Is the US right to cry foul about forced technology transfer to do business in China – and what is Beijing’s position?

  • Foreign companies’ concerns about having to share their tech secrets are among the matters being discussed in ongoing US-China trade talks
  • Beijing’s draft foreign investment law could legislate against the practice, but businesses are sceptical about enforcement
PUBLISHED : Thursday, 10 January, 2019, 11:32pm
UPDATED : Monday, 14 January, 2019, 2:08pm

As the trade war between China and the United States rumbles on, its focus has shifted from deficits and surpluses towards more technological matters. Washington is not only demanding Beijing end its practice of forcing foreign joint venture partners to transfer technologies to their Chinese collaborators, but also scrutinising the work of Chinese researchers based in the US. In the second of a series of reports on these issues, we look at the allegations of forced technology transfer.

Of the many criticisms of China from the Donald Trump administration, those on forced technology transfer have been among the fiercest.

It is a chronic and prevalent problem that Beijing uses “a variety of tools” to pressure the transfer of technologies to Chinese companies, the United States argues, and more tolerance of it would cause heavier losses to the US, especially with Beijing pursuing world dominance in many industries.

The Chinese government has rejected such accusations both publicly and in government-to-government communications.

Forced technology transfer (FTT) means that when a foreign company wants to enter the Chinese market, it has to surrender its technology to Chinese companies through a joint venture agreement, or in some cases regulations. Some foreign companies have said they were forced to do so.

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If there were coercion, Chinese officials claim, foreign companies could choose not to invest in China. If multinationals make hefty profits on the mainland then they benefit from investing in China under terms which are neither discriminatory nor coercive, they have said.

As China and the US hold talks after agreeing a 90-day truce in their trade war in December, their wide differences on how China acquires technology is threatening to help catalyse a broader rivalry between the two powers.

According to the office of the United States Trade Representative (USTR), China’s foreign ownership restrictions, such as those for joint ventures and equity, and various administrative review and licensing processes, require or push for technology transfer from US companies.

In an update in November, the USTR said China’s practices relating to technology transfer, intellectual property and innovation were “unreasonable or discriminatory and burden or restrict US commerce”.

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Evidence it cited was mainly surveys conducted by business chambers in China. Last July, the 2018 China Business Report of the American Chamber of Commerce in Shanghai stated that 21 per cent of 434 respondent member companies had felt pressure to transfer technology in exchange for market access.

This pressure was particularly evident in hi-tech industries, with 44 per cent of aerospace and 41 per cent of chemical companies having reported facing “notable” pressure to transfer technology.

Among other surveys cited by the USTR, the Business Confidence Survey 2018 of the European Union Chamber of Commerce in China indicated similar concerns.

It found that “unfair technology transfers continue despite government assurances”, with 19 per cent of 532 respondent chamber members reporting that they had felt compelled to engage in unfair technology transfers to maintain market access in China.

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The USTR has acknowledged the unlikelihood of a company accusing China directly, because there would be concerns about possible retaliation against their business in China.

That reticence could be driven by the value of China’s huge market and the barriers at Beijing’s disposal, regarding market access, administrative reviews and its licensing process, for instance.

Dan Prud’homme, associate professor at Pôle Universitaire Léonard De Vinci in Paris, classifies China’s FTT policies into three categories, based on their consequences.

The consequence of one kind of FTT is “losing the market”. The most well-known requirements imposed on foreign firms to transfer their technology to a foreign-Sino joint venture as a precondition for market access in China have been found in the traditional auto industry and high-speed trains industry.

Forced technology transfer is very real. I face the issue every day
International lawyer Steve Dickinson

There have also been local government procurement requirements in the wind power industry for products – or a percentage of them – to be made domestically, and excessive disclosure of trade secrets to government authorities required in industries such as the chemicals and pharmaceutical industries in exchange for licensing and other regulatory approvals, Prud’homme said.

The second kind of consequence is “violating the law”. It has been written into China’s technology import-export regulations that local Chinese firms must own improvements they make to technology involved in foreign-contracted research.

If the foreign partner does not comply with the policy, it is breaking the law.

Under the third FTT circumstance defined by Prud’homme, foreign companies find they are left with “no choice”.

When the letter of Chinese law is not followed in practice, unfair court rulings in civil intellectual property litigation will result in unexpected losses of technological knowledge, he said.

