Book Talk at USC

Several weeks ago I gave a talk related to my forthcoming book at the University of Southern California.  Watch as I attempt to summarize four years of research and a 300-page book in less than an hour.  :)

How fragmented is China's auto industry?

For anyone wondering where I've been for the past several months, I've been right here at my desk. But instead of posting to this blog, I've been in a push to complete a full first draft of my dissertation by the end of March -- which is beginning to look like a real possibility.

For now, here's a quick post of some numbers I've been looking at for the past few days on market shares in China's auto industry.

Probably the most consistent component of China's auto policy since the mid-80s has been the insistence of the central government on consolidation in the industry. Just looking at the raw numbers, I think most people would agree that this demand has been completely justified.

In 1978, the year that Deng Xiaoping launched the first experimental market reforms in China, there were 55 auto assemblers. The number peaked at 124 in the mid-90s, and by 2008 (the latest numbers available) there were still 117 -- clearly, way too many.

But just how fragmented is China's auto industry? Here is a quick comparison with the US.

This chart compares cumulative 2010 market shares for the top five auto companies in the US and China.








If China were to take the US as its example, then it would seem to have already achieved a fair amount of consolidation. China’s largest auto group has a slightly larger share of its market than does the largest automaker in the U.S., and the top five in both markets are practically even.

Of course, we already know that the US market is somewhat less concentrated than it used to be. In 1980, for example, the Detroit Three held 76 percent of the US market. But I think few people would argue that less concentration in the US market has not been good for consumers.

So while it would appear that China is starting to see some solid growth out of the players at the top of its auto industry, the problem lies with all of those tiny companies at the bottom that, for some reason, refuse to go away.

Who are these small players? Quite a few are small, locally-owned automakers that lack any kind of scale to be profitable. In any given year, they probably break even on a cash flow basis, which means that the local government is absorbing their cost of capital. If exposed to true market competition, these small firms would quickly disappear.

So why haven't they? Local governments don't want them to. They employ anywhere from a few dozen to maybe even a few hundred local people, and local governments are not inclined to create any more of an unemployment problem than they have to.

Of course, the central government, through the NDRC or MIIT, could force these local enterprises to close, but why would they? The central government is no more interested in putting people out of work than are the local governments.

So if we simply accept that some of these small players are part of a welfare system that keeps people gainfully employed, then China's leaders should at least be satisfied that, at the top of its auto industry, it appears to have the makings of an increasingly strong and competitive industry. Right?

I don't think so, and this next chart reveals why.

Here we have the top five companies in both the US and China along with their respective market shares.









What I notice about this chart is that each of the companies on the US side also corresponds with a brand, but each of the companies on the Chinese side is just a big old state-owned enterprise that assembles cars for foreign companies.

SAIC makes most of its money selling VW and GM cars. Dongfeng sells Nissan and Citroen. FAW sells Toyota and VW. Chang'an sells Ford, Mazda and Suzuki. BAIC sells Hyundai and Mercedes.

Yes, each of these companies also sells some cars under its own brand, but the numbers are comparatively small. Overall, only 30.9 percent of sedans sold in China in 2010 were of local brands -- up only slightly from 30 percent in 2009.

And therein lies the problem. China's central government wants its biggest SOEs to get bigger so that they can compete with the foreign multinationals. For now, they would just like to dominate in their own market, but eventually, they want to compete in overseas markets as well.

The problem is that, while these SOEs are indeed developing their own brands, it's just so easy to sit back and rake in profits while the foreigners contribute all of the intellectual property.

Designing your own stuff is hard.

In China, not all politics is local

I realize a lot of my posts are about BYD, and I think that attests to the prowess of their PR team and their ability to keep themselves in the news. (One could say the same for Geely.) Today's story, however, is not one that BYD's PR department would have wanted us to know about.

About a week ago the news emerged that BYD was being fined and having some of its factories in Xi’an confiscated as punishment for a land-use violation. This came as a bit of a surprise to me.

First, a little background

In July of 2009 BYD signed an agreement with the Xi’an High Tech Zone to build a factory that would expand production by 200,000 vehicles per year. That same month, two different village governments in Huxian County (in the Xi’an area) appropriated 725 acres of land for BYD’s project, and, according to law, compensated the people who were being moved off the land. As is turns out 91 percent of the land appropriated was arable.

