March 30, 2010
by John Lee
Detained since July 2009 in the midst of a high-stakes negotiation with the Chinese Iron and Steel Association, Anglo-Australian mining executive Stern Hu of Rio Tinto was sentenced to 10 years in prison on Monday for receiving bribes and stealing industrial secrets. Publicly, foreign companies will deny that the verdict indicates a deteriorating operational environment by reassuring shareholders that it is business as usual in China. After all, companies such as Rio Tinto can hardly afford to "do a Google" and contemplate pulling out of the Chinese market.
While Hu was sitting in the Shanghai No. 1 Intermediate People's Court last week, his chief executive, Tom Albanese, was in Beijing declaring, "Together with China, we can both continue to grow and prosper," on the back of an earlier announcement that Rio Tinto and Chinese state-owned company Chinalco had signed a $1.3 billion deal over a Guinea iron ore deposit.
Albanese is paid to be a pragmatist. But even he knows that the Chinese market entails unique risks. China's rise may well be the most spectacular one in history. But the romance of its rise is dying. If entering the Chinese market is still viewed as a matter of commercial necessity, it will no longer be seen as a market of choice for foreign companies. This is particularly the case for those businesses that deal with state-owned companies or sectors deemed vital to China's "national interests."
Only the willfully stubborn or ignorant will argue that Hu's admission of guilt on the charge of bribery means that concerns held about the Chinese economic legal and political environment arose out of Western hysteria or misunderstanding. Instead, a number of lessons are worth noting.
First, be very worried if any civil or legal disputes arise. Courts are explicitly under the authority of Chinese Communist Party (CCP) officials, and all decisions have to be approved by a committee of political officials. Ask any lawyer in China who has represented a private client against any serious civil or criminal charge brought by a state- or CCP-controlled organization and they will tell you that if the matter goes to court, the primary strategy is almost always about damages or sentence mitigation. One of Hu's lawyers, Duan Qi Hua, is known for using connections and developing effective face-saving strategies to minimize sentences for clients rather than a detailed knowledge of the Chinese criminal code. In this respect, Hu chose his lawyer wisely.
Likewise for high-profile cases, once the trial concludes, judges put as much thought into weighing the political ramifications for innocence or guilt and imposing a harsh or lenient sentence, as they do the legal merits of the case itself. After all, court decisions have to be explicitly ratified by a committee of CCP officials. In Hu's case, very high-ranking officials who answer directly to the Chinese Politburo will have been the ones who ultimately determined his sentence.
Second, whenever negotiations involve state-controlled entities (and this is almost always the case in China's state-dominated economy,) assume that one is ultimately dealing with the state. Even if Hu is actually guilty of receiving bribes, remember that he was initially detained by request of the Chinese Iron and Steel Association under the Secrets Act for espionage and stealing state secrets back in July 2009. The CISA--which is filled with political and intelligence officials--operates out of Chinese Premier Wen Jiabao's office and is the very same organization that was undertaking a high-stakes round of negotiation with Hu's team to determine iron-ore contract prices for the next 12 months. The CISA would have had to obtain the explicit permission from the Chinese Premier to activate the Secrets Act in this context in the first place.
A related point is that China is no longer communist, but neither is it capitalist or free market. The best way of understanding its political economy is to see it as a Leninist corporate state: The CCP is building up national champions such as Chinalco and reserving the most important sectors of the economy for these state champions in order to strengthen the economic and political standing of the Party. This is quite explicit in modern CCP doctrine, and the mindset and structure is messily replicated all the way down the layers of government. Local officials frequently climb CCP ranks on the back of state-owned enterprises (SOEs) that do well under their watch.
The implications for foreign businesses are significant. In China's state-dominated system--which largely resembles a messy mafia-style structure in which unaccountable CCP officials control much of the country's resources, access to markets, land and labor, in addition to influence over the police and courts--foreign companies need to tread carefully. For example, getting the better of negotiations with state-owned companies at any level will likely upset political interests, aspirations and expectations. In China's dog-eat-dog markets getting in bed with a local private company will often mean frustrating the ambitions of a state-owned competitor. This gives the notion of "negotiating political minefields" added meaning and makes forming a long-term strategy for the Chinese market impossible.
China is still developing, and Beijing still needs foreign companies--especially those with resources and technology--even though foreign companies are increasingly complaining about the deterioration of the operating environment and the increase in instances of R&D and technology theft by Chinese SOEs (intellectual property theft and illegal reverse engineering of patented hardware, for example). Will we see foreign companies resort to the Stern Hu precedent and bring criminal charges of stealing "industrial secrets" against Chinese SOEs? Not likely.
John Lee is a Hudson Institute Visiting Fellow and an Adjunct Associate Professor and Michael Hintze Fellow for Energy Security at the Centre for International Security Studies, Sydney University. He is the author of Will China Fail? (CIS, 2008).
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