June 13, 2019 | Washington Examiner

Red flags

The U.S.-China trade war is making headlines, but the most important aspect of the long-term economic competition with China isn’t soybeans or natural gas, it’s technology. The dual flashpoints of economic espionage and backdoor surveillance could precipitate the great uncoupling of the world’s two largest economies.

Although American politicians have just started to pay attention, China has been engaged in a decadeslong, systematic, state-sponsored effort to steal U.S. technology. Beijing has relied heavily on stolen trade secrets and intellectual property to build its own indigenous manufacturing and technology base. Recent U.S. intelligence community estimates suggest that China employs 30,000 military cyber spies and 150,000 private sector cyber experts whose job is to steal foreign secrets and technology.

China’s economy has thus grown substantially, often at the cost of American companies. China is estimated to be responsible for 50-80% of all international intellectual property theft worldwide. This costs our economy alone an estimated $300 billion a year. A congressional commission has found that Chinese espionage “comprises the single greatest threat to U.S. technology.”

In many high-tech areas, China is not only catching up with America, but moving ahead. In artificial intelligence and quantum computing, Chinese scientists are some of the world leaders. In advanced microprocessing, China aims to increase the percentage of Chinese-made integrated circuits in its market from 9% five years ago to 70% by 2025. These technologies will pose both economic and military challenges. There are even concerns about less advanced technologies, such as commercial rail cars and personal drones, which are increasingly dominated by Chinese producers. Last month, Senate Minority Leader Chuck Schumer, D-N.Y., called for an investigation into a Chinese company that has won a subway car-redesign contest, though hasn’t been awarded a contract to build them for New York City.

The research and development community in China is growing, and this has allowed Chinese firms to take a more active leadership role in setting global standards for information networks, as they are on 5G networks, for example. American technology firms often find themselves outgunned on international bodies that set and govern global rules, such as the International Telecommunication Union. As a result, Chinese companies are not only developing new networking technologies, but they’re often writing parts of the rulebook.

As China has caught and even overtaken the competition in critical technologies, the United States and other countries have taken notice. In 2015, the Obama administration put pressure on Beijing to end rampant Chinese theft of American intellectual property. But after a brief hiatus, Chinese hackers went back to work, although they were more careful to cover their tracks.

Technology theft is just one tactic the Chinese Communist Party uses to give its companies an unfair commercial advantage. China continues to limit access to its market, especially to major American companies such as Google, Twitter, and Facebook. Meanwhile, Beijing supports so-called national champions with massive state subsidies. The ruling Communist Party permits and sometimes underwrites widespread intellectual property theft, including intrusions conducted by the Chinese military against foreign businesses.

Frustrated with continued, unbridled efforts by Chinese companies and state-sponsored agencies to steal technology and flout U.S. laws, the Trump administration is targeting one of China’s worst offenders: Huawei Technologies Company Ltd. Administration officials worry that Huawei’s involvement in communications infrastructure in the United States and in allied countries might give the Chinese military access to sensitive information. Indeed, U.S. leaders often note that China’s 2017 National Intelligence Law requires Chinese people and organizations to “support, assist, and cooperate with state intelligence work.”

There are good reasons to be wary of Huawei, for it has a notorious record of refusing to play by the rules. Senior Huawei leaders have been indicted for violating sanctions against Iran. Huawei also faces charges that it paid employees to steal intellectual property. And it continues to receive massive state subsidies that give it an unfair advantage over commercial rivals. There are many active legal cases involving these offenses.

Nevertheless, President Trump is having trouble getting allies to join with him in a strategy of pushing Huawei out of foreign markets. U.S. officials have pleaded with leaders in the United Kingdom and elsewhere to eliminate Huawei from their 5G networks, but with limited success. As a result, Secretary of State Mike Pompeo has issued warnings to recalcitrant allies, expressing concern about sharing information with them that might fall into Chinese hands. He said the United States will “never put America’s national security secrets in a network that we don’t have confidence in.”

One big challenge for the Trump administration is that there is no major public case in which Huawei has been caught providing customer data to the Chinese government. Huawei insists it does not engage in spying and promises it “will not build backdoors or hand over customer data.” Back doors are systems that allow an outside force to gain unwanted and unauthorized access into private or official technology and to obtain sensitive information. American concerns have prompted many allies to review security procedures to make sure Huawei has not secretly installed back doors into their systems.

Amid mounting frustration, the Trump administration has escalated its fight against Huawei. In mid-May, it took several actions that undermine not only Huawei’s access to American markets, but also its ability to function as a commercial entity globally.