Huxian County then asked the Xi’an city government to approve an expansion of the BYD project land to about 807 acres (90 percent of which would be arable). Xi’an City then passed this request up to the Shaanxi Provincial government who approved the request in November of 2009.

By the following month, BYD had begun construction on seven factory buildings including a dormitory, a mixing plant and surrounding roads on about 121 acres of land, 92 percent of which was arable. (The difference between the acreage being used by BYD and that requested by Huxian County is not immediately apparent.)

All of this came to light in July of 2010 when the Ministry of Land and Natural Resources ordered a halt in construction and launched an investigation into illegal development of arable land.

As I mentioned in an earlier post, the development of arable land has become a serious issue in China, drawing much discussion at the National People’s Congress in March of 2010. The law, as it pertains to this issue, also seems pretty serious: any potential non-farm use of arable land, anywhere in China, must be submitted to China’s State Council (the Cabinet) for approval.

By agreeing to BYD’s use of arable land for factory construction, the Shaanxi Provincial Government was clearly in violation of this law. It had no authority to grant an approval.

BYD, for its part, thought it had covered all its bases. It went to the local government and filed its request, and within a few months, it received the approval it wanted. And this kind of behavior by BYD and local governments was not out of the ordinary.

The Ministry of Land and Natural Resources, however, did not see it that way. It fined BYD nearly $500,000 and confiscated all of its illegally constructed buildings. And since an entire hierarchy of local officials from village to county to city to province had granted approvals, Beijing handed out punishments to them as well, meting out fines, warnings and demerits to 14 officials at various levels.

What this means

The fact that both BYD and local officials were punished was a clear signal from Beijing that this law in particular is not to be broken – killing a few chickens to scare the monkeys. Monkeys all over China are now duly warned.

What initially surprised me upon the announcement of the investigation in July was that the Ministry of Land and Natural Resources (MLNR) would enforce this law against BYD, a company that appeared to be among Beijing’s favorite private companies due to its success in selling low-emission cars and development of new energy vehicles. BYD was even the favored recipient of a loan from Bank of China last December for building a solar plant.

My assumption had been that someone above the MLNR, perhaps in one of the more powerful ministries like MIIT or the NDRC, would trump MLNR’s decision, and BYD would get off lightly. Well, a nearly $500K fine and confiscation of buildings is anything but light. (Fortunately for BYD, they weren’t also forced to restore the land to its pre-construction arable state!)

And this comes at an unfortunate time for BYD whose sales have been dropping. In the summer it announced a significant scaling back in projected sales for 2010 from 800,000 to 600,000. Its F3 (a Toyota Corolla clone) was the best selling sedan in China in 2009, but it wasn’t even among the top-ten sellers last month. Also, for reasons that are not entirely clear, BYD has backed away from its previous intention to introduce its all-electric E6 crossover in California this year.

But BYD’s difficulties are not the most important part of this story. The issue here is that Beijing is getting serious about the use of arable land, and it is sending out the signal that such abuses of the law will no longer be tolerated.

(This is, in my opinion, related to China’s concern for self-sufficiency which borders on paranoia. The apparent fear is that other countries will hoard goods China needs as it may now be doing with the rare earth metals that Japan needs. Perhaps China is not aware that the United States sold grain to the Soviet Union at the height of the Cold War. But I digress…)

Many China-watchers observe local governments getting away with ignoring Beijing’s dictates and assume this means that Beijing is powerless to enforce its will in the provinces. This simply is not true. As this incident demonstrates, even a relatively weak ministry can get its way when it wants to. Just because you can get away with breaking the law today doesn’t mean you can do it tomorrow.

__________________

Chinese sources consulted for this article:

国土资源部公布四起部挂牌督办违法案件处理结果
比亚迪项目违规占地受罚
比亚迪西安违法占地案处理超预期 14名官员被问责

BYD Between a Rock and a Hard Place

The multinationals think they have it hard? It seems that one of China's rising stars of the auto world, BYD, has run afoul of the authorities in Beijing.

BYD, a Hong Kong listed automaker based across the border in Shenzhen, has aims of becoming bigger than Toyota someday, but in the short term at least, they may have to scale back their expectations. At the beginning of this month BYD broke ground on its second factory in the city of Xi'an. This new 5 billion yuan factory, due to open in 2011, has a projected capacity of 400,000 cars a year.

