China Case Study

Submitted By:Manisha Tripathy Roll No. 55 PGDM IB

China Legal Growing Pains in a Land of Opportunity

The case describes China as a Land of Opportunity, the country which has emerged to be the largest economy, fuelling global markets, after U.S.A. The country has gradually taken steps toward economic modernization and entry into foreign trade and investment. The evolution of Chinas economy from an autarkic phase to one formed on free market principles has been remarkable. The case goes on to elaborate why China attracts foreign companies in terms of international trade and the major factors contributing to this. However, its attractiveness as a business destination continues to suffer from an array of political and legal complications involved for an entrepreneur or investor. The unique political and legal environments make local operations a complex process. These forces have guided the modern transformation of the Chinese business environment and are deeply ingrained in the countrys contemporary business landscape. In the end, the case concludes that despite the hurdles faced by the foreign investors, China still poses as a lucrative investment opportunity. Businesses all around the world are jockeying for the opportunity to take on the challenges presented by China of doing business in the country.

Q 1) Outline the political and legal environment in China today and trace its evolution from 1979. Comment on increase or decrease in political rise over the years till date. Ans) China follows a Totalitarian government policy and until early 1970s, the country adhered to the idea that contact with foreigners would corrupt the nations political structure and pollute the cultural life. China had one of the world's largest and most advanced economies prior to the nineteenth century, while national product per capita remained average in global terms. The economy stagnated since the 16th century and even declined in absolute terms later on. 1976-1989 Also known as the Era of Restructuring, this period witnessed the agricultural reforms which had been a neglected sector till now. Deng Xiaoping (the Reformist) responded by decollectivizing agriculture and emphasizing the Household-responsibility system. This divided the land of the People's communes into private plots. Reforms were also implemented in urban industry to increase productivity. Price flexibility was also increased, expanding the service sector. The country was opened to foreign investment for the first time and Deng created a series of special economic zones for foreign investment that were relatively free of the bureaucratic regulations and interventions that hampered economic growth. 1984-93 - During this period, Deng Xiaoping's policies continued beyond the initial reforms. Controls on private businesses and government intervention continued to decrease, and there was small-scale privatization of state enterprises which had become unviable. A notable development was the decentralization of state control, leaving local provincial leaders to experiment with ways to increase

economic growth and privatize the state sector. Although the economy grew quickly during this period, economic troubles in the inefficient state sector increased. Heavy losses had to be made up by state revenues and acted as a drain upon the economy. 1993-2005 - In 1997 and 1998, large-scale privatization occurred, in which all state enterprises, except a few large monopolies, were liquidated and their assets sold to private investors. Tariffs, trade barriers and regulations were reduced. China joined the World Trade Organization (WTO) during this period. Also, in 2005, China was able to surpass Japan as the largest economy in Asia. 2005 to present - The government adopted more egalitarian and populist policies later in the millennium. It increased subsidies and control over the health care sector, halted privatization and adopted a loose monetary policy, which lead to the formation of a property bubble similar to U.S.A where the property prices tripled. For thousands of years, the Chinese legal system was based on Confucian ideology that emphasized ethics and relationships between the people and their leaders. Disputes were settled through relationship-based methods such as mediation. The court system was undeveloped and rarely used. The People's Republic of China (PRC) began developing its present legal system in the late 1970's. It was not until the economic reforms of 1978 that a true institutional legal system was introduced, mostly to deal with the demands of the growing economy. The passage of the Sino-Foreign Equity Joint Venture Law in 1979 was the first step by the Chinese government to build a legal structure governing foreign investment. Since then, China has continued to build a legal system that will protect their rights as well as the rights of their foreign partners. Even today, China does not technically have an independent judiciary or a legal system that operates outside the influence of the ruling Chinese Communist Party. Most tangible reform in Chinas legal system has taken place in the area of civil litigation. These primarily concern business disputes associated with Chinas rapid economic modernization in which people seek protection and redress from a wide array of abuses committed in the pursuit of economic competitive advantage: patent infringement, business transactions that are not honored, individuals who have been displaced by private and state-directed construction, and labor disputes, to name a few. However it still faces some fundamental challenges including legislative gaps, hazy interpretation, lax enforcement, and philosophical disagreement.

