Chinese President Xi Jinping’s push for home-grown innovation underlines the urgency of core technology development. China’s biggest imports are electronics, industrial machinery, information and communication services.
It is not unusual for Chinese leaders to talk about self-reliance. But the past year has seen the term mentioned extensively by President Xi Jinping explicitly linked to a concerted push for home-grown innovation underlining the urgency in China to grasp core technologies amid an escalating and all-out rivalry with the US.
Self-reliance was borne out of wartime necessity. About 80 years ago, Mao Zedong, leader of the Communist Party of China, framed the party’s self-reliance as diametrically opposed to the rival Nationalist Party’s dependence on US military aid to fight the Japanese invaders.
Xi’s frequent calls for self-reliance in modern times also come at a time of crisis, with the US shifting from a policy of engaging China to containing it, encapsulated in last month’s executive order by President Donald Trump that effectively banned Chinese telecoms giant Huawei from accessing US supply chains.
“Technological innovation is the root of life for businesses,” Xi said on a visit to Jiangxi province in May. “Only if we own our own intellectual property and core technologies, can we produce products with core competitiveness and we won’t be beaten in intensifying competition.”
Xi did not directly mention the US or the trade war currently at an impasse after the 11th round of talks ended in Washington without a deal. However, the emphasis on self-reliance was undoubtedly a rallying call to the country to prepare to fend off long-term challenges from the US, especially in the technology arena.
“It’s a wake-up call to the mindset prevailing in China for decades that globalisation is the main theme,” Wang Yiwei, Professor with Renmin University said.
“The environment has changed tremendously. The US wants to contain China’s technological development and China will not wait to be beaten. It will strive to develop its own core technologies.”
However, the push for self-reliance has come up against the reality that China’s technology industry is heavily dependent on global component suppliers, especially from the US.
China has made remarkable progress in recent decades in some technology application areas such as e-commerce, e-payment and artificial intelligence thanks to a huge domestic market, the openness of its consumers to novel technologies and a low sensitivity to privacy, as well as a big pool of diligent talent.
However, little progress has been made in core technologies, such as those used in making car engines, precise bearings, drilling platform derricks, chips and computer operating systems.
While China specialises in the lower reaches of hi-tech design, the upper echelons of the value chain are occupied by companies from the US, Japan, Germany, South Korea and Taiwan.
“China needs foreign technology to deleverage and sustain its catch-up with rich countries,” an S&P Global Ratings report said in May.
“China is producing more of its own technology, but foreign firms still provide key inputs along its supply chains through trade and investment,” the report said.
S&P surveyed 657 listed Chinese exporters in the electronics, semiconductors, cars, aerospace and defence sectors. According to its report, about 42 percent, or 323 companies, of China’s Tier 1 suppliers which supply components directly to the original equipment manufacturer have headquarters overseas.
The biggest proportion of these companies is headquartered in the Asia-Pacific region, excluding China, followed by Europe and the US.
Of the Tier 2 suppliers in China’s supply chain, 47 percent, or 362 companies, have overseas headquarters. Among them, 215 are from the Asia-Pacific region, while 84 are from the euro zone and 63 from the US. Tier 2 companies generate and supply Tier 1 with the components needed for the final products.
A closer look into China’s import basket by Harvard World Trade Atlas shows China’s biggest imports are electronics, industrial machinery, and information and communication services.
China imported US$260 billion worth of semiconductors in 2017, more than its US$162 billion imports of crude oil. US companies dominate the semiconductor industry, while domestic suppliers can only satisfy 5 percent of China’s annual demand, according to the country’s official data.
“US policy is converging on a strategy: slowing the pace at which China acquires new technology and deploys its own technologies overseas,” the S&P report said.
Legislation and beefed-up implementation are expected to make it harder for Chinese companies to acquire US assets and bring the associated technology home.
Already-increased prohibitions on the sale of technology hardware and software to some Chinese firms may be broadened to cover a wider range of products. And a broad range of technology products are being targeted in the import tariff net, according to S&P.
Robert D Atkinson, president of Information Technology and Innovation Foundation, a Washington-based think tank, said the investment restrictions or import tariffs alone would not be able to choke China’s technology development.
The China market combined with the economies Beijing wants to connect under its Belt and Road Initiative are big enough to provide Chinese firms with ample sales, he observed.
“But export bans, depending on the extent of the bans, can seriously set back China’s technology development,” Atkinson said.
“Different parts of China’s technology industry are dependent on US technology to different degrees. Certainly Huawei and ZTE and other IT hardware companies are highly dependent on US technology and an export ban would do significant damage to these and related firms.”
The toughening of US technology export controls began in August 2018 when the Export Control Reform Act was passed.
