Wednesday, September 30, 2009 6 comments ++[ CLICK TO COMMENT ]++

Operating in heavily protected markets

Bloomberg has a story that illustrates the difficulty of operating in a market that forces foreign companies to form alliances with local companies. The case here is China but it can apply to numerous other countries.

SAIC and other Chinese carmakers that work with overseas companies are introducing their own models to boost margins in a country set to become the world’s biggest auto market this year. Foreign automakers typically have no remedy because Chinese law forces them to work with a local partner.

“There’s nothing they can do,” said Scott Laprise, a Beijing-based CLSA analyst. “Your goal as a foreign automaker is just to stay ahead, come up with new technology, spend more money, and be one step ahead of your Chinese partner.”

SAIC will add about 30 own-brand models by 2012, threatening Volkswagen and U.S. government-controlled GM. China’s biggest domestic automaker more than tripled sales of Roewe sedans this year.

The set up is somewhat similar to how brand-name consumer goods companies such as P&G and Unilever use manufacturers who also produce goods under their own label. In consumer goods, brand reputation, quality, and other intangible benefits play a bigger role than the manufactured products. With cars, no so much. Maybe high-end cars rely on intangible factors but the mid-end and low-end depend more on the manufactured item. Therefore, I think foreign car companies will have a really tough time in China (and other countries like that.) If, say, GM's partner releases a product similar to GM, I think the partner will slowly come to dominate market share (this is especially true if the technology developed and owned by GM is also used in the partner's vehicle.)

It's a tough decision for foreign businesses and their shareholders. Given how countries like China present huge potential, it is difficult to stay away. But at the same time, the concessions made to the government essentially means that you are working with a partner who will, in all likelihood, become your biggest enemy in a decade or two.


6 Response to Operating in heavily protected markets

October 5, 2009 at 6:40 PM

We clearly need a trade war w China to force issues to the table for negotiation.  Otherwise, our investments (tech, IP, standard of living) will lose significantly over the long run relative to theirs.  They are, effectively, stealing our stuff.  It's up to us not to give it to them...

Sivaram Velauthapillai
October 6, 2009 at 2:01 PM

I'm more free-market-oriented and don't share your hostility. There is definitely a problem. Many, including me, have been warning about the so-called 'global imbalance' which arises due to the lop-sided and unsustainable trade between USA and China.

However, a big chunk of what is happening is simply what happens under a free market. Although you, as well as many others, finger China, the fact of the matter is that you can say that with almost any country in South America or Africa or Asia or even Middle East. If China did not exist, I would argue that the same trade dynamics will still materialize.

I don't think "steal" is the right word here. There is definitely a transfer of technology and the like but there are a couple of things to keep in mind. First of all, it is largely private companies who are moving their factories to China (if China did not exist, then other countries) under their own will. Therefore, it is not a policy decision that is within the reach of governments or citizens--it is essentially up to private owners (basically shareholders like me and you, if you own these companies.)

The second thing to note is that some of the transfer is simply because such use is not feasible in the developed world anymore. For instance, I am sure that GM is transferring a lot of their technlogy, production processes, and the like, but, if they did not, it wouldn't find much use in USA either. The market in USA is shrinking (at least for some aspects within the auto industry) and some of these companies are just maximizing the value before things become obsolete or the entire company shuts down.

Sivaram Velauthapillai
October 6, 2009 at 2:12 PM

In the long run, trade benefits everyone, although the distribution may be skewed towards one party. American standard of living is not declining because of trade with China. In fact, Americans will be better off in 20 years than now. I think what is happening is actually benefitial except for one thing.

I think if government were to do anything, it is not to control technology, intellectual property, or trade per se. Movement in those are natural. Instead, it is to somehow get China from manipulating its currency downwards. In my opinion, what is really killing USA is the fact that foreign competitors peg their currency to the US$ and, as an implicit tactic that goes along with the peg, manipulate the bond yields down (i.e. buy too many US govt bonds).

