Analysis

A common narrative is that China’s meteoric rise since joining the World Trade Organization in 2001—driven in part by government subsidized cheap labor and ample land, and access to world markets—helped make China the world’s factory. In doing so, it exacerbated existing trends that saw a mass relocation of US manufacturing out of the Rustbelt—including abroad and to elsewhere in the US like Georgia, Texas, and Arizona.

A more complicated—and perhaps more realistic—narrative is that the first so-called China Shock was not only China, but also automation. Moreover, even China itself unevenly affected different sectors (and communities) across the US and the world. Some industries, for example those making intermediary parts, benefited immensely from the globalized manufacturing boom that came with China’s industrial rise; others suffered as it became cheaper to offshore industrial processes. Indeed, one reason that the “China Shock” label has stuck, despite the more complex reality of winners and losers, is likely because it unevenly affected manufacturing jobs in the political states of the Midwest. From a US business perspective, understanding the first China shock’s varied shaping of different economic sectors across different locations will be vital to staying ahead of the curve and insulating corporations from potential headwinds.  

How does our understanding about this first China Shock inform our understanding of a potentially similar process happening today? Despite a decline in China’s manufacturing primacy in recent years, the Chinese Communist Party’s (CCP) prioritization of key sectors like AI (as the CCP’s journal Qiushi reports) will potentially erode the US’s headstart in these areas and shift high-tech manufacturing back to China. If this occurs, we are likely in for a second China shock that has the potential to harm the US more  than the first one. Signs that China is heading in the right direction are its recently announced second quarter growth of 5.2%, a surprisingly high figure (albeit one that should be questioned) given US tariffs and the resulting shifting global trade patterns. If (and it is a big if) we take these statistics at face value, it appears that US attempts to undercut China’s renewed attempt to dominate manufacturing are not working as the US government likely hoped.  

Notably, China is also acutely aware of the chance that it could be the victim of a “reverse China Shock,” whereby other states in Asia—most notably India—overtake China as the world’s manufacturing hub. Chinese political leaders will therefore put maximum effort into staying ahead of the curve in new technologies. This will involve intensive state investment in innovation and key industries, targeted talent recruitment (as we discuss in “Tech Futures” below), and increasingly leveraging new technologies like AI to improve economic efficiencies. For the CCP, “China Shock 2.0” is therefore not just a way to stay ahead of US competitors, it is fundamental to preventing the economic troubles seen in the US Midwest from happening in China. The drive to become the world leader in innovation is core to the party’s survival, and it is unlikely to change.

Analysis

On the sidelines of last week’s ASEAN meeting in Malaysia, US Secretary of State Marco Rubio met the PRC’s Foreign Minister Wang Yi, while tepidly promising Southeast Asian states that they would receive tariff rates “better than countries in other parts of the world.” In promising to engage US partners at the same time as the US government’s imposition of tariffs on those same countries, those governments and publics question the US government as a reliable partner. The US expectation of major concessions or tit-for-tat from countries in the region is leading to a broad questioning among US allies in East and Southeast Asia about how best to manage—rather than cooperate—with the US. As we explained earlier this month, trade-war tensions may not subside, but rather diffuse into Asian regional politics. This perspective was reinforced this week when Rubio cut planned trips to Japan and South Korea, and broadly sidelined ASEAN in favor of meeting with Chinese officials, likely in an attempt to arrange a potential Trump-Xi meeting later this year.

Rubio’s attempt to carry out the White House’s demand for a new global trade order is also unlikely to be implemented smoothly given his firings and budget cuts at US departments and agencies. Firing 1500 individuals from the State Department is likely to reduce the US government’s expertise and capacity to enact Rubio’s foreign policy objectives, including supporting the Philippines in the South China Sea, while, in the same week, firing the State Department's South China Sea team. This is not to mention staff working on US-China relations, quantum, AI, and other areas of vital importance to US competitiveness. 

