by Frank R. Mack
China has become the factory
of the world as international companies flock to the land of the dragon in pursuit of lower-cost manufacturing, access to an expanding
Asian consumer market, and premium returns on investment. This long-term trend
presents extraordinary opportunities and challenges for professionals in the
corporate renewal industry.
Even those whose current practices are primarily U.S.-based are likely to
experience a China component in future engagements. This article presents an
overview of opportunities for corporate renewal professionals to expand their
practices in China as the result of the country’s future potential reforms.
Since China began its economic reforms in the 1970s under then
re-empowered leader Deng Xiaoping, the country has evolved progressively into a
modern economic powerhouse and future superpower. The 1979 economic reforms
instituted by the Third Plenum of the 11th Central Committee of the Communist
Party of China represented a major policy shift from Mao Zedong’s “Great Leap
Forward” and “Cultural Revolution” Little Red Book policies. Under a “Four
Modernizations Program” targeting agriculture, industry, science, and defense
and its acceptance as a member of the World Trade Organization (WTO) in 2001,
China has achieved global investment and trade with the capitalistic economies
of the West and East.
China’s modernization path has been — and continues to be under President
Hu Jintao — both pragmatic and non-ideological. This is true despite challenges
such as the 1989 Tiananmen Square protests and subsequent demands for political
reforms (the Fifth Modernization – Democracy), and re-unification issues such as
the Communist and Kuomintang (KMT) parties’ positioning on the fate of Taiwan
and the reversions in 1997 and 1999, respectively, of the Hong Kong and Macau
sovereignties back to China under new Basic Laws using Special Administrative
results of China’s economic reforms over the past 27 years are impressive. More
than 300 million Chinese have moved out of poverty, and the average worker’s
income has quadrupled. The nation’s current production output approximates $1.6
trillion USD and is projected to grow to $4.8 trillion over the next 15 years.
In addition, China:
- Is the world’s fastest-growing large economy, averaging annual growth of
more than 9 percent since the inception of its economic reforms.
- Became the world’s third-largest trading nation in 2004.
- Is the world’s largest producer of coal, steel, and cement; the second-
largest consumer of energy; and the third-largest importer of oil.
- Is the second-largest holder of foreign-exchange reserves, mainly U.S.
dollars ($819 billion as of January 2006).
- Possesses the world’s largest military (2.5 million soldiers) and has the
fourth-largest defense budget.
- Launched its first manned spaceflight in 2003 and plans to launch two more
manned missions by 2007.
China’s exports to the United States have increased 1,600 percent
during the past 15 years, while U.S. exports to China have grown by only 415
percent. Its resulting trade surplus with the United States approximated $162
billion USD in 2004 and is expected to exceed $200 billion in 2005 (it was $166
billion USD as of October 31, 2005). Its material trading surpluses have allowed
China to fund deficits of its major trading partners and reduce the swings of
Some economists predict that China will overtake the United States as the
first-ranked world economic power before 2050, and by that time, China and India
together will account for approximately 50 percent of all global
Before China gained WTO membership, its economic achievements resulted
from government control over the planning, execution, funding, and management of
the country’s development, and enforcement of its commercial and trade policies.
China’s 2001 entrance into the WTO (Hong Kong and Macau were original WTO
members in 1995, and their respective Basic Laws enable these SARs to function
somewhat independently) obligated the country to meet a number of commitments.
Foreign investment and trade exploded in China as greater market access, import/
export benefits, and other forms of protection were provided under WTO
Although the Chinese government still primarily controls direct
infrastructure development, it designates zones to promote specific types of
foreign investment and trade in certain geographical areas. Special Economic
Zones (SEZs), Economic & Technical Development Zones (ETDZs), and High-Tech
Development Zones (HTDZs) offer differing legal, tax, and operative incentives.
At regional levels, industrial park structures contain Free Trade Zones (FTZs),
Export Processing Zones (EPZs), and Hi-Tech Parks (HTPs) that specify business
scopes and taxation rates.
