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Podcast episode

How Wall Street Can Help Democracies Survive w/ Marcos Buscaglia – EP225

Show host Gene Tunny interviews Marcos Buscaglia, former head of the Latin America economics team at Bank of America Merrill Lynch, and author of the book “Beyond the ESG Portfolio, How Wall Street Can Help Democracies Survive.” Buscaglia argues that, through their investment choices, many investors have inadvertently been supporting autocratic regimes, and he calls for a change in investment practices. Tune in to this thought-provoking episode to learn more about the ultimate impacts of our investments and how Wall Street can contribute to the survival of democracies.

Please get in touch with us with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. 

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcast and Spotify.

What’s covered in EP225

  • Introduction to the episode. (0:03)
  • Aligning investments with values and democratic growth. (4:32)
  • Autocratic regimes, EU funding, and corruption in Hungary. (9:41)
  • Investing in emerging markets while avoiding autocratic countries. (22:31)
  • Economic sanctions, autocratic regimes, and investment strategies. (28:06)
  • Economics, democracy, and the role of finance.

Takeaways

  1. Investing in autocratic regimes can inadvertently support and strengthen those regimes.
  2. ESG (environmental, social, governance) investing should also consider whether countries are democratic.
  3. ESG metrics and indices currently do not prioritize democracy as a factor.
  4. There are limited investment options that exclude autocratic countries, but investor demand can drive change in this area.
  5. Sanctions can be an effective tool in limiting financial support to autocratic regimes.

Links relevant to the conversation

Marcos Buscaglia’s book: Beyond the ESG Portfolio: How Wall Street Can Help Democracies Survive

https://www.amazon.com/Beyond-ESG-Portfolio-Democracies-Survive/dp/1265115605

Transcript: How Wall Street Can Help Democracies Survive w/ Marcos Buscaglia – EP225

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Marcos Buscaglia  00:03

By the time Russia invaded Ukraine ESG corrected government bond index of JP Morgan, right. Had a bigger share of Russia than then they they equal index that is not corrected by ESG. Let me open up parentheses to, to make to so everyone can understand. You know, a lot of the investments that finance autocrats end up being funnelled to them through funds that track indices.

Gene Tunny  00:40

Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show was to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, thanks for tuning into the show. My guest this episode is Mark Aasbo. Scalia is the former head of the Latin America economics team at Bank of America Merrill Lynch. And he’s the author of a new book Beyond the ESG portfolio, how Wall Street can help democracies survive, which we talk about in this episode. As I hope you’ll gather from my conversation with Marcos, he’s written a terrific book. It’s one that makes us think carefully about the ultimate impacts of our investments. have investors inadvertently been supporting autocratic regimes worldwide. Marcos argues that they have been and that should change. This is another thought provoking episode. So please get in touch with any comments or reactions, you can find my contact details in the show notes. And you can also find a link to Marcus’s book and other relevant information. Right, I would better get into it. I hope you enjoy my conversation with Marcos for Scalia. Marcus for Scalia, welcome to the programme.

Marcos Buscaglia  02:17

Thank you very much. Thank you for having me, Dean. Of course,

Gene Tunny  02:20

you’ve written a an excellent book, I’ve had a read of your book Beyond the ESG portfolio. How Wall Street can help democracies survive published by McGraw Hill, like us to start off with, could you tell us why did you feel the need to write this book, please? Yeah,

Marcos Buscaglia  02:40

it was it was great that a chance event, I would say, in the sense that I went to a meeting with a client in New York, about the time that Christina Kushner won the, you know, vice presidency, but But you know, she picked the president, the front runner, so she was everybody knew she was going to run the government, that this was the end of 2019. And I went to see this, this very nice client that very smart. And, you know, basically, you know, he argues that, you know, if these guys did the right thing in macro terms in economic terms, you know, they wouldn’t be ready to buy Argentina bonds. And I say, No, this is not right. This is not right, because I knew I suspected what you know, more than I knew, I suspected, you know, that. Christina Kidner will try to undermine democracy in Argentina, at least, you know, checks and balances, particularly not related to her corruption cases, you know, that were going on in courts and will try to undermine democracy in my home country. So I said, this is not right. And, you know, so you know, it was this, like, sort of, you know, small scale Rekha moments in her. And I say, Well, you know, there was something wrong with this. And I wrote a piece that, that the Financial Times blog, beyond breaks was very kind to publish at the beginning of 2020. Before the pandemic, and I got a lot of attention, you know, as so much people, you know, contacted me saying, Yeah, this is not right. For instance, some better roof journalists said, Look, you know, we’re, we’re being jailed. And at the same time, London houses, hold a lot of, you know, Belarusian bonds, but Belarus is, you know, outright autocracy for a long time. There’s no discussion, you know, about that. So, so basically, I say, you know, so So at some point, say, well, maybe I can turn this into a book, because I think this is, you know, this, this may be something important, something that can, you know, change the way we perceive things. Gotcha.

Gene Tunny  04:52

Now, what I’m wondering is, why do you think investors should care about this whether a country democratic mean, obviously, there’s the political reason or it’s the right thing to do. I mean, we want democracies, but they’re investors. So they’re trying to, you know, invest on behalf of clients and they want to get the best returns. I mean, I’d be thinking the things they’re looking at is, well, will we make money on this transaction? Or will this government actually pay its pay? Its its creditors? Will it actually pay the bondholders? So, why is it that this is something that investors should be thinking about? Well,

Marcos Buscaglia  05:37

I think it’s it’s twofold. I mean, there are two reasons. The first is is, you know, to align with your investment with your values, in the same way that you would not invest in companies that use child labour, or that basically, you know, attack one minority or that, you know, pollute, you know, outrageously pollute, you know, the environment, you know, and investors are already doing that, I mean, aligning their, their values with their investments with with the ESG framework, and that’s why we, you know, I put all this view within the ESG framework, you know, because that’s the framework in which, although, as you know, there is a lot of, you know, pushback now, but at least it’s a framework that tried to tries to align, you know, basically values with with with investment decisions, while in the same way that you will do that you will say, Well, you know, what, why would I finance, the finance the availa rules, you know, dictator, you know, or someone that is undermining democracy in his or her country. So, that’s that. So the first reason is to do good, right, to align values with with investment decisions. The second is that, I think that at the end of the day, you you end up doing better, you know, with with investing in democracies, the the empirical evidence on on this is not, there isn’t a lot of empirical evidence to be to be sure, I don’t want to, you know, be, you know, like selling something that is, that is not, you know, a lot of empirical evidence, but, but, look, if you look at what happens with with autocracies, you know, you know, the downsides that you face as an investor are downsides that you don’t face in, in democracies, in which, you know, there’s division of power, there is an independent press, there is an independent judiciary, look at what happened, for instance, we don’t know the litigation stocks in China, you know, a couple of years ago, look at what happened with you know, firms that were expropriated in Oh, no, in Egypt. You know, so there are so many examples of downside risk. And, and there is one thing that I, that there is a little more evidence, you know, that is that at the end of the day, democratic countries end up growing faster than non democratic countries. Of course, you know, there is China, you know, it’s, it’s, it’s, you know, it’s bad, when you put it all together, including China, the evidence suggests that democracy brings more growth, and then you will think, Well, you know, companies that are based in democratic countries, if the country grows faster, should should be doing better, right? It makes it it makes sense. You know, it is common sense to think that so, so again, although I cannot be selling to the people listening to this, you know, look, you’re, you’re for sure don’t going to do better investing in democracies, you know, the, it is reasonable to think that given that democracies tend to grow faster, on average, you know, compared to non democracies, that you would end up doing better. Yeah.

