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RESEARCH AND DEVELOPMENT, TECHNOLOGICAL ADVANCES IN KEY INDUSTRIES, AND CHANGING TRADE FLOWS WITH CHINA HEARING BEFORE THE U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION ONE HUNDRED TENTH CONGRESS SECOND SESSION _________ JULY 16, 2008 _________ Printed for use of the United States-China Economic and Security Review Commission Available via the World Wide Web: www.uscc.gov UNITED STATES-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION WASHINGTON: AUGUST 2008 U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION LARRY M. WORTZEL, Chairman CAROLYN BARTHOLOMEW, Vice Chairman Commissioners: PETER T.R. BROOKES Hon. WILLIAM A. REINSCH DANIEL BLUMENTHAL Hon. DENNIS C. SHEA MARK ESPER DANIEL M. SLANE JEFFREY FIEDLER PETER VIDENIEKS Hon. PATRICK A. MULLOY MICHAEL R. WESSEL T. SCOTT BUNTON, Executive Director KATHLEEN J. MICHELS, Associate Director The Commission was created on October 30, 2000 by the Floyd D. Spence National Defense Authorization Act for 2001 § 1238, Public Law No. 106-398, 114 STAT. 1654A-334 (2000) (codified at 22 U.S.C.§ 7002 (2001), as amended by the Treasury and General Government Appropriations Act for 2002 § 645 (regarding employment status of staff) & § 648 (regarding changing annual report due date from March to June), Public Law No. 107-67, 115 STAT. 514 (Nov. 12, 2001); as amended by Division P of the "Consolidated Appropriations Resolution, 2003," Pub L. No. 108-7 (Feb. 20, 2003) (regarding Commission name change, terms of Commissioners, and responsibilities of Commission); as amended by Public Law No. 109-108 (H.R. 2862) (Nov. 22, 2005) (regarding responsibilities of Commission and applicability of FACA); as amended by Division J of the “Consolidated Appropriations Act, 2008, “Public Law No. 110-161 (December 26, 2007) (regarding responsibilities of the Commission, and changing the Annual Report due date from June to December). The Commission’s full charter is available at www.uscc.gov. ii CONTENTS _____ WEDNESDAY, JULY 16, 2008 RESEARCH AND DEVELOPMENT, TECHNOLOGICAL ADVANCES IN KEY INDUSTRIES, AND CHANGING TRADE FLOWS WITH CHINA Opening statement of Chairman Larry M. Wortzel…………………………….. 17 Opening statement of Vice Chairman Carolyn Bartholomew………………….. 18 Opening statement of Commissioner Dennis Clarke Shea, Hearing Cochair…… 19 Opening statement of Commissioner Michael R. Wessel, Hearing Cochair…….. 1 PANEL I: CONGRESSIONAL PERSPECTIVES Statement of Michael H. Michaud, a U.S. Representative from the State of Maine 2 Prepared statement…………………………………………………………….. 5 Statement of Walter Jones, a U.S. Representative from the State of North Carolina 9 Prepared statement…………………………………………………………….. 11 Statement of Debbie Stabenow, a U.S. Senator from the State of Michigan…… 113 Panel I: Discussion, Questions and Answers …………………………………… 13 PANEL II: CHANGING NATURE OF CHAIN’S TRADE FLOWS Statement of Dr. Charles W. McMillion, President/Chief Economist, MBG Information Services, Washington, D.C…………………………………. 21 Prepared statement……………………………………………………………. 23 Statement of Dr. Mary Amiti, Senior Economist, Federal Reserve Bank, New York, New York…………………………………………………………… 24 Prepared statement……………………………………………………………. 27 Panel II: Discussion, Questions and Answers………………………………… 28 PANEL III: R&D: DOMESTIC AND FOREIGN-FUNDED Statement of Ms. Kathleen Walsh, Professor of National Security Affairs, U.S. Naval War College, Newport, Rhode Island……………………………….. 53 Prepared statement……………………………………………………………... 57 Statement of Dr. Kent H. Hughes, Director, Program on Science, Technology, America, and the Global Economy, The Woodrow Wilson International Center for Scholars, Washington, D.C…………………….……………………………. 57 Prepared statement……………………………………………………………… 60 Panel III: Discussion, Questions and Answers………………………………….. 60 PANEL IV: CHINESE DEVELOPMENT IN KEY INDUSTRIES iii Statement of Dr. Tom (Qingjiu) Tao, Assistant Professor of Management, Lehigh University, Bethlehem, Pennsylvania…………………………………………… 86 Prepared statement…………………………………………………………….. 89 Statement of Mr. Owen E. Herrnstadt, Director of Trade and Globalization, International Association of Machinists and Aerospace Workers, AFL-CIO, Washington, D.C………………………………………………………………… 89 Prepared statement…………………………………………………………….. 92 Statement of Dr. Ernest H. Preeg, Senior Fellow, The Manufacturers Alliance MAPI, Arlington, Virginia……………………………………………………... 92 Prepared statement........................................................................................... 