Western governments and companies routinely complain about the practice of ‘forced technology transfer’ in China, but are these grumbles justified? And beyond the trade war, what does the future hold for Chinese tech innovation?
10 minute read
Microchips, smartphone-testing robotic arms, wind turbines, solar cells, experimental glass made from crushed diamonds, Star Wars toys, chemical formulae for food colouring, data storage systems, firewall software – these are just some of the things Chinese companies have been accused of stealing from their Western counterparts.
As long ago as 1992, the George H.W. Bush administration persuaded the Chinese government to create laws to protect US companies’ intellectual property. But copyright piracy remained rife and over the last two decades Chinese appropriation of Western innovations has become a major geopolitical issue. It is one of the key sticking points in the current trade negotiations between Washington and Beijing.
The issue is not clear-cut. Many foreign firms have been able to thrive in the lucrative Chinese market without giving up their most prized technology. In areas such as 5G networks and artificial intelligence, Chinese technology is already superior to the Western equivalents.
But given the nexus of connections between Chinese companies and the state, along with the growing geopolitical tensions between China and the US, it seems likely technology will continue to cause friction between the two superpowers. So what are the implications for investors in Chinese firms and their foreign competitors?
The extent to which China can dominate every technological sector is a germane concern for companies, governments and investors
“As China is such a powerful economy, the extent to which it can dominate every technological sector is a germane concern for companies, governments and investors,” says Alistair Way, head of emerging market equities at Aviva Investors. “There are some things China is very good at and there are others where it is going to struggle without technology transfer. As investors, we have to treat it very much on a case-by-case basis.”
Forced tech transfer
The US government has become more vociferous in its criticisms of China in recent years. Under the foreign policy of President Obama, the US ‘pivoted’ towards the Asia-Pacific region to contain China’s rise. In 2015, Chinese President Xi Jinping agreed to clamp down on commercial cyber-hacking after Obama threatened sanctions.1
A recent CNBC poll found that one in five US companies believe Chinese firms stole their IP over the last year
Nevertheless, Chinese companies are still regularly accused of taking Western technology. A recent CNBC poll found that one in five US companies believe Chinese firms stole their IP over the last year.2 More often than overt theft, appropriation of foreign ideas occurs via the officially sanctioned practice of ‘forced technology transfer’ (FTT).
Dan Prud’homme, associate professor at EMLV Business School in Paris and the co-author of a forthcoming book on China’s intellectual property regime, says FTT takes various forms. ‘Lose the market’ policies, for example, effectively outline a quid pro quo – foreign firms must agree to transfer technology or give up access to the Chinese market – while others leave foreign companies active in China with no choice but to relinquish their IP.3
“Examples of ‘no choice’ policies include unfair IP civil litigation rulings, which involve IP in a variety of industries; and certain requirements to excessively disclose trade secrets directly to the state or state-organised panels as a precondition for regulatory approvals in the pharmaceuticals and chemicals industries, among others. Sometimes this information has been passed on to [Chinese] competitors,” says Prud’homme.
Needless to say, FTT is unpopular among foreign businesses and policymakers. A 2018 report by US trade representative Robert Lighthizer, which looked into FTT, cyber-hacking and state-directed acquisitions of US firms by Chinese rivals, formed the basis for a round of sanctions imposed on Chinese goods by the Trump administration last summer. The European Commission is also taking action against FTT via the legal mechanisms of the World Trade Organisation.4
Beijing has already ceded some ground. IP courts and tribunals have been established across China in recent years, providing both domestic and foreign companies with a way of seeking redress for IP theft. And China’s foreign investment law was revised in March 2019; it now requires Chinese government officials to keep confidential any trade secrets they learn during regulatory approvals, under the threat of criminal proceedings.
Not all sectors have been equally affected by FTT. Prud’homme’s research shows ‘lose the market’ policies proved particularly effective in high-speed rail during the 2000s. “Foreign firms that participated in FTT during that time – Siemens, Alstom, Kawasaki and Bombadier – unintentionally helped create CRRC, the Chinese company that now dominates the global high-speed rail industry,” he says.
