How Trump Understands China’s ZTE Better Than Congress Does

The U.S. Congress was not impressed. They were not impressed by the latest lift on ZTE ’s ban from buying American technologies, even with strings attached. They were not impressed that ZTE is required to pay a $1 billion fine, plus another $400 million in suspended penalty money, and is forced to replace its board and executive team within 30 days and to let the U.S. handpick a permanent compliance team embedded inside ZTE. They were not impressed by ZTE chairman’s acknowledgment of “problems in our compliance culture” and his vow for no more compliance breaches.

“We are literally embedding a compliance department of our choosing into the company to monitor it going forward,” defended Commerce Secretary Wilbur Ross. “This is a pretty strict settlement. The strictest and largest settlement fine that has ever been brought by the Commerce Department against any violator of export controls.”

Still, it was said an “overwhelming majority” of the Senate, including the Republicans, was “united against” Trump administration’s efforts to end the ban on China’s ZTE. “He may have unified virtually every United States senator to make sure that we stop this effort,” said Sen. Mark Warner (D-Va.), calling it “an awful, awful deal.”

What’s awful about ZTE for the lawmakers is not only about violating sanctions by re-selling American technologies in Iran and North Korea. But ZTE, like Huawei , poses national security threats. It was thought that hostile foreign powers, such as China, can build a “backdoor” into the U.S. network through routers, switches, and then inject viruses and malware to steal Americans’ data and to spy on U.S. businesses.

What is being misconstrued here is the belief that the epicenter of innovation begins in the United States. People believe that China, as well as a large part of Asia, are copycats who only beg, borrow, and steal. It is not that simple.

Take Apple AAPL -0.4%, the world’ biggest export company, with sales of $200 billion in 2017, which have led the Dow Jones Industrial Average through the longest stretch since the recession, and a company on which every pensioner who invests in the stock market directly or indirectly depends. The central processor inside an iPhone is designed in the United States, but its battery, displays, and most of its other parts are made somewhere else. The iPhone has hundreds of components, and approximately 90% of which are produced with the help of workers in Germany, Singapore, South Korea, Taiwan, China, and elsewhere. Thus, when I asked Siri—the virtual assistant—where she’s from, I was told: “Like it says on the box… I was designed by Apple in California.” On the back of my iPhone, a second line reads, “Assembled in China.”

The manufacturing of the central processor, or the brain of the iPhone, happens in three stages—design, wafer fabrication, and assembly. In the 1960s, the United States started to send low-skilled assembly to Asia. Skilled wafer fabrication followed in the 1980s, and within the last decade, some of the most complex design works have also moved overseas, mostly because of the sheer size of engineering talents abroad. TSMC in Taiwan and Samsung in South Korea, for instance, are the critical component suppliers to IBM, Apple, HP, and Dell. The point is, technological advances that have fueled the rise of our laptops, smartphones and self-driving cars hinge on this very global supply chain.

So, who’s the biggest winner in the rise of computing power, supported by this intricate network of foreign suppliers? Corporate America. Kenneth Kraemer from UC Irvine together with two other researchers from UC Berkeley and Syracuse University estimated that from an iPad sold for $499, Apple captures about 25% of the sales price as income, while LG and Samsung, through supplying display and memory chips, account for 7% of the retail price. Since China only provides manual labor, an estimated $25 is spent on the Chinese workers. In other words, while each iPad sold in the U.S. will add about $250 to the trade deficit (the import factory cost declared at customs), the value captured by China from an iPad sold at $499 is “at most about one-tenth that amount, and probably less.” That may be why Warren Buffett loves Apple. “We bought about 5% of the company. I’d love to own 100% of it.”

The reason why the global supply chain disproportionally leans in favor toward Apple or American companies, but not others, can be in part explained by the way it is structured. The regulatory governance through U.S.-style administrative law, demands transparency, participation, reason giving, and review in administrative decision-making.“If we don’t write the rules, China will write the rules out in that region,” former president Obama once said. It is a governance that encourages Western companies to innovate and thus avoid being caught up by copycat competition, and in the process, to capture value and generate wealth.

The danger of the Senate’s current position is that in the pursuit of retributive justice over ZTE, they would inadvertently dismantle or disrupt the global supply chain, and in the process, stun technological innovation in the IT sector. The alternative of shutting down or killing off a key player of an industry by fiat, is of course, direct engagement: Put your own people inside your adversary and monitor what they are up to. That’s evidently what Trump proposed in the case for ZTE. In this regard, Congress seems to know less about the nature of the global IT industry than the president.

Originally published on Forbes.


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