Over the past several decades, China has grown into an economic and financial superpower that only the USA, with all of its might, could rival. With an export-focused growth model, the country saw double-digit growth figures for decades, but, perhaps inevitably, this has come to an end due to the recent social and political events in China.
In 2018, China saw its slowest economic growth since 1990. This has been complemented by wage growth slowing, and corporate borrowing and spending falling. This economic slowdown can be attributed to a host of factors, including several domestic issues and some that are inevitable when a country sees rapid economic growth. For example, Chinese wages were amongst the lowest in the world at the beginning of the country’s transformation, and now wages have caught up with those in most emerging markets, so a slowdown in wage growth was bound to happen.
However, on top of the issues that stem from the economy, what cannot be ignored are the hugely influential social and political events in China that have made headlines over the past twelve months and have had extreme ramifications on the Chinese economy. Whilst complex and often confusing, these disruptions can be summarized into three primary issues; the US-China trade war, the resulting currency manipulation, and the Hong Kong protests that have run over the past several months.
This article will broadly explain these three factors and how they have impacted China, and the more importantly, the potential ramifications on the rest of the world. China has important position in the economic and financial world – particularly through Hong Kong (its ‘special administrative region’). Therefore, the country’s slowdown has global impacts, affecting stakeholders from everyday consumers in the West to traders in the Asian markets, to big multinationals with presences in Beijing and Shanghai.
First and foremost, let’s address the elephant in the room. Over the past year, the US and China have been locked in a trade war that has had impacts all over the world. This has mainly taken place in the form of the two superpowers enforcing strict tariffs on each other, as well as a range of eye-catching developments. These developments include American criminal charges against Huawei, and America labelling the Chinese government as currency manipulators – this will be discussed in detail later.
Trump has accused China of trading unfairly, with a particular point of tension being Chinese state subsidies to domestic firms that make American exports uncompetitive. In response, the Chinese government claims that the real reason behind aggressive American tariffs on their exports is due to their fear of increasing Chinese strength and that the tariffs are their way of curbing Chinese influence and growth. Trade negotiations broke down in May of this year, and since then, the trade war has taken an ugly turn, with insults and tariffs being traded regularly. In total, the US has imposed tariffs on more than $360 billion worth of Chinese goods, and in return, China has responded with tariffs on over $110 billions worth of US products.
Trade negotiations have reopened recently, but it is unclear how fruitful they will be. A fresh wave of American tariffs on Chinese goods is set to hit on 1st October 2019, with even more to follow in December. President Trump has claimed that the Chinese should aim at securing a trade deal now, as if the dispute drags on after the 2020 American Presidential elections, things will get “far worse” for China – of course, this is under his presumption that he wins the presidency once again.
Secondly, from the trade war, there arose a second issue – the accusation that China manipulated their currency, in response to fresh American tariffs announced in August. For a long time, China claimed that they wanted the yuan to be stronger than the seven yuan to the dollar rate, but they went back on this and allowed the yuan to depreciate to weaker than the seven to one ratio. This move would make Chinese exports cheaper for American consumers to combat the increase in prices that came as a result of the tariffs. It is unclear whether the accusations hold true, as Chinese authorities vehemently maintain that they did no such thing and that the yuan’s fall in value was a result of natural market forces. If it were true, it would represent an extreme move on behalf of China, as currency manipulation breaks global trading rules by giving countries unfair competitive advantages.
Lastly, running alongside the US-China dispute, are the current protests in Hong Kong. Hong Kong is an autonomous region within China and is hugely important to its economy. It is one of the financial capitals of the world, rivalled only by New York and London, and many companies use the territory, with its strong independent legal system and a free-market economy, as a way into Asia. However, in April of this year, pro-Beijing leader Carrie Lam introduced an extradition bill which would have allowed for criminal suspects to be extradited to mainland China, under certain circumstances. Thus, Hong Kong’s residents could be trialled in mainland China’s courts.
