Are companies really leaving their China partners behind, and if so…why are they leaving? Is it export restrictions making life too complicated for certain product lines? Is it the Uyghur Forced Labor Prevention law that makes pretty much any business operating in Xinjiang carry a red flag for importers? What about tariffs? Are companies leaving because of the imposition of Section 301 tariffs set in 2018?
Dan Harris poses these questions and gets answers to them every day. The (mostly) Seattle-based attorney at the Harris Bricken law firm helps companies do business in China, and leave it if they must. He errs on the side of leaving. Harris says that while companies are removing supply chains from mainland China, his biggest recommendation is to move to Mexico. “Some companies, though, are definitely coming here,” he says, fresh off a trip to Mexico City, a city he says keeps getting better for business and for lifestyle. Some reshoring is happening, too. “Those people that are reshoring already had some manufacturing capacity in the U.S,” he says.
One of the most interesting takes from the interview was that it’s not export restrictions, forced labor issues, or even tariffs (seeing how the markup on some goods coming from China is astronomical, and the dollar is so overvalued against the yuan). Harris says that what really lights a firecracker under the seats of decision-makers these days is Taiwan.
“We will talk to them about tariffs, and the geopolitical tensions involving China. People in business almost never mention that stuff. They are obsessed with Taiwan, though. They are always asking me about China invading Taiwan and I tell them that I have read everything I can on this and it may never happen. But businesses are terrified of an invasion ever since Russia rolled into Ukraine. They were not prepared for that and they think that if that happens, they are not going to get any product out of China whatsoever. This has caused them to think long and hard about that relationship. The Taiwan angle is frustrating for me because I can think of fifteen other reasons to leave.” – Dan Harris, partner at the Harris Bricken law firm and creator behind the China Law Blog
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CPA: What are the top reasons your clients are leaving China? To what extent can any of those reasons be quantified as increasing costs, decreasing profitability in China production?
Harris: Far and away the main reason today is Taiwan. In people’s heads, they know all of the China risks you mention. The small to midsize companies do the same thing a multinational does: they see Nike going into Cambodia, so they go into Cambodia. What about tariffs adding to costs? Well, there are companies that complained, but that is sort of old news now. We had a client in 2017-18 that had maybe 10 suppliers in China and got out before tariffs. Their prices ended up being lower than their competitors now because they got out fast. But most American companies will say ‘Oh, this 25% tariff sucks, but all my competitors have the same tariff anyway’. The benefit of the tariffs was the signal that maybe this merry-go-round in China isn’t going to go around forever. In 2018, tariff costs made everyone think about it, but then Covid hit and they didn’t want to do anything drastic. Then after Covid they said, ‘We can’t do it now because we have to get back on our feet.’ Then Russia happened and Taiwan took center stage.
“We have a client that makes a very common product. You have it in your office right now, I promise you. They have four suppliers in China. Their best supplier was automated and said, ‘let’s open a factory in Tennessee together.’ They ran the numbers and saw they could save money by doing this. While it was rumored that they were going to do this, they started getting calls from U.S. clients saying ‘we want all the widgets you’re going to make.’ Why? They wanted it because of the value of diversified, secured supply. They never even talked about price. Everyone acts like price is all that matters, and it does sometimes, but when tariffs started hitting the market I reached out to clients about it – ‘hey, it’s going to cost you more.’ One client in particular said they didn’t care about the tariffs because they were paying 8 cents for the product so they were looking at a 25 percent tariff over 8 cents and they are selling it here for $8. On the other hand, I have asked companies if they would want to have their product made in Mexico instead, even if it was 10 percent or 15 percent more to do so and they said yes, because of the China risk. People can quantify that risk. It depends on the company. The problem is that it is hard to get out of China, either way.” – Dan Harris, CPA interview, Sept. 19, 2023.
CPA: What do you tell companies that want to move? What’s top of mind for you in that moment of decision for your clients?
Harris: First, I tell them if they plan to leave China, tell nobody that you’re planning on leaving China. One day you call your supplier in China and say, ‘Sorry, I’m done’ and that’s it. Because if China gets wind that you are leaving, the vultures start circling. What we do with our clients leaving China is we set up everything to protect them: make sure they register a trademark, for example. Or you make sure you have a contract that says your molds belong to you so when you leave you at least still have them. You want to be able to ship those molds directly to Mexico instead of making new ones. That is why there is so much silence about this.
CPA: Have you run into any problems leaving joint ventures or any other business entanglements?
Harris: All of our clients have had difficulties leaving their JVs. In China, it is very easy to leave a JV if you are willing to leave with nothing. But if you want something in return then it is extremely difficult. If you get 50% of what you’re entitled to you’re lucky. Everyone got into these joint ventures 10 to 15 years ago, then about seven years ago they realized they were not going to make money off those deals, and about five or six years ago they started to give up on it and many learned that their JV partner was making their product and selling it to other markets. In this case, we would go look at the contract that these U.S. companies signed with their China partner, and guess what the contract says: it says yes, you can do this. They got bad advice from their Chinese legal team. The big auto companies were a lot smarter. They had good contracts. They made conscious choices about the deal. We’ve looked at the JVs that have worked and we determined that they worked so long as the Chinese company believed they were better off in the partnership than without it.
CPA: To what extent are your clients merely changing vendors and are some closing their own facilities in China.