Gene Tunny  08:56

What I think’s interesting about your book is that you give a lot of examples, and you do identify some major financial institutions that are that you or you’re suggesting, are potentially in given the the title of your book. Well, I mean, their actions at the moment aren’t contributing aren’t helping democracies survive and could actually be undermining democracies? Could you explain how that is? I mean, by buying bonds of foreign countries or by investing in those countries, how is that actually undermining democracy in those countries or or supporting the autocracies? Could you give some examples, please?

Marcos Buscaglia  09:41

Yes, of course. You know, at the end of the day, particularly when they’re building their their autocratic regimes, this one of the autocrats build the reputation of being successful, you know, typically they come to power let’s say, let’s say you know the case Since that I’ve started I have not covered, you know, all the autocratic countries, of course, but take the case of, you know, Erdogan in Turkey or Chavez in Venezuela, you know, or, or the commissioners in Argentina, you know, they typically come to power or pull in, you know, in Russia, so they come to power after a period of harsh, you know, economic contraction, and, you know, IMF, typical IMF, you know, austerity programmes, and they come to power and for different reasons, you know, sometimes they’re just lucky, you know, like the cases of Chavez in and occasionally, because commodity prices went up, and they were in the right place at the right time. And, and so, you know, these countries export commodities, namely, oil in Venezuela, and, you know, the cultural goods in Argentina, so, the countries, you know, became wealthier, and they were in power. So for different reasons, but, you know, they consolidate their power, because they’re successful, because they, they come and people say, you know, these guys are successful, but, so, if you’re financing them, you’re helping them to be successful. And, and the market was very happy to finance Venezuela, for instance, when Chavez was clearly undermining, you know, all constitutional checks and balances. Actually, what I’m showing this in the book is that Chavez dismantled, you know, democracy, almost from day one, day one, he called, you know, a constitutional assembly that basically changed the way the institutions of industrial change, work and, you know, forever. And, and, and, and markets, you know, at the same time, we’re, we’re, you know, we’re very happy, you know, you know, taking the bonds that that Chavez redeem, was sent into the market and the VESA, which is the ministry lost one company, so and this has this doesn’t happen in a vacuum in the sense that is not that is people is not aware of what is going on, because you have all these democracy watchers, you know, like, Freedom House, and, and V them and, you know, there are a lot of democracy workers around the world institutions that dedicate themselves to, to, you know, follow up what is going on with democracy. And, and basically, they, they, this, you know, this is this institutions are tracking on real time, you know, what is going on with democracy, and fagging that to the world. And the media also, you know, you know, reflects that. So, it’s not that you’re buying a bond on him off Venezuela or Russia. And you’re totally unaware, you know, that these countries are, you know, sliding into autocracy.

Gene Tunny  12:52

Yeah. Yeah. Good point. Good point. Okay. Now, yeah, what I found interesting is just the the broad range of countries around the world that you that you look at what’s been happening in Hungary, and you, you make the accusation or you identify that the EU has undermined democracy in Hungary? Could you explain that, please, Marcus? Well,

Marcos Buscaglia  13:14

you know, it’s it’s that, you know, Hungary has received for a long time, very important. transfers from the, from the EU, you know, this is part of the typical accession programme, when a country, you know, that is poorer than the average, you know, of the Euro bucks exceeds the European Union, you know, it gets, it gets a lot of money from the European Union, to union to build infrastructure. You know, we have seen that in Spain, for instance, you know, many, you know, some decades ago, and so that happened with Hungary. But the funny fact about Orban is that he speech is an anti Brussels as he called me, you know, speech, you know, he has been bashing the European Union, you know, because European Union puts a lot of constraints on this, of what these countries can do. And at the same time, at the same time that he was bashing the European Union, he was receiving money. Fortunately, you know, very recently, the European Union Fest has changed some rules, and has been withdrawing money, you know, to Hungary, so has not been sending the money to Hungary. So, so, because of violation of some articles, you know, I’m not an expert. Exactly. I don’t remember, you know, I don’t have them on the top of my mind, but it has to buy been violating some articles of the European Union. So, so basically, now, but but in the meantime, you know, it has sent, you know, several percentage points per year of funding a net terms to the to Hungary, the European Union, and, and moreover, there are significant you know, there are there are many indicators, several indications that there was a lot of corruption in this in the contracts for to build infrastructure. funded by the European Union, right? So so so, you know, basically, if you want to put it well, if you want to synthesise this is, you know, there is a band of brothers, you know that, that is managing, you know, Hungary, and these, these guys get all the contracts, you know, we’re almost all the contracts.

Gene Tunny  15:22

Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny  15:57

Now back to the show. One of the points you make in the book is that you think that ESG so environment, social governance, the this requirement or this, this commitment by companies to pursue ESG goals, you think that is not enough on its own to, to prevent or to or to just stop the investment in countries that are autocracies. So, why is ESG which does have you know, it’s got environment, social governance, why is that not enough on its own?

Marcos Buscaglia  16:36

Let me tell you a couple of things. We went into, you know, several, you know, let’s say books that analyse you know, ESG standards and, and to several metrics of companies that do that, and you don’t find the word democracy there. Sometimes you find human rights, you know, but But basically, it’s not a, it’s not a big component. So basically ESG is not built to, to reflect, you know, democratic values, as it stands now. So again, and again, we look into, you know, the metrics, that that several companies that they dedicate themselves to ESG standards look into. And let me tell you, a very, you know, telling example of why, you know, that you can see that inaction. You know, by the time Russia invaded Ukraine, that that day ESG corrected government bond index of JP Morgan, right, had a bigger share of Russia than then the the equal index that is not corrected by ESC. Let me open our indices to, to make two so everyone can understand, you know, two parenthesis certified indices, a lot of the investments that finance autocrats end up being funnelled to them through funds that track indices, right? Remember, I don’t know if you saw the news, you know, these days, but ETFs have surpassed, you know, active funds in, in, you know, in assets under management, well, ETFs track indices, you know, set let’s say in the, in the stock market, they are the most you know, popular ones on there are the Morgan Stanley MSCI indices in the in the, but there are many, of course, you know, and in the bond in the government bond indices in the market, the JP Morgan ones are the most common ones are out there, there are a lot of, you know, several indices. So, but they they, particularly for emerging markets, the JP Morgan indices are very important, right, so, so these indices, let’s say the dollar ones, the most common ones are called the NB you know, the MB them the global, the MB diversified. And then very more recently, you know, you know, JP Morgan issued, you know, the ESD corrected versions of this, right. So, so, what happens is that the, the banks or institutions that produce these indices, and then there are ETS or active funds that track these indices, what do I mean by this gene? You may know this, but Is that us imagine that you are an investor and institutional investor and you offer your services, you say, Well, look, I will track the JP Morgan in MB index, and you will see how I over outperform it, because I’m very good, you know, that’s, that’s your benchmark. Okay. So, so now, but back to track, so you have these two indices, and the the the weight of Russia in the ESG, corrected version of the JPMorgan MB was higher than the non ESD. Correct. What does what does that mean? That if Jean, if you were tracking the ESG corrected version of the index, you should have had a bigger share of Russian government bonds than in the non ESG corrected one. You know what I mean? So so you will be more apt supposed to Russia, if you were tracking and ESG index by the day Russia invaded Ukraine. Right? I don’t know if this was clear or not. Yeah.

