Future of the World Project: Johan Annell on the Future of China’s Business Climate

Headline Idea

Western attention toward China is often focused on negative news and overlooks the reforms being made to make the country’s business climate more attractive to foreign firms

About the Interview

In October, PRISM’s Johan Gott and George Coe sat down with Johan Annell to discuss the challenges of operating in China and how the business climate has been changing. Johan is a partner at the Asia Perspective consultancy, which focuses on helping companies navigate operating in Asia. He is a longtime resident of Beijing and is known for providing sober and nuanced commentary on business risks emanating from China. In light of the talk of “decoupling”, we were interested to hear what Johan had to tell us about the reality on the ground.

Our Takeaways

• The understanding of China presented in Western business news often highlights the dramatic political events that impacted the business sector negatively. While not inaccurate, it omits a series of reforms that are improving transparency and the rule of law for foreign firms has in some ways made China more attractive to do business in by creating a more rules-based system.?
• China’s strict measures to keep COVID-19 infections under control have been largely successful with only limited outbreaks. But the resulting extreme constraints on travel to China has come at the expense of limiting the ability to form business relationships and made it more difficult for foreign companies to control their Chinese operations.
• Chinese firms remain focused on growth within China, but as they conquer this market, they will increasingly look to foreign markets. While this has been predicted for a decade, the long delay is due to the focus on the Chinese markets and expansion in Tier II markets largely invisible to Western observers, like Africa, Southeast Asia and Latin America.
• Today the main priority of foreign companies is not focused on sourcing. China’s domestic market is increasingly demanding the kind of higher value goods that Western firms offer. That is one reason why foreign firms are increasingly looking to consolidate their position in China markets. At the same time Chinese producers are rapidly moving up in the value chain.
• Many of the challenges that China faces – such as the real estate sector being over-leveraged – are old stories in the country and have been being addressed for some time even though they seem shocking to the outside world. This should not minimize the severity of situations but underscores that the shocks are not surprising and that there is not really the sense in China that these news events represent some idea of there being? a “peak China” moment, as some Western pundits have claimed.?

The Interview

Below is our full discussion with Johan Annell. The transcript below has been edited for clarity.

PRISM: If you could just describe what you do in general, that would be a great place to start.

Johan Annell: I have been working with China in various ways for a long time, and now I am living in Beijing and running the Asia Perspective office here, which works primarily linking firms from Nordic countries to Asia. At a high level, our mission as a company for the last decade has been to help Nordic companies to be successful in Asia. Our company was started in Shanghai and now we're six partners, covering China and Southeast Asia. We focus a lot on sourcing and supply chain work. We also do market entry management, help large and mid-sized companies here with their operations, and work on M&A and financing. That means target screening and acquisition strategy for quite large companies and financing for smaller, entrepreneurial projects.?

I started studying Chinese in university, ending up in Hsinchu, the place where TSMC is headquartered and the epicenter of semiconductors. After that, I worked as a management consultant in the automotive sector back in Sweden before returning to China.

PRISM: Let’s dive straight into it. China is always evolving at a breakneck pace, and there's always something new happening. But what's the current mood among the executives that you talk to?

JA: To start, many are wise enough to understand what they don't understand. All have a basic grasp that China is huge and diverse and changing quickly, and quite a few are well informed. What I can contribute are perspectives from living here and how I piece together the picture of what’s going on. Many companies are doing very good business in China, and many are doubling down and investing more, usually to access domestic markets. They may not do as much new sourcing or set up completely new operations in China, unless it's for very specific industries, like electronics and other areas where China is extremely strong. There certainly is a regionalization trend, and companies are investing for a future China with an even larger market with demand for higher-level products.?

For Nordic companies, a good example is truck companies; in a 12-month span from 2020 to 2021, both Scania and Volvo Trucks announced $100M-plus investments in local production in China. I think they did pretty good homework on this and have been thinking about this for a long time. Their analysis is that China will be a good market and know that it has much space left to upgrade its transport sector and logistics. The trend is the same in industrial technology, energy, and some consumer products. Future demand will be there. There are many problems to capture that demand, but for many companies, it makes sense to increase their presence in China.

