Mark Rutte & China: From dream to nightmare?

Image: Qiang jun meng Zhongguo meng ( 强军梦中国梦), The dream of a strong army, the Chinese Dream” Chinese propaganda poster, 2015: see © No copyright infringement intended. All rights belong to their respective copyright owners

Feb 9 2022_Belatedly and somewhat reluctantly, European policymakers have started to think about economic relations with China much as their counterparts in Beijing have always done: as one more arena in an all-encompassing struggle for power. Even among die-hard free-trade advocates in European capitals, governments and parliaments calls for industrial policies and protection of strategic industries can be heard these days. Inherent in those ‘wake-up’ messages has been the call to finally view and treat  Xi Jinping’s economic approach for what it is: a form of mercantilist competition in which the state and the private sector are systematically joined in an effort to accomplish the state’s goals.

China’s entry into the WTO

When China joined the World Trade Organization in 2001, many European leaders thought that economic liberalization would lead to political reform in the PRC. Trade policy experts believed that communist China would embrace the free market, gradually remove all market restrictions and cease forcing companies to transfer technology. It never really happened. It has taken the better part of two decades for European policymakers and business leaders to fully acknowledge the emergence of Beijing’s alternative form of capitalism.

The strong belief in the benefits and workings of the free market explains why politicians and executives for a long time downplayed the national security aspect in the economic and technology exchange with the PRC. The modernizing China was not viewed as a strategic threat and believed to be firmly on the side of the West. Western companies and governments almost tumbled over each other in trying to realize their China dream: conquering the vast Chinese market. Trade with China became an engine of growth for both sides, who mostly managed to work together amicably, though signs of potential major discord were clearly visible from the start.

Whereas the CCP defined and stuck to industrial policies and identified strategic industries from the moment China opened up to the West, the advocates of the free market often didn’t bother to distinguish strategic segments in their own countries. In their opinion the free market would ensure everybody would grow and prosper and ultimately the winners and losers in the economic competition would be decided by the comparative advantage principle. But  free trade is good and creates wealth as long as you take a liberal worldview that we’re all in this together. This model of wealth creation only pertains when you’re dealing with trading counterparts, where the relationships are long term and the tone is primarily friendly and cooperative: for as long as you get wealthier, you shouldn’t really care if your counterpart gets even wealthier than you. Consequentially, in an ideal world China’s increasing wealth would lead to more consumption and eventually to more import and less export focused policies, so to more international stability. 

China’s domestic developments

Those same advocates usually tended to dismiss or quickly skip over the domestic political developments in the PRC, which strongly pointed towards a less ideal world. Under the leadership of Xi Jinping China opted for an extremely ambitious path of self-reliance, once very much cherished by his big inspirator, Mao Zedong. That preferred option had remained a strong undercurrent in the communist party since the beginning of its open door policy to the West, but frequently got neglected or ignored by CEO’s and political leaders that were too busy chasing their China dreams.

In 2012 Xi embarked on his road to selective engagement with the West: he wanted to ensure that the People’s Republic remained indispensable for international production networks in order to keep leverage over the outside world, while simultaneously aiming to replace foreign products with domestically produced ones in industries considered strategic. Moreover, with its doctrine of military-civil fusion, his regime intentionally deleted any distinction between what might once have been regarded as separate spheres. Beijing started seeing gaining advantages in critical technologies, by whatever means necessary, as an crucial part of its strategy for eventually attaining both commercial and military superiority over the US.

This China first policy had not really been anticipated by the free-market advocates nor were its implications fully recognized early on, because most of them could hardly imagine that the PRC would opt for a path of confrontation which would risk to undo all the benefits that China and the world had enjoyed under the existing international order and free trade umbrella. They misjudged. As we have now entered a time of extreme tension, even those free market advocates have become much more inclined to refocus from thinking in terms of absolute wealth and power to relative wealth and power vs. China. As a consequence China’s growing wealth, technological advancement and power are no longer considered a win-win situation: due to the absence of a level playing field and reciprocity in the economic relationship and China’s super power ambitions, the PRC is increasingly perceived as a threat to the West’s security and wealth. The modernizing China is more and more seen as a systemic rival.     

