Wednesday, 25 April 2007

Chinese Partners, Western Firms and the "Hotel California" effect.

In a series of posts charting the extent of corruption in China and how this affects Western companies comes an excellent summary article from the always consistent China Law Blog.

In recent economic papers by myself and others it has been shown that corruption has a negative affect on FDI (at the country and regional level) as well as damaging reputation effects (and why of course China likes to keep all publicity about corruption levels to a minimum). This is not, of course, much of a surprise although there is the "speed money" theory where high corruption levels act to attract FDI if the investor believes that well placed bribes can speed up certain processes (and may then even result in increases in economic growth).

It is interesting therefore to get a new perspective - that of the advice given by foreign partners to Western investors/partners.

What is particularly interesting is that the "advice" from the local Chinese firms gives us an excellent glimpse into what is really happening on the ground and the pereived levels of corruption from locals.

This is in no way is meant to encourage Western firms to break the law but what is does show is that Western firms who DO stick closely to their perception of what the law is, are at a competitive disadvantage compared to local Chinese firms who may be taking so-called "short-cuts". Local firms are therefore exploiting local knowledge for economic gain and thus making business harder in China that it would be in a corruption free economy.

The other interesting aspect is what could be called the "Hotel California" effect. This is where foreign investment is allowed in with few restrictions, but once there it is made very difficult to leave.

"'Relax,' said the night man,
'We are programmed to receive.
You can check-out any time you like,
But you can never leave!'"

The encouraging bit of this post is that it is clear that lawyers such as those at China Law Blog take Chinese law very seriously AND give the impression that things have been tightened up considerably. This bodes well for China being able to throw off its reputation as a "wild west (or should that be wild east) town"

I have posted this article in full so as not to disrupt the flow of the argument.

Foreign Partners In China Crime Do The Time

Yet another great post by Andrew Hupert over at the Chinese Negotiation/Negotiating in China Blog, entitled, Negotiating in China: Partners in Crime. Post is on how foreign companies must avoid engaging in illegal acts just because asked to do so by their Chinese partner.

Now I know many of you are saying/thinking, "Well, Duh," (which is what I always get from my daughters whenever I say something they deem particularly obvious), but I can assure you foreign business constantly engage in illegal activities in China on the advice of their Chinese partners.

Hupert's post starts out by noting how if an American company with were to ask you to issue a fake receipt, forge a contract or commit fraud, you would almost certainly say "no" and terminate your relationship. But when "many newly arrived westerners are asked to do the same type of things in China . . . a surprisingly large number actually do it."

The post correctly notes how China now has a functioning legal system, at least when it comes to foreigners against whom it does not hesitate to use it:

The days of back-room deals, special favors for connections and outright bribery are largely over for run-of-the-mill transactions. (Ok, there may still be a lot of corruption and back-channel deals at higher levels, but if you are reading this for business entry information then you shouldn’t be dealing with that sort of thing yet.) China has a new legal system that it is very proud of. So proud, in fact, that they are excited about showing it off to their new foreign friends. Trust me, you don’t want to see it close up.

Your Chinese parter will entice you to engage in illegalities by telling you "everyone breaks the rules," "the government expects you to cut corners," "no one does the paperwork," and, "you'll never be caught." Hupert's response to this is eminently sensible:

Well, they don’t, it doesn’t, they do, and you will.

Plenty of Americans evade taxes and break laws in the US, but that doesn’t make it a good idea. You certainly wouldn’t recommend that a newcomer to your town start his new venture by committing fraud and forgery. Well, don’t be that guy in China.

The post then points out THE relevant difference between you and your Chinese partner: he or she is Chinese and you are NOT:

Yes, your local lawyer, accountant and partners have had a ripping success evading the authorities and living by their wits. But that doesn’t mean it will work for you. The Chinese government is very sensitive about foreigners it perceives to be exploiting China or taking advantage of Chinese people – and breaking business laws will put you in that category.

Nearly every month, one of my firm's clients comes to us planning to do something blatantly illegal in China, solely on the instructions of and with assurances from one of its Chinese partners. This happens so often that I have a stock response, which is, "what makes you think Mr. so and so is an expert in Chinese law as it applies to foreigners?" I then ask whether it would make sense for their assistant plant manager here in the United States to be the one giving legal advice to foreign companies doing business in the United States.

The post then goes on to point out that making the money in China and keeping the money you made are two very different things:

Another issue in China is the exit strategy. You may be able to buy the property, you may be able to sell the product – but collecting the money, selling the business and getting the money out are all much different things. You will see the same bureaucrats on the way out that you saw on the way in – so you’d better have all your paperwork.

I found this part of the post particularly interesting because just last week I spoke with a U.S. company owner who kept insisting his million dollar China investment had to have been "completely legal" because the local government knew about it and had done nothing to stop it. My explanation that the governments in China (particularly the local ones) tend to be very liberal in allowing money to come into China but very strict (particularly Beijing) when it comes time for that money to leave China seemed to stun him. This had simply never occurred to him.

I have said it before and I will say it again. In practice, there are essentially two legal systems in China, one for foreign companies and one for domestic companies.

In many ways, figuring out what is legal and what is illegal is easier for foreign companies because those companies need to know only one thing: they must follow the law as it is written. Do this no matter what anyone may say.


China Law Blog said...

I am pissed you came up with that song rather than me, as I frequently use song lines in my post titles.

I have written frequently on how there are essentially two legal tracks in China: one for domestic companies and one for foreign companies and I usually talk about how there is absolutely no point in complaining. Take taxes (please do!) as one of the best examples. Right now, the so-called average tax rate for foreign companies is around 15% and for Chinese domestic it is supposed to be around 30%. Domestic companies complain about this as being unfair, but in reality, the numbers are that foreign companies do pay around 15% and domestic companies (due to gross underreporting) pay around 5%.

So what's a foreign company to do? "Don't worry, be happy." (There, got in a song for you). Don't go into a business in China unless you can make a go of it under Chinese law and take comfort in the fact that things are, ever so slowly, getting tougher on Chinese companies. For example, China just raised the tax rate a bit for foreign companies and lowered it for domestic companies to equal it out. This will likely prove to be a good thing for foreign companies as they will now be better positioned to argue for equality.

Messi said...

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