Chang p1 Developmental Strategies in a Global Economy: The Unexpected Emergence of China?s Independent Auto Industry To be presented at the 2010 Harvard East Asia Society Graduate Student Conference, ?Facing East: Conversations and Connections?, February 26 ? 28, 2010. Crystal Chang Department of Political Science, University of California at Berkeley crystalchang@berkeley.edu Introduction James Womack et al. (1990) famously described the automobile as ?the machine that changed the world?. A fully integrated domestic auto industry can contribute to economic growth, generate thousands of manufacturing jobs in assembly plants and auto component factories, and contribute to the development of numerous upstream and downstream industries. In developed countries, automotive-related industries account for upwards of 10 percent of gross domestic produc 1t. It is not surprising then that a thriving domestic auto industry has also become the holy grail of industrialization for developing countries. In 2009, China shocked the world by producing more than 13 million vehicles, accounting for roughly 18 percent of worldwide production, and surpassing the United States as the world?s largest automotive market and Japan as the world?s largest automotive producer. Decades of extraordinary economic growth and rising standards of living explain the surge in domestic demand for automobiles. The dramatic increase in production capacity can be largely attributed to China?s embrace of foreign direct investment (FDI) in the early 1990s. What is more difficult to comprehend, however, is how new independent automakers have been able to steadily increase their market share in face of severe competition from 1 Maxton and Wormald (2004:91). 14 Japan 12 Chang p2 U.S. 10 foreign automakers and their large Chinese state-owned automotive partners. I argue that the China rise of China?s independent automakers is largely the result of increased linkages between 8 Germany domestic actors and the global economy, not state-led developmental strategies. The puzzle 6 S. Korea In the late 1990s, as growth in mature automobile markets began to stagnate, China?s Mexico 4 automobile market took off. The rapid expansion of China?s auto sector is impressive both India when compared to industrialized markets as wel2l to other rapidly growing emerging markets. Figure 1: Annual Vehicle Production in Several Key Global Mark 2ets Brazil 0 9 0 1 2 3 4 5 6 7 8 9 0 0 0 0 0 0 0 0 0 9 0 0 0 0 0 0 0 0 0 1 2 2 2 2 2 2 2 2 2 Year Source: OICA Respondent Surveys (1999-2008 3) Growth in China?s demand for passenger cars has been driven by the increasing percentage of the population crossing the minimum income threshold needed to be able to afford their own vehicle. Growth in supply has been primarily met by cars produced by large-scale joint ventures (JVs) between Chinese state-owned enterprises (SOEs) and multinational corporations (MNCs) such as General Motors (GM). The cars produced by these JVs carry the brand name of the foreign partner and make up the majority of the cars sold in China. 2 Vehicle production statistics includes heavy and light commercial vehicles and passenger cars. In China, passenger cars currently account about 60 percent of all vehicle production. 3 OICA production data is not officially out yet for 2009, but most sources indicate that China will be the world leader in production with over 13 million vehicles. Japanese production probably remained close to 2008 levels at around 11 million. US production dipped below 2008 levels to less than 7 million. P r oduct i on ( i n m i l l i ons) Chang p3 Nonetheless, nearly 30 percent of all passenger cars sold in 2009 carry the name of a Chinese brand produced by independent automakers without foreign investment. Chinese brands are gaining increased recognition at home and abroad. Chery, the most well known Chinese brand, and is on target to produce over 400 thousand cars in 2009. BYD, the fastest growing brand, announced the world?s first plug-in hybrid car and of Warren Buffet?s US$232 million investment in 2009. Geely, the number three brand, gained world-wide media attention in 2009 by being selected as Ford?s preferred buyer for its Volvo unit. Great Wall, China?s leading light truck and sports utility vehicle producer, recently announced that it would be the first Chinese automaker allowed to sell cars to Australia. Why should we be surprised by the rise of Chinese brands? For one, opening local industry to FDI typically leads to market dominance by MNCs and ultimately the denationalization of local automake 4rs. Secondly, it may seem reasonable to assume that China, the ?world?s factory?, would be able to produce cars cheaply. However, upon closer examination, establishing an automotive firm from the ground up is very complicated. First, building and operating an auto assembly factory at efficient economies of scale requires enormous capital investment, typically in the billions of dollars. Designing a new platform can cost hundreds of millions of dollars. An average passenger has roughly 8 thousand different parts that must be cost-effectively sourced from the local supply chain. Countries such as Malaysia and Indonesia invested heavily to establish indigenous auto industries but ran into tremendous difficulties and have yet to produce globally competitive automakers. 