Competition policy promotes rivalry among firms to maximize societal and economic 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 other abuses, and barriers to market entry and exit. As China has reached a more advanced stage, 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, and 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 – 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 approved a proposal from the State Council to restructure China’s bureaucracy, including consolidating all antitrust responsibilities under a new General Bureau of Market Regulation. We may update our indicators depending on how reporting on 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 recover a viable profit margin in healthy markets.
Quarterly Assessment and Outlook
Beijing committed to establishing a “competitive market system” and increasing the market’s role in resource allocation in the Third Plenum decisions in 2013. A fair and predictable competition policy regime is critical for China as it pursues a more efficient economy driven by innovation and high technology. Intellectual property should be protected to fairly compensate investors for research & development (R&D) spending, and state-owned, private, and foreign companies should be treated equally to engender competition and promote consumer welfare. Our indicators measure the differentiated treatment of foreign and domestic firms in the China market, and they assess other important competition-related issues such as judicial transparency and market efficiency. This quarter, our indicators point to continued shortfalls in China’s competition regime. Our primary indicator shows that China’s Ministry of Commerce (MOFCOM) disproportionally targeted foreign firms in its mergers & acquisitions (M&A) review process and issued divestment requirements only for foreign-involved mergers. We also measure judicial transparency, which is critical for businesses to be able to understand and anticipate regulatory enforcement. We find that China’s courts are becoming less transparent. The ability of businesses to exit the market is another important barometer of competition conditions that we track in our indicators, but data on business exits have not been released for two consecutive quarters – making it hard to draw conclusions about whether or not the Chinese market is becoming more efficient.
Policy trends suggest that Beijing is aware of the shortfalls in its competition regime and that some improvement should be expected in future quarters. The government consolidated its fragmented antitrust review process during the National People’s Congress (NPC) by creating a new State Administration of Market Regulation (SAMR). This was long encouraged by business and legal advisors, and it should help to streamline M&A oversight procedures, professionalize enforcement of competition policies, and improve the predictability of review processes. The National Development and Reform Commission (NDRC) also stepped up efforts to curtail local protectionism, especially as related to procurement practices. There are signs that China’s judiciary is preparing to handle more bankruptcy cases – a positive development that if implemented could allow more companies to exit the market. Finally, in November 2017, the Unfair Competition Law was revised for the first time since 1993, which should help address new competition issues that were not covered in the old version, such as those related to the internet sector.
The overregulation of foreign-involved mergers raises skepticism among foreign investors about China’s investment environment, weakening their appetite for new and expanded investment.
This Quarter’s Numbers
Our primary indicator looks at the review of domestic and foreign M&A deals by China’s MOFCOM as a proxy to measure whether foreign and domestic businesses are treated equally. The indicator shows that foreign firms are vastly more likely than domestic companies to be targeted for an M&A review: 20% of foreign-involved mergers were reviewed by authorities, compared with only 3% of those among domestic companies. This quarter, MOFCOM also reviewed fewer domestic and foreign-involved mergers than in the previous quarter, even though the total number of mergers increased significantly. This suggests that not only did MOFCOM disproportionately target foreign firms, but it was also unable to keep up with the increased deal flow in the review period. Just 20 domestic and 44 foreign mergers were reviewed in the fourth quarter, down from 30 and 54, respectively, in the third. Yet the total number of domestic mergers jumped to 743, up from 586, and foreign mergers rose to 223 from 203.
Despite the lower number of total reviews, MOFCOM issued five penalty notices this quarter, the highest total number we have on record, and all targeted foreign-involved deals (see Results of Merger Reviews). These outcomes were expected and consistent with decisions made by competition authorities in other countries on the same cases. Each merger was ultimately approved with conditions. Still, it is disappointing to see that all penalty decisions were imposed on foreign deals, even though the number of domestic mergers was three times that of foreign mergers during the review period.
This skewing of antitrust oversight against foreign firms is harmful to China’s competition environment for two reasons. First, underregulation of domestic mergers breeds monopolistic power that disrupts market competition and hurts consumers. Second, the overregulation of foreign-involved mergers raises skepticism among foreign investors about China’s investment environment, weakening their appetite for new and expanded investment.
