The White House is planning to launch new investigations into China's trade and intellectual property practices, and soon. The move underscores how talks between the United States and China have broken down over Washington's expectations that Beijing would help rein in North Korea's nuclear program. With the 100-day action plan on trade that followed US President Donald Trump's April meeting with Chinese President Xi Jinping over, and with Pyongyang still aggressively pursuing a fully functional and deliverable nuclear weapon, the White House already had signaled it would no longer be constrained when dealing with China before Trump tweeted July 29 that he was "very disappointed in China" for its inaction on North Korea. And now that comprehensive trade talks are frozen, the United States is pursuing far more aggressive measures against China's economic policy — though it still retains the option to walk this pursuit back if needed.
According to several reports, the Office of the US Trade Representative will investigate technology transfers mandated by China pursuant to Section 301 of the Trade Act of 1974. Beijing requires foreign companies to share technology in exchange for allowing them to invest in China or access the massive and lucrative Chinese market. The investigation could be announced this week and is likely to be rolled into an executive order by Trump that includes other enforcement actions related to trade, investment, and intellectual property.
A Heavy Tool, With Limitations
Section 301 investigations are the sledgehammer in the trade enforcement toolbox that Trump and US Trade Representative Robert Lighthizer have at their disposal. In theory, Section 301 gives the trade representative the ability to investigate and remedy any "unfair trade practices." Such practices not only include other countries' potential violations of their commitments to the World Trade Organization (WTO) and other trade agreements, but also any practice that is "unreasonable or discriminatory and burdens US commerce." Before the WTO and the creation of its dispute settlement understanding, Section 301 investigations were the primary way the United States forced other countries to negotiate certain trade issues. Perhaps the best-known use of Section 301 investigations came in the 1980s when the United States examined barriers Japan had erected against US semiconductor exports. The mere threat of using Section 301's broad authority to punish Japan compelled Tokyo to enter into an agreement with Washington. If the United States finds that China is violating its commitments or is burdening US commerce, then it could take a number of potential actions in response, including restricting imports by imposing tariffs on them and suspending preferential treatment under trade agreements such as the WTO. The actions the United States take must be proportional, though it is unclear how proportionality would be determined when an action is not obviously related to trade.
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There are several factors that limit the United States' use of Section 301 investigations. Since the WTO established its dispute settlement understanding, Section 301 investigations largely have fallen out of vogue. In an early case between the United States and Europe involving Section 301, the WTO's dispute panel ruled that the United States had violated WTO commitments by pursuing unilateral sanctions against WTO members without going through the organization's various dispute and response channels.
Moreover, US law requires the United States to pursue any violations of WTO rules through the organization itself. Specifically, the domestic enabling legislation for the United States' ascension to the WTO not only binds the US trade representative to the bloc's dispute mechanism, but also forces the United States to refrain from taking any action unless a WTO panel or the WTO's appellate body rules in its favor and sanctions any US counteraction. This requirement prevents Trump from taking unilateral action for political purposes. Any attempt to get around the WTO process not only would be challenged in the WTO — where the United States almost surely would lose — but also in US courts, where companies affected by punitive trade measures could argue that the Office of the US Trade Representative is not following US law regarding how it must pursue Section 301 countermeasures. In a sense, the legislation restricts the Trump administration's push against the WTO in the name of national sovereignty.
These limitations apply only when the practice the US trade representative is investigating is covered by the WTO. The United States could argue that the WTO's rules do not address some of China's trade practices, though the issues of intellectual property rights and technology transfers mostly are covered. In fact, the United States previously has noted in official communiques that these practices are included in China's WTO commitments.
A Growing Political Issue
Another critical fact about the Section 301 investigation process is that it would force the US trade representative to request negotiations with China to resolve the dispute. In the past, this arguably has been the tool's most potent element. Because it is a sledgehammer that treats every problem as a nail, a successful Section 301 investigation could lead to significant trade measures against China. When the United States has threatened other countries with a Section 301 investigation, as it did with Japan and its semiconductor industry in the 1980s, they have often come to the negotiating table. It is not in China's interest to have the United States take substantial trade action against it. Moreover, the question of China's desire to acquire technology has grown as a political issue in the United States — and Europe — over the past few years as China's technology companies buy up foreign tech firms, potentially eroding the long-standing gap between China's technology companies and their competitors in Europe, North America, Japan, Taiwan and North Korea. Already Germany, France, and Italy have pushed the European Union to allow countries to block foreign takeovers — particularly by China — for economic reasons as opposed to national security ones. US Secretary of Defense James Mattis testified to Congress earlier this year that China's technological rise threatens US national security. And prompted by China's support for North Korea, Democratic Senate Minority Leader Chuck Schumer sent a letter to Trump this week calling for him to use investigations by the Committee on Foreign Investment in the United States to block all Chinese takeovers domestically.
For China, new investigations into intellectual properties hit at the heart of its economic strategy, and Beijing cannot and will not bow down easily to US pressure. Instead, it will argue that its moves are consistent with WTO law and that WTO law is all that matters, not the political whims and views of the United States. The acquisition of technology — particularly of high technologies — is the central component of China's "Made in China 2025" program. In conjunction with China's Internet+ plan (its version of Industry 4.0), the 2025 program aims to reduce China's reliance on foreign technology in the hardware, software and related sectors, and leapfrog China's manufacturing capabilities ahead of Western competitors. Beijing uses a number of tools to pursue its plans, including investment funds supporting state-owned enterprises and private-public companies, government procurement policies and informal linkages through the Communist Party to corporate leadership. This strategy is crucial to Xi's larger aspirations to rebalance the Chinese economy.
To put China's weakness in these sectors into perspective, its largest imported goods are semiconductors and integrated circuit boards and their components, which totaled 7.6 billion in 2016, or 14 percent of China's imports. That figure is over billion more than all of China's energy imports. It is a strategic vulnerability that Beijing needs and wants to rectify, but to do so requires technology acquisition. The wafer fabrication and design process is just one part of the semiconductor and integrated circuit value chain and China wants to improve its capabilities there, too. In 2016, China used 45 percent of the world's semiconductors, but 55 percent of the semiconductors used in China were produced by multinational original equipment manufacturers (OEMs) that have invested in China, rather than by Chinese companies. China hopes to increase its own OEM capabilities and consumption of Chinese-designed and -manufactured semiconductors. For now, however, many of China's leading technology conglomerates remain reliant on foreign-licensed technology, imported semiconductors or domestic foundries that are two or three generations behind the leading edge dominated by Samsung, GlobalFoundries, and other companies.
By targeting the issue of intellectual property and technological acquisition, the Trump administration is pushing back on a long-criticized Chinese policy, but one central to Beijing's economic strategy. The policy is also critical to the Communist Party's grip on power, which it maintains by using stable and strong economic growth to mitigate any domestic threats, whether they are alternative political viewpoints or issues like unemployment. Thus China is unlikely to cave to US pressure. Even so, with the United States launching Section 301 investigations, the opening shot in what is likely to be a long, difficult and active dispute between the Trump and Xi administrations has been fired.
The Trump Administration Reaches for a Trade Sledgehammer is republished with permission from Stratfor.com.