Adapting to Asia’s Shifting Regional Dynamics

By Eddy Mak, Director, Global Trade Consulting

From the vantage point of Asia, a new U.S. government was supposed to represent a sea change in America’s relationship with the Far East. For three years, Washington and Beijing have been locked in a battle of wills around trade policy, which continues to linger and drive up the cost of trade on both sides of the Pacific. It seems, however, the light at the end of the tunnel may still be a considerable distance away.

In early December, president-elect Joe Biden told the New York Times that he would likely leave existing tariffs on China-origin goods in place, preferring to take the time evaluate the proper strategy toward China in alliance with Europe and U.S. partners in Asia. The announcement wasn’t a complete surprise given Biden’s tough-on-China positioning in the election campaign. But politics aside, there is good reason to move fast on diffusing the ongoing animosity between Washington and Beijing.

Major Impact

The impact of the trade war has been deep. Moodys Analytics estimates the trade war shaved 0.3% off U.S. GDP in the first year alone, as well as 300,000 jobs. In mid-2020, a research report from the Federal Reserve Bank of New York and Columbia University confirmed that U.S. companies lost at minimum of $1.7 trillion in stock prices due to the ongoing row between Washington and Beijing. In China, the impact has been less severe, but still noteworthy. At the end of the trade war’s first year, China’s industrial output fell to its lowest level in 17 and economic growth saw its greatest contraction in 27 years.

This has resulted in declining investment on the ground in the U.S. and China. While many firms had been taking a wait-and-see approach, believing some meaningful form of détente would eventually come about, the lingering effect on landed costs coupled with the vulnerability of global value chains exposed by the COVID-19 pandemic, are now forcing firms to rethink their China strategies.

A long game

To be sure, China continues to be a critical market for U.S. firms. It’s important to remember that while China is often cited as an offshoring destination for U.S. producers, much of the production being carried out today on behalf of U.S. firms in China is destined to stay within China. The rise of China’s middle-class, now estimated at 400 million (larger than the entire U.S. population), means maintaining production in China will continue to make sense for the foreseeable future.

A recent survey by the U.S.-China Business Council (UCBC) shows only 15% of U.S. firms in China have definitive plans to leave, a negligible increase from the previous year, but admittedly almost double the volume of the pre-trade war period. The lack of urgency around the predicted exodus is interesting given that the same study revealed the trade war and the production disruption from the outbreak of COVID-19 are having an adverse effect. Almost half of U.S. firms (48%) reported losing sales due to customer uncertainty of continued supply. A comparable number have shifted suppliers or sourcing for the same reason. And 39% have lost sales due to tariffs implemented by either China or the U.S. Nevertheless, 16% say China remains a top priority in their overall business strategy and 67% say it’s among the top five priorities.

2021 China Policy

The reaffirmation of China as a part of U.S. firms’ overall business strategy means U.S. industry will remain inextricably tied to China’s market in the short to medium term. And while 24% of firms are reporting a stoppage in their investments in China for the coming year (a 300% increase from 2018), only one in five intend to shift investments to the U.S. (most will go to other countries in Southeast Asia or Mexico).

In short, the trade war is neither generating its intended manufacturing renaissance, nor is it reducing China’s influence in global trade. While there is good reason for the incoming U.S. administration to exert pressure on China for a range of transgressions – both political and economic – the trade war is doing more to hinder, rather than help, U.S. firms. That’s why the head of the Business Roundtable, a U.S. trade group of the country’s largest companies, publicly called for the incoming Biden administration to begin scaling down the ongoing trade war by discontinuing tariffs on China-origin goods. The goal is to re-engage Beijing in dialogue and potentially diffuse the tension that is injecting risk into the investment environment. The speed at which that re-engagement occurs is likely to depend on the extent to which Beijing is able to live up to its commitments in the Phase 1 agreement signed with Washington in December 2019. That agreement should see China purchase $200 billion in U.S. goods by the end of 2021, but at the close of the first year, the pace of purchases is well behind schedule.

Tariff Relief

Firms that continued to rely on production in China throughout the trade war were able to find relief for a period through the four tranches of tariff exclusions put out by the Office of the United States Trade Representative. The exclusions yielded some benefit, particularly for products in Tranches 1 and 2 where 34% and 37% of exclusion requests were granted. The rate of approval varied by product type. For example, 51% of requests associated with consumption products in Tranche 1 were approved but only 28% of intermediate goods. Conversely, for Tranche 2, intermediate goods saw an approval rating of 48% and consumption goods of 28%. Exclusion approvals for Tranches 3 and 4 were far more limited overall at 5% and 1.9% respectively.

Some firms have been looking to offset the cost burden of the tariffs by altering the composition of products. For example, a firm importing an intermediate good produced in China might take the product further along the production process so that it falls under a different product classification that isn’t impacted by the Section 301 tariffs. However, with so many products now covered under Washington’s tariff lists, the opportunity to achieve an unaffected product classification is far more limited today than it was in the early stages of the trade war. Others have attempted to circumvent the tariffs by using other countries, such as Vietnam or Mexico, for transshipment of goods into the U.S.

Normalizing Relations

The closing months of 2020 saw two critical developments impacting the U.S.-trade relationship. The first was the election of a president who has distanced himself from populism, but who has embraced protectionist sentiment in the past. The second is the signing of the Regional Comprehensive Economic Partnership (RCEP), a trade agreement involving 15 Asia-Pacific countries that make up one-third of global GDP. RCEP has the potential to cement China’s economic hegemony in Asia and is likely to serve as an incentive for Washington to re-engage with Beijing or otherwise experience waning influence in the region. At the same time, president-elect Biden’s stated intention of taking China to task on its transgressions via a multilateral coalition is likely to be ill-received in Beijing. Only time will tell which event will have more influence on future relations. In the interim, U.S. industry will be eagerly awaiting a resolution, preferably sooner rather than later.

Eddy Mak has extensive knowledge of logistics and operations, acquired after more than 20 years working in different industries. He specializes in global logistics strategy, inventory management, trade compliance, container terminal operations, warehousing shipping and customer services.