In 2003, research on drafting a Labor Contract Law began. In February 2005, it was announced that the Peoples Republic of China’s Labor Contract Law would be included in future legislation plans. In October 2005, the State Council, in principle, passed a draft Labor Contract Law. In December 2005, the draft was submitted to the Standing Law Committee of the National People’s Congress for review. In January 2006, the committee had the first review and discussion of the draft proposal. On March 20, 2006, the draft Labor Contract Law proposal was made public for the purpose of collecting opinions and comments. More than 190,000 proposals were received. There were many conflicts. Because of these proposals, the committee did extensive surveys all over China. The draft law was subsequently revised four times. Finally, the PRC Labor Contract Law was adopted at the 28th Session of the Standing Committee of the 10th National People´s Congress on June 29, 2007. The law became effective from January 1, 2008 and the implementing regulations of Labor Contract Law became effective from September 18, 2008.

This law has had an immediate impact on foreign and domestic companies in China and will influence business decisions for a long time to come. Many scholars in China have studied the law and evaluated its influence. Scholars have compared the draft version with the final version, from which they saw a shift from “double protection for the employer and employee” to “single protection only for the employee.” At the time when the Labor Contract Law was put into effect, the business community voiced their concern that the law would drastically raise the cost of doing business in China.

In December 2007, before the new law became effective, the HuaWie Company found a loophole. They canceled all current contracts with employees and asked them to sign new contracts. In effect, this would skirt the new Labor Contract Law provision giving long term employees permanent employee status. The company complained that the new law returned China to a socialist planning economy. This marked the beginning of a wave of dodging the new law. At the same time, the economist Zhang Wuchang argued: “The new law threatens to destroy the booming economy since the reform.” He said that the result of the new law would be a decline in the demand for employment, and a tremendous rise in unemployment. Prof. Wang Yijiang proposed that medium and small enterprises should be exempted from the Labor Contract Law. Many law scholars, such as Shanghai Professor Dong Baohua, claim that the new law will raise overall labor standards, and that its strict restrictions on dismissing employees will prevent businesses from integrating and optimizing human resources. He also predicted that the law would be ignored to the extent that it would be of no practical use. He claimed that this law was just for show and could not be enforced because local governments want to protect their business.

However, on the other side, the legislative agency of the new law and other scholars supporting the “single protection only for employee” system insisted that as the law came into effect, China’s labor market would see a long-term labor relationship that would be stable and harmonious and that the demands of employers would not be badly affected by the new law. China’s Deputy Minister of Human Resources and Social Services, Sun Baoshu, in a statement released by the China News Agency on March 9, 2008 said: “Whether to amend the new contract law or not is not a question. The question right now is how to enforce this new law effectively.”

Today, we are still at the stage of learning and publicizing the new law. Systematic theoretical and practical research needs to be done on changes in labor demand and other business reactions to the new law.

Comments on China’s New Labor Law: A View from Foreign Business

Mr. Ira Phillips has been working in China for nine years. Based on his experience of starting and managing companies there, Mr. Phillips successfully analyzed some of the real time issues that the new Labor Contract Law raises.

I agree with his opinion that China is too big to use only one inflexible means to do business in first- second- and third-tier cities. As a result, more and more foreign companies will have to confront the problem of uneven interpretations of laws and regulations. I think foreign companies would do well to follow his advice to employ local lawyers and to build a strong relationship with local officials, all of which are very important for their businesses.

In his article, Mr. Phillips mentions some businesses have characterized the effect of this new law as a return to the “iron rice bowl”, or a socialist system, where state-owned companies were responsible for all aspects of employees for their entire life. Here, I think, we could have a deep discussion on the meaning of the “iron rice bowl.” In fact, the market-oriented reforms of China’s economy have come a long way and have produced better outcomes in recent years. It is impossible for Chinese people to go back to the “iron rice bowl” years, which had been proved ineffective.

Regarding Mr. Phillips’s example of Zhang Yin, I would like to add some information that wasn’t included. During the period when the draft Labor Contract Law was made public for the purpose of collecting opinions, most employers in China were not aware of the new laws. They seldom paid much attention to these issues because they were able to successfully ignore previous laws due to poor implementation. Only when the new law took effect did businesses begin to recognize the importance of the Labor Contract Law and start to take actions against it. This shows there is a long way to go to build up the labor market law systems of China. Public awareness as well as enforcement of the new law needs to be improved.

Comments on China’s New Labor Contract Law: An Indian Perspective

Professor Suresh accurately grasps the spirit of China’s Labor Contract Law and makes a reasonable case that the law is a landmark piece of legislation towards achieving better labor standards in China. Based on his comparison between China and India, Professor Suresh proposes that India should not adopt a similar law because such a law would, in effect, legalize casual and flexible employment practices. This would not be a useful alternative for India’s otherwise ineffective labor laws.

