Ties That Bind, 2014 Edition

Project Sponsors Ties That Bind 2014 Edition

The San Francisco Bay Area’s Economic Links to Greater China

A Bay Area Council Economic Institute Report

Sean Randolph President & CEO Bay Area Council Economic Institute

Niels Erich Global Business/Transportation Consultant

Contents

PREFACE: Assessing China and the Bay Area...... v Tracking an Evolving Relationship...... vi Executive Summary...... vii Economy...... vii Students...... vii Professional Networks ...... viii Trade and Tourism ...... viii Affiliates and Invention...... viii Key Sectors...... ix Architecture and Urban Planning ...... ix Energy/Environment...... ix Cleantech...... ix Banking/Finance ...... x Mobile/Internet...... x Law...... x Life Sciences/Health Care...... xi Investment ...... xi Connectors ...... xi Paths Forward...... xii Conclusion...... xii 1. CHINA’S ECONOMY: Slower, but More Diversified ...... 1 In 2006...... 1 Today...... 2 The 12th Five-Year Plan ...... 7 Economy...... 7 Environment/Energy...... 8 Agriculture ...... 8 Investment Reform ...... 8 Livelihood ...... 8 2. THE BAY AREA CHINESE COMMUNITY: Beginnings ...... 9 Chinese Communities Take Shape ...... 9 The 1906 Earthquake ...... 10 Two-Way Trade Grows...... 11 The Immigration Profile Changes...... 11 3. CHINESE STUDENTS AT BAY AREA UNIVERSITIES: Land of Opportunity...... 13 Numbers Tell the Story ...... 13 Education as an Investment ...... 14 Student Trends...... 16 Unintended Consequences...... 18 “Sticky” Students ...... 20 Cross-Border Academic Collaboration Runs Deep...... 22 Endowments...... 23 Visas: The School-to-Work Transition...... 24 4. PROFESSIONAL NETWORKS/ASSOCIATIONS: Staying Connected...... 27 The Asia Foundation: Supporting Development and Reform...... 31 5. TRADE AND TOURISM: Poised for a Breakout? ...... 35 Drilling Down to the Regional Level ...... 37 Strong Export Potential for California Wine ...... 42 A Matter of Geography ...... 44 Up in the Air ...... 44 U.S.-China Trade in Perspective...... 44 Policy Concerns ...... 46 A Nascent Two-Way Tourism Trade...... 47 Tourism Trends...... 48 Rolling Out the Red Carpet...... 49 6. GROWING BUSINESS TIES: Affiliates and Invention ...... 51 Business Presence ...... 51 Research Collaboration ...... 51 Financial Investment...... 51 7. KEY INDUSTRY SECTORS: A New Set of Synergies ...... 55 ARCHITECTURE AND URBAN PLANNING: From Buildings to Towns and Districts... 55 ENERGY/ENVIRONMENT: Small Steps Matter...... 61 CLEANTECH: A Bright Future…Someday...... 67 BANKING/FINANCE: Slow Money ...... 71 MOBILE/INTERNET: Everything Is Interconnected ...... 76 Game Strategy...... 79 The Foxconn Connection ...... 84 The Taiwan Tech Community Plans its Future...... 86 LAW: The Wild West Settles Down ...... 88 LIFE SCIENCES/HEALTHCARE: Healthy Prospects...... 91 INVESTMENT: A Two-Way Street ...... 96 8. CONNECTORS: Building New Bridges...... 109 A New Kind of Overseas Office ...... 109 The Asian Art Museum: Come for the Art ...... 112 The EB-5 Advantage ...... 113 Two Local Examples ...... 115 Paths Forward...... 119 Higher Education...... 119 Tourism ...... 119 Immigration ...... 119 Energy and Climate ...... 120 Investment ...... 120 Connectors ...... 120 Conclusion...... 120 Acknowledgments...... 121 Sources...... 123

PREFACE Assessing China and the Bay Area

In November 2006, the Bay Area Council Eco-  a nexus of cross-border Chinese professional nomic Institute (then the Bay Area Economic networks and access to venture capital, which Forum) released Ties that Bind, a report that ex- combined to produce new technology start- amined the longstanding commercial and cultural ups and cross-border innovation. ties between the San Francisco Bay Area and Ties that Bind studied the infrastructure that greater China. developed around and behind this cross-border The report was a first-of-its-kind effort to collaboration—student trends; alumni connections; document a unique economic relationship that professional associations and the linkages among began with the arrival of the first Chinese immi- their members, sponsors, investors and foreign grants at San Francisco’s docks in 1849. These new government sponsors; cross-border collaboration arrivals sought—and found—both an escape from between research clusters; and the evolution of overpopulation and famine after the Taiping this ecosystem through redeployed capital, uni- Rebellion, and an often difficult fresh start as min- versity endowments and business mentorship. ers and prospectors in the Gold Rush, as contract We went on to study two-way flows of trade labor for railroads and canneries, as fishermen, or and investment, and focused on opportunities as workers in—and owners of—small businesses. and obstacles for companies active in China in We began with this history, discussing succes- key industry sectors: finance, law, the Internet, sive waves of Chinese immigrants to the Bay Area; information technology and computing, archi- the formation of Chinatowns with clusters of tecture and urban planning, advertising, energy, Chinese-owned businesses; the rise of family environmental protection and life sciences. In benevolent associations and later, a dramatic each case, we tried to present a balanced picture expansion of business and home ownership. of market and regulatory conditions in China for The central focus of Ties that Bind, however, the sector in question, accompanied by inter- was on a converging set of trends in the 1980s views and case studies highlighting firms’ experi- and 1990s, and how they were reflected in ences on the ground. the economy: We considered venture, private equity and  an influx of science and engineering graduates portfolio investment trends, examined high-profile from elite universities in Taiwan, Hong Kong cases of direct investment by Bay Area firms in and mainland China, often government-sup- China, and discussed early examples of Chinese ported, who were drawn by world-class univer- firms attempting to establish footholds in the U.S. sities and by opportunities in Silicon Valley; market, achieve global scale and take advantage  a recognition by governments, state-owned of synergies by merging with, acquiring or buying enterprises and family-owned industrial stakes in Bay Area firms. conglomerates throughout greater China Finally, the report laid out a set of guiding that emerging information technologies principles, strategies and recommendations for were the key to moving their industries up policymakers at all levels of government to the value chain; consider, in order to grow and deepen the Bay  a strategy among wealthy Chinese families Area-China economic relationship. These in- to invest in educating the next generation, volved education and workforce training, fund- exposing them to a wider world and new ing of basic research, visa policy, trade, tourism ideas, but also establishing an overseas and investment promotion, and freight infra- foothold amid political uncertainty; structure improvements.

v Ties That Bind, 2014 Edition

Tracking an Evolving Relationship Much has happened since late 2006. The global new sectors that have developed significant economic downturn has slowed demand for connections with China, including clean energy China’s exports and accelerated an internal shift technology, digital media and cloud computing. toward indigenous innovation and increased do- We examine new initiatives—some of them mestic consumption. A new Five-Year Plan having grown out of the original Ties That Bind through 2015 emphasizes continued urbaniza- report—that have capitalized on synergies among tion; cleaner energy, air and water; and a more cities, institutes, universities and companies in the robust healthcare and pension safety net. And Bay Area and greater China. China is increasingly venturing out into the We assess the new opportunities presented by world—encouraging even state-owned firms to the rising tide of outbound Chinese investment. raise private capital and invest overseas and enter Finally, we re-examine earlier policy issues and new markets. recommendations and report changing condi- California, for its part, has demonstrated its tions, progress made, and new concerns to capacity to innovate—in biofuels and energy monitor or address. conservation, cloud computing and big data, The first edition of Ties That Bind found a biomedicine and genomics, nanomaterials and level of connection between the Bay Area and mobile communications. China that is unique in its depth and breadth. These trends suggest both a converging Our conclusion was that this relationship—his- set of interests and new opportunities as the torical, cultural and economic—represents a Bay Area and China build on their close 160- major opportunity for the region. While no re- year relationship. port can fully capture such a deep and complex In this 2014 update of Ties That Bind, we relationship, in this new edition the Institute revisit earlier educational and institutional once again highlights for businesses and poli- relationships, professional networks, trade and cymakers the key market dynamics, deals, firms investment flows, and business connections by and innovators that form the close and lasting sector, to understand what has changed in the economic bond between the San Francisco Bay past eight years. In doing so, we also consider Area and China.

Executive Summary

China and the San Francisco Bay region enjoy a These trends point to important synergies, 160-year relationship dating back to the first arri- as the San Francisco Bay Area is a global cen- val of immigrants during the Gold Rush. New ter for much of the talent, innovation and arrivals came in the tens of thousands, built rail- technology crucial to China’s continued eco- roads, panned for gold, fished the Bay, worked as nomic transformation. servants, started businesses and built thriving communities in San Francisco, Oakland, San Jose, Economy Sacramento and the Delta. China’s economy is slowing and becoming Since then, successive waves of immigrants more diversified. from Hong Kong, Taiwan and mainland China have  Urbanization is driving growth, which is mov- made important contributions to the regional ing inland. This massive shift will continue, economy—as business owners, and most recently with another 200 million Chinese moving to as entrepreneurs with advanced degrees in sci- urban centers in coming decades. ence, technology, engineering and mathematics.  China’s labor force has shifted from agricul- The Bay Area has also contributed to China’s ture to manufacturing and services, serving development as a global economy. The region’s both export markets and a rapidly emerging universities, research laboratories and companies middle class. have played a role in building China’s Internet;  The economic, social and environmental impli- reforming its legal and judicial systems; planning cations of these shifts will be profound—with new, sustainable buildings and communities; and growth in incomes and markets, but also en- supporting entrepreneurial growth. vironmental challenges. China’s admission into the World Trade Organi- zation (WTO) in 2001 marked the beginning of an explosion in investment and trade that changed Students the global landscape, stimulating massive invest- Chinese students have made an important ment in China—primarily in manufacturing—and contribution to the region’s economy. Many generating large Chinese trade surpluses that have have chosen to remain in the area after produced more than $3 trillion in foreign exchange graduation, supporting technology innova- reserves. The 2008–09 recession marked a change, tion, launching start-ups, and becoming angel however. Nearly two decades of double-digit GDP and venture investors. growth ended, and with it the dramatic expansion  China contends with India as the top source of in U.S.-China trade. Trade growth has resumed but students from overseas. is slower; the assumption of a continuous and  The number of students in the Bay Area from steep upward economic trajectory has given way greater China—the People’s Republic of China to new pragmatism. (PRC), Taiwan and Hong Kong—has grown Within China, the largest mass rural migration from approximately 5,500 in 2004–05 to an to cities in world history is continuing. Rising estimated 7,000 in 2011–12. wage and land costs are pushing new industrial  Tuition, living expenses and other spending in development away from highly developed cities 2011–12 by Chinese students enrolled in Bay Area such as Beijing and Shanghai, to Tier 2, Tier 3 colleges and universities contributed nearly $219 and interior cities. And a growing and sometimes million to the state and regional economies. restive middle class is pressing the government  The Bay Area’s elite universities continue to for improved working conditions, a cleaner attract top talent, primarily at the graduate environment, a stronger social safety net and level where students concentrate in science continued upward mobility. and technology.

vii Ties That Bind, 2014 Edition

 Stanford has opened a facility in Beijing, Bay Area ports and airports in 2012. About $4 and Berkeley has a research presence billion of that $6.4 billion originated in the in Shanghai. region (the balance being goods in transit.)  Undergraduate enrollment at Bay Area univer-  While Bay Area trade with the PRC and Taiwan sities by Chinese students is up dramatically, has recovered to 2008 levels, imports from helping budget-strapped schools. Hong Kong have declined by half, as more car-  This has raised new issues, however, as many go moves directly to and from mainland ports. undergraduates show up unprepared, scho- As China’s middle class broadens its horizons, lastically and in English language proficiency. the number of Chinese travelers to the U.S. is  Reported endowments from Chinese donors growing. The Bay Area is a prime destination. to Berkeley and Stanford in the past two  From 2008 to 2012 the number of Chinese decades total more than $150 million. tourists visiting the U.S. grew from 275,000 to nearly 1.5 million, enabled by the Chinese Professional Networks government’s granting of “approved Professional associations provide robust en- destination status” for the U.S. and the U.S. trepreneurial and business networks, offering government’s streamlining of visa processing information, mentorship and access to busi- in China. ness opportunities.  SF Travel estimates that the city hosted 198,000  Associations such as the Asia America visitors from mainland China in 2011, 60,000 MultiTechnology Association (AAMA), the from Taiwan and 50,000 from Hong Kong. The Hong Kong Association of Northern California, association has offices in Shanghai and Beijing. the Monte Jade Science and Technology  The profile of Chinese tourism is shifting from Association, the Hua Yuan Science and lower-end packaged tours to more and Technology Association (HYSTA), and the wealthier Chinese traveling as individuals. Chinese American Semiconductor Profes-  Hotel chains such as Hilton, Starwood and sional Association (CASPA) continue to thrive Marriott have introduced Chinese-friendly and have evolved their offerings as member services at locations popular with Chinese interests and the channels for access to China tourists, including the Bay Area. have grown.  Four airlines—United, Cathay Pacific, Singa-  New associations have been added to the pore and Air China—offer a combined 49 non- region’s already rich landscape of China- stop weekly flights to Hong Kong, Beijing and related organizations. The Chinese Enterprise Shanghai through SFO, with a capacity of more Association, for example, helps more than 80 than 16,000 passengers. In 2013 China Eastern large mainland firms with a Bay Area presence Airlines began daily non-stop flights to Shang- stay current on technology advances and con- hai, with continuing same-plane service to Wu- nect with business and government leaders. han and Qingdao, adding over 1,600 seats per The Taiwanese American Industrial Technol- week. In 2014, United Airlines will launch same- ogy Association (TAITA) promotes Taiwan- aircraft service to Chengdu, via Shanghai, and Silicon Valley exchanges. will reinstate non-stop service to Taipei. Trade and Tourism Affiliates and Invention Trade with China is growing, but more slowly Cross-border investment and collaborative than in recent years. innovation are growing. The presence of Chi-  Between 2006 and 2012, U.S. exports to China nese companies in the Bay Area is increasing, doubled to $110.5 billion; imports from as is the presence of Bay Area businesses China increased by nearly 48 percent, to in China. $425.6 billion.  The Bay Area is home to 96 affiliates of com-  Nearly $18 billion in imports from China and panies from Taiwan, 51 from China, and 38 $6.4 billion in exports to China passed through from Hong Kong. viii Executive Summary

 The PRC ranks second among the top sites for Tianjin and its sustainable plan for Guangzhou’s Bay Area businesses abroad. Currently there city center; and Woods Bagot’s 78-story CBD are 795 Bay Area affiliates located in the PRC, Tower Z11 in Beijing. plus 303 in Taiwan and 216 in Hong Kong.  Collaborative patenting activity with China- Energy/Environment based inventors represents a growing per- China’s rapid growth has translated into rising centage of total foreign co-patenting in the energy demand and massive environmental region, expanding from less than 1 percent in costs, with the government under intense pres- 2002 to 9.9 percent in 2012. sure to address growing health problems induced  Investment from the Bay Area to China reached by poor air quality. The 12th Five-Year Plan aims $2.7 billion in 2011, representing 38 percent to cap coal consumption, promote clean coal and of all Bay Area investment abroad in that year. renewable energy technology, strengthen energy  China is also a growing investor in the Bay Area, conservation and building efficiency standards, with $495 million invested in 2011, or 7 per- and create pilot carbon trading programs. These cent of all foreign private equity and venture measures spell opportunity for Bay Area firms. capital flowing to the region. Conservation-related exchanges mainly involve government bodies, research institutions and non-governmental organizations. The China Key Sectors Energy Group at Lawrence Berkeley National Laboratory manages extensive joint energy effi- While China remains an important manufacturing ciency research and technical support projects base and markets continue to grow, Chinese ob- with Chinese counterparts and has helped Chi- jectives have broadened to include indigenous nese steel, cement, refining and textile firms innovation and the creation of globally competi- develop cost-effective operating efficiency stan- tive Chinese brands. As a result, today’s business dards and best practices. Energy Foundation environment is increasingly complex. China supports LBNL’s China Energy Group and Architecture and Urban Planning has more than 100 partner institutions in China. It Bay Area architecture and planning firms have has also advised China’s State Council in drafting brought cutting-edge design and sustainability particulate matter emissions standards and sup- principles to Chinese cities, as China has em- ports sustainable urban design projects in six braced daring forms and sustainable design, with cities; the furthest along is in Kunming, where planning and construction taking place on an Berkeley-based Calthorpe Associates is develop- extraordinarily scale. In the last decade, Chinese ing the master plan. demand has helped keep a number of Bay Area Cleantech firms afloat, particularly as new construction in California and the Bay Area contracted, and as China’s pressing need for renewable energy and China’s stimulus spending ramped up. A revival environmental solutions and California’s expertise of construction in California and the Bay Area in both cleantech and environmental management now offers increased opportunity at home, but (primarily concentrated in the Bay Area) point to Bay Area architecture and planning firms remain further synergies. Cleantech markets in both the in demand due to their prestige and reputation Bay Area and China are growing, but that has also for leadership in sustainable design. brought political complexity. Key projects include Gensler’s Shanghai Tower, Major Chinese solar panel makers and systems China’s tallest, and the China headquarters of providers Trina Solar, Suntech Power and Yingli Internet portal Tencent; Skidmore Owings and Green Energy have established North American Merrill’s Huawei Technologies Corporate Campus headquarters in the Bay Area. A glut of subsidized and the Knowledge and Innovation Community solar panels from China in 2009–10 squeezed U.S., technology park in Shanghai; Heller Manus’ China Chinese and other manufacturers but benefited Automotive Technology & Research Center in system installers. In 2013, the U.S. government

ix Ties That Bind, 2014 Edition imposed significant antidumping duties and with the smartphone. In 2013, one in three countervailing duties on Chinese solar imports. smartphones sold in the world were sold China has also made significant investments in in China. Bay Area cleantech firms, including Kaistar Light- Oracle serves its top 500 enterprise accounts in ing’s $25 million investment in Livermore LED China—mainly large institutions, government lighting technology firm Bridgelux, and Hanergy agencies and state-owned enterprises, such as Holding Group’s $120 million acquisition of Mi- China Mobile, China Telecom and China Unicom— aSole, a Santa Clara maker of thin-film solar cells. through a dedicated sales force and has an R&D center in Shanghai. Cisco was instrumental in de- Banking/Finance veloping China’s Internet infrastructure and works with universities and provincial governments to Foreign-owned banks in China continue to face expand delivery of public services. Intel has pro- headwinds. The most sophisticated global banks duction facilities in Shanghai, Chengdu and Dalian. make money but have small shares of an already Tech companies active in China since the thin slice of an otherwise huge market. Wells 1980s face challenges from both technological Fargo Bank has two branches, in Shanghai and change and from Chinese competitors. Global Beijing. Bank of America’s Asia-Pacific operations web portal Yahoo! and search firm Google once activities, with 27,000 employees, are headquar- enjoyed lead positions in China but were caught tered in Hong Kong, with client-serving offices in between government surveillance, censorship Beijing, Guangzhou and Shanghai. Opportunities policies and competition from indigenous portals. are growing to serve mid-market U.S. companies Yahoo eventually traded its China operations and with operations in China, and Chinese companies $1 billion to Alibaba.com for a 40 percent stake. that are expanding internationally. Bank of Tokyo- Google took down its China site and moved its Mitsubishi UFJ has been active in China since servers to Hong Kong in 2010 to offer unfiltered 1980; its U.S. subsidiary Union Bank leverages search via Google.hk. Its Android operating sys- this China presence through its Global Business tem, however, is found on most Chinese-made Coordination Unit in San Francisco. Silicon Valley handsets and enjoys a 90 percent share of the Bank has a strong focus on tech and innovation- China mobile phone market. centered companies and has subsidiary offices in iPhones are considered a luxury in China and Shanghai and Beijing and a banking license to sell mainly to high-end customers in major cities. handle onshore dollar-based transactions. As a result, Apple (served by China Unicom) has Hong Kong and Taiwan banks have a long his- only a 4.2 percent share of China’s mobile phone tory in the Bay Area, and now PRC banks are market. The September 2013 launch of its less making an initial approach. Industrial and Com- expensive iPhone5c in partnership with China mercial Bank of China (ICBC) has five Bay Area Mobile, however, is expected to increase its retail branches—in San Francisco, Oakland and market share. South San Francisco—through its 80 percent inter- Chinese IT companies are also expanding their est in Bank of East Asia, a Hong Kong-owned bank Bay Area footprint in R&D and as service provid- chartered in the U.S. The Bank of Communications ers. China’s leading Internet search engine, has been approved to open in downtown San Baidu, plans to open the Institute of Deep Francisco its second wholesale branch outside Learning (IDL)—its first wholly-owned research New York. center—in Cupertino. China Mobile and Huawei both have R&D centers. Mobile/Internet As the Internet matures, it has become the Law nexus where computing and communications China’s admission to the WTO created a market intersect, for consumers and increasingly for for investment-related legal services: cross-border enterprises. China has been quick to embrace regulatory and tax compliance; the formation of this change, and the Internet in China begins wholly foreign-owned enterprises (WFOEs); x Executive Summary technology licensing; and cross-border M&A The biggest news, however, is the dramatic and public listings. M&A and IPO business growth in outbound investment from China to the stalled during the global downturn. Business is U.S. and other countries. Chinese FDI in the U.S. returning now, but often in different areas: Chi- has been rising strongly, setting new records nese bank and SOE (state-owned enterprise) every year since 2009. Some proposed Chinese offshore financing and investments; structuring investments have failed, primarily due to strategic of overseas renminbi funds; and cross-border or security concerns. In response, a new strategy real estate transactions in both directions. Advi- may be emerging in favor of deals under $500 sory work on inbound Chinese investment across million; joint ventures, partnerships and equity a range of sectors is growing. As case law de- stakes rather than outright acquisitions; a focus velops, intellectual property disputes are fewer on privately held versus publicly traded firms; and but remain common. avoidance of companies that are likely to raise strategic or security concerns. Life Sciences/Health Care Property development in particular is attracting China represents a $300 billion-plus life sciences investment from China. Chinese developer Zar- market that is growing 15–20 percent annually, sion, a private company, has committed $1.5 bil- amid challenges of aging, chronic diseases, envi- lion to a partnership with Signature Development ronmental illnesses and pandemics. The 12th Five- Group to develop the Brooklyn Basin project on Year Plan aims to ensure comprehensive insurance Oakland’s waterfront. Vanke, China’s largest resi- coverage for over 90 percent of the population; dential developer, is partnering with U.S. firm upgrade the pharmaceutical supply chain; expand Tishman Speyer to build two high-rise residential drug coverage, and modernize and expand public towers in San Francisco’s South of Market district. health infrastructure. The Plan also seeks to reduce reliance on foreign vendors and suppliers. Connectors Bay Area firms are taking advantage of China’s New organizations have joined the already-rich growing pre-clinical and clinical trial research ca- landscape of institutional connectors between pacity, conducting trials at lower cost and in Bay Area and China business. shorter time frames than in the United States.  The Bay Area Council has opened offices in Chinese pharmaceutical, biotech and medical Shanghai and Hangzhou and will open a third device firms are also looking to the U.S. for part- in Nanjing. nerships and M&A that combine cutting-edge  The Governor’s Office of Business and Econom- U.S. science with low-cost production to more ic Development (GoBiz) has opened a California deeply penetrate Chinese and global markets. Office of Trade and Investment in Shanghai, in They are also investing in the Bay Area. partnership with the Bay Area Council.  China SF and China Silicon Valley are working Investment to bring Chinese investment to San Francisco The environment for foreign direct investment and San Jose. (FDI) between the U.S. and China is changing at  Regional centers are leveraging the federal both ends. Some U.S. investors in China have EB-5 program to bring investment to projects taken a defensive posture, favoring greater China such as Hunters Point in San Francisco and call plays—financial services in Hong Kong, and tech centers, logistics facilities and nursing homes manufacturing in Taiwan—that leverage the in Oakland. mainland market. Venture and private equity  Chinese entrepreneurs and developers have groups are favoring later stage investments in launched technology and life sciences companies with proven management and busi- incubators to connect start-ups, established ness models. Fund managers are using the Five- companies and investors for cross-border Year Plan as a roadmap to invest in sectors that collaboration with Chinese counterparts. Early address identified national priorities and enjoy entrants include InnoSpring, Hanhai Z-Park government support. and Hanhai-Zibo Life Science Park.

xi Ties That Bind, 2014 Edition

Paths Forward Overseas investors, however, need more security and transparency. The EB-5 program Several specific areas of opportunities emerge (which is currently only a pilot and subject to from this analysis. extensions) should be made permanent. U.S.  Education: The Bay Area is a major destination Citizenship and Immigration Services should for students from China, who bring tangible also be given the resources it needs to benefits to the region and its economy. To stay expedite applications processing (which can competitive, and support California students, take as long as 18 months), advance priority continued investment in public higher educa- projects, and exercise better oversight of tion in California is essential. While Bay Area regional centers. universities have opened teaching and research facilities in China, there is also a significant op- Conclusion portunity for Chinese universities to establish The Bay Area is in a strong position to interpret facilities in the Bay Area. China to the U.S., and the U.S. to China, as it con-  Tourism will continue to grow as an area tinues to build a positive, multifaceted relationship. of opportunity. While China will remain a sometimes contro-  Immigration: Current policy makes it unneces- versial topic in Washington, states, regions and sarily difficult for many graduates from China private companies tend to see China more prag- and other countries to stay and contribute to matically. The Bay Area has shown a particular the economy. Immigration reform is needed affinity and openness to China, and ever since the that removes country quotas for green cards historic creation of the Shanghai-San Francisco (which are quickly exhausted for high-volume Sister City Committee, has reached out to de- countries such as China), makes it easier for velop new relationships and channels. New in- entrepreneurs from China and other countries termediary entities such as ChinaSF and the Bay to stay in the U.S. to found companies, and Area Council’s Shanghai and Hangzhou offices enables foreign graduates of U.S. universities exemplify this trend and provide platforms for with advanced degrees in STEM fields to se- continued business growth. cure green cards. The wealth of opportunities outlined in this re-  Energy and Climate: California and China share port does not suggest that China will be an easy an interest in reducing the consumption of fossil place to do business or that significant barriers fuels, increasing the production of renewable don’t exist. China’s economy is slowing, labor energy, improving energy efficiency, and miti- costs are rising, and competition from Chinese gating climate change. This presents an op- firms is increasing both in China and overseas. portunity for the Bay Area, where the state’s Cyber security, intellectual property protection, cleantech industry is concentrated and where transparency, and government policies that require government, university and private initiatives technology transfer or favor national companies offer a rich basis for dialogue and cooperation. will remain significant issues for both businesses  Investment: As China sends ever-larger vol- and policy makers. umes of investment capital abroad, California Bay Area companies, however, have demon- and the Bay Area are positioned to capture an strated their capacity to succeed in China’s often outsized share. Evidence to date suggests that challenging environment, and local government Chinese investment is bringing positive bene- has chosen to lead as well. As the Economic In- fits through infusions of capital, job creation stitute found in its 2006 report, as China grows as and, in some cases by improving access to a major force in the world economy, the San Chinese markets. Francisco Bay Area continues to occupy the pole  The EB-5 program is a promising vehicle to position among its potential U.S. partners. Be- expand Chinese and other foreign investment cause of the scale of this opportunity, the rela- and can play an important role in financing tionship merits continued investment at both the infrastructure, housing and new businesses. public and private sector levels. xii

1. CHINA’S ECONOMY Slower, but More Diversified

In any discussion of the Bay Area’s economic ties costs and achieve global manufacturing scale. with China, it is important to first understand the Increasingly, those facilities were also positioned macroeconomic, political and market forces to serve an emerging Chinese middle class. driving China’s economy, including the evolving Technology and life sciences companies estab- role of the Chinese government in key areas of lished R&D centers to develop new generations of the economy—from state-owned enterprises to products, drawing on a talented labor pool of sci- ownership and local content restrictions applied ence, math and engineering graduates who could to foreign firms and investors; to labor, intellec- be deployed in large numbers to solve problems. tual property and environmental regulation; and China’s trade surplus with the world bal- to rule of law in commercial contracts. looned. Export growth stimulated the mass migration of 140 million workers from inland rural In 2006 areas to coastal cities. Nearly 100 cities grew in Since its opening to the world in 1978, China had size to populations exceeding 1 million; the num- seen steady, strong economic growth. But with ber of cars in China tripled to 20 million over China’s admission into the World Trade Or- 2000–05; the highway system grew to 23,000 ganization (WTO) in 2001 came a seven-year ex- miles; 37 new international airports were built; plosion of trade and investment that has arguably the rapidly expanding ports of Shanghai and altered the structure of both the Chinese econ- Shenzhen displaced Hong Kong and Singapore omy and Chinese society in irreversible ways. as the world’s leading harbors; Shanghai boasted With annual growth of 9–10 percent, China’s 4,000 new skyscrapers, with 1,000 more on the economy doubled during 1999–2005 to $2.2 tril- drawing boards. lion, almost overnight becoming the world’s As it assumed the role of the world’s manufac- fourth largest economy. State-owned enterprises turer, China’s demand for raw materials, energy, made up only a quarter of the economy by 2005; and capital equipment increased exponentially. At old economy industries such as oil, steel and the high point of its economic growth, surging autos were surpassed by the manufacturing for Chinese demand led to global steel, copper and export of a wide range products—from consumer aluminum shortages and raised oil prices on world goods and apparel to advanced electronics—and markets. In 2005, the U.S. trade deficit with China by new companies based in telecommunications was reached $201 billion; in 2006 China’s foreign and Internet services. exchange reserves—largely derived from trade— Annual foreign direct investment (FDI) into approached $1 trillion, with 70 percent held in China grew by nearly 50 percent over 2003–05; dollar-denominated securities, mainly U.S. Treas- and total cumulative FDI reached $941 billion, ury certificates. with the U.S. being the fifth largest investor. U.S. Growth brought challenges: Chinese export in- firms across a range of sectors—technology, en- dustries were heavily subsidized, displacing do- ergy, home furnishings, sporting goods, electrical mestic industries in other countries and leading to machinery and appliances, autos, apparel—set up trade disputes; with the “China price” came qual- manufacturing joint ventures to produce low-cost ity assurance problems in some sectors; the China goods for the U.S., using Chinese facilities to save price was rising, as wages and land prices soared;

1 Ties That Bind, 2014 Edition

Beijing did not have the means to enforce intel- and Europe became readily apparent in the crisis lectual property (IP) protections nationwide, nor of 2008–09. was it inclined to let IP concerns constrain exports; Successive years of double-digit GDP growth in most industries, foreign FDI came with strings ground to a halt during the global recession of attached, in the form of burdensome technology 2008–2009. In mid-2009, People’s Republic of transfer and local content rules aimed at support- China (PRC) exports were down 23 percent from ing competing domestic brands. a year earlier, as U.S. and European demand dried up. China had by that time displaced other Today emerging economies as the global manufacturer The extent to which China’s fortunes in the previ- of choice, so the impacts of global recession were ous decade were tied to foreign manufacturing immediate and dramatic. China’s economy has investment, exports and consumers in the U.S. recovered, but not to previous levels.

China GDP Growth, 2002–2012

15%

12%

Percent Growth in GDP in Growth Percent 3%

0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: Asian Development Bank; analysis by Bay Area Council Economic Institute

China Exports of Goods and Services as a Percentage of Total GDP, 2002–2012

40%

35%

30%

25%

20%

15%

10%

Percentage of Total GDP 5%

0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: Asian Development Bank; analysis by Bay Area Council Economic Institute

2 China’s Economy

China’s GDP in 2012 was $8.36 trillion. The Bank forecasts moderate annual growth of 8 per- government set a 7.5 percent growth target for cent through 2015. 2013, which was China’s lowest since 1990. As A weighted mix of manufacturing and services China’s economy continues to mature, growth in the China Purchasing Managers’ Index (PMI), should remain strong but is not likely to see the prepared by HSBC and consultancy Markit Eco- double digit levels of recent decades. The World nomics, validates the trend dating back to 2006.

Annual China Output Growth by Sector, 2002–11 (Percent Change)

18% Industry 16% Services 14%

12%

10%

Percent Change in Output Growth by Sector 0% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: Asian Development Bank; analysis by Bay Area Council Economic Institute

HSBC China Composite Output PMI

50 = no change on previous month, S.Adj. Increasing rate of growth 60

Increasing rate of contraction 40 2006 2007 2008 2009 2010 2011 2012 2013 Sources: Markit, HSBC

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Responding to the global recession, a USD easy credit, aided by a record expansion of the 585 billion stimulus introduced by the Chinese monetary supply. Taken together, these policies government in November 2008 included tax helped insulate China from the more severe ef- rebates in labor-intensive sectors, increased fects felt in Europe and the United States, though bank lending to small businesses, lowered taxes as will be seen below, there have been other on home sales, and large-scale financing for job- domestic consequences. creating infrastructure projects. At the same For the longer term, Beijing’s drive to sustain time, the government announced multiple in- economic growth is apparent in two other sets of terest rate cuts, and state-owned banks pumped numbers: population and labor force. money into the economy with fresh loans and

China Population Growth, 2006–2012 (Billions)

1.5 1.4 Urban Population Non-Urban Population 1.3 1.2 1.1 1.0 0.9 0.8 0.7 52.6% 0.6 49.9% 51.3% 45.9% 47.0% 48.3% 0.5 43.9%

Population in Billions 0.4 0.3 0.2 0.1 0.0 2006 2007 2008 2009 2010 2011 2012 Source: Asian Development Bank; analysis by Bay Area Council Economic Institute

China Labor Force Growth, 2006–2012 (Millions)

2006 2007 2008 2009 2010 2011 2012 Labor Forcea 763.2 765.3 770.5 775.1 783.9 785.8 788.9 Employedb 749.8 753.2 755.6 758.3 761.1 764.2 767.0 Agriculturec 319.4 307.3 299.2 288.9 279.3 265.9 257.7 Industryd 188.9 201.9 205.5 210.8 218.4 225.4 232.4 Servicese 241.4 244.0 250.9 258.6 263.3 272.8 276.9 Unemployedf 8.5 8.3 8.9 9.2 9.1 9.2 9.2 Source: Asian Development Bank/National Bureau of Statistics a. Active population aged 16 and over who are capable of working, are participating in, or willing to participate in economic activities, including the employed and unemployed. b. Persons engaged in social labor and receiving remuneration payment or earning business income. c. Primary industry that includes farming, forestry, animal husbandry, and fishery. d. Secondary industry that includes mining and quarrying, electricity, gas and water, and construction. e. Tertiary industry that includes hotel and catering services, and other services. f. Urban areas only.

4 China’s Economy

First, urbanization is driving growth. Since dried up, were left stranded in coastal cities with 1979, China has seen the largest rural migration no access to new state-allocated jobs, housing, to cities in human history. At the end of 2012, social services or education. Many, who had been China’s National Bureau of Statistics reported trained for specific factory jobs, had no choice that 263 million rural residents had migrated to but to return home. cities within or outside their provinces—roughly The government has promised gradual the equivalent of the U.S. population. China’s household registration reform beginning in late urban population reached nearly 712 million, up 2013, allowing rural migrants to establish resi- 21 million from the previous year, which pushed dency in smaller cities. One obstacle is that the percentage of urban dwellers in 2012 to 52.6 local governments bear most of the $400 aver- percent of the total population. age cost per year per new resident, yet they This massive shift will continue, with another have little taxing authority to generate new 200 million Chinese expected to move into cities revenue. As a result, cities have been reluctant to by 2025. The economic, social and environmental issue registrations. implications will be profound—with growth in Aggressive stimulus spending also created is- incomes, markets, and emissions. sues. Much of it went to state-owned enterprises Growth is also shifting from China’s well- (SOEs) where it could be monitored and distrib- developed Tier 1 and coastal cities (such as Bei- uted quickly. But SOEs only account for 20 percent jing, Shanghai and Guangzhou) to Tier 2 and of total employment, so the benefits were damp- Tier 3 cities in the interior. The Economist Intel- ened. In addition, ligence Unit reports that while growth in the  small businesses that accounted for most job most developed cities and coastal provinces has growth could not access credit easily; recently been in the 7.2–7.4 percent range, cit-  stimulus funds were often spent on projects ies and provinces in central and western China without receiving adequate review; are growing at double digit rates: 10.1–13.6  bad projects piled long-term debt onto percent. This reflects both Chinese government provincial and local government balance policy to encourage more balanced growth sheets; and between coastal and inland centers and a shift  stimulus channeled into securities and of manufacturing and other investment to cities property, driving development and creating where growth is accelerating and labor is asset bubbles. cheaper and more abundant. This shift of eco- Real estate, which is China’s leading source nomic activity inland has been enabled by the of wealth and contributor to demand, is an im- government’s large-scale investment in infra- portant economic bellwether. The Wall Street structure—highways, rail, ports, river freight Journal reports that at the end of 2012 China transport systems, and airports—that has helped had more than 4 billion square meters of resi- attract manufacturing to cities like Chengdu, dential property under construction, enough to Wuhan, Zhengzhou and Chongqing. meet estimated demand for four years without Second, as China’s urban population has any new construction. As a result, construction grown, its labor force has shifted from agriculture slowed in 2013, impacting global markets for to industry and services, much of that employ- raw materials such as steel and cement, as many ment tied to exports and manufacturing and developers sold down inventory. The govern- serving an emerging urban middle class. The ment has attempted to curb speculation— transition has not been seamless. While the gov- through taxes on profits from home resales and ernment has encouraged migration to reduce higher down payments and mortgage rates for rural-urban wealth inequality, it has left in place second home buyers. Cities have also tried to the old 1958 hukou household registration sys- tamp down speculation with curbs on the pre- tem aimed at regulating rural-urban workforce sale of new units. With credit readily available, mobility. Some 23 million migrant workers with however, and homebuyers fearful of rising costs, rural registrations, laid off in 2009 as exports housing prices in major cities continue to rise.

5 Ties That Bind, 2014 Edition

Longer-term forces also pose economic from Hong Kong and Taiwan to the mainland challenges. decades earlier. China’s labor market is changing. The Higher wages + higher prices = higher infla- workforce, now approaching 800 million, is tion. Inflation is a perennial concern. Consumer growing more slowly each year than in the past and producer prices have been volatile in recent and is forecast to begin declining in 2015, as years, surging in 2007–08; falling off dramatically China’s one-child policy brings fewer young peo- as economic activity stalled in 2009; then rising ple into the labor pool and as workers retire as sharply again until the second half of 2012. For the early as age 55. An aging population and grow- whole of 2012, CPI rose just 2.6 percent, coming competition for workers from the service pared to a 2011 year-on-year increase of 5.4 per- sector are leading to labor shortages, pushing up cent. Higher prices for food, housing, consumer industrial wages. goods and services have led CPI gains. CPI for Rising wages and production costs are the first half of 2013 grew at an annualized rate of pricing out some low-end manufacturing. 2.4 percent. Government investing and bank lending has Debt is an issue. Though still considered man- increased job opportunities throughout the coun- ageable, the surge of spending that grew out of try, but skilled, high-productivity workers are China’s 2008–09 stimulus program has increased in short supply. Protests over wages and work- China’s domestic debt-to-GDP ratio (estimated ing conditions at contract manufacturers have at 180–200 percent of GDP) and impacted its forced change. credit rating. Banks and local governments that The role of unions as employee advocates has embarked on large scale spending projects are strengthened; a 2008 law requires formal labor particularly burdened. contracts with employees that meet minimum In 2011, China’s National Audit Office found wage, benefit and workplace standards, although that local governments had accumulated debts the minimum wage was frozen in most areas of of RMB 10.7 trillion, equivalent to 26.5 percent the country in 2012 due to the slowing economy. of GDP. Other estimates, however, run as high Private sector wages grew by 14 percent in as 60 percent. (The figure in the U.S. is 18 per- 2012, according to the National Bureau of Statis- cent). While the central government probably tics, reflecting increases of 16.3 percent for rural has the resources to backstop the debt to pre- workers, 12.5 percent for urban workers and 11.8 vent a crisis, concerns are growing about impli- percent for migrant workers. While these figures cations for growth. represented a slowing from 2011, wage growth The banking sector is also vulnerable. While has diminished China’s competitiveness as an the level of non-performing loans at Chinese offshore manufacturing center, particularly when banks is officially low—below 1 percent—the compared to lower cost counties such as Vietnam growth of lightly-regulated off-balance-sheet or Indonesia. financing devices (shadow banking through Chinese government sources suggest that as trusts and other wealth management products) many as one-third of Chinese manufacturers of has raised concerns about China’s financial low-end products such as shoes, textiles and transparency and its potential vulnerability to garments have moved all or part of their pro- financial disruptions. duction outside China, primarily to Southeast The yuan is up 27 percent since 2005. Until Asia. While this reflects government policy to en- 2005, the yuan had been pegged to the U.S. courage Chinese companies to move upscale to dollar at an exchange rate of 8.277. At that point, produce more advanced, higher-value-added pro- China began a “managed float” of its currency ducts, it also reflects the reality of rising wages, that has since accelerated. thin profit margins, and increased competitive At the end of 2012, the exchange rate had pressures faced by China’s traditional manu- fallen to 6.230, with an average 2012 exchange facturing base. These pressures mirror the forces rate of 6.309; at the end of June 2013 the rate that drove the large-scale shift of manufacturing was 6.137.

6 China’s Economy

Exchange Rates: Yuan per U.S. Dollar 2004 2005 2006 2007 2008 2009 2010 2011 End of period 8.277 8.070 7.809 7.305 6.835 6.828 6.623 6.301 Average of period 8.277 8.194 7.973 7.608 6.949 6.831 6.770 6.461 Source: Asian Development Bank

Measured on an internal real exchange rate provides a broad strategy for addressing the (IRER) basis that also tracks prices of goods and problems described above and taking China’s services that cannot be imported or exported, the economy forward through 2015. rate has risen by 35 percent. Before the managed The Five-Year Plan begins by identifying 10 float was allowed, early estimates were that the factors that threaten continued development of yuan had been undervalued under the peg by as the economy: much as 40 percent, but with its recent deprecia-  resource constraints, particularly in energy and tion it does not appear wildly out of alignment. raw materials In political terms, the exchange rate poses an  a mismatch in investment and imbalance ongoing challenge for both China and its trading in consumption partners, which have accused China of keeping  income disparity the yuan artificially undervalued to effectively  weak capacity for domestic innovation subsidize exports. With exports slowing, China  a production structure too heavily weighted has an interest in keeping the yuan undervalued toward heavy industry relative to services and interest rates low, to encourage investment  an inadequate and declining agriculture sector in infrastructure and property development and  lack of coordination between urban and support employment in construction. But the rural development strategy also discourages consumption and favors  an imbalanced employment system saving by eroding purchasing power.  worsening “social contradictions” leading Is the economy rebalancing? The savings, in to unrest turn, have often been misallocated by the big-  persistent obstacles to scientific development gest, least efficient borrowers—public projects that are difficult to remove designed to bolster cities and provinces’ pres- In response, it sets a series of targets to be tige. SOEs alone account for 35 percent of completed during the 2011–15 period: China’s total business investment; local government debt equals 20 percent of China’s GDP. Economy Rating agency Fitch reports that lending ex-  a 7 percent average annual GDP growth panded over 2008–10 from 122 percent of GDP to  at least 45 million jobs to be created in urban 171 percent. China’s impressive savings rate, at 52 areas, with a 4 percent increase in the urbani- percent in 2011, provides a helpful cushion for zation rate to 51.5 percent of the population Chinese banks, and the government’s large foreign  service sector value-added output to increase reserves provide added security against serious from 43 percent to 47 percent of GDP; coastal financial disruption. But recent trends highlight the regions to transition from traditional manu- difficulty of rebalancing the economy toward re- facturing to hubs for R&D, advanced manu- duced reliance on exports and fixed investment facturing and services and increased reliance on consumption.  research and development spending in seven target sectors—energy efficiency and The 12th Five-Year Plan environmental protection; next generation information technology; biotechnology; In March 2011, the National People’s Congress advanced equipment manufacturing; new and the Communist Party of China (CPC) formally energy; new materials; and new-energy adopted China’s 12th Five-Year Plan. The Plan vehicles—to account for at least 2.2 percent

7 Ties That Bind, 2014 Edition

of GDP; value-added output of emerging China’s government faces conflicting pres- strategic industries to account for 8 percent of sures as it attempts to restrain runaway credit, GDP by 2015 (up from 3 percent in 2010) but at the risk of further dampening a slowing  transformation of the economy from an ex- economy. The rebalancing of China’s economy port focus to a balance of exports, imports away from its historic focus in fixed investment and domestic consumption; from a reliance and export dependence, and toward increased on foreign technology to domestic innova- domestic consumption, has been identified by tion; and from traditional to low-carbon/new Chinese leaders as critical to future growth and materials industries stability. For that to occur, more financial resources will need to be directed away from in- Environment/Energy frastructure and state-owned enterprises and  a 30 percent cut in water consumption toward consumers and private enterprises. In-  a 16 percent cut in energy consumption per creased consumption will require continued unit of GDP, and a 17 percent cut in carbon wage growth, which will be hard to sustain with- dioxide emissions out increased productivity. This is one factor  non-fossil fuel use to increase to 11.4 percent behind government policies to accelerate in- of primary energy consumption, with hydro- digenous innovation. power to account for more than half of that Change doesn’t come easily, however, even total by 2020 with the government’s extensive policy tools. In  reforestation projects aimed at increasing both 2012, the share of fixed investment in China’s forest coverage and stocks GDP rose to 46.1 percent from 45.6 percent in Agriculture 2011; at the same time, the share accounted for  minimum grain production of 540 million by household consumption was flat at 35.7 per- tons annually cent, as reported in The Wall Street Journal. In the first half of 2013, household consumption’s Investment Reform contribution to GDP growth fell significantly  agriculture, high-tech and environmental pro- compared to the same period in 2012, while tection sectors opened to foreign investment investment’s contribution to GDP growth rose—  qualified enterprises to be encouraged to suggesting a continued trend. At this writing, list on stock markets; reform monopoly in- China appears to be sustaining growth using dustries to achieve easier market entry and traditional levers. The shift to greater consumer- increased competition led growth is still a strong bet but is likely to Livelihood take years.  population to be capped at 1.39 billion; one- As China’s economy continues to mature, the year increase in average per capita life span days of double-digit annual growth are unlikely to  36 million apartments for low-income families return. But while it faces significant near and long- to be constructed or renovated term challenges, China continues to present a  per capita income to be increased to $10,000 large and growing market, and with that, important by 2020; 13 percent average annual increases opportunities for economic exchanges in fields in the minimum wage through 2015 where Bay Area companies, institutions, entrepre-  pension plans to be extended for all rural neurs and investors excel—agriculture, life sci- residents and 357 million urban residents; ences, clean energy technology, environmental publicly-funded healthcare services to be protection, cloud computing and 4G mobile Inter- expanded to ensure basic coverage net, and entrepreneurship to name only a few.

