US China trade deal

US-China Trade Deal As we have noted in previous posts, the trade war with China goes far beyond the Section 301 tariff action. The New Normal between the United States and China includes a host of U.S. government actions directed at China’s high tech sector, with an export ban under the Department of Commerce Entity List system as one of the most powerful tools.

Huawei was the first target under the Entity List ban and the Department of Commerce just expanded its Entity List to include five Chinese entities that develop supercomputers and supercomputer technology. The reason given for these latest bans is that China uses supercomputers for military purposes which negatively impacts United States national security.

This new ban falls within the traditional use of the Entity List to deal with technology having military uses. Note however that pretty much every high tech product has potential military uses and that just about every high tech Chinese company has at least some relationship with China’s military. This means this type of ban can be used very expansively against China’s high tech, electronics, and telecommunications industrial complex. The implications of these latest bans therefore extend beyond this specific action.

This new Commerce Department ban list can be found here. The list really breaks down into two sets of companies: one owned by Sugon/Dawning (曙光) and the other the Wuxi Jiangnan Institute of Computing Technology and its aliases:

Sugon Group.

  • Chengdu Haiguang Integrated Circuit, including two aliases (Hygon and Chengdu Haiguang Jincheng Dianlu Sheji);
  • Chengdu Haiguang Microelectronics Technology, including two aliases (HMC and Chengdu Haiguang Wei Dianzi Jishu);
  • Higon (Hygon), including five aliases (Higon Information Technology, Haiguang Xinxi Jishu, Youxian Gongsi, THATIC, Tianjing Haiguang Advanced Technology Investment, and Tianjing Haiguang Xianjin Jishu Touzi Youxian Gongsi)
  • Sugon (Shuguang), including nine aliases (Dawning, Dawning Information Industry, Sugon Information Industry, Shuguang, Shuguang Information Industry, Zhongke Dawn, Zhongke Shuguang, Dawning Company, and Tianjin Shuguang Computer Industry);

Wuxi Jiangnan Institute of Computing Technology, including two aliases (Jiangnan Institute of Computing Technology and JICT).

Sugon is one of the major manufacturers of supercomputers for public use and its product offerings can be seen here. The companies in the Sugon group are majority owned by Sugon and are infected by that ownership. The ownership of Sugon itself is unclear, but it started as a state owned company and the assumption is that it is still controlled by the PRC government. The ban notice justifies including Sugon by stating that “Sugon has publicly acknowledged a variety of military end uses and end users of its high-performance computers.”

The justification for adding Wuxi Jiangnan Institute of Computing Technology is more direct. Wuxi Jiangnan is owned by the 56th Research Institute of the General Staff of China’s People’s Liberation Army and as stated in the ban notice, “Its mission is to support China’s military modernization.” This means applications in battlefield communications, satellites, cyber-hacking and cyber-warfare. It is not clear why the U.S. waited so long to add this company to the Entity List.

The impact of the Entity List classification is the same as for Huawei. U.S. companies are prohibited from selling hardware or software or services to the companies named on the list and the ban extends to non-U.S. companies that include these U.S. items in what they sell to the banned Chinese companies. So the impact goes beyond hardware and it extends beyond U.S. borders.

The PRC has been very proud of its  supercomputing advancements. Now we will see whether supercomputing can continue in China without access to U.S. inputs in hardware, software and services.

The timing of these latest bans is significant also in its impacts on the restart of trade negotiations between China and the United States, with Presidents Xi and Trump scheduled to meet next week at the G20 summit in Japan. The purpose of these discussions is supposed to be to attempt to restart negotiations for resolving the Section 301 tariff issue. In a recent post, Does China WANT a Second Decoupling? The Chinese Texts Say That it Does,

I wrote about how the official China press has been indicating China is anything but enthusiastic about reaching a resolution with the United States. Timing this supercomputer ban to be effective on June 24, just four days before the G20 meetings in Osaka, indicates the U.S. also is less than enthusiastic about reaching quick resolution with China. Optimists who see a quick resolution due to the personal “chemistry” between Xi and Trump may want to take these developments into account.

Many believe there will be resolution before the 2020 election so President Trump can go into that election claiming victory. But I tend to think the exact opposite may be true. If President Trump reaches a deal with China, it is virtually certain not to be nearly as good a deal as the United States has been seeking and it will open Trump up to criticism by the Democratic Party nominee that he was not “tough enough” with China. If Trump holds out against China, he does risk weakening the U.S. economy, but he also will be able to claim he needs to be re-elected to finish the fight against China.

Either way, since October of last year, we have been pushing our clients to reexamine their China operations and plans in light of US-China tensions and we fully intend to continue doing so. We remain of the view that a US-China trade deal will — at best — merely slow down the straight-line worsening of relations between these two countries and we believe China-Europe relations will trail what happens between the US and China.

Literally the day before President Trump’s tweet regarding his plan to institute a 25% tariff on another $250 billion of Chinese goods, we wrote a long piece, entitled The US-China Trade War: Winter is Coming, in which we wrote how no trade deal between the United States and China will change much between them and how the trade war will merely go forward on other fronts. We concluded that post (as we have so many other posts) by exhorting foreign companies to look closely at their own business relationships with China:

How though should your business respond to all this? To quote an old investment adage, “the trend is your friend,” and right now the trend is for the West and China to continue decoupling. This means the most important thing for your business is to be cognizant of this and to monitor it. We keep writing about this because we see it as likely to impact nearly all foreign companies that do business with China, even those from countries whose relations with China are much better than those between the United States and China. No matter in what country your company is based, if you do business with the United States — especially if you have your products made in China and then sell them to the United States — your business is at risk of becoming entangled by the decoupling.

If you want to see your company go into China or have its products made by China or increase its China presence, you should be prepared to explain to your company’s decision makers why you believe your business will not fall prey to US-China tensions. If you are having your products made in China, you almost certainly are already looking to reduce your China exposure, but in doing your cost benefit analysis for that, consider whether yours is the sort of business whose sales might increase merely by being able to tell its customers/consumers that your company does no business with China. And yes, this is going to sound self-serving (and it is, but it is also true), you need to more than ever make sure you are not doing anything that might make you an easy target of the Chinese government. In other words, make sure your company is in full compliance with China’s laws, particularly its tax, environmental, employment and bribery laws.

This advice stands.