Institutional Environment and mnes'
Strategy in Transitional China
Yongqiang Gao
mnes face a complex institutional environment when doing business in
the international market. As a result, mnes adopt strategies to deal with
the institutional pressures. However, present studies seldom discuss the
institutional environment of a given country, specifically China. There-
fore, the strategies that mnes can use to cope with the institutions in
China are far from being discussed. This study contributes to making
up this gap. In this study, the identified important institutions in China
are Chinese culture, governmental system, and non-governmental or-
ganizations (ngos). They exert coercive and normative pressures on
the operations of mnes. Four strategies can be selected by mnes to deal
with the institutional pressures: guanxi strategy, commitment strategy,
competitive strategy and leverage strategy. Guanxi strategy and com-
mitment strategy are commonly used to build good guanxi with Chi-
nese governors and ngos. Competitive strategy is used when mnes
have high bargaining power against Chinese governments, while lever-
age strategy is used mnes in setting conflicts between different institu-
tions or parties to resist the unfavorable pressures from institutions in
China.
Key Words: China, institutional theory, institutional
environment/pressure, multinational enterprise (mne)
jel Classification: F23
Introduction
Since the openness policy in 1978, China has attracted more and more
FDi (foreign direct investment) from all over the world. Rapid economic
growth, big market opportunity, and inexhaustible cheap high-quality
labor forces have turned China into a paradise of investment. From 2004
on, China receives more than usd 60 billion every year. By 2000, 400 of
the 500 most famous mncs (multinational corporations) had invested in
China (Luo 2000). After accession into wto in 2001, the fdi that flows
into China is again accelerated.
Dr Yongqiang Gao is an Associate Professor
at the School of Management, Huazhong University
ofScience and Technology, China.
Managing Global Transitions 6 (1): 5-21
However, after entering into China, mnes find they confront a very
different business environment from their home countries. The business
settings in China are different from those in advanced Western countries
in many ways. The most salient difference lies in its authoritarian po-
litical system, which exerts great influence on business operations and
corporations' development (Chen 2004).
Although China is leading a transition of the economic system from a
central planning economy into a market-oriented one, government in-
fluence is however still overwhelming (Child and Tse 2001). Despite two
decades of reforms, officials at various levels of the government in China
still have considerable power to approve projects and allocate resources
(Walder 1995). As a result, arbitrary intervention from the government
remains a constant danger to many firms (Nee 1992; Peng 1997). There-
fore, an appreciation of Chinese business management will not be com-
plete unless we carefully examine the complex interactions between busi-
nesses and governmental agencies. Successful investing in China requires
investors to master a complex political and regulatory environment. Top
managers make their important decisions after taking into consideration
not only market factors such as customers, competitors and demand, but
also the important roles played by various government entities in China
(Li and Zhou 2005).
Regretfully, the political environment in China is seldom discussed in
academia except for Chinese guanxi (Hwang 1987; Xin and Pearce 1996;
Yang 1994; Yeung and Tung 1996). Besides, mnes' strategies and behav-
iors dealing with the governments in China are far from being discussed
either. This paper aims to make up the deficiency by focusing on the in-
teraction between mnes and the Chinese government.
This paper is organized as follows. The following section briefly re-
views the FDi and mnes received by China in recent years. Then we in-
troduce institutional theory as the theoretical background. The fourth
section discusses the political or institutional environment that mnes
have confronted in contemporary China. The fifth section analyzes the
mnes' response to the Chinese political environment. Finally, a conclu-
sion is proposed.
fdi and mnes in China: A Brief Review
The inflow of fdi or foreign mnes into China begins from the imple-
mentation of the openness policy in 1978. Records documented that, dur-
ing the 1980s, fdi flows into China increased slowly. But two important
events accelerate the inflow of fdi into China thereafter. One event took
place in 1992. In this year, Deng Xiaoping, Chairman of the State at that
time, visited southern regions and published 'South Talk'. 'South Talk'
ended the uptight disputation 'whether market economy is socialistic or
capitalistic' in China, and as a result, most provinces formulated favor-
able policies to attract fdi and mnes. Data show that in i99i,the actu-
ally used fdi in China is only usd 4.37 billion. But in 1992, the amount
arrives at usd 11.01 billion, and to 1993, it even amounts to usd 27.52
billion. The second event takes place in 2001. In this year, China joined
in wTo formally, which accelerated the inflow of fdi once again. The
number of actually used fdis increased from usd 40.72 billion in 2000
to usd 52.74 billion in 2002. The effect of these two events on the inflow
of fdi into China can be seen clearly in figure 1.
