US/China Digital Competition – and the Thucydides Trap

The current digital competition between the US and China could divide the two countries indefinitely — irrespective of whether there is a trade deal on the more conventional aspects of their negotiating agenda.

We have a digital contest between China and US, the same way there was a strategic nuclear competition between the US and the Soviet Union — with each side producing, developing and then manufacturing nuclear ballistic missiles. Then at the end of the day, they decided that it was better to stabilise this competition: the US and the USSR, substituted by Russia, signed a number of arms control treaties until George W. Bush denounced the ABM one and Donald Trump the INF one.

But in the case of digital, things are different because of the nature of the competition. There are limits to technical progress, but those limits are very far away, and so each time they try to go one technological level further, it is in a sense very similar to a commercial competition. There are, and will be, continuous new generations of smartphones or computers, as well as new disruptive developments in artificial intelligence (AI) and quantum computing. It is a strategic competition that is very difficult to stabilise.

What has been stable is that the Chinese are producing a lot of microelectronic components, and subsystems, with customers such as Apple. But at the same time Chinese Telecom companies such as Huawei and ZTE are hugely dependent on so called ​“smart microchips” (with sophisticated software incorporated in the silicon) designed and manufactured by US-based firms such as Qualcomm or Broadcom, and their smartphones need to offer Google Android software and apps. So, there has been a kind of balance of mutual dependency.

This balance has been increasingly destabilised for the last two years by the following chain reaction. It started with the increasing US perception that the Chinese have achieved since it joined the WTO in 2001 the most important technology transfer in history — by far — using two major tools: technology extortion, and economic/​conventional/​cyber espionage. This has all taken place at the expense of Western, mainly American companies.

Technology extortion is a ​“quasi legal process” resulting from leveraging the huge attractiveness of the Chinese market and of the specific Chinese regulations which were applied to joint ventures. This was a two-step process: step one meant every Western company rushing under a WTO umbrella to involve themselves in the Chinese market; then in step two, those companies being told that they could not sell in China if they did not create a joint venture with a local partner. Chinese law states that if the joint venture is dissolved, the IP contributed remains with each of the two partners — including the Chinese one who initially might well not have contributed anything technological at all. This process has created a huge amount of technology transfer in sectors going from high-tech electronic and communications, from transportation to even agribusiness — as Danone painfully discovered.

The devastating impact of the second tool, technology theft through conventional and mainly cyber espionage, has been widely publicised by the US Government since in May 2014 it indicted five officers of the Unit 63198 of the PLA for having conducted cyber espionage against Westinghouse, US Steel and two other US companies. After a near 3‑years truce following a September 2015 agreement prohibiting the use of governmental means to steal commercial IPs, Chinese cyber espionage has resumed at full speed following the start of the trade war by Trump in 2018.

The last and major input to an increasing American quasi-paranoia with China was the ​‘Made In China 2025’ plan announced by China’s Premier Li Keqiang in May 2015.The goals of this major initiative are first to suppress all Chinese dependencies in ten key sectors, including IT, aerospace, health, automotive and to be the equal and (if possible to get ahead) of any other competitor.

This overall context forged a remarkable consensus among the US political and economic establishment, explicitly summarised by the independent Council on Foreign Relations stating in March 2018 that ​“Made in China 2025 is a real existential threat to the US technological leadership.” (CFR March 28 2018).

This bipartisan consensus of the establishment triggered a series of actions aimed at curbing Chinese advances and protecting US defence and commercial high-tech dominance. Among actions taken, one can mention a new control of foreign minority investments in start-ups, and new implicit restrictions on the number of Chinese students in the US.

The Pentagon has been long concerned by the vulnerability of the US weapon systems equipped with Chinese components. It has seized the opportunity to obtain congressional and presidential support to make the elimination of any Chinese technological backdoors in US systems, and raised the alarm about a major strategic risk: the likely global dominance of Huawei in the deployment of the fifth generation of cell phone systems.