2. THE BAY AREA CHINESE COMMUNITY Beginnings

The first Chinese immigrants in California were Chinese Communities two men and a woman, arriving on the brigantine Eagle on February 2, 1848, and brought over as Take Shape servants for the family of C. V. Gillespie, a San As early as 1849, Chinese merchants in San Fran- Francisco merchant and importer from China. cisco formed a gongsi, or association, to mediate The following year, merchant ships calling at disputes within the Chinese community, facilitate Canton brought news of gold discovered in Cali- commercial dealings with outside interests, and fornia. Overpopulation and famine in China after participate in civic events. From 1851–54, six be- the Taiping Rebellion prompted families to send nevolent associations were formed representing young men abroad to earn money. Most of the immigrants from particular districts within Guang- arrivals were from rural areas in the Pearl River dong Province. These associations offered aid with Delta of Guangdong Province: of the estimated the immigration process, housing and local cus- 47,000 Chinese immigrants on the West Coast in toms. They lent money, helped start businesses 1860, fewer than 600 were women. Shipowners and represented Chinese interests in countering promoting Gam Saan, “Gold Mountain,” as a discrimination. Churches with missionary ties to land of opportunity were eager to attract passen- China taught English to parents and children. gers traveling “steerage” in cramped quarters Family associations were established (including below decks. The voyage to San Francisco took protective societies known as tongs), along with a 45 days and cost $55. separate benevolent society to arrange medical Many Chinese immigrants traveled to the U.S. care and lend money for return to China or to ar- under labor contracts with merchants in China or with American middlemen who solicited them range burial of remains in China for the elderly. In and arranged their passage. They worked as ser- 1862, a kung saw, or neutral public association, vants, cooks and waiters, and in laundries and was formed to settle disputes among associations. cigar or shoe factories. But contracts often Out of this business and commercial network, the proved unenforceable and many laborers ended Chinese Six Companies were formed in 1882. up mining or prospecting on their own in the From the 1850s on, the Bay Area Chinese Sierra foothills. community was a significant contributor to local In later years, Chinese laborers made up most economies. The dozen or so square blocks that of the workforce laying track for the San Jose formed San Francisco’s Chinatown spread out Railroad, the California Central Railroad from from the Long Wharf that linked the financial dis- Sacramento to Marysville, and the transconti- trict and northern waterfront, with its restaurants, nental California Pacific Railroad from Sacramento residential hotels and small factories. In the to Promontory Point, Utah. They also were in- 1870s, Chinese fishermen came to dominate the strumental in constructing levees in the Sacra- shrimping industry, with more than 20 camps mento River Delta area that later enabled the along the section of southeast San Francisco wa- large scale development of agriculture in the terfront now known as Hunter’s Point, and on the Sacramento Valley. San Rafael estuary that is still called China Camp.

9 Ties That Bind, 2014 Edition

This illustration, showing customs officers inspecting belongings of Chinese immigrants as others enter the room from a ship, appeared on the Feb. 3, 1877 cover of Harpers Weekly, entitled “Chinese Immigrants at the San Francisco Custom-House.”

In 1870, 24 percent of Chinese immigrants in San Francisco labor solidarity rally into three nights the U.S. resided in the Bay Area; by 1900 that of anti-Chinese rioting. percentage had nearly doubled to 45 percent. Congress subsequently passed the 1882 Immi- Chinatowns became fixtures in San Francisco, gration Act, also known as the Chinese Exclusion Oakland, San Jose, Sacramento and Stockton. In Act, barring U.S. entry for Chinese laborers en- the East Bay, Chinese laborers worked in factories tirely, and allowing in merchants, their servants and and on dam projects and sold fruit and vegeta- families, diplomats, travelers, teachers and stu- bles in Oakland’s five Chinatowns. dents, but prohibiting them from obtaining citizen- During this time, discrimination against Chinese ship. The Act remained in effect until 1943. immigrants—centering mainly on jobs—was an unfortunate reality. Calls for tougher enforcement The 1906 Earthquake of labor contracts, a head tax on foreign miners and outright immigration curbs were all beaten Chinatown was among the areas of San Francisco back, but each time by smaller margins. Economic totally destroyed during the earthquake and fire of depression in the 1870s, speculative investing and April 18, 1906. The earthquake proved both a drought cost many Californians both fortunes and blessing and a curse, producing a more permanent jobs, providing a tipping point that turned an 1877 and resilient Chinese community and offering a

10 The Bay Area Chinese Community way around the Chinese Exclusion Act. Denied any Bay Area exports to China grew from $2.6 mil- form of government relief, thousands of Chinese lion in 1894 to $8.7 million in 1906, according to fled the city in the aftermath of the earthquake. Chamber of Commerce reports. The San Francisco Most came to Oakland, where Lew Hing, himself a Chamber of Commerce lobbied the McKinley ad- refugee from the quake, opened the two city ministration to make it easier for Chinese mer- blocks of his Pacific Coast Canning Co. to the new chants to enter the United States. San Francisco arrivals. He provided food, tents and medical at- shipping and lumber magnate Robert Dollar led tention to those in need. Later, to help finance the the first business delegation to China in 1910 at rebuilding of San Francisco’s Chinatown commu- the urging of the Chinese Chamber of Commerce, nity, he partnered with merchant Look Tin-eli to “to create and increase the friendly feeling be- establish the Bank of Canton in 1907. A year later, tween China and the United States, and to in- it was the principal bank for 100,000 overseas Chi- crease our commerce.” nese in the U.S. and Mexico. Lew Hing, Look Tin-eli, the Six Companies and various family associations were instrumental in The Immigration Profile Chinatown’s reconstruction. Heading off efforts Changes by City Hall to condemn and raze Chinatown after a false bubonic plague scare, Look brokered con- Bay Area Chinatowns flourished in the decades struction of pagoda-style replacement buildings, that followed, home to thousands of small busi- by Irish contractors and workers, that helped nesses with their own newspapers, telephone make the city-within-a-city a permanent landmark. exchanges, banks, theaters and opera houses. One benefit for Chinese immigrants arising Angel Island Immigration Station, on San Fran- from the 1906 earthquake was the destruction of cisco Bay, served from 1910–40 as the country’s most San Francisco citizenship and residency re- principal entry point for Chinese immigrants. De- cords. Prior to 1906, the Chinese Exclusion Act had spite practices subjecting applicants to aggressive restricted travel between China and the U.S. to interrogations, medical examinations, separation of specific exempt classes of immigrants, primarily families and detention averaging two to three merchants and families of citizens. After, the West weeks but in some cases as long as two years, over Coast saw a spike in immigration applications from 175,000 Chinese immigrants were processed be- young men known as “paper sons,” most claiming fore the eventual repeal of the Exclusion Act. to be children of citizens. A 1965 overhaul of U.S. immigration policy, fueled in part by Cold War tensions, began to reshape the Bay Area Chinese community in im- Two-Way Trade Grows portant ways. Steel, oil and textile producers formed the The Immigration and Naturalization Act of American-Asiatic Association in New York in the 1965 eliminated the previous Eurocentric coun- 1890s, lobbying President McKinley to enforce an try quota system, and permitted more skilled “open door” China trade policy. Their target was workers and family members from around the a vast China market of as many as 400 million world to enter the U.S. At the same time, a flood people, where European and Japanese com- of some 5 million Chinese refugees displaced by petitors were trying to establish exclusive trade the Cultural Revolution had crossed into then- concessions and port leases. British Hong Kong, which had no way to absorb Some 30 percent of U.S. imports from China them. Across the Taiwan Strait, conflicts rou- and 17 percent of U.S. exports to China moved tinely flared between Beijing and the Kuomin- through the Port of San Francisco in 1898. North- tang (KMT) government of General Chiang Kai- ern California exported large volumes of agricul- shek—which maintained its claim to be the tural products and lumber to China, and Northern rightful government-in-exile of all China. The California companies introduced milled flour and KMT, in a constant state of siege at that time, kerosene heating oil to the Chinese market. had become autocratic and its economy had

11 Ties That Bind, 2014 Edition stalled. While Bay Area Chinatowns were mostly an insurance policy in case political instability made up of Cantonese-speaking rural immi- forced the family to pull up roots in future. grants from Southern China, there was also a Hong Kong arrivals set up traditional busi- KMT affinity dating back to the early 1900s. nesses, such as restaurants and laundries, but they Many Chinese immigrants had returned home also assimilated to a greater degree than preced- after the 1906 earthquake, seeking work oping generations, buying property, becoming doc- portunities and relief from persecution, during tors and lawyers, opening insurance offices and the relatively peaceful, prosperous KMT rule of accounting practices, and working for Bay Area Dr. Sun Yat-sen. companies. Taiwanese students gravitated toward In the 10 years following passage of the Immi- science, engineering, mathematics and business. gration and Naturalization Act, the Chinese com- None of these new immigrants fit well into munity in the U.S. nearly doubled. Many skilled the established Chinatowns that were designed business owners and professionals left Hong Kong. as insular communities of tiny apartments built Young Taiwanese arrived initially as students, for unskilled workers with no families. The new sent to eventually establish a business foothold in arrivals, over time fluent in English, moved out the United States. Family-owned companies typi- into the residential neighborhoods of San Fran- cally dispatched their eldest sons to learn about cisco, Oakland, San Jose and beyond, joining new technologies and processes. They were of- and adding to the cultural fabric of the wider ten set up in homes, on a path to a green card, as Bay Area community.

3. CHINESE STUDENTS AT BAY AREA UNIVERSITIES Land of Opportunity

Chinese students have made a critical contribution ecosystem, launching start-ups, redeploying to technology innovation and economic growth in wealth as angel investors, widening access to the the Bay Area over the past three decades. China market, and giving back through endow- Since the late 1980s, the best and brightest ments and participation in alumni networks. students emerging from mainland China’s tech- But changing demographics in China are be- nical universities with undergraduate degrees in ginning to alter the mix of students arriving in the science, technology, engineering and mathe- region, with significant implications for the new matics (STEM) fields have gone abroad to com- arrivals, the institutions they attend, and the Bay plete their education, with the U.S. and California Area’s innovation ecosystem. among their top destinations. Before them, a wave of Taiwanese science and engineering Numbers Tell the Story students arrived in the early days of personal computing and networks, as Taiwan was build- An emerging urban Chinese middle class with ing its reputation as a leading global original rising household incomes, property ownership equipment manufacturer. and a near 50 percent savings rate has enabled Chinese and Indian graduates formed much families from Tier 2 and Tier 3 cities in China’s of the talent pool for Silicon Valley innovation interior, and from rural areas, to self-fund their throughout the 1990s, moving from basic com- children’s study abroad—an opportunity further puting and networks to the Internet, mobile aided by China’s one-child policy. It is a trend communication and social media. that has both increased the number and altered Graduates in STEM fields have become an in- the mix of students arriving in California and the tegral part of an emerging cross-border innovation Bay Area.

Exchanging Students

250,000

U.S. students at PRC schools 200,000 PRC students at U.S. schools Note: U.S. figure for 2012–2013 not available 150,000

100,000 Number of Students

50,000

0 2004–05 2005–06 2006–07 2007–08 2008–09 2009–10 2010–11 2011–12 2012–13

Source: Institute of International Education

13 Ties That Bind, 2014 Edition

The number of students from greater China at formula for per-student expenditures in that year, U.S. colleges and universities grew from about those students contributed some $218.9 million 95,600 in 2004–05 to more than 225,300 in 2011– to the state and regional economies. 12. By contrast, U.S. students studying abroad in Leading fields of study by Chinese students greater China grew during that time from about have remained fairly constant over time: busi- 7,300 to more than 17,100; with most studying ness and management; engineering; mathe- over a summer or semester, not in a degree pro- matics and computer science; economics; and gram. The People’s Republic of China (PRC) sent physical and life sciences. Since the global no students to the U.S. until 1974. By 1988 it was downturn, however, emphasis has gradually the leading country of origin for foreign students shifted from STEM fields to business and eco- and has held the number one or two position nomics, particularly among undergraduates. since. In the 2004–05 academic year, the PRC A variety of factors—the bursting of the tech sent 62,523 students to the U.S., according to the sector bubble in 2000–01, post-9/11 visa restric- Institute of International Education (IIE). By 2012– tions, reduced foreign travel due to the SARS and 13, the number had more than tripled to 235,597. avian flu scares, and recruitment competition Numbers of Taiwanese students in the U.S. from U.K., Canadian and Australian universities— peaked in 1993–94 at about 37,500; they fell contributed to a slowing in Chinese student en- from just under 26,000 in 2004–05, to just over rollment from 2002–05. But those numbers have 23,000 in 2011–12. Hong Kong students peaked expanded each year since then; the number of in 1992–93 at just over 14,000, leading up to the PRC students has tripled. 1997 handover of the British territory to China. By The mix of students by academic level is sig- 2004–05, Hong Kong enrollments had dropped nificant: a fairly constant 54 percent of Taiwanese by half to just over 7,100 and in 2011–12 they students apply at the graduate level, while 70 stood at about 8,000. percent of Hong Kong students have been un- IIE reported 75,000 international students in dergraduates. But while PRC undergraduate and California for AY 2004–05, with a combined 18 graduate students have both grown in absolute percent, or 13,600 students, from greater China. In numbers, IIE data reveal a dramatic shift: under- 2012–13, over 111,000 foreign students enrolled in graduates as a share of total PRC students have the state, with 28.7 percent from mainland China, grown from 31 percent to 38 percent since 2010, 4.6 percent from Taiwan and a smaller share, per- while the graduate share has declined from 52 haps 2–3 percent, from Hong Kong. This suggests percent to less than 46 percent. that about a third of total foreign students in Cali- Graduate schools nonetheless continue to see fornia—almost 37,000—are from greater China. significant Chinese student enrollment. Annual A survey of leading Northern California aca- surveys of schools nationwide by the Council of demic institutions by the Bay Area Council Eco- Graduate Schools show PRC applications up by nomic Institute in 2006 indicated that more than an annual average of 20 percent over 2010–12, 5,500 graduate and undergraduate students with the highest percentage growth in applica- from mainland China, Taiwan and Hong Kong tions at schools in the western U.S. were enrolled at Bay Area colleges and universities during AY 2004–05. Those students contrib- Education as an Investment uted an estimated $149 million annually to the state and regional economies in tuition, living The U.S., and California in particular, are a draw expenses and discretionary spending. for Chinese students. Higher education is viewed Updated figures developed by the Economic as key to career opportunities for the country’s Institute, in combination with IIE data, suggest burgeoning middle class. In the past 10 years, that the number of students from greater China Chinese universities and polytechnic schools have enrolled in Bay Area colleges and universities seen growing enrollment, today turning out some grew to some 7,000 in 2011–12. Using IIE’s 8 million graduates annually. But rapid expansion

14 Chinese Students at Bay Area Universities of the system has led to uneven quality. Classes families from all walks of life are saving, borrow- often focus on lectures and rote learning, with ing or selling assets to send children to school little interaction between student and professor abroad. Here the Bay Area enjoys a number of or collaborative learning among students. advantages—shorter travel time, fewer time Middle-class families aspiring to greater edu- zones, one of the largest Chinese communities cational opportunities for their children are often outside of China, world-class universities and an at a disadvantage in the competition for spaces educational focus on critical thinking, and col- at better schools at home; most high schools are laboration and innovation that extends into an boarding schools that charge for tuition, books, entrepreneurial business culture. The 2013 Aca- exams and added tutoring. English proficiency is demic Ranking of World Universities, conducted required for the national exams that decide uni- by Shanghai Jiao Tong University, places Stan- versity acceptance and English teachers are in ford and Berkeley as number two and three out short supply. Parents often lack the education of 500 institutions rated, strengthening the ap- needed to help children with their studies. Ironi- peal of the region for families seeking prestig- cally, children scoring lower on the national ex- ious institutions. ams are typically channeled into lower-quality, Rising tuition costs at California schools have three-year polytechnic schools that can cost up to not, so far, put them at a serious disadvantage twice the tuition and fees of elite schools because in the competition for students; a weaker dollar they receive less in government subsidies. has helped offset rising costs, and although fi- This creates a perverse set of incentives for nancial aid is less available, it is estimated that families. Facing a more costly, less competitive fewer than 10 percent of international students outcome for a son or daughter at home, Chinese receive scholarships.

Chinese Students at UC Berkeley, 2006-11 (by Place of Origin)

1,100 Hong Kong 1,000 Taiwan 900 PRC 800

700

600

500

400 Number of Students 300

200

100

0 2006 2007 2008 2009 2010 2011

Source: U.C. Berkeley; analysis by Bay Area Council Economic Institute

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Chinese Students at UC Berkeley, 2006-11 (Undergraduates and Graduates)

900 Undergraduate 800 Graduate 700

600

500

400

300 Number of Students 200

100

0 2006 2007 2008 2009 2010 2011

Source: U.C. Berkeley; analysis by Bay Area Council Economic Institute

Chinese Students at UC Berkeley, 2006-11 (Percent Share of Total Intl. Students)

24% Hong Kong 22% Taiwan 20% PRC 18% 16% 14% 12% 10% 8% 6% 4% Share of International Students 2% 0% 2006 2007 2008 2009 2010 2011

Source: U.C. Berkeley; analysis by Bay Area Council Economic Institute

Student Trends share of the student population since 2006, while enrollments from the PRC have A survey of Bay Area universities mirrors the increased steadily. Chinese student enrollment trends reflected in  PRC undergraduate enrollment is up sharply national figures: relative to graduate applicants.  Taiwan and Hong Kong students have  A growing share of those undergraduates comes remained relatively constant in number and from Tier 2 and Tier 3 inland cities in China.

16 Chinese Students at Bay Area Universities

Chinese Students and Scholars at Stanford University

800 Undergraduate Non-Matriculated Students 700 Graduate Post-doctoral Scholars on J Visas* 600

500

400

300

200 Number of Students/Scholars 100

0 2005–06 2008–09 2011–12

Source: Stanford University *Includes post-doctoral students, research associates, faculty and staff on H visas(135 as of January 1, 2012).

 Principal areas of study have diversified either as freshmen or as transfers—double the beyond the STEM fields, primarily into number enrolled in 2010. business and economics. In all, nearly 800 Chinese students attended UC Berkeley data shows that the overall num- UC Davis in 2011—about 560 from the PRC, 121 ber of students enrolled from greater China has from Hong Kong and 101 from Taiwan. The 225 grown in every year but 2007, from 567 in that enrolled Chinese undergraduates each pay non- year to 1,301 in 2011. The numbers of Taiwan resident tuition of $38,000 annually, according to and Hong Kong students have increased mod- a report in the Sacramento Bee; add in living ex- estly from relatively small bases. penses, insurance, healthcare and other costs, At Stanford University, the numbers have been and the total can reach $54,000. The number of different, with continued emphasis on graduate undergraduates at Davis has increased ten-fold and post-doctoral students, primarily in the sci- since 2007. By contrast, Peking University costs entific and engineering fields. the equivalent of $950 per year; even at prestig- UC Davis, with its emphasis on agriculture, ious Chinese universities the quality of education medicine (including veterinary medicine) and en- is not considered as good as it is in better U.S. gineering, has been a strong draw for Chinese schools—classes are large and consist mostly of students, as China grapples with feeding and lectures, with grades heavily dependent on final providing adequate healthcare for its people. exams and little opportunity for student collabo- More than 20 percent of the 2,481 interna- ration or interaction with professors. tional graduate students entering Davis in 2011— For 2012, San Francisco State University 555 students—were from greater China. About (SFSU) reports 1,542 degree-seeking interna- 30 percent (or 160) of those students were en- tional students from 90 countries. Of those, 670 rolled in the College of Agricultural and Environ- are from greater China—560 from the PRC, 58 mental Sciences. Another 109 studied medicine, from Taiwan and 52 from Hong Kong. While the 105 studied engineering and nearly 60 others numbers of Taiwan and Hong Kong students studied biology and veterinary medicine. Davis have fallen modestly but steadily from 2003, the also enrolled 150 undergraduates from China, numbers of PRC students have steadily increased.

17 Ties That Bind, 2014 Edition

It should be noted that the Chinese student hope will either result in a better job back home profile at SFSU is different from other schools; it or enable them to run the family business. is made up primarily of children of immigrants The competition for international undergradu- and is overwhelmingly undergraduate. Thus, the ate students has also created market opportuni- relative changes in the SFSU Chinese student ties for new players. In 2010 and 2011, for exam- population may have more to do with the ple, the for-profit Academy of Art University in changing demographics of the previous genera- San Francisco made the Institute of International tion of arrivals and their families than with new Education (IIE) Top 5 list of academic institutions students coming directly from China. accepting international students in California, This fast-growing undergraduate cohort ex- with more than 4,400 foreign students enrolled in tends throughout Bay Area campuses, with 2012, all in the Bay Area. IIE does not break important implications. down state totals by country of origin, but apply- Schools such as Stanford, Berkeley, UCSF and ing the combined statewide share of students Davis have strong specializations that attract from the PRC and Taiwan, 26.8 percent, it is rea- graduates pursuing advanced degrees, and they sonable to extrapolate that as many as 1,000 have seen their student profiles remain relatively Chinese students—many of them children of im- constant. For example, Stanford accepts interna- migrants, as in the case of the CSU system—may tional undergraduates, but the numbers are attend the Academy’s various campuses. small; most students from China are still graduate-level and heavily concentrated in the science, Unintended Consequences technology, engineering and mathematics fields. International students make an increasingly im- It is at institutions like the University of San portant contribution to cash-strapped university Francisco (USF) that the demographic changes budgets nationwide, paying tuition rates that are can be seen in sharpest contrast, reflecting trends typically twice the in-state level or more. Students at smaller private and public universities through- from China are especially welcome since the vast out the U.S. majority are self-funded and do not request fi- USF, a Jesuit university, draws on the religious nancial aid. But for students under intense pres- order’s long history and deep connections in sure to succeed, the rigors of higher education, in China dating back to the 16th century when Jes- a foreign country and a second language, are uit priests served as scientific advisors to the Im- taking a toll. perial Court and ran the Imperial observatory. Many newly-admitted Chinese undergraduates Jesuit schools, libraries, observatories and at USF are not as English-proficient as they should churches can be found throughout China today, be. Most are pushed by family to pursue a busi- particularly in and around Shanghai. ness degree but lack the verbal and comprehen- Those connections, plus USF’s location in San sion skills to follow the lectures and required Francisco and the reputation of its School of reading or collaborate on student projects. Management and Business, have attracted appli- Screening overseas applications is difficult, and a cants from China in large numbers. According to cottage industry of “placement agencies” in China USF managing director of China programs and charges families $5,000 or more to fill out applica- professor of management Stanley Kwong, of the tions, write essays and in some cases forge tran- 781 Chinese students now attending USF, some scripts and recommendation letters. Most students 600 are undergraduates. Nearly all of these un- cannot afford a preliminary trip to the U.S. for ori- dergraduates are business majors. Many are from entation and arrive days before classes begin; they Tier 2 and Tier 3 inland cities and provinces like do not know what to expect and schools are un- Qinhai, Yunnan, Chongqing or Anhui. They are able to do needs assessment. not elite graduates, but the children of an Many of these students are under intense finan- emerging middle class whose parents have put a cial pressure; often parents have sold property premium on a quality education abroad that they and/or cashed out savings to send them abroad.

18 Chinese Students at Bay Area Universities

On tight budgets, with inadequate language and Precise numbers are not readily available for social skills to navigate a foreign culture, many of the numbers of foreign undergraduates who these students rarely leave their dormitories. With- do not complete four-year programs (Korean out proper counseling or language support, a students have faced similar difficulties); growing number fall behind and even drop out. anecdotally the numbers are small but grow- At USF, international students pay annual tui- ing. Emmanuel believes the answer over time tion of $36,000 plus living expenses. The university will entail expanded counseling services and “conditionally” admitted a number of Chinese parallel English instruction throughout the school students with weak English language skills, to the year, but ramping up such programs has been point that they initially needed translation headsets a challenge. for their orientation. They have had difficulty A larger issue—especially for a public univer- keeping up in their courses and collaborating with sity—involves the broader demographic student other students. In response, the university has body makeup, as higher-paying out-of-state and been in talks with California State University offi- international students fill more admissions slots cials to partner on English-language course pro- relative to in-state students. grams for USF Chinese undergraduates, in return What happens after a student graduates has helping CSU market its less well-known Bay Area particularly important economic impacts. A July campuses in Asia. 2013 article in The Economist cites estimates Since the trend is relatively new, no concrete from the China Western Returned Scholars Asso- statistics on student success rates will likely be ciation that, of some 2.6 million Chinese students available before 2015. Stanley Kwong estimates going abroad to complete their studies since that 15–20 percent of the students he sees will 1978, some 1.1 million have returned to China— complete college in five years, given the extra suggesting that 1.5 million have not. time spent attaining language proficiency. An- Many students who have chosen to remain in other 5 percent will complete their four-year pro- the Bay Area have become successful technolo- grams in less time by taking on more than a full gists, entrepreneurs and investors, magnifying load of classes. About 80 percent of USF Chinese their contribution to the economy. Those that master’s graduates return to China; most under- return to China bring a Bay Area/Silicon Valley graduates stay on for graduate school. perspective and often serve as two-way bridges, At UC Berkeley, a public university, Interna- developing products and operating companies in tional Office director Ivor Emmanuel says successive years of budget cuts have reduced state both countries. For returnees, the transition may funding to only 11 percent of Berkeley’s budget. not always be easy. Recent “sea turtles” are As a partial response, the university has raised its finding a bleaker picture in China. Slower eco- admission target for non-resident students to 20 nomic growth has curtailed hiring, and returnees percent, half from out of state and half from out- face longer waits to land lower-paying positions. side the U.S. International students currently As a distinct, uniquely Chinese Internet emerges, make up about 9 percent of the student body. tech entrepreneurs with Silicon Valley back- A rising flood of undergraduate applications grounds can find themselves out of step with in- from China caught Berkeley off-guard; most Chi- digenous technology, applications and customer nese undergraduates apply as economics or tastes and have difficulty managing local engi- business majors—subject areas heavily depend- neers and programmers. ent on language skills—Emmanuel says. Entering Also, an overseas degree may no longer carry freshmen often are not able to make a separate the same cachet with Chinese employers, as top trip from China for orientation and so are at a students from leading universities are snapped up disadvantage when selecting and signing up for by global employers while students with less ap- classes. Once in class, they may have trouble titude or questionable degrees find employment following lectures and discussions. prospects weaker.

19 Ties That Bind, 2014 Edition

“Sticky” Students education has led more undergraduates to pursue study abroad; Why are such trends important? The absolute  just over half of immigrant founders from all numbers and growth rates for international stu- countries received their highest degrees from dents applying to Bay Area universities, the levels universities in the U.S., a list that included at which they apply and the subjects they pursue large and small, public and private institutions; are determinants in whether and how long they  of the immigrant founders surveyed, 52 per- stay on after graduating—to work, start new busi- cent initially came to the U.S. to study; nesses, form households and make a lasting contribution to the regional economy. 43 percent came as the result of a job oppor- In a 1999 report, “Silicon Valley’s New Immi- tunity; only 1.6 percent came with the intent to grant Entrepreneurs,” AnnaLee Saxenian, dean of start a business. UC Berkeley’s School of Information Manage- In a June 2012 report by the New York-based ment Systems (SIMS), found that more than 2,000 Fiscal Policy Institute, analysis of 2010 U.S. Cen- Silicon Valley technology firms had been sus Bureau data revealed that immigrant business launched by Chinese entrepreneurs, many of start-ups have grown by 50 percent over 1996– them graduates of Bay Area universities. Those 2011—from 12 percent to 18 percent of total companies accounted for $13.2 billion in annual small businesses in the U.S.—and that Chinese sales and nearly 42,000 jobs—17 percent of the immigrants alone account for more than 34,000 Valley’s high-tech economy at its peak. small businesses nationwide, nearly 5,000 of In a 2007 update to that study, “America’s those in STEM-related fields. Immigrant Entrepreneurs,” Saxenian and col- In his 2012 book, The Immigrant Exodus, Wad- league Vivek Wadhwa, Pratt School of Engineer- wha suggests that the flow of immigrant entrepre- ing executive-in-residence at Duke University, neurs to the U.S. and Silicon Valley may have further noted that peaked, as foreign graduates with advanced de-  of approximately 28,000 technology and engi- grees return home or are lured by incentives other neering firms launched during 1995–2005 na- countries offer. Wadwha contacted a sampling of tionwide, more than 6,000 were established in 2,042 companies nationwide and found that the California; proportion of immigrant-founded companies had  52 percent of the Silicon Valley technology slipped from 52.4 percent five years earlier to 24.3 and engineering firms launched during 1995– percent. Among the 335 companies surveyed in 2005 had at least one foreign-born key foun- Silicon Valley, the share was 43.9 percent. der, compared with 39 percent for California Immigration policy and recession have both as a whole and 25 percent nationwide; played a role in the decline. Wadwha’s overarching  in 2005, 33 percent of the tech population in point is that as other countries join the competition Silicon Valley was foreign-born; for highly-skilled global talent, including graduates  96 percent of the Indian, mainland Chinese with advanced degrees from U.S. institutions, the and Taiwanese founders interviewed nation- U.S.—and by implication, Silicon Valley—cannot wide held bachelor’s degrees, and 74 percent afford to take for granted its current leadership held graduate and post-graduate degrees, role in fostering global entrepreneurship: mainly in engineering, computer science and  Australia has an annual cap of 126,000 visas information technology, applied sciences and for skilled immigrants and their families— mathematics; comparable to the 140,000 limit in the U.S—  half of Chinese founders, and 55 percent of for a country with a population 10 percent the Taiwanese founders, had graduated from four size of the U.S.; regional governments can elite schools in the PRC and two on Taiwan; award preferences in special skill categories;  PRC government initiatives to expand univer- qualified international students can remain in sity enrollment have put stress on the higher the country for 18 months after graduating, education system, and the uneven quality of compared to 12 months for the U.S.

20 Chinese Students at Bay Area Universities

 Canada evaluates green card applicants complaints that small and mid-sized private based on age, education, work experience businesses are disadvantaged relative to state- and other factors using a points system; un- owned enterprises. dergraduate and graduate degree holders can A growing number of wealthy Chinese families get work permits to stay in Canada for up to are exploring the option of an EB-5 investor visa three years without first having a job; PhDs in (see “The EB-5 Advantage” in the Connectors STEM fields can begin the application process chapter), under which a minimum $5 million for permanent residency while still in school; investment in a job creating venture—either entrepreneurs with viable business plans can directly or through a government-approved obtain visas, even without prior funding. regional center investment entity—can lead to a  China’s National Medium- and Long-Term conditional visa in two years and permanent Talent Development Plan offers returning residence in five years, for as many as 10,000 graduates and entrepreneurs educated over- investors annually. A provision in the law allows seas generous cash bonuses, free or subsi- qualified EB-5 investors to enroll their children in dized housing and multi-year exemptions from college at in-state tuition rates. business taxes. Even many less well-off Chinese are willing to  Singapore offers skilled immigrants an Employ- gamble on a new life overseas, working as taxi ment Pass that allows them to work and later drivers, farmers, and fishermen or in restaurants. apply for permanent residency; spouses are al- China’s Ministry of Commerce reports that some lowed to work; under the EntrePass program, 800,000 Chinese nationals work abroad; extended an immigrant with a government-approved families pool funds to send a son or daughter to business plan and $50,000 in outside invest- school as a first step toward emigration. ment is granted a one-year pass to start a busi- Significantly, leading Bay Area schools such as ness, with visa renewals and even government Stanford, Berkeley or UCSF report that 90 per- matching funds in certain fields if the business cent of graduates with advanced degrees stay in is initially successful. the U.S., often in the Bay Area and California; While the lure of an overseas degree may be among Chinese students overall, the share who diminishing as a determinant of job and income stay on drops to an estimated 60 percent. prospects in China, affluent families of elite STEM Over the last decade, immigrant workers students still see benefits to an overseas degree, from mainland China have grown as a percent- and to the pursuit of opportunities abroad. An age of the Bay Area’s foreign-born workforce, October 2012 New York Times article highlighted especially in science, technology, engineering a growing trend of professionals emigrating from and math (STEM) occupations. Between 2000 China, citing Organization for Economic Coopera- and 2011, Chinese immigrants increased from 8 tion and Development (OECD) data that 508,000 percent to 10 percent as a share of foreign-born Chinese nationals moved to the 34 OECD coun- workforce. In STEM occupations, Chinese work- tries in 2010—up 45 percent from 2000. ers increased from 8 percent to 13 percent of In 2012, U.S. Department of Homeland Security the foreign-born STEM workforce, adding an figures show more than 81,000 Chinese nationals additional 7,053 workers. establishing permanent residence in the U.S.— STEM talent from Taiwan and Hong Kong, easing from 87,000 in 2011 but up from 73,000 in while still substantial, has declined in absolute 2010. China’s share of new permanent residents terms and as a share of total foreign-born work- over 2010–12 has increased steadily from 7 per- ers. There were 3,633 fewer Hong Kong-born cent to 8.2 percent. The reasons include quality of STEM workers in the Bay Area in 2011 than in life concerns among a rising middle class and af- 2000, falling from 4.6 percent to 3.4 percent of fluent population about overcrowded cities, air total foreign-born STEM talent. While the total quality, food safety, education and healthcare; number of Taiwanese workers grew by 3,724 in political concerns about corruption, a lack of trans- the region over this period, there were 2,422 parency and prospects for upward mobility; and fewer STEM workers in 2011 than in 2000.

21 Ties That Bind, 2014 Edition

Chinese Immigrant Workers in the Bay Area

14% PRC % of all foreign-born workers 12% % of foreign STEM Workforce

10%

8% Hong Kong Taiwan 6%

2% Percent of Foreign-Born Workers

0% 2000 2007 2011 2000 2007 2011 2000 2007 2011

Source: American Community Survey, 3-Year Estimate; analysis by Bay Area Council Economic Institute

Cross-Border Academic Taiwan’s Industrial Technology Research Institute (ITRI) since 2004 on clean technology and green Collaboration Runs Deep cities innovation, through annual conferences, Over more than three decades, Bay Area universi- shared research and joint programs. ties have developed and strengthened relation-  The Berkeley-Tsinghua University Program for ships with Chinese academic institutions, and with Advanced Study in Psychology, funded in part government and businesses, through joint research by HTC co-founder Cher Wang and VIA Tech- and other collaborations. nologies CEO Wen Chi Chen, is coordinating Stanford and the UC Berkeley, Davis and San global research to address the rise in reported Francisco campuses in particular have assisted factory suicides and violent crime in China. China in areas of law, finance, corporate govern-  Berkeley’s Department of City and Regional ance, architecture and planning, alternative en- Planning (DCRP) has teamed with scholars ergy, environmental mitigation, healthcare and from Shanghai’s Tongji University to develop agriculture. Earlier initiatives are detailed in our transportation and environmental solutions to 2006 report. meet the needs of residents in outlying areas More recently, despite economic volatility and of Shanghai. fluctuations in U.S.-China political relations, these  UC Davis and BGI-Shenzhen, a non-profit re- academic connections have quietly, consistently search arm of the Beijing Genomics Institute, continued their work. The following are a few formed the BGI@UC Davis Partnership in 2011 key examples: to undertake joint genomic research relating to  The Stanford Law School China Guiding Cases food security, human and animal health and Project deploys a team of 60 legal scholars in wellness, biodiversity and environmental health. China, Hong Kong and the U.S. to translate Su-  The China Center for Energy and Transporta- preme People’s Court of China “guiding cases” tion (C-CET), a partnership of researchers and that are intended to establish legal precedents advisors from the UC Davis Institute of Trans- in civil, criminal and administrative law. portation Studies, Tsinghua and Tongji Univer-  The Stanford Program on Regions of Innovation sities, Ford Motor Co., the World Bank, the and Entrepreneurship (SPRIE) has partnered with Energy Foundation and Lawrence Berkeley

22 Chinese Students at Bay Area Universities

National Laboratory, is researching advanced government-supported park, with additional vehicle energy systems and future rural and funding from corporations. Haas School of Busi- urban vehicle designs. ness and the Boalt Hall School of Law are ex-  Peking University Center for Theoretical Biol- ploring similar arrangements. ogy researchers are at UCSF doing systems A rich platform for even deeper academic col- biology research to understand biological laborations is provided by alumni giving and net- processes and engineer treatments at the works. UC Berkeley in particular enjoys a large, molecular level, under a fellows program well-placed network of alumni in China. The funded by Chinese industrialist Li Ka-Shing’s Li process works both ways, as Tsinghua, one of Foundation. China’s leading universities, has 10,000 alumni in  UCSF’s AIDS Research Center has partnered the Bay Area—more than anywhere in the world with the Chinese Center for Disease Control to outside Beijing. address shortages of HIV/AIDS researchers and clinical investigators in China. In an effort to extend their reach to students, Endowments scholars and alumni in China without the need to The virtuous cycle of immigrant Chinese entre- travel on a visa, Stanford and Berkeley have each preneurship is readily visible in university en- opened China-based facilities. dowments from successful entrepreneurs and Stanford’s history with Peking University (PKU) investors who made their fortunes in Silicon Val- dates back to the 1970s, when the two schools ley and throughout the Bay Area, as well as from launched an exchange between their language prominent Chinese alumni and family members. programs as Stanford first began accepting Chi- Donations range from major health research nese graduate students. In 2004, Stanford began centers and libraries, to endowed chairs and offering study abroad and internship programs in fellowship programs for visiting scholars in spe- collaboration with PKU. cific fields, to individual scholarships fostering The Stanford Center at Peking University student exchanges. (SCPKU), completed in March 2012, is a 36,000- square-foot, $7 million facility available to Stan- Reported endowments from Chinese donors ford students, researchers and faculty working in to UC Berkeley and Stanford alone in the past China. Principal funding came from the family two decades total more than $150 million. foundation of Chinese investor and alumnus Among the largest are the $40 million Tan Kah Chien Lee. The Center provides an extension of Lee Hall, a chemical engineering research labo- the university, supporting its own scholars and ratory, and the $40 million Li Ka-Shing Center for programs—the Asian Liver Center, the Rural Edu- Biomedical and Health Sciences, at Berkeley; the cation Action Project, the Center for Sustainable $30 million-plus Li Ka-Shing Foundation donation Development & Global Competitiveness, and the to Stanford’s School of Medicine; and the $6.4 schools of business and engineering, among oth- million from Taiwan alumni to fund the Kwoh-Ting ers—and a venue for hosting conferences and Li professorships in engineering, economic de- research collaborations in China. velopment, medicine and Chinese culture. Berkeley signed an agreement in November More recent gifts include $30 million from 2011 to establish a center for its School of Engi- NVIDIA Corporation founder and CEO Jen-Hsun neering in the Zhangjiang High-Tech Park out- Huang, to help build Stanford’s 130,000-square- side Shanghai. The 50,000-square-foot building foot Jen-Hsun Huang School of Engineering opened in November 2013, with a primary focus Center, and a $2 million Li Ka-Shing gift to fund on university and industrial research collabora- “precision medicine” research—merging genome tion and is seen as a first step toward creating a research and molecular biology with big data full-scale academic center. It is being provided analytical tools toward more personalized to the university rent-free for five years by the predictive clinical care—at UCSF.

23 Ties That Bind, 2014 Edition

Visas: The School-to-Work Transition The link between international students and U.S. immigration policy is a crucial one for the Bay Area. Foreign students typically enter the U.S. on F-1 visas; visiting exchange scholars, professors and researchers enter the U.S. on J-1 visas. F-1 students must be enrolled full time at institutions approved by the U.S. Citizen and Immigration Services (USCIS), and they must be proficient in English, financially self-sufficient and have a permanent residence abroad. J-1 applicants must additionally provide documented evidence of specific academic proficiency or accomplishment. J-1 visas are for a set term; holders must return to their home countries within 30 days of expiration for a minimum of two years before then reapplying for a new visa to re-enter the U.S. to work. Remaining in the U.S. to work in STEM fields typically involves an H-1B visa for persons of special skills and abilities. U.S. visa regulations allow students holding F-1 visas to transition to H-1B work visas by earning work credit during their time at university and immediately upon graduating. The USCIS imposes an annual cap of 65,000 on the issuance of H-1B visas. An additional 20,000 visas are exempted from the cap and reserved for applicants holding advanced degrees from U.S. academic institutions. Another 6,800 slots are set aside outside the cap for new “H1B1” applicants under recently signed Free Trade Agreements with Singapore and Chile. Employers at universities, non-profit research facilities and government offices and facilities may apply for H-1B visas on behalf of employees year-round and are exempt from the cap. Also exempt are new visas issued to those already holding H-1Bs, to extend their stays in the U.S. or to reflect a change in job status. As a result, more than 117,000 H-1B visas were issued in FY 2010–11; more than 129,000 were issued in FY 2011–12. After a full academic year in school, F-1 students can undertake Curricular Practical Training (CPT), an internship with an outside employer in their fields of study, during the summer or part time. After graduating at either the bachelor’s or master’s degree level, students can remain under university sponsorship for 12 months and take jobs, known as Optional Practical Training (OPT), related to their fields of study. Since 2008, qualified STEM students have been eligible for a further extension of OPT for up to 17 months with an employer registered under the USCIS E-Verify program, the Internet-based system that allows businesses to determine employees’ eligibility to work in the U.S. Visiting scholars holding J-1 visas do not have access to equivalent options to CPT or OPT; limited extensions and waivers are possible, but at the discretion of USCIS, and they are difficult to obtain. Another immigration option for prospective students is the EB-5 investor visa, created by Congress in 1990. It makes up to 10,000 visa slots available to foreign nationals investing a minimum $500,000 to

24 Chinese Students at Bay Area Universities

$1 million in job-creating business ventures over a five-year period once job-creation requirements for the investment are fulfilled. Children of investors in the U.S. under age 21 during the five-year period are eligible to enroll in college or university at in-state tuition rates. (For more detail, see “The EB-5 Advantage” in the Connectors chapter.) The current annual limit of 140,000 green cards has produced a five-year backlog of applicants; for priority workers, advanced degree holders and persons of exceptional ability from China, the wait is 1–3 years; for the skilled workers category, it is 5 years or more. For H-1B visas, an application period opens each April 1, for the coming fiscal year. In periods of peak demand, the quota has been filled in as little two days, as it was in 2007 for the 2008 fiscal year. For 2011 it took 10 months; for 2012 the cap was reached in November 2011; and for 2013, the quota was filled by mid-June 2012. The fiscal year 2014 H-1B visa quota was closed on April 5, five days after the application period opened, by which time the USCIS had received 124,000; the quota was filled by computer lottery. Congress has grappled for more than two years with a range of proposals to reform the U.S. immigration system, including changes to the H-1B and EB-5 programs. The Senate passed S. 744, the Border Security, Economic Opportunity and Immigration Modernization Act, in June 2013. Among its provisions, S. 744 eliminates country-specific limits for employment-based visas but leaves the overall worldwide cap at 140,000; exempts STEM graduates and their families from the worldwide cap, raises the special allocation for master’s and doctoral degree holders to 25,000 and allows spouses in the U.S. to work; permits foreign graduates with PhDs and/or STEM graduates with master’s or doctoral degrees to apply directly for green cards; exempts STEM graduates and J-1 visiting scholars from the visa labor certification process; increases the H-1B visa allocation to a range of 110,000– 180,000 each year, depending on demand; raises the H-1B allocation for advanced degree holders to 25,000; reserves unused EB-5 visas for qualifying entrepreneurs launching start-ups in the U.S.; and permits F-1 student visa holders to enter the U.S. with “dual intent” to study and to immigrate. As of this writing, the House of Representatives is taking up immigration reform in a series of bills rather than a single one, and it is divided as to whether it will offer them as companion legislation in a joint conference to pass a single bill for signing. In June 2013, the House Judiciary Committee passed the Supply- ing Knowledge Based Immigrants and Lifting Levels of STEM Visas Act (H.R. 2131), known as the SKILLS Visa Act. The bill would reallocate 55,000 visa slots currently reserved under diversity and family reunifi- cation programs to increase the number of H-1B visas, offer green cards to advanced-degree STEM graduates, establish a new entrepreneur visa, strengthen the investor visa program and repeal the country-specific cap for employment-based visas.