The fact that foreign governments are willing to buy US govt debt is good in the short run but I believe it is seriously distorting the US economy. A lot of people blame the FedRes for the housing bubble, which they believe was due to really-low short-term interest rates, but the fact of the matter is that the long-term rates did not move when the FedRes started raising its short-term rates. In other words, the long-term rates, which are controlled largely by foreign purchases of US bonds, was artificially low and inducing America to leverage itself.

My view has always been that debt is the drug in capitalism. Everyone--citizens, businesses, governments--get addicted to debt. As long as China keeps influencing the bond yields, which drive the cost of debt, USA is going to be vulnerable.

But if USA tries to get China to re-value its currency then there are many others who are using the same strategy. Japan, most Middle Eastern countries, and so on, use a peg or intervene heavily in the currency markets as well. So this isn't a simple thing to undertake.

Anyway, the issue you have touched on, will likely be the most important economic issue once we are out of the current crisis. The current imbalances cannot go on...

October 6, 2009 at 5:08 PM

I dont think a trade war is nessecary because that would hurt both the US and China. And if US companies are hurt by the process, you can bet that they wont hire more workers. Plain and simple, the Chinese are more competative than the US in terms of pricing, and they should appreciate their currency. They are afraid of this becuase they have gone essentially "all in" in their export sector and this transformation will be somewhat painful just as the US saving more will be painful. As Pettis and others have suggested the imbalances of America not saving and China over saving will need to work out. This may in fact take years, since China does not have the social saftey nets that people in the US have. But I belive the best solution is to have economies have a healthy mix of producing goods and consuming goods rather than going to extereme levels. But as we know, markets tend to go towards extremes until there is a tipping point. The interesting thing that Joseph Stigletz said was that economies shouldnt be concerned with short goals such as hitting GDP growth but moreso with longer sustainable emloyment. I do think countries such as India, Brazil and China will consume goods as we have seen w/ the auto sector and so on, but to what extent and how much is the million dollar question.

Sivaram Velauthapillai
October 6, 2009 at 7:48 PM

The problem is debt! As I like to always say, debt is the drug of capitalism. I think the imbalances that persist will be more easily managed if it involved transfer of actual cash or wealth. Instead, most of the financial obligations far outweigh the underlying assets. This is also what makes it kind of scary to me, and makes it comparable to the 1930's.

Although the nature of the economy--as you suggest, a better mix between production and consumption--can be better, I really think the core problem is debt. For instance, US consumption--this applies to Canada, Britain, and others too, but with slightly differing numbers--is always suggested as being way too high, the reality is that it is only a few percentage points above the consumption ratio 30 years ago. I have to look up the numbers but American consumption is something like 8% to 10% higher than in the 60's or 70's.

Conversely, Chinese consumption has declined in the last decade but it is only like 6%, or something like that, below what it was in the late 90's.

So, even if the structure of the economy changed in America, I don't know how much it matters. The reason consumption looks really high is because the nature of the economy is different now. I don't think we can ever go back to what it was 50 years ago. Right now, a lot of the economy is involved in information services, for example, but that did not exist 30 years ago. It's really hard to see how one can argue that such services should be a smaller portion of hte economy now. Conversely, many deveoped countries simply don't have primary resources that they can export or add value to.

It remains to be seen how the imbalances are fixed.

October 7, 2009 at 1:00 PM

Well, I agree with you debt is at the core of the problem but it isnt as big of a problem as some suggest. I believe for the average person that has a home and a job and a car and they defaulted on all of their perosnal debt, they would still be okay. The problem however is the banks and the people in power that dont want the debt liquidation to actually happen. I think if all of the banks were restructued and home prices actually dropped it would be a tough 2-3 years with Americans lowering their debt levels, but the majority of the losses would hurt the banks and the investors in the banks, who are really powerful in Washington. Now on to the debts for the Government, there is no feasbale way to pay these debts and probably will result in a default or a war. This is what Marc Faber talks about when he says the medicare and social security payments in the next 10 years can baloon the deficit to levels that are unheard of and the only way the US can deal with this is essentally creating some war.

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