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

SvD: I have taken business contacts on free trips

"I have sent business contacts at free trips"

He has worked in China since 1997, e.g. as Vice President at Ericsson China and senior management position at Nokia but also as club owner. Many times have David Almström have closed encounter with the extensive corruption in the country. He himself have also done things with  business acquaintances that might be considered as bribery in Sweden.

This article was posted in Svenska Dagbladet, SvD

 - China is still extremely corrupt. I have been directly asked several times to give and get bribes. It's a kafkaesque system where all takes a lot of time, says David Almström

He has been in direct touch with bribery both within the iT and telecoms as well as in the restaurant business. David Almström's short time as part-owner in a nightclub ended up in a total fiasco, due to the extensive corruption. 

 - It was a lot of those things. I never got to see the daily business, only part-owner, but I did see any money there as well. I tried to recover what I invested but that was impossible.

Today, David Almström lives in Sweden but still owns a cafe in Beijing and works towards China as head of Scandinavia for the software development company, Symbio. And during his 15 years in China, he frequently was subject to bribery and got many requests from customers. 

 - One example was a fairly small deal of $50-60,000 whereby I met the CEO of the customer. He immediately declared he expected a new computer to sign the deal. We said no and also did not get the deal, says David Almström

And it is custom for both local and multinational companies use bribes in their daily business, according to David Almström. However, the Chinese government have increased their efforts to control the bribes during the last years. And when bribes get revealed, it may end quite badly for the parties. One of the top manager at China Mobile was prosecuted last year for accepting briberies from many telecom companies - Ericsson was one of them [NB: I actually did not mention any companies that was involved in the bribery]. Punishment: Death Penalty with a reprieve (normally not carried out).

 - It a fairly tragic situation. I know him for a long time and he had a reputation of being one of the more honorable in the industry, someone who do not accept bribes. But as it turns out, 15 years ago he accepted a bribe. And in China, almost every one at that level has done something not acceptable.

Though David Almström explains he himself has avoid the bribes, he has been in the gray zone. Traditionally, it's been important to maintain a good and close relation with the corresponding business partner in China, and it's not uncommon for companies to 'all-inclusive' nights out to pure tourist trips, he says.

 - I have myself taken a person on a trip. Surely, we had some meetings but it was definitely a covered tourist trip, he says

 - But today the situation is different, the relationships are cleaner. Multinationals keep bribery on an arm lengths distance, looking the other direction and pray all is good.

As the government been much tougher on corruption, the bribes have been far more sophisticated, says David Almström. One strategy to escape the government's sharp eyes is to use antiques to laundry money. The one who wants to give a bribe buys an antique for e.g. $250,000. Thereafter makes a copy at a fraction of the cost, to be able to show something during a revision. The original is being give as a bribe. The bribed returns to the antique dealer and sell it back and gets his $250,000 in cash.

 - As antiques are very difficult to trace, it has become an efficient way of laundry money. There a quite a few of these advanced methodologies to hide the bribes, says David Almström

If you as a businessman stays away from the bribes, you certainly will lose some deals, explains David Almström.

- But question is if you want those contracts. You may have something on the person you bribe, but if gets exposed, you yourself will suffer as much, he says.

What do you do as a businessman if you do not want to participate at all in the corruption carousel?

 - Primarily, you have to work with people that you trust, manage as much as possible by yourself and accept failure before cheating to be successful.

- But it is impossible to be 100% fault tolerant. You can sign clauses in the contract of zero tolerance; keep a tight control of your business, but it's really difficult to be sure that everything is according to the book.