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“With the exception of the ‘no choice’ circumstances, foreign firms have some choice about whether or not they want to comply with the so-called FTT policies,” said Prud’homme, who wrote a paper released last year, co-authored with three European researchers, based on surveys and interviews with executives in multinationals’ China operations from 2013 to 2016.

“So ‘forced’ may not be the most accurate word to describe those policies,” he said. “However, in all cases, the choice not to comply with the policies is met with consequences … some of which are quite significant.”

Joint ventures’ Chinese partners and local governments are motivated to get as many technologies as they can
A Chinese executive who did not wish to be named

A Chinese executive who has worked with two automotive joint ventures in Shanghai said foreign partners had largely tolerated forced transfer of non-key technologies because they wanted to maintain a good relationship with Chinese government.

When Beijing allowed foreign carmakers to set up in China in the early 1980s, they were required to enter joint ventures with local manufacturers so that the latter could learn and grasp key technologies.

A requirement that foreign partners hold a stake no higher than 50 per cent in their Chinese joint ventures is to be abolished by 2022, it was announced last year under pressure from the US.

“Developing a strong auto sector has been a national industry strategy, with the focus on grasping key technologies,” the executive said on the condition of anonymity.

“Guided by that goal, joint ventures’ Chinese partners and local governments are motivated to get as many technologies as they can.”

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While inferior Chinese carmakers bluntly copy car designs, skilled players try to learn details from their foreign partners in day-to-day operations, she said.

“However, foreign partners have been so shrewd that they keep key technologies and know-how top-secret and do not release new models until the last minute, which has generally helped prevent technology leakage or theft,” she said.

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The auto industry may be an example of a failure of FTT policies for China, as foreign companies have earned hefty royalties and profits in a prosperous market and China has failed to grasp key technologies. However, there are other cases in which China has been a winner.

“Forced technology transfer is very real. I face the issue every day,” said Steve Dickinson, a lawyer with international law firm Harris Bricken who has represented many US companies in China.

A well-known case is high-speed rail, Dickinson said, “and Chinese government called the theft the paradigm example of indigenous innovation”.

In 2004, China’s Ministry of Railways tendered for bids to make high-speed trains reaching 200km/h (124 mph). To win the contracts, foreign companies had to form joint ventures and make significant transfers of technology to their Chinese partners.

The Chinese buy one or two token items, insist on full training for the item, and then they copy the item using that training or using information that they have hacked off the internet
International lawyer Steve Dickinson

Alstom of France, a Japanese consortium led by Kawasaki, and Bombardier’s German subsidiary won parts of the contract.

Bombardier-Sifang and Kawasaki-Sifang transferred technology to subsidiaries of China South Rail and Alstom-Changchun transferred technology to China North Rail. Both China South Rail and China North Rail were state-owned enterprises.

In 2005, Siemens of Germany won a contract with China North Rail’s Tangshan Railway Vehicle Company to supply technology to build 60 passenger trains for the high-speed railway linking Beijing and Tianjin.

The first three trains were constructed in Siemens’ German plant, while the remaining 57 trains were made at China North Rail’s Tangshan plant in Hebei, China. Over a thousand of China North Rail’s technical staff were trained at Siemens facilities in Germany as part of the deal.

With all the technologies acquired and learned, China has become a strong rival to the world’s high-speed train producers.

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While Beijing attributed that success to people’s intelligence in absorbing the technologies, Western countries are aggrieved about the loss of cutting-edge technology and have criticised the FTT practices involved in significant Chinese government procurement contracts.

“The Chinese buy one or two token items, insist on full training for the item, and then they copy the item using that training or using information that they have hacked off the internet,” Dickinson said.

“If a foreign entity comes to us before they give everything away, we give advice and draft agreements that prevent the forced transfer and the resulting theft. This normally means that the deal does not go through.”

Peter Drysdale, a professor at the Australian National University, said: “All catching-up economies, including in the US, have acquired the technologies of more technologically advanced economies to engineer their industrial growth. Most of it is not stolen.

“Most technology is purchased directly or through purchasing advanced machinery and equipment and it is learned. In the process, technology is adapted and it is also created. China is no different.”

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Chinese firms are spending around US$40 billion a year on technology purchases. The amount spent on licence fees and royalties has been increasing rapidly in recent years, with year-on-year growth of this exceeding 30 per cent in the first half of 2018.

“Foreign firms enter into these arrangements because they are profitable,” Drysdale said. “While there are successes and failures, the average growth of the profits of foreign firms in China is very strong.”

