Chinese Innovation Mercantilism is Hurting American Manufacturers              

On Wednesday, December 5, 2012, Robert D. Atkinson, President of the Information Technology and Innovation Foundation (ITIF),  testified before the House Science Committee Subcommittee on Investigations and Oversight in a hearing on “The Impact of International Technology Transfer on American Research and Development.” His testimony was based on his book,  Innovation Economics: The Race for Global Advantage (Yale University Press, 2012) and the ITIF report, “Enough is Enough:  Confronting Chinese Innovation Mercantilism,” released February 2012.

Atkinson began his testimony by stating, “A nation’s investments in research and development (R&D) are vital to its ability to develop the next-generation technologies, products, and services that keep a country and its firms competitive in global markets. Until recently, corporate R&D was generally not very mobile, certainly not in comparison to manufacturing. But in a “flat world” companies can increasingly locate R&D activities anywhere skilled researchers are located….the United States has seen its relative competitive advantage in R&D and advanced technology industries decline. While the United States still leads the world in aggregate R&D dollars invested, on a per-capita basis it is falling behind.”

He testified that the “decline in America’s innovative edge is due to a number of factors, not the least of which are failures of federal policy, such as an unwillingness to make permanent and expand the R&D tax credit, limitations on high-skill immigration, and stagnant federal funding for R&D. But the decline is also related to unfair practices by other nations that collectively ITIF has termed as ‘innovation mercantilism.’”

The ITIF report cited above states that these policies “include currency manipulation, relatively high tariffs (three times higher than U.S. tariffs), and tax incentives for exports.” In addition, “some policies help Chinese firms while discriminating against foreign establishments in China. These policies include “discriminatory government procurement; controls on foreign purchases designed to force technology transfer to China; land grants and rent subsidies to Chinese-owned firms; preferential loans from banks; tax incentives for Chinese-owned firms; cash subsidies; benefits to state-owned enterprises; generous export financing; government-sanctioned monopolies; a weak and discriminatory patent system; joint-venture requirements; forced technology transfer; intellectual property theft; cyber-espionage to steal intellectual property (IP); domestic technology standards; direct discrimination against foreign firms; limits on imports and sales by foreign firms; onerous regulatory certification requirements; and limiting exports of critical materials in order to deny foreign firms key inputs.”

The report explains that “in the last decade China has accumulated $3.2 trillion worth of foreign exchange reserves and now enjoys the world’s largest current account balance. In 2011, it ran a $276.5 billion trade surplus with the United States. This ‘accomplishment’ stems largely from the fact that China is practicing economic mercantilism on an unprecedented scale. China seeks not merely competitive advantage, but absolute advantage. In other words, China’s strategy is to win in virtually all industries, especially advanced technology products and services… China’s policies represent a departure from traditional competition and international trade norms. Autarky [a policy of national self-sufficiency], not trade, defines China’s goal. As such China’s economic strategy consists of two main objectives: 1) develop and support all industries that can expand exports, especially higher value-added ones, and reduce imports; 2) and do this in a way that ensures that Chinese-owned firms win.”

The report states that “because China is so large and because its distortive mercantilist policies are so extensive, these policies have done significant damage to the United States and other economies…The theft of intellectual property and forced technology transfer reduce revenues going to innovators, making it more difficult for them to reinvest in R&D. The manipulation of standards and other import restrictions balkanizes global markets, keeping them smaller than they otherwise would be, thereby raising global production costs…if Chinese policies continue to be based on absolute advantage and mercantilism…the results will be more of the same: the loss of U.S. industrial and high-tech output, and the jobs and GDP growth that go with it.”

Chinese mercantilist policies are unprecedented in their scope and size. Atkinson testified, “A principal arrow in China’s innovation mercantilist quiver is to force requirements on foreign companies with respect to intellectual property, technology transfer, or domestic sourcing of production as a condition of market access. While China’s accession agreement to the WTO contains rules forbidding it from tying foreign direct investment to requirements to transfer technology to the country, the rules are largely ignored.”

