Silicon Showdown: the Competition for Technology Leadership between the U.S. and China
Aside from biweekly SCCEI China Briefs, we periodically feature relevant content from other SCCEI programs, like this conference keynote from Craig Allen, President of the U.S.-China Business Council
Craig Allen is the President of the U.S.-China Business Council (USCBC). Prior to joining USCBC, Allen had a long and distinguished career in U.S. public service, beginning in 1985 at the U.S. Department of Commerce. Over the years, he served in various diplomatic roles in Beijing and Tokyo, and also served as U.S. Ambassador to Brunei from 2014 to 2018. As President of USCBC, he has met repeatedly with China's top leadership, including Xi Jinping.
Craig Allen delivered the following keynote speech at the 2024 SCCEI China Conference on China's Economic Prospects.
Thank you for allowing me to speak on a personal basis. These views are my own, not reflecting the positions of the U.S.-China Business Council.
A short while ago, I had an opportunity to talk with the governor of one of China’s poorest, agricultural provinces. I asked him about his top economic priorities.
He quickly replied that semiconductors, software, biotechnology, robotics, aerospace, batteries, and new energy vehicles were his key priorities – neatly reciting all the key industries under the Made in China 2025 plan.
I would have thought that addressing the immediate needs of his overwhelmingly rural constituents, such as improving agricultural harvests, might be at the top of his economic priorities list. But I was mistaken.
The governor – and probably every other successful central, provincial, and local government official – is incentivized to contribute to the top priorities of the central government… and, like all of them, he was going to do his best to advance those central government goals. Their collective top priority is technology.
This incident reinforced to me the impression that the Chinese government – from top to bottom – is engaged in a techno-utopian quest that is breath-taking in scope.
China’s unswerving and unquestioning commitment to advance technology to resolve virtually every problem is going to have profound consequences for China and for the rest of the world. There is also very little discussion in China about the downsides, costs or tradeoffs.
Let me please discuss the techno utopian vision that I see is being advanced.
Background
Let’s start out with why techno-utopianism is such a natural fit for the Chinese government.
First, it is helpful to recall that China’s commitment to science and technology is not a new or recent phenomenon. Students of Chinese history will recall that over 100 years ago, the student protesters of the May 4th Movement called for a new culture based on science and democracy.
Second, it is also interesting to note that China’s current day techno-utopianism is perfectly congruent with Marxism. I suspect that Marx would be strongly supportive of the materialistic and the dialectic progress of ever advancing technology, toward an undefined utopian goal.
Third, Lenin would be even more enthusiastic with the Communist Party using technologies, especially information technologies, to advance economic planning and to extend control of the Party over society.
Fourth, Confucianism is not hostile to technology in any way. Indeed, you see some of the same techno-utopian tendencies in other Confucian societies – Japan, Korea, and Vietnam
Fifth, from a leadership perspective, President Xi studied chemical engineering at Tsinghua from 1975 to 1979, and his career shows a consistent interest in technology and science advance from the very beginning. Other officials around him have a similar background.
Finally, the policies and planning of the Chinese government are framed very much in accord with the CCP’s revolutionary tradition – they proclaim that they wish to be at the vanguard of technology to correct the injustices of former imperialists.
Techno-utopianism is deeply, deeply rooted in China’s historic and ideological structures. It fits — perfectly — as a guiding principle for the CCP in the current era.
Characteristics of Chinese Innovation
American views of China have historically oscillated between over-estimation and under-estimation. We seldom get it right. Currently, some of our more jingoistic American compatriots under-estimate China, believing that China is not innovative at all. This view is ill-founded.
China has already moved from being an innovation sponge to an innovation leader. However, in the process they have redefined innovation in a manner that better fits Chinese needs. China’s definition of innovation is different from Silicon Valley’s.
The McKinsey Global Institute helps us to understand the four drivers of Chinese innovation.