About the enactment of China’s new labor law, most scholars like Professor Suresh understand the Chinese reality and think the enactment of the present Labor Contract Law cannot miss the fact that it was formulated under intense societal pressure. However, here I would like to emphasize the fact that the enactment will help all Chinese workers to benefit from the reforms and share the outcomes of 30 years of reform policies. At the same time, the enactment can also guarantee that salaries will be raised and work conditions improved with the productivity of labor increasing quickly because of large investments of human capital over the past thirty years.

About the contract itself, I agree with Professor Suresh who thinks any employment requires a written contract that must contain details concerning remuneration, job description, working hours, and social insurance among other issues. However, facing the serious realities currently in China, only 20 percent of private companies sign contracts with their employees. I think the first thing is to help a majority of workers get a written contract. Then we can discuss the next step of the contents of the contract.

Concerning collective bargaining and trade unions, most scholars have the same opinion that a potentially important provision provided in the new law is the recognition of the concept of collective bargaining. The labor union has been assigned to execute the collective contract on behalf of the employees. However, Professor Suresh recognizes that there are two prevailing factors that will make collective bargaining different from that in developed countries. I think Professor Suresh is right. If we consider that China has its own political system, it is obvious that China will build up a Chinese style collective bargaining system. Finally, I would like to point out a misunderstanding in his article concerning the Beijing Workers Autonomous Union (BWAU). Professor Suresh stated BWAU is representing the workers. However, BWAU is actually not a real union as we often think of since it is forbidden by China and as a result can’t represent the workers.

The post The Evolution of Labor Contract Law and Comments on Two Papers appeared first on China Research Center.

Before examining the new law and its possible implications for firms and workers, it would be useful to recall the background of its origin. Toward the late 1990s there was an intensifying trend of worker strikes and protest demonstrations across China. The contentions between workers and enterprise managers were centered on issues such as arbitrary layoffs, low wages, payment arrears, employment insecurity, managerial high-handedness and denial of social security entitlements. The workers’ complaints reflected their growing anxieties about the shrinkage of livelihood rights in post-reform China. It is also widely known and well documented that Chinese workers, especially in the export-oriented manufacturing sectors in the coastal economic zones, are often subjected to a range of severe labor conditions including long working hours, low wages, pressure for overtime, shop floor violence and extremely poor living conditions in the work dormitories.

In the absence of any legal right to organize or collectively bargain, Chinese workers confronted serious challenges in securing a minimum living standard in the new market economy. The official All-China Federation of Trade Unions (ACFTU), the monopoly labor union in the country, has been assigned to promote the objectives of the reforms and therefore most often finds itself on the management side of worker-management conflicts. Local governments are more concerned with attracting investments into their region, often by promoting a labor-cost advantage, than with working to improve the lives of workers. Given these official propensities to favor investment capital, attending to worker complaints was not a high priority for local governments or their labor bureaus. Under these situations, growing worker discontent broke into open conflict with firms and local government, at times developing into low-intensity social unrest in many cities. This seems to have forced the Chinese government to acknowledge the seriousness of the problem and formulate effective institutional responses.

The New Labor Law

The new law is designed to remove some of the grievous anomalies in the existing labor contract system that evolved in the reform era. Prior to its enactment, most firms enjoyed nearly unbounded powers in determining the terms, tenure and time of termination of workers. The 1994 labor law did not have any specific provisions for making the terms of employment a binding contract. Therefore, to achieve cost advantages, most firms, both local and foreign, employed workers for shorter and more convenient periods just to complete their production requirements. This created an extremely flexible labor regime in which workers were repeatedly hired and fired, and in that process denied any claim over employment security and other benefits.

The new law has clear provisions to regulate labor contracts by making them binding on both firms and workers and explicitly setting forth rights, obligations and liabilities. The most important provision is that firms must conclude a written contract with workers; it lays down that only a written contract can establish a labor relationship. The law implies that the earlier practice of informal employment, in which workers were inducted into the production process without registering them and recording their work and remuneration cannot continue. Henceforth, employment requires a written contract that must contain details concerning remuneration, job description, working hours, and social insurance, among other things. This provision is a very significant step toward achieving minimum labor standards in China as it provides basic safeguards against labor violations arising from a lack of regulation.

At the same time, the government has recognized the varying labor requirements of companies and has provided scope for flexible employment. This has been achieved by delineating the limit and scope of specific labor needs as having separate categories of contract employment, with different claims and entitlements. The law has provided for three types of labor contracts: fixed-term contracts for limited tenure, non-fixed-term contracts for longer and unspecified periods, and a project-based contract for short-term employment.

