Investing in China - Assignment Example

Investing in China Order No. 261467 December ‘08 Investing in China China is one of the fastest-growing economies in the world. Foreign Direct Investment was one of the main pillars of the economic reforms initiated in 1979. China’s entry into the World Trade Organization has increased significantly the opportunities for overseas companies to invest in China. It has recently overtaken the USA as the most popular country for foreign direct investment. “China’s need for capital, raw materials, high technology, and modern management skills has opened a range of opportunities for foreign investors” (Ying Lin, Natalie Stoainoff, 2004). The government has been continuously taking measures for stimulating domestic demand and following macroeconomic policies that will spur expansion and growth. But all this has been undermined by some serious structural problems. China’s emergence as a popular destination for global business and investment over the last decade has resulted in a wider scrutiny of its economic system, its infrastructure, the social and political systems and the threats and risks. China’s economic growth has indeed been phenomenal. But this has exposed many weaknesses in the economic system. There is a huge imbalance between the growing cities and some rural areas. According to Hugh Cortazzi (2002), “The absence of democratic and accountable institutions and of a proper legal system with a fully independent judiciary is not conducive to stable government”. The economy is burdened with inefficient state industries and privatization is insignificant. And as Nick Louth (2005) says, “China’s political system, with its central control of capital and labour markets, its opaque decision-making process, its interference and corruption, is not up to the task of controlling it. The banking system in China is frail. Corruption poses a serious problem in all sectors, and developments are taking place without considerations of economic viability or impact on environment. China’s political structure shows a tendency to centralise, control and regulate which has put huge strains on the economy. Also China’s financial systems lack transparency. According to David Chua (2003), "Business practices in China are somewhat different. Some business norms such as mutual trust and keeping promises we have taken for granted may not be so in China. There is also a difference between policies of the central and local governments regarding taxation and charges”. Daniels and Radebaugh (1992) have identified six external factors to be considered when a company plans to expand into the global arena. According to them, they are ‘political, legal, cultural, economic, historical and geographic’ factors.” Some of the hurdles or threats, for foreign investors wanting to invest in China can be outlined thus: Administrative licensing: Securing licenses and approvals for new investments is indeed difficult in China. Lack of transparency in regulatory bodies makes it difficult for foreign investors to obtain approvals. .According to Yasheng Huang (1998),“China’s FDI regulatory regime still imposes tight restrictions. Project approvals are conducted extensively on both positive and negative-list principles. There are also aggressive localization, technology transfer and other performance requirements.” Human Resources: This is considered as an important issue by investors. Investors are finding it difficult to recruit and retain qualified professionals. Qualified professionals, especially in the middle manager level are in demand and this has driven up wages and increased the turnover of manpower A weak banking system: Government’s pressure to lend has resulted in domestic banks having weak lending portfolios and large amount of nonperforming loans. In addition, the state has bailed out many recently privatized banks and this has increased recurrent domestic expenditure. China’s banks have failed because of lack of transparency and faulty loans. Part of the problem is also because these banks are spending more to fund properties. There is a possibility of a serious banking crisis in the next few years in China. The legal environment: The legal environment and relationship with the Chinese Government are the main factors to be considered while investing in China. Many investors wanting to participate in the growing economy of China have been disappointed. They have spent time and money in the last few years but have little to show for it. However, the success story of Volkswagen is an exception. Its success is mainly because of its relationship with the Chinese government and a good understanding of the Chinese legal environment. According to John Child (2003), “Early entry and investment in building up a good relationship with local government are significant factors for joint venture success in China”. Volkswagen’s involvement in China began as early as 1978, when the Chinese minister of machinery and construction visited Wolfsburg. Several years of discussion and negotiation followed and it was by the end of 1981, that the Chinese government and Volkswagen agreed to work together. The