Stuck in the middle

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The Sino-US trade tussle has had the greatest impact on multinational corporations in China—precisely the group that the US started out trying to support. Many have begun considering radical courses of action to stay in business

As the Sino-US trade war heated up in the fall, the International Monetary Fund warned that the entire global economy would suffer if things got serious. But the group that has felt the effects most severely so far is the one that the United States is ostensibly trying to help: the many multinational companies doing business in China.

Apart from reducing the bulging bilateral trade deficit of the US, the Trump administration’s main justification for launching the trade war has been to force China to improve its treatment of foreign firms. Businesses continually complain of inadequate intellectual property protection, forced technology transfers and heavy subsidies for state-owned domestic competitors.

“The end goal of the US is to press China to abide by its World Trade Organization commitments and accept the norms of global trade,” says Tom Sun, an analyst at the Hong Kong-based consultancy Risk Advisory.

Yet the trade war has hit multinationals hard, with many forced to absorb much of the extra costs imposed by American and Chinese tariffs. “The trade war is having a profound impact on us—the tariffs on steel imports really hurt,” said an Asia-based executive of a global automaker, who spoke to CKGSB Knowledge on condition of anonymity.

More than 60% of the 430 US companies responding to a September survey by the American Chamber of Commerce in China (AmCham China) and AmCham Shanghai say that the first round of tariffs on $50 billion in goods adversely affected them.

Nearly 75% foresaw negative consequences to the second round of US tariffs on $200 billion of goods, and about 68% expect to be hurt by retaliatory Chinese tariffs on $60 billion of imports. More than half of the respondents to the survey expect the tariffs to result in a loss in profit, while 47% expect production costs to rise.

The trade tussle is hurting European firms too. A September survey by the European Union Chamber of Commerce in China (EUCham) found that 53% of the organization’s members view the US tariffs negatively, while 43% frown on the Chinese tariffs. One in five respondents say that they were holding off on expansion or additional investment because of the duties.

“The effects of the US-China trade war on European firms in China are significant and overwhelmingly negative,” Mats Harborn, president of EUCham, said in a September statement. “We share the concerns of the US regarding China’s trade and investment practices but continuing along the path of tariff escalation is extremely dangerous.”

The Relocation Game
Several firms have responded to the trade war by accelerating plans to shift part of their supply chains out of China, a trend that began several years ago amid rising labor costs on the mainland. In most cases, the companies are moving production of low value-added goods like textiles or toys to lower-cost markets, including Southeast Asia or India.

China is not opposed to this, says Kent Kedl, Managing Director risk analysis firm Control Risks in Northeast Asia. “They’re OK with letting the cheap stuff go.”

US President Donald Trump has repeatedly stated that the trade war will help revive the American manufacturing sector, tweeting in late November: “If companies don’t want to pay Tariffs, build in the USA.” However, there is scant evidence that this is happening.

Just 6% of AmCham China and AmCham Shanghai’s members are considering moving production facilities back to the US, the organizations say. By contrast, around 30% of the two groups’ members are trying to source components or assemble products outside both China and the US.

Taiwanese technology hardware firms, who produce many of the world’s consumer electronic devices in mainland Chinese factories, are shifting some production back to Taiwan “as the trade war is going to last for a while,” says Eddie Han, an industry analyst at the Taipei-based Market Research & Consulting Institute (MIC).

Han notes that Taiwan’s Hon Hai Precision Industry Co, commonly known as Foxconn, the world’s largest contract electronics manufacturer and the primary assembler of Apple’s iPhones, has production bases in India, Indonesia, Vietnam and Europe as well as mainland China.

“They may only need to adjust their capacity [at different plants] to alleviate the impact of the trade war instead of relocating supply chains to the US,” explains Han.

Foxconn is building a factory in Wisconsin with the help of a $4 billion package of tax breaks and incentives from the state government, but that facility was planned well before the outbreak of the Sino-US trade conflict.

Some multinationals that have moved production away from the US have no plans to bring it back—regardless of the trade war’s outcome.

“It’s not profitable for us in many cases to manufacture vehicles in the US,” the Asia-based auto executive says. While the person’s company still makes some luxury autos in the US, which it sells to the Chinese market, if the trade war drags on, the firm may consider shifting production of those vehicles to China.

To be sure, a prolonged trade war could force some multinationals to shift manufacturing out of China. Yet many firms will not take those steps right away. Even if they want to move production elsewhere, many alternative locations lack China’s state-of-the art infrastructure: the roads, ports, airports and advanced production facilities themselves.

“China is still the go-to place for assembly,” says Sun from Risk Advisory.

Carrots and Sticks
At the onset of the trade clash, some observers worried that nationalistic Chinese consumers would retaliate against US-based multinationals by boycotting their products. Foreign brands had faced that kind of backlash before.

In 2012, when Japan and China became embroiled in a territorial dispute, Chinese consumers put the brakes on Japanese auto purchases. It took months for Toyota and Honda sales to recover. Acts of vandalism against Japanese businesses also occurred.

Fortunately, given Beijing’s desire to keep relations with Washington on an even keel, no boycotts have materialized so far. “I think we are still far from this, but if these kinds of boycotts started and I were still living in Beijing I would be very nervous,” said longtime China watcher Bill Bishop in an October edition of the Sinocism newsletter.

