Washington hopes tariffs will force multinationals away from China, but times have changed. Companies use China for far more than cheap assembly now.

Eighteen months after US President Trump launched a bruising trade war against China, the two sides signed a truce in which Washington agreed to ease some tariffs on Chinese imports and Beijing agreed to step up its purchases of US farm products. The so-called “phase one” trade deal, signed on January 15, is a welcome piece of news because it defuses a conflict that has slowed global economic activity, disrupted supply chains, and hurt consumers on both sides of the Pacific. It does little, however, to address America’s main concern at the heart of the trade war – forced technology transfer – though we wouldn’t expect it to.

Trump’s decision to confront China in 2018 was based on the longstanding and broadly recognized concern held by the West that China uses unfair trade practices that force foreign firms to give up their technology in exchange for market access. Those practices were laid out in March 2018 in an investigation by the United States Trade Representative under Section 301 of the Trade Act of 1974. They include:

  • foreign ownership restrictions that compel foreign firms to transfer valuable know-how to their Chinese partners;
  • cumbersome administrative approval processes that pressure foreign firms to disclose sensitive business information;
  • restrictions on technology licensing terms that force foreign technology owners to set artificially low licensing fees;
  • state orchestrated acquisition of foreign firms to acquire cutting-edge technologies and intellectual property;
  • and cyber theft.

The current US administration is not the first one to act against Chinese trade practices. Former president Obama, for example, filed and won seven enforcement actions against China at the World Trade Organization for cases that included discriminatory aerospace tax exemptions and illegal aluminum subsidies. He also imposed tariffs on vehicle tires and dozens of anti-dumping measures against Chinese companies accused of selling their products at prices below fair value.

Trump’s trade actions against China have nonetheless been different from prior administrations in both scale and rhetoric. Instead of targeting unfair economic practices in specific industries, the Trump administration has slapped tariffs across the board on nearly two-thirds of Chinese imports, increasing the average tariff from 3 percent to more than 20. The argument for the tariff hike was simple: by threatening to dismantle the reliance of the world’s largest economy on Chinese imports, Trump hoped President Xi would be forced to change China’s economic practices.

Trump laid out his decoupling strategy in a tweet on May 10, 2019, saying US tariffs would primarily hurt China and not the American consumer because “[t]he Tariffs can be completely avoided if you buy from a non-Tariffed country, or you buy the product inside the USA (best idea). That’s zero Tariffs. Many Tariffed companies will be leaving China for Vietnam and other such countries. That’s why China wants to make a deal so badly!”

In other words, Washington believes it can force Beijing’s hand by coercing supply chains and manufacturing to shift away from China.

Such a decoupling strategy might well have worked 25 years ago. At that time, China’s manufacturing sector mostly specialized in footloose – easy to move – assembly activities that were in large part destined for the US market and were relatively easy to relocate to other low-wage countries. A US tariff hike could thus have effectively forced multinational firms to move their activities away from China.

China has moved up the value chain by specializing in more sophisticated activities that are hard to replicate and even more difficult to relocate.

After decades of rapid economic growth, however, China has moved beyond its role as the world’s assembler. Rising labour costs have eroded the country’s advantage in low-skilled assembly activities, and China has moved up the value chain by specializing in more sophisticated activities that are hard to replicate and even more difficult to relocate.

One way Chinese manufacturers have upgraded is by taking on more orchestration responsibilities in global value chains. Assemblers in China do more than provide simple assembly services; they select suppliers, coordinate supplier networks, manage inventory, and conduct quality control on the raw materials and supplies they purchase. These are more sophisticated capabilities that are harder to replicate.

A second way that firms in China have upgraded is by moving into the production of key components that they used to purchase abroad. The iPhone is a great example of this. In 2009, China exclusively did the assembly of the iPhone 3G, amounting to 3.6 percent ($6.50 US) of the bill for materials. In 2018, China was also making many of the complex components in the iPhone X including the printed circuit board, battery pack and camera module, raising the country’s share of the bill of materials to 25 percent, or $104 US.

This upgrading trend is generalized across the entire Chinese economy, recent estimates by the Organization of Economic Co-operation and Development show. Between 2005 and 2015, China’s domestic content in its total exports has increased from 74 to 84 percent.

All this means that today’s multinational firms operate in China to access capabilities that are difficult to replicate. They are not there simply for cheaper labour. For Trump, this undermines a key element of his decoupling strategy: firms are willing to go to great lengths to avoid US-imposed tariffs, but they try to do so without avoiding China. This limits the Trump administration’s ability to force China’s hand through a trade war. In today’s climate of uncertainty, we can therefore be confident that both the trade war and forced transfer of technology are here to stay.

Photo: Electronic circuit boards are produced in Jiangxi, China. Shutterstock by humphery.


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