You are on page 1of 12



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

Submitted by: Himani Gupta Roll No: 15 PGDM- IB


1.) Outline the major changes in the International business environment over the last 7 decades from an MNE s perspective which have significantly impacted business landscape in China for the MNE's? 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. China is a single-party state governed by the Communist Party of China (CPC). Its capital city is Beijing. The People's Republic of China is the world's second largest economy after the United States by purchasing power parity ($9.05 trillion in 2009) and the world's fastest-growing major economy, with average growth rates of 10% for the past 30 years. It is also the second largest trading nation in the world and the largest exporter and second largest importer of goods. Factors like these make it imperative for any MNE to invest in this country. China has history of nearly 4000 years and is one of the world s oldest civilization.China possessed one of the most advanced societies and economies in the world prior to 19 th century ; but through successive dynasties it then missed the industrial revolution and began to decline. In 1949, after a major combat ended in the Chinese Civil War, two states calling themselves "China" emerged: 1) 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). 2) The Republic of China (ROC) established in 1912 in mainland China, now commonly known as Taiwan.

The major changes in the International Business environment over the last seven decades that have impacted the business landscape in China for the MNE s are 1940-1949:This decade saw the sorrowful World War 2. The consequences of the war lingered wel l into the second half of the decade. The decade also saw the early beginnings of new technologies like computers, nuclear power and jet propulsion. In this decade (1949) , the Chinese Communist Party led by Mao Zedong, stormed into power in China overpowering the rule of the king. But even now the c ountry s relation towards international business remained hostile. The Government prohibited foreign investment and restricted foreign trade. Thus hampering the free trade and discouraging the foreign companies to start operations in China. A full scale ci vil war took place in china (1946 -1949), making the


internal environment hostile an unfavourable for the foreign companies. Thus, not many companies were interested to do business in China. 1950-59 :In 1950 China saw a cessation of major military hostili ties with 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 MNE s point of view.

1960-1969:This decade also saw the brutality of Vietnam War, The Bay of Pigs Invasion, Portuguese colonial war, Arab-Israel conflict and the Algerian War. After the Great Leap Forward Mao Zedong in the 1950 s Mao started the Cultural Revolution in China in May 1966 which continued till the mid of next decade. It was stated as one of the most damaging economic, social and political experiment in the history of the worl d. . 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. This was the decade of one pol itical entity trying to establish its power in the whole of China.

1970-1979:In 1976, at the end of the Cultural Revolution, China's planned economy was in ruins an d its people barely surviving. However, in 1978, China was to witness one of the most rapid periods of change in her 5,000 year history as reformer Deng Xiaoping initiated free market reforms that transformed China's economy. Only 30 years later, China had developed from an economically desolate country ruled by a totalitarian government into an industrial powerhouse, rapidly overtaking developed western nations in recession. The agent of this dramatic change, Deng Xiaoping, is sometimes known as "Deng Gong " or the venerated Deng, for his achievements.



Deng had maneuvered himself to the top of China's leadership by 1980and also embarked China on the road to Economic Reforms and Openness . Private businesses, which were banned in the Mao Era for being "Capitalist exploiters , were reinstated in the Deng Era. Another innovation instated during this period was the Chengbao system or contracting system, in which state assets were given to private operators, who gave the state the money needed for expenses as well as a share of the profits. This system was also rapidly adopted; in the 1980s and 1990s, many schools, hospitals and even bus lines passed from the state to private operators. Policies that began with the de -collectivization of the countryside, followed with industrial reforms aim ed at decentralizing government controls in the industrial sector. Due to increased liberalization increasing number of foreign companies especially from Japan, Germany etc started relocating to cost effective destinations like China. China just opened its business to foreign world in a step by step process inviting companies from US, Germany etc to invest in their country. Also its cheap labour and vast markets attracted the MNE s. 1990-1999:In the 1990s, many state enterprises were privatized and private individuals were allowed to create companies. In 1990, the Shanghai Stock Exchange was reopened after Mao first closed it 41 years earlier The government of the People's Republic of China announced major privatization of state-owned industries in September 1997. 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. After a decade of talks, China was finally admitted into the World Trade Organization. Standards of living improved significantly, although a wide urban -rural wealth gap was opened, as China saw the reappearance of the middle class. There was a hope for the betterment of relations between USA and China as Jiang and President Clinton exchanged state visits, but Sino-American relations took very sour turns at the end of the decade. 2000-2009:By 2001, China became a member of the World Trade Organization, which has boosted its overall trade in exports/imports estimated at $851 billion in 2003 by an additional $170 billion a year. Annual inflows of foreign direct investment rose to nearly $108 billion in 2008. The restructuring of the economy and resulting efficiency gains have contributed to a more than tenfold increase in GDP since 1978. China in 2009 stood as the second -largest economy in the world after the US, although in per capita terms the country is still lower middle income. China emerged as one of the world s super power in this decade. The most significant evolution of the early 2000s in the economic landscape was the lon g-time predicted breakthrough of economic giant China that had a double-digit growth during