4 See Bennett and Sharpe (1985) for a detailed history of Mexico?s auto industry. They argue that the political economy of Mexico has been continually shaped by its dependent relationships with the world capitalist system, and the Mexican automotive industry by its dependent relationships with the world auto industry. Chang p4 Japan and Korea are the only two countries to produce globally competitive automakers in the post-war era, but they are the exception, not the rule. Unlike its two neighbors, the Chinese government did not support independent automakers. Instead, their attention was focused on the SOEs and their JVs. To date, there are no less than 26 JV assembly plants producing and selling passenger vehicles in China, offering more than 200 passenger car models. Without strong government support, how did independent Chinese automakers emerge as serious competitors? Is China following the ?developmental state? model? Despite a strong desire to develop an indigenous auto industry, there are significant barriers to entry for late industrializing nations. The burden to find adequate capital and technology typically falls on the shoulders of the state, particularly in the early stages of industrialization. Scholars such as Polanyi, Weber and Gerschenkron have theorized at length about the capacity of the state for economic development. Polanyi (1957) saw that an effective state was essential for the creation and operation of markets. Weber (1968) argued that the key component of an effective state is a modern and competent bureaucracy. Gerschenkron (1962) recognized that state in late industrializing nations had to go beyond providing a stable environment and become involved in organizing financial markets. Analyzing the phenomenal growth of the East Asian regional economies, Johnson (1982), Amsden (1989), and Wade (1990) built upon the work of these earlier scholars and contributed to the articulation of the ?developmental state? model. Though there has been significant debate over the validity of this model, the idea that a more activist governmental role can be a decisive factor in rapid industrial growth has largely trumped the neo-liberal Chang p5 view that governments should stay out of markets altogether. As Evans (1996:10) so aptly put it, ?State involvement is a given. The appropriate question is not ?how much? but ?what kind.?? Further elaborating upon existing theories of development, Evans put forth his concept of ?embedded autonomy,? a bureaucracy that is coherent and competent yet deeply connected to society, which can provide the structural basis for successful state involvement in industrial transformation. Should China be characterized as a variation of the developmental state model? Does the Chinese bureaucracy exhibit ?embedded autonomy?? Although China?s state-led reform strategy possesses some similarities to the developmental state model, particularly the relentless pursuit of economic growth, the differences are far greater. The Chinese central government controls the banking system which lends to SOEs, but has no control over informal lending to non-state firms 5. China also lacks a single cohesive planning bureaucracy akin to Japan?s Ministry of Technology and Industry (MITI) or Korea?s Economic Planning Board (EPB). Huang (2002) writes that although the Chinese policy approach bears some broad similarities to the Korean model, the fragmented nature of the Chinese state planning apparatus has precluded it from successfully restricting new entrants into already crowded industries. Another distinctive aspect of China?s institutional arrangements lies in what Xia (2000) and others have called the ?dual structure? of the Chinese state between the center and the local. Local governments in China have much more autonomy with respect to economic policy than their counterparts in other East Asian countries, which on the one hand, allows for 5 See Tsai (2002) for a detailed account of the prevalence of informal banking in China. Chang p6 more policy flexibility and experimentation, but on the other hand, opens the door to overinvestment and corruption.6 There is an additional duality between the state and non-state sectors of the economy. Chinese SOEs continue to play a significant role in the economy and continue to receive special treatment from the state, such as preferential access to land, credit, and state procurement contracts. Private firms in China are excluded from such privileges. This bifurcated industrial structure is in stark contrast to Japan or Korea where the state is not a shareholder in key industries and economic policymaking is centralized 7. The development of the Chinese auto industry reflects the many differences between the Chinese development strategy and the developmental state model. In the following sections, I argue that China?s SOE-centric development policies laid an important foundation for the auto industry, they are unlikely to produce national champions on par with Korea?s Hyundai or Japan?s Toyota. Despite reform