US-China: Storm before the calm?

The May 2019 decision of the United States to place telecom giant Huawei Technologies and 70 of its affiliates on the US export blacklist is as provocative an action as one could think of against another country, short of war. But the effect of the action could have wider consequences because there are networks in many parts of the world that run on Huawei’s equipment.

The two countries are locked in an intense trade war having imposed tariffs on each other’s exports. So far, 11 rounds of talks have taken place but there seems to be no resolution. As of now, there are even questions about whether the Xi-Trump meeting expected at the sidelines of the G20 meet in Osaka will happen. By now, it is clear that the issues are not simply about trade and tariffs, but the larger relationship between the two countries.

A lot is at stake between US and China. The two countries have dense links as indicated by the fact that their trade totaled $660 billion in 2018 and China held more than $1.1 trillion in US Treasury Bonds.

The two countries are locked in an intense trade war having imposed tariffs on each other’s exports. So far, 11 rounds of talks have taken place, but there seems to be no resolution.

Earlier in June, the Chinese Ministry of Commerce underscored this point in a report showing how the China trade had been mutually beneficial. Another section of the report noted that, had the US not maintained strict export controls on China all through, the trade deficit would have not loomed so large.

US policy lines

Unlike the Secretary of State Mike Pompeo, who repeats the official line about Huawei’s links to Chinese spying, President Trump has been more forthright. According to the Washington Post, he told a meeting in the White House in mid-May that China’s technical prowess was the issue: “Unless we stand up now, there’s not going to be a chance to do it in the future.” It cannot be a coincidence that formal US policy, as expressed in its December 2017 National Security Strategy, has made it clear that America was shifting from a policy of engaging China to containing it.

The signal was obvious in the US legislation in 2018. The first was the Foreign Investment Risk Review Modernisation Act (FIRRMA) that expanded the scope of review and authority of the Committee on Foreign Investment in the United States (CFIUS). The expanded definition covered investment in properties in sensitive areas, and non-controlling investments in critical infrastructure and technologies.

The second was the National Defense Authorisation Act (NDAA) for FY 2019 which specifically prohibited US government agencies from procuring components and equipment from Huawei, ZTE, Hytera Communications, Hikvision Digital and Dahua Technology Co.

The NDAA also contained the Export Control Reform Act (ECRA) in August 2018 to enhance restrictions on exports, especially to China, of key emerging and foundational technologies and expanded the definition of what constituted “national security” as a reason for controls.

It cannot be a coincidence that formal US policy, as expressed in its December 2017 National Security Strategy, has made it clear that America was shifting from a policy of engaging China to containing it.

In November 2018, the Bureau of Industry and Security of the US Department of Commerce sought public comment on establishing a criteria to identify emerging technologies that were essential for US national security. These, a notice said, could relate to conventional weapons, intelligence collection, WMDs or counter-terrorism applications.

The Chinese response

As a sign of hardening positions, in the end of May 2019, the Chinese Commerce Ministry announced that it would publish a list of businesses or individuals that are “unreliable”. On paper, these firms would be those who have violated market rules and contractual obligations and have discriminated against Chinese entities.

A week later, China’s National Development and Reform Commission (NDRC) said it was mulling over establishing a national technological security management list system. Its goal seems as much to counter the US measures, as to strengthen long-term tech security for China.

China has also let it be known that it could use its advantage as the dominant supplier of rare earths that are vital for high tech products with defence applications. China’s NDRC has convened meetings with enterprises, regulators and experts “to promote high quality development of the industry,” a hint of their use in the trade war.

Chinese vulnerability

Actually Huawei was not the first target. It began with ZTE, a Huawei rival, which was brought to its knees and then given an unexpected reprieve by Trump in mid-2018. Then in October, 2018, the US banned American companies from exporting technology to Fujian Jinhua Integrated Circuit, China’s key memory chip producer which was accused of stealing technology from Micron Technology. The company has halted production from the beginning of 2019 and is seeking to sell its state of the art fabrication facility in China.

Whether Trump’s decision on Huawei was merely to arm himself for negotiations with Xi Jinping at the sidelines of the G20 meeting in Osaka in mid-June, or to stake out a new hardline position in his dealings with China is not clear. But even if he backtracks on Huawei, the die is already cast. China has been shown a mirror and what it sees there is not particularly reassuring.

Whether Trump’s decision on Huawei was merely to arm himself for negotiations with Xi Jinping at the sidelines of the G20 meeting in Osaka in mid-June, or to stake out a new hardline position in his dealings with China is not clear.

