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David Caploe PhD

David Caploe PhD

David is a writer for the popular economic news site Economywatch.

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Rio Tinto Case Indicates Chinese Leadership are Confident that Growth Will Continue

When four executives from Rio Tinto, the giant Anglo-Australian mining company, were arrested last July on charges of stealing commercial secrets, as well as taking and receiving bribes from Chinese officials, most Westerners interpreted the move as trumped-up retaliation for the debt-strapped company's rejection of a 19.5 billion US dollar cash injection from the state-run Chinalco last June, since Rio Tinto is one of China’s biggest suppliers, helping it import tens of billions of dollars worth of iron ore every year — a vital component for steel that is fueling its booming economy.

Given the deep inter-relationship between company and country, the confrontation was highly charged from the beginning.

But once the run-up to the trial began, as well as the highly un-transparent proceeding itself, the situation became even stranger, culminating in the announcement of unexpectedly harsh jail sentences of seven to 14 years for the four executives for taking bribes and stealing commercial secrets.

According to the New York Times account of the verdict,The case heightened the fears of foreign investors doing business here because the four were initially detained on espionage charges, fueling concerns that the prosecution was politically motivated, intended to punish Rio Tinto for its clashes with Chinese companies.

Until the verdict, Rio Tinto - one of the world’s biggest producers of iron ore had strongly defended its employees.
But the company issued a statement late Monday saying it had decided to immediately fire the four employees, describing the evidence released during the trial that they had accepted about $13.5 million in bribes as “beyond doubt.”

The verdict, which comes shortly after Google decided to pull its search engine out of Beijing, appears to be the latest indication that China is taking a harder line with foreign companies doing business here.

Rio Tinto was not charged in the case, but in announcing its verdict Monday, the court essentially accused the company of using stolen information to harm China’s economic interests, costing about 20 of this country’s steel mills an extra $150 million last year alone.

For reasons we discuss at the conclusion, this in fact appears to be the fundamental issue in the case.
But before explaining why, it also makes sense to look at several of the OTHER strange aspects of this situation, notably the announcement by Rio Tinto, just before the trial was set to begin in late March, that it and Chinalco had signed a non-binding, 1.35 billion US dollar deal to help develop a massive mine in Guinea, drawing a line under a period of turbulent relations with its biggest shareholder.

According to Rio chief executive Tom Albanese at that time, "We have long believed that Rio Tinto and Chinalco could work together on major projects for mutual benefit".

In that context, it looked as if the trial would conclude with a simple slap on the wrist or two.
But once it actually began, as this earlier New York Times article notes, a lot of "dirty laundry" on both sides began to appear, and it became clear that more was at stake than simply some relatively minor disagreements among close business associates.

Stern Hu, an executive at the British-Australian mining giant Rio Tinto, said in court that he accepted two large bribes in late 2008 and early 2009 totaling about $1 million from Chinese steel mills in exchange for agreeing to sell them long-term supplies of iron ore, his lawyer Jin Chunqing said.

Although the four Rio Tinto executives on trial here on charges of bribery and stealing commercial secrets had admitted taking bribes, the revelation shed new light on why they did and how corruption in the Chinese steel industry worked ...

“Two small companies bribed Stern Hu in order to get a long-term contract with Rio Tinto, which normally is not available for medium- and small-sized companies,” Mr. Jin said.

“It was during the economic crisis in late 2008 that large-scale steel companies were struggling with continuing their deals with Rio Tinto. That’s when the small companies decided to intervene, causing a corruption of the system.”

Steel industry experts say bribery has grown rampant here in recent years as Chinese steel mills have competed for valuable imports of iron ore, much of it controlled by foreign suppliers.
Analysts said a chaotic pricing system had created a two-tiered market, fueling corrupt deal-making.

Many large state-run steel companies in China agree to long-term contracts at a set price with foreign suppliers, while smaller steel mills compete to buy supplies on the open market, often for higher prices.

“Desperate steel mills would do anything to get hold of supplies,” said one steel industry executive in a telephone interview on Friday, speaking on the condition of anonymity for fear of government retribution.

“There was a huge potential for mischief and a huge incentive to bribe.”

Getting a discount on the open market price could mean saving tens of millions of dollars, experts say, giving tremendous power to iron ore salesmen working for companies like Rio Tinto.

In this context, the verdicts raised one immediate question:

If the Rio Tinto executives were guilty of accepting bribes, what about the companies that offered them ???

The Shanghai No. 1 Intermediate People’s Court partially answered that question on Monday, announcing it would soon charge at least two Chinese steel industry officials with passing trade secrets to Rio Tinto. But that certainly doesn't end the questions, not just for Rio Tinto, but ALL Western companies either actively doing or seeking to do business in China.

By the time of the convictions, there was a general consensus the convictions were significant not so much for the company, although it certainly complicates its relationship with China, but for the general state of China's often tough negotiations with foreign suppliers over iron ore prices.

Before the detentions, China’s steel industry association had repeatedly attacked Rio Tinto and other foreign iron ore suppliers for driving up the price of iron ore and negotiating unfairly.
On Monday, the court confirmed that iron ore negotiations were at the center of the case and insisted that Rio Tinto employees were passing secrets to top negotiators for the company.

It said that in 2009, Mr. Hu and Mr. Wang obtained confidential information from the China Iron & Steel Association, the government body that negotiates iron ore prices with foreign suppliers.

The court said the Rio employees had “damaged” China’s interests.

In this context, the MOST important take-away of the Rio Tinto case, at least to this point - there is, after all, the possibility that, having made its toughness clear, China will decide to soften the unexpectedly stiff sentences - seems NOT to be, a la Google, that Western companies seeking to do business in China had better watch their step,  although there's little doubt the surprisingly harsh convictions do, in fact, underline such a message, at least for now.


But if the whole issue area of iron ore prices / availability / negotiations really IS the central issue here, then the REAL significance of all this drama lies in its implications for what most observers of the global political economy see as THE key issue of the moment:

Is China's economic growth likely to continue -- or is it going to crash, whether in a hard or soft landing ???

If the country is willing to make such a stink about the whole area of iron ore - which, remember, is a key factor of production in the making of steel, THE crucial component in almost all manufacturing - then it's hard not to infer China's leaders are in fact certain growth is going to continue, and it is therefore in the country's short-, as well as medium- and long-term, interest to strike as hard a bargaining position as it can about prices / availability etc.

This being said, it wouldn't be beyond the Chinese leadership to realize that most shrewd observers would in fact infer this from the hard-line outcome of the trial, and take advantage of that inference to increase the credibility of projections of the country's continued growth as prelude to what they know is, in fact, going to be a slowdown of some sort, whether hard or soft.

But it could also mean what it appears to mean:
China's leadership is quite certain growth is going to continue, and they want to secure the most advantageous negotiating position as possible, with not just Rio Tinto and other companies, but also the other countries who serve as the ultimate source of that key ingredient.

Given the crisis in the Eurozone and, doctored BLS statistics aside, the on-going problems of the US, China's short-term economic profile remains key to the immediate future of the world political economy.

And if the Rio Tinto case is any indication - which, again, it may or may not be - then one would have to figure the Chinese leadership, at least, is confident about the country's ability to continue its remarkable growth, even within a general global context of weakness at best and steep recession at worst.

They could, of course, be arrogantly wrong in this assessment.

But the fact they would even take such a stance - given all the complications it will clearly bring with one of their most important private-sector partners is definitely a fact worth pondering.

David Caploe PhD
Chief Political Economist
Economy Watch

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