95 Panel IV: Discussion, Questions and Answers………………………………… 95 iv HEARING ON RESEARCH AND DEVELOPMENT, TECHNOLOGICAL ADVANCES IN KEY INDUSTRIES, AND CHANGING TRADE FLOWS WITH CHINA _________ WEDNESDAY, JULY 16, 2008 U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION Washington, D.C. The Commission met in Room 385, Russell Senate Office Building, Washington, D.C. at 9:00 a.m., Chairman Larry M. Wortzel, and Commissioners Dennis Clarke Shea and Michael R. Wessel (Hearing Cochairs), presiding. OPENING STATEMENT OF COMMISSIONER MICHAEL R. WESSEL (COCHAIR) HEARING COCHAIR WESSEL: Good morning. We'll get started. Congressman Michaud, thank you for being here this morning. It's unusual for us to start exactly on time. VICE CHAIRMAN BARTHOLOMEW: That's a reflection on us. HEARING COCHAIR WESSEL: Yes. We will delay our opening statements so that we can get right to your testimony. The Congressman was sworn-in in January 2003 to represent the Second Congressional District of Maine. He is a co-founder of the House Trade Working Group, a bipartisan organization committed to advocating for fair trade policies. The Representative, whose district includes a very long border with Canada, still our largest trading partner although that is changing a bit these days, is quite familiar with trade and international competition, all the more so since he worked for the Great Northern Paper Company for 30 years. He also served in the Maine legislature and at one time presided over the Maine Senate. Congressman, thank you for being here and please begin. PANEL I: CONGRESSIONAL PERSPECTIVES STATEMENT OF MICHAEL H. MICHAUD A U.S. REPRESENTATIVE FROM THE STATE OF MAINE MR. MICHAUD: Thank you very much for having me here this morning. I'd love to hear Representative Jones' remarks, but I have a markup in the Veterans Affairs Committee, and I've got seven bills from the Health Care Subcommittee that I-- CHAIRMAN WORTZEL: Take good care of us. MR. MICHAUD: I intend to. So that's why I want to make sure I get back there. But I do want to thank you for having me here today. It's an honor to testify and have an exchange of views with this distinguished group of experts on U.S.-China relations. Your work has been invaluable to those of us in Congress who are concerned about economic, political and security implications of the U.S. relationship with the People's Republic of China. Central to those concerns is the subject of this hearing: R&D in China, China's technological advances in key industries, and the changing nature of trade that has flowed between the two countries. According to the recent survey released by the School of Business at Duke University, the offshoring of product development increased from an already large base by more than 40 percent in the one-year period of 2005 and 2006. The study surveyed 530 companies as to their offshoring activities. The respondents to the survey reported that in the period between 2007 and 2010, they forecast that offshoring of product development would increase 65 percent for R&D and by more than 85 percent for engineering services and product design. Much of this investment is going to China that, as your prior work has documented, is a nation that is making spectacular gains in its R&D capacity. While U.S. investors increasingly depend on their China-based operation for R&D, they also expect patent protection there for their innovations. Otherwise, such investment will become impractical and uneconomic and quickly will go to other nations that respect patent rights. Currently, however, U.S. innovators are plagued by Chinese piracy, counterfeiting, and unauthorized, uncompensated use of their intellectual properties. Without proper safeguards here and in China, the infringement of patents will worsen as more companies outsource more of their R&D - 2 - and design work. The issues of providing such domestic protection, notably the details of U.S. patent laws, are one of the most controversial matters that was before the 110th Congress. While a bill passed the House in September of 2007, patent legislation stalled in the Senate because of the inability of the various interests to find a compromise on key issues. Some variant of patent legislation that was considered in the 110th Congress will probably return in the 111th Congress next year. In anticipation of that debate, the Congress would benefit greatly from the advice of this Commission on two points: protection of U.S. patents in China and premature publication of U.S. patent applications. These issues will play a major role in determining whether the U.S. will continue to have a first-rate patent system that nations such as China can aspire to attain or whether we will lower U.S. standards in a misguided effort to harmonize our patent system to the lower levels found in the rest of the world. Accordingly, our request that you prepare recommendations for Congress on how it can provide legislation and oversight designed to defend the rights of U.S. patent owners involved in the U.S-China trade. These and other questions are in my full written testimony that