Misconduct and Trust in China

Trust

Many around the world feel that there is a problem with trust in China. Does this feeling have a grip on reality or is it just a bad reputation? Laowaiblog’s Editor in Chief tries to explain

Chinese companies that fool investors in the New York Stock Exchange; lack of food safety regulations and insufficient enforcement of existing laws cause death and injuries among Chinese people; the exploitation of Western technologies by Chinese companies cause Western companies to lose market share after investing millions of dollars in China; and the inability of foreign companies to adequately protect themselves legally in China keeps many away from entering the Chinese market.

These are few examples of the extreme and silent change that is happening with the issue of Trust in China. China is getting to a point in which trust, misconduct and cheating are disrupting its normal course of growth. Not only that lack of trust has created a bad reputation for China as a nation, it also presents a dilemma for the future: How will China be able to sustain itself as the 21st century global superpower, if it cannot even protect the food that its own citizens eat?

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The Chinese wind energy industry has never seen better days. The wind energy market in China is booming, with Chinese companies dominating the technology and grabbing more than 85% of the market, aided by low-interest loans and cheap land from the government, as well as by preferential contracts from the state-owned power companies that are the main buyers of the equipment. Despite the success of the Chinese wind energy industry, an interesting story reveals how the technology used by some of the most successful wind energy companies in China might not be theirs.

Gamesa, an old-line machinery company that entered the wind turbine business in 1994, is a modern Spanish success story. Its factories in Pamplona and elsewhere in Spain have produced wind turbines installed around the world. With sales of $4.4 billion last year, Gamesa is the world’s third-largest turbine maker, after Vestas of Denmark, the longtime global leader, and G.E.

With its relatively low Spanish labor costs, Gamesa became an early favorite a decade ago when China began buying significant numbers of imported wind turbines, as Beijing started moving toward clean energy. Gamesa also moved early and aggressively to beef up sales and maintenance organizations within China, amassing 35 percent of the market by 2005. But Gamesa has learned the hard way, as other foreign manufacturers have, that competing for China’s lucrative business means playing by strict house rules that are often stacked in Beijing’s favor and that the issue of Trust in China is critical and essential to the success of the business. Nearly all the components that Gamesa assembles into million-dollar turbines here, for example, are made by local suppliers — companies Gamesa trained to meet onerous local content requirements. And these same suppliers undermine Gamesa by selling parts to its Chinese competitors — wind turbine makers that barely existed in 2005, when Gamesa controlled more than a third of the Chinese market.

With their government-bestowed blessings, Chinese companies have flourished and now control almost half of the $45 billion global market for wind turbines. The biggest of those players are now taking aim at foreign markets, particularly the United States, where General Electric has long been the leader. Gamesa’s market share has decreased significantly in China and is now only 3 percent.

Is There a Problem of Trust in China?

In a recently published article in the New York Times titled “The Audacity of Chinese Frauds”, the author, Mr. Floyd Norris, describes the problem of Trust in China by depicting a fraud by a Chinese company that is traded in the New York Stock Exchange. Longtop Financial Technologies, a Chinese financial software company, was exposed in what appears to be a tale of corrupt bankers and their threats to auditors who had learned of the lies. Mr. Norris describes a situation in which Deloitte, the accounting firm that was responsible for auditing Longtop, had to re-examine the financial situation of the company due to suspicion that was raised after Longtop had filed its financial reports. Deloitte sought confirmations from bank headquarters, rather than from local bank branches in which Longtop’s cash was really on deposit. Once Longtop found out that Deloitte was investigating beyond local bank branches, it intervened and forced the confirmation process to stop.

