The "Double museum" on the western outskirts of Yangzhou. The new building houses the Yangzhou Museum (recently moved from downtown) and the China Block Printing Museum. (Photo credit: Wikipedia)

“The mountains are high, and the Emperor is far away,” is an old Chinese saying that is indicative of the fact that decentralization has been part of the landscape in China for a long time. Contrary to what many might think, pronouncements and policies promulgated by Beijing are not always followed to the letter in China’s far flung cities and provinces.

The most recent example of this phenomenon is in China’s property market where, contrary to central government policy, local governments have begun loosening restrictions and providing various incentives to stimulate home purchases. In January, the southern city of Zhongshan increased a price cap on residential home sales, and the western city of Chongqing raised the minimum threshold where a property holding tax applies. In early February, Wuhu, in East China’s Anhui province, introduced a policy stipulating that those who buy homes would be exempted from paying taxes on those transactions and also granted stipends for purchases of homes up to 90 square meters. And just last week, housing-management authorities in Yangzhou, Jiangsu province, introduced a policy that rewards homebuyers who purchase already finished residences.

The threat of a housing bubble caused China’s central government to issue purchase-policy restrictions in 43 major Tier 1 and Tier 2 cities, including Beijing and Shanghai, in early 2011. Such housing restrictions included limits on the number of units that households can buy, curbs on purchases by non-residents, higher deposit requirements for homebuyers, and caps on the prices that developers can charge for apartments.

The Ministry of Housing and Urban-Rural Development devised five criteria regarding the implementation of purchase restrictions. Two of the criteria targeted cities in which residential prices climbed the fastest, as well as cities that experienced extremely high trading volumes in the first six months of 2011. Another two criteria addressed cities near provincial capitals, as well as small cities that have had a low degree of compliance with past regulations and the real estate policies of their city governments. The final criterion applied to Tier 2 and Tier 3 cities in which housing prices rose significantly in the first six months of 2011.

While the policies implemented by the central government in 2011 have been effective in stabilizing residential price growth across the country, they have come at some cost to the coffers of the local governments. China has more than 1,000 county-level governments and hundreds of city and municipal councils that rely on revenue from local taxes, land sales and central-government transfers because rules bar most from selling bonds. Land sales make up 30 percent of local government revenue and in some cities account for more than half, according to a June 2011 report by UBS AG.

The tug of war between the central and local governments over housing restrictions has begun, but the situation is still very fluid. Wuhu was forced to abandon its new policies four days after they were announced on February 9. Yangzhou’s policy that gives cash rewards to homebuyers who purchase finished homes began to draw controversy immediately after it was posted on the housing authorities’ website last Tuesday morning, May 8. By the afternoon, it had been deleted, only to be posted again in the evening. Alongside the circular about the reward policy was also posted an explanatory note. “In Yangzhou, we will strictly stick to the central government’s macro-control policies and strengthen our control and adjustment policies for the real estate market,” the note said. China’s local mandarins recognize that a tip of the hat to the emperor is always good politics!

In an attempt to explain Yangzhou’s position, an employee at the housing authority’s general office said “We introduced this policy simply because we want to promote sales of finished houses.” Unlike in the West, most apartments are sold completely unfinished in China, requiring the homebuyer to finish construction. Finished houses do not make up a significant percentage of all new residential apartments projects in Yangzhhou, and the reward policy is meant to change that situation.

Whether Yangzhou will be able to implement its new rewards policy when it is expected to go into effect on July 1, or whether the city will bend to the will of Beijing, like Wuhu, is anyone’s guess. “The local governments are testing the water, but the central government is saying we are not ready yet,” said Andy Rothman, CLSA Asia-Pacific Markets’ Shanghai-based China macroeconomic strategist. However, Mr. Rothman expects officials in Beijing to start allowing their local counterparts to relax housing enforcements in the second quarter.

Most experts agree that the recent leveling-off of housing prices in China is largely a product of policy, not fundamentals. The underlying demand for housing remains very strong due to a number of factors, including urbanization, rising incomes, high saving rates and the attractiveness of property as an investment in China. Due to the fundamental long term demand for more and better housing in China, Khiem Do, the Hong Kong-based head of Asian multi-asset strategy at Baring Asset Management Ltd., believes that China property stocks represent good long term investment opportunities.

Doing business in China is never dull, and this is truer today than ever before. The way in which China’s property markets play out will be one of the more interesting stories to follow in 2012.

Maps of Sichuan Province, China (Photo credit: Wikipedia)

As I downloaded my e-mails at 5:00 am in Beijing on Tuesday, I noticed that a friend of mine from New York City had asked if he could speak to me that morning. When I e-mailed back, I said that I had a 7:40 am flight, but was available to speak any time before that.

When we finally connected by telephone an hour later, the first thing my friend asked was: “Where are you headed?” When I told him Mianyang in Sichuan province, I could tell by the silence on the other end of the line that he had never heard of the city and that I might as well have said that I was off to Mars. So, I followed up by explaining that Mianyang is the second largest city in Sichuan with a population of over 5 million, almost as many people who live in Manhattan.

