2012年2月25日 星期六

New Push for Reform in China

"China 2030," a report set to be released Monday by the bank and a Chinese government think tank, addresses some of China's most politically sensitive economic issues, according to a half-dozen individuals involved in preparing and reviewing it.
It is designed to influence the next generation of Chinese leaders who take office starting this year, these people said. And it challenges the way China's economic model has developed during the past decade under President Hu Jintao, when the role of the state in the world's second-largest economy has steadily expanded.
A Chinese mine, a sector where state-run firms employ 44% of workers.
The report warns that China's growth is in danger of decelerating rapidly and without much warning. That is what has occurred with other highflying developing countries, such as Brazil and Mexico, once they reached a certain income level, a phenomenon that economists call the "middle-income trap." A sharp slowdown could deepen problems in the Chinese banking sector and elsewhere, the report warns, and could prompt a crisis, according to those involved with the project.
It recommends that state-owned firms be overseen by asset-management firms, say those involved in the report. It also urges China to overhaul local government finances and promote competition and entrepreneurship.
"China's state-owned sector is at a crossroads," said Fred Hu, chief executive of Primavera Capital Group, a Beijing investment firm. The Chinese government must decide "whether it wants state-led capitalism dominated by giant state-owned corporations or free-market entrepreneurship."
It isn't known whether "China 2030" will project a certain growth rate when it is released next week. But current forecasts by the Conference Board, a U.S. think tank, see the Chinese economy growing 8% in 2012, and slowing to an average annual growth rate of 6.6% from 2013 to 2016. Economists Barry Eichengreen of the University of California at Berkeley, Donghyun Park of the Asian Development Bank and Kwanho Shin of Korea University, after studying the history of other onetime growth champs, argue that China's annual growth rate will begin to "downshift" by at least two percentage points starting around 2015.
The World Bank says that China's economy will be derailed by 2030 if it doesn't commercialize its powerful state-owned enterprises. The WSJ's Deborah Kan speaks to Senior Editor Bob Davis.
While some reduction in growth is inevitable—China has been growing at an average of 10% a year for 30 years—the rate of decline matters greatly to the world economy. With Europe and Japan fighting recession and the U.S. experiencing a weak recovery, China has become the most reliable source of growth globally. Commodity producers in Latin America, Asia, North America and the Middle East count on China for growth, as do capital goods makers, farmers and fashion brands in the U.S. and Europe.
How much the report will help reshape the Chinese economy is unclear. Even ahead of its release, it has generated fierce resistance from bureaucrats who manage state enterprises, according to several individuals involved in the discussions.
China's political heir apparent, Xi Jinping, now vice president, has given few clues about his economic policies. Analysts expect the high-profile report will encourage Mr. Xi and his allies to discuss making changes to a state-led economic model that has alarmed Chinese private entrepreneurs while creating tension between China and its main trading partners, including the U.S.
The report's authors argue that having the imprimatur of the World Bank and the Development Research Center, or DRC—a think tank that reports to China's top executive body, the State Council—will add political heft to the proposals. The World Bank is widely admired in Chinese government circles, particularly for its advice in helping China design early market reforms.
They are also counting on the clout of the No. 2 official at the DRC, Liu He, who is also a senior adviser to the all-powerful Politburo Standing Committee, to help ensure that its findings are considered seriously by top leaders. Mr. Liu declined to comment.
Mr. Liu was among the top Chinese staffers who drafted China's current five-year economic plan and is considered close to China's current leaders as well as Mr. Xi, the presumptive next leader of China's government and party. Mr. Liu, who meets regularly with U.S. officials, has argued publicly that foreign pressure and ideas can help build momentum for change in China.
"Liu decides the flow of information, gives policy makers recommendations and organizes meeting agendas," said Cheng Li, a China scholar at the Brookings Institution in Washington, D.C.
World Bank President Robert Zoellick, in a statement announcing the report would be released, said, "The report lays out recommendations for a development growth path for the medium term, helping China make the transition to become a high-income society."
Neither the World Bank nor DRC would comment specifically on the "China 2030" findings.
