Insight Bite

Trade War Between World’s Two Largest Economies

In recent years, US President, Donald Trump, has voiced concerns to the WTO over China’s alleged violations of US intellectual property rights. Chinese law currently allows domestic companies to merge with or partake in joint ventures with foreign businesses, thereby gaining access to new technological developments; developments they then share with partners without permission. This process fails to recognise that companies have intellectual property ownership rights and that innovators have the right to patent new technologies. China denies any wrongdoing. To protect intellectual property, Trump has come down hard on China, imposing $200bn in tariffs on imported goods. He has also set restrictions on US exports of high technology. Chinese President, Xi Jinping, has responded in kind by putting $60bn worth of tariffs on US imports. Companies specialising in semiconductors and the essential materials and components required to make them, have found themselves embroiled in this international trade war.

Global Concerns about China’s (Alleged) Theft of Intellectual Property

The US has been unable to prevent the Chinese government from capitalising on the use of US intellectual property to further advances in R&D in its technological sector. However, at the beginning of this month, there were allegations that Chinese state-backed chipmaker, Fujian Jinhua Integrated Co. Ltd., along with its Taiwanese partner, United Microelectronics Corp., stole intellectual property pertaining to memory storage devices from Micron Technology Inc. Fujian Jinhua and United Microelectronics Corp. have been indicted for stealing trade secrets and the US Commerce Department has forbidden these companies from buying U.S. software or components. China deny these allegations. Other technologically advanced nations, including Japan, South Korea, and some countries in Western Europe, have also voiced concerns about Chinese state-backed intellectual theft.

US Crackdowns on Acquisitions and Exports, and Tariffs put on Chinese Goods

Acquisitions:
Acutely aware of these intellectual property concerns, the last two US administrations, as well as the Pentagon’s Silicon Valley department, have tried to prevent Chinese-backed companies from acquiring semiconductor assets. This firm stance has intensified under Trump. In February, China tried to acquire Xcerra Corp, a Boston-based semiconductor Automatic Test Equipment vendor, but this was blocked by the US national security panel. For the same reason, in March, Trump shielded Qualcomm, a San Diego-based chipmaker for smartphones, from a $117 billion takeover by Broadcom, a Singapore-based, rival chip manufacturer with links to China.

Sometimes, foreign acquisitions have been subtler: Canyon Bridge may be a California-based company, but is backed by Chinese state-owned and state-funded Yitai Capital. Due to this, Trump again intervened when it tried to acquire Lattice Semiconductors for $1.3bn, an Oregon-based manufacturer specialising in logic devices: CPLDs, SPLDs and field programmable gate array (FPGA).

Export Regulations:
As well as preventing foreign takeovers, the Trump administration has also increased regulation to prevent US semiconductor materials being exported to China. This move is designed to set back development in Chinese R&D. To give an example of the effect this has had, in April, the US announced a seven-year ban on sales to Chinese phone manufacturer, ZTE Corp – this move threatened to put the company out of business until, in May, Trump offered a conditional reprieve: the company complied by paying a $1.4bn penalty, firing its entire board and replacing the chairman.

China were forced to comply with US conditions as they depended and depend on US materials and knew that restrictions would hamper their capacity to improve their own semiconductor industry. The US offer of a reprieve may well be owing to pressures from US businesses that export to China – businesses that were likely to be detrimentally affected by the move.

Tariffs:
In September, the US placed $200 billion-worth of tariffs on goods produced and imported from China, including items critical for tech and telecom businesses. The US stated it would start taxing semiconductors, circuit boards and other China-made goods that are imported into the US. These tariffs started at 10% in September, but they are increasing and will increase to 25% by January. Intended to diminish Chinese export revenues, this move may also have an adverse impact on American companies like Intel, Apple, and Sonos, who currently assemble their products cheaply in China and then import them later for domestic sale in the US. Such impacts have been raised by those companies and, for their sake, the US has allowed for a number of exemptions in these tariffs.

A Chinese National Priority: Investment in R&D

Aware of their shortcomings in the sector compared to other major economies, the Chinese government under the Premiership of Le Keqiang has made R&D in the chip industry a national priority. His Made in China 2025 plan aims to have 70% of core materials produced in China by that year so that the country may attain the manufacturing capability needed to compete with Germany and the US. This is important for the country as, in 2016, $227bn-worth of integrated circuits were imported, not made. China does have some significant chip companies, including Huawei’s Hisilicon Technologies and Jiangsu Changjiang Electronics Technologies, but still the country only accounts for 1% of the global market.

Beijing’s ‘Big IC Fund’ is trying to improve this by investing heavily in companies like Anji Microelectronics and the Naura Technology Group, but since this only accounts for 8% of the funding those companies require, the Made in China 2025 plan has sought to encourage private companies and local government to invest too. On January 1, 2018, Beijing also implemented a five-year corporate tax exemption on chip products smaller than 65 nanometres with investment in excess of $2.39bn.

Despite these moves, China is still having a hard time attracting talent with the necessary skill set to produce high-end chips and is struggling to tackle technical difficulties. It is worth stating that there will also be difficulties ahead as it is precisely the products included on the Made in China 2025 list that have been put on the US list of tariffs this September; this will detract international talent from wanting to work in a country that is less productive and has a smaller international market.

Europe Follows Suit in Scrutinising China

Concerned that Chinese-backed investments in critical infrastructure have led to national security threats, the US Committee on Foreign Investment has begun to up it’s scrutiny of inward investment. The UK, France and Germany have all followed suit. The UK has been cautious ever since UK chip-making company, Imagination Technologies, was taken over by the Yitai Capital-backed, Canyon Bridge; France has been cautious ever since China’s Tsinghua Unigroup (majority owned by Tsinghua University and funded by the Chinese government’s chip fund) bought French chip-making company, Linxens, from the private equity firm, CVC, for $2.6 billion. In Germany, ministers are now able to block acquisitions aiming to invest a 25% stake or more in critical infrastructure. The EU too have pushed for stronger screening measures of state-backed takeovers of EU companies.

Impediments of Trade Policy

In September, China published a 71-page White Paper that accused the US of trade bullying and protectionism. They claimed that the US are preventing fair competition and asked for more “win-win cooperation.” However, cooperation seems not to be on the agenda: in the first half of 2018, eight Chinese M&A deals with the US were cancelled. The lack of international cooperation has led both countries to champion their major corporations – Unigroup for China; Dow Chemical, Applied Material, and Lam Research for the US – by investing heavily in R&D and offering them huge tax exemptions, in order, in the US’s case, to stay at the forefront of the sector, and in China’s case, to catch up.

There are a number of criticisms to be made of these non-cooperative trade policies. Currently, US companies like Intel outsource a large proportion of their production to China, where manufacturing and labour costs are lower. For them, Trump’s tax policies could force them to relocate, which will be expensive in and of itself, and could in turn mean that, to avoid a drop in their margins, they raise the prices of their products, shifting the financial burden over to the consumer. However, aware of this potential outcome, 300 products made in China were made exempt from September’s tariff, which included items required by major US companies like Apple for manufacturing their goods.

From China’s point of view, its leaders thought Trump would be under pressure to make a trade deal with China before the November mid-terms and that would have put China in a stronger economic position. This weekend it has been widely reported that a temporary ceasefire is on the cards –  yet, with the US economy surging and the ‘America First’ rhetoric still winning support, the US administration’s tough stance on China seems to be popular with the American public. As Stephen McDonell, BBC’s China correspondent notes,

“This is not a suspension of the trade war but a suspension of the escalation of the trade war.”