VVD/The Netherlands

This belated change of heart has f.e. been noticeable in the liberal democratic party in the Netherlands, the VVD,  and in its leader, Prime Minister Mark Rutte. For years Rutte tried to keep economics seperate from politics in the Dutch ties with China. He nor his own party didn’t seem overly concerned about the usage of Chinese technology in critical Dutch national infrastructure. Rutte’s prime focus, like many of his European colleagues, was to help his own nation’s business community in its efforts to conquer the Chinese market by building warm ties with the Chinese government, predominantly seen as a partner. Chinese investments and enterprises were warmly welcomed in the Dutch kingdom.  Up to 2019 our Premier even repeatedly maintained that the way in which the cabinet would deal strategically with China in the future would have nothing to do with the roll-out of the 5G network, in which Huawei was scheduled to play a major role.

Rutte originally seemed to be firmly in the camp of people who assumed that Huawei grew into a telecom giant as a normal private enterprise, and that its spectacular growth was purely the outcome of market forces: that it had skillfully combined private entrepreneurship with highly developed technical skills, a sophisticated understanding of the international market and a very competitive pricing strategy. No wonder that he also repeatedly expressed strong appreciation for the Chinese company as a long-term valued investor in the Netherlands. And that he was more than happy to pay a personal visit to the headquarters of Huawei in 2015 and meet its founder, Ren Zhengfei, whom himself was no stranger to Ben Verwaayen, the Dutch Prime Minister’s long time and close advisor.

Ben Verwaayen

Rutte’s views on Huawei were probably heavily influenced by Verwaayen, former CEO of British Telecom as well as Alcatel Lucent, the French-American telecom company, and a prominent VVD member. Verwaayen has been known as one of the strongest believers in the workings of the free-market.

In 2002 this former GM of PTT telecom (KPN) was appointed as CEO of BT to help transform the debt ridden British telecom company from an old school telecom company into a modern telecom operator in a very competitive international environment: he managed to change BT into a modern voice telephony provider, broadband company, technology innovator and global IT services player.

Under Verwaayen’s leadership BT gave Huawei in 2005 its first very big contract (valued at £10bn) in western Europe, using its equipment to modernize its copper broadband service. Huawei quickly turned into BT’s biggest equipment provider and effectively wiped out its traditional suppliers such as Marconi by offering advanced equipment at very low prices. Britain was the springboard for Huawei in Europe, where it quickly penetrated the increasingly deregulated and open markets.  The Chinese company was able to exploit its BT work to legitimize its systems in other parts of the EU.

The rise of Huawei

The Chinese company was a late entrant and disruptor in the telecom market. Founded in 1988 as a distributor of phone switches, it started to develop in-house technology by doing reverse-engineering of foreign products and technologies at a time when China was still 100% reliant on foreign imports for telecom equipment and foreign players had already established a foothold in the PRC via JVs. Huawei quickly expanded its product lines and sales focus, concentrating on the country side, where conditions were often extremely challenging and margins thin. The foreign players prioritized the markets in urbanized areas.

At the same time Huawei began to target its R&D to newer segments such as optical network equipment and mobile communication systems, driven by a strong ambition of Ren Zhengfei to become a competitive international player. Huawei landed contracts with the People’s Liberation Army and its success drew the attention of the central government and Chinese banks. In 1998 alone, the state-owned China Construction Bank lent Huawei (annual revenue <$1B) nearly $500 million in buyer’s credit. A big amount for Huawei at the time, but massive for the bank too; it represented 45 percent of the bank’s total credit for the year.

