15 September, 2020

Relations with China


  • Relations between the US and China have deteriorated in recent years. Although lately there has been an easing in the trade war of sorts, security issues have now become the focus. Relations between the two superpowers are likely to be challenging no matter who the next US President is.
  • New Zealand has so far trodden a fine line between its trading relationship with China and strategic relationship with its longstanding security partner, the US.
  • New Zealand’s relationship with China could experience challenges in the future. However, we expect New Zealand will likely continue to walk a tightrope to avoid major disruptions to its relationship with China.
China-US Relations

With the US presidential election only two months away, investors may ask how it may affect their international equities portfolio. After several rounds of trade tariffs, restrictions and sanctions on individuals and companies, some may question whether a new US President will reverse some of the policies made earlier. Some may also wonder which policies have a higher chance of remaining and which ones will be amended or rescinded if there is a leadership change.

While the outcome of the presidential election is still uncertain at this stage, we believe most policies, especially those concerning intellectual property rights, mutual market access, counterfeit goods and forced technological transfer, will stay. This is because many of them have been supported by both political parties in the US since the beginning of the drafting process and are vital to protect the US’s long-term interests. Even in the scenario where Joe Biden becomes the next US President, we consider he would only remove a few minor trade tariffs as a gesture of goodwill to China. After all, measures taken by the US so far have levelled the playing field with China in some areas, including intellectual property rights, technology transfer and Chinese market access. After two years of trade war, the US has improved its bargaining power in most of the areas mentioned above through the Economic and Trade Agreement, which is commonly known as the Phase One Trade Deal. The incoming US President will, therefore, have little incentive to offer concessions to China without trying to gain more from a new arrangement. As such, we believe if there is a change in political power in the upcoming US election, not many existing policies, especially those outlined in the Phase One Trade Deal, will be changed.

On the other hand, the progress of various principle-based programs led by the US may further impact China. The Clean Network Program and the Economic Prosperity Network are two examples of such programs. Some of these programs are quickly gaining traction amongst advanced economies, especially those that have long been reluctant to confront China on a one-on-one basis. If these US-led programs continue to gain popularity or are further copied by other countries or power blocs, China could face further setbacks in their global political and commercial ambitions. We believe banning Huawei from constructing the 5G network in the US and in many other countries like the UK, France, Australia, and Germany is just a start.

Based on the agendas announced by each US presidential candidate, it appears that political tension between China and the US will remain elevated if Joe Biden becomes the next US President. If President Trump is re-elected for a second term, it is quite likely China-US relations will worsen further.

Trade War Tactic for More US Exports and Fairer Trade Terms

Since January 2018, when the US first imposed trade tariffs on Chinese-made solar panels, further rounds of additional retaliatory tariffs were put in place by both sides through the end of 2019. At the low point of their negotiations, the announced trade tariffs encompassed the total amount of the bilateral trade between the two countries.

Nevertheless, with the conclusion of the Phase One Trade Deal in January 2019, many trade tariffs and threats were scaled back significantly. According to the agreement, the US halved trade tariffs previously imposed on $US120 billion of Chinese imports to 7.5%. While the 25% trade tariff on $US250 billion of Chinese imports remained, the US indefinitely suspended trade tariffs on another $US160 billion of Chinese made consumer goods including smartphones, computers, toys, clothing, and other consumer items. 

In exchange, China agreed to purchase an additional $US200 billion US goods and services over the next two years. The commitment represents a significant increase compared with the $US130 billion of US goods and services that China imported from the US in 2017. Of the $US200 billion of additional US imports, China will buy $US78 billion more manufactured goods, $US52 billion more energy products, $US38 billion more services, and $US32 billion more agricultural products.

Some US think-tanks estimated that the total amount of US trade tariffs announced by the Trump Administration on all foreign imports, including those from China, would increase US consumer costs by around $US46-57 billion per year, which is around 1% of US annual retail sales. Although the US will certainly incur some additional costs because of the trade war with China and other countries, the additional $US200 billion worth of exports to China alone will offset some of the negative impacts. Besides, China has also agreed to rectify long-standing issues around intellectual property theft, forced technology transfer, and difficult market access for US firms. Overall, it appears that the Phase One Trade Deal is a good agreement for the US and there should be little incentive for the US to renegotiate a new deal. Since the trade deal took effect in February 2020, affected US companies should have found ways to reconfigure their production processes or adjust their supply chains to compensate for the new regime. As a result, if Joe Biden becomes the next US President major changes to the trade deal would be unlikely.

