The China technology challenge

The China technology challenge

In January, Chinese company DeepSeek stunned financial markets with the release of its generative artificial intelligence model R1. It matched the efficacy of market leading US firm OpenAI’s most advanced models but was produced at a fraction of the cost. 

• The DeepSeek announcement is one in a series of recent developments that mark a new stage in China’s economic evolution.

• Over the last four decades economic reform and China’s entry into the global trading system has transformed China’s economy and raised it from low to upper middle-income status. There has been a sea change in the research and development capabilities of China’s universities and domestic companies, with Chinese businesses now on par with world leaders in several sectors.

• From being the workshop of the world, known for manufacturing basic goods at low-cost, China has evolved into a producer of technologically complex goods from computers and telecommunications equipment to electric vehicles, machine tools and drones. Western incumbents in high value-added sectors are facing increasing competition from China.

• Take EV batteries. Many modern ones are based on Lithium Iron Phosphate (LFP) technology, which originated in the US in the nineties but was largely ignored by manufacturers, given meagre short-term returns and doubts over its effectiveness. It was Chinese battery companies, especially CATL, that directed research towards this technology and made transformative refinements. CATL now accounts for about 40% of the global market for EV batteries. Just last month, CATL announced its Shenxing 2 LFP battery that delivers a range of 520km with just five minutes of charge.    

• UK reviewers have been impressed with the latest crop of Chinese cars. Autocar has said, “Chinese models are up there with the best in the business” with the Xpend G6 model described as a “credible Tesla Model Y rival, with an upmarket interior, decent ride quality and a price advantage over the American EV”.  Commenting on the market for small electric cars Topgear concluded, “When you dig into what the [Chinese-made] MG4 does for the money, it's probably the only car in the class to recommend”.

• Chinese companies have become world leaders in the markets for batteries and solar panels. But how innovative are they across other advanced industries?

• To answer this question, the US Information Technology and Information Foundation (ITIF) conducted a 20-month investigation of Chinese industrial capabilities in ten advanced technology sectors, from robotics and chemicals to biopharmaceuticals and nuclear power. Their study, published last September, found that Chinese firms are leading innovation in nuclear power and EVs/batteries. In four other sectors - robotics, quantum computing, artificial intelligence and display technology – China is not far behind the global leaders and are making rapid progress. The ITIF assesses that at this pace of development, China is likely to equal or surpass the Western leaders in less than a decade.    

• Other indicators point in the same direction. A study by Japan's National Institute of Science and Technology Policy in 2022 found that China had overtaken the US in the number of scientific papers published annually, accounting for 23.4% of the world's scientific publications between 2018 and 2020. For those harbouring doubts over the quality of publications, the Japanese study found that China is now also the biggest source of the world's top 1% most frequently cited papers (followed by the US and the UK).

• Patents tell a similar story. An ITIF study shows that, in 2010, Chinese firms accounted for less than 1% of patent granted by the US Patent and Trademark Office. By 2020, that had risen to 7%, with China granted the third highest number of patents behind the US and Japan. The US, nonetheless, leads on turning ideas into profit. World Bank data show that in 2023 China's intellectual property licensing receipts were less than a tenth of US levels.   

• Nonetheless, this is a remarkable transformation driven by a number of factors - rapid growth, private and public investment and, most of all, government policy.

• Through its 'Made in China 2025' initiative, launched in 2015, the government has poured money into ten key industries, with the aim of making them world leading producers of high-end equipment and goods. While some critics have questioned the efficiency of the initiative, it has significantly boosted government spending on R&D.

• According to the OECD, China's expenditure on R&D was 72% of America's in 2013. By 2023, it has grown to 96% and was rising at just under 9% every year, a significantly faster pace than the US.

• Government subsidies and tax credits, and a general rise in corporate profitability have also supported private sector investment in research. The European Commission compiles an annual list of the top 2000 businesses investing in R&D. In 2013, only 93 of these firms were located in China, compared to 658 in the US. By 2024, the number of Chinese firms in the list had risen more than fivefold to 524, compared to 681 in the US and 322 in the EU.      

• China's emergence as a global technology leader poses a threat to America’s domination in the field. The DeepSeek announcement wiped nearly a trillion dollars from the market value of American tech majors. US president Donald Trump said it was a “wake-up call” for US companies. Prominent venture capitalist Marc Andreessen called it AI’s “Sputnik moment” - a reference to the shock felt in the West in 1957 on the news that the Soviet Union had beaten the US in putting the world’s first satellite into orbit. 

• Unlike earlier competitors in the field of technology, such as Japan or South Korea, in China the West faces a strategic rival. Yet the relationship is complex and involves both interdependence and rivalry. As the EU puts it, China is a partner for cooperation, an economic competitor and a systemic rival.

• The launch of the sputnik caused alarm in the West and ignited a ‘space race’ that, with  the  moon landing in 1969, America won. Yet the Soviet Union was not a major rival in terms of economic heft or civil technologies. China, as the world’s largest trading nation and the world’s second biggest, most populous economy, is. 

• The US, like the EU, sees China as a systemic competitor. But the two great western blocs are responding very differently.

• The US has gone in the direction of economic ‘de-coupling,’ seeking to reduce economic and technological ties with China, especially in strategic sectors including semi-conductors, critical minerals and advanced technologies. The EU has explicitly rejected decoupling, and instead pursues what it calls ‘de-risking.’ It aims to reduce dependencies in key sectors, increase supply chain resilience and protect key technologies without severing economic ties. The UK has taken a similar approach, one that yesterday led the US chief trade adviser, Peter Navarro, to brand Britain a, “compliant servant of communist China.”  