PRISM: So what you're saying, I think, is two fold: First, there's a shift away from China for sourcing and supply chain. Second, there’s more focus on a more advanced customer market in China. Is that a fair assessment?

JA: Yes. China is still a very strong sourcing destination, and even after you take into account all the factors with supply chain disturbances and rising labor costs in China, there are still a lot of products that will be sourced and produced in China. There is still strong infrastructure, labor supplies, and industrial clusters with deep supply chains. So it's far from gone, but the focus for investment is shifting towards serving Chinese consumers and B2B buyers.

PRISM: Right. If you read Western business newspapers, there is a much more negative view of China currently. There’s a lot of talk about decoupling, which may be an extreme, but still telling, description for what’s happening. It seems that things are moving in a direction where the risk is increasing. Do you get a sense that clients have that perception, too? Is there a new hesitancy to make investments?

JA: It has always been risky to invest anywhere far away from home with a different culture and a different business environment. So, it's hard to say if the risks have really increased. The actual business environment in China is becoming more transparent, and it's easier to understand who you do business with and to get enforcement if you have an arbitration order, even if it’s from a foreign venue of arbitration – some companies are getting enforcement in China. So, those things are improving.?

Then, the focus in the news is very politically focused and, often, a lot of attention is paid to the flow of goods across the border. Companies are really waking up to that now that suddenly transport prices increased by over 500%. Those risks are there, of course, as is the risk of not being able to send people into China easily, which is being felt now. Two years into the pandemic, companies and managers are losing connections because people cannot visit. That’s something that comes up when we talk to companies: They have an extra layer of hesitancy because the decision-makers have sometimes never been to China or have never been in their current role. That will continue to add hesitancy, because it's harder to get good information, to get first-hand impressions, and to develop relationships in China without being here. I think that will continue to cause pain for a while.

PRISM: I recently saw Elon Musk talking about that in an interview. He’s asked about his China business and says that compared to other countries the lack of face-to-face contact during COVID has been an issue. Not being as familiar with China as you, I thought this was very interesting. Do you think that the lack of in-person connections has caused problems everywhere, but that the impact is worse in China?

JA: Yeah, I think it is, because on the Western side you may be less familiar with China, and it is such a huge market that you can’t afford to get it wrong. So, all the decisions related to China are high stakes. I can understand it is hard to make decisions if you only have a few trusted people in China that you rely on but don't get to see things on your own. Then, of course, there is the cultural challenge that making decisions and doing things in China is very reliant on face-to-face communication and the right people showing up. I know several examples where the global CEOs go to China and do the three weeks quarantine so they can attend key meetings. It is hard, but they are actually choosing to make sacrifices because China is so important that it’s worth it for them to move things forward.?

PRISM: That's really interesting because, in a sense, we've felt that as long as cross-border flows continue everything is fine. I think in the US, the lack of business travel during the beginning of the pandemic took a bit of a toll on things, but probably not as much as initially expected. In China that might be different. Could you tell us more about how the pandemic has been a major hurdle in doing business there??

JA: One hurdle is that decision-makers and leaders of companies cannot meet people, which makes it hard to build the trust that is developed over decades and helps to get things done when it comes to large investments, getting permits, and these types of things. That's the same for smaller businesses that need to develop good partnerships with distributors and other businesses, as they never get to meet and it becomes very hard to evaluate if they are making the right choice. It’s very hard from the Chinese side, as well, to know if a foreign business partner will be around for the long term or if they may be less willing to invest. Then, there’s the question of things that are made in China or that were made abroad for the Chinese market that are really technically complex. In these cases, it's not just buying the thing, it's co-development with suppliers, the supply networks, and design people, all of whom need to work very closely to develop the product, test it and do the rest of the R&D process. That's where we see many companies struggling because they were used to being able to send technical experts for a few weeks or months and now cannot.?

PRISM: In the US, and I guess other parts of the West, everyone talks about COVID-19 as an accelerant. There's been a lot of societal change in terms of work-from-home and everything like that, much of which I think will have lasting impacts. I guess apart from the perspective of travel to China by foreign executives, is there a sense that trends have not shifted as much in China because COVID-19 has been a bit better managed there and things have been open for longer?

