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When Honda Motor Co., Ltd., announced in January that it would build a new factory in the southern Chinese province of Guangzhou, the Japanese carmaker’s international rivals scoffed at the news. Despite China’s cheap labor, building cars there remains expensive compared with Japan, Europe, and the United States; the cost of importing sophisticated car parts far outweighs savings from wages. But Honda knew something its rivals didn’t. Marking a stunning shift in Chinese policy, Beijing granted the Japanese car company permission to own a majority stake of 65 percent in a new export-only factory, instead of the 50 percent maximum currently allowed to foreign investors. Honda won the contract “because of the 100 percent export plan,” says Masaya Nagai, a Honda spokesman. Once the factory is up and running, the cars will be shipped to Southeast Asia and Europe. Even with strings attached, Honda’s deal is a breakthrough for foreign automakers. It’s yet another sign that the new Chinese government is slowly prying open its laws, regulations, and practices to multinational businesses. In some cases � such as the country’s efforts to solicit public comment on pending legislation and loosened foreign ownership of banking and automotive joint ventures � China has lifted restrictions ahead of the deadlines specified in its agreement with the World Trade Organization, which it joined in 2001. And in areas where timetables haven’t been specifically laid out by the WTO, China has actively encouraged outside investment. The government opened its major stock market to foreign investors on July 9, much earlier than many outsiders expected. These are welcome steps to foreign businesses, and a reminder that, in the long term, doing business in the country will only get easier. But even with these steps forward, multinational companies in the biotech, chemical, and publishing industries, among others, are still wary about increasing their investments in the country. The perennial problems of doing business in China � piracy, copyright theft, sloppy corporate governance at state-owned enterprises, and regional red tape � remain. “There’s a lot of talk about the government pushing to loosen regulations quicker than the WTO timetable expects them to do, such as loosening regulations in the media industry, for example,” says Walker Wallace, a counsel at O’Melveny & Myers’s Shanghai office. “And to a certain extent, the government has had to do that to respond to all the rapid changes in the business environment. But what we are to expect from the government in the future remains to be seen.” Still, loosening the reins has been a bonanza for Beijing. GDP growth spiked 8 percent and $52 billion in foreign investment poured into the country last year. Even with the plunge in tourism from SARS earlier this year, the country is still expected to report robust economic growth for 2003. Multinationals across a range of industries � including photo-imaging giant Eastman Kodak Company, and mobile phone companies Motorola, Inc., and Nokia Corporation � raised their investments in China by almost twofold in the past two years. The new party leadership gets the credit for letting capitalism bloom. Last November the Chinese Communists, who ruled the country for more than half a century, admitted 100 private businessmen into the party at the Sixteenth National Congress of the Communist Party, a gathering every five years of political officials. It was the first time nongovernmental bureaucrats were allowed to join the party. At that meeting outgoing president Jiang Zemin described private entrepreneurs as “builders of socialism with Chinese characteristics” on par with workers and peasants. He added that “we need to respect and protect all work that is good for the people and society. . . . All investors at home or from overseas should be encouraged to carry out business activities in China’s development.” At the party’s March gathering this spring, the Communists elected Zhang Ruimin, CEO of Haier Group Companies, a corporation listed on China’s stock exchange that makes household appliances, as an alternate on the central committee. His appointment marked the first time a “red capitalist” earned a seat on the country’s key decision-making group. Most important, the party also appointed new leaders, President Hu Jintao and Premier Wen Jiabao. Their election was seen by political observers as a clear signal to the rest of the world that China intends to stay committed to open markets and foreign investment. “The trend is clear: The government wants to continue the track of liberalization it has started,” says Jonathan Woetzel, author of a recent book, Capitalist China, and a China veteran at U.S. management consultancy McKinsey & Co. in Shanghai. But that track has plenty of speed bumps. One of the biggest problems for foreign companies in China is regional red tape. Governments have significant influence over how multinationals conduct business in their localities, and many have put up roadblocks for outside investors. In-house lawyers at multinational companies say that local governments find “technical obstacles” to make it difficult for foreign businesses eager to break into lucrative industries such as automobiles, banking, and agriculture. These restrictions take many forms, including capital reserve requirements, licensing delays, and refusing to investigate complaints by foreign investors against their local partners. PepsiCo, Inc., for example, has been in arbitration for several months over a complaint it filed against a joint venture partner, an arm of the government of central Sichuan province, for misusing funds from the joint venture. Kodak has been trying to convince local governments to grant it licenses to set up photofinishing operations in the country. Photofinishing is considered publishing, however, and the government still maintains a tight grip over the flow of information in China. “But I would speculate that limiting our business scope also has something to do with protecting the state-owned enterprises and their turf,” says Kenneth Tung, director of legal affairs for Kodak’s greater China operations. TEST-DRIVING REFORMS The automotive industry serves as a clear example of how the government’s whims have benefited and frustrated foreign investors. China’s auto market is the world’s fastest-growing, up 55 percent in the first 11 months of 2002, according to China Automotive Consulting, a government-affiliated group in Beijing. Foreign manufacturers have been anxious to grab a piece of this market. Hyundai Motor Company, South Korea’s largest automotive company, started producing cars in the country late last year, and plans to spend $1.1 billion to produce 500,000 vehicles there by 2010. Initial sales have been so promising that Hyundai just doubled its 2003 sales target to 50,000. General Motors Corporation signed a joint venture agreement in December with a Chinese carmaker, Yantai Bodyshop Corp., in Shandong province, marking its fourth such deal in China. Still, Honda’s recent