China's efforts to centrally plan the economy make it difficult for foreign companies to enter the Chinese market while impeding domestic competition.

In 2016, China had 172 companies on the Forbes Global 2000 list.[1] Among them were the world’s three largest companies: Industrial and Commercial Bank of China (ICBC), China Construction Bank (CCB), and Agricultural Bank of China (ABC).[2] In addition to banks, other large-scale Chinese companies, including those in the technology and energy industry, have had a growing global presence. Many of these companies have become what can be considered as “national” champions for China in the global economy. As the Chinese government seeks to become the dominant world player in key sectors, the promotion of these “national champions” will continue and could ultimately change market competition domestically and globally.

National champions are companies which help further the government’s strategic aims and in return, the government supports these companies by providing easier access to financing, giving preference in government contract bidding, and sometimes oligarchy or monopoly status in protected industries, giving these companies a number of advantages over their competitors. China’s 10th and 11th-five-year plans encourage having national champions, particularly in pillar industries such as defense and national security. National champions are promoted for the purpose of job creation, technology and skill acquisition, and building competitive advantage. Specific brands were also selected for government subsidies to transform them into national champions.[3] As a result of champion policies, China’s largest companies are getting even larger, which makes them more able to compete on a global scale. One example would be Huawei, which because of government support, has become one of the world’s largest producer of smart phones.[4]

The majority of these “champion” companies are among China’s largest and many are state-owned enterprises (SOE). The SOEs’ mission is to support China’s rise as a global super power. Currently, 98 of the Chinese companies listed on the Fortune Global 500 list are state owned, including China’s 12 largest companies. Through government policies targeting the SOE sector, key companies have grown drastically in size to now be among the largest companies globally.

In 1998, when Zhu Rongji became prime minister, his strategy for overhauling China’s bloated state-owned enterprise (SOE) sector was called “grasping the big and letting go of the small.” This meant the government would retain control of the big SOEs, helping them to grow even larger, while selling off or merging the smaller ones. Next, SOEs began to list on the stock exchange, selling off minority interest to the public. In 1997, there were 262,000 SOEs, but a regimen of restructuring, mergers and closures reduced the number to 174,000 in 2001.[5] The majority of the 83 SOEs that were liquidated over the past 13 years were merged with other, existing SOEs, while a few were conglomerated into new SOEs.[6]

In 2003, the State-Owned Assets Supervision and Administration Commission (SASAC) was established to oversee the management of China’s SOEs.[7] Its purpose is to enact industrial policies which entail transforming the top 40 SOEs into national champions.[8] In 2016, China sent a clear message to the world that foreign companies would be facing bigger competitors from China, as the country’s continued SOE reform concentrates on making SOEs larger, not smaller.[9] This was further evidenced when Beijing announced that it would merge two state-owned nuclear energy companies.[10]

Recognizing that technological innovation plays a significant role in economic growth, the Chinese government introduced policies promoting domestic innovation in 2006. Beijing encouraged government departments to give preference to domestic firms when selecting bids for government contracts.[11] Having more government contracts meant that companies had more money to support research and development. One clear example of this is Huawei, whose first big break came when it was awarded government contracts to build domestic telecommunications networks.[12] This gave Huawei much needed capital which the company used to establish research and development centers in China, India and the US. Today, Huawei is the largest telecommunications company in the world.

In addition to developing new technology, Chinese companies have long been encouraged by the government to engage in merger and acquisition activity, targeted at foreign companies with technology and expertise, which has led to the re-innovation of Chinese products.[13] In certain sectors, such as certain types of technology, there are specific regulations banning foreign companies from entry unless their patents are filed and held in China. In other instances, foreign companies are banned from entry unless they agree to a technology transfer over to a local Chinese partner.[14]

