Los Angeles Times, April 6, 1994

COLUMN ONE

Networking Pays Off for Chinese

Emigrants are fueling their homeland's growth through guanxi, or `personal relationships

By KARL SCHOENBERGER, Times Staff Writer 

SHENZHEN, China -- A short walk up Jianshe Road from the train station in this booming frontier factory town reveals the timeless face of capitalism, as embraced unabashedly in the Shenzhen Special Economic Zone. 

In a Dickensian scene, prostitutes and filthy-faced urchins line the sidewalk by the Shangri-La, a shiny, marble-crusted, five-star hotel. Outside, a small boy hoists a seemingly lifeless infant on his shoulder and begs. Inside, sleek men in tailored suits mill about importantly in the lobby. 

The paradoxes of capitalism are nothing new to China, despite four decades of egalitarian Maospeak. Chinese civilization has long had its own brand of capitalism, some experts say, a force that spread its energy and its ethos across the Pacific Rim-and is now boomeranging back. 

Its essence, aside from the profit motive, is a way of doing business called guanxi-roughly translated as "personal relationships" or "connections"-that guides the ubiquitous networks of Chinese family entrepreneurs. 

Guanxi (pronounced "gwan-shi") also implies a moral code of sorts, offering an informal alternative to the legalistic trappings of Western capitalism-and prompting some observers to worry about its corrosive effects on the rule of law in the world's fastest-growing markets. 

The guanxi tradition flickered at home under Communist orthodoxy until it was rekindled a dozen years ago by Deng Xiaoping's economic reforms. China's industrial revolution started in test laboratories like Shenzhen, a special free trade zone across the border from Hong Kong. 

Abroad, the flame was nurtured passionately by the multitudes of the Chinese diaspora, the overseas progeny of an old tradition of economic migration and political asylum-seeking. 

Now, these wandering sons and daughters of Greater China-some 55 million strong-are bankrolling the dynamic economic development of their 1.2 billion cousins in the ancestral homeland, transcending national borders and political ideology. 

Countless small entrepreneurs-from Taiwan to Chinese enclaves in such places as Bangkok and Los Angeles-are proving that tiny is beautiful, and highly profitable. They have formed a spontaneous capillary system of investment, pumping tens of billions of dollars into small joint-venture factories and real estate projects, all the while penetrating deeper into the Chinese mainland. 

By most accounts, their stake in China's economy dwarfs that of the celebrated Chinese tycoons of Hong Kong or the giant multinationals from Japan and the United States. 

Experts say these networks of small investors are thriving, despite the high risks of doing business in China, because they are nimble on their feet, they speak Chinese-and they have good guanxi. 

"They're like guerrilla troops," said S. Gordon Redding, author of "The Spirit of Chinese Capitalism" and a business professor at the University of Hong Kong. "These enterprises are designed for the jungle, not for the parade ground." 

Guanxi also can be a euphemism for bribery-or, to put a positive face on it, incentive payments to trusted contacts in local governments, all in the name of expediency. 

The line between culturally correct and seemingly corrupt often is impossible to draw. But these methods are ideally suited to doing business in developing China, where the legal system is primitive and peevish bureaucrats are easily bought. Smart business deals aren't cemented by paper contracts that can't be enforced, the theory goes, but by informal relationships of trust and mutual obligation. 

Many overseas Chinese entrepreneurs have considerable experience in this gray ethical area, having for years conducted business across an unstable jigsaw puzzle of Third World legal systems and political regimes. Ethnic Chinese families and their enterprises have been repressed in Indonesia and Malaysia, for instance, and tightly regulated by authoritarian Singapore. 

"The continued vitality of overseas Chinese owes a lot to their dependence on personal relationships," said Wong Siu-Lun, a sociologist at the University of Hong Kong. "Partly, it's a way to resist interference by the state. If they build up big corporations and hierarchies, they can be easy targets." 

Indeed, entrepreneurs in Nationalist Taiwan were controlled by a military police state until 1987. Even today, the bulk of their estimated $10 billion to $20 billion cumulative investment in the mainland is underground, typically channeled through shell companies in Hong Kong and still technically illegal under Taiwan law. 

