China’s Economic Downturn and the Implications for YOUR Business
As economic uncertainty roils China, foreign companies operating in or with China face increasing risks. From capital controls to supply chain disruptions to Chinese companies turning against their foreign company partners, businesses worldwide must navigate a more precarious China environment.
This article very examines the current economic situation in China and its very real implications for international companies. It then explores how China’s economic downturn is impacting foreign companies, from regulatory hurdles to sourcing woes. It also provides specific strategies to mitigate foreign company risks, by bolstering compliance, protecting IP, conducting due diligence, and re-evaluating your China footprint.
Though economic fluctuations are inevitable, by getting back to basics, foreign companies can reduce their exposure in this climate. Heed this advice now to help safeguard your business as China’s outlook remains clouded.
China’s Current Economic Situation
Instead of delving into depth regarding China’s imperiled and declining economy, I will refer you to the following excellent articles on this topic, all of which were written this month:
A Brief History on China’s Economy and Foreign Business
In 2012, I wrote an article for the Wall Street Journal, China’s Slowdown and American Business, detailing China’s economic challenges. At that time, my law firm was being inundated with client concerns regarding how China’s economic downturn would impact their businesses.
The Wall Street Journal’s subheading for my 2012 article was: “Hardly a week goes by without complaints about payment problems or bankrupt debtors.” If today’s situation had a subheading, it would echo my 2012 article’s sentiment, with added emphasis on how “hardly a day goes by without complaints about getting bad product (or no products at all) from a Chinese manufacturer and hardly a week goes by without someone asking what will be required for them to shut down their China WFOE or move their manufacturing out of China.”
I would then add that hardly a week goes by without a company asking our international lawyers whether and/or how they should reduce their China footprint or whether and/or how they can move their manufacturing elsewhere or whether or how they can “silo” their China operations from their operations outside China.
Today’s Economic Slowdown in Real Life
Though economic fluctuations are par for the course for any nation, the current situation in China feels unprecedented. Chinese business owners are more pessimistic today than I’ve ever observed. Foreign companies seem not to be able to leave China fast enough, to where I now see only the three types of foreign companies:
Those who want to leave China and are trying to leave China. This group mostly consists of those who have their products made in China.
Those who want to leave China but cannot leave China for economic reasons. This group consists mostly of those who have their products made in China.
Those who profit from China and plan to stay in China so long as this is the case. This group consists of companies already in China and who sell their products or services to China. For the most part, even these companies are seeking to reduce their footprint in China.
1. China’s Tightening Currency Restrictions
I have lately been hearing from companies whose products are being delayed by their factory because their factory was unable to purchase needed components because the Chinese government is either not allowing them to use hard currencies to buy those components overseas or because the Bank of China is delaying approval of such payments.
This is not the first time China has clamped down on hard currencies leaving China, but this is the first time I have heard of it impacting its factories like this. For an example of a prior period where China cracked down on sending out hard currencies, See this 2016 post I wrote, entitled, Getting Money Out of China: What the Heck is Happening? In that post, I wrote that “if there is a common theme, it is that China banks seem to be doing whatever they can to avoid paying anyone in dollars.” That seems to be today’s theme as well.
2. Chinese Companies are Turning on their Foreign Partners
A notable shift since 2012 is the increasing willingness of Chinese firms to risk their relationships with foreign partners. As discussed in our piece, Your China Factory as your Toughest Competitor, this isn’t limited to the manufacturing sector. We often tell our clients: “Since you will essentially be educating your Chinese party in how to compete with you, you should be sure to have contracts in place that actually limit what they can do when they do so.”
Struggling Chinese firms seem ready to compete against, and potentially alienate, their existing customers. We’ve heard of instances where Chinese companies have (somewhat apologetically) told their Western “partners” that they had failed to provide them paid-for products because they needed the funds to pay their China employees or to move their factories to Cambodia, Vietnam, Thailand, or wherever.
3. China is Increasing Regulations
The CCP has intensified efforts to maintain stability and manage public discontent amid China’s economic downturn. Evidence of this includes the uptick in exit bans and arrests of foreign executives, making China increasingly precarious for them. The Wall Street Journal did an article titled China Is Becoming a No-Go Zone for Executives. My law firm has done more China personal risk assessments — typically done to assess how safe it is for someone to go to China or stay in China — in the last year than in the entire history of our firm prior to last year. Until this year, we would mostly just do these for executives caught by fake police in a brothel. See The China Brothel Scam. It’s Baaaack.
Scaring foreign executives is bad for China’s economy and it underscores the CCP’s emphasis on control over economic growth. See
4. China Product Sourcing Problems
China’s downturn is transforming how Chinese and international companies interact.
Chinese exporters, particularly those that compete with companies from lower-wage and/or lower tariff countries like Vietnam and Mexico, are suffering. This is particularly true of low-tech, low-wage industries like textiles, clothing, shoes and low-end electronics and toys.
Our China manufacturing lawyers are getting a steady stream of calls from companies experiencing problems with their product suppliers. Sometimes the foreign company has paid for product and the Chinese company it paid no longer exists. Sometimes the Chinese company still exists but it needs “more money” from the Western company to buy raw materials for the product it already promised to produce.
