China Gets Tough on Foreign Business

Vaughan Yarwood assesses the increasingly fraught relations between China and a number of high profile Western investors.

In late March a Chinese court handed long jail sentences to four executives of the Anglo-Australian mining conglomerate Rio Tinto, after finding them guilty of taking bribes and of stealing commercial secrets. Stern Hu, an Australian citizen who headed the company’s iron ore operation in China, received a 10-year term, while his colleagues were given seven to 14 years, for accepting a total of 92 million yuan (NZ$19 million).

When the employees were arrested in July 2009 it seemed to many observers that they were merely the victims of Chinese anger over Rio Tinto’s rejection of a NZ$27 billion investment by Aluminum Corp of China and of stalled iron ore negotiations with Chinese state-owned steel mills. However, it now appears that, despite a clean audit of the office by Ernst & Young, Rio Tinto knew months ago that its staff were guilty of at least some unlawful activity. For its part, the company later claimed that the four were ‘operating outside our systems’ and that they had since been fired.

Judge Liu Xin said the action of the four employees had caused significant losses to the Chinese steel industry — Rio Tinto is a lead industry negotiator in commodity price talks with Beijing — and that the sentences were intended to ‘protect market order and the normal management of business’.

A major issue for China is that, as home to the world’s largest steel industry — 800 companies, producing some 40 percent of the world’s steel output — it has an enormous appetite for iron ore. In 2009, for example, the country paid NZ$70 billion for imported ore. With none of China’s steel-makers controlling more than five per cent of the market, they have little leverage when it comes to negotiating prices for the commodity and, valuing security of supply over low costs, some resort to bribery.

Suppliers often take advantage of such periods of high demand by reneging on benchmark prices and backing out of contracts. Rio Tinto, for example, invoked contract clauses that allowed the company to withhold 10 per cent of the ore, which it then sold at the spot price.

Rio Tinto’s Hu acknowledged the practice in a 2008 interview. ‘He said he had no qualms with driving as hard a bargain as he could on price’, wrote Australian journalist John Garnaut. ‘But he had misgivings about whether Rio Tinto should risk its integrity in China by claiming ‘force majeure’ to wriggle out of long-term contracts to chase higher prices elsewhere. “we acted in accordance with the letter of the contracts, but not the spirit”, he said’.

For Hugo Restall of the Wall Street Journal, this was the crux of the issue: ‘The bosses in Australia made the mistake of leaving their Chinese executives in place for too long with too little supervision’ Restall wrote. ‘But the bigger mistake was destroying the trust of the handshake deals made with Chinese partners in the quest for a little extra margin. That is bad practice anywhere, but especially in China’.

In recent years China has striven to show the world how seriously it regards bribery and corruption by imposing severe penalties, though to date mostly domestic businesses have been targeted. The Rio Tinto trial has been characterised as a hardening of policy toward foreign companies in China.

The court’s decision to hold closed hearings for part of the three-day trial drew criticism from Australia’s foreign minister Stephen Smith, who called Hu’s sentence ‘very harsh’, and from prime minister Kevin Rudd, who said the lack of transparency left ‘serious unanswered questions‘ about the convictions — there have been claims, for instance, that the commercial ‘secrets’ in question were freely available on the internet. At a press briefing, Chinese Foreign Ministry representative Qin Gang replied that ‘the Australian side should respect [the verdict] and should stop making such irresponsible remarks’.

The English-language newspaper Beijing Today went further, claiming that the court broke precedent by allowing dozens of foreign journalists to witness the verdict — albeit on monitors in a separate room. The paper quoted veteran reporter Louisa Lim, a Shanghai-based correspondent for the United States-run National Public Radio, as being ‘absolutely astounded’ at the chance to see at close hand the workings of a Chinese court.

The high-profile trial, involving the world’s second-largest mining company, has also been criticised for ignoring the part played by Chinese nationals in offering the bribes — steel magnate Du Shuanghua, for example, paid one Rio Tinto employee NZ$13 million to help his company, Rizhao, sidestep state-dominated pricing arrangements.

