The China Track 与中国接轨

China's Internet: Are things improving?

China's Internet has never been an easy place to drive. Although theoretically a super-highway paved with thousands of kilometers of fiber optic lanes, the Internet is more like a highway with a toll booth at every mile. Data is scanned repeatedly and often. In techno-speak, the speed is high, but there is also high latency. That's why even when some enterprising souls turn on their VPN's as a way to get around the Great Fire Wall, their performance goes up -- the broadband speed declines but most of that latency (sitting around at toll booths) disappears. 

Things have gotten even worse since last Fall, most likely as a result of the 18th Party Congress. Not only are certain individual websites less accessible, in general it's felt as if another layer of filtering and security was added, molasses poured on top of glue. This has been the informal feeling of friends across China, north and south, off and on campuses, Chinese and foreign. 

Today is the first day I'm wondering if things have changed. Why? Because Skype today worked crystal clear for first time since I can remember. A clear video-to-video chat between China and the US, without VPN, over WiFi, with essentially no problems, save for my kids bouncing around the room not holding the camera steady. We could all see and hear each other clear as a bell with no static or delay.

I looked outside, the sky was still a semi-clear, semi-milk white haze (PM 2.5 reading still way up there). A few minutes later I got into a cab, and traffic still was snarled, and the drivers still darted left and right without warning. Pedestrians still hocked loogies on to the street. Bushes were still covered with dust, and tree branches still were naked. And the ground was still as dry as a desert - because yes, we are, in fact, living on top of a desert hidden by a city of 20 million.

Yet I still have a ray of hope that something positive happened today. 

Am I dreaming?

Apple's global supply chain

Here is a terrific story from the New York Times on the globalization of Apple. The company has moved jobs around the world to both save on costs and to take advantage of the more flexible and better quality manufacturing facilities and talent that are in Asia.

The reporters present a very balanced story; this is not just about a greedy company willing to exploit powerless workers to get rich. It has been forced to diversify production to become more efficient and produce better products. Some contracted workers in Asia work 12-hour shifts and 6 days per week. When an employee in northern California was asked if he would do the same, he said he wanted his Saturdays free so he could watch his kids play soccer. 

I saw one big thing missing from the piece. Although from an employment perspective Asia and China have benefitted imensely from globalization of the consumer electronics supply chain, China participates at the lowest value-added segments of the production of the iPhone. Most of the value-added comes from the US, and most of the profits go to Apple, not suppliers. China is having an extremely difficult time moving up the value-added chain; the story highlights China's ability to provide a flexible workforce and modify manufacturing on a dime; but Chinese firms contribute little to the design of the iPhone or other popular consumer electronics.  

The difficulty of being more innovative is a central concern across China. Following the death of Jobs, there was a big conversation on blogs here, "Why does China not have a Steve Jobs?" So far, the main solutions have been to crank out a lot of engineers and scientists, throw a lot of money at R&D, ramp up establishing patents and standards, and provide protection for domestic firms against foreign rivals. Still missing is encouraging creativity in the educational system, opening up the media and flow of information, more seriously protecting IPR for innovators, and making capital more accessible to private business. My guess is that there are lots of innovative people in China, they just live in a non-supportive environment. 

Hence, for the time being, China is mainly benefitting on the employment side of hi-tech; if it ever manages to move on reforms that would promote product-level innovation, then China would be in the driver's seat globally. So it seems as if the US and China are mirror opposites. China needs the US's innovative environment, and the US needs a deeper sci-tech workforce and better infrastructure to support manufacturing. Not surprising their economies are so intertwined.

Full disclosure: I'm an iPhone 3Gs owner and just switched from a Dell to MacBook Pro laptop. I love both, but I hope Apple will make Word work better on my Mac; it has been far from a seemless transition, which is the fault of Apple and Microsoft. Also, why on earth can't I easily delete text in front of the cursor (and not just back-up)? I can do so in email and on the web using Ctrl-D, but that does not work in Word; and really, I should just have to hit one key for this, not two. I suppose these are minor complaints, but Apple should be all about the user experience. 

The US-China Business Council and AmCham: Love vs. Tough Love

Yesterday the American Chamber of Commerce in China, located in Beijing, released its annual White Paper on the business environment in China. This lengthy document analyzes the evolution of Chinese policies across a range of issue areas and regions and the economic environment for American firms operating in China. AmCham uses a detailed survey of its members as well as information from additional research and interacting with the Chinese government. The White Paper contains both analysis and specific policy recommendations.

The US-China Business Council serves mainly as a business association representing a wide swath of international companies that do business in China, but it also provides customized consulting for individual members. Most of the Council's members are also AmCham members. Although the Council does not issue an annual white paper, it does release occasional reports and its staff testifies before Congress and privately offers advice to the US executive branch and the Chinese government.

Given their overlapping constituencies, it is somewhat surprising that the two organizations recently have struck different notes on China. Both organizations identify positive and worrying trends, but their emphasis differs. AmCham's phrasing is: Our companies are doing well, but the policy environment is worsening. By contrast, the Council's consistent message is: There are some worrying signs about the policy environment, but overall things are going in the right direction in China. AmCham seems to be ringing alarm bells, while the Council is tooting a small bicycle horn. 

