state of business in s china (amcham white paper 2015)

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© 2015 e American Chamber of Commerce in South China

2015

Reproduction for commercial use is strictly prohibited. is document is available free of

charge in electronic form at: http://www.amcham-southchina.org

Last updated: Feb 15, 2015

2015 2 15

e American Chamber of Commerce in South China

Suite 1801, Guangzhou International Sourcing Center,

No. 8 East Pazhou Avenue, Haizhu District Guangzhou,

Gungdong, PRC 510335

81801 510098

(86 20) 8335 1476 (Tel.)

(86) 20 8332 1642 (Fax.)

[email protected]

http://www.amcham-southchina.org

2015 W HITE P APER

ON THE B USINESS E NVIRONMENT IN C HINA

2015

T A C C S C

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Contents

Review Committee

omas PodgurskiGroup Director, Royal Service Air Conditioning

Guy Robertson Vice President, WMGS Consulting (Shenzhen) Co. LtdGuy Robertson

Diane Fermin RoederEditor in Chief, Paper Magazine

Andy Rusie Vice President Finance, Greater China Mead Johnson Nutrition (China) Ltd. Andy Rusie

Richard Ren VP-Corporate Affairs, Vitasoy (China) Investments Co.,Ltd.

-

Tim ShaverClub Manager, Harbour Plaza Golf Club Dongguan

Hui SunInternational Attorney

Tim Wen VP & China Rep., Allway Co. Inc.

Joe Zhou Vice President, American Appraisal China Ltd.

Harley Seyedin (Chairman)President, Sithe Global Pacic

.

(In alphabetical order )

David BuxbaumAttorney, Anderson & Anderson L.L.P.

Steven ChengVice President of Finance, Greater China RegionAmway (China) Co. Limited

David Hon, Ph.D.CEO, Dahon Technologies

Frederick Hong Attorney at Law / Chief Representative,Frederick W. Hong Law Offices

/

Christopher Laidlaw Director, Penultima Ratio Regum L.L.C.

Penultima Ratio Regum L.L.C.

Li SiGeneral Manager, AmCham South China

Yuki LuCommunication Manager, AmCham South China

David Peng Chief Representative,C.V. Starr & Co. Beijing Representative Office

President’s Message 6

Part I 81.1 Just Do It (in 2013) 101.2 e Double-edged Sword of SOEs (in 2013) 241.3 e Foreign Investment Environment

in China (in 2013) 321.4 Redening Reform (in 2015) 381.5 Shanghai Free Trade Zone 561.6 US-China Business Investment Treaty (BIT) 661.7 An Overview on the Annual Development of

Intellectual Property Law of the P.R.C. in 2014 721.8 Suggestions 88

Part II 922.1 Agriculture 942.2 Chemicals,Bio-Chemicals and Energy 1122.3 Machinery and Electrical Equipment 1342.4 Transportation and Logistics 1482.5 Products Classied by Materials 1602.6 Construction 1762.7 Manufactured Articles 1882.8 Hospitality 1982.9 Services 212

Part III 2323.1 Introduction to South China 2343.2 Guangdong Province 2383.3 Fujian Province 2463.4 Guangxi Zhuang Autonomous Region 2503.5 Hainan Province 2543.6 Hong Kong Special Administrative Region 2583.7 Macau Special Administrative Region 264

Part IV 2684.1 Demographics 2704.2 Revenue and Protability 2784.3 South China 2824.4 Investment Trends 2844.5 e Business Environment in South China 292

7

91.1 2013 111.2 2013 251.3 2013 331.4 2015 391.5 571.6 (BIT) 671.7 2014 731.8 89

932.1 952.2 1132.3 1352.4 1492.5 1612.6 1772.7 1892.8 1992.9 213

2333.1 2353.2 2393.3 2473.4 2513.5 2553.6 259

3.7 265

2694.1 2714.2 2794.3 2834.4 2854.5 293


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White Paper on the Business Environment in China e American Chamber of Commerce in South China

2015

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President’s Message

O UR 2015 WHIT E Paper on the Business Environmentin China occurs during an undoubtedly interestingjunction in the two year old administration of PresidentXi Jinping.

In 2013 and most recently in 2014, each year’s Plenum ofthe Communist Party of China has unveiled frameworks forbroad, bold and ambitious economic and legal reforms – plat-forms for reform which, if fully implemented, are bound notonly to transform the China of the future, but also have the po-tential to affect the rest of the world. e fact that implemen-tation of these groundbreaking and far-reaching reforms arebeginning to occur amidst the backdrop of the Chinese govern-ment’s aggressive anti-corruption campaign, makes PresidentXi Jinping’s two-year milestone even more remarkable.

is 2015 White Paper outlines, in exhaustive detail,the ongoing plans and initiatives being implemented by thegovernment in the wake of these reforms and cites a cross-section of informed opinions and analyses from both Chinaand overseas about the impact of these policies. At the sametime, to illustrate how far China has come since the time ofPresident Xi’s ascension to power in late 2012 and providea solid basis for comparison of China then and now, highlyrelevant sections of our 2013 White Paper are incorporatedin this latest version. Given all that is documented here, itis evident that China is now embarking on a transformativedecade, one that should exponentially benet its own people,as well as the foreign investors who are stakeholders in thecountry’s continued growth. It is noteworthy to point out thatresults of our latest Special Report on the State of Businessin South China indicate that member companies intend toincrease investment in their China business operations as longas they feel they are being treated equally and with utmosttransparency.

Providing a well-researched, objective and comprehensiveoverview of the business environment in China continues to beour goal with the publication of the 2015 White Paper which,we hope, adds value to businesses operating in this rapidly

evolving world. Last year, a combined total of 1,351 copies ofthe 2014 White Paper and Special Report were downloadedfrom our website, in addition to the printed copies we had incirculation. is year, we are increasing our print run by 60%in the wake of China’s continuing evolution.

A critical question confronts the leadership at this stage:

Can President Xi Jinping and his administration continue topress forward in aggressively tackling corruption while alsoercely undertaking economic reforms?

Our conclusion is, they must – they have to – and they

should. Last year, we urged China’s leaders to “Keep movingforward”, to continue to offer more opportunities for health, wealth and happiness for the Chinese people and elevate theirquality of life. is year, while we examine the issues and chal-lenges, we also applaud this administration’s accomplishmentsand successes and encourage China’s leadership to continue –to “Keep moving forward and accelerate the pace”.

With best regards,

Harley SeyedinPresident

e American Chamber of Commerce in South China Vice Chairman, China Affairs

e Asia Pacic Council of American Chambers of Commerce


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1.1 20131.2 20131.3 20131.4 20151.5 1.6 (BIT)1.7 20141.8

Part ICommentary

1.1 Just Do It (in 2013)1.2 e Double-edged Sword of SOEs (in 2013)1.3 e Foreign Investment Environment in China (in 2013)1.4 Redening Reform (in 2015)1.5 Shanghai Free Trade Zone1.6 US-China Business Investment Treaty (BIT)

1.7 An Overview on the Annual Development of Intellectual PropertyLaw of the P.R.C. in 2014 1.8 Suggestions


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1.1 (2013 )

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( e following sections have been incorporated from our 2013 White Paper.)

1.1 Just Do It (in 2013)

Standing Still or Turning Back Would beA Dead End

LONG YONGTU , THE man who negotiated China’sentry into the WTO in the late 1990s, is worried. “ e cost

of [failing to reform] could be high,” he told a symposium in2012, adding that “essentially, after 10 years, it seems China isdrifting away from t he WTO.”1

Expanding on his concerns, Mr. Long argues that, “Astatist model that denies fair competition for all enterprises,domestic and foreign, could st ie China’s economic growth,”and that “[China] cannot only have large-scale and state-owned enterprises. at is only the skeleton of the economy.We need thousands upon thousands of small and medium-sized private enterprises. ey are the esh and blood of theChinese economy,” reinforcing the argument made in section1.2 of this White Paper. 1

Mr. Long’s concerns are not unique to him, either.Increasingly, diverse stakeholders seem to agree that despiterhetoric and ideology, reality in China demands substantivepolitical reform.

“In a sense, both the CCP and its critics agree on the needfor political reform,” writesWall Street JournalcommentatorYiyi Lu. “Critics argue that the Party cannot stay in power formuch longer if fundamental reforms are not introduced—anotion echoed by an essay in the latest issue of the CCP’sown theoretical journal,Seeking Truth, that called for furtherreform and opening-up. ‘[S]tanding still or turning backwould be a dead end,’ it said.”2

“But even declarations of the need for reform from thelikes of Chinese leader Hu Jintao—who warned in a July23 [2012] speech that the party must ‘never ossify, neverstagnate’—fail to convince critics that the party is willingor able to undertake reforms that would genuinely tacklecorruption or threaten vested interests.”2

Progress has certainly been made in terms of furtherreform and ‘opening up’. In a survey of China’s economicperformance under President Hu and Premier Wen, e WallStreet Journal’s China Real Time blog observed that:

Top of the list of achievements is improved publicservices and welfare provision. Education spending hit4 percent of GDP in 2011, up from 2.2 percent in2002. Health and pension coverage have expanded,

and elimination of agricultural taxes helped raiseincomes for China’s 650 million rural dwellers.

