THE WORLD : Doing Business in China Could Give You a Big Mac Attack : When what’s between the contract lines is as important as what’s explicitly stated, investors can expect turbulence.
When the Chinese government recently ordered McDonald’s, barely into a 20-year lease, to relocate its profitable restaurant near the center of Beijing, the eviction notice was heard around the business world. Coupled with reports that many Chinese borrowers are in default on their loans from foreign banks, that Lehman Brothers is suing a Chinese organization for failing to cover trading losses and that the United States is threatening a trade war over Chinese piracy of U.S. “intellectual property,” the McDonald’s incident has fueled skepticism about the wisdom of doing business and investing in China. Such skepticism is long overdue--but it should not be exaggerated.
Business interest in China has been superficial and volatile since 1972, when President Richard M. Nixon visited the country, and, to a surprising extent, it has remained so. Americans flocked to China in 1972, lost interest in the mid-'70s, rushed back in 1978, trickled away in the mid-'80s and fled in 1989 after the Tian An Men Square tragedy. Under the influence of the most recent bout of China fever, too many American businessmen still travel to China as if they were the first, sign vague and meaningless letters of intent, rely principally on cultivating official goodwill to minimize risk (a well-drafted contract helps, too), hire intermediaries and advisers with inflated credentials and sign deals for ego gratification rather than for sound economic reasons. Most inexcusably, they make little effort to inform themselves about China’s current conditions and the experiences of foreign investors in China during the last 15 years. And, like McDonald’s, they hit unexpected barriers.
Foreign investors need an established legal framework that defines and protects their rights. China’s legal institutions, however, are new, immature and incomplete. Many laws have been adopted but their implementation is affected by a legal and business culture deeply rooted in Chinese tradition.
Before communism, law was little used to govern contracts and other business transactions. Personal and familial relationships, in general, supplied the social context in which business was conducted and disputes were settled. With relationships paramount, flexibility was a given; notions of well-defined and enforceable rights were secondary. Communism brought a planned economy and a huge Stalinist-type bureaucracy that only obscured but did not eradicate traditional styles of doing business.
Chinese leaders after Mao Tse Tung have encouraged the creation of legal institutions, though on a weak foundation left by Chinese tradition. The most reform-minded leaders agree that law should establish rules for the operation of the economy. But the rule of law has not been established. Accordingly, the courts enjoy no greater authority than the rest of the bureaucracy. Furthermore, the law is fragmented, with administrative agencies and the courts interpreting the same rules with often conflicting results.
Chinese law has been evolving, chiefly by means of loosely drafted general laws and incomplete implementing regulations. But Chinese law is often formalistic: After rules are established on paper, little attention may be paid to enforcing them or ensuring uniformity in applying them.
The real meaning and content of Chinese law turns on the discretion wielded by agencies that apply the law. Their practices are not uniform across the nation and are difficult to ascertain. Legal applications may also vary with policy. For example, when joint U.S.-China ventures sell products on the local market for local currency, their ability to obtain permission to convert revenue into foreign exchange has sometimes depended on the prevailing government view of China’s foreign-exchange situation.
The foreign investor encounters different notions of contract as well as law. Western investors usually regard a contract not only as a memorialization of the partners’ agreement but also as a charter or a constitution for their joint venture. To the Chinese, however, the contract may only be a form to be filled out. In many cases, Chinese negotiators insist on using a form contract that was prepared by the Ministry of Foreign Trade more than 10 years ago. In negotiations, the foreigner is often limited by the need to begin with that form, expand on and clarify it, but without making it unrecognizable to the higher-level officials who must approve it. Also, attitudes may differ in interpreting the contract, with the Chinese more prepared than Westerners to tease out broad obligations not expressly stated in the contract.
Differing cultural attitudes may complicate matters even more when overseas Chinese, such as Hong Kong or Taiwan intermediaries or partners, are involved. To the Westerner, the law and the contract establish a framework. The foreigner may try and enlarge the framework through the contract, but the overseas Chinese often regard the framework as a cage that can be unlocked by a key provided by relationships with important individuals and, thereafter, not taken seriously. Such relationships are important, but so is the feasibility of the project, its conformance with existing law and policy, and clear understandings between the parties.
If disputes and disagreements arise, the Chinese frequently want to wish the matter away. Most investment contracts provide for arbitration, sometimes in a third country like Sweden, but more often in China. Even when contracts call for arbitration in Beijing, the Chinese party may prefer to avoid it, and local officials whose aid is requested are likely to be of the same mind. Usually reluctant to acknowledge that a project such as a joint venture has failed, they will undoubtedly prefer a quietly negotiated compromise rather than litigation or arbitration.
Faced with such hurdles, the potential investor had better beware of hype and self-delusion. The uncertainties of investing in China are not new. China was just as difficult to invest in two years ago as it is today. So why the recent rush of foreign companies, particularly American, to China? The answer is found in numbers: During 1990-92, China attained an extraordinary and sustained rate of growth at a time when the West was in recession. Foreign investment bankers, excited by the opening of Chinese capital markets, have added to the momentum.
But the new wave of investors, mesmerized by the numbers, ignored much that was known at the time. Quite apart from the cultural differences that complicate business in China, there have long been warning signs. China’s leaders have no blueprint, no articulated vision of where economic reforms will take the country. Inflation remains a threat. Local governments continue to fund pet projects, defying the austerity measures ordered by Beijing. They also defy Beijing on many other issues, such as closing down factories that are pirating U.S.-made CDs and computer software. The Chinese government cannot collect much of the tax revenue it needs. The newly created capital markets are poorly regulated, and the banking system is primitive. And Chinese capital has been taking flight, often illegally.
Potential foreign investors should know that there are many Chinas, not one, and that they must carefully choose the locality in which to risk capital. Opportunities are selective, which has been true since China first “opened” to the West in the late 1970s. Investors must blend attention to the law, policy and local officials with patience and awareness that renegotiations are inevitable in the course of building long relationships.
The McDonald’s controversy will fade from notoriety once a new site is found. It is worth noting that even the developer of the building that will replace McDonald’s, Hong Kong businessman Li Kai-shing, has recently called for greater clarity in Chinese law and for consistency in Chinese policy to reassure foreign investors. Until greater certainty in law and policy becomes reality, investors will continue to encounter problems. Some, like McDonald’s, may find that neither the Chinese bureaucracy nor the legal system provides adequate support for well-founded claims, and may have to take their problems to the headlines. Perhaps the bureaucrats who provoked the controversy will realize that more than just hamburger lovers are watching.