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4. PROFESSIONAL NETWORKS/ASSOCIATIONS Staying Connected

Chinese immigrant networks in the Bay Area date Strategic competition between Taiwan and back to the Chinatown family benevolent asso- a rapidly developing PRC gave birth to two ciations of the 1800s. Modern professional net- associations, the Monte Jade Science and Tech- working organizations developed beginning in nology Association, a Taiwan-centric organiza- 1980 with the Asian Business League (ABL) in San tion formed in 1989 with seed funding from the Francisco and the Asian American Manufacturers Taiwanese government, and the Hua Yuan Sci- Association (now the Asia America MultiTechnol- ence and Technology Association (HYSTA), a ogy Association or AAMA) in Silicon Valley. ABL similar PRC government-supported group was comprised of Asian small business owners launched in 1999. Both were tied to science and and professionals in law, finance, real estate and technology parks—Hsinchu in Taiwan and other fields. AAMA’s membership included tech- Huayen in Shenzhen—which included incubators nology professionals in the semiconductor, com- that offered tech start-ups offices, lab space, puting and network fields. funding and contacts to domestic companies. These associations had common objectives: The goal was to entice the best and brightest networking opportunities, a sense of community, tech graduates back home, rather than lose and shared support in navigating a business them to Silicon Valley. environment that at times involved discrimina- By the mid-1990s, these groups had contrib- tion and a glass ceiling in hiring and promotions. uted to a cross-fertilization that gave rise to “as- Their growing schedules of annual dinners, tronauts,” scientists and engineers in constant monthly meetings with speakers, award pro- transit back and forth across the Pacific, innovat- grams and weekend trips provided opportuni- ing and forming companies, and to “sea turtles,” ties to share ideas, make valuable business con- young graduates striking out on their own with nections and socialize. new start-up ideas, often launched in Asia and AAMA’s early focus was tech, and its founders funded in California. Transnational “innovation were mainly Taiwanese, primarily in chip, PC and clusters” formed, with entrepreneurs leveraging network systems manufacturing, reflecting Tai- the comparative advantages of Silicon Valley, wan’s emergence as a hardware OEM. As tech Taiwan and China to pursue R&D, execute de- broadened during the 1980s into software, signs and test concepts, and manufacture fin- graphics and the beginnings of the Internet, and ished products for market. as mainland Chinese students began to arrive in AAMA, Monte Jade and HYSTA grew quickly Silicon Valley in the late 1980s, a new crop of in size and influence, institutionalizing the net- smaller, industry-specific associations emerged work model for sharing information, making busi- for professionals in semiconductors, networking, ness connections, funding start-ups, and mentor- storage, wireless, optoelectronics and other ing entrepreneurs on corporate leadership and fields. And as venture capital (VC) spurred entre- governance. Each had more than 1,000 individual preneurs to launch new companies, associations members and some 200–300 corporate members adapted their structure and activities. Traditional from tech fields and offering support services in lunch and dinner meetings gave way to pitch finance, banking, law and consulting. sessions, mentorship programs and discussions Annual meetings attracted as many as 1,500 about management strategy and IPOs. attendees and hosted CEOs from major tech

27 Ties That Bind, 2014 Edition companies in Silicon Valley, Taiwan and China, as cross-border collaboration, through alumni, well as government leaders and rising entrepre- company, investor and other contacts outside neurial stars discussing disruptive new advances. traditional associations. AAMA launched a VC/entrepreneur program and  A 2010–11 controversy over accounting and opened Beijing and Shanghai chapters; Monte valuation discrepancies in “reverse merger” Jade opened 12 U.S. chapters and organized an public listings of Chinese companies (merging executive mentorship program and an annual them into a dormant, already public shell tech study tour to Asia; HYSTA opened a Beijing company to expedite the listing process) chapter, expanded ties to multiple science and dampened cross-border M&A activity and technology parks in China, and formed a venture narrowed VC exit options. capital group and an emerging leaders forum.  Traditional associations have struggled to The three major Silicon Valley groups as well maintain relevance amid an explosion of new as the smaller associations were catalysts for in- consumer-based technologies in areas such novation. They provided Chinese engineers, pro- as mobile, cloud and social media. grammers and entrepreneurs with venues to Each of these changes has challenged the role meet, share ideas, develop concepts for new of traditional associations. Associations have re- businesses and products, access capital, find sponded by broadening their programming and mentors and strike out on their own. membership development into new industries Today AAMA, Monte Jade and HYSTA remain and geographic markets, opening offices in the dominant Silicon Valley organizations dedi- China, Taiwan, Singapore and Korea, and part- cated to fostering cross-border tech business nering with businesses and government to host formation and growth with greater China. Most of networking events on both sides of the Pacific. the industry-specific organizations remain active They have maintained ties to government-funded to varying degrees, the largest and most promi- programs and incubator facilities, but more as a nent of these being the Chinese American Semi- value-added service to members than as a central conductor Professional Association (CASPA). purpose. In addition to business formation alone, AAMA and Monte Jade have Bay Area member- new program emphasis has been placed on more ship numbers that have remained fairly constant customized mentorship and on cultivating next- over time, reporting 1,100 and 1,200 members, generation leaders. respectively, on their web sites; HYSTA, mean- Core activities remain largely the same: large, while, claims a Bay Area membership of 8,000, up themed annual events attracting senior-level tech from 6,000 in early 2011 and 2,000 as of 2006. professionals and highlighting growth trends; New economic forces have recently converged mentorship initiatives to help young entrepre- to re-shape the focus and influence of profes- neurs; targeted networking events, including for- sional networks: mal pitch contests where start-ups present new  China’s relative economic resilience early in business ideas to prospective investors; and the 2008–09 downturn attracted continued hosting of regular cross-border trips offering in- investment and growing numbers of returning troductions to business and government leaders. Chinese entrepreneurs. HYSTA executive director Leslie Yuan says in-  PRC-Taiwan political tensions have eased, terest in his group and in the China market grew resulting in expanded cross-Strait trade steadily throughout the global recession, as and investment. domestic U.S. markets dried up and China re-  Semiconductor, PC, server and other costs mained a relative bright spot. An annual trip to have dropped and more innovation is now China has been expanded to three times a year; being done in the cloud on open-source for the 2012 trip there were 100 applicants for a platforms, making incubator facilities less maximum 25 slots. The 2012 annual conference important to start-ups. in Santa Clara, “China and Technology’s Impact  More options are available to entrepreneurs on the Global Economy,” featuring Baidu co- to access the China market and engage in founder and CEO Robin Li and Microsoft Online

28 Professional Networks/Associations

Services President Dr. Qi Lu, drew more than Like Yuan, Vaughn credits the U.S. downturn 1,000 attendees. with spurring activity for her organization, as busi- Yuan, a former Hewlett-Packard executive, says nesses here sought out new markets and as immi- the relationships among organizations today are grant entrepreneurs saw more opportunity back less competitive and more a question of serving home. In both cases, cross-border networks were different customer niches toward the same end; important. She agrees that historic lines separating today there is a greater sense of a single overseas professional organizations, alumni chapters, tech Chinese—or even pan-Asian—network focused on incubators and other entrepreneurial channels are exploring potential business opportunities through blurring: “My whole philosophy is that it should be many points of contact. a collaboration more than a competition,” she A big difference for entrepreneurs today, says. “Chinese students may come to the U.S. for Yuan acknowledges, is that the cost of launching their education and return to China if they see a tech start-up has fallen dramatically. “Chips, greater opportunity, or work here for a couple of PCs, phones and network equipment have come years, gain experience and go home; many have down in price; more software is open source or opened offices here and in China as well. Entre- cloud based,” he says. “Advances that used to preneurs will go where the opportunities are.” take months or years and cost millions of dollars As the flow of Chinese investment into the now take weeks, if not days, and cost thou- U.S. increases, Vaughn agrees that AAMA and sands.” Talent, he adds, can be accessed glob- other groups can serve an important function as a ally, on a 24/7 basis; China’s consumer market is bridge in both directions, linking China with what poised to pass Japan’s in the near future at is unique in Silicon Valley and the Bay Area: “In current growth rates, and more Chinese national China you don’t see corporate management or champions like Lenovo, Huawei, ZTE and Haier entrepreneurism based on sharing information; are venturing abroad, so there is less need to it’s not part of the culture. And you can’t just lure entrepreneurs back home to the science transplant the VCs, lawyers, professors, and parks after university. schools and have another Silicon Valley; it’s a very With a new wave of Chinese investment al- special place in the world.” ready beginning to enter California, looking for As the major associations broaden their mis- exactly the kind of setup, management, compli- sions, and as their memberships become more ance and other expertise HYSTA members can diverse, new organizations are stepping in to ful- now offer in the reverse direction, Yuen says fill their earlier national objectives. “we’re going to see more billion-dollar deals The Chinese Enterprise Association (CEA) coming, and we would be selling ourselves short of Northern California, formed in 1997 as a so- if we focused only on tech.” cial networking organization to help successive AAMA has also diversified, both geographically waves of Chinese STEM students and entrepre- and in terms of member industry sectors. Replac- neurs in Silicon Valley adjust to unfamiliar ways ing the word “Manufacturers” with “MultiTechnol- of life and business customs, has more recently ogy” in its name signaled a broadening of its evolved into an association of Chinese compa- scope beyond chips, PCs and peripherals. The nies headquartered in China but with a presence group now has members and puts on programs in in Silicon Valley. the full range of tech fields including cloud, big “A couple of years ago the Chinese govern- data, gaming and social media, as well as tech- ment saw more companies going abroad and reliant verticals such as automotive and healthcare. decided to recognize us as an official organiza- AAMA executive director Charlene Yu Vaughn tion and provide more direct support to help notes that while three of the group’s Asian chap- organize events and build bridges with local ters are in China, its interests extend throughout associations and with government,” says CEA Asia to India, Singapore and Japan, and it has Northern California chapter president Ben Chen, opened a Seoul chapter in cooperation with the who is also west region operations president for Korea Trade-Investment Promotion Agency. China Unicom Americas.

29 Ties That Bind, 2014 Edition

Chen sees CEA’s benefits flowing in both direc- In addition to monthly meetings, study trips and tions, introducing member firms to Bay Area busi- networking events organized in China, GWC hosts ness and government leaders, but also making dual annual Global Mobile Internet Conferences them accessible to prospective local partners, (GMICs) in Beijing and Silicon Valley. The 2012 vendors and suppliers. CEA’s more than 80 mem- Silicon Valley event, held at Moscone Convention bers include the major Chinese telecom service Center in San Francisco, drew 5,400 attendees and providers and solar companies; mobile handset 170 exhibitors from 58 countries. Exhibits included and networking firms Huawei Technologies and a dedicated room for mobile app developers to ZTE Corp.; Internet firms Tencent, Alibaba and demonstrate their latest creations. HYSTA and Sina; PC manufacturer Lenovo; Chinese banks and AAMA have been GMIC co-sponsors. credit card processor China UnionPay; Air China; As larger established groups broaden their mis- and People’s Daily. sions and scope of activities to accommodate in- Along similar lines, the Silicon Valley Taiwan- dustry changes, few new groups have surfaced in ese American Industrial Technology Associa- the past decade and many that did have not tion (TAITA-SV) began with Taiwan government lasted. One group that has seen expansion is the support in 2003. TAITA-SV is Taiwan-specific and Silicon Valley-China Wireless Technology Asso- represents a more tightly-coordinated effort in ciation, formed in 2000. SVC Wireless member- support of the cross-border ecosystem of Taiwan ship is younger and caters to start-ups and venture tech industries, government-funded science parks and angel investors offering early-stage capital and overseas Taiwanese entrepreneurs. Its stated (from the Bay Area and China) and incubators. mission is to Its 2013 annual conference, “Mobile Pivots Fu-  facilitate technological exchanges between ture of Computing,” emphasized the technology Silicon Valley and Taiwan, paradigm shift from PC to mobile and beyond; the  foster Silicon Valley entrepreneurs and symbiosis between Silicon Valley and China in the U.S. businesses to explore cross- mobile revolution; and cross-border opportunities border opportunities, for entrepreneurs. In addition to discussions on  promote U.S.-Taiwan industrial, scientific wearable technology, mobile healthcare, con- and technological talent exchanges, and nected cars, big data and patent filing in China, a  help Taiwan industries expand their Showcase pitch session brought together entre- reach in global markets and raise their preneurs and investors. international profiles. The group also sponsors an annual Silicon Sponsoring members include ITRI, TECO’s Valley Youth Innovation Award to deserving high science and technology division, and the Taiwan school students. SVC Wireless claims 5,000 Trade Center and Hsinchu Science Park, plus members and 30 alliance partners. Among its modem and router manufacturer Actiontec, sponsors are IBM, Marvell Technologies, Micro- network server firm Supermicro, Chunghwa soft, China Unicom and Weibo. Telecom unit CHT Global, and Innobridge The rise of new incubator and accelerator facili- Capital Management, a Santa Clara early-stage ties throughout the Bay Area—some of the largest investor in Taiwanese and Silicon Valley hard- with close ties to China—is augmenting but also ware start-ups. providing an alternative to established associa- And it was only a matter of time before a truly tions. These new office park and industrial site de- global, partly virtual professional network ap- velopments offer start-ups lab, office and meeting peared on the scene. The Beijing-based Great space; technology and business mentorship; seed Wall Club (GWC) is a for-profit networking group funding; and connections to next-stage capital, for mobile Internet professionals, with a U.S. production capacity and prospective business branch in Mountain View, as well as branches in partners on both sides of the Pacific. (See the In- Japan, Singapore, Taiwan and Finland. vestment section for more information.)

30 Professional Networks/Associations

The Asia Foundation: Supporting Development and Reform Under the current Five-Year Plan, China faces a tipping point in its development. In four key policy areas—law and governance, the environment, opportunities for women and the poor, and disaster management—the San Francisco-based Asia Foundation is on the ground in China helping to address challenges and contribute to reform. The Foundation also supports programs that encourage constructive U.S.-China relations. “We’re trying to understand the very complex currents we see in China’s society, economy and government, and the extent to which they’re coming together to create policy change,” says Foundation vice president Gordon Hein. “It’s a top-down process, but partly it’s also bottom up, in terms of citizens’ demands and expectations; that’s the space in which we operate.” The Foundation has been active in China since 1979, beginning with a fellowship program with China’s Ministry of Foreign Affairs. Since 1980, over 90 emerging leaders from the Ministry have taken part in the fellowship program, earning master’s degrees in international relations from themost prestigious universities in the U.S. A major focus is on increasing citizen participation in lawmaking and policy and improving the transparency and accessibility of public information. Toward that end, The Asia Foundation has worked with Peking University, the Administrative Law Research Association, local law schools and government legislative affairs offices to support administrative law reforms in a number of provinces and cities and to offer legal consultations through walk-in clinics, hotlines and community visits. The Foundation also supports study tours in the U.S. for Chinese academics and government officials to better understand open government processes. Pilot projects have increased public involvement in budget reform in Heilongjiang Province, management and disbursement of poverty alleviation funds in Nigxia Autonomous Region, local people’s con- gresses and legal counseling to handle citizen complaints in six provinces, and training and education to increase public participation in local development in Anhui Province. The Foundation has collaborated with the Ministry of Civil Affairs, the Chinese Academy of Governance, Chengdu Education Foundation, Sichuan University and others on disaster management programs— including on leadership and interagency coordination, community- based mitigation initiatives, earthquake recovery/housing rehabilitation and risk reduction in schools. To support the government’s efforts to balance rapid growth with environmental protection and sustainability, the Foundation works to build local environmental protection capacity and to encourage policy and technological innovations through increased dialogue and communication among stakeholders. The Foundation’s programs in China have trained officials from municipal environmental protection bureaus

31 Ties That Bind, 2014 Edition

(EPBs), judges from people’s courts and representatives from environmental organizations, on the use of alternative dispute resolution for the increasing number of conflicts over environmental pollution. Other programs support work in southern China to better engage small and medium-sized enterprises in low carbon economy planning at the city level. Partnering with research institutes, local EPBs, civil society organizations and business associations, the Foundation is also helping to implement milestone directives on environmental information transparency and public participation in environmental decision-making. In four diverse pilot cities, the Foundation and its partners are working to foster constructive collaboration among government, civil society and business. Drawing on the Foundation’s extensive work to strengthen good governance in China, the project aims to develop and test practical mechanisms by which the public can access information about local pollution or make their voices heard in decisions about local environmental issues. “The way China initiates reforms is through experimentation at the provincial and local levels,” Hein explains. “Everything is tested at lower levels and then expanded, so that the process is centralized enough that they can make decisions and implement them, but de- centralized enough that they can experiment.”

Other groups with deep connections to greater through communication and exchanges and to China and the Bay Area Chinese professional enhance the image, visibility and participation of community also have significant educational and Chinese Americans within the U.S. It has commis- policy orientations. sioned nationwide surveys on American percep- The California-Asia Business Council (Cal- tions and attitudes regarding China, lobbied poli- Asia) was formed in the early 1990s as the Cali- cymakers on cross-border trade and commercial fornia-Southeast Asia Business Council, and in issues, pushed to expand classroom teaching 2000 extended its focus on industry sector trends about Asian-Americans and Asian history and cul- and economic policy to include China. It has ture, and in 2005 launched a national mentorship hosted senior-level briefings from government program for university students and young adults. and business leaders, visiting Asian delegations A senior-level, policy-focused organization, and—partnering with other local organizations— the 1990 Institute was formed by Unison Group business-focused China programs on legal re- Chairman C. B. Sung, along with former U.S. form, banking, online gaming, Hong Kong’s film Undersecretary of State Philip Habib, Federal industry and Tianjin city planning. Reserve Bank of San Francisco president Robert The Hong Kong Association of Northern Parry, UC Berkeley Institute of East Asian Studies California, founded in 1984, provides a focal director Robert Scalapino and others. Established point for businesses and individuals interested in to provide independent policy-based research in business and trade with Hong Kong. Its activities the U.S., focusing on economic and social devel- include social events, business forums, trade mis- opment and China’s modernization, the Institute sions, and meetings with Hong Kong officials. has sponsored studies and conferences and pro- A nationwide group of Chinese-American moted exchanges of research scholars in the U.S. business, arts and community leaders (architect and China. I.M. Pei and cellist Yo-Yo Ma are among the The Dui Hua Foundation was founded in founders), the Committee of 100 was formed in 1999 by former Occidental Chemical Co. execu- 1990 to foster positive U.S.-China relations tive and American Chamber of Commerce-Hong

32 Professional Networks/Associations

Kong president John Kamm. Dui Hua (meaning Founded in New York in 1956 by John D. “dialogue” in Chinese) works with government Rockefeller III to promote greater knowledge of officials in Washington, embassies and consu- Asia in the U.S., the Asia Society of Northern lates in China, foreign governments, human California fulfills its educational mandate through rights and other non-governmental organiza- a wide range of cross-disciplinary programming tions to keep international attention focused on that has expanded in more recent years to in- specific political prisoners and secure their re- clude Asian American issues, the effects of lease. In 2004, Kamm, credited with the release globalization, and issues in Asia including the of more than 400 political and religious prison- status of women, environmental challenges and ers in China, received the MacArthur Foundation rapid urbanization. The Northern California prize for his work. In 2005, Dui Hua was granted chapter opened in 1998, hosting a variety of special consultative status by the Economic and business-focused, cultural and high-level policy- Social Council of the United Nations. related events.

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5. TRADE AND TOURISM Poised for a Breakout?

The flow of goods, services and visitors between billion; U.S. imports from China grew from $102.3 countries, while not presenting a full picture, is billion to $287.8 billion. China’s two-way trade perhaps the most direct indicator in an eco- with the world more than tripled, from $509.7 nomic relationship. billion, to $1.76 trillion. Direct economic benefits from manufactured U.S. West Coast harbors and airports were trade passing through an area where major har- swamped with Chinese import cargo. China’s low bors and international airports are located—cargo wages, government subsidies, concessionary handling, warehousing and distribution, fueling loans and tightly controlled currency pegged to and repair services, tug and barge operations, the dollar brought down global manufacturing cargo vessel and jet maintenance and repair, costs. Low-cost Chinese products provided wel- freight brokerage, trade finance and legal ser- come breathing space for U.S. consumers at a vices, etc.—are obvious. time of stagnant wage growth, depleted savings Measuring trade using only data from ports of and overextended credit. entry and departure often misses the bigger This perfect storm fed a wave of discount re- question of where primary value is added; data tailing that, by 2005, added port calls, can fail to capture intercompany transfers and e- prompted expansion of cargo handling facilities commerce, where more trade today is now con- and spurred new harbor warehousing and distri- ducted; tourist arrival and departure data alone bution center development along the I-80 and does not give a full picture of the economic con- I-580 corridors, as far north as Reno, Nevada tribution of a visit. It is important to go beyond and east to Stockton and Tracy. Import con- raw numbers to understand the overall exchange tainer traffic from China through the Port of of goods and services. Oakland more than tripled over 2001–06, from In the five years following China’s 2001 entry 55,000 40-foot equivalent unit (FEU) containers into the World Trade Organization, U.S. exports to 188,000; exports doubled over 2002–05 from to China grew from $19.2 billion in value to $55.2 52,000 FEU to 102,000.

China’s Trade with the United States, 2002–12 (USD billions) 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 U.S exports 22.1 28.4 34.7 41.8 55.2 65.2 71.5 69.6 91.9 103.9 110.5 Percent change* +14.7 +28.9 +22.2 +20.5 +32.0 +18.1 +9.5 -2.6 +32.1 +13.1 +6.5 U.S. imports 125.2 152.4 196.7 243.5 287.8 321.5 337.8 296.4 364.9 399.3 425.6 Percent change* +22.4 +21.7 +29.1+23.8 +18.2 +11.7 +5.1 -12.3 +23.1 +9.4 +6.6 U.S. balance -103.1 -124.0 -162.0 -201.6 -232.5 -256.3 -266.3 -226.8 -273.1 -295.5 -315.1 Source: U.S. International Trade Commission (ITC), U.S. Department of Commerce *Calculated by The US-China Business Council. U.S.; exports reported on a free-alongside-ship basis; imports on a general customs-value basis.

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China Services Trade, 2011 and 2012 (USD billions) Imports Exports 2011 2012 2011 2012 Travel 2.691 2.812 5.689 6.486 Passenger Fares 0.614 0.678 2.051 2.284 Other Transportation 3.081 3.142 2.358 2.308 Royalties and License Fees 0.186 0.5 4.114 4.817 Other Private Services 4.757 5.858 12.49 14.138 Total Private Services 11.329 12.990 26.702 30.033 Source: Bureau of Economic Analysis (BEA), U.S. Department of Commerce

Top Bay Area imports included furniture, elec- reports that in 2012, China ranked fourth globally tronics, computers, toys, plastic products, tools, as a purchaser of U.S. service exports ($30.03 tires and sporting goods. Top exports were alu- billion) and tenth as a provider of services to the minum ingots and shapes, animal feed, bever- U.S. ($12.99 billion). This trade is broken out in ages, industrial clay, cotton, dried fruits and nuts, the table above. pharmaceuticals, earths/minerals, food products U.S. service exports to China have increased and hay. Non-containerized bulk exports included steadily every year since 1992, and have tripled scrap metal, wood pulp, petroleum products from $8.4 billion in 2005. Imports of services and chemicals. from China have increased in all but three years Nearly $9 billion in Chinese air cargo imports since 1992, and have doubled from $6.15 billion entered San Francisco, Oakland and San Jose in 2005. International Airports in 2005. Products ranged The “Other Private Services” category refer- from fashion apparel and luggage to pharmaceu- enced above is mainly comprised of education, ticals, seafood, gems, fresh-cut flowers and elec- financial services, insurance services, telecommu- tronics. Some $6.8 billion in Bay Area exports nications, and a catch-all category, “business, included fresh and frozen fruit and vegetables, professional and technical services,” which is vitamins, cosmetics, lab reagents, semiconduc- where the bulk of total U.S.–China services trade tors, medical devices, machine tools and data is conducted. Of the nearly $12.5 billion in 2011 processing equipment. “Other Services” exports to China, $10.3 billion Total two-way manufactured trade with greater was direct, unaffiliated trade, while another $2.2 China through the San Francisco Customs District billion was inter-company business involving U.S. in 2005 was nearly $27 billion: $18 billion in im- parent firms or affiliates. U.S. firms exported ports, and $9 billion in exports. nearly $5.2 billion in business, professional and Since then, from 2006–12, two-way U.S.-China technical services to China in 2011—the largest trade has grown steadily, with the exception of single services category. Topping the list of these 2009 at the peak of the world recession. U.S. ex- services, in order, were ports to China doubled, while imports from China  architecture, engineering and construction; increased by nearly half (48 percent); the U.S.  installation, maintenance and repair trade deficit grew by over 35 percent. of equipment; In 2012, the U.S. was China’s top trading part-  management consulting; ner, its top export destination and its fourth largest  operational leasing; and import supplier; China grew to become the third  industrial engineering. largest market for U.S. manufactured exports, after Chinese firms provided nearly $4 billion in Canada and Mexico. business, professional and technical services to Regarding services, the U.S. Commerce De- U.S. customers. The top services categories were partment’s Bureau of Economic Analysis (BEA)  research, development and testing;

36 Trade and Tourism

 computing/data processing; and Council (USCBC) lists the California’s top exports  installation, maintenance and repair to the PRC as follows: of equipment. During 2005–11, U.S. services exports to Hong Computers and electronics $3.9 billion Kong increased from $3.8 billion to $6.1 billion, Waste and scrap $2.4 billion while imports grew from $5.0 billion to $6.9 billion. Machinery (except electrical) $1.4 billion During that same period, service exports to Taiwan Transportation equipment $1.4 billion increased from $5.8 billion to $10.5 billion, and Chemicals $878 billion imports rose from $6.4 billion to $6.7 billion. As with mainland China, most of the services moving USCBC’s estimate of $13.6 billion in California in either direction involved business, professional exports to China in 2012 is down slightly from and technical services. $13.9 billion in 2011, but well above the $10.7 billion reported in 2008. Drilling Down to the The Council’s report, “U.S. Congressional Regional Level District Exports to China: 2003–12”, cross- references U.S. Census Bureau, U.S. Department California two-way trade with China totaled nearly of Agriculture and Moody’s Analytics trade and $142 billion in 2012—$127.7 billion in imports business databases to obtain a more detailed and $14 billion in exports, according to the Gov- snapshot of export origination by congressional ernor’s Office of Business and Economic Devel- district and county. Its export profiles for 12 Bay opment. A report from The US-China Business Area congressional districts are as follows:

District 2: Marin, Napa, Sonoma and other Counties 2012 China exports: $216 million Export growth to China, 2003–12: 297 percent Top 5 exports to China: Crop production; computers/electronics; seafood; machinery; waste/scrap.

District 5: Contra Costa, Napa, Solano and Sonoma Counties 2012 China exports: $226 million Export growth to China, 2003–12: 310 percent Top 5 exports to China: Crop production; computers/electronics; beverages; machinery; petroleum/coal products

District 9: Contra Costa and other Counties 2012 China exports: $207 million Export growth to China, 2003–12: 310 percent Top 5 exports to China: Transportation equipment; crop production; processed foods; waste/scrap; petroleum/coal products.

District 11: Contra Costa County 2012 China exports: $179 million Export growth to China, 2003–12: 287 percent Top 5 exports to China: Petroleum/coal products; transportation equipment; chemicals; primary metal manufacturing; computers and electronics.

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District 12: San Francisco County 2012 China exports: $45 million Export growth to China, 2003–12: 176 percent Top 5 exports to China: Waste and scrap; seafood; computers/electronics; chemicals; primary metals manufacturing.

District 13: Alameda and San Francisco Counties 2012 China exports: $255 million Export growth to China, 2003–12: 202 percent Top 5 exports to China: Transportation equipment; waste/scrap; computers/electronics; machinery; chemicals.

District 14: San Francisco and San Mateo Counties 2012 China exports: $177 million Export growth to China, 2003–12: 78 percent Top 5 exports to China: Transportation equipment; computers and electronics; waste and scrap; crop production; machinery

District 15: Alameda and Contra Costa Counties 2012 China exports: $386 million Export growth to China, 2003–12: 210 percent Top 5 exports to China: Transportation equipment; computers and electronics; machinery; waste/scrap; petroleum/coal products.

District 17: Alameda and Santa Clara Counties 2012 China exports: $1.33 billion Export growth to China, 2003–12: 58 percent Top 5 exports to China: Computers/electronics; machinery; transportation equipment; chemicals; electrical equipment.

District 18: San Mateo, Santa Clara and Santa Cruz Counties 2012 China exports: $442 million Export growth to China, 2003–12: 54 percent Top 5 exports to China: Computers and electronics; machinery; chemicals; transportation equipment; miscellaneous manufacturing.

District 19: Santa Cruz County 2012 China exports: $327 million Export growth to China, 2003–12: 20 percent Top 5 exports to China: Computers/electronics; machinery; transportation equipment; waste/scrap; miscellaneous manufacturing.

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District 20: Santa Clara, Santa Cruz and other Counties 2012 China exports: $141 million Export growth to China, 2003–12: 135 percent Top 5 exports to China: Computers/electronics; waste/scrap; machinery; processed foods; crop production

Bay Area companies across a range of indus- name (in Chinese characters), the Tesla T logo, tries have secured a foothold in the China market. and the Tesla logo. While uptake on all-electric The industries span technology and a wide range vehicles has been slow to date, the Chinese gov- of services as well as consumer goods. In the ap- ernment is actively supporting alternative energy parel sector, for example, outdoor apparel com- vehicle deployment, with subsidies of up to pany North Face has grown its sales in China $10,000 for all-electric cars. from $60 million to $1.7 billion in the last ten U.S. Census trade data focuses on the various years, with year-on-year growth averaging 50 harbor, airport and inland gateways that make up percent. North Face clothing is carried in more the San Francisco Customs District. As a result, than 600 stores throughout China. Levi Strauss figures include not only goods produced in or has operated in China for more than a decade. In destined for end users in the Bay Area, but also the China market for only two years, by the fall of cargo passing through en route to and from other 2013 Gap Inc. already had 73 stores in 19 cities locations. Still, gateway data is a useful indicator in mainland China, with plans to go to 80 by early of aggregate transportation, cargo handling and 2014. The company’s first Old Navy store in related trade support activities in the region. China will open in Shanghai in the spring of 2014, PRC imports destined for the San Francisco and the Gap brand will expand to Taiwan. Bay region and throughout the U.S. continue to Retailers such as North Face, Levi Strauss and outpace exports, but the Bay Area enjoys a more Gap benefit from strong brand awareness—for balanced trade with Taiwan. An apparent trade which many customers are prepared to pay a surplus with Hong Kong may actually reflect in- premium—and a consumer market that is moving creased transshipment cargo into China or else- upscale. Brand awareness has also exacerbated where in Asia. problems with counterfeit goods, which are ram- When the USCBC congressional district/county pant. Increasingly, affluent Chinese consumers origin data is overlaid onto the Census District PRC are gravitating to the prestige and quality of rec- trade figures, a significant data point emerges: ognized brands. For companies such as North some $4 billion of the total $6.4 billion in 2012 U.S. Face, however, the scale of the knock-off market exports moving through the San Francisco Cus- may exceed actual company sales. toms District to China—nearly two-thirds—origi- The Bay Area’s Tesla Motors faces similar op- nated within the San Francisco Bay region. portunities and challenges. Tesla first tested the While the San Francisco district runs a net market in Hong Kong, with a robust response trade deficit with China by value, exports moving (hundreds of would-be purchasers paid $500– by volume—petroleum products, soybeans, steel, $42,500 for reservations). Pre-order Model S machinery, bulk minerals and oils, industrial clays bookings on the mainland opened in August and earths, fertilizer—well exceed imports. Most 2013, with an 8,000-square-foot LEED Platinum of these cargoes move via bulk shipping. certified showroom scheduled to open in Beijing. Higher-value imports—auto parts, retail mer- While Tesla is in a strong position to establish chandise, home and garden supplies, furniture, itself in the high-end market, competition for the appliances, electronics—move in containers, most mass market from domestic companies such as via Oakland. Richmond and Martinez alone saw BYD will be strong. The company has also been cargo growth in 2012 reflecting increased ship- engaged in a trademark dispute with a Chinese ments of bulk petroleum products and, at Rich- businessman who acquired rights to the Tesla mond, automobile imports.

39 Ties That Bind, 2014 Edition

Trade Flows through San Francisco District Ports/Airports, 2008–12 (USD billions)

$20 Exports PRC $18 Imports $16

$14

$12

$10

$0 2008 2009 2010 2011 2012

Trade Value in Billions of Dollars $4 Hong Kong $3 $2 $1 $0 2008 2009 2010 2011 2012

$6 Taiwan $5 $4 $3 $2 $1 $0 2008 2009 2010 2011 2012

Source: U.S. Census Bureau USA Trade Online; analysis by Bay Area Council Economic Institute

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Imports from China through Top Bay Area Ports/Airports, 2011–12 (by USD value) By Water 2011 2012 Port of Oakland 13,436,625,321 12,499,541,756 Port of San Francisco 356,152,974 313,295,501 Port of Richmond 40,087,607 63,608,394 Port of Stockton 30,223,451 51,887,287

By Air 2011 2012 SF Intl. Airport 4,691,884,425 4,947,998,921 Oakland Intl. Airport 2,704,509 1,368,710 San Jose Intl. Airport 1,026,297 2,099,891 Sacramento Intl. Airport 207,094 170,639 Source: U.S. Census Bureau USA Trade Online

Top 10 Import Commodities, 2011–12 By Air By Water By Value By Volume Electric machinery Mineral fuel/oil Electric machinery Home furnishings Integrated circuits Crude oil Nuclear power eqpt. Plastics products Nuclear power eqpt. Vehicles Data processing eqpt. Electric machinery Data processing eqpt. Nuclear power eqpt. Telecom eqpt. Glassware Optical/medical eqpt. Electric machinery Office machine parts Nuclear power eqpt. Telecom eqpt. Data processing eqpt. Integrated circuits Iron/steel products Office machine parts Petroleum/coal oil Broadcasting eqpt. Fertilizers Repaired/returned goods Beverages/spirits Optical/medical eqpt. Toys/games/sports eqpt. Semiconductor eqpt. Home furnishings Elect. transmission eqpt. Vehicles Semiconductor devices Apparel Television/video eqpt. Chemicals/rare earths Source: U.S. Census Bureau USA Trade Online

Exports to China through Top Bay Area Ports/Airports, 2011–12 (by USD value) By Water 2011 2012 Port of Oakland 2,901,691,057 3,028,182,134 Port of San Francisco 204,083,731 116,800,361 Port of Richmond 75,598,188 68,943,631 Martinez 59,730,473 19,619,484 Port of Stockton 48,144,556 43,752,910

By Air 2011 2012 SF Intl. Airport 2,553,475,445 3,100,132,932 Oakland Intl. Airport 12,737,009 10,897,942 San Jose Intl. Airport 12,288,667 14,409,205 Sacramento Intl. Airport 4,291,777 4,087,991 Source: U.S. Census Bureau USA Trade Online

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Top 10 Export Commodities to China through U.S. Airports/Ports By Air By Water By Value By Volume Electric machinery Wood Pulp Electric machinery Wood pulp Optical/medical eqpt. Wastepaper Nuclear power eqpt. Wastepaper Oscilloscopes Fruits/nuts Optical/medical eqpt. Mineral ore Telecom eqpt. Meat Telecom eqpt. Iron ore Nuclear power eqpt. Optical/medical eqpt. Data processing eqpt. Mineral fuel/oil Data processing eqpt. Aluminum products Semiconductor eqpt. Petroleum coke Integrated circuits Nuclear power eqpt. Oscilloscopes Iron/steel Semiconductor eqpt. Aluminum scrap Semiconductor devices Scrap iron Semiconductor devices Cotton/yarn/fabric Integrated circuits Forest products Medical instruments Photographic products Test/measurement eqpt. Plastics products Source: U.S. Census Bureau USA Trade Online

Strong Export Potential for California Wine China’s wine market has grown dramatically in recent years, with sales of 266 million liters valued at $41 billion in 2012, up 20 percent from 2011; China’s wine imports are projected to grow by 54 percent over 2011–15, according to research prepared for Vinexpo, a trade show held alternating years in Hong Kong and France. Per capita consumption is still only a small fraction of that in Western countries. The U.S. ranks sixth among exporting countries supplying the China market, with about a 5 percent share—well behind France (48 percent) and Australia (13 percent), Spain (10 percent), Chile (8 percent) and Italy (7 percent). California accounts for 90 percent of total U.S. wine exports, according to the San Francisco-based Wine Institute. The state shipped $1.43 billion in exports overseas in 2012, up 2.6 percent from 2011. China imported $74 million worth of California wines in 2012, up 18 percent from 2011 and double the value shipped in 2010, making it California’s fifth largest wine export market. A major growth constraint is perception. Chinese consumers are largely unaware of higher-end California wines, and distributors expect a low price point—and volumes—that craft wineries often cannot meet. Hanson Li, head of cross-border investment banking and private equity firm Hina Group’s San Francisco office, says California’s wine export dilemma lies in the United States’ huge domestic market, which consumes most of what is produced and where the biggest wine distributors are owned by large food companies. “When a Napa winemaker decides to expand, the wine goes to Atlanta, New York or Boston,” he says. “They don’t know how to export.”

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China sales growth has partly stemmed from tourism, with Napa and Sonoma Valley increasingly on the itineraries of affluent Chinese visitors, plus more aggressive marketing by the state. The Wine Institute, for example, partnered with the public- private trade promotion agency Visit California to organize two wine delegations to China in April and June 2013, linked to Governor Brown’s visit. It also coordinated participation of 120 California wineries in a California Wines Pavilion at the Vinexpo Asia Pacific trade show in May 2012. Most California wine exports to greater China ship via Hong Kong, which eliminated duties and administrative controls on wine in 2008 in order to position itself as a regional wine trading and distribution hub offering specialized logistics and warehouse storage, as well as promotional events. Under the Mainland- Hong Kong Closer Economic Partnership Arrangement (CEPA), wine fermented and bottled in Hong Kong can enter China duty- free; imported wine entering via Hong Kong pays a 20 percent tariff. Wine imported directly into the PRC incurs duties and taxes of 38–56 percent. From 2007–12, Hong Kong wine imports increased four-fold, to 50.6 million liters valued at HKD 8.1 billion; 37 percent was re-exported, mostly to the mainland and Macau, with the rest consumed in Hong Kong. That included HKD 1.2 billion in sales of premium, investment-grade wines at auction in 2012. U.S. wine exports to Hong Kong represented only 6.4 percent of that market in 2012. A recent Bain Capital study of the global luxury goods market cited in SVB’s 2013 Wine Report, points to broadening interest in wine among affluent Chinese consumers, from very wealthy collectors of rare French vintages to younger professionals, especially frequent travelers, with a concurrent rise in e-commerce, direct-to-consumer winery sales and wine tourism. In September 2012, China UnionPay, San Francisco-based card processing and co-branding intermediary NuPay System International, East-West Bank and San Francisco e-commerce marketer The California Place hosted a St. Helena seminar to support area wineries with direct-to-consumer sales as well as exports to China. NuPay’s My Wine Card—a premium gift card currently offered initially through Chong Hing Bank in Hong Kong, provides special discounts on duty-free red wines popular with Chinese consumers. The card enables Chinese tourists to easily buy wine in California and have it shipped home, and includes a concierge ‘help desk’ service. The California Place is opening an e-commerce portal in 2013, and a physical store in Shanghai in 2016, that will import and sell California wines through Chinese foreign trade zones.

43 Ties That Bind, 2014 Edition

A Matter of Geography to mean less inbound container cargo from Asia that is destined for transshipment by rail to the More than a third of U.S. container imports from east, as more shipping moves by water via Pa- Asia enter the U.S. through Southern California, a nama directly to Atlantic and Gulf Coast ports. massive population and manufacturing center in In 2010, the Port strengthened its ties with its own right and a major gateway to rail corridors China through a memorandum of understanding serving the East, Midwest and Sunbelt states. with China Merchant Holdings (International) Importers can alternatively shave 1–2 days off Company Limited (CMHI), a leading Chinese con- transit time to Chicago or New York by shipping tainer terminal operator and logistics provider. The via the Pacific Northwest. As a result, container agreement creates a strategic relationship by es- lines tend to run loop services calling at Seattle- tablishing joint services and benefits for shippers Tacoma or Los Angeles-Long Beach first, then and ocean carriers. CHMI currently controls one- calling at the Bay Area before returning to Asia. third of Chinese container traffic. Relatively few lines call at Oakland first with inbound cargo. Two-way container cargo through Oakland has held steady in a range of roughly Up in the Air 850,000–900,000 FEU annually since 2005, total- On the air freight side, few international carriers ing 889,000 in 2012. The difference has been in operate pure air cargo services out of San Fran- the balance of imports versus exports. In 2005, cisco, Oakland or San Jose international airports, both were almost exactly in balance; in 2012, because regional volumes similarly tend to con- imports totaled 396,000 FEU while exports to- centrate in Southern California. Niche interna- taled more than 493,000. tional airlines in Asia are maintaining pure air That difference, in large part, is due to an ebb cargo service for specific customer bases, but in China trade during the global downturn that most airlines are scaling back and combination has continued since; China accounts for 48 per- passenger-cargo service is declining. The strong- cent of containerized imports moving through est growth has been at package express carriers Oakland, but less than 17 percent of exports, such as Federal Express, United Parcel Service which continue to grow but from a smaller base. and DHL, with an expanding online fulfillment Slower demand has inhibited growth in new har- cargo base from retailers like Amazon.com. bor warehousing and inland distribution center Oakland remains the dominant Bay Area air- development tied to the Port, and in trucking and port for these services, with FedEx and UPS hubs, rail traffic. but San Jose has been gaining market share due Amid the rapid growth in 2004–05, the Port of to improved facilities and proximity to Silicon Oakland was able to obtain federal funds to Valley, where companies originate shipments of complete dredging of harbor channels and ter- high-value, time-sensitive electronics products minal berths to accommodate larger container- and components. FedEx, meanwhile, is under- ships. Lines expressed interest at the time in in- taking a $30 million upgrade to its 75-acre Oak- bound first calls and held trials. As cargo demand land sorting facility, where it employs 1,300 eased, however, those services proved unsustain- workers. The expansion will increase international able. The Port is making a bet on future growth sorting capacity four-fold and domestic capacity with the $500 million development of the vacant by 40 percent, and will accommodate larger, 160-acre former Oakland Army base—now the more fuel-efficient Boeing 777 planes. The added Gateway Industrial District—with added container capacity is tied, in part, to the opening of new terminal acreage, near-dock rail access and logis- FedEx hub facilities in China and India. tics facilities. Another critical piece of the puzzle for Oak- U.S.-China Trade in Perspective land is the widening of the Panama Canal to accept larger ships, a project that will be completed As mentioned previously, weaknesses in the data by the end of 2014. Canal expansion is expected make it easy to inflate the economic impact of

44 Trade and Tourism trade with China, particularly in discussing trade  Less than half of that 2.7 percent share—1.2 imbalances. In a 2011 economic letter, “The U.S. percent of consumer spending—represents Content of ‘Made in China’,” the Federal Reserve the actual cost of the imported Chinese goods Bank of San Francisco (FRBSF) examined the after U.S. transportation, marketing and brand- share of U.S. consumer spending allocated to ing, warehousing, distribution and retail activi- goods and services “made in China” and how ties are backed out. much of that share reflects the actual costs of  Of every dollar spent by U.S. consumers on Chinese imports paid to a Chinese seller. goods labeled “Made in China,” an average FRBSF conducted its research in part to under- of 55 cents is spent on services originating in stand the true scope and impact of the U.S. mer- the U.S. chandise trade deficit with China, but also to  Factoring in the cost of Chinese-produced in- measure the potential impacts of Chinese infla- puts to consumer goods sold in the U.S., the tion on consumer prices over time. The study pro- Chinese share of U.S. consumer spending is duced some noteworthy findings. Among them are 1.9 percent. the following: FRBSF also cites the example of an Apple  Imports amounted to 16 percent of U.S. GDP iPhone sold in the U.S. in 2009 for $500 (a portion in 2010, but imports from China comprised of that cost carrier-subsidized), with an estimated only 2.5 percent of U.S. GDP. $179 cost of “manufacture” in China. Of that  Chinese-made goods sold in the U.S. are still amount, $172.50 was for components sourced concentrated in a small number of retail and in- globally (including $10.75 in U.S.-made inputs to dustrial sectors; they comprise 20 percent of foreign-sourced components) and $6.50 was for U.S. consumer purchases of furniture, house- assembly in China. hold goods/appliances and electronics; 35 per- Along these same lines, McKinsey & Company cent of clothing and footwear purchases; and developed a domestic value-added exports smaller shares in other categories like tools, (DVAE) measure in 2010 as part of an effort to as- hardware, toys, bicycles, sporting goods, sess Chinese exports’ actual contribution to building and garden supplies, and so on. China’s GDP during the global downturn. This was  Foreign goods make up only 11.5 percent of to- done by backing out raw materials, parts and sub- tal U.S. consumer spending, with Chinese goods assemblies imported for use in the manufacture of accounting for a quarter of that at 2.7 percent. finished export products.

