China and US: the tech fear behind Donald Trump’s trade war

The ZGC Innovation Center bills itself as a one-stop incubator for the tech start-ups of the American future. Its main facility is in Santa Clara, California, just down the road from the Google and Apple campuses. Its new Boston location is squeezed between two of the world’s most prestigious educational institutions — Harvard University and the Massachusetts Institute of Technology.

As well as abundant office space and laboratories, the centre offers another attraction to ambitious entrepreneurs in artificial intelligence, robotics and other technologies: capital via its investment fund. “Our full incubation and business supporting services in the centre will dramatically speed up your start-up growth,” its website declares.

Yet the incubator could also just as easily be ground zero in a 21st-century innovation war between the world’s two largest economies. Behind the Silicon Valley and Boston facilities is Zhongguancun Development Group, a venture capital fund that originated in Beijing’s technology district and is owned by the city’s municipal government. It is at the sharp end of what has become one of the most neuralgic issues in Washington.

While the headlines about the Trump administration’s trade war with Beijing often focus on raw materials such as steel, aluminium and soyabeans, the underlying motivation of the new protectionist mood is American anxiety about China’s rapidly growing technological prowess.

At a time when the US is engaged in a battle for technological pre-eminence with China, the ZGC project is exactly the sort of state-backed Chinese investment that American politicians across the political spectrum view with scepticism.

“China has targeted America’s industries of the future, and President Donald Trump understands better than anyone that if China successfully captures these emerging industries, America will have no economic future,” Peter Navarro, the White House’s director of trade and industrial policy and a leading China hawk, told reporters recently.

Mr Trump’s most immediate fight has taken the form of US tariffs on $34bn in imports from China that are due to take effect on Friday as part of a squeeze intended to end what the US says has been years of state-endorsed Chinese intellectual property theft. But it is also part of a broader battle against what the White House has labelled China’s “economic aggression”.

Viewed from America, President Xi Jinping’s Made in China 2025 industrial strategy is a state-led effort to establish Chinese leadership in the technologies of the next generation of commerce and military equipment — notably AI, robotics and gene editing.

Many US officials are now questioning one of the basic assumptions about how the American economy operates: its openness to foreign investment. Nathan Sheets, a former Treasury undersecretary for international affairs in the Obama administration, says that when he entered government, he was sceptical of any efforts to restrain foreign investment but left convinced of the need to fight back.

“When I open up my textbook and read about the glories of foreign investment . . . one doesn’t have in mind a government amassing a war chest of several billion dollars and then going into a country to systematically buy up companies and technology,” he says. “As I left the Treasury I was quite concerned about where this was heading.”

While some technology executives extol the potential for co-operation in areas such as AI, the Washington establishment increasingly sees them as central to a growing geopolitical competition.
Chinese investment in early-stage US technology deals

Some US analysts fear it might be too late to take decisive action to prevent Chinese inroads into the tech sector. “We may have missed the gluttony on this already,” says Ely Ratner, another former official in the Obama administration. “The time we really needed this was a few years back.”

The US does not have the infrastructure necessary to properly scrutinise investments, says Mr Ratner, who advised the then vice-president Joe Biden on China policy. For that reason alone a “freeze on Chinese investment makes sense in some industries”.

Chinese entities participated in up to 16 per cent of all venture deals in early-stage technology companies in the US between 2015 and 2017, a sharp increase in the previous years, according to Michael Brown and Pavneet Singh, industry experts working for the Defense Innovation Unit Experimental, the Pentagon’s Silicon Valley outpost. Between 2010 and 2017, China participated in 81 AI financings in the US which raised $1.3bn, and $2.1bn of deals in augmented reality start-ups.

Neither the Zhongguancun Development Group nor its US arm, ZGC Capital, responded to requests for comment. But on its website the Chinese parent company is open about the purpose of its overseas ventures.

“Following with national strategy ‘the Belt and Road Initiatives’ . . . ZDG is actively [expanding] its overseas business,” it says, citing Mr Xi’s global development strategy. The goal is to “learn overseas experience of [an] innovation ecosystem”.

The model is akin to that followed by a growing number of Chinese tech companies and funds that have turned up in places like Silicon Valley looking to absorb knowledge and start-ups, says Brewer Stone, a partner at boutique investment bank Nfluence, which specialises in US-China tech investments.

