Did China Just Blink?

Opening the automobile market is a great first step

Every country in the world would love to have successful automobile manufacturers, including China.  China is the largest auto market in the world and has many policies designed to help Chinese auto companies.  This is why it is so important that yesterday China announced it will dramatically open its auto market.  Tariffs will be significantly reduced.  Ownership restrictions will be lifted immediately for electric cars and within 4 years for all cars.  While opening the auto market alone isn’t enough to meet the expectations of the Trump administration, it is a great first step.  If China applies this approach to a sufficient number of other industries there will almost certainly not be a trade war. 

 

GM, Ford, and other foreign companies dominate Chinese auto market

The automobile market is actually a great vehicle through which to test some of the assertions that one hears relative to the Chinese economy.  Fifteen years or so ago, there was a major scandal involving Chinese engineers working at a General Motors joint venture who stole intellectual property.  At that time, China required foreign automakers to take on joint venture partners and limited the foreigners to 50% ownership.  China also required foreign automakers to transfer manufacturing technology to China.  Critics said the IP theft by those engineers was an indication as to the true intentions of China’s restrictions—to force technology transfer so as to give the Chinese manufacturers an advantage. 

 

China’s restrictions backfired

That may have been China’s intention, but it didn’t work.  Not by a long shot.  Today, foreign brands account for roughly 70% of China’s passenger vehicle market.  Ford, GM, Toyota, BMW, Audi, Volkswagen, and other foreign auto companies all make handsome profits in China and consider the market to be key to their future.  The state-owned enterprises (SOE’s) that are partners with the foreign companies all have their own brands as well.  None of them are very successful.  In fact, the most successful Chinese automobile companies are not the SOE’s that partnered with foreign companies and therefore had access to their technology, but the private companies started by entrepreneurs.  Over the past few years, the idea has been floated that the Chinese SOE’s should be forced by the government to sell down their foreign joint venture stakes because, if they couldn’t rely on those profits, maybe they would be get serious about making better cars themselves. 

 

Technology transfer does not necessarily mean technology stolen

We can learn a couple of lessons from this.  First, transferring technology does not necessarily mean technology is stolen.  Many foreign companies have made technology-related investments and transfers to China without losing competitive advantage.  Companies know how to do this and Chinese regulations generally leave room for a fair amount of self protection.  But it depends on the industry.  For example, it is easier to protect competitive advantage for mechanical parts as compared to hi-tech.  To build a successful car company, even if you steal a design, you still have to manage an enormous supply chain, maintain quality over thousands of parts, build brand awareness, and be able to make design enhancements every year.  That isn’t easy.  On the other hand, for many hi-tech products, key software code or chip design can be the make or break factor for a product and thus can have a much greater impact on competitiveness. 

 

Industrial policy doesn’t work, not even for China

Secondly, industrial policy doesn’t really work.  China’s economic success over the last 40 years is due its engagement with the global economy, the huge contribution of foreign investment, and its hardworking and resourceful workers, professionals, and entrepreneurs.  Subsidies and restrictions produce way more failures than successes.  That doesn’t mean we shouldn’t oppose subsidies and restrictions.  Such things can, under the right circumstances, injure competitors and disrupt industries.  But they don’t build an economy.  Gradual movement toward the free market builds an economy, as China has demonstrated.  This is why China’s president, Xi Jinping, has pledged to make the market “decisive” in China’s economy. 

 

The same approach applied to more industries: Good for China, US, and ROW

It seems, relative to the auto market, Xi is following his own advice, keeping his own promise.  That is good for China, the US, and the rest of the world.  Some issues and sectors, like high tech, will be particularly difficult.  But if China can apply this approach—lowering tariffs, removing ownership restrictions, increasing competition—to enough other sectors, we won’t have a trade war, and both Trump and Xi can claim victory.  The auto sector is just a start.  But it is a good start.