VCs, Greenspan and globalization

NYTimes on Silicon Valley VCs and China investments. Note the final paragraph.

WHEN Joe Schoendorf, a Silicon Valley venture capitalist, was in Shanghai a few years ago to hear a pitch from a Chinese start-up company, he sensed something familiar. He interrupted the meeting, walked to the window and pulled back the curtains.

"What are you looking for?" he remembers the would-be entrepreneurs asking.

"I just wanted to make sure I was in China and not back in Palo Alto," he responded.

China's high-technology community, with its brains and competitive spirit, is probably more like its counterpart in Silicon Valley than any other in the world.

Yet Silicon Valley's views of investment in China have tended to swing between wild optimism and deep anxiety - with the anxiety going beyond a fear of losing money. Some worry about helping Chinese start-ups move up the technology food chain.

These days, the Valley venture capitalists are sharply divided in two camps: one rushing into China and one holding back.

...The dominant perspective is that China is a vast sea of opportunity, from its low-cost skilled labor pool to its enormous consumer market that is more than one billion strong.

In fact, it is now routine for venture investors to demand that their start-up firms place the bulk of software development and manufacturing efforts in China or India. (A supply chain problem at a manufacturing arm in China, however, can easily ruin financial results in any given quarter.)

For China skeptics, the concern is that American investment will help energize a formidable competitor, which could come to dominate both markets and technologies.

The fear is based in the Valley's complex relationship with China as supplier, partner, customer and competitor. Most venture capitalists say this evolving relationship will define the future of the Valley and maybe even technology development in the United States.

The Ningbo Bird Company is one case in point. It went from being a contract manufacturing supplier for Motorola to being a serious rival in the Chinese handset market in a matter of a few years.

Still, last year, most of the Valley seemed to throw caution aside as venture firms invested nearly $1.3 billion in China, up nearly 30 percent from 2003, according to Zero2IPO, a venture capital research and consulting company based in Beijing.

But in the first half of this year, investment slowed drastically after several changes in Chinese securities regulations. Those new rules caused "a decline of 50 percent in the first two quarters," said Dixon Doll, managing director of Doll Capital Management, based in Menlo Park, Calif.

The lull is ending, though, in part because of the high-profile success of the initial public offering of Baidu, a Chinese search engine company that was able to raise $86.6 million in August, and a securities rule change in October. In September, Sequoia Capital, a major backer of Google, was reported to be planning a $200 million fund and hiring several employees in China.

That announcement followed an earlier joint agreement this summer by Accel Partners, a leading Silicon Valley firm, and the International Data Group to set up a $250 million fund.

There have even been reports recently that Kleiner Perkins Caufield & Byers, the Valley's highest-profile venture firm, was creating its own China fund, though people briefed on the firm's plans said that was not true. While Kleiner has recently added Colin L. Powell as a partner to serve as a "rainmaker" in Asia, it remains concerned about changes in Chinese security laws that could complicate the return of investment funds to the United States.

Mr. Schoendorf, who is an Accel partner, sees benefits in helping China to become a fierce new competitor. He likens this moment of anxiety and promise to the 1970's, when Japan began to compete successfully with the United States.

"The Chinese graduate more engineers than we do," he said. "They're smart, they work hard, and so the only way to compete with them is to remain more innovative."

WSJ: Greenspan comments on globalization of labor markets. (Holding down inflation is the same as diminished returns to labor...) The bond market reacted negatively to these comments, as Greenspan said the effect would eventually go away. But I think that was a mistake: only the leading edge of those 2 billion workers have been integrated into the world economy -- a distinct minority. It will take decades before that deflationary effect wanes. Not to say that there aren't other inflationary forces at play, like oil and commodity scarcity, but the labor component is deflationary as far as the eye can see. Not only do low-skill workers have little pricing power, but even engineers and service professionals are under pressure from abroad.

The integration of China, India and the former Soviet bloc into the world trading system is helping to hold down inflation but at some point, that effect will fade, Federal Reserve Chairman Alan Greenspan said.

...Mr. Greenspan said the addition of more than 100 million educated workers from former Soviet countries, large segments of China's 750-million strong work force, and workers from India "would approximately double the overall supply of labor once all these workers become fully engaged in competitive world markets," a development that "has restrained the rise of unit labor costs in much of the world and hence has helped to contain inflation."

But while these forces "may well persist for some time," he said, the process and its contribution to inflation control will wane and that "will need to be monitored carefully by the world's central banks."