How to (not) win friends and influence people

June 24, 2024

This week in The Red Report

From Zhongnanhai: This week in Chinese Politics

China woos Australia and New Zealand; and Malaysia wants more

China’s attraction appears to face an uphill battle in the Indo-Pacific, as US allies prioritize national security over enticing trade deals, and China’s partners begin to question the real benefit of some agreements.

Analysis

Beijing’s attempts to win back support in the Indo-Pacific received tepid receptions in a sign that China’s economic attraction is fading. Senior CCP leaders went on the charm offensive in Australia, New Zealand, and Malaysia to try to entice these countries away from the US’s vision for the Indo-Pacific. Premier Li Qiang 李强 visited the three countries in an attempt to emphasize China’s positive relations, to promote trade and commerce, and to increase mutual communication between governments. The subtext to the trips in the Southern Hemisphere, however, is to dissuade countries like New Zealand from joining an expanded AUKUS, which currently serves as a pillar of US security in the region. 

However, China’s leaders are sending contradictory messages. The CCP says that they want closer ties, while simultaneously antagonizing potential partners on issues ranging from people-to-people exchanges, to espionage, to dumping exports. The negatives seem to outweigh the positives and frustrate Beijing’s ambitions to pry countries away from Washington. Critics of the CCP in Australia in recent years, for example, were warned that they were likely being targeted by Chinese foreign interference operations, and an Australian journalist who spent three years detained in China was barred from attending media events during Li Qiang’s visits with Australia’s Prime Minister. Li’s efforts in Australia are therefore unlikely to shift public or government opinion towards China, with the news cycle still dominated by Canberra’s decision that Chinese investors must divest from rare earth metals in the country on national security grounds. 

Li’s visit to Malaysia found the country’s Prime Minister disappointed in China’s relatively small offering, notably pointing to Xi Jinping’s decision to send his Premier instead of visiting himself. Despite signing agreements and stressing the strength of bilateral relations, Xi’s decision to not visit Malaysia until 2025 has disappointed some in Kuala Lumpur. The signing of multiple bilateral agreements over the past few years has made Malaysia one of China’s closest regional partners and an applicant to China’s BRICS forum, yet questions remain as to the benefit of some of these agreements, as well as whether these moves will damage Malaysia’s relations with the US. In sum, China’s attraction appears to be flagging across the board. Not only states like Australia and New Zealand, that would have previously been won over with offers of trade deals, but also with states like Malaysia that are starting to weigh the benefits of business deals with other geopolitical concerns. Global businesses should therefore continue to both monitor geopolitical developments and to consider how operations might be affected by governments deciding to either expand or contract their economic ties to China.

On the Hill: Developments in US China policy

US pressures allies to align on China

The US’s pressuring European and East Asian allies to further restrict chip and AI technology exports to China means that countries–and companies–will likely need to increasingly choose between the US and China. The backfiring of a recent Pentagon campaign, however, suggests that, at least for now, US allies may have other ideas about picking a side.

Analysis

The US is determined to sever China’s access to the advanced chips that Chinese technology firms need for AI innovation. Washington is considering tightening its export controls further out of concerns that allies like South Korea and Japan are re-exporting US chips to China in contravention of US chip bans. In response, US policymakers headed to South Korea, Japan, and the Netherlands to emphasize that they should similarly tighten controls to prevent companies like Huawei from building semiconductor fabs in China. If US pressure succeeds, then it suggests that countries–and companies–operating in the US and its allies, including in Europe, South Korean, and Japan, will likely face increasing regulatory and political pressure to restrict investment and sever ties in China if they wish to maintain their connections in the US. Global companies should continue to make contingency plans in case they need either to isolate their China-based businesses, or to sever their connections with China entirely. 

Yet while China engages in similar zero-sum thinking about its partners, this could be a risky strategy for the US. While US pressure is catalyzing its allies’ decisions to decouple from China, it also risks pushing countries (and companies) into a binary choice that may end up alienating vital partners or even drive closer engagement with China. Forcing US partners to engage exclusively with the US over China also allows Beijing to emphasize that it is the US that is pushing such narratives. Most recently, this surfaced in reports that the US Department of Defense (DOD) ran clandestine campaignsdisinformation campaigns” to undermine trust about Chinese Sinovac vaccines during the Covid-19 pandemic. Chinese media argued that the reports reinforced the CCP’s view that the US is an adversary intent on undermining China’s rise. These accusations also highlight how the DOD’s prioritization of short-term gains over China risks alienating vital partners around the world, particularly in countries like the Philippines, which is in a particularly sensitive geopolitical position between the US and China. Where companies should continue to consider how to segregate their operations between global and China-based practices, the US government should therefore also consider how to make such a transition more attractive, rather than punitive.

