Comparing And Contrasting The Business Environment Of China And The United States

Demographics and Consumer Segmentation

This Australian Trade Commission (Austrade) commissioned report seeks to paint a clearer picture between the operating business climate of an emerging global business market China and a more established traditional trading partner, the United States of America. The report will compare and contrast the two economies to determine the more suitable investment destination for member Australian businesses and which economy offers the best chances on a return for investment made. Four varying criteria are used to make the distinction whereby each comparatively looks at both economies to determine weaknesses and strengths. The first variable will revolve around the demographics associated with both nations with a focus on current and future consumers.

Number of potential clientele will be reviewed along with future prospects as well as the locality of consumers i.e. urbanized or not. The second criterion to be employed is the legal environment in the nation with a bias towards enforcement of business contracts and the independence of the nation’s judicial system. The political climate as a factor in business is reviewed to in terms of stability of the country over a period of time. The last criterion evaluated in the report is the tax code used in the country and whether it complicates a business’s operations in the country. The two nations are compared because of their importance to the Australian business community as well as its economy.

The report makes use of the PESTEL framework to compare and contrast the two largest economies in the world which stand for political, economic, social, technological, environmental and legal. The framework analysis has been merged within the four tenets that guide the report.

The two markets have traditionally had different consumer segmentation in the past. However, in the recent past, internal migration patterns in china that has involved the peasant farmers moving from the countryside to the urban centers has led to a very rapid urbanization to close in on that of the United States. The current number of urbanized populations in china stands at 58.52% of the total population as at February 2018 to represent 813.47 million people (Murray, 2014). In comparison, the United States by far outstrips this figure with a higher percentage of an urbanized population with an impressive 81.62% of the population urbanized (USCB, 2018). However, the total number of the United States citizens is far lower at 259,253,271 because of its smaller base population of 325.7 million people compared to the much higher Chinese population of 1.379 billion individuals (USCB, 2018).

Legal and Political Environment

Urbanization matters to a business as it determines the ease with which a business can reach its customers/clients within a shorter period of time (Guilmoto & Jones, 2016). A higher rate of urbanization means that the market in the United States is much easier to exploit using the least amount of logistical resources available to a firm. Nevertheless, the higher rate of urbanization in China translates to a much brighter prospect for a business with a long term view of investing in the country (Murray, 2014). According to a recent study by Xinhua net, every annual percentage increase of urbanization of one percent leads to a 3.7 percent growth in investment.       

The total population in a country determines the number of consumers in a market and thus China has a considerable larger size of potential consumers as compared to the United States. However, this figure is does not automatically translate to higher profits as the spending power of a country’s citizens determines how much or the type of goods they can consume at any given time (Curtis, Lugauer & Mark, 2017). At $58,030 the United States per capita dwarfs that of China at $15,500 which means the citizens of the United States are far richer than the average Chinese (USCB, 2018). For businesses offering luxury goods and services, the United States may be more appealing using this measure as compared to the Far East nation.

Average disposable income in the United States is three times that of China. Due to the one child policy adopted by the Chinese government in the last century, future demographic trends are more likely to feature an aging population that mirrors that of Japan often leading to a stagnating economic environment as shown in the table below (Curtis et al., 2017)

 Whereas the United States has a similar trend where most families have fewer children, a robust immigration policy ensures that the net effect is a steady increase in population numbers. In a nut shell, the American market is today’s market but the Chinese market with its oversized population and a rapidly growing middle class represents a market for the future. 

The legal climate and rules that govern investment in a country are critical to the well-being of businesses and their growth prospects (World Bank, 2018). A business contract is enforced by courts within a jurisdiction and determines how businesses interact with one another. A failure or unwillingness to enforce contractual agreements that leads to business wrangles can have a crippling effect on an investment and lead to loss of capital. Following its accepted membership of the WTO, China had begun developing its legal system to meet western standards for accountability and transparency. Upon joining the organization, China committed to reforming its legal systems, laws and regulations governing the interactions of trade disputes between a state and a private entity and private entity against another (World Bank, 2018).

Tax Code and Investment Environment

The obligations made resulted in China having to make the recommended changes over a relatively short period of time. These changes have touched on investment by foreign entities as well as the other thorny issue of intellectual property rights (Ang, Cheng & Wu, 2014). The United States has in comparison a very liberal policy where foreign direct investment is encouraged at all levels rather than shunned. Intellectual property rights in the United States are strict by world standards and this serves to ensure that the inventor maximizes the benefits that arise from an investment in research and development (Ang et al., 2014). China has however lagged behind when it comes to the issue of intellectual property rights enforcement within its jurisdictions and any efforts to tame the problem can be termed as passive. Nevertheless, China has overtime improved its contract enforcement capabilities and is today ranked as the fifth best nation in terms of contract enforcement by the ease of doing business index (World Bank, 2018).

