CHINAMacroReporter

The Next U.S.-China Crisis: CEOs & Boards Are Not Ready

‘The bad news is that very few corporations engaged in China have contingency plans or long-term strategies to hedge against the downside risks of growing geopolitical competition.’
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May 22, 2022
The Next U.S.-China Crisis: CEOs & Boards Are Not Ready
Michael Pettis

‘U.S. Business Leaders Not Ready for the Next U.S.-China Crisis,’ by CSIS’ Scott Kennedy & Michael Green, is both a title and a statement.

  • And a startling report.

1 | ‘Overconfidence and resignation’ are not strategies

‘It is no exaggeration to conclude that U.S.-China ties have deteriorated to depths not seen since the late 1960s, when the two had no diplomatic ties and were actually shooting at each other in Vietnam,’ write CSIS’ Scott Kennedy & Michael Green.

  • ‘This transition has occurred so fast that global companies that have thrived on doing business with China are not well prepared to adapt to this new normal or to try and stem the tide.’

‘Extended interviews and in-depth crisis scenario exercises with dozens of companies and investors, have revealed an unexpected combination of overconfidence and resignation in their views.’

  • ‘Global businesses are for the most part keeping their heads down, hoping their China opportunities do not dry up, and aiming for greater home government support to relocate some of their supply chains.’

2 | 'Flashing red lights'

‘The good news,' they write, 'is that almost all business leaders the authors have engaged on these scenarios were already used to thinking about black swans.’

  • ‘The bad news is that very few corporations engaged in China have contingency plans or long-term strategies to hedge against the downside risks of growing geopolitical competition.’

Unbelievable? Well, it took the China tech ‘crackdown’ and stock market losses of over a trillion dollars to alert the investment community to China's risks.

  • And that ‘crackdown’ was predictable, as I explained last summer in ‘China's Tech Crackdown: 'Nobody Saw It Coming.' — Huh?’
  • Institutional investors I speak with now have gotten the message – they are factoring in China’s domestic situation and the geopolitical environment into their strategies.

CEOs? Around the same time last summer, I also wrote in ‘Don't Say Xi Jinping Didn't Warn You’:

  • Go ahead MNC CEOs, make fun of those dumb investors who got tricked by China.’
  • ‘But be aware: Your turn on the hot seat is coming.’

‘The good news: Investors’ travails are flashing red lights for CEOs.’

  • ‘They have a bit of time to take a big step back to thoroughly reexamine their assumptions about China and China business.’
  • ‘And in so doing, better prepare for the risks that lie ahead.’

But, as Drs. Green & Kennedy report, CEOs may not have gotten the message yet.

3 | Boards: ‘A fiduciary duty to mitigate significant risks.’

Fortune published ‘Present your China contingency plan at the next board meeting’ a week or so after ‘U.S. Business Leaders Not Ready for the Next U.S.-China Crisis.’

  • In that essay, entrepreneur and former Undersecretary of State Kevin Krach wrote:

‘Companies increasingly appreciate the heightened risk of doing business with China.’

  • ‘With Xi’s recent crackdown on private industry and the real probability of an attack on Taiwan (which China has refused to rule out), boards increasingly understand doing business with, in, or for China represents tremendous risk.’  

‘We have a fiduciary duty to the shareholders to mitigate significant risks.’

  • ‘That’s why many respected board members in corporate America are demanding a China contingency plan from their CEOs.’
  • ‘Similar discussions are happening among Europe’s top board members.

‘The world saw the Ukrainian attack coming, knowing full well that Putin is not in the habit of bluffing.’

  • ‘Neither is Xi.’

‘You can’t afford to get caught off guard on this one.’

  • ‘So prepare now.’
  • ‘When that moment comes, and you’re not ready, it will already be too late.’

‘When the dreaded becomes inevitable, you no longer need to fear it.’

  • ‘You must develop a plan and execute it.’

‘A China risk mitigation plan is not a drill.’

4 | Recalibrating is tough

Still, it’s one thing for boards to encourage CEOs to develop a ‘risk mitigation plan.’'

  • It’s another to ask them to create a new internal model of how China works to do it. (Or, if they are working just from bits and pieces of information about China, to create a coherent internal model at all.)

This is especially so for executives whose careers spanned the reform years and China’s fantastic economic growth.

  • It’s difficult for them not to unconsciously view the extraordinary, if incremental, changes brought on by Xi Jinping (think of the cliché about how to boil a frog – with the frog now pretty much cooked) through Deng Xiaoping-era lenses.

As for the executives newer to China, they probably got their China model from those experienced executives.

  • Just as I did from more experienced spies of a different era.

5 | From Mao to Deng to Xi

From my experience, I understand just how tough this transition is.

I began my China career in the late 1970s as a CIA case officer in China Operations.

  • Mao had died; the Cultural Revolution was over; the Gang of Four was on trial, and China had the per capita GDP of Zambia, about $5.

Then emerged a new de facto leader, Deng Xiaoping, who was promoting a few market reforms: de-collectivizing agriculture, opening up to foreign investment, and giving permission for some entrepreneurs to start businesses.

  • Still, it was far from clear whether or not these experiments would be successful – especially given the opposition from some of the die-hard Chinese Communist Party senior cadre. Or even how long Deng would hold power.

Turns out, of course, this was the beginning of a new era.

  • But at the time, many of the CIA’s China Watchers - some who had been spying on China since just after the Chinese Communist Party’s victory in 1949 – misread a lot of what was happening.

The reason, looking back, was that these officers were viewing Deng through Mao lenses.

  • Whether from habit, stubbornness, or conviction, or all three, they just couldn’t understand that they needed a new (excuse the term) paradigm.

For my part, having learned how to think about China from these officers, I held on to the same outmoded model for a time.

  • Even after I realized that this was, in fact, a new Deng-era, I still had to take care not to unconsciously revert to old Mao-era ways of analyzing China in working with clients as lawyer, investment banker, and adviser.
  • And I’ve had to recalibrate again with Xi Jinping and with the massive changes in how much of the rest of the world views China.

All by way of saying, I sympathize with the challenges CEOs and boards face.

  • But crises are coming, and they have no option but to work to understand China as it is and the geopolitical landscape they are operating in - and to prepare.

6 | ‘U.S. Business Leaders Not Ready for the Next U.S.-China Crisis’ – the next installment?

May Dr. Kennedy and Dr. Green’s next report tell us that executives have gone beyond ‘keeping their heads down, hoping their China opportunities do not dry up, and aiming for greater home government support to relocate some of their supply chains.’

  • And that the line, ‘very few corporations engaged in China have contingency plans or long-term strategies to hedge against the downside risks of growing geopolitical competition,’ has been excised.

But barring a crisis, I am not optimistic.

Until then, read their  ‘U.S. Business Leaders Not Ready for the Next U.S.-China Crisis.’

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