Investing in China: Why the Nine Nations Matter
Last week I published an interactive feature at The Atlantic online called “The Nine Nations of China.” In it, I described how we should look at China, not as a single homogeneous entity, but as a mosaic of nine distinct regions. Many readers commented that they found it a useful primer for understanding this complex and often overwhelming country. But the Nine Nations framework is more than an antidote to cultural curiosity; I believe it offers an essential practical tool for anyone – investors, CEOs, policy-makers – who need to think strategically about China. To understand why the Nine Nations matter, it helps to know how and why I came up with this framework in the first place.
In 2004, I was working in Chengdu, the capital of Sichuan province, for a private equity fund focused on small-medium enterprises (SMEs). Most people are surprised to hear that there actually is a PE fund in Sichuan, which is part of the region I call “The Refuge,” insulated deep in China’s interior. Given the unfamiliar and rather undeveloped business environment, we had to figure out an investment strategy that made sense. What was Sichuan good at? What resources did it possess? Out of all the different investment opportunities we were being presented with, which would enjoy a sustainable competitive advantage as China’s economy developed, particularly against rivals from more advanced parts of China?
Next to my desk was a copy of China’s annual statistical yearbook, and I also had access to similar but more extensive data online. To help guide our efforts, I began an extensive project of “industry mapping,” comparing provincial and other data on crops, minerals, and industrial output to identify regional patterns and relationships. Because I had traveled widely throughout China over the years, I already had a sort of “mental map” of the country based upon what I had seen. But the statistics I analyzed opened up a whole new window on China’s economy. They revealed, for instance, how the area I would come to think of as “The Yellow Land” accounts for over 60% of China’s wheat production – an output equivalent to the entire United States – more than 80% of its apples, and roughly half of its coal reserves; that “Shangri-La” in the southwest accounts for nearly 90% of China’s tin output and 70% of its sugarcane; and that “The Back Door” produces virtually all of its radios and stereos.
By themselves, these figures seem almost trivial; taken together, they began to paint a picture of nine distinct regions – the Nine Nations I presented in The Atlantic. Moreover, as I researched them further, these “nations” appeared to have consistent historical identities that reached back thousands of years. It was only several years later, when I joined another private equity fund in Hong Kong and had shared this framework with one of the partners, David Bussmann, that he introduced me to the research of William Skinner and other academics who had written on regionalism in China. Although my conclusions in some ways differed from theirs, the fact that people in other fields, focused on different concerns and using different methodologies, had arrived at findings that were quite similar – at times strikingly so – to my own made me think I might be on to something real.
My own discoveries coincided with a dawning realization among other people doing business in China that this huge country was turning out to be more complicated than it looked. In 2005, Businessweek observed that:
GM isn’t alone in discovering that China is not a monolithic market. The country, with 1.3 billion citizens speaking more than 100 dialects, is wildly diverse. What people eat, wear, and drive differs greatly from north to south, east to west, rich to poor, young to old, city to countryside. Urumqi in the northwest is further from Guangzhou in the southeast than Oslo is from Rome, and the desires and needs of people who have benefited from the economic changes of the past two decades barely resemble those of individuals who have been left behind. “It’s clear that you can’t treat China as just one country,” says Glenn Murphy, managing director of ACNielsen China in Shanghai.
That same year, in his book “One Billion Customers,” China veteran James McGregor advised readers that it was essential to understand that “China is not one market but a collection of many local markets, each with its own practices, traditions and methods of local protectionism.” In fact, such observations have become standard fare at China conferences.
Once the point is inevitably raised, however, discussion trails off, leaving the obvious questions unanswered: What exactly are those markets? How are they different? Why do those differences matter? The importance of these issues is widely recognized, but for the most part, we have lacked a vocabulary for talking about them in a meaningful way. Even professional marketing studies—where people presumably pay good money for insights into such patterns—tend to lump provinces into ad hoc directional groupings (southeast, southwest, central) with little regard for shared history or business trends.
The default solution has been to rely on broad dichotomies between urban and rural, coast and interior, and leave it at that. In response to my feature in The Atlantic, Dan Harris of www.chinalawblog.com commented that he finds these distinctions more useful than regional ones:
My problem I see with this map is that it is exactly that. A map. And as a map, it distinguishes among regions geographically and that is not how I view many aspects of China. Just by way of an example, I see Beijing having commonalities with Shanghai just because they are two powerful and relatively sophisticated big cities. Different as these two cities are (and they are plenty different, in their cultures, in their attitudes and even in their languages), they still share many commonalities in terms of business.
