The Multinational Monitor


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China sets Its Course

by Jonathan Ratner

After two years of host country false starts and wide-swinging foreign investors attitudes, economic relations between the Peoples' Republic of China and the industrialized West have begun to follow a more predictable pattern. In early 1979, a number of events deflated the general euphoria in the iriternational business community over potential corporate participation in Chinese development. In recent months, however, a new, more realistic attitude has emerged among corporations that have chosen to stay the course, as well as those making renewed preparations to enter the scramble. Corporations are learning that China, in the words off one business consultant for U.S. firms negotiating with the Chinese, offers "no big bonanzas, nothing for the get-rich quick." Beijing appears completely pragmatic in its recognition that corporations require profits, but its demonstrated ability to drive a hard bargain suggests that only firms prepared to enter China with a big stake, or who view business relations. with China as a long-term prospect, will want to negotiate with the Chinese.

The long-awaited final approval of the first joint ventures between the Chinese government and foreign firms may well be viewed as a symbolic close to the period of heightened uncertainty. Beijing's Foreign Investment Review Commission on April 22 announced the ,go ahead for three joint ventures, all in the tourist industry China hopes will become a major foreign exchange earner. The largest venture is a new luxury hotel in Beijing to be built and managed in partnership with E-S Pacific of San Francisco. This firm offers a particularly winning combination of financial interests for doing business in China: its two shareholders are Cyrus Eaton Jr., head of the Eaton family empire that for 30 years has specialized in trade and investment in Soviet bloc economies, and C.B. Sung, a leading Chinese-American businessman who is a former vice-president of Bendix Corporation. More than 100 firms, about equal numbers of Japanese, North American and Western European companies, are now in the advanced stages of joint venture negotiations, in spite of the fact that China has yet to provide much of the enabling tax, labor and patent legislation that will govern such enterprises.

There was a time last year when many investors predicted that no joint ventures would ever be established in China. The pessimism resulted from a sudden and quite necessary move by the Chinese leadership to reign in the search for foreign investment and imported technology. In late February, 1979, the State Council issued a "go-slow" order as part of a reassessment of the Chinese economy slated to last at least until 1981. .

The major reason for the reassessment was growing recognition of sectoral imbalances in the Chinese economy that the leadership believed required correction before an intensive period of output growth could be embarked upon. U.S. business and academic China watchers also believe the negotiations of the past several months had become uncharacteristically undisciplined: frenzied bargaining was fueled by competition among ministry and state corporation officials for what they felt would be limited revenues from the central government and limited lines of foreign credit. At least in part for this reason, the State Council clamped down hard, suspending more than 20 contracts with Japanese firms and temporarily shelving preliminary agreements with dozens of other Japanese, North American and European corporations.

Over the months, the popular view of the reassessment process has changed. A spokesman in the U.S. State Department's China section, for instance, considers it, "a very healthy development that foreign investors should welcome." And in spite of the reassessment, agreements with foreign firms have moved forward, albeit at a slower pace than had at one time been expected.

Most multinationals are hesitant to discuss their negotiations with the People's Republic, largely because the Chinese have requested they refrain from doing so. (More than one deal has been undermined by premature disclosures by firms anxious to win favorable publicity with news of China negotiations.) Most of what has been written and said, however, points to the Chinese as excellent negotiators who (with the exception of the brief winter 1978-79 period), take their time in bargaining, whittling down prices and picking up valuable technical information as they go. Strict guidelines have been established to ensure that no project is negotiated that lacks the necessary compliment of local inputs and infrastructure. When buying technology alone, the Chinese have been known to meticulously inspect imported equipment, taking apart and reassembling machinery, or to count the number of pieces in an imported box of bolts.

These techniques set a standard of excellence for the entire Third World, but to a degree, China is a special case, whose successes cannot easily be duplicated. Although the Chinese offer little opportunity for profit in the short run, the long-run potential of the market may make major corporations more inclined to accept arduous negotiations and harsher than ordinary contract terms. According to Norman Getisinger, exports director for the National Council on U.S.-China Trade, some corporations even view their first contracts with China as "loss leaders. "'The first is certainly the most difficult. Then you become the 'lao peng you' - the old friend.