“Much of it is just commercial investment . . . Their number one interest is in finding good quality companies to invest in and earn good returns,” Mr Stone says.

Many Chinese investors are looking for companies that can help their growth plans in China. But occasionally he has detected what in hindsight can seem like odd co-ordinated behaviour. A few years ago, Mr Stone says, he received three or four calls in one month from Chinese companies wanting to invest in businesses that were suppliers to tech titan Apple. “It implied that there could be some kind of co-ordination behind the scenes, although obviously I don’t have proof of that.”

While many in Washington look with growing suspicion on Chinese tech investments, there are no shortage of American companies eager for the funding — especially those that are looking to gain entry into a tricky but very large market.

Formlabs, a maker of industrial 3D printers based near Boston which counts former Google executive chairman Eric Schmidt among its early investors, recently set out to raise capital with one goal in mind: attracting investors who could help it crack China.

The result, announced by the company in May, was a $30m investment from a group that included Shenzhen Capital Group, a venture capital firm launched in the late 1990s by the southern city’s municipal government.

The new investors did not gain any board seats or secure access to any of its intellectual property, says chief executive Max Lobovsky, who founded the company in 2011 with two fellow MIT graduates. But they did bring promises to help Formlabs increase its “strategic ties” to China and relationships with potential customers and suppliers. “Those were really valuable things they were offering. That’s why we wanted to do it with them,” he says.

Even though Mr Trump’s focus on Chinese technology has strong bipartisan support in Washington, its tactics have been heavily criticised. The biggest blunder, many critics argue, has been the Trump administration’s willingness to wage concurrent trade wars. The IP-driven tariffs push against China has been accompanied by one that has hit allies such as Canada and the EU that might have joined a fight against Beijing.

Mr Trump has already backed down on some of his own threats of tough measures. An initial plan called for the US to impose tough restrictions on Chinese investment in key sectors such as AI and robotics and curb exports of “industrially significant” products — a rollout of the measures had been expected on June 30.

Instead, the administration decided last week, to defer to pending congressional reforms of the Committee on Foreign Investment in the US. The inter-agency committee scrutinises foreign acquisitions of US businesses for potential national security threats.

Administration officials insist the Cfius reforms will give it wide latitude to block Chinese investments as needed, something it has been doing with increasing rigour in recent years. But to many the softer approach announced by the administration amounted to a strategic capitulation.

“It just reinforces that this is the gang that can’t shoot straight,” says Rob Atkinson, president of the Information Technology and Innovation Foundation, a think-tank. “If I were the Chinese I’d think this is a pretty good thing . . . This is a battle that if it is not won in the next year it’s too late. This is our [Washington’s] last chance.”

The Trump administration, critics like Mr Atkinson say, has also blundered through other important recent episodes. When the US commerce department earlier this year banned ZTE, the Chinese handset and telecoms network equipment maker, from buying US chips and other components over the violation of US sanctions on Iran and North Korea, it in effect put the company out of business.

However, Mr Trump subsequently bowed to a request from Mr Xi to become involved in the ZTE case, tweeting that the ban meant “too many jobs in China lost”. His intervention led to a lifting of the ban and the adoption of a plea deal that was not only seen as a major concession but also left allies — being targeted at the same time with tariffs — bemused.

“We’re treating the Chinese better than we are treating our friends,” says Derek Scissors, a China expert at the conservative American Enterprise Institute, who sees the tariffs Mr Trump is threatening against European car imports as a similar bit of malpractice. “We’ve now got this threat looming in the distance over our allies that is far worse than anything we are doing to the Chinese. We really have lost the plot on who is causing our trade problems.”

Formlabs’ Mr Lobovsky worries that the efforts by Mr Trump and others to increase scrutiny of Chinese investment might discourage investors or thinly staffed start-ups from considering deals, he says. He also sees what looks to him like an industrial policy that could backfire by blocking US companies from interacting with dynamic counterparts in China, or being able to do business there.

From his vantage point the current protectionism seems short-sighted. In 3D printing lies a future for supply chains that might eliminate the need for companies to produce in low-cost countries like China. If that were to happen it could move the manufacturing that Mr Trump is so eager to repatriate one step closer to home.

“The Trump administration should focus on making our economy and tech industry stronger,” Mr Lobovsky says. “If everyone is so worried about Made in China 2025 why don’t we do Made in USA 2025 to compete?”

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