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ZTE: What is Trump Up To?

US prevented ZTE from receiving shipments of export cargo and import cargo in international trade.

ZTE: What is Trump Up To?

Let’s put any potential ZTE deal in perspective. More than a year ago, ZTE was caught selling telecommunications equipment to Iran that included US parts, thus violating sanctions. ZTE pleaded guilty in November 2017, paid a $900 million fine, punished the responsible executives, and—this was unwise—agreed that if it was later caught violating the terms of the settlement, it would be cut off from all US technology. This last condition was certainly not in ZTE’s interest and probably not good for the United States either.

In speaking to Chinese executives about the ZTE case, one problem they raise is the very different expectations about corporate compliance in China and the United States. Many big Western companies now have specialized units responsible for ensuring that they comply with all the rules and regulations that apply to their business for things like sanctions, technology exports, or corrupt practices. Some even have chief compliance officers. The opposite is true for many Chinese companies, reflecting China’s very different attitudes about the rule of law. The law (and its enforcement) is much more “flexible” in China, and some Chinese companies don’t expect to be held accountable. ZTE may have been one of them. This flexible approach to compliance is the norm in China, but not in the United States or other developed nations.

There was also a bit of disorganization at ZTE. The people who decide on bonuses may not have known that the company agreed not to pay bonuses to complicit executives (at least this is what some sources say), or they may not have cared. ZTE replaced a few executives, moved the company president, paid the fine, and thought it had put the US problem behind it. Instead, paying bonuses to implicated execs poured gas on the fire of ZTE’s noncompliance.

This had nothing to do with espionage or trade tensions. The punishment inflicted on ZTE the second time around would have happened to any US or foreign company (look at Volkswagen or Deutsche Bank) that flagrantly violated the law or the terms of a settlement. Courts and law enforcement agencies in the United States enforce the law. They do not ask the executive branch or the ruling party for permission. ZTE violated the law and then violated the terms of its settlement. ZTE would have been smacked down even if the United States and China were best friends, which they are not.

China’s leaders can be a bit paranoid; it’s a side effect of Leninism. The Snowden revelations about US spying only reinforced what they already believed. China has been trying to end its dependence on US technology for more than a decade. Worries about the risk of US espionage are part of this. Building national champions in different industry sectors (aerospace, telecom, information technology, cars, solar energy) is an important part of Chinese economic policy and fits the narrative of China’s “return to the center of the world’s stage” that party leaders cite as a major accomplishment of their rule. Finally, there is an espionage benefit for China. If you make and maintain other countries’ telecom networks, it is easier to spy on them.

ZTE depends on US technology to make its cellphones, the core technology (a “chipset”) that is the single most important part of what makes a cellphone work. Huawei is also dependent, but to a lesser degree as it has invested in the research and development needed to build its own chipset—not as good as the American version, but improving. China still depends on US (and Western) technology, and though it has made significant strides in many technology areas, it is not ready to stand on its own. In a global market for technology and research, it’s possible that no country can stand on its own, but China wants to try for all the reasons cited above.

Punishing ZTE for violating the settlement was a good idea, but cutting it off from US technology was not. Another whopping big fine would have been better. Denying access to US chipsets has been a near death experience for ZTE. It only accelerates Chinese efforts to build competitors (something the United States has inadvertently done before) to the US companies that supply ZTE. This would have happened in any case, but it is not in our interest to hasten the trend to design out US technology.

ZTE was not punished for trade purposes or as part of some larger anti-China strategy, but it turns out to be a useful bargaining chip. Left to their own devices, the Chinese have little desire to make concessions on trade. ZTE inadvertently gave the United States leverage in trade talks. The risks to national security are low; for all practical purposes, Chinese telecom is already banned in the US market. Nor is there an unfortunate precedent for export enforcement; most companies that get caught are eventually let out of the penalty box, and ZTE could have changed its compliance programs, fired a few people, offered to pay more, and come back in a few months to plead for mercy. This is not that unusual for these kinds of violations. The intent of the law is to punish, not destroy, so offering to cut ZTE and Beijing some slack in exchange for trade concessions is a good idea. ZTE will still need to do some kind of penance, but it will not be forced to collapse.

The ZTE case is an episode, not a precedent. China and the United States need to recognize their mutual dependence in technology. China needs to stop engaging in predatory trade practices and live up to global corporate norms. ZTE makes the case for these changes, but it will not change what promises to be a long fight over trade and technology. We will probably have to go through this kind of action again—not with ZTE, but just wait until China decides to sell its new passenger jets (loaded with key components made in the United States) to Iran.

