Is it time to abandon China? (Targeting foreign companies)

Is China becoming less welcoming to foreign companies?

 

Given all the bad news being reported from China—a slowing economy, mounting debt, rising costs, an increasingly hostile environment for foreign companies, and a political clampdown—we have prepared this series of blogs with the intent of providing some perspective to the dire headlines that draw so much attention.

 

Is China becoming less welcoming to foreign companies?

 

Summary

All emerging markets are challenging due to weakness in the rule of law. China is no exception. Among other issues, the general lack of transparency and procedural regularity makes it difficult to be confident in the system. For a variety of reasons, including the maturing of the Chinese economy, China is trying to more proactively enforce its own rules. The result is increased legal scrutiny in China—for all companies. Increased scrutiny and a system that isn’t transparent is not a good combination. But, when you look at some of the high profile cases that have received attention, in most of the cases China’s investigations have generally involved legitimate issues. For sure there are issues that are particularly concerning—like business intelligence and cyber security.   But, although the environment has changed a bit and is not easy, it is a mistake to say China is out to get foreign companies.

 

 Increase in legal scrutiny raises concerns

In 2014 and rolling into 2015, investigations, fines, and prison sentences created the sense among some that foreigners are under siege in China. While there are some areas of concern, overall it is premature to say that the government has turned against foreigners. Below are some of the salient points and high profile cases that relate to this question.

 

White glove treatment used to attract foreign companies

Special incentives help overcome obstacles such as rule of law risks

 

All emerging markets struggle with the rule of law which means that, in a place like China, foreign companies have often had to deal with a certain amount of corruption, arbitrariness, and bias from elements within the government. For many years, to overcome this obstacle and attract foreign investment, China gave foreign companies special treatment. For example, economic incentives, like tax breaks and special economic zones, were used extensively and were often geared toward foreign companies at the exclusion of Chinese companies. Also in the past, it was easy for senior executives of foreign companies to get face-to-face meetings with Chinese officials.

 

The days of white glove treatment for foreigners is over

China has matured economically and is no longer in awe of foreign companies

 

These days it is fair to say that this golden age of “white glove” treatment of foreign companies is over in China.   There are fewer economic incentives that are limited to foreign companies and officials don’t fawn over foreign executives as they used to do. If China used to be in awe of foreign companies, the media reports described below reflect what could be characterized as China’s new, more mature perspective: “Foreigners are fine, but they’re not perfect. We Chinese are pretty good, too.”

 

Media investigations target foreign firms

An indication that foreigners are no longer placed on a pedestal

 

State-owned media outlets have conducted a series of “journalistic” investigations of foreign companies.  A high-profile example would be a report that detailed how Starbucks prices in China are much higher than in much of the rest of the world. The Chinese public reacted mostly by mocking the report. Online comments noted that a very small percentage of Chinese frequent Starbucks and that the news agency should put more time into investigating real issues. There have also been a number of investigations into food safety at US restaurants and food distributors. Unfortunately in a number of cases the allegations of selling contaminated or unsafe food proved to be correct. It should also be mentioned that many Chinese firms have also been punished for food safety violations which is a significant and ongoing problem in China.

 

$500 Million fine for GlaxoSmithKline for Corrupt Business Practices

GSK gets caught up on China’s general anti-corruption campaign

 

GlaxoSmithKline was investigated for corrupt business practices and eventually fined $500 Million for a case that involved sex tapes, bribery allegations, and overzealous benefits to doctors, etc. Five GSK managers were found guilty and received suspended sentences. In 2013 China launched what has become the most intense anti-corruption campaign in China in recent memory. GSK got caught up in that campaign. Overall the campaign has targeted many more Chinese than foreigners. It is possible that GSK simply participated in corrupt activities that were considered, at the time, standard practice in China.   It isn’t completely fair that China is punishing companies for activities that were common, but that doesn’t make the practices right, either.

 

Foreign auto companies receive fines for antitrust violations

Foreign auto companies are doing very well in China and the impact of the investigations was minimal

 

Numerous investigations related to pricing practices were launched against US, European and Japanese automobile and parts makers. That’s the bad news. The good news is that foreign auto makers are doing very well in China with a market share of roughly 70% and prices that are often twice as high as other markets. The investigations, for the most part, were confined to a small part of the auto business, spare parts, for which foreign company prices are generally 3-4 times as high as other markets. An organization representing European auto parts makers actually asked the Chinese government to use its anti-monopoly laws to stop car makers from preventing dealers from selling their parts which reflects the fact that, to a certain degree, the spare parts issue relates to dealer rules which vary from country to country.

 

Qualcomm and Microsoft investigated for anti-trust violations

Both have been subject to similar investigations in other countries

 

Qualcomm, which sells chips and technology for smartphones, received a stiff fine from China for anti-trust violations. Qualcomm is being investigated in the US and Europe as well. Microsoft is also under investigation in China and has reportedly been ask to “explain problems of incompatibility and other issues caused by a lack of released information.” No action has been taken as yet against Microsoft. Of course we know Microsoft has been investigated and even punished in multiple countries. It is too early to say how China’s treatment of Microsoft might differ from other countries.

 

Prison sentences for Brit and American corporate investigators

China’s handling of business intelligence remains a serious concern

 

A British and Chinese-American couple who are corporate investigators were given sentences of 2 to 2.5 years for illegally gathering background data on Chinese companies and individuals. Business intelligence—what data can be collected, who can collect it, what they can do with it, how it is collected, etc.—is becoming a serious issue for foreign businesses in China, mainly because China invokes national security and criminality far more readily than other countries.

 

Cyber espionage and high-tech equipment

A serious trade issue is developing

 

For a number of years America was reluctant to allow Chinese telecomm equipment manufacturers like Huawei access to the US market because of concerns that Huawei might cooperate with the Chinese government to compromise US national security. Material from the NSA leaked by Edward Snowden purportedly showed that American high-tech companies had in fact cooperated in certain areas with the American government in ways that would give the government access to overseas networks. The Snowden revelations, in addition to creating tremendous controversy and conflict with other countries, resulted in American high-tech companies losing sales in many countries, including allies like Germany. In the wake of these revelations, China has taken actions and made proposals that have the potential to both exclude American high-tech firms from the Chinese market and to infringe on their intellectual property. Although American firms have already seen significant revenue decreases in China, the more serious restrictions proposed by China have yet to be put into effect.   Some would argue that China is using the political controversy as an excuse to give an advantage to their own local manufacturers. There might be some truth to this. But that doesn’t change the fact that America is in part responsible for being hoisted upon its own petard, so to speak. This is fast becoming the most serious trade issue in years between China and the US.

 

 

Recent investigations have generally addressed legitimate issues

Lack of transparency relative to adjudication remains a major concern

 

Legal scrutiny has increased in China but transparency remains limited—not a great combination. In that sense, China is more challenging. But as we’ve tried to show above, despite areas of serious concern, like business intelligence, in most of the high profile cases China has pursued legitimate issues. While China’s legal environment has always been challenging and may be a bit more so now, I don’t think it can be said that China is in some way trying to punish or intimidate foreign companies.

 

As was mentioned above, automobile companies have done well in China. Apple just reported record sales there. Most foreign companies operating in China are profitable. So it isn’t all doom and gloom for foreign companies in China. The rule of law is definitely a challenge in China. But China hasn’t turned its back on foreign companies.