Although the spiral of tariff increases keeps grabbing the headlines, there’s another trade war battlefront that may have greater long-term effect. To put it simply, the Trump Administration hopes to use expanded export controls to stymie China’s development of advanced technologies. Whether this effort is ultimately successful or not as a political gambit, it will have consequences for cross-border investment and technology transfers involving the United States, China and third countries. U.S. exporters should pay attention.
Section 301 and Intellectual Property Theft
You’ll recall that the Section 301 investigation was commenced in response to China’s allegedly massive theft of intellectual property and forced technology transfers. In fact, the initial tariff increase was intended to remedy the abusive practices documented in the investigation. The subsequent tariff expansions were styled as counter-retaliation against China’s response to the Round 1 duties, as well as the bogged-down negotiations to resolve the original issues.
Each round of tariffs provides a process whereby U.S. parties can seek exclusion of products based on non-availability of alternative sources or other hardships. Items that are covered by the “Made in China 2025” industrial development program are generally ineligible for exclusion.
The reasoning appears to be that China’s progress in advanced technologies will be impeded by increasing the effective cost of purchasing the products they produce. Likewise, if the intellectual property issues get resolved through Section 301, China’s advanced industries will no longer benefit from purloined technology. Tariffs seem to be a blunt tool to achieve these goals, however, since they do not block China’s access to other markets or stop non-coerced technology transfers. At the same time, they raise costs for U.S. companies that have a Chinese supply chain.
Proposed Controls on Emerging Technologies
A more focused means of limiting China’s access to advanced technologies is by blocking their export from the United States. That is the goal of the Review of Controls for Certain Emerging Technologies undertaken by the Bureau of Industry and Security.
We’ve already covered this initiative in detail, so suffice it to say here that it presents a preliminary list of the industry sectors viewed as cutting-edge by the U.S. government in which Chinese competition will be unwelcome. If adopted, we can expect them to be placed on the Commerce Control List, with restrictions on information flows from the United States to China. The license review policy will be the wild card in determining how restrictive the controls turn out in practice. For now, though, I think we can expect a heavy brake on technology transfers once the review is completed.
The Entity List as a Technology Control Tool
As described in 15 C.F.R. § 744.16, the Entity List “identifies persons reasonably believed to be involved, or to pose a significant risk of being or becoming involved, in activities contrary to the national security or foreign policy interests of the United States.” For the most part, the list traditionally has included foreign weapon of mass destruction proliferators and, more recently, parties engaged in political misbehavior, such as Russian-owned companies in the Crimea.
The designation of ZTE as an “entity” expanded the list’s use to punish violations of the Export Administration Regulations. That was followed by Huawei’s placement on the list as well. Both companies had been accused of massive violations of the EAR and Treasury Department sanctions regulations.
I found it interesting and curious that BIS used Entity List designations rather than seeking an export denial order for such alleged violations, but the broad practical impact was the same: two telecommunications industry leaders were cut off from advanced U.S. technology and competitively disabled as a consequence. The violations could reasonably be seen as activities contrary to U.S. policy and security interests that warranted their designation.
Now, however, BIS has added parties to the Entity List seemingly because of their leading competitive positions in “China’s development of exascale high performance computing.” Certain of the designated companies provide support for the Chinese military, and others have ownership stakes in them. The designations’ impact will likely go far beyond the military activities of ostensible concern, and instead affect all aspects of the companies’ businesses.
Procurement Restrictions as a Competitive Measure
Finally, the General Services Administration is poised to announce prohibitions on Federal procurement of telecommunications equipment produced by ZTE or Huawei, along with “video surveillance and telecommunications equipment produced by Hytera Communications Corporation, Hangzhou Hikvision Digital Technology Company, or Dahua Technology Company.” These will be reflected in an interim final rule amending the Federal Acquisition Regulations, to be effective on August 13, 2019.
Once again, while the rationale is couched in security terms, the effect will be to exclude equipment produced by highly-competitive Chinese companies from the Federal market. I’m not sure how significant this will be, given the existing restrictions on Federal procurement of Chinese-origin supplies in general, but it is noteworthy that the prohibition applies to “any equipment, system, or service that uses covered telecommunications equipment or services as a substantial or essential component of any system, or as critical technology as part of any system . . .” Limited exceptions are available.
To comply with GSA’s interim final rule, suppliers to the Federal government will have to ensure that their telecommunications and video surveillance end-products and components are not manufactured by one of the named Chinese companies or any of their subsidiaries or affiliates, or that an exception applies. To the extent that the same systems are supplied to both Federal and non-Federal purchasers, this may mean that the same restrictions will get applied in practice to commercial systems too, further reducing the named companies’ competitive position in the United States.
Huawei’s Entity List designation, and the imminent GSA procurement restrictions, have an immediate impact on U.S. companies’ ability to conduct business with the affected Chinese parties. The more far-reaching effect will be on their ability to share CCL-covered information with China regarding emerging technologies. Aside from the compliance challenge they will place on U.S. companies, they could well stunt China’s participation in such technologies. In that respect, the trade war may have continuing consequences long after the tariff disputes are finally settled.