In the nancial sector, the big four state-owned banks were listed on the public markets, bringing an elementof market discipline to their lending decisions. Interestrates, a key instrument of economic rebalancing, havebeen partially liberalized. at means higher returnsto household savers a step to increasing incomes andboosting consumption.

China’s exchange rate another instrument ofrebalancing has also been liberalized. e yuan hasrisen 31 percent against the dollar since the peg wasbroken in 2005. In 2012, the band in which the yuantrades was widened giving the markets a great say inhow it moves.

A stronger currency has helped reduce the imbalancein China’s trade, with the current account surplusshrinking to 2.8 percent of GDP in 2011 from a highof 10.1 percent in 2007.

Rebalancing is also receiving support from forcesoutside of the government’s control. A diminishedsupply of workers is driving up wages at a rapid clip.Liu Xingshun, a 40-year-old migrant worker from

Jiangxi province, currently working in a furniturefactory in Shenzhen, told China Real Time he madeabout 1,000 yuan ($160) a month in the year 2000.Now he makes 4,000 to 5,000 yuan. 3

Although “Higher wages are essential to fuel an increasein China’s household consumption, […] key elements ofthe reform agenda, from opening state-dominated sectors ofthe economy to competition, to strengthening farmers’ landrights, and reforming the iniquitous system of urban and ruralresidence rights, remain undone.”3

In last year’sWhite Paper , we argued that further reformand ‘opening up’ is not yet complete:

We are not alone in advocating further reform: Chi naInvestment Corporation Chairman and CEO Lou

Jiwei last year argued that although reform efforts

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is able to be accomplished.6

Not all are so pessimistic, however: “Li Jiange, chairmanof China International Capital Corp., [predicts that] GeneralSecretary Xi will introduce economic reforms in late 2013to reduce Beijing’s role in the economy and break up statemonopolies.”7

European Union Chamber of Commerce in China, Bei- jing President Davide Cucino commented (somewhat idealis-tically) that “ e transition of power offers the new leaders anhistoric opportunity to quickly implement a decade of stalledreforms that would allow China to shift its economy to a newstage of sustainable growth and towards a more inclusive,higher income society. is will not be an easy task, but we arecondent that the new leaders will take bold moves becausethey know that the required reforms are not only necessary,but now also urgent. In not doing so we see the risk of danger-ous outcomes in the business environment.”8

But instead of speculating about various officials’ attitudes, writes e Wall Street Journal’s China Real Time blog, “there isa simpler way to test the Party’s seriousness [about reform]: Wait and see if the leadership makes a big move on the issueof asset declaration by cadres after the 18th Congress.”2

Watch Brother, Uncle House, SmashingBlack

In August, a Shanxi provincial official earned the ire of theChinese public on not one, but two counts.Time summarizesthe events thusly:

[On] Aug. 26, a long-distance bus carrying 37 pas-sengers collided with a tanker loaded with highlyammable methanol on a Chinese highway in ShanxiProvince. Both vehicles burst into ames, killing 36passengers. Shortly after the tragedy, Yang Dacai, chief of theShanxi provincial work safety administration, wascaught grinning widely amid the wreckage. As Weibousers tried to gure out who this strangely smiley of-cial was, pictures of Yang wearing luxury watches

went viral. […] Yang was quickly dubbed ‘the smilingbrother,’ and his laughing visage became September’smost comical Internet meme.

[…]

One day after the Shanxi accident, Sina Weibo usersposted ve photos of Yang wearing ve different luxu-ry watches, including a $63,000 Vacheron Constantinand a $10,000 Rolex. Many netizens questioned how

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over the past thirty years have created a marketeconomy framework that is “now rmly in place,”this framework is also “incomplete, and that has ledto many problems including injustice,” and that “Inthe words of some Chinese government officials, thecurrent system is unbalanced, uncoordinated andunsustainable.”4

We furthermore highlighted a series of recommendationsput forth by the U.S.-China Business Council in February2012 as areas likely to see measurable, concrete gains fromreasonable investments in time and attention:

Ensure fair and open investment environments thatcreate jobs. e United States and Chinese governmentsshould jointly affirm the principle that foreign directinvestment is good for economic development, employment,innovation, competition, consumers, and public welfare.

Reduce investment ownership restrictions in China andencourage Chinese investment in the United States. Chinahas far too many ownership restrictions on US and foreigninvestors seeking market access. More investment by Chinesecompanies in the US means more jobs for Americans.

Continue to use WTO cases to settle trade disputes. Both countries have effectively used this channel to resolvetrade disputes in a non-politicized manner and shouldcontinue to do so.

Further improve rule-making transparency. China’scentral government has signicantly improved rule-making transparency over the past several years, but furtherimprovements are needed. China should fully implement itscommitment to publish all draft trade and economic-relatedlaws, administrative regulations and departmental rules for afull 30-day period.

Eliminate duplicative and inconsistent payroll taxes. e US and China should quickly move to ensure its respective

companies and employees are not required to pay payroll taxes(social insurance taxes in China) in both countries.

Adhere to non-discriminatory, mutually-benecialinnovation policies. China should continue to implement itspledge to delink its innovation and government procurementpolicies. is issue impacts the level playing eld for Americancompanies in the China market, but also impedes China’sgoal of becoming a more innovative economy.5

Some scholars worry that intra-party competition andsome groups’ concerns may limit the speed with which reform


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a government worker who would have not been mak-ing more than $15,000 a year could afford so manyexpensive watches on his public salary. In a nationstruggling with rampant local corruption, Yang soonacquired another nickname: “watch brother.” 9

By September 21, “Watch Brother” had been “relieved ofhis position and accused of serious discipline violations.”9

Less than a month later, the “[former] deputy chief of[Guangzhou suburb] Panyu district’s public security bureauand head of the district’s urban management bureau”, a civicofficial drawing a salary of roughly $1,600 per month, wasfound to own 22 properties throughout Guangzhou valuedat over $6.3 million.10 e official, named Cai Bin but nick-named “Uncle House”, reportedly told his superiors that heowned only two.11

e ouster of Bo Xilai based on a laundry-list of disci-plinary violations, however, was certainly the highest-proleincident of the year.

Mr. Bo, formerly the party secretary of the state-levelChongqing Municipality and once a front-runner for a seaton the prestigious Standing Committee of the CPC, was “in-vestigated within the party for alleged crimes including abuseof power, bribe-taking and involvement in his wife’s murderof the British businessman Neil Heywood,” before being“ejected from the Communist Party and China’s parliament”and thus losing his former immunity from prosecution.12

e Australian reported in December 2012 that in addi-tion to the host of charges Mr. Bo already faces, “Chineseprosecutors building a corruption case against Bo Xilai arebelieved to be investigating whether the fallen politician laun-dered an illicit fortune through Macau.”12

“Public demand for a transparent asset declaration sys-tem for government and party officials has grown strong inrecent years. For a party that calls itself ‘communist,’” arguescommentator Yiyi Lu, “Refusal to publish information aboutthe assets of office holders is clearly indefensible, especiallywhen such disclosures are already th e norm in many othercountries.”2

“ e party’s many failures in the past to reign in corrup-tion among its ranks—bar a few high-prole scapegoats—hasled to “Tsinghua University professor Sun Liping arguing thatthere are few options left to stem the spread and intensica-tion of corruption other than forcing officials to disclose theirassets.”2

Ill-gotten wealth is an increasingly problematic issue forthe Party as income inequality continues to grow.

An academic sur vey conducted in 2008 found that “ etop 10 percent of China’s urban dwellers had average dispos-able income of 139,000 yuan a year, 7 times more than aver-age earners, and 25 times more than the bottom 10 percent.

