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China Tries To Mend US Relations While Preparing For Trade War 

TRADE WARS ARE good, and easy to win, tweets US President Donald Trump.

This Bystander would contend that trade wars are bad, and no one wins.

The United States’ plan to impose across-the-board tariffs of 25% on imports of steel and 10% on those of aluminium following a Section 232 investigation will have less effect on Chinese exporters than those from many other countries, despite the fact that Beijing bears the brunt of Trump’s rhetoric about ‘unfair trade’.

China now ranks tenth in the list of sources of US steel imports, at 2.9% of the total — one place below Taiwan (3.2%) and far below table-topping Canada (16.7%). The United States is the world’s biggest steel import market at 35.6 million tonnes (2017), but China’s exports had already fallen by 30% from the previous year following Obama-era anti-dumping duties imposed two years ago. In only one category of steel imports, long products (rebars, drawn wire and the like), is China a top-five supplier.

The US import market for aluminium is smaller, at 6.8 million tonnes a year. China ranks fourth in the foreign suppliers list, with an 8.8% share of imports. Canada, again, tops the list, followed by Russia and the UAE.

Beijing’s public response to the Trump administration’s announcement has been the expected call for restraint, urging the United States to abide by multilateral trade rules and do nothing to damage the fragile global economic recovery. It is also quite content for the EU to take up the running as the belligerent critic in this case.

Behind the scenes, there is a growing sense of urgency about the probability of further such measures to come from Washington and the countermeasures that might have to be taken.

Chart of US exports to China by category, 2016. Source: MIT's Observatory of Economic Complexity.

The Ministry of Commerce is already investigating imports from the United States of sorghum, a cereal grain used to feed livestock, in response to previous tariffs from the White House on solar panels and washing machines.

Agricultural products are a fat target for Beijing to retaliate against. The scale of farm trade between the two countries is large, and US farmers have a heavy reliance on the Chinese market. The US runs a nearly $17 billion trade surplus with China in agricultural products.

US soya beans would be the bullseye, as the chart below of US vegetable product exports to China shows (the chart, like the one above is drawn from MIT’s Observatory of Economic Complexity data). They account for $14.2 billion of the $21.4 billion of annual US agricultural products exports to China (2016 figures) — or 12% of total US exports to China. The second biggest export category, ‘coarse grains’, essentially sorghum in this context, is only a $1 billion export market for US farmers.

Chart of US vegetable products exports to China, 2016

An alternative target for Beijing could be in aerospace. China is one of the largest export markets for US aerospace products, with sales of $13.2 billion in 2016, accounting for 58% of China’s total imports in the aviation sector. This would be a political target in that it would hit the high-skilled industrial jobs in the United States at companies like Boeing that Trump has said his America First trade policies are intended to restore.

The word doing the rounds (admittedly with no firm evidence) is that if tariffs start to cost Chinese exporters $10 billion a year that will be the trigger point for retaliation.

More tariffs are likely to be forthcoming from the Trump administration. As we have noted before, the president is ‘itching’ to impose tariffs on China. Trade is the one issue on which he appears to have long-standing, consistent and deep beliefs that foreign competitors and large trade deficits ‘cheat’ the United States. Also, ahead of November’s midterm Congressional elections, he needs to motivate his voting base, which holds China to the root of all the ill that has befallen it since the global financial crisis.

The steel and aluminium tariffs would follow a series of duties already announced on a range of goods including the solar panels washing machines mentioned above.

The particular concern in Beijing now is a Section 301 investigation into China’s practices in technology transfer, intellectual property and innovation. The Trump administration has already moved to constrain inward direct investment that would give Chinese companies access to US technology. The number of Chinese acquisitions of US tech firms in 2017 was 12% down from its 2015 peak.

While some of that can be attributed to tighter Chinese capital controls, on the US side, this has been achieved both formally through regulatory intervention and informally by, for example, Congress leaning on US telecoms firms AT&T and Verizon not to buy equipment from Huawei and ZTE — and the administration pressing allies to follow suit (though how imposing trade tariffs against allies like Canada, Japan and South Korea engenders the necessary goodwill is difficult to see).

Beijing’s efforts to re-engage the diplomatic and back-channels through which the economic relationship with Washington has been more or less successfully managed for many years are proving less fruitful, despite an assiduous courting of Trump from the outset of his presidency. In many cases, long-standing working points of contact between US and Chinese officials have halted.

