Hearing of the Senate Committee on the Judiciary Subcommittee on Crime and Terrorism On “Dangerous Partners Big Tech and Beijing” Limits are Overdue in the US-China Technology Relationship Derek Scissors Resident Scholar American Enterprise Institute March 4 2020 China is slowly stagnating economically due to aging and debt For those who disagree it is still true that China will remain partly reliant on foreign technology Beijing is committed to state monopolies in strategic sectors thus suppressing competition and innovation China also needs foreign capital and has opened its financial sector to some extent as a draw 1 The basic choice for the US is weighing money earned by American technology companies against the harms of supporting the Chinese Communist Party The US should enforce the rule of law implement the export control guidelines already passed by Congress and couple any technology restrictions with capital restrictions The first step in effective action is documenting the multiple dimensions of the US-China technology relationship Technology Relationship Facts To protect American technology wisely policy-makers need to understand the nature of the USChina technology relationship Person to person exchanges are an important element and some American scientists misrepresent their ties to China 2 muddying that picture A complementary gap there does not appear to be unclassified information on numbers of Chinese nationals working here specifically on technology projects Those numbers broken down by sectors and over time are necessary to ascertain Chinese priorities and US vulnerability Services trade can partially represent person to person exchanges The second-largest component of US services export to China after travel is use of American intellectual property IP which rose 12 percent to $8 5 billion in 2018 for the mainland plus a 50-percent jump for Hong Kong to $4 7 billion 3 Very little of this was exports to foreign affiliates of US parents – it’s all going to locals But the numbers include IP with no advanced technology Information services exports in particular were less than $1 billion to the mainland and smaller for Hong Kong Goods exports are more precisely defined American semiconductor and related equipment exports to China climbed 22 percent to a record $9 8 billion in 2019 4 despite a 12-percent decline in total exports to China Chip exports to Hong Kong fell 11 percent but added another $4 7 billion The combined total is also a record In the past rising American semiconductor exports were simply part of rising overall exports but last year chips stood out American direct investment in China can also carry with it advanced technology Through the first three quarters of 2019 direct investment in mainland China fell 15 percent from the first three quarters of 2018 to $4 6 billion 5 Direct investment in Hong Kong fell 37 percent to $3 9 billion At the end of 2018 cumulative American investment in computers and electronic KPMG “Accelerated Opening Up of China’s Financial Sector ” July 2019 https assets kpmg content dam kpmg cn pdf en 2019 07 accelerated-opening-up-of-china-s-financial-sector pdf 2 Ellen Barry and Gina Kolata “China’s Lavish Funds Lured U S Scientists What Did It Get in Return ” The New York Times February 6 2020 https www nytimes com 2020 02 06 us chinas-lavish-funds-lured-us-scientistswhat-did-it-get-in-return html 3 US Department of Commerce Bureau of Economic Analysis “U S International Services Tables ” October 15 2019 https apps bea gov scb 2019 10-october pdf 1019-international-services-tables pdf 4 International Trade Administration “TradeStats Express ” http tse export gov tse TSEHome aspx 5 US Department of Commerce Bureau of Economic Analysis “U S Direct Investment Abroad Balance of Payments and Direct Investment Position Data ” December 19 2019 https www bea gov international di1usdbal 1 products in China stood at $10 7 billion and had outpaced overall spending Investment in Hong Kong computers and electronic products was steady at $2 5 billion at the end of 2018 American portfolio securities investment can help fund Chinese technology programs In November 2019 the cumulative position stood at $209 billion 95 percent in corporate stocks 6 This was a 20-percent increase over the position in November 2018 The figures for Hong Kong are a 5-percent gain to $171 billion almost all stocks Chinese portfolio investment in the US can be an attempt to acquire technology indirectly by becoming financially influential in targeted American firms That spending stood at $1 54 trillion at the end of June 2019 down 4 percent from June 2018 7 The large majority though was held in Treasury bonds Holdings of American equities were $190 billion down 12 percent Chinese direct investment can also be an effort to acquire technology The Bureau of Economic Analysis BEA reports combined Chinese and Hong Kong direct investment at $2 7 billion in the first three quarters of 2019 50 percent more than the same period of 2018 8 BEA claims net investment in computer and electronic products was negligible through 2018 The American Enterprise Institute’s China Global Investment Tracker is not limited to advanced technology and has the stock of technology investment at better than $20 billion through 2019 However there has been very little fresh investment since 2016 and even some of that is being rolled back 9 A last category is less conventional than trade and investment but vital in US-China relations earnings of US affiliates in China Data are only complete through 2017 prior to the bilateral trade conflict American majority-owned affiliates in China reported sales of $376 billion in 2017 $86 billion of this in computers and electronic products 10 Minority-owned affiliates had almost no sales in computers and electronic products Majority-owned affiliates in computers and electronic products reported $3 6 billion in 2017 capital expenditure in China China’s Motives US technology firms’ willingness to comply with even