Telecommunications and the Internet in China

The Chinese have embraced telecommunications and the Internet as mighty allies in the country’s quest for economic modernization and growth. As a late starter, China is able to leapfrog technologies, particularly in the areas of communications infrastructure and wireless applications. Although per capita usage rates are still low, the absolute size of China’s market for telecommunications services and products is already among the largest in the world. The pace of change is breathtaking. A few facts and numbers to illustrate.

The number of fixed line telephones, already over 130 million, increasing at about 20% per year or about 2 million new connections per month. At this rate, China is adding an average sized regional U.S. Bell system every year. It is no longer uncommon for urban Chinese families to have a private telephone in their apartment.

The number of mobile phone subscribers is increasing at an even faster rate: by the end of 2000 it is expected to reach 70 million. Only the U.S. has more subscribers. China’s largest mobile phone company, China Mobile, has already almost as many subscribers as the world’s largest mobile phone company, Vodafone.

The number of pagers in use and annual sales are the world’s highest.

The number of Internet users is expected to more than double this year, to over 20 million, and double again in 2001. Business-to-business e-commerce is beginning to take off. Internet sales to private customers are constrained by the absence of reliable payment, credit, and delivery systems.

The fax, it seems, was invented for China; it made it possible for Mandarin and Cantonese speakers (using the same characters but a different tongue) to exchange documents with ease and without fear for the frequent coding and decoding errors that plagued the old domestic telegraph services. The fax arrived just when the process of domestic market liberalization started; the timing was perfect. It is now an ubiquitous telecommunications instrument in China.

 No other country has experienced a communications and information-access revolution as big and as fast as China is experiencing today. China’s government and Communist Party welcome and promote the revolution in principle as a boon for economic development. At the same time, they are trying to shield the country against the spread of e-pornography while ensuring information and monitoring exchanges. The longer-term social, political, economic, financial, and fiscal implications of the communications revolution that is unfolding will undoubtedly be significant.

Foreign participation in the manufacturing of telecommunications equipment in China is already high, but there is as yet almost no direct role for foreign companies in service provision. China’s impending WTO membership will change all of that. Most major multi-national telecommunications and Internet companies in the world are interested in getting a piece of Chinese action.

The dilemmas, contradictions, and paradoxes that have characterized China’s economic reforms since the early 1980s are nowhere as pronounced as they are in telecommunications and Internet development.

Basic Policy Shift

For many years, China’s leaders have emphasized the need for control over information flows and telecommunications networks for political and security reasons. More recently, in 1998, after Zhu Rongji took over as Prime Minister and reorganized the government, the focus of the domestic debate on information and telecommunications policy has shifted from control, towards creating a competitive business environment and industry restructuring. The driving force behind this shift is the need for continued high economic growth and technological development. WTO negotiations served as a catalyst to strengthen and consolidate liberalizing forces in the economic arena. But protectionist forces have also grown stronger. In the area of telecommunications, the newly created Ministry of Information Industry (MII)^[1] objected to the terms of the WTO accession agreement signed with the U.S. in November 1999. MII was overruled by the state Council, however.

European Union negotiators succeeded in strengthening some of the telecommunications terms for China’s accession to the WTO in bilateral negotiations that were concluded in May 2000. Under the Most Favored Nation (MFN) clause of WTO, these improvements will automatically apply to the U.S. and all other WTO members once China becomes a member.

Snags and delays in the implementation to China’s WTO accession terms must be anticipated. There is as yet no comprehensive telecommunications law in China, only a set of State Council-approved regulations administered by MII. This approach is typical; to develop market regulatory institutions, the Chinese often start with a relatively simple set of regulations. When they feel that they have gained enough practical experience with those regulation, they then draft the relevant legislation. By WTO standards, MII has at present too much discretionary power. MII also has significant direct operational and commercial involvement in the sector. It controls the three major existing telecommunications companies: China Telecom, China Mobile, and China Unicom^[2] and—through China Telecom—it also controls about 83% of all domestic Internet connections. Under WTO rules, MII cannot remain owner and regulator at the same time. The international Basic Telecommunications Agreement (BTA) which is linked to WTO (and to which China has agreed to subscribe), requires the regulator to be independent. Foreign equity participation in Chinese telecommunications and Internet companies may increase significantly under WTO. China Mobile and China Telecom are both seeking to establish a global business profile like other large operators in this field.

MII did not object to the further liberalization of China’s telecommunications equipment market under WTO. It felt that lower import tariffs [from a current average of 13% to 0% for goods and components that are covered by the International Telecommunications Agreement (ITA) to which China will subscribe as a WTO member] would reduce domestic manufacturing costs and thus improve China’s competitive position on international equipment markets. MII’s objections were exclusively concerned with what it considered an excessively rapid opening of domestic service markets to foreign competition and equity participation. MII would prefer to strengthen and consolidate the domestic and international position of the three major telecommunication companies it controls and other smaller national companies before opening markets. Important legal and institutional changes will be needed for the successful implementation of WTO accession terms in the area of telecommunications. Many of these changes are politically sensitive.

