Chasing the China Dream

China has long promised great commercial opportunities to outsiders. In recent years record investment flows and accession to the WTO have underlined China's importance in global business. But it remains a country with massive social and political problems, while its growing profile in corporate strategy places it on a collision course with external concerns, such as environmental standards, labour conditions, or national competitiveness. This potential clash represents a serious risk for corporate reputations: It may make business sense to invest in China, but what will it do to your reputation?

The China dream
From Marco Polo to Jack Welch, the idea of China has fuelled the dreams of business leaders for centuries. Yet this long history of commercial promise has been matched by an equally long history of failure and disappointment, with investments rapidly mired in local politics, corruption and confusion. The difficulties of realising the 'China dream' are well documented (as in a recent book of that name by Joe Studwell). But recent years have seen renewed interest in China, as a source and a market for goods and, increasingly, services.

Building on the reforms of Deng Xiaoping, China has been opening up for a generation. Entry to the WTO is just the latest commitment to restructuring the economy and enabling freer foreign involvement. As if by way of international endorsement, China emerged as the winning candidate for the 2008 Olympic Games and the 2010 World Expo.

This more welcoming stance to business has been rewarded with a growing surge of foreign direct investment. Reaching $52.7bn in 2002, these flows are dominated by US, European and Japanese firms and are expected to continue to grow for the foreseeable future. For example, Wal-Mart currently sources $12bn of goods in China; this is expected to be near $30bn in five years. Well-established apparel and toy manufacturing activities have been joined by a range of other sectors, including office, telecom and electrical goods production. Analysts are also pointing to China's potential as a centre of offshore services, such as R&D and IT development. Other developing countries are right to be alarmed as they are left behind in the rush.

Sleepers awake
But China still has a long way to go. Profound environmental, social and political issues remain. The country has massive unemployment and an army of about 150 million migrant workers, a dangerously decrepit banking system, rampant pollution, and persistent political corruption and oppression. In addition to these problems, many outsiders view its growing economic stature with mistrust or fear.

China's emergence has coincided over the last decade with the emergence of wider scrutiny of multinational behaviour, driven by NGO activism, media exposure, and growing corporate social responsibility (CSR) expectations. This coincidence of growing awareness of corporate activities, combined with increasing western involvement in China, will doubtless generate friction.

This is not to suggest that business in China is inherently wrong, dangerous or dirty. But there will be awkward issues to be confronted. Your corporation may have an exemplary environmental record in Europe, but are your Chinese subcontractors equally clean? China may be good for productivity, but what do your American customers think about rumours of labour abuse? What will happen to your brand if it appears your entire R&D function is moving to Shanghai? As the following examples show, a combination of issues on the ground, and negative perceptions at home can pose a serious reputation risk for corporations active in China.

Human rights
An abundant, low-wage labour force, plus an overstretched and often corrupt government, are a reliable recipe for poor labour standards. In China this mixture is combined with a world-class track record in human rights abuse. It is not surprising that many outsiders are worried about conditions in the 'workshop of the world'.

Officially, human rights and labour standards are in place. China is a signatory to the UN Universal Declaration on Human Rights, and recent reforms have led to improvements such as new laws on occupational health and safety.

But, like many developing countries, China suffers from lax enforcement, corruption and local toleration of corporate abuses. In practice, many workers are still unaware of their rights, and freedom of expression and association remains limited. For example, the only officially recognised union, the All-China Federation of Trade Unions, is subject to Communist Party oversight. Recent unrest in the North Eastern 'rust-belt' city of Liaoyang showed that there are few channels open to resolve worker issues. As a result the 'sweatshop' label sticks rather well to many Chinese factories.

Contrary to perceptions, western multinationals have a fairly good track record in labour standards. Foreign investment has generally been a catalyst for higher wages, improved rights and workplace innovation. But the factories of western companies are only part of the issue.

Most foreign supply chains in China require inputs from local subcontractors, for whom labour standards may not be adequately enforced. As a result, foreign companies have been beset by allegations of poor safety, abuse or even guolaosi ('over-work death') at subcontracting plants. And even where western companies have an active strategy for ensuring standards up the supply chain, cultural and political barriers will hamper compliance.

Foremost in the rush to China have been western toy and apparel manufacturers. Following a spate of controversies over the past decade (Disney was forced to stop production at a Guangdong factory after a vocal media campaign), the image of toys or clothes 'made with misery' has understandably prompted efforts at more effective management of subcontractor standards. For example, a consortium of retailers (including Debenhams, Sainsbury's, and H&M) is working with suppliers to eradicate overtime abuse in their supply chains.

