Magnetized North

Allegations of sleaze could topple the government and break up the country

SUDDENLY, an abyss has opened up under Paul Martin's minority Liberal government. Only a few weeks ago, Mr Martin's supporters were looking forward with equanimity to the prospect of the prime minister calling an election some time next year to restore their party to the parliamentary majority it enjoyed for more than a decade until last year. Now, Canada is contemplating the possibility of the Conservative opposition forcing a June poll and going on to form a minority government. In due course, say some alarmed federalists, a new attempt by French-speaking Quebec to secede from Canada would follow.

Allegations of sleaze could topple the government and break up the country

SUDDENLY, an abyss has opened up under Paul Martin's minority Liberal government. Only a few weeks ago, Mr Martin's supporters were looking forward with equanimity to the prospect of the prime minister calling an election some time next year to restore their party to the parliamentary majority it enjoyed for more than a decade until last year. Now, Canada is contemplating the possibility of the Conservative opposition forcing a June poll and going on to form a minority government. In due course, say some alarmed federalists, a new attempt by French-speaking Quebec to secede from Canada would follow.

All this is the result of the explosive turn taken by the Gomery inquiry. This is looking into the abuse of a C$250m ($200m) scheme to promote federalism in Quebec set up by Jean Chretien, Mr Martin's predecessor, in the wake of the narrow defeat of the last referendum on secession a decade ago. Last week, Jean Brault, a Montreal advertising man, told the inquiry that his agency had received C$23.4m for services that included adding Liberal Party workers to his payroll. He also said he had contributed $1.2m to Liberal funds, much of it in cash in brown envelopes or against fake invoices. In other evidence, the inquiry heard claims that a graphic-design firm headed by Jacques Corriveau, a friend of Mr Chretien and fundraiser for him, received sub-contracts worth $6.7m through the scheme.

Judge John Gomery's decision to ban publication of Mr Brault's testimony (some of which is contested) was reversed in part after this was posted on an American website. The effect of the ban was merely to draw more attention to the testimony. The damage to the Liberals showed up in an opinion poll by Ipsos-Reid (see chart). Another poll, by EKOS, put the Conservatives even further ahead of the Liberals, at 36% to 25%. In Quebec, it showed Liberal support having collapsed to 18%, with the separatist Bloc Quebecois at 48%.

These polls show the Conservatives level or even ahead in Ontario, a Liberal stronghold. That makes an early election attractive to Stephen Harper, the Conservative leader, as well as to the Bloc. If they combine their forces behind a no-confidence motion, they could outvote the Liberals in the House of Commons.

The Liberal ship is already showing signs of sinking. One of the 133 Liberal MPs this week left the party to sit as an independent. Another 33 Liberals defied Mr Martin and voted with the Conservatives to kill a government bill recognising same-sex marriage. Impatient Tories are urging Mr Harper to engineer a snap election. They argue that the best time for a vote would be late June, after a provincial election in British Columbia, a visit by Queen Elizabeth to western Canada--and the end of Judge Gomery's public hearings.

If the polls are right, Mr Harper could expect to win such an election, though the Tories might win only one seat in Quebec. It would be a close-run thing. Mr Martin, to whom no personal blame has attached over the scandal, remains slightly more trusted than Mr Harper. The polls suggest the leftish New Democrats and Greens would attract more disillusioned Liberals than would the Tories. Tellingly, some 85% of respondents told pollsters they want Mr Gomery to finish his work--his report is due in December--before an election.

By then the Liberals may have recovered and Mr Harper's moment might have passed. If he does go for an early election, the big winner could be Gilles Duceppe, the Bloc's leader. Some would expect him to capitalise by leaving federal politics and taking charge of the more powerful Parti Quebecois in the province itself. There he could challenge Quebec's clumsy Liberal premier, Jean Charest, and so pose a new threat to Canadian unity. All this is but speculation, but such is the febrile atmosphere in Canada's normally placid capital that it is being taken seriously.

