Ready for Take-Off China Steers Course Between Prestige and Profit

China's slowing economy has German industry worried about its exports to Asia. But as it goes about beefing up the transportation sector, the country poses a completely different threat in the longer-term.

REUTERS

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For a military site, the Dachang Air Base in the northern part of Shanghai has a very civilian appearance, a little like the campus of an American university, with widely spaced bungalows and buildings, plane trees, ponds, lawns and the Volvos, Jeeps and Buicks of employees.

Along with several assistants, aviation engineer Li Jieke, 66, a tall, elegant man, is giving a tour of the grounds along with an assistant. Foreigners are an uncommon sight here, and foreign journalists are especially rare. "No photos, please," says Li, as we approach the airfield, where several People's Liberation Army jet fighter are parked in formation. "Let's take a drive over to our building instead, to the civilian aircraft."

In Dr. Li's hangar, photographs are only permitted in selected locations, and only from specific angles. The ARJ21 Xiangfeng is being assembled there. It is China's first domestically developed modern airliner, the pride of its engineers and the hope of its aviation industry. ARJ stands for "Advanced Regional Jet," and Xiangfeng means "Flying Phoenix." The number 21 stands for the 21st century.

Development of the short-haul aircraft began in 2002, and it took off on its first test flight in 2008, after a few delays. But then the wings proved to be too weak, and there were problems with the aircraft's electronics, landing gear and ice testing. Certification had to be postponed several times.

COMAC, the Chinese state-owned aviation company, plans to deliver the first aircraft this fall, five years later than planned. "It wasn't easy to get the Phoenix off the ground," says Li Jieke. "Building a safe airliner is the biggest challenge for a modern industry."

China, the world's second-largest economy and largest trading nation, produces steel and cement, manufactures garlic presses and soccer jerseys and assembles smartphones, tablets and computers. But if the government planners in Beijing have their way, China will also develop and build pacemakers, high-performance cameras and industrial robots in the future. And eventually it will also build a large jet with engines that are not produced by General Electric, like those on the ARJ21.

Beijing is extremely ambitious. No matter how difficult it is, China must build its own large aircraft after the ARJ21, said President Xi Jinping during a visit to COMAC in Shanghai last year. The president currently flies to state visits on an American aircraft, a Boeing 747. He doesn't seem to like that. "In the past, someone said the best choice for us is to rent (passenger aircraft) from others and then buy (them) and that the last option is to make our own," he said. "We have reversed this notion. We will invest more to develop and produce our own large aircraft."

A Turning Point

The world is currently very interested in the economic issues associated with this claim. Exactly how strong is China's economy? Will the country remain the "workbench of the world," dependent on ideas and orders from the West? Or will it manage to complete the jump to an innovative economy, one that can compete in high-tech fields? And will this make the country, which is mainly a buyer of high-quality German products at this point, a threat to German industry?

China's ambitions as an industrialized nation are especially apparent in the three major areas of the transportation sector: the automobile, railroad and aviation industries. This is where it becomes evident how Beijing's planners are proceeding, what they have so far achieved and what setbacks they have already endured.

All three industries are currently at a turning point. The Chinese auto market, a guarantee of growth and profit for 35 years, is in crisis. Growth rates are noticeably declining for the first time, both those of domestic automakers and of some of their international partners and competitors. The Volkswagen Group, which generates almost two-thirds of its profits in China, reported a 4-percent decline in sales in the first half of 2015. And as a result of two devaluations of the Chinese currency, the yuan, the prospects for German carmakers have been further dampened in their most lucrative market.

In contrast, the Chinese railroad industry is fast becoming a world leader. Chinese railroad companies are receiving more orders than ever before. The country's rail, locomotive and rolling stock manufacturers are not just selling their products in China and in the developing countries of Asia and Africa, but are beginning to receive orders from the United States and Europe. German national railroad Deutsche Bahn will open a purchasing office in China this fall, which is alarming news for its main supplier, Siemens.