China Might Be Left Behind by Principle-Based Programs

In May this year, the US Government released a 16-page policy report titled “The Strategic Approach to The Peoples Republic of China”. The report outlined the US’s new principle-based approach to Mainland China. Since then, the US has significantly expanded its Clean Network Program as part of its new strategy. The Clean Network Program takes a comprehensive approach to protect critical US telecommunications and technology infrastructure from intrusions. This reflects the perceived threat of Chinese technology companies including Huawei, Lenovo, ZTE, Hikvision, by the US government. While these threats were documented as early as 2012 no serious countermeasures were taken to stop the expansion of these entities back then.

To tackle perceived threats, the Clean Network Program aims to disconnect some Chinese telecommunication operators from US networks. It will also remove untrusted Chinese software from US mobile app stores to prevent threats to US privacy, proliferating viruses, and spreading propaganda or disinformation. The program will bar Chinese smartphone manufacturers, including Huawei, from accessing trusted applications created by US and foreign companies. Due to the increasing popularity of cloud computing, the program will also prevent US citizens and corporates from storing and processing data to cloud systems that are accessible to Chinese technology companies including Baidu, Alibaba, and Tencent. Lastly, the program will also ensure all subsea data cables that connect the US with the rest of the world are protected from intelligence gathering by China.

The rising popularity of the Clean Network Program amongst US allies illustrates the rising risk China faces if it further asserts its political and commercial interests overseas in the same way it has done in the past. Since many arms of the Chinese government and entities with strong ties to the government are now being put under the spotlight of closer regulatory scrutiny it will be more difficult for China to continue to use them to extend its overseas interests. Although some may question whether initiatives like the Clean Network Program and other policies will continue if Joe Biden wins the election, we believe wider public awareness would make it difficult to argue publicly that cancelling these initiatives is beneficial to the US’s long-term competitiveness.

So far, more than 30 countries and 31 of the world’s largest telecommunications and technology companies have joined the network. All of them have committed to exclusively using trusted vendors in the Clean Network. While Chinese companies that are named in the program would certainly face restrictions, suppliers to these Chinese companies, both in the US and overseas, might also experience revenue pressure as their clients lose business opportunities due to this program. Micron, Broadcom, Skyworks, and Seagates are well-known companies that will certainly be impacted given their current revenue exposure to Huawei. On the other hand, companies that have joined the Clean Network Program may have fewer business opportunities in China due to retaliation from the Chinese government.

The US Government is investigating potential vulnerabilities in other strategic areas. Areas where additional programs could be implemented include products like rare earths, vaccines, drugs, surgical masks, and personal protective equipment. A way to mitigate strategic threats is to push private companies to move both their sourcing and manufacturing functions away from China. The US is ready to provide tax incentives and subsidies should these companies plan to move these functions back to the US. The US Government strategy of encouraging strategic companies to move away from China has already been adopted by countries like Japan, Taiwan, and France.

Tougher Political Environment Ahead for China

Should President Trump be re-elected he proposes that the US should end its reliance on China. Specifically, he aims to bring back one million manufacturing jobs from China with the help of government tax credits. To incentivise companies to bring factories back to the US his government will allow full expense deductions for essential sectors, including the pharmaceuticals and robotics sectors. The agenda also discusses barring companies that outsource to China from winning federal government contracts. Finally, Trump would like to hold China accountable for the spread of coronavirus. Trump’s agenda would likely see relations between China and the US deteriorate further.

In comparison, Joe Biden has been strategically less specific about his China policy. Although his track record suggests a different position relative to President Trump, discussion at the recent Democratic National Convention indicates the party supports a harder stand on China. Since existing measures on China are not likely to be removed any time soon and neither presidential candidate is expected to ease measures in the foreseeable future tensions between the US and China are likely to remain elevated in 2021.

Implications for China-New Zealand Relations

New Zealand’s economic and diplomatic relationship with China has developed enormously over the past decade or more. In 2008, New Zealand and China signed a comprehensive free trade agreement which, combined with China’s rapid economic development, has seen an explosion in trade between our two countries. China is now New Zealand’s largest trading partner, accounting for around 29% of New Zealand’s total exports and 20% of New Zealand’s imports.

New Zealand’s export relationship with China has developed to the point where in some product areas China is the dominant buyer of our exports. China takes 80% of our log exports, 73% of our milk powder, and around one-fifth to over one-third of several of our other key export commodities, as the table below shows.

China’s Share of New Zealand Exports

Category

Share

Logs

80.4%

Milk powder

72.5%

Total Dairy (incl. milk powder)

34.5%

Meat

39.4%

Seafood

35.8%

Pulp and paper

30.1%

Fruit and nuts

21.5%

Share of total exports

28.6%

Since 2006, Chinese students have been a staple of New Zealand’s overseas student intake. Chinese students have typically accounted for around a fifth of our country’s overseas student numbers, although this has dropped off since 2017 and now sits at around 12%. From 2010, tourists from China steadily increased and in recent years has levelled off at around 17% of our total visitor numbers, as the chart below show.