JA: We never really had the same transition. I often work with European companies, so I have had this Zoom life for a while. But for many who are working here for Chinese companies, they have not had this experience. There have been some lockdowns and then there have been some periods of outbreaks, but we never had a situation of being completely out of the office. Plus, as soon as you could travel, salespeople and executives were traveling domestically in China again. People may be a bit more hesitant to travel out of fears of lockdowns, but people are doing it. Face-to-face meetings only stopped for a month or so, and since, it's been mostly normal.

PRISM: In the US and elsewhere both international and domestic travel were disrupted for well over a year. Just now people are starting to do business travel again. But for China, it's exclusively an international thing that has lasted longer, which in a sense is even more severe. Do you think that the lack of interpersonal business relationships could have lasting impacts?

JA: I think we may have another year where travel in and out of China is reduced and the last two years have already had big consequences. For instance, there are no students coming in from abroad – thankfully, quite a few Chinese students are going out, although I think that has decreased a lot, too. This will be felt by having fewer people who have that deep experience of study and work between China and the rest of the world. Then, you also have the many expats who were living in China as foreigners and have had to leave, chose to leave, or never took on new assignments. So, there’s a very significant decrease in contact points between China and the world. Finally, there are the decision-makers sitting in Europe or the US who have this experience where for a year their supply chains were a mess and they couldn't get good goods into stores. That may impact decision-making in the future, as well.?

PRISM: Another thing I wanted to pick up on is what you said earlier, which is that on the one hand, China is becoming riskier from a sort of political point of view and because of its relationship with the US, but that in other ways, you are actually seeing the risks decreasing. Could you discuss that a bit more and what we can sort of expect going forward?

JA: I think a lot of the operational risks of working in China and the overall friction and transaction costs are going down. There are still lots of challenges and you still hear of a lot of things happening that might not happen in the West, but overall, the trend is that China understands that good governance and public infrastructure matter. So, there is now data about business partners, it's very publicly available, and for a fee you can get even deeper credit data on most companies, so that you actually know who you are doing business with. This is something that is often confused with this image that’s being painted of a kind of Orwellian social credit experiment where people think people are being tracked, but media often forget to mention all of the “corporate social credit”, which is like an umbrella term for the fact that China is gathering and publishing information like if a company is paying taxes, if they have they been fined, and if they have violated labor or environmental laws. That’s one area where there’s been a lot of improvement. Then you have IP protection and the legal system, which has produced better legal protections for most businesses. Doing business in China has become more rules based and there are clear efforts to limit the arbitrariness of local decisions that impact foreign investments. This is being done by the Chinese government to fulfill commitments with the outside world and to decrease the competition between provinces that occurs to attract foreign investment. There is a pretty big reform agenda that has come some way, but there remains much to do. I would expect China to move forward with having a more rules-based system in terms of how business is done in the country. Those kinds of developments are overshadowed by the global conflicts.?

I can also add a bit on issues related to data, as it remains unclear what is allowed and what is not when it comes to cross-border data transfers after reforms were passed. China has been regulating this for quite a while, and there was some initial uncertainty, but now the laws are coming into place and rules are being added to clarify things. We can debate if they are the right rules or not, but it is better to have clearly defined rules and not the gray zones that were there before.?

PRISM: Yeah, that's a really interesting topic. What we are hearing is that the cross-border data flow legislation is disruptive, and constitutes a threat in the US context, since it is a sort of market deterioration. But you don’t seem to share that same feeling.?

JA: I think for data that is in China, the rules are becoming clearer. So, while the situation before was very unclear – and therefore threatening – that is changing and things are becoming clearer. You can still say that it's a deterioration because it was easier before when it was less regulated and less enforced.

PRISM: One way to look at this is that there are two things happening. One is sort of a general thrust in reform and the strengthening of the legal framework of how to do business in China, so the government is consciously putting in effort to make it more transparent and make the legislative situation clearer, even though there are several strategic initiatives at the highest level that are getting negative attention, like strong enforcement actions against tech companies, changes to education, things happening within the gaming industry. The second is that most of the day-to-day activities are getting more predictable, it’s getting easier to operate, et cetera. Is that a fair way to look at it?

