Podcast: Assessing Chinese Industrial Policy and the Impact of U.S. Export Controls, With Dan Wang

March 8, 2021

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In the final weeks of the Trump administration, Rob and Jackie sat down with Dan Wang, a technology analyst and China expert at Gavekal Dragonomics Research, to discuss the successes and failures of Chinese industrial policy and to evaluate the impact of U.S. export restrictions. In the previous four years, there weren’t many Chinese tech companies that the Trump administration didn’t sanction or at least threaten. What did that achieve in the technological race with China? What was the impact on the American brand writ large? And what should the Biden administration do next?

 

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Rob Atkinson: Welcome to innovation files. I’m Rob Atkinson, founder and president of the Information Technology and Innovation Foundation. We’re a DC based think tank that works on tech policy.

Jackie Whisman: And I’m Jackie Whisman. I handle outreach at ITIF, which I’m proud to say is the world’s top ranked think tank for science and technology policy.

Rob Atkinson: This podcast is about the kinds of issues we cover, from the broad economics of innovation to specific policy and regulatory questions about new technologies. Today, we’re going to talk about industrial policy and particularly technology policy in China, including the impact of a series of U.S. export control restrictions.

Jackie Whisman: And our guest today is Dan Wang, a technology analyst at Gavekal Dragonomics Research, who writes on China’s technology progress and the effects of U.S. regulatory actions. He’s also a contributor at Bloomberg Opinion and publishes regularly on his website danwang.co. Thanks for being here, Dan.

Dan Wang: Thank you very much, Jackie and Rob, for this very kind invitation.

Rob Atkinson: I’d also just say to our listeners, Dan has been really invaluable for educating me and my colleague, Stephen Ezell, and others about what’s really going on in China, in the tech and particularly semiconductor spaces. Really valuable insights. So thank you.

Jackie Whisman: And Dan, you’re originally from Canada and you moved a while ago from Hong Kong to Beijing. Before we get into the details on China policies, can you say a little bit about what it’s been like living in Beijing in the last year and during the pandemic lockdown?

Dan Wang: Sure thing. Well, I was in Beijing since the end of Chinese New Year in February, 2020, and I experienced the worst of the pandemic lockdown in Beijing. But I think one thing to note here, first of all, is that about, basically by April of 2020, a lot of the worst of the lockdown in Beijing had already passed. Now there’s always some questions about Chinese data, but even if you magnify basically the Chinese COVID numbers by an order of magnitude, let’s say, I think it’s pretty clear that by April the country had mostly stomped out the virus. And then by that point, a lot of life had started to return to normal. Now, the lockdown I think was still much more intense and much more invasive than anywhere else in the world. I had a person basically stationed outside my apartment, checking for passes to make sure that we are able to enter in and out. Travel was very highly restricted. We have to have basically a health scanner app, basically a contact tracing app that lives in my WeChat everywhere that I go.

For basically two months, it was a very tough time living in Beijing. To say nothing of basically this centralized quarantine system that China imposed to separate sick people away from family so that they can quarantine on their own, to stop the transmission of the virus, which is a very key plank of controlling the virus in China. But since then, life has become quite a bit more normal. By September, I spent a month in Shanghai where life was basically completely back to normal. I was doing regular business meetings. We were sitting shoulder to shoulder in the cinema. We were eating out, all the smart restaurants were booked. The strangest thing to me was that people were reaching out to shake my hand, which I found a bizarre experience. I’m trying to turn most of those things into fist bumps. I find very strange that a culture that didn’t really start the handshake is now one of the only places that’s really perpetuating this tradition. That seems a little bit strange now.

Jackie Whisman: That’s fascinating.

Rob Atkinson: Yeah, that’s really interesting. I had planned to never ever shake anybody’s hand as far as I can tell.

Jackie Whisman: Rob and I are a little salty to begin with. So this is all fine for us to stop hugging and all of that.

Rob Atkinson: Yeah. I have a T-shirt from my favorite company, which is the Despair Corporation, and it says, “A lifetime of social distancing prepared me for this.”

Dan Wang: That’s great.

Rob Atkinson: I’m just curious on that. I assume everybody who was going outside during that period was wearing a mask. You had to wear a mask.

