For decades, France’s Valdunes SAS charged premium prices for the wheels it made for high-speed trains and other rail systems around the world. That strategy changed after a Chinese state-owned industrial conglomerate bought the company in 2014.

The new owner, Maanshan Iron & Steel Co., or MA Steel, slashed prices in a bid to dominate the market.

“We were told that we shouldn’t miss a single order. That was explicit,” recalled Jérôme Duchange, Valdunes’s former top executive in France. “They have an appetite for economic conquest.”

The French firm was now in the service of the steel company’s larger strategic goals—to give it the know-how to make wheels for high-speed trains in Chinese factories, and to gain access to Europe’s highly regulated rail sector and other markets world-wide. For that, Valdunes received low-cost credit from Chinese government banks and 150 million euros, equivalent to $181 million, from MA Steel to stay afloat.

Over the past decade, China has provided billions of dollars of subsidies to state-owned companies to acquire Western manufacturing rivals and to build factories beyond its own borders. Now, these overseas factories are roiling global markets with low-price goods in sectors ranging from automotive tires and rail equipment to fiberglass and steel.

“Chinese companies are expanding. They are investing everywhere,” said Luisa Santos, deputy director of BusinessEurope, the region’s main business association. “This means that the flaws we see in the Chinese market are now being exported to other markets.”

The European Union this week proposed legislation to rein in companies in Europe that are subsidized by foreign governments, one of a series of measures that aim to counter the global expansion of Chinese firms.

Zhang Ming, the Chinese ambassador to the 27-nation bloc, has said Europe’s stance has worried Chinese investors in the region and undermined the EU’s historical openness to foreign investment. “We often see the EU as our professor for building our market economy,” Mr. Zhang said. “So we don’t want to see our professor and our partner have any hesitation when it comes to these principles.”

The U.S. and nations in Europe and elsewhere also subsidize their own industries, often through tax breaks, export financing and research-and-development funding. What makes China different is the outsize role state-controlled companies play in its economy, and its willingness to support their expansion abroad.

Daniel Gros, an economist at the Centre for European Policy Studies, a think tank in Brussels, said those differences shouldn’t lead the EU to penalize China for investing abroad. “Sorry, we cannot export our own model,” he said. “And we have lots of other subsidies. The footprint of our governments in our economies is very, very large.”

The U.S. and Europe have long relied on the World Trade Organization and tariffs to penalize China for subsidizing exports with grants, tax breaks and credit from state-owned banks, measures that helped the country grow rapidly. But the WTO rules weren’t written to constrain subsidies that a government gives to its manufacturers overseas.

The result: Chinese-owned factories outside of China usually face lower tariffs than those imposed on factories inside the country—or escape them altogether.

Western officials and executives say financial support from the Chinese government allows Chinese-owned manufacturers overseas to operate on razor-thin margins or at a loss, while they grab market share or serve the strategic objectives of the government. The problem, they say, is particularly difficult to address when the manufacturer in question is operating inside a Western market.

“China may never care about a profit because it’s a nonmarket economy,” said Michael Wessel, a member of the U.S.-China Economic and Security Review Commission, which advises Congress on China policy. “We have to assess whether as a market economy we view that as acceptable.”

The commission is recommending Congress give the Federal Trade Commission the authority to block acquisitions by foreign companies that receive government subsidies, particularly if those funds are used to execute the transaction. It also says U.S. authorities should have the power to screen plans by Chinese-owned companies to build factories in the U.S. for potential threats to national and economic security.

The EU’s proposed legislation would allow the European Commission, the bloc’s executive arm, to stop acquisitions by companies subsidized by a foreign government or impose restrictions on them to stop distortions of the European market.

EU rules restrict how much aid member states can give the private sector. The bloc’s officials say the subsidies legislation aims to level the playing field: Chinese companies in Europe wouldn’t be allowed to benefit from Chinese government subsidies when European companies are forbidden similar support from their own governments.

China says the West’s criticism of its practices amounts to an attempt to stifle its economic development. “Major Western countries formulate most of the rules of world trade,” Hua Chunying, spokeswoman of China’s foreign ministry, said last month. “It is their customary practice to maintain their hegemony.”

To maintain access to the European market, the Chinese government is offering to remove restrictions on investment by European companies in China’s domestic economy, part of a preliminary investment deal struck with the EU in December. The EU says it is moving forward with the foreign-subsidies legislation regardless of the investment agreement.

