By:  Steve Dickinson

At the end of December, the NDRC issued its long awaited 2011 revision to the Catalog for Guidance for Foreign Investment 外商投资产业指导目录(2011年修订). It is a central policy of the Chinese government that foreign investment must be made in a manner that is consistent with Chinese policy and in a way that will promote China’s development. China therefore follows a policy of guided investment, and the Catalog is the guide.

The first Catalog was issued in 1995. This is the fifth revision, replacing the 2007 Catalog. This 2011 version of the Catalog will take effect on January 30, 2012. Foreign invested enterprises approved prior to the effective date will not be effected. However, any changes to existing foreign invested projects that take effect after the effective date must comply with the terms of the new Catalog.

The encouraged category shows where the Chinese government wants foreign investment to go. The restricted and prohibited categories show the sectors that are hands off in China. Even for those who are not considering investment in China, the Catalog is instructive. The encouraged category is quite detailed. For those who are looking for the next sector where China will push for dominance, the Catalog is quite revealing. In the same way, the Catalog can show which sectors the Chinese government has decided to limit or reduce. The Catalog is therefore a model for the development of Chinese industry for the next several years.

In what follows, I will summarize and comment on the official NDRC explanation of the background and policy behind the new Catalog, which can be found here. In a subsequent post, we will provide more detail on the changes introduced in the Catalog.

Foreign Direct Investment (FDI) remains an important element of the Chinese economy. In 2009 and 2010, China remained the number two destination in the world for FDI. Through the end of November, 2011, FDI amounted to $US103.8 billion, an increase of 13.2% over the previous period. It is anticipated that the total for 2011 will be around $US110-120 billion. Even in the face of the world economic crisis, China clearly remains a primary target for foreign investors.

Starting with the 2007 Catalog, China has moved to substantially change the structure of foreign investment in China. The 2011 Catalog follows on this basic program. For the developed Eastern regions of China, the goal of the Catalog is to move foreign investment away from 1) investment in low value added, high labor business, 2) investment in conventional technology, and 3) investment in high pollution and resource intensive technologies. The Catalog is intended to push investment in the East towards high value added and technically advanced manufacturing, strategic technology in both manufacturing and services
and low pollution energy saving technologies. The entire Catalog reflects these goals.

As stated by the NDRC, the new Catalog is intended to reflect the following changes:

1. Continued openness. The continues the trend towards opening up of the economy, consistent with China’s WTO commitments and the need to make us of advanced foreign technology.  The basic numbers reflect this. Three items were added to the encouraged category, while seven items were removed from the restricted category and one item was removed from the prohibited category. In addition, where joint ventures are required, the required Chinese share was reduced in eleven cases and was not increased in any case.

2. Modernization and technical advance in the manufacturing sector. Consistent with the 12th Five Year Plan, the Catalog focuses heavily on promotion of the traditional manufacturing sector. In particular, advanced technology in textiles, chemicals and equipment have been added to the encouraged category. The deletions from the encouraged category reflect the government’s desire to prevent excessive investment in conventional manufacturing technology, particularly where there is extensive current investment by foreign enterprises. This goal is reflected by the deletion of vehicle manufacturing from the encouraged category. The government also intends to prevent excessive investment in certain “trendy” sectors. This goal is reflected by deletion of mono crystalline silicon and chemical processing of coal from the encouraged category.

3. Promotion of strategic new industries. A central goal of the 12th Five Year Plan is to move China beyond reliance on traditional manufacturing and onto strategic new industries that will mark the
manufacturing world of the next several decades. The following seven such strategic industries have been identified:

— Alternative fuel cars:hybrid cars and electric cars as well as better fuel-cell batteries;

— Biotechnology: biomedicines, new vaccines, and advanced medical equipment;

— Environmental and energy-saving technologies: energy efficiency, pollution control, clean coal, waste-matter recycling and seawater usage;

— Alternative energy: ext-generation nuclear power plants, solar power, wind power, smart grids and bioenergy;

— Advanced materials: rare earths, special-usage glass, high-performance steel, high-performance fibres and composites, engineering plastic, nano and superconducting materials;

— New-generation information technology: cloud computing technology, high-end software, virtual technology and new display systems; and

— High-end equipment manufacturing: Aircraft, high-speed rail, satellites and offshore oil/gas equipment.

4. Modern service industry. Service businesses that have a direct, practical value to the Chinese people or to China industry will be encouraged. Among the new entries in the encouraged category are:

— Electric car fueling stations

— Enterprise start-up consulting

— Intellectual property consulting

— Marine oil spill cleanup technology

— Vocational skill training

In addition, medical enterprises and financial leasing have been removed from the restricted category.