nearly the whole decade. China (U.S. $4.98 trillion) went from being the sixth largest to the third largest economy, and in 2009 contributed to 8.6% of the world's economy, up from 3.3% in 1999 by nominal price or a rise from 6.9% to 12.6% adjusted for purchasing power. In terms of purchasing power parity it became the second largest in the world. In the second quarter of 2010, China's economy was valued at $1.33 tr illion, ahead of the $1.28 trillion that Japan's economy was worth. Preliminary estimates China's 2010 total GDP to be worth $5.7 trillion. [41] China could become the world's largest economy (by nominal GDP) sometime as early as 2020. [42] China is the largest creditor nation in the world and owns over 25% of US Treasury Bonds. China recently emerged as the second largest economy in the world surpassing Japan. Based on the current growth rate China is expected to ever take US as the largest economy in the world by 2025. The current market potential, mar ket performance, infrastructure, resources and Strategic positioning made the country the best place in the world for investment currently.

2.) Explain the key changes in the China's political environment decade by decade commencing 1940's. Which are th e major milestones in China's transition to a market based economy? In China it is the rule of man that rules the land; initially it was the rule of the king which later became the rule of communist party of China. No political party exists in the country other than the ruling communist and hence there is no democratic election in country. The various political environment and the key aspects that happened in China are

1940-1949:Prior to 1949, China had not developed a stable national legal system along the modern models of Western Europe, North America and Japan. The problems of rehabilitating the formerly Japanese-occupied areas and of reconstructing the nation from the ravages of World War II were huge. After its victory in the Chinese Civil War, the Communist Party of China (CCP) led by Mao Zedong gained control of most of Mainland China. On 1 October 1949, they established the People's Republic of China as a Socialist State headed by a "Democratic Dictatorship" with the CCP as the ruling political party, thus, laying claim as the successor state of the ROC. The central government of the Chinese Nationalist Party led by Chiang Kai-shek retreated to the island of Taiwan that it had administered at the end of

World War II, and moved the ROC government there. Major armed hostilities ceased in 1950 but no peace treaty has been signed. 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. In the early 1950s, the PRC undertook a massive economic and social reconstruction which was generally welcomed by a population desperately longing for stability. The new leaders gained popular support by curbing inflation, restoring the economy, and rebuilding many war-damaged industrial installations. To lead the social revolution, the Communist Party of China, which had legitimized itself into the guiding force of socialist China, had extended its rank-and-file to all Chinese regions and set up various institutions to lead changes in rural areas, the military, and the bureaucracy.

1960-70: The disaster of the Great Leap Forward decreased Mao's stature as national leader and even more so as an economic planner. Mao was subject to criticism within the Central Committee. In the early 1960s, President Liu Shaoqi, Party General Secretary Deng Xiaoping, and Premier Zhou Enlai took over direction of the party and adopted pragmatic economic policies at odds with Mao's communitarian vision, and disbanded communes, attempting to rework the system to pre-Leap standards. In 1965, Tibet became autonomou s region. The Cultural Revolution started which continued for a decade and was stated as one of the most damaging economic, social and political experiment in the history of the world .

1970-1979:Radical activity subsided by 1969, but the Chinese politic al situation began to antagonize along complex factional lines. In 1971, under UN resolution 2758, the representatives of Chiang Kai-shek to the United Nations were expelled from the intergovernmental organization. With the expulsion of the representatives, and effectively the Republic of China, the representatives of the People's Republic of China were invited to assume China's seat on the UN Security Council, the UN General Assembly and other United Nations councils and agencies. This decade also witnessed the death of Mao after which Mao s followers began to rethink country s economic posture. The power transition from Hua to Deng was confirmed in December 1978, at the Third Plenum of the Central Committee of the Eleventh National Party Congress, a turning point in China's history. In 1978, the country took the first step towards economic modernization and liberalization by enacting the Law on Joint Ventures using Chinese and foreign investments. China transformed from a planned economy to a mixed economy with an increasingly open market environment.


