Foreign businesses in China and their governments are becoming increasingly vocal about a “deteriorating business environment” there and attribute this mainly to Chinese protectionism. Although protectionism exists, it’s nothing new and dates back to 2002. Today, however, other factors are at work.

Misinformation and the Media

The evolving global economic and political situation, and in particular, tensions between China and the United States, have pushed claims of Chinese protectionism onto the front pages of newspapers. This general assertion, however, does not reflect today’s complexities.

Over the last 20 years the international media has sometimes failed to provide a balanced view of how China is changing, often erring on the positive side and exaggerating opportunities. Today, the media appears to be emphasizing negative aspects and inflating threats and problems.

While the role of foreign investment in China has changed dramatically over the last 10 years, we believe the current business environment remains good. Nevertheless, in some cases protectionism has become an obstacle. This has made corporate competitiveness—which requires a high degree of adaptation—even more important to achieving success in China.

The Will Behind the Way

The strongest hindrance to foreign participation in China’s economy primarily is due to the power wielded by Chinese companies, particularly state owned enterprises and their government backers. These interests seek industry consolidation and limits on competition. They also are less willing to adopt good corporate governance practices, including transparency and accountability.

Domestic politics also play a role. China’s emergence as a global economic power has infused the country at all levels of society with a strong sense of confidence. In turn, economic nationalism has become more prevalent and has received government buy-in. And with a leadership shakeup in 2012-13, the government is less risk averse and more likely to support domestic interests.

Lastly, many of China’s political, business and intellectual elite view economic rivalry as a proxy for security rivalry. This is reinforced by the Chinese perception that foreign companies are unwilling to transfer their most advanced technology to China, and instead seek to promote their own country’s interests.

Google’s approach to negotiating with the Chinese government was seen by many Chinese as disdainful and reflective of Google’s allegiance to the United States. This position was displayed in a China Daily, March 25, 2010, article that said “Anyone who thought China was going to cave in to the demands of an American search engine company has been reading The Wall Street Journal too long. The idea that a foreign company could dictate its will to a sovereign country died 150 years ago with the British East India Company.”

Today, an increasingly powerful and wealthy China is more actively seeking to develop its own financially and technologically strong “national champions.” Not only are these national champions expected to enhance China’s global competitiveness, but they also are expected to remain more loyal to the domestic economy in times of crisis than to their multinational counterparts. This perception was reinforced during the global financial crisis when Bank of America quickly sold a large part of its ‘strategic stake’ in Construction Bank of China while other foreign investors repatriated profits.

The Counterbalance Is External

The main counterforce to the reemergence of economic nationalism is external: China’s desire for respected global status. The international community expects China, as a major economic power and a huge beneficiary of the global trade and investment system, to become an increasingly responsible global player and has challenged Beijing’s perceived shift toward greater protectionism.

Nevertheless, the forces against Chinese protectionism have been fighting a losing battle during the last decade as China has completely altered its approach to foreign investment. That does not imply there is no place for foreign investment in China or that foreign companies can no longer do well there. It simply means foreign companies need to learn to adapt to be able to create win-win opportunities.

China Is Setting Its Own Agenda

At this stage of its economic development, Beijing will continue to focus primarily on doing what it believes is right for China. This includes developing its own technologies, creating national champions and, like it or not, protecting certain strategic sectors in order to encourage their development.

The current paradigms of world development, fostered by Europe and the United States following World War II, accompanied America’s rise as a superpower. Those economic and political values are being challenged by a newly confident China that intends to define its own place in the 21st century world as the U.S. did during the 1950s. The challenge: China must do it with a population already four times the size of the United States’ and it’s starting from a much lower economic base. This to some extent underscores why China is determined to develop its own innovative capabilities.

China knows it can no longer rely on older generations of technology given to it or transferred through investment from the United States or Europe. It believes it needs to develop its own technologies and will do so either through indigenous innovation or technology acquisitions. In addition, China is seeking to surpass developed countries in some new technologies, such as electric vehicles, and is acquiring other technologies through corporate acquisitions, then registering their patents and copyrights in China first.

These objectives will take time, and achieving them will require considerable involvement of foreign companies. However, we believe these trends are inevitable and no amount of diplomatic pressure will change them.

The Real Business Environment

Not only is the Chinese economy booming, it’s very profitable and a key contributor to global growth for many foreign firms, according to surveys conducted by the European Chamber and the U.S.-China Business Council. And as domestic consumption takes off, we can expect enormous market growth over the next 10-15 years. One notable example is General Motors, which relied on Chinese growth and profits of more than half a billion dollars in 2009 to help offset its problems in other parts of the world.

