Russia’s War Will Impact Your China Business, Part 2

In our initial post, Russia’s War Will Impact Your China Business, we talked about why there would be an impact. That post was less than a week ago, but since then we have become more certain that Russia’s war will impact your China business and we now view that impact as likely to be even greater than what we posited it would be just days ago. We discuss all that below and touch on what your company can do to reduce its China risks.

1. Russia’s War Has Already Impacted How Companies View Their China Risks

Our law firm has a flat fee program we internally call “China risks and revisions.” That program consists mostly of our analyzing a client’s China risks and then working with them to reduce their China risks by “lightening their China footprint.” Our goal is to reduce the client’s China footprint and thereby reduce their China risks, while at the same time capturing all or nearly all of the benefits the client gets from doing business in or with China. In just the last few days we have noticed both a massive increase in the fear of China risks and a willingness to take action to reduce those risks.

To get a sense of some of the things we look at to determine our client’s China risks, check out How to Evaluate Your China Risks. Reducing China risks tends to be incredibly specific by industry, by company, and by what exactly the company is doing in China. For a company that buys all its products from four suppliers in China, we might suggest it find at least one supplier outside China and then we help them do that. See How to Move Your Manufacturing Out of China Safely. For a company in a China joint venture with ten of its own people in China, we might recommend it switch from a joint venture arrangement to to a pure distributor-distributee relationship or, to achieve an even lighter China footprint, just license its products/technology/brand name to a Chinese company.

I have seen an increase in China risks (and a concomitant need for China footprint-lightening) in just the last few days, based largely on what has become clearer about China, and Russia and the world.

Since the inception of the US-China trade war, I have consistently lumped the EU into the US side of the China mix. I have done this on this blog, and even more emphatically on Twitter and LinkedIn. I have been often criticized for this — especially by the ever-decreasing number of people who want to absolve China of any blame for China’s growing isolation from the rest of the world. These people claim that the trade war is just between the US and China and that I should not be including the EU in it. My response always is that the EU has the same problems with China as the US, but it is just six months behind in terms of doing something about it and it will get there. I see the EU’s tough sanctions against Russia as proof that the distance between the EU and the US on issues such as human rights is actually quite small and that the odds are good that the distance between the US and the EU on China is likely quite small as well.

2. Russia’s War Will Increase the World’s Anger at China, Which Will In Turn Increase China’s Anger at the World

China is not a popular country right now. Many blame China for deliberately causing COVID (I do not think that it did) and many more blame China for having negligently allowed it to spread (I do think that it did). Lately, many are blaming China for current supply chain problems and inflation. The thinking on this is that the CCP uses its Zero-COVID policy to increase its control over China. Just yesterday, Al Jazeera (not exactly US or EU media) attacked China for exactly this. See Amid Ukraine crisis, China’s ‘Zero COVID’ weighs on global growth: Beijing’s strict pandemic policies add to supply chain and inflation risks amid economic fallout of war in Ukraine.

And then there is Ukraine. . . .

Yesterday, the media was flooded with stories about how China knew and encouraged Russia’s invasion of Ukraine well before it happened. Intelligence reveals that China made no effort to try to convince Russia not to invade Ukraine. Faced with a brutal war China had to have known would lead to the loss of thousands of lives (including children) and massive destruction, China’s only ask was that Russia not begin its brutal war until after the Olympics ended. A world that has coalesced around Ukraine is not going to take China’s extreme callousness lightly. A world that is appalled and furious with Russia’s brutality is not going to take kindly to a country that extols its “no limits” friendship with murderous Russia.

Adding insult to injury, China made clear yesterday that it opposed financial sanctions against Russia and would not participate in such sanctions, but would instead, “maintain normal economic, trade and financial exchanges” with both Russia and Belarus.

3. The World Has Changed. China Has Not Changed With It.

Yesterday, there were a ton of articles on how Russia’s war against Ukraine has drastically changed the world. I think it’s less about how the world has changed and more about how people are realizing that if the Davids of Ukraine can so successfully fight the Russian Goliath, they surely can fight to have their own governments support Ukraine. All over the world, people are realizing their own power and sending a message to democratic and quasi-democratic governments alike that they need to listen more to their people to stay in power.

The following articles (all from yesterday) document the change.

1. In As Russia Invades Ukraine, the West May Be Getting Serious, The Wall Street Journal describes what is happening with Ukraine as “a clarifying moment for the world”. It then notes how “crippling economic sanctions, Europe and North America in a rare show of unity, the strengthening of NATO, and the weakening of the pro-Russian forces in the West” will combine to inflict a lot of pain for Russia.

2. In Putin loses his key ally in the EU as Hungary’s Orban turns on the Russian leader, CNBC noted how even Hungary’s Viktor Orban, “a longtime ally of Russian President Vladimir Putin”, has turned against Russia because he realizes this is what he must do to “play well with his own electorate.”