Yesterday, BYD was ordered by the central Ministry of Land and Resources to halt construction of its new factory because of a "land use violation". The Ministry's announcement gave no further specifics as to the nature of the violation. In its defense, BYD said that it had conducted due diligence and obtained the necessary approvals from local government. So it would appear that the violation has been committed not by BYD, but by the local government.

Perhaps the violation comes as Beijing has stepped up its enforcement of land use policies. There was much talk during this year's National People's Congress of the need to prevent local governments from appropriating farmland to sell to developers, a situation that has led to much social unrest in recent years. Regardless, BYD has become yet another victim of the vagaries of doing business in China.

Until now, the conventional (yet somehow simultaneously unorthodox) wisdom has been for foreign companies to worry more about local governments when setting up their businesses in China. Just because you got approval from someone in Beijing didn't mean that all problems were solved. Local governments are the ones with the real power to make or break your business, and "as everyone in China knows" the central government devolved a lot of their powers to the local governments back in the 1980s.

So which governments should you be worried about? Perhaps the received wisdom (conventional or unorthodox, or whatever you want to call it) needs to be revisited. The real answer is, you need to worry about both.

Increased Worker Activism: Symptom of a Central-Local Issue?

For the second time in a month, local Chinese officials have been forced by workers to call off privatization of steel mills.

The first incident occurred in Jilin Province on July 27 during which thousands of workers protested the proposed privatization of Tonghua Iron and Steel. The manager of the mill was beaten to death by disgruntled workers who felt their needs were being ignored.

The latest incident occurred on Sunday as Henan Provincial officials, again, pushed by protesting workers, called off the proposed privatization of Linzhou Iron and Steel.

In both cases, the SOEs being privatized are owned by local governments, not the central government. The workers, on the other hand, are officially represented by the All China Federation of Trade Unions (ACFTU), which is a centrally-managed organization affiliated with the Communist Party.

While no evidence suggesting any corruption has been presented as of yet, local government officials have profited quite handsomely in the past from privatizations of local SOEs.

The focus of the Hu-Wen government -- in stark contrast with that of the Jiang-Zhu government which pushed for increased privatization -- has ostensibly been less on privatization, less on growth at any cost, and more on ensuring that China's common people get a chance to benefit from economic reforms.

There are a couple of apparent conflicts between central and local governments that we may see playing out in the steel industry (among others) right now. First, the ACFTU, according to the Wall Street Journal, "has been taking a more active role in trying to represent workers' rights", and as a result, their organization may have taken a role in encouraging workers, if not to protest, at least to demand their voices be heard. This is in direct opposition to the incentives to local officials who are highly motivated to privatize locally-owned assets.

Second, the central government has been adamant that China's steel industry, in its present state, is far too fragmented for any one company to become a major global player, not only as a steel producer, but as a negotiator with iron ore suppliers. While the central government's power to force locally-owned SOEs into mergers is questionable, further privatization of these assets would even further dilute the central government's power over this pillar industry.

As an aside, I also find it interesting that, the richer China's people become, the more rights they seem to demand. This connection between wealth and demands for rights has been pretty much debunked by economists and political scientists over the past decade or so, mostly because no one has been able to identify the causal mechanism connecting wealth and democratization -- this despite abundant empirical evidence pointing to a relationship* -- with (until recently?) one glaring exception: China.

*Robert J. Barro has called this relationship "an empirical regularity".

This is not to say that China's workers suddenly have rights simply because they've demanded it, but, while the ACFTU (with its access to the resources of the central government) is clearly in a position to help stop worker unrest, one wonders whether they may have been encouraging their organization.

At a minimum, we can identify clear conflicts between central and local governments here, and the workers seem to be caught in the middle.

In Lieu of an Actual Blog Post...

A decision to spend the rest of the summer in LA, followed by a decision to move to a different apartment, have interrupted my original research plans. Once my move is out of the way, I expect to spend the rest of the summer absorbing the content of the 30+ interviews I have conducted in China thus far and planning my return to China later in the year, as well as hopefully resuming a more regular blog posting schedule.

Meanwhile, I was recently interviewed about my research by the intrepid Aimee Barnes, a New Yorker and China specialist who interviews other China specialists with diverse backgrounds. I am honored to have been added to the mix.

