“The past year has been one of victories, pitfalls, and surprises in US-China relations"

“The past year has been one of victories, pitfalls, and surprises in US-China relations"

Trade tensions and tariffs are among the top concerns facing US companies operating in China this year, with the Covid-19 pandemic unsurprisingly also making a prominent appearance, all breeding uncertainty into the business environment.

The top challenge cited by respondents to the third US-China Business Council's (USCBC) most recent annual survey of its members, was trade tensions between the US and China. Just under half said they had lost sales due to customer uncertainty about continued supply from the US.

The survey, which draws from a pool of more than 100 member companies, took responses in late May and June 2020 across manufacturing, services, agriculture, and energy sectors. Slightly more than two-thirds of executives were based in China, with a third located in the US.

Despite the uncertainty around tariffs, around 83% of respondents counted China among their top five priorities for their global strategies, with optimism around the country's five-year outlook.

"The past year has been one of victories, pitfalls, and surprises in US-China relations," says the Council in its report. "Several of the most defining moments took place in the trade sphere, having a profound impact on US companies that do business in China.

"These tumultuous circumstances, and particularly the Covid-19 pandemic, have bred uncertainty into the business environment, clouding companies' perspectives on the short-term business outlook for China. Companies also remain concerned about long-held operational issues like fair competition, data and cybersecurity policy, and intellectual property protection. Despite high tensions, all indicators suggest that companies remain largely committed to the China market over the long term."

#1: US-China relations

86% of USCBC members report that bilateral trade tensions have impacted their business with China. In 2019, the most significant result of those tensions was lost sales due to retaliatory tariffs enacted by China. While Chinese tariffs continued to impact US company sales to China in 2020, 10% fewer companies cited this as a top concern this year compared to last.

In 2020, the most perverse impact of bilateral trade tensions— reported by half of respondents—was lost sales due to customer uncertainty about continued supply. Members were similarly concerned about sourcing products as a result of tariffs.

#2: Covid-19 impacts

Bilateral trade friction and especially the outbreak of Covid-19 are weighing on the investment decisions and near-term economic prospects of American companies in China.

A quarter of member companies have reduced or stopped planned investment in China in the last year – a historic high for the survey. The top reasons are increased costs or uncertainties from US-China tensions and uncertainty stemming from Covid-19.

The political uncertainty and lingering pandemic are also impacting revenue and wage projections. Only 30% of companies expect their revenue to increase this year – a historic low for the survey.

#3: Competition with Chinese companies

One-third of respondents observed accelerated preferential policy support for Chinese companies directly as a result of US-China trade frictions. Protectionism, particularly China's industrial policies such as Made in China 2025 and a push toward domestic procurement, has created a more difficult competitive environment for some US companies.

25% of respondents said increased competition with Chinese companies had hurt their profit margins last year.

While 77% either have concrete knowledge of, or suspect, state-owned competitors are receiving subsidies or benefits from the Chinese government, 23% report they do not believe SOE competitors are receiving tangible benefits.

#4: Tariffs

US companies remain overwhelmingly supportive of the Phase One deal, with 88% of respondents reporting a positive or somewhat positive view of the agreement.

Yet while roughly half recognise the progress China has made and report a positive or somewhat positive view of Phase One implementation, a significant portion—35%—take a neutral view.

And only 7% of respondents feel the benefits of the agreement outweigh the costs of tariffs incurred along the way, while 36% say that costs outweigh the benefits of the agreement. Importantly, a 56% majority believe it is too soon to say, suggesting that for most, the jury is still out on the Trump administration's policy approach to China.

#5: Cost increases

The top reasons for reducing or stopping investment in China are increased costs or uncertainties from US-China tensions and uncertainty stemming from Covid-19.

Indeed, 22% of respondents cited rising costs in China, while 52% cited the latter.

#6: Licenses and approvals

Market access restrictions, joint venture requirements, or administrative licensing requirements, such as those embedded in standardisation and industrial policies, often preclude a company's ability to enter the China market.

China has taken some steps to address the concerns over technology transfer, such as committing not to require or pressure foreign companies to transfer technology in the Phase One agreement and through language in its Foreign Investment Law that went into effect this year. However, without specifics, it is unclear how this will reasonably be enforced. Additional reforms to joint venture requirements and administrative licensing requirements would be beneficial in protecting companies' trade secrets.

#7: IPR enforcement

The lingering challenges of protecting intellectual property (IP) rights in China remain at the centre of the bilateral friction between the US and China. As in years past, respondents indicate incremental improvements in both the protection and enforcement of IP rights.

But despite improvements, the percentage of companies that curtail or choose not to embark on investments in China is not insignificant. Responses from several companies indicate that the impact of IP rights enforcement limits their products manufactured, licensed, and sold in China, in addition to their research and development (R&D) activities.

#8: Data flows

Over the past few years, China has expanded its cyber and data security regime for companies doing business in China. While the country's Cybersecurity Law went into effect in June 2017, the remainder of its implementing regulations are yet to be finalised. The percentage of companies that are somewhat, or very concerned, about China's information flow and technology security policies increased this year to 84% from 76% in 2019. These concerns are driven by the negative trajectory of the US-China relationship.

Top cyber-related concerns cited by companies this year are relatively unchanged from last year. 71% are concerned about US-China political tensions in relation to China's policies in this arena. Other concerns were data localisation requirements and restrictions on cross-border data flows, both of which have seen policy developments in the last year.

#9: Innovation policies

The intellectual property (IP) rights challenges in China that are at the centre of trade frictions with the US are also impacting innovation for many companies.

According to the report, when US companies are limiting their operations in China because of the lack of full protection for IP rights, opportunities for job creation and innovation are lost.

#10: Investment restrictions on foreign companies

Despite years of trade friction and swelling calls for economic disengagement by hawks in the US and China, USBC says both data and conversations with member companies indicate US companies remain committed to the China market over the long term. 83% counted China as either the top or among the top five priorities for their company's global strategy.

Consequently, 87% of companies reported no plans to shift production out of China. Only 4% have shifted or plan to shift operations to the US, and this is largely due to lagging consumer demand in China. The other 11% reported recent or planned production shifts to other parts of the world, with Thailand and Mexico as the leading alternative destinations.

But despite long-term optimism, bilateral trade friction and especially the outbreak of Covid-19 are weighing on the investment decisions and near-term economic prospects of American companies in China.

A quarter have reduced or stopped planned investment in China in the last year, and this is particularly apparent in R&D. This might partly be a result of increasingly onerous data flow restrictions, the development of Chinese export control policies, and changes in US tax policy incentivising investment in the R&D area.