1980-1989:Liberal forces began manifesting with different forms of protest against the Party's totalitarian leadership, which in 1989 lead to weeks of spontaneous protests in the Tiananmen Square protests. The government imposed martial law and sent in military tanks and soldiers to suppress the demonstrations, this lead to the suspension of formal ties by the western countries with China as they were directly responsible for the military curfew and bloody crackdown. 1990-2000: It was in late 90 s that the government started privatization of badly performing SOEs. This decade showed China consolidating its position as an attractiv e destination for MNE s, an attractive market and tremendous scope of profits for MNE s. 2000 - Present: Major 5 year economic plan was launched in 2005. China grew by approximately 10% through out. Post recession, the world sees China as one of the engin e that will pull the world out of recession. The most significant evolution of the early 2000s in the economic landscape was the long -time predicted breakthrough of economic giant China that had a double-digit growth during nearly the whole decade. The People's Republic of China claims to have succeeded the Republic of China as the sole legitimate governing authority of all of China, which, from the official viewpoint of the People's Republic of China, includes the island of Taiwan.

3.) 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. China is fast becoming the global investment hotspot and more and more foreign investors are expanding their business operations into the country. This situation may be attributed to China's competitive production cost, sound macro-economic policies, strong economic growth, and favourable business environment. The key aspects of Chinas legal environment and its implications for the MNE s are :

1) The Legal Environment for Foreign Investment in China China has established a legal system that is being strengthened by numerous domestic legislations as well as bilateral and multilateral agreements to encourage foreign investment and protect the legal interests of foreign investors. With liberalization China is

increasingly taking part in many international trade pacts. China has enacted new laws and constantly revised existing ones to improve its legal environment for investment. China is gradually creating a legal environment that is favourable to foreign commercial interests. The legal framework governing foreign enterprises comprises three basic legislations. To supplement these laws, a series of regulations and measures concerning the establishment, management, reform, purchase, investment, reinvestment, termination, and liquidation of foreign enterprises had been introduced. Industrial policies and guidelines on foreign investments are attempts by which China seeks to regulate the entry of foreign capital. In order to meet its obligations to the WTO, China allows foreign participation in many more industries, including the hitherto state -controlled telecommunication industry, and the financial, insurance, commercial and foreign trade. 2)Difference between State and Central Legal System The central Government s efforts to lower trade barriers and increase competition by allowing foreign firms to control local operations only to be thwarted by local officials who fear such initiatives will result in hometown unemployment and instability. 3) Bureaucratic Society Due to the bureaucratic structure of the society, any application has to pass through a lot of layers of the bureaucratic authority of the Communist Party. 4)Local 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. 5) High Legal Busines s Cost Legal costs are part of the cost of doing business. The need to navigate through legal and administrative passages will invariably add to the cost of doing business. Legal commercial costs are incurred by the need to disentangle the uncertainties arising from policy changes, practices that deviate from stipulations of laws, or arbitrary enforcement decisions. This cost is distinct from the normal operation cost of an enterprise and represents an added burden due to legal causes. 6) Hidden Rules and Creditability Gap The issue of "hidden rules" has attracted much attention in recent years. "Hidden rules" are applied arbitrarily and are generally violations of the laws. In reality, these rules have become the "norms" by which business enterprises are compelled to observe in the conduct of commercial activities. Foreign investors have often to operate in a "legal"

environment that has a negative impact on business. A survey in 2003 revealed that more than a third of the investigated enterp rises were affected by dishonest dealings such as failure to repay loans, infringement of contracts, and production and sale of faked goods.

7) IPR Intellectual property rights are a form of foreign capital investment and require legal protection. Upon entry into WTO, China signed the Intellectual Property Agreement Relevant to Trade and similarly amended corresponding laws and regulations. China is a party to almost all relevant agreements on the protection of intellectual property rights. Despite the existence of legal provisions, the protection of intellectual property rights is still ineffective and infringements persist. 8) Foreign direct investment (FDI) The government introduced legislation and regulations designed to encourage foreigners to invest in high-priority sectors and regions. Since the early 1990s, China has allowed foreign investors to manufacture and sell a wide range of goods on the domestic market, and authorized the establishment of wholly foreign -owned enterprises. 9) Problems Arising from the Legal Environment Although China has established a comparatively satisfactory legal framework governing foreign investments, yet many problems still remain. y y y The current Corporation Law and Bankrupt Law are yet to be consolidated. Laws and regulations relating to foreign-capital mergers and acquisitions are less than perfect. The current foreign exchange management system, especially the control of capital account, often compels transnational companies to adopt an evasion method to invest by setting up a foreign -capital enterprise in China and then to expand their operations through mergers and acquisitions There are also insufficient legal provisions to regulate the behaviour of the market. For example, there is as yet no anti-trust law.


