The role of government in late industrialization: A historical analysis on the Chinese automobile industry

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The role of government in late industrialization:

A historical analysis on the Chinese automobile

industry

Master Thesis

Faculty of Economics and Business

Business Administration – Small Business and

Entrepreneurship

Sheng Lin

1797085

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Acknowledgements

I would first like to thank my supervisor Dr. C.H.M. Lutz for his

guidance, time and efforts on my thesis which allowed me to make a

better performance. I would also like to thank Ms. Anderson for doing the

proof reading of language for me. My gratitude extends to Mr. Olthaar

who gave his valuable opinions on my thesis. More importantly I am

deeply grateful to my parents, thank you for providing me with the

opportunity to study in the Netherlands, this experience is a precious

fortune in my life. And last, but not least, I appreciate being supported

and encouraged by my family, friends and fellow students during my stay

in the Netherlands. My accomplishments could not have been possible

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Executive summary

Chinese automobile industry attained striking achievement in the past decades, it has become one of the pillar industries in the national economy. Although the Chinese government plays an important role in this industry, the unprotected private sector realized the best performance. Therefore the goal of this research is to gain an insight into the role of Chinese government in the automobile industry, find out the effect and flaw of the industrial policy, and what can be improved in the future. A historical analysis was conducted based on the literature study. This research focuses on three main areas of the Chinese automobile industry, namely FDI, technology transfer, and R&D. The FDI fulfills domestic capital needs and enables technology transfer to the local automobile firms. The joint ventures upgraded the technologies and the managerial knowledge of Chinese auto firms, especially the part-making enterprises made extensive technological progress in the past decades. These local suppliers consequently provide great technology support to the car assembling sector, both the SOEs and the private carmakers. However, the large state-owned carmakers still have not yet attained great progress in R&D, and still rely on the technologies from their foreign partners, rather, some newly emerged and unprotected local carmakers became the domestic pioneers in self-developed brands and technologies.

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1 Introduction

After the “open door” policy was implemented in China in 1979, the Chinese economy has been booming for decades. The automobile industry, which is considered as one of the pillar industries in China, also registered rapid growth during the 1980s and 1990s. It developed more strikingly after China entered the World Trade Organization (WTO) in 2001. From 2008 onward, numerous countries in the world have been impacted by the global financial crisis, their national economies suffered from the subsequent recession. Many countries’ automobile industry were also affected by the crisis, especially in the United States. However, the impact of crisis on the Chinese automobile industry is not that tremendous compared with those developed countries and the negative impact is mainly limited to the export market, the domestic market still continues to grow. After substantial growth for several years, in 2009 the annual output and sales volume of motor vehicles in China both exceeded 13 million units, with a year-on-year increase of 48.3% and 46.15% respectively (Baidu, 2010a). Subsequently China excelled the United States and Japan, ranking number one in the world on both motor vehicle output and sales volume. Moreover, some Chinese domestic carmakers, especially in the private sector, attained remarkable performance internationally, for example Geely took over Volvo in 2010 (BBC, 2010).

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“must-invest situation”, nowadays, all the major automobile TNCs have the joint venture in China (Liu and Yeung, 2008).

In the modern industrial society, government interventions and industrial policy have a long history. From the 1970s onward, Japan, followed by South Korea and Taiwan, attained great achievements in certain industries. The World Bank (1993) calls it the “East Asia Miracle”. Afterwards, the government intervention through industrial policy attracted wide attention internationally. China, as a late industrializing country, learned from its Asian neighbours, applied the industrial policy to foster the infant automobile industry, and tried to catch up with the developed countries. In the new periods, e.g. after entering the WTO and the global financial crisis, the Chinese government also adopted new industrial policies to promote the industry to develop to a higher level. The automobile industry is a medium to high technology sector in the OECD classification (Liu and Tylecote, 2009). In recent years, the Chinese government also encouraged and led the development of environment-friendly and new-energy cars, which is at the cutting edge of international trend.

Looking back to the history of the Chinese automobile industry, it took 54 years to develop from a rear position to a trendsetter in the world. The Chinese government plays an important role on the industrial development, and mainly fosters the public sector , but the private sector has better performance than the public sector. This leads us to the debate on the role of government, which has lasted for decades in developing countries. Neoliberals promote the free markets yet the structuralists advocate government interventions (Lall, 2004). So in the case of Chinese automobile industry, government intervention or the regulation of free markets is more effective? This is interesting and valuable to study, therefore the main research question of this thesis is:

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The goal of this research is to find out the effect of government policy on the Chinese automobile industry, what is the flaw of the policies and what can be improved in the future, should more government interventions or the free markets be promoted? This research conducts a historical and integrated analysis on the main thematic areas of Chinese automobile industry, and it fills the research gap of the role of government in this industry. The academic value is not only beneficial to future development of the Chinese automobile industry, but also to other developing countries who are eager to develop in this field.

In order to answer the research question, several factors should be considered. Government policy influences the Chinese automobile industry on many aspects, yet three of them are most relevant to the success of the industry, namely FDI, technology transfer, and R&D (see Liu and Yeung, 2008; Sadoi, 2008; UNIDO, 2010c; Lundvall, 1998; Amsden, 1988, 1990, 1991). First of all, FDI has been playing a significant role on many industries since the “open door policy” was implemented in China in 1979, the rapid growth of the Chinese automobile industry has been considerably shaped by huge inflows of FDI (Liu and Yeung, 2008). FDI fulfills domestic capital needs and enables technology transfer to the recipients (Sadoi, 2008), it solved the problem of lacking capital in the early stage and facilitated the technological development of Chinese automobile industry. Therefore the first sub-question is:

1. How did government policy affect the Chinese automobile industry through FDI?

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transfer happen? This is a question that should be investigated, for this reason the next sub-question is developed as:

2. How did government policy influence the Chinese automobile industry through technology transfer?

But only learning from the TNCs is not enough. Numerous successful companies have evolved as the learners by assimilating and tapping the existing technologies, and eventually developed their ability to generate their own technologies (UNIDO, 2010c). Lundvall (1998) states that dynamic technological competencies and innovation are crucial for the economic development, competitive economic growth and performance. Thus R&D capability is necessary for the automotive firms. The Chinese government asks the domestic firms to learn from the foreign TNCs, upgrade their technological capacity, and eventually develop their independent R&D capabilities, so that the domestic automotive firms can compete with the foreign TNCs in the international market. Therefore the Chinese government used the policy instruments to stimulate the R&D development in local automotive firms. This led to the last sub-question:

3. How did government policy affect the Chinese automobile industry through R&D?

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Left Review, Annals of the American Academy of Political & Social Science, European Economic Review, Journal of the Japanese and International Economies, Research Policy, China Quarterly, Industry and Innovation, Eurasian Geography and Economics, Transnational Corporations, Technology Analysis and Strategic Management, Journal of Economic Literature, Business and Politics, Asia Pacific Business Review, and Journal of Management Studies, because they deal with the topics of industrial policy and Chinese automobile industry. A historical and integrated analysis will be conducted to show how the government policies changed and influenced the above-mentioned aspects throughout the history of Chinese automobile industry.

