U.S.-China Business Relations: Rough Waters Ahead?

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As U.S. President Barack Obama was conferring with Chinese leader Xi Jinping at the Asia-Pacific Economic Cooperation Ministerial Meeting in Beijing this fall, major U.S.-based firms could take comfort from the fact that they were selling more of their goods than ever in China. 

Indeed, American firms exported $9.32 billion worth of goods to China this past September, more than three times the $2.82 billion in U.S. exports to China they recorded in September 2004. In 2014, 83% of U.S. companies surveyed by the U.S.-China Business Council (USCBC) reported beingprofitable in China, and almost three-quarters of those U.S. companiessawan increase intheir revenues in China. Only 15% reported a decrease in their revenues.

And yet U.S. firms seem to be less enthusiastic about their prospects for success in the world’s most populous nation. According to a recent poll by the USCBC, while most U.S. firms still consider China to be one of their top-five markets globally, there has been a steady 30 percentage point decline over the past four years regarding how U.S. firms view their prospects there, in the direction from “optimistic” toward “somewhat optimistic.” Despite China’s vast potential for future economic growth, only about half of the companies surveyed by the influential USCBC now plan to increase resources in China during the next 12 months, down from almost 75% of all firms just three years ago. 

Why have feelings cooled? Beyond such factors as rising costs and foreign competition — from fast-growing operations in Southeast Asia and elsewhere — U.S. firms said there is widespread insecurity about the policy directions the new Chinese government is enacting in its current cycle of reforms. U.S. firms “are particularly concerned with a lot of uncertainties in China,” says Erin Ennis, vice president of the USCBC. These concerns include:

U.S. firms “are particularly concerned with a lot of uncertainties in China.”–Erin Ennis

— growing competition with emerging and increasingly productive Chinese companies within China;

— China’s spotty enforcement of intellectual property rights (IPR); 

— local restrictions on foreign investment; 

— over-capacity in China’s industrial sectors; and 

— uneven enforcement and implementation of Chinese laws. 

Susan Kohn Ross, an international trade attorney with Mitchell Silberberg & Knupp in Los Angeles, notes that among her clients who trade with China, the main areas of concern include the Chinese government’s preferences for its domestic industry, bureaucratic corruption and intellectual property protection. 

Z. John Zhang, professor of marketing at Wharton, says the USCBC’s survey reflects uneasiness among U.S. and other foreign firms about uncertainties during the current Chinese political cycle. The political pendulum, he notes, has “swung to the other side” from earlier periods when the Chinese government went out of its way to be especially welcoming to foreign firms. “[U.S. and other foreign] firms are very profitable [now], but they don’t feel as welcome. This does not necessarily mean they are targeted by the Chinese government,” Zhang adds. “They just aren’t feeling the warmth they felt” in earlier years, when the Chinese government was especially eager to attract foreign investors. 

However, Zhang notes that when U.S. firms do business in China, they already accept some degree of uncertainty. “If you accepted the boom,” with all of the uncertainties that it entailed, he says, “you can accept the bust. We are in a period when the pendulum has swung to the other side.”

Stifling Foreign Competition

For many U.S. firms, an especially troubling source of uncertainty is China’s enforcement of its 2008 Anti-Monopoly Law (AML). Is China using this legislation, which is nominally aimed at fostering competition, to pursue goals that are essentially protectionist and anti-competitive? 

According to a recent report by the U.S. Chamber of Commerce, China’s growing enforcement of its AML may violate the rules of the World Trade Organization (WTO). Although China’s AML was expressly intended to encourage competition, in compliance with China’s WTO commitments, the U.S. Chamber of Commerce report warns that “if China applies the AML in a manner inconsistent with its WTO obligations, this would arguably constitute a violation of WTO law, despite being imposed under the guise of competition law.” 

