Why the US-China dispute is about so much more than a trade imbalance

  • While the evidence is unclear, charges of unfair trade policies are Beijing’s biggest concern in the negotiations with Washington
PUBLISHED : Sunday, 13 January, 2019, 11:04pm
UPDATED : Monday, 14 January, 2019, 1:52pm

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 third of a series of reports on these issues, we look at the how the US is using legislation to address its grievances.

When it comes to the trade war against China, US President Donald Trump likes to wield one particularly big stick: a piece of legislation that allows him to take unilateral action, free from the constraints of international treaties and World Trade Organisation (WTO) agreements, against another country.

Section 301 of the 1974 Trade Act may sound arcane to anyone not closely following the progress of the trade war negotiations, but in fact it is one of Washington’s most effective weapons in bringing pressure on Beijing.

For the president to be able to take such action against another country, an investigation initiated under Section 301 must first establish that it is engaging in “unfair trade policies”.

And, a month before Trump fired the first shot in his trade war against China last April, US Trade Representative (USTR) Robert Lighthizer produced just such a report.

Lighthizer – nicknamed the “trade war general” by Bloomberg – produced a 200-page document under Section 301 which reads like a charge sheet.

It paints a sinister picture, accusing the Communist Party of carefully orchestrating an elaborate onslaught against American businesses to weaken the economic and technological advantages enjoyed by the US.

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The report provided the legal basis for Trump’s escalating series of tariffs against Chinese imports, currently on hold at 10 per cent on US$200 billion worth of Chinese goods, but threatened to rise to 25 per cent if the 90-day truce does not end in agreement.

The USTR investigation was ambitious and extensive – going far beyond the US trade deficit with China – with almost every area of China’s economic and investment activities coming under scrutiny, particularly those related to technology.

The main allegations levelled against Beijing included forced technology transfer, discriminatory investment restrictions, predatory acquisitions, cyberattacks and espionage.

Beijing has vehemently protested the report’s findings and challenged the use of Section 301 at meetings of the WTO, which itself is coming under intense pressure from the Trump administration.

“The USTR feels China’s intellectual property and technology transfer are practices that are not sufficiently covered under the World Trade Organisation. The WTO is not clear enough on these issues,” said Craig Allen, president of the US-China Business Council.

“At least in my view, the Section 301 investigation is very significant. But what we hope from the [ongoing trade] negotiations is the lifting of Section 301 sanctions on March 2,” he said. 

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Some Chinese experts see the USTR report as an underhanded way to stop China from challenging US leadership in technology and the global economy.

Even more moderate observers agree the report lacks verifiable evidence and seems to have selectively chosen data and examples to fit its narrative. Some cases, particularly those related to technology transfer and outbound investment, are misleading and exaggerated, they say.

“The US administration has labelled China as one of its two strategic competitors, and the USTR report highlights US concerns on intellectual property and state-owned enterprises, although many of its accusations are not factual,” said Wang Huiyao, director of the Centre for China and Globalisation, a think tank based in Beijing.

For instance, the USTR report omitted findings by the American Chamber of Commerce in China and the European Union Chamber of Commerce in China which showed intellectual property rights (IPR) protection had gradually improved, although much work remained to be done, he said.

The EU Chamber of Commerce in China, in its “2018 Business Confidence Survey”, noted that European business sentiment about IPR enforcement had shown a steady improvement in recent years, with the proportion of respondents who viewed IPR enforcement as adequate or excellent rising from 13 per cent to 34 per cent between 2013 and 2018.

“There is still progress to be made, however, with 29 per cent of respondents reported having suffered significant damage as a result of IPR infringement,” the report said.

In 2016 AmCham China published an article on its website that said that while IPR protection remained a significant problem, it had “improved immensely since the 1990s, when it was the cause of major frictions between China and its trading partners”.

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By last year, further improvements were reported by AmCham China in its 2018 “American Business in China White Paper”.

“China continues to promote an innovation-driven society. In line with this, several reforms have been made to improve IP protection, such as introducing specialised intellectual property courts, the revision of the trademark law and the patent law, and the incorporation of the plant variety protection concept into the seed law,” AmCham China said.

“Although IP challenges receive considerable attention from Chinese authorities, significant issues continue to challenge both foreign and domestic companies operating in China.”

One Chinese trade policy adviser said that Beijing needed to “seriously study the [USTR] report, including its 1,139 footnotes” and “to think if there is room to fix the shortcomings in its rules and industrial policies”.

“No matter how mistaken or distorted the report is, this is a chance to create a [more] level playing field in China,” he told the South China Morning Post.

But the war of words rages on.

In an update to its report in November, the office of the USTR said China “did not respond constructively and failed to take any substantial actions to address US concerns”.

It said China had “largely denied” there were problems with its policies on technology transfer and intellectual property protection.

