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The trade and investment relationship between the U.S. and China is going through permanent change, with the current round of tariffs just the start. As the tariffs fail to bring a resolution, we should expect the United States to implement other restrictive measures, including, some combination of the following:
- Prohibiting the selling or licensing of technology to China.
- Prohibiting Chinese companies from purchasing all or part of U.S. technology companies.
- Prohibiting Chinese students from attending U.S. schools and universities.
- Prohibiting the hiring of Chinese nationals by U.S. business.
- Ending cooperative research programs with Chinese scholars and researchers.
This will be the “new normal” in China/U.S. business relations and U.S. companies that do business in or with China should start now to prepare for this new reality. Many companies are waiting to react because they believe this conflict is a temporary political problem and will soon blow over. This view is a mistake.
The tariffs are the first step in a much more general conflict over the entire Chinese system. The U.S. objects to virtually every aspect of China’s economic/trade/investment system. Rather than take on the entire Chinese system as a first step, the current tariff dispute with China has been narrowly defined.
The USTR 301 Report bases the US tariffs on two concrete issues: China’s well-documented propensity to engage in forced technology transfer and IP theft. When confronted regarding these two issues, the Chinese government response has been to deny every claim. In its White Paper responding to the 301 Report, the Chinese government flatly denied every claim in the report. On forced technology transfer: it does not happen and U.S. companies that transfer their technology to China do so voluntarily based on their own business calculations. On IP theft: it does not happen and accusations of trade secret theft and cyber-hacking are lies.
China’s consistent and complete denial of every statement in the 301 Report has been maintained by every layer of the Chinese government. For example, in the forced transfer area, the Chinese government has refused to even consider opening the network, e-commerce and cloud computing markets in China to foreign based businesses. In the IP theft area, the Chinese government has refused to cooperate in investigating and extraditing those sought under recent U.S. indictments in several high profile cases.
There is a reason for China’s hardline position. Its forced transfer and IP “assimilation” regimes are at the core of China’s economic system. China’s current leaders understand this and that is why they cannot even suggest a compromise on these critical issues.
With China standing resolute and with there being no hint or likelihood of this changing, quick resolution of the US-China trade war will require the U.S. trade team to capitulate. U.S. businesses have waited twenty years to see improvement in the Chinese system, only to see things grow steadily worse. China has lost nearly all of its former supporters in the U.S. business community. Since China has lost its main body of support in the U.S., there is little pressure on the U.S. trade team to back down. It is therefore unlikely it will.
The situation is critical and nearly all foreign companies that operate in China should be analyzing how they can best deal with the trade situation. These companies need to make concrete plans for dealing with the impact the US-China trade war is having and will have on their business operations. Many companies believe they must either abandon China or pretend nothing is happening and go on with business as usual. For nearly all companies, neither of these approaches make sense.
Some companies will continue to work with China the same way they have for the past decade. For these companies, their major adjustment should be that they quit dreaming anything will change. For other companies, developing product supply relationship outside China will become critical. For some of these companies a move out of China will be required. Others should split their production between China and other countries.
What is consistent for pretty much every company that operates in China is the need for it to evaluate its operations in China under the New Normal of increasingly restrictive trade and investment measures. In assisting our own clients with this sort of evaluation we’ve been targeting the following:
1. How will current and future tariffs impact the business? For some of our clients, the tariffs are largely irrelevant. For others, the impact is so severe that failing to move quickly could lead to their demise.
2. What can be done about the tariffs? Is an exclusion from the tariffs possible? Will the Chinese factory agree to a price adjustment? Should the supply chain be moved to another country? What country(ies)? Should the company shift sales of its products to countries (other than the U.S.) where tariffs are not being imposed?
3. If the supply chain needs to be moved to another country, a careful analysis is required. Will you need to build a factory in that other country or can you purchase your products from an existing supplier or contract manufacturer? Is the infrastructure and legal system in the target country adequate for your needs? How long will it take to move and what will be the cost? As high as the costs are going to get to manufacture in China, this analysis often reveals China is still many companies’ cheapest and best choice.
4. China currently requires many technology companies to license their technology into China.Such licensing is essentially required in the network, cloud, SaaS sector, e-commerce and fin-tech sectors. The Chinese government has made clear this policy will not change. Companies in these sectors that have held off on “going into” China in the hopes of a change in policy should now either accept the licensing requirement or just abandon China as a market.
5. Many foreign companies engage in co-development of technology and products in China, working with many types of Chinese entities. Over the past 15 years, the Chinese court system has been largely receptive to protecting the contractual rights of foreign entities, provided that the contracts are properly drafted. See China Contracts: Make Them Enforceable Or Don’t Bother. Will Chinese courts continue to enforce these manufacturing contracts, especially on behalf of American companies? Or will U.S. companies need to look at different ways of protecting their innovations that do not rely on the Chinese legal system? Fortunately, all signs still point to continued contract enforcement.
6. Will new rules (either from the U.S. or from China) make it difficult or impossible for U.S. companies to sell or license their technology to Chinese companies? For U.S. companies that want to bring in Chinese investment, what will be the impact of restrictions that are currently being proposed? For U.S. companies that rely on hiring large numbers of Chinese professionals, what will be the restrictions? For U.S. education and research institutions that want to work with Chinese researchers, will that be possible? What about Chinese scholars who have become naturalized citizens of other countries? Will they also be banned?
Every U.S. company that works with China in any way should be asking themselves at least some of the questions above. Foreign companies that sell their Made in China products to the United States should be doing the same. China will not be completely and permanently cut off from business relations with the United States, but the nature of the US-China relationship has changed and it is not going to return to the way it was for a very long time.
The US-China business relationship is fluid and its final configuration has not yet been settled. Nonetheless, businesses that wait for a final resolution will be left behind. Now is the time to evaluate and take action.
What is your company doing to get ready?