Russia’s war will impact your China business.
We live in an interconnected world and what is happening with Ukraine will impact doing business with China. It’s just a question of how and by how much. In this post and its follow-up post, I will discuss how Russia’s war against Ukraine is likely to impact doing business in and with China, and what you can do to try to minimize that impact.
1. Russia’s War Against Ukraine Reinforces the Importance of Country Diversification.
A few months ago, in Is your Company Sufficiently Diversified?, I explained why my law firm is always concerned about having too many eggs in one basket, and how our experience with Russia has influenced our concerns:
A long time ago, my law firm was known as THE law firm for the Russian Far East. We ate, drank and slept Russia and Russian law. If there was a mining deal, an oil and gas deal, a timber deal or a fishing deal between an American company and a Russian company in the Russian Far East, there was a good chance our law firm was acting as lawyers for one side of the transaction. Then came 9/11 and our Russian practice fell off a cliff. American companies found doing business with Russia too complicated and difficult and vice-versa.
Fortunately for us, it was around that same time that our China phone lines started ringing incessantly. I can remember telling our lawyers that for every ten hours spent trying to get China matters we got ten such matters and for every ten hours spent trying to get Russian matters we got just one. It made sense for us to pivot from focusing on Russia to focusing on China and that is what we did, and we never looked back.
Well not exactly. I say “not exactly” because the changes with Russia seared into my mind that it is never good for a company to focus too much on one country, and so our firm has always strived to take on as many good Vietnam, Thailand, Brazil, Mexico, Latin American, and Spain matters as we can.
This is known as diversification, and we have talked about the need for that with respect to China for years now, long before most others did. China’s ongoing trade wars, its intermittent and unrelenting lockdowns due to COVID, and now its siding with Russia, all hammer home the need for diversification when it comes to China.
2. Russia’s War Against Ukraine Will Worsen China’s Relations with the World. For a Long Long Time.
Since 2018, we have been predicting a straight-line decline in China’s relations with the world — in particular, the United States and Europe. The below is our timeline/proof of those predictions
- Way back in October, 6, 2018, In China, the United States and the New Normal we called the US-China trade war the “New Normal” and we predicted a “diminished future for foreign companies” manufacturing in China. We went on to say that “since pretty much the inception of the US-China trade war we have been saying that we do not see its end because we have always seen it as more than a trade war.”
- Also in October, 2018, in Would the Last Company Manufacturing in China Please Turn Off the Lights, we started advocating for companies to do whatever they could to reduce their China manufacturing and diversify, and we have done so relentlessly ever since, while recognizing that for some companies this simply is not possible.
- Then in January, 2019, in The Huawei Indictments are the New Normal, we wrote how what was happening between the US and Huawei would negatively impact US-China relations even further.
- In April, 2019, the Wall Street Journal quoted me in a cover story, Trade Deal Alone Won’t Fix Strained U.S.-China Business Relations, on how “There is no way any deal between China and the U.S. will cause everyone on both sides to say, ‘We were just kidding,’ and on how the tariffs, the arrests, the threats, and the heightened risk have impacted companies and that reality will not go away.”
- In May 2019, in Yet Another International Trade (AD/CVD) Petition Against China, we wrote of how the United States was upping the duties (retroactively and sometimes by more than 200%) against Chinese products as a way of conducting an anti-China foreign policy on the sly.
- In May, 2019, in The US-China Trade War: Winter is Coming we wrote how neither the United States nor China wanted relations to improve and we should therefore expect relations between those two countries to only worsen. We wrote how “the United States is aggressively and unabashedly doing what it can to isolate China and to remove it from the world of international trade” and of how shutting out China will become a regular thing in new U.S. trade agreements.
- In May, 2019, in The US-China Cold War Starts Now: What You Must do to Prepare, we proclaimed the start of the US-China cold war and we have been pushing this ever since.
- In June, 2019, in Has Sourcing Product From China Become TOO Risky? we laid out the many and growing and unpredictable risks inherent in having your products made in China and posited that China was indeed becoming too risky for many who make their products there.