On an operational level, I agree. The day-to-day realities of business – quality of infrastructure, prevailing wages, education levels, land prices — almost certainly vary more between urban and rural areas than among the nine “nations.” But on a strategic level, I could not disagree more. If you are thinking about where to invest in what industries, where to set up a sales office or factory, or what trends will shape the Chinese market over time, then I believe you ignore the Nine Nations at your peril.
A rural Chinese village in 1980 might have looked and felt the same whether it was located in the Back Door, the Metropolis, the Crossroads, the Rust Belt, or the Refuge. But today, that village in the Back Door is a thriving factory town, whose young female workers send their paychecks back to the village they left behind in the Crossroads. Their male counterparts are migrant laborers busy transforming that village in the Metropolis into a luxury condo community, while the town in the Rust Belt serves as a dumping ground for unemployed workers from nearby state-owned steel mills, and the one in the Refuge remains as quiet as it ever was, except for one family who made a fortune selling animal feed to local farmers. I’ve seen these changes with my own eyes, and the differences among the Nine Nations are critical to explaining how and why they happened, and what changes we can expect in the future.
As that Businessweek article I quoted points out, China is a land the size of Europe, and I would argue that the comparative advantages between different regions of China are as important as the comparative advantages between actual nations. This is something that Chinese leaders themselves have been slow to comprehend. When I travel all over China, I frequently meet with mayors and provincial governors, and hear them describe their economic plans. For the most part, all of them want to develop the same “pillar industries”: automobiles, information technology, clean energy, pharmaceuticals – and maybe, if they’re really ambitious, financial services. All of them are striving to imitate Shanghai and Beijing. But the fact is, hundreds of cities are not all going to succeed in becoming the “car capital” or “IT capital” of China. I hardly hear anyone asking the really essential questions, the ones we had to ask in Sichuan: What makes this place special? What is it better at than anywhere else? What competitive niche can it fill in the broader Chinese economy?
To be sure, there are other factors that matter. Generation gaps, urban and rural disparities, ethnic and religious differences, and shared cultural values often cut across regional lines and play important roles. But in my experience, China can seem so large, so overwhelming – such a jumble of conflicting images — that just breaking it down into a handful of smaller, more digestible pieces can make even those factors easier to comprehend.
When someone mentions Miami or Milan, Los Angeles or London, Detroit or Dublin, their names evoke certain associations in our minds. Even if we’ve never been there, we immediately think of beaches or fashion, actors or bankers, automobiles or pubs. These images don’t tell us everything we need to know, but they give us a starting point. But when someone mentions Changsha, Chongqing, or Changchun, our impressions – if any – are likely to be vague. Even if you have been there, it may not be entirely evident how they fit into the bigger picture. The Nine Nations framework tries to provide that context. Simply by knowing that Changsha is in the Crossroads, Chongqing is in the Refuge, and Changchun is in the Rust Belt, you already know something useful about them – not everything, but a good starting point.
Let me just close by sharing just one concrete example of how differences among the Nine Nations can matter, even in an operational business context. When the Sichuan SME Fund was first set up, the managing director – an American friend of mine – wanted to hire a Chinese investment team with the relevant training and experience in private equity. As I mentioned in The Atlantic article, The Metropolis (the region centered on Shanghai) tends to be the most cosmopolitan and sophisticated region in China, so most of the qualified candidates he initially hired came from there. He soon found out, though, that they were ill-suited to the task. None of them could speak the local dialect, and they looked down on the entrepreneurs we were working with as country yokels. The entrepreneurs, in turn, distrusted the Metropolitans, suspecting they were fast-talking city-slickers out to rip them off. Eventually, my friend had to replace the entire team with locals from The Refuge. Their financial skills were not always fully up to speed, but they were infinitely better at identifying promising opportunities and establishing trust and rapport with potential partners. True, people from Sichuan and Chongqing – the two provinces that make up The Refuge — sometimes display a kind of homespun, town-next-door rivalry, but compared to other parts of China, they share a similar outlook, values, and mannerisms. If we had recognized this – if we been aware of the Nine Nations of China and how they could impact our business – we might have saved ourselves a lot of headaches.