Enough is Enough: Confronting Chinese Innovation Mercantilism BY ROBERT D. ATKINSON FEBRUARY 2012 THE INFORMATION TECHNOLOGY & INNOVATION FOUNDATION | FEBRUARY 2012 TABLE OF CONTENTS Executive Summary ....................................................................................... 5 The Nature of Chinese Mercantilism................................................................. 7 The Shift to “China Inc.” Through Indigenous Innovation.................................. 8 Chinese Justifications for Innovation Mercantilism ............................................. 9 Why America Should Care About Chinese Mercantilism ................................... 10 What Should America, Europe and Other Market-Oriented Nations Do? ........... 11 Introduction ................................................................................................. 16 The Tra nsition From “China As FDI Attractor” to “China Inc.” .......................... 20 Chinese Mercantilist Practices ...................................................................... 27 Driving Exports and Reducing Imports ........................................................... 28 Currency Manipulation ........................................................................ 29 Tariffs................................................................................................. 29 Exemption from VAT and Other Taxes.................................................. 30 Helping Chinese-Owned Firms ...................................................................... 30 Government (and SOE) Procurement .................................................... 30 Forced Technology Transfer.................................................................. 33 Forced Joint Venture Requirements ....................................................... 35 Controls on Foreign Purchases .............................................................. 36 Weak and Discriminatory Patent System ................................................ 37 IP Theft .............................................................................................. 38 Cyber Espionage .................................................................................. 40 Government Sanctioned Monopolies ..................................................... 40 Direct Discrimination Against Foreign Firms .......................................... 41 Domestic Technology Standards............................................................ 42 Onerous Regulatory Certification Requirements...................................... 45 Limits on Foreign Sales......................................................................... 45 Limiting Exports of Critical Materials .................................................... 46 Benefits to State-Owned Enterprises ...................................................... 46 Preferential Loans from Banks .............................................................. 47 Export Subsidies .................................................................................. 48 Generous Export Financing................................................................... 49 THE INFORMATION TECHNOLOGY & INNOVATION FOUNDATION | FEBRUARY 2012 PAGE 2 Tax Incentives ..................................................................................... 49 Land Grants and Rent Subsidies ............................................................ 50 Making Sense of Chinese Mercantilism........................................................... 50 Chinese Justifications for Innovation Mercantilism .......................................... 52 China May Engage in Some Mercantilist Practices But so Does the United States 53 China is Doing Nothing Different Than America Did When it was at China’s Stage of Development ................................................................................. 54 China Needs the Jobs .................................................................................... 55 China Needs to Run Trade Surpluses to Maintain Adequate Foreign Currency Reserves..................................................................................................... 57 China Would Not Run a Trade Deficit With the United States if it Ended its Export Controls on High-Tech Products ................................................................. 57 Indigenous Innovation is Key to Raising Standards of Living ............................. 57 Indigenous Innovation is Needed to Reduce Dependency on Exports ................. 58 Indigenous Innovation is Needed to Deal With High Labor Costs...................... 58 Indigenous Innovation is Needed to Deal With a Declining Working-Age Population ................................................................................................. 59 Indigenous Innovation is Needed to Address Environmental Challenges, Including Global Warming.......................................................................... 59 Indigenous Innovation is Needed to Deal With Social Imbalances ...................... 59 Indigenous Innovation is Needed Because China Receives Such Low Returns on its Foreign Investments ........................................................................... 60 Don’t Blame China: It is Poor and Dependent ................................................. 60 Intellectual Property is a Form of Western Imperialism ..................................... 61 Give China Time: It is Still Learning to be a Market-Oriented Economy ............ 61 China Can Help the U.S. Economy by Investing its Massive Current Account Surpluses in the United States ...................................................................... 61 The United States’ Weak Economy is its Own Fault, Not China’s...................... 62 China Isn’t Mercantilist ................................................................................. 62 If the United States Pressures China, It Will Become Protectionist ..................... 63 The United States Has No Right to Interfere in Internal Chinese Matters ........... 63 THE INFORMATION TECHNOLOGY & INNOVATION FOUNDATION | FEBRUARY 2012 PAGE 3 Is Indigenous Innovation the Right Strategy for China? .................................... 63 Should America Care About Chinese Mercantilism? ......................................... 70 What Should America, Europe and other Market-Oriented Nations Do?.............. 74 Take Stronger Action Under Existing Authorities ............................................. 75 Address Current Weakness in U.S. Enforcement Capabilities ............................. 78 Empower U.S. Firms to Defend Their Collective Interests Against Chinese Mercantilism.............................................................................................. 78 Shift From a “Whack-a-Mole” to Results-Oriented Trade Approach ................... 79 Build a Global Free-Trade Coalition to Press China to Reduce Its Innovation Mercantilism.............................................................................................. 80 Arguments Made Against Taking Action .......................................................... 82 Claim: America Benefits From Trade With China, Even if China is Mercantilist.. 82 Claim: It’s Our Fault ..................................................................................... 83 Claim: Getting Tougher With China will Risk Starting a Trade War .................. 84 What’s Plan B? ............................................................................................. 85 Conclusion ................................................................................................... 86 Appendix A: Technologies Targeted By China’s MLP ........................................ 88 Endno tes...................................................................................................... 98 Acknowledgements ..................................................................................... 112 Cover Image: futureatlas.com THE INFORMATION TECHNOLOGY & INNOVATION FOUNDATION | FEBRUARY 2012 PAGE 4 EXECUTIVE SUMMARY In the last decade, China accumulated $3.2 trillion worth of foreign exchange reserves and now enjoys the world’s largest current account balance. In 2011, it ran a $276.5 billion trade surplus with the United States. This “accomplishment” stems largely from the fact that China is practicing economic mercantilism on an unprecedented scale. China seeks not merely competitive advantage, but absolute advantage. In other words, China’s strategy is to win in virtually all industries, especially advanced technology products and services. One may argue that all countries do this and assert it is the essence of competition. But China’s policies represent a departure from traditional competition and international trade norms. Autarky, not trade, defines China’s goal. As such China’s economic strategy consists of two main objectives: 1) develop and support all China’s strategy for industries that can expand exports, especially higher value-added ones, and globalization is to win in reduce imports; 2) and do this in a way that ensures that Chinese-owned virtually all industries. firms win. It is time for policymakers in the United States and other Autarky, not trade, countries to begin responding to today’s reality for Chinese mercantilism defines China’s goal. represents a fundamental threat to not only the U.S. economy, but to the entire system of market and rules-based globalization. Because China is so large and because it’s distortive mercantilist policies