- In August, 2019, in Hong Kong for International Business: Stick a Fork in It, we proclaimed the end of Hong Kong as a center for international business. This was probably the most difficult blog post I have ever written because I on the one hand had little doubt that the prediction was correct, but on the other hand, it pained me to pronounce this to the world, when I at that time had so many friends who lived there. It also was difficult because it led to more hate mail than any other post we’ve written. But today, few dispute this.
I give you this timeline not so much to brag, but to show that our predictions regarding China and its relations with the rest of the world have consistently been right, even though they have for the most part gone against both what most people were saying and what our own clients wanted to hear. This post will be in those same veins.
The world is angry and repulsed by Russia. Billions of people are looking at what companies and countries will do about Russia’s war against the Ukraine. Massive protests against Russia’s actions are proliferating and companies are being publicly shamed for their relations with Russia.
Many companies and countries are responding to the pressure. Germany, which at the beginning of the Russia war was hanging back, is now supporting removing Russian Banks from SWIFT and it is sending a massive amount of arms to Ukraine. Neutral Switzerland (the country that stayed neutral against literal Nazis) today agreed to freeze tens of billions in Russian assets. Neutral Sweden is sending military aid to Ukraine. Russia friends and allies, including Lebanon, Kazakhstan, Cuba, Venezuela, Argentina, Turkey and Brazil have spoken out against Russia’s war against Ukraine. BP has severed its ties to Russia, relinquishing billions in assets, rather than face the PR storm by staying in. See BP to ‘exit’ its $14 billion stake in Russian oil giant in stark sign that Western business is breaking ties over Ukraine invasion. Elon Musk’s Starlink satellite internet service has ramped up its internet services in Ukraine to help Ukraine, in response to a public tweet by a Ukrainian government official. Stores are pulling Russian vodka from their shelves. See Russian vodka being removed from shelves in U.S. and Canada.
On the flip side/dark side is China, which per this Global Times article continues to blame Russia’s war on the West and emphatically denies any Russian wrongdoing:
Chinese military experts said Russia has been restrained in using force to attack the Ukrainian army because most Russian forces are being deployed to prevent NATO intervention, but Russia does not want the conflict to last long, so it might change strategy depending on how the situation develops.
There is absolutely no way China’s position on Russia will fail to negatively impact China’s relations with most of the rest of the world and your business needs to prepare for what this will mean for it.
3. Russia’s Actions Hold Many China Lessons.
Russia is closing and China is closing. Russia is being blocked from much of the rest of the world, both financially (via economic sanctions) and physically (via border closures, denials of visas, and flight bans, among other things). China is slowly but surely turning away and being turned away as well. China has made it nearly impossible (but not quite) for foreigners to go there and it has made it extremely difficult for its own citizens to leave. You can ascribe this to COVID, but it goes beyond that. China is cutting back on pretty much everything foreign, not just on foreigners. See Can China Ever Reopen? Xi Jinping’s first and only priority is political security, making a quick reopening almost untenable See also The End Game of China’s Zero-Covid Policy Nightmare and How China Under Xi Jinping Is Turning Away From the World.
China has over the last few years slowly been cutting itself off from other countries. And over that same time period, many other countries have been slowly cutting themselves off from China. This sort of isolation usually takes decades to reverse. Look at North Korea. Look at China until the 1970’s and even then reintegrating into the world was not terribly fast nor ever truly completed. What is happening with Russia these days is what has been happening with China over the last couple years, but with Russia it is on steroids and at warp speed. Nonetheless the mechanics are similar and a dissection of what is happening with Russia can provide us with a roadmap for China.
Once two blocs (roughly, the EU-US-Australia-Japan on the one hand and China and/or Russia on the other hand) go into sanctions mode, the sanctions tend to keep increasing from both sides, leaving companies betwixt and between. This is what is happening with Russia right now and to a lesser extent with China as well. The world’s deccoupling with Russia will likely accelerate the world’s decoupling with China, unless China changes its stripes and fast, which is very unlikely.
