Case Study in China: Doing Business in an Authoritarian Society

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Quite possibly the most-discussed recent topic in world business dealings is the ascendancy of China to be a major player in global markets and one of the world’s largest exporters. Along with this phenomenon comes the question of why it has taken so long to occur. China has had a huge, educated, hardworking population for decades, as well as the natural resources to support an economic boom. The reason why China is only just now realizing its potential can be found writ small, as it were, in the case of the Wanxiang Group.

The Mao period of Communist China was a series of unmitigated disasters. The Chinese economy suffered not only from its fundamentally flawed underpinnings of Marxist doctrine (since proved by history to have been a failed philosophy) but also from the government’s irresistible tendency to meddle in matters large and small. Mao’s Great Leap Forward, actually a Great Stumble Backward, and the Cultural Revolution epitomized this. It often seemed that Party ideology trumped practical considerations and that human life was a mere commodity and a surplus one at that. As a result, the Chinese economy lurched and staggered through the first four decades following the 1949 communist victory. The few examples of private enterprise that were allowed, such as small private plots on communal farms, produced results that were proportionally far greater than those from massive state-run enterprises. Yet, the average Chinese citizen was wary. Government deceptions such as the Let a Hundred Flowers Bloom campaign showed citizens that privileges that were granted could be revoked at any time. The atmosphere was one of paranoia, corruption, and distrust.

Abrami, Kirby and McFarlan et al., in a case study performed at Harvard Business School, outlined the case study of Lu Guanqiu, who founded Wanxiang in just such a toxic atmosphere. The Great Leap Forward had just run its course. All businesses and all property belonged to the state; private enterprise was forbidden. All persons were theoretically guaranteed jobs, but Lu found himself unemployed when the state-owned steel plant where he worked laid him off. He then returned to his home village and tried to start a food processing plant, but he couldn’t get permission to do so since it would have been a private enterprise. This underscores one of the many, many inherent contradictions of the Chinese Maoist/communist state model. In freer societies, entrepreneurship is a natural response to a lack of employment. While the suppression of entrepreneurship by the Chinese government can perhaps be understood from an ideological standpoint, it made no sense when the government failed to provide a job for Lu and then prevented him from making a living on his own. Of course, Lu was only one of tens of millions of people who would have become entrepreneurs had they been allowed to do so (as shown by the number of Chinese who have done so since economic reforms were introduced). This was a horrible waste of human capital.

Lu, however, was determined. In 1969, he started up a farm-tool business with $500 in capital and six partners. His operation was legal because it operated in the context of a government-authorized commune; yet, the restrictions on the business because it was not a state-sponsored enterprise crippled operations. Wanxiang was restricted both from supplies of raw materials and access to markets in which to sell finished products. Lu survived by cadging raw materials from various quasi-legal sources, but he still lacked a market. Fortunately, a nearby state-run farm-tool company, after initially rejecting him, contracted with Lu to be a supplier because of the superior quality of his products. This gave Lu legitimacy in the eyes of the central government and he was granted access to markets that had been previously denied to him, thus ensuring the survival and success of his company.

There is a certain irony here, which underscores what was fundamentally wrong with the Chinese governmental and economic systems (and the two were basically inseparable). First and foremost, Lu and Wanxiang succeeded not by following government edicts but by circumventing them. He later secured a government contract not by bribing the proper official or by making the right friends (which had been the Chinese communist way) but rather, by personally marketing and demonstrating the quality of his products. In a novel approach, the state granted him and his company the job because they were the best for it. Lu had won out by being a superior entrepreneur, using what independence he had to create the best outcome for himself and his company.

