China's new regional trade deal is latest in economic battle with U.S.

Dec 15, 2020

In mid-November, China signed a regional trade agreement—the Regional Comprehensive Economic Partnership (RCEP)—with 14 other Asia-Pacific countries. Touted as the world’s largest regional free trade agreement, it includes countries that make up 30% of the world’s gross domestic product. But it does not include the United States, even though some of the countries that signed the pact—for example, Japan, Australia, Singapore and South Korea—are strong American allies. 

The partnership is one of the latest developments in the ongoing battle for economic dominance between China and the United States. News of the RCEP also comes as President-elect Joe Biden is preparing to take office, with a platform that we expect to include a more multilateral approach to China than we have seen under President Donald Trump. 

All of this prompts a question: How can businesses navigate the current geopolitical environment? Businesses want certainty and for their investments to be protected, but they need to be aware of the uncertainty that may come with investing or operating in China.  

While the economic benefit from the RCEP remains to be seen, it will provide a platform for trade and cooperation between China and its Asian counterparts, bolstering its growth and dominance. The Trans-Pacific Partnership, or TPP, which the United States pulled out of in 2017, was created in part as a counterweight to China’s growth. It is widely expected that the Biden administration will rejoin the TPP to reassert America’s role. But it remains to be seen if the new administration will have the political capital to win over critics of the deal, including some on the left who object to certain labor-related provisions in the TPP, and some on the right who have a more hawkish view on China trade.

The prospect of the United States rejoining the TPP comes as trade tensions with China continue to simmer. Trump, for example, recently signed an order barring American investments in Chinese firms owned or controlled by China’s military. If Trump issues more such executive orders in the final weeks of his presidency, it could constrain the next administration’s policies on China.

American manufacturing

These geopolitical tensions have dampened trade, specifically in the American manufacturing sector, which had a slowdown in 2018-19. But there is no singular path to reviving American manufacturing, and reshoring is not a binary choice. Industrial machinery companies have always manufactured closer to their customers. Many U.S. companies prefer to retain manufacturing of their low-value products in Asia because the current domestic cost structure is not competitive. 

In decisions to locate manufacturing operations, companies are increasingly looking at the total business cost of such decisions instead of just manufacturing and shipping costs. In other words, even if the cost of labor may be cheaper in China, the overall business cost that includes supply chain disruption risk, technology protection risk, and the cost of sacrificing investments in domestic workers and capabilities is far higher. 

Despite uncertainty in U.S.-China relations, one cannot discount China and the advantages that it brings to the table. China is critical not only from the demand side—given its huge customer base and proximity to other Asian markets—but also from the supply side given its efficient and comprehensive supplier ecosystem, trained labor force, and manufacturing infrastructure. It is increasingly becoming a center for advanced manufacturing and digital technologies such as robotics and artificial intelligence. Simultaneously, China has become a leader in the use of electric vehicles and renewable energies, and is the world’s primary supplier of many essential minerals and metals. In addition, the RCEP eases trade compliances between participants and will further strengthen trade among China-centric supply chains that are subject to that agreement. 

The path forward

Companies should manage their cash and tax strategies to ensure that while adequate funding is available for investments, they also avoid unintended financial and tax consequences such as cash buildup, inefficient tax and regulatory structures, and cumbersome trade barriers. 

Companies with China-based supply chains will need to ensure that financial and operational risks there are as low as they can be. Repatriating cash and profits out of China is not straightforward and requires sufficient planning and proactive strategies. Companies are looking into diversifying suppliers, regionalizing their supply chains, setting up regional manufacturing hubs, applying so-called “China-plus-one” strategies (i.e., not relying entirely on China for their sourcing needs) and establishing visibility across their networks to manage some of the operational risks. 

The takeaway

Irrespective of whether the RCEP will increase China’s dominance or if the United States is successful in reasserting its dominance, tensions between the U.S. and China will likely continue, even during a new administration. Agility and preparedness will help companies manage operations in a world with polarized global powers.

RSM contributors

  • Shruti Gupta
    Shruti Gupta
    Industrials Senior Analyst