Chinese Vice Premier Li Keqiang, who is expected to be named premier next year, endorsed the Chinese-World Bank project when Mr. Zoellick proposed it during a trip to Beijing in September 2010—another hint that the new crop of leaders will closely examine the report.
Currently, state-managed enterprises tower over the Chinese economy, dominating the nation's energy, natural resources, telecommunications and infrastructure industries. Among other things, they have easy access to low-interest loans from state-owned banks.
Zuma Press
Chinese Vice President Xi Jinping recently visited an Iowa farm.
U.S. Treasury Secretary Timothy Geithner and other Western officials argue that the subsidies to those firms distort international competition. Domestically, critics complain that the firms choke off internal competition, use monopoly profits to expand into other businesses and pay only meager dividends. A U.S. Treasury official said Wednesday the U.S. supports reforms that increase the ability of private firms to compete with state-owned enterprises.
The World Bank and DRC argue that asset-management firms should oversee the state-owned companies, say those involved in the report. The asset managers would try to ensure that the firms are run along commercial lines, not for political purposes. They would sell off businesses that are judged extraneous, making it easier for privately owned firms to compete in areas that are spun off.
"China needs to restrict the roles of the state-owned enterprises, break up monopolies, diversify ownership and lower entry barriers to private firms," said Mr. Zoellick in a talk to economists in Chicago last month.
Currently, many state-owned firms have real-estate subsidiaries, which tend to bid up prices for land, and have helped to create a housing bubble that the Chinese government is trying to deflate.
The report also recommends a sharp increase in the dividends that state companies pay to their owner—the government. That would boost government revenue and pay for new social programs, said those involved with the report.
"It's an innovative proposal," said Yiping Huang, a Barclays Capital economist. Neither the World Bank nor the DRC proposed privatizing the state-owned firms, figuring that was politically unacceptable.
Chinese and U.S. economists say that dividend money from profitable state-owned firms now is often directed to unprofitable ones by the State-owned Assets Supervision and Administration Commission, or SASAC, which regulates the firms and tries to ensure their profitability.
A customer pays for her vegetables at a local market in Shanghai February 9, 2012.
SASAC and the Communist Party's personnel agency name heads of state-owned firms and can replace them, giving the government great sway over the firms' decision-making. It isn't clear whether the report recommends changing that arrangement or proposes how the asset managers should be hired and fired.
How to handle such personnel "was the most contentious issue and was debated until the last hour," said a "China 2030" participant, who added that participants often differed on how much credit should be given to the state for China's economic development and how big a role the government and party should continue to play.
Even so, said individuals involved with the report, SASAC bitterly criticized the proposal in meetings of the "China 2030" group and is expected to try to block its adoption, out of concern it could lose power. Indeed, many of the recommendations are considered so politically fraught that the Chinese insisted that the report be labeled a "conference edition"—meaning that it is subject to change after comments at the Beijing conference where it will be presented Monday.
SASAC didn't immediately respond Wednesday to a request for comment.
In a signal of the challenges now faced by Chinese businesses, a gauge of nationwide manufacturing activity was slightly higher in February but remained in contractionary territory for the fourth straight month. The preliminary HSBC China Manufacturing Purchasing Managers Index was 49.7 in February, compared with a final reading of 48.8 for January, HSBC Holdings PLC said on Wednesday. A reading below 50 indicates contraction from the previous month.
China is vulnerable to a sharp slowdown, said Jun Ma, a Deutsche Bank China economist, because it relies too heavily on industries that copy foreign technology and doesn't produce enough breakthroughs of its own. South Korea was able to keep growing rapidly after it hit a per-capita income level of $5,000—about where China is today—because it pushed innovation. However, China lags behind South Korea badly in patents produced per capita, he said.
Chinese local governments often draw much of their revenue from the sale of land, rather than from taxes. The report urges that Chinese social spending be funded more by dividends from state-owned firms and by property, corporate and other taxes. "We'll be recommending that all resources be put on budget," Mr. Zoellick said in his Chicago talk, and "that public finance needs to be transparent [and] accountable."
—Kersten Zhang and Aaron Back contributed to this article.
Write to Bob Davis at bob.davis@wsj.com

