Is the West Pushing China on Intellectual Property Rights?

Editors’ Note: MarketMinder does not recommend individual securities. The below merely represent a broader theme we wish to highlight.

We don’t usually wish to be bugs, but if we could be a fly on a wall (or decorative plant) anywhere in the world, it would be in Chinese President Xi Jinping’s office. For absent this—or, we guess, technological bugs—we can only speculate on how he and fellow Chinese officials are reacting to the Western world’s tightening the economic screws on the Middle Kingdom and targeting their latest grand economic central plan. President Trump stole most of Wednesday’s headlines with a proposal to ratchet a potential new tariff on $200 billion worth of goods from 10% to 25%, but we think more interesting developments are flying under the radar. First US lawmakers tacked some language onto the Defense bill that will expand the government’s ability to block takeovers on national security grounds once President Trump signs the legislation, which the Senate passed Wednesday. Then the UK crafted a similar bill and sent it around for public comment just before Parliament’s summer break. Symbolically, today Germany’s government officially blocked a Chinese takeover of a machine tool manufacturer, the first merger rejection under a law passed last year.^[i] In short, it seems America and Europe are banding together to block China from potentially stealing trade secrets as it races to meet its “Made in China 2025” plan, which sets an ambitious goal to be a leading global technology producer by, well, 2025. But setting political aims aside, these measures might also seem to limit the flow of global capital, not to mention escalate a potential trade war, both of which markets might dislike. After looking over the details and considering recent history, however, it seems to us these developments don’t represent a radical sea change toward more protectionism.

If blocking Chinese takeovers were some new, sudden development, there might be some negative surprise power here. But in our view, the US, UK and German laws merely formalize the status quo. All three have blocked Chinese takeovers of companies in “sensitive” industries in recent years, either officially or by jawboning enough that the companies voluntarily dropped merger plans. Among the more high-profile examples, Chinese oil company Cnooc almost bought Unocal in 2005, before Congress lobbied hard for the Committee on Foreign Investment in the US (CFIUS) to review the deal, leading Cnooc to drop its bid. President Obama blocked a Chinese firm from building a wind power farm near a Naval facility in Oregon and barred a state-owned investment fund from buying a German chipmaker with American assets. The Trump administration has already blocked two potential Chinese acquisitions of US chipmakers. Across the pond, former UK Prime Minister David Cameron largely welcomed Chinese investment, but his successor, Theresa May, cooled the government’s stance before writing the new bill. Her cabinet blocked a Chinese firm from buying an aerospace company that manufactured parts for the Royal Air Force earlier this year. As for Germany, Chancellor Angela Merkel’s cabinet teamed with the Obama administration on that squashed semiconductor deal.

If these incidents inspired China to crack down on inbound foreign investment, then we could see cause for worrying about escalating protectionism of the non-tariff variety. Chinese officials made some noise to that end on Monday with their own proposals to review more mergers on national security grounds, but at the same time, they loosened other barriers to foreign investment in general. Moreover, despite the aforementioned blocked mergers, US and European joint ventures have survived and thrived. Tech firms have continued making inroads into China. Google is about to launch a state-sanctioned Chinese version of its search engine, complete with censorship, and has made investments in Chinese e-commerce firms. China did notably scuttle Qualcomm’s attempt to buy a Dutch chipmaker, being the only national regulator not to approve it on anti-trust grounds, but this saga long predates the US and UK’s legislative push.

Rather, like Trump’s tariffs, the goal here might not even be protectionism. Far be it from us to speculate (again, we aren’t flies and haven’t bugged anyone’s office), but we can see a strong case for this being a concerted developed-world effort to goad China into adopting more protections for intellectual property rights. Many think China’s “Made in 2025” strategy largely involves gleaning existing technology they can mass-market, rather than developing it anew. See this fascinating New York Times exposé for more. The government has long forced foreign firms to surrender trade secrets in order to open manufacturing facilities. Doing business in China also typically requires a joint venture with a Chinese firm, leaving patents and other sensitive information vulnerable. While Trump himself tried to rile up domestic support for his tariffs by couching them in the trade deficit, the rest of his team has been fairly clear those tariffs are all about getting China to agree to play by the rules. You may draw your own conclusions about the timing of the pending and newly enforced investment rules.

All that said, we aren’t so blasé as to say there will be zero pain as the new rules take effect. As some observers have noted, while they may not result in more takeovers getting blocked, they likely will require more mergers to face government review. The UK’s version would make businesses criminally responsible for reporting relevant sales to the government, including something as small as selling a laptop to a Chinese company. That probably adds mountains of paperwork and more than a few compliance headaches. In general, time and money spent on regulatory compliance, while important, are time and money that can’t be spent on growing the business. At the same time, it isn’t like this impedes day-to-day business operations across the whole of America, Britain and Germany (or nations with similar laws, like France). It may be a pain for the affected companies, but we have a difficult time envisioning a sweeping, deleterious economic impact.