You can find a transcript of the interview on Aimee's blog, here.

A Couple of Recent Auto Mergers: So What?

The past week has seen a couple of merger announcements in the Chinese auto space. These are significant, first of all, because they are more than mere rumors: the partners have shaken hands; these mergers will actually happen. Even more significantly, these may portend further movement in China's auto sector.

The first one was announced last week. Guangzhou Auto is buying a 29 percent stake in Hunan Changfeng Motors. A Guangdong SOE is buying a controlling stake in a Hunan SOE, which is significant because until now, many observers, myself included, have thought the greatest barrier to consolidation in the auto industry to be local recalcitrance. That is, despite the Central Government's calls for consolidation for years, it has not happened because local governments have been reluctant to give up control of their prized auto companies.

This particular merger will supposedly give Guangzhou Auto a stronger offering in terms of a domestically branded SUV. In terms of design, however, I'm not sure whether Changfeng will have much to offer. The Changfeng people I talked to were very proud of this atrocious pickup on display at April's Shanghai Auto Show.



The other interesting story is yesterday's announcement of a three-way merger in the parts industry. I won't bore you with their names, which you can see if you follow this link.

Though this is not a cross-provincial merger (all three parties are headquartered in Shandong) this may be an indication that the Shandong government expects consolidation down the road, and that by bulking up the size of their parts company, they may be more likely to come out on top if mergers become mandatory at some point.

There has been a question as to whether the Central Government actually has the power to force mergers, or whether power has become too decentralized. Some insiders I have spoken with believe that, since the Central Government has not forced mergers so far, this means they lack the power. Others believe that the Central Government still has the power, but sees no need to upset the applecart at this point. As long as everyone is making money, the Central Government is happy to "let a hundred flowers bloom".

If that is the case, let us hope the aftermath of this "hundred flowers" campaign isn't quite as destructive as that of its predecessor.

Local Govts Throw Full Weight Behind "New Energy" Auto Development

Encouraged by the attention paid to "new energy" vehicles in the Central Government's recent auto policy (Chinese), local governments have piled onto the new energy bandwagon with amazing alacrity.

Perhaps the projected output of 500,000 hybrid or purely electric autos and buses within three years is an indication of the Central Government's seriousness in becoming a global player in this market. Compare this figure with CSM Worldwide's projection of 1.1 million of such vehicles by Japan and Korea and only 267,000 by North American automakers. (Figures from Keith Bradsher's recent NYT article.)

An article this week in the 21st Century Business Herald highlights the preparation of a lot of local governments to take part in China's green car revolution. Many of these governments are forming local "new energy auto alliances" (新能源汽车联盟) that bring together local automakers, parts suppliers, universities and think tanks in an effort to plot strategy, recommend policy and ensure that local business benefits from such development.

Among the local regions that have already established formal alliances are Jilin Province, Chongqing City and Beijing City. In Jilin, First Auto Works (FAW) figures prominently as a center-piece of the local alliance, as does Changan in Chongqing. In Beijing, the central company is Beijing Foton (福田) which is controlled by Beijing Auto Group. Shenzhen, Hubei and Anhui are said to be planning similar alliances around BYD, Dongfeng and Chery, respectively.

The clear purpose here, as Bradsher's article reported, is for China to become a world leader in electric cars. To this end, China's Ministry of Industry and Information Technology also intends to convene a meeting in mid-April that will include several automakers (both foreign and domestic), State Grid and local auto industry authorities to begin planning the rollout of electric vehicle charging infrastructure (see article at Gasgoo.com). Does anyone doubt that China is serious in its bid to become a major global player in this space?

While China should be praised for its proactive approach, not only toward cleaning up its environment, but in its savvy attempt to get ahead of the curve in electric vehicle technology, there are also drawbacks to its state-led approach.

Because local governments have such a stake in the success of their local firms, local protectionism has already become a key component of local auto policies. As I wrote in a previous post, the City of Shenzhen is going all out to ensure that BYD becomes a major player by buying loads of BYD's vehicles for use by city government and public transportation, and now by subsidizing the purchase of BYD vehicles by city residents. Another previous post pointed out that the City of Changchun is rebating inspection fees for vehicles purchased locally. As long as China's domestic manufacturers sell most of their cars in their home provinces, it will be difficult for any automaker to develop the scale needed to make electric vehicles at a sustainable profit.

