The US-China Trade War Reaches a Truce: China Market Lessons to Learn

Op/Ed by Chris Devonshire-Ellis 

China and the US have reached a rapprochement in their 18-month long tariff war, with both sides agreeing to split their differences. The US has agreed to a rollback of half the tariffs imposed on US$350 billion of Chinese imports, while the Chinese have made commitments to buy US agricultural products, among other as yet unannounced concessions.

There is still some way to go to get back to normal trade; however, this “Phase One” agreement is a sign that attitudes are softening. China is letting the US off lightly here, with much of the media attention focused on President Trump claiming a victory. Calling the agreement an “amazing deal for all”, Trump said China had agreed to “many structural changes and massive purchases” of “Agricultural product, Energy, Manufactured Goods, plus much more”. He also confirmed that a new round of tariffs planned for December 15 on goods including laptops, toys, and video games would not go ahead “because of the fact that we made the deal”.

In fact, the US trade tariff stance against China has failed. After 18 months in which neither tariffs nor export restrictions put much of a dent into China’s trade balance with the US, a retrenchment of US policy is the rational course of action.

Trade officials on both sides said they had agreed on the text of a nine-chapter agreement covering intellectual property, technology transfers, agricultural products, and dispute settlement, among other topics. China’s vice-commerce minister, Wang Shouwen said both sides would need to go through legal checks, translations, and arrangements before an official signing ceremony.

Liao Min, of the office of the Central Commission for Financial and Economic Affairs, said China would also consider not implementing previously planned tariffs on US products, to go in effect on December 15 – tomorrow.

Although there remains much work still to do on the dispute, the high-water mark appears to have been reached, with tides now turning. But like many storms, this one will also leave its scars and it has changed the US-China dynamic, both politically and within trade. There are lessons to be learned.

China will continue to look for non-US solutions 

A sanctions and tariffs-happy Washington DC has done a lot of damage in global trade and diplomatic relations, and not just restricted this to China. Actions taken against Russia, Turkey, Iran, and India and threats against the EU have raised serious questions about the US as a reliable trade partner. Dealing with this new uncertainty requires alternatives and moving away from US controlled global structures. This includes developing alternative international payment systems, such as SWIFT, dropping the use of the US dollar currency, and investing in technology catch-up where the US is currently dominant in some, if not all sectors. The article China-US Technological Competition and its Opportunity Costs  by Chen Xi at the Nanyang Institute of Technology explains this well. These moves will, over time, slowly diminish US authority over global trade.

There have and will continue to be occasional problems with China trade 

There is nothing new in having to endure problems with China trade and commerce. In two years, Dezan Shira & Associates will be entering its fourth decade of advising clients about conducting business into the country. The US-China trade war has just been one of what generally seems to be a 10-year pattern of different, but serious trade obstacles that pop up. Just before we had established our business, the country had experienced domestic unrest in the capital. The early trade and investment that had just begun to enter the China market dried up and took several years to mid-1995 to recover. That was a tough time to be starting a China consulting practice.

A few years after that, the Asian financial crisis hit, and FDI into China completely stopped. Foreign investors were waiting for Beijing to depreciate the yuan and obtain cheaper investments. Beijing didn’t depreciate its currency, but foreign investor reluctance wiped out 95 percent of all FDI into China for pretty much most of 1997.

In 1999, NATO bombed the Chinese Embassy in Belgrade. That kicked off riots and violence against American citizens in China, with numerous individuals being beaten up. Protests were held outside US embassies; bricks and other objects were thrown. British nationals were also fair game. Running into a gang one evening in Shanghai, I was asked where I was from. Wisely, I said “Scottish”. Many US nationals in China returned home. Not all came back.

That was followed in 2001 by “Little” George Bush’s climb down over the Hainan Spy Plane incident, which at the time also threatened trade ties, with certain analysts predicting war. It was a storm in a tea cup, but a lot of American investors at the time were worried. Planned investments got put on hold or cancelled.

SARS in 2003 was much more serious; it saw an exodus of foreign employees from China, and our firm was advising how to mothball factories or run them on skeleton staff.  SARS had a 10 percent fatality rate and killed nearly 800 people. Trying to operate a China business at that time – now that was hard. Needless to say, no one invested in China at that time either.

The lessons here are that China does have occasional difficulties, as do foreign investors living and working in the country. When that is a given, businesses need to protect themselves. That means taking the following steps:

Build up capital reserves 

There is little point in stripping off all profits from an operating business unless you are prepared to reinvest in it again when things get tough. Emotionally, it’s also better not to have realized money that may one day be needed for operating costs during a downturn. Laying people off in China is expensive. Keep capital reserves – we recommend three months operating costs – on account – in China at all times.

