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). 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

China’s competition policy regime is inadequate, and our indicators for the third quarter suggest movement is not just stagnant but backsliding. Foreign firms were disproportionately targeted in anti-monopoly reviews, judicial transparency deteriorated, and a refusal to publish corporate dissolution data suggests sensitivities about bankruptcies and slowing growth. Our gauge of the pricing power of Chinese listed firms improved slightly, but state-owned enterprises (SOEs) and private firms now have roughly equivalent pricing power despite significantly less efficiency in the state sector.

Some positive competition-related policies were announced in the third quarter, but they will almost certainly face serious implementation challenges. The State Council enacted an earlier directive meant to prevent anticompetitive policies across the country. The NDRC punished the papermaking and electricity industries for price collusion, which included fining six central-level SOEs and curtailing government pricing intervention authority. These policies could reduce local government revenues at a time when fiscal conditions are deteriorating and reform imperatives are rising on that front, pointing to risks from weak implementation. A fledgling effort to expand intellectual property (IP) courts to 10 provinces took place in the third quarter, though our judicial transparency indicators speak to the institutional challenges China faces.

The chances for a merger involving foreign firms to be reviewed were roughly four times higher than that for domestic firms.

This Quarter’s Numbers

In the third quarter of 2017, MOFCOM stepped up enforcement of antitrust regulations and disproportionately targeted foreign firms in doing so. The percentage of foreign-involved transactions subject to merger reviews jumped to 27% from 19% in the second quarter. This means 54 foreign mergers were reviewed out of 198 transactions in 3Q2017, compared with 38 reviews out of 205 transactions in 2Q2017. This is the second-highest percentage since China’s antitrust law came into effect in 2008. The majority (33) of the 54 merger reviews were global mergers between multinational firms with a presence in China, reflecting Beijing’s growing attentiveness to the potential spill-over effects of global mergers on China’s economy and domestic firms. The percentage of domestic-only mergers reviewed grew moderately to 5% from 3% in the second quarter. Still, the chances for a merger involving foreign firms to be reviewed were roughly four times higher than that for domestic firms as of the third quarter.

Our supplementary indicator Results of Merger Reviews confirms this increased pace of activity from MOFCOM. In total, 84 mergers were reviewed in the third quarter, the largest number ever. Authorities restricted only one case, resulting in an approval with stipulations but not an outright rejection. That was the acquisition of Brocade (U.S.) by Broadcom (Singapore). MOFCOM’s decision in the matter was not surprising, as the deal was determined to be anticompetitive by the U.S. Federal Trade Commission a month earlier.

Other indicators suggest backsliding in the commitment to improve judicial transparency (see Transparency of Judicial System). In 2014, China’s Supreme Court required local courts to publish details on all cases within seven days of court decisions. But only a small number of cases are published today, and with lag times much longer than seven days. The government published only 7192 cases involving competition (antitrust and unfair competition) and IP (patent, copyright, and trademark) in 2017, 60% of the number published in 2016. The number of total cases published barely registers as a percentage of total cases heard: 152,072 competition and IP cases were heard in China in 2016 according to the annual report from the Supreme Court for that year.

Meanwhile, our Market Entry and Exit indicator shows that momentum behind starting new businesses slowed in the third quarter from the second, in a typical seasonal pattern. In 3Q2017, 1.59 million new domestic business entities were registered, down from 1.64 million in the second quarter but still 15% more than the 1.4 million in 3Q2016. SAIC failed to issue data on business exits for 3Q2017, suggesting the government was concerned about negative press on the investment environment ahead of the October Party Congress. Overall, our data continue to show a divergence between business starts and exits since 2013, suggesting high competition and barriers to exit in the marketplace.

Finally, our Pricing Power Index indicator depicts headwinds to profitability for Chinese listed companies. The index tracks the average ratio of revenue over production cost and fixed investments for listed Chinese firms. This allows us to gauge firms’ ability to be fully compensated for their production and capital needs. Over the past year, the average pricing power of Chinese listed companies improved to 15% in 3Q2017 from 9% in 2Q2016. But this improvement was largely driven by SOEs, which benefited from higher prices resulting from the government’s supply side structural reform (SSSR) push to cut production overcapacity in heavy industry. While SOE pricing power leveled off somewhat in the third quarter, our indicator shows that SOE pricing power and private corporate pricing power are now roughly equal in China, despite inefficiencies in the state sector. The pricing power of both Chinese SOEs and private companies remains well below Organization of Economic Cooperation and Development (OECD) levels.

Policy Analysis: 3Q2017

As capacity cuts related to the SSSR agenda pushed prices up, NDRC acted on price reform this quarter – one of the core objectives of the Third Plenum Decisions in 2013. The stated intent of the Plenum was to allow the market to “play a decisive role” in pricing commodities and public utilities such as water, oil, natural gas, electricity, transportation, and telecommunications. NDRC penalized the papermaking industry on July 12, 2017, for organized price collusion, resulting in fines for 17 companies and dissolution of the industry’s association. On August 4, NDRC also cracked down on price collusion in the thermal power sector by fining six powerful SOEs owned by the central government and 17 private companies. On September 8, NDRC published new rules limiting government price intervention authority to “key utilities, public service and natural monopoly industries.” Though the intent is laudable, restricting direct price intervention by fiat is insufficient to achieve real price liberalization, particularly when local governments are supporting inefficient local firms in many other ways.

China still has a long way to go in establishing fair and transparent legal mechanisms to better protect the intellectual property rights of domestic and foreign firms.

In June 2016, the State Council established a “fair competition review mechanism,” which aims to identify and eliminate government policies that are anticompetitive. NDRC published implementing regulations on October 27, 2017 (16 months later) with clear procedural guidelines. By November, 19 provinces had included fair competition review in performance metrics for local officials. On December 5, the State Council published an action plan requiring all government agencies to review their policies by the end of January 2018, report anticompetitive ones by March, and plan elimination of those policies by May. This tight timeline suggests top-level determination to limit rent seeking and anticompetitive practices by government. But the rules would constrain extra-budgetary or “back door” local government revenue before Beijing has implemented the fiscal reforms needed to shore up revenue from official channels (see our Fiscal Affairs cluster). This is likely to translate into more pushback and weaker compliance at the local level than Beijing hopes.

Finally, IP policy became a bigger focus for the leadership in the third quarter. The State Council discussed IP protection extensively in its weekly executive meetings over the past year: six times since December 2016, including twice in the third quarter alone. IP protection was also discussed at the first meeting of the Deepening Reform Small Leading Group just after October’s Party Congress. President Xi Jinping personally chairs that body. The increased activity could be partly an attempt to head off foreign criticism and potential action. But it is also driven by domestic needs to promote entrepreneurship and innovation in the face of growing pressure on the government to better protect the intellectual property of China’s own companies.

Discussions of IP policy by senior leaders translated into some piecemeal action in the third quarter: in July, the State Intellectual Property Office identified six cities (capital cities of Fujian, Shandong, Shenzhen, Hunan, Jiangsu, and a district in Shanghai) as pilots to carry out comprehensive IP reform. By the end of September, 10 more provincial IP courts were established. While these are welcome steps, our data make clear that China still has a long way to go in establishing fair and transparent legal mechanisms to better protect the intellectual property rights of domestic and foreign firms.

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