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    Will the US start a trade war with China driven by intellectual property rights?

    March 2018

    Its deliberations are opaque and its decisions have the power to kill multibillion-dollar international business deals. Its acronym strikes fear into companies and investment bankers. Its day-to-day staff is an earnest and elite band of 16 Ivy League educated lawyers who labor deep inside the US Treasury, ostensibly to protect America’s economic future. And it is poised to gain a lot more power.

    The committee on Foreign Investment in the United States (Cfius) is one of the most powerful – and enigmatic- regulators in the world. An inter-agency committee that brings together defense and intelligence staff with economic policy makers, it was created to vet inbound foreign investment doe potential national security threats.

    Yet reforms being pushed by President Donald Trump and contained in a bill now working its way through congress world, if enacted, expand its workload from a few hundred transactions a year to potentially thousands. And like so much of economic policy-making in Washington these days, it has one target in mind: China and its appetite for US intellectual property.

    The planned reforms fit with an international pattern. From Australia to the EU, jurisdictions are tightening their scrutiny of inbound investment largely in reactions to what many governments suspect has been a strategically driven Chinese buying spree that in the US alone has been worth 116.6 Billion US-Dollar in the past five years according to the Rhodium Group, a consultancy.

    Newly announced Chinese acquisitions in the United States in 2017 fell to 8.7 Billion US-Dollars, one-tenth the transaction value of acquisitions in 2016. It was the lowest level in six years, according to data from the Rhodium Group, which also tracks Chinese investments abroad.

    Some of the drop in deals last year had to do with China’s skepticism of its large private conglomerates and its crackdown on what it called irrational spending overseas on trophy assets like the Waldorf Astoria in Manhattan, which Anbang bought in late 2014 for nearly 2 Billion US-Dollar. High-flying giants like Anbang and its peers Dalian Wanda and the HNA Group, which have large amounts of debt, have started shedding assets overseas.

    For the first time, the bill now under consideration would give Cfius broad jurisdiction over major outbound investment by US companies that since 1990 has been worth some 250 Billion US-Dollar, and the overseas venture of US-based multinationals. And for the reason it has provoked a growing revolt from blue-chip American companies such as General Electric and IBM and debate in Congress over how best to curtail Chinese pressure on US companies. The plans for Cfius strike at the heart of the Trump administration’s dilemma over how to deal with China, which it has finally called a strategic “competitor”. White House officials and their allies in Congress are struggling to respond to what they see as an existential economic threat from a country that aims to be the leader in artificial intelligence (A.I.), autonomous vehicles and other new industries.

    The belief in that threat is driving much of Mr. Trump’s trade and foreign policy. A national security strategy unveiled in December says protection of the US “innovation base” is an important objective. Now at the centre of the Trump administration’s China trade policy is an investigation launched into Beijing’s intellectual properly regime.

    Just as the Chinese government announced it plans to take over Anbang last week, the American semiconductor testing company the Xcerva Corporation announced that its 580 million US-Dollar sale to Hubei Xinyan, an investment fund backed by the Chinese State, had been blocked by United States officials. It was the latest high-tech China deal blocked by Washington amid concerns that China could gain access to cutting-edge technology. A week before that, the United States Securities and Exchange Commission blocked a 20M US-Dollar deal by a Chinese group to buy the Chicago Stock Exchange. On the campaign trail, Donald J. Trump criticized the deal, using it as an opportunity to accuse China of taking American jobs and wealth.

    However, many of those plans are causing anxiety or are actively opposed by some leading US companies which see their growth prospects as closely tied to China, the second-largest economy in the world. Many fear the new rules would effectively become a murky system of technology controls and place a major regulatory damper on one of the most dynamic parts of the US economy.

    “This is a radical change,” says Rod Hunter, who oversaw Cfius while on President George W Bush’s National Security Council and is now a partner at law firm Baker McKenzie. “You would basically turn the US technology industry into a regulated industry. If there was ever a way to turn the US technology into British Leyland this is how you do it.”

