The story of the Chinese technology giant Huawei is, in miniature, the story of China’s extraordinary economic rise. Founded in 1987 in Shenzhen, which at the time was still an unglamorous backwater, Huawei’s early efforts centered around reselling telecom equipment imported from neighboring Hong Kong and, at the same time, working feverishly to figure out how to manufacture low-cost imitations of such equipment.
In less than a decade, Huawei went from being little more than a middleman to being one of Asia’s leading manufacturers of network technology, helped along by the support of the Chinese party-state, including the People’s Liberation Army, an early and devoted customer. Today Huawei is by one account the world’s seventh-largest tech company, and a mainstay of Shenzhen’s thriving hardware ecosystem. In recent years, the company has routinely sold more smartphones than Apple, and in 2018 it generated roughly as much revenue as Microsoft.
But that was all before Donald Trump made what could ultimately be one of the most consequential decisions of his presidency: By adding Huawei to what is known as the “entity list,” the Trump administration has cut off one of China’s most successful multinationals from the U.S. technology that it has heretofore needed to function. This is a decision that will have profound implications for the Chinese economy. Yet it will also test the United States, which has grown dependent on Chinese manufacturing prowess in building out its own network infrastructure. What happens next could forever transform the relationship between the world’s largest economies.
Trump’s decision to clip Huawei’s wings was not made lightly. It came in the face of evidence that Huawei’s growing reach poses serious security challenges to the United States and its allies. For one, Huawei has evinced a willingness to aid China’s clandestine intelligence-gathering efforts. In 2017, it came to light that Huawei-made servers in the African Union headquarters had been surreptitiously feeding classified information to a server farm in Shanghai on a nightly basis for more than five years. To date, nothing this brazen or damning has come to light in a G20 country, but there have long been concerns about Huawei’s eyebrow-raising security shortcomings. A March report from the British government suggested that despite Huawei being at the bleeding edge of 5G hardware, the security of its technology was “very, very shoddy,” a fact China hawks attribute to intentional design rather than a lack of sophistication.
To many in China, however, Trump’s blacklisting of Huawei looks rather a lot like a frontal assault on one of their country’s foremost national champions, if not an echo of the Opium Wars of the 19th century. The Chinese government has promised a forceful response that will target U.S. companies, and even individual U.S. citizens, it deems “unreliable.”
Understanding China’s vehement defense of Huawei is impossible without situating the company in China’s long-term vision for its economy. As Matthew Klein has perceptively noted in Barron’s, since the financial crisis China has moved away from its old strategy of deluging wealthy Western markets with low-cost goods. Despite China’s continued suppression of living standards, the cost of labor in China’s cities has risen as a result of a shrinking working-age population and sharp inflation in housing costs. Apple CEO Tim Cook has gone so far as to say that these pressures have moved Chinese manufacturing outside the low-wage target that multinationals such as Apple seek. This move away from being the “workplace of the world” is not a problem in itself. In fact, the “Made in China 2025” program reflects the Chinese Communist Party’s hope of aiming a new “China shock” at Silicon Valley. The issue, though, is that China’s enormous debt overhang might not allow for the seamless pivot the party is counting on.
Whereas the United States and Japan can service their debts at little cost, at least for now, debt service in China comes out to 20 percent of GDP. Given this debt burden, China was counting on its high-tech industries to win large market shares abroad and free up subsidies for the country’s struggling state-owned enterprises, which absorbed 70 percent of all new loans from 2013 to 2017.
Huawei, with its stratospheric rise, was the poster child for this approach. Yes, part of its competitive advantage still stemmed from government largesse, but the overall performance of the company more than made it a net benefit for the country. If the United States kicks off a trend of barring high-tech Chinese companies from lucrative Western markets, though, the Huawei model will be severely damaged. China would still press on with its push into high-tech sectors out of a desire to limit its own vulnerability to the type of supply-chain disruptions it is now facing, but the cost to the state would be far higher.
The purpose of “Made in China 2025” is to cultivate national champions, not create more wards of the state. Beneath all of the fawning media attention, the obstacles facing the Chinese economy are formidable. China is facing down the Japanese cocktail of high debt levels and an aging population, only it’s doing so before joining the ranks of the world’s richest countries. And unlike the government in Tokyo, the Chinese Communist Party cannot countenance a deep and lasting recession that could prove fatal to its legitimacy.
