The China Vortex

In the west, there is a whole industry called “risk consultancy”. Basically, this industry is built around informing large- and medium-sized corporations about risk. Originally, this was built around business risk and would answer questions like “How safe is it to invest $500M in an industrial diamond mine in the Congo (formerly Zaire)?” The consulting firm would then send practice consultants to the target country, where they would study sunk costs (including bribes which were never written about in the report, regulations, who was related to the president, political opposition, major competing firms, etc.) Most of these questions were positioned as questions which any board would ask the CEOs before they would greenlight an investment.

Underlying all this is the belief, at least in west and among western corporations that “risk” is something which can be quantified and measured objectively.

One of the big topics in the west now is China’s investments in Africa. What is fascinating about China’s investments in Africa is that while the amounts of money and people who go to Africa are huge, China really doesn’t have risk consultancies, and Chinese really have not yet started thinking in terms of quantifying risk in the ways western corporations have.

So how have the Chinese judged risk so far, and will the present method change over time to something more akin to the western way of thinking? When it comes to Chinese investments in Africa, many of the early-stage investments were a part of Chinese foreign policy aimed at securing raw materials for manufacturing, and more importantly, energy sources. The typical model has been to find a country, build a new palace for the president and a new sports stadium to win over the people. This would help state-owned construction firms to gain a footing in the country, which were then quickly followed by Chinese logistics firms and wholesale distribution firms which would sell products to the local African population.

Viewing the local African population as customers were one area where Chinese viewed Africa fundamentally differently from the west. While Beijing, Shanghai and the Chinese tier one and tier two cities are relatively modern, it is very easy to forget that when it comes to pervasive poverty, China is only 10-20 years removed from the levels of African poverty. Basically, Chinese companies know how to sell to poor people because they had lots of practice in China.

When you are working from a low cost basis, there really is not a whole lot of need to measure risk because the only way to go is up. Remember, in China labor is still very cheap compared to the west, and the Chinese government is always interested in keeping people employed in the interests of social stability. On the other hand, when you have large risks but your investments are backed by the Chinese government, there is not a need to measure them either. But things get complicated when you are in the middle, and are a mid-sized Chinese company (US50M-1B) which is private and are looking at Africa, as many are now.

Right now, the path many are taking is to send executives, management and staff wholesale to Africa, and basically telling them to figure things out on the ground. This is the Chinese version of “Let’s throw spaghetti at the wall and see what sticks” approach. But what happens when you don’t really have the protection of the Chinese government and local Chinese embassy, and the Africans start complaining that Chinese companies aren’t creating enough local jobs for local Africans? Obviously, these are the sorts of questions which are very complicated, since they include a social factor, in addition to the corporate and economic equation.

Will the Chinese companies turn to the western risk consultancies? Not likely. First of all, they are too expensive by Chinese standards; Chinese management is still very price-sensitive and is not likely to be willing to spend the large amounts which these companies charge. Also, they are not likely to entrust this kind of sensitive information to an outside firm which may recirculate some of the data for a competitor. Most Chinese companies are very tightly held, and risk is whatever the CEO thinks it is at that moment in time.

For western corporations which work from a high-cost basis, risk consulting is an item on “research” for executives, even though it may easily run into the millions of dollars.

For the Chinese, that’s way too much…

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