Multiply that transaction by thousands, and you have a sense of the “gray market” that has flourished for years along China’s southern border. Prime Minister Zhu Rongji charges that these fudged imports, along with outright smuggling, add up to as much as $30 billion in contraband entering China annually, from Chilean fruit to German cars to Korean steel. Since Zhu launched a crackdown last year, reportedly vowing to “kill, kill, kill” the illegal trade, his enforcers have arrested more than 600 mainland officials, executed a couple of dozen smugglers and assigned more than 3,000 new anti-smuggling agents to the Hong Kong border alone. That’s bad news for Chinese steak lovers. Zhu’s campaign challenges Hong Kong’s role as a cut-rate gateway to the China trade–and compels big-name multinationals to come up with new ways to stay competitive in that elusive World’s Biggest Market.
Finding the right mainland connections and cutting corners used to be the way to do it. Hong Kong middlemen like Cheung had plenty of foreign customers. The exporters dreamed of access to 1.2 billion Chinese consumers but faced a wall of steep tariffs, including 150 percent on luxury cars and 20 percent on computers. Then came a 17 percent value-added tax, a byzantine distribution system and other obstacles. No wonder that, before Zhu’s crackdown, Hong Kong’s middlemen got rich by devising cheaper ways into the market. Some analysts estimate that 80 percent of China’s imports avoided some official levies. “Everyone used gray channels before,” says the manager of a leading Asian computer company, adding that the standard cover line is " ’the company has never done any illegal things, and we support Chinese government regulations.’ But business is different. Surviving is different."
The system might have been shadowy, but it worked. Seventy percent of the foreign-made cameras and $400 million worth of U.S. chicken parts a year entered China through the gray market, according to Chinese and U.S. officials. China also has a voracious appetite for mobile phones, and in recent years as many as two of every three imported handsets avoided at least some official barriers. So did cheese for McDonald’s burgers, according to industry sources in Hong Kong, until the company began using mainland products. (A McDonald’s spokeswoman says she is not aware that the company or its suppliers used such routes.)
Sometimes the channels are convoluted. In the computer industry, “more than 90 percent of goods came in without paying 100 percent [duty],” says Jared Peterson, research director for the International Data Corp. in Beijing. Some multinationals manufactured PCs in China and then exported them, a tactic that allowed them to claim tax rebates on any imported parts. An independent trader then whisked the computers back into China through gray channels, avoiding full duty. As an “import,” the computer fetched a higher price than if it had stayed in China all along. IBM, for one, acknowledges that its desktops manufactured in southern China are sold inside the country as well as to distributors in Hong Kong, who sometimes ship them back to China. But “we have no information” about the use of gray channels, says an IBM spokeswoman. “We believe our distributors ship our products legally.”
The strategy was “gray,” after all, not “black.” The hundreds of middlemen involved in this market were never in the same league as big-time cigarette runners or the smugglers arrested in Hong Kong last week with a boatload of electronic goods and appliances worth $2.6 million. The middlemen, known as “converters,” took orders from Chinese distributors or Hong Kong suppliers, yet they assumed the financial risk: anything lost, stolen or confiscated came out of their pockets. The customers, meanwhile, got deniability. An executive of a foreign-car manufacturer, for example, says his sales of car parts bound for China all are arranged in Hong Kong. “How they get them in [to China] we don’t care,” he says. “We don’t ask.”
Still, Zhu’s crusade has hurt more than the converters, some of whom have had to switch to driving taxis or other work. In the key computer sector, shipments declined, burdened by full taxes and red tape, and the mainland prices of Hewlett Packard, Compaq and other imports rose, say authorized distributors in China.; Meanwhile, the market share of cheaper mainland brands like Legend and Great Wall has grown. In camera film, another fiercely competitive area, Kodak and Fuji imports have become more costly, according to analysts and film sellers (though Kodak says it does not know of a general rise in retail prices and says it has not changed prices to distributors because of the crackdown). Sales of the mainland brand, Lucky, have jumped 50 percent. Kodak and Fuji say they have no knowledge of gray-market handling of their film.
The flow of 9,000 foreign cars a month heading to China has dwindled to fewer than 2,000. About 8,000 Mercedeses, Mitsubishis, BMWs and other foreign luxury cars ticketed for the mainland are sitting in Hong Kong parking lots. (Built with left-hand steering columns, they can’t be sold in Hong Kong, which requires right-hand steering.) Also stalled are some familiar old scams. Converters would arrange with Chinese customs to “seize” cars as contraband, then “auction” them off for low prices to prearranged bidders on the mainland. The numbers no longer add up for many Hong Kong sellers. “You can’t have a market in China with heavy tax,” grumbles a trader for Asia Motor Enterprise.
Many multinationals have the resources to play the game Zhu’s way. Computer companies like IBM and Hewlett-Packard and cellular-phone giants like Motorola and Nokia have mainland factories that can produce more inside China. “Before, the entire market was built by relations,” says IDC analyst Kitty Fok. “Now, whoever can offer a better product wins. It’s a healthy move, especially for international companies.”
What about Hong Kong’s famed middlemen: can they adjust? “It will be tough for a while, because it looks like this guy [Zhu] is damn serious,” says one converter. The businessman says fear of Zhu hasn’t stopped him from underdeclaring the value of shipments. Still, he no longer dares misidentify his goods. Hong Kong’s wheeler-dealers are used to finding roadblocks on the way to China. They can only hope Zhu’s will turn out to be just like all the rest–temporary.
