VII. INVESTMENT CLIMATE A. Openness to Foreign Investment Government Attitude Toward Foreign Private Investment: Since 1978, China has actively sought foreign investment and technology. Austerity measures in 1988- 89 and the political tensions following the 1989 Tiananmen incident led to a temporary deterioration of the environment for investment. However, with looser credit and new calls for reform and opening following Deng's celebrated trip to South China in early 1992, China's growth accelerated and a number of new cities and sectors were opened to foreign involvement. Since then, China has started a series of "experiments" to allow limited foreign investment in service sectors. Basic Laws and Regulations Covering Direct Investment: The fundamental legislation dealing with foreign investment in China, the Law on Chinese-Foreign Joint Ventures, appeared in 1979. Implementing regulations issued in 1983 (which, like the Joint Venture Law, have subsequently been amended) detail the form and organization of joint ventures, ways of contributing investment, and rules on the organization of the board of directors and management. Provisions also cover acquisition of technology, the right to use land, taxes, foreign exchange control, financial affairs, and hiring and firing of workers. A third important central government decree is the October 1986 Provisions of the State Council Encouraging Foreign Investment (commonly referred to as the "22 articles"). Certain articles of this and related legislation deal with tax treatment, hiring practices and guarantees of autonomy from government interference. Forms of Foreign Ownership: In those sectors where foreign investment is allowed, foreign-invested enterprises can exist as holding companies, wholly- owned enterprises, equity joint-ventures or contractual joint ventures. Under China's new Company Law, foreign firms can also now open branches in China. Investment Screening Procedures: Potential investment projects usually go through a multi-tiered screening process. The first step is approval of the project proposal. The central government has delegated varying levels of approval authority to local governments. Formerly only the special economic zones and open cities could approve projects valued at up to $30 million. This approval authority has now been extended to all provincial capitals and a number of other cities throughout China. Most other cities and regions are limited to approving projects valued below $5 million. Projects exceeding these limits are approved by the Ministry of Foreign Trade and Economic Cooperation (MOFTEC) and the State Planning Commission. If an investment involves $100 million or more, it must obtain State Council approval. MOFTEC, however, is still authorized to review all projects, regardless of size. The approval process has become less of an obstacle given the current emphasis on promoting foreign investment, but government officials will evaluate each project against official guidelines to see if it: promotes exports to increase foreign currency income; introduces advanced technology; or provides technical or managerial training. Even if a project meets one or more of these requirements, it is still possible that the project will be rejected if it is determined that the contract is unfair, that the technology is available elsewhere in China, or that China already has sufficient production capacity of the given product. Investment Incentives: China has a complex system of investment incentives which has been developed and broadened since the late seventies. The special economic zones of Shenzhen, Shantou, Zhuhai, Xiamen and Hainan, 14 open coastal cities, certain inland cities, and provinces all promote investment with unique packages of tax exemptions, reductions, and incentives. In the past two years, the Chinese authorities have also established a number of free ports and bonded zones. There has also been a proliferation of locally- organized "development zones," some of which had no approval from central authorities and were later closed down. Incentives are not always automatically conferred upon foreign investors, who must sometimes negotiate for these benefits with the relevant governmental authorities on a case-by case basis. The incentives available include significant reductions in national and local income taxes, land fees, import and export duties, and priority treatment in obtaining basic infrastructural services. The Chinese authorities have also established special preferences for projects involving high-tech and export-oriented investments. Priority sectors include transportation, communications, energy, metallurgy, construction materials, machinery, chemicals, pharmaceuticals, medical equipment and electronics. Since early 1992, new service sectors have also been opened on an experimental basis such as retailing, insurance, legal services, and tourism. China encourages reinvestment of profits. A foreign investor may obtain a refund of 40 percent of the tax paid on its share of income which is reinvested in China for at least five years. Where profits are reinvested in high-technology or export-oriented enterprises, the foreign investor may receive a full refund. Export and Import Policy: China has begun to reform its highly-controlled trade regime to reflect its growing role as a major trading nation and to advance its effort to participate in the World Trade Organization (WTO), the successor to the GATT. On October 10, 1992, the U.S. and China signed a Memorandum of Understanding which