For foreign companies doing business in China, 2011 has been anything but dull. Over the past 12 months, they've been kept on their toes with a raft of new regulations. Some have been embraced wholeheartedly, others less so, and then there are those where the jury is still out — like the new laws issued by the Ministry of Human Resources and Social Securityrequiring all foreign workers to start participating in the national social insurance scheme. 

Encompassing some 230,000 expat workers in the country, foreigners and their employers are now required to contribute part of their salaries into the system covering medical and unemployment insurance and basic pensions along the lines of what urban Chinese workers have been doing over the past 20 years. The law affects any non-Chinese staff at local and foreign companies, and depending on where foreign workers are based and their residency status, it may mean compulsory contributions of the equivalent of nearly 50% of an individual's salary.

Reactions have been mixed. “Most of our expatriate employees do not see the benefit of paying into the Chinese social insurance system," says Jon Jonasson, chief operating officer of CCP, an Icelandic online games developer and publisher with 111 employees in Shanghai, says, "They just see it as an extra tax.” But others are more circumspect, acknowledging, among a number reasons, that regulation and implementation are often two different things in China. But that shouldn't lead anyone into complacency, warn HR experts.

Why Now?

The timing of the new law's arrival hasn't been lost on companies, local and foreign alike. After years of being known as the world's low-cost factory to the world and favored outsourcing destination, companies across China have been grappling with wage inflation for some time. Reliable numbers are hard to come by, acknowledged an April blog on, but cited a U.S. Bureau of Labor Statistics report, which revealed that between 2002 and 2008, real hourly wages in China’s manufacturing sector doubled, while they rose by barely 20% in the U.S. Though still relatively low, wage pressures have continued — in part due to new employment laws giving workers greater rights for, among other things, timely delivery of their pay and social insurance. However, other contributors include labor shortages in some parts of the country and rising food prices and various costs of living leading to waves of worker protests. Meanwhile, according to Shaun Rein, author of The End of Cheap China, 21 of China’s 31 provinces increased their minimum wage this year by 22%.

Against that backdrop, the new law may be tough for some companies to swallow. But China's authorities and experts involved in helping to design the country's labor policies point out that the new law is in line with international practice and is helping to bridge the pay divide between local and foreign workers. “Our view is that this is an issue of national treatment," says Jeffrey Wilson, a counsel at Jun He Law Offices in Shanghai, a firm that specializes in labor practice. "People who are working in China, both PRC nationals and foreign nationals, will be subject to the same rules.”

He Wenjiong, professor of Zhejiang University's Social Security Research Center, adds, "The social security fund levied on employees (including foreigners) is for the benefit of employees. Some foreigners that have been living in China for long time can now enjoy national treatment, which is favorable to them since all the money they'll be paying will be paid back to them later on. If the Chinese government and employers in China don’t protect employees in terms of social security fund, who will?"

Putting It to Work

He also says that the new social charges shouldn't have taken any employer by surprise. "Some provinces’ policy actually already have employers paying social security based on total salaries. In Zhejiang province, for example, employers started paying funds based on total salaries, for both local and foreign employees, a long time ago," he notes.

But getting a handle on how the new law works in practice is by no means easy, because it varies from province to province, and even city to city. And citizens of countries that have bilateral agreements with China, such as South Korea and Germany, are exempt.

The percentage of contribution for employers range between 31% and 37%, while the employee contribution ranges from between 8% and 11%. Employers in Shanghai must pay 37% of an employee’s salary and individuals 11%. However, the city has set a cap of contributions by both employees and employers at RMB 11,688 (US$1,834), which the local government says is the equivalent of three times the average monthly salary in the city in 2010. In comparison, the cap is RMB 12,603 a month in Beijing, RMB 11,392 a month in Suzhou and RMB 13,623 in Guangzhou.

At CCP, 31 its staff of 111 are foreigners. “Fundamentally for us, this is not a huge increase in cost as long as the caps are in place," says Jonasson. "But if the caps are removed, it would be very alarming and we would reconsider repatriating some of our people.”

