What is the Problem of Forced Technology Transfer in China?

By ·August 3, 2018
Carnegie Mellon University and Peterson Institute for International Economics

The Issue:

Much of the focus of the Trump administration's trade dispute with China has centered on the size of the U.S. bilateral trade deficit. Most economists agree that this focus is misdirected, and that the existence or size of bilateral trade deficits should not generally be a matter of concern or a target of public policy. Instead, there is bipartisan agreement regarding a different problem at the core of trade issues with China: China's persistent misappropriation of foreign technology. Forced technology transfer occurs when foreign multinational companies have to provide strategically significant technology to an indigenous entity they do not control in order to gain access to the massive Chinese market.
The cost is not just borne by the firms that have to give away a valuable asset. Ultimately, it could hurt innovative firms and dampen global innovation.

The Facts:

  • The problem of protection and enforcement of intellectual property rights in China is a longstanding one — and a concern for current and previous U.S. administrations. When firms cannot recoup the investments they have made in producing innovations, this has the effect of reducing the incentives to innovate. Weak intellectual property enforcement and forced technology transfer are two conceptually different sources of threats to innovation. Studies by the current and previous U.S. administrations have tried to quantify the financial losses that these practices impose on owners of U.S. intellectual property. The wide-ranging estimates have indicated that losses could be measured in the ten of billions — perhaps even hundreds of billions — of dollars (see for instance U.S. Trade Representative 2018, U.S. International Trade Commission 2011, and Commission on the Theft of American Intellectual Property 2017). These estimates mostly reflect the value of intellectual property believed to be infringed by Chinese entities, due to weak enforcement of intellectual property rights (see here). But, weak enforcement of intellectual property is only part of the problem. The costs imposed when foreign multinationals are forced to transfer strategic technologies are more difficult to estimate.
  • There are plenty of cases when multinationals based in the U.S. or Japan or Europe will voluntarily choose to transfer technology to other firms — even other firms that they do not control. For instance, if a firm has a supplier providing a critical input, it is in the firm’s interest to make sure that that input is of high quality. If it has technology that can help the supplier be more reliable, to produce a higher quality product, or a higher-performing product, it has a strong incentive to provide that technology.
  • But, rather than leave these technology transfers to the transacting parties to work out, the Chinese government is exploiting unique features of its economy to force multinationals to do technology transfers on terms that they probably wouldn't accept anywhere else. One of these features is through the use of joint ventures. The foreign direct investment regime in China is still partly closed. In order to operate in some industries in the country, foreign companies have to operate through joint ventures with local firms in which the multinational partner is not allowed to retain a controlling stake. This is the case in the auto industry for example, where the combination of foreign ownership restrictions and high tariffs forces foreign automakers to serve the Chinese auto market — the world's largest — through joint ventures. Operating under these conditions, European carmakers have complained that they are being pressured to turn over sensitive technology for electric vehicles to joint venture partners who may later compete with them in China and other markets. Another feature that contributes to the forced transfer of technology is the unusually prominent role of state-owned enterprises, particularly in sectors such as transportation, telecommunications, electric power, and airlines. Top executives at state-owned enterprises are appointed by the Communist Party. Their objectives differ from those of a board-appointed CEO at a private firm. Rather than seeking to maximize profits, their priorities may lie with meeting other government goals. A private airline, for instance, would seek to buy the best airplane for the price without regard to where it was produced. In contrast, a top airline manager appointed by the communist party, knowing that the Chinese government wants to replace Boeings and Airbuses with domestically manufactured aircraft, could require technology transfers to local suppliers as a condition for buying airplanes. Since state-owned airlines dominate civil aviation in China, a foreign airplane manufacturer would likely encounter similar demands across all its potential customers in China. Even in officially open sectors, foreign firms can be quietly pressured to provide local firms with technology in order to obtain necessary approvals from local regulators (see here).
  • The sheer size of the Chinese market makes it a difficult opportunity to pass up. For an aircraft manufacturer, for instance, no one is going to be buying more airplanes over this generation than China. Moreover, a company that pushes back on technology transfer pressure, or decides to stay out of the Chinese market altogether, runs the risk that a rival multinational will secure the deal and gain the profits that come with access to the massive market.
  • If foreign companies gain access to a huge market, how is forced technology transfer damaging? When China uses its control over state owned enterprises or the partially closed nature of its foreign direct investment regime to force firms to do in China what they would not do anywhere else, it creates problems. For one, companies give up something that is very valuable that they would not likely give up if they were operating in free market conditions. (If all U.S. airlines got together and secretly agreed to demand high concessions from plane manufacturers as a pre-condition for purchasing aircraft, it would be considered a cartel for anti-trust purposes and U.S. regulators would have justification to proceed against them.) Moreover, providing the technology creates a risk that the Chinese firm could eventually become a significant competitor, not just in the Chinese market, but globally. The industrial policy laid out by China in public documents explicitly states a goal of replacing leading western firms with Chinese firms in key sectors. This is what the Japanese manufacturer Kawasaki Heavy Industries alleges took place in the high-speed train market. Kawasaki has said that after signing technology transfer agreements with Chinese high-speed rail manufacturer CSR Sifang, its junior partner patented remarkably similar technology and Kawasaki now finds itself competing with its former partner for contracts both inside and outside China. A developing country like China could, in theory, subsidize its high-tech firms so much that they displace more innovative western firms in the marketplace such that the overall global pace of innovation slows down.
  • Imposing effective measures to limit forced technology transfer will require information that the U.S. and other governments do not currently have. Multinational companies are reluctant to openly admit that they are being pressured by a Chinese customer or by the Chinese government to transfer technology that they do not want to transfer. Doing so raises the risk of reprisal or of losing out on the opportunity to access the Chinese market. This lack of information makes it difficult for foreign governments to intervene.

What this Means:

Forced technology transfer in China is a real and harmful phenomenon. Finding an effective way to curtail it is challenging. In its efforts to negotiate a more level playing field, the Trump administration has applied tariffs to a broad range of Chinese exports. This strategy runs the risk of imposing large costs on a broad swath of American industries, consumers, and investors — especially once retaliatory tariffs are taken into consideration. In fact, the economic costs incurred by this indiscriminate tariff strategy on the U.S. are likely greater than the costs of forced technology transfer. An alternative option would be for the U.S. government to apply very narrowly focused sanctions on the specific companies or Chinese government officials involved in these forced technology transfer deals, such that it directly alters the incentives Chinese firms and Chinese officials face. This would require having investigative tools to access better information on the nature of technology transfer deals. Moreover, dealing with the problem would be more effective if it were done in a multilateral way. If the United States prevents its firms from transferring technology but Europe and Japan allow their firms to go forward, then the only thing that this is likely to accomplish is that it will prejudice the profits and opportunities of U.S. firms.

  • Editor's note: the analysis in this memo is based on the June, 2018 Peterson Institute For International Economics Policy Brief by Lee Branstetter: "China’s Forced Technology Transfer Problem — And What to Do About It."

  • Topics:

    China / Technology / Trade
    Written by The EconoFact Network. To contact with any questions or comments, please email [email protected].