On May 15, the president signed an order prohibiting a range of transactions involving communications technology designed or supplied by a “foreign adversary” that pose an undue risk to U.S. information and communications systems or American national security. Many expect the Commerce Department to identify China as a foreign adversary and to prohibit American companies from importing, installing, or using Huawei’s technology or services in their products. This would block Huawei from the American market.

Just one day later, on May 16, the administration added Huawei and dozens of its foreign affiliates to the Commerce Department’s entity list, making it significantly more difficult for the company to buy technology from the United States. In particular, American companies may not export controlled goods, such as sensitive technologies, to Huawei without a specific license authorizing them to do so.

The impact of this is massive. If Google wanted to submit software for incorporation into Huawei phones, for example, it would probably be prohibited from doing so without federal government authorization. Foreign companies that want to reexport American goods to Huawei also face restrictions. If a company wanted to provide Huawei with hardware that contained American technology, it too would probably need permission from Washington. European and Japanese companies have already frozen their relationships with Huawei. ARM, a chip designer, has cut ties entirely, kneecapping Huawei’s ability to build microprocessors for use in phones and other networking devices.

These actions seriously undermine Huawei’s ability to remain commercially competitive. If they stay in place, Huawei will probably lose access to America’s enormous market and, more important, to critical technology that is indispensable to many Huawei products. Unless Huawei adapts quickly, it may lose market share in advanced networking and other leading-edge technology. That, at least, is what the Trump administration appears to hope.

But, as ever, the devil is in the details. The Commerce Department has great discretion when deciding whether to allow specific companies to export products to Huawei. Because the licenses are private, the administration can give relief to certain companies if it is politically expedient to do so.

The ultimate pressure relief valve, however, might be Trump himself. Just one year ago, his administration took punitive actions against Chinese electronics giant ZTE Corporation. ZTE looked to be in deep trouble until President Xi Jinping called Trump and asked him to lift restrictions imposed on ZTE for sanctions violations. Trump agreed to do so in exchange for Chinese promises on trade and North Korea. Many experts now believe a similar story could be ahead for Huawei. Trump himself has suggested that Huawei could be “part of a trade deal.”

The battle lines are now drawn. Washington appears to be preparing to go after individual Chinese companies using a variety of economic and financial tools to punish “bad actors.” Chinese companies involved with intellectual property theft, sanctions breaches, and human rights violations all appear to be possible targets. Many foreign companies could be forced to disentangle themselves from Chinese counterparts. The process of decoupling the American and Chinese economies appears to be underway, especially in the technology sector.

China isn’t taking this all lying down. In early June, Beijing unveiled what it called an “unreliable entities list” modeled on the Commerce Department’s list. In a threat clearly directed at Washington, Beijing warned that foreign companies could be banned from operating in China if they engage in activities the Chinese dislike. In just the last few days, FedEx has been warned about a pending investigation, and Ford’s main joint venture partner has been fined for antitrust violations. These actions appear to be the beginning of Beijing’s retaliation against ramped-up U.S. pressure on Chinese companies.

But the irreducible fact is that the United States retains substantial economic leverage in areas that China cannot match. Most of the world still relies on advanced American technology and the dollar, which gives federal regulators substantial influence, even over foreign activities. The United States is still the center of global finance, which allows Washington access to many of the details of global transactions, which, in turn, gives it leverage over foreign institutions and companies. These may be fleeting advantages, but right now they provide U.S. officials with real power.

Over the past year, the administration has brought these more targeted tools to bear. We are now seeing a more focused campaign to change specific Chinese behaviors. In many ways, this is a welcome development. We argued as early as 2016 that broad economic actions against China could be politically difficult to sustain and would damage U.S. and global growth, whereas more targeted measures could succeed, and do so at an acceptable cost. These tools, including sanctions, export controls, and investment review, could force China to reform some of its unfair practices. Whether they can work with broader-based measures such as tariffs will soon be tested.

The trade war is now entering a new stage. Shortly after Xi became general secretary of the Chinese Communist Party, he proposed creating a new era of major power relations. There is no doubt we have now entered a new era, but it is not the one that Chinese leaders expected or hoped for.

Zack Cooper is a research fellow at the American Enterprise Institute and an adjunct assistant professor at Georgetown University. Eric Lorber is senior director of the Center on Economic and Financial Power at the Foundation for Defense of Democracies.


China Cyber Cyber-Enabled Economic Warfare Sanctions and Illicit Finance