with improper emission standards, will keep away about 2 million cars and improve air quality. We know that Beijing is enforcing higher emission standards from personal experience. The shuttle bus provided by our building was told to stop running several weeks ago because it did not comply with Euro III.

In addition to Beijing’s new traffic plan, chemical plants, power stations and foundries were told to cut emissions by 30 percent beginning Sunday. Dust-spewing construction in the capital was also to stop entirely. In our neighborhood, construction of the new Sanlitun retail complex is complete, and the workers are now focused on the finishing touches, including planting trees and flowers.

A step that Beijing is taking for security reasons, but which will also have a significant impact on traffic into the city, is the establishment of a series of checkpoints to search vehicles for explosives or other banned materials. About 100 checkpoints have been set up on expressways leading into the city, at entrances to urban areas, and at main roads in the downtown area. This will create further disincentives for motorists to come into Beijing proper. For example, ASIMCO has three factories in Langfang, a city that is halfway between Beijing and Tianjin. On a normal day, a trip to our headquarters near the Lido hotel from Langfang takes just over one hour. With waits of up to one hour at each of the three or four checkpoints along the way, however, these trips can now take three to four hours.

Needless to say, Beijing and China are taking security quite seriously. Airport check-in security has been enhanced, and an additional security check has been added at the Beijing airport. Before even entering the airport’s terminals, departing passengers must now go through a metal detector and random bag searches. Also, customs officials were using bomb sniffing dogs at the baggage claim on Sunday, something that I don’t recall seeing before in my time here.

Finally, it seems that the last of Beijing’s pirate DVD shops closed over the weekend. Several weeks ago, we began noticing such shops closing, one by one. While some of the best established ones managed to keep their doors open until now, they too have been forced to close. Visitors to Beijing may be buying a lot of sportswear at the new Adidas flagship store in Sanlitun, but they won’t be taking home any bogus DVDs.

The combination of a housing slump and oil at about $140 per barrel is proving to be the straw that is breaking the back of the U.S auto industry. U.S. auto sales plunged in June as the economic slowdown and high gasoline prices have hit all U.S. carmakers hard. Sales were down 28 percent at Ford and 18 percent at General Motors. Hardest hit was Chrysler, whose U.S. sales fell 36 percent after it discontinued some models in an effort to increase profit margins. Even the Japanese carmakers who have been gaining market share in the United States market at the expense of the former “Big Three” suffered sales declines. Toyota was down 21 percent and Nissan 18 percent. Only Honda managed a small gain. June was merely the worst of the months this year. Through the first half of 2008, sales were off 16.3 percent at GM, 14 percent at Ford and 6.8 percent at Toyota.

Poor sales have caused equity valuations for US assemblers and components companies to be slashed. The equity value of Ford, a $172 billion sales company, is just over $10 billion, while General Motors, with slightly higher sales of $180 billion, can be bought lock, stock and barrel for $5.3 billion. Stock market valuations of companies that supply the U.S. automakers are being taken down as well. Visteon, an $11 billion company which has a large amount of its sales to Ford, is only worth $285 million, while American Axle, with over 70 percent of its $3.0 billion of sales to GM, is trading at $326 million.

Detroit, which has already gone through one round of bankruptcies and restructurings several years ago, is beginning to brace for another. Rumors are swirling in the marketplace about Chrysler; Kirk Kerkorian is in discussions with the Ford family about the future of their company; and General Motors is scrambling for cash. General Motors today outlined further cuts in its salaried workforce and spelled out its plans for preserving cash. John Casesa, managing partner of Casesa Shapiro Advisors, said that General Motors will likely suspend its dividend payments. “I don’t see how the company can keep paying a dividend given the loss it’s racking up,” he said. A Merrill Lynch & Co. analyst went even further,  saying on July 2 that GM may need to raise $15 billion and bankruptcy is “not impossible” should demand continue to deteriorate.

