Intercedent Insight – August, The Socialist Market Economy Invests in the Global Market Economy

Enlightened reform policy underpins China’s economic miracle where the Government has forged the conditions for commercial activity to prosper within the framework of what here is called “the socialist market economy”.

In the socialist market economy however, the Government at all levels – central, provincial, city and local – plays key roles in the successful development and execution of commercial activity.  Local companies trade off Government participation in business to gain positioning to receive support from the Government in a broad variety of forms including financial assistance.  Against this background, it is not surprising that the Chinese business community has a mindset of not only tolerating Government involvement in business, but expecting Government to lend a helping hand and help clear the path ahead when the going gets tough.

When investing abroad however, Chinese companies are learning that this mindset is a potential liability to conducting successful business.  Just as executives of western companies were not equipped to understand China in the eighties, evidence is emerging that Chinese executives are finding it difficult to cope with the demands of the international marketplace in the conduct of their overseas ventures.

A problem plaguing Chinese companies abroad is to fully understand free market forces. For example, there is no socialist part of the western economy to subsidize or protect pricing mistakes.  China Overseas Engineering Company recently discovered this when it was removed from a road construction project in Poland. It had originally won the job by discounting its bid 50% below the competition, but then found it a challenge to service the contract using local materials and constructors priced locally.  The Polish government not only refused to re-negotiate the contract, but will reportedly hold the Chinese company to account for losses which may flow as a result of having to bring in a fresh contractor to complete the contract.  In the western world, media and shareholders are empowered with different rights and attitudes towards imposing commercial discipline on management. Muddy Waters ability to impose transparency and ultimately market forces on Chinese companies listed in the United States, Canada and Hong Kong has been a shock for many.

Another issue is the shortage of local market knowledge, business experience and relevant capacity within a company’s management team. This is amplified by a business culture that is adverse to hiring local management in the destination country, engaging international advisory services before and after the transaction, and top heavy in its adoption of Neo-Confucianism decision making processes. Recent announcements that several large iron ore projects in Australia invested by Chinese companies are being curtained due to cost overruns and concerns about resource quality underscore the importance of acquiring accurate local business intelligence and engaging quality professional advisory services with relevant in-country and sector experience.

Then, there is the misconception that in the west the Government will step in to help if there are problems in the execution of business.  Clearly, in most countries, for constitutional and other reasons, governments simply do not have such a mandate.  While they will monitor business activities and enforce compliance to taxation, labour, environmental, safety and product standards etc, generally speaking, governments cannot play an active role in business.  When Chinese companies step abroad, often, they quickly discover that governments do not have the political will or means to support them in a meaningful commercial way.

Chinese private and State companies are clearly keen to build on their experience gained over the last five odd years and expand further abroad to acquire resources, technology, and markets.  However, it would be worthwhile for them to reflect on the simplicity of the number one rule of the free market – “Let the Buyer Beware”.  Should Chinese companies continue to invest abroad without developing new mindsets and formal management review processes which are aligned with global market forces, then the majority of investments and trade deals will risk collapse. There is a reason that Warren Buffet is respected worldwide. This is because making a good investment without the benefit of government arbitrage to support it is hard.

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