Although the law covers technology exports to all countries, fear over Chinese efforts to acquire high-end technology was a key reason why the bill passed with broad bipartisan support in the US Congress, according to Dan Wang, a technology analyst with the Hong Kong-based consultancy Gavekal Dragonomics.
The US has also expanded the definition of what constitutes a valid “national security” reason for imposing controls.
For the first time ever, the Department of Commerce justified export controls based on allegations of theft of intellectual property that was not export controlled, asserting that the “theft” would help economically a foreign competitor of a US company that also supplied items to the Defence Department.
Meanwhile, US-imposed export bans can restrict sales not just by US technology firms, but also by foreign companies without a US presence. Foreign-made products in which American technology accounts for at least 25 percent of the product value must also abide by US export control laws.
The export control on Huawei came after Fujian Jinhua Integrated Circuit China’s most promising memory chip producer was accused of stealing trade secrets from the American semiconductor firm Micron Technology and was denied US technology just before mass production started last year. ZTE, a Chinese rival of Huawei, was brought to the brink of collapse after a similar ban by the US last year.
The Shenzhen-based Huawei sold as many smartphones as Apple last year, and is also one of the very few providers of network equipment for the fifth generation, or 5G, mobile technologies. Its revenues last year were around US$100 billion, twice that of Tencent, China’s social media giant.
Huawei is controversial because its founder, Ren Zhengfei, is a former People’s Liberation Army engineer, and also because the company is alleged to insert router back doors in its equipment.
Ren’s daughter Meng Wanzhou, Huawei’s Chief Financial Officer, was arrested in December by Canadian authorities after the US government charged her with fraud linked to alleged violations of Iran sanctions. She denies the charges and is in a legal battle against extradition to the US.
“By placing Huawei on the Department of Commerce’s ‘entity list’, thereby forbidding US companies from trading with it without explicit permission, the Trump administration has put a stranglehold on China’s most prominent technology firm,” Wang said.
Non-US firms like UK-based ARM, Germany-based Infineon and Japan-based Panasonic have publicly announced that they are restricted from supplying Huawei.
Huawei claims it can survive US export controls because, unlike ZTE, it has its own semiconductor design unit HiSilicon which can supply many of the chips that go into mobile phones.
“At best, HiSilicon can replace some of the mobile phone technologies offered by US firms like Qualcomm and Broadcom. But Huawei requires a bewildering array of different components, from CPUs to radio-frequency modules, that HiSilicon cannot make, and for which few non-US suppliers exist,” Wang said.
The critical components are not only chips. Huawei also uses speciality lasers from US firms for its network equipment business. The US order covers the supply of software and designs to Huawei as well, not just hardware. HiSilicon needs to license chip design software from US firms, and Huawei’s smartphones run Google’s Android operating system.
Because Android is open-source software, Huawei can continue to use the public version. But Google will have to stop supplying its own apps, such as Google Maps and Google Play Store, and services to Huawei under the ban, and that will make Huawei smartphones less attractive to consumers outside China, Wang said.
“The question now is whether the US government will continue to strangle Huawei until it goes out of business, or chooses to eventually stop squeezing and allow a weakened Huawei to keep operating under some limitations,” he said.
To make things worse, the US is working to create lists of “emerging” and “foundational” technologies that may be essential to US national security. These technologies could then be subject to tighter export controls. A list of proposed “emerging” technologies, including robotics and artificial intelligence, was released for public comment in November 2018. The list of “foundational” technologies is expected to follow.
Also, the US considers the transfer of any information about a controlled technology to a foreign national a “deemed export”. If the foreign person is a citizen of any arms-embargoed country (a list that includes, but is not limited to, China), such a “deemed export” would be subject to export controls.
This will put pressure on US companies to lay off Chinese nationals who are working on artificial intelligence and other technologies that are on the “emerging” list, Wang said.
Before the worst comes, China really will have to double down on its industrial policy and improve its own capability, he said.
“It’s politically intolerable that a foreign power has this at-will ability to shut down major companies, and that goes for basically any country in the world I think,” Wang said. “China will really have to figure out how to build its own supply chain for, among other things, semiconductors.”
Beijing has been increasingly critical of Washington in recent weeks over the breakdown of the trade talks and its treatment of Chinese technology giant Huawei. On Friday, it said it planned to publish a list of “unreliable” foreign entities deemed to have damaged the interests of Chinese firms, based on anti-monopoly and national security grounds.
A day later, Beijing announced an investigation into US logistics company FedEx for the “wrongful delivery of packages”, after Huawei accused FedEx of re-routing its packages from China to the US.
