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Testing Your Corruption Goggles

My evening Air China flight from Chengdu to Beijing last week was delayed due to bad weather in Beijing.  After waiting in the airplane on the runway for takeoff for three hours and then another two hours in the airport, Air China made the announcement at 11:30pm that the company would put the passengers up for the night in a “nearby” hotel.  We were given direction to buses parked outside the airport, and as we drove by the Air China hotel located conveniently outside of the airport, I thought “Here we go again, another long drive through the suburbs to some far-away hotel for a three hour rest only to take the long drive again to the airport in the morning.”

Why couldn’t Air China put the passenger first and put us up at the airport instead of driving 30km to some third-rate hotel where I had to pay an extra 120 RMB in order not to share a room with a strange and snoring fellow passenger?  Looking around the lobby, indeed other passengers were asking the same question.

To answer this question, we need to don our corruption goggles.  You know, the lenses that help us see how pirated DVD sellers get to stay on the block, day in and day out;  those spectacles that allow privately-driven-but-publicly owned autos on Beijing’s third ring road to glow like the red ooze that paid for them; or the x-ray glasses that penetrate the concrete walls of the CCDI’s detention center to reveal Wang Lijun removing a tattoo “Neil” from Bo Xilai’s six-pack using skin grafts from dead Chinese prisoners.

Today’s corruption goggle lesson is a focus on a ubiquitous corrupt practice: over-invoicing.  Over-invoicing is a popular mechanism used in both government organizations and private firms in China and the rest of the world to embezzle funds.

To illustrate how this works, imagine that your firm or relevant organ needs a new computer and budgets 3500 RMB for said computer.  In a cash-based economy, like China’s, where prices are settled through a negotiated person-to-person haggling process, a manager sends his employee with 3500 RMB in cash to the market make the purchase.  The employee bargains the price of the computer down below the budgeted level – say to 3000 RMB.  This is savings for the firm, right?  Wrong, the employee then requests the seller to create an official invoice for 3500 RMB and the employee, pockets 500 RMB.  Well not exactly.  The seller needs something out of the deal too, so he and the employee split the difference at 250 RMB each.

Is the firm worse off?  The purchase still came in at budgeted price – or even under-budget which makes the manager happy.  The receipt goes on the books and the employee’s effective wage has increased in a piece-meal fashion.  (In a variant form, sometimes the seller needs to receive the full 3000 to produce this receipt.  Here, he throws in an extra gift, say an external hard drive.  The buyer pockets the hard drive, and the seller gains the profit.)

Extend this example through the accounting system (i.e. bank manager as the seller; construction foreman working on your housing decoration project as the employee; provincial railway official applying for funds to build a high-speed rail network) and by donning our corruption goggles we can begin to observe the systemic and ubiquitous penetration of embezzlement practices throughout the China.

Last week I was talking to a friend, Cheng, whose lines of businesses range from retail fashion to IT repair to high-end dining services – a true gold standard of diversification.  He regaled me with his latest project – building five buildings within an 18 building luxury housing project.  Typically, launching into the real estate development business takes experience and capital, but not for this guy.

To provide context on his opportunity, the five buildings are to be used to relocate villagers whose homes were demolished to build the luxury lot; therefore, it’s a government sponsored project with very little oversight.  He and two other business partners bid among other investment teams to win the project – they put up zero capital and had zero experience in construction.  Yet their 90 million RMB bid won – thanks to the secret ingredient of a 3 million RMB bribe to a bank official!  So now they have a grant from the local government for 90 million, but what they didn’t tell the grant issuing bank was the project will only cost 70 million (over-invoicing in not-so-competitive bidding form).  So minus the 3 million for the bribe, the three investors split the difference of 17 million RMB in government funds.  To top it off, they can put 50% of the apartments in the five buildings on the market to make even more money.  Again, all for zero money down and zero experience at building apartments – not bad for a day’s work.  Why can’t I get in on this deal!!

Getting back to the China Air example, have your goggles led you down the road to true vision?  The hotel services 30km away are listed at a much cheaper price than the Air China owned hotel due to low rents in the suburbs and distance from a prime location.  Air China can charge itself a high price for a hotel room in a prime location and produce a receipt.  The airline is not worried about cost-savings with knowledge that as a state-owned enterprise it can engage in morally hazardous financial practices and rely on a bailout from the central government at nearly any time (indeed it may be getting one soon!).  Then it can then pay the cheap Podunk hotel at cost and then reap the difference in between.  I love it when opportunities are created out of crises (that you’ve also created).

In this game, all you need is a middle man who is willing to play the game with the marginal opportunity of creating an official receipt for you, and you can steal money.  In my next post, I’ll explore the growing role of the semi-private middle man in rising corrupt practices in China.  For now, let’s set our corruption goggles to glow pac-man yellow for middle-men!

 

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