President Trump has ordered an investigation into China for intellectual property theft, which threatens US-China trade relations.

In August of 2017, U.S. President Donald Trump asked U.S Trade Representative Robert Lighthizer to officially initiate an investigation of the People’s Republic of China regarding intellectual property (IP) rights and technology transfer under Section 301 of the Trade Act of 1974.[1] Section 301 gives the president the authority to order the US Trade Representative to take any necessary measures to stop any foreign government from actions which violate international trade agreements or restrict U.S. commerce.[2] Protecting IP rights is in the national interest; however, the means by which the Trump administration has chosen to do so undermines the emerging collaboration in US-China relations between the current administrations.

Past administrations have not used the act liberally for fear of retaliatory reactions against US trade. The industry magazine Technology, Manufacturing, and Transportation Insider (TMTI) reports that numerous US companies have made ongoing complaints relating to China’s insistence on technology transfers and alleged violations of intellectual property rights. In light of the new investigation, TMTI expects that US companies will have the opportunity to present evidence of these allegations, and that the president will enter into negotiations with China to remedy these grievances.[3] Should negotiations fail, the president has the power to impose tariffs or quotas against China within 30 days of receiving the results from the investigation. The results of an investigation under Section 301 generally have to be filed within 12 months from the start of the investigation. According to the statute, the recommended tariffs or other sanctions will be active for four years.[4]

The investigation has understandably caused upset in Beijing. Chinese officials feel that the US should have used World Trade Organization (WTO) mechanisms to resolve any disputes opposed to their own legislation. The strongest condemnation for the investigation came from statements issued by the Chinese government. China’s Ministry of Commerce (MOC) expressed “strong dissatisfaction” with the investigation.[5]

Beijing sees the launch of the investigation as a regression in globalization and US-China relations. This move comes shortly after the US and China entered into the China Comprehensive Economic Dialogue (also known as the 100 Day Plan), a trade agreement which resulted from the very successful and productive meeting between Donald Trump and Xi Jinping in Florida last year. The plan allowed for US beef to enter the Chinese market and to allow US financial and banking institutions to take a more active role in the Chinese economy.

The fact that the MOC mentioned the investigation within the context of the agreement may mean that in retaliation, China may cancel some aspects of the agreement.[6] In an official press release, the Ministry of Commerce of the People’s Republic of China stated, “We urge the US to act prudently and respect the facts, the strong cooperation will of industries from both countries, and multilateral trade rules.”[7] In the statement, MOC suggested that the US should adhere to international trade agreements, and indicated that the US should take the dispute to the WTO rather than to launch an investigation based on US laws. The MOC went on to say that they believed the move would be condemned by the international community.

A somewhat softer dismissal of the investigation came from The Beijing Review which put forth the opinion that rising wages and regulatory issues in China have already made China a less desirable place to base manufacturing firms, thus reducing opportunities for IP theft. Banking and finance are the main industries that the US wants to begin investing in; however, because these are protected sectors, investment has been slow and difficult. The Review’s stance was that trade could be a basis for US-China relations and the IP issue should be dealt with through the WTO.[8]

The US government’s opinion on the WTO handling this claim has been the opposite. Secretary Ross has already criticized the WTO for not being tough enough on China and has called China “protectionists dressed in free-market clothing”.[9] And Trump has expressed the view that he sees the WTO as infringing on US sovereignty.[10] Beijing sees this investigation as a regression in both globalization and in US-China relations which recently were given a tremendous boost by the new China trade agreement, the 100 Day Action Plan, outlined by Presidents Donald Trump and Xi Jinping.

A report by the American Enterprise Institute (AEI) called the most recent 301 investigation a good first step toward reforming US trade policy, but suggested that the investigation should go further to explore how special economic zones (SEZ) are contributing to IP theft. AEI alleges that state-owned firms in special economic zones pilfer American technology and crowd out US firms.[11]

Official accusations against China began long before this most recent investigation. The last time an official Section 301 investigation was launched was in 2010 against China’s energy industry.[12] A significant difference between previous 301 claims and the most recent one is that in the past, the investigations were called for by industry associations, whereas this time, it is the federal government who has initiated the investigation. In April of 2017, Representative Lighthizer issued a Section 301 report specifically naming China as a country of concern regarding IP infringement, and for engaging in “coercive technology transfer”.[13]

Earlier this year, the President announced that he was considering restricting China from trading in steel with the US under Section 232 of the 1962 Trade Act, which empowers the president to restrict trade based on the grounds of national defense. He has since stated that he is postponing his final ruling on the steel issue.[14] Shortly after launching the investigation into steel, President Trump launched a similar investigation into aluminum.[15] If these investigations indicate that Chinese steel and aluminum imports are compromising national security, then tariffs may be imposed.[16] The President could also block China trade by evoking the International Emergency Economic Powers Act of 1977 as previous administrations have done against other countries. Historically, the act has never been opposed by Congress.[17]

Regarding the current investigation of IP violations, most believe that while China is guilty, President Trump’s protectionist stance could severely damage the world economy.

