Trading with China: The Reality

Almost 150 years ago in California, and about 100 years ago in Alaska, the discovery of gold lured thousands to seek fortunes that seemed all but certain. Ultimately, of course, the only certainty was hardship. Very few of the adventurous prospectors ever got rich. Today, similar get-rich-quick illusions have inspired a rush to invest in China, and for many it may well end in disappointment and defeat. Those who are eager to invest or start a business in China would be wise to temper their optimism with the restraint of the realist— and perhaps even the caution of the paranoid.

The promise of macroeconomic benefits now paves the way for agreement between the People’s Republic of China and the United States that will allow entry by China into the World Trade Organization (WTO). Ratification, of course, is still subject to approval by the U.S. Senate and other nations, but the long-term virtues of China’s WTO membership will not be limited to international trade. China will find that in order to get what it wants and needs from the international community, it will have to discard its closed attitude in favor of transparency, which must eventually lead to the rule of law rather than rule by men. Basic freedoms— of information, the press, and communications (including the Internet)— will become undeniable. The United States will benefit from greater protection of patent and royalty rights and a vastly improved environment for banking, insurance, and other services. As these changes permit freer investments by Americans and others, U.S. exports to China will also increase, thereby reducing the enormous U.S. trade deficit. And as China becomes more thoroughly enmeshed in world commerce, it will find that unilateral decisions, such as those regarding arms trade or disputes with neighbors— including Taiwan — are constrained by repercussions at home. All told, China faces a future of great economic and political change, after which the “Middle Kingdom” might well become a new “Rome” to which all roads lead.

But upon closer examination, the microeconomic road to that promising future is far from smooth. Forget the romantic illusions about oil for the lamps of China, the friendly amah who raises your children, the Pearl Buck stories. Imagine yourself instead as the owner of a medium-sized business or as a young officer of a large corporation assigned the task of setting up a company in China. How does one get rich and glorious without taking too many hits in the process?

First of all, your company will need to be important— as defined by the Chinese government. An “index of importance” would include the following:

  1. companies that bring in processes and innovations that will move China forward in the technological age, including military applications
  2. export-driven companies able to secure additional foreign exchange;
  3. companies that develop import substitutions, thereby saving vital Chinese foreign exchange;
  4. companies that put Chinese people to work;
  5. companies that invest in rural districts and less-developed inland areas.

Unless your company falls in at least one of these categories, you can expect antagonism rather than cooperation toward your entry into the Chinese market. You may survive for one or two years, perhaps longer, but in the long run you and your company will be squeezed out or kept at a level of utter insignificance.

Above all, remember that the mental attitude in China is totally different from the United States. The Chinese leadership has two goals: to maintain the strength of the central government and to put people to work. Shareholders’ income is not a consideration. Therefore, think about locating your company in one of the rural inland provinces. It may be more comfortable to locate in Shanghai or Pudong or Guangzhou or Shenzhen, but there will be less interference and more help in less-developed areas.

Having established your company’s importance and decided that you can live with the mindset, now it is time to start operations. First of all, it is useful to bring into the company, or have as a consultant or partner, someone with guangxi— connections. Without someone who is familiar with local customs and local people, you will never be able to interpret what is actually going on behind the scenes. I am reminded of my early days in Japan when my Japanese counterpart would say, “Sssss. That’s very difficult.” I would immediately seek solutions to that difficulty. Later, I learned that he really meant, “Hell, no!”, which meant I would have to change tactics. An apparently insignificant process can turn into an intolerable obstacle unless you have help. Getting a vital piece of machinery through customs, for instance, could take weeks or months. Before World War II, foreign companies in China and throughout Southeast Asia would hire a local compradore, who literally ran the company— with or without the foreigner’s approval. Don’t go that far: you will lose control and fail to bring to China all those attributes that made your company great in the first place.

You may be encouraged to hire your workforce through a government manpower organization to which you will pay Western salaries. Avoid this. That manpower group will only pay Chinese salaries to your Chinese employees and pocket the difference. You will lose control of your workforce and be unable to establish the incentive programs that will grow your company.

