The actual outcome will obviously be path dependent on how both countries approach the economic and geopolitical trade-offs.
How much would a Tech Cold War Cost?
That’s the question DB’s new tech strategist Apjit Walia asks in a new research report, in which he looks at the interplay between the Post Covid Tech Rally and the Tech Cold War, which have emerged as two of the most salient aspects of the current market dynamic. And with tensions between US and China continuing to rise and spread to other parts of the world, the strategist conducts a top-down analysis of the impact on the Global Information & Communications Technology sector from a full-blown cold war.
The report finds that the ensuing demand disruption, supply chain upheaval and resultant “Tech Wall” that would delineate the world into rivaling tech standards could cost the sector more than $3.5 Trillion over the next five years.
But before getting into the details, we update on the current state of the DB Tech Cold War Index. As Walia writes, a nuanced observation of the tariff and geopolitical issues between the US and China over the past few year suggest they are primarily a smaller strategy that is part of a larger Global Tech Cold War. To reduce the noise from the subjective geopolitical commentaries, DB created a systematic measure using machine learning to quantify the intensity of the cold war at any given point of time. It quantitatively analyzes and tracks the sentiment of the Tech Cold War globally. Not surprisingly, the DB Tech Cold War Index has been trending higher since 2016 with peaks coinciding with tit-for-tat measures by US and China on technology IP protection and counter measures. It made an all-time high in April 2020 with the Covid crisis fueling tensions and has spiraled higher since then. The political headlines are matching the sentiment among the populace. Recurrent surveys from April to June show that post Covid tempers remain at elevated levels with 41%+ of Americans and 35%+ of Chinese stating they will not buy each other’s products. An election year in the US further complicates this geopolitical dynamic.
Cold War Impact on Global ICT Sector
US and China have been engaging in an increasing capacity since the 1970s and the level of integration between the two global tech regimes is unprecedented. The integration is a complex demand and labyrinthine supply chain network that has taken 40 years to develop. DB uses a top down approach to ascertain the level of revenues and supply chain links across the global ICT industries to China. To analyze and quantify this complex co-dependent Tech relationship between the two countries is a challenging task, the bank surveyed Tech managements, CTOs, Industry associations and supply chain experts globally. The estimate on the total impact is by no means a solid target but a reference point that should provide context if the cold war escalates significantly and decoupling picks up momentum. The bank’s strategist quantifies the downside impact on the sector from a material escalation of the tech cold war, categorized under the following three broad categories:
- Loss of domestic Chinese demand
- Costs of shifting global supply chain currently located in China
- Higher operating costs due to emergence of two divergent tech standards (the “Tech Wall”)
DB looks at a range of downside scenarios including one of a full-fledged tech cold war and estimate the total impact on the ICT sector from the three factors over a 5-year period to be around $3.5 trillion. And while the bank thinks that 5-8 years is an appropriate time period some supply chain experts believe the time to relocate the cluster of supply chain networks could take as long as 10 years.
Domestic Chinese demand
Globally, China has about 13% of revenues of the ICT sector amounting to around $730 Billion per annum. However, a significant part of this is demand from the Chinese tech sector that is re-exported after some value-add, assembly and packaging (“re-export demand”) – this constitutes supply chain risk. To analyze domestic end demand from China that could be at risk if tensions escalate leading to IP restrictions, product bans and export-restrictions, DB looks at the underlying ICT industry groups and their varied re-export mixes from China. The range varies widely with Telecom services sectors that have minimal revenue exposure all the way to software services that have pure domestic Chinese consumption (low or no re-export). For majority of the ICT sector, the range falls between 25%-75% in re-export mix (semiconductors, electronic components, computer hardware, computer peripherals, electronic equipment sectors). The weighted average of the re-export demand mix for the whole ICT sector comes to 45%. Stripping that out of the total ICT revenues, one gets 55% in current organic Chinese end-demand or $400 Billion in revenues. In the worst case scenario of a full-fledged tech cold war, the ICT sector would stand to lose these revenues.
Supply Chain Risk
A transition out of Mainland China could take 5-8 years to achieve successfully. Lack of infrastructure, clustered networks and skilled labor in other countries versus China are major obstacles. Vietnam, India, Malaysia, Indonesia and Philippines are the primary targets for this transition but most of them would need significant infrastructure upgrades to catch up with the Chinese supply chain cluster strength.
In most categories, exports outstrip imports, except for electronic components, where imports are 3x of exports. Electronic components, such as semiconductors are imported and used as inputs in consumer goods and communication equipment and exported out of China. While Electronic component manufacturers have the risk of end demand from China declining – e.g. semis used in communication equipment, majority of the supply chain costs would fall on the final goods manufacturers who use China as a manufacturing base. When they shift the supply chain outside, component manufacturers would simply shift the destination of where they ship components.
The supply chain risk of the ICT sector is estimated to be the built-up book value that is exposed to China that would require relocation in the event of disengagement. Although book value provides a decent lower bound measure for the capitaldeployed in hard assets, it does not fully account for the economic value of the supply chain network, which may be quite costly to rebuild. To arrive at an estimate of the book value that is exposed to supply chain facilities in China, DB analyzed the revenues and Export/Import ratio of various categories of Tech goods. The book value of the ICT sector tied to China comes to approximately $500 billion.
The average cost of rebuilding the supply chain will be approximately 1.5 to 2x of the book value based on feedback from Tech managements and supply chain experts. Using a sustainable capex rate, it would take 5-8 years to relocate the supply chains. The cost of a transition over a five year period would come to around $1 Trillion.
The statements, views and opinions expressed in this column are solely those of the author and do not necessarily represent those of The Duran.