He added, “Rather than doing the hard work to build its domestic technology industries, or better yet focus on raising productivity in low-producing Chinese industries, China decided it would be much easier and faster simply to take the technology from foreign companies… China’s government unabashedly forces multinational companies in technology-based industries-including IT, air transportation, power generation, high-speed rail, agricultural sciences, and electric automobiles-to share their technologies with Chinese state-owned or influenced enterprises as a condition of operating in the country.”

The ITIF report explains that in 2006, “China made the strategic decision to shift to a “China Inc.” development model focused on helping Chinese firms, often at the expense of foreign firms. Chinese leaders decided that attracting commodity-based production facilities from multinational corporations (MNCs) was no longer the goal…The path to prosperity and autonomy was now to be ‘indigenous innovation’…”

The document “advocating this shift was ‘The Guidelines for the Implementation of the National Medium- and Long-term Program for Science and Technology Development (2006-2020)’…to ‘create an environment for encouraging innovation independently, promote enterprises to become the main body of making technological innovation and strive to build an innovative-type country.’”

Some 402 technologies, from intelligent automobiles to integrated circuits to high performance computers were included so that China could seek the capability to master virtually all advanced technologies, with the focus on Chinese firms gaining those capabilities through indigenous innovation.

However, China is not alone in trying to force the transfer of technology and R&D from foreign multinationals ─ Indonesia, Malaysia, India, Portugal, and Venezuela have the same goal.

Why do so many nations engine in innovation mercantilism? Atkinson testified that there are two principle reasons. “First, these nations have embraced a particular and fundamentally limited model of economic growth that holds that the best way to grow an economy is through exports and shifting production to higher-value (e.g., innovation-based) production. Moreover, they don’t want to wait the 20 to 50 years it will take to naturally move up the value chain through actions like improving education, research capabilities, and infrastructure, as nations like the United States did. They want to get there now and the only way to do this is to short-circuit the process through innovation mercantilism. This explains much of China’s economic policies. The Chinese know that to achieve the level of technological sophistication and innovation that America enjoys will take them at least half a century if they rely on only their own internal actions. So they are intent on stealing and pressuring as much of American (and other advanced nations’) technology as they can to their own companies. If you can’t build it, steal it, is their modus operendi.”

Atkinson added that the second reason why these nations do this is because they don’t believe in the rule of law and the principles of free trade like Western nations and much of Europe do. These nations also “work on the ‘guilt’ of Western, developed nations. The narrative goes like this: the West has used its imperialist powers to gain its wealth, including at the expense of poor, developing nations and now it wants to “pull the ladder” up after it. This means turning a blind eye to intellectual property and giving our technology, including pharmaceutical drugs, to nations almost for free. After all, we are rich and they are poor because we are rich.”

The reality is that forced technology transfer is enabling China and other nations to gain global market share. It is doing “considerable harm to U.S. technology companies and to the U.S. economy, if for no other reason than reducing their profits and ability to reinvest in the next wave of innovation.”

Atkinson posed the question, “So what should the U.S. government do? He responded that “this is a difficult question because if there were easy solutions, they would have been done by now.” He recommended the following actions:

• Try to do more through conventional trade dispute channels and expand funding for the U.S. Trade Representative’s Office (USTR) so it can do more.
• Ensure that future bilateral trade and investment treaties (BIT) contain strong and enforceable provisions against forced technology and R&D transfer.
• Congress should make it clear that it will not judge any administration by whether a BIT with China is concluded, but rather by if the United States made a strong effort to conclude a treaty that provided full protection against mercantilist practices like forced transfer of R&D.
• Congress should pass legislation that allows firms to ask the Department of Justice for an exemption to coordinate actions regarding technology transfer and investment to other nations.
• Congress should exclude mercantilists from the Generalized System of Preferences (GSP).

Finally, he recommended that the United States actively explore alternatives to the WTO and  pursue a two-pronged trade strategy, continuing as best it can to improve conventional trade organizations like the WTO, but also creating alternative “play-by-the-rules” clubs of like-minded countries.

He concluded his testimony stating, “Pressured or mandatory technology transfer by other nations has, is, and will continue to negatively impact American R&D and innovation capabilities. It’s time for the federal government to step up its actions to fight this corrosive mercantilist practice.”

Curbing Chinese mercantilism must become a key priority of our trade policy if we want to address this serious threat to American manufacturers and the U. S. economy.