Alexandra Wrage of bribery watchdog Trace International claims that such omissions weaken the Chinese Government’s fight against corruption. ‘Add to this the suspicious timing of Hu’s arrest, the secrecy around the trial and the limited access to the defendants and the whole thing is best characterised as a step backward for transparency’, she said.

The Shanghai verdicts come at a time when the ‘opaqueness’ of Chinese legal proceedings has begun to unsettle many foreign companies. Following the trial, the Australian Chamber of Commerce called for clarity on ‘unanswered questions that arise about foreign nationals doing business with state-owned enterprises in China’. It also wanted more information on aspects of the Chinese legal system, including detention times and the lack of openness at trials involving foreigners.

In March, the American Chamber of Commerce released a report showing that 38 per cent of its members felt unwelcome in China due to commercial discrimination and inconsistent judicial treatment — up from 26 per cent three months earlier. Members believed some of China’s policies were ‘increasingly restrictive and protectionist’ and could deter foreign companies from active engagement in the world’s third-largest economy.

The report surfaced as American internet search company Google relocated its China-based search engine to Hong Kong, which has laws protecting free speech, in protest over China’s censorship policies. The move had its origins in a sophisticated cyber attack on Google and some 20 other American companies on 12 January 2010. Google subsequently determined that the mail accounts of ‘dozens of human rights activists connected with China’ were being routinely accessed by third parties. The attacks, along with attempts to further limit free speech on the internet in China, including the ‘persistent blocking’ of Facebook, Twitter, YouTube, Blogger and other websites, led Google to conclude that it could no longer censor searches on Google.cn.

Given Beijing’s declaration that self-censorship was a non-negotiable legal requirement, Google resorted to delivering uncensored search results in simplified Chinese from Hong Kong for users in mainland China, while maintaining the uncensored traditional Chinese service for Hong Kong users.

Predictably Google garnered praise from Wikipedia co-founder Jimmy Wales, whose company has itself been subjected to periods of heavy Chinese censorship, and from campaigners such as Human Rights Watch, which called it ‘a crucial moment for freedom of expression in China’, and Reporters Without Borders which sharply criticised the fact that ‘the world’s biggest search engine has been forced to close its Chinese version under pressure from the censors’.

However, Google is likely to pay a significant price for its actions. China has the world’s largest internet population, and its second-largest mobile company, China Unicom, is to stop using Google search on its handsets — which, ironically, use Google’s Android mobile operating system. Google search has also been removed from the tom.com portal, owned by Li Ka-shing, a Hong Kong billionaire with Chinese government connections.

Google first fell foul of the ‘Great Firewall of China’ in September 2002, three years before it had even entered the country, when Beijing blocked Chinese access to its site for 10 days. Traffic was later redirected to rival sites, including China-based Baidu.com which subsequently overtook Google as market leader in mainland China.

Technology company Go Daddy looks set to follow Google’s example. In March the domain registrar announced that it would stop registering internet domain names in China following new regulations requiring buyers to supply names, addresses and photographs.

- by Vaughan Yarwood

Fact Box: The Iron Glove of Protectionism

Beijing’s recently unveiled ‘buy China’ procurement policy has been seen as an attempt to exclude foreign companies from a multi-billion dollar market. The policy gives preference to domestic technology companies in government purchase decisions relating to computers, software, communication, office equipment, clean power and energy-efficient products. It also puts pressure on foreign tech companies to relocate research and development work to China and to transfer knowledge to local partners as part of an ‘indigenous innovation’ campaign.

There are concerns that the rules, which affect companies such as Intel, General Electric and Microsoft, could be broadened to include government purchases in energy, telecoms and other sectors.

Worsening the situation is Beijing’s insistence that companies wanting to be classed as domestic suppliers must make patent applications and register trademarks in China before  doing so in another country. Under Chinese law, the government may compel a patent holder to license technology to rivals and may decide against allowing a company to patent the same technology overseas.

- by Vaughan Yarwood

Photos:

• Rio Tinto's Cape Lambert loading facility in Western Australia - (c) 2009 Rio Tinto
• The new Wuhan train station, sourced on Wikimedia Commons