Ever since China opened its doors in the early 1980s, the auto industry has been an attractive sector for foreign investment and most major auto companies went into China to look for opportunities and set up their footholds. In June 1997, the world’s largest automaker, General Motors, formed a $1.52 billion, 50-50 joint venture with Shanghai Automotive Industry Corporation (SAIC) in Pudong New District, an emerging financial and trade zone set up in the early 1990s.
This paper will focus on GM’s investment in Pudong as well as Chinese government’s policies and strategies towards FDI in this district.
General Background of General Motors
Founded in 1908, GM had been the global automotive sales leader since 1931. In late 1990s, GM had more than 288 major subsidiaries and sells its vehicles in more than 200 countries. GM had assembly, manufacturing, distribution, or warehousing operations in 53 countries. GM’s major markets were North America, Europe, Asia Pacific, Latin America, Africa and the Middle East. GM cars and trucks were sold under the following brands: Cadillac, Chevrolet, Buick, GMC, Holden, Hummer, Oldsmobile, Opel, Pontiac, Saab, Saturn and Vauxhall. 1
As most auto companies turned their attention to the growing Chinese market from late 1980s, GM also took an active part in getting into China. In 1995, General Motors and Shanghai Automotive Industry Corporation signed an agreement for a proposed vehicle joint venture, a joint venture technical development center and other related projects in Shanghai, China. (Exhibit 1 – GM’s annual report 1995-1997)
China’s opening-up and the development of Pudong New District
China was one of the major developing countries. “New China” (socialist China) was founded in 1949. It went through a tortuous course in absorbing foreign investment during the period between its founding in 1949 and the economic reform in 1978. In the 1950s China managed to import technology, complete sets of equipment, goods and materials needed in its economic construction and national defense from the Soviet Union and East European countries through trade or by the Soviet government’s loans.2 China had kept away from foreign investment throughout the two decades of 1960s and 1970s. Direct foreign investment was nonexistent before 1979. From 1949 to 1979, all the enterprises in China were owned by the government. At that time, Chinese leaders believed that China should and could produce all the things it needed by itself. However, every thing was in severe scarcity and China was among the poorest countries in the world. People described China in that particular period as a tightly closed nation.
From 1978, China adopted “Opening-Up” policy and tried to build up its unique socialist market economy system. Along with the dismantling of the planned economy system and the deepening of the reform of the economic system, commodity, capital, labor service and technology markets had appeared one after the other in China. China had transformed its planned economy system into an initial market economy system in a gradual manner. As a result the regulatory function of the market had been strengthened tremendously. With the relatively stabilized political system and fast growing economy, China’s investment environment was getting better and it was becoming a hot spot for Foreign Direct Investments.
In order to deepen its reform, in April 1990, the Chinese government formally announced its plan to develop and open Pudong New District. Pudong is a part of Shanghai, which is a metropolis of 14 million people at the mouth of the Yangtze River and used to be one of Asia’s biggest trading centers. Shanghai developed along the west bank (Puxi) of the Huangpu River, a tributary of the Yangtze, leaving the east bank (Pudong) to agriculture and some heavy industries. (Exhibit 2, maps of Shanghai and Pudong) Being relatively undeveloped, Pudong offered an opportunity for Shanghai’s growth and modernization without the high economic and social costs of redevelopment in crowded, under-serviced Puxi.
Pudong had its unique historical advantages in attracting the foreign investments. Shanghai itself had a historical tradition of looking outwards during Europe’s involvement with the opium trade in the late nineteenth and early twentieth century. For nearly a century, until Liberation in 1949, Shanghai dominated foreign trade, and attracted the majority of foreign businesses and transactions in China. Because of this, the Shanghainese were more accustomed to dealing with foreigners than were people from other parts of China.3 Since Pudong belongs to Shanghai, it also enjoyed this tradition.
The development of Pudong New District was to some extent different from most other special economic zones in China, which were basing their appeal on low land and labor costs and incentives such as tax holidays. Pudong had the chance to be more than a preferred location for industries looking for short-term cost advantages.4 Pudong not only enjoyed many of the same preferential policies as an SEZ, such as reduced tax rates and exemptions from customs duty, but also in some instances even surpassed them. This is due to following reasons.
