institutional challenges for the global...

INSTITUTIONAL CHALLENGES FOR THE GLOBAL CHINA — SUSTAINABLEFOREIGN DIRECT INVESTMENT AND LABOUR RIGHTS AMONGST SUPPLY

CHAINS IN CHINA.

Serena Lillywhite*

ABSTRACT

This paper explores the relationship between sustainable foreign direct investment (FDI),corporate social responsibility and responsible supply chain management in China. Corporatesocial responsibility is increasingly being recognised as part of the global business landscape,however, supply chain management rarely gives recognition to labour rights andenvironmental standards. Sustainable foreign direct investment must include responsiblesupply chain management and investment practices that promote labour standards,particularly in developing countries such as China. An overview of the conditions required tosecure an enabling environment to attract foreign direct investment is presented. A case studyof the Brotherhood of St Laurence's experience in attempting to responsibly manage thesupply chain of its optical business—Mod-Style is the focus. The OECD Guidelines forMultinational Enterprises are the most important code of conduct that exists for business, andare unique in that they have the support of business, trade union and non governmentorganisation communities. These Guidelines are relevant to the discussion on sustainable FDI.

1. IntroductionForeign Direct Investment (FDI) in its broadest context is a major catalyst for thedevelopment and the enhanced integration of developing and emerging countries in the globaleconomy. However, there is increased recognition that the benefits of foreign directinvestment do not accrue automatically and the "spillover" effects are not evenly sharedacross countries, sectors, local communities, and workers. As such, many developingcountries are facing reduced foreign direct investment flows. This has prompted considerationof what is required to create an enabling environment that attracts FDI (OECD, 2002). Thecurrent decline in FDI and expectations that this trend will continue in 2003/2004 has resultedin global calls to strengthen sustainable FDI. At the OECD there has been discussion as tohow to establish the most conducive environment, to remove impediments, to reduce costsand to maximise the benefits of FDI1.

A further development is the growing global awareness that trade and investment areincreasingly integrated and that FDI needs to contribute to sustainable development.Sustainable FDI must consider the economic, social and environmental impacts of investmentin a multidisciplinary context. It means that investment needs to be driven by more thanaccess to cheap labour and raw materials, and requires a commitment to, and investment in,

* Social Action and Research, Brotherhood of St Laurence. E-mail: [email protected]

1 OECD. 2002, Global forum on international investment, Shanghai, 5-6 December.

Institutional challenges for the global China Melbourne, November, 2003

Serena Lillywhite—Brotherhood of St Laurence

human capital and the protection of labour rights, technology transfers, education and trainingand protection of the environment.

The idea of socially responsible investment (SRI) is also gaining momentum amongstportfolio investors. This also requires an increased willingness by enterprises to acceptresponsibility for labour and environmental standards and conditions within supply chains.Corporate governance, labour standards, corruption and the environment are likely to be themajor issues for SRI investors (Rosen, 2002, p13). With China’s accession to the WorldTrade Organisation (WTO) and the forthcoming Olympic Games in 2008, many foreignenterprises are assessing the opportunities and risks associated with doing business in China.This is set against the backdrop of a business culture and regulatory framework that continuesto offer FDI incentives—namely, cheap and compliant labour, improved access to both thedomestic and international markets, a stable political environment, a relatively (compared toother developing countries) well developed physical and institutional infrastructure and fiscalincentives.

So where does the protection of labour rights and the enforcement of decent workingconditions fit in, particularly for the low skilled, vulnerable, migrant workers in SouthernChina's manufacturing zones? Whereas many non government organisations (NGO) and civilsociety representatives have long understood social inequality and the structural imbalancesthat contribute to such inequality, this is only recently being recognised by governments andmultilateral organisations as an important contributor to an enabling environment that attractssustainable, quality FDI.

The business community is also beginning to recognise the global responsibilities oftransnational enterprises, including the complex issue of supply chain management indeveloping countries. An equitable, global economic system must promote socialdevelopment, fundamental rights and sustainable development. Within Europe, "therecognition that sustainable economic growth goes hand in hand with social cohesion—whichimplies respect for core labour standards—now underpins the strategic and social policy goalsof the Economic Union and recognises that global market governance has developed morequickly than global social governance" (Commission of the European Communities, 2001,p4). "Core labour standards underscore the close inter-linkage between trade and investment,economic growth and social development and the need to address these issues in an integratedmanner. This requires a multidisciplinary approach to the promotion of core labour standards"(Commission of the European Communities, 2001, p4).

The Brotherhood of St Laurence (BSL) case study presented here focuses on supply chainmanagement in the optical industry in China. In 2000, the BSL gained ownership of a smallbusiness, Mod-Style. Mod-Style imports and wholesales optical frames to Australia’sindependent optical retailers. In 2001-02, the company imported 152,000 optical frames, witha turnover of AUD$5 million. Most of the production occurs in China, where 90 per cent ofthe world’s optical frames are currently manufactured. The BSL accepted ownership of thecompany on the basis that it would investigate the ethical implications of owning a companythat sourced goods from China. Profits were quarantined for two years, and used to fund athorough investigation of the supply chain, the conditions of the workers, and the barriers toimprovements in these conditions and some creative responses to the issues.



2. Creating an enabling environmentDifferent countries may require different approaches to attracting FDI. However, regardless ofthe approach, policy does matter and governments, the business community and civil societyrepresentatives are not passive bystanders in this process. Policies need to be flexible yetuphold international principles, particularly core labour standards (ILO, 1998).

2.1 Contributing factorsCommon factors that contribute to an environment that attracts FDI include:• Strong macroeconomic fundamentals• Strong and predictable regulatory and institutional framework,• Political and economic stability• Dynamic and transparent business environment that promotes corporate governance and

business integrity• Good infrastructure• Geographic and sectoral distribution of the benefits of FDI• Human capital development,• Stable and predictable investment rules and practices• Commitment to improved international integration• Appropriate sequencing of the establishment of an enabling environment.

