Coming to Terms with Industrial Policy

In a recent conversation with some US-China Business Council (USCBC) member companies in Shanghai, the question arose of how to identify and capitalize on business opportunities in China while meeting the challenges of serving the China market, which is so different from most of the rest of the world. The conversation ranged from why companies choose to invest in China to difficulties in communicating the complex nuances of China’s investment environment to colleagues at headquarters. Toward the end of the conversation, one participant piped up, “But how do we explain China’s industrial policies to rural America?”

Some US companies may cringe at the thought of the mere existence of industrial policies, and those feelings probably stem from personal preferences rooted in one’s view of how markets should operate. A review of Chinese history shows that governing officials have almost always used some sort of industrial policy to manage economic growth. Industrial policies during China’s imperial dynasties may have looked a little different than today’s version but the underlying rationale was the same: to promote economic growth and industrial advancement in a strategic and coherent way for the benefit of the state.

Whether industrial policy is an effective economic tool is, in some respects, immaterial. PRC government officials have chosen to use industrial policies as a key feature of their economic development model. Industrial policies are a fact of life in China, and successful US companies there pay attention to them, making strategic decisions based on the risks and rewards that they present.

Where can companies learn about China’s industrial policies?

Transparency has increased significantly in China over the past decade. Though there is still room for improvement, the central government has made great progress in making government documents more accessible to the public: Companies can now go to government websites and read the policies for themselves.

One good place to start is the Guiding Catalogue for the Adjustment of Industrial Structure, which the National Development and Reform Commission (NDRC) released in 2005 and plans to update in 2010. NDRC is China’s chief macroeconomic planning body. With input from other agencies such as the Ministry of Industry and Information Technology and the Ministry of Commerce, it uses various administrative and regulatory tools to develop or restrict certain industries. One such tool is the industrial structure catalogue, which identifies 539 “encouraged” industries, 190 “restricted” industries, and 399 “to-be-eliminated” industries. No new investment is allowed in “restricted” industries, and existing investment in “to-be-eliminated” industries will be restructured or eliminated. The catalogue covers more than 20 industries including agriculture, power generation, transportation, textiles, services, and environmental technologies. Because it applies to all investment in China and not just foreign investment, the industrial structure catalogue is an excellent tool for foreign companies to better understand the government’s economic priorities and potential business opportunities.

Another tool that PRC policymakers use to manage and direct foreign investment is the Catalogue Guiding Foreign Investment in Industry. Last revised in 2007 and expected to be revised again in 2010, the foreign investment catalogue describes ownership restrictions and places industries into three basic categories—encouraged, restricted, and prohibited. (Any industry that does not fall into one of those categories is considered “permitted.”) For example, foreign companies that operate in restricted industries are often limited to joint ventures, in some cases with the Chinese partner as the majority shareholder, and also tend to be subject to higher-level government approvals. One potential mistake foreign companies may make is in interpreting the term “permitted” as favorably as the term “encouraged.” Industries in which foreign investment is permitted is simply that: It is permitted, and foreign investors should not expect any special accommodation, although that should not stop them from attempting to negotiate. The foreign investment catalogue makes government priorities clear, and only industries in the encouraged sector should hope to receive favorable treatment, such as speedy approval processes, reduced land use fees, or tax incentives.

In fact, there are a several types of documents companies should study to get a clearer sense of China’s industrial policy for their sector:

• Five-year plans are broad policy outlines that cover a specific five-year period; the next one will cover 2011-15 and be released next March. It discusses in general terms everything from the macroeconomic direction to key broad priorities that the government plans to achieve, such as universal healthcare and reducing energy intensity per unit of gross domestic product.
• Strategic plans are narrower in focus and cover longer periods. Some include more detail on specific targets, regions, or technologies that will be the focus of government efforts. Though often vague, these strategic plans give direction to relevant ministries about the principles they should follow when writing specific laws and regulations that govern the affected sectors. Examples of these types of plans include the Medium to Long-Term National Plan for Science and Technology Development (2006-20) and the Mid- to Long-Term Development Plan for Renewable Energy (2006-20).
• Industry-specific plans aim to give greater direction to a specific sector. Though there is no timetable for industry plans to be released or updated, they sometimes follow the beginning of a new five-year plan or the release of a broad strategic plan. Industry-specific plans often go into much greater detail about projects or technologies the government wants to promote. In addition to the industry revitalization plans that the central government released in spring 2009, other plans include the National Industry Technology Policies, the Renewable Energy Development Plan, and the Opinions on Expediting the Development of the Services Sector.
• Catalogues, such as those mentioned earlier, list specific industries, technologies, or products in several categories, often focusing on products and services that will receive preferential treatment. Some of these catalogues are updated annually, such as the Ministry of Environmental Protection’s Catalogue of Preferred National Environmental Protection Technologies (2009).

Risk before reward

Through these various documents and catalogues, investors can learn at least two important things. First, they can gain an understanding of which technologies the central government would like to see developed in each industry. (For example, the Electronics and Information Technology Revitalization Plan states that China should produce more hybrid integrated circuits and thin-film solar cells.) US companies should review these industry-specific plans to identify potential business opportunities and evaluate how the PRC government views that product or service within the context of the overall plan for that industry.

Second, a company can find clues about how the government will ensure development in that industry. This is essential because companies need to evaluate to what degree they can operate within the policies’ parameters and to what extent they can accept challenges presented by the implementation of that policy. For example, several of the industry revitalization plans specifically call for the development of “national champions”—companies strong enough to dominate the domestic market and compete internationally—through building up, supporting, and giving preferences to domestic companies. China seems to be making progress on this goal, as is reflected by the fact that “competition” ranks fourth on the list of top issues facing American companies in China, according to USCBC’s 2009 membership survey.

In short, companies need to use China’s industrial policies and product catalogues to fully and honestly evaluate business opportunities and marketplace challenges. Companies must be prepared to evaluate their own strategies and priorities in light of those of the central government. This is not to suggest that companies should put the government’s goals above their own priorities. Rather, a solid review of China’s industrial policies should enable a company to

• Identify more clearly which products it should introduce or develop in China and which products it should consider introducing or developing elsewhere;
• Determine how comfortable it is partnering with a Chinese company;
• Find ways in which it can advance China’s development goals while expanding its corporate footprint;
• Strategize how to manage or leverage internal resources such as intellectual property and links to other markets; and
• Develop a more comprehensive and realistic government affairs strategy that takes into consideration long-term company goals and short-term tactical considerations to address specific problems.

Companies have different products, services, technologies, and most important, different priorities. When it comes to managing investments in and trade with China, taking a long, hard look at China’s industrial policies will better position a company to make sound business decisions that are appropriate for its own growth and goals.

[author]Julie Walton is the US-China Business Council’s chief representative in Shanghai.[/author]