Trade war: What are the US and China really fighting for?

Key points

  • US-imposed tariffs on Chinese goods could actually be masking another rivalry between the two countries, namely technology
  • China is looking to technology to boost its economic growth. The trade war and rising economic imbalances from within could accelerate that ambition
  • The trade war may die down, but the tech war will likely endure for some time yet

The US/China trade war has been one of the major drivers of financial markets and economic sentiment since mid-2018. However, by late 2019, the two countries were making the final touches to their so-called “phase one” trade deal, which needs to be signed by Chinese President Xi Jinping and US President Donald Trump. The market has been cheered by the short-term positives, despite lingering uncertainties and President Trump’s back and forth mixed messages. But it seems fair to say that this is far from the end - and we believe the stand-off is ultimately covering up deeper tensions.

It’s all about technology
Up to 60% of the first batch of US$250bn worth Chinese goods subject to US tariffs since July 2018, according to our calculations are directly or indirectly related to technology and high-end manufacturing. And a new round of levies, which started in September, covered smart watches, smart speakers, Bluetooth headphones and other tech devices that were spared from prior rounds of tariffs.

But over the last two years, there has been continued friction between the US and China around technology. Big Chinese tech firms were sanctioned by the US one after another, with ZTE and Huawei at the front of the firing line. Tightened conditions for foreign investment in US-based tech firms in 2018 led to more than an 80% drop in Chinese investments that year.[1] Chinese students were also impacted, with those involved in robotics, aviation, engineering and hi-tech manufacturing studies facing tighter visa controls. And concerns about China acquiring more advanced artificial intelligence (AI) have led to calls for stronger controls on exports of this technology.

As the rivalry intensifies, the strategic importance of technology speaks for itself. The US has been the world’s superpower for decades, secured by its absolute dominance in three pillars – military, currency and technology. Does China, the world’s second-largest economy, have what it takes to be the next superpower? The US is unlikely to be challenged on the first two pillars in the short term, with its defence budget significantly higher than China’s, while the US dollar accounts for 60% of the global reserve system versus 2% for the Chinese Yuan. However, the third pillar – technology – has revealed itself to be the first real battlefield between the two converging powers.

Made in China 2.0
There are forces within China driving the country’s ambition to become a global technological leader, that have nothing to do with its rivalry with the US. China’s old growth model, heavily powered by labour and capital, is no longer viable, considering its increasingly ageing population and slowing capital formation.

With a need to rebalance its economy towards productivity-driven growth, powered by technology and innovation, the Chinese government launched Made in China 2025 (MIC 2025) in 2015. This is a state-led 10-year plan to update China’s manufacturing base by rapidly developing certain high-tech industries. Key among these are electric cars and other new energy vehicles, next-generation information technology and telecommunications, advanced robotics and AI, and so on. MIC 2025 has however since become a bone of contention for Trump’s administration, which is another indication that the trade war isn’t simply about trade.

The technology ambition is fuelled by significant research and development (R&D) spending. At 2.1% of GDP, originally set to increase to 2.5% in 2020, China’s R&D spending is above the Eurozone average of 1.9% - and is second only to the US, in absolute terms. Such investments in R&D have allowed China to catch up rapidly on innovation output.

On a macro level, China has been moving its economy up the value chain through tech advancement. Industrial production between the “old” - steel, cement and mining - and “new” - robotics, automotive and semiconductors - segments has diverged remarkably in recent years. Externally, while China was the world’s factory 20 years ago - as the major exporter of low value-added goods such as clothes, toys and plastics - the menu it offers now comprises mainly mobile phones, computers, automobiles and semiconductors.

Rapid growth in high-tech industries has bred companies like Alibaba, Tencent, Baidu, Huawei and DJI, which are not only household names in China, but are also starting to compete globally with giants such as Amazon, Facebook, Google and Apple.

 

In the fight for technology supremacy, China is catching up with the US in several areas, such as e-commerce, clean energy, high-speed rail, mobile payment, robotics, 5G, supercomputing and certain segments of AI. It is evident that China’s edge lies in the same factors which enabled tech to take-off in the first place - namely supportive government policies, strong demand from a growing middle-class population, efficient supply-chain and abundant domestic capital.

However, while China has done exceptionally well in applying new tech in traditional industries, and in areas driven by size such as sharing economy and e-commerce, it’s still lagging the US in inventing ground-breaking technology.

 
Source: AXA IM Research

What’s more, China’s ambition in technology transformation could become more urgent now that it’s witnessing slower economic growth. Amid the trade tensions and rising technology protectionism, the Chinese drive towards self-reliance has further accelerated over the past year. According to data aggregated by Wind, China’s leading financial terminal, R&D spending growth of China’s A-share listed companies accelerated to 22% in 2018, with 2019 set to see an even steeper increase. In September this year, Huawei unveiled a new 5G processor for its mobile devices, highlighting the company’s determination to take control of its supply chain facing political pressure from the US, an epitome of the country’s end goal as a whole.

A silver lining – but the rivalry looks set to last
During the US/Russia Cold War period, many technological advances that we take for granted today actually happened as a result of the one-upmanship between the two sides. With the US/China rivalry, a silver lining effect is still possible. The world could end up better off, provided both sides increase R&D, invest heavily in tech, education and skills - and provided the tech created doesn’t turn into something sinister.

However, the US will not concede the technology throne without a fight. The competition is bound to grow fiercer – and while exciting new technologies could be the result, there could also be a continued negative impact on trade as well as international relations. We may see the trade war easing or even being resolved if the White House gains a new President. But for now, the tech war looks set to continue – and we expect it could be long lasting.   

[1] Rhodium Group: Net Negative: Chinese Investment in the US in 2018

https://rhg.com/research/chinese-investment-in-the-us-2018-recap/