Some have quickly become national leaders before emerging on the international scene, competing with their former partners or licensors. The considerable profits made thanks to the size of the Chinese market and the competitiveness of their products have then been reinvested in research and development, which has also been the subject of significant state, provincial and local aid. And, of course, the considerable financial resources accumulated by the country and its companies have also enabled an increasing number of acquisitions of leading foreign companies in the deficient sectors.

Faced with this phenomenon, Europe and the United States woke up late for the 2008 Olympic Games and the Shanghai World Expo in 2010. They then jumped following a series of strategic acquisitions (or attempted acquisitions) such as Midea’s takeover of Kuka, the leading German robotics company, Micron US’s bid in 2015, and those of semiconductor producers Lattice and Fairchild, both blocked for national security reasons. Huawei’s lead in the development of 5G technology has also raised the prospect of Chinese standards dominating this key sector for the Internet of Things and information technology.

Eventually, the sudden shift towards an assertive Chinese posture was manifested by Xi Jinping’s announcement of the new Silk Roads in 2013, at the 19th Congress and during his passage to Davos of the “new era” and “the great rejuvenation of the Chinese nation” in line with the “Chinese dream”. Since then, the Chinese vision of leadership has been affirmed clearly, with an objective of achieving Xiaokang (status of a moderately prosperous society) in 2035 and of becoming a great modern socialist country in 2049, for the centenary of the People’s Republic.

Faced with the strong reaction of American and European leaders, China has however opted for more modesty and now points out that it is lagging behind. Official media have eventually criticized Chinese renaissance prophets, particularly the economist Hu Angang and the ideologist Wang Huning who have been told off for prematurely announcing Chinese successes and President Xi’s abandonment of Deng Xiaoping’s maxim.

The tariff war.

Lately, nonetheless, the rhetoric has given way to the imposition of protectionist tariff measures. As a reminder:

• July 6: the U.S. customs imposed a 25% tax on the first list of 818 Chinese products valued at USD 35 billion and announced the review of a second 25% taxable list worth USD 16 billion. On the same day, China imposed a 25% tariff on 545 American products for an equivalent value;
• July 10: a new American list of 6,000 products taxable at 10% (increased to 25% on August 2) was announced for a value of USD 200 billion;
• August 3: China responded by publishing a new list of 5,207 U.S. products worth USD 60bn, taxable between 5 and 25%;
• 23 August: the United States put into effect the second list of USD 16bn taxed at 25%; China immediately put into effect an equivalent list of 333 products at 25%;
• 17 September: implementation as from 24/9 of 10% tariffs on USD 200bn of Chinese products, with the threat of increasing them to 25% as from 1 January 2019;
• September 18: China announced a new 5 or 10% tariff bracket on USD 60bn of US products.

Discussions are at a standstill, but President Trump has also announced his intention to go all-in with the remaining 257bn that China is not in a position to match due to its surplus. The latter is therefore studying other non-tariff measures and has filed a complaint with the WTO. Meanwhile, protectionist retaliations have led to a profound disruption of supply chains and production structures:

• Acceleration of Chinese relocations to third countries whose trade surpluses with the United States will replace the Chinese surpluses. Deficits will keep increasing due to the use of Chinese components for local assembly operations (Taiwan, ASEAN, Mexico, Czech Republic);
• Switchover of Chinese supplies from the United States: gas agreement with Russia providing for the purchase of 70bn m3 over the next ten years and calling into question the viability of several LNG projects in the United States, seafood products in Thailand, soya in Brazil, luxury products, wines and spirits in France and Italy;
• Increase in Chinese production of soya, gas, cotton;
• Increase in some US industrial investments in China (automobiles and other US products exported to China).

Hence, the tariff war could lead to a decline in world trade (COSCO estimates that 10% of the decline in transpacific maritime traffic) and world GDP, which the Banque de France for instance estimated at USD 2500 billion by 2020 (equivalent to French GDP). However, China, which only exports 2% of its GDP to the United States, should only record a marginal decline of less than 0.5% in its growth resulting from the direct effects of the new tariffs. Still, American companies operating in China are considering serious disruptions, without considering repatriating their manufacturing facilities to the United States.

The root of the problem: the technological challenge.

The technical challenge is at the root of the whole U.S-China relationship problem, however.

As soon as he took power in 2012, Xi Jinping put the Internet at the centre of its concerns by creating a “leading group” (under its presidency) for cybersecurity and computerization, and by setting up a cyberspace administration agency (CAC), whose role is both to control the Internet space and to develop the digitalization of the entire economy.

China’s strategic vision is to become self-sufficient and eventually a leader in the sectors of semiconductors, robotics, blockchain, quantum communication, and artificial intelligence, which are the keys to the industries of tomorrow in which China’s ambitions are affirmed. For instance, clean autonomous vehicles, aeronautics, space, telecoms, biotechnology.

The focus is on research and education as well as strategic acquisitions. China’s main assets are the size of its market (according to CSIS, the Chinese middle class will number 550 million people in 2022) and the presence of 800 million mobile Internet users who are keen on innovations, which allows the emergence of world-class companies whose innovation is the permanent concern in the sectors of the sharing economy, financial technology, e-commerce and e-services.

The “made in China 2025” Plan.

