BNA Daily Report for Executives (subscription only) has an interesting article today that gives 6 examples of ways that various city and provincial governments are discovering and responding to violations of environmental laws.

A friend emailed me the other day asking for my thoughts on why Russia democratized after the fall of Communism and China did not. My initial, flippant thought is, Russia democratized? But that's too harsh. Let's give Russia the benefit of the doubt that it is a representative democracy, or a republic. Let's also give China the benefit of the doubt and not say "the fall of communism," but instead the beginning of the adoption of market economies. I think there are three factors for why Russia has democratized since the fall of the Soviet Union, and why China has not democratized since the fall of the Gang of Four and the rise of Deng Xiaoping Theory: 1) different solutions to the trilemma of international finance; 2) historical tradition; and 3) the particular circumstances in each country that led to the adoption of market economies.

Chinese Banks Are Making Easy Profits Off of Artificially Low Interest Rates at Money Game

Reports of China IP’s Demise Are a Bit Premature at China Hearsay

Manufacturing: Maybe It Isn't China at Free Exchange
Since the end of World War 2, US manufacturing output has grow steadily and manufacturing employment has declined steadily. Getting tough on China will not reverse this trend.

Have We Underestimated Chinese Consumption at China Financial Markets

Dan Harris at China Law Blog has been quite bullish on the China healthcare business prospects, particularly pharmaceuticals (see parts one and two). I am not one to disagree, and Chinese pharmaceutical R&D, manufacture, and sales does sound like quite the opportunity. But what if you are not in the enviable position of owning valuable pharma IP? I'd take a wager on construction.

On first impression, the eight Republican Senator's opposition to Huawei's bid to supply Sprint Nextel with telecommunications equipment in the US seemed like a typical political exploitation of xenophobia, particularly in a competitive mid-term election season. But Huawei has had some accusations against them over the years that make them seem more suspect than other Chinese companies. However, I think the nature of this particular business deal does not make it a serious security risk.

Robert Pozen wrote an op-ed for the WSJ yesterday arguing that the best way to shrink the trade deficit is for Chinese companies to increase wages, rather than faster yuan appreciation: Bashing Beijing Will Not Help Our Trade Deficit. He argues this because wages are the most expensive input for most of the goods exported from China to the US. And if wages increase, then Chinese will have more money to spend in China resulting in more of China's goods being purchased in China.

China Joint Ventures: Understanding the Intangibles at China Briefing

Americans believe relationship with China is most important at China Economic Review

Where To Locate Your China Business at China Law Blog

Multinational Companies Could Face Stricter Transfer Pricing Investigation By Chinese Tax Authorities at China Law Update

China Joint Ventures Again. This Time We Blame The Victims at China Law Blog

China Antimonopoly Law Update at China Realtime Report
Discussing two interesting lawsuits under the AML, one against China Mobile, and the other against Shanda and Xuanting.

Love The One You're With. When China Joint Ventures Make Sense at China Law Blog
Dan covers some instances where he thinks JVs are appropriate.

A Call For More Transparency In China’s Africa Investments at China Realtime Report

China Briefing's Series on Chinese JVs
China Joint Ventures as Strategic Investment
China Joint Ventures: Legal Due Diligence
China Joint Ventures: Financial Due Diligence

Preparing For Domestic Carbon Trading In China at China Law Update
Information on what may be China's first domestic carbon trading market.

Looking Under the Hood of the China Deal Machine at Deal Journal
Deal Journal getting excited about Volvo, Sino-Swedish relationships, and Qatari gas deals.

CIC Gives Rare Tally of Overseas Spending at China Realtime Report
It is what it is. Anybody else totally stoked about WSJ's way expanded China coverage?

China Antimonopoly Law Series at Antitrust & Competition Policy Blog
China’s Antimonopoly Law—One Year Down
China’s Antimonopoly Law—One Year Down: Part 2. China’s new merger review regime
China’s First Court Decision under the Antimonopoly Law: A Misreading of the Law?

Decoding China: Why Its Stock Markets, GDP Aren’t Linked at Deal Journal
"A unique characteristic of China’s equity market is the relatively high percentage of nontradable shares held by the central government, local governments and state-owned enterprises. One feature of this system is the transfer of risks to the country’s individual stock investors, causing price aberrations in the stock market, while keeping outsize returns for the government holders of nontradeable shares."

