Analysis

Reports of an underperforming Chinese economy clouded the CCP’s announcement of new economic policy priorities at its carefully choreographed Third Plenum. Market confidence remains shaky in the world’s second-largest economy, with signs of under-performing Q2 growth, a shaky real estate sector, and weakening consumer price growth that has led to a pivot towards exports to bolster the domestic economy. Undeterred, CCP leaders announced what fell short of the sweeping economic reforms needed to boost the economy, but which underscored the prioritization of politics–specifically the party’s control over the economy and society–over economic sense or stability. The emphasis on politics was also apparent in how the CCP handled the dismissal of two of its former ministers–Ex-Defense Minister Li Shang-fu and Ex-Foreign Minister Qin Gang–with the official line being that Li was fired while Qin “resigned,” a notable difference with Qin’s more lenient treatment likely owing to his closer ties with Xi Jinping. Far from fundamentally restructuring the economy to appease markets or consumers, the Third Plenum therefore underscores how the CCP will continue to operate as a “party-first, economy-second” organization. 

How the CCP adapts its grip over the economy, however, remains important. Science and technology are now central to the party’s vision for growth, and the private sector is viewed as an important vehicle for achieving the party’s technological ambitions. This means that while there may currently be encouragement for the private sector in China, particularly for those in the science and technology sectors, ultimately the private sector’s role is to innovate for the use of the party, rather than for other means. For foreign companies operating in China, this logic poses a particular risk for the forced transfer of IP to Chinese entities in the name of “new quality production forces,” Xi’s new favorite phrase that he hopes will both achieve economic growth and ensure the party’s grip on power. Foreign businesses should therefore continue to approach engagements in China with extreme caution and consider information shared with local partners–including through joint ventures–as effectively “lost” IP.

Analysis

What is Donald Trump’s position on China? A second Trump Administration will likely deepen the US’s hawkish position towards China, although Trump’s recent comments suggest that the Republican Party faces a split in foreign policy priorities. Trump commented that “Taiwan should pay us for defense,” and that “Taiwan doesn’t give us anything,” in contrast to vocal support for Taiwan from other Republicans. On trade, Trump will likely ramp up confrontation with China as part of his populist agenda to increase tariffs–between 50% and 100% for Chinese goods–that will purportedly support US-based manufacturers. This broadly supports the Republican Party’s position that China is an economic and security threat to the US. Yet tariffs continue to be unevenly enforced according to sector and purported point of origin, with Chinese tech able to navigate tariffs, for example, by first exporting to a third countries, like Mexico. Moreover, tariffs do not address Chinese investments in manufacturing lines in the US, which allows the same tech products to circumvent import restrictions because they are manufactured on US soil. 

The Biden Administration's continuation and expansion of Trump-era tariffs and restrictions against Chinese imports, particularly in technology, also suggest that these policies are likely to persist regardless of who wins the November election. The trend towards derisking, if not decoupling, will therefore continue. Consequently, companies that trade or invest in China will need to determine how to insulate their operations to avoid being targeted by US policies in the future. Moreover, higher tariffs on Chinese imports will also likely result in similar restrictions against US imports into China, which may further harm US companies. In short, U.S. companies need to assess second and third order regulatory risks for any China related parts of their business.

JD Vance, the Republican Party’s Vice Presidential nominee, has also publicly discussed his “dislike” for China, noting that he would push Trump to further increase tariffs on Chinese imports if elected. His statements on Taiwan, however, are not consistent with Trump’s. Vance argued that the US’s top foreign policy priority should be preventing a Chinese invasion of Taiwan. Trump, by contrast, is far more transactional about Taiwan, telling Bloomberg that Taiwan “...took our chip business from us” and that it should pay the US for protection from China. Trump and Vance’s comments highlight a potential rift in the GOP over support for Taiwan. 

Trump’s dismissing of support for Taiwan sent ripples through markets, with Taiwan’s TSMC stock taking a hit and many major companies noting their reliance on Taiwan’s chip and semiconductor manufacturing industries. Trump’s statements on Taiwan, however, are not just a concern for those in Taipei; letting go of Taiwan based on a crude transactional quid pro quo would at a minimum affect U.S. relations with every other ally in Asia and beyond; would spell the destruction of the US’s security architecture in the Pacific; and would effectively surrender US interests to China. Companies, even those without ties to Taiwan, should therefore continue to monitor comments from GOP leaders as they will likely affect market confidence in both Taiwan and East Asia more broadly.

Analysis

The intersection of business and national security takes center stage this week, as conversations among some NATO allies suggest the possible nationalization of Chinese-funded infrastructure projects in Europe should China continue to support Russia’s invasion of Ukraine. Beginning in 2013, many European countries signed onto China’s Belt-Road Initiative to help them recover from the effects of the 2008 financial crisis. The result is that Chinese companies now fully or partially own many key ports and railroads and other major infrastructure projects in Europe. NATO allies have not merely suggested the nationalization of such projects but, under the exhortations from the US, considered extending such measures to critical and high-tech industries, such as semiconductors, quantum computing, and telecommunications industries. While not official policy yet, the growing rift between the EU and China over China’s support for Russia makes the scenario one companies must consider.