To speed up its learning curve Huawei entered into joint R&D projects with foreign partners. Motorola agreed to  set up joint laboratories for communications system research in 1997. In 2000, Huawei and Lucent established a joint lab to focus on microelectronics and optoelectronics. That same year, NEC and Huawei established a “3G Internet Open Lab” in Shanghai in order to create an open platform to support the 3G mobile developments in China and to provide end-to-end total mobile solutions for mobile operators. Huawei and Siemens entered into another JV for wireless around that same time. Obviously all foreign CEO’s hoped that their willingness to create JVs and share R&D programs would help them to gain favor with the Chinese government in their efforts to conquer the Chinese market.

However, once China had developed domestic capabilities, it began to set up import barriers. It stopped arranging loans to import equipment and applied steep tariffs to imports. Next the communist government only allowed limited participation from foreign players in its domestic telecom industry: already under Deng Xiaoping it had been categorized as a strategic segment in which the CCP sought absolute control. By the mid-2000’s the government issued informal guidance to China’s state-owned telecoms operators to allocate no less than 70 per cent of 4G orders to equipment manufactured by Huawei and ZTE. This created clear advantages for China’s domestic telecommunications equipment sector.

Huawei & BT

When Verwaayen made his 2005 deal with Huawei, the company presented itself -as it is still doing today- as an ’employee owned’ enterprise. It didn’t have any detailed financial reports nor a clear ownership or transparent company structure. As it never opened its accounting books, no foreigner or customer really knew about its profits or losses or how it managed to fund its many new product developments, R&D projects and rapid overseas expansion all at once. In 2004 it reported to have ~$5.6B in annual sales, growing to ~$8.2B by 2005, compared to  Ericsson’s $14.6B & $16.7B and Nokia’s ~$35B & ~$39B. Part of the revenues of these Scandinavian giants was generated by the mobile phone segment, a market in which Huawei was also making its first mark and would become highly successful too.

Huawei could apparently use profits generated by the rapidly growing home telecom equipment market to offer extremely attractively priced packages abroad. Its proven domestic track record must have convinced BT of Huawei’s financial strength and credibility.  As the CEO of a major telecom operator, Verwaayen was of course more than happy to take advantage of Huawei’s aggressive pricing: if  Huawei could sell gear to BT cheaper than the British or Europeans could make it themselves, of course BT ought to buy that gear, allowing both BT & Huawei to prosper and driving the competing companies to either become more competitive or differentiate their business in line with the comparative advantage principle. He never -at least to my knowledge- expressed any national security concerns about using Huawei as a key equipment supplier in the British telecom network.

Verwaayen was highly impressed by Huawei’s strong customer orientation and its capability to provide extremely fast technical support as well as to quickly customize its development processes upon request. The dilemma Verwaayen and other telecom operators faced was that the benefits of chosing Huawei were tangible, measurable, immediate, and bestowed upon the buyer. The eventual risks of such a choice, especially in the days of 3- and 4G,  were still rather distant or unknown, unmeasurable and usually left to others. It simply made Huawei’s price offers hard to resist.

But curiously enough by the mid-2000s, virtually every network equipment maker was erasing China’s cost advantage with their own China-based manufacturing. Thus the outcome should have been a fairly flat cost range between most equipment vendors, with pricing moving up a little if a vendor would have a unique selling point and down when they would be hungry to win the business. Huawei was always extremely hungry to win and it frequently did: in general it underbid its rivals by 10-30%, sometimes even by >50%.   

Huawei’s bidding wars

Huawei entered bids for every contract they could, everywhere in the world. They bid at prices they knew their rivals couldn’t meet, at least not profitably. When they won those bids, they denied their competitors the revenue from the win. And even when they lost, the winners were usually requested by the end-customers to lower their final bid to Huawei’s level, killing their profit margins. By joining every bid, Huawei seriously weakened its competition.