The civil aviation industry, the youngest of China's transportation industries, is about to undergo the greatest transformation of all. Boeing estimates that Chinese airlines will buy about 6,000 passenger aircraft in the next 18 years, or about six aircraft a week. More than 60 of the country's current 200 airports are now being expanded and modernized, and there are plans to build 30 new ones. It is only a matter of time before China becomes the world's largest aviation market.

However, technical innovation cycles are longer in aviation than in the automobile and rail sectors. China will have to hurry up if it hopes to break the global duopoly of Boeing and Airbus -- and benefit from its own boom in the process. What lessons is the Chinese leadership learning from the two other industries? And what will the consequences be for Americans and Europeans?

The Automobile Boom

It's summer 2015 at a car show in Xiamen, a prosperous port city in Fujian Province. The first visitors are already standing in line outside the convention center at 7 a.m. Despite the ticket price of 50 yuan, or €7 ($8), per person, entire families are there.

The convention center consists of two large buildings. Cars made by Chinese manufacturers are exhibited in one building. Outside China, the domestic brands -- Chery, Geely, Great Wall, Dongfeng, SAIC -- are known only to industry experts. The dealers are advertising their small and mid-sized cars with ear-splitting presentations. Some exhibitors are sitting in their model cars with the windows closed, playing with their mobile phones while they wait for customers.

International brands -- BMW, Peugeot, Porsche, Daimler and Ford -- are on display in the other building. It is quieter there, even though the crowds of customers are significantly larger. "Demand fluctuates," says Xie Xiaoping, who is touting an SUV at the Toyota booth, "but interest has grown steadily over the years."

Western manufacturers clearly dominate the luxury category. German brands Audi, BMW and Mercedes alone command 70 to 80 percent of the premium market. About half of all of Daimler's S class models are now sold in China, where the S class is the first car purchased by 12 percent of customers. Unlike Audi and VW, which recently suffered significant setbacks, Mercedes saw its sales grow by 20 percent in the first half of 2015.

But foreign companies also dominate the small-car or so-called volume segment. About two-thirds of all automobiles sold in China have international brand names, while only 38 percent of the 1.5 million cars sold in June were entirely Chinese-produced.

Graphic: Chinese Automobile Sale
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Graphic: Chinese Automobile Sale

This Western dominance was never planned, and certainly not by the Chinese. The government in Beijing drafted three goals when it began building its own auto industry in the early 1980s. The first was to import Western technology. The second was to establish a clearly structured automobile market with a small number of efficient manufacturers. The third was to make money -- especially foreign currency, which China lacked at the time -- by exporting vehicles.

To achieve these goals, Beijing brought foreign manufacturers into the country, but it also forced them to enter into joint ventures with Chinese companies. To be a part of China's automobile boom, foreign companies had to enter into relationships with Chinese state-owned businesses.

Lessons Learned

Most of these goals were not achieved. There is no ongoing technology transfer, and Chinese cars have not become export hits, as planned. Even the Chinese have trouble distinguishing among their domestic manufacturers' logos.

Nevertheless, Beijing long adhered to the joint-venture requirement, because the Chinese-international joint ventures have reached, and even exceeded, another objective: They have been more money with the production of Western, brand-name cars for the Chinese market than both sides had ever dared to hope.

As US expert Gregory Anderson writes in his seminal book on the Chinese auto industry, "Designated Drivers," "it is more profitable in the short-term for state-owned enterprises to produce foreign-branded cars than it is for them to pour money into development of their own." If the money is right, Beijing's practitioners of state capitalism are apparently more interested in the capital than in state objectives, acquiring Western technology or international market dominance.

Anderson's explanation is that China's state-owned carmakers are geared toward quick profits, growth in absolute figures and preserving jobs. Entrepreneurial risks are systematically avoided. The managers of state-owned companies appointed by the government "have been most content to allow their foreign partners to contribute complete vehicle designs, which are then assembled by Chinese workers and sold under foreign brands."

There are three lessons to be learned from the development of the Chinese auto industry to date.

Firstly, the political leadership's objectives are important, but they are less influential than often assumed in the West. China has a large auto industry today, but it doesn't resemble what the government planners wanted at all.