Another problem is that local regions all over China are competing furiously to spend a lot of money on new vehicles whose technologies have basically been decided. No one is proposing anything like a "Back to the Future" car that runs on household garbage. As far as anyone is aware, all of the money is going toward variations on lithium-ion battery technology and hybrid or purely electric vehicles. A lot of duplication of effort is going on, and aside from employing a massive number of engineers, much of this spending is likely to have been wasted once these vehicles begin to hit the road in ernest.

Many people have been quick to praise the progressiveness of China's government in leading the charge to make itself into a global player for "new energy" vehicles -- myself included -- even to the point of criticizing other governments for not being progressive enough. However, I think the jury is still out as to which model will ultimately win: China's model of industrial planning, or the various degrees of market-led, government-assisted models employed in Japan, North America and Western Europe.

If I had to make a long-term bet, it would be on the unknown engineers at work in a garage somewhere in Silicon Valley who don't see the "Back to the Future" car as a mere dream of fiction.

Auto Industry Consolidation: Who Calls the Shots?

I am happy to see that my interest in consolidation in China's auto industry is shared by others. Part of the interest stems from my overall research agenda which is to understand the nature of business-government relations in general.

The auto industry presents a great opportunity to observe in detail how these relationships affect outcomes. It also gives us an interesting case to compare to the U.S. experience of about 80 to 90 years ago when, like China today, there were over 100 auto assemblers in the U.S.

My assumption today is that the U.S. government remained largely aloof from the consolidation process, but frankly, that's only an assumption. Perhaps the U.S. government had a bigger role than we realize. (That's not the topic of this particular post, but I'm just throwing that out there.)

A couple of interesting posts on other China-focused blogs have recently covered the issue of consolidation in China's auto industry to varying degrees.

First is an interview with Bill Russo, former Chrysler guy in China (still in China, but no longer with Chrysler) on Aimee Barnes' blog. (h/t ChinaLawBlog). I'm specifically drawn to the following passage in part 2 of the interview:

In China, there are over 100 licensed automotive OEMs. That can’t continue- this is a market that just isn’t big enough to sustain that many licensed manufacturers. So, what will happen is the weaker OEMs will merge with the stronger OEMs. The government will also act a lot faster to correct the supply and demand imbalance - this is a top down system. The government will act in a way that constrains the capital inflow and guides consolidation towards a particular and preferred outcome.

The other is a post specifically about China auto reform by David Wolf on his Silicon Hutong blog. Wolf offers several reasons why consolidation, while definitely in the cards, will not happen anytime soon:

1. Geographical concerns. Forcing one auto maker to be acquired by another would require the Central Government to make hard political choices favoring one region over another. Wolf also notes that, while local governments have the power to derail possible mergers (an argument I have made before as well), the Central Government ultimately has the power to overcome local resistance.
2. Hastily closing down excess capacity in China could hand market share over to the foreign joint ventures. Slowing the process would allow makers of independent Chinese brands to gradually gain a stronger local market position.
3. It is too early to tell which Chinese automakers will come out on top, so the government is wise not to pick the winners too early.
   

Wolf concludes:

The nation's auto industry will be reformed in stages rather than with the single stroke of a pen, and the speed of those reforms will depend not only on market growth and global finance, but on the demonstrated ability of China's automakers to withstand the successive waves of change they will face in the coming years.

Based on my reading of the above, Russo appears to believe that the Central Government will act to bring about consolidation when it wants; whereas Wolf sees the process as more of a negotiated outcome that will take place over a longer period of time. I will throw out a few additional points that I think have an effect on consolidation and close with a series of questions.

1. While the Central Government has been harping (justifiably, I believe) on the need to reduce overcapacity in the auto sector, now is not the time (from the perspective of China's leaders) to risk the additional unemployment that could result from forced acquisitions. Unemployment ≠ Harmonious Society.
2. Despite its continual calls for consolidation, the Central Government appears to be more interested in the development of independent Chinese brands, and is willing to continue tolerating inefficiency in order for that to happen. For example, rather than allowing the Export-Import Bank to give Chery a 10 billion RMB loan for expansion, the Central Government could have made funding contingent on a merger with another automaker. Why didn't the Central Government take this opportunity? My guess is that Chery's position as maker of the best-selling independent Chinese brand had something to do with the decision. (This argument is related to Wolf's point 2 above.)
3. Granted, the Central Government has the ultimate power to force consolidation. However, I am going to assume that the leaders in Beijing are intelligent enough to know that the cost of getting their way may not be worth the benefit.
   

