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Ivan Danilin

Head of the Department of Science and Innovation at the Institute of World Economy and International Relations of the Russian Academy of Sciences; Senior Fellow at the Laboratory of International Process Analysis at MGIMO under the Ministry of Foreign Affairs of the Russian Federation

On May 15, 2020, exactly one year after the United States launched its full-scale sanctions war on Huawei, the U.S. Department of Commerce unveiled new restrictions against the Chinese electronics giant. Starting from September 2020, companies will not be allowed to use U.S. technology and software to develop chips for Huawei or sell chips developed by the Chinese behemoth (unless they have been granted a special license by the U.S. government). While the sanctions will not come into effect immediately, past experience would suggest that many enterprises will start winding down their cooperation with Huawei ahead of schedule or look for some legal yet limited channels of interaction with the corporation.

At the same time, the U.S. Ministry of Commerce announced that it would no longer be issuing temporary permits for the export of American tech products for Huawei once the current permits expire in mid-August.

The sanctions did not come as a surprise, but their symbolic significance is huge. They represent not only an attempt to undermine the "shaky peace" that has defined relations between the United States and China since January 2020 in connection with the coronavirus pandemic, but also a new stage in the tech war that has been unfolding between the two countries.

At the same time, the possible response of the Chinese leadership is nothing to be scoffed at. Beijing has already vowed to introduce restrictions against U.S. tech companies (Apple, Qualcomm and Cisco), which is no empty threat, given that China remains the largest market for and largest importer of microelectronics in the world (over $300 billion in 2018). The country has also threatened to stop purchasing Boeing airliners.

Even greater cause for concern is just how the situation will develop in the long term. Washington is essentially trying to block Huawei’s ability to develop microelectronics and manufacture truly advanced products and components. A huge number of factors are at play here, from scientific and technological concerns to purely economic considerations.

Far more predictable are the actions of the two sides in the medium to long term. The President of the United States (whoever that is in 2021) will, in complete concordance with Congress, continue the full-scale assault on the Chinese hi-tech industry, especially as there are more than enough formal reasons for doing so. Meanwhile, China, to absolutely no one’s surprise, will concentrate on the accelerated development of its technology sector, as well as on import substitution for the most important categories of products and digital services (to be fully realized in 2024–2025).

The interesting part, as with the case of Huawei, is what consequences these machinations will bring. The main challenge here is time. If China wants to become technologically independent from the United States (to the extent that it is possible, as “complete technological independence” is both unrealistic and even counterproductive in today’s world), or to at least occupy strong positions on the global market, then it badly needs another five to seven, or even better ten years of stable technological, industrial and general economic development to catch up. But this is time that it simply does not have. The economy is slowing down, which is largely taking place regardless of the conflict with the United States. External constraints are incredibly significant and are only getting worse. Time-bound enormous government and private investments in research and development, training skilled workers, setting up innovative enterprises and developing the necessary infrastructure are of the essence and have an effect. It will take time, effort and money for China to develop its own innovative growth factors. And, given the realities of modern China, these are things that should be spent on achieving new breakthroughs, rather than on retreading a path that has already been travelled. Having said that, it will not be easy for Beijing to pursue a course of partnership and borrowing in the new political climate. In other words, China will be able to satisfy some of its needs via import substitution in the coming years, but it will not be able to replace to West entirely.

On May 15, 2020, exactly one year after the United States launched its full-scale sanctions war on Huawei, the U.S. Department of Commerce unveiled new restrictions against the Chinese electronics giant. Starting from September 2020, companies will not be allowed to use U.S. technology and software to develop chips for Huawei or sell chips developed by the Chinese behemoth (unless they have been granted a special license by the U.S. government). While the sanctions will not come into effect immediately, past experience would suggest that many enterprises will start winding down their cooperation with Huawei ahead of schedule or look for some legal yet limited channels of interaction with the corporation.

At the same time, the U.S. Ministry of Commerce announced that it would no longer be issuing temporary permits for the export of American tech products for Huawei once the current permits expire in mid-August.