Personal networking is not unique to Chinese entrepreneurs; it's the bread and butter for small-business people in any culture. But to many Chinese, guanxi takes on a special intensity in their Confucian ethos, where family values of obligation are paramount. 

Some of the practices aren't easily understood by a legalistic mind. 

"We don't bribe people in China, but giving them gifts is a matter of generating good feelings," said Wong Mau-Hung, a Taiwan native who has lived in Japan and Hong Kong for 30 years. Wong is investing heavily in mainland real estate development, using personal connections he acquired over the years as a tour operator. 

"China is a very poor place. If somebody needs a television or a car, we might give it to him. But it's for the development of the nation," Wong explained. 

"To me, it's a matter of profit-sharing," said Steve Tii-Ren Shaw, 32, a native Taiwanese educated at Cal State Long Beach. Shaw worked for a plastics firm in Toronto and is involved in opening a machinery plant in Shenzhen. 

"I just want these things done smoothly, so I give them a consulting fee or a service commission," Shaw said. "I'll save money in the long run by getting things done on time. It all goes into the guy's pocket, so I have to trust him." 

A recent study commissioned by the Hong Kong government suggests that local businesses investing in China typically spend 3% to 5% of operating expenses on "gifts and guanxi." But the study concluded that "such costs are as yet bearable and are not viewed by Hong Kong investors as an economic disincentive." 

Other sources say the guanxi margin is closer to 10% and recently has caused consternation as it rises as high as 20%. 

General discomfort over such practices makes many Westerners wary about investing in China-especially Americans, who are constrained from making questionable payments by the U.S. Foreign Corrupt Practices Act. 

British authorities in Hong Kong are also concerned, because Chinese practices appear to be contaminating the colony's own business climate. The trend threatens to undermine the British legal legacy as Beijing increasingly asserts its influence in advance of the colony's return to Chinese sovereignty in 1997. 

Reports of corruption in Hong Kong's private sector increased 52% in 1993, said Michael J. Bishop, assistant director of operations at the Independent Commission Against Corruption. 

"We're absolutely mystified" about the rise, Bishop said. "But you also have Hong Kong businessmen who are corrupt and exploiting people on the Chinese side of the border. I suppose you could call it a cross-pollination of corruption." 

The long-term viability of Hong Kong as an honest broker in the China trade is a critical point in the contentious debate over its future. One camp is boosterish. But the doubters are gloomy-especially in light of Beijing's vitriolic attacks on Gov. Chris Patten's attempts at eleventh-hour democratic reforms. 

"The problem is, after 1997 can you bring in $500 million into Hong Kong and trust it will be protected by the rule of law, or will you have to depend on the guanxi system?" asked a veteran American China-watcher in Taiwan. "That guy in the little white wig is no longer going to be sitting there." 

But Redding, the Hong Kong University business professor, argues that the fuss over questionable payments in business transactions "betrays a deep-seated misunderstanding of alternative moral values." 

Chinese entrepreneurs build such payments into their cost structure, Redding said, just as Westerners anticipate burdensome legal fees. "To me, it's preferable to paying lawyers, and the lawyer is the functional equivalent to this kind of middleman," Redding said. "I'd argue that paying lawyers is worse, because they control an insider's racket." 

Lee Chung-Ying, Taiwan's administrative vice minister of finance, is similarly nonchalant about payoffs in the Chinese business culture. 

"Americans don't bribe government officials, so they don't get any favors" in China, Lee said. "But Hong Kong and Taiwan people understand guanxi is very important when it comes to getting a permit or a supply of raw materials at the local level." 

It's an open question whether Western firms can tap successfully into Chinese business networks, taking on partners who will spare them the inefficiencies of official channels, erratic regulations and meaningless credit checks. 

A skilled purveyor of guanxi supposedly can find the right decision-maker to influence, much like an accomplished lobbyist in Washington. But establishing a genuine relationship of trust with the right Chinese middleman is critical. 

"Within a circle where the trust is implicit, they keep their word," Redding said. "If you're an insider, you can trust. If you're an outsider, they'll screw you blind." 

There are also drawbacks to relying on an agent who sees the world though his lens of personal contacts, arbitrary relationships and friends of friends, some veteran China investors warn. 

"When Japanese companies invest in China, we don't use overseas Chinese partners, because they always take us to their old friends," said Kazuhiko Otake, general manager of the Industrial Bank of Japan. "It's far more efficient to stay away from those narrow, limited channels." 

