ECON

The China–US Trade War: Deep-Rooted Causes, Shifting Focus and Uncertain Prospects

Chi Hung KWAN† Nomura Institute of Capital Markets Research

The USA has waged a trade war against China, whose rapid rise has come to be seen as a threat to US hegemony. Besides imposing additional tariffs on imported Chinese products, the USA is also tightening restrictions on the transfer of technology to China and the business activities of some Chinese high-tech companies, notably Huawei. The escalation of the trade war into a tech war could lead to a decoupling between the US and Chinese economies, if not a world economy divided into two economic blocs that centered on them.

Key words: Committee on Foreign Investment in the United States, decoupling, Foreign Investment Risk Review Modernization Act, Huawei, Section 301, technology transfer

JEL codes: F14, F21

Accepted: 24 July 2019

1. Introduction

The announcement of the imposition of sanctions against China based on Section 301 of the US Trade Act in March 2018 triggered an escalation of the trade dispute between the USA and China. As symbolized by the subsequent tit-for-tat exchange of tariff hikes, the situation has now developed into a trade war. Major factors leading to the trade war include the USA’s dissatisfactions with China’s “unfair trade practices,” a reflection of its political and economic systems, which deviate widely from those of the West, and the rise of China, which the USA has taken seriously as a challenge to its hegemony. The trade war signifies a shift of the USA’s China policy from engagement to decoupling, which involves restricting the flows of trade and investment, as well as technology and people between the two countries.

In particular, curbing technology transfer to China has become an important policy for the USA to deter the rise of China. The USA is strengthening its national security review system regarding inward foreign investments, making it more and more diffi- cult for China to import technology by acquiring US companies. At the same time, it is also tightening restrictions on US companies doing business with some high-tech

†Correspondence: Chi Hung Kwan, Nomura Institute of Capital Markets Research, Urbannet Otemachi Building, 2-2-2, Otemachi, Chiyoda-ku, Tokyo 100-8130, Japan. Email: kan-r7w6@jp. nomura.com

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doi: 10.1111/aepr.12284 Asian Economic Policy Review (2020) 15, 55–72

companies in China, notably Huawei. With the focus of dispute between the two coun- tries shifting from issues related to trade to issues involving technology, the trade war has escalated into a tech war.

The ongoing trade war between China and the USA will have negative effects on both economies. China should see a sharp fall in inward foreign direct investment as multina- tionals relocate their operations to other countries, as well as a decline in its potential eco- nomic growth rate as it loses the advantage of being a latecomer that allows it to import technology cheaply from abroad. On the other hand, the USA will not only lose its share of the Chinese market, but also have to import from more expensive sources. In the long run, the world economy is facing the risk of disintegrating into two economic blocs cen- tered on the two major powers, with adverse effects on global economic growth.

2. Why Has the USA Waged a Trade War against China?

As to why the USA has waged a trade war against China, there is apparently a clash of arguments between the US side that accuses China of being an unfair trader, and the Chinese side that criticizes the US assessment of the rise of China as a threat. Each side’s argument appears to have some grain of truth.

Attributing the cause of the US–China trade dispute and the ensuing trade war to China’s failure to comply with the principles set by the World Trade Organization (WTO) – openness and the leading role of the market – the USA is propagating the view of China as an unfair trader. US Ambassador to the WTO Dennis Shea’s criticism of China’s “trade-disruptive economic model,” which can be summarized as follows, is representative of this view (Shea, 2018).

1. Despite China’s repeated portrayal of itself as a staunch defender of free trade and the global trading system, China is in fact the most protectionist, mercantilist econ- omy in the world.

2. The government and the Communist Party continue to exercise control directly and indirectly over the allocation of resources through instruments such as govern- ment ownership and control of key economic actors and government directives.

3. The government and the Communist Party have for decades exercised control over state-owned enterprises through the appointment of key executives and the provi- sion of preferential access to land, energy and capital, and other important inputs.

4. China’s system treats law as an instrument of the state, in the sense that it is used to facilitate the government’s industrial policy goals and to secure discrete economic outcomes.

5. China is seeking to attain domestic market dominance and global leadership in a wide range of advanced technologies by implementing a large number of industrial policies, including the “Made in China 2025” plan (see Box 1).

6. China’s industrial policies deploy massive market-distorting subsidies and provide other forms of financial support for targeted domestic industries.

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Box 1 Growing Vigilance against the “Made in China 2025” Plan

Among China’s “unfair trade practices,” the USA is most vigilant of its industrial policy, particularly the “Made in China 2025” plan announced in 2015.