Figure 1 illustrates the achievement in using fdi that China achieved
in the past two dozen years. In 1983, the fdi that China really used is
less than usd 1 billion, but in 2005, China received more than usd 60
billion, which is more than sixty times the number of 1983. In 1991, the
fdi that China received only accounts for 2.26 per cent of the global to-
tal fdi inflow. But in 2004, the fdi that China received accounts for 9.90
per cent of the global total fdi inflow (United Nations Conference on
Trade and Development 2004). Today, China is the largest fdi destina-
tion among developing countries and the second largest in the world,
following the us.
It is said that the success of China in receiving fdi may be attributed
largely to the exhaustible cheap labor forces. But in recent years, the rapid
growth of gdp acts as another contributor. With the accompanying in-
crease in people's income, China is becoming a huge market for most
commodities and services. For most mnes, China is a market that they
cannot lose.
There are five types of fdi approved by the foreign direct investment
policy in China: (1) equity joint ventures, (2) contractual joint ventures,
(3) foreign-funded enterprises (so-called wfoes), (4) share-holding en-
terprises, and (5) cooperating development (Chen 2004). By the end of
June 1997, it was reported that over 200,000 business joint ventures had
been registered in China, with a total foreign investment of usd 204 bil-
lion (China Statistics Yearbook 1997).
In 2000, as many as 400 of the 500 most famous mncs had made in-
vestment in China (Luo 2000). Today, it is said that more than 450 of
Fortune 500 companies (listed in year 2004) invest in China. The amount
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
2.
II
-
II
II
4.37
3.49
3.39
3.19
31
2.24
96
1.42
0.92
11.01
60.30
60.63
53.51
52.74
46.8
40.72
40.32
45.46
45.26
41.73
37.52
33.77
27.52
figure 1 fdi inflow into China (in billion us dollars, drown from the China Statistics
Yearbook (see http://www.stats.gov.cn) for corresponding years)
of mnes that make investment in China totals 280 thousand, and the ac-
tual used foreign capital amounts to usd 600 billion (China Statistics
Yearbook 2005).
Theoretical Background: Institutional Theory
Businesses respond to their environment either to develop and exploit
opportunities or to react to perceived threats (Andrews 1987). Chan-
dler (1962) was an early contributor to a long tradition of research on
the relationship between environment and strategic behaviour. He sug-
gested that changes in strategy, and in structure, are directly related to
changes in the market or in general in the firm - relevant environment.
His work has opened the door to the important contingency theory con-
tributions and to a flurry of theories and studies that have confirmed
the close relationships between environment, strategy and structure
(Lawrence and Lorsch 1967; Thompson 1967; Venkatraman and Prescott
1990).
Different from the contingency theory that focuses mostly on the
task environment (Thompson 1967), institutional theory deals with
choices made in response to or in compliance with an organization's
institutional environment (Bluedorn et al., 1994). Institutional theory,
which developed from the behavioural theory of the firm, focuses on
the purposeful efforts of individuals to respond to environmental pres-
sures in ways consistent with the institution's rituals and formality and
based on values that are important to the institution (Stinchcombe
1997).
Institutions are defined as regulatory structures, governmental agen-
cies, laws, courts, and professions (Scott 1987a, 498). They 'define condi-
tions and set limits for maintaining a stable system; they regulate social
relations to maintain conformity with existing value patterns and con-
sistency among these patterns themselves' (Oberman 1993,215).
