Managing the Institutional Environment: Challenges for Foreign Firms in Post WTO China

Article excerpt

The impact of China's new membership in the World Trade Organization is much debated, but most agree that inflows of foreign direct investment will pick up. Foreign firms will have unprecedented access to geographic regions and economics sectors but must contend with China's general lack of codified laws, the regional diversity of "legal systems" and practices, and the absence of case precedents. A literature survey and in-depth interviews with business and legal experts in China make it clear that firms entering China must be fully aware of these challenges and quickly establish the personal connections and procedures needed to operate successfully.

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After nearly 15 years of negotiations, China was formally invited in 2001 to join the World Trade Organization (WTO). This capped an historic year that included the award of the 2008 Olympics to Beijing and the hosting of the Asia-Pacific Economic Cooperation (APEC) summit in Shanghai. Accession to the WTO offers many opportunities for China and multinational firms, as well as numerous challenges. With China agreeing to abide by global trade rules, barriers to foreign goods and services will shrink, and the door for foreign investment will be open more widely than ever before (Panitchpakdi and Clifford, 2001).

There are opposing views regarding the effects of China's WTO accession (Nolan, 2001a). On the one hand, foreign firms and labor unions worry about the ability of Chinese firms to dominate lower-end manufacturing similar to the way Japanese and Korean firms have in the past (Panitchpakdi and Clifford, 2001). While China's competitors fear its inexorable rise, China's firms worry about numerous, experienced, well-financed, technologically advanced foreign competitors that are almost certain to enter a wide range of Chinese markets and industrial sectors, many of which have been largely untouched by foreign competition (Nolan, 2001a; O'Neill, 2002).

Despite the divergent viewpoints most observers agree that an immediate result of WTO entry will be increased flows of foreign direct investment into China (Panitchpakdi and Clifford, 2001). The WTO agreement will also give foreign firms' more freedom to operate in a variety of industrial sectors and regions of the country (Nolan, 2001b). Restrictions on retailing and distribution will ease as foreign retail firms are able to set up wholly owned outlets; no longer will most goods sold have to be produced in China. Significant restrictions on distribution will be phased out over three years (Panitchpakdi and Clifford, 2001). In telecommunications, foreign players will be able to buy up to 50% of telecom carriers. A number of other regulations will be loosened, opening up a range of previously closed industries from banking to agriculture. In addition, the Chinese government is encouraging firms to locate in the country's more remote areas (Schievogt, 2001).

The cumulative effect of the relaxation of restrictions on foreign firms is that WTO will not only bring more foreign firms to China, but will offer them unprecedented access, particularly in industrial sectors and geographic regions that have seen few foreign enterprises of any kind. This has implications in a number of areas, but perhaps the most proximate is that China's accession to the WTO will increase the number of foreign firms entering China, which, in turn, will face problems issuing from China's underdeveloped institutional environment. This includes formal commercial laws and regulations, unwritten norms and practices, as well as common, taken-for-granted behaviors of firms and individuals (Boisot and Child, 1996; Scott, 1995, 2002).

Prior to WTO accession, foreign firms were compelled to enter China under strict guidelines and were limited to certain sectors. They typically chose to locate in the more developed coastal areas of the country where regulations were codified and commercial traditions well established (Scarborough, 1998). …