A recognition of China’s structural challenges, though, should not obscure that the United States has vulnerabilities of its own. With the exception of the dot-com decade from 1995 to 2005, the Unites States has seen lackluster productivity growth since the 1970s, which has contributed to wage stagnation and all of its associated ills. The economic wonders of 5G remain highly speculative, but unlike previous generations of wireless technology, there is reason to believe that 5G will have major cross-industry effects. To highlight a single but very promising example, when Ericsson installed its early 5G-sensor system in a factory for jet-engine blades, the defect rate was brought down by 10 percent, reducing the per blade cost by more than $4,000. Even if the 5G boosters are proved wrong, and its contributions to the economy end up being marginal, the upside is too large for the United States not to get in the race.
If blacklisting Huawei appreciably raises the cost of deploying 5G networks in the United States, American firms might find themselves at a distinct disadvantage. Over the next few years, as AT&T and Verizon build out their 5G infrastructure, swearing off Huawei means they will do so with hardware manufactured by Ericsson, a Swedish multinational, or Nokia, a Finnish one, as if to underscore the extent to which the United States has allowed its industrial know-how to atrophy. And Ericsson and Nokia hardware can be as much as 20 percent more expensive than Huawei’s offerings. When you consider this per unit premium compounded over the upper-bound estimate of 800,000 new 5G cells, the premium U.S. telecom companies will be forced to pay to guard against the threat of Chinese subversion is staggering. For smaller companies, particularly wireless providers for rural communities, the cost of moving away from Huawei could be prohibitive, unless the government steps in.
Consider the case of Nemont, as relayed by Charlie Campbell of Time. A pint-size wireless carrier operating in rural Montana, its tight margins forced it to rely on Huawei technology for its 4G hardware. Turning to a higher-cost supplier was simply not an option. Smaller players in the heartland such as Nemont would look to the federal government for relief should the Trump administration stick with the Huawei blacklist. The White House had already pledged $20 billion to expand rural broadband before the ban, a bill that may have to climb higher still.
While there’s nothing to say that either Ericsson or Nokia won’t find some cost-cutting innovations over the next few years to change this basic calculus, we should not bank on it. Instead, it would be wise to be seek out opportunities for cost-cutting and efficiency gains elsewhere in the process. At a minimum, the United States must overcome regulatory obstacles that have all but thwarted every other major effort to build out 5G infrastructure in recent years. Many of America’s larger cities and metros find themselves squeezed by soaring expenditures and cash-strapped voters who rightly resist new taxes. This has left ambitious politicians scrambling for revenue sources to paper over fiscal imbalances, even when this strategy risks deterring productive investment.
Take Portland, Oregon, where installing a 5G antenna required a $7,500 builders fee and then a recurring annual fee of somewhere between $2,500 and $3,500; or Dallas, where the right to build 5G antennae would cost you a one-time fee of $280,000. A recently announced Federal Communications Commission policy would constrain revenue-hungry local governments. Under the new guidelines, cities would be required to set their fees at however much it cost them to review the 5G-antenna application, which itself would have to be approved or declined within 90 days. It’s a policy that can’t hurt, but it won’t make the challenge of replacing Huawei’s technology all that much easier to overcome.
And so Trump has to make a decision. If he doesn’t want to cede the emerging 5G economy to a Chinese tech giant, whether out of security concerns or a larger anxiety about the loss of U.S. technological superiority, he must decide on an alternative course. One option would be to work with other market economies to reduce their collective dependence on Huawei’s low-cost networking technology. But that would require deft diplomacy—not the president’s strong suit—as America’s partners in this endeavor would need to be reassured that they have something to gain from willingly paying higher prices to fend off an amorphous Chinese challenge.
Alternatively, Trump could commit to a more ambitious strategy of rebuilding the U.S. industrial commons, and perhaps even building up U.S. national champions that can outcompete Huawei in manufacturing networking technology. In short, he could craft a “Made in the U.S.A. 2025” agenda fit to compete with “Made in China 2025.” Suffice it to say, the United States is not known for its ability to engage in this sort of long-term industrial planning, and even attempting to do so would raise hackles among free traders on the left and the right. Blacklisting Huawei is one thing. Figuring out exactly what to do next will prove to be quite another.
Regardless of the outcome of the Huawei controversy, it is yet another sign that the enmeshment of the Chinese and U.S. economies that has defined the past 20 years—the age of “Chimerica”—is coming to an end, and this will mean a painful adjustment for Chinese and Americans alike.