Book proposal and book review

41 The China Business Model. Copyright © D. Windsor. Published by Elsevier Ltd. All rights reserved.2017

http://dx.doi.org/10.1016/B978-0-08-100750-1.00003-6DOI:

CHAPTER 3

Interpreting China’s Model for Business: Roles of Corruption, Favoritism, Reliability, and Responsibility Duane Windsor Rice University, Houston, TX, United States

The contribution of this chapter is to provide a description and an inter- pretation of China’s evolving model for business. The description and interpretation emphasize these four key dimensions of business in the Chinese context: corruption, favoritism (including guanxi), reliability (political), and corporate social responsibility (CSR). The author argues that compiling empirical information about these four dimensions within the context of the changing Chinese political economy should help with scholarly understanding of China’s model for business. There is a consid- erable empirical research on Chinese firms (partly listed in the chapter’s references), much of it being published by Chinese scholars (national and ethnic), appearing in English-language business and economics literature. The contribution of this chapter is to structure that increasingly large lit- erature into a reasonably synoptic and revealing description and interpre- tation of the Chinese business model as guided by the party and state.

The methodology of the chapter involves two approaches. The first approach is identification of literature on the four dimensions of the business model—corruption, favoritism, reliability, and CSR—within an interpretive understanding of the Chinese political economy. The second approach is more tenuous, due to the apparent uniqueness of the Chinese context. This chapter positions the identified research within a proposed theory of comparative political economy relevant to China’s situation. The term political economy refers to the interaction of political and eco- nomic institutions and the influence of this interaction on other social institutions, in a specific country. Each country has a political economy, as just defined. Culture is one such institution, defined as shared norms

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and patterns of behaviors, illustrated by customs and traditions, and cog- nitive understandings of those norms and behaviors constituting a group or community identity and typically acquired by socialization. Nationality and culture are not necessarily coincident (see Zolfaghari, Möllering, Clark, & Dietz, 2016). Modern China is heir to an ancient civilization and rich cultural tradition, and has the world’s largest population. The literature concerning “varieties of capitalism” identifies a reasonably wide range of countries that can be classified under the definition of capitalism; there is no single unified model of capitalism (De Leon, 2015; Detomasi, 2015). However, China falls well outside the typical range of such capitalist polit- ical economies in being in transition from former command economy to present state capitalism toward possible future market capitalism.

The proposed positioning involves three key dimensions. One dimension concerns privately owned Chinese firms, as distinct from the state-owned enterprises (SOEs), whether listed on the Shanghai Stock Exchange (SSE) or the Shenzhen Stock Exchange (SZSE) or not. The chapter’s particular interest is information available about the motives and behavior of private business owners and managers (Guo, Jiang, Kim, & Xu, 2014). The second dimension concerns the domestic institutional context—political, economic, and social—within which those owners and managers operate. China is a single-party political regime, grounded in Marxism–Leninism–Maoism ideology and practices, if no longer strictly speaking a communist regime. China is neither a communist-style com- mand economy nor a full-blown market economy, but rather is positioned somewhere between the two models in a way that is difficult to define with precision. China may or may not be in true transition to a market economy; it may possibly remain strongly oriented toward communism. The third dimension concerns identifying the most relevant political economies to which China can be compared. China is unique—politi- cally, economically, and socially; so comparisons will be weak at best. The chapter suggests that the BRICS (China being a member of that five- country category) with particular attention to Russia and countries of Southeast and South Asia, especially Vietnam and India are the most rea- sonable comparison countries, although it is vital to bear in mind China’s essential uniqueness and the paucity of readily available comparative data. Much available research tends to focus on specific countries (China, India, Russia, or Vietnam for instance) rather than on cross-country comparisons.

The remainder of the chapter comprises four additional sections. The next section provides some basic relevant information about China’s

Interpreting China’s Model for Business 43

political economy: economic, political, and socio-cultural. The third sec- tion provides a conceptual framework for interpreting Chinese conditions. The fourth section discusses research findings about the Chinese business model with emphasis on the roles of corruption, favoritism (including guanxi), reliability (political), and CSR. Favoritism is closely intertwined with guanxi networking. Reliability involves how party officials view the pro-regime loyalty of business owners and managers. Chinese practice of CSR may arguably be closely influenced by corruption and reliability. The concluding section summarizes the chapter’s arguments.

3.1 SOME BASIC, RELEVANT INFORMATION ABOUT CHINA

In March 2016, China’s premier Li Keqiang, who has the leading respon- sibility for the economy, publicly announced that more market-opening reforms will be forthcoming, including (1) reducing the state-owned steel and coal industries, (2) further reforming the financial system to be more market oriented, and (3) further reducing the government’s role in business (Ecns.com, 2016; Houston Chronicle, 2016). This information helps to confirm that China remains on the path to marketization and privatization.

The emphasis of this chapter is on the motives and behavior of pri- vate business owners and managers in the Chinese setting. A second- ary interest is on the motives and behavior of the managers of Chinese SOEs, by way of comparison (Bruton, Peng, Ahlstrom, Stan, & Xu, 2015; Zhu, Liu, & Lai, 2016). In the prevailing theory of a firm operating in market economies (whether privately owned or publicly traded), manag- ers seek financial performance results within conditions shaped by their cognitive understanding (Mele & Ogunyemi, 2014), pressures from for- mal and informal institutions, and pressures from stakeholders and media. These conditions likely generate role dissonance for managers (Benjamin, Nisim, & Segev, 2015).

The “varieties of capitalism” theory accepts a range of such condi- tions across countries within the Organisation for Economic Co-operation and Development (OECD) (34 in 2015), with extensions to other con- texts. Conditions in China approach the extreme limit of this prevailing framing in that cognitive understanding arguably has been shaped by both socio-cultural traditions and explicit social control by a communist party which has effectively suppressed activism and media. Compensation, gov- ernance, philanthropy, political influence, regulation, and taxation arguably

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do not have the same meaning or role in China as in the OECD (adding Singapore and Taiwan as emerging economies which are not in the OECD to Japan and South Korea which are in the OECD), or in the rest of East Asia (Chua & Wellman, 2015; Cumming, Fleming, Johan, & Takeuchi, 2010) including Hong Kong as a special situation (Connor, 2014).

