MOFCOM Spills the Beans on "Industrial Security"

C O N F I D E N T I A L SECTION 01 OF 04 BEIJING 004623

SIPDIS

STATE FOR EAP/CM -- FLATT AND PENG
STATE FOR E -- YON
STATE FOR EEB/OIA SCHOLZ, HICKS, AND TRACTON
STATE PASS USTR FOR STRATFORD, WINTER, KALLMER, BAHAR
TREASURY FOR OASIA/ISA HAARSAGER AND WINSHIP
TREASURY FOR NOVA DALY
USDOC FOR NING LU
PARIS PASS OECD

E.O. 12958: DECL: 12/18/2018
TAGS: ETRD EINV WTRO EFIN CH

SUBJECT: MOFCOM Spills the Beans on "Industrial Security"

Classified By: Economic Minister-Counselor Robert Luke for Reasons
1.4 (b) and (d).


1. (SBU) Summary: In a frank and spirited discussion October 28 with
Treasury Deputy Assistant Secretary (DAS) for Investment Security
Nova Daly and Deputy Assistant United States Trade Representative for
Investment Jonathan Kallmer, Ministry of Commerce (MOFCOM) Industrial
Injury Investigation Bureau (IIIB) Director General (DG) Yang Yi
advised that his bureau's mandate had evolved to include
investigation of injury to domestic industries caused by foreign
investment. He said IIIB believes that China's security ultimately
depends on its continued economic development, which clearly benefits
from foreign investment. To ensure its security, China thus must
balance the need to welcome foreign investment while at the same time
sheltering key, emerging industries from foreign "attack," which he
said had intensified after China joined the World Trade Organization
(WTO). Yang said China's concept of national security includes
political and military security, national economic security, and
industrial security. IIIB is conducting a study on the impact of
foreign investment in China and will propose to China's leaders a
series of measures to "perfect" China's foreign investment policy, he
said. Yang asserted that China is more open to foreign investment
than the United States, but conceded that there is room to streamline
China's foreign investment approval process and improve transparency.
End Summary.

New Mandate -- Industrial Injury from Foreign Investment
-------------- --------------


2. (SBU) DG Yang said that the mandate of IIIB -- which was
established within MOFCOM after China's WTO accession to evaluate
proposed trade remedies and safeguards, like anti-dumping -- had
evolved to include investigation of domestic industrial injury from
foreign investment. He emphasized that IIIB is not directly involved
in the approval process for foreign investment, which the Foreign
Investment Bureau (FIB) leads within MOFCOM. (Note: An FIB official,
Deputy Director Zhang Xin, sat quietly through the whole meeting,
declining invitations to talk. End Note.) Instead, IIIB is
responsible for the relationship between foreign investment and the
security of China's domestic industries. Yang said IIIB had
established an "industrial injury early warning system" to monitor
the effects of imports on industry and look for signs of injury. The
warning system originally focused on the goods trade but had been
expanded to other issues that could affect the safety and security of
China's "key industries," including foreign investment. When IIIB
finds industrial injury from foreign investment, it produces reports
so that relevant government ministries and companies can "notice the
situation and try to improve their competitiveness."


3. (SBU) DG Yang said that in 2007, former MOFCOM Minister Bo Xilai
had instructed IIIB to study the impact of cross-border mergers and
acquisitions (M&A) on China's security. The study, which IIIB is
conducting together with the Research Center on Transnational
Corporations, a MOFCOM-affiliated think tank, had found that while
foreign investment has played an important role in China's
development, in recent years problems had emerged. IIIB found that
Chinese scholars and others had "heard a lot of questions,"
especially with regard to M&A by foreign multinational corporations
(MNCs). Specifically, "negative voices" had emerged when MNCs tried
to acquire "key companies" in China's "key industries." The research
project includes case studies on foreign M&A transactions that had
aroused opposition within China as well as Chinese enterprises'
attempts to acquire foreign firms. China is paying a lot of
attention to the experiences of other countries in regulating and
managing foreign investment. IIIB will propose policy reforms to
improve China's foreign investment regime, he said.