The degree to which the benefits are recognised—namely the integration of developingeconomies into the global economy and the "spillover" effects associated with the protectionof labour rights and environmental standards, technology transfer, human capital developmentand enhanced linkages with both domestic and international markets—depends on the hostcountry and their macroeconomic policies, regulatory environment and commitment to socialgovernance and the protection of fundamental rights.

Multinational and smaller enterprises alike have a role to play through ethical businesspractices that promote transparency and accountability in all business activities. This includessupply chain management, compliance with local labour and environmental laws and wherelaws in developing countries are not well developed or at odds with international bestpractice, international standards are promoted. The issue of transparency and businessintegrity amongst supply chains and subcontractors remains an important consideration,particularly with regard to the establishment and enforcement of a regulatory framework.

There are of course costs associated with FDI. The most frequently discussed include:• Balance of payment volatility in response to import and export patterns of FDI• Transfer pricing issues• Linkages with local enterprises• Environmental impact• Social disruption• Negative effects on competition, and• Loss of political sovereignty.

What is less often assessed is the impact on low skilled workers and the conditions underwhich they are employed. It is this aspect that will be reviewed here in the context ofresponsible supply chain management in China. The OECD Global Forum on InternationalInvestment 20022 concluded, that overall, FDI tends to compound both the advantages and 2 OECD. 2002, Global forum on international investment, Shanghai, 5-6 December.



disadvantages of investment, and FDI should not be seen as a substitute for getting domesticbusiness ‘right’. An economy based on exploitation and the erosion of workers rights cannotlead to sustainable development.

2.2 Foreign direct investment in China—against the oddsIn the last few years financial flows to emerging economies have slowed and this is closelyrelated to increased concerns about ‘risk’ and the ability of these countries to establish anenabling environment. The Asian Development Bank has advised that net private flows to theAsian and Pacific region decreased from approximately 475 billion in 2000 to about 460billion in 2002 (Lintjer, 2003). These countries are receiving only a small share (20%) ofglobal FDI, and what does go to these countries is spread unevenly (OECD, 2002). There areexceptions, and The People Republic of China (PRC) is one of them. In the region,approximately 80% of FDI goes to China, heavily monopolising inflows to other emergingeconomies in Asia. In 2002, FDI inflows to China reached almost $53 billion making Chinathe world's largest recipient of total FDI (OECD Observer, 2003).

According to the Asian Development Bank, China has been able to attract vast amounts ofFDI, despite having not put in place an overall-enabling environment. ‘The institutionalcapacity for a modern enterprise economy is not fully in place, the legal environment needsstrengthening and enforcement capabilities implemented, private property rights (includingintellectual property) need strengthening, local protectionism needs to be reduced, and thefinancial sector is insufficiently diversified and labouring under non-performing loans'(Lintjer, 2003, p40). However, there is little doubt that China's accession to the WTO, and thesignificant progress the country has made on structural reforms and efforts to bringregulations in line with international standards has enhanced their ability to attract FDI. Thishas played an important role in China's transformation to a market economy and a globalmanufacturing centre, albeit still under one-party governance.

A cautionary noteWhile much has been made of China's progress, it is suggested that official figures may havebeen exaggerated and regional performance overstated. An "indication of the discrepancies inFDI absorption is the large gap between FDI flows from OECD member countries into China(US$77 billion) and that reported by OECD countries themselves (US$39.3 billion)"(OECDObserver, 2003, p 5). Investment that is routed via Hong Kong and other sources, known as"round tripping", to take advantage of fiscal incentives such as tax breaks, is really FDI thatcomes from China itself—domestically generated, and therefore can be discounted from realFDI figures (OECD Observer, 2003). In addition, China's capacity to attract FDI is lessimpressive if population is considered. 'Inflows of FDI per capita are far lower in China thanin almost all OECD countries, even smaller than in the larger Latin American economies, andeven below some of the developing countries in south-east Asia, like Malaysia and Thailand(OECD Observer, 2003).

2.3 The regulatory, business and cultural environment

China’s Labour Law and regulatory environmentChina has a complex regulatory environment that needs to be understood in the context ofsustainable FDI. Chinese labour law sets standards and rules, which are as high as those inmost OECD countries (ACFTU, 2002). The extent to which they are implemented andinfluence behaviour in the factories is another matter. There is a gap between practise stated



by the Department of Labour in China, All China Federation of Trade Union (ACFTU)officials, some foreign enterprises and factory managers, and what actually occurs(Lillywhite, 2003). Implementation of the labour law also varies subject to factorymanagement practices. Authors such as Anita Chan have written extensively on themanagement practices of foreign companies in China, particularly, Taiwanese, South Koreanand Hong Kong joint ventures and wholly owned enterprises (Chan, 1998). For the majorityof rural women who work in these factories producing toys, footwear, garments and otherproducts for export, “low wages are not the worst of the workers’ problems” (Chan andSensor, 1997, p107). Physical punishment, verbal threats, coercive regulations, psychologicalharassment, dismissal and loss of pay are common.

Despite almost 90 per cent of production line workers in Guangdong, Southern China, beingmigrant workers’, they do not enjoy the same status as local residents and are particularlyvulnerable due to their temporary employment and residential status (Chan, 2000). There hasbeen considerable research into migrant workers (see Chan, 2001, Gao,1994, Li, 1996, Pan,2002), however it is the letters of migrant workers which provide a first hand account of notonly factory conditions, but lack of compliance with China’ labour law (Chan, 2002). Amongworkers’ various concerns issues related to wages, bonus payments and subsidies andgovernment set minimum standards were most common. It is common for workers’ not toknow how much they should be paid. Hours of work and overtime are another area wheremigrant workers are exploited and laws not implemented (Chan, 2002). Kenneth Roberts,(Roberts, 2002) offers some insight into why it is that rural migrants in China are willing todo the jobs that urban residents don’t want

The Chinese legal system and culture do not provide strong institutional support forcompliance with domestic law, and there are many inconsistencies within the laws andregulations. Chinese labour law is complex, made more so by provincial adaptations andexceptions in special economic zones. There is also a lack of expertise amongst manygovernment officials to assist with interpretation. Local labour departments may prefer not toinsist on compliance with laws—it is reported3 that staff have friends and relatives whomanage factories, and financial contributions and kickbacks are a reality (Lillywhite, 2003).