This paper is structured as follows: in chapter two the relevant literature will be reviewed to build a structure of success factors related to government policy. In chapter three I will present the history of Chinese automobile industry, and investigate the government policy regarding FDI, technology transfer, and R&D of this industry. In chapter four, a comparison and analysis between chapter 2 and 3 will be demonstrated. In the final chapter, chapter five, the conclusions will be drawn between the development of Chinese automobile industry and policy making in this industry, the recommendations will also be made for the future development.

2 Success factors related to government policy

2.1 Government industrial policy in general

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The government plays an important role for the development of an industry, in particular at the infant stage of the industry. According to Amsden and Suzumura (2001), it is appropriate for the governments in developing countries to implement some industrial policies to protect and foster the “infant industries”, and facilitate the take-off and success of these industries. Amsden (1990) claims that the state is the principal initiator of industrial growth. Many market theorists tend to share one view: the more pronounced the market failures are, the more backward the economy is. Therefore reducing the market failures is one of the roles of state government. But this is not enough to make the economy grow. One feature of a technologically advanced economy is a set of institutions to create the novel products, firm-specific skills, proprietary production processes and other “competitive assets” that may embody market failures. In many late industrialization countries the governments often neglected the production issues in economic development, therefore government policy is necessary not only for the market failure correction, but also for the competitive assets creation. In order for the latecomers to enter the industries dominated by developed countries, “their dynamic learning path has to be creating the competitive assets (organizations, resources and capabilities) rather than cultivate perfect markets” (Amsden, 1997, p.471).

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and wide sharing of information between private and public sectors. Some industries are promoted while others are not.

UNIDO has worked long time and is still working on making an effective contribution to the industrial development and sustainable development in developing countries. Its viewpoint is in accordance with Amsden’s. UNIDO (2009) states the main responsibilities of the industrial governance system, which include:

• Causing the actors of the learning system and innovation, the support institutions, private sector and the government agencies, to benchmark and analyze the performances and capabilities of their domestic industries;

• Developing a vision and a strategy to improve productivity, learning and innovation;

• Formulating and implementing an integrated series of policies and programmes to promote learning and innovation, and to enhance the learning and innovation system; and

• Constantly monitoring the implementation of the strategies and assessing the effect of the policies and programmes.

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On the other hand, Lall (2004) states that the structuralists see a crucial role for policy in industrial success. They put less faith in the free markets as the driver of dynamic competitiveness and more in the ability of government to implement interventions effectively. They also accept the mistakes of past industrialization strategies and the need for greater openness. The structuralist view considers that greater reliance on the markets does not preempt a proactive role for governments. The markets are powerful forces but not perfect, the institutions needed to make them work efficiently are often absent or weak. The government interventions are needed to improve on the market outcomes. Therefore the viewpoints of Amsden and UNIDO are in accord with the structuralists’.

2.2 Government policy on FDI

Nowadays it is accepted that FDI plays a crucial role in the industrial development of both the developed and developing countries and can help in boosting economic growth. FDI increasingly contains sets of interconnected operationalized business decisions by TNCs in response to the changing regional and global competitive, strategic considerations and the factor conditions (UNIDO, 2010b). According to UNIDO (2003), the policy framework for FDI is a crucial part of overall national strategies for industrialization.

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developed from the local initiatives to facilitate learning and innovation becomes the basis for local companies’ development (UNIDO, 2010e). If we look back to the economic development history of China, the key features of Chinese economic growth are capital and labour driven, the large-scale FDI is one of the major sources of the capital (UNIDO, 2010c). FDI had great impact on the development of many industries in China.

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At policy level, coherence implies a high degree of consistency between host government goals and the actual policies implemented to achieve them, in parallel with a strong connection and coordination between different parts of the government. Policy makers have always to keep in mind that attracting FDI does not constitute an end in itself but a means to boost the industrial development (UNIDO, 2002). Moreover, it is common that there are conflicts within a country between the goals of an incentives programme and the actual formulation of the programme, as well as the capacity of the national institutions to administrate it. Therefore policy coordination among different parts of the government is needed to reduce the possible negative influence (UNIDO, 2010b).

Additionally, it is vital for effective FDI promotion that policy coherence, which should exist at the different levels of government, also appears in the legal framework. For instance, local governments’ objectives and strategies on IP should be in accordance with that of central government, and central government should use the legal system to ensure the implementation of those promotion policies. In fact, “a strong and consistent judicial system is exactly what often lacks in developing countries though it is crucial for attracting foreign investors” (UNIDO, 2010b, p.23).

2.3 Government policy on technology transfer

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UNIDO (2009) elaborates this issue further. Industries in developing countries are usually not at the technological frontier, they upgrade and innovate their capabilities by learning and mobilizing to use efficient technologies existing in more advanced and industrialized countries. Those developing countries follow what UNIDO calls a strategy of linking, leveraging and learning (the LLL strategy): they identify and link with the external partners which have skills and technologies they need to upgrade their processes and products and to innovate. They leverage as much as possible the knowledge from those external relationships. They invest in learning to use and adapt those new product and process technologies in their companies and clusters. For example, a firm from a developing country looks for a foreign partner in more advanced countries and forms a joint venture with that partner. The firm tries to learn as much advanced knowledge and technologies as possible from its partner.