The judiciary should function as a transparent and reliable mechanism for foreign and domestic companies to defend their rights and interests. But our indicator of the Transparency of the Judicial System shows deterioration. We track the public release of competition-related cases, including antitrust, unfair competition, patent, copyright, and trademark disputes. Fewer than 2,000 cases were disclosed by China’s judiciary in 4Q2017. This means that the total number of competition-related cases concluded and disclosed in 2017 was just over 8,000, which is 25% fewer than in 2016 and 60% fewer than in 2015. China’s Supreme Court announced at the start of 2018 that it heard 213,480 competition-related cases in 2017, a 40% increase from 2016. Publishing details on fewer than 5% of those cases, compared with almost 15% three years ago, is a clear move in the wrong direction for China’s competition regime.
The ability of businesses to exit the market, via bankruptcy or closure, facilitates needed creative destruction and improves market efficiency. The Chinese government often provides heavy support to unprofitable companies, particularly state-owned enterprises (SOEs), which delays market exit, increases structural financial risks, and impedes efficiency. An accelerated rate of business exit would therefore signal improving competitive conditions. But data on the number of companies exiting the market were not released again this quarter for the second quarter in a row (see Market Entry and Exit). This is not entirely surprising as this data stream is released irregularly. During its quarterly press conference in January 2018, the State Administration for Industry and Commerce (SAIC) announced that 6 million new domestic companies were registered in 2017, up from 5.5 million in 2016. SAIC attributed this to streamlined business registration procedures. But it did not specify the number of companies dissolved in 2017 – a disappointing sign implying that officials do not consider business exits to be an important element of market efficiency.
Beijing restructured a key part of its competition policy regime at the NPC this March when the legislature approved a broad reorganization of the bureaucracy that consolidated all antitrust responsibilities into the new SAMR. The SAMR will report directly to the State Council and will take over antitrust responsibilities currently managed by NDRC, MOFCOM, and SAIC. Zhang Mao, the former director of SAIC, will lead the organization.
The move not only unifies China’s formerly fragmented antitrust review process; it also creates a dedicated body for antitrust oversight that is autonomous from agencies that have conflicting industrial policy mandates, such as NDRC and MOFCOM. This looks to be a clear step in the right direction for China’s competition regime. Putting Zhang Mao in charge of the agency reinforces the message, as SAIC, his former office, is more of a regulatory body than a policy-making institution.
The NDRC also continued its efforts to constrain anticompetitive behavior by local governments, following a June 2016 directive from the State Council requiring all government agencies to abolish anticompetitive policies. By January 2018, NDRC disclosed 56 cases of abuses of anticompetitive power by local governments in 2017. Most involved the use of procurement policies to preference specific, mostly state-owned companies in sectors including public utilities, pharmaceuticals, transportation, and intermediary services. All government agencies are meant to undertake self-reviews and issue remediation plans to the State Council by May of this year.
We also see signs that Beijing is preparing for more bankruptcies in 2018. This should improve our assessments of China’s competition conditions, if implemented faithfully. During our review period, a number of provinces, including Shandong, Shaanxi, Jilin, Hunan, and Fujian, announced plans to simplify company dissolution procedures. China’s Supreme Court also announced that settled bankruptcy cases increased to 9,542 in 2017, up 68% from 2016. In addition, 97 provincial and local courts established specific institutions to handle bankruptcy cases by the end of 2017, up from only 5 in 2015.
Finally, on November 4, 2017, the Standing Committee of the NPC passed the first update to China’s Unfair Competition Law since the law was passed in 1993. The revised law took effect on January 1. The revisions include new stipulations covering issues such as business bribery and competition on the Internet, and they also offer penalty reductions for companies that voluntarily report and self-correct unfair behavior. They also eliminated a clause that allowed the State Council to designate practices not explicitly mentioned in the law as anticompetitive, which should reduce regulatory uncertainty.