While delivering the keynote speech at the recent Asia-Pacific Economic Cooperation summit in Bali, Chinese president Xi Jinping stated that the government was drafting a “master plan for reform.” Speaking to a group of leaders who invariably have a stake in China’s continued development, Xi touched upon topics including politics, society, and the environment. Given the recent slowdown in growth, Xi’s remarks mainly aimed to assuage the concerns of economic and business leaders regarding the stability of China’s economy.
Some of the most discussed topics that come to mind when thinking about economic reform in the Middle Kingdom include liberalization of interest rates, freer access to capital for small firms, and correcting market distortions such as real estate prices. These factors are admittedly extremely important to rectify if the economy is to avoid stalling out, but there is also another issue on the minds of many business leaders looking to become or stay involved in China’s economy – corruption.
Corruption is rampant in China. From local officials claiming and selling government funded affordable housing units to complex bribery schemes involving moon cakes, graft in all its forms is a common element of doing business in China. Recent numbers suggest that corruption costs China at least 10 percent of GDP each year. High levels of corruption also substantially increase the cost of doing business thereby diminishing the amount of funds companies can channel toward investment, expansion, and growth.
Thus far, multinational companies have accepted the burdens, calculating correctly that the returns of operating in one of the largest markets in the world far outweigh the risks. However enforcement of extraterritorial laws such as the U.S. Foreign Corrupt Practices Act (FCPA) and UK Bribery Act has increased in recent years, making the risks and costs of operating in China much higher.
Under the FCPA, the U.S. Department of Justice and Securities and Exchange Commission can bring charges against listed companies if they are even remotely connected to any form of bribery. With respect to China, the most recent settlement involved Eli Lilly and Company paying $29 million for payments made by subsidiary companies to win millions of dollars of business. Another pharmaceutical company, Pfizer, paid an additional $45 million as a result of subsidiaries conducting graft.
The danger of such laws to foreign multinationals lies in the fact that companies are held liable for actions performed by their subsidiaries as well as by third-party agents. The result is that a company’s entire value chain falls under the purview of enforcement authorities. Even if a company does not directly disburse a bribe, third-party actors, such as consultants and contractors, can still be the source of a violation without the parent company even knowing. And when it comes to FCPA, ignorance is not a valid defense.
Compounding what some may call a culture of bribery and gift giving is the prevalence of state-owned enterprises in the Chinese market. Only bribes given to foreign officials fall under FCPA and similar legislation — however, because SOEs are considered an “instrumentality” of the government, all employees, from directors down to file clerks, are considered foreign officials. Thus any form of gift giving, be it cash, tuition, or moon cake, to the lowest level of a local SOE could result in an investigation and fines.
As enforcement continues to become more stringent, this business environment will continue to become more dangerous for multinational companies that inject large amounts of capital into China’s economy. Though they will not be scared away, the amount of capital that can be directed toward economic growth will be lower due to the expensive compliance programs that must be put into place. When combined with the unfair advantage enjoyed by companies that are not liable under FCPA and similar laws, the economic impact of MNCs is restrained.
Chinese companies as well as foreign firms have a stake in reducing corruption with relation to FCPA. Since any firm trading stocks and securities in the US is liable under the law, Chinese companies looking to expand and secure investment from overseas must comply with the regulations. As Chinese companies expand to become major players in global markets and not just pieces of supply chains, they will have to become more transparent and forsake practices such as gift giving and nepotism.
While president Xi has launched an anti-graft campaign within the Chinese Communist Party, the aims are geared more toward reducing social unrest and rebuilding the reputation of the party. So far, such efforts have been criticized as being window dressing, with more rhetoric than actual reform. These top-down efforts to punish officials who indulge in extravagance, while useful as a PR move, do very little to really combat corruption.
In order to truly clamp down on corruption and unleash the unhindered developmental power of business, China must undergo systemic reform that tackles corruption in both the public and private sector. Admonishing officials in an ad hoc manner for throwing expensive parties and buying sports cars does not attack the root of the problem: weak rule of law. Until laws are enforced uniformly in a transparent and accountable manner, corruption in China will remain a problem and extraterritorial laws such as FCPA will continue to restrain economic growth.
Frank Stroker is Assistant Program Officer for Global Programs at CIPE.