Gene Tunny  20:08

I mean, that’s extraordinary. So if you were, if you were conscious of ESG goals, and you would have been overweight in Russian bonds, more than the market as a whole, do you have any insight into why that was? Why Russia was disproportionately? In that? That index? You

Marcos Buscaglia  20:27

know, I don’t know, because I don’t I don’t have the the exact ways I just read this in, in a report. Yeah. But my take is that, you know, given that, let’s say, you know, they take into account, for instance, whether you should green bonds, right. So, so maybe, you know, some countries didn’t issue green bonds, and also they have a lower share in that index. And that Biden, by construction, you know, mean, that meant that Russia had a bigger way. You know, that’s, that’s, you know, that’s an alternative that I can think about, I can think of, but remember, at the end of the day yesterday, as it doesn’t take into account democracy, it takes into account, you know, other the other issues that say, let me give you another example, let’s say Poland, remember that Poland, up until very recently, when when the government was ousted in the elections, it was sliding towards autocracy, you know, and Poland is the bigger, biggest sovereign issuer of green bonds. Right? All right. So, come on gene, money is fungible. Right? You know, so yes, if you finance, if you finance the Polish government to let’s say, to build wind farms, that’s very nice. We all want that. Right. But money is fungible, maybe some part of that money was diverted towards, you know, you know, the Secret Service or, you know, or to buy a media company, or, or, or even if that wasn’t the case, you know, you free up space in the budget, you know, because you’re, you’re you’re funding the the wind farms, and then you’re, you’re freeing up space in the budget to, to finance, you know, the secret police or whatever, you know, whatever an autocratic government will be doing. Yeah,

Gene Tunny  22:13

absolutely. I think there’s several good examples in the book there. So, you, you talk about adding a D to ESG? So it would be what ESD, GE or Ed SG, or however you want to want to pitch it? What are your recommendations for going about that markets? How would you actually get the D in there? What are their regulations that need to change?

Marcos Buscaglia  22:39

I think, maybe regulations, but I think at the end of the day, it seems investors asking for this to happen. I mean, you know, there are several investors, which already do that, but not in the sense that I know, you know, some friends in the, in the financial industry, that tell me Well, you know, this is this is not gonna be, you know, recorded anywhere, but, you know, many, but some big clients come to us and say, We know, we want to invest in a portfolio of emerging market bonds, but please exclude you know, this, you know, x and y and z because they’re autocratic. Right. So one way more general, so, so I think that at the end of the day, is investors, you know, requirements that will bring the change, and that’s the purpose of the book, you know, to bring awareness that this is happening, you know, so investors can demand, you know, for instance, they index providers to do something, right, are the ESG score providers to do something, you know, so, so my take is that I want to bring awareness. But but other than that, you know, given that that may may take time, I provide some solutions to that, let’s say you can do that in your portfolio, say, Well, you know, I will, I will there are some ways to invest in, in, in, in both in the in the equity world and the fixed income world in to try to exclude some autocratic countries, for instance, or diminish the importance. Yeah, your portfolio.

Gene Tunny  24:07

Is this a way for some fund managers to differentiate themselves to attract new business? So, for those people around the world who are concerned about this, I mean, I think people should be concerned about this. I, I agree with you, do you see any companies or any hedge funds or investors, investment managers, fund managers doing this at the moment? Very

Marcos Buscaglia  24:29

few that I’m aware of, there are a couple of ETFs you know, one that is, is based on exclusion is an Emerging Markets Equity Fund is called I think life and liberty and, and it’s basically the Exclude autocratic countries. And then the the second one is an ex US equity fund, right? And instead of a It’s gruelling, it diminishes the weight compared to the benchmark, you know? Yeah. The benchmark again is is, is, you know, X US equity, you know, benchmark. And they diminish the, you know, the weight of the autocratic countries. So that’s in the ETF world. And then I have been in contact with this company, this is a rather new initiative called Tom. And Tom is, you know, French asset manager, who offers for it to situational investors in this case, not to, you know, not to individuals, and strategy, equity strategy, I think, or liberty or, you know, something like that. So, and again, I think there are a few more, but it’s not widespread, is not widespread.

Gene Tunny  25:45

Gotcha, gotcha. Few more questions. What’s the role of government here? So in your book, you mentioned something that the Trump administration did so in August 25 2017, President Trump imposed financial and economic sanctions on Venezuela, executive order 13 808, but the Venezuelan government and in its state owned companies in this joint public, private ventures from international credit markets, is this a type of thing that needs to be done? more widely? Should governments be actively promoting democracy using these economic weapons?

Marcos Buscaglia  26:28

Well, you know, there is a big discussion about this, you know, some people say that sanctions could have gone too far. And that, you know, they they undermine the standards of living of the locals. But I do think that I’m on the camp that thinks that, you know, yes, sanctions should, should be used. And this is because at the end of the day, as I said, you know, before autocrats even though they’re out to grads, they need the economy to be doing well, you know, unless, you know, it’s a very tight autocracy like North Korea, you know, probably the probably, they don’t, they don’t care what the economy’s were, but, you know, other other autocratic regimes at the end of the day, you know, the economy is not doing well, you know, they’re gonna suffer at some point. So, so my take is that you need to cut them off from from from fresh funds, you know, because in that way, you will undermine the the the autocrat, and, and basically that that would help, you know, the democracy movements inside the country. Yeah.

Gene Tunny  27:32

Do you have any thoughts on how the measures the sanctions, the freezing of bank accounts, assets in foreign countries, all the other restrictions that have been imposed on Putin’s regime? Do you have any insight into how they’ve they’ve gone? I’ve heard that. I mean, they, Russia seems to be, you know, living through it, or they sit? I mean, I’m sure it’s imposed some pain, but I don’t think they’ve been the take I’ve seen is that they haven’t those measures haven’t been as effective as US Treasury, as the US administration. Hope. Do you have any, any views on that?