Pursuing a learning and innovation strategy takes more than only opening up to the world market forces. It requires the development of global linkages with the business partners and sources of the technology combined with a constant upgrading of domestic skills and capabilities. The market framework conditions comprising macroeconomic stability and liberalization policies are necessary, however it’s not enough to trigger a process of the innovation and upgrading of capabilities in the domestic industries. What is also required are the new forms of industrial governance systems based on partnerships between the private and public sector. These are needed to formulate and execute the strategies, policies and programmes to stimulate the process of learning and innovation of domestic industries, and also to support the organizations of an efficient learning and innovation system (UNIDO, 2009).

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which Amsden (1988) emphasizes on this learning process. First, as a consequence of industrialization on the basis of learning rather than generating new technologies, the growth-productivity dynamic has assumed a specific pattern. Productivity increases in the late industrializing countries are not reliant on the highly variable process of innovation, they are reliant on how efficiently foreign technology is used (which might be termed learning by doing, it depends on how quickly output is expanding and the experience is accumulating); whether the scale of borrowed technologies are adequate (the quicker the growth and the market expansion, the greater the scope for the fulfillment of scale economies); and on how extensively borrowed technologies are introduced (which depends on the investment rate as well as determined growth). Second, the basis on which companies compete differs according to the form of industrialization. The innovators compete on the basis of new processes and products. Initially, the learners compete on the basis of low salary.

According to UNIDO (2010c), growth accounting analysis reveals that apart from the contributions by capital and labour, technological progress has also played an increasing important role in the economic growth over the past decades. Successful companies have evolved as the learners by assimilating and tapping the existing technologies, and eventually developing their ability to generate their own technologies. Catching-up involves constant efforts to mobilize and organize resources which firms have in hand.

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Furthermore, along with the increasingly demanding requirements of the global competition, the global production networks (GPN) have evolved as a major organizational innovation in the global operations. These networks have also acted as a catalyst for the diffusion of international knowledge, providing new opportunities for the local capability formation in lower-cost locations outside the industrial heartlands of Western Europe, North America and Japan (Ernst and Kim, 2002). The concept of a GPN covers both inter-firm and intra-firm transactions and forms of coordination: it links together the flagship’s (global corporation) own subsidiaries, joint ventures and affiliates with its suppliers, subcontractors, service providers, as well as partners in the strategic alliances. These arrangements might, or might not involve the ownership of equity stakes. Ernst and Kim (2002) also state that GPN typically includes various hierarchical layers that range from network flagships which dominate such networks, down to various usually smaller, local specialized network suppliers. This taxonomy helps to assess the different competencies of these companies to benefit from knowledge diffusion and to enhance local capability formation.

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For the mode of knowledge transfer, during the past decades, it’s common for the network flagships to use largely formal mechanisms such as FDI, FL (foreign licensing) and technical consultancies in transferring knowledge to local suppliers, if the latter are the subsidiaries or joint venture partners (Antonio, 2001). For example, Volkswagen, Toyota Motors, and General Motors, all have joint ventures in China, and they transfer the knowledge and technologies to their Chinese partners.

To summarize, the GPN have boosted international knowledge diffusion, provided new opportunities for capabilities formation by local suppliers or partners in the developing countries. Under the pressure from flagships, local suppliers or partners have a strong motivation to internalize the transferred knowledge via various forms of knowledge conversion. However, the baseline is the absorptive capability of the local suppliers or partners: it determines the effectiveness of capabilities formation. In order to stay on the GPN, the local suppliers or partners have to constantly upgrade their absorptive capacity (Ernst and Kim, 2002). In this case, the appropriate policies and support institutions are needed to enable local firms to exploit the pressures and opportunities which result from the network participation.

2.4 Government policy on R&D

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personnel management underpins innovative organizational practices to promote motivation, incentives and productivity and attract the R&D. R&D generates new knowledge and information underpinning searches for new markets and technical opportunities via innovation. R&D is equally relevant for exploiting and assimilating existing knowledge and information. In other words, it helps build the absorptive capability by tapping the existing knowledge.

Moreover, Lundvall (1998) claims that dynamic technological competencies and innovation are crucial for the economic development, competitive economic growth and performance. This can be seen by many countries who have increasingly realized the significance of innovation as the enablers of performance and are formulating the policies, or trying to create favourable entrepreneurial environment that are beneficial to innovation. Especially the industrialized countries, either individually or in cooperation as unions, are devoting increased policy space and resources to enhance the capability of those actors which are responsible for driving innovation at national level in order to increase transformational capability and transactional capacity.

The UNIDO Industrial Development Report (2002) stresses that economy development is affected significantly by the innovative activities of firms that lead to the technological change, not only at the level of firms, but also via nested aggregation, at the level of sectors, industries and macro-economy with obvious spatial impact. Although a country might have to rely on, or deal with external factors such as the advantages of FDI, the international assist and collaboration in order to enhance its industrial performance, it has to start its own innovative work either in parallel or at some stages in order to resolve local problems. Either way, the innovative activities are essential.

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practical R&D in their business strategies” (p.30). It is also important for the government to create favourable environment that is beneficial to upgrading capabilities for exchange and capacity for innovation. Although a firm may already be a leader in its own country, the investment as well as international joint ventures in innovative activities will help retain its position in its own country, more importantly it will increase the firm’s competitiveness internationally.

Let us take a look at some countries, to see how the governments made policies concerning R&D. In South Korea the large firms have been allowed to import foreign technology for years, but they have had to start investing in their own R&D. The Hyundai Motor Company, a typical automaker in South Korea established a design center to start reducing its reliance on foreign design inputs soon after its founding. Ultimately all small components were designed in-house and Hyundai set up a parts development department to enhance the technological capability of its parts subcontractors (Amsden, 1990). Other countries or regions in East Asia (such as Japan and Taiwan) have generally been more successful at industrialization than other learners not because they have bowed deeper at the free markets, but because they have operated with a different principle of subsidy allocation. In East Asia, beginning with Japan, there has been a great tendency for subsidies to be allocated based on the principle of reciprocity, subsidies in exchange for concrete performance standards regarding exports, output, and eventually R&D (Amsden, 1991).