2012年2月19日 星期日

Facebook and the St. Petersburg Paradox


If you are considering buying into Facebook's initial public offering of stock, take a moment to ponder the St. Petersburg Paradox, an old riddle still relevant to investing today.
Proposed in the 18th century, the paradox works like this: I will toss a coin until it comes up heads, at which point you get paid and the game ends. You get $1 if the coin comes up heads on the first toss, $2 if the coin comes up heads on the second, $4 if it is heads on the third, $8 on the fourth and so on. Your prospective payoff doubles with each successive flip until the coin finally lands on heads and the game is over.
Investors considering Facebook should think first about the St. Petersburg Paradox, the 18th-century mathematical riddle that helps explain why growth stocks can get overvalued so easily. Jason Zweig has details on The News Hub. Photo: Getty Images
How much would you pay to play? The paradox is that the potential payoff is infinite; after the first flip, you have a 50% chance of winning $2, plus a 25% chance of winning $4, plus a 12.5% chance of winning $8 and so forth. You will win $537 million if you get heads on the 30th toss; on the 50th, $563 trillion.
However, psychologists have found, most people won't pay more than $20 or so for a chance to play the game. After all, you could get heads as early as the first toss, leaving you with only a $1 payoff and no chance to earn those giant later gains. With that risk of quick, sharp loss looming at the outset, the infinite value of playing the game feels finite to most people.
A high-growth stock like Facebook is a lot like that St. Petersburg coin. The potential payoffs are enormous, although not infinite—and the game might peter out all too soon. At the end of 2010, 608 million people actively used Facebook every month; by this past Dec. 31, 845 million people did. If Facebook keeps growing that fast, more than 22 billion people will be using it 10 years from now, or three times the estimated population of the planet today.
The main difference is that the warm glow Facebook users get from its services may blind them to the St. Petersburg Paradox. Because Facebook connects people so powerfully, the people who use it may feel powerfully connected to the company, too—and to its stock.
[investor0203]Christophe Vorlet for The Wall Street Journal
Nevertheless, "it's an incredibly difficult thing to forecast the future cash flows of this kind of company, even for quantitative investors," says Charles Lee, a professor of accounting at Stanford University's business school and a former head of equity research at Barclays Global Investors (since acquired byBlackRock). Thus, says Mr. Lee, "once your projections go out beyond two or three years, you're in very murky waters."
The slightest stumble in high growth rates can lead to enormous changes in value at fast-moving companies, since today's stock prices are highly sensitive to projections of long-term future profits.
Just as the coin-flipping game in the St. Petersburg Paradox can end on any toss, even the fastest-growing company's upward trajectory can flatten in a flash. Just ask shareholders in Amazon.com, who this week lost 8% in one day on the company's warning that it might lose money next quarter.
If Facebook comes out at the high end of the valuation range proposed for the stock in its first sale to the public, the company would have a total market value of around $100 billion.
Now, let's say Facebook will be as successful in the future as Google already has been, suggests Jay Ritter, a finance professor at the University of Florida and an expert on initial public offerings. "Facebook is basically on Google's trajectory, so I think that's a very reasonable scenario," he says.
Facebook, at $3.7 billion in revenues and $1 billion in profits in 2011, already has nearly three times the sales and 10 times the profits that Google had when that company first listed in 2004.
Now, imagine that Facebook continues its torrid growth and expands over the next 10 years until it has grown as big as Google is today—with annual revenue of nearly $40 billion and net income of almost $10 billion. That would imply that Facebook will grow roughly tenfold over the coming decade—an average annual growth rate of about 26%, which is seldom sustained by big companies.
In this bullish scenario, what would happen to Facebook's stock?
At today's valuations, Google's shares trade at a total market value of just over $190 billion. If Facebook's shares rose from a total initial value of $100 billion to $190 billion 10 years from now, they would deliver a 90% cumulative gain, for an average annual return of 6.8%. Bottom line: "The valuation is so high today that the upside potential is limited," Mr. Ritter says.
Like most companies planning a public offering, Facebook declined to comment.
There certainly is a chance that Facebook's first public shareholders will be richly rewarded over the years to come—the same way someone taking the bet in the St. Petersburg Paradox could become fabulously wealthy. But, with Facebook, the odds would be a lot better if the price to make this particular bet were a lot lower.

