The ongoing commercial disruption between the PRC and the US is having a global effect
Asia-Pacific Economic Cooperation (Apec) leaders failed to agree on a final joint communiqué at the summit meeting held in Papua New Guinea in November. The deep division between the US and China on international trade appears to be the sticking point that made it difficult to reach a consensus. The escalating trade tension between the two countries is casting a long shadow on global trade and the world economy.
According to the US Census Bureau, in 2017, the US imported $505.47 billion worth of goods from China and exported $129.89 billion, a deficit of $375.58 billion. In the first three quarters of 2018, the US imported $394.73 billion worth of goods from China and exported $93.36 billion, a shortfall of $301.37 billion. The US has maintained a surplus in services trade with China, amounting to $40.2 billion in 2017.
Starting July 2018, the US imposed sweeping tariffs on $250 billion worth of goods imported from China. China, responding in kind, levied tariffs on $110 billion worth of goods from the US. So far, the on-again, off-again trade talks between the two countries have failed significant visible de-escalation of the trade tensions though recent discussions at the G20 meeting could have paved the way for progress. The US has threatened tariffs on an additional $267 billion worth of Chinese products. China, although fast running out of US products to set tariffs on, is apparently not ready to back down and has threatened to fight back with qualitative and quantitative measures.
The trading volumes between the US and China don't seem to be hugely affected for now, but in time, these trade tariffs are expected to reduce global trade activities and impact economic growth. According to an analysis by the IMF, the ongoing trade war between the US and China, taking into consideration knock-on effects on investor confidence and financial markets, could reduce China's economic growth by as much as 1.6 percentage points over the first two years. The IMF also revised down projections on global growth from 3.9% to 3.7% for 2018 and 2019, citing further disruptions in international trade policies. Uncertainty concerning the North American Free Trade Agreement (Nafta), Brexit and the Sino-US trade war are major contributing disruptive factors.
The US initiated the trade war from a position of relative strength. Although the damage of the US-led trade war is yet to register on macroeconomic data, financial markets and investors appear to believe that China will have more to lose. The US and Chinese economies are in different cycles. The US economy has seen healthy expansion, tax cuts, moderate inflation and robust employment figures, and its stock market has been going from strength to strength. The Dow Jones Industrial Average closed at 24,719.22 on the last trading day of 2017 and is sitting at 25,413.22 as of November 16 2018, a 2.81% growth. On the other hand, China's economy, although still expected to grow more than six percent in 2018, has entered a cycle of moderate growth, and is in need of reform and more sustainable high-value growth. The China Shanghai Composite Stock Market Index closed at 2,703.51 on November 19, a decline of 10.09% from the end of 2017. The Shenzhen Stock Exchange Composite Index closed at 1,417.43, a fall of 25.37% for the same period. The value of currencies also demonstrates market sentiment towards the two economies: the US dollar has so far appreciated 6.72% against the renminbi in 2018.
A wider impact
The term trade war is quite a misnomer, and falls short of describing the depth and scale of the conflict at hand. Although trade deficits and trade tariffs have been making headlines for months, the ultimate goal of the trade tactics is not reforming or rebalancing global trade, and the package of restrictive measures implemented by the US and partially matched by China target more than import and export activities. To preserve US dominance in the global economy and protect its technological supremacy, policy makers have elected to take comprehensive actions encompassing the intertwined correlation of international trade, investment and competition. The Chinese economy, however, relies more heavily on international trade and foreign investment to generate income and growth. Despite threats of qualitative measures against US interests in the tit-for-tat exchange of the trade war, China is unlikely to further restrict foreign capital access or mistreat foreign-invested enterprises in China.
As the trade tension between the US and China escalates, US regulators tightened scrutiny over Chinese investment, blocking several high-profile acquisitions and forcing Chinese investors to abandon other transactions. Although complete data is not available, publicly reported cases seem to show that all transactions blocked by the Committee on Foreign Investment in the United States (Cfius) so far involve Chinese buyers. The focused inhospitality, whether actual or perceived, towards Chinese investment has significantly dampened investor enthusiasm. According to reports published by the Rhodium Group, Chinese direct investment in the US dropped by more than a third (35%) in 2017 to $29.4 billion over 140 consummated transactions. An even sharper decline was recorded in the first half of 2018, when Chinese investors completed 36 deals with an aggregate value of $2 billion, a more than 90% drop over the same period in 2017.
Stepping up efforts
Despite the already shrinking direct investment by Chinese investors, the US has recently stepped up interventionist policies to restrict access to designated sensitive industries and technologies. On August 13 2018, the Foreign Investment Risk Review Modernization Act of 2018 (Firrma) was signed into law. Among other things, it significantly expands the mandate for Cfius to review M&A by or with foreign persons to determine the effects of such transactions on US national security. The enactment of Firrma responds to growing protectionist sentiment towards US technology supremacy, including technologies that fall outside the scope of traditional defense and national security concerns. Effective November 10 2018, Cfius has implemented a pilot programme that expands the scope of transactions subject to review by the Committee to include certain non-controlling investments involving foreign persons and critical technologies. In addition, declarations of certain transactions were made mandatory for the first time under the pilot programme.