abusive Chinese policies may be best explained just by those 2017 sales in striking distance of $100 billion And it can be much starker for individual firms Lists of companies most dependent on the Chinese market are dominated by US Department of the Treasury “Foreign Long-Term Securities Held by U S Residents in November 2019 ” https ticdata treasury gov Publish slt1f txt 7 US Department of the Treasury “Foreign Portfolio Holdings of U S Securities as of June 30 2019 ” https ticdata treasury gov Publish shlptab1 html 8 US Department of Commerce Bureau of Economic Analysis “Foreign Direct Investment in the U S Balance of Payments and Direct Investment Position Data ” December 19 2019 https www bea gov international di1fdibal 9 Derek Scissors “China Global Investment Tracker ” American Enterprise Institute January 2020 https www aei org china-global-investment-tracker and Bloomberg News “China Takes Charge of HNA Paving Way for Faster Asset Sales ” Bloomberg March 1 2020 https www bloomberg com news articles 2020-0301 china-takes-charge-of-hna-paving-way-for-hastened-asset-sales 10 US Department of Commerce Bureau of Economic Analysis “Activities of U S Affiliates of Foreign Multinational Enterprises MNEs ” November 15 2019 https www bea gov data intl-trade-investment activitiesus-affiliates-foreign-mnes 6 technology featuring Qualcomm Micron Texas Instruments Advanced Micro Devices and Indicator Technology Relationship Snapshot Main result Year Royalties for US IP in China 12% to $8 5 billion 2018 US semiconductor and related exports to China 22% to $9 8 billion 2019 US investment in computers and electronics in China $10 7 billion cumulative Thru 2018 US holdings of Chinese securities 20 % to $209 billion Thru November 2019 Chinese holdings of US stocks -12% to $190 billion Thru June 2019 Chinese direct investment in US technology all types $21 8 billion cumulative Thru 2019 US majority affiliate sales of electronics products in China $86 billion 2017 Sources see footnotes 3-10 others receiving 30 percent or more of annual revenue from China in one form or another The forecast is for more while Beijing massages all its economic statistics technology consistently outperforms other sectors One tailored measurement says technology revenue exceeded $1 trillion in 2019 growing far faster than official GDP 11 In contrast the motivation for China to engage American firms is multi-dimensional Acquiring advanced technology is obvious but understates the situation The Chinese economy is slowing it has run up enormous debt and its population is aging In 2010 official GDP growth was said to be 10 6 percent in 2019 it was 6 1 percent and most likely slower While many observers cannot imagine Chinese GDP growth below 2 percent within a decade that is a simple trend It’s also a sophisticated trend The World Bank says gross fixed capital formation – investment that actually contributes to GDP – stood at $5 7 trillion in 2018 Yet China reported its benchmark measure of investment at $9 4 trillion 12 Not all of that difference is outright wasted Yun Li “Wall Street Thinks These Stocks are Most Vulnerable in a Full-Blown Trade War ” CNBC May 6 2019 https www cnbc com 2019 05 06 here-are-the-companies-wall-street-is-worried-most-about-if-a-full-blowntrade-war-breaks-out html and Xinhua “China's Software IT Service Sector Expands Robustly in 2019 ” February 10 2020 http www xinhuanet com english 2020-02 10 c_138769569 htm 12 The World Bank “Gross Fixed Capital Formation % of GDP – China ” https data worldbank org indicator NE GDI FTOT ZS locations CN and Xinhua “China's FAI Maintains Stable 11 but a fair chunk is This is confirmed by the Bank of International Settlements which has outstanding credit as a share of GDP rising more than 100 percentage points from the start of the global financial crisis to the third quarter of 2019 The equivalent American rise is 20 points despite a recent surge in the US federal deficit 13 China is borrowing more to grow slower Its demographics are also deteriorating Median age is estimated at over 38 for 2020 headed to 47 by 2045 14 The latter is approximately Japan’s median now US median age is very similar to China’s today but will be a full five years younger in 2045 The Communist Party is well aware of debt and aging and frequently cites innovation as the key to avoid stagnation But the Party is intolerant of competition reserving perhaps two dozen sectors to state monopoly Firms which do not have to compete have much less reason to innovate and in fact state-owned enterprises are less innovative 15 In those sectors China will continue to rely on foreign technology This reliance is not Beijing’s only motive though Much attention has been paid to China’s edge in “big data” – population size is said to bolster firms who can gather information on consumer behavior While this is true with regard to competition within China distortions in the home market make Chinese data considerably less valuable to competition overseas This is one motive for firms such as Alibaba to gather foreign data through the Belt and Road and an additional motive for China to solicit American firms that hold large quantities of consumer data A third motive is financial American technology firms make money in China and China makes money from American firms’ technology It’s difficult to measure all the ways in which foreign technology is lucrative but China’s $1-trillion home market is suggestive Especially valuable is foreign exchange which funds the Belt and Road and possible acquisitions of more foreign technology In some years the single biggest contributor to Beijing’s foreign reserves has been telecom equipment exports to the US which passed $80 billion annually before falling back in 2019 16 The Party’s ideal is to use the proceeds to fund China’s own technology development Policy responses The US government should act only rarely when the aim is profitability – that is a matter for the private sector Many complaints by American technology