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China’s Ministry of Commerce responded swiftly that the accusations in the updated Section 301 report were “groundless and completely unacceptable”.

The “bad industrial and trade practices” documented in the USTR report are a key aspect of the negotiations which have been under way since December when China and the US agreed to the 90-day tariff ceasefire.

While many economists in China agree Beijing should use the opportunity to restart its stalled economic reforms, they also see the Section 301 report as biased and unfair.

The report was drawn largely from a public hearing and written submissions to the USTR, which sought comment from private sector advisory committees.

It received about 70 written submissions from trade associations, US companies and workers, academics, think tanks and law firms.

Chinese law and trade associations also submitted their opinions but these were largely disregarded in the final document.

The following are some examples from the four key issues listed in the USTR reports:

Unfair technology transfer

In many sectors that Beijing considers important, it requires foreign companies to set up joint ventures with Chinese partners. Car manufacturing and new-energy vehicles are two sectors cited in the report as examples of how China is using that strategy to gain access to US technology.

The report alleges that China is using complicated and non-transparent administrative approvals and licensing processes to force foreign companies to comply with its policy.

“Vaguely worded provisions and uncertainty about the applicable rules provide Chinese authorities with wide discretion to use administrative processes to pressure technology transfer, restrict investments to protect domestic competitors, or otherwise act in furtherance of industrial policy objectives,” it said.

“In addition, China imposes administrative licensing requirements on more than 100 different business activities, such as food and drug production, mining, or telecommunications services, for all enterprises in China.”

The report claimed these information disclosure requirements put US companies at risk of sensitive information leaking, with some of the reviewing panellists drawn from their competitors.

The USTR cited business surveys and studies, consultancies and Chinese government documents in the past decade to support its claim that China deliberately forced technology transfers.

At a USTR public hearing in October 2017, Stephen Ezell, vice-president of global innovation policy at the Information Technology and Innovation Foundation, said China had tied General Motors’ access to government subsidies for electric vehicle purchases to the company’s willingness to disclose key information about its electric hybrid car. Ford had been forced to do the same, he said.

The Chinese side said the claim was exaggerated and not supported by concrete evidence.

In response, Richard Ellings, of the Commission on the Theft of American Intellectual Property – who was also cited in the report – said most interviews had to be done in private and remained anonymous because companies were worried about possible reprisals by the Chinese government.

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The report quoted an annual member survey by the US-China Business Council in 2017, which found 19 per cent of companies polled had been directly asked to transfer technology to China in the previous year.

But the Section 301 report did not say that the council also found that the request had come most frequently from a Chinese business partner, rather than a government entity.

Of the companies that said they were asked to transfer their technologies, 33 per cent said the request came from a central government entity and 25 per cent said it came from the local government.

China watchers said the numbers were not solid evidence but agreed that China could do more.

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Two US consultants based in Beijing said on condition of anonymity that part of the problem was the poor negotiation skills of US companies.

“Forced technology transfer is not a state-sponsored issue, although there may be one or two cases,” said one.

“Part of the reason is insufficient preparation and the poor negotiation capabilities of US companies.”

Lu Xiang, a US specialist with the Chinese Academy of Social Sciences, said there was no national policy on forced technology transfer, but many Chinese partners may have acted aggressively to acquire technology from their foreign partners.

“Since the US has raised concerns, it is necessary for China to be more specific in its rules to eliminate any possible leeway,” he said.

A former trade official in Beijing said the fact some Chinese partners in these joint venture were state-owned companies made it difficult for them to convince the US side that contracts on technology transfer were based on market rules and “voluntary principles”.

In a draft law on foreign investment unveiled in December, China’s legislative body proposed to ban administrative authorities from forcing technology transfers from foreign companies and to offer equal opportunities for them to participate in drawing up industrial standards with domestic rivals.

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Discriminatory licensing restrictions

The Section 301 report also criticised discriminatory restrictions faced by American businesses, with some laws and regulations – such as the regulations on administration of the import and export of technologies (TIER) and contract law – applying unequally to domestic and foreign firms.

“TIER imposes a number of procedural requirements that the contract law does not,” it said, adding that the regulations imposed restrictions – such as indemnity items and ownership in technology improvements – on US companies to negotiate market-based terms for technology transfer into China.

“Under TIER, all technology import contracts must be notified to China and copies of such contracts provided. If such contracts are not duly notified as required, the foreign technology licencer is denied the ability to remit any royalty payments back to its home country,” the report said.

“From the outset, foreign imported technology licensers, including US technology licensers, must meet obligations that are not imposed on their Chinese competitors under the contract law.”

The US did not provide examples to support the argument but a Chinese law professor, who declined to reveal his name due to a reluctance to criticise the government, admitted there was room for China to fix the conflicts in the laws.