Made in China 2025 is a roadmap for the development of the manufacturing indus- try as envisioned by the Chinese government (State Council, 2015). The roadmap tar- gets the following 10 priority sectors: (i) next-generation information technology; (ii) advanced digitally controlled machine tools and robots; (iii) aviation and aerospace equipment; (iv) marine engineering equipment and high-tech vessels; (v) advanced rail transit equipment; (vi) low and new energy vehicles; (vii) power equipment; (viii) agricultural machinery; (ix) new materials; and (x) biopharmaceuticals and high- end medical equipment.

The US Chamber of Commerce criticized the implementation of Made in China 2025 as follows in a report published in March 2017 (US Chamber of Commerce, 2017). Unlike other countries’ plans to develop manufacturing industries, such as Ger- man Industry 4.0, Made in China 2025 is intended to promote Chinese companies’ research and development capabilities by providing them with preferential access to capital and to enhance their competitiveness by introducing technology from abroad. In concert with the 13th Five-Year Plan, the Internet Plus Action Plan, and other state-led development plans, Made in China 2025 constitutes a broad strategy to use state resources to establish comparative advantage for China in the manufacturing sector on a global scale. Regarding the implementation of Made in China 2025, it is necessary to keep a watchful eye over the following three aspects in particular: 1. Reinforcing government control of the commanding heights. Contrary to the princi-

ple of giving the market a decisive role in the allocation of resources, which was determined at the Third Plenum of the 18th Central Committee of the Communist Party of China held in November 2013, Made in China 2025 reaffirms the govern- ment’s central role in economic planning.

2. Intensifying preferential policies and financial support. Made in China 2025 illus- trates the Chinese government’s intent to leverage China’s legal and regulatory sys- tems to favor Chinese companies over foreign ones in targeted sectors. Moreover, industries targeted by Made in China 2025 will likely receive hundreds of billions of yuan in government support over the coming years. That could distort Chinese domestic markets and global markets. Such support may be used not only to invest in local innovation, but also to fund foreign technology acquisitions. State-backed support for acquisition of specific technologies represents a new feature and natural extension of China’s industrial policy.

3. Setting global benchmarks. Made in China 2025 represents the latest far-reaching industrial policy on a continuum of such policies to develop not only national cham- pions, but also global champions. Policy documents related to Made in China 2025 set global sales growth and market share targets that are to be filled by “domestic products.” The policies incorporated in Made in China 2025 will have an impact not only

domestically but also in other countries. Made in China 2025 aims to leverage the power of the state to alter competitive dynamics in global markets in industries core to economic competitiveness. However, Made in China 2025 risks generating market inef- ficiencies and sparking overcapacity on a global scale, according to the report.

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7. China has pursued a variety of unreasonable policies and practices that harm US intellectual property rights, innovation, and technology development.

These “unfair trade practices” have been widely blamed for the very large US trade deficit with China, which reached $419.2 billion (47.7% of the total US trade deficit) in 2018 (Figure 1).

Responding to the criticism from the US side, the People’s Daily, which represents the official view of the Communist Party of China, retorted that the real motive of the USA in waging a trade war is to contain China as a challenger to US hegemony and asserted that the view of China as an unfair trader is groundless and nothing more than an excuse (Ren, 2018). It postulates that US foreign policy follows a “60% rule,” which dictates that whenever a foreign country reaches 60% of the USA in economic size and continues to grow fast, threatening to overtake the US economy, the USA should view it as a rival and vanquish it by all means.1 China is now the target, as Japan was in the past (Figure 2). For the USA, China has become a threat to the “America First” principle. China is an unprecedented rival that is achieving faster economic growth and is richer in potential than either of its previous rivals – the Soviet Union or Japan – was. The real motive of the USA in waging a trade war is not merely reducing the US trade deficit but curbing China’s development in a broad range of fields.

This interpretation of US intentions is shared by some US scholars and policymakers. Professor Jeffrey Sachs of Columbia University, for example, writes: “The Trump admin- istration’s conflict with China has little to do with US external imbalances, closed Chi- nese markets, or even China’s alleged theft of intellectual property. It has everything to do with containing China by limiting its access to foreign markets, advanced technolo- gies, global banking services, and perhaps even US universities” (Sachs, 2018).

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Figure 1 Changes in the US trade balance in goods by major trading partner.

Source: Compiled by the author based on US Census Bureau data.

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Steven Bannon, while serving as White House Chief Strategist, also said in an inter- view with The American Prospect: “One of us (the USA or China) is going to be a heg- emon in 25 or 30 years and it’s gonna be them if we go down this path.” He went on to predict: “If we continue to lose it, we’re five years away, I think, ten years at the most, of hitting an inflection point from which we’ll never be able to recover” (Kuttner, 2017). This assessment of China as a threat appears to epitomize the Trump administration’s perception of the country, rather than reflecting Mr Bannon’s per- sonal opinion.

