The question I am most often asked by my Western counterparts is, “So what do we do about China?”

Back in June, I wrote an Expert Opinion piece about China vs. India in the API Race for contractpharma.com (visit http:// bit.ly/qBJcft). The volume of feedback was overwhelming.  My thesis was simple: western companies need to tackle China and India with vision, with facts and with conviction. A clear, well-formulated and balanced strategy is the name of the game.

Market opportunities in both China and India come with specific challenges. I’ll focus here on China as most of my customers face overwhelming difficulties in conducting business there. The core of the problem revolves around intellectual property enforcement and fair business practices.

When China entered the WTO (World Trade Organization) in December 2001, it announced itself as a “developing” country.  This allowed China to use WTO provisions when dealing with developed countries. Such provisions include, among others¹:

• Longer time periods for implementing agreements and commitments
• Measures to increase trading opportunities for “developing” countries
• Provisions requiring all WTO members to safeguard the trade interests of “developing” countries
• Support to help “developing” countries build the infrastructure for WTO work, handle disputes, and implement technical standards

In 2001, China had a GDP of nearly $1.3 trillion². It was sixth on the list of the largest economies behind France, the UK, Germany, Japan and the U.S. In 2011, China is the second largest economic power with a GDP forecasted to reach $6.5 trillion. In those 10 years, GDP grew 400% in China vs. 50% in the U.S.

A scorecard of business fairness in China yields unflattering results and would include, in order of decreasing impact on the business environment:

• Undervaluation of the renminbi: Despite a reevaluation of the renminbi against the dollar nearing 30%³ during the past six years, various methods still estimate the renminbi to be undervalued by around 40% to 60%⁴, which gives the country extra export power and amounts to a massive indirect subsidy from the state to all its local manufacturers. Even a 10% reevaluation could mean the difference between staying in business and going bankrupt for many companies competing against Chinese imports.
• Enforcement of Intellectual Property rights: a complex topic, where the Chinese government has opted for a selective enforcement with high-impact media events, but the realities in the marketplace are quite different.
• Direct state subsidies to Chinese-owned companies (whether state owned or private) in various forms, including easy access bank loans, low interest rates, state subsidies, local subsidies on utilities, free land and other perks.
• Indirect governmental and local support to Chinese-owned companies (whether state owned or private) in various tacit forms such as license grants, VAT policy, enforcement (or lack thereof) of commercial agreement and the administrative and capital burden for foreign companies.

Where Do We End Up?

In a better world, but not for all.

The statistics on the number of people lifted out of poverty in China (and other Asian and South American countries) are impressive, as is the rise of China’s middle class. This is un-debatable and factually documented.

Globalization made this possible, but is it truly a win-win for all, as economists claim? Or is it a zero-sum game? Countries individually produce more riches. Corporations have increased their profits. But for all the industries that disappeared from the European and the U.S. landscape, the workers who lost their jobs and have not been able to adapt to the “Service Economy” are the forgotten ones. One latest shocking statistic from the U.S.: more than 40 million Americans have been on food stamps, one out of every seven⁵. And whether they lost their jobs prospects to fair or unfair competition makes a difference.

How To Proceed?

Short of structural changes to the Chinese business and judicial environment, none of which are likely to happen in the short or long term, businesses seeking to address internal Chinese demand or profit from cost arbitrage in manufacturing in China have to manage with the cards they are dealt. Many German companies have found a balance between their financial interests and the transfer of know-how required to do business in China. Others have not. I contend that many U.S. companies have gone overboard outsourcing to China and other low-cost countries in the name of short-term profit.

The simple formulation, “Chinese operations for the Chinese market,” — or rather its short sibling, “China for China” — is probably the closest general statement one can make and still be somewhat correct. Building a comprehensive product segmentation for the local Chinese market and coupling it with a rigorous identification of the minimal technology transfer required to achieve production locally can be the most sustainable way lead to a win for foreign investors. If Alstom, Siemens and Hitachi or if Airbus and Boeing and (back then) McDonnell Douglas had a more cautious approach to technology transfers, we may not have today a Chinese Bullet Train or the Chinese Comac C919 plane. Those will compete head-to-head with the originators products and will inexorably lead to additional loss of jobs in the U.S., Japan and Western Europe, adding more stress on U.S./ European debt and distort further the balance of payment.

On the pharma front, massive efforts are being made by the central government in Beijing to implement universal healthcare access for its citizens by 2020. Healthcare spending is set to triple in the decade between 2008 and 2018. By 2013 China is forecasted to be the third largest single-country pharma market and reach nearly $70 billion in end-product sales. Its growth is outpacing every other emerging market. It is therefore a must for all pharma players to position themselves to benefit from this growth. One instance of this positioning cropped up in January 2011 when a “Healthcare Partnership Program” was announced during the state visit of president Hu Jintao to the U.S. This public/private sector initiative includes, among others, Pfizer, J&J and Abbott. The announcement outlined a long-term cooperation goal with China in the Pharma space, including research, training, and regulations.

I encourage the pharmaceutical industry to address the opportunity of the local Chinese pharma market, but I caution them to be very diligent about the technology they decide to transfer locally. Businesses are not the only players in this high-stake game. Political leaders in Europe, the U.S. and India, as well as global institutions such as the WTO, have to be more courageous in requesting fair competition from China. The reevaluation of the renminbi alone would

1. rebalance the trade flows between China and the world,
2. allow capital investments to be rechanneled locally, which would in turn generate job creation in the west, and
3. improve substantially the quality of life of the Chinese workforce.

It is the best alternative for a more harmonious global growth.

References
1. WTO website
2. China: Gross domestic product, current prices (U.S. dollars). International Monetary Fund, World Economic Outlook Database, April 2011
3. CNY/USD exchange rate: 0.156 on August 25, 2011; 0.121 on July 20, 2005 (since 1997, the renminbi was fixed at 8.2765 to the USD)
4. International Monetary Fund, World Economic Outlook Database, April 2011, Implied PPP conversion rate as of 2011 at 4.066 CNY per USD; Joshua Klein Lipman, Michigan Journal of Business, April 2011
5. http://money.cnn.com/2010/12/21/news/economy/food_stamps/index.htm

Andrew Badrot is chief executive officer of CMS Pharma, a provider of M&A advisory services and business strategy consulting to pharmaceutical custom manufacturing organizations. He can be reached at [email protected].