Secondly, if the market develops differently than expected, the system is flexible enough to adjust. Even if Beijing would prefer something different, the Chinese like Western car brands better than their own. As a result, Chinese state-owned companies are still producing Western brands after 35 years, and they are making money in the process.

Thirdly, the party wants to preserve its power and, in times of declining growth rates, is increasingly oriented toward social stability. Technology transfer and the development of domestic industrial capacity are seen as desirable, but it is more important to China's provincial and city governments that companies can guarantee jobs.

Railroads for the World

A high mountain valley in Qinghai Province, two hours from the village where the Dalai Lama was born. The D2704 express train from Ürümqi to Lanzhou has reached an altitude of 3,600 meters (11,811 feet) when it rushes through the first of two tunnels through the Qilian Mountains, traveling at 250 kilometers per hour (155 miles per hour). The train travels in darkness for one-and-a-half minutes, then it's light outside for a few seconds, and then dark again, as the train enters the second tunnel, the world's highest, and one that can accommodate high-speed trains.

"Four minutes," says civil engineer Ren Shaoqiang, 48. "It takes only four minutes for a train to travel along a stretch of rail that took us four years to build." Ren, a muscular man with a crew cut and a wrinkled jacket, supervised the construction of the most difficult segment of the 1,800-kilometer Lanxin route, which connects the sparsely populated western provinces of Ganzu, Qinghai and Xinjiang. Thanks to the work he and his 2,000 men put in, Ren appeared on the cover of an industry journal from Japan, a country that sets the highest standards in railroad construction.

"The Japanese are still a few steps ahead of us," says Ren, "but we are probably the best by now under conditions like those up here." The Qilian Mountains are a young, geologically unstable range. "It's as if we had driven two tubes through a mountain consisting half of sheer rock and half of millet gruel," he says. "But as you can see, it works."

The development of China's high-speed network is an epochal achievement. The first ultra-high-speed train began operating only eight years ago, and today the network covers 16,000 kilometers of track, more than the high-speed routes of all other countries combined. Some 2.5 million travelers use these routes every day, or a total of about three billion by the end of 2014. China has the longest and highest-altitude high-speed railroads, and the country's (and the world's) longest railroad bridge spans a distance of 164 kilometers.

Map: China's High-Speed Rail Network
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Map: China's High-Speed Rail Network

As with the development of its auto industry, Beijing also courted Western and Japanese partners in the rail sector, and as with the auto industry, the government demanded that they enter into joint ventures with Chinese state-owned companies and share their technology.

The railroad executives of the four world market leaders, Siemens (Germany), Bombardier (Canada), Alstom (France) and Kawasaki (Japan) faced a dilemma: Should they hazard their know-how, or access to possibly the world's largest railroad market?

In the end, all four companies and many suppliers went to China. They adhered to a logic that then Deputy Premier (and the current head of the government's anti-corruption unit) Wang Qishan summarized in a meeting with European business executives in 2009: "I know you have complaints. But the charm of the Chinese market is irresistible."

The results of this cooperation are completely different than in the auto industry, and became apparent much faster. There were also setbacks in the construction of the rail sector, including a severe train accident in 2011 and a series of corruption scandals. Nevertheless, Beijing has achieved what it wanted: a modern high-speed network and an internationally competitive railroad industry.

Ambitions and Criticisms

From railroad construction to signaling technology to locomotive and railcar construction, in almost every field the Chinese have managed to expand foreign construction plans (which they also continue to buy) and adjust them to their needs. Many engineers in middle management, like Ren Shaoqiang, have worked abroad, and some are now invited to the West to share their expertise. "We are standing on the shoulders of other giants," says Ren, "but now we have gathered experience and massive amounts of data, which others cannot have to this extent."

China's railroad companies have since become competitors to their former mentors. China is building railroads in Turkey, Saudi Arabia and Argentina, and subways in Kuala Lumpur, Ankara and Boston. It is bidding for major projects, with international partners in some cases, like the planned high-speed rail line between Los Angeles and San Francisco.

