Foreign Direct Investments in Automobile Industry in China

The modern automobile industry is a leading sector of mechanical engineering in developed countries, affecting the processes of economic development. The automotive industry gives impetus to the development of other industries and stimulates employment in the production of motor vehicles and their components. World experience shows that the presence of its own automotive industry is one of the key elements of ensuring national security. Car production is developed on the basis of achievements of fundamental and applied sciences and is an important factor in scientific and technological progress in general. As a result of economic reforms in China, there is a significant increase in production in most sectors of the national economy. China’s achievements in the development of the automotive industry and the automotive market are especially significant. The global car market structure has undergone significant changes over the past 10 years. Production and consumption of cars have moved from developed to developing countries. China has become the world center of car manufacturing. Today, the state can be characterized as a leader in the automotive industry among all developing countries. With the growing demands of consumers and the need to save a traditional share of domestic and foreign markets for domestic auto enterprises and to ensure the growth of production efficiency of modern competitive automotive vehicles, it is necessary to integrate domestic automobile enterprises in the global auto industry system. Most developing economies seek to maximize the inflow of foreign direct investments, but the policy of the Chinese government today ensures the attractiveness of the country for the constant growth of investment volume. This paper will examine the case of foreign direct investments in the automobile industry in China.

State of the Automobile Industry of China before Foreign Direct Investments

In China, the industrial organization of automobile industry was as follows before foreign direct investments. Car factories were under the direct control of the Ministry of the Automotive Industry. In addition, the vertical of power included the Ministry of Provinces and municipalities. In the early stages of industrialization, accommodation of companies in the country was subordinated to political decisions. When the first foreign companies entered the Chinese market, they were sent to different regions of the country for the establishment of joint ventures with local companies. The relative autonomy of Chinese provinces and the desire to create new jobs forced local authorities to build small assembly factories and plants with small production volumes. In the 1990s, in China there were 115 automobile companies, which determined a high degree of fragmentation of the industry, making the companies overlap and show low efficiency. In 2003, 88 Chinese companies produced less than 55 thousand cars a year, while 170 companies had a production capacity from 100 to 10 thousand cars a year. Of China’s 31 provinces, only 5 did not have assembly plants in their territory. Low concentration of production and duplication were caused mainly by two factors: the relative economic autonomy of Chinese provinces and the need to create local companies to absorb a high number of laborers. The main objective of the industrial policy was to create several national champions from this motley diversity.

The Prerequisites for Attracting Foreign Direct Investments into the Automotive Industry in China

In conditions of globalization and fierce competition, there may be observed an increase in the cost spent on research and development and the sales slowdown in the traditional markets of developed countries. In a situation when the world’s major markets were experiencing stagnation, developing countries, especially China, came to the forefront. There was predicted a moderate increase in global production of the global automotive industry due to emerging markets. With growing demands of consumers and the need to save a traditional share of the domestic and foreign markets for domestic auto enterprises and to ensure the growth of production efficiency of modern competitive automotive vehicles, it became necessary to integrate domestic automobile enterprises in the global auto industry system. In the process of addressing this problem, creating conditions for the effective use of foreign direct investments as an impulse for developing their own competitive automobile production occupied a special place.

Annually, in the world 70 million cars and trucks are produced. The industry provides millions of people with jobs. The share of industry output accounted for half of global oil consumption, half of the world’s rubber output, 25% of glass production, and 15% of steel production. It is not surprising that the automotive industry provides 10% of GDP in developed countries. According to the assessment, the annual turnover of the global automotive industry is now 2 trillion 750 billion Euro. Securities of companies in the industry have little or no circulation in the stock market. Overall, the automotive industry has been entering a period of decline in spite of its high social importance and political influence until recently. However, currently the automotive sector is very attractive for foreign investors.

In China, stable economic development largely depends on the quality of transport services and commodity circulation. The automotive industry is a leading engineering industry in the economy at the moment. This is due to several reasons. Firstly, people need more and more cars for a variety of economic reasons every day. Secondly, this industry is knowledge-intensive and high-tech. It cooperates with many other industries, which carry out its numerous orders. Innovations introduced in the automotive industry will inevitably make these industries improve their production. Due to the fact that there are a lot of these sectors, there is the rise of the entire industry and, consequently, the economy as a whole. Thirdly, in all developed countries the automotive industry is one of the most profitable sectors of the economy as it contributes to the turnover and brings a lot of revenue through sales both on domestic and international markets to the treasury of the state. Finally, the automotive industry is a strategically important industry. The development of this industry makes the country economically strong and more independent. The widespread use of the best automotive engineering samples in the army increases the defense power of the country. All this together makes the automotive industry have one of the leading positions for FDI.

