The China Vortex

China Law Blog is a good source of legal information about Chinese business and investment regulations and one of his comments in my previous post got me thinking about why Chinese entrepreneurs don’t like to work not just with American lawyers, but lawyers of any nationality.

Here is his comment in full:

Right idea. Wrong country. What you predict will happen, I am certain of it. I am certain of it because our German and Russian clients have over the last few weeks been calling us (here in the US) like crazy to help with this or that deal they are doing or want to do. The deals range from high tech to old line manufacturing (that’s right) to real estate. When we tell them our legal fees I can almost hear them gasp (particularly the Germans) at how low they seem for those used to paying in Euros. That’s right, step right up, the US is on sale to foreigners ….. Like it or not. BTW, no calls from Chinese and I don’t expect many either, both because they tend not to use lawyers so much and they also tend not to be big buyers of existing US companies. At least not yet.

So why is it that Chinese entrepreneurs don’t like to use lawyers and legal services, even when using them the right way, and intelligently, will help them to greatly expand their businesses?

I have a theory.

For many Chinese, “the law” is whatever the Chinese government says it is. Just because some new kind of business is done in China, does not mean it is legal, it is just tolerated. It usually means that it is so new to the slow-moving bureaucracy that it hasn’t figured out whether it should be legal or illegal, so it’s “tolerated”.

Your business may be tolerated, then the government says it is “illegal”, or it may be tolerated, then the government says it is “legal”. Then it might switch from “legal” to “illegal” and told to shutdown almost overnight. This happens, and continues to happen all the time. This is part of the price of doing business in China.

Here’s another example.

The Chinese government says that new businesses in China have to list their “business categories” and the business they are in. Think about it; does this make sense? From a business point of view, it makes little if any sense. Let’s say a consulting business needs to do a marketing survey. They may run afoul of the law because this is not allowed; they registered as a consulting business but need to do a marketing survey for a client who wants to enter the Chinese market. So while it makes perfect business sense to do this, the bureaucrats and regulators prevent it from doing so, because from their POV (the government regulators), categorizing businesses makes more sense.

Among Chinese business people, there is a large degree of frustration at these sudden changes which come out in the morning, and may change before the sun goes down. For Chinese entrepreneurs, this is the face of the law.

So, in order to succeed, they spend a huge amount of their time avoiding the regulators and getting warned, or even shut down. If the regulation comes from Beijing and they are in Hangzhou, they will go talk with Hangzhou city government officials to avoid getting crushed because local Chinese officials have the power to “interpret” the law. Sometimes this means ignoring what Beijing says, without openly confronting Beijing.

And this is why many Chinese entrepreneurs avoid lawyers, because so much of the time, the government officials are the face of the law, and are not there to represent their rights, but are there to warn them, or even shut them down. So, from their perspective, the law is bad news.

When Chinese companies go overseas, they continue to act this way. They avoid relatively small up-front legal fees, thinking that they can outmaneuver them and the regulators, never thinking that the law can in fact work both ways, and can help them to gain benefits. They are guilty of thinking that they are still in China and behave as if they were still in China.

Moreover, they know that the advantage of Chinese businesses lie in their cost structure, and fear losing it if they go overseas. This means that they act very cheap when they go overseas, and acquire reputations for being cheap and micro-managing their foreign employees, trying to extract every little bit of time and value out of them.

In the long-term, this hurts the reputation of Chinese companies as a whole.

In fact, company cost structures evolve and adapt to the market and society they are a part of. No country can have the same cost structure as China, just as no country can have the same values as America does.

And there is no reason that they should.

In an article for the Oct. 29 issue of Caijing, writer Xu Shanda (许善达) claims that Chinese corporate earnings are inflated. In the Chinese language article, Xu claims that there is an earnings bubble. The article summary says this (my translation):

The government should no longer listen to Chinese enterprises’ requests to turn their costs to social costs. It can no longer listen to their efforts to infringe on the rights of all citizens to suit only their own unreasonable and illegal corporate earnings requirements. In real terms, this means that the government must step up its own efforts to build a social welfare system, an environmental welfare system, strengthen legal enforcement, and at the same time, create a new market system for the trading of resources so that a pricing system which more realistically reflects market realities can take root.

In the article, Xu claims that corporate earnings for many Chinese companies have continued to go up because they have not had to pay for social security and environmental costs. With such low operating costs, of course they would have high corporate earnings.

Now here is where it gets interesting. Xu Shanda is not an outsider; he serves as an independent director of ICBC, one of China’s state-owned banks, and was the former vice director of the National Tax Bureau.

In effect, Xu is arguing for a social security system to protect the poor, and for increased taxes to clean up the environment during China’s high-growth phase. High-growth was a top priority during the last years of Deng Xiaoping and during the Jiang Zemin years. In contrast, the administration of Hu Jintao is recognizing the high costs of the environmental damage created by reckless growth. The person now leading the charge re environmental affairs is Wen Jiabao, who is reviewing many major engineering projects.

For many Europeans, Xu sounds like a social democrat, or what is called in US politics, a liberal.As a an American, it is very ironic to see a Chinese government official argue for the kinds of things which the Bush administration is so keen on dismantling in the US, even though US public opinion largely believes that there are serious environmental issues which need to be addressed.

For the Chinese government, the current situation is about finding the right balancing point for China. If China adopts a social welfare system like western Europe’s, they are afraid that costs will go up and so will unemployment. Chinese goods will be less competitive on the global market. However, if they do not raise them, the destruction of the environment in China will continue, and many businesses will not be held accountable. It would become like the US, where the system favors large corporations while offering lip service to the little guy. (It was not always this way in the US, but it has markedly changed because of recent US changes to the US Supreme Court and recent court rulings.)

There are early signs that the Hu administration is taking steps to bring market realities to resource pricing; yesterday the Chinese government raised oil prices by nearly 10%.

So, there is strong internal pressure in China to make corporations more accountable, just while the US is privatizing more public sector services and is making them less accountable.

For those in the US who believe that privatization is the answer to all of the country’s problems, they would do well to come to China and look at some of the effects. A lot of this damage is done by a combination of corruption, cronyism and privatization.

Ironic, isn’t it?

UPDATEIf you are interested in how the Bush administration’s proposed tort reform would largely take away from US citizens the right to sue corporations for environmental and product violations, please visit the Wikipedia entry on tort reforms. This is the kind of legislation China needs to curb corporate excesses, although the Chinese are very conscious that they want to limit misuses and abuses of the system as have occurred in the US. What the Bush administration is proposing though, is not a reform, but more or less turning the clock back and making consumers rely on the “goodwill” of large corporations to protect them. Since I am not an attorney, this may be an area Dan Harris, publisher of China Law Blog, may want to shed some light.

Richard Spencer also has an article which suggests that the western interest in China’s conditions and policies may be more tied to China’s rise as an economic power than to a true interest in those issues.

Hmmm…That’s good food for thought.