contracts were signed in 1984 and first major production plant was opened in 1991. This shows that it takes a long time to set up business in China and one has to work within the system of the host country. Corruption: Corruption is one of the biggest challenges an investor faces in China. Corruption is very common among lower level government officials. The central government’s policy of devolving political power to the regions is one of the causes of the rampant corruption. Officials in China rarely get caught and punishment remains low. Companies are often asked to make a payment for a contract, even though it is not legally required. Foreign companies have noticed that local officials are very creative in finding ways to make a little extra money For instance a large international company found that only 30% of the licenses it was asked to obtain were legally necessary. All foreign companies in China face corruption. But one has to learn to deal with it. Take the case of Shell that has taken the issue of bribery and corruption seriously. The company which operates in over 145 countries has encountered ‘social corruption’, which is difficult to tackle. Shell has adopted six measures to counter corruption: Adhering to Shell general business principles; creating an anti-corruption culture; facilitate internal communication and training; ensuring transparent reporting; and interacting with stakeholders and experts. Lack of intellectual property rights: Many companies especially in consumer goods, auto parts and chemicals face stiff competition from fake goods that are much cheaper. China has to put up with serious intellectual property rights (IPR) infringements due to ineffective and weak enforcement of laws. Counterfeit products are posing a threat to the reputation and sales of international brands. Western companies are finding it difficult to win legal cases. Lawyers representing Western companies say that there are major loopholes in Chinese law and in the country’s trademark and patent system. Many Chinese patents are granted without proper examination of their originality. Competition and overcapacity: Foreign enterprises face stiff completion in all sectors from auto to construction to steel and cement. Chinese enterprises get easy credit and are able to invest in diversified product lines. They do so without regard to market forecasts, sometimes creating an oversupply of goods. Foreign investors do not get a level playing field in China. Pollution: One of the first things to hit foreigners visiting China is the pollution. Burning of coal to heat homes, factories emitting chemicals, the huge increase in automobiles emitting CO2 and the weak implementation of environmental protection codes has made China one of the most polluted countries in the world. Cultural and social environment: Foreign investors may not only face formal constraints such as economic, political and judicial rules but also informal constraints such as culture and ideology in a society. Jiaqin Yang and Huei Lee (2002) have described China “As the largest country in population, China has 50 plus different minority groups of people each have its own culture, custom, norm, tradition, even unique holidays and languages. Also, as one of the top three nations in land size, China is geographically divided into many regional centres cross the nation – each has unique cultural aspects in terms of tradition, value, social norm, belief, and organizational features.” Therefore a foreign enterprise has to know about the culture and preferences before starting operations. Here fast food restaurants like KFC and McDonalds provide good examples. Both are entirely American brands. They have incorporated the Chinese cultural essentials of respect, recognition and assimilation and understanding into their management styles. Despite the difficulties foreign investors in China foreign business is in many respects impressive. By bringing in a large number business legislation, approving many economic treaties and strengthening legal institutions China has improved much of the infrastructure that is required for foreign investors to invest in China. The measures taken by China have helped investors to cut costs, reduce taxes and repatriate profits and resolve some of the administrative and contract problems. Of the many measures a few are discussed in the following paragraphs. The Chinese government has introduced a number of economic laws to provide a framework for foreign investment activity for a better legal environment, such as the Company Law (1994), the Commercial Banking Law (1995) and the Mergers & Acquisition (M&A) Law (2002). It is trying to create a soft environment for foreign investments by either opening up or amplifying certain sectors like finance, insurance, telecommunication, etc., relaxing to some extent the share right restriction on foreign investment in certain fields like automobile, commerce, foreign trade, etc., and taking up development projects in the area of energy, infrastructures and mineral resources. China is also trying to reform the State sector in order to liberalize the economy. It has sold