Liu He, the Harvard educated economist who is close to President Xi Jinping and the architect of much of China’s economic policymaking since Xi came to power, was in Washington this week. He met senior administration officials, including US Treasury Secretary Steven Mnuchin, White House economic adviser Gary Cohn and US Trade Representative Robert Lighthizer, but not, notably, Trump, in what looks like a calculated snub on the president’s part.

There is no doubt to this Bystander’s mind that Trump’s realization of America First through measures such as tariffs moves the global economy into more dangerous territory because the risk of a tit-for-tat trade war is escalated.

Redefining protectionism as a matter of US national security rather than as a matter of economic fairness, as the steel and aluminium tariffs will do, allows all countries to claim the same.

This is the new world of hard-power realism, and it will have its costs, perhaps very heavy ones.

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China’s Unwanted Kokang Conundrum

THE ESCALATION OF the fighting just over Yunnan’s border in the Kokang region of Myanmar’s Shan state leaves Beijing with an unwanted humanitarian, security and strategic headache. China is providing food and shelter for some 30,000 refugees that have fled across the border into Yunnan, state media say. Most of the refugees can be assumed to be Kokang, who are ethnically Chinese, and Chinese migrant workers.

China first set up refugee camps following the outbreak of hostilities between the separatist Kokang National Democratic Alliance Army (MNDAA) and Myanmar government forces on February 9. The clashes have since intensified leaving 70 dead, including at least one Red Cross worker after an attack on a Red Cross convoy. The government in Naypyidaw has declared a state of emergency and martial law in the region.

China does not like such instability along its borders at the best of times and has sent troops to reinforce its side of this particular one. Beijing will initially be hospitable to those fleeing the fighting, firstly because they are Chinese, and secondly because the MNDAA was once part of the Chinese-backed Communist Party of Burma.

The MNDAA’s former leader Peng Jiasheng has been in exile in China, if not very publicly, since being driven out of power in 2009 — an event that triggered a similar influx of refugees fleeing the fighting, and which China was less prepared to deal with then than this time. It is Peng’s return now that has caused the renewed flare-up of fighting, ending the ceasefire than has existed since he was driven out.

Peng’s return, this Bystander would hazard, is neither sanctioned nor wanted by Beijing. It has been trying to broker peace deals between the Myanmar government and a score of ethnic groups in the northeast of Myanmar who want varying degrees of autonomy. Naypyidaw wants to strike a comprehensive peace deal ahead of national legislative elections due to be held later this year.

Beyond ensuring peace and stability along its borders, China’s bigger strategic imperatives in Myanmar have changed. The country has natural resources such as jade and desirable crops such as sugar. But more importantly, Naypyidaw’s growing rapprochement with the United States has undermined Beijing’s position as Myanmar’s principal political ally. It is not going to damage that relationship any further by backing separatist groups.

Myanmar is also an important link in President Xi Jinxing’s ‘One Belt One Road’ strategy. This is the development of the ‘Silk Road Economic Belt’ and the ’21st Century Maritime Silk Road’ — or China’s overland and maritime shipping routes to the Middle East and Europe through which political ties and strategic influence are intended to flow as voluminously as energy, natural resources and manufactures. Myanmar is a particular way station in this endeavour between China and Southeast Asia and the Indian Ocean as well as being a prime candidate for Xi’s ‘periphery diplomacy’.

To that end, Beijing wants a stable Myanmar. Its preference is for Naypyidaw to reach a peace settlement with its ethnic rebels to put and to conflicts such as that with the Kokang and with the Kachins, which flared up in 2012 and 2013. It has called for just that course of action.

If, against the odds, Peng does regain control of Kokang, China will be at least passively accommodative towards him. It has done the same in Pakistan or Afghanistan, where it has proven deft at working with local warlords and the central governments. However, that is not a situation Beijing wants to see as it will furnish it with neither border stability nor strategic leverage.

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Will Unravelling China’s VIEs Pull The Rug Out From Under Alibaba?

IS THE LAW of unintended consequences — or intended ones — in play with the new draft revisions to China’s foreign investment law? And if the later, whose intentions need to be examined?

What may be at stake is control of three of the fastest growing sectors of the Chinese economy — the internet, e-commerce, and cloud computing. Privately owned companies, not state-owned enterprises dominate all three. More to the point, these are about the only sectors of the economy to create large privately owned Chinese companies and from which state-owned behemoths are absent.

