China’s tech sector blasted for ‘innovation mercantilism’ and other protectionist policies aimed at giving it an unfair advantage

Nation joins India, Indonesia, Turkey, Russia, Nigeria and Canada on list of worst offenders in terms of adhering to such trade-distorting agendas

PUBLISHED : Tuesday, 12 January, 2016, 7:43pm
UPDATED : Tuesday, 12 January, 2016, 7:59pm

China’s efforts to exclude foreign technology companies through new laws and funnel investments into its domestic semiconductor industry are among the worst protectionist policies hurting global innovation, a new US study said.

“We are seeing a disturbing trend where innovation mercantilist policies are becoming the norm rather than the exception, and the global trading system is doing little to try and roll back these destructive practices,” Robert Atkinson, the president of US think tank the Information Technology and Innovation Foundation (ITIF), said on Monday.

The ITIF roughly defines “innovation mercantilism” as a national strategy to achieve prosperity through technology-based exports, while relying on protectionist tactics.

We are seeing a disturbing trend where innovation mercantilist policies are becoming the norm rather than the exception, and the global trading system is doing little to try and roll back these destructive practices
Robert Atkinson

China, India, Indonesia, Turkey, Russia, Nigeria and Canada are implementing the most glaring examples of such protectionist and trade-distorting policies, according to the ITIF’s third annual survey of innovation mercantilism around the world.

It suggested that China’s central government expanded the range of discriminatory measures against foreign technology companies last year through the implementation of new insurance, banking, cybersecurity, counterterrorism and national security laws.

“While China used a mixed set of pretexts — the [NSA whistleblower Edward] Snowden revelations, the need for banking and insurance sector reforms, and new legal frameworks for security issues — to introduce these laws, what really drove the changes was the central government’s aim to refine and expand its innovation mercantilist agenda,” the report said.

“These policies build on China’s ongoing aim to either force foreign technology companies to disclose valuable intellectual property to domestic firms or to force them out altogether in order to protect domestic tech champions.”

On July 1, the Standing Committee of the National People’s Congress — China’s top legislature — established the National Security Law, which became effective on the same day.

This law’s general framework provided for the state to develop key infrastructure in important sectors that are “secure and controllable”.

It also provided that the state “should actively develop independent controllable key technologies in important sectors”.

What it did not provide was the specific requirements to ensure that information technology systems are secure and controllable.

In January last year, China adopted new banking regulations that set annual targets for Chinese banks to reach in terms of their use of “secure and controllable” equipment, culminating in 2019 when three-quarters of their equipment would have to meet this requirement.

China suspended that regulation after trading partners, such as the US, criticised the move.

That rule, however, has not been withdrawn. So Chinese banks have avoided purchasing foreign technology products because of the regulatory uncertainty.

Those laws also did not provide specific requirements to ensure how information technology systems are would be secure and controllable.

The ITIF report pointed out that China was also committed to force local data storage requirements.

It pointed out that Article 31 of the cybersecurity law requires “critical information infrastructure operators” to store citizens’ personal information and other important data collected or generated in the country.

The country’s draft insurance rules last year also specified that all insurance business data that originates in China must remain in the market.

The ITIF survey said China’s flagship policy for its semiconductor industry, which was launched in June 2014, is now driving funds towards an aggressive mergers and acquisitions campaign by domestic companies.

It said the National Guideline for Development of the Integrated Circuit Industry has helped mobilise an initial US$100 billion for the domestic semiconductor sector, mostly through national- and city-level funds as well as funding from state-owned enterprises.

“The country is interested in all parts of the semiconductor supply chain and is keen to leverage its ample capital supply to elevate the capabilities of its domestic industry quickly,” Bernstein senior analyst Mark Li said last week.

Li expected this state-backed “shopping spree” to continue going strong this year, making China drive more mergers and acquisitions in the global semiconductor industry.

Chinese companies have so far spent close to US$15 billion to acquire controlling or minority stakes in 10 semiconductor firms involved in key stages of the chip development process, according to the ITIF.

Tsinghua Unigroup, known as the largest semiconductor design company on the Chinese mainland. Its subsidiaries have been making strategic investments over the past two years to push forward the central government’s goal.

“China claims that its large trade deficit in semiconductors — US$232 billion in 2013 — justifies its efforts to replace foreign imports with domestic production,” the ITIF report said.

It added that the import-substitution scheme for chips was made clear in the “Made in China 2025” initiative launched in May last year, which targeted “40 per cent self-sufficiency in semiconductors by 2020, rising to 70 per cent by 2025”.

The ITIF called China’s justification “a facade” because half of its semiconductor imports are re-exported from China as part of global production networks.

“China also leverages its status as the world’s largest and fastest-growing consumer of [chips] to dictate if and when foreign firms can enter and on what restrictive terms,” it said.

US firm Qualcomm, the world’s largest supplier of mobile chips, agreed to pay a massive US$975 million fine to the Chinese government last year to end a 14-month-long investigation into anti- competitive practices.

Following that resolution, Qualcomm announced that it had agreed to set up a new joint venture with a Chinese company that involved the transfer and development of advanced semiconductor technology.

“China’s approach to its semiconductor sector shows that it wants to have it both ways: using the free market to purchase foreign firms, while disregarding free market principles and processes and international trade rules at home to support domestic firms,” said Nigel Cory, a trade policy analyst at ITIF and author of the report.

Cory said “trade-distorting policies do promise to deliver some short-term gains for nations in employment and economic growth”, but ultimately they lead to adverse consequences such as higher cost of goods and reciprocal protectionist policies by other countries.

Other major examples of innovation mercantilism last year in the ITIF study included India implementing local content requirements for companies bidding for solar energy projects.

Meanwhile, Indonesia last year adopted local content requirements on smartphones. It also released draft rules for the local storage of data, including disclosure of software source code to the government.

In Canada, the ITIF found that its government continues to allow the courts to apply an unrealistic evidentiary burden on pharmaceutical patent applications in order to benefit domestic generic drug producers.