MNCs Weigh New China Risks (w/ David Hoffman)
May 30, 2021
Is global enthusiasm for China investment cooling? That’s the question I pose in this week’s episode. My guest is David Hoffman, Senior Vice President for The Conference Board in Asia, and Managing Director of the China Center for Economics and Business. We got together on the back of an article David just posted insisting that now was a critical moment for MNCs to step up their game, align their internal communications, and ensure that the rhetorical noise from on high doesn’t detract from the real story on the ground. This isn’t to say that doing business in China today doesn’t come with some significant risk. But it does suggest that the reasons for staying, doubling down or retreating, require new levels of thoughtful consideration. Are overseas investors still bullish? Are foreign companies still welcome? Is a China strategy still essential? Over the course of the next 40 minutes we explore these questions and more.
Stine: Welcome back to Inside Asia. I'm your host, Steve Stine, Is global enthusiasm for China Investment cooling? That's the question I pose in this week's episode, my guest is David Hoffman, Senior Vice President for the Conference Board in Asia, and managing director of the China Center for Economics and Business. We got together on the back of an article David just posted, insisting that now was a critical moment for MCs to step up their game, align their internal communications and ensure that the rhetorical noise from on high doesn't detract from the real story on the ground. This isn't say that doing business in China today doesn't come with some significant risk, but it does suggest that the reasons for staying doubling down or retreating required new levels of thoughtful consideration, our overseas investors still bullish, our foreign companies still welcome is a China strategy still essential. Over the course of the next 40 minutes, we explore these questions and more. Now, here's my conversation with David.
Stine: As always, it's a pleasure to spend time with you. Thanks for joining us on Inside Asia.
Hoffman: It's great to be here, Steve.
Stine: We're going talk about something. You know a lot about the US, China or Western China business environment. I guess there's been a few indications recently that are concerned one of foreign direct investment is down partly because due to Covid, but there could be other underlying issues which I think will examine a bit, but then also there seems to be a trend now where China is moving more towards an isolationist approach and disengaging stunt to some degree. I guess I wanna start with just first, your thoughts on reduced foreign investment in China, where is that coming from? Why is it happening now?
Hoffman: Yeah, well, there's a lot in that question. The FDI numbers are indeed down, and as you and I have discussed, rhodium group put out some recent reporting on that that shows that figures are reduced. This isn't surprising to me, given all things considered, many foreign businesses in China are already at scale, so you might have say... You might say that the 80s and 90s, and even in the early 2000, that was an investment boom, a lot of companies invested, scaled up, and it's only natural that is the market matures and so forth, they're going to invest less and they're gonna harvest their investments more. I think that's one explanation for this, secondly, many large enterprises there have significant domestic businesses and capital resources on shore, or access to on-shore capital resources, they're not gonna necessarily bring capital in from abroad, so that's another explanation for this, and third, and finally, maybe to your point about isolation. I don't know if I would say that China is re-isolating, but there are signals in that direction, and for that reason, I think many foreign businesses are inclined to sort of take a more transactional approach to their China business development at this juncture, and not really commit to long-term strategic investment, so I think a confluence of all three of those, or why we're seeing this reduced FBI, so take more of a COO cautionary note when you look at the numbers because it suggests it's more complex, there's underlying reserves, there's the opportunity to... If you will, we can flatten out after many, many years of investing, so therefore, don't build or make too much of those numbers. At the same time, there are lots of geopolitical issues and diplomatic challenges which are giving organizations pause for thought.
Stine: How would you characterize those? How serious are they resolve them themselves under a new administration in the US, at least, could you just give us a walk-through on that one? Yeah, I think the geopolitical considerations are significant, there is great uncertainty about what the future direction of US policy is a EU policy and of China policy.
Hoffman: At present, our operating assumption is that hard sanctions won't be forthcoming. That will force a stop to business in a broad-based way, so we may see sanctions on individual companies or individuals and the companies and individuals involved, we'll have to stop business, but we don't see, for example, a sweeping ban on US chip imports to China, although we might see Chinese retaliation against certain America, American or European chip makers, but we don't think there's going to be a broad-based sanction policy across all of these sides, and the reason being is that would induce too much harm to US companies or Chinese firms, and then consequentially harmful impacts on their respective economy, so I guess I'm saying that We think pragmatism ultimately will win out, but that doesn't make these issues any less concerning the business environment is becoming more complicated and more expensive, and for this reason, firms are finding it much harder and more expensive to do business there, with respect to US-China relations, has anything changed with the turnover from the Trump to the Biden administration, and are there glimmer of hope or negotiations back and play...