Q2) why does China continue to attract large inbound FDI in spite of its political and other country risk factors? Which entry strategies do MNEs based outside China use for their operations in China? Why? Ans) The success of China's economic policies and the manner of their implementation has resulted in foreign companies flocking the country for investment opportunities. The major factors contributing to this are:-

Market Potential: China has a large population and the economic growth has reduced poverty to a large extent, lifting millions to the middle income group. This fact places Chinese markets into the growth stage of PLC and promises huge potential to MNEs. Market Performance: As described in the previous point, the rapid industrialization in the country has led to sudden rise in the purchasing power of its citizens. Thus, there is a higher level of consumer spending making the Chinese markets one of the most lucrative business opportunities. Infrastructure: China invests trillions of dollars every year on developing its infrastructure. These support mechanisms like numerous highways, airports, seaports, dams, power plants as well as communication networks are vital for industries to survive. Resources: Another strength that China exploits on is its well-educated population and immense pool of productive labor. The manufacturing industries particularly in China are thriving due to massive skilled workforce available on wage rates far below than many other countries. Strategic Positioning:

China has remained a primary recipient of the worlds destination of FDI in recent years. Over 190 countries from around the world invest in China, which includes 450 of the Worlds Fortune 500 companies. The companies considering China as a prospective investment zone should also realize the fact that it is in no way a uniform and homogenous market. The primary entry modes for such risky countries are listed below:a) Joint Venture This business model can be seen as a low cost and lower risk strategy in a volatile market like China. The companies majorly go for this entry method because it is an appropriate option to avoid red tape and other bureaucratic complexities which are prevalent in the country. It also has an added advantage of utilizing existing work force and facilities of the local partner as well as sales and distribution channels. The MNEs gain on the local culture which acts as a huge benefit for building good trade relationships and a loyal customer base. b) Licensing Licensing the brand to individuals and companies in China or sub-contracting with local manufacturers is one of the easier options. It requires less capital expenditure but provides limited control. c) Wholly Owned Subsidiary Entering the market by equity investment strategy in certain sectors like Manufacturing, Trading, or Services proves to be a cost effective method for MNEs. It gives them full control of operations of the subsidiary. The large skilled work force available in the country is available at low wage rates and hence it becomes a highly profitable venture. The government also welcomes this proposition since it leads to hefty revenues earned through taxes and duties. And the country economy prospers in the long run. d) Contract Manufacturing It is also one of the strategies followed by the MNEs to enter the Chinese markets due to massive labor available at affordable rates. The cost involved is minimal and the risk associated is also very low. This is of utmost importance to the companies since the government ideologies in China have been known to change abruptly and frequently in the past. Hence companies prefer options where it is easier for them to manage the operations in the face of such systemic risks posed by the country.

Q3) Explain in detail how Chinas accession to WTO in 2001 has affected its following stakeholders: a) b) c) d) Citizens China based companies Foreign companies in China Government of China

Ans) In recent years, Chinas entry to WTO and rapid economic development since the late 1990s have made it one of the most attractive places for international investors looking to gain more profit, away from the relatively saturated markets in the developed countries. Listed below are the stakeholders and the effect of this development on them:a) Citizens The living standards of the Chinese citizens have improved by leaps and bounds. Millions of them have risen to the middle class standards. China comes right after US in terms of second largest economy and Purchasing Power Parity. However this has also lead to higher income inequality as well as environmental degradation in China. b) China Based Companies - Throughout the past decade, Chinas GDP has grown at an average of nine percent per year. It moved from being the fourth-largest trading nation to the second, in both exports and imports. China has emerged as a source of outbound investment, in addition to being one of the hottest destinations for foreign direct investment (FDI). Beyond trade and investment, China has become a major creditor nation. But this export driven economy has given way to a new problem. China is facing growing external pressure to further increase its domestic consumption, as a way of contributing to rebalancing the global economy. Also, there is stiff competition faced due to international players flocking the market. The processes followed are standardized and the domestic manufacturers are always on toes to innovate due to rivalry from competitors. c) Foreign Companies in China - The legal policies and regulations appear to be a little unclear as to the specific requirements or impediments to operating a wholly owned subsidiary in China. Initially there was a foreign-owned cap of 65% that cannot be exceeded. However with WTO accession, this ceiling has been increased up to 100% in certain sectors. Another option open to foreign companies is to gain an equity position in an already existing office supply store via a merger or acquisition. This method of foreign investment is much quicker in regards to getting through approval processes as a result of Chinas WTO membership. There is also an added bonus of more transparent system in place for international trade. It forms a major advantage while dealing with an unstable and highly volatile market conditions for MNEs operating in China. d) Government of China - Since China gained entry to the organization in 2001, the belief that the WTO is a public good has taken hold in China. The 15-plus years of negotiations for WTO accession was a test of Chinas patience, but since then, WTO membership has been a driving force for market reforms. WTO entry catalyzed a transformation in how the global multilateral trading system is viewed, not only by skeptics in the government, but more importantly, in the public mindset. The Chinese government and academia undertook a major public engagement program to increase societys understanding of the multilateral trading regime. Several

