China and US must meet halfway on investment and technology ties

On June 27, US President Donald Trump announced his intention to enforce a markedly tougher foreign investment screening regime against China and other designated countries of concern. A wider swathe of Chinese investors, henceforth – be it majority or minority equity-holders, seed-stage venture capitalists, or IP licensees, are to be barred from acquiring militarily and industrially significant technologies in the United States. Earlier last month, Trump had imposed a 25 percent duty on $50 billion of goods from China. Duties on the first tranche of 818 tariff lines representing $34 billion worth of goods went into effect in July constituted the single most regressive trade policy enforcement action against a major trading partner since the Smoot-Hawley tariff impositions of the Great Depression era.

The Trump administration’s hardline policy measures stem from an investigation earlier this year of China’s technology transfer, intellectual property rights (IPR) and innovation policies, conducted under Section 301 of its trade statute. The (predictably) damning findings of the investigation report were essentially two-fold. First, it claimed to find that in its rush to become an advanced manufacturing superpower, the Chinese government unfairly facilitates the systematic acquisition of US companies and assets by Chinese enterprises in order to obtain cutting-edge technologies and IPR. And, second, the Chinese government uses its administrative licensing procedures and foreign ownership restrictions, including joint venture requirements, to coercively pressure US companies to transfer technologies on non-market terms to their local partners when investing in China. Together, these policies and practices are unreasonable and discriminatory, had harmed US commercial interests, and undermine the fairness of the international economic system.

There are grains of truth, and mis-truth, in these accusations.

China does not formally require foreign companies to surrender their IP at their time of investment. Doing so would be a material violation of China’s 2001 WTO Accession Protocol, which forbids the conditioning of investment approvals on the transfer of technology. The US has implicitly admitted this by acknowledging that it has no legal case to mount at the WTO against Beijing on this count. By and large, foreign firms voluntarily share their IP on commercial terms to make inroads into the vast and profitable Chinese market.

It is noteworthy too that Washington’s Section 301-based determination standards do not require the trading partner to have violated US rights. An “unreasonable” policy that harms US commercial interests can simply be one which “while not necessarily in violation of, or inconsistent with, the international legal rights of the US, is otherwise unfair and inequitable”. Unfair and inequitable is a vague and infinitely malleable standard. While this shallower burden of proof may appear to be an adequate basis to impose retaliatory tariffs and investment restrictions in the US’ eyes, it is understandably not so in China’s view.

Equally, while it is accurate to state that Chinese government entities facilitate the acquisition of cutting-edge technologies in the US, it is not fair however to characterize that as “theft.” To the contrary, these entities, including provincial governments, typically pay top-dollar for such IP. Their purposes stem from the desire to induce the acquired US company to set up shop back home within the burgeoning technology corridors in China and thereby foster an advanced manufacturing eco-system that incubates innovation domestically.

This having been said, US accusations are not meritless.

The subsidized acquisitions in the US by deep-pocketed, state-backed Chinese buyers does end up distorting the play of market forces in these high-tech sectors. The privileging of the Chinese joint venture partner as the nodal point of contact with regulators during the investment approval process, does lead at times to opaque deal-specific requirements that end up resulting in the leakage of the US investors’ IP. By design or accident, this risk of loss of technology and knowhow is exacerbated when the Chinese joint venture partner maintains parallel operations within the same business line independently that compete with the joint venture operation. In rare instances, the foreign investment regime in advanced manufacturing sectors has even been known to become more restrictive (than liberalized), as Chinese enterprises – after having digested, absorbed and re-innovated foreign IP and technology, scale up their operations behind the tariff and investment barriers and elbow out foreign competition.

These unappealing practices need to be discarded and the investment regime progressively liberalized – especially as local investors ‘go out’ and China becomes a significant capital exporter and acquirer in its own right.

In the late 1980s, Deng Xiaoping’s coastal development strategy irrevocably altered the course of global manufacturing – and China’s role therein – by engineering a far-sighted liberalization of China’s trading regime. Foreign-invested and export-oriented enterprises in China’s coastal regions were at the foundation of this transformation. As their supply chains took root, an ever-increasing share of parts and components began to be sourced domestically, such that China now retains a lock over the development of these supply chains in key medium-technology intensive sectors such as computers and electronics.

Thirty years later, should President Xi Jinping engineered a similarly far-sighted liberalization of China’s investment regime – much like Deng had engineered of its trade regime three decades earlier, China will become the advanced manufacturing center, and leader, of the world by mid-century. Paring down China’s negative list, scrapping it joint venture requirement (except for critical sectors), and allowing foreign-invested enterprises to retain control over their intellectual property on Chinese soil is a necessary condition for this transformation to take effect.

This article originally appeared in China Watch.