SILICON GOLD RUSH: TAIWAN’S CHIP MAKERS CAN’T RESIST THE LURE OF CHINA, THE WORLD’S LARGEST CONSUMER OF SEMICONDUCTORS

IEEE Spectrum

Copyright – IEEE Spectrum
BY LINDA GEPPERT
In just 15 years, the farmland of the Pudong district of Shanghai has disappeared under gleaming skyscrapers, monuments to, among other things, the fastest-growing semiconductor industry in the world. Within this charmed circle, the fastest-growing start-up is Semiconductor Manufacturing International Corp. (SMIC). In the five years since its founding, it has become the leading chip maker in China, the next big chip-making power in the world.
Ironically, China’s ascendance in semiconductors is almost entirely attributable to assistance from Taiwanese technologists. SMIC itself was founded by a Chinese-American raised in Taiwan, and many of its employees are from Taiwan. Hundreds of them, just weeks off the airplane, are bedding down in the company’s massive employee community, complete with gym, supermarket, beauty parlors, and a school for 1200 children.
SMIC is not the only foundry with roots in Taiwan that has set up shop here. A report by a U.S. chip industry group, the Semiconductor Industry Association, in San Jose, Calif., estimated that in the second half of 2001 alone, more than 3000 engineers left Taiwan to work in China’s semiconductor industry. Far more have evidently arrived since then. In Pudong, where three of SMIC’s foundries started operation two years ago, the Minnan dialect of Taiwan can be heard in local bars and restaurants.
You’d think the outflow of expertise from Taiwan to the mainland would make the Taiwanese very, very afraid. After all, they invented the foundry model—the manufacture under contract of chips by one company for another—and their government has spent hugely on incentives to secure so much of the global market.
The idea was for the foundries to grow, even at a loss, in order to attain economies of scale that would deter others from entering the business. And so far, the plan has worked. Taiwan controls nearly two-thirds of the worldwide sales of the US $20 billion foundry business, a business that is nearly a tenth of global chip sales. What’s more, the fraction of chips made in foundries is projected to grow steadily for years to come.
Yet whatever their government may think, Taiwan’s engineers aren’t afraid about ceding that lead to the mainland; they’re here in China, in the thousands.
“I seldom if ever talk to a non-Taiwanese person when I visit SMIC,” says Michael G. Pecht, a mechanical engineering professor at the University of Maryland, in College Park, who has written extensively about Asian electronics industries. He adds, “I’m not talking to senior management, and I’m not talking to the factory workers—I’m talking to the people who know how to make things work and understand the technology.”
In fact, besides being home to Chinese foundries that are at least partially staffed with Taiwanese workers, China also now boasts shimmering new fab facilities built and operated by Taiwan-based companies. Foremost among these is Taiwan Semiconductor Manufacturing Co. (TSMC), in Hsinchu, the contract chip-making giant founded in 1987 [see photos, “A Piece of the Action”].
It’s tempting to look at the relationship between TSMC, the largest foundry chip maker in the world, and the smaller SMIC and see in it an ironic reversal of their respective countries’ big-brother-little-brother status. Viewed from a global perspective, TSMC’s worldwide sales of $7.6 billion last year dwarfed the $1 billion in sales of SMIC. But within China itself, SMIC is the bigger player, selling half the chips made there. So with the foundries, little brother is growing up fast, and big brother is acutely aware of it [see photo, “In the Chips”].
It is just one of the many twists in this complicated, high-stakes, fast-moving game. Even the basic parameters can be hard to fathom: China provides incentives; the engineers come from Taiwan to help staff local start-ups; Taiwanese companies feel compelled to set up subsidiaries in China to compete with the start-ups other Taiwanese are leading; then Taiwan’s government passes laws to slow things down, partly because of acute diplomatic sensitivities but mainly out of concern that mainland China is going to eat its lunch.
GIVEN THAT SOBERING LONG-TERM PROGNOSIS, why do Taiwanese companies keep flocking to China? First, China offers sweeteners. Until recently, China tantalized outsiders by taxing China-produced chips at a significantly lower rate—up to 14 percent less—than foreign-made chips. But that helping hand was withdrawn after China joined the Geneva-based World Trade Organization three years ago. Now China relies on more informal understandings, which are harder for outsiders to criticize. The most important of them is the unofficial requirement that at least 30 percent of the total value of electronic goods made in China be supplied by local companies.
Second—and more important—China is where the growth is. This year its electronics industry will buy chips worth $59 billion, more than any other country in the world, according to the research firm iSuppli Corp., in El Segundo, Calif. Less than 5 percent of those chips are now made locally, leaving the other 95 percent up for grabs [see graph, “Plenty of Room at the Top”].
No company understands those economics better than TSMC. Its founders invented contract chip making in the late 1980s, when they noticed that the cost of a fab—now generally a 10-digit figure—was spiraling in relation to other industry costs. They realized chip makers that could no longer afford to own their manufacturing capacity would have little choice but to rent it.
In an interesting parallel to the role of Taiwanese engineers in China in this decade, it was technologists who returned from the United States two decades earlier—TSMC founder Morris Chang among them—who gave Taiwanese foundries their start.
These foundries bred new chip makers, the so-called fabless companies. Later they began getting business even from the biggest players, as such companies as Intel Corp., in Santa Clara, Calif., and Motorola Inc., in Schaumburg, Ill., came to realize that sometimes it made more sense to rent a bit of spare capacity than to build a fab that wouldn’t be fully exploited.
