Build Your Dreams
“Good artists copy, great artists steal.” – Pablo Picasso
The ongoing trade skirmish between the US and China escalated last week when the latter announced it would limit exports of gallium and germanium, two primary inputs into the production of semiconductors, missile systems, and other important military supply chains. The move was in retaliation for the US placing restrictions on sales of advanced semiconductor chips to China. In response to China’s response, the US then announced it may confine China’s access to “cloud-computing services that use advanced artificial-intelligence chips to Chinese customers.” And on it goes.
The affair poses a fascinating question: who has more economic power—the side that dominates the beginning of a complex supply chain, or the one that controls the final few steps of production? In this instance, time frame is everything.
While China has a near monopoly on the current production of the two minerals in question, ramping up new supply outside of its control is rather straightforward, especially with the proper economic incentives and government support. In the case of advanced chips, there is no doubt that the US and its allies control the harder, more value-added steps, which is why China has embarked on a national strategy to forward integrate, investing tens of billions to do so. The race is now on to see which side closes its respective gaps first, and the recent spate of retaliations-in-kind is adding urgency to both initiatives.
Anyone who has competed against Chinese state-owned enterprises (SOEs) will recognize that it is mid-stream in its evolution in the semiconductor industry following an all-too-familiar playbook. To gain a foothold, the country does the dirty work the West finds unpalatable—in this case, the basic mining, processing, and other ecologically damaging steps. Next, it undercuts international competition until near-monopoly status is achieved in as many foundational steps of the chain as possible. Then, it dangles access to its vast consumer market as leverage to force multinational corporations to relinquish their valuable downstream intellectual property, either directly through the formation of joint ventures (JVs) or indirectly through outright theft, threatening to eject any company from its market that dares to protest too much. This is how China has come to dominate the production of rare earth metals, magnets, solar panels, lithium-ion batteries, electric motors, transformers, and countless other valuable goods that make our society work.
Back to that question of economic power—China knows the best answer is one that controls it all.
The automotive industry stands as a prime example of this strategy working to perfection. For decades, foreign vehicle manufacturers were pressed into JVs with local Chinese companies with minimal prior assembly experience—arrangements that jump-started China’s scramble up the complex learning curve. Before long, advanced technologies, ostensibly protected by JV formation documents, began finding their way into 100% domestically owned competitors. In many cases, the domestic producers could mix and match the very best technologies from several foreign companies, adding a powerful synergistic force to the advantage of skipping decades of investment otherwise needed to achieve such expertise from a standing start. With Wall Street pressing Western manufacturers to demonstrate growth on a quarter-to-quarter basis, few were willing to take the risk of protesting these developments. Even if they did, what recourse would they have?
With the ongoing push to mandate the replacement of internal combustion engine (ICE) cars with electric vehicles (EVs) in the name of climate change, China looks set once again to press its myriad advantages to create a domestic winner that can outcompete on the global stage. Almost under the radar, BYD Auto has exploded into the top-selling EV maker in the world. Recent developments indicate an intent to press its many advantages beyond China’s borders. In our view, the consequences of this development and its impact on Western automakers are being substantially underestimated by market analysts. Let’s find out why.