success aside, the government’s limits on factory ownership in China have frustrated foreign automobile manufacturers. Even though they have equal say in business strategies, they can only own a minority share of the joint venture. The risks of managing joint ventures in China are real, such as PSA Peugeot-Citroen S.A.’s high-profile failed Guangzhou joint venture. In the mid-1980s Peugeot and Guangzhou Automobile Group Co., Ltd., agreed to jointly manufacture and sell cars in the country. But when the two disagreed over distribution and marketing efforts, Peugeot said that at that time it felt it had nowhere to appeal because Guangzhou was an arm of the local municipality; Peugeot ended the joint venture in the mid-’90s. (Guangzhou declined to comment.) Since then, most other multinationals, such as Honda, GM, and Volkswagen AG have successfully partnered with local businesses rather than government offshoots. Executives at foreign car manufacturers declined to discuss details of their operations in China. But lawyers and management consultants who have worked closely with these companies say that car manufacturers want more of an ownership stake and the right to sell their own cars in China. Leading manufacturers Mitsubishi Corporation, GM, and Nissan Motor, Co. Ltd. have already applied to distribute their own cars. “As a car manufacturer, you want to be able to control the production and the sales,” says Paul DiPaola, managing director of the U.S.-based management consultancy Bain & Company in Beijing. “But if you can produce foreign cars domestically and sell domestically, then why would anyone want to buy a Chinese car? . . . It’s no great secret that the government is worried, and some of these applications [to distribute] have been sitting around for a while.” FAKE DIAPERS Making sure that intellectual property rights are protected is an even greater concern. Piracy has been rampant in China for decades and takes many imaginative forms, from DVDs of Hollywood blockbusters to counterfeit cigarettes and fake diapers. In response, the government introduced new patent and copyright laws over the past year that hand down tougher penalties. A new intellectual property court was introduced earlier this year to respond to the growing number of cases. And police are conducting raids targeted at the source of the piracy rather than just the distributors. The Supreme People’s Court and the Economics Crime Divisions at the Ministry of Justice have also held frequent seminars over the past two years to update judges and prosecutors at the municipal and provincial level on the latest laws and regulations guarding intellectual property rights. And the Corporate Brand Protection Council, a nonprofit organization loosely affiliated with the American Chamber of Commerce, works with the central government to trace purchases of chemical ingredients that are used to make counterfeit medication, says Chris Murck, head of the council and AmCham’s chairman. Still, these changes still aren’t happening fast enough, says John Huang of Shanghai’s AllBright Law Offices. He defended Microsoft Corporation and Adobe Systems Incorporated against local technology outfits that “borrowed” their logos, pirated their software, and illegally distributed their products. The problem, Huang said, is not in getting the judge to rule in favor of his clients. The hard part is to actually get the guilty companies to pay up. “The right regulations are coming into play now,” Huang says, “but it’s almost impossible to track down the violating companies. Sometimes you can’t find the company any more. Other times, you just can’t get the local judge to enforce the ruling.” These concerns have kept the lucrative biomedical industry from making significant investments in China. Rohm and Haas Company, E.I. du Pont de Nemours and Company, and Eli Lilly and Company all operate actively within China’s borders, but none has been willing to set up a full research and development facility there. In the past, chemical and drug companies only imported out-of-date technology to China because “we wanted to protect ourselves. Plus, although it was old technology elsewhere, it was considered advanced in China,” says Cherry Fan, in-house China counsel for Rohm and Haas in Shanghai. “Now competition [with other companies] is fierce. So how are we going to bring technology that is new and targeted toward the Chinese consumers, but at the same time protect ourselves against infringement? We don’t have the answer to that yet.” Foreign banks face a different set of obstacles in their efforts to get their hands on the money of China’s 1.2 billion people. China’s WTO membership has meant a greater opening in the banking industry to outside competitors. Foreign banks such as Citibank, N.A., The Hongkong and Shanghai Banking Corporation Limited (HSBC), and Standard Chartered PLC have been allowed to market their financial products in the country. Still, restrictions remain: The number of branches and automatic teller machines are limited, as is the type of bank accounts they can offer. Right now foreign banks can only offer foreign currency accounts. Even so, the pool of foreign currency deposits is significant: $100 billion out of $1 trillion in total bank deposits. “The banks want to get a foot in the door,” says Allen Merrill, who heads the banking practice in Asia for Bain. After capturing a share of the foreign currency market, they are eagerly awaiting the WTO-mandated opening of the domestic currency market in 2006, he says. Foreign banks have also bought minor stakes in established local banks as another way to reach Chinese consumers. Citibank, for example, purchased a stake in Shanghai Pudong Development Bank. A U.S. private equity fund, San Francisco�based Newbridge Capital Group, recently acquired a 15 percent stake in Shenzhen Development Bank Co., Ltd., the largest ownership percentage among foreign banks, and one that makes it the majority shareholder in Shenzhen, Merrill says. In the credit card business, Beijing is also loosening up, although foreign banks such as Citibank are only allowed to issue cards to Chinese citizens for spending outside China. These restrictions frustrate the banks, but access to that international credit card market, estimated at $24 billion, is worthwhile. Anticipating the gradual opening of the financial industry over the next few years, foreign banks are scrambling to set up back-office operations such as processing centers and customer service centers. HSBC opened a second processing center in Shanghai in March to supplement its Guangzhou center, which combined will save the bank millions. ABN AMRO Holding N.V. is trying to cut costs by leveraging its existing Taiwan operations. “The banks are starting completely from scratch on the consumer banking side,” Merrill says. “They are trying to fill positions from tellers to marketing people. It’s time-consuming, costly, and a real challenge for foreign banks. Some will do well. Some won’t, but that’s the case with any company doing business in China.”

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