Doing Business in China Risks Analysis

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Abstract

The liberalization of the Chinese markets has given an unprecedented boost to the Chinese economy in the last few decades. The emerging Chinese wealth and development, however, is something of a mixed bag in the sense that China’s economic growth appears to be more of an urban phenomenon. Still, there is no denying the fact that Chinese economy is continually developing at a fast pace. Discernibly, the scenario seems to be fraught with propitious opportunities and possibilities for the foreign investors. Since the last couple of years, the Chinese GDP has been growing at a steady pace of approximately 8 percent per annum (McGregor 2007). The Chinese GDP in 2007 stood at $3.42 trillion (McGregor 2007). Credible experts and institutions expect the Chinese economy to become the world’s largest economy by the end of 21st century. However, the development in China exhibits gross income disparities, a trend bolstered by the ensuing liberalization of the domestic markets. Not to mention that an undemocratic political setup has multifarious ramifications those have a direct detrimental impact on the economy. The growth of human capital in China has been non-uniform and sluggish, with the fruits of progress captured by urban centers and politically elite (Plafker 2008). Western companies tuned to a lot of liberal and transparent structure seem to be optimistic but apprehensive about joining the Chinese world.

Doing Business in China Risks Analysis

Table of Contents

  • 1.0 Introduction
  • 2.0 PESTEL Analysis
    • 2.1 Political Factors
    • 2.2 Economic Factors
    • 2.3 Social Factors
    • 2.4 Technological Factors
    • 2.5 Environmental Factors
    • 2.6 Legal Factors
  • 3.0 Risk Analysis of China
  • 4.0 Risk Analysis Commentary
  • 5.0 Recommendations
  • Appendix
  • Works Cited

1.0 Introduction

The economic reforms China implemented in the 70s and 80s definitely succeeded in transforming China’s global image. It was only owing to these reforms that the sectors devoid of state interference exhibited a marked growth. The opening up of the Chinese economy definitely made way for foreign investment and trade. However, the momentum of reforms in China though steady has been more or less cautious and slow. Ushering the changes has resulted in a modest but definitive transfer of power and obligation to local actors (Hexter 2007). Still, these reforms failed to yield the expected results owing to the rampant corruption and the stringent control of the state government. The per capita income in China is very low when compared to the global standards. However, the Chinese economic setup has proved to be resilient and adaptable. The calculated decentralization of power and the establishment of special economic zones definitely succeeded in attracting the foreign investors. Yet, the Chinese economy is predominantly agrarian, though the over all contribution of the agriculture sector to the national GDP is negligible. On the one side, China is trudging towards a market-oriented economy, but on the other side, the inbuilt political constraints and social mores have failed to respond commensurately. This makes it utterly difficult for the foreign investors to develop a balanced perceptive towards China, an economy opting for capitalism, while being inherently totalitarian and communist (Zeng & Williamson 2007). The purpose of this report is to assess the type and level of risks expected by any organization intending to enter China.

2.0 China PESTLE Analysis

     A PESTLE analysis of the macro environment in China, which the foreign corporations will have to face, will certainly help in grasping the potential risks and constraints they may have to bear with. Definitely, most of these factors are beyond the control of the businesses intending to venture in China. Still, they need to be cognizant of them to chalk out a China specific strategy. It will help them align appropriately with the salient factors influencing and defining the business environment in China.

  • 2.1 Political Factors

Traditionally, the Chinese political system has been communist and totalitarian. However, in the recent years, a yearning for political reforms has gained acceptance amongst the top politicians in the Communist Party. Leaders hailing from the top echelons of power, which includes the President Hu Jintao and the Prime Minister Win Jiabo, have tacitly, but discernibly expressed the need for political reforms. The leadership in China is awakening to the fact that it will be practically impossible to sustain the economic reforms and growth in the absence of wide scale political reforms (Gao & Tian 2006). There is a growing realization that democracy and modernization go hand in hand. However, realistically speaking, such lofty sentiments for democracy have utterly failed to wrought significant changes at the grass root level (Jiang & Hall 1996). To a majority of the Western intelligentsia, Chinese clamour for political openness sound pure and insincere rhetoric. However, some Western political thinkers and think tanks are of the view that the scale of democracy alone cannot gauge the political progress in China. Still, the scope for political reforms in China vacillates between the possibility of an eventual metamorphosis into a free and democratic society to a chaotic deterioration to a state of civil war and conflict (Huchet 2006). However, the contemporary reality is that China stands to be a free market economy governed by a totalitarian, single party system. Any Western organization intending to do business in China will have to strike a balance between a need for political openness and economic imperatives.