The institutional environment comprises the rules and requirements
with which organizations must comply to gain the desired rewards of
support and legitimacy (DiMaggio and Powell 1983; Meyer and Rowan
1977; Zucker 1988). Institutional theory identifies three types of pres-
sure: coercive-conforming in response to unavoidable requirements,
such as regulatory pressure, normative-conforming in response to cul-
tural norms, and mimetic-conforming to meet (mimic) the behaviors of
competitors (DiMaggio and Powell 1983).
Institutionalists emphasize that rules, laws and regulations, norms
of behaviour, and cultural-cognitive orientations all but determine be-
haviour more than do contingency and competitive factors (DiMag-
gio and Powell 1983). Institutional actors include not only the state
and the professions, but also interest groups and public opinion (Scott
1987b).
In the search for legitimacy and acceptance, organizations tend to be-
have in ways that are alike rather than different. Isomorphic behaviour is
therefore seen as widespread, conditioning even strategic behaviour. It is
considered essential for organizational success in a complex institutional
environment.
In this study, the main institutions that mnes face in China include
unique Chinese culture, the governmental system and non-governmental
organizations (ngos). The corresponding institutional pressures that
mnes confront include coercive pressure from government policies and
regulations and normative pressures from Chinese culture and ngos.
mnes have to develop strategies to deal with the pressures.
The Institutional Environment in China
The typical institutions that mnes have to cope with are Chinese culture,
governmental system and ngos. The characteristics of these institutions
are introduced in this section.
the confucianism culture
Chinese traditional culture is also called Confucianism, due to the influ-
ence of Chinese sage Confucius (ca. 551-479 bo). Confucianism is not
a religion but a set of guidelines for proper behavior (Hofstede 1991;
Tu 1998b). Confucianism has shaped the social interaction of people in
eastern and southeastern Asian countries for more than 2000 years (De
Bary 1991; Slote and DeVos 1998; Tu 1998a; 1998b). Recent economic mir-
acles in Hong Kong, Singapore, Taiwan, and other southeastern Asian
countries have aroused interest in Confucianism (Yan and Sorenson
2006).
The most outstanding characteristic of Confucianism culture is guanxi
(relationship). Confucianism considers people as a part of the social
network. The whole society is just a huge network in which a person
plays different roles. In general, Confucianism uses five virtues to de-
fine the relationship between individuals (Tu 1998a). The five virtues are
humanity/benevolence (ren), righteousness (yi), propriety (li), wisdom
(zhi), and trustworthiness (xin). Five basic social relationships are also
defined: father and son, ruler and ruled, husband and wife, elder brother
younger brother, and friend and friend (Tu 1998c; Xing 1995).
As a result of Confucianism culture, the legal system of China is rel-
atively weak, while 'guanxi' among individuals is very strong. It is well
known that the Chinese are enthusiastic in building guanxi with oth-
ers. Business often takes place between two parties that are connected
with each other. The importance of guanxi in China is well recognized
figure 2 The Structure of Chinese Governments (adapted from Bulletin of State
Council, 30 April 2003)
by many scholars (Leung and Yeung 1995; Tsang 1998; Xin and Pearce
1996).
Culture as an institution exerts normative pressure on mnes, which
requires mnes to recognize the cultural differences between home and
host country and respect the host country's culture. Business opera-
tions should comply with the norms and values embedded in the host
culture.
the governmental system
The governments in China can generally be divided into two levels: the
central government and the local governments. The central government
includes the State Council and its directly controlled organizations. Lo-
cal government can further be divided into provincial, municipal, county
and township governments. The structure of Chinese government insti-
tutions is illustrated in figure 2.
Many organizations are authorized by State Council to formulate poli-
cies and regulations aiming at mnes. For instance, the National Develop-
ment and Reform Commission (ndrc) is authorized to issue the 'Cata-
logue for the Guidance of Foreign Investment Industries', and the State
Administration of Taxation (sat) is authorized to formulate preferential
tax policies about fdi, and the like.
