How to React to a China Economy in Decline

If you believe China’s economy is still growing at a 6+ percent clip, I’ve got a bridge I’d like to sell you.

1. China’s Economy is Hurting

But how is it that pretty much everybody who follows China knows its six percent GDP growth figure is inflated? Everybody seems to have their own way of knowing China’s economy has been suffering. Our food clients insist China food production is way down and food prices are way up and this is causing China no end of problems. Wells Fargo looks at China’s diesel fuel consumption and notes it is down by more than 30% in just the last couple of months and considers this to indicate its economy is way down as well. See An under-the-radar way to measure economic growth in China is painting a bleak picture. Many of our clients (especially our European ones for some reason), insist they can tell China is hurting just by how their factories are treating them.

I personally use the following six measures, all of which historically increase when China’s economy declines and all of which went warp speed earlier this month:

A. The number of foreign companies getting into legal trouble in China is up

Whenever China’s economy slows, its government starts looking for foreign companies out of compliance with Chinese laws. It does this both to show its citizens that it is working on their behalf and to raise money by collecting on unpaid taxes, with interest and oftentimes steep penalties. In particular we are seeing yet another increase in China going after foreign companies doing business in China without a WFOE. See Doing Business in China Without a WFOE: Will the Defendant Please Rise and China’s Tax Authorities Want You.

B. The number of China scams is up

The one we are seeing most often these days is a true oldy-but goody come to China to sign a contract scam. See The Come to China to Sign the Contract Scam: A Classic for Good Reasons. I just love the email I got this morning from a company that was being baited for this very scam: “We’ve been contacted by a Chinese company with a pretty basic website and ambiguous addresses, that right after receiving our product list placed an order for more than 200k euros of our product without even trying a sample. They will pay 40% t/t in advance so we can prepare the goods (they gave us 4 months time) and 60% before we send everything. We are wondering how they intend to screw us.”

C. The number of Sinosure problems is up

The number of foreign companies coming to us with Sinosure problems. We have seen more Sinosure issues in the last 23 days than in probably the last 23 months. See China Sinosure: What You NEED to Know. Our China lawyers attribute this to Chinese factories believing late payment or non-payment (even if due to a quality issue) is because their foreign company buyer is planning an exodus to start having its products made in Taiwan or Thailand or Vietnam or Indonesia or Mexico or wherever and they had better move fast to get paid.

D. The number of China quality control issues/disputes is up

These go up when times are bad because the Chinese factories cut quality to save money and care a lot less about trying to retain their customers because they believe they will be fleeing to Thailand/Taiwan/Vietnam/Mexico/Indonesia or wherever. See China Manufacturing and How to Prevent Quality Problems when Manufacturing Internationally.

E. The number of foreign companies with China counterfeiting and trademark issues is up

See China Trademark Theft. It’s Baaaaaack in a Big Way. Chinese factories are increasingly thinking, “why not copy my customers’ product and brand name since they are going to be leaving me soon for Taiwan/Thailand/Vietnam/Mexico/Indonesia or wherever in any event.”

F. The number of companies needing help recovering their stolen molds is up

China Mold Ownership/Mold Protection Agreements: More Important Than Ever. Mold issues typically arise when a foreign company seeks to leave its existing China supplier. With so many foreign companies leaving their Chinese suppliers, mold disputes are on the rise.

G. The number of companies seeking to move their manufacturing out of China is up

In the last 23 days, we have done a roughly equal number of NNN Agreements for Mexico, Taiwan, Thailand and Vietnam (combined) as for China. See U.S. Imports from Vietnam Soar as Chinese Factories Simply Move Countries, noting how “American imports from Vietnam rose 40.2 percent in the first three months of 2019, compared to the previous year.” See also, Mexico reaps gains from US-China trade war, on how Mexico just passed China as the leading exporter to the United States.

H. The number of companies looking to lay off China employees is up

The number of foreign companies coming to us for help in figuring out the intricacies involved with terminating some or all of their China employees is way up.

No matter your method of measure or your perspective, the US-China trade war is generating change, increasing risk and uncertainty, and more than anything, upending the way many Chinese and American companies do business.

Since the very beginning of US-China trade negotiations we have been unequivocally negative on the likelihood of a deal and our response to this has been consistent. We first publicly sounded this warning call back in October, 2018, in China, the United States and the New Normal, though we had been warning our own clients months about this for months. In this post, we wrote about how no matter the resolution to the US-China trade war, things would NOT revert back to the way they had been. We dubbed the present tense situation between China and the United States as the New Normal.”

