China - Industrial organization and efficiency case study : the automotive sector

Report No. 121 34-CHA China Industrial Organization and Efficiency Case Study: The Automotive Sector December 31, 1993 industry and Energy Operations Division China and Mongolia Department East Asia and Pacific Regional Office FOR OFFICIAL USE ONLY MICROGRAPHICS Report No: 12134 CN Type! SEC Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization  CURRENCY EQUIVALENTS Curretcy Unit = Yuan (Y) November 30, 1990 December 30, 1993 $1.00 = Y 5.22 $1.00 = Y 5.80 Y 1.00 = $0.19 Y 1.00 = $0.17 FISCAL Y9EAR January 1 - December 31 WEIGHTS AND MEASURS Metric System ABBREVIATIONS AND ACRONYMS .f. - cost, insurance and freight MMI - Ministry of Machinery ndustry XKD - completely knocked down MNC - multinational corporation CNAIC - China National Automotive Industry MOFERT - Ministry of Foreign Economic Corporation Relations and Trade CRS - contact responsibility system MOME - Ministry of Materials and Equipment EC - European Communities NAW - Nanjig Auto Works FAW - First Auto Works NIC - newly industrialized county FYP - five-year plan OECD - Organization for Economic GATT - General Agreement on Trade and Cooperation and Development Tariffs QR - quantity restrictions GDP - gross domestic product R & D - research and development GM - General Motors (USA) SAE - Society of American Engineers GOC - Government of China SAIC - Shanghai Automotive Industry JICA - Japanese Intermational Cooperation Corporation Agency SAW - Second Auto Works JIT - just-in-time SKD - semiknocked down km - kilometers SOE - state-owned enterprise km/h - kilometers per hour SPC - State Plaming Commission MES - minimum efficient scale SVW - Shanghai-Volkswagen MFN - most-favored-nation TVE - township and village enterprise MM - Ministry of Trade and Industry (Japan) ZEV - zero emissions vehicle  FOR OFFICIAL USE ONLY CONTENTS Preface ........................................... v ExecutiveSummr ........... . ....................... vii 1 Developmer&A of Automotive Industry in Cktaa .................. 1 A. Rationale for Automotive Sector Work ...................... 1 B. Development of the Automotive Industry in China ............... 4 First Phase: Beginnings of the Domestic Industry ............. 4 Second Phase: Modemization Drive ...................... 5 China Natior.al Automotive Industry Corporation .............. 5 Pilr Industry ........... ........................ 7 Large Investments ................................. 7 infu-ion of Foreign Technology and Capital ................. 8 C. Currer t Industry Trends. 9 High Growth and Product Mix Change .................... 9 Import Substitution ....... 11 Fragmentation and Dispersion .......................... 13 Dualistic Industry and Emerging Leaders ................... 13 D. Looking Ahead: Developmental Objectives ................... 18 2 TrennaionaTedandDometlc Demand .................... 20 A. Trends in the World Industry ............. ............... 20 B. DomesticDemand ................................... 27 Freight Vehicles .......... ........................ 27 Passenger Vehicles ................................ 28 Projections of Domestic Demand ........................ 30 Implications of Domestic Demand Projections ................ 31 3 Policy Framework and Its Impact on the Automotive Industry .... .... 36 A. Entry Policy . ..................................... 36 B. Exit Policy . ...................................... 38 C. CompetitionPolicy . .................................. 38 D. Foreign Trade Policy ................ ................. 41 E. Demand Management ................................ 43 F. Sector Management ................. 45 G. Localization Programs ................. 49 This document has a resticted distrton and may be used by recpien only in the pof thr offcial duties Its contents may not otbwie be disclosed witbout World Bafik __  H. Foreign Direct Investment Policy ....................... .. 50 I. Enterfise Govenance ................................ 50 4 Perspectives on a Strategy for the Automotive Industry ............ 54 A. Comparative Advantage ............ .. ................. 54 B. Mniimum Efficient Scale .............................. 56 C. TechnologcaEfficiency ............................... 58 Phased Development .............. ................. 59 Less o From Experience ........... .. ............... 61 D. VerticalDisntegration and Subcontracting ....... .. ........... 64 E. Role of Govemment Intervention and Competition ..... .. ........ 66 F. Issues and Opportunities ...... ......................... 72 5 PolicRecommendations ................................ 74 A. BaIancing Proection and Competition ............ .. ......... 74 B. Creating ncentives t Innovate ....... .................. 75 C. The Role of Government in Facilitating the Creation of an Efficient Industia Structe ................ .................. 76 D. Long-Term Goals-The Development of Product Technology ... ..... 78 E. Conclusion ................... .................... 79 ArEX StatiCS . ................... ...................... 81 BOX 1.1 Leading Players in the Automotive Industry ................... 17 2.1 Tariffs on Autos in Selected Countries ...................... 23 TAnuM 1.1 Eighth Five-Year Plan Investment in the Automotive Sector .... ..... 