One of my main duties as a lawyer is to minimize risk. Properly forming/registering a Chinese entity minimizes risk. A great contract minimizes risk. Registering a company’s intellectual property minimizes risk. Written employment contracts and a written employer manual minimize risk. An FCPA compliance manual (usually part of the employer manual) minimizes risk. The list of how we help our clients reduce their risks goes on and on.
But there is only so much we lawyers can do.
There are certain risks on which we have little to no impact. We can write the world’s best contract, but if your Chinese counter-party is a crook without any real assets, he can breach the contract with impunity. Our registering your IP greatly reduces the likelihood of someone stealing it and makes it easier for you to sue them if they do, but it does not preclude anything. An FCPA compliance manual is not guaranteed to stop your employees from countermanding it.
Then there are the really big risks. We can tell you that doing something is legal today in China, but what is legal today may not be legal tomorrow. We had a client who purchased a relatively expensive building for a particular business and then within months, the local government made it illegal for foreigners to operate that particular business from a building they own.
And then there is the biggest risk of all: China itself.
Joseph Sternberg, the dead-bang brilliant and far too young (not sure he’s even 30 yet) Editor of the Business Asia column at The Wall Street Journal just came out with an article discussing China’s too-quick willingness to retaliate against whole countries or to act against their “own economic interests.”
The article is entitled, “Nobel Sentiments, Business Risks,” and its thesis is, essentially, that businesses should be taking lessons from China’s recent reactions to the way it has dealt with businesses from countries China perceives as having slighted it. These reactions give rise to “new questions . . . about policy risk in China.” They sure do.
The article makes note of how China this week canceled a meeting with Noway’s fisheries minister in apparent retaliation for a tiny committee of private citizens. Sternberg then comments on how this sort of thing is taken too much in stride by businesses in China:
Exporters are optimistic that political disagreements won’t dent trade in the end. But it’s worth asking how they can possibly know. Conspicuously, the only basis for this conclusion is surmise. Norway is a big oil exporter, and China is a big oil consumer. Ergo, Beijing will understand that its self-interest lies in not antagonizing Norway.
No senior officials in Beijing have made any clear statements about whether they will retaliate against Norway. Beijing hasn’t formally said why it canceled that meeting with the minister. There has been no public debate on the matter, so there is no way of knowing how divided the leadership is on whether to pursue a more vigorous response or to let the whole thing blow over.
Everyone simply assumes Beijing will act “in its own best interest.” But absent democratic institutions like a parliament and a free media, there’s no way to know what Beijing thinks its self-interest is.
I could not agree more. Far too often I have had clients just assume the major goal of China and its provinces and its local officials is to bring in foreign business that can provide good jobs for the Chinese people, but that is just one of many goals. I am convinced the main goal is actually to keep the Chinese people happy in a political sense and though that goal can and often does include jobs, it can and does oftentimes include much more than that, sometimes even to the exclusion of that.
Sternberg goes on to describe the capriciousness of it all:
At heart this is a question of risk versus uncertainty. Policy risk is the ability to estimate with some degree of precision (the risk) the probability that government will do something stupid (the policy). Uncertainty is far more capricious, involving the completely unknown or unknowable. China may be more uncertain in this sense than some have realized.
The question is not whether China’s government will do foolish things. All governments do, as American businesses staring down the barrel of ObamaCare will attest. In the democratic world, however, businesses can see bad policies rolling in their direction like thunder clouds on the horizon. As a result, they enjoy ample time to estimate how bad the hit to the bottom line would be. Policy making in a democracy follows a certain logic of poll numbers, votes, media spin and the like. Because so much of it happens in the open, it is possible to make educated guesses about the outcome. As a corollary, understanding the logic—how congressmen think, say, or where the campaign money comes from—makes it easier to lobby effectively.
Not so in China. This comes up repeatedly as China increasingly asserts its political and economic might. Japanese companies have found themselves deprived of Chinese rare-earth minerals owing to a political spat over maritime sovereignty. Foreign executives like Rio Tinto’s Stern Hu have found themselves arrested, tried and convicted on corruption charges seemingly as a result of commercial disputes.
According to Sternberg, China is so random and the events that trigger China are themselves so random, that there is pretty much no way to know the odds of your company getting caught in a maelstrom.
So how could a Japanese executive relying on rare-earth minerals from China have estimated his risk from a politically motivated cut-off in supply? How could a Norwegian handicap the odds that a Nobel Peace Prize might adversely affect his business?
Already there are signs companies are realizing they’ve made mistakes. Google withdrew when it concluded it had wrongly estimated the upside policy risk of censoring search results in exchange for doing business in China. The company discovered Beijing’s internal logic evidently rules out allowing a foreign Internet search company to succeed no matter how accommodative it is.
Like it or not, China no longer feels terribly inclined to care much about the foreign companies in its midst and it will not hesitate to place big picture politics over economics. Those who believe otherwise are neglecting real risk. And sometimes, the impact of these things is so small and so subtle that I have suspected something is happening, but I cannot be sure. For example, in the last couple of months, as tensions between the United States and China have been rising on the economic and military fronts, I have gotten the strong sense that China is cracking down on Americans in China without work visas. I can tell you that the number of calls we have gotten on those has greatly increased. Is this random? Is this due to something else? Might this be happening to people from countries other than the United States? I don’t know, but I think there is something going on and this is not the first time.
What then is a foreign company to do? I am not a business expert, but if it were me, I would at least take note of the potential risks and at least be thinking of contingencies to try to alleviate it. If my product costs $1.00 to make in China and $1.20 in the United States, I would NOT shut down my entire U.S. operations and move it all to China. And I know it is not good form not to be all rah rah on China, but I will note that in my own portfolio right now, I own country funds for three countries: Vietnam, Brazil, and Turkey. I sold my China country fund a year ago. If I had to pick one country that is going to grow the most during the next ten years and do so in the best way possible for American companies, I would pick Vietnam.
Who’s with me?