China’s Economy, Unfair Trade, And The Role Of Government

 

800px-shanghai_-_pudong_skyline_-_0010

Shanghai skyline (by Stefan Fussan, via Wikimedia Commons)

 

On January 16th, 2010, Chinese President Hu Jintao made a visit to the Shanghai headquarters of UnionPay. A plaque commemorating the event urges the company to “step up the effort to internationalize and strive to build UnionPay into a major global brand for bankcards”.

UnionPay has only 0.5% market share globally, but it dominates China‘s 6.3 billion-card-strong market. 99% of UnionPay’s cards are in China, which accounts for almost 45% of all bank cards in the world. After having achieved a domestic monopoly, UnionPay is now looking to expand beyond China’s borders to establish its position as a major bank card operator alongside rivals like Visa and Mastercard.

UnionPay was established in March 2002 under the approval of the State Council and the People’s Bank of China. The Chinese government regards it as a major part of its national development programme, as the company itself explains on its website:

As China grows stronger, it calls for a robust and independent bankcard industry, which entails concerted efforts made by the entire bankcard industry in China. UnionPay will, in line with the new requirements of the government, sufficiently exert its function as a card organization, and collaborate with commercial banks to maintain the discourse right and a dominant position in China’s bankcard industry, safeguard the economic and financial security of China, further promote the development of bankcard industry, as well as provide quality, safe and efficient bankcard service for the public.

The ultimate goal of UnionPay is to become a bankcard association with national authority and trustworthiness as well as international competitiveness and influence, and to create an independent payment brand of China with global influence that serves China and more countries and regions.

But how did the Chinese government succeed in creating a successful bank card association from scratch? The answer is simple. Following the precepts of the infant industry argument, the Chinese government gave UnionPay a dominant position on the domestic market by requiring all yuan-denominated payment cards issued in China to work with the UnionPay network, and by requiring every merchant and ATM to accept UnionPay cards. Other companies like Visa, Mastercard and American Express (AXP.N) were only allowed to process foreign currency transactions.

As a matter of fact, in 2012 the United States won a Trade Organization (WTO) case against China, which was found to have discriminated against US bank card suppliers. China ended its UnionPay monopoly in 2016, but the firm was by then ready compete both in China and abroad.

The UnionPay story exemplifies China’s approach to economic development. Believers in neoclassical economics fail to appreciate the nature and effectiveness of the Chinese development model, which in many respects resembles that of Japan, Singapore, Taiwan, and other countries. It is a system of hybrid capitalism, a synthesis between government intervention and market forces.

Free marketeers often tend to view China’s economic development as a result of liberalization. “China’s meteoric rise over the past half century is one of the most striking examples of the impact of opening an economy up to global markets,” wrote Thomas Hirst in an article published on the website of the World Economic Forum.

However, such view is highly misleading. We shall argue that China’s success is not due to simply opening up the economy, but in selectively opening up the economy and using the regulatory powers as well as the investment capabilities of the state in order to pursue developmentalist policies. To put it simply, China does not have a laissez-faire economy, where the private sector is left to itself and supposedly balances itself, but a hybrid economy – a market economy in which the government acts both as regulator and entrepreneur.

Joint Ventures

In late 1978 China announced that it would “open up to the outside world”. However, it did not simply privatize its state-owned enterprises, or allow companies to buy and sell in the country. Chinese leader Deng Xiaoping wanted to attract foreign direct investment in order to spur development, absorb advanced technology, gain new sources of capital and managerial skills (Margaret M. Pearson, Joint Ventures in the People’s Republic of China: The Control of Foreign Direct Investment under Socialism, 1991, p. 3).

China did not liberalize its economy the way Russia and other Communist countries did. Rather, Beijing aimed at using foreign capital for its own long-term goals of upgrading the structure of the economy. The socialist economy was not dismantled. The state plan, government participation and regulation remained fundamental parts of the system. Beijing hardliners were weary of “bad” capitalist influences. They also worried about the possibility that foreign powers might exploit China as they had done during the “century of humiliation”, when the country had become a semi-colony of Western states and of Japan.

