Friday, July 30, 2010

Is China being beastly to foreign investors?

by Charles Grant

When I visited China a year ago, I was struck by the strong feeling among many foreign firms there that the business environment was getting tougher. Western businessmen complained, in particular, about discrimination against foreigners. On a recent trip to China, I found a more nuanced situation. In some sectors, notably those where intellectual property (IP) is important, there are growing complaints of unfair treatment. But in other sectors foreign companies are making good money, without grumbling much.

Western business leaders are certainly complaining more loudly than they used to. In July, the Financial Times reported Jeffrey Immelt, the chairman of General Electric, as saying that he was “really worried about China. I am not sure that in the end they want any of us to win, or any of us to be successful.” A few days later Jürgen Hambrecht, the CEO of BASF, told Wen Jiabao, the Chinese prime minister, that foreign firms were being forced to transfer know-how to Chinese companies, in return for market access. Hambrecht told him that this did “not exactly correspond to our views of a partnership”. At the same meeting Peter Löscher, the CEO of Siemens, urged Wen to ensure that foreign firms could compete fairly for government procurement contracts. (Like a lot of western business leaders, Löscher had previously taken the Chinese government’s side, as when he criticised German Chancellor Angela Merkel for meeting the Dalai Lama.)

One government measure that has provoked foreign business leaders is the regulation on ‘indigenous innovation’ that was published last November. This would, if enforced, exclude foreign firms from public procurement contracts unless they agreed to hand over IP. The regulation seems to have been driven by the Chinese Communist Party’s belief that market forces alone will not provide a high-tech economy, and that the state therefore needs to get hold of and control advanced technologies. The EU, the US and many other governments lobbied strongly against the measure.

Whether this regulation will bite remains unclear. The government announced a delay in implementation and Chen Deming, the minister of commerce, said the regulation would not affect firms that could prove they added value in China. Some western business lobbies fear that, despite recent reassurances, the regulation will in the long run take effect. If it is enforced, firms like IBM and Microsoft are likely to cut back on R&D in China. On Capitol Hill, Microsoft is now taking a hard line on IP issues in China; until recently, it tended to sympathise with the Chinese point of view. China can no longer assume that US business leaders will, as a bloc, support its interests in Washington.

A similar shift is evident among some European companies. According to the head of one large German firm in China: “They assume their market is so big, that foreigners will stay, and put up with losing IP. That’s a miscalculation. Most foreign investors think IP is very important and that they have a duty not to hand it over.” He thinks that enforcement of the indigenous innovation regulation would dampen FDI in China. Big western manufacturers would not pull out but would source more components to countries such as Vietnam, Taiwan, Malaysia, Indonesia and Singapore. China’s free trade agreements with these countries now make it easier to supply Chinese factories from them.

Within the past two years, some high-tech foreign firms have had to pay higher rates of tax, while new restrictions on representative offices – each is allowed only three non-Chinese staff – are proving irksome. Foreign firms involved in making wind turbines, such as GE, Siemens and Vestas, are particularly annoyed that, as they see it, procurement rules have been skewed to exclude them from the Chinese market (the largest in the world), to the benefit of local firms.

Two-fifths of European businesses in China surveyed by the EU Chamber of Commerce in June 2010 expected the regulatory environment to worsen in the next two years. The same proportion described the discriminatory application of laws and regulations as a ‘significant’ obstacle. The EU Chamber concluded: “Optimism in the overall economic climate has been dampened dramatically by concerns about regulatory interference and unpredictability in the market.”

Some of the shifting balance of power between foreign investors and the Chinese authorities is the inevitable result of the country’s development. A lot of Chinese companies are now stronger and better-equipped to compete with European or American rivals. Twenty years ago the Chinese needed western capital, skills and technology. Now they need the technology, but they have less need of the skills, and plenty of their own capital.

Another issue for foreign investors is that costs are rising, in part due to labour unrest that has been prevalent in the Pearl River Delta area. The emergence of free trade unions is an important and positive step for the country’s future development, signalling the emergence of a civil society that is not controlled by government or party. But many foreign businesses see the new trade unions merely as a source of growing costs.

