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China's manufacturing sector -- virtually nonexistent four decades ago -- has helped transform the country into the world's second-biggest economy. (Original photos by AP, Getty Images)
The Big Story

Chinese state tightens grip 40 years after Deng's reforms

Companies face headwinds amid trade war, cooling growth

KENJI KAWASE, Nikkei Asian Review chief business news correspondent, and NIKKI SUN, Nikkei staff writer | China

HONG KONG/BEIJING/TOKYO -- During his history-making trip to Japan in October 1978, Deng Xiaoping marveled at the state-of-the art Nippon Steel factory on the outskirts of Tokyo. The plant was a gleaming symbol of Japan's postwar rise, and Deng knew that China needed one like it.

"Would you be able to build something similar to this for us?" Deng, then China's vice-premier, asked his hosts.

Yes, replied Nippon Steel Chairman Yoshihiro Inayama. Eishiro Saito, the company's president, went a step further, vowing to build "something better" in China.

Deng glimpsed a future for his impoverished country during that visit to Japan -- the first by a Chinese leader -- where he rode the bullet train and toured automobile, steel and electronics factories. Two months later, Deng would put his stamp on a political framework that unleashed an epochal transformation of his country.

On Dec. 22, 1978, the Communist Party set out a strategy of "reform and opening up," a Deng-led attempt to turn the page on decades of economic stagnation that followed a series of disastrous political campaigns, including the Cultural Revolution and Great Leap Forward.

Deng Xiaoping visits Nippon Steel's Kimitsu factory in October 1978 as part of his tour of Japan. China's reform and opening up officially kicked off two months later. (Photo provided by Nippon Steel & Sumitomo Metal) 

Steel would be essential to this economic revival, and the Japanese executives quickly began to make good on their promise. The following spring, they began sending 10,000 advisers to help build a plant in Shanghai, while 3,000 Chinese workers came to Japan for training. The Japanese government provided funding for the project, including by offering low-interest loans.

The factory in Shanghai opened in 1985, forming the foundation of what today is the China Baowu Steel Group. Baowu is now the world's second-largest steelmaker, one notch above Nippon Steel & Sumitomo Metal in the global ranking compiled by the World Steel Association. It is an outcome that the Nippon Steel executives could never have imagined during that meeting with Deng in 1978.

"There was a very strong sense of self-confidence that we will not be caught up," Hideaki Sekizawa, former vice president of Nippon Steel, told the Nikkei Asian Review. "We thought we could always lead in terms of technology."

Sekizawa is hardly alone among business executives and political leaders who failed to predict China's astounding rise. Now, as the country celebrates the 40th anniversary of Deng's reform, some governments and companies that aided China's economic revival are expressing serious reservations about the result. In the U.S., foreign policy experts are asking if they "got China wrong" -- a sharp contrast to the refrain in China, where leaders are celebrating the "correctness" of their post-1978 approach.

The belief that China would become more democratic as its economy opened up -- the guiding doctrine of U.S. policy since the Deng reforms began -- is being questioned. The "technology transfers" that companies have long accepted as the cost of doing business in China are now at the center of the Trump administration's broad fightback against China's trade policies.

Nippon Steel, like others in the global industry, has had to contend with the massive amounts of steel churned out by China over the last decade -- sending prices lower and putting intense pressure on its rivals.

Sekizawa said the company -- and Japan -- had expected a different outcome from China's reforms.

"If China prospers and stabilizes, that will in turn bring prosperity and stability across Asia and the world, and eventually it will benefit Japan and the company as well," he said, describing Chairman Inayama's mindset at the time.

A  Dongbei Special Steel plant in Dalian: China is the world's undisputed leader in steel output.    © Reuters

Yet even as debate rages over decisions made in the Deng era, a more pressing question looms. What happens if China, the world's second-largest economy, is turning its back on the ideas that underpinned "reform and opening up"?

Under President Xi Jinping, the state has asserted tighter control over the economy, partially reversing forces set in motion by Deng. As characterized by the phrase guojin mintui -- meaning "the state advances as the private sector recedes" -- the Chinese Communist Party and the state are tightening their grip on business.

"Xi Jinping is a fervent disciple of Mao Zedong, not Deng Xiaoping," said Willy Lam, an adjunct professor at the Chinese University of Hong Kong's Centre for China Studies. "That's why in the six years Xi has been in power, we have seen Xi rolling back many major economic and political reforms introduced by Deng in the '80s."

Chinese companies that have risen along with the country are finding themselves facing more political controls at home and less welcoming partners abroad. And as China searches for the next growth engine beyond manufacturing and property investment, entrepreneurs are trying to adjust to the new reality as the long tailwind of Deng's economic reforms fades.

In recent official events to commemorate the 40-year anniversary of the decision to open up, Lam noted, there was little mention of Deng, known in school textbooks as the "chief architect" of China's economic reform. Instead, Xi has been promoting zili gengsheng, or self-reliance, in public speeches -- an apparent reference to Mao's political ideology.

