The US-China Trade War: Winter is Coming

1. China has Broken its Promises to Open Its Economy

I’ve had a front row seat to China for well over a decade. My law firm started this blog in January, 2006, and we were representing foreign companies in China and the rest of Asia long before that. When we started this blog we were unabashedly optimistic about China, but in the last ten or so years China has gotten more difficult for foreign companies and it has rarely missed an opportunity to prove that its promises to open its economy ring hollow.

Elizabeth Economy, who is smart as hell and knows as much about the US-China relationship as anybody, puts it best in her recent piece, Trade: Parade of Broken Promises:

The trade war signifies far more than President Trump’s desire to rebalance the bilateral trade deficit. It represents the culmination of decades of pent-up frustration within the United States over China’s failure to make good on the promise of its 2001 accession to the World Trade Organization (WTO): to open its markets, develop transparency and the rule of law within its trade regime, and protect intellectual property (IP). Notwithstanding the skyrocketing level of bilateral trade and the successes of some individual U.S. companies, many U.S. administrations have come to understand the U.S.-China trade relationship as a succession of broken promises. The trade war also reflects Chinese President Xi Jinping’s failure to follow through on his early promise of economic reform; during his first six years in office, his initiatives instead signaled a shift away from greater openness and from free and fair competition. And finally, the trade war represents a move toward at least a partial decoupling of the two economies as part of a much larger geostrategic competition, primarily between the United States and China but also more broadly between two models of development.

2. Just About Everyone is Anti-China These Days

It is getting difficult to find an American or a European businessperson who regularly deals with China who does not feel likewise, especially if you exclude the China consultants whose incomes are directly tied to the idea that everything will be fine between China and the West once the US and China reach a trade deal or once President Trump is voted out of office.But how will this be the case when so many governments now believe they were duped by China and when their citizenry are in full agreement on this?

In the United States right now, Democrats and Republicans are fighting to out anti-China the other. In China Isn’t Cheating on Trade, an article calling on the United States to tone down its burgeoning cold war with China, Peter Beinart admits that being anti-China sells tickets these days on both sides of the political aisle:

But the slide toward cold war with China will likely continue for reasons that go beyond Trump himself. While Trump’s language is particularly extreme—during the 2016 campaign, he portrayed the relationship between the Chinese and American economies in the language of rape—describing Beijing’s economic behavior as predatory, and demanding that America respond with punishments and threats, has become commonplace in both parties. From Elizabeth Warren, who earlier this year claimed that China has “weaponized its economy,” to Marco Rubio, who last year tweeted that the Chinese aim to “steal & cheat their way to world dominance,” leading Democrats and Republicans describe China’s economic practices as uniquely malevolent and getting worse.

Being anti-China gets votes, in the United States and elsewhere in the West.

Ask those who write about China about the hate mail they receive. I think of this blog as hewing pretty close to center when it comes to China and yet hardly a day goes by where someone doesn’t challenge us with a question like “how can you support a regime that does xyz horrible thing?” Many of these come as messages on our China Law Blog Facebook page and an increasing number of them include gruesome pictures of executions and slaughtering of dogs, etc., purportedly from China. And I know from talking to reporters that a huge number of foreign businesses do not want their customers to know they are either in China or doing business with China because doing business with China can be bad for doing business elsewhere this will only continue to get worse. Yesterday the United States called out China for interning three million Muslims in concentration camps and I am quite certain this sort of thing will escalate even if there is resolution to the trade war, which itself is not likely.

When I was in student government back in my college days, the big issue was apartheid in South Africa and our student government voted to have the college divest from any of its investments in South Africa. That didn’t happen but many companies did pull out of South Africa to placate their customers/clients. We are seeing similar things happening with Saudi Arabia these days and there are China stirrings as well. I am NOT saying this will have a major impact on most companies, but if you pitch your company as socially conscious and you are not thinking of ending your dealings with China, you are behind the curve.