In all fairness, because Russo's point was taken from a much larger interview whose focus was not consolidation, perhaps I have read too much into his belief in the Central Government's power to force consolidation. If that is the case, then I shall stand corrected. Nevertheless, I think the juxtaposition of these two points-of-view -- regardless of who holds them -- raises very interesting questions about business-government relations in China:

• Which level government will have the greatest influence on the ultimate outcome?
• Can the Central Government design its preferred outcome and gradually exert influence to ensure that it happens?
• Or do the local governments have enough power to affect the ultimate outcome -- one that could be different from the Central Government's preference?
• If local governments do have power to affect the outcome, do some local governments have more power than others? For example, could the richer or more well-connected provinces have a bigger say in the outcome?
  
• Finally, does the market have any role at all in what will happen to this industry?

I realize these aren't open-ended questions, so please feel free to elaborate.

Thanks for reading!
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UPDATE: As a former business person, I'm a bit embarrassed to admit that I left out one very important constituency in this process: the auto firms. Here are some more questions:

• How do the automakers fit into this equation? How much influence do they have in the process?
• What factors affect the influence of auto firms: size, market share, ownership (SOE vs private, Central SOE vs Local SOE, listed vs unlisted, etc.), company leadership, brands (local vs foreign)...
  
• Okay, that's enough. Feel free to talk amongst yourselves...

Leadership Thinking in the Airline Industry

Today's SCMP has an interview with Liu Shaoyong, Chairman of China Eastern Airlines, the weakest among the "Big 3" central state-owned airlines. The 51-year old Liu is a former pilot and former head of China Southern Airlines, another of the "Big 3".

Some readers may remember that, five years ago, China Southern was loaded with debt and in desperate straits. Liu is credited with taking the helm then, and turning things around in two years' time. A similar feat is now expected of him at China Eastern.

Unfortunately for Liu, the bull market that drove demand for air travel as he worked his magic on China Southern has long since ended. He's performing without a net this time.

If I have any regular readers, I'm sure you have recognized by now my particular obsession with business consolidations in China. The China Eastern story presents an interesting case as highlighted in SCMP's interview with Liu Shaoyong:

Q: You have said that a merger between Shanghai Air and China Eastern would be a good thing. Is it on your agenda as one of your aims?

A: It is more complicated than it seems. China Eastern is owned by the central government, while Shanghai Airlines is owned by the Shanghai municipal government. There are no talks between the two companies. However, I do not know whether government officials have entered talks. I am not at liberty to discuss things that involve the government level.

One of the issues with which I have been fascinated is how and why mergers take place in China. Who initiates discussions? Who carries out the negotiations? Who has more influence, firms or governments?

In this instance, assuming that Liu is speaking truthfully, it would appear that Liu expects discussions to be initiated by the relevant levels of government, and that he may or may not be involved once discussions are initiated.

Presumably the companies themselves would eventually become involved so that a proper valuation of the acquiree can be reached, but that may be assuming too much. The story on last summer's consolidation in the telecom industry was that the details were arranged in high level government/Party discussions, and the companies were only notified after the decision had been made.

It is also quite likely that who the respective owners of these airlines are would determine how discussions begin. If both airlines were centrally-owned, then Li Rongrong, chief of Central SASAC, could probably wave his hand and make a merger happen. Since one of the owners is the Shanghai Government (represented by the local SASAC which reports, not to Beijing, but to the local govt), a lengthy negotiation is likely to take place.

Despite its authoritarian reputation, the government in Bejing does not always get its way. And while it may be able to force, say, the government of Sichuan Province to sell its provincial airline to Air China (as it did a few years back), Shanghai's government tends to carry more negotiating heft.

Despite Liu's denial, the SCMP interviewer presses him on the rationale for a potential merger anyway:

Q: State-owned enterprises cannot implement layoffs, but the benefits of mergers and acquisitions are mainly derived from reducing staff. So what would be the real benefit of a consolidation between Shanghai Air and China Eastern, if any?