As a result, China’s most advanced economic areas are the Bohai Bay
Economic Area, which includes Beijing; the Yangtze River Delta Area, which
includes Shanghai; and the Pearl River Delta Area, which includes Hong Kong and
Shenzhen. These three areas have attracted the majority of foreign investment
and trade because they possess world-standard infrastructures, offer favorable
zone incentives, contain good educational and cultural institutions, and have
economically vibrant commercial and consumer sectors.
Economic policies China adopted after its acceptance into the WTO have
enabled it to develop into a dominant world leader in mass manufacturing, and it
likely will remain so as it continues to expand capacity in its traditional
industries — textiles, toys, and other commodity products — as well as rapidly
adding capacity in developing industry sectors. These include digital electronic
products; consumer appliances; electronic technology, including semiconductors;
chemicals; steel; petrochemicals; automotive; and heavy
The comprehensive capacity of China’s traditional industries stems from
access to inexpensive raw materials, cost-effective technologies, managed
low-cost labor, and strong international and domestic demand. Although managed
low-cost labor is another key element of China’s traditional industries, recent
labor shortages and high employee turnover have increased annual labor costs and
eroded margins in some cases.
Textiles exemplify the comparative advantages of a traditional Chinese
industry. In 2004, China accounted for about 20 percent of the global textile
trade, a figure that is expected to rise to 50 percent for 2005 now that
30-year-old global trade agreement quotas have been
However, China’s traditional industries continue to face retaliatory
tariffs imposed by certain trading partners and to generate heated political
discussions, particularly with the European Union and the United States. These
traditional industries also are being challenged by other Asian countries, such
as Vietnam, Pakistan, Cambodia, and Indonesia, which are developing capacities
and workforce skill sets that allow them to compete with China as low-cost
producers of commodity-type products.
As such, the Chinese government is placing greater emphasis on developing
technological innovation. China is shifting to an economy based on
state-of-the-art manufacturing from one of low-cost production centered on cheap
labor. This shift is evident in China’s current automobile and light-truck
industry, which is located primarily in
In 2005, China produced about 3 million passenger automobiles and ranked
third in world vehicle production. Advances in manufacturing and logistics
methodologies have enabled Chinese companies, such as GM Shanghai and SAIC —
along with key automotive suppliers, such as Delphi Packard and TRW Automotive —
to achieve record levels of production and
Technological advances also have resulted in breakthroughs in industries
relatively new to China, such as microelectronics, nanotech, and aerospace
industries primarily located in HTDZs. The rate of technological contributions
currently is constrained by a lack of collaboration among China’s research and
development (R&D) institutes and its industries, and the country’s lack of
enforceable intellectual property protections. However, multinationals are
expected to conduct more serious R&D in China once anticipated reforms to
laws and business practices in these areas are
Outside of manufacturing and technology, the Chinese government also is
reshaping the nation’s economy by developing service industries, such as
telecom, retail, and tourism, which are located primarily in the East Coast
Region of the country. China’s continued economic development will materially
shape the global economy of the 21st
China’s demographics, as well as the growing affluence of its
people, play important roles in the country’s economic development and in
securing foreign investment. China’s population dwarfs that of the United States
— at 1.3 billion, its population is four times that of the U.S. China’s East
Coast Region, which includes Hong Kong, Macau, Shenzhen, Fuzhou, Hangzhou,
Shanghai, Nanjing, and Beijing, has a population of 376 million and produces an
annual gross domestic product of approximately $1.1
Many inhabitants of this region are educated and affluent. They also are
passionate consumers. China currently has the largest base of cell phone
subscribers in the world, estimated at 350 million. It is also one of the
world’s largest markets for computer-related products and services. Mandarin is
the second-most-used language on the Internet, and China probably will overtake
the United States in homes connected to broadband by
China’s emerging middle class has proven to be a fast-growing market for
sophisticated consumer multimedia electronics, from MP3 players to plasma
television sets; automobiles, including high-end European, Japanese, and
American brands; homes and apartments through real property leases and
structural ownership; and durable home products, from furniture to appliances.