With rich households saving more of their income than poor,that income inequality helps explain China’s high savings rateand low consumption.”3

A more recent study by a professor at Southwestern Uni- versity of Finance and Economics and Texas A&M Universityshows that “the gap between China’s haves and have nots is ex-tremely wide, perhaps the widest of any country in the world[and that] China’s top 20 percent command 68.4 percent ofincome, and the bottom 20 percent just 0.5percent.”13

“ e Gini coefficient is a widely used measure of incomeinequality,” writes e Wall Street Journal’s China Real Timeblog. “A score of 1 m eans perfect inequality, with one personcontrolling all a country’s income, a score of 0 means perfectequality. [Recent independent results] put China’s Ginicoefficient at 0.61. at’s signicantly higher than an estimateof 0.44 by a Chinese NGO based on the official householdincome data.”13

Corruption among China’s top earners will feature in anyexplanation for the growing wealth gap: “Government controlof major investment projects, and key resources like land, of-fers multiple opportunities for graft.”3

Moreover, in the face of vague official data one professorat a prestigious Mainland university estimates “180,000 massincidents in 2010”, compared to 50,000 in 2002. Corruptionis considered one of the most widespread causes of protests,along with land grabs and environmental degradation.3

Rule of law, the oft-cited catchall category for systemic im-provements in favor of which foreign stakeholders like Am-Cham South China member companies have been tirelesslyarguing for more than a decade, still proves elusive and is anexcellent example of the central proto-issue that manifests it-self in arguments for reform, arguments against corruption,arguments against SOEs’ privileges and more.

at issue is simple: doing the right thing for the coun-try—the thing that nearly everyone seems to agree is neces-sary—requires the Party’s loosening its grip on governance infavor of a system dened by the rule of law .

Notably, it seems that whenever an editor needs a polemicagainst the crass capitalism of the West they roll out the sametired, ridiculous universal-suffrage-demanding straw man:

When it comes to polit ical systems, Western opin ionleaders are still stuck in a narrative of dichotomy: de-mocracy versus authoritarianism. But the competitionin the 21st century, as scholar Zhang Weiwei says, isbetween good and bad governance. China has devel-oped the right formula for choosing political leadersthat is consistent with its culture and history and suit-able to modern circumstances. It should be improvedon the basis of this formula, not Western-style democ-racy. 14

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is passage from China Daily hits all the right rhetoricalnotes but is totally tone-deaf in terms of its overall argument.Rule of law, not “Western-style democracy” (the phrase itselfbeing somewhat handwavey in terms of what it signies), iswhat most informed critiques of Chinese politics call for.

Indeed, things like transparency, accountability and rule-based governance are what is sorely needed and what wouldbe bolstered by meaningful political reform.

is position is certainly not limited to foreign observers.China Daily itself quotes Shandong University president XuXianming as saying that, “ e r ule of law, if implementedproperly, will be instrumental in helping the country copewith prominent risks, such as cor ruption [because] govern-ment officials will be deprived of their privileges, which are aroot cause of corruption.”15

Xinhua , ever one to join a popular cause, notes that notonly has the Party itself warned that “corruption could lead to‘the collapse of the Party and the fall of the state,’”11 but that:

Seven hundred years ago, during the Ming Dynas-ty, Chinese officials convicted of taking bribes wereskinned alive in public. But even severe penalties likethose failed to deter greedy and reckless officials; the‘national disease’ of corruption contributed signi-cantly to the fall of the dynasty. 11

“Having tried out different remedies,” Xinhuaconcludes,“China is just one step away from a cure that has been proveneffective in countries the world over: the public disclosure ofgovernment officials’ assets.”11

e Economic Picture

Beyond public anger over officials’ conduct, observers areincreasingly pointing to signs that China’s economy is in needof fundamental rebalancing.

e Washington Post writes:

e rst and most pressing issue [the newly-appointedStanding Committee of the CPC] will t ackle is China’sslowing and hamstrung economy. e party has longsaid its goal is to wean the country off its dependenceon investment growth and exports while increasingdomestic consumption. But changing policies couldprove difficult, requiring a host of reforms—such asallowing interest rates to rise and letting China’s cur-rency oat freely—that party leaders have long re-sisted.

Equally difficult will be disassembling industries

monopolized by state-owned enterprises, given thevested interest of [certain groups].16

is is arguably an understatement of the economicchallenges that China currently faces.

Discussing why “China’s domestic stock markets arelanguishing near three-year lows and on the nose with retailinvestors,”17 Reuters offers a laundry list of issues currentlyfacing the economy:

Two-thirds of Chinese companies that have postedthird-quarter earnings missed expectations, accordingto Citi Private Bank. Prots fell an annual 5.8 percent,and analysts, on average, are still cutting earnings ex-pectations for next year.

Leverage has soared above comfortable levels, withBeijing-based consultancy GaveKal-Draganomicsexpecting corporate debt to hit 122 percent of GDPby the end of the year, up from 108 percent at end-2011.

Rising non-performing loans (NPLs) pose a risk forthe banks, a hangover from cheap credit as part of the2008/09 stimulus. Goldman Sachs & Co estimatesthe NPL ratio is more than six times the official re-ported rate of 0.97 percent.

Further, China’s industrials were owed more than 8trillion yuan in net receivables at the end of Septem-ber, up 16.5 percent from a year earlier, according tothe National Bureau of Statistics. 17

“Today, Chinese economic policy-makers are hamstrungin trying to revive economic growth,” writes widely-publishedprofessor of government Minxin Pei. “ e combination of lo-cal government indebtedness, massive bad loans hidden in thebanking system, anemic external demand, and diminishingreturns from investments has made it all but impossible forBeijing to use the same old economic playbook to re up theeconomy.”18

e issue of primary concern is that there is currently nofeasible replacement for the investment-driven growth mod-el that has propelled the Chinese economy over the past 30years, and the that same investment-driven model grows moredangerous by the day.

A recent International Monetary Fund (IMF) report ob-served that “a sustained period of over-investment [means]that China now [requires] ever higher investment to gener-ate the same amount of growth, forecasting that investment’sshare of GDP could soar to 60-70 percent from current levels

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around 50 percent,” and that “Under such a strategy, vulner-abilities will likely grow in the form of hidden deadweightthat will have to be paid in future in one form or another. ecost of nancing such an elevated level of investment couldundermine overall economic stability.”19

Reuters notes that “ e potential for severe internal eco-nomic imbalances in China stemming from an extended pe-riod of investment-driven growth, plus the risk that the excesscapacity it creates spills into the global economy, are a recur-ring theme of IMF research.”19

“Many countries in the past one hundred years have gonethrough periods of extraordinary growth, powered by veryhigh and rising levels of investment,” observes Peking Univer-sity professor of nance Michael Pettis. “In every case thesecountries developed serious imbalances, either internally, ifthe investment was nanced by consumption-constrainingpolicies, or externally, if they were not.”20

He continues:

In the early stages, it was always relatively easy to ndeconomically viable investments, but as institutionalconstraints required the persistence of high levels ofinvestment, and as it became increasingly difficult toensure that investment was economically viable, inlater stages investment was always misallocated anddebt grew faster than debt servicing capacity.

is combination of extreme imbalances and high lev-els of debt, driven by misallocated investment, result-ed in a subsequent period of rebalancing that turnedout to be far more difficult than even the skeptics hadpredicted. China’s development model has differedfrom its predecessors only in that the imbalances haveexceeded any that we have seen in prior history, andthe amount of misallocated investment may have alsoexceeded all precedents.

For this reason it would be surprising, and an histori-cal anomaly, if China’s rebalancing were not a verydifficult one. Not only has China pushed the imbal-ances associated with the investment growth modelto extremes that exceed any seen before, but it is be-coming increasingly clear that the obstruction to anymeaningful adjustment by sectors that have benettedmost from domestic economic distortions will makethe adjustment politically very difficult. 20

Nick Lardy, a China expert with the Peterson Institute,takes the position that “Rebalancing is a medium term projectthat will not be easy. To be successful the government willneed to phase out policies that favor prots at the expense of

wages, borrowers at the expense of savers, and manufacturingat the expense of services.”21

Still, Mr. Pettis argues, rebalancing is likely to be harder,rather than easier, than precedent cases in other countries:

[After many years] several groups within China havebenetted mightily from the distortions associated

with the current growth model, especially di stortionsin interest rates, the currency, and China’s heavy de-pendence on investment. Given how deep these dis-tortions have been, and how long they have been inplace, it would be surprising if these groups had notbecome extremely powerful.

ese distortions need to be reversed. e historicalprecedents for developing countries that have attempt-ed to reverse similar distortions, however, suggest thatthe biggest impediment to the adjustment process willbe opposition from these groups. Jeffrey Frieden in his1993 book on Latin America, for example, argues thatthe Latin America adjustment in the late 1970s wasextremely slow and painful precisely because power-ful vested interests were so successful in retarding ordiluting reform. 21

“ e intellectual case for an accelerated pace of economicreform has been well established in China,” argues Mr. Lardy.”“If Xi and Li can overcome the entrenched vested intereststhat have slowed reform to a crawl in recent years they will belaying the foundation for stronger economic growth over themedium term.”20

Problematically, “It is still unclear what Beijing can doto replace the source of growth [after the required dramatictransformation of the nancial sector and the relationship be-tween the state and the economy].” One option, a consump-tion-driven model, is possible but unlikely in the short termas “China would have to not just to maintain the last decade’sconsumption growth rate [but] substantially to increase it.”21

“A massive transfer of wealth from the state sector andfrom China’s economic elite to the household sector wouldof course do the trick,” says Mr. Pettis, “But it may well bethe only way.”21

Mr. Lardy argues that major policy changes, including“further [reducing] and eventually [eliminating government]intervention in the foreign exchange market; [eliminating]subsidies to industrial energy consumption; [continuing] tobuild out the social safety net [and] ending the extreme -nancial repression of recent years—reected in a real one-yeardeposit rate that has on average been in the negative territorybeginning in 2004” will all contribute to a controlled rebal-ancing on the back of increased domestic consumption.21

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If reforms such as these can be accomplished, says Mr.Lardy, “China will not resume double digit growth but it willprobably escape [Mr. Pettis’] postulated 3 percent to 4 percentpace of expansion.”21

Built to Last

“China has progressed about as far as it can within itsexisting political framework. Further reform would threatenthe Communist Party’s hold on power, so it will not spon-sor change of that sort,” writesForbes commentator GordonChang.