Nationalizations would hold broad political and economic implications. Recent data reveals that the Chinese economy underperformed last quarter, worrying economists and politicians alike, and the vague guidance emerging from China’s Third Plenum (see item one in this week’s report) has done nothing to inspire confidence for future recovery. In a follow-up to last week’s Red Report, China’s rare-earths industry has also taken a hit due to tightening government regulations. While Beijing is seeking paths toward economic stability, it is not only subject to continued US export controls but also the developing “de-risking” of the EU, which was compounded by the European Commission’s recently proposed tariffs on Chinese-made EVs. In short, China’s leaders are connecting two phenomena to blame the US and the EU for the Chinese Communist Party’s (CCP’s) economic mismanagement: (1) China’s economy is in trouble; and (2) China’s leaders contend that Europe and the U.S. are preventing China from developing key industries, effectively by expelling Chinese companies from key markets, or by making Chinese products less competitive in those markets.

While a nationalization strategy is perhaps a logical choice from a national security standpoint, the implications for private businesses could be dire. More specifically, it risks triggering the race-to-the-bottom nationalization of foreign companies in both China and the West. We know that China is not above such a tit-for-tat response, too, as it has responded in kind to each new US and EU trade restriction. Western companies that have operations in China or Hong Kong, then, could become collateral damage. Volkswagen Group’s 39 factories in China or Tesla’s new EV battery plant or existing gigafactory in Shanghai could all become quick and easy targets (although Elon Musk’s toadying to Xi Jinping might spare his company that fate). Regardless, the sudden acquisition of all China-based operations could become the next frontier of the global trade war with China, and companies would be wise to start insulating their bottom lines from too heavy a reliance on Chinese-based goods and services.

Analysis

The CCP sees AI and large-language models (LLMs) as part of its “new quality production forces” that will use technology to achieve growth through increased efficiencies in the Chinese economy. At the same time, these technologies present the CCP with a potential all-encompassing tool for social surveillance, including Minority Report-style predictions to clamp down on anti-CCP sentiment within China. Yet such is the party’s fear that generative AI might provide alternative (non-approved) perspectives to Chinese citizens that the party is taking no chances in allowing its tech companies to innovate without the party’s strict oversight. In response, the Cyberspace Administration of China, the body responsible for managing the internet and AI, has instructed tech giants to participate in mandatory government reviews of their LLMs, which must strictly comply with the CCP’s directives and enshrine CCP values and priorities. 

Where the party is potentially “strangling” domestic AI innovation, this framing misses the party’s broader prioritization of politics and adherence to the party over economics, a prioritization that was keenly on display at the recent Third Plenum. This prioritization poses challenges for global tech companies operating in China. First, any tech company in China will have to comply with the CCP’s demands that its AI models adhere to the party line, which will likely include diverging LLM source code to CCP operatives. Second, China’s success in pushing its tech overseas as an alternative to Western models will increase the risk that global markets will rely on Chinese AI models, and therefore be fed the CCP’s positions on economics and politics. This dynamic increases the risk that US companies will either be crowded out of global markets through competitive alternatives from China, or that LLMs will encourage a shift in public opinion–particularly in non-Western markets–towards China and Chinese competitors. Where LLMs therefore present a new front in the CCP’s tight control over Chinese society, they therefore also threaten Western companies–and Western values–around the world.

Analysis

In a sign that Five Eyes partners are adhering more closely to US demands that they take security and economic threats from China more seriously, the Australian, Canadian and New Zealand governments made announcements about coordinated espionage threats from China within their borders. In the case of Canada, this announcement also included a detailed mapping of Chinese secret police operations, a common approach to espionage used by the CCP, operating on Canadian soil. At the same time, a report by a European think tank about CCP-linked associations’ tech transfers to China has sharpened European governments’ resolve to further crack down on Chinese IP theft and economic espionage. 

Focusing on CCP secret police stations, diaspora associations, and “work stations,” these reports highlight China’s persisting threat in “non traditional” espionage activities, including using France-based Chinese citizens through diaspora associations legally registered in France. These associations underscore the challenge for overseas Chinese caught between CCP demands to conduct espionage or IP theft–a legal imperative if they remain PRC citizens–and wanting to avoid the CCP’s long reach. It also highlights how tech and science are a particular focus of Chinese espionage efforts, with the CCP often co-opting individuals overseas to help avoid export controls and foreign investment screening. 

Reports like this, and those of Canada and New Zealand, will add pressure on Western governments to respond more forcefully to perceived threats from China, and will make it more challenging for companies to engage with Chinese partners. Companies should therefore ensure that they have strong due diligence systems in place on their employees and partners so as to minimize the risk of IP theft or of accusations that they are assisting CCP tech transfer efforts, even unwittingly.

Analysis

The Wall Street Journal’s firing of one of its Hong Kong-based reporters, Selina Cheng, for maintaining her position at the pro-press freedom Hong Kong Journalists Association has sent shockwaves through the media industry. Cheng’s firing for her advocacy work stands in strong contrast to the WSJ’s own advocacy about its reporter Evan Gershkovich, who remains detained in Russia, and highlights how media companies in Hong Kong are increasingly capitulating to political demands that they align with the CCP’s priorities. A recent survey of journalists in Hong Kong, for example, noted that 70% of reporters had self-censored out of fear of repercussions. 

Importantly, this means that media reports from Hong Kong should be increasingly viewed as either inconclusive or unreliable, with journalists in the city under pressure to produce pro-China reports that downplay negative stories. Companies with large Hong Kong-based operations should therefore seek alternative media sources for economic or political reports. While independent media in Hong Kong is not entirely dead (yet), the trend towards the “Mainlandization” of Hong Kong means that businesses should treat the city as if it is firmly part of China.