Some economists predict that China has the potential to become the world’s
largest consumer market during the 21st century. For multinationals, these
demographics and consumer trends make China an extremely appealing market in
which to invest.
China has experienced many obstacles to development under its communist
dictatorship. The country lacks well-defined property and civil rights;
comprehensive laws for banking, capital markets, and bankruptcy; and judicial
processes and systems. In part, the nation’s profound achievements are the
result of the Chinese government’s continuing control over the planning and
management of development and the commercial entities that comprise China’s
economy, the imposition of trade subsidies, and the manipulation of its
currency, the Yuan [also known as renminbi
China’s success also lies in part in its acquisition after achieving WTO
membership of the intangible assets that come bundled with foreign investment:
Western-educated and internationally experienced executives, managers, and
engineers represented by professionals providing services in law, tax,
operations, logistics, risk, engineering, R&D, and sales and marketing. To
date, China has succeeded by balancing the benefits of the government’s direct
controls with the financial and intangible contributions made by its foreign
investment and trading partners.
But as foreign investment and trade continues to flow to China, more of
its citizens benefit from expanding development, and more WTO requirements need
to be satisfied, additional reforms are necessary to achieve a fair and
sustainable balance among the government’s regulatory efforts, its citizens’
rising expectations, and the demands of the international marketplace. Economic
reforms offer increasing potential for corporate renewal professionals to expand
their practices into China.
advantages of state ties for state-owned enterprises, Sino-Foreign Joint
Ventures (JVs), and Foreign-Invested Joint Stock Limited Companies (FISCs) can
be enormous. State-owned enterprises in key industries are chosen by the
Communist Party to lead China’s economic development, and these companies
receive lucrative contracts, tariff protection, cheap land, easy credit from
state-owned banks, and preferential treatment for listing shares to facilitate
their charters. The Chinese government also steers foreign partners to these
companies to ensure that they have access to critical resources, such as
executive management, technology, R&D, and foreign
Each state-owned enterprise, JV, and FISC has a Communist Party
organization that acts as a shadow management and approves all major decisions
and management appointments. For example, the state-owned holding company of
Assets Supervision & Administration Commission has a controlling stake in
nearly 200 major companies, monitors management and performance of operations,
and actively intervenes whenever it best serves the interests of the Communist
For American multinational companies that are foreign invested
enterprises (FIEs) in JVs and FISCs, the long-term benefits generally more than
offset the inherent inefficiencies of Chinese businesses. JVs and FISCs benefit
from a variety of Chinese policy incentives. In addition to those mentioned
earlier, tax breaks and operative incentives are often provided. Controlling
state-owned partners in JVs and FISCs also tend to permit the executives
provided by their foreign partners to manage these companies consistent with
agreed-upon business plans.
The concept of
applies. As long as foreigners
understand the expectations of the Communist Party and what and who is important
— what is expected of them from whom and when — JVs and FISCs managed under
foreign stewardship can be enormously successful and
Two forms of limited liability JVs currently are available: equity
joint ventures (EJVs) and cooperative joint ventures (CJVs). A holding company
(HC) is a special-purpose limited liability company that
permits foreign partners with multiple investments to coordinate its
A FISC is a form of FIE that allows issued
shares to be traded on China’s stock exchanges. Foreign partners in these types
of FIEs tend to be well-capitalized, well-managed multinational corporations
that are represented by experienced professionals, including international
attorneys, investment bankers, tax advisors, and corporate renewal
Foreign entities can now operate businesses in China without government
involvement by forming Wholly Foreign-Owned Enterprises (WFOEs) and
Representative Offices. WFOEs are limited liability FIEs in which one or more
foreign entities own 100 percent of the equity. WFOEs permit management to
control the company’s business plan and execute it — with no Chinese partners or
shadow management — although certain scope restrictions may exist, depending on
WFOEs are most favored by American middle-market companies comfortable
with foreign equity investments requiring optimum control and seeking to engage
in direct business operations in China, including the domestic sale of products.