Throughout the 1990s, as tech-related exuberance built to a crescendo, TSMC thrived. It now has 11 foundries—8 in Taiwan, 1 in Singapore, 1 in Washington state, and 1 in China. The Chinese plant is run by a subsidiary, TSMC Shanghai, which won approval from Taiwan’s government in February 2003. Y.C. Chao, the president of TSMC Shanghai, in the city’s Songjiang suburb, says he is now ready to take orders.
In the competition between the two companies, convolutions abound. Start with SMIC’s charismatic chairman, Richard Chang. China-born but Taiwan-bred, he graduated with a degree in mechanical engineering from National Taiwan University, in Taipei, in 1970 before earning a master’s degree from the University at Buffalo, the State University of New York, in 1973 and a Ph.D. in electrical engineering from Southern Methodist University, in Dallas, in 1986. After working for 20 years in Dallas at Texas Instruments Inc., he returned to Taiwan to found the Worldwide Semiconductor Manufacturing Co., quickly selling it to none other than TSMC. Then he moved back to China, in 2000, to found SMIC.
By 2003, SMIC had three plants running in Shanghai. And last year, the company bought a plant in Tianjin from Motorola. Earlier this year, the company began operating one more in Beijing, and two more Beijing plants are being readied for production. At his spacious steel-and-glass headquarters in Pudong, 15 kilometers east of the old, historic part of Shanghai, Chang can gaze out at an employee village that makes up for the deficiencies in local infrastructure by providing apartments, supermarkets, sports fields, and that school for 1200 students, who can study in English, Mandarin, or both.
Lately, the investment seems to be paying off. Slowly but surely, SMIC is creeping closer and closer to TSMC’s cutting-edge capabilities. SMIC’s best plants, in Beijing, can now make chips with 90-nanometer wires on 300-millimeter wafers—which is the state of the art. Those are the parameters typical of fab facilities used to make gigabit memories and chips for cellphones. Chang points out that SMIC makes chips only for commercial applications, not for military ones.
In other aspects, though, SMIC still lags. Its Pudong plants produce chips with wires only as narrow as 130 nm on 200-mm wafers, good enough for controllers for DVD players, sensor chips for low-end digital cameras, or decoders for high-definition television sets. One of the three Pudong plants supports the other two by connecting circuit elements with copper, the metal of choice; it also offers the increasingly obsolete standby, aluminum.
SMIC’s engineers have not yet mastered the technique of putting a thin veneer of silicon over a layer of silicon dioxide, a technique that lets circuits run faster than those on ordinary silicon wafers. Nor does it yet embed germanium atoms in the upper layers of silicon wafers to strain their crystalline structure, tremendously speeding up the passage of signals. Still, matters have improved significantly over what they were a decade ago, when China’s semiconductor makers were laying down wires 10 times wider than those used in the most advanced processes.
Meanwhile, TSMC isn’t resting on its laurels. Chao plans to focus his production on local Chinese markets, building chips for Chinese customers and also for international customers who want to sell to Chinese electronics and appliance companies. He says that at the beginning of this year, the plant was cranking out 5000 wafers per month—a third of its planned capacity and only a small fraction of the 120 000 wafers that SMIC’s foundries can produce.
But production numbers don’t tell the whole story about the competition between SMIC and TSMC. In that battle, TSMC is prohibited from deploying its most potent weapon—superior technology—to full effect. As a Taiwanese entity, Chao’s company is not allowed to produce circuits with wires smaller than 0.25-micrometers. But Chao expects that the Taiwanese government will soon approve more advanced technologies, capable of making wires with widths down to 0.15 µm. Once that happens, he says, the company will install the equipment and ramp up production rather quickly.
Chao tries to put the best face on the restrictions: the resulting chips are good enough for cars, toasters, power controllers, and analog circuits, though not for most portable applications—including cellphones and laptops—which require, above all, the low power and compactness that the most advanced technologies offer.
“We spend according to the market needs and according to the level of approvals from Taiwan,” he says. There’s plenty of demand in China for chips built with older technologies, he adds, and as demand for more advanced technologies grows, TSMC will be able to keep up with it.
Other experts disagree with Chao’s outlook, noting that local customers are already paying for better chips than he can provide. SMIC data supports this view. In the third quarter of 2004, the company produced more than two-thirds of its chips at 0.18 µm or less. While TSMC and other firms tagged with Taiwan’s flag may lobby their government for permission to use more advanced technology, the express political point of the export restrictions is to limit trade—and the economic point is to limit transfer of technology.
TRACE IT BACK to Gen. Chiang Kai-shek, the defeated nationalist leader who, with other Chinese refugees, moved to Taiwan and set up an alternate Chinese state in 1949. His policy was “no contact, no negotiation, no compromise” with China, a line long reciprocated by the mainland communist government.
But this mutual animosity between the two governments is not altogether shared by Taiwanese and Chinese engineers, who maintain an allegiance to Chinese culture that transcends political systems and financial considerations.
After Chiang’s death in 1975 and the coincident opening of China to the world, however, Taiwanese investors began to skirt the rules, originally by dealing with China through shell companies in Hong Kong.
The shell game continues with a vengeance in the form of transplanted operations masquerading as independent start-ups. In the foundry business, they are organizations funded and run by experts from a particular Taiwanese company who disavow any connection to it. The most widely known of those is He Jian Technology (Suzhou) Co., about a 2-hour drive from Shanghai.
