China

Legal Growing Pains in a Land of

Opportunity
(China: The Inscrutable Market)

International Business
Individual Assignment
Trimester II

Submitted to: Submitted by:

Prof. C.P Joshi Meenu Mittal (34)
PGDM –IB
2010-2012
Q1) Outline the major changes in the international business environment over the last 7 decades from
a MNE’s perspective, which have significantly impacted business landscape in China for the MNE’s?

Answer) China is the oldest continuous major world civilization, with records dating back about 3,500
years. Successive dynasties developed a system of bureaucratic control that gave the agrarian-based
Chinese an advantage over neighboring nomadic and hill cultures. Chinese civilization was further
strengthened by the development of a Confucian state ideology and a common written language that
bridged the gaps among the country's many local languages and dialects. Whenever China was
conquered by nomadic tribes, as it was by the Mongols in the 13th century, the conquerors sooner or
later adopted the ways of the "higher" Chinese civilization and staffed the bureaucracy with Chinese.

1940-1950: The Chinese Civil War was a civil war fought between the Kuomintang (KMT or Chinese
Nationalist Party), the governing party of the Republic of China and the Communist Party of China (CPC),
for the control of China which eventually led to China's division into two Chinas: Republic of China (now
commonly known as Taiwan, ROC) and People's Republic of China (Mainland China, PRC).

The war began in April 1927 and represented an ideological split between the Western-supported
Nationalist KMT, and the Soviet-supported Communist CPC. In mainland China today, the last three
years of the war (1946 - 1949) is more commonly known as the War of Liberation. The civil war
continued intermittently until the Second Sino-Japanese War interrupted it, resulting in the two parties
forming a Second United Front. Japan's campaign was defeated in 1945, marking the end of World War
II, and China's full-scale civil war resumed in 1946.

In view of this civil war, which amounted for china’s political risk, China did not attract any major foreign
investment from MNE’s in this period. The frequent closures called in by ROC also added to the cost of
doing business in China.

1950-1960: The banking system was nationalized and centralized under the People's Bank of China. To
bring inflation under control by 1951, the government unified the monetary system; tightened credit,
restricted government budgets at all levels and put them under central control, and guaranteed the
value of the currency. The Soviet approach to economic development was manifested in the First Five-
Year Plan (1953–57). Soviet planners helped their Chinese counterparts formulate the plan. Large
numbers of Soviet engineers, technicians, and scientists assisted in developing and installing new heavy
industrial facilities, including many entire plants and pieces of equipment purchased from the Soviet
Union. By 1956 approximately 67.5 percent of all modern industrial enterprises were state owned, and
32.5 percent were under joint public-private ownership. In 1958 the Second Five-Year Plan (1958-1962),
which was intended to continue the policies of the first plan, was abandoned. The result of the Great
Leap Forward was a severe economic crisis. In 1958 industrial output did in fact "leap" by 55 percent,
and the agricultural sector gathered in a good harvest. The government prevented an even worse
disaster by canceling nearly all orders for foreign technical imports and using the country's foreign
exchange reserves to import over 5 million tons of grain a year beginning in 1960.

1960-1970: Faced with economic collapse in the early 1960s, the government sharply revised the
immediate goals of the economy and devised a new set of economic policies to replace those of the
Great Leap Forward. During the 1961-65 readjustment and recovery period, economic stability was
restored, and by 1966 production in both agriculture and industry surpassed the peak levels of the Great
Leap Forward period. The Cultural Revolution, unlike the Great Leap Forward, was primarily a political
upheaval and did not produce major changes in official economic policies or the basic economic model.
Nonetheless, its influence was felt throughout urban society, and it profoundly affected the modern
sector of the economy.

1970- 1980: During the early and mid-1970s, the radical group later known as the Gang of Four
attempted to dominate the power center through their network of supporters and, most important,
through their control of the media. The interlude of uncertainty finally ended when the Gang of Four
was arrested in October, one month after Mao's death. After the fall of the Gang of Four, the new
policies strengthened the authority of managers and economic decision makers at the expense of party
officials, stressed material incentives for workers, and called for expansion of the research and
education systems. Between 1976 and 1978, the economy quickly recovered from the stagnation of the
Cultural Revolution. The first few years of the reform program were designated the "period of
readjustment," during which key imbalances in the economy were to be corrected and a foundation was
to be laid for a well-planned modernization drive.

