China’s Sputnik Moment?

In 2016, AlphaGo, a computer program developed by machine learning experts in London, beat the world’s top players of the classical Chinese board game Go. It was a revolutionary breakthrough in artificial intelligence: AlphaGo had demonstrated an unprecedented capacity for intuition and pattern recognition. That a Western program had been the first to achieve this AI feat prompted some commentators to declare that China had experienced a “Sputnik moment,” an event that would trigger widespread unease in the country about its perceived technological lag. Indeed, China has had a Sputnik moment in recent years—but it wasn’t prompted by AlphaGo’s victory. Rather, since 2018, tightening U.S. trade restrictions have threatened the viability of some of China’s biggest firms, fueling anxiety in Beijing and forcing Chinese companies to reinvent the U.S. technologies they can no longer access.

The Chinese government has long had twin ambitions for industrial policy: to be more economically self-sufficient and to achieve technological greatness. For the most part, it has relied on government ministries and state-owned enterprises to pursue these goals, and for the most part, it has come up short. In semiconductor production, for example, China has barely crossed the starting line. Rather, China’s private entrepreneurial firms have driven the bulk of the country’s technological success, even though their interests have not always aligned with the state’s goal of strengthening domestic technology. Beijing has, for example, recently begun cracking down on certain consumer Internet companies and online education firms, in part to redirect the country's efforts towards other strategic technologies such as computer chips. This has meant that China’s most impressive technological achievements—building state-of-the-art capabilities in renewable energy, consumer Internet services, electronics, and industrial equipment—have as often been driven in spite of state interference as they have because of it.

Then came U.S. President Donald Trump. By sanctioning entrepreneurial Chinese companies, he forced them to stop relying on U.S. technologies such as semiconductors. Now, most of them are trying to source domestic alternatives or design the necessary technologies themselves. In other words, Trump’s gambit accomplished what the Chinese government never could: aligning private companies’ incentives with the state’s goal of economic self-sufficiency.

A MIXED BAG

The Chinese state has intervened in the economy since the early days of the People’s Republic. In addition to its famous five-year plans, the first of which was implemented in 1953, the government developed several discrete plans explicitly focused on advancing its technological capability. For decades, industrial policy mostly consisted of empty statements. The 1990s, in particular, saw the government issuing a series of industrial policies that functioned as aspirational goals rather than binding targets and, unsurprisingly, achieved little.

As the economist Barry Naughton has noted, the turning point came with the implementation of the government’s “medium- and long-term plan for science and technology” in 2006. In stark contrast to its lackluster execution of previous industrial policies, Beijing devoted substantial financial and administrative resources to the plan. The State Council, China’s highest administrative authority, outlined the development of 16 “megaprojects,” each under the mandate of a designated ministry, and directed $5 billion to $6 billion to these efforts every year—something that had not occurred under any previous policy. Although a few of these megaprojects did make small inroads, the program as a whole spent large sums without appreciably improving the country’s technological capabilities.

As it happened, however, the medium- and long-term plan turned out to be a warm-up exercise for China’s evolving industrial policy. In 2010, the State Council unveiled another initiative, which designated emerging technologies, such as electric vehicles and next-generation computing, as the drivers of economic growth. By then, the global financial crisis had shaken Beijing’s purse loose, and the government began lavishing resources on favored projects. In addition to direct financial support, the Chinese government has helped domestic technology companies through other means—by using government buying power, for example, to increase demand for solar panels.

But the centerpiece of the Chinese state’s industrial planning apparatus is the “Made in China 2025” plan. Announced in 2015, the plan highlights ten high-tech industry segments in which Chinese firms should make breakthroughs, and it sets self-sufficiency targets in striking detail. One advisory document, for example, specifies that Chinese semiconductor production ought to reach between 49.10 and 75.13 percent of the domestic market size in 2030, that domestic industry should master extreme ultraviolet lithography by 2025, and that the country should be producing multicore central processing units for computer servers by 2030. Such specific targets bring to mind the days of China’s planned economy, when the state micromanaged all industrial output.

Made in China 2025 triggered a fierce backlash among many industrialized countries, which were wary of China’s efforts to dominate advanced technology. Having failed to anticipate this reaction, Chinese leaders subsequently tried to dismiss Made in China 2025 as an aspirational planning exercise developed by overly confident academics. But by then, the state had already released a stream of plans focused on advancing select technologies—such as semiconductors and artificial intelligence—as well as enormous proposals for direct subsidies, cheaper access to capital, and investments from public-private funds. Beijing had already showed that it was keen not only to catch up on the technologies of the past but also to dominate the industries of the future—and that it was willing to spend vast sums to get there.

