China’s ‘Indigenous Innovation’ Policy Creates Obstacles for Foreign Business
By Stanley Lubman, The Wall Street Journal, China Real Time Report
Stanley Lubman, a long-time specialist on Chinese law, teaches at the University of California, Berkeley, School of Law and is the author of “Bird in a Cage: Legal Reform in China After Mao,” (Stanford University Press, 1999).
Chinese government emphasis on giving priority to “indigenous innovation” in government procurement has generated rules that will limit foreign companies’ ability to transfer technology and to sell products to government entities. This represents a huge market. Like many other Chinese government initiatives, the scope of the policy and how it will be interpreted and applied in practice remain unclear, but early indications show that it is having a detrimental impact on foreign companies. Whether it should be viewed as reflecting a broader trend toward economic nationalism is also a question. The policy is clearly inconsistent with the WTO Agreement on Government Procurement (GPA), which would help guard against protectionism. China has not yet acceded to the GPA, and the negotiations that have already begun will be lengthy.
In March 2010, the American Chamber of Commerce (AmCham) released the results of a recent survey of American companies: 28% of the 203 respondents reported that they are losing business because of the policy, and over half of the 49 technology companies surveyed foresaw that the new policy would affect their business.
The policy has been applied to government procurement in a series of documents on “indigenous innovation” issued in recent years by the State Council, the Ministries of Foreign Trade (MOF) and Science and Technology (MOST) and the National Development and Reform Commission (NDRC).(reviewed in this PDF article).
To qualify as “indigenous innovation,” a product must be produced by an enterprise that owns the intellectual property (IP) in China; has a trademark owned by a Chinese company and is registered in China; embodies a high degree of innovation; and is certified by the Chinese National Certification Commission. Companies that have first developed IP outside China will apparently be excluded from the government procurement market in China.
A recent circular applies the accreditation process to six broad product categories: computer and application devices; communication products; modernized office equipment; software; “new energy and equipment”, and energy-efficient products. Preference in government procurement will be given to accredited products that are listed in a national catalogue that is being developed, and which may be expanded in the future beyond the listed categories. Administrative decentralization in China may also lead to inconsistent interpretation of whatever rules on accreditation are issued. It has already been reported that in some cases, provincial-level officials are implementing “their own preferential purchasing policies.”
This policy has understandably troubled foreign businesses and governments. The 2009 National Trade Estimate Report on Foreign Trade Barriers (NTE), issued by the U.S. Trade Representative (USTR) on April 1, 2010, referring to the circular mentioned above, states that the United States has “expressed serious concerns to China about this measure, as it appears to establish a system designed to provide preferential treatment in government procurement to products developed by Chinese enterprises” (report available as PDF here.)
A group of international trade associations has requested a delay in the implementation of the national catalogue currently being prepared, and the accreditation policy has been discussed by U.S. government officials with their Chinese counterparts.
The “indigenous innovation” policy has broad implications for the entire Chinese government procurement market, which is very large. China does not now belong to the WTO Agreement on Government Procurement (GPA) that covers 41 nations including the U.S, and commits each signatory to provide most-favored nation treatment to the others, but China has begun to negotiate on the terms of its accession, which U.S. firms want very much. The 2009 USTR Report on China’s WTO Compliance states that China has committed to treat products produced in China by foreign-invested enterprises the same as products produced in China by Chinese enterprises. That commitment is difficult to reconcile with the “indigenous innovation” policy.
Viewed from a domestic perspective, the policy may be understandable: Why should China be criticized for reorienting its development policy to promote technological innovation at home rather than being dependent on foreign technology? Isn’t that one possibly promising way out of dependence on low-priced exports, provided that the strategy adopted is consistent with China’s WTO-related and other international obligations—including the obligations it undertakes if it accedes to the GPA?
Opinion is not uniform in China: Professors Scott Kennedy (University of Indiana), Richard Suttmeier (University of Oregon) and Jun Su (Tsinghua University) suggest a division between “techno-globalists,” officials, economists and media representatives who are “skeptical of the national technology-development project” and “techno-nationalists” who believe that China should promote its own national standards to satisfy national needs.
Foreign business’ perspectives will vary, too. Some foreign multinationals might consider reducing their stakes in China, while others might consider a very different alternative. Last month, in an article entitled “China Drawing High-Tech Research from U.S.” the New York Times reported that the chief technology officer of Applied Materials, a major high-tech company, “one of Silicon Valley’s most prominent firms,” was moving with his family to Xian, where his company had built its largest research laboratory. Applied Materials is the world’s largest supplier of the equipment that is used to make semiconductors, solar panels and flat-panel displays. As a high-tech leader, it is attractive to China, while China offers the company the potential for high profits, as well as relatively low-paid engineers and subsidies. Nor is Applied Materials the only company that is attracted to work in China. The same article reports that “small clean-energy companies” are going there as well.
The Chinese emphasis on promoting “indigenous innovation” may herald China’s entry into a significant new phase in its economic development. However, the way ahead is unclear. One observer notes that the Chinese public procurement regime “lacks coherence and is highly fragmentary” (see here for PDF article). Also, as has been true since the policy of “opening” launched historic economic reforms, measures such as those discussed here have taken shape slowly and application of the new rules will be subject to considerable bureaucratic discretion.
Furthermore, it is useful to recall that “indigenous innovation” is not a new theme in Chinese industrial policy. Professor Scott Kennedy notes that although China “has issued distinctive standards for a range of technologies,” most such efforts have failed because “large segments of Chinese industry are integrated into business alliances based on non-Chinese standards” (PDF here.)
Might the new policy encounter the same difficulties?
The implications for foreign companies will differ according to their technology and their willingness to hazard investment in a nation that is still finding its way. The conclusory label of “economic nationalism” may eventually prove to fit the policy discussed here, but not yet, pending the outcome both of the Chinese government’s application of the policy in practice and international negotiations on the WTO-GPA.