What does all this mean for Asian, and specifically Chinese, auto companies? It essentially means that the center of gravity in the massive global auto industry is now accelerating its shift to Asia and China. Over the medium and long term, the Japanese, Korean and Chinese carmakers will be the major beneficiaries of the turmoil in the U.S. auto industry. Caught with a high percentage of gas guzzling models in their product portfolios and running out of cash, General Motors, Ford and Chrysler, however they emerge from their current set of problems, will never be the same. That leaves approximately 40 percent of the large U.S. market up for grabs. While Toyota, Nissan, Honda and Hyundai are best positioned to benefit in the short term, a market for more affordable cars from China will undoubtedly develop.

In the meantime, China’s auto industry continues to grow at double digit rates. While tighter government monetary policies and record high oil prices are contributing to somewhat slower growth, passenger car sales nonetheless increased by 17.7 percent to 3,003,347 units in the first half of 2008, according to the China Association of Automobile Manufacturers. That’s why the $9.2 billion market value of Dongfeng Motor Group, only China’s third-largest automaker, is almost twice the value of General Motors, still the world’s largest car producer. Interestingly, Dongfeng Motors’ revenues of 180 billion are the same as General Motors. However, Dongfeng Motors sales are in renminbi, not U.S. dollars!

Apart from sales that they might ultimately get from the North American market, there has been speculation that some of the Chinese carmakers may be “white knight” candidates for all or parts of the troubled assemblers. For example, it has been rumored that Dongfeng may be in discussions to buy Volvo, a unit of Ford. So far, all of these rumors have been denied.

With the market the way it is, even the extremely low valuations for U.S. components companies may prove to be pricey at the moment. One person I spoke to equated buying a U.S. components company today to buying a “melting ice cube.” However, there is a great deal of hard-to-get technology tied up in these companies, and once the market settles down, Chinese components companies may find some interesting bargains to be had. With the market for cars now ending up in the hands of the Asian carmakers, the flow of a lot of technology in this industry to Asia will not be far behind.

I was recently interviewed by a major Chinese automotive magazine regarding China’s global competitiveness. Apart from the information contained in the answers to their questions, the questions themselves provide some useful insights into what is on everyone’s minds in China. What impact is inflation having on China’s global competitiveness? Is China becoming less competitive with India, Vietnam and its other Asian neighbors?

1. Jack, with RMB appreciation and increased inflationary pressures, does China still have an advantage in the export of automotive components in your opinion?

It’s true, inflation has spiked up in China over the past year, primarily due to rising costs of food and raw materials. Raw material prices are priced globally, however, so companies in other countries are affected to the same degree as those in China by rising prices for these manufacturing inputs. As a result, there is no loss of competitiveness by China based companies from higher raw material prices alone.

Many cite rising labor costs in China as a threat to China’s competitiveness globally, particularly given the changes brought about by China’s new labor law. While absolute labor costs have indeed gone up, rising wages have not contributed greatly to inflationary pressures in China because productivity has increased by a greater amount. For example, ASIMCO’s overall wage costs went up by about 18 percent across the company in 2007. Yet, we don’t consider rising labor rates a significant risk factor going forward due to the increased productivity of our work force. In the words of one of our General Managers, “Yes, Jack, our wage costs have gone up, but the base rate has remained the same. We are paying more for productivity.”

At ASIMCO, and at good companies all across China, the implementation of lean manufacturing to reduce waste and inefficiencies in the manufacturing process; the move to higher value added products, and an increase in the capital/labor ratio over the past five years has resulted in increased productivity of the work force. If productivity goes up faster than wages, then there is no impact on inflation or relative competitiveness.

A more productive labor force, and a move to higher value added products, can also act as partial offsets to the impact of an appreciation in the yuan. Increases in the value of the yuan strike hardest at products that are highly labor intensive. With products that requires more raw materials, for example, a higher valued yuan will make it cheaper for companies in China to buy raw materials. That is why exports from Japan to the United States from 1985 to 1988 increased substantially, despite a 50 percent increase in the value of the yen against the US dollar during that same period. It’s also why exports from China to the United States continue to increase, despite an almost 20 percent appreciation of the yuan against the US dollar since mid 2005. While a rising currency may impact the relative competitiveness of particular products, it does not necessarily impact the relative competitiveness of the country as a whole.