This categorization of contract employment into three distinctive types recognizes the existing labor-market segmentation, which in turn will give ample institutional leverage for companies. Furthermore, it reflects a careful approach that avoids any strong legal claim for employment security and permits enterprises to determine the strength of their workforce based on competitive concerns. By insisting on a written contract, the new law attempts to provide protections against violations and abuses that were widespread under the earlier system. In that sense it is only a limited intervention.

As such, the new law does not encourage labor market rigidities as has been argued by some foreign firms and industry associations. The legislative intent is limited to removing some of the gross anomalies in the earlier system. For instance, Article 9 by implication forbids companies from collecting residential identification cards or other papers from laborers as collateral when hiring. This will free both migrant and local workers from involuntary attachment to companies that have in the past sometimes used their most important legal documents as bargaining chips.

For employees who have been working in a company for many years, the new law extends certain legal protections. Article 14a stipulates that a laborer who has been working in a company for a consecutive period of 10 years is entitled to a non-fixed-term contract. This type of labor contract ensures relative employment security as it does not stipulate a termination date. The same is also applicable to those workers who are less than 10 years away from the statutory retirement age.

It appears that there has been a general weakening of China’s public institutions in recent years. In the context of accelerating reforms and rapid economic growth this has been particularly the case with the country’s regulatory institutions. On the one hand, there has been a deliberate policy orientation to facilitate speedy investments and transactions. But on the other hand, effective regulation has become elusive in a range of areas. Many companies found they could easily circumvent or flout existing administrative (guidelines and even clear rules) with little interference from the local authorities. The provision for a written contract in the new law also faces the same challenge. In an apparent attempt to make this provision foolproof, the law stipulates that if a firm fails to sign a written contract within one year from the time of hiring, the unit will be deemed to have already signed a non-fixed-term contract with the laborer. The clarity of this clause and the prospect of penalty implied here may become effective deterrents to those firms who will still try informal employment.

Among the contentious issues that provoked labor protests in the past were layoffs and arbitrary reduction of the workforce. The new law has addressed this question by prescribing certain guidelines. The government seems to have taken into account circumstances that make it necessary for the firm to reduce existing work force and render a labor contract non-performable. Enterprises that are in difficulties such as bankruptcy-related restructuring or changes in production scales can lay off 20 persons or more under Article 41. Here it seems that the law is more sensitive to the competitive concerns of the firms as it quietly endorses management prerogatives by conceding the need for staff reduction owing to “adjustments of managerial operation style.” By defining the circumstances of workforce reduction in the broadest possible range which include, in addition to the above, “major changes in the objective economic circumstances,” the government has conceded a great deal of autonomy to the firms and investors. An enterprise can lay off a significant number of workers whenever it deems necessary by taking refuge in Article 41.

During the public debate on the draft law it was strongly argued by labor activists and the ACFTU that such staff reductions must require prior agreement by the company’s union. However, this demand did not make it to the final text, which contains a prescription that firms shall explain only the circumstances to their union and report the staff reduction plan to the labor administration department. This suggests that neither the trade union nor the local labor bureau has any meaningful say in firm-level staff reductions and layoffs. Here again we see that the Chinese government has given substantive leverage to management and investors in strategizing their workforce deployment.

A potentially important provision provided in the new law is recognition of the concept of collective bargaining. Chapter 5 incorporates a special provision for collective contracts between enterprises and employees reached after negotiations. Labor unions are assigned to execute collective contracts on behalf of the employees. The potential scope of this provision will be steeply curtailed by two prevailing factors. First, China does not recognize any independent labor union, and in recent years all the initiatives to form independent labor unions have been nipped in the bud. The All-China Federation, even though it is the only official union, does not enjoy any meaningful organizational autonomy and is strictly subordinated to the Communist Party’s overall policy framework. Therefore, a significant section of the Chinese workforce is much less sure that the Federation can genuinely represent worker interests. Second, labor unions are not allowed in the majority of the foreign firms. In recent years allegations of widespread labor abuse at firms with leading global brands and their contracting suppliers have come into sharp focus. There is a growing sensitivity toward this issue. Without independent labor unions, the idea of collective bargaining will have only notional relevance. To have any practical consequences, the government must recognize independent unions and allow them in foreign-owned firms.

