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China’s open-door-then-close-door approach to foreign investment

ASK THIS | August 25, 2011

The author of a new book on the Chinese regulatory state asks and answers questions about how market liberalization followed by government re-regulation serves the central government's plans.

By Roselyn Hsueh 
Headlines herald the arrival of China as a rapidly developing and industrializing global power that builds its own high-speed trains, produces its own cars and wind turbines and sets its own telecommunications networking standard. Chinese state-owned and quasi-private companies are contracted to manufacture steel structures for the Bay Bridge in San Francisco and build mobile communications infrastructure in Africa. Every multinational corporation in every industry has a China strategy. But behind the buzz of “China’s rise” is a complex story of how the Chinese government has selectively used market liberalization followed by re-regulation in a way that enables the Communist leadership to promote domestic industries, enhance its technology base and retain power, including the power to control the flow of information. Among the questions reporters should be asking about the intersection of politics and economics in China are:  
Q. What does market competition really mean for Yahoo and other foreign companies operating in China? 
A. The omnipresence of multinational corporations such as Yahoo in China today is a testament to the Chinese government’s openness toward foreign direct investment (FDI), which contrasts with the much more restrictive FDI policies of its East Asian neighbors and India and Russia. But in March, China’s Alibaba Group, a privately-owned family of Internet businesses, disclosed that it had unilaterally spun off Alipay, a third-party online payment platform, forcing Yahoo out of the most lucrative part of its joint venture with the group’s publicly traded company. Alibaba justified the move on the grounds that it was simply complying with a government rule stipulating that only Chinese-owned companies could be licensed to engage in e-payment. 
But Alipay had operated for years without the government requiring and enforcing licensure -- so what changed? What changed is that now that the domestic e-payment sector has developed, in part due to Western expertise, existing rules are being enforced and new rules are being introduced to privilege domestic industry. 
Yahoo’s experience illustrates a recurring pattern of market liberalization and subsequent sector-specific reregulation of industries -- from automobiles to financial services and renewable energy -- that China considers strategically important because of their contribution to the national technology base or national security. 
Q. Are compulsory divestments typical for foreign companies in China? 
A. No. The actual mechanisms of state control in strategic industries depend on sectoral attributes and the state goals in question. Yahoo’s experience is similar but not exactly the same as what has already occurred to achieve state goals in other subsectors of telecommunications services. The perfect examples of this are the mandated divestment of FDI in basic telecommunications services in the late 1990s and the expansion of state control over business scope in telecommunications value-added services in the post-WTO era, which has affected the China strategy of companies like Google. 
For most of the 1990s, despite a formal ban on FDI, the Chinese government permitted the de facto entry of FDI and quasi-private domestic capital, which helped build second-generation Global System for Mobile Communications (GSM) networks. Shortly before China’s accession to the World Trade Organization (WTO) in 2001, however, the Chinese leadership merged previously separate telecommunications equipment and services bureaucracies to enhance state control in policymaking and regulatory enforcement of the entire industry. The newly established Ministry of Information Industry vigorously enforced the FDI ban in basic services to check rival bureaucratic stakeholders (which operated competing state-owned carriers), manage infrastructural development and retain state control of the most lucrative telecommunications assets. The compensation received by foreign and quasi-private investors varied across companies based on firm-level bargains with the regional subsidiaries of the state-owned carriers in question; but the end game was the same: modernization of telecommunications infrastructure, state ownership of telecommunications networks and state management of operations.  
In the post-WTO era, despite China’s liberalization commitments -- which include treating FDI as domestic companies and permitting up to 49 per cent foreign equity in telecommunications basic services and 50 per cent in value-added services -- foreign telecommunications operators hold less than 10 per cent stakes in Chinese carriers. Moreover, the formation of the Ministry of Industry and Information Technology restructured the state-owned carriers and mandated the adoption of TD-SCDMA, China’s homegrown networking technology. After the various value-added sectors reached a respectable level of development, the government issued new rules that  threatened to crack down on licensure violations and encroached on business scope. Domestic partners of foreign-invested value-added service providers, less high profile than Alibaba, have also used these new rules to break existing contracts. The deliberate scrutiny of business activity is where Google’s story of doing business in China becomes significant. 
