Testimony to the US-China Economic and Security Review Commission on Innovation, Technology, and Intellectual Property

The Information Technology and Innovation Foundation (ITIF) appreciates the United States-China Economic and Security Review Commission’s invitation to provide testimony regarding U.S. concerns with China’s innovation, technology, and intellectual property (IP) practices. This testimony examines the impact of Chinese mercantilism on U.S. and global innovation, then outlines recommendations for a domestic and allied response.

Summary

There is much talk about “decoupling” between China and the United States. As one report notes, “China has launched an intensified effort to “de-Americanize” its supply chains.” The report continues, “For many in the leadership who always wanted to make China less dependent on others, the U.S. trade war and Huawei sanctions [initiated by the Trump administration] have arguably given decision-makers in Beijing the necessary cover for something it has long desired.” But in ITIF’s view, this gets it wrong: China’s desire for absolute advantage and autarky means it has long sought these goals. Indeed, that was the mission behind a seminal document called the “National Medium- and Long-Term Program for Science and Technology Development (2006-2020),” the so-called “MLP,” which called on China to master 402 core technologies, everything from intelligent automobiles to semiconductors and high-performance computers. Of course, China later updated its MLP with its Made in China 2025 strategy, which sought to establish Chinese leadership across 10 critical emerging technologies. Across these 10 industries, China developed a series of national and provincial funds to progress Chinese firms toward three key strategic goals: 1) “localize and indigenize,” meaning “to indigenize R&D and control segments of global supply chains”; 2) “substitute,” meaning to replace foreign suppliers with domestic sourcing wherever possible in value chains toward the production of final products; and 3) “capture global market share,” meaning to “go out into the world” and compete.

So certainly the Trump administration’s actions, including its Special 301 investigation, imposition of tariffs, and entity listings for firms like Huawei and others since (while likely certainly a wake-up call for China) did very little to animate goals that China has already long desired. That this is clear is so from a review of China’s National Integrated Circuit Plan, which seeks for 70 percent of the semiconductor chips used by companies operating in China to be domestically produced by the year 2025. Such a clear import substitution goal is worrisome when about 36 percent of U.S. semiconductor company revenues, or $75 billion, in 2018 resulted from sales to China. This dependence upon China for foreign sales creates a long-term vulnerability for the industry (and many other high-tech ones), as noted in the 100-Day Biden administration supply chain review report.

The point is that it is China, not the United States, that seeks decoupling in advanced-technology industries: from aerospace to solar panels to clean energy, China will trade with the world up until the point it has capable domestic suppliers in advanced-technology industries, at which point its intent will be to close off, or severely restrict, its market to foreign competitors, while still enjoying the opportunity WTO membership gives the country to sell its goods in international markets. For instance, China’s so-called “De-IOE” initiative sought to reduce China’s reliance on IBM, Oracle, and EMC in large business and government environments, and has helped drive Alibaba’s cloud business. (Indeed, De-IOE might be better termed De-IOEAWS to include Amazon Web Services.) In fact, examining the economic impact of market access restrictions and other constrains like forced joint ventures that China has imposed on U.S. cloud providers, ITIF conservatively estimates (based on market-share comparisons) that Google, which withdrew from the Chinese market in 2010, subsequently lost $32.5 billion in search revenue from 2013 to 2019, while Amazon and Microsoft’s cloud services (IaaS, which is restricted in China) lost a combined $1.6 billion over the two-year period from 2017 to 2018. Indeed, if COMAC could produce commercially viable civilian jet aircraft, Airbus and Boeing’s market share in the country would crater rapidly. This is fundamentally not consonant with the commitments China made in joining the WTO.

Of course, prevailing upon China to come into full and immediate compliance with its WTO commitments is the optimal solution, and every instrument the United States and likeminded countries can bring to bear to make that a reality is the preferred outcome. But that can’t be the only option pursued. The United States and likeminded countries need to make a concerned effort to build up the technology ecosystems in a wide range of countries and regions, from East Asia to South America, from Africa to India, to Europe itself, to diversify global supply chains in information technology and other advanced-technology industries, so that collective dependence on the Chinese market is lessened, and indeed the economies of likeminded, rule-of-law, democratic free-market economies are strengthened. Here, there’s great opportunity for collaboration among countries involved in the Indo-Pacific Economic Framework. Further, the United States must extract greater leverage from the U.S. International Development Finance Corporation (DFC), created by the Better Utilization of Investments Leading to Development (BUILD) Act in 2018, which will be providing $60 billion in development financing to attract more private-sector investment into global emerging markets, especially by more-effectively connecting DFC with similar agencies from likeminded countries. Indeed, the United States and likeminded countries need to collaborate to develop more-sophisticated and holistic responses to China’s One Belt One Road and Digital Silk Road Initiatives. This should include collaborative export credit offerings, mutual investments in development initiatives, and greater collaboration around digital technology infrastructure development projects (i.e., smart cities, smart grids, intelligent transportation systems, high-speed rail, etc.) in developing countries.

There’s a battle being fought now for the soul of the global trade and economic system; it’s imperative that like-minded nations collaborate to emerge victorious in it.