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ECONOMY

Can This Marriage Be Saved? Chinese-U.S.Integration FraysAs trade talks stumble, a broader decoupling between the world’s two largest economies looms

The sudden deterioration of trade talks between the U.S. and China this week has raised theprospect of a once-unimaginable rupture between the world’s two largest economies.

Whether talks ultimately yield a deal, the decadeslong integration of the two economiesappears bound to go into reverse as mutual suspicion and geostrategic rivalry permeatepolitical and personal relationships.

The signs are accumulating: Manufacturers of shoes, cameras and iPhones are looking to moveproduction beyond China. American officials are forcing Chinese investors to sell their stakes inAmerican startups. Chinese scientists’ visas to visit the U.S. are facing delays.

How much further this decoupling goes depends critically on what sort of deal, if any, emergesfrom the current negotiations. A new Cold War of limited and tightly controlled interactionsisn’t likely: China is simply too big and too globally integrated. Nonetheless, American andChinese investors, businesses and scholars could find themselves increasingly operating inseparate spheres pursuing separate strategies.

Some of the early trends are apparent. Trade flows once driven by cost, quality andproximity to customers increasingly reflect political priorities, whether it is Chinese

purchases of U.S. energy and agriculture or the location of manufacturing plants.

Even if President Trump eventually lifts tariffs, multinationals will know they can be reimposedif tensions flare again. And China could slap tariffs, too. So to limit their exposure, many willshift assembly of U.S.-bound goods to third countries less exposed to protectionist threats. Insome cases, the uncertainties stemming from trade tensions were the final nudge forcompanies, already facing rising costs in China, to go elsewhere.

Updated May 9, 2019 10�47 p.m. ET

By Greg Ip and Yoko Kubota

Camera maker GoPro is moving production for the U.S. market from China to Guadalajara,Mexico. Shoemaker Steve Madden is moving production to Cambodia. Ford Motor Co. haslargely scrapped plans to export vehicles from underused Chinese factory space back to the U.S.Taiwan-based Foxconn Technology Group is weighing assembling Apple Inc.’s iPhones in India,a huge emerging smartphone market.

Consumers often won’t notice: A camera or a shoe once labeled “Made in China” will now say“Made in Mexico” or “Made in Cambodia.” U.S. imports from China will shrink while importsfrom Mexico or Southeast Asia will rise.

But elsewhere China’s absence will be more noticeable. The U.S. has effectively banned HuaweiTechnologies Co. from supplying equipment for American telecommunications networks forfear it could become a “back door” for China to spy on Americans. As the definition of nationalsecurity expands, more companies and sectors may get the Huawei treatment. Senators haveproposed barring local governments from using federal funds to buy railcars from China’sstate-owned rail company, ostensibly because the cars could be used to spy on Americancommuters.

If China agrees to open previously closed markets to U.S. investment and exports, thenAmerican products such as Tesla electric cars and services such as cloud computing may makeinroads.

But some American brands may suffer a nationalistic backlash. Some Chinese consumerssuggested boycotting iPhones after a Huawei executive was arrested for allegedly violatingsanctions on Iran. Ethan Allen, an upscale furniture manufacturer and retailer, recentlyreported sales in China have been hurt by the trade war. However, Chinese consumers no longerassociate many U.S. brands such as KFC, Coca-Cola and Pizza Hut with the U.S., said DoreenWang, global head of BrandZ.

Investment is likely to decouple even more than trade. Starting in 2010, Chinese investment

Bundles of aluminum ingots stack up in Wuxi, China, amid rising trade tensions with the U.S. PHOTO: QILAISHEN�BLOOMBERG NEWS

began surging into the U.S. American officials now worry those investment flows enableChinese state and private actors to appropriate American commercial and military knowledge,and want to curtail them.

