Tuesday 3 April 2018

Made in China 2025 Initiative a Nightmare For Everyone Else?

Written by Lorand Laskai, Council on Foreign Releations

China's grand plan to bolster hi-tech industries at home is not receiving much love abroad. There's a good reason why. 

On the same day that the Trump administration announced $60 billion in tariffs against China last week, the Office of the United States Trade Representative (USTR) dropped the results of its Section 301 investigation into China’s unfair trade practices. The nearly 200-page report presents a searing indictment of China’s disregard for intellectual property, discrimination against foreign firms, and use of preferential industrial policies to unfairly bolster Chinese firms. Interestingly, the report singles out one Chinese government initiative, in particular, as a prime example of Beijing's egregious behavior: Made in China 2025.

Made in China 2025, originally approved by China's State Council in 2015, is mentioned or cited an astounding hundred and sixteen times. In contrast, China's Cybersecurity Law, which has caused a perennial headache for many U.S. multinationals, is only mentioned thirteen times. And for good reason. Beijing's grand plan to upgrade its manufacturing base has riled governments around the world, confirming their suspicion that China is not looking for a 'win-win' in trade relations as its overseas emissaries often insist. In the saga of the U.S.-China economic rivalry, Made in China 2025 is shaping up to be the central villain, the real existential threat to U.S. technological leadership. 

What is Made in China 2025? Made in China 2025 is a blueprint for Beijing's plan to transform the country into a hi-tech powerhouse that dominates advanced industries like robotics, advanced information technology, aviation, and new energy vehicles. The ambition makes sense within the context of China’s development trajectory: countries typically aim to transition away from labor-intensive industries and climb the value-added chain as wages rise, lest they fall into the so-called “middle-income trap.” Chinese policymakers have diligently studied the German concept “Industry 4.0,” which shows how advanced technology like wireless sensors and robotics, when combined with the internet, can yield significant gains in productivity, efficiency, and precision.

However, China’s intention through Made in China 2025 is not so much to join the ranks of hi-tech economies like Germany, the United States, South Korea, and Japan, as much as replace them altogether. Made in China 2025 calls for achieving “self-sufficiency” through technology substitution while becoming a “manufacturing superpower” that dominates the global market in critical high-tech industries. That could be a problem for countries that rely on exporting high-tech products or the global supply chain for high-tech components.

Which countries will feel the heat of Made in China 2025? The Mercator Institute for China Studies
What’s wrong with China setting quotas for self-sufficiency? For one, such quotas violate WTO rules against technology substitution. Made in China 2025 lays out targets for achieving 70% “self-sufficiency” in core components and basic materials in industries like aerospace equipment and telecommunication equipment by 2025. That could devastate countries like South Korea and Germany, where hi-tech sectors constitute a large share of industrial output and exports.

The supply chains for hi-tech products usually span across many borders, with highly specialized components often produced in one country and modified or assembled somewhere else. Rather than abiding by the free market and rule-based trade, China is intent on subsuming the entire global hi-tech supply chain through subsidizing domestic industry and mercantilist industrial policies. Semi-official documents lay out even more specific quotas for Chinese manufacturers. Officials at China's Ministry of Industry and Information Technology (MIIT) insist these targets are not official policy, though a report from the Mercator Institute for Chinese Studies argues that officials are using internal or semi-official documents to communicate targets to Chinese enterprises in order not to openly violate WTO rules.

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How is Beijing acquiring advance technology for Made in China 2025?  Equally problematic to Beijing’s goal of “self-sufficiency” and becoming a “manufacturing superpower” is how it plans to achieve it. Chinese officials know that China lags behind in critical hi-tech sectors and hence are pushing a strategy of promoting foreign acquisitions, forced technology transfer agreements, and, in many cases, commercial cyber espionage to gain cutting-edge technologies and know-how.

While the Obama administration spent years pressuring Beijing to rein in commercial cyber espionage, Washington and other capitals are only beginning to grapple with the repercussions of Chinese investment and technology transfer agreements. Unlike cyber theft, neither is illegal per se. Surging Chinese investment in the United States and Europe have been a recurring story over the past few years. However, lawmakers are increasingly concerned that such investments, especially in high-tech sectors, are not just a product of market forces, but guided by Beijing as well.

Circumstantial evidence confirms this suspicion. Chinese investment in the United States and elsewhere, especially in hi-tech sectors, has skyrocketed since 2015. Often these investments evince a broader coordinated strategy. Take the example of Fujian Grand Chips, a purportedly private Chinese company that attempted to acquire German machine maker Aixtron in 2016. Shortly before it staged a public takeover of Aixtron, another Fujian-based company San’an Optoelectronics canceled a critical order from Aixtron on dubious grounds, sending its stock tumbling and presenting Fujian Grand Chips with an opportunity to swoop in. Both Fujian Grand Chip and San’an Optoelectronics shared a common investor: an important national semiconductor fund controlled by Beijing. The acquisition was stymied by an 11th-hour intervention by government officials but demonstrated how Beijing can drive investing abroad, often in a highly coordinated manner.

Technology transfer agreements and restrictive market practices in China present a similar problem. Foreign companies often enter agreements to transfer valuable intellectual property to Chinese partner in exchange for market access. These agreements can be exploitative and highlight the asymmetries in market access between China and the rest of the world. Speaking about Chinese takeovers of German firms, Germany's Economic Minister Sigmar Gabriel said Germany should not sacrifice “its companies on the altar of free markets” while China denies German firms equal access to invest in the Chinese market.

What can realistically be done? The keyword in Trump's recent tariffs against China is "reciprocity." That's the right approach. An Asia Society task force concluded last year the United States should urgently insist on reciprocity in the U.S.-China trade and investment relations, even if it adds tension to the relationship. However, a trade war, as Scott Kennedy points out, is no cakewalk, and it's unclear whether the administration has a clear idea of its desired end-game. Moreover, Trump is using a wrecking-ball when a more precise tool would have provided a better outcome. In addition to trade action against China, Trump has also announced a blanket tariff on foreign steel, which affects U.S. allies as well as China. While many allies have secured temporary exemptions to the tariff, Trump's pugilistic behavior is burning valuable goodwill. As Matthew P. Goodman and Ely Ratner argued in Foreign Affairs, many countries share Trump's desire to combat Chinese hi-tech mercantilism, but Trump is dividing allies rather than unifying them to confront China.

Instead, the administration should focus on the long-game of building a political consensus at home and abroad. That should include updating the Committee on Foreign Investment in the United States (CFIUS) to better vet Chinese investment into hi-tech sectors; using existing venues like the WTO to present a case against Chinese industrial policies; and rejoining the Trans-Pacific Partnership, which set high bars for intellectual property protection, labor standards, and safeguards against unfair competition from state-owned enterprises. Common sense investments at home should also be a priority. Investing in education, infrastructure, and basic science does not generate the same headlines as a trade war, but will do more to ensure the United States maintains its edge.

Lorand Laskai is a research associate in the Asia Studies Program at the Council on Foreign Relations. This article was originally published on Council on Foreign Relations.
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