Dan Wang: You had to wear a mask often in most public spaces. And even now in Beijing at this present moment, China is dealing with another outbreak. There’s been a few dozen or a few hundred cases, especially in Hubei Province, which completely encloses Beijing city. And so Northern China right now is under a state of semi lockdown. The Chinese government is trying to discourage people from returning home to Chinese New Year, which is the major travel event of the year. So right now, things are getting a little bit back up, back tied up again. But I think even at the most relaxed time in Beijing, which I would say something like late summer or early autumn, I would say that’s still maybe two thirds of the people on the streets were still wearing masks everywhere they went, even though there hasn’t been local transmission for months. But right now, most people, almost universally now, are wearing masks in public again.

Rob Atkinson: There’s many things that I know that I’m glad we don’t adopt from China. The surveillance and all that. But mask wearing would be one of them, that we should adopt. It’s phenomenal that we don’t do that. So Dan, I want to jump in more obviously to the tech issues. When we look back on the Trump administration, which we will in less than a week, obviously a core component of what they did was China policy and a core component of that was export controls, where they really had this view that if we cut off certain technology exports to China, particularly in semiconductors and semiconductor equipment, that we could frankly cripple Chinese tech firms. There’s a whole push they had against Huawei for legitimate security reasons. But rather than just stop at that and say no one can install Huawei telecom or 5G equipment in the U.S., they said no, we’re going to go further and try to really cripple and put out of business Huawei by export controls. Can you say what’s your thoughts on that? I know you had, as we did, a lot of concerns about that. Is it working? What happened with it? What did the Chinese do? What were the effects?

Dan Wang: Sure. Well, taking a look just a little bit narrowly at the entity list and then I want to talk a bit about broader sanctions. First of all, if you take a look at all the companies on the entity list, which includes Huawei, which includes some other chip makers, the effect has been mostly pretty varied. Some of it has been very severe, especially on the chip makers, as well as on Huawei. Some of it hasn’t been very effective at all. Now, I think just zooming in on a little bit on what’s happened with Huawei, first to give a bit of background, Huawei joined the entity list in May, 2019. It hadn’t really suffered a huge deal for its very first year on the entity list. As best as we can tell, Huawei was still able to acquire very substantial amounts of U.S. semiconductors for the most part, so long as they were produced overseas, that was non U.S. production.

And if you take a look at the semiconductor value chain, so many semiconductors are designed in California by major firms like Qualcomm and Nvidia and Broadcom, and then actually manufactured in Taiwan, namely by a big company called TSMC. And for the most part, Huawei was still able to acquire quite a lot of semiconductors that way. Its main effect of having been designated to the entity list was to lose access to Google mobile services, which very substantially crippled it’s smartphone sales overseas. But the U.S. Department of Commerce took a look at that situation, the White House and the National Security Council took a look at that situation and said, “Well, Huawei isn’t quite suffering enough.” And so it tightened restrictions that only for Huawei in May, 2020, and then tightened them once again in August, 2020, basically placing every semiconductor in the world under Department of Commerce jurisdiction and then imposing the license requirement. As best as I can tell now with Huawei, I spent two days visiting the company in Shenzhen, its headquarters, in November.

Its smartphone business is in very deep trouble. Basically, it doesn’t have necessarily a huge amount of smartphones on stock to be able to continue selling them in retail stores. It’s base stations will still be able to continue production for most of 2021 and its enterprise business will be quite a bit okay. But the company as a whole is pivoting much more into being an automotive company, making not just infotainment systems but also a powertrain. And so it’s becoming a less familiar Huawei in terms of selling mostly smartphones and base stations. The U.S. export controls has also really significantly affected a company called Fujian Jinhua, which had at one point been China’s leading DRAM maker, a memory chip maker, who was alleged to have misappropriated trade secrets from Micron. But for a lot of other ways, Chinese companies have not necessarily been very substantially affected by the entity list designations. Mostly because there is substantial offshore production and not everyone needs U.S. origin semiconductors to the same degree as every other company.

Now, I would also just want to point out that Huawei and Fujian Jinhua have not been the only companies that have faced some sort of sanction. Over the summer, the president signed two executive orders that band WeChat in the U.S., as well as TikTok in the U.S. These things are now being held up in federal court, but it could’ve included the scope of much larger sanctions against these two companies. CFIUS is now also in the process of forcing TikToK to be sold to a consortium of a U.S. investors. So really there’s been a lot of efforts in addition to export controls that the U.S. Government has brought to bear on Chinese firms.