My friend’s reaction is not unusual. Despite the fact that China’s Tier 3 cities are where all the action is in China today — whether it’s urbanization, new government policies, industrialization, or property development — they are the best kept secrets in the world.

Cities in China are typically classified according to location, population, and general economic statistics. Beijing, Shanghai, Guangzhou, Shenzhen, Tianjin and Chongqing are generally classified as Tier 1 cities, while provincial capitals are generally classified as Tier 2. Important cities, like Mianyang, are classified as Tier 3, and many analysts carry the classifications further and use Tier 4 to denote cities that are large and important by any standard, but are even less well known. China currently has well over 100 cities with populations of one million or more.

Known as the “Western Silicon Valley of China,” Mianyang has a total population of 5.2 million people and is in the heart of the newly established Chengdu-Chongqing Economic Zone (the “Cheng-Yu Economic Zone”), which will benefit greatly from China’s “Go-West” policy. Mianyang has gained its reputation as a technology center due to its importance as a base for national defense, scientific research and production. Over 18 research institutes are located in Mianyang, including the China Academy of Engineering Physics and the China Aerodynamics Research Institute. It is also home to many Chinese and foreign-invested companies in industries as diverse as electronics, defense, pharmaceutical and advanced materials.

In May, 2011, China’s Central Government created the Cheng-Yu economic Zone and stated its intention to develop the zone as China’s “fourth economic pillar.” The three existing pillars are the Bohai Economic Rim, which consists of the cities of Beijing and Tianjin and Shandong, Hebei and Liaoning provinces; the Yangtze River Delta Economic Zone, which includes Shanghai and Jiangsu and Zhejiang provinces; and the Pearl River Delta Economic Zone, which covers Guangdong Province. As the first major regional development plan under the 12th Five-Year Plan to receive State Council approval, the Cheng-Yu Economic Zone has effectively been chosen to lead the development of China’s interior.

Already, 160 Fortune 500 companies have established operations in Sichuan Province. Hewlett-Packard has built a manufacturing base in Chongqing to assemble 40 million laptops annually, with planned production capacity likely to reach 80 million units. Similarly, Intel moved its manufacturing and testing plants from Shanghai to Chengdu in 2009. Most recently, Siemens AG announced that it will set up an automation manufacturing and R&D base in Chengdu, which will serve as Siemens’s largest digital factory in China and its third global R&D center for its industrial automation business.

Under China’s “Go West” policy, cities like Mianyang will benefit from the government’s investment in transportation and other infrastructure projects, as well as from favorable government policies that will encourage direct investment. As a result of increased investment and a continuation of the urbanization trend, these cities will benefit from significant population growth and the need for new residential and commercial facilities. Mianyang is the only city in Sichuan Province, besides Chengdu, to receive State Council approval to develop as a million-plus population city. Mianyang’s center city population has grown from 600,000 three years ago to over 1 million today, and is expected to increase to 1.5 million by 2020.

Mianyang is already well connected by both highway and rail, with more transportation networks currently under construction. A first-grid highway connecting Mianyang and Chongqing is nearing completion, and Mianyang Airport has direct flights to Beijing, Shanghai, Guangzhou, Shenzhen, and other major cities within China. In addition, a new high-speed urban rail connecting Chengdu and Xi’an – and passing through Mianyang – is set to be completed by the end of 2012. The current trip between Chengdu and Mianyang takes approximately 2.5 hours, but the new urban rail will reduce travel time to just 15 to 20 minutes.

While the vast majority of China’s economic development to date has occurred in Tier 1 cities and along the country’s coastal regions, many manufacturers – driven by increasing land, labor, and operating costs – are beginning to relocate their facilities to cities in the interior, like Mianyang, where costs are substantially lower. With more people moving off the farms and growing affluence, consumer goods companies are also finding millions of new potential customers in China’s Tier 3 cities. As these trends continue to play out in the years ahead, names like Mianyang will soon become household words, just like Chicago, Minneapolis and Atlanta are today.

BEIJING, CHINA - MARCH 09: China's Chongqing Municipality Communist Party Secretary Bo Xilai leaves after the third plenary meeting of the National People's Congress (NPC) at The Great Hall Of The People on March 9, 2012 in Beijing, China. China's Chongqing Municipality Communist Party Secretary Bo Xilai said he was surprised to learn that his ex-police chief had run off to a US consulate during the the National People's Congress Chongqing group meeting today. (Image credit: Getty Images via @daylife)

Political events in China have dominated the news over these past few months, overshadowing stories about the country’s economy that usually make the headlines.

It began on February 6 when Wang Lijun, Chongqing’s chief of police, sought refuge in the United States Consulate in Chengdu. Fearing for his life at the hands of Bo Xilai, Chongqing’s powerful Party Secretary, Wang told U.S. diplomats that Bo’s wife had poisoned a British businessman and one-time confidante to the Bo family. Wang’s action was the event that triggered the fall from grace of the former rising star of the Chinese Communist Party that has been playing out in the press ever since.

