Doing Business In China: Post Coronavirus

Following China’s accession to the World Trade Organization (“WTO”) as a “developing country” in 2001, the United States and the rest of the world looked the other way as China’s economy grew from $1.3 trillion to $14.3 trillion, with the country running roughshod over one international trade convention after another in the process. The United States first called out China on March 22, 2018 when President Trump announced that his administration was investigating the idea of imposing tariffs on $50 to $60 billion worth of Chinese goods in response to China’s unfair trade practices in violation of Section 301 of the Trade Act of 1974, most notably, theft of U.S. intellectual property. Trump’s announcement touched off a dozen rounds of negotiations between the two countries, culminating in the signing of the Phase One trade deal on January 15th of this year.

While the Phase One agreement promised to lower the temperature of the heated rhetoric of 2018 and 2019, the prospects for a calmer Sino-American relationship were short lived. On January 20, just five days later, the first confirmed case of COVID-19, a novel coronavirus that began in the city of Wuhan in China’s Hubei Province late last year, was reported in the United States.

The arrival of COVID-19 soon led to travel bans between the two countries and a shutdown of the U.S. economy, the impact of which will be felt for many years to come. With such disastrous consequences, everyone is prepared to believe the worst about China’s role in the origins of the pandemic. One theory that has gained circulation is that COVID-19 may not have originated in one of Wuhan’s wet markets where live animals are sold, as originally reported by the Chinese government, but may have instead escaped from a nearby laboratory where researchers were conducting risky viral disease experiments, including coronavirus in bats. According to this theory, lax safety protocols at the lab were reportedly responsible for the virus “escaping” from the lab. Meanwhile, various Chinese government officials have alleged that the virus may actually have originated with American servicemen who attended a conference in Wuhan in October.

Needless to say, conspiracy theories on both sides have raised the rhetoric to levels not seen during the height of the Trade War. Given the cumulative impact of intellectual property infringements by China over the years; concerns about the use of Huawei products in the United States; demonstrations in Hong Kong and now COVID-19, one U.S. lawmaker after another is calling for the United States to completely disengage from China.

While many observers around the world considered the Trade War to be “Trump’s War,” or at the very least, a trade dispute between the United States and China, the COVID-19 pandemic is a world problem. As of May 17, there have been over 4.6 million reported cases of coronavirus and 316 thousand deaths in over 200 countries and territories. Virtually the entire global economy has been shut down due to the virus, at a cost of trillions of dollars. In its April World Economic Outlook, the International Monetary Fund (“IMF”) projected global growth to fall to minus 3 percent, a downgrade of 6.3 percentage points from its projection in January. According to the IMF, the “Great Lockdown” will cause a recession that is the worst since the Great Depression, and far worse than the recession following the Global Financial Crisis.

As a preview of how China’s relationships with other countries are likely to change in the years ahead, Australia called in April for an independent investigation into the role that China played in the outbreak of COVID-19.  Foreign Minister Marise Payne said that Australia would "insist" on a review that would probe China's early response to the outbreak, and that the relationship between China and Australia was likely to change as a result of the pandemic. In advance of the World Health Assembly that convened on May 18th in Geneva, Russia joined over 100 other countries in backing a resolution calling for an independent inquiry into the coronavirus pandemic. The impact of COVID-19 on the global economy is clearly changing Beijing’s relationships with the rest of the world, even with countries considered to be among its staunchest allies.

While many countries may still be unwilling to confront China as aggressively as the United States, they will at least be more sympathetic to future American efforts to push China to conform to international standards of behavior. Meanwhile, China will be more defensive in future dealings with the United States and other leading countries as it struggles to revive its own economy. For the first quarter, China reported its worst economic data in a hundred years, and the IMF is projecting the growth of China’s economy to fall to 1.2 percent in 2020 from 6.1 percent last year. As for its attempts to shift the blame for the outbreak of the virus, very few of its own citizens, let alone members of the global community, believe the theory that U.S. servicemen actually caused the outbreak.

Going forward, every government leader will need to figure out how to deal with China in a post coronavirus world. It is impossible at this time to predict exactly how this will play out, but it is safe to say that the leading industrial countries in the world, starting with the United States, will be less forgiving of China and more willing to confront the country over international trade matters.

Given that the relationship between China and the United States promises to be more confrontational than in the past twenty years, what should American companies do? Should they try to continue to try and do business in China as they have in the past? Or, should they completely disengage from the country and focus on other markets. Unlike politicians, businessmen do not have the luxury of opting out of the world’s second largest economy. Despite the geopolitical issues that have arisen as a result of the virus, China remains the second largest economy in the world and the world’s single biggest consumption story. Companies that do not engage with China run the risk of being marginalized in the future.

Taken together, the U.S. economy at $21.4 trillion, and China’s at $14.1 trillion, accounted for almost 41 percent of global Gross Domestic Product (“GDP”) in 2019. A distant third was Japan at $5.2 trillion. If a company wants to grow in a post coronavirus world, there is simply no other big market in which to find growth. If a company wants to remain a global leader, it has no choice but to actively engage with the China market. Otherwise, it risks losing its scale advantages as successful Chinese companies grow increasingly larger. In Fortune Magazine’s tabulation of the 500 largest companies by revenue in 2019, American companies accounted for 121, while China accounted for 129, including 10 Taiwanese companies.

Historically, the two major reasons for companies to engage with China have been to take advantage of the country’s low cost of labor and to participate in the growth of the China market. When China’s economy was much smaller, and the per capita income of its population was much lower, the cost advantages of “Made In China” were more compelling than they are today. Meanwhile, other factors such as quality, the proximity and reliability of suppliers, the cost of shipping and the need to carry extra inventories to protect against supply disruptions can easily offset any cost benefits that may be realized. That is why some companies, like Toyota, never embraced sourcing strategies based on cost considerations alone, preferring instead to source from suppliers located at or near where the products are being used.

Because it is nearly impossible to penetrate the China market through exports, participating in the China market has meant committing to a physical presence in the country. Concerns about the difficulties of doing business in the country and the potential loss of intellectual property have been the two principal reasons for companies to forego the China opportunity. While China remains a difficult country in which to operate, the rise in per capita income to over $10,000 means that more consumers in China are able to afford Western products. Meanwhile, there are no longer foreign ownership restrictions in most industries. With 100 percent ownership of its operations in China now possible, and the ability to fully control its operations in the country, intellectual property concerns are now much less.

In a post coronavirus world, the global supply chains for most key products will be re-thought, and there will be more emphasis by global companies to buy locally. Therefore, sourcing from China will be less attractive. The good news is that policymakers in the United States and elsewhere are likely to develop tax and other incentives for companies to locate the supply of critical items in the home market.   

Meanwhile, the China market still has a large opportunity to grow. The first quarter in China was terrible, but the country has been back to work for most of the second quarter, and the government will be putting in place stimulus, particularly for important technologies in key industries. As a result, economists predict a strong second half of the year, and a strong rebound in 2021. The IMF, for example, is predicting 9.2 percent GDP growth for China in 2021.

Despite the fact that government to government relations with China will be frosty in the months and years ahead, potential partners, customers and consumers in China will welcome American products, services and technology. While supply chains will certainly shift, there is no better time than now to embrace the China market.