Understanding China’s Business Environment

China’s business environment is rapidly changing and complex — especially for foreigners. The following sections should give you a good idea of the factors that play the biggest roles in China’s business environment.

The economy: Getting the goods

China’s economic growth is one of the major changes of our time. Over the past 20 years, its gross domestic product has grown by an average of approximately 11 percent annually. But there’s much more to the story than impressive numbers. Read on.

A history of government ownership and production

When the communists won the civil war in 1949, they began to take control of banks and most large businesses. Basically, the government started running the economy. Following the Soviet model and communist doctrine of the time, the Chinese focused on the rapid development of their heavy industry. The most important goal of most state-owned business was output, output, output — even when that meant losing money! China’s economy more or less stumbled along that way until Chairman Mao Ze Dong died in 1976.

Rapid growth and opening markets: China as a social(istic) climber

Since 1976, China’s economic strategy has changed a bit (see Chapter 3). For one, China didn’t want to collapse the way the Soviet Union did after years of ignoring calls for economic reform. In the 1990s, the Chinese focused almost single-mindedly on boosting GDP growth. Their thinking was that high GDP growth would create jobs — and they were right. China’s investment and economic policies opened the country up to foreign investment. At the same time, the central government gave local and provincial governments a lot of control over their local economies.

Today, industry accounts for almost half of China’s economic output. Officially, agriculture is a little over 10 percent, but that number is probably low because it doesn’t include a large group of subsistence farmers. About 40 percent of the economy is services.

Private businesses create more jobs than state-owned enterprises (SOEs) do now because many SOEs are shedding jobs and/or becoming privately owned in order to become more efficient. Foreign visitors often talk about how China is now more capitalist than the West — and it’s still supposed to be a communist country!

Continued government involvement

Despite moving to a much more market-based system, the government still exercises some old-fashioned economic control. For instance, the government keeps tight control over the renminbi (RMB), or yuan. The RMB isn’t fully convertible (see Chapter 10), which means that you usually can’t exchange it outside of China, Hong Kong, and Macau.

Also, China still protects some sensitive industries from foreign and even domestic competition by enacting laws that prohibit or make it hard for businesses to compete. Such industries — such as telecom, energy, and air transportation — may be key to national or economic security.

Or these protected industries may be politically sensitive because they employ a lot of people or make a lot of money for the government. One very high profile example of this was the attempt of the Carlyle Group, an American private equity firm, to acquire Xugong. Xugong is a profitable state-owned heavy construction equipment manufacturer; however, the planned transaction became a political flashpoint in China. Ultimately, Carlyle had to buy far less of the company than it had planned.

Although the state-owned enterprises (SOEs) are becoming a smaller portion of the economy, they’re still a major force. The government uses them to carry out policies, such as creating jobs in areas with high unemployment. In other instances, the government is letting SOEs fail and training the former workers to work in private industry.

Resulting problems of China’s development

Although the living standards and incomes of virtually all Chinese have improved during the past 20 years, the economy hasn’t benefited the Chinese equally. There are enormous (and growing) differences between the haves (a relatively small but rapidly increasing number) and the have-nots. About 1 billion of China’s people live in abject poverty. Three hundred million or so have achieved at least middle-class lifestyles. Among that 300 million, China has sizeable numbers of millionaires, making it among the largest markets for many luxury good sellers.

The differences in progress are clear when you compare areas on the coast with areas in the interior, cities with the countryside, and the well-educated with the not-so-well-educated (a relatively large number). Most of China’s wealth is along the coast, with some wealthy cities farther inland along the Yangtze River. The have-nots notice the differences in development and wealth because they were taught that China is a socialist country.

Some of China’s economic growth is from unproductive investments. By unproductive, we mean that the investment capital is used in a way that doesn’t make business sense. When the government gave provinces and cities a lot of power over economic decisions, the only requirement was that the local governments deliver GDP growth and jobs. In response, many local governments went crazy building things — especially skyscrapers, roads, and bridges. Sure, these projects created jobs and put money into the economy. But in many cases, funding the projects cost the government much more than they were worth. Plus, many local governments were kicking peasants and farmers off land for these frivolous investment projects. (For more on how the sensitivity of land rights affects your business, see Chapter 7.)

By 2004, almost every small city in China wanted to resemble a mini-Shanghai and light up the sky at night with dazzling neon displays, which the government often paid for. Partly as a result of this and similar waste, China began having electricity shortages in many areas at this time, even causing factories to shut down. Private businesses also got into the act, with a number of industries in China adding capacity at any given time when there was already too much. Unfortunately, economists can’t even come close to agreeing on the amount of unproductive growth in China. (The West isn’t immune to this phenomenon, either — remember the dot-com bubble?)

The road ahead

China’s government has launched a drive to make a “harmonious society,” the idea being that it’ll be more balanced, particularly economically. The central government realizes that to make this idea happen, it needs to reestablish control over parts of the economy that it gave up to local governments in the 1990s. Don’t expect the local governments to necessarily play along — they’ve realized it’s good to be king!