As Steve Dickinson of the China Law Blog points out, Baidu, Sina, and Alibaba are at risk of getting their wings clipped. To be fair, that is not the wording he uses. However, this Bystander sees it as a consequence of the significant implication he does note will result from the draft foreign investment law newly published by the commerce ministry: it will end a corporate governance structure known as the Variable Interest Entity (VIE).

All three companies and hundreds of others, particularly technology and telecoms firms, use VIEs to get round the investment regulatory rigidities of sectors of the economy the government deems strategically important and so proscribes or limits foreign investors.

The new draft revisions specifically set out to end VIEs. The revisions’ other main goals are:

  • to lessen the red tape for foreign direct investors wanting to own businesses in China;
  • to switch to a system of monitoring foreign investors via annual reports from pre-approvals for new foreign investments, save for in sectors of national significance; and
  • to put Chinese companies with foreign investors under the same legal regime as domestic companies.

China’s foreign investment law is outdated, so modernisation is to be welcomed — even if the draft law runs to a weighty 179 articles across eleven chapters.

VIEs are a loophole that has let foreigners operate businesses in the country through Chinese front companies. They are a corporate sleight of hand by which an investor controls a company through contractual legal agreements rather than through share ownership.

In short, VIEs say to authorities in country A ownership resides in country A while at the same time telling investors in country B that ownership resides in country B. This Bystander doesn’t need to be a lawyer to see that doesn’t pass many smell tests for good corporate governance.

There have been a number of VIE-related scandals, including involving Alibaba, Sina.com, and New Oriental Education, as VIEs open too many creases along which any or all of regulatory, ownership and operational risk can spread.

Nevertheless, VIEs have become widely used. At first, they were a way for inward foreign investors to enter parts of the Chinese market otherwise closed to them. Increasingly they have been used by privately-owned Chinese companies that list overseas, especially those from industries in which having any foreign shareholders is forbidden or restricted, such as tech and telecoms.

They circumnavigate regulatory rigidities: the constraints on Chinese firms raising capital domestically and the need for private firms to get permission to invest overseas, and restrictions on foreign investors and firms having ownership of Chinese enterprises in certain sectors of the Chinese economy. But given those restrictions on foreign investment exist, VIEs aid and abet in breaking the spirit of the law, if not its letter.

The straightforward solution would be to remove the regulatory rigidities. However, Beijing is not going to abandon keeping sectors of the economy ‘off-limits’ to foreign investors. Its new draft foreign investment regulations use where ‘effective control’ of a company resides to determine ownership.

At a stroke of the legal drafting pen, VIEs becomes irrelevant. Any business that authorities determine to be effectively foreign controlled will be breaking the law if it operates in a restricted or prohibited industry.

All of which would leave the likes of Baidu, Sina and Alibaba and all the other internet businesses that operate as VIEs in China, in a pickle. So, too, foreign investors who bought into the initial public offerings with such gusto and who could end up holding the paper of a company that is illegal.

Now, we don’t doubt that between drafting and final promulgation of a new foreign investment law, accommodations will be made to resolve any such discomforts. While the regulators appear to have rejected lobbing from the companies to, in effect, grandfather them into legality, the draft regulations would let a VIE that is controlled by Chinese to be considered a Chinese company. That determination would be made by authorities on a case by case basis. It would be incumbent on the VIE to show it should be exempted from being put out of business like every other VIE.

Beijing has to walk a fine line if it is not to discourage the development of those industries in which Baidu, Sina and Alibaba operate. All of them could play critical roles in encouraging domestic consumption and thus help meet the government’s goal of rebalancing the economy away from infrastructure investment- and export-led growth. On the other hand, it can’t be too blatant in showing that there is one rule for the powerful and well connected and another for all the rest.

Such companies could also switch their governance to a two-share-class model, and keep the relationship between investors and owners as effectively separated as they are with a VIE. (We don’t approve of companies having A and B shares as a matter of good governance, but that is a topic for another day.)

However, the cost of that will be greater government regulation over them and possibly the promotion of state-owned enterprises to rival them, though perversely it may also give the big, established players some protection from new entrants who won’t be allowed to go the VIE route or anything that looks like it (though opening the capital account would mitigate the need to).

There are several parts of the political establishment, from the security and propaganda arms to the state-owned enterprises themselves, who would welcome reining in the big private Internet groups. Abolishing VIE’s might be intended primarily to kill a lot of flies, but, intentionally or not, there are some endangered tigers, too.

