China-EU trade spat’s next swipe may hit LVMH

Fashion victims. Few Western corporate chieftains command as much attention in China as Bernard Arnault. The 75-year-old boss of $340 billion LVMH routinely rubs shoulders with senior government officials and was the talk of Chinese social media during a whirlwind trip to the People’s Republic in June 2023. Even so, the French luxury giant could get sucked into China’s ongoing faceoff with the European Union.
Brussels has raised tensions with Beijing by proposing extra tariffs on Chinese-made electric vehicles, arguing that they are unfairly cheap due to state subsidies. Pending an EU members vote, the bloc’s move to impose additional tariffs of up to 38% of the value of Chinese-made EVs will become binding for the next five years by November at the latest. Since the European Commission first mooted the duties in June, the question has been how and whether China responds.

It remains possible that Chinese President Xi Jinping pulls his punches. Faced with a more hostile United States, Europe is a strategically important market for the People’s Republic. China has launched anti-dumping probes on European brandy, pork and dairy, but has yet to impose any additional tariffs. Besides, the combined import value of these goods totalled just 6 billion euros ($7 billion) in 2023. In contrast, the EU is targeting nearly 10 billion euros’ worth of battery-powered electric cars shipped from China to the EU last year.

European politicians may also buckle. Spanish Prime Minister Pedro Sánchez broke ranks this month to advocate going easy on tariffs on Chinese-made EVs. His country had supported a hardnosed approach, before its 1.5 billion euros of pork exports to China came under threat. If other governments like Italy follow suit, the tariffs may yet get watered down.

Yet the ball remains sufficiently in Beijing’s court that some sort of riposte could lie in wait. European luxury goods, which includes leather bags, perfume, jewellery, shoes, suits and other apparel, accounted for 11 billion euros of imports in 2023. There are a host of reasons why they fit the bill for Chinese retaliation.

Unlike pharmaceutical, manufacturing and aircraft imports, luxury is far from essential to Chinese productivity. As with French cognac, overpriced status symbols hold less cachet in the stuttering Chinese economy. If their prices went up further, the number of irked buyers would be limited: the richest 2% of customers usually account for about 40% of luxury sales, according to Bain & Co.

A second factor is internal European dynamics. Unlike Germany, which still counts the People’s Republic as a big market for its cars and with whom China trades essentials like chemicals, France has been a particularly vocal champion of European EV tariffs. Handily enough the country, along with Spain and Italy, is one of the key exporters of luxury goods like $10,000 Christian Dior handbags: a third of the EU’s $5 billion of leather and plastic handbags sent to China came from France last year. LVMH is the crown jewel: the group’s 24 billion euros of fashion exports accounted for 4% of 2023 French exports, according to a study by consultancy Asterès.

The main issue with a luxury thwack is that it’s ostensibly hard to do. Ever since China joined the World Trade Organization in 2001, it has been steadily lowering tariffs. Handbags from the EU, for example, are only levied a 6% tariff when they are imported into the country, according to Chinese custom brokers. But commencing an anti-dumping probe on pricey Balenciaga bags is tricky to do with a straight face, and a tariff onslaught would risk China falling foul of WTO rules.

Xi has a more oblique way of targeting Arnault, though. Currently, China collects a “consumption tax” on 15 categories of goods, and only six of them fit the luxury tag: high-end watches, cosmetics, jewellery, yachts, golf equipment and sports cars. These items are taxed at varying rates on top of a standard 13% value added tax. Watches exceeding 10,000 yuan ($1,409) are taxed at 20%, for example, while diamonds face an additional 5% levy.

Extending this sort of consumption tax to LVMH fare like leather bags would be relatively easy. Currently most of these taxes are collected directly by the Chinese customs agency when they arrive in the People’s Republic, but some are levied at the point of sale. Either way, logistical challenges to levying them should be minimal: most luxury goods are sold in stores, the likes of LVMH usually keep a detailed record of customers, and receipts are often necessary for customer care. And the idea has local support. China should institute a 100% luxury tax to teach the EU a lesson, argued Zhao Hongwei, a senior research fellow at the Chongyang Institute for Financial Studies under state-owned Renmin University of China.

Because it’s not a tariff, this sort of targeted sales tax wouldn’t fall foul of trade rules. It would also fit into a wider trend which has seen Beijing push for domestic tax reforms. Local governments desperately need new and expanded sources of income to repay infrastructure debts as a real estate crisis chokes their main source of revenue from land sales. And the six pre-existing consumption taxes are already levied to “promote wealth redistribution”.

Such a response from China could cause a stink for LVMH and peers like Kering. While neither discloses sales from China, the country makes up the bulk of their regions that take in Asia excluding Japan – and those areas represented about a third of global revenue for each company in 2023. While luxury goods groups would be tempted to pass higher costs on to Chinese consumers, price hikes are harder to pull off when the economy is in a protracted downturn. Bank of America analysts already expected most luxury companies to swerve aggressive price increases.

One potential hole in the plan is that a luxury tax might push more Chinese consumers to do their luxury shopping abroad. In Japan, for example, a surge in Chinese tourists and a weak yen led to a 57% jump in sales for LVMH in the three months to the end of June. Yet that would still be worse than the status quo: prices there were on average 12% lower than in China, per JPMorgan analysts, while the cost of Japanese inputs like labour is higher.

Arnault is far from guaranteed to become a Sino-Europe trade war victim. But from Xi’s perspective, the luxury sector looks like a relatively pain-free way to get back at Brussels over the next few months if Europe doesn’t back down on Chinese electric cars. And unlike quite a few other ways to turn the screw, it looks both politically and practically straightforward to do.