Look at China alternatives

American businesses reliant on China manufacturing their US market products have been especially hurt during the trade war. Many should have seen the potential for trouble by the inherent risk of putting all their manufacturing eggs in one basket. It is long been time to diversify away from that model. Our Vietnam practice – we have three offices in the country – has boomed the last couple of years (we’ve been there since 2003) and it is time to consider relocating part, if not all of your manufacturing base. Other Asian manufacturing destinations to consider include Indonesia, Malaysia, Philippines, Thailand. Singapore is an excellent regional HQ from which to run these operations. Some outsourcing is moving to India, which also has the advantage of having a huge domestic consumer market. Our firm has offices in all of these countries.

Compliance 

Compliance with China’s laws and fiscal procedures makes sense, if only to have a health check on your own business. It is normal for things to go wrong in business – compliance is a way to ensure you are within the laws and operating as best you can. And if you are non-compliant – fessing up and admitting mistakes while agreeing to correct them goes down well in China and considerably reduces the risk of having a run-in with the authorities. Our complimentary guide to China Compliance can be accessed from here.

Make China efficiency investments 

In today’s hi-tech world there are many business administrative processes that can take up time, money, and personnel. You can save operating costs by reducing headcount and replacing admin with technology, either in-house, or outsourced. Payroll is a primary area for outsourcing, and we wrote about that in the article IT Solutions: Improving Efficiency and Transparency in Payroll Processing. As a rule of thumb, if your business has a head count of five or more, you can save money through out-sourcing payroll. Look at your head count and work out human processes that can be automated for less money.

Don’t panic  

Once invested in China (or anywhere else) it is tough to leave and then start over. It is far better to tough it out. That means taking considered, if painful business decisions and it can get emotional, especially when laying off staff. There are procedures to follow of course, and it is better to follow them to avoid additional problems down the line. Lessen potential problems by following China’s laws and regulations. Don’t panic. In terms of staff, we dealt with the issues facing layoffs in the articles Common Labor Issues Encountered During the Reduction of Business Operations and Handling Layoffs in China’s Manufacturing Sector.

Losing the battle isn’t the same as losing the war 

If things really have got too difficult in China, it is possible to liquidate and close the business. It should be remembered though that there are of course laws and regulations in place to protect creditors. China doesn’t take kindly to foreign investors leaving debts behind. If you do, you can find yourself in serious trouble next time you enter the country, and especially so if you are the Legally Responsible Person. China can detain you until debts are repaid. It may be financially tough, but closing a business down properly is the way to go, if you have reached that end point. Doing it correctly means you live to fight another day and can have another crack at China when another opportunity arises. Our complimentary Guide to Closing Down A China Business can be found here.

And here’s what not to do:

Don’t be a fair-weather friend to China 

Doing business in China is tough. That’s one reason you’re in this market – because not everyone can hack it. As mentioned above, China has its occasional troubles, so expect them and plan for them. After all, anyone can make money when the going is good, but doing it when it is tough is far harder. Also, tough times are good – they weed out your competition.

This is why it makes sense to steer clear of China advisers who are fair-weather friends and run for the hills as soon as it gets difficult. Headlines like these, from the increasingly anti-China, American lawyer-written China Law Blog are happy to take credit (and your money) when its easy, and happy to take your money and persuade you to leave when it gets tough. The following, somewhat unhelpful, and very anti-China articles illustrate the issue well:

Would the Last Manufacturing Company in China Please Turn Out the Lights ; When Will the US-China Trade War End – it’s the New Normal; China’s Undiplomatic Behavior Has Only Just Begun; Doing Business in China: The Only Guarantee is That There Are No Guarantees ; Mid-Sized American Companies Are Moving Away from China and So Should You; Hong Kong’s Demise, and China and the West Are Decoupling. Please Act Accordingly with its comment: “relations between China and the West are not getting any better and they will only get worse.” So much for optimism.

This one was also impressive for its sheer paranoia: How to Protect Your Company Information When Travelling to China. They are all from the same firm, headed up by Seattle-based lawyer Dan Harris from Harris Bricken, and who can be seen on YouTube here.  This is a guy who has been suggesting Pakistan is a viable investment alternative to China for American manufacturing businesses. The US State Department has in place travel advisories against travel to Pakistan. Pakistan might be cool, but do you really want to swap Beijing for Islamabad and Shanghai for Kandahar? You first, Mr. Harris, you first.

