Subject: Is China being beastly to foreign investors? - Charles Grant - CER
From: "Michael Andrews" <[email-masked]>
To: "Eric Schwerin" <[email-masked]>, "Hunter Biden" <[email-masked]>
Date: Fri, 30 Jul 2010 12:16:42 -0400

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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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