The presence of skilled workforce and a strong network of suppliers of components for cars in China have encouraged many global firms to expand invest in the industry. Diversification, creation of an attractive investment climate, cheap, but quality work and high-quality human capital, efficient elite, and participation in the Chinese business of investors from Hong Kong, Singapore, Taiwan, the United States, and other countries lie at the heart of the development of China’s economy. China’s WTO accession has provided a broad opening of the market on road, transportation, storage, warehousing, and transport infrastructure construction. Three years after joining the WTO, China allowed the domination of foreign capital in the joint venture. After six years, the presence of foreign subsidiaries has been allowed. These are the reasons for the attractiveness of China’s automobile industry for foreign investments.

Implementation of Foreign Direct Investments

Soon after the start of economic reforms, the central government has developed a policy of creating a joint venture with the world’s leading automakers. Foreign direct investments entered the automotive industry in China in the early 1980s with the arrival of several Western companies into the country. Invested funds were controlled by the state and provincial authorities, along with the scale of production, the level of prices, sales volume in the country, subcontracting, and production components. Regulation by the central government was primarily concerned with the level and nature of localization. Transaction costs were exceptionally high. For example, it took eight years for the AMC company to set up production of its Beijing Jeep model in Beijing.

In the mid-1980s, the first companies appeared. They were Shanghai-Volkswagen in Shanghai, in which from the German automaker had a 50% stake the very beginning; Beijing-Jeep in Beijing with the US Chrysler (foreign partner owned 33% of shares); Guangzhou-Peugeot in Guangzhou with the French PSA (25%); FAW-Volkswagen in Zhilin (a foreign partner had 40%); and Dongfeng-Citroen in Hubei province with PSA company (25%). The share of the foreign partner in the joint venture could not exceed 50% (except for the production of components where 100% participation was possible). Joint ventures preferred to acquire licenses and large initial investments of foreign partners gave the opportunity to quickly organize production. In 2001, a joint venture in China with leading foreign car companies accounted for 100% of the total car production. By 2012, this proportion dropped to 89% due to the output of a number of national Chinese manufacturers with its proprietary brands to the domestic market.

Specificity of Foreign Direct Investments in China’s Automotive Industry

Foreign investors coming into the Chinese market had different strategies. Thus, the Volkswagen company created a joint venture in Shanghai in the ratio of 50:50, which gave it the opportunity to have a significant impact on the operation of the enterprise. On the contrary, Peugeot had only 25% of shares in its joint venture and was not able to implement its own corporate strategy, as well as make its Chinese partner fulfill obligations on investments. In all cases, the state had a greater influence on the development and growth of the business in the sector (with a credit policy, regional regulation, and prohibition of sales, for example, of Citroen in Shanghai).

Because of such organization, the Chinese auto industry has acquired features of the three main stakeholder groups and market sectors. Firstly, it is state-owned enterprises and companies, which include the five leading producers (SAIC, FAW, Dongfeng, BAIHC, and Changan). Each of them has joint ventures with foreign companies, which can hold up to 50% of the shares. State-owned companies produce and sell cars under foreign brands. Secondly, foreign car companies and factories are located in different provinces in accordance with the decisions of the state. In this case, key technologies are in the hands of foreign automakers. Thirdly, national private Chinese companies are supported by local authorities and municipalities. These companies produce their own brands.

As foreign car companies creating a joint venture in China are not always interested in the transfer of advanced technology to Chinese domestic companies and often seek to fully absorb them, the government has developed a program of development of the automotive industry. The aim of the policy is to turn China into a major player on the global automotive market with the possibilities to export high-quality products, create competitive automotive corporations that can join the ranks of 500 world leaders, and encourage their development. In the field of technological innovations, the policy seeks to create incentives for companies and enterprises that develop their own new technologies. It is aimed at encouraging development of clean and efficient vehicles and fuel technologies and reducing the average fuel consumption of new cars by 15%. Branding involves stimulation of the marketing of national brands and enhancement of the awareness of the need to form brands among all car companies and parts manufacturers.

