(This OpEd by Bay Area Council Economic Institute Senior Director Sean Randolph ran in the San Francisco Chronicle on Sunday, June 17.)
By Sean Randolph
The interdependence of the United States and China is easily lost in the political debate and headlines. The future of trade between the world’s two largest economies depends on policies that recognize that interdependence and the national interests behind them. ZTE is a case in point, where the United States has penalized the company for its actions, and President Trump has correctly decided not to shut it down. ZTE also tells us something about the technological race that both countries are engaged in.
China is climbing the innovation ladder. Whether from the standpoint of government investment in science; internationally-cited scientific articles; R&D on artificial intelligence; advances in mobile commerce; the strong position of companies like Alibaba, Tencent and Huawei; or the explosive growth of domestic accelerators and venture capital, China’s capacity to innovate is advancing with its economy. At some point, the technology gap between the United States and China will significantly shrink.
But not yet.
It’s easy to think of China as a relentless juggernaut whose growth and technological competitiveness is preordained. Besides the technology generated from market competition China has adopted a suite of Chinese industrial policies designed to create national champions, dominate or lead in key strategic sectors, and extract technology from foreign companies — a cause for deep concern in the U.S. and other economies, which is now being challenged bilaterally and in the World Trade Organization. But even if they went unchallenged, having these policies doesn’t mean that Chinese technology is on a par with that of the United States — or soon will be.
Take, for example, the explosive growth of venture investment in China. Last year it reached levels approaching that of the United States. But as impressive as this may be, it’s important to understand the large role that government money plays. Unlike the United States, where venture investment is overwhelmingly private, much of the venture capital deployed in China comes from government entities.
More than $230 billion reportedly has been deployed so far, including most recently as much as $15 billion in the semiconductor sector. While this is significant, and leverages private investment, its source suggests that Chinese and U.S. venture numbers aren’t strictly comparable.
Or take Chinese cell phone maker ZTE, the fourth-largest provider of smart phones in the United States and producer of a range of consumer electronics and telecommunications infrastructure equipment. Two months ago, the United States barred American companies from selling components, including semiconductors, to ZTE, because of the company’s violation of Iran and North Korean sanctions (an issue unrelated to the current tariff dispute). Soon after that ZTE, one of China’s leading technology companies, announced that it would stop major business operations.
How could that happen?
Because ZTE depends heavily on U.S. companies such as Qualcomm for the semiconductors in its phones and on other U.S. suppliers for an array of critical components. Despite years of enormous government investment designed to vault China to the forefront of chip design, nearly 90 percent of the $190 billion in chips used in Chinese products are either imported or produced in China by foreign-owned companies, and the sophistication of its production continues to lag. The proposed U.S. cutoff may prod China to accelerate its efforts to upgrade the quality of domestically produced chips, but for now it’s still just a goal.
So what are we to make of this? One takeaway is that while innovation in China is accelerating, in key fields U.S. companies are continuing to innovate faster. Notwithstanding the government’s support and the sophisticated capabilities of companies Tencent, Alibaba and Huawei, the lead in innovation is still anybody’s game and the United States continues to hold strong cards.
The other takeaway from the ZTE case is that when it comes to trade and technology, the United States and China are deeply intertwined. ZTE phones sold in China and around the world, and counted in U.S. trade statistics as Chinese exports, in fact incorporate high levels of U.S.-made content. Much the same can be said for Huawei, whose products are largely made with externally sourced components.
President Trump is right to make a deal that helps keep ZTE in business. The penalties it imposes are draconian and appropriate. Our goal should not be to bring down a high-profile pillar of China’s economy. The world’s two largest economies, and their companies are deeply connected in ways that are both challenging and beneficial. Finding a way of operating that recognizes the interests of both sides will be essential for the future.
Sean Randolph is senior director at the Bay Area Council Economic Institute and author of its recent report “Chinese Innovation: China’s Technology Future and What It Means for Silicon Valley.”