K J SOMAIYA INSTITUTE OF MANAGEMENT STUDIES AND RESEARCH

International Business
Individual Assignment no. 2

Topic: CHINA- Legal Growing Pains in a land of Opportunity

Submitted by Dhaval Trivedi Roll No. 153 PGDM B

Q1) Outline the major changes in the international business environment over the last 7 decades from an MNEs perspective which have significantly impacted business landscape in China for the MNE's? China is one of the world's oldest civilizations. Prior to the 19th century, it possessed one of the most advanced societies and economies in the world; but through successive dynasties it then missed the industrial revolution and began to decline. In the 19th and 20th century, imperialism, internal weakness and civil wars damaged the country and its economy, and led to the overthrow of imperial rule. In 1949, after major combat ended in the Chinese Civil War, two states calling themselves "China" emerged:
I.

II.

The People's Republic of China (PRC), established in 1949, commonly known as China, has control over mainland China and the largely self-governing territories of Hong Kong (since 1997) and Macau (since 1999). The Republic of China (ROC) established in 1912 in mainland China, now commonly known as Taiwan, has control over the islands of Taiwan, Penghu, Kinmen, Matsu, the Pratas island group, and a few other outlying islands.

The People's Republic of China (PRC), commonly known as China, is the most populous state in the world with over 1.3 billion people. The major changes in the international business environment over the last 7 decades from an MNEs point of view are: 1940s The civil war continued intermittently until the Second Sino-Japanese War interrupted it, resulting in the two parties forming a Second United Front. Japan's campaign was defeated in 1945, marking the end of World War II, and China's full-scale civil war resumed in 1946. In mainland China today, the last three years of the war (1946 - 1949) is more commonly known as the War of Liberation. After World War 2 and subsequent internal conflicts, Communist Party of China hailed over China. But due to continuous wars China became economically weak with little resources and policies to attract foreign trade. The political risk in China was very high and so MNEs were absolutely not interested in entering China for business. 1950s In 1950 China saw a cessation of major military hostilitieswith the newly founded People's Republic of China controlling mainland China, and the Republic of China's jurisdiction being restricted to Taiwan, Penghu, Kinmen, Matsu and several outlying Fujianese islands. The Constitution of 1954 drastically curtailed the role of Non-Communists. The Great Leap Forward which was designed to overcome the backwardness of China's economy, industry, and technology severely backfired and together with bad agricultural seasons led to severe loss of lives and and unstable environment from an MNEs point of view.

1960s In 1966, Mao and his allies launched the Cultural Revolution, which would last until Mao's death a decade later. The Cultural Revolution, motivated by power struggles within the Party and a fear of the Soviet Union, led to a major upheaval in Chinese society. The roots of Chinas political system and the one man rule concept had its root in this decade. 1970s In 1972, at the peak of the Sino-Soviet split, Mao and Zhou Enlai met Richard Nixon in Beijing to establish relations with the United States. In the same year, the PRC was admitted to the United Nations in place of the Republic of China for China's membership of the United Nations, and permanent membership of the Security Council. After Mao's death in 1976 and the arrest of the Gang of Four, blamed for the excesses of the Cultural Revolution, Deng Xiaoping quickly wrested power from Mao's anointed successor Hua Guofeng. Although he never became the head of the Party or State himself, Deng was in fact the Paramount Leader of China at that time; his influence within the Party led the country to significant economic reforms. This turn of events marked China's transition from a planned economy to a mixed economy with an increasingly open market environment, a system termed by some "market socialism", and officially by the Communist Party of China "Socialism with Chinese characteristics". China embarked on free market reforms in 1978 with agricultural reforms. Farmers were allowed to own lands, grow crops that were economically profitable to them and price for agricultural products were drastically increased, which led to a boom in agriculture. 1980s In these years, the government emphasized raising personal income and consumption and introducing new management systems to help increase productivity. The government also had focused on foreign trade as a major vehicle for economic growth. In the 1980s, China tried to combine central planning with market-oriented reforms to increase productivity, living standards, and technological quality without exacerbating inflation, unemployment, and budget deficits. Reforms began in the agricultural, industrial, fiscal, financial, banking, price setting, and labor systems. The country lacked the legal infrastructure and knowledge of international practices to make this prospect attractive for many foreign businesses, however. In the early 1980s steps were taken to expand the number of areas that could accept foreign investment with a minimum of red tape, and related efforts were made to develop the legal and other infrastructures necessary to make this work well. Laws on contracts, patents, and other matters of concern to foreign businesses were also passed in an effort to attract international capital to spur China's development. These years showed the maximum increase in FDI, percentage wise. Government policies were more favorable for MNEs and China had become an attractive destination for MNEs.