The White Paper shows that American companies are still doing extremely well in China. 78% of respondents said they are profitable or very profitable, compared to only 71% in last year's survey. Most firms say their incomes have gone up subtantially. However, arrayed against these positive macro trends are worrying policy developments that are presenting severe challenges to their members. Over a quarter of respondents say that "Indigenous Innovation" policies are negatively impacting their business. Many believe that the protection of intellectual property rights is not improving, and opportunities for government procurement are threatened by various buy-local incentives or even orders.

Given these challenges, AmCham makes a case for more forcefully raising these issues with Chinese officials and offers a long list of suggested reforms.

The US-China Business Council comments about worrisome trends in China's business climate, including reports on Indigenous Innovation. Many of these have extensive details about policies that may be harmful to US interests, but these reports do not strike a worrying tone. They appear to be intentionally dry, fact-based descriptions of the current scene and avoid preaching as much as possible. At most, they mention "international best practices" China should seek to follow. But otherwise, they are highly respectful and avoid being seen as emotional or critical.

A good example is a paragraph from the executive summary of a recent report on indigenous innovation policies:

The Council also appears to believe that the key to responding to the challenge of China's policies are not pressuring China to change but rather having the US government adopt policies that promote innovation and the competitiveness of US industry at home and abroad. The Council also released this month a 28-page report, "China and the US Economy: Advancing a Winning Trade Agenda, A Guide for the 112th Congress." No where in the report is there a mention of Indigenous Innovation or many of the other concerns that appear in AmCham's White Paper. The report highlights the continued prominence of American manufacturing, the small percentage of American manufacturing that has moved to China, and China's much lower per capita income.

The tone from AmCham now sounds more similar to that of the U.S. Chamber of Commerce, based in Washington, D.C. The US Chamber represents a wide variety of corporate interests, including firms that doing well in China and those that see China as a competitor. For many years, AmCham sounded more sympathetic to official China, but that phase seems to have passed. It is now the Council that looks distinctive among this group.

None of the above is meant to pass judgment on either position, just to note the apparent differences in approach. Given that AmCham and the Council have overlapping membership, one wonders what is the source of the difference. Perhaps it is that the Council is headquartered in Washington, DC (but with offices in Beijing and Shanghai) and needs to interact more with Congress. Or perhaps this difference reflects the contrasting styles of their leaders, John Frisbee in the case of the Council and Chris Murck in the case of AmCham. Or perhaps we have a game of good cop-bad cop being played.

I have no idea which it is, but look forward to continuing to engage in chamber-ology -- searching for clues in their respective statements -- in the years ahead.

Neat Reading: From smart phones to Huntsman's farewell address

I've been trying to catch up on reading and lately came across some interesting stuff:

1) David Wolf, writing in Silicon Hutong, has a nice piece analyzing the burgeoning standards war for smart-phone operating systems. Baidu just announced it will soon offer its own version in an already crowded field. There are at least seven globally relevant smart phone operating systems, and there are three others available in China, offered by China Mobile, China Unicom, and Kai-fu Lee's Innovation Works. Wolf notes that all this competition creates consumer confusion, but he points out that only 7% of mobile subscribers in China have a smart phone, and hence, in the Chinese context it makes sense for there to be a period of operating system competition.This contest over smart phones is similar to the old conflict over video player formats -- SVCD, CVD, EVD, etc. And at least from what we know, the initiative for the contest appears entirely commercial; there may be government subsidies lurking somewhere, but the inspiration seems to originate in the creative minds of business executives, not bureaucrats.

2) The US-China Economic and Security Review Commission (USCC) held a hearing on trends in Chinese foreign policy on April 8. The most interesting panel from my perspective was on "New Interest Groups in Chinese Foreign Policy." Although there's some debate about what constitutes a "real" interest group" as opposed to a branch of the Chinese regime, the three panelists collectively demonstrate that Chinese companies, banks, and bloggers are playing both a direct and indirect role in the policy process. This trend is driven by globalization, the spreading interests of Chinese industry around the world, and technological trends that make it easier for all of us to join the public sphere (my word, not theirs).

3) The USCC also just issued a report with its take on China's Indigenous Innovation policies. Although there are worries about China using a variety of policy levers to ply technology knowhow from foreign hands, the most interesting thing about the report is that it is quite skeptical that China's policies will lead to extensive innovation. If so, foreign firms need to grab hold tight of their IPR now, but this policy initiative is not the long-term threat many worry about.

This reminds me of an interview a few years ago. An executive from an American telecom firm told me that despite the headaches, some in his firm want China to continue its top-down policies to promote innovation because they are so unlikely to succeed; if the Chinese government were to actually be a much greater promoter of genuine innovation, through reducing barriers to market entry, encouraging non-state financing of product development, reforming the education system, etc., then Chinese industry would present a much greater challenge to his company.

4) Two different takes on Huawei and Chinese telecoms abroad: One is from Bloomberg, highlighting the importance of China Development Bank's $30 billion line of credit to Huawei. The second is a piece on the presence of Huawei and ZTE in the Middle East written by William Foster and Hannah Thoreson. Foster and Thoreson see Huawei and ZTE as commercially driven companies, but they highlight how their Internet filtering technology has been widely adopted across the Middle East. "Taking advantage of security tools and techniques developed in the Chinese market," they write, "Huawei and ZTE help their overseas partner telecom companies fashion networks that meet the information control needs of their domestic governments." Not surprisingly, the companies haven't run into the same kind of scrutiny they have faced in the United States and India.

