China’s Current Business Environment: It’s Not Tough, Just Comply

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Op-Ed Commentary: Chris Devonshire-Ellis

Jan. 4 – Recent media commentary has been suggesting that the business environment in China has worsened for foreign investors over the past year. Although China is still evolving as an emerging market, I disagree with the basic premise that it is becoming tougher, and even unwelcoming, to foreign investors.

A sense of foreign investors being singled out for specific abuse seems to be portrayed in certain circles, and as the founding partner of Dezan Shira & Associates – a company that has been providing consulting services to foreign investors in China for over 20 years – it is a subject of great personal interest. Yet amid these recent dissatisfied comments about China’s business environment declining, I see nothing new. Instead, it seems to be rather more of a failure to accept that compliance has become key in China. Non-compliance is now, more than ever, a false economy.

That China has not provided a particularly level playing field for foreign investment is granted. Companies are discriminated against through skewed bidding processes for contracts, by having to apply for unobtainable licenses, and when fighting through many blatantly erected barriers to foreign investment. Yet, while these realities are regrettable, the parameters regarding which industry sectors remain officially permissible yet practically awkward have long been known. So although the situation may be unfair, such knowledge is out there.

I have personally advised numerous foreign investors over the years not to enter the China market because we knew full well that barriers will be erected to discourage them from competing with domestic companies. Yet for the majority of “normal” widget-making or service industries in China, such issues have long since disappeared. It was only a little over 10 years ago that foreign investors were permitted to set up trading companies in the form of FICE. This had previously been disallowed. So although much still needs to be done, doing business in China has gotten far easier over the last decade, not more difficult.

That being said, there are issues that have cropped up over the past three years that have impacted upon China business. The global economy has sharply reduced consumption, just at the same time that operating costs in China have been increasing. But this is a global issue, and should not be portrayed as a decline in attitudes by China towards foreigners per se. After all, while China costs have been increasing, alternatives remain. Relocating operations to Vietnam, or even “re-shoring” back home has been much discussed over the past two years. This is essentially an economic matter, not a worsening of China’s business environment specifically targeting foreign investors. Business climates are always changing. Adapt or die is not a law of the corporate jungle specifically unique to the Chinese, and it is churlish to infer that it is.

Larger corporations with larger workforces built up over the years may well be feeling more of a squeeze on margins. A tightening of labor laws and increasing labor costs are eating into margins. Yet this has not yet reached a level where businesses are losing profitability. Again, opportunities that existed in China 10 years ago may not be quite so valid today. Manufacturing in China purely to take advantage of cheap labor is not what it was. Such businesses must either adapt to sell to China, or make a move to cheaper locations. Expecting China to retain the business environment of 10 or 20 years ago is clearly rather foolish wishful thinking.

Additionally, China has now been more actively enforcing laws and regulations that certain businesses have long chosen to ignore. It has, for example, always been illegal to work permanently in China on a multiple-entry business visa. Yet that hasn’t deterred many expatriates from doing exactly that. Now these regulations are being enforced, they cry foul. That’s unfair.

China has always had rules and regulations in place that can be, and often have been, ignored. These include relatively common “business” practices as follows:

  • Working in China on inappropriate visas
  • Being paid cash in hand and not paying tax
  • Under-declaring income (salary and revenues)
  • Being paid part in China and part overseas to reduce China income tax
  • Expatriates not paying social insurance
  • Paying Chinese staff off the books
  • Earning RMB income through representative office licenses
  • Not issuing official receipts (fapiaos)
  • Not purchasing Microsoft office licenses and running other pirated software
  • Operating a business in a restricted industry (e.g. HR or financial consulting) using an RO
  • Under-declaring China income and topping up margins in Hong Kong

The list goes on and on. Yet all have long been illegal, and the regulations have been in place for years in many cases. Others, such as mandatory expatriate social insurance contributions in certain locations are more recent, but have been well publicized. However, the fact remains that all the above specifically break the law.

The truth about China’s business environment is the same as it has ever been – aspects of it, especially barriers to certain industries, remain unfair, yet these are identifiable and known. More recent complaints by foreign investors in my view come largely from executives that have long followed a business model that contains illegal aspects and/or has taken advantage of lax enforcement in the past. Now that China is enforcing its own regulations, the inherent weaknesses in such business cases are becoming exposed. The real issue is not one of China’s business environment becoming tougher, it’s about getting into compliance and running a business in accordance with the law. Because if you cannot afford to do so, the ducking and diving and evading of rules is both a false economy, and ultimately unsustainable. Suggesting that China’s business environment has become tougher purely because they now enforce long existing laws demonstrates just how long many foreign investors have in fact been operating business models that require non-compliance to remain viable or artificially inflate profit margins. They are now being found out.

The choice for foreign investors is clear. Abide by the law. There remain plenty of opportunities for foreign investors in China that do so to make plenty of money. And this remains the real truth about China’s business environment.

Chris Devonshire-Ellis is the founding partner and principal of Dezan Shira & Associates  – a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.

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3 thoughts on “China’s Current Business Environment: It’s Not Tough, Just Comply

    Tim says:

    I generally agree with your statements. To be honest, this is an old chestnut that crops up every one or two years: China is getting more not less difficult. Another is how localization is making the expat an endangered species – just not based on the stats.

    The only thing I would mention is that China is still a rule by law and not a rule of law country. Meaning, that there is a higher authority than the law itself and as we both know, laws are intentionally ignored as the authorities decide whether or not a particular activity is useful, harmful, or benign. The financial services industry focused on expats is a perfect example of the last.

    That being said, being compliant and being legal are not always the same thing and I would agree that you don’t want to find yourself on a blacklist here.

    @Tim – I concur. China’s laws, the cross-referencing, application and interpretation of them do not permit anyone, or any business, to be in compliance. For example, breaching “State Secrets” as a journalist but no definitive category for what a state secret is has been made public. If China’s own Government departments advice an FIE incorrectly with rules that blatently break the law, the foreign enterprise carries the can, not the Government.
    Experienced consultants know most of these pitfalls in many different sectors, but they can still creep up under badly advised or unforeseen circumstances.
    The best way to deal with these anomolies is to have experienced professionals either in-house or third party firms look after these issues, and that can refer to international standards as a guideline for China business practice.
    It is a huge mistake imo to have Chinese managers completely in charge of an FIE. They resist external involvement. In nearly every single case of internal control problems we have audited over the years, it has been Chinese management of FIEs milking the company and / or putting it way out of compliance with international norms.

    However, this issue is well known, and the authors of these “it’s getting worse” pieces and those who promote them clearly do not now their ways around the concepts of getting compliance into a business based in China. Yet the knowledge is out there. Such issues, as I said are nothing new. That doesn’t mean they not need to be dealt with, but the experience and professional intelligence has existed for quite some time to mitigate against these long standing issues.

    I appreciate your comments – Chris

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