Going forward, China should continue to grow its manufacturing and to move into higher-end products. But with China’s rapid aging population, something will have to eventually give — either the one-child policy or China’s dominance in manufacturing. Services will continue to develop, but China needs to continue to invest in education to really develop services well. Right now, India appears to have an edge on China in the service area, mainly because India has more people who speak English.

One of the really interesting trends to watch over the long-term is how much consumption grows. Among the world’s largest economies, China has the lowest amount of consumption as a percentage of GDP. If the Chinese aren’t consuming, they’re saving. That means that most of the things they produce are bought in other countries, which becomes a very political issue in the importing countries. It also eventually limits how much the economy can grow because the world can import only so much from China. The government is actively encouraging Chinese to save a little less and spend a little more to simulate the domestic economy. We’ll see how it plays out.

Politics: Grasping the state of affairs

Although you should be careful about talking politics with your business acquaintances in China, having some understanding of the subject definitely helps. Chapter 3 provides an overview of the Chinese Communist Party (the CCP). In this section, we discuss the political environment.

A lot of Westerners misunderstand the extent of the CCP’s power. China is a one-party state, but it’s not held together as tightly as a lot of people think it is. For most of China’s history, the nation was a feudal society with weak central control. A country as massive as China — in land and people — was and still is very difficult to govern. Each year, China reports many tens of thousands of official “disturbances” in which people have rioted or protested at least somewhat violently.

Government efforts to modernize the country

For better or worse, the CCP sees itself as the best way for China to modernize and raise its people’s standard of living. Although Westerners sometimes perceive the CCP’s actions as heavy-handed, the CCP views them as necessary for the greater good. This divergence in views is most apparent in assessing the government’s June 1989 reactions to the Tiananmen Square rallies.

The CCP is constantly performing a balancing act. It wants to modernize the country and provide greater opportunities for its people. In order to modernize, though, China has to end the “Iron Rice Bowl” policies that guaranteed workers lifelong gainful employment at state-owned enterprises. Because China has been a poor country until recently, and also because of the effects of the Cultural Revolution (see Chapter 3), the majority of Chinese people lack modern skills or education. As a result, when a state-owned factory is privatized and the new owners lay off workers, the outlook for those workers isn’t bright. The government is trying to address this problem by training laid-off workers.

The large and growing numbers of displaced workers threaten stability. With some people in China becoming quite affluent, the unemployed workers’ anger intensifies. For this reason, China often seems to have to take two steps forward and one step back in its drive to become a modern economy and society. But despite the need to slow down or postpone some reforms, the pace of change in China is still incredible.

Suspicion of foreign investors

Foreign investors are always a political issue in China. The Chinese are quite proud of their rich culture and long history. For centuries, they were an extremely advanced civilization. However, the Chinese also view themselves as having been humiliated throughout the late 19th and 20th centuries by various foreign powers. In the late 1800s, the British actually went to war with China because the Chinese government tried to stop Great Britain from selling opium to the Chinese. Foreign wars, such as World War I, often resulted in treaties that carved up parts of China among foreign nations, without giving China any say-so in the matter. In World War II, the Japanese invaded China and were so brutal in their occupation that it remains a major obstacle in their relationship today. When you take a proud people who feel like they were humiliated by foreigners, you get some mistrust.

On the other hand, the Chinese are practical enough to realize that they can learn a lot about business from foreigners. They also know that foreign investment capital is crucial to their economic development. However, you often see political pressure to protect Chinese businesses from foreign competition. The effectiveness of that pressure varies. Occasionally, it can even make foreign investors targets of public blame for problems such as environmental pollution and land seizures from peasants and farmers.

The Chinese may be suspicious of each other as well. See the upcoming “Gaining trust” section for details.

Sudden changes in governmental policies

Chinese politics, even before the CCP took power, have been legendary for their intrigue and unpredictability. Westerners still can’t totally understand how the Chinese government works. Some scholars see a constant battle between reformers and conservatives; other scholars think members of the government are pretty much on the same page but are just making Westerners think it has disagreements. Sometimes your Chinese friends may be able to read the tea leaves and figure out whether a change will affect your business; other times, the government will catch everybody by surprise.

Birth-planning and the labor force After the famines in the 1960s and 1970s, China instituted a policy that limited urban families to one child per household. Some estimates hold that if there were no one-child policy, China’s population would be 300 million people larger than it is today! However, because of the policy, China is becoming a society with fewer workers to support more retirees. So far the government has shown no sign that it plans to get rid of the policy, although it has been loosened slightly. China’s government isn’t worried about a manufacturing labor shortage now, but because of the growing number of manufacturers, along with the one-child policy, the nation may see an uneven balance of work-to-workers in the long-term. The birth-planning policy has also had some small short-term effects. Over the past few years, wages in China’s two major manufacturing regions, the Yangtze River delta (around Shanghai) and the Pearl River delta (in Guangdong province), have been rising as manufacturers have had to compete a little harder for labor.