He Jian was founded in 2002 by former executives of United Microelectronics Corp. (UMC), in Taipei, the world’s second-ranking contract chip maker. A 2003 report by the Semiconductor Industry Association says bluntly that many in the industry believe “He Jian’s Suzhou operation constitutes what will at some point become UMC when the pretenses are dropped.”
SLOWLY BUT SURELY, CHINA’S FOUNDRIES ARE GETTING CLOSER TO CUTTING-EDGE CAPABILITIES
An industry executive based in Taiwan who wishes to remain anonymous confirmed that. “All of He Jian’s key senior managers come from UMC; the fabs use equipment from UMC; if the managers want to quit He Jian and return to UMC, they can,” he says. This past winter, in fact, the Taiwanese government began investigating the UMC-He Jian link. UMC denied that it violated any laws, claiming that it provided only consulting services to He Jian and did not transfer any technology. In a recent statement, however, UMC’s chairman, Robert Tsao, acknowledged that he hoped to acquire He Jian if the government relaxes rules on China-bound investment. Presumably, he would acquire it on good terms.
SMIC, too, has been charged with some sleight of hand. Chang asserts he built the company’s technological base by collaborating with Fujitsu, Infineon, Toshiba, and other foreign clients. But TSMC alleged in a lawsuit last year that SMIC had purloined its industrial secrets by hiring away dozens of its employees.
The suit was settled early this year, when SMIC agreed to pay TSMC $175 million over six years. As part of the agreement, the two companies will share their patents. It’s not a lot of money for either company, notes Bill McClean, president of IC Insights Inc., a market-research firm in Scottsdale, Ariz. But SMIC’s leaders will benefit the most from the agreement. They’ll now be able to focus on business and reassure customers who might have hesitated to buy chips incorporating intellectual property of dubious provenance.
MUCH OF THE ANTAGONISM WILL ABATE, of course, if it turns out that there is plenty of profitable business for everybody. However, SMIC, TSMC, and other prospective entrants to the market differ on how fast demand for their wares will build. And some wonder whether China’s foundry rush makes sense to begin with. While SMIC’s Chang builds plants at breakneck speed, TSMC’s Chao worries that China is building too much production capacity. He believes that for the next several years most of the demand for logic chips will be filled by far more advanced manufacturing plants overseas. “Intel alone,” he points out, “sold $5.8 billion worth of chips to China last year.” That’s almost three times what the indigenous companies sell.
Dynamic random-access memories are also likely to come mainly from abroad for a while. “I don’t think the Chinese will be able to compete against [the Korean company] Samsung or [Boise, Idaho-based] Micron Technology in dynamic memory,” says the University of Maryland’s Pecht.
Foundries, by their nature, yield thin margins, don’t create a lot of jobs, and do just as well no matter where they stand. Ed Chang, deputy director of TSMC’s China operations, is the first to concede that it is no cheaper to make chips in China than in Taiwan. He notes that although land, labor, and construction tend to cost less in China, electricity and other infrastructure cost more. But over the long term, as the Chinese economy grows and the chip industry matures, labor costs will rise and electricity prices will fall. “We expect that the cost of making ICs here will be a few percent lower than in Taiwan when the supporting infrastructure matures,” says Chang.
Meanwhile, the start-up foundries are reducing their risk of failing by tying their fortunes to local officials. Not that they have much choice: the officials are necessary every step of the way. They let you know it, too. According to the unnamed Taiwan semiconductor executive, municipal governments may ask firms to make a donation to some project, but “the donations aren’t voluntary, they’re required.”
Still, competition among regions—not unlike that seen in the United States whenever a corporation thinks out loud of relocating—makes officials bend over backward to help their chip makers. Last summer, for example, when Shanghai was experiencing rolling blackouts, local officials told SMIC not to worry, that its electricity would not be cut off. And it wasn’t.
For TSMC Shanghai, help from local officials has come in the form of land. Its plant is built on a much more generous parcel of land than Chao recalls from his days in Taiwan’s industrial parks. Chao, an avid golfer, likes to say that even using a No. 1 driver, “you couldn’t hit a golf ball from the street to our building.” When he suggested to local officials that the wide expanse could be used to build a second plant, they told him that he really needed more land and that they had already set aside another section to the west for expansion.
Besides cultivating the locals, managers must, of course, keep their customers happy. And in China, famous for its intellectual piracy, that means working doubly hard to protect customers’ secrets, principally circuit-design data. (They also work hard to protect their own manufacturing secrets, as TSMC’s lawsuit against SMIC attests.)
To keep industrial spies from sneaking secrets out of the plant, the TSMC foundry in China bans its employees from bringing their personal laptops into the office; back in Taiwan, the same rule holds. At SMIC, employees must sign an agreement not to reveal its customers’ or its own intellectual property. Most employees in the foundry are barred from using the Internet, and even senior managers aren’t allowed to bring their own notebook PCs into the company. Only two people have access to the data for making the masks used to etch a customer’s wafers.
EVEN WITH THE INCENTIVES and the skyrocketing electronics industry, China’s semiconductor industry will grow only slowly, says IC Insights’ McClean. That’s because many of the ICs sold come not directly from foundries but from fabless semiconductor companies, which design ICs and sell them into the electronics market, relying on the foundries to build them.
Today, China’s fabless semiconductor industry is immature. Although the number of these companies has grown from fewer than 100 in 2000 to about 500 in 2004, most observers believe that few of them are likely to survive, because they lack experience in IC design. As more Chinese designers return from overseas and go to work for local fabless companies or start their own, that situation may change.
