Observations From My Trip To China

by: Whitney Tilson

I got back on Friday afternoon from a fascinating 10-day trip to China – the first time I’ve been to mainland China in 21 years. I spent the first half of my trip in Shanghai, China’s most populous, modern, wealthy, capitalistic city, and the second half in Tengchong, in remote, rural, south-central China, bordering Burma, attending a conference of Teach for All, a growing network of Teach for America-like organizations in 32 countries (see this op ed in the NY Times, Meet the Makers, by Tom Friedman about it). I’ve posted pictures and comments from each part of my trip here and here.

I want to share a few observations about China – with the caveat that I am very emphatically not holding myself out as an expert on the country. I’m just endlessly fascinated by China on many levels, most importantly as an investor. Though I’m primarily U.S. focused, China has become such a large and rapidly growing part of the world economy that I can’t ignore it – if China sneezes, the world (and my portfolio) will catch a cold.

So is China about to catch a cold? That’s an important and vexingly difficult question. Jim Chanos is perhaps the best-known China bear and he makes a cogent argument (see here and here) that China is experiencing the mother of all infrastructure, real estate and financial bubbles – “Dubai times 1,000” – that is on the verge of bursting.

And it’s not just Chanos. Just about every day, I read another story about fraudulent businesses, corrupt officials at all levels, crudely authoritarian and thuggish behavior by the government (censorship, jailing truth-tellers, etc.), rich people leaving (or at least stashing a lot of money outside the country), ghastly pollution, tainted products, out-of-control real estate prices, banks lying about their loan losses, untold amounts of lending that’s not reflected in official statistics – the list goes on and on...

So one of the main reasons for my trip was to see the country for myself and meet with as many smart people as I could so I could form my own judgment.

The skeptics are no doubt correct about many things – for example, there’s no question that there’s widespread corruption and terrible pollution. And I think Chanos is right when he emailed me, after reading this article: “Over the long-term I believe China will continue to grow, and modernize. The problem is that non-Chinese investors, as always, will not benefit from it, in aggregate. The rent-seeking behavior by the elites/Party, coupled with no real “rule of law”, equals trouble for passive Western investors.”

But is China a house of cards that will soon collapse? I’m not so sure. After my trip, I’m a bit more likely to think that China, for all of its problems, might avoid a huge calamity.

Earning Your Way Out of Trouble

If so, it will likely be for the same reason that Wells Fargo and American Express avoided bankruptcy in early 2009. At the time, as I argued in my book, More Mortgage Meltdown: 6 Ways to Profit in These Bad Times, both companies were insolvent, meaning that my analysis of the likely losses embedded in their balance sheets at the time exceeded the companies’ tangible equity. So why did both companies not only survive but thrive (both stocks have skyrocketed from around $12 at that time)? For two reasons: 1) the losses didn’t come all at once – rather they trickled in over time; and 2) the companies were (and are) highly profitable.

In other words, every quarter the companies’ losses created a hole, but each time they were able to fill it with profits – and over time they earned their way out of trouble. So it’s important to not only analyze the balance sheet, but also the income and cash flow statements. If a company (or country) is highly profitable and productive, that can offset a lot of bad investments resulting in big losses.

Things are Getting Better

I asked everyone I met a simple question: are things getting better? Every person, even those most critical of the country and/or its government, said yes (though with different degrees of conviction). The businesspeople said the government’s crackdown on corruption is having an impact (at least at the margins), there’s been some progress (from a very low base) in protecting intellectual property, and the government is very serious about tackling the terrible pollution. The teachers and other educators I met with said the educational system is steadily getting better. The rural peasants told me that their lives are steadily getting better as well. China has a long way to go, but I got the strong sense that it’s moving in the right direction in many key areas. One person I spoke with said it best when he said he’s “hopeful but cautious.”


China leads the world in infrastructure spending, and I saw evidence of this everywhere I turned – cranes, scaffolding, rock quarries, lumber yards, etc. I’ve never seen anything like it.

