China

Ask the ordinary businessperson on the street what is their impression of China, and two answers emerge. The first presents China as a vast and largely untapped potential market for Western goods, the ‘1 billion new customers’ approach which sees China as either a mecca or a minefield, depending on one’s attitude to the associated risks and obstacles (Barro 1995). The second sees China as a vast workshop, turning out low-cost consumer goods for both domestic consumption and export. China is the largest developing country in the world.

The country has vast territories and abundant natural and human resources. The country has huge domestic markets of great potential. Through trade and economic cooperation, China can achieve resource complementarity and market sharing. Combining capital, technology, and management expertise with China’s low-cost labour and huge domestic market will bring enormous opportunities of common interest to other countries. The expansion of the Chinese economy is not a phenomenon that affects China alone, or even East Asia alone.

All of us are touched by this growth, and will be even more affected by it in the future. If we wait for this phenomenon to reach its full form before discussing it, it may be too late and great opportunities will have slipped away. It is time to start thinking about the presence and impact of Chinese-based international and multinational businesses, even if the practical outcome may be long deferred. This paper will discuss how the political, economic and cultural issues may affect the attractiveness of China.

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The determinants of FDI for market-seeking investors are mainly related to market attractiveness, trade barriers, investment risks and the host country’s attitude to provide foreign investors with positive conditions for business activities. Market-seeking MNEs are attracted by the market potential (size and growth), the costs of market access (entry/participation), the government’s control over supply, pricing and distribution, etc. Since European MNEs in China are strongly oriented towards R&D intensive industries, intellectual property protection may also have a substantial impact on the entry path and on the type of resources committed by these firms. As trade barriers are often associated with other entry conditions – such as the allowed degree of foreign ownership, the sectoral and geographic location requirements or incentives – they equally influence the investment decisions by MNEs.

The economic size of the Chinese market has significantly expanded since the end of the 1970s. The total GDP of China reached US$ 961 billion in 1998, which brought GDP at a per capita level at US$ 776. The average annual growth rate of China’s GDP reached 9.8 per cent between 1977 and 1987 and 10.3 per cent during the period 1988-1998. The existing market size and its expected expansion are undoubtedly among the driving forces of the enormous FDI flows into China during the last decade (Chen 2001).

The structure of the Chinese economy has changed tremendously. The proportion of the industrial and service sectors in the GDP increased, respectively, from 47 and 23 per cent in 1977 to 49 and 33 per cent in 1998. The increasing importance of the industrial sector, in particular manufacturing, resulted in the integration of China into the Asian production system and to a certain extent even in the global one. The exports of China increased from US$ 9 billion in 1977 to US$ 208 billion in 1998, an annual growth of 18 per cent during the period 1977-1987 and 14 per cent between 1988 and 1998. This economic performance, especially of manufacturing production and exports, largely explains the boom of China’s economy (Kaufman 2001).

The existence and the level of trade barriers, such as tariff duties and quotas, customs procedures and specific standards as well as all kinds of technical requirements, have been major determinants for market-seeking investors in China. China often uses prohibitively high tariffs in combination with import restrictions to protect its domestic industry. As import tariffs are much higher for finished goods than for upstream inputs, they result in a high effective rate of protection. Tariffs may range from 3 per cent on promoted imports to over 150 per cent on discouraged imports, such as automobiles. These tariff measures are often associated with a lack of transparency in customs procedures with regard to the necessary documents, registration procedures or licensing system. China’s tariff and non-tariff barriers present major obstacles to foreign companies waiting to penetrate the Chinese market by way of exports. These trade barriers consequently encouraged many foreign companies to shift from exporting to local assembly and move on to a local production activity, especially when there are local content requirements. European MNEs producing in the automotive industry have typically followed such a sequence in China (Burkett 2004).

Over the last 2-3 years, China has gradually reduced its tariffs in order to be admitted to the WTO. To facilitate negotiations for its membership requests, China already in 1996 cut its import duties on some 4,600 items, from an average rate of 35.9 to 23 per cent and scrapped a third of its import quotas (Chen 2001). While such reductions of import tariffs increased export opportunities for foreign companies, industries such as automotive and consumer electronics are still highly protected.

A further reduction of import tariffs and the elimination of many non-tariff barriers by the Chinese government, as a result of its newly gained membership of the WTO, will also lower protection in a number of specific industries. As a result, the foreign MNEs that are producing in previously protected industries within China will be facing stronger competition from imported products. For these reasons, many European MNEs that moved into China at an early stage are rationalising their operations within the country by engaging into larger-scale operations and more specialised activities. A number of MNEs are reorganising their links with suppliers, especially by creating local sourcing capabilities and/or bringing with them suppliers from the home country into China.