But the University of Maryland’s Pecht says China’s foundry strategy will finally make sense when its fabless companies and its electronics and appliance manufacturers use China’s own domestic fabs to bootstrap their way to world-class operations. “What these companies are going to see is that if they design those chips internally and have them built by Chinese semiconductor manufacturers, they can make their products much more cheaply,” he says.
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CHINA’S TECH REVOLUTION
HOW TECHNOLOGY IS DRIVING THE COUNTRY’S ECONOMIC BOOM, AND WHAT THAT MEANS FOR THE WORLD
BY JEAN KUMAGAI & MARLOWE HOOD
It’s a sunny Sunday in Chengdu, a sprawling city of 10.4 million in China’s southwestern hinterland, and that can mean only one thing: shopping. The gleaming new indoor malls that line every downtown boulevard teem with young and old, laughing, talking, walking arm in arm, checking out the latest from Tommy Hilfiger, Disney, and Esprit. Along Tai Sheng East Road, the scene really heats up. Once a sleepy street lined with hardware and electrical-supply shops, it’s now the city’s bustling cellphone district. In store after store, block after block, thousands of cellphone models from more than a hundred domestic and foreign brands beckon from store windows. Amid the crowds, the cacophony of ring tones, and the sales clerks hawking new calling plans, it’s tough to move or think. No wonder the largest cellphone maker in the world, Finland’s Nokia Corp., in Espoo, recently disclosed that China will soon overtake the United States as its top market.
Just behind the bright storefronts, in the network of back alleys, a market for secondhand cellphones has sprung up [see photos, “Conspicuous Consumption”]. If the commerce seems aggressive out on the street, here it’s downright raw. Like farmers on market day, hundreds of vendors flock here from the outskirts of Chengdu to sit cheek by jowl, their battered wares arrayed on narrow card tables. In nearby stalls, eagle-eyed technicians hunch over jeweler’s benches making precision repairs; they’ll earn less in a month than what you’d pay for a new handset half a block away.
Chengdu’s cellphone district is a microcosm of the new China, with its ravenous consumerism and its unflinching entrepreneurialism. Here and all over China, the newly wealthy and middle class can now tap into every kind of technological wonder. Those still stuck on the economic bottom rungs, though, are scrambling to catch up, without the safety net that the communist regime once provided.
The place also speaks to China’s growing technological prowess: its 300 million cellphone subscribers—the most in the world—its two national wireless carriers, and the hundreds of domestic and foreign service providers and manufacturers that now vie for a share of its burgeoning telecom market [see photo, “China Calling”]. And it illustrates, more generally, how China’s emergence as an industrial powerhouse is driven by, and is driving, its interactions with the world. In ways scarcely imaginable 25 years ago, when Deng Xiaoping first opened the economy to market forces, China’s fortunes are the world’s. And what happens now, even in remote Chengdu, matters—not just for the Chinese but for everyone.
In planning this special report, the editors of IEEE Spectrum were most intrigued by this last phenomenon. How is China’s tech revolution unfolding? Who are the key actors, and why are they there? Is everyone a winner, or is this in some ways a zero-sum game? What are the sources of friction—within China, as well as between China and its trading partners—that could slow down or even halt this juggernaut?
This special report is not intended as an exhaustive survey of China, nor a primer on doing business there. No doubt there are lessons to be learned here, but our aim is to tell a handful of stories that illustrate the complex web of connections being formed, shaped, and exploited by China’s awesome rise.
“CHINA HAS STOOD UP!” With those words, Mao Zedong, speaking from atop the Gate of Heavenly Peace to a jubilant throng gathered in Beijing’s Tiananmen Square, conjured a nation into being on 1 October 1949. Mao, obsessed with self-reliance and selfless egalitarianism, could hardly have envisioned what China would look like now.
Today, the country’s heft is felt worldwide in nearly every sector and along the entire chain of economic activity. China’s ferocious appetite for the energy and raw materials needed to fuel its prodigious growth is the driving force of commodity markets on every continent. For several years running, China has been the world’s biggest consumer of coal, grain, meat, iron ore, steel, and concrete. Once a net exporter of oil, last year it imported half of what it consumed and 40 percent more than in the previous year. If the global markets for coffee and cocoa remain depressed, it’s probably because the Chinese don’t have much of a taste for either.
At the other end of the manufacturing spectrum, China has emerged as a major producer—often the major producer—of consumer goods, ranging from clothes and toys to televisions and
personal computers. Its ability to manufacture quickly and cheaply has, in a brief span, conquered or disrupted national markets all over the globe. Case in point: China’s share of the U.S. textile market stood at 70 percent at the end of 2004, and textile imports from China jumped by 40 percent after the remaining U.S. tariffs were removed in January. The competition, in the United States, the European Union, and elsewhere, is left with a stark choice: match the China price or perish.
Still, China buys almost as much as it sells. True, a large percentage of those imports are materials and components that it uses to assemble goods it then exports. But China’s foreign spending spree in 2004 topped US $500 billion.
The allure of the Chinese market—a chimera until very recently—has attracted nearly every multinational on the planet. From fast food (KFC, McDonald’s) and pharmaceuticals (Pfizer, Merck) to retailers (Carrefour, Wal-Mart) and automobiles (General Motors, Volkswagen), China is simply the world’s hottest market, thanks to the newly awakened Chinese consumer. Little wonder, then, that foreign direct investment hit a record $66.5 billion last year, second only to the United States’ $121 billion. Even venture capitalists are flocking to China looking for the next 51job.com, the leading Chinese employment Web site, which returned $260 million in four years on Menlo, Calif.-based Doll Capital Management’s $14 million investment.