Beyond the negotiating process, it is easy for prospective investors to lose sight of the extraordinary level of regulation the Chinese can bring to the operations of foreign firms, a level unmatched elsewhere in the Third World. China's declared willingness to permit up to 100 percent foreign ownership of enterprises, for instance, must be viewed in the context of the country's planned economy. "China will always control. It's like controlling the water in which the fish lives," says Harvard Law professor Jerome Cohen, on leave working as a consultant for Coudert Brothers in Hong Kong. "China controls the labor supply, the raw materials, the customs, the sale of output." Cohen, who has recently taught courses on Western legal systems at the University of Beijing, at the same time stresses that shortages of Chinese technical personnel will often indirectly give the foreign partner greater day-to-day control. "The Chinese are being very flexible in the short run due to their need to learn from others," says Cohen. They see the joint venture as a teaching enterprise, where they are going to get a free education and gradually phase out the foreigner."

Cohen and other China business experts stress that the government's capacity to control the entire investment environment increases the importance of an investment relationship founded on a mutual understanding of the necessary rate of return for a particular foreign investor. As a consequence, the preoccupation of some firms considering entering the China scramble with Chinese corporate tax rates (as yet unannounced) seems off the mark. Beijing, with its complete control over the price of local joint venture inputs, can indirectly "tax" by determining how much-"profit" a joint venture will earn.

China's negotiations over the past year with Western oil companies provide an excellent indication of the country's well-developed bargaining capacities and its determination to transfer technology at the least cost. The success with which China develops its offshore oil will probably be the single most important variable in the country's plans for modernizing by the end of this century. Oil exports are viewed as the country's leading foreign exchange earner, down through the end of the century, and hard currency will be critical for the technology transfer necessary if China is to develop as a modern, industrialized economy. Although much of China's oil development is still in the early exploratory phase, the authoritative China Business Review recently estimated that the Chinese will export approximately 50 million tons of oil annually by 1990, accounting for 23, percent of import payments.

It is generally recognized that Western oil companies hold a near monopoly over the technology necessary to economically exploit oil deposits in some of the deeper ocean areas of the South China and Yellow Seas. The Chinese, nevertheless, have adopted a hard line in gaining the cooperation of the oil giants in developing these reserves. "The Chinese are driving a very hard bargain,"- confirms Dennis O'Brien, who, has been following China's dealings with the companies in the U.S. Department of Energy.

The Chinese have closely studied the oil o companies' most recent dealings with host countries and, for the early exploratory phase, have succeeded in winning terms that industry analysts consider as good or better than those arranged anywhere else in the world. In order to strengthen their control over the future offshore oil development process, they have signed no long-term contracts. Instead, they have convinced upwards of 50 Western oil companies 10 accept all of the costs of conducting seismic exploration in the South China and Yellow Seas, scheduled for completion in mid-1981. After conducting the studies, companies have agreed to interpret their data, and make their information available to the Chinese, as well as all other interested companies. In exchange for their efforts, they will be entitled to bid for plots to do exploratory drilling on terms as yet undecided by China. In short, for initial investment of upwards of $4 to $5 million (to quote the title of a recent article in the Asia energy journal Petroleum News), the companies have won "a seat at the craps table." According to an analysis of one (non-oil industry) U.S. businessman who spends about a third of each year in China, "The Chinese did a very good job of handling the oil companies and basically getting them into a bidding war against each other."

It is not ordinary procedure for the oil companies to take risks they don't expect will pay off with profits at a later point. Several oil company executives, however, have expressed disillusionment with their involvement in China. They said they have been surprised, in recent months, by the level of technical expertise the Chinese have demonstrated they command. According to one official in the Commerce Department's Bureau of East-West Trade, the amount of offshore areas the Chinese will be able to exploit themselves, or simply through the purchase of technology, is far greater than many had anticipated a year ago. "The chances of most of the majors being shut out are great," predicts one DOE official. And as a consequence of their greater command over expertise, the Chinese should be able to extract better terms 'from their prospective partners than had previously been expected. "It'll be the toughest deal we've ever done, if it is done," said the international vice-president of one U.S. company involved in the seismic exporation.

No doubt, China's dealings with the Western, oil companies has helped promote the recent expertise build-up. Beijing has aggressively promoted reciprocal visits with U.S. oil companies, and Chinese personnel are like "vacuum sweepers" in their efforts to develop expertise during these exchanges, according to one DOE official. One industry executive described the Chinese as approaching the transfer of technology and expertise "in a very systematic and categorical way. They want our technology. They'll pick you to death to get it."

