Quest for Fire

This weekend the big tech news story was the ongoing drama around TikTok, it’s putative US ban and potential sale to Microsoft (or maybe Apple). One sub-theme of this saga has been the parallel with Ant Financial, the financial subsidiary that Alibaba “transferred” out of Yahoo ownership ten years ago. For many, this was a surprising, shocking display of business practices in China, but for those with long experience in China there was little surprise in the move. For us, this has just been a reminder of one of the root causes of the current trade war – forced IP transfers.

For a very long time, China has used various forms of “persuasion” to “encourage” US and European companies who want to do business in China to transfer some of their intellectual property (IP) to Chines companies. This includes everything from investment in Chinese brands to wholesale hand-overs of semiconductor files. We have direct experience at both ends of that spectrum and many others.

This is a highly emotive subject, sparking strong feelings in the US. And while we do not enjoy being the subject of such “persuasion”, we think it is important to examine it through a rational, historical perspective. All developing economies seek to learn things from more developed economies. When we were in grade school, we were taught about early American economic spies who toiled in English steam mills and brought that technology back to help spark the industrial revolution in America. More recently, IP transfers have been an important recipe for the economic growth of many countries including Japan, South Korea and Taiwan. (Joe Studwell wrote an great book about the subject.) We are not arguing about the morality of the matter, simply the fact that it is common practice, and has been since the first neolithic tribe invented fire only to have a neighbor tribe copy them.

That being said, something has clearly changed in China. Over the past ten years or so, it feels a lot like that government has greatly increased the pressure. There is a lively debate in China watching circles as to how much the current government in China is doing something new or if they have just become more direct about a long-standing policy. Either way, the intensity of the problem has grown for American companies, the experienced transfer feels more acutely painful. To the point, that many large US companies, who are traditionally very muted in their public comments about China, became vocal supporters of the US government’s Trade War.

As semiconductors are now a big part of China’s development strategy, semis companies have borne an immense burden in dealing with China. Nearly every large company we know has entered into Joint Ventures (JVs) in China over the past decade, and there are clear signs that all of these agreements included some form of IP transfer, often highly valuable IP.

Here’s how that works. A chip company wants to do business in China, selling into domestic electronics makers. The easiest way to accomplish this is to establish a joint venture with a Chinese partner, there are alternative structures but for chip companies those all get closed off, one way or another. The government’s official policy is that there is no IP transfer requirements for establishing a JV. But when the US company finds a partner, inevitably that company has some form of government backing, and they insist on having IP transfer included in the JV agreement. The US company can try to find another partner, a whole complicated process in its own right, but any alternative partner will insist on the same transfer. The new potential partner may have very different commercial terms for the JV, but they all insist on that transfer. This is not a coincidence, and is almost certainly an undisclosed national policy that Chinese executives all know about it, even if it is never published in a forum which foreigners can access.

One of the big changes of the past decade has been a ratcheting up the quantity and quality of the IP demanded. In the 1990’s we know one consumer food brand who was “persuaded” that if they wanted to expand their sales network in China, they needed to create a domestic food brand. We once had the Chinese partner in a consumer goods JV try to hire us to be their “eyes and ears” inside the JV and report back everything about how the US company built a brand and ran operations. (We declined that opportunity.) These are not fun for the US side, but the amount of work it required and the long-term impact were minimal.

By contrast, today US chip companies are being asked to hand over the entire IP for a working product and to help the JV stand up its own design team – essentially creating a full blown competitor. We also know one company that licenses IP for various electronic devices. For some products, they found that Chinese companies were happy to work with them, to sign licensing deals and acquire the IP, saving them considerable R&D work. However, in another category, they could not sign a single licensee. We cautioned them that the silence they heard was a clear sign of a national policy to avoid IP commitments in that sector.

As we noted, it is natural for companies to seek to acquire new technologies and IP, what is different now is the degree to which the State has become so deeply involved in the process and the extent to which the process has become so strongly organized.

Photo by Adam Wilson on Unsplash

2 responses to “Quest for Fire

  1. Good analysis and cautionary tale. A little background might help readers unfamiliar with how China’s attitudes were formed.

    In 1994 the US and EU, with fifty-six percent of global GDP, controlled the creation of the WTO whose rules forced developing countries to exchange raw materials for paper IOUs within a global capital market beyond their control. Though China had requested inclusion in the WTO’s predecessor ten years earlier they did not approve her accession until 2001.

    Their confidence rested on the unique terms for accession which required China to accept reduced rights against other members; open her economy to competition; eliminate state monopolies on imports and exports; overhaul domestic laws, regulations, procedures, and administrative and judicial institutions across all levels of government; make deep tariff commitments for imports; significantly liberalize services; make all regulations affecting trade nondiscriminatory; make government standard-setting transparent and based on international standards; and submit to stringent IP protection and independent review of all trade-related administrative actions by foreign judicial and administrative tribunals. China would also grant other members greater rights against herself than China had against them–thus violating the core nondiscrimination norm in WTO law–a galling provision given her legacy of unequal treaties with imperialist powers–and reduce tariffs on trade goods to ten percent while, for example, richer Brazil agreed to 31% and India to 48%. China was also required to make broader and deeper commitments than any comparable economy on financial, telecommunication, professional, and distribution services.

    The US told the world that membership would transform China into a market economy and a liberal democracy and, when I warned a Chinese banker friend that membership would retard his country’s development and advance neoliberal reforms, he reflected for a moment and responded, “I agree with your analysis but disagree about our vulnerability. This is a game we can win”.

    He was right.

    • Sorry for the delay in replying, WP is behaving oddly
      Thanks for the analysis. There has been a pretty in-depth debate going on among China watchers in recent months about this exact topic (as I’m sure you know). I follow it through Twitter mostly. There is a generational shift taking place among US China analysts. And it is interesting to see people who came into the field in the 80’s and 90’s getting questioned heavily by people who came into the field in this century. I’m in that earlier camp, but see the other side. I think it is clear that something in China has changed, and whether this is a new direction or just an de-cloaking of the original plan is unclear to me and also less interesting a conversation (to me) than thinking about how the US should respond.

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