Let’s also remember that cost is not the only reason why companies source from China. Most global companies now have ambitious plans for the China market that depend on them developing an effective supply chain in China. Apart from cost, that is another major reason why Chinese companies have an export advantage over companies from other countries.

2. How do Chinese auto components companies deal with increasing cost pressures?

There are a variety of ways. First, a company needs to rethink and rebalance its customer and product mix. Products or customers that were profitable before may not be profitable now with the higher input costs. Second, companies need to do “value engineering” to reduce the use of expensive raw materials in its products. Third, companies need to implement lean manufacturing to reduce waste in the manufacturing process. Finally, companies need to increase their product development efforts. Margins are highest when a new product is first introduced, and then decline as the market becomes more mature. A steady stream of new, higher value added products is the single best way to combat higher costs.

3. Are there any threats from India to exports from China?

From time to time, we run into direct competition from India, but not very often. The China auto market is much bigger than India’s; the China market has many more components companies and is more competitive; and I believe that, overall, costs are lower in China. I don’t see Indian components companies as any greater competitive threat than companies from other countries.

4. Are multinational companies now thinking of moving their purchasing projects from China to India other low cost Asian countries?

For market reasons, I sincerely doubt that many multinationals are considering moving a substantial portion of their purchasing programs from China to other low cost Asian countries. MNC’s want to be bigger players in China, and they need to develop their China supply base.

Moreover, I doubt that costs in India are lower than in China, and any labor cost advantages that countries like Vietnam may have can quickly disappear with 25 percent inflation, which Vietnam is experiencing today. You have to remember that Vietnam is a much smaller country than China. Its population of 85 million people, while large, is only 7 percent of China’s; and its GDP of $71 billion is a fraction of China’s $3.2 trillion. Any significant increase in investment and jobs can quickly lead to inflation, as it is dong currently.

Finally, China manufacturers are much better developed than those in most other Asian countries. Exporting to the global auto industry requires a certain amount of manufacturing sophistication. A great deal of technology has already been transferred to China, and Chinese companies have been developing more sophisticated capabilities for some time.

5. Are there any lessons that China can learn from Vietnam’s current financial crisis?

Vietnam is in a different place than China from a development point of view. It is more like China was in 1994 when inflation peaked at over 21 percent. Time and time again, in country after country, inflation has proven to be any country’s biggest threat to economic development. The major lesson from Vietnam is that every country has to be vigilant about nipping inflation in the bud. All governments, not just China’s, have to have sound fiscal policies that keep spending under control and monetary policies that ensure its money supply does not grow too quickly. Inflation results when there is more money chasing the same amount of goods.

6. Are there any suggestions you can give to local auto components companies who want to export?

If a company wants to develop exports, the most important thing it can do is to change the “mindset” of its managers and employees. Although the China market is changing daily, global customers are still more demanding than Chinese customers. “Close” is not good enough in international markets, as it sometimes is in China. Processes and specifications need to be followed exactly, with no deviation or changes. And. deliveries have to be made on time. Every employee has to understand the requirements of selling to the international market.

Apart from the mindset change, Chinese companies have to improve their quality and management systems to compete internationally.

7. Are there any different plans or actions that ASIMCO is taking in its export program?

Eighty-five percent of what ASIMCO makes in China, we sell in China. Exports are important, but our main focus is the China market. If we can sell the right product to the right customer at the right price, we will export. If not, we prefer to focus on the China market. Because ASIMCO’s China business is growing so rapidly, I do not see our percentage of exports, which is currently 15 percent of sales, changing dramatically in the years ahead. In all of our export contracts, we negotiate clauses which provide for price adjustments for changes in raw material prices and currency fluctuations. In today’s market, you have to do this. Otherwise, you are certain to lose money.

In the chapter on China’s Two Markets in my book, Managing the Dragon, I describe how every product in China has two markets: a highly visible market that resembles those in the most developed economies in the world, and a second, much less visible one that is purely local and unique to China. While the world focuses on the first, much of China’s population deals on a daily basis with the latter.