Foreign managers need to understand what is happening in their own industries within China. This might mean having someone you trust visit your Chinese factory, warehouse, or office to look for warning signs of a company in distress. Or it might mean taking out insurance to cover your China business or transaction. A number of Chinese manufacturers are owned by Taiwanese, Singaporean or Hong Kong companies, and sometimes it is possible to secure guarantees from the foreign parent. Our law firm has also had a surge in conducting due diligence on Chinese factory companies.
Even more troubling is that hardly a week goes by where my law firm does not hear from a company that is being hounded by Sinosure (China’s government owned export insurance company) for fake/dubious debts allegedly owed to a Chinese factory. See Fighting Back Against Fake (and Real) Sinosure Claims: A Primer. Chinese factories are using Sinosure to pursue claims against their customers because they need money quickly to avoid having to shut down.
5. Geopolitical Implications
China perceives Western sanctions against Russia as a precursor to what will be imposed on them. Chinese companies also see the various Western sanctions, tariffs, and duties already imposed on Chinese companies, and they are worried more are coming (and they are).
In the West, the sentiment is that if China supports Russia more overtly, China will face increased sanctions. But in China, most seem to believe that the West is seeking to halt China’s ascent, leading to the view that decoupling from Western economies is imminent. This has caused Chinese firms to shift their strategies, or at least to weight things differently. An increasing number of Chinese companies believe that their route to higher profits is by competing with and/or stealing from their foreign customers, rather than by providing such great service or products that they will never want to go elsewhere. Frankly, in many instances I think they are right.
None of what we are seeing coming out of China over the last year or so has been a surprise because these things have always become more common when China’s economy is hurting.
Protecting Your Company Against China
Using China-specific contracts is vital to prevent Chinese companies from leveraging your IP against you. See China Contracts: Make Them Enforceable Or Don’t Bother. The key is early protection, when you still have leverage and before your Chinese counterparty has run off with your product, your software, your design, and/or your customers. For what you can do to protect yourself from this sort of competition, I suggest you read the following:
Our China lawyers are also seeing an increase in Chinese companies taking foreign company money and then disappearing.
For how these thefts usually go down, check out China’s Most Common Scams. The best defense against these sorts of thefts is to conduct due diligence on the company to which you will be sending funds, before you send funds. See On the IMMEDIATE Importance of China Manufacturer Due Diligence (which applies with equal force to all Chinese companies, not just manufacturers).
China’s slowing economy and its causes are increasing the risks for nearly every company that does business in or with China.
Most companies realize this and seek to respond to it. Our law firm has a flat-fee package we internally call “China risks and revisions.” This package consists mostly of our analyzing a client’s China risks and then working with them to reduce those risks by fortifying those things which protect them, and by reducing those things which put them at risk.
Our goal is usually to reduce our clients’ China footprint, and thereby reduce their China risks, while concurrently balancing that against the goal to retain all or nearly all of the benefits our client gets from doing business in or with China.
The methods my law firm employees to reduce our clients’ China risks tends to be specific by industry, by company, and by what the company is doing in China. For a company that buys all its products from four suppliers in China, we might suggest it find at least one supplier outside China, and then we help them do that. See How to Move Your Manufacturing Out of China Safely. For a company in a China joint venture with ten of its own people in China, we might recommend contracts or IP registrations to protect their IP from their joint venture partner and/or we might recommend it switch from a joint venture arrangement to a distributor-distributee relationship. Or, to achieve an even lighter China footprint, we might suggest they leave the JV entirely and license its products/technology/brand name to a Chinese company (perhaps even their former Chinese joint venture partner) instead.
There are all sorts of risks out there and all sorts of options for reducing them. For a company that has operations in China, our advice usually leans towards strengthening their existing legal systems, especially as relating to their relationships with their employees and other companies. See A China Employment Best Practices Guide.
Conclusion
The risks for foreign companies that do business in or with China will remain elevated, and I expect to see Chinese companies continue acting desperately to survive, even if that means turning on their foreign partners and product buyers.
Turbulence in China also has geopolitical ripples as relations with the West continue to sour. This means every company involved with China should be constantly re-evaluating its China strategy and exposure.
If your company is doing business in or with China, you should be constantly looking to strengthen your compliance and due diligence, redouble your efforts to protect your IP, and reconsider your China footprint. Keep a pulse on China’s economic situation and, in particular on your industry landscape within China.
Few foreign firms are immune from China’s economic downturn. Be careful out there.
Dan Harris is a founding member of Harris Sliwoski, an international law firm where he mostly represents companies doing business in emerging market countries. Most of his time is spent helping American and European companies navigate foreign countries by working with the international lawyers at his firm in setting up companies overseas (WFOEs, Subsidiaries, Rep Offices and Joint Ventures), drafting international contracts, protecting IP, and overseeing M&A transactions.
In addition, Dan writes and speaks extensively on international law, with a focus on protecting foreign businesses in their overseas operations. He is also a prolific and widely-followed blogger, writing as the co-author of the award-winning China Law Blog.
