Trade War Redux but This Time It’s Different

The Escalating Trade War

President Trump imposed fresh levies on $200 billion in Chinese imports, prompting Beijing to respond with tariffs on $60 billion of American goods. Thousands of goods now face border taxes of up to ten percent, including grocery store staples, household objects, and industrial equipment. The rhetoric is heating up, and there is no sign of an amicable settlement yet.

If this reminds you of the trade war with Japan in the 1980s, you are not mistaken. At that time unprecedented trade deficits led members of the Reagan Administration to embrace protectionism. The narrative then was that Japan was steadily displacing American firms in all the important industries through unfair trade practices. The United States imposed a wide range of trade restrictions on Japan in the 1980s. Much like Trump’s focus on autos, steel, and emerging technologies, Reagan focused on autos, steel, and new semiconductor technology. The 1980s policy also employed a series of tariffs, quotas, and other import restrictions to give US companies a leg up in the threatened industries.

While the setup this time is essentially similar, there are some critical differences between the impact of tariffs then and now.

Japan cooperated with the US to a certain extent rather than engaged in a back-and-forth. By contrast, China has announced retaliatory tariffs on US goods, and, following the Trump crackdown, Chinese officials consistently emphasized that the country is not afraid of a trade war with the US.

Valuable Cross-Border VC Investments at Risk

One unintended consequence of the ongoing tariff skirmish is the potential disruption of the VC funding for startups on both sides. There has been a smooth flow of venture funds between the two countries in the last ten years. According to Rhodium, US investment in Chinese tech companies has taken off in recent years, as has Chinese investment in foreign startups, particularly in American companies. Since the beginning of 2010, Chinese venture capitalists have completed more than 1,000 deals for American companies worth roughly $36 billion, with most occurring between 2014 and 2017. Leading US unicorns have been recipients from major Chinese VCs. Uber, for instance, is backed by Hillhouse Capital Group, a prominent Chinese VC; WeWork by Hony Capital and Legend Holdings; and Airbnb from China Broadband Capital Partners. According to PitchBook, a total of $84.2 billion was invested in US-based startups in 2017. Of that, $3.1 billion, or nearly 4%, came from China.

The biotechnology industry is particularly susceptible to negative consequences as a result of the trade war. American biotechnology firms received nearly $1.4 billion from Chinese venture capitalists during the beginning of 2018, according to The South China Morning Post. This is approximately 40% of the $3.7 billion that these companies raised. Firms like Moderna Therapeutics Inc. and Harmony Biosciences LLC recently received hundreds of millions of dollars in single rounds of funding, much of which came from China. Tariffs and deteriorating relations with China threaten this valuable stream of capital to US biotechnology startups.

Similarly, Chinese companies, including some of the world’s most valuable, have garnered significant backing from American investors. Ant Financial, for example, has raised substantial capital from Sequoia and private equity funds such as The Carlyle Group and General Atlantic. Didi Chuxing is also backed by US firms including 2020 Ventures, Matrix Partners and several others. According to TechInAsia, Chinese startups raked in $58.8 billion in 2017. $5.5 billion, or well over 9% of total investment came from US venture capital firms.

But all this could be changing at a time when China’s private markets were beginning to blossom. In the first half of 2018, Chinese foreign direct investment into the United States totaled only $1.8 billion, down 90% from the comparable period last year and the lowest level in seven years. And money is being rapidly pulled out, with nearly $10 billion in US asset divestiture by Chinese investors in the first five months of 2018. This is against the backdrop of Silicon Valley’s declining dominance in VC investments and China’s growing prominence. According to a Wall Street Journal analysis, US investors enjoyed a 97% share of international venture finance in 1992. In 2017, however, only 44% of worldwide venture finance was led by US-based investors with Chinese investors accounting for 24% of global venture finance.

Bottom Line

With elevating tensions, US-based firms may have to expect less flow of capital from China.

While this decrease in capital from China may not be detrimental to the US venture capital landscape, firms that are based in the US and that are backed by Chinese investors could suffer.

That said, the hope is that this trade impasse is settled amicably, just as the US-Japan trade impasse was settled amicably in the 1980s.