America’s last venture capitalist in Beijing: Here are the strategic miscalculations undermining America’s tech competition with China

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On October 10, the Biden administration announced a series of sanctions aimed at cutting off the flow of American talent and equipment to China’s semiconductor industry. The policy marked a significant departure from the administration’s initial forays that sought to expand American leadership in the industry via funding grants, such as the $100 billion CHIPS and the Science Act.

The latest actions make it clear that the United States believes it must couple defensive and offensive actions to “maintain as wide a lead as possible” over China, as National Security Advisor Jake Sullivan has described it. What is becoming clear, however, is that Americans have already lost the initiative in many key technology areas.

Since 2017, the US government has pursued a strategic “decoupling” whereby US economic and technological systems were to be disentangled from China. Many of the resulting sanctions, particularly against China’s tech industry, foreshadowed those now being taken against Russia.

Putin’s descent to global pariah status has been a long time coming – yet the effectiveness of these sanctions has exposed the unintended consequences of China sanctions. As one of the last American VCs in China and the son of the US Air Force pilot who flew Henry Kissinger to Beijing, I saw firsthand the nuance of our relationship.

To be clear, the US-China relationship is experiencing significant tensions. However, China is not Russia.

For starters, decoupling has pushed China further toward technological self-sufficiency, highlighting China’s technological vulnerabilities and providing a window to close those gaps. The effectiveness of future sanctions will be reduced compared to those currently imposed on Russia. This divergence will not only be the result of the size and sophistication of the Chinese economy, but also because America has given China years of lead time to prepare.

Sanctions against Russia have been significantly increased precisely because America still controls Russia’s digital rails (operating systems and app stores). The US policy of decoupling has unnecessarily made China fully aware of these vulnerabilities, prompting the Chinese to protect themselves and ultimately expand their commercial and political influence.

In the field of semiconductors, massive human talent, private and public capital, and regulatory support are enabling China to move up the evolutionary ladder of chip development. A recent report claims that SMIC took only two years to go from 14nm to 7nm, faster than TSMC and Samsung, without the most advanced production equipment.

The history of unilateral American material sanctions against the Chinese is not a good one. In the 1990s, we decided to cut off China’s access to US-made satellites. Other nations rushed to fill the market void. Today, China consumes around 40% of the world’s chips. The Dutch, Koreans and others will hate to give up this market to match US sanctions. A former senior National Security Council official recently told me that even typical Chinese hawks such as Japan and India question the logic of recent US action, which may actually trigger a stampede from other countries. to design American products as quickly as possible, so as not to fall under the sanctions. The net effect here is clearly “self-harm”, as a former senior NSC official told me this week.

Sanctions on China have also impacted America’s ability to win hearts, minds and wallets around the world. Decoupling actually encouraged Chinese dominance in other battlefield markets by forcing Chinese technology to take over app stores, hardware, and operating systems that were historically ceded to the Americans.

In 2019, Google forcibly removed its operating system and app store from Huawei phones after the US Department of Commerce added the Chinese company to its list of trade restrictions. By 2020, Huawei has announced that it will use its in-house built HarmonyOS on all its hardware and seek to replace Google Play Store with its own AppGallery.

Once US-controlled app stores are removed from phones in emerging markets, Chinese companies will be able to pre-load or provide exclusive access to Chinese apps, rather than US competitors. Imagine that a Huawei, Xiaomi, Oppo, Vivo or Techno user in Africa can only access Didi affiliates instead of Uber, Alipay mobile payment partners instead of PayPal, e-commerce platforms affiliated with Shein instead of Amazon, TikTok instead of Facebook, Youku instead of YouTube, iQiyi instead of Netflix, etc. Chinese companies control 78% of the African feature phone market and supply nearly 70% of Africa’s 4G networks. A significant segment of the African market now uses mobile interfaces which could potentially rule out US-built apps. Aside from Samsung, there is no global handset alternative (whether smartphone or feature phone) to Chinese-made hardware.

China’s growing technological independence has also transformed US-China competition around the world. At a time when goodwill and economic ties are changing exponentially through digital connectivity, decoupling hinders America’s strategic relationship with countries and global consumers, as it forces them to make a binary decision about technological partnerships. Pushed by America to choose sides, many key emerging markets could choose to work with China.

To understand the growing power of Chinese competition, look no further than TikTok. Since entering the US market, TikTok has exploded as the dominant social and entertainment platform. In 2021, Americans spent an average of 25.6 hours per month on TikTok. This eclipses the average time spent by Americans on TikTok’s competitors: Facebook (16.1 hours) and Instagram (7.7 hours). Only YouTube came close to 22.6 hours per month. Who did Netflix name among its most formidable competitors in a letter to shareholders? ICT Tac. Although TikTok and Netflix offer different products, they compete for the same thing: your attention. Time (or to be more precise, screen time) is over. Netflix has a production budget of $10 billion. TikTok users generate its content for free. The more time users spend on TikTok, the less availability there is for other forms of socializing or entertainment.

TikTok is not just a threat to traditional American social media, entertainment and news platforms. Google’s undisputed dominance as a search engine for two decades is eroding, as TikTok’s native search capabilities become GenZ’s go-to hub. The company is now expanding into e-commerce and logistics, threatening American giants like Amazon.

The true cost of miscalculation

TikTok’s growing dominance is emblematic of the advantage Chinese technology has over its American counterparts in the global competition for users. The dominance of Chinese models is not only motivated by the lowest production costs. Core technological innovation is what drives it, especially when it comes to TikTok’s highly addictive algorithmic recommendation engine.

In 2018, I hosted a dinner with Peter Thiel and Zhang Yiming, the founder of Tiktok’s parent company, Bytedance. When our Chinese interviewees asked Thiel about Facebook’s recent lack of innovation, he brought up a content partnership with Major League Baseball. Zhang laughed. After years of being told that Chinese technology was only capable of copying the American giants, this moment must have seemed justified. It was probably as rewarding for Zhang as when Facebook’s TikTok knockoff called Lasso (where Thiel was previously a board member) crumbled and crashed in just under two years.

America’s tech giants have been effectively insulated from competition since the mid-2000s. Their near-monopoly position — and the rent-seeking it once allowed — has made them complacent.

Chinese technology can now challenge Silicon Valley in a growing number of areas. Models popularized in the Chinese market pose a challenge for American technology, especially in emerging markets. There are hundreds of other apps built, funded or inspired by China that share TikTok’s voracious ability to cling to consumers’ minds and wallets. In addition to TikTok, e-commerce platforms such as Shein and AliExpress, short-form video app Kuaishou, and various Tencent-owned gaming companies (like Fortnite) have a combined global customer base in the billions.

US policy toward China must not turn into a self-defeating prophecy. We are not locked into a zero-sum dynamic. As the world’s two largest economies and strategic powers, America and China still have much to gain from cooperation.

There is no way to solve the great global challenges of our time (reversing climate change, managing pandemics, nuclear disarmament, avoiding the global financial crisis) without the direct collaboration of China. If Russia resorted to the use of tactical nuclear weapons in Ukraine, no other nation could play a more central role in averting World War III than China. Decoupling is the wrong political choice to deal with these multiple and complex tensions.

Worse still, the loss of China as a market and increased zero-sum competition with China will reduce economic opportunities for American companies and cloud American growth prospects. We will miss globalization when it is gone.

Ben Harburg is the Managing Partner of global investment firm MSA Capital.

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