How the U.S. Ban Against ZTE Could Backfire

(Bloomberg) -- Hi folks, it’s Shelly Banjo. ZTE, the Chinese manufacturer of smartphones and telecommunications gear, is in a heap of trouble.

Or is it? Bear with me here. 

The U.S. government slapped ZTE with a seven-year ban on buying American-made chips and components as punishment for violating a sanctions settlement over the sale of products to Iran and North Korea. Those parts are critical to growing ZTE’s business, and analysts jumped to proclaim the end of China’s second-largest maker of base stations, switches and network communications (Huawei is the largest).  The company’s shares were suspended in Hong Kong.

“All hell breaks loose,” wrote one analyst. 

Fear over China’s growing tech might has already led the U.S. government to block wireless providers from carrying Huawei’s phones and thwart Broadcom’s takeover bid for Qualcomm. The broader picture is that the world’s two largest economies are increasingly edging closer to an all-out trade war.

ZTE plays a critical role in helping China build a fast, 5G wireless service that could rival American tech prowess. In many ways, China’s large tech companies no longer trail the U.S. in terms of innovation and ingenuity. Still, the U.S. remains the leader when it comes to the technology and intellectual property embedded in chips critical to operating smartphones, base stations, and optical equipment.

China is already pouring billions of dollars into catching up. Huawei, ZTE, Xiaomi and other Chinese tech companies are rapidly developing their own chip technology. While U.S.-made components account for only 10 to 15 percent of ZTE’s production costs, “these are essential parts that aren’t easily replaced,” says Nomura analyst Joel Ying. ZTE’s smartphones, for instance, rely on Qualcomm’s chips. “At least for the next five to ten years, ZTE can’t exist without American companies.”

But now that the U.S. administration has made its protectionist tendencies clear, you can be sure that China’s government will do everything it can to avoid being caught flat-footed again. The country’s most likely reaction will be to close the gap, devoting even more money and resources into chips and other research. The measures against ZTE could help accelerate China’s independence from U.S. technology firms and transform the country into an even more aggressive competitor to the U.S. And ultimately, that will benefit Huawei, ZTE and other rivals. 

There’s nothing like getting told no to incentivize you to work harder. That’s essentially what the U.S. is doing to Beijing by cutting off Chinese companies from sought-after American technology.

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To contact the author of this story: Shelly Banjo in Hong Kong at sbanjo@bloomberg.net.

To contact the editor responsible for this story: Reed Stevenson at rstevenson15@bloomberg.net.

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