On Thursday March 24, President Trump announced a US$50 billion Trade Action against China in response to massive ongoing intellectual property theft. The move was enacted under Section 301 of the US Trade Act, which allows the president to take “all appropriate action against unjustified, unreasonable, or discriminatory” trade practices by another country. By any account, China falls right into this category; but this is specifically in response to their dismissive and illegal practices involving US intellectual property and IP rights.
Immediate concerns from people is that this is the start of (another) trade war – just like the reaction to the US Steel and Aluminum tariffs imposed earlier this month – one with our biggest by far trading partner. However, the Steel tariffs have actually moved other countries to come to the negotiating table with the US to come up with more fair and reciprocal trade deals. (As of March 28, China is preparing a list of retaliatory tariffs on US companies.)
The President said China, Japan, the European Union, and NAFTA countries have all initiated trade talk renegociations – and have not engaged in “Trade Wars” as feared, or assumed, by politicians and pundits in Washington. (Many of whom do not understand basic trade practices or economics, in my estimation – but they will happily repeat “trade war” over and over again.) Think of the US Tariffs as the opening move on a chessboard – open with a pawn to draw out your opponent; Now set up your knight and bishop to protect that space with a Section 301 Trade Action.
Alas, to understand this new move against China it is important everyone knows how this came about. Most of the trouble with IP and Trade is because of cultural differences between the United States and China. Cultural differences that dictate business ethics, markets, and industries. There are fundamental differences between the two countries and how they view business relationships between people, companies, and how market economies should work. And it is not merely because of Communism and Free-Market societies.
We generally have a basic understanding of how business practices operate in a free-market, e.g. the United States. There is market competition for goods and services, there are no monopolies allowed in industries, no price-fixing, and there are protections afforded to businesses to protect their products and brands in order to secure the share of the market they’ve created for themselves. At the forefront of these protections are patents and trademarks, respectively.
You cannot patent an idea. A patent specifically protects exactly how the product is made. Think of the ingredients in a soft drink; change one or a few ingredients and your drink is different. This is where a Trademark comes into play; the name of your product is used to distinguish your soft drink from all the similar tasting beverages on the market. You build your brand name, create brand recognition, and carve out a piece of the soft drink market because your customers are loyal to your brand.
Those are the basic tenets of a fair and free-market society. You cannot stop someone from selling a similar product that seemingly looks or tastes identical to yours on the face of it – because this is the essence of free-market competition. The economy needs market competition (consumer choices) in order to survive, grow and prosper.
T
he patent and brand name that is associated with a company (including copyrights) is called Intellectual Property (IP). Copying or stealing another product or brand name is called Intellectual Property Theft, and it is more than just making the exact same product and calling it something different. (That can be either a trademark violation or patent infringement.) Usually a knock-off product is lower in quality, and sold at a cheaper price (taking market share).
A quick example from the 1800’s when America was expanding during the industrial age and building railroads all across the land to connect the East to the West. There were strong solid iron spikes used to secure and connect the tracks and the number one brand was called McCoy. McCoy iron railroad spikes were the only ones used during the project. McCoy spikes had to be shipped from east to west, and the tracks were rapidly extending, with demand outpacing the supply. Well many prospectors got the idea to just hammer out some metal spikes, stamp “McCOY” on the box, and sell them along the construction route. These low-quality spikes often broke during construction or failed afterwards causing train derailments, wreaking havoc along the lines. The stern message came down from investors back East to only use real McCoy spikes exclusively during the rest of the project. And so, every materials purchaser, every foreman, and every worker wielding a sledgehammer looked conspicuously at every rail spike handed to him and was heard to ask, “Is this the real McCoy?”
Cultural Differences and Chinese Business Practices
However, in China, business practices and what defines a fair and free market differ greatly from the West. In particular, how we define market competition. If a company in the United States has a better product than all of its competitors, that is called a competitive advantage. To us, “fair” allows for companies to enjoy a competitive advantage over its rivals, and thus have a larger market share and the ability to charge more and make more in profits. And therein lies the difference.
