Tag Archives: Economics

Evaluating 3 key recommendations of the Blair-Huntsman IP Commission report

The U.S. government needs to do more to stop the theft of U.S. intellectual property (IP), mostly by China, according to a new report produced by a group of political and business leaders under the leadership of Dennis Blair, former director of national intelligence under Obama and former commander of the U.S. Pacific Command, and Jon Huntsman, former U.S. ambassador to China and former governor of Utah.

The report endorses the claim that recent developments in online IP theft represent “the greatest transfer of wealth in history” and names actors in China as responsible for “between 50% and 80% of the problem,” with India and Russia as secondary concerns. Further, the report  pushes for at least some IP theft to be prioritized as a matter of national security, not merely economic welfare.

Who’s behind the report? The “Commission on the Theft of American Intellectual Property” has the sound of a government-backed group; instead, it was backed by the National Bureau of Asian Research (NBR) and its new Slade Gorton International Policy Center*, named for one of the commission’s members, former Senator Slade Gorton (R-Wash.) — who was a member of the official 9-11 Commission. The rest of the membership is well qualified and, when politically affiliated, well balanced between Democrats and Republicans.

It’s worth keeping in mind that the individuals gathered independently over 11 months to produce a report on this particular problem. Thus, we should perhaps not be surprised to learn that they believe “the American response to date of hectoring governments and prosecuting individuals has been utterly inadequate to deal with the problem.” The resulting report is nonetheless carefully done, and it will be provocative both in the U.S. policy environment and in the ongoing trade and economic discussions between the United States and China.

Some will argue the measures recommended in the report don’t go far enough. Indeed, the commissioners explicitly do not recommend legalizing aggressive cyber attacks in retaliation for incursions. Meanwhile, some specific recommendations and the focus on China will add to ongoing concerns among Chinese investors that they face an unfair playing field when seeking investment opportunities in the United States. Finally, they note but do not evaluate the “sense that IP theft is justified by a playing field that benefits developed countries”—a real point of disagreement, especially when “fairness” in competition is a central goal.

In the remainder of this post, I evaluate three of the specific recommendations for underlying implications and potential successes or pitfalls.

Recommendation: “Designate the national security advisor as the principal policy coordinator for all actions on the protection of American IP.”

As the first recommendation and one that comes closest to calling for personal involvement on the part of the U.S. president, this statement deserves special attention. Specifically, the authors have clearly been careful about the extent to which they wish to declare IP protection a national security issue. “The theft of American IP poses enormous challenges to national security and the welfare of the nation,” the report states. It continues: “Although it is certainly true that not all problems rise to a national security challenge, the means by which IP is stolen (including foreign government involvement) and the recent assertion by the president’s national security advisor that the U.S. government must take action to safeguard American companies in response to massive cyber and other attacks demonstrate that IP theft is a national security priority.”

I’ve added emphasis to illustrate the tightrope walk being performed here. The authors are calling for IP theft to be coordinated by the president’s top national security advisor, but they are careful to qualify that not all instances constitute a challenge to national security. Meanwhile, the word “threat” is pointedly absent. This recommendation recognizes the important distinction between IP thefts that are obviously national security–related (for instance targeting military contractors) and those that are more of an economic or commercial challenge (for instance counterfeiting U.S. clothing brands).

Though the authors make the distinction between national security challenges and broader challenges, this boundary deserves a great amount of attention in policy and even ethical analysis. It is a boundary often blurred in journalism or think tank reports on the increasingly discussed cybersecurity issue. And it is a crucial distinction when establishing rules and policies for retaliation, whether commercial or otherwise. In any case, the elevation of the issue to top levels of government would mirror the perceived importance of the issue in U.S.–China relations over the past year.

Recommendation: “Empower the secretary of the treasury, on the recommendation of the secretary of commerce, to deny the use of the American banking system to foreign companies that repeatedly use or benefit from the theft of American IP.”

There are two elements worth noting here, in addition to the way in which the recommendation involves two more top officers of the U.S. executive branch.

First, denying access to the U.S. banking system is similar to sanctions we see elsewhere, including, for example, those targeting companies that do business with Iran contrary to international sanctions. Existing U.S. legislation has been used to name firms, including some from China, as ineligible to use the U.S. banking system. The recommendation here implicitly targets another major element of the financial system, too: listing on U.S. exchanges. Chinese companies are already on shaky ground in the United States exchanges due to regulatory conflicts regarding transparency and auditing. This could make the prospect of continued listing even more uncertain for Chinese firms, depending on what kind of process would lead to a ban. The question for the U.S. government and market is whether it would see a drastic decrease of Chinese listings in U.S. exchanges as a detriment. Some argue that keeping firms listed in the U.S. could help pressure them to engage in more internationally trusted accounting practices.

