Business in China   -   Just a few months ago, China´s President Xi Jinping announced to give markets a decisive role in economic development. However, in the past the Chinese government - with its historical background in communist economic thought - has not at all been reluctant to direct or at least strongly influence the economy. This obviously affects the chemical industry in China.

China faces a number of major economic issues. The Chinese government does generally not hesitate to use its available tools to address these issues. What are these issues, in particular those that are related to the chemical industry? What tools are being used to direct the chemical industry? And what are the objectives and desired outcomes?

Objectives In Focus

China´s wealth distribution is highly imbalanced. This does not only apply to individuals within the same regions, but also to average wealth in different regions. Average income in Shanghai is about seven times higher than in the poorest province, Guizhou. In order to promote greater regional equality, China - using the colorful "Go West" slogan - has implemented a massive program to improve the infrastructure in the Western provinces. A "Scheme for Central China to Advance the Region's Raw Material Industry Structure Adjustment, Optimization and Upgrade" announced the promotion of the basic chemicals industry in Central China by building large-scale coal chemical groups. In some areas, companies relocating from Eastern to Western China get a lower rate of corporate tax. Chemical companies may also benefit - BASF is believed to have received state subsidies when setting up their new MDI plant in Chongqing in central China. State-owned chemical companies also heavily invest in some of the more remote provinces, e.g., Xinjiang and Inner Mongolia, not only because of the raw materials available there but also as a political tool to expand state presence and create additional jobs in poorer regions. In addition, new projects are approved more easily in Western provinces than in Eastern China.

Environmental issues are getting more and more important to the government, as a consequence both of the increasing severity of pollution and the increased awareness among the newly created middle classes. Consequently, legislation is being implemented on issues such as air pollution and energy consumption. The government also aims to discourage the production of harmful chemicals, e.g., by cancellation of export rebates for particularly polluting chemicals, and regulates the use of some of the more damaging production technologies in areas such as PVC, calcium carbide and chromium salts. Rules for the management of new chemical substances have been tightened. Generally, foreign companies are somewhat less affected by the stricter regulation as they already produce at higher standards, but companies such as Lanxess have recently shifted some of their production away from focal points of environmental protection (such as Wuxi, which is located close to the major and environmentally vulnerable Lake Taihu).

Overcapacity management is an area in which the Chinese government hesitates much less than Western governments to engage in. For example, in 2013, the relevant ministry reduced capacity in a variety of chemical fields such as calcium carbide, ethyl alcohol, monosodium glutamate, and chemical fiber. Generally, the capacities closed were either based on old technology or of a small size, leading to the additional benefit of improving the technology level and average production cost of affected segments. In addition, restraints are placed on foreign companies to enter areas already suffering from overcapacity, such as polysilicone.

Government Activities

Many chemical segments in China show a high degree of fragmentation, which is a concern for the government due to the low profitability of these industries and the low technological standards. Consolidation is therefore a government objective which is pursued by setting entry conditions for specific chemicals, e.g., for ammonia, calcium carbide, fluorite, magnesium, rare earths, soda ash, specifying items such as the plant location or minimum size, the maximum energy consumption or the production process used. For some segments, the consolidation objective is quite specifically aimed at creating globally competitive champions - for example, in the carbon fiber industry, the Ministry of Industry and Information Technology (MIIT) aims to establish two or three internationally competitive carbon fiber groups. Mergers - particularly those that save weaker players from going under - are often actively supported by the government, for example by giving weak state-owned players to stronger players for free.

Segments considered to be strategic are actively promoted by the government (more specifically, the MIIT). Activities include strengthening of R & D support, promotion of foreign investment and accelerating general development in specific areas such as rare earths, specialty glass, functional ceramics, semiconductor lighting materials, high performance membranes, carbon fibers, hydrogen storage, fluoropolymers and nano materials. Also, state-owned enterprises (SOEs) are supported in acquiring assets overseas, in particular in the areas of basic raw materials such as oil and in specialty chemicals.

Recently, the government announced that it will continue to reduce restrictions on foreign capital in China's manufacturing industries including the chemical industry. However, so far basic coal chemicals and petrochemical projects can only be done by multinational corporations (MNCs) as part of a JV with a domestic player. In addition, the government also restricts foreign expansion in areas deemed to already be crowded. On the other hand, foreign investment is supported in production of advanced materials as well as in chemical R&D and in establishing regional headquarters. These activities are aligned with China´s goal to continuously modernize its economy, both with regard of the type of materials produced and with regard to the more general shift from production to services.

Finally, social stability is of course a major government goal, which in terms of economic policy translates to avoiding large-scale unemployment. The government generally prevents state-owned enterprises from large-scale lay-offs even if (as in many state-owned entities) the number of workers far exceeds the number necessary to run the business (indeed, mergers involving state-owned chemical companies often include the unspoken condition of not involving massive layoffs).

This discussion shows that indeed - unsurprisingly - the government has a major influence on the chemical industry in China. However, it should also be pointed out that many of the objectives targeted, and tools utilized, are not massively different from those utilized by Western governments. Directing investment via subsidies, controlling the impact of imports via duties, or balancing the interests of production with environmental protection via legislation are all familiar aspects for the chemical industry in the Western world. One main principal difference is the much bigger presence of state-owned enterprises, which can be expected to target non-profit objectives such as avoiding layoffs much more directly than private companies. The other is the lower reluctance of the government to be visible as a strong driver of specific segments of the economy, something that at least conservative Western governments are somewhat more hesitant to admit openly.

Conclusions

The info box below provides a summary of a number of hypotheses aiming to give a qualitative forecast about the future development of government influence on the chemical industry in China.

Hypotheses for future government influence on the chemical industry

1.    Despite the above mentioned objective of giving a bigger role to market forces, it is very likely that the government will remain a major influence on the chemical industry in China. As long as state-owned enterprises keep their current importance (and there are no strong indications otherwise), this influence will be bigger than in the West.

2.    Government policy will keep affecting basic chemicals more than specialty and fine chemicals. This is both due to the larger size of individual basic chemicals companies and their perceived larger importance for China´s self-sufficiency.

3.    The government will continue to promote specific segments of the chemical industry, such as advanced materials. However, the effect of these activities will probably not be much stronger than similar activities of Western governments.

4.    Environmental protection will be pushed further by the central government, however this will be resisted by provincial and lower-level governments.

5.    While for foreign chemical companies it will remain important to understand and anticipate government policy, the overall influence of it on their business is likely to remain at a similar level as now.