Stine: Any hopeful sign on the horizon?
Hoffman: The Biden administration is busy studying many things, and I think they have been slow moving a little bit on China because it's so politicized in the US now that anything they announced would just be received with so much scrutiny on all sides, from everybody on everything. So we think they're kind of trying to lay low there, but what we're seeing, of course, is a very significant change in style and also approach, again, we're a non-partisan research institution think tank, and we're not trying to make a judgment call here, but there are two things to realize. Firstly, the Trump administration believed that if they exerted hard power on China sanctions, tariffs, so on and so forth, that China would see that strength and change. So that was the view. That was the strategy. And for what it's worth, the Biden administration embraces a strategy where they're not trying to change China, they're trying to change the US and its allies become more competitive, so that's a pretty significant change in strategic orientation, and secondly, they've returned, I guess, to what you might say process and professionals, the China people, they've layered into the National Security Committee and all of the agencies is really significant, both older Jen people like me, with Kurt Campbell is the head of the edification Al Security Council, very experience. And lots of young China people that are really exceptional. And there's a very high degree of alignment across these people, they've worked together for years, they worked with President Biden in many cases for years, Anthony Blinken himself like three decades with the President, and so that was what was symbolic, for example, in the Alaska meeting in March, Antony Plank in the Secretary of State, Jake Sultan, the National Security Advisor, met with their Chinese counterparts together, and that was actually symbolic because several administrations ago, the National Security Advisor and the Secretary of State at the time were famously divided by their Chinese negotiators.So there's a very high degree of alignment, the US government now is speaking on the same page, on the same line, I guess, if you will, towards China, that doesn't mean things will get better soon, and it's certainly true to say that the Biden administration is not going soft, but this return to professionals to process, to dialogue, and that consistency across the White House and the agencies, I think matters a lot, and it will probably ensure that things don't get worse, so symbolically it votes for a more pragmatic approach, but nothing yet to be seen and of course, under Trump, it was trade, which was the cornerstone issue, the thing that broke them apart, tariffs... Everything that followed from it.
Stine: Is there a concern under Biden and a Democratic administration that human rights, for instance, what's happening in Xinjiang or Hong Kong or even Taiwan to some degree, will interfere with their ability to bridge the differences? Yeah, it's typically true to say that the Democratic Party probably elevates human rights issues more than the Republican Party, although maybe that's disputable today. What's important to note is that the trade war, if you will, with the Trump administration began in the White House.
Hoffman: It then extended into the national security apparatus with the China initiative that Jeff Sessions, the outgoing Attorney General initiated in November 2018. And then it finally moved into Congress, and today in congress, we have, gosh, I don't know, upwards of 500 different pieces of paper circulating by contrast, after the 9-11 terrorist attacks and all of the concern on the hill for anti-terrorism legislation, there were 150 bills circulating that gives you an idea of the activity that is happening in Congress at this juncture, and there are many in Congress and in the Senate who favor a much stronger human rights position, and we're seeing bills mouth move through that are very assertive in that regard, and I guess what I'm saying here is that to some extent, it's a little bit out of the White House, and at this juncture, I'm sure the president might veto things, but in general, there's a lot happening on that issue in the Congress, and we expect some pretty hard nose legislation to come out very soon that will probably impose new sanctions that are related to these human rights issues, as China waiting in other trading partners, waiting on the US to sort out this problem before they move forward, initiate any new endeavors with the Chinese government, or are they moving ahead unilaterally with their own decisions, vis-a-vie investment or trade or what might be at stake. I think Europe has actually moved the fastest on calling out the human rights challenges, and as you know, Europe and China had completed the negotiations on this comprehensive agreement on investment between the EU and China, in parallel to that, they issued some sanctions against four Chinese individuals and I think one firm and China responded with retaliation that were very significant, and again, maintain this line that human rights is an internal matter and shouldn't be a subject to trade discussions. I think that that Bird has flown, and Antony Lincoln in that Alaska meeting tied the human rights issues to the economic and trade issues, I think very eloquently, the first time I've ever heard a policy official do it... That it's all part of the same package. So I think we're seeing sort of a unified line on this from America and its allies, and to that extent, we expect that position to harden... The more difficult question to answer is how well China respond? Well, that acquiesce to some of these demands