Chinese Economy and Government: The Risk of Foreign Investment in China - Assignment Example

Question Analyse the possible threats that foreign companies face when investing in China and discuss the measures Chinese ities are taking to combat some of these threats. There have been a variety of entry mode choices in China available since the implementation of the first “open door” policy of 1979, with the continuous momentum of foreign direct investment (FDI) (Charles, 2005). Interestingly, by the end of May 2000, the contractual FDI in China had totalled $623 billion in 349,500 investment ventures (Charles, 2005). Moreover, the influx of FDI fuelled rapid economic growth, creating jobs and technological change to the country. The figures in 2000 coupled with China’s desire to close the economic gap with other developing nations led to the Government driven “Western Development Strategy” as part of the tenth year plan (2001-2005) covering six provinces.. Notwithstanding the economic policies favouring commerce and FDI, the OECD in particular have regular reported on challenges facing FDI in China’s regional development and the focus of this analysis is to critically evaluate the various types of business organisation and entry modes into the Chinese Market. In particular, this paper will evaluate the possible threats faced to foreign businesses in entering the Chinese market. Whilst foreign investors are ultimately autonomous on the mode of entry into the Chinese Market from equity joint ventures (EJV), wholly foreign owned enterprises (WFOE) and contractual or cooperative joint ventures (including licensing and technology transfer agreements) joint exploration, and co-operative development; it has been submitted that the reality of entry into the market has been challenging in practice (Luo, 2000). Since, the late 1980s the predominant mode has been EJVS and WFOES (Luo, 2000). Until 1996, EJVs were the most popular entry vehicle; however the last decade has seen the proliferation of WFOES (Charles, 2005). Between 1993 and 1997, the actual use of WFOEs in China grew at an annual rate of more than 25 per cent while EJVs grew by only 6 per cent (Rugman & Hodgetts, 2003). This indicates a fundamentally changing dynamic of the way China is attracting foreign investment, with WFOEs becoming dominant entry mode into the market (Charles, 2005). This is significant in placing a foreign company at a competitive edge in the market. Arguably, the causal effect is the disappointing performance of EJVS in China, the expectation that performance problems will accelerate along with the perception that foreign investors dissatisfaction is unlikely to change unless competitive compromises are given (Charles, 2005). Various problems have been associated with the Chinese EJVs, namely joint ownership, which often involves management by at least two parent firms (Grant, 2007). However, with shared management, partners can disagree on just about every aspect and thereby paralyse decision making (Child et al, 2005). Indeed, it is evident with Sino-foreign decision making and business practices, whereby social and cultural differences contribute to the intrinsic flaw in the “today’s mercurial Chinese Markets” (Ping, 2001). Indeed Ping refers to Vanhonacker’s reports that Lucent Technologies saw its share of the market for optical fibre transmission equipment in China decline from 70 to 30 per cent in 2000 (Ping, 2001). Ping argues that the key reason is that Lucent’s business relied on EJVs in China and because of shared operational control management; it had to negotiate technological change in a product with a local partner. Therefore if a local partner proves uncooperative, such internal problems cannot be addressed quickly enough to ensure minimum damage to market entry and market position in a foreign territory (Ping, 2001). Additionally, the involvement of local partners often exacerbates the effect of China’s narrow business licences and prohibits JVs from consolidating distribution of their various products (Ping, 2001). Moreover, an EJV in China cannot sell anything other than its own products; a company with several EJVs therefore often has to set up multiple marketing and distribution systems to serve the same customers, making economies of scale, overheads and scope difficult to achieve and effectively operates as a disincentive to operate in China. For example, Ping argues that Sino-foreign EJVs are essentially characterised by differences in a partner’s strategy objectives (Ping, 2001), which is evidenced by the lack of success in Chinese EJVs. This further undermines part of the five year plan as the primary motives for the Chinese entering into an EJV are to obtain technology, capital, management expertise, and short-term success (Ping, 2001). The aim of foreign investors is to gain market access to China with long term goals and growth, therefore the competing interests of both parties is creates a tension from the outset. Equity joint ventures are equity sharing arrangements between two partners or a consortium of three or more partners, whereby the risk of joint venture entity, profits and losses are shared in direct correlation to their equity ownership (Charles, 2005). Equity joint ventures are further considered to be a relatively risky entry mode to the Chinese market as they are inherently dependent on the success of the relationship with the managers from another company in a local territory (Luo, 2000). Conversely, EJVs may reduce the risk because local Chinese partners may help foreign companies understand how to be more successful in the Chinese Business environment and understand the nuances and differences in local markets (Boilon & Michelon, 2000). Alternatively, wholly owned entry modes include the development of subsidiaries either from scratch using a Greenfield approach, or through the acquisition of existing Chinese companies (Charles, 2005). Moreover, it has been argued that since the wholly owned strategy mode of entry has been legally acknowledged by the government in China, there is been a sharp proliferation of FDI (Charles, 2005). Export strategies are generally perceived as being a less risky method