Human Resource Issues in China
Klaus Koehler, Managing Director, Klako Group

Many Foreign Investment Enterprises (FIEs) are now finding that the biggest obstacle to their growth in China is the acute shortage of high quality and experienced management. Foreign direct investment has soared in recent years and with it has the demand for quality management. As established businesses have grown, the need for new and far more complex management roles has emerged, which previously hardly existed in China's old state run enterprises.

Furthermore the rapid rise in the economy has resulted in a workforce with career aspirations and attitudes that have been forged solely from the experience of knowing a booming market. Job-hopping has become commonplace. With traditional local education still largely focused on academic knowledge to real life business situations, there is an acute shortage of practically skilled young people joining the workplace.

As a result, the HR function has become one of the key issues for any developing foreign business in China. Pressed with the need to fill positions quickly, HR departments are hiring it seems at any price, lowering the qualifications they are prepared to accept to dangerous levels. This does not only result in a wage spiral, but also with a far lower level of competence in high end management positions. HR departments are now being thrown into a new era. Whereas originally HR was mainly about recruitment, the focus has shifted increasingly to development and retention and there are indications that salary levels are already beginning to rise - particularly when fringe benefits are taken into account. Average employee life may be no more than a year and so HR departments are under increasing pressure to find ways to retain staff. Candidates are also more sophisticated these days. They are getting choosier and are far more particular about what a company has to offer.

Attracting Talent with Additional Benefits

So what are companies offering to appeal to their prospective employees?
Career development and training schemes are popular. However what is vital is that the training is delivered. It has been found in surveys that a large number of staff looking for jobs have left their previous positions because training or career development promises were never fulfilled. This stands in contrast to the belief of many companies that employees leave because they seek better pay.

Other strategies that companies are using to boost retention rates are company car, home loans, generally run over five years, or an MBA or EMBA sponsorship run over three years. Stock options are another perk for senior management that are being used in the market. There is also a trend to give local managers greater responsibility for managing their own affairs between clients / customers in China and the overseas offices.

The salaries of highly qualified staff, especially those with work experience, will continue to climb. Foreign enterprises will have to learn that key employees must be paid according to their marginal revenue product i.e. to the value that they add to the company, not to quickly out-dated and simplistic ideas about cheap Chinese labor. There is no adequate business reason to pay different salaries to two equally qualified employees, simply on the grounds that one is Chinese, and the other is a foreigner. The value of a staff member lies in what they produce, not in how little they can be paid.

Retention of Staff

Retention of staff, particularly at a senior level is becoming a major company priority, not just for the costs in recruiting replacements, but because when senior management leaves, it is commonplace for members of the subordinate management team to leave with them. A reason for this is that generally senior management changes are amongst the most unsettling for staff. They feel insecure with how they will fit in with a new boss, and many decide it is time to look elsewhere. They also find it reflects poorly on the company and its image.

Local Management

The effects of China's rapid growth are being felt everywhere. In Human Resources, a significant repercussion is that the demand for Chinese management talent is far outstripping the supply. Foreign firms in China need local people with local knowledge to overcome their most common blind spot, namely ignorance of the way business is done here as opposed to anywhere else. Domestic companies, likewise, need well-trained managers in their ranks to be able to compete effectively with foreign competitors.

What all these companies need is quality local managers who understand internal business practices. That is why the master of business administration degree has suddenly become such a must-have in China management.

Business education in China is still young. All that is certain right now, is more talent is needed. Look for the number of schools, the number of students and the list of areas of specialization to grow as China continues to work to build a managerial workforce that is as impressive as its labor force.

Return of Overseas Chinese

The role of an overseas Chinese in the development of the mainland's economy has repeatedly been emphasized as a key factor for China's overall ascension into the global competitive arena.

More than a year ago, Beijing officials publicly encouraged foreign-living Chinese to return to the motherland and contribute to China's imminent prosperity. From the perspective of the government officials, the motivation to promote their return is clear. Overseas Chinese bring with them a wealth of trade contacts, new ideas and capital, all of which will inevitably add value and more stability to an economy that is bursting at the seams.

The so-called "returnees" have naturally a distinct advantage today over the local Chinese, and subsequently, they hold many desirable positions in multinational companies in China.

Statistics show that the number of returnees has increased by 13% every year. Companies seeking replacement for their Western expatriates see returnees as a viable option for many reasons. Prime among them are fluency in English and knowledge of western business models. They are also a less expensive talent pool than their foreign counterparts. Most of these returnees match their western expatriates in terms of degree of education, language skills, and work experience acquired within companies in China.

However, over the past few years, the competitive advantage of the returnees over the locals is changing. The main reason for this has been the additional cost that many companies have invested in training local employees. Some companies today place returnees on par with locals and test them equally for skills and specifications required for the job at hand, and then decide on recruitment. The preference earlier given to Chinese returnees is fast disappearing in the compensation arena, too.

Blue Collar Workers

For foreign companies looking for cheap factory labor, they may be surprised to find that China will not retain its dominant position forever. Recently, companies in southern Guangdong province have complained of labor shortages. Despite China's population of 1.3 billion, much of which remains unemployed in the agriculture sector, the appeal of becoming a migrant worker and traveling to find a job in a coastal city has dropped. According to a report from the Chinese policy research institute of Dongguan, there is a shortage of nearly two million migrant workers in the Pearl River Delta region alone.