efforts, China?s SOEs are still mired by many of the same managerial problems laid out by Steinfeld (1999). China?s independent automakers, on the other hand, are thriving not because of China?s development strategy but in spite of it. Successes and failures of China?s state-led development strategy in the auto sector In 1978, China?s auto sector was highly fragmented with 56 regionally dispersed auto assembly plants that produced 149,062 vehicles of all types and 2,640 sedans.8 Early reformers led by Deng Xiaoping recognized the need to encourage consolidation and bring foreign technology and investment into the sector. Joint ventures with the world?s premier 6 In his highly acclaimed study of the Chinese auto industry, Eric Thun (2006) offers a sophisticated argument articulating the ways in which local institutions in China shape industrial development and integration into the global economy. 7 Taiwan, however, did have a number of SOEs in the 1970s and 1980s. In Taiwan, like in China, the public sector specialized in capital-intensive and import-substitution industrialization while the private sector specialized in export-oriented industrialization. For more comparisons between Chinese and Taiwanese development, see Baek (2005). 8 Ministry of Machine Industry (1994:63 and 73), quoted in Thun (2006:54). Chang p7 automakers were seen as the first step in addressing the industry?s backwardness, though the government was careful to implement a 50 percent limitation on foreign ownership. This single policy precluded the type of denationalization experienced by other countries that allowed FDI into the local auto sector. Foreign firms were willing to compromise on ownership in order to access China?s large domestic market. However, of the early JVs, only the partnership between Shanghai Automotive Industry Corporation (SAIC) and Volkswagen was able to successfully produce cars for the Chinese 9 market. Despite government efforts to promote industry consolidation, the number of new automakers grew significantly in the 1980s, tapered off in the 1990s, and has remained at plus or minus 120 automake 10rs. Not only did consolidation fail, Chinese SOEs learned very little from their foreign partners, as MNCs were careful not to transfer valuable intellectual property to their JV partners. The cars produced at early JV plants were built from complete knock-down kits (CKDs) often shipped to China from the home country of the MNCs. Because Chinese workers at the JV plants were only assembling kits made up of modules and components designed and built abroad, they were exposed to little of the underlying technology in the cars. To make matters worse, far fewer passenger cars were produced in the early 1990s than Chinese officials had expected. In 1991, about 81,000 passenger cars were produced, accounting for roughly 11 percent of total vehicle production.11 In contrast, the United States produced more than 7 million cars per year. Unsatisfied, the Chinese government announced the country?s first comprehensive 9 See Mann (1989), Harwitt (1995), Thun (2006) and Gallagher (2006) for detailed histories of Chinese auto policy throughout the Communist era. 10 The number of Chinese automakers that most industry observers refer to is 120. This was the number mentioned by two industry executives interviewed for this study. Interview 67 with ex-SGM president (12/27/2008) and Interview 83 with ex-SVW executive (4/13/2009). 11 China Automotive Industry Yearbook (2007). Chang p8 industrial policy for the auto industry in 1994. In this document, the government reiterated its desire to see consolidation in the industry and remained committed to the 50 percent cap on foreign ownership of JVs. However, several aspects of the new policy were designed to protect and promote China?s SOEs. Import quotas and stiff tariffs (80-100 percent) were placed on both vehicles and parts to stifle international competition. JVs were issued new localization requirements of at least 40 percent, with powerful incentives to go beyond compliance. Foreign firms that wanted to enter the Chinese market would be required to establish joint technological development centers for training Chinese engineers and workers. Despite these stricter requirements, nearly every MNC bid on projects to establish new JVs in China. GM established a new JV with SAIC called Shanghai GM and injected US$1.3 billion of capital, which was in 1997 considered the single largest foreign investment ever in China. According to government statistics, total investment into the motor vehicle and related industries from all sources nearly US$60 billion during the 1990s.12 Although passenger car production grew rapidly during this decade, by 2000, the total annual production of cars in China (604,677 units) was still a fraction of other industrialized count 13ries. To sum up, after twenty years of development policies, China?s auto industry still lagged far behind that of the industrialized world. The Shanghai Volkswagen Santana sedan ? little changed since its market debut in the early 1980s ? continued to be the best selling car well into the 2000s, revealing just how little the Chinese had gained with respect to technology. Consolidation stalled. Protectionist policies did not produce the desired result of more sophisticated SOE capabilities. Domestic retail car prices remained high while quality and 12 Quoted in Gallagher (2006:40). 