Corporate Governance,Economics & Finance
• 10 minute read

Food Safety: Deeper than Politics

Hsu, Vernon Ning(徐寧)

Will China improve its safety and quality of food with the newly upgraded State Food and Drug Administration?

By Louisa Wah Hansen

The food safety issue in China was a hot topic during the National People’s Congress in Beijing in March, culminating in the decision by Chinese lawmakers to upgrade its existing State Food and Drug Administration to a ministry-level general administration to better oversee food and pharmaceutical safety standards across the country.

But would this measure alone help improve the safety and quality of food in China, or is it just another bureaucratic gimmick to mask a much deeper problem?

According to Prof. Vernon Hsu from the Decision Sciences and Managerial Economics Department at The Chinese University of Hong Kong (CUHK) Business School, consolidating the disparate and non-coordinating government departments that were previously in charge of food safety supervision could help solve the food safety problem — but only partially. He believes it can only be solved in the long run by tackling the root causes of the problem: the lack of accountability and ethics in society, and the predominantly low-cost, low-quality orientation of supply and demand in the consumer market.

Lack of Political Will

“In the past, one of the problems was obvious: the regulatory bodies were too fragmented. Everybody was in charge and nobody was in charge. You wouldn’t know who was responsible for what,” he says. “The Chinese government has realized this and is doing what is necessary to combat the problem. But this does not necessarily mean it will be effective. A more streamlined regulatory regime is just a small part of the solution to China’s rampant food safety problem. It’s often the lack of will of the government to create tougher rules and to enforce the existing regulations that is the biggest problem.”

One of the hottest debates on food safety pertains to infant milk formulas. China’s existing standard on protein content and bacterial counts in raw milk are very low in comparison to those of many other countries in the world. Prof. Hsu does not believe the loose regulations will be improved in the short run, because they are considered a matter of “national interest.” He explains that the major domestic milk-production companies in China, namely, Mengniu and Yili, depend on small farms in Inner Mongolia for their raw material supplies. However, lacking industrialized farming scale, these small farms can only supply lower quality milk with low protein content and high bacterial counts. Raising standards on raw milk would have wiped out many farmers and small businesses overnight, suggests Prof. Hsu.

For a developing country as vast as China, one may argue that it is a tough choice between setting higher food safety standards and protecting domestic industries. But Prof. Hsu disagrees.

“It’s due to a lack of will, rather than lack of ability, that the government failed to act in many areas. The food safety issue is just an example. By blindly seeking non-sustainable high growth during the past decades, the decision makers in the Chinese government were often reluctant to tackle issues that they perceived to be anti-growth. Badly damaged environment and poorly regulated and monitored food and drug industries are just a few examples of the consequences which increasingly affect the basic well-being of the Chinese people.”

The Central Government has no excuse when the safety of its people is at risk, stresses Prof. Hsu. On the other hand, the lack of incentive among local governments to enforce safety regulations makes the situation worse.

“The local governments are interested in protecting their local businesses, and it is not their priority to help the Central Government to maintain a clean system. They are unwilling to enforce the regulations for fear of driving out some of the small businesses, many of which are basically hanging on to the little profits they make by reducing their production quality or through illegal practices. So, in my view, the root cause is not going to be solved by the decision of one People’s Congress to consolidate the authorities in charge of food safety supervision,” he says.

Collapse of Credibility

The lack of ethics, credibility and a system of accountability in China, according to Prof. Hsu, is another root cause of the problem with food safety. Both government officials and local business managers share the responsibility. “In China, there are often varying degrees when it comes to the interpretation and implementation of laws and regulations,” explains Prof. Hsu. “The more leeway the local government officials have in the interpretation and enforcement of regulations, the more ‘economic rent’ they can extract from it. This is a fertile ground for corruption and, in the long run, for the creation of a governing system that lacks trust from its own people. The Chinese government is keenly aware of the serious consequence of this problem.”

When it comes to company managers, there is also often a lack of a strong sense of accountability, credibility and business ethics, according to Prof. Hsu. He cites the example of a Walmart China branch manager who ordered the labeling of ordinary pork as “organic.” If this had happened in the West, he says, it would be the end of his career. However, in China, business people can often get away with unethical behavior because many people in society believe that cheating is normal.

“There is such a widespread attitude that if you make a mistake, it’s too bad. You’re just unlucky to get caught but you can still find another company to work for. Were this to happen in the U.S., your career would very likely have ended,” says Prof. Hsu.

In the case of Mengniu and Yili, even though they were engaged in the 2008 melamine scandal, they were able to exert their influence in 2011 when the government was drafting new regulations on raw milk content such that the final decisions were tilted in their favor. “Where is the accountability and credibility in such a society?” asks Prof. Hsu. “If it happened in the Western world, these two companies would have been wiped out due to their badly damaged brand images and strong competition in the market.”

