China Cuts Off McKinsey, Other U.S. Consultants To Retaliate Against Cyber Indictments

May 25 2014, 7:50pm CDT | by

Today, the Financial Times, citing “people close to senior Chinese leaders,” reported that Beijing has ordered state enterprises to cut dealings with U.S. consulting firms, accusing them of spying for Washington.  The “instruction,” as the paper called it, was handed down after U.S. Attorney General Eric Holder announced indictments against five Chinese military officers for “serious cybersecurity breaches.”

“The top leadership has proposed setting up a team of Chinese domestic consultants who are particularly focused on information systems in order to seize back this power from the foreign companies,” the paper quoted a “senior policy adviser to the Chinese leadership.”  “Right now the foreigners use their consulting companies to find out everything they want about our state companies.” 

Beijing has not signed the World Trade Organization Agreement on Government Procurement, so the Chinese government is free to discriminate against foreign companies when it obtains goods or services.  Nonetheless, if the FT’s reporting is accurate, the instruction looks like a violation of the WTO General Agreement on Trade in Services, especially when state enterprises act in a commercial as opposed to a government capacity.  In Part A of Annex 5 of that agreement, China undertook not to limit market access to “Management Consulting services” and agreed that foreign parties are entitled to “national treatment” with regard to such services. 

Moreover, China, when it joined the WTO, confirmed that state enterprises would make purchases based “solely on commercial considerations, without any governmental influence or application of discriminatory measures.”  Furthermore, Beijing, in negotiating its entry into the government procurement agreement, is now arguing that purchases by state enterprises should not be covered by the pact.  In short, China’s ordering such enterprises to not do business with foreign consulting companies, as reported by the FT, is a clear violation of its WTO commitments.

Beijing does not seem to care.  The central government’s order to state enterprises is part of a concerted attack on foreign IT.  On Friday, the National Development and Reform Commission, China’s chief economic planning body, said it would strengthen national security review checks on foreign investments coming into China.

On Thursday, the State Internet Information Office announced it would establish a new screening process to vet most foreign IT products and services in China, including those in the communications, finance, energy, and other sectors the government deems related to either national security or the “public interest.” 

And shortly before the Holder announcement, Beijing banned the further purchase of Windows 8, Microsoft’s latest operating system, for central government networks.

Many say that none of these initiatives is a real threat.  The anti-consulting services measure, which Beijing will implement despite its trade obligations, means that state enterprises will be cut off from McKinsey, Boston Consulting Group, Bain, and other first-rank consulting firms.  It could take decades for the Chinese government to build a domestic consulting industry, and in the interim state enterprises will probably fall even further behind.  In the meantime, American consulting firms can concentrate on other clients, private Chinese firms and multinationals. 

The State Internet Information Office’s vetting procedure does not exist yet and could take years to put in place.  Cisco Systems and SAP, in statements to the South China Morning Post, said the new procedures are not expected to affect their Chinese businesses.  The NDRC did not detail how it would strengthen its national security checks, a clear indication that the decision to announce enhanced review was made on the spot.

And Windows is already thoroughly imbedded into central government computers, so Beijing is making sure it does not get upgrades.  As the FT notes, Beijing’s efforts to create domestic software to challenge Microsoft have floundered.  The failure of Red Flag Software, a project of the prestigious Chinese Academy of Sciences, is symptomatic of the inability of Chinese leaders to adapt their Maoist model to the 21st century.

These initiatives—and others—make the Chinese political system look not only backward-looking but increasingly anti-foreign.  As the South China Morning Post reported, observers suspect the IT vetting process announced on Thursday will probably result in Beijing favoring Chinese suppliers over foreign ones.

China’s accession to the WTO in late 2001 was supposed to prevent Beijing discriminating against foreign business.  More broadly, the entry of China into the global organization was intended to “enmesh” the country into a rules-based system. 

Unfortunately, in the last several years Beijing’s trade behavior—the country’s predatory practices are directed from the top—has markedly deteriorated.  The string of China’s losses in the WTO dispute panels—General Motors and Chrysler are the big beneficiaries of a preliminary decision handed down in Geneva on Friday—should be no surprise. 

Looking forward, it appears that China’s state enterprises will take advantage of the prevailing anti-foreign wave to entrench their position in the economy.  The thinking is that every yuan a foreign company makes is one less for Beijing.  Chinese leaders now believe they are living in a zero-sum economy, and foreign business will be the first casualty in this new environment.  China will the second.

Follow me on Twitter @GordonGChang and on Forbes

 
 

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