Joint ventures with foreign invested firms (FIE) were often approved only on the basis of the FIE having technology which the Chinese partner could absorb to increase its own competitiveness. The 12th Five-Year Plan identified certain sectors as “Strategic Emerging Industries”. These included energy (including nuclear, wind, and solar power, and clean energy vehicles); health care (drugs and medical devices); and technology (including rare earths and high-end semi-conductors, IT and including broadband networks, and aerospace and telecommunication equipment.[15]

China’s preferential treatment of SOEs and national champions is detrimental to foreign companies in China. The US Chamber of Commerce reported that member companies in China have complained that Chinese regulations related to intellectual property and licensing favor Chinese companies over foreign invested enterprises (FIE). The European Union Chamber of Commerce reported similar experiences, which seem to make fair competition in the Chinese market impossible.[16] “Moreover, European companies are being shut out of the bidding process for China’s $1.1 trillion public projects market due to opaque bidding procedures, inconsistent enforcement of regulations, and local content rules”.[17]

In the long run, crowding out creates systemic inefficiencies because it eliminates competition and hampers innovation.
The existence of national champions has also created difficulties for domestic non-champion companies. Economists use the term “crowding out” to mean that when the government outspends the private sector in a given sector, it becomes impossible for the private sector to compete, and removes any impetus for the private sector to invest. In the long run, crowding out creates systemic inefficiencies because it eliminates competition and hampers innovation. In China’s case, the government favoring a small number of firms and rewarding them with more financing and greater opportunities contributes to wealth disparity and a lack of free market competition within China. China supports its large SOEs to make them competitive with foreign companies; however, domestic competition suffers as a result of this strategy.[18]

As China’s economic growth slowed in 2016 and 2017, the number of Chinese companies on the Forbes Global 2000 fell from 232 to 172.[19] Without government support, many SOEs cannot hold their position. The preferential treatment given to champions, particularly in restricted sectors, grants monopoly or near monopoly rights to these companies and essentially removes pressure to increase performance.[20] As a result, the profitability of these companies is lower than expected. Today, 42% of total profits claimed by publicly traded SOEs can be attributed to 20 companies, most of which are in protected sectors such as oil, steel and utilities.[21] In 2012, the average return on assets for nonfinancial SOEs was 3.1%, which is well below the cost of capital.[22]

Despite the slow economic development and potential stagnation of these companies, China’s SOEs and national champions will continue to grow. This growth may or may not result in increased profits for the companies themselves. The ever growing SOEs and national champions will continue to have an impact in the global market and make entering the Chinese market more difficult for foreign companies while also making it difficult for domestic non-champion companies to grow.

References

[1] Shreya Agarwal, Global 2000: China’s Largest Companies 2016, May 25, 2016

https://www.forbes.com/sites/shreyaagarwal/2016/05/25/global-2000-chinas-largest-companies-2016/#11744e302b29

[2] Steve Schaefer, The World’s Largest Companies 2016, Forbes, May 25, 2016,

https://www.forbes.com/sites/steveschaefer/2016/05/25/the-worlds-largest-companies-2016/#4bc4e02345a6

[3] Thomas A. Hemphill and George O. White III, China’s National Champions: The Evolution of a National Industrial Policy — Or a New Era of Economic Protectionism?, Wiley Online Library, 2013 Wiley Periodicals, Inc. • DOI: 10.1002/tie.21535 (pp. 196, 198)

[4] Archibald Preuschat, Huawei Aims to Be World’s Second-Biggest Smartphone Maker by 2018, September 1, 2016

[5] The Economist, We are the champions, China’s state-owned enterprises want to make their mark on the world stage. They will struggle, The Economist, March 18, 2004

http://www.economist.com/node/2495172

[6] Wendy Leutert, Challenges Ahead in China’s Reform of State-Owned Enterprises, The National Bureau of Asian Research, Seattle, Washington, Asia policy, number 21 January 2016, 83–99 http://asiapolicy.nbr.org