Geography of U.S. Personal Consumption Expenditures, 2010

81.9% Made in U.S. from U.S. parts

Made in U.S. from parts imported from other countries 5.9% Made in U.S. from parts imported from China 0.7%

6.1% Final goods imported from other countries

1.2% Final goods imported from China 2.7% 1.5% U.S. content of "Made in" other countries

U.S. content of "Made in China"

Source: Bureau of Economic Analysis, Bureau of Labor Statistics, Census Bureau; analysis by FRBSF

45 Ties That Bind, 2014 Edition

Measuring total export growth relative to total  use of antidumping and countervailing duties GDP growth, a standard benchmark, China’s ex- investigations as retaliation for unrelated ports have typically been characterized as con- actions by foreign countries that China tributing an average of 60 percent to real GDP finds objectionable; growth since 2000. Using the DVAE measure,  inadequate enforcement of intellectual property McKinsey estimated that only about half of the rights, particularly with regard to trade secrets total value of Chinese exports reflects actual and to online and software copyrights; value added in China, and that exports contrib-  delays in opening China’s government pro- uted only 19–33 percent of annual GDP growth curement system to foreign suppliers as from 2002–08. required under WTO rules; At the same time it should be noted that  export restrictions on rare earths, tungsten China's export mix is gradually moving up the and molybdenum, for which there is significant value chain and, as it does, domestic content is global demand and China is the dominant increasing as a share of finished product. Over global producer, and on upstream raw materi- 2011–12, Chinese exports of electronics products als used in the production of aluminum and and components, computers, auto parts and op- chemicals, where China also competes with tical devices grew 24 percent to $129 billion, buyer countries; even as apparel and footwear shipments in-  China’s establishment of a national champion, creased only 5 percent to $47 billion. This is also UnionPay, as the exclusive provider of elec- in part a reflection of rising PRC production costs tronic credit card payment processing ser- and the migration of lower-end manufacturing to vices, through which all foreign credit card elsewhere in Asia or to Latin America. Analyses firms must process transactions for a fee, by the WTO and OECD confirm that the share of versus using their own networks; and local content in Chinese exports overall is rising.  central government and provincial subsidies to The Wall Street Journal cites a Hangzhou com- auto parts manufacturers in regions of China pany, Inventronics, Inc., as an example of the designated as “export bases.” trend. The company, founded in 2007, makes More recently, a dispute directly affecting LED lighting power supply units and has grown in Northern California surfaced regarding tech ex- six years to a workforce of 1,000. Inventronics ports. WTO talks over expanding a multilateral units power the nighttime light display on the San 1996 Information Technology Agreement (ITA) Francisco Bay Bridge; while its primary suppliers broke down in July 2013 over China’s objection to are in China, the integrated circuits in its units are including 148 technology products on a list of 256 from the U.S. targeted for tariff elimination. Among the products in contention were semiconductor manufacturing Policy Concerns equipment, high-end memory chips, medical devices and audio-visual equipment such as DVD In its 2012 Report to Congress on China’s WTO players and video cameras. The expanded product Compliance, the Office of the United States list would cover an additional $800 billion in trade Trade Representative (USTR) asserts that by 2006, and would translate into a further $2.8 billion in having substantially met its commitments as a U.S. exports annually. China maintains that the WTO member, China was moving to consolidate items in contention are “sensitive” and is report- and strengthen its state-owned enterprises (SOEs) edly reluctant to abandon the tariffs it uses to in ways that “led to institutionalized preferences encourage indigenous innovation. for state-owned enterprises and the creation of High levels of government subsidy to industry national champions in many sectors.” Key issues have raised issues of competitive fairness for that were raised included many foreign companies and their governments,  technology transfer requirements as a leading to a range of investigations and in some precondition for foreign direct investment cases significant compensatory tariffs (for example, in China; for telecommunications equipment, automobiles,

46 Trade and Tourism steel and solar panels). One recent analysis finds partnership agreements, and emails and contact that companies listed on China’s stock exchanges lists from victim organizations’ leadership,” adding received more than $13 billion in subsidies in that the targeted companies “match industries that 2012, up 23 percent from 2011 and equivalent to China has identified as strategic to their growth, 4 percent of those companies’ total profits. including four of the seven emerging industries Subsidies come from both national and local that China identified in its 12th Five-Year Plan.” government in the form of cheap land, tax re- Finally, it should be noted that political issues bates, support for loan repayments, and cash, can impact trade in both directions, particularly often connected to economic development, R&D, for larger U.S. companies doing business with environmental or other goals, such as the crea- government-affiliated entities. Sales by Bay Area tion of national companies that can lead in global IT companies, for example, were likely impacted markets. Analysis by Hithink finds that more than by public disclosures in 2013 of the National Se- half of the 2,400 companies listed in mainland curity Agency’s monitoring of global communica- China receive government support, of which tions, as well as by issues surrounding market more than half are state-owned enterprises. access in the U.S. for Chinese companies. Intellectual property (IP) protection and cyber security are also continuing concerns, particularly for many Bay Area companies whose product A Nascent Two-Way value is IP-based. A 2013 report by the inde- Tourism Trade pendent bipartisan Commission on the Theft of Intellectual Property found that annual losses to Tourism is an especially high-value services trade. the U.S. economy from international IP theft total Its benefits ripple out beyond air fares, hotel some $300 billion per year, 50 percent to 70 per- rooms and car rentals, to include restaurant and cent of which (depending on the industry) is retail sales, and support services from taxis to linked to China. tour guides to conference organizers, parking The report, reflecting analyses from a variety services, sporting events and the arts. of sources, attributes this to industrial policy While business travelers arriving in the U.S. goals that encourage IP theft and an extraordi- from China are hardly a new phenomenon, it was nary number of Chinese business and govern- only in December 2007 that China granted the ment entities engaged in the practice. While, U.S. “approved destination status,” allowing Chi- under foreign pressure, administrative improve- nese citizens to visit as tourists. At that time, ments have been made that address these con- 397,000 Chinese nationals visited the U.S. annu- cerns, their application has been uneven and, if ally, spending an average $6,000 per person anything, cyber attacks are increasing. while here, for an average three-week stay. An High-profile hacks of the New York Times, estimated 275,000 visited California in 2008. Wall Street Journal, Google and other firms have As China’s emerging middle class broadens its been reported. In early 2013 Mandiant, a major horizons, Chinese vacation travelers are emerging private security company, traced “one of the as a fast-growing market. The Bay Area is a prime most prolific cyber espionage groups in terms of destination, for many reasons: it is the closest the sheer quantity of information stolen” to a destination on a long trans-Pacific flight; many People’s Liberation Army intelligence facility in visitors have friends or family here; the region Shanghai, one of 20 Advanced Persistent Threat boasts the largest Chinese community outside of (APT) groups it had been tracking in China. China and cultural ties dating back 160 years; and Mandiant found that the unit has “systemati- it is home to iconic attractions such as the Golden cally stolen hundreds of terabytes of data from at Gate Bridge, cable cars, Chinatown, Silicon Valley least 141 organizations” spanning “broad catego- and the Napa-Sonoma wine country. ries of intellectual property , including technology The U.S. Department of State, which issues blueprints, proprietary manufacturing processes, travel visas and records visitors on a fiscal year test results, business plans, pricing documents, basis (October 1 through September 30), reports

47 Ties That Bind, 2014 Edition nearly 1.5 million Chinese visitors in the U.S. during cities such as Chongqing, Chengdu, Shenyang 2012, up from 1.18 million in fiscal 2011; China’s and Dalian to educate agents about U.S. travel. In National Tourism Administration (NTA) forecasts 2 November 2011, Visit USA teamed up with the million visitors annually by 2015. U.S. Commerce Department to host a U.S. tour Until early 2012, many prospective Chinese by more than 30 agents, to connect them with visitors were discouraged from traveling to the pre-screened travel providers. U.S. by the burdensome tourist visa process, an The Chinese Tourism Academy reports that outgrowth of 9/11 security initiatives. Visas could vacations now make up 85 percent of outbound only be obtained through the U.S. Embassy in Chinese travel, owing to several factors, among Beijing and four consulates in Chengdu, Guang- them an appreciating Chinese currency, more zhou, Shanghai and Shenyang. An in-person in- public holidays, reduced travel restrictions, more terview is required and high demand created travel product and service options, and more two-month average wait times in Beijing and Approved Destination Status countries. Shanghai in 2011. Top travel trends among Chinese visitors go- China views this as a trade issue: the visa ing abroad include the following: process disadvantages its international air carriers  Sightseeing and shopping are the major pur- because they are heavily reliant on outbound poses of leisure trips. travelers for their core business. As a result, the  Travel spending grew by 25 percent in 2011, to government has been slow to expand landing $69 billion, and is estimated to have reached rights in Tier 2 and Tier 3 cities to U.S. passenger $85 billion for 2012. airlines—another reason is that China’s military  Travel is highly seasonal, in May, October only opens 30 percent of the country’s airspace and December. for commercial flights—and the existing interna-  Younger, high-income professionals account tional airports are limited in number and are at or for much of the growth in travel demand. near capacity.  More visitors are moving away from price- Beginning in 2012, the State Department has based tours to more individualized visits. expedited Chinese tourist visas with expanded  Most travelers research trips online, but most embassy and consulate waiting areas and office bookings are still made through travel agents. space, more interview windows and added staff, Recent visitors spend more time at fewer loca- cutting wait times in most cases to about a week; tions for a more in-depth experience; cost is still repeat visitors can renew their visas through a bank the main driver in choosing a destination; other drop-off service, with processing as quickly as five factors include safety, good food (preferably days. In the first two quarters of fiscal 2012, State Asian), comfort (Chinese-style service standards, had issued 453,000 visas. By the end of the third cultural sensitivity) and world-famous landmarks. fiscal quarter (June 30), a year-to-date total of Shoppers look for Chinese-friendly service, bilin- more than 1 million visas had been issued. gual staff, acceptance of China UnionPay credit cards and international shipping. San Francisco International Airport (SFO) is the Tourism Trends only Bay Area airport with scheduled passenger flights to and from greater China. In 2012, 4.3 An average Chinese tourist’s stay in the U.S. is million passengers traveled to and from Asia via two weeks. Most trips center on some mix of four SFO—about 45 percent of its total 9.5 million destinations: San Francisco, Los Angeles, Las Ve- international passengers, and a 5 percent in- gas and New York City. Most visitors book their crease from the nearly 4.1 million Asia passengers trips through travel agents, and tend to use in 2011. SFO is one of only 10 U.S. airports with agents in the big cities with more experience and non-stop connections to China, Taiwan and relationships with major tour groups. Hong Kong. China’s NTA has opened a Visit USA Center in The airport does not provide a breakdown of Shanghai, and has made presentations in Tier 2 Asia regional data by country, and total passenger

48 Trade and Tourism numbers include travelers passing through on countries that meet DHS security and information connecting flights. San Francisco Travel (formerly requirements can obtain advance online authori- the San Francisco Convention and Visitors’ Bu- zation through the DHS electronic system for reau) estimates that San Francisco hosted some 4 travel authorization (ESTA) and can visit the U.S. million international visitors in 2011, up 10 per- for up to 90 days without a visa. After South Ko- cent from 2010 and 30 percent from 2009. Of rea was admitted to the VWP in 2008, Kiely said, that 2011 total, some 800,000 visitors arrived the number of Korean visitors to the Bay Area from Asia, including 198,000 from China, 60,000 nearly doubled. Singapore and Japan are the from Taiwan and about 50,000 from Hong Kong. other Asian countries on the VWP list. More than a third of Chinese visitors were traveling on vacation, and more than a quarter came for business, 19 percent visited family or friends, and 13 percent were students. Up to 60 percent Rolling Out the Red Carpet were connecting through to other U.S. locations, China became California’s number one source of while 40 percent were staying in the area. international visitors in 2012, when an estimated Most visitors from China still arrive in tour 677,000 Chinese tourists spent almost $2 billion groups, spend a day and night in the Bay Area in the state, a 31 percent increase over 2011. taking photos of major attractions, drive down Continued strong growth in tourism from greater the coast to Los Angeles, and from there head China is expected, and California and the Bay east to Las Vegas, stopping on the way at outlet Area have laid the groundwork for receiving it. In malls that have sprung up in Barstow and else- 2009, despite the recession and budget pres- where along the route. From there they continue sures, the California Travel and Tourism Commis- either to the East Coast, mainly New York City, or sion (CTTC) opened offices in Beijing, Shanghai to Hawaii before returning home. and Guangzhou to promote the state as a desti- San Francisco Travel executive vice president nation. San Francisco Travel has opened offices for tourism Tom Kiely says that little by little, however, the market is trending younger, more affluent of its own in Shanghai and Beijing. and more sophisticated. “They’re moving away CTTC’s marketing arm, Visit California, hosted from traveling in groups on a budget; they’re 20 tour groups with a combined 650 Chinese staying at more affluent hotels, not out at the air- visitors to the state in early 2012. It has also port,” he says. “They’re shopping at some very launched China Ready, a package of educational high-end stores, but it’s just beginning. We’re and promotional materials to help travel profes- working very hard to get them to stay in the city sionals better understand the culture and service longer to enjoy all we have to offer. We expect to requirements of Chinese visitors. Hotels and see a real shift over the next five to ten years.” travel professionals have also established online The growing impact of Chinese shoppers can presences on Chinese search portals like Baidu, be seen at the Livermore Premium Outlets mall in and on travel sites such as Ctrip, where visitors the East Bay, where more than 54 buses of Chi- research and plan their vacations. nese shoppers visited in the month of October Hilton, Starwood, Marriott and other hotel 2013. More than half of Chinese visitors to the chains have introduced Chinese-friendly services at mall are individuals who are not on organized select hotels in areas popular with Chinese tourists, tours, suggesting that more than 5,000 Chinese including in the Bay Area. Hilton’s Huanying pro- visitors made purchases in Livermore in that gram, for example, provides a front desk team month alone. member fluent in Chinese; tea kettles, slippers, Kiely expects a short-term uptick in Taiwan Chinese TV programming and a Chinese welcome visitors, following an October 2012 announce- letter in the room; and traditional Chinese break- ment by the U.S. Department of Homeland Secu- fast, including congee, dim sum, Chinese tea and rity (DHS) adding Taiwan to its Visa Waiver Pro- fried rice or noodles. Hilton reports that Chinese gram (VWP). Under the VWP, visitors from 37 bookings at participating hotels in the first seven

49 Ties That Bind, 2014 Edition months of 2012 increased 129 percent over the interior city of Chongqing. China Eastern Air- same period in 2011. lines launched daily non-stop Shanghai flights In 2012, four airlines—United, Cathay Pacific, in April with continuing one-stop same-plane Singapore and Air China—offered a combined 49 service to Wuhan and Qingdao on alternating non-stop flights each week to Hong Kong, Beijing days, thereby adding over 1,600 seats per week and Shanghai via SFO, with a combined weekly to China. capacity for more than 16,000 passengers. In 2014, United Airlines will reinstate daily In March 2013, Air China increased capacity non-stop service to Taipei at the end of March, from B747 combi aircraft (passenger-cargo) to connecting San Francisco with the main hub of full-passenger aircraft, adding some 450 seats the new Star Alliance member, EVA Airways. per week on its daily Beijing service. Later, in Additionally, United will launch three-times- August, Air China extended this service with weekly, same-aircraft service to the interior city one-stop same-plane service via Beijing to the of Chengdu, via Shanghai, in June.

6. GROWING BUSINESS TIES Affiliates and Invention

As China’s economy grows and diversifies, its include a Bay Area inventor and at least one co- business ties to the Bay Area continue to grow inventor located in China increased 422 percent and evolve. Earlier chapters described how Chi- between 2002 and 2012. In absolute terms, nese immigrants represent increasing shares of these patents have increased from 6 to 259 over science, technology, engineering and math oc- the decade. Co-patenting activity with China- cupations in the region as well as students in Bay based inventors represents a growing percent- Area universities. Chinese professional associa- age of all foreign co-patenting in the region, tions and networks help new immigrants get a expanding from less than 1 percent in 2002 to foothold in the region’s economy and help en- 9.9 percent in 2012. trepreneurs get their businesses going. Co-patenting with China has increased par- While the Chinese community is diversifying ticularly quickly in key technology areas. For ex- and growing locally, cross-border invention and ample, since 2005–2006, registrations have in- investment are also increasing. These activities creased by a factor of 5.7 in Computers, Data that generate shared value serve to deepen the Processing & Information Storage and by a factor ties between the Bay Area and China. The pres- of 8.5 in Communications. With the exception of ence of Chinese companies is on the rise in the three technology areas—Apparel, Textiles & Bay Area, as is the presence of Bay Area busi- Body Adornment; Dispensing & Material Han- nesses in China. dling; and Furniture & Receptacles—all other technology areas have witnessed growth of at Business Presence least 100 percent. Foreign companies make up an important part of the Bay Area’s innovative ecosystem. Increas- Financial Investment ingly, foreign companies are opening up R&D Since the economic downturn in 2000, private centers in the region to tap into local talent pools equity and venture capital investment abroad by and research facilities. The Bay Area is home to Bay Area firms has grown significantly. Venture 96 affiliates of Taiwanese companies, 51 affiliates capital in particular represents not just the flow from China, and 38 from Hong Kong. of cash but also the flow of business acumen, as The PRC ranks second as a top location for well as access to talent and technology. These Bay Area business affiliates abroad. Currently, high-value transactions require relationships of there are 795 Bay Area affiliates located in the trust. Therefore, the growth of this activity is an PRC, making up 8.6 percent of all Bay Area affili- indicator for growing interdependencies be- ates abroad. The Bay Area’s representation tween economies. abroad also includes 303 business locations in China accounts for a major part of this growing Taiwan and 216 in Hong Kong. activity. While total investment waned in 2008 with the global financial crisis, the region’s interest in Research Collaboration investing in China held strong. Investment to China Bay Area inventors are increasingly collaborating reached $2.7 billion in 2011, representing 38 per- with inventors in China. Patent registrations that cent of all Bay Area investment abroad.

51 Ties That Bind, 2014 Edition

Foreign Affiliates in the Bay Area and Bay Area Affiliates Abroad, 2013

1,000 Bay Area firms with affiliates in foreign countries 900 Foreign firms with affiliates in the Bay Area 800 700 600 500 400 300 200 100 Number of Establishments 0

U.K. Italy India Korea Brazil Israel Japan France Mexico Canada Australia Germany Singapore China (PRC) Hong Kong Taiwan (ROC)

Source: Uniworld 2013; analysis by Bay Area Council Economic Institute

Patents with Bay Area and Chinese Co-Inventors

300 12% Patents with Bay Area and Chinese co-inventors Percent of total patents registered with Bay Area and foreign co-inventors 9.9% 250 10%

8.6%

200 7.7% 8%

6.3% 6.2% 150 6%

3.9% 100 3.5% 4% Number of Patent Registrations 2.0% 50 1.4% 2% 1.0% 0.8% 1.2% 0.6% 0.8% 0.5%

0 0% Percentage of Total Patents with Bay Area and Foreign Co-Inventors

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: U.S. Patent and Trade Office; analysis by Bay Area Council Economic Institute Note: Patent counts refer to all patents with an inventor from the Bay Area regardless of inventor sequence number.

52 Growing Business Ties

Bay Area and Chinese Co-Inventor Patent Registrations by Technology Area

450 Dispensing & Material Handling Apparel, Textiles & Body Adornment 400 Transportation/Vehicles Teaching & Amusement Devices Furniture & Recepticles 350 Food, Plant & Animal Husbandry Construction & Building Materials Manufacturing, Assembling & Treating 300 Health Chemical & Organic Compounds/Materials Chemical Processing Technologies 250 Measuring, Testing & Precision Instruments Electricity & Heating/Cooling Communications 200 Computers, Data Processing & Information Storage

150 Number of Patent Registrations 100

0 1999–2000 2001–2002 2003–2004 2005–2006 2007–2008 2009–2010 2011–2012

Source: U.S. Patent and Trade Office; analysis by Bay Area Council Economic Institute

Bay Area Global Investment Flow, 1995–2012 (USD billions, inflation adjusted)

Flows to the Bay Area Flows from the Bay Area 2012 2011 Rest of the World 2010 China 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 $25 $20 $15 $10 $5 $0 $0 $2 $4 $6 $8

Source: Thomson Reuters investment database; analysis by Bay Area Council Economic Institute Note: Investment includes private equity and venture capital deals.

53 Ties That Bind, 2014 Edition

China is also a growing investor in the Bay investors to recoup their investment and to raise Area. Reaching $495 million in 2011, Chinese capital to support a company’s expansion. investment in the region represented 7 percent of Cross-border IPOs accounted for 19 percent all foreign private equity and venture capital that of all global activity from 2002 to 2011. London flowed into the Bay Area that year. and New York are the most international ex- The launching of companies on foreign stock changes; 41 percent of all cross-border IPOs took markets is on the rise globally. An initial public place in London and 23 percent in New York. offering, or IPO, is the event in which shares in a Growing numbers of Chinese companies are company are offered for sale to the public on a choosing to go public abroad. Over this period, stock market. Particularly with high-tech compa- 135 Chinese companies exited in the U.S., ac- nies, this has served as the primary exit for counting for 51 percent of total IPOs in the U.S.

7. KEY INDUSTRY SECTORS A New Set of Synergies

Less than a decade ago China’s economic rela- landscape often involves a complex exchange, as tionship with the San Francisco Bay region—as a mandatory local partner can easily become a with the U.S. overall—was fairly straightforward. long-term competitor. With WTO membership, China emerged as the In recent years, significant business activity has world’s contract manufacturer and the beneficiary begun to flow in both directions. Chinese firms of a flood of foreign manufacturing investment initially aimed at delivering low-cost goods in have located in the Bay Area to be closer to re- home markets and later at serving the emerging search and innovation clusters and to serve the China market. U.S. market. They have initiated M&A to achieve Trade is still largely composed of equipment scale and vertical integration, and they are in- and raw commodities flowing into China and fin- vesting in technology incubators, extending the ished consumer and business goods flowing out. science park model to Chinese and U.S. entre- But the more than $3 trillion in foreign exchange preneurs in STEM and life sciences fields. reserves from that trade is funding a moderniza- In this chapter we will examine current cross- tion of China and its economy that is taking place border exchanges in key Bay Area business sec- at impressive speed. tors, along with future areas of growth potential. Bay Area architects are building high-rise office towers, retail corridors and mixed-use ARCHITECTURE AND URBAN PLANNING neighborhoods in Shanghai, Beijing, Shenzhen, Hangzhou and a growing number of inland cities. From Buildings to Towns China’s core Internet architecture, government and Districts and university computer networks, and the enter- China has been a major market for foreign archi- prise software running many of its largest state- tects since the 1990s. Internationally renowned owned banks and industrial companies originated firms not only bring innovative designs to city in Silicon Valley. skylines, but also lend cachet that raises lease Early exchanges initiated by Bay Area lawyers, and occupancy rates. Bay Area architects and judges and law schools assisted China in ad- planners additionally bring to the table expertise vancing its system of civil and commercial law in green design, achieving energy and environ- and in modernizing its courts. Lawrence Berkeley mental efficiencies that, over time, more than pay National Laboratory, alongside California utilities for themselves. and regulatory agencies, have provided training and technical support in developing energy effi- The Landscape ciency, renewable energy and utility demand-side Foreign architectural firms typically compete at management programs. Bay Area tech firms and the high end of the market on high visibility, venture investors have funded some of China’s signature developments. China has embraced most successful banks, technology firms, health- western design practices, but has limited foreign care providers and retailers. firms to preparing and providing design services Investment has been welcomed, but not with- and lending aesthetic, structural, materials, en- out conditions—ownership limits, joint venture ergy efficiency, spatial use and other expertise. and local content requirements, and technol- Completed and accepted design drawings are ogy transfer in exchange for market access—all handed off to “local design institutes” (LDIs) of to ensure that domestic industries are mod- architects, construction engineers and building ernized and become competitive. Navigating this code compliance specialists.

55 Ties That Bind, 2014 Edition

Requested drawings may be only 50–75 per- While office and retail construction had out- cent complete—compared to more detailed paced demand, China’s financial markets remained plans submitted in the U.S.—allowing flexibility neither deep nor liquid, leaving individual investors for the LDIs to lock in a final design. A developer with few options beyond real estate or stocks. may retain a representative of the foreign firm to They flooded into real estate, borrowing to buy work with the LDI through the construction phase multiple homes and bidding up residential prices. or may terminate its relationship once drawings In the government’s view, the problem in both are submitted. Foreign construction firms can cases is speculation: “hot money” flowing in from serve as general contractors, but the actual con- overseas, distorting prices and crowding out do- struction work is subcontracted to local firms. mestic investment; and, fueled by excessive bank Lower overall labor costs and shorter lead lending, individual investors driving home prices times required to break ground have resulted in a and rents out of reach for most Chinese. highly advanced market, often incorporating new Beginning in 2010, new rules limited project building technologies that have not yet been approvals, project financing and the formation implemented in the U.S. of project companies. These were followed by Because land is owned by the government, tighter restrictions on foreigners investing in or public projects are awarded by government- acquiring domestic real estate entities and on sponsored competition. Private development pro- foreign purchases and use of properties. In jects entail a “scheme gathering” solicitation to 2010, Chinese insurance firms were permitted to design firms to prepare concepts. These are sub- allocate up to 5 percent of their holdings to real mitted to “expert” panels that evaluate and rank estate, in an effort to encourage more stable, design concepts for creativity, relationship to con- long-term institutional investment. text and constructability. Top finalists receive sti- Additional measures have subsequently been pends; winning design firms have an opportunity put in place to cool the residential market: re- to negotiate to provide further design services. strictions on the number of units purchasers could buy; higher minimum down payments on A Volatile Market second homes and luxury first homes, as well as Property development has been a key driver of for first-time homebuyers; suspension of new China’s economic growth: according to the Urban mortgage loans for non-local residents or for Land Institute (ULI), the real estate sector accounts purchases of third homes; and an increase in for 13 percent of the country’s GDP; 80 percent of mortgage interest rates. Despite a decline in development activity is in residential property. sales, foreign buyers continued to shore up China’s property market has been on a roller prices in larger cities, rushing to buy in anticipa- coaster since the global downturn began in late tion of an appreciating currency. 2007. At that time, property prices in major Chi- Demand for high-end office, large-scale retail nese cities fell by as much as 30 percent, and new and government projects remained strong in the projects dried up as foreign and domestic inves- major cities. But land and labor costs were rising, tors pulled money from managed funds and and development sites were increasingly scarce. cashed out shares in property developers. Developers searching for yield turned their atten- The government’s $585 billion stimulus pro- tion to Tier 2 cities—Dalian, Tianjin, Chengdu, gram, with its major housing construction com- Suzhou and Hangzhou—and beyond, to Qingdao, ponent, helped to restore confidence and lure Chongqing, Xiamen and Wuhan, where costs were investors and developers back into the market, lower and investment and ownership rules were spurring a flood of land acquisition deals and less restrictive. The focus in these outlying areas project proposals. The result, by 2009, was a was residential and retail, followed by grade-A binge of overbuilding and reports of vacant, office space and finally by hotels and logis- underperforming or delayed projects, mainly in tics/distribution facilities. the Tier 1 cities of Shanghai, Beijing, Shenzhen Local investors and developers jumped into the and Guangzhou. market, supported by pan-Asian private equity,

56 Key Industry Sectors

Chinese banks and insurers, and local govern- Group. The pension fund’s last China investment ments that saw new projects as ways to broaden was in 2007. their revenue base through transfer taxes. In August 2013, a Blackstone Group Asia-fo- Results were mixed. Land expropriation for cused real estate fund made a $322 million bid to development increasingly sparked corruption acquire Chinese property developer Tysan Hold- claims and threatened public unrest. Average ings, Ltd. A month earlier, Texas private-equity apartment rents were 8–10 times the average firm Century Bridge Capital invested USD 44.4 nationwide income in 2012 in many Chinese cit- million in a joint venture with Hong Kong-listed ies; in Beijing and Shanghai the ratio approached property developer Coastal Greenland Ltd. to 30 times the average. Mortgage defaults were on build a residential project in Wuhan. the rise. By 2011, second home mortgages required a Bay Area Architects Ride Out the Storm 60 percent down payment and carried interest Even with volatility and a market slowdown in rates of 110 percent; second homes sold within 2011–12, Bay Area architectural and urban plan- five years of purchase were subject to high ning firms have seen their business in China grow. transaction taxes. Pilot property tax programs “We were clearly in a highly speculative stage of were introduced in Shanghai and Chongqing. the real estate economy leading to 2008–09,” The city of Beijing established a five-year resi- recalls Gene Schnair, managing partner for the dency requirement for buyers not holding a Bei- San Francisco office of Skidmore, Owings & jing hukou permanent residency registration and Merrill LLP (SOM). “Opportunities for the most limited the number of homes local and non-local part seemed random. The first generation of real buyers can own. estate developers put up cash for their invest- Home prices fell in late 2011 by a cumulative ments because it was one of the few places be- 0.3 percent across 70 cities; investment fell nearly yond a very limited equity market to invest.” 4 percent. Office space under construction na- The move to Tier 2 and Tier 3 cities reflected tionwide fell 8.8 percent as projects were put on government policies and the trend toward mass hold or cancelled; residential floor space con- urbanization. “Government has to raise revenue tracted nearly 25 percent. China’s National Bu- at the municipal level, and land transactions are reau of Statistics reported a 54 percent year-on- the most direct way to do that,” Schnair says. “To year drop in foreign fund investment in the China maximize the value of development rights, cities property market in the first half of 2012. caught on to the fact that they need master plans Projects on the drawing boards for Tier 2 and to create value. This spawned a whole cycle of Tier 3 cities have fallen off sharply, as more large-scale, mixed-use developments.” speculative proposals dried up. The shakeout has Surviving stable projects outside the major cit- left the mature office and retail segments in Tier 1 ies have tended to involve established developers cities more or less intact but also growing more with strong government connections and support slowly. Occurring as the economy was already and no strong public opposition. Schnair says SOM slowing, the economic effects have been unset- benefitted from longstanding relationships with tling, impacting both property values and mu- major developers, following them as they moved nicipal finances that are highly dependent on into Tier 2 and Tier 3 markets. But for the most land sales. Property markets turned up again in part, his firm has focused on Tier 1 projects. 2013, but concern with unsold inventories and a Among these are the Ritz-Carlton Financial Street potential asset bubble remain. Hotel, the U.S. Embassy, the China World Trade Foreign investors are slowly returning, but in- Center, and the Poly International Plaza office vestments are selective. In August 2012, for exam- complex in Beijing; the Huawei Technologies Cor- ple, the California Public Employees Retirement porate Campus and the Knowledge and Innova- System (CalPERS) announced a $530 million in- tion Community technology park in Shanghai; and vestment in two new funds offered by ARA Asset the 71-story solar and wind temperature-controlled Management, part of Li Ka-Shing’s Cheung Kong Pearl River Tower in Guangzhou.

57 Ties That Bind, 2014 Edition

Poly International Plaza, Beijing Source: SOM

San Francisco-based Gensler currently has 35 million square feet under construction in China— equivalent to the entire financial district of San Francisco—with another 35 million nearing construction. A further 20 million square feet are in the conceptual design stage. Included are projects such as the Shanghai Tow- er, the second tallest structure in the world, with an even taller tower about to break ground in Suzhou. The spiraling, wind-powered Shanghai Tower is considered a model of sustainable construction in China, having earned both LEED Gold and the equivalent China Green Building Design Label three-star ratings. Gensler clients include General Motors, retailer Diesel, and Chinese headquarters companies such as Tencent and ICBC Bank. Most of these projects are in cities in China’s interior, not Beijing or Shanghai, which may lead Gensler to open an office in Chengdu. The firm is working on master planning projects ranging from individual blocks to a city-scale 100-square-kilometer site in Zhuhai. Gensler’s Asia practice head Dan Winey notes that sustainability and green design are in growing demand and that 90 percent of the firm’s buildings in China are either China three-star or LEED certified. But the big answer to sustainability, he believes, is in how you design cities. Shanghai Tower Source: Gensler

58 Key Industry Sectors

Guangzhou Textile Industry & Trade Complex Source: Heller Manus Architects

With 300 employees in China now, and 500 ex- committed to China, the firm is looking now to pected in the next few years, 80 percent of the take more advantage of domestic opportunities. firm’s clients are Chinese companies. This is having The shakeout has not been entirely negative; secondary payoffs, as Chinese clients are starting many projects that fell by the wayside were nei- to call on the firm’s services as they expand out- ther well-planned nor fully funded and ate up side of China: new projects include a 10,000- time and resources with proposals that went no- square-foot office for Tencent in Palo Alto, and a where. “From our view, the ‘slowdown’ in China regional headquarters in Laos for ICBC Bank. validated our focus on working with seasoned Steps taken by the Chinese government to clients capable of supporting high quality devel- cool the property market focused on housing, opment,” says Carsten Voecker, a director of hitting the newer, more speculative projects Woods Bagot based in San Francisco. “We cer- hardest. Jeffrey Heller, president of Heller Manus tainly shared our colleagues’ concern, but ulti- Architects, said China accounted for two-thirds mately the new government policies have helped of his firm’s business at the beginning of 2012; a to stabilize the market.” year later it was around half. “Suddenly every- Woods Bagot—with U.S. studios in San Fran- thing was on hold, going in slow motion; people cisco and New York and China studios in Beijing, were slow to pay. I checked with colleagues; Shanghai and Hong Kong—has designed a wide everyone was in the same boat.” range of projects in the region. The firm’s Beijing San Francisco-based landscape architecture projects alone include Sunshine Insurance CBD firm SWA Group confirms the experience of other headquarters; the Vanke Retail and Mixed-Use firms—that China business provided a lifeline for Center; and the 1.5-million-square-foot, 790-foot- architecture, planning and design firms in the lead- tall mixed-use CBD Tower Z11. Other current pro- up to and during the global downturn, but that jects include Wanxiang Century Center, a three- improving markets at home are leading to a re- tower mixed-use development in Hangzhou; the balancing. Since its establishment in 2010, SWA’s master plan for the 900-acre China Southern Air- Shanghai office has grown to thirty employees, port City in Guangzhou; the master plan for Dalian and during the recession China accounted for Harbour, a mixed use waterfront development in more than 50 percent of its business. While the port city of Dalian; the award-winning master

59 Ties That Bind, 2014 Edition plan for Xiasha Eco Business Park in Hangzhou; the Plantronics, designed and constructed by an- Pinggu Eco-Resort in the Zhejiang province; and other Bay Area firm, Bechtel Corp. GT Land’s Landmark Plaza East twin mixed-use China’s own equivalent of LEED, the Green towers, each measuring 920-feet, in Guangzhou. Building Design Label three-star system launched Woods Bagot’s global studio model also in 2006, has certified more than 200 mostly supports U.S. clients in building their overseas government buildings. The Ministry of Housing presence. The firm’s San Francisco and Hong and Urban-Rural Development program is a Kong studios have partnered with one highly points-based rating system that offers develop- recognized company based in California to de- ers more flexibility than LEED to choose the liver projects in China. High-level design work is credits they want to pursue, with ratings in each carried out in San Francisco in collaboration with of six categories—land savings and outdoor the client, while documentation and construc- environment; energy savings; water savings; tion administration is delivered from one of the materials savings; indoor environmental quality; Woods Bagot local Chinese studios. and operations and management—that range In Pursuit of Green from one to three stars. Bay Area firms bring specific expertise to the ta- Woods Bagot’s Carsten Voecker, with his spe- ble in bidding for China projects. The region is cial interest in the design of high-performance strong in urban planning, with a focus on livable building systems, says that the comparatively communities and sustainable, green develop- young China market is particularly exciting be- ment. Leadership in Energy and Environmental cause the rapid pace of change has encouraged Design (LEED) certification from the U.S. Green an openness to new ideas. “There is a more im- Building Council (USGBC) carries cachet in China, mediate focus on finding the best solution and a suggesting advanced design, materials and proc- peer-review-based approvals system to support esses that command higher sale and lease prices innovation,” he explains. “Here, our more estab- while lowering overall operating costs. lished practices and relative conservatism have LEED-certified building space amounting to made it harder to advance new approaches.” some 80 million square feet was completed in Architects agree that working with the local de- China by the end of 2011—more than any other sign institutes (LDIs) has not been a constraint, as country outside the U.S. The first LEED-certified they have become increasingly sophisticated in facility in China in 2006 was the $18 million terms of design, and the LDI relationship is im- Suzhou manufacturing and design center for portant in the same way as the developer relation- Santa Cruz-based maker of Bluetooth headsets ship in navigating a volatile market.

Xiasha Eco Business Park, Hangshou Source: Woods Bagot

60 Key Industry Sectors

Government has also embraced clean tech- studio in Shanghai and later with Shui On Land), nology and energy conservation, as it faces Steinberg arranged a trip in 2008 that led to his mounting demand from a growing urban middle first China project—a 25-year master plan for the class to address poor air and water quality—much 175-acre City University in Hong Kong. of it from coal-fired utility plants and state-owned From there, an employee connected Steinberg factories. For the longer term, attention is fo- with his fellow Tsinghua University alumnus work- cused on the concept of “eco-cities” that feature ing with a local design institute. That led to a din- zero-energy buildings, zero-emissions transport, ner meeting in Chengdu with the CEO of a major recycled resources and sustainable development. Chinese development firm, Overseas Chinese A 30-square-kilometer prototype city of 350,000, Town Group, who asked Steinberg to look over a cooperative venture of China and Singapore, is some design drawings and offer his thoughts. Not under construction outside Tianjin, with comple- long after, Steinberg Architects was managing the tion scheduled for 2020. design for a 5-million-square-foot 5,000-unit resi- Demand for master-planned commercial dis- dential project in Chengdu. tricts, residential neighborhoods and new commu- From a cramped representative office in nities has grown in recent years. Larger projects Shanghai, Steinberg won the contract for a 150- need to address issues like transit, climate, energy acre master plan for the city of Chengdu and two and water supplies, and open space. mixed-use projects in downtown Shanghai. By Jeffrey Heller says that most master plan pro- 2011, Steinberg had 15 China projects in the jects are real and are going forward, especially works. In early 2012, it began design for the now that uncertainty over the 2013 government 7,000-acre, 80 million square foot Changsha transition has been resolved. For Heller-Manus, Songya Hu residential/office/retail complex in Tier 2 cities are where the new opportunities are. southern China, working with developers Songya The firm began working in China in 2006, with an Lake Co. and Aptech. Steinberg Architects now emphasis on large, planned, sustainable projects, has a staff of 25 in Shanghai that is expected to including the China Automotive Technology & double over time. China accounts for about 20 Research Center in Tianjin; the Guangzhou Inter- percent of the firm’s total business. national Fashion Center; master planning for the Bay Area architectural and planning firms see a Guangzhou city center and business district; the new set of opportunities on the horizon, as Chi- Xiangyun Island International Cruise Terminal in nese investment in businesses and property out- northeast China; the Nansha Eco-City master plan side China ramps up. So far, outbound investment at the mouth of the Pearl River; and the Ulanhot has been modest and has not extended to signa- Hedong District urban design in inner Mongolia. ture projects, but that is expected to change. Steinberg Architects has a 60-year history in When it does, the skill sets of local firms in pushing the Bay Area, and played a leading role in the the design envelope while navigating the complex development of Silicon Valley from what had system of building codes and planning review will been mostly orchards. As the Santa Clara resi- be essential. And existing relationships with Chi- dential market matured, the Steinberg Group nese clients, investors and developers will provide expanded throughout the Bay Area and later into a helpful competitive edge. Southern California. Rob Steinberg graduated from UC Berkeley, ENERGY/ENVIRONMENT joined his father’s firm in 1977 and took over as president in 1994. His exposure to China came in Small Steps Matter 2007, just before the global downturn. “We had a China is second only to the U.S. as a consumer of general awareness that China was a market we energy. With domestic consumption rising and should look at but we weren’t sure how to go increased production of shale oil in the U.S., about it,” Steinberg recalls. Through architect China is expected to become the world’s largest David Nieh, (formerly chief architect for the City oil importer by 2014. It is also the world’s largest of San Jose, then director of SOM’s urban design generator of CO2 emissions.

61 Ties That Bind, 2014 Edition

Coal is a uniquely important issue in China. By Even if coal were not the dominant energy the end of the 11th Five-Year Plan in 2011, China source in China, explosive economic growth and ranked first in coal production, with an output of urbanization would be taking an environmental 3.18 billion tons; first in hydropower generation, toll. Residential and commercial buildings account with 230,000 megawatts (MW) of installed capac- for about 20 percent of China’s total energy con- ity; and first in nuclear power, with 15 operating sumption. China adds an average 1.7 billion plants and 26 more on the drawing boards with a square meters of building space annually. Building combined generating capacity of nearly 42,000 energy consumption increased by 150 percent MW. China was the leader in wind generation, from 1996–2008, particularly in cities in the hot with 47,000 grid-connected MW. summer/cold winter areas of China’s interior. An China boasts 90 percent energy self-suffi- estimated 20–25 billion square meters of urban ciency, largely because of coal, which generates residential and government buildings will be con- 77 percent of the country’s electricity and is the structed over 2010–20. leading fuel for heating and industrial production. Such dramatic growth has amplified the short- In addition, while urban residential use is banned, comings of China’s conventional energy infrastruc- coal and biomass are the principal fuels for heat- ture. Notably, political uncertainty and “quality of ing and cooking in rural areas. life” issues, including health concerns from Chinese coal demand has risen steadily since environmental degradation, are among the most 2000, growing at about 6 percent annually. So commonly cited factors driving an estimated has mine output, growing from 1 billion tons in $225 billion in capital flight abroad in the 12- 2000 to 3.8 billion tons in 2012. In 2008, the gov- month period to the end of September 2012. ernment shut down some of its mines for safety Respiratory ailments are common in major cities, or environmental violations. Coal shortages in particularly among children. In 2013, severe air turn closed nearly 60 utility plants and led to pollution in Beijing led the city to introduce new electricity rationing and outages. For the first regulations that shut down factories, limit vehicle time, China became a net coal importer; imports use, and suspend classes when conditions are have increased each year since 2009, reaching particularly bad. In October, heavy smog in North- 227 million tons in 2012. Similarly, oil imports east China forced the closure of all expressways accounted for 57 percent of consumption in and a major airport due to poor visibility as well as China in 2011, up from 32 percent in 2000. the suspension of primary and middle school China sees coal as essential to its continued classes in Harbin as a health precaution. Visibility in economic development and its overall energy Harbin was down to 20 meters. security: oil exploration and drilling at home In the face of these pressures, China has em- involves foreign joint ventures, and imports are barked in the past decade on a nationwide pro- vulnerable to geopolitics, supply disruptions gram of energy restructuring, including heating, and price volatility in global markets. Coal is a cooling, window, lighting and insulation retrofits low-cost, plentiful, accessible, domestically for buildings and a heightened focus on sustain- available energy source. It is also taking a toll, able and green design principles. In part to ad- however, on health and on air and water quality dress growing environmental concerns, and in across China and, because China burns more part to create national industries that can pene- coal than all other countries combined, on trate global markets, China is also aggressively global CO2 emissions. promoting the research and deployment of re- As one of many indicators pointing to environ- newable energy and electric vehicles. mental pollution as a source of political discon- China’s electric vehicle market is the world’s tent among Chinese citizens, a recent study by fifth largest after Japan, the U.S., France and Ger- MIT, Peking University, Tsinghua University and many. Despite substantial government subsidies Hebrew University of Jerusalem found that in for purchases of domestically-produced electric parts of China, life expectancy had been cut by vehicles (EVs), high costs have limited consumer more than five years due to coal combustion. uptake. With central government encouragement,

62 Key Industry Sectors however, EV producers are aligning with local the Pearl River Mouth Basin of the South China governments to develop large-scale pilot pro- Sea, discovering oil in 1985 in the Huizhou oil grams throughout the country. fields. Production began in 1990. The 12th Five-Year Plan includes an “all-of- Today Chevron has production-sharing con- the-above” energy diversification strategy that tracts covering eight oil and gas exploration  caps annual coal consumption through 2015; blocks in China. In four of these, Chevron has an  expands coal mitigation measures, from wash- operating interest—one for deepwater drilling in ing and land reclamation at mines to liquefied the South China Sea, two signed in 2012 for coal and methane capture technology; shallow-water blocks in the Pearl River Basin, and  mandates greater energy efficiency for indus- a fourth onshore at the 487,000-acre Chuan- trial plants and commercial buildings; dongbei gas field in Sichuan Province. The com-  sets targets for non-fossil fuel as a share of pany is developing two other fields in the area total energy consumption—11.4 percent in and is building two gas processing plants with a 2015, rising to 15 percent in 2020; combined daily capacity of 740 million cubic feet  sets reduction targets for energy consumption at a combined cost of $6.4 billion. First-phase in 2015 at 16 percent below 2010 levels, and completion is scheduled for late 2013 as initial

for CO2 emissions at 17 percent below 2010 exploratory wells are drilled. levels; and In 2012, Chevron began exploratory drilling  creates new energy efficiency and conserva- for shale gas in the Qiannan Basin in south- tion standards. central China, with additional drilling to com- Despite these initiatives, China’s reliance on mence in 2013. It is also a 50 percent partner in coal and other fossil fuel sources is unlikely to the CPChem polystyrene plant in Zhangjiagang, change soon. which produces 100,000 metric tons of petro- In September 2013, China took another step chemical resin annually for use in manufacturing to rein in its coal consumption, banning new coal- plastics products. fired power plants in the vicinity of Beijing, San Francisco-based construction and engi- Shanghai and Guangzhou. But even as China neering firm Bechtel Corp. has offices in Beijing, moves to cut coal’s share of primary energy con- Shanghai, Shenzhen, Hong Kong and Taipei and sumption, the absolute amount of coal burned has been active in China since 1979 with more will continue to increase. than 80 projects. Its signature energy-related California companies, utilities, government project was managing construction of the $4.3 agencies, non-governmental organizations, entre- billion CSPC Nanhai Petrochemicals Project in preneurs and investors are involved at virtually all Huizhou, a CNOOC-Shell complex of 11 plants— levels in advising on and helping with implemen- including an 800,000-ton annual capacity ethyl- tation of China’s Energy Development Plan—from ene cracker—completed in 2005. shale gas drilling joint ventures and consulting on In April 2012, Bechtel signed a consulting nuclear plant design, to start-ups offering new en- agreement with the China Nuclear Power Engi- ergy metering and sensor technologies, to pilot neering Co. (CNPE) to provide training and projects bringing cleaner, energy-efficient motors, education in project management, as the govern- boilers and solar cookers to rural areas. ment moved to end its moratorium on new nuclear plant approvals and complete inspections of ex- Conventional Energy isting plants following the March 2011 Fukushima Chevron Corp. sold kerosene for lamps and plant meltdown in Japan. China has since re- home heating in China as early as 1904, later stored nuclear power to the mix of non-fossil fuel opening service stations and sales outlets in ma- energy sources, along with renewables, with a jor Chinese cities and marketing petroleum prod- target to generate 30 percent of the country’s ucts under the Caltex brand. It re-entered China power by 2015. in 1979 as an offshore exploration and drilling Chinese energy firms, meanwhile, are eyeing partner with China National Petroleum Corp. in the fast-growing U.S. natural gas market: in

63 Ties That Bind, 2014 Edition

February 2013, China Petroleum & Chemical CEG receives roughly a third of its funding from Corp. (Sinopec), Asia’s largest refiner, announced each of three sources: government, mainly the it would pay $1.02 billion for half of Chesapeake Department of Energy, Department of State and Energy Corp.’s 850,000-acre Mississippi Lime the U.S. Environmental Protection Agency (EPA); shale reserves in Oklahoma. Sinopec had already foundations and nongovernmental organiza- bought a third of Devon Energy’s interest in five tions, in particular the San Francisco-based En- gas fields for $2.2 billion in January 2012. Sino- ergy Foundation; and other sources such as in- chem Group bought a stake in Pioneer Natural kind gifts from private companies. Resources Co.’s Wolfcamp shale field assets in Energy conservation and efficiency have be- Texas for $1.7 billion in January 2013. come key components of Chinese policy regarding Chinese clean energy producer ENN Group not only energy production, but also the manage- Co. Ltd. announced in March 2013 a limited partment of economic growth and urbanization. This is nership with CH4 Energy Corp. of Salt Lake City occurring as an emerging middle class and mass (operating as Blu LNG) to build 50 natural gas migration from rural areas to cities is generating fueling stations along U.S. highways in its first major impacts in transportation, utility usage and year. ENN already operates a network of similar construction, making this a national priority. The air stations in China. The move is a “build it and they quality impacts of energy use are receiving even will come” effort to meet projected future de- greater attention recently, and there are numerous mand in the long-haul trucking and fleet vehicle efforts to link improved energy efficiency with re- markets across the nation, including California. duction in local air pollutants. LBNL’s research and consulting work has ac- Efficiency and Conservation cordingly expanded in recent years, helping to In June 1987, Lawrence Berkeley National Labo- build the policy framework and introduce tech- ratory (LBNL) researchers Mark D. Levine and Bo nological advances to support increased adop- Adamson presented a paper, “Energy Use in tion of energy efficiency. Some examples include Buildings: The U.S. Experience and Lessons for the following: China,” at a joint U.S.-China symposium in Nan-  CEG supported the development of govern- jing sponsored and organized from the U.S. side ment regulations for appliance energy effi- by the U.S. Department of Energy. ciency standards and labeling, testing manu- The report noted that commercial and residen- facturer claims and compliance, and improving tial buildings accounted for 36 percent of total U.S. efficiency for over 30 consumer appliances. energy consumption at the time; outlined potential  CEG helped draft China’s building energy stan- energy savings from better insulation, window dards in the 1990s. It has advised on building glazing, lighting and passive design, and more codes in Shanghai and four cities in southern efficient heating, cooling and appliances; dis- China and has rolled out a pilot windows rating cussed policy options for encouraging adoption of and labeling program in Guangzhou. best practices, from new government standards to  The Group introduced the concept of negoti- rebates and low-interest loan programs; and ated agreements through a pilot project which stressed, as a first step, the need for comprehen- led to China’s Top-1,000 (now Top-10,000) sive energy consumption data collection in Chi- Energy-Consuming Enterprises program. nese cities. The Group provides resources and technical LBNL at that time already had a track record assistance for this program, including bench- advising Southeast Asian governments on en- marking the performance of China's major ergy efficiency. But interest and projects grow- energy-consuming industries such as steel ing out of that initial presentation led Levine to and cement production. found a separate China Energy Group (CEG) at  Modeling tools developed by CEG enable the Lab in 1988, to manage joint research and cement, steel, textile and process heating technical support projects with companion in- firms to analyze relative environmental and stitutes and government bodies in China. Today cost impacts of various strategies.