3. China Policy of the USA Shifts from Engagement to Decoupling

Indeed, against the backdrop of China rising as an economic superpower while maintaining its "trade-disruptive economic model," the USA has adopted a confronta- tional stance toward China. The USA characterized its relationship with China as a “strategic partnership” under the Clinton administration, as a relationship with a “responsible stakeholder” under the Bush (junior) administration, and as a “partner- ship based on mutual respect and win-win cooperation” under the Obama administra- tion. However, in the National Security Strategy Report published in December 2017, the Trump administration emphasized that economic security is the foundation of national security and labeled China and Russia “strategic competitors” (White House,

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2017; p. 45). Page 2 of this report offered the following observations concerning the geopolitical situation:

China and Russia challenge American power, influence, and interests, attempting to erode American security and prosperity. They are determined to make economies less free and less fair, to grow their militaries, and to control information and data to repress their soci- eties and expand their influence.

Based on these judgments, the Trump administration has shifted its China policy from engagement to decoupling. At the core of the previous policy of engagement was fully accepting China as a member of the international community and supporting China’s economic development, hoping that the country would gradually move to a more democratic form of government. In contrast, decoupling aims to prevent China from threatening US leadership in the world by constraining China’s behavior and eco- nomic growth through such measures as raising import tariffs on Chinese products, restricting exports of high-tech products to China and strengthening the restrictions on direct investments in the USA by Chinese companies.

The economy is not the only area of confrontation between the USA and China. In a speech at the Hudson Institute on October 4, 2018, US Vice President Mike Pence strongly condemned not only China’s economic policies and systems but also its politi- cal systems, religious policy, Taiwan policy, foreign policy initiatives (e.g., the Belt and Road Initiative), maritime expansion, and interference in the internal affairs of the USA (particularly interference in US elections) (Pence, 2018). Moreover, he made clear the USA’s readiness to confront China not only by raising tariffs and strengthening the control of foreign investments in the USA on the economic front, but also by rein- forcing the military and strengthening cooperation with Indo-Pacific nations that share values with the USA.

4. Imposition of Sanctions on China Based on Section 301 of the Trade Act

US President Donald Trump, who ran for office in 2016 on a protectionist platform, has played a key role in waging the ongoing trade war against China. In fulfillment of his election pledges, he issued a memorandum directing the Office of the United States Trade Representative (USTR) to conduct investigations into China’s acts, policies, and practices concerning technology transfer, intellectual property, and innovation under Section 301 of the Trade Act in August 2017.2 The report on the investigation, which was released on March 22, 2018, is a scathing critique of China. What is notable about the report is that the focus is on technology transfer, rather than on the trade imbal- ance (Office of the United States Trade Representative, 2018a, 2018b). The report argued the following four points:

First, China uses foreign ownership restrictions, including joint venture require- ments, equity limitations, and other investment restrictions, to require or pressure

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technology transfer from US companies to Chinese entities. China also uses administra- tive review and licensing procedures to require or pressure technology transfer, which, inter alia, undermines the value of US investments and technology and weakens the global competitiveness of US firms.

Second, China imposes substantial restrictions on, and intervenes in, US firms’ investments and activities, including through restrictions on technology licensing terms. These restrictions deprive US technology owners of the ability to bargain and set market-based terms for technology transfer. As a result, US companies seeking to license technologies must do so on terms that unfairly favor Chinese recipients.

Third, China directs and facilitates the systematic investment in, and acquisition of, US companies and assets by Chinese companies to obtain cutting-edge technologies and intellectual property and to generate large-scale technology transfer in industries deemed important by Chinese government industrial plans.

Finally, China conducts and supports unauthorized intrusions into, and theft from, the computer networks of US companies. These actions provide the Chinese govern- ment with unauthorized access to intellectual property, trade secrets, or confidential business information, including technical data, negotiating positions, and sensitive and proprietary internal business communications, and they also support China’s strategic development goals, including its science and technology advancement, military mod- ernization, and economic development.

In light of China’s “unfair trade practices” shown in the report, President Trump signed a memorandum directing the following acts:

• imposing tariffs on Chinese products; • filing a WTO case against China for discriminatory licensing practices; and • restricting investment by China in key technology sectors.