Methods of Regulation of Foreign Direct Investments

The elements of protectionism in the foreign trade of some countries manifested in the application of a series of protective measures lead to the fact that major automotive transnational companies continue moving production to foreign countries through foreign direct investment. Countries develop the automobile industry based on attracting direct investments by the following steps: import of cars; assembling of the vehicle of leading foreign multinational corporations using imported parts in the local production; and assembly of motor vehicles using domestically produced components of the country’s production. Analysis of international experience shows that for the purposes of the national auto industry development there are certain methods of regulation of foreign direct investments. These methods include setting high import duties on components and vehicles; requirements for localization; regulations regarding compulsory export of a certain percentage of output; exchange rate adjustment; requirements for technology transfer; and tax exemptions. In the analysis of the methods of state regulation of the car market, the underdeveloped state of the market, which limits both the consumption and production of passenger cars, should be considered.

Barriers to growth of demand for cars in the domestic market can be distinguished. It is caused by the absence of policies to promote demand for cars in the country. This is expressed, for example, by the fact that in some provinces some protectionist measures are taken to limit the import and sale of vehicles produced in other regions; therefore, there is an artificial segmentation of the market. The high level of duties and a complicated vehicle acquisition procedure also reduce the activity of people relating to the purchase of vehicles. Range, prices, and services offered by producers do not meet needs of those requirements when buying a car. There is a lack of advanced technologies and opportunities for producers to carry out research, which hinders the emergence of new products on the market and the diversification of options for consumers. Backward technology and deficient quality control reduce competitiveness of products made in China.

The crisis years have had an indirect impact on car manufacturers in China as the financial system of China is fairly closed. This influence has not been directly felt through financial institutions of the country, but it has been manifested, for example, in reducing the population’s purchasing power in the national market, as well as in reducing the export of China-made cars and reduction of foreign investors’ investments in joint ventures.

Trends

In modern conditions, investors from around the world place hope on China. While in Europe and the United States huge financial resources allocated by the state do not lead to a positive result, China continues increasing its GDP, increasing the volume of bank lending, and reducing inflation. In 2009, China’s economy was ranked to have the second largest GDP in the world after the United States with its huge gold reserves and a stable banking system. At the moment, the China’s government plans to support key industries through the reorganization in the next three years. The automotive industry, which has been developing very actively in China, has also been waiting for reorganization. At the national level, major automakers in China will become the FAW, Dongfeng, Shanghai Automotive Industry Corp., and Changan. At the regional level, the State Council encourages consolidation around companies such as Beijing Automotive Industry, Guangzhou Automobile Group, Chery Automobile, and China National Heavy Duty Truck. According to the plans of the State Council, in 2016 China plans to produce and sell 15 million vehicles and ensure an average growth increase in production and sales of vehicles by 10% per year. Cars with an engine capacity of fewer than 1.6 liters should be 65% of the Chinese car market, while small-displacement cars with an engine capacity of fewer than 1.1 liters will amount to 25%. Such automotive support is also different from Western methods. The US auto industry does not know how to pay off creditors even with huge infusions of the government, European and Japanese car manufacturers have been cutting costs and damages, and Russian car manufacturers have been trying to get help in the form of state support. In China, without waiting for the end of the crisis the government has been able to create big players who will be able to compete successfully in the global market with frayed giant global automotive industries after some time.

Today, no one is able to develop the automobile industry independently. It is simply impossible to do because the lack of investment resources will affect it. When the Chinese government did not have FDI, it concluded agreements with many major automotive companies and now Chinese manufacturers have access to the latest technologies. Using an external factor is, in fact, the only way for China’s rapid progress in the development of the national automotive industry. However, the Chinese government tightly controls the creation of joint ventures in the automotive industry. In China, the government introduced strict requirements for foreign manufacturers regarding the use of parts and components of domestic production, namely the achievement of the use of 40% of these parts and units within five years. Then, over the next three years there must be an increase of that figure to 60% and achievement of 80% solution of the use for the eighth year; otherwise, the customs duties on imported items will be so high that the product will lose all of its competitive advantages.