Since pretty much the inception of the US-China trade war we have been saying we do not see its end because we have always seen it as more than a trade war. At first, we saw the US tariffs as an effort by the United States to get China to “open up” and “act right” on things like the internet and IP. But because we did not see China changing on these things, we did not see the trade war ending.

The day before President Trump’s May 5 tariff tweet, we came out with our most unabashedly negative post yet, The US-China Trade War: Winter is Coming, noting how “the United States is aggressively and unabashedly doing what it can to isolate China and remove it from the world of international trade. The new free trade agreement between the United States and Canada is further proof of this as it essentially blocks Canada and Mexico from engaging in free trade with China. See What Trump’s new trade pact signals about China. Word is that shutting out China is going to become a regular thing in all new U.S. trade agreements. See US Commerce’s Ross eyes anti-China ‘poison pill’ for new trade deals. Will the EU and Japan and Latin America play ball on this? I predict that most if not all of them will.

We then listed out our previous blog posts on what foreign companies should do in light of the then new tariffs imposed against China (much of which information is relevant for the tariffs that will go into effect at 12:01 a.m. THIS Friday:

What though does a slowly China economy really mean for the companies doing business with China and/or in China? One of the compound questions our China lawyers get almost daily from our clients is “what is happening with China’s economy and what should we do about it.” I will below try to partially answer both halves of that question.

My law firm’s assessment of China’s economy is based on what we read in the mainstream Western media, in the Chinese media, and on both Western and China social media. Perhaps most importantly, it is based on what you, our readers, tell us in your comments and in your emails to us and on what our own clients tell us.

As you can see from the above, what we have been reading and hearing and seeing is that China’s economy continues to sink. A few months back, The South China Morning Post did a story on how China’s manufacturing profits have fallen nearly 16 percent year-on-year, to their lowest level since 2011 and the “biggest crash since 2009.” See China’s economic concerns mount as industrial profits crash to lowest since 2011. The numbers have no doubt only gotten considerably worse since then. Way back in October, 2018, we came out with a controversial post, titled, Would the Last Company Manufacturing in China Please Turn Off the Lights. In that post we unequivocally stated that American and European companies were moving their manufacturing out of China:

The title is an exaggeration, of course. But with my law firm’s international lawyers fielding a steady stream of client requests for help with leaving China for Vietnam, Thailand, Malaysia, Cambodia, India, Mexico, The Philippines, Indonesia, [Taiwan] India and Turkey (mostly), it does sometimes feel as though within three years nobody will be making widgets in China anymore.

On top of the client and potential client calls, we have also been getting a steady stream of reporters asking us for permission to talk to our clients leaving or looking to leave China. We tell them that for various reasons, none of our clients are likely to want to discuss their leaving China and then they usually tell us that they “understand.” See How to Leave China AND Survive.

Yet all this can for you as a foreign business (and not just in manufacturing) can be a good thing.
During a prior China downturn (2008-2009), in Recession Resistant China Businesses, we highlighted how when an economy declines, let’s say 10%, not every industry sector declines 10%. Some really tank and others thrive:

One of the things I have always found fascinating is how macro economic issues can have such widely varying micro economic impacts. By this I mean that when an economy starts tanking, let’s say 10%, the impact on individual businesses can be all over the map.

I remember becoming starkly aware of this during the 1997 Asian Crisis, as I spent a considerable amount of time in Korea that year. The Korean news was doing a story on the drop in imported goods coming into Korea. Now I do not remember the numbers very well, but I think imports had declined about 20%. But the interesting part was how unevenly this fall in imports was among various products. The one that stands out for me is that some fruit (I am 99% sure it was either kumquats or quinces) had gone from $20 million in imports the year before to absolutely zero. Zero. The reason given for this was that it was a luxury and that such luxuries were no longer in demand. Some staple food products had seen virtually no decline.

I have a lawyer friend who represents a huge number of medical practices. He told me of a surgeon client of his whose practice had been decimated when insurance companies reduced their payments and stiffened their reviews. Giving my best guess to the numbers again, he said that surgery rates had declined about 5% across the board in the country, but this doctor’s practice had been hit so hard, his income had gone from something like $450,000 a year to around $50,000. There were various reasons this had happened, but obviously this particular surgeon contributed a lot more than most of the others to the overall 5% decline in surgeon payments.

I mention all this because I have seen very little written about how China’s decline has impacted businesses differently. My firm has seen increased business of late from companies related to energy and fuel savings, food companies, gaming companies, health care companies, education related companies, and, (no surprise here) debt collection companies. All these companies seem to have relatively stable (or even rising) income flows and they are seeking to expand in China or take advantage of China cost savings. Those businesses which seem to have been hit hardest are luxury goods companies, clothing companies, and financial services companies.