Over the past two weeks, Chen Guangcheng, the “blind lawyer” and dissident from Shandong province, has taken center stage. Under house arrest in Shandong Province for the past two years for railing against forced abortions and sterilizations that occur as part of China’s “one-child policy,” Chen somehow managed to escape the week before last, only to show up at the U.S. embassy on the eve of a high level visit to Beijing by U.S. Secretary of State Hillary Clinton and Treasury Secretary Timothy Geithner. “Should I Stay or Should I Go,” the 1981 hit song by the English punk rock band The Clash, could have been the theme for last week’s talks between Chen and U.S. diplomats.

The Bo and Chen sagas have once again raised questions as to China’s stability and the impact that local and international politics may have for companies doing business in the country. As serious as these recent events might be, though, it’s important to keep in mind that we’ve encountered similar bumps in the road over the past 20 years. Somehow or another, China has remained stable and the U.S. and China have managed to patch up any differences through it all.

No doubt, the Tiananmen Square protests of 1989, also known as the June Fourth Incident, is the most notable of the destabilizing events that have occurred, interrupting as it did over 10 years of economic progress in China. Afraid that China was reverting to pre-Deng days, scores of Western companies chose to pack up and leave the country as a result. The lure of the Chinese market proved too great, however, so in the end, all of the companies found their way back.

In the years since, there have been at least three smaller, but no less important, incidents that threatened political stability in China and were wrapped up in the Sino-American relationship. I was in Beijing for all three, and all of them seemed quite scary at the time.

The first was the 1995–1996 Taiwan Strait Crisis that came about as a result of a series of missile tests conducted by China in the waters surrounding Taiwan from July 21, 1995 to March 23, 1996. The missiles fired in mid-to-late 1995 were allegedly intended to send a strong signal to the Taiwan government under President Lee Teng-hui, who was seen as moving Taiwan away from the One-China policy. The second set of missiles fired in early 1996 was allegedly intended to intimidate the Taiwan electorate in the run-up to the 1996 presidential election. The crisis began when Lee accepted an invitation from Cornell University to deliver a speech on “Taiwan’s Democratization Experience” in June 1995. In May, resolutions overwhelmingly passed by both houses of the U.S. Congress asked the State Department to allow Lee to visit the United States. China was furious over the U.S. decision and the state press branded Lee a “traitor” who was attempting to “split China.”

NATO’s bombing of China’s embassy in Belgrade on May 7, 1999, was the second of such events and perhaps the scariest for Americans doing business in the country. The bombing killed three Chinese reporters and outraged the Chinese public. President Bill Clinton apologized for the bombing and said that it was accidental, while China insisted that it was deliberate. The days after the bombing were tense to say the least for those of us in country. Even my closest Chinese friends looked at me with disbelief when I tried to argue the U.S. side. With all of the U.S. technology in precision bombing, it was impossible for them to imagine how the bombing could have been accidental.

In early 2001, the collision of a U.S spy plane and a Chinese fighter jet in the South China Sea exacerbated political and military tensions between the two countries. The incident came on the eve of a decision by the Bush administration on whether to sell advanced U.S. anti-missile and air defense systems to Taiwan. Although the Chinese pilot was killed, with no casualties on the U.S. side, the initial U.S. reaction was strident and aggressive. The Chinese were miffed that the U.S. offered no apologies or regrets regarding the death of Chinese pilot. Again, it was tough to be an American in China, trying to explain how the U.S. could be so callous.

Each of the three events brought to the fore any divisions that may have existed between the doves and the hawks in China and the U.S. and threatened to rupture the Sino-American relationship. In each case, however, cooler heads prevailed after a few tense days and weeks. Whatever their differences, the various factions within the Communist Party came together in each case in a way that prevented events from getting out of hand. As a country, China just had too much to lose if they didn’t. Government leaders in both China and the U.S. realized that it was in neither country’s interest for the two most powerful countries in the world to be at serious odds with one another.

By week’s end, the Chen crisis seemed to have been resolved with China allowing Chen to accept a fellowship offer from NYU. With respect to Bo, there is serious concern that his plight is indicative of a serious rupture within the Communist Party. Everyone doing business in China should be concerned, of course, and watch events closely, but if the past is any guide, this too will pass. If China had too much to lose in 1995-1996, 1999 and 2001, the stakes are even higher today.

China Eastern Airlines YN022 2357 (CEA) 737-700 Exteriors and Take off (Photo credit: Wikipedia)

On the eve of the May 1 holiday in China, China Eastern Airlines, based in Shanghai, announced that it is buying 20 Boeing 777 jets worth nearly $6 billion, while also selling five Airbus A340s to the U.S. plane maker. China Eastern said it’s selling the Airbus A340-600 airplanes worth $708 million to Boeing because they have high operating costs and “relatively weak route competitiveness.” The new Boeing jets will be delivered in stages from 2014 to 2018. The announcement represents a big win for Boeing, but a huge loss of face for Airbus.

The Boeing Company is traded on the New York Stock Exchange (“NYSE”) under the symbol BA and is an American icon with a great product that appears to be winning everywhere. Last week, Boeing announced that revenues rose 30 percent in the first quarter and that it is raising production rates to meet increased demand. Therefore, it should come as no surprise that China Eastern would select Boeing aircraft for such a large purchase. Other factors may also be at work, though.

