China’s rise is one of the key narratives of the 20th and 21st century with its rapid development giving rise to the notion that it will become the preeminent economic, if not cultural power of the latter 21st century. This narrative is certainly a powerful one, with China’s rapid economic development clear for all to see, but recent political developments have illuminated the growing risks of doing business in China.
The recent anti-corruption campaign has uncovered the unsteady foundation of China’s business environment and shed light on the nexus of political and business interests that underpins much of the Chinese economy. With Chinese companies and individuals making increasingly large investments abroad and continuing foreign investment into China, a closer look at the business environment and its risks is sorely needed.
China’s economic rise has been notable for two reasons in particular; its speed and its effects on inequality. The scale and speed of economic growth has been astounding, with average economic growth from 1978 being just under 10%, and levels of poverty decreasing on a scale previously unheard of; but this breakneck speed of economic growth has come at a cost, with inequality levels increasing rapidly and public anger over this situation becoming increasingly widespread .
China’s growth has also been marked by the rise of a new class of powerful and influential business leaders, often with close ties to the communist party. This development is also present elsewhere, with other countries such as the US and UK going through similar processes during periods of rapid economic development in their history, but China is unique due to the particularly strong links between the government and these new business elites.
For all the talk about China developing modern standards and norms of doing business, the reality is often far more opaque with China’s legal foundation being predicated on party control and power rather than the rule of law. The situation of property rights shows how the CCP’s interests prevail over the rule of law.
Public Private Property
Though China has private property rights enshrined in its 1982 Constitution and particularly, the 2004 amendment to the Constitution, the party has sweeping powers to expropriate property under the auspices of “public interest” – the most prominent examples of this being the widespread destruction of villages and homes for mass infrastructure projects such as high-speed rail networks and dams, often without the consent of people affected directly.
This has resulted in a situation where, due to party control, it is impossible to undertake large scale business development and expansion without direct links to local, regional and even national political figures. This is plain to see on even the faintest examination of China’s prominent business people.
Ma Huateng, founder and CEO of Tencent has served as a representative in the National People’s Congress and is on record as supporting the censorship policies of the CCP. Wang Jianlin, the founder of the Dalian Wanda Group, served as deputy to the 17th National Congress and has often highlighted the need to stay close to party officials. The list goes on, with essentially all business leaders having some level of official or unofficial link to the CCP.
This close relationship between business and the party has been an established pillar of the Chinese economy since the reforms of the Deng Xiaoping era which began in 1978, but recent political developments have exposed the fractious nature of this situation. The political risks associated with investing or conducting business in China or with Chinese companies have been clearly highlighted by recent events.
Since becoming General Secretary of the CCP Xi Jinping has made his anti-corruption drive a key pillar of his domestic policy agenda with the campaign having resulted in some high-level arrests and convictions of previously powerful party officials such as Zhou Yongkang and Su Rong.
Though public anger is certainly a key driver for the establishment and continued prominence of the anticorruption drive, the individuals that have been targeted and the manner in which the campaign is being prosecuted does imply that the underlying reason for its undertaking is political. Analysis of the officials that have been implicated in the campaigns paints a picture of Xi’s political opponents being the key targets, specifically those with links to the previous Chinese regime under Jiang Jemin.
Business and Politics
It has not taken long for these political skirmishes to spill over into the Chinese business community, and for those outside of the direct factional infighting to see the sights of the campaign turn towards them due to ties to individuals who have previously fallen foul of the campaign.
The newest phase of the anti-corruption drive seems to have resulted in a shift towards targeting the affiliated business interests and allies of the CCP officials that have been targeted previously in earlier phases. Numerous business people have either gone missing or have been arrested by Chinese police. Often those targeted are released weeks or months later after seemingly assisting authorities in undisclosed investigations. Though these kinds of actions would be expected in any country with embedded patronage systems and the weak rule of law, the fact that this is so openly occurring in the second largest economy in the world is clear cause for concern going forward.
So far these developments have not had a material impact on the Chinese economy in an obvious way, but there is clear potential for escalation. Recent high profile arrests have ensnared companies and individuals with extensive interests abroad. Considering the rapid increase of overseas investment from Chinese companies and individuals, as well as continued growth of foreign direct investment into China, this may potentially expose western economies and companies to a new layer of political risk.
This situation has created a number of new risks in operating within China and with Chinese companies abroad. Firstly, due to the Chinese requirement for foreign companies to establish joint ventures and partnerships with local firms, there is a growing danger for foreign companies to be caught up in these investigations due to their connections with local firms and individuals. Some of these situations have started to play out.
In 2014 Alcatel-Lucent’s joint venture was investigated for bribery and its relationship with executives at China Mobil. Though seemingly nothing came of the investigation, with no charges or fines being levelled at ASB or China Mobil, the ASB executive who had acted as a whistle-blower was eventually found dead some months later, seemingly ending the affair. Now, though this situation seemed unconnected to the new phase of politically motivated investigations, it is illuminating due to a number of key factors.
ASB is an interesting case because it was the first joint venture to have been created in China between a western company and local partner firm, with its foundation in 1984; it is also known to have very strong links to the CCP and has previously been criticised for these overt links.
This is an indicator that companies that have a long and established presence in China, and with the CCP in particular, are not safe from these risks and with the new political focus of the anti-bribery campaign may become more exposed due to these longstanding links with the party.
The second new development is the growing risks associated with Chinese firms and individuals investing in foreign companies. Since the global financial crisis of 2008/2009 there has been a significant uptick in Chinese investment in foreign markets as restrictions on monetary outflows from China are reduced, and China becomes more integrated into international financial markets.
Underestimating Political Risks?
Though the opening of Chinese financial markets and the growing presence of Chinese firms overseas are seen as positive developments for the global economy as a whole, recent events have suggested that the political risks associated with Chinese companies and individuals are underappreciated. One of the most high profile examples of these risks has been the recent fall from grace of Wu Xiaohui, Chairman of Anbang Group, and leader of one of the most prolific Chinese companies when it came to international investments.
After reports emerged that Wu had been detained by Chinese authorities, he was forced to step down and delegate authority to other executives in the company. What is very important about this case, in particular, is that Wu and Anbang were seen as one of the safest Chinese companies to do business with due to their long standing personal and financial ties to the party. It is concerning that a company and individual of this stature are at risk, and it suggests that much greater scrutiny should be directed at acquisitions by Chinese investors to protect against undue exposure to this growing political risk.
Indeed, there have been rumblings of a change of strategy from regulators into Chinese investment in western companies. The European banking regulator, the Single Supervision Mechanism, has suggested it will conduct an investigation into HNA’s 9.9% stake in Deutsche Bank over concerns over HNA’s financing and strategy. This may well signal the emergence of a less receptive regulatory environment for Chinese investment into western countries, but it remains to be seen whether political and economic pressures will stymie these efforts.
Political risks are a growing issue in China, both for inward investment into the country by international companies, as well as with regard to the increased presence of Chinese companies and investors in international markets.
It is unclear as to how the anti-corruption campaign will develop from this point, and whether it will continue to focus on the business community, as it has for the last two years, but it has clearly exposed the cracks in the foundation of the political-business nexus that has been such a large part of China’s growth. Ultimately, greater scrutiny and awareness of these dynamics will be key, going forward, for those looking to do business with China, and the scrutiny placed on Chinese companies by regulators is almost certainly likely to increase in the short-to-medium term.