First, China benefits from the sheer size of its consumer market, which helps companies to commercialize new ideas quickly and at scale. Chinese consumers are exacting. Many consumer-oriented companies that thrive in China will do well elsewhere. We should not be surprised at the success of TikTok or Temu. There are many more like them.
Second, China has an ecosystem that is optimized for efficiency driven innovation in manufacturing at scale. These manufacturers use lots of agile manufacturing, modular design and flexible automation. Shein and Xiaomi are examples. Shenzhen is the world capital of fast prototyping.
Third, do not underestimate China’s capabilities at engineering-based innovation. They have millions of engineers and STEM workers. Huawei may be reviled in the U.S., however, they have demonstrated some of the world’s top engineering capabilities. Tencent, DJI and BYD are other outstanding Shenzhen-based examples.
Fourth, do not underestimate China’s rapidly expanding capabilities at science-based innovation. In the most recent budget, R&D spending has been increased 10 percent – more than any other budget item. China has surpassed the EU in R&D spending. They may catch up to the U.S. soon – unless we up our game.
New Productive Forces
This innovative ecosystem is different from Silicon Valley. In some ways, it is synergistic with Silicon Valley, but that will not necessarily be the case in the future.
So, what exactly is the Chinese government doing from a policy perspective to create a technology lead over the U.S. and the rest of the world? In China, this is being broadly discussed in terms that the Chinese call the New Productive Forces.
At the recent National People’s Congress, on March 8, Xi Jinping gave a speech on this. Let me quote him.
He said, “it is essential to promote the integration between scientific and technological innovation and industrial innovation in a coordinated way to develop strategic emerging industries, and to arrange the development of industries for the future as well as to accelerate the development of a modern industrial system.”
While Xi clearly outlined the objectives of Chinese industrial policy, we need to get more granular. There are five things about the new productive forces that are new to the mix and may distinguish Shenzhen from Silicon Valley.
First, “New Productive Forces” implicitly recognizes that China is facing an acute labor shortage at the factory level. Thus, government guided efforts focus on factory automation and efficient production in mature industries. They want to rapidly move up the value chain with robotics, precision manufacturing and mass customization.
Second, they want to spur innovation and create new industries at almost any cost. In a manner that is not constrained by the market, they are willing to throw vast sums of capital and unlimited numbers of engineers into developing the products of the future.
Third, there is an overwhelming mandate for self-reliance and import substitution. The role that foreign companies can play has been described in official media as follows: “China should continue to introduce cutting edge technologies from outside, without over-reliance and thus should focus on providing experiences for breakthroughs in original technologies.”
One can summarize this by saying foreign technology should be allowed in so as to spur domestic technology development. This is in accordance to the Chinese practice of re-innovation or (zai chuangxin).
Fourth, there is plenty of government money. On the financing side, there is a huge sum of public money to support the New Productive Forces. Barry Naughton of UCSD has calculated that about 11 percent of GDP is available over 5 years. Scott Kennedy of CSIS calculates that China uses about 1.8 percent of GDP annually for this purpose. These numbers are about 4 times larger than the next highest incentive supplier: South Korea.
Fifth, I think that we should all watch China’s plans to turn “data” into the “fifth factor of production”, behind – land, capital, labor, and entrepreneurship. The NDRC has developed a “Data Division” which is to work hand in hand with the Cyber Administration of China.
In short, the New Productive Forces represent a doubling-down of the Made in China 2025 type policies – to be implemented with yet more attention, vigor, and more resources.
Chinese Domestic Perspective
In my discussions with Chinese government officials, they believe that their policies are 100 percent correct and that they are absolutely committed to their systematic implementation – regardless of the costs.
In my opinion, the main victim in this drama are the Chinese people, especially those living in rural China – far away from the glitzy cities and dazzling companies. Stanford’s very own Scott Rozelle has done a superb job at highlighting the profound challenges that non-elite Chinese face. It is doubtful that the New Innovative Forces will help them. Arguably, the New Productive Forces will lead to yet more inequality and widen the rural-urban gap.