China Eastern Airlines Corp. Ltd., is also listed on the NYSE under CEA, but the company is 62 percent owned by China National Aviation Corporation, a large state-owned company in China. With such strong government oversight, the impact of China’s geopolitical objectives  — on the timing of the company’s decisions and on the decisions themselves — cannot be discounted.

In March, the chief executive of EADS, the parent company of Airbus, Boeing’s large European competitor, said that China has blocked purchases of Airbus planes by Chinese companies in reaction to a disputed European carbon tax. EADS Chief Executive Louis Gallois said Airbus is being subjected to “retaliation measures” by Beijing and warned that the European commercial-aircraft maker stands to lose business if the EU fails to heed protests from airlines around the world about the emissions scheme that took effect at the beginning of this year.

“The Chinese government is putting on hold approval” for 35 wide-bodied Airbus aircraft ordered by Chinese airlines, Gallois said. “We are worried that this conflict is becoming a commercial war … and that there is a risk that Airbus will be taken hostage.”

China is among 27 countries that have said they will consider retaliatory steps following the European Union’s extension of its carbon market to aviation. The EU decided in 2008 that aviation should become part of its cap-and-trade carbon program after airline discharges in Europe doubled over two decades.

China is set to become the world’s second-largest air travel market after the United States by 2014, according to a report released by the International Air Transport Association. I could almost hear the cheers that must have gone up in Boeing’s China headquarters across the street from my office in Beijing when the news of China’s decision on Airbus came across the tape. Could the new order that China Eastern announced on April 30 be the first step in the implementation of China’s boycott of Airbus?

Last week, Chen Guangcheng, a Chinese dissident, escaped from house arrest in China and has reportedly sought refuge in the U.S. embassy in Beijing. On Monday, Secretary of State Hillary Clinton and Treasury Secretary Timothy Geithner left Washington to lead a U.S. team to the “strategic and economic dialogue” with China that is a regular annual meeting between the two countries, aimed at broadening ties between the world’s two largest economies.

With the Chen Guangcheng situation threatening to bring human rights issues to the fore and overshadow the talks, the timing of China Eastern’s announcement is interesting, to say the very least. The U.S. economy is still struggling, so such a large export order is very welcome news, particularly in an election year. It’s also noteworthy that Gary Locke, the American ambassador to China, is from the state of Washington where Boeing was once headquartered and still maintains a significant presence. Could the timing of China Eastern’s large order for Boeing aircraft have been designed to take some of the edge off the talks?

As many prominent American companies have found, a company’s business in China can be impacted both positively and negatively by geopolitical considerations. When the U.S. and China are at odds, government approvals come more slowly. When other factors are at work, however, American companies may find themselves on the receiving end of large orders from China. As America’s largest exporter, Boeing may now be benefiting from a strong China tailwind.

A foreign model shows off a foreign model at the Beijing Auto Show.

First-quarter passenger car sales in China may have been flat, but that does not seem to have dampened the enthusiasm for the Beijing Auto Show, which opened earlier this week. Every year, China’s major auto show alternates between Beijing and Shanghai, and every year, the show seems to get bigger.

This year’s show requires 230,000 square meters of floor space, 156,000 square meters for the assemblers in the new China International Exhibition Center, which opened in 2008 in the Shunyi District of Beijing, and 74,000 square meters of space in the old China International Exhibition Center, just off the 3rd Ring Road. As a measure of how big the auto business has become in China, the assemblers and components companies were all able to fit in the old convention center prior to 2008. The components companies are not too happy with the new arrangement where they are forced to display their brake, transmission, engine and other components 20 kilometers away from the glitz surrounding the car models. I know of several, including some of the biggest auto suppliers in the world, who aren’t participating in this year’s show for that reason.

Unfortunately for the residents of Shunyi, traffic will be every bit as bad as in 2008 and 2010, the last two times the show was held in the new venue. Over 800,000 visitors are expected to visit the show in the one week that it is open. In addition to the visitors, of course, every player in the global auto industry will be present and contribute to the heavy traffic. Over 2,000 assemblers and component suppliers from 14 different countries are showcasing their products this year.

Despite the large amount of space that the new convention center has added, space to show off both existing and new models is at a premium. A total of 1,125 vehicles are on display, including 120 new models — 36 from international assemblers and 84 from Chinese carmakers. In addition, 74 “concept” vehicles, highlighting new styling and product features that may be used in the cars of the future, as well as 88 new energy vehicles, will be unveiled. Gone are the days when auto companies brought only their existing models to China. Today, every company wants to bring their latest designs to the world’s largest car market.

Also gone are the days when automakers sold the same models worldwide with few local changes. The China market is now so large and so important that the most ambitious carmakers, including the world’s luxury automakers, use the annual auto show to showcase sedans and SUVs with China-specific features.

Aston Martin, Bentley, Lamborghini are among the brands introducing new vehicles at the show. Aston Martin may take the prize for the most expensive car at this year’s event. The company’s Dragon 88 will be priced at more than 5 million yuan (almost $800,000). If you want one, though, you had better hurry because only 88 cars will actually be produced. Earlier this year, the Rolls-Royce “Year of the Dragon” special edition Phantom sold out in a matter of months, despite a $1.2 million price tag.

