4 July 2018

Huawei's Success Puts It in Washington's Sights

By Matthew Bey

Washington's wariness about Huawei will prevent the Chinese company from making inroads in the United States, but it will continue to expand elsewhere, including Europe. Despite pressure applied by Washington on U.S. companies to steer clear of Huawei, it will remain an important partner for giants like Google. If the United States applies pressure tactics against Huawei, Beijing could interpret the move as an attack against itself. While Chinese telecommunications company ZTE has drawn attention in the United States as questions swirl around measures that ban U.S. suppliers from selling to it, the emergence of one of its chief rivals, Huawei Technologies, has truly showcased China’s arrival as a global technological superpower. The United States is shaping policies to resist China’s increasing technological prowess, and Huawei has come to embody that progress, as well as Beijing's goal to make the country a world leader in artificial intelligence, robotics, new energy and nanotechnology by 2025.

Few companies play such an outsized role in geopolitics as Huawei, which has become a global leader in the development of several key technologies, including 5G telecommunications infrastructure. Despite more than a decade worth of efforts, however, Huawei has struggled to break into the U.S. market in the face of near-constant resistance. Allegations that the company has stolen U.S. technology have combined with suspicions over its ambiguous ties to the Chinese Communist Party and the People’s Liberation Army (PLA) to drive bipartisan political opposition to its U.S. ambitions. The unwanted attention from Washington, however, will do little to hinder Huawei’s global rise — or reduce its importance to Beijing.

The Big Picture

Amid their growing conflict over trade, Washington and Beijing find themselves in the middle of a cold war over technology as China emerges as a power in the field. The success of Chinese companies in developing and manufacturing new technology has raised worries in Washington that China could harness those achievements for espionage and other purposes. In such a climate, Huawei is likely to find itself in the middle of the storm.

An Unremarkable Beginning

Much of the anxiety surrounding Huawei, including the accusations that it has close links to the Chinese government and the PLA, revolves around its reclusive founder, Ren Zhengfei, and the company’s growth in its first 15 years. But while Huawei has developed into a national champion and possesses a symbiotic relationship with the government, its ascent was never a foregone conclusion.

Ren, who has a background in engineering, joined the PLA's engineering corps in 1974 and spent a decade in the service until the military began downsizing to free economic resources for Chinese leader Deng Xiaoping’s reforms. After leaving the PLA, Ren worked for the logistics unit of the Shenzhen South Sea Oil Corporation before he and a few others founded Shenzhen Huawei Technologies as a private company in 1987. At the outset, Huawei boasted a mere 20,000 yuan ($5,000) in capital and was a technology company in name alone.

Some in the West have alleged that Huawei was established to benefit from China’s 863 Program, which Deng launched in 1986 to reduce the dependence on imported technology, but the company was not well positioned to take advantage of the program. Instead, rivals that grew out of the Chinese government, such as Julong/Great Dragon (the military) and ZTE (the Aerospace Ministry), better benefited from such opportunities.

In fact, unlike its state-backed compatriots that obtained cheap loans from state-owned banks, Huawei initially operated on the fringes of the Chinese financial system. It was forced to turn to state-owned enterprises and other firms to raise capital, often at interest rates far in excess those offered to its competitors. Its initial profits came from the trade of imported products, and Huawei began to invest a portion of that revenue — often 10 percent or more — into research and development in an effort to develop domestic technology.

In 1993, Huawei finally broke through with its first major project, a digital telecommunications switch. As a result, Huawei gradually emerged from the fringes of China’s technology sector to attract the attention of political leaders including then-President Jiang Zemin. Until the dot-com bubble burst, Huawei grew on the back of China’s economic miracle, expanding its product lines and competing to win government contracts large and small. Of course, the extent to which Huawei developed its technology in-house is unclear, as it was certainly involved in the reverse engineering of some competitors' technologies.
The World Meets Huawei

Counterintuitive though it may seem, the driving force behind Huawei’s larger success was not the eventual support the government gave it (even today, it does not rely on government backing). After all, other Chinese companies that have followed the same path have failed to match the technology giant's achievements. In fact, state ownership arguably hindered Huawei’s rivals since it forced them to work within Beijing’s defined priorities and focus on the domestic market. Instead, Huawei, ultimately courted the international market —although it did not neglect the domestic market to do so.