13 OICA (2000) production statistics. Chang p9 reliability remained low. The one bright spot was that the strict localization requirements began to force the hand of the MNCs to develop the local supply chain.14 In 2004, the government updated its auto policy. Certain aspects of the 1994 policy were carried forward, notably the government?s familiar call for greater consolidation and continued commitment to the 50 percent limitation on foreign ownership. But there was a marked difference in the language of the 2004 policy due to China?s accession to the World Trade Organization (WTO). As part of its WTO obligations, China had to drastically reduced tariffs and import quotas and relinquished localization requirements. The government encouraged greater R&D activities through preferential tax policies rather than explicitly requiring foreign firms to open R&D facilities in China. But without the muscle of specific industrial policies, it was not clear how the government would achieve its goal transforming SOEs into national champions. This tension between the government?s goal of technological self-reliance and its desire to allow market forces to stimulate competition and economic efficiency plagues not only the auto industry, but nearly every other 15 sector. To sum up, the Chinese government?s strategy to modernize the country?s automotive SOEs has had mixed results. On the one hand, China has become the world?s largest market for autos and the largest automobile producer. The industry has created hundreds of thousands of jobs in upstream and downstream industries, and generated a significant source of new tax revenues. The automotive industry as a whole contributed about 7 percent of GDP in 2007, up from 2.5 percent in 1990.16 On the other hand, the Chinese state-owned ?Big 3? 14 Localization refers to the process of transferring the production of components that were previously manufactured abroad to local suppliers. Localization is the key to strengthening the local supply chain and enabling an indigenous auto industry. 15 The telecommunications sector and the Chinese government?s TD-SCDMA project present another clear example of this tension. 16 China Automotive Industry Yearbook (1991, 2008). National Bureau of Statistics of China (www.stats.gov.cn). Chang p10 ? First Auto Works, SAIC and Dongfeng ? could hardly be considered national champions on par with Japan?s Toyota or Korea?s Hyundai. Although these state-owned behemoths have learned how to produce cars more efficiently, they have not harnessed the ability to develop their own cutting edge platforms from concept to mass production. They remain dependent on their foreign partners for product development, marketing and branding of new vehicles. Efforts to produce their own line of cars have not been well-received by Chinese consumers, and none of the Big 3 has successfully penetrated foreign markets. Some Chinese auto executives openly admit that the JV model is hampering the further development of SOEs.17 One ex-SVW executive said, ?JVs were the only way for China to start up its auto industry. But today, JVs are running into a wall. Innovation is slow in a JV because there are two partners with often divergent interests. MNCs have a continued interest in producing cars for the Chinese market, but definitely want to see an end to the 50-50 policy... JV policy is a protracted window of opportunity with semi-protection. 18? The JV relationships, akin to golden handcuffs, have ensnared the Chinese firms in dependent relationships and hamper the possibility for technological self-reliance. As another SAIC deputy managing director put it, the JV model is a ?dead-end 19?. In contrast to the SOEs, independent Chinese automakers have been forced to learn all aspects of the automotive business on their own, from product development and marketing to production and after sales service. To be sure, independent automakers have ?borrowed? more than their fair share of foreign intellectual property, but they are learning through 17 Interview 67 with ex-CEO of SGM (2/27/2009), Interview 82 with auto industry consultant (4/13/2009), and Interview 83 with ex-SVW executive (4/13/2009). 18 Interview 83 with ex-SVW executive (4/13/2009). 