Still, Beijing has other ways to signal its displeasure with American tariffs, such as not allowing US firms to take advantage of opportunities in the China market. In some cases, that may to be the benefit of European firms. In December, Switzerland’s UBS became the first foreign bank to receive approval to take a majority stake in its securities joint venture under new rules announced in 2017.

Beijing may play favorites in the financial sector, analysts say. “We shouldn’t be surprised if a small number of initial applicants receive expedited approvals whether because the institution is based in a country with friendly bilateral relations ... or because the applicant institution enjoys a strong relationship with regulators,” says Ross Feingold, a Taipei-based attorney and political risk consultant.

At the same time, Beijing is dangling carrots to some US firms. In October, electric carmaker Tesla secured land near Shanghai for a $5 billion factory, its first outside of the United States. Significantly, Tesla will retain full ownership of the facility, making it the first foreign firm ever to operate a plant without a local partner.

Producing cars locally will be essential to Tesla’s future in China, its largest market outside the US. The brand’s cars are currently subject to China’s 15% import tax for autos, plus an extra 25% tariff that Beijing applied to US cars in a tit-for-tat move earlier in 2018.

China has said it will get rid of this extra charge on January 1 while the two sides negotiate a trade deal. However, it has made clear that the tariffs will return if no agreement is reached.

Uncertain Future
Beijing and Washington have been in talks to avert a further escalation of the trade war, but it is still far from clear what the outcome will be. Other multinationals are girding themselves for market uncertainty.

For most firms, according to Control Risks’ Kedl, it is “pretty much a wait-and-see” situation. “[The uncertainty is] coming at a challenging time when many companies are making plans for 2019 and beyond,” he says. “To have a potential hit like this hanging over your heads, and budgets, is not a comfortable position to be in.”

At the G-20 meeting between President Trump and his Chinese counterpart Xi Jinping on December 1, China agreed to a limited series of concessions. These included cutting tariffs on US automobiles, buying an unspecified number of goods to reduce its bilateral trade surplus and cracking down on exports of the toxic opioid fentanyl, which killed nearly 30,000 Americans in 2017.

However, it may be much harder to make progress on the thornier parts of the dispute—and the ones most relevant to multinationals in China—such as market access for foreign firms, forced technology transfer and special treatment for state-owned enterprises.

China has made moves to open more sectors to foreign businesses in recent months, though many of these reforms would have happened anyway. In June, Beijing reduced the number of restrictions on foreign direct investment from 63 to 45 in its latest so-called “Negative List.”

Among the most significant changes was the removal of foreign shareholding restrictions on commercial and passenger vehicle manufacturing by 2020 and 2022 respectively, according to Feingold.

Beijing also appears to be accelerating opening its financial markets, says Zennon Kapron, founder of Shanghai-based research firm Kapronasia. “We are finally seeing action behind the talk” in the banking and capital markets, he says. “How far the reforms go still remains to be seen, but the initial progress seems positive.”

There has also been growing speculation that Beijing may make more substantial concessions on issues including the Made in China 2025 industrial strategy. Many multinationals view this as a tool for squeezing out foreign competition in a range of high-tech industries.

In December, the Wall Street Journal reported that Chinese officials were drafting a new strategy to replace Made in China 2025. President Trump previously claimed in a news conference that “China got rid of their China ’25 because I found it very insulting.”

If substantial changes are made to Made in China 2025, it would be celebrated as a big win by many foreign firms in China. EUCham has been particularly vocal in its criticism of the policy, calling it a “large-scale import substitution plan aimed at nationalising key industries” or “severely curtailing the position of foreign business.”

But any changes to the strategy could prove  cosmetic. Though several liberal commentators in China have used US pressure as an excuse to push for more market reforms, others have used it to justify current policies. In a June commentary, Liu Chuntian, a law professor at Renmin University, argued that US complaints that companies were forced to hand over technology to Chinese partners to continue operating in China were misplaced.

“The transfer of technology by US companies to Chinese companies is a normal business activity,” said Liu. He added that companies handed over technology not due to government pressure, but “independently.”

Unless China proposes substantial and verifiable market reforms, it is possible that the US negotiating team—led by the hawkish US Trade Representative Robert Lighthizer—would reject a deal and move forward with more tariffs.

A worst-case scenario would be the US upping its tariffs on $200 billion of Chinese imports from 10% to 25%. A spike in the tariffs could accelerate the relocation of some supply chains to Southeast Asia, says Darson Chiu, Vice President of the Taiwan Institute of Economic Research, a think tank.

If the tariffs hit 25%, “most global companies doing business in China will be more interested in moving production to Southeast Asia,” from where they can still supply the US and China, he says. “Exports to the US from Southeast Asia can avoid the tariffs on Chinese goods, while exports from Southeast Asia to China can take advantage of the China-ASEAN free trade agreement.”

Foreign firms generally remain keen on the China market but are disillusioned with the slow pace of economic reforms. For China, the best way to regain the confidence of this key group—which provided $135 billion of investment in 2017—would be to make good on longstanding promises to reduce trade and investment barriers.

“Now that it is the world’s second-largest economy, China can afford to open its doors all the way,” Kenneth Jarrett, President of AmCham Shanghai, told Agence-France Presse in November.

[This article has been reproduced with permission from CKGSB Knowledge, the online research journal of the Cheung Kong Graduate School of Business (CKGSB), China's leading independent business school. For more articles on China business strategy, please visit CKGSB Knowledge.]