Foreign Companies Must Bring More to the Table in China

By Thomas Clouse

Today’s Machining World Archives January 2009 Volume 05 Issue 03

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China’s Communist government began its experiment with capitalism in 1978 by opening a small area in southern China to foreign investors. The special economic zone offered preferential taxation policies, inexpensive land and China’s cheap and seemingly inexhaustible labor supply. China’s then President Deng Xiaoping, well-known for his practicality, proclaimed, “It doesn’t matter if a cat is black or white, as long as it catches rats.”

The experiment, to follow the metaphor, caught many rats. Foreign money poured in, and pro-growth policies spread across the country as municipal and provincial leaders competed to attract new investment. This foreign investment boosted the national economy to an average growth rate of almost 10 percent during the three decades that followed. The tremendous growth pushed 10 Chinese citizens onto last year’s list of the world’s billionaires and pulled millions of others out of poverty.

This year, as China celebrates the 30th anniversary of its opening and reform, its leaders are adjusting their growth centered model. The accomplishments of this approach are clear but so are many of the drawbacks. Income disparity is increasing, the environment is deteriorating and product safety scandals are rampant. The country’s heavy dependence on exports has left the economy vulnerable to global economic swings, with recent turmoil in global markets forcing factory closures around the nation. Foreign investment provided fuel for China’s economic rise, but domestic demand must eventually step up to sustain it.

For these reasons, policy makers are shifting their priorities toward more balanced, environmentally friendly, safety-conscious and domestically centered economic growth. Recent policies reflect these shifting priorities. China decided last year to unify its corporate income tax code for both foreign and domestic firms at 25 percent, with only a few selected industries, mostly in high tech fields, qualifying for reductions.

Previously, foreign firms paid 15 percent, while domestic firms paid 33 percent. A new labor law took effect at the beginning of this year limiting overtime hours, setting minimum wages and guaranteeing severance pay. In October, the government reformed its land policy, allowing farmers to buy and sell land use rights, reducing the power of local governments to secure low cost land for economic development.

Foreign companies cannot afford to ignore this policy shift. China is outgrowing its role as the world’s low-cost manufacturing base, and companies need to re-evaluate their strategies accordingly. Higher pay, better employee benefits, environmentally friendly practices, advanced technology, these are the aspects of growth Chinese officials now seek out in foreign companies. Companies that offer low skill, low paying manufacturing jobs can no longer expect the warm reception they once enjoyed.

Some companies, daunted by the changing landscape, are already relocating to nearby markets such as Vietnam, India and Bangladesh. Others have taken strong steps to establish more sustainable practices in China. Wal-Mart is one example. The company gathered Chinese suppliers, government officials, and non-government organizations together in October 2008 for a special meeting to outline new company policies demanding that sup-pliers obey relevant environmental, safety and labor regulations. The retailing giant signed a memorandum of understanding (MOU) with the Ministry of Science and Technology to pursue a number of sustainability goals. The MOU will likely serve as a model for other large foreign corporations that want to gain traction in the Chinese market.

The evolving landscape in China will also open opportunities for companies in high-tech and service industries. Following the lead of neighboring countries such as Japan and Korea, China is setting up special technology parks to attract high tech manufacturers and research and development offices. Such areas can offer well-trained and relatively inexpensive workers for such facilities, and some international companies are taking advantage. Microsoft is currently building a $280 billion R&D center in Beijing, its largest such facility outside of the US.

The companies with the most to gain will be those willing to focus on China’s domestic market. The country’s service industry is extremely under-developed and policy makers will focus on strengthening this sector as the global economy slows and export growth falls. China’s domestic economy shows encouraging signs, with retail sales up 22 percent year on year in the third quarter. The country already has to the world’s largest mobile phone market and Internet using population. Opportunities to participate in industries such as telecommunications, health care and education are likely to open. Well-prepared foreign companies can capitalize on those opportunities to join in on the next phase of China’s economic miracle.

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