Attacking China’s Tech Companies Will Backfire

(Bloomberg) -- Inconsequential tariffs don't cause trade wars; the U.S. bankrupting China's technology companies just might.

Trade rhetoric between the countries will likely escalate, but the potential bankruptcy of ZTE Corp. after the U.S. banned exports to the company last month could turn out to be the shot that triggers the war. China would likely respond with a strong reprisal against U.S. companies operating on the mainland.

Resulting government actions and reactions could escalate to the point where irreparable damage is done to relations between the two countries. China's economic future is widely thought to depend on its technology sector — and it will not stand idly by as the U.S. decimates some of its most important firms.

To be clear, ZTE is not an innocent victim. The company skirted U.S. embargoes by selling banned goods to Iran and North Korea. After failing to comply with a settlement agreement about the matter and then making false statements to investigators, it received a debilitating seven-year ban on purchasing any U.S. goods.

While a penalty is justified, though, an outright export ban of this magnitude could be viewed as excessive. The demise of ZTE, one of the world's largest telecommunication equipment makers, would deliver a serious blow to China's most critical sector and likely induce President Xi Jinping to retaliate. This could kick off a series of quid pro quos by both governments toward increasingly protectionist policies — to everyone's detriment. Intel Corp., Micron Technology Inc. and Microsoft Corp. are all important suppliers to ZTE.

In this scenario, China holds a distinct advantage. The country's political and legal institutions allow it to quickly and harshly target American companies. The U.S. system, given its various checks and balances, means that President Donald Trump's administration faces higher hurdles in taking similar steps in return.

Three-quarters of U.S. companies doing business in China already feel that they're less welcome than in the past and say their biggest challenge is inconsistent regulatory interpretations and unclear laws, according to a survey by the American Chamber of Commerce in China and Bain & Co. This could significantly worsen.

The knee-jerk response from the U.S. would likely feature tariffs, over which the president maintains the most direct control, as well as limits on Chinese investment in the U.S. through CFIUS, an interagency panel that reviews potential acquisitions for national-security concerns. It's been reported that the U.S. has already opened a similar investigation into Huawei Technologies Co., another major Chinese tech company, and that Trump is considering executive orders banning the sale of Chinese telecom equipment in the U.S.

Broad executive orders, however, may be challenged in court. In addition, tariffs are necessarily limited to what China sends to the U.S.; China can begin to find alternative buyers for its exports to help offset U.S. constraints. China's six largest telecom equipment manufacturers together account for more than a third of global smartphone shipments, led by Huawei at 10.7 percent.

The Beijing trade talks — which are unlikely to bear any meaningful fruit — have captured the headlines. But the front line in the trade war rests in China's tech sector, starting with ZTE's fate.

To contact the author of this story: Michael McDonough at mmcdonough10@bloomberg.net.

To contact the editor responsible for this story: Timothy Lavin at tlavin1@bloomberg.net.

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