The PRC adopted its current constitution on 4 December 1982. In 1984, China allowed the formation of Town-Village Enterprises (TVE)- a peoples cooperative in small and medium scale industries engaged in light manufacturing and services.TVE absorbed surplus rural labour and resulted in tremendous growth of the countryside. Another 14 coastal cities were opened up to attract FDI with similar facilities like SEZ with free ports etc and reduced tax rates of 25% as opposed to nominal tax rates of 35%. In 1988, PRC law on Industrial Enterprises Owned wholly by the People and Sino-Foreign Cooperative Joint Venture Law was passed. 1990s The Chinese economy continued to grow at a rapid pace, at about 9.5%, accompanied by low inflation. China faced slowing growth and rising unemployment based on internal problems, including a financial system burdened by huge amounts of bad loans, and massive layoffs stemming from aggressive efforts to reform state-owned enterprises (SOEs). It was in late 90s that the government started privatization of badly performing SOEs. 2000s The country formally joined the World Trade Organization in 2001. Wholly owned subsidiaries were allowed in China from 2004. Major 5 year economic plan was launched in 2005. China grew by approximately 10% through out. China's total trade in 2006 surpassed $1.76 trillion, making China the world's third-largest trading nation after the U.S. and Germany. MNEs are looking at China and India as their consolidation destinations post recession. Special Economic Zones (SEZs) were created to encourage FDI in Shenzhen, Zhuhai, Shantou and Xiamen. Following is a graph showing GDP of China over decades.

Q2) Explain the key changes in the China's political environment decade by decade commencing 1940's. Which are the major milestones in China's transition to a market based economy? Key changes in political environment are summarized decade by decade since 1940 are given below: 1940-1950: In this decade, China witnessed War of Liberation and the World War. War of liberation ended in 1949 and world war ended in 1945. The political risk in China was very high and so MNEs were absolutely not interested in entering China for business. In the final stages of the World War 2, United States provided massive assistance to Nationalist China, but the Chongqing government, weakened by inflation, impoverishment of the middle class, and low troop morale was unable to take full advantage of it. In January 1946 a cease-fire was negotiated by United States and the United States supplied the Chiang government with an additional $2 billion. After the fall of Nanjing and Shanghai, KMT resistance evaporated. By the autumn, the Communists had taken all mainland territories except Tibet. On Oct. 1, 1949, Mao Zedong proclaimed the establishment of the People's Republic of China. 1950-1960: This decade saw Mao Zedong gaining control of most of Mainland China. He established the People's Republic of China as a Socialist State headed by a "Democratic Dictatorship". This was more of a rebuilding decade for China. Even though things were getting better, but still the damage done by the war was too evident and the environment was still bad for business. The constitution of 1954 drastically curtailed the role of non-Communists. Real power, however, lay with the Communist party, especially the Central Committee, which held together the triad of power--army, government, and party. The inner circle of the Central Committee was the 19-member Political Bureau and its seven-member Standing Committee. The Agrarian Law of 1950 began the nationwide land reform, distributing land from landlords to the peasants. Land reform erased the social distinction between landlord and peasant. The CCP announced the first five-year plan in 1953 to speed up the socialization of China through a planned economy. The plan's aim was to produce maximum returns from agriculture in order to pay for industrialization and Soviet aid. By May 1956, 90 percent of the farmers were members of cooperatives, 80 percent of heavy industry and 40 percent of light industry were in government hands. To speed China's development even more, Mao Zedong, Liu Shaoqi, and others, after overcoming some opposition within the leadership, launched the Great Leap Forward in 1958. The Great Leap Forward was designed to overcome the backwardness of China's economy, industry, and technology. It was to be achieved through use of the vast manpower and indomitable spirit of the Chinese. The effect of the Great Leap Forward on the people and the