[7] The Economist, We are the champions, China’s state-owned enterprises want to make their mark on the world stage. They will struggle, The Economist, March 18, 2004

http://www.economist.com/node/2495172

[8] The Economist, We are the champions, China’s state-owned enterprises want to make their mark on the world stage. They will struggle, The Economist, March 18, 2004

http://www.economist.com/node/2495172

[9] Bloomberg, China Tells Foreign Firms to Brace for Bigger Competitors, Bloomberg News, March

https://www.bloomberg.com/news/articles/2016-03-15/china-congress-to-foreign-firms-brace-for-bigger-competitors

[10] Greg Levesque, China’s Evolving Economic Statecraft Beijing’s use of commercial actors to carry out Party-state objectives requires a coordinated response, The Diplomat, April 12, 2017

http://thediplomat.com/2017/04/chinas-evolving-economic-statecraft/

[11] Thomas A. Hemphill and George O. White III, China’s National Champions: The Evolution of a National Industrial Policy — Or a New Era of Economic Protectionism?, Wiley Online Library, 2013 Wiley Periodicals, Inc. • DOI: 10.1002/tie.21535 (pp. 199)

[12] Jay Greene and Roger Cheng, Inside Huawei, the Chinese tech giant that’s rattling nerves in DC, CNET,August 27, 2012

https://www.cnet.com/news/inside-huawei-the-chinese-tech-giant-thats-rattling-nerves-in-dc/

[13] Greg Levesque, China’s Evolving Economic Statecraft Beijing’s use of commercial actors to carry out Party-state objectives requires a coordinated response, The Diplomat, April 12, 2017

http://thediplomat.com/2017/04/chinas-evolving-economic-statecraft/

[14] Thomas A. Hemphill and George O. White III, China’s National Champions: The Evolution of a National Industrial Policy — Or a New Era of Economic Protectionism?, Wiley Online Library, 2013 Wiley Periodicals, Inc. • DOI: 10.1002/tie.21535 (pp. 199, 200)

[15] Thomas A. Hemphill and George O. White III, China’s National Champions: The Evolution of a National Industrial Policy — Or a New Era of Economic Protectionism?, Wiley Online Library, 2013 Wiley Periodicals, Inc. • DOI: 10.1002/tie.21535 (pp. 196, 198)

[16] Thomas A. Hemphill and George O. White III, China’s National Champions: The Evolution of a National Industrial Policy — Or a New Era of Economic Protectionism?, Wiley Online Library, 2013 Wiley Periodicals, Inc. • DOI: 10.1002/tie.21535 (pp. 193, 194)

[17] European Union Chamber of Commerce, 2011a cited in Thomas A. Hemphill and George O. White III, China’s National Champions: The Evolution of a National Industrial Policy — Or a New Era of Economic Protectionism?, Wiley Online Library, 2013 Wiley Periodicals, Inc. • DOI: 10.1002/tie.21535 (p. 194)

[18] John Lee, A long march for China’s national champions

Business Spectator, November 13, 2013

http://www.theaustralian.com.au/business/business-spectator/a-long-march-for-chinas-national-champions/news-story/4f2215462586493fe68bc30397dadf31

[19] Shreya Agarwal, Global 2000: China’s Largest Companies 2016, May 25, 2016

https://www.forbes.com/sites/shreyaagarwal/2016/05/25/global-2000-chinas-largest-companies-2016/#11744e302b29

[20] Wendy Leutert, Challenges Ahead in China’s Reform of State-Owned Enterprises, The National Bureau of Asian Research, Seattle, Washington, Asia policy, number 21 January 2016, 83–99 http://asiapolicy.nbr.org

[21] The Economist, We are the champions, China’s state-owned enterprises want to make their mark on the world stage. They will struggle, The Economist, March 18, 2004

http://www.economist.com/node/2495172

[22] Wendy Leutert, Challenges Ahead in China’s Reform of State-Owned Enterprises, The National Bureau of Asian Research, Seattle, Washington, Asia policy, number 21 January 2016, 83–99 http://asiapolicy.nbr.org