An Indian Perspective

From an Indian perspective, three key points concerning the Indian case may well be useful for understanding the contrasting scenarios prevailing in the two countries. First, India’s labor laws are a collection of specific statutes enacted over half a century that concern separate areas such as industrial disputes, minimum wages, labor contracts, social security and so on. Since the legislative matters pertaining to labor involve power sharing between central and state governments, great variation exists in labor standards across states in India. These labor laws are applied mainly in what is called the formal or organized sector, the bulk of which is composed of state-owned enterprises and public institutions. However, they cover only a small fraction (around 7%) of the total labor force in the country. While employees in state-owned institutions and formal sector industries are covered under the protective regulations, and therefore enjoy relative employment security, better wages and other social security benefits, laborers in the unorganized sector do not receive any protection at all. Well over 90% of the estimated 406 million workers in India do not get even the statutory minimum wages provided by legislation let alone other benefits. Why India failed to secure minimum protection for its vast laboring masses – notwithstanding progressive legislation, trade unions and a democratic polity – is an extremely confounding question.

Secondly, for all practical purposes, it is extremely difficult for an ordinary worker in India to access the institutions of labor protection. One of the main reasons for this general exclusion of workers from the institutions of labor is the excessive legalism in the working of the labor laws. This is again complicated by time-consuming procedures involving a multitude of administrative and legal offices. An attempt to seek justice can push an Indian laborer into a labyrinth of administrative and legal procedures that cannot be settled in a short time. The reality is that the Indian justice system is just not affordable for poor litigants.

Thirdly, in marked contrast with China, India has not introduced a single new piece of legislation on labor since the country started economic reforms in 1991. Even though all earlier labor laws are in force, the reforms have introduced, and of late increased, flexible employment even in organized sectors. In order to accelerate reforms and attract more investment, the government has weakened the existing machinery of labor regulations such as the office of the labor inspectorate. In addition, post-reform India is witnessing a trend of competitive federalism where state governments are competing with each other for investment and opportunities for industrialization by projecting the existing low wage rate as a comparative advantage.

China’s new labor contract law, when viewed from the Indian experience, offers far greater scope in ensuring better labor standards. Although it serves to reinforce the imperatives of the new market economy by legalizing flexible labor regimes, it tries to extend minimum protective coverage to all workers, including the migrant laborers. This seems to be the real strength of this new law – that irrespective of the nature of employment every worker is entitled to a minimum wage and social security benefits. For India the inclusive nature of the Chinese law presents a vitally important lesson. As indicated above, the vast majority of India’s laborers are practically excluded from the purview of existing law. The main reason for this situation is the absence of a clear law that provides comprehensive coverage to all workers. The existing laws are too fragmented, focused on separate categories of workers such as permanent employees, contract workers, apprentices, and the like. A national law applicable to all enterprises (including state-owned enterprises, private businesses, and foreign firms as is the case with China’s new law) would be more effective as a legal instrument. China’s new law would be the latest instance of the country’s transition to a unified national legal framework that will progressively replace the earlier administrative regulations and laws concerning labor.

Some provisions in the new law are designed to remove the sources of the unfair labor practices by firms rather than targeting them when they occur, as in the case of the Indian labor laws. For instance, Article 19 stipulates periods of probation according to the length of a contract. It also prescribes that an enterprise may stipulate only one probation for any given worker. This can preempt the creation of dual labor markets within firms as practiced by some large companies in India. For example, the Hyundai Motor plant in Chennai and some leading automobile components suppliers in the region have a disproportionately large segment of short-term workers. They are employed as probation workers, apprentices, contract workers and so on for many years at drastically reduced wages.

For India, however, adopting a similar law, which in effect would legalize casual and flexible employment, would not be a useful alternative. China’s reforms have come a long way and have produced better outcomes both in terms of poverty reduction as well as employment creation and increasing income. India has a long way to go in achieving similar social and economic transformations. Therefore, labor reforms in India cannot begin with the same market economy imperative that guides the Chinese labor law.

The post China’s New Labor Contract Law: An Indian Perspective appeared first on China Research Center.

The current crisis may directly or indirectly create economic problems for China, but China will not reverse direction and move away from opening doors to the outside. However, the current global financial crisis strengthens the Chinese government’s belief that China’s growth strategy will need to change.

China cannot rely solely on exports as a growth engine. China has to adjust its economic structure and start looking inward for sustained growth. President Hu Jintao has outlined a new, balanced growth strategy that stresses stimulating domestic demand as a center piece for the economy’s future development.

Many academic scholars view this as a wise move. But research shows that household consumption as a share of total economic activity has actually decreased as reforms deepened (Qi and Prime 2008 ¹ ). This poses serious challenges to the new growth plan.

However, Beijing is determined to experiment with and develop policies to “pull up domestic demand” (ladong neixu).

This refers not only to increasing investment demand, which has been the main force driving China’s economy, but also to expanding household consumption. The lack of a well-established social security and insurance system has led Chinese households, especially urban households, to hold large amount of savings in banks. Rural households largely depend on land and offspring for financial security. Collective management of social security and insurance is highly desirable to free Chinese households from precautionary savings.