thousand books have been published in the past decade to help raise awareness of the norms and rules of the WTO, in addition to a massive undertaking to modify laws and administrative practices to align them with WTO commitments. The Chinese government is putting concerted attention into ensuring that domestic stimulus measures do not violate WTO rules. Chinese authorities are listening to external complaints that are purported to be based on WTO rules.

Q4) Evaluate and explain China overall from MNEs perspective as: a) Manufacturing hub b) Distribution and Marketing hub c) Sourcing of components Ans) In 2009, China attracted a record of 105.7 billion of foreign direct investment, being the fastest growing economies of the world (Economy watch, 2011). However, many foreign companies still have reservations about establishing business there, some worry about the lack of rules and regulations of operation, the vague future of profits gain, others worry about the strategy and some other issues revolved around corruption, the rent and tax structure and intellectual property protection. The overall perspective from MNEs of China under the following heads is:a) Manufacturing Hub - China manufacturing industry has enjoyed a very fast development and its general scale has ranked in top places in the world with very obvious comparative advantages internationally. At current, as the pillar industry of the national economy of China, the manufacturing industry serves as the dominant sector for economic growth and basis for economic transformation. As an important basis for the economic and social development, the manufacturing industry is the main channel for employment in cities and towns of China and the major embodiment of international competitiveness of China. Today, however, China faces new challenges as economic growth slows wages and other factor costs rise, value chains become more complex, and consumers grow more sophisticated and demanding. For Chinese-owned and multinational manufacturers alike, the imperatives now are to boost productivity, refine product-development approaches, and tame supply-chain complexity. b) Distribution and Marketing Hub - Chinas 2001 World Trade Organization (WTO) entry brought more foreign competition, which led to the elimination of many local distribution points and the centralization of main provincial hubs. These changes allowed for greater privatization of distribution at a local level. Over the last decade, China has invested in improving infrastructure in interior cities, with a focus on building larger interior cities into major logistics and distribution hubs. Wuhan, Hubei, is becoming the multimodal logistics hub of central China. The city has one of Chinas largest inland ports, handling up to 40 million tons of cargo annually, with shipping lanes that lead to 14 countries. National highways and railway lines link Wuhan to other major Chinese cities. Foreign firms do not enjoy the same inland distribution and logistics rights as their Chinese counterparts. However, the distribution puzzle is not only faced by

foreign firms, but also by Chinese firms that operate nationwide. Chinas government regulations and regional protectionism fragment the distribution channels throughout China. The country's marketing landscape also has experienced sweeping transformation. China is a huge market and every company wants to be there, so Chinese consumers are used to having things done their way. Companies need to adapt to Chinese consumers and Chinese marketing channels to be successful. The country is still rooted to its original culture and hence brands such as Starbucks, Haagen Dazs and Nike have succeeded by bringing their products into alignment with Chinese cultural imperatives. Social media channels continue to grow in popularity across China. For a country with over 1.3bn inhabitants, use of social has become a key way for individuals and businesses to communicate. China's population has rapidly adopted mobile internet use as well and so the consumers have become significantly aware. Thus ability to create a more uniform and integrated experience across digital media has helped MNEs to engage with citizens. c) Sourcing of Components - China is the top sourcing destination for global manufacturing companies outside of their home country, as they increasingly move to maintain their R&D units closer to their production base. Other major factors influencing this response include a favorable business operating environment, availability of skilled talent, and lowest overall total cost. However, when it comes to MNEs known for their high quality technical components, China is less desirable due to their questionable quality issues. These foreign players prefer to play it safe and in-source the manufacturing of these components rather than risking the quality and overall brand dilution.

