Prime Minister Kevin Rudd’s warning to Beijing that the world is carefully watching the trial of Stern Hu is not an overstatement. The international business community is still assessing what this extraordinary episode means for foreign companies doing business in China. After all, Hu was detained while leading multi-billion dollar negotiations for Rio Tinto against the Chinese Iron and Steel Association (CISA). He was initially detained on ‘national security grounds’ and arrested for ‘stealing state secrets’.

It was only after international political pressure, mainly by American Secretary for Commerce Garry Locke, that Hu’s charges were downgraded to those of ‘receiving bribes’ and ‘theft of industrial secrets’. When the dust eventually settles after his ‘three day trial’, the international business community will take a significantly dimmer view of both China’s business environment and of the country’s political-economy.

The dominant narrative is that authoritarian China has been an enormous beneficiary of economic globalisation and is rising as a responsible stakeholder within the global economic system. Since the mid 1990s, Beijing has promoted China as dependent, and therefore, welcoming to foreign businesses. Beijing’s message has been that its political values will not detrimentally dilute the existence of a pragmatic rule-of-law environment within which foreign businesses operate.

For the most part, especially in the low-technology manufacturing and export industries, this remains true. But as the Stern Hu situation attests, problems potentially arise when foreign companies engage with state-owned champions, or else operate in the dozen or so sectors that Beijing deems vital to China’s national interest.

Beijing will protest that Stern Hu has admitted to accepting bribes and that his trial is therefore legitimate. True, but bribery is so widespread in China that the decision to prosecute is almost always a political rather than judicial one. But two aspects of Hu’s predicament and trial remain of enormous concern. First, there is the question of timing. Hu was first detained once it became obvious that the CISA were ‘losing’ in their negotiations with Rio Tinto. It also occurred at a time when tensions between Beijing and the Rudd government began to surface. Second, there is still the significance of the initial charge of ‘espionage’ which was then downgraded to stealing ‘industrial secrets’.

This will feed a number of growing uncertainties for the business community.

Chinese laws are written so broadly that they can be selectively applied to suit the commercial or political purposes of the state and its agencies. It is no coincidence that Hu was detained after it became apparent that the CISA had been out-negotiated by a Rio Tinto team that possessed superior tactical information about Chinese steel mills. Moreover, state agencies such as the CISA can retrospectively deem a piece of information as a ‘state secret’ or even an ‘industrial secret’. It is no surprise that the part of the trial to assess whether Hu was in possession of an ‘industrial secret’ will be held behind closed doors.

The issue of the lack of ‘due process’ in China’s legal system is also set to become more prominent. The trial, which ought to be a complex one, will last two or three days. Hu’s lawyers face severe limitations in calling witnesses or in cross-examining the prosecution’s witnesses. His lawyers have been given only limited access to the prosecution’s documents. More broadly, courts explicitly remain under the authority of the CCP and all judges are appointed directly by the CCP. Court decisions are also subject to ratification by the Party.

International observers will reach the conclusion that state-owned champions remain agents of the state and Party. The vast majority of senior management of these SOEs are CCP members; and board members CCP officials (The other side of Chinese business, March 23). The CISA which negotiates on behalf of China’s state-owned steel mills is stacked with CCP political and intelligence officials. The decision to first detain Hu on grounds of espionage, and then to pursue him on the lesser charges were made by high ranking political officials rather than lawyers. Indeed, Beijing has consistently reiterated that securing a cheaper price for long-term iron ore contracts is a matter ‘that goes to the heart of national security and interests’.

These realities have certain ramifications. For example, it will influence the way foreign governments and regulatory authorities view take-over bids by Chinese SOEs. Foreign businesses will also realise that their chances of access and success in the Chinese market may be partially dependent on the status of their government’s relationship with Beijing. For companies with operations already in China, deteriorating relationships with government officials entail personal and corporate risks.

Finally, the episode hints at what could be a broader development — the regulatory, protectionist and political environment in China is becoming increasingly difficult for foreign companies. A number of memos and articles indicate that many CCP officials believe that the Chinese economy is less reliant on foreign companies — resource companies an exception — to help it develop and modernise than it once was.

Foreign companies are increasingly complaining about rising Chinese protectionism, lack of market access and even the absence of token efforts by officials to protect intellectual property rights. Many executives sense that there is now less emphasis on promoting the attractiveness of ‘brand China’ to foreign companies. If so, foreign companies who have been at the forefront of advocating closer political and economic engagement with China in order to get a slice of the pie could soon change their tune.

The article first appeared on Business Spectator