  • 2.2 Economic Factors

According to a recent report promulgated by the World Economic Forum, the dipping of China’s growth rate below 6 percent poses a grave risk to the local and global economy (Billskis 2009). Considering the size of the Chinese economy and its stature of being the main creditor to the US means that a slowdown of the Chinese economy may translate into a major deterioration in the global economy (Billskis 2009). One major factor that is hampering the Chinese economy at present is a sharp plummeting of the exports originating from China. The resulting economic slump has the potential to give way to a social unrest in China. The belief that the Chinese economy may prove immune to the current global crises is fading fast. The Chinese economy that was resilient and stable until date is eventually crumbling before the sub-prime induced global economic meltdown (Einhorn 2009). As per the latest available data, the rampant global crisis has hit hard the manufacturing industry in China (Einhorn 200).

The irony of the situation is that at a time when the world expected China to be an engine of growth, it is sinking deep into an economic slump (Lim 2008). The resulting inflation has escalated the cost of raw materials and labour. A majority of the Chinese manufacturers are reporting a 40 to 45 percent decline in the turnover (Lim 2008). The worst hits are the small businesses in China that acted as ancillaries to big companies.

  • 2.3 Social Factors

Foreign firms often find the business environment in China to be strange and unfamiliar. China being a predominantly Confucian society has close knit and tight business networks. Surprisingly, the business decision making in China is often dependent on the right connections and affiliations, rather then on the cost or quality of the products or services (Chi-Yue 1990). Chinese business community believes in a mutual and continual exchange of favours that are often devoid of sound business values and ethics. Such considerations in the Chinese enterprises are contrary to the universal paradigms of performance and efficiency. In such a scenario, foreign enterprises often find it hard to integrate into the Chinese social and business networks. Even if they somehow manage to adapt to such unique circumstances, it does not guarantee success.

This peculiarity on the part of the Chinese society does not mean that it is rigidly monolithic and impervious to change. The unstoppable wave of modernization in the last three decades has immensely changes the social fabric of China. On particular thing that is the hallmark of the Chinese society is its ability to grapple with paradoxes (Faure & Fang 2008). With the onset of affluence, China is gradually giving way to sweeping socio-cultural changes. Still, the contemporary Chinese society is largely bound to the age-old ways of thinking and perceiving. A march towards the future anchored inextricably to a reverence for the ancient traditions.

One contemporary trend that is ubiquitous in China is the glaring economic disparities. Chinese growth is lopsided in the sense that economic development is exclusive to the urban centres alone. An exponential rise in the number of rural immigrants to the cities and towns is giving ways to problems like crime, political unrest and substance abuse (Chow 2004). Such maladies have a direct impact on the quality of labour and work ethics.

  • 2.4 Technological Factors

One of the primary priorities of the Communist Party, when it came to power was to modernize China in the sphere of science and technology. China regards technological development to be its number one priority, as far as its objective of becoming a global economic and political power is concerned (Wingrove 1995). With the onset of the economic reforms, China’s resolve to advance technologically has further strengthened. China well understands that in the 21st century, status and influence is all about technological advancement. Hence, it is adamant to bridge the technological gap existing between it and the developed world.  Maoist China lagged in technological development owing to the research model it adopted from the Soviet Union that negated the research in universities and concerted all the scientific research and development in some assorted academies (Tang 1984). The post Maoist China tried to ameliorate the situation worsened by the centralized Soviet style model by trying to improve on the existing system (Ishikawa 1972). However, an opening up to the external influences confirmed China that far researching reforms need to be wrought to overcome its technological paucity. Therefore, once again, the universities and professional institutions in China have become the centres of all the futuristic research and development. China is strengthening its relations with the centres of scientific research and development in the West. The contemporary China is well equipped to vie for contracts at a local and global level dealing with science and technology.

  • 2.5 Environmental Factors

Air pollution is the biggest environmental issue in China (Smil 1997). China is the primary emitter of green house gases and sulphur dioxide. To fulfil its energy requirements, China still primarily relies on fossil fuels. This has given way to drastic environmental problems like acid rain, water shortage, desertification, soil erosion, deforestation and much more. Since the advent of the economic reforms and liberalization, China’s atrocities towards environment have multiplied manifold. Floods are an annual catastrophe in China that claim human life and destroy infrastructure.

The carbon dioxide emissions attributed to China stand to be amongst the highest in the world. The ozone depletion potential of China is the central issues amongst the environmentalists all around the world. Until now, China had been proving obstinate to the international community’s pleas for environmental concern and reduction in the greenhouse gas emissions. However, recently China has realized that the traffic of FID is sensitive to its responsiveness towards environmental issues. Therefore, lately it has started adopting the policies and parameters that are more environment friendly and responsible (Zeng et al. 2005). China remains largely non-committal to extending any credible and long-term guarantees towards reducing its lot of greenhouses gases and carbon dioxide emissions.

