The U.S. trade imbalance with China exceeded $200 billion in 2005. Many of the Chinese imports were the outputs of light manufacturing ventures. U.S. industries being pressured by China are pushing Congress to address particular aspects of the imbalance, such as the value of China's currency and the insufficient enforcement of intellectual property rights laws in China. If the U.S. pursues these issues aggressively, official Chinese retaliation will likely be felt most strongly by U.S. exporters of infrastructure equipment to China. U.S. service companies do not have a significant negative trade imbalance with China.
China's trade balance with the United States is often front-page news. While many focus on the strong growth in China's exports to the U.S., far fewer appreciate China's healthy appetite for imports of U.S. goods and services. From an investment perspective, it pays to dig below the rhetoric to understand what is really being bought and sold between the U.S. and China--this may even affect one's domestic investing. And savvy investors may want to contemplate how a trade war might affect their current investments, as well as load up on Western companies that are successfully exporting to China, despite the trade imbalance.
The following companies are mentioned in this article:
U.S.-China trade has increased rapidly over the past decade. U.S. consumers, companies, and retailers have benefited from low-cost production translating to lower prices and broader selection. Conversely, U.S. industrial commodity manufacturers have lost domestic production facilities and local jobs. In 2006, the U.S. was China’s top export market with $287.8 billion of goods and China was the U.S. 4th largest export market with $55.2bn of goods. (See Figure 1) China’s main exports to the U.S. are computer equipment, low-end manufactured products such as toys and games, apparel, audio-visual equipment, and communications equipment. (See Tables 1-2). U.S. exports to China are primarily computers and electronics products, transportation equipment (primarily aircraft from companies such as Boeing), waste and scrap, chemicals, and machinery.
|Waste and scrap||1.1||2.3||1.9||2.5||3.7|
|Resin, rubber, fibers||0.8||0.9||1.2||1.6||2.1|
|Total All Commodities||19.2||22.1||28.4||34.7||41.8|
|Source: US International Trade Commission Trade Data Web|
|Total All Commodities||102.3||125.2||152.4||196.7||243.5|
|Source: US International Trade Commission Trade Data Web|
This widening trade imbalance has driven domestic policy makers toward increased U.S.-China trade confrontation. Already, US policy makers are pushing for
China will likely negotiate to protect its exports. China’s bargaining position is stronger supported by its vast US$1 trillion in foreign currency reserves making it influential in interest rates, rising Chinese domestic demand and unparalleled economies of scale.
Increased exports from China would fuel profitability for mass-market retailers, as China branches from lower-end consumer products, electronics, and textiles. Lower-cost products either contribute to retailers’ gross margins or enable them to attract more consumers by passing on lower prices. Gradually China is moving into food and more sophisticated manufacturing – both of which require greater investment.
In order to export food, China needs to invest in food processing equipment to meet foreign phytosanitary standards outside of its borders. For example, unbeknownst to many, China is already the largest producer and exporter of apple juice in the world. (See Figure 2) However the recent scare regarding melamine-tainted pet food from China highlights the fact that China still has to invest far more in food safety technology and standards. This creates significant opportunities for Western food processing equipment manufacturers like FMC and Tetrapak, at the same time it augurs more competition for certain farm-centered companies whose product portfolio clashes with China.
The other area where China is seeking to increase its export is in higher-end manufactured products. To produce high-end equipment and components, China requires both foreign investment and foreign expertise. In more competitive industries, such as automobiles, China has been gaining the expertise by restricting foreign companies’ access to the Chinese domestic market to those foreign companies who are willing to create joint-ventures with local Chinese companies and transfer their expertise to their Chinese partners. The result of these joint-ventures is that the Chinese are now better positioned to compete in higher end markets, both domestically and abroad. For example, Shanghai Automotive Industry Corp., a Chinese government-owned company, has been the domestic joint-venture partner of General Motors (GM) and Volkswagen (VLKAY) for many years. Now Shanghai Automotive is planning to launch its own luxury, four-door sedan to compete directly with vehicles made by head to head with that will compete head to head with some cars produced by GM and Volkswagen.
