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February 16, 2012 8:00 AM Enough with the Politeness: China’s “innovation mercantilism” threatens the world economy, and Washington needs to speak up

By Rob Atkinson

Chinese Vice President Xi Jinping is in the United States this week for a courtesy call and, sure enough, there has been plenty of courtesy on display. The obligatory rhetorical cocktails of phrases such as “mutual cooperation,” “strategic partnership,” and the like have been served up at every appearance. But behind closed doors, let’s hope China’s likely next top leader is also hearing that the United States and other countries have had enough of China’s innovation mercantilism and that he goes home reflecting on ways to help China and its trading partners succeed simultaneously.

Over the last decade, China’s currency “misalignment,” foot dragging on intellectual property enforcement, export subsidies, illegal dumping, and a host of other unfair trade practices have come under scrutiny at the World Trade Organization or in public debate. Yet somehow, as China’s foreign reserves have come to add up to $3.2 trillion, the prevailing wisdom in Washington has been that we need to be patient as China emergences from its status as a developing-world country with a state-directed economy. We should, the thinking goes, exercise great caution when handling China, as if it were a porcelain doll rather than the soon-to-be largest economy. Skeptics of this mindset are routinely denounced as “protectionist.” However much these less China-friendly sentiments resonate with the public, they have not generally translated into policy, either because they are unworkable or because of political timidity, or both. That needs to change and it needs to change soon.

Since the early 1980s when Deng Xiaoping made the strategic decision to open up China to international investment, China’s strategy was to ride on coattails of multinational corporations (MNCs) in China. In 2006, the strategy changed to what the Chinese call zizhu chuagnxin, or indigenous innovation. The path to prosperity and autonomy now rests on helping Chinese-owned firms (often at the expense of MNCs) and to systemically identify areas where China can import technology and figure out ways to produce it by Chinese firms. Now instead of just exporting Happy Meal toys and DVD players, China also wants to export passenger jets, pharmaceuticals, cars and computer chips. There is nothing wrong with trying to move up the value chain of goods. The problem is how China is doing it.

For years U.S. firms have cut deals with Chinese officials to get a foot in to that vast and growing market. Now it is becoming increasingly clear that China wants to extract everything it can from these companies to empower Chinese firms to out-compete them. These policies take numerous forms. They include massive subsidies for Chinese exporters land grants, rent subsidies, cash subsidies, preferential loans from banks, special tax incentives and massive amounts of export financing. They try to “assimilate” foreign MNC technology through discriminatory government procurement; a weak and discriminatory patent system; joint-venture requirements; forced technology transfer; intellectual property theft; and outright theft of IP through cybercrime and espionage. They engage in direct discrimination against MNCs through favoritism for Chinese firms with unfair monopoly laws and domestic technology standards. And they limit exports of critical materials in order to deny foreign firms key inputs.

It is dismaying that so few in the Washington trade establishment are not more alarmed at these policies and the turn of direction of the Chinese government. Instead, many influential thinkers tell us that it’s okay if China bends the rules a little. After all, it needs to create jobs to avoid political turmoil. They claim that Chinese reform is just around the corner, so we must be patient. They warn that any action to push the Chinese will start a “trade war.” Believe it or not, this is the counsel of Americans as often as it is that of Chinese. There are also economic gurus who argue that it is the United States that needs to change, to save more and get our own house in order before we have the right to tell the Chinese what to do. Still others say China’s policies are unsustainable. We should just wait for China to fail the way Japan supposedly did when it embarked on a similar economic strategy 50 years ago and the superior U.S. free-market model will prevail. Whatever kernels of truth exist in these views, all of them are rationales for non-action when action is needed.

The reality is that China’s leaders seem to believe that it is not enough to make a better product but to destroy the competition and make the only product in nearly all sectors. The great leap forward from competitive advantage to absolute advantage using unfair or in some cases illegal polices puts in peril the entire rules-based global trading system from which China has benefitted from so extraordinarily.

China’s embrace of innovation mercantilism poses a threat to the economic interests of not only the United States but also other countries that generally embrace free trade and have market-based economies. We are already seeing India, Brazil and other countries emulate some of China’s policies. If the emerging nations abandon a rules-based system and start down the road of export-led high-tech growth through innovation mercantilism, we all lose.

You don’t have to be a protectionist to acknowledge these truths, and indeed, the answer is not in sealing off the United States from Chinese competition. Despite China’s growing innovation mercantilism, the potential benefits of close economic ties compel us toward more cooperation, not estrangement. Nor is the proper response to emulate China’s heavy-headed government intervention in the economy. Free market devotees are more right than wrong on that issue.

Domestically, what we can do is recognize at last that countries - and not merely firms - compete. We can do more to support U.S. firms with tax, technology and talent policies that help them compete globally. We can facilitate better cooperation between our universities, private sector employers and public R&D activities to encourage the adoption of technologies and boost productivity and competitiveness.

But that won’t be enough. Internationally, the United States needs to work more diligently to press China. That requires more resources for the Office of the U.S. Trade Representative and will result in more WTO cases. In order to shield U.S. firms from retaliation by the Chinese government, the government itself can initiate these actions. The administration took an important step in that direction with the President’s call in the State of the Union for a trade enforcement task force. But we can’t stop there. The WTO itself needs to be strengthened and have a mandate broader than tariff levels. It should be given stronger enforcement power on a growing array of non-tariff barriers as well as heavily-subsidized State Owned Enterprises that are plainly at odds with fair competition. And perhaps most importantly, the United States needs to bring other like-minded free trading nations, particularly our European allies, to the table to collectively pressure China to abandon its untenable and reckless policies.

The United States should not be timid with regard to China. Putting it starkly, let’s not forget that China still needs the United States more than it needs China. China needs our consumers and our technology. But the United States and other countries also need China. But we need China only if they play by the rules and that is not going to happen with words of courtesy and complacency. We need to contain the spread of China’s worst impulses and convince the Chinese to begin rolling back innovation mercantilism before it is too late.

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Rob Atkinson is president of the Information Technology and Innovation Foundation, a non-profit, non-partisan economic and technology policy think based in Washington.

Comments

  • Big River Bandido on February 17, 2012 11:16 AM:

    This piece doesn't seem to take into account the leverage China holds over the United States as financier for its debt...

  • Gaius Gracchus on February 17, 2012 11:24 AM:

    America grew as a protectionist nation. In the 50's, protectionism and high income taxes allowed the US to pay off the costs of WWII, the New Deal, and the Great Depression, wbile also funding the Marshall Plan, rebuilding Japan, building for the Cold War, creating a massive strategic nuclear threat, etc. And America was extremely prosperous and income and wealth inequality was at their lowest levels in American history.

    We only became a true free trade nation in 1972. Since then wages have stagnated, massive trade deficits have formed, and inequality now surpasses that of the Gilded Age.

  • Dave on February 17, 2012 6:03 PM:

    @Big River Bandido: actually, even though China owns a lot of our debt, we could simply default on it. Any country can default on its debt, and the only recourse for the creditor country is to invade the debtor country. Which China probably would be loathe to do, seeing as all of NATO would probably side with us over them.

  • rover27 on February 17, 2012 6:55 PM:

    China only holds about 7% of our debt.

  • giantslor on February 28, 2012 11:28 AM:

    "Nor is the proper response to emulate China’s heavy-headed government intervention in the economy. Free market devotees are more right than wrong on that issue."

    Nice assertion. Evidence, please?