Think of what the term ‘fair’ really means; one sense of the word connotes equality. Yet, in another sense, the terms “fair and just” are frequently used together to denote “legal” and “not breaking any laws,” which does not necessarily mean “equal.”
The Chinese prefer to define a fair market as equal when it comes to business. The idea of competitive advantage is 
looked at as unjust. If someone has a product of higher quality and value, then a truly fair market would afford competitors to also sell the same product exactly like the number one brand. Copying or reselling the same product is/was not illegal; and the competitive advantage is gained through good old fashioned hustle – to cleverly outwit your opponent to gain customers or to sell the same product in a new market. China is a vast land and different people or companies can sell in different cities and towns across the country and profits are generally not affected. The original company may not have the resources to sell to every corner of China. This is all acceptable business practice that has been in place long before we were a country with intricate rules of trading goods and services.
Long ago US companies outsourced manufacturing operations to China, and we import all of our finished consumer goods back into the United States. What happens at these factories is that some of the manufactured products get shipped back to America, and a substantial portion gets shipped out the back door into the Chinese market at low cost. The exceptional benefit to the Chinese consumer is these goods are not lower quality knock-offs; they are the real McCoy.
US companies lose market share in China because they aren’t the ones selling all of their products in the market; goods that are imported back into China cost more so why would consumers purchase them at the real retail cost? This happens because foreign imports are subjected to high tariffs and duty taxes in order to protect the Chinese nation state monopoly. Every product made and manufactured in China is protected from foreign import competition: mobile phones, golf clubs, clothing, computers, shoes, car parts – anything you can imagine. And for so long US companies have accepted this as the cost of doing business with China – the biggest consumer market within one country on the planet.
This standard operating procedure has caused such big trouble for China that for years they were not allowed into the World Trade Organization unless they cracked down on pirated goods and relaxed tariffs and duty fees on trade. And they did, to an extent. Police started to raid factories that were known distribution centers of pirated goods. But not all of them were shut down (because every one of them was doing it). And in a strict communist country you can easily guess which factories were targeted: the ones that did not pay-off the right politician or crime boss. After a few years of showing a good faith effort China was allowed to become a full member of the WTO. And the rest of the world was happy about this – no companies actually stopped doing business with China.
All the manufacturing was firmly cemented in China, the cost would be too great and logistically impossible to suddenly reopen factories and manufacturing jobs in the US and Europe. Plus the giant consumer market in China is unmatched in the world. Even if 20-30% (or more) of pirated goods were available in China a company could still make more in profits than they would in Europe and the United States combined by selling in China. Again, this is simply the cost of doing business.
But things started to change between, 2005-2010 I’d say. As China became a dominant exporter of manufactured goods, the products started to show up in other consumer markets – either under different names or as de facto counterfeit goods. For example, Callaway Golf Clubs could be bought at half the price in some stores across the world, where Calloway might not sell and with none of the profits going back to Calloway Company. [Calloway suffered real acute damage because they were spending so much time and effort chasing pirated goods to get them off the shelves; meanwhile a small factory in China could keep making them non-stop in perpetuity.]
China has transformed itself from a manufacturing country to a manufacturing and consumer country, and during this transition big name service companies from the United States started to move into the new market. Think banks, restaurants, and technology companies like Apple, and Google.
Apple already had all their iPhones and iPads made in China. Pirated iPhones and iPads could be had at any market 
bazaar in China, but Apple still made a profit nonetheless selling iPhones across the globe. When China became a consumer country, however, this business model began to show some cracks. Apple opened up Apple Stores in China, only to find there already were ‘Apple’ stores in some parts of the country. Purveyors of pirated goods had scaled up their underground economy. iPhone demand was so high that it was no longer feasible to just sell some phones on the sly; so they opened up little box stores and customers came to them. (The stores could then close up after selling all of the ‘inventory’ or shutter and move on before a police raid.)
