Put China’s Intellectual Property Theft in a Larger Context

August 15, 2017

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 U.S. 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 (described here by my colleague Scott Kennedy). 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 coproduction, where Chinese companies worked with Western aircraft firms to make parts for Western commercial aircraft. Coproduction, 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 U.S. 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, D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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