companies about China concern barriers to profitability and it is not a core government responsibility to help already prospering firms do still better Government intervention in this case is primarily about when to sacrifice Growth in 2018 ” January 21 2019 http www xinhuanet com english 2019-01 21 c_137762281 htm 13 Bank for International Settlements “Credit to the Non-Financial Sector ” March 1 2020 https www bis org statistics totcredit htm 14 United Nations Population Division “World Population Prospects 2019 ” https population un org wpp DataQuery 15 Derek Scissors “Making the New Normal Meaningful ” American Enterprise Institute March 2015 https www aei org wp-content uploads 2015 02 Making-the-new-normal-meaningful pdf and Caleb Foote “Fact of the Week Former Chinese State-Owned Enterprises Produce More Patents than Current SOEs but Still Lag Private Firms ” Innovation Files January 28 2019 https itif org publications 2019 01 28 fact-week-former-chinese-stateowned-enterprises-produce-more-patents 16 Kaixi Huang Hongyuran Wu and Han Wei “In Depth ChemChina Wins Syngenta — Now Comes the Hard Part ” Caixin June 30 2017 https www caixinglobal com 2017-06-30 chemchina-wins-syngenta-now-comes-thehard-part-101108059 html and International Trade Administration “TradeStats Express ” http tse export gov tse TSEHome aspx op cit profitability for the sake of broader national interests There are multiple issues that require setting aside some private sector goals 1 The rule of law is often skipped over or assumed but should not be when China is involved Huawei is now under federal indictment for both racketeering and theft of trade secrets yet the administration continues to hand out temporary general licenses for the sake of American firms gaining from Huawei business Chinese firms have for years ignored disclosure requirements for listing on US stock exchanges yet calls for delisting are resisted on the basis of wildly exaggerating the cost 17 If our existing laws and regulations are not enforced properly creating new policies is mere posturing 2 The Department of Commerce’s Entity List effectively encourages offshoring by restricting only US-based exports Commerce’s proposed in December implementation of a May 2019 executive order on supply chain security is vague18 and could be altered at any time both of these features increasing uncertainty for little reason evident to date Congress passed new export control guidelines in summer 2018 on a bipartisan basis In the 20 months since draft regulations have been issued for one technology The most important step in changing the US-China technology relationship is implementing Congressionally-mandated changes to export controls 3 While capital flows are not typically seen as vital for national security capital is a partial substitute for technology Whatever the level of technological restriction – from minimal to sweeping -- capital restriction must reinforce it It would be self-defeating for the US to block transfer of a technology yet permit unrestricted investment in China’s efforts to develop it locally Because China can raise money from other rich countries the US must pressure friends and allies not to provide capital to firms or programs chasing restricted technology This will require a clear and consistent American rationale and possibly a clear and consistent threat 19 4 The Committee on Foreign Investment in the United States CFIUS has been the first line of defense for advanced technology However the low volume of recent Chinese investment means CFIUS should focus at present on identifying patterns in small transactions Mitigation may not be required but these cases help identify China’s tactics and priorities improving policy-making US Department of Justice Office of Public Affairs “Chinese Telecommunications Conglomerate Huawei and Subsidiaries Charged in Racketeering Conspiracy and Conspiracy to Steal Trade Secrets ” February 13 2020 https www justice gov opa pr chinese-telecommunications-conglomerate-huawei-and-subsidiaries-chargedracketeering and Jay Clayton et al “Statement on Continued Dialogue with Audit Firm Representatives on Audit Quality in China and Other Emerging Markets Coronavirus — Reporting Considerations and Potential Relief ” US Security and Exchange Commission February 19 2020 https www sec gov news public-statement statementaudit-quality-china-2020-02-19 It should be noted that the cost to US investors of delisting a firm is a very small fraction of its market capitalization 18 “Securing the Information and Communications Technology and Services Supply Chain ” Federal Register November 27 2019 https www federalregister gov documents 2019 11 27 2019-25554 securing-the-informationand-communications-technology-and-services-supply-chain 19 Derek Scissors “China’s Quest for Capital Motivations Methods and Implications ” testimony before the US China Economic and Security Review Commission January 23 2020 https www uscc gov sites default files Panel%20III%20Scissors%20Written%20Testimony pdf and Derek Scissors “In Need of Direction The Case for Moving Supply Chains out of China ” War on the Rocks November 18 2019 https warontherocks com 2019 11 in-need-of-direction-the-case-for-moving-supply-chains-out-of-china 17 A particular recommendation approval of initial investment should not create presumption of approval for additional investment to guard against the tactic of a first innocent foot in the door In any action along these lines the US should deemphasize individual Chinese companies For the economic reasons outlined above as well as socio-political reasons the Communist Party works hard to dictate technology development The goal is to benefit Chinese technology firms only as part of benefiting the Party It’s the Party that orders large-scale programs and subsidies at home and acquisitions and theft overseas It’s the Party that coerces The US should not focus on a few Chinese enterprises but instead think in terms of whole supply chains and industries