64 Key Industry Sectors

The China Energy Group also provides advice California’s recently-adopted carbon trading pro- and training for the China Energy Conservation gram. China currently has cooperative cap and and Environmental Protection (CECEP) group, a trade pilot programs with the European Union in state-owned enterprise charged with developing Beijing, Guangdong, Shenzhen and Tianjin, and it conservation, emissions reduction and environ- plans a nationwide market as part of the 12th mental protection technologies and projects. Five-Year Plan. CECEP, with more than 170 subsidiaries and a In June 2013, following on the governor’s workforce of 40,000, oversees $3.7 billion in cen- trip, the California Air Resources Board (CARB) tral government investment in some 3,000 pro- signed a memorandum of understanding with jects in China. the Shenzhen Development and Reform Com- In all, LBNL has over 50 active projects under- mission (SDRC) to exchange information and way in collaboration with China, involving future expand cooperation relating to their pilot cap low-emissions pathways, low-carbon eco-city and trade programs. The collaboration is in- development, policies for low-carbon markets, tended to monitor research, share best practices energy system planning and grid integration, low and build effective systems for data gathering, emission and efficient industries, and low emis- emissions verification, market monitoring, com- sion and efficient buildings and equipment. pliance and enforcement. As a further outgrowth The China Energy Group’s U.S.-China Clean of the governor’s trip, and additional MOU was Energy Research Center for Buildings Energy signed in San Francisco in September 2013 with Efficiency (CERC-BEE)—one of three centers the National Development and Reform Commis- established at U.S. universities and national sion for the sharing of low-carbon strategies and laboratories—was launched in 2011 following the development of China-California joint ven- meetings between President Obama and Chi- tures for cleantech. The agreement is believed nese President Hu Jintao. The LBNL center is to be the first on climate change between the specifically focused on building energy effi- Chinese government and a U.S. state. ciency. The two other centers, at the University The Energy Foundation, a San Francisco- of West Virginia and the University of Michigan, based sustainable energy grantmaking entity are devoted to research on clean coal and en- formed by major philanthropic foundations— ergy-efficient vehicles, respectively. among them the William and Flora Hewlett Foun- LBNL has partnered with CalCEF, a non-profit dation, the Kresge Foundation and the David and venture-funding group created to accelerate Lucile Packard Foundation—launched Energy cleantech breakthroughs to market, and with Cal- Foundation China with Packard Foundation seed Charge, a consortium of more than 30 battery- funding. It currently has more than 100 partner technology start-ups, to form a Joint Center for institutions in China, including research institutes, Energy Storage and Research (JCESR). JCESR has think tanks, universities and government agencies, been approved as a U.S. Department of Energy as well as partners in California, including the innovation hub, and CalCharge hopes to partner California Public Utilities Commission, the Califor- with Chinese companies to manufacture lighter, nia Energy Commission, and UC Davis. cheaper, longer-life vehicle and industrial batteries. The Energy Foundation has a representative of- In a related effort, the Lab hosted a battery fice in Beijing with sponsorship from the govern- technology workshop in China in April 2013, co- ment’s National Development and Reform Com- inciding with a China delegation led by Gov. mission (NDRC). Its Senior Policy Advisory Council Jerry Brown, during which Fremont-based Tesla includes ministerial-level officials and it counts Motors announced the opening of Beijing and ministry director-generals among its Dialogue Shanghai dealerships for its line of high-perform- Partners. With a $29 million annual budget, Energy ance electric cars. As part of that delegation, Foundation China acts as a catalyst for capacity LBNL co-hosted a conference at Tsinghua Univer- building and sharing of best practices, supporting sity on the “California Carbon-Free Economy,” initiatives in low-carbon development, transporta- examining the effectiveness and implications of tion, renewable energy, electric utilities, buildings,

65 Ties That Bind, 2014 Edition industry, environmental management and sustain- six Chinese cities, designing mixed-use, transit- able cities. Program grantees advised China’s oriented communities with dense street networks, State Council in drafting the stricter PM 2.5 par- bicycle lanes and pedestrian walkways, short ticulate matter emissions standards, to be imple- commutes and mixed-use zoning, as an alterna- mented first in major cities and nationwide by tive to the previous Chinese model of single-use 2016. Prior to adoption of the standards in 2012, residential or commercial “super blocks.” The the government had refused to even monitor fine- Foundation has supported the design of a BRT particle emissions, which are associated with many (bus rapid transit) project for Jinan City. The pro- serious pollution-related health effects. ject that is furthest along is in Kunming, the capi- Some other projects in which Energy Founda- tal of Yunnan province in southwest China, where tion China has been involved are Berkeley-based Calthorpe Associates is devel-  a Beijing Sustainable Development Center- oping the master plan. Tsinghua University program to promote clean Lin sees huge opportunity in China’s commit- vehicle fuels and technology for use during ment to sustainable energy, carbon reduction, the 2008 Olympic Games in Beijing; conservation and environmental mitigation con-  an initiative by the Chinese Academy for tained in the 12th Five-Year Plan. In clean energy Environmental Planning to develop alone, China has committed a total expenditure enforcement regulations for a national cap and of $473 billion over 2011–15. That suggests sig- trade policy; nificant business opportunities for overseas ven-  a 12-year collaboration with China National dors and for venture-funded energy technology Institute of Standards (CNIS) to develop and start-ups on both sides of the Pacific. implement energy efficiency standards for A San Francisco-based public-private partner- appliances, lighting, water heaters, air ship formed in 2004, the China-U.S. Energy conditioning and home electronics; and Efficiency Alliance, with funding and technical  a detailed 2012 status report on building support from the U.S. Agency for International energy efficiency in China, prepared by the Development (USAID) and the non-profit National Global Buildings Performance Network in Resources Defense Council (NRDC), has negoti- cooperation with Chinese government, ated a series of memoranda of understanding with university and professional experts. Chinese government bodies. Among them are According to Jiang Lin, the Energy Founda-  MOUs with Hebei Province and Chongqing tion’s senior vice president for strategy and analy- Municipality to provide policy planning and sis, the net annual energy savings projected once technical and training support for utility the CNIS standards are fully implemented by demand-side management (DSM) pro- manufacturers nationwide will exceed the 18,000 grams, and with Shanghai and Sichuan MW of power generated by the Three Gorges Province for energy savings and emissions Dam in a year. reduction programs; “Our primary goal is to help China transition to  a framework agreement between the State a more sustainable energy future,” says Lin, who of California and Jiangsu Province to share believes that the most significant challenge facing information and best practices and to col- China today is mass urbanization. “Hundreds of laborate in the areas of emissions reduction, millions of people are moving from rural areas to renewable energy, energy efficiency and the cities. That means China has to build hundreds environmental protection; and of new cities. How those cities are built will have a  a May 2013 MOU with the U.S. Department of huge impact—in terms of congestion, of the car- Commerce to jointly market U.S. energy effi- bon footprint—on how livable those cities are. ciency and smart building products and We’re trying to bring a new pattern of urban de- services and increase access to the Chinese sign and land use from the very beginning.” market for related firms. Reflecting this, Energy Foundation China and Alliance partners include California’s three its environmental design partners have projects in major utilities, Pacific Gas and Electric, Southern

66 Key Industry Sectors

California Edison and San Diego Gas & Electric, federal stimulus money, such as Solyndra now a unit of Sempra Energy. The group also Corp., Fisker Automotive and A123 Battery; includes venture investors, Honeywell, and niche  oil prices stabilizing in the $90–100 per barrel energy efficiency firms with active China strate- range, and an expanded supply of domestic gies, including: natural gas which has driven down conven-  Nexant, a global consulting firm headquartered tional energy costs relative to renewables; and in San Francisco that specializes in advising  inability to reach a global climate change con- utility, energy, chemical and financial sector sensus that would capture the full competitive clients on energy management, cleantech, cost of fossil fuel consumption through emis- hedging, billing and other solutions. It has had sions standards, cap-and-trade programs or a presence in Shanghai for several years and carbon taxes. expanded into Beijing in 2012 through a China and California find themselves at the partnership with local petrochemical industry intersection of these trends, both shaping and consulting firm Chem1. reacting to the global cleantech market. China is  EnerNOC, a smart-grid designer and developer driven by growing energy and environmental specializing in utility demand response (DR) concerns at home, and by government policies programs to manage power consumption by designed to support Chinese emergence as a large commercial and residential customers global player in the renewable energy sector. during peak demand surges. Based in Boston, it California, for its part, leads all other U.S. states has offices in San Francisco and Walnut Creek. in advancing energy and climate policies and en-  Opower, a company launched in San Francisco couraging renewables development; is the recipi- in 2007 with Silicon Valley venture capital ent of the lion’s share of U.S. cleantech investment; funding. It now has 250 employees and is the nation’s largest market for clean energy designs customer energy conservation technologies; and is the largest U.S. producer of incentive programs for 75 U.S. utilities, using those technologies. Most of the state’s cleantech behavior models and data analytics. companies and related investment are concentrated in the Bay Area. This suggests potential CLEANTECH synergies. How California, the Bay Area and China A Bright Future…Someday engage on these issues will have a significant im- On its surface, the public and commercial benefit pact on both national and global trends. of clean technology is obvious: reduced energy Comparing investment, according to Bloom- consumption, cleaner air and water, cost savings berg New Energy Finance (BNEF), the U.S. claimed through efficiency, and the slowing or arrest of the leading position in cleantech investment in climate change and its impacts. Over time, the 2011, totaling $48.1 billion versus China’s $45.5 transition to clean technology and processes is billion. In 2012, China’s investment grew 20 per- widely accepted as a certainty. cent to $68 billion, while U.S. spending fell 37 The path forward has not been easy. Following percent to $35 billion. The U.S. (primarily Cali- a period of expansion, market capitalization of fornia) enjoys a large lead in venture investment, and venture investment in cleantech companies but China benefits from much larger govern- worldwide fell sharply in 2012, as the industry ment investment. remains hostage to a range of external factors: Many of these issues and opportunities are re- primary among these are fossil fuel prices on flected in the solar power sector. Reflecting the world markets; government regulation, research growing importance of the California market, funding and subsidies; and global climate change China’s major producers of solar panels— policy. Since 2008, cleantech companies in Cali- SunTech Power, Trina Solar and Yingli Green fornia have been hit by a convergence of Energy—established North American headquar-  global recession; ters in the Bay Area. Also operating in the region  cuts to U.S. cleantech R&D spending following are smaller producers such as Silevo, a Fremont- the high-profile failures of firms accepting based solar manufacturer with Chinese-American

67 Ties That Bind, 2014 Edition management and venture funding from the Chi- and Greece. Since 2011, many European solar nese affiliates of U.S. venture firms Madrone manufacturers have, like their counterparts in the Capital and Mayfield Fund. Silevo recently opened U.S., either failed or scaled back production, due its first production line in China, but eventually to a combination of weakening demand and Chi- plans to manufacture in the U.S. nese imports whose prices have fallen 75 percent China’s low-cost advantage in producing solar since 2009. In June 2013, the European Union and wind generation equipment has helped make announced provisional tariffs on imported Chinese both large-scale generation projects and small- panels, but in August reached a compromise un- scale residential installation cost competitive. It has der which it would waive antidumping tariffs for also, however, led to trade frictions with domestic Chinese manufacturers who agreed to a schedule manufacturers, installers, and companies with so- of minimum prices and volume limits. The agree- phisticated solar panel and wind turbine technol- ment was confirmed in December 2013 with ogy. At the heart of the debate is the allegation participating Chinese exporters being exempted that Chinese producers unfairly benefit from gov- from antidumping levies ranging from 27 to 64 ernment subsidies and are dumping panels (i.e., percent. Chinese solar companies, faced with selling at below cost) in the United States. overproduction and falling prices, are themselves Domestic stakeholders have been divided on under financial pressure, with Suntech Power, the such complaints, with manufacturers feeling in- world’s largest solar panel manufacturer declaring tense competitive pressure (Chinese competition bankruptcy in March 2013 and being absorbed by was a factor in the high-profile demise of Bay two competitors in a rescue arranged by Jiangsu Area solar company Solyndra). Installers and con- Province, where all three firms are based. Other sumers, however, who have benefitted from fal- companies are also facing large debt burdens. ling prices, see increased costs from higher tariffs Parallel developments are affecting wind gen- on Chinese imports negatively impacting what eration. In December 2012, Commerce upheld a has been a fast-growing market. Tariff opponents similar complaint from five domestic wind turbine and advocates of clean power cite the stimulative manufacturers—among them General Electric effect of falling prices on solar deployments and Corp. and Siemens AG—against Chinese and the substantial employment generated by the Vietnamese firms and imposed 46–71 percent domestic installment industry. antidumping penalties plus 21–35 percent coun- In October 2012, the U.S. Department of tervailing duties. A federal grand jury in Wiscon- Commerce sided with domestic solar panel sin indicted employees of Sinovel, China’s largest manufacturers on a 2011 complaint brought by an wind turbine manufacturer, for conspiring to steal Oregon-based subsidiary of German panel maker electricity flow control software from Massachu- Solar World Group. The complaint alleged that setts-based American Superconductor Corp. Chinese manufacturers, with government support, (AMSC) in 2011. Following the theft, Sinovel re- were dumping panels below cost on the U.S. mar- fused delivery of a $700 million order from ket in order to lock in market share in a nascent AMSC, resulting in a loss of 500 jobs at the firm. growth industry. Commerce imposed antidumping penalties of 18–32 percent on 61 major Chinese Solar Flare companies who participated in the U.S. Interna- Trina Solar was launched in 1997 in Changzhou, tional Trade Commission investigation (companies Jiangsu Province by CEO Jifan Gao, who had been declining to participate saw 250 percent penalties a solar panel installer in China in the early 1990s. imposed), and countervailing duties of 14–16 per- With its U.S. headquarters in the Bay Area, the cent on companies determined to be receiving company entered the California market in 2009, anticompetitive government subsidies. responding to the California Solar Initiative (CSI), a In addition to being the major source of solar rebate program for home and building owners panels installed in the U.S., China is also the main who install solar heating and electrical systems on supplier of solar panels in major European markets rooftops to displace power they would ordinarily including Germany, Italy, France, Spain, the U.K. draw from utility grids. CSI rebates are in addition

68 Key Industry Sectors to federal tax credits amounting to 30 percent of At the end of 2012, Trina’s installed base in system acquisition and installation costs. As of the U.S. totaled approximately 3 GW, half of it in June 2013, California boasted more than 153,000 California. Among its major projects are a 32- solar projects generating nearly 1,600 megawatts acre, 5 MW project with nearly 30,000 panels in (MW) of electric power statewide. Porterville for Southern California Edison (SCE), With market growth, the global market share completed in 2011; a 1.25 MW rooftop panel of China’s five largest module producers—Trina, project at Treasury Winery Estates near San Luis Suntech Power, Yingli Green Energy, Jinko Solar Obispo, completed in 2010; and a 45 MW supply and Canadian Solar—grew. Production also grew agreement signed with SCE in 2010, involving rapidly, producing a worldwide glut that drove third-party installation of solar panels on com- solar panel prices down by 75 percent between mercial rooftops in Southern California. 2009 and early 2013. Trina is a supplier to third-party developers and The effects of overproduction in China have installers like Solar City, SunRun, Sungevity and been aggravated by a falloff in demand from SunEdison (formerly chip manufacturer MEMC Europe, which until recently accounted for nearly Electronic Materials) that have projects nationwide, 60 percent of global demand. This occurred as including in California. It also draws on Silicon Val- recession, tight credit and government austerity ley suppliers like National Semiconductor, Applied have reduced subsidies and taken large projects Materials and QBotix of Menlo Park for integrated off the drawing boards. As demand from Europe circuits, materials and software tools that help op- has slowed, China has increasingly focused on timize panel performance. It also relies on high- the U.S. market and California in particular, where grade polysilicon from the U.S. in the manufacture policies to support cleantech deployment and of PV cells for its modules. address climate change are most advanced. Despite 18 percent antidumping duties and 16 China’s government is also seeking to stimulate percent countervailing duties which Trina begins domestic demand, targeting 10,000 MW of new paying in 2013, Mendenhall—who left SunEdison installed base in 2013. to take over Trina’s U.S. operations in 2012—says Trina president for the Americas Mark the company can still compete in the U.S. market Mendenhall remains hopeful about California, through modular construction that offers installers which has more installed solar capacity than the innovation, cost savings and convenience in a next five states combined. “Trina came to the ready-to-install package. U.S. expecting that California would become one of the leading areas of solar deployment in the Small Solutions, Big Benefits in China U.S., and it’s true,” he says, but another reason With funding tight and domestic markets grow- was access to capital markets—from banks like ing but constrained, California firms—including Wells Fargo and Bank of America—as well as small and medium-sized businesses with new from venture capital, solar developers, green energy efficiency technologies and services— funds and other sources. have turned their attention to overseas markets, California’s consistent policies to encourage including China. For its part in recent years, deployment of renewable energy—from the CSI China has begun to invest in U.S. energy tech- to 2006 legislation (AB 32) setting a target of re- nology firms, even as the sector has cooled for ducing California’s total greenhouse gas emis- domestic investors. sions to 1990 levels by 2020 and mandating a Bridgelux, a Livermore industrial LED lighting minimum percentage of utility electric power technology developer, saw opportunity in the generation from renewable sources—have pro- China market where the government has used vided an incentive to project developers and local government procurement and high tariffs on suppliers to invest in the California market. In imports to encourage broad deployment of LED. 2010, voters upheld AB 32 against a repeal chal- In 2012, Kaistar Lighting (Xiamen) Co. invested $25 lenge, Proposition 23, confirming the state’s million in Bridgelux to accelerate R&D and pro- commitment to these policies. duction of LED chip and packaging technology.

69 Ties That Bind, 2014 Edition

The combination of Bridgelux technology and for smaller firms and start-ups. A case in point is Kaistar’s manufacturing cost advantage is ex- MakeSens, a Silicon Valley producer of energy- pected to expand the LED market in China and saving position, directional and current sensors, help both companies compete against global most notably used to identify potential failures brands like GE and Philips. and re-distribute lithium-ion battery power in MiaSole, a Santa Clara maker of copper in- electric vehicles and smart grids. MakeSens prin- dium gallium selenide (CIGS) thin-film solar cells, cipal Dr. Xian (Sean) Yan says lithium-ion battery raised $550 million in venture funding over 2006– and electric vehicle technology have enormous 12 from firms such as Kleiner Perkins, Bessemer potential, but the economics are daunting. The Ventures and VantagePoint. In 2012, MiaSole unique characteristics of China’s market and became a casualty of the solar panel glut and California’s policies, however, offer an opening. falling prices; it was acquired for $120 million by “California is really way ahead in electric vehi- Hanergy Holdings Group, a Chinese renewable cles and energy storage,” Yan explains. “California energy developer. Hanergy has pledged to policies and incentives are one reason we have maintain MiaSole’s U.S. workforce of 100, pump Tesla, for example.” But the jump from a laptop new investment into the company and increase with six cells to a Tesla sports car or S-model se- its sales in China. dan with 6,800 cells entails huge operating com- Some firms have made inroads by bringing plexity and cost. “The bottom line with battery technology to the table that brings added effi- storage is price versus performance; if you can ciency and value to lower-cost Chinese produc- balance the two, then the market really takes off.” tion. Petaluma-based Enphase Energy, launched More than 20 million motorbikes and scooters in 2006, makes microinverters that attach to indi- are sold each year in China, nearly all powered vidual solar panels in an array, convert direct until now by inefficient lead-acid batteries. In current solar power to AC current that supplies some respects, 2012 saw a “perfect storm” in the electricity grids, and automatically monitor and sector: sales still struggling since 2008 from the optimize power output for each panel. Enphase global downturn were further hit by government has an office in Shanghai and its microinverters air quality restrictions on motorcycle use in large are embedded in panels made by Upsolar and cities; 70 percent of China’s 2,000 conventional Hanwha SolarOne. battery factories have been closed since 2011 Advanced battery developer and manufacturer due to lead poisoning concerns; and multi- Envia Systems, based in Newark, is on track to industry competition among autos, motorcycles bring to market in 2015 an electric car battery and electric vehicles (including e-bicycles and e- with three times the efficiency of a Chevrolet Volt scooters) has increased, as electric vehicle battery while lowering the vehicle price by an manufacturers have expanded urban and rural estimated $5,000. A recipient of federal stimulus sales networks. Lithium-ion batteries are three as well as venture funding, Envia’s strategic ad- times as efficient in terms of storage capacity and vantage lies in patented nanocomposite battery battery life, but are also three times the cost. cell technology that increases storage capacity, Made more efficient and reliable through sensor battery life and safety. The company holds 20 technology and produced at the scale of China’s patents for its technology and counts among its market for motorbikes—as well as small fleet util- partners the U.S. Department of Energy, the De- ity vehicles or urban two-passenger smart cars— fense Advanced Research Projects Agency and this represents a sweet spot for his company and General Motors. Its Newark headquarters infor the broader industry. cludes a materials innovation lab and a pilot pro- Yan, originally from Shanghai, travels to China duction facility for fabrication of battery materials; frequently to meet with potential battery partners cell prototyping and manufacturing are done in and vehicle customers, and he has headed Jiaxing, China. CASPA delegations at conferences organized in Finding that optimum mix of technology at the cooperation with its PRC counterpart, SEMI right price point is not always simple, especially China. Local governments in Tier 2 and Tier 3

70 Key Industry Sectors cities are eager to attract new technologies that BANKING/FINANCE ultimately help build research clusters in already established industry sectors such as automotive. Slow Money A more immediate challenge for companies China’s banking market has more than $18 trillion such as MakeSens is capital. Yan notes that in total assets, $13 trillion in deposits and $9.3 venture capital support for both cleantech and trillion in loans. A 2011 report by PwC estimates for early-stage financing has ebbed in recent that China will overtake the U.S. as the world’s years. For now, the company is getting by on largest banking market by 2023. Foreign banks, angel investor support as the hunt for Chinese however, are not sharing in the prosperity. partners continues. Overseas banks in China have invested more ZAP, a Santa Rosa supplier of electric utility than $60 billion in domestic banks, branch net- trucks and vans, motorcycles, scooters and ATVs works, technology, branding and training. As of using the company’s advanced drive train and mid-2012, Bloomberg estimated those 181 banks battery technology, entered the China market in from 45 countries earned back a combined $10 2009 through a joint venture with Hangzhou elec- billion, held 1.6 percent of deposits and made 1.7 tric metering firm Holley Group and with financing percent of loans from only 387 of the country’s from Chinese VC investor Better World Interna- 67,000 bank branches. Three foreign banks— tional. The venture, ZAP Hangzhou, was estab- HSBC, Standard Chartered and Citi—account for lished to combine ZAP and Holley technology in more than 230 of those branches. building fleet vehicles for the China market. Barriers to market entry are considerable and In January 2010 ZAP, with financing support have changed little in more than a decade. For- from Chinese cross-border VC firm Cathaya Capital eign banks must have at least $10 billion in as- LLC, undertook a $36 million, 51 percent acquisi- sets and maintain a representative office for two tion of Zhejiang Jonway Automobile Co., Ltd., a years before they can incorporate and obtain a maker of electric cars, motorcycles and scooters. banking license. They are limited in the number The acquisition was completed in early 2011, and and location of branches they may open each the company was renamed ZAP Jonway. Its first year and must operate for three years—two of product was the E-380, a lithium-ion battery- those years showing a profit—before they can powered version of Jonway’s A380 three-door and offer a full range of local currency banking ser- five-door small SUVs featuring ZAP’s electric drive vices on par with domestic competitors. Reviews train. A lower-priced lead-acid battery model is and approvals at each step can add months or also available and a hybrid version is under devel- years to the process. opment. The acquisition substantially improved Foreign bank loan portfolio value may not ex- ZAP’s access to the China market: the new vehicle ceed 75 percent of capitalization; with deposits is sold through Jonway’s nationwide dealer net- constrained by branch limits, so are lending ca- work and is eligible for government incentives pacity and market share unless banks recapitalize offered to electric car buyers. internally. Regulatory barriers have delayed ap- In late 2010, ZAP signed an agreement with the provals to issue RMB credit and debit cards, dis- city of Shanghai to supply battery swap, charging tribute mutual funds, set up trust funds and serve and maintenance facilities in the Yangpu District. as custodians of investment accounts. Until banks ZAP also agreed to develop a pilot Electric Vehicle can offer full local currency services, they are ef- Eco-City program, deploying its vehicles in fectively denied access to state-owned enterprises, Yangpu’s transit shuttle, taxi and government wealthy private banking clients and other key cus- vehicle fleets. In 2012, ZAP Jonway received $12.7 tomer segments. million in dealership financing from China What is left for the banks has largely been a Everbright Bank and won China National Grid ap- mix of offshore and approved onshore dollar- proval for its E380-S battery-swap model vehicle to denominated loans and deposits, Chinese off- be used in Hangzhou taxis and leased commercial shore corporate and private banking, and business vehicles as part of a fast-swap pilot program. advisory services.

71 Ties That Bind, 2014 Edition

Do You Know Where Your Money Is? lending at unsustainable levels; short term inter- It should be noted that there is logic to the regu- bank rates rose 200 basis points in a week. lations beyond simply protecting domestic banks In such an environment, government caution from competition. Slower GDP growth, lending about further market opening is not surprising. excesses over successive property and commod- While foreign banks have limited their exposure ity bubbles, and state-directed lending to SOEs from ownership positions, they are also reassess- and local governments have left major Chinese ing their strategies and carving out geographic or banks exposed. service niches for the long term, either alone or Local government debt alone, much of it held through tie-ins with Chinese banks. by Chinese banks, is believed to total $1.7 trillion. Total non-performing bank loans are estimated at Bay Area Banking Flows $73 billion. Much of the bad debt is in local gov- San Francisco-based Wells Fargo Bank has two ernment financing vehicles (LGFVs), instruments branches, in Shanghai and Beijing, and offers first introduced by China Development Bank, remittance services through an affiliation with which lends for public infrastructure development. Agricultural Bank of China. In 2010, Wells bought Local governments have little autonomy to raise out HSBC’s remaining interest in their joint Wells taxes to finance public works. LGFVs create an Fargo HSBC Trade Bank venture, which had op- incentive to seize land, collateralize it, then borrow erated since 1995. The subsidiary facilitates against it to fund large projects. Many projects— trade transactions at either end with letter of housing, office towers, stadiums—increase land credit, bankers’ acceptance, receivables financ- values but may not generate sufficient revenue to ing, documentary collection, foreign exchange repay debt. This creates pressure to seize even and other services. more land to pay the interest and borrow against Bank of America’s Asia-Pacific operations that to build more, in a vicious cycle. activities, with 27,000 employees, are head- Banks, under government instructions to roll quartered in Hong Kong. Even with growth over this debt, have rushed to raise fresh capital slowing, the bank sees opportunities in China, through offshore debt and share listings and particularly in serving mid-market U.S. compa- through securitization of troubled loans into high- nies with operations in China. Activity by Chinese yield “wealth management products” (WMPs) companies that are expanding internationally is sold through unregulated pools. also increasing. The bank has offices in Beijing, China’s shadow financial system is signifi- Shanghai and Guangzhou serving corporate cant—as much as $4.8 trillion at the end of 2012, clients, but no retail branches. according to an April 2013 San Francisco Federal Silicon Valley Bank (SVB), headquartered in Reserve report, equivalent to 57 percent of GDP Santa Clara, holds a unique position in China due and 31 percent of total bank assets. Shadow fi- to its technology specialization and strong ven- nance may include mortgages from trust compa- ture/private equity client base. SVB became active nies or brokerages, small business loans from in China in 1999, organizing visiting delegations, SOEs, and WMPs offered by trust companies, hosting seminars and arranging introductions in insurers, private equity firms or brokerages as both directions. It opened Shanghai and Beijing short-term investments with higher interest rates subsidiary offices in 2005 and 2010, respectively, than banks can pay. Much of this business is ulti- and received its license in 2011, enabling it to mately financed with money initially borrowed handle onshore dollar-based transactions. from the banks. SVB has a stake in a Hangzhou loan guaranty The shadow banking system has grown 34 corporation and manages two local renminbi percent annually, adding leverage and risk to the funds for the Yangpu District in Shanghai. In formal system. In June 2013, the People’s Bank of 2012, it formed a joint venture bank—SPD Silicon China tightened the money supply, withholding Valley Bank—with Shanghai Pudong Develop- RMB 2 billion ($325 million) from the market in a ment Bank, the first joint venture bank to obtain a signal to banks that it would no longer support license in 15 years.

72 Key Industry Sectors

“We need to work in China in renminbi; that’s firms with specialized products and services being the holy grail for foreign banks,” says SVB chair- promoted by the current Five-Year Plan—in man Ken Wilcox, noting that 95 percent of tech healthcare, telecom, IT, cleantech and environ- industry business in China is done in renminbi. mental mitigation—will stand to benefit. For Chi- “For China, it’s all about the banks’ ability to fi- nese companies and investors looking to expand nance innovation. There are as many as 2,000 VCs into new overseas markets, Chinese banks do not in China today. Government plays a role in all of yet have the global reach, expertise or range of them, but much of the investment is misallocated.” services to assist much of that business, he says. Not enough attention is paid to business model Garrett adds that investment capital flows from innovation and sound management, Wilcox says, China represent “a huge opportunity for Califor- and that has worked to SVB’s advantage. nia. It’s going to come as Chinese firms take their In addition to providing specialized financing businesses global, and they’ll be looking for the and trade-related services for the cleantech, life biggest markets, where the culture is the same or sciences and venture/private equity sectors, SVB close to theirs. It’s California’s to win.” also has developed a specialization in the wine Hong Kong and Taiwan banks have a long industry, representing more than 300 West Coast history in the Bay Area, and now PRC banks are wineries in California, Oregon and Washington. making an initial approach. Industrial and Com- Bank of Tokyo-Mitsubishi UFJ (BTMU) has mercial Bank of China (ICBC) has five Bay Area been active in China since 1980. It has 16 retail branches—in San Francisco, Oakland and branches in Tier 1 and Tier 2 cities and a China South San Francisco—through its 80 percent in- workforce of 2,400. The scale and scope of its terest in Bank of East Asia, a Hong Kong-owned activities has helped its U.S. subsidiary, Union bank chartered in the U.S. The ICBC application Bank, land China-related business on both sides was approved in May 2012 after lengthy U.S. of the Pacific. Federal Reserve and Federal Deposit Insurance In 2009, Union Bank created a Global Business Corp. reviews, since it entails retail banking and Coordination Unit to leverage its California pres- thus federally insured deposits. ence and BTMU’s China network. In addition to The Bank of Communications, after a three- traditional trade finance and foreign exchange year wait, has been approved to open a second services, the new unit works with BTMU China to wholesale branch outside New York, in down- offer to cross-border businesses in-country credit, town San Francisco. The bank offers business-to- cash management, and investment solutions, as business services aimed primarily at Chinese and well as international RMB-denominated trade Chinese-American clients in the Bay Area. settlement and currency hedging instruments both onshore and offshore via the Hong Kong Credit Cards: A Charged Issue CNH market. Despite staggering growth in the past decade, Union Bank senior vice president and global credit card penetration in China remains relatively business manager Bob Garrett sees enormous low. McKinsey Global Institute estimated that the opportunities in both directions. “Anyone who number of credit cards issued in China grew from makes things or provides services in California 11 million in 2004 to 124 million in 2008, and either has a China strategy or is thinking about People’s Bank of China data for 2011 placed the one; they’re looking to make an acquisition, open number at 268 million; 42 percent of urban resi- a sales office, or access manufacturing partners or dents told a 2011 survey they had at least one source materials,” he says. “People went to China credit card. originally as an export platform, but much of the But those numbers can be deceptive in terms of foreign direct investment we see today is aimed actual revenue. With a near 50 percent savings at selling into the China market itself.” rate, a tendency to pay off outstanding balances Garrett observes that many businesses with within the month, and household debt already the resources and track record to succeed in high from big-ticket home mortgage, medical and China are already there. However, small California education expenses, discretionary spending on

73 Ties That Bind, 2014 Edition credit cards in China has been limited. That, in branded cards; works with client banks to expand turn, has also kept merchant fees low. Major its acceptance network through installation of discretionary card purchases are often made point-of-sale terminals and ATMs; develops overseas: credit card purchases made abroad by credit, debit and prepaid options for consumers, Chinese tourists have grown sharply; U.S. pur- as well as corporate card products; promotes chases have increased more than 30 percent security in the payment card industry and fights annually for most of the past decade. bankcard fraud; and partners with government Card issuers such as Visa, MasterCard and and trade groups on China tourism promotion. It American Express normally earn payment proc- has played a leading role in the transition from essing fees, but in China all card issuers must use a magnetic stripe to embedded-chip ‘EMV’ cards, single domestic payment processor, China Union- and in 2008 it launched the first Visa ‘contactless’ Pay (CUP) for yuan-denominated transactions. CUP card product in China—the Peony-Parkson Pay- was founded in 2002 by 85 Chinese banks under Wave card, a tie-in with Beijing Parkson Shopping the auspices of China’s State Council and the Peo- Center and ICBC. ple’s Bank of China. All merchants and ATM ma- Visa is hoping these long-term investments will chines in China are required to accept CUP credit be rewarded over time in a more open credit and debit cards; CUP is the world’s largest issuer card issuance and payment clearance market, of credit and debit cards, with 2.9 billion cards in particularly as the anticipated easing of currency circulation (Visa is number two with 2.3 billion), and controls goes forward. the third largest in terms of transaction value. Responding to a U.S. complaint, the WTO Hong Kong—The Financial Intermediary ruled in July 2012 that China must end CUP’s China is pursuing incremental financial re- effective monopoly on payment processing, but it form—on its own timetable. It has a stated inter- determined that foreign credit/debit card issuers est in internationalizing its currency and opening can operate in China through co-branded part- its markets. As an interim step, it is taking full nerships with Chinese banks, and it upheld advantage of Hong Kong’s status as a special China’s right to regulate cross-border clearance administrative region of the country since the end of payments into China. To date, China has nei- of British colonial rule in 1997, using it as a labo- ther challenged the ruling nor outlined specific ratory for financial modernization. steps or a time frame for reform. Under the “one-country-two-systems” arrange- Visa, headquartered in Foster City, became ment guaranteed through 2047, Hong Kong’s the first international card brand accepted in common law system, predictable regulatory China when Bank of China’s Guangdong branch framework and simple tax structure (16.5 percent began providing cash service in 1979 to Visa profits tax; salaries tax capped at 15 percent; no cardholder customers with Hong Kong’s Bank of sales, dividend/interest or capital gains taxes) have East Asia. The first Visa card in China was issued supported its continuing role as a major global by Bank of China in 1987. financial center and China gateway, with The firm set up representative offices in Bei-  over 200 licensed banks and deposit-taking jing and Shanghai in 1993 and 1996, respectively. companies, plus some 61 overseas bank rep- Guangdong Development Bank issued the first resentative offices from 35 countries and a RMB-denominated Visa card in China in 1995; daily interbank turnover of HKD 212.4 billion ICBC issued the first dual-currency card in 1996. (as of the end of August 2013); Visa was a technical consultant to China’s Golden  one of the world’s major insurance centers, Card Project, the precursor to China UnionPay. with 154 authorized insurance companies of CUP became a Visa principal member in 2002 which 71 (46 percent) are from 20 overseas and the two have been collaborators and com- countries or mainland China; petitors since.  an offshore RMB center handling cross- Working with 23 domestic and international border trade settlement of some RMB 2,600 financial institutions in China, Visa develops billion in 2012; in the first eight months of

74 Key Industry Sectors

2013, RMB trade settlement handled through RMB, first allowed for five provinces in 2009, ex- banks in Hong Kong amounted to RMB 2,285 panded to 20 in 2010, and permitted nationwide billion, representing a year-on-year increase in 2011. Settlement volume by Hong Kong banks of 35 percent; in the first eight months of 2013 reached RMB  Asia’s second largest stock market, with more 2,285 billion. That, in turn, has contributed to a than 1,570 listed companies (including close total of RMB 857 billion in accumulated offshore to 750 mainland enterprises) with a combined deposits and certificates of deposit in banks in market capitalization of $2.8 trillion as of Hong Kong as of August 2013—big business for August 2013; foreign banks registered in Hong Kong.  Asia’s second largest ETF market in turnover, But how long will this situation last? China is with USD 85 billion traded in the first eight internationalizing its currency, but the process is months of 2013, 61 percent in mainland shares; gradual and closely managed. This is benefitting  a liquid debt market of USD 261 billion in out- Hong Kong, but competition is coming. standing debt securities (at the end of 2012) with an average UAD 2.4 billion traded daily, Partners Across the Border? plus over 1,840 authorized unit trusts and The next phase of the experiment may take place mutual funds; at Qianhai Bay, a 15-square-kilometer planned  an active market for initial public offerings development in Shenzhen. Qianhai is to be es- (IPOs), with USD 33 billion raised in 2011 tablished as a finance, information and logistics (although 2012 IPOs were off by two-thirds, hub offering a low 15 percent corporate tax and raising USD 12 billion); and concessionary personal income taxes to attract  a leading international fund management hub, talent—a profile similar to Hong Kong, but with with USD 1.1 trillion in assets under manage- an important added feature. ment in 2012. China’s National Development Reform Coun- Investment options are scarce in China, be- cil (NDRC) has invited large mainland and for- cause of the tendency to create asset bubbles and eign financial institutions and fund managers to a relative inability to assess and manage risk. Pent- locate within Qianhai, permitting them to raise up demand for liquidity and higher yield is putting renminbi offshore—in Hong Kong—to invest on pressure on China to liberalize its financial markets. the mainland. Companies registered in Qianhai In this context, Hong Kong has provided the will be able to issue bonds and obtain loans via mainland with a window into markets for ETFs, Hong Kong. index funds, options, futures and derivatives and Qianhai is the government’s third attempt at a offers foreigners a platform to play the China special zone enabling currency internationalization, market through H shares (mainland-incorporated following programs launched and later discontin- firms listing in Hong Kong) and P-chip shares ued in Wenzhou and Tianjin. At its heart are eased (Chinese companies incorporated offshore and restrictions on offshore investment by institutions listed in China). These shares permit VC and pri- and wealthy individuals as Qualified Domestic In- vate equity investors to buy stakes in PRC com- stitutional Investors (QDIIs) and Qualified Foreign panies, structure IPOs or merge firms, and then Institutional Investors (QFIIs). The first of the new exit and repatriate profits. and revised rules were issued in early 2013. The Similarly, Hong Kong was the test location be- challenge for regulators is to set thresholds that ginning in 2007 for issuance of “dim sum bonds,” attract large financial institutions, but also to set yuan-denominated bonds sold by the Chinese limits that effectively manage risk. government, banks and companies to offshore Shanghai also sees its role as a global finance investors. From its first year when RMB 10 billion hub expanding in tandem with easing of currency in bonds were issued, the total outstanding controls. Settlement of trade transactions in reached RMB 292 billion by September 2013. Shanghai dates back to 1842, and the original Hong Kong also benefitted from the gradual Shanghai Stock Exchange opened in 1891. The introduction of cross-border trade settlement in Exchange closed following the 1949 revolution

75 Ties That Bind, 2014 Edition and was re-established in 1990. In 2012, the Na-  Computing has moved from the desktop to tional Development and Reform Commission mobile devices and the cloud, and as bank- (NDRC) released a long-term development plan ing, retail, entertainment, travel and govern- for Shanghai that includes development of an ex- ment services become available online, on panded Shanghai Financial Center. By 2015, China demand, on a 24/7 basis via multiple chan- plans to launch an international board on the nels, brick-and-mortar businesses have seen Shanghai Stock Exchange to allow overseas com- wide-scale disruption. pany listings and trading in foreign stocks, deriva-  Big data, social media and mobile payments tives, bonds and gold. The 2013 launch of a 28- are creating rich personal and brand-driven square-kilometer free trade zone in greater Shang- business ecosystems that keep users con- hai will, among other things, facilitate cross-border nected in a real-time feedback loop of settlement of yuan transactions and expand the marketing data. currency’s use in trade, finance and insurance. In China, as in most emerging economies, In October 2013, the government took a further mobile technology has leapfrogged an inefficient step toward internationalizing the yuan by an- national wireline telephone monopoly. China’s nouncing during a visit by Vice Premier Ma Kai that online markets are growing exponentially: data London will become the first major trading hub for storage and management firm Network Appli- Chinese currency outside Asia. ances estimates annual turnover in China’s data All of this will necessitate conformity with in- storage and management market at $2 billion, ternational standards and practices in law, taxa- among the world’s largest. Alibaba expects trans- tion, and supervision. A 2011 Brookings Institu- actions hosted by its main online shopping sites, tion report suggested that Shanghai’s success will Taobao and Tmall, to reach $473 billion in the depend on a broader offer of financial products; next five years. According to the Boston Con- wider global use of the renminbi; an expanded sulting Group, online retail sales in China are “soft” infrastructure of related services; and a projected to triple to more than $360 billion by liberalized commercial law framework for struc- 2015, overtaking the U.S. as the world’s largest turing and adjudicating transactions. In a 2012 online market. PwC survey, foreign banks stressed two overarching prerequisites: meaningful currency and It Starts with a Phone Call interest rate liberalization. China’s state-owned telecom providers are at the heart of the country’s Internet architecture. In MOBILE/INTERNET 1999, the monopoly wireline phone company, Everything Is Interconnected China Telecom, was broken up, its assets in 10 It is much more difficult today than in the past to northern provinces given to China Netcom (now make distinctions among tech market seg- China Unicom), formed in 1994 as a wireless pager ments—computing, networks, mobile and wire- and mobile provider. China Mobile, launched in line broadband, data storage and analytics, so- 1997, emerged as a nationwide wireless provider cial media, entertainment—as the lines between after the China Telecom breakup. them become more and more blurred. All are As demand for more sophisticated mobile ser- increasingly part of a single set of tools that vices has grown, China Mobile has often strug- work in various combinations to serve particular gled to innovate. Introduction of the 3G smart- markets. The trends shaping the tech sector phone in Tier 1 cities was initially handed off to today include the following: China Telecom and China Unicom in 2009. China  The cost of computing—both on the hardware Mobile remains the baseline national provider of side and the software side—has fallen sharply, 2G rural services and has steadily expanded its even as devices become smaller and more pow- 3G phone and data offerings. It is the world’s erful, and as computing finds new applications largest mobile provider, with 745 million sub- in cars, appliances, smart buildings, manufactur- scribers; in Q1 2013, it had 114 million 3G cus- ing, power generation and agriculture. tomers, up from 60 million a year earlier.

