1. Worsening US-China Relations Should Be No Surprise
Since the very beginning of US-China trade negotiations, we have been unequivocally negative on the likelihood of a deal and we have taken huge amounts of heat for that, via hate e-mail, online, and even from some of our own clients who accuse us of being too cynical or too negative about China. Our response to all of this has been consistent. NOW is the time for foreign companies (especially those that sell their products to the United States) to work hard on reducing their China footprint.
We first publicly sounded this warning in October, 2018, in China, the United States and the New Normal, though we had been warning our own clients about this for months. This “New Normal” post was an attempt to get in the face of those who had been sending our lawyers hate mail because we had in a September 2018 post predicted manufacturing orders from China were declining and would continue to decline:
I got a badly written and angry email yesterday in response to my post, On the Impact of China Tariffs: Is This a Dead Cat Bounce? In my post I predicted a decline in manufacturing orders from China, starting in the next few months. The email accused me of “hating China” and wanting “to impede its peaceful” rise and of being “jealous of its progress.” All this because we have lately been writing how so many of our law firm’s own clients and so many others are leaving China, or looking to leave China. We have been getting quite a lot of these sorts of emails lately
In April of this year, the Wall Street Journal quoted me in a cover story, Trade Deal Alone Won’t Fix Strained U.S.-China Business Relations, saying the following:
“There is no way any deal between China and the U.S. will cause everyone on both sides to say, ‘We were just kidding,’” said Dan Harris, managing partner at Harris Sliwoski, a law firm that specializes in investment with China. “The tariffs and the arrests and the threats and the heightened risk have impacted companies and that will not go away.”
Then on May 4, 2019, (one day before President Trump’s May 5 tariff tweet that changed everything) I wrote The US-China Trade War: Winter is Coming on how no matter what happens in the US-China trade war, things would NOT revert back to the way they had been:
The acceleration of this decoupling trend has been unleashed and no trade deal is going to end that. Why would it? The tariffs may disappear or be reduced but the tension is going to remain and my law firm’s China lawyers and international trade lawyers are seeing evidence of this everywhere, both in how the US treats Chinese companies and how China treats US companies. The US is cracking down hard on China deals with US companies on national security grounds. And China is doing what it can to stop its own companies from dealing with the United States.
We then listed out our previous blog posts on what foreign companies should do in light of the 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:
- China/U.S. Tariffs and How to Fight Back
- On the Impact of China Tariffs: Is This a Dead Cat Bounce?
- U.S. Tariffs Against Vaping Imports from China: Don’t Let Your Industry go up in Smoke
- China, Wine, and Tariffs
And so began our steady stream of posts exhorting companies to look more closely at countries other than China.
2. Western Companies are Moving Out of China
The reactions to these exhortations from our own clients has been the most interesting, because those have been all over the map. Many have insisted there would be a US-China trade deal and their reasoning was usually something like, “it only makes sense for there to be a trade deal.” These people believed the war was a purely monetary one and once the two countries were truly pushed up against a wall, the Chinese side would agree to buy x billion dollars more of soybeans and other US products and services and the United States would then walk away. These clients did not want to hear our incredibly long explanations as to why we did not believe this to be the case.
But some of our clients really listened and I am going to highlight two of them now, without discussing enough to reveal who they are. I chose these two companies because they both “played” their cards so wisely and because they are such completely different companies.
The first company is a big U.S. company that makes electronics and I cannot get more specific than that. The head of this company “loves” geopolitics and from day one he was convinced there would not be a quick deal between the United States and China, no trade deal could solve the issues between China and the U.S., and problems between the two countries would be ongoing for decades. This person declared his company would within six months reduce its purchases from China by 50% and be out of China entirely in nine months and he wanted my law firm’s help with the following to achieve this:
- Deciding the countries to target for its purchases.
- Figuring out how to pressure its existing China-based suppliers to move outside China.
- Figuring out whether to manufacture on its own in countries outside China.
- Protecting its IP outside China.
- Drafting its manufacturing contracts with the companies outside China.
- Making sure its products made outside China would for tariff purposes truly and legally qualify as having been made outside China.