1980-1990: The period of readjustment produced promising results, increasing incomes substantially;
raising the availability of food, housing, and other consumer goods; and generating strong rates of
growth in all sectors except heavy industry, which was intentionally restrained. By the end of 1984,
approximately 98 percent of all farm households were under the responsibility system. The practice of
remitting taxes on profits and retaining the balance became universal by 1985, increasing the incentive
for enterprises to maximize profits and substantially adding to their autonomy. The foreign trade in 1980
was 15 percent, in 1984 was 21 percent, and in 1986 it reached 35 percent .Laws on contracts, patents,
and other matters of concern to foreign businesses were also passed in an effort to attract international
capital to spur China's development. These years showed the maximum increase in FDI, percentage
wise. Government policies were more favorable for MNE’s and China had become an attractive
destination for MNE’s.

1999 – 2000: China's economy regained momentum in the early 1990s. During 1993, output and prices
were accelerating, investment outside the state budget was soaring, and economic expansion was
fueled by the introduction of more than 2,000 SEZs and the influx of foreign capital that the SEZs
facilitated. The government approved additional long-term reforms; state enterprises would continue to
dominate many key industries in what was now termed a "socialist market economy". Fearing
hyperinflation, the authorities called in speculative loans, raised interest rates, and reevaluated
investment projects. The growth rate was thus tempered, and the inflation rate dropped from over 17%
in 1995 to 8% in early 1996.

In 1996, the Chinese economy continued to grow at a rapid pace, at about 9.5%, accompanied by low
inflation. The year 2000 showed a modest reversal of this trend. Gross domestic product in 2000 grew
officially at 8.0% that year, and had quadrupled since 1978. In 1999, with its 1.25 billion people but a
GDP of just $3,800 per capita (PPP), China became the second largest economy in the world after the
US. In 2000, China claimed success in its three year effort to make the majority of large state owned
enterprises (SOEs) profitable.

2000- Present: October 2003, Chinese legislators unveiled several proposed amendments to the state
constitution. One of the most significant was a proposal to provide protection for private property
rights. The Fifth Plenum in October 2005 approved the 11th Five-Year Economic Program (2006–2010)
aimed at building a "harmonious society”. China grew by approximately 10% through out. Post
recession, the world sees China as one of the engine that will pull the world out of recession. China's
total trade in 2006 surpassed $1.76 trillion, making China the world's third-largest trading nation after
the U.S. and Germany. This decade saw China at its mightiest.

Q2) Explain the key changes in the China’s political environment decade by decade commencing
1940’s. Which are the major milestones in China’s transition to a market based economy?

Early 20th Century in China - The Chinese Communist Party (CCP) forces embarked on a "Long March"
across some of China's most desolate terrain to the northwestern province of Shaanxi, where they
established a guerrilla base at Yan'an. During the "Long March," the communists reorganized under a
new leader, Mao Zedong (Mao Tse-tung). The bitter struggle between the KMT (Kuomintang or "Chinese
Nationalist People's Party"), and the CCP continued openly or clandestinely through the 14-year long
Japanese invasion (1931-45), even though the two parties nominally formed a united front to oppose
the Japanese invaders in 1937. The war between the two parties resumed after the Japanese defeat in
1945. By 1949, the CCP occupied most of the country. Chiang Kai-shek fled with the remnants of his KMT
government and military forces to Taiwan, where he proclaimed Taipei to be China's "provisional
capital" and vowed to reconquer the Chinese mainland. The KMT authorities on Taiwan still call
themselves the "Republic of China."  

 The People's Republic of China- In Beijing, on October 1, 1949, Mao Zedong proclaimed the founding of
the People's Republic of China (P.R.C.). The new government assumed control of a people exhausted by
two generations of war and social conflict, and an economy ravaged by high inflation and disrupted
transportation links.

In the early 1950s, China undertook a massive economic and social reconstruction program. The new
leaders gained popular support by curbing inflation, restoring the economy, and rebuilding many war-
damaged industrial plants. The CCP's authority reached into almost every aspect of Chinese life. Party
control was assured by large, politically loyal security and military forces; a government apparatus
responsive to party direction; and the placement of party members into leadership positions in labor,
women's, and other mass organizations.

