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Inside China 10 May 2018

The trade war is really about future technology

Jeremy Stevens

China’s cyclical path seems in a comfort zone; growth set a steady pace, at 6.8% y/y in Q1:18. The higher-frequency data implies that modest deceleration is underway. And, the central bank will watch out for producer prices falling back into deflation. Nevertheless, authorities will be delighted with the macroeconomic scoreboard showing an early lead, even though credit growth is expanding at a rate close to the slowest on record – the result of continued pressure on de-risking the financial system and suppressing debt growth of SOEs and local governments.

Indeed, then, more broadly, the overarching scaffolding for policy can remain structural considerations: one necessity (the shift to quality growth); one main task (supply-side-structural reform, which deals with overcapacity, housing inventory, corporate debt, lowering costs and improving weak links); and three “tough battles” (defusing financial risks, alleviating poverty and controlling pollution).

That said, one important addition to the “tough battles” occurred during the Politburo’s meeting on 24 April. A fourth task has been added: develop core technologies and new industries. Herein lies the crux of the trade war with the US: it is not about trade balances; rather, it is about who can lead the advance along the technological frontier. In fact, Liu He himself – China’s chief economic policymaker and lead in negotiating with the US – visited the Ministry of Industry and Information Technology (MIIT) – responsible for industrial policy – in late April, stressing that China must become a manufacturing and a cyber “superpower.”

The rationale for the task was clearly set out by President Xi Jinping back in 2016 during his speech at the Work Conference for Cybersecurity and Informatization: “Our country once was an economic power in the world, but afterwards, when the industrial revolution occurred…it lost a historical opportunity to progress.…In the present world, informatization is developing rapidly, those who do not move forward will fall behind.” Xi Jinping doesn’t want to just manage China, he wants to transform China. In case the leaderships focus was in any doubt, also in late April China held the inaugural National Cybersecurity and Informatization Work Conference in Beijing, and the entire Politburo Standing Committee attended, including Xi Jinping.

That is precisely why China developed “Made in China 2025 – Beijing's grand plan to upgrade manufacturing. However, it is the same ambition and plan that is the heartbeat of tensions between the US and China. Consider that in the Section 301 investigation into China’s trade practices, the report cites “Made in China 2025” an unparalleled 116 times – specifically, the use of preferential industrial policies to bolster Chinese firms.

Now, if China's industrial policy is the primary reason for economic tensions with the US, and that China is not going to consider compromising this policy thrust, then it seems safe to say that any hope for a swift resolution to the looming trade war is implausible. Perhaps sufficient concessions on both sides may pause tit-for-tat tariffs in the short term (even though it seems is unlikely given the laundry list of demands the US has made) (please refer to the G10 Daily “Trade Tactics” of 10 May). Nevertheless, tensions will likely persist for some time.

Meanwhile, China’s sense of encirclement is elevated. For all the talk of “win-win” partnership, China’s reliance on foreign technology, like US semiconductors, is seen as a potential vulnerability by Beijing. China imported USD250bn in electronic circuits in 2017. For context, crude oil imports for the year were just USD162bn. The exposure has been laid bare by the 7-year “denial of export privileges” on ZTE and investigation of Huawei. Without doubt, the Chinese regulators are frustrated with ZTE (and Huawei) because they view these violations as reckless behavior that has cast doubt over the Chinese government and corporates. Nevertheless, China’s sense of urgency in developing core technologies is now more urgent.


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