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By Cyril Tuohy

For years the expression "Made is China," was the manufacturing world's equivalent for cheap, poorly made products churned out by Chinese factories with inferior quality controls.

In 2008, for example, the Sanlu Group, China's largest producer of powdered milk, recalled 700 tons of baby formula. The recall was instituted after the tainted formula was blamed for the death of an infant and linked to kidney problems involving another 50 infants.

Investigators who raided the factory discovered that the formula had been contaminated with melamine, an industrial chemical used in plastic manufacturing. In that case, it was Chinese consumers who paid the heaviest price.

Other recalls of Chinese-made goods have involved millions more consumers, and many of them in Western markets.

In 2007 the El Segundo, Calif.-based toy manufacturer Mattel Inc., said it would recall as many as 10.5 million Fisher-Price infant toys worldwide for possible lead-paint hazards.

More recently, contaminated drywall used to supply the U.S. building boom and replace damaged homes in the wake of hurricanes, has led to a massive sheet rock recall and long, costly court disputes.

For all the bad press levied at Chinese-made products and the expensive and embarrassing recalls, the quality gap between Chinese-made products and the expectations of global consumers is closing fast.

None other than Carlos Ghosn, CEO of Nissan Motor, told reporters that established automobile companies like General Motors Corp. and Toyota Motor Corp. would soon be competing against China's most successful brands, not only in China but abroad.

"I have no doubt about it," Ghosn said, as quoted in a Reuters news report in 2010.

And in case anyone needed reminding, it is Foxconn's factories in China that are responsible for churning out iPads, iPhones Kindles, PlayStation 3s, Wii's and Xbox 360s by the tens of millions.

Long-time China insurance experts said companies making products in China are becoming more globally oriented. Companies know that the products they make will have to stand up to scrutiny half-way around the world.

As China's domination of low-cost consumer manufacturing from toys to consumer electronics and processed foods continues to grow, risk managers and the C-suite are paying more attention to process controls.

Those controls are often one of the few barriers standing between a company delivering a product accepted by global consumers, and the hit to a corporate reputation if a product needs to be recalled.

"A majority of the world's products come out of China, toys, consumer electronics and food products, so protecting those protocols and good process controls -- that's where companies are spending their money," said Katherine Ann Cahill, global managing director for product risk services with Marsh Risk Consulting.

Tightening manufacturing processes and quality control means hiring lawyers, consultants and supply chain and manufacturing experts to help steer clear of product defects. In the end, though, it means that doing business in China will invariably be more expensive.

The challenge of raising the bar to satisfy global consumers isn't as easy as it sounds, even with a significant cost advantage. Chinese consumers are often prepared to tolerate higher risk, whether it is the amount of lead in paints used for toys or the amount of mercury in fish, than would a U.S. or a European consumer.

"Corporate governance and transparency and product safety are big, and from the perspective of the risk manager, they want the proper information for good manufacturing techniques, so that we have good products," Cahill said. "It's driven by economic reasons, not insurance reasons."

Even if insurers aren't selling as much coverage as they might like, carriers still benefit because they would rather sell coverage to companies with stringent procedures rather than insure companies making mediocre products with a higher likelihood of having a claim, she said.

Tort Reform, for Real?

As companies in China look to sell products to the global community, the pressure exerted by the marketplace has forced them to improve manufacturing procedures and impose stricter safety controls.

But the Chinese government has also played a role giving consumers more power to fight back against wrongdoing -- either perceived or real -- by manufactures and their suppliers.

The Tort Liability Law that took effect in 2010 consolidated and enhanced tort-related provisions of Chinese civil law.

The updates pertained mainly to product liability, medical malpractice, environmental pollution liability, and motor vehicle traffic accident liability. A separate, related Food Safety Law passed in 2009 also gives consumers more rights to fight back.

But it is the punitive damage clause of the Tort Law of the People's Republic of China that is most noteworthy for companies, according to legal experts and consultants.

Under tort reform, consumer protections against defective products have been expanded, and manufacturers and sellers are now jointly liable for defective products. The reforms also give manufacturers and sellers the right to sue third parties.

Though punitive damages on the scale routinely seen in the U.S. and Europe are unlikely, the cost of product liability and product recall insurance is going to rise. "Do I think punitive damages will make insurance more expensive?" said Cahill. "Yes, I do."

Skeptics of tort reform suggest that despite China's westernization of tort laws, the changes are mostly incremental. They also point to the stalled reform initiatives surrounding class-action litigation, and note the Chinese government's "aversion to mass torts," according to postings on chinacomment.com.

In China it is common practice to settle out of court, and for those cases that make it before a judge, consumers may well find that they have less power than they have been led to believe. "In court, I'm not so convinced that consumers have the power they think they have," Cahill said. "I think they should have more power."

Calculating the amount of punitive damages is another story and whether plaintiffs will actually be able to collect on any punitive damage awards remains to be seen as companies await clarification by the courts on punitive damage methodologies, according to lawyers with expertise in China's tort reforms.

Still, taking on punitive damages is a sign that the government is willing to give, or at least consider the rights of consumers in the face of companies responsible for making and distributing shoddy products.

Tort reform, according to one China expert, is a signal that China is willing to consider a more global way of looking at risk, and a more consistent, scientific approach to looking at civil wrongs.

Hammering out a way to allocate punitive damages is particularly important to China's fledgling aerospace industry, according to Peter Coles, a partner in the Hong Kong office of Barlow Lyde & Gilbert LLP, in a 2010 analysis of China's tort reform law.

China already provides parts to Airbus and Boeing Co., and Comac, the Commercial Aircraft Corporation of China, is preparing to launch its own family of narrow-bodied commercial jets, the C919.

The C919 program could be delayed as Comac's ARJ 21 regional jet faces certification delays after a part failed a test, according to news reports published last year.

In the end, the world's most powerful emerging market wants to do business with multinationals from around the world. China wants to provide those companies with labor and expertise, and in return benefit from companies setting up shop on Chinese soil.

China and the rest of the world only stand to benefit. "They want to get it right," said Cahill. "What we're starting to see is a very large country starting to engage in this global marketplace, and realize they have to get up to speed globally, not just in one region."

CYRIL TUOHY is managing editor of Risk & Insurance®. He can be reached at ctuohy@lrp.com.

May 1, 2012

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