China is now undertaking a whole-of-society effort to improve domestic technology.

What has China really accomplished with these plans? If the country’s recent industrial policy programs had reached fruition, the country would be a technological giant today—but it is not. Chinese tech firms have mastered the production of certain goods, including renewable power technologies, electric vehicles, high-speed rail supplies, heavy machinery, and automotive parts. China is at the fore of 5G network deployment, boosted by Huawei’s strength in mobile networking equipment.

But on bigger-ticket items that are explicit government targets, such as semiconductors and aviation technologies, China’s industrial policy has failed. Long-term programs devoted to semiconductor development have yielded a few modest successes but have mostly resulted in floundering companies that are nowhere near the cutting edge. The Commercial Aircraft Corporation of China (COMAC), China’s answer to Airbus and Boeing, is years behind schedule in its development of a new fleet of planes. China has worked for decades to develop a car brand that can rank among the world’s top automakers—but its car companies have had difficulty producing anything that consumers in developed countries actually want to buy.

Even the success stories require caveats. When Chinese companies master a product, they often end up turning it into a commodity, tanking profits across the board—including for themselves. Chinese companies may dominate the solar panel industry, but the market is so fiercely competitive that few companies make much profit. China may be at the fore of high-speed rail, too, but it has accomplished this by requiring foreign companies to turn over sensitive technologies to potential competitors, embittering many foreign partners. And many of China’s leading companies are still critically dependent on U.S. technologies.

In other words, Chinese central planning has not defied economic gravity and proved that the government knows better than the market. There is a meaningful difference in China between companies that are formally designated as part of the state system and those with entrepreneurial founders: state-owned enterprises, such as COMAC, China Telecom, and China Petroleum and Chemical Corporation, or Sinopec, are not the country’s most globally competitive firms. Successful Chinese firms, such as ByteDance (the company behind TikTok) and DJI (a top consumer drone manufacturer), have grown around the state sector rather than out of it. State-owned companies are insulated from real market competition and treat their private counterparts with jealousy, sometimes wielding state power to squeeze them out of existence. More often than not, reliance on government spending results in lazy firms surviving on subsidies rather than private firms capitalizing on state assistance.

It is true that Chinese industrial policies have had some success. China today is a huge market featuring a growing number of dynamic firms. A large manufacturing base trains many workers to produce sophisticated technologies. China’s enormous size has facilitated competitive state procurement infrastructure, which has hastened some strong technological advancements, as it has, for example, in solar power. But these policies have not propelled China to the lead in foundational technologies such as semiconductors—and the government has had little to do with the direct achievements of China’s largest technology firms. The private Internet giants ByteDance, Alibaba, and Tencent are the only companies that can look upon their Silicon Valley counterparts as peers. In hardware, the entrepreneurial firms DJI, Huawei, and Lenovo are the only Chinese companies developing cutting-edge consumer products.

TOO FAR?

The limitations of Chinese central planning did not stop Made in China 2025 from setting off alarm bells in Washington. In the final week of Barack Obama’s presidency, the White House released a plan to defend U.S. primacy on semiconductors. By the time Trump took office, there was a broad bipartisan appetite to confront predatory Chinese business practices.

Many of the Trump administration’s early actions to that effect made sense. China requires domestic firms to invest in overseas businesses to acquire the technologies they lack at home, a policy that has stoked fears that China could end up owning large chunks of the U.S. technology sector. After the state-owned Tsinghua Unigroup, a semiconductor company, made a brazen bid in 2015 to acquire Micron Technology, the last American memory-chip maker, the Trump administration responded in 2018 by stiffening the process by which it reviews foreign investment in domestic companies. Congress and the White House granted the Committee on Foreign Investment in the United States new authority to block foreign investments in sensitive technology companies. The Department of Justice also channeled more resources into prosecuting the theft of trade secrets. And the Office of the United States Trade Representative detailed China’s unfair economic practices and created the legal basis for tariffs on certain Chinese products outlined in Made in China 2025.

Had the Trump administration stopped there, the response would have constituted an appropriate plan to protect U.S. firms from predatory Chinese practices. But it went much further, putting in place an extensive export-control regime that weaponized U.S. dominance of technologies such as semiconductors to cripple Chinese firms. Because these sanctions deprived Chinese companies of access to American-made components, they threatened the viability of Chinese firms even in their domestic market.

China’s state and its leading firms are working together so that no Chinese firm is at the mercy of U.S. trade policies.