The emerging urban affluence is also contributing its share of environmental degradation. The density of automobiles in China is constantly on the rise, which is becoming an additional source of environmental pollution (Day 2005). The organizations hailing from the developed countries may find the environmental norms in China to be utterly lacking and pathetic.

  • 2.6 Legal Factors

One of the biggest impediments to foreign ventures in China is the bleak scenario so far as the sanctity of intellectual property rights is concerned. Chinese regime is increasingly getting cognizant getting cognizant of the fact that an assurance of intellectual property rights to the foreign investors is vital to its objective of achieving a comprehensive and broad based growth is concerned (Cheung 2009). China is fast improving its legal frameworks to extend intellectual property rights to the foreign companies. Yet, foreign organizations and companies continually complain of the infringement of intellectual property rights, trademarks and copyrights, courtesy the burgeoning Chinese counterfeit industry.

A major factor that is inhibiting China from moving towards an authentic intellectual property rights regime is a severe scarcity of resources. Chinese officials are often more then unwilling to allocate the requisite personnel and resources to investigate cases of intellectual property rights infringement. Besides, China’s relatively limited experience of working with foreign organizations makes it deviate towards local protectionism. Even if the authorities prove willing to take action, procedural hurdles do make the possibility of investigation and apprehension next to impossible.

Earlier the foreign companies were encouraged to shift their manufacturing operations to China, enticed by its cheap labour. Yet, the Chinese style protectionism often inhibited them from moving ahead. However, China has appropriately dealt with this problem by passing a new Labour Contract Law in 2007, which intends to strike a balance between the need for organizational flexibility and labour protection. The primary objective of this law is to encourage better relationships between the employers and the employees. Labour abuse by the local companies is a standard practice that has attracted the ire of the developed world.

3.0 Risk Analysis of China 

The risk analysis under consideration relies on eight factors and their respective sub factors. Each of the sub factors is scored on a scale of 1 to 10 and then weighted as per the importance associated with each factor. The economic factors are obviously given more importance as compared to other factors. This is evident from the table given below.

Country Risk Analysis Table on China
Factor 

Item

   
Relevance WeightingReliability Avg.Level
Economic factors

 

 

Size of GNP and rate of growth

Nature of development plans

Resistance of recession

Trade balance

Foreign exchange methods

Stability of currency

Remittance and repatriation rules

Balance of economy(industry, agriculture and trade)

Market of product: size

Per capita income

Income distribution

Inflation rate

Other

 

           14%

5%

10%

5%

5%

8%

5%

8%

 

10%

10%

8%

8%

4%

          9(1.26)

7(0.35)

9(0.9)

5(0.25)

5(0.25)

7(0.56)

6(0.3)

6(0.48)

 

9(0.9)

8(0.8)

6(0.48)

7(0.56)

4(0.16)

  High

Low

High

Low

Low

Medium

Low

Low

 

High

High

Low

Medium

Low

 

 

 

Totals100%              88(7.0)  High
Political factorsStability of government

Conflict between social groups

Attitude towards private foreign investment (government and other)

Nationalization threats

State industry (presence)

Protectionism

Political groups: their power

Other

                10%

20%

30%

 

15%

7%

8%

6%

4%

             9(0.9)

7(1.4)

8(2.4)

 

6(0.9)

5(.35)

6(.48)

4(.24)

3(0.12)

  High

High

High

 

High

Low

Medium

Low

Low

Totals100%            48(6.79)  High
Governmental factorsFiscal and monetary policies

Competence of bureaucracy

Fairness of courts

Modern corporate law structure

Intellectual property law

Price controls

Ownership controls

             20%

10%

15%

15%

25%

8%

7%

          9(1.8)

6(0.6)

4(0.6)

4(0.6)

5(1.25)

6(.48)

4(.28)

 

  High

Medium

Medium

Medium

High

Low

Low

Totals        100%         38(5.61)  Medium
Geographical factorsNecessary infrastructure(ports, power, roads, communications)

Raw materials availability

Distance to markets and suppliers

Supporting industry (packaging, etc.)

Ease of import and export

Cost of suitable land and buildings

Other

 

20%

15%

15%

10%

20%

15%

5%

8(1.6)

8(1.2)

7(1.o5)

6(0.6)

9(1.8)

7(1.05)

4(0.02)

High

High

High

Medium

High

High

Low

Totals          100%          49(7.32)  High
Labour factorsAvailability, quality and reliability of all levels of staff

Labour climate

Expatriate labour cost and availability

Mandatory costs (minimum wages, fringe benefits, etc.)