commits China to: -- phase out nontariff import barriers including licensing requirements, quotas, controls, and restrictions; -- publicize all laws related to trade and refrain from enforcing unpublished laws; -- reduce tariffs on a range of goods and eliminate scientifically unsound standards and testing barriers. In addition, China has adopted the Harmonized System for customs classification and statistics (effective January 1, 1992), has eliminated import regulatory taxes, and has begun publishing many of its trade rules, laws and regulations. National Treatment: Article 6 of the May 1994 Foreign Trade Law provides for extension of national treatment on a reciprocal basis to contracting parties of international treaties to which China is also a party. Article 23 of this law provides for extension of market access and national treatment for international trade in services under similar conditions. In practice, however, China's restrictive foreign trade and investment regulations deny foreign companies national treatment in all service and industrial sectors. The U.S. is working bilaterally and with other GATT contracting parties to encourage China to grant national treatment in more sectors as part of its accession to the WTO. Acquisitions and Takeovers: This concept, as understood in the West, is not applicable to the foreign investment environment in China. A simple share buy-out could occur under existing regulations, but would be subject to the approval of all partners in a given venture and of the supervising Chinese government agency. Such deals have been approved and consummated, but only rarely. Foreigners can also purchase B shares in Chinese companies listed on the Chinese stock exchanges, but foreign portfolio investment is restricted to less than majority ownership. Government Financed Research and Development: A significant portion of research and development funding is allocated through the "TORCH" program of the State Science and Technology Commission. China encourages foreign joint ventures (but not wholly-owned foreign enterprises) to participate in TORCH programs as a means to introduce high technology. B. Conversion and Transfer Policies Repatriation of profits from China can be difficult if they are not generated in foreign exchange. Chinese regulations establish the general principle that foreign-invested projects must balance their foreign exchange receipts and expenditures. Moreover, these regulations require that foreign-funded enterprises must keep the foreign exchange they earn in a special account from which they repatriate profits. Approval for the repatriation of funds from this account must be obtained from the bank and the State Administration for Exchange Control. Few cases exist of Chinese authorities flatly refusing to release foreign exchange from the accounts of foreign-invested enterprises, but the authorities often require that extensive documentation accompany all requests for release. The procedure can be slow and there is room for official obstructionism. Cases arise where a foreign company has a large profit in the local currency, renminbi (RMB), but is unable to repatriate that profit abroad until it is able to earn foreign exchange. Foreign-invested companies can arrange for currency swaps with other foreign-invested companies. C. Expropriation and Nationalization There have been no cases of expropriation of foreign investment since China opened to the outside in 1979. In fact, the joint venture law was amended to forbid nationalization, except under "special" circumstances. Such protection had already existed for Taiwan investments and wholly-owned foreign enterprises. The "special" circumstances have not yet been defined; officials claim that they would include national security considerations and obstacles to large civil engineering projects. Chinese law calls for compensation of expropriated foreign investments, but it does not define the terms of compensation. In one still unresolved case involving a U.S. investor in Dalian, municipal officials closed down the investor's store and small factory in order to use the location for redevelopment. After the intercession of the U.S. government, the Chinese central government ordered the Dalian municipal officials to compensate the investor appropriately. Since the investor may eventually negotiate a settlement with the city, this case cannot formally be considered an expropriation at this time. D. Dispute Settlement The Chinese place strong emphasis on resolving disputes through informal conciliation. If it is necessary to employ a formal mechanism, the authorities greatly prefer arbitration through Chinese agencies. Litigation is considered only reluctantly, as a final option. Many foreign investors have found the Chinese approach time-consuming and unreliable. China is a member of the International Center for the Settlement of Investment Disputes (ICSID). China has also ratified the New York Convention on the Enforcement of Foreign Arbitral Awards. Investment contracts often stipulate arbitration in Stockholm because the forum there is considered neutral. Many trade and investment Chinese contracts stipulate arbitration in China by the China International Economic and Trade Arbitration Commission (CIETAC). Another forum for resolving investment and trade disputes is the Beijing Conciliation Centre (BCC), an organization affiliated with the China Council for the Promotion of International Trade (CCPIT). The BCC signed an agreement with the American Arbitration Association (AAA) in 1992 