Marcos Buscaglia  28:08

Well, you know, I’m not an expert again, but but my take of what I’ve been reading about sanctions is that it depends on what you want to achieve with the sanctions, you know, some sanctions are just, and, you know, are not aimed at bringing regime change. They’re just thought to be to make the life of those, the, you know, the, the autocrats and their Aiders and abettors, you know, Marmee several, you know, so, so, so, you should not, you know, measure the success or not in on whether there is regime change, because they were not aim at that, to start with, you know, so So some of the sanctions, you know, came out of the Magnitsky Act in the US, then then became the global Magnitsky Act, and several counties have, you know, copied that, and this, this arc was born out of, you know, the work of, of an American investor, Bill Browder, who, who had a fund or the Hermitage fund in, in Russia, and suddenly, you know, he got into the wrong people. And, and he got sacked, and everybody escaped Russia, except for this lawyer that was representing him. Magnitsky and he was basically illegally taken to jail and he died there. And so, will rather say, Well, you know, I, I will try to make the life of those people that that, you know, made Magnitsky life miserable, miserable myself, you know, so, so, and, and, and so, so, again, so, the sanctions that I was talking about what not that ones were related to the sales and trading of government bonds, you know, so that’s, that’s those are the sanctions that I referenced in borg in the sense that say, Well, you know, maybe, you know, the trading of bonds that are already out there, you can you can prohibit you will be hurting, you know, the, the American or the or the Western, you know, investors, but, you know, let’s, let’s stop them from from getting new bonds, you know, you can do that. And I think that that, that would be good. Although, you know, I take notice, you know, there are two sides on this debate, you know, of, you know, whether sanctions are to match, you know, my side is don’t give out to grads or out to God wannabes, you know, new money for them to look good on the population of their countries. Yeah,

Gene Tunny  30:41

yeah. And just try and around all around this often just try to summarise it all, is this a, is this essentially an enlightened self interest? So even though in the short term, you might be able to get higher yields on these, you know, that’d be paying a higher interest rate on these bonds from autocratic countries? In the long term? This is not a good thing. I mean, obviously, there’s the moral question. But if there’s this spread of these autocratic regimes, and you raised some concerns about populist regimes potentially becoming autocratic, if there’s this spread of them across the world, ultimately, that’s worse, makes us all worse off? If so, is it a matter of enlightened self interest?

Marcos Buscaglia  31:24

I think so. And again, they’re the metrics particularly, there is no very good research on the fixed income side, but there is some research on the equity side that you end up doing better, you know, in investing in democratic countries. So So So, you know, let’s let’s, you know, yesterday was seen in, in X, you know, formerly known as Twitter, the, you know, chart of, you know, the, the s&p against the, I don’t remember what, what Chinese stock market index, you know, well, you would have done so much better investing in the US or for the sake of the example, you know, against, you know, any European or, or democratic country compared to China, right? And, and we’re talking about the darling of the autocracies in economic terms, right? You know, because remember that for any, you know, China in economic terms, you have 10, you know, failed economic autocracies, you know, autocratic regimes, particularly in Africa, of course, but but you’re talking about in economic terms, the darling of the of the autocracies, and even in that case, you know, on the long run, you will not have done any money in China.

Gene Tunny  32:38

Yeah, yeah. Gotcha. Okay. Finally, before we, before we wrap up, but you’re coming to us from Argentina. Argentina, has a new president who has, you know, really made a huge impact on the world stage with his speech in Davos, what are the what are the prospects for, for him getting things under control there? In Argentina? I mean, I know that you’ve had, you know, very high inflation. There are huge issues with with the government budget, aren’t there? I mean, what are the prospects for, for him getting things under control? Do you have any insights into that? Well,

Marcos Buscaglia  33:15

you know, he doesn’t have an easy job. Because the, you know, the imbalances that he inherited are so big, let’s say, utility prices, transport prices are so out of whack compared to the costs, you know, money printing has been, you know, huge in the last four years. You know, the exchange rate was totally misaligned. I mean, you have so much misalignments on the macro side to correct, you know, for to start with, and then, you know, he’s also trying to change, you know, the economic structure of Argentina, which basically, you know, it’s, it’s an economy that closed, you know, to foreign trade, trade many, many decades ago. And then, on top of that, you know, it assembler, and all sorts of regulations and vested interests, you know, that live well, in a country that is important getting poorer than the rest of the population is getting poorer day by day. So he’s trying to disentangle those, you know, benefits, special benefits, and these special interests will fight and they’re fighting. So, so it’s not a it’s not an easy task. It starts particularly he’s, you know, President carrier Malay is in, in a minority government. So, so But basically, you know, he, I think he has, you know, still a fair chance of success because, you know, Argentina has been stagnant for the last 12 years, you know, we have 12 years of stagnation or decline in per capita terms with very high inflation with a very high poverty rate with a lot of immigration now, so So I think that The population said, you know, further up. So basically there is a there is a chance for him to succeed, you know, he’s not guaranteed because you know, the Sisa isn’t a minority government in an in a delicate macro and structural, you know, programme. Yeah,

Gene Tunny  35:19

yeah, gotcha. It’s fascinating because he’s a Libertarian candidate. Well, he was a libertarian. I mean, now he’s got to manage a government and it’s going to be, it’ll be interesting to see. I mean, I’ve seen it as some sort of experiment into how, you know how that sort of approach can go a libertarian approach to government. So we’ll have to, we’ll have to see how that all works out. Okay, Marcus Pascale, it has been terrific. Yeah, I’ll put a link in the show notes to your book and encourage you if you’re listening, I think this the books definitely worth reading. I learned a lot about the global economy and, and, you know, all sorts of interesting, interesting transactions. And so there’s reference to all of you know, major players, Goldman Sachs, for instance, gets gets called out for some of their their actions. So, yeah, it’s been terrific. Any final thoughts before we close? Marcos?

Marcos Buscaglia  36:22

No, no, I mean, again, I think that that my interest is in bringing awareness that this is happening, that sometimes he says it’s happening unwittingly, that you may be financing autocracy in your portfolio, and you don’t realise it so that it’s time to take action that there is a real struggle in the world for democracy. You know, democracy has been sliding. And and I don’t think that we want to be, you know, involuntary complicit with that, you know? Yeah,

Gene Tunny  36:49

absolutely. I mean, it’s the sort of thing I might start asking questions of myself. So the big thing at the moment here in Australia is we’re looking at how can we improve improve disclosures relating to climate change? What what’s the impact on climate change? What are companies doing in terms of mitigation adaptation? Whereas maybe what we need is to have more focus on what the least the banks and the financial businesses what they’re doing with regard to democracy, why we should have maybe we should have more insight into that, I’ll have to think about that. And he’ll probably

Marcos Buscaglia  37:26

meet let me give you a small but important example of that. A little bit over a month before the presidential election in Turkey, the Turkish government issued the first ever green bond, and the market was very happy $2.5 billion dollars. At the same time, another one was spending money like crazy to win reelection, the polls indicated that he would lose the election, but he was spending like crazy giving handouts to everyone. And he won the election. So you may say, Well, you know, maybe the market thinking that they were, you know, contributing to the environment in because it was a green bond. Maybe they contributed to consolidate autocracy in Turkey.

Gene Tunny  38:06

Yeah, yeah. Very possible. Very possible. Yes. Lots to lots to keep an eye on, Marcos, for sure. Look, this has been fascinating. I really enjoyed your insights. totally recommend your book. So well done. And yeah, I look forward to the to seeing your work in the future and hopefully catching up sometime in the future. Thanks so much for your time.

Marcos Buscaglia  38:32

Thank you, Jean. But it was very nice talking to you.

Gene Tunny  38:35

rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.

39:22

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Credits

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.

Categories
Podcast episode

Enterprise China: what western businesses need to know w/ Prof. Allen Morrison  – EP171

Professor Allen Morrison has been studying China for over three decades, and he’s an expert on the Enterprise China model, the close relationship between business and state in China. Chinese companies take the lead from Beijing to help meet state objectives, including reduced dependency on the west. In return, they get competitive advantages over western businesses trying to break into China. In this episode, Prof. Morrison, from the Thunderbird School of Global Management at Arizona State University, talks to show host Gene Tunny about his new book with INSEAD’s Prof. Stewart Black on Enterprise China. 