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exchange for the performance standards. Subsidized firms in South Korea have received cheap capital but they have had to produce, not speculate. The firms have been allowed to sell the products in a protected home market, but they have had to increase productivity and quality to enlarge their share of foreign markets. Usually only good performers were rewarded and poor performers were punished. The Korean government often refused to bail out poorly managed companies in otherwise healthy industries, and relocated the assets of such companies to other firms with better management (Amsden, 1990). In Taiwan the government provided the technological support at the beginning of the product cycles, but left crucial tasks of project execution and rapid growth to the private firms (Noble, 2005).

The Chinese government also emphasizes the national R&D projects and formation of science and technology enterprises which are neither state-owned nor private. The State Planning Commission announced a policy to set up around 100 national key laboratories in selected fields of the basic science in which Chinese competencies already excelled. However some researchers question the efficiency of Chinese R&D because the R&D investment in China is less intensive in the private than in the public sector (UNIDO, 2010c). So how the capabilities of R&D in the public and the private sector of the Chinese automobile industry compare will be elaborated in the latter part of this paper.

2.5 Summary of the government’s role

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FDI boosted economic growth in many countries, especially in the developing countries. It brings the capital to the host countries and other indirect effects, the most typical one being the technology spillovers to local firms. On FDI promotion, 1) it is quite important that there is a high degree of consistency between host government goals and the actual policies implemented to achieve them, 2) it requires a strong connection and coordination between different parts of government. In many countries, there are usually conflicts between the goals of an incentives programme and the actual formulation of the programme, as well as the capacity of the national institutions to administrate it. Therefore policy coordination among different parts of the government is needed to reduce the negative influence. Additionally, 3) developing countries usually lack a strong and consistent judicial system even though it is crucial for attracting foreign investors, hence 4) the policy coherence on FDI promotion should exist at the different levels of government, also appear in the legal framework.

Learning rather than generating new technology is the hallmark of late industrialization. TNCs can bring the advanced skills, know-how and technology to the host countries. Joint venture is a common mode to achieve the knowledge and technology transfer under FDI. Usually the local firms upgrade their capabilities by learning and mobilizing to use efficient technologies already existing in the TNCs. 5) It is necessary to have new forms of industrial governance systems based on partnerships between the public and private sector. These are needed to formulate and implement the strategies, policies and programmes to stimulate the process of learning and innovation of domestic industries, and also to support the organizations of an efficient learning and innovation system.

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knowledge is internalized and transformed into the capabilities of the local firms. In order to stay on the GPN, 7) the local suppliers or partners have to constantly upgrade their absorptive capability.

Learning the knowledge and technology from the advanced countries is quite important for the late industrialization countries. However when the technological capabilities of domestic firms have been upgraded to a certain level, the government should stimulate the R&D development among those the domestic firms, because it has been widely accepted that technological advances and innovation are positively correlated with the economic growth. Research shows that many successful companies have evolved as the learners by assimilating and tapping the existing technologies, and eventually developing their ability to generate their own technologies. In this way many countries have increasingly realized the significance of innovation as the enablers of performance and are formulating the policies, or 8) trying to create favourable entrepreneurial environment that are beneficial to innovation. 9) Further, government induced incentives play an important role. Given the right incentives, the private businesses will be willing to include innovative and practical R&D in their business strategies.

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Table 1. Effect and success factor related to government policy on FDI, technology transfer and R&D.

Field of policy Effect Success factors related to government policy FDI _• Fulfill the domestic

capital needs • Technology

spillovers

1. High degree of consistency between host government goals and the actual implemented policies on FDI promotion 2. Strong connection and coordination

among different parts of government 3. Strong and consistent judicial system 4. Policy coherence of FDI promotion

should exist at different levels of government, also appear in legal framework

Technology transfer _• Technological upgrading of domestic firms

5. New forms of industrial governance systems

6. Transferred knowledge needs to be internalized and transformed into the capabilities of the domestic firms

7. Domestic firms have to constantly upgrade their absorptive capability

R&D _• Acquire own proprietary products and technologies, and create other competitive assets • Increase the

international competitiveness

8. Create favourable entrepreneurial environment that is beneficial to innovation

9. Industrial policies and governance systems can induce the automotive firms’ incentives in R&D

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3 Automobile industrial policy in China

3.1 The history of Chinese automobile industry

The automobile production in China started when the First Auto Works (FAW) was set up in 1956. FAW was designed by Russian technicians , and it was duplicated the mode of Russian’s vertically integrated automobile enterprises. The government chose Changchun city in north-east China as the factory of FAW because of the geopolitical concerns regarding the Cold War, even though Shanghai’s industrial tradition was obviously stronger than that of other cities in China. Shortly after FAW’s establishment, four local automobile assemblers emerged in Beijing, Shanghai, Nanjing, and Jinan, the survivors among more than 100 small factories tried to produce cars during the Great Leap Forward (1958-1960), a period characterized by grassroots industrialization and decentralization (Liu and Yeung, 2008).

In 1962, the Sino-Soviet friendship broke up, this forced the Chinese government to adopt a “third front” defense strategy, namely to locate new industries in remote mountainous regions to avoid possible military attacks. Three new assemblers emerged during this “third front” period: the Second Auto Works (SAW, later renamed as Dongfeng Automotive Group) and two heavy-duty truck factories. To ensure its protection from military attacks in times of war, SAW was located in a remote town in a mountainous area in northwestern Hubei province. At the same time, local assemblers increased again because of the local initiative unleashed by the collapse of central government’s control during the Cultural Revolution (1966-1976). The existing firms and three new firms in Wuhan, Shenyang, and Tianjin, became the important automobile producers in that period.

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11.8%1 (Liu and Yeung, 2008). Moreover, commercial vehicles (mainly trucks) were the focus of production as the Chinese government viewed the automobile industry as a producer goods sector.

After China’s economic reform and the opening in 1979, the huge inflows of FDI and continued restructuring began to emerge in the Chinese automobile industry. In the mid-1980s there was a sudden surge in car imports into China. 150,000 cars were imported between 1985 and 1986, nearly eight times more than the number of domestically produced cars during the same period (Liu and Yeung, 2008). In view of this, Chinese government had to adopt more open policies to boost domestic production more specifically by promoting FDI through the formation of joint ventures. In 1985 a guideline regarding the automobile industry was released, the “Notification of Automotive Industry Development Planning and Reformation of System”. It is worth noting that even before this guideline was issued, the automotive joint venture had emerged in China. The first foreign TNC to test the water was the American Motors Corporation who established Beijing-Jeep (BJC) in 1983, followed by Volkswagen (VW), Citroen, and Peugeot. By 2003, all the major automobile TNCs had joint ventures in China. The surge of passenger cars in imports also made the Chinese government recognize the existence of a vast domestic demand of cars. Accordingly, the government decided to shift the focus of the industry from commercial vehicles to passenger cars.