This is true even in the case of capital. On the one hand, China’s commercial banks are now among the largest in the world and have become highly active, and visible, players in global financial markets. In the stock market, the ups and downs of the Shanghai Stock Exchange are reported on in the same breath as those of the exchanges in New York or London. At its peak last year, the valuation of China’s A share listed companies was a lofty 43.7 times earnings, more than double valuations on most stock markets around the world. Even with the 55 percent decline from last October’s peak prices, A share companies trade at 18.5 times earnings, slightly more than the price/earnings multiple for the S&P 500.

While China’s largest companies enjoy rich stock market valuations and can readily borrow money from banks at interest rates less than 8 percent, most private companies in China are forced to resort to a large and growing network of illegitimate, unregistered and unregulated private lenders that charge interest rates of 20 percent or more. This underground network constitutes China’s less visible, purely local market for capital. Though it has always existed in one form or another, China’s recent credit tightening measures are drying up bank financing that most private companies find it difficult to obtain even in the best of times.

Rampant entrepreneurialism in China and the 85 million private enterprises that Ted Fishman, author of China, Inc., estimates exist in the country, belie the fact that being an entrepreneur in China is no easy matter. Despite the enormous amount of capital that has flowed into the country over the past thirty years, and the vast amount of wealth that has been created during that period, obtaining capital to start or build a business in China is one of the biggest hurdles faced by budding entrepreneurs.

Bank loans, a traditional source of financing for new companies in other countries, have been largely reserved for state-owned enterprises in China, where the implicit guarantee of the state makes it unnecessary for loan officers to learn how to analyze a business plan. A survey by the Guangdong provincial government showed that small and medium sized enterprises in that province only got 2 billion yuan in bank loans in 2007, 2 percent of the total loans extended in the province.

Leasing and other institutionalized forms of secured lending are still in an embryonic stage of development in China. Even selling shares in the stock market, an option available to companies of all sizes in most other stock markets around the world, is not an option for private companies in China, no matter how promising their growth prospects. Which companies go public in China is determined by state regulators, not the investment bankers.

With traditional channels for obtaining capital closed to them, a purely local market for capital has developed as many private companies have been forced to go “underground” to obtain start-up or working capital. A recent story in China Daily Business described some of the aspects of this purely local market and the dilemma faced by entrepreneurs in the country.

When Yuan Xing needed 800,000 yuan to start his organic farm, he turned to private lenders in his hometown for financing at a 20 percent annual interest rate.

“I knew I could get a better rate from a bank,” said the 29-year-old fruit and vegetable producer. “I tried Bank of China and Industrial and Commercial Bank of China, but they didn’t even want to look at my business plan.”

“A lot of small firms come to us. Only the bigger enterprises go to the banks,” said an underground lender, who declined to be named. He has lent out 10 million yuan - he declined to say how he made that kind of money - at 30 percent annual interest rate.

“Interest is not an issue. They will go bankrupt if they don’t get our short-term loans,” he said. “Our money is available at short notice. We can deliver the cash within 24 hours, while a bank loan might take at least six months.”

Despite usurious interest rates, underground lending is becoming a big business in China. In a survey conducted by Beijing’s Central University of Finance & Economics, it was estimated that underground lending totaled 1.98 trillion yuan in 2007, equal to 28 percent of the amount lent by banks.

China is a study in contrasts and nowhere is this more apparent than in its capital markets. Countries like the United States have found that the biggest sources of new jobs are the small and medium sized enterprises, not the large Fortune 500 companies. One of China’s biggest problems is its lack of effective capital markets to distribute capital to those individuals and companies that can use it most effectively. One of China’s biggest opportunities is to develop capital markets that do.

On May 16, the Chinese version of Managing the Dragon was published by China Youth Press.  The book is now available at book stores throughout the country, as well as through China’s two major on-line booksellers, Dang Dang and Joyo Amazon.  The book has been well received by Chinese readers and China Youth Press has already gone into a second printing.

