The Trump Administration is continuing to work on a possible trade deal with China that would result in China purchasing more U.S. goods and making it easier for U.S. companies to operate in China, while at the same time averting major tariffs. But some voices within the Administration, including Trade Representative Robert Lighthizer, believe that the discussions are not taking into account sufficiently the threat posed by China’s activities in the information and communication technology (ICT) arena. These voices are right. The Trump Administration must continue aggressively prioritizing that threat over virtually all other aspects of U.S.-China trade. In fact, for economic and national security reasons, it is time for the United States to begin taking aggressive steps to move its highly vulnerable ICT supply chain out of China.
Approximately 40 percent of Chinese exports to the United States (the equivalent of almost $200 billion) are ICT-related. Some of those exports are from Chinese firms, such as Huawei, ZTE, or Lenovo. But the vast majority are from household U.S. brands like Apple, Microsoft, and Hewlett Packard, that assemble their products, or source components, in China. A recent study by the U.S.-China Economic and Security Review Commission examined the supply chains of America’s top seven ICT companies and found that each one had a substantial portion of its supply chain in China—an average of 51 percent, with one top U.S. company originating a whopping 73 percent of its shipments in China.
In many instances, Chinese companies (in some cases partly owned by the Chinese government) are manufacturing and assembling on behalf of American companies. In cases where the American company wants greater control over its supply chain, the Chinese government still requires that the American company establish a joint venture with a local Chinese entity under which it willingly or unwillingly ends up transferring significant know-how along with sensitive, proprietary information to the local Chinese partner. And in recent years, the Chinese government has been pressuring U.S. companies to make source code available for review and to store some of their data on servers in China.
As a result, U.S. companies have effectively been building up China’s ICT sector. It is estimated that the transfer of U.S. know-how and technology to China, together with the outright theft of U.S. intellectual property through Chinese corporate espionage, totals up to $500 billion in value per year. Put differently, over the past decade China has appropriated trillions of dollars of ICT-related value without paying for it.
As shocking as this is from a commercial perspective, the national security implications are even more disconcerting. ICT forms the backbone of the U.S. economy and underpins other key sectors—financial services, energy, and transportation, all of which are heavily reliant on ICT systems. China, meanwhile, is actively trying to breach U.S. government databases and has successfully done so on several occasions, in one case resulting in the theft of more than 20 million Social Security numbers. It has been trying to identify vulnerabilities at American power plants and other critical infrastructure installations. China would happily install backdoors on technology products destined for the U.S. market, and it has likely requested access to source code precisely in order to better discover weaknesses. Telephones, computers, routers, switches, cables, flash cards, and many other ICT products could be exposed to backdoors and malware, putting at risk American consumers, American companies, and the American government itself.
Thankfully, the United States has finally woken up to the ICT threat posed by China—and the Trump Administration deserves credit for drawing attention to the issue in a way that previous administrations have not. The Committee on Foreign Investment in the United States (CFIUS) has stepped up its actions, preventing Chinese companies from acquiring businesses in the United States that would result in China accessing sensitive know-how or technology. There is legislation in Congress right now to expand the scope of CFIUS that would provide added authority to block non-control transactions, which is good. And the government recently completed an investigation under Section 301 of the Trade Act of 1974 that reached damning conclusions about China’s forced technology transfers and IP theft.
But despite these efforts, it remains unclear whether the Trump Administration truly is prioritizing ICT over other aspects of the U.S.-China trade relationship. Earlier this month President Trump floated the idea that he would relax sanctions on ZTE, a Chinese telecommunications company that has evaded North Korea sanctions and may be spying on U.S. citizens. Furthermore, to this day nobody has put forward a serious proposal for moving the American ICT supply chain out of China. There is little point in spending so much effort scrutinizing and in some cases blocking inbound transactions, while at the same time turning a blind eye to the fact that American companies continue to operate in a country where their supply chains are compromised, and where they are forced to transfer sensitive know-how and technology.
The U.S. government has a wide range of tools it can use to get American ICT companies to move their supply chains out of China. The key challenge is to use those tools creatively and aggressively.
For sensitive technologies that have a dual-use application or otherwise provide China with capabilities that the United States does not want it to have, the Commerce Department could apply its expansive export control powers. It would need to develop a list of specific items that may no longer be exported to China. The scope of the authority is very broad; Commerce would have significant discretion in drawing up the list of items. American companies would then be prohibited from exporting those items to China or manufacturing them there.
