Friday, August 26, 2005

The Value of Money

Does China have the Second-Largest GDP in the World?

According to statistics reported by the China Daily, China's gross domestic product for 2004 was in the neighborhood of 13.65 trillion yuan (or 1.65 trillion USD, with an exchange rate of 8.28 yuan per dollar). Using only the exchange rate to convert yuan to dollars, however, does not reveal the entire story. Indeed, the CIA ranks China second in the world, behind only the United States, in terms of GDP. The figure they use is 7.26 trillion USD for China's GDP.

In terms of only the exchange rate (8.28 yuan per dollar) the World Bank ranks China's economy 7th in the world at 1.65 trillion USD. The IMF ranks China sixth in terms of GDP.

But when purchasing power parity, rather than the exchange rate, is used to “compare” China's GDP to those of other countries, the situation changes. This is why the CIA ranks China second in the world. This is also true of data from the IMF (see list here).

Purchasing power (also known as PPP, or purchasing power parity) is the principle that money used domestically can be exchanged for a certain amount of goods and services. Put simply, money has a certain value. To compare the value of money, one cannot rely simply on the exchange rate. The value of 1 yuan in China, that is the amount of goods and services it will buy, can be compared to the value of 1 USD in the United States. To make this comparison, economists choose a “basket” of goods and services and then compare the price in different countries, usually using the U.S. basket as a benchmark. In theory, a vast discrepancy between exchange rate and purchasing power will lead to arbitrage, since one can simply keep buying goods at the lower price until the exchange rate equalizes. China pegging the yuan to the dollar, however, keeps the rate stable regardless of inflows of foreign dollars. (There is a good article in the April 4, 2005 Business Week on “Hot Money,” but it is available to subscribers only).

The Economist has compiled a Big Mac Index which uses the price of a Big Mac to relate the purchasing power of currencies to each other (the benchmark is a $3 U.S. hamburger, so if the same burger is cheaper in China, purchasing power is greater there). For China, they cite a figure of 3.43 as the PPP of the dollar. This would imply, using the Economist Intelligence Unit's figure of 1.68 trillion USD for China's GDP, a "Big Mac" adjusted GDP of 5.76 billion USD. That is, in terms of purchasing power, China's has a GDP of 5.76 trillion USD (FIY the Economist Intelligence Unit’s own figure for GDP in terms of purchasing power is 7.55 trillion USD, using 4.5 for its purchasing power ratio or a yuan-to-dollar rate of 1.84).

The more common figure for understanding the purchasing power of China's economy is 1.8 (from the World Bank's World Development Indicators report, listed here). Using quick and easy math, divide the exchange rate (8.28 yuan per dollar) by the purchasing power conversion factor (1.8 yuan per dollar) and you get a unit-less ratio of 4.6. What it means is that 1 USD buys 4.6 more value in China than in the United States. Converted in this way, China's GDP ranks second in the world.

I am not an economist. The above was gleaned from the web over the past week. I can only provide my experiences as a confirmation of the relevance of purchasing power to converting statistical figures that come out of China these days.

Two anecdotes
Before I went to China for the first time with University of California's Education Abroad Program in 2000, I attended an orientation hosted in Berkeley. One of the speakers, a past participant, noted that one should not argue vigorously with petty traders over a few yuan. Later, I expressed my unease with such a blanket statement. An economics undergraduate, who was giving me a ride, vehemently defended the speaker. The ride home was quite unpleasant as I stuck by my conviction that despite the fact that a couple of yuan was only a quarter or two, I did not want to give away my quarters. I also felt that such unequivocal rendering of exchange was dismissive of the context one might encounter in China.

Living in Beijing for several years since the yuan polemic, I discovered the real power of money. In Beijing, in Zhongguancun, a nice two-bedroom apartment cost me 2,400 yuan a month (about 300 USD). This was a nice area, convenient, clean, and safe. But my friends in China chided me that it was too expensive, since the apartment lacked a refrigerator. I scrimped money by eating fast food (a bowl of rice topped with one item of cuisine) for 5 yuan a meal. But herein is the evidence for purchasing parity calculations.

In China, or Beijing nonetheless, the cost of daily living is much cheaper than in equivalent cities in the U.S. Therefore, a figure such as the ratio 4.6 worked out above for multiplying China’s GDP (or other figures such as the Big Mac Index) is reasonable. An 8 yuan meal in Beijing converts via the exchange rate to a 1 USD meal. But using the purchasing power multiplier, it is really a 4.6 USD meal. That is much closer to actual experience, since I can buy rice topped with food items in San Francisco for about 4 USD. Rent, too, should be viewed this way. My two-bedroom apartment in Beijing only cost 300 USD a month. But in real purchasing power terms, it cost 300*4.6 = 1,380 USD a month. That seems to fit reality much closer, since 300 USD rents you only a storage unit in San Francisco, while 1,380 USD would get you a nice two-bedroom apartment.