The oil market softens a bit

IT MAY seem absurd to ask, but has the price of oil peaked? Only last week, the price of West Texas Intermediate (WTI) breached $58 a barrel for the first time. Goldman Sachs, an investment bank, gave warning recently that "super-spikes" of $100-plus might come. Yet there has been plenty of bearish talk too. This week, the bears were having their way, as the price of WTI slid back towards $50.

The oil market softens a bit

IT MAY seem absurd to ask, but has the price of oil peaked? Only last week, the price of West Texas Intermediate (WTI) breached $58 a barrel for the first time. Goldman Sachs, an investment bank, gave warning recently that "super-spikes" of $100-plus might come. Yet there has been plenty of bearish talk too. This week, the bears were having their way, as the price of WTI slid back towards $50.

Their case rests on three arguments. First, fundamentals. On the demand side, Chinese oil consumption is slowing at last. The International Energy Agency (IEA) says that in January and February, Chinese demand was only 5.4% greater than a year before, having risen by 20.8% in the year to early 2004. Supply is rising too: the output of the Organisation of Petroleum Exporting Countries (OPEC) rose by 300,000 barrels per day in March, estimates the IEA. With stocks also growing, the agency concludes, "there seems less reason for concern."

Second, the market is in "contango"--meaning that the spot price is below the forward price (see chart). In bull markets, this is often a sign that prices are on the turn. Oil stocks are likely to rise, because purchasers will load up at today's lower prices rather than wait, thereby easing prices in a few months' time. Alan Greenspan, chairman of the Federal Reserve, recently cited the contango as a reason why he was relaxed about oil prices.

The third and most contentious argument concerns speculators. Official data suggest that the net long positions (in effect, bets on higher prices) held by non-commercial investors are the largest for a year. Hedge funds have long been blamed for pushing up prices. But it seems that pension funds, which used to regard direct exposure to oil as too risky, are joining in.

In the past year or so, seeking fatter returns than on shares and bonds, they have piled in, helped by structured products that were pioneered by Goldman Sachs and linked to commodity indices run by Goldman, Morgan Stanley and others. Simply put, every month investors sell spot and buy one month forward. Some blame this device for pushing the market into contango.

Goldman vigorously denies this. The bank's Jeffrey Currie estimates that pension funds, hedge funds and others, even combined, cannot shift the oil price by more than about $7 a barrel. Philip Verleger, an energy economist, is not so sure. He thinks that the scale of pension-fund investment could be far higher than Goldman believes, and worries that this inflow could be inflating a bubble.

In essence, he says, the new investment is a huge bet on higher oil prices. The trouble is that there are not enough sellers in the futures market. Oil-producing countries and oil companies dislike hedging against rising prices. So do many institutional investors, who buy oil shares precisely for exposure to rising prices.

For all that, a crash remains unlikely, and there may be more upward spikes. But there is a lot of froth. If the fundamentals erode faster than expected, prices could fall sharply as speculators rush out. Investors are in for a bumpy ride.

Charges against its middlemen roil the Big Board

LOTS of money can be made in the tiny gaps between the buying and selling prices of shares. But the "specialists" on the New York Stock Exchange (NYSE), who match buy and sell orders, walk a fine line between their duty to their customers and that to their employers. Too fine, it seems. This week federal prosecutors in America charged 15 specialists with making $19m for their firms from improper trading. At the same time the Securities and Exchange Commission (SEC) settled civil charges against the NYSE for poor oversight of its floor, where most trades are still done.

Charges against its middlemen roil the Big Board

LOTS of money can be made in the tiny gaps between the buying and selling prices of shares. But the "specialists" on the New York Stock Exchange (NYSE), who match buy and sell orders, walk a fine line between their duty to their customers and that to their employers. Too fine, it seems. This week federal prosecutors in America charged 15 specialists with making $19m for their firms from improper trading. At the same time the Securities and Exchange Commission (SEC) settled civil charges against the NYSE for poor oversight of its floor, where most trades are still done.