Cash-rich Chinese companies are also moving funds in the other direction. When a relatively unknown Chinese TV maker called TCL, based in Guangdong province’s Huizhou, bought the TV division of France’s Thomson SA, in Boulogne, last year, it instantly became the largest TV maker in the world [see “Digital TV’s 100-Meter Dash,” in this issue]. And when Chinese computer maker Lenovo Group Ltd., in Beijing, picked up IBM Corp.’s PC division for an estimated $1.75 billion, the symbolism was thick enough to cut with a cleaver: China had taken possession of the brand that was once synonymous with computers. “Will your next boss be Chinese?” the normally reserved conservative daily Le Figaro asked its French readers with a mixture of alarm and awe.
Fifteen years ago, CEOs and analysts carefully weighed the risks of doing business in China. Today, attracted by the siren call of opportunity and driven by the fear of being left behind, they are far more likely to be weighing the risks of not doing business there. “Any company that is not involved in China or doesn’t have well-developed plans in that direction is totally asleep,” Donald Straszheim, an institutional investment consultant in Los Angeles and former chief economist for Merrill Lynch & Co., recently told Spectrum. “If you own shares in that company, sell them.”
HERE IN CHENGDU, in China’s Wild West, hundreds of high-octane multinational companies, including Alcatel, Corning, Ericsson, and Microsoft, have established branches. An hour and a half’s drive from the city, Phoenix-based ON Semiconductor Corp., which spun off from Motorola Inc. in 1999, operates a joint-venture IC assembly-and-test plant with 2000 workers. It is now building a semiconductor facility next door; the 150-millimeter wafer fab will be the first in western China. Negotiations are also under way with IBM for what would be its largest software outsourcing center anywhere. In 2004 alone, Chengdu attracted $7 billion in foreign capital investments, making it the fastest-growing high-tech center in western China. Domestic powerhouses have also come, including China’s leading foundry, Semiconductor Manufacturing International Corp. (SMIC), based in Shanghai.
In some ways, the dizzying influx makes no sense. If you look on a map, Chengdu isn’t on the way to or from anywhere. It sits in the middle of the southwestern province of Sichuan, on a wide, flat plain 1500 kilometers southwest of Beijing and 1600 km northwest of Shanghai [see “China at a Glance,” in this issue]. Although Chengdu dates back more than 2400 years and at one point was renowned for its lively trade and intellectual life, for most of the last two millennia it was little more than a sleepy backwater. After the communists came to power in 1949, Mao chose Chengdu as the base for their most sensitive military work, specifically because it was so cut off from the world.
Six years ago, though, Beijing realized that industrialization was bypassing China’s inner provinces, so it launched the Great Western Development Strategy [see photo, “Construction Ahead”]. It began funneling billions of dollars into the hinterlands, to extend new highways, rail lines, and telecom links and build new international airports, industrial zones, and power plants. Chengdu was reborn.
These days, Chengdu is at the frontier of China’s economic boom. Although the coastal provinces and municipalities—from Beijing and Tianjin in the north to Shanghai, Guangzhou, and Shenzhen in the south—still generate 90 percent of Chinese exports and attract an even greater proportion of foreign investment, there’s still plenty left over for Chengdu. Picture the industrialized east as the arc of a drawn bow and the Yangtze River as the arrow, suggests Li Gang, director of foreign investment for Chengdu’s high-tech development zone. “We are the nock in the arrow,” he says. Its other end, the tip, points toward the world.
Last year the city landed its biggest fish yet, when Intel Corp., in Santa Clara, Calif., after two years of negotiations, announced it would build a $375 million factory for assembling and testing its chips. Intel currently employs about 4000 people in China and has a similar assembly-and-test plant in Shanghai and a research-and-development center in Beijing. [To learn about another Intel project in China, see “The Panda Connection,” in this issue.]
So why Chengdu? City promoters tout its cheap and stable labor, free land, and generous tax breaks. But it’s not alone. The growth rate in some of the more remote cities exceeds 40 percent, notes Ian Yang, Intel’s country manager for Intel China Ltd. But companies that want to succeed in China also feel pressure from Beijing to move west. “It’s a combination of where the government is heading, with its ‘Go West’ policies, and where the market is growing,” Yang concludes.
Where Chengdu separates itself from other would-be tech havens is in its combination of manufacturing capability and its bargain-priced engineering talent. The city’s 29 universities turn out about 40 000 graduates each year, adding to the half-million professionals who now call the city home. An engineer with a bachelor’s degree, for example, earns anywhere from $130 to $400 per month in Chengdu—20 to 30 percent less than on China’s east coast. “We have an almost endless supply of capable and skilled people,” says Wang Lin, deputy director of the city’s 82-square-kilometer high-tech park and a member of the all-powerful Communist Party committee that oversees its development.
The brainpower of Chengdu’s engineers is on display at the Alcatel Optical Communications R&D Center. There, 180 design engineers work on software, hardware, and systems integration for the company’s optical-fiber products. It is one of five Alcatel centers devoted to optical communications; the others are in France, Italy, Germany, and the United States. The average age of the company’s Chengdu engineers is 29, says Wang Xianming, the center’s R&D director. Although most have never set foot outside their hometown, they still need to be able to work effectively with colleagues and customers halfway around the globe. Wang himself interacts daily with his counterparts at the other Alcatel labs.