In the service industry, there exists a stringent restriction regime to direct foreign investment in most segments. These segments include telecommunications and finance where foreign participation is severely restricted and generally creates a very poor environment for investment. Barriers to trade in these fields make it hard for businesses to freely move capital between their mother firms and branches in the country (World Bank, 2018). Meanwhile, the United States does not have market barrier segmentation in most of it industries and foreign investors are free to move capital into and out of the country at their pleasure.

Foreign businesses entering into contracts with a Chinese company will have to be wary of certain hurdles. Unlike in the united states where prove of a formal relationship can be shown and accepted in a court of law through admittance of materials such as phone calls, emails and pieces of paper the same are not admissible in a Chinese court of law (Murray, 2014). The law in China requires a formal written contract to be in place for it to be considered valid or else a claim will not be considered binding and thus not enforceable. In the United States, judgments from other jurisdictions of repute are taken into account when disputes arise between businesses and can be enforced if deemed appropriate. However, in China, courts do not consider judgments rendered by foreign courts to be binding within their jurisdiction (Murray, 2014). For contracts to be enforced in China they must be grounded in Chinese law and any deviation usually means not binding.

The cost of doing business in a country usually determines the profit margins earned by any particular business (Perak, 2017). The cost usually depends on many aspects of the business environment such as the amount of taxes one has to pay, regulations a business has to adhere to, the average wage a firm pays to its workers as well as interest charged on borrowed capital. In the United States most tax laws are settled due to the many years of applying a similar system unlike in China where most laws governing taxation are constantly evolving to meet new needs and demands. Constantly changing laws mean that companies have to pay more for tax compliance officers to comply with the continuously shifting taxation landscape (Perak, 2017).

Generally, producing in china has always been considered to be the cheaper option; however, businesses thinking of investing in China have to rethink this fact. Operational expenses have been rising in China over the recent time period (Eunice, 2017). Foreign company firms based in mainland china have been required by law to remit part of their incomes to urban upkeep and building taxes thus raising the cost of doing business. In addition a social security safe net was introduced in 2011 for workers without an insurance cover.    

Although labor wages have nearly doubled in China since 2008 they have remained comparatively lower than those of the United States. The lower wages has meant that it is far cheaper to produce any good in china than it is in the United States more so when the good does not require high levels of sophistication. Some industries have however proven to be the exception and not the rule, as the Council of American States in China president put it, “American workers earn a lot of money compared to their Chinese counterparts, but the U.S. comes out on top when costs are taken as a whole.” The beginning of a changing American tide towards cheaper levels of production started when different states started offering incentives for businesses to relocate to their states such as Virginia intangible property is not taxed like a manufactures inventory (Business Facilities, 2016). A host of other tax credits are on offer for investors willing to set up shop in the state and are in use against a firms tax liability such as;

• Worker Retraining Tax credit
• Green job creation tax credit
• International trade facility tax credit

These tax credits helps to attract foreign direct investments in particular states are the same is mirrored across the nation with each trying to outdo the others and create job opportunities for its residents. The current clamor for more protectionism policies in the United States has led to more plans being mooted to further reduce the cost of doing business a case in point being the administrations’ push to cut the corporate tax by a five percentage point (Business Facilities, 2016).

China employs a progressive tax regime on individual income from with the percentage rate ranging from a low 3% to a high of 45%. Foreign firms operating in the country are expected to remit the taxes of their employees to the authorities. The process of collecting individual tax returns largely mirrors that of most advanced nations and is both simple and easy to understand as well as follow (Brean, 2013). The employer remits the tax to the authorities as well as their contributions to social security for their members. The corporate tax payable does not discriminate between local and foreign owned companies operating in the country by a applying a standard rate of twenty-five percent to each. However, start-up firms do get a tax break and are eligible to a twenty percent corporate tax which is a 10% decrease (Brean, 2013). The policy move is aimed at fostering innovation as well as nurturing upcoming businesses that would otherwise suffocate once exposed to the same rules as the multinational juggernauts. Each province in China, however, has a different tax regime depending on the attractiveness of the region.

Provinces such as Guangzhou that need to attract direct foreign investment in order to meet their development goals have to offer much more incentives to lure businesses that would otherwise head to the urban centers of Beijing and Shanghai (Jia et al., 2014). The region offers a ten percent corporate tax to this end. Certain types of businesses do however get better tax regimes than others. High technology intensive firms pay lower corporate rates of fifteen percent. The capital gain made by an individual is taxable in China at the rate of twenty percent irrespective of whether the person is a foreigner or not. A local company gets to have its capital gains tax lumped together with the other tax deductibles while a ten percent cut is applied at source for foreign owned enterprises (Jia et al., 2014).

Table of Income Tax Rates in China for an Individual in 2017

As shown in the table above, the Chinese government has implemented strict regime as of July 2018 that highly taxes individuals’ earnings exceeding 80,000 while reducing the tax burden of the middle class in order to boost spending.

