2019-02-11
Author: Eric (Tianli) Wen, Head of Research
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Happy Chinese New Year!
A capitalist society produces winners and losers, or it will be a socialist one. The winners will try to persuade the losers their losing is just, until at some point some losers will throw the table and declare it does not matter. The society turns left. A few years later, leftism cannot produce the economic efficiency. The society falls behind in global competition. The right wing takes over.
Such is the story of today for America. In our view, it is also the story of today in China, at a different time point. Trump likes to push through his reform in small clichés. So does Xi. OK, we have been operating at the out-looking sector of the Chinese economy. But we shouldn’t be oblivion to some of the side effects of China’s 40 years of reform, such as income disparity, corruption, environment disruptions and intellectual property thefts, lack of basic research, etc.
The last side-effect illustrates the point that although China does take advantage of the global trade system to leverage its human capital base, the developed worlds, especially America, also benefit from persuading China to adopt American technologies, standards and rules. Decoupling these technologies, standards and rules brings major disruptions to China and represents a key long-term risk despite numerous short term gains. The near death experience of ZTE, the possible sanction against Huawei and the psychological effect on Chinese economy after the US-China trade dispute are all symptoms of this risk.
Xi wants to turn China to the left at a time when Trump wants to turn his country to the right. Xi’s anti-corruption campaign has been swift and decisive. His approaches in South China Sea and Taiwan have been populistic. But now the trade war might overturn his direction to the right. The question is: does Xi really believe in what he is doing? Or he is practical in his actions? Can he separate his personal ambition from his country’s abilities? Is there a correcting mechanism within the Party ? Are there different opinions within the Party?
In our view, despite capitalism produces the highest possible efficiency, periodic left turn is inevitable. A good system must make the left turn as quickly as possible and try to rebalance equality issues during regular times. Therefore, the US-China trade talk represents a major opportunity for the Xi administration to take advantage to move its policy to the right.
The US-China trade negotiation has temporarily entered tough waters
From our angle of observation, there have been two moments when nationalistic outburst in China rallied to take a hard stance against America.
The first moment was in October 2018, when Vice President Pence delivered a speech at the Hudson Institute that is widely perceived as the replay of Winston Churchill’s “Iron Curtain” speech on March 5, 1946. The speech was likely a response to a possible collision of warships between China and America in the South China Sea. We need to make it clear here about our position regarding the South China Sea dispute. China’s claim to South China Sea arose from China’s status as part of the victorious party of WWII against Imperial Japan, in which China suffered a civilian-and-military casualty of 35 mn. At the time Southeast Asian countries were European and American colonies, therefore could not make a claim for themselves for the disputed territory in question. The Chinese territory claim in South China Sea was first adopted by the Nationalist government in 1945 and late inherited by the Communist government in 1949. Today, the same territorial claim is made by the Taiwan government as well. Similar case was handled ambivalently by the global community but in general I agree the disputed area should be returned to the relevant SE Asian nations. The root cause of the South China Sea standoff is China’s area denial strategy against the US Pacific Fleet.
The second moment happened during Chinese vice premier Liu He’s visit to Washington in January 2019, in which the seating arrangement of the press conference made Liu look like being a criminal under interrogation.
Figure 1 Vice premier Liu He appearing to be interrogated by Trump
In the previous Pilgrimages, we have questioned the wisdom and intention of having Mr. Liu act as the chief negotiator. Mr. Liu’s experience has mostly been with the State Council, which means he is a domestic expert on macro matters, but not a practiced expert on foreign trade. Such practice should rest in the Ministry of Commerce (MOFCOM). During China’s last negotiation to enter the WTO in 1999, chief negotiator Long Yongtu held the post of vice minister at the Ministry of Foreign Trade, a predecessor to MOFCOM until 2003. His superior Madame Wu Yi was minster of Foreign Trade from 1991-1999. Premier Zhu Rongji directly oversaw the final negotiation.
We believe some of the reasons lies in Xi’s anti-corruption campaign. MOFCOM minster until 2017, Mr. Gao Hucheng (高虎城), was removed likely due to a corruption probe related to JP Morgan’s offering an internship position to his son in New York. JP Morgan paid US$264mn to settle the case with the US government under the Foreign Corruption Practice Act (FCPA). JP Morgan’s China Head was arrested by Hong Kong’s Independent Commission Against Corruption (ICAC). But this does not explain why after so many rounds of fruitless discussions Liu still holds the spot. In our view, this can only mean one thing, which is that President Xi is predetermined to a certain outcome of the US-China trade negotiation.
We are still optimistic on US-China reaching trade agreement
If President Xi is predetermined to a certain outcome, what outcome can it be? We still think the best possible outcome is to reach a deal. But the question is whether the US is also inclined to make a deal. A deal takes two sides.
We think so. First, the US China relation is a low priority for the American society, as many polls have shown. Honestly speaking it is not worth for president Trump’s time. Second, Trump and his lieutenants understand to keep China in check, foreign trade can only help this much. Eventually US and China must do their own homework well. If Trump’s vision is to reshape the rule of trade for the world for the future, it doesn’t look so right if a protracted trade war with China continues to be blocking the way.
Let the real race begin!
Recently I am studying China’s smartphone industry and I was deeply impressed by Huawei’s astonishing rise, not only in unit volume, but in revenue and ASP.