The "Great Leap Forward" and the Sino-Soviet Split- In 1958, Mao broke with the Soviet model and
announced a new economic program, the "Great Leap Forward," aimed at rapidly raising industrial and
agricultural production. Giant cooperatives (communes) were formed, and "backyard factories" dotted
the Chinese landscape. The results were disastrous. Normal market mechanisms were disrupted,
agricultural production fell behind, and China's people exhausted themselves producing what turned out
to be shoddy, unsalable goods. Within a year, starvation appeared even in fertile agricultural areas.
From 1960 to 1961, the combination of poor planning during the Great Leap Forward and bad weather
resulted in one of the deadliest famines in human history. 

The already strained Sino-Soviet relationship deteriorated sharply in 1959, when the Soviets started to
restrict the flow of scientific and technological information to China. The dispute escalated, and the
Soviets withdrew all of their personnel from China in August 1960. In 1960, the Soviets and the Chinese
began to have disputes openly in international forums. 

The Cultural Revolution-In the early 1960s, State President Liu Shaoqi and his protégé, Party General
Secretary Deng Xiaoping, took over direction of the party and adopted pragmatic economic policies at
odds with Mao's revolutionary vision. Dissatisfied with China's new direction and his own reduced
authority, Party Chairman Mao launched a massive political attack on Liu, Deng, and other pragmatists
in the spring of 1966. The new movement, the "Great Proletarian Cultural Revolution," was
unprecedented in communist history. For the first time, a section of the Chinese communist leadership
sought to rally popular opposition against another leadership group. China was set on a course of
political and social anarchy that lasted the better part of a decade. 

In the early stages of the Cultural Revolution, radical youth organizations, called Red Guards, attacked
party and state organizations at all levels, seeking out leaders who would not bend to the radical wind.
In reaction to this turmoil, some local People's Liberation Army (PLA) commanders and other officials
maneuvered to outwardly back Mao and the radicals while actually taking steps to rein in local radical
activity. 

Gradually, Red Guard and other radical activity subsided, and the Chinese political situation stabilized
along complex factional lines. The leadership conflict came to a head in September 1971, when Party
Vice Chairman and Defense Minister Lin Biao reportedly tried to stage a coup against Mao; Lin Biao
allegedly later died in a plane crash in Mongolia. 

In the aftermath of the Lin Biao incident, many officials criticized and dismissed during 1966-69 were
reinstated. Chief among these was Deng Xiaoping, who reemerged in 1973 and was confirmed in 1975 in
the concurrent posts of Politburo Standing Committee member, PLA Chief of Staff, and Vice Premier. 

The ideological struggle between more pragmatic, veteran party officials and the radicals re-emerged
with a vengeance in late 1975. Mao's wife, Jiang Qing, and three close Cultural Revolution associates
(later dubbed the "Gang of Four") launched a media campaign against Deng. In January 1976, Premier
Zhou Enlai, a popular political figure, died of cancer. On April 5, Beijing citizens staged a spontaneous
demonstration in Tiananmen Square in Zhou's memory, with strong political overtones of support for
Deng. The authorities forcibly suppressed the demonstration. Deng was blamed for the disorder and
stripped of all official positions, although he retained his party membership. 

The Post-Mao Era- Mao's death in September 1976 removed a towering figure from Chinese politics and
set off a scramble for succession. Former Minister of Pubic Security Hua Guofeng was quickly confirmed
as Party Chairman and Premier. A month after Mao's death Hua backed by the PLA, arrested Jiang Qing
and other members of the "Gang of Four." After extensive deliberations, the Chinese Communist Party
leadership reinstated Deng Xiaoping to all of his previous posts at the 11th Party Congress in August
1977.

At the pivotal December 1978 Third Plenum (of the 11th Party Congress Central Committee), the
leadership adopted economic reform policies aimed at expanding rural income and incentives,
encouraging experiments in enterprise autonomy, reducing central planning, and attracting foreign
direct investment into China. The plenum also decided to accelerate the pace of legal reform,
culminating in the passage of several new legal codes by the National People's Congress in June 1979. In
late 1980, Mao's Cultural Revolution was officially proclaimed a catastrophe. Hua Guofeng, a protégé of
Mao, was replaced as premier in 1980 by reformist Sichuan party Chief Zhao Ziyang and as party General
Secretary in 1981 by the even more reformist Communist Youth League chairman Hu Yaobang. 