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored. 

What we discuss with Prof. Morrison

  • How the business model in China differs from the model in the west [01:50]
  • How the Chinese Communist Party oversees businesses in China [10:20]
  • What western businesses need to know when doing business in China [12:40]
  • Does China have an imperial ambition? [17:28] 
  • Companies which have done well and those which have done badly in China [22:29]
  • Challenges to the Enterprise China model and the CCP [27:48]
  • Gene’s takeaways from the episode [39:30]

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com or sending a voice message via https://www.speakpipe.com/economicsexplored.

You can listen to the episode via the embedded player below or via podcasting apps including Google Podcasts, Apple Podcasts, Spotify, and Stitcher.

About this episode’s guest: Allen Morrison

Allen J. Morrison is professor in the Thunderbird School of Global Management. Morrison previously served as CEO and director-general, senior advisor for global management education and executive education initiatives at Arizona State University. Before joining ASU in 2014, Morrison was professor of global management and the holder of the Kristian Gerhard Jebsen Chair for Responsible Leadership in the Maritime Industry at IMD. Professor Morrison was also director of the IMD Global CEO Center, which focuses on the challenges CEOs face while leading their companies in the global economy.

For further information about Prof. Morrison, check out his ASU page:

https://search.asu.edu/profile/2551923

Links relevant to the conversation

Get a copy of Enterprise China: Adopting a Competitive Strategy for Business Success:

https://amzn.to/3YMb1aI

Prof. Morrison’s article “Competing with “Enterprise China” vs. Chinese Enterprises” on the Thunderbird School of Global Management website:

https://thunderbird.asu.edu/thought-leadership/insights/competing-enterprise-china-vs-chinese-enterprises

William Kirby’s HBR article “The real reason Uber is giving up in China”:

https://hbr.org/2016/08/the-real-reason-uber-is-giving-up-in-china

Transcript: Enterprise China: what western businesses need to know w/ Prof. Allen Morrison  – EP171

N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.

Gene Tunny  00:00

Coming up on Economics Explored.

Allen Morrison  00:03

The Chinese model is the enterprise China model. If you want to do business, you will wait for the signalling and the support of the government, the government or the there that like the puppeteer is controlling this.

Gene Tunny  00:16

Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny, broadcasting from Brisbane, Australia. This is episode 171 on enterprise China. My guest is Professor Allen Morrison of the Thunderbird School of Global Management at Arizona State University. Allen is the co-author of the new book enterprise China, adopting a competitive strategy for business success. In this episode, I chat with Allen about the close relationship between Chinese companies and the Chinese government and what that means for businesses wanting to compete in China. I also ask Allen about just how worried we should be about China’s global ambitions. Please check out the shownotes relevant links and information and for details they can get in touch with any questions or comments. Let me know what you think about this episode. I’d love to hear from you. Right now in my conversation with Professor Allen Morrison on enterprise China. Stick around to the end of the conversation for what I think are the big takeaways. Thanks to my audio engineer, Josh Crotts visit assistance in producing this episode. I hope you enjoy it. Professor Alan Morrison, thanks for joining me on the programme. 

Allen Morrison  01:30

Great to be here. 

Gene Tunny  01:33

Excellent. Allen, I’m keen to chat with you about your new book, Enterprise China. Could you begin please, by explaining what motivated you to write this book? And then what do you mean by Enterprise China, please?

Allen Morrison  01:50

Right. Right. Well, thank you. It’s good to be here. Thanks for having me. So I’ve been working in and around China for my entire professional career, well over 30 years. In fact, I was in China in Beijing in Tiananmen Square when they declared martial law. I’ve been a visiting professor several times in China, I’ve spent well over a year living in hotel rooms in China, advising Western companies, Chinese companies, also state enterprises in China. So my interest in background in China goes back more than three decades. What has fascinated me about China is that the story about China is very different than anywhere else in the world. And the business model is very different, how the approach to business is very different. In the West, we have long held the belief that if we invest in China, China will grow and it has grown. If we help them with technology, China will grow, and it has grown. And we have believed based on our own experience and values that as China advances up the per capita income curve that the public would hunger for democracy, China would open up would befriend everyone in the West. We also believe that as capitalism flourished, the role of the state would diminish. China has flourished, the economy has prospered the people are richer, 800 million people have been taken out of poverty. But the system didn’t change. In fact, the state is doubling down. And what has emerged is a very successful model we call the enterprise China model, where the state and the enterprise in a free market environment, a free market background, if you will have come together to create a very different model of competing, the model has enabled China to prosper. And we in the West are a not we’re not accepting of the model. We just don’t understand it. We are convinced it’s going to fail. It hasn’t failed and may not fail, and we don’t have a good solution for it. So that really prompted us my clue my co author, Professor Steward Black, was affiliated with INSEAD great business school, that really prompted us to better understand how the Chinese model works with the state and companies working together and how we in the West can best respond.

Gene Tunny  04:40

Gotcha. What I think is great about the work you’ve done, Alan, is that you’ve highlighted just how extraordinary this change has been just what’s been happening with China and there was an article that you wrote a couple of years ago Competing with Enterprise China versus Chinese enterprises, which summarises this, and I might just read this out, because I think it’s fascinating. In 2020, China dethrone the US from the top of the Fortune Global 500. In 2021, China extended its lead with 13 more firms on the list than the US, 135 versus 122. And I think that would, that would surprise a lot of people. So could you tell us a bit more about this enterprise China model, please? How did you learn about it? What is there a framework? I mean, are they are these companies? Are they been directed by the administration? I mean, how does it work?

Allen Morrison  05:39

Yeah, so enterprise, China consists of three types of Chinese enterprises, which captures most of the economy. Okay. On the one hand, we have state owned enterprises owned by Beijing, we’ll just say 100 of these firms. Not many of them. Many of the biggest firms in the world on that Fortune list are these firms. They are owned by the state, they’re an appendage to the state. The second level of firms are also state owned enterprises. But they’re owned by provincial governments, municipal governments, there’s 150,000 of these firms. Some of the big firms on that list are also in this set. But there are a lot of these firms out there, the third set are privately owned enterprises. These are firms like Alibaba, Tencent, and so on. But these firms are also heavily influenced by the state. And that owner influence comes in two ways. One is the state typically owns a small piece of these enterprises. They own 4% or 8%, or 12%, either of the parent or subsidiary organisations. So you scratch the surface of we’ve been quite, quite rigorous and looking at a whole swath of mid sized and large Chinese firms. Every single one of them has some component of Chinese ownership, albeit 4% 6%. So the second way they influence these firms is simply by, you know, through regulation or through signalling. So for example, you know, we go back to 2020, when, when Alibaba Jack Ma, Alibaba has, you know, market cap was $665 billion. Jack Ma himself personally was worth about $50 billion. And part of Alibaba is ecosystem is this company called Ant Financial, Jack Ma wants Ant to go public, it would bring in about 300 would value at $315 billion and bring in about $35 billion from the IPO, that would value add at more than Deutsche Bank, Credit Suisse, Barclays, ING, Goldman Sachs, together, huge. But then Jack Ma makes a few comments that this state viewed as disrespectful, shall we say? The IPO is shut off. Jack Ma is basically exile, the stock plummets in value. And this is just a signal to other tech companies that who’s in charge. It’s the state. And so the state can influence these and they influence them directly and indirectly, that what is very typical with these firms, even the privately owned firms are those that are traded in Hong Kong or those that are traded in the NASDAQ. These firms will partner with a state enterprise or a municipality, and they’ll say look, you know, municipality will say here’s the deal, we’ll give you the factory, we’ll give you the land. We’ll provide infrastructure, we want 6% ownership of your company. And we’ll give you discounted finance. So the Chinese partner, the Chinese, privately owned enterprise, they work with the state, then the state will say we’d like you to work with another company, a sister company, and so they’re matchmakers that put it together. This is this kind of ecosystem. If you want to compete in China, you have to be part of that ecosystem. And that we kind of refer to as the enterprise China It ecosystem. Right. Okay.