This leads to the second point: how determination of violations would be made. The report trusts that the Departments of Commerce and Treasury would be able to handle this well. However, without a transparent, responsive process, foreign firms including those from China may view a wide variety of transactions with the United States as highly risky. This has the potential for a real chilling effect on U.S.–China commercial activity.

Similarly, under a different recommendation advocating for quicker seizures (“sequester”) of suspected IP-violating goods being imported into the United States, the commission backs a “probable cause” standard for placing this hold, after which the exporting entity would have to prove that the goods were not IP-violating. I’m not a lawyer, but the combination of probable cause and the requirement to prove a negative seems ripe for abuse. (I stand willing to be schooled if U.S. case law would call for strict standards and transparency in such a policy.)

The commercial relations between the United States and China have been called the ballast of the bilateral relationship, without which the stormy seas of the 21st century would pose a greater risk of conflict or instability. Recently, the U.S. business community is increasingly concerned with IP theft and unfair practices. If the U.S. response to these concerns further sours  bilateral commercial ties by angering Chinese firms or triggering retaliation, rough waters may indeed be ahead.

Recommendation: “Consider the degree of protection afforded to American companies’ IP a criterion for approving major foreign investments in the United States under the Committee on Foreign Investment in the U.S. process.”

This recommendation is perhaps the most likely to raise eyebrows among Chinese policymakers and investors. The Committee on Foreign Investment in the U.S. (CFIUS) is already a major point of concern for many Chinese who would wish to invest in the United States. The inter-agency body has the responsibility for evaluating foreign acquisitions and investments for national security concerns. For instance, if a Russian firm wanted to buy Boeing, CFIUS might reasonably seek to block the transaction, because aviation and aerospace is an important national security industry. Less clear-cut examples include the recently blocked acquisition by a Chinese firm of a wind farm in Oregon.

Some Chinese investors are nervous about the extent to which investment efforts might be arbitrarily rejected through the CFIUS process. U.S. experts including Dan Rosen of the Rhodium Group have argued that the CFIUS process is largely appropriate and not much of a barrier. Others in the U.S. argue that China itself restricts foreign control in a litany of sensitive industries, much broader than the areas covered by CFIUS. But adding a “strength of IP protection” criterion to the CFIUS process could be a drastic increase of the committee’s purview.

The authors are walking another tightrope: “As demonstrated by the flood of counterfeit parts discussed in chapter 1, as well as by widespread cyber infiltrations discussed in chapters 1 and 5, the Commission assesses that the theft of American intellectual property has direct implications for national security. Given that CFIUS has a large amount of flexibility in evaluating potential transactions, it seems appropriate for CFIUS to factor into its judgment the degree to which the foreign actor protects intellectual property” [emphasis added]. From this wording, we could take a less proactive reading: that CFIUS need not be given a new mandate, and indeed that it should already be considering IP insofar as it is a national security issue. The obvious question is whether the committee is already taking IP protection into account. (I have no idea, but others probably do.)

No matter the interpretation, this call for greater scrutiny by CFIUS will likely be of significant concern for Chinese investors and some in the Chinese government.

Conclusion

In summary, “The IP Commission Report” is an excellent resource, and it should be understood as moderately hawkish on IP protection issues, at least on China. It includes a specific list of policy measures that the authors believe would go too far. But it makes bold calls for action and tends toward the generous assessment of how much money and how many jobs are lost because of IP theft. Ultimately, the economic impact of IP theft is nearly impossible to estimate, though I could imagine a methodology that came in significantly lower than the “hundreds of billions of dollars a year” estimate.

The scope of the report is such that it does not evaluate how appropriate the IP laws and concepts of fairness being discussed are. Needless to say, many have faulted the copyright system for unduly empowering large copyright holders in book and music publishing, and many have questioned the ethical value of a patent on a life-saving drug that makes medicating patients prohibitively expensive. The issue of fairness is central here, and the Chinese (or broader developing economy) views of fairness deserve real attention. The reality of the world market is that it exists across legal regimes, ethical views, and enforcement capacities. New policies need to be based firmly in that reality.