“This is what China should eradicate – the conflicts of rules – and offer equal treatment, but this part matters little to the overall investigation,” he said.

Cyberattacks and cyberespionage

“Starting in 2008, experts expressed concern that China’s cyberintrusions were becoming more frequent, more targeted, and more sophisticated,” the USTR report said.

Citing law enforcement and private sources, it said the Chinese government had gained access to trade secrets, technical data, negotiating positions, and sensitive and proprietary internal communications in the fields of oil exploration, shale gas technology and high-end steel production.

Beijing, it said, provided the intelligence to Chinese state-owned enterprises “through a process that includes a formal request and feedback loop, as well as a mechanism for information exchange via a classified communication system”.

The USTR report also cited a 2013 study by cybersecurity firm Mandiant that the People’s Liberation Army stole data from at least 141 organisations, 115 of which were based in the US, representing 20 major business sectors, to support commercial interests in China.

In another example included in the report, the US Steel Corporation filed claims of unfair trade actions – under Section 337 of the 1930 Trade Act – to the US International Trade Commission in 2016 against China’s largest steelmaker Baosteel, claiming it “was known to be one of the beneficiaries of China’s state-sponsored cyberattacks”.

But the US Steel Corporation dropped the cyberattack claim in February 2017 due to a lack of evidence.

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Lu, the US specialist from the Chinese Academy of Social Sciences, said China and the US had yet to a reach consensus on how to identify state-backed cyberattacks and the US had barely offered any evidence to China.

“The accusations are groundless,” he said. “Both countries really need to sit down and take the time to negotiate. There is still a long way to go.”

In its updated report in November, the USTR quoted cybersecurity firms and government reports that China had increased cyberattacks on the US in 2018, including hacking related to an Alaskan trade mission to China and around the US midterm elections.

The accusations of cyberintrusion and cybertheft have expanded to include Australia, Germany, Japan and South Korea, with the USTR report citing Japan and Australia considering bans on Chinese hi-tech giants ZTE and Huawei.

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However, Arne Schoenbohm, head of Germany’s Federal Office for Information Security, has expressed scepticism about the calls to boycott Huawei.

He told news weekly Der Spiegel in December that the IT watchdog had found no evidence Huawei could use its facilities to spy for the Chinese government.

“For serious decisions such as a ban, you need evidence,” Schoenbohm said, after his office examined Huawei products and visited its facilities in Bonn.

Outbound investment

Nearly 100 pages of the USTR report are devoted to China’s outbound investment policies over the past two decades, from government approval procedures through financial support to attempts at acquiring foreign technologies.

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Despite Chinese participants in the public hearing asserting that all Chinese investment in the US was driven by market considerations rather than government policies, the USTR said it “does not find these statements persuasive”.

The report quoted official US data on investment flows, as well as US research agencies such as Rhodium Group and the American Enterprise Institute, to assert that China’s outbound investment had grown significantly in the technology and innovation-related sectors targeted by Chinese industrial policies.

It also said Chinese state firms had “played an important role in shaping these investment flows”, with a quarter of acquisitions from 2000 to 2016 carried out by state firms, representing a 29 per cent share in the total transactional value, according to Rhodium data.

In its updated report, the USTR said multiple data sources – including Chinese and foreign media reports, data providers and company filings to stock exchanges – had concluded that “China’s sustained interest in acquiring technology in the United States increasingly relies upon venture capital investment”.

The report reviewed in detail China’s acquisitions in seven hi-tech sectors in the US: aviation, integrated circuits, information technology, electronics, biotechnology, industrial machinery and robotics, renewable energy and the car industry.

It also listed 25 outbound acquisition projects conducted or led by Chinese state-owned companies.

“In short, the Chinese government has the means and authority to prevail (and does prevail) on Chinese firms on where to invest, what to invest, and how much to invest,” the report concluded.

Shou Huisheng, a researcher on international relations at Tsinghua University, said foreign companies were worried about losing competitiveness in the face of Chinese state intervention in outbound economic and investment activities.

“This has caused the US-China rivalry to escalate to a full-blown competition about ideology,” he said. “There have been voices in China to reform the state support model given the severe external situation we are facing, because a strong government hand will ultimately strangle enterprises’ ability to innovate.”

More than a trade imbalance

Whatever the outcome of the US-China negotiations, it is clear from the wide-ranging claims of the report that the dispute is about much more than a trade imbalance.

How effectively Beijing can address the concerns it raises may determine the success or otherwise of the talks and what happens after the current truce ends.

Chinese government advisers have said that even though both sides want to find a solution to the trade war, it is unrealistic to expect Beijing to make any radical changes of its industrial and technology catch-up policies, while Washington is unlikely to stop boycotting Chinese technology.