Corruption, Reform, and Foreign Investment in China


While delivering the keynote speech at the recent Asia-Pacific Economic Cooperation summit in Bali, Chinese president Xi Jinping stated that the government was drafting a “master plan for reform.” Speaking to a group of leaders who invariably have a stake in China’s continued development, Xi touched upon topics including politics, society, and the environment.  Given the recent slowdown in growth, Xi’s remarks mainly aimed to assuage the concerns of economic and business leaders regarding the stability of China’s economy.

Some of the most discussed topics that come to mind when thinking about economic reform in the Middle Kingdom include liberalization of interest rates, freer access to capital for small firms, and correcting market distortions such as real estate prices. These factors are admittedly extremely important to rectify if the economy is to avoid stalling out, but there is also another issue on the minds of many business leaders looking to become or stay involved in China’s economy – corruption.

Recent years have seen a growing international consensus on the need to fight corruption.  Whether it’s the United Nations Convention against Corruption or the Organisation for Economic Co-operation and Development’s Anti-Bribery Convention, the global community is rallying to root out corrupt practices in the public and private sector.  Companies operating worldwide have stepped up efforts to adhere to anti-corruption laws such as the U.S. Foreign Corrupt Practices Act (FCPA) and UK Bribery Act. As multinational firms emphasize compliance with anticorruption laws, they are building accountable global value chains.

Standing as a contrast to these efforts is China, where corruption is rampant. From local officials claiming and selling government funded affordable housing units to complex bribery schemes involving moon cakes, graft in all its forms is far too common.  This has ramifications for the future of China’s economy not only because it significantly increases the cost of doing business and constrains domestic growth, but also because foreign companies looking to expand internationally are increasingly wary of operating in heavily corrupt environments.

China’s economy is currently at a critical juncture.  As growth slows and the cost of manufacturing continues to rise, the country risks falling into the middle income trap.  If this is to be avoided, firms in industries other than manufacturing must be able to grow and compete globally.  In today’s globalized world, one of the most effective methods of tapping into the global market is by joining value chains as a supplier, contractor, or partner to a larger multinational firm.  But as the movement to combat graft surges internationally, Chinese firms face growing obstacles to partnering with increasingly wary multinational companies.

In societies such as China where bribery and corruption are regarded as business as usual, it is difficult for small and medium enterprises to tap into the wealth and opportunity for growth that these international value chains offer.  If they adopt the policies and codes of ethics required by foreign companies it can become difficult to remain competitive or even continue to keep the business open.  Just think about what would happen if a small business owner refused to bribe to local inspectors.

Even larger firms that are not necessarily looking to become part of global value chains have a stake in reducing corruption.  Any foreign company trading stocks and securities in the U.S. is subject to the accounting provisions of the FCPA (all U.S. firms, listed or not, must comply with the anti-bribery rules). Therefore, Chinese companies looking to expand and secure investment from overseas must comply with the same regulations as U.S. and Europe-based multinationals. As Chinese companies expand to become major players in global markets and end their reliance on low-value-added assembly factories, they will have to become more transparent and forsake practices such as gift giving and nepotism.

While president Xi has launched an anti-graft campaign within the Chinese Communist Party, the aims are geared mostly towards reducing social unrest and rebuilding the reputation of the party. So far, such efforts have been criticized as window dressing, with more rhetoric than actual reform.  These top-down efforts to punish officials who indulge in extravagance, while useful as a PR move, do very little to really combat corruption.

In order to truly clamp down on corruption and unleash the developmental power of business, China must undertake systemic reform to tackle corruption in both the public and private sector. Admonishing officials in an ad hoc manner for throwing expensive parties and buying sports cars does not address the root of the problem: weak rule of law. Until laws are enforced uniformly in a transparent and accountable manner, punishing both public and private sector participants when violations occur, corruption in China will remain a problem that restrains economic growth.

Frank Stroker is Assistant Program Officer for Global Programs at CIPE.

Originally posted at CIPE Development Blog