The United States, on the other hand, employs a tax regime that taxes its non-resident citizens on worldwide income. The USA imposes taxes at all the different levels of administration being the federal, state and county administrations (Hickman & Duke, 2013). The capital gains tax in the USA is not implemented uniformly but varied to reflect the firms’ tax bracket and the period an investment has been held in the United States. Generally, long-term capital gains are taxed at a lower rate as compared to short-term capital gains. The United States has some of the most regressive payroll tax regimes on the globe with high earning individuals enjoying tax breaks. The rate of taxes imposed on goods depends on the origin of the goods with all goods being required to label their countries of origin. The standard duty paid for goods is 20% of the total value of the imported items and collected by the Internal Revenue Service (IRS).

Conclusion

The United States represents what could be termed as a settled market with a very high percentage of the population urbanized. The economy relies mostly on the consumption power of the middle class and a huge percentage of it is the service industry which is a hallmark of a consumer driven economy. The service industry accounts for 76% of the total private sector GDP. The economy is largely stable and grows at a steady rate of 2-3% annually. The market is largely known and presents few risks that are not accounted for or well documented. Laws in the country are also by and large settled and are therefore not prone to changes every now and then.

On the other hand, the Chinese economy is an export driven economy that relies heavily on foreign markets and is only now experiencing an urbanization boom. A huge part of its economy is taken up by the manufacturing sector at 40% of the total GDP of the country. The country has however, in the recent past taken up measures to shift its reliance from the manufacturing industry into a more consumer driven economy. The economy has been stable over a prolonged period of time registering growth rate of over 10% for a period before settling into a 7%-8% rate of growth that is more sustainable.

Both countries are prime investment destinations depending on the nature of business an investor would like to invest in any of them. An outsourcing kind of business that needs low technology to produce its products would be best suited investing in China that offers an excellent climate to mass produce goods at a competitive market rate. However, finance based businesses or any other corporate ventures that are not labor intensive would be better off investing in the United States. Other factors that do come to play include the long term vision of a business. The United Sates economy represents a ready-made market for investors to exploit while the Chinese economy is more of a market for the future. In the latter, a first move advantage is key more so in ultra-advertising corporate market of the day where brand exposure determines success or failure.

On the whole, the Chinese market represents an unknown quantity for any business that plans on venturing into the market and would be based advised to seek risk reducing measures. Such risk reducing measures can be in the form of local partnerships or franchising for the Aussie Investor. Spreading of risks is also another option for businesses wary of partnering with local players. The investors can choose to partner with other international firms or Australian firms with the same objective of conquering the Chinese market.

References

Ang, J.G., Cheng, Y., & Wu, C (2014). Does enforcement of intellectual property rights matter in China? Evidence from financing and investment choices in the high-tech industry. Retrieved from: https://www.mitpressjournals.org/doi/abs/10.1162/REST_a_00372 

Brean, D.J.S.(2013). Taxation in modern China – TAXATION AND TRANSITION TO A MARKET ECONOMY. Retrieved from: https://books.google.co.ke/books?

Business Facilities.(2016). Virginia Incentives and Workforce Development Guide. State incentive guide. Retrieved from: https://businessfacilities.com/2016/03/

Curtis, C. C., Lugauer, S., & Mark, N.C. (2017). Demographics and aggregate household saving in Japan, China, and India. – Journal of Macroeconomics. Retrieved from: https://www3.nd.edu/~nmark/wrkpaper/J_MacroPublishedVersion.pdf   

Eunice, Y. (2017).’Made in China’ could soon be made in the US. CNBC- World markets. Retrieved from: https://www.cnbc.com/2017/05/30/

Guilmoto, C.Z., & Jones, G.W. (2016). Contemporary Demographic Transformations in China, India and Indonesia. Retrieved from: https://www.researchgate.net/profile/Nandita_Saikia2/publication/301242418  

Hickman, K.E,. & Duke, L.J. (2013). Administering the Tax System We Have. Retrieved from: https://heinonline.org/HOL/LandingPage?handle=hein.journals 

Jia, J., Q Guo, Q., & Zhang, J. (2014) Fiscal decentralization and local expenditure policy in China. Retrieved from: https://www.sciencedirect.com/science/article/pii/S1043951X14000030 

Murray, G. (2014). Doing business in China: The last great market. 265, 11-25. Retrived from: content.taylorfrancis.com

Perak, I.N. (2017). COST OF DOING BUSINESS. Retrieved from: https://www.investperak.gov.my/wp-content/uploads/2018/03/CODB-2017-Opt.pdf 

United States Census Bureau (2018) USCB, population at census.gov. Retrieved from: https://www.census.gov/topics/population.html 

World Bank. (2018) Doing Business – Measuring Business Regulations. Ease of Doing Business. Retrieved from: https://www.doingbusiness.org/en/data/exploreeconomies/  

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