Since the reform period, the Chinese government has tried to use the central planning tools to guide the development of this industry, not only by controlling the entry of TNCs but also by choosing potential “national champions”2 according to their industrial experiences, technological and production capacity, as well as other factors. These “national champions” were also provided with special support such as financial

1

The average annual growth rate of automobile production in South Korea was 34% in the 1970s,

Source: Korean Auto Manufacturers Association, Statistical Reports (various years).

2

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support, tax reduction and priority for joint ventures with TNCs. The central government nominated three major carmakers (FAW, SAW, and Shanghai-VW) and three small carmakers (Beijing-Jeep, Tianjin-Charade, and Guangzhou-Peugeot) in 1988. This was later called the “Big Three and Small Three” strategy (Liu and Yeung, 2008). This strategy was not completely implemented for a number of reasons: for example, Guangzhou-Peugeot was shut down in 1997, and Beijing-Jeep was not economically viable because it only produced jeeps. Nevertheless, this strategy did provide the outline for a basic framework of the automobile production in China. Because the central government gave priority to these six carmakers, this consequently put them in a favourable position for approved assembly joint ventures with TNCs and in the process of industrial consolidation.

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Figure. 1. Automobile production output at major locations in China, 2000–2007.

(source: Liu and Yeung, 2008)

Learning from the experience of Japan and South Korea, the first official automotive industrial policy was enacted in 1994: “China Automotive Industry Policy”. In this policy the Chinese government began to encourage the carmakers to establish their own R&D centers and develop their R&D capability. Besides, this policy also emphasized the product localization3. Although the Chinese automobile industry registered rapid growth during the 1980s and 1990s, it did not really take off until the new millennium, especially after China entered the WTO in 2001. In order to qualify for entry to the WTO and to promote the development of Chinese automobile industry further, an updated industrial policy, the “Automotive Industry Development Policy of China”, was announced in 2004. The government encouraged the carmakers to

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research and develop the environment-friendly car and the new-energy car. In this policy the localization rate was not required, but the entry barriers of this industry were largely raised. Between 2000 and 2007 the average annual growth rate of motor vehicle production in China was 23.5%, almost double that in the 1990s (12.6 percent). In 2007 alone, the output of motor vehicles in China totaled 8.9 million units, five times as high as that in 2000 (figure 2). The growth rate of passenger car production is even more striking, rocketing skyhigh after China entered the WTO. The total output has increased by almost one million units in each year since 2002 (see figure 3), with the average annual growth rate of 34.3% (Liu and Yeung, 2008).

Figure. 2. Growth of motor vehicle production in China, 1991–2007.

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Figure. 3. Growth of passenger car production in China, 1991–2007. SUVs and crossovers are not included.

(source: Liu and Yeung, 2008)

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In the following sections the policy making of the Chinese automobile industry will be divided into several periods. The first period is from 1985 to 1994, the second period is from 1994 to 2004, followed by the period between 2004 and 2009, and the last one is from 2009 to present. Because the new industrial policy was just executed last year, the effects remain to be seen, therefore the policies of this period will not be the focus of this paper but it will be reviewed in the latter parts. Additionally, not all aspects covered by the automobile industrial policy will be analyzed in this paper. I will focus on FDI, technology transfer, and R&D of the policies.

3.2 Policy making of FDI in Chinese automobile industry

3.2.1 From 1985 to 1994

Due to the implementation of the “open door policy”4 in 1979, a huge number of car imports surged into China in mid-1980s. This triggered a high degree of concern from the Chinese government regarding the automobile industry. In order to accelerate the automobile domestic production and guide the industry development in the right direction, the central government issued the Notification of Automotive Industry Development Planning and Reformation of System in 1985. Shortly afterwards, the Chinese government pledged to develop the automobile industry to a pillar industry of national economy in the future. However during this period (1985-1994), the Chinese government only issued some notifications, guidelines and regulations regarding the automobile industry, which were not systematic.

Granting access to the domestic market in return for capital and technology is the basic bargaining strategy used by the Chinese government towards the automotive FDI, since the founding of early joint ventures in the 1980s. The aim of this strategy was to accelerate the development of the automobile industry, and at the same time

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avoiding ceding full control of the industry to the foreign TNCs. According to Lee (2007), the state retains a controlling share in many large auto firms, usually the government is the biggest shareholder of these firms, and the Chinese partners of joint ventures were mainly from state-owned enterprises (SOEs). Liu and Yeung(2008) state that compared with other developing countries, China has been able to impose greater control on inflows of FDI because of the magnitude of the Chinese market and the state-controlled political economy. Before 1994 the provincial governments had the rights to approve FDI-related projects with an investment ceiling of US $30 million in automobile industry. The central government did not have systematic and consistent industrial policies towards automobile-related FDI inflow until 1994, with only one exception, that the assembly-related FDI had to be in the form of a joint venture (Liu and Dicken, 2006).

3.2.2 From 1994 to 2004

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government took back the rights for approval of FDI-involved projects in car assembly and engine manufacturing from provincial governments, all these projects regardless of investment amount have to be approved by the central government. Apart from the requirement for approval for investment projects, the import of new car models in existing joint ventures also needed approval from the central government (People, 2004).

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Figure 4. Foreign direct investment by contract in the automobile industry in China, 1983－2003

1983 Beijing Jeep 1997 Shanghai—GM

1985 Shanghai—VW 1998 Guangzhou—Honda and Chengdu—Toyota 1990 FAW—VW 1999 Nanjing—Fiat

1992 Dongfeng—Citreon and Jinbei—GM 2000 Yueda—Kia

1993 Chang’an-Suzuki 2001 Tianjin—Toyota and Chang’an—Ford 1995 Nanjing-Iveco and Changhe—Suzuki 2002 Beijing—Hyundai

1996 Yaxing—Benz 2003 Dongfeng—Nissan

(sources: Wheelon Co Ltd, 2002; data on the assembly FDI in 2002 and 2003 refer to Beijing-Hyundai and Dongfeng-Nissan respectively, which are based on the news reports on these two joint ventures in China).