76 Key Industry Sectors

China Telecom and China Unicom operate on penetration. Most Chinese are still on 2G feature conventional CDMA standards prevalent in the phones without Internet capability. U.S. China Mobile has gradually migrated from Industry analyst Canalys estimates that 30 per- the European GSM mobile standard, to a new, cent of the 840 million mobile phones sold distinctly Chinese version TD-SCDMA, that fo- worldwide in 2013—some 240 million—will be cuses on data capacity rather than voice call clar- sold in China. Research firm IDC estimates that ity. This is significant for handset and chipset China accounted for 26.5 percent of global makers seeking access to China Mobile’s cus- smartphone sales in 2012, passing the U.S. as the tomer base. world’s largest smartphone market. Apple’s early decision to adopt the GSM The total number of people online in China— standard for the iPhone, with an eye toward the via wireline or mobile—is about 560 million, a 42 high-end European market, delayed the phone’s percent penetration. Most access the Internet on release in China, but the firm did obtain a li- phones, while more expensive personal com- cense to offer the iPhone on China Mobile’s puters are used in cafes and workplaces. network, with rollout in late 2013. By providing Much of China’s original Internet infrastructure access to its more than 700 million subscribers, was developed by major Silicon Valley companies the partnership with China Mobile, which in- like Cisco Systems, Sun Microsystems and Oracle. volves the lower-cost iPhone 5, may improve Equipment and software were installed within Apple’s market share (5 percent), which has government agencies, SOEs and universities at been declining relative to competitors such as concessionary prices in the 1980s and 1990s, in Samsung (18 percent), Lenovo (12 percent), the hope of building early ecosystems of users Huawei (9 percent) and fast-growing Xiaomi (5 that would generate repeat contract business percent). Apple’s high cost—$815 for an iPhone over time. 5 compared to an average smartphone cost of Many of China’s premier Internet companies $200—has been a factor that the lower-cost also have roots in Silicon Valley. Baidu, the model offered through China Mobile may also leading Chinese search portal, was founded in help to address. Apple’s current customers are 1999 by Robin Li, who previously headed search concentrated in affluent cities such as Beijing engine development at Infoseek in Sunnyvale, and Shanghai, while the fastest market growth is and Eric Xu, a UC Berkeley graduate in bio- now in smaller and inland cities where China chemistry with extensive Valley connections. Mobile enjoys a strong position. Consumer Web portals Sina Corp. and Sohu.com received trade-ups in those cities, from older feature early venture funding from Valley investors, as phones to smartphones, offer an opportunity for did Internet portal Tencent, online payment Apple—if it can hit the right price points. provider YeePay, social media site 51.com, ap- In the meantime, Google’s Android operating plications developer NetEase, online travel ser- system dominates in China, with just over 70 per- vice Ctrip, and game designers Shanda Inter- cent of smartphone market share as of July 2013, active and The9. up nearly 9 percent from a year earlier. Prices for Global web portal Yahoo! and search firm 3G smartphones are falling sharply, to as little as Google got off to successful starts in China, but $99, and Android powers most of the low-cost stalled over freedom of speech and censorship phones made by Chinese producers like Huawei, issues. Yahoo! complied with Chinese law in ZTE, Lenovo and Xiaomi. 2005 and provided the government with IP ad- As of April 2013, China’s Ministry of Industry dress information on dissidents which led to and Information Technology (MIIT) reported 1.16 their arrests and imprisonment; Google agreed billion mobile phone users nationwide, up 13 to filter politically sensitive key search terms percent year-on-year. In the same time, 3G sub- from its system in 2006. Both incidents proved scribers grew by 84 percent to 293.1 million and damaging. In 2013, Yahoo! Mail was closed are projected to reach 375–400 million by year down in China, after falling to a 2 percent mar- end 2013—still at best a 40 percent market ket share.

77 Ties That Bind, 2014 Edition

China’s Online Search Traffic Market Share, September 2013

70% Traffic Share in Page Views 60% Traffic Share in Unique Visits 50%

40%

30%

20%

10%

0 Baidu Qihoo 360 Sogou Soso Google Bing Yahoo Youdao Others (So.com)

Source: Marbridge Consulting, Beijing

Yahoo! had been instrumental in the launch partnership to provide filtered search for of business-to-business (B2B) search engine mainland portal Qihoo 360. Alibaba.com, and in the face of political and LinkedIn has been operating in China for a market challenges eventually traded its China decade, with more than 4 million members. It will operations and $1 billion for a 40 percent stake in offer a new Chinese language site in 2014 and Alibaba, which has since bought back half of that plans to comply with government requirements position. The transaction netted Yahoo! $7.6 that may limit some content. Facebook and billion; its remaining stake in Alibaba continues to Twitter have not agreed to government censor- account for a significant share of Yahoo’s capital ship and are not available in China. value. Alibaba is rapidly expanding its reach Hong Kong is aggressively marketing itself beyond B2B, to include consumer transactions and as a location for secure data center operations finance: its Tmall claims 70,000 online storefronts, to serve the mainland market; Apple has been and in 2012 it’s 11.11 Shopping Festival processed scouting locations for its first offshore data $2.5 billion in transactions in 24 hours, more than center in Hong Kong, targeted to open in Black Friday and Cyber Monday combined. 2015. Bay Area suppliers such as San Jose- A 2009 cyber attack on Gmail accounts of based data storage media manufacturer Microdia Chinese human rights activists in 2009, presuma- and Arkologic Ltd., a Fremont supplier of high- bly at government direction, led Google to pub- capacity solid-state drive storage solutions licly announce that it would no longer censor its for the chip design, biotech and cloud com- search results. In March 2010, the company an- puting sectors, base their Asia operations in nounced that it would shut down its Google.cn Hong Kong. site and offer unfiltered China search via its Hong The digital economy connects China and Kong site Google.hk, while keeping its mainland the Bay Area not only through telecom and R&D center and sales presence. In December Internet, but through emerging sectors such as 2011, Google broke ground on a 2.7-acre, $100 gaming. San Francisco Game developer Zinga, million data center at the Tseung Kwan O Indus- for example, employs 250 game developers in trial Estate in Hong Kong. It has since entered a its Beijing office.

78 Key Industry Sectors

Game Strategy Online gaming is rapidly going global, and game developers and ani- mators speak a common technical language. No surprise, then, that interactive animation development lends itself well to cross-border collaboration—not just for games but for apps, feature-length films, and beyond. San Francisco digital art and animation studio Concept Art House (CAH) has been in China since its inception in 2007, with a studio in Shanghai’s Yangpu District. It began with three founders and two employees and as of early 2013 had a staff numbering 140–200 in San Francisco and 120 in Shanghai. Founders included concept artist James Zhang, who provided digital art solutions for Star Wars Galaxies published by LucasArts and Lair for PlayStation; Matthew Le Merle, a Booz-Allen consultant and gaming enthusiast who joined as an investor; and Xuan Li, who led CAH’s China expansion by building capacity and winning contracts with Shanda and Tencent, including work on Worlds of Warcraft, a fa- vorite online game in China with 7 million users. Other clients have included NBC, Disney, AOL and Sina. CAH chose Yangpu for its proximity to universities and the cluster of digital artists that had begun to form in what had been an industrial area. “We got a brand new facility, with infrastructure just being built out, near the largest concentration of students studying digital arts in the world.” Le Merle says that the Bay Area-China linkage makes good business sense on several levels: demand for higher-quality entertainment is growing among China’s rising middle class; costs of making traditional live action films (or buying older titles from catalogues) and physically distributing them to larger audiences in emerging markets are up sharply; Bay Area companies are at the cutting edge of digital technology, but lack enough skilled workers locally to serve global markets; Chinese studios have upped their game significantly in terms of quality; and the time difference enables CAH to work on client projects 24/7. “China has a reputation as a place to get rapid turnaround of product,” Le Merle says, “but it has also proven to be an active market in its own right.” The Shanghai studio has recently taken on more autonomy, he adds, doing its own business development and account management. The volume of available skilled talent is key. “We pay normal wages and work normal hours, we’re fully compliant with all regulations and standards,” he stresses, “and we still have a cost advantage.” Using this business model, CAH sees new market opportunities going forward, beginning with digital trading cards or graphic novels. But the big market could be online education, particularly as libraries become digitized and schools offer courses beyond their physical, local boundaries. “I see a lot of value in examining how we use technology to educate a much larger population,” Le Merle says. “Why doesn’t it make sense for 100 million Chinese to get an education without neces- sarily having proximity to professors or classrooms?”

79 Ties That Bind, 2014 Edition

Major Firms Find Their Niche known brand and the right connections. In all, Legacy Silicon Valley tech firms, active in China Oracle has 16 branch offices, 4 R&D centers, since the 1980s, have seen their early investments 3 solutions centers, 1 customer support center, in infrastructure, R&D centers and university pro- 2 consulting centers and some 1,500 partners, grams pay off. But as the China market matures 25,000 customers and over 4,500 employees and domestic competitors expand their low-cost, in China. off-the-shelf solutions and services, margins are Oracle’s clients include the following: being squeezed, and success is a function of  Ping An Bank uses Oracle’s FLEXCUBE core scale and finding new niche business. banking solution to cross-sell products and Oracle Corp. entered China in 1989 with a assess related risk. clear strategy—to partner with government, busi-  China Mobile, China Telecom and China ness and academia to embed their technology in Unicom use Oracle’s Exadata Database as much of China’s initial computing and network engineered system for a variety of data architecture as possible, laying the foundation for management solutions, including both long-term business growth. online transaction processing (OLTP) and “Going back twenty years,” says Oracle senior data warehousing. director of business development Brad Tewks-  Metallurgical Corp. of China in Chongqing bury, “you’d go in, find a partner, then to get uses Oracle software to create a Database as anywhere in winning government contracts you a Service (DaaS) model to run its business of needed to show skin in the game by building constructing steel plants around the globe. R&D centers. For software companies you’d in- Oracle was an early partner in 2005 with Chi- vest in centers of excellence focusing on key ver- nese developer Shui On Land at SOL’s knowl- ticals—finance in Shanghai, government in Bei- edge and innovation community in Shanghai’s jing, manufacturing in Shenzhen. Moving forward Yangpu district. An Oracle Advanced Technology over the years, you’d need to do training through Solution Centre has been testing software prod- the universities and through the R&D labs for ucts for the China market in areas such as dis- customized projects.” tance learning, broadband content, e-commerce Oracle currently serves its top 500 enterprise and radio frequency identification (RFID) technol- accounts in China—mainly SOEs, government ogy. A Dalian global support center opened in agencies and large institutions—through a dedi- 2007, and is expected to become a full-service cated, direct sales force. A multi-channel focus is outsourcing center for the region. selling database, middleware and application Tewksbury believes Oracle is well-positioned solutions in key public-private verticals such as in China to compete in the big data space, given healthcare, pension benefits and infrastructure. its leadership in data management and analytics One important channel is Chinese software out- solutions. At the low end of the market, large sourcing partner Neusoft: Oracle often places accounts—and especially the government—are staff in its six software centers, providing train- resistant to cloud/software-as-a-service providers ing in particular verticals, and it teams with like Salesforce.com because data resides outside Neusoft to bid on projects. “They can just bid China’s borders; at the other end, China’s tech on a solution and go to market with Oracle as an sector has recently been getting stronger in ISV partner,” Tewksbury says, “and on some hardware but less so in database software and huge-scale government contracts we can go in has no real indigenous database companies to as a quasi-Chinese company.” compete with Oracle for large accounts with In Tier 2 and Tier 3 cities, Oracle is now selling complex data management needs. database, middleware and application solutions Intel Corp.’s Intel China Research Center in retailing, government services, banking and (ICRC), established in 1998 in Beijing, is made up telecom. Once a solution is installed and proves of two labs for research in communications and mi- successful, Tewksbury says, bidding the next job croprocessor technology and an Advanced Plat- and the one after become easy, especially with a form Development Center to develop component

80 Key Industry Sectors technologies and system architectures for Intel’s records and 400,000 electronic medical future chipsets and platform products. In Shang- records, on a monthly basis; hai, the company has a wafer manufacturing  expanded its nationwide Cisco Networking plant; an R&D center that focuses on Flash silicon Academy (CNA) to 51 schools in Sichuan design, chip package development, and digital and all of the province’s vocational colleges, home system development; and a software de- providing information and communications velopment center. Intel opened a $2.5 billion technology (ICT) training for 7,400 students semiconductor manufacturing plant in Dalian in and teachers over 2008–11. 2010 and has a testing and assembly site in The nationwide CNA program, launched in Chengdu. Its combined investment in China to- 1998, offers a blended program of classroom and tals roughly $4.7 billion. cloud-based curricula for training in the design, Intel has more recently partnered with Chi- building, securing and maintenance of computer nese laptop and smartphone manufacturer networks. It has provided university, vocational Lenovo on a new rugged Classmate-Plus laptop and continuing education training to more than for students and the power-efficient, high-end 207,000 students through 2012. K900 smartphone, both powered by versions of The Cisco China Research and Development Intel’s Atom processor. Center (CRDC), established in 2005 in Shanghai’s Cisco Systems has had a China presence since Caohejing Economic Development Zone, is the 1994. It was instrumental in developing China’s firm’s third largest R&D center with 3,300 em- Internet infrastructure and in offering network ployees and branch offices in Hangzhou, Suzhou, connectivity and big data solutions to help gov- Hefei, Beijing and Shenzhen, representing a cu- ernment and business clients achieve scale and mulative $100 million investment. improve productivity across large enterprises. Be- CRDC has launched a joint lab for green tech- yond that, it has partnered with universities and nology with Tsinghua University, the University of provincial governments to provide new education Electronic Science and Technology of China and training opportunities as well as pilot pro- (UESTC), and Chongqing University of Posts and grams that expand delivery of public services. Telecommunications (CUPT), to develop network Rebuilding after the 2008 earthquake in Sichuan platform-based architectures and systems that Province provided a laboratory for redesigning improve energy conservation, emissions reduc- Sichuan’s healthcare and education systems and tion and sustainable growth. The Center also has transforming its workforce, using information and various joint research projects with Tongji Univer- communications technology. Under a three-year, sity, Zhejiang University, the University of Science $50 billion public/private partnership, Cisco: and Technology of China (USTC), Shanghai  developed 94 online schools with 1,140 Jiaotong University, Fudan University, and Beijing technology-enabled classrooms benefitting Jiaotong University. 135,000 students and 8,000 teachers, along More broadly, CRDC’s R&D supports service with a 26-site TelePresence professional de- providers, large enterprises, small and medium velopment network that has helped 112,000 businesses, and consumers domestically and teachers enhance their skills; worldwide, covering a range of networking tech-  built 66 healthcare organizations, 6 regional nologies, including next-generation networks, data healthcare centers, 2 operational centers video, mobile internet, data center virtualization, and an emergency response center in the collaboration and cloud computing, and border- establishment of smart hospitals, mobile less networks. clinics, telehealth services in remote or inaccessible areas and a regional healthcare A Tough U.S. Sell for Chinese Suppliers cloud; today, the system supports 7,000 Global competition from China in telecom has doctors and practitioners, 15,000 inpatients developed more quickly than expected. Huawei, and 280,000 outpatients, and processes 60 the world’s second largest producer of telecom- million rural cooperative medical insurance munications equipment, had $2.7 billion in global

81 Ties That Bind, 2014 Edition revenues in 2002, 10 percent from sales outside nationwide carriers, including in the U.K., Can- China. Its 2012 global revenues totaled $35 bil- ada, Australia and India. lion, 70 percent of that from overseas. In recent With Huawei expanding in the U.S., the issue years Huawei has emerged as a major competitor is significant. At the end of 2012, it posted $1.3 for equipment suppliers like Cisco, both in China billion in revenues and had 1,750 employees in and overseas. the U.S. Its California workforce numbered about Building on its base in telecommunications in- 700, engaged primarily in R&D and marketing— frastructure equipment, Huawei is also seeking to with more than 620 in Santa Clara and more than become a leading global brand for smartphones 100 in San Diego—according to Dean Sirovica, and mobile devices, rivaling dominant players vice president for business development with Samsung and Apple and other producers such as Huawei R&D USA. Nokia, Lenovo, LG and HTC. To compete at Huawei opened its U.S. headquarters in Plano, higher levels globally, like its principal Chinese Texas in 2001 to be close to key telecom firms competitor, ZTE, it is investing more than 10 such as Nortel Networks, AT&T and Texas In- percent of its annual revenues in R&D. struments. “After a few years, they realized that In the U.S., Huawei and ZTE have made in- the telecom market was colliding with the Inter- roads selling basic, high-quality, low-cost network net communications markets, and that the line systems to small business customers and small between delivering telecom and Internet was regional telephone companies. An important becoming very fuzzy,” Sirovica says. Over time, specialty has been high-speed regional broad- Huawei’s flagship R&D center in Santa Clara— band and municipal Wi-Fi in underserved rural one of four in the U.S., has become an increas- areas, as customer demand shifts from wireline to ingly important part of the firm’s growth strategy. wireless and from voice calls to Internet usage, “As the world continues to globalize, any and as major incumbent phone providers have company needs to source technology wherever been reluctant to take on build-out and service it’s being developed,” Sirovica explains. Huawei’s costs in a highly regulated market segment. focus in Silicon Valley is on new growth markets— Huawei not only fills an infrastructure gap for consumer mobile handsets and enterprise cloud rural providers, it is also one of only three global storage and IT. Key verticals include education, competitors—none of them in the U.S.—capable healthcare and electric power. Much of the R&D of building out a 4G-LTE network entirely with its work involves technology licensing. “If you look own equipment, operating system and software. at the way business is evolving in Silicon Valley, U.S. mobile carrier customers include Clearwire, everybody is evolving toward collaborative inno- Hibernia, and Leap Wireless. AT&T and Sprint vation,” he adds. “The days of the white coats at offer Huawei handsets at retail outlets. Bell Labs are gone; they’re looking to start-ups. Both Huawei and ZTE have encountered Huawei is no different. Our desire is to be a pushback in the U.S., U.K., Canada, Australia regular member of the ecosystem and do busi- and India over questions about their technology ness in a regular way.” and pricing structures: whether government That has not been simple. A 2003 joint venture ownership and subsidies give them an unfair between Huawei and network infrastructure firm price advantage; the extent to which they owe 3Com combined licensed 3Com technology and their rapid innovation to illegal technology Huawei’s manufacturing and marketing resources transfer; and whether their network infrastruc- in Asian markets. But a subsequent 2008 Huawei- ture contains Chinese government-mandated Bain Capital bid to acquire network infrastructure “back door” vulnerabilities that enable remote firm 3Com was blocked by the U.S. government, access to monitor data or disable systems. due to 3Com unit Tipping Point’s cyber security Huawei, which is an employee-owned company, work for the U.S. military. 3Com was absorbed in points out that such concerns have never been 2010 by Hewlett-Packard. substantiated and that the company and its gear A similar 2007 joint venture with Mountain View are globally deployed and work with major Internet security firm Symantec ended in 2012

82 Key Industry Sectors when Symantec sold its 49 percent stake back to firms have assured Washington lawmakers that Huawei. A 2011 bid for the technology assets of Sprint would not integrate Chinese equipment into bankrupt 3Leaf Systems, a Santa Clara virtualiza- its network and would replace the Huawei equip- tion company with processing technology to link ment used by Sprint partner Clearwire. servers for low-cost supercomputing, was with- Governments in Canada and Australia also ex- drawn after a negative review from the Committee clude Chinese equipment suppliers from their pro- on Foreign Investment in the U.S. (CFIUS), which curement programs; New Zealand has explicitly regulates security-sensitive foreign investment. opted not to do so. The U.K. and India require Security issues create a conundrum for Huawei inspection and certification of Chinese telecom and for U.S. regulators. Independent analysts equipment imports. The EU threatened an anti- have identified specific security vulnerabilities in dumping investigation into pricing and possible Huawei equipment, but have not alleged that illegal subsidies to Huawei and ZTE involving some they were intentional. A 2012 White House Secu- $1 billion annually in network equipment sales rity Council report cleared Huawei of spying alle- throughout the EU. In August 2013 the investiga- gations, but an October 2012 House Permanent tion was put on hold pending China Mobile’s Select Committee on Intelligence report focused awarding of the contract for its 4G network build- on the difficulties in fully identifying hardware and out; that same month, European vendors Ericsson, software backdoors in a network and criticized Alcatel-Lucent S.A, and Nokia Siemens Networks what it felt were inadequate responses from were together awarded nearly a third of the $3.2 Huawei and ZTE about their business structures billion in contracts. and government ties. The report recommended a Huawei’s Americas revenue grew by only 4.3 ban on federal purchases of Chinese telecom percent in 2012; U.S. revenues, while not made equipment and urged state and local govern- public by the company, were reportedly less ments and U.S. companies not to do business than $2 billion. With sales slowing, a senior with Chinese suppliers. A classified annex of the Huawei executive told an April 2013 analyst call report is said to identify specific network security that the company no longer sees the U.S. mar- breaches but is thinly documented. In light of the ket as a strategic priority, although it will con- fact that no evidence of actual wrongdoing was tinue to sell handsets and service its existing presented, it is difficult for companies like Huawei U.S. customer base. to address such charges. China has criticized these allegations as un- China Calling founded and insists that they reflect a political By contrast, China Telecom and China Unicom agenda and are motivated by protectionism. In maintain comparatively low-profile sales and tech- late October 2012, two weeks after the report nical support offices in San Jose, and China Mo- was released, China Unicom removed core Cisco bile opened a Milpitas R&D center in 2009—its cluster routers from its China169 backbone net- first overseas. China Telecom and China Unicom work serving Wuxi in Jiangsu Province, claiming offer cross-border business voice and data services security issues—a move largely seen as retalia- between the U.S. and China. China Unicom has a tion. Cisco supplies core routers to both China stronger Bay Area presence and also offers tai- Unicom’s China169 network and China Telecom’s lored cloud data and mobile payment solutions. 163-Network, which together handle 80 percent Ben Chen, president of West Region operations of China Internet traffic. for China Unicom Americas, says his company has Congress subsequently enacted a federal ban invested more than $30 million in hardware and on Chinese telecom equipment purchases as part infrastructure for its enterprise service, which offers of the March 2013 budget continuing resolution up to 200 gigabyte capacity. This provides Chi- signed by the president. Language in the provision nese businesses in the U.S. with a level of comfort is vague, referencing both subsidized pricing and about assured capacity, tailored services and secu- security concerns. At about the same time, Japan’s rity. It also makes it easier for a U.S. firm to set up Softbank bid to acquire Sprint-Nextel, and the two an office or facility in China.

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Chen also looks for telecom and Internet in- payment, data centers and the holy grail for tap- novations that potentially benefit the China ping emerging markets—a low-power, full-fea- wireline and mobile markets. China Unicom has tured smartphone delivered for under $100. the largest 3G subscriber base of the Chinese China’s leading Internet search engine, carriers and was Apple’s first iPhone partner in Baidu, has announced plans to open the Insti- China. Its WoStore, launched in 2010, sells tute of Deep Learning (IDL)—its first wholly- mainly apps for Android phones and fills an im- owned research center—in Cupertino. In an- portant niche since Apple sells its own apps, nouncing the new initiative at Baidu’s January Google has scaled back its China presence, and 2013 annual meeting in China, CEO Robin Li private app stores are notorious for pirated code said the IDL will focus on research in the ma- that steals user information. chine learning field, in which computers use So far, China Unicom has taken a risk-averse data analytics to simulate the way a human brain approach in Silicon Valley, licensing technology absorbs information and applies context. A well- but avoiding acquisitions. Among the areas of known example of machine learning is Apple’s innovation it is watching closely, says Chen, are Siri voice recognition feature.

The Foxconn Connection If any one company can be said to embody U.S.-China trade during the past decade, it is arguably Foxconn Technology Group, the original design manufacturing (ODM) unit of Taiwan electronics contract manufacturer Hon Hai Precision Industry Co. Foxconn designs and manufactures products to customer specifications, and the finished product is sold under the customer’s brand. The ODM re- tains rights and related patents to design contributions it has made to the product. The company has manufactured the Apple iPod, iPhone and iPad; the Amazon Kindle; Sony’s PlayStation; Nintendo’s Wii U; and, as early as 2001, motherboards for Intel. In 2013, it announced plans to make the Google Glass wearable computer at a facility in Santa Clara and has licensed technology to Google relating to head-mounted displays. Foxconn is the world’s largest electronics manufacturer, with a workforce of 1.2 million—900,000 of them at 13 factories in nine Chi- nese cities. The largest and most well-known such facility is Foxconn City in Shenzhen, with some 230,000 employees; another 120,000 work in Zhengzhou Technology Park. Most Foxconn workers live in company dormitories; the company’s Chengdu complex has 70,000 dormitory residents. At least 40 percent of Foxconn’s $132 billion in annual revenues is estimated to come from Apple, and Apple has become closely associated with headlines about working conditions and wages at Foxconn facilities—from worker suicides and wage protests in Shenzhen to a factory explosion and worker riots in Chengdu. Foxconn’s growth and the challenges it faces reflect the evolution underway in Chinese manufacturing and trade: mass urbanization as rural Chinese flock to cities for work; pricing and margin squeezes due to global competition; and manufacturing moving further inland to cities like Chengdu and Chongqing as land becomes scarce and production costs rise nearer the coast.

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This growth has come at a price. Apple has worked with Foxconn to resolve workforce issues that have compromised its branding, Fox- conn workers have received pay raises, and overall safety and living conditions have improved. But as Foxconn has added capacity, the worker training, safety measures and amenities needed to support it have not always kept pace. The company’s employee turnover rate has been 10–20 percent, in the mid-range for China, particularly as overall wages have risen and workers routinely quit for higher-paying jobs with promotion opportunities. Foxconn is vulnerable, however, to Apple’s business flow, including slowing growth in U.S., European and Japanese markets, and a slow rollout of Apple products in China due to price point and network limitations, as well as competition from Android and Samsung. Apple CEO Tim Cook announced in December 2012 that the company will invest $100 million to manufacture Mac computers—possibly the Mac Pro or Mac Mini—in Texas. It is not yet clear whether Foxconn, which has a Texas production facility, will do the manufacturing. Foxconn reported a 20 percent drop in earnings in Q1 2013, in large part due to slowing Apple and Nokia demand, although Q2 earnings rose modestly. The company is expanding and diversifying its U.S. activities with Google, and has branched into new products of its own— 60-inch flat-screen televisions sold under the VIZIO brand in the U.S. and by RadioShack in China (which may eventually play a part in Apple’s television strategy), as well as a wearable watch computer that syncs to an iPhone of iPad, and a reported line of low-cost tablets that run on an open-source Mozilla Firefox operating system. Apple, meanwhile, is sending more of its lower-end business to contract manufacturer Pega- tron, a Taiwanese spinoff from computer-maker ASUS that employs 70,000 workers at plants in Shanghai and Suzhou.

Cashing In on Chips standard has no dominant chipset supplier, as Global suppliers are closely monitoring China Qualcomm and Samsung are in 2G and 3G and in Mobile’s continued rollout of 3G service in rural the 4G FDD-LTE standard prevalent in the United China, its issuance of 4G TDD-LTE licenses, and States. China Mobile’s subscriber base, the rapid the overall success of its TD-SCDMA standard growth seen in smartphone sales, and the Android both within and outside China. The standard is a operating system’s leadership position in China test case for indigenous innovation, following suggest a potential market larger than that of Veri- the Five-Year Plan. China Mobile’s scale pro- zon and AT&T combined. vides a critical mass customer base that puts Marvell was co-founded by Dr. Sehat Sutardja domestic suppliers on a more level competitive and his wife, Weili Dai, immigrants from Indonesia playing field in the world’s largest market. Fi- and China, respectively, in 1995. Both are UC nally, it is expected to drive innovation in low- Berkeley alumni and are the principal donors for cost, low-power handsets, Internet television Sutardja Dai Hall, the home to CITRIS (the Center and advanced broadband deployment in the for Information Technology Research in the Inter- Middle East, Africa and Asia. est of Society) and a nanofabrication laboratory on Marvell Technology Group Ltd. sees dramatic the Berkeley campus. They have also supported new opportunities in China Mobile’s scheduled 4G the MIT Media Lab’s One Laptop per Child pro- TDD-LTE rollout because the nascent Chinese ject; the Smart Electronics Initiative cross-industry

85 Ties That Bind, 2014 Edition collaboration to cut energy consumption in con- television set-top boxes, LED-screen TV processors sumer electronics; and the U.S.-China Green and computer hard disk drives. Energy Council, a public-private partnership in The “sweet spot” for Marvell lies in a systems- California and China. on-chip (SOC) solution for TDD-LTE that includes Marvell employs nearly 2,000 people in China, full applications and integration processing. Down with Shanghai being the largest R&D site. Many the road, as China’s government builds out fiber China-based engineers are focused on the mobile optic cable to the home to reach China’s 175 mil- sector in silicon design, digital signal processing, lion cable television subscribers, Marvell sees a protocol stacks and Android software. In addition, valuable growth market for chipsets supporting 10 Marvell has mobile R&D design centers in the U.S. gigabits per second transmission network infra- and Israel. Marvell has provided 3G chipsets for structure, eventually ramping up to 100 gigabits— Samsung, Motorola, Huawei, ZTE and other An- the standard for instant delivery of feature-length droid handset makers. It also designs chipsets for HD programs.

The Taiwan Tech Community Plans its Future Taiwan faces its own challenges as it attempts to reposition itself as an innovator in a fast-evolving technology landscape. The task is made more difficult in the shadow of the mainland’s rapid rise. The scale and speed of the PRC’s economic growth and technological advance has, to an extent, crowded out Taiwan’s efforts to diversify its innovation and promote its own global brands. More than anything, commoditization of hardware and migration of value-added away from production, have disrupted an OEM culture and infrastructure dominated by Taiwan’s leading global chip foundries, Taiwan Semiconductor Manufacturing Corp. (TSMC) and United Microtech- nology Corp. (UMC), as well as low-cost manufacturers like Acer, ASUSTek, Quanta and MiTAC. Government is an active partner: Taiwan’s tech sector grew out of a 1979 Ministry of Economic Affairs initiative to redeploy foreign exchange reserves toward moving the island’s economy up the value chain from basic manufacturing to semiconductors, computers and peripherals. The Industrial Technology Research Institute (ITRI) administers the program, oversees Taiwan’s Hsinchu Science and Technology Park, selected the early students to go abroad, and provided seed funding for professional organizations such as Monte Jade and CASPA in the 1980s. Today ITRI maintains a worldwide office network—including a Bay Area office in San Jose—that engages in early-stage incubation, R&D collaboration, contracted research, technology licensing, recruiting and training. Worldwide, ITRI employs 5,800 people, administers some 18,000 patents and generates half of the Taiwan government’s R&D budget. It works in close coordination with Taiwan’s trade promotion arm, TAITRA, and with the science and technology division of the Taiwan consulate, the Taipei Economic and Cultural Office (TECO), both with offices in Santa Clara. They cooperate closely to facilitate trade and technology exchanges, and to encourage Taiwanese graduates and entrepreneurs to return home and help expand and diversify Taiwan’s skills and knowledge base.

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Major Taiwanese tech firms with presences in Silicon Valley include semiconductor foundries TSMC and UMC; ASUS, which has a service center and also collaborates with Google on the Nexus 7 tablet; Acer, which has its U.S. headquarters and an R&D lab in San Jose and in 2011 acquired Mountain View cloud software firm iGware, leading to the launch of its CloudMobile Android phone in 2012; GPS, server, workstation and cloud services firm MiTAC International, which has a factory and assembly configuration center in Fremont and division offices in Fremont and Santa Clara; motherboard and PC peripherals maker GIGABYTE; and monitor/display maker BenQ. A number of major Silicon Valley tech firms also have presences in Taiwan. Hewlett-Packard opened a global R&D center, the Comput- ing Hub, in 2010 and a service center in 2012. Cisco has operated a networking lab since 1997 in collaboration with the Institute for Infor- mation Industry and four major Taiwan OEMs, including Acer and Tatung, and has been a leading provider of networking equipment and services to Chunghwa Telecom. Oracle’s database, middleware and applications programs are taught through its Oracle Academy program at 26 Taiwan universities. Applied Materials opened a flat- panel display/thin-film solar equipment manufacturing center in Tainan in 2008, and has applied to build a $5 billion flat-panel LED R&D facility in Southern Taiwan Science Park. In the Bay Area, CHT Global is the U.S. telecom solutions arm of Taiwan’s premier phone and Internet provider Chunghwa Telecom. CHT, based in San Jose, provides wholesale business voice, data, conferencing, hosting and cloud/data center services over its secure private network, as well as international residential phone service via its Net2Asia calling card. CHT’s primary market is business customers with extensive cross-border Asia-U.S. activities and a need for high- capacity, secure broadband connections. It has reciprocal relationships with national carriers in more than 100 worldwide locations, among them China’s three main operators. CHT expects to launch mobile service in late 2013. Taiwanese cell phone designer and manufacturer HTC Corp. has its HTC America U.S. headquarters in Seattle, but expanded to San Francisco in 2008 with the acquisition of industrial design firm One & Co, designer of the HTC One Android and Windows phones. HTC recently introduced the co-branded Facebook HTC First phone, which boots up to a specially designed Facebook Home user interface. HTC America advanced technology manager Gary Yao is tasked with scouting for innovations in hardware, user interface and rich audio-visual features. Yao says he talks regularly with venture investors and their portfolio companies. Discussions with universities and laboratories, he says, are often likely to lead to technology acquisitions or IP licensing deals. Intellectual property protection, whether in patents or licensing, remains a minefield, Yao admits. He is currently hunting for new companies and technologies working in low-power design, enhanced multimedia features and device contextual intelligence.

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Meanwhile, semiconductor engineers—many from Taiwan—are increasingly concerned that the industry and its related knowledge base in Silicon Valley are gradually hollowing out. On the surface, little appears to have changed over two decades for the Taiwanese engineering community in Silicon Valley. The flow of students has been steady, but with relatively flat growth; their focus is still largely chip design and hardware for computing and networking, with some growth in mobile Internet. Attendance at annual conferences and after-work meetings is still strong, but numbers have remained fairly static. Engineer Joseph Lin, an advisor to and former president of CASPA, has worked in Silicon Valley since the mid-1980s. He says that the industry continues to attract highly-skilled engineering students and workers because of the cutting edge work done there. But as chipsets and integrated circuits become faster and smaller and provide more storage and security, prices are falling. That has translated into mergers, consolidation, layoffs and clean rooms either closing or staying without moving into more advanced technology modes. Lin worries that Silicon Valley is losing talent and historical knowledge, and that loss will contribute to the long-term erosion of its manufacturing base. “Silicon has always been the DNA of this place,” he says. “It’s why they named it Silicon Valley when it was first built on orchards. Now a lot of that is going away.”

LAW (CIETAC), a panel of international lawyers established in China in 1989. Intellectual property (IP) The Wild West Settles Down cases are the exception and are typically heard in Foreign law firms were not officially permitted court. IP cases can be highly technical and if the into China until 1992, but as early as 1979, firms arbitration panel gets it wrong, there is no appeal such as Coudert Bros., Baker & McKenzie and process, as in civil court. Also, the absence of juries Graham & James took advantage of a loophole in and punitive damages in Chinese courts moder- Chinese law allowing in trade-related consultants. ates potential awards, and courts have the power They established legal “consultancies” in their to grant immediate injunctive relief to plaintiffs. home countries or in Hong Kong and then Foreign attorneys officially practice the laws of opened informal China subsidiary offices. their home countries only. They may not represent China had not yet reinstituted a formal legal clients in Chinese courts or render opinions on system; criminal and civil cases were decided by Chinese law, nor are they permitted to take the the government and the Communist Party. In the Chinese bar exam. Where representation of a for- absence of commercial contract law, precedent eign or Chinese client touches on issues of Chi- determined a loose legal framework for joint nese law, the work must be done by a Chinese law ventures until a dispute arose or the government firm. This wall preserves the opacity of Chinese law intervened. At first, arbitration was permitted only and is designed to protect and ensure a role for within China. Over time, Hong Kong and Sweden Chinese firms in the growth area of international were allowed as arbitration venues. Today the commercial law. The wall has two sides: Chinese arbitration venue is left to negotiation by the lawyers may not join foreign law firms without first contracting parties. surrendering their Chinese law licenses. The favored arbitration venue specified in Representatives of foreign law firms in China commercial contracts is the China International must be attorneys in good standing with at least Economic and Trade Arbitration Commission three years’ practice experience in their home

88 Key Industry Sectors countries. Senior representatives must spend at SOEs exploring overseas real estate, brown least 180 days of the year in China, bringing them field and M&A opportunities in the U.S. under Chinese tax jurisdiction. Thomas Shoesmith, a partner at Pillsbury Law firms initially acted as advisors to home Winthrop Shaw Pittman in Palo Alto, heads the country clients on trade and customs issues, firm’s China practice. He previously ran Pillsbury’s contract preparation, intellectual property pro- Shanghai office, which he joined in 2008 when tection and formation of joint ventures. Since Pillsbury absorbed Thelen Reid Brown Raysman & China’s admission to the WTO, the market for Steiner’s China practice. Despite early signals that investment-related legal services has expanded China would open its legal service market further to include cross-border regulatory and tax com- to foreign firms, Shoesmith says little has changed. pliance; establishment of wholly foreign-owned But as the business environment becomes in- enterprises (WFOEs) and R&D centers; M&A creasingly sophisticated, he adds, that has not transactions and related due diligence; cross- been a serious problem. Divisions of labor with border technology licensing; real estate transac- Chinese law firms are as rigid as ever, but years of tions; and public share listings. working together on cross-border cases have taken U.S. law firms active in China were not hurt both sides beyond the initial learning curve to seriously by the global downturn in and of itself, build closer bonds. And in areas such as intellec- as China experienced a counter-cyclical upturn tual property, foreign firms and their counsel have thanks to stimulus, and U.S. client firms turned a clearer sense of where the technical and legal to China to offset slack demand in the U.S. risks begin and end. Where they saw business was in due diligence Pillsbury, which has an office in Shanghai, ex- and advisory work involving cross-border start- pects to open a Beijing office later in 2013 in up investment and IPOs, as venture capital and order to focus on state-owned enterprises and public equity retreated and as the Chinese gov- financial institutions. Shoesmith sees likely ernment clamped down on an overheated prop- China-related business prospects in the Bay erty development market. Area coming in three key areas: large public- The already weak market fundamentals were private development and infrastructure projects exacerbated by the rise of Chinese “reverse like high-speed rail; sports/retail complexes or IPOs,” mergers of private Chinese firms into mixed-use housing and commercial projects; dormant publicly-listed U.S. companies in order and ongoing investment in tech and selective to expedite listings with minimal financial disclo- outbound M&A to China. sure (see “A Two-Way Street” in the Investment U.S. law firms are also active in taking Chinese section of this chapter). Some 20 Chinese firms companies public in the U.S. Value-added te- came under attack from hedge funds and other lephony (mobile apps), which is growing rapidly, short sellers over accounting and valuation issues. is another area where limitation of foreign activity Business is gradually returning, but in different is creating the need for work-arounds advised by areas. Among the recent trends for overseas law U.S. lawyers. firms in China are “Things are kind of settling down; it’s not a  intensified focus on attracting large, relatively fire sale anymore,” Shoesmith says, “We’re safe Chinese banks and state-owned firms seeing the rise of China as a market, not just a as clients; place to build things cheaply.” What looks like  increased presence in Beijing, to build and tightening, Shoesmith suggests, is mainly greater maintain government contacts, and in Hong caution on the part of the Chinese government Kong, to concentrate on offshore financing and foreign investors. and investing; Beijing is gradually allowing more wholly for-  meeting the needs of growing renminbi funds eign-owned investment versus joint ventures, but and other domestic Chinese investment vehicles; it wants more rigorous reporting; and foreign  leveraging cross-border expertise to serve investors are adapting to a market that lacks Chinese banks, construction companies and transparency and favors domestic competitors,

89 Ties That Bind, 2014 Edition taking smaller stakes in companies with invest- Renren Information Services in 2009—a chal- ments structured to mitigate risk and exit easily. lenging case because China’s Anti-Monopoly Shoesmith has represented Chinese computer Law on the books at that time had no imple- maker Lenovo in its international joint venture with menting rules. Massachusetts-based cloud computing/big data Orrick was lead counsel for aluminum pro- firm EMC Corp.; has represented San Jose IT solu- ducer China Hongqiao’s $943 million IPO in tions provider Ingram Micro on several international 2011, and attorneys from Orrick’s San Francisco, acquisitions; and has participated in the public Hong Kong and Shanghai offices represented listings of more than 15 China-based companies. VanceInfo Technologies in its 2012 merger with A sampling of other Bay Area law firms active rival HiSoft Technology International. in China includes the following. Wilson Sonsini Goodrich & Rosati (WSGR) Davis Polk & Wardwell, based in New York, has its roots in Silicon Valley, providing cross- serves Silicon Valley through an office in Menlo border legal support to firms in debt placement, Park and maintains a China presence in Hong public listing, M&A, trade and financial regulatory Kong and Beijing. Its Hong Kong office was up- compliance, technology licensing and IP pro- graded in 2010 to become a Hong Kong law tection. Its initial China presence was in Shanghai practice, bringing together legal expertise in beginning in 2007, but it has more recently Hong Kong, the U.K. and the U.S. to serve global opened offices in Hong Kong in 2010 and Beijing financial clients. in 2012. The firm advised Baidu in its purchase of WSGR represented Chinese chip foundry Shanghai-based PPS Net TV’s online video busi- Semiconductor Manufacturing International Corp. ness in 2013 and in an earlier 2012 acquisition of (SMIC) in a five-year patent infringement trade a majority stake in video platform Qiyi. It helped secrets case brought by Taiwan Semiconductor prepare New China Life Insurance Co.’s public Manufacturing Corp. (TSMC) in California. It also listings on the Shanghai and Hong Kong ex- advised on SMIC’s 2004 IPO, and on the Bank of changes; Charles River Laboratories Interna- China’s 2006 IPO. In 2012 WSGR represented tional’s proposed $1.6 billion takeover of Wuxi Boyu Capital in the complex, multi-party 2012 Pharmatech in 2010; Dalian Wanda’s acquisition financing for Alibaba’s buyback of a portion of of AMC Theaters; and the management buyout Yahoo’s early stake in the company, and it repre- of Shanda Interactive by a family-owned offshore sented Chinese Internet service provider Tencent company led by Shanda chairman and CEO in a licensing deal with Activision Blizzard to Tianchao Chen. launch the “Call of Duty Online” game in China. Orrick, Herrington & Sutcliffe’s history in the Cooley LLP, founded nearly a century ago in Bay Area, and specifically San Francisco, dates San Francisco, developed early specializations in back to 1863. The firm expanded into China in emerging Bay Area industries such as venture 2005 through its acquisition of the China practice capital, information technology and life sciences. of Coudert Brothers. Coudert had been the first The firm opened its first PRC office in Shanghai in foreign law firm to open offices in Hong Kong in 2011 but has been active in greater China since 1972, the first in Beijing in 1979, the first to be 1989. It advised on the formation of the first in- licensed in China in 1992, and among the first to stitutional venture capital fund investing in China, practice in Shanghai. and has since handled cross-border M&A trans- In 2006, Orrick lawyers served as U.S. counsel actions for U.S. clients and securities and corpo- to Sinopec Beijing Yanhua Petrochemical Com- rate matters for Chinese companies. In 2012, its pany Ltd. in its $500 million privatization by global investing fund formation group closed China Petroleum & Chemical Corp., a transac- three Shanghai funds representing a combined tion that created a new path for PRC companies $1 billion. to privatize overseas listed companies. The firm Cooley has advised clients on market entry; also defended Baidu in an antitrust action distribution and licensing agreements; U.S. ex- brought in China by rival search firm Tangshan port control compliance; and antitrust and IP

90 Key Industry Sectors protection, most notably representing San Jose of these forces are occurring naturally, while analog chip designer Monolithic Power Systems some are consciously directed by government and three Taiwanese firms in a patent suit policies. Mass migration from the countryside to brought against O2Micro, a Taiwanese maker of cities over the past decade is already ap- battery and power management systems. proaching a quarter of a billion people. By 2025, Los Angeles law firm O’Melveny & Myers China is expected to have 220 cities with popu- (OMM) traces its roots back to 1885. OMM lations exceeding 1 million; by 2030, China’s opened offices in San Francisco in 1988 and in urban population will pass 1 billion. Metro areas Silicon Valley in 2001. Its China presence launched will likely merge into megacities with as many as in Hong Kong in 1994, followed by offices in 20 million residents, where chronic ailments and Shanghai (1996) and Beijing (2003). It was one of disease prevention will pose growing problems. the first U.S. law firms registered to practice Hong China’s middle class is expected to more than Kong law, and its greater China practice today double by 2020, to 700 million people; a grow- deploys a team of more than 110 professionals. ing number of wealthier Chinese will have OMM represented Chinese Internet marketing higher expectations and the ability and willing- technology firm Allyes in a 2006 acquisition by ness to spend more for healthcare. More than China advertising company Focus Media and 185 million Chinese are over the age of 60 to- advised security software provider Symantec day—13.4 percent of the population. The most Corp. on antitrust compliance in its 2007 joint common illnesses in this cohort are chronic: cir- venture agreement with Huawei Technologies to culatory, vision, neurological, endocrine, nutri- manufacture and sell telecom network equipment tional and metabolic, all requiring long-term with integrated security software. The firm also treatment and making up 23–40 percent of the represented Mountain View-based Complete prescription and 40–50 percent of the over-the- Genomics in the firm’s 2012 acquisition by Chi- counter market. Government spending com- nese gene sequencing and bioinformatics group mitments for a social safety net in healthcare BGI-Shenzhen. (For more detail, see the Life Sci- and pensions will add to demand. ences/Healthcare section below.) Until the late 1970s, China’s healthcare system was entirely government funded and government LIFE SCIENCES/HEALTHCARE run. Economic reforms launched with the country’s opening in 1979 moved the system in the Healthy Prospects opposite direction, toward a free-market model Bay Area research laboratories and medical facili- under which government support was withdrawn ties are engaged in cutting-edge science with and healthcare providers were expected to oper- major implications for healthcare worldwide. China ate as profit centers. The focus of care shifted to is a huge urban and rural market building a state- higher-priced tests and treatments, patients un- of-the-art healthcare infrastructure from scratch able to pay were denied care, and service quality amid challenges of aging, wealth inequality, declined, sparking civil unrest. chronic diseases, environmental illnesses and pan- China eventually dialed back the experiment demics. The synergies are most clearly seen in and has since been searching for a hybrid distinctly China’s ongoing healthcare reform effort; in its Chinese model. In 2009, the government com- ambitions as a global provider of pharmaceuticals, mitted RMB 850 billion ($124 billion) to a three- medical devices and treatment; and in financial year healthcare overhaul focusing on the following: and policy trends influencing R&D and delivery of  Comprehensive insurance coverage for 90+ care in the U.S. percent of the population, through expansion of programs for urban employees, non-working 1.3 Billion Patients, 95 Percent Coverage urban residents and the rural population; be- Powerful demographic forces are at work, in- fore 2007, only urban workers and retirees had cluding urbanization, the rise of affluence, and access to defined-contribution insurance plans the effects of an aging population. Some results through their employers.