In October 2015, 12 countries agreed to a Trans-Pacific Partnership (TPP) trade agreement: Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, United States, and Vietnam. Japan, Singapore, and Vietnam are included; China and Taiwan are not members of this recent TPP agreement.

The World Factbook (U.S. CIA, n.d.) estimated China’s population at about 1.367 billion and India’s population at about 1.252 billion (July 2015), although a higher growth rate in India might lead to a reversal of these first and second positions sometime in the future. The World Factbook identifies the government of China as a Communist state; India is a fed- eral republic. Hong Kong is a special administrative region within the People’s Republic of China (PRC), and identified as a limited democracy. This chapter is not directly concerned with Hong Kong enterprises, or the Hong Kong exchanges. China is not ethnically homogeneous; there are various minority groups (as was the case in the now disintegrated USSR).

Measured by estimated 2015 gross domestic product (GDP), in US dollars, China is the world’s second largest economy at $11.4 trillion after the United States at $17.97 trillion. Japan ($4.1 trillion), Germany ($3.4 trillion), and the United Kingdom ($2.9 trillion), the next three national economies in size, are much smaller on this measure (Statista, n.d.). The GDP of the 28-country European Union (EU), which is larger than the 19-country eurozone, aggregates to about 13.1 trillion euros. Depending on conversion rate to US dollar, the EU economy is somewhat larger than China’s economy (Statista, n.d.). China’s growth rate has slowed recently, attributed in part to shifting from investment and manufacturing expan- sion toward consumption and services for the population (Pylas, 2016).

China is an emerging (or industrializing) market in transition from a command communism approach to a more free market approach. One empirical condition in support of this conventional characteriza- tion is emergence of privately owned enterprises (such as Alibaba Group, Dalian Wanda Group, Haier, and Lenovo Group) alongside important SOEs and significantly state-influenced and politically connected pri- vate enterprises (Chang & Wong, 2004; Xia & Walker, 2015). However, the present situation is better appreciated as a party model for business

Interpreting China’s Model for Business 45

rather than a business model, in the sense that one might expect vari- eties across the OECD. Chief elements of this Chinese model for busi- ness involve political reliability (to the party) and CSR practiced through extracted philanthropy, in addition to realities of corruption (commer- cial and governmental) and favoritism. For example, the warehouses of Rui Hui International Logistics exploded in Tianjin (Binhai New Area). Corruption and favoritism explain how ineffective regulation permit- ted unsafe conditions to persist until there was a disaster. The Fonterra- Sanlu IJV milk scandal in which melamine was added to milk to mimic proteins led to a terrible scandal in adulterated infant formula powdered product, resulting in the bankruptcy of Sanlu and evidence suggesting absence of testing by Fonterra, a New Zealand company (Chen, Zhang, & Delaurentis, 2014; Pavlovich, Sinha, & Rodrigues, 2016). Here again, within China corruption and favoritism for Sanlu may have been at work, with Fonterra unable to exercise closer supervision of a Chinese partner.

The information provided above gives a general picture of Chinese political economy. That general picture is one of uniqueness, making use- ful comparisons to the other BRICS or to other countries in Southeast and South Asia difficult, compounded by the difficulty of finding useful cross-country comparative data.

3.2 INTERPRETIVE FRAMEWORK FOR EVALUATING THE CHINESE MODEL FOR BUSINESS

In addition to providing a general description of the Chinese political economy, in a process of evolution toward marketization and privatiza- tion within a one-party regime itself evolving away from communism, the author argues that one must formulate a reasonable interpretive frame- work for evaluating the Chinese model for business. The framework for- mulated in this section emphasizes corruption, favoritism, reliability, and CSR as aspects of the business model highlighted in recent empirical studies. That empirical literature, however, deals with these aspects essen- tially separately as standalone considerations. This section seeks to provide a better integration of the four aspects.

The Chinese regime’s approach for its economic transition since the reforms under Deng Xiaoping might be characterized as either “state capitalism” or a “socialist market economy.” Under either label, there is a dominant state-owned sector and a state-influenced and state-guided as well as regulated privately owned sector. In Russia, for comparison, the

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state-owned sector was dismantled through privatization by a now dis- placed democratic regime; and the authoritarian Putin regime has been emphasizing recovery of ownership and control of natural resources (Dufy, 2015; Rutland, 2015). Even a “constitutional democracy” formally defined can be quite illiberal in actual practice (Innes, 2015). One study argues that the Chinese regime, characterized as a “shareholding state,” has morphed into a shareholder and institutional investor in the Chinese economy and shifted to financialization of economic management of ownership, assets, and public investments (Wang, 2015). That study char- acterizes this specific shift as politically endogenous to Chinese conditions.

Put simply, the state controls the economy through a unique verti- cal economic structure, organized top-down (Li, Liu, & Wang, 2012). In this model, the SOEs control key upstream industries and markets, while downstream industries and markets have been opened to private competi- tion. Li, Liu, and Wang report that the SOEs have outperformed private firms since c.2000, whereas the private firms outperformed the SOEs in the 1990s. Those authors argue that the upstream SOEs have benefited from international trade more than the downstream private firms through the abundance of relatively cheap labor in China. Recent reports sug- gest that China’s manufacturing costs are rising significantly (AlixPartners, 2013), and this increase is one of the drivers for relocation of produc- tion activities to other countries viewed as having relatively lower costs (Das, 2015; Hwang & Chen, 2016; Rivoli, 2015; Sacchetto & Andrijasevic, 2015).

The “varieties of capitalism” interpretation, anchored in the OECD, should be expanded to recognize newer varieties of state capitalism. One study distinguishes between the four varieties of state capitalism: (1) wholly owned SOEs; (2) the state as a majority investor; (3) the state as a minority investor; and (4) the state as strategic supporter of specific sec- tors (Musacchio, Lazzarini, & Aguilera, 2015). China appears to combine these various approaches. One taxonomy of political regimes (Mukand & Rodrik, 2015) uses the three dimensions of property rights, political rights, and civil rights (meaning equality before the law across individuals and minorities). Liberal democracy combines these three dimensions. In this theory of political regimes, elites seek to protect property rights and the majority seeks to obtain political rights. Electoral democracies may not automatically include civil rights as minorities lack the resources and numbers to be effective in bargaining for those rights. Industrialization emphasizes class cleavages; decolonization emphasizes identity cleavages.