“From the government to businesses, the Chinese society and economic system lacks a basic trust that is the foundation to better governing and healthy market competition,” says Prof. Hsu, pointing out that the situation has been particularly severe during the past 20 years. “Everyone in the society pays. If you don’t have basic trust, you end up with a ‘market for lemons.’”

A “market for lemons” was coined by Nobel Prize laureate in economic sciences George Akerlof to describe the problem of quality uncertainty. It is a market where the bad drives out the good.

This describes the Chinese consumer market to a tee. Prof. Hsu uses the following analogy to explain: “If the consumers cannot distinguish a genuine product from a fake one, they will not be willing to pay a premium for the genuine product. Because genuine and fake products are undistinguishable, when a consumer receives a genuine product, he would first ask for a discount to cover his risks. Something that is worth RMB1,000 can only be sold at RMB800 because you cannot guarantee its genuineness. But once you go across the border to Hong Kong, you can immediately sell it at RMB1,000 because people trust that it is genuine there.”

Prof. Hsu says the only way to solve this issue is to establish a system that holds people accountable—a system that works in the West—and this is a fundamental change in society that is going to take time.

Supply and Demand: Completing the Puzzle

From an economic viewpoint, the issue of food safety has a lot to do with the food supply chain and market demand.

According to Prof. Hsu, who is an expert in supply chain management, the supply chain for food products is much more complex than that of ordinary industrial goods. Unlike mass-produced standardized products, the sourcing of food products in China originates from individual farmers—often small in scale. By the time a raw material reaches the top of the chain where it becomes part of a processed product, there are too many layers involved and any quality issue would be hard to trace.

“Quality assurance is a tall order in the food supply chain; if managers don’t have the skills and ethics to ensure quality, it would be an impossible mission,” he says. “In addition, it requires non-trivial resources and efforts to manage quality along the supply chain. Many producers of food products often seek short-term financial gains by abandoning more sustainable, long-term solutions which could have prevented potential problems such as food safety.”

The nature of the consumer market in China is the other side of the equation that explains why food safety is such a sticky problem.

Prof. Hsu points out that the mass consumer market in China is still a basic value-oriented market dominated by low-income consumers. They are mostly concerned with survival at the lowest cost as they cannot afford expensive imports. This is the case with infant milk formula. The vast majority of Chinese consumers are aware of the higher quality imports, but what they can afford are the cheaper domestic brand products.

He says many foreign brands cannot seem to penetrate the Chinese market because there are simply too many low-priced competitors competing on an unfair playing field thanks to government’s protection of domestic producers often through subsidies or tolerance of illegal behavior. This has resulted in a two-tier market: the upper tier is supported by the middle and upper-class consumers who are willing to pay more for quality, and the lower tier is the mass market with very weak brand recognition.

“The consumers in the lower tier market have nurtured a great deal of businesses that are only interested in making short-term gain,” says Prof. Hsu. “A business driven by short-term financial gain is more likely to engage in illegal conducts. Such firms are most conducive to creating food safety risks. For companies targeting consumers in the upper-tier market, because they believe that credibility and brand recognition are essential to their competitiveness, they would less likely dare to risk people’s lives. In addition, they can extract enough premium in the market to afford such a strategy.”

Prof. Hsu gives an example in the food supply chain to illustrate his point: A food manufacturer needs to ship a perishable product that requires proper refrigeration. There are two logistics service providers. One offers refrigerated transportation at a specific temperature all the way to the destination to ensure safe storage, while the other does not guarantee temperature control as long as the food does not spoil at its destination. The former is more expensive. “Which one would you choose? In a lower-end market, a manufacturer without a long-term strategy would choose the low-cost shipper and induce a much higher risk of food safety as a result of illegal or unethical conducts.”

Are Quality and Safety Unreachable Goals?

The low-end market is a fertile ground for illegal activities, but low-cost and basic value driven consumption is not the future for China, says Prof. Hsu. “The future for China lies in the rapidly rising middle class. They have fulfilled their basic needs and are going to demand more and are willing to pay more for better quality. Hopefully many Chinese firms are going to wake up soon enough to catch this market trend.”

If Chinese firms catch on to the demand for quality, they would have to leave the low-end market and compete with products that are truly driven by the market itself, he says. These companies would then be able to invest in various business processes in order to build a strong brand, such as careful selection of suppliers, creation of win-win partnerships with them, and proper monitoring and tracking along the supply chain.

“One weak link in a supply chain could paralyze or even destroy everything, including the company’s brand. So if businesses realize this, and they have a market that is willing to pay them for building a strong brand and supply chain, then China will be hopeful at that stage,” says Prof. Hsu.

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