    One of President Xi Jinping’s top economic advisers will visit Washington by end of February bearing promises of accelerating economic reforms in are effort to forestall a possible trade war with the US But Liu He, a politburo member who is set to assume responsibility for economic affairs next month, is likely to meet a frosty reception from a Trump administration laying the groundwork for a trade crackdown on China and increasingly skeptical of the value of economic dialogue with Beijing.

    Mr. Liu took a similar reform message to Davas this year, where he promised series of “reform and opening surprises” that would exceed “international expectations”. Among the measures Chinese officials are quietly touting is the further liberalization of the banking, services and manufacturing industries and a significant loosening of foreign shareholding limits.

    Chinese officials, who confirmed that Mr. Liu would be in the US for talks on trade and the economic relationship are also keen to stress that Mr. Xi is eager to maintain positive relations with Washington. President Donald Trump has made it clear he feels the same way but he sees the US trade deficit of 400 Billion US-Dollar with China as an impediment to better relations. Our opinion is clear, if President Trump and the Congress don’t crack down on their rapacious trade practice, China will continue eating their lunch for years to come and as well all know, there is nothing like a free lunch in business. And Mr. Trump told reporters repeatedly, “We’re developed a great relationship with China, other than the fact that they’re been killing us on trade for the last long period of time – killing us, absolutely killing the United States on trade.” He also mentioned, “As much as I like and respect – really respect – President Xi we have t o straighten out the trade imbalance.”

    His administration, which includes longtime China hawks such as US trade representative Robert Lightkizer, is now expected to roll out a series of actions in the coming months that some fear could provoke a trade war with Beijing. Those include proposed tariffs on steel and aluminum imports and an investigation into China’s intellectual property practices that is widely expected to lead to tariffs and investment measures. We understand the situation as follow: “At one end of the spectrum is order and at the other end is disorder- China and the United States are clearly on the same end of the spectrum” and that is the challenge.

    The fear among some in the US agricultural and business community is that those measures could lead to retaliation by Beijing against companies operating in China or imports of agricultural products such as US soya beans, which last year were worth some 14 Billion US-Dollar. Mr. Liu is considered one of China’s most able and ascendant economic emissaries. At the annual session of China’s parliament, which opens next week, he will replace Ma Kaias Vice-premier with responsibility for financial and economic affairs, according to two people briefed on the upcoming leadership changes. People close to Chinese policymaking circles say Mr. Liu will also play a vital role in Sino-US relations, potentially replacing Wang Yang as head of China’s team for its “strategic and economic dialogue” meetings with the Trump administration.

    Despite Mr. Liu’s reputation as both a reformer and one of Mr. Xi’s most trusted economic advisers, the two men have delivered on very few of the bold economic and financial reform measures outlined by Beijing five years ago.

    Protecting technology of the US.

    One reason why the Cfius bill is attracting a lot of attention is that it is one of the few ideas that has won support from both Republicans and Democrats in an otherwise divided Congress this year.

    “China has weaponised investment in an attempt to vacuum up US advanced technologies and simultaneously undermine our defense industrial base “, John Cornyn, the Texas Republican who is the legislations chief backer, told Congress this month. Over the past few years, scrutiny of Chinese purchases of US and European semiconductor and other technology companies has increased. But the proposed legislation would require Cfius to monitor overseas joint ventures in places like China that US officials fear often involves the forced transfer of vital and potentially sensitive technologies in exchange for doing business.

    “We’re all for overseas investment”, says Robert Pittenger, the North Carolina Republicans sponsoring the legislation in the House of Representatives. “We just don’t want our business in a position where they are coerced or they are exploited by a foreign government… to obtain critical data and security – related technologies.”

    Critics say export control rules provided a way to monitor the relatively small number of transactions involving sensitive technologies. They fear the legislation would vastly expand the mandate of the overstretched Cfius and harm the ability of US businesses to compete by subjecting any overseas deals they make to the rigorous scrutiny of Cfius. The committee reviewed around 240 transactions but that could expand to thousands to thousand or even tens of thousands of business deals around the world, experts say.