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Drought Diplomacy

A group of more than 40 officials from China, Africa and the U.N. have been in Beijing for three days discussing how to reduce the risks of drought. It has been technical stuff for policy makers on drought monitoring, water resource management and drought resilient farming, as well as dealing with the social and economic impacts of droughts. The meeting was part of Beijing’s overall dialogue with Africa, but these are all topics of obvious mutual interest, given the severe droughts that China has been experiencing such as the one continuing in the south and southwest of the country and the recurring ones on the North China Plain.

Africa’s droughts, like those in China, are expected to become more frequent and widespread as a result of climate change. The Horn of Africa is currently suffering the continent’s worst drought in 60 years, for which Beijing has promised $82 million in emergency grain and relief aid. Techniques and practices that China uses at home as well as farming methods such as film mulching to preserve for crops what water there is in arid areas are applicable in Africa (and vice versa).

Drought is one of the leading threats to Africa’s development as agriculture is the main means of livelihood for most of the continent’s vast rural population. Beijing is rarely rigid over what aid it will provide a country, and Chinese firms see investment opportunities in water management systems and export markets for technology they develop for home. More than 90% of Africa’s farmland relies solely on rainfall for irrigation.

The lack of water management systems in Africa means that drought also has a far more profound impact on food supplies there than it does in China, which is yet again forecasting a record grain harvest. However, this relatively greater vulnerability prompts a second-level concern among Africans, that China might divert grain and livestock production from the farmlands it owns in Africa to make up potential food shortfalls caused if not by its own droughts then by its growing food demands and changes in consumption patterns. That could put Africa’s ability to feed itself even further beyond it. Last year, African nations needed to import $34 billion worth of food to feed their growing cities. Apart from a potential need to increase the volume of its food imports, it also faces the risk that Chinese demand would drive up the cost of food on world commodities markets.

For the past two decades, Chinese companies have been buying African farmland, mostly but far from all, smallholdings and family farms. Chinese own farms in 18 of Africa’s 50 or so countries through at least 63 investments from Angola to Zimbabwe. There are at least 1,100 Chinese agricultural scientists and experts working in Africa, where China has at least 11 research stations, and at least 1 million farm laborers.  All those ‘at leasts’ are because the numbers are based on Chinese official estimates from 2009. They likely undercount the country’s current farming activity on the continent.

It is easy to scaremonger here and to be critical of China’s engagement with Africa. In fact, cheap credit, world-class infrastructure companies, political pragmatism and, as noted above, a willingness to build what is asked for make for a compelling case to many African leaders to accept Chinese aid and investment. That said, China has its national interests, as does any Western aid donor to Africa, even if it is likely to express those in different ways. There is also a lack of transparency which commingles China’s state aid, trade financing and private investment. Nor should the impact that Chinese aid and investment often has on local environmental, social and labor conditions be sugarcoated.

The result of the Beijing meeting will likely be the emergence of some consensus on priority areas for co-operation between China and Africa on drought alleviation, and more infrastructure contracts related to that for Chinese firms in Africa. No doubt critics will deride them as further Chinese colonization of Africa this time by way of “drought diplomacy,” but this is increasingly the modern face of development assistance, which looks a lot more like commercial investment.

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Agri-Colonialism In Africa

Chinese agribusinesses are a familiar sight across Africa, not always one welcomed by locals, but a new scheme in Zimbabwe is proving particularly controversial. Under the so-called twinning program, investors from Hubei would be paired with farmers in Mashonaland East, one of the most fertile regions of Zimbabwe. The farmers would provide land and labor, the investors capital and equipment; the crops grown would be shipped to China.

It is unclear who would own the land. Some reports suggest the Chinese investors would be given all or some of the land, others that they would just own the farm business they operate on it. The twining program is a provincial government-to-provincial government agreement and the details have been kept quiet.

Provincial officials from Hubei have recently returned from a visit to Mashonaland East. Much of the land in question was originally taken from white farmers in 2000 after independence and redistributed to friends of the regime regardless of whether they had any experience of agriculture. Since independence Zimbabwe’s once-prosperous farming based economy has collapsed, with the country facing food shortages. Hence the need to import expertise and finance to get fallow and failing farms back on their feet.

How much benefit this scheme would provide to local farmers or put food on local tables is questionable, given the crops will be exported to China. There is already a backlash against investors from China, South Korea and some of the Gulf states buying up farmland across Africa to produce cash crops for export at the expense of local subsistence farmers. Giving it away smacks of a bizarre reverse new colonialism.

