China's Tightening Grip

October 24, 2018

The third in a four-part series, Fulcrum looks at some of the key ways the China of the past is quickly being thrown out the window. 

Anyone that’s done business in China knows you have regulation, and then you have reality. For decades there has been a cat-and-mouse game calling into question the legitimacy of China’s rule of law mechanisms. Governmental inspectors visit a factory, having given plenty of notice so the site could present a picture-perfect image of its operations. Boxes are ticked, hands are shaken, and a great meal is had by all. The second auditors leave, things go back to normal. For all the stringent policies China has on paper, enforcement has often been an afterthought.

 

That is, until now.

 

Over the past year, Chinese regulators have been shoring up enforcement mechanisms throughout the country. The focus is on highly polluting industries and the factories that service them. To create room for policy measures like Made in China 2025, shifts to consumer-based economies, and sustainable development, the tightening grip of rule of law was an inevitability. Still, though, the force with which Beijing has dropped this anvil has caught most analysts, and factory owners, by surprise.

 

According to governmental records, nearly 40 per cent of China’s factories have been shut down over the past year. To emphasize just how serious it is, the Government is also allowing for individuals to be held accountable for their actions. During this same period, officials from more than 80,000 factories have been punished for their parts in flouting environmental regulations. These include managers and supervisors as well as Party officials in areas where these factories operate.

 

For the factories able to reopen, they are born again with heavy monitoring technologies in place. Officials from the Ministry of Environmental Protection watch these in real time, ensuring factories on probation are keeping within Government emission limits. Although the Ministry monitors, they are not the ones taking action for non-compliance. Instead, fines from the national tax authorities are levied on factory owners. This is what makes this new era of enforcement unique. It’s no longer a piece of paper in a record folder somewhere citing your discretions. Now, when you run afoul of environmental regulations it hits your bottom line.

 

Breaking down the who’s who of these astronomical numbers is difficult. One can assume the majority are either mom-and-pop operations or major state-owned assets. Highly polluting industries in the heavy manufacturing, pharmaceutical, and textile sectors are likely feeling the biggest hit from these inspections.

 

These moves are, of course, great for the streamlining of Chinese manufacturing and the environment. They are also an indicator of things to come. Once Government inspectors have finished their rounds, which should be completed by the end of 2017, another targeted sweep will likely begin. Think of this as a tightening noose around the neck of underperforming factories. The initial closures were obvious choices: highly polluting, front-facing factories. With these closed, what factors will inspectors look for next? Perhaps they will focus on health and safety for employees. Maybe, they’ll look at transparency and bookkeeping. With recent urbanization measures taking place in the capital, inspectors might want to identify where a factory’s labor pool is coming from and if they are working legally.

 

All of this points to an era of uncertainty for businesses operating in China.

  • Firstly, there is the impact these closures are having on global supply chains. Monitoring suppliers has always been a headache for companies with operations running through China. Now, there is the risk or actuality of permanent disruption. Whereas it was once enough to understand and have a relationship with your first-tier suppliers, companies must now dig deeper into second- and third-tier operations. To get ahead of any potential issues, companies should seriously consider doing a thorough risk assessment of all suppliers. Having a strong crisis strategy and back-up plan is also a wise idea.

  • Secondly, multinational and domestic firms must ensure their own houses are in order. While we may be seeing the closure of environmentally polluting factories today, tomorrow closures could be based on a number of other factors. Labor issues, wage payment histories, or financial disclosure are all fair game. This means operating a fly-by-night business is no longer sound strategy when it comes to China.

 

As we advance through this New Era, the tightening grip of regulation will entirely shift perceptions of Chinese quality. Factories making the grade can now position themselves on par with suppliers in the developed world when they offer their services to multinational companies. As with a consumer-based economy, this means quality will come at a premium and competition will become fierce. The days of China as a cost play for businesses are long gone. With these enforcement mechanisms well in place, we are seeing the emergence of high quality, innovative, compliant Chinese suppliers.

 

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