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Should the U.S. Start a Trade War with China over Tech?

A ChinaFile Conversation

At an already volatile moment in the United States’ trade relationship with China, the Treasury Department appears to be planning new restrictions on Chinese investment into what the White House calls “industrially significant technology” in the U.S. The measure would attempt to combat the effects of Beijing’s support for its technology sector, which the Trump administration says gives Chinese tech an unfair advantage and endangers national security. In May, the U.S. Congress advanced a bipartisan bill that would strengthen the Committee on Foreign Investment in the United States (CFIUS), which reviews foreign investments in the U.S., a move that could slow Chinese efforts to acquire critical technologies. The United States is not the only front in this brewing “tech war”: policymakers in the United Kingdom, Australia, Canada, and Germany have all recently considered or implemented greater oversight of foreign investment from China.

How should the U.S. government address the industrial policy challenges posed by Chinese techno-nationalism? Is it a threat to U.S. security? Is a contest for technological dominance between the United States and China inevitable? —The Editors

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The narrative that China is ‘winning’ by cheating has grown more popular since the 2008 financial crisis, most significantly with the anti-China protectionism of Donald Trump. Though politically appealing, this narrative obscures the reality that China became the world’s second largest economy largely because its leaders decided to follow the rules of the existing liberal economic order. The fact that Chinese companies like Alibaba and Tencent have climbed up the value chain to become global household names reflects the achievements of China’s opening; at the same time, the problems of overcapacity and excessive debt in “strategic sectors” like steel and coal testify to the limits of state industrial policy. This is not to trivialize the barriers that still impede market access or to deny the influence of techno-nationalism on Chinese policymaking, only to point out that China did not cheat its way to the top—but is becoming more competitive in the game of globalization.

Although China presents a real challenge in terms of the scale of its industrial policy and IP infractions, these problems are not new and there is danger in responding with knee-jerk economic nationalism. Vulnerability is a feature of economic interdependence, not a bug. Policies that aim to reduce vulnerability by restricting Chinese investment risk throwing out the baby with the bathwater. The problem with this approach is that it is difficult to objectively determine what is sensitive technology. China famously invented both gunpowder and tea, but it was imperial policy to guard the secret of tea cultivation while no regard was paid to the technology of fireworks making. This industrial policy backfired spectacularly in the Opium Wars (in which both tea and gunpowder played prominent roles). This history lesson also shows that industrial policy is often captured by special economic interests and not driven by strategic thinking. It is unclear whether expanding CFIUS’s purview would lead to decisions whose “national security” basis are any more substantial than those in the MoneyGram and Qualcomm deals. An escalating ‘tech-war’ with China would not only deny American consumers of Chinese technologies from mobile payments to high-speed rail and prevent talented Chinese from contributing to the American economy but also undermine the structural foundation for peace and stability that economic engagement has built.

Finally, nothing would vindicate Chinese techno-nationalists more than for the U.S. to follow them down the road of state-intervention in the technology sector. The U.S. has a thriving innovation eco-system but its political system is poorly equipped to do industrial policy. China is the opposite, it struggles to retain world-class talent but has no shortage of state planners. It does not make strategic sense for the U.S. to try to compete technologically on Chinese terms. The U.S. should instead strive to sustain the openness that is integral to its dynamism and competitiveness. Rather than reinforcing national boundaries, the U.S. should to align itself with internationalists interests in China to push for greater reciprocity in market access.

The U.S. government has a limited ability to push back against Chinese efforts to develop a more independent tech industry. Programs to support “indigenous innovation” in “core technologies” have decades of history (including both successes and failures), and China’s government has only doubled down in the face of recent U.S. threats. 

Most recently, the case of Chinese company ZTE demonstrated a U.S. capability and willingness to deny Chinese companies access to crucial high-tech components. Whether the for-now-reversed “denial order” was an impartial function of sanctions enforcement (never a favorite policy tool among Chinese officials) or a shot across the bow in a trade and investment confrontation, the imperative for China to develop independent capabilities in semiconductors has grown only stronger—more strongly tied to national security.