So-called 5G will have so many advantages in terms inter alia of response time, speed and rate of the data flow. For cost effectiveness reasons, it will become the preferred network for the massive data exchanged between more and more digitised and robotised industrial facilities and utilities. Whatever Huawei executives might say, they could be obliged by Chinese law to obey any orders given by the PRC national security authorities. And, obviously, none will be better positioned than the likely main architect of 5G systems to leverage strategically, through intelligence or intimidation, the future central role of these systems in the global economy.

At this stage of the rising anti-Chinese mobilisation in Washington, Trump comes in. As everybody knows he is pursuing two goals in his trade policy: to reduce materially the US trade deficit with each of his major partners, and to reach this objective by playing hardball bilateral negotiations with each major trade partner without caring for the multilateral rules he hates. Initially the US President used tariffs, his traditional trade war tools, to confront China. But the Huawei challenge was too pregnant for Washington to ignore, and on 15 May this year, a presidential executive order gave the President the ability to bar US operators to buy equipment from companies he considers national security risks. Simultaneously, the Commerce Department put Huawei on its Entity List of companies that cannot buy US products without the US Government approval. The former decision as implemented in the new guidelines on imports of foreign information and communication technologies announced by the Commerce Department on 26 November gives this Department the ability to bar any acquisition of Huawei 5G Systems by a US operator. And the latter could potentially bankrupt its smartphone business, global number one, that still needs to buy Qualcomm or Broadcom smart microchips until the Chinese substitutes are fully available.

They also need access to Android software and to Google, Facebook and other major US apps desired by its global customers .In practice Huawei has received sequentially three General Temporary Licences allowing it to buy US microchips, while it has difficulties in getting similar authorisations to buy all the US software and apps it needs for its smartphones. Clearly the Trump Administration is trying to get the best possible outcome of the ​“phase one trade deal” that the two countries hope to sign by the end of the year and that should be mainly an agreed rollback of tariffs, in exchange for significant additional Chinese imports from China. Since both leaders need this transitional agreement for domestic political reasons, it will likely be signed in this month. But the key question remains: how will Sino-American technology confrontation evolve?

Looking ahead it is convenient to distinguish between the likely, the known unknown, and the unknown unknown, to make use of Donald Rumsfeld’s famous turn of phrase.

What is likely is a continuation in the decoupling of the most sensitive parts of the US and Chinese digital sectors. The Pentagon will pursue an ambitious effort initiated by its technology scouting agency, DARPA, to develop secure-by-design microchips which could resist any cyber-infiltration, and to rebuild a fully US-based chip manufacturing base.

As for China, the Huawei saga has been a very strong incentive to accelerate the already planned objective of microelectronic industrial autonomy. This would aim to reach a new objective of producing 70% of all semiconductors it uses by 2025, and would most likely achieve total self-reliance in the smart microchips that it has been able to produce successfully in space grade chips — after a first ban decided in this field by the US.

The known unknown is whether the final trade agreement, including effective restriction of Chinese technology extortion through Chinese legislative changes, will be reached. This is the clear goal of US Trade Representative Bob Lighthizer, who will certainly try to reach it before the presidential election. But Xi seems sure to use Trump’s desire to announce a new success during the campaign to propose a final agreement with new additional business for US companies in China, if no real structural concessions on the technology issue are forthcoming.

The unknown unknown is what could happen in 2020 with a newly elected President who could be either a born again, totally unleashed Donald Trump, or a Democrat promoting both US jobs and technologies and Chinese human rights.

However, in any scenario it is likely that the Chinese will continue trying by all means to replace the US as global technological leader, just as the Americans will resist this wave as strongly as they can. In fact, US academic Graham Allison who has talked up the Thucydides Trap model, of a relatively declining power launching a war against its rising rival, may be far better describing the increasingly acute technological competition between the US and China, than their geopolitical rivalry which receives most attention at present.