Posts of the Week: 4/20/09 - 4/26/09

Beware foreign bluster about tapping the Chinese consumer at dragonbeat
Missed this post (and blog) earlier. Important topic, especially in the face of the recent McKinsey report, and all the talk surrounding it.

Quality Control Basics, Part 4/4: Putting It All Together at China Sourcing Blog
I've enjoyed this series. Thank you!

China v. United States: A Visual Comparison at Mint.com

Chinese Drywall Cases. Show Me The Money! at China Law Blog
Don't take a contingency fee on this litigation...

Wanna Get Sued In China? Your Ex-Employees Can Help at China Law Blog
Plus, Part II.

Who Says Tax Incentives in China Are Dead?

Well . . . Maybe not that China . . .

In a push to better compete with China's ports and to reverse the declining volume in Taiwan's ports, the Council for Economic Planning and Development of Taiwan is proposing significant tax incentives to foreign companies that establish logistics and distribution centers in Taiwan.

The proposed incentives are:

1. business income tax exemption on exports;
2. business income tax exemption on domestic sales limited to 10% of total revenue;
3. faster customs clearance; and
4. lower domestic employment requirements.

Establishing your HQ in Taiwan could lead to even bigger tax incentives.

I can't help but question the scope of impact of this proposed legislation. I think the global impact will be limited. But with the recent opening of direct transportation between Taiwan and mainland China, these incentives could have a significant impact on businesses focusing on regional distribution and logistics between Taiwan and the mainland.

Posts of the Week: 4/13 - 4/19

Bets on China Growth: Slow at China Journal
A list of estimates of China's first quarter GDP growth. We can see who won when Beijing releases the first half stats.

Tradeshow and News Round-up at Silk Road International
Take a look at David's notes on the Chinese economy.

Working With Chinese and Korean Lawyers. The Big Four Issues With Each at China Law Blog
My bosses have had foreign JDs which I think did a lot to diminish or eradicate these issues.

A Couple of Posts on the new McKinsey Report on the emergence of a wide class of wealthy consumers in China
At China Business Blog
At China Solved
I read the report, and the main I thing I got out of it is that is a superficial (not in the pejorative sense) guide to consumer behavior and how to begin crafting advertising campaigns to have an optimal impact on your target consumer group. For the real deal they're offering their services at Insights China.

Lessons from a 16th Century Italian Salesman in China

The salesman is Matteo Ricci, a Jesuit missionary. Born in Macerata, Italy, trained in Rome, and under the patronage of Portugal, he traveled on mission first to Goa, India in 1578, and on to Macau in 1582. From 1583 until his death in 1610 he traveled back and forth across China. During this time he came under the patronage of the Emperor Wanli, and allowed free access to the Forbidden City. I just finished reading Jonathan Spence's innovative biography of Ricci, The Memory Palace of Matteo Ricci, and there are plenty of lessons to learn on doing business in China from Ricci's efforts in selling Catholicism to China.

Marketing Techniques Need to Be Adapted to the Local Market
Catholicism can be a difficult sell to a civilization with a trinity of its own (Confucianism, Daoism, Buddhism). To get the bodies into his spiritual store, Ricci desired to train the sons of the wealthy and powerful in the Memory Palace technique (or Method of Loci) to help them pass their government exams. Ricci was not entirely successful in this endeavor because the Chinese had plenty of mnemonic devices already specifically tailored for the exams.

But Ricci's own use of the Memory Palace drew audiences to him because they were convinced that it was evidence of his skill as a masterful alchemist, and that the Jesuits themselves were powerful alchemists. Silver was valuable in China at the time, and the Jesuits seemed to always have endless supplies of silver which they traded for silk and mercury. The silk was from Portugal's silk monopoly with Japan where silver was in abundant supply. The mercury piqued Chinese interest much more than silk, though, because in all civilizations mercury was suspected of having alchemical properties. Turns out the mercury was being used to treat ore to amalgate out pure silver in Portugal, Spain, and the New World, which was then shipped back for trade in China.

Technology Sells as Well in the 16th Century as It Does Today
So Ricci had the appearance of magic on his side, but he also brought Chinese into his spiritual store and eventually to conversion with technology and science, specifically imported maps, mathematics, and clocks.

The Portuguese were the greatest sailors in the world at this time, and their maps matched their prowess at sail. This was impressive to many Chinese which by this time were not trading on the seas, and even viewed the coast as dangerous due to the prevalence of Japanese piracy in China in the 16th century. Ricci had maps commissioned with all of the place names translated into Chinese. These maps brought many into the fold.