whereby the BCC and AAA will work together in joint conciliation to resolve trade and investment disputes between U.S. and Chinese parties. A recent case draws into question the willingness and ability of the Chinese government to follow through on its international arbitration commitments. One U.S. company has tried unsuccessfully since December 1993 to file a Swedish arbitration award with an intermediate court in Shanghai. Under Chinese law and the New York Convention, the court should have acknowledged the request within seven days. If China will not enforce foreign arbitral awards in cases such as this, foreign investors will be forced to arbitrate in China. The domestic arbitral process, however, has at times been unfair and domestic awards are also difficult to enforce. China's Legal System: The supreme legislative authority in China rests in the National People's Congress and its standing committee, working primarily through the Legislative Committee. In accordance with the 1982 Constitution, the State Council and the People's Congresses at the provincial and municipal level each have the authority to formulate administrative regulations and local legislation that are not inconsistent with national law. China's formal legal system consists of the people's courts, the people's procuracy, and the police or public security administration. The Supreme People's Court, directly under the jurisdiction of the Congress, is the highest judicial organ. It supervises the work of the lower level people's courts. The 1979 Organic Law of the People's Courts authorizes the establishment of economic, as well as civil and criminal courts, at the intermediate, higher, and supreme court levels. The economic courts are given jurisdiction over contract and commercial disputes between Chinese entities; trade, maritime, insurance, intellectual property rights, and other business disputes involving foreign parties; and various economic crimes including theft, bribery, tax evasion, and trademark disputes. Mortgages/Secured Interests In Property: Under Chinese law, the land is owned by the whole people and cannot be privately owned. However, enterprises, including foreign-invested enterprises, can obtain long-term leasehold rights to the use of land. Moreover, individuals and enterprises can own and dispose of buildings and other forms of property. Though China does not yet have a developed or uniform national legal system governing mortgages or secured transactions, there are national laws that acknowledge the existence of secured transactions. In addition, a variety of regional and internal regulations governing secured transactions and mortgages have recently been adopted. The National People's Congress may pass a Mortgage Law by the end of 1994. Until a more comprehensive law is enacted, the primary and clearest source of creditor's security rights will be the written agreement between creditor and debtor. Creditors involved in financing transactions in China will likely continue to rely on alternative means of protecting their loans to or investments in Chinese entities. The most common of these alternatives are obtaining payment guarantees from authorized guarantors and transferring the use of equipment or goods (for example, through leasing) rather than transferring title. Bankruptcy: China's bankruptcy law, passed in December 1986, provides for membership in creditor's meetings to discuss and adopt plans for the distribution of bankrupt property. The resolutions of the creditors' meetings, which are binding on all creditors, are adopted by a majority of the attending creditors, who must account for more than half of the total amount of unsecured credit (for which no property has been put up as security). E. Performance Requirements/Incentives Export Requirements: Under Chinese foreign investment laws, the repatriation of profits and other monies in foreign currency is subject to China's foreign exchange control and external debt registration rules. In most cases, enterprises can only repatriate profits in foreign exchange if they have an adequate amount of self-generated foreign exchange funds in their accounts. While Chinese law does not require it, many contracts reached between Chinese and foreign partners stipulate export targets. Local Content: Chinese regulations grant foreign- funded enterprises freedom to source inputs both in China and abroad, except that priority is given to Chinese products where conditions are equal. Chinese regulations forbid the imposition of "unreasonable" geographical, price, or quantity restrictions on the marketing of a licensed product, and the venture retains the right to purchase equipment, parts, and raw materials from the source of its choice. Nonetheless, Chinese officials strongly encourage localization of production, and investment contracts often call for foreign investors to commit themselves to gradually increasing the percentage of local content. Under a recently announced automotive industrial policy no joint venture will be approved unless it provides for 40 percent local content. Localization can benefit the foreign investor by reducing the price of his product and, more importantly, by decreasing the need for foreign exchange to pay for imported components. The poor quality of many domestically-produced inputs, however, is often a problem for joint ventures attempting to localize production, especially for high-tech ventures. Technology Transfer: Most joint ventures involve the transfer of technology, either from the foreign partner as part