What is China’s Obligation to Make Firms Feel Comfortable?

Monday, March 22, 2010 11:27
Posted in category The Big Picture

A lot of discussion these days about how China is clamping down on foreign firms, restricting markets, and acting downright unappreciative. Perhaps it is a simple case of miss communication, and China just playing a bit hard to get, or perhaps the relationship has hit that 15 year wall where it needs a trip to a Thai beach for a bit of R&R.

Either way, while US business feeling unwelcome in China, Premier Wen Jiabao was out making sure that US Firms knew he was taking their concerns seriously and would use the next SED meeting in May as an opportunity to work through this rough patch.  A rough patch that some say begun overtly when Wen stood Obama up in Copenhagen, while others would look towards more subtle clues of economic protectionism that were a result of the recession, and those nasty preferential buying policies.  Overtures that have been repaid in kind from U.S. Senators on a variety of trade related issues, the RMB, and protectionism in general.

But before going into whether or not China is or is not taking actions that are limiting its markets to others, I think now is as good a time as any to ask whether or not it is China’s obligation to make firms feel comfortable across the board, or if it should have the right to hold up a flag that indicates a line that should not be crossed.. just as several US senators have done themselves.

It is a question I ask because if you were to read the western press, one would think that it is the right of every global firm to enter China’s energy, food, information and resources markets on a “fair playing field” without thought or consideration of why China may or may not have a problem with such openness. Secondary to that, and regardless of whether or not one would believe China would have some sort of right to determine the level of openness and transparency around a market (or set of markets), I find it equally interesting that firms who enter those markets, and fail to crack them, feel little responsibility for owning up to their own failed strategy to try and penetrate a market that was so clearly being protected.

The fact is that, since 1979, China has had a very clear trajectory that it wished to follow, and that trajectory was not to open itself up in a manner that would wipe out domestic industries.  Even if that is exactly what should have happened, and would have resulted in China”s best long term outcome, and that goes double for a number of core industries (defense, energy, food, etc).  It was always a game where JV arrangements would be allowed so that the domestic partner could access the technology of the foreign party, and it was always the hope that through these relationships domestic enterprises would develop – even if that technology was 3rd generation.  In many cases, and after a significant JV incubation period, the market would be opened, but again.. China was hoping that domestic competition would have developed to such a point where an all out routing would be avoided, and if possible, the domestic middle/ lower markets could be held (Chinese firms typically believed those to the be the best long term markets anyway)…  and everyone in China knew this game was being played.

Well. Almost everyone.

Yet, to this day, it appears that there are still those who have yet to fully understand this game, or who have yet to fully appreciate that the game really is not going to change in a material way (for them).  That, when entering China, it will have to fully incorporate the rules of this game as they exist into the strategy, and play out that strategy by those rules,  knowing full well that the rules were drafted by the home team and, regardless of how well those rules were drafted, it is typically the interpretation and enforcement of the laws that is actually going to be where friction occurs.

Think of it in baseball terms.  there is a strike zone that everyone knows exist, but depending on the eye sight of the umpire, the skills of the catcher, and the position of the batter.. that strike zone can move. Is it the umpire’s job to make the batter feel comfortable by holding up a square to provide a clear strike zone for the visiting team?  Or is it the opposing teams responsibility to roll out their playbook?  Of course not, that batter has to go in knowing that they will have to play the game by the rules handed to them, and that at times they may get hit by the ball when standing too close to the plate.. and while one may be able to convince the umpire to review the tap and overturn his / her call, spitting in the face of the umpire and throwing a tempertantrum will get you nowhere in the end but thrown out of the game.

So, coming back to my original question, is it really “China’s” job to make sure that every firm entering China feels comfortable in doing so?  Or is the onus on the firms themselves to accurately assess the local playing field, and develop a strategy that will provide them with the best opportunities to drive in runs within the context of the environment that exists.. and is built in a way that remains flexible to the fact that rules and interpretations may change over the course of the game (the US and EU pass regulations from time to time as well)?

For me, the trajectory it is pretty clear.

The 8.2 RMB is gone, there are no more tax breaks for foreign companies, and China’s domestic economy is a primary focus of attention. There are opportunities here, boundless in many ways, but a new measure of respect for developing clear strategies needs to be present as China continues its path to development and economic rebalancing.

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5 Responses to “What is China’s Obligation to Make Firms Feel Comfortable?”

  1. Chris says:

    March 23rd, 2010 at 4:44 am

    Richard, all great points and astute observations as foreign investment was never going to be a ‘free for all’ in China. Far too many western investors and entrepeneurs have failed to understand China’s development strategy and have frequently tried to enter areas (telecoms, education, publishing) that were clearly off limits under China’s investment rules.

    When the game was trying to get production moved to China for overseas consumption, it was all happy, happy. China was indeed quite accommodating. Now that the primary target is China’s consumer markets and Govt procurement, it is all getting much, much tougher.

    Foreign firms are feeling the squeeze primarily in 3 areas of compliance: business scope, taxation and human resources. Restrictions on business scope and activity are generally not ones that most Western business are used to… indeed it’s an issue that I frequently have to remind HQ that we do not have a license to undertake XX activity, that the cost to do this would be XX or that it may not be possible. Overseas HQ generally tend to think that once a legal entity is established any activity can be undertaken.

    Tax is becoming a major issue for foreign firms. China’s tax rates are not over the top on any given tax (corporate profit, corporate income, VAT, personal income etc) but for compliant enterprises the overall tax take is actually quite high. Personal income tax kicks in at low levels so expats paying in full can often be paying significantly more than in their home country with comparatively few permitted deductions. China is not at all tolerant of foreign enterprise corporate structures designed to reduce nominal profitability. Most foreign enterprises are well aware that domestic competitors, often headquartered in regional cities with close relationships with local government, have significantly reduced tax burdens based on grace, favour complex internal arrangements or plain old evasion.

    Human resource issues are getting complex and costly. Recruiting and retaining staff is just one component and it is getting tougher. The on-costs for social insurances on top of staff salaries (36-44% depending on Province or city) are very high by international standards. Compulsory union levies on the entire payroll of 1-2% also quite high. Employees are certainly becoming more conscious of their rights, particularly since the new Labour Law was introduced in 2008. Keeping staff happy, developing and productive is an on-going challenge.

    These are all issues that foreign companies are simply going to have to face and deal with. If production is located in China for the purpose of export then many firms may find the total costs, even given the strengths of the supply chain, are too high or comparatively high, then it may be time to consider getting out and relocating. Total costs are going to rise and then rise again.

    If the game plan is to grow presence and sales within China then it’s time to get much more savvy. As Richard notes, the opportunities are enormous. There are many, many foreign firms doing extremely well in China. There are obstacles and barriers but many of these are compliance issues that foreign firms will also be managing in other developed countries.

  2. Jason says:

    March 23rd, 2010 at 7:01 pm

    If you think about it, why would any nation invite you to freely come to their shores, make as much as you can, wipe your mouth, and leave? The only reason the average country will welcome foreigners is so that they can get something.

    China’s careful control of industries open to FDI and JV’s has demonstrated this, and when they no longer need foreign capital or technology, that sector is closed to outside investment. Why would Beijing encourage foreign companies at the cost of local enterprise? No government with an eye to its fledgling economy would do so. (Which is what makes outcry over “protectionism” ridiculous – we all do it, or we die)

    We all know it, but often forget – there’s no such thing as a free lunch.

  3. Why the negativity? » Taikongren's Advice says:

    March 26th, 2010 at 1:59 am

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    March 29th, 2010 at 1:22 am

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