What are the Chinese readers saying about the book?  We have translated a few reviews for you here: 

“Managing the Dragon describes Jack Perkowski’s journey, experiences and feelings at different stages in his life–it is the essence of his life.  It is also a book about a very special company created and based in China, ASIMCO, which was founded by Jack and developed over the past 15 years, and closely relates to the same period of China’s reform and opening-up process.   It is a sound example of what many companies in China experienced.   Jack, like all the other entrepreneurs in this era, saw many opportunities but had to deal with many challenges.   The book not only showcases the spirit of an entrepreneur and wisdom of business, but also the relentless pursuit of a man with dreams.”
— Liu Wei, Publisher at China Youth Book., Inc., a division of China Youth Press

“It is a fairly recent phenomenon that foreigners think of China as an ideal market and attractive location to build a business.   Jack, however, was a pioneer.   Through his experiences described in detail in the book, he tells people willing to invest in China that you had better try your best to understand the country, people and culture.  Indiscreet action is very dangerous.”
— Hu Yong, Chief Editor of “Win in China”, CCTV

“Nowadays, the global automotive industry competes fiercely and China has fortunately become the main battlefront in this competition.  Through 15 years of effort which started from scratch, Jack has made an admirable business achievement in China.  No matter if you are a foreigner willing to build a business in China or are just interested in understanding the rules of business here,  or you are Chinese and looking to take your business into the global market,  Jack’s,  Managing The Dragon,  is the book you should read.”
— Yan Ping, Chairman of Yuchai
 
“As one of his Chinese Partners, I personally witnessed how Jack reformed a State Owned Enterprise (“SOE”) and helped them to become the globally competitive company.   All the difficulties and challenges he faced in China and how he overcame them are summarized in his book with clear explanations and insightful perspective.   It is a book worth reading.”
 — An Qingheng, Former Chairman of BAIC, President of Association of Beijing Auto Industry 
 
“The most estimable attribute of Managing the Dragon is that it speaks fairly about China’s positive and negative issues and problems during its “Reform”.  Furthermore, Jack took a very positive and active approach in analyzing all these problems and issues which will give all foreign investors a comprehensive knowledge and understanding of how China and China’s reforms.”
— Annonymous – Joyo Amazon

If you are intentionally avoiding China and Beijing during the Olympic Games, thinking that the country and the city will just be too crowded, you may want to reconsider.

August is always the hottest and most humid month in China’s capital city, and most expatriates living here typically take the month to return to their home countries. This year’s exodus is being exacerbated, however, by new rules that are making it difficult to renew visas; and the visa restrictions, plus concerns about the availability and high prices of hotel rooms and tickets, are causing would-be Olympic travelers to stay at home. As a result, it now appears that there will not be nearly as many visitors as previously expected to enjoy the $40 billion of new infrastructure that has been put in place in China’s capital city over the past seven years.

The new visa restrictions, which China has adopted for security reasons are definitely having an impact on tourism. The number of foreign visitors to Beijing in May dropped by 12.5 percent from a year ago, China’s tourism bureau said. Among the biggest drops were Japanese visitors, down 45 percent. The number of American visitors fell by 17.15 percent.

As a result, many are predicting that the Olympics may be a bust for Beijing’s hotels. “We are not full at the moment, and we have rooms to fill,” said Anthony Ha, general manager of the newly-opened Marriott Courtyard Beijing Northeast. “There’s not much time left, and we have a way to go.” With the opening ceremony of the Olympics just seven weeks away, only 44 percent of the rooms in four star hotels and 77 percent of five-star hotel rooms are booked, according to the Beijing Tourist Bureau.

Many other cities in China are also feeling Beijing’s pain of fewer tourists, including Shanghai, where some hotels say occupancy rates are down 15 to 20 percent. The new visa rules are not only affecting tourism but also business travel:

Nothing is more of an obstacle than the new visa policy. Businessmen, particularly from the United States, Hong Kong and Taiwan, have complained that new visa restrictions have prevented business meetings from taking place and crimped deal making. Many Hong Kong-based businessmen, for example, say new visa rules require frequent and complicated applications, often including proof of a hotel booking, round-trip airline tickets, and in some cases, a letter of invitation.

The visa restrictions are also having an impact on expatriates living and working in China. Because the new rules may require expatriates to return to their home countries to renew visas, many are simply staying home and telling their Beijing colleagues, “We’ll see you in September!” This hit home over the weekend when I learned that John T. McAlister, a good friend and a driving force behind the Yale Club of Beijing, has lost his months-long battle with the visa authorities, and is being forced to leave Beijing after being here for eight years.

