If China turns inwards on technology, will IP be far behind?

One word can be said to describe the position of the West to technology transfer and hi-tech sales to China—ambivalence. On the one hand, leading Western hi-tech companies continue to salivate at the prospect of selling their wares to the local Chinese market. On the other hand, companies are said to face the challenge of how to maintain control of such transferred technology. There is nothing new in this dilemma, but it rests on the assumption that China remains eager to import Western technology and products. What is new, however, is the emergence of early signs that this assumption may not be entirely correct. If the 18 December Bloomberg News item, “China is Planning to Purge Foreign Technology and Replace With Homegrown Suppliers" portends a change in orientation, the West may be at the cusp of a dynamic by which China is seeking to wean itself from reliance on both Western technology and the hi-tech products supported by such technology.

The gist of this potentially tectonic change was stated by the Bloomberg piece as follows:

“China is aiming to purge most foreign technology from banks, the military, state-owned enterprises and key government agencies by 2020, stepping up efforts to shift to Chinese suppliers….” 

 The pilot for this program is reported to have taken place in a city in the northeast of China—Siping, where the Windows operating system was replaced by a local system called NeoKylin, while a local purveyor of servers, Inspur, replaced various foreign products. The program was characterized as “successful”. This step follows a series of events during 2014 wherein Chinese regulatory and competition law provisions have been applied to curtail the Chinese activities of Microsoft, Apple and Qualcomm. "The shift is real," said Charlie Dai, a Beijing-based analyst for Forrester Research Inc. "We have seen emerging cases of replacing foreign products at all layers from application, middleware down to the infrastructure software and hardware."

What seems to be giving particular impetus to this program is a heightened sensitivity in China about threats to its security coming from the West. The revelations by Edward Snowden that the United States National Security Agency has been engaged in widespread spying, including of key Chinese research centres, highlighted these concerns. As well, it appears that the recent judicial developments in U.S., where courts seek to issue orders requesting U.S. companies to disclose information maintained beyond U.S. borders, may also be playing a role. While the Bloomberg piece mentions that U.S. tech companies seeking to maintain a substantial presence in China will be expected to share their core technology or at least allow Chinese inspection, there is nothing new regarding these expectations. If the ultimate goal is to replace foreign with local technology, this Kat wonders whether compliance with these requests will enable non-Chinese companies merely to postpone a form of the inevitable.

Generally speaking, such a move by China, if it gains traction, suggests a form of import substitution, where a country seeks replace foreign products with those of domestic provenance. Economic theory frowns on the long-term effects of import substitution (even if there may be short-term benefits, especially to domestic employment), because it runs counter to the benefits that derive from comparative advantage and the efficient specialization of resources that comparative advantage is said to engender. While it is said that, in the 20th century, places like South America and India had unsuccessful experience with import substitution, no less a figure than Alexander Hamilton, the first Secretary of the Treasury and the architect of U.S. economic policy following the American Revolution in the 18th century, was an avid proponent of the policy. As well, we may be in somewhat uncharted waters, given that China is at once wealthy and poor, technologically advanced and technologically backward and it is perhaps pursuing this policy more for security then economic reasons.

How will this policy, if it proves to be durable, impact on intellectual property rights? While
the Bloomberg piece does not address this issue, this Kat will take a stab at several conjectures:

1. Should technology become increasingly intertwined with security concerns, it may lead to an impairment of the flow of technology and related information, as more and more technology may be protected by trade secrets rather than by patents. This may mean fewer patents and the public disclosure of inventions that patents provide. While trade secrets are a valuable form of IP right, excessive reliance on secrecy at the expense of patents might have a deleterious effect on aggregate technological development, as a decreasing quantity of inventive information is publicly shared.

2. The increased intertwining of technology and IP with security issues might also affect the continued integration of the IP system at the international level. If this happens, international cooperation regarding technology, development and the protection of rights could be deleteriously affected.

3. If China succeeds, even in part, in bringing about import substitution of technology by local production, the owners of IP rights and, in particular, patents, may well find themselves in the difficult position of seeking to protect their rights in a market in which they will have diminished commercial presence. This will be even more difficult if, as suggested, technology will be increasingly protected by trade secrets rather than patents.

There may well be other considerations should China engage in this form of import substitution. If this is not enough to be of concern to Kat readers, consider the concluding observation of the Bloomberg piece, given by Ray Mota, chief executive officer of Gilbert, Arizona-based ACG Research.  "I see a trade war happening. This could get ugly fast….It's not going to be a technology discussion. It's going to be a political discussion." It is difficult to conceive how the IP community will benefit from such an eventuality.