In response, on March 23, 2018, the Office of the USTR initiated dispute settle- ment procedures under the WTO and requested bilateral consultations with China as a first step. On April 3, the Office of the USTR announced a sanction plan that would impose additional tariffs of 25% on 1,300 items of products imported from China, including high-tech products, which are worth $50 billion. The following day, China responded by expressing its readiness to impose additional tariffs of 25% in retaliation on 106 items of products imported from the USA, including soybeans and automo- biles. In the light of the Chinese announcement, which was viewed as an unjustified retaliation by the US side, President Trump immediately ordered the Office of the USTR to consider whether more US imports from China should be subject to new tar- iffs. In this way, the trade dispute between the two countries started to heat up.3

By September 2018, three rounds of additional tariffs had been implemented on each other by both sides. On the one hand, the total US tariffs applied exclusively to China amounted to $250 billion (equivalent to about one half of the USA’s imports from China in 2017), with a tariff rate of 25% for the first two rounds (July 6 and August 23, 2018) totaling $50 billion, and 10% (initially scheduled to be raised to 25%

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by the end of 2018) for the third round (September 24, 2018) amounting to $200 bil- lion. On the other hand, total Chinese tariffs applied exclusively to the USA amounted to $110 billion (which is equivalent to about 70% of China’s imports from the USA in 2017), with a tariff rate of 25% for the first two rounds totaling $50 billion, and 5% or 10% for the third round amounting to $60 billion.

As a major step toward reconciliation, at a meeting between US President Donald Trump and Chinese President Xi Jinping held on December 1, 2018, on the sidelines of the Group of 20 summit in Buenos Aires, the USA gave China a 90-day reprieve (until March 1, 2019) from additional import tariffs. On February 24, 2019, President Trump announced that he would extend the March 1 trade deal truce deadline, citing progress in trade talks, raising the hope that a final deal to end the trade war might soon be forthcoming.

However, this hope was betrayed when President Trump suddenly announced on May 5, 2019 a plan to hike the additional tariff rate imposed on the $200 billion of Chinese goods covered by the third round from 10% to 25%, which had been post- poned twice, on the ground that China had backtracked on commitments it made in earlier negotiations. The new tariff hike was implemented on May 10, when high-level economic and trade talks were taking place in Washington DC. China retaliated by announcing on May 13 that it was raising the additional tariff rate on the $60 billion of US goods covered by its third round of tariffs, effective June 1. On the same day, the Office of the USTR released a new list of Chinese imports amounting to about $300 billion that could be subject to a proposed 25% tariff hike (the fourth round). This list covers virtually all remaining imports from China that had not yet been sub- ject to additional tariffs.

Vice Premier Liu He, Beijing’s chief negotiator, told a group of reporters after trade talks ended with no deal on May 10 that there were three main points of contention between China and the USA (Bloomberg News, 2019). First, the USA must remove all the additional tariffs imposed on China. Second, the targets set by the USA for Chinese purchases should be in line with real demands. Third, the text of any deal should be “balanced” to ensure the “dignity” of both nations.

In the meeting between US President Donald Trump and Chinese President Xi Jinping held on June 29, 2019, on the sidelines of Group of 20 summit in Osaka, it was decided that the USA would put off its plan to impose additional tariffs on the $300 billion-worth imports from China covered by the fourth round, and high-level trade talks would soon be resumed. However, the trade war escalated again on August 1, 2019, when President Trump stepped back from his promise and announced that additional tariffs of 10% would be imposed on the 300 billion dollars’ worth of prod- ucts imported from China covered by the fourth round from September 1, 2019, although the implementation of some new tariffs was later postponed to December 15, 2019. China retaliated by announcing its own fourth round of tariffs covering $75 billion-worth of US goods on August 23, which was followed on the same day by Pres- ident Trump announcing his plan to add another 5% to the additional tariff rates that apply to the Chinese goods covered by all four rounds of tariffs.

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5. Tightening of US Restrictions on Investment by Chinese Companies

What makes things worse is that the dispute between the USA and China has spread from issues related to trade to those involving technology. In particular, to deter Chi- nese companies from acquiring cutting-edge technologies through direct investments in the USA, including mergers and acquisitions (M&A), the US government is strengthening its national security review system for direct investments by foreign companies.

In the USA, an inter-agency committee called the Committee on Foreign Invest- ment in the United States (CFIUS) is charged with the task of monitoring foreign direct investments based on the Foreign Investment and National Security Act of 2007 (FINSA). CFIUS is empowered by law to review national security risks that may arise from M&A through which foreign companies aim to acquire control over US compa- nies. If CFIUS judges that a foreign investment in a US company is posing a threat to the national security of the USA, CFIUS recommends “mitigation measures” that, if not accepted, could lead to the withdrawal of the application.

