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Though the bicycle and animal-drawn cart remain widely popular in China, automobiles have made steady--if slow--inroads over the past 20 years. In 1978 there was not a single privately owned motor vehicle in China. Today there are close to 3 million. Twelve years ago, China produced 5,000 passenger cars a year. By last year, total output had reached 389,200, a 78-fold increase (see Table 1). Moreover, in addition to the 1.54 million motor vehicles (including passenger cars, buses, trucks, and off-road vehicles) produced in 1996, the country made and sold 2.4 million farm transportation vehicles.

Despite such impressive growth, China's auto industry faces numerous roadblocks. The remnants of a centrally planned economy--reflected in central government policymaking--combined with expanding market forces and the resulting decentralization of decisionmaking, have made it difficult for auto makers to respond to market demands. As a result, automobile production over the past three years has slowed considerably--average annual growth rates dropped from 37 percent between 1990-93 to 4.7 percent during 1993-96. The high growth rate of passenger-car investment in the mid-1980s and early 1990s has created a problem of overcapacity in the industry. By the end of 1997, the combined production capacity of the leading car manufacturers will likely reach 900,000 units. Total output for 1997, though, is estimated at no more than 450,000 units, or roughly half of capacity. Such disappointing figures have prompted the central government to reassess its ambitious growth plan for the sector, and promise to force some difficult structural changes upon the industry in coming years.

Who's who in China's auto industry

The leading PRC automobile manufacturers, in terms of both production capacity and the types of vehicle produced, are referred to as the "Big Seven." These are, in addition to FAW and DMC, Beijing Automotive Industry Group Corp. (BAIC), China National Heavy-duty Truck Corp. (CNHTC), Shanghai Automotive Industry Group Corp. (SAIC), Tianjin Automotive Industry Group Corp. (TAIC), and Yuejin Automobile Group Corp. (YAGC). In the passenger-car market, eight firms--six of which are Sino-foreign joint ventures--dominate. These assembly facilities are referred to as the "Big Three" (DMC, FAW, and SAIC), the "Little Three" (BAIC, Guangzhou Peugeot, and TAIC), and the "Two Minis" (Chang An Automobile Co., Ltd. and Guizhou Aviation Industry Corp.) (see Table 2).

Supervising the country's automobile industry is the central government's Ministry of Machine-Building Industry (MMI). MMI, through its Department of Automotive Industry, in general is responsible for industry-related investment, project approval, production planning, and overall policy decisions. Except for CNHTC, DMC, and FAW, which are under the direct authority of the State Planning Commission (SPC), all of China's car makers are under direct control of a ministry or a provincial or municipal government. BAIC, SAIC, and TAIC, for example, are under jurisdictions of the respective municipalities of Beijing, Shanghai, and Tianjin. The Guangzhou city government oversees Guangzhou-Peugeot. Chang An and Guizhou are, respectively, under the control of the ministerial-level entities China North Industries Corp. (NORINCO), and China National Aviation Industry Corp. (AVIC).

Foreigners in the fray

Foreign investment generally has helped the PRC auto sector upgrade its technology and efficiency levels. For example, Shanghai-Volkswagen Co. Ltd., which was established in 1985 and holds a 52 percent share of the domestic sedan market with its 1.8-liter Santana, has recently decided to expand its technology center by investing an additional $98 million in new model development. Meanwhile, SAIC recently teamed up with General Motors Corp. in a $1.5 billion mid-size sedan project and a $50 million technical center. The Two Minis have both recently announced joint-venture deals with Japanese technology providers to improve scale economies in production. Chang An is working with Suzuki Motors to boost production of the 0.8-liter Alto, and Guizhou has partnered with Fuji Heavy Industries Ltd. to expand production of the 0.54-liter Skylark.

Other foreign firms have helped diversify China's auto market. A joint v enture between Ford Motor Co. and Jiang-ling Motors Corp. in Nanchang, Jiangxi Province will introduce the Transit van in December of this year. Ford has recently announced its intention to increase its 20 percent equity stake in Jiangling by another 10 percent. Ford has also set up four auto component joint ventures. Other van or light-bus joint ventures include Fuzhou-China Motors Corp. (China Motors is a Taiwan-based affiliate of Japan's Mitsubishi Motors Corp.), Jinbei-Hiace, Nanjing-Iveco (a joint venture with Iveco, a unit of Italy's Fiat S.p.A.), and Sanjiang-Renault. In addition, Nissan Motor Co. has a 5 percent equity interest in the Zhengzhou-Nissan Automobile Co. to produce Nissan pick-up trucks.

