Monday, March 29, 2010

Questions raised by Geely’s Volvo Purchase

As recently as the day-before-yesterday, I was still expressing my skepticism that the Geely-Volvo deal would ever happen. From my perspective, Ford had far more reasons to keep Volvo than it did for selling it at a huge loss, and for a comparatively small amount of cash that will barely knock a dent in its debt.

But neither Li Shufu nor Alan Mulally asked for my opinion, so the deal has apparently gone through.

What now?

Now that Li Shufu appears to have succeeded, against all odds, in his quest of owning a well-known foreign brand, how will he repay the generosity of the various organizations that helped him to achieve his dream?

A Political Issue

As the Financial Times’ "Lex" column points out today, “(China’s) biggest auto deal to date is not a strictly private transaction”. Of the total purchase price of $1.8 billion, $1.6 billion is in cash. Of that amount, about half is coming from several local governments in China who will be “helping” Geely to build Volvo factories in their areas. In addition, about $900 million in working capital is coming from state-owned banks – the banks that are frequently criticized for lending only to state-owned companies.

Furthermore, now that a global luxury brand has Chinese ownership, we can be almost certain that the black sedan of choice for state officials will no longer be an Audi or a Mercedes. It will be a Volvo.

China’s government has made no secret of the fact that the state intends to remain the major player in the automobile industry, nor of their desire to build “national champions” able to compete on a global scale. Geely is ostensibly private, but it has needed government help to move into the big leagues, further blurring the line between public and private (an issue I highlighted in relation to Geely last June).

What will be the eventual cost of this help? Will Beijing now begin to have influence on Geely’s strategic direction?

As before, I think many Chinese may find this line of questioning a bit ridiculous: Well of course the government will expect something in return! This is how business works! The business brings in expertise, the government offers support. It is a symbiotic relationship.

I approached this question from a different direction just a few weeks ago in relation to the failed Hummer deal. Sichuan Tengzhong was unsuccessful in its bid for Hummer largely because the proposed deal was in violation of government policy. Geely has been successful in its bid for Volvo for the opposite reason: it is completely in keeping with government policy.

The lesson seems clear. The price of not following policy is likely to be failure. The reward for following policy is not only a greater chance of success, but also material support where needed – regardless of whether the business is private or state-owned. But what will be the price of following policy? For this we can only speculate at this point.

What is fascinating about this case, however, is that following government policy in China need not always be detrimental to business strategy. Perhaps the goals of both the government and Geely are met in this single transaction, and neither side loses.

To me, this is a mind-blowing revelation. Neo-liberal economic theory tells us that governments cannot run businesses because they are conflicted with political objectives (and perhaps the US government’s ownership of GM bears this out), but is China the exception that proves the rule, or has it found some way around the strictures of Western economic theory? Is China re-writing the rules of capitalism, or is it merely breaking them?

There is one other question this transaction raises, and it is more of a business issue than one of political economy.

A Business Issue

In discussing the Geely-Volvo deal with a (Chinese) executive at a Chinese automobile company about two months ago, I asked whether he thought Geely could manage Volvo if the deal were consummated. His response was that Geely would need a lot more money than it currently has.

As he explained it, an auto company not only needs to fund research and development for new models, but it also requires about $1 billion of R&D a year on each existing product line, just to keep the models fresh and to introduce incremental innovation. (The figure seemed high to me, so I asked again, and he repeated the number, $1 billion.)

“If Geely is relying on the government for at least half of a comparatively small purchase of Volvo, how can Geely possibly fund Volvo’s ongoing R&D pipeline? Add to this the likelihood that Ford has probably way underinvested in Volvo over the past few years. I’m not sure Li Shufu fully understands what he is getting into”.

Will Geely need to get further into bed with the state in order to feed the R&D pipeline? And if so, at what further cost, if any, will this help come?

Saturday, March 27, 2010

国进民退: Is China Really Re-nationalizing? (I)

Please note that this is the first in a series of several posts on this topic. Subsequent posts can be found here, here and here.