Currently, foreign entities are not permitted to set up branch offices in
Rep Offices are non-FIEs that are prohibited from engaging in direct
business operations in China. Foreign entities that establish Rep Offices are
limited to conducting local research and promotional and marketing activities,
including assessments of FIEs performing Chinese outsourced operations. They are
preferred by smaller American companies that require low-investment entry into
China to acquire first-hand market information and that are not averse to being
responsible for such an office’s liabilities, such as debt the company assumes
and wages and benefits promised to its
WFOEs and Rep Offices offer growing opportunities for corporate renewal
professionals providing services in North America and China. U.S. companies
utilizing North American production in markets in which lowest landed cost is a
decisive factor are increasingly losing market share and realizing operating
losses as a result of competitors that already use China
American companies that find themselves at such a competitive
disadvantage can set up WFOEs or Rep Offices, establish China-based
manufacturing operations, wind down their North American operations, divest
themselves of these assets, and settle resulting liabilities. Corporate renewal
professionals can provide operational, logistical, and financial services to the
China operations and manage or advise the wind down, asset conversion, and legal
processes of the discontinued North American
Traditional crisis management and insolvency services can be provided to
at-risk American companies that don’t implement successful China outsourcing
strategies. Professionals engaged to sell American companies or their assets
should consider Chinese companies as potential purchasers for certain assets,
especially intellectual property.
Mismanaged government-owned banks represent one of the greatest
risks to China’s continued economic development. China’s banks, especially the
“Big Four” — Bank of China, China Construction Bank, Industrial & Commercial
Bank of China, and Agricultural Bank of China — haven’t acted as “banks” in the
Western sense of the word, but rather as financing arms of the Chinese
government to fund centralized planned development. As such, China’s banks lack
the credit and risk controls, information technology systems, and management
processes typical of Western banks.
The Big Four have provided most of the funding provided to favored
state-owned enterprises, and their combined uncollectible loans are estimated at
$120 billion, or 10 percent of their portfolios. Although Shareholding Banks,
City Commercial Banks, and Rural Banks historically have been more rational in
their lending practices, their respective portfolios also contain unacceptably
high levels of risk and bad loans.
China’s banking practices have resulted in significant opportunity costs
as well. Financial products necessary to facilitate future development, such as
consumer and trade financing, are currently materially underrepresented in the
portfolios of China’s banks. The banks have received about $100 billion in
bailout subsidies from the government and may require an additional $200 billion
by the end of this century to remain operational.
China is opening its banks to foreign investment in 2006 not only to
comply with WTO requirements to open its bank sector to full competition by
2007, but also to minimize future government-funded bailouts and expand the
financial products necessary for continued economic development. After the
reform takes effect, China will be obligated to begin permitting foreign-funded
banks to provide RMB services to their Chinese clients. Those services likely
will be phased in gradually.
The China Banking Regulatory Commission initially
capped the maximum amount of foreign investment in a single Chinese bank at 25
percent, although it is widely expected that this cap will be increased soon to something
approaching 50 percent.
The Chinese government already has consented to investments by Bank of
America and Temasek Holdings Pte. in China Construction Bank; Goldman Sachs,
American Express, and Allianz in Industrial & Commercial Bank; Citigroup in
the Shanghai Pudong Development Bank; and UBS AG, Temasek Holdings Pte., Royal
Bank of Scotland Group, and Asian Development Bank in the Bank of China. In
addition, HSBC has been granted a 19.9 percent stake in China’s fifth largest
bank, Bank of Communications.
Although it is unlikely that the government will allow its foreign
partners to exercise significant control over China’s banks, foreign partners
are being allowed to import the senior executives, management processes,
information technologies, and financial products (commercial, trade, and
consumer) typically found in Western banks. For corporate renewal professionals
experienced in bank turnarounds, credit and risk management, portfolio
development and securitization, and workouts of high-risk loans, banking reform
in China represents significant
China’s current bankruptcy laws are primarily found in
Regulations of the Supreme People’s Court on Several Issues in the Hearing of
Cases of Enterprise Bankruptcy (2002), which attempts to clarify The Law of the
People’s Republic of China on Enterprise Bankruptcy of 1986 (applicable to
government-owned enterprises), the Civil Procedural Law of the People’s Republic
of China, the Company Law of the People’s Republic of China, and the Measures on
Liquidation Procedures for Foreign Investment Enterprises (these are applicable
to all non-state-owned enterprises).