19 Interview 39 with deputy managing director of component development at SAIC, (9/8/2009). Chang p11 trial-and-error what Chinese consumers desire, and adjusting their product positioning, marketing and after-sales strategies accordingly. They do not have the luxury of relying on the expertise of MNCs or the support of the government. As one Chinese professor explained, this more independent business model, which was at first a disadvantage for independent automakers, has become the very source of their competitive strength.20 New global linkages and the unexpected emergence of China?s independent automakers The main objective of China?s development strategy was from the beginning to modernize the established SOEs through JVs with foreign firms, not to foster new domestic automotive upstarts that would compete with SOEs. Yet, from the mid-1990s onward, the industry has continued to witness new automakers without ties to the central government. In fact, the emergence and increasing presence of Chery, Geely, BYD and Great Wall has been a great surprise to not only industry observers but policymakers themselves. But if sector-specific development policies were not designed to encourage new entrants, what explains the emergence of China?s independent automakers? I argue that China?s broader policies of economic liberalization permitted new linkages between the global economy and China?s domestic economy, enabled private entrepreneurship, and laid the foundation for an independent auto industry. Without FDI, gaining access to the necessary capital and technology was very difficult for private automakers. To overcome these challenges, independent automakers took advantage of new opportunities that grew out of China?s accession to the World Trade Organization (WTO). The concessions China made as part of its commitment to join the WTO had a significant 20 Interview 12 with Chinese professor at Peking University, (7/2/2008). Chang p12 impact on the development trajectory of its domestic auto industry, albeit in unexpected ways. Prior to China?s accession, pessimists and critics of free trade feared that WTO membership and increased foreign competition would inevitably result in significant losses for SOEs, increased unemployment, and the denationalization of local firms aspiring to upgrade and export.21 Importantly, China was able to hold ont5o its 050 p0erce,nt 0limit0ation0 on foreign ownership in assembly JVs, which has kept SOEs in business. 450,000 Optimists argued that China?s WTO obligations and the influx of foreign goods and 400,000 services would compel coddled Chinese SOEs to become more efficient, better managed, and 350,000 BYD Auto internationally competitive. Moreover, WTO commitments would provide the Chinese 300,000 Chery Auto leadership justification domestically for politically painful but economically necessary 250,000 reforms. At the same time, China?s WTO accession would open doors to private firms in Geely Auto 200,000 China. As seen in Figure 4, the car production of the most well-known independent Great Wall Auto 150,000 automakers did grow quickly after China?s 2001 accession to the WTO. But how did WTO 100,000 membership enable infant automakers to grow? 50,000 Figure 2: Post-WTO Annual Production of Top Independent Chinese Automakers - 1 2 3 4 5 6 7 8 9 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 Year Source: China Automotive Industry Yearbook 2005-2008. 21 See Harwit (2001) for pessimistic and optimistic perspectives on the impact of WTO membership on China?s auto industry. A nnual V ehicle P roduction Chang p13 New linkages to the global trading system In anticipation of WTO membership, China began to dismantle its rigid central planning apparatus in the 1990s 22. In the past, the government carefully restricted the allocation of automotive production licenses to new players, except to those SOEs with strong political ties in Beijing. As the Chinese leadership moved away from direct management of the economy, however, they loosened control over production licenses for passenger cars. Chery, after a period of illegal car sales and a brief relationship with SAIC, was finally awarded its own production license in 2003. In the same year, BYD was allowed to buy Shaanxi Qinchuan Auto Company Limited and began to use the defunct firm?s production license to produce passenger cars, without great objection by Beijing. After a decade of making pickup trucks, Great Wall was awarded a production license in 2007. At the same time, the government also began to open up China?s relatively closed trading system. Gradual tariff reductions and the relaxation of the quota system made it easier for domestic automakers to import materials, components and specialty machinery that still could not be made in China. Such items included high quality steel from Japan and sophisticated electronic control systems supplied by companies like Germany?s Bosch. After the gradual liberalization of trading rights, the right to import and export was extended to nearly all foreign and domestic firms, thus paving the way for Chinese automotive exports. Notably, although China does not export many vehicles compared to major auto producing countries like Japan or the U.S., the cars that are exported are primarily produced by the independent automakers, not the SOEs or the JVs. Exporting not only enables small automakers to 22 See Lardy (2002) for a detailed assessment of China?s accession to the WTO. Chang p14 generate greater economies of scale, but allows them to earn foreign currency to purchase imported parts and to learn from consumers and distributors in foreign markets. Finally, the government began to relax the country?s rigid system of foreign exchange. In the pre-reform era, exporters were required to surrender 100 percent of their foreign exchange earnings to the government. Over time, exporters were allowed to retain a share of their foreign exchange earnings, which