In a letter, Jeremie Waterman, the Chamber’s executive director for China, and Sean Heather, vice president of the Chamber’s Center for Global Regulatory Cooperation, noted: “Implementation of the AML provides an enormous opportunity for China to accelerate its economic transition by boosting competition and reducing the prominence of monopolies and oligopolies in its economy; increasing consumer welfare, choice and consumption, and stimulating market-driven innovation. In short, the AML has the potential to stimulate a new round of dynamic growth and efficiencies across all aspects of the Chinese economy — an outcome that would also contribute positively to U.S.-China relations.”

U.S. and other foreign firms “just aren’t feeling the warmth they felt” in earlier years. –Z. John Zhang 

However, note Waterman and Heather, China’s enforcement of the AML is not yet living up to this ideal. As a further report, “Competing Interests in China’s Competition Law Enforcement,” by the Chamber argued, “AML remedies often appear designed to advance [China’s] industrial policy and boost national champions.” China’s AML enforcement authorities — which include the National Development and Reform Commission (NDRC), the Ministry of Commerce (MOFCOM), and the State Administration for Industry and Commerce (SAIC) — rely insufficiently on sound analysis. That report argues that MOFCOM has established AML remedies that create greater market concentration both within China and abroad, as well as “negotiate down prices on goods and IP [intellectual property] for domestic consumers/licenses,” in some cases to protect famous domestic Chinese brands.

For his part, John Frisbie, president of the USCBC, questioned whether the Chinese government is using the AML to force U.S. firms to lower their prices rather than letting the market play the decisive role, a goal that is outlined in China’s new economic reform program. “The answers are not fully determined yet, but in at least some cases so far, USCBC sees reasons for concern,” Frisbie notes. 

A USCBC survey of companies this year found that 86% of respondents said they are at least somewhat concerned about the way the AML has been implemented. The perception that foreign companies are being disproportionately targeted is also fueled by China’s domestic media reporting, which has emphasized foreign-related investigations versus those aimed at Chinese companies. Widespread concerns among U.S. firms include not only unfair treatment and discrimination, but a lack of due process and regulatory transparency, lengthy time periods for merger reviews, and the process through which remedies and fines are determined. 

Some foreign firms accused of violating the AML have been pressured to admit their guilt, despite the fact that they were not allowed to view — or respond to — the body of evidence against them. U.S. corporate representatives were not even told why they were under investigation or on what grounds an investigation had been launched, but were informed that they would face a reduced penalty if they cooperated with Chinese authorities. Allegedly, enforcement officials, who conduct “dawn raids,” are sometimes unwilling to wait even a short amount of time to allow companies to arrange for their legal representation.  

Regarding the AML, Wharton’s Zhang says foreign firms would do well to remember that this “new tool the Chinese government is using is not really meant to target monopolies,” since a lot of Chinese state-owned firms are themselves monopolies, almost by definition. “If I were a government official, I would try it on foreign companies first.” A lot of reports suggest that imported automotive parts have, for example, been too expensive for many Chinese buyers. 

A Vague Boundary 

Wharton management professor Minyuan Zhao provides this perspective on the contentious issue of intellectual property protection: “A lot of people portray IPR enforcement as a legal issue. It’s not news that China is known for reverse engineering or the grass-roots movement to copy whatever the multinationals have to offer — known as Shanzhai in Chinese. But when China started to put ‘indigenous innovation’ into the five-year plan, the boundary between imitation and learning became very vague. Many multinational companies got very frustrated. But I also see companies learning to work with the Chinese, using their complementary resources to gain value in China. They know that chasing after the Chinese is not cost-effective.”

Zhao adds it’s futile for the U.S. government to chase after the Chinese government to improve IP protection. “The laws have been pretty good. The legal system has improved tremendously,” she says. “The court system has its problems, but compared with years ago, it is much better now. However, when it comes to the government mandate on indigenous innovation, the legal battles will not help the multinationals as long as they want to participate in the market’s growth.”