economy was devastating. Coupled with three straight years of poor harvests, it resulted in a severe food shortage and industrial decline. 1960-1970: This decade saw Mao and his allies launching the Cultural Revolution. It led to a major upheaval in Chinese society. This was the decade of one political entity trying to establish its power in the whole of China. The roots of Chinas political system and the one man rule concept had its root in this decade. 1970-1980: This decade shows China's transition from a planned economy to a mixed economy with an increasingly open market environment, a system termed by some "market socialism", and officially by the Communist Party of China "Socialism with Chinese characteristics". The year 1976 marked the end of an era. Zhou Enlai died in January. Mao himself, the chairman of the party and the embodiment of the revolution, died in September.This decade saw initiation of economic liberalization of China in 1978. Government had slowly started accepting globalization. 1980-1990: In the early 1980s steps were taken to expand the number of areas that could accept foreign investment with a minimum of red tape, and related efforts were made to develop the legal and other infrastructures necessary to make this work well. The new policies were confirmed in the party and state constitutions adopted in 1982. These included accelerating China's economic development by the best possible means; for example, by rewarding good work, even if this resulted in some inequalities in society. Steps were also taken to prevent the concentration of power that had marked Mao's time. Thus, the new state constitution limited state leaders to two consecutive terms. Nevertheless, the new leadership remained firmly committed to Communism. The 1982 constitution stated again the Four Fundamental Principles that should guide the society: the leadership of the Communist party, the "people's democratic dictatorship," the socialist road, and Marxism-Leninism-Mao Zedong Thought. The new constitution allowed a greater measure of political freedom and civil rights, and legal safeguards were introduced. It was evident, however, that there were limits to the new liberalization. The new regime's goal was the development of China's economy by means of the Four Modernizations: of agriculture, industry, national defence, and science and technology. In 1987 Deng retired and was succeeded by Zhao Ziyang as general secretary and Li Peng as premier. The Tiananmen Square protests of 1989, culminating in the deaths of hundreds of civilian protestors, were a series of demonstrations in and near Tiananmen Square in Beijing, China. Led mainly by students and intellectuals, the protests occurred in a year that saw the collapse of a number of communist governments around the world.

1990-2000: It was in late 90s that the government started privatization of badly performing SOEs. This decade showed China consolidating its position as an attractive destination for MNEs, an attractive market and tremendous scope of profits for MNEs. The 1990s saw two foreign colonies returned to China, Hong Kong from Britain in 1997, and Macau from Portugal in 1999. Hong Kong and Macau mostly continued their own governance, retaining independence in their economic, social, and judicial systems. Economic growth averaged at 8% annually, pushed back by the 1998 Yangtze River Floods. 2000- Present: The political environment, even though was one man rule like government, but the policies for were favorable for business. MNEs looked at China and India as their consolidation destinations post recession. The country formally joined the World Trade Organization in 2001. Wholly owned subsidiaries were allowed in China from 2004. Special Economic Zones (SEZs) were created to encourage FDI in Shenzhen, Zhuhai, Shantou and Xiamen.

Q3) Explain the key aspects of China's legal environment and its implications for MNE's? China launched one of the biggest legal reforms in history in 1978. It still has some problems like legislative gaps, hazy interpretation, lax enforcement and philosophical disagreement. The key aspects of Chinas legal environment which has implications for MNEs are: I. Local Authorities Interest: In China local economic interests often take precedence over other interests and local governments are prone to act in ways as to protect their own interests. The overlapping judicial and administrative systems mean that the judicial department at the local level is subordinate to both the local government and the judicial authority at a higher level. Democratic dictatorship: China has long relied on the rule of man that legal rights derive from the will of the individual who has the power to enforce them. Conflict between State and Central Legal System: China being a huge country, it is not physically possible for a government to gain control over the whole nation. So the result is conflict between central and state governments. These two entities are often found to be at loggerheads policy wise. As a result the FDIs from MNEs are the main victims of this clash. Red tapism: The bureaucratic infrastructure of Chinese working brings in a whole lot of extra coat for an MNE when it plans its operations in China.

