Rising Protectionism. Economic Distress. Navigating a New Era of International Trade

Go forth and conquer the world.

That was the prevailing dictum for U.S. and other Western multinationals as, starting in the 1970s, it became easier and easier – and cheaper – to move goods around the globe. They had the know-how. Asia supplied the inexpensive manufacturing. Meanwhile, local governments and global regulatory organizations held the doors open, consistently enacting rules that greased the wheels of international trade.

But now some of those doors are closing. World trade is projected to shrink by a third in 2020. The U.S. is engaged in an increasingly hostile trade war with China and has pressed for substantial reforms to the World Trade Organization and the way it resolves trade disputes. A global wave of protectionism has produced a slew of new export bans, domestic subsidies, foreign investment regulations, and tariffs.

Image: ©World Trade Organization

The chaos wrought by COVID-19 accelerated and exacerbated the shift and could very well produce an entirely new set of trade policies and priorities. But the turn toward protectionism didn’t start with the pandemic.

“At this point, business leaders can’t ignore the fact that the world has fundamentally changed.”

“Well before COVID-19, we saw the pendulum swinging back from globalization to increased economic nationalism, with reshoring activities and more regional supply chains,” says Ted Murphy, a partner in Sidley’s Washington, D.C. office. “At this point, business leaders can’t ignore the fact that the world has fundamentally changed. They can’t merely take their plans from four years ago and try to implement them. They’ve got to largely start over; they need to embrace the flux and chart a new path through it.”

For many stakeholders, the reconsideration of global trade, combined with COVID-19, economic distress, and a widening sense of inequality, could lead to significant changes. There are indications it may usher in an era of new rules that, at least on their face, champion workers’ rights, environmental stewardship, and improved health and safety measures.

For even as the world appears to move away from globalization, new and meaningful cooperation between countries will persist, whether it’s collaboration on clean technologies, more information sharing between certain countries, or new (or updated) bilateral and regional trade agreements, like the United States-Mexico-Canada Agreement.

Business leaders charged with navigating a path into the future have their work cut out for them. They’ll need to adapt to the new reality of increased export controls and tariffs, more regionalized supply chains, increased trade remedy protections, and complex foreign investment screenings.

But while risks abound, so do opportunities. Each of the following segments looks, through business leaders’ eyes, at a critical aspect of the new international trade landscape.

Not long ago, tariffs remained something of an afterthought for most products coming into the U.S. – but in 2018, the country doubled its tariff revenue. “Now, tariffs are one of the biggest impediments for multinationals importing into the country. It makes it harder to make a profit,” says Barbara Broussard, a partner in Sidley’s Washington, D.C. office.

Though the recent spike in U.S. tariffs emanated in large part from trade tensions with China, the effects were felt more broadly, with the U.S. driving up import prices for goods like aluminum, steel, and washing machines – and engaging in tariff duels with the likes of Turkey, India, and the EU.

On the export side, there’s been a concurrent rise in the application and enforcement of economic sanctions and export controls, involving, for example, Iran and Russia – oftentimes with conflicting regulations from the U.S. and EU. “There’s also a stronger focus on human rights and sustainable sources,” says Sven De Knop, a Sidley partner in Brussels, “which adds an additional layer of complexity to compliance.”

“The question becomes: How do I plan for a resilient supply chain in the face of protectionist tendencies around the world?”

The importance of technology has brought tech companies – even early-stage startups – into the fray as well. “Young entrepreneurs may be working on the next big thing in their garage and have no idea that they have to worry about U.S. export controls,” says Jen Fernandez, a Sidley senior associate in Washington, D.C. “There can be a real lack of awareness in the industry.”

Guidance: Revamping supply chains for the new era of international trade

The bevy of new import/export policies certainly reflects a more protectionist world – and COVID-19, which instigated new export restrictions on goods like personal-protective equipment and ventilators, has only exacerbated the shift.

“All the rhetoric around resourcing to home shores is a huge issue,” says Todd Friedbacher, a Sidley partner in Geneva. “The question becomes: How do I plan for a resilient supply chain in the face of protectionist tendencies around the world?”

Diversification and regionalization have been touted as solutions. But in today’s uncertain moment – with a constant stream of new rules and intensifying geopolitical tensions – this may be easier said than done.

So what should business leaders know when reassessing their supply chains? Here are five things to keep top of mind.

1) Understand your supply chain – and look for patterns. As Friedbacher notes, “There are hundreds of international trade agreements – bilateral, regional – that are much less vulnerable to the protectionism trend we’re reading about in the newspapers. Multinational leaders have to analyze that web of agreements and take advantage of reliable supply chain relationships.”

2) Leverage government allies. Executives and board members at large corporations should activate their network of natural government partners to ensure that a diversified supply chain doesn’t fall apart in other parts of the world. “Businesses can have those allies shout from the rooftops about adherence to WTO rules, then threaten to enforce them if they aren’t being followed,” Friedbacher says.