Brian O’Shaughnessy, an IP attorney at Dinsmore & Shohl LLP and president and chair of the Board of the Licensing Executives Society (an organization for IP professionals), confirmed that most economists around the world are in agreement that China has problems with IP theft.[18]

Tim Worstall of Forbes Magazine had a unique take on the investigation. While he generally believes that China or companies in China are stealing US IP, he believes the US should simply look the other way. First, ignoring the issue would help to avoid a costly trade war. Second, the wealth of the US is based on its ability to create IP. As a result, the US will continue to develop new IP and remain wealthy while China will only be able to copy IP and remain middle income.[19]

Business Insider has more or less condemned the investigation, calling it “the first shot in a trade war with China.”[20] China, according to Business Insider, interprets Section 301 as an act of aggression because it permits the president to act without first consulting the World Trade Organization (WTO).

In defense of allegations of not enforcing IP protection, the Chinese government pointed at the 13th Five Year Plan which included provisions for increased IP enforcement. According to government news agency Xinhua, the plan called for an improvement of “the rules and regulations related to intellectual property rights in newly-emerged fields including Internet Plus, e-commerce and big data.”[21]

However, the US China Business Council and The American Chamber of Commerce in China report that while there have been some judicial improvements in cases of companies suing for IP violations, they specifically cited technology transfer rules as being the real issue. Chinese law forces foreign firms to agree to transfer technology to their Chinese joint-venture partners as part of the terms of gaining access to Chinese markets.[22] This technology transfer represents a tremendous leakage of US intellectual property into China.

A trade war between China and the US could have detrimental effects for both economies as both are key receivers of exported goods.

Forbes Magazine warns that protectionist measures by the US may hurt the Chinese economy and setback US-China relations or possibly even start a trade war. The US accounts for 20% of China’s total exports and a trade war could have a significant impact on the Chinese economy.

However, losing China as a trading partner would also cause the US economy to take a hit. In 2016, China accounted for 62% of US soybean exports, 25% of US aviation exports, 14% of US cotton exports, 17% of US automobile exports, and 15% of semiconductor exports.[23]

The China Daily reported that “A full-blown trade war between China and the US still doesn’t seem inevitable, but that shouldn’t prevent Beijing from taking measures to cope with the US’ trade protectionist weapon: Section 301.”[24] According to the Brookings Institute, historically, when China is challenged on trade violations, they retaliate.[25]

Retaliation may already have begun. In mid-August, the Chinese government launched an anti-dumping investigation into hydrogenated butyl rubber from the United Sates, the European Union, and Singapore. At a press conference, Ministry of Commerce spokesperson Gao Feng said that this investigation was simply routine and not related to any other case.[26]

Since 1974, Section 301 investigations have been imposed 120 times, although most have not resulted in sanctions. In fact, the 2010 investigation against China’s renewable energy sector did not result in sanctions being taken.[27] There are numerous theories which suggest Trump’s initiation of a 301 investigation is simply a means to some other end.

Some journalists believe that Trump’s threats under Section 301 might just be a case of using trade as a bargaining chip in dealing with the North Korea situation.[28] Another theory is that Trump is using the investigation to gain Chinese concessions for the US steel industry.[29] Yet another theory is that the US is looking for concessions in light of China’s cyber security law, which requires US companies to store their data in China. As the law was enacted under the guise of national defense, it is non-negotiable. Therefore, it is possible that President Trump is trying to use the 301 investigation to negotiate some other trade-related issues as compensation for forced compliance with the cyber security law.[30]

A Game of Back and Forth with No End

As the US government tightens its sanctions on North Korea, it is imposing secondary sanctions on countries which continue to support the North Korean economy. The U.S. Department of the Treasury’s Office of Foreign Assets Control (OFAC) added ten companies to its sanction list, five of which were Chinese. These sanctions are imposed on countries purchasing coal and oil from North Korea, and China represents 90% of North Korea’s total trade.[31] China opposes the US sanctions as being extraterritorial legal restrictions that bypass the UN and other international bodies. Meanwhile, China has increased tariffs on semiconductors which the US claims violates their WTO agreements.

