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, 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 – 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 recover a viable profit margin in healthy markets.
Quarterly Assessment and Outlook
Our assessment of the state of China’s competition policy reform remains negative for this reporting period. Enforcing a legal regime that protects fair competition is critical for China to optimize market forces and encourage innovation. Beijing recognized this when it identified “safeguarding fair competition” as an important goal in the 2013 Third Plenum Decisions. But our primary indicator, which tracks the treatment of foreign firms in M&A reviews, reveals that the country’s competition policy environment remains skewed in favor of domestic players.
In 1Q2018, MOFCOM reviewed 24% of foreign-involved mergers but only 5% of domestic ones. Other indicators point to persistent shortfalls in the country’s policy regime to protect fair competition: transparency in the judicial system related to competition-related cases deteriorated, business starts slowed, and existing firms struggled with weaker pricing power. These data point to the challenging economic realities Beijing faces today and the urgency required to improve competition conditions to support future growth.
The government pursued some promising competition-related policy reforms in the review period. Efforts to reduce protectionist practices by local governments in areas like price setting and procurement continued. In March, the NPC consolidated competition regulators into SAMR as part of a broader bureaucratic reshuffling. In our last Dashboard edition, we flagged that SAMR’s creation might reduce the influence of industrial policymaking institutions like the MOFCOM and the NDRC over competition policy. SAMR began operating in mid-May. So far, the body appears to be merely a compilation of the same staff and divisions from previous institutions, though it is too soon to judge definitively. However, the refusal to approve U.S. chipmaker Qualcomm’s proposed purchase of Dutch company NXP by the deal’s July 25 end-date implies that China’s M&A review process remains influenced by political interests and raises concerns that competition policy has become an integral part of the U.S.-China trade conflict.
Not only are M&A transactions involving foreign firms more likely to be reviewed, but reviewed transactions involving foreign firms are also more likely to result in penalties or restrictions by the government.
This Quarter’s Numbers
Our primary indicator shows that China’s competition policy regulators are treating foreign and domestic firms unequally, a clear signal that the country’s competition policy regime is inadequate. The indicator tracks the percentage of foreign and domestic M&A deals reviewed by China’s antitrust authority MOFCOM (as mentioned above, M&A review responsibility was shifted to the new SAMR in the second quarter, just beyond our data review period). The indicator shows that Beijing’s promise to ensure “all firms participate in market competition on an open, fair and just footing” is unfulfilled. In 1Q2018, MOFCOM reviewed 43 foreign-involved mergers, equivalent to 24% of 182 foreign-involved deals announced in the quarter, but only 25 domestic mergers, just 5% of 460 domestic deals announced. The spread between the number of foreign and domestic deals reviewed narrowed slightly: MOFCOM reviewed five more domestic deals this quarter than last quarter, but one less foreign-involved deal. The gulf in fair treatment between the two remains wide, as domestic transactions are rising while foreign investments are declining.
Not only are M&A transactions involving foreign firms more likely to be reviewed, but reviewed transactions involving foreign firms are also more likely to result in penalties or restrictions by the government. In fact, all the conditional approvals ever issued by China in its M&A review process relate to foreign-involved mergers. In 1Q2018, the dynamic looked more equitable, but data points are insufficient to conclude there is any change in the trend: MOFCOM issued four penalties and restrictions regarding M&A reviews, including one conditional approval for a foreign-involved merger, one fine of a foreign company for not complying with previously agreed conditions when its M&A deal was approved, and two fines for domestic companies for not reporting mergers (see Results of Merger Reviews).
A competent and transparent judicial system is a critical element of effective competition policy. Beijing recognized this and promised that all firms operating in China would receive “equal protection and oversight according to the law” in the 2013 Third Plenum Decisions. But poor transparency in China’s judicial system makes it impossible to assess whether Beijing is delivering on this promise. By tracking the number of competition-related cases (antitrust, unfair competition, patent, copyright, and trademark disputes) published on China’s Supreme Court website, we find that transparency regarding competition-related judicial activity has deteriorated consistently since 2015. Only 1,078 cases concluded this quarter were made available to the public, compared with 10,495 cases concluded in all of 2017 (see Judicial System Transparency). Chinese courts are handling many more competition-related cases (they reviewed 213,480 cases in 2017, a 40% rise from 2016), but the transparency needed to judge the credibility of the system is not on offer.