5) On April 6th, American Ambassador to China Jon Huntsman gave what was billed as a "farewell speech" in Shanghai. It stands out for both his commitment to cooperative solutions to address thorny problems in the relationship, but also his frustration with the limits on civil liberties in China that has made it harder to have an open conversation between the two countries, which he suggests helps explain the continuing misunderstanding and distrust. I came across a thoughtful Chinese response to the speech in Wen Hui Pao penned by Guo Xuetang, a professor at the Shanghai University of Political Science and Law. Although Guo also wants the two countries to reduce misperceptions and find ways to peacefully co-exist and cooperation, he sees the burden for change as on the American side. Americans need to remember, he says, that China is recovering from over a century of mistreatment from the outside world; moreover, China is a larger powerful country that deserves America's respect, but it is still developing, and hence, its international responsibilities must remain limited. This certainly sounds self-serving from an American perspective, but it is not an uncommon view in China. The question is whether there is space for imagination in both countries to find common group: Can Chinese recognize that an American call for great liberalization in China is not part of a conspiracy to contain China but is actually suggested with China's interests at heart? And can Americans recognize that given China's history and American deep intervention in many countries around the globe that Chinese understandably might see the various elements of American policy toward China as part of a self-interested plan to keep the US on top?

USITO job openings

The US Information Technology Office (USITO) in Beijing is looking to expand their staff by hiring a Policy Manager (Download Policy Manager JD) and Senior Policy Director (Download Senior Policy Director JD). I've followed USITO since its very early days in the 1990's, and the organization has become an integral part of the policy process in China for information technology.

Robert Putnam of Harvard is famous for his theory about "two-level games," in which negotiations between national governments are affected the internal negotiations each side has with their own domestic industry. USITO is a living, breathing example that shows how outdated Putnam's two-level games are. Although representing primarily American industry, USITO is in direct contact with the Chinese government and local industry on a regular basis.

Just fyi, this post is meant as a public service announcement and not as an endorsement.

The NY Times, IPR Theft, and Software Piracy Data

It's the day before Christmas and all through the house...we're reading the NY Times editorial about China's growing thievery of intellectual property rights (IPR). It's rare for the world's "paper of record" to run an editorial about such a specific issue coupled with details about Siemens, railroads, etc.

As I've written before in this space and elsewhere, Indigenous Innovation policies are troubling, but mainly for their potential future harm, not for what has occurred so far. In the case of Siemens, I wonder why they haven't gone to court. Is it that they're afraid of upsetting the Chinese and being locked out of further business? That what the Chinese side did was hardball but legal?

The editorial notes that at the recent JCCT the Chinese promised to better protect software. On this point, it'd be instructive to look at some data. IPR theft data is extremely difficult to compile, and much of what is compiled is methodologically flawed (more in a second). But let's see what we've got. The most common measure is provided through an annual study released by the Business Software Alliance (BSA) and the International Data Group (IDG). The BSA/IDG studies have been released since 2004, and before that BSA released its own report for several years. But to be sure we compare apples to apples, let's just look at data from the seven BSA/IDG studies issued so far. I've compiled the data on China and the US in two graphs and a table:

Two things stand out from this table: (1) China's piracy rate, in terms of the percentage of pirated software to total software sold, is much higher than that in the US; but (2) the piracy rate in China has been consistently on the downward trend. Whereas it used to have the first or second-highest piracy rate in the world, in the 2010 study, China was tied for 26th.

Things look differently if we compare the China and American piracy rates in terms of dollar value of pirated software: 

From this perspective, the United States has been and continues to be the world's leader in terms of software piracy. Just using the last seven years, total software piracy in the US is valued at almost $53 billion, compared to almost $38 billion for China. Earlier this month BSA lobbied Washington to take a new approach on IPR toward China, focusing on achieving actual results. Perhaps BSA should push Washington to change its approach toward protection software IPR in the United States.

Two wierd things about these tables stand out: (1) The reduction in China's piracy rate, in terms of percentages, appears to have accelerated in 2005 and 2006, just when China had launched the first stage of its Indigenous Innovation policies; and (2) Despite the decline in percentage terms, the dollar value of software piracy in China seems to have grown. That must mean the total hypothetical software market expanded dramatically during the past few years, and thus it is likely that actual software sales are also rising quite quickly. 

What to make of these numbers? I think they're highly suspect guesses about what is going on.BSA/IDG explain that their data reflects the "value of pirated software if it had been sold in the market. It is calculated using a blended average price of software in an economy, as sold in retail stores, using volume licensing, and as bundled with hardware" (BSA/IDG, 2010 Survey, p. 8). This assumes that consumers would have paid for the software at the average price had the piracy option not been available. But we know that is not the case, and much less software would have been in use. This type of calculation may make sense when calculating the cost of stolen cars, but it doesn't transfer well to copyright infringement. Even the researchers at IDG who conducted the study for BSA disagree with terming the calculated figures as "lost sales" since it is likely only one in ten of those sales would have occurred at the retail price.