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the FDI in these six regions accounted for 77% of total FDI inflow into the Chinese automobile industry (Liu and Dicken, 2006).

Figure 5. Share of major cities in the total foreign direct investment into China's auto industry by 2002.

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Figure 6. Spatial concentration of the cumulative auto-related foreign direct investment (FDI) by contract in China.

Major auto FDI clustering regions (% of total)

Shanghai–Nanjing: 35% Beijing–Tianjin: 12% Changchun–Shenyang: 15% Wuhan Region: 5% Chongqing: 6% Pearl River Delta: 4%

(source: Wheelon Co Ltd, 2002)

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regulatory framework of the Chinese government and the existing geography of the Chinese automobile industry (Liu and Dicken, 2006).

The new assembly joint ventures permitted in the new millennium are mainly located in the coastal regions, for example Yangtze River and Pearl River deltas, and the coastal regions have emerged as the booming car market in China (Liu and Dicken, 2006). Actually even the assembly joint ventures headquartered in inland areas have begun to set up assembly plants in the coastal regions. By 2003 all of the world's leading automobile producers had invested in China and all of these investments took the form of joint ventures, as required by the automobile industrial policy of Chinese government.

3.2.3 From 2004 to 2009

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level of industry concentration. In assembly and engine-producing joint ventures the foreign equity could not exceed 50%, with the exception of cars or engines for export, this was one of the measures to encourage export in this industry. The regulations of localization rate and foreign currency balance were abolished (NDRC, 2004).

Ever since China officially opened its doors in the late 1970s the automobile industry has become an attractive sector for foreign investors. In the 21 years spanning the period from 1983 to 2004, the total number of joint ventures and automobile cooperatives (including components and parts) projects reached 1449 (Sadoi, 2008).

3.3 Policy making of technology transfer in Chinese automobile industry

3.3.1 Before 1985

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3.3.2 From 1985 to 1994

In 1985, the first “national guideline” concerning the automobile industry reaffirmed this strategy: assembly-related FDI had to be in the form of joint ventures. In 1988, the State Council made the decision to provide special support to three large carmakers (FAW, SAW, and Shanghai-VW) and three relatively small carmakers (Beijing-Jeep, Tianjin-Charade, and Guangzhou-Peugeot). This was called the “Big Three and Small Three” strategy. Because central government gave priority to these six carmakers, this consequently put them in a favourable position for approval of assembly joint ventures with TNCs. The central government made every effort to foster large domestic carmakers. It has not only given priority to nominated firms (e.g. Big Three and Small Three) by permission of their new assembly joint ventures with foreign TNCs, but has also encouraged these large firms to merge with smaller domestic companies in a process of industrial consolidation (Liu and Yeung, 2008). Officially, during 1980s and 1990s the central government did not approve the establishment of new assembly plants except the joint ventures between existing Chinese carmakers and foreign TNCs. This policy was premised on the hope that the Chinese firms could upgrade their technological capacity through “learning by doing” in joint ventures and develop into the “national champions” in automobile manufacture.

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made great efforts on the localization projects. The central and Shanghai government prioritized the raise of localization rates for the Santana project. This project began and a number of protective policies for local parts suppliers were developed, involving tax reductions and other measures (Sadoi, 2008).

3.3.3 From 1994 to 2004

In 1994, the central government presented its first official automobile industrial policy. The parts localization strategy was iterated, a new assembly joint venture was required to have a local content of at least 40% at the beginning and to increase this to 60% within three years. The localization rate of 40% was required in order to qualify for the tax exemption. The Chinese government enacted many regulations for joint ventures with foreign TNCs in order to speed up the technology transfer and upgrade R&D capabilities and productivity. For instance, joint ventures had to produce the car models from 1990s or later, they had to give priority to local components suppliers and have an internal R&D division (Sadoi, 2008). After this policy was announced the FDI on parts and components production increased substantially.

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effectively fulfilled the obligations of localization. For instance, VW provided its Chinese partners with the necessary technical documents of parts making, and actively promoted the business links between German and Chinese suppliers, though it did not invest in parts-manufacture in China itself.

As a result of the joint efforts by the enterprises and government, a high localization rate has been achieved in the carmakers in China since the 1990s. Among all the car-assembly regions of China, the most striking localization process of parts was in Shanghai region. Taking Santana project for example, the local content of Santana increased quickly to 85% by 1994 and 92.9% by 1997 (figure 7). In this period, the amount of local suppliers to Shanghai-VW increased to about 300, most of whom were small and medium-sized enterprises (SMEs) who were flexible and adaptive. Almost two thirds of its suppliers are located in Shanghai, which provided half of Shanghai-VW’s outsourced components and parts in terms of value. In the early 1990s, 26% of Shanghai-VW outsourced parts were from Shanghai firms, the share had risen to around 50% by 2002 (Liu and Dicken, 2006).

Figure 7. Local content percentage of the Santana model built by Shanghai–VW.

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Sadoi (2008) claims that in the process of localization, technical training of the supplying enterprises is a very important part, as training can help improve the local parts suppliers’ technological capabilities. The evidence shows that imposing localization requirements on foreign TNCs had to be met with the commensurate capability development in the local suppliers to ensure fast absorption of technology from foreign enterprises. Therefore many employees of local suppliers are required to take part in the training programmes held by their foreign partners, for example, training in the technical colleges in the United States, Europe, or Japan. Guangzhou Honda is a good example of this. When Guangzhou-Peugeot was closed after suffering massive losses, Honda took over its plant and most of its employees in 1998. Honda also set up a new engine plant with Dongfeng nearby. The localization regulation forced Honda to seek out and enhance the capabilities of its parts suppliers. Honda’s “mother plants” in Japan provided guidance to both the assembly plant and engine factory, and nearly 250 employees from Guangzhou took part in the training at the mother plants. Honda’s vehicles soon became the pacesetters in China (Noble, Ravenhil, and Doner, 2005).