All of this is having an impact on business, and the Olympics may not be the economic boon that many expected. There has already been a visible drop in traffic at restaurants, bars, hair salons and other establishments frequented by tourists and the expatriate community. Most shop owners that I know can’t wait for the Olympics to be over so that Beijing can return to normal.

In addition to there being fewer people than expected on the streets of Beijing, there will also be fewer cars. Beginning July 20, the odd/even license plate system will begin and the number of vehicles will be cut in half. The only experience I have in this regard was the 50th year anniversary of the founding of the People’s Republic of China in 1999. All traffic inside the Third Ring Road was restricted, and the flow of people in and out of Beijing was reduced considerably. October is one of the nicest months to be in Beijing weather-wise, but the traffic restrictions certainly helped ensure blue skies for the parade.

Although there are peculiar circumstances such as the visa rules in the case of China, Beijing’s experience may not be so different from what I have been told about other Olympic cities. Vlad Reyes, a good friend of ours who runs the Beijing Hilton, managed a hotel in Sydney when that city hosted the Olympic Games in 2000. Just like Beijing, all of the hotels were fully booked one year in advance of the games. As the games approached, however, rooms were let go and many rooms became available.

Similarly, another friend of ours who lived in Los Angeles in 1984 when the games were held there, sent his children away, figuring that traffic during the games would be horrific. He said it was the biggest mistake he ever made. The freeways were empty and getting around LA was easy. Everyone thought as he did and stayed away from the city. With the much anticipated Games only weeks away, it appears that potential visitors to Beijing and the city’s residents are having the same reaction.

Ted Fishman, the author of China, Inc. and a good friend, shocked me and the audience in Florida in late 2005 when he stated, matter of factly, that there are 85 million private companies in China, more than three times as many as the 25 million in the United States. Ted and I were serving on a China panel together, and I learned something that day that I still cannot get out of my mind. I always knew that China is an entrepreneurial country, but I had no idea as to the sheer magnitude of the numbers– until then, that is.

Entrepreneurism in China is infectious, and there is no known antidote or cure as far as I can see. It seems like everyone in China—young, old, Chinese, non Chinese— is starting some type of business. If you aren’t an entrepreneur before you get here, I guarantee you; you will become one before you know it.

Despite the difficulties of doing business in China and the fact that the country is already the third-largest economy in the world, China remains one of the best places in the world to start and build a business. Why? First, the economy is growing at double-digit rates, so whatever business you pick, it is likely to have a strong wind at its back.

Second, China is a large economy, but it is also one that is in an embryonic stage of development. That means there are many “gaps” that need to be filled. How many times have you met someone who has just returned from his or her first trip to China and is literally brimming with ideas for new opportunities in China? That’s because there are a lot of opportunities and gaps to be filled. Services and products that are readily available and familiar in a well-developed economy may not be so available or familiar here. Finally, despite China’s rapid development, it’s surprising how many otherwise well-informed business people around the world are not even aware that there may be opportunities for their products or services in China. If you happen to spot one of these “opportunity gaps,” don’t assume that it will soon be filled. The people or companies most likely to fill it may not even be aware it exists.

Having gone down the entrepreneurial road myself, I am always happy to help those that are beginning their own journey in whatever way that I can. That is why I was more than happy to accept an invitation by Jim James and Matt Lewis to speak to the Beijing chapter of the Entrepreneurs’ Organization (EO). EO is an organization that represents a global network of more than 6,600 business owners in 38 countries. Founded in 1987 by a group of young entrepreneurs, EO provides a platform that enables entrepreneurs to learn from each other.

The event in Beijing was well-attended, and I was delighted to meet many people whom I have known by name over the years, but whom I had not yet had the opportunity to meet in person. Most in attendance have been in Beijing and China for several years, so it was a very experienced group. I was particularly happy to meet Paul Denlinger, who not only wrote a review of my book, but also wrote about the event on his blog, The China Vortex.

I congratulate Jim and Matt for their hard work in building the Beijing Chapter of EO. In Jim’s words, “EO is a forum for entrepreneurs to share, learn and support one another here in Beijing. We welcome people who are taking risks, making decisions and building a business here in China.”