Is this a huge waste and bubble – a Google search for “China infrastructure bubble” yield 4.3 million hits – or a wise investment in the future? I’m not sure. I’ve certainly seen the reports of white elephant projects – even entire ghost cities (though they may not actually be, as this article notes) – and I saw an empty housing development outside of Tengchong that could have been transplanted directly from the outskirts of Las Vegas circa 2009.

But China’s infrastructure was very impressive. Every road was paved and in good condition, even far outside of Tengchong. The four airports I flew into and out of were modern and beautiful – even the small one in Tengchong (see my photos). One of the Teach for China teachers told me that one of the newest buildings in every town in China is the school – and, sure enough, though the school I visited was in old, wooden buildings, right down the road a large new building was almost complete for the school to move into next year (again, see my photos). Lastly, remember all the stories about China’s high-speed rail network, which was characterized by corrupt contracting, shoddy construction, and numerous accidents? Well, read this story in the NY Times last month, Speedy Trains Transform China. Here’s an excerpt:

The cavernous rail station here for China’s new high-speed trains was nearly deserted when it opened less than four years ago.

Not anymore. Practically every train is sold out, although they leave for cities all over the country every several minutes. Long lines snake back from ticket windows under the 50-foot ceiling of white, gently undulating steel that floats cloudlike over the departure hall. An ambitious construction program will soon nearly double the size of the 16-platform station.

Just five years after China’s high-speed rail system opened, it is carrying nearly twice as many passengers each month as the country’s domestic airline industry. With traffic growing 28 percent a year for the last several years, China’s high-speed rail network will handle more passengers by early next year than the 54 million people a month who board domestic flights in the United States.

Li Xiaohung, a shoe factory worker, rides the 430-mile route from Guangzhou home to Changsha once a month to visit her daughter. Ms. Li used to see her daughter just once a year because the trip took a full day. Now she comes back in 2 hours 19 minutes.

Business executives like Zhen Qinan, a founder of the stock market in coastal Shenzhen, ride bullet trains to meetings all over China to avoid airport delays. The trains hurtle along at 186 miles an hour and are smooth, well-lighted, comfortable and almost invariably punctual, if not early. “I did not think it would change so quickly. High-speed trains seemed like a strange thing, but now it’s just part of our lives,” Mr. Zhen said.

China’s high-speed rail system has emerged as an unexpected success story. Economists and transportation experts cite it as one reason for China’s continued economic growth when other emerging economies are faltering. But it has not been without costs — high debt, many people relocated and a deadly accident. The corruption trials this summer of two former senior rail ministry officials have cast an unfavorable light on the bidding process for the rail lines.

The high-speed rail lines have, without a doubt, transformed China, often in unexpected ways.

For example, Chinese workers are now more productive. A paper for the World Bank by three consultants this year found that Chinese cities connected to the high-speed rail network, as more than 100 are already, are likely to experience broad growth in worker productivity. The productivity gains occur when companies find themselves within a couple of hours’ train ride of tens of millions of potential customers, employees and rivals.


It would be incorrect to say that China is only investing in physical infrastructure. At the Teach for All conference, we heard from education officials in both Shanghai and Tengchong and, overall, I was very impressed. China is investing heavily in this area and is doing a good job of providing a decent education to nearly all of its citizens through 9th grade (and, increasingly, beyond this) (for more on this, see Tom Friedman’s recent op ed, The Shanghai Secret). The officials proudly cited precise statistics: 99% of students enrolled in primary school, etc.

Yes, the statistics are probably exaggerated (like most in China), yes, school is only required through the 9th grade and then drops off sharply after that (which compares very poorly to developed countries) and, yes, the system is much too focused on rote learning (witness the surge in wealthy Chinese sending their children to U.S. high schools and colleges), but the focus and progress – by both the government and the citizens – are undeniable.

Check out this chart (from a New York Times article):

One of my Chinese friends told me that most colleges in China are useless and a Wall Street Journal article notes that two-thirds of the graduates just want cushy jobs with the government or state-owned enterprises, but nevertheless the trends are impressive.

If anything, China is currently overeducating its people. It may well be the only country on earth in which the unemployment rate rises the more education a person has, as shown in this chart:

So which problem would you rather have: undereducating our population (as we do) or overeducating (as China is doing)?

