July, 2018

The price of economic espionage

Original article: The South China Morning Post

With the U.S. and China locked in an escalating trade conflict, it's tempting to assign blame. It's Trump's fault because he wanted a trade war. He says they're easy to win, and he's obsessed with lowering the trade deficit with China. It's China's fault for not adhering to the accepted rules of global trade. 

There is no single cause of the trade war, but China's persistent misappropriation of American intellectual property, whether by cyber espionage, forced technology transfer or physical theft, emboldened hardliners in the Trump administration to strike back and drained the good will China has long enjoyed in the U.S. business community. As a result of tariffs and the tension fomented by the trade war, the Chinese economy will face greater headwinds in the near future. That will create a headache for the Chinese leadership


In recent weeks, the U.S. media has published several reports about outright theft of American intellectual property by Chinese nationals. In all of the cases, former or current Chinese employees of U.S. companies were charged with the crimes. Most recently, California-based Cathy Chen pleaded guilty in Orange County to the illegal transfer of sensitive military technology to China. 

Chen had previously provided accounting services to U.S. aerospace companies, among them U.S. defense contractors. Federal prosecutors say that the equipment included advanced radar, military-grade communications jammers, low-noise amplifiers and Ka-band space communications. Chen faces up to 50 years in federal prison and a $1.75 million fine. 

"The defendant and her co-conspirators executed their conspiracy through multiple entities, including Archangel Systems Space, Inc., Century Electronic International Company and Star Aero Investment Limited, all of which maintained addresses in Shenzhen, China, as well as TAA Electronics, Inc., that used an address in Hong Kong,” Chen wrote in her guilty plea, according to The Epoch Times. “On multiple occasions, [she] made false representations to the suppliers about the end user and country destinations of the items.”

Also earlier this month, a former Apple engineer was apprehended by the FBI before he could depart on a plane to China with stolen schematic designs and plans for a self-driving vehicle. The engineer, Xiaolang Zhang, downloaded information about Apple's self-driving car from the company's network and was captured on security footage leaving the company's grounds after hours with a keyboard, cables and a large box, according to an FBI agent quoted by The New York Daily News. 

It is incidences like these that have helped rally an unlikely bipartisan coalition in Washington against China, even if they didn't initially support tariffs. Senator Marco Rubio, formerly a free trader, has called the tariffs a "theft tax" on China. “China is systematically stealing the fruits of American innovation in an attempt to displace us as the most powerful economy and military in the world," he was quoted as saying by The Washington Examiner in June. Hitting China with tariffs is thus justified - it shows "American leadership," he said. 

Meanwhile, populist Democrats have backed Trump's war on outsourcing, with China as the main target. In March, Ohio Senator Sherrod Brown lauded Trump's aluminium and steel tariffs. “This welcome action is long overdue for shuttered steel plants across Ohio and steelworkers who live in fear that their jobs will be the next victims of Chinese cheating," Brown was quoted as saying by Reuters in March. 

Beijing is still struggling to contain the fallout from the trade war, analysts say. In a recent op-ed for The Wall Street Journal, Donald Luskin, chief investment officer of Trend Macrolytics, highlighted the risks the trade conflict poses to the Chinese economy. Luskin believes the Chinese economy is fragile - he cites slowing growth and overinvestment in real estate and commodities - and that "the escalating trade war with the U.S. could tip China into the unknown territory of recession."

We think that Luskin is jumping the gun. The Chinese economy is a long way from contracting, despite real headwinds aggravated by the trade conflict. Most indicators are solid. In the quarter ended June 2018, the economy grew 6.7%. Retail sales in June increased 9% from a year earlier. The jobless rate remains a modest 4.8%. 

Unfortunately, resolving the trade dispute with Washington will be hard for Beijing. President Xi Jinping is unlikely to offer major concessions, given the assertive stance he has struck on national rejuvenation. But vague promises to balance trade or protect IP of the sort seen during the Obama and George W. Bush administrations won't satisfy Trump or his hardline colleagues. 

Some China watchers say that Beijing is convinced Trump will be ready to negotiate after the Mid-term elections, that he's eager for a deal. Perhaps they've received the wrong information. Trump isn't consulting the China consultant class who advised his predecessors. Former officials considered "friends of China" like Henry Kissinger and Hank Paulson don't have The Donald's ear, The South China Morning Post noted in a recent report. 

The best way to defuse trade tensions between Beijing and Washington would be for China to lower market barriers - especially joint-venture and technology-transfer requirements both implicit and explicit - as well as call off its economic cyber warriors. Otherwise, the U.S. government will continue to restrict or even sever trade and investment channels between the two countries. Neither businesses nor consumers will benefit.