China's Close Government-Business Ties Are A Key Challenge In U.S. Trade Talks

Mar 6, 2019
Originally published on March 6, 2019 10:35 am

In the 1980s, China was beginning a long economic boom that would transform the global trading system, and Michael Korchmar decided to go there to launch a joint venture.

He quickly soured on the country.

"It didn't feel right," recalls Korchmar, whose family runs a 102-year-old Florida-based company that makes briefcases and travel bags. The Chinese government maintained a heavy hand in his staffing and factory decisions, and its minders followed him everywhere.

So Korchmar cut his ties to China and eventually opened a plant in the Dominican Republic. But he could never quite escape China's orbit.

Over the years, companies in his field have faced bruising competition from Chinese firms that could undercut his prices because they were heavily subsidized by the government, he says.

"The government runs the economy," he concluded. "To think the government's not involved in any business practice in China is really I think a bit naïve."

Today, the United States and China are locked in intense negotiations aimed at resolving their trade differences. But there's an elephant in the room: Far more than other major economies, China's government plays a large, powerful role in how its businesses operate, giving them preferential treatment over their rivals.

Critics say this gives Chinese companies an unfair advantage over outsiders and makes it hard for foreign firms to really compete in China.

"The China that we trade with and compete with today is very different from the one that we had hoped would emerge," says Democratic Rep. Richard Neal of Massachusetts, who chairs the powerful House Ways and Means Committee. "China's economy, which has taken on some market characteristics, remains fundamentally state-directed."

Consider this: China has more companies in the Fortune 500 than any country except the United States. More than half of those firms are controlled by a single government agency, the state-owned Assets Supervision and Administration Commission, wrote Harvard law professor Mark Wu, in a 2016 article, "The 'China, Inc.' Challenge To Global trade Governance."

Many of these companies are in essential sectors such as railroads, energy, shipbuilding and telecommunications. But government officials also maintain strong ties to private companies, says Jennifer Hillman, a professor at Georgetown University Law Center.

"They're able to direct resources and push resources into those industries and those entities they are trying to favor," Hillman says. She notes that at least one member of the Communist Party sits on the board of virtually every company of any size, and they exert considerable power over corporate decisions.

The Chinese government's influence extends to the financial world as well.

The largest shareholder of China's "Big Four" commercial banks is Central Huijin Investment Ltd., which is managed by the China Investment Corp. The government can order Central Huijin to direct funds and make loans for favored projects.

"The closest analogue would be if, in the aftermath of the 2008 financial crisis, the U.S. Treasury Department set up a single government entity to act as the controlling shareholder of JPMorgan Chase, Bank of America, Citibank and Wells Fargo," Wu wrote.

Even when a company has no explicit ties to the government or the party, executives must work hard to stay in Beijing's good graces, if they want their companies to have access to the best contracts, Wu says.

"People understand what the objectives are and they'll operate within those confines," he says.

"A lot of private companies in China, even publicly listed companies, take a lot of direction from the government, or are picked by the government as state champions," says Patrick Chovanec, chief strategist at Silvercrest Asset Management, who taught in China for years.

None of this is unprecedented, Wu notes. Governments own or control major companies in other places, and there's a revolving door between business and government all over the world, including the United States.

But few states exert the kind of strong control over their economies that China does, Wu says. And those ties have only gotten stronger under President Xi Jinping.

When China joined the World Trade Organization in 2001, it essentially promised to open up its economy and adopt free-market principles. Reformers inside China argued that the country's economy needed to look more like that of the United States.

Events of the past decade have undermined the reformers and given Beijing more confidence in its hybrid system, Chovanec says.

"In the wake of the 2008 financial crisis, China took a different look at what its economic model should look like. And a model that was more state-driven looked a lot more attractive to them," Chovanec says.

Successive U.S. administrations have argued that these policies violate the spirit — if not the letter — of WTO regulations. One of the aims of the current trade negotiations is to get Beijing to stop corporate subsidies.

But the opaque nature of China's economy makes it hard for outsiders to understand the true nature of the relationship between companies and the government, Chovanec says.

In a country such as France, a telecommunications or energy company may be part of the state sector, eligible for special subsidies or tax credits, but the ties are supposed to be on the record, he says.

"Whereas in China, a lot of this is behind the scenes and it's very nebulous," Chovanec says.