Interpreting China’s Model for Business 47

This author argues that the Chinese regime dominates key property rights upstream while allowing privatization of nonkey property rights down- stream, and the party functions to appear to represent the majority indi- rectly; civil rights particularly in the form of protest and access to Internet information are regulated for protection of the party.

There are two points of comparison. The BRICS category puts China in a set of emerging countries that meet periodically in an invitation-only summit for governmental discussions. Russia is the closest country within the BRICS for comparison with China. Both Russia and China are for- merly communist regimes. The other point of comparison is the countries in Southeast Asia, among which Vietnam as a formerly communist regime is the closest country for comparison with China. North Korea is too extreme an example of a communist regime that continues to be a totali- tarian state and uninterested in privatization steps for useful comparison to China. The term BRICs (Kiely, 2015), not including South Africa, was used until 2010, when addition of South Africa resulted in a shift to the term BRICS (Robinson, 2015). While Cuba may be in a similar situation of transition away from communism like China, Cuba is just starting that transition and is relatively isolated in the Caribbean and does not begin to approach the economic importance and population size of China, Russia, or Vietnam (Backer, 2015; Villalobos, 2014–2015). Cuba is thus not a use- ful comparison case.

A continuum for comparative political economy analysis leaves North Korea at one end-point as the pure totalitarian regime (control passing within a family) engaged in state terrorism and Vietnam as the other end- point as the centralized one-party-state in the hands of pragmatists and technocrats seeking to attract foreign direct investment (FDI) to sup- port economic development. Russia, centralizing control of rich natural resources, is engaged in a strategic policy of revanchism to reverse territo- rial disintegration. Identifying a mid-point along the continuum, Russia lies somewhat toward North Korea, while China lies somewhat toward Vietnam. The Eastern European countries, once dominated by or part of the disintegrated USSR, are “westernizing”; and the Central Asian coun- tries, once part of the USSR, are also following separate paths little influ- enced by or connected to the example of China. The importance of the continuum is that it helps to reveal that China is a unique and original case, uniqueness making interpretation and comparison challenging.

There is literature on the various comparison countries, both among the BRICS (Lopes, 2015) and among the countries in the region. Vietnam

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is also following a path of economic liberalization, in which the coun- try’s provinces have been playing an important role in experimenta- tion (Hansen, 2016; Schmitz, Tuan, Hang, & McCulloch, 2015; Yang, Ramstetter, Tsaur, & Ngoc Phan, 2015). North Korea, a militarized one- party state technically still at war with South Korea and its allies (there is an armistice in place) and engaged in nuclear weapons and long-range missile development, suffers periodically from what amounts to state- induced famine and incompetence (1994–2000 and 2010–2012) while a prison population of about 200,000 is subjected to penal starvation (Howard-Hassmann, 2012; H. Lee, 2015). North Korean refugee sur- vey responses suggest that there was some marketization following the 1994–2000 famine (Haggard & Noland, 2010). The same responses suggest increasing inequality, corruption, and internal debate about pathways to social status and income—and widespread dissatisfaction with the regime (Haggard & Noland, 2010). Singapore (Huat, 2015; Rodan, 2015) has used SOEs transforming into global enterprises and sovereign wealth funds (as a strategy) to protect the domestic economy and also support political sta- bility under the center-right People’s Action Party (PAP) founded in 1954 by Lee Kuan Yew and in power since 1959. The PAP has a social demo- cratic orientation in its domestic policies.

In Singapore, sovereign wealth funds contribute to government social expenditures without having to increase taxes (Huat, 2015). Sovereign wealth funds globally hold about $6.65 trillion dollars (Alhashel, 2015). Although the motives of fund managers appear to be economic rather than political, there is conflicting evidence concerning whether such funds typically increase economic value for the owning governments or not (Aguilera, Capape, & Santiso, 2016; Alhashel, 2015). Poor fund per- formance might result in no economic gains or possibly even economic losses to the owning governments, for whom fund managers are agents.

Formal institutions

PartyState

Outward FDI, exports

Inward FDI, imports

SocietyBusiness

Informal institutions

Figure 3.1 Key considerations in interpreting China’s model for business.

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Fig. 3.1 provides a depiction of the key considerations involved in an interpretation of China’s model for business. The figure differenti- ates between the two formal institutions of party and state, and the two informal institutions of society and business. One can think of party, state, society, and business as four sectors of the Chinese political economy. The term formal institution refers only to the party and the state. The term informal institutions is adopted to convey that in Marxist–Leninist–Maoist ideology, society and any form of private enterprise exist only at the per- mission and design of the party. The essential attribute of the Chinese situation is that the regime is a modernizing totalitarian one-party state that directly or indirectly attempts to control everything in the country, releasing such control at its discretion. The party dominates the state and dominates society; the party influences business both through the state and through infiltration of corporate governance—shown through a dashed line from party to business. The top elite of the party, advancing to power through nondemocratic processes, is in effective control of the country, with a judiciary (which in reality is not yet independent) and a legisla- ture which in reality can change laws without respect to constitutional principles. As mentioned earlier, the party and state are formal institutions (Holmes, Miller, Hitt, & Salmador, 2013), while there are informal institu- tions such as kinship networks (Meyer & Lu, 2013) and guanxi (personal networks of influence through favors) in business and society, which may reach into the state if not the party. This chapter does not predict how the political system will progress in relationship to market economy develop- ment, as prediction is difficult. As Fig. 3.1 depicts, the party is dominant and effectively insulated from other pressures (in theory, if not in practice); pressures operate through the perceptions and preferences of the party leadership.