U.S. tariff threats (or a tit-for-tat escalation to trade war) will not turn back Chinese efforts in the industries officials see as crucial to national security and prosperity. Made in China 2025, one in a long line of national development programs, will not be substantially altered, especially in the context of public threats from the U.S. administration. Barring major domestic disruptions, China’s economy and technological competitiveness will continue to grow for some time.

U.S. actors, therefore, should strive for intelligent competition and employ well-placed pressure against development plans and discriminatory legal structures that harm their interests. This means using all available legal measures to penalize Chinese competitors for violations of WTO and other international trade disciplines—a task best undertaken, alas, in close coordination with the allies the present administration has alienated through misguided trade actions making disingenuous use of national security exceptions.

The U.S. government should support the bottom-up innovation that comes from U.S. companies and universities. It should not cut federal research funding or impose nationality-based immigration policies that drive away global talent, including from China.

U.S.–China trade and supply-chain links should be defended for their efficiency and as a counterweight to rising cold-war dynamics in both countries. There is a need for improved national security reviews, and they should be as transparent and impartial as possible. To maintain credibility, they should never blend national security with economic competitiveness.

U.S. officials and businesspeople should act strategically in pressuring China. They should not try to reverse the unstoppable tide of “indigenous innovation,” but rather lobby and push back where leverage is greatest.

And finally, U.S. companies should compete around the world against Chinese competitors by committing to independence from government and employing strong and transparent design principles to ensure human rights such as privacy and freedom of expression are built in—commitments and design choices Chinese companies cannot credibly make.

In the strategic competition for technological dominance, the U.S. can win only by sprinting ahead, not just building walls. Anxieties over Chinese techno-nationalism are provoking policies that are reactive and defensive, such as potential restrictions on Chinese investments and acquisitions in “industrially significant technology.” While countermeasures are clearly warranted – given China’s history with and continuation of tech transfer and industrial espionage – U.S. policy must be targeted and calibrated to balance the risks and benefits of the deep “entanglement” and extensive interdependence between U.S. and Chinese innovation ecosystems. At worst, policies that result in harmful escalation or prove too indiscriminate in their impact could damage U.S. competitiveness, at a time when the U.S. must reinvigorate its own innovation ecosystem.

China’s approach to indigenous innovation has involved the exploitation of tech and knowledge transfers, including in academia. For example, an engineering student named Liu Ruopeng took advantage of the openness of academic collaboration while at Duke and has since leveraged that sensitive research on metamaterials in support of the Chinese military. Certain joint laboratories and research collaborations that involve partners closely linked to Chinese military research will also merit greater scrutiny. In response to these issues, there is a clear rationale for the review of such partnerships and screening on the basis of ties to a foreign military or government.

But the openness that is so integral to American innovation should be sustained and safeguarded. Visa restrictions that target Chinese STEM students purely on the basis of nationality are damaging and discriminatory.

It is critical to look beyond today’s concern with limiting China’s access to U.S. technologies, and instead recognize that the essential strategic challenge will be China’s emergence as a “science and technology superpower” (科技强国). Increasingly, China is progressing beyond relying on foreign technologies and instead aspiring to achieve truly original and disruptive innovation. China has the ambition – and the potential – to emerge as a true leader in emerging technologies: its rapid advances in biotechnology, artificial intelligence, and quantum technologies are starting to reflect truly “made in China” innovation. The U.S. thus confronts a competitor that is not merely seeking to steal but rather aspiring to “offset” its current innovation dominance.

The U.S. must go on the offensive, not fearing competition with China, but rather embracing it. That is, the U.S. must recognize and reinforce its own enduring advantages in science and technology through policies that have enabled and can revitalize its own innovation ecosystem. These include a focus on STEM education at all levels, robust and sustained investments in basic research, and openness to welcome talented scientists and entrepreneurs, including from China. Although the U.S. should not attempt to pursue what Jack aptly characterizes as ‘American techno-nationalism’ and China-style industrial policy in response to Chinese indigenous innovation, greater public-private partnership to expand cooperation and coordination in research in strategic technologies, including quantum computing, will be critical going forward. Rather than fighting a “tech cold war,” the U.S. must rise to the challenge of a rising China.