of doing business in China, which is considered to be unstable and difficult. There are two forms of export strategies as part of entry mode strategy. Firstly, home based sales persons to acquire export contracts from China who work as representatives of the foreign companies and build up relations with the Chinese (Grant, 2007). The primary advantage is the low risk as no capital investment is required at this point; therefore it enables the market to be tested and early pullout with minimum financial consequence. However, the downside of this export strategy is that foreign exporters are often unwilling to stay behind the contract and there is no room for building up a relationship with the Chinese and as the Chinese company has a permanent presence in China, it is arguably better to utilise a Chinese distributor (Rugman & Hodgetts, 2003) With regard to contractual joint ventures, in China, in addition to the problems of EJVs mentioned above, whilst termed as “joint ventures” these are more akin to licensing agreements as foreign companies will not take up ownership in ventures with the Chinese (Grant, 2007). Licensing agreements and technology transfers are common examples and often with the payment of a one off license fee and royalty payment structures. Alternatively, the advantage of the contractual joint venture is the low risk to foreign companies (Grant, 2007). Most foreign companies involved in these ventures are likely to recover the cost from the up front fee. There is however opposition from the Chinese and foreign companies to this approach as the Chinese prefer to work with foreign companies who have taken some ownership in the venture to ensure national benefit, therefore this clearly impacts co-operation and royalty payments under a contractual joint venture (Grant, 2007). Additionally, many foreign companies believe that taking minority interest in a joint venture with Chinese is disadvantageous due to the clout of major shareholders, which again sets up this medium as potentially obstructive to effective FDI from the outset (Charles, 2005). This is further compounded by concerns regarding intellectual property protection as there is little protection for foreign technology in the Chinese market (Luo, 2000). The concern regarding technology control and the imposition of controls over is a valid concern for foreign companies because this practice could eventually result in new international competition for the foreign companies who were putting up technologies in this pool (Rugman & Hodgetts, 2003). As mentioned above, EJVs are encouraged by the Chinese government as these provide great benefits to the Chinese economy and standard of living for Chinese (Luo, 2000). Therefore notwithstanding the inherent power struggle issues raised by this mode of entry, the Chinese government offers the most incentives for this particular mode of entry such as land, factories and tax concessions (Luo, 2000). These benefited the Chinese with higher incomes, long term technologies and strategies and have learned western management skills that can benefit China in the long term (Charles, 2005). However, the main concern from a foreign company’s perspective is finding suitable partners in China and most available partner organisations in China are state owned companies, which imports the inherent problems of the political and legal framework directly into an FDI initiative (Pei, 2008). These Chinese parent companies, mainly state owned companies and government departments can exercise controls on the joint venture and bring management philosophy into the business, which is creates a breeding ground for conflict (Pei, 2008). Additionally, foreign company concern is the lack of control on investment in China and Chinese have in certain cases ceded control to foreign companies even when they had majority ownership of a venture (Pei, 2008). However, such moves are subjective and inconsistent in practice and are motivated by economic goals and not by any establishment of a consistent framework within which to enter the market (Pei, 2008). On the other hand, whilst foreign companies prefer to use wholly owned subsidiaries, the common problems underlying all of the possible entry modes into the Chinese market are cultural differences, foreign exchange, quality of local employees, training needs of the Chinese, the high cost of doing business in China and intellectual property (Luo, 2000). Additionally, Saxon asserts that “corruption is wide spread in China. Although the government launched a high profile anti corruption campaign, these efforts are hampered by the lack of truly independent investigative bodies”(2007:73). To this end, Saxon highlights how corruption in China impacts foreign business in terms of finding appropriate local partners and payment practices (Saxon, 2007:73). Moreover, whilst corruption is a problem within the Chinese national framework, the problem for foreign enterprises is the extent to which national cultural practices central to business success in China can create problems under national regulatory frameworks (Saxon, 2007:73). For example, Saxon highlights the point that in China, gift giving in return for business is a culturally accepted practice in China, whereas and “in some instances, giving gifts is an alternative to strict interpretation and enforcement of regulations and taxes, as well as speeding up the acceptance of applications and proposals (Saxon, 2007:73). This in turn can create problems at national level for example in the United States where such practice would create liability issues under the Foreign Corrupt Practices legislation (Saxon, 2007:73). Another problem of doing business in China is the fact that there are different states and regulations and laws applicable to each state (Yang, 2003:180). Additionally, each ministerial government organisation can issue regulations and rules and therefore Yang highlights that there are: “simply too many regulations and, as a consequence, it is almost inevitable that companies encounter confusing and paradoxical regulations from different governmental organisations” (2003:181). This is compounded by the lack of consistency and the fact that “administrative control has been strongly influenced by local protectionism” (Yang, 2003:181). For example, each province is regulated by different regulations without centralisation. As such, the lack of co-ordination fuels protectionism particularly when cross province disputes occur and Yang highlights that this has become particularly problematic for foreign enterprises with regard to intellectual property disputes (2003:182). Accordingly, notwithstanding the economic drive towards globalisation and proliferation of FDI, many barriers operate to effective FDI in China, which is inherently rooted in the entrenched political framework wanting to retain tight controls, which is intrinsically paradoxical with a capitalist market (Pei, 2008). As such, this effectively narrows the wide range of entry modes into the Chinese market with the selection of an adequate and worthwhile entry strategy proving a difficult task. Indeed, aside from the Chinese business and political environment, some foreign companies have expressly referred to the local Chinese business environment as “hostile” to foreign enterprises (Grant, 2007). This is further compounded by the instability of the Chinese infrastructure evidenced by recurrent policy alterations and lack of effective enforcement provisions for the protection of technology transfer. To this end, it is submitted that ultimately any entry strategy for business in China requires a subjective risk assessment from the business perspective going forward. Q2) To what extent will the current rapid growth in the Chinese Economy be sustainable in the future? The Cultural Revolution in China and Deng Xiaoping’s ambitions to modernise China, brought the issues of legal reforms and the rule of law to the fore (Clarke, 2008). A significant aspect of China’s recent advocacy of the rule of system was clearly intended to facilitate foreign investment (Perenboom, 2002). Appurtenant to this has been the change in China’s economic transition towards a capitalist business model within its aims for globalisation and development (Columbus, 2003:1). Columbus refers to Zhang’s study of Chinese economic growth, which observes that “China has emerged as the most dynamic FDI host country, and the contributions of FDI to the Chinese economy have burgeoned in ways that no one anticipated” (In Columbus, 2003:1). Moreover, the previous twenty years has seen China demonstrating an average annual growth rate of nine to ten percent (Wyne, 2006). In turn, economic growth has been fuelled by multilateral trading initiatives through China’s membership of APEC and China’s Free Trade Area Agreement with ASEAN. This is further reinforced by the recent APEC meeting in Singapore earlier this month, where APEC reiterated the requirement to work towards sustainable growth through mutual co-operation and resistance of protectionism to keep markets open (www.apec.org). However, it is precisely the Chinese measures to attract FDI and its increasing reliance on FDI to boost economic growth that fuelled debate as to whether the recent proliferation of economic growth in China is sustainable in the future. In reviewing this debate, it is posited at the outset that whilst China’s economic growth and ascendancy in transition to a capitalist economic model has propelled its growth into the third largest world economy, Wyne highlights the underlying weakness in the current economic model as follows: “While many analysts view China as the world’s next economic superpower, surprisingly few consider two central obstacles to its growth: increasing income inequality and a weak innovative capacity” (Wyne 2006:1). The central basis of Wyne’s argument is that the Chinese have focused on an economic reform agenda since 1978 rooted in the objective of securing FDI. Since the 1978 reforms, the Chinese have been the largest recipient of FDI (Jiang 2004:1). However, on the other side of the spectrum, China has also to a degree ignored the need to harness local business initiatives to develop Chinese home grown business that can compete on an international scale. Moreover, the complex socio-political framework for China means that the reality is that as the wealth gap widens, the economic foundations of the Chinese business model continues to fragment (Shirk, 2007:31). Indeed, Shirk refers to the wealth gap causing unrest in China with the government placing the narrowing of this gap on the agenda as part of a five year plan (2007:31). On these grounds, Wyne suggests that in the long term, China’s growth will not be sustainable. Additionally, Wyne refers to the weakness of arguments of Kuznet (1951) in relation to transition economies. The central basis of Kuznet’s argument is that transition economies eventually result in declining income inequality when moving towards high productivity sectors in industry (1951). As a result, Kuznet’s suggestion is that income inequality is a short term effect of industrialisation and transition economies. However, Wyne criticises this assumption as regards China. For example, notwithstanding the economic growth in China, the middle class population is still very low and “while countries can achieve, and often have attained impressive rates of economic growth without a thriving middle class, none have been able to sustain this fractured development” (Wyne, 2006). Indeed, the growing wealth gap in China is a hindrance to long term economic growth and sustained transition and it is submitted that continued inequality and divides will fracture the economy. However, it would appear to a degree that China views this as a necessary consequence of economic growth. Nevertheless, the harmonisation of the wealth gap reflects China’s acknowledgement of the instability caused by the income divide and it remains to be seen how far the five year plan will reverse this. As such, it is submitted that a central stumbling block in sustaining China’s economic growth is the complex socio-political backdrop. For example, Shirk suggests that “it looks to many people in China as though fortunes are made not through hard work and ingenuity, but through official corruption” (2007:31). This argument is further supported by Wyne’s assertion