Other

35%

 

25%

15%

20%

5%

 

          9(3.15)

 

8(4)

8(1.2)

7(1.4)

5(.25)

High

 

High

High

High

Low

Totals          100%          37(10)  High
Tax factorsRates

‘Morality’ (fairness)

Long-term trends

Incentives

Treaties

Other

30%

25%

20%

15%

7%

3%

          8(2.4)

8(2.0)

6(1.20

5(.75)

5(0.35)

4(.12)

High

High

High

Medium

Low

Low

Totals          100%          36(6.82)   High
Capital factorsLocal availability, cost and terms

Availability of efficient banking system

Home country attitudes to source of capital

Other

Total

40%

30%

20%

10%

100%        

         5(2.0)

6(1.8)

7(1.4)

5(0.5)

23(5.7)

High

High

High

Low

High

Business methods factorsGeneral ethics

State of development of the marketing system

Normal profit structure

Local competition

Other

Total

40%

20%

15%

15%

10%

100%

          5(2.0)

          7(1.4)

          7(1.05)

8(1.2)

6(.06)

 

33(5.71)

  High

  High

  High

  High

  Low

 

High

Firm-or industry-specific factors critical to the success of the product or service    
Totals                    
 Grand TotalsN/A         352(54.95) 

     High

4.0 Risk Analysis Commentary

The given commentary will delve upon the factors that pose a high risk to the organizations thinking of venturing into China.

With the busting of the boom bubble, the business climate in China smacks of a high to medium risk. A sharp decline in the GDP and the growth rate portends a serious risk to the Chinese economy, which is indicative of a stunted access to capital and restrained growth potential. Going by the fact that China is greatly dependent on its manufacturing industry and export of the finished goods, this debilitating crash has vitiated the business climate in China.

However, China tends to project a stable situation, a sudden fall in exports and high inflation is threatening the viability of businesses in China. Luckily, China’s huge foreign exchange reserves do have the potential to offset the consequences of this chronic economic slowdown.

In general, China’s attitude to private business and foreign investments is healthy and favourable. This trend is going to be bolstered by the need to retain global competitiveness in the times marred by recession. Besides, Chinese government is making massive investments in infrastructure projects.

The biggest gnawing problem eating into the possibility of an all-inclusive growth is the wide scale corruption in China. Irrespective of the drastic measures taken by the state, corruption is still rampant in China’s political and economic framework.

Lax intellectual property rights laws are one other major problem in China. In the existing recessionary environment, China may restrain from controlling this problem owing to a dire need to go for domestic protectionism. With a fall in the demand of finished goods, the counterfeit industry in China may prosper in a big way, cashing on the established brand names and copyrights.

It is understood that a further push to the Chinese economy is to a great deal dependent on political reforms. Capitalism is a system that refuse to align with any other political system except democracy.

5.0 Recommendations

  • The redeeming feature about China is that it has a gargantuan domestic market that largely can compensate for the fall in exports. The foreign corporations facing tough situations at home can certainly benefit by entering into the Chinese market. An affluent urban middle class in China can still afford to spend money.
  • The cheap Chinese labour with the latest Labour Contract Act offers an ideal opportunity to the foreign investors to build on their global competitiveness by shifting their manufacturing facilities to China. This will not only allow for cost effective exports, but the foreign organizations can also benefit from the behemoth local markets.
  • The foreign organizations should try to collaborate with the well-established local competitors. This will allow for an efficient pooling of resources, besides a chance to benefit from the expertise and understanding of the local players.
  • The foreign organizations should develop the expertise to safeguard their intellectual property rights in China. The Chinese government is already showing an enhanced predilection for respecting the sanctity of intellectual property rights.
  • The Chinese environmental laws being not that stringent, the foreign organizations can save the expenditures incurred on the costly green technologies by shifting their manufacturing operations to China.

Appendix

  • Sources resorted to for general reference purposes: Euromonitor International: <http://www.portal.euromonitor.com/>
  • World Trade Organization (WTO): <http://www.wto.org>
  • International Bank for Reconstruction and Development (IBRD): <http://www.worldbank.org/ibrd>
  • CIA- The World Factbook: <https://www.cia.gov/library/publications/the-world-factbook/>
  • Economist Intelligence Unit (EIU): <http://www.eiu.com/>
  • UK Trade & Investment: <www.uktradeinvest.gov.uk/>

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