As far as business is concerned, Chinese governments show the follow-
ing characteristics:
1.	Extensive government intervention in economic affairs. It is said
that in the 1990s, to get government approval, a typical major con-
struction project experienced checks by 7 ministries, 8 examining
and approval bureaux, and had 58 red stamps and 169 officials'
signatures, and this process lasted two years (Tian et al. forth-
coming). After the implementation of 'Administrative Approval
Law', there are still 500 items/projects need to be approved by
the related government agencies. Procedures to acquire official ap-
proval are very time-consuming (Holtbrugge and Berg 2004) and
costly.
2.	China is a country with a decentralized government structure. Na-
tional laws are often only broadly drafted at the central level and
their implementation is left to the discretion of regional and lo-
cal administrations (Holtbrugge and Berg 2004). The decentralized
government structure gives provincial and local governments the
freedom to intervene in economic activities. 'In this context any
prominent administrator is in a position to give a go-ahead to an
exception and can find out a suitable reason for it, such as to re-
lieve rural poverty, to reduce losses incurred by a state-owned firm,
or to defuse disturbances among a group of employees' (Blackman
2000).
3.	There are conflicts among different administrators. Firstly, since
local governments face different primary interests from the cen-
tral government, it is inevitable that there is conflict between local
governments and the central government. Conflict among different
levels of authority arises for the following reasons: (a) inconsistent
interpretations of laws and regulations, (b) different political prior-
ities of economic issues, and (c) various stakes acquired from mnes
(Chen 2004). Besides, the division of jurisdiction among different
ministries is not very clear in China. As a result, different ministries
often issue conflicting regulations.
Government acts as a coercive pressure on mnes. mnes are not only
demanded to abide by the policies and regulations issued by government,
but also to meet the expectations of government, such as large scale of in-
vestment, transferring high technologies or management skill, and so on.
Institutional Environment and mnes' Strategy in Transitional China 13
the ngos
The rising influence of non-governmental organizations (ngos) is one of
the most significant developments in international affairs over the past
20 years. The emergence of ngos seeking to promote more ethical and
socially responsible business practices is beginning to cause substantial
changes in corporate management, strategy, and governance (Doh and
Teegen 2003).
There are about 800,000 ngos in China, including media, char-
ities such as China Charity Federation (oof), China Welfare Fund
for the Handicapped (owfh), China Foundation for Poverty Allevia-
tion (ofpa) and China Youth Development Foundation (oydf), trade
unions, and other ngos such as All-China Association of Industry and
Commerce (aoaio), All-China Women's Federation (aowf), All-China
Federation of Trade Unions (aoftu) and All-China Youth Federation
(aoyf), etc.
Among the ngos, the media play an outstanding and increasingly im-
portant role. They can lead public opinion, which in turn imposes on
business operations. However, the media and other ngos are controlled
by the governments in China. Although the media can comment on and
criticize the misconduct of businesses or even governments, the underly-
ing rule is that if a conduct or business is approved by the governments,
the media within the jurisdiction of the governments should not say 'no'
(Gao 2007). To understand this point is critical for businesses dealing
with ngos in China.
ngos bring normative pressure to bear on mnes. mnes are expected to
do business in China ethically. They are also expected by the NGosto give
a helping hand in settling down laid-off workforce, providing charitable
donations, improving the community's medical and sanitary conditions,
and the like (Gao 2007).
mnes' Strategies towards the Institutional Environment
Facing institutional pressures, some firms adapt themselves to the pres-
sures passively, while more firms respond to the pressures proactively,
by taking into account both their resources and the strength of the in-
stitutions involved. Oliver (1991) has suggested five strategies that could
be used by mneS: acquiescence, compromise, avoidance, defiance, and
manipulation. Although the typology of Oliver (1991) is widely used in
academia, here we would like to provide another typology. We think if
mnes want to strive for a favourable institutional environment or to deal
with the unfavourable institutional pressures in China, four strategies are
recommended: guanxi strategy, commitment strategy, competitive strat-
egy and leverage strategy.