In line with Chinese policy, Huawei rapidly expanded overseas in the 2000s. In time, it captured a larger share of the router market, turned its attention to more cutting-edge technologies and contributed to the development of standards for 3G and 4G mobile networks. To compete internationally, Huawei funneled some of its domestic revenue into research and development while adopting a more Americanized operations model (it hired IBM as consultants to complete the transformation). It expanded its R&D overseas, establishing research centers with universities and foreign companies in hotbeds like Silicon Valley.

What strikes fear into the United States and others is the extent of Huawei's market share in so many key technologies.

Huawei: China's Achievement

Today, there is little doubt that Huawei has become a global technology giant that will continue to challenge U.S., South Korean, Japanese and European counterparts as it further develops its technology. But what strikes fear into the United States and others most is the extent of Huawei's market share in so many key technologies. Today, Huawei is the world’s largest producer of telecommunications equipment. It has also emerged as a pioneer in 5G technology, developing the first Chinese-backed standard for a coding scheme to be adopted internationally.

Huawei is also the world's second largest producer of ethernet switches and routers. Likewise, Huawei is one of the top six server producers by shipment. Among software-defined compute (SDC) software vendors — makers of cloud computing equipment — Huawei is also in the top five alongside IBM, Oracle and Red Hat. Finally, Huawei is in select company in terms of smartphones.

Huawei plans to increase its involvement in software and cloud computing services, and it has successfully developed its own fabless chip unit, Hisilicon, which is designing some of the chips for the firm's smartphones, like the iPhone competitor Huawei P20 Pro. In short, the unit makes Huawei capable of producing smartphones that are on par with Western and Korean rivals.

Huawei is ultimately developing or researching critical base technologies that contribute to China’s development in robotics, artificial intelligence and other key portions of the government's Made in China 2025 initiative. While Huawei is not focused on developing software, building complex algorithms or writing computer code to benefit from big data or artificial intelligence technology breakthroughs like Baidu, Alibaba and Tencent, it is building the infrastructure and physical networks to support those programs. Moreover, many of Huawei's products also have military applications.
On a Global Collision Course

In some ways, the cash flow from the domestic market and R&D investments eventually allowed Huawei to match its foreign rivals in technology — even as trade theft, reverse engineering and the abuse of patents overseas also aided it in its rise. Indeed, the more Huawei expanded abroad, the more scrutiny it attracted from the West. In 2003, Cisco accused Huawei of infringing on its patents, eventually forcing the Chinese company to pull its routers from the U.S. market.

During this period, the United States and China came to view each other as rivals. National security fears increasingly came to dominate Washington's view of Huawei, leading U.S. officials to block the takeover of several U.S. companies when Huawei was involved. U.S. authorities voiced their strongest opposition to Huawei in 2011 when the House Intelligence Committee launched an investigation into that company as well as ZTE, ultimately deeming the two a risk to national security. Since then, Huawei has struggled to break into the U.S. market.

Washington's worries over Huawei will continue on several fronts, including in areas that pose legitimate national security threats. Many U.S. officials harbor concerns that Huawei-produced gear may feature back doors that would give Beijing access to sensitive information. Unsurprisingly, Huawei has flatly denied the allegations, and no back doors have been discovered in its products. Even so, the United States is unwilling to risk any data breaches — especially in relation to smartphones and 5G networks — suggesting that Washington will continue to block Huawei and other Chinese telecommunications companies from doing business in the country and pressure Google and other U.S. tech giants to end any partnerships with the firm.

The United States, of course, is not the only country worried that Huawei could use its infrastructure to gather intelligence. Australia has also pushed back against Huawei and other Chinese companies. Huawei had been hoping to win a contract to build an underwater data transmission cable between Australia and the Solomon Islands, but Canberra blocked its involvement over national security concerns. Additionally, Australia prevented the company from bidding on providing gear for the country's 5G network.

