Cost of Doing Business: China Versus Emerging Asia

Concerns are being leveled at all stages across Asia and beyond as to whether the government of President Xi Jinping can successfully transition China to a consumer-driven economy, while at the same time holding onto what is a significant global manufacturing base and continuing to make the nation attractive to foreign investors.
 
The old development model, essentially spearheaded by Jiang Zemin and Zhu Rongji over 20 years ago, saw China emerge as a low-cost destination for global manufacturers. Local labor was cheap, tax breaks of up to five years attracted foreign investors, and the corporate income tax rate for those same investors could be as low as 12% in some areas of China and a regular 15% for others.
 
These tax breaks and low rates for investors were scrapped by the government of Hu Jintao and Wen Jiabao in 2008. The corporate income tax rate has now risen to 25% plus another 10% on top of that for foreign investors to repatriate their profits.
 
Although it is true to say that a number of China’s double tax treaties reduce the dividends tax from that 10% burden to 5% under certain circumstances, it still represents an effective doubling of the corporate tax burden from 15 percent to 30 percent in the past five years.
 
That has coincided at the time when recession has hit many North American and European Union countries hard. Both are among China’s largest trading partners. Absorbing such a hike for MNC investors into China has proven troublesome.
 
Rise of competitors
In addition to the income tax increase in China, alternative destinations have started to emerge as competitors. Here is a rough guide to how China stacks up in terms of its corporate income tax burden against its Asian competitors.
 
Click image to enlarge 
Corporate Tax Rates
Sources: OECD and government websites.
 
Of additional concern has been the relentless rise of wages in China. While the government quite rightly wants to improve the financial well-being of the average Chinese national, the stark fact remains that for China, internal political pressures on the government to keep the prosperity of Chinese nationals on the up is happening at a far faster rate than that of anywhere else in Asia.
 
Below are the mean average minimum salaries estimated across emerging Asia. For China and India especially, a large degree of movement can be found in either direction, and especially at the higher end in the major cities. The average monthly salary in Shanghai now is over four times the US$238 quoted below, at US$1,133. In Mumbai, it is now about US$550.
 
Click image to enlarge 
Salary Estimates
Sources: OECD and government websites.

The amounts are “rule of thumb” and should be used as guidelines only. This is due to the various complexities of calculating and assessing amounts across countries, while attempting to standardize differing cross border measurements and tax treatments for general comparison purposes. For complete details and comparisons, please email [email protected]

 
Where China’s employment costs really start to get above what should be a regional mean is in the extraordinary cost of mandatory social welfare – 50% of salary. This is a somewhat unique situation and again demonstrates the cost of doing business in what remains a one-party state determined to maintain social order by giving its workforce increasing amounts of money.
 
The mandatory social welfare cost may be absorbable by the country’s numerous state-owned enterprises, but it is becoming an unattractive proposition for foreign investors.
 
Many of the countries in the above table do not actually impose mandatory welfare – the figures are based on what is considered normal corporate practice. But in China, that 50% addition to the cost of salary is a legal requirement to be borne largely by the employer.
 
VAT and Capital Gains
Another area where China scores high in expenses is in value added tax, most of which is claimed by the treasury. Additionally, VAT is not fully claimable on export, meaning an additional cost of business exists there also.
 
China imposes the highest VAT rate in emerging Asia, impacting on every single product, again adding to the cost of doing business and living in the country.
 
Average Value Added Tax Rates
Sources: OECD and government websites. The amounts are “rule of thumb” and should be used as guidelines only. This is due to the various complexities of calculating and assessing amounts across countries, while attempting to standardize differing cross border measurements and tax treatments for general comparison purposes. For complete details and comparisons, please email [email protected]
 
Foreign investors also pay the highest capital gains tax in emerging Asia. Like India, China levies capital gains taxes on all gains. Indonesia, Philippines and Malaysia impose capital gain taxes only on property transactions, and at far lower rates (5% to 10%, versus 25% in China).
 
Capital Gains Tax
Applicable to Foreign Investors
 
Sources: OECD and government websites.
The amounts are “rule of thumb” and should be used as guidelines only. This is due to the various complexities of calculating and assessing amounts across countries, while attempting to standardize differing cross border measurements and tax treatments for general comparison purposes. For complete details and comparisons, please email [email protected].
 
Conclusion
At present, China’s tax regime and cost of business platform are too high, and are running far out of synchronization with emerging Asia. Rather than the Chinese leaders thinking the country is comparable to Japan (apart from the economic size, it is not), China needs to realize it is still very much an emerging economy and should begin to tailor its reforms accordingly.
 
Chinese nationals in Nanning earn three times those in Hanoi, pay double the costs, and have no better overall living or disposable income standards than their Vietnamese counterparts. The cost differential doesn’t make sense.
 
As for foreign investors, the bean counters will be sharpening their pencils. The rule of thumb appears to be that if you can get manufacturing productivity up to 70 percent of that currently achievable in China, then it usually makes financial sense to relocate.
 
And with ASEAN’s free trade agreements with China kicking in fully come 2015, the Chinese Communist Party needs to introduce some serious reforms and policies to head off what has the potential to turn into a slow decline in China’s overall fortunes.
 
About the Author
Chris Devonshire-Ellis is the founding partner and principal of Dezan Shira & Associates, a specialist foreign direct investment practice that provides advisory services to multinationals investing in emerging Asia. This article was first published in China Briefing and was reedited for clarity and conciseness. For further details or to contact the firm, please visit www.dezshira.com.

    

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