or will it demir... Or reject them out of hand. And I think if that happens, I think we actually may see more of an isolationist sort of trajectory will. Diplomacy and politics aside, what is the business landscape in China today, how easy or difficult are the Chinese authorities making it to do business there? The rhetoric from the top is difficult to parse. I'd mentioned to you this new dual circulation strategy that was announced at the National Party Congress last October and reiterated at the National People's Congress this March, and this dual-circulation strategy is thus basically, China wants to become more self-reliant, more dependent on its internal market, and more independent in terms of supplying its internal market with its domestic supply base, now in theory, that includes foreigners that are active in producing goods and services in China as well as Chinese firms, the external circulation part of this dual circulation strategy. Conceptualize becoming less dependent on the global system and detaching where needed, and many foreign companies are having trouble reading this, they don't know what the party envisions as the future for multinational corporations in China, and many foreign businesses are there for adopting a more transactional approach towards China. They're doing business while they can based on the current platforms they've built, but they're pretty reluctant to commit to long-term strategic investment, and this is why you're seen reduced FDI in that respect.
Stine: David, what prompted this? Why this turning inward?
Hoffman: Well, I think China perceives rightly more unfriendly, if not hostile, external environment, so I think China... China cares about two things. Really, it cares mostly about its domestic political stability, and to the extent that things threaten, that it will clamp down or regulate or manage with an end to assuring political stability, and to the extent they're seen external pressure on human rights issues and economic reciprocity issues and level plain field issues and fair trade issues, they are sort of battering down the hatches to try to preserve their domestic political stability at the expense of more integration and accommodation with the west, that's basically... It's a conflict of systems, it's an incompatibility of systems, and in my view, China will have to undertake some important reforms on its side to create the space for accommodation, and if it doesn't, this divide will only grow. And the question therefore is, can western business play both sides? Will this divide the separation be peaceful and amicable, or will it be hostile and maybe even... Maybe even worse. That's the big question. Are there any indications at all that China is making it easier to do business in China, or is it still skewed towards friends, the larger, more highly capitalized businesses, the auto industry, the chip industry, high tech areas where they need and want to see that type of foreign investment, in other words, any policy decisions that have been taking the last 18 to 24 months that sent a signal to the multinational companies to say, we are open for business, we're encouraging and we want you here. The rhetoric, even from the top, is that the door remains open to business and that the Chinese welcome foreign investors, and the experience of many of our members, some 50 global multinationals, European American and Asian alike, are experiencing actually counter-intuitively, a very high degree of hospitality at the local government level, China's economy, even though the recovery data don't admit this is under a lot of stress, it's imbalanced, they've got 840 million people who are low income, if not poor and low educated, they've got a lot of domestic issues to deal with. De-leveraging their debt overhang and so on and so forth, and while there are some really fantastic companies in China, by and large, most of them are pretty retrograde, so foreign investors are really important, they are the providers of quality investment, quality employment, quality tax payment, quality CSR and so forth, and they often are instrumental in ecosystem modernization, and the local government officials really recognize this, and oddly enough, for foreign investors, what determines their opportunity is the gap between contemporary realities and the aspirations of the plan at any given time, and the plan that China now aspires to is really a great leap from where it is now, to where she in ping and team want to go, and the role of foreign players in that is essential, and so its precisely when caps like that exists, that the opportunities for foreign investors are highest now, let me give you an example of this conflict between policy and opportunities, so China would like the bio-pharma and med tech industries to localize more in China, who doesn't. On the one hand, there's the demand for pharmaceuticals in China is endless, we all know that it's an aging population, it's a huge population, the health care needs are only going to rise, many foreign companies would like to build out their businesses there for that reason, and China is welcoming it and even incentivizing it on one hand, and on the other hand, they are driven by cost pressures to try to control the cost of the healthcare sector, so they're debating whether to introduce Price controls in some areas they already have, and also limit what we call term of patent tenure, so reducing the amount of time a patented drug is protected by patent, and so on the one hand, for an investor and pharmaceuticals, it looks great on the demand side, on the other hand, there are potential policy policies forthcoming that would absolutely destroy the margins of any future business.