The lack of a well-structured and transparent legal system in China poses serious problems for foreign-owned firms. A clear and strict hierarchical system of norms does not really exist yet. Moreover, there are many diverse regulations issued by different ministries and offices of the central and local/regional governments. Western companies, especially SMEs, are often unable to find out which regulations exactly apply to them. In some cases, unpublished regulations may have precedence over officially published ones. Sometimes, the officially published and unofficially applied rules from the central and local governments are simply contradictory.

However, since the liberalisation of FDI, the Chinese government has made great efforts to build up an appropriate business environment for foreign investors within the context of the transition of the Chinese economy towards a more market-oriented system. With regard to market-seeking foreign investors and their initiatives to expand their scale of operation and their specialisation based activities, the measures taken by the Chinese government mainly consisted of the introduction of market mechanisms that allow for a better resource allocation and product distribution. First, the foreign exchange restrictions that were the main barrier for foreign enterprises to sell in the domestic market were gradually lifted by the introduction of new regulatory and administrative measures. Also, the unification of the dual exchange rate system in 1994, through the elimination of the so-called Foreign Exchange Certificates (FECs), which existed alongside the local currency Renminbi, was an important step towards the convertibility of the Chinese currency.

Second, the centrally controlled and unified pricing system was converted into a mechanism based on demand factors and production costs. The state plan for the supply of inputs and the distribution of products was gradually eliminated and replaced by market transactions. Market mechanisms such as stock exchanges and labour markets were established and a number of new economic institutions were set up and opened for foreign investors to facilitate transactions of capital, technology, labour and commodities. In 1995, the Chinese government allowed foreign companies to invest through the stock exchange and to set up ‘foreign joint stock companies’ and ‘investment-oriented companies’. The introduction of such flexible investment forms not only improved the investment climate in general, but also allowed foreign companies to achieve a better co-ordination among their different activities in China and thus to operate more efficiently. Additionally, more intensive vertical and horizontal linkages with Chinese domestic enterprises were fostered.

Third, with the increasing use of the market mechanism for business transactions in China, the government introduced a set of regulations to explicitly facilitate market transactions and to stimulate efficiency. Also, the national regulatory framework was brought more into line with international standards, for example, in the areas of contract law, dispute settlement procedures, patent and trade mark protection, accounting systems and copyright protection. Between 1979 and 1994, the Chinese government promulgated more than 500 regulations and laws concerning foreign trade and economic co-operation, of which about seventy concerned FDI. China also signed bilateral and multilateral treaties to protect and promote FDI activities within its territory with no less than sixty-five countries (Child 1999). Most EU countries signed such bilateral treaties with the Chinese government during the 1980s.

The most significant change in the Chinese business regulations for foreignowned firms was the introduction and improvement of intellectual property rights during the 1990s. The introduction of patent law has removed a major obstacle to attract foreign investment in high-tech sectors and has extended the perspectives for the development of industries with high R&D investments and high specialisation. Yet, the full implementation of these regulations is not completed yet.

In reviewing the development of the Chinese FDI policy and its impact on the attractiveness of Chinese LSAs for FDI during the last two decades of the twentieth century, three major characteristics can be identified. First, the liberalisation and upgrading process of LSAs by the Chinese government has been closely linked with the geographical extension of FDI incentives on the basis of special tax measures and administrative regulations. Second, China has gradually introduced a set of sectoral and performance requirements for FDI within the context of its economic development strategy that is based on import substitution, export promotion and technological upgrading. Third, the control about ownership/entry forms of FDI has been gradually liberalised with the improvement of the market mechanisms and expansion of the private sector.

The specific FDI measures, which were introduced by the Chinese government to support its geographical and sectoral monitoring system, consist of the liberalisation and upgrading of local resources, the introduction of a market system to improve resource allocation and product distribution, the building-up of a legal system geared to market transactions, the decentralisation of macroeconomic management, the diversification of ownership control and the introduction of performance requirements. These measures will be briefly analysed within the geographical and sectoral dimensions of the Chinese FDI policy.