China wanted to introduce elements of the market resource allocation while at the same time maintaining a high degree of state control over the economy. To achieve this objective, the government permitted foreign companies to set up equity joint ventures with local Chinese partners. The advantage of this form of foreign direct investment was that foreign firms often had to work together with Chinese state-owned enterprises (ibid.).

The Chinese government used its own bargaining strength to channel and control foreign direct investment in a way that it found most desirable for the overall goals set by the Communist Party (ibid., p. 8).

China’s socialist political and economic structures provided the state with an advantageous position in negotiating with foreign investors. The government had a monopoly on approving and rejecting joint ventures. It favoured joint ventures with Chinese state-owned enterprises, which were under the direct control of the authorities. Foreign firms depended on Chinese government regulation regarding labour, money supply and other resources such as raw materials.

Moreover, foreigners were attracted by the huge Chinese domestic market, and only the government could allow or prevent them from selling their products to 1.2 billion potential customers. That was, indeed, the primary reason why foreign companies were so eager to invest in China (ibid., pp. 14-15).

The three major pieces of legislation that formalized China’s opening up to foreign direct investment were the 1970 Law of the People’s Republic of China on Chinese-Foreign Joint Ventures, the 1983 Regulations for the Implementation of the Law on Sino-foreign Equity Joint Ventures and the 1986 Provisions to Encourage Foreign Investment in China.

Article 3 of the Regulations states that joint ventures “established within China’s territory must be able to promote the development of China’s economy and the improvement of the science and technology for the benefit of socialist modernization”. Article 4 stipulates that joint venture applications may be rejected in case of “nonconformity with the requirements of the development of China’s national economy”.

The general public in the West is often unaware of the fact that many Chinese companies are or were joint ventures between Chinese state-owned enterprises and Western firms. Let us look some examples.

In 1984 The New York Times wrote about a joint venture between Beijing Jeep Corporation, a Chinese state-owned car manufacturer, and the American Motors Corporation (AMC). AMC wanted to build inexpensive cars that would challenge Japanese competition in Asia. The American corporation bought a 31.35% stake in the Chinese company.

The deal was very much the work of Tod Clare, then vice president of AMC’s international operations. After having lived and worked in Hong Kong for several years, he became interested in China and was eager to do business in the country. Clare visited Beijing for the first time in 1979.  Jim Mann described Clare’s experience in his 1997 book Beijing Jeep:

Chinese auto officials adjusted the obligatory sightseeing tours of Beijing to take account of the interests of their AMC guests. Virtually all visitors to the capital city were escorted to the Great Wall, but the AMC executives were allowed to drive there in the Chinese jeep, the BJ212, as it was called. Clare couldn’t believe it; the thing had no springs and drove as if it had ninety pounds of pressure in the tires. On a cold winter day there was nobody around at the Wall, just the AMC people and a car that seemed to them almost as strange and old as the Wall itself.

The AMC executives were also given a special tour of the Beijing Automotive Works, the factory that made the BJ212 and that Chinese officials hoped AMC would help modernize. Clare didn’t think it was so bad. He had seen some pretty lousy car plants in his time. When you looked at the Chinese plant, you couldn’t judge it by American standards; you had to compare it with Jeep plants like those in Iran, India, and Sri Lanka. In some ways the Chinese plant was great. The layout was good. The plant was made of brick, and it had a good roof. By contrast, the AMC plant in Venezuela had a roof of corrugated tin. Sure, the Chinese plant was poorly tooled, but AMC had a few third-rate operations of its own …

At least for the days when the AMC executives were visiting, the people on the assembly line seemed to be working hard. Of course, the AMC officials had no way of knowing how things looked on a routine day, when there were no foreign guests touring the factory. But everything seemed to be in order. Pieces were coming in and going out. Clare thought to himself that the quality was crappy, but that some of it was fixable. There were some simple, obvious steps that could be taken to improve the plant. All in all, the AMC executives were pleased (Jim Mann, Beijing Jeep: A Case Study of Western Business in China, 1997, pp. 43-44). 