Guide Capital to Where it's Needed
--------------


4. (SBU) DG Yang sought to clarify that while China attaches great
importance to an open investment policy -- noting that since opening

BEIJING 00004623 002 OF 004


up in 1978, China had attracted 650,000 foreign invested enterprises,
including 56,000 U.S.-owned firms, which had invested $887 billion,
promoting development -- China is now seeking to "summarize, review,
adjust, and perfect" its investment policies to accord with China's
"general strategy as a nation," especially with "scientific
development," which China elevated to a national economic development
strategy at the Chinese Communist Party's 17th Party Congress in

2007. To serve the goal of scientific development, Yang said, China
wanted to ensure that foreign investment improves and speeds China's
development. Thus, China encouraged foreign investment in
high-technology, research and development, and the services
industries. In other words, he said, China had shifted emphasis from
attracting a greater "quantity" of foreign investment toward
attracting a "greater quality." Going forward, China would seek to
"harmonize" foreign investment with economic development goals by
guiding it to particular areas.

Security = Pol/Mil, Economic and Industrial
--------------


5. (SBU) Following Treasury DAS Daly's overview of the Committee on
Foreign Investment in the United States (CFIUS) national security
review process, DG Yang observed that in contrast to the more
"general concept of national security" that CFIUS employs, China sees
investment security as composed of three different ideas. The first
is "military and political security," which he called a broad
concept. (Comment: By "political security," we believe Yang was
referring to maintaining the Communist Party's monopoly on power and
the media, as well as protecting sovereignty over regions where some
factions favor more autonomy, like Taiwan, Tibet, and Xinjiang. End
Comment.) "Under the umbrella" of military and political security
was the separate concept of "national economic security," Yang said,
which includes the financial sector and other "sensitive economic
areas."


6. (SBU) The third concept is "industrial security." Yang said he
noticed it was "rare to find such a concept in more developed and
Western" countries. This concept had emerged following China's WTO
accession. Due to its stage of development, China is more interested
in "industrial security" than the United States, he said. Because
the industrialization of developing countries is occurring later than
in developed countries, developing countries' manufacturing and
industry lagged behind that of developed states. In developing
countries, many industries have not existed in the past, so
developing countries were building "nothing into something, small
into big, and weak into strong," he said. (Comment: Yang's
implication was that Chinese firms cannot compete on an equal footing
with firms from developed countries, so they thus require protection
to nurture their development. End Comment.)


7. (SBU) DAS Daly responded that of the three concepts Yang
described, the United States' view of national security is most like
Yang's description of "military security." As for the broader
concepts of "national economic security" and "industrial security,"
the United States concluded long ago that the best approach is to let
the market work and focus on the more narrow interpretation of
national security.

Infant Industries "Under Attack" by Foreign Firms
-------------- --------------


8. (SBU) In addition, China's opening up had brought about a new
problem that did not exist when the economy was planned.
Specifically, after opening its doors to globalization and building a
market economy, China needed to figure out how to "grow healthy local
firms" when these firms faced "attack" by other countries' industry.
China paid special attention to "infant industries and weak
industries at early stages of development," he said.


9. (SBU) IIIB believes that "national security" exists when "China's
key industries are free from attack by foreign firms." At the same
time, IIIB believes that further opening up benefits China's security

BEIJING 00004623 003 OF 004


by promoting China's development, as China can't close its doors and
develop itself. IIIB has a different view of security from industry
itself and from a more general macroeconomic perspective. IIIB is
trying to clarify the concept of industrial security and determine
how to protect it. IIIB does not believe that all sectors of the
industrial economy need protection, only "key and pillar industries
of the national economy" need IIIB's attention, Yang said.


10. (SBU) Yang added that "industrial security" is not a uniform
idea. People in different industries have different ideas. Some
believe that industrial security lies in international
competitiveness. Others think that industrial security is found in
the control of a particular industry by domestic, as opposed to
foreign, capital. Others thought that the housing sector was related
to security, he said. (Comment: Yang may have been alluding to the
idea that housing is a public good, requiring China to maintain
control over the sector. End Comment.)