The U.S. in January imposed antidumping tariffs on tires from Thailand, South Korea and Vietnam after Chinese companies set up production in those countries to escape Western tariffs on tires imported from China. The Chinese investments helped transform Thailand into the world’s biggest exporter of tires. Chinese companies also are building tire factories in Algeria, Serbia and elsewhere to export to the West without antidumping tariffs.

The EU last year levied tariffs against Chinese glass fiber manufacturers that built factories in a Chinese-run industrial zone in Egypt. EU investigators found that the Chinese companies in Egypt had received hundreds of millions of dollars in loans and funds transfers that were either provided directly by China’s state-controlled banks or funneled through the Egyptian subsidiaries’ parent companies in China. The Chinese companies are challenging the tariffs at the European Court of Justice.

In February, the EU opened a probe into Chinese government subsidies for building one of the world’s largest stainless-steel smelters in a special zone in Indonesia.

China Railway Rolling Stock Corp., or CRRC, a state-controlled rail giant, has built two factories in the U.S. The investments helped CRRC win over local politicians and satisfy rules that require a minimum percentage of goods purchased by public-transit agencies to be made in the U.S. CRRC underpriced the nearest competitors by as much as 20%, securing contracts with Boston, Chicago, Los Angeles and Philadelphia, according to U.S. government documents.

In 2019, Congress passed a law that forbids using federal transportation funds to purchase passenger railcars and buses made by Chinese-owned firms. But CRRC won a grace period that allows the company to receive funds for new contracts for two years, thanks to allies in Congress such as Democratic Rep. Richard Neal, chairman of the House Ways and Means Committee, whose Massachusetts district is home to one of CRRC’s U.S. factories. Rep. Neal said he wants to extend the grace period indefinitely.

Marina Popovic, general counsel of the CRRC subsidiary that is building the cars for Chicago, said the company is determined to stay in the U.S. passenger rail market.

When MA Steel bought Valdunes for just €13 million, the French company was in financial trouble. MA Steel saw the acquisition as a way to expand its overseas sales channels—Valdunes’s brand is well-known in the industry—and to acquire know-how to make precision wheels for high-speed trains.

The company, renamed MG-Valdunes, got support from state-owned banks such as the Bank of China and China Construction Bank, according to corporate documents, receiving credit at interest rates of 1% to 2%.

After observing Valdunes for a year, MA Steel told the company’s French executives to ensure that its order book was filled, regardless of the price and the cost of production, former executives said.

That strategy caused losses to balloon, they said. Mr. Duchange, the former CEO, said MA Steel officials told him Valdunes could raise prices again after taking market share. Mr. Duchange recalled that one MA Steel executive explained the strategy with a Chinese saying: “There is no such thing as barren land, only farmers who don’t work enough.”

Valdunes and MA Steel didn’t respond to requests for comment.

Valdunes began to export low-price wheels to Australia for mining operations. The surge of imports from both Valdunes and MA Steel’s plants in China led Australia to impose antidumping tariffs against the two companies.

The same year, as losses mounted, MA Steel’s board approved another €70 million in capital for the French company. “Valdunes is a bridge for the company to further penetrate into Europe and other overseas markets,” MA Steel said at the time.

MA Steel has used Valdunes to navigate the procurement rules of big European wheel purchasers such as Deutsche Bahn, Germany’s state rail company. Chinese rail-wheel exports to the EU have nearly quadrupled since Valdunes was purchased by MA Steel.

MA Steel sent Valdunes engineers to help its factories in China make wheels for high-speed trains. Those wheels require far more precise engineering than the ones MA Steel already makes for freight trains. China’s vast high-speed train network still uses wheels made in partnerships with European manufacturers.

Deutsche Bahn is now testing high-speed-train wheels made by MA Steel in China. MA Steel has increasingly used Valdunes to finish and package wheels for customers in Europe and elsewhere that were made in China.

“The fear was that, little by little, we wouldn’t produce in France anymore,” said Mr. Duchange, who left Valdunes in 2019. “But for certain products, we couldn’t resist.”

Toward the end of 2019, MA Steel was absorbed into China Baowu, the country’s largest steel company, which is owned by the central government. Under the new ownership, MA Steel said its rail business is continuing the strategy of global expansion using Valdunes.

“The Biden administration shows great interest in the development of rail transportation,” said MA Steel chairman Ding Yi when discussing the company’s results in March, “which provides us with a great opportunity.”

Source: Matthew Dalton | May 7, 2021