Head West, China: An Interview with Private Equity Consultant, Song Jin by Aimee Barnes

In the October 24th edition of The Economist is a concise case study of Infinity , a private equity company that has been operating successfully in China since 2004. The article identifies the two major problems that PE companies have in China, and the article identifies reasons why Infinity has been able to overcome these problems.

The two problems:

Western private-equity firms trying to enter China run into two problems: getting their money and getting their money out. The Chinese government keeps an asphyxiating foot on currency conversions. It is hostile to investment that involve restructuring (sacking people and selling assets) and financial engineering. And it has not interest in outsiders flipping assets for fast profits.

How Infinity has overcome these problems:

1. The "Chinese government entities are co-investors in the firm's two funds in the country."
   • Spreading the wealth around is sure to make friends.
   • Their website is too opaque to fleece out the legal structure of Infinity's firms in China. The company was issued a venture-license, which makes it possible to assume that the company is an FIEVC. What isn't clear is what the underlying structure of that FIEVC is? EJV, CJV, WFOE? Research has shown that CJV's are popular in private equity and venture capital as a means of creating the legal fiction of preferred equity in private equity firms, but there is nothing definitive on Infinity's structure.
2. Infinity's "investments have helped create viable Chinese companies in areas rich in technology and intellectual property."
   • Infinity's deals tend to be structured around the shifting of high tech manufacturing to China while maintaining ownership of the technology abroad. While it seems that the government would usually prefer the technology to be transferred to the Chinese entity, it appears that they are satisfied with the technology merely making its way into the country regardless of who actually owns it.
3. "Infinity raised $30m for its first fund in China, perhaps just enough to intrigue China's government but not enough to frighten it."
   • The just right, Goldilocks' sizing of the fund is certainly part of it. But I'd venture that Infinity's country of residence, Israel, plays a considerable role in it, too. Israel just seems less dangerous of a country of origin than, say, the United States, where the sophistication and capability of the PE firm is more presumed. That's not to say a fund from Israel is not sophisticated, but the optics count. Additionally, Infinity's website plays up the close ties between both Israel and China, and the Chinese and Jews in a way that I have never seen on a private company's website.

So, sounds like a good model for succeeding in PE in China. There are two extra hurdles, though: 1) you must have some technology that you want to manufacture in China, and 2) the "transfers of technology and production across multiple countries and entities is horribly complex."

China's New Patent Law Effective October 1, 2009 at China Law Update

China’s Energy, China’s Power: An Interview with China Energy Specialists, Elizabeth Balkan and Chris Brown by Aimee Barnes

UBS Lays Out Their China’s Big Four Themes. Forgets One at All Roads Lead to China

Yuan May Rise Later Rather Than Sooner at China Journal

While some blogs seem obsessed with drywall and its litigious matters, we here at this blog don't seek to lay blame, we are just concerned with how the homeowners stuck with toxic walls can get a tax deduction.

In 2006 alone, enough drywall for 32,000 homes was imported from China into the US and used to build homes in Florida, Virginia and Louisiana. People spent good money for those homes, or at least took out bad loans to finance the purchases. These homes became worthless when it was discovered that the walls were toxic. If an individual sells their home at a loss, they can not use that loss as a deduction against their income. Deductions can only typically be taken on losses from transactions entered into for profit and for casualties, and although a home is considered to be an American's biggest investment, a home purchase is not considered a "transaction entered into for profit" according the US Tax Code.

But Senators Jim Webb and Bill Nelson are doing all that they can to allow taxpayers to take a casualty loss for the houses they have purchased that used the defective drywall. The IRS is currently awaiting reports by the CPSC and the EPA before making any definitive ruling about whether these homes will be deductible as casualties.