Rob Atkinson: So Dan, one question I had is, I know for example that some Trump administration officials have had the view, when the semiconductor industry says, “Well, look, if we don’t sell those, we’re going to be heard and we’re going to have as much money to invest in R&D.” Their response, I’ve heard is, “Well, you’re just going to lose that market anyway in 10 years. The Chinese will take it over. So you might as well take your lumps now.” That’s not a position we agree with but I’m just curious, how much have some of the Chinese companies been able to acquire what they need from other sources, non U.S. sources? Or have we been able to shut them down completely and pretty much across the board?

Dan Wang: I think it is pretty difficult to shut these companies down completely. For the most part, the view of quite a lot of folks in the semiconductor industry in the U.S. is that the U.S. is not necessarily a monopolist on basically every type of technology. Now, there are certainly types of semiconductor technologies like EDA tools and certain types of semiconductor manufacturing equipment where U.S. firms are highly dominant, but there is also supply from European firms as well as Japanese firms. And also, this offshore entity list basically is creating a little bit of an incentive for U.S. firms to move their production overseas, out of the U.S. so that they do not necessarily have to seek a license from the Department of Commerce when they engage with entity list designated companies.

And so, you can wonder a little bit about whether the Trump administration’s policies have really substantially helped industry or is really just creating a lot of regulatory hurdles, which they’re willing to jump through, I think to preserve their access to China, which I think is worth pointing out, that is basically every semiconductor company’s largest market or fastest growing market if you take a look at their revenue, because this is just a huge space for their continued operations.

Rob Atkinson: Yeah. That’s, to me, one of those law of unintended consequences here because the Trump administration’s major goal really all along was to bring more production of all kinds back to the U.S. And in fact, the export control regime and the entity list has actually pushed that away. But the other thing it’s done is really I think, I’d love to hear your thoughts on this, reduce the trust in American suppliers. I was in Italy a while back and there was an Italian company I spoke with that had a semiconductor or some kind of chip in its machine. It was a machine company. And it said it was seriously thinking of switching over to a Japanese supplier because it just didn’t want to take the risk of getting caught up in some sort of export control regime. So it really seems like we’re helping foreign companies, helping offshoring of U.S., exactly the opposite of what we’re doing there. What’s your thoughts on that? Did you see that as well?

Dan Wang: I see that a great deal in China. So, everyone has observed what’s happened with Huawei, which is really struggling to maintain operations right now. And many firms are saying, “We don’t want to be the next Huawei.” And I think you’ll see basically a lot of stories about U.S. export control actions, which are not always very carefully reported in China, basically attacking the American brand writ large and saying, “Well, if you’re using American components, this might be cut off at any time,” which is possibly close to truth for a lot of different companies.

I have heard from companies in industrial sectors, which are not necessarily very high tech, this is an American company being told by its customers, “We want to audit your products for American content because we don’t want a rug being pulled out from under us at any minute.” A lot of American companies are having fears that their market position is going to be threatened because they are just unreliable suppliers. I like that the Economist recently reported that chicken farmers in China are wondering if these baby chicklets, these very fancy chicklets that they get from American poultry farms might be cut off by the Trump administration. And so basically, we’re seeing also that Japanese firms are marketing themselves as being more politically reliable than U.S. firms. And so I see this as sort of a very strange antitrust action that the U.S. Government has brought to bear against basically the entire American brand.

Jackie Whisman: You also talk about the unintended consequences of these in your Bloomberg article that you... I think it was in December. “U.S. Sanctions Against China Will Make China Great Again,” is the title. And you talk about how this interruption of their supply chains is really long-term going to force them to find local suppliers or create local suppliers.

Dan Wang: Well, one of the favorite topics that Rob and I like to discuss is Chinese industrial policy. Now, U.S. actions have a great deal of bearing on the future of Chinese industrial policy. So, I would say that if you take a look at the broader track record of Chinese industrial policy over the last, to say nothing of the last 20 years, but over the last 50 years when they’ve been doing their five-year plans, it’s been, I think, mostly a failure, although with a few successes here and there. You think you can point to successes in something like solar panels, you can point to successes in something like high-speed rail and certain types of heavy machinery, but if you take a look at bigger ticket items, namely things like semiconductors and aviation, Chinese industry has for the most part been an enormous failure.