Business Matters

Ties to China – real or perceived – jeopardize companies’ access to Western markets

Fast-fashion company Shein prepares its London IPO after failing on Wall Street; anti-China sentiment combined with heightened scrutiny are to blame.

Analysis

While the European Commission’s highly anticipated ruling regarding its anti-subsidy probe into Chinese EVs was finally announced – resulting in tariffs of up to 38% on Chinese EVs – this issue’s attention focuses elsewhere in Europe, namely the UK, and its courtship of fast-fashion company Shein. Founded in China in 2012, Shein moved its headquarters to Singapore in 2022 as part of its efforts to increase its global appeal through de-Sinicization. In November 2023, Shein then filed for its IPO in New York Stock Exchange (NYSE) at an estimated value of US$90B, but its ambitions were short-lived. Much like the fate of Chinese EVs and TikTok in the US, Shein came under intense scrutiny because of its Chinese origins, and allegations of using forced labor in Xinjiang to source its cotton ultimately derailed its US IPO; new research conducted to identify the source of Shein’s cotton found only 2.1% was from Xinjiang, which was well under the average of 14% found in the products of its competitors.

Armed with such findings, Shein has now set its sights on the London Stock Exchange (LSE), where it has filed for an IPO valuing the company at GBP$50B (approximately US$66B). If approved, Shein’s IPO will be worth more than all new listings on the LSE since 2018 combined. This prospect is putting the UK in a difficult position. US Senator Marco Rubio wrote the UK Chancellor of the Exchequer to express his concerns about the potential forced labor in Shein’s supply chain and also the company’s dubious shipping practices. The latter point refers to Shein’s exploitation of a “de minimis” loophole that allows small packages to avoid paying import tariffs, meaning that the majority of their products are bypassing customs in both the UK and US. While Shein has won support from the UK’s Labour Party, the British business and regulatory community has expressed concerns. Shein’s fate remains too uncertain to predict.

Of interest in both the US and UK cases is the question of whether or not Shein is a Chinese company. While founded in China, the company is officially registered in Singapore (as of 2022) and its elusive founder, Xu Yangtian (also known as Sky Xu and Chris Xu), earned permanent residency there the same year. More recently, Shein executive chair Donald Tang claimed that Shein could be considered an American company because of the values it supposedly shares with American culture, like fair competition and rule of law (not to mention that 28% of Shein’s 2023 sales were in the US market). At the same time, Shein had originally applied to and received tacit approval from the China Securities Regulatory Commission for its US-based IPO, a step required of companies with significant operations in China. Whether the Commission will approve the LSE IPO remains to be seen, but the need for such approval in the first place undercuts broader claims of Shein’s de-Sinicization.

Regulators and politicians in the US, the EU, and now the UK, are showing a clear trend toward heightened scrutiny on companies with any ties to China, creating significant instability and unpredictability for business outcomes. Even if Shein ultimately succeeds in the UK, its failure on the NYSE still casts a pall over the potential fates of other companies with even residual ties to China. This can be seen, too, in scrutiny brought to Tesla’s and Ford’s use of EV batteries supplied by Chinese companies Contemporary Amperex Technology Co. Ltd. (CATL) and Gotion High Tech, which have been accused of hiding forced labor in their supply chains. Shein’s IPO struggles should serve as a warning to all companies that, as they perform due diligence on their supply chains or consider partnering with companies that have Chinese origins or affiliates, they are courting a potential regulatory scrutiny. This is especially true as Chinese companies have become increasingly adept at concealing their origins through techniques such as “Singapore washing” (as in the case of Shein) and joint ventures in countries that are on friendlier terms with the West (such as Brazil, Morocco, Mexico). Unless companies are prepared to lose its investment altogether, It is advised that they avoid high-profile Chinese collaborations for the time being and continue vetting not only their supply chains but the suppliers of their suppliers in order to stay ahead of regulatory scrutiny.

Tech Futures

The Party drives the future of AI in China

A speech to party leaders hints at the CCP’s ambitious plans to use AI as a tool to become a technological superpower. These ambitions will co-opt Chinese government, academic, and business entities to achieve the party’s goals.