FINSA, which was enacted in 2007, is a modified version of the Exon-Florio Provi- sion of the Omnibus Foreign Trade and Competitiveness Act of 1988. On the basis of

Table 1 Factors that should be taken into consideration in the Committee on Foreign Investment in the United States’ (CFIUS’s) national security review process

1. Domestic production needed for projected national defense requirements. 2. Capability and capacity of domestic industries to meet national defense requirements,

including the availability of human resources, products, technology, materials, and other supplies and services.

3. Control of domestic industries and commercial activity by foreign citizens as it affects the capability and capacity of the USA to meet the requirements of national security.

4. Potential effects of the transactions on the sales of military goods, equipment, or technology to a country that supports terrorism or proliferates missile technology or chemical and biological weapons; and transactions identified by the Secretary of Defense as “posing a regional military threat” to the interests of the USA.

5. Potential effects of the transaction on US technological leadership in areas affecting US national security.

6. Whether the transaction has a security-related impact on critical infrastructure in the USA. 7. Potential effects on US critical infrastructure, including major energy assets. 8. Potential effects on US critical technologies. 9 Whether the transaction is a foreign government-controlled transaction.

10. In cases involving a government-controlled transaction, a review of: (i) the adherence of the foreign country to nonproliferation control regimes; (ii) the foreign country’s record on cooperating in counter-terrorism efforts; and (iii) the potential for transshipment or diversion of technologies with military applications.

11. Long-term projection of the US requirements for sources of energy and other critical resources and materials.

12. Such other factors as the President or the Committee may determine to be appropriate.

Source: Compiled by the author based on the CFIUS statute as summarized in Jackson (2019).

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FINSA, CFIUS’s guidance concerning national security review cites 12 factors that should be taken into consideration in the national security review process (Table 1).

Among them, factors (6)–(12), which were added through the FINSA Act, have broadened the scope of CFIUS’s reviews and investigation (Jackson, 2019). Previously, CFIUS had been directed by Treasury Department regulations to focus its activities primarily on investments that had an impact on US national defense security. The additional factors, however, incorporate economic considerations into the CFIUS review process in a way that was specifically rejected when the original Exon-Florio amendment was adopted and refocuses CFIUS’s reviews and investigations on consid- ering the broader rubric of economic security. In particular, CFIUS is now required to consider the impact of an investment on critical infrastructure as a factor for consider- ing recommending that the President block or postpone a transaction. Critical infra- structure is defined in broad terms in section 2 of FINSA as “any systems and assets, whether physical or cyber-based, so vital to the United States that the degradation or destruction of such systems or assets would have a debilitating impact on national security, including national economic security and national public health or safety.”

As a further step toward curbing technology transfer, the National Defense Autho- rization Act (NDAA) for Fiscal Year 2019, signed by President Trump on August 13, 2018, contains the Foreign Investment Risk Review Modernization Act (FIRRMA) of 2018, which strengthens the authority of CFIUS, and the Export Control Reform Act (ECRA) of 2018, which provides for countermeasures against the transfer of critical US technologies to other countries. Although no particular country has been specified, it is widely believed that these new laws are “tailor-made” for China.

As a result of the enforcement of FIRRMA, the scope of transactions under CFIUS review has been broadened to include the following business activities by foreign persons:

• a purchase, lease, or concession by or to a foreign person of real estate located in proximity to sensitive government facilities;

• nonpassive (but noncontrolling) investments in US businesses owning critical tech- nology, critical infrastructure, or the personal data of the US citizens;4

• any change in a foreign investor’s rights resulting in foreign control of a US busi- ness; and

• any other transaction, transfer, agreement, or arrangement designed to circumvent CFIUS jurisdiction.

Even before the enactment of FIRRMA, Chinese companies had already found it difficult to acquire cutting-edge technologies from the USA through M&A. Of foreign companies’ acquisition plans that have been abandoned due to the failure to obtain CFIUS approval since the inauguration of the Trump administration, Chinese compa- nies accounted for the largest number by nationality (Table 2). Consequently, Chinese direct investments in the USA dropped from $46 billion in 2016 to $29 billion in 2017 and to $4.8 billion in 2018 (Hanemann et al., 2019).