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 Upgrading the pharmaceutical supply chain substitution program aimed at replacing mid- and from production to procurement and distribu- high-end imported devices. tion, in particular for drugs classified as essential Overlaying the above strategies is an in- and/or eligible for government reimbursement. creasingly strict and sophisticated regulatory  Expansion of the National Essential Drug List regime to force quality and safety improve- (NEDL) and the National Reimbursement Drug ments, alongside price caps on essential drugs, Lists (NRDLs) from a combined 300 drugs to limits on wholesale markups, crackdowns on 520, adding children’s vaccines, cardiovascular fake drugs and limits on advertising of non-pre- and chronic disease drugs, and anti-cancer scription remedies. medications, allowing more direct purchasing A 2013 KPMG report on healthcare and life and capping prices. sciences in China points to three key trends as  Strengthening public health service disease Chinese companies scale up to compete globally prevention and control programs, giving and as domestic and foreign companies turn their added emphasis to prevention and vaccine attention to a growing Chinese market: programs in central and western China. 1. Overproduction of cheap basic products is  Adding more than 300 county hospitals, giving way to more efficient manufacture of 1,000 town-level health centers and 13,000 higher-quality products to satisfy a growing village-level clinics to the country’s grassroots and more demanding middle class; R&D healthcare infrastructure, to increase cover- spending is up, as are vertical pipeline acqui- age and competition. sitions and foreign licensing arrangements.  Modernizing nationwide public healthcare 2. Companies are extending their sales and and hospital infrastructure, standards and marketing into Tier 2 and Tier 3 cities as well practices, including funds for medical devices as the countryside, offering more affordable and IT systems. products tailored to niche markets. The 12th Five-Year Plan picked up in 2011 3. As the drive for quality has thinned margins, where those reforms left off, focusing on the firms are aggressively squeezing costs out development and restructuring of indigenous of their sourcing, manufacturing and supply industry. It sets goals for consolidating a frag- chains through acquisitions, partnerships mented pharmaceutical industry through M&A and re-engineering. and vertical integration to create at least 5 drug manufacturers with RMB 50 billion or more in From the Outside Looking In annual revenues and 100 with revenues of RMB In the meantime, forces are converging that 10 billion or more. It also encourages companies make the China market especially attractive for to set up overseas R&D centers and manufac- global healthcare providers and life sciences turing facilities. technology firms. A similar strategy applies to pharmaceutical In 2012, global pharmaceutical companies saw distribution (3 national distributors with RMB 100 patents expire on more than 40 brand-name billion or more in revenue; 20 regional distribu- drugs earning a combined $35 billion annually. tors with RMB 20 billion or more), and encour- For those companies, China represents an attrac- ages consolidation of small retail pharmacies into tive market for off-patent drugs in partnership regional and national chains. with local distributors, to help offset price de- Finally, the Plan commits government sup- clines with volume sales. In some cases, domestic port to build an indigenous medical device Chinese manufacturers see opportunities to pro- industry that serves the domestic healthcare duce their own generic versions, or to license in market: 8–10 manufacturers with sales above the better-known brands. RMB 5 billion; funding and other support for 10– In the U.S., lower risk tolerance for long clini- 15 medical device groups, 40–50 technology cal trials and regulatory uncertainty have damp- companies plus manufacturing and demonstration ened investment flows into earlier-stage life sci- bases for device innovation; and an R&D/import ences ventures. China is an exception, however,

92 Key Industry Sectors due to the government’s push to accelerate trials. Chinese generic drug companies are healthcare reform. showing particular interest in partnerships or co- The result is that the market potential for development of products with innovative U.S. branded, quality imports is high at the low end of companies. the market—basic hospital supplies, lab testing Dr. Jimmy Zhang, greater China lead for li- equipment, basic over-the-counter and prescrip- censing, acquisitions and external research at tion medications. At the high end are licensing Merck & Co., as well as the current chairman of opportunities for specialty and orphan drugs as trade association BayHelix, shuttles back and well as facilities and treatments tailored to the forth between China and the Bay Area regularly. affluent, private Chinese healthcare market. For Prior to joining Merck, he was senior vice presi- the longer term, Chinese firms are investing over- dent at Synergenics LLC, a professional services seas, looking to manufacture low-cost generic and investment company founded by biotech drugs and acquire innovative products, technol- pioneer Dr. Bill Rutter of UCSF. While at Syner- ogy and know-how to move up the value chain genics he brought two early-stage Bay Area back home. companies—one in diagnostics, the other a “Life sciences investment has been way down maker of monoclonal antibodies—to Shenzhen since the recession, in part because the exits are and Hangzhou, respectively. very difficult,” explains Gail Maderis, president Dr. Zhang agrees about the natural synergies and CEO of BayBio, a regional association of between biotech start-ups seeking funding in the more than 800 life sciences companies of all absence of government research funding or IPO sizes. She notes that only 14 life sciences IPOs activity in the sector, and Chinese firms—both were launched in 2012, seven of those involving state-owned and private—under government California companies. “As financing has become pressure to produce original drugs and medical more difficult, especially in the early stages, devices for the Chinese market in a relatively we’ve seen a clear business model emerge, short time frame. The Chinese government is also where executives have the knowledge but don’t going out of its way to encourage nimbler private have the labs, so they work through contract re- firms to enter the market and scale up, while mu- search facilities. The other trend is that they have nicipalities are competing to attract talent and to partner early to gain financial support because investment for new research clusters. of the diminishing availability of VC and public Yet despite considerable interest in develop- R&D investment.” ing cross-border cooperation, real activity has That suggests synergies between small and been slow to build. “Expectations on the U.S. and mid-sized Bay Area life sciences ventures and China sides are still far apart,” Dr. Zhang sug- Chinese investors, and Maderis acknowledges gests. “The U.S. side wants the cash right now; that many of her member companies have ex- China wants a long-term relationship and is not plored collaborations with Chinese companies in willing to pay up front; they want a more gradual the past three years to cover clinical trial research development arrangement.” One solution has costs in exchange for rights in China. been a co-development model for products and The realities in searching for the right China treatments, where each side covers its own costs partner, however, can be complex. In general, and both share the clinical trials data. Chinese companies prefer investing at the clinical Dr. Zhang sees longer-term prospects for for- stage of co-development, compared to the pre- eign firms on the pharmaceuticals side of health- clinical stage, which many consider too early. care, since 80–90 percent of innovation currently Particular opportunities may exist in partnering takes place outside of China; others place the between U.S. and Chinese companies to enroll number higher—at 95 percent. The medical de- Chinese patients in clinical trials for conditions vice sector has lower barriers to market entry and endemic to China or Asia. This may be enabled lends itself more readily to copying by Chinese by a recent shift by the FDA allowing earlier en- companies that are able to bring products to rollment of Chinese drug candidates in clinical market more cheaply and quickly. “There has

93 Ties That Bind, 2014 Edition been a saying in the China healthcare market,” (two-thirds) and private spending (one third). he says. “Look at what GE, Phillips and Siemens Market growth, now 15–20 percent per year, are doing and follow them.” should accelerate to 25–30 percent over the next The good news is that as China’s market ten years. Approximately 80 percent of health- grows and its drugs, distribution and devices care is provided through government hospitals, sectors consolidate, there will be a growing need the growth of which is limited only by govern- for overseas innovation, while sales and distribu- ment funding. As incomes grow, more Chinese tion networks will become more robust and effi- will be able to afford better care, and private ser- cient. If there is bad news, it is that, over time, vices will grow, but this process will take time and M&A attention will focus increasingly on later- will focus on the high-end—those who can afford stage companies, as execution and time to mar- to pay. U.S. hospitals, health groups and inves- ket become as critical as innovation itself. tors are looking at the market. The pharmaceutical market—focused on hos- Pharmaceuticals: Finding the Right Fit pitals and retail pharmacies, with city and provin- According to a 2012 report by McKinsey & Com- cial governments holding competitive tenders—is pany, China is now the world’s third-largest moving upscale, and in the future will look in- pharmaceutical market, with healthcare spending creasingly like other international markets; in expected to triple to $1 trillion by 2020. But ne- other words, multinationals will be able to rely gotiating that market presents challenges. Gov- less on older, generic products. The medical de- ernment pressure is growing, for example, for vices and supplies market is also growing quickly. foreign companies to discount some of their most Foreign companies face strong competition, expensive drugs. This recently happened with however, from Chinese companies that produce Novartis, which reached a negotiated agreement cheaply and are working hard to move up the with the government of Jiangsu province to con- value-added scale. As part of that trend, both tribute three doses of its leukemia drug Gleevec pharmaceutical and devices companies in China for each one sold, lowering the cost of an annual are increasing their focus on overseas investment, regimen from as much as $100,000 per year to with the goal of developing more competitive $12,000. While this cuts into profits, negotiated products for the domestic market. discounts of this kind may prove preferable to Predictably, the process is complex. Apart compulsory licensing or the denial of patent from basic language and cultural barriers, due protection. In the summer of 2013, Chinese diligence is problematic: even large Chinese life regulators revoked the patent protecting Gilead sciences and healthcare firms do not have long Science’s HIV and hepatitis B drug Viread, in a track records in advanced medicine and lack move designed to pressure drug makers to offer familiarity with global practices, quality stan- lower prices. dards and regulatory processes. Smaller firms Distribution is also a growing but complex here, with little experience on the ground in field. Cardinal Health, a Fortune 500 distributor China, rely heavily on consultants and advisors of healthcare products such as non-capital medi- to screen likely partners in what can be an cal and laboratory supplies, entered the China opaque market environment. market in 2010 and now has several billion dollars One overarching concern is intellectual prop- in turnover annually. Cardinal Health China presi- erty protection, which may be at risk when dealing dent Eric Zwisler notes that China has a well- with Chinese life sciences companies. Industrial developed bio-medical manufacturing industry espionage—through data room breeches or IP that includes both pharmaceutical raw materials theft—is a significant issue for larger U.S. bio- and end products and that buys extensively from pharma companies. This concern lies behind overseas companies. Merck’s decision to scale back its planned $1 bil- Overall, the dynamics of China’s healthcare lion R&D center in Beijing and explains the much market are strong, with growth based on expen- smaller scale of other new U.S. R&D centers. It is ditures by the government’s health insurance plan important, therefore, that U.S. companies protect

94 Key Industry Sectors themselves in the due diligence phase of any deal. Phase 3 trials in China beginning in 2013. Similar Caution is also advisable when accepting Chinese trials are underway in the U.S., Europe, Japan and funding, which may or may not require transferring Russia. Other kinds of partnerships and invest- or sharing access to IP. ments are also significant connections. One example of a successful collaboration is Foster City pharmaceutical company SciClone the five-year marketing agreement signed in Sep- expanded sales in China of its hepatitis and can- tember 2012 between Emeryville maker of anti- cer drug Zadaxin, as well as other drugs, by ac- infective skin and wound care products NovaBay quiring Chinese drug distributor NovaMed. Pharmaceuticals, Inc. and Naqu Area Pioneer While the company has subsequently faced legal Pharma Co. Ltd. of Shanghai. Pioneer is paying and regulatory challenges, sales have grown from $500,000 up front to market NovaBay’s Neutro- approximately $85 million in 2010 to over $135 Phase, a solution of disinfectant hypochlorous acid million in 2013. The company currently employs and saline. It has won FDA approval for some, but 700 people in China, 15 at its Foster City head- not all, proposed uses. Pioneer Pharma (Singa- quarters and 10 in Hong Kong. pore) Pte. Ltd. has committed an equity invest- Mindray Medical International Ltd. of Shen- ment of as much as $5.5 million over 2012–13, and zhen in June 2013 announced an agreement to will provide contract research support to develop acquire Mountain View ultrasound imaging tech- antibodies for use with non-healing wounds. “An- nology firm ZONARE Medical Systems, Inc. for tibody development can be done at 20 percent of $105 million. ZONARE offers high-end imaging the cost in China,” says Maderis. “That means you and sales and marketing channels in the U.S, get five shots at the goal instead of one, in effect Canada, Scandinavia and Germany. Mindray five times the work. That’s driving companies of all contributes efficient engineering and manufac- sizes to consider China.” turing platforms capable of bringing down costs One such firm is FibroGen, Inc., a San Fran- and expanding ZONARE’s global reach. cisco biotech company specializing in tissue Tianjin-based Andon Health Co.’s iHealth unit, growth and repair as well as production of re- which manufactures digital personal healthcare combinant human collagens and gelatins. In products, has established an R&D lab in Mountain 2010, FibroGen received approval from China’s View. The company produces a home blood State Food and Drug Administration (SFDA) to pressure testing system that measures blood perform Phase 1 and Phase 2 clinical trials for an pressure through an arm cuff that transmits the affordable oral treatment for anemia associated results to an iPhone, iPad or iPod Touch through with chronic kidney disease (CKD). an app. Future products include a similar device The benefits are mutual: one byproduct of to measure blood glucose levels. China’s urbanization has been a rise in CKD, as In March 2013, BGI-Shenzhen, a group of re- changes in diet and exercise have increased dia- search institutes and commercial gene sequencing betes and hypertension, which are risk factors for application firms in the medical, environmental and the disease. Some 125 million Chinese suffer agriculture sectors, finalized acquisition of Com- from CKD, and 300,000 patients die from it an- plete Genomics, a Mountain View company nually. The disease is often accompanied by known for its “sequencing-as-a-service” map- anemia, adding to a patient’s debilitation. Nearly ping/sampling technology used in disease pre- all terminal patients are anemic, as are an esti- vention, diagnosis and treatment. Prior to the mated 6–8 million patients not yet on dialysis. acquisition, BGI had to do its own sequencing on While insurance reform has made dialysis more equipment purchased from competitors in the accessible and affordable, only 10 percent of space. Complete Genomics offered sequencing patients are now treated for anemia, due to cost for as little as $5,000 per genome for volume and the fact that current injectable vaccines must orders to build a market presence, but struggled be clinically administered. financially at those rates, eventually laying off FibroGen has successfully completed Phase 1 employees and hiring an advisor to explore stra- trials and dosing in two Phase 2 studies, with tegic alternatives.

95 Ties That Bind, 2014 Edition

The $117.6 million offer price from BGI repre- sciences start-ups with offers of funding support, sented an 18 percent premium over the Complete shared lab space and China connections, possibly Genomics share price when the offer was accepted to do collaborative work. in September 2012. The acquisition was cleared by Firms have expressed interest in incubators, but the U.S Committee on Foreign Investment in the some are wary. Early stage funding help and af- U.S. (CFIUS) and the Federal Trade Commission fordable shared facilities are needed; life sciences (FTC) following a complaint from San Diego-based incubators are proliferating, offering the best start- Illumina, a market leader in sequencing machines ups a range of choices. Bay Area entrepreneurs are and BGI’s former supplier. Complete Genomics tempted by the idea of collaboration with China, will continue to operate in Mountain View as a but they remain concerned about intellectual separate company. property protection. “It’s still a relatively new area In December 2012, Biorichland LLC, a pub- for our companies; we’re feeling our way as we licly traded Chinese holding company that owns go,” says Maderis. “The opportunities with China China’s largest contract research organization and are huge, but businesses are being cautious. They pre-clinical laboratory, JOINN Laboratories, paid need a comfort level; what they want to see more $50 million to acquire the 53-acre East Bay Berlex than anything is greater transparency up front.” research facility site most recently owned by QB3 has pioneered life sciences incubation in Bayer Healthcare Pharmaceuticals. Berlex, until the region through multiple locations of its highly 2006 a unit of Schering AG, had expanded the successful “Garage.” In recent years, QB3 has Richmond site to include 355,000 square feet of been courted by both Chinese tech parks and lab, manufacturing and administrative space and universities to help establish incubators, but there had hired 300 employees to work on cancer and have been few results so far. The challenge is that immune-based disease drugs. Bayer bought early-stage incubation of the kind supported by Schering in 2006, moved its research activities to QB3 is too small for most tech parks, and Chinese Mission Bay in San Francisco and by 2010 had universities are adept at catch-up innovation but phased out the Richmond operation. are not at the same level as UCSF in generating JOINN was formed in 1995 in Beijing to per- cutting edge, disruptive innovation. QB3 director form drug screening, safety evaluations, animal- Regis Kelly also notes that while Chinese partners based clinical trials, efficacy studies and registra- are anxious to draw on QB3’s expertise, reciproc- tion for clients in China, Europe and Japan. It has ity has been limited. Though the Chinese have facilities in Beijing and Suzhou, as well as an office yet to respond, he points to joint research as a in Maryland, adjacent to FDA headquarters, that way forward and is continuing to explore oppor- provides clients with technical consulting on FDA tunities: “I’m an optimist, and keep going back.” compliance. Plans for the Richmond property, to be called the JOINN Innovation Park, include a bioresearch center, contract research facilities and INVESTMENT a biotech incubator, with a combined estimated workforce of up to 500. A Two-Way Street Hanhai-Zibo Life Science Park opened in June Cross-border investment funds encountered a 2013 in Burlingame (see the Investment section of radically changed environment coming out of the this chapter), with combined funding and technical global recession, as cash remained on the side- support from Hanhai Investments and China’s Zibo lines, central bank easing kept interest rates and New & High-Tech Park industrial development yields low, and investor skepticism of Chinese zone. Six life sciences companies from that zone shares deterred new IPOs and, with them, ven- have a presence in the Burlingame facility, includ- ture and private equity exits. ing Xinhua Pharmaceutical, SHINVA Medical, In China, slower growth and an overhang of Jinjing Group, Jincheng Pharmaceutical and public and bank debt and tighter government Chemical, Jinyang Pharmaceutical, and Fushan curbs on speculative real estate deals, bank Group. The park hopes to attract Bay Area life lending and public listings have combined to

96 Key Industry Sectors narrow investment options. China attracted the U.S. thus far in 2013, down from three in $111.7 billion in new foreign-invested enterprises 2012, 11 in 2011 and 38 in 2010, according to (FIEs) in 2012, down 3.7 percent from a record Bloomberg data. $116 billion in 2011, according to China’s Minis- In China, foreign investors have adopted a try of Commerce. The number of FIEs declined defensive posture, focusing on offshore invest- by more than 10 percent. ments that allow earnings repatriation and that, Domestic Chinese RMB venture and private through structures such as variable interest enti- equity investment has been growing. In 2011, Chi- ties (VIEs), allow greater investor control through nese domestic VC investment totaled $7.8 billion, a minority interest—although government re- according to Asian Venture Capital Journal, for the serves the right to intervene. first time passing foreign VC fund investment, Unable to fully compete in the domestic Chi- which amounted to $7.4 billion. And while private nese RMB market, many investors are reconsid- equity deals doubled in value over 2009–11, for- ering strategic benefits offered by “greater eign fund investment fell by 45 percent. China”—financial services in Hong Kong, and U.S. listings of Chinese companies are only tech manufacturing and IP protection in Taiwan— now beginning to recover from a rash of “reverse that leverage the mainland market. IPO” listings in 2009–10, which were associated PRC investment flows, guided by the Five-Year with accounting irregularities. Reverse IPOs, or Plan, reflect broad, long-term trends in Chinese reverse mergers, circumvent the formal IPO list- society—an aging population requiring more ing process by taking over an inactive U.S.-listed advanced healthcare; urban migration and its company and merging the shell with a private environmental impacts; emerging middle-class Chinese company so that the private entity as- consumer needs and expectations; the rise of sumes control and can raise funds in equity mar- mobile Internet; and the need for cleaner, reliable kets with less transparency up front. Over 2007– supplies of energy, food and water. 11, more than 150 Chinese companies with a combined market capitalization of $12.8 billion Chinese FDI in the U.S.: entered U.S. financial markets through reverse A Complicated Environment IPOs, versus 50 companies using traditional IPOs. Meanwhile, Chinese investment in the U.S. has In 2011, nearly 20 reverse IPO firms saw their grown steadily, setting new records every year shares plummet amid allegations from hedge since 2009 and increasing from $5.8 billion in funds and other short sellers that they had falsely 2010 to $6.7 billion in 2012 and $4.7 billion in inflated valuations. just the first half of 2013, according to business Skepticism was not limited to U.S. shares. In consultancy Rhodium Group. While deal volume October 2012, the China Securities Regulatory has tapered, total deal value is up. Private Chi- Commission (CSRC) imposed a freeze on initial nese enterprises (as opposed to state-owned public offerings on the ChiNex, a NASDAQ-style enterprises) account for a growing share of for- exchange set up for small-cap and mid-cap tech eign direct investment (FDI). growth companies. The freeze was imposed to Well-known deals include Wanda Group’s $700 address market volatility and concerns that many million purchase of Kansas City movie theater listed firms were weaker than initially assessed. A chain AMC Entertainment Holdings; Wangxiang planned July 2013 lifting of the moratorium was America Corp.’s $257 million buyout of battery delayed as implementing rules are written; more maker A123 Systems; BGI-Shenzhen’s $118 million than 80 companies have IPO applications pending. takeover of Mountain View-based Complete Ge- A market recovery is suggested by three suc- nomics (see the Life Sciences/Healthcare section of cessful Chinese IPOs in the tech space: online this chapter); and the $4.7 billion Shuanghui Inter- retailer Vipshop Holdings, Ltd. and social media national Holdings purchase of Smithfield Foods. network YY Inc. in 2012 and LightInTheBox A number of deals have also fallen through Holding Co., another online retailer, in 2013. Still, due to strategic concerns, prompting greater LightInTheBox has been the only Chinese IPO in caution and due diligence among Chinese

97 Ties That Bind, 2014 Edition investors: state-owned oil producer CNOOC’s of advisors we never had before—the returnees, proposed $18.5 billion dollar acquisition of Uno- the sea turtles.” cal Corp. in 2005; Superior Aviation Beijing Co.’s At the same time, Cooper says, recent years 2012 bid to buy Hawker Beechcraft’s civilian air- have brought increased uncertainty. “There are craft assets for $1.8 billion; and the proposed things we think about a lot because our clients development by construction company Sany of a do, because of the risks involved—the transition solar wind farm in Oregon at a site near a classi- of power, pervasive corruption, the China-Japan fied U.S. Navy installation. conflict, the flattening of the Chinese economy Over the long term, global expansion will be and how it affects business.” To those he adds critical for large Chinese companies seeking a higher land and wage costs, high turnover and stronger global profile. Only a few Chinese com- labor unrest, IP concerns, tightening liquidity re- panies so far have broken through to achieve sulting from the shadow banking system, and recognition as global brands, among them difficulties shifting from an export to a consump- Lenovo, Haier and Huawei. The most prominent tion economy. example may be Lenovo, which purchased IBM’s To attract fresh capital, China raised invest- personal computer business in 2005. Lenovo cre- ment limits under its Qualified Foreign Institu- ated dual headquarters, in Beijing and Morrisville, tional Investor (QFII) program, developed in 2002 North Carolina, where the IBM unit was located, to allow licensed foreign investors to buy and sell and made English the company’s official lan- yuan-denominated A shares on the Shanghai and guage. Since then, ThinkPad sales have doubled, Shenzhen exchanges. QFII sets size, governance while profit margins have been maintained a and other requirements for investors, as well as healthy 5 percent. investment limits. The limit on total QFII invest- For most Chinese firms, FDI in the U.S. is ment was raised from $30 billion to $80 billion in aimed at achieving scale, vertical integration and April 2012, and again to $150 billion in mid-2013. technical expertise. For the U.S. partner, acquisi- The quota for RQFII investment in mainland tion typically brings a fresh injection of capital, shares using renminbi held offshore was raised in and improved access to Chinese markets. April 2012 from $20 billion to $44 billion, and in The successful acquisitions of Complete Ge- 2013 QFIIs holding renminbi in Singapore, Tai- nomics and A123 Systems reflect a pivot in Chi- wan and London were permitted to reinvest nese strategy toward deals valued at less than those funds directly into China, rather than via $500 million; joint ventures, partnerships and eq- Hong Kong. uity stakes rather than outright acquisitions; a focus QFII has so far attracted just $43 billion and on privately held versus publicly traded firms; and the RQFII program has attracted RMB 105 billion avoidance of companies and technologies where ($17 billion). Foreign investors account for 1.6 there are potential security-related issues. percent of total China market capitalization. At the same time, a large share of RMB investment Investment into China: The New Normal growth is in structured wealth management FDI into China is generally thought to have products (WMPs), high-yield securities made up reached a plateau, given slower GDP growth, of troubled loans moved off bank balance sheets. currency controls, rising production costs, intel- “Our strong sense is that there’s an awful lot of lectual property and transparency issues, and stress right now in the way wealth is concentrated political risks. “The good news is that due dili- in China,” Cooper says. “It’s also obvious from gence has gotten easier if for no other reason the economic data that wealth has been exiting than experience,” says Deloitte & Touche LLP China at an accelerating rate.” partner Chris Cooper, who serves as Americas Experienced investors and fund managers in leader of Deloitte’s Chinese Services Group. China, foreign and domestic, continue to see po- “We’ve got lots of people on the ground with the tential in well-managed small and mid-sized com- knowledge and the tools to bridge the gaps that panies with the capability to scale up and become exist between the U.S. and China, including types national or global brands; in a more sophisticated

98 Key Industry Sectors retail sector to serve a growing and aspirational an asking price of $800 million. Other invest- middle class; and in technological advances in ments include China Grand Auto, the world’s growth sectors such as healthcare, energy, envi- largest car dealership, and shoe retailer Daphne. ronmental mitigation, agriculture and an expanded Lee Ting has viewed China through both the and improved supply chain/logistics infrastructure. venture and private equity lenses, as a managing San Francisco-based private equity firm TPG director, general partner and advisory director at Capital has invested more than $6 billion in Asia WR Hambrecht + Co since 2003, and more re- since 1994. It has exited some 30 of 50 invest- cently as an advisor to Singapore-based private ments to date, earning 2.5 times the value of the equity firm Novo Tellus Capital Partners. He is initial investments. TPG was an investor in also an independent director with Lenovo Corp. Lenovo’s acquisition of IBM’s PC manufacturing Hambrecht’s funds have been fully invested business in 2005. Its Newbridge Capital unit ac- for several years and focus on technology, in- quired an 18 percent controlling interest in cluding companies such as Lenovo and PayPal. Shenzhen Development Bank as part of a gov- He says the old model of looking for disruptive ernment-approved turnaround effort. Newbridge technologies that can be applied in key Chinese exited in 2009, selling its stake to Ping An Bank industry verticals at huge scale to emulate ad- for Ping An shares valued at $2.44 billion. vances in the U.S. is much more difficult today. TPG Capital senior partner Tim Dattels sees The China market is less dependent on foreigners bargains in China even as the environment be- and returnees to provide management and tech- comes more challenging. There are fewer buyout nical expertise or access to venture capital; often, opportunities, mainly state-owned enterprises and local entrepreneurs can provide solutions more family or entrepreneur-owned businesses; offshore closely attuned to consumer tastes and industry banks are unwilling to lend against onshore assets; needs, and they have connections to proliferating Chinese banks are already overextended through domestic VC funds. government-directed, non-performing loans and “Being a local company does provide a certain high-risk private banking products; and there were advantage over a foreign competitor, even if the only 24 Chinese IPOs in the first half of 2012, half foreign company is larger and more established,” the number for the first half 2011, even before the Ting explains. The difference begins with lan- ChiNex exchange stopped accepting new listings. guage and cultural differences in the way people Dattels points to China’s 4.3 million small and use and interact with technology, he adds, but it mid-sized businesses that account for 60 percent doesn’t end there. “Local Chinese companies of GDP and 75 percent of jobs and have trouble move much faster than multinationals. Local ca- getting financed. “There’s a lot of capital in China pabilities from a technology standpoint have also but it’s misallocated,” Dattels says. “With so many improved a lot.” They also have the RMB capa- entrepreneurs and capital so restricted, it creates bility and government connections to execute opportunities for private equity.” large onshore SOE deals. In 2012, TPG acquired HCP Holdings, a Tai- In the healthcare space, Ting sees opportu- wan packaging company for the cosmetics, skin nity in Chinese contract research organizations care and fragrance industries that had moved its (CROs) doing clinical trials, and in compounding manufacturing to Suzhou. The $500 million pur- laboratories that can partner with global pharma chase price made HCP the largest leveraged and innovate for the China market. “The gov- buyout to date in China. The plan is to scale up ernment is making a huge push,” he says. They the firm’s operations to compete globally. TPG know they can’t continue to depend on western- also teamed with Singapore sovereign wealth style drugs: they’re too expensive. With more fund GIC, investing $120 million in a turnaround original research, their own scientists can start to of Beijing-based sneaker and sportswear maker Li uncover new compounds and find medicines Ning. It has recently put up for sale UniTrust Fi- more tailored to Asian populations.” He cites as nancing and Leasing, a Shanghai equipment les- an example the fact that western cancer re- sor that it acquired in 2008 for $275 million, with search focuses heavily on breast and prostate

99 Ties That Bind, 2014 Edition cancer while stomach cancer has much higher encouraging the development of a stronger Chi- rates in Asia but is neglected. nese private equity sector, and restrictions on the In general, Ting says, the investment landscape ability to do IPOs in China with USD funds, the remains lucrative but more complicated: IPOs are incentive to create an RMB fund was there. off the table until a later stage when a company Among the major Bay Area venture invest- has proven it is a real business and has scale, re- ments in Chinese companies are the following. curring customers, cash flow and profitability; M&A Kleiner Perkins Caulfield & Byers has funded remains a challenge either because of government some 60 Chinese companies, most notably Baidu restrictions or difficulties agreeing on valuation, and Alibaba.com. Target sectors range from clean- especially with firms not already publicly traded; tech (environmental products firm Universtar; solar and slower economic growth suggests smaller and wind power inverter maker Sungrow; water returns over a longer period of time. treatment technology company Scinor Water) to Hanson Li, head of investment banking and advertising (mobile ad firms Madhouse and Limei; private equity firm Hina Group’s San Francisco advertising data mining company Miaozhen Sys- office, concedes that the investment field is tems) to life sciences (testing laboratory services crowded. “The biggest change in the last five firm Kindstar Global; orthopedic implant and in- years is the available capital that has entered the strument maker KangHui; biology CRO GenScript) market from both outside and within China,” he to business and consumer services (China Auto says. “On the corporate side, companies are Rental; B2B travel service Intohotel). more sophisticated; enough people call and you Since 2003, New Enterprise Associates has in- realize you can pretty much take your pick from vested some $400 million in more than 20 China the outside capital.” companies focused in three fields: IT, healthcare In pure technology, Li sees growing investor and energy technology. It has funded mainland interest in biotech, particularly given the small chip foundry Semiconductor Manufacturing Inter- number of Chinese companies in software and national Corp. (SMIC); digital wireless chip de- the increasing commoditization in semiconduc- signer Spreadtrum; healthcare provider HYGEIA tors. Other investment targets are in healthcare, Medical Services Group; e-commerce platform retail, energy, agriculture and real estate, as well Redbaby, China’s largest multi-channel direct con- as services like hospitality, insurance and logistics sumer products marketer; and China’s leading tied to a booming online retail sector. green lighting company, Shenghui Lighting. Recent Hina investments focus on “copy-me” San Francisco-based IDG Ventures has made companies in China that in many cases replicate VC and private equity investments in China Silicon Valley firms that bring scale and disruptive through its IDG Capital Partners affiliate since technology to key service sectors. A Groupon 1992. IDG Capital Partners, with $2.5 billion copycat is part of the company’s current portfolio, under management, invests in the $1 million to as is a cleantech firm that helps utilities optimize $100 million range, at all stages of the company energy usage for enterprise and retail customers, life cycle. It has successfully exited 60 invest- and a niche high-end travel agency offering ser- ments through M&A and IPOs in the U.S., Hong vices to affluent customers that indigenous agen- Kong and China A-shares markets. Portfolio cies—often spinoffs from SOEs—can’t match. firms include real estate portal SouFun, online In 2011, Hina opened its own RMB fund, out travel service Ctrip, game developers G-bits and of necessity. “In the domestic exit market of NetDragon, chain retailer WuMart, online retail- 2007–11, it was possible for a small company to ers VANCL and Dangdang, medical device maker go public in China,” Li recalls. “If you looked at Andon Health, orthopedic implant developer the amounts U.S. dollars funds were raising, it KangHui and advanced battery nanotech com- was staggering. At the same time, China was en- pany CNano Technology. couraging the development of a structured RMB Sequoia Capital manages eight dollar- market that offered speedy deployment of capital denominated China funds with a combined value with fewer restrictions.” With the government of $2.5 billion, plus the equivalent of another

100 Key Industry Sectors

$640 million in RMB funds. Sequoia focuses on Outbound foreign FDI from China is a rela- high-growth companies at all stages, with a tively new phenomenon. In 2005, Chinese buy- portfolio that includes school test preparer and ers—almost exclusively state-owned firms—made admissions consultants Beijing Wanxue Education $12 billion in non-financial investments outside Technology; car rental firm Reocar; social net- the country; in 2012, the total passed $77 billion. working site 51.com; micropayment solutions firm Overseas investment has grown for a variety of 19pay.com; LED lighting/solar cell producer reasons: China’s need for energy, minerals and Changelight; medical sterilization/purification de- agricultural commodities; government strategies vice maker Laoken, municipal waste treatment to build national champions that can compete firm CSO Environmental Protection; and hema- globally; and firms extending their reach to gain tological/cardiovascular drugs maker Nuokang. technical and business expertise and an edge on Most recently, Sequoia, GGV Capital, NLVC and competitors back in China. Steamboat Ventures have invested $50 million in As noted above, Chinese FDI in the U.S. has Chinese mobile entertainment startup Chukong. been rising steadily, setting new records every year Draper Fisher Jurvetson’s China portfolio in- since 2009. The scale of transactions has also includes a range of investments beginning with early creased in that time, from small tech acquisitions positions in Baidu online payment platform and equity stakes to large-scale M&A. Accordingly, YeePay, and advertiser Focus Media. Other portfo- total deal volume has moderated as the total value lio firms include Jing-Jin Electric, a maker of high- of deals has continued to rise. As the mix has performance motors and drive trains for hybrid and shifted to larger, more complex transactions, the plug-in electric cars; online shoe retailer OkBuy; share accounted for by private Chinese firms has and sports and entertainment portal UUSee. grown to 80 percent of transactions by number and 50 percent by value in 2012. California: U.S. Trade Dollars California accounts for the largest number of Return Home Chinese investment transactions of any U.S. state; It was only a matter of time before some of New York, however, accounts for a larger share of China’s $3.4 trillion in foreign exchange re- Chinese investment by value. This may reflect the serves—largely export earnings—began to mi- fact that capital-intensive investments in manufac- grate out of U.S. treasury securities and bonds turing or resources tend to flow to less expensive and into outbound foreign direct investment jurisdictions, while California attracts more invest- (FDI). The strategy began with the 2007 creation ment in smaller, innovative companies. New York’s of China’s sovereign wealth fund, the China In- numbers are also high due to Lenovo’s acquisition vestment Corp., and continues with the May 2013 of IBM’s laptop business, a particularly large trans- opening of a State Administration of Foreign Ex- action. The principal drivers of Chinese investment change (SAFE) office in New York. in California—apart from real estate—are market SAFE oversees China’s foreign exchange access and the development of strategic assets, reserves, and the new office is charged with ac- defined as brands, technology and knowledge, celerating China’s diversification from U.S. gov- that can enable Chinese companies to penetrate ernment securities to alternative U.S. assets such markets and advance up the value chain. as property and infrastructure. Rhodium Group reports cumulative Chinese “The U.S. has always been very underin- FDI in California for 2000–11 of 156 deals valued vested,” says Hanson Li of Hina Group. “It’s a at more than $1.3 billion, of which $463 million, difficult place to deal with relative to other places or 35 percent, was in the Bay Area. Another 20 in the world, but about four years ago we started deals worth $800 million were done in 2012 and to see interest from Chinese companies in busi- the first half of 2013. Investments in California ness-oriented assets overseas. That interest has were spread across a range of sectors—software really picked up in the last 12–18 months, as Chi- and IT; consumer electronics; semiconductors; nese conglomerates, and even mid-sized compa- leisure and entertainment; food; transportation; nies, are looking to scale up.” pharmaceuticals; healthcare; and aerospace—

101 Ties That Bind, 2014 Edition with a focus on value-added services, either investment in ecommerce company Fab.com, upstream (R&D) or downstream (supply chain, and Alibaba Group Holdings led a $206 million branding, after-sales service) from the core man- investment in ShopRunner.com, which provides ufacturing processes in which Chinese investors services similar to Amazon. Alibaba established a are already strong. Large greenfield investments U.S. investment group based in San Francisco in were located primarily in the Los Angeles and San 2013. Tencent’s offices in Palo Alto actively scout Jose areas; M&A was spread throughout for investment prospects, wielding a $760 million Southern California and the Bay Area. Key deals fund for emerging companies that was created in were done in the Internet, electronics and solar 2011. The company subsequently invested in energy sectors. venture firms such as Andreessen Horowitz and Internet SV Angel, giving it early access to emerging start-  Shanda Games acquired San Francisco-based ups. In 2012, it acquired majority ownership in flash gaming ad network/payment platform game maker Riot Games for $231 million and a Mochi Media for $80 million in 2010. minority stake in Epic Games for $330 million.  Online gaming operator Perfect World Co. Ltd. Both Alibaba and Tencent’s formidable market acquired Los Gatos game developer Cryptic caps are enabling their respective moves to go Studios from Atari in 2011 for $50 million. global, with the help of Silicon Valley start-ups.  In 2010, e-commerce portal Alibaba.com Beyond Tencent and Alibaba, a growing range bought majority stakes in Auctiva (Chico) and and number of Chinese firms have opened of- Vendio Services (San Mateo), two developers fices, R&D centers and/or sales and support pres- of software tools to help customers list and ences in the Bay Area. Among these are China’s sell on eBay. three major telecom providers China Unicom, China Telecom and China Mobile; equipment Electronics makers Huawei Technologies, ZTE Corp. and  Microprocessor manufacturer MEMSIC Semi- Spreadtrum; search engine Baidu; web portals conductor purchased the non-military inert Sina and Sohu; solar module firms Trina Solar, sensor and wireless sensor business lines of Jinko Solar and Yingli Green Energy; Bank of Milpitas-based Crossbow Technology for Communications, Nanyang Commercial Bank and $18 million in 2010. Industrial and Commercial Bank of China; com-  China WLCSP, a wafer-level chip packaging puter maker Lenovo; airlines Air China and China and testing supplier for the mobile and RFID Eastern, plus Taiwan’s China Airlines and Hong markets, opened an R&D center in Sunnyvale Kong’s Cathay Pacific; container shipping lines in 2011. COSCO and China Shipping; Andon Health Co.’s Solar Energy iHealth unit; and the Jun He law firm.  Yingli Green Energy’s Yingli Solar unit opened More than 80 Chinese companies belong to a solar R&D lab in South San Francisco in 2011. the Chinese Enterprise Association, a Bay Area  LDK Solar acquired a 70 percent stake in trade association that mainly helps Chinese firms Sunnyvale vertically-integrated solar developer locating here navigate the business, regulatory Solar Power, Inc. in 2011, a deal that included and cultural environment (see section on Profes- LDK’s assumption of control over operations of sional Networks). a manufacturing facility in Shenzhen. West Summit Capital, with offices in Beijing,  GCL Solar, a solar project developer, which Hong Kong and Palo Alto, is a cross-border in- opened an office in San Francisco in 2009, vestment firm with 13 portfolio companies and currently has 300 megawatts of solar projects approximately $300 million under management. under construction. Its focus is on growth-stage companies with $10 Most recently, Chinese web companies are million or more in annual trailing revenue, more expanding their footprint. In 2013, social net- than 20 percent revenue growth, and a proven working and gaming company Tencent Holdings, business model, mainly in China or the U.S., in with $5 billion in cash reserves, led a $150 million the technology, new media or cleantech sectors.

