Friday, November 12, 2010

Let's have more competition!...Just kidding!

An interesting bit of news came across the teletype today. The annual China-Europe Auto Manufacturers' Forum took place toward the end of last month (October 2010). Sometime during the discussion, the Assistant Director of the State Council's think tank, the Development Research Council, made a provocative statement that apparently freaked out a lot of people.

Let the foreigners have more than 50 percent?

The Assistant Director, Professor Liu Shijin, someone whose views on the auto industry are highly respected and influential, suggested that it was about time for China to end its 50 percent ownership restriction on foreign auto companies that invest in China. Currently, China's policy limits foreign auto assembly joint-venture (JV) partners to an ownership stake of 50 percent or less. (This only applies to whole vehicle assembly operations; parts companies may be wholly foreign-owned.)

(A Chinese source for Liu's statement and the controversy that followed may be found here.)

According to a writer for China's "First Finance" website, "the audience members with blonde hair and blue eyes applauded and nodded in agreement, while those with dark hair and dark eyes shook their heads [in disagreement]." I think what the writer intended to convey was that the foreigners in the audience agreed with Liu and the Chinese did not.

No! We're still not ready!

The Chinese arguments against Liu echoed those made prior to China’s joining the WTO: the Chinese auto industry is not yet mature enough to take on the foreigners head-on. If restrictions were lifted, foreigners would completely occupy China’s market to the exclusion of the Chinese manufacturers.

However, there was at least one Chinese auto executive who fully agreed with Liu: Li Shufu, Chairman of Geely. Li was later quoted:
Only complete lifting of the restrictions [on foreign investment] will help the development of the Chinese auto industry. The current policy of the 50 percent limit on foreign investment is disadvantageous; it does not protect the Chinese auto industry at all. On the contrary, it restricts foreign car companies from entering China.
Reflecting a refrain that Li has been preaching for years, he continues to be so confident in his company’s ability to compete with foreign producers (especially now that Geely owns Volvo) that he welcomes increased competition. (Here's a post on this blog from March of 2009 where Li lays out his argument that the private firms will eventually triumph over the SOEs.)

What Li most likely expects is that increased foreign competition within China would more quickly drive out the weaker competitors. That, of course, is anathema to the central government.

Since an overwhelming majority of China’s automakers are state-owned, it logically follows that an overwhelming majority of the weaker players are state-owned. And because the auto industry has been designated as a "pillar" industry since the mid-80s, it just wouldn't do to have an auto industry dominated by foreign and/or private enterprises.

Well, ... nevermind

The interesting news that came across the wires today is that Liu Shijin has now completely backed away from his earlier suggestion: "I never said I support opening up the restrictions on foreign investment."

Setting aside the fact that he clearly said exactly that at the conference, we have to ask why he's now backing down. Either he said something he shouldn't have, and was threatened with punishment if he didn't go to the media and retract what he said, or he was deliberately floating a trial balloon to gauge the reaction.

Knowing that Chinese planners at the NDRC and MIIT are hard at work on the next version of China's auto policy right now, I am leaning toward the latter explanation. And since he's backing away, it seems reasonable to assume that the 50 percent ownership restriction will remain in the next iteration of the auto policy.

Let the flowers bloom!

From an objective point of view (i.e. from someone who has no vested interest in which auto companies succeed) I think this is a mistake, and here's why.

Joint-ventures are notoriously inefficient -- particularly those that attempt to meld vastly different business cultures. Having worked for a 50/50 US-Japanese JV, I have experienced this first hand. When no single owner dominates, everything -- and I mean everything -- has to be negotiated, from corporate strategy to the temperature of the office.

I am not saying that all JVs are, by definition, contentious -- there are exceptions that prove the rule -- but the exceptions are extremely rare.

The original intent of forcing all foreign auto companies into joint-ventures was technology transfer, but over time, it became clear that the foreigners were withholding their best stuff from their Chinese partners. So why didn't the Chinese decide to dispense with the foreigners altogether and just import their cars to reverse-engineer?

Because Chinese consumers love foreign brands. And they love them so much that Chinese-foreign JVs have become cash-cows. National pride runs pretty deep in China, but if there's anything that runs deeper, it's a love of money, and the huge SOEs have become drunk off of cash generated by their partners' foreign-branded cars.

And here's why I think Liu's suggestion was a trial balloon. If the true goal of having foreign partners is no longer tech transfer (though I recognize the ostensible reason is still tech transfer), then why not be willing to take a smaller share of what could become a much larger pie?

Rather than take 50% of the profits of an inherently inefficient JV, why not take 49% of a much more efficient, foreigner dominated JV? And if there are certain things you don't want the foreigners to do with their increased economic control, then just circumscribe those behaviors by law.

If Li Shufu and the handful of China's planners who believe increased competition would more quickly lead to a shaking out and consolidation of China's auto industry are correct, then the quickest way would be to remove the 50 percent restriction. Entering the WTO did not devastate China's auto industry in the way that everyone feared it would. Indeed, it has become even larger and stronger.

No matter how much the SOEs are urged and ordered to be innovative, they will never do anything more than copy what others have already done. The problem is that SOE incentives are political, not economic. SOE leaders are only interested in their next assignment, but private sector leaders don't have a next assignment. They have no choice but to succeed.

If China truly wants a dominant auto industry, it needs to get over its obsession with state ownership and unleash the creativity of its hungry private sector. One way to do that is to open up competition.