The SEC also brought civil charges against 20 specialists (including those criminally charged) for "pervasive" fraudulent trading between 1999 and 2003. The reason, says the commission, was that the specialists traded for their own accounts when they should have been filling customers' orders first. (Specialists are allowed under certain circumstances to buy and sell stocks for their firm; this helps keep the market moving if liquidity is low.) For example, when a buy order comes in at a higher price than a sell order, the specialist's duty is to match the customers rather than profit from the spread. The SEC says that some such practices went awry--and also that the specialists sometimes abused their positions by trading in advance of customer orders.

The specialist firms--which include elite names such as Bear Wagner and Spear, Leeds & Kellogg (a Goldman Sachs subsidiary)--have been braced for this blow. Last year the companies settled with the SEC for over $240m. One of them, a Dutch firm called Van der Moolen, has seven ex-traders facing charges this week.

For the NYSE, it is another black mark for its efforts at self-regulation, though its standards have been toughened since 2003. The exchange got into trouble with the SEC in 1999, when it was charged with failing to stop illegal trading schemes perpetrated by groups of floor brokers. As part of this week's settlement, in which the Big Board, as in 1999, neither admitted nor denied charges, the NYSE is due to pay $20m to buttress supervision of its regulatory system. It must also begin pilot video and audio surveillance of floor trading of certain highly liquid stocks.

This week's charges may hasten the exchange's switch away from the floor. "Electronic trading systems are much less scandal-prone," says Benn Steil of the Council on Foreign Relations. The NYSE already plans to become more electronic--and, says Mr Steil, if John Thain, the chief executive, and Marshall Carter, just appointed as chairman, want to get serious about an initial public offering, the trading floor might just have to go altogether. Specialists would rue that day, but would have only themselves to blame.

Problems recruiting and retaining workers, particularly skilled ones, are raising the cost of doing business in China

Problems recruiting and retaining workers, particularly skilled ones, are raising the cost of doing business in China

CAN China--population 1.3 billion--really be running short of people? In many of the most important parts of its booming economy, the answer, increasingly, is yes. Though China has a vast pool of unskilled labour, firms in the south now complain that they cannot recruit enough cheap factory and manual workers. The market is even tighter for skilled labour. As the economy grows and moves into higher value-added work, the challenge of attracting and retaining staff is rising with the skill level, as demand outstrips supply. The result is escalating costs for firms operating in China. "If you think that China is a cheap place for labour, think again," says Vincent Gauthier of Hewitt Associates, a human-resources consultancy.

The particular shortages mentioned most often are of creativity, of an aptitude for risk-taking and, above all, of an ability to manage--in everything from human resources and accounting to sales, distribution, branding and project-management.

Though developing economies often encounter talent shortages as they start to grow, China's history has left it with some peculiar deficits. Its Confucian heritage, which emphasises rote learning and hierarchy, may partly explain why many graduates, despite good paper qualifications and English language skills, are often cautious about taking the initiative. Some firms complain that China's one-child policy has made it harder for them to find natural team-players. That there are few MBA programmes in China may not help either.

Large parts of China's economy remain in thrall to the state, where loyalty to the Communist party more than business acumen drives career success. Jeff Barnes, "chief learning officer" at General Electric (GE) in China, says that the "issue we have is finding mid-level and top-level leadership. The Chinese talent is first-generation. They don't have role models. Their parents worked for state-owned companies."

The wrong sort of chairman

Chairman Mao's Cultural Revolution in 1966-76 wiped out a generation of management potential, as millions of Chinese learned that capitalism was evil. After a lifetime under socialism, many lack the mindset to adopt western working practices. In China, says Jack Perkowski, boss of Asimco Technologies, a supplier of vehicle parts, "the talent pool consists either of managers from state firms who are too bureaucratic or entrepreneurs who have come up through the private sector and are unconstrained by capital or the law."