This year, Bentley is unveiling an EXP 9 F SUV concept which, if interest is high enough in China and elsewhere, the British company may put into production. Other luxury automakers like Lamborghini and Range Rover are following Bentley’s lead and using the show as a platform to unveil gas-guzzling SUVs. Range Rover is introducing its Evoque, which was designed by Victoria Beckham and Land Rover’s design chief. The Evoque will be available in October at a price of around £80,000 ($129,192). Not to be outdone, Lamborghini is showing off its Urus SUV concept, which Lamborghini describes as a potential “Cayenne-killer” in China.

All automakers positioned in the premium segment are putting on their best face for the China market. GM announced plans to bring five to 10 new Cadillac models to China over the course of the next four years, and to build at least one China-based factory that will produce only Cadillacs. Jaguar unveiled its XJ Ultimate, which includes a special feature for China—embedded iPads, a staple in today’s China. BMW also debuted a China-focused version of its 3 Series sedan featuring a longer wheelbase that has become a must in the country.

And to show off all of those new car models, China’s real life models are also getting into the act. Chinese models can make 5,000 to 10,000 yuan per day ($750 to $1,500) at this year’s show to look exotic alongside the exotic car models. Not bad work if you can get it.

Bentley Continental GT Speed Emblem (Photo credit: theignitionpoint.co.uk)

First quarter passenger car sales in China may have been flat, but that does not seem to have dampened the enthusiasm for the Beijing Auto Show, which opened earlier this week. Every year, China’s major auto show alternates between Beijing and Shanghai, and every year, the show seems to get bigger.

This year’s show requires 230,000 square meters of floor space — 156,000 square meters for the assemblers in the new China International Exhibition Center, which opened in 2008 in the Shunyi District of Beijing, and 74,000 square meters of space in the old China International Exhibition Center, just off the 3rd Ring Road. As a measure of how big the auto business has become in China, before 2008 the assemblers and components companies were all able to fit in the old convention center. The components companies are not too happy with the new arrangement where they are forced to display their brake, transmission, engine and other components 20 kilometers away from the glitz surrounding the car models. I know of several, including some of the biggest auto suppliers in the world, who aren’t participating in this year’s show for that reason.

Unfortunately for the residents of Shunyi, traffic will be every bit as bad as in 2008 and 2010, the last two times the show was held in the new venue. Over 800,000 visitors are expected to visit the show in the one week that it is open. In addition to the visitors, of course, every player in the global auto industry will be present and contribute to the heavy traffic. Over 2,000 assemblers and component suppliers from 14 different countries are showcasing their products this year.

Despite the large amount of space that the new convention center has added, space to show off both existing and new models is at a premium. A total of 1,125 vehicles are on display, including 120 new models — 36 from international assemblers and 84 from Chinese car makers. In addition, 74 “concept” vehicles, highlighting new styling and product features that may be used in the cars of the future, as well as 88 new energy vehicles, will be unveiled. Gone are the days when auto companies brought only their existing models to China. Today, every company wants to bring their latest designs to the world’s largest car market.

Also gone are the days when automakers sold the same models worldwide with few local changes. The China market is now so large and so important that the most ambitious car makers, including the world’s luxury automakers, use the annual auto show to showcase sedans and SUVs with China-specific features.

Aston Martin, Bentley, Lamborghini are among the brands introducing new vehicles at the show. Aston Martin may take the prize for the most expensive car at this year’s event. The company’s Dragon 88 will be priced at more than 5 million yuan (almost $800,000). If you want one, though, you had better hurry because only 88 cars will actually be produced. Earlier this year, the Rolls-Royce “Year of the Dragon” special edition Phantom sold out in a matter of months, despite a $1.2 million price tag.

This year, Bentley is unveiling an EXP 9 F SUV concept, which, if interest is high enough in China and elsewhere, the British company may put into production. Other luxury automakers like Lamborghini and Range Rover are following Bentley’s lead and using the show as a platform to unveil gas-guzzling SUVs. Range Rover is introducing its Evoque, which was designed by Victoria Beckham and Land Rover’s design chief. The Evoque will be available in October at a price of around £80,000 ($129,192). Not to be outdone, Lamborghini is showing off its Urus SUV concept, which Lamborghini describes as a potential “Cayenne-killer” in China.

All automakers positioned in the premium segment are putting on their best face for the China market. GM announced plans to bring five to ten new Cadillac models to China over the course of the next four years, and to build at least one China-based factory that will produce only Cadillacs. Jaguar unveiled its XJ Ultimate, which includes a special feature for China — embedded iPads, a staple in today’s China. BMW also debuted a China-focused version of its 3 Series sedan featuring a longer wheelbase that has become a must in the country.

And to show off all of those new car models, China’s real-life models are also getting into the act. Chinese models can make 5,000 to 10,000 yuan per day ($750 to $1,500) at this year’s show to look exotic alongside the exotic car models. Not bad work if you can get it.