Figure 2 Global unit volume market share of smartphones
Out study on Huawei shows what Chinese companies are capable of when their global counterparts making mistakes
To put it short, Apple made a mistake. We can illustrate this mistake with the table below.
Figure 3 Key parameter and selling points of flagship models from Apple, Samsung and Huawei
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We know in the late stage of each generation of telecommunication standards, innovation starts to slow. Companies start moving to the directions of (1) aesthetic form factors; (2) business features (as it has the highest profit margin); (3) connectivity features, (4) useless technology marvels, (5) other people’s cakes. Apple did exactly the same. Its innovations in the years of 2015-18 have been: (1) full screen display, (2) biometrics, (3) Apple Pay, (4) Siri, (5) Face recognition, (6) remote battery charging, all of which are good, but largely irrelevant to the end users’problems. Further, Apple releases its product once a year, at a time when the market starting to fragment, like it did in each of the late stages of 2G, 3G and 4G.
Samsung followed Apple’s mistakes. It rolled out quad-edge curved displays, exclusive use of AMOLED screens and iris scanner.
Apple and Samsung overlooked the most frequently-used phone features are getting online, making phone calls and taking photos. It is perhaps not a coincident that Samsung had the 2.5mn Galaxy Note 7 battery recall in 2016 and Apple has been suffering poor 4G modem performance issues since 2016 due to switching from Qualcomm to Intel. And lastly what happened? Social media exploded by moving from text/graphics to photo and videos.
Starting from 2015, Huawei has been focusing on photo taking. It first adopted the three camera setup with two rear cameras, one black-white and one color. The black-white camera is designed to capture the contrast level of the photo scene and combine digitally with the color camera to produce a sharp looking photo. Starting from Huawei P9 in 2016 (Huawei’s 2nd smartphone. The first was a flop), Huawei has been adding one camera per year to its flagship model, until it is rumored that the flagship for 2018 will have four cameras in the back. Samsung did not adopt dual rear camera until 2017 and Apple until 2018 (as Apple only releases new product in September).
Certainly Huawei’s success with its own application processor called Kirin and first incorporation of an NPU (Neural Processing Unit) gave Huawei an edge to claim its phone is AI-based. But Kirin’s NPU isn’t made by Huawei but by Chinese AI startup Cambricon. Nevertheless, The race between Qualcomm’s Snapdragon, Apple’s A-series, Huawei’s Kirin and Samsung’s Exynos processors has been fierce. Huawei is able to refresh its application processor about two times a year, putting pressure on Apple and Qualcomm.
Huawei and Samsung are today only two smartphone companies who can make both the RF modem and application processor by themselves. In a recent court paper released from the FTC-Qualcomm trial, it was revealed 54% of Huawei’s RF modem was made by itself, comparing to 52% for Samsung. Qualcomm only supplied 22% of Huawei and 34% of Samsung. Apple has to rely on Intel’s RF modem which has been a disaster. This showed that Huawei has joined the group of first class in terms of smartphone’s core semiconductors.
Figure 4 A rumored picture of Huawei Mate 30 with 4 cameras in the back (and 1 in the front)
I suspect Huawei did not come up with the idea of photo taking by itself. It was originally the market focus of Chinese phone maker Oppo, which had such focus in as early as 2014. Another technology focus of Oppo is battery fast charging technology, of which the majors also overlooked until recently. From studying Huawei’s rise in smartphones, I do suspect Huawei as a company does competitor intelligence well. By this I mean a compliment. Huawei learns from its competitors and execute relentlessly, combined with deep deposit of decades of core technology pursuit. Huawei pays its engineers well. I found its R&D budget to be 30x of Xiaomi’s and its number of R&D engineer to be 10x. I believe it is very likely that Huawei will surpass Samsung in smartphone shipments this year and pose a serious challenge to Apple if Apple doesn’t put its act together, quickly.
The rise of Huawei illustrates what the new Chinese technology companies can do to their Western competitors when they make mistakes. In the past these Western competitors are beyond reach, even when they make mistakes. The rise of Huawei in smartphones reminds me of what Jack Ma said of eBay in competition with Alibaba, that eBay’s view of Alibaba evolved from cannot-see (too small) to cannot-understand (too strange) and finally tocannot-catch-up (too late).
Chinese does things differently, but it doesn’t mean they do things wrongly
During this Chinese New Year another hot topic galvanized the nation’s attention, China’s first sci-fi film
Figure 5 A post of
We believe US and China will conclude a truce and the full-blown competition of the two will start
I believe this is the best possible outcome. As long as the competition is fair and just, whatever the outcome is unimportant, and likely positive for both countries.
For the outcome of the US-China trade talk, while we maintain positive for the eventual outcome, we have to make sure what we are talking about is the same thing:
- In terms of agreeing on a solution of the tariff war, we believe it will be concluded by C2Q-C3Q19;
- In terms of ending the animosity of the two nations, it will never happen for a while.
Logically speaking, since the tariff action ended so well for the US side, it is tempting to let it roll over to at least see what it happens. For China to persuade the US to not do so, it must offer a concession the US will not get EVEN AFTER the rollover of the tariff action. The trick is “will not get” is a subjective assessment, not an objective one.
We stay optimistic for the future.