of its capital contribution or under a licensing agreement, or from a third party. While China's investment laws and regulations do not require technology transfer, they strongly encourage it, and foreign investors are likely to encounter pressure to agree to it. A range of incentives are available to attract tech transfer. Employment of Host Country Nationals: Rules for hiring Chinese nationals depend on the type of establishment: wholly-owned, joint venture, or representative office. (See section D below on labor regulations.) Wholly foreign-owned enterprises are not required to nominate Chinese nationals to their upper management, although in practice expatriate personnel normally occupy only a small number of managerial and technical slots. In some ventures, there are no foreign personnel at all. The amended Chinese-Foreign Equity Joint Venture Law provides that the joint venture partners, by consultation, shall determine the chairman and vice chairman, leaving open the possibility for either a foreign or a Chinese representative to hold either of these positions. However, the consultation or election process is restricted by the provision that, if the foreign side assumes the chairmanship, the Chinese side must have the vice chairmanship, and vice versa. While FIEs are free to recruit employees directly or through agencies, representative offices of foreign companies must hire all local employees under contract with approved "labor service companies." These labor service companies pay contracted local employees only a fraction of the amount paid by foreign companies for their services and at times have been unwilling to allow local employees to continue with the same foreign firm after the expiration of their labor services contract. The inability of representative offices of U.S. firms in China to hire directly, train, compensate, and retain local workers is the subject of on-going bilateral talks with the Chinese government. Enforcement Procedures for Performance Requirements: Article 13 of the same Joint Venture Law provides that the failure of a party to fulfill the obligations prescribed by the contract is a basis for termination of the joint venture. To the extent that performance requirements such as local content and export performance are set forth in contracts establishing joint ventures, article 13 provides the legal basis for enforcing these performance requirements. F. Right to Private Ownership and Establishment In China's partially-reformed command economy, there are numerous restrictions placed on the establishment of business enterprises. Foreign audio-visual companies, for example, lack the right to establish wholly-owned subsidiaries or joint ventures. China is currently formulating a new "industrial policy" to orient foreign investment under which various sectors are described as prohibited, restricted, and encouraged. This policy also emphasizes investment in "leading industries" and high technology. China hopes to introduce further measures to relax restrictions on ownership and establishment. Many of these steps are necessary for China's eventual accession to the GATT. China, for example, is expected to loosen partially its restrictions on foreign investment in service sectors. China has also encouraged foreign investors to invest in or buy some state-owned enterprises in an attempt to improve their performance. In May 1994, for example, China formally announced its intention to allow limited foreign investment in Chinese airlines. G. Protection of Property Rights Since the successful conclusion in January 1992 of a U.S.-China Memorandum of Understanding (MOU) on the Protection of Intellectual Property Rights (IPR), China has followed through on its commitments to join relevant international conventions or enact/amend legislation. However, enforcing IPR rights through either judicial or administrative means remains difficult. Patents: Under the Chinese Patent Law enacted in 1984, domestic and foreign patent applications have increased steadily. Patent protection was extended in January 1993 to pharmaceutical and chemical products, as well as processes, and the period of protection was lengthened to 20 years. The amendments also provide the patent-holder the rights of importation as well as expand the scope of patent infringement to include unauthorized sale or importation of products manufactured with the use of patented processes. Under the provisions of the MOU, China extends transitional administrative protection to some U.S. pharmaceutical and agrichemical products for up to seven-and-a- half years. China acceded to the Patent Cooperation Treaty on January 1, 1994 and will perform international patent searches and preliminary examinations of patent applications. Under the Patent Law, foreign parties must utilize the services of a registered Chinese agent to submit the patent application. Preparation of the application may be done by foreign attorneys or the Chinese agent. Copyrights: In March 1992, China established bilateral copyright relations with the U.S. and in October 1992, acceded to both the Berne Convention and the Universal Copyright Convention. China also joined the Geneva Phonogram Convention in April 1993. Following accession to the Berne Convention, China explicitly recognized computer software as a literary work and extended protection to computer programs for 50 years without mandatory registration requirements. Despite a legal framework for copyright protection, however, enforcement remains problematic. Book, recorded media and