Often Huawei appeared to be selling with no profit margin, not even covering the costs of making, installing, and supporting the equipment. A stock-listed company would have faced multiple questions of share-holders over its financing and liquidation risks by taking in billions of losses with such massive below-cost offerings, but Huawei somehow managed to make a profit and survive: as a private company it didn’t owe any detailed explanations to any shareholders, financial analysts or customers.  

It would take many more years before some explanations shed a bit more light on Huawei’s remarkable success story; in December 2019 a research team of the Wall Street Journal calculated that Huawei had received $75 billion in state support during its rise to world dominance, allowing the company to undercut rivals’ pricing and still pour billions into R&D. The company obtained more than $3 billion in outright grants and land discounts, most of those since 2008, and enjoyed $25 billion in tax incentives. The WSJ also discovered that Huawei assembled the land for its massive new campus in Shenzhen through uncontested auctions where they paid as little as 10 percent of the comparable market price, saving billions of dollars. The WSJ furthermore quoted the mayor of Shenzhen who acknowledged that “local officials began waiving or reducing levies on Huawei…from the early 1990s onwards.” It also is suspected that Huawei received substantial state support via direct subsidies and loans for its overseas expansion and R&D programs.

Some CEO’s of competing companies started to share a few of their observations as well: Samsung’s EVP Woojune Kim, responding to a question in a 2020 session before a British parliamentary committee, would testify, “We have frequently seen bids that do not seem to make sense in the pricing. No company beholden to shareholders and to make profits could offer that sort of bid.” Kim confirmed that Samsung  was highly efficient in sourcing and assembling gear, but even his company couldn’t approach a cost basis that would let them compete with Huawei, and that their pricing was not sustainable.

Earlier Lucent’s [former CEO] Pat Russo reminisced about a competition her company participated in to roll out a network in Southeast Asia. “We bid,” she said. “Nortel also bid. We later learned that we were about a million dollars over them, at $23 million. Then Huawei came in at $10 million.”

Verwaayen at Alcatel-Lucent

Interestingly, Verwaayen’s next CEO job (2008-2012) was as successor of that same Russo at Alcatel-Lucent, a > €10B merger between the French and American telecom equipment enterprises, which was supposed to help it cut costs and better compete with the Chinese gear makers Huawei and ZTE! Verwaayen set himself a three-year target to streamline and grow the company, which was struggling to increase its annual sales (~€ 17B in 2007 & 2008) and to its net losses under control.

In his new role, Verwaayen was no longer a customer of Huawei, but in fierce competition with the booming Chinese company. In 2009 he optimistically said Alcatel-Lucent’s comeback would begin in lucrative markets like China, where it would be bidding for the supply of its first high-speed wireless networks to the 3 big Chinese telecom operators. He proved to be too optimistic. When the year was over AL’s sales revenue had dropped to € 15.1B and its China sales were still far less than 1% of its total revenues.

During his tenure as CEO there were a lot of rumors of a take-over by Huawei of AL, though both sides denied there had been any talks. Despite trimming AL’s product line and cutting the global workforce, Verwaayen did not manage to turn the tide. AL’s annual sales continued to drop: from € 15B in 2011 to €14.4B in 2012, while net losses increased from € 1.1B to €1.4B.  The poor performance in 2012 was especially blamed on lower sales in Europe (where Huawei was expanding rapidly, E.R.) and China (where the above mentioned bids had apparently been deferred. E.R.). Exit Verwaaijen, the shareholders had enough.

Exit Verwaayen

The CEO took his defeat against the Chinese competition graciously: he said that Alcatel-Lucent had a superior product and market understanding, but Huawei “ran circles around us” on getting their products to market. “They were relentless in focus, relentless on price.” Two years later AL’s fate was sealed: the Alcatel Lucent group, the core of the company focussing on the telecom equipment market, was sold to Nokia, while its service branch called Alcatel Lucent Enterprise had been spun of before and acquired by Chinese investment company Huaxin. Another Western telecom equipment maker had left the scene.