Our lawyers were thrilled to work on a project with such a wide scope, but I have to confess now (I have confessed this to the client previously, so no worries there) I did not believe this company’s goals were achievable, in large part because of the nature of this company’s products: electronics. If it had been shoes or clothes or furniture or even doors or toasters I would have 100% thought it could move out of China. But electronics. No way.
But this client has in about seven months moved about 80% of its production outside China and it has made clear to its few remaining China suppliers that if they cannot soon supply their products from factories outside China, it will cease buying from them. In other words, this client company — in the electronics industry — will soon be buying all its products from outside China. And what has this move out of China done for this company? It has improved its positioning when making sales because it can and does tell potential buyers that its products do not come from China and therefore its pricing is not dependent on which way the US-China trade war winds are blowing.
The second company is a start-up that makes children’s products. This company initially came to us for a China NNN Agreement. I asked whether its products would be subject to the “Trump tariffs” and I was told yes. I then asked why it was having those products made in China, rather than in Thailand (I picked Thailand both because it seemed like a really logical product to be made in Thailand and because my law firm have worked on a lot of successful manufacturing deals with Thailand — we even have a lawyer, a Thai Business Specialist and an International Manufacturing Specialist who speak Thai.
The response to my Thailand suggestion was very positive, but I was then told that the company “did not even know where to start with Thailand.” I said we could help pretty much every step of the way and we did and the new products will soon be coming to market, with lower costs than they would have been in China and 100% tariff free. I am guessing this client too will use its made-in-Thailand-ness as a selling point, because let’s face it, American and European consumers tend to have a much better “feeling” about Thailand than they do about China, especially with something like a child’s toy.
3. The Roots of the US-China Impasse
Let’s now though talk about the new (permanent?) impasse in US-China trade talks and how we got here. I’ve already heard from friends and clients who just could not wait to remind me that they too predicted this would happen. Many of these people point out how “what China did here is exactly what __________[Chinese company] tried to do to us.” And it is.
But what exactly did China try to do to the US and why was that no surprise to those with substantial experience negotiating with Chinese companies? What China tried to do was to completely change an agreed-upon deal at the very last minute, believing the Western side (in this case the United States government) was so desperate for a deal (any deal) it would go along. We have written about this tactic countless times and our recommended tactic for dealing with it is just what the United States has done. Stand firm or get even tougher. See Negotiating With Chinese Companies: Walk and Don’t Look Back.
It is exactly this sort of common negotiating tactic, among a whole host of other things, that has caused us to be skeptical of the US and China doing a trade deal and skeptical of any trade deal changing much if anything in any event.
Literally the day before President Trump’s tweet regarding his plan to institute a 25% tariff on another $250 billion of Chinese goods, we wrote a long piece, entitled The US-China Trade War: Winter is Coming, on how a trade deal between the United States and China will not change much between them and how the trade war will merely go forward on other fronts. We concluded that post (as we have so many other posts) by exhorting foreign companies to look closely at their own business relationships with China:
To quote an old investment adage, “the trend is your friend,” and right now the trend is for the West and China to continue decoupling and your business needs to be cognizant of this and monitor it. We keep writing about this because we see it as likely to impact nearly all foreign companies that do business with China, even those from countries whose relations with China are much better than those between the United States and China. No matter in what country your company is based, if you do business with the United States — especially if you have your products made in China and then sell them to the United States — your business is at risk of becoming entangled by the decoupling.
If you want to see your company go into China or have its products made by China or increase its China presence, you should be prepared to explain to your company’s decision makers why you believe your business will not fall prey to US-China tensions. If you are having your products made in China, you almost certainly are already looking to reduce your China exposure, but in doing your cost benefit analysis for that, consider whether yours is the sort of business whose sales might increase merely by being able to tell its customers/consumers that your company does no business with China. And yes, this is going to sound self-serving (and it is, but it is also true), you need to more than ever make sure you are not doing anything that might make you an easy target of the Chinese government. In other words, make sure your company is in full compliance with China’s laws, particularly its tax, environmental, employment and bribery laws.
I linked to this Winter is Coming post on Linkedin where it has been viewed by nearly 15,000 people and has engendered a healthy discussion regarding the US-China trade war. I urge you go there and join the discussion.