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Turning to ECRA, it authorizes the Department of Commerce to establish appropriate controls on the export, re-export, or transfer (in country) of emerging and foundational technologies. Under ECRA, emerging and foundational technologies are those essential to the national security of the USA, to be determined by an interagency process. The repre- sentative general categories of technology for which the Department of Commerce cur- rently seeks to determine whether there are specific emerging technologies that are essential to the national security of the USA include: (i) biotechnology; (ii) artificial intel- ligence (AI) and machine learning technology; (iii) position, navigation, and timing (PNT) technology; (iv) microprocessor technology, such as advanced computing technol- ogy or data analytics technology; (v) quantum information and sensing technology, such as logistics technology; (vi) additive manufacturing (for example, 3D printing); (vii) robotics; (viii) brain-computer interfaces; (ix) hypersonics; (x) advanced materials; and (xi) advanced surveillance technologies (Bureau of Industry and Security [US Department of Commerce], 2018). Not surprisingly, this list to a large extend over- laps that of the 10 priority sectors of “Made in China 2025.”

The NDAA also puts restrictions on government use of products manufactured by a number of China-based technology firms, including telecommunications equipment makers Huawei and ZTE, and a number of video surveillance manufacturers such as Hytera Communications Corporation, Hangzhou Hikvision Digital Technology Com- pany, and Dahua Technology Company.

Table 2 Acquisition plans abandoned due to failure to obtain the Committee on Foreign Investment in the United States approval under the Trump administration

Target Would-be acquirer Country When killed Deal size

Qualcomm Broadcom Singapore March 2018 $117 billion Xcerra Hubei Xinyan Equity

Investment Partnership China February 2018 $580 million

MoneyGram International

Ant Financial Services Group

China January 2018 $1.2 billion

Cowen China Energy Company Limited

China November 2017 $100 million

Aleris Zhongwang USA China November 2017 $1.1 billion HERE NavInfo China September 2017 $330 million Lattice Semiconductor

Canyon Bridge Capital Partners

China September 2017 $1.3 billion

Global Eagle Entertainment

HNA Group China July 2017 $416 million

Novatel Wireless T.C.L. Industries Holdings (Hong Kong)

China June 2017 $50 million

Cree Infineon Technologies Germany February 2017 $850 million

Source: Compiled by the author based on McLaughlin et al. (2018).

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6. The US Ban on Huawei and ZTE

Some Chinese high-tech companies, notably the two telecommunications equipment giants Huawei and ZTE, are facing higher and higher hurdles, even in areas outside the jurisdiction of CFIUS, when doing business in the USA.

The USA has publicly treated Huawei, the world’s largest supplier of telecommuni- cations networks, the second-biggest maker of smartphones and the leader in 5G tech- nology, as a threat to national security since 2012, citing the risks associated with allowing its hardware into US communications networks: that the Chinese government will use it as an espionage platform (Morell & Kris, 2018). The US government has taken a series of steps to block the firm from US markets, including banning sales of its equipment to public agencies. Huawei’s chief financial officer Meng Wanzhou was arrested in Vancouver, Canada on December 1, 2018, at the USA’s behest, for allegedly violating US trade sanctions against Iran.

On May 15, 2019, the US Commerce Department added Huawei and 68 affiliates to its Entity List, which comprises individuals and entities subject to specific license requirements for the export, re-export, and/or in-country transfer of specified items. This move in effect bans Huawei from buying parts and components from US compa- nies without US government approval. On the same day, President Trump signed an executive order barring US companies from using telecommunications equipment made by firms posing a national security risk, paving the way for a ban on doing busi- ness with Huawei. On August 19, 2019, another 46 affiliates of Huawei were added to the Entity List.

The US ban on Huawei would not only hurt Huawei, but also its suppliers world- wide, many of which are US companies. Out of the $70 billion Huawei spent for com- ponent procurement in 2018, some $11 billion went to US firms including Qualcomm, Intel, and Micron Technology (Jiang & Martina, 2019). Concerns over the negative impact on their profitability have prompted sharp declines in the stock prices of these companies following the May 15 announcements. In response, the US Department of Commerce issued a 90-day reprieve on their ban on dealing with Huawei on May 21, saying breathing space was needed to avoid huge disruption. The reprieve was later extended for another 90 days. President Trump also promised to remove some curbs on Huawei when he met President Xi in Osaka on June 29, 2019.

Besides Huawei, ZTE, China’s second-largest producer of telecommunications equipment, is another target of US sanctions (Stafford Powell et al., 2018). ZTE was first added to the Entity List by the US Commerce Department in March 2016 for alleged violations of US sanctions and export control laws. Transactions involving ZTE were only authorized under a series of temporary licenses to minimize the crippling effects of the action. In March 2017, ZTE was removed from the Entity List subject to a 7-year suspended denial order, on the condition that it agreed to plead guilty and pay a combined penalty of up to $1.19 billion. Then, in April 2018, the Commerce Department activated the suspended denial order based on apparent false statements made by ZTE. As a result, the company became cut off from sourcing the US parts

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and components necessary to manufacture its products. The denial order was termi- nated in July 2018, after ZTE agreed to, and fulfilled its obligation to put $400 million into an escrow account, pay a $1 billion fine, replace its board of directors and senior leadership, and fund a team of US compliance officers to monitor the company for 10 years.