3) It’s not just about efficiency – it’s also about politics. “We used to talk about rationalizing supply chains,” says Richard Weiner, a Sidley partner in Washington, D.C. Executives would look at an overlay of different trade agreements and decide, say, that it would make sense to do a degree of manufacturing in Colombia, take the finished product to Peru, and then assemble it in Mexico. The decisions were based almost entirely on efficiency. But now, Weiner says, “you have to think through the politics of trade in addition to efficiency, and that’s a different Rubik’s Cube.”

4) If possible, reduce third-party reliance. Third parties can pose risks – especially if business leaders aren’t aware of, for example, the end use of foreign manufacturers’ materials or the other markets they’re serving. “From an enforcement perspective,” De Knop says, “authorities expect operators to take responsibility and exert more control over their supply chain.”

5) Think about exports in coordination with imports. Companies need to think holistically about international trade compliance, which means considering imports and exports in tandem. For instance, Broussard explains, the U.S. has put a number of restrictions on technology transfers to certain Chinese companies. “Even if tariffs may not pose a danger, you still have to consider your relationships with manufacturers with respect to these technology transfers.”

Broadly speaking, these supply chain adjustments present new long-term challenges for business leaders around the world. “People are literally starting with maps,” says Murphy. “There will be a real period of adjustment. It’s a new game.”

The recent slide toward protectionism isn’t historically unique; governments have long responded to economic downturns with policies intended to bolster domestic industry, often at the expense of competitors abroad.

“It’s an age-old tendency,” says Friedbacher. Trade rules, he explains, were created to limit the discriminatory action that governments can take at moments they’re most inclined to do so.

COVID-19 and the recession it set off have indeed prompted governments worldwide to offer subsidies aimed at bolstering domestic businesses. We’ve seen this play out in countries that were already firmly committed to taking protectionist steps, such as with the CARES Act in the U.S. But domestic subsidies have also appeared in places where protectionism hadn’t taken hold: the EU’s state aid package grants and public loans and Canada’s wage subsidies, tax deferrals, interest-free loans, and loan guarantees are just a few examples.

But nothing in this world comes for free. Just as in previous recessions, experienced observers agree the new polices will trigger a slew of anti-dumping and anti-subsidy litigation – at the WTO and elsewhere – claiming the domestic subsidies had a discriminatory or otherwise unfair impact on foreign competitors.

In China, for example, the price for goods produced in factories is falling by the fastest annual rate in years, because while Chinese production is back online, demand remains low. This is sure to cause a raft of anti-dumping and countervailing duty cases brought by the U.S. and others, under domestic laws anchored in WTO agreements which say, essentially, that countries can shield themselves from imports of goods that are unfairly priced or subsidized.

“Chinese producers will say that injury derives solely from COVID-19,” says Weiner. “The U.S. will say that’s not the only reason. We just have to prove that your imports are a cause of injury to our domestic industries, not the only – or even the predominant – one.”

How to head off litigation – or pursue it

With the prospect of litigation all but assured, Friedbacher says business leaders have to play both offense and defense.

On the offensive side, “if you see your competitor abroad is getting unbelievable subsidy support from its government, you want to learn everything you can about those subsidies to see whether your own home government can challenge it in the WTO.”

As for defense, it’s a matter of being thoughtful about the types of support you may be getting. “Governments are allowed to give below-market funding to domestic players in a given industry. That’s perfectly legal – as long as you stay within certain bounds.”

For example, if subsidies go on to cause aggravated economic harm to foreign competitors in global markets, it can be cause for litigation. However, Friedbacher says, “it takes a lot of hard econometric slogging to prove economic harm in a foreign market.”

“Governments are allowed to give below-market funding to domestic players in a given industry. That’s perfectly legal – as long as you stay within certain bounds.”

What multinational leaders really need to avoid are other sorts of bells and whistles that get attached to government subsidies, which in turn make them per se illegal – even without proof of economic harm.

“They should avoid any subsidy tied to the export of their product or to the use of domestic inputs as opposed to imported inputs,” Friedbacher adds. “You want to avoid a tendency that governments have to try and boost export revenue or encourage a ‘buy American’-type policy.”

Companies on the receiving end of relief money can negotiate with home governments to make sure none of these per se violations are attached – which means it’s crucial for executives to engage with their government representatives.

Importantly, while anti-subsidy laws in individual countries have their own nuances, they generally follow the principles established by the WTO Agreement on Subsidies and Countervailing Measures. The SCM Agreement defines countervailing subsidies as government measures that provide a financial contribution, confer a benefit, and are specific.

Covid-19 support measures, Weiner says, should easily satisfy the financial contribution and benefit elements of the SCM Agreement. So it really depends on whether these measures may be considered specific – meaning that the legislation at issue explicitly limits access to certain enterprises or that the factual circumstances at hand indicate as much.

“Most support legislation, however, is drafted to avoid any explicit semblance of specificity, so the answer to this question turns on those particular factual circumstances and the nature of the measure’s implementation,” Weiner says. “As such, an analysis of these risks is a highly fact-intensive exercise.”

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Earlier this year, long-awaited regulations came into force that greatly expanded the reach and authority of the Committee for Foreign Investment in the United States (CFIUS). At the same time, EU leaders enacted their own foreign investment screening framework. Despite being subject to each member state’s interpretation, this framework reflects a growing movement towards a more CFIUS-type approach by governments around the world.

