U.S. and Chinese national flags fly outside a company building in the China (Shanghai) Pilot Free Trade Zone's Waigaoqiao free trade zone and logistics park in Shanghai, China, on Tuesday, Oct. 22, 2013. The area is a testing ground for free-market policies that Premier Li Keqiang has signaled he may later implement more broadly in the world's second-largest economy. Photographer: Tomohiro Ohsumi/Bloomberg

Since May, Chinese officials have been counselling, cajoling and sometimes outright banning its state companies and government agencies from buying US high-tech goods, while the state press has lambasted America’s tech giants as “ pawns” of the country’s intelligence agencies.

In the shadow of spying allegations being hurled by both sides, high-level talks between officials of both countries at the US-China Strategic and Economic Dialogue (S&ED) got under way on Wednesday. The thorny issue of US corporate access to Chinese consumers will be a key topic of discussion, and the dispute demonstrates just how far apart the two sides are.

So far, say many US businessmen privately, China is just escalating a war of words. But few doubt Beijing’s intention behind them. Following revelations from former National Security Agency contractor Edward Snowden about the US technology sector’s alleged complicity in spying, China has decided to act decisively to buy more locally and rely less on tech giants such as IBM, Hewlett-Packard and Cisco.

Many analysts believe Mr Snowden may have simply given China’s leaders the excuse to do what they have long wanted to do – favour their domestic tech industry. China is the world’s largest exporter of IT goods, but it still lags behind advanced economies in producing high-end products, analysts said.

Washington intensified the quarrel over Mr Snowden’s revelations in May by indicting five alleged Chinese computer hackers on charges of stealing commercial secrets. Beijing, in turn ratcheted up its reaction.

“While I don’t think you can tie each action and perceived reaction together, it does feel like were in a tit for tat environment,” said Andrew Levine, a partner at Jones Day law firm’s New York office who represents Chinese companies in mergers and acquisitions.

This is underscored by Beijing’s decision to ban Microsoft Windows 8 from government computers, while existing users are reportedly being encouraged to switch to a domestic Linux-based operating system. The Chinese government then said it would implement a security review system for high-tech imports, according to QQ Tech, the online news service. Last month, Google was fully blocked, amid sharply critical state-media articles over US tech companies’ alleged co-operation with the NSA.

“This is just part of the business climate here. It can get so political at the drop of a hat,” said one US business consultant in Beijing.

Some analysts have suggested that switching to more locally produced goods has been the Chinese plan all along, even before the US Justice department indictments. Moody’s, the credit rating agency, said this month that China’s move to cut back on foreign suppliers predates the mid-2013 Snowden revelations.

IBM and Cisco both said they had noticed slowing demand from some state corporations in early 2013, following changes to procurement policy which favoured local companies. Both have told investors that Chinese demand may fall. However, IBM has said it has not aware of any Chinese policy recommending against the use of its servers.

While the ultimate aim may be to support domestic manufacturers, there is a question about the capacity of the Chinese technology industry to fill the gap.

Leping Huang of Nomura Securities said Chinese companies can already do most of the consumer electronics that western vendors do, except for high-end chipsets made by the likes of Qualcomm. As for high tech infrastructure, Chinese telecoms groups Huawei and ZTE can replace Cisco’s routers, he said, but It is still impossible for Chinese vendors to substitute for high-end servers made by IBM, storage made by EMC and databases made by Oracle.

But pushing domestic manufacturing and technological learning has long been a key priority for Beijing. Foreign tech companies who want to keep their China market share have been strong-armed into manufacturing more domestically.

This month, China’s tech firm SMIC announced it would be working together with US computer chipmaker Qualcomm to manufacture advanced Snapdragon computer chips domestically, a step which was widely interpreted as sign Qualcomm was seeking to solve a long-running dispute with Chinese anti-monopoly authorities over licensing fees it charges for mobile phone technology.

“This collaboration can be seen as part of the agreement between the Chinese government and Qualcomm with regard to the ongoing antitrust investigation against Qualcomm in China,” Leping Huang, an analyst at Nomura, wrote in a note last week. Qualcomm declined to comment on this interpretation.

Trade of ICT goods

Derek Aberle, Qualcomm’s president, agreed in a recent interview that the high-tech sector has recently become more politicised. “Obviously the relationship between the US government and the Chinese government is very fluid, and a lot of things were seeing from the sidelines are making the relationship a bit more tense historically than it has been,” he said.

Aside from the argument over US tech companies, US trade officials at the S&ED will be trying to push forward negotiations to reach a broad agreement aimed at eliminating trade barriers on high tech exports known as the Information Technology Agreement. No decision is expected to be reached.

Officials said that separate to the ITA, the issue of “forced localisation”, such as government demands to ban US tech imports and favour domestic suppliers, would be addressed at the economic track of the S&ED.

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