Results of Attracting Foreign Direct Investments into the Automobile Industry in China

Half a century ago, the Chinese government announced the development of the state automobile industry to be a paramount task of the state. The result was not long in coming. Today, the automotive industry accounts for more than 1.5% of the GDP in China. This figure continues growing steadily. Last year, the industry enterprises produced 5.07 million cars of different classes. Experts predict that this year’s vehicles production will reach 5.64 million cars. The Chinese have already begun to focus on the export of their vehicles to European countries, especially Russia.

In November of 2002, the XVI Congress of the CPC declared the course on the creation of a new type of industrial economy, involving activation of basic research in the field of high technologies, the policy of openness of the economy, and the use of foreign investments. These decisions were primarily related to industries, which are the engine of the national economy, including automotive vehicles. Attracting high technology and foreign investments has enabled China to improve considerably the quality of vehicles and increase production to occupy the first position in the global automotive industry, whereas in 2001 China occupied the 8th place in the world in terms of production.

Nowadays, the Chinese automobile industry is one of the leading sectors: it employs more than 2 million people directly and additional 12 million people in related industries. In 2009, all types of car production amounted to 13.79 million units and production of parts and components for cars was actively developing. In 2015, the Chinese auto market became the most dynamic and largest in the world as its total sales reached 13.6 million units, which was 46.2% higher than in the previous year. The market share of passenger cars produced by domestic producers increased to 29.7%. Such successes largely result from the attraction of foreign investments and active state regulation of production and the car market, as well as the macroeconomic environment in general.

Recommendations for Future in terms of FDI Attraction

Most car manufacturers in China are joint ventures of foreign investors who have fully experienced the impact of the global crisis. Therefore, foreign investors seek to reduce rather than increase their investments in China. The key tasks of the Chinese car market in terms of attracting FDI are as follows. In modern conditions, due to resource constraints, which became evident during the crisis, it is necessary to give preference to environmentally friendly and economical vehicles with a small volume of the engine and work on new energy sources in the Chinese automobile industry. Further reducing the cost of production of cars is necessary as many manufacturers try to save on research and development and introduce advanced technologies. Active state intervention in the development of the sector, as the foreign practice shows, helps to balance the negative effects of the global crisis on global automotive development. Leading automotive corporations are considered to be attractive investment areas, especially in those regions and countries where there occurs the development of market relations, while financial, personnel, and technological relationships are ready for storage innovation in developed countries. In this case, the state support of the automotive industry in these regions is important. Besides, it is important to increase the investment attractiveness of the Chinese automotive industry and its integration into the world automotive industry. In order to achieve this goal, a program of preferential taxation and export support implemented in 2004-2005 for domestic companies should be developed. However, in 2010 these programs were terminated as this was no longer required by the maturing automotive industry that was already capable of providing a high level of profitability, accumulating the required amount of funds for R & D due to the intensive growth of sales, as well as attracting foreign investors. Obviously, the Chinese automotive industry is a very important area for foreign investors as profit from joint production significantly overrides corresponding costs.

Conclusion

Since the 80s, China has actively attracted foreign auto companies to the domestic market to create joint ventures with local state-owned companies. This is how a number of major joint ventures such as Shanghai-Volkswagen, Beijing-Jeep, Guangzhou-Peugeot, and FAW-Volkswagen appeared. In all joint ventures, local companies own at least 50% of the shares. Thus, state control over the joint venture has remained in place. Besides, restrictions on sales in China have been introduced and each company has its own markets. The specificity of FDI in China’s automotive industry is strict state regulation of the activity of foreign companies in terms of investments, location of production, the level of prices, and, more importantly, compliance with containment requirements. Almost 100% of the cars manufactured in China were produced by joint ventures with investments from foreign companies in the mid-2000s. However, by 2012 their share had fallen to 89% due to the entering of domestic brands to the market. Withal, distinguishing features of the Chinese automotive industry are as follows. Leading national automotive companies are joint ventures with foreign automakers and they account for the significant bulk of sales in the domestic market. In spite of the fulfillment of the requirements for localization, the Chinese side does not transmit the key technologies to foreign companies. The private national automakers have been intensively developing.

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