Chrysler Corp.'s joint venture, Beijing Jeep Corp., has been turning out its multi-purpose vehicles since the mid-1980s and now has an annual capacity of 100,000 Jeep Cherokees and lower-end Beijing Jeeps. Although the first vehicle joint venture in China, Beijing Jeep remains short of the minimum annual production capacity (150,000) the central government requires before a company can introduce a new vehicle model. Given the overcapacity in the Chinese sedan market, though, the central government has reportedly advised Beijing Jeep to continue to concentrate on production of sport utility and light vehicles.

Success in
parts and components

The Asia Strategic Investment Corp. (ASIMCO), a Beijing-based US investment company, also has contributed significantly to the Chinese auto-parts industry. Founded in 1993, ASIMCO has raised $250 million from pension funds, insurance companies, and private investors in the United States, Europe, and the Middle East to fund 13 Chinese auto-parts factories. With an average equity ownership of 58.5 percent, the ASIMCO group now produces such components as brake systems, compressors, diesel nozzles and injectors, friction materials, fuel pumps, gears, horns, ignition coils, jacks, motorcycle wheels and gears, motors, oil seals, piston rings, precision castings, rubber seals, and valves.

Productivity levels in the PRC auto-parts industry, in particular, have b enefited from foreign investment. The Tianjin Wix Filter Corp., a joint venture between Tianjin Automotive Filter Factory and Dana of the United States, is a case in point. In 1991, the joint venture's first year of operation, the number of oil filters produced per employee increased by 74 percent over the preceding year. By the end of 1995, with 200 fewer employees and a shorter work week, productivity had increased by 600 percent, according to Kuang-Ming Lin, president of Dana China.

Gauging demand

Much to auto makers' dismay, however, the dramatic increase in domestic production capacity was not matched by growth in demand among individual consumers. China's passenger-car market is largely an "institutional" market--buyers are government institutions, State-owned companies, and taxi fleets rather than individuals. In rural areas, according to China Business Update--Automotive, in 1996 there was one farm vehicle for every 100 residents; in urban areas, there was one auto for every 400 residents. And despite the fact that the number of privately owned automobiles in China has increased on average by 27 percent annually over the past 10 years, the vast majority of these are trucks, buses, and cargo vans (farm vehicles are not included in this category). Ironically, the small consumer car market in China hinders further efforts to lower sticker prices by expanding production scales. Some experts believe that the rise of a family car in China will not begin until roughly 2005, when the average per capita annual household income is expected to reach RMB60,000 ($7,230). Until then, the typical Chinese family is unlikely to be able to afford a car.

Even if high car prices do not deter individual buyers, heavy auto-related taxes and fees put cars beyond the reach of many potential car owners. Taxes that apply nationwide to the purchase of a new car are a 5 percent consumption tax, a 17 percent value-added tax, and a 10 percent vehicle-purchase tax. But certain regions impose on car buyers more than 20 different taxes and fees, amounting to more than one-third of the retail price of a car, according to recent surveys by PRC government agencies. In some provinces and cities, car buyers are even assessed taxes that go toward family planning and local education programs. The dearth of expressways, highways, parking facilities, and advanced traffic contro l systems further discourages automobile use in China's major cities.

In light of such circumstances, car maker Shanghai-Volkswagen developed and expanded the Santana model's production capacity to 300,000 units to target the institutional market. Because it started production three years earlier than the rest of the sedan makers, the company secured a sizable consumer base ahead of its competitors. As a result, Chinese partner SAIC has been the least affected by the problem of overcapacity. SAIC's decision to join with General Motors to produce the high-end 3.0-liter Buick Regal is similarly aimed at cementing its strength in the domestic institutional market for luxury cars, as well as competing with imports.

Crafting an
Industrial policy

Since 1994, all new auto projects have faced the stiffer localization requirements contained in the State Council's automotive industrial policy (AIP). Under the AIP, auto ventures must start production with 40 percent local content to qualify for 37.5 percent import duties on parts. Auto makers that reach loca l content levels of 60 or 80 percent may import parts at Customs rates of 30 percent and 20 percent, respectively. Leading companies have already reached a localization level of more than 80 percent.