After many years of the inflow of FDI into the Chinese automobile industry , by 2003 all the big names of world’s automobile producers had set up production facilities in China in various forms. Therefore, in varying degrees, the Chinese automobile industry has been becoming integrated into GPNs of TNCs. The Chinese government made a great difference to this integration (Liu and Dicken, 2006). Sadoi (2008) indicates that “the majority of engine parts and metal processing parts were locally available in China in 2005, this was largely due to the technology from TNCs as a joint venture partner” (p.161).

3.3.4 From 2004 to 2009

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environment-friendly car and new-energy car. Toyota Motors, the world’s biggest producer of gasoline-electric hybrid cars, worked with FAW to assemble its hybrid cars in China in 2005. General Motors Corporation announced a plan for developing and commercializing fuel-cell and hyrid vehicles in China, with its partner Shanghai Automotive Industry Corporation (SAIC) (Zhao, 2006). The technology transfer regulation existed in the draft version of the industrial policy which enacted by NDRC in 2003. It proposed that a foreign firm owning more than 10% in a joint venture must transfer R&D, sales and production know-how to its Chinese partner. However when the NDRC finally released the policy in 2004, the technology transfer provision was dropped. Moreover, there was no localization rate requirement for the carmakers in this policy (Noble, Ravenhil, and Doner, 2005).

To sum up, in the localization process of the Chinese automobile industry, the government policy requiring joint venture and technology transfer conditions played an important role. The Chinese automotive parts and engineering suppliers were the big beneficiaries of localization and government-led technology transfer strategies. The successful implementation of the industrial policy helped automobile firms fulfill localization at a rapid rate in China. The technological capabilities of the local suppliers upgraded to a great degree.

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3.4 Policy making of R&D in Chinese automobile industry

3.4.1 From 1985 to 1994

In the 1980s the trucks in China were mainly produced by domestic carmakers, but the R&D capability in the passenger car sector was extremely weak, and the passenger car production was dominated by the joint ventures with foreign TNCs. The SOEs put little effort in R&D and followed long platform upgrade cycles. The R&D spending in these firms was less than 1% of the revenue, much lower than foreign TNCs’ R&D investments. The upgrade cycles were usually longer than 20 years (Zhao, Anand, and Mitchell, 2005).

The earliest R&D activities backed by the Chinese government can be seen in the localization process of the Santana project. In 1988, the Shanghai government founded the Community of Localization of Santana, which included 140 suppliers, financial institutions, and R&D institutes. The members of this community enjoyed the favourable financial treatment and could get access to updated information on international and domestic parts production (Liu and Dicken, 2006).

3.4.2 From 1994 to 2004

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competitive. This industrial policy provided three strategic guidelines for the development of local R&D capabilities. Firstly, carmakers should include 5-10% of total reinvestment for expanding or developing their technical centers. Secondly, the R&D spending should reach at least 2-3% of sales within 5 to 10 years. Thirdly, key parts suppliers should apply 10-20% of their reinvestment to establish R&D facilities and technological centers. However, these guidelines were very hard to enforce, especially towards those large SOEs due to the soft constraint that will be elaborated in section 4.2. The government provided taxation and financial support for joint R&D projects (People, 2004).

Many years after the localization process was launched in the Chinese automobile industry, the parts localization and capability building of the local suppliers achieved substantial success, whereas the large domestic carmakers remained weak in developing their own technological capacity and remain reliant on foreign joint venture partners for advanced automobile technologies. For this less than ideal outcome, Liu and Tylecote (2009) offer two main reasons. Firstly, the 1994 Automobile Industry Policy erected entry barriers such as strict capacity and assets requirements for entrants, in order to consolidate the highly fragmented automobile industry to build a group of globally competitive large corporations, investment was only formally encouraged in “Big Three and Small Three”. This favouritism curbed the domestic competition and firms’ motivation to develop internal technological capacity. Secondly, when the large SOEs relied on the technology spillovers passively from foreign partners, little improvement was made in their innovation capabilities. The foreign firms essentially chose what would be transferred and how, not necessarily teaching their Chinese partners something significant. Such flaws in the industrial policy failed to foster capability development and innovation among the SOEs.

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diffused and transferred, it is likely that their partners will become their powerful competitors in the international market. Usually the vehicles produced by the foreign TNCs in China were the obsolete models from their home countries and they tended to postpone the upgrade of the products in their join ventures, especially in the 1980s and the 1990s. For example, Shanghai-VW began with the import of a small outdated assembly line from Germany, and for 13 years the production remained limited to the single, aging Santana model. Another example is Peugeot who was unwilling to replace the old car model in its joint venture in Guangzhou and eventually pulled out after suffering massive losses. This situation changed to a certain extent later. Due to the intense competition in the Chinese auto market in the late 1990s, the foreign TNCs were driven to accelerate the technology transfer and products upgrade in their joint ventures. Later on, more and more car models became available on the Chinese auto market.

3.4.3 From 2004 to 2009

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requirement was eliminated. Perhaps the Chinese government considered that this target was unattainable by 2010.

The Chinese government initiated an R&D programme on electric-driven vehicles in new millennium. The central government provided RMB 880 million (US $110 million) of support, and the Chinese Academy of Science invested US $ 12 million in a three-year programme called “proton exchange membrane fuel-cell development” in 2002 (Zhao, 2006). It is a huge R&D investment for the Chinese government though this amount is not so large compared with the investment in R&D on electric vehicles of industrialized countries. Apart from using these technologies to solve energy and environmental challenges resulting from increasing car population, the Chinese government expects to leapfrog the auto technology and strengthen the capacity of the Chinese automobile industry to compete in the international market.

Liu and Yeung (2008) contend that although the Chinese government strongly encourages the development of independent R&D capability in the automobile industry, it continues to support and protect the large domestic carmakers. The technology development of Chinese “national champions” is still remains at a low level in recent years which several examples can attest. Apart from the joint ventures with Toyota and VW, FAW has three other car assembly firms, FAW Hainan, FAW Car Co. Ltd, and Tianjin-FAW, that mainly depend on imported models in vehicle production. And more than 20 years after its first joint venture with VW, SAIC has no self-developed/owned car models except for ROEWE, which was introduced in the Chinese market in 2007. Even this car model is actually a modified version of Rover 25 and 75 bought from MGRover. Dongfeng is the extreme example, it closed its technological center for car development in 2002 and consequently effectively abandoned the effort to design its own car models.

