How to Navigate the Ethical Risks of Doing Business in China

For decades, companies have poured into China to take advantage of the country’s manufacturing prowess and to serve its enormous market. While firms were largely aware of potential business risks, like intellectual property theft and the need to navigate corruption, executives have been less concerned about risks to their firms’ ethics and reputation. But in recent years the situation has changed dramatically, and companies such as Google, Disney, and the NBA have to steer through a much more perilous, and in some cases impassable, ethical landscape.

There are two factors that are driving this changing context. First, instead of becoming more democratic as the country grew richer, the Chinese party-state has grown increasingly repressive. And second, instead of becoming a responsible member of the liberal international order, China is increasingly seen as a threat to it — and to U.S. interests in particular.

As a result, Xi Jinping’s China is different than the country companies dealt with in the 1990s and 2000s. Moreover, China’s size, state capacity, and specific policies create unique ethical risks. The opacity of the party-state and businesses, the growing influence of the party over business, and the difficulty of monitoring supply chains all make it hard for businesses to know where they stand. There’s a high risk of inadvertently being involved in human rights violations or efforts to build up the Chinese military, especially through third parties. Companies can, for example, unintentionally become complicit in the government’s cultural genocide against Uyghur Muslims in Xinjiang, where there’s well-documented mass detention, forced labor, separation of children from parents, forced sterilization, and destruction of mosques. As China has rolled back freedoms in Hong Kong and rolled out new repressive policies across the mainland, a growing list of products and services are becoming compromised.

This has created an unprecedented dilemma. China is America’s largest supplier of imports. American businesses have invested over $275 billion in the country since 1990. And investor holdings of Chinese equities and bonds are steadily rising.

For the moment, most companies navigate the challenges of operating in China on an ad-hoc, per issue basis. Google, for example, pulled out of the country in 2010 over censorship concerns. Yet it later founded an AI research center in Beijing and worked on a censored Chinese search engine, code-named “Dragonfly,” which it was forced to suspend after outraged employees protested in 2018. This ad-hoc approach only increases the risks companies face.

Right now, Western companies need a clear set of principles to guide their actions and limit ethical risks. Just like other risk-management schemes, these principles should answer complex questions — recognizing that complex political-economic dynamics, ethical blind spots, investment implications, and personnel considerations at play.

Growing Challenges, Different Responses

Despite growing commitment to business ethics and corporate social responsibility — including environmental, social, and governance (ESG) standards — there is little public discussion among Western companies about the ethics of operating in China. Broadly speaking, however, there are four different approaches.

Withdraw:

First, some firms have decided the risks are too great and have withdrawn from the country. Yahoo, for example, withdrew from China in November 2021 due to an “increasingly challenging business and legal environment,” according to a statement by the company. The move coincided with the government’s introduction of new rules on the management of data. This followed on the heels of a similar move made by Microsoft’s LinkedIn, who left because of “significantly more challenging operating environment and greater compliance requirements in China.” Reformation, a women’s clothing brand, completely stopped using cotton from China (though it still does some manufacturing there) because it couldn’t guarantee that it was not produced with forced labor.

Continue and contain:

Many others maintain ambitious plans for the country, only trying to limit their exposure to abuses and avoid attention from Western activists, media, and the Chinese government.

Disney remains bullish on China even though its streaming service, Disney+, is banned from the country. Still, the company operates theme parks, distributes films, and develops content. This has risks, as the movie Mulan highlights. Shot in Xinjiang, the credits thanked several government entities, including one operating detention camps and sanctioned by the U.S. Commerce Department. The lead actress supported the crackdown on Hong Kong protesters. In response, activists in Hong Kong and the West called for a boycott of the movie.