Just as China pursues asymmetric strategies in the military domain, using cheaper missiles and mines to offset expensive American carriers and bases, so too is it pursuing asymmetric approaches in the economic domain. Chinese technology theft and transfer – through cyber-espionage, forced technology sharing, state-backed purchases of Western companies, and the repatriation of researchers – constitute a longstanding, documented, and asymmetric shortcut to the technological frontier relative to laborious and costly American investments in research and innovation.

As China gains ground in a technological race with the United States, many argue that the United States should “run faster” by recommitting to basic science research, high-skilled immigration, and funding for STEM research. These are necessary prescriptions, and they are increasingly important as China itself becomes a leading innovator, but they are insufficient to cope with China’s technological challenge. Running faster will do little good if China takes shortcuts to the finish line; pouring funds into innovation will produce little economic and strategic advantage if those breakthroughs are promptly transferred to China.

The essential question for U.S. policy, then, is not simply whether and how the United States should run faster—virtually all agree that it should—but how it should recalibrate economic and technology interdependence with China without undermining its own technological dynamism.

The United States needs a “managed interdependence” with China in the technology domain, one that recognizes how essential China’s innovative ecosystem in hardware is to U.S. companies—as Matt Sheehan has shown—but also acknowledges that certain practices in technology investment, education, and supply chains need adjustment. When it comes to sensitive technologies, Washington should not treat all activities of a Party-state that blurs the public and private as if they are as benign as those of a U.S. ally.

A policy of “managed interdependence” should not be thought of as a one-off legislative quick-fix or a set policy destination. Instead it should involve a process of routine adjustment and long-term calibration, and it should be based on several principles.

  • Consultation: By regularly consulting industry and academia through formal structures – such as the now-disbanded FBI National Security Higher Education Advisory Board—Washington can better ensure protections for sensitive technology are balanced with imperatives for innovation and research.
  • Institutionalization: By institutionalizing capabilities for coping with technology transfer, perhaps through an executive branch office, Washington can better coordinate policy in multiple domains (e.g., academia, investment, start-ups) and nimbly readjust U.S. policy as circumstances change.
  • Level-Headedness: Policymakers should not overhype the risks. Not all Chinese companies, even those that are state-owned, pose a potential security risk; scrutiny should focus on sensitive sectors. Conversely, those who caricature efforts to prudently manage interdependence with China as “racist” or “McCarthyite” should endeavor to more substantively join the debate and avoid the misuse of such charged labels.

As Evan Feigenbaum has shown, Chinese techno-nationalism is not new and is unlikely to disappear. Dealing with it will be a long-term and iterative process and an increasingly prominent feature of the bilateral relationship.

The White House’s proposed investment restrictions reflect the premise that China’s rise is a threat to America’s technological supremacy. But diffusion of technology between firms and across nations is the key to increasing productivity both at home and globally. Beijing sees restricting technology transfer as tantamount to preventing it from progressing to high-income status and escaping the so-called middle-income trap.

It is the way this diffusion occurs, however, that is the problem. Much attention has been focused on China’s alleged theft of intellectual property. To the extent it exists, it should be and is being addressed. The more serious concern is whether China is violating WTO guidelines, in particular by “forcing” foreign firms to transfer their technology to China as a condition for accessing its domestic market. China denies that this is the case and examples of “forced” transfers are nearly impossible to document.

What is fair depends on globally accepted norms. WTO guidelines indicate that as part of the bargain to protect IPR, “developed country members are required to provide incentives for their companies to promote the transfer of technology to least-developed countries.” While the reference is to the poorest countries, the principle is seen as applying to all developing countries and regulations that conflict with this sense are often ignored. What makes China’s actions seem unfair is the huge size of its market. China sees access as a benefit to be negotiated since if one firm is unwilling, there will likely be others that are. There is logic, however, in arguing that China’s size gives it monopsony power in dealing with foreign firms, and that this needs to be addressed.

