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The China-US Trade "War": Decoupling Is a Marathon, Not a Sprint - Part 4

BLOG - 18 February 2020

As fate would have it, the coronavirus crisis has provided a live experiment of the consequences of a massive, if perhaps short-term, involuntary decoupling. The interruption of global value chains leads to the sudden stoppage of factories far away from China – tourism and the travel industry, the auto industry, pharmaceuticals where China is a leading provider of ingredients, smartphone production, and a dive in prices for energy and raw materials. Financial consequences are less easy to ascertain as we write, simply because the direction of China’s foreign trade and the current account has become unpredictable over the next few weeks or months. It also has implications for future preventive measures against such an event: overdependence on any single supplier is obviously a hazard. Regardless of geopolitical trends, the virus crisis will lead many companies to further diversify their choices of location for production capacities and sourcing.

In the name of national security

"Decoupling" has been the keyword lurking in the shadow of the US-China trade conflict since the election of Donald Trump. It is not recognized as a policy by his administration, even as it restricts some exports and exchanges with China in the name of national security. Yet, it is often cited by Chinese commentators and by partners alike, especially in East Asia. The measures taken – and to some degree contemplated or partially enacted by the European Union and Japan – are much more narrowly focused on a few key areas: a reinforcement of oversight over foreign direct investment, placement on an "entity list" of companies suspected with acquiring items related to national security and critical technologies, a reinforced law enforcement effort against technological espionage, including illegal tech transfers.

"Decoupling" has been the keyword lurking in the shadow of the US-China trade conflict since the election of Donald Trump.

At its most extensive, the administration has owned up to the word decoupling by explaining that this had been China’s actual policy for years, through restrictions on foreign investment and public markets, a largely closed internet, the drive for self-reliance and domestic technologies. Requiring "reciprocity" from China may indeed lead to asymmetrical decoupling from the Chinese economy.

How politically hard it is to implement in practice, has been immediately demonstrated with two examples: ZTE and Huawei. ZTE, China’s second major telecom supplier, has first been placed on the Department of Commerce "entity list" under the Obama administration in 2016, removed from that list in 2017, added to it again in 2018, and removed again the same year after a high-profile plea by Xi Jinping to Donald Trump. Some of its affiliates were again placed on the entity list in October 2019. Even more telling is the ambiguity surrounding the placement of Huawei on the same entity list in 2019. It has almost immediately been tempered by exemptions allowing US component makers to keep supplying Huawei with what amounts to an 11 billion dollar per year market for chip manufacturers. In February 2020, even as new revelations on alleged Huawei spying were made public, and charges against the company for long-standing Intellectual Property theft were raised to charges of racketeering, these exemptions were extended again for 45 days. Generally, placement of a company on the entity list prevents any sale to it of components by American firms. The same prohibition of component sale only applies to third-country companies if these exported American components represent more than 25 % of the final product, a rather high bar.

The growing halo around the national security clause

Perhaps a more serious element, is the possibility of market denials by the United States to international companies which do not follow these restrictions: the IT industry – as well as the aerospace industry if it was one day included – are so integrated that almost all companies supply both China and the United States. An effort is underway from the US to relocalize chip production for military purposes. TSMC, the Taiwanese chip foundry, is particularly concerned because it is a huge exporter to mainland China and also has production sites there. In fact, it had already been 16 years since a Rand report concluded that the close ties between Taiwan’s silicon industry and the mainland made it impossible to prevent the transfer of critical technologies.

Another potential aspect of decoupling is the oversight and limitation of direct investment or Mergers and Acquisitions (M&A) activity by Chinese companies – or by their proxies, as offshore capital centers from Hong Kong to the Caribbean provide a convenient opacity to the ultimate investors. With varying speed, scope and strength, the United States, the European Union and Japan all strive towards the same goal: preventing technology leakage in critical sectors. In fact, they have started cooperating in an unprecedented effort to prevent forced technology transfer and to fight state subsidies. The EU framework for investment screening of foreign investment due for introduction in October 2020 will potentially have the widest scope. It cites "public order" as a cause for screening, but it is also non-binding to Member States in most cases. The revised Japanese Foreign Exchange and Foreign Trade Act enacted in November 2019 are the most demanding. The threshold for prior notification and oversight is set at 1 % of capital in a broad list of activities and services.