Apart from the tit-for-tat actions, China is prepared for long-term hardship in its technology development, Chinese official and academic sources said.
China’s semiconductor industry needs more than a decade to catch up with its global peers due to a weaker industrial base, according to Jay Huang Jie, founding partner of Jadestone Capital and former Intel managing director in China.
“This is an extremely challenging and brutal industry, heavily reliant on long-term industrial accumulation,” Huang said at a forum in Hong Kong last week.
“China should be prepared for a marathon of at least a decade, which will also be loss-making [along the way],” he said.
China has made clear in recent years its ambition to become a global technology superpower, with top leadership, including Xi, reiterating that science and technology was one of the main battlefronts of the economy. The “Made in China 2025” strategy, unveiled in 2015, aimed to break the country’s reliance on foreign technology in sectors such as robotics, aerospace and new energy vehicles.
Last year, China spent 1.96 trillion yuan (US$291.58 billion) on research and development, or 2.18 per cent of its GDP – an 11.6 per cent increase from 2017, and in absolute terms putting it just behind the US spend.
However, according to Chinese scientists, basic research has accounted for just 5 to 5.6 per cent of the nation’s annual overall research and development spending for more than a decade. And the lack of development progress in certain key technologies was mainly because the focus had been on applied research, instead of basic research.
Tong Jinnan, professor at the China University of Geosciences, said the funding for basic research was seriously lacking.
“To be frank, [pouring too much money into applied research] just puts the emphasis on quick results. It’s not possible to make breakthroughs if we do not put enough resources into basic research,” Tong said.
Si Jiannan, a researcher with the China Machine think tank, said China’s high-end equipment manufacturing sector was troubled by conspicuous problems ranging from weak domestic innovation capability to a lack of talent and clients’ trust. As a result, Si said, China must import more than 900 hi-tech products, from aeroplanes to robot malfunction diagnostic equipment.
Jim Lewis, a senior vice-president at the Centre for Strategic and International Studies (CSIS) in Washington, said: “The bigger problem [of domestic innovation] is that technology is now created by a transnational innovation base. No country is self-reliant.”
A source close to China’s science and technology authorities said Beijing had realised this global reality and that its talk of “self-reliance” was mainly aimed at invoking a spirit of endurance and to rally public sentiment at home.
At a meeting on comprehensively deepening reform last week, Xi stressed that China should pave the way for technology innovation with a global vision which attracts and fosters talent, improves its capability of utilising global innovation resources, opens to global cooperation and “integrates with the global innovation network”.
CSIS’s Lewis said: “Chinese companies need to be able to partner with foreign companies, but now you’ve got a hostile US and a lack of trust about Chinese law around the world.”
“The fundamental problem is that nobody expects China to play by the rules that any other economy plays by, and this increases distrust – governments and companies no longer trust the Chinese government,” he said.
Unsurprisingly, China is actively seeking cooperation opportunities with other countries. Chinese Vice-President Wang Qishan visited Germany and the Netherlands last week, hard on the heels of visits by another top Xi aide, Li Zhanshu, the Communist Party’s third-most powerful cadre, to countries including Hungary, Austria and Norway.
A China-Israel cross-border investment forum was also held last week in Jinan, in the eastern province of Shandong, where about 100 companies from Israel, a key US ally, met with more than 1,000 Chinese investors.
While Israeli start-ups used to aim to attract American investors, China could be another choice for its non-military technologies, according to a person who attended the meeting in Jinan.
The prospect of cooperation with European countries, however, seems more uncertain given the tug of war between China and the US.
“Europe is looking to hedge in the best way it can and avoid getting dragged into a US-China confrontation in which it has to make a stark choice,” said John Seaman, research fellow at the Centre for Asian Studies, part of the French Institute of International Relations.
Sourabh Gupta, a policy specialist at the Institute for China-America Studies in Washington, expects China to make fewer attempts at technology acquisition in Western markets and more “learning-by-doing” domestically – offering Western owners of quality intellectual property “protection under an incentive structure”, which would include full in-house control over proprietary IP rights, to entice them to relocate their high-end design and manufacturing chains to China.
James McGregor, chairman of APCO Worldwide’s greater China region, said Chinese entrepreneurs, scientists, engineers and venture capitalists working together were more than capable of building a world class tech sector.
“If there was open and fair competition in China, the world would welcome Chinese technology companies,” McGregor said.
“Instead, leading global technology companies and their governments are aiming to protect themselves from Chinese technology developments because the intervention of state money, state plans, state regulators and state controlled market access in China threatens the global future of private companies that depend on real profits, not state assistance and state subsidies.
“The result of all this is that China’s technology progress will be delayed and in some sectors could be derailed,” he said.