UALA LUMPUR: Technology is at the heart of the US-China dispute as technology, not the bilateral trade deficit, is the key US focus, S&P Global Ratings says.
In a report entitled "A new great game -- China, the US, and Technology" issued on Wednesday, it said technology is also what matters for China.
“Slower technology transfers caused by persistent trade and investment friction would make it much harder for China to successfully rebalance its economy, S&P Global's China senior analyst group said.
S&P Global Asia-Pacific chief economist Shaun Roache said China's long-term growth objectives rely on continuous technology improvements and productivity enhancements to close income gaps with the West.
"Slower tech transfer means slower potential growth and a much tougher rebalancing," he said.
The report focused on what the conflict might mean for technology supply chains, often the source of technology and growth spillovers for emerging economies, and link that to China's macroeconomic prospects.
US trade and investment policies aim to slow technology transfer unless China does more to protect intellectual property, widen market access for foreign firms, and level the playing field with domestic champions.
“In our view, the trade balance is of second-order importance. The short-term effects of this 'Great Game' are manageable.
Absent a major escalation, China can offset the impact of higher tariffs through domestic stimulus and allowing the exchange rate to depreciate," S&P Global economist Vince Conti said.
S&P Global's China senior analyst group said in its view, it is the long-term impact that matters more and deserves more attention.
This is because China still needs foreign technology to lower its reliance on debt-fueled growth, while sustaining its catch-up with rich countries.
China is already producing more of its own technology. China's own domestic contribution to total output in the technology hardware sector rose about 10 percentage points to almost 90% between 2008 and 2014.
China's success in climbing the value-added chain reflects, in part, its own efforts in improving human capital and creating fertile ground for innovation and learning.
Roache said nonetheless, the research also confirms that foreign firms still provide key inputs along its supply chains through trade and investment. One obvious example is China's hefty net imports of integrated circuits used in high-end electronics technology.
“As another example, S&P Global Market Intelligence data show foreign firms account for over half of the suppliers of 657 Chinese exporters that rely on technology inputs. Many of these suppliers are headquartered in the US and the rest of Asia.
“Of the suppliers from the US and Asia, more than half are in tech manufacturing industries. Without these foreign inputs, which may be hard for China to produce itself anytime soon, 'new economy' sectors may struggle to sustain rapid growth.
"If the US and China are unable to resolve their trade conflict, the long-term effects on China's macro-credit prospects are significant, and are likely being underestimated," said Roache.
He said a comprehensive resolution is achievable but this may take time.
Although not S&P Global Ratings base case, the risk is that the dispute drags on, China suffers from a deep slowdown in potential growth, and policymakers respond with excessive stimulus and low quality, credit-intensive growth in a bid to sustain rapid catch-up.