Alcatel’s Chengdu operation is, in other words, global. Some Chinese fret that their country’s rise has been a “headless boom”—that too often, foreign investors leave their best technology and ideas at home. Many of the R&D centers that have been set up by foreign companies recently are directed toward “localizing” existing products for the Chinese market, rather than developing products for international consumption.
That’s not the case at Alcatel. Wang notes with pride that his big priority this year is fulfilling a $1.7 billion contract with SBC Communications Corp., in San Antonio, to extend its new fiber-optics network to 18 million U.S. households.
Twenty-five years ago, most people would have been astounded to hear that a U.S. telecom network was being developed by a group of researchers in a remote interior city of China. These days, it’s fast becoming the norm.
IN 2004, three years after its entry into the World Trade Organization (WTO), in Geneva, and a quarter-century after China began welcoming foreign investment, China’s trade volume hit $1.2 trillion, displacing Japan as the world’s third largest trading nation, behind the United States and Germany. This milestone is all the more staggering in light of the fact that China’s two-way trade, barely $20 billion in 1978, has increased 60-fold since then. For the first time in history, what China does, or does not do, ripples with consequence across the planet.
But this dramatic transformation is putting huge strains on China. It’s easy enough to see on a quick tour through Chengdu. The city’s environmental quality and headache-inducing traffic congestion, for starters, leave much to be desired [see “China’s Cyclists Take Charge” and “A Market for Clean Air,” in this issue]. Fifteen percent of city sewage goes untreated—practically pristine by national standards, but still too high to make the tap water drinkable. More critical are the power shortages. Rolling blackouts throughout the year leave some neighborhoods (although never the wealthiest ones) without power for up to five days per week.
Another source of tension is land. Here as elsewhere, real estate developers are gobbling up whole neighborhoods to make way for office high-rises, malls, and apartment complexes, bringing a mostly modern sheen to the city [see photo, “Urban Renewal”]. In the vast high-tech development zone, amid the hundreds of corporate complexes stand crumbling stone farmhouses. Although Chengdu’s official boosters insist that “nobody lives here now,” clearly some still do.
Just southwest of Chengdu, zealous land grabs have turned explosive. In November, tens of thousands of farmers in Hanyuan County seized the local government headquarters and held the Communist Party chief hostage for several days. Their beef: the government had unfairly claimed their land for a dam project, and to add insult to injury, officials had pocketed most of the money earmarked to compensate them.
The Chinese are still not allowed to own the land they live on, making it easy for an unscrupulous official to expropriate a farmer’s fields or a town dweller’s house to make way for a new factory or golf course. It took 10 000 paramilitary troops to quell the Hanyuan disturbance, and one policeman was killed and several protesters injured in the process, according to news accounts that appeared in Hong Kong and the United States.
Most such incidents go unreported in China, where the government still maintains tight control of the news media. But there are tens of thousands of spontaneous uprisings every year against corrupt officials and abusive police, according to official statistics. The number of incidents has increased steadily during the last several years, as have individual petitions to the central government seeking redress against local officials who collect illegal fees, steal compensation funds, or persecute personal enemies.
Far from having a monolithic and highly centralized government, China is in fact quite decentralized, and local and provincial leaders have enormous leeway. When the system works, it works quite well. Chengdu’s mayor and party chief, Li Chuncheng, is seen as one of the driving forces behind the city’s high-tech successes and has been anointed in the official Chinese media as “one of the 10 rising stars in Chinese politics.” An electromechanical engineer by training, he is reputed to be close to China’s president, Hu Jintao.
But when the system breaks down, it can do so spectacularly. In late January, the media reported that officials in Gansu province, one of China’s poorest, had embezzled nearly $1 billion set aside for infrastructure and compensation for evicted homeowners.
Social unrest is not confined to the rural interior. In some heavily industrialized cities, including Shenzhen, worker unrest is palpable. Workers in China are barred from organizing, and those who do risk being fired, beaten, or imprisoned. Even so, labor protests are proliferating, triggered by unpaid wages and pensions, sudden and massive job terminations, and an end to most of the socialist benefits that had been guaranteed since the earliest days of the Communist regime in the 1950s. Indeed, many Chinese ruefully note that the United States, with its unemployment insurance, Social Security, and Medicare, is now more socialist than China.
ARE LABOR UNREST AND LAND DISPUTES enough to retard or even unhinge China’s spectacular growth? If not, then what could? China’s economic locomotive has been barreling along at full throttle for so long—it has averaged a 9.5 percent annual growth rate for more than two decades—that you could lose sight of how devastating a derailment would be, not just for China but for the global economy.
Simply maintaining an optimal growth rate has been a delicate balancing act. On the one hand, anything less than a breakneck pace—the government’s red line is 7 percent—would lead to unmanageable unemployment and, most likely, social unrest. As it is, severe underemployment in the countryside has driven at least 140 million rural dwellers to the cities and other parts of the country in search of jobs [see photo, “Get a Job”]. At the same time, tens of millions of urban workers have been laid off from state-run factories, according to Huang Ping, a researcher in the Chinese Academy of Social Sciences, in Beijing, who tracks worker migration. The hard truth of China today is that this marvel of economic efficiency is born of brutal competition, with too many people chasing too few good jobs [see “Management American Style,” in this issue].