In terms of change, China also has developed a more rules-based economy with more transparent laws and regulations, vanquishing many of the grey areas that were the norm 10 years ago. And although enforcement is still weak for various reasons, the playing field is fairer for Chinese and foreign companies alike.

The situation may not be as transparent as in the West, but it continues to improve. As a result, foreign investment continues to grow. Thus, FDI in China—which remains one of the largest FDI recipients in the world—reached $90 billion in 2009 and will likely equal or surpass that level this year.

Nonetheless, in some sectors protectionism has increased and has become a major obstacle. In general, however, what matters more is the competitiveness of companies and their level of adaptation to China. This is true even in so-called protected sectors.

Reality I: Limited access in some sectors by foreign investors will have to be accepted.

Growing government influence varies greatly across different sectors, but is particularly obvious in strategically important and centrally regulated sectors such as financial services, telecommunications, railways and air transport. China has largely met its WTO accession commitments by partially opening those sectors to foreign investors. But it’s not further opening these sectors.

Many companies, especially banks, mistakenly anticipate a further opening of their sectors. This is unlikely to occur within the next 10 years and perhaps longer unless political pressure is applied. As a result, companies in these industries should adopt a realistic attitude about what they can and cannot anticipate in the medium and long term.

Reality II: Business remains solid in many “protected sectors” where competitive foreign companies are flourishing.

Many industries offer a mixed bag of opportunities and restrictions. On one hand there are protectionist pressures; on the other—for a wide variety of reasons such as sector fragmentation, a lack of local champions, technological limitations and regional differences—there are substantial opportunities for foreign firms. But companies must understand the dynamics of their sectors and be willing to adapt.

Wind energy equipment provides a good example. While protectionism at the central government level is strong, many multinationals have taken the right actions at the local government level through lobbying. Newly installed wind turbine capacity produced by foreign companies increased from 75 percent of 200MW in 2004 to 25 percent of 6,300 MW in 2008. Of course, the market share of multinationals in the Chinese wind market decreased substantially, but their market scale increased nine times in four years.

Many western companies are doing very well in so-called protected sectors and remain very important. These sectors include wind power, railway (rolling stock), aircraft, cars and vehicles, machinery, petrochemical, steel, and cement production.

Successful companies often have long histories in China and a thorough understanding of the market. They also have an experienced China team, as well as a strategy that accurately fits the development of its sector, plus a competitive product offering. Nokia is an outstanding example.

Reality III: Failure to grow with the market is often about competitiveness, not protectionism.

The key challenge facing many companies in China is not whether they are doing well (in most cases they are), but rather, whether they are doing well enough to keep growing with the market. Interestingly, many foreign companies discover that their typical 5-10 percent annual growth rates are well below market averages and trajectories of their Chinese competitors.

As Chinese markets boom, they become more complex. And as lower tier cities come into play, localized solutions will become more important.

The food sector provides a good example where many western companies have problems maintaining high growth rates and struggle against local competition in rural areas and lower tier cities. Taiwanese companies operating in this sector, such as Want Want and President, are very successful due to their high levels of competitiveness.

But being competitive in China requires a set of capabilities quite different than those needed in developed markets. And it is essential to have a strong local team with real decision-making power and freedom to utilize a framework different than that employed in other markets (e.g., one which allows faster decision making, faster product development and/or different investment decision processes, etc., and a sophisticated government relations approach that addresses concerns of all stakeholders).

Anticipate More Complexity

The main challenge for foreign companies doing business in China is not protectionism, but the whole set of issues affecting their level of competitiveness. As the Chinese market booms, it is becoming more complex and sophisticated while competitors—mainly Chinese and Taiwanese—quickly adapt. These competitors are flexible, fast, have experienced local teams, understand the customer at all levels and all segments, control costs, and know how to work with the government at different levels.

Rather than focusing on market protection, foreign companies should concentrate their attention and energies on the arduous task of improving their competitiveness in an increasingly challenging market.

This article appeared in Impact Analysis, May-June 2010.

Jan Borgonjon and David Hofmann
About The Author Jan Borgonjon and David Hofmann
Jan Borgonjon, a Belgian National, was one of the founding partners of InterChina Consulting in 1994 and is now president of the company. He has resided in China for 20 years. David J. Hofmann, an American national, is head of InterChina’s office in Washington D.C.

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