Harris: Both are happening: they are changing vendors and closing their facilities in China. The smart players moved to Vietnam five years ago. We had one leave in 2018. Here’s how that happened: they went to their Chinese manufacturers and said ‘Look, we love you but the politics are not right’ and the Chinese manufacturer said, ‘Why don’t you work with our Vietnamese facility or our Philippines facility?’ Other Chinese companies were tricky and said they had a facility in Taiwan, but they didn’t have one there at all so luckily our client did the proper due diligence there and ultimately did not go for it. It was really just the mainland company transhipping out of Taiwan. It is all very product-dependent. One product that is really frustrating to get out of China is sneakers. It’s not that complicated of a product, but Vietnam is at full capacity. I can’t find anyone in Mexico that wants to make sneakers. And there are things like small engines for something like a leaf blower. You can ask a million people and they will say, ‘Forget it, it’s got to be made in China.’Chinese companies know what is happening in the U.S. supply chains. So we are seeing many Chinese companies going to our clients and, in one case I know of, contracting with American companies to make their product here in the U.S. via licensing agreements so they don’t lose that relationship.
CPA: It seems like Mexico is clearly the top choice in a post-China market. But who are the others? What are the top five?
Harris: Yes, Mexico is number one. Part of what I am seeing is biased, however, because I am on the West Coast. But after Mexico, I would say the other countries benefiting from the post-China market would be Vietnam, then Thailand, and Indonesia, with a shocking amount in Colombia, too. In Europe, you see some manufacturing being sourced now in Poland, Romania, and Portugal. Colombia is a surprise. We have no trade treaties with them but our tariffs are so low we are hardly tough on them with tariffs. They have an over-educated workforce and it is a nice country.
CPA: Where does the U.S. fit in all of this? What do you see on the reshoring front because that is what a lot of these trade policies of late are trying to accomplish.
Harris: It’s happening. I know people who think the U.S. should just be spending massive amounts of money to build factories in Mississippi and start making everything again. The companies that are bringing manufacturing here, as I said, were already manufacturing here, so they are adding more capacity.
See the International Trade Commission’s March 2023 report titled “Economic Impact of Section 232 and 301 Tariffs on U.S. Industries. The ITC found more capital investment in roughly 10 key industries it reviewed for this study on account of tariffs, with steel and aluminum being the most prominent beneficiaries.
CPA: Are any of your clients moving manufacturing here?
Harris: We have had one move back. We represent some huge companies and they don’t tell us where they are moving their supply chains. Our smaller company clients are the ones that are looking more for advice and I don’t see them sourcing supply here right now.
CPA: If you were President, what top three things would you do to dramatically increase the number of companies moving back to the U.S. rather than Mexico or Southeast Asia.
Harris: Whenever I testify in Congress on this issue, I feel like an idiot giving my answer because I’m not a policy person. You can spend a ton of money doing this or that to help manufacturing. But here is something I can say, though I don’t know if this can be done with policy. One, you have to educate Americans to do the work, to want to work as blue-collar laborers. That’s important. I’d also say to Americans that you have to remember that every dollar that goes from China to Mexico is a victory for the United States. There are people who say that for every dollar spent in Mexico, some 50 cents come back here and in China it is like four cents. Plus Mexico is not out to take us down. You can complain about Mexico all you want, but it benefits us for Mexico to do well and vice versa. We have to be realistic, not jingoistic. As president, I would tell people that manufacturing jobs can be very good jobs. I grew up in Michigan where I dreamed of making mobile homes for $14 an hour, which was a lot of money when the minimum wage was like $3.80. I worked there and I made a ton of money. The person who cuts my hair, her parents made her go to college even though all she wanted to do was to be a hairstylist. She got her degree and got out. Probably should not have gone. It’s a prestige thing, but it’s probably a waste of money and time for many. Go learn to be an electrician; get a vocational degree. We need a lot more people who want to work making things.
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The Section 301 tariffs, coupled with a rise in geopolitical risk, are now giving China a taste of what outsourcing can do to a country’s workforce. China can now understand what outsourcing to them did to American manufacturing and blue-collar labor towns across the country.
Smartly, China would prefer to have its manufacturing firms stay on the mainland. But many companies are setting up shop in Southeast Asia, with Vietnam an outpost for Chinese solar companies now. That’s thousands of jobs lost in China.
China’s economy was built on being a protective unit, set up to manufacture goods for the U.S. and Europe. Because of manufacturing, China went from a $2-a-day Happy Meal toy-making economy to the world’s No. 2 economy, with pristine urban centers, European-style public transportation, and global market leaders in 5G (Huawei), social media (TikTok), and computers (Lenovo and Lexmark). It is the world’s No. 1 manufacturer of EV batteries and solar panels. China is now as much a brand name throughout the world as Coca-Cola and McDonald’s used to be. In finance, Chinese banks are all over Latin America, while U.S. banks like Citibank have a shrinking presence. And everyone has heard of China’s top fast fashion seller Shein.
“Peak China has occurred,” said Harris. “End of story.”
But what happens when the West and China return to a pre-2018 era when everyone loved China and no one ever dreamed of leaving it?
“Once the businesses that left are in Mexico they are not going to leave there to return to China,” said Harris. “Companies don’t move that fast. But if Xi was gone and China was Western-facing, it could become less risky. That’s going to take a long time. The company that moved out last week is not going back there any time soon.”