Chinese government's tech decoupling a blow to US firms

China's latest move in the US-China trade war is the first real sign by China of a "decoupling" from US tech

The ongoing trade war between the US and China has taken another potentially decisive turn after a new report suggested Beijing has ordered all government offices to remove foreign technology. Although the order is ostensibly designed to ensure compliance with a much-publicised cybersecurity law, it will be seen as the first real sign by China of a "decoupling" from US tech.

It's a path that commentators believe could result in further retaliation from Washington, harming US tech companies and potentially leading the world to the brink of a new recession.

The trade war escalates

The report in the Financial Times claims that the order to banish foreign tech from all public sector organisations came from Communist Party Central Office earlier this year. It's been confirmed by a brokerage, China Securities, and two unnamed cybersecurity firms whose government clients apparently cited the instructions. The scheme would start in 2020 with an estimated 20-30 million pieces of hardware set to be swapped out. The policy's nickname of "3-5-2" derives from the quantity of kit to be replaced in each of the next three years: 30% in 2020, 50% in 2021, and 20% the year after.

China can argue with a fairly straight face that the move is being made on national security grounds, given the Snowden leaks of several years ago which revealed how US intelligence agencies were trying to spy on foreign countries by tampering with home-made technology. It also comes in response to an increasingly aggressive US policy, which has centred around telecoms kit makers Huawei and ZTE. That has effectively prohibited the firms from selling equipment in the US, and placed them and many others on an entity list, which prohibits US firms from selling them vital components.

What happens next?

Several questions remain unanswered. For one thing, it remains to be seen how strict the ban on foreign tech will be. As the FT piece argues, even Lenovo kit features Intel chips. It's also unclear exactly how much this will affect US tech firms financially. Jefferies estimates that they generate annual revenues of $150 billion, although it admits that much of this comes from private sales, which this ruling doesn't affect.

That said, the government policy is a sign of how far the stand-off between the world's two superpowers has escalated. Although it has world-beating hardware, China still doesn't have a home-grown operating system to rival Windows, so it would seem to be taking something of a gamble with its latest move. It's also likely to be just the first in a series of moves by China to decouple from US supply chains.

China watcher Bill Bishop had the following comment on the news in his Sinocism newsletter:

"Question: Does this include financial institutions, or are those separate? Because de-Americanizing the IT stack in that industry is coming too. China wants to decouple in technology, just at its own pace, and in while in some key areas it is not yet ready, its capabilities are getting ‘good enough' in more and more areas."

China's plans for self-sufficiency in high-tech manufacturing have long been public knowledge: Beijing's notorious Made in China 2025 policy was launched four years ago. But it could be argued that an over-zealous response from Washington has accelerated the process.

The future's fragmented

All of which paints a pretty bleak picture for foreign tech firms with a stake in China. And for Chinese investment in the US economy as a whole. From 2016-18, Chinese FDI into the US sank by almost 88% to $5.4 billion and is expected to decrease again in 2019.

It will also have an impact on China, of course. It's not just US firms that are moving operations out of the country. In the printer space alone, Ricoh (Thailand), Konica Minolta (Malaysia), Sharp (Thailand) and Kyocera (Vietnam) have all announced plans to shift production from the Middle Kingdom, at great cost. These are not decisions that will be easily reversed.

Some have predicted that as supply chains are unpicked and battle lines drawn, future trading blocs could increasingly be organised around ideological lines, such as the Five Eyes intelligence coalition compromised of the US, Canada, UK, New Zealand and Australia. For those firms still hopeful of a long-mooted "Phase One" deal which will see a détente in the trade war, there are some home truths from China law specialist Dan Harris.

"Even if the Phase One deal does happen, it will be so limited as to be meaningless for most companies and nothing but a short-term pause in the decoupling. Look at all that has happened between the United States (and the West) and China over China's treatment of Hong Kong and the Uighurs and tell me that the US and China are millimetres away from patching things up. Look at how ‘Beijing orders state offices to replace foreign PCs and software' and tell me who you think will stop the straight line deterioration in relations between the West and China," he writes in the China Law Blog.

"Decoupling is happening and will continue happening and you and your business need to act accordingly."