What harm might China's model do to free-market innovation?
The escalation of the U.S.-China trade conflict is producing unease about the pace of global growth. As such, it is time to look beyond the debate pitting free trade versus tariffs. Though that debate is important, we should also consider a parallel approach: giving firms in each nation more incentive to share ideas.
Peter Navarro’s White House Office of Trade and Manufacturing Policy produced a report warning that “China’s acts, policies, and practices threaten not only the U.S. economy but also the global innovation system as a whole.” A number of U.S. government agencies -- Treasury, Commerce, State and the Office of the U.S. Trade Representative -- agree that China’s actions could interfere with the profit incentives for American (and global) businesses to innovate and spur growth.
It’s not easy to measure innovation or entrepreneurship -- thousands of measures exist with no consensus -- so we’re left with little more than qualitative evidence of Navarro’s claim. Here we see plant closings, layoffs, and losses among industries in bitter competition with Chinese firms.
What’s more, the U.S.-China Chamber of Commerce reports that at least 20 percent of its binational members have expressed concern about technology theft or unfair market access. This would be a manageable number if China were just another developing country. But the size of its economy makes the problem impossible to ignore. The U.S. reaction has been tariffs added to tariffs, with China responding in kind.
China has no interest in remaining with other “developing countries.” Its leaders intend to climb the technology ladder and sit atop the global value chain, and for this they are to be commended. But their approach -- bolstering state-owned oligopolies that can dominate a range of emerging global technologies -- raises concerns in capitals throughout the world, as well as with the World Bank and the International Monetary Fund.
Navarro’s report points to four ways China’s ambitions can impose costs on innovative for-profit firms.
First, Chinese firms have a source of funding, state-owned banks, that enables them to withstand the vicissitudes of the business cycle.
Second, they can unload excess supply on international markets. Even if they lose money doing so, they can still stay in business and drive out firms that are more dependent on market sources of funding.
Third, China’s growing supply of skilled engineers can replicate and produce new products so quickly that private Western firms don’t have time to recover their own R&D costs.
Fourth, Chinese firms are better situated to pursue profitable opportunities in developing regions by offering affordable versions of Western products.
China’s intentions are nothing new, but until recently have not given the West this type of pause. Indeed, the West was confident that a socialist society could not be innovative without resorting to private ownership of the means of production. The heightened apprehension isn’t so much about the feasibility of China’s model as the harm it might do to what the late economist William Baumol called the “free-market innovation machine.”
Baumol tells us that the basic reason for the transformational economic growth experienced by the West beginning around 1700 was the acceleration of technical progress. Today, private firms supply more than 83 percent of the $356 billion spent on U.S. R&D, according to 2017 figures from the National Science Foundation. In some industries -- such as computer and data processing or health -- R&D spending exceeds 10 percent of total revenues.
These companies are wary of entering into a collaboration that turns their hard-won innovation into an opportunity for a Chinese partner to expropriate. There’s a downside for China, too: Expropriation today risks tomorrow’s foreign investment opportunities, and will quickly run into diminishing returns. In the long run, no country benefits by going alone.
Rather than seeing who can inflict the most damage, it’s time to encourage a healthier dissemination of ideas. One possible solution would enable formal, amicable, and mutually beneficial transfers of intellectual property among firms on both sides of the Pacific.
A technology licensing market needs a proper rule-bound environment -- a consortium of sorts -- that can incentivize this voluntary dissemination. There are many reasons why a firm specializing in a particular technology might rent out access to its intellectual property. A firm already at full capacity may simply choose to license a product. Inventive firms may not excel at marketing, production, or distribution. Universities routinely face this limitation.
With formal dispute resolution arrangements in place, we can at least partially resolve the conflict between innovation and dissemination. Companies can benefit from the respective advantages of their partners. It may be cheaper, faster, and easier than starting from scratch.
Voluntary technology transference may also be necessary to avoid patent infringement or to acquire a technology that is necessary for successfully commercializing a different technology. An amiable transfer is cheaper and quicker than a hostile one. Competitive mechanisms make dissemination a normal part of business, and transfers occur in the thousands. When both parties can confidently agree on the rules, both can spend more on innovation and specialize in what they do best.
Once it becomes clear that consortium members gain products, opportunities, and advantages, others will invariably join. The market may punish firms that choose to say outside it. Isolated firms, just like isolated nations, will only be able to offer products that result from their own efforts.
Most important, companies are shielded from competitors gaining absolute superiority, enjoying protection-by-cooperation from a surprise attack by one side possessing advantages the other lacks.
The only durable solution to the current dispute is to find areas in which China’s long-term interests align with the West’s. Focusing on trade deficits is the short game and can yield no more than an early harvest. Everyone’s long-term interests lie in playing the long game. This makes the credibility of our institutions more important than ever.
If we work toward cooperation, then success in innovation in one economy can aid the other, enhancing the incentive for independent activity in both.
Hilton Root is a professor at George Mason University and author of “Dynamics Among Nations,” published by MIT Press. The views expressed are the author's own.
