Tobacco & Free Trade

[Robert Weissman <rob@essential.org>]

TOBACCO AND FREE TRADE
Tobacco executives at the same time fear and look forward to Chinese WTO
accession.

By Chuck Bennett

Tobacco Reporter, September 1999

China must open its market and suffer the pain caused by foreign
competition," says a Chinese tobacco executive about his country's
inevitable entry into the World Trade Organization (WTO). While presenting
opportunities, true free trade will almost certainly hurt the country's
domestic industries. What can the tobacco industry expect when China
eventually joins the WTO?

This month, Chinese President Jiang Zemin and his U.S. counterpart Bill
Clinton will discuss the WTO issue when they meet in New Zealand for the
Asia-Pacific Economic Cooperation talks. WTO accession requires a unanimous
vote of all 134 members, but the U.S.—the WTO's most influential member—and
China have not been seeing eye-to-eye (see sidebar). In July 1999, the U.S.
Congress extended its "normal trade relations" with China for a year, which
bodes well for accession. However, few are optimistic that China will join
the WTO in November, when the governing body will again decide on China's
application.

A SLOW PROCESS.

Even if China is admitted this year, don't expect an overnight change in
that country's tobacco industry. Back in 1978, when Deng Xiaoping initiated
the economic reforms of his "socialism with Chinese characteristics," many
hailed the end of the so-called Bamboo Curtain. Twenty years later, many
foreigners doing business in China, including those in the tobacco industry,
will tell you that the Bamboo Curtain hasn't been lifted—just replaced by a
"Bamboo Bureaucracy." Conducting business in China requires navigating
through an extra- thick mess of regulations and red tape. However, WTO
accession won't be a panacea for these headaches.

"In the long run, the WTO will force open the market for foreigners, the
question is how fast and what exactly will change. I can't see it happening
very quickly," predicts Francois Stettler, vice president of R.J. Reynolds
Tobacco International (HK), which sells brands such as Camel and Golden
Bridge in China. Stettler estimates that it will be at least 10 years before
China's WTO accession will make a significant difference.

The July 1999 issue of Eastern Tobacco News (Dongfang Yancao Bao), a trade
publication for the Chinese tobacco industry, warned that China's domestic
industry will "take a big hit." More international brands will be allowed to
compete with domestic brands as non-tariff barrier policies on cigarettes
will be lifted along with a reduction of tobacco duties and the abolishment
of special import licenses. The article cautions machinery manufacturers
that, "After China joins the WTO, foreign machinery companies will enforce
the regulation of intellectual property protection." The article also warns
of the wave of competition which will flow in with WTO membership. China's
protectionist policies have so far been very kind to the domestic industry
and very frustrating to the foreign industry.

PROVINCIAL PROTECTIONISM.

WTO membership is expected to deal with internal trade barriers, as well.
While foreign companies have been banging their heads against national
protectionist policies, trade within China has been frustrated by
protectionism on a provincial level. A high level source with the Yunnan
Provincial Tobacco Monopoly Administration says inter-provincial rivalries
cause huge problems. "For example," he explains, "eastern provinces are
hesitant to allow Yunnan cigarettes."

A spokesperson for the Three Gorges Cigarette Factory in Hubei province says
his company has experienced similar problems. The factory sells its Three
Gorges and Cowboy brands in the mid-eastern provinces of Hubei, Hunan,
Zhejiang, Anhui and Jiangsu. The spokesperson complains of encountering
"resistance" when trying to expand into other provinces.

WTO membership requires adherence to the principles of "equal trade, free
competition and unprejudiced trade." The provincial tobacco monopolies will
have to open their market and establish markets that allow nationwide
circulation of goods. It is expected that the central government in Beijing
will enforce these reforms when China joins the WTO.

While plenty of domestic companies undoubtedly fear the consequences of free
trade, others are more confident. The director of a growing machinery
factory in southeastern China told Tobacco Reporter that he is confident
about his company's success in a post-WTO accession China. "Our factory is
part of the backbone of the China National Tobacco Corporation," he says.
The director further cites a long list of cigarette manufacturer clients
ranging from Beijing, to Jinan, to Wuhan, and a 1998 profit of rmb120
million as evidence of his company's strength. The company is currently
being exposed to cutting edge rolling and packaging technology by
cooperating with two European machinery suppliers."Our company has a fluid
structure. Because we can adapt to any situation, we have more opportunities
to do business, and will continue to improve sales," he concludes.

INTERNATIONAL PERSPECTIVE.

