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China Trade – How Companies Circumvent Trade Barriers

China Handel: Unternehmen suchen sich Umwege

The designer Yang Liu lived in both China and Germany in her youth. In her experience, Western and Eastern cultures take very different approaches to problem-solving: westerners face the problem head-on and look to solve it, while in the Far East, there is a general tendency to circumvent even the most minor issues.

Of course, Europeans are not entirely unfamiliar with circumvention, for example when it comes to tax avoidance, or systems like Toyota’s Poka Yoke production system where it is an important element in the prevention of sources of error. As such, Chinese companies’ attempts to overcome trade hurdles in the current environment present an interesting case study.

Trade war – a big word

The term ‘trade war’ originally referred to the disruption of enemy trade by military means, such as the continental blockade during the Napoleonic wars or the shooting down of oil tankers in the Persian Gulf during the first Gulf War, between Iran and Iraq. But nowadays, the phrase is also used liberally for trade conflicts such as the current one between the U.S. and China. This type of conflict is typically enacted through bureaucratic means: customs duties, assessment bases, safety regulations and unfilled positions at the World Trade Organization. A timeline of this conflict can be found at Bloomberg.

The U.S. imposes additional duties on its annual Chinese import volume of EUR 212 billion, corresponding to nearly half of the import volume of 2017. Similarly, China is imposing an additional EUR 50 billion of duties on its roughly EUR 100 billion of imports from the U.S. The next phase of escalation will take place at the turn of the year, with the U.S. threatening to raise the tariff rate from 10% to 25%. U.S. tariffs are primarily focused on the Chinese metal industry, while Chinese measures are generally concerned with U.S. agriculture. As such, Chinese companies may face additional U.S. duties on either the sales side or the purchasing side, or worst case scenario: both.

China Trade: Metal industry as target of US measures

The globalized Hồ-Chí-Minh Trail

One relatively simple circumvention option is the diversion of trade flow. Business between American soybean farmers and Chinese pig farms has been disrupted by customs duties. The Chinese are now buying their soy in Brazil, making Brazilian soy scarcer and more expensive for European buyers. Coincidentally, U.S. farmers have been flooding the market with significant volumes of cheap soybeans. Due to this shift, business has temporarily slowed, though demand is still being met all around. Similarly, the Chinese metal industry has already responded to selective measures by the U.S. by increasing exports to Europe. European metal companies, in turn, began exporting more to the U.S.

Other companies have found loopholes in the “Paris Gun” of this trade war: the 194-page U.S. customs list. For example, the list covers a wide variety of mattresses, but a mattress manufacturer can slip through this net by producing a different, unlisted type of mattress. The same applies to upholstered furniture. In his article, “Making Tariffs Corrupt Again”, Paul Krugman, winner of the 2008 Nobel Memorial Prize, describes the significant influence of lobbying in getting a product on – or keeping it off – the list. But the Wall Street Journal takes a rather different view of this list. It sees the exceptions as a necessity in securing U.S. supply.

Third-party countries: manufacturing and relocation

Another workaround is through foreign third parties. If a Chinese product is integrated into a German car, then it will enter the American market as a German product, even if it was produced in a manner that distorts competition in the U.S., or allows the German manufacturer to undercut an American competitor. This method can also be implemented much more directly: Chinese companies may actually  manufacture in and export their products from a third-party country in order to circumvent U.S. measures.

If all else fails, the solution may be to relocate production. The American Chamber of Commerce has found that as a consequence of the trade conflict, over a third of U.S. companies with factories in China are considering relocating production. But only 6% want to return State-side. Another 30% are looking at third-party countries, which may offer lower labour costs and less conflict. Chinese companies are doing the same, not only due to the trade war, but also in response to the increased cost of certain manufacturing processes, choosing to relocate instead to countries such as Vietnam and India.

Winners and losers in China

Peter Debaere of the University of Virginia considers the punitive tariffs to be largely ineffective due to the aforementioned loopholes. The Chinese economy has so far remained rather unruffled in dealing with the trade conflict, managing to lower its export quota in favour of domestic consumption despite all the doom-and-gloom prophecies. However, many of these loopholes are being closed as the U.S. is capturing ever larger volumes of imports from China. Curiously, it is the Chinese counterfeit industry in particular that is benefiting. Counterfeit products are brought to the U.S. through the black market, avoiding all duties, while original products affected by the measures become even more expensive in comparison.

China Trade: Counterfeit industry benefits from trade conflict

But those profiting most directly are the service providers who support companies in relocating production. One such company is Kerry Logistics, based in Hong Kong. The company has been feeling the trend of production relocations since 2016, when significant wage increases became noticeable in China. In the first half of 2018 alone, they saw sales increase by 27% to EUR 1.9 billion, and profits by 20% to EUR 104 million, due to the effects of the trade war. The share is currently close to a three-year high.