 

*Disclosure: I briefly worked in communications strategy with NBR and interviewed Gorton for its website. I had no involvement with this report, nor did I know it was coming until this week.

Five points on the deeply flawed U.S. Congress Huawei report

A U.S. Congressional committee released a broadside attack on the Chinese telecommunications firms Huawei and ZTE this week, charging that their products represent a security risk to the United States and recommending that U.S. government and private sector organizations avoid their products. The report followed about a year of investigation that included hearings and a fair amount of press coverage. Here, I offer some points on the report, which I believe is deeply flawed both in its analysis and in its positioning.

Communication infrastructure is definitely an important area for national security, and it is entirely possible that these firms and the Chinese government coordinate efforts to accomplish espionage or other activities. But I argue this report doesn’t get there, and that it seems designed to distract readers from its thin evidence (at least in the non-classified version we get to see). What it is not is a balanced examination of a risk. Five points and a conclusion follow.

Huawei seems to have decided not to provide much detailed information. This furthers the trust problem, and raises questions about government control of disclosures. 

The report charges: “One of the companies [Huawei] asserted clearly both verbally and in writing that it could not provide internal documentation that was not first approved by the Chinese government. The fact that Chinese companies believe that their internal documentation or information remains a ‘state secret,’ only heightens concerns about Chinese government control over these firms and their operations” (12). This is a legitimate point, though concerns about state secret disclosure are hardly unique to telecom firms, and the suggestion that the companies consider their internal documents state secrets is laughable: they are either afraid of bringing the wrath of their government, or this is a handy way to avoid disclosure. Given Huawei’s apparently ham-fisted and ever-changing attitude with the U.S. investigators, either seems possible to me.

A drastic rebuild of most public- and private-sector information infrastructure would be necessary to achieve the standard of security allegedly threatened by Huawei and ZTE.

Warning: tech-speak in this section. The problem with buying communications infrastructure rather than building it from scratch yourself is that you cannot, ever, be sure there is not a software backdoor baked into the machine. The report cites a classic speech by Ken Thompson in 1987 that outlines the fundamental challenge of backdoors in software: They can be detected in the source code, but our computers don’t run source code; they run compiled code, which can almost never be reverse engineered to reveal the underlying code. So all one needs for a backdoor is to insert it before the code is compiled for deployment. [update] Or, in Thompson’s example, the determined engineer could pack the vulnerability into the compiler itself. [/update] This means it’s entirely possible that I am typing on a compromised machine right now, that someone at Google has inserted something into Chrome, that someone at Cisco has compromised my VPN client, or that Apple’s operating system is vulnerable in secret ways. (I’m sure the U.S. government would never try to gain this kind of access.)

The report correctly notes that you don’t even need cooperation at the highest level to insert backdoors. “Even if the company’s leadership refused [a government] request, Chinese intelligence services need only recruit working-level technicians or managers in these companies” (3). So what would be necessary to build secure infrastructure? The report has it right, saying that monitoring would be needed “from design to retirement [including] aspects such as discrete technology components, their interactions, the human environment, and threats from the full spectrum of adversaries” (6–7). Great. How can we get this done? First, one would build a redundant monitoring system under a trusted hierarchy. Then, every piece of telecommunications infrastructure, from hardware and software at the user level to infrastructure at the network level, including both private and public sector machines, would need to be redesigned from the lowest level to the highest, then everyone using machines would need to be monitored—clearly not a realistic option. But without this level of effort, anything we do now will at best prevent new vulnerabilities.

The essence is this: No system will in itself ever be completely secure.

Committee staff either do not understand the Chinese business environment or actively seek to mislead others by suggesting that good loan terms and Communist Party committees are unusual.

For some reason, the report repeatedly cites what is essentially an opinion article reprinted by an Australian business magazine to make its case about Chinese state and Communist Party penetration in business. Though they also offer a couple of footnotes to Richard MacGregor’s excellent The Party, they for some reason quote this opinion piece by an adjunct professor at the University of Sydney named John Lee.

Lee’s article is not an evidence-based analysis, but an argument against Huawei being involved in Australian broadband projects. That’s just fine, but he is not an unbiased observer, and his expertise is not in business-government relations in China. A look at his publications suggests he is an analyst of international geopolitics, and he has a U.S. affiliation at a conservative-leaning think tank—again, fine, but hardly the source that an honest inquiry would seek for fine points of Chinese politics.