So the track record of Chinese industrial policy is mixed at the very best. And I think the fundamental problem with Chinese industrial policy has been that the government has been able to rely mostly on the state sector, namely government ministries, as well as state owned firms, to buy obviously inferior Chinese products and then hope that basically through this massive, buying through inter provincial competition, there could be a world beating brand out of this market. And sometimes that works, in the case of a high-speed rail, and often it doesn’t work. Now what the U.S. actions have done, is that it has really aligned in my view, basically a lot of the leading Chinese firms, a lot of the leading Chinese technology leaders, I would point to names like Huawei, as well as Tencent and ByteDance and Alibaba and SMIC, China’s largest chipmaker.

There hasn’t been very many companies here that have not been actually sanctioned by the Trump administration or face the threat of a sanction from the Trump administration. And now, all of these companies are asking, “Well, now we can’t necessarily depend on American supply.” If you take a look at their procurement practices in the past, they’ve overwhelmingly buying from American technology. Tencent and Alibaba uses basically about the same number of software tools from Silicon Valley as a lot of the California firms themselves. If you take apart a iPhone as well as a Huawei phone, apart from the processor, they’re using broadly comparable amounts of Chinese hardware, as well as U.S. hardware. And so a lot of these major Chinese firms are now in the position where they are very much aligned with the state’s industrial policy incentives of self-sufficiency as well as technological greatness.

And so, I think the issue here for the U.S. is that first of all, a lot of its brand has been sullied somewhat by U.S. Government actions, that Chinese companies now are much more aligned with the Chinese government’s goal of doing much more industrial policy. And this is going to create some problems. And just to inject a bit of a space analogy here, to editorialize a little bit, one of the things I’ve noted is that the U.S. has mostly responded to the technological rise of the USSR, as well as Japan, by investing much more in itself. And it’s responding to the technological rise of China mostly by kneecapping Chinese firms.

And so, instead of realizing its own Sputnik moment, it is triggering one in China. To carry the space analogy just a little bit further, I think what the U.S. Government has done is to put Huawei in the position that NASA was in the 1960s when it was purchasing semiconductors purely on the basis of performance, not on cost. And so smaller Chinese companies that would never have the time of day given to it by a major company like Huawei, now are finding that, “Oh, well now its products are getting sold to a major customer.” So now this has the possibility of broadly raising the technological capabilities of the entire ecosystem.

Rob Atkinson: Yeah, talk about really unintended consequences. And again, with 10 days left in the Trump administration, we’ve always been, I think as you know Dan, it really since I think 2011, we wrote really the first think tank report calling out what we call Chinese innovation, mercantilism, and that is a threat to the U.S. economy and we need to take it seriously. So initially, we were somewhat pleased that the Trump administration was going to be taking a harder line than the Obama administration. But the core mistake I think they made here was they really didn’t listen to people. They had a few people there like Peter Navarro, who had really made up their minds and they were just going to do what they were going to do. And they didn’t really have the dialogue with industry or with experts like yourself, in my opinion.

And it led them down this path, which at the end of the day, it could be very, very, very troubling. One of the discussions we have that goes on in the U.S. all the time and it really drives me absolutely crazy, it’s this view of, “Well, we don’t have to worry about China. There’s no reason for us to pass the CHIPS Act,” which as you know, is this bipartisan bill, was in the defense authorization act to support the chip industry and reassure it. “And there’s no reason to do that because the Chinese will never, ever develop a chip in a sector.” And again, that drives me crazy because they’re making progress. I just love to hear your thoughts on that. Am I right? Are they making progress? Yeah, they’re now down to five nanometer, but they seem like they’re making progress. And do you think they’ll continue to make progress and where will that go?

Dan Wang: Well, the Chinese industry writ large, I would say, is capable of making progress, even including in these higher technology areas like semiconductors and aviation, but it’s just a fantastically slow process. They are able to do things but none of it happens overnight. There are not, I think, about to overrun U.S. industry any day now, but they are making fairly steady credible progress. And the data point here that I really like to use is that the original iPhone, when that first came out, it was assembled in China, was designed in California, as everyone knows from the label. And people used to say that, “Well, it’s simply put together in China.” If you take a look at the value added of Chinese production in an Apple iPhone in 2008, it’s only about 2 percent, which is purely basically the labor involved in putting an iPhone together.