Purchasing power arguments notwithstanding, the official exchange rate of 8.28 (or, now, 8.11) yuan per dollar tells us little about what a dollar or a yuan actually purchases in China. Certainly, the point can be made that Starbucks coffee in Beijing is more expensive than it is here (it costs 16 yuan or 2 USD for a cup of Starbucks coffee in Beijing). But the point is that that coffee costs more in value in China than it does in the U.S. To understand the equivalence in value, rather than in monetary, terms, one must use purchasing power. Hence that cup of Starbucks coffee really costs you 9.2 USD in terms of equivalent value forsaken to imbibe the brewed beverage. There are real reasons to vehemently bargain over “a few yuan.”

Tuesday, August 16, 2005

What is Piracy to Microsoft?

Piracy or Monopoly?

In Zhongguancun, China's Silicon Valley, piracy of Windows XP is rampant. That is beyong dispute. From the migrants who approach you outside the major electronics markets to the DIY (do-it-yourself) computer assemblers, no one pays for Windows. The reason: cost. It costs over 2000 yuan ($250) to buy Windows. Pirated copies cost 6 yuan (three quarters). But does this subvert or sustain Microsoft's monopoly on operating systems?

"The bird who sticks out its head gets shot," goes a proverb in Chinese. The meaning, for large companies like Baidu, UFIDA, and Lenovo, is that if they use pirated software, they will be "shot" by Microsoft, in court. The fly-by-night migrant, who only make 800 yuan ($100) a month selling pirated software can be arrested, bankrupted by fines, and sent home. But what would that net Microsoft? Nothing, since the fines would go to Beijing city government police. How does piracy help Microsoft?

The answer, from one point of view, is that by continuing piracy, Microsoft is able to sustain its monopoly in China. There are no Chinese operating systems. There are none even in the works. Why? Because they will be pirated as well. Piracy undercuts Microsoft but it also undercuts would-be Chinese entrepreneurs who could (undoubtably) create a Chinese proprietary operating system that could sell for 200 yuan ($25). That is the threshold price that would keep Chinese entrepreneurs profitable and return their investment costs. But why doesn't Kingsoft, the Microsoft of China, attempt it? Piracy.

Piracy, in the case of China, does take profit from Microsoft. But I would argue that Microsoft also benefits, and even profits (as the proverb predicts) from piracy. Without piracy, 100 operating systems, like Chairman Mao's flowers, would bloom. They would undercut and eventually end Microsoft's monopoly on operating systems.

Next time Microsoft complains about piracy, make sure they point out exactly why. 4/5 of the computers in Zhongguancun are name-brand, and come with official Microsoft licenses. 1/5 are DIY, are cheaper, and come with pirated Windows. So where is profit lost with respect to profit gainined?

Wednesday, August 10, 2005

Report on Zhongguancun

The First 6 Months


graphic courtesy of The Beijing News
(see map source here)

Zhongguancun in the First Half of 2005
Translated and adapted from the original Chinese by Tyler Rooker on August 10, 2005 for Zhongguancun Blog

“Year-to-Date Income for the Zhongguancun Science & Technology Zone Surpasses 190 Billion”
(article source)
Reporter: Zheng Jinwu of Science Times (Kexue Shibao)
Original article reported on July 28, published on July 29.

Information released by the Zhongguancun Science & Technology Zone management committee revealed that, in the first half of 2005, Zhongguancun enterprises had a total income of 191 billion yuan, representing an increase of 29.6% over last year.

Exports had foreign currency profits of 3.2 billion USD, an increase of 91% over last year.

Industrial production reached a value of 104 billion yuan, an increase of 29.8% over last year.

This income was structured in the following ways:

Product sales had an income of 121 billion yuan
Technology had an income of 25.0 billion yuan

If income is separated according to the different parks of the Zone, we find that:
Name_____________2005 Income_______Percentage of total
Haidian Park 99.9 billion yuan52.2%
Fengtai Park 23.4 billion yuan12.2%
Changping Park 12.5 billion yuan06.5%
Electronics City 17.0 billion yuan08.9%
Yizhuang 37.5 billion yuan19.6%
Desheng Park 0.78 billion yuan00.4%
Jianxiang Park 0.25 billion yuan00.1%

Enterprises in the Zone during the first 6 months of this year had total profits of 4.91 billion yuan, a decrease of 9.8% from the same period last year.

Software enterprises in the Haidian Park have had a total income of 10.3 billion yuan during the first five months of 2005.
System integration has earned 7.16 billion yuan during the same period.