Although students and intellectuals urged greater reforms, some party elders increasingly questioned
the pace and the ultimate goals of the reform program. In December 1986, student demonstrators,
taking advantage of the loosening political atmosphere, staged protests against the slow pace of reform,
confirming party elders' fear that the current reform program was leading to social instability. Hu
Yaobang, a protégé of Deng and a leading advocate of reform, was blamed for the protests and forced
to resign as CCP General Secretary in January 1987. Premier Zhao Ziyang was made General Secretary
and Li Peng, former Vice Premier and Minister of Electric Power and Water Conservancy, was made
Premier. 

1989 Student Movement and Tiananmen Square-The death of Hu Yaobang on April 15, 1989, coupled
with growing economic hardship caused by high inflation, provided the backdrop for a large-scale
protest movement by students, intellectuals, and other parts of a disaffected urban population.
University students and other citizens camped out in Beijing's Tiananmen Square to mourn Hu's death
and to protest against those who would slow reform. Their protests, which grew despite government
efforts to contain them, called for an end to official corruption and for defense of freedoms guaranteed
by the Chinese constitution. Protests also spread to many other cities, including Shanghai, Chengdu, and
Guangzhou. 

Martial law was declared on May 20, 1989. Late on June 3 and early on the morning of June 4, military
units were brought into Beijing. They used armed force to clear demonstrators from the streets. There
are no official estimates of deaths in Beijing, but most observers believe that casualties numbered in the
hundreds. 

After June 4, while foreign governments expressed horror at the brutal suppression of the
demonstrators, the central government eliminated remaining sources of organized opposition, detained
large numbers of protesters, and required political reeducation not only for students but also for large
numbers of party cadre and government officials. 

Following the resurgence of conservatives in the aftermath of June 4, economic reform slowed until
given new impetus by Deng Xiaoping's dramatic visit to southern China in early 1992. Deng's renewed
push for a market-oriented economy received official sanction at the 14th Party Congress later in the
year as a number of younger, reform-minded leaders began their rise to top positions. Deng and his
supporters argued that managing the economy in a way that increased living standards should be
China's primary policy objective, even if "capitalist" measures were adopted. Subsequent to the visit, the
Communist Party Politburo publicly issued an endorsement of Deng's policies of economic openness.
Though not completely eschewing political reform, China has consistently placed overwhelming priority
on the opening of its economy. 

Third Generation of Leaders- Deng's health deteriorated in the years prior to his death in 1997. During
that time, President Jiang Zemin and other members of his generation gradually assumed control of the
day-to-day functions of government. This "third generation" leadership governed collectively with
President Jiang at the center. 

In March 1998, Jiang was re-elected President during the 9th National People's Congress. Premier Li
Peng was constitutionally required to step down from that post. He was elected to the chairmanship of
the National People's Congress. Zhu Rongji was selected to replace Li as Premier. 

Fourth Generation of Leaders- In November 2002, the 16th Communist Party Congress elected Hu
Jintao, who in 1992 was designated by Deng Xiaoping as the "core" of the fourth generation leaders, the
new General Secretary. A new Politburo and Politburo Standing Committee was also elected in
November. 
In March 2003, General Secretary Hu Jintao was elected President at the 10th National People's
Congress. Jiang Zemin retained the chairmanship of the Central Military Commission. 

Q3) Explain the key aspects of China’s legal environment and its implications for MNE’s.

Chinese subscribes to philosophy of the rule of man and thus to a system that equates the decision of
one man (or person), whether emperor, party, or local bureaucrat, with the law. China faces
fundamental challenges, including legislative gaps, hazy interpretation, lax enforcement, and
philosophical disagreement. Although many sectors of China's economy have become more market
oriented, numerous restrictions and a massive bureaucracy still hinder full implementation of
regulations and make the approval process unpredictable.

Legal risks faced by MNE’s in China include:

 Difficulty in complying with the innumerable laws and regulations at the central, provincial, and
local levels of the government;
 Keeping up with new laws and regulations that are constantly being enacted;
 Reluctance of Chinese business associates to enter into binding contracts;
 Lack of sanctity of contracts and contractual obligations not being carried out fully, leading to
disputes.

The framework recommends to practitioners several measures to manage the legal risks.

 Relationship-based strategies like establishing close relationships with the Chinese government
officials and Chinese business associates and careful selection of Chinese business partners.
 Conducting due diligence on the legal and financial background and reputation of key joint
venture (JV) partners, acquisitions, senior managers, vendors, and suppliers before entering a
formal relationship.
 It is recommended that foreign professionals adopt the mindset that in China, the contact is to
be continuously negotiated and reinterpreted. To achieve this, industry practitioners should
provide a substantial contingency sum.
 Emplace permanent staff in China so that they can understand the local environment and
monitor the changes taking place there. It is advisable to conduct pre-employment screening of
all employees.