I asked an attorney once how his clients were dealing with pirated goods and what efforts China was making to help out. He answered that China was “doing very well, actually,” policing trademark infringements, gray-market goods, and IP theft in general. I only slightly believed him. Afterall, he represented US companies trying to get into the Chinese consumer market and would not be starting off on the right foot with his clients if he told them to be prepared to take 40% of revenue off the top due to the business practices over there. As former Ambassador to China Max Baucus recently said, “The Chinese are very good at doing just enough to keep us at bay,” in terms of IP enforcement and trade policies. (March 22, CNN)
The real IP theft is in technology.
Google tried to break into the China search engine market but ended up leaving in 2010. At first Google spent a lot of time working with the Chinese government to implement search controls; because everything is still censored in China and the government wants strict control over what its citizens get to see and read online. In order to comply Google would have to create a whole new search engine platform; one that doesn’t search everything or excludes certain websites or doesn’t include certain news outlets or blocks most countries. And China especially did not want citizens to see things like Facebook or Twitter. One way to control this was to have everything stored on-site in China on government or Chinese-owed servers. [Google and Facebook are blocked in China, along with Twitter and most major Western news outlets. Apple operates in the country, but under strict censorship. (Reuters, 2017)]
Still, China is the world’s largest internet population, with over 715 million users. In the end Google left – but not before finding out that the whole time they were working with the Chinese engineers and computer scientists, the Ministry of State, the Ministry of Commerce, the Ministry of Foreign Affairs… the Chinese military was stealing Google’s code. All the different search algorithms, all of the software code – everything that made the search engine function. Everything that made Google google.
This was shocking to the company and those who had never done business in China before; but it was really just par for the course. Imagine a government holding up a deal with a company for just enough time to siphon off all of their trade secrets. (Times have changed; in 2018 Google is working with the Chinese government again now on a new software project: Artificial Intelligence software; Google has moved most of its AI operations over to China.) Another cost of business with China is the strict rules and regulations foreign companies must abide by in order to crack the consumer market.
China makes companies share a lot of their technology and trade secrets; matters we would consider secret an unalienable rights of US companies. Technology sharing is a prerequisite for doing business in China, meaning companies must, in effect, divulge their trade secrets. While this is going on US imports to China are held up by the Chinese government – allowing Chinese companies to implement the technology into their own products. Thus, Chinese brands make it to the consumer market first, with the full backing of the government.
China does this with all trade imports, from high tech to food, and implements harsh tariffs and duty taxes on all foreign imports (ranging from 25%-30%). Imposing tariffs on top of duties creates a significant disadvantage to foreign imports into China. But again, the pay-off is seen as worth it to these import companies because of the size of the Chinese consumer market.
What US companies have long failed to see is that they are really not gaining significant market-share in China, and are effectively losing any competitive advantage they once had before entering the China market. Also, remember that China does not depend on the United States market as much as the United States depends on the Chinese manufacturing market. If the United States tries reciprocal trade actions, China can simply increase their manufacturing exports to other parts of the world, namely the European Union, Russia, the Middle East, and Africa. American consumers seldom hears about, or buys, finished goods from those regions named above; yet every American knows how important China is the the US economy.
The internet search company in China that benefitted from this intellectual property theft is Baidu. At the beginning of 2009 Baidu was a $10 dollar stock [NASDAQ: BIDU], by the end of the year the stock quadrupled. In 5 years the stock peaked at $250 and now trades between $166-$275 over the past volatile year and is the world’s 8th largest internet company by revenue.
The other company that profited is Alibaba [NYSE: BABA] which is the Chinese version of Google, Facebook, Twitter, e-Bay, and Amazon all in one. The Alibaba Group Holding company was one of the most anticipated IPOs since the 2008 Great Recession having been in operation since 1999. BABA debuted in 2014 at $90, and now trades around $200.