Foreign firms now invest some $1 billion a week in China. As they expand, they increasingly need workers able to handle the complexities of multi-site operations. Staff shortages threaten these plans. In a recent speech, Arics Poon, managing director of Oracle for South China and Hong Kong, said that "we need a group of strong, professional managers or we may fail to support our growth in China." Anthony Wu, head of accounting firm Ernst & Young (E&Y) in Hong Kong and China, admits that "we have decided not to tender for some major clients because we feel we don't have the staff to service them."

Business plans for China rarely reflect the cost and time involved in recruiting and retaining local staff. Firms are finding that they cannot replace expensive expatriate staff with cheaper local hires ("localise" in the jargon) as quickly as they hoped. Many underestimate the cost of local staff. Chinese graduates often have an inflated view of their own worth, complain some foreign managers. Multinationals are also competing for talent with China's domestic companies, which need to improve the quality of their people as their markets open to foreign rivals.

Chinese people returning from overseas (lyrically named hai-gui or "returning turtles") are plugging some of the shortages, particularly at the most senior levels. David Wei, president of B&Q China, Yifei Li, managing director of MTV China, and Zhu Min, head of restructuring at Bank of China, all worked or were at least partly educated outside China. But at a more junior level, returnees can sometimes have problems reintegrating, may lack local market knowledge and are expensive.

Recruitment, retention and localisation of staff is now top of the agenda for firms in China. Paolo Gasparrini, head of China for L'Oreal, a French cosmetics firm, says that "to find good people in China is not easy. Technically and in administration they are very good. But in marketing--a crucial discipline--there are just a few people with short experience and everyone is competing for them. You find yourself micro-managing more than you'd like." Mr Poon concurs: "If the tasks are across departments, or if it means working in a team or trying to relate to others, they [Chinese staff] still have a long way to go."

Fierce competition and a limited supply of talent is resulting in high turnover rates. "The biggest issue is retention of people," says E&Y's Mr Wu., "Retention is much cheaper than recruitment." One in ten executives changed job in the southern city of Shenzhen last year and one in 12 in Beijing, according to Hewitt. The same research points to a nationwide employee churn rate of 11.3% in 2004, up from 8.3% in 2001. Some smaller firms see turnover as high as 30%, but leading global firms are not immune. L'Oreal, with 3,000 people in China, says that staff turnover in its marketing department is nearly 15%. "A lot of fresh graduates leave. We lose almost all we hire in the first three years," says Daisy Dai, its human-resources director.

Pay and benefits are soaring. A Chinese middle manager at a foreign company in Beijing or Shanghai can now command total annual cash compensation (salary plus bonus) of $27,000-$32,000, says Hewitt. Senior managers receive between $46,000 and $54,000 and top executives can expect $80,000 to $90,000 or more. While underlying inflation in China is around 2%, average annual salary increases for mid-level and senior managers are now 6-10%. Lai Kam-tong at the Hong Kong Institute of Human Resource Management says that accountants' salaries are rising by 14% a year. Jurgen Viethen, general manager for F&G China Electric, a small Spanish-owned electrical switchgear-maker, is offering key employees raises of up to 50%--and still losing them.

Bonuses, longer-term incentives, free housing and meals, a mobile phone and a set of wheels are becoming standard perks. More than one-third of 1,600 multinational firms surveyed by Hewitt now offer a company car. More holidays, maternity and paternity leave, more frequent job rotation and share options also now feature. Add in the big contributions that employers must make to China's national security fund system and the total cost of an employee can be double his basic pay.

Above all, Chinese employees want good training, as they are acutely aware of the limitations of their educational system and keen to acquire marketable skills. Ping-on Mak, senior human resources manager for GE Consumer Finance in Asia, says that the attitude of many young Chinese managers is "if I want training, I'll go work for a multinational and then after three years I'll leave." But GE, with an in-house "university", and L'Oreal, which provides mentoring, say that training produces employees who tend to stay longer.

Some foreign firms hope to persuade the expatriates they send out to stay longer than first planned--despite their higher cost. Some are relocating operations from the coast to smaller, cheaper cities to tap new markets for talent. Some are even considering outsourcing from China itself, by moving parts of their operations to, say, Vietnam and Cambodia, where the workforce is even cheaper and younger.

