China Is Not As Healthy As You Might Think

It is not uncommon to come across criticisms of the current trade war with China to the effect that China is simply too strong of a country economically to be impacted by tariffs, or that it is somehow inevitable that China will become the dominant power. For instance, in June 2018, David P. Goldman argued that instead of tariffs, the United States needed to focus on innovation. Goldman argument was:

Tariffs won't do much. The Trump administration appears to think that the threat of tariffs will scare the Chinese into giving up their technological ambitions. They won't. Tariffs will hurt us as much as they hurt the Chinese, and the Chinese are much better at taking pain than we are.

His solution was something like what happened after the Soviets launched Sputnik: America realized its precarious situation vis-a-vis technical innovation, and by various means--including the Apollo program--invested heavily in STEM education and R&D and were able to leapfrog the Soviet Union.

      Retired General Robert Spalding made similar comments just a few days ago. Breitbart reports:

      Opportunities for nation-building at home are being squandered by misappropriation of funds abroad, assessed Spalding. He said American investment in education, particularly in STEM fields, is falling behind Chinese competitors.

      “We have, today, 152,000 Chinese kids in STEM education,” said Spalding, “where in one year [of spending] in Afghanistan, we could afford to put 200,000 kids through four years of STEM education here in the United States. Back then, for that space race, we educated the scientists that built the technologies that grew this economy to be the number one economy in the world.”

      Spalding went on. “Whether it’s industrial policy, whether it’s research and development, whether it’s STEM education, there’s so much that we did and benefited from just on the basis of the industrial effort that went into the space race, and we’ve lost it all.”

       Political narratives of economic determinism driving democratization — popularized by Francis Fukuyama’s End of History predictions and adopted by many political leaders — had borne out to be false while weakening America’s geopolitical position, determined Spalding.

      “We fell into this trap of believing that open markets lead to wealth, and wealth leads to democracy, and, therefore, if we just open ourselves up to the world, that the world would automatically democratize,” noted Spalding. “In the space of that 20 years, we essentially deindustrialized our entire country to the point where we almost can’t manufacture any of the things we need to defend ourselves.”

     I'm not saying that Spalding or Goldberg are incorrect about the need to focus on STEM and R&D and a nationalistic industrial policy. I think we need to have a vibrant manned space program, return to the Moon and get to Mars and the asteroid belt. But I don't agree that tariffs are not, and should not be, part of the answer.

     This was particularly brought home reading an article at The Diplomat entitled, "China's Tech Sector Is in Trouble: Chinese tech workers are stuck in the cold as relations with the US freeze" by Viola Rothschild and Benjamin Della Rocca (both of whom work for the Council on Foreign Relations). The whole article is worth the read, but let me see if I can distill the most relevant parts:

      Just two years ago, the rise of China’s tech sector (often termed its “new economy”) looked unstoppable. Between 2014 and 2017, Chinese telecommunications giant Huawei doubled its revenue, and a whopping 34 Chinese tech startups topped $1 billion valuations. By one forecast, the new economy was on track to create over 1 million jobs annually. But today, the once-prolific sector has reversed course: startups and tech giants alike have been reeling the past year. In the last quarter of 2018, WeChat owner Tencent saw net income fall by a third, and e-commerce giant JD.com lost $700 million. Alibaba forecasts that, this year, its sales will drop over 20 percent. And across publicly listed technology, media, and telecommunications (TMT) companies, last year’s earnings dropped 140 percent from 2017 — a larger plunge than any other Chinese sector.

      What is going wrong? Since 2017, a volatile blend of political, economic, and social pressures have plagued new economy firms—and, therefore, new economy workers. However, one major driving force of China’s tech-sector turmoil, which has compounded these other headwinds, is the past year of conflict in the U.S.-China relationship. In particular, the ongoing trade war and disputes over data security and intellectual property have slashed profits, scared off investors, and created new operational risks for Chinese tech firms.

      The faltering of China’s new economy also carries significant social consequences: worker suffering, simmering social unrest, and crackdowns on dissent from Beijing. Looking at this broader picture, it becomes clear that recent U.S. policies have done more to China than threaten Huawei’s bottom line. They are fanning the flames of broader social pressures — which, in turn, push Beijing to take steps that widen the growing rift between the U.S. and Chinese tech spaces.

      ... Tariffs have weighed on Chinese tech through a few different channels — each of which has affected new economy firms disproportionately among Chinese companies. First, tariffs slow exports to America, eating into firms’ revenues. Many new economy firms are particularly vulnerable to falling U.S. sales — for Chinese companies on the MSCI stock index, the information-technology sector derives a higher percentage of revenue from the United States than any other sector. Second, China’s retaliatory tariffs cause the new economy outsize pain. Sourcing many technology inputs from outside the U.S. is difficult — as telecommunications giant ZTE learned when a U.S. export ban forced it to shut down last year — so tech firms using U.S. components have seen costs skyrocket.