Interpretation of constructs and behaviors such as business–government relations, corporate political activity, or corporate philanthropy requires con- ceptual positioning within the motives, goals, and practices of the Chinese one-party-state system. The existing literature appears to contain conflict- ing views concerning the motives and goals of the regime with respect to political reform and anticorruption reform (Chen & Cao, 2016; Jiahong, 2016; Kipnis, 2016; Ortmann & Thompson, 2016; Tian & Slocum, 2016; Yang, 2016). Rather the motives and goals of the regime are to maintain party control of the country through the process of economic development, requiring a controlled and guided market-like economy—at least, as long as possible. It is in this sense that there is a modernized version of a totalitarian

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regime characterized by one set of authors as authoritarian capitalism (Hofman, Moon, & Wu, 2015). This modernization of control reflects the history of the party since taking power in 1949. Totalitarianism is now prag- matic with respect to means. Yet, the Chinese regime undertakes to acquire key resource positions abroad as in Africa (Hudson, 2014).

Economic arrangements reflect regime political preferences: “… monopoly control in the Chinese political economy is not simply an economic phenomenon but also a phenomenon deeply embedded in a comprehensive system of power that draws from the legacy of a centrally planned economy and from Chinese societal traditions” (Duan & Saich, 2014, letter). The state controls strategic sectors and releases nonstrategic sectors to private actors through a kind of “bifurcated capitalism” varying considerably by sector (Hsueh, 2016). Ideological orientation and strategic control will presumably tend to attenuate over time with new generations of more pragmatic leaders (Wu, 2015).

This chapter generally follows the political history interpretation pro- vided by Yang (1998) and the economic history interpretation provided by Coase and Wang (2013). The Mao era was from 1949 (establishment of the PRC) to September 1976 (when Mao Zedong died). This era was a communist-style command economy dominated by a full-blown totali- tarian one-party communist regime under Mao’s personal and ideological control (Yang, 1998, p. 137). The defining characteristic of a communist regime is the rationalization of revolutionary actions and policies through Marxist–Leninist interpretation. The Chinese communists explained revo- lutionary history as two stages: democratic revolution (achieved in 1949) and socialist revolution (initiated in 1956) (Yang, 1998, p. 138). Coase and Wang date post-Mao reform from the end of 1976 and transition to a market economy by the end of the 1990s, with China joining the World Trade Organization (WTO) in 2001. Ramo (2004) termed this reform process the “Beijing Consensus” to characterize a state-dominated Chinese economic development model different from the “Washington Consensus” among the IMF, World Bank, and US government promoting market-oriented reforms.

Coase and Wang suggest two phases of reform efforts. The central regime in Beijing initiated the first phase in 1978 with the explicit goal of revitalizing the state sector and thereby saving socialism. Hua Guofeng, Mao’s designated successor who arrested the “Gang of Four” and ended the Cultural Revolution, emphasized heavy industry investment. At the end of 1978, Deng Xiaoping and Chen Yun came to power in place of

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Hua Guofeng and changed direction. At the same time, left alone by the regime, private farming, township and village enterprises, urban private businesses, and Special Economic Zones were transforming the econ- omy through grassroots initiatives. The student democracy movement (Tiananmen Square protest) occurred in 1989, then in 1992, after Deng Xiaoping’s southern tour, regional competition generated a market econ- omy. There was a price reform in 1992, a tax reform in 1994, and privati- zation of SOEs in the mid-1990s (Li, Vertinsky, & Zhou, 2004). The result, according to Coase and Wang (2013), was a more integrated common national market. There are 32 provinces, 282 municipalities, 2862 counties, 19,522 towns, and 14,677 villages according to Coase and Wang’s figures. Competition meant multiple economic experiments throughout the coun- try (see Dai, Alon, & Jiao, 2015, on the pharmaceutical industry in China).

Coase and Wang (2013) argue that the Chinese regime is commu- nist only in name, and has transitioned to a one-party state and the most recent presidents are no longer charismatic “strongman” leaders. Radical ideology has been succeeded by a more pragmatic political philosophy. Deng reduced stress on class struggle, emphasized efficiency and prosper- ity, supported rule of law but not criticism of the regime, and increased economic and spiritual attention to the Western advanced countries (Yang, 1998, p. xii). A speech by Deng (Party Center’s work conference, December 13, 1978) entitled Liberate Our Minds, Seek Truth From Facts, and United to Look Forward emphasized that “Any party, any country, or any nation, if its mind is bound by doctrines and superstitions, cannot advance, and it will lose its vital life and eventually die away” (Yang, 1998, pp. 204–205).

Yang (1998, p. xiii) criticized the “… ultimate futility of trying to combine a market economy with a Leninist political system.” There is an active debate concerning whether China’s political regime is moving toward a constitutional democracy. One view is that China is an authori- tarian regime seeking to preserve a one-party monopoly of power by pro- moting economic liberalization (Bell, 2015; Chen & Kinzelbach, 2015; Minzner, 2015). Another team of authors recently characterizes the regime as authoritarian capitalism (Hofman et  al., 2015). An alternative view is that the foundations for future democracy can be discerned in a process of development (Miquel, Qian, Xu, & Yao, 2015; Owen, 2015). Assessment is difficult (Cooper & Farooq, 2015), in part because what appear to be “democracies” may be in reality “illiberal” as has been argued about Hungary (Innes, 2015). The task in this chapter is less to assess political

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development and more to characterize China’s business model in this transition process (see Huang & Chen, 2016). In this regard, I empha- size a timeless methodological point made by Yang (1998, p. 84): “Politics entails complexity and paradox, and is not always subject to simple laws of causality as contemporary politicians claim and later political observ- ers believe.” Although in late 1978, Deng stressed “truth from facts” he reportedly regarded this principle as the “essence of Marxism” when it might be characterized as “a traditional Chinese teaching” (Coase & Wang, 2013). During a speech in early 1979 (Party Center’s theoretical confer- ence, March 30, 1979) entitled Persist in the Four Cardinal Principles Deng emphasized the socialist road, the proletarian dictatorship, Communist Party leadership, and Marxism–Leninism–Maoism thought (Yang, 1998, pp. 207–208). More recently, the Chinese regime has turned more to mil- itary-naval development and territorial claims, as occurring in the South China Sea (Dittmer, 2015).