Ricci, with the help of Chinese disiciples, produced the first Chinese translation of Euclid's Elements. This brought a theoretical understanding of geometry and astronomy to China that had been lacking. Additionally, Thomas Aquinas had viewed mathematics as an "admirable topic of study," and the Church endorsed this view.

Clock making, from large clocks on the wall to clocks that could be worn around the neck, was flourishing in Europe. China had a strong history of clock-making, but the skills had disappeared in 1127 with the Northern Song. Ricci used the clocks to gain favor with many an official.

Recognize the Importance of Chinese Technology
Ricci was not blind to all that was going on around him, and he noticed that the Chinese had profound scientific knowledge in astronomy. The knowledge was observational, not based on theory grounded in geometry, but it surpassed astronomical observation and prediction in the West.

Just Because It's a Developing Nation Does Not Mean the Chinese Are Not Perceptive
When Ricci traveled he brought with him gifts for eunuchs and powerful bureaucrats, clocks, art, and the like. When he first arrived in Beijing, all of the foreign guests were forced to stay in one particular boarding house. The other guests brought gifts, but they were of an inferior quality, such as sick horses. Ricci not only quickly moved out of the boarding house, but he also eventually had his own house.

Don't Be Afraid to Make Mistakes & Learn Chinese Culture
When he first arrived, Ricci thought that he should dress like a Buddhist monk because they are the holy men of China. After he learned their status in society, he quickly changed tact and dressed as a Mandarin, bearded and in the most expensive clothes he could afford.

Ricci also learned the language fluently. It took him 10 years before he was confident enough to write in Chinese for general consumption, but this time paid off.

Conclusions
Ricci was fairly successful in converting Chinese to Catholicism. It might not be Catholicism as we tend to think of it. He had a hard time convincing beyond the notion that the Virgin Mary was not his God, but he was almost executed after a eunuch took offense at his cross.

The style of the book is not for everyone, but it teaches a lot about 16th century China, Portugal and world trade. Plus, it has a few universal lessons that are even helpful today.

I Predict No Rise in "Bad" News About China for the Next 3 Months

A few weeks ago, George Mason University economists Carlos Ramirez and Rong Rong gave us a handy tool, available free of charge at SSRN, for predicting the US news cycle on bad stuff that China does, China Bashing: Does Trade Drive the 'Bad' News About China in the US?

The authors found that there is a 95 to 99 percent chance that US-China trade deficit shocks lead to a sharp rise in bad news about China reported in the US. The authors' index is based on the number of news items filed in Dow Jones Factiva per month between January of 1990 and December of 2008 containing "China," and one or more of the following five indicators of bad news: "human rights," "Tibet," "child labor," "democracy," and "repression."

The data shows that bad news about China is a lot less proportionally frequent and less volatile than it was before December 2001:

A glance at the figure reveals that the index is very volatile, especially during the early part of the period, but the volatility declines significantly starting when China joins the World Trade Organization (WTO) in December 2001. This decline in volatility makes intuitive sense. Before China joined the WTO, the United States periodically extended Most Favored Nation (MFN) status to China, but shortly before each extension was approved, one or more of the grievance keywords invariably gained prominence in the media as Congress debated the renewal.

There has been a shock to the US-China trade deficit, but it is no traditional shock. Rather, the latest trade data shows a continued narrowing of the deficit. According to Ramirez and Rong's research, we shouldn't be seeing any large proportionate uptick in bad news in China as a result. There might be no news like bad news, but dang, I hope they're right. Their data is good.

Posts of the Week: 4/6 - 4/12

Guess What's NOT in China's Auto Policy at ChinaBizGov
My first instinct was a sarcastic response along the lines of, "a design budget," but the real answer is something we should start expecting more and more of. The laws have been pushing this pay, and it looks like their will be harmonization with policy.

Quality Control Basics, Part 3/4: When to Inspect at China Sourcing Blog
I don't know anything about any of this stuff, and it is always good to learn.

The Anti-Monopoly Law: Taking the Fight to China Mobile at CER
Good for lawyer Zhou! Let's see how "nationalism-infused shenanigans" look when applied to domestic behemoths.

