Trump Says He Wants Fairer Trade with China. Will His Latest Move Work?

The Trump Administration is rightly concerned about Chinese demands that U.S. companies transfer technological know-how as a condition for doing business in China. U.S. companies are caught between a rock and a hard place. They can turn down the request and close shop in China, but more frequently, they will succumb to Chinese demands and turn over important intellectual property rights (IPR) to a potential competitor in order to avoid losing access to the large and growing Chinese market.

IPR issues have been front and center in the U.S.-China trade agenda for over 20 years. To be fair, important progress has been made over that time. China has implemented a series of laws and regulations to protect IPR and has stepped up its enforcement efforts, both nationally and locally. Beijing has taken steps to monitor and confiscate counterfeit goods; has leveraged new technologies to combat online copyright infringement; and has set up special IPR courts to adjudicate transgressions.

Nevertheless, IPR issues continue to mount and take new twists. There is widespread agreement in the United States that technology transfer is a serious problem that needs to be addressed. The question is how. The Trump Administration has decided to go down the unilateral path, setting the stage for invoking Section 301 of the 1974 Trade Act. Under this statute, the U.S. is in essence the judge, jury, and executioner, deciding what is acceptable and what is not.

I have four concerns with this approach. First, once the statute is invoked, it’s difficult to see how China would come to the negotiating table. Second, other trading partners whose companies are also impacted by this Chinese practice will think twice before they support our efforts. They abhor Section 301, and many of have experienced its use against them in the past. Third, if the United States were to raise tariffs against China at the conclusion of the 301 investigation, this would violate our World Trade Organization (WTO) obligations and open the door for China to retaliate against the U.S. in such sectors as soybeans, aircraft, and autos. Finally, we would be sure to lose the public relations war, as the focus of attention would shift from China’s unfair IPR practices to the U.S. flaunting the global trading rules.

A better course of action is for the office of the U.S Trade Representative (USTR) to use its time wisely before officially initiating a Section 301 investigation by (1) working with China to get its trade negotiators to the table to find a negotiated solution; (2) sending teams to Brussels, London, Tokyo, and other capitals to gain support for addressing this practice; and (3) identifying WTO-consistent actions that could be taken against China, if necessary.

It’s good to see the Trump Administration finally starting to focus on the inequities in the U.S.-China economic relationship that are most harmful to American interests. The dynamism of the American economy depends on its technological innovations, not on old sectors like steel and aluminum. The American system, with its strong legal system, openness to foreign investment and immigration, transparent corporate governance, superb higher education, and intellectual freedom has a great advantage in a fair competition. But how do we level the playing field when the Chinese government is closing off entire sectors to foreign investment and strong-arming foreign firms into sharing their technology as a price of entry?

In effect, the Chinese government is exploiting the magnetic attraction of its huge market to pursue a kind of high-tech import substitution industrialization strategy. On international platforms like Davos, Xi Jinping espouses open global trade and investment, but the reality in China is far different.

Because the U.S. and China have become so economically interdependent, it’s difficult to get a handle on the problem of coerced tech transfer or other non-tariff barriers to foreign companies without harming ourselves. Most of these issues are not covered by WTO rules. Yet Wendy Cutler reminds us that a unilateral Section 301 approach is likely to alienate the the British, Europeans, and Japanese who are just as frustrated by China’s technological protectionism as we are; and that it will certainly provoke retaliation from Beijing.

We can gain some leverage on the problem by taking advantage of the eagerness of Chinese firms to invest in the U.S. and invoking the principle of reciprocity. But as we consider various forms of restriction on Chinese investment—for example by expanding the scope of the CFIUS reviews beyond a narrow definition of national security or possible legislative action—we should be very careful not to lose the dynamism of our open market economy and turn ourselves into China.

If only American trade laws and the WTO adjudication system were effective in dealing with China Inc. Then I would agree with Wendy. America should follow the rules and uphold the global trading system. But where will that get us? Where has that been getting us?

China’s unique system of authoritarian capitalism is going global, with detailed and specific plans for dominating future leading technologies and capturing “smart manufacturing” supply chains. China is not doing this in secret. The details have been laid out in plans ranging from Indigenous Innovation in 2006, Strategic Emerging Industries in 2009, and Made in China 2025 unveiled in 2015. Under these plans, China is focused on global leadership in such sectors as artificial intelligence, cloud computing, industrial robots, 3D printing, information technology, electric and self-driving vehicles, and semiconductors, among many others.