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 changed a lot in terms of economy in the past century. to the pioneering work and arduous efforts by the People's Republic of China over the past 50 years, especially over the last 30 years or so since the beginning of reform and opening -up of the economy, the overall national strength and the living standards of the people have been improved in no small ways. The key macroeconomic parameters that lead to the economic development of China over the last 3 decades are China s Population: Chinas population has played an important role in shaping China s political, social and cultural environment. With more than 1.3 billion consumers and a huge labour force of over 800 million workers makes china a very attractive destination for the foreign investors and contributes significantly towards the economic development. The cheap labour force attracts the MNE s to open up manufacturing units in China, thus increasing the FDI. GDP:-

Chinas GDP have risen from Rmb362.4 billion in 1978, at the start of the reform period, to Rmb30 trillion in 2008. During the 1990s, living standards continued to rise, as evidenced by the proliferation of consumer durables, especially among the urban population. Continuing FDI inflows helped boost foreign exchange reserves to record heights in the late 1990s. FDI:As a result of the active government promotion through various policy measures, FDI in China has grown rapidly since the 1978, especially in the 1990s. From early 1980s to late 1990s, contracted FDI inflow to China has grown from about US$ 1.5 billion a ye ar to more than US$ 40 billion a year in 1999. During the same period, China s actual use of FDI grows from about US$ 0.5 billion to more than US$ 40 billion a year. China has been the world
10 | P a g e

largest FDI recipient among developing countries since early 1990 s. In recent years, FDI to China accounts for 1/4 to 1/3 of total FDI inflow to developing countries. Foreign investment has become an important source for China.s investment in fixed assets. FDI can also lead to indirect productivity gains through spill overs. For instance, multinational firms may increase the degree of competition in host -country markets which will force existing inefficient firms to invest more in physical or human capital. MNCs may also provide training of labour and management which m ay make them become available to the economy in general. Rising World Trade Power :In the early 1950s, China had trade relations with only about 60 countries and regions. Its trade partners were mainly the former Soviet Union and other socialist countri es, because of the economic blockade by the West. At present, the country's trade partners have increased to 227. In the early 1950s, China's annual import and export values stood at only several hundreds of millions of U.S. dollars. By 1998, the figure ha d risen by more than 300 times to hit 323. 9 billion dollars. China is the world's 11th largest trade power in 1998, compared to the 32nd in 1978. Economic reforms:Included the decentralization of economic production, led to substantial growth in Chinese household savings (these now account for half of Chinese domestic savings). As a result, savings as a percentage of GDP has steadily risen; it reached 49% in 2004, among the highest savings rates in the world. Inflation:Inflation in China soared during the 1930s and 1940s, when the country s economy became highly unstable. In the early 1950s, the government implemented a series of recuperative measures, such as currency reforms, nationalization of banking institutions and the strict regulation of product prices and money supply. These policies continued till 1978. Owing to this, China succeeded in achieving record breaking price stability. Between 1950 and 1978, there was only a marginal increase of 0.6% in the retail prices of consumer products . As the government reduced its control, China s inflation reappeared. In 1980, urban residents were hit by a 7.5% inflation rate. The current inflation rate is 3.30 % but re ports say that the inflation rate would increase to around 5 % by the end of the year. The key challenges that the Government of China will face are:

1) 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 MNE s trust in China. 2) Intellectual Property Rights: This remains one of the biggest concerns of MNE s when they work in China. This culture of using intellectual property without

11 | P a g e




6) 7)

paying for it is engrained in Chinese working culture. This has resulted in MNE s making huge losses. Public unrest over pollution, government corrupt ion, and growing income inequality poses threats to social stability over such issues as pollution, government corruption, and land seizures. The lack of the rule of law in China has led to widespread government corruption, financial speculation, and misal location of investment funds. In many cases, government connections, not market forces, are the main determinant of successful firms in China. Economic development has been more rapid in coastal provinces than in the interior, and approximately 200 mill ion rural labourers and their dependents have relocated to urban areas to find work. One demographic consequence of the "one child" policy is that China is now one of the most rapidly aging countries in the world. Deterioration in the environment - notably air pollution, soil erosion, and the steady fall of the water table, especially in the north - is another long-term problem.

12 | P a g e