This scene shows one often overlooked aspect of China’s development. The country, despite being poor, was already partly industrialized. Foreigners did not have to build industrial infrastructure from scratch; they were simply asked to upgrade an industrial system in its infancy.


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Eventually the relationship between AMC and Beijing Jeep Corporation ended due to disputes. The owner of Beijing Jeep Corporation, BAIC Group – which is itself an enterprise owned by the Beijing municipal government – later partnered with other automakers, including Germany’s Daimler and Korea’s Hyundai.

Foreign automotive manufacturers are not allowed to wholly own their own operations in China and must partner with Chinese firms. Moreover, foreigners are permitted to own a maximum of 50% of the shares of a joint venture. According to Bloomberg Markets, “[t]he so-called ’50:50 rule’ … has for years been a sacred cow for the auto industry, seen as necessary to buy local carmakers time to gain the technology and build their brands before giving overseas carmakers unfettered access to what’s now the world’s biggest car market.”

Haier Group, a maker of home appliances, is not a state-owned enterprise, but it is supported by the state. The ownership structure of Haier is murky. It is categorized as a “collective”, which, according to Jing Wang, is a business model that conceals the presence of government stakeholders (Jing Wang: Brand New China, 2009, p. 156).

In 1984 the municipal government of Qingdao, a city in Shandong Province, appointed Zhang Ruimin, a member of the Chinese Communist Party (CCP), as the manager of Qingdao Refrigerator Company, a factory dating back to the 1920s (Lawrence Sullivan, Historical Dictionary of the Chinese Economy, 2013, p. 185).

One year later Zhang formed a joint venture with the German company Liebherr. Qingdao Refrigerator Company was then renamed Haier. In this case, too, the Chinese state benefitted from the managerial skills and technology of a foreign firm.

Similarly, Huawei, a telecommunications equipment manufacturer, formed a partnership with IBM, entered into joint ventures with Panasonic, NEC and Symantec. As The Conversation explained in 2012, Huawei “operates in what Beijing explicitly refers to as one of seven ‘strategic sectors’. Strategic sectors are those considered as core to the national and security interests of the state. In these sectors, the CCP ensures that ‘national champions’ dominate through a combination of market protectionism, cheap loans, tax and subsidy programs, and diplomatic support in the case of offshore markets.”

China’s Trade Barriers

Trade barriers are one of the major tools of states which seek to protect and nurture their infant industries. According to government-led developmentalist strategies, foreign competition must be regulated and restricted in order to promote the growth of local manufacturing.

For years Western businesses have complained about China’s unfair competition. A 2017 national trade report by the United States government described some of the trade barriers facing American companies willing to do business in China.

In 2016 the United States had a trade deficit in goods with China amounting to $347 billion. US goods exports to China were $115.8 billion, while US imports from China were $462.8 billion. The US had a trade surplus in services, with exports amounting to $48.4 billion in 2015 and imports of $15.1 billion.

The US government remarked that Washington uses “outcome-oriented dialogue at all levels of engagement with China, while also taking concrete steps to enforce U.S. rights at the WTO as appropriate,” with the purpose of removing trade barriers. However, many years of diplomacy do not seem to have worked. The document stated that “China’s trade policies and practices in several specific areas cause particular concern for the United States and U.S. stakeholders.”

Some of these issues concern intellectual property rights protection, including theft of trade secrets for the benefit of Chinese companies, bad faith trademark registration, and counterfeit goods.

“China continued to pursue a wide array of industrial policies in 2016 that seek to limit market access for imported goods, foreign manufacturers and foreign service suppliers, while offering substantial government guidance, resources and regulatory support to Chinese industries. The principal beneficiaries of these constantly evolving policies are China’s state-owned enterprises, as well as other favored domestic companies attempting to move up the economic value chain,” the report stated.

Some of these policies include the promotion of indigenous innovation; technology transfer and technology localization (for instance by granting approval preferences to companies agreeing to shift their manufacturing to China); government subsidies to domestic industries which cause “injury to U.S. industry” and in some cases “appear to be prohibited under WTO rules”; excess capacity through government financial support in key sectors like steel and aluminum production, resulting in overproduction that distorts global markets and hurts US industries; preferential value-added tax rebates; the promotion of “rapid growth in government-selected industry sectors viewed as economically and strategically important for transforming China’s industrial base into one that is more internationally competitive in cutting-edge technologies; import substitution policies; import ban on remanufactured products.