Huawei’s expansion in Europe continued unabated up to 2019 as it scored major 5G contract wins in the Netherlands, Belgium, UK, Spain, Germany etc. It also greatly benefitted from Chinese governmental initiatives like the Belt and Road plan which favoured Chinese companies such as Huawei and ZTE worldwide. Annual sales of Huawei in 2020 were at an impressive $139B, but in 2021 the US sanctions started to bite, especially affecting its mobile phone line business: Huawei informed that its revenues dropped by nearly 30% to $99B. Its total revenues do nonetheless far exceed the combined sales revenues & R&D budgets of its two major competitors: Ericsson and Nokia.

Ericsson & Nokia in China

These 2 foreign players have been able to ob- and maintain a tiny market share in the PRC telecom equipment and network market. However, for fear of upsetting the Chinese government and losing this tiny share, their CEO’s have never dared to publicly and loudly complain about Chinese market restrictions nor demanded protection of their home markets. By just allowing them a completely marginal market share in China, Beijing has already managed to keep leverage over these Scandinavian CEO’s….   

Ericsson’s sales to China were $2.2B in 2020, accounting for 8% of its total revenues. The PRC is not even among Ericsson’s Top-5 country markets. After the Swedish government banned Huawei in its 5G network in 2020, Ericsson 2021 sales to China nosedived to less than $1.5B. Ericsson loss was probably Nokia’s win as it concluded its first 5G radio contract in the PRC, securing a small share in one of three tenders by China mobile, worth ~$240M, or ~1% of its total annual sales revenue. For Nokia and Ericsson, China’s huge market will remain…just a dream.

It took the frontal attack against the PRC and the Chinese enterprise by the Trump government to finally ignite a wider discussion about China and Huawei in Europe. The geopolitical technology war erupted: politics were taking over from economics while the international climate steadily deterioriated. Slowly even staunch free-market advocates like Rutte began to have second thoughts about Huawei, but were afraid to admit so publicly.

Recurring stories about Huawei’s IP theft, espionage and eavesdropping and the relentless American pressure made Rutte reconsider Huawei’s trustworthiness and have him re-think Huawei’s role in the Netherlands. But in true Rutte fashion he never made his real opinion of the Chinese company known, afraid of damaging Holland’s extensive trade relationship with the PRC. Nor has he ever publicly clarified how he would like to keep the 5G roll out/Huawei topic separate from his overall China strategy and the trade relationship with the PRC. Since 2020 the 5G roll-out and Huawei’s involvement has been classified a national security topic, only to be discussed behind closed parliamentary doors.

Meanwhile the Dutch public is still awaiting the conclusions of the Telecom Agency (AT) about the alleged Huawei tapping of KPN mobile phone numbers back in 2009-2010. Or did the Volkskrant present fake news in the spring of 2021? The AT report should have been published before the end of 2021…

The VVD in 2022

Rutte’s own party, the VVD, has become much more critical over the past 2 years about China’s economic policies and trade practices. Liberal MPs can be seen challenging take-overs of Dutch companies by Chinese entities, questioning high-tech R&D projects with Chinese partners and very recently even openly denouncing Chinese human rights violations in Xinjiang as genocide. Less than a year ago the VVD was not ready to join its coalition partners in cabinet Rutte III in a (non-binding) motion condemning the PRC of the same.

Though this latest VVD move on Xinjiang is remarkable, its immediate effect is mostly symbolical. The coalition parties have agreed that the new cabinet will only make the same condemnation if, for example, like-minded countries or the EU as a whole will also do this at the same time. The Netherlands does not want to operate solo in this. Hoekstra (CDA), the new minister of Foreign Affairs, recently said:  “the accusation of genocide is so serious that certain criteria should apply. And one of those criteria is that an international court of justice must also have ruled on it”. That’s not likely to happen anytime soon, as he knows.

The VVD also explicitly mentioned the fear of an economic punishment from China as a key argument that the cabinet should not operate on its own. Many Dutch companies and sectors depend on China, as we all know. But if fear for Chinese economic repercussions stays the leitmotif for the Dutch government’s China policies, Xi Jinping has the Netherlands exactly where he wants it.