Workers in China are often not well informed of their rights. The weakness of Chinese legalinstitutions means too that workers are reluctant to take steps to secure their legalentitlements, adding to a culture of avoidance of legislated standards. China is not a countrywith a strong civil society. The trade unions are not particularly effective in protectingworkers rights, independent NGOs have very little space in which to operate and there are fewconsumer protection mechanisms. As such, factories are under no pressure from Chinesesociety to reform and comply with labour law, thereby adding to an environment that missesopportunities to maximise the benefits of FDI. This is most evident with regard to wages,hours of work, social security entitlements and overtime. The practices of not paying legalminimum wages, appropriate overtime and bonus payments, and of imposing arbitrary finesand deductions force many workers to choose a factory where they are able to work illegalamounts of overtime in order to survive. Interestingly, as part of the Brotherhood of StLaurence research into the optical industry in China, factory managers are now openly sayingthey cannot comply with the legal hours of work and remain competitive. One view is thatNGOs should accept this and campaign to ensure workers receive the appropriate wages forhours and overtime worked. However, this does not address the issue of industrial accidents 3 Discussions held with optical industry factory managers in Southern China as part of the Brotherhood of StLaurence research in supply chain management.



and work-related deaths caused by excessive overtime (Liu, 2002). For further information onindustrial accidents and occupational health and safety see Liang, Fu & Gu, 2001, andSchauble, 2002.

The key to labour rights reform in China is collective bargaining and an increase in employeeautonomy. China has a variety of collective contracts, but these do not touch on the subject ofcollective disputes. In this regard trade union reform is needed to ensure that representativesare democratically elected, professional and represent the workers concerns (Dong, 2002).These are complex issues of national scope, and there is very little a small firm can do toensure the guaranteed, full enforcement of all laws.

Codes of conduct, monitoring and complianceIn addition to the national laws, there are various requirements of large customers, in the formof corporate codes of conduct or certification with reporting instruments such as SA 8000.Whilst important in contributing to the promotion of core labour standards (particularly wherenational laws are inadequate or poorly regulated) and in identifying some problems andcompliance issues, codes too often represent a shallow attempt to understand the realdifficulties in transnational supply chain management. They do not provide an accuraterepresentation of conditions. They are often developed at distance with a lack of involvementand commitment from both workers and managers. They are frequently poorly promoted andunderstood within factories, and workers are usually not consulted or given an opportunity tocomment freely and without reprisal on their operation. Monitoring, compliance andenforcement is complex and problematic, and inspections are ad hoc and not necessarilyundertaken by skilled personnel able to accurately identify falsified information. In addition,some codes are insensitive to local laws and customs and ignore the reality of Chinese labourrelations by claiming that the principle of freedom of association is adhered to.

The proliferation of corporate codes of conduct does detract from a factory’s capacity tocomply with the Labour Law of the PRC. In isolation, codes cannot be relied on to protectworkers’ rights or promote worker empowerment, nor should they be seen as an alternative tonational labour law or as a substitute for government ratification of international labourstandards. Codes of conduct are, however, a useful first step in harnessing an enterprise’scommitment to promoting sustainable FDI.

2.4 Enhancing the FDI environment in China

Structural reformThe OECD has identified a number of policy options to assist China (equally suited to othercountries) attract the high-technology manufacturing and service related investment they seek.These include: eliminating local protectionism, streamlining the foreign investment approvalprocess, reviewing foreign ownership restrictions, opening up the capital markets to foreigninvestors, strengthening competition policy, strengthening the effectiveness and independenceof the legal system, and strengthening the regulatory environment for property rightsprotection (OECD Observer, 2003).This reform process is not always easy to implement indeveloping countries. However, in the case of China there has already been significantprogress which suggests China has the capacity to implement structural reform, albeit slowly,and within a framework of central planning.

The Asian Development Bank has suggested that in addition to the above, sequencing ofstructural reform is very important. First and foremost should be the establishment of a



regulatory environment and appropriate institutional framework, followed by financial sectorreform and finally an opening of the capital markets. This should be in a context of politicaland economic stability and willingness for global market cooperation (Lintjer, 2003).

Regional inequalitiesAs noted, the benefits of FDI do not accrue automatically, nor are they evenly distributedamongst geographic regions, industrial sectors, communities and workers. Between 1983-2001, 88% of China's total inflows of FDI for this period were directed to the eastern coastalregion, the central region just 9% and the western region only 3 %. The anticipated "spillover"of the benefits into these regions has not occurred. Economic reform that has favoured thecoastal regions, the sheer size and distance from world markets, the relatively poor domesticmarket, the burden of inefficient and debt-ridden state owned enterprises, capital flight tocoastal regions, and a loss of skilled workers have all contributed to the uneven distribution ofFDI benefits and a reduced regional capacity to attract sustainable FDI (OECD Observer,2003). Despite China's Great Western Development Strategy, launched in 2000, the fact thatmany of China's regions can offer both skilled and unskilled labour, have university basedresearch capacity in several provincial capitals, have abundant natural resources and tourismpotential, to date this has not been enough to attract FDI (OECD Observer, 2003). What isrequired is a comprehensive and multidisciplinary response that that improves long-termbusiness opportunities in the region so that FDI is not only attracted but that the benefits aremaximised and maintained in a sustainable and equitable manner.

Geographic isolation is not the only barrier. Within the manufacturing cities in southernChina, despite being part of the more affluent economic zone, low skilled workers are notappropriating the benefits of FDI. Undoubtedly the vast inflow of FDI is creating employmentopportunities, however, there are inequities and discrimination between skilled and unskilledlabour and migrant and urban labour. Conditions in factories vary significantly based onsector of industry, size, capital investment, management practices, and compliance withlabour and environmental standards. In addition, reform of the social security system has notkept pace with China’s transition to a market economy and this impacts on enterprise capacityto comply with China’s labour law and social governance (Labour Law of the PeoplesRepublic of China, 1994).

