Business Sours on China

Business Sours on China
Foreign Executives Say Beijing Creates Fresh Barriers; Broadsides, Patent Rules

By ANDREW BROWNE And JASON DEAN

BEIJING—Foreign businesses say their relationship with China is starting to sour, as tougher government policies and intensifying domestic competition combine to make one of the world's most important markets less friendly to multinationals.

Interviews with executives, lawyers, and consultants with long experience in China point to developments they say are making it much harder for many foreign companies to succeed. They say the changes suggest Beijing is reassessing China's long-standing emphasis on opening its economy to foreign business—epitomized by the changes it made to join the World Trade Organization in 2001—and tilting toward promoting dominant state companies.

In the latest broadside against foreigners, authorities in a wealthy province near Shanghai Tuesday assailed the quality of luxury clothing brands from the West, including Hermès, Tommy Hilfiger and Versace.
(Related article, page B2.)

Next week, the American Chamber of Commerce in China is coming out with a new survey of its members that is expected to document a downturn in sentiment.

Technology executives say they are highly concerned about government procurement rules issued late last year that would favor local suppliers who have "indigenous innovation." The rules, if implemented, could limit foreign access to tens of billions of dollars in contracts for computers, telecommunications gear, office equipment and other goods.

Patent rules imposed Feb. 1 threaten to increase costs in China for foreign innovators in industries such as pharmaceuticals, and let authorities force foreign drug companies to license production to local companies at state-set prices.

Executives in several industries say the liberalization spurred by China's WTO entry is stalling. Foreign makers of wind turbines and solar panels say they are being shut out of big renewable-energy projects.
Regulatory barriers effectively cap participation in insurance: Foreign companies had just 4.7% of China's life-insurance market as of June, and 1% of its property and casualty market, according to PricewaterhouseCoopers.

"I am pro-China and I am in favor of doing business in China, but I have some serious concerns about what has been happening in the last year,"
says Fraser Mendel, an attorney with U.S. law firm Schwabe, Williamson & Wyatt.

Chinese officials dismiss complaints that the environment for foreigners has worsened, but there are signs top leaders are noting their concerns.
Commerce Minister Chen Deming called top China executives from more than 20 multinationals to a meeting this month billed as "a chance to listen and hear issues of concern," said one participant. Mr. Chen pledged China would "resolutely continue" to open its markets, but he also criticized protectionism in the West.

On Sunday, Premier Wen Jiabao vowed China will "unswervingly implement its opening-up policy." He conceded that his "contacts with foreign investors haven't been close enough," and pledged to increase interaction.

Many foreign executives say they see an upsurge in economic nationalism, accelerated by China's world-beating performance during the recession and a new disdain for Western economic management.

"The economic crisis and downturn emboldened those who had been pushing back" against efforts to liberalize markets, says Duncan Clark, chairman of BDA, a Beijing-based consulting company.

Signs of nationalism are evident in the grooming of state-owned companies to dominate their industries as "national champions," often at the expense of private Chinese companies as well as foreign firms. From airlines to coal mining to dairy products, government policies are expanding the state's role.

A year ago, in a move foreign critics called protectionist, Chinese regulators rejected a bid by Coca-Cola Co. for China Huiyuan Juice Group Ltd., saying it could crowd out smaller companies and raise consumer prices. The two combined held just a fifth of China's juice market.

In July, four executives of Anglo-Australian mining giant Rio Tinto were detained, initially accused of stealing "state secrets," amid tense negotiations between global miners and China's steel industry over iron ore prices. Rio Tinto denies wrongdoing by the men, who await trial on reduced charges of bribery and theft of commercial secrets.

Google Inc.'s woes highlight the angst. The search company, long troubled by Chinese censorship rules, threatened Jan. 12 to depart China after it said a Chinese hacking attack penetrated its computer network.
Related attacks hit dozens of other multinationals. Google is expected soon to close its Chinese site, Google.cn., leaving local companies dominating an Internet market of 400 million users.

"The Google issue has had a crystallizing effect," says Lester Ross, managing partner in Beijing for U.S. law firm Wilmer Cutler Pickering Hale and Dorr. "It raised the consciousness of government and of the boardrooms and other stakeholders" about the difficulties of doing business in China, he says.

Foreign investors have long complained of China's haphazard legal system and regulation. These were mere annoyances when China was an emerging market. Today, the huge Chinese market is fundamental to the health of large Western multinationals. Lose here, say Western executives, and multinationals are weakened globally.

The new patent rules providing for what is called compulsory licensing aren't unique to China. But China's pharmaceuticals industry is dominated by state-owned firms, and Western lawyers worry the rules will favor them. One provision requires companies to pay Chinese employees at least 2% of profit derived from their inventions in China unless the employees explicitly waive that right.

The law "imposes significant new requirements on multinationals operating in China," says Mr. Mendel, the attorney. "You no longer have absolute control over what comes out of your R&D facility."

Executives interviewed for this article declined to comment publicly. In December, a group of 34 business organizations from North America, Europe and Asia sent a letter to three Chinese government ministers blasting the indigenous-innovation preferences for procurement as "discriminatory" against foreigners.

Beijing denies the rules are discriminatory, yet governments are taking note. "Recent events...have reminded us of the continued challenges faced by foreign and U.S. companies operating in China," U.S. Commerce Sec. Gary Locke said in a January speech. "China needs to continue making strides to be more transparent, predictable and committed to the rule of law."

Some are more upbeat. A U.S.-China Business Council poll of members last year showed 93% were "optimistic" or "somewhat optimistic" about their future in China over five years. Robert Poole, head of the council in China, says it "is really concerned about some of these policies," but "the broad themes of continued openness and reform continue to be there."

Some sectors haven't been much hindered. Car makers like Volkswagen AG and General Motors Co. benefited hugely from China's booming market last year. But state-run media have reported government plans to increase domestic brands' share to over 50% of passenger vehicles by 2015, from 44% last year.

For many multinationals in China, today's profits follow years of investment, much of it encouraged by government policies designed to lure capital. Now, at the point when their dream of access to a giant market is becoming reality, China is so prosperous that it has less need for foreign funds. Foreign investment has grown much slower than the rest of China's economy, amounting to 1.8% of gross domestic product in 2009, down from a peak of 6% in 1994.

Beijing has long harbored suspicions the West wants to hobble its economic rise. Analysts say lately, such insecurities have strengthened the hand of leaders who want to limit foreign presence in the economy.
There are backers of openness, says Mr. Ross of WilmerHale, but "there are louder voices pushing China to be more protectionist and to be more nationalist."
—Loretta Chao contributed to this article.Printed in The Wall Street Journal, page A1

Copyright 2009 Dow Jones & Company, Inc. All Rights Reserved