China has emerged as one of the leading international traders of textile products. According to official statistics compiled by the WTO, China was the world’s largest exporter of both textiles and clothing in 1999, accounting for 9 percent and 16 percent of the international market, respectively. (Overall, China leads the world industry with a total market share of 13 percent) While China is not a big importer of clothing, it is the world’s second largest importer of textiles (many of which are reexported after processing), taking in 7 percent of total international sales in 1999 (Child 1999). By any measure, therefore, China has become a major player in the world industry. Indeed, textile trade is critical not just to the Chinese industry itself (e.g., exports account for slightly more than one-half of China’s production of textiles and clothing by value), but to the entire Chinese economy, as well. While the share of textile and clothing products in China’s total exports had declined to 22 percent by 1999 from a high of 30 percent in 1994, it was
still close to the 23 percent share recorded in 1980. This record is especially remarkable given the quantity-based restrictions placed on China under the MFA. Indeed, it suggests how successful the industry has been in moving upmarket. While the relative share of textile and clothing products in China’s total exports has declined modestly over time, the absolute value of these sales has continued to rise steadily, reaching U. S. $43 billion in 1999. In fact, only
in 1996 did the textile sector finally relinquish its leading position in China’s export profile to the machinery and electronics sector. Rather amazingly, therefore, nearly U. S. $1 out of every U. S. $4 of Chinese exports is still earned from the sale of textiles and clothing, this despite
the rapid growth of Chinese exports across an increasing number of industrial sectors (Hansen 1996).

China has also made commitments to grant foreign companies foreign trade and distribution rights, which include wholesaling, retailing, maintenance, after-sale services, and transportation. American businesses can distribute imported products and products that are made in China, which will in turn provide export opportunities for American products. After China joined the WTO, the investment environment was further improved. Foreign investment in China was increased as a result of the increased attractiveness of the vast market.

For some companies the rise of Chinese business can be seen as a threat, but for others prepared to think creatively, there will be plenty of opportunities. Important though Honda’s announcement that it will begin to build cars in China may be, an arguably still more important announcement was made later in 2002. The Chinese car maker Brilliance China is hooking up with a series of Western car makers in joint ventures in different areas. A BMW joint venture is allowing Brilliance to effectively become the BMW distributor for China, which should be good news for both parties as the market for luxury cars in China is growing. But Brilliance is also establishing technical joint ventures with Western car makers which will allow it to participate in R&D projects and learn the latest methods of both designing and building cars. The global car industry is a tough one to enter; the barriers are high, and the investment required is substantial. Brilliance is taking its first tentative steps in this industry by learning from its bigger overseas partners.

More cogently, there is a tendency to think of China as a developing country, and of Chinese businesses as under-managed and inefficient. Once upon a time, yes, but the picture is rapidly changing. ‘Developing country’ is a label which many Chinese are beginning to question, regardless of the fact that certain parts of the country, at least, are still very much in an early industrial or even a pre-industrial mode. And the typical Chinese business is no longer the SOE, grossly over-manned and insolvent, its tens of thousands of workers housed and fed from the iron rice bowl, churning out its quota of goods regardless of market demand. The typical Chinese business today is a small to medium enterprise run by a close group of family or friends, perhaps graduates from the same university class, often young, conscious of the fact that they still have a lot to learn but acutely focused on a particular business opportunity and prepared to work until they drop to make it happen. These young Chinese managers are tough, flexible and determined. They know they have before them an opportunity which might not come around again. They are, in terms of intellect and commitment, our equals if not our superiors, and they deserve our respect.

One of the biggest changes in China in the last few years has been the emergence of this new generation of entrepreneurs. Born at the tail end of the Cultural Revolution or early in the reform era, they were still at school at the time of Tiananmen Square. They are well-educated and used to living with Western influences. They are prepared to take on the world. In other words, they see us as a potential market – very much as Westerners see them. In that common outlook, we should be able to arrange a meeting of minds on other issues as well.

China, according to a series of reports in the Financial Times, is becoming the workshop of the world. With companies sourcing everything from toys to electronics components there, China is finding that its economic strength is turning from being a vast market (and occasional dumping ground) for Western goods to being a supplier of cheap retail goods and, increasingly, a supplier of labour and materials for the manufacturers of the West. And already, the trend towards exporting more sophisticated finished goods is beginning. The most important implication of all this is to repeat the comment that doing business with the Chinese is no longer just a matter of doing business in China. Chinese customers, partners and competitors are beginning to come to the West to do business on their own account, and are doing so with increasing confidence, competence and financial backing. More and more Western managers will end up doing business with, or in competition with, Chinese firms as the years go by, and this without the Western side ever setting foot in China. This is all part of globalisation, of course, but it is part to which more thought must be given. We are accustomed to the triad – America, Europe and Japan, though the last is steadily losing power and influence as its economic crisis shows no sign of ending – running the show. The idea that China could be a new entrant into this power game is not always taken very seriously. But if current trends carry on, by 2020 – maybe earlier – China’s economy will overtake Japan’s and China will be the number 2 economic power in the world. It may be only a matter of time before it goes on to become number 1.