Meanwhile, for remaining State Department and intelligence officers, analysts like Prof. David V. Gioe and former Director of CIA, General Michael V. Hayden (USAF, Retired) argue that calls for officers to prioritize political loyalty above objective analysis severely undermines the US government’s ability to collect intel and erodes our allies’ trust in partnerships with the US. Slashing the US’s capability to respond to China, all while China is dramatically accelerating its diplomatic, trade, and scientific efforts, will weaken the US governments’ future negotiation position and make it harder, not easier, for US businesses to compete against Chinese counterparts in key economic sectors. 

Instead, US allies—and their businesses—will likely increasingly collaborate with each other while excluding the US. For US businesses, this poses an acute issue whereby some countries may try to reduce market share or involvement of US corporations in key sectors, or favor future deals with companies from alternative origins. It also opens countries to potential trade deals with China to balance the potential trade loss from US tariffs. For US businesses, the challenge will therefore be in navigating shifting geopolitical landscapes and minimizing potential fallout from the US government’s continued pursuit of tariffs as its cornerstone trade policy. The US government’s expanded use of trade policy as a political weapon is therefore likely to continue to affect US businesses in global markets. Businesses should plan accordingly for how best to insulate different areas of their global footprint or supply chains from these trends.

Analysis

It is not only the US’s messaging to its Asian allies that is raising questions (see Item 2), but also its approach to managing the complex and interrelated issues of US national security and global trade. Under intense lobbying from the semiconductor industry, particularly Nvidia CEO Jensen Huang, the administration announced last week that it would begin approving export licenses for inference-capable semiconductors to be shipped to China. This comes as a stark reversal of the administration’s earlier restriction on the sale of these advanced technologies to China just three months ago.

What the US has gained from this policy change remains unclear. US Secretary of the Treasury Scott Bessent had earlier hinted that granting China access to advanced US semiconductors was a bargaining chip in getting China to ease access to rare earths, while Commerce Secretary Howard Lutnick has more explicitly suggested that this is precisely intended as a tit-for-tat exchange. The administration may be surprised to find, then, that the Chinese Ministry of Commerce just imposed new export controls following the completion of its public consultation process on limiting sales of gallium extraction technologies and equipment for the preparation of battery cathode materials. While the US may have extracted promises that applications for rare earth exports will be approved in a timely manner, this relies a great deal on China being a good-faith actor, which has rarely proven to be a valid assumption.

The real winners, instead, seem to be Nvidia and AMD. When the announcement was made that they can resume sales to their largest market, both companies' stock values jumped by 4%. To be clear, neither company is approved to sell their most advanced chips to China; Nvidia can only sell its H20 chip and AMD its MI308 chip, both of which were explicitly designed to match the 2022 Biden-era export controls that still kept the most advanced technology out of Chinese hands. Given the fact that Nvidia was under federal investigation just months ago for potentially violating export controls by selling their chips to the company that made Deepseek, the Chinese AI platform that upended the industry, this is a dramatic turnabout.

The House Foreign Affairs committee met last week to hold a meeting on “Breaking China's Chokehold on Critical Mineral Supply Chains,” emphasizing the undeniably important role of rare earths to US strategic interests. Why the government would capitulate to market demands without securing access to rare earth—a national security necessity—is somewhat of a mystery. This failure may explain, in part, the reason for why the US government decided to take a 15% stake in MP Materials, the US’s only domestic, rare earth mining company; if China cannot or will not supply the necessary materials, the US then needs to produce them itself. Shortly after the deal’s announcement, Apple also issued a statement that it had agreed to procure a significant portion of its rare earths from the government-backed company going forward. Collectively, these moves suggest the government’’s attempt to create a fully US-based rare earths’ supply chain. The question remains, however, whether such a long-term goal can be realized before China potentially decides to end its sales of rare earths  to the US and its allies.

Analysis

The CCP is prioritizing “returnee talent”—that is PRC citizens who have trained and worked abroad, but who choose to return to continue their careers—as perhaps its most valuable asset in the global tech race. PRC citizens are often at the cutting edge of tech innovation, particularly in Silicon Valley. Meta’s recent hiring blitz in AI, for example, has currently recruited 11 individuals with rumored packages worth up to $100 million; 7 of whom are PRC citizens. These technologists, along with the thousands of others across the globe, have the talent, training, and insider knowledge of how US tech companies think and operate, not to mention access to sensitive IP, that the CCP sees as the next front in its tech Cold War with the US. 