3.3 ASSESSMENT OF FOUR DIMENSIONS OF BUSINESS MOTIVES AND BEHAVIOR

Fig. 3.1 in the Section 3.2 provided a perspective on the Chinese politi- cal economy emphasizing the formal institutions of party and state and the informal institutions of business and society. The party remains domi- nant both politically and ideologically in Chinese life. This perspective is applied in this section to four basic considerations affecting business motives and behavior: corruption, favoritism, reliability, and responsibil- ity. State, party, and business in China are infected with corruption, which may be pervasive below the party’s top elite. Kinship networks and guanxi create favoritism and nepotism, which may be emulated by foreign firms attempting to curry influence. Politics are about reliability in terms of loy- alty to the party. Responsibility is defined in China in terms of “philan- thropic” contributions deemed desirable directly or indirectly by party officials, but this definition does not automatically correspond to Western conceptions.

A survey of over 600 business students in Canada found a significant difference between female Canadians in particular and Chinese from either the mainland or Taiwan. The Chinese considered it more appropri- ate to use ethically questionable negotiation strategies. However, Canadian males were also more in that direction than Canadian females (Xiao & Ma, 2015). How to evaluate such findings is unclear: mainland Chinese,

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Taiwanese, and Canadian males view ethically questionable negotia- tion strategies as more appropriate than do Canadian females. The find- ings are thus neither strictly cultural (Chinese vs Canadians) nor strictly gender (males vs females). Underlying the findings may be difficult to assess conflict between conceptions of economic rationality (the purpose of negotiation is to win something) and business ethics (there are rules governing negotiation) lacks resolution in the literature (Windsor, 2015a). While China’s political economy is essentially unique, it does not follow that Chinese businesspersons necessarily are also unique as a result.

Managers may develop their own operational philosophies focused on practical matters of turf, reputation, and coalition building (Windsor, 2015b). For example, consider the situation of the SOEs in China. There are three conflicting views toward taxation of SOEs (Cui, 2015). One view is that taxation is meaningless, because the government as sole share- holder can directly demand distribution of profits. The second view is that SOE taxation should aim at making SOEs and private firms competitive, instead of affording an advantage to SOEs. The third view is that SOE tax- ation forces profit distributions. Cui provides evidence that Chinese SOEs including centrally owned SOEs engage in extensive tax lobbying and tax planning, as one would expect of private firms.

This possible conflict between the expectations of the party and state and the motives and behavior of businesspersons—in state-owned or pri- vately owned enterprises—may inform how businesspersons engage with corruption, favoritism, reliability, and responsibility. Each dimension is addressed in a separate subsection below. For each subsection, the author provides a general or broad definition of the dimension followed by a spe- cific and narrower formulation for China. Chinese motives and behavior should be interpreted in light of the general definition being applied to Chinese conditions.

3.3.1 Corruption An aspect of business and government in China is reportedly a pervasive corruption (Gao, 2011; White, 2015). Corruption takes the form of brib- ery in various forms of government officials and also personnel of com- mercial entities. Corruption specific to China is the pervasiveness and the particular forms of bribery, extortion, gifting, and so forth. Detailed information is difficult to obtain in any country, because corruption is secret and illegal. Table 3.1 provides Transparency International (TI)’s 2014 corruption perception index (CPI) and 2011 bribe payers index (BPI)

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estimates for the five BRICS and a number of countries (including Hong Kong) in China’s region. TI reports CPI data annually and BPI data peri- odically. The CPI estimates perceptions of in-country corruption of public officials; the BPI estimates perceptions of out-of-country bribery by the country’s businesses. Within each category (China’s region and BRICS), countries are listed in order of the 2014 CPI score and rank; then for each country the table displays the 2011 BPI score and rank. China is perceived to be less corrupt than Russia, but somewhat more corrupt than India. Other listed countries in China’s region and Hong Kong are much less corrupt than South Africa. On the BPI, China and Russia are the two worst of 28 entities (including Hong Kong). The table notes show some comparison countries for CPI and BPI. North Korea and Somalia are tied for the worst in the world on CPI. Vietnam and Kazakhstan are more corrupt than China, while Mongolia is about as corrupt as India. Cuba is about as corrupt as South Africa.

A 2008 random sampling method survey of 1604 residents of Shanghai assessed citizens’ perceptions and attitudes concerning the government’s

Table 3.1 Transparency International’s 2014 Corruption Perceptions Index (CPI) and 2011 Bribe Payers Index (BPI) estimates for selected countries and territories Country by CPI rank order

CPI 2014 score (0–100 scale)

CPI 2014 rank (175 entities)

BPI score 2011 (0–10 scale)

BPI rank 2011 (28 entities)

China’s region

Singapore 84 7 8.3 8 Japan 76 15 8.6 4 Hong Kong 74 17 7.6 15 Taiwan 61 35 7.5 19 South Korea 55 43 7.9 13

BRICS (Brazil, Russia, India, China, South Africa)

South Africa 44 67 7.6 15 Brazil 43 69 7.7 14 India 38 85 7.5 19 China 36 100 6.5 27 Russia 27 136 6.1 28

Source: http://www.transparency.org/cpi2014 and http://www.transparency.org/bpi2011. Notes: A score of 100 (CPI) or 10 (BPI) means zero domestic corruption or zero bribing abroad, respectively; a score of 0 means pervasive domestic corruption or always bribing abroad, respectively. CPI: Denmark best (92, 1/175), New Zealand second best (91, 2/175), North Korea and Somalia tied at worst (8, 174/175). Cuba (46, 63/175), Mongolia (39, 80/175), Vietnam (31, 119/175), Kazakhstan (29, 126/175). BPI: Netherlands and Switzerland tied at best (8.8, 1/28).

