Why tech secrets, not steel, could cause the real clash between the U.S. and China

U.S. trade moves could spark Chinese retaliation
U.S. trade moves could spark Chinese retaliation

Steel and aluminum tariffs aren't the only explosive trade issue between the United States and China.

Stolen trade secrets are also poised to become a flash point as the United States weighs how to transform President Donald Trump's tough talk on China into policy.

The Trump administration opened an investigation into intellectual property theft by China in August. Officials have more recently signaled that an announcement on next steps is imminent.

U.S. Commerce Secretary Wilbur Ross called high tech the "next area of challenge" with China. Trump teased a "very big intellectual property fine" against China in a recent interview with Reuters. IP theft was even name-checked in Trump's State of the Union address.

But defending intellectual property is a notoriously thorny issue — and any push from Washington runs the risk of retaliation from Beijing.

"As with every administration, there seems to be a range of options on the table from the extreme to the modest," said William Reinsch, a trade expert at the Center for Strategic and International Studies who also served in the Bill Clinton administration. "What is different is I think this president is more inclined to the extreme."

Why we're talking about tech secrets

Chinese intellectual property theft from U.S. businesses has been an area of concern for years, both because of its security ramifications and its cost to companies.

IP theft includes the sale of counterfeit goods and pirated software, as well as stolen corporate secrets. It costs the American economy between $225 billion and $600 billion per year, according to the 2017 report from the Commission on the Theft of American Intellectual Property, a group co-chaired by former U.S. ambassador to China Jon Huntsman.

The issue has become a particular point of contention as China works to remake its economy, shifting from low-end industry into high-tech incubation.

"China has gotten increasingly concerned that it's not going to be able to survive as the low cost manufacturer to the world," said Phil Levy, a fellow at the Chicago Council on Global Affairs who previously served as a trade adviser to President George W. Bush.

In 2015, China formally announced its intention to be a technology leader in a state industrial plan called "Made in China 2025." Priorities include ramping up domestic production of electric cars and developing a premier 5G mobile network.

China also plans to dominate in the field of artificial intelligence by 2030 and is rapidly expanding its capacity to make computer chips.

To achieve these goals, China needs a lot of industrial and technological know-how — which is where the country's interest in foreign intellectual property comes in.

How intellectual property theft happens

Cybertheft has been less of a problem since President Barack Obama received assurances from Chinese President Xi Jinping in 2015 that China would stop hacking corporate trade secrets.

The prevailing concern now is the fact that companies are forced to transfer technology in order to do business in China, according to experts.

China typically requires companies that want to enter the country to pair up with domestic firms in joint ventures. Such partnerships can give Chinese companies access to information that foreign companies would otherwise keep private.

"In order to play in that market, you have to disgorge information [and] you have to make it available to local operators," said Brian O'Shaughnessy, an attorney who specializes in IP law at the law firm Dinsmore & Shohl.

In June 2017, China enacted a law that tightened restrictions on cross-border data transfers and mandated that critical data be stored locally. The Chinese government framed the law as an effort to shore up cybersecurity, but critics see it as further means for China to monitor and control online information.

"Companies could be asked to submit source code to the Chinese government under the auspices of a security review," said Samm Sacks, a senior fellow in the Technology Policy Program at the Center for Strategic and International Studies. "But in doing so, they risk revealing their IP."

Such policies and arrangements have built up skepticism among American companies that are otherwise eager to tap into China's massive market.

More than 80 percent of members of the US-China Business Council, a leading trade organization for American companies that do business in China, said they're concerned "about China's policies on data flows and technology security," according to a 2017 member survey.

To comply with the new data law, Apple (AAPL) said in July that it will store the iCloud data of mainland customers with a state-owned company in Guizhou. In November, Amazon (AMZN) Web Services sold the hardware it uses for cloud storage to its local Chinese partner to satisfy the new rules.

The next steps

Experts say it's not clear how the Trump administration's intellectual property investigation into China will play out.

There's one scenario in which President Trump takes a more restrained route, opting to file a complaint with the World Trade Organization once the investigation is complete.

Concerns over trade violations are typically taken up with the WTO from the start, so that course would help normalize the situation at hand.

But Trump could also decide to act unilaterally, citing the scope of the IP theft problem and the need for harsh penalties.

That could mean dramatic restrictions on Chinese investment in the United States, or tariffs on a wide range of consumer products, without the WTO's blessing.

Such moves would shake the global trading system — and would be impossible for China to ignore.

At a press conference in January, China Commerce Ministry spokesperson Gao Feng criticized the United States' decision to launch the investigation via domestic laws, thus circumventing the WTO.

"If the U.S. insists on adopting unilateral protectionist measures no matter what, and hurt China's interests, [the Chinese government] will take necessary measures to firmly uphold China's legitimate rights and interests," he said.

If Trump goes big on tariffs, the U.S. economy would be affected, too.

"A [U.S.] retaliation sufficient to change China's conduct would be so large as to significantly injure both the United States' and China's economies," said Matt Gold, an international trade law expert at Fordham University. "So one questions whether that's the most effective way to go about this."

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