China’s fight with firms is its loss

China’s move to fine Qualcomm a record $975 million for tactics the government claimed hurt consumers hardly seems like a win for the San Diego-based chipmaker. Still, it’s a slap on the wrist for CEO Steve Mollenkopf’s company, which generated more than $13 billion in revenue in China last fiscal year and remains well-positioned to profit from the emergence of a huge Chinese middle class.

The real loser is China’s economy. Despite Beijing’s claims of unfair practices, the clear perception is that Qualcomm’s travails are part of an inquisition against foreign companies, particularly American ones. Over the last seven months, U.S. icon Microsoft has seen its offices in Beijing, Shanghai and elsewhere raided on vague charges of “monopolistic behavior.” Chrysler, Johnson & Johnson and non-U.S. firms such as GlaxoSmithKline, Samsung and Volkswagen have been hit with multimillion-dollar fines for arbitrary reasons that still baffle executives (Daimler, too, is under investigation).

Beijing’s nationalist impulses run deep. Back in 2009, after three decades in which the Chinese economy thrived by exporting to global markets, then-Premier Wen Jiabao took aim at Washington for sparking the global financial crisis, publicly demanding that the U.S. safeguard the $2 trillion of U.S. debt China owned at the time. People’s Bank of China Governor Zhou Xiaochuan rallied support around the globe for replacing the dollar as the reserve currency, a push that resonated from Moscow to Brasilia.

The anti-Western signals have only grown louder since Xi Jinping rose to become the Communist Party’s general secretary in November 2012. In the last two years, Beijing has targeted a slew of multinationals on a disturbingly ad-hoc basis. The 14-month probe into anti-competitive practices at Qualcomm concluded that the company’s license fees for its chips were too high and that executives used their dominant position to force customers to pay up. Yet by that definition, isn’t China’s entire economic system anti-competitive? The Communist Party, too, holds a dominant position in the economy and has shown little compunction about strongarming foreign companies with unfair and oft-shifting rules, forcing them to pay up when officials demand.

In reality, Chinese officials are unhappy with the quality of Qualcomm’s chips and the power of its patents, which are essential for connecting phones with high-speed wireless networks. As part of the settlement, Qualcomm agreed to offer licenses to 3G and 4G patents without bundling of those rights with other patents in its portfolio. The settlement is a boon for local upstarts like Xiaomi, Lenovo and Huawei that will now pay much cheaper licensing fees. China itself, though, has suffered a distinct reputational hit. Not satisfied with its joint-venture scheme - whereby foreigners must partner with a local company which controls 51 percent - China now looks to be using something awfully close to legal extortion to control those making serious money in its growing market.

That perception could damage the mainland economy at the very worst time. While conditions aren’t as worrying as in 2009, China’s economy is facing major headwinds: tepid global demand, another euro crisis, a weaker yen and rising deflation risks. In January, consumer prices rose just 0.8 percent from a year earlier, the weakest in more than five years. Factory-gate deflation deepened, falling 4.3 percent and extending a stretch of declines to 35 months. To stabilize the slowest growth in 24 years, China needs a steady inflow of foreign direct investment. Instead, FDI is already declining (it’s now at a two-year low). The dragnet ensnaring foreigners makes China even less appealing as an investment destination. Nowadays, multinational companies have more and more options when locating new factories in Asia. They can hardly abandon China’s 1.4 billion-person market, but they can spread their bets to nations that are rapidly raising their manufacturing capabilities, including India. In 2013, the five biggest Southeast Asian economies - Singapore, Malaysia, Indonesia, the Philippines and Thailand - overtook China in FDI. That trend accelerated in 2014, due in part to China’s lack of predictability.

Driving away foreign companies would also work against Xi’s larger reform ambitions, which involve using competition and market discipline to force Chinese companies to operate more efficiently. By coddling and promoting national champions, China risks hobbling the development of small-and-midsize private companies that are critical to shifting the economy’s emphasis from exports to services. What’s more, by limiting or driving out foreign companies, China is slowing the flow of ideas, talent and technologies needed to create a more vibrant and prosperous domestic market.

The point isn’t that foreign firms like Qualcomm need to play by China’s rules; they do. It’s that those guidelines themselves must change, becoming fairer and more transparent, if China is to thrive. It’s time Xi’s government followed its own advice and let the market work in China.

*The author is a Bloomberg View columnist based in Tokyo and writes on economics, markets and politics throughout the Asia-Pacific region.

by William Pesek