On the other hand, BSA and IDG are consistent, and although you don't want to be inaccurate when doing surveys, it is much more important to be consistent, that way your research maintains the same bias over time and space, and it is easier to make adjustments from that starting point.

 

The Costs of Chinese Tech Policy: The US ITC Weights In

On Monday, December 13, the US International Trade Commission (ITC) issued the first of two reports that seek to quantify the economic losses to American industry as a result of China’s lax protection of intellectual property rights (IPR) and the combination of emerging policies that are collectively geared to promote the “Indigenous Innovation” of Chinese technology. Despite press accounts suggesting the report was strategically released just prior to this week’s meeting of the US-China Joint Commission on Commerce and Trade (JCCT) as a means of putting more pressure on China, the purpose of this report was to simply outline the problems that exist with regard to China’s IPR and Indigenous Innovation policies and sketch out the likely methods the commission will use in the months ahead to actually calculate the costs of these policies.

Although one could offer quibbles – don’t worry, I will – the report is quite careful and measured in its approach, and offers no mouth-dropping conclusions that “stick it” to the Chinese. The authors appropriately point to the widely recognized gap between China’s legal IPR framework and implementation, though they also note that there are aspects of China’s laws and regulations that need to be addressed. They provide a long list of policies geared to promote the development and commercialization of Chinese technologies, from government procurement to accreditation processes.

They conclude, though, that the costs of Indigenous Innovation have, in the main, yet to be felt because the policies are in their early stages. Hence, they write:

This conclusion differs substantially from that offered by a U.S. Chamber of Commerce report authored by James McGregor issued this past summer, calling Indigenous Innovation “a blueprint for technology theft on a scale the world has never seen before.” [“China’s Drive for ‘Indigenous Innovation’,” p. 4.] This week’s report takes the appropriate position that we ought to do some systematic data collection before reaching any conclusions. Hey, what an idea!

The last part of the report then suggests how they plan to go about collecting and analyzing data. They will use a combination of surveys of companies, econometric analysis using quantitative data, and simulations. The authors review previous efforts at quantification and seem quite aware of the daunting task that lies ahead.

I’d offer three modest suggestions as they move forward:

1. Use scenarios. Since most of the costs are really in the future, instead of identifying a single dollar amount, the authors should provide alternative estimates based on certain scenarios that would vary according to changes in Chinese policies, different IPR theft rates, and different US company business strategies. The costs of government procurement will vary depending on whether China becomes a signatory to the WTO’s Government Procurement Agreement; the costs of Chinese standards efforts depends on the extent to which Chinese companies participate in both domestic and international standards efforts and how effective they are in these settings.

Scenario 1 might be called, “Full-Out Mercantilism,” in which the Chinese aggressively use every lever identified in this report to privilege domestic companies at every chance they get regardless of the complaints of foreign industry, their governments or the World Trade Organization. Scenario 2 might be called, “Muddling Industrial Policy,” that is, a continuation of the fuzzy status quo in which some distorting policies are expanded and others are modified or withdrawn in reaction to both complaints and their own learning of what works best. And Scenario 3 might be called, “Liberal Enlightenment,” in which IPR rules are more intensively enforced and Indigenous Innovation policies are radically scaled back in favor of a focus on improving China’s education system and other components of the “innovation eco-system.”

2. Consider the potential benefits. Although the costs may appear most obvious, it is a certainty that some American companies will substantially benefit from IPR theft and Indigenous Innovation policies. That may seem counter-intuitive or immoral, but you can bet the farm it’s true. Some American companies have received contracts for 3G telecom equipment, contracts that wouldn’t exist without an aggressive state-led effort to move from 2G to 3G telephony. They did not win as much as they would have had it been a perfectly even playing field, but the more accurate metaphor is a pie: industrial policy led to a larger pie, even though foreign companies got a smaller piece than they should have. Some American companies benefit from cooperating with Chinese companies which use others’ IPR without having fully compensated them. All American computer hardware companies benefit from Chinese who use pirated versions of Windows yet still pay for their computer hardware. If the ITC assumes that stolen IPR and more active Indigenous Innovation policies are by definition harmful to foreign interests, their results will be biased in favor of a larger cost estimate than is justified.

3. Delineate between losses due to different reasons. It is possible that the ITC will conclude that to the extent the market share, sales and exports of American companies decline in China, that trend may entirely be the result of unfair Chinese policies. They will certainly play a role, but that is not all that will be at work. US firms may also lose out because Chinese firms and their employees genuinely improve their capabilities and the quality of their products and services. And US firms may lose out because they make mistakes in strategy, product design, government affairs, human resource management or some other aspect of their business. American companies have been known to fail before outside China, even in the United States. It would be wrong to blame everything on the Chinese. The more their report’s methodology can account for these different factors, the more persuasive and valuable it will be.

Did China intentionally divert Internet traffic?

In last week's post I filleted the most recent annual report of the US-China Economic and Security Review Commission. I'll admit, I didn't read every page. If I had, I would have come across the whopper that for a brief period on April 8 China Telecom re-routed 15% of the Internet. The claim was way deep in the report, pages 236-247. The implication is that the global Internet is vulnerable to Chinese manipulation, and fits together seemlessly with manipulation of the Renminbi, the supposed sudden halting of rare earths exports, and mercantilist policies in support of Indigenous Innovation, among other policies. In short, this is another example of how China isn't playing fair.