• The rise of China is causing a reset in trade and economic cooperation among its western partners. What, precisely, that means is open to a wide variety of interpretations.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 2.2% at 8,603 as equity markets continue to recover from the lows seen in early April 

Economics

• US GDP contracted at an annualised rate of 0.3% in the first quarter of this year, down from a 2.4% expansion in the previous quarter. The contraction was due to a large rise in imports driven by companies seeking to pre-empt the introduction of tariffs in April. Imports are subtracted from total output  
• The US S&P 500 equity index has now recovered to the same level as on 2 April, when US president Donald Trump announced the US’s reciprocal tariff scheme
• Donald Trump said that he wants to introduce a 100% tariff on foreign films coming into the US
• Donald Trump issued an executive order to reduce the effects of import tariffs on automotive parts for car manufacturers with US factories. However, the original tariff rates of up to 25% on cars imported into the US remain in place 
• US consumer confidence fell in April for the fifth consecutive month, to its lowest level since May 2020, according to the Conference Board
• The US Personal Consumption Expenditures Price Index, the Fed’s preferred inflation measured, increased by more than expected to 2.3% in the year to March. Markets expect the US Federal Reserve to maintain interest rates at their current level when it meets later this week 
• The US added 177,000 jobs in April in an unexpectedly strong sign of the continued resilience of the US jobs market
• Euro area GDP increased by a healthy 0.4% in the first quarter of this year from the previous three months, according to initial estimates, with the German economy growing 0.2%
• Chinese state media said there would be “no harm” for China if it were to engage in trade talks with the US – a story that suggests a tempering of China’s stance on recent trade tensions
• Chinese manufacturing activity fell in April at its fastest pace since December 2023, according to a survey of purchasing managers
• Chinese investments into gold exchange traded funds peaked in April, with inflows more than double the previous record, according to the World Gold Council, an international trade association
• The Central Bank of Japan maintained interest rates at 0.5% while cutting its 2025 growth forecast to 0.5% from 1.1% due to ‘extremely high uncertainties’ regarding global trade

Business

• McDonald’s recorded its largest fall in US sales in the first quarter of this year since the pandemic, citing heightened consumer uncertainty
• The Irish Data Protection Commission fined social media app TikTok €530m for sending EU users’ data to China and a failure of transparency requirements. ByteDance, the owner of TikTok, said it would appeal
• A US federal judge referred Apple to a criminal prosecutor for failing to adhere to a legal order to change some of its App Store rules. Apple disagreed with the decision and said it will appeal
• Ford said it expects a $1.5bn reduction in profits this year due to US tariffs
• Harrods is the latest UK retailer to suffer a ransomware attack. This follows an earlier cyberattack on Marks & Spencer, resulting in the supermarket having to suspend online orders and halt recruitment
• Deutsche Bank’s profits in the first quarter of this year hit a 14-year high, driven by a surge in revenues of its trading unit during recent global financial market volatility. Other banks including UBS, Société Générale and Barclays also reported a boost to revenues from increased trading activity
• Energy company Shell announced a $3.5bn share buyback after posting higher than expected earnings in the first quarter this year, despite the recent low oil prices
• Banjay Group, a French Media organisation, announced plans for a takeover bid of UK broadcaster ITV or its studio production arm, the FT reports
• European aerospace manufacturer Airbus confirmed a deal to takeover some operations of US organisation Spirit AeroSystems, including factories in the UK and US

Global and political developments

• The US and Ukraine signed an economic partnership, giving the US access to Ukraine’s critical minerals and natural resources and establishing a ‘reconstruction investment fund’ for Ukraine
• The UK Reform Party won the Runcorn and Helsby parliamentary by-election, previously held by the Labour Party, by six votes. The right-wing party, led by Nigel Farage, also made strong gains in the local elections at the expense of both the Labour and Conservative parties
• Mike Waltz was sacked as US national security advisor, following the use of the private messaging app Signal to share US military plans. Secretary of state Marco Rubio is acting as an interim national security advisor
• The Liberal Party won the Canadian election and is expected to form a minority government. Former Bank of England governor Mark Carney will continue as the prime minister of Canada
• The EU threatened to impose a time limit on any agreement to reduce barriers for UK food and drinks exports to the EU if it does not have long-term access to the UK’s fishing waters
• Spain declared a state of emergency following a huge power outage across the nation. The exact cause of the outage is still unknown, according to Spain’s grid operator 
• Electricity bills in London are forecast to be around £100 cheaper compared to north Wales or the north of Scotland over the coming year, according to analysis from Cornwall Insight, mainly due to the variation in charges billed to customers to maintain regional distribution networks
• A report by the UK Climate Change Committee branded the UK’s preparations for climate change as “inadequate”, saying progress on adapting to climate change “is either too slow, has stalled, or is heading in the wrong direction”
• The UK Financial Conduct Authority announced plans to ban retail investors from borrowing money to finance cryptocurrency investments, as part a wider regulatory framework for the industry
• US student interest in UK university courses surged in March, according to online website traffic data by Studyportal, amid rising tensions between the US administration and elite US universities

And finally… a lorry containing $800,000 worth of US dimes overturned while driving through Texas, spilling the newly minted coins across the highway. The Department of Transportation closed the road for several hours while the coins were collected – loose change