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.