China Business. Which Comes First The Wealth or The Low End? at China Law Blog
Below is a comment I posted over there (plus a story that I just couldn't help but to add):

What concerns me is that the contributions of the Western company would be negligible in most cases, and any Chinese manager good enough to run your low end in China should probably be an entrepreneur (or might leave soon enough to start his/her own business). The staff and management would have to be wholly Chinese. Any Westerner on staff would be dead weight because they'd command too high of a salary while not being able to understand the low end market (at least as well as a Chinese manager for a comparable salary). The only real contribution the Western company could make is cash and a TM, and in limited cases a patent. All significant, but the banks are being encouraged to lend, low end economically exploitable patents I presume are rarer, and the use of your mark might dilute your quality in the eyes of the consumers (Buick, anybody?).

In the face of naysayers like me it is helpful to remember the words of businessmen. Before Tesco entered the largest market in the world with Fresh&Easy, they conducted years of research on their target country's eating habits, developed superior logistics lines, and imported their unique computer software which tracks and responds to customer purchasing habits unlike anything else in the country. The CEO said that it only cost $1 or $2 billion, and if they fail they can easily afford it. So, maybe it's time a Western company gave it a whirl.

Last year in Munich I was sitting in a pub on St. Patty's day having a beer, and I started talking to the gentleman sitting next to me, distinguished looking, well-coiffed, nice suit. I asked him what he did and he said that he was designing a customer tracking and response system for a German company. The details sounded similar to the one at Tesco, and I asked him about that. He said that he had actually designed the system for Tesco. Then I asked him about Tesco's CEO's words on the American market. Ashen would be an appropriate adjective to describe the color his face turned. Lesson: brazen words about $1 or $2 billion bets stay fresh in the mind, and they don't go down easy when the bet doesn't pan out.

DTT on Government Innovation

This afternoon, I eagerly e-opened an e-book that appeared in my RSS feed from DTT on government innovation, The Public Innovator's Playbook: Nurturing Bold Ideas in Government. In an age when fiscal policy is expanding tremendously in an effort to stimulate the private sector, I thought it would be nice to learn how the government could nurture innovation. Additionally, the CCP always seems to be trying to find some way to foster innovation in China, and I thought there might be something in the book relevant to China.

A few paragraphs into the book it was clear that the topic was not about the government fostering innovation that would spread to the marketplace, but how to nurture innovation within government departments to develop novel approaches for solving governance problems. The topic proved interesting, the reading proved easy, and I had a few hours to kill before corporate taxation.

The part that proved most interesting to me was how the government could successfully develop new ideas in the "suffocating grip of bureaucracy." Here is how the book frames the question:

Bureaucratic structures developed to enforce compliance with rules and procedures can kill budding ideas because innovations often require challenging the status quo or questioning long-held assumptions that may have worked well in the past. Without loosening the sometimes suffocating grip of bureaucracy over the more creative employees, it will be difficult to motivate them to innovate. This means dismantling or bypassing structures and systems that ensure conformity and stifle creativity, and building new structures that encourage fresh thinking.

The answer is to use safe havens. There are three examples of safe havens:

• Pilot Programs. Pilot programs allow "employees the time to develop emerging ideas and protects them from short-term budget constraints and premature criticism."
• Skunk Works. "Skunk works are composed of a small group of highly talented and motivated people who are freed from bureaucracy, paper work, and most routine administrative responsibilities." Many of us are familiar with the original private sector Skunk Works. And, the book also points to the Manhattan Project as a sort of skunk works on steroids.
• Intrapreneurs. "A person within a large corporation who takes direct responsibility for turning an idea into a profitable finished product through assertive risk-taking and innovation." Examples include Google and 3M, where employees are allowed to spend almost 20% of their time developing business ideas. An example in the government includes the creating of self-supporting business units within the US Forest Service used to deliver services to forest managers.

How Does China Stack Up?
China stacks up pretty well. If you remember from my post on the Central Party School (CPS), one of the CPS functions is as a skunk works, and the CCP then tests several of the ideas generated in pilot programs across the country. Intrapreneurship seems to be a lot less common.

The book directly discusses China twice, and both are presented as positive examples of innovation within the government. The first example is an early success that China had in replicating bold ideas in government from village to village:

Replicating an idea from one locality to another local context also requires managing stakeholders who want to preserve the status quo. In 1978, in response to Deng Xiaoping’s new aphorism “to get rich is glorious,” several local cadres in a small village in east China secretly got together to split farming land across households and privatize the right to use and derive profit from it. When they learned what the farmers were doing, however, party leaders objected. Deng intervened, prevailing on the party leadership to legalize and approve the
initiative, actively promote the replication of the model, and accept the replacement of people’s communes by village governments. The results of this experiment were documented and paved the way for the Household Production Responsibility System. By 1984 this family-based model covered 99 percent of Chinese villages; agricultural output increased by 8.2 percent annually from 1980 to 1985, with half of the increase attributed to growth in productivity.