The results are already evident. Chinese investment into the U.S. plummeted to $5 billion lastyear, a seven-year low, from $29 billion in 2017, according to a report Wednesday by RhodiumGroup. That is because China clamped down on capital outflows and more of the U.S. became offlimits. The firm estimates $2.5 billion in Chinese acquisitions were abandoned because ofconcerns raised by the Committee on Foreign Investment in the U.S., a secretive Treasury-ledpanel that vets foreign investment for security risks.

Last year “proved that the five-decade trend of closer engagement in U.S.-China relations wasnot inexorable, and patterns propelled by powerful commercial logic can be stalled or reversedby policy,” the firm observed.

Legislation last year vastly expanded Cfius’ remit from traditional security-related industriessuch as aerospace to a broad range of industries from biotechnology to batteries.

The panel has told one Chinese company to abandon a purchase of Grindr, a gay dating app, andanother to sell its controlling stake in PatientsLikeMe, which helps people with similar healthconditions find each other. Cfius appeared to worry those investments could be used to obtainsensitive personal information about Americans.

Meanwhile, new export controls may bar American companies from sharing key technologythrough joint ventures or other investments with partners in China. This may be why new U.S.

SHARE YOUR THOUGHTS

What would be the benefits and costs of the U.S. curtailing ties with China? Join theconversation below.

Eastern Oregon Telecom uses Huawei Technologies products—for now. PHOTO: MICHAEL HANSON FOR THE WALL STREETJOURNAL

investment in electronics in China plummeted last year while total investment was stable,according to Rhodium.

The effect of these changes may be hard to notice at first. Neither China nor the U.S. lack forcapital. Over time, though, decoupling could rob both of valuable synergies, says Adam Lysenkoof Rhodium. “The U.S. and China share the two largest cohorts of artificial intelligenceresearchers and brainpower so certainly bifurcating that talent pool will lead to less-efficientAI” development. Trump administration advocates respond that is a small price to safeguardAmerican values and leadership against the rise of China’s autocratic state capitalism.

Bifurcation is also a risk for the broader technology universe. Technology products are highlystandardized, reflecting integrated supply chains, free-flowing capital and knowledge, andinternational cooperation on standard-setting.

In coming years, products, applications and standards could gravitate toward separate U.S. andChinese spheres. “In the early days of mainframe computing, the community divided intovertical stacks of IBM vs. Burroughs vs. Control Data,” says Peter Cowhey, an expert ininformation technology policy at the University of California at San Diego. “That is what wouldbe happening here.”

Last October the Commerce Department barred sales of U.S. technology to Chinesegovernment-backed semiconductor startup Fujian Jinhua Integrated Circuit, allegedly overtheft of U.S. intellectual property. Fearing repeats, China has intensified efforts to reduce itsdependence on foreign technology. For example, it imports almost all its semiconductors. Thisweek Chinese Premier Li Keqiang called on government officials to speed up policies that woulddevelop China’s semiconductor industry, according to the State Council, China’s cabinet.

It will take many years for China to develop indigenous capacity throughout the supply chain, ifit ever does. Still, as supply chains decouple, so might technology ecosystems. Chinesesmartphone makers already run their own app stores and use localized versions of Alphabet’s

U.S. authorities have told a Chinese company to abandon a purchase of Grindr, a gay dating app, on national-security grounds.PHOTO: CHRIS DELMAS�AGENCE FRANCE�PRESSE�GETTY IMAGES

Android operating system. Facebook and Google are unavailable in China and Chinese giantTencent’s WeChat has a limited presence in the U.S. Huawei has developed its own operatingsystem as a backup in case it loses access to Android, a person familiar with the matter has said.If China breaks the American duopoly on operating systems, expect even more differentiationin available apps around the world.

While the world has converged on common standards for superfast fifth-generation (5G)mobile networks, individual countries and carriers may use different software, which will bemore important than in previous generations, to govern how devices, from phones to Internet-enabled appliances, operate on the network. If the U.S. or its allies bar Chinese suppliers, theirbusinesses and consumers may miss out on functions and devices in countries that allowChinese suppliers.