Importantly, the PRC is already home to over half of the world’s top AI talent, with additional PRC citizens increasingly choosing to return to China because of a combination of enticing packages, cuts to US government funding, and an increasingly hostile environment for Chinese talent in the US. Enticing additional returnee talent is therefore not just about increasing the number of world-class individuals in the PRC, it is also about removing those individuals from the US’s innovation ecosystem.   

One sign that returnee talent is increasingly important to the CCP is its top billing in People’s Daily, with a recent article decrying potential accusations against returnees that they should be viewed with suspicion as foreign spies, traitors, or sellouts. In an about face from recent years, when a foreign degree or experience was sometimes either decried as inferior to China’s own institutions or students opted for Chinese universities to get ahead of networking opportunities at home, returnees with foreign experience appear to be increasingly prioritized with state-backed incentive packages. 

As we wrote in our last Red Report, state and local governments in the PRC see returnee talent as crucial for kickstarting China’s tech ambitions to rival the US. The CCP is therefore preemptively defending returnees against accusations that they are only returning now that China is more developed and “reaping what others have sown,” that they are “less capable” than their peers who remain abroad, that they are “traitors” for having left in the first place, of that they will be favored over domestic talent. Such a defense underscores a crucial point: Returnee talent is not just a feather in the CCP’s cap, it is essential to the party’s national security strategy. 

Tech companies are therefore likely to face stiff competition for talent from both US giants like Meta and PRC companies that can rely on state support to entice PRC citizens in particular to relocate to China. These facts of life make it critical that American companies establish reporting mechanisms for employees who are likely to be approached by talent recruiters, ensure that employees cannot access sensitive IP that is not essential to their job function, and how to attract employees to remain with the company rather than opt for supposedly greener pasteurs abroad.

Analysis

A cyber attack against DC law firm, Wiley Rein, by a suspected Chinese government-affiliated organization highlights the clear and present threat from Chinese espionage to US businesses. As we argued in our previous Red Report, Chinese espionage employs a two-pronged approach: “trawler net,” whereby intelligence operatives try to collect information on a broad range of topics, and “line caught” targeted recruitment of individuals or highly specific information. This recent case in DC highlights how effective China’s “line caught” espionage can be in extracting targeted information of particular interest. In the case of Wiley Rein, hackers obtained proprietary information from emails pertaining to highly specific topics: trade, Taiwan, and US government agencies involved in tariffs and foreign investment. 

Each of these topics is a vital component for the CCP’s national security concerning Taiwan and how the US (and its allies) might react to a potential invasion of the island. Concerns about how US tariffs and trade restrictions will undermine China’s economy are similarly important to how the CCP strategizes its approach to negotiations with Washington, as well as how the party positions China as a potential alternative market for other countries that are responding to US tariffs. Companies with information pertaining to US trade, in particular, should be hypervigilant over sharing potentially sensitive information electronically, as they will likely be targets of interest to Chinese intelligence operatives. 

This recent example also underscores how US companies will increasingly need to grapple with cybersecurity threats from state-backed actors, particularly those with ties to the Chinese government. The attack against Wiley Rein, for example, targeted Microsoft 365 accounts of key individuals, which suggests that attackers knew precisely who to target and how to access their Microsoft accounts. While likely unrelated to this particular breach, Microsoft’s continued engagements in China, particularly in its recently revealed use of Chinese engineers to help maintain US Department of Defense IT infrastructure, means that standard cybersecurity measures are therefore likely to be ineffective against the growing sophistication of Chinese cyber actors. Instead, additional security measures, ranging from purple and red teaming, to compartmentalizing employees and upgrading hardware will need to become central to corporate decision making to avoid ending up as a case study in how China attacks the US private sector.