Business Environment in China

Arun Kottolli

Introduction

• China is the largest market on the planet

• China’s immense diversity, variety, complexity, and is has enormous competitive intensity is unrivalled in the world

• China’s historical development,political structure and climate, & international relations influences its economy and foreign trade.

• China’s infrastructure and energy structure, legal framework pose a challenge to business

• China possibly has the toughest business environment in the world

Area & Population

• Land area of 9.56 million square kilometers• 3th Largest country in the world • Largest Population – 1.3 Billion in 1997• Population growing at 0.9% per year• Two thirds of people live in eastern lowlands of

yellow river, pearl river and Yangtze river valleys – population density of > 200 per sq km!

• 10% of china’s land is arable • Vast sections of Northern, western & Tibet is

sparsely inhabited

Ethnic and Linguistic Group

• Han is the dominant race – 91.9% of population sharing common language.

• 55 ethnic minorities

• Major Religious groups are Daoist & Buddhist

• Muslim (1-2%) & Christian (1%)

• Mandarin is the official standard language

• There are also 50 minority languages

China Ethnic Distribution

Political Structure

• Centralized unitary government – not federal

• Single Party with one legislative house

• CCP and the Parliament has separate constitutions

• All national legislative power is vested with the parliament (CCP controls the parliament)

• CCP – Communist Party controls all the law making and other important decisions

• President is the head of CCP, national Legislature, and the Army – CCP thus has overall control

Images of CCP

CCP

• CCP has legislature and Executive branches• Legislature is the National People’s congress represents

58 million party members and meets every 5 years• CCP Executive branch called Central Committee (CC) has

151 full time members and 191 alternate members• Executive meets twice a year• Politburo (PB) represents the Central Committee and

consists of 20 members• Politburo standing committee(PBSC) is the most authority

to deal with any issue with which it wants to deal• The seven members of PBSC are the seven most

important men in the country

Role of CCP

• CCP is the all powerful entity in China – 58 million members

• CCP controls the government at all levels of hierarchy – central, provincial & municipal

• CCP sets the strategic direction and monitors the implementation of policies

• Government bureaucracy executes the policies

• CCP controls all the key government job appointments

CCP and Government

• It is difficult to isolate CCP from the government• Functions, responsibilities and authority often

overlap between CCP and bureaucracy• Many government official are also CCP members• Independent Government institutions do not really

exist in China – Judiciary, Army and Executive are all under CCP control

• CCP controls all the key appointments in all branches of Government!! In short CCP is the Government !!

Political Structure - Graphic

Bureaucracy

• Bureaucracy is organized along territorial and functional lines

• Three territorial lines are – Central, Provincial and Municipal

• Functional lines is based on various ministries and departments

• Note that the prestige of the person determines the power of the office and not the vice-versa

• To understand Chinese politics, one need to understand the power struggle of the individuals

Government

• Legislature: – National people’s congress (NPC) of 3000 members

meets once a year– Elected for five years. – Between sessions NPC is represented by a standing

committee of 200 members– Legislature appoints members to the Executive

Government - Executive

• Executive: legislature appoints the executive board of 15 members consisting of premier, Vice premiers, State councilors and Secretary General– Subordinate to Sate Council are the various ministries,

commissions and important SOE (State Owned Enterprises)

– Premier and Vice-Premier are nominated by the president for a term of 5 years (max of 2 terms)

– Decisions by the executive board becomes the law– Each member of executive board is in charge of one

sector

PLA – China’s Army

• People’s Liberation Army is the world’s largest standing army – with more than 3 million men

• In addition, army can summon 197 million men who are in reserve

• PLA also runs a sprawling business empire – arms exports, and other businesses, Employs more than 600,000 people in its factories

• Army therefore plays a major role but is under the control of CCP

Judiciary

• Supreme People’s Court is the highest judicial authority

• NPC appoints all the judges in the supreme court and other Lower People’s Court

• A parallel hierarchy of Procurate courts headed by supreme people’s procurate oversees regional and local procurates

• People’s procurate is responsible for ensuring observance of the law and prosecution of criminals

Democratic Organizations

• Chinese People’s Political Consultative Conference (CPPCC) oversees democratic parties, trade unions and other organizations

• China has 8 registered democratic parties – all controlled by CCP

• There are also several other mass organizations such as writers guild etc,

• These organizations ensure social control and political discipline

• Neighborhood committees in cities and municipalities ensure control over family planning and crime at grass-root level

Provincial Administration

• China is unitary in administration, but provinces with its huge population needs provincial administration

• 22 provinces + Taiwan and four special municipalities which have the status of a province – Beijing, Shanghai, Tianjin, Chongqing

• 5 autonomous zones which have high minority population and have limited self government (Tibet, Xinjiang, Qinghai, Inner Mongolia etc)

