Capitalism in China is ‘work in progress’

by Hongwei Shang on April 30, 2008

in News

International Business

April 28, 2008 By: Meredith Hobbs

The Chinese crackdown on protests in Tibet in the run-up to the summer Olympics in Beijing has not had any real effect on business activities, said Peter A. Neumann, a Shanghai-based shareholder at Greenberg Traurig.

At a Georgia Tech conference on doing business in China, Neumann acknowledged that those in China and its territories “can’t question the authority of the Chinese Communist Party to rule,” but he added that the country is “much more open than it was in the early 1980s” in permitting political dissent.

“China wants to be a world player and benefit from the world economy,” he pointed out.

China’s increased openness to the global economy means more opportunities for U.S. companies, said Neumann and representatives of the U.S. Department of Commerce and the U.S. China Business Council at Georgia Tech’s annual Global Business Forum on Wednesday.

But they warned the audience that it’s important to enter the Chinese market well-informed, because the market and the rules governing it continue to change rapidly.

China is still “a work in progress,” said Neumann, who advises foreign companies that want to establish a foothold there. He has worked in China since 1993 and joined Greenberg Traurig almost three months ago to establish a Shanghai office for the firm. Greenberg Traurig was one of the conference’s sponsors.

Rapid change

Neumann pointed out that China has transformed from a feudal society to a market economy in just 30 years, since Deng Xioping began a series of reforms in 1978 to open China gradually to the outside world.

In the pre-market system, the time-honored capitalist ideal of “buying low and selling high” was considered disruptive in a state-run economy, said Neumann.

“Someone engaged in unauthorized entrepreneurial activity may have committed the crime of speculation,” he said. He recalled a case in the early 1980s, when he was a student in China, where a man doing a brisk business selling roasted watermelon seeds was repeatedly jailed for “capitalist crimes.”

Under China’s state-run economy, Neumann added, manufacturing and investment were handled by the government and an individual was tied to his danwei or work unit, which also supplied his family’s housing. People had to obtain government permission to change jobs or to move.

“The landscape has changed entirely,” he said.

Government experiments in selling off state-owned factories and allowing private ownership have accelerated in the past 10 to 15 years, said Neumann.

“Maybe there was a time when it was China Inc., but that has changed,” he said. “The government is pulling back from its direct role in business.” The government has privatized small and medium-sized businesses while keeping key state-owned businesses, such as petrochemical factories, he added.

Neumann said most of the companies he’s advised in the past five years have entered China through acquisitions.

No shortcuts

The most common pitfall for foreign companies, he said, is taking shortcuts. A company might operate its China outpost without proper accountability or program management controls, for instance.

“Most problems are avoidable,” he said. “The first thing I tell them is ‘Don’t rush into a deal just to be in the Chinese market.’"

As an example, Neumann said, a large building materials company initially retained him with the idea of acquiring a Chinese company in its industry. It discovered that the building materials market was saturated and “ripe for consolidation,” he said, and the client elected to bide its time instead.

The client established a local trading company, which allowed it to learn the local market, gain an understanding of its Chinese competition and become more sophisticated in marketing to Chinese buyers. In the heated building materials market, it can afford to wait to buy a local company that does not have the capital to weather the increased competition, Neumann said.

“You have to really understand the business proposition and look for ways of defining and managing risk,” he said. A foreign public company buying a Chinese company often must budget for an initial dip in revenues as they “clean up the operation,” and weed out bribery and kick-backs, he added.

Going green

The Chinese government is taking on a larger regulatory role to combat the rapidly growing market economy’s two big problems of corruption and environmental damage, said Neumann. The central government has upgraded its environmental protection agency to a full-fledged bureau, he said, but local governments often don’t curb polluting companies.

Even so, said Neumann, “there is a huge potential for green business.”

“Chinese companies are scouting the countryside in the United States for green technology,” said Neumann, in response to government directives to reduce energy consumption.

As China has opened to foreign investment and private enterprise has developed, business activities are becoming governed more by rules and regulations than relationships with party officials. “A rapidly developing market economy has different requirements than a simpler, relationship-driven agrarian society,” said Neumann.

China established its first business laws in response to foreign investment, he said. At this point, “there is an expectation that transactions will take place according to published rules.” On the other hand, he noted that legal institutions with their own independent power still do not really exist.

Comment on laws

In another sign of openness, China now allows outside entities to comment on laws in the drafting stage. Sara E. Hagigh, the deputy director of the Department of Commerce’s Office of the Chinese Economic Area, said the United States provided extensive feedback on China’s new anti-monopoly law. U.S. anti-trust lawyers met with the Chinese drafters and succeeded in getting some less favorable provisions dropped, she said.

In the same way, the United States wants to influence the reforms that China is currently making to its health care system, and it wants input on the national technology standards that China is developing. Hagigh expressed some concern that China is using these standards to promote domestic industry. While China has become more transparent, it has allowed only a three-day comment window for some standards, she noted.

Hagigh cautioned that China’s increased openness to foreign business has limits. The country’s latest five-year plan, established last November, calls the foreign acquisition of companies in key Chinese industries, such as automotive, machinery and petrochemicals, a “threat to national security,” she said. This could indicate a retrenchment, stemming from “concerns about stability and maintaining a harmonious society in the face of rapid change and growth in the last several years.”

In some areas, Hagigh noted, Chinese policies favor domestic over foreign companies through the use of subsidies, price controls, favoritism in government procurement contracts and technical regulations and standards that she said are unfair to foreigners.

“In some regions there seems to be a bias in favor of local companies” for government procurement contracts, agreed John Frisbie, the president of the U.S.-China Business Council, whose members are U.S. companies doing business with China.

Frisbie said his group’s member companies are concerned about protectionism. “There is an active debate in the Chinese media over the role of foreign companies. Some say they are too dominant and need to be restricted,” he said.

But Frisbie said his members’ top concern is recruiting and retaining qualified personnel. Salaries are increasing rapidly in China, and turnover is high, he said. Other big concerns are securing necessary licenses and approvals and intellectual property enforcement.

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