When the Trump administration banned the sale of critical U.S.-made parts to the Chinese telecommunications company ZTE, for example, its operations collapsed as a result. It did the same to Fujian Jinhua, then China’s leading memory-chip maker, which subsequently failed, too. The bloodletting reached its peak in the final days of Trump’s presidency. The U.S. Department of Commerce had by then added the Chinese firms DJI, Hikvision (a video security company), Huawei, and Semiconductor Manufacturing International Corporation (SMIC) to its list of entities that, for national security or foreign policy reasons, have restricted access to U.S. technology. The White House also issued executive orders intended to ban TikTok and WeChat in the United States, but the language was so broad that it might have prevented any American person or firm from interacting with each of their parent companies. 

The White House reserved its most intense firepower for Huawei. The Commerce Department wrote a highly complex rule for Huawei alone, asserting extraterritoriality on all items sold to the company that are based on U.S. technologies, even if they were produced by foreign firms overseas. This restriction has prevented Huawei from working not just with U.S. companies but also with many of its Chinese, Taiwanese, and European vendors, leaving it in a precarious position. Today, the company is unable to procure new components and has been forced to rely on its dwindling stockpiles to sustain operations. Huawei’s smartphone sales are collapsing, and in response, the company has pivoted to far less lucrative low-tech endeavors, such as automotive parts and fish farming technologies.

AN UNLIKELY UNION

Beijing watched with anger as the Trump administration successively labeled its companies national security threats and imposed severe restrictions on them. China’s foreign ministry repeatedly pledged to take “all necessary countermeasures,” while the nationalist news outlet The Global Times promised retaliation against Apple, Boeing, Cisco, and Qualcomm.

But Beijing’s actions have not matched its fierce rhetoric. Far from doing unto Apple what the U.S. government has done unto Huawei, the Chinese government has, for the most part, continued to roll out the red carpet for foreign firms. Tesla, for example, was granted an unprecedented license to establish a wholly owned auto production plant in Shanghai. It is clear why Beijing wants to maintain good relations with U.S. firms: they are major employers in China, continue to provide critical technology, and act as a moderating force against the hawkishness of the U.S. government.

At the same time, Beijing is pushing hard for technological self-sufficiency. Top officials including President Xi Jinping have discussed the importance of improving “indigenous innovation” and gaining control over “chokepoint technologies.” The 2020 Central Economic Work Conference, an annual meeting that sets the national agenda for the Chinese economy, identified advancements in science and technology as the top two economic priorities of 2021—neither of which had ever been discussed independently in this forum before, let alone taken the top spots. Greater state funding will almost certainly follow—far more than the $5 billion to $6 billion spent on Made in China 2025. And for the first time, China’s drive for technological self-sufficiency is being matched by private-sector efforts, thanks to U.S. trade restrictions.

The ripple effects of Chinese technological success will be felt beyond China.

China’s entrepreneurial companies have sometimes benefited from the state’s largess and protection, but they have also worked to keep the state at arm’s length. In order to be truly competitive globally, firms such as Huawei and Alibaba have decided that they need to use the best components on the market, many of which are American made. China’s leading tech companies rely on U.S. technologies to sell some of the best smartphones, computers, and Internet services in the world. A Huawei phone, for example, has a Chinese-designed processor but otherwise uses American hardware in quantities comparable to the iPhone. If Huawei had followed the government’s directives to buy domestic, it would not have become the behemoth it is today, nor would it be suffering so deeply from U.S. trade restrictions.

Leading entrepreneurial firms can no longer ignore the state’s commands to source products domestically, however. Enhanced U.S. export-control measures have made that decision for them and united China’s government and its leading firms in a shared goal: to pursue technological and industrial self-sufficiency so that no Chinese firm is at the mercy of U.S. trade policies. By imposing restrictions on American products, the U.S. government has inadvertently done more than any party directive to incentivize private investment in China’s domestic technology ecosystem.

Washington is right to target Chinese firms that are obvious military actors or complicit in human rights abuses. But the sweeping nature of the Trump administration’s sanctions did not suggest a careful selection process. Rather, they gave the impression that the United States would punish any Chinese company that achieved success. Chinese firms are no longer sure if they can depend on U.S. products—or if they will be added to another opaque government blacklist and face potential collapse. U.S. export controls have already encouraged other foreign firms to exploit anxieties around U.S. sanctions by marketing themselves as more reliable vendors. And they have created a perverse incentive for some American firms to move production overseas in order to maintain access to China’s enormous market.

