Of Supply Chains and Fireworks: A Trade War with China is Easy to Lose

May 30, 2019

IP Watchdog

Over the course of two weeks, the United States has imposed tariffs on hundreds of billions of dollars of Chinese goods and has blacklisted Huawei, the world’s largest telecommunications company, on national security grounds. Google, Intel, Qualcomm and Micron have announced that they will stop doing business with the company. The United States has even threatened to withhold intelligence from our key allies if they go forward with plans to use Huawei equipment.

Although there are many issues driving this newly escalated trade war between the United States and China, chief among them is the concern that China and its companies are engaged in intellectual property theft. Say what? Upend global markets over infringement of private technology rights? This must be pretty serious. Let’s take a closer look.

First, a bit of historical perspective. Spying between countries to get access to military and other state secrets has been common for thousands of years. Economic espionage arguably got its start 500 years ago, with the introduction of patent laws, which at the time rewarded whoever was first to import useful technology into the country. No need to be an inventor; just find something new and hurry back to your home country’s patent office.

When I was working at the United Nations in Geneva, we encouraged developing countries to adopt strong IP laws. Their diplomats often took pleasure in reminding me that the United States had launched its industrial revolution with textile technology stolen from England. (You can find the real story of Samuel Slater’s 18th century escapades here.)

By the middle of the 20th century, America had become an economic superpower, and it witnessed Japan rebuilding its economy with cheap knockoffs of U.S. merchandise and some outright trade secret theft. However, over time, Japanese industry innovated, and laws protecting intellectual property followed. The same natural progression based on self-interest in domestic innovation happened in South Korea, which now has a very strict set of laws protecting trade secrets.

The Copycat Becomes a Tiger

For China, going from industrial copycat to tiger (or more appropriately, dragon) has followed a similar path. For example, starting from scratch in the 1980s, China took only 30 years to build the largest and one of the most respected patent systems in the world. This was possible only because the government established domestic innovation and the intellectual property to accelerate it as top strategic priorities. And it has made considerable progress in harmonizing its laws, as I have recently explained.

But China is a special case when it comes to risk of information loss. Not only is it roughly the same size as the U.S. market, but its economy blossomed during the global transition to the information age. That means that secrets are much easier to acquire than back when everything was on paper. And given our dependence on global networks for the transmission of critical data assets, it’s easy to see why Huawei, building the gear to drive those networks, seems like a serious threat. This is so even though the company is privately owned and insists that it will not obey any orders from the government to tap into the systems it is building; after all, critics point out, China’s economy is controlled by the Communist Party.

Is Coercion Really the Path to Reform?

This begs the question of what to do about the problem. The Trump administration has decided that China has more to lose than the United States in a trade war, and so it has turned to tariffs, and the banning of Huawei, as a way to squeeze the Chinese and force them to stop stealing, reform their laws and open their markets. Coercion can sometimes work, I suppose (unlike the president, I have not written a book on how to make a deal). But history, and the fundamentals of negotiation, point to serious danger.

When one party to a transaction raises the stakes to existential levels to get attention, it risks that the other party will be driven away, not just from the transaction, but also the relationship. Here, the Chinese show more signs of digging in than backing down. Within days of the tariff announcement, China’s president, Xi Jinping, together with the vice-premier responsible for U.S. trade negotiations, paid a very public visit to a large factory processing rare earths, the ingredients essential to lithium ion batteries and other modern technologies. China controls 90% of the world’s supply. And the chosen factory happened to be located in Jiangxi, where in 1934 the Communist Party began its famous “Long March,” a 4,000-mile strategic retreat in painful preparation for its eventually successful fight against the Nationalist forces of Chiang Kai-shek.

The message could not have been weightier or clearer. China is preparing its government and people for a long struggle against the increasingly adversarial United States. It has vowed to “take all necessary measures” in response to the blacklisting of its national champion Huawei, which could result in reinforcement of Huawei’s position in markets not controlled by the United States. According to the company, it has stockpiled critical components as it prepares to manufacture its own semiconductors, freeing it from reliance on U.S. manufacturers.

While it’s possible that the U.S. strategy may produce some sort of agreement in the short term, it’s at least as possible that another result will be the long-term “decoupling” of the Chinese and U.S. economies. That outcome would cause significant harm not only to U.S. industry, which continues to see China as a growing market (trade between the two countries tripled from 2004 to 2018, reaching $660 billion), but also to the global technology-based economy, which relies on common standards and accessible markets.

A Plea for Common Sense Diplomacy

While the concerns around trade secret theft are real and need serious attention, we should be considering ways to address them that don’t create so much risk of collateral damage. We should accept that China is a controlled economy and that certain aspects of its governance will not change to match our own. As we have done in the past—most notably beginning with the 1994 negotiations leading to the TRIPS Agreement—we should engage in multilateral diplomacy to establish new agreements for the robust enforcement of intellectual property rights, including trade secrets. And we should use our current technological advantage to develop a new generation of encryption tools and other measures to detect and prevent espionage. This would mimic the framework for trade secret protection in our own country, where we provide strong enforcement mechanisms but also require that companies exercise their own “reasonable efforts” to reduce their information security risk.

U.S. industry has invested decades of effort and billions of dollars in securing footholds in the Chinese market, which holds enormous promise over the long term. Our domestic companies have come to rely on global supply chains, most of which run through China. It would be very difficult to disentangle and relocate all those supply relationships. And in the meantime, China has the power to cause our businesses a world of hurt. It’s not just about rare earths. China provides 95% of the world’s fireworks. Think about that during the upcoming Independence Day celebrations.

What is at stake in this trade war animated largely by intellectual property is nothing less than the life blood of global trade. Innovation is like growing fruit trees. You get the best results from cross-pollination. While we should not tolerate theft of our intellectual capital, neither should we give up the chance to find mutual benefit from old-fashioned diplomacy and negotiation. We worked hard to interest China in joining the World Trade Organization and other multilateral institutions so that we could all enjoy the synergies of free trade; we should consider making more use of those institutions and relying less on unilateral boycotts.

Laws to support trade secret rights are critical to the information economy. It may seem counterintuitive, but by enforcing confidential relationships through trade secret laws we make it possible to disseminate and commercialize innovation. Erecting a new iron curtain that separates technology markets and standards between Chinese and American spheres of influence would seriously diminish that effort.

Yes, it’s important to stand up against theft of IP; but creating new barriers may not be the best way to do that. As Denzel Washington said in the 2014 film The Equalizer, “When you pray for rain, you gotta deal with the mud too.”

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