Semiconductor companies such as Intel AMD by comparison, has less competition than automotive manufacturers and has been able to setup operations in China without being required to setup a joint-venture with a local company. For example, Intel recently announced its plan to spend $2.5 billion on a plant that will use 300-millimeter wafers to make semiconductor chips. Thus, while Intel may not transfer as more of its expertise to Chinese enterprises, it is bringing significant capital investment into China. Nonetheless, Intel is still being careful about its investment. Industry analysts expect to rely on its older 90-nanometer manufacturing process in China rather than the more advanced 65-nanometer process it is deploying elsewhere. Regardless, the eventual result will be the export of higher-end semiconductors from China.
The experiences of Intel, GM, and VW offer an important lesson for prudent investors: if a company announces it is expanding aggressively into China, investors need to understand what kind of China strategy the company has in mind. If the move into China results in significant technology transfer, investors need to balance the short-term access to the Chinese market against additional long-term competition.
As China moves up-market in its production, its exports abroad may increase in volume and dollar value, further tilting the balance of trade between the U.S. and China.
U.S. sanctions could likely include anti-dumping penalties and countervailing duties.
If the U.S. government makes a determination that a Chinese company is selling products in the United States at a price below the cost of those products in China, anti-dumping fines may be leveled on that company. Industries where dumping allegations are most likely to be made are those involving commodity-like manufactured products, such as paper and steel. Dumping allegations regarding commodities are less likely because customers and commodity investors would capitalize on sales below cost rapidly. Dumping allegations against higher-end manufacturers are less likely because higher-end products tend to be more unique and thus more difficult to prove which importer is truly a competitor solely on the basis of price.
These, however, may be applicable to all types of goods imported from China if the manufacturers of those goods receive state subsidies to reduce their manufacturing costs. Because many Chinese companies are presently or formerly government-owned, it is difficult to determine whether their costs are truly subsidized by the government. For this reason, in the past the United States has not pursued countervailing duties against companies from non-market or transitional economies.
However, China is now a member of the WTO and it is to be treated more so as a market economy, despite continued heavy state involvement in its commercial economy. As a result, petitions for countervailing duties on Chinese importers will increase, alleging that Chinese state involvement in the economy proves the presence of subsidies of Chinese exporters. One of the first shots across the bow in this regard is the petition for countervailing duties to be imposed on Gold East Paper, which manufactures coated paper rolls in China for export. In the future, petitions may be filed by U.S. companies seeking countervailing duties on even higher end Chinese imports, such as automobiles, if the U.S. companies have a shot at showing Chinese government support of the importer. Investors in U.S. companies facing an increasing Chinese threat should evaluate whether the Chinese competitors seems to be receiving some form of state support – if so, countervailing duties may yield a short-term reprieve for the U.S. company. In this most recent paper case, domestic manufacturers such as International Paper and MeadWestvaco could benefit.
As surely as there are short-term winners in trade wars, there are also potential big losers. It is not unlikely that China would retaliate against U.S. trade sanctions that it deemed inappropriate – such as a perceived mis-characterization of Chinese subsidization of its exporters. Rather than heighten its own tariffs and face scrutiny from the WTO, the most likely avenue for Chinese government retaliation in a trade war is for the government to use its own buying power and influence to reduce purchases from the U.S. The Chinese government controls the purchase of massive amounts of infrastructure, including airplanes, power plants, telecommunications networks, and the construction of roads, hospitals, airports, and railways.
Thus, U.S. companies selling products in these sectors (e.g. Boeing in the aviation sector; GE in the power sector) stand to lose in the event of a trade war. There are usually multiple foreign providers of infrastructure (e.g. Siemens and Alcatel (ALU) in the telecommunications sector, ABB in the power generation sector) waiting to pounce in the event U.S. companies are tripped up by a trade war. Notably, as part of an effort to support Chinese interests prior to trade talks, Chinese businesses recently signed a $4.3 billion buying commitment for software, semiconductor components, and telecommunications products from Microsoft, Oracle, Cisco Systems, and Hewlett-Packard.
U.S. companies producing goods to be consumed by individuals and private enterprise have less to fear from a trade war. For example, the sales of Yum! Brands Kentucky Fried Chicken in China are driven by the hunger of millions of kids and parents for a Western treat, rather than by a bureaucratic decision about how much fast food will be sold in the following year. Similarly, the value of the Levi’s trademark on a pair of jeans is also unaffected by decisions of the Chinese government. A key driver of demand for these kinds of goods stems from the rise of China's middle class.