U.S. sanctions against Chinese technology companies have deeply offended many in China, especially given their perceived arbitrary criteria and severe effects. Many engineers at top companies such as ByteDance, DJI, and Huawei have studied and worked in the United States and were bewildered by claims that their work constituted a threat to U.S. national security. Chinese officials scratched their heads when the Pentagon declared that the Chinese electronics firm Xiaomi had ties to the military; some joked that Xiaomi was in American crosshairs because the company’s founder, Lei Jun, contained the character for “soldier” in his name. Now that Huawei’s phones are difficult to find in stock, every consumer in China knows that U.S. restrictions have started to bite. It is not unusual, these days, to see people on the Beijing subway watching video explanations of the semiconductor supply chain.

THIS TIME IS DIFFERENT

China’s true Sputnik moment has been its realization that it cannot count on the United States to supply its technology—and that it must cultivate domestic alternatives. Washington bristled at Beijing’s ambitions for semiconductor self-sufficiency and then proceeded to punish Chinese companies naive enough to depend on American technologies. U.S. companies are now facing uncomfortable questions on whether they can be counted on to be reliable suppliers. For all the complaints about Xi’s efforts to drive “offensive decoupling,” it is the United States, not China, that is forcing Chinese firms to abandon American products—and now these companies are pursuing domestic self-sufficiency with a vengeance.

The combined efforts of China’s state drive and its innovative industry will accelerate the country’s technological advancement. In the 1960s, integrated circuits were developed when the National Aeronautics and Space Administration was willing to pay any price for technology that could send astronauts to the moon and bring them safely back. Today, the U.S. government is putting Huawei in NASA’s position: a cash-rich organization willing to pay for critical components on the basis of performance rather than cost. Smaller Chinese companies that previously never stood a chance of selling to Huawei are now sought after as vendors, and they receive infusions of cash and technical expertise that will accelerate their growth. Private and state-owned chip manufacturers are ramping up their operations. Once siloed industries now collaborate in the service of tech innovation: the Chinese Academy of Sciences, for example, has begun coordinating regular sessions that bring together math professors and private companies. China is now undertaking a whole-of-society effort to improve domestic technology, specifically around what Chinese leaders think will drive not only economic growth but also geopolitical power.

Is all of this enough to make Chinese industrial policy work this time around? It is likely that in a decade, China will have made greater technological advancements under the U.S. export-control regime than it would have had the United States not forced China’s leading companies to buy from weak domestic firms. Had the United States implemented necessary but measured reforms—strengthening the Committee on Foreign Investment in the United States and prosecuting intellectual property theft—and stopped there, Made in China 2025 would have likely played out in the usual way, with inefficient state-owned enterprises and government ministries taking the lead rather than innovative tech firms.

But this time is different. True, China has big technological hurdles to overcome, including weak basic research, ambiguous intellectual property protections, and excessive bureaucratic meddling. Yet the United States cannot assume that China’s leading firms will stay down forever: companies are rushing to fill the demand that U.S. firms can no longer supply. Chinese firms have to reinvent only certain wheels, with many simply working to recreate technologies that already exist. And no U.S. restriction can change the fact that China is an enormous market loaded with entrepreneurial talent and technical expertise.

The ripple effects of Chinese technological success will be felt beyond China. For one thing, they will shape American politics. A Beijing less dependent on U.S. products will feel less apprehensive about retaliating against American firms, giving it license to respond to perceived affronts. For another thing, technological dominance will shift the Chinese leadership’s calculations on Taiwan. Beijing knows that any armed invasion of the island would prompt U.S. sanctions that could inflict great pain on the Chinese economy. Greater self-reliance would deflate the threat of those sanctions and remove a deterrent against military action.

The economic consequences of Chinese technological dominance on the United States would be no less significant. For the most part, U.S. technology firms have stayed a few steps ahead of their Chinese competition. But they might fall back as their sales dip and as Beijing launches a more powerful drive to replace them. If China comes to dominate semiconductor production in the way it has dominated solar panels, then the United States will have lost its last crown jewel in manufacturing as the products become commoditized and profits disappear.

At this point, no effort on behalf of the U.S. government can deter China’s state from its end goal of industrial self-sufficiency. But Washington can still change the calculations of private Chinese tech companies. Many of these businesses would rather not have to reinvent their tools and find new suppliers and would likely stick with U.S. technologies if given the chance. The United States should therefore roll back its most punitive restrictions on the Chinese technology sector, lest it force some of the most innovative companies in the world to work within their domestic tech ecosystem. At stake is the future global center of technological innovation: Washington should know better than to fuel its greatest competitor.