Much has happened in the last couple days between the US and China and the below is my initial attempt to put it all into perspective. I say “initial” because my views will no doubt change as more things occur and as I have time to discuss with others what has just occurred and will occur.
4. The US and China Are and Will Continue to Fight Over Just About Everything
My first thought based on the last few days is that this trade war is at its core a fight between the United States and China for which country determines from where products are purchased. I am obviously not the first person to say this but I have to admit this did not really hit home for me until yesterday when one of my law firm’s Spain lawyers off-handedly mentioned something along these lines to me. Both President Trump and President Xi are using their powers to influence global buying decisions. I know when I say it like this it seems obvious, but I’m not so sure it was or even is until you hear the following explanation. But hey, if I’m all wrong on this, just let me know — as the saying (sorta) goes: “there are no bad ideas here.”
Earlier this week I read how President Xi controls China’s economy. Well duh, right. No, I mean like really controls it, down to just about every nib. China wants to pay Canada back for Canada’s abiding by international law in arresting Huawei CFO Meng Wanzhou. See The Huawei Indictments are the New Normal. China chooses to do this by essentially telling its businesses they better not buy any canola oil from Canada and — pretty much just like that — they don’t. This is on top of China already having taken hostage two Canadians and snap-deciding to sentence to execution another Canadian whose previous sentence was 15 years in prison. In other words, President Xi and those at the highest echelon of China’s government can snap their fingers and create a new business reality.
Lacking in such nearly unmitigated power, but wanting that same power for himself, President Trump has been using tariffs to essentially accomplish the same thing. He has been raising tariffs against China and then negotiating with China and then threatening to raise tariffs against China and then raising tariffs against China, all the while pressuring various U.S. governmental bodies to increase their pressures against China products via non- tariff actions like anti-dumping and countervailing duties (AD/CVD). See Another International Trade (AD/CVD) Petition Against China: This Time it’s Metal File Cabinets.
President Trump is doing whatever he can to convince American companies — really any company from anywhere in the world that sells its products to the United States — to stop doing business with China. In ‘We’re freaked’: Trump startles US businesses with fresh tariff hike, CNN explains how this works by focusing on how Trump’s last minute tariffs will harm U.S. businesses that did not prepare for this:
Importers received just five days’ notice about the sudden rise in the tariff rate to 25% from 10%.
Phil Page, the CEO of Missouri-based Cap America, estimates that his company has more than $1 million worth of baseball hats already ordered that will now be hit with the higher tariff. “It’s very difficult to understand what the President is going to do by a business perspective. To spring it on us all at once like this is a very poor judgment on his part,” Page said. “I thought this thing was going to be worked out this week,” he added.
* * * *
Trump imposed three rounds of tariffs last year. The third and biggest tranche on $200 billion of Chinese goods went into effect in September. But the President threatened to escalate the tariff rate to 25% from 10% on January 1 if progress wasn’t made on a new trade deal — and then pushed the deadline to March 1.
When the second date came and went, it appeared trade tensions were easing up and businesses adjusted to the new normal.
“I thought we were finally figuring out how to make this work, and now we have to start all over,” said Tiffany Zarfas Williams, owner of the Luggage Shop of Lubbock in Texas.
About 84% of the luggage, backpacks and briefcases she sells were hit with tariffs. Earlier in the year, she would receive emails from vendors on a daily basis about price increases. Zarfas Williams raised her own prices accordingly, and adjusted the assortment of items on the floor.
But by Monday afternoon, she had already received a new email from one of her biggest vendors reminding her that a higher tariff would result in a higher price.
Sales of the higher-end items at Luggage Shop of Lubbock have already taken a hit and adding another 15% to the price would be “a whole new ballgame,” she said.
The article then notes how “Trump’s top trade negotiators on Monday brushed off criticism that US businesses and executives were not given sufficient notice ahead of plans to escalate tariffs on $200 billion of Chinese goods.”
“The fact is that we’ve been in a position where that very well could happen,” Lighthizer told reporters at a briefing. He also opened the door to possible exemptions but did not offer any further details.
The message was echoed by Mnuchin. “It’s obviously been a big time commitment, so I would just emphasize that nothing that’s been done has been on short notice,” he said. “Although certain expectations may have changed over the last week from the other side.”