Q4) Using key macroeconomics parameters, comment on China’s economic development over the last
3 decades. What was government’s role in China becoming world’s 2nd largest economy? What is the
key challenges government of China will face during 2010 to 2015? Why?

Growth Performance in the Five Year Plans

Realizatio
Plan Period Target n
Sixth Plan (1980–84) 5.2 5.5
Seventh Plan (1985–
89) 5 5.6
Annual Plan (1990–
91) - 3.4
 Eighth Plan (1992–
96) 5.6 6.5
Ninth Plan (1997–
2001) 6.5 5.5
Tenth Plan (2002–
2006) 7.9 7.7

It shows that the economy grew at 6.5% per year in the Eighth Plan period (1992–1996) and then
decelerated to 5.5% in the Ninth Plan period (1997–2001), but recovered sharply to achieve a growth
rate of 7.7% during the Tenth Plan. The last four years of the Tenth Plan recorded an average of about
8.7% and this momentum has continued into 2007–08 which is the first year of the Eleventh Plan, and is
likely to record a growth of around 8.5% or, perhaps, even a little higher.China has achieved growth
rates exceeding 9% for two to three decades.

Tenth Eleventh
  Plan Plan
Investment Rate (% of GDPmp) 32.4 36.7
Domestic Savings Rate (% of GDPmp) 30.9 34.8
Current Account Deficit (% of GDPmp) 1.5 1.9
ICOR 4.3 4.1
GDP Growth Rate (% per annum) 7.5 9

GDPmp - GDP at market prices.

Sectoral Growth in Recent Plans

Eighth Ninth Tenth Eleventh

Plan(1992- Plan(1997 Plan(2002 Plan(2007-
Sector 96) -2001) -06) 11)
Agricultur
e 4.72 2.44 2.3 4
10.00-
Industry 7.29 4.29 9.17 11.00
Services 7.28 7.87 9.3 9.00-11.00
Total 6.54 5.52 7.74 9

Investments and Savings Rate

Investment Savings
Year Rate Rate
Eighth
Plan 24.4 23.1
Ninth
Plan 24.3 23.6
2002-03 25.2 26.4
 2003-04 28.2 29.8
2004-05 32.2 31.8
2005-06 35.5 34.3
2006-07 35.9 34.8
Tenth
Plan 32.1 31.9
Eleventh
Plan
targets 36.7 34.8

Government’s role in China becoming world’s second largest economy:

 China can implement economic policy a lot easier and faster than other large economies like the
US, Japan, or European economies can due to its central, communist structure. This makes it
easier to dictate the country’s direction in times of economic need or crisis, without the back-
and-forth debates and indecision seen elsewhere.
 GDP growth in China has been impressive in the past years. China’s robust financial system, high
per-capita savings, and export-led, manufacturing-based economy have contributed to its
growth and long-term potential.
 The Communist Party has sought to portray a climate of progress, stability, and an overall
smooth transition into the market economy China is becoming. And without bipartisan debate
or dispute, it has been very easy to project whatever figures to the world it wanted.
 In the 1990s, the financial sector was liberalized. After China joined the World Trade
Organization (WTO), the service sector was considerably liberalized and foreign investment was
allowed. Restrictions on retail, wholesale and distribution were ended. Banking, financial
services, insurance and telecommunications were also opened up to foreign investment

The key challenges government of China will face during 2010-2015:

 Corruption- Companies routinely battle bribes and attempts to steal property while struggling to
establish clear titles to land and physical equipment.
 Intellectual Property – MNE complains that China’s industrial surge is being powered by the
sophisticated theft of their intellectual property.
 China has made great progress in poverty eradication, some imbalances remain, with wide social
gaps in mountainous areas, in places where minorities live and where there are epidemics, and
these are the regions which are the primary task for social development.
 Environmental problems and natural disasters, new epidemics, and risks of market failures
where the poor are vulnerable to international crises.
 A migration trend with the difficulties from increased urbanization as there is no insurance
system to guarantee the migrants’ social security.
 The income gap is still widening between urban and rural and eastern and western regions.
 The masses of non-performing (unpaid) loans the financial system has to absorb.
 Unproductive state-owned enterprises