Chinese government officials are adept at giving preferential treatment to their own companies without leaving their fingerprints anywhere, he says. They also know how to make life tough for foreign businesses.

"They will just say, 'Well, there's a slowdown in inspections of this type of product from your country. It's for safety.' It makes it hard for you to then turn around and say, 'OK, you're engaging in illegal activity.' Because there's complete deniability," Chovanec says.

As Trump administration officials seek to overhaul China's trade policies, they need to be realistic. Chinese officials believe their system has served them well, and they're not going to change it overnight, Wu says.

"To the extent that we're expecting major, fundamental structural reforms, that's going to be very difficult to obtain, because they see this governance structure as being having been vital for both their political and economic successes," he says.

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STEVE INSKEEP, HOST:

U.S. trade talks with China face a fundamental problem. The two countries are negotiating to end a trade war. It was triggered by President Trump's demand for better terms. Now, it's easy for the Chinese to, say, promise to buy more U.S. goods. They've got the money. But it's hard for China to alter a basic fact of its economy. Unlike the U.S. government, China's government owns half the country's largest companies, and many receive big subsidies. That is the advantage the United States wants China to give up. NPR's Jim Zarroli reports.

JIM ZARROLI, BYLINE: Michael Korchmar runs a company that makes travel bags and briefcases. It's been in his family for four generations. Over the years, he has watched one company after another in his field go out of business. And for those that survive...

MICHAEL KORCHMAR: Oh, that means you lose. I lived it. We lost. We had, you know, 500 people employed in the U.S. And we went down to five.

ZARROLI: Korchmar says a big problem for companies like his is brutal competition from Chinese rivals. He says they can undercut his prices because they're subsidized by their government. And this is at the heart of the current trade talks - the extent to which China props up its companies. Just last week, Massachusetts Congressman Richard Neal, who heads the powerful House Ways and Means Committee, spoke about it.

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RICHARD NEAL: The China that we trade with and compete with today is very different from the one that we had hoped would emerge. China's economy, which has taken on some market characteristics, remains fundamentally state-directed.

ZARROLI: More than half of China's biggest companies are owned by the government. They include essential sectors like railroads, energy, shipbuilding and telecommunications. But government officials also maintain strong ties to private companies, says Jennifer Hillman of Georgetown University Law Center.

JENNIFER HILLMAN: They're able to direct resources and push resources into those industries and those entities that they are trying to favor.

ZARROLI: Hillman notes that Communist Party members sit on the board of virtually every big Chinese company. The four largest banks are controlled by the government. Mark Wu of Harvard Law School says even when a Chinese company is privately owned, it works hard to stay in Beijing's good graces.

MARK WU: People understand what the objectives are, and they'll operate within those confines. It's especially true when the state asserts a strong enough control over the key elements of the economy, as the Chinese economy still does.

ZARROLI: It wasn't supposed to be this way. When China joined the World Trade Organization in 2001, it agreed to reform its system to become more free market. But Patrick Chovanec of Silvercrest Asset Management says events of the past decade have made China more confident about its own system.

PATRICK CHOVANEC: In the wake of 2008 financial crisis, China took a different look at what its economic model should look like. And a model that was more state-driven looked a lot more attractive to them.

ZARROLI: Under President Xi Jinping, the government's role in the economy has only gotten bigger. U.S. officials say these policies violate the spirit if not the letter of trade law. And they've pressed Beijing to stop subsidizing businesses. But the ties between the government and business in China can be opaque. Chovanec says Chinese officials know how to give preferential treatment to their own companies at the expense of outsiders without leaving their fingerprints anywhere.

CHOVANEC: They will just say, well, there's a slowdown in inspections of this type of product from your country. It's for safety. It makes it hard for you to then turn around and say, OK. You're engaging in illegal activity because there's complete deniability.

ZARROLI: Harvard's Mark Wu says the Trump administration needs to be realistic about what it can achieve.

WU: To the extent that we're expecting major fundamental structural reforms, that's going to be very difficult to obtain because they see this governance structure as having been vital for both their political and economic successes.

ZARROLI: Wu says China believes its economic model has served the country well. And it's not going to give it up easily. And that means U.S. trade negotiators have their work cut out for them. Jim Zarroli, NPR News.

(SOUNDBITE OF CALYPS' "THE GIRL FROM SUKHUMVIT" Transcript provided by NPR, Copyright NPR.