Why It's Sweet In The Middle For China's Go-Betweens

As long as an authoritarian government is above the law, there will be a premium on “connections.” In fact, for those inside this system, the Chinese political economy can be very efficient. The middleman has long thrived in this situation, connecting people in a dynamic mixture of power, information, resources, and opportunity.

In recent years, this business model has begun to change, at least when it comes to foreign investors. The growing experience and wherewithal of foreign businesses operating in China is increasing pressure on middleman margins. This has led middlemen to professionalize their services and expand their offerings throughout the supply chain. No longer are connections always enough to attract customers. Technical and analytical skills are often needed. Even then, the high profit margins of the early days of reform may be over for many.

Take one middleman whom I first spoke to in 2007. Mr. Wang, as I’ll call him, said he was fed up with paying bribes to Chinese government officials on behalf of his American customers. I had come to his office in Shanghai on a bad day. He was in the middle of negotiating bribe payments with government officials to secure a host of approvals needed for his American customer to build and manage a plant in China. Before the deal was done, more than half a dozen officials would receive bribes, taking some 30 percent of Wang’s profit. Negotiations were tense because Wang was right in the middle, fighting off demands from the American customer to lower costs and from the Chinese officials to fatten the pot, all the while trying to minimize his own losses.

When I caught up with Wang again in 2010, his story was different. Instead of the tiresome demands for bribes from government officials, they were now portrayed as old, trusted friends. Government budgets had swelled since 2007. He was no longer dipping into his own profits to get government approvals, but kicking back cash to government officials who were over-paying for products and services. Middleman Wang had become a “money washer” and grown even richer in the process.

It hadn’t been an easy ride. In 2009 Wang had been arrested by undercover policemen amid enforcement of expanded anti-corruption laws. They pulled him off the street and held him for two days in an undisclosed location. The police wanted him to provide evidence that particular government officials were taking bribes. Without food or sleep during that time, and while being subjected to continuous questioning, Wang held out. He would not give up his connections.

The incident illustrated the shift from the bare-knuckle negotiations seen in 2007. The Chinese government had raised the risk for would-be money grabbing officials and the companies that would pay them. Wang’s prized possession, his competitive advantage one might say, is his long-standing relationships that he has with particular government officials going back some 25 years to the beginning of the reform period. In a period of increasing government prosecutions for corruption, trust is a very valuable commodity.

There are mounting pressures facing the Chinese government as more people leave the agricultural economy and enter one based on providing goods and services. But in this economy, insiders with government connections seek to siphon off the lion’s share of profits, making it difficult for the new entrants to find a place. There is also pressure for more efficient distribution systems, side-stepping every mid-level bureaucrat who seeks a side-payment. However, if the government doesn’t become more transparent and accountable – and cut out the need for bribes – professional distribution will be stymied. The result will be higher distribution costs for Chinese companies at a time when other price advantages such as cheap labor and natural resources are in decline.

This takes us to longer-term questions concerning the government’s role in the economy and society. Does the market exist in China for the benefit of the government or society? An argument can be made for the former. This is one reason why 60 percent of the country’s millionaires are said to be seeking second passports. The government is aware of the problem and says it will address it. Ten years ago, the previous incoming leadership made similar statements. Time will tell their real values. In the meantime, Wang and others are likely to continue to exploit their connections, albeit in an increasingly subterranean world of “old friends.”

When I last met with Wang in 2010, he was driving a $50,000 Lexus SUV. He has also recently invested over $1 million in the United States to diversify his operations and secure a base beyond the long reach of the Chinese government.