China's New Price Controls: Well, So Much For Competition

Beijing sets minimum prices to stanch deflation

Shifeng Group, a northern Chinese manufacturer of farm vehicles for the huge rural sector, had high hopes after beating out rivals and becoming the largest producer in China. Its goal was to sell 600,000 vehicles and reach $300 million in sales this year. But regulators in Beijing had other plans. They slapped state-owned Shifeng with a $110,000 fine and forced it to scale back production by 50%. The crime: The efficient producer was selling its products too cheaply--about $30 cheaper than its competitor's $700 price.

It's not just farm equipment. Beijing officials worried about the Chinese economy are now setting minimum prices in 21 industries, ranging from electronic appliances to sugar processing. The aim is to stop the price wars that threaten to destabilize Chinese industry, particularly state-owned enterprises.

SMUGGLED GOODS. The policy shift smacks of communist-era controls. Not long ago, China's leaders were praising competition as a means of weeding out the most inefficient companies. But now they claim that by tinkering with prices and blunting competition, they can keep unemployment from rising and stave off political problems. "Many state enterprises are losing money," says Men Xiaowei, an official at the State Economic & Trade Commission. "If everybody continues selling their products so cheaply, that will mean a major loss of state capital" and lower tax revenues for the government.

Deflation coupled with slower economic growth is a growing problem. October saw a 2.9% drop in prices, the 13th straight month of decline. Cheap imports from the rest of Asia are washing up in China's markets, adding to deflationary pressures. And while Beijing is trying to beat back rampant smugglers, such low-price goods are adding to price pressure. Economic growth, forecast at 8% this year, is unlikely to meet that target--meaning that the Chinese economy will fall short of its job-creation goals. Unsold inventories are adding to the woes. Ailing state enterprises keep cranking out products they can't really sell. As a result, some $500 billion worth of goods, totaling 55% of gross domestic product, is piling up in warehouses.

China's TV manufacturers are the most visible example. With current sales just half of capacity, they are struggling through a particularly brutal price war. In recent years, TV makers have ramped up production in hopes of grabbing export markets in the region. But with the Asian economic crisis, China now finds itself with far too many TV production lines. Industry leader Sichuan Changhong Electronics Co., for one, welcomes efforts to halt price-cutting. It has just reported its suggested prices to the local price bureau of the State Economic & Trade Commission, which will soon fix price minimums. Gong Yu, director of Changhong Electronics' pricing department, complains that competitors are selling their 35-inch color TVs for around $500, up to 40% less than Changhong's. "It's a vicious competition and could trigger a financial crisis for China," he says. "Everyone is losing money, and many enterprises won't be able to pay off their loans to banks."

China's sugar industry likewise finds itself with mountains of oversupply. Long battered by smuggled goods and production costs that are too high, the industry will set minimum prices in late November. Sugar costs $360 per ton to process in China, while wholesale prices have slid below $320. Estimated losses for the industry hit $240 million last year, says one official with Guangxi Sugar, Tobacco & Wine Corp. Now, with the recent bankruptcy of one of China's largest producers, Acheng Sugar Mill, which went under with debts of $85 million, the price policy has taken on a particular urgency. "The whole industry has been dumping its products," says the Guangxi official.

China's car industry is in almost as bad shape. With more than 100 producers scattered across the country, China has capacity estimated to be twice this year's output of 1.6 million vehicles. Growth in auto sales has fallen from what in recent years often exceeded 50% annually to an estimated 4% for this year, say industry analysts. And rampant smuggling is believed to have brought in more than 100,000 cars last year. The car glut touched off a price war earlier this year, with China's foreign automobile manufacturers dropping sticker prices by as much as 20%. "That's crazy. We couldn't continue like that," says the head of the Beijing office of one Western auto maker in China. Yet companies like General Motors Corp. are still plunging ahead with billion-dollar investments, despite cars being more expensive now in China than in the rest of the region.

BARTER. In response to the price wars, the State Economic & Trade Commission (SETC) announced in late October that China's top 13 auto manufacturers would now follow Ministry-set minimum prices. Despite concerns about Beijing bureaucrats taking over price policy, most manufacturers seem pleased with the props. "If everyone cuts their prices, everyone loses," says Zhang Suixin, chief representative of the Beijing office of Volkswagen, which dominates China's car market through a Shanghai-based joint venture. Regardless of whether they agree, car manufacturers are legally bound to follow the new rules.

Even so, Beijing may have some trouble making the rules stick. Many carmakers are now so strapped that they end up paying their suppliers in cars rather than cash--using barter--which is estimated to total some 20% to 30% of business today. That means even less control over final prices, as cash-hungry suppliers unload vehicles cheaply into the already saturated market.

And lack of unanimity among Beijing policymakers may allow some cracks in the new directives. While the SETC fully backs price controls, officials at the State Development & Planning Commission (SDPC) are strongLy opposed, saying that controls are anticompetitive. "The outcome of price controls is to protect the backward and frustrate the advanced," a vice-director at the SDPC was quoted as saying in the official China Daily.

Such backroom discord among Chinese policymakers is sure to confuse foreign investors and Chinese businesses alike. But until Chinese policymakers can step up growth and whittle down excess capacity, the deflationary spiral will continue--and so will the meddling.