James Andrew Lewis is a senior vice president at the Center for Strategic and International Studies in Washington, D.C. This article originally appeared here.

Trump has imposed tariffs on Chinese shipments of export cargo and import cargo in international trade.

Trump’s IP Tariffs: How Much Have the Chinese Actually Taken?

President Donald Trump announced $60 billion worth of tariffs and other penalties on China for its theft of intellectual property (IP), technology, and trade secrets. The administration says this theft has cost the US economy billions of dollars in revenue and thousands of jobs. These assertions of loss are correct.

Until recently, the United States probably lost between $20 billion and $30 billion annually from Chinese cyber espionage. This does not count the losses from traditional espionage (e.g., using agents). The cumulative cost may reach $600 billion, since this kind of espionage has been going on for more than two decades.

Any estimate has to take into account that some stolen IP cannot be turned into products, making the loss in these instances zero. In other cases, however, the victim company suffers revenue losses for years to come. Chinese companies are getting an illegal “subsidy”; they can spend less on R&D, since they can access US research. The range of Chinese economic espionage, from simple household goods like wooden furniture and house paint to the most advanced high-tech products, is part of the explanation for China’s rapid growth.

Cyber espionage accounts for a majority (but not all) of IP theft. To summarize how we arrived at this figure, the United States lost roughly $100 billion annually to cyber crime in the decade before the Barack Obama–Xi Jinping agreement renouncing commercial cyber espionage. Roughly a third of this was due to IP theft (the other two-thirds reflect losses from financial crime and recovery costs). China accounts for a majority of economic cyber espionage against the United States (perhaps three-quarters of the losses are from Chinese spying).

For some companies, the cost of Chinese IP theft can be fatal (when combined with other business problems). There is also an effect on employment. Research by the International Trade Administration and the European Union found that that $1 billion in exports created roughly 6,000 jobs. Chinese IP theft reduced US exports, meaning the United States could have lost thousands of jobs annually. “Lost” is an inaccurate term, since the “net” employment loss can be smaller if workers displaced by IP theft find other jobs. But these new positions can pay less, since IP theft can shift employment away from high-paying jobs.

China has sought to acquire US technology by any means, licit or illicit, since Deng Xiaoping opened China to the West. Espionage and theft were part of this, but so were forced technology transfers or mandatory joint ventures as a condition for doing business in China. China’s development in automotive, aircraft, information technology, high-speed trains, and defense industries all benefitted from espionage. Many US companies yielded to these forced transfers, calculating that the immediate benefit of access to China’s market outweighs the eventual loss. After 30 years, those chickens have come home to roost.

Companies also calculated that they could shield their most valuable technologies and that the technologies would have moved to a new generation by the time the Chinese were able to enter the market. These strategies were partially successful, but they worked better when China was less developed. Now that it is the second-largest economy in the world, what was tolerable before is no longer acceptable.

Sometimes you hear the arguments that the United States stole technology in the nineteenth century when it was growing and that China is only doing the same. But these arguments are feeble, and those who make them are feebleminded. In the nineteenth century, it was possible to steal a book, but with digital technologies, you can steal the entire library. The United States was a net contributor to the world stock of knowledge in the nineteenth century, and its innovations spread to other countries, given the absence of international IP protections. In the nineteenth century, countries recognized that inadequate protection for IP hurt global economic growth and disincentivized innovation (people invest less in innovation when their work can simply be stolen). In response, they created a series of agreements to protect IP and trade in the international market. China routinely ignores these agreements, subsidizing its own growth at the cost of global innovation. China has become a country that can innovate, but it is unwilling to give up the crutch of economic espionage and will never do so unless it is pressed.

We can take issue with the style of this administration in confronting China (a more astute strategy would not begin by alienating key allies), and we can worry that it has not thought carefully about how to deal with the inevitable Chinese retaliation or how to construct a path for China and the United States to come to a new accord on trade. China will not change its behavior absent external pressure, and pushing back against the constant drain from Chinese IP theft is long overdue.

James Andrew Lewis is a senior vice president at the Center for Strategic and International Studies in Washington, D.C. This article originally appeared here.

Trump China policies will impact shipments of export cargo and import cargo in international trade.

Putting China’s Intellectual Property Theft in Context

China competes unfairly in international trade, it has long-standing policies to extract intellectual property (IP) from Western companies, and its companies often show scant respect for IP protection. Confronting China over these practices is long overdue, but the central issue is not IP theft but the unfair treatment of US companies in China.