Institutional and Technological Aspects of System Expansion

When market economic reforms started under Deng Xiaoping in the 1980s, China had fewer than one million telephones, almost all in Party and Government hands. There was only one telephone operator controlled by the Ministry of Post and Telecommunications. Smaller towns and villages generally had no telephone. The national telecommunications infrastructure was extremely thin. The leadership soon realized that improved telecommunications and access to information are sine-qua-non for successful market reform and rapid economic growth. The construction of a national fiber-optic trunk line network was started in in the late 1980s and later supported by the World Bank. Ten years ago it would have been impossible to undertake such projects on a private-commercial basis. Since the mid-1990s, the development of new infrastructure in China—including some telecommunications infrastructure—has become increasingly commercially financed, from both public and private sources.

Today, China’s infrastructure for telecommunications (wired and wireless), switchgear, transmission stations, house connections and so on, is, for the most part, relatively new and state-of-the-art. Cellular phone circuits tend to be overloaded in many cities and give less reliable service than the hard-wired system. Some small analog wireless telephone systems are still in use, but the vast majority of all telephones in China are already digital. The wired system expanded from 10 million connections in 1990 to 130 million at the end of July 2000. This represents an average annual growth rate during the decade of almost 30%! In spite of this extremely rapid rate of expansion and contrary to what most industry experts had expected, the quality of service in China has generally improved. Waiting times for new connections in urban areas have been reduced while connection charges were lowered.

These improvements are, to a large extent, the result of domestic completion or the threat of it. To break the domestic monopoly of China Telecom, the Government created, in 1993, a second public phone company, China Unicom. This rapidly growing company now has about 5% of the total telephone market and close to 20% of the wireless market. Its $4.9 billion international initial public offering (IPO) in Juen 2000 was the largest Asian IPO outside Japan until the $6.6 billion international share issue by China Mobile in October. Both issues were significantly over-subscribed which confirms a strong international interest in China’s telecommunications development. China Mobile, which was originally part of China Telecom and separately incorporated in 1999, is planning to start wired telephone an related services. It is already offering cheap mobile services in limited areas based on fixed-line technology. Smaller Chinese state-owned telecommunications service companies are China Netcom (broadband data communications), Jitong (data networks), CSTNet and CERNet (educational networks). Under WTO, foreign companies will be allowed to enter the service field.

Because wireless systems are in greater demand and can be installed more quickly—and often at a lower cost per subscriber than wired systems—the mobile phone system in China is expanding even faster than the wired system. In terms of numbers of mobile phone subscribers, China has already surpassed Japan and is now ranking number two in the world after the U.S. China is expected to have over 250 million mobile phone subscribers by the middle of this decade, far more than any other country. The dominant mobile phone transmission technology used in China at present is Europe’s Global System for Mobile communications, GSM. New technologies are being developed. China’s second largest mobile phone service company, Unicom, plans to construct a new wireless communications network using Code Division Multiple Access (CDMA) technology patented by Qualcom of the U.S. At the same time, Siemens of Germany is collaborating with the Chinese Academy of Telecommunications Technology to develop the latter’s TD-SCDMA^[3] technology.

China has already become the largest market in the world for mobile phones and related equipment. Motorola, which earns a significant part of its global corporate profits in China operations, is the market leader for some product lines while Nokia and Ericsson lead in others. They compete fiercely on the Chinese market and also manufacture in China for export. Such exports are likely to grow rapidly after China joins WTO. Motorola recently gained approval from the Chinese to build a $1.9 billion communications chip factory in Tianjin (where it already owns and successfully operates a large equipment factory). Several of the larger foreign telecommunications equipment manufacturers in China, including Motorola, provide middle and high-level technical training at schools and universities they finance or help finance. The training associated with foreign-led telecommunications and Internet development is significant for technological development in China.

MII is actively promoting the growth of some nine small domestic telecommunications equipment manufacturers that together have a market share of 5% at present. In support of the growth in market share of local companies, MII has been trying to introduce import restrictions and production quotas for foreign companies. This is inconsistent with WTO rules and with the government’s own announced intention to level the domestic market playing field for all companies, regardless of ownership.

Foreign companies are actively competing to develop and market mobile Internet connection systems. The pressure to go mobile is greater in China than it is in the U.S. where access to low-cost and reliable wired systems is omnipresent. China may well become the first major country in Asia after Japan to popularize mobile Internet use on a large scale.

WTO Accession Terms

Subject to possible modifications and clarifications made during the ongoing multi-lateral phase of WTO entry-negotiations, the main accession terms relevant for the telecommunications sectors as negotiated by the U.S. and the E.U. are:

1. A significant reduction in tariffs on telecommunications equipment and component imports (to 0-3%).
2. 2. Elimination of all current restrictions on domestic distribution and trade by foreign companies.
3. Uniform application of domestic taxes to all companies, regardless of ownership.
4. Foreign companies permitted to own up to 50% in companies providing Internet, email, voice mail, on-line info, data retrieval, paging and enhanced fax services, and 49% in wired and wireless telephone service companies.
5. Adoption of internationally accepted norms for the promotion and regulation of competition in domestic and international telecommunication services.