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anticorruption campaign (Li, Gong, & Xiao, 2016). The study identified two findings that affected a respondent’s expectation for positive anticor- ruption outcomes: (1) the perceived unfairness of income distribution increased expectation; and (2) acceptance of power intrusion into income distribution decreased expectation. A study of self-reported direct per- sonal bribes paid by art students at examinations and in college admissions attributed individual willingness to bribe a personal characteristic and not to attributes of the admissions process (Liu & Peng, 2015). Students from middle-income families reported higher propensity to bribe than students from either poor or rich families. Gender had no effect. A 2011 nationwide survey found that citizens benefiting from economic growth may tolerate corruption (Li, Xiao, & Gong, 2015). A large state sector in a growing economy means considerable investment in public construction, which is likely the most corrupt sector in China (Shan, Chan, Le, Xia, & Hu, 2015). The authors of that study used semi-structured interviews with 14 experts and a questionnaire survey of 188 respondents. Another study using qualitative investigation of corruption cases and statistical analysis of a unique dataset of corruption rates to conclude that natural resource dependency significantly increases propensity for corruption among state employees (Zhan, 2015).

The available data suggest that corruption is pervasive in China, and that this condition likely affects businesses in various ways. While China is somewhat more corrupt than India, it is less corrupt than Russia or Vietnam. The Chinese regime is conducting a serious anticorruption campaign. In September 2014, a Chinese court found GlaxoSmithKline (GSK), a British pharmaceutical company, guilty of systematic bribery of doctors and fined the company about $490 million (₤297 million) and gave GSK’s former head of Chinese operations a suspended sentence—as reported in multiple news services.

3.3.2 Favoritism Favoritism, occurring in various forms, such as nepotism, tying arrange- ments, guanxi, is partiality on grounds considered to be social-welfare- harming in a competitive market economy which should aim at efficiency in resource allocation and distribution of goods and services. This general conception of favoritism, which may occur in any number of countries in various forms, may take specific forms in China requiring detailed empirical investigation. Relationships, political and private, may provide the specific forms of favoritism in Chinese business. Guanxi (roughly

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“relationships”) is exchange of personal favors, in a network of personal relationships regarded as more important than either laws or formal agree- ments such as contracts (Goh & Sullivan, 2011). There is an increasing literature on guanxi in business. Guanxi may operate throughout China, although less is likely known about party and government circles (Chen, Chang, & Lee, 2015; Hu, Schaufeli, & Taris, 2016; Murray & Fu, 2016; Warren, Dunfee, & Li, 2004).

A study about a decade ago of a sample of 790 newly and partially privatized firms reported that almost 27% of the CEOs were former or current government bureaucrats (Fan, Wong, & Zhang, 2007). As with other empirical findings on Chinese firms, such information should be placed in comparative cross-country context. Difficulty in assessing empirical findings for China is the absence of such detailed cross-study comparisons. The authors reported that firms with politically connected CEOs underperformed financially by almost 18% when compared to nonpolitically connected firms—based on comparison of 3-year post-IPO stock returns reflecting poorer earnings and sales growth and change in returns on sales. The first-day stock return for the IPO was also negative. Politically connected CEOs were more likely to appoint other former or current government bureaucrats to the board of directors. The essential implication of such findings is that in 2007 political connections were of importance and resulted in relatively poorer performance of newly and partially privatized firms. Nonpolitically connected firms performed bet- ter financially following privatization. There is a similar study for Vietnam listed firms (Phung & Mishra, 2016).

Clearly, the specific data in Fan et al. (2007) is likely to be significantly out of date after a decade, without current data available that replicates the specific approach. Furthermore, a regulatory change reportedly occurred in China to prohibit bureaucrats from being members of boards of listed firms: Han and Guangli (2015) tested for the market reaction to the change. There was a positive cumulative abnormal return for firms with politically connected directors affected by the regulatory change relative to a matched sample; and the effect of resignation announcement by a politically connected director is also positive and higher than the effect for resignation of a nonconnected director. The agency cost of the politi- cal connection outweighs the business value of the political connection. Reportedly consistent poor performance of China’s stock markets has been attributed to political connections. A study of samples of publicly traded privately owned firms finds 74% are politically connected and also

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that such firms are more likely to report significant financial performance deterioration following IPOs (Zhou & Li, 2016). Findings supporting the importance of political connections are reported in Wu and Cheng (2011). Chinese experience might be compared to commercial bank performance in Malaysia (Poon, Yap, & Lee, 2013).

There are a few studies of Chinese auditors that bear on favoritism. One study conducted two experiments with 174 Chinese auditors (Du, Ronen, & Ye, 2015). The first experiment investigated auditor awareness of attempts to manage earnings induced by a delisting rule. The authors conclude that the auditors believe that the classification of investment transactions could be appropriate in order to avoid losses. The second experiment investigated the role of guanxi between managers and auditors. The authors conclude that guanxi does undermine auditors’ ability to cor- rect earnings management attempts. Given guanxi, auditors are less likely to recommend adjustments, but, increased regulatory penalty does improve auditors’ willingness to challenge managers’ decisions. A reading of these findings is that in absence of sufficiently harsh penalties auditors default to guanxi. Another study examined auditor choice (Guedhami, Pittman, & Saffar, 2014). Public firms with political connections are more likely to appoint a Big Four auditor, for the purpose of improving accounting transparency to outside investors. One should bear in mind, however, that Big Four auditors in China are affiliates rather than direct offices (Rapoport, 2015). Affiliates are generally owned and managed indepen- dently, and operate within the national regulatory setting of the country. The study on political connections also found that the relationship to Big Four auditors is stronger for connected firms with ownership structures favorable to insiders. The connected firms with Big Four auditors exhibit less earnings management and other positive attributes such as higher val- uations and cheaper equity financing (see also Liu, Li, Zeng, & An, 2016; Tsai, 2012).

A study of a sample of 1435 Chinese foundations during 2005–11 (Johnson & Ni, 2015) found no relationship between the presence of state employees on an NGO’s staff and private donations. The presence of state employees was used as a measure of political guanxi. The study did, how- ever, find a small but positive relationship between amount of government funding of an NGO and private donations. The authors interpret govern- ment funding as a signal of legitimacy of the NGO. The implication is that donors are seeking to develop a robust civil society of legitimate and high-quality NGOs rather than seeking future favors from government.

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This subsection has assembled information on the dimension of favor- itism in relations between the Chinese party-state and enterprises, both state-owned and privately owned. It seems reasonably clear that there is a complicated relationship between political connections and business activities in China. Politically connected firms may perform more poorly than nonpolitically connected firms. Political connections involve a con- flict or tradeoff between agency costs of the connections and the value of favoritism.

