China prepares tech sector for battle as US trade team arrives

As a US trade delegation heads to Beijing for talks starting Thursday, China’s race to catch up to the United States in technology looms large.

The skirmish is taking place upstream of the consumer applications made by tech giants like Google and Facebook or Alibaba and Tencent, and focusing on semiconductors, the critical building blocks of electronics.

Semiconductors, or computer chips, are the brains of electronic devices, enabling them to run programmes and store memory.

Most are made by US giants such as Intel, Qualcomm and Micron, which have decades of experience developing the integrated circuits, as well as manufacturers in US allies South Korea and Taiwan.

Chips are among China’s biggest imports, rivalling oil, and have become a stark reminder of its dependence on American technology.

Semiconductor consumption

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Last month, Washington banned Chinese telecom and smartphone giant ZTE from purchasing crucial US components for seven years, threatening its survival, as punishment for breaking US export controls.

The US has also reportedly opened a similar probe into another Chinese telecom major, Huawei.

Both companies depend on US chips to build their gadgets and equipment, reinforcing for Beijing the need to control every piece of the technological supply chain.

China must rely on itself for core technologies, President Xi Jinping told scientists when visiting an IT firm last week.

– China can do ‘big things’ –

“In the past we had no choice but to rely on our own efforts. Back then we even created two atomic bombs and launched a satellite while tightening our belt and gritting our teeth,” he said.

China’s advantages, he said, include being able to “gather our strength to do big things”.

And that is what concerns Washington.

China’s marshalling of industrial policy to catch up in semiconductors and other technologies figures prominently in the Trump Administration’s findings against Beijing in an investigation that has led to proposed tariffs on tens of billions of dollars in Chinese goods.

The Trade Representative probe looked at Beijing’s intellectual property practices and innovation policies, with a subsequent report taking aim at its “Made in China 2025” programme, which is designed to spring China from a maker of sports shoes and denims into high-tech goods.

Chinese telecom and smartphone giant ZTE has been banned from purchasing crucial US components for seven years, threatening its survival, as punishment for breaking US export controls

China relies on foreign imports for 80 percent of its chips, which Beijing intends to change.

To get there, central and local governments have sunk roughly $100 billion into building its semiconductor industry since 2014, the US report said.

About $20 billion has been funnelled through the China Integrated Circuit Industry Investment Fund. After the export ban against ZTE was announced, officials in Beijing confirmed they were mustering investment for a second national fund.

One firm to benefit recently was Hua Hong Semiconductor, a state-controlled company listed in Hong Kong that in January received a major investment from the state chip fund, with which building a $2.5 billion chip factory in the eastern city of Wuxi.

– Long way to go –

Hua Hong benefits from a lower tax rate and said in filings it expects its Wuxi venture to receive plentiful debt financing from Chinese banks, along with land subsidies and help recruiting talent from the city.

The project is just one of the fund’s more than 50 investments, with cash pouring into chip designers, new factories, and testing and materials firms across China, according to corporate records.

Before boarding a plane for talks in China, US Commerce Secretary Wilbur Ross called the plan “frightening”, and noted the trade deficit was in part “inspired by evil practices”.

Washington has blocked several attempts by Chinese firms to buy up American semiconductor companies.

But even with the large outlays, China remains behind in the semiconductor race, analysts say.

“It will take many, many years for those kinds of investments to make progress,” said Cao Cong, an expert in China’s science policy at the University of Nottingham’s campus in Ningbo, noting state-led efforts may be less effective for semiconductors.

China can direct state-owned enterprises to make purchases of the large aircraft and high-speed trains it builds, Cao said, but the consumer is the end user for semiconductors.

“They don’t want to use second-rate technology,” he said.

State-led investment can also push funds the wrong way.

A decade ago, Beijing lavished funding on a breakthrough in domestic chip production called the “China chip”.

The project came crashing down when a whistleblower alerted authorities that the professor behind the programme was buying imports, etching off their markings and stamping on those of his own company.