As another example, the report notes that the reclusive CEO of Huawei, Ren Zhengfei, was invited to be a member of of the National Congress of of the CPC in 1982 before he founded the company (23), and goes on to build a case that Huawei gets better-than-market loan terms. The report complains: “Huawei refuses to provide answers to direct questions about how this support was secured, nor does it provide internal documentation or auditable financial records to evaluate its claims that the terms of these agreements comply with standard practice and international trade agreements” (29).

There are two things going on in this quote. First, a reader unfamiliar with the Chinese business environment might think that good loan terms are rare for big Chinese companies, rather than easily available at various times. Second, we see a shift from implying that the “support was secured” through some murky method, over to an essentially unrelated complaint that they might not comply with international trade agreements—hardly the job of the House Intelligence Committee. This leads to my next point.

The committee spends much of the report on issues unrelated to intelligence or national security.

Entire sections of the report focus on claims that Huawei may have stolen intellectual property from Cisco, or that its affiliates may be working illegally in the United States, or that it may not be operating in full compliance with international economic agreements. These may be legitimate points, and they may be cause for litigation or regulatory penalties under U.S. law, but these points are all a distraction from the duties and purview of the House Intelligence Committee.

Further, they open up the report to charges of playing politics with national security. Such charges would hardly be avoidable in a campaign season or when dealing with the high-profile U.S.–China business relationship, but confusing the matter with these unrelated charges undermines the idea that the committee’s investigation and report are motivated by good-faith execution of its duties. The committee could even have referred these findings to the executive branch as a courtesy, without including them in the report.

This is perhaps the most frustrating element of the entire endeavor. It is entirely possible that there are very real concerns about using Huawei, ZTE, or other foreign-produced telecommunications equipment in sensitive roles in U.S. networks. The committee’s recommendation that “U.S. government systems, particularly sensitive systems, should not include Huawei or ZTE equipment, including component parts” is probably good policy, precisely because of uncertainty (vi).

But putting that recommendation next to (and indeed, below) a recommendation that the Committee on Foreign Investment in the United States (CFIUS) prevent these companies from acquiring or merging with U.S. firms—a major point of concern in U.S.–China business ties—undermines the security case by clouding motivations. It leads the reader to suspect ulterior motives, and it makes the committee’s recommendations less trustworthy even within the United States.

The report is seemingly written in an imaginary world where U.S. companies would readily disclose to the Chinese government their modes of cooperation with the U.S. government on surveillance efforts. 

Imagine this: “U.S. telecommunications companies provide an opportunity for the U.S. government to tamper with the Chinese telecommunications supply chain. That said, understanding the level and means of state influence and control of economic entities in the United States remains difficult. As U.S. analysts explain, state control or influence of purportedly private-sector entities in the United States is neither clear nor disclosed.” This statement is true, but all I did to write it was reverse the country names (11).

Perhaps the most gaping hole in this report, if it is to be viewed as any kind of overview of the situation, is the offensive side of U.S. intelligence efforts. The report elsewhere notes that analysts say China is responsible for the most cyber attacks of any country; I wonder what analysts without U.S. security clearance and therefore not subject to disclosure restrictions would say.

The point is that espionage is never exclusive to the other party. As a rule, every government is trying to gain information about the every other, and private companies that work with governments are likely to hide their efforts. Frustrated by what the committee saw as insufficient response to questions about government ties, the report remarks, “Any company operating in the United States could very easily describe and produce evidence of the federal entities with which it must interact, including which government officials are their main points of contact at those regulatory agencies” (22). Would Boeing or Northrop or Lockheed describe in detail their interactions with government? Perhaps the weasel word above is “must.” Sure, a U.S. defense contractor might happily describe its required interactions, but what about optional ones that lead to more business? How does candor work out when warrantless wiretaps are executed with the assistance of phone providers?

Conclusion: This report seeks to paint Huawei, ZTE, and China as shady, and asks the reader to trust that the classified portion of the report contains evidence of wrongdoing. 

It does not score highly for its analysis of Chinese business structures, nor realistic priorities for maintaining and improving security, nor for avoiding the perception of political bias and ulterior motives. This is a frustrating report, because the underlying issue is serious. It is frustrating because it could do damage to U.S.–China business ties that benefit both countries. And it is ultimately unrevealing except as an indicator of this committee’s agenda.