3. In Europe’s Sleeping Giant Awakens, Atlantic Magazine talks about the”cataclysm” in German politics wrought by Russia’s war with Ukraine. Over the weekend … Olaf Scholz rose to the podium in the Bundestag and … shattered German foreign-policy taboos dating back to the founding of the Federal Republic more than 70 years ago. We are entering a new era,” Scholz told Parliament. “And that means the world we now live in is not the one we knew before.” The German government’s policy shift was “a reaction to the overwhelming pressure his government had come under—both within Germany and among Berlin’s closest allies” and “an acknowledgment that the world has indeed changed.” Germany now understands that it “must pay an economic price to defend its values, that it cannot remain a larger version of Switzerland in a world of systemic rivalries.” On the same day Scholz made his announcements, hundreds of thousands of people came out in Germany to show their solidarity with Ukraine.

The Atlantic sees this political cataclysm impacting Germany’s (and hence the EU’s) relations with Beijing as well:

It is unclear what the implications are for Berlin’s relations with Beijing, which has sealed a “no limits” partnership with Putin and refused to condemn his aggression. China is markedly more important to the German economy and its leading businesses than Russia is. And its threat to Germany’s security, though slow-burning rather than in-your-face like Moscow’s, is no less real or concerning.

But the die has been cast. “Peace and freedom in Europe don’t have a price tag,” German Foreign Minister Annalena Baerbock said last week. It is freedom over prosperity after all.

4. In Biden rallies Congress behind Ukraine, says Putin has ‘no idea what’s coming, Reuters discusses how Congress “stood together to applaud Ukraine, many waving Ukrainian flags and cheering in the chamber of the House of Representatives” and of how this coming together over Ukraine may lead to an uptick in Biden’s approval ratings. In other words, supporting Ukraine is good politics in the United States.

Getting tough on China is also good politics. In early 2021, about 70 percent of Americans had a negative view of China and that number is almost certainly considerably higher now. Since being tough on China is good politics and since mid-term elections are fast approaching, we should expect to see more sanctions and restrictions imposed by the United States as against China.

5. In U.S. Moving to Confront China on Trade, Industrial Policy, The Wall Street Journal (yesterday) discussed how the U.S. government is taking steps to further curtail trade with China, by using Section 301 of the Trade Act, which allows “U.S. officials to single out certain practices of a trading partner and take punitive action should they determine those practices violate trade law.” It also noted that “the White House is also weighing heightened scrutiny of U.S. companies’ investments in China, tighter export controls on sensitive technologies and greater cooperation with European and Asian allies and partners on subsidies and other issues.” In other words, expect trade between China and the United States to become increasingly more difficult.

The die has been cast, and in more than just Germany and Hungary, and with respect to more than just Russia and Ukraine. In large part, Hungary and Germany are opposing Russia because so many of their citizens are horrified by Russia’s brutality in Ukraine. When Russia’s war against Ukraine ends, there will be other human rights issues against which people can press their governments to act, and I think China’s brutality in Xinjiang, Tibet and Hong Kong, and its bullying of Taiwan will become the next big thing. The people power that pushed Hungary, Germany and the United States and countless other countries to get tough on Russia will do the same thing with China.

4. Russia’s War Will Increase Oil and Gas Prices and That Will Increase Your China Costs

The war and the sanctions against Russia are already causing oil and gas prices to rise and that will likely continue at least until the war ends. This will undoubtedly lead to yet further increases in shipping costs from China to Europe and it will also very likely increase your China manufacturing costs as well. One of the worst kept secrets is that Chinese companies typically charge American and European companies more than companies from elsewhere and that is mostly because they are perceived as rich, unreliable, and not friends of China.

As relations between China and the West continue to decline (due in part to Russia’s war), you should expect your Chinese manufacturing costs to increase due solely to that. You should also expect your costs to increase due to Chinese factories having to pay more for their energy costs. Your shipping charges are also likely to increase due to rising oil and gas prices. Lastly, as tensions between China and the rest of the world increase, there is a good chance tariffs on Chinese goods will increase as well. Overall, I see overall China product costs as likely to increase by at least 10 percent within the next three months.

5. Our Cold War Future, With China on the Other Side

When I was in college, many of my classes focused on the Russia-US Cold War. In one class we read about a half dozen books that discussed differing approaches to the Cold War. My professors fed me a constant diet of Graham Allison and John Foster Dulles. I must have read at least 25 books on the U.S.-Russia Cold War. I grew up during the Cold War and it is starting to feel very much like we are in the middle of another cold war that will require countries and companies to choose sides.

Just like the last Cold War, we have Russia and the United States staking out opposing positions, and other countries having to choose one side or the other. I just today did an NDTV interview with Don Ma on how Chinese tech companies are in what Ma called a “lose-lose” situation in having to choose between China and the West. I agreed with him but emphasized that this choice between blocs is something that American companies have been facing for some time and will only increase. The idea of companies having to comply with the varying requirements and sanctions between the U.S. and the EU (and to a certain extent, Australia, Japan, Norway, Switzerland, and India) on the one side and China and Russia on the other side is much of what I discussed in my original post on Ukraine’s impact on doing business with China.

If I am right about this future cold war, we should expect the decoupling between China and the rest of the world to accelerate. You should expect American and EU companies that do business with China to be heavily scrutinized by the U.S. and the EU and also by their own customers and employees. You should expect more laws limiting what your company can do with China and also more moral outrage about doing business with China. See Doing Business with China: Peng Shuai and Your Reputation Risks.

I see this battle/decoupling between democracies and autocracies as the single most important political and economic issue over the next five years. What will your company do to ensure its own international future as this battle rages?