Monthly Archives: December 2011

China's Murky Ownership Laws

I’ve always found the notion of private enterprise in China somewhat confusing. This is not because private enterprises do not exist in China, but because it’s incredibly difficult to determine whether, or to what extent, “private” companies are really State-owned enterprises (SOEs) in disguise. This is especially true for large corporations.

With that in mind, I found a recent Economist article on the subject especially timely (see Capitalism Confined). The article details how Chinese companies fall into 4 general categories: large state-controlled enterprises (SOEs), joint ventures between private (often foreign) companies and SOEs, companies with minority state ownership but state influence, and companies backed by government-owned investment funds. The main take-away is that the Chinese government is still involved at almost every level of economic organization.

According to the Economist:

The first category [state-controlled enterprises] comprises the vast banks and transport, energy and telecoms providers that were, and to some extent still are, government ministries…they account for perhaps 1% of privatised companies… Most of these huge companies have been turned into vaguely conventional-looking businesses. They have been restructured, recapitalised and rebranded. A minority of their equity has been sold to the public and is traded on the stockmarket.

The second category of firms, joint ventures, is also small in number…Often the private partner is a Western company hoping to gain access to a huge and growing economy. In return the Chinese gain [access to] Western know-how. For the Westerners, this involves obvious risks beyond the usual differences of opinion in a joint venture: that they will be pushed aside once the Chinese have acquired their knowledge.

The third group, largely in private hands, contains the most successful privatised companies: …[those] that ended up in the hands of their managers…In only 1% of these firms did the state have a shareholding of more than 20%…[The state] does, however, continue to exert influence, notably through party representatives.

The success of this third group of companies has encouraged the development of the fourth. Officials in cities and provinces have created hundreds of municipally backed funds to invest in promising ventures.

Taken collectively, these iterations of state engagement reflect how China’s government has not only held on to its economic control but found subtle ways to extend it. At the very least, these iterations constitute an important series of large-scale economic experiments with implications for China’s economy and, effectively, the world’s too.

Given China’s increasing role in the global economy, I agree with the author’s inference about the implications of this kind of experimentation with economic organization. I also think it calls for further research into the costs and benefits of structuring economic activity in this way. One point the article details is how, as a consequence of state influence, Chinese companies have struggled to compete abroad. Although they benefit from cheap financing capital and political favor domestically, large Chinese companies struggle to compete with their more organizationally (and technologically) efficient foreign counterparts abroad.

Nevertheless, truly interesting stuff! I encourage you to read the article in its entirety.

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Indian Retail Laws Changing??

Early last week, India’s government looked set to change its retail laws, freeing up restrictions on foreign direct investment (see Let Walmart InWholesale ReformFury erupts as India opens door to Wal-MartsIKEA set to announce retail plans for India). Foreign retailers that sell multiple brands (Walmart, Tesco, Carrefour, etc.) will now be allowed to own 51% of retail operations in India; single brand retailers (Ikea, Nike, Apple, etc.) will be allowed to own 100% of retail operations.

India’s hope? The hope is that foreign entry can help modernize infrastructure, distribution, and supply chains, and ultimately, reduce prices paid by end consumers. In this way, India views foreign investment as a way to stimulate the local economy.

For some foreign companies, this legal change is the green light they’ve been waiting for. IKEA, for example, which previously refused to enter the market, is now in India considering a retail foray. However, the change in law comes with a catch:

Foreign retailers will be obliged to invest $100m over five years. And at least half has to be spent to develop rural infrastructure and to establish a cold-chain system. Firms will also have to commit to sourcing 30% of their wares from small and medium-sized suppliers. Finally, foreign retailers will only be allowed to set up shop in cities with a population of over a million.

Political and public reaction has been split. Parliament and the opposition BJP (Bharatiya Janata Party) are outraged, some even going so far as threatening to burn down foreign-owned stores opened in the country.

…half of India’s states say they will refuse to implement the reform…Trade unions have promised strikes. Parliament has been shouted to a standstill. Already there is talk that the government might back down.

Many small business owners fear the effects of foreign entry.

Experts predict that stepped-up competition will sharply reduce the number of small retailers — the nation’s second-largest employer after farming, with 35 million workers.

I am generally pro-trade, in favor of open economic exchange. So I believe that this would be a welcome change. Nevertheless, it will be interesting to watch how things play out politically.

There was word last week that, in the face of significant domestic pressure, the Indian government was actually reconsidering its decision. However, even if the Indian government decides to go ahead with the proposed law change, I’m not so sure that it will bring about a flood of foreign entry.

India, with its underdeveloped political and economic institutions, remains an exceptionally difficult place for foreign firms to conduct business, …even with the legal change. Moreover, the mandates built into the legislation (minimum $100m investment, mandated infrastructure development, etc.) are particularly onerous. It will make entry more costly, and potentially, unattractive. So although the law makes it theoretically more feasible for multinational retailers to conduct business in India, in practice, I’m not convinced it will have a great effect.

UPDATE: Bowing to public pressure, the Indian government decided to hold off on implementing the controversial retail law (allowing multibrand retailers to own 51% of their operations in India) until a broader consensus can be reached (see India retail reform unravels after backlash). It is interesting to note that the government has only suspended one of the two retail law changes; single brand retailers will still be able to own 100% of their retail operations.

Although I did not anticipate that the multibrand retail law change (had it taken effect) would result in mass foreign entry, I generally view any step closer to free trade and lower foreign entry barriers as a step in the right direction. For this reason, I think the Indian government is bowing to pressure from a powerful minority that runs counter to the greater national good.

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