One world, two systems? From semiconductors to artificial intelligence, China is loosening the US’s grip on the global technology industry. It is a development that investors view with a mixture of hope and trepidation.
Their worry is that an intensification of Sino-US rivalry could plunge the world into a tech Cold War, creating an entangled web of technological standards and ushering in a period of geopolitical instability.
But competition from China could deliver a positive outcome. History shows that rivalries can serve as a powerful spur for human ingenuity. Just as the US-Soviet space race in the 1970s led to numerous scientific and engineering breakthroughs, competition between the US and China could deliver a renewed burst of technological progress. That would be positive for global productivity.
It is indeed in the interests of China and the US to find common ground. The two economies are too interconnected: total traded goods between them – imports and exports – are worth more than half a trillion US dollars.
But even under this more positive scenario, not everyone stands to benefit. China’s inevitable rise will bring an end to US tech hegemony and the exceptional profitability that American tech firms have enjoyed in the past decade.
This will have implications for investors. Capitalising on the tech industry’s next phase of growth will require venturing beyond Silicon Valley. A little less US, a little more Asia.
Technonationalism: inching closer
The tech battle has been brewing for some time. In 2015, China unveiled an ambitious blueprint to develop high-tech industries to reduce its dependence on foreign – and especially US – technology.
Under what was previously known as its “Made in China 2025” programme it hopes to become 70 per cent self-sufficient in several tech-related industries, such as electric cars, next-generation information technology and telecommunications, advanced robotics and artificial intelligence.
Yet it is China’s ambition in semiconductors that worries the US most. Not only do US chip firms employ more than 200,000 Americans, but they also wield enormous market power. Their semiconductors are the backbone of every electronic device – from laptops and smart phones to electric cars and factory robots.
Currently, US chip firms have a 47 per cent share of the global market. By contrast, China accounts for about 60 per cent of world demand while its homegrown suppliers can barely meet a third of what it needs.
But the landscape is changing fast. When combined, the market share of China, Taiwan and Korea now stands at 30 per cent, compared with just over 20 per cent a decade ago [1].
China recognises that chip self-sufficiency will not come cheap. It understands that investing heavily in research and development is essential if it is to produce state-of-the-art semiconductor components. That is why it has unveiled a new USD 29 billion investment programme to develop the domestic chip industry.
The surge in semiconductor-related R&D testifies to the benefits of competition. Rivalries are, after all, an essential element of a dynamic economy. The challenger, armed with a strategic vision, brings much-needed investment and confronts lazy thinking. The incumbent, meanwhile, is forced to address long-neglected problems and increase research budgets, too.
The semiconductor industry is not the only market where China is asking difficult questions of its rivals.
China’s R&D expenditure – a good proxy for tech-related spending – has more than tripled in the last 20 years to 2.1 per cent of GDP in 2018 [2].
- On a purchasing power parity basis, its R&D spending is almost on a par with that of the US.
The US is beginning to mount its response, but it has to move aggressively, and quickly. Federal research spending has declined to 0.8 per cent of GDP from 1.2 per cent in the late 1980s, when the government gave generously to institutions like Stanford University to help build Silicon Valley.
If the US raised R&D investment to a level that matched China’s, that would be a welcome development for a world economy whose productivity is suffering as its working-age population dwindles.
Academic studies have found that the benefits of R&D investment extend well beyond both the firms and industries that incurred such expenditure in the first place. A discovery made by one firm, sector or country can lead to new avenues of research, inspire new projects or find new applications. The social rate of return can be as much as seven times as large as the return on investment in equipment and services that support R&D [3].
R&D spending can boost productivity by improving the quality of existing goods or reducing production costs. Another benefit is the spill-over effect. Studies show that other countries can also boost their productivity by trading with those that have large “stocks of knowledge” from their cumulative R&D activities [4].
Tech race: key battlegrounds
Thanks to China’s world-changing ambitions, competition is intensifying in several key areas of the tech industry:
5G: Next-generation mobile phone networks are the new frontline in the battle to control global information technology infrastructure and set international standards. With pandemic-induced lockdowns stretching data capacity to its limits, 5G tech has taken on greater global importance. China’s Huawei, which has a 30 per cent share of world telecoms equipment, has taken the lead in the global roll-out, but has since faced a clampdown in the US. In response, Huawei is developing an alternative supply chain with rival firms such as Taiwan’s MediaTek.
Cloud computing: This market is growing nearly 20 per cent annually to be worth USD 661 billion by 2024: Behemoths such as Amazon, Google, Alibaba, Tencent and Microsoft are vying for dominance [5]. Each sees Asia as the main engine of growth. In aggregate, they have increased their data centre footprint in the region by almost 70 per cent over the past three years [6].
E-commerce: The COVID lockdown encouraged millions of people to embrace online shopping. That was especially the case in China, where e-commerce represents more than half of total retail sales, compared with just over 10 per cent in the US [7]. China is said to be “a good four or five years” ahead of where the West is in terms of logistics and digital commerce and retail [8]. China’s advantage here lies in the sheer scale of the mobile ecosystem – a population of 1.4 billion – which integrates everything from online shopping, messaging, gaming and digital payments in one app. What is more, Chinese firms are better positioned than their peers in the US and Europe, where growing concerns about misuse of personal data and anticompetitive practices could lead to greater regulation.
Artificial Intelligence: AI represents one of the biggest commercial opportunities, poised to provide USD 15.7 trillion of global economic growth by 2030 [10]. Already home to the world’s largest AI companies, Baidu, Tencent and Alibaba, China filed more than 30,000 public patents for AI in 2018, a roughly 10-fold jump in five years and about 2.5 times more than the US [9]. The US, meanwhile, is doubling its AI R&D spending in the next two years from the current USD 974 million.
Europe should not be written off as a mere observer in the global tech race – the region also vies for a slice of the pie. Specifically, Europe is launching Gaia-X, a new joint cloud initiative among some 100 leading companies and organisations to challenge the likes of Amazon and Alibaba on data infrastructure. The UK is also home to big chip companies such as ARM.
If China and the US find a way to co-exist as global tech powers, the next decade promises genuinely exciting technological advances.
Tech may seem ubiquitous to those who live in the digitalised world, but less than 60 per cent of the world’s population has access to the Internet. What is more, cloud penetration stands at a paltry 20 per cent, while only 12 per cent of the global consumer spending of USD 24 trillion takes place online.
For investors, this new world order will throw up new challenges. To capitalise on tech’s long-term growth potential they will need to look further afield. They should cast their net beyond the familiar – and increasingly expensive – companies in Silicon Valley and allocate more of their capital to rapidly growing businesses in other hotspots, such as Asia.
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Notes:
[1] Semiconductor Industry Association 2020 Factbook
[2] European Commission
[3] Lichtenberg, F., R&D Investment and International Productivity Differences, NBER Working Paper No. w4161
[4] Hall, BH., Mairesse, J., Mohnen, P., Measuring the returns to R&D, Handbook of the Economics of Innovation, vol. 2
[5] Compound Annual Growth Rate between 2019 and 2024. Source: GlobalData
[6] FT, Synergy Research
[7] Marketer
[8] Michael Zakkour, New Retail: Born in China Going Global
[9] Nikkei Asian Review
[10] PwC
Information, opinions and estimates contained in this document reflect a judgment at the original date of publication and are subject to risks and uncertainties that could cause actual results to differ materially from those presented herein.
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