How the trade war could make China even stronger

At a machinery firm near Shanghai, China’s sprawling business capital, engineers rely on the United States for parts they need to make precision measuring equipment for automakers and other industries.

But the company, Suzhou Osaitek Photoelectric Technology, is now speeding up plans to produce the components itself, according to He Zhongya, its chief engineer.

The reason? New tariffs in the trade clash between the United States and China have made the American-made parts too expensive.

The company, which employs about 100 people, would have made the shift to local production eventually, but “the trade war accelerates the transition,” He told CNN.

The world’s top two economies have imposed tariffs on hundreds of billions of dollars of each other’s goods. The measures are expected to take a heavier toll on China’s economy, which relies more on exports and has already started losing steam this year.

But the conflict is encouraging Chinese companies and government officials to move ahead with changes that could eventually make the economy more competitive and more appealing to foreign investors.

“The crisis incentivizes China to develop faster,” said He.

A factory in eastern China that makes medical equipment, one of the industries where the Chinese government wants to boost homegrown technology.

‘Doubling down’ on tech

The US Commerce Department starkly exposed China’s reliance on American technology this year when it blocked US companies from selling vital components to Chinese telecommunications hardware maker ZTE, forcing it to halt almost all of its operations.

In China, ZTE’s crisis reinforced the belief that the country needs to become more self-sufficient.

“You’re going to see probably more intensive efforts at domestic innovation,” said Scott Kennedy, an expert on the Chinese economy at the Center for Strategic and International Studies.

But developing advanced tech industries, such as semiconductors, while cutting dependence on the United States “will be difficult” in the short term, he cautioned. That’s because Chinese companies rely heavily on American-made chips to build smartphones and mobile networks.

Beijing’s aggressive campaign to build more sophisticated manufacturing industries is one of the US government’s main grievances in the trade war. The Trump administration has accused China of using unfair practices, such as intellectual property theft, to get hold of American tech secrets. The Chinese government disputes the allegations.

The deteriorating relations with the United States may prompt China to step up cooperation on advanced technology with Japan, South Korea, Israel and European countries Kennedy said.

Beijing has been pushing through reforms in areas like intellectual property protection in recent months as it seeks to encourage the development of more homegrown technology, according to Kenny Liew, an analyst at research firm Fitch Solutions.

“The government is doubling down,” he said. “The trade war will definitely accelerate these kinds of reforms.”

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Updated 6:15 AM EDT, Thu October 4, 2018

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Can Xiaomi survive a trade war?

01:39 - Source: CNNMoney

‘China is no longer a cheap place’

China has already come a long way. Over the past 20 years, its giant export machine has shifted away from goods such as clothes and toys toward electronics and smartphones.

“China is no longer a cheap place to produce low-end goods,” said Xu Bin, a professor of economics and finance at the China Europe International Business School in Shanghai.

Chinese companies are “very responsive to changing environments” and tariffs add “an additional force to push Chinese private companies to upgrade,” he added.

China has shifted toward higher-end exports such as smartphones made by companies like Huawei.

Will it open its markets?

The waves of new tariffs are also raising questions about China’s appeal as a manufacturing hub. Companies say they are considering shifting production to other countries to avoid the extra costs, putting pressure on the Chinese government to find ways to offset the damage.

Beijing has long been criticized for restrictive economic policies that shut foreign companies out of large swathes of its economy and favor local businesses, particularly big state-owned enterprises. Chinese leaders insist they are committed to gradually opening the economy at a suitable pace.

The trade war could speed up that process.

Chinese Premier Li Keqiang has promised more pro-business reforms.

Analysts and business leaders have in the past questioned China’s commitment to reforms that make it easier for foreign investors to do business there, but some think it now faces little choice.

“China must open the market,” Jack Ma, the executive chairman of Alibaba (BABA), said last month.

Beijing has already taken a series of steps recently to help the slowing economy, including tax cuts. Premier Li Keqiang last month pledged more pro-business measures.

If that includes allowing greater competition from foreign companies, it could force Chinese companies to up their game and become more productive.

Such changes “will boost the competitiveness of the economy in the long run” and help China to “generate better quality of growth,” said Aidan Yao, senior emerging markets economist at asset management firm AXA Investment Managers.

Julia Horowitz, Serenitie Wang and Joseph Kleinhenz contributed to this report.