Why Chinese Firms Will Dominate Western China

New cars in a parking lot of Changan Ford Mazda Automobile Co. Ltd, Ford Motor’s joint venture in China in January. Reuters-Landov

If there was ever a city that exemplified the economic future of China, it's the western metropolis of Chongqing. A frenetic sprawl of 32 million people, it's also a place where you will find surprisingly few foreign visitors, or even non-Chinese firms. At one recent trade show of companies bidding for business in the fast-growing region, some 80 percent of the firms offering everything from heavy machinery to automotives to financial services were Chinese—up-and-coming names like Lifan, BYD, and many others that may one day be global brands. Most of the buyers were Chinese, too—many of them government officials or executives from the state-owned firms that increasingly dominate the Chinese economy.

All this speaks to China's new growth trajectory, one that is defined by Chinese companies and Chinese demand, rather than outsiders. The epicenter of the new growth is the country's vast western expanse, rather than its eastern coastline. While economists inside and outside China are bearish on export-oriented coastal cities with worrisome property bubbles, they are extremely bullish on the prospects of western China, which enjoys higher growth rates, more favorable government policy, and the possibility of a huge consumption binge: western Chinese have less than half the number of cars and air conditioners per capita than their counterparts to the east. Western China also happens to be where 68 percent of the country's natural gas, 53 percent of its coal, and 30 percent of its iron ore are located. But while foreign firms are salivating over the potential gains to be had from all this, it's the Chinese themselves, rather than outsiders, who will likely tap them.

The shift is a function of China's new place in the world. When the country began opening itself up to development in the 1980s and '90s, its economy was 8 percent the size it is today. Beijing knew it needed both income and expertise from foreign players. "The political thrust in the 1990s was to integrate China into global economic relations," says Hans-Joerg Probst, ERGO Insurance Group Beijing's chief representative, who was present at the time. Foreign companies, buoyed by favorable policies and weak domestic competition, thrived along with the coast itself.

Now the eastern seaboard has a respectable per capita income, and development policy has shifted west. Just last week the government announced new western infrastructure projects totaling $101 billion, even more than the 2009 figure. But unlike in the late 20th century, China has the financial resources, experience, and confidence it gained to build the west largely on its own. What's more, the fact that the region is rich in natural resources (largely the purview of state-run energy and power firms in China) and borders politically troublesome areas like Tibet and Xinjiang means that the government is more likely to want to exert greater control in commercial affairs there. "The central government has definitely given the west more investment" than it gave the eastern coast in the 1990s, says Yu Hejun, director of western development at the NDRC, the powerful Chinese government agency tasked with economic reform. While eastern China was more of a private-sector entrepreneurial growth story, the development of the west is a study in state-led capitalism.

Witness this week's massive IPO of the Agricultural Bank of China, the major commercial bank serving the western part of the country. Unlike the public offerings of other state-owned banks, this IPO was done without a foreign partner, in part because of mistrust toward overseas financial institutions that, post–financial crisis, are increasingly perceived as unreliable. The financial crisis has also exacerbated the transfer of capital from West to East, so that even if U.S. banks weren't out of political favor in China, the Chinese themselves would simply have more cash on hand, both in the public and private sectors, to fund their own development. "Over the next 10 years, there's going to be a huge shift in the nature of private investment in China; much more of the money is going to come from Chinese rather than foreigners," notes one well-known American consultant operating in the region. In fact, it's a change that's already well underway. In 1996 foreign investment (not including Hong Kong and Taiwan) represented 8.2 percent of total investment in China. In 2008, the most recent year for which figures are available, it was 4.9 percent, according to Roland Berger Strategy Consultants.

China's current emphasis on rebalancing its economy toward domestic demand (spurred in part by American pressure for China to resolve its trade imbalance) also means less of a golden handshake for foreign companies. In the '80s and '90s local governments in eastern China would attract foreign investment by providing infrastructure parks where firms could put their factories and outsourcing operations, says Ben Simpfendorfer, chief China economist at RBS. "Now, with the focus on domestic consumption, you need to provide things like lower-cost housing, and that's not something that foreign companies can do," given that housing markets not only in China but around the world are hyperlocal.

Beyond the sectors such as telecommunications and steel that are explicitly off limits to foreigners, local firms also have a leg up in the fast-growing west, where few multinationals have yet to venture (a Roland Berger study found that only 6 percent of foreign firms registered in China have a western presence). "It was really not sexy to go out west until the economic crisis hit," says Dan Foa, COO of FairKlima Capital, a Chinese investment company. Foreign firms' relative lack of business experience in a region where connections, trust, and relationships with the local bureaucracy play an even larger role than they do on the country's eastern seaboard is a major disadvantage. "The guanxi network gets even thicker when you move to less-developed places," says a foreign business executive who asked to remain nameless because of business problems involving communication between Beijing and the western regions.

Even if all things were equal, basic geography will always favor Chinese development of the west. Transport costs are much higher for foreign firms than they are on the coast, and the proximity and cultural similarity of countries like Singapore, Taiwan, and South Korea—the so-called Asian tigers—favor regional partnerships dominated by the Chinese, rather than ventures run by Western multinationals. "There's a good reason why Shanghai isn't 2,000 miles inland," says Fraser Howie, an expert on the Chinese stock market. And many good reasons why the next Shanghai will be located inland.