computer software piracy is widespread. The Chinese government has yet to specify an agency in charge of administrative remedies for software infringement. A change in the criminal law authorizing criminal penalties for copyright infringement is now being considered by the National People's Congress. Trademarks: Although problems remain with enforcement, China's trademark regime basically conforms to world standards. In October 1989, China joined the Madrid Pact for Protection of Trademarks, which grants reciprocal trademark registration to member countries. China amended its trademark regime in February 1993 to add special regulations allowing criminal prosecution for trademark infringement. China has a first-to-register system that requires no evidence of prior use or ownership, so the registration of popular foreign marks is open to anyone. China's 1993 Unfair Competition Law extends IPR protection to trade dress. Under the Trademark Law, foreign parties must utilize the services of a registered Chinese agent to submit the trademark application. Preparation of the application may be done by foreign attorneys or the Chinese agent. Even with improved laws for trademark protection, however, trademark infringement remains one of China's most serious infringement problems. In many areas of China, U.S. business efforts to enforce trademark rights have been stymied by local protectionism. Trade Secrets: In September 1993, the Chinese government adopted the Law against Unfair Competition. This law defines unfair competition to include conduct that infringes the "lawful rights" of another business operator, including acts that violate "commercial secrets" rights. Commercial secrets are defined to include technical and operational information not known by the public, which can bring economic benefits to the authorized users and which are protected by taking appropriate security measures. Sanctions under the law include civil remedies such as damages, administrative sanctions such as fines, as well as criminal penalties for "serious violations." (As this law is very new and untested, however, most firms continue to rely upon confidentiality and non-competition clauses in contracts to protect business or technical information.) China is further obligated to protect trade secrets under the Paris Convention for the Protection of Industrial Property, to which it is a signatory. Legal Environment: In response to the increasing importance of the resolution of IPR disputes, China has established special IPR courts in several cities and provinces, including Beijing, Shanghai, Guangzhou, Fujian and Hainan. Judges in Chinese courts are charged with fact finding and have greater discretion than those in the U.S. in the adjudication of cases. The lack of legal training of many of the trial court judges detracts from the effectiveness of these courts. Authorities are attempting to remedy this training gap by establishing IPR law centers at Beijing University and People's University. Membership in International IPR Organizations: China is a member of the World Intellectual Property Organization (WIPO), the Paris Convention for the Protection of Industrial Property, the Berne Convention, the Madrid Trademark Convention, the Universal Copyright Convention, and the Geneva Phonogram Convention. H. Regulatory System: Laws and Procedures There are over 150 major laws and regulations which apply to foreign investment. In general, however, China's legal and regulatory system is characterized by a general lack of transparency and inconsistent enforcement. Investors may also face excessive bureaucratic influence in joint venture operations. Since the original legislation and regulations on foreign investment were formulated, some measures have been introduced to simplify procedures for foreign investors. However, these laws and regulations are still fraught with ambiguities, and no prospective foreign investor should venture into the China market without experienced counsel. China's leadership is attempting to reform the legal system to deal with changes in economic policy, and rationalize the various sets of regulations governing commercial activity. At the end of 1993 and beginning of 1994, China implemented new laws on foreign trade, taxation, company law, accounting, and unfair competition. New laws to regulate labor, securities, insurance, and banking may be passed in the second half of 1994. I. Efficient Capital Markets and Portfolio Investment China's spectacular growth since 1979 has fueled a concomitant demand for financial institutions to provide sources for investment capital. China's securities market has developed in response to these continuing needs. The year 1981 witnessed the first post-1949 issuances of treasury bonds and other debt instruments. In 1984 the first post-1949 public issue of corporate shares was offered. A secondary stock market then gradually began to evolve in 1986, initially via the Industrial and Commercial Bank of China. The Shanghai Securities Exchange opened in November 1990. The city of Shenzhen in southern China's booming Guangdong province opened a second exchange in July 1991. Besides the two officially- recognized exchanges, there are now also several "securities exchange centers" in cities such as Wuhan, Shenyang, and Tianjin. These markets are approved by the People's Bank of China (PBOC), China's central bank, and are used mostly by local companies to attract small amounts of capital. When rioting erupted at the Shenzhen stock exchange in August 1992, Beijing authorities