off many small and medium-sized state owned enterprises (SOE). The remaining large-scale, provincial-level SOEs have been incorporated into the ‘State Asset Management Commission’. The reduction in the state’s equity in the industrial sector has helped to reduce asset stripping and the use of soft loans to sustain firms that are not viable. The Government has undertaken numerous measures to fight corruption. The government, police and military officials have been forbidden from participating in business enterprises; different accounting channels have been allotted for revenues and expenditures. The Government has also launched a system of ‘accountant accreditation’. A new Administration Permit Law that attempts to streamline the various permits required for business into a “one-stop” system and wihich insists on written applications to avoid personal contacts has been recently introduced. The Government has also issued a notice requiring all laws and regulations regarding trade, services, intellectual property and foreign .exchange to be published in the Ministry of Commerce gazette. This will improve to some extent the transparency in transactions. China has recognized that rising water and air pollution and deforestation may threaten China’s economic development. Consequently it has issued regulations to reduce the emission of greenhouse gases and has in addition recently launched a five-year pollution control plan that is estimated to cost around US$84 billion. The Government has also introduced initiatives to reduce the use of coal by introducing a tax on high sulphur coals. The Chinese government is giving priority to investment in energy infrastructure. It is increasing its use of nuclear power and it is expected that by 2025, the share of nuclear power used for China’s electricity generation will increase by 4%. China is planning to embark on a multi-million dollar renewable energy strategy with the help of the United Nations and the United States, China has drafted new laws to protect intellectual property rights (IPR). For instance, in the pharmaceutical industry, the clinical trial data used in the drug approval process is protected. The government has signed an agreement on trade-related aspects of IPRs under the auspices of China’s WTO accession. The EU and China are also holding a formal dialogue to try and improve enforcement of IPR rules. The government implemented initiatives during its 10th and 11th five-year plans to ease environmental pollution. It has passed laws to counter pollution, the Renewable Energy Promotion Law to develop clean and renewable energy sources, being one of them. Here Shaun Rein (2006) says, “Many environmental issues still need to be addressed. But on the positive side, both government and the people of China are pushing for better environmental controls “. In conclusion it can be said that foreign investment in China is fraught with problems. The social and cultural factors and legal system have been serious obstacles for foreign investors doing business in China. However one has to learn to work with the system and this can turn out to be rewarding as in the case of the large joint venture, the Shanghai Volkswagen Automatic Co. Foreign investments in China has been a success and have realized profits for the foreign investors. The key to China attracting foreign investors is China’s wages and the attractiveness of investing in China has been further increased by reducing some of the threats mentioned earlier. As Jianfu Chen (1999) has said, “There are many issues that are important and relevant in regard to doing business in and with China. Indeed, an understanding of Chinese political and legal systems and sensitivity to Chinese social and cultural issues are indispensable.” References 1. Chen Jianfu (1999), Chinese Law: Towards an Understanding of Chinese Law, Its Nature, and Development, Martinus Nijhoff Publishers, 1999 2. Child John (2003), in an interview to Sarah Powell, Available at www.formulatrade.com/.../John%20Child%20-%20the%20challenges%20of%20establishing% on 12/12/08 3. Cortazzi Hugh (2002), China: opportunity or threat? Available at http://search.japantimes.co.jp/cgi-bin/eo20020413hc.html 4. Chua David (2003) Quote retrieved from http://www.atimes.com/atimes/China/EH02Ad01.html on 12/12/08 5. Daniels J.D and L H Radebaugh, International Business: Environments and Operations Prentice Hall, 2001 6. Huang Yasheng, .FDI in China: an Asian Perspective,Chinese University Press,1999 7. Louth Nick (2005), Why investing in China is best avoided, Available at http://money.uk.msn.com/investing/articles/nicklouth/article.aspx?cp-documentid=4752221 8. Jiaqin Yang and Huei Lee (2002) ‘Identifying Key Factors for Successful Joint Venture” in China, Industrial Management+ Data Systems (2002) 9. Rein Shaun (2006), Investing in Chinas New Environmental Consciousness, Available at http://seekingalpha.com/article/22817-investing-in-china-s-new-environmental-consciousness 10. Ying Lin, Natalie Stoainoff, (2004), Foreign Investment in China: The Cross-Cultural Dilemma, Available at http://www.austlii.edu.au/au/journals/MqBLJ/2004/1.html Read More