The China Joint Venture. It's BACK!!!

I thought you were heavily ANTI Joint-Ventures and had posted a lot of legal reasons why you shouldn't get into them. Now I'm confused. They are either good because of the financial situation for American manufacturers as a cheaper route into China or they are bad because the legal system for them is poor and its easy to get ripped off. So which is it? Has the legal situation changed at all? I think we need some clarification from you here.

Listening about the reasons why there is shift in JV's, I think that the lack of credit for US companies is going to be something of a long term trend. Before the crash, the ultimate source of capital for American companies came from China. Chinese companies deposited their foreign exchange with the Chinese government that bought mortgage-backed securities which were used to finance investment banks which then had capital available to SME's.

With the collapse of the credit system, China is no longer exporting as much capital. Since capital is staying in China, it's getting routed to foreign companies through joint ventures.

The source of this capital is because by building a factory in China, productivity massively increases, which creates capital which can be used to increase productivity.

People are thinking short-term benefits and not long-term. JVs are very dangerous and if the Chinese partner decides to throw you out of the operation entirely, you are done and if you want to fight it in a Chinese court....Good luck with that. This looks like a disaster waiting to happen. When will Americans ever learn? Maybe never.

Twofish, you have a distinctly Chinese perspective on things.

Just listened to the whole of the podcast and I thought I've got too much work to handle this morning and would only listen a bit. Well, the excuse I offer myself for delaying work for this is that though it's not more urgent than my work at hand, it's very important for my work to understand all these issues and hey, work aside, it was pure pleasure listening to such sensible stuff.

Craig,

Just for you, I have gone back and done exactly that.

Justin,

Why thank you....

JamesWu,

I never thought I would see the day where I am defending China Joint Ventures, but it is here and here is why.....Stay tuned.... I am working on a post explaining why they sometimes do make sense. Expect it by Monday.

Robertb,

1. What the heck does that even mean?
2. Even though I think I have a VERY American lawyer perspective on China joint ventures (I find them scary), I completely agreed with what TwoFish has been saying.

Handan,

Thanks for the compliments. That, or I am just plain slow!!??

JamesWu,

I think you raise a deeper issue that is not easy to discuss directly. Untrustworthiness is not unique to China, as it occurs in all countries, including the US, and it seems to be high in Russia these days. But I think few would disagree that it is more pervasive in China as compared to Western countries. The current use of henchmen in China is thankfully shocking to most Westerners. And I rarely feel the need to check the lids on bottles in the West, but take it as a matter of daily life in China.

My question to anyone, is what do you think are the root sources of this more pervasive Untrustworthiness? I had a Russian friend that said it became common to take what you could when everything belonged to the state. You tried to get your extra share when you could. Do people see this issue related to the effects of communism? Or would you say it stems farther back in the history? Or just that there are so many competing for the same piece of the pie? My own personal theory sees a change in Chinese culture when the idealism of the late 80's was squashed and what remained was the unfettered pursuit of wealth. I have friends in China who say that in the past they felt more genuine curiosity in foreigners. Now they mostly feel like they are viewed as possible dollar signs $$$.

A thesis could be written on this, but perhaps some brief insights on the sources of this issue might be helpful in navigating the business environment in China.

I think my perspective is less Chinese than Wall Street. It's very common in these parts for two people to be shaking hands with one hand, and fighting with daggers drawn with the other.

Duncan: You can pretty much rest assured that your "partner" will land you in it the moment the business starts making money. Fools and their money...

But even then a JV may not be a bad thing. You need to remember that the purpose of a business is to make money, and if you get into a JV, and then three years later (as expected) your partners stab you in the back and toss you out the train, you could still end up making more money than had you done nothing.

Remember that in the "new style Js" it's the Chinese partner that is putting up capital, so when your partner does stab you in the back, they aren't going to end up with much of your money. Also, since you aren't putting much of your money in, if things go bad, you can walk. If you can walk, you can play hardball.

Also if the thing that you are bringing to the table is something like a US distribution chain, it's harder for the Chinese partner to get much when they do stab you in the back. I think someone mentioned that the "new style JVs" are curiously not intended to build product for local markets. That makes sense. If you are building something for local markets, you are a fifth wheel that doesn't bring anything useful.