Claremont McKenna College professor of governmentMinxin Pei holds that “a market economy requires the ruleof law, which in turn requires ‘institutional curbs’ on govern-ment. Because these two limitations on power are incompat-ible with the Party’s ambitions to continue to dominate soci-ety, China cannot make much progress toward them withinthe current system. China […] is now trapped.”7

“China has been caught in such situations before,” con-tinues Mr. Chang, “But has managed to implement criticalreforms. at happened at the end of 1978, for instance,when Deng Xiaoping launched more than three decades ofgrowth.”7

Brookings Institution analyst Cheng Li argues that “With-out political reform, China cannot have structural changefrom an export-led economy to an innovation-driven, domes-tic consumption-driven economy,” because “an innovation-led economy needs political openness. And consumption orservice-sector development needs stronger rule of l aw.”22

Mr. Li furthermore posits that “China’s fth generationface a tough choice: Either save the party, which means boldpolitical reform and even giving up some of their power andprivilege, or they will be out of history.”22

e trillion dollar question, it seems, is whether or not theParty will display the strength of character necessary to wrestitself from “various self-defeating loops”7 and start the nationon another 30 years of growth, prosperity and—hopefully—anew era of Chinese rule of law.

Works Cited

1 Paul Eckert and Stella Dawson. “Ten years on, Americanbusiness rethinks China dreams.” Reuters . December 9, 2011.http://www.reuters.com/article/2011/12/09/uk-usa-trade-wto-idUSLNE7B801C20111209. Accessed December 6, 2012.

2 Yiyi Lu. “A Test Case for the Communist Party’s Commitmentto Reform.” China Realtime Report. October 23, 2012. http://blogs.wsj.com/chinarealtime/2012/10/23/a-test-case-for-the-communist-partys-commitment-to-reform/. Accessed December6, 2012.

3 Tom Orlik. “Charting China’s Economy: 10 Years Under Hu.”China Real Time . November 16, 2012. http://blogs.wsj.com/chinarealtime/2012/11/16/charting-chinas-economy-10-years-under-hu-jintao/. Accessed December 6, 2012.

4 Lou Jiwei. “Six Paths for Advancing China’s Market Reform.”Caixin. August 2, 2011. http://english.caixin.com/2011-08-02/100286752.html. Accessed February 14, 2012.

5 Statement of Priorities for the US-China Commercial Relationship.e U.S.-China Business Council. February 10, 2012. https://

www.uschina.org/public/documents/2012/02/board_priorities.pdf. Accessed February 14, 2012.

6 Ben Blanchard and Sui-Lee Wee . “China names conservative,older leadership.” Reuters . November 15, 2012. http://

www.re uter s.co m/ar ticl e/20 12/ 11/ 15/ us-c hina -con gres s-idUSBRE8AD1GF20121115. Accessed December 6, 2012.

7 Gordon Chang. “China’s Anti-Reformers Take Over.”Forbes. November 18, 2012. http://www.forbes.com/sites/gordonchang/2012/11/18/chinas-anti-reformers-take-over/.

Accessed December 11, 2012.

8 Nick Edwards. “Analysts View: Chinese Communist Partyunveils new leadership.”Reuters . November 15, 2012. http://

www.reuters.com/article/201 2/11/15/us- china-congress-view-idUSBRE8AE0C720121115. Accessed December 6, 2012.

9 Gu Yongqiang. “Bringing Down ‘ Watch Brother’: China’s OnlineCorruption-Busters Tread a Fine Line.” Time . October 10, 2012.http://world.time.com/2012/10/10/bringing-down-watch-brother-chinas-online-corruption-busters-tread-a-fine-line/.


10 Zheng Caixiong. “‘Uncle House’ under investigation”. People’sDaily . October 23, 2012. http://english.peopledaily.com.cn/90882/7987674.html. Accessed December 11, 2012.


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11 “Time to publicly disclose officials’ assets.” Xinhua . December6,2012.http://usa.chinadaily.com.cn/china/2012-12/06/content_15992478.htm. Accessed December 11, 2012.

12 “Bo Xilai linked to illicit fortune in Macau.” e Times .December 4, 2012. http://www.theaustralian.com.au/news/

wor ld/ bo- xil ai- lin ked -to- ill ici t-f ort une- in- mac au/ stor y-fnb64oi6-1226529215946. Accessed December 11, 2012.

13 Tom Orlik. “Charting China’s Family Value.” ChinaReal Time . December 10, 2012. http://blogs.wsj.com/chinarealtime/2012/12/10/perception-vs-reality-charting-chinas-family-value/. Accessed December 11, 2012.

14 “China’s political system suits it best.”China Daily . November16,2012.http://usa.chinadaily.com.cn/2012-11/16/content_15935662.htm. Accessed December 11, 2012.

15 “Rule of law crucial to stability, prosperity.” Xinhua . December4,2012.http://usa.chinadaily.com.cn/china/2012-12/04/content_15985764.htm. Accessed December 11, 2012.

16 William Wan and Keith B. Richburg. “China’s new leadershipteam not expected to push drastic reform.” e WashingtonPost. November 15, 2012. http://www.washingtonpost.com/

world/as ia_pacic/chi nas-new-lead ership-team- not-expected-to-push-drastic-reforms/2012/11/15/6cfe8b9a-2f29-11e2-9f50-0308e1e75445_story.html. Accessed December 11, 2012.

17 Vikram Subhedar. “Analysis: “Caveat emptor” as foreigners rushto ride China rebound.” Reuters . November 26, 2012. http://

www.reuter s.com/ artic le/20 12/11 /26/ us-chin a-inves tment-idUSBRE8AO0D720121126. Accessed December 12, 2012.

18 Minxin Pei. “Superpower Denied? Why China’s ‘Rise’ MayHave Already Peaked.” e Diplomat. August 9, 2012. http://thediplomat.com/2012/08/09/superpower-denied-why-chinas-rise-may-have-already-peaked/. Accessed December 12, 2012.

19 Nick Edwards. “China investment levels excessive, risks arerising: IMF research.” Reuters . November 28, 2012. http://

www.reuters.com/articl e/2012/11/ 28/us-china- economy-imf-idUSBRE8AR09Z20121128. Accessed December 12, 2012.

20 Nick Lardy and Michael Pettis. “Lardy vs. Pettis – DebatingChina’s Economic Future.”China Real Time . November 2, 2012.http://blogs.wsj.com/chinarealtime/2012/11/02/lardy-vs-pettis-debating-chinas-economic-future/. Accessed December 6, 2012.

21 Nick Lardy and Michael Pettis. “Lardy vs. Pettis: Debating China’sEconomic Future, Round 2”. China Real Time . November 7,2012.http://blogs.wsj.com/chinarealtime/2012/11/07/lardy-

vs-pettis-debating-chinas-economic-future-round-2/. AccessedDecember 12, 2012.

22 Cheng Li and Minxin Pei. “Li vs. Pei on China’s Prospects forPolitical Reform.”China Real Time . November 8, 2012. http://blogs.wsj.com/chinarealtime/2012/11/08/li-vs-pei-on-chinas-prospects-for-political-reform/. Accessed December 12, 2012.


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SOEs Enjoy A Second Life

THE CHINESE GOVERNMENT’S preferentialtreatment of and strategic mandate for state-ownedenterprises, or SOEs, has a curious history. According tosome, it also has a grim outlook if substantive changes arenot made.

