When China detained four Shanghai-based executives of the Anglo-Australian mining giant Rio Tinto on spying charges earlier this month, Western governments and business leaders feared the possible implications for Western firms doing business in China. But the real meaning of the incident could lie elsewhere, and be part of a major shift of gear in China’s economic strategy.

One reason the arrests rang alarm bells was that a month earlier, Rio had pulled out of a major buy-in by China’s state-owned aluminium firm Chinalco. More immediately, Stern Hu, the senior executive arrested and an Australian citizen, was Rio Tinto’s leading negotiator in fraught negotiations over the ‘benchmark’ price for iron ore.

Rio Tinto, BHP Billiton and the Brazilian company Vale are said between them to control 75% of the world’s iron ore supplies. The Chinese Iron and Steel Association had been holding out in talks for cuts of some 40 to 50% in the ‘benchmark’ price to reflect falling world demand, as against the 33% said to have been offered by the ‘big three’, and accepted by the Japanese and South Korean steelmakers.

According to the Financial Times on 15 July ‘The state-owned China Daily quoted an unnamed “industry insider” claiming Rio bribed each of the 16 Chinese steel companies involved in this year’s negotiations to set the benchmark iron ore price, a process that brings together steelmakers and suppliers of iron ore, steel’s key ingredient...Rio computers seized in Shanghai this week, Chinese media reported, revealed data about Chinese steel companies so detailed, one unnamed source in the China Daily claimed, that even the presidents of those companies might not have known them. Such information could be used to boost Rio’s negotiating position in the iron ore pricing round with Chinese steelmakers.’

Whatever the facts of this case, such methods of industrial espionage are of course not unknown on all sides. Earlier this month AP reported that ‘A Chinese-born engineer was convicted Thursday of stealing trade secrets critical to the U.S. space program in the nation's first economic espionage trial. A federal judge found former Boeing Co. engineer Dongfan "Greg" Chung guilty of six counts of economic espionage and other charges for hoarding 300,000 pages of sensitive documents in his home, including information about the U.S. space shuttle and a booster rocket’.

Of course the Chinese Government, like Rio, has vigorously denied the charges.

Chinese sources have stressed that the inquiry was under way before Rio pulled the plug on Chinalco’s attempted U$19.5 billion buy-in. But the background to the case shows up the multiplicity of motives for China’s ‘going out’ policy of encouraging leading Chinese companies to increase their overseas investments, especially in natural and energy resources.

As well as the widely credited motive of securing access to key raw materials, a stake in major players would also give China a say in influencing global market conditions - a point reinforced by the fact that the breakdown of the ‘benchmark’ price negotiations followed soon after Rio ditched the Chinalco deal for an alternative arrangement with BHP Billiton, the world’s largest mining company. In effect, this was a deal between two of the industry’s big three, to which China has responded by threatening action under its new anti-trust laws.

Chinese concern on the issue is all the more understandable when we bear in mind that these developments happened to coincide with the IMF’s attempt to obstruct China’s US$9 billion ‘infrastructure for copper’ deal with the DRC.

China’s policymakers would have to be only slightly paranoid to see a connection between a frustrated attempt to get direct access to the raw material, a frustrated attempt at a partnership with one of the three monopoly suppliers of that material; and undermining of their negotiations over its price.

But China’s response has been to reinforce its ‘going out’ drive, explicitly stating that its record foreign exchange reserves will be used for the purpose. The Financial Times of 21 July quoted Chinese Premier Wen Jiabao as telling diplomats ‘“We should hasten the implementation of our ‘going out’ strategy and combine the utilisation of foreign exchange reserves with the ‘going out’ of our enterprises,”

According to the FT, ‘Qu Hongbin, chief China economist at HSBC, said: “This is the first time we have heard an official articulation of this policy ... to directly support corporations to buy offshore assets.” China’s outbound non-financial direct investment rose to $40.7bn last year from just $143m in 2002. ... Mr Qu said this was part of a strategy to reduce its reliance on the US dollar as a reserve currency.

“This is reserve diversification in a broader sense. Instead of accumulating foreign exchange reserves and short-term financial assets, the government wants the nation to accumulate more long-term corporate real assets.”

The same report quotes Chen Yuan, chair of China Development Bank, as forecasting that ‘Chinese outbound investment would accelerate but should focus on resource-rich developing economies’.

Thus continued overseas corporate acquisitions serve a triple purpose for China ; helping secure access to key raw materials and to the firms that help shape markets in them; enlarging the global role of major Chinese State-owned corporations; and providing a way of diversifying China’s foreign exchange reserves away from the dollar without risking undermining its value, and hence that of China’s dollar-denominated assets.

However, the implications of the ‘Rio affair’ extend beyond the direct issue of China’s raw material interests, crucial though these are.