As a result, hundreds of thousands of protesters took to the streets, and in the past months have defaced parliament and stopped airports from functioning through their protests. They have been faced with harsh police crackdown and brutality. Despite the fact that the original bill has since been withdrawn, protests remain strong, as the situation has grown into a fundamental fight for freedoms. China has responded with harsh rhetoric, labelling the protests as ‘near terrorism’, and at one point, the use of Chinese military seemed extremely likely (and is still not unthinkable).
The situation in Hong Kong remains the most volatile and unclear, prone to change on any given day, and as a result, the impacts are harder to predict. Much of the impact for China depends on the Chinese reaction; if worst fears are realised and Chinese tanks and troops roll into Hong Kong, it could prompt aggressive disapproval from not just the US, but the West as a whole, potentially resulting in further tariffs and possible sanctions and embargos. The instability in Hong Kong also harms China – domestic business in Hong Kong alone is suffering, and prolonged instability will deter companies from both openings or maintaining a presence in the region or from using its financial services.
Hong Kong has long faced competition from Singapore to be Asia’s financial sector, and while it has so far always shrugged off that competition, this could soon change. In recent years, Hong Kong has had to deal with mainland cities taking up business, such as Beijing and Shanghai, but with recent developments, if there is any winner from the instability, it is in all likelihood going to be Singapore. Being a country that can provide the stability and prosperity that the world’s largest corporations need, and with links to Islamic finance centres such as Malaysia and Indonesia, it is looking like an extremely attractive proposition.
However, looking at the bigger picture, the most obvious impact is that none of these three factors are good for the Chinese economy, contributing further to the most extreme economic slowdown that the country has seen in almost 30 years. The fact that this happens at all means a period of uncertainty amongst corporations and investors, as they are forced to wait out the current on-goings. This means a lack of investment in the country, which perpetuates the slowdown further. It is also damaging for countries that rely on exports to China, as consumer demand will slow, harming the economies of nations such as Australia, Brazil and Indonesia. A weakened yuan will make it even harder for Chinese consumers to import goods. In a year where a global recession looks imminent, this is by far the biggest takeaway from the socio-political situation in China; when China’s economy slows, so does the world’s.
Naturally, this will be made worse by any further escalation in the trade conflicts. The ongoing talks might turn out to be fruitful, but there is a danger that markets are overly optimistic about where they will go. Put simply, prices of stocks, bonds and other assets remain unreasonably high, as investors rely on American and Chinese comments in recent weeks that signal the possibility of an end to the conflict. This could prove to be a grave mistake on their part, as no actual, tangible progress has materialised. Investors are increasingly reliant on algorithms that use these comments to forecast an overly positive image for global business transactions. They ultimately mean very little in the context of US-China relations, and even if US-China talks are positive, there is no escaping that fact that other factors point to recession, including slowing economies in Asia and across Europe. Even the US is starting to show weakness, shown by recent interest rate cuts to stimulate activity. As a result of this over-optimism in the markets, It is possible that stock prices fall dramatically in the next twelve months.
In terms of specific legal impacts that stem from the volatility surrounding Asia’s largest economy, it is unclear what the ramifications will be. This is primarily a commercial, financial and political situation, that has its impact on law firms through how it impacts their clients and international corporations. Firms will have to be particularly wary of a downturn in business, particularly with mergers and acquisitions and a potential slowdown in IPOs. This is symptomatic of any potential recession but is further amplified if the two major superpowers of the world are the ones that suffer the most.
For what it is worth, firms have yet to show any movement away from China; Herbert Smith Freehills recently established a joint operation in Shanghai, and Linklaters added a competition partner to their Beijing office. Additionally, the Law Society of Hong Kong have scrapped plans to tighten rules surrounding foreign lawyers practising in Hong Kong, so this should help to offset any deterrence caused by the instability. In truth, it is unlikely that we will see any movement away from China or Hong Kong in the coming years, as offices are long term commitments and there is likely to be a demand for firms to help navigate the uncertainty. If anything, we would see the shift take place in new offices being opened, in places like Singapore, Tokyo and Seoul.
Where business goes, firms will follow.