The pilot programme applies to all countries, but is interpreted to aim principally at China, which US officials have repeatedly accused of trying to access valuable American technology through investments. From China's perspective, its manufacturing prowess has reached a bottleneck. The traditional operation of cheap labour-intensive product lines face challenges from increased living cost, shrinking working age population, depletion of resources and heavy pollution. In 2015, the Chinese government announced the Made in China 2025 strategic plan. Seeking to update and grow China's manufacturing capacity, the plan identifies 10 key areas of development that include information technology, advanced robotics, artificial intelligence and agricultural technology. Acquiring advanced technology through market transactions has so far seemed a logical option. However, as the trade war heats up, the plan itself had become a focus of discontent. Under the Cfius pilot programme regulations, the US Treasury Department has identified 27 industries, many of which overlap with the 10 key areas of development identified in the Made in China 2025 plan. Some of the overlapping areas and industries include information technology, new materials, and aerospace and nautical equipment. It is also observed that technologies related to the Made in China 2025 plan would be subject to heightened scrutiny by Cfius even if they do not strictly fall within the pilot programme industries.
China's position on the role of foreign investment in the trade war is very different. It made case-by-case concessions on existing foreign investment constraints and revamped foreign investment regulations to more broadly scale back such restrictions. Regulatory actions taken by China indicate that the country intends to further open up to foreign capital.
In July, China permitted BMW to raise its stake in its onshore joint venture to 75%: the German company became the first foreign carmaker to gain super majority control over its onshore operation. Tesla was also given the green light to establish a wholly foreign-owned enterprise in Shanghai and will have 100% control over its future Shanghai plant.
The pilot programme is interpreted as aiming principally at China, which US officials have repeatedly accused of trying to access valuable American technology through investments
On July 28 2018, the Special Administrative Measures on Foreign Investment Access (Negative List), jointly promulgated by the National Development and Reform Commission of China and the Ministry of Commerce (Mofcom), became effective. The Negative List partly replaces the Catalogue for the Guidance of Foreign Investment Industries which had been in place since 1995. The Negative List is a list of industries in which foreign investment is either prohibited or restricted. Unlike the Negative List, the Catalogue also contains a list of encouraged industries for foreign investment, which benefit from special incentives. The list of encouraged industries remains effective and is now separate from the Negative list. Industries not included in the Negative List are open to foreign investment, in which foreign-invested enterprises are treated equally or more favourably then domestic enterprises. The 2018 Negative List contains 48 restrictive measures on foreign investment in 34 industries, comparing to 63 prohibitions and restrictions in the 2017 Catalogue.
On July 30, the Special Administrative Measures on Foreign Investment Access to Pilot Free Trade Zones (FTZ Negative List) took effect. It is similar to the national Negative List but only applies to the 11 FTZs. The number of special administrative measures on the FTZ Negative List has decreased from 95 to 45 from its 2017 version. Generally speaking, FTZs enjoy less restrictive foreign investment access regulations than the rest of mainland China.
Among the alleviation of restrictions, the financial sector has seen significant opening-up measures, which are set forth below in more details:
- Commercial banks – removal of restrictions on foreign ownership percentage and certain investor qualification requirements. The banking industry is omitted from the Negative List and has effectively become a permitted sector for foreign investment.
- Securities companies – foreign ownership cap of 51% replaces domestic control requirement, cap to be removed in 2021.
- Securities investment fund management companies – foreign ownership cap of 51% replaces domestic control requirement, cap to be removed in 2021.
- Futures companies – foreign ownership cap of 51% replaces domestic control requirement, cap to be removed in 2021.
- Life insurance companies – foreign ownership cap raised from 50% to 51%. The cap is set to be removed in 2021.
The overall objective, as stated by the China Banking and Insurance Regulatory Commission (CBIRC) will apply the same market entry and administrative approval policies for both Chinese and foreign investment in the sector. In furtherance of the change under the Negative List, the CBIRC published its decisions to abolish existing administrative measures that implemented the now removed ownership percentage restrictions. The China Securities Regulatory Commission has taken comparable actions to implement the policy changes.
Steps were also taken to simplify administrative procedures for foreign investment. Under the Mofcom decision to amend the Interim Measures for the Administration of the Formation and Modification of Foreign-Funded Enterprises, notice filing for foreign investment in encouraged and permitted categories with the Mofcom and registration with the State Administration of Market Regulation (SAMR) agencies can be conducted at the same time and on a single form, instead of having to deal with multiple agencies and offices. Further, an online platform for business registration will be set up through which foreign investors will be able to complete much of the registration process online and free of charge.
The efforts appear to be paying off as foreign direct investments in China has so far remained stable this year. From January to August 2018, newly approved foreign-invested enterprises amounted to 41,331, up by 102.7% year-on-year. The actual use of foreign investment reached $86.5 billion, up 6.1% year-on-year.
The trade war between the US and China is unlikely to relent in the immediate future. The global economy and business of all kinds and all origins will need to adapt to the reality and uncertainty associated with the changing political wills of the largest economies of this world.