Follow-up Edit (August 2011): Please note that some of my initial speculation in this particular post about the meaning of certain Chinese terms proved to have been misguided. It is important to read the three posts that followed this one for a better understanding of these terms and the guo jin min tui phenomenon.
This is the first of at least a couple of posts on the topic of public vs private ownership of business in China. Chinese speakers may find the beginning of this post a bit tedious, but I want to lay out a few definitions for those who may be interested in the topic, but whose Chinese isn't quite up to speed.

Those who follow Chinese economic discourse may have noticed the terms 国退民进 and 国进民退 in the news recently. (I also wrote another post on this topic about a year ago.) If you speak Chinese, you already get the subtle -- yet profound -- difference between these two terms. For non-Chinese speakers, let me briefly explain these terms.

Each term contains two nouns and two verbs.

The nouns are:

国 meaning "state" (pronounced guo)
民 meaning "people" (pronounced min)

The verbs are:

进 meaning "to enter" (pronounced jin)
退 meaning "to withdraw" (pronounced tui)

So the first term "guo tui min jin" means "the state withdraws and the people enter". The second term "guo jin min tui" means the opposite: "the state enters and the people withdraw".

These two terms refer to processes. Guo tui min jin, at the risk of oversimplification, is basically the process of privatization. Guo jin min tui, again at the risk of oversimplification is the opposite: nationalization. From here forward, I will refer to these terms as "privatization" and "nationalization", respectively (quotation marks included). (Again, let me acknowledge that these are gross oversimplifications.)

One might think that these two terms emerged simultaneously in economic debate; however, those who have followed the Chinese economy for a decade or more know that this is not the case.

"Privatization" (国退民进) was first introduced over a decade ago to describe a deliberate continued policy of privatization that had begun under Prime Minister Zhu Rongji. The idea, at least on its surface, was that, as the state continued to withdraw from ownership of business, the people would gradually move in to take the state's place.

To determine to origin of "privatization" I consulted an official economic history of China which credits Professor Wang Jue (王珏) of the Central Party School for introducing the term in 2000.*

"Nationalization" (国进民退) did not really begin to emerge until very recently, but it did not emerge as a statement of policy. Rather it arose as a criticism of what appeared to be a reversal in economic reforms as the state's share of a number of important industries has begun to increase.

In order to determine whether my perception of the emergence of these terms matched reality, I consulted a couple of sources: a database of Chinese academic journals** and People's Daily, the main Communist Party daily newspaper.*** Below are two charts showing the trends in usage of these two terms.

This first chart shows that the number of academic articles using the term "privatization" (国退民进) became significant around 2000, and peaked around mid-decade before falling off significantly. The number of articles using the term "nationalization"
(国进民退) did not become significant until around 2008, nearly surpassing usage of the other term, "privatization" in 2009.

The point here is that China's academic community appears to at least acknowledge a trend in behavior, if not in policy.

A search for these terms in the People's Daily archives yielded the following chart. Not quite as exciting (and with numbers so small as to be of questionable significance) the data seem to support the academic debate. "Privatization" clearly emerged as a policy around 2000, got a few mentions around mid-decade, then barely got a mention in 2009 -- except possibly in contrast to mentions of "nationalization" which began to show up for the first time last year.

So clearly, there is some sort of a debate going on in China. But this is China, so the debate cannot be very vigorous, nor can it be held in the open, right? While the average Chinese may not be surprised to learn this, the richness of debate taking place in China, particularly in the economic arena, may surprise some outside observers.

A fascinating article about this debate was published this week in China Economic Weekly, a news weekly published by People's Daily. (Thanks to Paul Denlinger for bringing this article to my attention.) The article, entitled “国进民退” 真伪 is the cover story of this week’s issue, and, roughly translated, it means, “'Nationalization' True or False?”

Over several pages, the article presents a fascinating debate that has been taking place in China over the past year, and that managed to generate some attention during the recent annual meeting of the National Peoples Congress. Is the Hu-Wen government really in the process of re-nationalizing a lot of the enterprises that were privatized under Zhu Rongji and Jiang Zemin?

In a later post, I will summarize the debate and identify some of the players. I will also take a look at the origin of the term "
privatization" (国退民进) to determine whether the original meaning was everything we thought it was (or is).

The next post in this series can be found here.

章迪诚,著,中国国有企业改革编年史,(北京:中国工人出版社,2006) pp.556-7.
** database of full-text Chinese academic journals, through UCLA East Asian Library.