The same US-China Economic and Security Review Commission which reported that President Trump had launched a Section 301 investigation against China also stated that the US trade deficit with China had increased by 10% since the previous year due to an increase in US imports. Additionally, US oil exports to China also increased.[32]

Therefore, it seems for every action there is a similar reaction. The Section 301 and 232 investigation, and the isolated tariffs and restrictions on various products from both sides simply represent the ups and downs in a complicated relationship between the world’s two largest powers.

The global media often predicts that some cataclysmic event will occur, dramatically and permanently changing the US-China economic relations, but what seems more likely is that the relationship will continue as it is now, plagued by suspicion, marred by distrust, occasionally heating up or flaring into legal action. However, at the end of the day, nothing will have changed. The Section 301 investigation will eventually be negotiated away and simply become one more bump in an already rocky road.

There is no doubt that China has a history of weak IP protection and that mandatory technology transfer has been a component of many joint-venture contracts in China. It is also true that when challenged, China lashes out. Therefore, confronting China on IP issues at this exact moment in time, while justified, will undoubtedly set back US-China trade relations. This is particularly disappointing coming on the wake of the 100 Day Action Plan which represented the largest positive step in US-China trade relations in decades. As always, a trade war between the US and China is extremely unlikely; however, this dispute may undo the progress made earlier this year.

References

[1] Office of the United States Trade Representative, USTR Announces Initiation of Section 301 Investigation of China, August, 2017, https://ustr.gov/about-us/policy-offices/press-office/press-releases/2017/august/ustr-announces-initiation-section

[2] Cornell Law School Legal Institute, U.S. Code › Title 19 › Chapter 12 › Subchapter III › § 2411, 19 U.S. Code § 2411 – Actions by United States Trade Representative, n.d., https://www.law.cornell.edu/uscode/text/19/2411

[3] Jeffrey Neeley, Trump Administration Moves Forward on Case That Could Affect All Chinese Imports, August 15, 2017, Technology, Manufacturing, and Transportation Insider, http://www.tmtindustryinsider.com/2017/08/trump-administration-moves-forward-on-case-that-could-affect-all-chinese-imports/

[4] HKTDC, USTR Launches Section 301 Probe Against Mainland China, September 1, 2017, Hong Kong Means Business, http://hkmb.hktdc.com/en/1X0ABCS8/hktdc-research/USTR-Launches-Section-301-Probe-Against-Mainland-China

[5] Charlotte Gao, China ‘Strongly Dissatisfied’ with US Trade Investigation, August 22, 2017, The Diplomat, http://thediplomat.com/2017/08/china-strongly-dissatisfied-with-us-trade-investigation/

[6] Charlotte Gao, China ‘Strongly Dissatisfied’ with US Trade Investigation, August 22, 2017, The Diplomat, http://thediplomat.com/2017/08/china-strongly-dissatisfied-with-us-trade-investigation/

[7] Ministry of Commerce of the People’s Republic of China, MOFCOM Spokesman Comments on the 301 Investigation of the US against China, August 23, 2017

[8] Clifford A. Kiracofe, Trouble Brewing? Washington hawks must not be allowed to disrupt China-U.S. relations, September 7, 2017, Beijing Review, http://www.bjreview.com/Opinion/201709/t20170904_800103796.html

[9] Zheping Huang, Two little-used trade weapons Trump might employ against China, August 03, 2017, Quartz, https://qz.com/1045448/section-301-and-the-ieeepa-two-trade-weapons-trump-might-employ-against-chinese-ip-theft/

[11] Clay R. Fuller, China investigation should scrutinize Special Economic Zones, September 13, 2017, AEI, http://www.aei.org/publication/china-investigation-should-scrutinize-special-economic-zones/

[12] Wang Li, US using Section 301 probe as a weapon, China Daily, September 5, 2017, http://europe.chinadaily.com.cn/opinion/2017-09/05/content_31575393.htm

[13] The Office of the United States Trade Representative, U.S. Trade Representative Issues 2017 Special 301 Report, May 04, 2017, http://www.patentdocs.org/2017/05/us-trade-representative-issues-2017-special-301-report.html

