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UPDATED: December 20, 2006 NO.40 OCT.5, 2006
A Foreign China
Having grown up on FDI, China now is weighing down its ability to cut loose and cultivate domestic enterprise

This is not your father's China. Compared to state-monopolized industries of yesteryear, China has come a long way in attracting foreign investors. But in doing so, it appears to have given away control of major industries.

In every one of China's industries open to other countries, the top five enterprises are actually controlled by foreign investors, according to new survey results. And among China's 28 major industries, 21 have most of their assets controlled by foreign investors. The survey results, revealed by the Development Research Center of the State Council, shocked Dr. Shi Weigan from the Institute of World Economics and Politics, Chinese Academy of Social Sciences (CASS).

"It's time for the country to readjust foreign capital inflow in China", said Shi, in an essay.

Beyond Shi, quite a number of economists feel anxious and uneasy about the increasing share of foreign capital in China's economic activities. They are afraid that dominant positions of foreign companies will do harm to China's economic security.

In fact, the Chinese Government is working on just such a readjustment.

In July, measures limiting foreign investment in industries like real estate and steel and its acquisition of Chinese enterprises were issued. For example, foreigners are only allowed to buy one apartment in China. Foreign currency in foreign institutions' special accounts is banned from investment in Chinese real estate. And foreign investors are required to apply for approval with the Ministry of Commerce if their acquisition will or is likely to impose a negative impact on China's economic security.

The Provisions for Foreign Investors to Merge and Acquire Domestic Enterprises that came into effect in September also put forward clear regulations—including limitations on foreign investors' takeover of Chinese enterprises.

But are such measures enough? Can domestic companies come into their own, rising to the top of industry? And what practical solutions are there to make this happen?

Too controlling

As early as December 2005, the China Economic Monitoring Center of the National Bureau of Statistics reported that the five top elevator companies, whose manufacturing accounts for more than 80 percent of the country's total elevator production, have had their shares controlled by foreign investors.

Further, among the country's 18 national-level electrical appliance makers, 11 are now operating in the form of Sino-foreign joint ventures; China's cosmetic industry is under the control of 150 foreign-funded companies; 20 percent of the country's pharmaceutical industry is at the hand of foreign investors; and 90 percent of the sales of the auto industry can be attributed to foreign brands.

The list goes on ad nauseam.

This situation will likely not change for the time being as foreign investment plays an important role in China's economy.

"On one hand, the influx of foreign investors will stimulate market competition in China and promote the improvement of corporate management and technical level of Chinese enterprises, leading to the effect of technical overflow," said Wei Houkai, a researcher from Institute of Industrial Economics, CASS. "On the other hand, enjoying such advantageous intangible assets as technology and management skills, foreign investors are evolving into manipulating forces in the Chinese market."

According to statistics issued by the United Nations Conference on Trade and Development, in 2005, China attracted $60 billion of direct foreign investment (FDI), ranking third in the world, next only to the United Kingdom ($219 billion) and the United States ($106 billion).

Favorable policies aiming to attract foreign investment began to appear in the early 1980s during the early stages of China's market reforms. Today, the average tax rate for Chinese companies ranges from 22 percent to 24 percent, while that for foreign companies is only between 10 percent and 13 percent.

By July 2006, China had accumulatively absorbed FDI of $655.1 billion, which greatly contributed to the growth of the Chinese economy.

"However, when a large part of major Chinese industries' share holding is in the hands of foreign companies and when quantitative changes are likely to result in qualitative changes, there is the potential to see serious conflicts and problems in the coming days," said Wei.

First of all, the competitiveness of the Chinese economy will decline, Wei continued.

By now, Coca-Cola has grabbed over 70 percent of China's soft drink market and in large and medium-sized cities, foreign chain supermarkets have snatched 80 percent of the market share.

If such a trend continues, the whole Chinese market is likely to be gradually taken up by foreign investors, Wei said.

Second, problems are looming in the country's industrial security, he added.

Consider this: Import and export volume accounts for 60 percent of China's GDP, FDI amounts to 10 percent of the GDP and 40 percent of its basic energy depends on imports; while the country only has 4 percent of independent intellectual property rights.