JA: I would agree that the overall direction is positive on the day-to-day level and there is still so much reform left to do to make the economy more efficient. I think Chinese policymakers understand that they need reforms to avoid stagnation and continuously lift China and that they need to have more market economies so that they can basically run a capitalist system within a rules-based one, but then that clashes with the highest levels and strategic interests, which includes relationships with the rest of the world and between the power centers within China. You can see that there are parts of China pulling in different directions. Some of this leads to the other conflicts that we are seeing like Big Tech clashing with the government.?

PRISM: I guess from the outside, there are multiple things here. There’s the growing energy crisis in China, the Evergrande thing, there's the crackdown on tech, and so on. It seems like from the narrative over here in the US that it’s a bit of a disruptive moment in China. And people are talking about “Peak China.” But is there any sense in China that this is a moment of change??

JA: It has been surprising in recent months how quickly some regulators have acted, such as with the crackdown on tech and on online education. That really surprised a lot of people here. But when it comes to things you mention such as the economic problems of Evergrande, that stuff is not so new; it’s been known for a long time that the real estate sector is very over-leveraged and that the size of the real estate sector is a big problem. The government has been trying for a while to implement new capital requirements for real estate developers to cool down the sector. Another thing that has not received so much attention is that the reason why the Chinese invest so much in real estate rather than other assets is because the stock market isn't that well developed yet. But the Chinese government is trying to do something about that by opening a new stock exchange in Beijing for certain growth companies and is loosening some of the rules to make it easier for foreign wealth managers to come in and help Chinese savers find alternatives to real estate. That really just started happening.

PRISM: I also wanted to explore a bit more about relationships with the outside world, particularly the West. I think we're starting to see a sort of deterioration – not just related to China, this is very much driven by the US, particularly after the previous administration but also from this one. I mean, how do we see this relationship evolving? At the highest level it’s been a trade war involving Huawei and actually involved heads of state, but it now seems to be expressing itself at almost every level. China's been much more aggressive in terms of how it uses its commercial relationship with other countries, like by using boycotts with Australia. And things are even changing at the individual level where people in China say that foreign cultural influences are far less plentiful than they were 10 years ago and that younger people are turning more inward. So, are we seeing some sort of relationship breakdown between China and the rest of the world? Or, how should we be looking at that aspect??

JA: I think part of it is a conscious move for strategic reasons to be more independent in certain areas; they’ve done things with data and semiconductors, and there’s the whole Belt and Road initiative. A lot of this is to build more redundancy in how you're able to trade and secure energy and food so those are all strategic considerations that are driving certain policies. China is also much stronger than 10 years ago, and so much more significant when it comes to global trade. I think the relationship between China and the rest of the world from an individual level is also weakening because of COVID simply cutting off much of China from the rest of the world.

PRISM: Right, I think it’s clear that China is much stronger than it was 10 years ago, but you don't see some sort of relationship decoupling like China turning inward? I think for some isolationists, there may be a sense of “Why even bother? We have everything here in China. Why care about the rest of the world?”

JA: I think an example that is good to compare with is Japan. Japan is like one-tenth of the population in China, so for that reason it is different, but in many ways the journey that Japan went through in becoming rich in the 80s and when it started being considered a threat from a trade perspective, buying up a lot of assets, and then later on coming in with a cheap cars that are now dominating a lot of Western markets, that’s something to compare China against. When looking at future scenarios for China, Japan is a pretty modern, rich place and very good in many ways. It’s welcoming but also insular. They have had some of their own standards for mobile phones and other things for a long time and the culture is very disconnected from the rest of the world. I can certainly see China moving in that direction; it will be a completely different culture, but that may not be an entirely bad scenario. It would still be an integrated player and lead some industries, but it would not be completely disconnected from the rest of the world.

PRISM: That's a really interesting scenario, and definitely a sort of more benign one. I think a really good parallel for this sort of thing is the West’s – particularly the US’ – sort of freakout over Japan. But at the same time, it feels like there was a bit of a grand bargain between the US and Japan – at least on the economic front – at some point. Obviously, the two countries had a different relationship. Is something necessary to create that outcome? Or do you see that just over time things will calm down?