Stine: Yet that sounds like a healthy internal debate, and aren't these issues related to escalating healthcare costs? In the US its out of control, it's nearly twice the cost to to be given or provided healthcare in the US versus anywhere else in the world China sees that, they recognize it and they're wondering by our share mass, might we be able to control it or at least have a designed growth versus unfettered growth in such a way where they can serve the population but also manage their healthcare cost? That does seem reasonable. Does it not?
Hoffman: Yeah, I think you're right, it's... Many of the issues China faces with inequality, with healthcare costs, with demographic change and so forth, or issues that are faced elsewhere, China's coming at it from a large government position, whereas the US is kind of coming at it from a small government position, and many in the US think that the government should be bigger to assure adequate health care to the entire population, and China is actually thinking We can do this, but by force of government, fiat and so it's coming at the same problem from two different angles... Fair enough, so you're raising a interesting point which speaks to the increased need to communicate what's going on in China, back to headquarters, and you've recently written a paper to address some of these challenges saying it's not sufficient to be able to just to speak in these high high level terms about whether it's a good investment or a bad investment or the right thing or the wrong thing to be in China, you have to do the analysis to understand both short-term and medium-term what's at stake, but you're also articulating and advocating for the idea that companies more so than ever before, need to take a long-term view and China...
Stine: Could you explain that a little more?
Hoffman: Well, right now, the geopolitical tensions, the mass media attention to these tensions, to human rights issues, to covid accountability, all of these things are taking a big toll on people, people at headquarters, people in China, and customers and suppliers in China and in home markets. And if you think about a big multi-national in China, how is an average employee of a big US firm to feel divided loyalties are problematic, and we have seen a terrific breakdown in trust, not just between the US and China, the diplomatic level between... Between China organizations and their headquarters, and this has been exacerbated by covid travel restriction, so general managers don't spend time in China as they once used to to build rapport with their Chinese colleagues and learn the market by visiting customers and government, and also Chinese talent isn't rotating through talent mobility programs globally, so there's a divide and the understanding in the meanwhile, these China issues are really big and difficult to think about it. I do this all day long for my living, and I have many, many outstanding questions. So the average company has significant differences of opinion, and the only way to effectively address these challenges is to align on opinions, and that requires trust, but it requires a lot of discipline, engagement.
Stine: So what you're saying is, by virtue of this isolation, people are taking strong positions either for or against, so I would suspect then on the ground, as you described at the local level, things are better than anyone back in Headquarters might truly understand because of the rhetoric, because of the press, is that what you're saying?
Hoffman: Well, I think that the China organizations, by and large, feel that there are good investable opportunities, good opportunities for growth and prosperity, that their presence in China actually helps with social issues and human issues. Foreign companies in China do a great deal of work in CSR and related activities, and in general, feel that their presence is actually helping improve US China, Sino-Western relations and that peaceful relations are paramount, so that's kind of a, I guess, a position most would have headquarters is probably increasingly concerned about the viability of China business, the policy directions, whether there are reputational risks that are too high, and these are valid concerns, and the China organizations really need to embrace more thorough risk management, a more thorough calculation on the evaluation of business opportunities, so up until now, it's been the case where why wouldn't we invest in China, it's only going up, but in the pharmaceutical example, I told you those policy questions are huge, and oftentimes, I would say China organizations feel like headquarters concerns are over reactive in reality, both sides have good points. And those points need to be brought together and hashed out through difficult conversations, or headquarters doesn't wanna think that local organizations think they don't trust them, local organizations typically don't wanna talk