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Weekly Economic Briefing

Emerging Markets

ZTE, arms embargo, and tech

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At the risk of hyperbole, the US embargo on ZTE may turn out to be a highly consequential turning point in US-China relations and Chinese industrial policy. Irrespective of the fact that ZTE was guilty of evading sanctions, and the ban ostensibly having nothing to do with the current trade spat, at a minimum it confirms Chinese suspicions that the US isn’t serious about resolving the current trade dispute. It also further raises suspicions that trade is not the primary factor; rather, US intent is to contain China’s technological advances. Going back as far as 2010, Chinese officials and state media have contended that if the US were to lift export controls on high-tech items it could be a simple win-win solution for reducing the US trade deficit. Now with the US further banning exports in the tech sector, in this case on items not even controlled by export controls, it gives the appearance that either the US is not ready to engage in serious negotiations on trade, or that trade may not even be the main focus of US policy. Furthermore, it reinforces the view that the US is hypocritical in denying China's plans to invest in US technology, while conversely complaining about China not having a level playing field. While US objectives vis-à-vis China are still emerging, they are likely one or any combination of a) reducing the bilateral trade deficit, b) expanding market access, and/or c) changing Chinese industrial policy and slowing advances in tech. We always contended that if (a) or (b), the current dispute is negotiable and stands a higher chance of being resolved without resorting to a trade war; however, if (c) is the primary US objective, then negotiations are unlikely to resolve the current stand-off and tensions will persist. The self-imposed export reduction will surely make it harder to reduce the deficit, and will likely give the impression US intentions are to contain China’s tech rise.

Slowing, maybeDomestic priorities

The other impact will be felt through increased Chinese support for its domestic tech sector and resurrection of the phrase ‘indigenous innovation’, as China seeks to replace foreign tech reliance with domestic production. In this respect, China’s defence industry could provide interesting context for how China’s tech sector might evolve over coming years. The Chinese defence industry has been under a Western arms embargo since 1989, meaning its ability to import defence equipment and technology has been severely limited by export controls. Despite this, China has actually emerged as a leader in defence technology and one of the world’s largest exporters of advanced systems, pointing to its improved technological capabilities. China’s technological gains were confirmed in the latest Pentagon defence strategy, which highlighted China’s rapid advances. These advances were achieved through world-leading growth in defence spending (see Chart 10), which supported innovation efforts (among other efforts). Furthermore, as is often cited, China spends more on domestic security than on military spending; not only is the total quantity larger but the growth rate in recent years has far surpassed military expenditure (see Chart 11). So why does this matter? Historically, many innovations have come from the commercial applications of defence research and development, and China is proving no different with recent advances in facial recognition and A.I. driven in part by domestic security demands. The ban could be a negotiating strategy and may be lifted; nevertheless, it will push Beijing harder in its efforts to reduce its reliance on foreign technology. If Chinese tech catches up as defence has, the world could be in for a few surprises.

Alex Wolf, Senior EM Economist