8 1.2 ChineseAuomotivebyType, 1955-92 ...................... 10 1.3 Annual Production Targets of the Eighth Five-Year Plan .... ....... 10 1.4 ProductionPlan, 1993 ................................ 11 1.5 Production and Imports of Automotives, 1980-91 ................. 12 1.6 Share of Knock-Down Parts in Imports ...................... 13 1.7 Enterprises in Chinese Automotive Industry, 1980-90 ............. 14 1.8 Distribution of Automotive Assembler by Production Capacity ... .... 14 1.9 Geographical Diprsion of Production Capacity ................ 15 1.10 Passenger Car Prices ................................. 17 1.11 Truck and Bus Prices (1990) .18  -'Il- 2.1 Desired Stock of Vehicles Projeed for the Year 2000 ............ 30 2.2 Annual Demand for Vehicles, 1995 and 2000 . ................. 31 2.3 Output-Demand Deficit Projections by Type of Vehicle: Unconstined Scentio .. .............................. 32 2.4 Increase in Highway Capacity Over the Eighth Five-Year Plan Period ... 33 2.5 Motor Veh.le Emission Pollution Contribution to Total Man-made Pollution in the Beijing Urban Area (Witiin the Third Ring Road) ..... 35 3.1 LnportTariffs . . .42 3.2 Enterprises and Production by Supervising Entity, 1989 .48 4. 1 Raw Matera Price Comparison . .55 4.2 Fragmentation of Production in Trucls and Buses . .59 4.3 Stylistc Presentation of the Four Stages of the Development of Industry . 60 CHMTS 3.1 China: AutomotiveIndustrySupervisoryControl ............... 46  PREFACE This report is based on the findings of three missions that viited China between Sepeiber 1990 and December 1992. The report was prepared by Jae-Hak Kim C(ask Manager). Peter Harrold (Lead Economist) made contributions to the Executive Summary. Jyoti Shukla (Consultant, Economist) contributed to Chapter 2 and assisted in drftng the report. The report draws extensively on the findings of members of the earlier missions: Sally Zeijlon (Economist), Harbaksh Sethi (Senior Advisor, Engieering and Steel Industries), irtcolas Mathieu (Senior Economist), Wang Yuan (Economic Officer), Arnaud Domel (Economist), Jerry Saunders (Consultant), Bor-Ruey Fu (Consultant), and T. subramanian (under a UNDP-World Bank training program). Yongmiao Zhang at the Resident Mission in Beijing and Li (Local Consultant) also provided invaluable information. The missions received invaluable support from representatives of the Chinese automotive industry. The CNAIC countrpart team was led by Mr. Zhang Zheng, General Manag,er, Strategy PoLhcy and Computer Dvision, and included Messrs. Yijian Zhou, Wu Dongling, Zhu Shui Yu, and others too numerous to list. Assistance was also received from the First Auto Works, Second Auto Works, the Shanghai Automotive Industry Corporation, the Beijing Jeep Company, Nanjing Motor Company, China National Heavy Duty Truck Corporation. The mission also met with govemment officials in Shanghai and Beijing.  - ',ii - EXECUTIVE SUMMARY INMODUCnON L. The process of economic reform and decentralization has raised new challenges for China in the areas of industrial strategy and organization. While the role of the state in resource allocation and investment planning has been declining, the market forces are not in full play yet, with China's economy still in transition toward a market- driven one. This raises particular questions for the government in determining policy towards particular industries, and in deciding wheni and in what ways to ease transitional difficulties hindering the development of such industnes. Moreover, in the current state of the reform program, there are also questions about what instruments the government should use to effectively shape the future of the industry and at the same time to advance further development of market forces. iu. The automotive industry is perhaps the sector that best exemplifies these issues for two primary reasons. First, this industry is capital-intensive with particularly large ec cnomies of scale. We have thus observed in many countries, including developed countries, that the state has had a significant role in developing industry, either in its early stage of development or in its restructuring. Second, from the standpoint of economic strategy, the automotive industry is important for its industrial, macroeconomic, and social impact. This industry has the potential for becoming a leading sector through enormous backward and forward linkages; it is inextricably linked to national transport strategy and to the integration of the domestic market; and it has many externalities such as pollution and urban xongestion. iii. The Chinese automotive industry has now become a significant contributor to industral output, having reached 1 million units of vehicle production in 1992. The Chinese automotive industry rnks twelfth in world production, approaching that of Brazil. A substantial part of this production came from the commercial vehicle segment, making China the world's fifth largest producer. The passenger car segisent, which contributed modestly with about 160,000 units, however, is growing rapidly already, and has great potential for additional expansion. This level of production is the result of the rapid growth in the 1980s-18.7 percent per annum-and an acceleration in the '990s. Vehicle output has nearly doubled during the last three years. Nevertheless, given the size