In the mid-to-late1990s, former President “Jiang Zemin andthen-Premier Zhu Rongji took a knife to China’s bloated andunprotable state sector, closing thousands of unproductiveenterprises. at opened up space for private sector rms toourish, underwriting the growth of the last decade [2000-2010].”1

Since that time, however, “some of those gains have beenreversed, as the government has thrown its weight behindstate champions. e number of state-owned enterprises as ashare of the total has continued to fall, dropping to 5 percentin 2011. But with SOEs still dominant in the commandingheights of the economy, their share of total output has re-mained relatively buoyant at 26 percent.”1

According to a study performed by “Curtis Milhaupt, ascholar of comparative corporate law at Columbia Law School,and Li-Wen Lin, a graduate student in sociology at ColumbiaUniversity […] the network of SOEs in China “Is based on‘vertically integrated groups’ of large state-owned and relatedcompanies. Each group has a ‘central holding company,’ theState-Owned Assets Supervision and Administration Com-mission (SASAC), which is the majority shareholder in a‘core company.’ at company, in turn, owns a majority ofshares in the state-owned companies that comprise the group,including a nance company that is a source of nance formembers.”2

Additionally, “the Chinese Communist Party (CCP) struc-ture exists parallel to the structure noted above. e Organi-zation Department of the Party is decisive in choosing topmanagers of the SOEs, and in turn some managers hold posi-tions in government and the CCP e authors emphasize thatmore than a chain of command from top to bottom is impliedby this structure: “ ese hierarchical structures are embeddedin dense networks –not only of other rms, but also of partyand government organs,” and exchange and collaborate onmany matters of production and policy implementation.”2

Milhaupt and Lin also observe several signicant issueswith China’s current model for the administration of SOEs.

One such issue is that “SOEs are exempt from anti-trustenforcement. Also, asthe Economist noted in a recent overview,the government ‘enforces rules selectively, to keep private-sec-

1.2 e Double-edged Sword of SOEs (in 2013)tor rivals in their place’ and foreign rms can be blocked fromacquiring local rms.”

Another is that “Corporate governance is very weak.Shareholders have no voice in corporate affairs and can notaccess the courts. Lack of transparency means that corporatemisgovernment is easy to hide.”3

Also at the Communist Party Congress, SASAC chief Wang Yong told reporters that “ e direction of the SOE(state-owned enterprise) reform should be: SOEs must bemore market-oriented and they must keep strengthening their vitality and inuence.”3

According to author and former AmCham China (Beijing)chairman James McGregor, the group of “117 huge centralSOEs,” of which many are monopolies, “have evolved overthe past decade so that the party controls these SOEs morethan the government does.”4

Mr. McGregor explains:

e Central Organization Department of the partyappoints the top leaders and they outrank the bureau-crats who are nominally supposed to be the SOEs’regulators. e party is also able to use the SOEs forpreserving political power as much as for building theeconomy. at’s the heart of [what McGregor terms]the Authoritarian Capitalist system in China today. 4

Mr. McGregor, who has been in China for 25 years and has witnessed the nation’s extensive changes since ‘opening up’,posits that some officials “saw the Russian oligarchs takingover state assets as private individuals—and the party decidedit would be the oligarchy. And so in 2003 they formed theSASAC [State-owned Assets Supervision and AdministrationCommission] to bring the state shares under central control.

en in 2006 there was a directive that took about two dozenkey industrial and technology sectors and made them fullystate controlled or majority state controlled. Finally, you havethe global nancial crisis and the 600-billion-dollar stimulusprogram. at money ushed into SOEs—and they were off and running.”4

Curiously, this has all happened as many observers—theauthors included—expected that the Chinese government would continue to open markets and cultivate a more dynam-ic and sustainable economy based on private enterprise. “[ eChinese economy] was headed toward a more free marketeconomy with more private companies. But the country hasstrongly reversed course to building up state-owned enterprisethat is increasingly incompatible with global trade regimes

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and threatening to multinationals.”4

e move is even more curious because, in the words ofMr. McGregor, “SOEs add zero growth—zero job growth,zero innovation. e private sector is what Deng [Xiaoping]used to pull this country out of a hole and they’re going tohave to use the private sector to move it to the next step.”Moreover, while it is unlikely that these SOEs will become“the new General Electrics in 10 or 20 years […] they can de-stroy a lot of companies and distort global markets and busi-ness practices along the way.”4

According to Reuters , “Chinese reformers and Westerngovernments say [SOEs’] sheer size and market dominancecreates a drag on the economy through vast opportunity forcorruption and waste, leading to higher costs for consum-ers,” and that critics of current SOE-related policy claim that“without further reform of the state sector, China’s growthwill stagnate. ey call for equal opportunity for private rms,which provide most of the new jobs in China.”3

e Chinese government’s oft-repeated call for indigenousinnovation and the development of key high-tech industries isexceedingly unlikely to be answered successfully by complacentSOEs and those entrepreneurs who are the nation’s best hopein achieving a substantive economy based on innovation “areunable to get nancing so they often live off loan sharks.”4 Banks in China offer SOEs preferential treatment, often at theexpense of private enterprises.

Overseas Expansion No Easy Task

In more global terms, Wall Street Journal commentatorStanley Lubman argues that, “ e need to better understandChina’s system goes beyond abstract arguments about the fu-ture of the global economy. e continuing expansion of thestate sector of China’s economy limits the private sector andfavors state-owned enterprises (SOEs) over foreign companiesin some domestic markets. As SOEs extend their investmentsabroad, nations in which China seeks to invest need to be-come more aware of frequent links between state ownershipand state control.”2

China’s increasing support for SOEs at the expense ofmarket-based competition in a variety of industries—“Chinagoing in a direction that the West didn’t think China was go-ing in”4 after joining the WTO in 2001—is likely to be asource of increasing friction between the P.R.C. and the restof the world.

At the above-mentioned 18th Communist Party Congress,“[SASAC leader Wang] and other state-rm bosses empha-sized their importance to what they called ‘national economicsecurity’ in their gathering, laying out plans for further invest-ment and overseas expansion.”3

Historically, Chinese companies that are given licenses to

invest abroad have been SOEs or otherwise related to the gov-ernment. But the government’s intimacy with companies—and not only SOEs—which are looking to invest in abroadhas been a source of considerable suspicion among foreignregulators in recent years. Several high-prole acquisitions offoreign companies by Chinese rms have been halted, blockedor aborted in recent years.

In September 2012, President Obama issued “an executiveorder prohibiting a Chinese company from owning and oper-ating a wind farm near the Naval Weapons Systems TrainingFacility in Boardman, Ore [which] is said to be home to aeet of unmanned drones and planes specializing in electronic warfare.” is was the rst time in 22 years that a presidenthad prevented a foreign acquisition of a US business.5

e Chinese company in question—machinery giantSany—“is controlled by China’s second-richest man, Liang Wengen, who has recently been appointed to the CentralCommittee of China’s Communist Party.”5

Around the same date, Chinese authorities were shocked, just shocked when the “U.S. House of Representatives’ Intel-ligence Committee warned […] that Beijing could use equip-ment made by Huawei, the world’s second-largest maker ofrouters and other telecom gear, as well as rival Chinese manu-facturer ZTE, the fth lar gest, for spying.”6

Although “neither Huawei nor ZTE is state-owned,” thereport “cited the presence of a Communist Party cell in thecompanies’ management structure as part of the reason forconcern” while “suspicions of Huawei are partly tied to itsfounder, Ren Zhengfei, a former People’s Liberation Armyofficer.”6

Reuters recalls that:

China suffered the biggest knock to its deal-makingcondence in 2005, when state-controlled oil rmCNOOC Ltd withdrew an $18.5 billion bid for U.S.oil rm Unocal after the Senate moved to block it onnational interest grounds.

[…]

In 2009, the state-owned China Non-Ferrous MetalMining (Group) Co dropped a $400 million bid for50.6 percent of Lynas Corp , owner of the world’srichest deposit of rare earth minerals, saying the con-ditions set by [Australia’s Foreign Investment ReviewBoard] were too stiff.