A: This is "socialism with Chinese characteristics". Chinese enterprises are operating in a tougher environment than other companies in the world. Companies in other parts of the world can either sack people or resort to bankruptcy protection when they are not doing well. Airlines can cancel or delay aircraft where necessary. But this is not applicable in China. We solve problems by growing bigger and lowering unit costs. We aim at making profit by increasing revenue.

Q: Analysts suggest that merging two loss-making companies may not work? Do you agree?

A: Generally speaking, when a company reaches an optimal scale, all the benefits from economies of scale will come along, such as cost-effectiveness.

While profit is a good thing, and keeping people employed is even better, ultimately, the leaders of SOEs gain promotion by expanding their empires. While I have yet to see any empirical evidence that this is true across the board, everyone with whom I have discussed this issue -- and this includes many knowledgeable people both inside and outside of China -- seems certain that organizational size is among the most important factors for a leader's career.

Liu will probably not be successful in turning around China Eastern in the near term. The economic downturn will give him a perfect excuse for not succeeding, and anyway, the government has no problem pumping more money into big SOEs in order to keep them afloat. Hard budget constraints rule in the new China...until they don't.

Translating Central Policy into Local (in)Action

Despite its having been piloted in three provinces (later extended to another 10 or so) over the past year, the new nationwide policy of "home appliances to the countryside" has suffered some difficulties in implementation.

Today's SCMP offers anecdotal evidence that some farmers are having difficulty getting rebates on appliances they bought months earlier.

Under the programme, suppliers offered tenders for the right to participate in the scheme, and farmers had to buy their appliances from designated retail outlets to qualify for the rebate. But policy loopholes, bureaucratic inertia and lax oversight are making it very hard for the scheme's intended recipients to reap the benefits and farmers, retailers and officials are blaming one another for the programme's failings.

One of the farmers' complaints is that lower-level governments have little interest in implementing the scheme.

This highlights a common problem in which the Central Government promulgates a policy and then leaves implementation details to lower levels of government. While the costs of rebates are intended to be split 80/20 between Central and Local Governments, apparently no one in Beijing thought to ask whether the cities and provinces could afford to cough up their shares of the cash. Obviously some local governments are more willing than others.

Some fingers have also been pointed at participating retailers:

Higher-than-expected numbers of subsidy applications drained the fund in November and December, according to one Chongzhou (Sichuan) commerce official, as well as deception by some retailers. The Chongzhou government felt forced to pay the subsidies out of its own budget.

"The retailers collected many farmers' identification cards and used them to apply for the subsidies, but they did not sell as many electronic products as they claimed," the official said.

I suppose in this regard, China really is no different from any other country. Government programs, regardless of how well-intentioned, open windows of opportunity for corruption.

This illustrates the difficulty of implementing policies in China. It is comparatively easy for the State Council to debate and craft a policy, but translating that policy into real action where the Local State touches the people often proves more difficult.

Some scholars claim that the Communist Party's nomenklatura system of Party appointments and promotions helps to keep lower level officials in line: they listen to their superiors because they want to be promoted. But this discipline apparently does not reach into the lower depths of government.

Not So Fast, Chongqing

Back in December, the City of Chongqing approved a measure to reduce the tax on housing transactions. At the time it was reported, the stock market reacted by boosting the share prices of housing developers.

I remember being a little surprised at the time that a local government had the power to change tax rates -- particularly in markets in which the Central Government has frequently attempted to exert macro-control. Chongqing is run by Bo Xilai, a "princeling" son of late Party elder Bo Yibo, so, I reasoned, maybe he is given a little more leeway for creativity than the average provincial governor.

Well, apparently the State Council was also surprised by the tax cut, and today, they basically told Chongqing to knock it off. As it turns out, not even princelings have the power to change tax rates without consulting the Central Government.

We know what the Central Government thinks, but what about the tax rebate itself?

One of the arguments against the tax rebate was that it would have little effect on the lives of the laobaixing (common people) -- only the relatively small sliver of society that can afford to buy a home would be helped. However, I would argue the same probably applies to recent tax breaks on autos approved by the State Council.