Culture: Taking in the social scene

Even though you can find some of the most modern cityscapes in the world in China, China and its people still reflect their thousands of years of cultural heritage in many ways. Here are the most important cultural differences for you to understand when you first do business in China.

Staying on the same page

The Chinese place a premium on acting as a group. This idea really means two things:

✓	Decisions are often made by consensus rather than by one person.
✓	Members of the group are expected to fully support and respect the decision after it’s been made.

Some Westerners who’ve witnessed closed-door Chinese meetings observe that after enough people (or enough senior people) have stated that they prefer a certain choice, the rest of the group seems to magically express the same opinion when asked. So it’s tough to say how much of a consensus is really behind these “consensus” decisions. Nonetheless, don’t expect a Chinese person to break ranks with his or her group to help you.

Pulling rank

The Chinese pay a lot of attention to hierarchy. Typically, Chinese employees are very aware of where they rank in the company food chain. Power always has its perks in China — and the differences in perks between pay grade are often not that subtle. Chinese people typically defer in public to people who outrank them in ways that may seem strange to Westerners. For example, on the way to a casual lunch, junior employees may all but dig their nails into the doorframe rather than walk through the door before their mid-ranking colleagues do. For more on hierarchy in the workplace, see Chapter 9.

Don’t assume that subordinate Chinese will appreciate your egalitarian insistence that they’re entitled to the same perks as you are. Breaking with the system may make some subordinates uncomfortable, even if you think they’re benefiting from your flexibility. Also, the Chinese may think that you’re disrespectful if you don’t respect the higher positions of your superiors.

Saving face

Face is a key cultural concept to understand when doing business in China. If you cause somebody, even by accident, to lose face (honor), don’t expect to ever receive their cooperation again. In fact, the consequences can be a lot more extreme than that. To make sure you don’t make mistakes with face, read Chapter 11, which also tells you how to give face.

Identifying the in-group

Relationships are an important part of doing business in China (see Chapter 15). One reason is that the Chinese usually don’t trust or even concern themselves with people who aren’t their friends. This idea has its roots in Confucian philosophy, but the Cultural Revolution reinforced it. For more on trust issues, see “Buckle Your Seatbelt: Preparing for Common Challenges,” later in this chapter.

Laws: Surveying the government say-so

The biggest myth about China is that it’s lawless. China has plenty of laws — and many of them are actually enforced! Fortunately for businesspeople, you’ll recognize a lot of the laws governing contracts in China. However, that doesn’t mean you can rely on your experience dealing with the law elsewhere. On the whole, the legal framework is getting better, but many Chinese laws are intentionally vague. Just know that there are laws to protect you and laws that pester you. Enforcement can vary by locale, but as we discuss in Chapters 17 and 18, you can protect your rights. The following sections explain how laws are written and implemented, as well as the hierarchy.

Vague for a reason

Many of China’s laws are vague to allow officials to use their judgment. Consistent and clear laws are easier to understand, but on the other hand, the way some countries rigidly apply their laws regardless of the result makes the Chinese way seem to make sense. As some say, in China nothing is permitted, but everything is possible. Thank you, ambiguity!

The legal suggestion box All levels of the Chinese government are constantly at work making new laws. Fortunately, the process is becoming more open. With many important laws, the government now circulates drafts of the laws before they make the laws official. That way, lawyers, businesses, and other people who have a stake in the law are able to comment. The best way for you to give feedback on a draft law is to contact your country’s chamber of commerce in China and ask them to convey your views. The government’s even listening to the comments, too!

The way Chinese laws are usually enacted may seem strange to many foreigners because the law is usually extremely vague. In fact, it’s usually more or less just a long statement of legal principles. For example, a law may say that companies with dominant market share need to receive antitrust approval before a transaction, but it won’t define dominant. Sometimes, these questions are answered when the implementing measures come out for a given law. The implementing measures are regulations that explain how officials are supposed to interpret and apply the actual law. You may wait for a year for implementing measures to come out, and then the measures may be vague in order to give local officials authority to develop their own policies.

Following a hierarchy

Usually, laws enacted by the central government take priority over provincial government laws, which usually take priority over municipal government laws. Finding laws enacted by different levels of government that are in complete conflict with each other isn’t unusual. Even stranger, you may find laws enacted at the same level (national, provincial, or municipal) that conflict! Even laws on the same tier have a hierarchy.

China is an administrative state, which means that various bureaucracies can issue their own laws and regulations — this is a significant risk to foreign businesses. Explaining the hierarchies is beyond the scope of this book, but just know that it can be complicated, so get expert advice from lawyers when you encounter conflicting laws and regulations. For more on dealing with lawyers and other professionals, see Chapter 4.

Laws dealing with foreign investments

Some laws deal specifically with foreign investments. They may restrict how much of businesses you can own in certain areas. Just keep in mind that you have to pay attention to a combination of laws, especially those that discuss foreign companies.