[…]

[Also in 2009, ] Treasurer Wayne Swan forced Chinesemetals group Minmetals to withdraw a $1.7 billion bid

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for OZ Minerals until it revised the deal to exclude amine situated in a restricted weapons testing area. 7

More generally, the U.S. report found that for the mostpart “[overseas] investment [is] spearheaded by Chinese state-owned enterprises that enjoyed government subsidies andother market-distorting policies that support industrial policyand non-market goals of the Chinese government.”3

As Mr. Lubman observes, “China’s ‘state capitalism’ willcontinue to number among those issues on which leaders inWashington are likely be ‘hard-edged,’ and rightly so. If anSOE appears as a possible investor, [the Committee on For-eign Investment in the United States] will most likely havedifficulty probing its relations to Chinese government agen-cies of concern. And the Chinese side will most likely notdisplay satisfactory transparency.”2

e U.S. Chamber of Commerce further notes that “Chi-na and other countries lavish regulatory favors and generoussubsidies on their state-owned rms, making it very difficultto compete,” and that “No adequate and effective internation-al disciplines now exist to deal with this problem.”8

In December 2012, Canadian authorities “approved Chi-na’s biggest ever foreign takeover [a $15.1 billion bid by state-controlled CNOOC Ltd for energy company Nexen Inc.] butdrew a line in the sand against future buys by state-ownedenterprises.”9

Prime Minister Steven Harper said: “To be blunt, Cana-dians have not spent years reducing the ownership of sectorsof the economy by our own governments, only to see thembought and controlled by foreign governments instead.”9

Reuters notes that “ e international community has de-manded greater transparency from China on a number offronts for years, wary of its intentions as the country grew tobecome the second-biggest economy in the world and sym-bolic of a shift in global power to emerging nations.”10

Moreover, “China’s state-secrets laws, massive bureaucracyand cronyism [which] make it difficult to get key, veriableinformation from Chinese companies.” even in cases wherethe largest security concern is nancial.10

More pragmatically, Mr. McGregor argues that fast-mov-ing and adaptable entrepreneurs, not SOEs, present the besthope for China’s future overseas investments: “[ e ‘goingout’ policy] can’t be led by SOEs: ey’re not China’s bestand brightest.”4

What Next

At this point it appears that the continuing relevance ofSOEs in China owes more to political inuence and vested in-terest than in their ability to successfully compete domesticallyor even internationally; while the Communist Party’s de-factocontrol over the enterprises themselves may insulate them

from signicant failures in their domestic market, that samecontrol will likely lead to increasing backlash against China’soverall mandate to ‘go out’ and invest abroad. In other words,the continuing prosperity of SOEs at home due to practicesthat, once again, “ [are] increasingly incompatible with globaltrade regimes and threatening to multinationals.”4

is is just one facet of the overall paradox of reform incontemporary China: despite a wide-ranging consensus withinand without China that substantive political reform is necessaryfor the long-term relevance of the Communist Party, the short-term consequences of that reform—both real and imagined—remain too unpalatable for much progress to be made.

In light of the overall situation, it would appear that no-body in a position of authority has yet been willing to riskhalting the ow of lucre that many vested interests in Beijingno doubt enjoy as a result of SOEs’ success-by-at, even if it would mean an overall healthier national economy and evenas an increasing number of economic measures indicate thatChina may be on the cusp of signicant economic hardship.

Strictly pragmatically, the most likely candidates for suc-cessful investment overseas are not the SOEs that authoritiesseem to want to prop up as industry champions, but rathersmaller—and more independent—enterprises which are morelikely to evade signicant concerns about propriety and trans-parency. In our opinion, these rms are also most likely tomake signicant positive contributions to overseas economiesand China’s own.

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Works Cited

1 Tom Orlik. “Charting China’s Economy: 10 Years Under Hu.”China Real Time . November 16, 2012. http://blogs.wsj.com/chinarealtime/2012/11/16/charting-chinas-economy-10-years-under-hu-jintao/. Accessed December 6, 2012.

2 Stanley Lubman. “China’s State Capitalism: the Real WorldImplications.” China Real Time . March 1, 2012. http://blogs.

wsj.com/chinarealtime/2012/03/01/chinas-state-capitalism-the-real-world-implications/. Accessed December 6, 2012.

3 Charlie Zhu and Lucy Hornby. “WRAPUP 1-Chinese staterms say reform should mean more growth.”Reuters . November9,2012.http://www.reuters.com/article/2012/11/09/china-congress-idUSL3E8M91LK20121109. Accessed December 11,2012.

4 Andrew Browne. “Eight Questions: James McGregor, ‘No Ancient Wisdom, No Followers’.” China Real Time . October1, 2012.http://blogs.wsj.com/chinarealtime/2012/10/01/eight-questions-james-mcgregor-no-ancient-wisdom-no-followers/

5 Christopher Helman. “Obama Blocks China’s Second-RichestMan From Owning Wind Farm Near Secret Navy Base.”Forbes . September 29, 2012. http://www.forbes.com/sites/christopherhelman/2012/09/29/obama-blocks-chinas-second-richest-man-from-owning-wind-farm-near-secret-navy-base/.


6 Lucy Hornby. “China derides U.S. “Cold War mentality”towards telecoms rm Huawei.” Reuters . November 10, 2012.http://www.reuters.com/article/2012/11/10/us-china-huawei-idUSBRE8A905520121110. Accessed December 11, 2012.

7 Zhou Xin and Tom Miles. “UPDATE 1-China to vet inwardM&A deals for national security.” Reuters . February 12,2011. http://www.reuters.com/article/2011/02/12/china-ma-idUSTOE71B00L20110212. Accessed December 11, 2012.


9 Michael Erman and David Ljunggren. “Canada OK’s foreignenergy takeovers, but slams door on any more.”Reuters . December8, 2012. http://www.reuters.com/article/2012/12/08/us-cnooc-nexen-idUSBRE8B619M20121208. Accessed December 11,2012.

10 Rachel Armstrong and Michael Flaherty. “CNOOC pledge smallstep for China transparency, skeptics abound.”Reuters . December10,2012.http://www.reuters.com/article/2012/12/10/us-investment-china-idUSBRE8B80FJ20121210.AccessedDecember 11, 2012.


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Recent developments

IN THE YEAR from November 2011, Foreign DirectInvestment (FDI) into China dropped 11 out of 12months, with only minimal growth in May 2012 bucking thetrend.1

e Chinese government “has blamed the slump on theslowdown in global economic growth, the prolonged Europeandebt crisis and rising costs and weak demand at home.”1

e South China Morning Post’ s Victoria Ruan reported inNovember 2012 that “For the rst 10 months [of 2012] FDIis down 3.45 percent at US$91.7 billion [while] outwardinvestment by non-nancial Chinese rms rose 25.8 per centin the 10 months to US$58.2 billion.”2

“ e steady decline in foreign investment,” she observes,“Highlights the challenges facing Beijing’s new leaders as theycope with a global economic downturn while rebalancing thedomestic growth model as rising labor costs begin to hurt thecountry’s manufacturing competitiveness.”2

A more detailed breakdown of FDI shows t hat “Servicessector inows in the rst 10 months of the year were $43.7billion, down 1.8 percent on a year ago,” while “Manufactur-ing sector inows meanwhile stood at $40.4 billion betweenJanuary and October, down 7.3 percent versus the same pe-riod in 2011.”3

Curiously, the year-on-year decline in “newly approvedforeign-invested enterprises” was signicantly higher, at 10.49percent, than the drop in overall investment volume.4

is suggests that FDI in 2012 has been more concentrat-ed in large projects, and that fewer Small and Medium-sizedEnterprises (SMEs) are seeing value in entering—or expand-ing within—the Chinese economy.

Contemporary to the Ministry of Commerce’s relativelygloomy FDI gures, the State Administration of Foreign Ex-change announced that “it would cancel the complex reviewprocedures related to capital ows and currency exchangequotas of foreign enterprises,” a move which Standard Char-tered economist Li Wei suggested “will encourage more for-eign direct investment.”5

Still, Li cautioned, “it’s yet to be seen whether t he weaken-ing FDI trend will reverse in the short term because it hingesmore on the domestic and overseas economic situat ion.”6

e Good

Despite increasing wages—and thus ever-shrinkingcompetitiveness for low-end manufacturing—large amounts

1.3 e Foreign Investment Environment in China

of money continue to be invested in China.Reuters observes that “What keeps the money coming to

China is a steady shift away from cheap assembly lines to high value-added production and from volatile external demand tothe spending power of a new mainstream consumer class thatanalysts at McKinsey reckon will rise 10-fold between 2010and 2020.”6

Accordingly, “Vietnam, Bangladesh, Indonesia and ailandcombined managed to snag only $141.6 billion in FDI betweenthem from 2007 to 2011, despite being repeatedly touted as theplaces to which manufacturers eeing China ock.”6

e continuing evolution of FDI in China has led thenation to capture “$625 billion [since 2007], based on datafrom United Nations agency, UNCTAD.”6

AmCham Sout h China members have been at the fore-front of this transition from labor-intensive manufacturing tohigher value-added services.

In addition to focusing mainly on the manufacture of elec-trical equipment, appliances and other higher-tech products,in 2013 fully 80.7 percent of State of Business study partici-pants indicated that their primary business focus was the pro-duction of goods or services for the Mainland China market,rather than for export.