Promoting labour rights and social governanceThe relationship between globalisation, trade and investment and social development iscomplex and links a number of policy areas in the pursuit of sustainable development.Improving social governance and promoting core labour standards in the context ofsustainable FDI and trade liberalisation requires a comprehensive approach

"Poverty, poor governance and extensive informal sectors are often the main cause of theweak implementation of core labour standards in developing countries" (Commission of theEuropean Communities, 2001, p.11). Sustained economic growth can contribute to the respectand effective application of labour standards and of the social regulatory framework and viceversa. Strengthened core labour standards can increase economic growth and efficiency, andthe creation of an enabling environment to attract FDI can therefore play an important role inpromoting core labour standards.

Social governance in China will require, among other things, reform of the social securitysystem. Historically "China’s social security system was oriented towards maintaining socialand political stability through social control" rather than promoting social justice (Saunders



and Shang, 2001). The current social security policy focus is on pension insurance,unemployment insurance and workers’ compensation, however, current employer socialinsurance contributions also cover medical, housing and maternity (The EconomistIntelligence Unit, 1999). Responsibility for these schemes rests with the Ministry of Labourand Social Security. In reality, these schemes are managed and administered at a provinciallevel which impacts on portability of funds. This creates enormous difficulties for migrantworkers who are unable to access benefits as a result of the household registration system(hukou), and temporary employee status and this contributes to high levels of non-participation by migrant workers and enterprises that lack faith in the current system(Lillywhite, 2003). Foreign-invested enterprises in China’s major cities are concerned aboutincreasing costs, with many being asked to pay up to 60% of the payroll to local labour andsocial security bureaux (The Economist Intelligence Unit, 1999). The insurance funds’sustainability is a major concern and contributes to the adhoc unification of the system

Sustainable FDI and social incentivesThe Brotherhood of St Laurence research in China has confirmed that some factory managersare increasingly interested in how a business can be both ethical and competitive, particularlyin sectors such as the optical industry, which are highly competitive. There is increasingawareness that corporate responsibility and improved compliance with corporate codes,national laws and international standards could be turned into a competitive advantage.Improved compliance is already resulting in certain factories being more desirable to largebrand name customers, and could be used by those companies to bolster their reputation as anorganisation committed to sustainable FDI. This situation provides benefits for the factorythrough increased production contracts, benefits for the enterprise that is investing in thefactory through improved supply chain management and corporate responsibility, and benefitsfor the factory workers who enjoy improved labour conditions. This is an area that deservesconsiderable attention, and foreign enterprises have significant scope to pursue innovativemechanisms based on this concept. It suggests that competitive advantage is the driving forceas opposed to the promotion of labour rights, and that may reflect where the internationalcommunity is currently positioned. As long as labour rights are part of the sustainable FDIdialogue and debate, that is an important first step.

The European Commission has also flagged the idea of adopting a social incentive schemewhich goes beyond traditional import export incentive schemes and is based on the effectiveimplementation of core labour standards in all trade and investment (Commission of theEuropean Communities, 2001).

2.5 Opportunities for enterprises to support sustainable FDI

How can companies ensure their impact is positive?Enterprises have a significant role to play in ensuring that FDI is sustainable and that thebenefits are more evenly distributed throughout society. There is no one answer or quick fixremedy to ensure sustainable FDI amongst supply chains. What is required is a variety ofcustomised responses, however, compliance with universal treaties and national laws touphold basic labour rights and environmental standards should be the non-negotiable startingpoint. How enterprises then apply these conventions and statements, many of which areaddressed to States, is the real challenge. It is necessary for an enterprise to then translatethese principles into a form that can be applied in individual workplaces. This could includean emphasis on governance and SRI (particularly for publicly listed companies), improved



compliance with local law, occupational health and safety, education and training programsfor workers and managers etc.

Significant work needs to be done to strengthen the capacity of China’s regulatoryenvironment to enable governments to develop, enact and implement national labourlegislation that adapts the ILO conventions to local realities. Thereby facilitating, ratificationand implementation, and realistic monitoring and enforcement mechanisms likely tostrengthen compliance with China’s labour law by both domestic and transnationalemployers. All these undertakings contribute to incremental and progressive steps that willpromote sustainable FDI, and a more even distribution of the benefits.

Enterprises and factories in China do not yet have well developed communication systemsand processes. This means valuable opportunities to communicate with workers, NGOs andother external players are not being taken up. The BSL has developed a process ofengagement, in response to the complex issue of supply chain management. It involvesundertaking research, the establishment of stakeholder dialogue and building long-termmeaningful relationships with contractors and suppliers to discuss innovative ways to improvesupply chain management and protect workers’ rights.

This process promotes education and training as the most appropriate mechanism toencourage worker empowerment and self-determination, and to the development ofsustainable improvements to labour and environmental standards. This is a dynamic processthat requires a commitment to continuous dialogue and establishing partnerships and allianceswith all stakeholders. The BSL has adopted a non-confrontational approach in discussionswith factories. This supports the view that the most useful first step is to engage directly withworkers in some way that benefits them and which will be acceptable to the localmanagement. This latter qualification is essential to have any hope of success.

The BSL is pursuing a number of strategies, which involve global collaboration with brandname customers, NGOs and other key stakeholders. Factory-based workshops are beingplanned. These could build on the existing education and training that is currently beingprovided by some global brands in the optical industry. Discussions are under way toinvestigate opportunities for small and large enterprises to work together in shared factories ina way that allows each to benefit from the purchasing power of global brands, and theproduction and industry knowledge of Mod-Style. An occupational health and safety (OH&S)needs assessment involving workers, managers and external technical expertise has also beenconsidered.