These policies are focused on zero-sum mercantilism with a goal of self-sufficiency in any sector deemed essential to the industries of the future. The Chinese leadership has established specific domestic market share goals for Chinese companies. This includes 70 percent for “basic core components and important basic materials,” 70 percent for industrial robots, and 80 percent for renewable energy equipment by 2025. To accomplish this, China plans to replace foreign tech companies that lead in China today, and then use their market’s economies of scale as well as standard setting and subsidies to pursue global market leadership.

The tools to accomplish this include a new cybersecurity regulatory regime and national security technology controls that will require foreign companies in China to localize their data, obtain compulsory certifications, and apply for various licensing schemes that could force them into revealing their trade and tech secrets and will likely push them into asset sales and joint-ventures with Chinese partners to survive in the market.

While China has a comprehensive set of tools for accomplishing its goals, the U.S. lacks effective tools for dealing with China’s aggressive “innovation mercantilism.” The WTO is almost useless. If cases are filed, they linger for years, and rulings are often ineffective, ignored or too late to help. China can also employ anti-monopoly raids and price investigations to persuade companies that filing WTO cases against China is not a wise way to go.

So where does this lead us? Treasury, Commerce, USTR, DOD, and other agencies are scrambling to assemble a set of tools to push back. Congress is looking at expanding CFIUS to include reviewing Chinese acquisitions for threats to American economic as well as national security. All of this goes against the grain of the American system. We don’t want to block Chinese investment in the U.S. We don’t want to pursue trade actions that go against our laws and treaty obligations. But it is also becoming increasingly clear that America’s open economic system and adherence to rule of law are weaknesses when facing China Inc.

President Trump has directed U.S. Trade Representative Robert Lighthizer “to examine whether China should be investigated for unreasonable or discriminatory policies that may harm American IP rights, innovation, or technological development.” Mr. Lighthizer should use this opportunity to clearly expose and analyze China’s policies, plans, and practices and what their effect will be on the American economy, American companies, and American innovation and technology leadership.

After the USTR clearly defines the problem, the U.S. needs to assemble new tools and solutions. We certainly have a sufficient number of creative lawyers in D.C. to figure this out.

The striking thing about this administration’s trade policies is how empty they have been. Since the theatrical withdrawal from the Trans-Pacific Partnership in January, we have seen decisions to a) not name China a currency manipulator; b) modestly renegotiate, rather than exit, NAFTA (and ironically, trying to make NAFTA incorporate many features of the reviled TPP); and c) shelve efforts to restrict steel imports on national security grounds. The latest tepid action on China’s alleged forcible technology transfers—to request a probe that will take a year to complete, with no clear indication of what if any sanctions will follow—continues this pattern. Reversing Teddy Roosevelt’s advice, Trump’s approach to trade policy has been to speak loudly and carry a small stick.

There are two main reasons for Trump’s failure to instigate a trade war. First, U.S. companies now derive so much of their income from cross-border activities that a trade war would almost certainly hurt the U.S. economy as much as if not more than our trading partners’. The U.S. business community and most of Trump’s cabinet understands this, and they have been forceful and effective advocates for a more restrained approach.

Second, the ability of the U.S. to launch unilateral trade actions is severely constrained by the rules of the World Trade Organization and other international agreements. Section 301, which is the basis of Monday’s order, is a case in point. It was used in the 1980s and the early 1990s to browbeat Europe, Japan, and China into trade concessions. But since the WTO’s creation in 1995, it has largely lain dormant, because its timetables and remedies are inconsistent with or in violation of WTO rules. Imposing tariffs on China under this law would almost certainly invite severe retaliation, as well as a WTO lawsuit that the U.S. would lose.

The good news is that we can confidently ignore Trump’s campaign threats to upend the global trade order, because the forces of economic realism have won out. The bad news is that by wasting time on symbolic trade politics, the administration fritters away energy better spent on tackling the true obstacles to improved U.S. competitiveness, which include an outdated corporate tax code that discourages investment, and Chinese barriers that restrict U.S. firms’ access to the world’s fastest growing consumer market.

The Presidential Memorandum for the U.S. Trade Representative directs the agency to determine whether to investigate any of China’s laws, policies, practices, or actions that may be unreasonable, discriminatory, or harmful to U.S. intellectual property rights, innovation, or technology development. With globalization, it becomes harder to distinguish exclusively U.S. intellectual property rights. One reason is that high-technology research and development is increasingly moving towards China. China’s leadership has been massively successful at its stated goal of promoting China’s economic interests and growing its economy.