So what do we know about how China’s slowing economy is impacting China’s industries and how can you benefit? We know manufacturing is down and this invariably leads to an increased willingness by Chinese factories to reduce costs or required quantities. On the flip side, on the very same day it came out with its article on the decline in China’s manufacturing sector, the SCMP did a story on how China’s private tutoring industry is booming despite economic slowdown. This article also noted how international schools are rapidly increasing as well.

On May 12, 2019 (yes that’s right, seven days after the newest tariffs and after many months of relentlessly downbeat news) we did a post not at all sardonically titled, Why NOW Is a Good Time to Double Down on Doing Business in China. In that post, we wrote how even though relations between China and the West are declining, Western companies are moving as fast as they can to go into China and why:

Our client companies that are going into China know what is happening with China and in China and those things are actually fueling their decisions to go into China, and quickly. Those same things are fueling decisions by other clients to increase their footprint in China. These companies are telling us that they are doing so much business with China or will be doing so much business with China that it makes no sense for them to just walk away. That being the case, they are rightly concerned that if the only business they do with China comes from their corporate entities outside China, they are at risk of getting cut off by changing tariffs and/or changing trade relations. But if they are actually doing business in China through their own Chinese company (such as a WFOE or a Joint Venture), they will be better protected against the vicissitudes of international trade. And they are correct.

This move by Western companies to deepen their relations with China has only accelerated since then, and this is especially true for European companies.

2. These China legal issues are trending up

Our China lawyers had a team meeting yesterday and as is so often the case at such meetings, much of the meeting involved our talking about what we have been seeing lately. We mostly focused on the following trends:

1. A year ago, we rarely worked with our firm’s international trade lawyers. Sure, we would occasionally call one of them in to help with a sticky customs issue or a client concerned about getting hit with antidumping or countervailing duties, but these days we find ourselves working with them constantly. Companies that are getting hit or will soon be hit with having to pay 25% tariffs are looking for help in figuring out how to have their Made in China products made elsewhere so that they can legally avoid having to pay the tariffs. See US-China Tariff: What You Can do NOW.

2. A year ago, about 90% of the international contracts we drafted involved China or the EU. That number is now nearing 60% as our existing and new clients are diversifying outside China.

3. International litigation is on the rise. We are reading about this and we are seeing it. This is happening because of the uncertainty and the disruptions stemming from the tariffs. With disruptions and uncertainty comes disputes.

4. China is more open to foreign businesses than it has been in years. Forming a WFOE is a bit faster, cheaper and easier than it was just a few years ago, especially if your WFOE will be operating fully legally. Check out The NEW Steps for Forming a China WFOE.

5. Chinese factories are copying and selling their foreign customers’ products faster than ever before. Almost every week we hear of a Chinese factory that sold its foreign customer’s product before or right after shipping out the foreign customer’s first order. The tariffs are causing Chinese factories to question the viability of a long-term relationship with their foreign buyers and they are simply calculating that they can make more by selling their customers’ products online themselves. In the past, our lawyers did not push back when start-up companies wanted to test their product in the marketplace before spending for a contract to protect against their Chinese manufacturer competing with them. Now though we make very clear that this a very bad idea because by the time market strength has been determined, there may no longer be a product to sell. See China Trademark Theft. It’s Baaaaaack in a Big Way, China and the First to Market Fallacy, and Protecting Your Product From China: The 101.

6. Following the law makes sense if you are going to be doing business in China. The number of companies coming to us with big China legal problems has gone way down but the number of companies coming to us seeking help in avoidingChina legal problems has gone way up. This is a good thing because it means foreign companies have come to realize China has gotten both serious and effective at enforcing its laws as against foreigners. See Doing Business in China Without a WFOE: Will the Defendant Please Rise for a good example of where China has really cracked down against foreign companies and see China Employer Audits: The FAQs for a good example of the sort of thing foreign companies are doing in China to avoid future legal problems.

We then talked about how China has so far mostly “gone out of its way to welcome Western businesses into China and assure them of their economic security. Indeed, China has enacted laws designed to make it easier for foreign companies to do business in China.”

Chinese consumers and Chinese companies prefer buying from foreign companies that have boots on the ground in China. This has always been true and we see no reason for this to change. Foreign companies truly in China are viewed as being committed to China (because they are) and better able to stand behind their products and/or services. Or as one of our clients told us, they believe that “by making a strong commitment to bolstering their China presence now, they will be greatly rewarded by their customers who will view them differently from their competitors that are either not there at all or are looking to leave or to reduce their presence there.”

In the final analysis, what makes sense for your business will depend on your business and your industry but for many businesses now is indeed the time to fish or cut bait with China and for many businesses, doubling down on China is the way to go.

What do you think?