II.

III.

IV.

V.

Corruption: A long and tedious bureaucratic infrastructure, unlimited power in the hands of state and central officers has resulted in a wide spread of corruption. This cost is a major cost that MNEs incur while doing business in China. Intellectual Property Rights: IPR are a form of foreign capital investment and require legal protection. Despite the existence of legal provisions, the protection of intellectual property rights is still ineffective and infringements persist.

VI.

VII.

International Arbitration: Challenging a local partner in a Chinese court will ruin local business relationships and are mostly worked through out of court settlements. Most of the China run businesses are looking at arbitration as an option for their problems. Judiciary and law enforcement: The enforcement of court judgments is yet another source of legal problems. The arbitrariness of the court often gives rise to injustices and undermines the reputation of the judiciary system. Mergers and Acquisition: The current regulation on mergers and acquisitions involves many government departments and each has its own law enforcement procedure. Thus it is difficult for foreign investors to enter China by means of mergers and acquisitions. No comprehensive Bankruptcy laws and Anti-Trust Laws

VIII.

IX.

X.

4) Using key macroeconomic parameters, comment on China's economic development over the last 3 decades. What was government's role in China becoming world's 2nd largest economy. What are the key challenges government of China will face 2010 to 2015? Why? China was a centrally planned economy up to 1978, i.e. pre liberalization period. 1960s and 1970s saw investment by Chinese Central government in human and infrastructure capital. As a result, by 1978 nearly three-fourths of industrial production was produced by centrally controlled state-owned enterprises according to centrally planned output targets. Government policies kept the Chinese economy relatively stagnant and inefficient, mainly because there were few profit incentives for firms and farmers. There was absolutely no competition for these centrally owned ventures. Chinese government launched several economic reforms, which are listed below.

  

Rapid productivity growth: They also concentrated on increasing their overall productivity to boost their production. Increase in productivity also included bettering there product quality, product flexibility, etc. Chinese government setup special economic zones (SEZ) so as to attract FDIs. Large scale capital investments: This has allowed China to go for huge economies of scale and attain the quantitative production it currently has. Decentralization of economic production: It led to substantial growth in Chinese household savings. As a result, savings as a percentage of GDP has steadily risen. Farmers were encouraged by giving them incentives and allowed them to sell their output in free market. This increased the over agricultural output in China. Local and provincial governments were allowed to establish and operate various enterprises on market principles, without interference from the central government. In addition, FDIs in China brought with it new technology and processes that boosted efficiency. Chinese government encouraged people to save more. This helped the government to invest more in infrastructural endeavors. When the government increased their spending, the whole market was set to gain. Coastal regions and cities were designated as open cities and development zones, which allowed them to experiment with free market reforms and to offer tax and trade incentives to attract foreign investment.

The key challenges that the Government of China will face are:
o Intellectual Property Rights: This remains one of the biggest concerns of MNEs when they work in China. This culture of using intellectual property without paying for it is engrained in Chinese working culture. This has resulted in MNEs making huge losses. o Human rights violation: The Xingjian riots have shown the world the real state of human rights in China. This reality poses a great challenge for Chinese authorities to consolidate MNEs trust in China. o The lack of the rule of law in China has led to widespread government corruption, financial speculation, and misallocation of investment funds. In many cases, government connections, not market forces, are the main determinant of successful firms in China. o Public unrest over pollution, government corruption, and growing income inequality poses threats to social stability over such issues as pollution, government corruption, and land seizures. o Loss making State-owned enterprises (SOEs): SOEs account for about onethird of Chinese industrial production. The loss making SOEs put a heavy strain on Chinas economy. Government support of unprofitable SOEs diverts resources away from potentially more efficient and profitable enterprises.

o The banking system faces several major difficulties due to its financial support of SOEs and its failure to operate solely on market-based principles. Chinas banking system is regulated and controlled by the central government, which sets interest rates and attempts to allocate credit to certain Chinese firms. o Corruption poses another problem for Chinas banking system because loans are often made on the basis of political connections. This system promotes widespread inefficiency in the economy because savings are generally not allocated on the basis of obtaining the highest possible returns.