For better (if still largely one-sided) analysis from the U.S. government, see Northrop Grumman’s report to the U.S.–China Economic and Security Review Commission on China and cybersecurity. While this work still lacks introspection, it uses a broad source base and outlines potential threats without the name calling.

China Tops Japan as Biggest Holder of U.S. Debt

Just a little note.

It had been on my mind since Tobias at Observing Japan noted Japan’s erstwhile distinction as the holder of the most U.S. Treasury bills. He was discussing Niall Ferguson’s column, named with the “unfortunate word” Chimerica, and noted: “Ferguson does not mention that Japan holds more US treasuries than China, meaning that surely US-Japan bilateral negotiations are no less necessary thank US-China negotiations.” (He noticed the news, and updated the post.)

China increased its holdings to $585 billion in September, compared with $541.4 billion in August. Meanwhile, Japan shaved its holdings from a high of $600.7 billion in March of this year down to $571.4 billion in September.

China’s now the leader, but at least if we judge by dollar holdings, Japan still deserves attention.

Is Venezuela selling oil to China instead of to the U.S.?

The United States is importing less oil from Venezuela, and China is buying more. Is Venezuela putting its resources where Hugo Chávez’s mouth is and using the country’s major export as a geopolitical lever? Or are U.S. imports just catching up with a 10-year decline in Venezuelan production?

The U.S. Energy Information Administration released April data on Monday, revealing that imports of crude and petroleum from Venezuela in the first four months of 2008 fell 10.7 percent from the same period last year—from about 1.3 million barrels/day to about 1.16 million b/d.

If we take a longer-term view of U.S. imports of Venezuelan crude and petroleum, the drop is even more significant: Venezuela sold about 1.6 million b/d to the United States in January–April of 2005, as it had since the mid-1990s (except in the oil strike years of 2000 and 2003). This means that Venezuelan sales to the United States have declined 30 percent over the past three years. Why?

AP’s Rachel Jones reports that the drop is likely due to three factors: (1) falling demand in the United States, (2) falling production in Venezuela, and (3) Venezuela’s decision to sell more oil to China. Does this make sense? Let’s take a closer look at the numbers:

  1. Total U.S. oil imports in January–April 2008 dropped 2.5 percent compared with the same period last year (you can download the raw data here, or check out the Transpacifica digest below (after the jump). This, then, might explain one-fourth of the decline in imports from Venezuela.
  2. There are no reliable numbers on Venezuelan oil production, but those that exist (for example, the monthly OPEC report) indicate at most a 2 percent drop in production from last year—which, like the change in U.S. demand, would explain only part of the 10.7 percent drop in sales. Over the past 10 years, however, Venezuelan production has declined about 25 percent—about the same as the change in U.S. imports over the past three years (according to EIA data here).
  3. The AP report states that Venezuela now sends 250,000 b/d to China, up from next to nothing a few years ago. The story does not source this figure, and PDVSA, Venezuela’s state oil company, recently stated that China buys 398,000 b/d, as a result of increased CNPC operations. Venezuelan President Hugo Chavez has said that the country plans to sell China 1 million b/d by 2012.

Is China buying 250,000 b/d or more of Venezuelan oil? If so, does that purchase explain declining sales to the United States? Or would sales have declined anyway, as a result of falling production in Venezuela? What is the role of Chávez’s oil donations to countries throughout the region? Perhaps there are other explanations. If the United States wants control over how much oil it buys from Venezuela, the answer is critical. Continue reading

Cuba–China Ties in Focus as Standing Committee Member Visits Fidel

Fidel Castro met with He Guoqiang, a member of China’s powerful Politburo Standing Committee, for more than two hours yesterday, discussing numerous and diverse topics such as Tibet, Taiwan, food prices, the Olympics, and Fidel’s health (He conveyed President Hu Jintao’s wish for Castro’s speedy recovery). Earlier in the week He met with Cuban President Raul Castro.

He’s visit is just one of many recent signs of strengthening Cuba–China relations. Trade between the two nations surged to $2.2 billion last year, up 23 percent from 2006, and nearly 250 percent from 2005; China is Cuba’s second-largest trading partner (after Venezuela). China recently expanded broadcasts in Cuba of Chinese television stations and sold railway engines to the Cuban government for use in the public transport system.

He Guoqiang’s Cuba visit marked the beginning of a four-country tour that will take him to Brazil, Angola, and Trinidad and Tobago.