As foreign capital has controlled a high rate of core industries, China, a developing economic power, is doomed to face severe problems in industrial security, according to Wei.

Nevertheless, he said, China should keep absorbing foreign capital, which is an important part of China's reform and opening-up policy. Instead of blocking foreign capital inflow, China should try to guide or restrict the investment scale in certain areas through policies, he said.

As Liu Changquan, a researcher from CASS, has pointed out, so far, all over the world, no country risks exposing all its economic areas to foreign capital. In some important industries, obstacles and legal restrictions are imposed on foreign capital. In spite of differences in specific details, all countries share some practices in common: First, unfair competition laws and anti-monopoly laws are used to prevent the foreign investment inflow.

"If China fails to adjust its policies on foreign investors in a timely manner and does not exert necessary restrictions over foreign investors' merger and acquisition of Chinese industries, disastrous results are expected to come," said Liu.

Liu suggested that foreign investment be absorbed in a selective way and attention should be paid to two important aspects.

First, China should raise the threshold for foreign investment to allow those with the most advanced technology in the market and keep those with lower technological abilities at bay.

Second, China should try to absorb foreign investors in the fields of research and development, design, branding and key machinery parts.

The monopoly misinterpretation

Dominating, perhaps, but foreign investment isn't monopolizing any industry, according to China's Ministry of Commerce.

True, foreign investors have grabbed a large share of the market in some sectors, but this does not mean monopoly, said Wang Zhile, Director of Research Center on Multinational Corporations of the Chinese Academy of International Trade and Economic Cooperation under the Ministry of Commerce. Foreign companies involved in the same sector also compete against each other, so it's unwise to treat all the foreign investors as an entity that is trying to wrestle market share from the Chinese companies, he said.

Besides, he said, a large market share is only one of the conditions for monopoly. Monopoly occurs when a competitive entity tries to hinder others from becoming its rivals by making use of its dominant role in the market. So to judge whether a company is practicing monopoly, it must be determined whether this company is restricting free competition through its predominance in the market, he said.

"Our survey shows that foreign investors possess an absolutely high proportion of market share in certain sectors, but monopoly is not what's happening yet," Wang said.

Wu Yi, Vice Premier of China's State Council, indicated in early September that although among the world's developing countries, China is the biggest receiver of FDI over the past 15 years, the proportion of per-capita FDI remains low, and in this sense, China's foreign investment absorption is below the world's average level.

Tax reform

One way to clean up the foreign over-investment may be through tax reform.

Shi Weigan from the CASS believes that 20 years ago, foreign capital was badly needed to fill the country's domestic reserves and to learn advanced technology and managerial experience. At that time, most products manufactured by foreign investors were exported to the overseas market.

However, today, these investors believe China has already evolved from a low-cost production center into a burgeoning big market, so their products mainly target the Chinese market instead of the international market.

"If they mainly work for overseas market, it's acceptable to grant them certain favorable policies, as it is helpful to China's employment and taxation, but the truth is nowadays, most foreign companies produce and sale in China, so why should they enjoy better policies than our domestic enterprises? It's unfair to the latter!" Shi said.

The Ministry of Finance is working on a solution for the much-disputed problem of unified taxation of both Chinese and foreign companies and relevant policies are due out in two years.

But the answer isn't just reforming the tax system. It's creating a fair competition environment, said China's National Development and Reform Commission spokesman Li Pumin.

"A fair environment in these industries should be created for Chinese and foreign companies," said Li.

Nevertheless, without favorable policies for foreign companies, foreign investors may retreat. Already, there is concern within the European Union, for example, that China is beginning to support "economic nationalism," as stated in a position paper released September 5 by its chamber of commerce here.

"Members would like to see China achieve its domestic goals in an open market environment and not through increased protectionism," the paper said.

If foreign investors began retreating in droves, their capitals' dominance in the Chinese economy would weaken, but the economic growth rate would also slow-not something desirable if considerable, said Li.

So control, monopoly-whatever you want to call it-of Chinese industry by foreigners will likely continue for some time. 

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