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smaller local assemblers (e.g., Chery, Geely, and BYD) have survived the biased industrial policy of the central government as well as the market competition to become the real national champions, with their own capabilities for model development. Chery is an example of this. Chery was established in 1997 and was not supported by the central government at the beginning. It started investing heavily in R&D and technical training after winning the first buckle of gold in the Chinese market. Chery spends 10-15% of its revenue on R&D and from 2000 to 2005 its research institute expanded to 11 departments with 800 staff. In order to foster its own development capacity, Chery jointly worked with some of the most capable firms, its cooperation with AVL in Austria (the world’s fourth engine designer) is a good example of this. Chery was responsible for addressing ideas and making standards while AVL specializes in blueprints and designs. More than 100 engineers of Chery went to AVL to attend training, another 900 engineers went to other countries for training during the past few years. The strategies of learning by doing and learning by training enabled Chery to develop the first China-made engine with its own intellectual property (Liu and Tylecote, 2009).

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There are some much deeper reasons for the unsuccessful outcome in the designated “national champions”. Guangzhou-Peugeot was shut down in 1997, and Beijing-jeep was not in a good economic shape since it only produced jeeps. Early automotive joint ventures often tumbled on the same problems: the legacies of Stalinist socialism5, failing to set up the rule of law, and the weakness of the existing management (Noble, Ravenhil, and Doner, 2005). Sometimes it is difficult to transfer capabilities to the Chinese carmakers because the recipient firms usually lack the absorptive capacity needed to understand and incorporate many skills of the source firms. Zhao, Anand, and Mitchell (2005) indicated that the limits in absorptive capacity occurred most strongly from organizational limits of the joint ventures. A corporate culture of hierarchy and limited responsiveness which developed during many years in the planned economy of China often continues to dominate firms throughout the large corporations. Several researchers believed that the Chinese enterprises needed to unlearn the old mentalities and be more market oriented in order to attain advanced R&D capabilities. They noticed that technical education helped them learn about the new capabilities, but those organizations dominated by old cultures curb the ability to incorporate new skills .

Liu and Tylecote (2009) suggest that the large SOEs, especially the “Big Three and Small Three”, had problematic corporate governance systems6. The government parachuted its officials into the firms who did not necessarily have the industrial expertise, and they were shifted out not long after. For example, 4 CEOs ruled SAIC sequentially since 1978, three of them were shifted from senior positions in Shanghai government, and two remained officials after they left SAIC. The executives came to their positions with assigned tasks, either to enhance capacity or to increase profit, both are quantitative, visible and easy to measure. Since they did not have much time, nor did they have sufficient expertise, it was sensible for them to select bundled

5

The socialism related to Joseph Stalin or his times.

6

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technologies which were from TNCs partners—it is easy to understand, readily available and quick in effect. On the other hand, it is recognized that independently developing a new car model needs 4-5 years, the R&D investment is approximately US $1-2 billion and it has great market risks. If the new products are not accepted by the consumers, the company will suffer large losses even bankruptcy. In this situation, the large SOEs therefore lost the incentives for R&D and relied on technologies from their foreign partners.

In contrast, Sadoi (2008) indicates that most presidents of supplier firms in China have had long careers in the engineering field, which has been helpful in driving the upgrading of human resource management systems. Automobile production is a knowledge-intensive activity, the leaders of these Chinese supplying firms created the environments to motivate workers to enhance productivity and technological capacity. Although company training is not very developed in most of the SMEs, the merit system introduced in them has encouraged the employees to improve their technological capabilities and knowledge by attending the technical colleges. Those new emerging local carmakers were not supported and protected by the Chinese government at the beginning, and yet over time, many of these firms showed impressive flexibility, ingenuity, and growth. Some of them are private firms, such as BYD and Geely which have favourable corporate governance systems, because the presidents or CEOs manage their own companies, and they have to be responsible to the shareholders. These firms usually have long-term planning for future development, and they did not have mature products introduced from the foreign TNCs which forced them to work hard on R&D and develop their own car models. Unlike those protected large SOEs, these independent brands are market-oriented, flexible, and proactively learning the new knowledge and technology.

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emerging local carmakers and local parts suppliers create new governance systems and by bringing together skilled individuals, are more able to absorb new knowledge.

4 Comparison and analysis

4.1 Comparison of success factors and industrial policy in China

In this chapter, a comparison will be made between the success factors presented in chapter 2 and the Chinese automobile industrial policy of chapter 3, to find out whether the Chinese government used the relevant theories or learned from the successful experience of other late industrialization countries, and whether the industrial policies of China were effective or not. The goals of automobile industrial policies and the current situation will also be demonstrated. Then an insightful analysis will be conducted on the industrial policies.

4.1.1 On FDI

The Chinese automobile industrial policies do not contain explicit objectives and measures regarding FDI promotion. The Chinese government did not even make a great effort to promote FDI in the automobile industry, because the case of China is unique in many aspects. TNCs in many cases are able to play off one country against another to attain the best deal. However in China the automobile industry is universally considered as a must-invest situation, hence the unique bargaining position of the Chinese government has enabled it to play off one TNC against another.

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bargaining power remains strong (Liu and Dicken, 2006). To sum up, the FDI promotion success factors were not followed by the Chinese government, however the government succeeded in introducing FDI into the Chinese automobile industry.

4.1.2 On Technology transfer

UNIDO (2009) stresses the necessity of new forms of industrial governance systems to trigger a process of innovation and upgrading of capabilities in a domestic industry. However the new forms of governance systems are missing in the Chinese automobile industry as a whole and in many domestic automotive firms.

Ernst and Kim (2002) claim that GPNs have acted as a catalyst for the diffusion of international knowledge, providing new opportunities for the local capability formation in the late industrialization countries. The Chinese government made great efforts on the localization in automobile industry, the industry has been becoming integrated into GPNs of TNCs. In order to fulfill the localization regulations of Chinese government, the foreign TNCs need to transfer the technical and managerial knowledge to the local suppliers, and the suppliers constantly upgraded their absorptive capability in order to keep staying with the TNCs. It’s also necessary to upgrade the suppliers’ technical and managerial skills, so that they can meet the flagships’ technical specifications.

The role of government in late industrialization: A historical analysis on the Chinese automobile industry