5. Adaptation to differences in regional development. The basic approach of the Catalog is actually concentrated on the development of the already advanced coastal region. The goal of pushing China to high
technology modernization conflicts with the extremely low state of development in the Western, Central and Northeast Regions, where the vast majority of the Chinese people actually live. For development in these regions, the government will need to take a different approach to FDI. For example, low value added, high labor content manufacturing that is strongly discouraged for the East may be permitted or even encouraged in the less advanced Western and Central regions. To date, however, no clear policy has emerged. These matters will therefore be addressed in the proposed revisions to the Catalog for Foreign Investment in the Western and Central Regions (2008) 中西部地区外商投资 优势产业目录, which are expected next year.

The intention of the Chinese government towards foreign investment is clear. Foreign investment is intended to support China’s manufacturing sector by providing access to modern advanced technology. There is no longer a focus on job creation and there is little interest in foreign investment in any sector of the economy outside those areas which will help China modernize. Potential foreign investors should take this into account. Investing against the trend in China seldom succeeds.

By: Steve Dickinson 

Yesterday we were greeted in the foreign press with the following headline: Southern China Sees Wave of Manufacturing Bankruptcies. This was predictably followed by vehement denials vehement denials from the Chinese government. For example, the CCTV Channel 9 business news was full of stories today stating that Chinese SMEs throughout the country are operating smoothly. The result being the usual complete lack of clarity about what is really going on in China as the coastal regions restructure their manufacturing base in the face of reduced demand and higher costs.

The basic story is that that low value added/high labor content manufacturers from Wenzhou in Zhejiang down to Zhuhai in Guangzhou are undergoing extreme financial stress. The affected sectors are in the traditional outsourcing industries: textiles, toys, shoes and furniture. The reports are that many of the oldest and largest manufacturers in these sectors are closing their doors, leaving behind bad debts and unpaid workers.

These stories may be true or false.Certainly the bankruptcy of one or two companies in a competitive world does not constitute a trend. So the truth may be somewhere in between the “the sky is falling” and “what me worry” positions we are seeing in the discussion.

What I find interesting is the consistent misunderstanding of foreign observers on the Chinese government position on the matter. Specifically, many observers are surprised at the relatively casual response of the central and local governments to the issue. This is because these observers do not see that this process is completely consistent with central government policy.

Let’s state the situation more clearly. Assume for now that the stories are true. If true, the process is exactly what the central government intends to happen to manufacturing in China’s coastal regions, particularly in the Zhejiang/Fujian/Guanzhou region. Stated bluntly, if Chinese government policy is causing the bankruptcies, this is intentional. If the bankruptcies are the result of market forces, the government intends to do nothing to soften the blow.

Here is a basic explanation of what is going on:

1. The 12th Five Year plan clearly states that a primary goal is to eliminate low value added/high labor content export manufacturing from the entire coast. The intent is to shift to high value added, technologically advanced manufacturing and modern services in this region. The bankruptcies in the low value added sector are entirely consistent with central government policy.

2. Many of the manufacturers in this sector are controlled by foreign capital: Korea, Taiwan, Hong Kong and Singapore. Where not foreign owned, the owners are rebels against the state like the group centered in Wenzhou. The central government is not happy with either group and is quite happy to see them go.

3. It is important to understand that the vast majority of these export based manufacturers are not economically viable. They exist because of VAT rebates, open violation of the Chinese wage and labor laws and subsidized energy and raw material prices. They have been tolerated in the past solely because they provide jobs. They provide no other benefit to China and are in many cases actually harmful. Moreover, the jobs they provide are for migrant labor, which is a source of social unrest in China. China wants these migrants to return to Sichuan and elsewhere. They want the businesses to operate according to the requirements of Chinese law. For these reasons it is a sound policy to force these export manufacturers to either become economically viable and law abiding businesses or to force or allow them to simply go away. It makes little sense to continue to support them with subsidies and loans.

4. On a much deeper level, as the 12th Five Year Plan states, the center seeks to transform the Guangzhou/Fujian/South Zhejiang industrial zone. The goal is to eliminate of most or all of the private, export oriented, low value added/high labor content businesses located in those areas. Though the discussion is couched in economic terms, the underlying reason is political. The center is tired of the independence of the southern coastal regions. Since there is no longer any strong economic reason to tolerate this independence, the center is now moving to reassert control in these regions.

It therefore makes perfect sense that the center is relatively unconcerned about a “wave of bankruptcies” in the south. They believe they can handle the results in various ways. In terms of job loss, the message is: go home and find a job back in Sichuan or Henan or wherever the migrant workers were originally located. There are plenty of jobs for Guangzhou residents, so the issue is really convincing the migrants to go back home.

In my own lectures on this issue, I have commented that elimination of low value added manufacturing on the coast seems to be a bad policy on economic grounds. That is, China is still in the situation where low value added/high labor content manufacturing is a good way to take advantage of the large number of low skill workers available in China. However, now that I look at the situation from the standpoint of the center, I find that it makes sense to conclude that there is no benefit to China in keeping these really bad companies alive through loans and subsidies. It therefore seems that the transformation of this sector and the resulting closing of unviable manufacturers will continue unabated. This is because the process makes political sense, which is the most important consideration in China. The fact that it makes economic sense is a secondary, collateral reason for continuing.