Table 1 may assist organisations that are interested in sustainable FDI and responsible supplychain management. It is by no means exhaustive, and the inherent risks associated withchecklists in terms of omitting important issues and narrowing the complexity of the debatemust be recognised. It may, however, provide new ways of thinking to assist organisations inensuring ethical business practices are embedded in the corporate culture [Take in Table 1].

2.6 Limitations to enterprise capacity to support sustainable FDI

Core labour standardsThe core labour standards themselves create limitations to an enterprises’ capacity toinfluence the protection of labour rights amongst supply chains. Core labour standards are‘big picture’ issues addressed to Nation States and it is all the more difficult for enterprises to



support compliance as many factory managers in China—and indeed, in many developedcountries—do not see the links between labour rights and human rights, environmentalstandards and social justice.

Complexity of the issue: conceptual and ethical considerationsIt is important to recognise that corporate responsibility amongst supply chains is a verycomplex issue. The conceptual and ethical task of dealing with Chinese factories is difficultfor the small firm, even one committed to operating in an ethical manner. It requires time,resources and commitment. Specialist staff are needed with expertise and knowledge of thelabour and environmental issues and regulatory environment of developing countries.

To demonstrate this complexity, the BSL has recognised that there are no easy answers to thedifficult questions raised by our work. For example:

• What is the best approach to ensure sustainability and an enduring culture of corporateresponsibility amongst our supply chains? Can this realistically be achieved?

• Do we only deal with factories that are open to our approach of continuous improvementand withdraw from dealing with the bad ones?

• To what extent can we accept willingness to change as a basis for an ongoing relationshipwith a supplier, irrespective of the time frames for achieving real change?

• How do we determine the point at which conditions are just so bad that nothing is to begained by our continued involvement with that factory?

• How do we honour the ILO principles to which we are committed where they are simplyimpossible in the non-complying State?

• In which areas should we concentrate our efforts in terms of improved compliance—wages, hours, social security entitlements or the less threatening area of occupationalhealth and safety—and who should make this decision?

• Would dealing with fewer suppliers increase the capacity to bring about an improvementin individual factory conditions as production increases?

Complexity of the law and ineffective regulationThe existence of a system of law that ensures compliance is essential to protect workers'rights. However, the complexity of the Chinese legal system is, in itself, a limitation toenterprises pursuing CSR amongst supply chains. Chinese labour law, whilst reasonablyprogressive, is diminished as a result of poor implementation and enforcement. Enterprisesinterested in investing in China need to work within the regulatory environment as best theycan, and where possible, contribute to dialogue concerning simplification of the law.Enterprises need to become familiar with the Labour Law of the PRC and then makedecisions about where they stand on issues such as: wages, hours, access to social securityentitlements, OH&S, freedom of association, collective bargaining, and the role of theACFTU. They need to determine criteria by which they will assess FDI in terms of the social,environmental and economic impact. This requires a good understanding of the working andliving conditions amongst the supply chains, opportunities to improve those conditions andmechanisms to monitor compliance. The prospect of such an undertaking can in itself be alimitation for enterprises.

Costs of complianceIn highly competitive industries, product cost and relationships are often the onlydifferentiating factor. Improved compliance means operating costs will escalate and lead tohigher unit costs for customers. The failure of enforcement and the tight competition means



that many factory managers believe they cannot afford to comply with local laws in theabsence of any guarantee that competitors will also do so. There is a fear of losing customersto less compliant factories, or even to other countries such as Vietnam and Indonesia wherelabour is even cheaper and more compliant, and the regulatory environment less welldeveloped. In this regard, foreign enterprises have a responsibility to ensure production is notmoved from factory to factory in search of the cheapest labour and least rigorous standards,and that improved corporate responsibility amongst supply chains does involve some costsbut many more benefits in terms of sustainable business practice.

Customer leverageThe reality for many small or medium enterprises is that, on their own, they have limitedinfluence. Even those enterprises such as Mod-Style with the best intentions and commitmentto core labour standards, are limited in what they can do as a result of their relatively smallproduction. However, factory managers have, for the most part, appreciated the Mod-Styleapproach of direct dialogue to pursue corporate responsibility rather than arms lengthdirectives and threats to cut production. Currently, some of the large enterprises are beginningto think about corporate social responsibility in China, however the total number of small tomedium enterprises investing in China is significant and this needs to be harnessed throughglobal collaboration and industry-led initiatives.

Corporate governance and production networksA further limitation for enterprises is the difficulties they can encounter in navigating globalproduction networks that are often a maze of licensing arrangements shrouded in secrecy.Trading houses are often responsible for managing the production of various products inChina, yet many are unwilling to acknowledge that they are being made in China. This lack oftransparency and accountability hinders efforts to promote sustainable FDI and labour rightsamongst supply chains.

3. Foreign direct investment in China—the realities of corporate responsibility in supplychain management

3.1 Case Study: Experiences of an Australian non-government organisation (NGO) managinga supply chain in ChinaIntroductionThe Brotherhood of St Laurence (BSL) supply chain management case study highlights therealities of sustainable FDI in China. The BSL is looking beyond relying on codes of conductand monitoring to demonstrate corporate responsibility and protection of workers rights. Itsemphasis is on direct engagement with suppliers and the promotion of education and trainingas the most meaningful way to support labour rights and participation. This has involvedextensive discussions with factory owners in China and their representatives in Hong Kongand the Hong Kong Optical Manufacturers Association. In addition, brand name customerswho use the same suppliers in China have been contacted. Relationships with NGOs based inHong Kong and Australia—such as the Asia Monitor Resource Centre (AMRC), Hong KongChristian Industrial Committee (HKCIC) and Oxfam, academics, trade unions, industrialhygienists and representatives of organisations such as Business for Social Responsibilityhave been established.

The research confirms that no one organisation has all the answers to achieving sustainableFDI. The best results are achieved through innovative incremental progress and global



collaboration amongst enterprises, trade unions, industry associations, NGOs andgovernments.