Analysis

A speech by an expert from the Chinese Academy of Sciences (CAS) to senior party members hints at how the CCP thinks about AI as the future for governance and economic development. Sun Ninghui 孙凝晖, a computer scientist and dean at CAS, laid out a vision for AI as a tool for the CCP to pursue dual-use technological innovation, target dissent, promote efficiency in China’s flagging economy, and outcompete the US. Notably, Sun underscored how AI also presents a risk that the CCP will need to manage, particularly regarding the potential for AI to express alternate viewpoints that do not align with the party’s perspectives (aka freedom of speech). Like the internet boom in the late 1990s, the party’s desire to champion AI is therefore multifaceted. AI is a tool to accelerate China’s path towards superpower status, notably by providing the necessary efficiencies to achieve “New Productive Forces.” At the same time, the party sees AI as a risky technology that needs to be managed so that it serves the CCP’s agenda, rather than undermines its monopoly on information. 

In pursuit of AI leadership, the party is operationalizing a whole-of-government approach to catch up to the US and to seize first-mover advantage in AI innovation. This approach also includes relying on Chinese businesses and universities to conduct research on AI in service of the party’s ambitions. This means that companies or institutions working on AI should be particularly cautious about engaging Chinese entities, which are all subject to direction by the CCP to steal IP furthers China’s goals on AI. This risk extends to company employees, including both Chinese and non-Chinese citizens, who are increasingly targeted to provide sensitive information to Chinese actors. Companies should therefore educate employees about these risks and screen for potential malicious and unintended by dangerous behavior. 

Espionage Alert

Hacking Europe

Surge in Chinese espionage reports suggests that China’s spying efforts are far more extensive than previously thought. Western governments, institutions, and businesses are increasingly at risk of being targeted by Chinese hackers and need to significantly strengthen their cybersecurity procedures.

Analysis

Reports of Chinese espionage have persistently populated European media outlets this year, but a report from Dutch authorities notes that Chinese cyber spying is even more prevalent and widespread than European governments suspected. The report notes that the extent of China’s hacking scandal against Western governments, international organizations, and defense companies in 2023 was such that those targeted should assume that their information had been breached and act accordingly. The original hacking accessed 20,000 FortiGate edge devices–including firewalls and routers–through a new remote access trojan called “Coathanger.” Edge technologies are frequently targeted by hackers and often lack security technology to defend against such attacks. They are therefore an extremely important, yet vulnerable, component within a company’s digital infrastructure that deserve far more attention than most entities currently grant. 

The uptick in reports of Chinese spying efforts from Germany to Canada also points to a broader trend of China increasing the scale of its already massive level of espionage. Where Chinese diplomats try to swat away such accusations, the prevalence of these reports across the public and private sectors suggests that China is increasingly willing to employ a variety of means to achieve competitive advantages for Chinese state and business actors. Companies, even those that are not directly engaged with partners in China, therefore need comprehensive physical and cyber infrastructure strategies to defend against a likely breach or theft of sensitive IP.

One more thing…

Judging Hong Kong

Foreign justices depart Hong Kong’s highest court as the CCP’s tightening grasp crushes what little remains of the city’s unique status.

Analysis

A slew of resignations by foreign judges from Hong Kong’s highest court is sounding the city-state’s death knell. Foreign judges are a feature of Hong Kong’s unique political situation that have served to reinforce businesses’ confidence in the judicial system as a bastion of British-style common law since handover in 1997. After the passing of the controversial National Security Law in 2020, however, the judges’ presence on the court has been questioned by both foreign governments as upholding a draconian CCP policy, and by Chinese nationalists, who see the persisting presence of foreign decision makers as antithetical to the CCP’s authority. 

These recent resignations triggered a scramble by Hong Kong’s leaders to assure businesses that the courts would continue in their current impartial role, but the departures signal a continuing erosion of Hong Kong’s unique status as the CCP collapses legal and political distinctions between Hong Kong and the Mainland. Businesses in Hong Kong should therefore either continue to seek potential options for relocation or be aware that a future presence in Hong Kong will likely need to operate as if they are located in Mainland China. This means that businesses in Hong Kong will increasingly be unable to rely on the independence of the city’s formerly respected judicial system to enforce contracts, be required to conform to the CCP’s priorities through its enforcement of the purposefully vague National Security Law, and be susceptible to potential political interference in the form of employee detentions or data seizures as in the Mainland. The departure of foreign judges from Hong Kong therefore signifies a much broader undermining of the city’s legal, political, and global status.

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