Mining companies, energy firms, banks and insurers, among others, still face restrictions on their activities in China. Many of them nevertheless make money. That is the case for Shell and BP, which are significant investors, often through joint ventures, but would like to engage in a wider range of activities than they currently do. In many other sectors, such as retailing, advertising, hotels, pharmaceuticals and cars, companies report they are doing well without too much government interference. For example Tesco finds it easier to open stores than two years ago, as central government permission is no longer required; but Tesco says that Chinese retailers face less hassle from red tape than do foreign ones. WPP is allowed to own 100 per cent of local advertising agencies and says that as a foreign firm it faces no discrimination – except that it pays more tax than local competitors. Car companies are doing particularly well: BMW has doubled sales in China over the past year, and Daimler is forming a joint venture to develop electric vehicles.

Since the spring, the government has made an effort to appear friendly to foreign firms: Premier Wen met foreign business leaders to listen to their complaints; several ministries opened their doors to foreign investors in China and asked how they could help; and in July the government appeared to accept a compromise in its dispute with Google, with the result that Chinese citizens can search uncensored via Hong Kong. Chinese analysts point out that many local authorities still compete for FDI and therefore offer special deals (for example, on tax and utilities) to foreign firms.

When China joined the World Trade Organisation in 2002, it failed to sign the agreement on public procurement that prevents discrimination against foreign firms. In July China made new proposals for acceding to this agreement – but western governments think them inadequate (for example, China is not offering to open up local government procurement). Also in July, Chen Deming wrote in the Financial Times that China is “ever more open to business”. He is right that most of the formal rules applying to foreign investors are less restrictive than they were ten years ago. According to his figures, global FDI fell by nearly 40 per cent in 2009, but only by 2.6 per cent in China.

My conclusion is that China still welcomes FDI, but that it is becoming more insistent on setting the terms. For example, it wants to choose the location for big foreign industrial investments – often in the underdeveloped west of the country, where a lot of foreign firms would rather not go. The Chinese government is probably right to calculate that, for all their grumbling, most foreign firms will stay; China is just too big a market to ignore. In any case, despite the difficulties, many foreign investors in China claim that they are managing to hang on to their IP.

China’s strategy is to exploit foreigners’ desire for access to its markets as a means of gaining their technology. From China’s point of view that is a reasonable policy. If a lot of foreign investors clubbed together to speak with one voice and make credible threats to China, they might persuade its leadership to re-examine that strategy. But neither the big foreign companies in China, nor the European and American governments, are likely to get significantly tougher with China. So do not expect much change in China’s policies towards foreign investors.

Charles Grant is director of the Centre for European Reform

Monday, July 19, 2010

Who is winning Eastern Europe's great game?

By Katinka Barysch

The US is withdrawing from the former Soviet space; the European Union struggles to be taken seriously there. Does that leave Russia free to strengthen its influence in the countries around its borders? Not necessarily, for the situation in the region is complex.

Hillary Clinton toured the Caucasus recently to reassure Georgia, Armenia and Azerbaijan that Washington had not abandoned them in its quest to ‘reset’ relations with Russia. Nevertheless, the predominant feeling in those countries is that the US is a lot less interested and engaged than it had been during the presidencies of George W Bush and Bill Clinton. Similarly, many Central Asians feel that the Obama administration pays little attention to them, unless they can serve as launch pads for planes destined for Afghanistan. NATO membership for Ukraine and Georgia is no longer on the cards.

While much of America’s attention has moved elsewhere, the European Union hardly has a foothold in the region. The EU’s neighbourhood policy has proved rather ineffective, and the 2009 ‘Eastern partnership’ has not yet had time to make much of a difference. Ukraine, still smarting that the EU has never offered the prospect of membership, appears to be turning towards Russia. Moldova looks keener than ever to get closer to the EU – with few people in Brussels and other capitals taking notice. The EU’s Central Asia strategy has lacked political backing and consistency. In the Caucasus and Central Asia, the EU is a rather new player and its traditional approach of exporting norms and values as the basis for bilateral relations has not been received well. The fact that the EU’s foreign policy machinery is currently in bureaucratic paralysis does not help.