Gene Tunny  10:03

Now, this is yeah, this is interesting. I think I understand how they’re getting a competitive advantage. It’s because they’re getting some support from the state. Is that right? You mentioned that they might get land for a factory or there could be some rights, some incentives.

Allen Morrison  10:20

Right, but it’s more than that. It’s the ability to play in it to be in the game. Okay. So if you want to compete in China, you will be part of this ecosystem. You know, the, the Japanese had their model, the Keiretsu Model, the Koreans had the Chaebol Model, the old Hong’s of Hong Kong, it’s these interlocking ownerships and so on, the Chinese model is the enterprise China model. If you want to do business, you will wait for the signalling and the support of the government, the government or the there, they’re like the puppeteers controlling this. So it’s not just that we’ll give you a little discount on the financing, it’s not just that we’ll give you an old factory, it’s that if you want to play the game, here, you will listen to take direction from the subordinate to the state. One other thing many in the West don’t recognise is that companies in China with 50 or more employees must have on site and office of the Chinese Communist Party. They have a representative on site, medium companies, well, any company over 50 employees. So they’re all listening waiting for the signalling of the state. So it’s a matter of, you know, come almost arranged marriages and partnerships, that, that and I don’t want to say that that government is always, you know, always has tremendous foresight, they don’t. But even if the initiative is taken at the company level approvals, and a wink and a nod from the government, at the state, municipal level, are, are essential. Now I have to say, that’s a Chinese from a Western perspective, you have to think so what are we as are, what do we do about that? We want to do business in China? How do we integrate ourselves with that model? And that’s what much of our book is focused on? What do we in the West do about this?

Gene Tunny  12:29

Okay, okay. Well, I might ask about that, then, Alan, what do we do about it? I mean, I guess when you’re in Rome, you have to do as the Romans do, is that what you’re arguing in your book.

Allen Morrison  12:40

to some degree, it’s obviously not black and white. The first thing we look at in our book is, is we create a model or identify a model for strategy involving China. And on the one hand, one kind of strategy for China involves companies that are primarily focused on accessing China as the factory of the world. So I want to do business in China because I can buy, you know, my cheap couches or coffee pots, or whatever that is they become the factory that was so I’m interested in. That’s my, that’s my focus for China. There are other Western companies that are focused on the Chinese market. So I want to be in China because I want to access corporate or individual customer accounts. And in many industries, China is the second largest market in the world. And in many industries, it’s the biggest market in the world. So your approach to China depends in part on why you’re there. Most companies in the West there’s over a million companies in the West, doing business in and with China today, a million companies. Most of them are small, have a small, relatively inconsequential presence. They’re basically buying an option. They’re there, they don’t really understand why they’re there. They kind of burned the box checking business. Those companies are at risk. They’re at risk. So number one is understand why you’re there. Secondly, is to think very carefully about the industry you’re in because China has targeted 10 industries. Where if you’re a Westerner you’re going to be in deep, deep trouble. If you don’t think you know two or three steps ahead of the Chinese. These are the industries we typically think of associated with the Fourth Industrial Revolution, the kind of the industries of the future, robotics, pharmaceutical, aerospace, advanced materials. The Chinese have put a big umbrella up You know, and they keep reading, readjusting the definition. But these are the industries most in the West who would say, look, we’d really like to be there. In those industries, if you’re a Western company competing in those industries, the Chinese have been clear about this. They have identified market share levels, hurdles, and they go from 70, to 80, to 90%, domestic production domestic market share in these industries. So if you’re an aerospace, it’s going to be about 80% of the industry must be controlled by Chinese enterprises, period, doesn’t matter how good your technology is, doesn’t matter how good your service is, your market share it has been determined will be reduced to at most that 20%. But you’re gonna have to cut that up and share it with other Western firms. So be very cognizant of what the Chinese are after the Chinese are, after three things, they’ve been very clear about this, it’s been published, it’s not, you don’t have to be a spy and go in there and take pictures of their, you know, secret ID documents, their strategy is based on three steps. Number one, we want to become less dependent on the west, we want to reduce our dependency. Number two, they want to dominate domestically. And number three, they then want to go out into the world and lead the world to flip that dependency relationship. So we in the West are dependent on China. That’s that’s their approach. And they’ve been doing this for 30 years. And they have articulated it since the early 2000s. And so in the West, we need to be very aware of, of what we’re up against. That does not mean that China wants to decouple from the west. I think the worst thing that could happen to China is it would decouple from the west. And by the way, it would not be a good thing for the West to decouple from China. But they clearly have an engagement strategy and a strategy. That’s whose objective is to ultimately win and flip that dependency relationship.

Gene Tunny  17:28

So do you think that’s the main thing thereafter? It’s, it’s reducing that dependency, rather than? I mean, to what extent do they have imperial ambitions I suppose you could call it was one of the concerns we’ve had in or people in Australia have had is that there are concerns about espionage. And we blocked the telecommunications company, Huawei from being involved in our 5g rollout. So to what extent should we be concerned about that? It’s not just about them, wanting to become more independent. It’s a broader, it’s a bigger game.

Allen Morrison  18:08

You have a former, well, relative of mine, Morrison, who was the prime minister who lashed out on some of this. So yes, by the way, if we’re not closely related, okay. Don’t blame me. So look, I think that the Chinese to understand the Chinese you understand need to understand the history. Every country has its history. But China fresh in China’s memory is what happened in the 19th century when China was subjugated by the West by Britain, to a lesser degree, the US, but you know, that particular animosity visa vie, the Japanese, it was a last century is the century of embarrassment for them. A humiliation is what they refer to it, as they do not ever want to go back to that. They that is, even though it’s 150 years old, it is still part of the Chinese psyche. So they, rather than think of them as imperialist, I would think of them more than seeking respect and seeking a return to what they we all refer to as the Middle Kingdom of China. You know, for 900 years, China led the world as the world’s biggest, most influential, most prosperous economy. And they want to return to that. And so, you know, to the degree imperialism, you know, helps, sure, they’re not going to push back on that, but it’s not. They’re not culturally, an imperialist by mentality, as opposed to say the Russians. So it’s about respect. It’s about power. It’s about control. It’s about influence. More than I would think it’s about imperialism. Now, does that mean we shouldn’t be a lot smarter about it? We should be a lot smarter about how we think about China. And we’ve been, I think, pretty naive about the Chinese. And we’re starting to wake up in the West about what it means to contain the ambitions of China.

