Competition policy promotes rivalry among firms to maximize the efficient allocation of resources and the lowest prices for the consumers of goods and services, thereby increasing societal welfare. In advanced economies, competition policy includes antitrust laws that protect consumer welfare from monopolistic behavior and other rules to prevent firm collusion, unfair practices that restrict competition, and barriers to market entry and exit. As China has reached a more advanced stage in its economic development, it has ratcheted up its competition policy objectives. Beijing passed a long-awaited antitrust law in 2008 after 13 years of discussion. The 2013 Third Plenum plan declared “developing an environment for fair competition” a priority, as well as making the market a decisive touchstone. However, long-standing instincts to do the opposite and favor the interests of strong firms over consumers – and domestic firms over foreign ones – are still embedded in the Chinese system with little regard for consumer welfare. This fuels misgivings about China’s convergence with international norms.
Competition policy is an amalgam of law, economic analysis, and politics, and gauging outcomes is challenging. Our primary indicator looks for convergence in reviews of foreign versus domestic mergers conducted by the Ministry of Commerce (MOFCOM), one of the three Chinese authorities responsible for competition policy (along with the National Development and Reform Commission (NDRC) for price abuse of market power and the State Administration for Industry and Commerce (SAIC) for non-price-related behaviors). In March 2018, the National People’s Congress (NPC) approved a proposal from the State Council to restructure China’s bureaucracy, including consolidating all antitrust responsibilities under a new State Administration for Market Regulation (SAMR). We may update our indicators depending on how reporting on mergers and acquisitions (M&A) reviews changes under the new structure. Supplemental data look at the number of merger cases reviewed, disclosure of results of competition court cases, new business starts and closures (entry and exit), and the ability of firms to obtain viable profits in healthy markets.
Quarterly Assessment and Outlook
Our assessment of competition reform remains negative, unchanged from the previous period. While it is still unclear how the newly consolidated market regulator, SAMR, will function, results so far depict no substantive progress toward 2013 Third Plenum pledges regarding fairer and more transparent competition policy. Contrary to promises to level the playing field, our primary indicator reveals that foreign firms are still disproportionally targeted in merger reviews. Judicial transparency, particularly in competition-related cases, remains poor, even though predictable market rules to govern corporate behavior is a critical element of an effective competition policy regime.
Other data were mixed. The number of new businesses registered reached a historic high, with a surge of foreign entity registrations in the Great Bay Area - an ambitious scheme to transform the Hong Kong–Macau–Guangdong region into China’s “Silicon Valley.” Many of those foreign entities, however, could have been Chinese companies utilizing Hong Kong subsidiaries to take advantage of policies favorable for foreign investment. Bankruptcy cases are becoming more common, which is an important improvement for both competition and financial reform, although the pace of improvement is modest and the number of bankruptcy cases in China today remains well below the level that would be expected for an economy of China’s size and dynamism. Among listed companies, private firms held up their pricing power well this quarter, while state-owned enterprises (SOEs) experienced a significant loss of pricing power, possibly because of government mandates for SOEs to lower prices or undertake new investments.
Policy developments over the period did not point to likely improvement in the near term. Detailed organizational plans for the new SAMR were released, showing that the body will hold significant authority over competition-related policies, but it is still unclear if the newly merged antitrust team within SAMR will function differently from its predecessors. On the legislative front, a newly passed E-Commerce Law sought to better regulate online sellers and protect consumer rights, but potential penalties under the law appear inadequate to prevent future cases of consumer harm or monopolistic behavior.
Contrary to promises to level the playing field, foreign firms are still disproportionally targeted in merger reviews.
This Quarter’s Numbers
This quarter our primary indicator of China’s competition policy regime exhibited the same pattern as in previous reviews: foreign firms were still targeted disproportionately by merger reviews, contradicting 2013 Third Plenum pledges to level China’s competitive environment between domestic and foreign firms (see Merger Reviews). In 2Q2018, SAMR reviewed 22% of 179 foreign-involved mergers, but only 4% of 557 domestic ones. Operational since May, SAMR has so far shown no signs of improvement in its treatment of foreign and domestic firms in M&A reviews.
Poor Judicial System Transparency remained a major hindrance for companies seeking protection in intellectual property (IP) and competition disputes. China’s Supreme Court published details on only 3,687 cases related to IP and competition laws in 1H2018, despite the fact that the Chinese judicial system handles more than 200,000 such cases each year. Judicial transparency is a critical element of effective competition policy, which gives companies insight into how rules governing market behavior are applied and also keeps pressure on governments to ensure such rules are applied equally among all domestic and foreign companies. In the 2013 Third Plenum, Beijing promised to allow all companies to “participate in market competition on an open, fair and just footing” and receive “equal protection and oversight according to the law.” So far our data show this bar has not been met.