These accession terms would be implemented over adjustment periods of varying length from immediate (upon accession) to a maximum of six years. The terms are nothing less than revolutionary. When fully implemented, the Chinese market for telecommunications equipment and services will be one of the most open in the developing world. Much will have to happen in terms of domestic legal, judiciary and regulatory systems development in China, however, before all of the above terms can be fully implemented and enforced through local courts. The WTO dispute settlement mechanism offers alternative protection, but under this mechanism only WTO member states (not individual companies) can request a WTO ruling on disputes.

The long-term social, political, financial, and economic consequences of full implementation of the accession terms are likely to be great. There are also fiscal implications. China Telecom is the second largest taxpayer. Growing domestic competition in the fixed line, wireless and related telecommunication services may reduce profit margins and room for indirect taxes. By agreement to the accession terms, China has accepted major risks in order to create important new opportunities and incentives for economic reform and development. There is no clearer indication of China’s intention to become a modern and open economy, than its signing of WTO accession terms as negotiated with the U.S. and the E.U.

The Internet, Information Flows and the “Knowledge Economy”

Some small local Internet experiments started in 1987. China’s Internet was formally launched in 1991. It was initially limited to interconnections between university research laboratories, but it has since been expanded nationally. The market for Internet Service Providers (ISPs) is dominated by state-owned telecommunications companies that are regulated and controlled by MII. The dominant ISP is Chinanet, owned by China Telecom, which controls 83% of all current Internet connections. Many small local Internet companies exist, but most are struggling financially, in part because of high rates charged to them by China Telecom. This should begin to change under WTO.

The Government tries to control the Internet in three ways:

1. Internet Content Providers (ICPs) need government permission to connect to ISPs to disseminate news, information, etc.
2. The Net (including chat rooms, email, websites) is censured by Internet police in most provinces. The police can and does block transmissions it considers pornographic, illegal or against national interests. Since such censuring obviously cannot screen all transmissions and websites, great reliance is placed on self-censorship.
3. The Government sets specific guidelines for mass media (newspapers, TV, radio) and for Internet content providers, including “links” between them.

There are many loopholes in the Government’s control system. Anyone with direct access to servers in Hong Kong or abroad has unrestricted access to the Internet. This often includes personnel working for foreign invested companies and organization of which there are thousands. Even domestic transmissions are often not fully controllable. In his speech to the nation, April 8, 1999, endorsing Permanent Normal Trade Relations (PNTR) status for China, President Clinton compared efforts to control the Internet to trying to nail Jell-0 to the wall. It is hard to find a more apt description of the difficulties that Chinese Internet censors are up against. The Internet, more than any other medium for information dissemination and communication, will inform China about the rest of the world and itself. Even if it does not change the political scene, the Internet explosion in China will at least lay the foundation for a new  “knowledge economy.”

Foreign Investment in Telecommunication Equipment, Services and the Internet

Major investments and technology transfers from abroad have already been attracted. Motorola is China’s largest single foreign investor in telecommunications equipment manufacturing. European companies are also heavily invested and Japanese companies have also become active. Foreign portfolio investments in Chinese state-controlled telecommunications service companies, at current market values, exceed $20 billion. This amount is likely to grow much larger with new international IPOs and when the government decides to sell more of the shares it holds in listed state-controlled telecommunications companies to finance development. The amounts involved in telecommunications investments are typically very large. To obtain a strategic foothold on the Chinese mobile market, Vodafone recently acquired a 2% interest in China Mobile in a negotiated $2.5 billion cash transaction. If this transaction reflects a realistic market value of the shares, it implies a market capitalization of $125 billion for China Mobile which would make it the largest company in Asia (in market capital terms) outside Japan.

Conclusion

Among developing countries, China is number one in the pace at which telecommunication services and the Internet are being developed. In absolute size, China’s market for mobile telephones and related equipment is already the largest in the world. Many of the world’s major telecommunications equipment manufacturers such as Motorola, Ericsson and Nokia, are already heavily invested in China and compete fiercely on the rapidly expanding domestic market. Some foreign manufacturing companies also use China as an export base. Once China enters WTO, China’s market for domestic telecommunications and Internet services will also open to foreign participation and competition. The agreed terms on which China will enter suggest that China will become one of the most open markets for telecommunications and Internet services among developing nations and even among many developed countries.

These developments will contribute enormously to China’s modernization and integration into the global economy. They will also have significant domestic social and political impact. While increased access to telecommunication and Internet services for a rapidly growing share of the population does not guarantee political democratization, it will promote development of the “knowledge economy” and facilitate exchanges between people. China should be applauded for trying to screen the Internet for pornography. Its efforts to screen for information and exchanges that the Party and the government consider undesirable are more questionable. In the long run, these efforts are not likely to be terribly successful.

Image credit: FILE CHINA NOKIA SAMSUMG MOBILE PHONE by Jonas Forth via Flickr.