Similarly, Wall Street remains publicly bullish. BlackRock, the world’s biggest asset manager — and a large supporter of ESG — urged investors to boost their portfolio allocations of Chinese assets by up to three times. Driven by Beijing’s opening of its financial markets, J.P. Morgan, Goldman Sachs, and others have taken a similar stance. George Soros called BlackRock’s approach a “tragic mistake” that is “likely to lose money” for clients and “damage the national security interests of the U.S. and other democracies.”

Operate with opposition:

A third set of firms have tried to make clear their opposition to rights abuses while continuing to do business on a large scale in the country, and many have faced backlash within China. After H&M voiced concerns about forced labor, Beijing orchestrated a boycott of the company, erasing its presence on e-commerce sites and map apps and fanning outrage through state and social media. Twenty H&M stores were forced to close, and sales dropped 28% in China from the previous year. While H&M maintains its public stance on Xinjiang, firms such as Zara owner Inditex have removed or altered their statements to avoid any conflict with the party-state.

Support China’s standards:

Some companies — typically those most dependent on China — have stood strongly in support of China’s actions. Muji, the Japanese retailer, has advertised products made with “Xinjiang cotton.” Cathay Pacific replaced its CEO (he resigned under pressure) and fired some staff due to their support of the protests in Hong Kong. The owner, Swire Pacific, vowed support for China’s actions in the territory after its access to mainland routes was threatened. Some companies, such as Nike, Coca-Cola, and Apple, have even lobbied against U.S. legislation that would force them to restrict their exposure to Xinjiang.

Principles for Ethical Engagement

Given China’s growing repression and threat to the liberal international order, companies should be reevaluating their approach. Additionally, in China, the line between any purely civilian endeavor that benefits the population and contributions to state-led repression are getting blurrier by the day. The U.S.-China Economic and Security Review Commission, an independent government agency tasked with evaluating the risks stemming from China, warns, “U.S. businesses and investors must recognize that their participation in the Chinese economy is conditioned by the CCP’s policy priorities and subject to its control.” It is often hard to know when any reasonable line has been crossed.

Here are five principles to help executives find “the reasonable line” and proactively guard against risk:

1) Do more due diligence.

Firms should perform much more rigorous due diligence on any initiative involving China and Chinese firms. Many may be doing this in response to regulatory pressure, but they likely need to go a step further than what regulations require. Tracking down links to the country’s huge security and surveillance apparatus is much harder than it looks — and is only getting harder. For example, the Xinjiang Production and Construction Corps (XPCC), a paramilitary organization run by Party and China’s central government that has been sanctioned by the U.S. Department of Treasury for its human rights abuses, has, according to one accounting, “over 862,600 direct and indirect holdings, including minority, majority, control, and non-control positions.” These touch 147 countries and involve as many as 34 layers of ownership.

The environmental movement’s sophisticated auditing methods, which examine every aspect of a company’s environmental impact — checking its supply, manufacturing, and distribution chain for everything from energy usage to waste products to air emissions — provide some cues on how this might be done. In this case, the audits would check for any connection to China’s myriad human rights violations.

2) Proactively consider the alternatives to doing business in China.

While it’s hard to ignore the market, there are fewer and fewer justifications for buying products from or manufacturing in China if there are other options available. This is especially so given the growing regulatory, legal, and reputational risks. In France, for example, the prosecutor’s office has opened an investigation into whether four apparel companies — Inditex, which owns Zara; Uniqlo; Skechers; and SMCP, the owner of Sandro and Maje — have profited from and concealed “crimes against humanity” by using Uyghur forced laborers. The World Tennis Association recently reconsidered its justifications for doing business in China when it threatened to stop — and forego hundreds of millions of dollars — unless the country confirmed the safety of star player Peng Shuai.

If companies take ESG seriously, stepping back from China makes particular sense. The country is now arguably many companies’ largest ESG risk, and ratings agencies consistently overrate Chinese companies. For example, Chinese banks such as China Construction Bank (S&P Global ESG ranking of 45) often have higher ESG ratings than Western banks such as Credit Suisse (S&P Global ESG ranking of 86) despite their deep involvement with China’s human rights and environmental policies.