In the 1970s, there were very few non-state-run business operations; Wanxiang, however, was one of them. Lu grew the business until it employed over 300 people. When China’s rulers allowed a number of limited economic reforms in 1979, Lu saw an opportunity to become a manufacturer of universal joints to serve the demand that would be created by the state-mandated increased manufacture of trucks. However, there was a major snag. The government decided to drastically reduce the number of universal joint manufacturers from fifty to three. Thus, due to government intervention, Lu was faced with entering a market that had just shrunk by over 90%. Nonetheless, Wanxiang obtained one of the three slots by manufacturing a superior product. Once again, Lu had succeeded despite what must have seemed like the concerted efforts of the government to stop him from doing so.

Lu, as an entrepreneur, recognized the fundamental flaws and failures of the Chinese economic system. In 1983, he pioneered a bargain with the government whereby in return for a greater degree of autonomy, he contracted to pay the local government a fixed annual sum. He then introduced a system whereby his employees would be paid based on performance rather than on state-mandated norms. These new approaches contained the first faint whiffs of private entrepreneurial capitalism and coincided with the very gradual easing of restrictions that had begun with the death of Mao in 1976. By 1985, Lu had tripled his company’s output, but he was still hobbled by one state-imposed shortage: a lack of human capital.

Since the first days of communism in China, people had not chosen their professions but rather, had been told by the state where and how they should work. Since Wanxiang was not a state-run enterprise, university graduates would not be steered by the government toward his business. There was, however, another pool of talent from which to draw: those who had been unable to get into state universities. The government didn’t care nearly as much about where such people worked. Lu knew that many people who had failed the extremely rigorous state university admission exams were nonetheless quite capable and talented. He grew his workforce by hiring such people. He still wanted to employ university graduates, however, and eventually struck a deal whereby he would essentially buy them from the government, paying a fee for each employee. Thus, Lu had circumvented the state control of human capital and essentially used bribery to get what he wanted.

The reforms of Deng Xiaoping further opened up the Chinese economy. By the time of Deng’s death in 1992, entrepreneurship was no longer a forbidden concept. The Chinese government had realized that with its continued adherence to the obsolete system of a state-run, centralized economy, China was falling further and further behind the rest of the world. Thus, a hybrid capitalist-style controlled economy was introduced. The government kept tight control over the people’s political and social life but essentially gave free rein to capitalism. In 1994, Lu made Wanxiang a private company and sold its shares on the Shenzhen Stock Exchange. However, the Communist Party remained a major influence; Party officials occupied many major positions in the company. This was and still is characteristic of Chinese hybrid capitalism, and contributes to the country’s ongoing problems of corruption, nepotism, and the fact that position is gained not by merit but through influence. Nonetheless, Lu and his company have prospered.

The past few years have seen Wanxiang become a global player in the auto parts market. The company’s market share has grown continually over the last two decades. Its entry into the US market, inspired by Lu’s visit to the US in 1985, was not without problems. Specifically, there were quality control issues. Lu opened up a US subsidiary partly in response to those concerns. It is interesting that a manufacturer originally based in China would feel that the best way to solve quality control issues at home was not to improve the quality of the domestically produced product but rather, to start from scratch in the US.

The experience of Lu and Wanxiang can be generalized to the Chinese economy as a whole. Those who succeeded in the Mao days were those who managed to circumvent the system in some way, as Lu did. Even a slight easing of economic control allowed entrepreneurs such as Lu to flourish, even as Party meddling continued to act as a brake on economic development. Now that China has, while continuing to keep a tight rein on other personal freedoms, at least allowed its citizens the freedom to make money, the Chinese economy and presence in the world marketplace have grown exponentially. Should the Chinese ruling class ever allow, in addition to Western-style innovations and capitalism, Western-style personal freedoms, rule of law, and pluralistic, democratic-style government, China would rule the world economically if not politically. Entrepreneur-driven companies such as Wanxiang would dominate their respective industries, much like Microsoft, Nokia, and similar businesses have worldwide.

Work Cited

Abrami, R., Kirby, W., McFarlan, F., Wong, K.C., and Manty, T. (2008). Wanxiang Group: A Chinese company’s global strategy. Harvard Business School. Web.