Nicholas Lardy, senior fellow at the Peterson Institute for International Economics, said the US was exaggerating the FTT issue.

“There has been a problem for years that firms don’t want to supply the information on forced tech transfer that the USTR needs to bring a World Trade Organisation [WTO] case, because they fear retaliation by the Chinese government,” Lardy said.

The [FTT] accusation is by and large invalid, but there are grounds to believe that at the margins there might be some suspect practices
Sourabh Gupta of the Institute for China-America Studies

“Why can’t the USTR organise a group of companies in an industry to bring a case, spreading the burden of any retaliation? My view is that if firms don’t want to supply the information, maybe they aren’t really being that disadvantaged by tech transfer.”

American companies’ China operations posted US$36 billion in profits in 2015, which rose to US$39 billion in 2016, data released by the Chinese government showed.

From a narrow perspective, performance requirements which include technology transfer are specifically barred by China’s WTO accession protocol, said Sourabh Gupta, a senior policy specialist with the Institute for China-America Studies in Washington.

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“If China’s policies in this regard are out of line, the US could easily have brought a case to the WTO,” Gupta said. “On this specific issue of technology transfers, USTR did not – acknowledging that China’s policies are consistent with its international legal commitments.

“The [FTT] accusation is by and large invalid, but there are grounds to believe that at the margins there might be some suspect practices.

“And because of the top-down and intertwined executive branch and judicial branch of a one-party system, it rests on Beijing’s shoulders to supply the assurance that these practices, however marginal, are in no way systemic.”

Regardless of the validity of the accusations, China has promised to change.

Huo Jianguo, former research head with the Ministry of Commerce, said: “China has always claimed forced technology transfer does not exist.

“The latest development is Beijing recognises the problem may exist at local government levels as part of preconditions for market access, so it is addressing the issue through legislation.”

A draft foreign investment law was revealed last month as pressure mounted on Beijing. It states that forced technology transfer through administrative measures is prohibited, and technology cooperation should be “based on voluntarily agreed terms and business practices”.

Chinese analysts said this was a potential guarantee for multinationals, but foreign businesses are sceptical about enforcement of the law.

Shi Yinhong, director of the Centre on American Studies at Renmin University, said China was likely to agree to set up a monitoring mechanism so that the US could keep an eye on enforcement.

“If the US does not press too hard for a radical change, China is likely to make concessions,” Shi said.

Such promises are not expected to dispel fears and distrust from the US that have built as China has become a threat to it, while the involvement of China’s government in its economy remains heavy, analysts said.

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“The US has cause to complain in the first place largely because a disproportionate share of US investment flows into China are in hi-tech manufacturing: pharmaceuticals, chemicals, electronics, automobiles, etc,” said William Ridley, a researcher at the University of Colorado.

“These are sectors where proprietary intellectual property is particularly important and in which China is eager to get its hands on advanced foreign technology.

“Whether Trump was president or not, US authorities would not tolerate a large economy – one that is rapidly catching up on the technology frontier – continuing to force technology transfer as China does, particularly as Chinese firms like Huawei get closer to their American counterparts.”

Chad Ohlandt, senior engineer with the Rand Corporation, an American research organisation, said distrust stemmed from China’s intellectual property (IP) management system.

“In China, it is essentially a centrally managed IP system, party-controlled scientific institutes, and companies create IP and party-controlled courts selectively enforce IP laws,” Ohlandt said.

“IP is managed for the benefit of those in power, not for the creators or the public.”

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While China takes advantage of the US’ “open and innovative” environment to actively invest in American start-ups and innovative companies, China’s own market is closed off and state-run, said Lee Branstetter, professor with Carnegie Mellon University in Pennsylvania.

The state-driven “Made in China 2025” initiative to take on Western tech giants in cutting-edge technologies, unveiled in 2015, has intensified US fears, said Cheong Kee Cheok, senior adviser with the Asia-Europe Institute at the University of Malaya.

“It is not just US businesses that are concerned,” he said. “The US strategic community is also alarmed by China’s rise.”

As the trade war between China and the US rumbles on, its focus has shifted from deficits and surpluses towards more technological matters. Washington is not only demanding Beijing end its practice of forcing foreign joint venture partners to transfer technologies to their Chinese collaborators, but also scrutinising the work of Chinese researchers based in the US. In the second of a series of reports on these issues, we look at the allegations of forced technology transfer.