If you are using a JV to build product for the US market, then if your partner stabs you in the back, you call up Long Beach customs and have them seize shipments to the US, tear up the JV agreement, and since you have little of your own capital invested, you lose very little.

Not every business relationship is a long term marriage. There are lots of business relationships which are quick alliances that both sides know are going to fall apart the second things change.

Dan, two days ago, I watched a webcast by Jing Ulrich saying that Chinese banks' new lending in 2009 will not result in any NPLs.

Now I read Twofish

1) rewrite history by claiming that the majority of trade account USD recycled back into the U.S. by China this decade went into mortgage backed securities instead of funding U.S. gov't debt.

2) claim that China has 'chosen' to keep capital in China, but failing to distinguish between the RMB expansion that PBoC is now on course with, which has been the source of funding of new capital investment, and the USD they were forced to recycle back into the U.S., due to the trade surplus, in order to maintain their currency peg. With the trade surplus easing, it's a lot easier to maintain that peg.

3) confuses capacity with productivity. How on earth does building a factory increase average levels of productivity?

I agree with James Wu. This new JV fad is extremely short-sighted and will end badly for the foreign partners, because now, with control of capital funding, the Chinese partners will feel even more entitled to the business than they were with the previous JV model.

You guys have been "drinking the kool-aid".

history,

I think it is history. I'm being serious. I have been dealing with Russia since the fall of communism and I have definitely seen a lot of change on this front there. I also think having a legal system is a great thing for honesty as well.

Twofish,

You are right that an American company that gets booted out of a JV within the first few years might still have done right by getting into it in the first place. We are working with a US company that is contributing a relatively small amount of money and some not all that current technology and, in return, expects to learn China from the inside. So if they get the boot quickly, they will still likely have accomplished quite a bit for a relatively small price.

But I was also contacted by someone who is contributing valuable technology to a clearly unworkable (because it is illegal) joint venture and I see this guy getting the boot (and probably losing his technology for good in China) within months not years. I told him my firm would not touch his project and I gave him a list of law firms in China and told him he needed to hear from more people on what a mistake he was making because I obviously was not getting through to him. I will email him in 6-7 months for an update.

TwoFish,

I completely agree with you that the joint venture problem is NOT cultural. The problem is playing a game in someone else's stadium. You talk about other countries. For years, my firm did a ton of fishing joint ventures with Russian companies and then with Mexican companies. I can remember one Friday afternoon all or most of us from the firm were sitting around the conference room musing as to whether anyone could prove that any of the Mexican joint ventures we had done or that we had heard of had been successful for the American company. None were. These were deals where the Mexican company was supposed to get the fish quota and the American was to fish it and then they would share. Almost without exception, the quota came in well under what had been promised. And in the few instances where it was all that was promised, the Mexican entity was soon making up reasons for how the American entity had done this or that and had breached the joint venture agreement and so now the Mexican company was justified in fishing the quota on its own. The American company's recourse was to bring a complicated lawsuit in Mexico....

Marty,

What "smacks of advice being given to take advantage of a change of US economic circumstances?" My interview? If so, then I strongly suspect you didn't listen to it, because I made clear there had been no major changes in law and I was also very clear that these deals are risky. However, they are not always a bad idea and I never thought they were. My job is to set out the legal risks and then if the client chooses to go forward, to set things up as best as possible to minimize the risks. All I am saying now is that economic reality is forcing joint ventures on companies that would have gone into China as a WFOE a few years ago. Is it bad to be realistic about any given situation?

Also the fact that productivity increases in China are capital driven increases explains why China is growing at 8-12% while the US is growing at 1-2%. In China you still can get massive increases by pouring concrete. In the US, the concrete has already been poured, so you have to focus on technology and efficiency.

In China focusing on efficiency too much is something of a *bad* thing because if you focus only on efficiency, you end up with lots of idle workers.

Also I agree with Jing Ulrich, that NPL's aren't going to be a huge problem this time around.

One other thing about JV's. One problem is that there is a "dishonesty effect." Someone that is honest is much less likely to promise you the moon and the stars.

