ITIF Filing to USTR on Section 301 Investigation of China’s Policies and Practices Related to Tech Transfer, IP, and Innovation

Stephen Ezell October 25, 2017
October 25, 2017

As ITIF has written in numerous reports and testimony—including “Testimony Before the U.S. House Foreign Affairs Subcommittee on China’s Threat to U.S. Advanced Industries” (April 2017), “Stopping China’s Mercantilism: A Doctrine of Constructive, Alliance-Backed Confrontation” (March 2017), “Testimony Before the U.S.-China Economic and Security Review Commission on Chinese Foreign Direct Investment” (January 2017), “False Promises: The Yawning Gap Between China’s WTO Commitments and Practices” (September 2015), and “Enough is Enough: Confronting Chinese Innovation Mercantilism” (February 2012)—for too long, China has systematically flouted the spirit, and often even the letter, of its World Trade Organization (WTO) commitments. Even 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 (IP) 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 (ICT) to solar panels, steel, and automobiles.

It’s important to recognize that China’s objective is to become competitive across virtually all advanced-technology industries—and that the techniques China is using to become so pose a direct, and even existential, threat to America’s high-tech industries and those of foreign counterparts. China’s economic development policy has fundamentally evolved over the past decade and a half from a foreign direct investment (FDI) attraction strategy to an indigenous innovation strategy. That approach was originally articulated in China’s 2006 Medium- and Long-Term Program for Science and Technology Development (MLP), which was updated earlier this year by the “Made in China 2025 Strategy,” which calls for China to develop and become global leaders in at least 10 key strategic emerging industries―including artificial intelligence, integrated circuits, 5G mobile telecom, biotechnology, aircraft, robots, electric cars, and high-speed rail, among others.

Backed with over $330 billion in funds, the strategy seeks to leverage low-interest loans from state-owned investment funds; production subsidies; a vast panoply of mercantilist practices including IP theft or forced tech or IP transfer; and assistance in buying foreign competitors or their technology in order to foster Chinese competitiveness in these sectors. A core objective of the Made in China 2025 Strategy is to supplant foreign imports of advanced-technology products with Chinese domestic production of these same goods. For instance, with regard to ICT-enabled manufacturing (i.e., “smart manufacturing”) the Strategy calls for 80 percent domestic market share of high-end computer numeric controlled (CNC) machines by 2025; 70 percent for robots and robot core components; 60 percent for big data; 60 percent for IT for smart manufacturing; and 50 percent for industrial software. An import substitution mindset clearly lies at the heart of China’s Made in China 2025 Strategy.

One clear manifestation of this is China’s National Integrated Circuit (IC) Strategy, which calls for investing $160 billion over the next decade to create a completely closed-loop semiconductor manufacturing ecosystem in China, including every stage from IC design and manufacturing to packaging and testing as well as producing the related materials and equipment. 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.

The fundamental issue here is that, especially in advanced-technology industries like these, Chinese policymakers reject the principle of “comparative advantage”—the classic trade notion that countries specialize in production of goods or services at which they are the most efficient and then trade for the rest—for they would rather have China achieve “absolute advantage” across any number of high-tech industries. Essentially, China desires to become autarkic, or self-sufficient, in production of advanced-technology goods such as wide-bodied aircraft, semiconductors, biologic drugs, and high-speed rail while still enjoying unfettered access to global markets for its exports of these products. Moreover, it wants to shield domestic enterprises in advanced-technology industries from foreign competitors, allowing them to achieve scale and competitiveness in domestic markets, empowering their subsequent ability to compete more effectively on global markets.

While some contended that China’s accession to the WTO would lead to the gradual yet continuing abatement of its use of innovation mercantilist practices, the reality is that China’s aggressive innovation mercantilism has only grown stronger in recent years. As The Economist writes, “to modernize its economy, China has remained wedded to industrial policies, state-owned enterprises (SOEs), and a ‘techno-nationalism’ that protects and promotes home-grown technologies.” In thatarticle, even Long Yongtu, who as China’s chief trade negotiator in 2001 helped the country win WTO admission, admitted that China is now moving further away from the organization’s principles. As the Mercator Institute for China Studies (MERICS) in Germany writes in its report, “Made in China 2025: The Making of a High-Tech Superpower and Consequences for Industrial Countries,” “Made in China 2025 in its current form [means that] China’s leadership systematically intervenes in domestic markets so as to benefit and facilitate the economic dominance of Chinese enterprises and to disadvantage foreign competitors.” This is diametrically opposed to the fundamental principles that underpin the multilateral trading system embodied in the World Trade Organization.

It’s also important to recognize that, while the U.S. and Chinese economies have been locked in increasingly fierce competition for some time, the last contest was about low- and mid-tech manufacturing, in which Chinese policies hollowed out many sectors of traditional U.S. manufacturing; whereas the current contest revolves around who is going to lead in advanced industries. As Michael Schuman, writing for Bloomberg’s Business Week, notes, the U.S.-China contest now is nothing less than “a battle for the high-tech industries of tomorrow.” As he writes, “China is an economic rival to the U.S., and Washington has to start acting like it.”

In this contest, assimilating foreign technology and knowhow represents 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 compelled joint ventures; or, failing that, then resort to mergers and acquisitions (M&A), often state-directed or state-supported, of key foreign enterprises and their technologies. Finally (though often overlaying the above efforts) China has resorted to outright intellectual property theft, whether of technologies, trade secrets, or even corporate strategies. Not coincidentally, and appropriately, such practices represent several of the focal areas of the administration’s Section 301 investigation, which as stated include an investigation into:

  1. Chinese policies that induce forced technology and intellectual property transfer across a wide range of advanced-technology industries;
  2. Chinese policies that engage in state-directed foreign direct investment as well as mergers and acquisition activity that specifically targets foreign advanced-technology enterprises as part of efforts to move China “up the value chain” in advanced-technology sectors;
  3. Chinese policies that orchestrate cyber-based IP and technology theft in the context of overall commercial espionage;
  4. Chinese policies that compel exchange on unbalanced licensing terms;
  5. Chinese policies that utilize a range of additional “innovation mercantilism” measures that disadvantage U.S. (and other foreign) advanced-technology enterprises.