On June 1, China combined its two rail giants, CSR and CNR, creating a railroad company that is larger than the rail divisions of the previous world market leaders combined.

But as ambitiously as Beijing is pushing its way into the world market, there is still persistent criticism within China of the country's railroad policy. "The project to build high-speed rail lines no longer makes economic sense," says transportation expert Zhao Jian of Jiaotong University in Beijing. "I would stop further construction immediately."

A few of the 33 high-speed routes, such as the one between Beijing and Shanghai, are profitable, says Zhao, but the majority of the routes are losing money. "Of the planned 160 pairs of trains, only 27 now travel between Xi'an and Zhengzhou." Instead of its high-speed network, he explains, China should expand freight traffic by rail, which now accounts for only half as much freight volume as in 1998. "It's time that we started budgeting more reasonably."

There are also three lessons to be learned from the short history of China's high-speed rail routes.

Firstly, Beijing now has a better idea of what it wants from foreign companies than when its car industry took off, and it is concluding agreements with them that are advantageous for its own companies. Its engineers are also more advanced than they were 30 years ago, and the time when they merely copied what others had invented is drawing to a close.

Secondly, in contrast to the early stages of its industrialization, China now has the financial resources to implement projects that promise more prestige than economic gain. If the leadership feels it is appropriate, as it did after the global financial crisis in 2008 and 2009, it can mobilize resources the way the United States did when it expanded its national highway network in the 1950s.

Thirdly, even the Chinese central government's assets are not unlimited. Beijing still wastes billions on infrastructure projects that will probably never pay off. But calls for efficiency and sustainability are getting louder. The leadership's master plan to transform China from an investment and export-driven economy to a consumption and service economy will only reinforce this tendency.

The Dream of Flying

With the possible exception of the Internet economy, civil aviation is currently the biggest challenge for the industrialized nation. "If China can succeed fully in aerospace, then in principle there is very little that it cannot do," US aviation expert and Atlantic journalist James Fallows writes in his book "China Airborne."

Unlike the auto and railroad industry, where Chinese manufacturers compete with a large number of international brands and companies, the competition in aviation stars one, or rather, two names: Boeing and Airbus. It would be unrealistic to assume than an economy as big as China's today could accept an American-European duopoly in the long run, especially in a sector that Beijing declared a "key industry" 10 years ago.

Today Beijing has divided up the domestic market almost equally between the Americans and the Europeans. Boeing produces its aircraft in the United States and has Chinese suppliers. In 2008, Airbus and a joint venture partner built an exact copy of its Hamburg final assembly plant in Tianjin, where it has already assembled more than 200 jets in the A320 family. A planned A330 cabin equipment center is expected to become operational in 2017.

The nucleus of what will one day become China's Boeing or Airbus is the hangar on the edge of the Dachang air base in Shanghai, where Li Jieke works. A model of the new COMAC headquarters stands in the lobby. The site will be located directly at the fifth runway of Shanghai Pudong International Airport. "The buildings that are already complete, and where we will assemble the ARJ21 regional jet in the future, are in blue," says Li. "The planned production line for our medium-range aircraft is in white and the long-haul aircraft production facility is in red."

The timetable, typology and nomenclature for Chinese civil aviation have already been determined. The C919 short- and medium-range jet is being advertised at aviation conventions. After several delays, the aircraft is now scheduled to complete its first test flight this year, and the C929 widebody jet will be ready by 2020.

"I don't want to hazard a prediction as to whether these plans will succeed," says Wang Yanan, 45, of the Beijing University of Aeronautics and Astronautics. "Chinese aviation managers are big on setting fixed dates for maiden flights, dates that they don't stick to." The embarrassing delays with the ARJ21 regional jet have injected a dose of humility into the patriotically charged atmosphere in the industry, he adds.

"In aviation, we have learned that it isn't enough to take apart a foreign product to be able to copy it perfectly," says Wang. For instance, minute details in alloys are critical when it comes to the blades in aircraft turbines. This, according to Wang, is good news for European and Americans concerned about their intellectual property. Certain things simply cannot be copied and need to be independently developed, he explains.

