Foreign firms should expect China to react more swiftly to sanctions imposed by the US and its allies. Beijing has been ramping up its ability to retaliate against economic sanctions and is now beginning to flex its muscles by using those new measures in a selective and careful way to retaliate.
This Insight captures key points of discussion and comments at a recent China CEO Forum briefing on the intensifying challenge, guided by a leading China commentator, who detailed the new policies and their likely impact on foreign firms operating in China.
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+ China has developed a suite of policy tools to better retaliate against the economic sanctions imposed upon it.
+ Since early 2023, China has been stress-testing its policy tools, namely the Anti-Foreign Sanctions Law, The Unreliable Entities List, and the Export Control Law.
+ To date, China has retaliated cautiously to minimise harm or costs to its economy.
+ Alongside its official sanctions, China will continue to use unofficial sanctions when red lines are breached (e.g., around Xinjiang, Taiwan, and Hong Kong). The strategy will create an unpredictable environment.
+ China will target foreign firms deemed ‘bad actors’ if they fail to support the state's goals. China wants FDI, but only from firms it deems ‘good actors’.
+ China’s laws combined with home-country sanctions will put many foreign companies in a bind. China CEOs must be sensitive to how headquarters perceive an ‘in China for China’ message.
Foreign firms should expect China to react more swiftly to sanctions imposed by the US and its allies. Beijing has been ramping up its ability to retaliate against economic sanctions and is now beginning to flex its muscles by using those new measures.
‘China is gearing up – not to intentionally drive an escalation of geopolitical tensions – but to respond commensurately to external actions imposed upon it.’
The most recent example of China using the new laws was the export controls it slapped on rare earth minerals germanium and gallium.
‘China is currently building and stress testing a suite of policy tools to respond to foreign governments in a targeted, agile, and reciprocal fashion.’
A cautious approach, thus far
China has been selective and careful in its response, even if this is not how the headlines represent it.
‘China has exhibited caution in retaliating because advisors believe these tools have weaknesses. Potentially retaliation may cause more pain to China than the intended target.’
China has limited options – hitting back hard will be costly. Micron’s case offers clues to the dilemma they face. China went after Micron because they were a smaller player, not a large one.
‘Micron is not that important to China. The same can be said of Raytheon and Lockheed. None were dependent on China for revenue nor was China dependent on them.
‘Micron was perceived to have harmed China’s interests even if it is a small-scale player. China’s actions were narrowly scoped: they did not challenge FDI, and Micron’s products were replaceable.’
Targeting Micron was also a test of the cybersecurity review mechanism. The mechanism has proven to be an agile tool and an effective stopgap while they strengthen other measures.
‘This was the first time China used the Cybersecurity Review against a foreign company or a hardware firm. In the past, they targeted domestic platform companies. They recognise that China’s retaliatory capacity on the export side is weak but not so the cybersecurity mechanism. Cybersecurity reviews can go on indefinitely and when they decide to end a review they can do so with a big fine. When the AFSL1 was rushed out the door it was riddled with holes.’
China is a relative newcomer to unilaterally imposing ‘official’ sanctions. Up until 2018, China mainly participated in sanctions as a member of the UN Security Council. Since 2019, China has upped its use of unilateral sanctions but tends to focus on individuals and certain companies in a targeted way to send a specific message.
Before the trade war, when China wanted to punish what it deemed were bad actors, it typically did so with unofficial sanctions through adhoc administrative decisions designed to send a message to foreign firms or individuals, e.g., South Korea’s Lotte chain, blocking trade with Lithuania, and the ban on Canadian Canola. The continued use of such unofficial sanctions coupled with official sanctions is likely to foster an unpredictable environment.
More tit-for-tat: licensing approvals
Much to China’s dismay, after the CHIPS and Science Act was passed, the US worked with its allies to further block China from gaining access to the most advanced semiconductor chips.
‘China made a big diplomatic attempt to stop it from happening, but those attempts were unsuccessful. Now, all they can do is respond to the strength at which those controls are implemented.’
The US, its allies and even China will use licensing approvals as the policy tool of choice to control technology outflows.
‘How the allies grant licenses will be critical. If the Japanese approve some export licenses and rejects others, China will do the same. If the Dutch are very strict on license approvals, the Chinese will do the same.’
Good vs bad companies
China intends to send a clear message with how it uses sanctions. Foreign companies are welcome in China, but they must adhere to China’s terms or at least not actively go against them. Bad actors will face tough sanctions.
‘If you are a bad actor, as Micron was perceived to be, then China does not want that company to stay. Although, those bad actors can “kiss the ring” to stay.’
The goal is behaviour modification. Local firms come under even more pressure than foreign ones. The crackdown on tech platforms and its resolution is a case in point.
‘Things will not necessarily return to normal now that the tech crackdown is over. The party does not want a bunch of big powerful tech companies in an argumentative relationship with the government, that shrug off penalties and fines, and persist in illegal or risky behaviour.’
Tech companies in a socialist market economy are expected to follow the government’s lead.
‘The government expects tech companies to help it reach it strategic technological goals. Officials want companies to contribute R&D funding to achieve those goals. They also want employers to follow the labour law and protect customers’ data. Lastly, the government wants firms to make money. Being profitable is on the list, but not a top priority.’
What has happened in the tech industry offers valuable takeaways for foreign firms.
‘The Chinese government don’t expect the same level of loyalty from foreign firms as local ones, but they do expect companies to behave in a way that is beneficial to the state and its technological priorities.’
While China believes its messaging is consistent and clear, it fails to consider that foreign firms must please stakeholders at home as well.
'The charm offensive with top-level meetings with Bill Gates, Tim Cook, and Elon Musk sends the message that they want foreign investment. But at the same time, with the Micron review and crackdown on due diligence firms, they are sending signals that it is harder to do business in China.’
China does not acknowledge the contradiction.
‘China wants FDI and to be a premier destination for business. At They also want companies in China to behave in a manner that is beneficial to China, and not to undermine China's interests.’
A compliance vice
China CEOs must avoid getting stuck between two masters as sanctions ratchet up in China and at home. The strategy and messaging that works for China will increasingly not work at HQ. The message needs to be tailored the audience.
‘It's important to formulate a nuanced approach and consider what foreign governments need to see you doing in China. That's the trick and it certainly isn’t easy.’
The challenge is only going to get tougher. The US is set for another fractious election cycle. The EU will add more sanctions to the pile. And China will reciprocate more actively.
‘The US intends to ratchet up pressure on China through all available channels for the foreseeable future. China will respond in-kind and reciprocally. The surprise is what does China think “in-kind” means? And what will your home government expect to see from your China operations?’
What to do next
China CEOs will need to ensure their teams keep close tabs on how China expands its sanctions policy toolkit. China will be strengthening its hand with new rules and stress-testing with more enforcement cases.
Firms will need to monitor the following:
+ How is China writing rules related to the Anti-Foreign Sanctions Law and supporting regulations?
+ How is China shoring up its export control regimes with rules and regulations that support the implementation of controls?
+ How are licensing approvals being weaponised?
+ How is China using its cybersecurity review mechanism?
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