But in other sectors Western companies have been able to use joint ventures with local partners to their own advantage. Take the car industry: since the financial crisis hit auto sales a decade ago, big US and European car manufacturers have sought access to the fast-growing Chinese market. For the most part they have done so while successfully protecting their technology.
Over the past 10-20 years, Western automotive companies have sounded alarms over technology transfer in China. In reality they have benefited a lot from the opening and widening of the Chinese market, to a much greater degree than Chinese companies have benefited in terms of gaining technology.
As part of its recent package of reforms, China has announced it will lift the 50 per cent cap on foreign ownership of joint ventures; BMW says it plans to increase its half share in a venture with Shenyang-based Brilliance China Automotive Holdings to 75 per cent when the law change comes into effect in 2022. Other car manufacturers such as Daimler are expected to follow suit.5
The change in the rules signals the Chinese government is willing to see how domestic companies fare without the support of foreign branding and marketing expertise. Unlike Japan or South Korea, China has struggled to create a ‘national champion’ auto manufacturer that can compete on the global stage, although companies such as Geely, which acquired Volvo in 2010, are fast progressing in electric car technology. Other Chinese firms have spied opportunities to make inroads in the global supply of auto parts, such as airbags.
“China’s domestic auto parts industry is developing quickly; not so much due to FTT but through targeted investment and acquisitions. Shanghai-based Joyson Electronic, for example, has been on a buying spree, acquiring German and Japanese suppliers. It aspires to be a credible global competitor to Robert Bosch, Continental and Aptiv, although it has yet to prove it can make a serious impact beyond China,” says Rovelli.
The complaints over technology transfer have a sharper edge in industries such as IT, robotics and semiconductors, which have been prioritised by the Chinese government.
“China is keen to upgrade its current manufacturing base,” says Xiaoyu Liu, emerging market equities fund manager at Aviva Investors in London. “As it develops, China is aware of the risk of getting caught in the middle of the value chain between countries that offer low-cost outsourced labour and nations where manufacturing is of better quality, such as the US and Germany.”
China currently spends more on importing semiconductors than it does on oil
In particular, China wants to curb its reliance on foreign technology such as computer chips; it currently spends more on importing semiconductors than it does on oil.6 It has been unable to close the gap through foreign acquisitions, which tend to be blocked by wary Western governments. The US, along with South Korea, enjoys a commanding lead in chip technology and is fiercely resisting China’s attempts to buy expertise to catch up.
As Alistair Way points out, one consequence of such protectionism is that leading dynamic random-access memory (DRAM) chip makers have gained a defensive moat against fast-growing Chinese rivals, at least in the short term.
“The political focus on IP protection has been positive for global investors in the leading chipmakers,” he says. “Chinese companies, such as state-owned Fujian Jinhua Integrated Circuit, had been catching up with the biggest DRAM producers amid allegations of IP theft from Micron and others. But in 2018, the US government banned American companies from supplying it with parts, which made it impossible for Fujian Jinhua to operate. Its is now focusing on other areas.”
Faced with these political obstacles, China may have to develop the requisite semiconductor expertise the hard way, through long-term investments in training and R&D (it has reportedly earmarked $100-150 billion of public and private funds for this goal).7
Creating market-leading semiconductors has become harder as chips get physically smaller, which is slowing the progress of the leaders and may yet give China an opportunity to catch up. And emerging industries such as the Internet of Things do not require cutting-edge chips, only the kind of middling semiconductors China is already adept at developing.
What is more, the power of the US to maintain its lead through punitive measures on foreign companies is somewhat constrained by the intricate global supply chain for semiconductors – each chipmaker relies on several thousand specialised component suppliers. Consider Trump’s move to ban US firms from supplying Chinese telecoms company ZTE, which had been accused of violating sanctions in Iran and North Korea. This brought the Chinese company to its knees – but so many American firms were caught up in the economic fallout that the ban was quickly reversed.8
Where there’s a will, there’s Huawei
For now, the US is continuing to exert pressure on another electronics firm, Huawei, which is accused of stealing technology and violating US sanctions on Iran. Washington has banned domestic purchases of Huawei’s equipment, but has not yet moved to prevent US suppliers from doing business with it.
