In Testimony for Section 301 Investigation, ITIF Commends Trump Administration for Undertaking Serious Investigation of Chinese “Innovation Mercantilism”

October 10, 2017

WASHINGTON—The Information Technology and Innovation Foundation (ITIF), a leading science and tech policy think tank, today applauded the Trump administration for pushing back against China’s systematic pattern of “innovation mercantilism” in strategically important industries. ITIF Vice President for Global Innovation Policy Stephen Ezell provided the following oral testimony to an interagency committee conducting a Section 301 investigation into China’s policies and practices related to technology transfer, intellectual property, and innovation:

I’m Stephen Ezell, VP Global Innovation Policy at the Information Technology and Innovation Foundation, and I thank you for the invitation to testify this morning. We commend the Trump administration for undertaking a serious investigation of China’s economic, trade, and IP practices and the impact these have on U.S. industries, enterprises, and jobs.

As ITIF has written in numerous reports and testimony, for too long, China has systematically flouted the spirit, and often the letter, of its WTO commitments. More than 15 years after it joined the WTO, China remains the world’s leading purveyor of “innovation mercantilism,” fielding every mercantilist policy imaginable—from forced transfer of technology or intellectual property as a condition of market access to IP theft, production and export subsidies, and currency and standards manipulation—in sectors ranging from information and communications technology to solar panels, steel, and automobiles. We need to be quite clear that China’s objective is to become competitive across virtually all advanced-technology industries—and that the techniques it is using to become so pose a direct, even existential threat to America’s high-tech industries along with foreign counterparts. For instance, its Made in China 2025 Strategy is a $300 billion plan for China to become a global leader in 10 strategic industries, including semiconductors, biotechnology, aircraft, and robots.

One clear manifestation of this is China’s National Integrated Circuit Strategy, which calls for investing $150 billion over the next decade to create a completely closed-loop semiconductor manufacturing ecosystem in China. The strategy unabashedly calls for China to reduce imports of U.S. semiconductors by half in 10 years and to eliminate them entirely within 20 years, with 70 percent of the semiconductor chips used by companies operating in China to be domestically produced by 2025 and China becoming the world’s leading semiconductor manufacturer by 2030. Put simply, in advanced-technology industries like this, China fundamentally rejects the notion of comparative advantage and instead seeks absolute advantage, wanting to limit imports and replace them with domestic production while still enjoying unfettered access to global markets. Assimilating foreign technology is a key component of China’s efforts to become a global innovation leader. In general, China’s technology acquisition strategy is to develop the technology indigenously if possible; if not, then to try to induce technology or IP transfer, often as part of joint ventures; or, failing that, then to resort to mergers and acquisitions or even outright IP theft.

Chinese technology or IP transfer requirements as a condition of market access continue unabated and have affected scores of enterprises in industries as diverse as aviation, automotives, renewable energy, and high-speed rail. While China’s federal government often denies such practices exist by arguing they’re not codified in writing, government action in China can and does occur by informal “administrative guidance,” and many provincial governments retain such policies. For instance, global auto brands have long been allowed to manufacture cars domestically in China only through joint ventures with local partners. More recently, China made General Motor’s access to subsidies for electric-vehicle purchases contingent on the company handing over the IP behind its electric hybrid car, the Chevrolet Volt. Ford was forced to do the same.

A related issue is that China’s Technology Import and Export Regulations (or TIER) compel exchange on unbalanced licensing terms by: (i) mandating Chinese ownership of any technology improvements for imported technology, and (ii) imposing other non-market terms in licensing and technology contracts. Effectively, this means that foreign licensors, including U.S. firms, cannot negotiate to own any improvements or share them with Chinese licensees, even if both licensing parties desire for the improvements to be shared or owned by the foreign licensors. Another discriminatory aspect of TIER is that it obligates a foreign licensor into China to offer an indemnity against third-party infringement to the Chinese licensee. This obligation only attaches to a foreigner licensing technologies into China; the Chinese licensor has no such obligation. It should be noted that a submission made by the China Chamber of Commerce for Import and Export of Machinery and Electronic Products (CCCME) contended that China’s TIER accords with the UN International Code of Conduct on the Transfer and that TIER’s relevant Articles 24 and 27 are “neutral in nature.” Yet they are not, for CCCME omits that the articles only apply in a “technology import contract.” The Administration should seek adjustment of these policies, or else enact a regime whereby if Chinese entities seek licenses in the United States they must license on the same terms foreigners are required to license into China.

China is the leading instigator of IP theft and the cost to the U.S. economy in terms of counterfeit goods, pirated software, and theft of trade secrets may have grown as high as $600 billion. But a growing concern is “secure and controllable” measures mandated by China’s National Security Law and Cybersecurity Law, which may induce or force the localization of design or manufacturing processes of ICT products such as semiconductors or servers. Under the pretext of attempting to ensure technology products are secure, some of these measures require the disclosure of sensitive information and/or that the IP rights be Chinese-owned. Moreover, Chinese draft technical measures require American innovators of microprocessor technology enterprise servers and operating systems to disclose design secrets. Also problematic are China’s Multi-level Protection Scheme (MLPS) and draft regulations published in July 2017 for Critical Industries Information Protection (CIIP), which effectively induce the localization of IP in China as a condition of market access by mandating adoption of indigenous IP.

Elsewhere, China’s Anti-monopoly Law (AML) has been designed to treat legitimately acquired IP rights as a monopolistic abuse, even when firms charge market-based IP licensing fees to Chinese companies. Moreover, when China’s State Administration for Industry and Commerce finalized its antitrust-related enforcement regulations in 2015, its interpretation of Article 7 of China’s AML made certain refusals to license critical IP to third parties, most notably including competitors, a potential violation of the AML. But treating a refusal to license IP as an antitrust violation is inconsistent with global antitrust law and even a violation of TRIPS commitments.

Finally, whereas most FDI represents profit-seeking greenfield investment made on market-based terms, Chinese FDI is increasingly state-directed and predicated on the acquisition of technology, knowhow, or talent in advanced-technology industries. Over the past 16 years, 99 percent of Chinese U.S.-bound FDI in electronics and 95 percent in ICT sectors were for acquisitions. In the semiconductor industry alone, through early 2016, there were more than 27 attempted, completed, and/or pending international M&A deals, totaling $37 billion, initiated by Chinese-headquartered firms, with more than half these deals financed or backed by Chinese government. Whether its Micron, Aixtron, or Lattice in semiconductors or Germany’s Kuka in robotics, Chinese FDI is increasingly state-backed and financed, directed at gaining technological capacity and ultimately global market share across a range of advanced-technology sectors.

ITIF’s post-hearing testimony will elaborate on these practices in more detail, but we want to stress that we hope the outcome of this investigation is to prevail upon China to abide by the commitments it made in joining the WTO and to embrace rules-based, market-determined, enterprise-led commerce in accordance with the foundational principles of non-discrimination reciprocity, and national treatment in a way that benefits China, the United States, and the world.