That didn’t matter when Chinese technology was inferior. Today, though, Chinese equipment,such as Huawei’s, is often cheaper and better than its competitors’. Earlier this year VodafoneGroup PLC chief executive Nick Read warned a ban on Huawei “would have significant financialcost, would have significant customer disruption and would delay 5G rollout in severalcountries.”

The barriers coming between U.S. and Chinese investment and trade may also come betweenpeople. The latest data show China accounted for a third of the foreign students studying in theU.S., a third of foreign students in science, technology, engineering and math, 9% of temporaryH1B specialty work visas, and 14% of employment-based green cards, according to theMigration Policy Institute, a think tank. This diaspora has seeded the U.S. with manpower andtalent and China with American expertise and values.

But U.S. officials say the diaspora is also a vehicle for espionage. “China has pioneered a societalapproach to stealing innovation any way it can,” including “through graduate students andresearchers,” FBI director Christopher Wray said in April. That may lead to toughened visarequirements that throttle the inflow of Chinese students, researchers and workers.

Ford dealerships such as this one in Shanghai could su�er if the U.S.-China trade row escalates. PHOTO: QILAISHEN�BLOOMBERG NEWS

Chinese scientists are waiting longer for visas to visit the U.S. In February, Pan Jianwei, China’sleading quantum physicist who is working on hack-proof communications, couldn’t attend aceremony after his team won a prestigious science prize from the American Association for theAdvancement of Science.

Chinese applications to Ph.D. physics programs fell an average of 16% in 2018, according to asurvey by the American Physical Society. At Kansas State University, Chinese went from a thirdof graduate physics students a few years ago to 10% now, says department head Brett DePaola.He said students from other countries have filled the gap, but overall, foreign applications aredropping. “Maybe it’s tied to the current administration, maybe it’s tied to other universitiesaround the world opening doors a little more.”

American officials could conceivably designate any technical discussion between an employeeof an American technology firm and a Chinese national—even one who works for the same firm—as subject to export controls, says Dan Wang, an analyst at Gavekal Dragonomics, a China-based research service. “It’s plausible that to stay in compliance with U.S. export control laws,

China’s state-controlled Tsinghua Unigroup project is part of a plan to create a domestic semiconductor industry. PHOTO: NGHAN GUAN�ASSOCIATED PRESS

The nation’s busiest container port, in Los Angeles, could see its mix of business change depending on how the China tradedispute plays out. PHOTO: MARIO TAMA�GETTY IMAGES

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these firms may have to sequester their foreign, especially Chinese, nationals, or just terminatethem.”

As with diminished ties in trade and investment, reduced human contact won’t have anyimmediate or noticeable effect. The impact will build over time as the U.S. competes with aslightly diminished pool of human capital.

Ultimately, howfarapartthe U.S.andChinadriftwilldependon howhardbothcountrie

s try to contain their current disputes. National-security hawks in the U.S. believe economicinteractions have to shrink considerably if the U.S. is to maintain American economic andmilitary hegemony. In China, nationalists see further self-sufficiency as essential to economicdominance and a state-of-the art military.

Against that, more moderate voices may try to compartmentalize national-security risks so asto keep broader commercial ties unchanged. “There is this theory in the U.S. that the futureworld would consist of two circles. One is the U.S. centric economic order and the other is theChina centric economic order,” says John Gong, a professor at The University of InternationalBusiness and Economics in Beijing. “It’s an economic version of the Cold War. It’s somethingthat we should all avoid.”

—Julie Wernau, Chunying Zhang and Yang Jie contributed to this article.

Write to Greg Ip at greg.ip@wsj.com and YokoKubota at yoko.kubota@wsj.com

An optical cable production facility in Dongguan, China. PHOTO: ALEKSANDAR PLAVEVSKI�EPA�SHUTTERSTOCK

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This copy is for your personal, non-commercial use only. To order presentation-ready copies for distribution to your colleagues, clients or customers visithttps://www.djreprints.com.