Q5) Outline Chinas economic environment today and explain in detail its implications for MNEs based outside China. Ans) Since the late 1970s China has moved from a closed centrally planned system to a more marketoriented one. In 2010 China became the world's largest exporter. Reforms began with the phasing out of collectivized agriculture, and expanded to include the gradual liberalization of prices, fiscal decentralization, increased autonomy for state enterprises, creation of a diversified banking system, development of stock markets, rapid growth of the private sector, and opening to foreign trade and investment. The restructuring of the economy and resulting efficiency gains have contributed to a more than tenfold increase in GDP since 1978. On November 1991, China joined the Asia-Pacific Economic Cooperation (APEC) group, which promotes free trade and cooperation the in economic, trade, investment, and technology spheres. After reaching a bilateral WTO agreement with the EU and other trading partners in summer 2000, China worked on a multilateral WTO accession package. China concluded multilateral negotiations on its accession to the WTO in September 2001.

However, U.S. exporters continue to have concerns about fair market access due to China's restrictive trade policies and U.S. export restrictions. Measured on a purchasing power parity (PPP) basis that adjusts for price differences, China in 2012 stood as the second-largest economy in the world after the US, having surpassed Japan in 2001. Export growth has continued to be a major component supporting China's rapid economic growth. To increase exports, China pursued policies such as fostering the rapid development of foreign-invested factories, which assembled imported components into consumer goods for export and liberalizing trading rights. China's investment climate has changed dramatically with more than two decades of reform. Since the early 1990s, the government has allowed foreign investors to manufacture and sell a wide range of goods on the domestic market, eliminated time restrictions on the establishment of joint ventures, provided some assurances against nationalization, allowed foreign partners to become chairs of joint venture boards, and authorized the establishment of wholly foreign-owned enterprises, now the preferred form of FDI. Since foreign investment remains a strong element in China's rapid expansion in world trade it has large number of implications for MNEs based outside China. There is a huge scope for industries in the manufacturing sector because of huge workforce and cheap labor rates. However it has lead to a certain level of saturation and market is now flooded with low quality goods. Chinese services sector is widely underdeveloped and has a lot of potential as the new investment hotspot. China has recently invested heavily in infrastructure projects. Thus the country is more well connected than ever leaving a wide set of opportunities for MNEs to establish their R&D center closer to their manufacturing zone. China is the world's largest producer and consumer of agricultural products making it the most desired sourcing destinations for MNEs operating in Food industry. Also, the rapid industrialization in China has created an import avenue for minerals from abroad. Thus MNEs operating mainly in Australia and United States have been thriving in the profits due to soaring imports of iron ore in China. The contribution of automotive and steel industry has been staggering in the total GDP of China. Thus it is the most coveted sector for FDI due to the comparative advantage this country has in terms of manufacturing and technology. China will also soon make further announcements regarding affordable housing and more accessible healthcare. These investments would allow the consumers to save less and spend more. The new One child plus policy will substantially raise the birth rate, contributing up to 2 million new children to the 2014 economy, a 15% one-year lift that will only further boost consumer morale and spirit.

References: 1. Global Value Chains- International sourcing to India and China : http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Global_value_chains__international_sourcing_to_China_and_India 2. History of China : http://en.wikipedia.org/wiki/History_of_the_Republic_of_China 3. Economy of China : http://en.wikipedia.org/wiki/Economy_of_China 4. Picking the World Champion of Trade | The Economist : http://www.economist.com/news/finance-and-economics/21594343-which-country-gets-mostout-international-commerce-trading-up?zid=306&ah=1b164dbd43b0cb27ba0d4c3b12a5e227 5. Chinese Capital Flows Hot & Hidden | The Economist : http://www.economist.com/news/finance-and-economics/21594345-despite-strict-currencycontrols-money-finding-its-way-china-hotand?zid=306&ah=1b164dbd43b0cb27ba0d4c3b12a5e227 6. Whats next for China? Economists are split : http://www.cnbc.com/id/101348391