Gene Tunny  20:26

Right? And what does that mean for a company say that? I mean, there are plenty of Chinese companies that are operating in the West, does that mean we need to have closer there needs to be closer scrutiny? There’s a lot of talk about tick tock in the US, for example. Do you have any thoughts on that?

Allen Morrison  20:45

Yeah, I mean, that what you need, just think about the kind of mindset I hope we can communicate with with this book, is when you think about China do not think about it as Chinese enterprises, as individual entities, think of them as having an umbilical cord back to the state. So when you do business with Chinese enterprises, you are ultimately doing business with this whole ecosystem, and ultimately, with the state, so it doesn’t mean you can’t do business with them. But you have to recognise that whatever you share, whatever you give them will be absorbed and spread throughout the Chinese eco ecosystem. In terms of best practices. I think that one of the keys to the you know, for the West, is to understand how that model provides big advantages to China, but also provides some significant barriers and problems for the Chinese.

Gene Tunny  21:55

Okay, we’ll take a short break here for a word from our sponsor.

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Gene Tunny  22:29

Now back to the show. Allen, do you have any examples of companies that are engaging with China? Well, and then perhaps some that have been burned or that are doing it badly?

Allen Morrison  22:42

Yeah, absolutely. So the companies easily that had been burned or doing it badly. I think they come in a couple of different categories. The first stars are many of these tech companies, which have been pushed out of China. These are companies like Amazon and Uber, typically tap tech companies that have through because they’re threatened because of their target industries, their initial investments have been wasted, and they’re out of the country. So it’s not difficult to find those examples. Companies that have done it well, in China. I think I would, first we and we do this in the book identify kind of a continuum of what that means and how they’ve done it. But on you have companies like for example, Honeywell, Honeywell is approach to China has to basically go in with the following premise. That is, they want to be in China, for China. They’re not in China, you know, to suck profits out to invest in another part of the world. They are in China to look after the Chinese to as best they can to become an insider in the Chinese market. And because of that they’ve had a CEO who has become fluent in Mandarin. He just recently retired. They’ve been fully engaged with Chinese partners, ingratiating themselves with the Chinese ecosystem. And so other companies like Coca Cola have done the same. They have a myriad of partnerships in China. They every one of these has some tie in, typically with a municipal government. Their approach to China is to be in China, for China. Then you have a company like Yum brands, these are the guys who are Kentucky Fried Chicken, Pizza Hut. They went so far as to say if we’re really going to be in China for China, we cannot have ties back to the corporate parent.  And there are some reasons for that because of public relations because of oversight. And so they have determined that for them, they need to create a separate publicly listed company, Yum China, which is only focused on China. And there are some good reasons for that. By the way, it does protect the parent company, from Chinese behaviours that many in the West will find embarrassing. So we’re seeing companies that are having problems in China, are the ones who, despite making lots of money in China, are compromising some of their values to be there. We’re seeing examples, left, right and centre, whether it’s Daimler Dolce and Gabbana, or the NBA National Basketball Association, whether it’s Apple, Apple, which has a heavy overhang in China, heavy exposure to China, they have made in many ways deals that would be unacceptable were they to be brought to full light in the West. One of those, for example is their iCloud, basically data farm, in that they’ve created with a Chinese partner, which they had to do to bring on a partner in order to do this. But they then stepped out to let the partner manage it gave them the encryption codes. And this partner has ties to the state. So if you are using Apple in China, the state can access all of your data. And by the way, that includes a data that could compromise potentially your identity and your and your personal security. In the West, Apple would never engage in this kind of behaviour. Nor if it was really made public. With China, would Apple be able to survive? I think the torrent of negative press that that would overwhelm it. So I think you’re seeing a lot of these deals going on, to make peace with China, through apology tours, that in the West, are going to cause some problems. So working in that, you know, that model of in China for China is going to require Western companies to rethink some of their global values and the degree to which they need to cut the umbilical cord, just like we’ve seen with young China.

Gene Tunny  27:48

Yeah. Okay. One last question, Allen. Can I ask you about how sustainable you think this enterprise China model is given that economists would argue that this is not the best way to run a company or that it’s going to you’d have less efficient corporations? I mean, how sustainable is this and also, there are the issues with the lack of democracy in China, just how sustainable is this whole model in the next, over the next decade, two decades, etc.

Allen Morrison  28:23

You know, we have been more than happy to interpret China through the prism or the lens of the West, which may not be the most effective lens out there. And let me add the other caveat, we’ve been wrong about China too many times to to do predict with any accuracy, what’s going to happen. So here’s a couple of things that the Chinese have to deal with, which are significant problems. Problem number one is the shift from what we call vertical China to horizontal China. Vertical China’s a command and control going back to Mao the state controls everything, you know, why did your factory makes shoes you know, pairs of shoes because we’re only told to make the left shoe and not the right shoe. Just stupid things that come when the state controls everything. That’s traditionally been the model, horizontal China’s where we have empowered consumers educated informed with resources with money, the ability to travel, the ability to think for themselves. And horizontal China also includes municipal you know, mayors and governors, which are pulling and tugging, you know, and trying to fight the horizontal model of Xi Jingping. So there is that pressure out there. And that pressure is not going away. If anything, it’s going to get worse. Number two, despite China’s efforts to break the dependency curve, the dependency cycle, they have not been able to do that in the areas of highest technology, which, you know, I’m thinking semiconductors microprocessors, for their most advanced three nanometre chips. They are wholly dependent on Western technology, including Taiwan Semiconductor, which is, you know, across the straits. They don’t have the capability to do they barely have, they certainly don’t have enough capacity by indigenous Chinese firms even handle five nanometer technology at a level that would satisfy demand. They have not been able to do this. They’re several generations behind. They have committed $250 billion to kick starting this. But there are some reasons why I’d be concerned that they’ll be able to do this, I’m not sure they will be able to do this, because we in the West have increasingly stopped allowing the shipping of tools, foundry tools and so on for these plants. Number three, there are some phenomena in China called a byline, which translates to let it rot. That’s it. That’s this kind of younger millennials, the Gen Z age who are, you know, 28 years old, who are because of the clamp down on technology in particular, finding themselves unemployed, underemployed, and spend their days playing video games, and fighting and chafing against the state, the state with the motto in the West, translated, let it rot, we hope the whole system burns down. So there’s this anger palatable. I would also argue demographics are, are probably China’s worst enemy. We saw this exact model play out in Japan, where we saw the Chinese population peak in the 90s, has been on a steep decline. It’s paralleling that in China, Chinese population reached its peak in about 2007. Between now and 2050, China’s slated to lose about 230 million people, 230 million people, when the economy shrinks by that amount, the only way the economy can keep its own, if you will, is by dramatically increasing its productivity levels to offset declining population, or they can open the door and have all kinds of immigrants coming in. There’s not a chance of the second happening. And, so can they increase productivity? Not like they have in the past. They have many internal problems, those agrarian farmworkers who left to come to the cities, that’s all played out the ability tp increasingly used capital, that’s to drug jackup product that is decreased, particularly as the economy gets so big, this issue of the challenge of numbers. So China is facing some serious headwinds. And we haven’t even talked about the political blowback from the west restrictions increasingly blocking the transfer of technology. Huawei, you mentioned earlier, Huawei is in many ways, yes, absolutely world class company. But pretty much every major technology advanced made by China made by Huawei, was made outside of China at Huawei facilities outside of China. So China’s seem very adept at importing expropriating technology from the West, not the greatest at doing it in house. They are facing a lot of headwinds, China.