The ESG risks are particularly underplayed in the financial sector, which is both establishing new ventures and funneling a growing share of investors’ capital into the country, despite the difficulty in avoiding entanglement in the country’s varied rights violations. For instance, Alibaba, which has developed facial recognition software targeting Uyghurs and helped build the prison camps where over a million Uyghurs have been imprisoned, has the second highest weighting in the MSCI Emerging Markets Index. Given that a commitment to both ESG and China is not possible, companies and investors should beware of the hidden risks given that ESG ratings and the financial sector may paint a rosier picture of doing business in China via their ratings vs. reality.

3) Be extremely careful with sensitive technology.

Firms should not only avoid transferring technology that might have military or surveillance applications (a practice already regulated by the U.S. government), but should avoid investing in ways that might make the knowledge of any related technology more available. Given the Party’s increasing oversight of private business, emphasis on civil-military fusion, and plans for overtaking the West in key technologies, the risk of unsuspectedly helping it have grown substantially. Even if an action breaks no law — the scope of what is banned is relatively small but steadily growing — it may be a clear breach of any reasonable ethical standard.

Products developed in collaboration or shared with a Chinese company could be repurposed for military use — without the foreign company’s consent or even knowledge. Technology developed in a research center or used in a factory could easily be transferred to another company when an employee leaves or works clandestinely elsewhere. Bill Bishop, a digital-media entrepreneur, calls out this naiveté: “I know people in Silicon Valley are really smart, and they’re really successful because they can overcome any problem they face. … I don’t think they’ve ever faced a problem like the Chinese Communist Party.”

Companies that deal in highly sensitive technology should strongly consider not selling to or deploying their tech in China. In other sensitive cases, they should strictly limit who has access — e.g., the technology or know-how could be used in a fully-owned factory with tight controls, but not in a joint venture or in a sale. Less sensitive but still at-risk technology might be sold but only to firms that have been carefully vetted. In addition, firms should invest more in cybersecurity and other safeguards to avoid the kind of IP theft that has become all too common in recent years.

4) Embrace transparency.

Be as transparent as you can be about your operations and investments, and highlight all the measures you are using to ensure ethical practices are being followed. This will not only help identify ethical risks — the process itself will force greater compliance with standards — but also limit the reputational fallout if some unexpected information about a partner or supplier or investment appears.

Consider publishing a comprehensive list of Chinese suppliers, collaborators, and partners, including government entities, state-owned enterprises, public research laboratories, universities, and any other entities that you are working with. While the pressure from the party-state can be great at times, publishing your ethical standards and then regularly reporting on how you are accounting for your actions according to them will limit surprises.

5) Be open to dissent.

Finally, firms should give employees with conscientious objections to doing business with China a way to voice these concerns and opt-out of specific projects. Such objections are becoming more common, with companies being forced to balance competing needs to maintain an efficient as well as attractive place to work. In most cases, this won’t affect a company’s decisions. However, if it turns out that a significant number of staff feel this way, executives may have no choice but reconsider their plans. In Google’s case, 600 employees signaled their objection to Dragonfly in an open letter demanding that it be ended, writing “We object to technologies that aid the powerful in oppressing the vulnerable.”

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Doing business in China ethically is likely to get harder and harder going forward given Xi Jinping’s expanding mandate and agenda. Executives should utilize the five principles above and remember, as George Magnus, former chief economist at UBS, writes, “As a more restrictive regulatory and governance system is brought to bear on everything from Chinese schools and universities to companies, media and entertainment, and often abruptly and without recourse to appeal, investors in Chinese assets will have to weigh the risks more carefully.”

All of this suggests that the narrative on China ought to change among executives. Too many companies are operating as if it is still 2005 — as if the market was full of rich pickings, the government was increasing people’s freedoms, and doing business in the country did not pose so many moral questions.