A short refresher: the war against Huawei started back in 2018, after the United States accused the company of espionage, reverse engineering and all manner of other sins and launched a campaign to pressure U.S. and foreign companies to cut ties with the Chinese tech giant. The standoff turned into sanctions in May 2019 (the restrictions imposed against China in April 2019 were merely an ace up the sleeve for Trump’s negotiations with Xi Jinping in Osaka and were quickly lifted). The first stage of the sanctions involved prohibiting U.S. government agencies from purchasing technology produced by Huawei and ZTE, as well as a blanket ban on all government bodies from working with companies that use such technology (these restrictions will come into force in August 2020). The second stage was to oblige U.S. companies that supply American-made technologies to Huawei (components, subsystems, software, etc.) to obtain a state license before they could continue carrying out these services. This led to interruptions in the import of Qualcomm chips, for example, as well as to problems with Google’s Android operating system and Huawei severing ties with the U.S.–Singapore company Flex, its largest phone assembly contractor (the second-largest contract manufacturer of electronics and related products in the world). And even though, after some very difficult negotiations, the U.S. Department of Commerce did issue a number of American companies temporary permits so that they could continue deliveries (a practice that, we repeat, will come to an end in August 2020). The actions of the United States nevertheless caused serious problems for Huawei, first and foremost financial problems, including the loss of a slew of clients and the need to urgently seek a replacement for a number of suppliers. In addition, the company also suffered damage to its reputation and was forced to acknowledge that it needed to find substitutes for these imports quickly and create a parallel innovation system involving China, friendly countries and partner companies.

Activity in this area has led to a number of significant results. These include Huawei developing its own technologies (including its own operating system), the emergence of Chinese electronics manufacturers and startups, the opening of an AI lab in Moscow, increased cooperation with Russia, the strengthening of technology divisions in other countries, an agreement with Tencent on the development of the mobile app market for Huawei phones, signed in 2020, etc. Shady schemes and other indirect ways of purchasing the necessary technology, products and services were obviously worked out. It is no coincidence, for example, that the space left behind by Flex was quickly taken up by the Chinese company BYD, which, in addition to its electric cars, is known for supplying optical and plastic components for Huawei phones.

It was these rather successful efforts on the part of Huawei to circumvent the U.S. sanctions that led to a new package of restrictive measures being developed, with discussions already in full swing by early April at the latest.

In this sense, the sanctions did not come as a surprise, but their symbolic significance is huge. They represent not only an attempt to undermine the "shaky peace" that has defined relations between the United States and China since January 2020 in connection with the coronavirus pandemic, but also a new stage in the tech war that has been unfolding between the two countries.

A Victim of Liberal Globalization

Those who are looking for an insight into the impact that the new round of sanctions had on Huawei don't need to look any further than the minutiae of the modern electronics market and China’s place on it.

Over the past three decades, globalization processes have created an entirely unique situation on the electronics markets. The outsourcing of assembly and then production sites to developing countries with low labour costs has led to a number of technologies and competencies being gradually transferred to local subcontractors. Regional market factors and the active support of local governments have brought about rapid growth in Asia, first of manufacturers of individual standard components, then of contract manufacturers (foundries, the best-known of which is Foxconn) that own advanced manufacturing technologies and assets, and finally of “national” consumer electronics manufacturers.

The stabilization of the norms and rules of international trade, the growth of global competition and the strategy of focusing on key technological advantages have led most companies in the industry to turn to outsourcing. All non-core (development, design and production) functions have been transferred to third-party contractors, especially those in Asia, where large manufacturing and technology hubs and clusters have emerged.

A complex, cellular market structure has thus formed. And the fact that the industry is regulated by unified standards that make it easy for all structures involved in it to cooperate with one another, regardless of their “home” country, makes it even more complex and cellular.

There are enterprises that integrate the most important functions (for example, research and development, chip design, product development and proprietary software) or individual groups of functions, or which specialize in certain areas (foundries concentrate on production; Fabless develops and designs chips, but does not manufacture them; small and medium-sized innovative companies release specialized software and hardware solutions, etc.). Even the biggest Western companies operate in this fashion — from the American AMD (the second-largest producer of CPUs in the world behind Intel) to Apple, whose products are manufactured by third companies and integrate a huge number of third-party solutions.

In these conditions, the “standard” target model of electronics companies from developing countries assumes advanced product and R&D competencies and the ability to develop and manufacture individual microelectronic components, as well as part of the final product, on its own. All this happened by relying on external sources for specialized services, including production and technological services, technical know-how and equipment, access to which, again, was guaranteed by the liberal trade and economic regime.