JA: I think it’s possible. There are some signs that it might be happening with China perhaps turning down the rhetoric in recent weeks. It's mixed signals as usual, but it’s also China wanting to be seen as a responsible international player, particularly on the environment and on decarbonization. That's one topic where China is trying to be seen as a member of the global community. You have standards, as well, where China is trying to adopt and influence global technical standards, and that’s because of the benefits to China and the fact that that’s part of being integrated into the world economy. Then there is the rest of the world, not only Western Europe and the US; their perceptions of China will be different and there will be some move toward economic integration. That's perhaps where China will try and expand its soft power. It is hard to do in the West, but it is happening. We may not recognize the extent to which it is happening in Africa and Southeast Asia.

PRISM: I wanted to change topics a bit. If you think about five years in the future, what do you think people get wrong when they think about the future in China? What are the blind spots? What are the things where we need to retune our mental models to prepare for the future?

JA: I think the general blind spot is the diversity of China with one thing being the different geographies, as you really need to understand the different parts of China and how these clusters are different. That's true not only for consumers and local culture but also from a business perspective, as it impacts how they will do business and what niches will develop. I think many companies may miss that. They could have good pockets of the demand in China for very specific solutions, but they don’t understand that there are Chinese companies willing to pay very good money for technology. And then – I don't know if it's a blind spot – on the competition that you have in China, you already have Chinese firms that have come quite far and are already operating in Western Europe, like electric carmakers entering Norway. I think that we'll see even more Chinese firms pop up in other countries. Most likely what will happen first is that Chinese companies currently competing with the Western ones in Africa will soon enter Europe. There are a lot of firms that are quite sizable in China but are still focusing on the Chinese market, and this means that at some point they will look outside it. There are a lot of companies that we've never heard of that will – maybe even as things start to open up after the pandemic –? start a new wave of entry into other markets, either by doing it organically or doing acquisitions for growth in the rest of the world.

PRISM: The rise of the Chinese multinational was a hot topic like 15 years ago, but that hasn’t materialized yet, right? There are a few Chinese companies that have gone overseas, and sometimes with catastrophic results, like Huawei. We still see a lot of focus on Africa and other markets where things are already developed, but when will we actually see the sort of rise of the global Chinese companies?

JA: I think one reason it's not happening is because for many companies, there's still so much left to do in China, as it is such a large market to serve. They may choose to focus on their home turf instead of going out in big numbers. Then there is the current sentiment towards China, which may make it less favorable for Chinese companies to enter new markets. There are also examples of companies that actually wanted to enter new markets and decided to do it, but then had trouble executing. Some have been quite successful, and I actually think Huawei is an example of a company that was pretty successful in setting up a global company and running that for a long time. Geely is another example of this, but there are plenty of Chinese companies that have not succeeded.?

Often at the highest levels of management, you don’t have enough awareness about the rest of the world and how to manage foreign managers. And then for Chinese companies, they may not have the right pool of Chinese expats to send out to run things. So, in some cases, I think the companies have tried and then said “It didn't work,” but maybe it could have worked had they done some things differently, localized strategies more, and put more resources in the right places without micromanaging their foreign operations. Those are the kind of lessons that foreign firms operating in China have learned. There is a large class of Chinese companies that need to learn this if they want to be successful abroad.

PRISM: I am actually really interested in your last point about what it takes to succeed in China. Is there anything that is noteworthy about companies that come over from abroad and find success? Are there any success criteria for operating in China that are different to other places?

JA: I think there's many things that are different, and many companies will underestimate how different China is, so they will not properly do their homework. In other markets they may get away with that, because new markets that they try to enter are relatively similar, for instance if a European company is moving into new markets within the continent. They often have a pretty good plan and understand their competitive advantages, but what really helps foreign companies be successful is to have the technological advantages, to continuously innovate, and to do so quickly in China. Those who can implement that approach will have an advantage. The companies that manage to keep their processes and culture – that is to be part foreign and part Chinese – tend to have advantages in terms of global technologies and attracting talent. There are a lot of Chinese who would prefer to work for these companies and really like elements of these companies’ cultures, which are harder to find in China.

PRISM: Perfect, this has been a great conversation and a useful reality check with a lot of counter intuitive insights about what's actually happening in China versus what is in the headlines. I think we got to talk about a lot of subtle things that have not been as appreciated. Thank you for speaking with us!?