For non-sensitive technologies—such as basic routers, telephones, and televisions—export controls would be too blunt an instrument. American companies should still be allowed to sell these items into the Chinese market, and even manufacture them in China for local sales. But because of the concerns around a compromised supply chain for goods that end up in the United States, non-sensitive technologies that are intended for the U.S. market (and all related components) ought to be manufactured and assembled outside of China. To accomplish this goal, the United States could gradually phase in tariffs and quotas, ultimately moving towards an effective ban on technology imports from China. In addition, the Federal government can use its procurement authority (which it already does to a large extent), and the leverage that it has over state governments and academic institutions that receive federal grants, to ban all purchases of ICT products for which any element of the supply chain touched mainland China.
American ICT companies will surely balk at such a proposal. China has become the linchpin of the American ICT supply chain; moving that supply chain out of China would present significant financial and logistical complexities. But of course that is exactly why this is so urgent as a matter of U.S. national security. Unfortunately, China has turned out to be America’s top adversary in the realm of cybersecurity and cyberespionage. On top of that, it has become the supplier-of-choice of technology products for authoritarian governments around the world, including Iran and North Korea, that pose an ideological and strategic threat to the United States. It is nothing short of flabbergasting that the United States has placed its entire ICT sector within the jurisdiction of a country with such intentions and such a track-record.
Phasing in these new restrictions gradually will help ease the burden on American companies and enable them to plan strategically on how to best achieve compliance; but in addition the U.S. government will need to provide affirmative assistance to American companies in moving their manufacturing into alternative markets that present some of the same advantages as China but that do not pose the threat that China does. There are many countries that have an equally low-cost labor force, as well as interests more closely aligned with those of the United States: Vietnam, the Philippines, Thailand, Sri Lanka, and Malaysia, among many others.
Rather than roll back free trade initiatives across Asia (such as by pulling out of the Trans-Pacific Partnership), the United States should instead put in place high-standard free trade agreements with other countries that could take over China’s role in America’s ICT supply chain. These trade agreements would include best-in-class IP protections, ironclad investment dispute resolution mechanisms, and the elimination of other tariff and non-tariff barriers that might otherwise present hurdles for the two-way commerce necessary for an ICT manufacturing supply chain. If countries knew that it was America’s stated desire to move its ICT supply chain out of China and into other markets, they would have a strong incentive to make meaningful trade concessions. The possibility of landing an Apple or Hewlett Packard manufacturing facility would prove a powerful motivator for, say, Sri Lanka, Vietnam, or the Philippines—all of which, incidentally, will only become more valuable for America’s strategic interests across the Asian continent over the coming years.
At the same time, America’s financing agencies—including OPIC and EXIM—would need to be mobilized to help offset the costs that American companies will incur in establishing new manufacturing facilities. These agencies can provide lower-cost, longer-term financing. Once the specific alternative countries are identified, and free trade agreements are in place, it would be important for the Administration to give these agencies explicit instructions to provide as much support as possible to U.S. firms to ease their relocation burden.
In the end, such a strategy would yield many simultaneous benefits. First, the U.S. ICT supply chain would become far more secure and diversified—located in friendly countries over which the United States in many instances also has far more influence than it does over China, an important consideration in case any problems arise. Second, it would reduce the theft of IP and reduce the annual trade deficit with China, thereby stemming the flow of hundreds of billions of dollars annually into the coffers of a country that is fast becoming America’s most potent economic rival. Third, it would deny China valuable know-how that it has been using to America’s detriment—which would be done even more effectively if the United States can get Europe, Australia, Japan, and other technologically advanced allies to take similar steps to move sensitive technology out of China. And fourth, it would boost the economies of, and stimulate America’s strategic relationships with, other key countries throughout Asia.
The United States must take a nimble and differentiated view toward its trade relationship with China. In many areas, there is room for strong cooperation—and China can still play an important role in America’s non-ICT supply chain. But in the ICT sector the national security implications of America’s over-reliance on China have become too significant to ignore any longer. It will take coordination across various U.S. agencies and strong determination in the face of what will surely be initial pushback from some corners of the business community. But moving the ICT supply chain into friendlier countries—and in some cases even back onshore to the United States—is an urgent priority.