It would seem that the world, in the words of Thomas L. Friedman, has become “flat.” Many had started to believe that a company from a developing country could now (with some help from the state) become a world leader, and that developing countries could catch up and even overtake the countries that have thus far set the pace in terms of information and communication technologies. And the example of Huawei appeared to be clear confirmation that the global playing field was now equal in the world of electronics. Huawei has almost made it to the summit, having become a major developer of original consumer, industrial and infrastructural products and certain microelectronic components, as well as a leader in 5G technologies. The company also has its own advanced microchip manufacturing capabilities (its HiSilicon subsidiary) and is pushing for leading positions in other areas.

The only problem is that there are only really three areas on the electronics market where the playing field is truly equal for all, and those are product assembly, the production of individual standard components and the creation and production of consumer solutions. The remaining sectors — semiconductor technology, software development for chips, equipment and specialized chemicals for the production of microelectronics, the production of the most complex components — are still part of a rigid hierarchy. At sitting atop this pyramid of competencies, technologies and assets is the United States, which remains the global leader in electronics (with over half of the production equipment market, two-thirds of the specialized software market, etc.).

A consequence of this is that, despite the enormous amounts of money that Huawei pumps into R&D and building its own factories, the company is still heavily dependent on foreign, primarily American, suppliers in terms of technology and its production capabilities. New chips and other electronic components for personal electronics are developed using software produced by Cadence Design Systems and Synopsys, which are both American companies. One of the industry’s leading companies, the United Kingdom’s Arm Holdings, which used to provide specialized services for Huawei, also uses American technology. The situation with regard to the production of microelectronics, smartphones and other such products is demonstrably better, although Huawei produces approximately 10 per cent of all its products at its own factories (which is quite impressive by today’s standards). A developed network of foundries operates in China and in the Asia Pacific in general. Huawei’s biggest partners here, including in the production of chips, are the Chinese company Semiconductor Manufacturing International Corporation (SMIC) and Taiwan Semiconductor Manufacturing Corporation (TSMC). However, even we factor out the White House’s relentless pressure on TSMC (it was no coincidence that the company announced in May that it was planning on building a new factory in the United States, of all places), it will not change the fact that all these companies primarily use U.S.-made equipment from the companies Applied Materials, Lam Research and KLA. That said, according to estimates, SMIC is still not able to produce all the chips Huawei needs. All this without taking the “small” complex solutions into account, where Huawei also counts several small and medium-sized U.S. companies among its contractors.

Despite the “modular” nature of modern electronics, financial and technical considerations often make it exceedingly difficult to move away from U.S. technology. For example, even if we were to assume that Japanese competitors might ignore the White House’s threats for the sake of huge profits and start supplying Huawei or its partners with production equipment, the transition to new equipment will mean that production lines and technological processes will have to be readjusted across all its facilities, which is a costly, complicated and drawn-out process.

Dodging an Attack? Or Striking Back?

While Huawei was quick to assure everyone that it would cope just fine during the new crisis, even the company’s management was forced to admit the severity of the blow. And it will only get worse as August approaches, when the remaining restrictions under the 2019 sanctions will come into effect (and new measures are expected to be introduced).

In the medium term, Huawei does, of course, have options, and it is working through each and every one of them.

First of all, the company urgently needs to replenish its stocks before the new restrictions take force, while at the same time accelerating the development of its industrial base. SMIC and (as far as we can tell) other companies have already received $2.25 billion from the national and Shanghai regional funds for the support of the semiconductor industry to boost production. Other measures, such as increasing HiSilicon’s capacities, are also being worked out.

Second, the company needs to buy “standard” microelectronic components (that is, components not developed by or for Huawei, according to its specifications) from third-party manufacturers. Talks have begun with MediaTek (Taiwan) and Unisoc (China), and Samsung has been approached as well. However, MediaTek and Unisoc do not currently produce all the hi-tech chips that Huawei needs and require new investments and, again, equipment in order to do so. The companies risk falling into a number of pitfalls here, as it is still unclear how U.S. regulators will interpret the new rules. This is why MediaTek refused to make any firm commitments. No matter what happens moving forward, this will be a major defeat for Huawei in terms of creating its own advanced microelectronics. And this is why the idea of creating its own production lines using equipment made outside of the United States (put forward by both TSMC and Samsung) was not met with any kind of enthusiasm.

Third, in the case of infrastructure and industrial equipment, a rather exotic workaround is possible: having suppliers ship chipsets directly to Huawei customers and installing them on-site. Even if the cost and difficulty of these strategies is not an issue for these companies, it is unlikely that they will be able to escape the watchful gaze of the U.S. Department of the Treasury and the Department of Commerce and avoid becoming a target of new White House attacks.