Another argument, one that stands on firmer footing, is that the State Council still thinks housing prices are somewhat overvalued, and that such policies serve to place an as yet unwanted floor under current prices. And while this would certainly help the share prices of listed housing developers, again, it would do very little to help the laobaixing.

I see a couple of takeaways here:

• Despite the many arguments about decentralization and loss of influence by the Central Government, they apparently still have the ability to order changes to local policies that run counter to central policy. (Would anyone argue that Chongqing/Bo Xilai has sufficient power to ignore Beijing?)
  
• The State Council seems determined that the benefits of economic stimulus not accrue only to the upper class -- or at least that they not appear to do so.
  

Source: Economic Observer

All Politics is Local in China Too

Well, the market was quite unimpressed with yesterday's announcement by the State Council of support for auto firms. This will probably result in yet another plan from the State Council a few months down the road, and/or local governments will have to come up with their own measures to support their local auto firms.

There was a time when local authorities would simply pick up the phone and order the local branch manager of one of China's state-owned banks to make loans to favored industries, but Zhu Rongji supposedly put an end to that by centralizing lending authority in the late 1990s.

Another measure that local governments have traditionally taken is to order other locally-owned or -regulated businesses to offer discounts to favored industries. For example, they may order the local power company to knock a few zeros off a certain firm's energy bill.

Unfortunately for local governments, now the central government isn't too keen on energy discounts either, as the NDRC and State Electricity Regulatory Commission jointly announced today. "NDRC price regulators ... expressed concerns those incentives would negate Beijing's previous policy to phase out inefficient and pollution-prone plants by raising their power prices..." (SCMP, 16 Jan 2008)

So what's a worried local government to do? Local leaders are faced with mandates from the top to tamp down social unrest -- this is built into their incentives -- and one of the best (i.e. cleanest) ways to do that is to ensure that everyone has a job. Even if the NDRC is successful in getting local governments to stop energy subsidies to their local industries (and that's a big IF), local leaders will simply find other ways to keep their factories humming and their citizens happily employed.

Getting to the top of China's political ladder must be well worth the aggravation of trying to implement conflicting policies from above.

The Central Govt's Power to Consolidate, or Not

The South China Morning Post is reporting that the State Council is considering measures "such as tax cuts and incentives, to promote consolidation in the slumping steel industry". ("Beijing to Discuss Steel Industry Incentives and Consolidation", 13 Jan 2009.) These measures are apparently separate from the previously announced four trillion RMB stimulus package.

Consolidation among steel industry firms is certainly desirable; China's steel industry currently suffers from over-capacity among dozens of firms. This news, however, is probably not anything new. China's government has been talking about consolidation for years -- among both the steel and auto industries. So why has nothing happened until now? Is it due to the central government's unwillingness or inability to force consolidation?

The evidence would seem to argue for the former.

There are plenty of examples in which the central government was able to force consolidation and/or reorganization. Recent moves with the telecom industry come to mind. Also, several years ago, the central government was successful in consolidating the civil aviation industry. Local governments all over China had their own airlines, and in one fell swoop, these local airlines (with the exception of Hainan Airlines) were divvied up among China's current Big Three SOE airlines. Regardless of the reason, it can be assumed that the central government simply decided it was time for consolidation and took steps to make it happen.

If they could force this kind of consolidation on the airline industry, then why not the steel industry, or the auto industry? Why only use incentives and suggestions? Are the reasons political or institutional?

I had a conversation this afternoon with a visiting scholar from Beijing who took a stab at a hypothesis: Not surprisingly, it has to do with the staying power of the Communist Party. The logic here (at the risk of oversimplifying) is that, planes falling out of the sky run a much greater risk of causing widespread social instability than do problems with the quality of mainland steel or autos.

Poor oversight of a fragmented airline industry could potentially lead to maintenance problems, and ultimately, to plane crashes. Such news would cause people to question the viability of the Party which has staked its legitimacy on social stability, not to mention economic growth and more nationalistic themes such as technological prowess (which could be called into question should planes start to fall).

The perceived potential for social instability necessitated actions to force the consolidation of the airline industry. The lack of such potential in the steel or auto industries means that the central government is only willing to spend enough political capital to give really strong suggestions to the local government owners of firms in these industries. Suggestions that, until now, most have chosen to ignore.

At least that's my friend's theory. Does it sound plausible? Is there any evidence that would confirm or refute this theory?

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