7. The Escalating Tech War

The tech war between the USA and China is escalating, with the USA taking new ini- tiatives and China preparing counterattacks on multiple fronts.

On the US side, in addition to Huawei, more and more Chinese companies have been added to the Entity List that bars them from buying US parts and components without US government approval. Most of the Chinese entities found on this list are involved in high-tech areas such as electronics, aviation, semiconductors, engineering, and materials used for hi-tech components, including China’s leading supercomputer maker Sugon.

At the same time, the US government is seeking the cooperation of its allies to ban Huawei and other Chinese high-tech companies. So far it has gained support from Japan, Australia, and New Zealand. Japan, for example, effectively banned Huawei and other Chinese companies from public procurement involving 5G technology in December 2018, amid heightening pressure from the USA. It also announced in May 2019 that 20 sectors in information and communications industries would be added to a list of businesses for which foreign ownership of Japanese firms is restricted, effective August 1, 2019 (Kihara & Kajimoto, 2019).

Meanwhile, in US policy circles, suspicion of China is starting to resemble a new “Red Scare” (Trivedi, 2019). Universities are heightening scrutiny of research proposals from China and, in some cases, restricting collaboration. Chinese scientists’ visas are being delayed for conferences and exchanges. Visas for Chinese graduate students study- ing topics such as robotics or advanced manufacturing have been shortened to one year from five. In April 2019, the M.D. Anderson Cancer Center in Houston dismissed three senior researchers of Chinese ethnicity after the US National Institutes of Health said they had potentially violated disclosure and confidentiality rules. Workers at various technology companies have been charged with stealing trade secrets in recent months.

In response to these offensive moves by the USA, in addition to raising tariffs on imports from the USA, the Chinese side has started to explore other retaliatory mea- sures. First, China is gearing up to use its dominance of rare earths to hit back (Rogers et al., 2019). Shortly after President Xi’s visit to a rare earth firm, a flurry of Chinese media reports in late May 2019, including a column in the People’s Daily on May 29, raised the prospect of Beijing cutting exports of rare earths that are critical in the defense, energy, electronics, and automobile sectors. Second, on May 31, 2019, China announced that it will establish its own “list of unreliable entities” based on relevant laws and regulations. Foreign enterprises, organizations and individuals that do not comply with market rules, violate the spirit of contracts, block, or cut supplies to Chinese firms

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for noncommercial purposes, and seriously damage the legitimate rights and interests of Chinese enterprises, will be added to the list of unreliable entities (Xinhua, 2019a). Third, Xinhua (2019b) reported on June 8, 2019, that China’s National Development and Reform Commission has been tasked with organizing a study on establishing a national technological security management list system, with the aim of more effectively forestalling and defusing national security risks. While these new “weapons” may enhance China’s bargaining power when negotiating with the USA on one hand, they may become new sources of friction between the two countries on the other hand.

8. A War with No Winner

The trade war between China and the USA, which has now escalated into a tech war, is a war with no winner that would deeply hurt both sides.

A prolonged trade war with the USA could depress China’s potential economic growth rate through supply-side factors. First, in order to avoid additional costs associ- ated with US tariff hikes against Chinese products, some multinationals will relocate their business operations out of China to Southeast Asia and other regions. Moreover, the US government’s move to tighten restrictions on acquisitions of US high-tech com- panies by Chinese companies may slow down the pace of China’s productivity growth. For China, which is catching up with the industrial countries from behind, importing technology from abroad has been one major factor contributing to its high economic growth. If, as a result of its trade war with the USA, China can no longer make the best use of this advantage of being a latecomer to raise productivity, its potential economic growth rate, which has already been falling on the back of an aging population and the drying up of surplus labor in rural areas, may decline further.

The USA’s trade war with China is a negative sum-game that also hurts the USA itself. China is not only the world’s second largest economy, but also the core of global supply chains. In addition to final consumption goods, intermediate goods such as parts and components make up a large share of US trade with China and the produc- tion of US companies in China. With restrictions on doing business with China becoming tighter and tighter, more and more US companies will have to move their operations from China to other countries at the expense of efficiency. As a result, the USA would not only lose its market share in China, but would also have to import from more expensive sources.

