Forget the rhetoric, China still lurks at end of US tech supply chain

The trade-war may have accelerated a shift toward a more diverse range of suppliers, but southern Chinese manufacturers haven't lost their grip


By Ross O'Brien

Between US-China trade tensions and an accelerating global economic slowdown, technology manufacturers in the Greater Bay Area had a daunting 2019. However, southern China’s leadership over global supply chains largely remains unchallenged – although many trading relationships are shifting. While the optics suggest that these shifts are the result of successful US pressure forcing procurers (American and other) to seek alternative sources, the reality is that China continues to supply electronic components and materials to producers elsewhere.

As US buyers change procurement practices to hedge against shifting geopolitical realities, the GBA’s technology supply chains are actually benefiting as they remain “in control” of core sub-processes and technology components while assembly that is less strategic (but more optically acceptable, from a trade war perspective) takes place elsewhere. Rather than dismantling Chinese technology manufacturing hegemony, GBA suppliers may be using these shifts to cement their global leadership position. 

While Chinese manufacturers of all sorts have been targeted by wide-ranging tariffs, it is producers of communications and computing technology, such as Shenzhen-based ZTE and Huawei, that have received particular sanction for their perceived threat to US cybersecurity – as well as their more tangible competitive threat to American tech firms. 

And yet, Shenzhen – the GBA’s fast-beating high-tech heart – has seen technology production volumes remain relatively buoyant. Through September, the value of computer, communications and electronics goods produced in Shenzhen rose 5.4 percent over a year earlier, to 1.49 trillion yuan (about US$202 billion) – almost 60 percent of the city’s industrial output, according to Shenzhen Municipal Bureau of Statistics data. Overall, exports have indeed flagged, but they haven’t collapsed: they fell 0.7 percent by value in the first three quarters, to 993 billion yuan, the data show. Volumes, however, continued to grow: sea freight increased 1.1 percent in container terms and 2.6 percent by volume, and air freight volumes – a more relevant indicator for the health of smartphones and other small, high-value technology exports – grew 3.3 percent. Partially, this is due to the fact that while draconian-sounding, many injunctions levied against southern China’s tech giants have not been implemented. Huawei, arguably Washington’s primary bête noir – and which contributed fully 7 percent of the city’s GDP in 2016 – has been given not one but three 90-day reprieves on the original ban prohibiting its purchase of chipsets and other critical technology from US suppliers, the latest in November. Huawei’s position as the world’s largest manufacturer of telecommunications network solutions, and a leader in next-generation 5G technology, has presented US policy-makers with a quandary: the Chinese tech giant is both a formidable market adversary and a valuable customer for US tech champions such as Qualcomm and Google. 

Made in China...

While the trade war has not broken the stride of China’s technology giants, it has certainly added urgency to a long-standing strategy to achieve self-sufficiency in semiconductors. China only produces 20 percent of the semiconductors it needs, but has plans to double that figure by the end of 2020, and supply 70 percent of its own demand by 2025. SEMI, a global electronics manufacturing industry association, reckons that Chinese semiconductor “fab” production capacity has grown 12 percent annually since 2017, the fastest pace in the world, and will reach 4 million wafers per month in the coming year. In 2018, China surpassed Taiwan to become the world’s second-largest producer after Korea. 

China’s semiconductor industry has lagged behind in the production of more advanced chips, as well as larger-diameter wafers that help create economies of scale. But it is making progress here as well: SEMI estimates that China’s output of 200mm wafers will be higher than domestic demand in 2020.  Which is not to say that the tech trade war has had no impact. Manufacturers of digital components report that buyers are seeking multiple supplier bids from other destinations in light of trade-policy uncertainty, crimping sales and prolonging sales cycles. 

The notion that other export destinations are “winning” as a result of China’s loss obscures a more fundamental point: alternative suppliers are increasingly large customers of southern China’s electronics and technology sector’
 
Technology exports to the US from other manufacturing hubs in the region are rising, notably from Southeast Asia. However, the notion that other export destinations are “winning” as a result of China’s loss obscures a more fundamental point: alternative suppliers are increasingly large customers of southern China’s electronics and technology sector. Vietnam, perhaps the Asean market that has best emulated China’s approach to building a focused export manufacturing sector, is as much a client as is it a competitor. Vietnam’s imports from China have grown fivefold over the past decade; the country has now overtaken Germany as China’s fifth-largest export customer. Intermediate goods comprise the vast majority of China’s exports to Vietnam – and significantly, electronics and related components alone make up over a quarter of their value. 
 
This implied that many of smartphones and other technology exported from Vietnam to the US are thus comprised of large amounts of Chinese inputs, wrapped in an export badge of Vietnamese assembly. As a result, China can retain its hold on technology supply chains, even as US purchasers are able to demonstrate the ability to diversify away from Chinese imports. This trend is not the direct result of the trade war, but rather a steady evolution of a trend that has seen Chinese producers slough off labor-intensive assembly processes while retaining core technology and more easily automated manufacturing process. Despite a three-year wage freeze from 2015 to 2018, Guangdong, and in particular the Greater Bay Area, have seen some of China’s steepest salary rises over the past decade. At 2,200 yuan per month, Shenzhen is tied with Beijing as having the country’s second-highest minimum wage, behind Shanghai.

All part of the program... 

Southern China’s technology export manufacturers have thus embarked on a similar cost-optimizing journey to that which their peers in Japan, Europe or North America began a generation ago. But while southern China’s path toward cost-effective productivity is directionally similar to its competitors, it involves two significant differences. China has been choosier in determining which links in the global supply chain it is willing to surrender or outsource. Rather than abandoning low-value sub-processes wholesale, China has maintained a lead in many basic, but essential electronics components, aided by automation technology – recent Stanford Institute for Economic Policy Research found that since 2012, robotic production in China increased 20-fold. This has insulated China’s technology manufacturing ecosystem somewhat from labor arbitrage, and allowed it to develop and grow supply relationships with up-and-comers like Vietnam.

The other critical detour has been China’s drive to build capabilities at the top end of its technology innovation pyramid. This is still a work in progress: at the end of October, the Ministry of Finance and China Development Bank led a collection of government bodies in launching a US$29 billion state fund to invest in semiconductor businesses, ranging from chipset design to production facilities. 

Given China’s enduring hold on the production of much of the world’s stock of semiconductor-dependent computers and devices, its ability to wean itself off foreign semiconductors seems more likely than the rest of the world being able to successfully re-create China’s ecosystem.