Provinces of China

Shanghai’s Skyline

Map of Shanghai Province

Map of Tianjin Province

Political Climate

• China follows incremental reforms based on clear consensus of the leadership

• Reforms have introduced open, transparent and responsive style of government

• Maintaining order and stability is of highest importance to Chinese leadership – which is managed by monopoly power of CCP

• Leadership believes that democracy at national level will throw China into chaos and endanger political stability – like in USSR(Russia)

Corruption & Lawlessness

• China is fighting against Corruption and lawlessness• Public protest against corruption is tolerated • Government is becoming increasingly responsive to

people’s concerns• Protests against the political system and constitution is

not tolerated – dissidents are prosecuted • Legal procedures are evolving and courts have a wide

leverage in interpretation of the law • Corruption is still widely prevalent and a major problem

for businesses• CCP members and their family yield enormous influence

leading to corruption

International Relations

• China believes in multi-polar world – sees itself as a superpower

• Foreign policy is dominated by territorial and political integrity – Often the cause of friction with the US on issue of Taiwan and democracy

• China will maintain a strong military force to maintain its freedom and avoid any domination by the US

• China can project its military power far beyond its borders – invasion of Taiwan if Taiwan becomes independent

International Relations - Asia

• China sees itself as the power center of Asia

• Seeks to maintain friendly relations with other countries as long as they acknowledge China’s superiority

• China’s need for Oil is driving relations with Vietnam, Africa and the middle-east

• Relations with India, Japan and Australia is strained or cold at very best – because these countries represent alternate power centers in Asia

Economic Policy

• China initiated economic reforms in 1978• Flexibility and pragmatism is the hallmark of economic

reforms• CCP and leadership acknowledge that reforms are

irreversible – and need faster/more reforms to sustain the current growth

• CCP and Government are concerned about the future economic challenges

• Policies are aimed at minimizing boom-burst cycles, controlling inflation and maintaining growth

Development Challenges

• Recent boom in urban and industrial sector has created an imbalance vis-à-vis with rural agricultural sector

• Rising Power shortages, food imports and income imbalances is a major cause of concern

• Defunct Banking sector and highly inefficient SOE places enormous burden on future economic growth and development

• SOE uses up 95% of bank loans (many default)• Reforms have not touched Banks and SOE

Growth Engines

• China’s fast growth is fuelled by supply side – by massive increase in industrial production to feed exports – Funded by FDI (total for > $300 billion)

• Domestic consumption remains low and has marginal impact on growth – Recent trend towards higher local consumption is driving growth in 2004

• Local Banks and Domestic savings are used to fund SOE (94% of domestic savings are loaned to SOE)

Domestic Savings

• China has the highest level of family savings – A whopping 40% saving rate

• High domestic saving is channeled to fund inefficient SOE via state owned banks (94% of all bank loans goes to SOE)

• In 2003-2004, Banks are changing priority of loans to housing, cars and other public consumption goods – Driving recent surge in demand for cars and consumer goods

• Privatization of Banks will spur local business growth – channel loans to local businesses

Economic Reforms

• China embarked on free market reforms in 1978 with agricultural reforms

• Farmers were allowed to own land, grow any crop and the selling price for agricultural produce was increased dramatically

• In 1981 prices of industrial products was liberalized and private enterprises were allowed to setup factories in rural areas

• By mid 1980’s a substantial portion of rural countryside had private farms and had developed basic industries

TVE – Cooperative firms

• In 1984 China allowed the formation of “Town-Village Enterprises(TVE)” – a people’s cooperative in small scale or medium scale industries engaged in light manufacturing or services

• TVE enabled to absorb surplus rural labor

• TVE’s resulted in a tremendous development of the country side – A real growth engine

• Private initiative with a collective thought - TVE

Investment Reforms - FDI

• MNC’s were encouraged to establish joint ventures in China

• Prior to 2004, all MNC’s were required to have a joint venture with a Chinese firm – either SOE or TVE

• Wholly owned MNC subsidiaries were allowed only in 2004

• Special Economic Zones (SEZ) were created to encourage FDI - Shenzhen, Zhuhai, Shantou, & Xiamen

SEZ Benefits

• Firms located in SEZ can benefit from low cost of labor, tax exemptions, duty free imports of raw materials and technology– Income tax level in SEZ is 15%

• In 1984, another 14 costal cities were opened up to FDI with similar incentives like SEZ with free ports etc– Tax rate at costal cities is 25% Vs national rate of 35%

• Later other cities and towns have been converted into development zones

Living Standards

• High growth rate is raising local living standards – slowly but limited

• Not all are enjoying a higher living standard as most of manufactured goods are exported

• Demographic – Psychographics segmentation