Education is another main spending item for Chinese households. A large proportion of precautionary savings is for children’s education particularly for low-income rural households. The Chinese government in recent years has allocated a large amount of funds to fulfill a goal of providing nine years of free, obligatory education goal for all children. To ensure the successful implementation of this program, the central government made great efforts to earmark fiscal transfers from upper level to lower level government units.

Additionally, a floor is being placed under the social security system to ensure that low-income households meet minimum consumption and living standards.

Policies aimed at “pulling up domestic demand” go much further than the above-mentioned expenditure-oriented measures. The government has begun some critical institutional reforms that will fundamentally change the economic structure. One of the policies is to allow rural farmers to transfer their land use rights in the market. This is largely consistent with the ongoing rapid urbanization process and will substantially enhance land allocation efficiency. With more free choices to rural households in allocating economic resources, income levels and living standards are expected to rise.

Fiscal system reform is also under consideration to nurture a more dynamic microeconomic environment. In fact, the current global financial crisis may speed up some specific reform steps. In particular, favorable tax and fiscal policies being considered to help small-and-medium enterprises aim to provide more sales outlets in the domestic market. In the long term, all these institutional changes should greatly help boost domestic demand and domestic market development.

There will be many adjustments along with way. To many Chinese people, “sub-prime” is a new and unfamiliar word. Indeed, the financial products offered to Chinese consumers are much more limited and conservative than those available in the U.S. For example, all Chinese consumers we talked to were surprised to discover that U.S. consumers can borrow to finance a 20% down payment to purchase a house. “Here, the 30% down payment is non-negotiable. We never dreamt that we can buy a house without saving up for a 30% down payment,” said Hu Wei, who is considering purchasing an apartment near the 5th ring road in Beijing.

Merchants in the export sector have already felt the shock of the global economic downturn, although many are still trying to understand what sub-prime is and are baffled by how quickly Wall Street has tumbled.

Yiwu, a city that was unknown to the Chinese people and the world not long ago, is now the frontier of China’s light-industry export sector. Business has been slowing since January. “We are getting fewer orders from foreign buyers stationed at Yiwu,” says Jing Zheng, who regularly goes to the Yiwu International Commodities Fair. This downturn is felt by thousands of enterprises, which are reluctantly adjusting their production plans and inventory. Further, some are concerned that the economic recession in the U.S. will boost the anti-free trade movement.

The newest business data confirm the concerns of these enterprises. Yiwu’s exports to the U.S. dropped by nearly 5% in the first quarter of this year, the first decline since the start of the Yiwu International Commodity Fair in 2002.²

The banking sector also worries even though assets generally have not been lost. Thanks to the still rather tight control of international capital movements, most Chinese banks do not hold a large amount of securities and assets that have been battered by the U.S. financial crisis. China holds a large amount of U.S. Treasury bills and does not want to see a weakening dollar. Still, China is not likely to dump U.S. Treasury Bonds in the short or medium term because the economy is highly dependent on foreign trade.

The Chinese banking industry welcomes U.S. government’s rescue plan but is concerned about more indirect losses. Cutting interest rates may help boost demand for loans but may shrink bank profit margins. A banking official we talked to also pointed out that many enterprises will have to delay plans to go public in the U.S. market as this is a bad time for IPOs. This no doubt will restrain many Chinese firms from raising capital in the international market.

The post The Financial Crisis and China’s Future Growth appeared first on China Research Center.

The new labor law was enacted in response to increasing public concern that employers were mistreating employees. Low wages, non-existent benefits, lack of contracts and poor working conditions are among the issues that workers have been dealing with. This law fits into the central government’s current “balanced development strategy” to build a “harmonious society” that tries to tip the scales toward hard-working people and to lessen reasons for unrest.

While improving workers’ rights is a positive and needed step, some have characterized the effect of this new law as a return to the “iron rice bowl,” where state-owned companies were responsible for all aspects of employees for their entire lifes. Only now, it is all companies that would have these responsibilities, and would bear the associated costs.

The new law has several important components with perhaps one of the most important being all employees must have a contract within one month of being hired. This has created severe problems for exporting companies that rely on seasonal orders and therefore have used temporary employees. They kept their costs low because they did not have to provide social benefits such as health insurance and retirement contributions. Many companies—both Chinese and foreign—are relocating to other Asian countries where the labor laws are less strict. Under the new law employees can only be fired for cause, and not for downsizing or other business reasons. Once an employee has a contract they have many options open to them to air a grievance, such as contacting the labor department, labor tribunals, or through grievance mechanisms.