Not surprisingly, foreign tobacco companies are unanimously anxious to see
China join the WTO. Under current monopoly policy, all industry transactions
need to be approved by the China National Tobacco Corporation or one of its
branch companies. Furthermore, there are numerous restrictions on the
activities of foreign companies. Dickie Green, country manager of DIMON
China, predicts, "WTO membership for China may cause changes in the China
tobacco monopoly structure, which could open up further opportunities for
us. DIMON, as well as the other [leaf] dealers, could possibly ship
processed Chinese leaf to the domestic manufacturers by virtue of our leaf
and processing knowledge. It could reduce the other controls that the China
National Tobacco Import & Export Corporation (CNTIEC) has on dealers. A
cooperative partnership…may require fewer administration steps in order to
gain approval of the CNTC."

Current partnerships between foreign companies and Chinese companies
generally tend to favor the Chinese. The advantage for foreign companies in
these deals is to establish a foundation in China and build the
all-important guanxi (relationships). Leaf dealers such as DIMON China and
Standard Commercial have had Compensation Trade Agreements with local
tobacco authorities for over a decade now. The foreign companies provide
leaf technology and in exchange are given a discount on leaf purchases up to
the value of the technologies. Machinery companies have made similar
arrangements by providing technology in exchange for contracts with domestic
manufacturers.

 An official with the Yunnan tobacco monopoly predicts WTO accession will
aid in Chinese exports. Exports of Yunnan produced cigarettes, in particular
those of the giant Yuxi Hongta Group, to southeast Asian countries such as
Thailand, Burma and Vietnam, are growing each year. Aside from an obvious
increase in competition, the official was uncertain how the increase in
foreign cigarettes would directly affect the domestic market.

It is likely that with WTO accession, quotas and excessive taxes on imports
will change to more international standards. The monopoly may allow more
joint ventures and may loosen control of marketing and distribution. As
foreign cigarettes make up only an estimated 3 percent of the Chinese
cigarette market, there is plenty of incentive to grow. Brenda Chow,
director of public affairs for British American Tobacco (BAT) China Limited,
is optimistic about BAT's future after China's WTO accession. "We believe
China will have a progressive plan for the opening up of the market," she
says.

INEVITABLE.

In the short run, foreign companies will be the winners after WTO accession.
However, the managerial and technological superiority of foreign companies
is not an eternal advantage. Companies that rush into a newly opened China
relying only on these factors alone may face some difficulties down the
road.

In the long run, established domestic companies with solid management and
technology and foreign companies that have been engaging China for years
will have the best advantages in a post-WTO accession China. It's said over
and over, "the key to doing business in China is relationships." Regardless
of any WTO-related changes, companies that have already established their
own solid relationships—their guanxi—will have the firmest footing in China
for the next millennium.

PRC, USA and WTO: The Past and Present

Since 1986, China has been attempting to join the WTO. Thirteen years later,
the terms and conditions of China's entry have yet to be settled. Back in
1948, the Koumintang government of China was one of the 23 original
signatories of the General Agreement on Tariffs and Trade (GATT)—the
precursor to the WTO. The next year, Mao Zedong proclaimed the communist
People's Republic of China (PRC) and the Koumintang government took up exile
in Taiwan. In the following years, communist China was embroiled in its
mass-industrialization effort, The Great Leap Forward and the political
chaos of the Great Proletariat Cultural Revolution. Foreign trade and GATT
wasn't an issue.

It's been a big issue for over a decade now. By becoming a member of the
WTO, China will enjoy the lower tariffs of WTO membership for its exports.
Likewise, imports to China will enjoy the same privileges. Conditions for
joining the WTO are not set in stone. Each country's unique situation is
taken into account by the governing body when setting criteria for
membership. WTO accession can take years. The applicant country must meet
not only the rules and obligations of the WTO's market economy principles,
but also grant market access for goods and services from other WTO members.

In order for accession to take place, all 134 WTO members and the country
seeking membership must be in agreement that their individual concerns have
been met and that all outstanding issues have been resolved. Each applicant
country can have "annexes" added to their application. These annexes, in WTO
terms, are "legally binding and address specific issues related to the
applicant's trade regime." Along with arguing over whether China should be
admitted as a "developing" or "developed" nation, China and the U.S. have
been arguing about annexes for years. China insists on being admitted as a
"developing" nation.

Under the administration of U.S. President George Bush, tobacco interests
were included in talks. However, President Clinton, who is a fervent
anti-smoking activist, has dropped tobacco from the agenda. Currently, U.S.
disagreements over foreign investment in China's growing telecom industry
and China's trade surplus are key issues of contention. The WTO governing
body is more concerned with reformation of China's banking system. Political
issues have also been interfering with China's accession.
Regardless, China's accession to the WTO is inevitable. When Prime Minister
Zhu Rongji's concessions to the U.S. were rejected in April 1999, Americans
with business interests in China were angry with the U.S. government that a
compromise could not be reached. As the world's 9th largest exporter and
11th largest importer, not to mention the world's largest population, China
cannot be excluded forever. Chinese officials are oft to say, "Without
Chinese participation, the WTO is not complete."—C.B.