Our supplemental indicator Market Entry and Exit tracks the number of new businesses started and dissolved in China to gauge the impact of competition policymaking on market conditions. The indicator shows that 1.31 million new domestic companies registered in 1Q2018, up only 5% from 1Q2017 and the slowest first quarter performance since 2013. A modest slowdown in business starts is not entirely surprising as the number of new businesses created in China grew on average 30% each year between 2012 and 2017, while the economy grew by around 7% each year in that period. Still, the deceleration shows that Chinese authorities must lower market entry barriers, enforce antitrust laws, and prevent abuses of market power by big companies to attract new investments and encourage entrepreneurship. Noncompetitive firms must also be allowed to go bankrupt and exit the market to restore the pricing power of healthier companies, but market exit data are again missing this quarter, so conditions are difficult to judge.
The supplemental Pricing Power Index uses firm-level data to measure the ability of Chinese companies to charge a reasonable markup and cover their cost of production and investment. Chinese corporate pricing power was already below OECD levels and weakened further in the review period. Pricing power for China’s listed companies on average has deteriorated since 2014. For listed state-owned enterprises (SOEs), pricing power declined again in the review period, suggesting that the recovery exhibited in 2017 (due to government-mandated production cuts that pushed up prices in industries dominated by SOEs) was not sustainable. A decisive role for the market is a better remedy than state intervention for cleaning up inefficient firms and restoring longer-term profitability.
A decisive role for the market is a better remedy than state intervention for cleaning up inefficient firms and restoring longer-term profitability.
Policy developments show that Beijing is attempting to strengthen its competition regime in some areas. In the last Dashboard edition, we assessed the consolidation of antitrust regulation under SAMR to be a positive development. With less than one quarter to judge, data points are insufficient to draw real conclusions about how things are going. But official activity during the review period offered some insight into policy intentions. On April 26, Zhang Mao, the newly appointed head of SAMR, announced the body’s restructuring plans; on May 2 and 3, he specified that its remit would include several issue areas previously managed by the SAIC and NDRC, such as regulating the competition-related behaviors of local governments and public utility companies. On May 14, SAMR began to accept M&A filings previously handled by MOFCOM. So far not much has changed: the same staff and offices as before are handling antitrust regulations, even if nameplates were transferred to SAMR from previous agencies. The body will presumably usher in more competition policy–related changes in future quarters, but for now, it looks status quo.
The potential for political influence to affect decision making is a key constraint on SAMR’s ability to emerge as a fair and effective regulator. But political interests continued to influence antitrust enforcement during the review period, as highlighted by Beijing’s unwillingness or inability to approve the proposed merger between the U.S. chipmaker Qualcomm and the Dutch semiconductor maker NXP. Beijing was expected to approve the merger, as it cleared eight other authorities globally, but on April 16 (the same day that the United States cut off exports of U.S. components to Chinese telecommunications equipment company ZTE over its violation of a sanctions-violations settlement), MOFCOM instructed Qualcomm and NXP to withdraw and resubmit their application. In the following months, Chinese officials implied that they would clear the Qualcomm-NXP deal once confident that the United States would relax its export ban on ZTE. On July 14, the Trump administration lifted the ban on ZTE. But China remained silent and did not approve the deal, causing Qualcomm to finally drop efforts to purchase NXP when the deal expired on July 25.
Beijing also continued efforts to reduce protectionist behavior by local governments in areas like licensing and procurement policies, as we have highlighted in past editions. In the last Dashboard, we flagged that local governments were told to review their anti-competition practices and submit remediation plans to the State Council by May. This task was completed and moved on to the next stage this spring. On May 5, the State Council issued another document requiring all government agencies to clean up any policies that impair property rights or discriminate against private business and report the results to NDRC for review. This guidance is ambitious but highly unlikely to be comprehensive given the pervasiveness of these types of challenges at the local government level.