21 March, 2013

China and Corruption

Spinning further on doing business in China and the main topic of the day and for the new leadership in China: Corruption. To be fair, they have other pressing issues as well, like pollution, income disparity, grassroots democracy.

However, corruption is tightly integrated into the whole society and not necessarily in the way that we think of it. For example, it's quite common that sales people do not have salary, nor 'real commission', instead they are advised/told to get the commission from the customer and the seller states what he wants. Say, you are selling software. The company expects to get $1,000 and the customer is prepared to pay $1,250-1,300. The salesperson can pocket $100-150 of the deal and $100-150 goes back to the buyers. The sales person avoids paying salary tax, the company reduces their risk and also not paying social security fees and the buying company probably gets a better price (as if all the costs would be in the product sale, the price might even be higher).

As any macro economist would tell you, this model does not really work well for the society overall as its arbitrary who gets the benefits of the 'tax exemption'. And maybe this is one of the reasons why the government now imposes that kids can not deny to take care of their parents when they are older. The system can simply not take care of elderly in China. But even economists in China argues that the tax burden (link is in chinese) might be too heavy for Chinese companies (as a side note, foreign companies really have to fulfill their duties in paying full taxes).

Another example of how this kind of system really destroys value is water wells. A few years ago, there was a minor earthquake in a city outside Beijing and the city's largest problem was availability of fresh water. But instead of drilling new wells, bottled water was brought from all over the country. Why's that? It turned out that a cost of drilling a well is actually not that high. Say $2,000, but the actual cost for the local government ordering wells were rather close to $15,000 as a lot of leaked out. Thus, cheaper to ship bottled water. 

And the level corruption is unfortunately so deeply rooted that it will not be possible in near-term to extinct corruption; though it is now far more dangerous to be corrupt. With the widespread use of Weibo, whistleblowers can much easier cause trouble. And there are many examples only the last couple of months of government officials owning 10-20 apartments worth tens of millions dollars.

But the Chinese Communist Party strives first and foremost for stability - more important than economic development, human rights and democracy. The China Dream mandates a stable China. I'm not going to dive into the subject of democracy, but stability as the number one objective have implications. One is how/if democracy will be deployed but more pressingly, corruption can only be dealt with to a certain level as the Party needs its people to stay intact.

One of my acquaintances was a very high-level ranked executive in the telecommunications industry. His reputation was that he was fair and didn't accept bribes. He seemed to work for the company's best interest. In comparison with others, he was less interested in personal benefits. However, a few years ago, my friend received suspended death penalty for bribes he took more than 15 years ago. He was caught because one of his young mistresses were trying to gain some personal benefits, using my friends name. And the internal affairs started dig and dig and it seems like everyone has something to hide.

Now, he is one of those who weren't really corrupt and still got caught. Normally, this has been a sign that the person is out in the cold, cut off politically. This is also totally clear in the case of Bo Xilai. But as the Party is somewhat rotten internally from corruption and authoritarianism, it will take time to clean up. This article in Caixin sums up the Bo Xilai story well if you want to read more.

For anyone doing business in China, stay out of corruption of course. First, you don't really know how to play the game and secondly, the implications of being caught are too negative for both individuals and the company. As the case with Bo Xilai shows, never trust guangxi, as you can't predict political power changes in China.

As an anecdote, I just want to highlight that isn't only foreigners who gets scammed in China. Chinese gets cheated too.. I came across a Chinese gentlemen who seems pretty solid and with a good experience in the telecommunications and energy industry. Now, he told me a story that was not very nice. He met a Swedish businessman who he started a JV with and at the end, the Swedish businessman basically stole his company, knowhow and products and started another company. Not only outmaneuvering the Chinese business man but nearly bankrupting him. Everyone needs to do Due Diligence. If done, he would have found that the Swede were convicted for economic frauds and tax evasion in Sweden and escaped to China to avoid prison.

Not easy to do business

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