 If you would like more information about EO Beijing, you may contact Jim directly by e-mail:jim@eastwestpr.com

As a result of rising crude oil prices, and taking advantage of a drop in the country’s inflation rate in May, China raised gasoline and diesel prices for the first time in eight months this Friday. As of midnight, gasoline prices were raised by 0.8 yuan (12 cents), and diesel 0.92 yuan (13 cents), per liter. This brings gasoline prices to 6.2 yuan per liter in China, or approximately $3.47 per gallon. In most parts of the United States, gasoline now sells for $4.00 or more per gallon. However, taxes account for 11 percent of the retail price, so the net price per gallon in the U.S. is approximately $3.56 per gallon.

It appears that the Chinese government took advantage of the drop in inflation from 8.3 percent in March to 7.7 percent in May to bring energy prices in the country more in line with global prices. At the same time, China announced that it will raise electricity charges for commercial units as of July 1.

With prices in China’s A share market falling precipitously from their October 2007 peak, and many in China calling for the government to do something, anything, to stop the stock market’s slide. I wrote a post on April 29, Sometimes, the Market Just Wants to go Down, where I argued that further intervention by the Chinese government would be the worst thing it could do. The duty of any government is to implement sound economic policies, and to ensure transparency and fairness in its capital markets — not  to guarantee that its citizens and investors earn positive returns through the stock market.

Sometimes, despite any government’s best efforts, stock markets react to global events or trends that are outside the government’s control. In these cases, the market just wants to go down, and the government should let it. This is how vibrant, well-functioning capital markets that efficiently allocate capital in any country’s economy are built.

Anxious to ease the pain of investors, the government nonetheless continued to intervene. Despite these efforts, China’s stock markets have continued to slide, with the Shanghai Composite Index dropping below 3,000 last week. On Tuesday, June 17, the Index plunged another 2.76 percent to close at 2794.75, a 15-month low. The Shenzhen Component Index tumbled 4 percent on the same day.

Commenting on the market, a recent Wall Street Journal editorial summed up the futility of government intervention in the country’s stock markets, and the distortions it causes in capital allocation:

There are good economic explanations for this week’s bear run. As the U.S. and European economies slow, there are worries about China’s export growth. Domestic consumer price inflation hit 7.7% last month. Beijing is trying to slow the economy in response – most recently by increasing banks’ capital reserve requirements Saturday. In any normal market, investors would be worried about corporate earnings right about now.

But China’s stock market isn’t normal; underlying economic growth is less important than government meddling. In the past few months, regulators have reduced the stamp tax on stock transactions, imposed new regulations to limit large block sales, and even told mutual fund managers not to sell their holdings too quickly.

As a result, investors are punting on what the next new regulation will be, rather than on the economic fundamentals of listed companies. This leads to inefficient capital allocation, herd behavior and boom-and-bust cycles. It may also prove self-defeating. Now that Beijing has shown it can’t hold the market above 3,000, the danger is that investors lose faith completely and a sharper plunge might ensue.

In “Managing the Dragon,” I argue that one of China’s biggest problems is the current state of the country’s capital markets. There is plenty of capital in China — it’s just not distributed efficiently. In the book’s final chapter, where I review the bumps ahead for China’s economy, I wrote:

Inefficient use of capital, as I’ve discussed on a couple of occasions, is another big problem. The amount of capital required to generate an additional 1 percent growth in the country’s GDP’s increases each year. Unless China develops a better way to channel capital to the individuals and companies that can use it best, the country won’t be able to achieve its full economic potential.

Despite their current shortcomings, the development of efficient capital markets represents one of China’s biggest opportunities going forward. If you think that the country’s growth over the past 30 years has been something, wait until China develops deep, diverse and independent thinking pools of capital — “cold-nosed capital” that seeks only the highest returns as Charlie Williams, one of my Harvard Business School professors, used to say. The economic growth caused by the eruption of entrepreneurial activity that will occur as a result will be nothing short of spectacular.

As a first step towards that goal, the editors at The Wall Street Journal said it best:

If Beijing wants to create conditions for a healthier market in coming months, it will let this slide run its course.