China-US cyber espionage dispute: the fallout continues

by Chris Zappone

There are some who would describe management consulting firms as one of biggest boondoggles in US capitalism, so there is an irony that American ones are being cut off from China’s state-owned-enterprises in retaliation for the indictments of the Chinese hackers.

report in the FT says Boston Consulting Group, McKinsey & Co, and the firm formerly known as Booz & Company (Strategy&) may all be effected.

All snickering aside, presumably these companies would offer China’s SOEs practical advice on the kind of reforms that would make them more market responsive. SOEs in their current form are a hazard to the longer-term health of China’s economy because of their poor efficiency, transparency and allocation of resources.

China’s decision to cut these ties brings to mind the Western sanctions on Russia. It also brings to mind Russia’s warnings that all sanctions boomerang. If the long-term effort to reform the SOEs becomes longer because of a lack of help in reorganizing them, the decision to banish US consulting firms may come back to haunt China.

My former colleague Peter Cai at the China Spectator argues that the dispute “will be disruptive to the beneficial process of globalization of technology and standards” potentially leaving Americans and Chinese companies trapped in their own markets.

“We cannot afford to have technological tribalism in a globalised economy, especially a damaging fight between China and the US. Businesses should be wary of protectionist policies enacted in the name of national security. The growing trend of paranoia will hold back the development of technology globally and make the world a less connected place.”

Yet, globalization is plainly in retreat anyway. China is stronger now and no longer needs the constant flow of Western technology to grow. Western economies are facing ever-growing inequality linked to the globalization process of the past few decades.

Globalization has allowed big companies to arbitrage their labor costs and shift production and profits to whatever country is the most welcoming, all over the head of legitimate governments and civil society. This corporate power in the West has triggered a strong populist political backlash.

Already, the Balkanization of the internet is happening. China has the Great Firewall. Russia wants bloggers who get more than 3000 hits a day to register. Even the US indictments of the Chinese hackers seem to mark an inflection point following the Wild West era of the Internet. So it’s only natural that with the Balklanization of the Internet comes the Balkanization of technology to some degree, hence “technological tribalism”.

It’s interesting that in the kind of services the US management firms provide, the US actually ran a trade surplus with China in 2012 of $17 billion. But in goods, of course, there is little to stop the torrent of Made-in-China products pouring into the US.

The bigger question for the US is how profitable US-China trade is.

AP writes: Trade in goods between the U.S. and China last year hit a record $562 billion. American companies earned nearly $10 billion last year in China, another record. American direct investment in China exceeds $50 billion.

To put these figures in perspective, General Motors (which is very active in China) had an adjusted EBIT in 2013 was $8.6 billion in 2013. Google’s net income in 2013 was $3.4 billion.

If AP is correct, that means earnings to US companies from the $122 billion in goods exported to China was just over the amount of the total profit for GM in 2013. Meanwhile, in 2013, the US imported $440 billion of goods from China, leaving the US with a trade deficit of some $318 billion with China, according to the US Census Bureau.

The goods forming that trade deficit help the US enjoy “Always Low Prices” which seem to go hand-in-hand with “Always Low US wages.” It doesn’t necessarily add up to the most robust kind of trade situation from the US perspective, particularly given the large and growing barriers for US companies active in China. So this tit-for-tat response from China is really not the end of the world by US corporate standards.