3.2 Mapping the Mod-Style supply chain

Identifying the factoriesThis has involved identifying and regularly visiting factories that supply Mod-Style, thendeveloping an understanding of the customer profile and subcontracting relationships of thefactories, and understanding the workforce. Time and resources have been invested inunderstanding labour rights issues in China —an undertaking which, whilst difficult for manysmall or medium enterprises, needs to be done. Mod-Style’s largest Chinese supplier (alsoone of the largest producers for the global market) has 4500 workers, 20 production lines, anda monthly production capacity of 1.1 million optical frames. It is listed on the Hong Kongstock exchange and has a market value of more than US$ 50 million4,

Mod-Style has approximately 10 suppliers in China, all of which are wholly Hong Kongowned family businesses. The well-educated and business astute second generations aresignificantly involved in managing the operations. Those factories with 1500 workers or morehave clearly appropriated the benefits of FDI, adapted technologies and processes fromEurope and Japan and created highly competitive operations in global markets, demonstratingthat size does matter. In other respects, however, it cannot be said that the Chinese workers inthese factories have benefited from the "spillover" effects of FDI and achieved "decent work",in the sense understood by the International Labour Organisation (ILO).

Companies pursuing sustainable FDI in China need to familiarise themselves with labourrights issues and management practices. However, cultural differences do not justify theerosion of basic labour rights, and the emphasis should be on compliance with The LabouLawof the People’s Republic of China (PRC), 1994.

Customer profile and subcontracting relationshipsThe Hong Kong owned optical factories based in China are producing for the domestic andexport market, particularly the large global brands, many of which have no idea whichfactories are producing their products or the conditions under which they are being made.They rely on complex licensing arrangements with trading houses and agents that do notnecessarily share the stated values and business practices of the brand name company. Thislack of transparency is, in some cases, a calculated risk management strategy to assist inensuring minimal damage to companies’ reputation as a result of potential labour rights andenvironmental concerns. It also suggests the enterprise is not accepting their corporateresponsibility for the global dimension of their business, or they consider China "just toohard" and the less they know about it the better.

The size of the factory in China influences not only conditions but also the complexity of sub-contracting arrangements. The smaller factories often outsource production processes such aselectroplating and injection moulding, and are not able to access the advantages of the largervertically integrated operations. In addition, our research has shown that those factories thatare able to produce cheaper products than their competitors, are often doing so throughcompromising labour standards and the necessary investment in capital equipment andfacilities that would ensure higher occupational health and safety standards.

4 Frost, S., South East Asian Research Centre (discussions), November, 2002, Hong Kong.



Understanding the workforceThe workforce in the optical industry is representative of much of the manufacturing sector inSouthern China. The majority of workers are young women aged 17-25 years who havemigrated from surrounding rural provinces to work in the burgeoning industrial districts. Theprimary aim is to earn as much money as possible. Generally speaking, they appear to have arelatively low level of education, and for the most part are not well informed of their labourrights. Most are employed in repetitive, low-skilled jobs. Staff turnover is high, with mostworkers staying with a factory for one to two years.

3.3 Understanding the labour and environmental conditionsThe BSL experience has shown that not all factories are the ‘sweatshops’ often attributed toChina. Factories and their processes vary in terms of conditions for workers, compliance withlabour and environmental standards, and managerial style, as they do in Australia. Forexample, some factories meet their obligations and provide social security contributions onbehalf of workers, but have a heavy security presence and an arbitrary system of fines anddeductions. Other factories provide state-of-the-art facilities and architect-designed plants, yetexpect excessive overtime without appropriate remuneration. In pursuing sustainable FDI, itis necessary to recognise that the physical conditions of a factory can be misleading andthereby divert attention from poor labour conditions. All workers migrating from rural areasare in a vulnerable position because of their temporary residential and employment statusresulting from the Chinese system of residential registration, or "Hukou". This system willneed to be reformed if China is to continue to develop and meet the needs of its highly mobilelabour market

Environmental standards and physical conditionsEnvironmental standards and physical conditions vary significantly among factories in China.With regard to the optical industry, the larger factories, which undertake electroplating onsite, had sophisticated equipment, ventilation and waste management. Indeed, worseconditions have been witnessed in Australian electroplating facilities. All factories appearedto collect, and in some cases treat, wastewater before it was sent to an outside plant for furtherprocessing. Some factories had acetate dust collection bags, and in one case all acetateshavings are sold for recycling into personal goods such as combs and toothbrushes.Chemicals and paints are, for the most part, well labelled and stored, and most of the largerfactories had a chemical inventory. The same cannot be said of the smaller optical factories.

The physical conditions of the factories also presented a complex picture. Generally, theywere better than anticipated, particularly in terms of occupational health and safety (OH&S)standards. Most of the factories visited were clean and well lit with adequate heating andcooling. Dust masks are often provided (though rarely worn), and some factories havespecialised ‘hands-free’ machines to reduce finger injuries. The overall impression, confirmedby Hong Kong based NGOs such as the Asia Monitor Resource Centre, is that these factoriesprovide better facilities and working conditions than usually reported in the toy, footwear,textile and apparel industries, that are relatively well understood and accessible toindependent monitors. The same cannot be said of the electronics and petrochemicalindustries in China which are very much off limits and where conditions are reported to beharsh (Liu, 2002).

In other respects, however, it cannot be said that the Chinese workers have achieved ‘decentwork’, in the sense understood by the International Labour Organisation (ILO). For example,



worker accommodation is often spartan and dehumanising. In the worst cases limitations areplaced on water usage and time allowed for toilet breaks. Large, clean new factories do notguarantee reasonable working conditions and can often mask serious human rights abuses.

Labour standardsSignificant human and labour rights issues exist, particularly with regard to wages, hours, andsocial security entitlements. In these key conditions there were evident breaches of TheLabour Law of the PRC. Managerial regimes are strictly hierarchical and at times repressive.It is often difficult for workers to raise grievances and have disputes resolved without riskingreprisal. Fines and disciplinary action are common, and in some factories workers appeardespondent. The BSL experience has confirmed that overall workers are compliant and inreality do not participate in the co-determination of their workplaces in any meaningful way.

