- The tech war is prompting Chinese firms to look for or develop alternative sources of hi-tech components themselves. This will make global supply chains more secure
- The world might also be better off with two independent but parallel and mutually compatible 5G systems
The phase one trade deal between China and the US, signed on January 15, signalled a truce in the trade war. This is a welcome development, not only for the two countries but also for the rest of the world. It is expected to usher in a period of relative calm and reduced uncertainty, which should increase both investment and consumption globally.
However, it is not a net win for either country, even though they are both better off with the truce. They have both suffered economic losses from the mutual tariffs. In fact, China's estimated loss in gross domestic product is higher than that of the United States, in both absolute and relative terms.
Unfortunately, the conclusion of the phase one trade deal does not mean that things will revert to the status quo ante. US tariffs, with rates averaging almost 20 per cent, will remain on around US$360 billion, or more than 60 per cent, of Chinese exports of goods to the US. Similarly, Chinese tariffs will remain on slightly less than 60 per cent of US exports of goods to China.
Moreover, under the agreement, China has committed to increasing its purchases of US goods by US$200 billion before the end of 2021. However, these purchases cannot be regarded as pure losses as China has a tremendous need for certain goods such as soybeans and pork, oil and natural gas, planes and advanced semiconductors.
But at least the mutual escalation of tariffs has stopped, and the promise of the start of negotiations for a phase two agreement, to be concluded after the US presidential election in November, augurs well for a year of relative peace on the trade war front.
The trade war, which started in early 2018, has threatened to decouple the established technological supply chains, because of both the mutual tariffs and US restrictions on exports of hi-tech goods and services to China. The US has put Chinese hi-tech firms, such as Huawei and ZTE, on an Entity List, which in effect prevents them from buying US hi-tech components, equipment and services.
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The motivation for adding Chinese companies to the Entity List has little to do with the US-China bilateral trade deficit. The US has had a large bilateral surplus in the trade in hi-tech goods and services. Halting this trade will only enlarge the US-China trade deficit. The US restrictions primarily aim to slow the development of China's hi-tech industries.
This effort can be quite effective in the short term. For example, Huawei had been using Google's Android system as the operating system of its mobile phones but, because of these restrictions, it has been forced to develop its own Harmony operating system. It will probably take a year or so for the new operating system to be perfected and another couple of years for developers to create apps for it.
In the meantime, Huawei is virtually banned in the US and has lost business in Europe. However, given the large Chinese domestic market and the markets of developing economies, where affordability is an important consideration, Huawei's mobile phone business will survive and prosper, although it will incur significant additional research and development costs.
The phase one agreement is silent on whether US restrictions will be lifted. This is unlikely and competition for economic and technological dominance between the two countries will persist. Talk of the decoupling of the global economy and its negative impacts, especially on established global hi-tech supply chains, has continued unabated.
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However, decoupling also has potential benefits. It is actually a good idea for the world to have at least a second source for any link in a supply chain. A supply chain can potentially be disrupted not only by trade disputes and geopolitical tensions but also by natural disasters " such as earthquakes, tsunamis and typhoons " and by epidemics.
Having a second source can be costly but it provides insurance against unexpected contingencies and prevents a supplier from overexploiting its monopoly position. Decoupling provides the conditions under which second sources may be successfully developed. In fact, for Chinese hi-tech firms on the Entity List, alternative, non-US, sources must be found, whatever the costs.
But the short-term pain can turn into long-term gain as, ultimately down the road, the developed second sources will not only allow the Chinese hi-tech firms to resume doing business as before, but will also become available to all other users in the world. This will provide some restraint to the exercise of monopoly power by some of the hi-tech firms and lower the cost to all users.
Just as the world has benefited significantly from having two major commercial passenger aircraft manufacturers, Airbus and Boeing, instead of just one, having two independent but parallel and mutually compatible 5G systems for wireless communication is not a bad idea.
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It will prevent a single firm from becoming a monopoly supplier of 5G equipment and services. Competition can only result in higher welfare at lower cost for all consumers in the world. Some diversification, separation and redundancy are good for the stability and sustainability of any system as a whole, so that when disaster strikes, not everything will go down together.
Moreover, with the rise of artificial intelligence and big data, consumers are even more vulnerable to being exploited by an unrestrained monopoly. Given access to the massive information on its potential consumers, a monopoly could practice perfect price discrimination, charging different customers different prices for the same good or service depending on their willingness and ability to pay. This abuse of monopoly power can only be curbed with effective competition, that is, through a second source of supply.
The decoupling of global hi-tech supply chains as a result of US-China technological competition will be costly for everyone, and perhaps unavoidable, in the short term " for Chinese hi-tech firms, their US suppliers and consumers in general. However, in the long run, the world will be better off having two suppliers of similar goods or services who have to compete with each other.
Lawrence J. Lau is Ralph and Claire Landau Professor of Economics at the Chinese University of Hong Kong, and Kwoh-Ting Li Professor in Economic Development, Emeritus, at Stanford University
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