Baidu and Alibaba enjoyed explosive growth in part by essentially having no costs for research and development; all their technology is lifted from other US companies, like Google. China runs the world’s most prolific intellectual property theft organization, and shares that technology with Chinese companies.
Industrial Espionage
There is evidence abound about China stealing IP technology from US companies. Companies that do not have relationships with China are still not insulated from China’s unfair Intellectual Property Rights (IPR) practices because of computer network intrusions run out of China, called Industrial Espionage. Chinese computer hackers conduct network intrusion attacks daily on US companies, and are state-sponsored by the Chinese government. (The government denies official involvement; one excuse is that since China’s government is so large, and intrusive, it is nearly impossible to do anything without the government being aware on some level.)
Be that as it may it is still well-known in the West that China’s great leap forward in technology advancement is solely due to industrial espionage. And this is a critical National Security issue for the United States. Hacking into companies like Intel or HP for computer technology is one thing; however hacks against Boeing, Northrop-Grumman, Lockheed Martin, Raytheon, General Dynamics, L-3, Bechtel, and Booz Allen, to name a few, are all government contractors vital to our national defense. All of these companies have been breached.
These companies are all working on next-generation technology used in military, aeronautical and space engineering. Airplanes that are undetectable by radar, submarines that run silent and deep and do not have to surface for six month or longer at a time, top secret satellite and communications components, and stealth technology.
The United States Military does sell weapons, ordinance, and defensive capabilities to allies around the world (but not secret Next-Gen technology). However most advanced weaponry is embargoed and the US prohibits sale to most foreign nations, and nations that do business with countries on the embargoed list. Yet China is able to get its hands on this technology not just through trade but through computer hacking and industrial espionage, which puts the United States and its allies in peril. The Chinese are able to use this technology, implement it in national defense, or sell technology to US adversaries.
Take the example of Taiwan. The Chinese and US have long disagreed 
with US arms sales to Taiwan, but by knowing the technology the US is sharing with Taiwan, China gains the upper-hand in this stand-off. China has recently become more emboldened in the Asia-Pacific Region with its “Island Building” in the middle of the South China Sea. These are not fishing ports, they are military bases built in the middle if the sea, on man-made islands, in disputed territories claimed by numerous other countries, and has been deemed illegal by the United Nations.
So what would embolden China to ignore warnings and flagrantly violate international maritime rights? Probably because they are no longer afraid of being three generations behind the US in military capability. There are small military actions taken by countries every year to see what they can get away with before the international community or the United States reacts. However these shows of force are usually contained regionally. But the recent actions by China are much bigger and bolder; they are flexing their military muscles not just at the United States, but the entire world. We can only hope that the United States still has a leg up on China – but it is impossible to tell because of the military industrial espionage perpetrated by the Chinese government and its seeming unwillingness to stop.
In conclusion, the efforts of China in regards to Intellectual Property theft do merit out attention and vigilance. In the past we have relied on the World Trade Organization to sort out differences in trading practices. But the US Military would not seek indemnification via a public session at the Hague or WTO; in fact the military would work just as hard to keep any espionage under wraps. As for unfair trade practices, the end result is that it hurts the US economy; while we enjoy cheap manufactured goods from China, US companies do not enjoy huge profits from the Chinese consumer market. The United States and the American consumer pays a heavy price in the long-run for having China as a number one trading partner, and the partnership is heavily tilted in China’s favor – at the expense us all.
Global Times: China Preparing Retaliatory Tariffs on US Imports.
Beijing –“Compared to China’s list, the U.S. list hurts itself more than China. The tougher the move, the stronger the impact on Washington,” said the Global Times in its editorial. “This will deal a heavy blow to Washington that aggressively wields the stick of trade war and will make the U.S. pay a price for its radical trade policy toward China,” the tabloid outlet said. Reuters, March 28
Stock Market Reaction: Stocks dropped 700 points the day President Trump announced trade tariffs, and over 1000 points in two days. Stocks have mostly rebounded in the three days since.
China US Trade Relations, 2006-2018
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