After more than 20 years of economic openness, China remains a rich opportunity for international business and is living up to its promises as a member of the World Trade Organization. But global companies doing business in China must be mindful of politics. The division of power between local jurisdictions and the central authority often shifts unexpectedly and can have a major impact on business operations, says  Linda Y.C. Lim, a professor of corporate strategy and international business at the University of Michigan Business School, who spoke recently at the Wharton Advanced Management Program in Philadelphia.


Lim believes that the recent SARS outbreak, which affected only a fraction of China’s population — 5,300 of the worlds’ 8,000 cases — is significant for what it revealed about Chinese politics. The central government in Beijing has come under strong criticism at home for its failure to contain the illness better. It is possible that central administration officials acted slowly because they did not have accurate information from local jurisdictions. In addition, Lim says, the SARS epidemic shows that China’s health system has deteriorated in the past 20 years.


Many people suspect that the SARS epidemic may be a sign that an even worse kind of contagion could emerge in China. “People say we’re overdue. Every major disease seems to have come out of Southern China during the last 100 years,” Lim notes. “If a disease that is more deadly than SARS develops, it will be difficult to control.”


The panic over SARS among rural Chinese, who barricaded villages against outsiders, clearly has political implications. “It revealed a huge gap between Shanghai and the villages,” Lim says, adding that many Chinese people don’t trust their government. In fact, SARS might be as troubling for the central authority as the uprising at Tiananmen Square was during the 1980s. “Their own people don’t believe them,” she says. “Once the government has lost its credibility it becomes difficult to govern.”


In recognition of this, the Chinese government has recently put great emphasis on meeting the SARS challenge, necessitating unprecedented cooperation with the World Health Organization. For now, this policy seems to have borne fruit and the disease seems to have been overcome, at least temporarily, Lim explains.


Democracy vs. Central Authority

Lim notes that Chinese politics are constantly changing. “Historically the central government is in a weaker state now, but things could change. I don’t think the central government is likely to want to give up its control. We may have seen the low point. SARS has shown the weakness of an overly decentralized system,” she says. “The government may want to tighten up. From a business point of view, the last thing you want to go is the central government because then it could be chaos.” Lim says the Chinese are suspicious of the United States’ constant emphasis on democracy. They fear that democracy would eventually break China apart into small, weaker provinces, leading to less military and political standing in the world.


Still, China continues to seek foreign investment. Some scholars have suggested that the government prefers to bring in outsiders, rather than allow local capitalists to flourish. “If China allows local business to grow up, it may have no control on citizens with money and clout.” The Chinese are willing to accept a patriarchal leadership as long as it delivers stability and economic growth. While the country’s 7% growth rate seems robust compared to the rest of the world, it does not seem too strong in China where millions are unemployed as state-run industries collapse. The official unemployment rate now stands at 4.5%.


While the central government still controls which companies come into China to do business, international firms have become more familiar with dealing with local authorities in the past 10 to 15 years. “The local authorities determine the terms at which you come in, which land you must take, who is your partner and who you must hire,” Lim notes.


Still, multinational corporations actually prefer doing business with the central government. Now, as China’s industrial overcapacity swells, local provinces are promoting industrial deals that ultimately may lead to even greater overcapacity. For example, the government of one province in China, where workers are being laid off from state-owned auto factories, may be happy to offer a foreign automaker deals to locate there. At the same time, the next province over may do the same for another foreign automaker.


Despite the messiness of its politics, Lim maintains that China has a lot to be proud of. “If you look at what China has accomplished in the last 20years, it is amazing,” she says. “Two generations of Chinese have known peace and improvement in the material conditions of life.” In addition, China has made significant progress in opening its economy in the year it has been a member of the World Trade Organization. “I would say China is working remarkably fast given its politics,” she says.


China’s authoritarian system makes it easier for it to make difficult changes, such as shutting down protected, state-owned industries as required by the WTO. “The U.S. has to protect its steelworkers and farmers,” she notes.. “I think it is easier for an authoritarian government to accelerate change.”


Manufacturing Base

Lim said that while there is opportunity in China, not every business there is a success. China remains a good location for low-cost manufacturing because of its low labor rates. For capital-intensive industries, such as autos, however, the business environment can be harder. While labor costs are low, other costs, such as real estate and hidden costs such as bribery, are not.


The Chinese mass consumer market is only for companies selling at very low price points. Intellectual property violations are common in China, but a greater threat to foreigners attempting to build a market in the world’s most populated nation are local imitators. She said some businesses selling into the Chinese market say they assume a 50% erosion in price over three years as local companies begin to mimic a consumer product designed and introduced by foreigners. “Everyone will jump into the business, not necessarily just small firms, but state-owned operations that are trying to survive,” she says. “You can buy a fake Volkswagen in China.”


Lim argues that Japan will continue to play an important part in China’s development. “The Japanese have a much better tolerance for risk, and they are able to better assess it because of their proximity to China,” she says. “There is a long history of Japanese companies sending patient capital to China. They are willing to wait longer and have a higher tolerance for risk than western companies.”


As Chinese manufacturers move up the technology chain, they will expect foreign companies doing business in the country to bring in more high-tech production. “China will provide education and supportive policies but international companies must bring in the technology,” says Lim.


For now, many Chinese exports remain subsidized through state-owned industries, but that will change. Over time, however, China will no longer be able to offer such subsidies, especially after the WTO agreement has been in effect for a few years. Still, Lim adds, China is a key part of what she calls the Asian Value Chain in which everything from high-end product development and services and low-wage manufacturing are all within a three-hour flight. “China anchors the global manufacturing chain,” she said. “People in Latin America and Mexico should be worried.”