Some claim that the shortage is specific to southeastern China, arguing that other regions such as Shanghai are still attracting large numbers of factory workers, others point to structural problems. China's implementation of special economic zones (SEZ's) on its coast in the early 1980s created a system where workers traveled to the factories. It is now believed this system may not be sustainable and that factories may have to move to the regions where the workers are located, not vice versa.

MNC's with better reputations and better working conditions than local, Hong Kong or Taiwanese companies have been more successful in recruiting and retaining blue collar workers. And some MNCs have been successful by offering perks and increasing worker satisfaction. But while China remains the "factory of the world", labor shortages and rising wages, especially on the east coast, will undoubtedly affect the strategies of firms looking to use China as a manufacturing base.

General Rules and Regulations for Staff Employment

Foreign Representative Offices are not permitted to hire their own local staff. Government organizations such as China Intellectual Corp or FESCO are required to hire the local employees on behalf of the foreign companies. According to Chinese officials, as Representative Offices are not legal entities, the foreign labor service market needs to be regulated and standardized in order to guarantee that welfare and social benefits are provided to the employees by the Representative Offices.

Wholly-Foreign Owned Enterprises or Joint Ventures are limited liability companies and therefore have the right to employ local staff directly without using a government agency. There are certain issues all employers should address when designing labor contracts. There are two types of labor contracts: individual or collective. Individual contracts are made with employees on a one-to-one basis and collective contracts are made between the employer and the trade union. Individual contracts can be filed for certification within a month of signing whereas collective contracts must be filed with the local labor bureau within seven days of signing.

For workers, overtime payment is typically 150% of the normal base wage, 200% for non-holiday "rest days" and 300% for public holidays. Salaries and individual income tax must be paid monthly. Other types of compensations include bonuses, benefits, housing, transportation, meal allowances (if any) and leave.

In the case of foreign-invested enterprises (FIEs) there are major differences between western and Chinese business practices, which make it more effective to provide employees handbooks in conjunction with employment contracts in order to convey company policy and expectations.

Rules and Regulations for the Employment of Foreigners

When deciding to employ foreigners in China particular care should be given towards the application and licensing process. This is to ensure that neither the company nor the individual overlooks or neglects to comply with any regulation that may subject them to fines, revocation of working status or in serious cases, expulsion from the country.

Once arriving in China, the foreign expatriate must receive a Health Check performed by a specific government hospital before receiving the work permit and residence permit.

It is important to note that employment permits and residence permits are subject to annual inspections and renewals by the local labor authorities. It is the employer's responsibility to present these documents to the issuing certificate office. Failure to observe and follow the regulations in general can lead to fines, deportation or in severe cases, criminal prosecution.

Individual Income Tax payment is a big issue in China. In simplified terms, if an expatriate is less than 183 days in China, the income does not have to be declared in China. If an expatriate is in China for more than 183 days, this person has to declare their worldwide income to the tax authorities. Foreign companies should be aware that it is common for expatriates to under report the period of residency, salaries received in or outside China, or if they travel all over China instead of being based in one location.

To discuss a remuneration package for foreign employees that includes the fact that they will have to pay IIT in China, is important, because if the employee undervalues or does not pay the correct amount, it may lead to consequences for the company as well.

Potential Risks of Under-Declaring Salaries and Expenses

Many companies setup local personnel accounts in China under the name of the Chief Representative or local Chinese staff to fund the WFOE or the RO and pay related expenses which are not officially booked in the WFOE / RO accounts in order to reduce tax liabilities. Other common practices include the General Manager / Chief Representative withdrawing money through the local ATMs from foreign accounts to fund RO related expenses, under declaring salaries, not registering foreign or local staff.

Again, the foreign company should understand the common practices, in order to put monitoring systems in place avoiding these are used without the company's knowledge.

If the company does not officially declare all expenses through the WFOE / RO account or have separate funds to finance the local activities, then firstly, it is not in compliance, and secondly there is the risk of staff turning this against you when they are dismissed or leave the company (blackmailing and threats to disclose malpractices to local authorities are common in order to seek own financial gains). Local staff may even manipulate the company records to ensure it is not in compliance - in order to hold leverage against the company in the event of any disciplinary action being taken against them at a later stage. It is common. China is no exception to the rule that it does not like tax evasion. The penalties for late payments, non-payment and other transgressions (naivety is no excuse) can be severe - often five times the amount due, plus the original liability. In cases of blatant evasion, businesses can have their licenses withdrawn and assets seized.

Conclusion

Whereas previously, foreign companies may have invested more long term in their HR strategy, in today's China, companies are under more pressure to deliver in a shorter timeframe. Consequently, expatriate managers with only two to three years in which to make an impact may not have the time or motivation to develop a long-term focused HR strategy because the benefits are not going to come in their tenure. What is required is a far greater long-term involvement by companies in educational activities and internships, and for a policy shift to make the educational system more focused on servicing the needs of the evolving business community. Such developments may take a long time to make a difference. For some time to come, effective Human Resources management will remain a tough challenge for foreign companies and one that is only likely to get tougher.

If you require assistance with the above subject, please contact us at info@klako.com with your detailed questions.

All information in this report is verified to the best of our ability and is assumed to be correct at time of release; however, Klako Group does not accept responsibility for any losses arising from reliance on the information provided within.