International Business Environments

International Business Environments China Focus Political, Economic and Technology Focus Dr. Thomas D. Lairson

The Chinese Economy

Summary China has been very successful but many important questions about its future Chinese government both promotes and harms reform and growth Can China move beyond heavy reliance on TNCs? Major economic issues: Income distribution SOEs and banking system Undervalued exchange rate Structural problems of private domestic firms

State of the Chinese Economy

 One of the most successful growth stories ever in history  Fast and sustained GDP growth  More than 200 million people lifted above absolute poverty in the 1980s and 1990s  From an autarkic economy to one of the most open economies: Trade/GDP ratio close to 70%  A substantial buildup of manufacturing capacity and export

Political Economy of Chinese Business Environment

 More than most, Chinese government is deeply involved in business – not liberal  Post-Communist semi-market economy mixed with a Communist government  Chinese government manages market reforms and international opening but protects domestic groups from global competition via SOEs, banking, price subsidies  Developmental state role – promote growth, free market, competitiveness  Central government – Provincial and local governments – fragmented government and markets in China  Central government cannot enforce IP rights – weak state  Case of WTO and adjustment of government and economy  Large role for TNCs in China – preferences for TNCs over domestic firms  Negotiations between China and TNCs;  Relationships of TNCs and domestic firms – technology, supply chains, access to global markets, links to global production networks  Reform of Chinese economy limited by political needs of government  Government role in China business mixes international relations with domestic business policy – Toyota and problems with Japan

Important questions:

 Can Chinese government link support of Chinese firms to global performance as did the Korean and Japanese governments?  Can Chinese government support powerful local firms and help them move into global markets?  Can the Chinese government support a truly innovative and dynamic economy?

Basic Data:

China and FDI: Regional distribution of FDI 2002 Eastern 87%; Central 9%; Western 3% 2002: Guangdong 22%; Jiangsu 20%; Shandong 9%; Shanghai 8%; all other provinces 41%

Center of global manufacturing (global market share): Toys: 70% Bicycles: 60% Microwave ovens: 50% Shoes/clothing: 50% Televisions: 33% Air conditioners: 33% Mobile phones: 33% Washing machines: 25% Refrigerators: 20%

Source WIR 2007, 10.

WIR 2007, 26

Income distribution:

China as a consumer market: Household income Households $10,000 73 million $20,000 26 million $50,000 3 million

Hard Infrastructure: Physical – Communications, Transportation, Utilities

Soft Infrastructure: Financial – ability to raise capital at favorable rates Credit rating agencies – Govenmental/Legal –Legislation/regulations, able to make and enforce contracts Business - Legal, Financial, Logistics, Marketing, Brokers, other intermediaries, etc. Human – Managerial, Technical and Administrative skills

Three-way National Economic Strategy:

1) Incentives and support and preferential treatment for TNCs

2) Chinese Government promotes certain pillar industries – national champions and special treatment

3) Government promotes intense competition within these industries

Major problems in Chinese Economy:

Macroeconomic policy of low interest rates (below the cost of capital) and undervalued exchange rate – encourages overinvestment and falling prices

Large role of local officials in creating too many firms, including SOEs

Potential Massive shake-out of firms

This huge number of firms is repeated in the heavy industry area, with too many firms created by each province and local area

Provincial champions instead of national champions

Firms have large barriers to differentiating themselves Weak Intellectual Property Environments Rapid diffusion of innovations (new to firm and business system) Firms’ strategy in this environment: compete with new products and lower prices exports Shift production to Vietnam More investment

Cost of capital in China is 13-14% ROA is 2-3% Low rate of return is possible because of subsidized capital Leads to diversification into unrelated businesses Especially by local firms headed by former local officials Effect of internal protectionism across provinces = markets are to small to support efficient firms operating at highest economies of scale – Too many car companies Bubble of credit to firms that are losing money

Low investment in energy efficiency China: 866 million barrels of oil (equivalent) = $1billion of GDP US 221 million barrels of energy - $1 billion of GDP How many of the world’s most polluted cities are in China? China as an energy and environmental pariah