Freedom of association outside of the only legal trade union (All China Federation of TradeUnions—ACFTU) is not possible. Whilst some optical factories had trade unionrepresentatives, these positions are usually held by supervisors and managers. There was noevidence of collective bargaining, and conditions were set by unilateral managementdecisions.

Consideration will need to be given to the issue of freedom of association and collectivebargaining if discussions and progress on the complex issue of human rights and businessintegrity is to be progressed. In this regard, individual firms have little capacity to bring aboutchange in China, as this is a matter of national law. However, it should be noted that severalof the major footwear companies have been involved in a significant capacity building projectwhich is encouraging worker participation through occupational health and safety committees(IGC, 2002). Furthermore, one of these companies (Reebok, 2002) has been involved infacilitating ACFTU elections within a factory, a significant first step in the process ofensuring workers participate in choosing their union representative. These examples helpdemonstrate that progress is taking place in China, often at astonishing speed and there isscope for enterprises to contribute.

4. The OECD Guidelines for Multinational Enterprises and supply chain managementin ChinaThe OECD Guidelines for Multinational Enterprises (Guidelines) which were adopted in2000 are a set of recommendations addressed by governments to MNEs. Although voluntary,they are supported by all OECD countries in which most MNEs originate. The Guidelinespromote corporate social responsibility, the contribution of business to social developmentand the promotion of basic workers’ rights. The Guidelines advise that MNEs shouldcontribute to the economic, social and environmental progress with an aim of achievingsustainable development and respect for human rights of those affected by their activities asconsistent with host governments’ international obligations and commitments (OECDGuidelines for Multinational Enterprises, 2000)

Implementation of the Guidelines in non-adhering countries such as China is problematic;however opportunities do exist for enterprises to pursue sustainable FDI. There is little doubtthat complex subcontracting and supply chain arrangements make application of theGuidelines more complex. However, there is a role for home governments in supporting thoseenterprises seeking to do the right thing. Assistance can be provided to firms, particularlysmall and medium sized enterprises, through ensuring they understand the realities ofsustainable and socially responsible investment in developing countries. This requiresgovernments to make the connections between human rights and international business, and



to accept some responsibility for the business activities of enterprises abroad to contribute tocompliance with labour and environmental standards. Enterprises need to be persuaded toimprove their transparency and accountability, particularly regarding their global productionnetworks, licensing arrangements and portfolio investments. This will require a shift from thecurrent emphasis on ‘confidentiality’, which is often presented as a commercial imperative,but can be also be interpreted as a calculated risk management strategy to reduce perceivednegative consumer or shareholder backlash. Similarly, the contractual relationships alongsupply chains could be disclosed, for example, in annual reports of firms. This is consistentwith the Guidelines in terms of disclosure.

The OECD Guidelines, whilst not binding, do commit OECD member States to activeparticipation in the corporate responsibility debate and practice. This requires Governments torespond to the increased global integration of trade and investment and to ensure policiesaimed at corporations are in keeping with the OECD Guidelines. Incentive packages, such assubsidies and export credit regimes, designed to both attract inward investment and promoteexternal investment, both trade and portfolio, need to be consistent with the OECD Guidelines(Van de Gaag, 2001). The European Commission has suggested that all incentive schemesand development programmes should be considered in the context of the integration of corelabour standards. The Guidelines make explicit reference to ‘suppliers and sub-contractors’(OECD Guidelines for Multinational Enterprises, 2002, general Policies, Chapter II,paragraph10) which clearly recognises the global integration of trade and investment and themandate to include supply chain and subcontracting relationships within the scope of theGuidelines.

5. Concluding remarksChina’s astonishing capacity to change and develop provides an important backdrop againstwhich to address the issue of sustainable FDI. This paper has confirmed that the benefits ofFDI do not automatically accrue or are evenly spread, and this, coupled with an anticipatedfurther reduction in FDI flows, necessitates consideration of the enabling environment. Inaddition to the various macroeconomic and regulatory factors, an assessment of whatcontributes to sustainable development is required. Economic growth must encompass socialcohesion and respect for labour rights.

A multidisciplinary, innovative response that suits the needs of all stakeholders, and that isbased on internationally recognised principles that contribute to the protection of labour rightsand environmental sustainability is essential. This is best achieved through alliances andpartnerships between business, NGOs, trade unions and governments. The OECD Guidelinesfor Multinational Enterprises are currently the best placed corporate responsibilitymechanism, and with additional attention to the issues of implementation, monitoring andimproved transparency could be a powerful tool.

Trade and investment are clearly integrated in the global economy and greater attention needsto be given to the complex area of corporate responsibility amongst supply chains andsubcontracting arrangements in developing countries. The experience of the BSL with itsoptical enterprise firmly entrenched in China clearly demonstrates that it is possible for smallenterprises to contribute to the global debate and practice if there is a strong commitment andwillingness to invest in ethical and sustainable business practices.

Global discussions reflect the increasing overall support for the promotion of core labourstandards and greater recognition of social development as a necessary component ofsustainable development. Within the international community there is a slow but steadilyincreasing recognition of the need to ensure full respect of core labour standards, without



falling foul to protectionist measures. However, there is still some way to go in adequatelyaddressing the relationship between globalisation, trade and investment, and socialdevelopment. In addition, the protection of labour rights and the promotion of core labourstandards needs considerable attention and imagination to ensure social governance is part ofthe mainstream debate on sustainable FDI.

References

www.acftu.org.cn/labourlaw.htm electronic [accessed 27 November 2002].

Chan, A. and Senser, R. (1997) “China’s Troubled Workers”, Foreign Affairs, Vol 76 (2),pp.104-117.

Chan, A (1998) “Labour Standards and Human Rights: The Case of Chinese Workers underMarket Socialism” Human Rights Quarterly, Vol 20 (4), pp. 886-904.

Chan, A. (2000) “Globalisation and Labour in the Asia Pacific Region”, Asia Pacific BusinessReview, Vol 6 (3 & 4), pp.260-281.