Energy and conservation companies are rapidly expanding in the Changping Park. For example, three notable companies are

Great Wall Drilling Company (GWDC)
National Electricity Fuel Company (NEFC)
China National Logging Corporation (CNLC)

There are over 196 companies in the Zhongguancun Zone that have an income over 100 million yuan in 2005. These companies have 63.7 billion yuan in production value, have created 2.4 billion USD in export reserves, and have 6.5 billion in profit.

Already in 2005, 2,236 high-tech companies have been created.

There are currently 73 companies listed on the Shenzhen, Shanghai, Hong Kong, and NASDAQ stock exchanges that come from Zhongguancun.

Tuesday, August 09, 2005

Proposal for California-China Free Trade Agreement (CCFTA)

In this post, I call on the Gubernator, Governor Arnold Schwarzenegger of California, to use his trip to Beijing (November 13-18, 2005) as a stepping stone to negotiate a free-trade agreement with California. One important reason, as a review of the recent Central America Free Trade Agreement (CAFTA) shows, is that California is subsidizing socks, skirts, shirts, and other garments being produced in Alabama and North Carolina.

What is it about China?

Two articles in The Economist last week (entitles “How China runs the World Economy” and “From T-shirts to T-bonds,” both published in the print edition on July 28, 2005) give us a reasonable understanding of the relation between China, the U.S., and the world economy.

First, China: it has a massive, cheap labor force to the extent that shoes, toys, clothes, electronics, and other manufactured goods are made cheaper by being made in China. Of at least as much important, however, is the second thing about China, namely that is usually open to trade (total goods and services in export and import is equivalent to 75% of its GDP according to The Economist).

Why does this affect the U.S.? Because the yuan or renminbi (China’s currency) has been pegged to the dollar at around 8.27 yuan per USD, the more investment and export of goods and services, the more foreign (U.S.) currency China has. Since the exchange rate is supposed to remain constant, China must push the U.S. dollars it earns back out of the country (or else the yuan will rise naturally due to less dollars in the world economy). China’s central bank does this by purchasing treasury bonds from the U.S. government. As a result, money spent comes back as money loaned out, in effect, by China’s central bank.

Needless to say, if China’s bank decided to stop buying treasury bonds or even sold some off, the U.S., its banks, and its consumers would have to pay up or face high interest rates.

Revaluing the Yuan
Some politicians call for measures to penalize China since it pegs the yuan to the dollar. With a cheaper yuan, the cost of exports from China would rise, making the price of goods (shirts, socks, and televisions) more expensive and hence more competitive with manufacturers of these goods in the U.S. The U.S. does not manufacture televisions. But, apparently, it still does manufacture shirts, socks, and skirts. To protect their constituents, politicians pressure the government to pass measures to restrict competition. Not only is this unfair trade and more typical of big government interference than free-market capitalism, it ends with consumers paying more, or subsidizing, for goods that could be made cheaper elsewhere. This is a same and I call on Governor Schwarzenegger to stop it.

Note: According to an August 2, 2005 New York Times article, entitled “Bush Administration Will Ask China to Agree to Broad Limits on Clothing Exports,” the Bush administration was forced to concede to politicians from Alabama and North Carolina to pass the Central America Free Trade Agreement (CAFTA). First, in elaborate conditions, shirt pockets and skirt waistbands must be “made in America” in order to be “freely traded.” This is essentially a subsidy on clothing imports from central America, and it is endemic in this type of agreement (see a wonderful book by Pietra Rivoli entitled The Travels of a T-Shirt in the Global Economy). Second, the Bush administration promised to force quotas in China imports. This is grossly unfair competition. I hope that the mechanisms of free trade and competition can put an end to subsidies that are wasting away on shirt pocket and skirt waistband manufacturing in Alabama and North Carolina. I am sure the workers can find something better, more productive, and more competitive to do.

But as for California, it is a dynamic state. It’s GDP is high, with vast farmlands, world-class technology, and cultural resources. Why should California subsidize the workers in Alabama and North Carolina? It shouldn’t. Therefore, California should negotiate a free trade agreement with China, independent of the rest of the United States.

This would have several advantages: first, California would no longer be forced to pay higher prices for consumer goods made more cheaply in China. California’s consumers would enjoy low prices on many consumer goods, leaving them with money to invest in business, home, and well-being. Second, removing subsidies to Alabama and North Carolina would attract businesses into California. California has lost much business due to its concern with worker welfare and corporate responsibility. A free trade agreement with China would allow business to purchase unsubsidized goods and deploy resources where they are most effective.

If Alabama and North Carolina want to outlaw Target and Wal-Mart in order for their shirt, sock, and skirt factories remain subsidized, I will grant them that freedom. But I do not believe California, California business, or Californians should be forced to bear this subsidy. Negotiate a California-China Free Trade Agreement today! Make California a better, richer, and more productive place to live!