The first turn of the Yangtze (Changjiang) at Shigu (??), Yunnan Province, where the river turns 180 degree from south- to north-bound (Photo credit: Wikipedia)

As China’s already large economy continues to industrialize, the country’s growing thirst for oil has been well documented. Many believe, however, that water, not necessarily oil, may ultimately prove to be the most valuable liquid in the Chinese economy. While a rich country can buy oil from the global marketplace, and it is economic to ship oil virtually anywhere, water is another story. In most cases, a country must learn to live with and survive on its own water resources. In this context, water scarcity is not just a China issue; it’s a matter of concern for all of the world’s developing countries.

Within the next 50 years, the world population will increase by another 40 to 50 percent. This population growth — coupled with industrialization and urbanization in developing markets like China, India and Africa — will result in an increasing demand for water. The World Water Council, founded in 1996 to promote awareness, build political commitment and trigger action on critical water issues, notes on its website that more than one out of six people (1.1 billion) in the world already lack access to safe drinking water, and that more than two out of six (2.6 billion) lack adequate sanitation.Due to population increases and increased per capita usage of water as a result of lifestyle changes, the proportion of water needed for human use is increasing.

China’s water issues are particularly acute. The country’s water supply is smaller than that of the U.S., yet it must meet the needs of a population nearly five times as large. Industrialization has taken its toll on this already limited resource. Industrial and biological pollution has contaminated almost 90 percent of the underground water in Chinese cities. The World Health Organization (WHO) estimates that one out of four (300 million) Chinese do not have daily access to clean water, and that one out of two (700 million) are forced to consume water below WHO standards. High population density, a poor ratio of available water to demand, and regional imbalances in available water supplies are serious challenges for China in managing its usable water supply. Frequent floods ravage cities in the south and east, and droughts are a regular occurrence in the north and west.

When China opened up in 1978, economic development was given first priority and little attention was paid to environmental considerations. At the beginning of this century, China began taking steps to mitigate the harmful environmental impact of its rapid economic development. Air quality was addressed first as the country began implementing tighter vehicle emissions standards and new environmental regulations. Although much has been done, the impact of 30 years of neglect has been considerable, as any visitor to China will attest. Those of us living here get used to suffering from periodic bouts of the “Beijing cough.”

In its 12th Five-Year Plan that began in 2011, China will shift its environmental focus to water. From 2011 to 2015, the country will spend a total of $536 billion on water purification and wastewater treatment plants, irrigation systems and flood control projects. Currently, only 50 percent of urban sewage is treated. By 2015, the government intends to add 42 million tons of daily sewage treatment capacity to increase its urban wastewater treatment rate to 85 percent.

In 2006, new safe drinking water standards were introduced that increase the water quality monitoring parameters from 35 to 106 items. Unfortunately, very few of China’s existing water purification plants can meet these higher water standards, so the law has not been rigorously enforced. Over the next five years, it is estimated that additional investment of RMB 220 billion (US$ 35 billion) will be needed to upgrade existing purification facilities and bring them into compliance.

Finally, a new regulation on Water Resources Utilization will limit the annual consumption of water to 635 billion cubic meters by 2015, further increasing the need for water recycling facilities. For this reason, China expects to spend $69 billion on industrial wastewater treatment. Because per capita water resources in China are only a quarter of the world’s average, and industrial water consumption constitutes a quarter of the country’s total water consumption, the recycling of deeply treated industrial wastewater is essential.

Implementation of the water related programs called for in the 12th five year plan has already begun. In 2011, the first year of the plan, total spending on water resources management increased significantly to RMB 345.2 billion ($54.6 billion). In addition to water treatment and recycling, China has already initiated programs to limit the loss of human life and property damage caused by flash floods. At the end of last year, RMB 3.8 billion ($603 million) was earmarked to subsidize flash-flood forecasting projects in 1,100 counties throughout the country. It is expected that the number of counties will be increased to 1,800 and that $1.8 billion will be spent on flash flood forecasting programs by 2013.

Although China is the second largest economy in the world, it is still in an embryonic stage of development. There are many product, technology and service gaps yet to be filled, each of which represents a new business opportunity. Helping China to quench its thirst for water appears to be one of them — and a big one at that.

Factory in Datong, Shanxi, China (Photo credit: Wikipedia)

A major global think tank asked my opinion on the challenges of entering the China market for international companies for a white paper that it is currently preparing. Although many books have been written on the subject, important topics like this are worth re-visiting from time to time. After all, the China market grows more compelling by the day, drawing more and more companies into the discussion, and China does change. What is true today may not be true tomorrow.

At the top of everyone’s list of challenges, and the topic I am asked about most frequently, is the question of how a company can protect the technology it brings to the country. When combined with the lack of legal enforcement, the issue of protecting intellectual property rights (IPR) is the single biggest hurdle for most companies to overcome when thinking about entering the China market.

My answer to companies puzzling over this issue has several aspects. Before addressing the broader issues, I point out that there are a variety of ways to protect technology in China. None, of course, are foolproof, but taking certain precautions can substantially lessen the risk. For example, setting up a wholly-owned foreign company where possible to manufacture the product, rather than entering into a joint venture, provides more control over who has access to the technology and know-how. Breaking the manufacturing process into several discrete operations that are located in different facilities can prevent any single group of employees from seeing the whole process. Another good way to prevent technology leakage is to manufacture more components, where much of the technology is contained, in-house, rather than outsourcing.