In terms of China Law Blog’s China business advice, they appear to be blowing constantly freezing cold air these days, and that’s not very helpful in times of trade difficulties. We already know what the problems are – businessmen need solutions, not depressants. So be sensible – if your advisers are down on China – change them to ones who can take a longer-term, more balanced perspective. Handling a downturn in your China business requires strength of mind, not self-interested, anti-China viewpoints when times get tough in the country. Reading China Law Blog these days is a bit like having a drink with a guy at a bar going through a bad divorce.

So much for fair-weather friends. And besides, US-China bilateral trade hit US$560 billion this year. There remains plenty of growth opportunity in the China market, and that includes for American investors. Don’t listen to people who will make you feel bad or bring you down.

What to expect from China in 2020 

Given the unpredictable nature of the Trump Presidency, anything is possible – including a resumption of the US-China trade war. However, with hawks such as John Bolton having left the US government, the signs are that things will start to get better. One can be cautiously optimistic about further tariff rollbacks, although as I mentioned above, things will not return to the same state as they were back in 2017. This is especially true for US based businesses selling to their own domestic market but sourcing from China. That category has undergone some extreme pain and will have learned not to rely on their own government’s trade policy to keep them in business.

Following US policy then makes sense for US companies when it comes to China, and they should also be marrying that with Chinese policy too. This means that certain business trade sectors will continue to be impacted, and especially in IT and hi-tech.

While trade in certain goods and services will be allowed to continue as normal, others will not. We can divide them into basic happy and unhappy lists:

US-China trade happy list 

• Agriculture
• Automotive
• Chemicals
• Consumer products
• Industrial machinery
• Basic electronics
• Garments
• Plastics
• Metals

It should be noted that at any time, specific items on the happy list could be targeted to punish certain sectors to make political points. The US has, for example, imposed tariffs on fairly bog-standard items as part of the trade war to make a point about the US-China trade deficit.

While that is causing some short-term pain for affected businesses reliant on China production resold on the US market, it does not have any other strategic trade value. In other terms, none of the above categories are future game changers, meaning trade can be expected to largely resume over time or continue unimpeded in these areas. If your business is involved in the sectors above, then the US-China trade space should continue to be buoyant – petulant trade officials and bumps along the way notwithstanding. The lesson here is also – not to put all your manufacturing or overseas market eggs in one basket. That is the primary reason our offices in Vietnam have been doing so well this year.

US-China trade unhappy list 

• AI
• Aviation
• Aerospace
• Biomedical
• Computing
• Communications
• Energy (oil, gas, solar)
• Hi-tech
• Nano-technologies
• Robotics

The unhappy list contains some large commodity areas such as energy, in addition to advanced technologies in a number of sectors, including aviation, aerospace, biomedical research, communications, and an entire array of computing and related industries, such as semi-conductors, software, and other pioneering aspects, such as AI and the development of nano-technologies. As has recently been seen, the US has been pushing back against Chinese companies, such as Huawei, while the Chinese government has issued a ban of all foreign computer and software use in government offices. If you have a business involved in any of these areas, and are an American company, then you can essentially kiss China goodbye – the Chinese will either develop these technologies themselves or partner with another hi-tech nation (such as Russia) to do so.

This means that now, more than ever, China needs to be viewed as a strategic market in both import and export terms. The lessons from the US-China trade war is just that; it is why tariffs have been and will in future be imposed – a more longer term balancing act that will see certain industry sectors once permitted in China be gradually placed off-limits as we enter a new technological development era, and the race for global dominance around that. That will not apply to all foreign investors – but it will apply to Americans. Hence the use of specific national tariffs against US companies in these sectors to enact this.

That hi-tech caveat aside – the overall reality is that in the right areas, US-China trade is doing well. At Dezan Shira & Associates our China business – which exclusively handles foreign direct investment into the country – has increased overall by 13 percent this year. American businesses continue to want to sell to China and continue to want to purchase Chinese-made products. It makes sense to choose advisers who are both in-country and know where the investment trends and opportunities are. US$560 billion suggests there are rather a lot of them. 2020 is the China year of paying attention to policy, getting efficiencies into your business, and investing elsewhere if China is no longer the right market for your business. But for those for whom China makes sense – we see the trade war storms have large passed, and that US-China trade will probably tick up – maybe back to that US$634 billion it hit in 2017. There is, after all, a US$74 billion trade difference between the normal then and trade war affected now to make up. After all, US consumer spending has increased this year, and in 2020 we can expect to see more Chinese produced goods added to the American shopping basket.

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