    Some companies have backed the legislation, with Software Company Oracle declaring in a November letter that the changes were needed to close loopholes that now were “putting out risk critical innovations that bolster and ensure our national security.” But tech rivals such as IBM have mounted a public fight against the bill, “A system of technology controls that unilaterally stops American firms from doing business abroad will not advance national security interests if it simply hands markets to foreign competitors,” Chris Padilla, IBM’s vice-president of government and regulatory affairs, told the Senate Banking Committee during a January hearing. The current version of the bill would capture all manner of innocuous business done overseas by IBM such as the sale of servers or the licensing of trademarks “that could not be less threatening to national security.”

    The push back from business has forced congressional aides to promise the release of a finessed version soon. Treasury officials have also said that they would make sure that any Cfius interest in outbound investment remains narrowly focused on national security. “From Cfius ‘prospective we don’t want to be looking at lots of transactions that are unlikely ever to raise national security concerns,” says senior US Treasury official.

    There are also signs that some in Congress see the business concerns as valid and would like to see the outbound measures put into separate legislation updating the export control regime, a much more transparent process managed by the US commerce department.

    Mr. Pittenger says he and his colleagues are eager to address business concerns. “We’re listening. We’re listening very hard. We want to be responsive”, he says. But he and Mr. Cornyn also say they remain committed to monitoring transactions involving overseas joint ventures, with a particular eye on China. They have accused opponents of being alarmist and even unpatriotic. “I would call this a patriotism deficit on their part.” Mr. Cornyn said in a speech last month that raised eyebrows in a business community that he accused of trying to “perpetuate the status quo”. Mr. Pittenger, meanwhile, likens abandoning the proposal about overseas deals to removing airport security checks because of complaints that the queues have become too long.

    Would that be a smart thing to do? Most probably not. And it would not be smart either to allow people to bypass a security review by Cfius in our opinion, especially from a country which is financially as in transparent as China.

    If Beijing alleged manipulation of the renminbi once drew the greatest ire from Washington, these days the dominant obsession is control of technology in the world. In a world, where the biggest geopolitical question has become how to manage a developing clash between a rising China and a divided America, the market for “foundational” technologies such as artificial intelligence is becoming a key battleground. Let’s call it the innovation war. In its recently released National Security Strategy the Trump administration labeled protecting the “national security innovation base” a priority. “The genius of creative Americans, and the free system that enables them, is critical to American security and prosperity”, it said.

    The administration wants to crack down on what it sees as a plethora of legal ways that make it easy for China and other strategic rivals to acquire important technologies. Backing a strengthening of the committee on Foreign Investment in the US is one way the administration is doing that. In a report last year, a venture capital arm of the pentagon, which invests in tech start-ups doing work with potential military uses, recommended that the US use Cfius to cut off the flow of foreign investment in to early stage tech companies and look at outbound investments as well.

    The White House has made an attack finally on Beijing’s intellectual property regime the centre piece of its approach towards China. It launched on investigation last summer into intellectual property theft and Chinese policies that pressure companies to transfer technology in return for market access. That probe could prepare the ground for new tariffs and measures to curtail Chinese investment in US sectors in which Beijing will not allow reciprocal investments.

    In our opinion also the European Union should set up a committee like Cfius as soon as possible as hours after becoming the largest shareholder in Daimler, Geely chairman Li Shulu sought to play down fears about the Chinese group’s intentions. “No current car industry player will be able to win this battle against the invaders from outside independently”, he said. “In order to succeed and seize the technology highland, one has to have friends, partners and alliances.” But for those in Germany, the Chinese carmaker and its fiercely ambitious owner must strive to avoid being seen as the “invader”.

    Through acquisitions and stake building, Zhejiang Geely Holdings has quietly become a major force on the global automotive stage. It owns or controls Volvo cars, British sports car brand Lotus, Malaysian carmaker Proton, Hong Kong listed carmaker Geely Automotive, London taxi maker LEVC, Saxo Bank, flying car start-up Terrafugia, as well as being the largest shareholder in truck maker Volvo Group. A 9.7% stake in Daimler, held in Mr. Li’s name and worth about 9 Billion US-Dollar, is the latest addition to the entrepreneur’s swelling portfolio – and the biggest auto investment yet by a Chinese entity. The rapid pace of Geely’s acquisitions comes as other Chinese industrial groups have been told to unwind exposure to sectors such as real estate, entertainment and sports. Yet Geely has faced no such constraints from the Chinese government, spending more than 10 Billion US-Dollar in foreign M&A deals in the past three months alone.