President Trump’s is likely to be disturbed by the very strategic plan “Made in China 2025” which was officially published by the State Council in May 2015 (see China’s letter outside the walls n°6 of June 2015).

More comprehensive than the German Industry 4.0 plan, than the Japanese Industry White Paper and than the French concept of the “Factory of the Future”, the “Made in China” plan aims to modernise the Chinese industry, which has become less competitive, by focusing and providing considerable resources on ten strategic sectors. Three steps are set: reduce the gaps in 2025, reach an average level of 4.0 in 2035 and take the lead in 2045.

Faced with the dangers that this development presents for their companies, the United States and the European Union are therefore implementing countermeasures, the former forcefully and the latter in a more consensual way:

• Strengthening the review of acquisitions or cooperation projects by Chinese companies or entities in relation to broader national security risks (Foreign Investment Risk Review Modernisation Act signed by Donald Trump in August), although the problem of large offshore funds held by Chinese companies and their subsidiaries reinvesting their profits complicates the policies.
• Visits by Emmanuel Macron, Angela Merkel and Jean-Claude Juncker to establish fair reciprocity mechanisms and accelerate negotiations on the Sino-European Investment Treaty.
• Prohibition of supply of critical components or equipment to Chinese companies: the US Department of Commerce decree prohibiting the purchase by ZTE of critical semiconductors has been suspended by the President but could be reintroduced. The state-owned companies China Aerospace Science and Industry and China Electronic Technology Group and their subsidiaries have been blacklisted because of their proximity to the Chinese defence sector and most recently the services of the Chinese Department of Defence which violated sanctions against Russia by buying aircraft and missiles from it.
• Ban on the marketing of Chinese products in strategic sectors: as of August 2018, many restrictions are imposed on the purchase by US government agencies of telecom, video surveillance and other services products provided by 44 Chinese companies including Hytera, Hangzhou Technology, Dahua, ZTE and Huawei; the latter two, as well as China Mobile and Ant Financial, are restricted for reasons of public safety and national security.
• Restriction on the number of Chinese graduates admitted to further studies or to collaborate with American institutions and on the duration of visas for Chinese students.

In turn, China has reacted with restrictive measures against American companies:

• Blocking of US acquisition projects (Qualcomm/NXP, Disney/20th century Fox, Carlyle/Akzo Nobel/USG, United Technology/Rockwell Collins…) due to anti-competitive practices.
• Cancellation of Facebook’s license for its innovation center in Hangzhou.
• Increased administrative difficulties for American companies operating in China.
• Threat of boycotting U.S. products. Apple’s sales in China in 2017 amounted to USD 47 billion, to mention only the technology sector. Boeing has just re-evaluated the size of the Chinese market to 7,690 aircraft over the next 20 years worth USD 1,200 billion. The Chinese commercial fleet, which currently accounts for 15% of the world total, is expected to represent 18% in 2037.
• Threat of embargo on strategic products that have been exempted from duties following lobbying by importing American companies (rare earths, human hair, iPhone headphones, etc.).

Confrontation or cooperation?

While China’s successes and advances are partly due to the government’s directive and proactive policy of directing investment towards strategic sectors of the future, President Trump’s argument attributing this progress to state-owned companies and their unfair practices ignores the reality of the incredible dynamism of the Chinese market and the entrepreneurs who know how to take advantage of it.

The Chinese technology stars, Baidu, Alibaba, Tencent, JD, NetEase, Lenovo, Xiaomi, Didi, Meituan, Toutiao and Lufax, are actually private companies (although some are close to power) created by visionary entrepreneurs along the lines of those in Silicon Valley.

In reality, all you have to do is go to Shenzhen and the other cities in the Greater Bay Area, as the Greater China CECs have recently done, to find an incredibly dynamic technical, scientific and financial ecosystem that is conducive to innovation and entrepreneurship, and that can overcome or circumvent the tariff or non-tariff barriers that Trump could raise in its wake.

>> Related Reading: Trump’s Trade policy will make China great again

The real question.

In this context, one question arises: how can we assess the effectiveness of the measures taken by the Trump administration to halt China’s inexorable progress towards global technological leadership?

It is illusory to hope to stop this evolution and it is counterproductive to want to “isolate” China, its next billion Internet users and its engineers and researchers from the global technology community. This would only accelerate the development of China’s own standards, which, through market forces, the B.R.I. (Belt and Road Initiative) and demographics, could only eventually become global.

European opportunities.

A window of opportunity however opens for Europe to set up a vast technological catch-up plan, to draw up with China a framework for collaboration based on reciprocity and mutual respect and to work with China and the other partners on redesigning the architecture of global governance, giving it its full place while the Trumpian sulk and China’s expressed desire to play the game of liberal multilateralism persist.

Meanwhile, President Trump’s trade war and withdrawal from multilateralism have already accelerated China’s conclusion of new trade agreements: 16 agreements in force with 24 countries or economies, 13 others undergoing deepening and 10 under negotiation, including the RCEP, scheduled for signature in 2018.

This insight was originally published in French as part of the Lettre de la Chine hors les murs – n°25 – septembre 2018 (spécial 120 ans), by the French External Trade Advisors (Comite National des Conseillers du Commerce Exterieur).