Another group that can be considered collateral damage due to the government’s excessive focus on technology is the Chinese private companies’ writ large. This is a group in a deep, deep funk. Their access to credit from the government banks is highly circumscribed. Internal markets are poor. They are worried about deflation. There is overcapacity everywhere – and they realize that they cannot compete against SOEs.
Now that I have laid out what I believe are the contours of the New Productive Forces, let’s look at them from the perspective of the WTO and the IMF, and then in terms of U.S. economic and national security concerns and finally from a U.S. corporate perspective.
WTO Perspective
Thus far, I have emphasized only subsidies. The subsidies are important, if for no other reason than they are actionable under the WTO. But it is important to note that in Chinese industrial policy, in addition to subsidies, the Chinese government uses a whole armory of WTO compatible and WTO non-compatible measures to reduce imports, promote domestic champions, and support their own technological standards.
Indeed, USCBC maintains a database of some 130 Chinese industrial policy measures that the Chinese government uses to promote its own industry – often at the expense of China’s trading partners. These 130 industrial policies fall into a number of different buckets, including: government procurement, state owned enterprise procurement, industrial standards, IP policy, taxes, customs and others.
Under the WTO, all WTO members are obligated to keep trade related documents in the public sphere. Secret documents are not permitted. However, in the case of technology in China, we know of two classified Chinese government or party documents that have an impact on technology trade.
Specifically, Document 551 was proclaimed last year by the Ministry of Finance and the Ministry of Industry and Information Technology. This document lays out a time frame for elimination of imports of many medical devices in some 300 different categories. This is clearly intended to remove foreign technology products with domestically made alternatives. We have copies of this document and have asked for it to be repealed – with no action taken thus far.
Also, Document 79 is purportedly published by the State-Owned Assets Supervision and Administration Commission – which owns the State-Owned Enterprises. This secret document – which I do not have – purports to remove all foreign technology from the tech stack of Chinese SOEs in a short period of time. We see reflections of document 79 and its implementation in many bid and tender documents.
It is true that the WTO was written before the advent of the Internet or the widespread use of genomics. The WTO does not provide a good “rule book” on how to manage trade in the technological arena. But suffice it to say China is not living up to its WTO obligations in almost all technology related trade issues. The U.S. is not doing a great job at this either.
The current WTO system of rules simply cannot survive the intense rivalry between the U.S. and China in trade, technology, and finance.
IMF Perspectives
In a way, the WTO may be irrelevant. The IMF perspective may be more helpful.
Some economists have said that China is responsible for 18 percent of the world’s population, and about 17 percent of world GDP. But China is responsible for only about 12 percent of global household consumption. The inevitable consequence of under consumption is over investment. China is responsible for about 30 percent of total investment, which has led to China to control 31 percent of total global manufacturing.
Through financial repression, Chinese government policy limits the ability of Chinese citizens savings to invest anywhere other than the manufacturing endeavor. Chinese government policy perpetuates excessive savings and investment, at the expense of household consumption.
China’s fixation on expanding the supply side and limiting growth of the demand side has reached its natural limits. Further supply side stimulus produces diminishing returns. The basic problem is that there is no room for Chinese manufacturing to increase. The world is too small to accept additional Chinese overcapacity.
The IMF recognizes this disequilibrium and suggests that corrections are urgently required. The IMF suggests that China has to expand pensions, remove hukou restrictions, increase the role of the private sector, increase healthcare insurance and unemployment insurance, restrain SOEs, and improve the lives of ordinary Chinese. This is surely correct.
But these demand-generating policy initiatives are not the highest priories for the current Chinese government. They do want a little more demand. But they want a lot more supply-side stimulus – exactly the opposite of what the IMF suggests.
