China: Economic war and the humbling of multinationals

14 August 2014 

http://www.lowyinterpreter.org/

'I really worry about China. I am not sure that in the end they want any of us to win', confided GE boss Jeff Immelt to a group of fellow multinational business-people dining in Shanghai in 2010.

So far, GE has mostly stayed out of trouble in China. But many other Fortune 500 companies have been whacked by the Chinese authorities: for corruption (GSK), food safety problems (KFC and MacDonalds), security concerns (Cisco, IBM and others), quality problems (Samsung), forced upgrades (Microsoft), monopolistic behaviour (Qualcomm), and 'unparalleled arrogance' (Apple).

Offshore deals have been postponed or even forbidden by Beijing. And recently, foreign carmakers have been hit for excessive pricing on the mainland (more on this later), an accusation which has also been directed at Starbucks, milk suppliers, luxury goods companies and drugs firms. The list is practically endless.

Beijing uses three agencies to prosecute foreign firms, depending on their sin: the National Development and Reform Commission (NDRC) reviews pricing, the Commerce Ministry approves mergers and acquisitions, and the State Administration for Industry and Commerce (SAIC) probes anti-trust matters. It is a formidable trio, and the Chinese state rarely loses cases on its home turf. Multinationals can also find themselves simultaneously brutalised in the Chinese press; almost all succumb meekly to the charges, correct their mistakes and apologise for hurting the feelings of the people.

To be fair, the Chinese authorities usually do have good grounds for complaint. Foreign companies often behave badly in China. But it seems that successful foreign companies are targeted, as if Beijing deliberately wants them humbled. Immelt appears surprised by this possibility. He shouldn't be.

China is, first and foremost, a state capitalist. Like all nations, it covets the mercantilist objective of commercial success. Countries don't fight economic war like they fight militarily, but sometimes it feels that way. The AFR's Angus Grigg, in an intriguing short piece on the deteriorating business climate for multinationals earlier this week, reported a Chinese official acknowledging this point forthrightly: 'It's an economic war'.

Twenty years ago, John Fialka's superb War by Other Means described in scary detail how nations conduct underground conflict in the commercial realm; Japan then was America's most feared rival, although China was charging up the list. The Japanese, led by the masterly bureaucrats at the Ministry of International Trade and Industry, had achieved global success based on a level of chauvinism in their home market that China has never approached. The Japanese were much too polite to say what the Shanghai official told Grigg, but no doubt embraced 'economic war.'

Unfortunately, this term literally applies to the worsening situation with Russia, which faces sanctions and other forms of 'lawfare'. Both China and Russia are perceived to be at the vanguard of growing anti-Western statism, but China is a more formidable and subtle player than the Soviet Union ever was. 'The Chinese were never as stupid as the Russians, who came to us and said repeatedly "we will bury you"', as Zbigniew Brzezinski splendidly put it last week.

Indeed, China's strategy in the state capitalism game seems beyond such easy explanation. Back to the car market.Chinese consumers have long complained about paying 2-3 times what Americans pay for luxury cars. Most of this gap is explained by formal levies, such as import duties and sales taxes. But not all. The authorities worked backwards through the pricing layers and found three anomalies. First, carmakers have been stiffing local dealers. Second, carmakers overcharge for spare parts. Third and most damning, Beijing has found that premium cars rolling out of German factories are marked up outrageously when heading for China, which may account for one-third of German carmaker profits. Chinese consumers are being gouged and Beijing is angered by this unfairness. Beijing probably also resents the fact that the brands are 'skimming' this money back home rather than sharing the profits with their China joint ventures.

Yet forcing foreigners' prices lower is the very opposite of what other mercantilists do. Japan and Korea are delighted to see foreign cars at huge premiums compared to indigenous alternatives; all the better to encourage buy-local preferences. Nations criticise each other at the WTO for 'dumping' — exporting below cost or home-market prices — yet China's objection is the reverse. Forcing foreign carmakers to lower their prices doesn't help China's national champions either; it hurts them by lowering prices relative to domestic brands. Are Beijing's actions about consumer advocacy, or does it simply want to take away the super-profits of foreign companies who might otherwise further dominate China's booming car market?

The claim of 'monopolistic' behaviour is iffy. Competition in cars is fierce and consumers can choose between many brands. Chinese car buyers act more affluently than Western ones, so it is hard to argue for greater affordability. Western companies in China are doing what all businesses do: charging whatever price the market bears. If Beijing is so concerned about monopolies, it could do much more by investigating its own state-owned enterprises. And perhaps Beijing should consider why domestic agricultural prices are soaring above international levels, a direct result of subsidising farmers at the expense of urban households. In other words, there are plenty of domestic pricing anomalies to investigate.

International business people are often told here that 'they are not invited to China to profiteer; they are invited to make the Chinese better'. The guests are held to higher standards than locals, and they should be. Chinese officialdom is making a mighty effort to build future Chinese global champions like Immelt's GE. Knocking foreigners is part of their strategy, forcing them to be more responsive and competitive. Multinational companies are 'making China better', but China is making them better too.