That joint ventures can be a powerful vehicle in transferring knowledge is the subject of a recent NBER study which concludes that joint ventures between US and Chinese firms led to benefits from technology transfer that were twice as high as those done through wholly foreign owned investments. Because the Chinese partners were likely to be large and productive, stronger firms, U.S. firms also benefited from the arrangement. Thus, the authors conclude that doing away with joint ventures might weaken the benefits for both sides.

A commonly held view is that as China’s economy becomes more developed, institutions will evolve, leading to better IPR protection. This, in fact, is happening; 96 percent of the respondents to the 2018 AmCham China survey responded that China’s IPR enforcement has improved in recent years. But there is still much that China can do to change the atmospherics, such as strengthening the effectiveness of its adjudication courts and eliminating the requirement for joint ventures in some activities. WTO guidelines also need to be revised to address contested investment practices. Meanwhile the best means to resolve America’s specific concerns is to revive discussions on the Bilateral Investment Treaty that the White House has put on hold but the EU has now agreed to address.

Much analysis of what we at Eurasia Group have been calling the “U.S. China Tech Cold War” tends to treat the U.S.-China relationship as if the two countries’ technology industries were operating in separate spheres. In fact, the U.S. and Chinese tech economies are hugely interdependent. Worries about a “ U.S. loss of competitiveness” and a new “arms race” in artificial intelligence, quantum computing, 5G, semiconductors, and other domains neglect what I have dubbed “competitive entanglement” between the U.S. and China. This entanglement spans areas including basic research, applied engineering, venture capital and investment, and the international standards-setting process for AI just getting underway.

The U.S. and Chinese firms in the driver’s seat in advanced technology are heavily invested in talent and startups on both sides of the Pacific. Microsoft and Google benefit from China’s large pool of software engineers, while U.S. auto industry, sensor, and AI firms partner with Chinese AI leaders on autonomous vehicles. U.S. semiconductor companies dominate China’s huge market for the GPUs that are driving AI applications in the cloud, and China’s AI startup sector is awash in U.S. money.

Semiconductors are another example of interdependence – one where the U.S. enjoys overwhelming advantages. China’s $200 billion plus a year in semiconductor imports fuels innovation by major western players. Joint ventures in China between companies like Qualcomm, Intel, and Broadcom facilitate some technology transfer, but also produce new products for both China and global markets. U.S. semiconductor manufacturing equipment makers also benefit as China invests heavily to boost its production capabilities. Most of the facilities under development remain 1-2 generations behind the cutting edge, and pose little threat to the U.S. dominance.

The deployment of next-generation 5G mobile networks will be a smorgasbord of globalized technology supply chain collaboration and competition, with collaboration from European firms, with no one country’s companies achieving “dominance.”

Decoupling global supply chains poses huge risks to U.S. company innovation and competitiveness, the depth of which is underappreciated in debates about the U.S. “confronting” China’s industrial policies and market access restrictions. The current trade and technology conflict rightly highlights these issues, but the debate tends to neglect the legitimate innovation and technology development that does not rely on IP theft or forced technology transfer.

How to deal with China’s technology-related policies? The first step is to acknowledge that U.S.-China tech competition is not a zero-sum game. A more nuanced approach could include a version of Rush Doshi’s “managed interdependence,” focused on bridging Asia, Europe, and the U.S. by bringing international best practices to China in areas such as cybersecurity reviews and cross border data flows. This could be coupled with a serious government push on long-term multilateral engagements and pressure to reduce market access barriers and counter industrial policies.

A thoughtful long-term strategy that recognizes both China’s problematic ind U.S.trial policies and its critical role in global technology innovation is more likely to produce a win-win that maintains U.S. technology excellence, while allowing China to move up the value-added chain.