A few weeks ago, I wrote about the need for the United States and its European allies to duplicate our supply chains outside of East Asia to insulate ourselves from the repercussions of an increasingly assertive China. The Russian war against Ukraine and the resulting supply chain issues have made these recommendations even more pertinent.
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What China and the United States have in common is that they both view themselves through a lens of exceptionalism. Both think that due to their history and achievements they deserve for some of the rules to not apply to them. They are multilateralists as long as it serves their purpose. Both have repeatedly waged wars of choice and gloss over it. Both are proud nations and do not think the other is that special and is hypocritical. China comes out of a century of humiliation where foreign powers had control over China and did not treat it well, ranging from the Opium Wars starting in the 1830s to the Japanese war and occupation ending in 1945.
Since the opening of China and Deng Xiaoping in the 1980s, no other country has seen more economic progress and increases in living standards in such a brief time as China. With this increase in wealth, China spent both internally on everything from excellent transportation, good hospitals, increased living standards, the largest military in the world, some of the best-funded and increasingly inventive universities in the world, and externally through its Belt and Road Initiative it provided billions of dollars of loans. China wants respect, and when you look at their success over the last 40 years, it deserves respect for its economic achievements.
When we talk about China, we must recognize the country has a hybrid state capitalism model. While private businesses exist, they only exist at the whim of the Chinese Communist Party (CCP), which is communist in name only. Private individuals can bring in their ingenuity and profit from it as long as they follow the rules laid out by the CCP. You cannot draw a line where private Chinese business ends and where the State and the CCP begins – they are all intermingled and held together by the iron grasp of the CCP. When Jack Ma, China’s richest person with similar stature as Jeff Bezos, dared to publicly mouth off against some government actions, he was quickly humbled. Since this incident, the most common headline that Jack Ma generates is the question, “Is Jack Ma still around and what does he do now?”
At the same time, China recognizes that its wealth is based on being the factory of the world. It is critically dependent on many key underlying technologies and equipment that have been developed and patented in the United States and Europe. To become less dependent on foreign components in its economy and thereby supply chain, China instituted – already in 2015 – its Made in China 2025 program. While there has been backlash from Europe and the United States, the publicity around the program has subsided but not the effort and intensity to see it through.
Actually, the intensity and effort has increased after the Trump administration’s incomplete efforts to break Huawei. While the handset division of Huawei outside China got destroyed, its other businesses are relatively unscathed. Huawei’s reaction was focused and on point when it launched its Hubble Ventures Co., Limited, Huawei’s new private equity fund, which was almost completely ignored in the West. When you scour the registration document you will find that the focus of the venture will be “chip design, electronic design automation, packaging, testing, materials and equipment.” This is the whole supply chain of chips in one sentence.
When we look at the current Ricardian model of global chip supply chain efficiency we have:
1. Chip design – U.S. leads
2. Electronic design automation – U.S. and EU lead
3. Packaging – China leads
4. Materials – global endeavor including China
5. Equipment – U.S. and EU lead
The decoupling of the global chip supply chain that grabs headlines in the U.S. and EU press because Intel announced building two fabs in Ohio and two in Germany are an important part, but only a part, of the supply chain. Huawei has already invested in more than 50 companies in the entire value chain. This is what happens when you only wound a company instead of killing it. It comes back with a vengeance.
Fast forward to current events and Russia’s invasion of Ukraine. The “foreign special operations” by the U.S., EU, and the remaining G7 countries show that when these countries are serious about inflicting pain on a country through sanctions there are huge consequences for an economy like Russia. The economy of Russia is being crushed as the Russian supply chain was torn. The dependence of Russia on western technology and equipment is a cautionary tale. The lack of sanctions on energy, nickel, neon and other important goods for the West has also not gone unnoticed in Beijing.
The lesson for China is twofold: For some industries, be as separate and distinct as possible; for other industries, be as integrated as possible. In fighting terms China needs to be outside and inside the reach of Western economic sanctions. As shown by Made in China 2025, Huawei’s Hubble Ventures, and huge investment in its STEM universities, China is laying the groundwork to go it alone. It is investing significantly in all the underlying technologies of the 21st century, building the necessary IP that will be the foundation of our connected lives in the future.
The lesson China learned is to invest in the entire supply chain for electric vehicles, mobile technologies, next generation computing that will allow it to not only function but thrive without Western IP. Anyone hit with Western sanctions can also find a safe harbor with China as long as it pledges fealty.
At the same time, in other parts it will be as integrated as possible and create critical dependencies. Raw materials like chromium, antimony, baryte, and rare earth minerals come to a very significant degree from China. The EU’s Critical Raw Materials in Technology and Sectors Foresight study estimates that between 30% and 60% of critical materials and components currently originate from China. In comparison only 12% come from Russia and this is already creating issues. The West is actually more dependent on these raw and intermediate products from China than vice versa, which gives China leverage.
Furthermore, a significant amount of manufacturing is concentrated in China. If there were sanctions against products manufactured in China, the world would be without new iPhones for a few years until a more distributed supply chain could be established. If such sanctions would be imposed from either side, no new iPhones for a few years would be the least of our problems. A dictatorship with a reasonably autarch economy like China would be able to survive and maybe even thrive, while the West would struggle. The calculation is that such an insulation from the impact of sanctions is a necessary precursor to weather the repercussions of a potential invasion of Taiwan.
For almost a decade China has been insulating its supply chain from the potential of Western sanctions, while the West has been until recently oblivious to the issues. The surprisingly strong Western response to Russia’s invasion of Ukraine has served as wake-up call for China and will cause it to accelerate its two-pronged approach.
Roger Entner is the founder and analyst at Recon Analytics. He received an honorary doctor of science degree from Heriot-Watt University. Recon Analytics specializes in fact-based research and the analysis of disparate data sources to provide unprecedented insights into the world of telecommunications. Follow Roger on Twitter @rogerentner.