GUANXI (RELATIONSHIP) STRATEGY
Confucianism culture indicates that a guanxi strategy is the most impor-
tant strategy for doing business in China. Guanxi generally refers to re-
lationships or social connections based on mutual interests and benefits
(Yang 1994). It is a way for mnes to adapt to the institutional environ-
ment and to obtain scarce resources such as legitimacy and approval in
China.
How to build social and business guanxi in China is the core problem
for mnes. Present literature on guanxi has shed light on the ways to build
guanxi in China (Fock and Woo 1998; Pearce and Robinson 2000; Yeung
and Tung, 1996). Put simply, as Gao and Tian (2006) and others identi-
fied, the frequently used ways to build guanxi with Chinese government
officials are gift-giving and money-giving, inviteing officials to banquet,
visiting officials frequently, paid travel, honoraria for speaking, inviteing
officials to inspect workshops, personal help, and so on.
The main difficulty in adopting a guanxi strategy lies in its ethics. To
build guanxi often means to give a gift, as Yeung and Tung (1996) iden-
tified, gift giving is one of approaches to build a guanxi (relationship) in
China. Although formal gift-giving is different from bribery in China
(Steidlmeier 1999), it is very difficult to identify an ethical gift-giving
from an unethical gift-giving or bribery. Just as Steidlmeier (1999) noted,
'from an ethical perspective, it is very difficult to know when it is proper
to give or receive a gift, what sort of gift is appropriate, or what social
obligations gift giving imposes.' Therefore, mnes should be careful in
adopting a guanxi strategy.
commitment strategy
Commitment can be taken as a tool to build good relationships between
mnes and the Chinese governments. However, as we discussed previ-
ously, since Chinese governments and ngos have expectations regarding
mnes, the latter can meet the expectations by 'commitment'. Commit-
ment strategy can help mnes to build a favorable institutional environ-
ment even though they do not have guanxi with governmental officials.
Hung's study (2002) of mncs in China showed that, after 20 years of
economic development, commitment is still the strongest element for
demonstrating multinationals' determination to do business in China
and an incentive to gain the support of the Chinese government. mnes
have demonstrated four ways of showing their commitment to the Chi-
nese authorities. The first is to increase their investments in China. The
second is to use their advanced technologies and management tech-
niques for the betterment of Chinese society, and the third is to devote
themselves to communities and social affairs, such as donations and par-
ticipating in the Project of Hope for poor children's education in the
rural areas. The last approach is to localize multinationals' practices in
China by hiring and training Chinese employees (Chen 2004).
competitive strategy
When an mne has high bargaining power against Chinese governments
due to its substantive capital and advanced technologies, it can adopt a
competitive strategy. A competitive strategy means that mnes can bar-
gain with the Chinese government. It can be seen as an action taken by
mnes to reduce institutional uncertainty and ensure the resource supply
in China.
To take a competitive strategy, the first step is to identify and evalu-
ate the bargaining power of mnes against the Chinese government. If
an mne's bargaining power is low, then a coalition may be built or the
collective organizations such as Chamber of Commerce are utilized.
A good example is the coalition of 54 foreign companies in China to
bargain with the State Council of China. When they heard that the Chi-
nese government wants to integrate income tax for domestic and for-
eign companies (foreign companies enjoy revenue alleviation in China
since 1978, the income tax rate for domestic firms is 33%, while for for-
eign companies it is 15%) and to increase the income tax rate of for-
eign companies in 2004, 54 foreign companies built a temporary coali-
tion. The coalition formulated a report named 'Some opinions on the
new income tax law for enterprises from foreign companies in China'
and, in January 2005, sent it to the Legal System Office of State Coun-
cil of China, Ministry of Finance, Ministry of Commerce and State Ad-
ministration of Taxation. The report requests the Chinese government
to give a 5-10 year transitional period and hopes that the Chinese gov-
ernment will provide a 'reasonable and competitive' income tax rate for
mnes. The collective action of foreign companies obstructs successfully
the integration of income tax for domestic and foreign companies (Gao
2008).