What are you seeing in the South?

Update: Dan actually gave a TV interview relating to this subject a few weeks ago when he was in China. That interview can be found here.

On April 13, I will be speaking in Anchorage, Alaska, on the practice of international law. My talk will be before the International Law Section of the Alaska Bar Association (of which I am a proud member). This talk will be a variant of a talk I have given a few times to law schools. For more information and to register, go here [link no longer exists].

On April 12, Steve will be speaking at the Sofitel Hotel in Chengdu, China, on China’s 12th Five Year Plan. Steve’s talk is being put on by the American Chamber of Commerce in Southwest China.  For more information on that talk and to register, go here [link no longer exists].

Then on April 14, Steve will be speaking again on China’s Five Year Plan, but this time in Beijing as part of an event jointly sponsored by the Swedish Chamber of Commerce in China, The Singapore Chamber of Commerce and Industry in China, MayCham (The Malaysian Chamber of Commerce) and the Hong Kong Chamber of Commerce in China (HKCCC). To find out more about that talk and to register to see it, go here [link no longer exists]. That one will be during breakfast.

Let us know if you will be at any of these so we can be sure to say “hello.”

By: Steve Dickinson

On Monday, March 14, The PRC National People’s Congress approved China’s 12th Five Year Plan and the outline of the plan was released to the public yesterday. The full 105-page document can be found (in Chinese) here. I am now reviewing the plan and over the next several weeks I will provide a series of reports on its contents.

I can make some preliminary remarks at this time.

The striking thing about the plan is its lack of originality. In the policy documents that have been promulgated over the past year, the party and the National People’s Congress (NPC) concluded that China must boldly reform its entire economic structure. The idea was to have China move away from a export and infrastructure driven economy to a balanced, consumer demand driven economy. The Communist Party of China (CPC) issued an outline of a bold plan that would bring about this transformation. The conclusion of many Western economists was that 1) the transformation would be essential for the long-term health of the Chinese economy but that 2) the transformation would be extraordinarily difficult. See the recent writings of Michael Pettis on this issue.

Apparently, the NPC also concluded that the consumer driven economy simply would be too difficult to achieve. As a result, the 12th Five Year Plan basically abandons the concept of creating a consumer driven economy and falls back to the standard Chinese economic model of depending on massive infrastructure projects and export driven growth as the primary models. Though some lip service is paid to increasing household consumption, that concept is basically brushed aside in favor of domestic infrastructure spending.

The list of projects is breathtaking. In just a preliminary review, I noted the following:

  • Highways, conventional rail and high speed rail
  • New airports
  • New ports and port upgrades.
  • Oil and gas pipelines
  • Electric transmission lines, especially high voltage lines
  • Coal transport and storage
  • Environmental upgrades of virtually the entire system of coal fired power plants, together with constructing substantial new coal fired power plant capacity
  • Modernizing the entire heavy industry sector: steel, cement and aluminum, in particular
  • Expanding mineral mining, particularly coal
  • Oil and gas field development in Inner Mongolia and Xinjiang
  • Creating an entirely new industrial base, focused on seven strategic industries
  • Urbanizing rural China to allow at least 10,000,000 rural residents per year to move to the cities
  • Investing in massive amounts of new nuclear power and hydropower facilities
  • Major expansion of domestic oil refining capacity and LNG storage and transmission
  • Sewage and waste treatment facilities throughout the entire country
  • New hospitals throughout the country
  • Waterworks focusing on irrigation and water transport from the South to the North
  • Developing coastal marine resources, primarily focusing on maritime infrastructure
  • Developing the Central and Western regions
  • Redeveloping China’s Northeast industrial base
  • New jobs for 45,000,000 workers

Note that this set of projects is not designed to encourage the domestic household economy; all of it is designed to maintain China’s position as an export-oriented manufacturing powerhouse. It seems that the NPC has rejected the idealistic notion of reforming China’s economic structure and instead has adopted the easier plan of simply improving what China has been doing for the past ten years. No major changes here: just upgrades and refinements.

Of course, as is typical, there is no mention of how much this huge list of projects will cost and no mention either of from where the money will come to pay for all of this. If the past is any indication, the projects will feature a mix of direct central government expenditures and bank loans to local governments. The recent huge jump in bank lending supports the notion that the banks will be instrumental in funding this truly massive set of infrastructure projects. There is also no discussion of how this massive spending program will mesh with the China’s current concern with controlling inflation. Nonetheless, the basic plan is clear. Spend, spend, spend on creating manufacturing capacity and then export the surplus in order to pay for it all. 

In other words, we should be expecting more of the same.

What do you think?