3.3.3 Reliability For purposes of this chapter, reliability is a perception of businesspersons’ compliance with party and state expectations. This reliability may have different specific meanings in each country. In China specifically, reliabil- ity means the party’s perception that an individual is sufficiently loyal to the regime itself in addition to being compliant with expectations such as paying taxes. An important purpose of the current anticorruption cam- paign, whether effective or not (C. Lee, 2015), may be to place individu- als in charge of SOEs and state-influenced enterprises who demonstrate political reliability to the party (Wei & Davis, 2014). The Chinese censor- ship system arguably aims not at individual dissent or content but at sup- pressing collective action against the regime (King, Pan, & Roberts, 2013). Evidence suggests that reported earnings quality for politically connected firms is significantly poorer (Chaney, Faccio, & Parsley, 2011), and not due to firms with poor earnings quality establishing political connections more often as a substitute for performance. Rather, politically connected firms can disclose lower quality information because of lesser need to respond to market pressures. Also, such firms apparently do not face a higher cost of debt, which does occur for nonpolitically connected firms (Chaney et  al., 2011). These findings for China seem to echo cross-national evi- dence reported for 47 countries. Otherwise, standalone data for China— frequently the only data that can be conveniently located—is of course difficult to interpret contextually. Politically connected firms have higher leverage and higher market shares, but underperform on accounting mea- sures (Faccio, 2006, 2010). Differences between politically connected and unconnected firms vary with level of corruption and degree of economic development in each country (Faccio, 2006, 2010).

Empirical studies tend to confirm that political connections affect firm- level actions and outcomes (Zhu & Chung, 2014, report on political con- nections and business groups in Taiwan). One study found that politically

Interpreting China’s Model for Business 59

connected boards were negatively associated with top executive pay and dispersion between top executive pay and average employee pay; the study also found that politically connected boards weaken the pay–performance relationship (Chizema, Liu, Lu, & Gao, 2015). A study of earnings fore- casts by financial analysts, based on firm-level data from 17 jurisdictions around the world (1997–2001), found that analysts had greater difficulty predicting earnings of politically connected firms (Chen, Ding, & Kim, 2010). In jurisdictions with relatively high corruption, the firm’s politi- cal connections have stronger influence on earnings forecast accuracy. This study suggests that anticorruption measures can reduce the negative effect of political connections. Another study across 22 countries finds significant effect of political connections on M&A activities and postmerger perfor- mance, the effect being dependent on the institutional setting (Brockman, Rui, & Zou, 2013). In countries with strong legal systems or low corrup- tion, politically connected bidders underperform by about 15% abnormal stock returns over a 3-year period. In countries with weak legal systems or high corruption, politically connected bidders outperform by more than 20% on the same basis. The postmerger performance difference is greater for domestic mergers than for cross-border mergers.

It is important to bear in mind that party and government may seek to influence even private enterprises, and derive benefits from mar- ketized state ownership through FDI (Alon, Leung, & Simpson, 2015; Cui & Jiang, 2013; Miska, Witt, & Stahl, 2016). A longitudinal study of 973 Chinese publicly listed firms finds that advantages to firms with mar- ketized state ownership (central and local levels of government) are con- tingent on firms being affiliated with certain institutional structures such as state business groups reallocating resources member firms (Li, Cui, & Lu, 2015).

In China’s business model, the role of reliability is assurance to the party that businesspersons are loyal in the sense of supporting the regime. Such assurance may occur through direct and partial state ownership, political connections, and various economic incentives (such as subsi- dies) or possibilities for sanctions of firms. China’s business model may be highly unique in how reliability is defined and enforced. One possible effect is that the greater the reliability, the more the party and state may be willing to move further in marketization and privatization. Partial state ownership, political connections, and incentives may substitute for direct state ownership and may help generate incentives leading to businessper- sons to support the regime.

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3.3.4 Responsibility This chapter draws a distinction between CSR as a general orientation and corporate philanthropy as a specific practice. CSR is generally defined by many scholars as voluntary choices to contribute social benefits beyond legal requirements. Thus, paying taxes is not voluntary CSR; making donations in support of various causes is voluntary. This general concep- tion of CSR must be assessed within the special context of China’s model for business (Hofman et  al., 2015; Li & Zhang, 2010). The specific ques- tion in China is whether CSR activities, including donations, are wholly voluntary or at least partly function as responding to political connec- tions or seeking political influence. Many scholars define CSR as volun- tary actions in the public interest not required by law. This widely adopted definition, however, effectively makes CSR synonymous with altruism, while philanthropy is defined somewhat more narrowly as donations of corporate monies and employee volunteers. The author views CSR more broadly as the avoidance of irresponsibility (that is, violations of ethics and laws causing harm to society and/or other stakeholders of the firm) on the one hand and good citizenship contributions to social benefit on the other hand. Absence of irresponsibility may have a more important influ- ence on social welfare than does practice of altruism (Windsor, 2013). The latter is a net addition to social welfare only if there has been ethical or legal violations causing harm to society and/or other stakeholders; other- wise altruism may be only a minor reduction in the harm caused.

3.3.5 CSR and Business Ethics A study of CSR across 50 companies in seven Asian countries (India, Indonesia, Malaysia, the Philippines, Singapore, South Korea, and Thailand), based on analysis of Web site reporting, found considerable variation across countries in CSR explained by factors in each national business system rather than by stage of development (Chapple & Moon, 2005). The study found also that multinational enterprises (MNEs) are more likely to adopt CSR than purely domestic firms. CSR profile, how- ever, reflects profile of the host country of operation rather than the home country or origin.

For China, studies of 292 employees from 53 companies and 224 middle-level managers from 40 companies found that ethical leadership and external stakeholder pressure significantly and positively influence CSR implementation (Tian, Liu, & Fan, 2015). The effect of external

Interpreting China’s Model for Business 61

stakeholder pressure weakens with higher level of ethical leadership and strengthens with lower level of ethical leadership. These findings suggest that ethical leadership is the dominant consideration.