Beside the contemporary coalitions, some permanent coalition of
mnes have emerged in China, for example, the us Chamber of Com-
merce and European Chamber of Commerce.
leverage strategy
Leverage strategy refers to using one part to beat another part. mnes
have three ways to take a leverage strategy. The first is making use of the
local government to resist the influence of central government, or one
Ministry to beat another. The second is making use of home government
in bargaining with the Chinese government. The third is making use of
international institutions such as wto to resist the Chinese government
(Gao 2008).
At first, China is a country with a decentralized government structure
(Holtbrugge and Berg 2004). The decentralized government structure
gives local governments the freedom to intervene in economic activities
to some extent. Since local governments face different primary interests
from the central government, it is inevitable that there is conflict between
local governments and the central government. Conflict among different
levels of authority arises for the following reasons: (1) inconsistent inter-
pretations of laws and regulations, (2) different political priorities of eco-
nomic issues, and (3) various stakes acquired from mnes (Chen 2004).
In addition, the division of jurisdiction among different Ministries is not
very clear in China. As a result, different Ministries often issue conflict-
ing regulations. As a consequence, many mnes influence Chinese busi-
ness policies toward their preferred directions by gaining support from
their governmental partners or by leveraging one governmental unit
against another. For example, the Tianjin Technological and Industrial
Development Zone Authority (tidza) completely supported its biggest
client, Motorola China, and challenged Beijing in a number of regula-
tions to assist Motorola in becoming a member of the zone (Post et al.
2002).
Secondly, some mnes ask home government for help in bargaining
with the Chinese government. Through negotiations of bilateral agree-
ments, mnes are empowered to affect Chinese policies or regulations as
a whole nation. This gives mnes more power by changing the political
structure wherein negotiations take place from state-to-state rather than
state-to-firms. In addition, putting the business issues at an international
level allows foreign firms with hegemonic states as home countries to
affect China's decisions through the operation of international organi-
zations (Chen 2004). Amway China applied this strategy when dealing
with the Chinese ban on direct selling in 1998.
Thirdly, after China joined the wto in 2001, some mnes begin to use
the rules of wto to influence the decision-making of the Chinese govern-
ment. Petras (2000) argued that China's integration into global markets
through wto membership produces a greater subordination to the usa,
based on its aggressive economic, military and political power inherent
in the international system. He argued that by further lowering barriers
of foreign business operation and trade as required by the wto, the usa
gains strategic advantages and us-based mnes obtain access to China's
financial sector, agricultural market and high-tech consumers. Pearson's
analysis (2000) of China's accession to gatt/wto found four significant
driving forces in the formation of Chinese foreign trade policy: elite pref-
erence, pluralization of domestic actors, external influences and public
opinion. As to the external influences, Pearson (2000) argued that in-
ternational pressure originated from international leadership seeking to
force China into an existing international market and system in order
to be able to regulate and monitor its actions. She further pointed out
that the most decisive international influence is to learn from norms and
beliefs applied in international regimes.
Conclusion
China, as a huge market and the supplier of exhaustible cheap qualified
work forces in the world, has attracted more and more mnes. However,
China is a very different market from the West's due to her unique in-
stitutional environment. This paper acts as an endeavour to discuss the
institutional environment, especially the political environment in China
and the responses of mnes.
The main institutions in China are Chinese culture, governmental sys-
tem and ngos. They exert either coercive pressure or normative pressure
on mnes. In dealing with the institutions, mnes can take four strategies:
guanxi strategy, commitment strategy, competitive strategy and leverage
strategy. The guanxi strategy and commitment strategy aim at building
good guanxi with governments. Competitive strategy is used when an
mne has bargaining power or can gather bargaining power by collection
against the Chinese government. mnes have three ways to take a leverage
strategy: (1) Making use of the local government to resist the influence of
central government, or one Ministry to beat another; (2) Making use of
home government in bargaining with the Chinese government; (3) Mak-
ing use of international institutions such as wTo to resist the Chinese
government.
Acknowledgments
This paper is financially supported by Humanity & Social Science
Fund of Education Ministry of China (No. 06JC630011).
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