The geopolitical tussle between the US and China would perhaps not overly concern New Zealand if it were confined to trade issues between the two superpowers. New Zealand has so far not been noticeably affected by the tit-for-tat tariffs between the US and China over the past two years, with exports to China continuing to increase at a robust rate. To some degree, New Zealand benefits from the two-way trade spat as China chooses to substitute some of its imports from the US with imports from other countries like New Zealand. New Zealand dairy and meat exports to China are beneficiaries in this regard.

The problem for New Zealand is that tensions between the US and China are increasingly widening to include security issues that require a more coordinated international response. Security concerns around Chinese telecommunications company Huawei and social media company Tik Tok are recent example of issues with international consequences. Restrictions on Chinese companies operating in other countries, such as the restrictions that have been put on Huawei and other Chinese technology companies, and criticisms of Chinese actions risk retaliatory restrictions on certain imports or foreign operations in China.

So far New Zealand has trodden a fine line between its trade relationship with China and the strategic and security relationship with the US. The New Zealand Government has not followed other countries such as the US, UK, and Australia in banning Huawei in participating in local 5G infrastructure. Regarding concerns over China’s handling of COVID-19, New Zealand has been mild in its questioning, in contrast to the more accusatory tone of some countries. Consequently, New Zealand has so far not faced Chinese restrictions on its exports to China because of this issue. This compares to Australia, for example, which recently had some beef exports to China banned by the authorities in that country and an investigation into Australian wine dumping because of its criticism of China’s initial handling of its COVID-19 outbreak. Although New Zealand recently followed the US, Australia, UK, and Canada in suspending its extradition treaty with Hong Kong following China’s imposition of a controversial national security law for that region this has so far only attracted a stiff rebuke from China.

The relationship between New Zealand and China is not a one-way street, however. Chinese restrictions or additional tariffs on New Zealand exports would also cause disruptions for some Chinese consumers and industries. For instance, New Zealand accounts for 57% of China’s imports of dairy, 50% of its imports of apples pears and quinces, 24% of its imports of logs, and 13% of its imports of beef. Restrictions or increased tariffs on these products would result in more cost and inconvenience for those local consumers and businesses that have come to rely on them.

China’s openness to trade and investment has hugely contributed to the country’s rapid development over the past two decades, thus enhancing the credibility and legitimacy of the CCP amongst the Chinese population. China’s wealthier consumers have developed a liking for New Zealand’s high-quality primary products, such as dairy, meat, and fruit. Attachment is growing in China to products such as infant milk formula, which New Zealand is rapidly gaining Chinese market share. Unless an alternative source can be found (for example, sourcing dairy products from Ireland) reducing imports from New Zealand in these areas would lessen China’s choice and increase the cost of premium food products. In many of these areas there is no ready local Chinese substitute or there are consumer doubts about the quality of local products. For example, after Chinese milk and infant formula was found to contain toxic melamine, local consumers turned away from local milk products towards imported substitutes. China’s authorities will need to be careful that its actions on trade do not become a source of dissatisfaction with the Government amongst Chinese people.

New Zealand’s relationship with China will likely continue to be fraught with challenges in the future, particularly if the US chooses to become more combative with China. It may be possible to gloss over or sidestep some issues, but others may in the future require New Zealand to take a clearer side. Given the expected geopolitical landscape, therefore, New Zealand exporters highly dependent on the Chinese market could be vulnerable to restrictions and tariffs of various degrees. New Zealand’s tourism and education sectors may also be vulnerable when our borders are eventually reopened. However, given the importance of trade and cross-border investment in enhancing the living standards in both countries, in our view it is likely that New Zealand will continue to walk a diplomatic tight-rope and be spared substantial disruption to its China exports.

Ted Tsui
Global Equity Strategist

John Carran
Strategist/Economist

This advice is general or “class” in nature, not specific or personalised to you. It does not take into account your financial situation or goals and, accordingly, does not constitute personalised financial advice under the Financial Advisers Act 2008. If you require personalised financial advice, there is a process to go through before that can be provided to you.

News & Insights

FNZ1739 LinkedIn Website Welcome

FNZC becomes Jarden

09 June, 2019

New Zealand investment and advisory firm FNZC today becomes Jarden, connecting people, insights and capital solutions. The firm’s new website is ​www. jarden. co. nz​.