August 18, 2022

One of the countries that have always fascinated me has been China. I made my first trip to China in the early 1990s and have gone on many business trips to various cities in China over the last 30 years. It has a rich and complex history, and its people, culture, and food are mysterious to many outside Asian cultures.

One of China’s architectural wonders is the Great Wall of China. On two business trips to Beijing, I took an afternoon off and went to the closest entry gate to the Wall from Beijing, called Badaling. This is where most tourists and escorted tours start and thus is often crowded. However, it is a great starting point to see the Great Wall’s architecture close up and hike a portion of the broad and easy wall to climb. On my last trip, when I had more time, I made it to the highest section of the Great Wall in that area that people can get to and saw a stunning view of a broader region around Beijing.

That wall, which spans 13.000 miles, was erected in the third century B.C. to keep out barbarian nomads.

A modern-day version of the Great Wall of China is being built today with similar objectives, but this time it is technology and digitally driven. Chinese President Xi Jinping has stated two directives that are in the process of creating this new great technology wall that has significant ramifications for China and the rest of the world.

The first significant policy, which has serious technology overtones, is based on the idea that all products used inside China need to have Chinese manufacturers make the components.

According to a Reuters story last August:

“China’s government quietly issued new procurement guidelines in May that require up to 100% local content on hundreds of items including X-ray machines and magnetic resonance imaging equipment, erecting fresh barriers for foreign suppliers, three U.S.-based sources told Reuters.

Document 551 was issued on May 14 by the Chinese Ministry of Finance and the Ministry of Industry and Information Technology (MIIT), with the title, “Auditing guidelines for government procurement of imported products,” said one former U.S. government official, who obtained a copy of the previously unreported 70-page catalog and read portions to Reuters, but requested anonymity.

Sent to Chinese hospitals, companies and other state-owned buyers, the document sets local content requirements of 25% to 100% for 315 items. They include medical equipment, ground-based radar equipment, testing machinery, optical instruments; items used for animal husbandry; seismic instruments, and marine, geological and geophysical equipment, the former official said.”

This reflects an evolving set of rules that could eventually mean that the Chinese businesses and their people can only buy things made in China using Chinese parts. While this particular set of Chinese government rules is not absolute, the general concept of a China Only policy moving in this direction is troubling the U.S. and many other countries that currently sell all types of goods to China today.

There was another development recently that hints further that China is moving in this direction.

According to Bloomberg-

“China has ordered central government agencies and state-backed corporations to replace foreign-branded personal computers with domestic alternatives within two years, marking one of Beijing’s most aggressive efforts so far to eradicate key overseas technology from within its most sensitive organs.

Staff were asked after the week-long May break to turn in foreign P.C.s for local alternatives that run on operating software developed domestically, people familiar with the plan said. The exercise, which was mandated by central government authorities, is likely to eventually replace at least 50 million P.C.s on a central-government level alone, they said, asking to remain anonymous discussing a sensitive matter.

The decision advances China’s decade-long campaign to replace imported technology with local alternatives, a sweeping effort to reduce its dependence on geopolitical rivals such as the U.S. for everything from semiconductors to servers and phones.”

In a note to our Creative Strategies customers, one of our analysts pointed out one big problem for China if they continue to move with China Only strategy-

“One of the biggest challenges facing China’s technological independence is the fact that the country’s core technological I.P. is lacking. One of the primary areas in which this becomes obvious is semiconductors. China has been pouring hundreds of millions of dollars into developing core semiconductor I.P. and yet they still lag drastically behind the rest of the world in everything from process technology to packaging, manufacturing, architecture, and more. This has been a pain point for China and continues to irk them as they have tried to acquire a number of foreign companies that own proprietary I.P. around semiconductors but have failed due to other governments blocking the sale.

Operating systems, and the ecosystems that surround them, are another critical point of weakness for China. This became painfully evident when the U.S. government blocked China from using some of the most critical features Google offers for Android, including many apps and services, which led to Huawei unsuccessfully attempting to recreate critical parts of the Android ecosystem on its own. Users not having access to all of Google’s apps and services led to one of the weakest sales years Huawei has seen in recent times, with sales dropping by double digits percentages in markets outside of China.

President Trump’s ban on China is easily the best example to showcase how deeply China relies on technology from the U.S. and many other countries. And without access to those critical technologies, Chinese companies were hurt financially.”

This lack of IP will especially be true when it comes to advanced semiconductor manufacturing. The U.S. supplies almost all top-end semiconductor manufacturing equipment, which is already under a trade ban to all Chinese chipmakers. This is one of the underlying reasons China wants to take back Taiwan since TSMC, which has one of the most sophisticated high-end semiconductor manufacturing facilities globally, would come under China’s control if China ever successfully takes over Taiwan.

There is another major problem for China as they move toward a China Only strategy. One of the significant factors in China’s economic growth has been to allow major companies outside of China to create factories inside China and attract inexpensive labor from people in the surrounding regions. For example, when I first visited Shenzen in the early 1990s, it was a small city surrounded by agricultural fields. Today, because of its unique trade zone status and hundreds of large and small manufacturing sites that brought people in from the fields to work in higher-paying manufacturing jobs, Shenzen is a bustling city, making many local citizens far richer than if they continued working in the fields.

Indeed, China used a similar strategy in cities around China to build all types of manufacturing facilities, many homegrown but created by partnerships with Taiwanese companies like Acer, Foxconn, Compal, and Quanta. Korea also does some manufacturing in China, and in 2010, Intel opened its first chip manufacturing plant in Dalian, China.

This strategy was done to bring more wealth to many regions by providing manufacturing jobs, especially for the local youth who wanted to move from working on family farms and into jobs that paid a lot more.

In talking with many major tech companies who today rely on manufacturing their products in China, they tell me they are scrambling to move all manufacturing of their products out of China permanently. Many have already moved a great deal of their manufacturing to Viet Nam, Malaysia, India, and even Mexico. They fear China’s policies could cripple their ability to make products in this country that appears to be heading towards isolation.

If that happens, it means significant job losses in Chinese manufacturing all over the country and could have a severe economic impact on China very soon.

This fall, China will hold the next Chinese Communist Party’s 20th National Congress, which leaders worldwide will observe to see the direction China will take for the next five years.

However, given the extreme possibility that president Xi’s leadership role will be extended, his directives over the past two years suggest that China will be strengthening their Great Technology Wall and drive China into a stronger “China Only” nation going forward.

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