The only problem -- this is very likely a misreading of the April 8th events. As explained in a  blog entry by the consulting firm Renesys, and elsewhere, it is very likely that China Telecom unitentionally routed  Internet flows in its direction, and that such mistakes occur quite often, so much so that at the time no one seemed to pay it much attention. I'm told by an Internet expert that this does reflect a real weakness of the Internet that needs to be addressed, but it's not a China-specific problem whatsoever.

This looks like a problem for the Internet Engineering Task Force, which by the way, just had a major conference in Beijing.

The Tale of Competing China Reports

Today two well known participants in the China Policy Dance issued reports that reflect important concerns about China's business environment and how China engages the world. Yet there were also important differences between them that reflect that value of being careful and not painting China with a single broad brush stroke.

The US Economic and Security Review Commission released its annual report, and as usual, the commission went overboard in its criticism of China, painting almost everything China does as a violation of international norms. (The commission does deserve credit for recognizing progress in cross-strait relations and admitting that Chinese holdings of US Treasuries doesn't threaten the American way of life.)

Leaving aside their analysis of security issues, there are two parts of their report on the business environment and trade that are typical of their bias. First, they go overboard in their criticism of China's Indigenous Innovation policies and in particular the November 2009 policy to promote government procurement of domestically-made technology products. However, they fail to report that this draft policy was subsequently revised in April 2010, largely satisfying the demands of foreign business and government critics. China is still not a member of the WTO's Government Procurement Agreement (GPA), and it doesn't make sense to harp on the backsliding and ignore the positive adjustment.The report also claims these policies have been quite costly to American industry, but these claims are not substantiated, and that's where the rubber meets the road.

Second, the report inaccurately accuses China of continued widespread "noncompliance" with its WTO commitments. Yes, China still has a variety of non-tariff barriers, and some of these are more substantial than when it joined the WTO in 200; but it is inaccurate to characterize these policies or industrial policies in general as "noncompliance of WTO commitments" (p. 46). As the report indicates, when the US and others bring China to the WTO, China has lost most of the cases, but in those cases it has routinely complied with the verdict and changed the relevant policies. (One should note that respondents typically lose WTO cases, the US being no exception -- though the US is exceptional in that it regularly delays modifying domestic laws longer than any other loser.)

But what the report's authors really mean is that it isn't that China is overtly noncomplying, but that China's system is inherently incompatible with the WTO's norms of openness and reciprocity. Hence, they write,

Atlhough the commission may not like industrial policy, the WTO as a rule doesn't ban it, and it likely never will.

Why does the commission have such a consistent record over going overboard? I can't say for sure, but in reading their reports and informally talking with the commissioners, I don't think it would be unfair to suggest that the commission views China's rise as an inherent threat to the United States, and everything China does or says is viewed through that prism. The predictability of the Commission's reports may be why they have so little effect on the American debate, even in Congress.

The second report released today is the US-China Business Council's 2010 Member Priorities Survey Results. They ask their members about trends in profitability, business strategy, and problems with China. Since the Commission's discussion of China's business environment for American companies is geared toward identifying problems for American companies and how things should be made better, it would seem to me that the Commission's report above ought to be somewhat consistent with what the US-China Business Council found. They're not. Instead, there are huge, unbridgeable differences.

First, whereas the Commission paints a picture of China as an economic threat and damaging to US economic interests, the Council reports that 87% of its members report being profitable in China, with 65% saying their profits grew by 10% or more. Surprsing to many who think foreign industry goes to China just to take advantage of cheap Chinese labor and then sell the goods back in the US, 96% of respondents said they are operating in China in order to sell to the Chinese market, compared to 40% who said they use China as an export platform (multiple answers allowed). And 94% of their respondents were optimistic about their China business going forward.

Second, the Council identifies substantial problems companies face in China, but it is a much more complex picture than the one painted by the Commission. This is summarized in the below figure (printed here with the Council's permission).

Some company problems are consistent with those identified by the Commission. Continued and growing problems with administrative licensing, competition from SOEs, market access in services, protectionism risks, government procurement, and standards all fit the Commission's story. Yet there are some major differences to note:

1) The #1 problem is human resources, that is, obtaining and keeping quality employees. This is complemented by another worry, the growing cost of doing business in China, which companies said is primarily the result of rising wages (which is in part the result of labor reform laws passed since 2007);

2) Some problems that are still serious enough to warrant being in the Top 10 are nevertheless improving. It's incredible to see that American industry believes there has been a general improvement in protection of intellectual property rights and that Chinese policy and the policy process are becoming more transparent. This is a major change from just a few years ago. Moreover, although companies are worried about Indigenous Innovation policies, over 70% report that these policies have yet to substantially harm their business interests; and

3) The Commission spilled a lot of ink harping on China's nefarious manipulation of the Renminbi and quoted the (weakly defended) claims of Fred Bergsten and others that the US is losing over a million jobs due to China's policies. By contrast, the forex problem is irrelevant to the US-China Business Council's members. Currency is not (and has not been) among their members' Top 10 concerns, and it doesn't even make it into the top 20. It'd certainly be a shame for Washington, DC, to go to the mat over currency when much of industry finds the issue largely irrelevant to their concerns.