[14] Jeffrey Neeley, Trump Administration Moves Forward on Case That Could Affect All Chinese Imports, August 15, 2017, Technology, Manufacturing, and Transportation Insider, http://www.tmtindustryinsider.com/2017/08/trump-administration-moves-forward-on-case-that-could-affect-all-chinese-imports/

[15] John K. Veroneau and Catherine Gibson, Trump moves on aluminum under Section 232; Steel investigation update, Global Policy Watch, April 28, 2017, https://www.globalpolicywatch.com/2017/04/trump-moves-on-aluminum-under-section-232-steel-investigation-update/

[16] Sara Hsu, Rising U.S. Protectionism May Hurt China’s Economy And Begin A Trade War, September 12, 2017, Forbes, https://www.forbes.com/sites/sarahsu/2017/09/12/rising-u-s-protectionism-may-hurt-chinas-economy-and-begin-a-trade-war/#647618491a32

[17] Zheping Huang, Two little-used trade weapons Trump might employ against China, August 03, 2017, Quartz, https://qz.com/1045448/section-301-and-the-ieeepa-two-trade-weapons-trump-might-employ-against-chinese-ip-theft/

[18] Linette Lopez , The US fired the first shot in a trade war with China, August 18, 2017, Business Insider, http://www.businessinsider.com/us-begins-section-301-investigation-2017-8

[19] Tim Worstall, Here Comes The Trade War – US To Investigate IP, China Won’t Sit By, August 19, 201, Forbes, https://www.forbes.com/sites/timworstall/2017/08/19/here-comes-the-trade-war-us-to-investigate-ip-china-wont-sit-by/#64f3d376b02c

[20] Linette Lopez , The US fired the first shot in a trade war with China, August 18, 2017, Business Insider, http://www.businessinsider.com/us-begins-section-301-investigation-2017-8

[21] Xinhua, China strengthens protection of intellectual property rights, Jan 17,2017, The State Council for the People’s of China, http://english.gov.cn/news/top_news/2017/01/17/content_281475544047740.htm

[22] IAM, A controversial Chinese tech transfer regulation could become the focus of the Trump 301 probe, September 17, 2017, http://www.iam-media.com/Blog/Detail.aspx?g=ade1075d-f054-4ef8-842a-e695981eb248

[23] Linette Lopez , The US fired the first shot in a trade war with China, August 18, 2017, Business Insider, http://www.businessinsider.com/us-begins-section-301-investigation-2017-8

[24] Wang Li, US using Section 301 probe as a weapon, China Daily, September 5, 2017, http://europe.chinadaily.com.cn/opinion/2017-09/05/content_31575393.htm

[25] Charlotte Gao, China ‘Strongly Dissatisfied’ with US Trade Investigation, August 22, 2017, The Diplomat, http://thediplomat.com/2017/08/china-strongly-dissatisfied-with-us-trade-investigation/

[26] Sun Wenyu, Anti-dumping probe into US rubber not countermove to Section 301 investigation: Ministry of Commerce, September 01, 2017, People’s Daily Online, http://en.people.cn/n3/2017/0901/c90000-9263246.html

[27] HKTDC, USTR Launches Section 301 Probe Against Mainland China, September 1, 2017, Hong Kong Means Business, http://hkmb.hktdc.com/en/1X0ABCS8/hktdc-research/USTR-Launches-Section-301-Probe-Against-Mainland-China

[28] Zheping Huang, Two little-used trade weapons Trump might employ against China, August 03, 2017, Quartz, https://qz.com/1045448/section-301-and-the-ieeepa-two-trade-weapons-trump-might-employ-against-chinese-ip-theft/

[29] Ana Swanson , China and the U.S. are both going for trade’s nuclear option, July 19, Washington Post, https://www.washingtonpost.com/news/wonk/wp/2017/07/19/china-and-the-u-s-are-both-going-for-trades-nuclear-option/?utm_term=.dc5d09b9cd6b

[30] Ana Swanson , China and the U.S. are both going for trade’s nuclear option, July 19, Washington Post, https://www.washingtonpost.com/news/wonk/wp/2017/07/19/china-and-the-u-s-are-both-going-for-trades-nuclear-option/?utm_term=.dc5d09b9cd6b

[31] The US-China Economic and Security Review Commission, Economic and Trade Bulletin, September 6, 2017

[32] The US-China Economic and Security Review Commission, Economic and Trade Bulletin, September 6, 2017