In theory, US neglect and European weakness could leave Russia free to consolidate what President Medvedev likes to refer to as a ‘sphere of privileged interests’. Russia is certainly trying. But success has been patchy at best.

Although by far the most populous and prosperous country in the region, Russia does not necessarily have the means to project power into the neighbourhood. Its tools looked more formidable before they were actually used. Now some of them have turned out to be blunt.

Russia’s use of military force in Georgia last year backfired when even Moscow’s staunchest allies scrambled to become less reliant on their dangerous-looking big neighbour: Belarus turned to the EU, Armenia started talking to Turkey and not a single one of the former Soviet countries has followed Moscow in recognising the independence of Abkhazia and South Ossetia.

Russia has repeatedly used trade embargoes and other economic means to put pressure on its neighbours, in particular smaller ones where Russia’s own business interests are limited, such as Georgia or Latvia. But there is arguably not a single instance where the use of economic sanctions has got Russia what it wanted. Businesses in the countries affected have reinforced their efforts to find alternative markets and sources of investments, making them less dependent on Russia in the long term. Russia’s strategy of gaining influence through directly controlling local businesses has proven more successful: in Armenia for example, various sectors from banking to transport are dominated by Russian-owned companies. How this will translate into political leverage remains to be seen.

This leaves energy as the most promising tool of Russia’s neighbourhood policy. Russia has used pipeline plans, nuclear projects, gas prices and oil deliveries to get what it wants from its neighbours. But even here, Russia’s success rate is mixed. In Belarus and Ukraine, Russia is making headway towards its aim of gaining control over transit pipelines. The recent standoff between Belarus and Russia over gas prices and transit fees only highlighted Minsk’s lack of options: Lukashenko’s announcement that he would buy gas from Venezuela was little more than symbolic. In Ukraine, Russia managed to use the offer of cheaper gas to get the lease for its Black Sea fleet in Sevastopol extended. It has also successfully pressured Kyiv into at least considering merging parts of the two countries’ gas monopolies, Gazprom and Naftogaz, which would give Moscow effective control over Ukraine’s transit pipelines.

The situation is very different in the Caucasus and Central Asia, where energy producing countries are gaining room for manoeuvre through building stronger links with China, Iran and Turkey. Turkmenistan opened a large gas pipeline to China at the beginning of the year and signed another gas delivery contract with Iran in June. It has invited international oil majors to help build an internal pipeline that could one day deliver Turkmen gas from the massive Yolotan field to the Caspian shores and from there to Europe. It had previously promised to let Russia build the pipeline and buy much of the gas. Azerbaijan has spurned a Russian offer to buy up all the gas from its new Shah Deniz 2 field, instead committing it to Turkey and to European buyers. Russia’s attempts to lock up Caspian gas supplies by foiling pipeline projects such as Nabucco are looking increasingly desperate.

The perceived withdrawal of the US and the ineffectiveness of EU policy in the region has not so far played into Russia’s hands. Russia (like the EU and other players in the region) has had to learn that the former Soviet Union does not constitute a homogenous neighbourhood. There are cocky and cash-rich energy suppliers such as Azerbaijan and Kazakhstan, and there are poor and divided countries such as Moldova and Armenia. Russia can cajole and coerce in one place but it has to plead and please in another. All countries in the region will benefit from being less dependent on Russia, in trade and energy terms as well as in politics. While the US might pay less attention to the region, the EU should redouble its efforts, while also taking more account of the the specific situations of individual countries.

Katinka Barysch is deputy director of the CER

Thursday, July 08, 2010

Membership for Russia a step too far for NATO?

by Tomas Valasek

There are growing signs that Russia’s relations with NATO are on the mend. Senior Russian thinkers, some close to the government, have been cautiously talking up the possibility of Russia joining the alliance, as have several western officials and think-tanks (including the CER.) While some powerful forces in Russia continue to view NATO as a hostile force, the latest signs from Moscow are encouraging. But even assuming that the more pro-western forces within Russia prevail, membership of NATO will remain at best a long-term goal. In the short and medium term, Russia and NATO need to put considerable effort into reducing mistrust.