"Limited" Tools to Protect Chinese Industry
--------------


11. (SBU) In response to a question from DAS Daly, Yang sought to
clarify that China, like all countries, relies on a narrow and
limited set of tools to protect its industry, primarily trade
remedies covering "unfair imports." China is a disproportionately
large target of foreign trade remedies, he claimed -- a quarter of
all anti-dumping cases are filed against China while China only
exports 14% of the world's goods. Apart from these trade-related
tools, industry is not protected, he asserted. (Comment: Yang's
statement that China has limited tools to protect infant industries
is incorrect. One obvious and potent tool China deploys to protect
infant industries is its investment approval process, in which NDRC,
MOFCOM, and other regulators enjoy broad discretion to approve or
block investment projects. The Embassy has heard reports that China
uses administrative tools like the SAIC-issued business license,
which is required to operate and must be regularly renewed, to
control the scope of foreign firms' businesses. China also has a
highly developed "indigenous innovation" strategy, reported septel.
End Comment.)

China More Open than the United States
--------------


12. (SBU) In fact, Yang said, China is very open to foreign
investment, maintains many preferential policies to attract foreign
capital, and approves almost all foreign investment applications. In
contrast, there had been cases recently where the United States
rejected Chinese firms' proposed acquisitions of U.S. companies,
which had raised the Chinese people's concern. Many big Chinese
companies were frustrated. These firms had complained to the Chinese
government that the United States maintains "very restrictive"
policies that prevent them from investing. They complain that the
United States blocked the "Lenovo and CNOOC transactions." (Note:
In 2005, CFIUS approved Lenovo's acquisition of IBM's notebook
computer division after the two parties agreed to mitigate the
national security risks, while the 2005 China National Overseas Oil
Corporation (CNOOC) bid for Unocal was not reviewed by CFIUS, as
CNOOC withdrew its bid in the face of intense criticism in Congress.
End Note.)


13. (SBU) Yang added that in contrast to the United States, China's
policies on inward investment are transparent, as described in the
Foreign Investment Catalogue and in the Five-Year Plan for Foreign
Investment released by the National Development and Reform
Commission, most recently in November 2006. In addition, regulations
issued in August 2006 by MOFCOM and five other agencies also
"clearly" spell out the provisions governing China's review of
foreign M&A transactions. Yang said he had the impression that
MOFCOM maintained an "open attitude" in its interpretation and
employment of the 2006 rules. China needed time to improve the
transparency of these procedures, he said. (Comment: The August
2006 rules spell out filing requirements, like transactions that

BEIJING 00004623 004 OF 004


transfer "actual control" of a domestic enterprise in a "key
industry" with "potential impact on national economic security" or
that would alter control of a "prominent Chinese old brand."
However, key terms like "control," "key industry," and "national
economic security" have never been defined and China has never
released the standards that it uses to evaluate filed transactions.
In any case, China maintains the discretion to change its "open
attitude" when it believes it is in China's economic development
interests to do so. End Comment.)

Room to Improve -- Streamline Process, More Transparency
-------------- --------------


14. (SBU) In closing the meeting, DG Yang asked a series of technical
questions about how CFIUS operates and the roles of its member
agencies. In contrast to the U.S. system, he said China's inward
investment review process was fragmented and less organized. Whereas
in the United States, one interagency committee reviews investments,
in China several agencies worked independently, including MOFCOM,
NDRC, the Ministry of Finance, and the State Administration of
Foreign Exchange.

Comment -- IIIB a Key Player in Industrial Security Policy
-------------- --------------


15. (C) This meeting was a follow-up to earlier substantive
discussions with IIIB officials on China's investment policy. The
bureau clearly is already playing a role in China's investment
policymaking and may also be "consulting" on a limited basis on
specific cases. While IIIB says it does not have a role in the
foreign investment approval process, we have heard from a reliable
source that at least in one prominent case -- Carlyle's failed
investment in Xugong -- IIIB was asked to provide an opinion on the
impact of foreign investment in the industrial equipment sector. In
that case, according to our source, IIIB's opinion contradicted the
analysis of the industry association, which claimed a Carlyle
takeover would seriously damage Xugong's competitors. Regardless, a
well-placed foreign law firm source expressed surprise and concern at
the possibility of IIIB's involvement in any aspect of the reviews.
Going forward, the Embassy suggests continuing to engage IIIB in a
low-key way to share ideas on the tradeoffs between openness and
security.

RANDT