Who is Huawei?

John Pomfret has one of the best stories I've seen on Huawei in the Friday, October 8, edition of the Washington Post. He details the rise of the company and the continuing concern among Western governments that the company has special ties with the Chinese PLA that make doing business with Huawei an inherent security risk for other governments. Last year, as AT&T was preparing to install a next generation phone network, it had planned to buy the telecom equipment from Huawei; but the National Security Agency told AT&T if it did so AT&T's contracts with the US government would be threatened. The NSA was worried Huawei could insert secret backdoors to allow the Chinese government to clandestinely track confidential calls and information. AT&T bought the equipment from the politically more reliable Ericsson and Alcatel-Lucent.

Over the past couple years Huawei has taken several steps to address concerns about it ties to the PLA. Pomfret notes that Huawei has publically outlined the distribution of its ownership. Its 60,000 workers hold 98.6% of the company's shares. Through my own work, I've noticed they've done a variety of other things as well. The company has been audited by outside accountants, and it has releasd a great deal of information about its business. For example, it provides a detailed description of its IPR protection scheme, including a list of all of its American and European patents. Although Huawei has been accused of stealing the IPR of others, most notably in the 2003 Cisco case and the ongoing case with Motorola, Huawei is largely now in the position of having to go to court against smaller companies trying to use its technology. The company also discloses its efforts to comply with export control and other regulations in the markets it operates in.

In many other ways, Huawei operates like an independent-minded, aggressive Western firm. A visit to its headquarters in Shenzhen or a conversation with any of its employees reveals a corporate culture that is so distinct from any state-owned enterprise I've ever come into contact with. No offense to the very good people at ZTE and Datang, but their corporate cultures still have an old-school Chinese feel to them. Not so with Huawei. In addition, although Huawei has received extensive government support, including billions in export financing from the State Development Bank, Huawei's business choices, in terms of products and markets to focus on, also indicate a strong independent streak. Huawei is not falling in line with Beijing's 5-year plans.Similarly, Huawei has become one of the most active and sophisticated participants in international standards bodies, playing a critical role at the International Telecommunications Union and several standards consortia. Huawei has moved up the learning curve faster than any of its Chinese cousins (China Mobile is probably #2, though a distant #2), and its view of standards differs from the techno-nationalist position one hears elsewhere in China. 

All of these actions make it seem less plausible that Huawei is a secret tool of the PLA or Zhongnanhai. Why would a company that operates so independently risk its global business in such a way? On the other hand, there is one big step Huawei could take to ameliorate the fears of outsiders: have an IPO and list on an exchange with tight disclosure rules, such as Nasdaq or the NY Stock Exchange. And then create a board of directors composed primarily of outsiders to provide oversight. If Huawei had to comply with SEC disclosure laws and subject itself to the scrutiny of shareholders, CNBC's Squawk Box, and Bloomberg, that might give the US government and others the confidence they need to allow Huawei to sell its products in the US without regulatory obstacles or political intrusions.

Then again, listing might not make a difference. For one, most Chinese companies that list typically keep part of their assets unlisted, often in a holding company, and Huawei could park its most sensitive stuff outside the scope of the new corporate governance regime. Second, it is likely Huawei employees, including leader Ren Zhengfei, would own the great majority of shares. In China minority shareholders, no matter how uppity, typically are powerless to affect a company's management and business decisions. And third, one has to wonder whether Ren could countenance giving up any authority or making himself accountable to outsiders. Leaving aside the potential disclosure of things they'd want to keep hidden, by any measure Huawei has done remarkably well, rising from a small outsourcer to one of the world's largest telecom equipment designers and manufacturers. Why change what works?

And lastly, there is a great irony in the most recent story involving the NSA. In the last decade, one of China's most ardent fears was that Microsoft had inserted backdoors into Windows that once installed would allow the NSA to peak into the computer networks of the PLA, Chinese intelligence, the Party, and government agencies. The charge was leveled by nationalistic Chinese who claimed to have technical evidence but never produced any. Microsoft had to go to great lengths to reassure its customers that it wasn't a secret arm of the NSA. The parallels make one wonder whether Huawei is similarly the victim of a scare campaign.

So who is Huawei? You decide.

Indigenous Innovation: Determining "Our" Position

Last year iron ore was the big worry with China. This year it's "Indigenous Innovation" and rare earths. The latest take is given by Adam Segal, a senior fellow at the Council on Foreign Relations. A long-time astute observer of Chinese technology policy, in a brief commentary posted on the Foreign Affairs website yesterday, Adam recognizes that the Chinese government has given in to pressure and relented on some of the most odious elements of Indigenous Innovation, such as by modifying government procurement policies. Yet he expresses deep concerns that these concessions are only limited changes in tactics and keep in place China's worrisome larger strategy. Here's the key paragraph in his piece:

The problem for the United States is that these concessions are more tactical than real shifts in underlying policy. China’s leadership is broadly committed to the goals of reducing dependence on foreign technology, producing Chinese intellectual property, and creating Chinese technology champions. Even if China reverses certain policies under U.S. pressure, it will remain dedicated to those goals. U.S. policy is likely to become a game of Whac-a-Mole, beating down one Chinese initiative on indigenous innovation only to see another pop up.