The findings raise the issues of the philosophical orientation of busi- ness leaders and the role of moral education of those business leaders (Windsor, 2015a, 2015b). In China, how to understand responsibility and concepts of duty, obligation, power, and right must be studied in context (Lu & Koehn, 2015). Coase and Wang (2013) report that premier Wen Jiabao was impressed with Adam Smith’s The Theory of Moral Sentiments (1759), appearing in various Chinese translations. Those authors express the view that Adam Smith appeals to the Chinese because there is an affinity with traditional (pre-communist) Chinese thought on economy and society. Viewed in this way, China might be returning to its tradi- tional cultural foundations. The only philosophical competition with or substitute for communist ideology arguably lies either in pre-Maoist Chinese philosophers or in modern market economics theory. The three dominant pre-Maoist Chinese philosophies are Daoism (or Taoism), Confucianism, and Legalism (Ma & Tsui, 2015). Legalism seems bet- ter characterized as political realism in a condition of competing and warring states; individual morality is irrelevant and impersonal systems should guide personal selfishness to benefit the state in effect indirectly (Goldin, 2011; Pines, 2014). Ma and Tsui (2015) analyzed articles report- ing interviews with fifteen Chinese business leaders to determine rela- tionship between their leadership practices and the three traditional philosophies. Applying any of these traditional philosophies to busi- ness ethics and leadership practices involves both contextualization and decontextualization (Liu & Stening, 2016). Contextualization means placing specific Chinese moral concepts back into original context for accuracy of understanding and interpretation. Decontextualization means adjusting those concepts to the modern business environment in China (Liu & Stening, 2016).

There is no available evidence discovered by this author concerning the beliefs of Chinese businesspersons (whether in state-owned or pri- vately owned enterprises). The three options appear to loyalty to the pre- vailing party ideology, interest in pre-Maoist Chinese philosophies, or the economic rationality of business (Windsor, 2015a, 2015b). What is impor- tant to appreciate is that Chinese business executives likely choose for themselves among these options; and the empirical distribution of choices may affect business–government interactions in China.

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3.3.6 Corporate Philanthropy Philanthropy in China is reportedly low relative to India, but significantly higher than in Russia (Cunningham, 2016). In 2014, philanthropy in China was 0.1% of GDP; the proportion in India was 0.4% of GDP (see Ren & Ye, 2016). However, in Russia philanthropy was only one-tenth of the GDP proportion in China (Cunningham, 2016). In India, a statute from 2013 requires corporate philanthropy of some 8000 domestic and foreign firms above certain minimum requirements (Godfrey, Branigan, & Khan, 2016). While philanthropy in the United States was 2% of GDP, as reported by Cunningham (2016), the United States or other developed countries do not seem to be proper comparison standards. Comparative data may be located in a recent handbook on global philanthropy (Wiepking & Handy, 2015). A recent study of the 100 largest donors in China completed during September 2014–August 2015 (the China Philanthropy Project) provides information about the economic elite (Cunningham, 2016). According to this study, tax breaks are not much of a factor in China. Rather, top donors appear to desire to cement personal and family legacies. Education was the leading recipient. Giving appears to be generally local and single-cause focused. The top 100 donors provided $3.8 billion in donations or pledges amounting to 0.03% of GDP. Beijing is a net recipient of this top donation set, receiving 15.7% of 2015 total donations; and 87.3% of this total was given by donors with corporate headquarters not located in Beijing. In the reverse direction, Beijing located donors gave 86.5% of their donations and pledges to organizations outside of Beijing.

3.4 CONCLUSION

The contribution of the chapter is to identify information about four key dimensions of the business model in China: corruption, favoritism, reli- ability, and CSR. No other work known to the author provides an inte- grated framework of this kind for assessing where businesses stand in China’s evolution toward marketization and privatization. The framework facilitates insight into Chinese businesses, both state-owned and privately owned enterprises.

This chapter has used a theory of comparative political economy to position interpretation of China’s transition from communist-style com- mand economy to a more market economy opening to international trade and globalizing Chinese MNEs (He, Chakrabarty, & Eden, 2016). The comparison benchmarks may be the other BRICS particularly Russia and other countries in Asia and Southeast Asia, with particular attention

Interpreting China’s Model for Business 63

to Vietnam. North Korea is too extreme an instance for reasonable com- parison to China. Singapore and Taiwan are also relevant in China’s region; Hong Kong is a special subject in being more market oriented and polit- ically liberal than but politically dominated by China. The Chinese set- ting appears to be unique, making direct comparisons relatively difficult. Hence, the methodology of comparison has relatively limited value in assessing the Chinese business model. Comparison is not useless, but rather must be viewed as relatively distant from Chinese conditions. Russia and Vietnam may be closer than India, Singapore, or Taiwan.

Several important suggested findings bear emphasizing. The Chinese economy appears to be still vertically structured. SOEs dominate the upstream economy, with privatization progressing more downstream in consumption of goods and services. The party dominates the state, and the regime still considerably controls or influences the private economy in multiple ways. While one can argue that the party is no longer “com- munist” in the classical sense, leadership appears to be still in a state of transition from Marxism–Leninism–Maoism to pragmatism. This trend presently remains more pronounced in the economic sphere than in the political sphere, possibly due to increasing decentralization to the prov- inces and subprovincial units. The regime still manages political thought and dissent, although the strategy has been characterized as one of per- mitting individual dissent to release pressure while preventing collective mobilization against the regime.

The chapter assessed four dimensions of the model of business with emphasis on the motives and behavior of business managers: corruption, favoritism (with emphasis on guanxi), reliability (meaning loyalty to the regime), and responsibility separated into CSR and philanthropy. Business owners and managers will tend to emphasize financial performance and develop their own operational philosophies partly influenced by but partly independent of either official ideology or traditional Chinese philosophies. This characterization invokes in part the inherent nature of market com- petition on the one hand and the inherent realities of turf, reputation, and coalition within organizations. Guanxi in the private sphere and political connections in the party-state sphere are under empirical investigation as ways in which networking functions within a one-party regime operat- ing a vertical structured, bifurcated variety of capitalism. State capitalism, or market socialism, remains the dominant factor in this approach to date. Studies of Chinese businesses will remain, for the present, subject to the problem of having to be positioned within the conditions of the Chinese political economy.

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