"Xi has doubled down on the fact that the party-state apparatus must control the economy," Lam said.

Preparing for winter

While the Chinese state begins to exercise more control over private companies, its exporters are facing headwinds as governments -- led by the Trump administration -- hit back at what they view as unfair trade practices coming from Beijing.

Among those feeling the heat is Haier Group, which in the last 35 years has been transformed from a failing state-owned refrigerator maker to the world's largest white goods company with $23 billion in sales in 2017. Its rise to global dominance was cemented in 2016 when it bought GE Appliances, for decades a symbol of high-quality American dishwashers, refrigerators and washing machines.

But that acquisition is costing Haier today. In an ironic twist, the company has found itself suffering from its own country's imposition of $60 billion in tariffs on U.S. imports. Those tariffs forced Haier to cancel its plan to launch a new line of high-end products aimed at affluent Chinese under the GE Appliances name.

Zhang Ruimin, chief executive of the group, says the protectionist wind facing Chinese companies is a new threat for his company -- and a rising one.

"The situation right now is very different from the initial stages of reform and opening up," Zhang said in an interview with Nikkei. Chinese companies were welcome in most countries back then, but now they are facing pushback in key markets. "They think Chinese companies have caused competition for local players," Zhang said.

Zhang was a general manager for the company in the early years of Deng's reform movement. The company was on the brink of bankruptcy then, but Haier's fortunes began to lift when it entered a joint venture with German refrigerator maker Liebherr. There was also another factor in the company's revival: Zhang's own competitive juices were able to flow freely in the new environment.

By 1985, the 35-year-old Zhang had become obsessive about quality control at the refrigerator factory. One day, after receiving a report of a product defect from a customer, he pulled out a hammer and began smashing 76 dud refrigerators. "If I allow these 76 refrigerators to sell, you will produce 760 or 7,600 of these again tomorrow," he bellowed. His workforce was stunned, but the message about the importance of quality was received. The hammer is now housed in the National Museum in Beijing.

Zhang says Chinese companies will have to reinvent themselves if they are going to survive the trade war. Instead of making products for international companies, they are going to have to develop their own brands. "If companies only manufacture other brands' products, they will lose all their value once heavy tariffs are implemented," he said.

"The winter is coming," he continued. "Can you change the temperature? No. What you can do is to put on your cotton-padded jacket."

Slowing growth

For foreign companies operating in mainland China, the problems are different. The once-blistering pace of economic growth in China -- it peaked at 14.2% in 2007 -- has cooled, and competition from Chinese companies is beginning to rise. Volkswagen, one of the earliest Western carmakers in China, is feeling both trends.

Few foreign companies have had as much success in China as Volkswagen. In 1984, Volkswagen signed a contract with state-owned Shanghai Tractor & Automotive Industry Corp., now known as SAIC Motor, after six years of tough negotiations. The resulting 45-year agreement created China's second car-making joint venture with a foreign enterprise -- Shanghai Volkswagen Automotive.

The company produced the Santana, one of country's best-selling models, which at its peak in the late 1990s reportedly commanded 60% of the local sedan market.

But the process of introducing the popular German car model to China was "extremely challenging," Zhang Suixin, executive vice president at the Group's China operation, recalled. Zhang, who has been with the group for 28 years, said Chinese authorities were eager to localize the production of the Santana to showcase the country's credentials in high-end manufacturing in the 80s.

Politicians -- including then-Shanghai Mayor Zhu Rongji, who later became premier -- could not believe that China, which had successfully put a satellite into orbit, was incapable of making steering wheels for the Santana. But the reality was that most local suppliers were unable to provide parts that met German standards. Only small components, such as horns and radio receivers, were produced locally.

Another problem: Volkswagen's international suppliers were reluctant to enter underdeveloped China, so the company was forced to deploy "bad cop" tactics. "We told them, 'If you don't go [to China], you'll lose our business entirely,'" Zhang said. Under threat, about 300 of its suppliers entered China either through joint ventures or technology transfers. "They are very happy now," Zhang said.

Today, the Chinese auto market has overtaken that of the U.S. to become the largest in the world, selling 28.87 million vehicles in 2017, its ninth straight year of being the global leader.

Volkswagen has been a major beneficiary, selling 4.18 million cars in China last year, accounting for over 40% of its global sales.

"In the '90s, nobody -- including myself and colleagues of mine -- could imagine that things would develop at this speed in China," said Jochem Heizmann, president and CEO at Volkswagen Group China.

He still remembers the ocean of bicycles in Beijing on his first visit in the early '90s and was amused to see horses and donkeys walking on the main streets of the capital, as part of the city transport system. "There were not many cars in Beijing," he said.

After decades of fast growth, however, China's auto industry is at a turning point. Its sales are on track to post their first annual decline in 28 years, as people are buying fewer cars amid a slowing economy.

Competition is also intensifying. From being one of only a few carmakers in China 30 years ago, Volkswagen is now competing with international peers, Chinese brands, and internet companies who are investing heavily in "smart cars."

