How Asian exporters can navigate a volatile trading environment
As trade barriers intensify, Asian exporters need to urgently reassess their supply chain strategies and consider investing in third country operations, says Christopher Corr
After a year and a half of surprise US trade moves and growing global fears of overcapacity caused by China's aggressive industrial policies, multinationals today are like ancient sailors on a dark and perilous sea, navigating uncharted waters in capricious winds. The great merchant houses of prior centuries planned in advance for tempests and squalls by investing in more seaworthy fleets and establishing a network of safe harbors. Multinationals now must similarly plan for turbulent times by ruggedizing their investment and supply chain strategies.
The stormy trade climate has been stirred up by an unprecedented series of Trump administration trade actions in the past year, including:
* Unilateral import barriers imposed for national security reasons under "Section 232", and retaliation by a number of US trading partners.
* Escalating salvos of punitive tariffs against imports from China under "Section 301", a, countered by retaliatory tariffs by China.
* More aggressive use of trade remedies against imports under the antidumping, countervailing duty, safeguards and customs laws.
* Threatened withdrawal from long-standing trade agreements like NAFTA, withdrawal from regional agreements the US once championed like TPP, and disengagement from the WTO, the arbiter of the international trade order.
In the current environment, Chinese exporters face massive new barriers in the US and growing protections elsewhere, US exporters face retaliation by China and traditional allies, and multinational companies in the rest of the world, especially in Asia, find themselves caught in the middle. They face not only the direct effects of new US and China tariffs on listed goods, and indirect effects on downstream products, but also disruption of their domestic and third country markets as goods blocked from one market are diverted to flood others.
Like the mariners of old, exporters must make their bases of supply more durable and flexible to adjust to these new and unpredictable hazards.
Asian companies with an important stake in the US market should consider investing in US production or assembly on the other side of the tariff wall to adapt to increasing protectionism in the US.
Exporters also should assess investing in third country operations (i.e. outside the US and domestic markets) because:
First, it could help them obtain crucial free-trade agreement (FTA) benefits – There are a number of important regional trade agreements on the horizon in Asia, such as the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and Regional Comprehensive Economic Partnership (RCEP).
Relocating to or investing in these regions will allow exporters to reduce costs on shipments within the region, and thereby compete with rivals who also have a multi-country production base, and gain a competitive advantage over rivals who do not.
Second, for Asian exporters facing tariffs in crucial markets this strategy may afford flexibility to shift sourcing to unobstructed locations.
Third, it can provide "China insurance. Fears about China's government support for sectors prioritized for growth (per the "Made in China 2025" industrial plan) could lead to increasing global countermeasures against Chinese companies viewed as threats to critical sectors. Many companies in Asia have substantial investments in China production and could be caught in the cross-fire. Prudent investment in alternative third country production should enhance options and resiliency.
Lastly, it diminishes dependence on the home market – Many exporters in China are embracing this strategy as they face increasing barriers abroad. As China-owned companies expand operations to other locations in Asia, companies based in those locations may suddenly find there is more domestic competition from the China transplants, and also that increasing exports from these transplants may expose all exporters from the domestic market to increased protectionist actions abroad.
In addition to standard investment due diligence, companies considering offshore investments should:
1. Conduct a risk assessment of a contemplated location's susceptibility to protective trade actions
Investments in operations that will assemble or further process imported parts require special scrutiny under anti-circumvention rules to ensure that the operations are rigorous and add sufficient value to avoid claims of improper evasion or "transshipment". This is especially sensitive where the operations involve China-origin inputs.
2. Vet locations under national security investment controls
In the US, this includes possible exposure to Committee on Foreign Investment in the United States (CFIUS) review. Congress recently expanded the sectors deemed "national security sensitive" and hence subject to CFIUS vetting. Outside the US, investors face a growing trend toward closer national security review of inbound investments in countries like France, Russia, Germany, Canada and China.
3. Ensure the investment is located where it will most benefit from trade preferences under existing or pending FTAs
Exporters who fail to position operations in important FTA regions could fall behind more diversified competitors who gain price and cost advantages via FTA preferences. This may be less of a concern for exporters in countries such as Japan, Singapore and Vietnam, who will be charter members of the pending RCEP and CPTPP mega regional agreements, and more pressing for exporters in countries such as Taiwan and the US which are presently part of neither.
4. Enhance compliance measures
Investing in operations abroad brings exposure to local restrictions on exports, technology transfer and embargoed countries and entities. The recent draconian US sanctions against Chinese telecom equipment maker, ZTE, which affected many suppliers and vendors around the world (before settling), serves as a case in point. Asian companies can protect their expanding global operations by designing and implementing a world-class internal system for complying with all applicable local laws, including oversight of robust internal screening of customers, shipments and tech transfers, with related training and self-checks.
Waiting and hoping for more tranquil times is a risky strategy. Should President Trump be re-elected, his trade policies would continue through 2024. China's implementation of the "Made in China 2025" industrial policies could well face strengthening headwinds as the target date approaches and implementation gains traction.
Exporters in Asia who adopt prudential investment and supply chain strategies can survive and even thrive in these volatile and uncertain times. Failure to adjust could mean increasing isolation and diminishing market share.
Christopher Corr is counsel, Beijing, Washington, DC, White & Case
11 Oct 2018