Chan, A. (2001), China’s Workers Under Assault: The Exploitation of Labour in aGlobalising Economy, East Gate, USA.

Chan, A. (2002) “The Culture of Survival of Migrant Workers Throgh the Prism of PrivateLetters” in P. Link, R. Madsen and P. Pickowicz (ed) Popular Thought in Post-SocialistChina (Boulder: Rowman & Littlefield) pp, 163-188.

Commission of the European Communities, (2001) "Communication from the Commission tothe Council, the European Parliament and the Economic and Social Committee", Promotingcore labour standards and improving social governance in the context of globalisation,Brussels.

Dong, Baohua. (2002) (unpublished) Labour Law and Reform in China, China.

Gao, Mobo. (1994) “Migrant Workers from Rural China: Their Conditions and SomeImplications for Economic Development in South China” in D Schak (ed) Entrepreneurship,Economic Growth and Social Change: The Transformation of Southern China (Australia-AsiaPapers, No.71)

http://www.igc.org/mhssn/China3.htm electronic [accessed 22 July 2002]

International Labour Organisation (ILO), 1998 Declaration on Fundamental Principles andRights at Work and its follow up, Geneva.

Labour Law of the Peoples Republic of China (PRC), 1994.

Li, Cheng. (1996) “Surplus Rural Labourers and Internal Migration in China”, Asian Survey,Vol. 11.



Liang, You Xin, Fu, Hua, Gu Xue-Gi."Provision of Occupational Health Services in China"Asian Pacific Newsletter. Electronic [accessed January 2001]www.occuphealth.fi/e/info/asian/ap298/Liang&Gu.htm

Lillywhite, S. (2003) "Sustainable foreign direct investment in China—supply chainmanagement and labour rights in China", in OECD Attracting International Investment forDevelopment, OECD, Paris.

Lintjer, J. (2003) "Creating the enabling environment for quality investment", in OECDAttracting international investment for development, OECD, Paris.

Liu, Kaiming. (2002) (unpublished) Working Together to Build a Sustainable ImprovingModel, China.

OECD (2002). Foreign Direct Investment for Development: Maximising Benefits,Minimising Costs, OECD,Paris.

OECD, (2000) Guidelines for Multinational Enterprises, OECD, Paris,

OECD Observer, 2003, Paris, electronic [accessed 14 July 2003]http://www.oecdobserver.org/news/fullstory.php/aid/101.

OECD Observer, 2003, Paris, electronic [acessed14 July 2003]http://www.oecdobserver.org/news/fullstory.ph…/Getting_Chinas_regions_moving.htm.

Pan, P. (2002) “China’s new labourers forced to work till they drop” in The Guardian Weekly,May 23-29.

Reebok. (2002) Towards Sustainable Code Compliance: Worker Representation in China,Reebok International Ltd.,Hong Kong.

Roberts, K. (2002) “Rural Migrants in Urban China: Willing Workers, Invisible Residents”,Asia Pacific Business Review, Vol.8 (4) pp141-158.

Rosen, R. 2001-2002. "Asia Beckons", Ethical Investor, Issue 7, December-January.

Saunders, P. and Shang, Xiaoyuan. (2001), "Social Security Reform in China’s Transition to aMarket Economy", Social Policy & Administration, Vol.35, No.3, p.277.

Schauble, J. (2002) "China's working wounded", The Age, 4 April.

The Economist Intelligence Unit, (1999) “Human resources” in China Hand

Van der Gaag, P. (2001) Governments and Corporate Social and EnvironmentalResponsibility (presentation text), Washington DC.



TABLE 1

IMPROVED SUPPLY CHAIN MANAGEMENT AND SUSTAINABLE FDI IN CHINA: ACHECKLIST

! Acknowledge that the organisation’s corporate responsibility includes its global activities, including supplychains and subcontracting relationships and ensure this is included in any triple bottom line reports

! Undertake research and allocate resources to ensure social responsibility and sustainability is an ongoingcomponent of international trade and investment

! Understand and map all supply chains and subcontracting arrangements! Visit factories and workplaces regularly and continue to discuss issues of corporate responsibility and

sustainable FDI! Develop non-confrontational ways of communicating with factory managers! Understand the labour, environmental conditions and regulatory framework! Develop an understanding and working knowledge of the role of trade unions and other arbitration and

negotiation processes! Respond to the central government’s current regulatory emphasis on OH&S and other efforts to improve

workplace conditions! Develop open, transparent and direct long-term relationships with suppliers rather than relying on ‘arms

length’ contracting and licensing agreements.! Develop joint venture and other business contracts that incorporate criteria for sustainable FDI and corporate

responsibility! Invest in capacity building offshore, including education and training for workers and managers, and the

promotion of ethical business practices! Avoid the attraction of searching for the cheapest labour and goods, at the expense of social and

environmental responsibility and sustainability! Commit time and resources to understanding the business environment and culture of the countries of

operation and be prepared to employ specialist staff! Recognise that corporate responsibility becomes more complex as transnational activity increases! Recognise that a code of conduct and monitoring does not provide all the answers or protect workers rights! Recognise the limitations and opportunities facing enterprises seeking to contribute to sustainable FDI—

incremental progress based on a commitment to action is worthwhile! Develop alliances and partnerships with NGOs, worker representatives, academics, other enterprises and

government representatives to contribute to corporate and social responsibility through global collaboration! Commit to and act in accordance with the appropriate international treaties, conventions and guidelines—

particularly the OECD Guidelines for Multinational Enterprises, in all dimensions of the business! Document your experiences in managing supply chains offshore, both the good and the bad, and make this

information available to others, including Chinese officials who will welcome feedback on how to continueto attract FDI

! Encourage your industry association or professional body to engage with the issue of sustainable FDI anddevelop an industry wide strategy and plan of commitment for incremental improvement

! Contribute to consumer education and campaigns—assist consumers to make informed choice based on aclear understanding of where goods are produced and investments made, this could include labelling.

institutional challenges for the global...

Documents