But worker rights are also an issue in other 'cleaner' industries. For example, there have been recent allegations of worker exposure to toxic substances even in high-tech computer and telecoms factories. As new types of production ramp up over the coming years, western companies will need to ensure that conditions in their facilities, and those of their suppliers, meet ever-rising expectations.

Not least of the complex problems facing corporations is how to accommodate the requirement for higher labour standards within the constraints of Chinese politics. Even where companies can afford to significantly raise wages, reduce overtime or support collective bargaining, such policies need to be acceptable to local and central authorities, to avoid possible antagonism or commercial black-balling. Corporations have a reputation to manage both at home and in China.

Dirty development
China's rapid economic development is generating huge demand in the extractive, energy and construction industries, with plenty of opportunities for foreign investors. The Three Gorges Dam project on the Yangtze is a good illustration of the epic scale of these development projects. Designed to provide power and flood protection, the dam is halfway to completion. The 20 year project will eventually displace nearly two million people with a reservoir 350 miles long.

But the same project also shows how western business involvement can conflict with international expectations. Banks involved in the financing of the project, such as HSBC, Morgan Stanley and Goldman Sachs, have faced high profile criticism by environmental groups such as Friends of the Earth, while other backers have withdrawn support.

Fears of environmental degradation have also impacted on the primary sector, including oil, mining and forestry companies. Western firms are involved in the sourcing of lumber that is leading to rapid deforestation and desiccation. Swedish furniture retailer IKEA spotted this conflict with its environmental credentials, inaugurated a 'Forest Action Plan', and is now certified by the WWF China sustainable forestry programme. Extractive firms should look to follow this proactive approach. Keenly courted by the Chinese government for their skills and resources, they may well encounter substantial environmental controversy with plans to develop the oil and gas fields of Western China.

China's development is above all an urban phenomenon. With factories clustered in special administrative zones and close to labour, and with poor local enforcement of environmental regulations, it is not surprising that China has 9 of the world's 10 most polluted cities. The polluted sprawls of the Pearl River Delta or Chongqing may not yet be familiar to western audiences, but they could be soon. This is another issue up the supply chain for western contractors.

National interests
In ages past, China was renowned for sophisticated technology and refined products, such as porcelain or silk. It is now best known for producing low value goods, but increasingly is being seen as moving back up the value chain. As this continues, western companies will face a new range of reputational issues.

By offering an environment for advanced manufacturing, and for the delivery of services such as R&D and IT development, China is raising fears about the national competitiveness or 'hollowing out' of Western economies, reminiscent of the era of 'Japan-bashing' in the US in the 1980s.

The issue of Chinese competition is part of a broader debate on geopolitics and the politics of trade, where nationalistic concerns, particularly over manufacturing, are generating calls in the US for the revaluation of the Chinese currency, the Renminbi, or the introduction of 'anti-dumping' trade barriers. By being seen to contribute to Chinese economic ascendancy, western investors in China are a part of this politically sensitive debate.

One particular aspect of China's move up the value chain concerns offshore outsourcing, where service jobs previously based in the West can now be supported remotely by technology and talent in the developing world. This field is currently dominated by India, where a number of companies (including BT, Prudential and Microsoft) have experienced a reputational backlash from unions, NGOs and the media for outsourcing activities such as call centres and back office processing. Although there are clear economic benefits for both the developed and the developing countries, emotive negative perceptions about the 'jobs exodus' are highly potent. With China starting to attract an increasing amount of this offshore business, it is possible that the political and reputational backlash could shift there in years to come.

So what?
Western companies see irrefutable business logic in tapping into China, and, in so doing, they offer massive development potential for a country where hundreds of millions live below the poverty line. Businesses might conclude that CSR reservations are an unaffordable luxury, with fears of a jobs exodus no more than a protectionist irrelevance.

Many would dispute this on moral grounds. But even on a purely commercial level, it misses a major point. Valid justifications of a global strategy can be overcome by the emotive concerns of Western audiences. If a multinational active in China fails to meet expectations, there will be plenty of people willing to ensure its reputation suffers.

This is an issue that many companies in China have already encountered, and now take extremely seriously. But for companies entering China for the first time, there are some lessons to be learnt.