The AIP, aimed at transforming the auto sector into a "pillar industry" of the PRC economy, epitomizes the government's prominent role in the sector. Though the industry's decentralization and growing protectionism on the part of the local governments have made it difficult for Beijing to implement the policy, the basic goals--consolidating production and directing foreign investment--remain in place for now. In an example of the sector's lack of economies of scale, China had 124 automobile assemblers in 1994 with an annual output of just over 10,000 units per assembler. The AIP thus lays out a two-stage framework to streamline the vehicle-manufacturing sector. During the first stage, from 1996-2000, the State intends to support reorganization efforts that will lead to the evolution of 2-3 large national enterprise groups, 6-7 key vehicle manufacturers, and 8-10 internationally competitive motorcycle manufacturers (see p.19). Other first-stage goals include:

• Motor vehicle production of 3 million units, of which 1.5 million will be passenger cars (in 1996, the targets were reduced to 2.7 million and 1.3 million, respectively);

• Annual capacity of 300,000-500,000 units in each of the 2-3 large enterpris e groups;

• Consolidation of the present 3,000 parts and components manufacturers into 300 companies to serve as major domestic suppliers (and product developers) for original equipment manufacturers (OEMs).

During the second stage, from 2000-2010, Beijing will support the reorganization efforts for the formation of 3-4 large, internationally competitive enterprise groups. Other goals for 2010 include:

• Total vehicle production capacity of 6 million units, of which 4 million will be passenger cars;

• Annual production capacity of more than 1 million units from each of the 3-4 automotive conglomerates;

• Formation of 5-10 internationally competitive components groups, which will form a supplier base for the OEMs, the after-sales market (service and parts replacements), and the export market.

The AIP also calls for safety, pollution-control, and energy-saving regulations for automotive products, and "gradual" implementation of the current international automobile safety and environmental approval standards.

Notably, auto parts manufacturing receives significant attention in the AIP, likely because the government realized that this subsector was becoming unable to meet the demands of vehicle assemblers. The policy lists 60 auto parts and components, on the basis of technology level and suitability for mass production, for preferential development during the Ninth Five-Ye ar Plan (1996-2000) period. The listed parts are divided into three groups: Groups I and II consist of the 25 key auto parts and components specific to the passenger-car industry; Group III consists of parts and components that have long been produced domestically but that cannot yet be manufactured on a mass scale. For these 60 parts, the government will contribute funds and encourage foreign participation in their development.

For each of the three high-tech components in Group I--engine-management systems (for gasoline engines), anti-lock braking systems, and safety air bags--one foreign partner is supposed to be chosen to work with a consortium of Chinese companies for development of domestic production facilities. For example, Bosch has signed an agreement with China United Auto Electronics Co., Ltd., a consortium of 15 Chinese auto companies based in the Pudong New Area in Shanghai, to form a 50-50 joint venture to produce engine management systems. For items in Group II, which include filters, pistons and piston rings, radiators, shock absorbers, and steering systems; and in Group III, which include carburetors, distributors, mufflers, seating, and spark plugs, the government intends to support 3-5 leading domestic manufacturers to reach its goal of about 300 large parts suppliers by the end of the century.

The AIP and
foreign firms

In an effort to prevent domination by any given foreign manufacturer, the AIP prohibits a foreign vehicle manufacturer from owning more than two joint ventures of the same vehicle type. For example, Volkswagen, with two existing sedan joint ventures in China, is not permitted to establish a third sedan venture. The AIP also stipulates that a foreign partner in a vehicle or engine joint venture can hold no more than a 50 percent equity share. The AIP requirement that all new assembly ventures begin with 40 percent local content is another example of the policy's goal of improving overall PRC product development capability.

By contrast, foreign investors in the parts industry in general are not limited to a certain percentage of equity ownership, though there are exceptions. Parts manufacturers may even establish wholly owned ventures, such as AlliedSignal's turbocharger plant in Shanghai and Delphi 's $50 million steering systems plant, also in Shanghai. Foreign partners in ventures producing high-technology anti-lock braking systems, engine-management systems, and safety air bags, however, may not hold more than 50 percent equity.

Some of the AIP provisions--local- content requirements, preferential treatment for domestic firms, and the restriction on foreign investment levels--are inconsistent with World Trade Organization (WTO) principles, and have received criticism from some foreign firms. Though China considers its auto sector an "infant industry," which would make it eligible for longer phase-in periods for certain WTO regulations, the slow negotiations for PRC entry into the WTO have left many foreign auto industry firms in limbo. Late September negotiations between US and PRC negotiators over the content of China's WTO accession protocol, according to official government reports, failed to resolve major issues of relevance to the auto sector.