In The invasion of Ukraine changed everything for Wall Street, CNN quotes Credit Suisse’s global chief investment officer, Michael Strobaek, as saying that “we are now moving to a new multi-polar world . . . and that means investors will have to think differently about how they deploy their resources. Investors should carefully choose their asset allocations and systematic and strong investment processes and due diligence procedures before investing will become even more crucial. Active investing will become more important given the potential for shifting economic, political and social developments in individual regions.” I agree.
In Facebook, Apple and Other Tech Giants Face Rising Pressure Over Ukraine, the Wall Street Journal discusses how the big tech companies “are under pressure from both Russia and the West to respond to the conflict in Ukraine, highlighting their power over global discourse but also escalating a recent trend in which their businesses are squeezed by geopolitical events.”
The article goes on to discuss how Russia’s war “could accelerate the fracturing of the internet, which not so long ago was largely split between China and the rest of the world.” And then in what I see as its money quote for nearly all international businesses, it notes how companies are increasingly becoming “beholden to a patchwork of local rules, leading some to believe the “splinternet” is coming closer to reality.” It then describes how Russia is penalizing the big tech companies for violating Russian laws (ane/or desires) in large part because they are choosing to abide by the laws and public relations dictates in the West — all while trying to balance the two blocs while minimizing their own damages. This same balancing act is happening to foreign companies that do business in and with China.
The WSJ article then talks about how geopolitical tensions have “pinched sales and cut into profits by forcing companies to increase spending on compliance with local laws, according to analysts, former executives and legal scholars. They said the phenomenon has curtailed some internet users’ access to services and information, and forced companies to assess whether they should subscribe to largely U.S. values about freedom of information or adhere to local laws that are often in conflict with those principles”:
The effect is a drag on businesses, with margins being squeezed by having to hire more staff, said Brian Wieser, an ad-industry analyst with GroupM. “A few thousand employees could run the products, but individual countries imposing obligations makes that impossible,” Mr. Wieser said
Google has reported that the number of government requests it receives to remove content has increased fivefold since 2015 to about 50,000 requests annually. Facebook has reported a nearly 40% increase in requests over the same period to about 90,000 requests for the year ended in June 2021.
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In the months ahead of its invasion, Russian President Vladimir Putin sought more control over those companies [Apple, Facebook, Google] by signing into law a policy that requires companies with an audience of at least 500,000 people to set up offices in Russia that would be responsible for violations of its laws.
“It creates potentially a hostage situation for staff,” said Daphne Keller, a fellow at Stanford University’s Cyber Policy Center and former associate general counsel at Google. She said policies like Russia’s have also expanded the debate inside countries from being about which content should be taken down to which content should stay up.
As an example, she pointed to a report that Russia’s internet agency this week demanded that Google unblock the channel of a separatist leader in Ukraine’s Donetsk region, even as U.S. sanctions suggested such channels be taken down.
“It’s a weird tug of war,” she said.
Nu Wexler, a former policy communications staffer at Google, Facebook and Twitter, said some companies might ignore requests and rules in small countries with weaker ad markets. “When it’s a large country with a large ad market and employees in that country, it’s a more difficult calculation,” he said.
The issue is also creating strains inside the companies. At Google, staff posted on the company’s internal messaging system about what could be done to support Ukraine in the wake of the invasion. Someone proposed taking Russia’s state-backed media channel, RT, off YouTube, according to people familiar with the post.
A Google spokeswoman declined to comment on whether it would take RT down globally. It has restricted access to the channel in Ukraine and may take further actions, she said.
These “weird tug of wars” have been happening with China for years. China’s Internet is shut off from the rest of the world and if you want to be on it, you pretty much need to be in China and you need to behave however it is the CCP wants you to behave. And that has caused no end to the legal and reputational issues the big tech companies have faced. But this is also true for considerably smaller companies as well.