I will hazard the guess that, absent a limited policy exception, these homes will not be deductible as casualty losses because the loss to the taxpayer is not a casualty. A casualty loss must be sudden, unusual, and unexpected. Toxic drywall, even if, as it appears, it only amounts to the emission of sulfur gases and does not rise to the level of radioactivity, is quite unusual. Whether the loss is unexpected would require a factual inquiry into the taxpayer's awareness of the possibility of sulfur-ridden drywall. Even if it is unexpected, the toxic drywall isn't sudden. It was made in a far off land, shipped here, installed, the houses were held on the market for some period of time, sold to home buyers, and then started causing problems. There is nothing sudden about that.

The casualty loss provision is simply not for losses of this nature. The kinds of losses that fall under this provision are the ones where there is some sort of event, such as a fire, a flood, or the first instance of a plague of beetles that eat your trees over the course of 5-10 days. Not the walls of your house emitting sulfur gas.

I guess we might actually need those trial lawyers to start suing away.

Why Did 70% of Caijing's Staff Resign? at Cup of Cha

Dual Language China Contracts Double Your Chance Of Disaster at China Law Blog

Money well spent? at Free Exchange

The Tangled China Immigration Web Some Weave at China Law Blog
I'm a sucker for war stories, and there are some good ones in here.

What is that makes a good China business book?

1. A detailed, refined case study comparison of a hand full of major players in a single industry over the course of almost 30 years; or
   
2. A rip-roaring romp through booze-fueled negotiations, shady backroom dealings, and outsized personalities.

The king of the latter is undoubtedly Mr. China. Haven't read it? Shame on you. Mr. China also takes on the mantle of greatness by offering several good lessons.

As for the former? Until Chocolate Fortunes by Lawrence Allen landed in my mailbox, I was unaware that such a staid book could make such a fascinating read. Mr. Allen meticulously describes the Big Five chocolate sellers' forays in China with attention to company goals both globally and in China, manufacturing, logistics, the products, marketing, and retailing. Mr. Allen has spent career in chocolate, and he knows his subjects.

The Big Five are Ferrero Rocher, Cadbury, Hershey, Nestle, and Mars. Fascinating absent the China angle are the profiles of these companies. I found myself deeply fascinated in the different approaches these companies took in their global development and in their internal structure. Mars and Nestle were particularly interesting, mostly because I simply was not aware of either how vast an empire each commands nor was I aware of how Mars' status as a private company translates into how privately it indeed conducts itself.

Chocolate is a very special product for several reasons. Chocolate requires a wholly refrigerated logistics chain to maintain flavor and consistency, and this is difficult enough to achieve in 2009. Chocolate consumers are very loyal, and once a company establishes itself as a preferred brand, customers are slow to switch. There was essentially no chocolate in China between the late '30s and the entrance of Ferrero Rocher into the market in 1982. It is estimated that 70% of chocolate purchases are on an impulse basis. The Chinese viewed chocolate as an exotic delicacy. Chocolate enjoyed virtually no regulatory oversight by the government. Mr. Allen writes that this unique combination made it so that the Big Five were given a level playing field, and the game would be decided by the application of the executives' "experience, management skills, and leadership capabilities."

If you know your chocolate brands and you've been to Shanghai, you probably know who the winner is. But I don't want to spoil it for everybody else. I'm not going to give any names, but here's how it all broke down and why:

1. One company prospered, and continues to prosper, by offering a single unique, decadent product designed to take advantage of the gift-giving tradition in China.
2. Another had big dreams, but made big mistakes in its agricultural and manufacturing side that led to poor quality. There was a slight rebound, but management shakeups spelled its doom.
3. A household name, and a reluctant player on the international stage, found that the Chinese instantly took to one if its most iconic chocolates. Management problems found another victim, though.
4. The biggest of the five found some success, but didn't follow up the success aggressively enough. Probably didn't matter too much because all of their market shares were in line with their global market shares, and they were raking in dough hand over foot, but there were some weird things going on in the boardroom with the confectionery business
   
5. The tenacious one seemingly did everything right. But it took them a long time to start realizing a profit, a luxury the others were without.

The opportunity to view management decisions in a relative vacuum is enlightening. Mr. Allen shows and evaluates how management decisions affect the viability of the whole business model. He also shows his readers certain management techniques that are particularly effective and particularly ineffective in China. His analysis of managing in China is that it is different, but he soberly explains the difference.