As with most laws in China, the labor statute was promulgated without sufficient guidelines for implementation. Therefore, implementation and enforcement are left to local labor bureaus where interpretation varies from province to province, city to city, and desk to desk within the local labor bureau. However, to help ensure that the law is enforced, the central government has new guidelines for punishment of officials who do not properly enforce the law. The effect has been immediate. There have already been strikes triggered by employers trying to lay off or outsource workers. Also, foreign companies are usually held to a much higher compliance with the law than their domestic counterparts.

Even powerful people have been unable to push through changes in the law. Zhang Yin, one of the richest women in China, attempted to get the government to amend the law to exempt companies from having to sign permanent contracts with employees with 10 years service. China’s Deputy Minister of Labor and Social Services, Sun Baoshu, in a statement released by the China News Agency on March 9th said, “Whether to amend the new contract law or not is not a question. The question right now is how to enforce this new law effectively.” If one of the most powerful and wealthy women in China with access to its national political advisory body – the Chinese People’s Political Consultative Conference – was unable to get the new law amended, this sends a strong message that the law is intended to be enforce, at least for the near term.

Another problem with the law is how it relates to other statutes. For example, an employee of a foreign owned company based in Shanghai accidently hurt his back during his time off. The company continued to pay his salary for fifteen months, but finally reached an agreement with the employee that his employment contract was terminated since he was unable to work. The employer and employee signed a termination contract saying that the employee had been sufficiently compensated and it was approved by the Labor Bureau. However, the employee then went to the court system in his home town of Wuxi and filed a lawsuit against the company for a half million RMB ($56,561). The local court accepted the lawsuit, and the outcome is pending.

Shanghai, Beijing, and a hand full of other cities are more advanced in transparent interpretation of laws. However, second and third-tier cities still present major problems for foreign companies. The American Chamber of Commerce in Shanghai’s AmCham Shanghai 2007 China Business Report, page 20, lists the top five business challenges in second and third-tier cities as: bureaucracy, inconsistent regulatory interpretation, lack of transparency, management-level human resources constraints, and unclear regulations. Second and third-tier cities are now offering more incentives and government support to attract foreign firms than the first-tier cities that have significant industrial development. As a result, more and more foreign companies have begun doing business in these cities and will confront the problem of uneven interpretations of laws and regulations.

There are two avenues to counteract the problem of inconsistent interpretation of laws. First and most obvious is to have local lawyers prepare all labor contracts and make them long and very detailed because they understand what language will meet the needs of the labor bureau, which will help keep the employer out of difficulty. The second and perhaps the most effective method to avoid the potential of long and uncertain legal battles is to build strong relationships with local officials. Large companies such as GM seldom have these issues for two reasons. First, they set a good corporate example by obeying the laws, and second, they have built strong relationships with top officials such as the mayor of Shanghai and district governor of Pudong.

Attraction, retention, and motivation of high quality employees have been major problems for several years and continue to grow larger as work experience is gained and demand increases. Foreign companies are constantly raiding other companies’ “top talent.” This issue is addressed in Article 22 of the new Labor Law. The article basically makes workers who breach employment contracts liable to pay compensation to employers who offer funds for training beyond that required by state regulations. However, if an employee leaves the firm after being trained, getting the agreement enforced and compensation paid is nearly impossible.

The new law is also explicit on penalties for not having a new labor contract with employees in place effective January 2008. Fines can be up to three times the employee’s salary times the number of years of employment.

Employee representation on boards of directors is another of the many requirements of the Labor Law. Companies must select an employee to represent the employees on their boards. This person is non-voting and the purpose is to report to the employees and the government on the actions of the board.

The following is an example of how local governments enforce laws. We were setting up a new company in an east coast province. When registering the company the local government told us we had to add one person to our listed board members as the union representative of the employees. Because we were in the initial start-up process we did not have employees to meet this requirement and informed the government. They said. “No problem!” (This is a common phrase one will encounter when doing business in China.) “Just put (one of our partners) on the board and designate her as the employee representative.” They said that she qualified because she was Chinese and an employee. We were happy with this outcome because we did not have to appoint an employee with no business experience, and apparently the government was satisfied as well.

The foregoing example demonstrates the importance of extra care in setting up a business now that the new Labor Law is in force. Understanding how to operate a business in China is key. Being extra careful in the set-up phase of a business in China is well worth the time and effort. The new Labor Law does need not be a deterrent.

The post China’s New Labor Law: A View from Foreign Business appeared first on China Research Center.