102 Key Industry Sectors

A major investor at West Summit’s inception City multi-screen digital advertising solutions pro- was sovereign wealth fund China Investment vider Yume. Corp. (CIC), which was the sole investor in its first fund and an anchor investor in its second. But Location, Location, Location West Summit managing director David Lam says Real estate is becoming an increasingly important investments are not strategically (government) draw for Chinese investors, throughout the U.S. directed. “We invest in Chinese companies to but particularly in the Bay Area. For Chinese in- help them connect with the rest of the world,” he vestors, the U.S. real estate market has few barri- explains, “and we invest in companies outside of ers to entry. In China, slowing economic growth is China, mostly in the Bay Area, serving as a stra- prompting companies and investors to accelerate tegic partner to connect them to business expan- their globalization plans, both to access new mar- sion in China. All of our efforts go into building kets and technology and to diversify risk. Recent great companies that derive returns.” U.S. acquisitions have ranged from high profile Lam, who previously was managing director at properties in Manhattan to distressed commercial VC firm W.I. Harper and vice-president at global buildings and hotels that are in default or need private equity firm The Carlyle Group, says West turnaround capital. The San Francisco Bay region Summit seeks out established companies poised is a natural destination, but investors face a for growth, typically in the enterprise space rather learning curve regarding entitlement, disclosure than the consumer side, with technology already and other complexities in U.S. law. embedded in a viable product. Enterprise soft- Hong Kong investors have long been active in ware is perhaps the weakest area of China’s tech commercial real estate in San Francisco. For ex- sector and is also an attractive market for inno- ample, the Great Eagle Group, a major global vators because programs and applications cannot investor in commercial, retail, and residential be replicated quickly. properties through San Ramon-based Pacific An example of the possible synergies is Dan- Eagle Holdings, owns the 353 Sacramento Street ish online 3D game platform, Unity Technolo- tower in San Francisco’s financial district and re- gies, in which Summit invested. It moved the cently acquired 123 Mission Street, a 29-story company headquarters from Copenhagen to San building currently occupied by Salesforce.com Francisco to build a larger developer community, and McKesson Corp. then opened a studio in Shanghai and partnered Recent transactions highlight the Bay Area’s with Qihoo to add its anti-virus software and sup- attractiveness for development, most notably in port to the platform. Asia revenues have more housing, office parks and tech incubators, hotels than doubled since 2011. and infrastructure. An early acquisition was Chi- That said, Chinese investors remain heavily nese investment firm Upsky Enterprises’ purchase hardware-focused because it is what they know. in 2011 of the 309-room 10-story Crowne Plaza “China consumes more than half the chips used in Hotel near San Francisco International Airport. the world, so a lot of investment is still around that Yorbarn Investments, a Chinese investment group ecosystem,” Lam says. Four West Summit portfolio specializing in boutique hotels, has announced companies are in the semiconductor space; an- plans for its first hotel in the United States at 1409 other three are in cloud computing and storage. Sutter Street in San Francisco, investing $3.5 mil- Other West Summit Bay Area investments lion in design and build-out. Chinese investors include Accent, a Palo Alto system-on-chip de- have also acquired office buildings in San Fran- signer and manufacturer for the smart grid sector; cisco and Milpitas and the largely-vacant Silicon Mountain View cloud computing/software-as- Valley office park that was at once the head- a-service platform Mirantis; San Jose multi-core quarters of Borland Software. processor developer for cloud computing Tilera; One of China’s largest publicly-listed devel- Santa Clara cloud storage software developer opers, China Vanke, is teaming with New York Nexenta Systems; Mountain View social media construction firm Tishman Speyer to build two data analytics firm NetBase; and Redwood high-rise residential towers of 37 and 42 stories

103 Ties That Bind, 2014 Edition in downtown San Francisco at a site adjacent to and Treasure Island—involving 12,500 housing the new Transbay Terminal. The 655-unit project units, office and retail uses and open space—did is expected to cost $625 million, including $175 not go forward in 2013 despite a memorandum million from China Vanke and $75 million from of understanding signed in 2012 between the Tishman Speyer. bank and developer Lennar Corp. This experi- And in a $1.5 billion investment partnership ence points to the complexity of navigating deal announced during Governor Jerry Brown’s China’s investment environment, where political April 2013 China trip, Chinese property devel- support, finding the right partner, and aligning oper Zarsion Holdings Group Co., Ltd. has be- interests can be essential. come a co-developer in the Brooklyn Basin project (formerly known as Oak-to-Ninth), a 65-acre Second Home former industrial property on the Oakland water- Residential investment by private individuals is also front where local developers Signature Devel- increasing. Over 2007–12, National Association of opment Group and Reynolds and Brown plan to Realtors data reported by Rhodium Group shows build a new neighborhood of 3,100 residential that Chinese buyers increased their share of total units and 200,000 square feet of retail space, with U.S. home purchases from 5 percent to 11 per- a 200-slip boat marina and 30 acres of parks and cent, ranking second among foreign buyers behind open space. Zarsion has committed an initial $28 only Canadians, and potentially contributing as million for infrastructure and environmental much as $1 billion in 2012 capital inflows to Cali- cleanup for the first phase of the development, fornia. Real estate services firm Jones Lang LaSalle with more to follow as the project proceeds. sees residential property investment by high net Developers concluded the $18 million pur- worth Chinese (those with 10 million yuan, or $1.6 chase of the land in June 2013 from the Port of million in assets) particularly growing. As reported Oakland and the State Lands Commission, and by China Daily, the most popular offshore destina- project build-out will take an estimated 15 years, tions are the United States, Canada, Australia and beginning in 2014. Signature was introduced to the U.K. Considerations for these investors include Zarsion through a UC Berkeley connection: asset diversification (security), establishing an over- Oakland Mayor Jean Quan and Bay Area attor- seas anchor for the family, and the potential for ney Bruce Quan (no relation), now a professor at appreciation—down payments can run as high as Peking University and a Zarsion partner, were 30–50 percent in major Chinese cities, compared classmates. Zarsion was looking to diversify to to the U.S. where 20–25 percent is the norm and other markets with different business cycles and interest rates are low. toured the U.S. looking for projects. When Brooklyn Basin was selected, local attorneys and Start-up Stimulus accountants were hired to advise on the trans- Cross-border start-up incubators and accelerators action. Funding is now going into demolition, have emerged as another potential growth area remediation and site improvement, with further for Chinese investment. Some have tacit or di- infusions to follow. Zarsion now has a permanent rect government support and are intended to three-person office in the region and is looking provide seed funding and technical support to to grow its U.S. portfolio. For many years the Chinese-born entrepreneurs in the U.S. and to Oak-to-Ninth project had languished due to the U.S. start-ups looking to engage in China. lack of investors; Brooklyn Basin is expected to Incubators typically house applicant start-ups, bring new residents and energy to the Oakland offering low-cost office and/or lab space in ex- waterfront and contribute to the revitalization of change for equity or as a straight rental arrange- the city’s downtown. ment. The length of time a company may stay in Not every deal works. A similar proposal, in- the incubator is flexible, up to a maximum cap. volving a $1.7 billion five-year loan by China Most facilities offer add-on support services Development Bank for two large development such as business mentorship and training, net- projects at San Francisco’s Hunters Point Shipyard working events, and introductions to investors.

104 Key Industry Sectors

Brooklyn Basin Source: Signature Development Group

Accelerators accept for a fixed period small “pre-seed” and “post-seed” programs that in- teams from applicant companies that are usually clude a mix of services and support with funding, beyond the start-up stage. Like incubators, they mentoring, workshops, in-house accounting and offer business mentorship and training immersion paralegal advice, and venture/angel investor programs that may or may not involve shared contacts, plus physical office space and related workspace; founder applicants are typically pro- services. Post-seed companies can also connect vided with seed funding and a convertible note in with and obtain workspace at satellite offices of exchange for equity upon successful completion. larger firms in related fields. The model began in 2005 with Y Combinator, a InnoSpring has also established a seed fund as Mountain View accelerator launched in 1998. part of its program through which start-ups re- In all, the Bay Area is home to more than 60 ceive, upon acceptance, $25,000 plus an addi- incubators and accelerators of various kinds, pri- tional $250,000 upon completion. In return, the marily serving tech and life sciences start-ups. accelerator takes a 1 percent to 5 percent equity Chinese participation in this space is relatively stake in the company. Seed fund partners include new, often with unique characteristics—beginning Kleiner Perkins Caulfield & Byers, Northern Light, as a commercial real estate investment, possibly GSR Ventures, China Broadband Capital and with strategic tie-ins to Chinese science and TEEC Angel Fund. As of May 2013, InnoSpring’s technology parks or a China-focused source of seed fund has invested $2 million in 12 firms ac- capital. Consistently, the goal is to facilitate cross- cepted from among 300 applicants. border linkages of entrepreneurs and companies Portfolio companies have included low- and access to technology and innovation. noise/low-power integrated circuit maker Accusili- The first of these accelerators was InnoSpring, con; mobile-to-mobile file-sharing technology firm a 13,500-square-foot facility opened in Santa Clara Dew Mobile; mobile security app developer in April 2012. Partners in the venture include TrustGo, a Silicon Valley start-up with a Chinese Tsinghua University Science Park (TusPark), prop- founder; Empower Micro Systems, a designer of erty developer Shui On Group, China-focused power inverters for energy storage and electric VC firm Northern Light Venture Capital and Sili- vehicles; Lex Machina, a data analytics firm that con Valley Bank. InnoSpring offers six-month uses big data to search and analyzes intellectual

105 Ties That Bind, 2014 Edition property litigation for law firms, businesses and start-ups. With RMB 10.2 billion in registered public interest groups; and OncoHealth, a maker capital, the fund works through Hanhai Z-Park to of protein marker diagnostics to screen for and indentify companies in the Bay Area and elsewhere diagnose cervical cancer. for possible funding. The 80,000-square-foot Hanhai Z-Park, opened Tenants include cloud computing/file sharing in San Jose in June 2012, manifests China’s grow- company Synaptop; project management/pro- ing focus on innovation-led economic growth and ductivity app developer Moxtra; cloud-based text on attracting overseas talent. The facility is a joint message health management service Health- venture of Beijing Hanhai Zhiye Investment Man- Crowd; online dermatologist health exchange agement Group, a developer of office parks and DermLink; NanoSatisfi, a firm that leases incubators in China, and Zhongguancun Science crowdsourced time on satellites for running Park, China’s largest such park with some 23,000 space-based research and other projects; com- companies. Vice President Joe Biden and China’s mercial building smart energy management then vice president Xi Xinping were in the audi- company EZ Green; and distributed wind power ence at the February 2012 signing ceremony generation company ArborWind. Larger Chi- when Hanhai chairman Wang Hanguang pur- nese firms, among them Baidu, Tencent and chased the property. retailer Suning, have also taken space in the The park currently has 70 members, primarily park, either to do sales and marketing or to ac- IT and cleantech companies, 20 of which are in cess local engineering R&D talent. residence and receive a higher level of support. In June 2013, a second Hanhai-affiliated incu- Resident members are assigned managers, who bator, the Hanhai-Zibo Life Science Park, opened help them design a China strategy and facilitate in Burlingame to focus on biotech, cleantech, mi- contacts with potential Chinese partners. Three- crodevices and new materials. The $24 million, fourths of tenant start-ups are U.S. businesses 113,000-square-foot facility is a joint venture be- with plans to enter the China market, some with tween Hanhai and the Zibo New and High-Tech Chinese-born founders; Chinese tenants include Industrial Park, a biotech and new materials facility universities or economic development zones in in Shandong Province which is a majority stake- China and entrepreneurs with cross-border ex- holder. The business model is similar to Hanhai Z- pansion plans. Park’s with paid members. Hanhai-Zibo’s six ten- Hanhai Z-Park is a hybrid model, an incubator ants at the time of opening relocated from the that primarily offers office and R&D space plus Zibo Park. incubator services. It has no structured accelerator Twenty-five U.S. companies have also been in- program but brings to the table a $5 million angel troduced to potential partners and funders in investment fund and plans to invest $100,000– Shandong Province, where assistance may be pro- 300,000 each in selected tenant companies. vided in finding engineers and grants may be Through its relationship with Zhongguancun and available from local research parks. At the start, other parks, Hanhai Z-Park aims to help start-ups nearly all the members (95 percent) were local, but scale and enter the China market. In the fall of the ratio is shifting as more Chinese companies (up 2013, the Park hosted its first Zhongguancun- from 5 to 20 percent of members currently) are Silicon Valley Innovation and Entrepreneurship seeking help coming to the Bay Area. According Competition where twelve start-up finalists, win- to Sue Xu, Operations Director of zPark Venture, nowed through several rounds of pitches and increasing competition in China is pushing Chinese screenings, competed for prizes of $20,000– companies to come to the Bay Area, to gain a 50,000, a tour of Z-Park in Beijing, and mentorship competitive advantage and a 6–12 month lead by venture capitalists and experienced Chinese time in product development on companies at and American entrepreneurs. Another player is the home. Like Bay Area companies going to China, Zhongguancun Development Group, an equity these companies receive professional advice and investment arm of the Science Park and the City of introductions to potential employees and local Beijing that focuses on high-tech, high-growth service partners.

106 Key Industry Sectors

Hanhai is also a limited partner in QB3@953, a fulfillment company, PCH International. PCH has biotech incubator located in San Francisco’s Mis- been in China since 2000, with operations in sion Bay district. Shenzhen’s Futian Free Trade Zone. Its U.S. Start-up activity is also supported by Accel- headquarters in San Francisco is a 30,000- erator zPark Venture, a venture fund that sup- square-foot industrial space that houses a de- ports companies housed in incubators. In its first velopment and engineering lab, a rapid proto- year (2013), the fund invested between $5,000 typing facility, a sustainable packaging facility, and $350,000 in 25 companies, 95 percent of collaborative workspaces for Highway1 and PCH which are start-ups based in the U.S., with 80 clients, and an events space. percent in Silicon Valley. Highway1 accepts up to 10 companies at a HAXLR8R and Highway1, both in San Fran- time for its four-month program and offers cisco, are hardware accelerators for start-ups in- $20,000 in seed funding plus office and manu- volved in advanced manufacturing. Both provide facturing space, in exchange for 3–6 percent seed funding; training in design, engineering, equity down the road. Part of the program in- sourcing and supply chain; and mentoring and volves travel to Shenzhen to tour PCH’s Chinese contacts to take innovative hardware products contract manufacturing facilities that may even- and technologies from idea to production. tually make successful graduates’ products. PCH HAXLR8R offers hardware start-ups with up to already has a separate accelerator that has four people $25,000 in seed funding; training in graduated companies such as Lark, maker of a sourcing, manufacturing and supply chain at a 111- sleep monitoring device, and MetaWatch day boot camp in Shenzhen, China’s manufactur- Strata, developer of a digital watch that can ing center; and an additional $25,000 note upon sync to a smartphone, using Bluetooth, to re- successful completion of the program and pres- trieve emails and text messages. entation at a demonstration day in San Francisco. More incubators, with investment, are on the Portfolio start-ups include Melon, an EEG con- way. CFLD, a major developer of new towns and nected headband device that helps enhance cog- technology parks with 19 sites in China, will open nitive function; Nomiku, designer of an affordable a technology incubator in Mountain View in 2014, precision temperature cooker that enables sous focusing on hardware and medical devices. Its vide cooking in airtight plastic bags; and Spark, strategy is to develop companies in the Bay Area developer of a cloud-based open-source kit that that might one day expand to China, creating adds Wi-Fi to any electronic product. employment in the new towns. An associated Highway1 was launched in early 2013 by venture fund, CFLD Capital, will provide invest- an Irish electronics contract manufacturer and ment support.

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108

8. CONNECTORS Building New Bridges

As has been noted throughout this report, the Food and Agriculture. Another network of trade Bay Area and greater China have benefited from promotion centers had developed, linked to cross-border trade, investment and technology community colleges and designed to serve small, exchanges based on an infrastructure of talent, new-to-export firms. These programs to some capital and innovation. degree continue but have also suffered from A changing landscape has now produced a budget cuts. new set of “connectors,” oriented toward pro- A new public-private model for state trade and moting cross-broader business exchanges and investment promotion surfaced in early 2013 sustaining a cross-border talent and innovation when Governor Jerry Brown, on a trip to China, infrastructure: public-private trade and invest- announced the opening of the California-China ment partnerships at the regional, state and city Office of Trade and Investment, the state’s first levels; privately developed incubators and accel- overseas office in a decade. The office in Shang- erators; EB-5 regional centers linking immigrant hai was a creative response to budgetary neces- investors with local development projects and sity: the state had no funds to operate foreign green cards; and sector-specific trade associa- offices. In September 2012, California lawmakers tions arranging targeted cross-border contacts had approved legislation to allow the joint, pub- and events. lic-private establishment and operation of overseas offices. This legislation paved the way for the A New Kind of Overseas Office California-China Office of Trade and Investment to open as a public-private partnership between California has not had a dedicated overseas trade the Governor’s Office, the Governor’s Office of and investment promotion program since 2003. A Business and Economic Development (GoBiz), robust program launched in 1983 within the of- and the Bay Area Council. The Council’s Shang- fice of Governor George Deukmejian included hai office, which had been in successful operation services such as export finance in cooperation for three years, provided an efficient base for with community banks; low-cost, California- launching the new program. themed trade show participation; and a network The California-China Office of Trade and In- of overseas offices in more than a half dozen lo- vestment serves exporters throughout California, cations. Over time, that network grew to 10 inter- helping them gain access to the Chinese market, national trade and investment offices, supported and serves as a portal for Chinese investors seek- by domestic teams in Long Beach and Sacra- ing opportunities in California. While that invest- mento. By the mid-1990s, these activities and an ment could go in many directions, the state sees office for foreign investment promotion were infrastructure projects, agriculture, online com- centralized in the California Trade and Commerce merce, and high tech as particular opportunities. Agency, until budget cuts forced its closure. As China faces major energy and environ- When that occurred, California essentially had no mental challenges, climate and energy will also overseas representation. be an important focus. California has developed Other sector-specific trade promotion pro- effective environmental polices over many dec- grams were housed within the California Energy ades, leads the U.S. in developing climate policy, Commission and the California Department of and is the nation’s leading center for cleantech

109 Ties That Bind, 2014 Edition development. Both share an interest in improving employees and $5 million invested to date, Sun- energy efficiency and addressing climate change. ing plans to increase its investment and to grow This led to a September 2103 MOU signed by its employee base to 200 in the next two years. California governor Jerry Brown and National Its initial focus will be on advanced technologies, Development and Reform Commission (NDRC) online commerce and Internet-based retail. vice chairman Xie Zhenhua, to cooperate on cli- Other organizations have moved to formalize mate change, clean energy and low carbon de- ties at the regional and city levels. The Bay Area velopment—the first agreement of its kind be- Council, a business-sponsored, public policy ad- tween a subnational government and the central vocacy organization for the nine-county Bay Area, Chinese government. This followed a separate had launched a series of China initiatives begin- agreement, signed with Guangzhou Province ning with the first edition of this Ties That Bind during the governor’s trip to China in the Spring report in 2006, followed by venture capital and of 2013, to cooperate on carbon markets. cleantech conferences in Shanghai in 2007–08 The California-China Office of Trade and In- and the opening of an office in Shanghai’s vestment is committed to raising $1 million in Yangpu District in 2010 to help Bay Area firms private sector funds to operate the office and access the China market. Since then, the Council support staff in California that will provide cross- has introduced 15 companies to China; 90 per- border advisory services to California businesses cent are American, and 70 percent of those are and Chinese investors. Founding advisory board from the Bay Area. A steady flow of Bay Area members include Bank of America, Driscoll’s, Council delegations have visited China, and Chi- FedEx, Hanson Bridgett, HSBC, Invest LA Re- nese delegations from Shanghai and other cities gional Center, JM Eagle, MEBO International, have visited the Bay Area, meeting with compa- Royal Business Bank, Signature Development nies and participating in events such as the Group, Shui On Land Limited, Silicon Valley Council’s first U.S.-China Smart Cities Sympo- Bank, Sun World International, Visa, and Wells sium, held in San Jose in 2012. Fargo. Critics in the past have questioned the In 2012, the Bay Area Council opened a effectiveness of overseas offices in producing second China office in Hangzhou, a major tech- significant new business, but Diane Long, ex- nology center south of Shanghai, and a third ecutive director of the Office, says that the Of- office will open in Nanjing in 2014. Additional fice has been structured according to the best offices in south, north and central China are practices of other states, has developed realistic being considered. performance metrics, and will make improve- “We’re in a good position because we’re a ments as needed. non-profit—for businesses entering the China The Office’s first undertaking was Governor market and trying to figure out where to go first, Brown’s April 2013 trade mission to China. Dur- trust is important, ” explains Council chief of staff ing that trip, over $1.8 billion dollars in deals John Grubb. The Council’s office is located in the were announced, including the investment by 207-acre Knowledge and Innovation Community, Zarsion in Oakland’s Brooklyn Basin. The gover- an urban live-work neighborhood developed by nor also signed several sweeping agreements Shui On Land to foster technological innovation with Chinese leaders to expand trade relations, and entrepreneurship similar to that of Silicon further knowledge and technology exchange, and Valley. The Yangpu District is also home to 14 build a trans-Pacific approach against climate universities and colleges. change. A major success came in November Individual Bay Area cities are also marshaling 2013, when it was announced that Suning Com- their China business, academic and cultural re- merce Group, the largest retail enterprise in sources to build distinct public-private networks. China with more than 1,600 chain stores in over ChinaSF was established in 2008, in part to or- 600 cities in mainland China, Hong Kong, and ganize an upcoming China business delegation led Japan, will open an R&D Center in the Bay Area, by then San Francisco mayor Gavin Newsom. its first research institute outside China. With 20 Since then, it has leveraged the official resources

110 Connectors of the Mayor’s Office of Economic and Workforce Communications and solar firms Trina Solar, Development with the business and investment Yingli Green Energy, GCL Solar Energy and expertise of the San Francisco Center for Eco- ReneSola, and in helping online game developer nomic Development (SFCED), a non-profit busi- Shanda Holdings expand its Bay Area presence. ness promotion arm of the San Francisco Chamber In June 2012, San Francisco entered into a of Commerce. memorandum of understanding (MOU) with ChinaSF’s sponsors include Deloitte; devel- China’s National Energy Conservation Center— oper Lennar Urban; investment firms BlackRock, part of the National Development and Reform Morgan Stanley, Hina Group and Warburg Pin- Commission—to undertake technical coopera- cus; law firms Pillsbury, Morrison & Foerster, K&L tion in promoting energy efficiency. Putting the Gates and Nixon Peabody; architects Gensler and MOU into action, an initial step has established HOK; commercial real estate firms CB Richard a partnership with the city of Nanchang in Ji- Ellis and Kidder Matthews; and Cisco Systems. angxi Province for cross-border business and The group’s bilingual staff works out of the Bei- technical exchanges on two large development jing and Shanghai offices of Hina Group and Nixon projects of comparable type and scale: San Peabody, respectively. Its work builds on San Fran- Francisco’s 500-acre Hunters Point Shipyard cisco’s longstanding relationship with China dating project and Nanchang’s 200-acre mixed use back to the administration of then mayor Dianne development, also to be built on former indus- Feinstein and the establishment of the San Fran- trial land. A key provision encourages participa- cisco-Shanghai Sister City Committee, which tion from Chinese and Bay Area financing, sup- continues to lead mayoral delegations to China. pliers, vendors and subcontractors. San Francisco also boasts close ties to Taiwan and ChinaSF partnered with another San Francisco- Hong Kong dating back decades. based connector, the China-U.S. Energy Effi- “San Francisco is comfortable for Chinese in- ciency Alliance, to secure the MOU, and the two vestors; there’s a large Chinese community here organizations are assembling a delegation of en- and they see a lot of opportunity in the Bay ergy efficiency firms with proven business models Area,” says ChinaSF executive director Darlene and technologies to visit Beijing, Tianjin, Chiu Bryant. “And now we have a Chinese mayor Chongqing and Qingdao in 2014. The Alliance who is seen as very friendly to Chinese invest- includes among its members California’s major ment, and that helps as well.” For many Chinese utilities, the state Public Utilities and Energy firms, the city’s geographic location and interna- Commissions, Bay Area clean energy companies, tional focus are also an attraction. “A lot of com- Lawrence Berkeley National Laboratory and the panies have made their name in China and want Natural Resources Defense Council. to become global,” she explains. “They can A second San Francisco MOU signed in 2013 come to San Francisco, cross fewer time zones, with the China International Culture Association and access 75 countries through our network of provides an official door for future cultural and trade offices and consulates.” artistic exchanges with organizations throughout Since 2010, ChinaSF has been instrumental China, a development that should significantly in bringing to San Francisco China’s Bank of benefit the city’s Asian Art Museum.

111 Ties That Bind, 2014 Edition

The Asian Art Museum: Come for the Art

San Francisco’s Asian Art Museum houses a world-class collection of classic and modern Chinese art—the largest in the Western Hemi- sphere—and regularly hosts both large and small scale visiting exhibits. The museum is already a draw for Bay Area residents and visitors, and museum director Jay Xu would like more visitors from China to experience it. Xu says that a dual-track strategy is needed to fully leverage this valuable asset—one that combines community support and more concentrated, coordinated tourism promotion. “Our museum, like others, forms a very important pillar of the economy—cultural tourism,” he says. “China should be one of the big growth areas.”

The year-long Celebration of Shanghai series of exhibits and programs in 2010, tied to the World Expo in Shanghai at the time, provides a template. The Asian Art Museum provided a focal point for 30 programs hosted by 15 different China-related cultural organizations. An early 2013 exhibit of terra cotta warriors from the burial complex of Emperor Qin Shihuang in Xi’An, Shaanxi Province featured a reception with Chinese-American organizations, reprising an earlier exhibit in 1994 that was the Museum’s best-attended event. Xu is optimistic about increasing Chinese tourist traffic at the museum. While most travelers from China currently come to the Bay Area on package tours, he’s counting on the trend of more affluent travelers visiting on their own and looking for a richer cultural experience. There is an added challenge of expanding museum exhibits beyond traditional art, that involves complex relationships with Chinese museums, galleries, collectors, artists and government agencies. While there are established procedures for curating cross-border exhibitions of classic works with national and provincial museums, similar arrangements for contemporary art are still uncharted territory in terms of logistics, liability, documentation and government involvement. All

112 Connectors

must be handled on a case-by-case basis among multiple parties, adding to cost and risk. Xu is hopeful that tourist and exhibition obstacles will recede over time, and that the Asian Art Museum can become a cultural hub connecting and promoting understanding between the Bay Area and China. The City of San Francisco’s new cultural MOU with the Chinese government should help. “With the rise of Asia, the museum becomes all the more relevant,” he says. “It connects art to life and offers a platform to help people be better informed about Asia—a hub where people from all walks of life connect.”

The City of San Jose launched its own con- the EB-5 visa program was referenced in the nector, China Silicon Valley, in June 2013. The context of investors pursuing green cards with a group’s mission is to attract inward Chinese in- dual strategy: as insurance in case they want to vestment by providing access to local govern- relocate abroad and as a way to enroll their chil- ment and business leaders and to supportive dren in U.S. schools or universities at resident regulatory, tax, legal, and other services. tuition rates. Board members include Hanhai Z-Park general The federal EB-5 program, established in manager Victor Wang; East-West Bank first vice 1990, has emerged as a potentially valuable eco- president Stephanie Xu, a commercial real estate nomic development tool for cash-strapped cities and EB-5 specialist; and Fred Greguras, a partner and counties in California and as a source of with Bay Area law firm K&L Gates, specializing in funding for both large and small-scale projects. cross-border M&A. Business partners include the This is particularly the case as California’s rede- Chinese Entrepreneurs Association, Stanford Uni- velopment program and its network of 400 local versity, global commercial real estate firm Colliers redevelopment agencies with bond-issuing ca- International, the Pillsbury law firm, the California pacity was eliminated in 2012. Given this eco- Development EB-5 Regional Center, the Singer- nomic environment, Chinese investors and Cali- Lewak tax practice, and the cities of San Jose, fornia cities and counties have found their inter- Sunnyvale, Cupertino and Campbell. ests aligned, and regional centers (RCs) are China Silicon Valley is particularly targeting emerging as key points of intersection. large Chinese companies willing to locate manu- Under the EB-5 program, investors, their facturing and R&D facilities that create jobs in spouses and unmarried children under 21 be- areas with high commercial vacancy rates or, as in come eligible to apply for a permanent resident locations such as North San Jose, in areas with visa (green card) if they make a $1 million in- large tracts of available industrial land. Develop- vestment anywhere in the U.S. that results in the ment of this kind can, in turn, attract additional employment of at least 10 qualified individuals, investment from EB-5 and other sources. The or if they make a $500,000 investment in rural or group is talking to large potential Chinese part- high-unemployment areas or through a govern- ner firms that already have presences in Silicon ment-approved EB-5 non-profit regional center Valley and has met with officials of Guangzhou’s that syndicates investments to fund larger de- Yiexiu District in Guangdong Province to explore velopment projects. investment prospects. It plans to open offices in Regional center investments operate on a five- Shanghai and Beijing. year time frame, coinciding with the EB-5 visa process. During that period, the investment must The EB-5 Advantage generate at least 10 full time jobs per investor within two years. In an earlier discussion of visas in this report (see At that point, investors are eligible for condi- “Visas: The School-to-Work Transition” in the Chi- tional resident visas similar to those granted to nese Students at Bay Area Universities chapter), spouses of green card holders. They may exit the

113 Ties That Bind, 2014 Edition investment at any time after the job-creating 29-year-old Anshoo Sethi, charging that his conditions of the EB-5 are met, and after five Chicago RC fraudulently raised $145 million in years residing in the U.S. they are eligible for a investments and another $11 million in adminis- permanent green card. Regional centers typically trative fees from 249 mostly Chinese investors charge fees in the $50,000 range to administer for a dubious green hotel and convention center the project investments, reporting requirements project next to O’Hare International Airport, on and visa processing. vacant land owned by Sethi’s family. Investments have different characteristics and Such cases are rare but highlight weaknesses in offer varying types and levels of return, so exits the EB-5 program. Targeted Employment Areas, may come well before the five years or well after. which permit lower investment in disadvantaged Most investments made through regional centers areas, are subject to manipulation. Regional cen- are passive, but they must be structured and ters are lightly regulated and monitored on the represented as “at risk” investments, not loans front end, and rules can be vague or contradictory for which returns are guaranteed. Qualifying jobs regarding marketing representations, fee struc- created can be direct—hotel desk clerks, cus- tures and project milestones. Detailed assessments tomer service representatives, manufacturing line take place when investors submit I-526 petitions workers, event planning and catering staff—or for conditional visas as job requirements are met indirect in construction or services from vendors (up to two years into the process), or later when and suppliers, such as room furnishings or land- they file I-829 petitions for the government to re- scaping. Jobs do not have to be specifically move conditions and grant a permanent visa. identified and can be calculated using federally- USCIS can decertify an RC and/or deny an I- approved statistical models. 526 for not meeting investment requirements. A total of 10,000 EB-5 visa slots are allocated Projects—and the green cards they are to gener- nationwide each year; up to 3,000 are made ate—may therefore be disallowed after the in- available for investment in targeted employment vestment funds have been spent. In a 2012 case, areas (TEAs), and up to 3,000 are available for for example, 23 foreign investors sued USCIS for investments through regional centers. U.S. Citi- disallowing visas relating to a warehouse project zenship and Immigration Services (USCIS) figures in Riverside, California after the investments had show that since the EB-5 program’s inception, it already been made. USCIS ruled that the RC has attracted $6.2 billion in investment, created could not count jobs created by tenant busi- 49,000 jobs, and issued more than 13,000 per- nesses after the warehouse was completed. The manent visas to investors. As of July 2013, USCIS USCIS California service center saw its backlog of reported 18 approved Bay Area regional centers, I-526 cases double from fewer than 3,000 in May out of more than 80 registered in California. 2012 to more than 5,800 in April 2013, with the The proliferation of RCs—from 11 in 2007 to oldest cases dating back a year; pending I-829 more than 300 in 2013—and dubious operators petitions, by contrast, dropped sharply from can crowd the market and at times damage the 2,500 in late 2011 to around 700 in March 2012 reputation of an otherwise beneficial program. and have held at those levels since. Applications to create new EB-5s surged several As shown in the following tables, the annual years ago as registration fees were about to be percentages of I-526 and I-829 petitions ap- hiked, but less than 20 percent of those regional proved over 2005–12 increased until 2012, in part centers are currently active. Chinese investors, due to the volume of petitions received and the mostly individuals, may be sophisticated but of- resulting backlogs. The surge in volume is mainly ten rely on friends for advice and need help un- attributable to Chinese applications. For the first derstanding what is and isn’t a good project in time in the program’s history, EB-5 applications the U.S. Some EB-5 developers see the program are approaching the total cap of 10,000 visas; of as easy money, so investors need to be cautious. 7,600 applications in 2012, more than 6,100 were A case in point is the February 2013 Securi- from China, and USCIS is now reportedly consid- ties and Exchange Commission lawsuit against ering a country cap.

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USCIS Service-Wide Receipts, Approvals, Denials (Fiscal Years, 2005–2012)

Form I-526, Immigrant Petition by Alien Entrepreneur Approval Fiscal Year Receipts Approvals Denials Percentage 2005 332 179 156 53% 2006 486 336 124 73% 2007 776 473 148 76% 2008 1,257 640 120 84% 2009 1,028 1,262 207 86% 2010 1,955 1,369 165 89% 2011 3,805 1,563 371 81% 2012 6,041 3,677 957 79% Grand Total 15,680 9,499 2,248 81% Source: USCIS; Association to Invest in the USA (IIUSA)

Form I-829, Petition by Entrepreneur to Remove Conditions Approval Fiscal Year Receipts Approvals Denials Percentage 2005 37 184 112 62% 2006 89 106 108 50% 2007 194 111 49 69% 2008 390 159 68 70% 2009 437 347 56 86% 2010 768 274 56 83% 2011 2,345 1,067 46 96% 2012 712 736 60 92% Grand Total 4,972 2,984 555 84% Source: USCIS; Association to Invest in the USA (IIUSA)

Two Local Examples those projects and a planned third call center will The San Francisco Regional Center (SFRC), generate over 2,000 jobs. SFRC CEO and Bay based in Oakland, structures its projects like pri- Area real estate investor Tom Henderson is plan- vate equity funds. Three projects—two Call ning more projects, including a restaurant, an Socket customer service call centers and Com- LED lighting company, a company that produces prehensive Care of Oakland, a subacute care and distributes hearing aids, and a third-party nursing facility affiliated with Kaiser Perma- logistics company. The companies are located in nente—have launched, delivered their financing buildings that Henderson has acquired, including and obtained conditional or permanent green Oakland’s Tribune Tower and a 90,000-square- cards for 80 investors. When fully operational, foot industrial building near the Port of Oakland.

115 Ties That Bind, 2014 Edition

He has also leased 30,000 square feet at 1355 to help fund housing construction, raised $50 Market Street in San Francisco, in the same million. SFBARC proceeded with a third fund for building occupied by Twitter, to house an EB5- the Shipyard, with investors in all three funds funded incubator. coming from nine different countries. Henderson has a background not only in real Fang says an RC is a good route for prospec- estate but in import-export, primarily with Asia. tive EB-5 investors because it manages both the Most of his investors—about 80 percent—are investment and the visa details and is a regulated mainland Chinese, and the rest are from Hong entity with reporting requirements. It also allows Kong, Pakistan, Singapore and Vietnam. His investment at the lower $500,000 level (“At the investors are sophisticated, understand the EB-5 $1 million level it’s often difficult to find some- rules, and are adept at analyzing business pro- one,” she says), and since Hunters Point is in a posals. “It’s the project that drives investors,” he high unemployment area, investors are eligible says. “The Chinese from China are the smartest for both the RC and the targeted employment in the world; they’re capitalists in a communist area allocations, making them less likely to be country, they have to deal with competitors on closed out in a given year if either category the ground while protecting themselves from reaches its limit. the government.” Lennar’s Kofi Bonner agreed that EB-5 in- He is skeptical of most regional centers and ex- vestors have been important to Hunters Point. pects many will end up suspended by USCIS for When Lennar’s financing discussions with the inactivity. He is also wary of centers tied exclusively China Development Bank (CDB) ended in early to real estate and to large projects requiring too 2013, the project already had been courting EB- many investors without a sound underlying value 5 investors. The publicity around the CDB talks proposition in specific growth sectors. Pure real had raised the profile of both Lennar and Hunt- estate plays are complex, Henderson maintains, ers Point in China. requiring an LLP, an environmental impact report For Hunters Point, Bonner describes a series and other supporting documentation translated of tranched deals with offerings made only for into Chinese. “A lot of RCs go out with five pages, specific activities the investor funds will go to- sometimes even just one page,” he says, noting ward. Through the second fund, 88 townhouses that other RCs appear to have no clear business and condos were under construction by mid plan or sectoral expertise; they apply for the 2013 and construction was scheduled for an- broadest geographic scope and industry mix pos- other 159 residential units, bringing the total to sible and shop for projects. 247 for 2013. Approximately 280 more are Like Tom Henderson at the San Francisco Re- planned for 2014, with the infusion of an addi- gional Center, Ginny Fang, CEO of the San Fran- tional $100 million in investment. cisco Bay Area Regional Center (SFBARC), has A key factor for investors is how the EB-5 and seen success. SFBARC was initially approved in overall development timelines mesh: since large, 2009 and was reorganized under its current lead- complex construction projects like Hunters Point ership in 2011 when Ginny Fang left her position have prolonged construction time frames sur- as ChinaSF’s founding executive director to lead passing two years, construction jobs can be SFBARC’s efforts to direct EB-5 financing into counted toward fulfilling the EB-5 mandate to job-creating enterprises in the San Francisco Bay meet the two-year initial job creation requirement Area. The principal focus of SFBARC’s EB-5 funds for investors to get their conditional visas. “Large is the 495-acre Hunters Point Shipyard site in San residential projects can qualify as EB-5 projects Francisco, a former U.S. Navy shipyard being re- due to their lengthy employment of construction developed by Lennar Corp. labor beyond two years,” Fang explains. Helping to finance development at the Hunt- Given that, large real estate development ers Point Shipyard, the first of two SFBARC funds, projects—housing, hotels, shopping centers— covering street, utility and sewer infrastructure, are attractive because they are job generators raised $27 million from 54 investors. The second, at all stages. And if a big name architect, builder

116 Connectors or company is behind the project, that gives  California Energy Investment Regional investors an added comfort level. “There are Center, with offices in Cupertino, Fresno and hundreds of regional centers registered, but if Sacramento, focuses on solar farms selling you’re out in China, there are probably only electricity to utilities, advanced extraction frack- about ten names you hear about in terms of ing rigs, and reopening closed ethanol plants. actual projects.” SFBARC is now considering  California Wineries and Vineyards Regional potential projects throughout the State Center in San Mateo invests in winery and vine- of California. yard properties in Napa and Sonoma County To maximize investment prospects, some RCs TEAs; it has recruiting and support services af- try to identify development sites and projects in filiates in the PRC, Hong Kong, Japan and Korea. rural locations or targeted unemployment areas Regional centers from outside California are (TEAs), defined by law as areas where unem- also stepping in. The Kor Group is renovating the ployment is at least 50 percent higher than the vintage but run-down Renoir Hotel in San Fran- national average. With nationwide unemploy- cisco’s mid-Market area with $40 million in Chinese ment in the 8–10 percent range over 2009–11, investment from EB5 Global, a regional center RCs tended to shop for projects in counties with based in Portland. In addition to accommodations, pockets of 12–15 percent unemployment: Oak- the boutique hotel will have several bars and res- land, Richmond, Eastern Contra Costa County, taurants to capitalize on its mid-Market location the Central Valley, East Palo Alto and North San adjacent to expanding companies such as Twitter, Jose. Some examples of other regional centers Dolby, Square, and Yammer and to large housing in the Bay Area include the following: developments under construction nearby.

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118

Paths Forward

As the Economic Institute found it its 2006 study, As more U.S. and international universities and the San Francisco Bay Area enjoys a depth and business schools open campuses and offer pro- density of economic connections with China that grams to connect students with the region’s inno- is unique in the United States. This reflects more vation and entrepreneurial system, the potential than 160 years of interaction that has produced for a greater presence by Chinese universities is demographic ties and a depth of cultural intelli- growing. Strong Bay Area alumni networks from gence regarding China that is difficult to find leading Chinese universities offer a unique foun- elsewhere. It also reflects the fact that the Bay dation to build on. Area’s economic strengths—in technology, urban There are also outbound opportunities. The design and environmental planning, life sciences, 100,000 Strong Initiative, launched by former innovation, and entrepreneurship—mirror China’s secretary of state Hillary Clinton in 2010, aims to own needs and priorities. While the business and send 100,000 U.S. students to study in China by policy landscapes are complex, this presents the 2014. The 100,000 Strong Foundation, created in Bay Area with major opportunities for growth and 2013, is tasked with carrying out the Initiative, leadership, as China continues to expand its and the Chinese government is offering scholar- presence on the global economic landscape. ships for 20,000 U.S. students to study in China. Several specific areas of opportunity emerge As of early 2013, approximately 6,500 U.S. stu- from this analysis. dents had taken advantage of the program. Bay Area students studying in China can help to build Higher Education both cultural intelligence and relationships that Because of the large number of colleges and uni- will support stronger economic ties. versities in the region and the presence of world- renowned institutions such as Berkeley and Tourism Stanford, the Bay Area is a major destination for The growing flow of Chinese tourists venturing students from greater China. China consistently overseas, their increasing wealth, and the fact vies with India for the top position as an overseas that more are traveling independently all suggest source of students. This flow remains strong and that tourism will remain a major area of opportu- is likely to grow. The Bay Area benefits from the nity for the region. The Bay Area’s location on the direct spending of those students but more im- West Coast, iconic attractions, easy access portantly from the energy and skills they ulti- through SFO, and cultural receptiveness to Chi- mately bring to the economy. Even those who nese travelers make it a natural destination. return to China bring benefits through the personal and business ties they develop with the Immigration region, enabling further trade and investment. In the last two decades, students from China have For public colleges and universities (UC and chosen to remain in the Bay Area in large num- CSU), however, it would be unfortunate if Chi- bers, populating research laboratories, founding nese and other foreign students (who pay full companies, and becoming venture capitalists. tuition) were to be seen as an adequate substi- Current policy, however, makes it unnecessarily tute for long-term investment by the state in its difficult for many of these graduates to stay and higher education system. Budget cuts to higher contribute to the economy. Immigration reform is education can also undermine the long-term needed to (1) remove country quotas for green global competitiveness of the state and its econ- cards (which are quickly exhausted for high-vol- omy. Continued investment in public higher edu- ume countries such as China), (2) make it easier cation in California is essential. for entrepreneurs from China and other countries

119 Ties That Bind, 2014 Edition to stay in the U.S. to found companies, and (3) Connectors enable foreign graduates of U.S. universities with While China will remain a sometimes controver- advanced degrees in STEM fields to secure green sial topic in Washington, states, regions, and cards on an expedited basis. private companies tend to see China pragmati- Energy and Climate cally. More than most, the Bay Area has shown an affinity and openness to China. Ever since the Despite policy differences, China and the U.S. historic creation of the Shanghai-San Francisco share a common interest in reducing the long- Sister City Committee, the Bay Area has shown term consumption of fossil fuels, increasing the that it is prepared to reach out to develop new production of renewable energy, improving en- relationships and channels. New intermediary ergy efficiency and addressing climate change. entities such as ChinaSF and the Bay Area California leads the nation in its commitment to Council’s Shanghai and Hangzhou offices exem- addressing these issues and in the progress it has plify this trend and provide platforms for contin- made. This is particularly true in the Bay Area, ued business growth. The State of California’s new where the state’s cleantech industry is concen- China office gives California an official presence in trated and where government, university, and China for the first time in a decade. For organiza- industry initiatives offer a rich foundation for dia- tions that play this role, investment attraction will logue and cooperation. be an increasingly important focus. Investment As China begins to send ever larger volumes of investment capital around the world, California Conclusion and the Bay Area are positioned to capture an outsized share. Because of its strength in smaller, These opportunities do not mean that China will entrepreneurial and technology-based compa- be an easy place to do business or that significant nies, the region is more likely to attract invest- barriers don’t exist. China’s economy is slowing, ment from private Chinese companies than from labor costs are rising, and competition from larger state-owned enterprises. Areas of particu- Chinese firms is increasing, both in China and lar opportunity include real estate, healthcare, overseas. Cyber security, intellectual property hospitality, and technology. protection, lack of transparency, and government Supplementing direct investment by larger policies that often force technology transfer or commercial entities, the EB-5 program is a favor national companies will remain significant promising vehicle to expand Chinese and other issues for both businesses and policymakers. foreign investment, and it can play an important Bay Area companies, however, have demon- role in financing infrastructure, housing, and new strated their capacity to succeed in China’s often businesses, particularly in the wake of the 2013 challenging environment, and local government closing of California’s redevelopment programs. has chosen to lead as well. With this experience, Overseas investors, however, need more secu- the region is in a strong position to interpret rity and transparency. The EB-5 program for China to the U.S., and the U.S. to China, as it regional centers, which is currently only a pilot continues to build a positive, multifaceted rela- and is subject to annual extensions, should be tionship. As the Economic Institute found in its made permanent. USCIS should also be given 2006 report, as China grows as a major force in the resources required to expedite applications the world economy, the San Francisco Bay Area processing (which currently can take as long as continues to occupy the pole position among its 18 months), advance priority projects, and exer- potential U.S. partners. Because of the scale of cise better oversight and screening of question- this opportunity, it merits continued investment able or ineffective regional centers. by both the public and private sectors.

120

Acknowledgments

This study was developed and written by Dr. Diane Long Sean Randolph, President & CEO of the Bay Area California-China Office of Trade and Investment Council Economic Institute, and Niels Erich, a Regis Kelly consultant to the Institute who also worked on California Institute for the original 2006 edition. Quantitative Biosciences (QB3) The Institute wishes to thank the following Eric Zwisler sponsors, without whose support this study could Cardinal Health not have been produced. Darlene Chiu Bryant Deloitte LLP ChinaSF Gensler Ben Chen Jeffrey Heller China Unicom / Chinese Enterprise Association Pillsbury Winthrop Shaw Pittman LLC Joseph Lin Port of Oakland Chinese American Semiconductor Professional Association (CASPA) Advisory Board SFO Xia Xiang Silicon Valley Bank Chinese Consulate General Skidmore Owings & Merrill LLP (SOM) Joe Yang United Airlines CHT Global Woods Bagot Gordon Feller We are also grateful to the many individuals Cisco Systems who generously shared their expertise through Matthew LeMerle personal interviews. Their insights regarding the Concept Art House trends and issues impacting their organizations Chris Cooper added critical insight to the analysis. Deloitte & Touche LLP Gordon Hein Jiang Lin Asia Foundation Energy Foundation Charlene Yu Vaughn Jennifer Gee Asian American MultiTechnology Gap Inc. Association (AAMA) Dan Winey Mark Perry Gensler Bank of America Jeffrey Heller John Grubb Heller Manus Architects Bay Area Council Hanson Li Gail Maderis Hina Group BayBio Subrina Chow Michael Keyoung Wendy Au Burrill & Company Hong Kong Economic and Trade Office Barry Sedlik Gary Yao California Business Ventures HTC

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Lee Ting Gene Schnair H&Q Asia Pacific Skidmore Owings Merrill (SOM) Leslie Yuan John Pearson Hua Yuan Science and Technology Stanford University Association (HYSTA) Rob Steinberg Dean Sirovica Steinberg Architects Alison Jenkin Alan Wong Huawei Technologies Suning Commerce R&D Center USA Sean S. H. Wang Bruce Fuh ITRI International Taipei Economic and Cultural Office Mark Levine Jerchin Lee China Energy Program Taiwan Trade Center Lawrence Berkeley National Laboratory Tim Dattels Kofi Bonner TPG Lennar Mark Mendenhall Chris Chiang Trina Solar Marvell Technology Group Yingyi Qian Brad Tewksbury Tsinghua University Oracle Corp. Bob Garrett Bruce Quan Union Bank Peking University Dan Weiss Thomas Shoesmith Melinda Yee Franklin Pillsbury United Airlines Ginny Fang Ivor Emmanuel San Francisco Bay Area Regional Center University of California, Berkeley Jeff Hoglind Stanley Kwong San Francisco International Airport University of San Francisco Tom Henderson David Katz San Francisco Regional Center Visa Tom Kiely David Lam SF Travel West Summit Mike Ghielmetti Carsten Voecker Signature Development Group Woods Bagot Kenneth Wilcox Sue Xu Silicon Valley Bank zPark Venture

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