What it reveals is that China’s technology industry is heavily dependent on global component suppliers, especially from the US. While China has used its domestic market to advance in areas like e-commerce, e-payment or AI, it has not made a comparable progress in core technologies, whether they relate to computer operating system and chips, car engines, or precision bearings.

Though it has invested heavily in trying to promote its high-tech sector, it is still at the lower rungs with US, Japan, Germany and Taiwan ahead. In 2018, China spent $291.58 billion on R&D, an 11.6% increase from 2017, placing it just behind the US in terms of spending. But a lot of this is in applied research, the country still lags in basic research. Take semiconductors — China imported $ 260 billion worth in 2017, mainly from the US and even now, domestic suppliers can only handle just 5% of the annual demand. The vulnerabilities revealed by ZTE, Fujian Jinhua and Huawei are symptomatic of this weakness.

Huawei: Whistling in the dark?

Meanwhile Huawei says it production levels are normal and as reports have indicated, the company began stockpiling crucial chips that would cover anything up to a year’s production. Huawei says that it will launch a self-developed operating system later this year. The company has obtained 46 commercial 5G contracts in 30 countries globally according to Xinhua. It has shipped more than 100,000 5G base stations, the highest amongst its competitors. The government is now seeking to fast track the 5G rollout in China itself.

The Nikkei Asian Review citing IHS Markit, says that in the first quarter of the year, Huawei has remained the top telecom supplier of the world with a global share of 28 per cent followed by Ericsson at 26, Nokia 18, Samsung 13 and ZTE 12.

Huawei also has its own captive semiconductor design unit HiSilicon which is a major manufacturer of chips for mobile phones. But while it can handle some of the requirements, it cannot take care of all the super high-tech inputs that come from companies abroad. But, the problem is not merely that of chips and other components, but issues like Google suspending Android operating system updates, US-based chip design tool provider Synopsys also stopped providing crucial software updates and, perhaps more crucially British mobile device software design firm ARM, Germany’s Infineon and Japan’s Panasonic have said they would stop working with Huawei and its subsidiaries in compliance with the US ban.

Huawei also has its own captive semiconductor design unit HiSilicon which is a major manufacturer of chips for mobile phones. But while it can handle some of the requirements, it cannot take care of all the super high-tech inputs that come from companies abroad.

Conclusion

Investment restrictions and import tariffs cannot by themselves stop China’s technology juggernaut. With its huge internal market and the economies already connected to China there is enough scope for Chinese firms to remain profitable. But what can happen is that the current trajectory of high-tech growth might be seriously affected. China’s cutting edge companies like Huawei and ZTE will bear the brunt of the impact because they still depend on US technology for critical inputs. In the worst case scenario, China will have to be prepared for a longer-term hardship which will require ingenuity and effort to overcome. In the end, this could actually benefit the country by compelling it to develop technologies it may have not done otherwise and undertake reform measures it has been hesitating to take.

As of now, there is no indication that Beijing is ready to throw in the towel. Indeed, even as the US is threatening to decouple China from the global economy, Beijing is moving briskly to develop closer links with the world economy. This, in essence, is the aim of the BRI. In the recent months we have seen important moves on this score. Italy, a G7 country, has signed up on BRI. On the other hand, countries like the UK and Germany have publicly distanced themselves from efforts to isolate Huawei on the 5G issue. Indonesia, Malaysia, South Africa, Mexico, and Brazil have already indicated that they will not ban Huawei.

Even as the US is threatening to decouple China from the global economy, Beijing is moving briskly to develop closer links with the world economy. This, in essence, is the aim of the BRI.

Indeed, there are now voices complaining that the US investment and export controls on China could actually hurt the US itself. According to Andrew Kennedy, Chinese investment in the US has been limited and it contributes “relatively little” to US R&D development. But the real difference is in the role of the 350,000 or so Chinese students in the US, one third of all international students, who contribute significantly in terms of “talent and energy” to the American science and engineering programmes.

In the meantime, US tech companies have also told the Commerce Department that the ban on selling to Huawei will significantly hurt their bottom lines and prevent them from developing innovative technologies, including those needed for national security.

Just how intertwined US businesses are with China became apparent last week when, in a letter to the US Vice President Pence and nine members of the Congress, the acting director of the White House Office of Management and Budget sought a two-year delay on a ban prohibiting companies that do business with Huawei to provide services to the US government. The step, the OMB officials said, was to enable companies to extricate themselves from Huawei and the Chinese technology companies.

orfonline.org JUne 12, 2019