I have 2 problems with this argument. First, the whac-a-mole strategy has been an unmitigated success. The US has the opposite problem of Ah Q (maybe we should call it "Z Q"): it walks around imagining defeats when it has achieved substanial victories. As I wrote in a piece published earlier this month for China Economic Quarterly (and posted with their permission), there is a consistent pattern of China issuing unacceptable technology policies and then modifying them in the face of massive public criticism by foreign industry and government and quiet complaints from Chinese businesses with extensive foreign partnerships and pro-liberal Chinese experts. The most worrisome policies -- software encryption, WAPI, the CCC Mark for information security products, Green Dam, the Indigenous Innovation catalogues, government procurement rules -- were all challenged and defeated.

The second problem is the implicit view that the US government and US industry have the same interests and should have the same position on Chinese policies. I can see why American companies would be quite worried about interventionist Indigenous Innovation policies even if they are compliant with WTO rules -- the rules in some ways reduce market access to China and in some instances will yield more competitive Chinese companies who may take market share away in China and elsewhere. However, the USG, or at least USTR, has a different mandate: whether China breaks the rules. And on that score, the pattern of Chinese behavior -- its initial policies and then retreats -- is not as worrisome. By and large China has skirted the line and crossed ocassionally, but it has pulled back and crossed back when challenged. 

The issue of whether China should have an interventionist technology policy is less about the rules and more about what would be in the best interests of Chinese and foreign industry. There we can have a very good argument about the strengths and weaknesses of indsutrial policies as opposed to government taking a lighter touch. BTW, I don't know many folks who now encourage an entirely "free hand of the market" approach. The "ligher touch" means government facilitating and supporting instead of directing, not sitting on its hands. Framing Chinese behavior as about compliance may be a good lobbying strategy for US multinationals, but that's not the real issue; it's competitiveness.

Indigenous Innovation: More Indigenous than Innovative?

Indigenous Innovation: an oxymoron or a critical link in helping Chinese industry move up the value-added chain? If last year was all about the exchange rate (and this hasn't disappeared), Indigenous Innovation is definitely the hot issue of the year in China's foreign economic relations.

It's not that it is new. China has long had an activist policy to develop technology, civilian and military. What's new is the degree of intensity and simultaneous use of multiple tools -- technical standards which privilege local technology, patent rules for national standards which allow use of proprietary technology for free and without the owner's consent when that technology is vital to developing the standard, an indigenous innovation catalogue, required disclosure of sensitive technology for information security products sold to the PRC government, and more generally reserving government procurement for local technology.

All of this has the international business community and their home governments up in a tizzy. American, European, Japanese, and South Korean industry are all on the same page and cooperating. We are also seeing a rise in media coverage of the continuing obstacles to innovation in China. Don Lee wrote a couple weeks ago in the LA Times about the frustrations of an MIT professor turned lithium-ion battery entrepreneur who set up factories in China only to see similar technology soon emerge out of other factories. They would hire good talent, but, as their CTO said, "we ended up having to teach these guys how to make our state-of-the-art, world-class batteries. … And some of them are now competing with us directly." John Pomfret has a long piece in today's Washington Post arguing that China lacks famous global brands because of the obstacles to innovation. Lenovo, China's most recognizable brand which bought IBM's PC division in 2004, has only achieved success by re-focusing on the Chinese market. If Geely's acquisition of Volvo is to pay off, it will need to do the same -- go local not global.

The underlying message is loud and clear: China is not only not playing fair with the international community, it is shooting itself in the foot. Hyper techno-nationalism is actually likely to hinder innovation and hurt the chances of Chinese industry moving up the value-added chain.

I am sympathetic to this perspective, but I do worry that it may be going a bit overboard. After watching Chinese technology policy for the last decade and a half, there seem to be some consistent themes and points I see:

1. China is doing very well without famous global brands. I was going to say, "because it has no global brands," but that's a little too strong. Nevertheless, China's comparative advantage is in assembly and manufacturing, because of a highly educated labor force and government investments in infrastructure and policies encouraging partnerships between China and the rest of the world. 10% annual GDP growth for 30 years is proof enough that despite a variety of mistakes, the Chinese basically have gotten it right. You have to crawl before you walk and walk before you run, and the Chinese have been excellent crawlers and walkers. Chinese should not obsess about not having lots of famous brands.

2. You can find lots of stories of obstacles to innovation, stolen IPR, etc., but it's wrong to say innovation is absent in China. Process innovation related to manufacturing abounds, and there have been a slew of incremental product and service innovations. Dan Breznitz and Michael Murphee's soon to be released, Run of the Red Queen: Government, Innovation, Globalization, and Economic Growth in China (Yale University Press) documents regional patterns of innovation, with a variety of real-world examples. A larger point is that innovation is not simply a bottom-up, government-get-out-of-way process. There is a role for government, even an activist role, though the exact contours of what works and what doesn't, what's fair and what isn't, is not clear.

