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

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.

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

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.