We Americans of a certain age all remember the Life Cereal commercial where three brothers sit around their kitchen table worried about the new cereal their parents just brought home.  The two eldest brothers solve the problem by deciding to have the youngest, Mikey, eat the cereal becuase “he hates everything.”  Mikey ate the cereal, his two older brothers proclaimed that “he likes it,” and a commercial icon was born.

Substitute China for the two older brothers and foreigners for Mikey and you have a pretty good measure of China’s economic reform policy.  China initiates reforms by letting foreigners do it.  Beijing seems to reason (quite rightly, I think) that foreign companies doing business in China are best equipped to initiate/handle reform and, should anything go wrong, they serve as easy scapegoats, insulating the government.

In a recent article, entitled, “China Asks Foreign Banks To Build Up Local Presence,” the Wall Street Journal noted that Chinese “regulators have also begun asking foreign banks to localize more of their operations within China. The effort reflects a desire by regulators to see foreign banks structure full banking operations in China, with a chief executive on down, rather than simply extend branch networks that are legally owned from overseas.”  In other words, the government wants foreign banks to become more involved in China’s economy.

I see this as a smart way for Beijing to improve China’s banking system.  Unlike Chinese domestic banks, foreign banks are generally run strictly on a profit and loss basis.  Because of this, their loan decisions usually depend strictly on a business decision, not on local government fiat or influence.  The more foreign banks penetrate China, the more the domestic banks will need to become more business-like to compete.

The Chinese government’s recent liberalizing of the foreign investment merger and acquisition (M & A) laws is similar.  Strategy+Business Magazine (put out under the aegis of leading international management consulting firm Booz Allen Hamilton and the Wharton Business School) just did an article on China M & A aptly titled, “Reform from the Outside in,” positing that China is opening up foreign investment not to bring in dollars, but to help push reform of its state owned enterprises (SOEs):

The big news is not that foreign companies are investing in Chinese firms; this has been going on, mainly through joint ventures, for some 15 years. What makes the latest wave of deals so unusual is that for the first time the Chinese government is offering outsiders ownership positions in its thousands of state-owned enterprises. The shift is an unmistakable signal that China has made reform at its biggest companies a top priority. No longer silent partners, foreign investors will be in a position to bring new management approaches, better incentive systems, greater transparency, and a whole new level of corporate governance. ‘This is not merely a transactional process, but a starting point for deep change,’ says Edward Tse, managing director of Greater China for Booz Allen Hamilton.

Indeed, the Chinese government’s sale of SOEs is not about gaining access to foreign capital. Marshall Meyer, professor of management at Wharton, points to China’s $800 billion in foreign reserves to make that point. ‘China doesn’t need the money,’ says Meyer. ‘For them, it’s secondary.’ Rather, China’s move is aimed at importing Western business expertise. Quickly moving state-owned firms to sound commercial footing, says Professor Meyer, requires not just cash but experience. Once a firm becomes a shareholding company rather than a wholly state-owned enterprise, it is required by Chinese securities law to install directors and corporate governance systems, which increase transparency and help companies become competitive in an open market. ‘Clearly the aspiration of the Chinese government is to raise overall management capabilities within these businesses,’ says Mr. Tse.

That was the explicit purpose of the December 2005 sale of a 24.975 percent stake in the country’s third-largest insurance company, China Pacific Life Insurance Co. (CPIC Life), also to the Carlyle Group, for $410 million. At the time of the transaction, Carlyle announced the partnership would provide CPIC Life with ‘strategic, operational and industry expertise to strengthen the company’s performance and competitive position.’ Carlyle outlined additional areas of support, including ‘corporate governance, risk management, investment management, product sales, marketing and IT systems.’

I agree.

Mikey ended up both liking Life cereal and becoming famous.  No reason the same thing cannot happen to foreign companies taking up China’s reform cudgel.

Update:  The Going Global Blog has a thoughtful take on this same Strategy+Business article in a post entitled, “Business Processes and Investment in China’s SOE’s — The American Export that Won’t Show Up in the Balance of Trade.

  • In a July 29 post entitled “Business Processes and Investment in China’s SOEs – The American Export that Won’t Show Up in the Balance of Trade” the Going Global blog also reviewed the comments in the Strategy+Business Magazine article discussed here, although in a slightly different context.
    On the downside, I expressed more skepticism about the assumption that China is in no need of investment capital as practically taken for granted in the article.
    On the upside, however, I think the change in policy relative to investment in SOE’s is absolutely positive — and I include the somewhat more subtle impact of these transactions as an export of American management expertise and the payment for that expertise by China, assuming of course that the investing company doesn’t overpay for the investment.

  • Craig —
    Thanks for checking in. I missed your post because I am in a place even more remote than the Maine mountains, where you were: Pentwater, MI. My only internet access is to sit outside the public library (which is hardly ever open) and bum off its wi-fi. I updated my post to reflect your post.

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