For China, a Cautionary Tale

Insularity, Unfamiliar Ways
Strain Investments in South America
By JOEL MILLMAN in San Juan Marcona, Peru and PETER WONACOTT in Shanghai
Wall Street Journal. January 11, 2005; Page A18

Peru Mining Union started protest against Shougang ©ReutersResource-hungry Chinese companies are increasingly scouring the world for acquisitions, from farms to oil assets. But China Inc.'s early experiences in the place where it has made the greatest headway, Latin America, show the difficulty companies are having adapting to locales and challenges very different from home.

Throughout South America, Chinese managers have developed a reputation for insularity by cordoning off Chinese workers from their local counterparts, and by failing to work with local businesses and services. Unaccustomed to facing recalcitrant unions or angry shareholders at home, the firms have also reacted slowly to demands from local workers. What Chinese managers view as discipline and thrift, local communities have interpreted as arrogance and stinginess.

The problems haven't derailed Chinese interest. For years, Chinese investment flowed mainly to Hong Kong trading firms as a way to draw foreign companies into the country and pump up Chinese exports. But last year, for the first time, South America topped Hong Kong and the rest of Asia as the top destination for Chinese foreign investment, garnering about half of the $889 million China invested abroad in the first 11 months of 2004.

The swelling investment in South America reflects China's voracious appetite for oil, minerals and agricultural commodities -- and the fat coffers of Chinese firms, stuffed with foreign capital. Beijing has promoted a "go-out" strategy for Chinese companies, epitomized by the barnstorming trip China's President Hu Jintao made late last year in Latin America, where he stopped at four national capitals.

Operating abroad will become a growing challenge for China, as its firms look to transform themselves from their traditional role as low-cost suppliers to Western companies into full-blooded rivals. Many Japanese companies had similar reputations for insularity when they first ventured abroad. But they learned how to operate effectively and dominate markets; their investments were courted by host governments.

Several Chinese companies recently have made high-profile acquisitions. International Business Machines Corp. agreed to sell its PC division to China's Lenovo Group Ltd., a cut-rate computer maker. Meanwhile Chinese electronics firm TCL Corp. recently bought the television arm of France's Thomson SA, as well as the handset operations of France's Alcatel SA. Now China's third-largest oil and natural-gas company is looking at whether to make a bid for Unocal Corp., a U.S. oil giant.

From the perspective of many South American firms and communities, Chinese firms look rapacious. When Ecuadorian oil-services company Dygoil SA won a $69 million contract to upgrade wells for Ecuador's state oil company, Dygoil's financing options were dire: International creditors refused to lend the company operating capital and local banks were changing interest rates of up 20% annually. So Dygoil turned to China National Petroleum Co., which had access to rates of 3% to 4% from the Bank of China. CNPC agreed to come in as an investor. But just before the project began, CNPC decided to work alone and reduce Dygoil to a subcontractor.

"That's the way the Chinese work," says Dygoil president César Guerra. "Once they learn how, they don't need you." CNPC's unit in Ecuador, CNPC International (Amazon) Ltd., declined to comment. But Zhou Chunming, Beijing's commercial attache in Ecuador, says "Mutual cooperation is our only goal."

In the little town of Lago Agro in Ecuador's Amazon rainforest, the aloofness of Chinese companies is easy to spot. A tiny CNPC compound, with a single basketball hoop, sits near a mammoth campus, built in the 1970s by Texaco Corp. Storekeepers and restaurant owners say that their trade with the Chinese is almost nonexistent.

"We work on internal principles," explains Lijun Wang, a CNPC manager. "Each employee is restricted to the compound."

Gree Electric Appliances, from Zhuhai, China, had big plans to manufacture air conditioners in Brazil, but has cut its proposed investment by half. Gree managers grumble that Brazil's labor unions interfere with everything from holiday work schedules to efforts to enforce discipline among workers. "It's simple in China," says Ye Yonqing, a Gree investment executive. "The managers decide everything."

Huawei Technologies Co. says it has learned the way to succeed in South America is for Chinese companies to stop being so Chinese. After six years of doing business in the region, China's biggest maker of telecom equipment has picked up these lessons: adapt to the culture, follow government policies and hire locals, according to Li Jie, spokesman for the Shenzhen-based company. Huawei appointed Brazilians to help manage its marketing and sales office, and technical support center.

Perhaps the most troubled Chinese investment -- and the one that did the most to damage the reputation of China in South America -- is Shougang International Trade & Engineering Co.'s purchase of Peru's state-run iron works, Hierro de Peru. The Chinese firm paid $120 million for the mine in 1993, five times the price of the closest bidder, and pledged another $130 million in investment.

Townspeople in San Juan Marcona buzzed with talk about how China would revive the dying Pacific port. A decade later, the town of 13,000 faces ruin. Last June, scores of workers blocked a highway to demand a pay raise of 85 cents a day and a daily ration of canned milk. Many were fired. Graffiti scrawled across the dirty walls recalls a decade's worth of protests and strikes. One reads: "Go Home Chinese Dogs."

A collapse in the demand for steel and iron ore during the 1997 Asian financial crisis damaged Shougang's business prospects. But the company's local practices also alienated workers and the community. It failed to honor its pledge to modernize the company, and paid Peruvian officials a $25 million fine instead. Without the needed improvements, mine safety declined. According Peru's Labor Ministry, there were more than 170 accidents -- two of them fatal -- at Shougang facilities in 2003, the last year for which complete figures are available. Union leaders say conditions have improved somewhat in 2004.

In China, unions are arms of the government and workers rarely walk off the job, leaving Shougang unprepared for work stoppages in Peru in response to pay freezes. Shougang eventually brought over as many as 270 Chinese employees, who had been through crash courses in Spanish. But the two nationalities rarely worked together. Zhang Baoshan, a former Shougang vice general manager, recalls seeing a Chinese team repairing the wheel of one earthmover and the Peruvians repairing a second earthmover. Chinese who dated locals were asked to report to Shougang headquarters and often had their passports seized, says Mr. Zhang, who retired from Shougang in 2002.

When Shougang later decided to send its imported laborers home, it replaced them with cut-rate temporary workers who received none of the health or housing benefits that unionized workers are entitled to under Peruvian law. In time, those employees formed their own union to wring better wages and conditions from the Chinese.

For most of the past eight years, Shougang has barely broken even on the mine, despite recent high prices for steel. Shougang declined to discuss its labor problems. Shougang's chief spokesman in Beijing, Gu Liyun, says the company has abided by Peruvian law.

Some Chinese companies say they are learning from Shougang's many mistakes. After signing a deal to help build a chemical plant in South America, Sichuan Lu Tian Hua Co. dispatched executives to Bolivia to learn about the investment environment, raw material supply, local taxes as well as salaries and conditions for workers, according to Zhang Bin, an executive in the company's securities division, who adds, "We know a little bit about Shougang's stories."