3. As distasteful as many of China's indigenous innovation policies are, it's far from apparent that they violate China's international commitments, to the WTO or to individual trading partners. China has mastered how to get right up to the line without breaking the letter of the law. Take standards. I have a hard time envisioning a standards case at the WTO. There have been around 400 disputes brought to Geneva, and exactly one has involved standards -- for sardines, not your typical high-tech product.

4. One reason bringing a case would be hard is that announced policies and rules are typically scaled back, either during the drafting process, which is more accessible than in the past, or early in implementation once obvious, major problems emerge. Mandatory implementation of WAPI was suspended in 2004. Green Dam was busted in 2009. Over the last year the mandate for turning over sensitive technology for cetain Info Security products was scaled back to a narrower group of products and only applied to those provided in government procurement. WAPI has been resuscitated, but it now shares space on mobile technology with WiFi, an extra burden for consumers and manufacturers, but not the ban on WiFi originally planned.

5. The scaling back and revision of plans is due to both the patient and well organized lobbying of multinationals and the quiet lobbying and popular criticism leveled against these policies by Chinese industry and the public. Internationally oriented companies and consumers who want the best technology regardless of its national origins have gotten quite uppity about techno-nationalist policies that go against their interests. They are more open to a techno-globalist view of Indigenous Innovation that stresses innovation, in which promoting innovation in general is good for local and foreign industry.

The short of it all is that it makes little sense to attack Indigenous Innovation head on as an inherent oxymoron. It has potential for great harm and great good. Engagement with the Chinese government and other stakeholders on a case-by-case basis is the way to go. That means lots of little battles, but it makes more sense than going nuclear.

China, Inc. Myth Exposed Yet Again

Welcome to The China Track, where you will find commentary about the political economy of China's engagement with the world. One of the most well-worn phrases of contemporary China is, "get on the international track" (与国际接轨), which implores China and individual Chinese to adapt to global norms and international best practices. But all tracks run in two directions, and the world is also grappling with adjusting to China in ways big and small. Those who live and work in China must adjust to the amazing pace of life, cab drivers, Chinese food, and rules and procedures that vary dramatically from those at home. Companies and societies the world over are affected by China as the world's fasting growing consumer and producer. As someone who has lived in China off and on for 5 of the past 20+ years and who does research on these issues, it's an honor and challenge to contribute to this conversation. I welcome your comments, feedback, tips -- and sympathy.

This week two stories have reached a stage that shows the complexity of China's policymaking process and challenges the myth of "China, Inc." -- a well-oiled centrally controlled, hierarchical policy process.

Case #1: Green Dam. From seemingly out of no where, the Chinese in early June announced all Windows-based PCs sold from July 1 had to come with the anti-porn Green Dam software pre-installed. It took about 10 seconds for the Chinese Internet community to essentially unleash an electronic riot in opposition. Rebecca MacKinnon's RConversation has captured much of the conflict. If there was more time to quietly engage the Chinese government, foreign industry could have let the Netizens take the entire lead, but with time running short, the international business community organized quickly and loudly, bringing out the big guns in the form of the US Trade Representative and Secretary of Commerce threatening China with a WTO case if they didn't back down. Low and behold, China did just that, and the dam burst.

The story challenges the China, Inc. picture in several ways: 1) The Internet allowed Chinese society into the policy debate; 2) Chinese industry showed through their actions (not installing Green Dam) that they opposed the policy. Too bad for Sony and Acer; they read their cards wrong and apparently were obediently intstaling Green Dam. Oops! 3) A Chinese software company played on the Chinese government's vulnerabilities and used the "protect our children" slogan to sell MIIT a defective product. One hopes MIIT included a clause in the contract: "If you sell us pirated software and a firestorm erupts, we get our RMB 40 million back." 4) From my own observations, MIIT internally was not fully unified behind Green Dam.; and 5) Most assuredly, the firestorm attracted the attention of senior officials, and they put the cabash on Green Dam for the time being.

Case #2: The deadline for concluding negotiations over annual iron ore benchmark prices came and went on July 1 without a deal. The Chinese side was "led" by the China Iron and Steel Industry Association, but CISA never was able to exercise any discipline over those it claimed to represent. By contrast, the oligopoly of the Big 3 iron ore producers (Rio Tinto, BHP Billton, and Vale) held together amazingly well. Small and medium-sized Chinese steel producers and traders went behind CISA and negotiated private deals to buy iron ore on the spot market. The Big 3 had previously not sold to the smaller producers since they had enough contract business with the larger Chinese mills via the benchmark contract system. Going around them was pure genius -- actually, it's a simple and effective strategy. What is also amazing is that despite the economic importance of the industry and the political connections of the largest steel firms, they could not get the Chinese government to throw them a bone and offer them any sort of regulatory support that might have given them a fighting chance at the negotiating table.

That China is more pluralistic and the process more complex and subject to innumerable forces is overall a positive development. China is less likely to go hell-bent down a crazy path because internal opposition will mobilize to tamper down such desires. China is having a difficult time manipulating international prices despite its size because fragmentation trumps size any day of the week. 5-6 Japanese steel companies could sit and decide prices for steel in Japan because they controlled 80% of the market; China's top 70 firms don't control that much.

China's growing pluralism has consequences across the many areas in which China engages the world, and I look forward to discussing those issues in future entries.