This book is highly informative, and reads at a good speed. Recommended if you want to know more about managing a global business or if you like chocolate, highly recommended if you want to know more about managing in China. The book is not without its flaws, though.

There are a lot of China cliches. I don't necessarily know if this makes me like the book more or less, but my high school English teacher said cliches are bad, so I'll just follow her advice on this one.

The other glaring problem is that Mr. Allen's story doesn't come through enough in the pages. He was a senior executive at both Hershey and Nestle, but we don't really learn much about him. More personal anecdotes would have made the book that much better.

If you want to learn something about managing in China, do yourself a favor and buy this book. Be forewarned, though: there is not even a slight reference to baijiu in its pages.

Then read Andy Xie's latest opinion piece over at Caijing, Can interest rate adjustments, currency devaluation and zigzag policymaking help unwind economic stimuli? It depends. Something's brewing over at Caijing, but Mr. Xie will always come up with something interesting to write.

The stimulus for the article seems to be Australia's increasing its interest rate by 25 basis points, and Andy Xie carves out what he thinks is the best case global scenario if the central banks manage policy competently. And he thinks that central banks should make his scenario their goal.

The goal for the global economy? 2% growth and 4% inflation. "Mild stagflation."

In the US, he sees interest rates climbing 4.5% through 2012, with an inflation rate of 4-5% by 2012. He sees the current devaluation of the dollar as a down payment for the this future inflation.

Despite the EU's difficult internal economic problems, he doesn't see the European Central Bank allowing the euro to decline in value because the bank "was structured solely to maintain price stability." He thinks that this will result in lower real economic growth rates than in the US.

He sees the same thing happening in Japan because of the "strong yen psychology."

And in China? Well China and the rest of the developing world still have asset bubbles according to Xie and others (according to yet others, including the Economist, there is just a serious potential for asset bubbles in China). This means that China's central bank will pursue a zigzag policy in which the yuan will likely remain pegged to the dollar resulting in similar interest and inflation rates as in the US, and credit controls, through the expansion and curtailing of lending, will be employed by the state to heat up or cool down asset markets as the need arises.

Cheery, isn't it?

In their annual survey, the US-China Business Council's (USCBC) finds that US companies' China outlook since 2008 remains largely unchanged. This is probably because 84% of the companies China operations remain profitable, and 76% have experienced revenue growth. Of the top 10 business issues in China, there is one new problem, the economic downturns impact on China operations, and one problem has deteriorated since 2008, protectionism. The increase in protectionist worries goes in hand with the economic downturn, but the reality of the situation does not (yet) justify the fears of US companies in China.

The obvious problem that the downturn has led to is in a reduction in sales in China, further investment in China, and employment of staff in China. The not so obvious problem, and the one that is raising cries of “Protectionism!” is the perception that FIEs are being excluded under the “buy local” requirements in much of China's $600 billion stimulus package. The worry is that the products of FIEs will not be included as “domestic” under the provisions of these rules. The facts just don't bear this fear out, though.

FIEs are domestic Chinese companies, so their products should be domestic. The report's take on the legal issue:

[T]he Ministry of Commerce and NDRC have publicly stated that products manufactured in China by FIEs should be considered “domestic.” This position was confirmed by Vice Premier Wang Qishan in the outcomes issued jointly by the United States and China following the July 2009 meeting of the Strategic and Economic Dialogue.

Sounds open and shut, but the optics aren't there for the US companies.

The problem seems to be in what US companies aren't perceiving any stimulus benefit, what companies are optimistic about the stimulus, and what companies have received a stimulus benefit. Companies in the consumer goods, IT, payroll, services, logistics industries have not reported any benefit from the stimulus. Pharmaceutical companies are optimistic about “capacity-building projects in the stimulus plan and the healthcare reform plan,” but these have yet to be implemented. Companies in the heavy equipment, infrastructure, high-tech component, and telecom industries have reported benefits from the stimulus package.

Frankly, it sounds like some companies are disappointed by their China performance and are looking for a scapegoat. There have been complaints about this before in regards to the “domestic” policies in the financial incentives given for boosting indigenous innovation, even though companies were unable to point to a single clear instance of discrimination.

Much ado about nothing? Time, I suppose, bears all out, but for now, looks like it.