The trade war between China and the USA has also cast a cloud over the world economy. The USA’s efforts to decouple itself as well as its allies from China may lead to the disintegration of the global economy into two major economic blocs centered on the USA and China, respectively. With the flows of capital, goods, technology, peo- ple, and information between them tightly regulated, multinationals could no longer optimize the allocation of resources by investing globally, and supply chains would have to be reshaped to adapt to this new environment. The negative impact on global trade and investment, as well as economic growth, may far exceed that of the United Kingdom’s withdrawal from the European Union.

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9. Whither US–China Relations?

As symbolized by the ongoing trade war, US–China relations, probably one of the world’s most important bilateral relationships, are at a crossroads. Opinion leaders have identified various scenarios regarding these relations. Among them, the following three have attracted the most attention.

(i) Thucydides’s Trap

Professor Graham Allison of Harvard University suggests that “Thucydides’s Trap” is the best lens for understanding the future course of relations between the USA and China.5 Thucydides’s Trap refers to the thesis that “when a rising power threatens to displace a ruling one, the most likely outcome is war.” Reviewing the past five hundred years, the Harvard Thucydides’s Trap Project has identified 16 cases in which an ascending power challenged an established power, with 12 of these rivalry ending up in war (Allison, 2017). It is natural for China under the Xi Jinping administration – which has made a major shift from the policy of “hiding your strength and biding your time” that was set by Deng Xiaoping in the early 1990s to the policy of seeking to real- ize the “Chinese Dream” of achieving the “great renaissance of the Chinese nation” – to clash with the USA under the Trump administration, which has pledged to “make America great again” by applying the “America First” principle.

(ii) A new cold war

Former US Treasury Secretary Hank Paulson warns of an “economic iron curtain” dividing the world if the USA and China fail to resolve strategic differences (Paulson, 2018). More people in both the USA and China are advocating policies that could forc- ibly de-integrate the two countries. Some in the USA are advocating a “Cold War-style technology denial regime” that may disrupt supply chains. In trying to isolate China, the US risks isolating itself. Companies may look to base themselves in countries that are less hostile to China, instead of in the USA. US actions against China risk setting up a new round of conflict with partners that the USA needs to alter Chinese behavior.

(iii) Cooperative rivalry

Professor Joseph Nye of Harvard University describes today’s bilateral relations between the USA and China as “cooperative rivalry” (Nye, 2018). He rejects the notion that China and the USA are destined for war or even for a cold war. During the Cold War, the USA and the Soviet Union targeted tens of thousands of nuclear weapons at each other and had virtually no trade or cultural ties. By contrast, China has a more limited nuclear force, and close ties with the USA through trade and human flows. China and the USA each face transnational challenges that are impossible to resolve without the other, including climate change, illicit drugs, infectious

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diseases, and terrorism. Some aspects of the relationship will involve a positive- sum game. US national security will require power with China, not just over China. The key question is whether the USA is capable of thinking in terms of a “coopera- tive rivalry.”

While the final outcome is still highly uncertain, there is little doubt that the future of both the U.S and the Chinese economies, if not of the global economy, will hinge crucially upon it.

Notes

1 China’s GDP reached 65.4% of US GDP in 2018. The International Monetary Fund (IMF) predicted that China could become the world’s largest economy by 2030 (IMF, 2018).

2 Section 301 of the Trade Act of 1974 provides for consultations with trading partner countries engaging in unfair trade practices and for sanctions to be imposed when problems are not resolved. When the Office of the USTR has concluded that a country is engaging in an unfair trade practice, the president has the power to take retaliatory measures, such as increasing tariffs.

3 Earlier on March 8, 2018, President Trump signed a decree ordering the imposition of restric- tions on imports of steel and aluminum products on national security grounds. While exempting some countries from the restrictions, the USA imposed tariffs of 25% on steel imports and 10% on aluminum imports. In response, on March 23, China announced the imposition of additional tariffs of up to 25% on imports of 128 items of US products, includ- ing pork, wine, some fruits and nuts (the additional tariffs took effect on April 2). In addition, China filed a complaint with the WTO on April 5.

4 Non-passive investments include an investment that affords the foreign person: (i) access to any material non-public technical information; (ii) membership or observer rights on the board of directors or an equivalent governing body of the business or the right to nominate an individual to a position on that body; or (iii) any involvement, other than through voting of shares, in substantive decision-making regarding sensitive personal data of US citizens, crit- ical technologies or critical infrastructure.

5 The term “Thucydides’s Trap” is derived from the ancient Greek historian Thucydides’s asser- tion, put forward in his seminal study of the Peloponnesian War (431 BC– 404 BC), that what made war inevitable was the growth of Athenian power and the fear which this caused in Sparta (Thucydides, 1972).

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