The other example of success in China was in making the government an attractive place to work, a problem that has not been solved in the US where prospective employees who want a career in public service prefer NPOs to the government:

Mobility across jobs, projects, and teams stimulates commitment from employees. The Chinese government provides considerable flexibility to new recruits in selecting jobs that match their career plans and needs. It invests in improving competencies within its young talent pool through training and even temporary leadership positions in public agencies.

I guess the other half of the G2 might have something to learn from China.

Posts of the Week: 3/30 - 4/5

China Combats Tax Treaty Abuse at China Law Update

China Implements Measures To Combat Tax Evasion at asiatax blog

Info On China's Public Database of Judgment Debtors
At Chinese L aw Prof Blog
At China Law Blog

Quality Control Basics, Part 2/4: The Acceptance Quality Limit at China Sourcing Blog

Coke, Huiyan and the audiences that matter at Imagethief

China has the harshest tax regime in Asia: Forbes at asiatax blog

Turns Out China is NOT Losing Its Competitive Edge in Manufacturing

But the recently released 2008-2009 China Manufacturing Competitiveness Study by Booz Allen Hamilton and AmCham China (that link is just to the order page) as summarized by Knowledge@Wharton finds that manufacturers in China are facing new obstacles to success. It seems like it was just a year ago when the net abounded with cries of the demise of China, and the Pearl River Delta in particular, as a manufacturing hub. Factories were shutting down and moving to Vietnam, India, Thailand, and Malaysia in the face of RMB appreciation, inflation, tougher labor laws, higher wages, and lower government incentives. The details revealed that this was true, but only for low value added manufacturers. A lot has happened in the past year, and this year's edition of the study reveals new challenges faced by manufacturers. What follows is a summary of K@W's summary.

What has changed for the worse from last year:

• Exports are down, sharply.
  
• Domestic sales are down.
• Credit markets are tight. Not as much in China as in the countries abroad that order manufactured goods from China.
• Currency fluctuations, but not the RMB which has remained stable against the dollar, but other currencies. Additionally, there is fear that the RMB will resume appreciation against the dollar because of inflationary pressures in the US.

What has changed for the better, from a China and Pearl River Delta manufacturing standpoint:

• "Fewer companies are planning to move, either within the country or overseeas." Not necessarily a good thing, though. Some respondents said that they're not moving because they can no longer afford to move, while others said that they're not moving because they want to focus on the domestic market.
• Commodity prices are way down.
• Wages are not rising the way they were a year ago. Unfortunately, this is due to increasing unemployment.

Conclusion of the report:

The only companies likely to survive the new conditions are those that are efficient in their manufacturing practices, and that market their goods both inside China and overseas.

So Long Banking Anonymity . . .

. . . It's been good to know ya.

It looks like the G20 Summit will put the final nails in the coffin of anonymous banking in sensible jurisdictions such as Switzerland, Luxembourg, Barbados, and the likes. That's a shame. I've noticed that when people start discussing these jurisdictions they start to confuse tax havens and anonymous banking, and the purposes that each serve.

The bourgeoisie seem to be a popular target right now, and tax havens tend to be associated with organized crime, privileges of the extremely wealthy, and philandering husbands hiding assets from their suspicious spouses. Sure, these things happen, but tax havens and anonymous banking serve important functions. I'm going to run through the purposes of tax havens and anonymous banking, and then I'm going to link to a couple of summaries on recent developments in China regarding the use of tax havens.

Tax Havens

What is the difference between a taxidermist and a tax collector? The taxidermist only takes your skin. - Mark Twain

The other day I was on the phone with an old friend and he started fuming about tax havens and corporate fat cats. I changed the subject. I like to gesticulate when describing the purpose of tax havens, and that is difficult over the phone. It is also difficult over the internet, but here we have the benefit of charts:


Tax havens are an integral part of facilitating investments with investors from more than one country. The above is an example for a real estate fund from one of my courses. In the above example the holding companies at the bottom buying and selling real estate in their various jurisdictions are subject to income tax on their gains in those jurisdictions. This money then goes to the Cayman Fund where tax will be minimal to non-existent. A return on investment is then distributed to the feeder funds which are typically pass through entities where income tax will be paid by the individual investors. This results in two layers of tax: one for the government where the property is bought and sold, and one government where the money ends up. If the Cayman Fund was setup in a non-tax haven jurisdiction, then the investors would be subject to a third level of income taxation for the government where that fund is formed.

