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