What if you are just a run of the mill start-up or SME? What should you do? Should you flee China now to avoid social problems later? Almost certainly not. But if you can slowly and relatively painlessly move your supply chain elsewhere, you probably should. Everything being equal, would you not rather tell your customers (and even your own kids) that your company does business with Mexico or Thailand as opposed to China?

Just as many companies boast of how their products are organic or cruelty free, companies seem almost eager to let the world know their products are NOT made in China or at least that they are doing all they can to accomplish that. See the Wall Street Journal article, Trade Deal Alone Won’t Fix Strained U.S.-China Business Relations, whose theme is that the smart money wants to invest in companies that are out of China, getting out of China, or at minimum, have a plan to do so.

2. China’s Decoupling from the West is Inevitable

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.

The numbers starkly reflect this. In 2018, “Chinese companies completed acquisitions and greenfield investments in the United States worth only $4.8 billion, down 84% from $29 billion in 2017 and 90% from $46 billion in 2016,” per the trusted Rhodium Group. I fully expect 2019 numbers will make China look profligate in 2018. It is that bad. The US is cracking down hard on imports from China and a trade deal will likely accelerate this. We are seeing similar things happening in much of Western Europe as well, just a bit more slowly.

In Another International Trade (AD/CVD) Petition Against China: This Time it’s Metal File Cabinets, one of my firm’s international trade lawyers, Adams Lee, wrote about the unrelenting and unprecedented number of trade petitions being filed in the United States against incoming products from China. Adams made a point to say that even though he makes his money off these trade cases, he is starting to question how the US Government is using them to encourage/force US companies to look outside China for their products:

Again, the international trade lawyers at my firm make our money by representing the Chinese manufacturers and their US importers so the more petitions brought against incoming Chinese products the more money we make. The more petitions, the more our law firm financially benefits and the more I personally financially benefit.

And yet, from an economic and policy standpoint even I am starting to get concerned by all these cases. I say this because of the massive onslaught of AD/CVD cases being brought against China and how aggressively (on multiple levels) the United States Commerce Department has been on these cases. To the point where I am finding myself wondering how important a trade deal with China will be if the United States giveth on the one hand and then taketh via these AD/CVD cases on the other hand. And is it right for the United States government to almost “on the sly” be pushing American (and foreign companies as well) away from China, without making this policy clearer?

Based on all that I hear from my own firm’s China lawyers and international manufacturing lawyers, many American and European companies are decreasing or eliminating their business with China. See The China-US Trade War and the Winner is….MEXICO. It appears US foreign policy is to drive business from China to countries like Mexico, the Ukraine, Vietnam, Thailand, the Philippines, and Indonesia, among others. What this means big picture is that slowly but surely the price of products from China in the United States is rising and will continue to rise. So as one of our China lawyers so often tells our clients: “you need to act accordingly.”

The always excellent China File did “a conversation” last week with six top policy analysts/leading scholars on If the U.S. and China Make a Trade Deal, Then What? To grossly simplify, the conclusions are that no trade deal will stem US-China decoupling. In other words, don’t get your hopes up.

Winter is coming.

And just to be absolutely clear, when I say “winter is coming” I am saying we will be entering a long and difficult period in US-China relations and in US-China trade and much of this will spill over to other countries. I am most emphatically NOT saying anyone should prepare for war and I am even more emphatically not saying this because I want to see this cold war turn into a real war. The freeze in US-China relations brings me no joy and I would urge leaders on both sides to do what they can to prevent further escalation. Just as is true of so many who read this blog, the former trade relationship between China and the United States was very good for me.

I should also note that whenever “all the smart people” feel a particular way, that is the time to hunt out and listen to the minority of good and smart people who feel the exact opposite. So though I have in this post (and in previous posts) marshaled thoughtful views of those who speak about the inevitability of US-China relations going downhill, I urge everyone to respectfully read other views and I welcome other views in the comments below or anywhere else. I talk about it being hard to find those calling for the US and China to step back and try to work together again and so I would welcome people sending me links to good articles or books that call for exactly that. I cited to one such article above: China Isn’t Cheating on Trade. And I urge everyone to read Blaming China, by Ben Shobert, which I last year listed among the top eight China books.