The US considers Huawei’s involvement of telecoms infrastructure a potential security threat
Huawei is a genuine innovator. Its AI-powered smartphones are considered best-in-class and it is the world leader in 5G infrastructure. Its R&D spending topped US$15 billion last year and it filed some 5,400 international patent applications (its Finnish competitor Nokia filed 550 over the same period).9 But the US considers Huawei’s involvement of telecoms infrastructure a potential security threat, because in theory it gives the company – and by proxy, the Chinese government – access to secure data flows.
Huawei has already been banned by US allies such as Australia and New Zealand from operating 5G networks, although the UK may allow it to supply ‘non-core’ 5G.10 The European Commission is also considering limiting Huawei’s involvement in mobile infrastructure, despite the company’s efforts to reassure European politicians by opening cybersecurity labs in Brussels and Bonn.11
“Huawei’s phones are impressive, and they are selling well in European markets, but the concerns around national security may prevent it from offering 5G in Europe,” says Federico Forlini, TMT credit analyst at Aviva Investors. “This could benefit rivals such as Nokia and Ericsson, along with Samsung, which is developing new 5G technology. But as Huawei’s technology is both cheaper and more advanced than its competitors, it should find opportunities in emerging markets.”
While Huawei shares are not publicly listed, international investors can get exposure to the company via the debt markets. Despite having strong fundamentals, the news-flow surrounding various IP-related controversies – as well as the bigger rivalry between the US and China, in which Huawei is considered a geopolitical pawn – caused Huawei’s bonds to fluctuate this year.
Governments and investors alike are keeping a close eye on the trade talks between US and Chinese representatives, which could result in further agreements on FTT. But while it may make some concessions, Beijing tends to bristle at the suggestion that it merely steals all its ideas – and with good reason.
China has invested heavily in high-quality education, and now produces 2.8 million science and engineering graduates, five times as many as the US (although the US still leads on a per-capita basis).12 Many of these graduates end up at leading tech companies such as Baidu, Alibaba and Tencent – the so-called BATs – which are developing products and services to match anything on offer in the West, especially in so-called ‘online-to-offline’ booking systems and integrated mobile payments.
In areas such as the internet, AI and payment systems, China is already more advanced than most Western countries
“In areas such as the internet, artificial intelligence and payment systems, China is already more advanced than most Western countries. ‘Deep learning’ and artificial intelligence were first discovered in the US, but implementation and product development are being led by China,” says Rovelli.
Chinese tech companies tend to be much more efficient than their Western rivals at building on existing discoveries and bringing new products to market, from mobile phones to LCD-screen televisions to consumer drones. This is partly because they have access to a vast population of tech-savvy consumers who are comparatively more willing to try out products and services compared with their peers in the West.
With US companies increasingly looking to China for inspiration – dockless bicycle sharing is just one idea that has crossed the Pacific from Guangzhou’s bustling tech scene to the start-ups of Silicon Valley – Chinese companies are beginning to defend their own IP as vigorously as their Western rivals, at home and overseas. The legal framework is improving, although work still needs to be done.
“The Chinese state has made an incredible number of commendable reforms in recent years in an attempt to make its IP regime more conducive to R&D and technological innovation for both foreign and domestic companies. Nonetheless, China’s IP regime could benefit from further reforms,” Prud’homme says, pointing to the need to expand IP enforcement and administration infrastructure and strengthen deterrents against IP infringement, among other measures.
Gunpowder, paper, movable type, the compass, the mechanical clock, alcohol, silk, tea drinking, porcelain, toothbrushes: China has a long history of inventions that are copied by other nations. As it rediscovers its knack for world-changing innovations, the arguments over technology protection could soon become a two-way street.