Board Matters Quarterly, June 2014

Growth and reform in China

Excerpts of an interview with Dr. Robert Lawrence Kuhn

  • Share

Recent media and economic reports indicate that China is well positioned to overtake the US as the world’s biggest economy, maybe as soon as this year. By any measure, China is a market that can’t be ignored by many large companies — whether they are multinational or not.

Dr. Kuhn is Senior Advisor, Office of the Chairman, Ernst & Young Global Limited. He is available for private client meetings.   Mark Manoff, Americas Vice Chair, is the Executive Sponsor of the EY Center for Board Matters.
 

Mark Manoff, Americas Vice Chair at EY, talked with Dr. Robert Lawrence Kuhn, one of the world’s foremost experts on Chinese politics, economics and business.

Below are excerpts from the interview. For the full interview, please download our report.

Mark Manoff: Dr. Kuhn, what do you think board members should know about China as they fulfill their governance obligations?

Dr. Kuhn: Doing business in China today is different than it has been in the past. Partnering with certain Chinese companies could help some foreign businesses. However, the complexity and dynamics of the China business environment require boards and management to be detailed in their comprehensive analysis and diligent in their continuous monitoring.

 
Potential risks

MM: Risk is an important issue for the board and audit committee. Can you talk about some of the current business risks in China, including any political risks?

RK: There are diverse risks of doing business in China. Political risk as defined as change in government or instability within China is low. Very few people say that an overturn of the political system is necessary — or even desirable.

MM: What about economic risk or other areas of risk?

RK: If there’s an economic problem in the world, China will be affected more than other countries. For example, if certain sanctions slow the world economy, China will feel it more intensely.

Companies should consider regulatory risk, which can be triggered by indirect politics or focused in order to achieve some industrial policy.

IP risk is a major problem even for Chinese companies, but China is really cracking down on it. They’re doing so because they want to become a world- class business locale and in order to do that, IP must be protected.

Corruption also is a serious risk, endemic in a one-party system without a free media. However, the Chinese leadership seems determined to minimize corruption as much as possible.

Finally, there are risks related to public opinion. Social media is powerful in China and if foreign companies are perceived to be taking advantage of Chinese consumers they will be attacked. Most companies are not prepared for this.

The bottom line though is that opportunities usually trump risks.

MM: China’s economy continues to see growth of more than 7%. Do you think that rate of growth will continue?

RK: People around the world worry about China’s slowing growth, but I don’t find many of them in China. When I talk to Chinese leaders and businesspeople, they worry about many things, such as disparities, industrial restructure and pollution, but the slowing growth rate is not high on their lists.

Reforms and change

MM: Can you provide your perspective on the reforms currently underway in China?

RK: Under President Xi Jinping, China has instituted its most significant reforms in two generations. From China’s perspective, initiatives in anti-corruption, frugality for officials, transparency for government, judicial independence from local government, public participation in the process of governance, and the like, are substantial and needed to support China’s continued development.

MM: What about inequality, which is considered by many to be China’s most serious issue.

RK: Economic disparity is absolutely China’s most serious issue, and it is top of mind for China’s leaders. They are focusing on certain industries where equality can be more quickly created. These include sectors like health care and education, and even entertainment and media.

MM: So the focus on inequality, and people’s personal needs, may present areas of business opportunity for multinationals and companies based in China?

RK: Yes, absolutely. We will see great opportunities for businesses focused on the environment, health care, education, housing, senior living, food safety and media/entertainment. These are the areas that China’s leaders are promoting.

Some of these sectors do not yet have robust policies, which could be an opportunity for companies to help set policies on a local or national level.

MM: How does the politico-strategic framework actually work for multinationals doing business in China?

RK: If I had to pick one word to describe the politico-strategic framework, it’s “alignment,” which occurs when a company’s way of doing business is consistent with the interests of the people and thus with the over-arching policies of China’s leaders. If you’re an executive or board member of a non-Chinese company, you must understand the relevancy of this alignment. If you understand the policies of China’s leaders, you can craft an approach that helps the Chinese managers or officials see your success as their success and thus facilitate your business.

 
Industry focus

MM: You talked about industries a bit, but what sectors do you think are going to experience the most growth?

RK: I often start with health care, but then I add a caveat that health care involves complex regulatory and market issues. Key sectors include technology, IT, life sciences, energy and energy efficiency, alternative energy, environmental protection and pollution control, anything having to do with water — all these are extraordinarily important. Food safety and supply are vital.

Consumer products and sectors related to urbanization have bright futures. The lifestyle industry, which includes media, entertainment, tourism and sports, also shows great potential.

MM: In closing, what advice would you give board members that are contemplating investment relationships with China?

RK: China is becoming progressively more of an innovation center, and companies that are not operating in China will find themselves at an increasing disadvantage. China is a market that can’t be ignored for long-term investment. If you discount it, you may lose your international competitive position, even in your home market. That said, board members must evaluate all the risks.