3. US-China Relations Will Continue Going Downhill

But I also urge you to go to China File and read the entirety of this six person conversation, but for those who will not do that, I provide the following somewhat long summaries below.

1. Michael Hirson believes any truce between China and the US will be both fragile and limited and will not address the “heightened geopolitical competition and fundamental divergences in economic models the trade war has laid bare.” He sees the United State and China continuing to use “non-tariff measures, such as investment restrictions and regulatory actions, to seek independence from each other in strategically important sectors such as 5G networks and artificial intelligence. . . . [hindering the] ability of global supply chains to link the two economies as efficiently as in the past.”

Hirson also believes the “openly geopolitical nature of the trade dispute—with U.S. officials publicly celebrating China’s economic slowdown under tariffs, and taking aim at Chinese firms like ZTE and Huawei—does more to strengthen China’s nationalist voices and Xi Jinping’s statist impulses. It only furthers China’s determination to achieve self-reliance from the U.S. in areas such as semiconductors and software.”

Hirson sees the “fundamental divide between U.S. and Chinese interests on core issues” leading to any trade deal implementation being “rocky,  with a real risk that the U.S. will reimpose tariffs in the next one-two years.” American companies that do business in China “may see improvement in the formal business environment, but will still face pervasive informal obstacles where China sees an advantage to limiting the role of foreign firms.”

Hirson sees tensions between the U.S. and China increasing because the “U.S. political establishment will grow more hostile towards China in coming years, driven by consensus that it is the country’s most formidable strategic competitor as well as frustration with China’s lack of political and economic reform. Trump’s hard-edged campaign against China now ensures that both parties will compete in upcoming elections on who can be toughest against Beijing.” He also believes “the shortcomings of Trump’s trade deal will force the U.S. to develop a more unified and coherent strategy towards China. It should involve taking the strong point of Trump’s approach—recognition that the past mode of U.S. economic engagement was not working—and addressing its major weaknesses: the failure to fully enlist allies such as the EU and Japan, and the missing link to domestic policies to boost U.S. economic and technological competitiveness.”

2. Graham Webster does not see a trade deal solving the “U.S.-China economic problem” because “the U.S. government and various U.S. businesses have numerous gripes with Chinese digital economy and cybersecurity regulation, especially regarding the 2017 Cybersecurity Law and conditions of access to China’s cloud services market”:

[W]hat specifically the U.S. side wants, and what the Chinese side can give, is tough to discern. This is in part because a wide range of Chinese government regulations and standards affecting digital economy sectors are in draft form or still awaiting release. Moreover, the U.S. government is far from a comprehensive and transparent regulatory regime on issues regarding market access, data protection, or cybersecurity. Neither side has a well-defined status quo against which to measure wins or losses.

3. Suisheng Zhao sees the trade war as having “forced both countries’ leaders to find a solution not only to the alarming trade imbalance, but also to China’s trade misconduct, which engendered the imbalance.” He views the trade war as having “harmed the Chinese economy much more than the American economy” and “exposed” China’s leadership to criticism. He too believes any trade deal will be only “temporary” and will not “help stop or even reduce the unprecedented economic and geostrategic competition between the two largest economies and heavily militarized nuclear powers.” But he also thinks that because “neither the U.S. nor China can afford to decouple or disengage from the other” and because they are “not inevitable enemies . . . . engagement remains the foundation for healthy competition.”

4. Orville Schell essentially says a trade deal will not really change anything:

Even if the Chinese do sign some delicately calibrated agreements to protect IP, open markets, and agree to buy billions more in soybeans and Boeing aircraft, China will still be run by an increasingly Leninist, mercantilist, statist leadership that believes in maintaining and subsidizing an economically dominant state-owned sector, putting “private” entrepreneurs and companies on notice that they exist only at the sufferance of the Chinese Communist Party, a highly regulated and censored media and Internet, extrajudicial punishment, political thought reform, severely constrained religious institutions, and Party dominance over the rule of law.