The updated American Foreign Exchange and Foreign Trade Act enacted in November 2019 does not differ much in actual scope from the planned EU mechanism – including a lack of definition of what constitutes "national security" but they are mandatory and go along with a host of other measures against illegal technology transfer, including a nation-wide move by the FBI against offending universities and laboratories. Japan has also enacted precautions and limitations on human scientific and educational exchange. Nothing, of course, comes close to existing Chinese restrictions to foreign investment, technology and data transfer, and human exchanges.

With varying speed, scope and strength, the United States, the European Union and Japan all strive towards the same goal: preventing technology leakage in critical sectors.

One key issue remains: the uncertainty factor. It could change the scope of the actual decoupling sought by the United States and promoted towards allies and foreign companies with a stake in the US market. There is a halo surrounding the decoupling measures taken in principle on the basis of national security. Steel and aluminum were deemed to be issues of "national security", and auto imports are regularly cited as possibly falling under the same heading. This is clearly an overextension of the WTO clause that allows protective action in the name of national security. The lowering (down from 25 % to 10 %) of the entity list’s ceiling for third-country companies’ sales of US components will certainly hit consumer products that rely on highly imbricated value chains. The rumored ban of exports of General Electric-Safran’s Leap engine to China would also be a doubtful measure: over the past five decades, China has never been able to reverse engineer a modern jet engine, and it struggles in the military area to produce domestically a viable fighter jet engine. The measure, on the other hand, would strangle the much-heralded COMAC airliner project, and therefore has a large commercial impact. It also happens as the Trump administration increases tariffs on European-produced planes, and as Boeing goes through an unprecedented crisis. Although China has passed legislation allowing for sanctions on companies implementing foreign bans on supply, it is not well-placed to enforce these sanctions, which would in fact increase the likelihood of a larger decoupling.

From a mood shift to a marathon

China fundamentally does not want to change its industrial and technology strategies.

Overall, the actual decoupling seems to be much more limited than what would be suggested from visible fears in East Asia – the region most closely integrated with China’s production centers.

But decisions by companies to diversify or even leave China appear more momentous. Some of it comes from the recurring friction they encounter with policies supporting indigenous industries against foreign companies. Another part has to do with the damage from the trade conflict. Southeast Asia has benefited most from this trend, on which India finds it harder to capitalize. It is likely that, for pragmatic reasons, the coronavirus will accelerate the trend, as some global industries are suddenly deprived of components sourced in China: the exact damage remains impossible to, so long as the crisis does not abate.

Beyond these trends, one cannot deny a shift in strategic thinking by governments from the United States to Europe, Japan and Australia. We are nowhere near the Cold War ban on high technology exports to the Soviet Union. A Coordinating Committee for Multilateral Export Controls (CoCom) list could be infinitely more difficult to establish and would need constant updating. Still, the limited measures in key areas of national security with their potential extension, the screening of foreign investment, the counter-offensive against science and technology theft, the growing apprehension about human exchanges mean that the era of one-world globalization is over. Chinese officials describe this as an attempt to contain their country’s rise. They neglect the fact that their policies of industrial cocoons, and the drive for technology acquisition abroad by all means, have finally provoked a reaction. China fundamentally does not want to change its industrial and technology strategies. Advanced economies no longer accept China’s mixture of special benefits under WTO and capture of leading-edge technologies, including in the military sector. This will increasingly lead to tests and conflicts, in what is likely to be a long-term marathon, rather than just a sprint before any election.

 

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