Furthermore, study participants report that “Investmentin new China facilities” is among their top business priorities,in addition to reporting a more than 40 percent increase in3-year investment budgets over last year’s results. Both thesepoints suggest that companies are beginning to resume ex-pansion plans that had been put on hold following the globalnancial crisis.

e Bad

Bloomberg reports that “Companies are less optimisticabout their business prospects in China than they were threeyears ago. China’s recent economic slowdown is one reasonfor that, but so is a rising concern about favoritism given toChinese companies in the market.”7

Similarly, “Many companies say that they can only expandso far into certain sensitive industries, such as oil and informa-tion technology, before hitting a ceiling in which the govern-ment makes it difficult to expand.7

A Foreign Policy opinion piece observes that, “Althoughthere are individual exceptions, U.S. companies’ share of theChinese market has been shrinking. Industrial output by for-eign-invested rms in China as a share of the national total

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peaked around 36 percent in 2003 and has declined ever sinceto about 27 percent in 2010, the most recent year for whichdata is available.”8

is decline can be attributed to several causes. For one,a November 2012 report by the Economist Intelligence Unitfound that, “ half the executives surveyed in big companies[out of the total 328] were concerned or very concerned theywould be forced to give up their intellectual property in ex-change for market access.”8

Similarly, ‘technology transfer’ can also happen throughless official channels: “Technology rm American Supercon-ductor claimed 70 percent of its business disappeared in 2011after a Chinese partner convinced one of its employees to stealsome of its technology.”8

According to one CEO who asked to remain anonymous,“ e government can close us down suddenly, or it can helpnative Chinese rms to steal our technology and graduallyreplace us in the market.”8

Another hazard for foreign investors is the fact that Chinacan “de facto nationalize assets by exercising such strict con-trol over taxes, regulations, and costs t hat it effectively controlsand drains foreign rms’ prots,” as was the case with “Nearly40 foreign electricity producers [that] rushed into China inthe 1990s [of which nearly all] have since exited, often sellingtheir plants to the Chinese after being unable to make moneyas rising coal prices outstripped electricity-rate increases set bythe state and as Chinese rms beneted from access to statecredit and subsidized coal.”8

A 2012 survey conducted by AmCham South China’scounterpart in Beijing found that “61 percent of companiessurveyed report operating margins that are comparable to, orless than, their worldwide margins,” withForeign Policyadd-ing that, “Many CFOs would disqualify investments thathave only a 39 percent chance of exceeding average prots, ina country much riskier than their home market.”8

None of these issues should be particularly surprising atthis point in time, as foreign companies in aggregate have ac-cumulated extensive experience operating in the China marketfor 30-plus years. What is surprising, however, is the fact thatthese concerns are essentially the same ones that have coloredforeign business dealings with China since the ‘opening up’.

For many observers, there seemed to be an implicit promisethat when China joined the WTO—and as it became moreprosperous—it would also adhere more closely to internation-al norms in terms of transparency, corruption and rule of law.

In retrospect, this was perhaps naïve.“ e country took a huge leap in the 1990s as it prepared

for WTO entry, slashing red tape, removing layers of protec-tion for domestic factories and farms and opening its markets.

at work is widely credited inside and outside China withturning the country into the industrial dynamo of today.”9

But the work was never nished. Some U.S. experts, sayReuters , hold that “China turned away from market liberaliza-tion as early as 2003”9

“Nobody who was watching China enter the WTO backthen saw this change coming,” said Heritage Foundation ana-lyst Derek Scissors. “It was as if a different government withdifferent priorities came in.”9

General Electric CEO Jeffrey Immelt says, “ e notion was, if we’re part of the Chinese economy, we should be al-lowed to win.”9

Just over ten years later, a new pragmatism seems to beoffsetting bright-eyed enthusiasm about the potential for far-reaching success in China. “Some chief executives are question-ing whether the United States is pressing China hard enough tohold up its side of the bargain in join ing the elite trade club.”9

“Until recently,” Reuters continues, “American businessleaders had been loath to speak of China’s practices for fearit would lose them lucrative contracts or result in regulatoryscrutiny that harms their China operations. Several have gonepublic in the past few months.”9

“Indeed, China has been known to punish companies thatpublicly complain about doing business there,” explainsFor-eign Policy .8

ese issues have not escaped foreign governments’ attention.“In Europe, EU Trade Commissioner Karel De Gucht even

oated the idea of speaking out against abuses on companies’behalf—and taking the heat—sparing companies from retali-ation triggered by the ling of official complaints.”8

At the macro level, “Washington is growing concernedthat China has lost its commitment to freer trade and thatas new leaders prepare to take over next year, China is aban-doning its march toward market capitalism in favor of statemercantilism.”9

Foreign Policy summarizes growing pessimism about for-eign companies’ future success in China: “U.S. companies arebanking their future success on tapping into the enormousChinese market. ey’re in for a nasty surprise.”8

Simultaneously, China is becoming increasingly aggres-sive in its overseas ambitions. is, combined with foreigncompanies’ growing dissatisfaction with their opportunities inChina’s domestic economy, is beginning to have a signicantqualitative—if not yet quantitative—effect: “the worsening ofChinese image around the world.”10

Academic and commentator Minxin Pei writes: “Ascountries around the world, for their own reasons, raise their vigilance against Chinese inuence and start to push back,Beijing no longer enjoys a free hand in expanding its economicfoothold and securing access to markets and resources.”11

How this sort of resistance will change foreign-investedenterprises’ experiences on the Mainland—if at all—is yet tobe seen.

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Works Cited

1 “Foreign direct investment in China declines.” Taipei Times .November 21, 2012. http://www.taipeitimes.com/News/biz/archives/2012/11/21/2003548206. Accessed December 12,2012.

2 Victoria Ruan. “Foreign direct investment in China dropsfurther.” e South China Morning Post . November 21, 2012.http://www.scmp.com/business/money/markets-investing/article/1086948/foreign-direct-investment-china-drops-further.


3 Aileen Wang and Nick Edwards . “China 2012 FDI inows slow,stay on track for $100 billion.” Reuters . November 20, 2012.http://www.reuters.com/article/2012/11/20/us-china-economy-fdi-idUSBRE8AJ06C20121120. Accessed December 12, 2012.

4 “Statistics of FDI in January-October 2012.” e Ministry ofCommerce of the People’s Republic of China. November 23,2012. http://english.mofcom.gov.cn/aarticle/statistic/foreignin

vestment/201211/20121108461051.html. Accessed December12, 2012.

5 Victoria Ruan. “China eases rules on foreign investment.” eSouth China Morning Post . November 22, 2012. http://www.scmp.com/business/economy/article/1087879/china-eases-rules-foreign-investment. Accessed December 12, 2012.

6 Kevin Yao. “Analysis: Investors make $100 billion bet on China’sdrive up value chain.”Reuters . November 20, 2012. http://www.reuters.com/article/2012/11/20/us-china-economy-investment-idUSBRE8AJ1FH20121120. Accessed December 12, 2012.

7 Elizabeth Dwoskin. “It’s Not Currency at’s Sapping U.S.Condence in China.” Bloomberg Businessweek . October 10,2012. http://www.businessweek.com/articles/2012-10-10/its-not-currency-thats-sapping-u-dot-s-dot-confidence-in-china.


8 Richard D’Aveni. “ e China Bubble.” Foreign Policy . August30, 2012. http://www.foreignpolicy.com/articles/2012/08/30/the_china_bubble. Accessed December 12, 2012.


10 Minxin Pei. “Sorry World: What Happens in Beijing WON’TStay in Beijing.” e Diplomat . October 22, 2012. http://thediplomat.com/2012/10/22/sorry-world-what-happens-in-beijing-wont-stay-in-beijing/?all=true. Accessed December 12,2012.

11 Minxin Pei. “Superpower Denied? Why China’s ‘Rise’ MayHave Already Peaked.” e Diplomat . August 9, 2012. http://thediplomat.com/2012/08/09/superpower-denied-why-chinas-rise-may-have-already-peaked/?all=true. Accessed December 12,2012.

e previous highly relevant sections of our 2013 White Paper havebeen incorporated into this latest 2015 version to provide a solid basis forcomparison of the late 2012 situation in China with the present.