recognized that China's lack of adequate securities law and regulation was a serious problem. The State Council later established a two-tiered regulatory structure to oversee policy-making and day- to-day regulation. The first tier is the State Council Securities Policy Commission (SCSPC) chaired by Vice Premier Zhu Rongji. It consists of top officials from relevant government departments such as the PBOC and its jurisdiction includes determining the number of listings and volume of issues. The second organization is the China Securities Regulatory Commission (CSRC) under Chairman Liu Hongru (former Vice Minister of the State Commission for Restructuring the Economic System). This commission is analogous in some respects to the Securities and Exchange Commission (SEC) in the U.S. It is responsible for such tasks as designating firms for listing and licensing brokerage companies. Legal Framework for Equity Investment: One lingering problem that affects China's securities market is the lack of a sophisticated national legal framework. This causes many disputes with no clear system for resolution. Although CSRC promulgated provisional regulations in May 1993, and issued supplemental regulations in 1994 on auditing Chinese enterprises wishing to list abroad, China still has no national securities laws. A new, heavily revised draft of a proposed securities law is now being discussed and is expected to be enacted by the end of 1994. State Banking Sector: China's capital markets are dominated by the state banking sector, which channels the majority of its funds to state-owned enterprises on the basis of public policy rather than market considerations. For the most part, other domestic firms must find different sources of financing including direct investment, grey-market sales of stock, and borrowing from other firms or non-bank financial institutions. Foreign firms that need working capital, either foreign exchange or local currency, may obtain short-term loans from the Bank of China and certain other Chinese financial institutions. However, priority in lending by these institutions is given to those investments that bring in advanced technology or produce goods for export. Foreign- invested firms may also borrow funds from abroad but they must register all foreign loans with the State Administration for Exchange Control. Restriction on Debt-Equity Ratios: According to regulations promulgated in March 1987, the Chinese government restricts the debt-to-equity ratio of foreign-funded firms and sets minimum equity requirements. For investments under $3 million, debt cannot exceed 30 percent of the total investment. Debt for investments in the $3-10 million range cannot exceed 50 percent, and for investments in the $10-30 million range, it cannot exceed 60 percent. Debt for investments over $60 million is limited to two-thirds of the total value of the investment. It is legally possible for foreign-invested enterprises to raise funds in China through the sale of bonds, but only a few have tried to do so. J. Political Violence Rapid price inflation, corruption, layoffs from state- run enterprises, the growing gap between coastal regions and the interior, and economic disparities between rural and urban areas have contributed to dissatisfaction among the Chinese populace. Northwestern China has been troubled by occasional unrest among minority ethnic and religious groups. Dissatisfaction has not translated into widespread political activity since 1989, however, because the government is working to minimize tensions and because most people believe Beijing is able and willing to swiftly repress any sizeable anti-government protests. K. Bilateral Investment Agreements While periodic discussions have been held, the United States does not have a bilateral investment treaty with the China. The two sides still disagree on a number of issues such as national treatment, third party arbitration, and compensation for expropriation. At present, such subjects are covered in the body of each investment contract. China has entered into bilateral investment agreements with 52 countries. Some of the more important countries that have bilateral investment treaties with the China are Japan, Germany, the United Kingdom, France, Italy, Thailand, Romania, Sweden, the Belgium- Luxembourg Economic Union, Finland, Norway, Spain, Canada, and Austria. The provisions of these existing agreements cover such issues as: expropriation, arbitration, most favored nation treatment, and transfer or repatriation of proceeds (in general terms). L. OPIC and Investment Insurance Programs In the past, OPIC had a very active program in China. As of the end of 1990, 31 U.S. investments had OPIC political risk insurance. These projects represented an investment of approximately $300 million in China. OPIC's program in China has been suspended since June 1989, first by executive action, and then by the legislative sanctions that took effect in February 1990. The deterioration of worker rights conditions in 1989 also prevented OPIC from undertaking new programs in China. OPIC programs will remain suspended in China subject to U.S. foreign policy concerns, the terms of the sanctions legislation enacted, and improvements in worker rights conditions. OPIC does, of course, continue to honor outstanding political risk insurance contracts. Although OPIC may remain unavailable for the foreseeable future, the Multilateral Investment Guarantee Agency (MIGA), an organization affiliated with the World Bank, can be a source of political risk