Calculating the value of intellectual property is difficult. One way is to estimate what stolen IP would fetch on the market if offered for sale or licensing. Companies can value their intellectual property by estimating the income it produces or is expected to produce. The most common error is to value IP at what was paid to develop it. The real value (and hence the cost of IP theft) is how much a product made with the IP will fetch on the market. If I spend a billion dollars to develop a square car tire, its market value is zero, not a billion, and the loss from IP theft is zero. Similarly, if I steal IP and can’t figure out how to make a product with it, the loss from the theft is zero.

The most accurate measure is to look for competing products. If there aren’t any, the harm to the victim is zero. A country could steal $600 billion in IP and not gain $600 billion in value. Can we point to products made in China with stolen IP? This explains the difficulty China has faced in its efforts to create a domestic semiconductor industry. Making high-tech products requires know-how that can’t be obtained by stealing IP.

At the high end, there are products in telecom hardware, high-speed trains, and solar power. Copies of designs for consumer goods—furniture, toys, clothing—do real damage to Western companies. However, these losses, while troubling and harmful, are not the issue anymore, and IP theft does not explain China’s advances in technology.

Stolen IP does not mean that the victim company has lost the ability to make products. What has happened is that it now faces a new competitor. This is the real problem, since China flouts its World Trade Organization commitments and hobbles foreign competition. It has created a protected Chinese market, provides subsidies for foreign sales, and imposes nontariff barriers to hamper Western companies. Subsidized Chinese companies operating from a closed domestic market and selling to an open international market have an immense advantage, and this is a logical strategy.

China’s excuse has been that it is still a poor country, a developing country, and deserves a pass from its trade commitments. Privately, some Chinese say the treatment of foreign firms is owed to them after the Century of Humiliation, and even more privately, a few consider this a return by China as its rightful place as the Middle Kingdom at the center of global affairs. All of this is complete nonsense when coming from the world’s second-largest global economy, but there is no reason for China to stop if no one objects.

We do not want to become fixated on IP theft, however. It reflects a mindset from the days when the United States effortlessly led in technology. Those days are gone. If IP theft was so valuable, China would not be trying many other approaches: buying entire Western firms to gain know-how; opening research facilities in Silicon Valley; continuing to demand technology transfer as part of the cost of doing business in China; and spending billions on science education and on research and development. China, after decades of spending, is creating its own culture of innovation, not as effective as America’s but better than most countries and lavishly resourced. China will increasingly make its own IP, so stopping IP theft will not keep the United States competitive.

IP theft is part of a larger industrial strategy. China uses a variety of policies to displace Western companies, including investment, subsidies, barriers to trade, security regulations, procurement mandates, licit and illicit acquisition of foreign technology and Western firms. Western companies find themselves under pressure to make concessions in technology transfer or services like cloud storage in exchange for market access.

China’s recent development of a commercial airliner is a good example of the declining importance of IP theft. China’s old Soviet-supplied aircraft factories made shoddy aircraft. When China opened its market, Western firms rushed to sell it aircraft, and part of the requirement for market access was co-production, where Chinese companies worked with Western aircraft firms to make parts for Western commercial aircraft. Co-production, over 20 years, taught Chinese companies essential production know-how, and the quality of Chinese aircraft has improved markedly. Most of this transfer did not involve IP theft. The problem now is not that China wishes to build commercial airlines, it is that China will be tempted to use subsidies, pressure on domestic airlines to buy Chinese, and barriers to foreign companies to give their manufactures an edge in China and in the global market.

The lessons from the aircraft story are that the United States needs to push back hard on Chinese requirements for transfer technology for market access (something playing out now in the information technology sector) and on Chinese barriers to trade. With skilled diplomacy, we can probably gain support from Germany, Japan, and other major Western economies. They all suffer, but some are reasonably afraid that China will retaliate against their companies. Nor is a trade war a good outcome. If China followed international market practices, a decision to invest in a domestic industry, while having potentially profound effects on the business, would be unobjectionable. Moving China to adopt these practices is not impossible. Steady diplomatic pressure accompanied by skillful use of existing trade authorities (like Section 301 of the US Trade Act of 1974) can change China’s behavior.

The word that gives China qualms is reciprocity. The long-overdue message to China should be that the United States and its partners will hold China accountable for its trade commitments and begin to treat Chinese companies the way China treats Western firms unless there are observable changes. This is half of an effective strategy. The other half is that the United States needs its own strategy to speed and increase its own creation of intellectual property. Complaints alone will not solve this problem.

James Andrew Lewis is a senior vice president at the Center for Strategic and International Studies in Washington, DC.