Beyond the tactical suggestions, there are two broader issues that I raise. First, I ask if the company can really afford not to bring its products to China. Secondly, I emphasize that China is evolving in technology and innovation, and that provides a measure of hope for all technology owners.

At the request of a friend, I spoke about China with the CEO of a $60 million, U.S. manufacturer of specialty engineering equipment several years ago. When I called on the appointed evening from my home in Beijing, the CEO told me that his company had more than a 50 percent market share in the United States and had begun seeing strong interest in its products from China. The company had hired an agent, a Chinese national, to develop the market, and the company’s export sales to China were growing as a result.

The CEO wanted my opinion as to whether he should begin thinking about setting up a manufacturing facility in China. Before I could answer, I had a question. “How much do you think your revenue opportunity might be if you manufactured in China?” Straight off, he said, “I think we could do as much as $40 million per year.”

Hearing that, my advice was clear. “If the market is that big in China for your product, you’d better start producing here,” I told him. I then went on to explain. “Your product is a labor-intensive, assembled product. With transportation and duties, the imported price is already pretty high. And given the high labor content, there’s plenty of room for a Chinese company to reverse engineer your product and sell it for a great deal less.” He immediately saw the point and agreed, but I wasn’t quite done. “Losing sales in China isn’t your biggest problem if you don’t start manufacturing here,” I added. “How long do you think it’ll be before your Chinese competitors begin to eye the market, and those higher prices, in the United States? If you don’t get over here, your 50 percent market share at home could also be in jeopardy.”

Needless to say, this was a sobering thought which he hadn’t considered. Silence can be deafening sometimes, and all I heard was silence at the other end of the telephone. I had just told him that, in many ways, the decision to manufacture in China had broader implications than he had realized. As the CEO of the company, he needed to worry about a lot more than just the prospective size of the China market. The future viability of his company might very well be at risk if he didn’t set up shop in the country. The CEO was gracious and thanked me at the end of our conversation, but I’m sure that I had ruined his day.

This same dilemma faces every company that has good technology and a large market share outside China today. If the company doesn’t learn to compete with its upcoming competitors in China, it may soon be battling these same companies on its own turf. The old football adage that the best defense is a good offense has plenty of application here.

There is a second, more hopeful, point that I always make, though, and that is that China is changing. A Thomson Reuters research report,  published in December, showed that China became the world’s top patent filer in 2011, surpassing the United States and Japan as the country steps up innovation to improve its intellectual property rights track record. The report said that the country’s goal was to transform itself from a “made in China” to a “designed in China” market, with the government pushing for innovation in sectors such as automobiles, pharmaceuticals and technology.

The report said that published patent applications from China were expected to total nearly 500,000 in 2015, followed by the United States with close to 400,000 and Japan with almost 300,000. Published applications from China’s patent office have risen by an average of 16.7 percent annually from 171,000 in 2006 to nearly 314,000 in 2010, the study showed.

As more and more Chinese companies become patent holders, they will then have a vested interest in protecting their technology, just like their international counterparts. More than any other factor, this trend will drive the future of IPR protection in China.

Symbol used for vehicles powered by compressed natural gas. (Photo credit: Wikipedia)

With the price of a gallon of gasoline in the United States now at $4 — and climbing — CNBC’s Rick Santelli is making it his personal mission to demonstrate to the world that cars can easily be converted to run on natural gas. Santelli is best known for starting the Tea Party movement with his famous rant about being forced to pay for his neighbors’ mortgage. If Santelli is right about natural gas, he may start an even more powerful trend. Natural gas is in abundant supply in the United States, and the U.S. is the world’s lowest-cost producer. Lured by the promise of fueling their vehicles at a fraction of the cost of using gasoline, Santelli is sure to have a lot of followers.

The price of gasoline is set by the government in China, and prices were last raised in March to the equivalent of $4.42 per gallon — high for a country with a much lower average per capita income that is quickly developing a car culture. With Santelli’s mission in mind, I thought it would be useful to see where China is in terms of using natural gas as a fuel.

Compressed natural gas (CNG), liquefied natural gas (LNG) and liquid propane gas (LPG) are all fossil fuel substitutes for gasoline and diesel that can be used to fuel cars, trucks and buses. In addition to its low cost, natural gas fuel combustion produces significantly less harmful emissions than gasoline. Gas engines emit 97 percent less carbon dioxide and 72 percent less hydrocarbons. The principal disadvantages to using natural gas are that there are presently far fewer refueling stations and that the upfront cost of a vehicle that can run on natural gas is about $1,000 higher than one that uses gasoline.

In December, 1999, China’s National Science and Technology Ministry (NSTM) and State Environmental Protection Administration (SEPA) set 10 percent as a target for clean vehicles as a portion of the overall vehicle population, and set a target of 40 to 50 percent for taxis and buses. Additionally, the policy called for the launch of clean vehicle model zones in 19 cities, including Beijing, Shanghai, Tianjin, and Chongqing.

