Will the Anti-monopoly Law assist central regional development?

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Additional M&A activity anticipated if China can banish SOE cartels

By Chris Devonshire-Ellis

SINGAPORE, Feb. 26 – Could China’s new anti-monopoly law, promulgated last August and coming into effect August, assist with paving the way for a resurgence of investment into China’s central and western regions? The new law also includes provisions for anti-monopoly policing, which often involves large enterprises and the government, and demands that anti-monopoly law enforcers possess sufficient independence and authority. While many commentators on China law only look at the immediate impact on foreign investors, the implications for FDI in China and the development of infrastructure elsewhere – of critical strategic importance to foreign investors has been ignored. Yet let us look at the implications here.

China’s domestic M&A activity over the past three years, which has increased from US$20 billion to US$80 billion in 2007, has largely been driven by the State. Essentially, the Chinese government has created a market situation whereby it’s own, diverse, unconnected and badly planned infrastructure problems are being realigned, via M&A activity, into better managed, interconnected entities with better management control, funded by both the domestic and international investor. It has to be this way. Just look back a couple of weeks to the government’s serious problems with the weather. China is no stranger to the cold, yet the heavier than normal snap threw the country’s infrastructure into chaos, especially in the power sector with entire cities of millions of people being without electricity for days. There are many who say that China’s infrastructure is great. It plainly isn’t – it’s creaky, inefficient, poorly connected, badly managed and under-funded. The government knows this – and as was reported yesterday – many of its larger M&A deals have indeed been to realign diverse energy businesses into one entity, as the Beijing government’s acquisition through Hong Kong of Beijing Gas aptly demonstrates. 

So, what are we to make of the new anti-monopoly law? What is predictable are the groans of the foreign lawyers. What isn’t, and what hasn’t been heard are the true implications. So let’s just pause for a moment and reflect. Anti-monopoly law…China…inefficient SOEs…monopolistic practices…lack of competition…it sounds like the China we love to knock. Yet what are the major problems with getting development and FDI into the central regions? Exactly those same issues..

China has to develop its interior, it has no choice. Without unlocking the key to its heartland, and getting its rural population (about 50 percent of its total population) involved in the new wealth of the country, the Communist Party will just run out of steam. Revolutions have always begun in the countryside, and that is no way to develop a country. Getting more income into the central and western regions, a higher standard of education, goods flowing to and fro…this is the lock that China must pick to sustain its growth and prevent it from sliding backwards. Doing away with a few noisy and vociferous State-owned enterprises political bargaining to continue as de facto local monopolies will be a small price to pay for such a prize.

Back in November 2006, we ran an issue of China Briefing entitled China’s Central Regions and the Go Inland Campaign. In it, we ran a piece on the cost of manufacturing for export in the six provinces identified by the State Council as being part of the “Go Inland Campaign”, being Anhui, Henan, Hubei, Hunan, Jiangxi and Shanxi, and their main cities of Changsha, Hefei, Nanchang, Taiyuan, Wuhan and Zhengzhou. We then compared these with the costs of manufacturing and exporting in the more expensive cities of Beijing / Tianjin, Shanghai, and Guangzhou in Guangdong province. In every single case, it was more expensive to manufacture and export via the inland city and region than the coastal one, despite the fact the land and labor costs were significantly cheaper. It cost more to export from Hefei, in Anhui, than it did from nearby Shanghai. It was even more expensive to manufacture in Anhui and attempt to export via Guangzhou. The same was true for other locations compared with their closest sea ports. The only feasible economic justification to manufacture inland is if you intend to sell on the domestic markets. For export, it’s economically unviable.

And here is the rub. China’s national transportation network is badly connected, under-funded, and controlled by SOE cartels. The Ministry of Rail, for example, has roughly the same amount of track in China as the US has in the States, but is running at a capacity 5 times higher. It’s also highly expensive due to demand. The same is true of the Yangtze River network. Shipping goods from a manufacturing base say in Chongqing to Shanghai is eminently feasible. Except the two operators who are licensed to do so run appallingly bad services with no incentive to improve. Such problems remain the largest hurdle for the central government to overcome to finally shift focus into the central and western regions.

If the anti-monopoly law is given bite by State enforcement, it could just be the catalyst that China needs to break the iron grip of inefficiency in the national transportation systems and permit the nation, finally, to open up its heartland. The focus of the legislation may yet prove to be just that, and if so, foreign investors and merchant bankers should be doing their homework on the likely Chinese companies within these regions that stand to benefit most, instead of the current knee jerk reactions about protectionist measures being introduced to curb foreign investment interests. The real implications of the law are far more significant if one reads beyond the rhetoric.

China M&A activity unlikely to slow down
China to introduce more M&A rules
Foreign investment will not be affected by new anti-monopoly laws

5 thoughts on “Will the Anti-monopoly Law assist central regional development?

    Maryanne So says:

    Chinalawblog thinks differently than you do: http://www.chinalawblog.com/2008/02/moving_to_inland_china_hefei_i.html#comments
    But I think they are far too simplistic. If Anhui was so attractive – it would have been popular amongst exporters already. We manufacture there but only for the domestic market, for export as you say the production costs are too high and the MOR just raised its rates again. Good article, it will be interesting to see if what you say about Anti-Monopoly being extended to Domestic cartels is correct.