While such a system can have certain developmental advantages, it will never be able to merge with the market-based economies of liberal democracies—at least not with any real congruence. Add China’s growing tendency to use its new wealth and power to skirt the fragile rules-based global order and engage in self-serving belligerent and bullying behavior to get its way around the world, and we are left with a recipe for conflict that will make it difficult for even the most skilled negotiator to find common ground.

The Trump administration is right to challenge China with tariffs in the hopes of rectifying some of the inequities that have persisted like a low-grade infection for too long in our trade and investment relations. However, the bitter reality is that the dysfunctional aspects of our trading interaction—intellectual property theft, whole sectors of the Chinese market shut to U.S. entry, currency manipulation, arbitrary detentions of businessmen and consultants, etc.—are hardly isolated problems that, once adjusted, will allow the ship of bilateral trade and the overall relationship to right itself. They are expressions of two economic and political systems that are in almost every way the obverse of each other. Thus, the inability of American businesses to operate comfortably in China is part of the far larger problem that China not only has a system and structure of government borrowed from Joseph Stalin’s USSR in the 1950s, but has now abandoned the pretense of reform under Xi Jinping and is moving farther away from, not closer to, convergence with our own system.

In sum, because our bilateral relations face far more than a friendly competition in need of a few minor adjustments to function smoothly, we’d be foolish not to recognize that behind the current dispute over tariffs lie two very different systems of governance, as insoluble as oil and water. Especially as the Chinese state becomes more interested in using its economy as a strategic tool in increasingly adversarial ways that have both a military and geopolitical dimension, it would be naïve to imagine that a trade deal will be anything more than an epiphenomenon.

5. Roselyn Hsueh believes no trade deal can change a China that operates so as to “advantage indigenous Chinese industry”:

[O]ver the last few decades the Chinese government has welcomed trade and foreign direct investment and then deliberately calibrated rules on market entry, investment level, business scope, domestic contents, and ownership structures. With so many multinational corporations doing significant business in China, Chinese regulators and courts now regularly exercise their influence over global markets to advantage indigenous Chinese industry, particularly in the high-tech sectors identified by Made in China 2025 and other industrial plans.

Trade war or not, the implementation of China’s regulatory state will continue to enhance China’s position in the tech race. China’s recent offer to increase imports, the new foreign investment law, and new penalties on intellectual property violations do not change the dominant patterns of market governance. Moreover, China’s management and response to the political pressures of the forces which have contributed to regime stability and China’s global competitiveness will further shape the future of U.S.-China relations.

6.  Charles Edel says that regardless of the outcome on a US-China trade deal, “tensions between China and the United States are unlikely to abate” and the “fundamentally divergent and perhaps irreconcilable objectives of Washington and Beijing” mean any deal will be “temporary at most and partial at best.” He sees China-US relations getting considerably worse:

Competition in multiple critical sectors, antithetical political systems, and changed political dynamics suggest that competition is likely to get sharper, broader, and deeper. In Washington, there is an increasing, and bipartisan, concern over China’s unfair trading practices, military buildup, and abysmal human rights record. All of these pose a direct challenge to America’s core national interests. Meanwhile, although there is an emerging American—and increasingly international—consensus on the challenges posed by China, there is not yet an agreement on the nature of the challenges, nor the appropriate response.

On the economic front, intellectual property theft, forced technology transfers, and massive industrial subsidies, along with China’s bid to outpace U.S. efforts in artificial intelligence, quantum computing, and robotics, threaten to undercut not just the country’s technological edge, but its prosperity and security. The aggressive use of the Chinese military and Chinese non-state actors against America and American allies threaten Washington’s traditional security partners. On human rights, the Chinese Communist Party’s oppression at home—seen most clearly in the forced detention, torture, and re-education of as many as 1-2 million Muslim Uighurs in internment camps in western China—and the export of its surveillance systems abroad are not only an affront to American sensibilities, but to human dignity. This is in addition to Beijing’s attempts to interfere, shape, and silence public debate in the United States and among its allies, which strike at the heart of the principles of democratic society.

4. What Should Your Company Do?

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.

What are you seeing out there?