On the other hand, an overheated economy could easily spin out of control, leading to inflation, recession, or both. China’s last phase of inflation, in 1988, sparked a wave of popular discontent and led to a showdown among the country’s top leaders over economic policy. The power vacuum that ensued set the stage for the dramatic and tragic events in Tiananmen Square the next year.
Another Achilles’ heel is China’s excessive reliance on trade, which leaves the country vulnerable to economic downturns and protectionist measures in key trading partners, especially the United States. An ever-increasing share of output destined for export “cannot be sustainable and should be reversed,” Liang Hong, chief China economist in the Hong Kong office of investment bank Goldman Sachs Group Inc., noted in an interview. “It is not efficient, and it is not healthy for the economy.”
China’s embrace of market mechanisms and growth through exports began only haltingly in 1979, when Deng Xiaoping emerged from political disgrace to guide the country out of the decade-long cataclysm of the Cultural Revolution, Mao’s woefully misguided attempt to rekindle China’s revolutionary spirit. Under Deng, the first five-year phase of reform focused on the redistribution of land rights to individual households in the countryside and the gradual removal of agricultural production quotas, measures that rapidly improved the lot of China’s overwhelmingly rural population.
Urban reforms began in 1985, along with a progressively liberalized trade regime and an open-door policy toward foreign investment. Change was breathtakingly rapid, but turbulent: an old vanguard of communists more than once succeeded in throwing roadblocks across the path of Deng’s reforms, notably in 1987 and again after the Tiananmen Square crackdown. Several times Deng mustered the full force of his authority and prestige to overcome his market-averse comrades and keep his policies on track.
Throughout much of the 1980s and early 1990s, foreign investors fretted that China’s leaders would roll back economic reforms or that political infighting would give rise to a conservative backlash. But nothing of the kind has happened for more than a decade.
True, the Communist Party still calls all the shots worth calling, whether through edicts of the central government or decisions made by party leaders at the regional or local level. But it is hard to imagine under what circumstances China’s increasingly technocratic leadership would attempt to turn back the economic clock. Indeed, for the first time in the history of communist China, none of the nine members of the Communist Party’s ruling Politburo is a career ideologue or a soldier, historically the two bastions of conservative communism. All, in fact, are engineers by training [see sidebar, “In China, Engineers Rule”]. It is probably safe to say that the era of personality cults—at least communist ones—has passed.
But the willingness to allow China’s market-oriented reforms to continue more or less unhindered does not translate into a willingness to let China evolve toward a politically open society. The jailing of dissidents, the conviction of journalists on trumped-up charges of “revealing state secrets,” the incessant monitoring and blocking of Web sites that stray from the official line—these acts simply confirm the government’s oft-stated determination to maintain a tight grip on the reins of political power [see “The Net Effect,” in this issue].
In neighboring South Korea and Taiwan, the dictatorships that held sway for decades eventually allowed free and open elections, as rising middle classes laid claim to their own political futures. But to the extent that the burgeoning Chinese middle class yearns for democratic expression, it finds no institutional outlet.
GIVEN CHINA’S WEIGHT IN WORLD MARKETS, it would seem to be in every nation’s long-term interest to ease it along the road to becoming a more open and liberal society and a more self-sufficient, less export-dependent economy. But there remain serious areas of dispute between China and its main trading partners, problems that in recent months have turned what should be increasingly cooperative relations confrontational.
The biggest of all is intellectual property. By any measure, China is the runaway leader when it comes to counterfeiting and piracy, accounting for nearly two-thirds of such goods worldwide [see photo, “Street Scene”]. “They can copy anything,” says Michael Pecht, a professor at the University of Maryland, College Park, and an expert on the Chinese electronics industry. From pirated software to counterfeit game consoles and faked pharmaceuticals, the thefts are bold and sophisticated. In a particularly brazen incident, an entire KFC restaurant was copied, right down to the smiling Colonel Sanders [see “Steal This Software,” in this issue].
Although the Chinese government has made some progress in combating the problem, the United States Council for International Business, a lobbying group in New York City that favored China’s entry into the WTO, recently found that “piracy and counterfeiting at the wholesale and retail level, and over the Internet, remain rampant.” The council cited “inadequate penalties; uncoordinated enforcement among local, provincial, and national authorities; and the lack of transparency in China’s administrative and criminal enforcement system.”
Countries that have embraced the Chinese economy, whether as a manufacturing base, a source of cheap imports, or a big new market, are turning wary. A number of U.S. politicians claim an undervalued yuan, currently pegged to the dollar, gives Chinese goods an unfair edge. Chinese leaders counter that revaluing the yuan would unduly harm their economy, and thus the world’s.
In Europe, which in 2004 became China’s biggest trading partner, sharp debate centers on whether China poses an economic threat or a blessing. “To say that some will win and others will lose is a euphemism,” Daniel Cohen, a professor of economics at the University of Paris, commented recently in Le Monde. “Taking into account China’s size, it would be better to say: some will be utterly ruined, and others will become fabulously rich.”
Labor unions in Europe, alarmed at the flow of factory jobs from the continent, worry that their constituents will be the losers. Meanwhile, European leaders are doing their utmost to curry favor with their counterparts in Beijing, even going so far as to try to lift an embargo on military sales to China.
China’s claims on Taiwan also need to be resolved, especially given the increasingly strong business ties between the two [see “Silicon Gold Rush,” in this issue]. Although the United States and a few of its allies, most notably Japan, have stood by Taiwan’s right to determine its own future, China recently enacted a law authorizing the use of force against Taiwan should it move toward independence.
