The Implications of Digital Isolationism

Jack Ablin Market Commentary

Ever since the advent of the Internet, the World Wide Web has truly spanned the globe, fostering cross-border communication ranging from political discourse to lip sync videos and helping to bring the world closer together. Free speech, as we know, means different things in different countries, particularly in Communist-controlled China. The Great Wall of China, built during the Ming Dynasty beginning in the 1300s, has given way to the Great Firewall of China. This modern virtual edifice was erected during the paramount leadership of Xi Jinping and Hu Jintao to block access to US internet services, like Google and Facebook, and filter news and other information that enters China, including pro-democracy and human rights content. These restrictions, while serving the larger ideology, has fostered a homegrown tech industry that in recent years has begun to expand beyond China’s borders. Companies like Alibaba, Baidu and WeChat would probably not have prospered had they been forced to compete head-to-head with Amazon, Google and Facebook.

Now, a tech backlash against Beijing appears to be underway. President Trump last week threatened to ban two popular Chinese social media apps, TikTok and WeChat, in the latest round of US-China tension.  This move is a follow on to Washington’s efforts to limit the access of Huawei – the world’s biggest maker of smartphones and networking equipment – to US chips and other technology. Lawmakers, citing security concerns, also barred US government funds from paying for Huawei equipment in US networks. The United States has pressured its allies to follow suit; the United Kingdom recently blocked Huawei equipment from going into its networks.

As China and the US go their separate ways in the online technology arena, there’s speculation that the World Wide Web could wind up no longer being truly worldwide. Any move to bifurcate the Internet would make it more difficult for Chinese technology companies to succeed outside China. Putting up electronic barriers between countries threatens economic and political harmonization, as nations retreat to their ideological blocs.

The battle between US and Chinese tech superpowers is playing out in India, a market of 1.4 billion people. Chinese tech investment in India, led by Alibaba and Tencent, has totaled $4.3 billion since 2017.  Among India’s top 10 unicorns – start-up companies worth over $1 billion – seven are backed by a Chinese strategic investor, while only one was funded by a US counterpart. From a technology perspective, China is looking to achieve in India what it did at home. However, it suffered a setback in its quest in June when a border skirmish between the two countries left 20 Indian soldiers dead, threatening to ice their bilateral trade relationship. New Delhi responded by banning 50 Chinese mobile apps, including TikTok, on national security grounds.

American technology giants, eager to fill the void, have stepped in. Last month, Google pledged investment of $10 billion in India. The company recently announced taking a $4.5 billion stake in Jio Platforms, a fast-growing digital business launched in April with a $5.7 billion investment from Facebook. Google Pay has emerged as the biggest digital payment provider in India.

Disentangling US-China supply chains and trade relationships will prove both difficult and costly.  Escalating US-China tension on top of coronavirus-driven production challenges will force US technology supply chains to evolve over time, according Fitch Ratings. Supply chain changes that lead to less reliance on China and greater US production of core semiconductor components could have significant credit implications for the sector. Costs would rise and substantial capital investment would be required, with returns being delayed due to the time required to build infrastructure and amass highly skilled manpower. At the same time, China represents an enormous market with an estimated 140 million households, or 400 million people, in today’s middle class. The country has wielded its economic power of persuasion by cutting off imports of beef and barley from Australia in response to that country’s government calling for an investigation into the origins of the pandemic. Consumer giants Apple and Nike, who reap billions in revenue selling into the Chinese market, would be particularly vulnerable to a retaliatory strike by Beijing. The smartphone maker also relies on China’s manufacturing capabilities, and garners nearly 20 per cent of its $270 billion annual sales from the Greater China region. Chip companies, like Nvidia, Texas Instruments and Qualcomm, depend on China for between one quarter and one half of their revenue.

Meanwhile, China continues to innovate. The country has written most of the international rules and standards surrounding fifth-generation (5G) wireless, alarming US policymakers. The perceived threat has prompted a proposed decoupling of Chinese tech companies and American businesses. Devolving relations could result in a “VHS vs Betamax” 5G war. China aims to seize the initiative in dictating standards development in order to give Chinese communications companies an edge in developing chips and software for 5G phones.

Here at home the kindness of foreigners cannot be overstated, making isolationism impractical. The US has been a beneficiary of globalization over the last several decades, enabling the country to grow without inflation. The interconnected nature of global finance has facilitated the purchase of nearly $7 trillion of US Treasury debt by foreigners, with Japan and China each holding more than $1 trillion each.  The US current account deficit, which reflects the combined balances on trade in goods and services and income flows between US residents and residents of other countries, typically runs over $100 billion per quarter.

Despite our countries’ differences, Chinese and American investors have managed to peacefully invest bilaterally. Ongoing issues remain, data security chief among them. China’s history of spying on its citizens is widely known. US companies like Google have in fact facilitated Chinese government surveillance. It isn’t a stretch to image that allowing Chinese companies access to the personal data of Americans citizens would pave the way to wider surveillance. Capitalist democracies protect intellectual property rights but centrally planned, Communist countries do not. Intellectual property (IP) protection was a hot-button issue between Washington and Beijing long before the tit-for-tat TikTok ban. The IP issue represents table stakes in maintaining trade relations. Data security is a thornier topic that, like spying, requires a “trust, but verify” solution. Simply put, Communism and capitalism don’t mix.  Ultimately, China’s overbearing political system will stymie Beijing’s capital aspirations.

In the recent years, government-controlled investments have benefitted China, for example in alternative energy innovations, like solar, which couldn’t justify their economics from a near-term profit perspective. Beijing’s willingness to look beyond a quarterly profit cycle propelled them as an industry leader in solar power, helping lower generation costs by 80 per cent. US policymakers, hamstrung by entrenched interests, were not able to get that industry off the ground.

Like most sciences, technology and innovation require one part cooperation and one part competition.  Tech isolationism comes with costs, as competing standards vie for customers. When deciding to purchase their first computer, customers were forced to choose between a PC or a Mac. Left-brain users opted for PCs while MACs captured the right-brain market. The advent of the Internet and the Cloud enabled both standards to work effectively with each other. The world is too technologically interconnected to break into ideological blocs. We should build common technology platforms, not firewalls.


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