Despite China's three-decade transformation into a manufacturing powerhouse and its rapid transition to a capital-intensive economy, the country still lags behind the West in key high technologies.
Nowhere is this more apparent than in semiconductors. Also known as integrated circuits, semiconductors are the lifeblood of all things digital, enabling everything from data processing to computerized defense systems.
But Beijing's quest to catch up with -- or even leapfrog the West, as more ambitious Chinese officials intend -- is getting harder by the day. U.S. President Donald Trump's trade war is looming ever larger. Meanwhile, Western companies, which have in the past transferred technology to China in return for market access, now fear that this approach could cost them their technological lead.
Even if they don't openly support Trump's hard-hitting approach to China, they will quietly acquiesce in his protectionist drive. This would have been unthinkable a decade ago, but years of Beijing's strong-arm tactics and self-serving behavior have created a historic tipping point.
According to Sanford Bernstein, a research company, China imported around $160 billion worth of integrated circuit-related technology in 2016, making semiconductors its number one import -- surpassing even oil imports. Every area of Beijing's "Made in China 2025" technology master plan is dependent on foreign-owned integrated circuit technology, with much of it coming from five American manufacturers: AMD, Intel, Micron, Nvidia and Qualcomm.
Developing a homegrown semiconductor industry, therefore, has become Beijing's top priority. It is, for example, reportedly investing $31.5 billion in a National Integrated Circuit Industry Investment Fund.
Currently, Chinese makers like Shanghai-based SMIC make integrated circuits which are sold globally, but these chips are in the 350 to 28 nanometer range, far behind the latest generation, which run to 10 nanometers.
However, Trump and technology are combining to conspire against Beijing's central planners. As the U.S.-China trade war morphs into an economic cold war and a technology race, Washington will resort to blocking the flow of key technology to Chinese companies. Think of the example of ZTE, the Chinese telecoms equipment maker that the U.S. briefly threatened to punish for sanctions busting by banning access to American suppliers. Washington settled on a fine, otherwise, ZTE may have gone out of business.
Meanwhile, despite the temptations of China's huge market, the appetite of foreign companies to engage in joint ventures and strategic partnerships with Chinese counterparts is rapidly diminishing. What was once a big western tech advantage has become so narrow that companies fear that new technology transfers could cost them their lead.
The Trump White House has justified its punishing tariffs on China by referring to the huge bilateral trade deficit but its actions are rooted largely in a backlash against intellectual property and technology-transfer practices.
The next phase of Washington's countermeasures, therefore, will shift toward increased technology export controls and outright bans on transfers. The U.S. Department of Commerce's Emerging Technology and Research Technical Advisory Committee is said to be reviewing the critical technologies needed to support the Made in China 2025 plan. Business insiders should pay close attention, as the committee's findings will likely result in an expanded list of controls.
Meanwhile the Committee on Foreign Investment in the U.S. is expected to step up scrutiny of intended acquisitions by Chinese and other foreign companies in the U.S. tech sector.
One company that would be immediately impacted is Yangtze Memory and Semiconductor Manufacturing International Co., Beijing's state-funded, rising national champion. The company recently broke ground on a $24 billion facility in Wuhan city and is set to become the first Chinese company to produce a 64-layer 3D NAND flash memory chip.
However, when it plans mass production, Yangtze Memory will depend on critical early-stage equipment from Applied Materials and KLA-Tencor, both American companies.
Critical niches in the global semiconductor ecosystem are dominated by a small number of highly advanced manufacturers, almost all based in the U.S., Japan, Europe, South Korea and Taiwan.
How will the world's leading semiconductor makers react to the Trump's escalating technology war against Beijing? For the most part, on both a political and commercial level, companies will go along with and even encourage the president's policies.
On a political level, as Beijing continues to fund its own companies, key microchip makers in Japan, South Korea, Taiwan -- and even America -- will increasingly turn to their governments for similar support. The fact that foreign companies have been grappling with an already challenging business environment in China will make this choice even more justifiable.
America's big technology groups are, for example, being drawn into government partnerships and publicly funded ventures, increasingly in defense-related fields.
On a commercial level, foreign companies have been playing a game: partnering with Chinese groups in the production and sale of second and third-tier generations of microchips, while betting they can continue to build on their existing lead in innovation -- outside China -- and keep the latest generation of IP out of reach from their Chinese partners.
Foreign companies will have to think hard about continuing this approach. One major consideration: the vast new sums of money being spent by Beijing -- which will tilt the playing field. To maintain a lead, foreign groups will need to dramatically increase their own spending, thus it will become justifiable to obtain funding from their own governments.
Historically, foreign companies that have agreed to do technology transfers in exchange for market access have lived to regret it. Consider Siemens and Kawasaki Heavy Industries, the German and Japanese companies that transferred key high-speed rail technology to Chinese JV partners. Both Siemens and KHI must now compete for global rail projects with their former Chinese partners -- not only is this an issue of lost market share, it has created downward pressure on prices.
The same thing could eventually transpire when China's next-generation microchip companies come on line. The integrated circuit industry is sensitive to price fluctuations but since Beijing's planners are committed to keeping China's national champion semiconductor makers afloat -- at any cost -- there is a real danger of a future oversupply of microchips and a global price collapse.
To fight this, the leading global semiconductor players will largely support the Trump administration's countermeasures against Beijing's state-centric technology goals. And as sanctions, export controls and blocked tech deals become more of a reality, the decision to accept a helping hand from Washington will seem ever more pragmatic.
Alex Capri is a senior fellow in the Business School at the National University of Singapore.