These weird tug of wars were accelerating with China before Russia invaded Ukraine, and not just on the Internet front. Take Xinjiang and the Uyghurs and China’s forced labor practices. Various countries have blocked or limited imports of goods produced in Xinjiang. In response to this, China enacted an Anti-Foreign Sanctions Law to fight back against the United States, the European Union (EU), and others. To a certain and as yet not entirely clear extent, this means that foreign companies doing business with the US and EU and China are in the untenable position of having to comply with Western sanctions that will put them in violation of Chinese law and expose them to counter-sanctions by China. This has raised the complexity and risk of doing business globally. The ever increasing compliance and international trade complexity for those that do business with China is great for my law firm’s China and international trade lawyers, but it is expensive and risky for international businesses.
In 2019, in the Top 14 China Wild Cards, the below four items made our list of China risks and as I explain in italics, these are particularly relevant in light of Russia’s war against Ukraine:
2. The situation in Hong Kong has continued for over two months, with no resolution in sight. The PRC government has already blamed the U.S. and Taiwan for the unrest and it has warned the HK protestors against starting a color revolution (the CCP’s biggest fear). The PRC has massed 12,000 riot police on the border and the PLA is on alert. If the PRC takes military action in HK, the impact on trade will be immediate and severe. Sanctions against China will likely come from the U.S., Japan, Australia, and Europe, disrupting trade for many years. The unity on sanctions against Russia does not portend well for China, if China continues its crackdown on Hong Kong, Xinjiang, and Tibet, or continues to increase its aggression against its neighbors, including but not limited to Taiwan.
4. China has started importing oil from Iran in direct defiance of U.S. sanctions. Violation of Iran sanctions is the reason for the U.S. banning sales to Huawei and detaining Meng Wanzhou in Canada. The U.S. might impose sanctions on the companies importing Iranian oil. More significantly, the U.S. might impose sanctions on the China banks financing these oil trades. Some in the U.S. have even proposed a “nuclear” option where the entities and banks involved would be cut out of the CHIPS and SWIFT systems. Replace the word “Iran” with “China” and you have what could very well happen in the next few months. Now that the world has so quickly and aggressively (and almost certainly successfully) imposed such wide reaching sanctions against Russia, there will likely be less friction against imposing similar sanctions against China.
10. There may be a tipping point when consumers in the US and the EU and elsewhere become so troubled with how China treats its Uyghur and Tibetan populations (see this and this) or how it is acting against Hong Kong or Taiwan or with its efforts to exert control outside China. These sorts of things are leaking out more of late as the bloom is off the rose and we are hearing more and more from our own clients (American and otherwise) saying that they are having employees refuse to go to China or consumers complaining about their goods being made in China. Take a company like Patagonia which has a stellar reputation for caring about the environment and people and even goes so far as to call itself The Activist Company; how much longer can it maintain its moral high ground while still having some of its products made in China? That tipping point hit Russia incredibly fast, but with that tipping point, “the people” feel emboldened. Go to Twitter and you will see the huge number of tweets (with huge numbers of likes) from people extolling how the big corporations were wrong to downplay the role of morality in international business. This newfound increase in “people power” will not be confined to just Russia and there are already many saying it will be coming for China next. As mentioned above, we have had clients (not in tech and not on the Coasts) lose good employees because of our clients’ China connections. Heck, in one case, we had a client lose multiple employees because it was considering doing a China deal.
14. There are a host of internal factors in the PRC that could have a major impact. Factors I look at are: a) the inability of the PRC leadership to take any stand other than defiance, leading to no chance of any resolution of issues by diplomacy and mutual agreement, b) African swine fever cuts Chinese pork supply in half, c) African army worm substantially reduces Chinese grain crop, d) consumer price inflation coupled with factory price deflation. If China continues to support Russia, look out.
In my next post I will explain what I see for China’s future with the rest of the world in light of Russia’s war against China. In particular, I will discuss why I think there is a good chance we will be seeing increasing sanctions on trade with China and what your company should consider doing now to reduce its China risks.
Please stay tuned.