that “China’s economic growth operates under a myriad of constraints” (2003:1). It is submitted that these propositions are further supported by the arguable fallacy of China’s move towards a rule of law. For example a cursory look at the legal framework suggests a heavy government influence and clearly all these powers are interrelated and the separation of the legislative, administrative and judicial power arguably is symbolic at a functional level only, further supporting the trapped transition argument in explaining the relationship of China’s legal system and the rule of law. Indeed, this fits into the Western argument regarding the lack of the rule of law in the contemporary Chinese system. Indeed, Clarke propounds the shortage of trained legal workers, lack of precedent in the Chinese legal system and the CPC’s superior position over law as prime evidence of this (Clarke, 2008). Moreover, the lack of a meaningful rule of law has further created scepticism among scholars on issues regarding China’s active involvement in international commerce, which raised serious concerns regarding China’s membership of the WTO (Pei, 2008). Alternatively, Peerenboom argues that the rule of law can be split into the liberal democratic version of free market capitalism and multiparty democracy on the one hand; and state socialist rule of law as extrapolated by Jiang Zemin and other Statist Socialists on the other; which sanctions the concept of a state centred rule of law. In China this effectively means a market based economy rooted in socialist norms of public ownership and a non-democratic party system (Peerenboom, 2002). This would therefore suggest that the complex political backdrop of China and the paradox of the capitalist business model within a socialist state further fuel the argument that the current rate of economic growth remains unsustainable. Indeed, Wyne observes that “with 160 million Chinese Living under $1 a day and 486 million living under $2 per day, the government’s failure to address income equality could sow internal chaos on a mammoth scale” (Wyne, 2003:2). Therefore, it is arguably it is the inherent paradox of the theoretical free economy model operating within a controlled socialist political framework which propagates the income gap, which in turn creates a fragmented economic foundation for sustainable long term growth. To this end, Wyne comments that “even if one believes that establishing the aforementioned dichotomy – economic and political- is not problematic, one would yet find it difficult to argue that China’s economic prospects are assured” (Wyne, 2006:2). Moreover, a significant element of China’s success in economic growth has been the manufacturing sector, for example by 2005, manufacturing accounted for nearly 91% of exports (Wyne, 2006). However, whilst FDI initiatives clearly fuelled growth in this sector in the last twenty years, the current economic crisis has reduced FDI overall and the manufacturing sector in China has been hit hard by a global economic downturn (Roach, 2009). As such, the current situation particularly in the manufacturing industry would appear to support Wyne’s earlier arguments that “the sector that has all but anchored China’s expansion is no longer a guarantor of its long term success” (2006:3). Nevertheless, China has attempted to alleviate these problems through innovation initiatives as highlighted by the Government’s “National Medium and Long term Programme for Scientific and Technological development program” announced in 2006 (Wyne, 2006:2). However, the core element of successful innovation is intrinsically dependent on the global competitive position of its firms and quality and consistency in the workforce (Wyne, 2006:2). Accordingly, whilst increased investment into innovation would suggest part of the way forward to increase stability in the foundations for sustainable growth in China, the current socio-political framework continues to operate as an obstruction. Additionally, as highlighted above, the economic initiatives and growth fuelled by the manufacturing sector have propagated foreign direct investment into China, which reduced the need for national home grown companies to compete (Wyne, 2006:2). On this basis, it is arguable that the current economic prognosis and difficulties faced by foreign companies investing in China has left foreign businesses questioning Chinese entry point strategies more than ever and therefore part of the problem of sustaining long term economic growth has been Chinese reliance on FDI. Indeed, the current situation would appear to support Wyne’s earlier arguments that “withdrawal of FDI would likely have serious consequences for China’s economy considering that the role of foreign funded companies therein has steadily grown” (Wyne, 2006:2). This problem of home grown success is compounded by the weaknesses in strategic management with increased need for national training initiatives. Indeed, it is argued that China’s reliance on manufacturing has led to an education system based on practical utility and government spending on education has declined, particularly in encouraging innovation. In highlighting the weak infrastructure for innovation in China, Wyn suggests that Solow’s proposition “that long term economic growth is ultimately a function of exogenous technological innovation, rather than endogenous determinants, one becomes further convinced that China’s economy has reached a most critical, uncertain juncture” (Wyne, 2006:3). Additionally, recent industry reports suggest that China’s reliance on a manufacturing supply model indicates that the country is heading for an economic downturn in 2010 precisely as a result of the pre-existing national growth model (Roach, 2009). Accordingly, it remains to be seen how far the five year plan will operate to reverse the effects of the Chinese model, however it is submitted that increased investment into national initiatives geared towards innovation and self-sufficiency of home grown companies are clearly recommended objectives to address the instability at the core of the current economic business model in China. 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