Now, an academic who came up with that figure of 2 percent recently looked at the calculations once again. In 2018, the iPhone 10 incorporated around 25 percent of Chinese value added in an Apple iPhone. Now, it went from in 2008, from 2 percent, to 2018 of 25 percent of a much higher value phone and there’s much more Chinese content in a normal iPhone. These are things like speakers, saw some of the mechanical parts, some the simpler parts, but it has been very steady progress made by Chinese firms that have basically figured out one of the most complex electronic products in the world. And that’s how I see a lot of Chinese progress. It is basically a slow and steady affair. Yes, you have some fantastic consumer internet companies, but for the most part, even in the most fundamental, hardest technologies, we are seeing some steady progress in a lot of fronts.

Rob Atkinson: Yeah. No, it’s funny you mentioned that study. That was from the folks at UC Irvine. And we actually did a Hill event with them early on when they did that initial report. And I saw that later when they did it. It’s striking. And you mentioned Comac, or their jet aircraft. And Comac is essentially, for the listener, their state-owned, Boeing, if you will. They’re trying to make essentially the equivalent of a 737 and they have a plane that flies. They’re testing it. But I was struck by a article I read a recently where one of the engineers-

Jackie Whisman: I love this article I wrote.

Rob Atkinson: Yeah, I wrote an article about engineering and Comac because I’m a part-time aerospace engineer.

Jackie Whisman: That’s brilliant.

Rob Atkinson: I don’t tell you these things, Jackie. But one of the aerospace engineers made a simple mistake in a spreadsheet or something like that. And it ended up costing the company, I don’t know, millions and millions of dollars because the measurement was wrong. And oh my gosh. But even with that, Comac is making progress. And to your point about buying, almost every Chinese airline company is state-owned. And so they will be forced to buy Comacs and then they’ll get better. I don’t see Comac challenging Boeing or Airbus for 10 years, but at some point, if they keep going, they will. And I think that’s the point you were making, Dan.

Dan Wang: That’s right. And if you take a look at a subsidy driven, wide body aircraft company that was very tenacious and succeeded, it’s not exactly Boeing, but Airbus fits that model. And if China can follow exactly the same ladder that Airbus did, well it might be a success. I agree with you in not less than 10 years, but maybe a bit later on.

Jackie Whisman: By the time this podcast airs we’ll have a new president. Any advice you would give the Biden administration as they begin to navigate these issues?

Dan Wang: Well, I would say first of all, to think very, very carefully about what the Trump administration has done. I think the Trump administration has reacted correctly, that Huawei has some security concerns and we need to make sure that its equipment is not in our network, as well as the network in our allies. But is this course of action really the correct one? What exactly has been the strategic objective of designating Huawei to the entity list and what exactly does the administration really hope to achieve? And if you take a look basically at these other actions that the U.S. Government has taken, is it really correct to trash the American brand writ large and make American firms as a whole, a pretty unreliable. And I would encourage basically the next administration to think a bit more about how to stay ahead in this technological race. Is the right path to really try to keep taking down Chinese firms?

I don’t think that a firm that assumes that Chinese companies will stay down can be a winning one in the longer term. I think Chinese firms will always try to catch up and they are very determined to do so. And now it’s time for the U.S. to really think about how to extend its lead. Does that mean, for example, welcoming more immigrants? Does that mean supporting more universities? Does that mean more support of whatever form for its leading companies, including semiconductor companies? These are much tougher questions than trying to kneecap Chinese firms. And these are now the very important questions to focus on.

Rob Atkinson: But yeah, that was great. I really appreciate you. Thank you so much for being with us.

Dan Wang: Thank you again for inviting me.

Jackie Whisman: And that is it for this week. If you liked it, please be sure to rate us and subscribe. Feel free to email show ideas or questions to [email protected]. You can find the show notes and sign up for our weekly email newsletter on our website, itif.org, and follow us on Twitter, Facebook and LinkedIn, @ITIFdc.

Rob Atkinson: And we have more episodes and great guests lined up. New episodes air throughout every other Monday, so we hope you will continue to tune in.

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Podcast: Assessing Chinese Industrial Policy and the Impact of U.S. Export Controls, With Dan Wang