The big thing in JV's are Chinese companies forming JV's with US companies to do business in the US. I'm fully expecting that a lot of these will come to grief with the Chinese partner mumbling something about how Americans are lawless and dishonest.

Here is an interesting quote from Wikipedia's section on Corruption in China: "In the PRC the reforms of Deng Xiaoping were much criticized for reintroducing of corruption, as the cost of economic development."

The thing that scares me about living and doing business in China is the sense that if I have a problem with the police or government, that reporting the problem to their superior feels like a gamble. Upon returning to the US, this is one thing I hope never to take for granted, that if I run into a corrupt officer I am fairly certain I can eventually find a superior who will address the problem.

Despite this difference in corruption, the thing I love about Dan's China Law Blog is that he reminds us that there are ways to have China's legal system work for you. One cannot go into China expecting the same sense of fair play one has grown accustomed to in their own country.

History: Upon returning to the US, this is one thing I hope never to take for granted, that if I run into a corrupt officer I am fairly certain I can eventually find a superior who will address the problem.

But have you really tried? This is where talking with lawyers gets you a different point of view, since you find areas of the US where petty corruption in the legal system is pretty pervasive and accepted. What tends to happen is that once you do have corruption in the system, people learn to live with it, and people generally don't make a big deal about it because it's seen as the "cost of doing business."

Both China and the United States have parts of their legal system which are corrupt and parts that are clean. I would say that the US has more clean parts than China does, but at the same time the fact that you do have a mix says that we don't have an issue with national culture.

One reason to hire lawyers is that a good lawyer in the US will tell you where you want to file a lawsuit to get either a fair hearing (or an unfair hearing in your favor). If you go into a foreign country, you don't have that knowledge.

History: One cannot go into China expecting the same sense of fair play one has grown accustomed to in their own country.

It depends on what country. I'm pretty sure that someone from Sweden would consider the Chinese legal system to be somewhat of a mess. However, judging from the reaction of lawyers with extensive international experience, they tend to be quite favorable to the Chinese legal system, because it's *much* *much* better than what they've had to deal with in Thailand, Indonesia, the Philippines, Latin America, Russia, or Vietnam.

Yes, it may seem odd for an American to become an economic hostage in a contract dispute in China, but most everyone I know would rather have this happen in China than in Russia, and it's a pretty standard business practice once you leave the US and Western Europe.

One thing that is the case with business people that do business in China is that while "economic hostage taking" happens, I don't know of anyone in China who ever thought that they where being threatened with death in business dispute. This isn't the case with doing business in Russia and Indonesia.

The other thing that gives the lawyers I know a favorable impression of China is a) things are improving dramatically and b) the Chinese government is quite unusual in actively getting foreign expertise.

I should point out here that my background is in Wall Street and investment banking. It's really tough for me to say that there is a big difference between Chinese CEO's and yuppies and US CEO's and yuppies since you are talking about groups of people that all went to Harvard law school anyway. It's also tough for me to say that the investment and financial situation on how big companies *really* work in the US is much different from how they work in China.

Joint ventures rarely work..... Period..... It's not a US/China thing. If you put two US companies in a joint venture in the US with nothing to do with China, then after about three years, people are going to be stabbing each other in the back, and it's going to end in tears.

People in the US that think that China is hopelessly corrupt also tend to get a bad impression of Wall Street, high finance, and US politics, which leads me to suspect that when people are comparing US with China they are really comparing stereotypes rather than the way things actually work.

If you want to do anything significant in business in the US you *have* to make payoffs to politicians and you *have* to have large amounts of "guanxi" and working the political, financial, and economic systems. There is a social process and etiquette that you have to do, and you have to know the limits, but in the end you are making a payoff and building relationships in a way that isn't that much different from what you have to do in China.

and BTW, my name is James or Mr. Wu to you Twofish. The only people that were allowed to call me by my last name were my fellow marines when I served in the United States Marine Corps. My parents don't even address me by my last name. So watch your ignorant mouth and show people some respect.

Twofish,

Also, regarding corruption, my point is which country would you prefer to travel to the capital and protest about local corruption? I continue to come across disturbing stories of what happens to the average person in China who tries to raise an issue.

What about today? Now that the economy has somewhat recovered, are you still seeing these desperation joint ventures?