2012年2月14日 星期二

Apple, Suppliers Test Tablet With Smaller Screen


Apple Inc. is working with component suppliers in Asia to test a new tablet computer with a smaller screen, people familiar with the situation said, as it looks to broaden its product pipeline amid intensifying competition and maintain its dominant market share.
Officials at some of Apple's suppliers, who declined to be named, said the Cupertino, Calif., company has shown them screen designs for a new device with a screen size of around eight inches and said the company is qualifying suppliers for it. Apple's latest tablet, the iPad 2, comes with a 9.7-inch screen. It was launched last year.
The Apple Store in Shanghai earlier this year.
One person said the smaller device will have a similar-resolution screen as the iPad 2. Apple is working with screen makers including Taiwan-based AU Optronics Co. and LG Display Co. of South Korea to supply the test panels, the person said.
Apple, which works with suppliers to test new designs all the time, could opt not to proceed with the device.
An Apple spokeswoman in California declined to comment.
The move comes as Apple is preparing to announce a new iPad in early March, according to people familiar with the matter. That device is expected to have a higher-resolution screen than the iPad 2 with a similar screen size, according to people familiar with the matter. A version will run on fourth-generation wireless networks from Verizon Wireless and AT&T Inc.
A smaller tablet device would broaden Apple's portfolio and could help it compete with rivals such as Samsung Electronics Co. and Amazon.com Inc. It would also begin to emulate the strategy it took for its iPod music player, which it released in a number of shapes and sizes over time. The company has taken a different tack with its iPhone, releasing one design at a time.
Analysts said a tablet with a smaller screen would help Apple expand its market share in the increasingly competitive market.
Diana Wu, an analyst at Capital Securities in Taipei, says that consumer demand for Samsung's 5.3-inch Galaxy Note and Amazon's 7-inch Kindle mean "consumers want a tablet that is smaller than the existing 9.7-inch iPad." "IPad's features are good enough, but pricing would be an important factor in the mass market, especially in big emerging markets like China and India," she said.
The iPad represented more than 61.5% of world-wide tablet shipments in the third quarter, down from 68.3% in the second quarter, according to market researcher IDC.
Samsung, which supplies Apple with key components such as memory chips and processors used in iPads, sells its Galaxy Tab iPad competitor in three screen sizes: a seven-inch, an 8.9-inch and a 10.1-inch.
Amazon.com's Kindle Fire has a seven-inch screen size and is priced at $199, well below the iPad's entry-level price of $499.
Apple has long contemplated different tablet designs, according to people familiar with the matter. But it had indicated it was wedded to the iPad's current size.
In October 2010, Steve Jobs, Apple's late co-founder and chief executive, criticized smaller tablets, saying the iPad's 9.7-inch form was "the minimum size required to create great tablet apps."
Apple, like many other big personal-computer and consumer-electronics brands, doesn't actually make most of its products. It hires manufacturing specialists—many of which are from Taiwan and have extensive operations in China—to assemble its gadgets based on Apple's designs.
They use parts from other outside suppliers, many of which also are from Asia. The arrangement frees Apple and its fellow vendors from running complicated, labor-intensive production lines, while the ability of Taiwanese companies to slash manufacturing costs helps cut product prices over time.
Apple, facing growing scrutiny about working conditions in its supply chain, Tuesday continued to combat the criticism.
Apple Chief Executive Tim Cook
Apple CEO Tim Cook , appearing at a Goldman Sachs technology conference in San Francisco, said the company takes working conditions very seriously. "The supply chain is complex. We believe every worker has the right to a safe working environment. Apple's suppliers must live up to this to do business with Apple," he said.
Mr. Cook said Apple is constantly auditing facilities. At the beginning of the year, he said, Apple collected weekly data on over a half a million workers in its supply chain. Apple will now be reporting its audits on a monthly basis on its website, which Cook said is unprecedented in the industry.
In the quarter ended in December, Apple hit new sales and profit records based on runaway holiday demand for the iPhone and iPad.
The company's share price has climbed in the wake of those results, closing above $500 a share for the first time Monday.
—Jung-Ah Lee in Seoul contributed to this article.
Write to Lorraine Luk at lorraine.luk@dowjones.com and Jessica E. Vascellaro atjessica.vascellaro@wsj.com