While the VVD’s call for the Netherlands not to go solo is understandable, it will start to ring hollow if the party doesn’t know itself what it wants. It should by now have a clear mind of what it wants the Netherlands to share or protect in the exchange with the PRC, in terms of values, products, trade, know-how, technology, security and culture etc. Three successive Rutte governments were not able to come up with a solid vision or guideline on the question how to interact with the PRC, leaving the responsibility to companies, universities, provincial and local governments. It has played into the hands of the divide and rule strategies of Beijing, as all those different players rarely could oversee the wider (geopolitical) implications of their actions and decisions.

The need for a national China strategy

If the new Dutch government wants to unite others in Europe in a common China strategy, it should above all first coordinate its own China policies and approaches at home. It should take control of a national China strategy. Market forces and interdependency with China are no longer a guarantee for stability or harmony, in particular since the PRC is increasingly resorting to economic coercion to have other countries comply with its views and positions. Tensions over trade and especially technology are both cause and effect of the continuously deteriorating relations between the West and China. As the level of distrust is reaching new heights, the market will no longer be able to break this virtuous circle.  

The new cabinet has to even ask itself how it would like to avoid, mitigate and manage economic damage if the relationship with China is going to spiral downward further. It should evaluate the economic impact of such a potential decline and formulate risk mitigation plans. Will f.e. the government encourage/support Dutch companies to relocate? Will enterprises be told to leave or give up trading with Xinjiang? Will technical universities be instructed to stop taking in students from the PRC?  Will joint R&D programs in sensitive technologies be halted, cancelled or forbidden? What if Dutch companies or city governments are going to face economic coercion?

Systemic rivalry

Instead of succumbing to the irresistible charms of liberal democratic capitalism, the Chinese Communist Party is determined to keep a monopoly on domestic political power and ultimate control over the nation’s economy. In its march to a glorious future it has created a new form of  state-led political and authoritarian capitalism, which appeals to a lot of non-democratic countries around the world.

With its recent ideological focus on ‘common prosperity’, Beijing even proudly proclaims its policies reflect true democracy, as domestically and globally it intends ‘to distribute wealth evenly and equally’, instead of just letting the rich getting richer as the West is blamed to have been doing. Hence the rivalry is no longer just economic, but turning ideological too, a fact which probably has caught people like Rutte and Verwaayen offguard as it completely contradicts their conviction that liberal, free-market principles are the only reliable way of generating sustained economic growth.  

What we have been witnessing is the birth of ‘a new socialism’ in the PRC. Western businessmen and policymakers tended to ignore or disregard the CCP’s resilience in adjusting its communist ideology and policies to the changing international climate after the break-up of the Soviet Union. The CCPs determination and ability to restore China to its former glory on its own terms was underestimated. The China dream of the West never matched the China dream of the CCP. And as long as China is under the CCP and Xi’s spell, it never will. Market forces or an investment agreement (the CAI of the EU) are not going to provide a quick fix to re-unite and re-align those dreams. A much more comprehensive plan of action is needed covering foreign policy, economics & trade, technology, cyber- and national security, academic exchange as well as human rights in the context of our relationship with the PRC.

2021 has been another lost year as there was not even an official Dutch government. Prime Minister Rutte better make up his mind very quickly about a national China strategy if he doesn’t want to be overtaken by reality again and see his China dream turn into a nightmare.

also refer f.e.:

Chinese investment in Europe: corporate strategies and labour relations Publisher: European Trade Union Institute. Chapter 11 Huawei in Europe: strategic integration of local capabilities in a global production network Jan Drahokoupil, Agnieszka McCaleb, Peter Pawlicki and Ágnes Szunomár

Jonathan Pelson , Wireless Wars: China’s Dangerous Domination ot 5G and How We’re Fighting Back, 2021