First, Pudong targeted to be a new business center in the Asia. It had integrated functional zones, which enjoyed functional diversity and can meet all kinds of requirements of foreign investors. It was divided into four major specialized zones as: Lujiazui Financial and Trade Zone, Jinqiao Export Processing Zone, Zhangjiang Hi-Tech industry Park and Waigaoqiao Bonded Zone. Shanghai GM’s plant was in the Jinqiao Export Processing Zone.
Second, Pudong had human resources advantage since it was inside the city of Shanghai. Shanghai was described as a big magnet for talented personnel. In 1993, the Shanghai municipal government sent a delegation to the United States to recruit Chinese students studying abroad. Attractive employment terms were offered, with the intention of employing up to 1000 overseas students in the fields of banking, trade, real estate, urban planning, construction, computer science, telecommunications, electronics, medicine, biology, management, accounting and law.5
Third, Pudong was close to the largest markets in China – Yangtze Basin. Yangtze Basin was home to 400 million people who would, over the coming decades, demand most of the items that people in developed countries were consuming. This was an opportunity international companies cannot ignore, and Pudong was ideally placed to act as the link between the outside world and this huge market.
The Waigaoqiao Bonded Zone was a prime example of incentives and opportunities that were unique to Pudong. Located at the northeastern tip of Pudong, approximately 20 km from the city proper, and bordering the Yangtze River Estuary in the east, it combined free trade with export processing. Traders were exempt from having to obtain visas, and business executives working the zone may hold multiple entry and exit visas.6 Preferential policies within the zone included:
1. Goods to and from the zone would be exempt from import and export duties;
2. No export or import licence was required for the transfer of goods between the zone and overseas;
3. Domestic or overseas enterprises were allowed to set up foreign trade bodies within the zone and can undertake important and export agency business or transit trade;
4. All enterprises in the zone were allowed to retain all their foreign exchange earnings and were free of risks with regard to fluctuations of the exchange rate;
5. Enterprises in the zone can either trade goods among themselves or with enterprises outside the zone through the free raw material market.7,8
Besides all the advantages Pudong had, a number of problems did threaten its attractiveness to the foreign investors.
First, inadequate of infrastructure was always cited as a major barrier to FDIs. Because it is a ‘clean slate’ development, most of the infrastructure had to be built from scratch. 9 Links from Puxi to Pudong, such as bridges, tunnels, roads and subway lines all had to be built quickly. New occupants of the zone required the establishment of water, electricity and telecommunications systems. Many foreign investors were reluctant to move into Pudong, citing problems of transportation.
Second, the arrogance of the Pudong administration was another factor of hindering FDIs. Many foreign investors felt that Pudong had been so puffed up by hype that the development companies running it had become notoriously difficult to deal with.10
Third, there were government officials who abused their position of power for personal gain. And the existence of many opportunities for corruption and profiteering in Pudong discouraged FDIs to some extent.
The automobile industry of China
The period between 1953 and 1965 was the founding period of China’s automobile industry. In 1956, the Changchun No.1 Automotive works turned out China’s first truck, putting an end to the time when China was unable to produce its own motor vehicles. The sector grew in the 1966-1980 period, involving a total investment of 5.1 billion Chinese yuan. At that time, China was able to independently manufacture trucks, and to design and assemble large and medium-sized trucks through its own technical forces.
The 1981-1996 period saw the all-round development of China’s automobile industry. In 1986, the government designated the sector as one of its pillar industries for the national economy, and in 1987, the government decided to speed up the car industry, thus beginning the modernization process of China’s car industry. Eight car production bases including SAIC had been set up throughout the country. In 1992, the output of automobiles exceeded 1 million. By 1997, the sector had produced 1,577,900 and had sold 1,567,500 motor vehicles. During the 1996-2000 period, the state planed to invest 120 billion Chinese yuan, which would have the production capacity of 3 million automobiles and 12 million motorcycles. It was estimated that China’s automobile output would reach 16 million by 2010, of which, 4 million would be sedans and 12 million motorcycles.11
Since Chinese government intended to build the auto industry as one of its pillar industries, it had set up a series of policies accordingly.