Culture and Work Ethic

I think a country’s culture (broadly defined) is enormously important in determining its long-term future, but it’s an area that isn’t discussed much for two reasons I suspect: it’s really hard to measure and one runs the risk of being accused of incorrect generalities (or, worse yet, racism). Key questions to ask are:

  • Is the social fabric strong and are families and communities intact?
  • Do people sacrifice and save for the future?
  • Are people focused on education and developing their skills and improving themselves?
  • Is there a strong work ethic?

Forgive the gross generalization, but my impression is that, with the possible exception of the Koreans, the Chinese are the hardest working people on earth. Everywhere I went in China, I saw and spoke with people who were really hustling: studying and working incredibly hard, saving and sacrificing for the future.

A good example is a young man I met whose father is the head of the state-owned company. He’d clearly grown up in privilege, attended one of China’s top universities, works for a foreign investment firm, and has been accepted at one of America’s top business schools – in short, just the kind of guy one might expect to be a lazy, entitled, good-for-nothing “princeling”. But he wasn’t – this young man was on top of his game: he’d read the classics of value investing (Security Analysis, The Intelligent Investor, Margin of Safety), peppered me with questions about my work, and had good insights about the stocks we discussed.

I wish I met more young Americans as sharp, focused and driven as him. If he is at all representative of the post-Cultural Revolution generation in China, then China is in good shape for the future.

Contrast With Southern Europe

In sharp contrast, my impression is that the people of southern Europe, in general, work to live (as opposed to live to work). One entrepreneur I spoke with this week who ran a medical device business in southern Spain from 2008-2012 said he had enormous difficulty finding employees with a strong work ethic and was driven crazy by the innumerable national, regional and local holidays – “and heaven forbid you ask anyone to work on one of those days.” When he finally gave up and moved his business to Switzerland, he only asked one employee to come with him – and said the others didn’t even care. They just wanted to make sure he filled out the paperwork so they’d be sure to get their government benefits. And this is in a country with an unemployment rate exceeding 25%!

Contrast With Dubai

There was also a sharp contrast with what I saw in Dubai a few years ago. The construction boom there was an obvious bubble, with no long-term fundamentals underlying it – prior to the discovery of oil (of which Dubai itself actually has almost none), there really wasn’t much there. And as for hard work, Dubai hires an army of migrant workers (living in generally deplorable conditions) to do all of it.


I knew the coastal regions of China were booming, so I wasn’t surprised by what I saw in Shanghai (it’s a lot like Hong Kong), but was quite surprised and impressed with Tengchong and the surrounding areas, which I expected to be very poor and underdeveloped, with lots of dirt roads, etc. – but I was totally wrong. Tengchong itself is quite developed and prosperous – it’s popular among Chinese tourists for its clean air, scenery and nearby hot springs – but even the surrounding area, which is among China’s poorest, is doing pretty well. From what I could see, the Chinese government has done a good job sharing the wealth being created along the coast with the poorest, most remote interior areas. Every road was paved, there’s universal basic healthcare, education, and housing – I saw no signs of extreme poverty – and (no surprise) there’s lots of construction going on everywhere.

Competent vs. Incompetent Corruption

I’m sure there’s quite a bit of truth to the stories about large numbers of Chinese government officials being corrupt but, in general, they also seem to be competent: they might line their pockets a bit, but the road gets built. Compare this to many developing countries, in which the government officials are too often drunken illiterates who steal all of the money – and don’t build the road.

My Cousin’s Skeptical Views on China’s Long-Term Competitiveness

My cousin, a Stanford engineer and Silicon Valley entrepreneur who just sold his venture-backed medical device company, accompanied me in Shanghai and emailed me the following observations:

One of my conclusions from the trip is that China faces major headwinds relative to costs and its competitive position. For a country that built itself of being the low-cost producer for the world, it faces major challenges.

Environmental: Harbin had 20-meter visibility last week. 20 meters! The Chinese government lied about its pollution problem for a long time, but it can no longer keep up that farce. Eco issues are a major embarrassment for China, and they will have to spend a lot of money to fix things. It has a major effect on the willingness of people – both Chinese and foreigners – to live and work in China, and imposes real costs on businesses.