The Chinese success in facing international corporations in the development of its offshore oil sets a high standard for the country at the bargaining table. But as what will inevitably operate as a capital-intensive enclave, physically removed from the mainstream of Chinese society, offshore oil drilling raises few difficult political questions for the Chinese. On shore and away from the bargaining tables the opening to foreign investment adds layers of complexity to the domestic political debates over the direction of Chinese social and economic relations.

One of the major issues that still remains to be resolved is the establishment of guidelines for the remuneration and treatment of labor. In the wave of euphoria of late 1978, many foreign investors envisioned China's emergence as an export-processing giant; with customary wage rates that are generally far lower than the major capitalist exporting countries of East Mia, they reasoned that China could Fompete quite favorably for foreign investment in these areas. China--in this early stage--has quite clearly rejected the "cheap labor" alternative as a major attraction for foreign investors. Higher wages will be paid in enterprises with foreign ownership, though just how high remains an open question. Recent East Asian press reports indicate the government will announce a joint venture wage code that will generally require at least 80 percent of the wage scales standard in Hong Kong. Such wage levels would considerably dampen foreign corporate interest in the establishment of export-oriented labor intensive manufacturing on, the mainland.

The worker incentives question is central, both to labor-intensive and capital-intensive enterprises in which foreign firms would like to participate. The government has indicated that only exemplary workers will be permitted to work in joint ventures, but no overall policy has been formulated on the amount of additional income these workers will be allowed to command and how much will be taken in taxes. Says John Eaton of E-S Pacific. "If joint venture workers are not permitted higher incomes, it will be a tremendous disincentive to foreign investors."

Since the fall of the Gang of Four, the leadership has openly recognized the need to increase material incentives and has stepped up the production of consumer goods necessary to make increased monetary incentives meaningful. The slogan "overcome egalitarianism" and the principle "to each according to his work" indicate a move away from the Cultural Revolution "iron rice bowl" policy, under which it was next to impossible for a worker to be fired from his job, and production incentives were few. At the same time, the leadership is cognizant of the risks inherent in creating a "labor aristocracy" of high-income workers, especially those that might tend to see their interests allied with those of foreign economic interests.

The incentives question is crucial at the macroeconomic level, as well. With increased frankness, the leadership is acknowledging serious problems in the central planning_ bureaucracy. "Redtape" (not a Chinese equivalent-the English expression) is recognized as an obstacle to modernization efforts. As part of the current readjustment process, Beijing is experimenting with the decentralization of economic management by granting greater autonomy to approximately 3000 state enterprises and several of the country's 37 provinces, allowing them to circumvent the central state trading boards in conducting foreign trade, and permitting them to retain control over the use of their foreign exchange earnings. Two maritime provinces near Hong Kong, Fujian and Guangdong, have received the right to recruit foreign investors independently.

While the experiment appears, at this early stage, to be promoting desired increases in productivity, it has not progressed problem-free. The leadership is still searching for a mechanism that will decentralize decision-making and grant incentives without creating new income inequalities relating to preexisting endowments of capital, resources or the artificially-set prices for output. rather than the quality of labor. Opposition to the decentralization experiment is strong within the state trading bureaucracy, as officials find it more difficult to meet their procurement quotas and see their own monopoly commercial positions undercut.

Finally, the leadership, sobered by the negotiating errors ministries made during the winter 1978-79 period of bargaining mania, is hesitant to see control slip too far from its hands for prudential reasons.

Foreign investors, many of them frustrated by the time-consuming, bureaucratic, investment negotiation process and worried about the prospects of arranging steady supplies of production inputs through the state trading network, of course favor greater decentralization of economic management. John Eaton of E-S Pacific presents a sympathetic business view of the dilemmas involved for the Chinese. "China is just a huge country. What is the central government going to do when a joint venture is being put together between a U.S. corporation and a commune near Tibet'? They've got to keep control over it, otherwise they leave themselves open to exploitation. The problem is, how in the world is foreign participation going to go forward, if the Foreign Investment Review Commission has to review every detail of every joint venture? The Chinese have got to find a middle way."

(Kathleen Carson assisted in researching this article.)

The second part of this two-part series on China will focus on the increasingly important role of ethnic Chinese citizens of other countries-the Overseas Chinese-in the modernization efforts of the People's Republic. The Overseas Chinese represent a double-edged sword. Wooed for their capital, technical expertise and sentimental attachment to the mainland, they bring in their train an array of new social tensions the Communist leadership is now beginning to confront.

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