Products containing unique intellectual property are also less likely to be affected by a trade war due to their uniqueness. For example, a new highly effective cancer drug developed in the U.S. is less likely to be affected by a trade war because it offers benefits that cannot be replicated elsewhere, due either to intellectual property protections or sheer ingenuity.
Key pharmaceutical products would remain in high demand, although counterfeit drugs remains a constant problem. Likewise, category leaders with a significant performance-to-price advantage over their competitors, like Texas Instruments in some sectors of the digital signal processing market, are unlikely to be affected by a U.S.-China trade war because the economics of using their products is too compelling.
A trade war should have scant impact on U.S. exports of software, music, and movies. These are all highly unique products for which a substitute cannot be readily located. Further, purchasing decisions about these products are largely directed by individual consumers who receive some exposure to the world media. Thus, even if the Chinese government cared to do so, it could not hide from consumers which movies won U.S. Academy Awards or how so many readers are enthralled by the exploits of Harry Potter. There is a significant risk of such intellectual goods being pirated in China, however even a trade war between China and the U.S. will not instigate the rise of state-sponsored piracy in China. Further, the failure of China to enforce intellectual property rights of Western companies would escalate a trade war further, rather than taking "an eye for an eye."
The service sector of the U.S. economy could be hurt significantly by Chinese retaliation to U.S. trade sanctions. Under the WTO, services are not as liberalized as trade in goods. Thus, China also has more leeway to retaliate by restricting access to its market by U.S. service companies. Further compounding this risk is that services are often crucial in stimulating product exports. yuahn For example, if a U.S. architect is involved in a project, he might specify U.S. construction materials.
The United States is the world’s largest producer and exporter of services, which include all economic activity outside of agriculture, mining and manufacturing. Further, services are the largest share of the U.S. economy, representing 80 percent of GDP and private employment outside of agriculture. The U.S. exported over $380 billion of services in 2005 and over $413 billion in 2006. This offsets nearly half of the U.S. trade deficit in goods during those years. Chinese trade retaliation could negatively impact many of these service exports.
The largest single category within the U.S. service sector is travel and tourism. Due to restrictions on visitor visas, relatively few Chinese travel to the U.S. regularly, however this dynamic is changing as China’s middle class burgeons and yearns to see the world. In the event of a U.S.-China trade, the Chinese government could easily slowdown the rate at which its citizens are permitted obtain a passport and visit the U.S. Cities like Las Vegas depend, in part, on visiting Chinese gamblers.
Transportation services would also be affected by Chinese trade retaliation because there would be fewer imported goods to transport. This would impact air freight, railway, trucking, and shipping companies, as well as the ancillary businesses, such as truck stops, that support them. Companies sensitive to this are shipping companies such as China Shipping, rail and trucking freight services.
A significant U.S. export to China is architectural, construction, and engineering services. Given the involvement of the Chinese government in almost all infrastructure projects, a trade war could dramatically reduce opportunities for construction engineers, as well as for architects. The Beijing 2008 Olympics and China’s National Housing Reform provide enormous opportunities for foreign architecture and engineering companies who can stay in the government’s good graces. According to the U.S. Embassy in Beijing, China expects to build between 486 million and 549 million square meters of floor space annually in the first 20 years in the 21st century. Foreign engineers and architects have a major role to play because native Chinese architects often lack experience with large-scale projects such as skyscrapers, and many new building technology and materials also come from abroad.
In addition to furloughing construction projects involving U.S. firms, China could also retaliate against U.S. construction services by heightening its standards for the licensing of professionals, thus rendering it difficult for foreign firms to be certified to bid on projects and obtain necessary permits and licenses. The same restrictions could also be applied to the licensure of other service professionals, such as lawyers, accountants, and management consultants.
While U.S. financial institutions are very competitive internationally, this is a highly regulated industry where the Chinese government could easily impose new regulations or otherwise restrict market access in the event of a U.S.-China trade dispute. Citigroup, Morgan Stanley, American International Group, and Merrill Lynch, amongst others have developed joint ventures or acquisitions in China. Ongoing deregulation opens the doors for more insurance companies into the market, and credit card companies.