Q. How does Google fit into the rise of the Chinese regulatory state? 
A. Google’s experience is another example of the Chinese government’s strategy of reregulation after initial market liberalization, with a chief goal in this case being the ability to control information. Like most Internet businesses in China operating on backbone infrastructure already owned and managed by state-owned carriers, Google functioned for many years without much government intervention as long as it filtered Internet content that the government deemed offensive and subversive, including information about the Tiananmen Square massacre, the Dalai Lama and Taiwanese independence. Google also operated with the operating license of a Chinese contractor with the full awareness of the government before going through the cumbersome process in 2007 of licensure.
After getting its own operating license, Google faced regulatory encroachment on the type of value-added businesses that it could enter, just as Baidu, its top domestic competitor, continued to capture market share and toe government line in censoring search and other matters of information dissemination. 
Most of the representatives of companies I interviewed for my book explained that they tolerated the growing restrictions and regulatory activity because the potential financial gains were too great. The tipping point for Google came in 2010 when it revealed that “sophisticated cyber attacks on its computer systems that it suspected originated in China” were making it seriously consider leaving the Chinese telecommunications market. Google also cited China’s attempts to “limit free speech on the Web,” including Internet censorship and the government’s requirement of filtered searches as reasons. In the end, Google decided to offer limited services, including advertising, in China and direct users to its uncensored Hong Kong-based Chinese language search engine.
Q. What is the environment like for foreign businesses operating in sectors the Chinese government deems less strategic than telecommunications? 
A. Market entry in nonstrategic industries is completely liberalized. State-owned, private domestic and foreign-invested companies in industries from consumer appliances and textiles to foodstuffs compete fiercely for market share. The business and politics of these markets are local and companies have to contend with the vagaries of local politics, regulatory arbitrariness and lack of central will and regulatory capacity in enforcing macroeconomic and economy-wide rules. Local governments provide fiscal and infrastructural incentives to attract domestic and foreign capital; and local stakeholders set technical standards and institute nontariff market barriers, which favor well-connected economic players and constrain the market access of others. Market saturation and overexpansion are commonplace; and labor and environmental and safety violations and other corrupt practices run rampant in government-business relations in nonstrategic industries.
Q. Is China’s globalization strategy successful?
A. Yes and no. It depends on which goals and by what measure. Let us consider the telecommunications industry. Economically, the introduction of market competition has attracted global players from AT&T to Motorola and MySpace to participate in the largest telecommunications market in the world, exposing Chinese industry to foreign technology and know-how. The sector-specific reregulation, which quickly followed, has fostered a vibrant Chinese telecommunications industry in which service providers, such as Yahoo and Google compete. Foreign equipment makers from Ericsson and Nortel to Qualcomm also enjoy market share thanks in part to the purchases by state-owned carriers, which have embraced foreign technologies, in addition to implementing indigenous ones. Moreover, Chinese companies now sell telecommunications equipment and provide services in global markets, particularly in developing countries such as Iran and Nigeria, with which the Chinese government has strong diplomatic ties. Politically, with complete control of telecommunications infrastructure, top leadership can mandate blackouts of Internet and mobile communications in China proper and Tibet and Inner Mongolia when Beijing deems particular issues too politically sensitive and socially destabilizing.
At the same time, industry insiders and market watchers have questioned the technical quality and marketability of China’s indigenous networking technology; they doubt global market adoption will ever occur. Aside from a few market standouts, such as Huawei and ZTE, most Chinese equipment makers compete in consumer telecommunications equipment and not the high tech, more value-added segments. Price-cutting is the dominant strategy between the fiercely competing carriers; this is not a sustainable strategy for the provision of quality services, which will limit the globalization potential of Chinese operators. Last but not least, it remains to be seen whether sector-specific reregulation to control information infrastructure and dissemination will exempt the Chinese Communist Party from the political effects of the global information revolution being witnessed in the Middle East with the Arab Spring. Developments thus far show that it is very possible to have freer markets and more authoritarian control. 

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