The guy we spoke with from [a major U.S. manufacturer] said that China’s “eco-compliance standards are as stringent if not more stringent than anywhere else” and “our factories are newer here, so we have to buy the newest, cleanest stuff, which costs more.” And the woman from [a major U.S. fast food company] also said their costs were higher: “Our world-wide standards are high, and we have to spend a lot more here than elsewhere because they need more help and because we need to watch them much more closely.” For a country that used to offer the advantage of lower eco-compliance costs, they are now a high-compliance-cost country.

Land: It was surprising to see that Shanghai home/apartments cost more than the Bay Area. And, compared to any other U.S. area, the Bay Area already devotes the highest percentage of its paycheck to accommodations. Shanghai land and housing is really high cost, which sets a very high floor for labor costs.

Labor: Average wages in China have quadrupled since 2000. Quadrupled!!! U.S. wages are going up 2 to 3% per year – Chinese 10% to 15%. Talking to people on our visit, I think that engineers and assemblers today make 4-5x more in the U.S. than in China, which means that, in seven to ten years, the gap will be down to 2-3x. That is not much of a cost advantage for a country that has a lot of inefficiencies and operates much lower on the productivity/quality/price/product/margin curve.

China’s demographics are not favorable, as the number of new entrants into the workforce is already falling [and will decline by 30 percent in 2020 compared to 2010, according to this article, though another friend points out that “The government is considering allowing families to have a second baby. This can help China to regain cheap and young labor forces in the long term.”]. My friend at Apple told me, “We keep on having to build factories further and further away, as we can’t find any more people in the cities.” This sounds like a perfect combination of events for ongoing wage inflation, which China cannot afford.

Materials: China has higher material costs than the U.S. With commodity prices fluctuating (and rising), this is a big issue that can quickly and radically cut into margins.

Equipment: Most of their fancy equipment comes from the U.S., Germany, or Japan. No cost advantage here.

Brands: Obviously, they have few-to-none. It’s expensive to develop brands, but they afford higher margins. China’s inability to create them is a major problem and may doom them to eroding margins as they get squeezed by all of the above costs, but cannot increase prices in the absence of high-value brands. Brands require creativity and innovation that you don’t often associate with the Chinese education system.

Overall, if I were a Chinese CEO (or a Chinese government official), I would be very concerned about my competitive position.

I was also really surprised to see the divisions in society. The wealth and educational disparities were shocking. The disdain for migrants – and the challenges they face – were surprising.

Don’t Despair About America

I want to end on a positive note. While I’m long-term bullish on China, I’m also long-term bullish on America. I don’t think it’s a zero-sum game – both countries can prosper over time.

After his speech at the Teach for All conference last week entitled Flat World 4.0: The Role of Education in a Hyper-Connected, Global World (you can watch it here), I asked Tom Friedman the following question:

Your point about “think like an immigrant” resonated with me. I’ve seen the Chinese immigrants in the U.S., and boy do they think and act like immigrants – they’re really hustling. But what’s incredible to me, having spent the last week in China, is seeing that the Chinese are acting like immigrants in their own country! I think the U.S. used to be this way, but fear that we’re losing our hustle and drive. Do you agree and, if so, how to we get it back?

Friedman replied:

I don’t think we’ve lost it. If you want to be an optimist about America, stand on your head. Our country looks so much better from the bottom up, than from the top down. What you see if you look at the country from the bottom up is that it is full of people who just didn't get the word. They did not get the word that China is going to eat our lunch or that Germany is going to eat our breakfast and so they just go out and start stuff, and invent stuff and collaborate on stuff. If I were to draw a picture of America today it would be the Space Shuttle taking off. You've seen that picture -- all that thrust coming from below. That's all those people who didn't get the word. But in our case, our booster rocket – Washington, DC – is cracked and leaking energy. And the pilots in the cockpit are fighting over the flight plan. As a result, we cannot achieve escape velocity to get into the next orbit -- the next phase of the American Dream. We have all the attributes to succeed in the 21st century. If we could just fix the booster rocket and get the pilots to agree on a flight plan, we would just take off -- we would separate ourselves from the rest of the world.

Well said!