insurance for investors interested in investing in China. Some commercial insurance companies also offer political risk insurance, as does the People's Insurance Company of China. M. Labor Labor Availability: Foreign-invested enterprises can take over a joint venture partner's workforce, hire through a local labor bureau or job fair, advertise in newspapers or rely on word of mouth. As described in the above section on performance requirements, however, representative offices must hire their local employees through a labor services agency. Skilled workers are often in short supply, although many companies have found an abundance of recent university graduates who are talented and highly motivated. Shortages can be especially acute in south China, which has far fewer institutions for higher education than exist in the north. While engineers and technicians can sometimes be difficult to find, finding -- and keeping -- managers and those with marketing skills is especially difficult. Foreign ventures often find workers move rapidly from job to job within the foreign-invested and private sectors. Compensation: Workers are either paid a salary, hourly wages or piece-work wages. The provision of subsidized services, such as housing and medical care, is very widespread, and compensation beyond the basic wage constitutes a very large portion of a venture's labor expenses. Local governments also tax enterprises and workers to support social security and unemployment insurance funds. In general, foreign ventures are free to pay whatever wage rates they want. Chinese income tax laws often make it desirable to provide greater subsidies and services rather than higher wage rates, and these decisions are often taken after observing local practice. Termination of Employment: The ability to terminate workers varies widely based on location, type and size of enterprise. In general, it is easier to fire in the south than in the north, and in smaller enterprises than in larger ones. Terminating individual workers for cause is legally possible throughout China but may require prior notification/consultation with the local union. Large-scale layoffs, especially in north China can arouse opposition from the local government and from the workers themselves. Where workers are hired by short-term contracts or agreements, it is generally relatively easy to let them go at the end of the contract period. Worker Rights: Chinese law requires foreign-invested enterprises (FIEs) to allow union recruitment, but does not require an FIE to set up the union (as management does in state enterprises). In recent years, most coastal provinces have passed stricter regulations that require unions in all foreign-invested enterprises. To date most such enterprises do not have unions and some (in contravention of Chinese law) have agreements with localities not to establish unions in their factories. A dramatic increase in incidence of labor disputes in FIEs in 1993 prompted labor officials to begin drafting industrial relations legislation. At the same time, the All- China Federation of Trade Unions (ACFTU) has declared its intention to establish unions in 50 percent of all FIEs before the end of 1994. Foreign investors should be aware that it is illegal according to Chinese law to oppose this effort. Although China is a signatory to a number of ILO conventions, it has not signed any key ILO conventions on freedom of association or forced labor. N. Foreign-Trade Zones/Free Ports China has established a number of duty-free import/export zones. Some of the main ones are located in Dalian, Tianjin, Shanghai, Guangzhou, and Hainan. Other free trade zones are envisioned in other special economic zones (SEZs) and open cities in China. Privileges similar to those offered in the officially- designated free zones can also be found in the other SEZs and open cities, but there are still a range of restrictions and charges that affect venture operations and business. In order to make progress towards a consistent national trade regime as part of its GATT accession, China has indicated that it will not introduce nay new investment incentives for its SEZs and will decrease existing incentives over time. China will try to make its SEZs "special" by improving their investment environments, not by having preferential policies inconsistent with international practice, a top Chinese official said in May 1994. China's Customs General Administration claims success in controlling the duty-free importation of production inputs into the zones, but the lack of physical barriers makes it difficult to control the flow of non-dutied items out of the zones. O. Capital Outflow Policy As a capital-poor country, China's development strategy calls for net capital inflow. China does, however, allow Chinese firms to invest abroad, but it is difficult to track the size of such investments. Official statistics on Chinese direct investment overseas are useful as a relative guide to capital outflows, but greatly understate the actual outflows. The ballooning "Errors and Omissions" category in China's Balance of Payment suggest that there are large unrecorded capital outflows. Retained income form overseas trading and investments through Hong Kong- invested companies conceal large sums of Chinese capital invested overseas. In the past, most of China's overseas investments were in the Third World; however, a growing number are in industrialized countries or regions, notably Hong Kong (most), the U.S., Japan, Canada, the Netherlands, the United Kingdom, and Germany.