Even with the cap, however, Jonasson is concerned. For one thing, under the current interpretation of the law, the contributions of foreign individuals can be cashed out when they leave the country, but employer contributions will be forfeited. Jonasson is dissatisfied with other provisions, including the unemployment benefit, which accounts for around 3% of total contributions. "If you’re a foreigner here and you lose your job, you lose your visa and have to leave," so unemployment wouldn't be collected, he says. "Second, most of my foreign employees have their own health insurance and don’t want to rely on the medical service, which they find is not up to their standard.” (The basic medical insurance contribution is around 5%, with an additional 2% going toward maternity and work-related injuries, while pensions make up the bulk, at 23%.)

Others, Jun He Law's Wilson, are less critical of the scheme. “The insurance programs include basic pension and basic medical coverage. This coverage is not necessarily something that will satisfy everybody’s needs," he says. "Many foreign nationals for the time being will likely not want to use local hospitals and clinics. The situation is similar for many professional [mainland China] nationals, who prefer private medical plans and clinics over the state-run system.” Wilson also points out that other countries, such as the U.S. and the U.K., have rules requiring foreign workers to pay into local social insurance funds even if they don't ever benefit from them.

However, the major difference among the systems is China's high rate of contribution. In the U.S., the employer and employee contributions to Social Security and Medicare are less than 15% of a salary, with a cap of US$106,800annually. In the U.K., National Insurance contributions on a weekly salary of £500 is around £93 for both employee and employer, or less than 20% of a salary. In Shanghai, total contributions for a monthly salary of RMB 11,688 is 48%.

The Big Squeeze

For entrepreneurs like Chen Xi, who runs a small English-language school in Shanghai, the law has created new anxieties. “We’re paying our English teachers not too much more than the cap set by the government. Our costs will go up 40%, but what can we do? We’re not like other companies that can localize to Chinese staff and pay lower wages. We need foreign English teachers.” 

Other employers have lost no time in exploring how to bend the corners of the new law. According to a December newsletter from HR consultants at Deloitte, authorities have pledged to "intensify" administration of the funds and crack down on any non-compliance, fining employers that try to skirt around the law a penalty of 100% to 300% based on the level of discrepancy of actual remuneration against the total remuneration reported could be imposed on the employer.

That said, “there’s been a lot of underreporting of salaries," observes Adam Livermore, regional manager of Dalian office of Dezan Shira & Associates, a firm specializing in payroll processing for multinational companies in China. What's more, companies are lowering basic monthly salaries, while keeping staff sweet with cash payments or reimbursements to make up the difference from the previously higher salaries. "This is a very common practice for Chinese enterprises. For MNCs, however, which have to adhere to strict auditing rules, it’s not an option for them,” he says.

Livermore is facing a thornier challenge. His office, and those of many clients, is based in the northeast in Dalian, the only city in the country whose caps on contributions, for both local and foreign firms, were suddenly lifted. “On August 31, the announcement was sent out that the cap has been lifted, and on September 1, we were told that everyone had to comply with the new rule,” says Livermore. This means that for an individual salary of RMB 60,000 a month, the contributions have increased to more than RMB 20,000 from around RMB 3,000. "There are a huge number of high-level and highly compensated people in Dalian, both local and foreign hires, and this has squeezed employers," he says. "Their costs have gone up dramatically, but they cannot pass on [the increase] to customers. Many employers have now adopted a wait-and-see attitude because they feel that they cannot afford to pay it and will not pay it.”

Thus far, no official statements have been made to explain why Dalian has been singled out. While some wonder whether it could be a test run ordered by the central government before expanding it further, “maybe the social security system in Dalian is underfunded,” guesses Livermore.

Some Dalian companies have been discussing whether it makes sense to continue recruiting senior employees, or to leave the city altogether. “Nationwide, this new regulation won’t have a huge affect because the number of foreign employees in China is small and the cap is in place," says Livermore. "But if the lifting of the cap goes nationwide, the consequences [could] be grave.”

Frank Mulligan, a managing partner at Accetis International, an executive search and training company in Shanghai, says the intention of the new regulation is good, even if the actual execution may not be. “The central government makes good decisions," he says. "It’s run by technocrats and engineers, but when [a policy] gets down to the local level, then the problems start. China is becoming home to many international talent, especially with many international headquarters moving to Shanghai and Beijing. The benefits of a good pension system and medical benefits will help recruiting and retaining talent. The problem is that the good intentions of the technocrats are not yet supported by the actual structure.”