Despite concerns about intellectual property theft, in large-scale projects from large engines to commercial aircraft, numerous U.S. multinationals have established a presence — not handing over their technologies to the Chinese, but building value together with Chinese firms, Zhao explains. For example, IBM recently opened its Power Systems Linux Center in Beijing. The Chinese are very excited about participating in it, Zhao says, and there is tremendous learning opportunity for the locals. “But at the same time, IBM is cultivating this ecosystem for itself,” she notes, and the U.S.-based company will ultimately reap benefits from it, including use of the large talent pool in China to develop complementary applications for the IBM power system, and also access to China’s large customer base.

“For any economy with over-capacity, [an escalation of trade wars] is the last thing you want.”–Minyuan Zhao

Bilateral Investment Needed

Many U.S. firms are hopeful that the conclusion of a Bilateral Investment Treaty (BIT) between the two countries would help by establishing rules of the road for foreign investment in each other’s countries. The United States currently has BITs with 42 countries, but no such treaty with China. The USCBC’s Ennis notes that if China’s new leadership makes significant progress in implementing its market-based reforms and moves forward with a U.S.-China BIT that has a “strong outcome,” both countries will reap significant benefits from it.

In the absence of a BIT, American companies aren’t permitted to operate in many industries and sectors in China, and in some sectors, Chinese regulations require that U.S. companies partner with domestic firms to operate. According to Ennis, a successful BIT would level the playing field for American and Chinese companies by providing meaningful market access for American companies into China, removing many of the restrictions the Chinese government places on foreign companies and giving stronger protections for U.S. companies that invest in China. 

To a significant degree, the success of such a BIT would be judge on the number and range of sectors that China would be willing to open to foreign companies. In a key move, China agreed in 2013 to use a “negative list” approach in which the terms of the BIT will apply to all sectors except those that are expressly excluded from coverage in the text of the new treaty. That approach contrasts with China’s traditional investment approval framework, which restricts foreign companies from participating in over 100 industries and sectors throughout China, based on a “positive list.”

A Double-Edged Sword 

One of the concerns that U.S. companies have about doing business in China is the country’s industrial over-capacity. Zhao notes that there are historical reasons for this over-capacity. For example, she says, “every little town wants to develop its own biotech center. It’s ridiculous. For industries with economy of scale, such as steel and glass, you see all this regional competition. All the local governments are providing subsidies to nurture local production so they can lower their costs and take market [share]. The result is increasingly large bad debt accumulated by the state banks that were forced to lend to those enterprises, and plummeting prices in markets from steel to glass, solar panels to wind-power equipment. A lot of people consider this a potential risk for a hard landing of the Chinese economy.” 

Zhao notes, however, that not every foreign company is negatively affected by this problem. In fact, some companies benefit from it. “If you’re an auto company, the fact that the market is flooded with steel is great. But the steel industry [in the U.S.] is persuading the U.S. government to come up with tariffs and other trade barriers because they are so frustrated by the cheap Chinese imports. The over-capacity issue is hurting the Chinese economy more than the multinationals.”

Zhao’s concern is that when American companies persuade the U.S. government to push for trade barriers, “then you see the backlash from the Chinese, and there’s escalation of trade wars. For any economy with over-capacity, that is the last thing you want to have…. In the steel industry, the U.S. is accusing China of dumping, and China is accusing the U.S. of subsidizing steel. It is messy.” 

Betting on China’s Future

Despite all of the concerns expressed by U.S. companies about the uncertainties of the Chinese market, no major multinational can afford not to have a presence in the country, economists and trade groups agree. “The China market is very big,” notes Zhang, “and it is growing at a fast rate,” despite any recent slowdown, when compared with other major markets such as Europe or Latin America. Rather than focus on the challenges involved in adjusting to China’s current political cycle, companies should remain focused on the long-term potential, he argues. 

Most U.S. firms will likely follow that advice, he says, noting that it is very hard to imagine non-Chinese companies avoiding a look beyond the current political uncertainties. In coming years, it is clear that China will continue to grow and that there will be many Chinese companies that want to buy goods provided by U.S. firms, Zhang concludes.

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