about the risks and the policy uncertainties, 'cause they don't wanna damp and headquarter enthusiasm for investing they've gotta get off out of that mode, they've gotta come together and embrace the realities of risk and reward and agree on a consensus basis that these are navigable. So what's missing is that the analysis, is it the ability, the training required in order to ask good questions and listen actively to the responses to back away from preconceived ideas or stereotypes that may be prevailing. What would you advise as somebody who's in the midst of this day-in, day out... Yeah, it's really around communication disciplines and making sure that the right conversations can happen and that they happen frequently, and it is... Some firms are doing this, if I take you back a little in time, when I was doing work in my consulting era career long ago in the early 90s, companies were very divided on China, I spent time in many an executive committee meeting or a board meeting at headquarters, where you'd have one group of board members who thought China is the biggest opportunity to happen in a millennia and we needed to be big, and in the same room, there were two or three others who said, China is a communist country, we shouldn't go there to begin with, it was that divided. And the companies that succeeded in that early era were those that aligned effectively where headquarters invested in China, understanding and the China organization spent ample and adequate time explaining going on to foreigners, the headquarter people and often ex-patriots would rotate both ways to assure that connection and the companies that had a long view and a shared understanding did well, and those that did less well, some failed, but they just did less well, so alignment was identified as a key success factor. In some ways, we're back to that problem of the early 90s of the 90s for different reasons, but just like then the two sides need to come together, and I remember it being very novel, it was like the CEO at the time, John actors, who made the first visit was very common that global CEOS didn't actually visit China, certainly not boards. And in the 2000s and on, most major multi-nationals would have one of their quarterly or tri-annual Board meetings in China, and there was a dedicated brain function at headquarters to sort of be abreast of China developments and so on and so forth. And that has broken down.
Stine: Could it be relative to other issues which are combating multinationals, that China is losing its position, but in other words, It's no longer seen as essential in the last five to 10 years. The whole rhetoric was, if you're not in China, you're not in business, but now it seems to be shifting to... There are other concerns we have sustainability, environment, social governance issues are now raising their heads, the ESG world would say, You have to report on these things, and maybe China isn't the best bet with respect to ESG, does that come up? Is it something that you think is figuring in or is that just too early now?
Hoffman: I think it's beginning to factor in more and more, if not already a lot, and I think the position that most foreign companies would have operating in China is that by virtue of their presence there, they can improve ESG performance in China, and all of our members are certainly very advanced in their sustainability efforts there, and it's important, it's a change driver. But you're right, on the other hand, there may be those who feel like because ESG performance is weak or deteriorating, especially on the social side, with the issues you raise, like Xinjiang and Hong Kong. We shouldn't be there at all. There's a growing voice in that camp, and it's a very difficult decision to make... My own personal view is that companies play a very big role in convene good values and good practices, and it's better that they be there and do what they can to help remedy them. I would see very few of them today actually contributing to it, so to your point, the idea of going just to low cost manufacturing and a lower environmental standards to produce more cheaply, that that day is over, at least for China, some of that has moved to other... Emerging markets like South Asia, and it's not good. But I think in China, it's more advanced than that, we're already at a different stage, in many ways, it's one.
Stine: There's this parallel dimension, David, that that's coming to mind. Whereas I remember in the early days, post-to investment in China, the idea of the whole narrative there was, it's good, we can demonstrate what the power and promise of capitalism by being on the ground, and we'll show them that there's something better than Communism. And now, I guess the same argument is being made that there are sustainable practices that are profitable as well, you could have both, and it's our role and a responsibility to participate in that way?
