How to Think about China: A Guide for Boards
For boards, China operations are about strategy, but also core values.
Most every multinational company has a connection to China, whether in the form of supply chains, investment or economic and geopolitical risk.
Following China’s entry into the World Trade Organization in 2001, China became a central node in many supply chains and an increasingly important consumer market. For the international business community, the watchwords when it came to China were “openness” and “interdependence.” But the same breakneck growth that made China an economic powerhouse over the past few decades also planted the seeds of geopolitical rivalry with the United States and other countries, imposed major environmental and social costs and exacerbated long-standing human rights issues. For corporate boards and directors, thinking about China has become much more complicated and multidimensional. China strategy is no longer just about the bottom line, but also about core values.
I come to these issues as a researcher, not an executive. But I had the business community in mind when I wrote my latest book, China’s Next Act: How Sustainability and Technology Are Reshaping China’s Rise and the World’s Future. What I learned is that China’s future is defined by sustainability issues on one hand and emerging technologies on the other. Both trends have major implications for foreign businesses, and they are on the front lines of major China-linked challenges like climate change, surveillance and supply chain resilience. Based on my research, I have identified some major China-related issues that boards must contend with and how decision-makers can address them. These issues include whether to exit or diversify away from the China market and how to reduce exposure to China-related geopolitical risk.
But before diving in on these profound questions, it’s worth revisiting how and why we moved from an era of openness and interdependence to rivalry and risk when it comes to China – and why the current environment is likely to persist for the foreseeable future.
China’s decades-long, export-led growth story is one of the most dramatic in economic history. But even the best stories have endings, and, in China’s case, annual GDP growth began to fall after 2010. That led some economists, and some of China’s leaders, to fear the country was entering the dreaded middle-income trap, in which previously fast-growing, developing economies start to stagnate. Escaping this trap requires innovation, productivity growth and, often, painful and fundamental institutional reforms. Yet there was an even deeper reason the prospect of the middle-income trap caused palpitations in Beijing: in modern history, only a few countries have crossed from middle- to high-income status without becoming significantly more democratic.
For China’s leaders, this new chapter in the country’s epic growth story meant three things. First, it had to completely transform the economy from one dependent on resource-intensive, low-value-added, export-led manufacturing to one that looked much like that of richer countries: dominated by services, investment and innovation. To do that, China had to leapfrog its competitor countries by developing and deploying advanced technologies, from electric vehicles to artificial intelligence. Second, Beijing had to drive this transformation without ceding political control, which according to Chinese Communist Party dogma would only serve to plunge the country into chaos. Third, while China would continue to rely on foreign trade, investment and exchange, an important goal would be to become more self-sufficient in all fields and sectors.
This fateful strategy of economic transformation, combined with political control and an inward turn, planted the seeds of China’s growing confrontation with liberal democracies. It helps to explain why Beijing would undertake ambitious commitments to tackle climate change by deploying clean technologies while also becoming a world leader in artificial intelligence – all while becoming more politically authoritarian, more economically protectionist and more ideologically nationalistic. By the late 2010s, it was clear that, even as the world faced shared challenges in the form of an accelerating climate crisis and the COVID-19 pandemic, China was growing more repressive at home and more belligerent abroad.
New Horizons for Boards
The fact that China has become indispensable to tackling global challenges and deploying advanced technologies, and also a more problematic player on the world stage, has created new challenges for boards. The most immediate of these is the growing risk of conflict between the United States and China, especially over Taiwan. This once-unimaginable scenario would devastate the global economy and have severe effects on Taiwan-linked supply chains, most notably advanced semiconductors. In such a scenario, U.S.-based companies with substantial operations in mainland China would be vulnerable to sanctions, mass boycotts and even nationalization.
While a Taiwan conflict ranks among the highest-impact scenarios that boards must now contemplate, they must also address issues of higher likelihood. One is the growing prominence of sustainability issues. The combination of more ambitious environmental policies and growing consumer awareness of sustainability issues means that foreign companies will come under increasing pressure to minimize the environmental impact both of their direct China operations and their wider supply chains. Sustainability commitments will need to be as or more ambitious in mainland China as in other markets. At the same time, these commitments may erode the profitability of China operations, especially if coupled with significantly increased compliance costs.
Meanwhile, Beijing’s investments in advanced technology have three implications for business. One is a greater focus on ethical issues. This is particularly marked for companies that produce equipment or systems that can be used for surveillance: several U.S. companies have already been accused of indirectly contributing to human rights abuses in Xinjiang. A second implication pertains to data. As part of its drive to make China’s economy higher-tech, but also more amenable to state control, Beijing has put forward stringent data security and privacy rules that restrict firms’ ability to export data and intellectual property outside China.
A third and, in many ways, contrasting implication concerns human capital: While in most fields the most advanced technology continues to be grown in developed-country markets, Chinese researchers and firms are catching up fast. Without China-based research and development operations, foreign firms may lose out on access to a globally important innovation ecosystem. This concern is especially significant given the fact that the pandemic, immigration restrictions and political tensions promise to reduce the number of highly skilled Chinese willing to live and study abroad.
Contending with China-Related Risks
There are no easy answers for foreign firms when it comes to China, especially decisions concerning the scale and footprint of China operations. Staying and growing their China operations exposes them to greater political and ethical risk, especially in the likely event that U.S.-China relations continue to deteriorate and Beijing’s human rights abuses intensify. But, on the other hand, leaving means potentially losing access to an important market, human capital base and other resources. So, how should boards think about weighing these China-related tradeoffs?
The first step is to maximize the use of no-regrets strategies. The supply chain and production location diversification strategies that many multinational firms have been pursuing for years, largely in response to cost issues, make even more sense in light of growing political risk. Similarly, sustainability is a global phenomenon and should cause boards to push executives to articulate global, firm-wide visions and strategies that apply both to the China market and elsewhere.
Boards should also ensure executive teams understand how dependent future business growth is on access to individual consumer data, China-generated intellectual property and applied research and development. The more a given company’s growth strategy depends on any of these inputs, the more important it will be to remain in the China market. There is one sector where this is especially important: biotechnology. But even for other sectors, China will be an important player at the intersection of data, analytics and life sciences.
Third, it is critical that companies’ China strategies be led by a well-articulated set of core values. Developments within China, as well as growing attention placed on human rights abuses in places like Xinjiang by the civil society sector, mean that it is increasingly difficult – and irresponsible – for foreign companies not to consider ethical and moral issues with respect to their China operations. Having a solid set of core values is important to address not just human rights concerns, but also sustainability and technology-related ethical issues.
The global business community must also find their voice on contentious as well as commercial considerations related to China. Part of this effort will involve traditional government affairs and public relations work. But given how contentious China-related issues have become in countries like the United States, and the wariness with which many foreign firms are viewed in Beijing, advocacy is best pursued through global, sectoral organizations and forums. Globalizing China-related issues has the advantage of lowering the political temperature and mediating political risk while helping the international business community speak with one voice and be more effective advocates for priority areas like climate change.
The hard truth is that China is likely to present more and more difficult challenges for boards for the foreseeable future. Foreign businesses will have to think differently about China in a future marked by emerging issues in sustainability and technology.
Scott M. Moore, Ph.D, is director of China programs and strategic initiatives at the University of Pennsylvania.