Intriguingly, Huawei has not faced similarly fierce resistance in Europe. The firm's smartphone market share in Europe, for example, now stands at 16 percent and is rising following its introduction of flagship models to compete with Samsung and Apple (in the first quarter of 2018, it registered a 38 percent year-on-year increase in smartphone sales in Europe). The European market is notorious for its privacy demands, but, unlike their U.S. counterparts, European authorities have not perceived Huawei as a threat to security.

In fact, the United States has even highlighted the continued use of Huawei products by its allies in the so-called Five Eyes intelligence bloc: Australia, Canada, New Zealand and the United Kingdom, as a national security concern, although that has not stopped the United Kingdom's National Cyber Security Centre from stating as recently as February that it would continue to collaborate with Huawei. The United Kingdom's Huawei Cyber Security Evaluation Centre Oversight Board produces annual reports on whether the company threatens British national security, but three reviews have failed to raise any red flags about the company.

A second area of concern centers on the broader economic and technological competition between the United States and China. For many in the former, the oft-repeated accusations that Huawei is stealing technology, coupled with the perception that the firm has endless access to state-backed resources, has made the company the symbol for China’s industrial policy and Made in China 2025, its latest initiative. The veracity of the perception is immaterial: The United States has prioritized its efforts to counter the rise of China — and thus Huawei — meaning it will push back against leading Chinese companies as Beijing becomes the United States' peer in economic, military and technological terms.

The United States will continue to expand investment restrictions on Chinese technology companies wishing to enter the United States, but of greater significance is the possibility that Washington could expand export controls on technology to include technologies specifically identified by China’s Made in China 2025 program. If so, authorities could — depending on the scope of the measures — limit U.S. companies or persons from supplying Huawei with various inputs for its products. While a resolution is possible regarding the export ban on ZTE for violating U.S. sanctions on Iran and failing to abide by the terms of a subsequent settlement on the matter, the measures have highlighted the potential damage of blanket export bans for Chinese companies. Huawei has been the subject of similar accusations, meaning Washington could use a potential clash with the company to impose sanctions on it.

Such threats of action will continue to place U.S. companies in an uneasy spot. Some of Huawei's U.S. competitors, such as Dell and IBM in the server market, would stand to benefit from action against the Chinese company, but the interconnected nature of technology supply chains means that it would be difficult to isolate Huawei without also harming U.S. companies. Moreover, Huawei — given its global reach and huge research and collaborative footprint — is a strategic partner for many U.S. firms and will continue to be an important partner for many, such as Google.

Washington's worries over Huawei will continue on several fronts, including in areas that pose legitimate national security threats.

The competition between the United States and China has put Huawei and Beijing in an interesting dilemma. Huawei maintains that it has limited connections to the government in Beijing — an assertion that is somewhat true. It does indeed have a Communist Party Committee, but that’s a requirement for all Chinese companies with more than 50 employees. But in order to achieve many of its commercial goals, Huawei recognizes that it must maintain some distance between itself and Beijing. In fact, if revelations emerged that Huawei devices do possess a back door, it would deal a devastating blow to its global business operations as concerns over cybersecurity grow in importance. Nevertheless, Huawei has become a victim of its own success, becoming an entity that Beijing cannot ignore, as well as a company that is almost too big too fail — at least from China's perspective. Huawei's size presents a Catch-22 for China, which wishes to both control its technology companies in the interests of security and give them free rein in the interests of aiding them commercially.

As Chinese-U.S. tensions grow over economic matters, Huawei will continue to be a focal point. Its rise and continued upward trajectory make it a key strategic weapon for China and, accordingly, a target for the United States. Washington has yet to single out Huawei as a target of its most powerful tools of pressure, but that does not mean it won't consider the option in the future. Regardless of what the United States does, Huawei’s global importance will only rise. And lest there is any doubt, China will view any war against Huawei as a war against the Chinese state.

Matthew Bey is an energy and technology analyst for Stratfor, where he monitors a variety of global issues and trends. In particular, he focuses on energy and political developments in OPEC member states and the consequences of such developments on oil producers and the international oil market. Mr. Bey's work includes studies on the global impact of rising U.S. energy production, the recent fall in oil prices, Russia's political influence on Europe through energy, and long-term trends in energy and manufacturing.

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