At the same time, the possible response of the Chinese leadership is nothing to be scoffed at. Beijing has already vowed to introduce restrictions against U.S. tech companies (Apple, Qualcomm and Cisco), which is no empty threat, given that China remains the largest market for and largest importer of microelectronics in the world (over $300 billion in 2018). The country has also threatened to stop purchasing Boeing airliners, which, given the massive losses the company incurred as a result of the issues with its 737-MAX planes, could turn into a serious problem for the American commercial aircraft construction industry.

In other words, China will find a solution to the issue, and it may be difficult at times. In any case, there is little chance that Huawei will “sink” in 2020.

Even greater cause for concern is just how the situation will develop in the long term. Washington is essentially trying to block Huawei’s ability to develop microelectronics and produce truly advanced products and components. A huge number of factors are at play here, from scientific and technological concerns to purely economic considerations.

Huawei as an Episode of Technological Warfare

There are objective reasons why the current focus is on Huawei, namely its size and the company’s role in the development of 5G technology. The White House is methodically and systematically destroying the jewel of the Chinese electronics industry. But it is no secret that these steps (like the pressure that is being put on ZTE) are the bare minimum in the major tech war that is unfolding.

The long-term strategy of the United States is to weaken the Chinese hi-tech industry as a whole, for both economic and military-technical reasons. And Washington has made it clear that it is not interested in any kind of deal that would detract it from this goal. It should be noted here that the events of late April to May 2020 finally confirmed that technological warfare is a completely separate, albeit interconnected, “track” of the United States’ policy alongside the more general trade and economic conflict with China.

Even if we forget about Huawei, it is clear that these are more than simply new steps in the confrontation between the United States and China. We are witnessing an entirely new stage in the tech war between the two countries, carried out in the form of “waves” of systemic (the reform of export control and capping of foreign investments in 2018–2019) and targeted (two rounds of sanctions against small, medium-sized and large Chinese companies in June and October 2019, not counting those against Huawei and ZTE,) measures.

On April 27, news broke that measures had been adopted to prevent critical U.S. technologies from falling into the hands of the Chinese (as well as the Russian and, for no apparent reason, Venezuelan) armed forces, including through commercial Chinese companies. Immediately following the announcement of steps against Huawei in May 2020, sanctions were introduced against 33 small, medium-sized and large Chinese tech companies involved in the development of AI systems, cloud technologies, etc. (the official reason being that the Chinese side uses these solutions to keep an eye on the country’s Turkic minority).

In this context, the White House is not easing the pressure on Western governments and companies to limit the sale of important technologies to China, block the access of Chinese technological solutions and investments to local markets, and curtail the “dialogue” between U.S. corporations and Chinese investors (and it is even stepping up the pressure in certain cases).

Regarding the latter, the steps taken by NASDAQ, one of the backbone structures of the hi-tech industry, are worth mentioning here. On May 18, 2020, NASDAQ announced that it would be tightening the rules on IPOs for Chinese startups, as well as introducing other restrictions for Chinese companies that already trade on the exchange. Unsurprisingly, similar bills are being drafted by the Senate and in Congress, as well as by federal regulators.

Chinese innovations have suffered significantly as a result of the measures taken in 2018–2020. Academic ties with the United States and a host of other developed countries, which are crucial to the continued development of science in China, have shrunk significantly. Bilateral cooperation in the venture capital segment has also suffered a serious blow following the outflow of Chinese capital from Silicon Valley and the ostracization of Chinese investors from the U.S. tech industry that started in January last year. The venture capital market in China has sagged too. Chinese corporations are leaning towards delisting from NASDAQ (for example, Baidu) and the NYSE (SMIC has already left), a decision that has nothing to do with Trump's incessant calls to "remove" Chinese companies from the U.S. (read: world) capital markets.

Wind from the East or Wind from the West?

The actions of the two sides in the medium to long term are both clear and predictable.

The President of the United States (whoever that is in 2021) will, in complete concordance with Congress, continue the full-scale assault on the Chinese hi-tech industry, especially as there are more than enough formal reasons for doing so.

Meanwhile, China, to absolutely no one’s surprise, will concentrate on the accelerated development of its technology sector, as well as on import substitution for the most important categories of products and digital services (to be fully realized in 2024–2025).

The announcement in May of a new $1.4-trillion programme for the development of promising breakthrough technologies, which caused quite a stir, is just one of the steps in this direction. A wide range of activities will soon follow, from investing in human capital to developing industrial infrastructure, and from cooperation with Russia and other countries to the introduction of new reforms and the development of the venture and other segments of the financial markets.

