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Is China being beastly to foreign investors?

by Charles Grant, 30 July 2010

When I visited China a year ago, I was struck by the strong feeling
among many foreign firms there that the business environment was
getting tougher. Western businessmen complained, in particular, about
discrimination against foreigners. On a recent trip to China, I found
a more nuanced situation. In some sectors, notably those where
intellectual property (IP) is important, there are growing complaints
of unfair treatment. But in other sectors foreign companies are making
good money, without grumbling much.

Western business leaders are certainly complaining more loudly than
they used to. In July, the Financial Times reported Jeffrey Immelt,
the chairman of General Electric, as saying that he was "really
worried about China. I am not sure that in the end they want any of us
to win, or any of us to be successful." A few days later Jürgen
Hambrecht, the CEO of BASF, told Wen Jiabao, the Chinese prime
minister, that foreign firms were being forced to transfer know-how to
Chinese companies, in return for market access. Hambrecht told him
that this did "not exactly correspond to our views of a partnership".
At the same meeting Peter Löscher, the CEO of Siemens, urged Wen to
ensure that foreign firms could compete fairly for government
procurement contracts. (Like a lot of western business leaders,
Löscher had previously taken the Chinese government's side, as when he
criticised German Chancellor Angela Merkel for meeting the Dalai Lama.)

One government measure that has provoked foreign business leaders is
the regulation on 'indigenous innovation' that was published last
November. This would, if enforced, exclude foreign firms from public
procurement contracts unless they agreed to hand over IP. The
regulation seems to have been driven by the Chinese Communist Party's
belief that market forces alone will not provide a high-tech economy,
and that the state therefore needs to get hold of and control advanced
technologies. The EU, the US and many other governments lobbied
strongly against the measure.

Whether this regulation will bite remains unclear. The government
announced a delay in implementation and Chen Deming, the minister of
commerce, said the regulation would not affect firms that could prove
they added value in China. Some western business lobbies fear that,
despite recent reassurances, the regulation will in the long run take
effect. If it is enforced, firms like IBM and Microsoft are likely to
cut back on R&D in China. On Capitol Hill, Microsoft is now taking a
hard line on IP issues in China; until recently, it tended to
sympathise with the Chinese point of view. China can no longer assume
that US business leaders will, as a bloc, support its interests in
Washington.

A similar shift is evident among some European companies. According to
the head of one large German firm in China: "They assume their market
is so big, that foreigners will stay, and put up with losing IP.
That’s a miscalculation. Most foreign investors think IP is very
important and that they have a duty not to hand it over." He thinks
that enforcement of the indigenous innovation regulation would dampen
FDI in China. Big western manufacturers would not pull out but would
source more components to countries such as Vietnam, Taiwan, Malaysia,
Indonesia and Singapore. China's free trade agreements with these
countries now make it easier to supply Chinese factories from them.

Within the past two years, some high-tech foreign firms have had to
pay higher rates of tax, while new restrictions on representative
offices – each is allowed only three non-Chinese staff – are proving
irksome. Foreign firms involved in making wind turbines, such as GE,
Siemens and Vestas, are particularly annoyed that, as they see it,
procurement rules have been skewed to exclude them from the Chinese
market (the largest in the world), to the benefit of local firms.

Two-fifths of European businesses in China surveyed by the EU Chamber
of Commerce in June 2010 expected the regulatory environment to worsen
in the next two years. The same proportion described the
discriminatory application of laws and regulations as a 'significant'
obstacle. The EU Chamber concluded: "Optimism in the overall economic
climate has been dampened dramatically by concerns about regulatory
interference and unpredictability in the market."

Some of the shifting balance of power between foreign investors and
the Chinese authorities is the inevitable result of the country's
development. A lot of Chinese companies are now stronger and better-
equipped to compete with European or American rivals. Twenty years ago
the Chinese needed western capital, skills and technology. Now they
need the technology, but they have less need of the skills, and plenty
of their own capital.

Another issue for foreign investors is that costs are rising, in part
due to labour unrest that has been prevalent in the Pearl River Delta
area. The emergence of free trade unions is an important and positive
step for the country's future development, signalling the emergence of
a civil society that is not controlled by government or party. But
many foreign businesses see the new trade unions merely as a source of
growing costs.

Mining companies, energy firms, banks and insurers, among others,
still face restrictions on their activities in China. Many of them
nevertheless make money. That is the case for Shell and BP, which are
significant investors, often through joint ventures, but would like to
engage in a wider range of activities than they currently do. In many
other sectors, such as retailing, advertising, hotels, pharmaceuticals
and cars, companies report they are doing well without too much
government interference. For example Tesco finds it easier to open
stores than two years ago, as central government permission is no
longer required; but Tesco says that Chinese retailers face less
hassle from red tape than do foreign ones. WPP is allowed to own 100
per cent of local advertising agencies and says that as a foreign firm
it faces no discrimination – except that it pays more tax than local
competitors. Car companies are doing particularly well: BMW has
doubled sales in China over the past year, and Daimler is forming a
joint venture to develop electric vehicles.

Since the spring, the government has made an effort to appear friendly
to foreign firms: Premier Wen met foreign business leaders to listen
to their complaints; several ministries opened their doors to foreign
investors in China and asked how they could help; and in July the
government appeared to accept a compromise in its dispute with Google,
with the result that Chinese citizens can search uncensored via Hong
Kong. Chinese analysts point out that many local authorities still
compete for FDI and therefore offer special deals (for example, on tax
and utilities) to foreign firms.

When China joined the World Trade Organisation in 2002, it failed to
sign the agreement on public procurement that prevents discrimination
against foreign firms. In July China made new proposals for acceding
to this agreement – but western governments think them inadequate (for
example, China is not offering to open up local government
procurement). Also in July, Chen Deming wrote in theFinancial Times
that China is "ever more open to business". He is right that most of
the formal rules applying to foreign investors are less restrictive
than they were ten years ago. According to his figures, global FDI
fell by nearly 40 per cent in 2009, but only by 2.6 per cent in China.

My conclusion is that China still welcomes FDI, but that it is
becoming more insistent on setting the terms. For example, it wants to
choose the location for big foreign industrial investments – often in
the underdeveloped west of the country, where a lot of foreign firms
would rather not go. The Chinese government is probably right to
calculate that, for all their grumbling, most foreign firms will stay;
China is just too big a market to ignore. In any case, despite the
difficulties, many foreign investors in China claim that they are
managing to hang on to their IP.

China's strategy is to exploit foreigners' desire for access to its
markets as a means of gaining their technology. From China's point of
view that is a reasonable policy. If a lot of foreign investors
clubbed together to speak with one voice and make credible threats to
China, they might persuade its leadership to re-examine that strategy.
But neither the big foreign companies in China, nor the European and
American governments, are likely to get significantly tougher with
China. So do not expect much change in China's policies towards
foreign investors.

Charles Grant is director of the Centre for European Reform.

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