Hoffman: Well, the first story is played out, and now a lot of people are saying we gave away too much, we over-invested in some ways, relinquished control over IP, granted too many concessions during the WTO, gave China everything it wanted and got actually a lot less back. Could the same be true all over again, or is the whole ESG movement a bit different by nature? Gosh, that's a good question. Again, I think we're in a very different phase of development now, and companies need to be very mindful, as you and I have discussed at length of their purpose and really staying true to that purpose, and I would say that characterizes large western companies in China and in some ways they can actually contribute more by virtue of their purpose there because of all these problems, you mentioned China needs help and they can provide that help, but to your point about sort of where Washington sees it and capitals, I think it's... A lot of what drove China policy out of the US in the 80s was a business interest, and perhaps in retrospect, business interest drove the relationship too much, now it's swim the other way around entirely, where business is demonized for participating in China. And that too is an extreme view, and there needs to be a middle role in something I'm working on as an intellectual pursuit, is figuring out, trying to figure out and articulate what the role of business interests should be in foreign policy. Businesses obviously can't be compromising on national security issues or human rights issues or any of these things, or environmental standards, absolutely not, but it also seems like there are many things they can do well and that are useful and good by being there, rather than to say, China is treating the weaker as badly we should exit. And again, it's a very difficult issue. It's a really hard conversation for companies to have, both internally and externally, how do you communicate to your employees about issues like this or your customers... It's super hard. I'm definitely not saying it's hard, but I think there's more benefit from having our companies be there and do good by being there, then exiting because they get determined that it's not good to be there at all. Yeah, it's really an interesting point because if you think on the crown day-to-day businesses have legitimacy and they have position, I have influence, whereas all of the political wrangling that's going on actually clouds the problem versus adding clarity on a day-to-day level, so in the absence of business and a business presence in China to advocate for these types of changes and ESG protocols and whatnot. Who else is there to do it? Well, I think the governments in Europe and in the US should hold their companies to very high standards, and there's no question about that foreign business in China should do its utmost to do well by doing good, and it should work hard before we can address these broader geopolitical and societal issues. What an MNC can do is actually make sure that it is aligned internally, I mean, if they can achieve harmony between their Chinese staff and colleagues on these tough issues and their headquarter staff and colleagues on these tough issues, if they can achieve that... That's already a pretty good start, if there are models were sort of doing it internally first that can then be sort of projected outward, that seems like a worthwhile course of action to me, it's already been hard enough to do business in China, and now it looks like it's gonna get a lot harder. It's what you're saying. Yeah, it's true to say that business there has never been easy, and it is going to get harder, but it's always interesting.
Stine: David, thank you so much as always. Super insightful. Let's stay across this one...
Stine: That was my conversation with David Hoffman, Senior Vice President for the Conference Board Asia and managing director of the China Center for Economics and Business. There's little doubt that overseas sentiment vis-a-vis China has shifted. It was the darling of the investor world, whether the objective was to tap China as a low-cost manufacturing hub for export or hone in on the buying frenzy of a billion consumers through imports. China was hot now, well, not so much, or perhaps it's best to say less, so the fundamentals that should make China and exciting markets still hold true, and yet the optic obscure that fact, too many uncertainties can have a compound effect, layer geopolitical discord on top of human rights violations, regulatory Al-picnics and domestic favoritism, and bit by bit the attractiveness of a place like China begins to fall away, perhaps for companies deeply vested in China, the situation is less severe, but for those contemplating new market entry or phase to expansion, it's easier now to hit the pause button than in any time in the past 30 years for a direct investment in China tailed off in 2020, falling to levels, not seen since 2009 in the first half the year, that can be largely attributed to the outbreak of covid, but as the market recovered then stabilized the Compact that might have occurred.
Didn't the prevailing question is, Will it has the recent pandemic and the direct and indirect associations of China with the virus taken the shine off the world's most promising economic star? There are a few things that might help from the US, the Biden administration could re-engage with a pragmatic range of commercial and diplomatic gestures if trying to reciprocate its game on, on the other hand, if the anti-China rhetoric continues to grow, legitimate or not, any attempt at reconciliation would most surely be cast by the political opposition as a sign of compilation politics aside, MNCs have a few added challenges of their own, as David and I discussed, the ESG Environment, Social and Governance spotlight is on, no part of a publicly listed organization is safe from prying stakeholder eyes, one misstep in China could prove disastrous like what you ask, like further investment in China-based manufacturing when pressure is on to restore jobs in the US or Europe, or how about identification with the third-party supplier suspected of using forced labor, their sustainability risks as well, can... And CES now with certainty that their China operations and affiliates aren't violating some unspoken or unwritten environmental compliance, more diligence and better communication or insurance policies against these kinds of blind spot says Hoffman, companies with a long view and a shared understanding do better than organizations that default the hyperbole or surrender to geopolitical gas lighting for anyone who's done it, doing business in China has never been easy.
The only way to combat it is to go deeper and get smarter, learn to better manage the risk and brave the hard conversation says Hoffman, failing that there's always prayer and wishful thinking, or what some might call the long view. That's it for this week's episode. I hope you enjoyed it, and if you did, please share it with friends and colleagues. Every podcast is a new experiment, each week will work to introduce a new topic or trend that shows how corporate purpose... Sustainability and 21th century thinking are stacking up to guide Asia's future as always. We thank you for listening.