China is the largest market for General Motors, but there is no GM China. Instead, there is SAIC-GM, a joint venture between China’s largest state-owned auto company and GM.
All auto companies operating in China have a similar partner, such as SAIC-Volkswagen, GAC-Toyota and Changan-Ford. And the partners are typically state-owned companies, and their names come first.
Doing business in China requires such joint ventures in several other industries as well, including finance and telecommunications. Even when they are not formally required by law, joint ventures are often needed to help foreign companies navigate the complex Chinese business environment. This restricted entry leaves foreign companies choosing between sharing profits and technology with a local partner, sometimes affiliated with the government, or forgoing the largest and fastest-growing market.
Not surprisingly, despite these market entry rules, foreign companies invest in China anyway, because of the unrivaled growth prospects. In 2000, the year before China entered the World Trade Organization (WTO), fewer than two million vehicles were sold in China; last year 23.9 million were sold. In comparison, about 17.5 million vehicles were sold in the United States in both years.
For China, the benefit of strict entry rules is that the government or local companies get a sizable chunk of the profits that would otherwise accrue to foreign companies. Because competition is limited, the main costs are higher prices and less product variety than would be the case in a free market. New products are frequently absent on the Chinese market because US and other foreign companies don’t want their Chinese partners to gain access to cutting-edge technology.
The Growing Problem
During the 2000s, while China's economy was growing at double-digit rates, there were few complaints about the compromise. US companies were glad to have access to the growing market. Now, with slower global growth and the rise of Chinese competitors, they are becoming less complacent.
Among the foreign companies’ concerns are laws aimed (directly or indirectly) at boosting technology sharing. For example, to combat pollution, China’s five-year plan targets 8 percent of vehicles sold to be electric by 2018 and 12 percent by 2020. From an environmental perspective, the plan is impressive, but from a manufacturing perspective, there are some strings attached.
A 25 percent tariff on foreign autos means less than 5 percent of cars in China are imported. Foreign producers are essentially being told to bring their new electric-vehicle technologies or go home.
Rules tend to be especially strict for computer and technology companies. IBM divulged propriety source code to get support to expand in the Chinese market. Apple was temporarily barred from selling a phone that was similar to one offered by a Chinese brand.
After facing a $975 million fine in 2015 for anticompetitive behavior, Qualcomm is now working on high-tech computer chips with a government-financed partner on government-supplied land. All tech companies are struggling under data localization requirements.
China is charging a high entry fee, one that many companies choose to pay to gain access to its large and fast-growing market. To the extent the rents extracted by China’s government or local companies help fuel development, it has been a smart policy.
But China is a big economy, which should start behaving in line with world norms to help make globalization sustainable. Such policies are not entirely novel for a rising economy (the United States pursued British trade secrets in its early years, smuggling in textile workers and technology, with the support of government funds under Alexander Hamilton). But they should be phased out as an economy develops. In China, investment reform has been slow.
Remedies or Deals?
The concerns of the US government and American companies in China are real. One way to respond is with tariffs and investment restrictions on Chinese companies operating in the US market. The rumored Section 301 investigation of China’s intellectual-property abuses would be a step in this direction, potentially allowing the president to impose tariffs on China.
This type of method might work if the United States could impose more pain on China than China can inflict on the United States. But escalating trade tensions is a risky strategy, given our interdependence in the global economy. The US government will also be perceived as violating international rules, making the United States, not China, the villain.
There is little doubt China will retaliate if duties are put in place. In 2015, when the United States put antidumping duties on Chinese solar panels, China responded with antidumping duties on a US input to the very same panels.
Even the threat of tariffs can lead China to respond. Back in 2011, when the United States threatened tariffs on solar panels, China responded with antidumping tariffs on several American SUV models. Punitive across-the-board tariffs on Chinese goods would likely lead China to target major US exports, like soybeans and airplanes, and make it even more difficult for American investors to do business there.
Instead, what is needed is a coordinated effort to bring China back to the negotiating table. Only if the advanced nations bind together can they encourage China to open markets, limit state aid or face penalties. Any unilateral push will only backfire.
The United States should continue to work through the World Trade Organization and the G-20, but the best way to design new trade rules is through regional agreements, such as the Transatlantic Trade and Investment Partnership, the EU-Japan agreement and the Trans-Pacific Partnership (or a US-Japan agreement).
These mega-deals can include the kind of strict rules on intellectual property, state-owned companies and foreign investment that the United States and other advanced countries want. Meanwhile, Chinese companies would be at a major disadvantage if the United States, Europe and Japan have preferential access in one another’s markets. The only way for China to regain its footing would be to join the new agreements and play by the rules, or if these big deals become a template to bring deeper integration into the WTO.
This strategy has many advantages. It does not risk a costly trade war, putting US businesses and jobs in danger. It provides American companies with better market access in many of the world’s biggest markets. It also positions the United States as the global trade leader and rule writer, as opposed to the global villain.
Instead, China is now the one praising free trade, negotiating new regional agreements and offering to help countries reduce trade costs through its Belt and Road initiative, which is financing major new infrastructure projects throughout Europe and Asia.
In a world where the United States was leading on trade issues, China’s actions would fall short, but that is not the case today. The United States will quickly find itself isolated if unilateral punishment becomes its modus operandi.