Finding a Balance

"Perhaps the aerospace industry will reveal the limits of the Chinese model rather than its limitless power," writes US expert Fallows. "A China capable of creating its own Boeing, its own Airbus, would have to be a transformed China from the one we know now." The recipes the country used to develop into a major economic power -- high volume, quick profits, low cost and a great tolerance for product defects -- are precisely the opposite of what is needed in this sector, Fallows explains.

It does not appear that China will be able to make do without foreign expertise in high technology in the foreseeable future. But it would be just as premature to assume that the country will continue producing only mass-produced goods into the future.

Aviation engineer Li, who spent a long time working in the United States, returned to China 10 years ago and is optimistic. "We will cooperate with international companies in all fields," he says, "but there will be areas in which we have to press ahead alone." They include electronics and, most of all, a central element in the civil aviation industry, the development of domestically produced engines. Li suspects that this development will probably take longer to achieve than by the current target of 2020.

Perhaps this is the lesson that China, as an industrialized nation, will learn from its experiences in auto and railway construction: That even a country of its size and its ambition must find a balance between political expectations and economic reality, and between prestige and profit. It can study this relationship in economies that also began their path to becoming highly industrialized nations as imitators of foreign products, and as the "workbench of the world": Germany, Japan and South Korea.

A red banner hangs from the ceiling above the "Flying Phoenix," the first modern airliner that China will deliver this fall. The motto on the banner could have been expressed by an engineer in any of these countries: "Relying on quality = success."

Translated from the German by Christopher Sultan

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spmullan 08/20/2015
1.
"China is building railroads in Turkey, Saudi Arabia and Argentina, and subways in Kuala Lumpur, Ankara and Boston." 1.) China is not building a subway in Boston. 2.) CNR is building an assembly plant in Springfield, Massachusetts (literally up the road from where I am sitting) where it will assemble MBTA subway rail cars. The contract was for rail cars, not a subway line.
Inglenda2 08/21/2015
2. The wrong brains at the top!
There is less reason for the German industry to be worried about its exports to Asia, than there is about China taking over the industry itself. Already – and it does not matter whether you are buying electrical equipment, car-parts, clothing, or just a simple article like buttons - the chances are, although it bears a German trademark, all, or part of it, will have been made in China. Skilled German workers are being thrown into unemployment, just because short-sighted industrial owners, want to make a quick profit. On the long term, this is industrial suicide of the sort seen in England twenty years ago. Not even the souvenirs, which one can now buy in the British holiday resort, Brighton, are made there! The result, less customers and an increasing number of unemployed. In the NRW area of Bielefeld and Gutersloh, the signs of this development can already be clearly seen.
afhack62 08/21/2015
3.
The author is right in assuming that a country of 1.3 billion people should be able to innovate many new products. But when you’re referring to the reality that is China you’re talking about a country that is prolific in its theft of foreign technology and in its copying of many foreign made products. The author’s naiveté can be forgiven for seconding China’s bold assertion that they will one day make a large aircraft engine for a large domestically produced aircraft. It’s almost an absolute certainty, though, that every component of which will contain stolen technology. And if China were to build a domestic aircraft engine there is no question that it would be an exact duplicate of a foreign made engine, maybe down to a crass, modified version of the victim’s company logo.
awareadams 08/22/2015
4. Coming Down to Earth
Today the U.S. stock marker took a big plunge (8/22/15). It is said this results partly from the bigger plunge in Chinese stocks and its economy. I write to post that the Chinese government policies which built a lot of these costly projects are not "coming down to earth" and China is about to pay the price for not planning its growth in more fiscally responsible ways.
wilpost37 08/28/2015
5. Jet engine turbine blades
Pratt & Whitney, GE and Rolls-Royce have been making jet engine turbine blades since the mid 60s. This is technology neither Russia nor China have sufficiently developed to build modern jet engines. Hence GE, P&W and RR engines in Russia and China and all over the world. It would take China, etc., many years to copy THAT technology.
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