    Tom says:

    I posted on China Law Blog about this issue but they didn’t permit my comments. Thats the second time. I do not believe they are looking for constructive comments that maybe do not agree with their view. Its all getting rather biased there I feel, but what do you expect from a lawyer who wants to concentrate on China? Its not in ChinaLawBlogs interest to admit any other country maybe a better marketas it takes business away from their firm. Otherwise, I agree that currently the inland regions for investment need to be studied with a firm eye on the finances. Just because Anhui is near Shanghai just not immediately justify setting up a plant there. There are a lot of other considerations in addition to land and labour costs. I’ll be interested to see any comparison with Vietnam / South India / Pune if CB can get this together.

    燕迈锟 says:

    I posted a response on my website, located here. I’d be interested to hear your thoughts, if you have any, as I’m not quite the old China hand that you are.

    Chris Devonshire-Ellis says:

    Well Dan runs his site as he sees fit. I guess its a bit difficult for him being based out of Seattle to comment accurately on China issues. However, at least he tries, and he does a good job as an early warning system for bringing to boot the perils of conducting business in China, even if he does stretch his knowledge a wee bit. Concerning the provision of China / India / Vietnam comparisons, it’s something (plus more) we’re working on now and you’ll be reading more on the subject shortly both here and in the magazine. It’s all about Asia, not just China. Heres some additional comment over at 2point6billion about China and Vietnam, Cambodia, Burma & Sri Lanka: http://www.2point6billion.com/2008/02/25/will-china-lose-its-cost-advantage-to-vietnam-cambodia-and-sri-lanka/

    Chris Devonshire-Ellis says:

    Hi 燕迈锟,good to see you here. I tried to comment on your site…but it seemed too time consuming (you may want to look at that). Anyway, I appreciate your thoughts, which for the benefit of our readers I reproduce below. Essentially my gripes about foreign lawyers when looking at new legislation is the annoying auto-asumption that whenever new regulations occur they specifically target foreign businesses. An example is last years tax unification, when many shouted “China’s tax raised to 25% !” whereas in fact for domestic businesses it had reduced by 8% ! Often such commentary about Chinese legislation is rather one sided, and the potential larger implications – many of which can be very positive – overlooked. So it is with the anti-monopoly law. You make valid comments on the MOR, and my thoughts are just a theory. But if the law was targeted later at China’s inefficient transport system, which is beset by a lack of competivieness and collusion – then that may well be a great way for them to open up the central regions. I don’t even know if it’s occured to them – but if not, I’m sure it will. For sure I’ll be bringing it up at my annual Ministerial meetings next month. Thanks again – and your comments are below if anyone else wishes to add their tuppenny worth – Many thanks – Chris

    “Chris Devonshire-Ellis of China Briefing suggests that China’s new Anti-Monopoly Law could be used to encourage investment in China’s interior, specifically in the realm of inefficient state-owned enterprises like the national rail transportation network. Though unclear from his article, legally his proposal hinges upon the second paragraph of article 7 of the Anti-Monopoly Law, which requires that state-owned enterprises “shall not impair consumer interests by taking advantage of their dominant positions or exclusivity and monopoly positions.” (See Peter Wang’s article on the subject here for more discussion) It also relies upon article 51, which reads as follows:

    Where administrative agencies and organizations that have authority for public affairs management as conferred by laws and regulations abuse administrative powers and performing acts which eliminate and restrict competition, their immediate higher-level authority shall order them to make corrections; and impose administrative sanctions on persons in charge that are directly responsible and other directly responsible persons in accordance with the laws. The Anti-Monopoly Law Enforcement Authority may put forward a proposal for handling the matter in accordance with laws to the higher-level authority.
    Though his argument is an interesting one, there are several reasons why I think it will not come to pass, at least with respect to the transportation system.

    First, Devonshire-Ellis does not identify a specific mechanism in the AML that would encourage FDI in China’s state-owned enterprises. More to the point, despite AML article 51, there is no procedure with teeth that would subject state-owned enterprises to the ambit of the AML and remedies like divestiture, if that’s indeed what he’s getting at. (And what are substantive laws without procedures with which to enforce them?) Second, the Ministry of Railways has significant political capital, as evidenced by the fact that when China recently moved to consolidate the Ministry of Communications, the Civil Aviation Administration and the State Postal Bureau into a “super Transport Ministry,” the Ministry of Railways was left alone. Third, the Ministry of Railways is somewhat special in that it boasts its own court system, and therefore is more closely tied to political issues and encumbered by issues of local protectionism. Fourth, while the all-important NDRC/MOFCOM Catalogue of Industries for Guiding Foreign Investment technically encourages foreign investment in railway transport, the catalogue specifically encourages investments in railway equipment and infrastructure, not ownership and operation of the railways themselves. (Scroll down here for more information) Finally, one cannot forget the importance of railways to national security, so I would not be surprised to see a foreign investor seeking to invest in China’s railways forced through the national security review required by article 31 of the Anti-Monopoly Law. (English language PDF version available here)

    Absent more specifics, I can only envision Devonshire-Ellis’ theory working if a state-owned monopoly gets caught red-handed fixing prices. Would a foreign investor be willing to jump through the hoops required for a national security review that is, as of yet, not entirely defined under the new AML? Particularly given the risk of being on the receiving end of a PRC reprisal for the failed 3Com-Huawei deal? Probably not. But perhaps my thoughts are, as Devonshire-Ellis puts it, simply “groans of the foreign lawyers.”

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