      Perhaps worse, the trade war has hemorrhaged tech firms’ domestic revenues. Tariffs squeeze the incomes of all Chinese companies and consumers, which has triggered a cycle of falling domestic spending that slows the whole economy. By all indications, this broader downturn is severe. Already, Chinese retail sales growth has plunged to a 16-year low, and the IMF forecasts that, this year, tariffs could slash China’s GDP growth by a staggering 1.6 percentage points. This, too, harms new economy firms disproportionately. E-commerce firms suffer more than most since retail sales closely track the economy’s boom-bust cycle. Furthermore, the new economy’s rapid rise itself leaves it ill equipped for today’s slowdown. In 2017, as investors poured into Chinese tech at breakneck speeds, many companies used new cash to expand operational capacities beyond what they can easily sustain during recession.

      But beyond the trade war, other U.S.-China disputes have cast a pall on internet-based firms. Chinese tech leaders today worry that the United States is more willing than ever to retaliate against Chinese companies it considers threatening, economically or politically. Recent events justify these concerns. Last year, in two separate incidents, Washington arranged the arrest of Huawei’s chief financial officer and fined ZTE $1 billion, after each company violated American sanctions on Iran. Even more strikingly, in May, espionage concerns led the United States to place Huawei and a handful of other Chinese tech firms on an export ban list (though it has since relaxed these measures).

     Such U.S. retaliation can prove devastating. ZTE was China’s second-least profitable company last year in part because of the $1 billion it paid the United States. And because it relies on U.S. parts, Huawei estimated that a U.S. export ban, if maintained, would cost it $30 billion this year and next. So, while most Chinese internet companies have yet to suffer America’s wrath directly, fears that the scope of U.S. retaliation may broaden have caused many firms to contract. Last summer, Alibaba cited political tensions as a reason for canceling plans to enter the U.S. cloud-data market. More generally, investment bankers in China cite these tensions as factors pushing Chinese tech firms to delay initial public offerings and capital expenditures.

      Making things worse, all these developments in U.S.-China relations have caused investors (particularly foreign ones) to pull back. Internet firms, once awash with capital, are seeing funding dry up. Last year, renminbi-denominated private-equity fundraising plummeted to just $11 billion from $31 billion in 2016, and final quarter venture capital deals shrank 25 percent year-over-year. “It’s become very hard to raise money” for startups, as one Beijing-based founder put it. “That’s a fact.”

And, as noted, there is the issue of potential social unrest. Spalding, earlier, noted that there were "152,000 Chinese kids in STEM education," but what this article in The Diplomat explains is that the Chinese economy can't absorb all of the STEM graduates: tech companies are slashing workforces and reneging on contracts to hire new workers.

      And, perhaps more dilatoriously, their existing workers are being asked to put in more hours at the same or lower pay. This is causing unrest and opposition:

       First, workers are pushing back against managers’ attempts to cut costs and squeeze more out of employees. The clearest example of such pushback is the “anti-996” movement, which protests the 9 a.m.-to-9 p.m., six-days-per-week work schedule that has become the tech-industry standard. Once, the “996” culture symbolized a rite of passage for China’s ambitious young programmers; now, as wages and benefits dwindle, it has now become a rallying point for a restive workforce. Last month, when an anonymous activist launched an anti-996 protest project on Github, it quickly became the site’s most bookmarked project, garnering hundreds of thousands of followers. Prominent companies “blacklisted” for unhealthy cultures and labor law violations include Alibaba, JD.com, Huawei, and Bytedance.

      China’s gig economy workers are also dissatisfied. Gig economy workers form the backbone of China’s e-commerce and express food delivery industries. However, they lack formal labor contracts, have limited access to basic social insurances, and put in long hours with little pay. (The typical driver for Didi nets only about $17 for 10.5 hours of driving.) In response to lower salaries and increasingly demanding delivery times, couriers and warehouse workers are taking to the streets. According to China Labor Bulletin, about half of all protests in 2019 have occurred in the service, retail, and transportation industries, which are now heavily dominated by internet companies. In some cases, these protests seriously disrupt normal business operations.

      Going forward, unemployed tech workers, as well as the jobless populations who used to count on finding tech-sector work, will be another source of social discontent. Recently, for China’s 8 million annual college graduates, programming or tech-firm management jobs were coveted opportunities. The tech sector also represented a new beginning for displaced wage laborers –including 33 million former manufacturing workers who found new economy jobs as couriers, warehouse workers, or security guards since 2015. Today, tech firms can no longer absorb these workers at the same rate.

We need to strengthen our own industries in favor of China. While tariffs against China, alone, will not get industry to return to America, it can at least discourage it in China.