Tax havens don't avoid tax. Taxes are still being paid on the income, and they're being paid in the jurisdictions where the money is being made, and where the investors reside. The haven merely allows a neutral place for the investors to pool their cash for investments around the world without being needlessly taxed. A lot less harmful than we're typically led to believe.

Banning tax havens would be a nice punitive measure against making money, but I can't think of any reason of fairness for why a third level of tax should be levied because it would be a third tax on the exact same income. The third level of tax might even discourage some international investments form taking place. That would be bad because it would slow the velocity of the spread of wealth around the world. And tax havens are good because they facilitate international investment with tax on the income being paid in the most appropriate jurisdictions

Banking Anonymity

I've got nothing to hide. - Anonymous

The other day, one of my professors was railing against the demise of banking anonymity. I was discussing this with a friend, and I admitted that I was confused about the benefits of banking anonymity. He sent me a link to the second most downloaded paper from SSRN--a paper that was printed in the San Diego Law Review as part of a symposium on privacy, 'I've Got Nothing to Hide' and Other Misunderstandings About Privacy by Daniel Solove. Here's a gem from the paper:

As one comment to my blog post noted: "If you have nothing to hide, then that quite literally means you are willing to let me photograph you naked? And I get full rights to that photograph--so I can show it to your neighbors?"

The paper never explicitly discusses banking anonymity. Instead, the author presents his Taxonomy of Privacy, and he argues that privacy is not just an individual right, but has value to society. The main social benefits of privacy are that it prevents the "chilling of socially beneficial behavior (for example, free speech and association," and it prevents "power imbalances that adversely affect social structure (for example, excessive executive power)." As privacy decreases more intrusive regulations limit the kinds of decisions people can make about their lives. Solove argues that privacy regulations are not about balancing individual rights against the social problems that privacy can cause, but balancing the social pros and cons that privacy brings to society.

In finance, limitations have an adverse effect on entrepreneurship. Though there are many bad things that banking anonymity facilitates, these must be balanced against the entrepreneurial creativity that anonymity affords. A simple form of the balancing test is whether making it more difficult for criminals to launder money is worth the price of chilling entrepreneurial activity?

As for adverse imbalances of power, it might help to look back on the origins of banking anonymity laws. From the Straits Times and the asiatax blog:

European politicians conveniently forget the origins of offshore financial centres. Switzerland - by far the biggest in this business - offered international banking services for centuries. And the Swiss thrived not by attracting money from crooks but, rather, by earning the confidence of law-abiding individuals.

At a time when the rest of Europe was constantly embroiled in warfare and when private property was frequently nationalised or just stolen, the Swiss remained an oasis of stability, a place where one’s assets were secure.

The current Swiss bank secrecy legislation was enacted during the 1930s, in order to prevent agents of Nazi Germany from snooping on people.

Yes folks, the slippery slope is just THAT slippery.

Developments in China
In just about every income tax treaty that China has, the PRC retains the option to disregard the application of the treaty if the terms of the treaty are being abused. In a blog post at Sheppard Mullin's China Law Update, the author discusses a recent decision on tax treaty abuse which was subsequently endorsed by the State Administration of Taxation in Notice No. 1076 of 2008. Here are the conclusions offered by the author:

China will now focus on the purpose or motive for a commercial transaction in order to combat tax treaty abuse. Foreign investors should pay careful attention to commercial arrangements that might be considered a mere attempt to avoid, reduce, or delay tax. In order to prove a valid purpose, foreign investors should be prepared to demonstrate, with appropriate documentation, the economic substance of companies located in jurisdictions with which China has entered into tax treaties.

At asiatax blog, the author discusses the implications of Tax Notice 81 of 2009. This tax notice has to do with the application of special withholding taxes on dividends for special purpose vehicles located in the tax havens of Singapore, Hong Kong, Mauritius, Barbados, and Ireland. Here is the author's summary of the notice's rule:

The tax authorities are now empowered to scrutinise not just the form but also the substance of the ownership structures of SPVs to satisfy themselves that the investors have bona fide residence in the tax havens and that the SPVs are not merely established for the purpose of avoiding tax or remitting funds out of China.