Other indicators showed slightly more positive trends. New business registrations increased 18% year-on-year (yoy), reaching an all-time high; the increase reversed a slowdown from 2Q2017–1Q2018 (see Market Entry and Exit. Official reports suggest that renewed entrepreneurship was due to (1) an active services industry; (2) steady growth of real estate activities; and (3) a surge in foreign investment, with reportedly 45,000 new entities registered as foreign owned – 97.4% growth year-on-year for the quarter. These numbers seemingly contradict a burgeoning sense of negativity among foreign businesses about China’s investment environment and uncertainty about the economic repercussions of a trade war with the United States. So, we are somewhat skeptical. More than half (54.7%) of new foreign businesses registered in 2Q2018 were located in Guangdong Province, where the government is implementing the so-called Great Bay Area plan to integrate Hong Kong and Macau with Guangdong Province and transform the region into a global technology hub. Any investments made by Hong Kong entities under this plan would still be counted as “foreign” investments under the current data regime; therefore, it is difficult to differentiate how many of these investments were actually driven by the Hong Kong subsidiaries of Chinese companies. We will be watching this number closely going forward.
Despite the lack of full market exit data since 2017, bankruptcy cases surged in 1H2018 to 6,392, more than the 4,081 cases during the whole of 2016, and on track to exceed 2017’s 10,195 cases. The fact that more companies are using this formal process to balance investor interests and manage liquidation to settle insolvencies is a positive development for the competition environment, though the number of bankruptcies at play in China today remains below that of advanced economies. In the United States, for example, 23,157 bankruptcy cases were filed in the 2017 calendar year according to the U.S. Federal Courts system.
Finally, we see some surprises in data on the pricing power of listed Chinese companies (see Pricing Power). Our indicator shows that SOE pricing power continued to weaken this quarter, while private company pricing power improved slightly. The latter may be a result of increased market concentration, as smaller private firms are being acquired by larger ones or are being forced to exit the market because of deleveraging efforts, which limit available credit. But this would not explain why SOE pricing power is also deteriorating. As shown in our SOE assessments, SOEs’ share of revenue among listed companies has been relatively stable, and SOEs are also crowding out smaller private players in the market. If, despite these advantages, SOEs are still losing pricing power, this suggests the government may be pressuring them to cut costs or invest more than they can afford and what the market should bear. Either would be unhealthy for the competition environment.
In September, the National People’s Congress published its legislative agenda for the next five years, which included revising the Antitrust Law. Proposed revisions would establish competition policy as the 'foundation' of market regulations – reaffirming a key goal of the 2013 Third Plenum.
A new and more detailed organizational structure for the SAMR was announced in August, confirming the body’s increased authority and institutional heft in the bureaucracy, particularly regarding competition policy. SAMR will now have 807 staffers across 27 subagencies ranging from antitrust to food safety – a significant expansion compared with only 272 staffers under its predecessor, the SAIC. SAMR will also manage a bigger agency responsible for IP registration, the China National Intellectual Property Administration (CNIPA, formerly the State Intellectual Property Office), which now has 143 staffers, up from 85 in 2008.
Also in August, the NPC Standing Committee approved a draft E-Commerce Law, which regulates competition in the Internet marketplace. Among other provisions, the law addresses the use of personal data by companies, forbids using or soliciting fake reviews, and bars companies from tying merchants to one platform. However, the law contains many concessions to Internet companies, for example, limiting their joint liability with merchants and capping possible fines against them at only RMB 2 million ($288,000). These numbers appear insufficient to dissuade China’s massive Internet platforms from abusing their market power despite repeated accusations of neglecting consumer safety or bundling sales. The law came as a disappointment to competition policy analysts and advocates within China.
In September, the National People’s Congress also published its legislative agenda for the next five years, which included revising the Antitrust Law. Proposed revisions would establish competition policy as the “foundation” of market regulations – reaffirming a key goal of the 2013 Third Plenum – and institutionalizing the “fair competition review mechanism” introduced by the State Council in June 2016, which requires government bodies to conduct self-review and eliminate all anticompetitive regulations (see Fall 2017 and Winter 2018 for details). However, final approval of the draft revisions may take five years, or even longer: it took more than ten years to pass China’s first Anti-Monopoly Law’s (AML) in 2008.
Finally, a judicial case in July 2018 provides a useful anecdote about the current state of China’s competition-related policy. In late 2017, the Chinese government set up a new intellectual property court in Fuzhou, Fujian Province, with expertise on handling the semiconductor industry. In July that court imposed a temporary ban on chip sales in the China market by a prominent U.S. semiconductor firm, after a case was brought against that U.S. firm by a Taiwanese competitor. The Taiwanese firm is separately accused of stealing intellectual property from the U.S. firm in coordination with a domestic Chinese partner. The court issued its injunction without any direct notice to the U.S. company, and its action was perceived as a potential retaliatory move in U.S.-China trade conflict. Taken together the case speaks to ongoing shortfalls in China’s competition-related policy regime, particularly when it comes to putting domestic and foreign firms on a level playing field as promised in the 2013 Third Plenum.