A group of prominent Russian thinkers recently invited their western counterparts to talk about the possibility of Russia joining NATO. What prompted this initiative is not obvious, but the atmospherics have clearly changed. Russia is being nicer to its neighbours, while a number of European countries – including those in Central and Eastern Europe – are being nicer to Moscow. NATO has effectively put enlargement on hold. Barack Obama’s ‘reset’ seems to be changing attitudes on all sides. The challenge before Russia and NATO is to try to turn this opportunity into a lasting improvement in relations.

The allies are not of one mind on the subject of Russian membership of the alliance. But conversations with NATO officials and diplomats suggest that NATO could be ready by its November summit to offer Moscow the possibility of joining, if and when the latter meets accession criteria. With additional persuasion – though this is more questionable – NATO may even create a special accession track for Russia, different from the one NATO used for previous candidates, so that Moscow feels that it is being treated like a great power. But the allies’ bottom line is that, one way or another, Moscow will need to adopt many of NATO’s norms, including those on democracy and transparency, before it can become a member.

Those Russians who want to explore the possibility of accession seem to have a different approach in mind. They are looking for a bargain of sorts with NATO. The alliance would promise not to enlarge eastward or arm regimes deemed unfriendly by Russia. Moscow would gain a veto over alliance decisions on matters which may affect Russia. In exchange, NATO would get better co-operation from Russia on things like missile defence or Afghanistan. NATO’s rules or norms do not seem to be a part of the bargain. Tellingly, few Russians use the term ‘membership’ with regard to NATO. They talk either of ‘integration’ or ‘organisational unity’. The former implies that both sides adopt some of the other side’s rules; the latter implies that neither side compromises internally. Either model is distant from what NATO has in mind.

But if membership is not the right thing for NATO and Russia to focus on in the near term, are there other viable ways to improve co-operation in the next few months and years? One Russian speaker at the meeting in Moscow put forth a possible solution. Instead of exploring membership, NATO and Russia should ‘demilitarise’ their relationship. Moscow would stop holding exercises that simulate a war with NATO, like the ‘Zapad’ exercise last year, in which 12,500 Russian and Belorusian troops repelled a fictitious attack from NATO. Russia would also change its strategic documents to make clear that NATO is not a ‘threat’ or ‘danger’. NATO would respond in kind, with no exercises and no new bases near Russia’s borders. If demilitarisation is successful, the theory goes, NATO and Russia would gradually come to view each other as partners. And that could open doors to even closer forms of co-operation in the future.

This is a sensible idea but not without difficulties. For a start, is Russia ready? The government is sending out mixed signals. Besides being nicer to its neighbours lately, Moscow has also launched sweeping defence reforms. These will change the Russian military from a grand force built to fight NATO into a smaller but more agile army better suited for regional conflicts like the one in Chechnya. That is good news for NATO. But only last year the Russian government also agreed a new military doctrine, which calls NATO’s activities the greatest danger to Russian security. So there is presumably a large segment of the Russian establishment that would oppose closer ties with the alliance.

In order to take up demilitarisation, NATO would have to be convinced that Russia is equally serious. Just as important, this initiative would need to win the support of the new allies in Central and Eastern Europe. Some of them feel that NATO has been neglecting the possibility of a conflict in Europe, and they want the alliance to adopt new ‘reassurance’ measures. These would involve, among other things, the creation of a new centre at NATO tasked with keeping an eye on future crises, including those involving Russia.

Some in NATO will argue that ‘reassurance’ would kill the hopes of a rapprochement with Russia, by provoking Moscow. But in fact the opposite is the case: without reassurance NATO will not reach the consensus it needs to offer Russia a new relationship – whether it means demilitarisation or, in the long run, integration. The right approach for NATO is to rebuild trust among the allies through reassurance while striving to reform its relationship with Russia. ‘Demilitarisation’ sounds like a useful idea to explore. The new allies should be supportive: after all, they stand to gain the most should Russia stop rehearsing attacks on Central and Eastern Europe. ‘Demilitarisation’ would be the ultimate reassurance measure.

Tomas Valasek is Director of foreign policy and defence at the Centre for European Reform.