The interesting part, as with the case of Huawei, is what consequences these machinations will bring.

The main challenge here is time. If China wants to become technologically independent from the United States (to the extent that it is possible in today’s world, as “complete technological independence” is both unrealistic and even counterproductive), or to at least occupy strong positions on the global market, then it badly needs another five to seven, or even better ten years of stable technological, industrial and general economic development to catch up. But this is time that it simply does not have. The economy is slowing down, which is largely taking place regardless of the conflict with the United States. External constraints are incredibly significant and are only getting worse. Time-bound enormous government and private investments in research and development, training skilled workers, setting up innovative enterprises and developing the necessary infrastructure are of the essence and have an effect.

To begin with, they cannot completely make up the decades that the United States and other Western countries have on them. Keep in mind that China only started intensive development of the electronics sector in the mid-1990s (it is probably not appropriate to bring up the era of “screwdriver assembly” here), compared to Japan, which had been investing in the industry since the 1960s. Even South Korea had a head-start on China, getting the ball rolling in the 1980s. Second, China still needs to import knowledge, competencies and technologies on a massive scale (intellectual property, equipment, software, materials, etc.), including through the purchase of companies and services, and it needs to gain access to “smart capital” from Western markets. It will take time, effort and money for China to develop its own innovative growth factors. And, given the realities of modern China, these are things that should be spent on achieving new breakthroughs, rather than on retreading a path that has already been travelled. Having said that, it will not be easy for Beijing to pursue a course of partnership and borrowing in the new political climate. In other words, China will be able to satisfy some of its needs via import substitution in the coming years, but it will not be able to replace to West entirely.

Paradoxical as it may seem, but the key factor in the new tech war between the United States and China is not technology itself, but rather general trade and economic factors. It all comes down to three interconnected issues.

First, are the Chinese corporate and consumer markets powerful enough to become a factor that is capable of counterbalancing the desire of the White House and Capitol Hill to weaken the hi-tech segment in China? In other words, to what extent does the hi-tech sector and, more broadly speaking, to what extent do the economies of the United States, Europe and Japan depend on “Chinese income” in the context of intense global competition? So far, the U.S. strategy of encouraging companies to move their production out of China and into other countries concerns a small group of functions only, and it will take several years to reconstruct the global value chains, especially since Vietnam and India will not be able to turn into the “new China” over the course of three to four years. Thus, in the medium term, the price of “decoupling” the U.S. and Chinese economies, including in the tech industry, may turn out to be too high. And then there are Japan, South Korea and the countries of Western and Northern Europe to consider. The slow economic growth in the European Union and the Land of the Rising Sun, as well as the difficult situation in the South Korean electronics industry, may very well mean that the United States will not have enough tricks up its sleeves to keep its allies from being enticed by the “long yuan” in the next three to five years. And we have not even mentioned the possible “consequences” that China’s response might have for a number of important sectors and sub-sectors of American industry and knowledge-intensive services, including aircraft engineering.

Second, it is unclear exactly how effective Washington’s financial leverage — including restricting the access of Chinese businesses to the global capital markets and the disciplinary actions of the Department of the Treasury — will actually be. Even disregarding its attempts to enter the European or Asian stock markets and develop the Hong Kong and Shanghai exchanges, China will be looking to answer in kind. One example could be the creation of regional digital currencies based on the digital yuan as an alternative to international payment systems.

Third, it is unclear how complicated, expensive and realistic it will be to reverse global trade and investment trends in the “hi-tech” sector, which, perhaps more than any other sector, requires market and technological processes to be stable and reliable. The same goes for the reconstruction of global value chains, which took years and even decades to build.

Whether or not the United States will eventually return to the table of real, rather than tactical, negotiations depends on the answers to these questions, as does China’s to slip between Scylla’s sanctions and Charybdis’ institutional restrictions on innovative development. However, it seems that no one has the answers right now. The White House, where Trump breaks the accepted patterns of economic strategy and global norms because, well, “why not?!” certainly does not have the answers. Nor does Beijing, which is busy tackling the complex issue of finding a suitable response to Washington’s strategists (one that does not scare off investors and partners in one fell swoop) and hurriedly building, using semiconductor technologies, a modern industry and an innovative system. And nor do the companies of the two countries, which are thinking feverishly about how to act here and now in conditions that are changing in front of our very eyes and leading the global technology sector into uncharted standards and practices.


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