The Chinese Social Credit System: Foreign Entities

Updated: Nov 28, 2020

China undoubtedly plays an integral part in the global economy. China is the world’s largest exporter by a healthy margin, supplying the United States alone with $522.9 billion worth of goods in 2017. Further, China is a hotbed for foreign investment. Rapid growth over the last 30 years has enticed multi-national corporations and institutional investors to explore the Chinese market. Currently, foreign entities invest over $135 billion into the Chinese economy each year!

But, despite a rapidly growing economy and ever-increasing globalization, China has made it clear that it will continue to operate in the manner it deems best. Chinese officials tend to support a top-down approach to economic guidance. Generally, the government seeks to be the primary economic decision-maker instead of exclusively reacting to external market influences. To some foreigners, this approach can appear somewhat restrictive, even coercive. The soon-to-be-released “social credit” system highlights an instance of the Chinese government implementing a policy that will affect companies from top to bottom—from the large, multi-billion-dollar industries to the smallest local markets.

By 2020, China plans to roll out a national system that will assign a “social credit score” to each business entity located in the country. The Chinese government says that the core principle of this system is to “maintain the normal order of economic activities and … promote the healthy development of the economy and society.” To achieve this goal, the government will implement standards for emissions, intercompany relationships, and overall compliance with Chinese law. Chinese officials plan to quantify compliance through a basic point system—obeying the rules increases points and vice versa.

Among other repercussions, the implementation of the social credit score could increase tension between foreign investors and the Chinese government. An unfamiliar party might wonder, “If foreign entities already abide by the host country’s laws, why would this be any different?”

The reason that this particular piece of legislation might appear unnerving to foreign entities is simple: unless transparency is noticeably improved, the Chinese government has free reign to control the business sector. With this comprehensive system, the government will both set the rules and choose the penalties; in short, it can potentially choose which companies win and lose. Moreover, the government has yet to publish a list of standard penalties. Therefore, foreign entities might be wary of inconsistent application and misinterpretation.

In an unrelated survey administered in 2018, the American Chamber of Commerce in the People’s Republic of China (AmCham China) in partnership with Bain & Company found that the main deterrent keeping foreign investors from allocating more resources to China has been the regulatory environment—its lack of transparency, predictability, and fairness. Further, almost half of the survey respondents claimed foreign companies are treated unfairly compared to local businesses, and 75 percent agreed that foreign businesses are less welcome in China than before. So, many foreign entities already feel in the dark regarding China’s federal regulations; another opaque policy is the last thing they want to see.

This social credit score might play a part in the respondents’ indication that “regulatory compliance risk” is one of the largest problems facing their companies in China. The risks that come with the social credit score system can be detrimental to businesses in any sector. Upon infraction of the policies laid out by the government, foreign entities could be subject to raised interest rates on loans, higher tax rates, inability to issue bonds, loss of permission to invest excess cash in public securities, decreased chances to participate in publicly-funded projects, and restriction of e-commerce. In other words, serious financial inconveniences and penalties can be handed out.

Why does this legal network seem repulsive to some foreigners but necessary to the Chinese? Much of the disagreement can be explained away by Geert Hofstede’s scale of individualism versus collectivism. Hofstede observes that countries lie on different points of a scale, with individualism on one end and collectivism on the other. Countries that value individualism typically believe that citizens have a right to private life, a nation’s identity is found in the individuals therein, and people should take care of themselves. On the other end of the spectrum, collectivist countries tend to make decisions based on what is best for the nation, expect absolute loyalty to the group, and maintain a “we” mentality. The social credit score is a prime example of a staunchly collectivist policy. An individualist-minded person might learn about this policy and immediately have several impulsive, yet justified questions:

“What if I’m falsely accused? What if my company is mistreated? My stock options won’t be affected, right? What happens if I lose my job because compliance is too costly?” The list goes on. To the disciple of individualism, this policy could cause genuine concern.

Unsurprisingly, China is one of the most collectivist-leaning countries in the world. To the typical Chinese mind, the individualist’s seemingly urgent questions might reflect arrogance and impatience. A marked collectivist might think, “Don’t they know that this is for the benefit of the entire nation? If almost a billion people are benefitted through this, who cares if you have to find another job?” Essentially, a pure collectivist might “see the bigger picture” of any given policy more easily. If the federal government insists a policy benefits the whole nation, the collectivist will find honor in promoting the policy over his or her personal agenda.

Although China receives a large amount of foreign investment each year, roughly 88 percent of it comes from countries who also fall on the collectivist side of the spectrum (Hong Kong, Singapore, Taiwan, South Korea, Japan). Unfortunately, between 2015 and 2017, China’s inflow of foreign direct investment only increased by half of a percent.9 China’s recent difficulty in attracting additional foreign investment logically involves any number of variables, one of which could be its collectivist position on Hofstede’s scale.

Cultural differences inevitably influence policies, business practices, and global relationships. In this case, these differences could partially explain why the big players in foreign investment (most countries in North America and Europe) are slower to work with China. To become a more attractive investment for foreign investors, China might have to appeal to foreigners’ cultural norms instead of pushing its own. On the other hand, foreign investors might be incentivized by the rich Chinese economy to stifle their own cultural preferences and collaborate with a government that holds dissimilar beliefs.

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