to the complexity, certain local governments, such as Beijing and Shanghai, have
their own rules on the liquidation of foreign-owned enterprises. China’s current
web of bankruptcy laws is based on traditional Communist Party policies — that
is, they focus on domestic stability rather than on the economic ramifications
of foreign investment and economic reforms. The impetus for a uniform bankruptcy
law also lies in the Chinese government’s desire to discontinue subsidies to
state-owned enterprises for overcapacity, uncompetitive methodologies,
corruption, and business failure. Given the inadequacies of the current
bankruptcy law for both state and foreign investors, ratification of a uniform
bankruptcy law is necessary and expected.
The State Council and the Standing Committee of the
National People’s Congress have reviewed numerous drafts of the new bankruptcy
law as prepared by the Committee of Finance and Economics of the National People’s Congress.
Drafts of China’s uniform bankruptcy law incorporate concepts familiar to
American bankruptcy and insolvency professionals: uniform bankruptcy criteria;
requirements of bankruptcy petitions; venue choices; rules for court-appointed
administrators responsible for managing a debtor’s assets; rights of creditors
to supervise the bankruptcy case; reclamation rights for creditors; recovery of
fraudulent conveyances and preferential transfers; processes for effectuating
plans of conciliation (reorganization), liquidation, and dismissal; provisions
for cross-border insolvency issues; and processes for the payment of creditor
Although a uniform bankruptcy law is viewed as a
critical reform for China, when such a law will be finalized and ratified is unknown. However,
corporate renewal professionals specializing in bankruptcy and insolvency
services will have an excellent opportunity to expand their practices into China
once its uniform bankruptcy law is ratified.
Much to Do
Communist Party of the People’s Republic of China is to be commended for its
stewardship over the successes of its economic reforms, measured rate of change,
and cultural stability. However, China still must resolve significant issues
that materially threaten the sustainability of its economic development and
prosperity. Some of the issues foreign investors, trade partners, and their
respective professional advisors are watching include:
- Avoiding one of the Communist Party’s worst fears — domestic social unrest
- Resolving international geopolitical and trade issues consensually and
avoiding adversarial resolutions, especially war.
- Accomplishing the reunification of Taiwan consensually within the
framework of a “One China Policy” or being prepared to compromise.
- Successfully reverting Hong Kong and Macau back to Chinese sovereignty
after their respective Basic Laws expire.
- Creating policies with India that create a market-driven “Chindia” or
reforming its economic policies faster than India can create infrastructure
and effectuate cultural change.
- Facilitating education and job creation for the tens of millions expected
to enter the workforce annually and preventing substantial numbers of people
from sliding back into poverty.
- Facilitating continuing education and career advancement for the hundreds
of million of workers who comprise China’s growing middle class.
- Continuing to implement economic policies that attract multinational
investment to China’s vast heartland, and promoting economic development of
its second-tier cities and the continuous development of their respective
- Remedying ecological problems, such as air and water pollution and ground
- Implementing energy policies to source and use oil, natural gas, and other
energy resources more effectively and efficiently.
- Enacting and enforcing uniform property laws, including intellectual
property; contract laws; and other critical business reforms, including
uniform bankruptcy laws.
- Creating federal and regional court systems that can equitably resolve
domestic disputes involving commercial laws and other business matters that
cannot be remedied under the nation’s current system of arbitrage.
- Evolving the People’s Bank of China into an entity that sets market-driven
monetary policies and regulates banks and financial institutions.
- Criminalizing corruption and other questionable business practices and
- Creating regulatory agencies that enforce reforms, laws, and transparent
Economic and cultural reforms in China present opportunities for
corporate renewal professionals and their clients. However,
China remains one of the world’s riskiest, most complex markets, and any party
contemplating entering it should be advised by qualified