Like seemingly every other element of international trade, COVID-19 accelerated and expanded that trend – and not just to the usual suspects.

“Historically, investment screening was perceived to be necessary only for very sensitive sectors, if at all,” says De Knop. “But the COVID-19 pandemic and related issues around the supply of PPE and medicines – plus a more general concern of foreign investors raiding undervalued assets – really created an urgency for screening foreign investment in much wider sectors of the economy.”

Hence, several EU Member States, including Germany, Italy, and Spain, accelerated reform to provide additional protections to, for instance, domestic healthcare industries. In the U.S., some fear predatory investment in distressed assets, though CFIUS is likely to rely on the existing expansions of its jurisdiction and mandatory filing requirements to address these fears.

“We’ll also see added scrutiny on companies receiving funds from Defense Production Act Title III programs – even for organizations that wouldn’t traditionally be a target of those funds.”

“There’s a concern in the U.S. that companies in the defense supply chain, for example, could be lured into accepting foreign money just to stay afloat,” says Fernandez. “We’ll also see added scrutiny on companies receiving funds from Defense Production Act Title III programs – even for organizations that wouldn’t traditionally be a target of those funds.”

Investors into the U.S. may have to regularly file mandatory notifications where they didn’t before, while the EU takes a critical industries-type approach. “Sectors like healthcare and pharmaceuticals now fall under that umbrella,” says De Knop. “The scope of investments covered will be significantly expanded.”

Of course, this means that foreign investors into the EU and U.S. will need to take a more strategic approach. Fernandez outlines three factors business leaders need to consider in this respect:

• The nature of the buyer and/or the vulnerability of the asset.
• The investor’s appetite for risk.
• An awareness of the disclosures and potentially onerous procedures involved as part of the deal process.

“If you go through this process, you’ll get a lot of invasive questions – and you must respond,” Fernandez says. “Even if you may not be concerned about a specific issue, you have to ask yourself whether you can or want to provide documentation around it.” In addition, De Knop adds, “you will need to consider the screening procedures when structuring deal documents and setting deal timelines.”

The prevalence of foreign investment screening among like-minded countries may also lead to increased collaboration, which could force companies to coordinate various filings for multijurisdictional investments. On the bright side, one of the newer aspects of CFIUS regulations offers certain exemptions to investors from select countries; while the UK and Canada are alone on this list now – and for a trial period – others may very well be added down the line.

“Among allies, it could really strengthen information sharing and drive decisions on how to better structure transactions and where to file,” Fernandez says.

Just like the other issues and challenges buzzing around international trade right now, heightened investment screenings present both a slide towards protectionism and opportunities for enhanced cooperation.

As in so many other industries, COVID-19 has thrown into focus just how much Western life sciences companies rely on China and India. According to one estimate from the European Fine Chemicals Group, more than 80% of chemicals used to make drugs sold in Europe now originate from one of those two countries.

Thus, even as pandemic-related export restrictions around drugs, medical devices, and other PPE begin to decline, industry executives in the U.S. and EU are viewing the crisis as a wake-up call to shift the balance of production back toward home shores.

Of course, it’s not that simple. So-called reshoring raises “a whole lot of cost issues that can potentially fall onto the patient,” says Tatjana Sachse, counsel at Sidley in Geneva.

And when it comes to medical devices, which some automakers claim they’re ready to manufacture, the question remains whether it will really be effective and safe for patients.

“Even when companies make their blueprints available online, as some have done, it’s not like a pill you pop – people have to be trained on how to use them,” Sachse adds, noting that the Ventilator Training Alliance, which provides free training to healthcare professionals on the use of such equipment, is a “great step in the right direction.”

Still, for others in the life sciences space, now may be as good a time as any to make the move. U.S.-based active pharmaceutical ingredient (API) manufacturers, for instance, may want to exploit the politics of the moment to try and encourage the government to do what it can to expose their resourcing requirements. “It’s not always about fighting protectionism, says Friedbacher. “If you can’t beat ‘em, join ‘em.”

In the next year, we can expect to watch these tensions continue to ripple through efforts to beat back COVID-19, whether it involves boosting production of drugs to treat the virus or the eventual scaling up of vaccines. On the latter front, Sachse predicts companies may have to collaborate with competitors or turn to generics manufacturers, many of which are in India, but warns that challenges may ensue around differences in manufacturing technologies.

“There are different capabilities and technologies used in plants across the world – even within companies themselves – which may complicate scaling up the production process of an eventual vaccine.”

“There are different capabilities and technologies used in plants across the world – even within companies themselves – which may complicate scaling up the production process of an eventual vaccine,” she says.

In the meantime, Sachse notes the importance of ongoing (and often overlooked) initiatives by the WHO, often in coordination with the WTO: for instance, exploring whether it’s possible to reduce tariffs on essential goods, including medical products.

While some countries, like New Zealand and Singapore, have moved collaborative initiatives like this forward, it remains to be seen whether more will follow suit – and what the impact of COVID-19 and rising protectionism will be on the life sciences industry writ large.