gave them the ability to finance imports without the need to seek government permission to purchase foreign exchange 23. Meanwhile, as the Chinese currency was devalued during the 1990s, exporting goods from China became a more lucrative business proposition for domestic firms, including automakers. The State Council?s decision to exempt export products from value-added taxes (VAT) further reduced the bias against exports. VAT rebates are permitted by the WTO because they allow firms in countries such as China, which rely heavily on indirect taxes, to compete fairly with firms in countries like the United States, which generate tax revenue through direct taxes. Great Wall, for example, relies on VAT rebates (17 percent for automobiles) to make up for losses associated with exporting its cars to markets demanding particularly low pr 24ices. New linkages to global capital markets At the same time it opened up its trading system, China loosened its grip on capital markets. As a capital scarce country, China looked to FDI to fund its rapid economic development. The reliance on FDI is particularly pronounced in capital-intensive industries such as the auto sector. By 2002, cumulative FDI into the auto sector amounted to between US$10-12 23 Lardy (2002:48-49). 24 Interview 56 with Great Wall manager, (12/3/2008). Chang p15 billion.25 Given the fact that Beijing favored the established SOEs as the recipients of FDI, automotive upstarts had no choice but to look elsewhere for funding to expand their operations. Several of the more ambitious firms looked to foreign stock exchanges. The Chinese government first allowed domestic firms to list abroad in 1993 when it issued the first regulation on overseas listings entitled, ?A Special Regulation on Raising Capital and Listing Overseas by a Joint-Stock Company.? Initially, the government hoped this would be one way in which restructured SOEs could raise capital. To prevent poor-quality SOEs from rushing to foreign stock markets, the government instated an IPO quota system which would be divided among the provinces and ministries as the Chinese Securities Regulatory Commission (CSRC) saw fit. In 2000, the CSRC replaced the IPO quota system with new rules, which reduced the CSRC?s power to approve IPOs and increased the responsibility of lead underwriters. As rules governing overseas listing were liberalized and the CSRC?s direct control IPOs was reduced, private Chinese firms, including several private automakers, took advantage of the opportunity to raise capital abroad. Table 1: Private Chinese Automakers that Raised Capital in Foreign Stock Markets Private Chinese Year Foreign Stock Stock Amount of Automaker of IPO Exchange Ticker USD$ Raised BYD Company , Ltd. 2002 Hong Kong 1211 US$210 million (owner of BYD Auto) Stock Exchange Geely Automobile 2004, Hong Kong 0175 US$113 million, Holdings, Ltd. 2009 Stock Exchange US$138 million Great Wall Motor 2003, Hong Kong 2333 US$207 million, Company, Ltd. 2007 Stock Exchange US$220 million Sources: Company websites, Businessweek.com, Chinadaily.com. Among Western industry observers and executives based in China, Great Wall has an 25 Dicken and Liu (2006:1232-1234) claim US$10 billion was invested while Gallagher (2003:1) writes that the amount of registered capital was closer to US$12 billion. Chang p16 excellent reputation of sound management and is well-respected for its conservative expansion strategy 26. According to Great Wall?s management, the private company is driven by profitability and is the only Chinese automaker never to take on any debt. All of the funds for facility expansion and product development have come from either profits or their two stock offerings on the Hong Kong Stock Exchange (HKSE). In 2003, Great Wall became the first privately-held company to list abroad. Overall, Great Wall has raised over US$427 million which has gone to toward a world-class testing facility, a modern new passenger car factory at its headquarters in Baoding, and new assembly facilities in foreign countri 27es. After raising US$210 million on the HKSE, BYD Company purchased Qinchuan Auto, a failing automaker in Shaanxi Province, and launched BYD Auto. BYD?s large cash infusion enabled the company to purchase Qingchuan, work on plans for its first car (the F3), build production facilities at its headquarters in Shenzhen, and develop capabilities to manufacture a range of automotive components. Remarkably, in just six years, BYD became the fastest growing Chinese-branded passenger car and launched the world?s first plug-in hybrid, the F3DM 28. BYD Company was able to further shore up its cash position when Warren Buffet invested US$231 million in 2008. Like BYD, Geely Auto could not rely on state funding, FDI or subsidized loans to finance expansion. Fortunately, Geely has been able to tap foreign IPO markets twice (2004 and 2009) for over US$250 million dollars. Funding from the first IPO helped the company hire more experienced engineers to help adjust its product mix toward more expensive 26 Interview 13 with US commercial service officer (7/3/2008), Interview 33 with Chrysler executive (9/5/2009), and Interview 43 with UBS Warburg investment analyst (9/12/2008). 