Press reports have claimed that the charges

Another area in which sections of central government may be making use of the conjuncture to boost restructuring is environmental regulation. On 25 June Reuters reported that China's environmental ministry has won its latest battle with influential state-owned power firms after forcing two of them to stop hydropower projects in the southwest province of Yunnan.

‘This is being interpreted as a clear sign that the government is starting to shift its macroecomic focus’.

The shift, according to the journal’s correspondents, is away from the emphasis on stimulating demand in the first phase of the economic recovery package, to a new emphasis on a fundamental economic restructuring. This means a shift away from the loose regulation that characterised the first phase of the package, when the emphasis was on growth above all. It also means an attempt to avoid the problem of over-capacity , which was seen in the stimulus package introduced to counter the Asian financial crisis of ten years ago.

The emphasis in the first round of the package was on investment in infrastructure, which took up 50% of the total spend. But critics pointed to the danger that once the boost from the initial spend had passed, there would be little lasting benefit to the rest of the economy.

But now, according to Economic Observer’s analysis, ‘Although the stimulus package will continue to be carried out as originally planned, it will now be combined with a new emphasis on economic restructuring. Investment will be encouraged in areas that benefit the livelihood of ordinary people and a focus will be placed on upgrading technology in key sectors of China's economy.

‘Many ministries and departments view this focus on technical upgrading as an additional round of investment, but unlike the government backed stimulus package of the past seven months, they hope this investment program will be backed by enterprises.’

In this context, the increase in activity by the Ministry of Environmental Protection [MEP] is seen as a sign of central government’s intention to take restructuring seriously. If so, the emphasis is certainly needed, as it seems that between January and May this year projects begun without official approval from the MEP outnumber those with official approval by some 340 to one - or a staggering 590 times if projects already under way are included.

According to experts at the National Development and Reform Commission, this growth in unvetted projects was due to local officials getting as many projects under way as quickly as possible. But figures show that this boost in new investment is not being followed through in terms of value added or sales of industrial goods.

Hence the new emphasis on restructuring - and enforcement of environmental regulations is seen as part of this.

According to EO ‘In detail, the MEP will strengthen the environmental approval process that all industrial investment projects are required to pass through and the Ministry of Finance (MOF) and the China Banking Regulatory Commission (CBRC) will restructure the rules in relation to credit institutions.
‘Aside from strengthening the environment impact assessment process, the reforms also seek to speed up the process of upgrading industrial technology and ensure the outdated capacity is eliminated.
‘Furthermore, the State Council has made it clear that a detailed development plan concerning how to restructure ten key sectors must be released before the end of July,
‘According to sources familiar with the situation, as excess capacity is a shared problem for each of these ten sectors, the new program will not only focus on expanding domestic demand, but will also involve more fundamental economic restructuring’.

It is significant that the analysis in EO substantially coincides with a recent study on the Carter Centre’s China Elections and Governance website. Sam Verran argues that;

‘This momentum has the potential to go beyond simple increases in government investment, and alter specific policy areas and sectors of the economy as the government uses this momentum to make necessary reforms. Reform in the healthcare system is one such example of the central government using the current downturn to tackle long needed reforms....’

Indeed, on the environment Verran predicts - as we can now see, accurately - that ‘Beijing had considered the idea of linking promotion for officials with the degree to which they had engaged in environmental protection. Now again with the stimulus package, internal politics may once again prove to be a potent deterrent for any true change to be accomplished. ..., it is entirely conceivable that local officials will seek to bypass the EPM's approval process and use the stimulus money to immediately begin construction, under the pretext of improving the standard of living in their respective areas.

Nonetheless he insists that ’It is undeniable, however, that China is making a definitive and concerted effort to improve environmental conditions domestically and to become a global environmental leader’. Indeed he points to a review of China’s emerging ‘green industries’ in the US magazine Business Week which concludes that China’s lead in this sector is already such that ‘The rock-bottom prices for made-in-China green technology could make it impossible for cleantech ventures in the U.S., Europe, or Japan to compete’.

In common with most Western observers, Verran is sceptical about the feasibility of economic restructuring within the existing political framework of central control of SOEs. But the Chinese authorities evidently feel that the Rio iron ore scandal resulted from too little central control over China’s 16 major state-owned steel mills, which entered into a cosy relationship with Rio and other suppliers. Officials at all 16 are now said to be under investigation. The major Chinese importers had little interest in getting a low price, as they could pass on any increase to the rest of the industry. They did have an interest in maximising the amount of ore they were able to import, and in selling on the surplus to smaller mills.

When the China Iron and Steel Association [CISA] took over the negotiations this year and tried to leverage China’s market power as the world’s biggest iron importer, the cosy relationship was disrupted. As one anonymous source at Baosteel put it "the Rio Tinto affair is really a struggle between the market power of China's steel companies and the political power of China's government planners."

* Stephen Marks is research associate and project coordinator with Fahamu's China in Africa Project.
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