Footnote: Chinese business have stepped into an economic void caused by U.S. and European sanctions imposed in 2002 against Zimbabwe’s human-rights record. Chinese-made goods are a common sight in local stores. Trade between the two countries totaled $560 million dollars last year, with three-fifths of that accounted for by Zimbabwean imports of Chinese products, particular mobile communications hardware.

Zimbabwe’s leading export to China is apparently tobacco, a surprise for such a minerals-rich country, though that may change with the easing of international restrictions on sales of Zimbabwe’s diamonds. Two of the five companies with diamond-mining licenses are Chinese. However, we note in passing trouble at one of them, Sino-Zimbabwe, state-owned cement maker China Building and Material Co.’s joint venture with Zimbabwe’s state-owned Industrial Development Corp., which reportedly fired local workers at its diamond mining operation earlier this month (via Bloomberg).

Political relations between Beijing and Harare are warm. In February, Foreign Minister Yang Jiechi called for the lifting of sanctions against the country. The following month, China provided Zimbabwe with a $700 million loan, to be used primarily to develop farming. Meanwhile, Chinese-owned businesses have been exempted from a recent law requiring Zimbabwean businesses to be 51% indigenously owned.

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U.S. Taxpayers To Make China’s Food Safer?

Three more child deaths from adulterated milk, the poison being nitrite additives in this case (via BBC), underlines how broken China’s food production system remains despite extensive efforts to fix it in the wake of the melamine-tainted infant formula scandal of 2008. The sheer numbers of small subsistence farmers scrabbling to make a living by any means and the prevalence of local officials overlooking transgressions by local cronies further up the supply chain has overwhelmed the endeavors of central government.

Help may be at hand from an unlikely source: new food safety legislation passed in the U.S. in January. The Food Safety Modernization Act (FSMA) tightens the purview of the U.S. Food and Drug Administration (FDA) over imported foods, including inspections at source. In a timely post on the China Law Blog, guest blogger Marc Sanchez, an attorney specializing in food and product safety matters and who writes the Food Court blog, writes:

China is the fourth largest exporter of food to the U.S…..Foreign inspection of Chinese facilities means increase pressure for China to modernize [food production]…China has attempted reform legislation, but its vast food production system remains largely unchanged. If FSMA receives its funding, it will act as a new push for rapid modernization of China’s food safety system. it will place FDA on the ground in China and it will increase border inspection of Chinese food coming into the United Sates. There is no way the FDA can do what the Chinese bureaucracy has been unable (or unwilling) to do, but it can act on China’s pride. China will not want to make the list of countries blocked from being able to export its foods to the United States.

Two comments: First, the U.S. will have to be prepared to fund FSMA foreign food inspections. With budget cutting, not spending, the crie de jour in the U.S. that is not a given. As it is some polls have shown Americans think 15% of the U.S. budget is spent on foreign aid (the actual number is less than 1%) so paying to clean up China’s food supplies, as it will inevitably be portrayed in some quarters of the U.S., will not go over well with some American taxpayers. Second, acting on China’s pride can always be a double-edged sword.

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U.N. Warns On Drought, Land Loss Threats To China’s Food Security

A senior U.N. official says that loss of farmland poses a major threat to China’s ability to be self-sufficient in grain. The warning comes from Olivier De Schutter, the U.N. Human Rights Council’s special rapporteur on the right to food, in a preliminary report based on a visit to China in December. De Schutter writes:

Since 1997, China has lost 8.2 million hectares of arable land due to urbanization, forest and grassland replanting programmes, and damage caused by natural disasters, and the country’s per capita available land is now at 0.092 hectares, 40 per cent of the world average. This shrinking of arable land represents a major threat to the ability of China to maintain its current self-sufficiency in grain. China has adopted the principle according to which any cultivated land lost for other purposes should be reclaimed elsewhere, and it has set a “red line” at 1.8 billion mu (120 million hectares) beyond which arable land will not be allowed to shrink further. But China is already dangerously close to this limit.

De Schutter also highlights the issue of drought:

Water scarcity is a huge problem: per capita water availability is less than one third the world average. According to one estimate, climate change may cause agricultural productivity to drop by 5 to 10 per cent by 2030 in the absence of mitigation actions, affecting principally wheat, rice and maize. Indeed, already today, droughts affect between 200 and 600 million mu of farmland in China every year.

De Schutter recognizes the progress Beijing has made in improving food security, but says more needs to done to improve living conditions in rural areas, to improve the security of land tenure and to move to more sustainable farming. All these are challenges that Beijing acknowledges it faces, though that makes addressing them none the less urgent.

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