In 1980, as Chinese reforms were just getting under way, the country’s gross national income amounted to 9% of the figure reported by the United States. Last year, China’s GNI had climbed to 51% of the U.S. level. China has been growing at stunning, double-digit rates for years, capturing headlines for achievements in trade, investment, and most recently, the 2008 Olympics. As China exports 30% more than it imports and the U.S. is a top trading partner, trade friction with U.S. has also become a major issue. Clearly, the world is paying attention to China as it develops into a multi-faceted economy with strong growth coming from various sectors — service, manufacturing, tourism, banking and finance and trade, coupled with substantial infrastructural projects.

The world is also paying attention to China in connection with the global financial crisis triggered by the housing and sub-prime meltdown in the U.S. I believe China is in a position to help the West alleviate the impact of the crisis. China’s currency should remain stable. Chinese banks have limited exposure to sub-prime instruments as they rely more on traditional deposits to fund assets. Exports will surely be affected by any global slowdown, but the impact for China may not be as severe as some may think. China should be able to maintain 8%-9% growth, and the crisis may even offer China opportunities to invest in the West and help ease the crisis.

China’s economy is changing. For the first time, the service sector accounted for about 50% of China’s GDP in 2007. This trend is to expected to continue due to increasing domestic consumption and China’s progress in moving up the value-added chain. Since the early 2000s, China has been moving its manufacturing to utilize cheaper labor in Southeast Asia (especially Vietnam). In addition, China is changing the world’s major trading blocs as the Asian pie is growing at close to double digit rates. Case in point, China-India trade was less than $5 billion ten years ago and in 2007, two-way India-China trade was over $30 billion. The same can be said for Latin and South America where trade with China has taken off since the early 2000s. China’s trade with Africa and Middle East has also seen noticeable growth. Simply said, the 19^th and 20^th century trading blocs made up of the US/Europe/Japan is shifting in favor of China-led Asia/US/EU/Middle East and Africa/Latin America.

For Chinese companies to survive in their domestic markets, they must go abroad to set up offices and manufacturing plants closer to their customers. This strategy can add to profitability given the cutthroat price competition in the domestic market. Brand awareness created from overseas operations can help increase domestic sales. Obtaining financing overseas makes it easier to obtain funding domestically. Operating abroad makes it easier for the Chinese companies to tap into financing in the West and to improve managerial and human resources skills, branding and marketing. Chinese companies are already major investors in Africa, Middle East, and Latin America.

Though the Chinese government has been controlling its overheated economy in 2007 and 2008 via tight monetary policy, authorities are facing up to many different challenges, including the sub-prime crisis and a related reduction of confidence in Chinese stock markets. The Shanghai Index dropped about 65% from its high in October of 2007 to its recent level of 2,000. As the private sector continues to grow, and as the regions seek to develop their own local economies, policy makers in Beijing are likely to find it harder to control the economy, particular with the limited policy tools that are available. In 2008, China is experiencing greater volatility in the economy. The Sichuan earthquake and the flood in the southern region have contributed to higher inflation and to a smaller extent, a drag on the economy. Beijing’s current policy focus is on curbing inflation (currently growing at over 8%) and maintaining financial stability. While the pace of the local currency appreciation is likely to be of secondary importance, a stronger currency is likely to support the authorities’ overall aims.

Recent Developments in the Chinese Banking Sector

In line with this broader economic context, ten years ago there was no Asian bank representation among the world’s top ten largest banks. Who would have thought that in May of 2008, Industrial and Construction Bank of China would become the largest bank in the world in market capitalization of $278 billion! As a matter of fact, as of May 2008, three of the top five banks were Chinese (the others being China Construction Bank as #2 and the Bank of China as #4).

China’s banking sector has made significant progress since the launch of economic reforms and “opening up” in 1980. Generally speaking, the planned reforms and restructuring of the banking industry has been well under way for the past several years. Some of the more profound changes include: significant strengthening of banking supervision, ownership diversification, corporate governance reform, and a consistent and vigorous focus on risk management and internal controls. The “opening up” policy has already benefited the overall vitality of the banking sector with an accelerated pace of reform and improved global competitiveness. Total banking sector assets exceeded $6.5 billion as of the end of 2007. Other key statistics are as follows:

*There are 14 joint stock commercial banks and 114 city commercial banks.

*There are three policy banks owned by the government to support various industries; this role is no longer played by the main banks.

*China’s big five banks (ICBC, Bank of China, China Construction Bank, China Agriculture Bank and the Bank of Communications) accounted for about 57% of total banking system assets.

*Non-performing loans have been reduced dramatically from 40-45% in 2000-2001 to the 2-8% range in 2007.

*Over 29,000 credit cooperatives are operating in China.

There have also been major foreign investments in local banks. Here are some of the highlights:

*Over 20 banks had been granted local banking licenses in 2007, with the first group being Citibank, HSBC, Standard Chartered Bank and Bank of East Asia.

