Is Chinese AI all it’s cracked up to be?

Is DeepSeek an avatar of revived innovation in China or a Beijing-coordinated deepfake? The surge on Chinese stock exchanges at the artificial-intelligence company’s market entry pushed the idea that China could pose a serious challenge to U.S. tech. But early evidence suggests that challenge has a shoddy foundation, which Washington could undermine with effective policy.

China’s AI advances rely heavily on American tech, data and expertise. Both DeepSeek and Ant Group, the other Chinese firm making a stir, present their new AI products as open-sourced, sophisticated competitors to U.S. models. But DeepSeek allegedly relied on illicitly acquired data along with technical expertise from Microsoft and other U.S. tech leaders.

The New York Post reported that Microsoft’s Chinese research labs helped train four key DeepSeek researchers, three of whom spent five to 10 years working at the lab. Anonymous sources told Bloomberg that Microsoft’s security researchers also observed people they believed may be connected to DeepSeek—in Bloomberg’s words—“exfiltrating a large amount of data using the OpenAI interface.” OpenAI itself has alleged that the Chinese company used the American firm’s proprietary models to train its own systems. The U.S. Commerce Department is also reportedly investigating DeepSeek for possible use of Nvidia chips subject to American export controls. DeepSeek hasn’t commented on these allegations.

Considering Beijing’s hostility to the U.S., it’s alarming how much access Chinese tech firms and researchers have to American expertise. The chief technology officers of Alibaba and Baidu, as well as the founder of TikTok, worked at Microsoft’s Chinese labs alongside U.S. experts. Chinese mobile telephone operators Xiaomi and Oppo last year began sensitive research and business collaborations with Google and Apple involving AI. Respectively the third- and fourth-largest handset vendors worldwide, Xiaomi and Oppo both use Google’s Gemini on their smartphones sold outside China.

The West also gives Chinese tech companies crucial financial support, with investors lured by what Franklin Templeton analyst Christy Tan calls the “Xi put.” Foreign investors are confident Beijing has committed to a Chinese version of the “Fed put,” the U.S. central bank’s previous tendency to boost American tech stocks with easy money aided by massive fiscal stimulus.

The stock-market jump at DeepSeek’s unveiling also got a boost from Xi Jinping’s highly choreographed event embracing Ant Group founder Jack Ma, whose firms had been under government assault since his 2020 tirade criticizing Beijing. The People’s Bank of China poured in liquidity last December when it shifted monetary policy from “prudent” to “moderately loose” for the first time in 14 years.

On the regulatory side, Beijing has issued guidance to “undervalued firms”—whose stock values were well under their book value and didn’t reflect their market potential—to take steps to increase shareholder returns by buying back their own shares. Authorities have also directed domestic banks—beneficiaries of China’s growing trade surplus—to make funds available to stockbrokers by collateralizing their shareholdings and authorizing loans to firms buying back their own shares. On top of this very convoluted subsidy, Beijing in late March announced it would inject $69 billion into China’s largest banks to help supply loans to stockbrokers.

Yet the Chinese economy remains anemic. The Rhodium Group estimates real growth was between 2% to 3% in 2024, well below the official number. They project 2025 growth will be slightly above 3% but assume Beijing will raise debt financing to its official 4% target and that the trade surplus will stay above $1 trillion. Fitch Ratings estimates that the overall Chinese government budget deficit in 2025 could be as high as 9% of gross domestic product—when all hidden local government debt and social financing is included—as Beijing struggles with persistent deflation and falling tax revenue.

Weak growth and Chinese tech’s reliance on the U.S. presents an opening for Washington. The Trump administration should take five steps. First, tighten export controls on technology and expertise related to AI or national defense. America should also coordinate export controls with allies on semiconductor production and equipment.

Second, work with Congress to limit Chinese access to U.S. financing, with stronger outward investment controls and limited access to listing on American stock exchanges.

Third, impose sanctions on Chinese banks. Washington has largely not pursued them, though reporting indicates Chinese banks have facilitated and financed illicit commerce such as technology transfer to Russia, drug trafficking and money-laundering, as well as the purchase of sanctioned Iranian and Russian oil.

Fourth, show Chinese tech companies reciprocity. China effectively bars most American firms from its markets by either forbidding them or making entry contingent on ridiculous requirements, such as revealing source code. Washington should bar firms tit-for-tat, especially in response to intellectual property transfers demands from China.

Finally, enlist allies in the fight. The administration has competing foreign-policy priorities, but limiting China’s ability to compensate for losing the U.S. market would measurably enhance success. Early reactions to President Trump’s April 2 tariff announcement, however, signal his administration is off to a poor start at building support among allies.

Such a strategy could undercut the liquidity bubble supporting Chinese shares and its ability to acquire advanced technology, data and expertise without the vast capital investment needed by Western firms to innovate.

Mr. Duesterberg is a senior fellow at the Hudson Institute.