Gene Tunny  33:52

Right. Okay. So I mean, are you saying that we’ll look at there are a lot of challenges. So look, I mean, who knows what could happen? I mean, there is there is this growing dissatisfaction. That we’ve got the demographic issues. So yeah, the whole, so the legitimacy of that administration. Am I right, that it was based on strong economic growth since the 80s. Since the liberalisation and bringing hundreds of millions of people out of poverty that underpins the legitimacy of the administration. Right.

Allen Morrison  34:30

right. Yeah, it does. And, of course, COVID crackdown hasn’t helped. Yeah, I’ll just share one story with you. And maybe the the audience would be interested in this in the late 1980s, when I was in in Beijing, and we had all those demonstrations and martial law. I had dinner with a very senior university administrator, very senior, I don’t want to embarrass him or implicate him. And we were talking about These demonstrations and the tanks rolling and so on, I asked his opinion, his opinion it kind of shocked me, very informed guy. He said, first off, I doubt that the demonstrations really took place the way they’re portrayed in the West. Like, really? Secondly, he said, but even if you’re accurate, he said, What you fail to understand in the West is that in China, we don’t care particularly about democracy. I said, Really, that’s shocking to me. He said, Here’s the reason what I am one vote. In a country with over 1.2 billion people. My vote has no impact on anything. What I care about, is economic prosperity. That’s what I care about. And so when you look at this, from that perspective, where that stability and prosperity, what will propel the regime forward is prosperity, economic growth, and so on, when you start to make compromises, and when you start to say, no politics trumps prosperity, politics trumps economic growth, then you’re going to see this, you know, empowered middle class and upper class begin to change more and more and more, I’m by no means predicting that, you know, that we’re going to see a change in regimes in Beijing, what I am predicting is that tensions within China are going to continue to rise. And either the government will clamp down on that, or we’ll have to become more open. And I’ve taken great, you know, satisfaction and seeing Xi Jinping relaxed, some of those COVID restrictions, based a week or 10 days ago on kind of this groundswell of, of opposition. So I think the Chinese are in for a very interesting 5,10, 15 years going forward. I’m not predicting that, you know, we’ll see a groundswell of change. But I do think that the Chinese model will evolve. One final thing I will say about this is that, it would be a mistake to think that Western companies, by in large, are losing money are getting somehow hammered in China. Some of Western companies, most profitable businesses, one of the kind of ugly secrets out there, they’re coming out of China. There many companies are making embarrassing amounts of money in China. And the Chinese are fine with that. The Western companies are kind of hiding that obfuscating that through transfers, through creating, you know, trading centres in Malta or something, and funnelling money, very smart about this. Where the Chinese will get very upset is if you’re in one of these targets, very upset, and focus is your one of these target industries. And if you refuse to play in their sandbox in their ecosystem, you can figure out how to do that. And you can get out of the way of these strategic industries, China can and will remain or can be and will remain a very viable market for Western firms into the decades ahead.

Gene Tunny  38:37

Okay. Oh, that’s, that’s been great. I think it’s a well researched book, published by Wiley. Is that right? So very reputable.

Allen Morrison  38:46

Wiley and yeah, thank you. We love the book.

Gene Tunny  38:50

Yes, absolutely. So I’ll put a link in the show notes to it. So people who can get a copy. Any final thoughts before we wrap up?

Allen Morrison  38:58

No, I’m delighted you’re you’re talking about this. China’s a huge issue of the day. I will only say that our book steers clear of politics, and focuses on what’s happening with business and what business leaders can do to prepare their companies better in a world where China is not going away.

Gene Tunny  39:19

Okay, gotcha. Righto. Well, Professor Allen Morrison, thanks so much for appearing on the show. I really enjoyed the conversation.

Allen Morrison  39:27

Thank you so much.

Gene Tunny  39:30

Okay, so what am I big takeaways from my conversation with Allen? My first takeaway is that enterprise China, this close relationship between business and government has a wide reach, and it has huge implications for companies wanting to do business in China. In the words of Allen and his co author, enterprise, China extends far beyond this core cluster of state owned enterprises and includes virtually all privately owned enterprises of any significant size or importance. That’s pretty concerning if you’re trying to compete in China. This leads into my second takeaway, but it is very challenging for Western businesses to do business in China. Various Western companies such as Uber have lost a lot of money trying to break into the Chinese market. It couldn’t compete against enterprise China. I found a great quote from Harvard Business School professor William Kirby in 2016, about what happened with Uber. Uber is leaving China, not because of interference from its rivals, but because of interference from the state. It was worried about the prospect of unfavourable national regulations that would damage its business in China. Disney is another prominent example of a company which has had difficulties in China. As Allen and his co-author noted the book Disney’s 2020 Milan film was not only bad for Disney’s reputation in the West, because it was filmed in a region where Uighurs are oppressed. But the Chinese government shut down coverage of the film in China, so very few Chinese people ended up seeing it. The government apparently was concerned that a lot of the media coverage drew attention to China’s human rights abuses. Reflecting on what happened with Disney, Allen and his co author write in the book, beyond appeasing the Chinese state with carefully chosen words and at the ready heartfelt apologies. Western companies face an even larger challenge, responding to rules and regulations that are inconsistent with their home country values. Many of these rules govern the collection and sharing of sensitive data with the Chinese state. As an example, many Western executives in China report being pressured to facilitate China’s social credit system that uses data on such things as credit scores and parking tickets to determine social benefits, and even employment opportunities for Chinese citizens. Okay, that’s very concerning for sure. My third takeaway is that China faces some big headwinds, which will challenge the enterprise China model and the regime in the coming decades. These include China’s ageing and declining population, demographic changes will reduce the rate of economic growth. As I discussed with Allen, economic growth in recent decades has helped the regime stay in power. And I expect that as growth slows, the regime will become even more unpopular as an economist to expect that the enterprise China model will ultimately deliver inferior results to our more free market style of capitalism in western economies. Okay, those are my big takeaways from my discussion with Professor Allen Morrison on enterprise China. Do you think I pick the most important ones? Do you agree or disagree with my takes? If you’re willing to share your own takeaways from the episode, please send them to me via contact@economicsexplored.com or send me a voice message via SpeakPipe. You can find the link in the show notes. Thanks for listening. Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact@economicsexplored.com and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye

Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au. 

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EP102 – Arrow’s Impossibility Theorem

Nobel Prize winner Kenneth Arrow proved a startling theorem in his PhD thesis. Arrow’s Impossibility Theorem raises big questions about democratic decision making. Episode 102 of Economics Explored features a conversation regarding what it means and how much it should concern us. University of Queensland Senior Lecturer Dr Priscilla Man discusses Arrow’s Impossibility Theorem with Economics Explored host Gene Tunny.

https://economics-explained.simplecast.com/episodes/arrows-impossibility-theorem

Links relevant to the conversation

Arrow’s Impossibility Theorem

Kenneth Arrow’s legacy and why elections can be flawed

The paradox of democracy: Arrow impossibility explained

Please get in touch with any questions, comments and suggestions by emailing us at contact@economicsexplored.com. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.

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