"We are not afraid of that," Heizmann said. The German carmaker is investing in new areas such as mobility solutions and self-driving, partnering with local startup Mobvoi to develop voice control systems, as well as with Baidu and Huawei Technologies in autonomous driving.

"Things are changing," he said. "We still have good chances here. It's a different business."

The real headache for VW in China, however, is the uncertainties in government policy, Heizmann said. "In our industry, what you need is a long-lasting, foreseeable and stable regulatory framework," he said, as it typically takes four years to put a new product into the market. 

Keeping an eye on tech

China's economic reforms created a vibrant private sector that provides most of the country's jobs. But in the Xi era, companies -- including fast-growing tech companies -- are under rising pressure to pursue closer ties with the Communist Party.

Didi Chuxing, China's largest ride-hailing app, is one of them. In October Didi said it was planning to recruit 1,000 party members. The announcement came on the heels of reports that two passengers had been killed by its drivers this year, drawing severe criticism from Beijing and the public.

The party recruits are expected to serve as "role models," and they are in addition to the 3,750 party members already working for the company, which has 10,000 staff nationwide.

Jean Liu, Didi's president, was born the same year as the Deng-era reforms kicked off. She is a daughter of Liu Chuanzhi, founding member of the world's largest PC company Lenovo, and a granddaughter of one of China's earliest lawyers practicing patent right protection.

Jean Liu, president of ride-hailing startup Didi Chuxing, was born the same year the Deng-era reforms kicked off. (Photo by Kei Higuchi)

Her company, with a valuation estimated at $56 billion, is pursuing wider collaboration with local governments on AI transportation projects. Liu said it already operates in more than 20 cities and wishes to expand further.

In response to emailed questions, Liu said entrepreneurship always comes with "great social responsibilities."

"As a young company, we made our share of mistakes too, but clearly the only way to go is to integrate that 'tech' epithet into the broader social-economic system," Liu said.

Other new economy companies are being prodded to employ party members. Video streaming and online entertainment companies -- including popular services like Toutiao, Tik Tok and Kuaishou -- have vowed to recruit tens of thousands of staff to ensure their platforms promote "correct social values." Party members are preferred in these "content examination" positions.

The companies had been called in by regulators for promoting "vulgar" content or material that was considered humiliating to revolutionary martyrs.

U.S.-listed Bilibili, a site popular with younger Chinese viewers that allows them to share animated videos, is taking a more straightforward approach to building ties with Beijing. It has invested in animated films that tell the glorious history of the party and livestreamed lectures that promote party ideology to its young audience.

Such pressure on private companies comes as monopoly state-owned enterprises are reasserting themselves under Xi.

Zhang Lifan, a Beijing-based scholar of modern Chinese history, noted that  state-owned companies have taken controlling stakes in at least two dozen listed companies this year. This has raised concerns among private entrepreneurs, as well as some ruling party elites who worry about new burdens being piled on small businesses that are already coping with the trade tensions, Zhang said. 

He says the Communist Party has been tightening up its grip over private businesses that grew rich during Deng’s reform era. “[Beijing] wants to take advantage of the private entities to strengthen its own rule,” he said.

While Beijing has adopted a more supportive tone to private businesses since October, Zhang said it could be “too late” given that these companies are more fragile than state-run enterprises. 

All of this marks a reversal of Deng's policies, which began to separate government and business in the 1980s. "Deng Xiaoping did not do the nitty-gritty stuff. He just explained the big direction and let his subordinates work on the details," said Ezra Vogel, a prominent scholar on Japan and China, in a recent interview with Nikkei.

Xi, Vogel continued, "is a micromanager [who] wants to work on the details on his own."

Losing the spirit?

The rising influence of the state is alarming to foreign companies, especially now that China is pushing further into cutting-edge areas such as advanced semiconductors, artificial intelligence and driverless cars.

"The problems that companies in the West are facing is when you have those state-owned enterprises which are protected domestically with subsidies and preferential loans, and taking these companies into the international marketplace with continued support," said William Zarit, chairman of the American Chamber of Commerce in China and a former U.S. diplomat with long experience in the country.

A billboard in central Shenzhen carries Deng Xiaoping's statement that the Communist Party's fundamental policy of reform and opening up is to remain in place for a century.   © Kyodo

"I hope that we are not losing the spirit of Deng Xiaoping's reform and opening up," Zarit said. "But if you look at the direction that the economic policies have taken in the past six, seven, or eight years, it seems that the reform is not opening up, it's not privatization, it's not being based on competition, but it's much that is strengthening the state enterprises."

Such concerns lie at the heart of the Trump administration's trade battle with China, which many longtime observers in the region believe is not going to end anytime soon.

Victor L.L. Chu, founding chairman of Hong Kong-based First Eastern Investment Group, believes tougher times are ahead for Chinese companies.

"China was able to execute 40 years of reform with the support of the international community," said the veteran China-focused investor. "But the support and sympathy have turned into concern and envy, and also rivalry, not unconditional support. Chinese leaders need to manage expectations carefully."

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