As part of this program, city governments in China have implemented policies to encourage the industrialization of CNG passenger cars, LNG heavy-duty trucks and engines, LPG engines, and direct-injection LNG engines. Measures that have been used include offering preferential gas price policies and constructing refill stations. At the end of 2010, more than 80 cities across China had gas refilling facilities and the number of CNG/LNG refill stations totaled more than 1,000. During the course of China’s 12th Five-Year Plan, it is projected that an additional 1,000 refill stations will be constructed. Finally, municipal governments have been working with automobile companies and industry research institutions to accelerate the development of new technologies.

Are these measures working? CNG/LNG vehicles have already been incorporated into bus and taxi fleets in 100 cities across the country. In Chongqing, 85 percent of taxis and 92 percent of buses are using an LNG engine. In Shanghai, Chengdu, Xi’an, Xinjiang and Hebei, these percentages are above 90 percent. Despite a decline in the commercial truck market in 2011, trucks using natural gas fuel increased by 7.6 percent.

Since the central government began to implement natural gas policies in pilot cities across the country, China has developed a domestic industry for natural gas products. In 2010, more than 60 natural gas vehicle manufacturers produced over 150,000 natural gas vehicles, and approximately 20 engine manufacturers had capacity to produce 1.0 million natural gas engines annually. Within the passenger car market, taxis are the target segment for natural gas engines because of the potential for operational cost savings.

The total nationwide taxi volume in China is more than 1.1 million units, with an estimated 50 percent having adopted gas engines. China is already among the top seven gas vehicle markets in the world, and with stricter emission regulations providing an impetus for cleaner vehicles, natural gas vehicles will likely increase in demand. According to the country’s national plan, China’s natural gas vehicle ownership will be 1.0 million in 2012, 1.5 million in 2015 and 3.0 million in 2010.

That’s a good start, but there is still a long way to go when taking into account that China produces over 18 million vehicles annually and has a vehicle population that already totals 112 million. As in the United States, high and rising gasoline prices may provide a strong stimulus for growth.

Correction: An earlier version of this post had the price of gasoline in the U.S. at $5 per gallon — the average price is closer to $4 per gallon.

Business Center of ICBC in Beijing (Photo credit: Wikipedia)

In the United States, large banks have been criticized because they are “too big to fail.” In China, the country’s largest banks have recently come under criticism because they are “too big to lend.” In both countries, there is a growing body of thought that large banks need to be downsized and broken up.

According to Richard W. Fisher, President and Chief Executive Officer of the Federal Reserve Bank of Dallas, and Harvey Rosenblum, Executive Vice President and Director of Research at the Dallas Fed, the share of assets controlled by the five largest banking institutions in the U.S. has tripled to 52 percent from 17 percent in the early 1970s. Because complexity has come with greater size, magnifying the opportunities for opacity, obfuscation and mismanaged risk, Fisher and Rosenblum believe that restructuring is a far less drastic solution than the quasi-nationalization that occurred in 2008 and 2009 as a result of bank bailouts. They believe that downsizing can improve competition and market discipline.

In comments made in a China National Radio website interview last week, Premier Wen Jiabao came to the same conclusion regarding China’s large banks, but for a different reason. Premier Wen believes that China’s largest banks are too big to lend.
Premier Wen said that China’s four main banks are a monopoly that must be broken up so that smaller private firms can get access to loans as the global economy slows. He went on to say that the current banking environment in China has squeezed private businesses and that the large banks’ stranglehold on lending needs to be broken to ease the flow of private capital.

“In regards to financing costs,” Premier Wen said, “let me honestly say that our banks are making a profit too easily. Why is this so? It’s because a few big banks are in a monopoly position. What we can now do to ease private capital flow into the financial system, fundamentally speaking, is to break this monopoly.”

Although many new banks have been established in China over the past 30 years — there are now 3,800 banks in China compared to 7,357 in the United States—the country’s banking system remains heavily concentrated. China’s top four banks currently account for approximately 40 percent of total loans. In the fourth quarter of 2011, the five largest Chinese banks accounted for 62 percent of total bank profits.

Even though Premier Wen’s comments are very unusual for a senior Chinese leader, they come on the heels of a bold new experiment that is being carried out in the city of Wenzhou where there has been an explosion in underground lending. Due to credit restrictions that China has implemented over the past two years, independent business owners have had to borrow money at high interest rates from informal lenders after being rejected by major banks, who favor other state-controlled enterprises because their debts are implicitly guaranteed by the government. The Wenzhou experiment, which was announced two weeks ago, will legitimize private lending in that city.

Premier Wen’s comments and the Wenzhou experiment reflect the step by step development of China’s capital markets that we have been following over the past year, as well as recognition by China’s leadership that small and medium enterprises (SMEs) are the backbone of any economy and must be encouraged.

In a presentation at the Cheung Kong Graduate School of Business in Beijing in late 2008, Yijiang Wang, professor of economics and human resource management, said that he did not believe that China was doing enough for its SMEs, given that history shows that SMEs determine the economic vitality and strength of a nation. In his comments, Premier Wen said that the experimental reforms being introduced in Wenzhou to help struggling private firms could be expanded nationwide. Professor Wang’s message seems to have been heard.