*Since the early 2000s, foreign banks have been acquiring equity interests in local banks (20% maximum under current law and 25% for groups of financial institutions). They include HSBC, Bank of America, Royal Bank of Scotland, Deutsche Bank, Scotia Bank, Standard Chartered Bank, Citibank, Goldman Sachs, AE Bank, ING Bank, ANZ, Commonwealth Bank of Australia, among others.

The Current Banking Regulatory Environment

To strengthen China’s banking regulatory and supervisory framework, the China Banking Regulatory Commission (CBRC) was set up in April of 2003 to assume supervisory responsibility from the People’s Bank of China, which serves as China’s central bank. Up until that time, the People’s Bank held dual responsibility for both monetary policy and banking system supervision. To support these reforms, the CSRC (China Security Regulatory Commission) and CIRC (China Insurance Regulatory Commission) were also set up in 2003.

Financing Issues

Local companies have been relying heavily on bank financing as the corporate bond market is not fully developed. Tightening monetary policy (the reserve deposit ratio was increased 6 times this year to 17.5% currently) and loan reduction guidelines have made it difficult for local companies to obtain financing since the fourth quarter of 2007. On a quarterly basis, CBRC has asked both local and foreign banks to reduce their loans outstanding (10-15% range) as a way to prevent banks from excessive lending, in particular to property lending. Recently, local banks have been given permission to invest their customers’ money in U.S. stocks and mutual funds to provide diversification and options for investors. Changes in local security laws since late 2007 also make it easier for local companies to obtain financing from local and foreign banks using short term assets as collateral.

Though competition is intense in China, many banks, both local and foreign, recorded substantial growth in earnings in 2007 (30-60% increases are not uncommon). With Chinese banks having cleaned up their balance sheets, they are in a very good position to acquire banks outside of China to allow them to enhance their international exposure and to reduce concentration in terms of geography and product offerings. Recent examples include a Chinese bank buying a minority interest in United Commercial Bank in California (UCB bought Summit Bank in Atlanta a few years ago), another local bank buying equity interest in an Africa bank, and another buying a majority interest in a commercial bank in HK.

While major Chinese cities are well-served by local and foreign banks, one serious problem the country is facing is the lack of financial institutions’ presence in smaller villages and counties in China. It is estimated that about 3,000 villages and counties in Western China have no banks at all. Farmers and small business owners simply have little access to bank loans to support their businesses. Micro-finance has been growing leaps and bounds in rural areas, as directed by the People’s Bank and CBRC, to help alleviate these funding problems. The spread of formal bank branches to rural areas, however, is also needed.

Challenges facing Chinese Banks

In summary, challenges facing the Chinese Banking Sector include:

*Penetration of banking in first, second and third tier cities is much deeper than in rural areas.

*Foreign bank assets, though growing, are only about 5% of total banking system assets. *Control over second and third-tier banks in their nationwide expansion. On a micro level, headquartered banks find it more difficult to control the growth of smaller branches in remote areas simply due to lack of good management information system (MIS), credit and compliance risk approval and control, funding issues, and qualified employees.

*Better control of foreign exchange inflows via electronic registration and reporting to manage the flows of “hot” money.

*Develop a corporate bond market to provide alternative funding sources for local companies.

*Close monitoring of small and medium-sized enterprises that are facing serious financial stability resulting from CNY appreciation, loss of export orders from the US and Europe, and tightened loan policy.

*Brand consciousness is quite low among Chinese consumers in credit card products and thus many local banks are not making money on card business.

*Extremely low fee income as percentage of total income, making capital costs for Chinese banks higher. For example, a typical bank in the US would earn 25%-45% of their income from fees, while Chinese banks currently earn only 1%-15% .

*Consumer education and awareness about banking products are very limited and could create problems for banks introducing new offerings. Banks have not done a good job explaining to their customers the risks associated with certain bank product offerings. Banks customers have a habit of turning to local authorities complaining about banks’ ignorance in handling their accounts and managing their cash and investments. For example, bank customers obtain very little information on the risk and returns associated with structure deposits and yield-enhancing investments. Quite a number of banks were fined by the CBRC due to insufficient disclosure and customer education. In the U.S., banks need to obtain certification to sell structure products while in China, this type of procedure does not exist yet.

Despite the challenges, there is good reason to be confident that the Chinese authorities will continue to focus on reforms and structural changes to further improve and strengthen the banking and financial sectors. Further opening up of domestic financial institutions to the rest of the world and globalization of domestic banks (in the form of foreign branches, equity investment and joint ventures with banks in the West) will bring about a more stable financial system driven by market forces of supply and demand.

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