Humbled ambitions

The AIP's goal of establishing nationwide an efficient auto industry has also been thwarted by regional protectionism. It is a common practice, for instance, for a provincial government to protect favored automobile assembly operations located in its province, either by giving local tax breaks for locally procured goods or restricting the use of vehicles made in other provinces (see p.10). SPC issued an administrative order last year mandating that local governments rescind all restrictive measures on the use of affordable economy models. But many of these restrictive regulations remain in force. Beijing municipality, for example, continues to limit the use of TAIC's Charade, 1-liter minivans, and low-end Beijing Jeeps on the city's downtown streets to every other day. Taxis, however, are excluded from the rules.

Though high tariffs on imported cars have allowed Beijing to achieve its goal of expanded domestic production, the tariffs have also contributed to the inflow of illegal passenger cars, estimated at 40,000 a year. Despite this pervasive smuggling, and the country's efforts to join the WTO, the central leadership justifies the tariffs on the grounds that the auto sector is an infant industry. China reduced its import tax on automobiles as of October 1, 1997, but only slightly: import taxes on passenger cars went from 100-120 percent to 80-100 percent, depending on the size of engine displacement.

In search of
a family car

Thus, the answer to the question, "Is there a family car in China?" can be found in the 10 million farm vehicles now on the road. These vehicles, which are diesel-powered and travel at low speeds--typically no more than 50 km per hour--are owned mostly by families in China's rural areas. Motor vehicle ownership in the countryside averages one for every 20-25 families.

The rise of these inexpensive farm vehicles highlights the strength of market forces compared to that of central government support. While heavy government investment helped build the country's passenger-car subsector, with central planners pushing for expansion of passenger-car production capacity, farm vehicle projects have involved little State funding, and have taken their cues largely from the market. Moreover, a sedan in China costs at least RMB100,000 ($12,195) including all taxes and fees, while a farm vehicle can sell for as low as RMB6,000 ($722). Further, farm vehicle purchases incur much lower t axes than automobiles--and run on government-subsidized fuel. Not surprisingly, 80 percent of the passenger cars produced in the country are bought on credit by fleet companies and government institutions, but 99 percent of the farm vehicles are purchased with cash by individuals.

The manufacturers of farm vehicles target rural individual consumers. Current freight transportation needs in rural areas are estimated by the government at roughly 20 billion tons a year, with an annual growth rate of 5-10 percent. Such needs are presently met through a combination of transportation vehicles: 730,000 automobiles, 10 million motorcycles, 10 million tractors, 10 million farm vehicles, and 70 million ''rickshaws'' and animal-drawn carts. Despite the slowdown of the growth rate of farm vehicles last year, experts believe that demand for these inexpensive farm vehicles--in the form of trucks, pick-ups, vans, and sedans--will steadily increase to 3.5 million units a year by the turn of this century and 5.5 million units by 2010.

As the market grows, China's farm-vehicle and passenger-car industries are destined eventually to merge into a single motor-vehicle industry. The manufacturing costs of pick-ups and sedans should drop significantly as production volumes rise, eventually making retail prices affordable. At the same time, farm vehicle producers, especially the largest manufacturers, will improve and upgrade their products and move into pick-ups and sedans, either independently or by teaming up with automobile manufacturers.

In fact, automobile and farm-vehicle manufacturers are already joining forces. The BUAMMC-Futian Vehicle Corp. (Futian), the country's largest four-wheel farm-vehicle manufacturer, was formed from the merger of Beijing United Automobile & Motorcycle Manufacturing Co., a leading light vehicle producer, and Zhucheng Vehicle Plant, a small farm-vehicle manufacturer in Zhucheng, Shandong Province. In 1994, the first year of the merger, the company produced 4,000 "Beijing"-brand four-wheel farm vehicles. By 1995 Futian had become the ninth-largest four-wheel farm-vehicle producer in the country, turning out 9,680 units. Last year the company expanded into a shareholding corporation by combining the resources of about 100 companies around the country. The new corporation became the country's top four-wheel farm-vehicle manufacturer in 1996, with output of 26,313. Futian's goal is 55,000 for 1997, according to company president Wang Jinyu. The company's goal for the year 2000 is 450,000 units.

Striking a Balance

For the foreseeable future, however, the family car in China will have to be able to function both for business and for personal use. It is safe to predict that on the road to motorization there will be a range of family cars in China. Any model made in China, whether by a Chinese or a joint-venture company, is unlikely to earn the "family car" distinction if it is out of reach of the 200 million rural families. To succeed in China, then, foreign automotive companies should be prepared for some stiff competition down the road.