In Trade Talks, China Is Too Clever by Half

(Bloomberg) -- Treasury Secretary Steve Mnuchin and a team of White House heavies are expected to visit Beijing, possibly as early as this week, for talks aimed at defusing a tense, U.S.-China trade standoff. The delegation comes amid optimism in Washington that its get-tough strategy is working after Beijing announced a slate of reforms to open up sectors including automobiles, finance and aerospace.

But as is often the case in China, how things appear on the surface is not actually how they are. That’s especially true with China’s recent market reforms. Beijing isn’t groveling before a tariff-rattling Washington, nor honestly addressing the frustrations of international CEOs. That’s just not how China works.

The real beneficiary of China’s proposals is China. The goal is to marshal foreign companies, foreign capital and foreign technology to help China defeat foreign competitors in the global economy.

A classic example is the recently announced deregulation in the automobile sector. Beijing promised to eliminate a requirement that overseas carmakers form joint ventures with Chinese partners to manufacture cars locally. For electric vehicles, that restriction could be dropped as early as this year. Some international firms will benefit by being able to set up wholly owned operations, most of all Tesla Inc.

But that’s not the real purpose of the change. Electric vehicles are a targeted industry in China, marked for special support in the nation’s “Made in China 2025” industrial program. The Chinese want to dominate the production of electric vehicles, and this “reform” is a necessary step to get there.

I’ll let Bill Russo, founder of Shanghai consultancy Automobility, explain: The reform “eliminates the only reason that may block global EV manufacturers and suppliers from investing in China capacity, making China the odds-on winner in the global race to electric transportation.”

It’s notable that the joint-venture rule for regular cars will be lifted far more slowly. Unlike new energy vehicles, old-fashioned combustion engine cars aren’t a priority. And even when the reform actually happens, it won’t make much difference. The JVs have been so entrenched for so long that, at this stage, it probably isn’t in the interests of foreign companies to change the status quo.

“The Chinese market might not necessarily justify the investment and risks for foreign manufacturers considering setting up their own operations,” Fitch Ratings noted in a recent report. “The potential for sales growth has weakened as the market has matured.” In other words, China has already got what it wanted.

The situation is all too similar in finance. Last year, the Chinese government announced it would ease ownership limits on offshore investors in banks, brokerages, insurance companies and other financial institutions. Again, these measures are good news for foreign financial firms that want to beef up their operations in China, especially in fund management and securities, where they will be able to gain majority control.

But again, the ultimate winner may be China.

With a financial sector riddled with bad loans and worse practices, China will be happy to gorge on fresh capital from international investors. How much progress those investors will make in China’s market is another matter. Foreign banks can already operate wholly owned businesses in China, but they’ve made almost no inroads, commanding less than 2 percent of total banking assets. The problem is similar in insurance, where existing JVs have a minute share of the market.

The reason is ownership restrictions are only one strand of a web of regulatory hurdles overseas financial players face in China. The ability of U.S. banks, insurers and other firms to operate and expand in Asia’s largest economy is seriously hampered by delays in receiving licenses; intrusive, informal “window dressing” guidance from regulators; and discriminatory practices.

In the end, the proposed financial sector liberalization may end up making only a minor difference. As research group Capital Economics Ltd. said in a report: “The benefits to China of an injection of capital and expertise are clear. The benefits to foreign firms if the deck is still stacked against them are less so.”

What international investors, businessmen and policymakers need to digest is that China’s leaders are not ideologically committed to free markets in and of themselves, despite what they repeatedly assert in nice-sounding speeches. They are willing to utilize market forces as a tool to help achieve other, usually state-determined, goals. That means China won’t “open up” just for the broader benefits of spurring competition and productivity. It will do so when it sees tangible benefits for its own economy.

Hopefully, Secretary Mnuchin and his colleagues will bear this in mind. They must make sure the promised reforms will actually benefit U.S. companies by clearing away non-tariff regulatory barriers and ensuring a level playing field with local rivals. The broader issue of the market-distorting effects of China’s industrial policies must also be addressed.

The danger is that Team Trump will accept Chinese reform proposals at face value, eager to proclaim victory. But the details matter. With China, “wins” all too often spell big losers.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story: Michael Schuman at contactschuman@gmail.com.

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