Sweet Is Turning to Sour

By Stephen Koepp

During Vice President George Bush's visit to Peking last October, Chinese officials beamed as he ceremoniously climbed behind the wheel of a locally made vehicle. This was no clunky black sedan, but a slick four-wheel-drive Cherokee fresh off the assembly line of the Peking Jeep factory. A joint venture of American Motors and a Chinese government-run automaker, the newly retooled plant stood as a promising symbol for Western companies planning to do business in China. Yet after turning out just 800 Jeeps and operating for less than a year, the factory expects to halt production in mid-June for two months or more because of financing difficulties.

Now the plant has temporarily turned into another kind of symbol: a warning sign to any capitalists who are still deluded by the thought that China is an easy place to make a fast yuan. Despite Leader Deng Xiaoping's promise to let profits bloom, hundreds of foreign entrepreneurs have found that the country can be a financial quagmire for unsavvy or impatient outsiders. Newly arriving businesses face a bewildering array of problems, ranging from inflated labor costs to poor communications to whimsical tax policies. All this has discouraged many of the once optimistic foreign ventures that have been arriving in China since 1979, when the country began allowing outside investors.

Western companies are now closely watching the fate of the Jeep plant to see whether the Peking government is serious about making its economic climate more hospitable to outsiders. The factory's troubles are typical of the unexpected snafus that foreign businesses often face. In this case, the Chinese government blocked the financing that the plant needs to buy Jeep kits from an AMC factory in Canada. Reason: Peking had to impose an across-the- board clampdown on import purchases in the wake of a consumer-products buying binge last year, which seriously eroded the country's foreign-exchange reserves. AMC announced last week that Peking has agreed in principle to provide the needed funds. With good reason: failure of the Jeep venture might be a highly embarrassing episode in the country's open-door policy.

Bureaucratic tangles like the one hobbling the Jeep plant could cool off China's reputation as a hot new business frontier. In 1985 the number of partly foreign-owned ventures jumped 130%, from about 1,000 to 2,300. Among the participants: Celanese, which will produce cellulose acetate for cigarette filters; Japan's Matsushita Electric (TV picture tubes); and West Germany's PolyGram (compact music disks). But most Western embassies in Peking are now at least tacitly advising their business leaders back home to avoid new joint ventures. Says one Western diplomat: "There is a general perception that in the past six to nine months the foreign investment situation has become less attractive."

Still, the new awareness that doing business in China is not easy could simply represent a healthy sobering-up at the end of a speculative binge. Faced with the gritty realities, foreign capitalists must now find ways to adapt. Said Treasury Secretary James Baker, when he visited China earlier this month for the annual meeting of the U.S.-China Joint Economic Committee: "I would tell American businesses that are suffering to hang in there. (The Chinese) are going to confront these problems and deal with them."

Perhaps the most common gripe of Western executives is that Chinese officials often make up taxes, rules and regulations as they go along, rather than following any written policy. Thus foreign companies in China find their profits eroded by hundreds of unforeseen expenses. For example, the food-and- beverage manager of a Western-operated hotel notes that the tax on a shipment of food from Hong Kong varied from 20% one month to 60% the next. "When I complained, the official just said, 'Look, the regulations say we can charge from 20% to 60%. If you want to make an issue out of it, I will retroactively charge you another 40% on the last shipment so that we will be consistent.' " One reason for such vagaries is that China is only now setting up detailed legal and tax systems. When the country followed strict Maoist principles, central planners dictated all policy.

Many foreign ventures in China run into problems with the labor force. Says a British management expert: "Your labor costs may be half what they would be elsewhere, but the employees normally work only half as fast." The government tries to persuade foreign firms to hire as many people as possible at the highest wages it can negotiate. Cardio-Pace, a St. Paul company that plans to begin manufacturing heart pacemakers in July at a joint-venture factory in Baoji, near Xian in central China, found that local officials wanted the plant to be staffed with a hefty squad of assistant managers, who would serve no useful function. But the Minnesota company insisted on a lean payroll of 35 instead of double or triple that number, and the Chinese eventually gave in.

Because so many workers must be trained in high-tech methods, some manufacturing projects have very low productivity rates, at least initially. McDonnell Douglas, which began assembling twin-engine MD-80 airliners last month in a joint-venture plant in Shanghai, has had to allot three months to produce each fuselage, compared with one week at a U.S. plant. But after spending nearly ten years negotiating the deal to build 25 of the $20 million jets, the St. Louis company insists that it is delighted to be operating instead of just haggling.

Other joint ventures have run into the red because Chinese officials have been unusually zealous in trying to squeeze money out of the foreign capitalists. Said one U.S. trader in Peking: "Doing business in China is like being staked to an anthill. They nibble away all the time. One day it's a retroactive road tax, the next it's a 70% rent increase, the next it's a doubling of the fees you pay for Chinese staff." Chinese Journalist Shu Hanfeng, writing last December in Shanghai's World Economic Herald, scolded his country's officials for driving away foreign businesses with "a form of over-cleverness that lacks intelligence." He concluded, "You can only make money if you let other people make money."

Among the few foreigners making profits at the moment are those such as hotel operators and consultants who provide services for other newcomers. So far the Chinese have tended to block any direct access to their much coveted marketplace of 1 billion consumers.

While China's cost of living is very low for its citizens, the price of accommodations for foreigners can reach astronomical levels. Renting a comfortable two-room office in Peking costs nearly $70,000 a year, about twice as much as in New York City. Honeywell's Peking office is so cramped that staffers have stacked filing cabinets in the bathroom. Even so, more than 520 businesses set up China offices last year, bringing the total to 1,448 in 26 cities.

Foreign manufacturing ventures in China are not the only ones running into snags; firms hoping to export goods to the country have seen the door practically slam in their face. The problem began in 1984 and early 1985, when local Chinese officials, given the power to buy imports for the first time, went on a consumer-products shopping spree to boost the standard of living of the masses. The country imported so many goods, including such consumer products as autos, TV sets and refrigerators, that its trade deficit ballooned from $2 billion in 1984 to $14.9 billion in 1985 and foreign-exchange reserves plunged. In mid-1985 alarmed central-government officials cut back on imports, particularly those from Japan, where many of the consumer goods came from. Laments an official from a major Japanese home-electronics maker: "The China boom is over."

Yet China's trade with the U.S., its third largest trading partner after Japan and Hong Kong, is expected to continue growing because many American products--notably computers, oil-drilling gear and mining equipment--are essential for Chinese industry. Total trade between the two countries in 1985 neared $8 billion, an increase of about 25% from the previous year.

Many experts see China's erratic policy changes, like the import cutback with Japan, as temporary course corrections on the long march to a consumer society. While China's progress sometimes seems slow to outsiders, it is revolutionary when viewed from within. Deng's seven-year-old program to move toward a market-oriented economy has produced some painful side effects, including a tripling of the inflation rate, to 8.8% last year. Says Roger Sullivan, president-elect of the National Council for U.S.-China Trade: "The Chinese are moving pretty fast. But they had such a long way to come that it is very difficult to make all the adjustments quickly enough."

Despite the emerging realities about doing business with China, many companies remain enthusiastic. Earlier this month Kentucky Fried Chicken, which has already franchised 561 restaurants in Japan, announced plans to open shops in Peking. John Portman, the Atlanta developer, aims to build a three- tower structure in Shanghai, which will include a 50-story hotel. Clearly, foreign capitalists have been cautioned but not cowed. They now realize that success in China arrives on a slow boat rather than a jet airliner.

With reporting by Jaime A. FlorCruz and Richard Hornik/Peking