Further opening or gradual deglobalization?

Expectations for the annual economic work conference of the Central Committee and the State Council

China is at a crossroads, so is the world: Will we move down an accelerating spiral of deglobalization, where indigenous manufacturing, indigenous innovation and import substitution will trump open markets, fair competition and a global division of labor?

The soon to be held annual joint conference by the Chinese Communist Party and the State Council will not only chart the course for China’s economic policy in 2017. Fully aware of China’s global weight, the world will listen whether the conference will send credible signals of further opening and reform. The CCP’s Political Bureau has set the tone in its session on economic work on 9 December. From Germany’s perspective, the signals so far are mixed at best. The keywords seem to be stability, security and unified thinking, not bold reform, equal competition and liberated thinking.

The conference could give a huge boost towards restoring confidence in China as an investment destination by setting a few clear principles:

  • Equal treatment between indigenous companies, joint venture and foreign companies is a guiding principle of China’s economic reform.

  • China is currently at the bottom of the OECD investment restrictiveness list of G20 countries, which measures protectionism in the investment field. China will commit itself to move up on this list, commensurate with its economic position in the world.

  • China is committed towards fair competition. It will accelerate its efforts to create a level playing field between state-owned enterprises and privately owned companies by exposing state-owned enterprises to market forces.

German companies have been partners to China during its modernization drive of the last thirty-five years and want to remain partners for the next thirty-five, and of course beyond. Germany has and will remain deeply sympathetic and supportive of China’s rise. We are not geostrategic rivals but partners.  Germany is the world’s leading country in smart production, commonly called “industry 4.0.”. We want to cooperate with China to develop this crucial driver for economic modernization. However, how can we stimulate such cooperation if companies have to fear that they might just be used as expendable tools, to be discarded once they have transferred sufficient technology?

Over the last year or so, our investors have seen a shift in China’s approach towards foreign companies in precisely this direction. A recent survey among German companies has shown a steep decline in their willingness to bring new investments to China, the lowest in three years. EU investment in China is down significantly in the first nine months of 2016 compared to 2015. Maybe the most worrying finding of the survey: Less than half of German companies believe that economic reform will do anything toward improving the investment climate.

A core concern of our companies is a lack of legal certainty and predictability. There seem to be more and more “rules behind the rules”: Industrial policy favoring “indigenous” producers. Three developments have triggered these concerns:

Firstly, a series of new security laws, most recently the cyber security law, have broadened the scope of what is considered security-sensitive. This has potentially broad ramifications for economic cooperation. Rule for indigenous production, data localization and explicit calls for replacement of foreign-made IT products suggest that this legislation is also driven by protectionist industrial policy aims.

Secondly, the “Made in China 2025” initiative is at risk of becoming a tool for protectionism. Take the car industry: A roadmap for the State Council’s “Made in China 2025” plan provides that by 2025, three of the five leading energy-saving vehicle manufacturers in China have to be indigenous Chinese brands. The document decrees that their reputation has to exceed that of joint-venture manufacturers. In other words, China in 2015 seems to have already drawn up the list of the number one, two and three new energy vehicle suppliers of 2025. This is only one of many stringent quotas favoring indigenous companies. Plans such as these are at loggerheads with a reliable and predictable legal framework. No number of laws promising equal treatment can effectively counter the effect of plans setting goals that enshrine inequality between “self-reliant” indigenous companies and foreign investors.

Thirdly, knee-jerk decisions undermine legal certainty and threaten to damage long-term investment strategies. China has just come up with a hasty plan to bring quotas for new energy vehicles forward from 2020 to 2018. Currently, it is trying to push these unexpected rules through a WTO procedure, even there trying to shorten the process. China claims that their aim is to fight air pollution. However, over 80% of the power generated for electric consumption will come from highly polluting coal plants. This suggests that the goal is not primarily to improve air quality but to help Chinese companies get ahead of the game, as laid out by the quotas of the government’s “Made in China 2025” roadmap. If enacted, these regulations would leave less than one year for car companies to fundamentally adjust their investment and production plans, an impossible task at such short notice. The German car industry alone has investment plans exceeding 20 billion US dollars in the coming years. Plans such as these require predictable, transparent and fair legislative procedures.

These plans, if carried out, could lead to a long-term deglobalization of the Chinese car industry. Unfortunately, this is not an isolated case. The best that China could do to increase investor confidence are predictable and clear rules that set the framework for fair competition.