The international spill overs from Chinese policy to expand innovation and manufacturing at all costs also creates economic distortions in China and around the world – including in the U.S. Technology is a big part of the problem. But we should clearly recognize that over-investment in the technologies of the future is only a part of the problem.
U.S. Economic Perspective
I think that Treasury Secretary Janet Yellen during her recent visit to China was correct to highlight the international costs of overcapacity in the industries that China choses to subsidize and support.
We know that a combination of subsidies and other types of industry specific incentives created over capacity in steel, aluminum, solar panels and wind turbines. This led to price destruction on a global basis. It is the only companies that receive the unwavering support of the Chinese government that survive this process.
With industrial policies at the scale of China’s, the trade policies of any WTO member are simply overwhelmed and become irrelevant. Industrial policy has eaten trade policy for lunch.
So, governments around the world which are concerned about their own competitiveness are reacting to China’s policy orientation with measures that are ironically similar to China’s. In the case of the United States, the IRA, Infrastructure Bill and the Chips Act were largely passed to counter the Chinese challenge.
But there is much more. In the panel session, I will talk about our own government’s novel use of (1) outbound capital controls, (2) controls over outbound data, (3) controls over American cloud service providers, (4) and proposed controls over American pharma companies purchasing services from Chinese companies.
We could also talk about TikTok, Chinese port cranes, Chinese steel and EV restrictions. This might be a “small yard, high fence” but the yard appears to be expanding, and the fence seems to be getting taller. All of these are reactions to Chinese policies.
U.S. National Security Perspective
It is important to note that China’s fixation on technology has direct implications for the national security of the United States and our allies. This is brought into stark relief by China’s unwavering support for Russia, especially in the context of Russia’s brutal invasion of Ukraine and Russia’s ongoing threat to all NATO member countries.
China’s partnership with Iran and North Korea are also concerns, as these countries are sometimes operating independently and sometimes in consultation or partnership with China… and Russia.
The concerns associated with technology transfer and joint technology development are ever more acute given China’s Foreign Intelligence Law of 2017 and the top leadership’s commitment to Civil Military Fusion.
In addition, China is expanding its production of nuclear weapons and their delivery systems many times over in a very short period.
Given China’s geopolitical ambitions as a rising power and America’s commitment to the status quo and defending the international rules-based order, it is hard to see how these geopolitical constraints might be better managed. While conflict is not inevitable, tensions will need to be carefully managed as we nudge our way to a sustainable rules-based order.
Corporate Perspective
If you look at this set of issues from the perspective of a corporation with global operations, you must be worried about the decline of U.S.-China relations. To date, Silicon Valley and Shenzhen have had a pretty complementary relationship. Silicon Valley companies have been able to outsource labor intensive operations to China and have benefitted from Chinese excellence in manufacturing.
However, we need to ask: is the model sustainable? If it is to be sustainable, what changes have to be made?
It is important to recognize that we live in a political world. Companies all recognize that a potential future conflict between the United States and China would make it impossible for most international trade or investment to continue. This is not limited to direct conflict between the U.S. and China. If there was conflict between China and any treaty allies of the U.S., there would be an abrupt cessation of normal trade and commerce.
It is for this reason that many American companies are scenario planning to ensure that they would be able to continue in the event of Russia-like sanctions being placed on American companies doing business in China. This is an intensely difficult process, and yet one must always hope for the best and yet plan for the worst.
Short of Conflict…
Short of conflict, there are many other concerns that need to be managed. Let me say a few words about some of the most salient issues for American companies invested in China: export controls, the tech stack, data flows, R&D and – the most important and difficult issue – talent.
U.S. export controls have had an enormous impact on American companies. The New York Fed summarized this by saying:
“By forbidding U.S. firms to export to a selected list of Chinese firms for national security reasons, export controls aim to generate a selective decoupling of U.S. firms from China.
This broad-based decoupling of U.S. firms from China is not offset by the creation of new supply chain relations in other countries.
