China is the world’s most populous country — 1.39 billion people and counting. That means it has more people who want to buy things than anyone else. Companies from all over the world have been flocking to China to sell stuff there ever since President Richard Nixon pried open the door to doing business there in 1972. What company wouldn’t want to be part of the biggest market in history?
The 50-50 Rule
The Chinese government saw its nascent manufacturing sector being inundated beneath a flood of outside companies, so it required those foreign corporations to partner with a local company. The 50-50 rule, as it came to be called, meant foreign companies would have to share some of their manufacturing expertise with local Chinese companies, rather than just setting up shop in China and dominating Chinese manufacturing.
Most of those foreign companies bit the bullet and played ball according to the Chinese rules. Today, companies like Mercedes, Audi, Volkswagen, General Motors, Ford, Jeep, Toyota, Honda, and Hyundai are working with local partners and finding their sales in China are a significant proportion of their total global sales. They fuss and complain about having to share their knowledge with those partners but they do it because the Chinese new car market is so huge — about 30 million cars a year — it can’t be ignored.
This week, the Chinese government announced that it will eliminate the 50-50 rule for manufacturers who manufacture new energy vehicles — defined as battery electric or plug-in hybrid cars — in China by the end of this year. For companies making commercial vehicles, the rule will expire in 2020 and will disappear completely by 2022.
Is This Good News For Tesla?
That should be wonderful news for Tesla, which has been negotiating with officials in Shanghai for over a year for permission to build a factory in the free trade zone outside that city, right? Several industry analysts have asked that question and come up with different answers. Bloomberg notes that building cars in China is just one piece of a highly complex puzzle. After making them, a company has to sell them. China offers incentives of up to $8,000 on new energy vehicles with longer range batteries. Bloomberg thinks foreign companies may still need a local partner in order for its cars to be eligible for those incentives.
Bloomberg goes on to say that Tesla found out recently how important incentives are to success in foreign markets. Once Hong Kong removed its electric car incentives, sales of Tesla automobiles plunged. China also introduced a new system of credits last year that requires all manufacturers to produce a certain number of electric or plug-in cars. The system is designed to encourage cooperation among manufacturers.
The subtext to all this is the ongoing war of words between Beijing and Washington over trade. China has dangled the possibility of increasing its import tariff on foreign made cars to 50%, a penalty Tesla might be able to avoid if it decides to work with a local partner.
Sticking With The Status Quo
Most of the major car companies say they are satisfied with the local partnerships they have forged and do not see ripping up those relationships to build wholly owned factories of their own. BMW, for instance, tells Reuters, “We believe a more free and flexible business environment will benefit both Chinese and foreign companies in China and the Chinese economy. BMW will continue pursuing mutual benefit and win-win solutions with the local partners.” It adds it intends to expand a joint venture with Chinese company BBA and is exploring a new partnership with Great Wall Motors to build MINI branded vehicles in China.
A Volkswagen spokesperson tells Reuters, “We will carefully analyze whether this opens up new opportunities for Volkswagen and its brands.” Daimler says it is happy with its current business arrangements in China and is watching regulatory developments there with interest. An anonymous source at General Motors claimed the company will not sever its relationship with SAIC Motors and that GM would not be successful in China on its own. In a statement, GM said its growth in China was “a result of working with our trusted joint venture partners. We will continue to work with our partners to provide high-quality products and services to consumers.”
Honda also says its business in China has grown significantly because of its relationship with its local partners. “At the moment we have no plans to change our capital relationship,” a spokesman said. James Chao, Asia-Pacific chief at consultancy IHS Markit, tells Reuters, “Foreign companies may already be in a box (in China). While getting a bigger share could be advantageous in terms of boosting profits, they may actually be already too dependent on their Chinese partners to sever those ties.”
Time To Move On?
Donald Trump, of course, will take all the credit for forcing China to knuckle under to US demands because of his superior deal making skills. But it is unlikely this new course for China happened overnight. Shanjun Li, a professor of economics and policy at Cornell University, tells The Verge that China has gotten what it wanted from the joint venture policy — a stable domestic auto manufacturing base that can thrive without foreign partners. “Chinese domestic automakers have improved dramatically in their technology know-how during the past decades,” he says. “They are in a better position than ever to compete directly with international rivals for the domestic and international markets.”
In a related development, China will also remove joint venture rules in the shipbuilding and aircraft manufacturing sectors this year. YiCai Global reports that China’s National Development and Reform Commission now says on its website, “China’s full opening of the manufacturing industry is a clear indication of our opposition to trade and investment protectionism, and shows our strong support to widening and deepening the development of economic globalization.”
Be Careful What You Wish For
While all that is happening on the surface, an article in the New York Times on April 13 warns that the communist party is taking a more active role in many areas of Chinese life, including manufacturing. At the 5-year meeting of the party last year, president Xi Jinping called on party officials to strengthen the party in “government, the military, society and schools, north, south, east and west.” Since then, several foreign companies that have entered into joint venture agreements with Chinese companies have been pressured to amend their contractual agreements to provide party officials a more active role in managing the businesses.
Shortly after Xi’s speech, the Times reports the Delegation of German Industry and Commerce said it was concerned about “proactive calls on foreign-invested companies to promote the development of theCommunist Party of China within companies.” The European Chamber of Commerce has called such incidents a “great concern” that could represent “a significant change from the legal framework under which joint ventures were negotiated and under which they have been operating successfully for decades.”
“Infiltration by party operatives into the executive circle of foreign-invested enterprises is not extensively apparent at this time but things are certainly going in that direction,” says James Zimmerman, a lawyer in Beijing whose clients include American multinational corporations. He tells the Times that several of his clients in joint ventures had received explicit requests to give their internal party organizations a greater say in the company’s operations. At some companies, the requested language requires a board of directors to consult with the committee before making business decisions.
All that glitters is not gold. For decades, foreign companies have chafed under the joint venture rules in China that require them to share manufacturing expertise and some intellectual property with their Chinese parties. They have been hoping for years for permission to do business in China the way they do in their home countries. That day may be at hand, but as the old expression warns, “Be careful what you wish for. You just might get it.”