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1.4 Redening Reform (in 2015)

ECONOMIC REFORM IN China had begun slowly inthe 1980s but radical reforms only took place after DengXiaoping’s southern tour in early 1992. According to a 2007report by the China Policy Institute, it was “heavily debatedwhether China should adopt a market economy approach,until 1992 when the 14th National Congress of the ChineseCommunist Party (CCP) clearly stated that China’s economicreform intention was to establish a socialist market economy.

e clarication of “market economy” status provided thenecessary conditions for China to begin large-scale economicdecentralisation.”20

In the decade succeeding Deng Xiaoping’s rule, ChinesePresident Jiang Zemin and his Premier Zhu Rongji oversaw thehandover of Hong Kong in 1997 and led their country until2002, by which time it had propelled millions out of povertyand become one of the world’s most powerful economies.

ey guided China into the World Trade Organization and“ presided over a series of wrenching reforms that saw muchof the state-sector dismantled and the welcoming into the[Chinese Communist] Party of “advanced productive forces,”i.e. businessmen.”18

Zhu Rongji was appointed Vice Premier in charge ofChina’s economic reform in 1991. As Deng’s economic czar,Mr. Zhu drew many admirers as he tamed ination withoutsnuffling out growth by devaluing the yuan in 1994 by 33percent. He also laid the foundation for a banking system andwas even considered as a possible recipient of the Nobel Prizefor economics.20In the mid-1990s, Zhu Rongji formulateda new strategy for SOE reform, which was called “graspingthe big and letting go the small” (zhua da fang xiao). It wasofficially established as China’s new economic reform strategyat the Fifteenth National Congress of the CCP in 1997, whenZhu Rongji became the Premier-elect. is strategy gave theSOE reform a clear direction, especially in the case of largeSOEs. After Mr. Zhu became the Premier in 1998, thisstrategy was implemented to its fullest extent.20 “Grasping thebig” meant making efforts to cultivate strong and competitivelarge enterprises and enterprise groups and develop theminto cross-regional, cross-sectional, multi-ownership andmultinational rms. “Letting go the small” implied that thegovernment allow the small and medium-sized SOEs to facemarket forces. e ultimate goal of this strategy was that thegovernment would be able to privatize most of the SMEs andwould only control a limited number of large central and localSOEs. 20

Mr. Zhu is regarded as the architect of the economic poli-cies that ushered in China’s second wave of growth. He broke

down trade barriers, cut runaway ination, rescued Chinafrom the Asian economic crisis in 1997, sold off state enter-prises, broke up monopolies, ended state planning, introducedcompetition and deregulation, streamlined the bureaucracyand secured China’s membership to the World Trade Organi-zation. Mr. Zhu’s tough-minded policies included driving themilitary out of many of its commercial enterprises, reducingthe number of easy loans and credits to money-losing state-owned enterprises, introducing a value added tax and divert-ing tax revenues to the central government. To create jobs, helaunched Keynesian public works programs.

In 1997, the Chinese government set a three-year phasedgoal for the SOEs to turn around their loss-making condi-tion. In September 1999, during the Fourth Plenary Sessionof the Fifteenth Congress, the government adopted the policyof diversifying SOEs’ share ownership to establish a moderncorporate system.20

In a 2009 special report published by FIRST Magazine tocommemorate the 60th anniversary of the founding of thePeople’s Republic of China, James McGregor, China expertand former journalist for the Wall Street Journal , paints acolorful description of China during the early Jiang years,“China is simultaneously experiencing the raw capitalismof the robber baron era of the late 1800s; the speculativenancial mania of the 1920s; the rural-to-urban migrationsof the 1930s; the emergence of the rst-car, rst-home, rstfashionable-clothes, rst college-education, rst-family- vacation, middle class consumer boom of the 1950s; and evenaspects of the social upheaval similar to the 1960s.”23

At the Sixteenth National Congress of the CCP in 2002, when Hu Jintao and Wen Jiabao came to power, the direc-tion of SOE reform was further readjusted. e governmentcontinued to make efforts to restructure the state-ownedeconomy and reform the state assets management system. Inthe rst half of 2003, the Stateowned Assets Supervision and Administration Council (SASAC) of the State Council wasestablished “to guide the reform and restructuring” of stateassets.20 However, most pundits observe that China duringthe decade of rule under Hu Jintao and Wen Jiabao, whilemarked by breakneck economic growth and seeming to re-main stable despite an overseas nancial crisis in 2007-2008, was generally characterised by a lack of action on reform.

Much of the credit for that economic boom must goto Mr. Hu’s predecessor Jiang Zemin and his Premier ZhuRongji, who had spearheaded far-reaching reforms that laidthe foundations of the decade’s growth. Under Mr. Hu’sadministration, some of those gains have been reversed, as

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the government again lent support to its state champions.According to the Wall Street Journal , the number of state-owned enterprises as a share of the total continued to fall,dropping to 5% in 2011. But with SOEs still dominant, theirshare of total output remained relatively high at 26%.21

A lending splurge in 2009-10 as China responded to theglobal nancial crisis also hurt its future growth prospects.

e ratio of outstanding credit to GDP increased fromaround 116% in 2002 to 172% in 2011, according to ChinaReal Time [Wall Street Journal] estimates.21

Critics of [Mr. Hu and Mr. Wen] argue that reforms stalledon their watch, as they focused, “above all, on keeping Chinastable.” “Hu Jintao and Wen Jiabao’s generation could haveachieved a lot, but they did not,” said Yao Bo, a formerChinaDaily columnist. “ ey inherited good foundations, but theydid not make a difference,” he added.22

On November 2012, President Xi Jinping assumedleadership of China as a strong advocate for a new wave ofeconomic reforms. He inherited an economy that was alreadyshowing a sharp deceleration, likely to sink to 6.8 percent in2015 and 6.5 percent in 2016, according to a recent forecastoutlined in Newsweek magazine by Wang Tao, the chief Chinaeconomist at UBS.2

After years of double-digit annual growth, this type ofslowdown – “growth that falls too far below 7 percent” couldbe “dangerous” for China’s ruling Communist Party, statesthe same Newsweek report, visualizing that “the prospect ofyoung college graduates not being able to nd jobs, or of poorfarmers migrating to new urban areas only to be unable tond work, or of large rms going bankrupt, triggering layoffs,worries China’s leadership.”2

Mindful of this, China’s leadership had earlier alreadybegun an active discussion on the process of promoting andimplementing economic reform but the discussion was notaccompanied by any actual meaningful implementation. Asobserved by theUS-China Business Council Economic ReportScorecard , the discussion process really “advanced in late2011, more than a year before China’s 2012-2013 leadershiptransition”, just a year before the ascension of Xi Jinping asChina’s president and head of the Chinese Communist Party(CCP) and Li Keqiang as premier and head of the powerfulState Council. e US-China Business Council noted thatMr. “Xi came to power as a strong proponent of economicreform, fueling speculation about its scope, scale, and speed.”1

In 2013, the US-China Business Council continued to ob-serve, China’s government agencies began issuing “official reg-ulations, statements, and editorials supporting reform goalsand hinting at the evolving internal discussions about reformimplementation. ese releases covered an array of reform is-sues, including nancial liberalization, the role of state-ownedenterprises (SOEs) in the economy, administrative licensing,

and tax reform.”1

Also in 2013, two major developments of signicanceoccurred – widely perceived as the response of President Xi Jinping and his new generation of advisers and leaders tomitigate the risks of a m ajor economic slowdown:

In September 2013, the Shanghai government announcedthe launch of the China (Shanghai) Pilot Free Trade Zone(SFTZ), a pilot area for broader economic reforms in areassuch as investment approvals, trade facilitation, nancialinnovation, risk management, and administrative licensing.1

In November 2013, President Xi Jinping and hisgovernment laid out, at the Communist Party’s ird Plenumof the CCP’s 18th Party Congress, a road map for thereform necessary to replace the current economic model andreinvigorate China’s growth. Known as the “Decisions ,” thereport at its core called for market forces to assume “a decisiverole in allocating resources.”2 e ird Plenum served asa platform for the broader reform agenda, through bothhigh-level statements and a set of post-plenum documentsthat provided more detail on the direction of reform. esedocuments included key indicators of priorities, includingsetting a “decisive” role for the market in the economy,reforming China’s tax and nance regime, and improvingforeign investment1

Daniel Rosen, a principal at the Rhodium Group, a New York consultancy, and author of a November 2014 reportpublished by the Asia Society on the prospects for economicreform in China, argues that “China’s development model isobsolete and in need of urgent, not gradual, replacement.”2

In Mr. Rosen’s report, he notes that “to justify the risks [ofreform], President Xi quoted an impassioned plea for policymodernization by his predecessor Deng Xiaoping: the only way to avoid a dead end – a blind alley – is to deepen reformand opening both at home and with t he world.”15

In the same report, Mr. Rosen outlines the intriguingconundrum faced by China in the next several years, specu-lating that “if Beijing shifts direction along the lines it hasannounced, the behavior of Chinese companies, governmentagencies, and individual members of society is likely t o changein remarkable ways – and thereby create opportunities for therest of the world. Should the reform program stall, the ef-fects will be just as profound. Either way, China’s new policydesign, and its success or failure in achieving it, will have amajor inuence on the international economy and stabilityand security in Asia and beyond.”15

e core document issued in November 2013 during theCommunist Party’s ird Plenum of the CCP’s 18th PartyCongress, known asDecision of the Central Committee of theCommunist Party of China on Some Major Issues ConcerningComprehensively Deepening Reform, or simply the Decisions , was accompanied by personal Explanatory Notes under

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state of business in s china (amcham white paper 2015)

Documents