Meanwhile, the United States, with an eye toward China as well as North Korea, has encouraged Japan to rearm; given the perpetually cool diplomatic ties between Japan and China, leaders in Beijing view the move as a direct provocation. Nor is the Chinese government pleased about Japan’s claim to a string of East China Sea islands that holds natural gas reserves.
The Chinese people themselves still harbor deep resentment over Japan’s imperialist forays during the last century, in which many millions of Chinese were killed. In April, a wave of well-choreographed anti-Japanese protests and boycotts swept through several Chinese cities, including Chengdu, where demonstrators attacked a Japanese-owned supermarket. To what extent such developments will impede the sizable commercial traffic between the two countries is unclear.
BARELY 25 YEARS AFTER EMERGING from the turmoil of Maoist rule, China today is not only still standing, it is bestriding the world as an economic colossus. And the Chinese people regard this growing prominence as their due. After centuries of decline, the Chinese nation—the 3700-year-old Chinese civilization—is regaining its place in the world. And as the very name Middle Kingdom suggests, that place is at the epicenter of global affairs.
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WIRING SMALL-TOWN CHINA
THE FIBER-OPTIC TENTACLES OF CHINA’S INTERNET EXTEND DEEP INTO THE HEARTLAND
BY MARLOWE HOOD
If your picture of a gritty, coal-choked town of 140 000 souls in central China’s Henan Province doesn’t include high-speed Internet access, look again. More than 40 percent of the population of Yima, a town that is neither rich nor poor by Chinese standards, regularly goes online. Even outlying mud-wall villages have 8 megabit-per-second connections.
That connectivity is transforming the way the good citizens of Yima work, communicate, study, and entertain themselves. Six months after upgrading to a broadband connection and launching a Web site for his pig farm, Liu Zhaiguo—a wily peasant-cum-entrepreneur straight from central casting—was selling a third of his production at premium prices via the Net to buyers in neighboring provinces who did not even know Yima existed before seeing Liu’s site (http://www.ympy.com).
Liu is not unique. Farmers in a neighboring village, the poorest in the region, consult a newly installed intranet run by the agricultural ministry to decide what to plant and where to sell.
Nor is Yima unique. Small Chinese cities turn out to be far more connected than generally thought. The assumption that China’s exploding population of Internet users—conservatively estimated in January at 100 million—are concentrated in and around Beijing, Shanghai, Shenzhen, and other metropolises is just plain wrong.
A pioneering study in 2003 of Yima and four other small cities by Internet expert Guo Liang, a researcher at the Chinese Academy of Social Sciences, in Beijing, showed that cities and towns all over China were using sophisticated information technology. They used it to promote e-government, find new markets, rationalize work flows in businesses and municipal governments, and, yes, fritter away billions of hours in real-time combat and conversation. A follow-up study this year revealed that change is continuing apace and once-prevalent dial-up links have given way almost entirely to high-speed broadband connections.
“Yima is more developed compared with its neighbors,” acknowledges Zhang Jianwei, director of Yima Telecom Co., which installed the city’s Internet infrastructure and is one of two Internet service providers in town. “But almost all county-level cities in China”—there are about 2000—”have broadband now.”
If Yima remains ahead of the curve, there are two reasons. One is Communist Party chief Zhang Yinghuan, who has adopted with singular zeal the central government’s call to promote “informatization.” Merging into the “information highway,” he told IEEE Spectrum, as his staff scribbled furiously to keep up with his utterances, “is a vertical revolution that has changed people’s mentality, social structure, and economic development.”
Hyperbolic, no doubt, but not far from the truth. Each of Yima’s 1500-odd government and political officials has undergone a two-week training program on intranets, document management, and the Internet. Bureau chiefs who refuse to take the exam or who fail it are demoted and replaced.
Since mid-2004, all interrogations in the State Inspection Bureau, which investigates corrupt officials, are now carried out and recorded in a state-of-the-art facility with six hidden video cameras manipulated from a control room. Data is entered into an intranet that officials can use to consult and compare cases from across the country. “This system guarantees the rights of the detainees and allows us to use the video in court as evidence,” an official said.
The second reason Yima is ahead of the IT curve is China Telecom Co., in Beijing, whose local affiliate spent more than US $800 000 to build Yima’s Internet infrastructure, including the fiber-optic backbone, routers (Cisco Systems and Huawei Technologies), and servers (Hewlett-Packard and Lenovo Group).
Guo Liang, a social science researcher, says he is convinced that the Internet is helping to make China a more open society, and anecdotal evidence from Yima bears him out. He points in particular to the impact of tens of thousands of Internet cafés in which young people, most of whom cannot afford a computer and Internet subscription, pay 15 to 25 cents per hour to go online. “This is helping to erase the digital divide before it happens,” he says. Some 60 such cafés have sprung up in Yima in less than a year, with a total of nearly 1000 screens. Gaming is still the most popular activity, but it’s rapidly ceding ground to online education and other forms of information retrieval.
Then there are subtler changes in attitude that are more difficult to measure and, perhaps, to control. “I love to read negative news reports online, especially ordinary people’s complaints,” one respondent told Hu Xianhong, a Beijing University researcher who conducted the Yima survey in Guo’s study. “Those courageous reports could never be released in the traditional media.”
That is not necessarily the kind of openness that Communist Party chief Zhang is striving for, but it is part and parcel of China’s ascendance into the ranks of information superpowers.

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