The US government also noted that “China’s regulatory authorities in some instances seem to be pursuing antidumping and countervailing duty investigations and imposing duties for the purpose of striking back at trading partners that have exercised their WTO rights against China, even when necessary legal and factual support for the duties is absent.”

In 2017 the European Union Chamber of Commerce in China also issued a report putting forward similar complaints about China’s trade barriers and regulations.

“Government Is Your Silent Partner” – The Socialist Market Economy

The term “socialist market economy” used by Chinese politicians and scholars to describe China’s economic system has generated confusion in Western countries. “While China’s government may be officially communist, the Chinese people express widespread support for capitalism,” wrote the Pew Research Center in 2014.

If one understands capitalism as an economic system in which resources are invested for the creation of profit, then China has definitely transformed itself into a capitalist economy. However, it has not adopted a laissez-faire type of economic system (where the market is supposedly left to itself and government intervention is minimal). Rather, the Chinese government plays a decisive role in economic development.

China has a regulatory environment that makes sure that foreign investment stays “in line with ts macroeconomic policies” (Building a Successful Plant in China. Investing in China’s Growth Potential, 2004).

In 2004 China divided foreign investment into 3 categories: encouraged, restricted, and prohibited. All non-listed sectors were considered “permitted”. Encouraged investment projects included the following sectors:

Agricultural modernization; communications, energy, raw materials, infrastructure, and other fundamental industries; information and electronic industries, biological engineering, new materials, aeronautics and astronautics, and other high-tech- industries; use of advanced technology to help China advance its machinery, light industry and textile industry; utilization of resources; environmental protection.

Moreover, the government encouraged investment projects in poorer areas of western China as well as projects for the promotion of exports of all permitted items.

Restricted investment projects included those of products that are not technologically advanced, projects involving prospecting and mining of special minerals classified under state protection. Prohibited projects related to sensitive sectors such as the operation of power grids and aviation transport (ibid., pp. 136-138).

One of the main characteristics of China’s socialist market economy are state-owned enterprises (SEO). The current SEO system in China is important both economically and politically. The existence of state companies symbolizes traditional-style socialism and legitimizes CCP ideology (see Deng Feng, Indigenous Evolution of SEO Regulation, in: Regulating the Visible Hand? The Institutional Implications of Chinese State Capitalism, eds. Benjamin L. Liebman, Curtis J. Milhaupt, 2016, p. 4).

SOEs support government policies with public goods and services, and they allow the government to control key natural resources, industries and land. After the end of the Soviet-style experiment in central economic planning in the late 1970s, China looked at the Singapore model to reorganize its SEOs. Singapore SEOs are professionally managed, private-like, profit-seeking corporations (ibid., p. 11).

In order to restructure its SEO system, during the 1990s and early 2000s China sold out assets or property, laid off workers and formed joint ventures with private foreign companies (ibid., p. 13). Thanks to their political function and their control over vast resources, Chinese SEOs have huge power. SEOs are exempt from the Anti-Monopoly Law and are in the position of putting pressure on private businesses. One notable example was Sino-petroleum’s threat to cut off gas supply in western areas so as to force local entrepreneurs to sell their gas stations (ibid., p. 23).

Nevertheless, SEOs often operate in a competitive environment. In the telecommunications sector, for instance, the government let China Telecommunications, China Mobile and China Unicom compete with each other.

Business people are aware of the pervasive presence of the Chinese state in the economy. And many of them seem to have accepted this fact. As a business handbook explains:

Government in China has considerable powers. It can deny approval for proposed projects and can withdraw licences from existing ones … On a single day in 1996, the government of Tianjin withdrew licences for over a hundred joint venture, for reasons ranging from disputes between partners to lack of profitability … [Government] is your silent partner (Tim Ambler, Morgen Witzel, Chao Xi, Doing Business in China, 2017, pp. 88, 138).


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