Among China’s many successful economic policies is use of the Ministry of Commerce’s Catalogue of Foreign Investment Industries to control Foreign Direct Investment (FDI). Revised about 6 times since the 1980s, it now allows FDI into 348 different industries, but blocks completely, or requires Joint Ventures with local companies for only 63 industries. The blocked industries are those related to industries the government considers essential to national interest, national resources, such as mining and forestry, or defense, such as military, publishing, or Internet.

Another major reason for the movement towards China is that the government policies support growth and development, including construction of factories, industrial development zones, and a very large university-educated population. In 2000, China graduated 1 million 4-year college graduates per year. In 2015, about 7 million students graduated from regular 4-year colleges.

Granted, the rapid increase results in a diminishment of quality for a large number of those graduates, but still leaves a very large pool of qualified workers.

As to IP that is clearly the property of U.S. companies, much of the issue is lack of effective enforcement. The issue has been the same since before China joined the WTO. The hope was that membership in the WTO would increase the incentives for IP protection. However there are so many factories willing to produce pirated goods, and so many others willing to register Chinese copyrights and design patents for products they have seen from foreign companies. That is a different issue from the common occurrence of trademark squatting, where a company can register a trademark in China for a brand it saw in another country. Unless the brand is famous in China, there is no violation of trademark law. While the legal principle is the same in any first-to-file nation, the result is different with China because it has become the world’s manufacturing base, and exports those goods to nearly every country in the world.

The size and scope of piracy and infringement has overwhelmed the legal infrastructure, and most foreign companies’ appetite for legal actions. U.S. industry groups like the International Intellectual Property Alliance have complained for decades about China’s policies that fail to stop or reduce piracy of music, movies, software, etc. China has been on USTR’s Priority Watch List or Watch List for nearly every year since 1985. IP enforcement problems still plague business, even in the Internet age. Online platforms’ Take Down Notice procedures, for example, can be so onerous as to defeat the purpose of enforcement. For example, while Alibaba’s English-language platform has a very good response system, other Chinese language platforms, like Tmall.com and Taobao.com, require third party validation of IP rights, such as a court judgment.

However, changing economics have created more opportunity for American IPR. Chinese consumers know that the quality of products they can purchase in China tend to be substandard, with a high rate of failure or piracy. This causes Chinese consumers to be eager to purchase genuine products for themselves. This was a substantial factor in the recent rapid increase in Chinese tourism.  The amount of Chinese consumer spending on tourism and shopping is estimated at $261 billion per year as of 2016. The numbers are significant enough that the Chinese government will institute a new policy to monitor overseas spending by RMB bank and credit cards. Of that total, $33 billion was spent in the U.S. That amount is far from sufficient to resolve the $347 billion trade imbalance between China and the US in 2016. However, the outflow of Chinese tourists in recent years has convinced American businesses that the Chinese market can be a source of income. American businesses are selling more into China than ever before, as educated Chinese consumers search for genuine goods, especially for home appliances, pharmaceuticals and neutraceuticals, etc. where the health and safety of their families is concerned.

A measure of the growing Chinese recognition of foreign brands is that foreign brands are finally winning administrative and legal actions based on fame. (Coca-cola and McDonald’s have long been sufficiently ubiquitous in China to be considered famous, but few other foreign brands could achieve that level of recognition.) For example, FACEBOOK was registered for use on beverages by a local Chinese company, but Facebook, Inc. challenged the registration based on its two Chinese trademark registrations. Facebook, Inc. initially lost its opposition, not surprisingly since Facebook.com is not available on the Chinese Internet. Nevertheless, Facebook, Inc. finally won after multiple appeals. The decision did not explicitly state that FACEBOOK is a famous trademark in China, but that finding is implicit. Other famous mark cases have involved Chinese transliterations of foreign celebrity names, such as BEYONCE, LEBRON JAMES, and QIAODAN, a transliteration of Jordan, from MICHAEL JORDAN. Many such marks have found some measure of protection as famous marks in recent years, often after lengthy battles with multiple appeals.

One of the strengths of the Chinese system is that the government has continuously adjusted its policies on foreign investment and IP Protection. When China’s accession to WTO was negotiated in the 1990s, China was a very different place than it is now. The U.S. government must adjust to the changing world. Opening a 301 investigation is a 30-year old tool. If used as part of a reconsideration of the trade relationship to produce data from which U.S. policy makers can derive new policies to rebalance the U.S. economy, it will be a very helpful exercise.However, if only used to shift blame to China, without addressing upgrades to U.S. infrastructure, it will not be helpful.

It is time to refocus on China, to recognize its growth and success, and consider what the U.S. can do to stay attractive to high-tech industries. Reconsidering its status as a developing country is one way to do that. One of the questions the U.S. can ask: Should the world’s second most powerful economy still receive developing nation privileges?