Firstly, Chinese government adopted the strategy of incremental localization by introducing foreign capital and technology to develop its auto industry. This strategy had tremendous influence on its various central and local policies. China intended to increase local content rate. The government linked tariff on imported parts with local content rate, and called it “Classified Tariff”. By doing so, the government tried to reward the automakers that increased their local content rate and penalized those that made little efforts. (Exhibit 3, Chart of Classified Tariff) If the automaker achieved 40% of local content rate after the 4th year, it can avoid the penalty of high tariffs–a life-and-death choice for a company. There were also policies to help the local auto companies and limit the foreign investment into auto industry. Foreign car companies, such as Ford, General Motors and Toyota, were told that to qualify for entry to China as full fledged participants in car manufacturing they must first invest in the components industry, and transfer technology to the Chinese partner in a joint venture project, where the foreign share must not exceed 50 per cent.12
Secondly, since most of China’s auto companies were lack of economies of scale, the outlines in the auto policies were directed at encouraging economies of scale, through tax incentives favoring large-scale producers. China had the “Big 3, Small 3” system in its auto industry. The big three were First Auto Works (FAW), Dongfeng Automotive Co. and SAIC. The big three enjoyed tax holidays and preferential governmental policies, which other auto companies didn’t have.
Thirdly, state owned enterprises were still the dominant power in auto industry since the government treated the industry as one of its strategic industries. The “Big three and Small three” were all owned by the government. Government controls and policies played major roles in this industry. Foreign companies’ choices of finding suitable Chinese joint venture partners were limited. The government tended to decide who would be paired off with whom.
GM’s investment in Pudong
Despite the limit and control from Chinese government, for decades, most multinational auto manufacturers had their cars winding up in China, either through importing agents or more illegitimate channels developed in the later stages of China’s transition towards a market economy. The lure to China was easy to understand. With a population of 1.3 billion, China had only 8.3 million motor vehicles, and just 15 percent were passenger cars in 1994. China’s economy was expected to keep growing for coming decades, increasing the number of people who were wealthy enough to afford a car. And the government announced that it would not only drop restrictions on private car ownership but actually began encouraging individuals to buy autos.13 (Exhibit 4, Passenger Cars in China)
However, there were also many downsides of investing in China’s auto industry as many critics said. There had to be a long-term commitment, a readiness to transfer technology to the Chinese and the introduction of Chinese employees into upper management. In short, foreign companies would have to function as a Chinese company, for the Chinese, and not as a foreign company in China.14
GM was among dozens of auto companies who were trying to further develop Chinese market. Jack Smith, the CEO of GM, was enthusiastic about China’s market and found that Shanghai was GM’s appropriate place. As said by Smith, GM would try to forge a long-term strategic relationship with the Chinese, to get a head start in the market. If that meant giving away modern technology, so be it. The time that GM tried to invest into Shanghai happened to be the second round of Pudong’s development. Shanghai government intended to have big investors in Pudong. GM’s enthusiasm and long-term plan made Shanghai believe that GM was its right partner.
GM’s Chinese partner was Shanghai Automotive Industry Corporation (SAIC). It was also one of the partners of Volkswagen in China. SAIC, which was a state owned enterprise, was the most efficient auto maker in China and its joint venture with Volkswagen was the only one factory that reached economies of scale in making passenger cars. The car model Santana made by Shanghai Volkswagen took the biggest market share in China. (Exhibit 5, Introduction of SAIC)
After a hard negotiation of the terms of joint venture between GM, SAIC and Shanghai government, Shanghai GM’s factory rose miraculously from a site in Pudong – 140 acres of marshy paddy field with no roads, electricity or drainage. The first piles were sunk in January 1997, and to everyone’s amazement, not least the GM engineers, the first car rolled off the line on Dec. 17, 1998. “The government helped us enormously with infrastructure,” says Mr. Chen Hong, president of Shanghai GM. In 1998 Shanghai GM was designated Shanghai’s No. 1 economic project. Mr. Chen conceded this was not how most foreign companies were treated. “Without this priority, it would have been very difficult to have built it in 23 months.” 15