    On top of that the sheer number of deals – and the company’s vagueness about its funding for the deal – has raised questions about whether it its acting entirely on its own. “The most plausible explanation is a China Inc Deal,” says a research note from Bernstein in Hong Kong.

    It is likely, according to Bernstein, that “Geely was the vehicle chosen by China’s top brass to make a deal, or at least received their blessing to do so.” Mr. Li, speaking to China’s CCTV, did not fully deny such links. “For this particular investment, our aim is to support the growth of the Chinese auto industry through the growth of Geely to serve our national strategies,” he said.

    All of this is happening at a time, when China’s official gauge of manufacturing activity suffered its largest fall since 2011 in February, an unexpectedly shop slowdown that left it near the zero-growth level. The Manufacturing purchasing managers index from China’s National Bureau of statistics dropped to 50.3 down a point from January and the largest fall in more than six years. The decline marked the gauge’s nearest brush with the 50-point mark that separates growth from contraction since August 2016.

    Simultaneously, Mr. Xi Jinping has put an end to a presidential term limit in China, which is going to have a global implication. Xi Jinping was already regarded as China’s most powerful leader since Mao Zedong, leader of the 1949 Communist revolution. But an announcement that Beijing plans to scrap the two – term limit for the presidency show that Mr. Xi is now eliminating the remaining institutional checks on his authority. This monumental change, which sets him up to stay at the helm beyond 2022-23, has profound implications for South China and the world.

    The end of the term limit is a break with hallowed tradition. Deng Xidoping, architect of the economic reform era that began in 1978, introduced the two – term cap into the state constitution. His aim was to prevent a return to the disastrous personality cult that had surrounded Chairman Mao and contributed to the Cultural Revolution. Scrapping the limits sweeps away four decades of careful balancing Chinese state power, leaving the country at risk of sliding back into dictatorship.

    Much will now depend on how Mr. Xi uses his immense authority. Some argue that consolidated power will allow Mr. Xi to advance much – needed structural reforms. Strengthening the role of state – owned enterprises in the economy, building strategic industries, de-risking a debt-mired financial system and combating pollution are some of the tasks that some analysts say require a strong hand at the tiller.

    But a greater centralization of power also carries risks. The sense that power accrues to institutions rather than to individuals, which took decades to inculcate, is already unraveling. The pressure to express loyalty to one all-powerful leader may crowd out honest policy debate, creating an echo chamber reminiscent of Mao’s latter years.

    In addition, the creative disobedience of local governments – long a source of economic dynamism as well as corrupt practices – may be crushed. The speed with which Mr. Xi has amassed power since his appointment in 2012 shows how quickly the politics of the world’s second – largest economy can change in fundamental ways.

    In 2016, he was declared the “cove” leader, a status never achieved by his predecessor Hu Jintao. Last year, “Xi Jinping thought” was enshrined in the party constitution, an honor shared only with Mao.

    For the west autocratic rule in China presents a distinctive set of challenges. Although Mr. Xi has said Beijing does not intend to export its political model to the rest of the word, his government also promotes the idea of a “China Solution” that sees Beijing stepping in to the developmental arena when the US and Europe steps back. For instance, the Belt and Road Initiative, a grandiose project to build infrastructure in more than 80 countries, is promoted by Beijing as a better alternative to the west’s attempts to foster prosperity in the developing world.

    Such language should remind western leaders that Mr. Xi’s China has no intention of being integrated into a world created under Pax Americana. It plans to make its own rules for international interaction, follow a government model that if regards as superior to western – style democracy and promote a distinctive developmental philosophy.

    Such a reality throws up an urgent challenge. The west should strive to develop a coherent and consistent China strategy that prioritizes core interests such as reciprocity in cross – border investments, the protection of intellectual property rights and the defense of US and European political systems against potential Chinese interference. There may be long years of strongman rule by Mr. Xi ahead. The west must gird itself for a long haul.