of China's economy and its current rate of income growth, a redoubling of the subsector is surely expected during the rest of this decade. iv. This report intends to examine these challenges facing the government of China in formulating industrial policy and strategy, using the automotive industry as an example. Although the report's recommendations focus on how to address these issues in  - viii - the context of this particular industry, these considerations should equally apply to other subsectors. The study of this subsector is significant because the industry is at a relatively early stage of development and because of the potential links to the rest of the economy. Decisions taken today will have a lasting impact on the pattem of economic development in China over the rest of this decade, and beyond. Fiially, it is fitting because our examination of the present strategy has revealed serious problems that need to be addressed with some urgency. v. The report first reviews the deveiopment of the automotive industry in China in the light of world trends. It then analyzes the issues, both technical and policy-oriented, that impede the industry's progress toward international competitiveness. It then presents policy recommendations for the automotive industry in China. DEVELOPMENr OF THE AUOMOVE INDUY IN CINA vi. The automotive industry was first established in China in 1956 but grew only slowly until the early 1980s. 'his level of development was owing to the government's transport stratgjl that emphasized railroads for long-haul freight transport and the use of nonmotorized vehicles, particularly bicycles, for short-distance passenger traffic. In its early years, the automotive industry thus focused primarily on the production of trucks and buses. The industry remained technologically backward, as it was isolated from the rest of the world at a time when many technological breakthroughs were taking place. vii. Since the early 1980s, however, the character of the automotive industry has changed dramaticaly, with the infusion of foreign technology and large investments to modernize the industry. Several major joint ventures have been set up with intemational producers-for example, Volkswagen, Citroen, and Peugeot for the production of passenger cars and Chrysler for the production of the Jeep. Licensed production of light trucks with Iveco and Is w technology and of heavy trucks with technology from Steyr and Cummins has also started. viii. As a result of large investments, the industry has changed in size, product mix, and quality. Vehicle production increased fourfold in the last five years to reach the one million mark in 1992, already exceeding the production target of the Eighth Five-Year Plan (1991-95). The product mix has changed, with the passenger car and light-truck segments showing high rates of growth. International collaboration has also radically improved the product quality of passenger cars and light trucks, although the dominant medium-size truck segment is still largely reliant on the sturdy 'Jiefang" and "Dongfeng' built with 1950s Soviet technology. ix. The rapid increase in domestic production allowed the Chinese automotive industry to supply almost 90 percent of the market in recent years. Imported vehicles as a percentage of domestic sales declined from a high of 44 percent in 1985 to 12 percent in 1991. The reversal in the position of imports is particularly significant for passenger cars. Imports of 27,600 passenger cars in 1992 represented only Lo percent of domestic production, in contrast to the situation in 1985 when domestic demand was larI -ly met  -ix - with imports. However, the 1993 import spree of sedan cars tipped up the import share slightly to 20 percent in the first three quarters. x. The development of the industry has seen two pattems emerge in recent years. First, growth has been largely led by the original, large producers as well as some new players gradually emerging from the fragmented industrial structure, a subset of which are likely to be the industry leaders in the years to come. At the same time, the decentralization of investment decisionmaking has pernitted the establishment of vast numbers of small-scale producers that essentially asse.ble kits. xi. In the small-passenger vehicle segment, eight enterprises are leading the growth in the industry:1/ (a) The Big Three - First Auto Works (FAW), Second Auto Works (SAW), and Shanghai Volkswagen (SVW); (b) The Little Three - Tianjin Daihatsu, Beijing Jeep, and Guangzhou Peugeot; and (c) The Mini Two - Chongqing Suzuld and Guizhou Fuji. Among the foreign partners, Volkswagen has clearly emerged as the dominant player in the passenger car market. Two Volkswagen cars, the Santana produced by Shanghai Volkswagen and the Audi by FAW, captured 60 percent of the domestic market in 1992. When the presently planned production capacity becomes operational, Volkswagen- designed cars are expected to provide 50 percent of the toal domestic passenger car production in 1995. xii. In the light truck segment, Nanjing Iveco, Southwest Isuzu, Beijing Isuzu, and Shenyang Goldcup are emerging as the industry leaders. The production of medium trucks continues to be the domain of PAW and SAW and the China Heavy-Duty Truck Manufacturing Group dominates production of heavy trucks. INTERNA