Despite the limitations, guanxi's obligations can be coldly calculating-not necessarily sticky and emotional like the nepotism that festers in many Asian societies. 

"In a small Chinese business, it's the owner who's taking all the risks when he uses his guanxi," said Wellington Chan, a history professor at Occidental College who studies business networking. "He'd drop off his first cousin like a stone if he thought he was going to hurt his business." 

As a result, it's the little guys who are cleaning up in China, investment bankers say, not the large, lumbering foreign corporations that are slow in making decisions. Although they face high risks, small entrepreneurs are reportedly taking home 70% to 90% returns on equity with their investments. 

Reliable information about the profitability of such networkers is extremely difficult to obtain, however. These aren't publicly listed companies. The bookkeeping is typically spread across borders, split between sub-family units and channeled through evanescent ghost corporations. So-called transfer pricing-which hides profits from tax authorities-is the name of the game, inside and outside China. 

"It's difficult to pin down who is doing what," said Li-Pei Wu, chairman of General Bank, which serves the Chinese community in Los Angeles. "They don't want people to know. There are tax considerations. When you have so many companies operating, you can manipulate which ones make money." 

Frankie Leung, a Los Angeles lawyer and prolific author of advice on doing business in China, sees a collusive mind-set in the Chinese business networks. 

"The Chinese don't like to talk about networking. It's like they're a sect," Leung said. "They don't like to be intellectually analyzed. When you describe it, the mystique value is lost. They think their practices can be learned and used to attack them." 

Clannishness among the guanxi capitalists might be attributable to the fact that many, indeed, do business through their clans. But geographic links are considered even more important. 

A preponderance of Taiwanese investment in China, for example, is believed to be routed surreptitiously through Hong Kong banks to Fujian province, just across the Taiwan Strait, to which the vast majority of Taiwan's 21 million people trace their roots. 

With rising labor costs at home, small manufacturers have been in a frenzy to relocate their plants on the mainland. 

But the risks can be high. Joey Peng, a former Los Angeles resident who runs a trading company in Taipei, said he and his brother lost $2 million on a joint-venture factory making computer disk drives in Hanzhou, China. Peng is networking aggressively, hoping to make a comeback. 

All networks don't necessarily lead to China. Taiwanese investors have swarmed into Southeast Asia in search of cheap labor, using guanxi with ethnic Chinese partners from Indonesia to Indochina who often speak a common dialect. 

The trend is encouraged by the Taipei government, which hopes to derive diplomatic advantage from its $85-billion cache of foreign exchange reserves. Taiwan holds the largest foreign investment stake in Vietnam and rivals Japan in other key markets. 

In the reverse flow, ethnic Chinese in Southeast Asia are pumping capital toward the Chinese heartland. Mainland entrepreneurs, having secretly stashed billions of dollars from trading profits in overseas banks, are bringing home hard currency under the guise of foreign investment, experts say. 

Most often, the guanxi spreads widely through expanding concentric circles of mutual friends and sometimes rather distant acquaintances. So long as there is a web of interlocking entanglement, enough trust can be maintained to conduct business with confidence. 

At its most refined stage, Chinese networking is a speculative game, where contacts are made and gifts or favors exchanged without any immediate expectations. Someday, the thinking goes, there might be a benefit. 

Shane I-Feng Wang, a real estate developer based in Monterey Park, is one entrepreneur who thinks that way. 

Wang, whose father was a high-level official in the Nationalist government that retreated to Taiwan in 1949, said he recently entertained the son of Chinese Premier Li Peng in Los Angeles. 

The son of the Communist and the son of the Nationalist did not discuss business or politics, Wang said. But it was a promising guanxi for the future. 

Last year, Wang invested nearly $5 million in a joint-venture commercial real estate development in northeast China's Jilin province, he said. 

Wang reverently displayed drawers and shelves packed with business cards-the most important guanxi in a set of special binders-and boasted of having more than 30,000 contacts in Los Angeles alone. 

"I spend money to take care of people when they come to L.A., not for any purpose. I don't expect anything in return," he said. "But when I go to China, they introduce me to people they know. In many cases, this becomes very useful for business." 

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