None of this has, yet, slowed China's economic growth. Basing production in mainland China remains cost-effective for most foreign firms. But the growing shortage of executive talent may make the growth assumptions written into many business plans over-optimistic. F&G's Mr Viethen's lament that, despite being a business manager, "I spend most of my time on human resources, not sales," rings true at many foreign firms in China.

China's anti-Japan protesters are a big problem for both countries

China's anti-Japan protesters are a big problem for both countries

"IT'S a scary country," Japan's trade minister, Shoichi Nakagawa, said of China this week, following demonstrations in several Chinese cities by thousands of protesters, some of whom smashed the windows of Japanese shops and restaurants and threw stones at Japanese diplomatic buildings. For all their seeming reluctance to quell the unrest, Chinese leaders probably find it scary too.

The protests first turned violent in the south-western city of Chengdu on April 2nd, and erupted with particular fury in Beijing a week later. They were the biggest to take place in China since tens of thousands took to the streets across the country in 1999 in response to the bombing of China's Belgrade embassy by American aircraft during the Kosovo war. Those protests, initially condoned by the authorities, fizzled out after three or four days, when the government made it clear that enough was enough. This time the government appears more hesitant. Some Chinese activists predict further disturbances.

The big difference is that this time Japan is the target. In a country where public protest is usually quickly suppressed, anti-Japanese sentiment has proved hard for the authorities to handle. The party bases its legitimacy in part on its (somewhat overstated) record of fighting Japanese occupation forces in the 1930s and 1940s. It traces its intellectual origins to a movement inspired by anti-Japanese protests in 1919. Animosity towards Japan is regarded as the hallmark of a patriot.

The authorities' dilemma is reflected in their handling of these protests, which began as a show of opposition (on the grounds that Japan has failed to show sufficient contrition for its wartime atrocities) to Japan's campaign for a permanent seat on the UN Security Council. They were fuelled by a decision by Japan's education ministry to approve a school textbook (unlikely to be widely adopted) that plays down the extent of the atrocities. Chinese officials expressed outrage at the book, but quietly banned coverage of the protests in the Chinese-language media. Calls for a boycott of Japanese goods, widely circulated on the internet, also went unreported in the state-controlled press.

In Beijing, the authorities mobilised thousands of police and paramilitary troops to guard the Japanese embassy and ambassador's residence, and to patrol the route of the march. Yet the security forces took no action as protesters threw stones and plastic water bottles at the diplomatic buildings and overturned a car. Activists say the protests were unauthorised. In China, this makes them illegal. Yet no arrests have been reported in connection with the Beijing protests. A foreign-ministry spokesman said that it was up to Japan to "reflect carefully" on how to prevent "the situation getting out of control".

The burden of the past

Chinese officials are doubtless thinking carefully too. On April 13th, Japan said it would soon allow Japanese gas companies to explore in an area of the East China Sea claimed by both countries, a move that will further rile Chinese nationalists. And the year is replete with potential flashpoints: May 4th (the anniversary of the 1919 protests), July 7th (Japan's full-scale invasion of China in 1937); the 60th anniversary on August 15th of Japan's surrender and September 18th (the Japanese occupation of Manchuria in 1931).

So far, the business impact of the protests and boycott calls appears limited. But the products of some companies, such as Asahi, a beer manufacturer, and Ajinomoto, a food-maker, which have been accused by protesters of supporting the textbook revisions (the companies deny it), have been removed from some shops.

China's government worries that if it is seen as too weak towards Japan, or cracks down too hard, the protesters could turn against the party. In the last century, pro-democracy unrest in China was often closely linked with patriotic demonstrations. Many participants in the recent protests have been university students, a group kept under particularly close watch by the authorities since the student-led protests in Tiananmen Square in 1989. The internet and mobile phones have enabled rapid mobilisation (organisers say more than 20m people have signed an electronic petition against Japan's UN bid). The nationalist genie, once unbottled, could prove hard for China to restrain.