27 Interview 58 with manager at Great Wall?s Baoding headquarters, (12/03/2008). 28 Although the F3DM plug-in hybrid is not in mass production, its 2008 launch received a lot of media attention around the world. The author was lucky enough to test drive an F3DM during her visit to BYD. Chang p17 models. Some of the funds from the 2009 IPO will likely go toward financing the expansion of the new luxury brands Geely launched this year at the April 2009 Shanghai Auto Expo: the Shanghai Englon, the Gleagle and the Emgrand. Access to foreign capital markets has been absolutely crucial to the operational expansion of China?s upstart automakers. Without such access, these firms would not have been able to expand production or bring competitive products to market so quickly. Being listed on a foreign exchange also gives these firms greater legitimacy in the eyes of domestic and foreign customers, partners and investors. New linkages to global production networks Over the last few decades, the technical complexity of cars continues to grow at the same time the product lifecycle of each model continues to shrink. Competitive pressure to produce more models with advanced features at lower price points has forced the major global automakers to outsource more of the design and production of parts and subsystems to their suppliers. As a result, the model of automobile production has gradually evolved to one in which component suppliers control more and more of the technology and value in new cars. Maxton and Wormald (2004) estimate that vehicle manufacturers such as Ford or GM today control about 25 percent of the value of the cars they produce, while suppliers control the other 75 percent. This is a dramatic change from 1955, when vehicle manufacturers and suppliers controlled 75 percent and 25 percent of the value respectively. This shift in the model of production presented enormous opportunities for Chinese automotive upstarts. Chinese firms today can purchase most of the sophisticated components and modules from foreign suppliers. Accession to the WTO has reduced the tariffs and quotas Chang p18 on such parts. WTO commitments also forced China to relaxe the 50 percent limitation on foreign ownership of JVs in the component sector. Unlike foreign assemblers, foreign component makers can now establish either JVs or wholly-owned subsidiaries in China. This shift in policy has led to a flurry of investment activity by all of the world?s major automotive component companies, including Bosch, TRW, Johnson Controls, Visteon and Delphi, to name a few. Once the major tier one global suppliers set up factories serving MNCs at their various JV assembly operations, they began to court the business of China?s largest independent automakers. For example, Great Wall buys engines from a Mitsubishi JV, anti-locking brake systems from a Bosch JV, and a number of electronic components from a Siemens JV 29. Great Wall also worked closely with Bosch to design a sophisticated common rail system diesel engine for its Hover SUV. In a similar deal, Chery worked closely with AVL Technologies of Austria to co-develop a line of eighteen engines called the ACTECO series which meet Euro IV emissions standards that are being adopted by the Chinese government. AVL gave Chery access to turbo diesel technology, as well as other advanced technologies such as aluminum alloy cylinder blocks and direct fuel injection. In March 2009, Geely Auto purchased Australia's Drivetrain Systems International (DSI), the world's second largest automatic transmission producer, for US$40 million. Geely plans to build a DSI transmission manufacturing facility in China. The China-made DSI product will be installed in Geely's new luxury cars and all other models with the engine size above 1.5 liters. With new opportunities to partner with, purchase from, or acquire foreign suppliers, 29 Ibid. Chang p19 Chinese automakers do not have to ?reinvent the wheel?, nor do they have to pay high duties on imported parts or rely on China?s comparatively-speaking weak domestic supply chain. Access to foreign suppliers and their technology is a key factor enabling independent automakers to build cars that can compete with foreign brands on price performance. Conclusion New global linkages are increasing the market power of private firms vis-à-vis state-owned firms. The primary developmental objective of the Chinese leadership, the transformation of the largest SOEs into national champions, has not been achieved. I would argue that the chances of fulfilling this objective are slim. After all, risk-averse SOEs are incentivized to stick to their lucrative JVs rather than whole-heartedly pursue the risky and expensive strategy of building their own brands. To the surprise of industry observers, it is the independent automakers that are taking the lead in producing and selling Chinese-branded cars at home and abroad. These firms, most of which are privately-held, are meeting the challenges of capital scarcity and technological backwardness by tapping into global resources made accessible through China?s broader economic liberalization policies. 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