Defense Update

On October 4th 2018, Bloomberg Businessweek released a bombshell story on large scale industrial espionage committed by the Chinese security services that has impacted Amazon, Apple and 30 other major corporations. The company at the center of this espionage is SuperMicro, a San Jose based contract electronics manufacturer. SuperMicro is a leading producer of motherboards, and other electronics products. Like many other contractors, SuperMicro subcontracts work to smaller companies when the load of work is to high. The Chinese government has been able to bully and cajole these small subcontractors into allowing the Chinese government to surreptitiously insert microchips the size of a grain of rice that can give the Chinese government access to American national defense and trade secrets. The Chinese government, Amazon and Apple have vehemently denied the accusations, in language that leaves little ambiguity or wriggle room suggesting that Amazon and Apple genuinely believe the story is inaccurate. If these accusations prove true, this would be the largest and most sophisticated cyber attack by China.

The cyberattack needs to be considered in the context of rising trade tensions between the US and China. The US has steadily raised tariffs against China, including $200 billion in tariffs in September of 2018 alone. So far, the Trump administration has arbitrarily applying tariffs to allies and enemies alike. However, there are signs that the US government has a much more focused anti-China approach. For example, the USMCA includes a host of provisions that are squarely aimed at China the most important of which is a provision that any member of the USMCA can withdraw if another USMCA member makes a trade agreement with a non-market economy. The Trump administration has long supported revoking China's status as a market economy, and effectively blocks USMCA nations from signing trade agreements with China without American consent. The USMCA is expected to be just the first step in coalescing according Larry Kudlow "a Trade Coalition of the Willing".

The Chinese economy has so far been able to shrug off the impacts of the US trade war. GDP growth is expected to be 6.8% in 2018, and Chinese exports have grown by more than 10% for five consecutive months (although this may be because of exporters rushing to expedite orders before tariffs take effect). However, these positive numbers mask real weaknesses in the Chinese export machine. Chinese electronics exports global market share soared from 5.9% to 25.8%. However, since 2015, China has actually losing market share against global competitors. Rising wages has seen low cost production move from China to countries such as Bangladesh and Cambodia. Chinese attitudes towards intellectual property has led manufacturers to move facilities to Mexico and Eastern European countries. It is likely rising tariffs will see taiff global value chains shift to countries such as Vietnam, where electronics exports have increased from $4 billion to $107 billion. Increasing Chinese government sponsored espionage is part of a greater move towards interventionism in markets. Access to global markets and strong ties to foreign invested firms has sparked massive growth and innovation by Chinese firms. Economic adventurism such as this type of industrial espionage puts these ties at risk, and does far more harm than short term good.

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