It appears that local bank branches were a part of a massive audit scam in Longtop. Longtop, so it seems, reported to have larger profits than it actually had, and the company’s chairman, Jia Xiao Gong, said that there was “fake cash recorded on the books” because there had been “fake revenue in the past.” In the article, the author cites at least two other big Chinese companies (China MediaExpress and ShengdaTech) that betrayed investors confidence in the American stock markets; These companies increase people’s fear from what could be a serious problem of Trust in China. Mr. Norris sums up by stating that: “Frauds and audit failures can, and do, happen in many countries, including in the United States. But the audacity of these frauds, as well as the efforts to intimidate auditors, stand out. If investors such as Goldman Sachs and Hank Greenberg cannot fend for themselves, something more needs to be done if Chinese companies are to continue to trade in American markets.”

What About Smaller Businesses?

So far, the frauds about which most of us have heard are all related to big companies. Yet, smaller businesses are also influenced by a weak rule of law in China. In a discussion I initiated in the website Linked-In approximately six months ago, I asked for the opinion of experienced people about the issue of Trust in China: “If the companies that are cooperating (in China) wish to achieve one goal – success, and that goal means money and prestige delivered to both sides, where does the motivate to cheat come from and why is it there?”

The discussion has generated more than 320 comments over a six months period and, in general, revolves around two main view points: The first is that “cheating” happens everywhere and that it is a normal stage as a country such as China develops. The second is that “cheating” in China is much more severe and widespread than it is in other parts of the world.

In a previous post that was published several months ago, I shared some of the comments posted on the discussion. Since then, the discussion has grown and become more significant, and I would like to share some of the more interesting comments that have recently been added:

One person indicated that one of the problems in China is lack of creativity and greed: “China LOST its creativity in the past centuries by creating a school system that puts the sole emphasis on memorizing in stead of learning problem solving skills, by hanging on to the old ways, and then suddenly going into an equalitarian society where all creativity was banned effectively.” He continues to say that: “(Cheating) is caused by the fact that apparently many Chinese entrepreneurs seem to have no problem to even poison their own people for profit! Look at the recent years, the seemingly perpetually recurring milk scandal, the problems with babyfood, with baozi that contained paper instead of meat, to name just a brief selection of facts that you all know so well.”

Another person concurs with the notion that there are trust issues in China: “Whether there are more scams and cheaters in China than other places is hard to say. It definitely looks like there are though, just off the top of my head from the last few years I can remember: fake eggs, fake baby formula and other milk products, tainted pet food, child slaves working in kilns, government officials running ant farm ponzi scheme, embezzled sichuan earthquake donations, even a fake US army unit started by a mainland Chinese guy in the US to cheat other Chinese. I can’t list that many high profile scams in my own country for the past 20 years put together.”

Yet, some people feel that there are too many negative comments on the thread, and that “cheating” might be a natural process of growth: “China has opened its doors to the outside world and embraced ‘capitalism’ only in the last 30 years. It is still a very young capitalist environment. We are not as experienced and de-bugged as the UK or the USA. In the late ’70s, China unleashed a billion of who would be “money earners”, business people, to engage in business in global markets without much guidance or restrictions while policing these individuals using a very weak legal system. Give it time, folks…. we will clean up our act.”

The Problem with Discussing Trust in China

Obviously, when dealing with a sensitive issue such as misconduct, trust and cheating, one needs to choose his/her words carefully. The questions of what constitutes as cheating and whether there is indeed a problem with Trust in China are difficult to answer. Yet, the debate on Linked-in has generated some very interesting and diverse comments about the nature of doing business in China.

Since one cannot truly measure whether there are more cases of cheating in China than elsewhere in the world and since what constitutes as cheating remains obscure, the debate remains open and the answer to the question whether there is a problem with Trust in China remains unanswered. With that being said, it is clear that if China wants to be an innovation powerhouse (as defined in the 12th five year plan) and to be a “harmonious” society, it must enforce stricter rules, encourage people to be creative and think out of the box and educate people to treat each other with respect. It must again remind people what is the value of trust in a society. Only when trust is regained will China be able to be considered a role-model for other countries. Right now, that is not the case.


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About the Author

Lior Paritzky is the Editor in Chief and Manager of Laowaiblog, an internet platform that provides opinion and views about social phenomena in modern China. Look for Lior on Twitter: Liorpari