Indeed, the total number of customers (of American tech companies) declines, potentially inflicting collateral damage upon the same U.S. firms whose technology export controls are trying to protect.”
Let me summarize. On the export control side, it is especially unfortunate for American companies when export controls are unilateral, enforced by the American government only on American companies. In such cases – and there are many – unilateral export controls asymmetrically hurt American firms and long-term American competitiveness.
On the tech stack, as I hope I have demonstrated, the Chinese government is trying to force Chinese companies to eliminate foreign products – starting in government purchases and now moving to State Owned Enterprises. The most recent iteration of this was that Micron and AMD chips were to be discouraged in government purchases of telecommunications equipment. The Chinese have no sited no viable national security reason to do so.
Unfortunately, we are seeing that American tech companies in China are coming under increasing pressure from the Chinese government and suppliers to the Chinese government. It is hard for me to see why this would stop.
The Chinese government procurement actions are going to put Chinese SOEs in a very bad place. SOEs outside of China will probably use American products in their international subsidiaries, but they may not be able to do so in their home office. This will not contribute to smooth operations.
It is unclear how far the tech stacks in both China and the U.S. will bifurcate and what the costs will be to market players – in both countries. The unfortunate question is who will be hurt more.
Data flows are another sensitive issue. China’s Cyber Administration of China (CAC) has announced a bevy of controls that American companies are finding it very difficult to implement. The main problem is that the CAC wants to be able to regulate cross border data flows that may involve “important” information. They decline to define the word “important” and but note that they would be pleased to make a judgement after you show it to them.
The uncertainty over China’s outbound data regulatory regime is causing anxiety for all multinational companies. We do not know how to invest in our IT structures. We do not know how to maintain connectivity between our China operations and our global operations. Frankly, we do not know when we will cross over an invisible line and be subject to Chinese penalties.
The U.S. government appears to wish to join the Chinese government is regulating outbound data flows – according to a recent Executive Order from the White House. This is also filled with uncertainty for American companies – who may have to seek Department of Justice advice on what had been routine data exchange.
On R&D, I would note that a German CEO recently suggested that Germany and China set up an R&D Silk Road to enhance the mutual benefit of both German and Chinese companies.
It is not only the Germans who benefit from joint R&D with China.
Many American companies also do R&D in China, to the benefit of their overall corporation. Much of the American corporate R&D in China is done to help to localize the international product. But more and more we are seeing that R&D coming out of American-owned facilities in China is impactful for their global operations. I expect that this will be yet more true in the future.
The Big Kahuna is talent. I would cite a U.S. multinational company who found that one of their lead scientists in China was denied a visa for the United States. This scientist is the leading scientist in his field and was responsible for global R&D, including all efforts in a particular product line in the United States. This type of story is becoming more and more common.
Let’s be clear. American companies need access to Chinese talent if they are to remain globally competitive. If American companies are barred from hiring Chinese talent, then other companies will be given a long-term structural advantage that will – over time – impact American technological and scientific competitiveness.
In Conclusion
Let me conclude by saying that the Shenzhen model of innovation and the Silicon Valley model of innovation are the envy of the world.
It is probably true that Silicon Valley and Shenzhen — and indeed the U.S. and China — have much more in common than we realize, but the differences are important.
My own view is that the Silicon Valley model, which we might call libertarian, will win due to its acceptance of diversity and its inherently global nature. We have confidence in our own system.
However, let’s give the Shenzhen model the respect that it deserves – as a very strong competitor with large ambitions. The Shenzhen model has advantages over the Silicon Valley model.
In an ideal world, companies associated with the Silicon Valley Model and companies associated with the Shenzhen Model would be able to integrate — competing and cooperating on a level playing field with well-known, well-enforced rules.
But unfortunately, neither the level playing field, nor the well-enforced rules, exist.
This is truly the greatest show on earth, and it will play out for the rest of our lifetimes. Thank you.