Essentially, we have on the one hand businesses saying President Trump’s new round of 25% tariffs and his threatened next round of 25% tariffs were a complete surprise. And on the other hand, we have the Trump administration (mostly LIghthizer and Mnuchin) disputing this and accusing those who say this of having not made much of an effort to read the tea leaves regarding impending US tariffs against China.
5. This is the New Normal
I somewhat side with Lighthizer and Mnuchin on this because we on this blog have been relentlessly downbeat about US-China relations by basically screaming to anyone who will listen that you must start looking beyond China for your products. We have done this as recently as Sunday, in The US-China Trade War: Winter is Coming and we did it more than seven months ago in China, The United States and the New Normal.
So to at least some extent, those who assumed China-US relations would soon return to how they were before the United States initiated its first round of tariffs were either not reading enough or were misinterpreting what they did read. Nonetheless, I completely get where these complaining companies are coming from because most of my own law firm’s clients that were having their products made in China last year are still having their products made in China right now this is mostly because leaving China is neither fast nor easy.
Some of our clients have left China entirely, moving their production to Thailand, the Philippines, Mexico, Indonesia, Vietnam, India, Taiwan, Sri Lanka, and the Ukraine, among others. Some of our clients have diversified their supply chains away from China, while remaining in China. Others are working on exiting China entirely. Many though — and for various reasons — feel they have no choice but to remain in China for the short term and even beyond. So yes, there are some companies that should have left China 6-12 months ago but didn’t, but there are more companies that simply could not leave China fast enough to avoid this next round of tariffs.
In September 2018, in How to Leave China AND Survive, we wrote about how difficult it is to stop having your products manufactured in China and how to do that in a way that minimizes myriad potential problems. I would urge anyone looking to move away from China to read that post before instituting any actions that might lead anyone in China to think you might be leaving.
But if you are going to leave China, where should you go and how even should you go about determining this? And what can you do to try to secure an exemption from these new tariffs? In China/U.S. Tariffs and How to Fight Back, one of our international trade lawyers explained how to try to secure an exemption to previous tariffs and much of what was written there will apply to this new round of tariffs as well.
I am about to do something we have literally never done even once in any of our other 4,781 blog posts and something I swore to myself we would never ever do: I am going to suggest you reach out to my law firm for assistance. I swore we would never do this because I have never wanted anyone to view this blog as an advertisement for our law firm because I’ve always known that would be the kiss of its death. We don’t accept paid advertising and we never will and we have never suggested in any blog post that anyone contact us.
But what is happening with China right now is extraordinary and it will no doubt lead to tough times for many companies. Finding a landing spot other than China is not easy, but between the international lawyers and foreign business specialists at my law firm and the many fine consultants and manufacturers we know around the world, we definitely can help and we want to help. Our international trade lawyers can help as well in trying to get your products exempt from the upcoming tariffs as well. So I do urge you to reach out to us.
I do not want to see more articles quoting companies that were not prepared for this mega-storm or do not know what to do in the face of it. And if we can’t help you, we will endeavor to recommend to you those who can. Of course there are many companies that cannot or should not leave China. China is the second largest economy in the world and it has a billion+ people and so it cannot be completely written off or ignored.
And just as we are seeing so many of our manufacturing clients beating down the doors to get out of China, our China WFOE formation work is at its highest level (by far) in the history of our law firm. This means we are on the one hand working to get many clients out of China, while at the same time working to get many of our clients more deeply embedded into China with their own Chinese companies.
What sort of companies are going into China? Mostly tech companies and companies that sell their products and services to China. Most of these companies either do not care much about the tariffs or are going into China because of the tariffs. For example, one company that does a lot of manufacturing in China is going into China to start selling its made in China products there, while at the same time looking to have its products made outside China for selling to the United States. As I am always saying, lawyers thrive on change, whether the change is for the better or for the worse.
We will over the next few months be writing a lot about what is happening and providing more specifics on how best to respond to it. I apologize for the length of this post; there is though so much to say and I did not feel it could wait to be strung out over many days.
Winter is upon us. And as much as it pains me to say this, the US-China cold war starts now.