Next, you will need to bridge the gap between the Chinese government’s interest in your technical innovations and the size of your workforce, and your own interest in your company’s bottom line. Try to have one leg of your operations outside China. You might, for example, have a significant portion of your sales outside China, so that you can make a profit on exports and keep the profits outside the country. Another solution might be to have certain essential imports originate under your control so that you can make a profit on them, again retaining the profits outside China. Those companies depending on Chinese raw materials and Chinese labor and selling to the Chinese market will have enormous difficulty getting profits back to a parent company overseas. In fact, their long-term existence in China is doubtful.

Of course, basic rules of management remain the same. It is imperative that, as a local manager, you get to know your customer and your market. In China, this means that you need to learn some of the language, even if you never become fluent. Learn some Chinese history. Walk your factory floor and get to know your employees. Despite some huge differences, people all over the world basically respond to the same kinds of influences.

At the senior levels in the organization, it is simply not enough to send out a first-class manager and provide support from the home office. Senior management must regularly visit operations in China and personally become acquainted with their bureaucratic counterparts at central as well as local levels. This will give “face” to the local manager as well as improving understanding with important Chinese officials. Make sure to cultivate relationships with rising young officials who will one day determine your company’s future in China.

Next, be prepared to struggle with China’s infamous bureaucracy, both at central government and local levels. Worst of all, expect no consistency between the two. In 1980 and 1981, my company began shipping huge quantities of fertilizer and grain to China, which the country needed badly to feed its people. Bagging such bulky commodities in the U.S. and Europe made the cost prohibitive because of American labor, increased stevedoring costs, slower loading and discharging of the ships, and so forth. In order to reduce costs, we installed bagging equipment at Taichung, Taiwan. We shipped material in bulk to Taichung and bagged the material there, which cut costs enormously. We then transshipped the goods to various Chinese ports ranging from Dalien in the north to Zhanziang on the Vietnamese border. With the tacit permission of the buyers, we exchanged bills of lading at sea in order to conceal the transshipment port. After further study, we found it more cost effective to set up transshipment at Hong Kong. We converted barges into bagging machines and transshipped on smaller vessels to the various Chinese ports from Hong Kong. Hong Kong was British at that time, but the Chinese preferred it. Subsequently, after several meetings in Beijing, we began to set up bagging operations at various Chinese ports, starting with Guangzhou.

That is when we learned what bureaucracy really meant. Meetings with local authorities were interminable and invariably no agreement would be reached, because the various departmental heads could not agree as to who would milk this new cow. At senior levels in Beijing, we had total approval because we were cutting costs and saving foreign exchange for vital imports. However, at the out-ports it was a dreary repetition as to who was going to be rewarded. In addition, transport by road from Hong Kong and Shanghai to these out-ports was horrendous. The unpaved, bumpy roads claimed at least three of our trucks’ crankcases. Hotels were primitive at best, and nonexistent at worst. Eventually, we persuaded the central government to authorize bagging facilities at the several ports so that we were then able to ship in bulk directly to destination ports.

And then there is the matter of corruption, which is to be expected at every level. “Contributions” can be reduced to acceptable proportions, distributed at lower levels in order to smooth the way for daily operations. Again, guangxi will be vital. Corruption at high levels will, unfortunately, continue— both in the U.S. and China.

Last, but not least, you will need great patience. There will be no instant success. Some months ago, I attended a week-long seminar in Shanghai sponsored by the Wharton School that included about 32 American, European and Asian companies with operations in China. Everyone was starry-eyed about the future, but during the frank discussions it came out that not a single company had yet turned a profit. Clearly, an investment in China is a long-term affair.

As a fortune-seeker heading to China, you would be well advised to exchange your illusions for the advice passed on by one of America’s distinguished businessmen: “Only the paranoid survive.” Take that wisdom along with your ideas and money, and go west, young man.