Beware the Dragon

Chinas modernization has been headline news. Unless youve had your head in the sand, youre aware of the rapid progress within the worlds most populous country. China has overtaken Japan as the second-largest global economy. It is frequently referred to as the workshop of the world. It hosted the 2008 Olympics and 2010 World Expo with flying colors.

Chinese government policies since 1979 have lifted half a billion people out of poverty, built the worlds largest high-speed rail network as well as the worlds largest dam, and embarked on the worlds largest infrastructure construction projectthe Grand Canal water diversion, which transfers Yellow River water from the south to the arid north. China also has the worlds largest telecommunications network with more than 800 million active cell phone numbers and more than 420 million internet users.

Given such rapid economic growth, many American companies consider participation in China to be critical, and rightly so. However, careful planning is imperative for businesses going to China. Failure to plan properly can put valuable intellectual property at great risk and create strategic, long-term problems.

While Chinas rapid development has been accomplished through the hard work of the Chinese people, firms from developed countries have provided a critical catalyst in enabling such development: hard technology in the form of machinery and tools, and soft technology in the form of designs, blueprints, ideas and know-how. This infusion of foreign technology has helped speed the breathtaking development in China, and during the past 30-plus years many foreign companies providing technology have also benefited.

In an effort to better control which foreign technologies come into China, the Chinese government enacted the indigenous innovation industrial policies. These policies are intended to stimulate domestic innovation and technological development, and although they have been in place for several years now, the global financial crisis has thrown them into sharp relief as the shape of the worlds economic landscape has changed.

American companies need to be aware of the intellectual-property-related risks posed by these policies. The problem is that in addition to spurring domestic innovation, these policies also require non-Chinese businesses to transfer their technologies to Chinese state-owned entities in order to do business in China. The thinking is that Chinese firms will then internalize those technologies and re-innovate, eventually to become global champions.

There are a number of ways the Chinese indigenous innovation industrial policies can directly affect foreign companies. These include:

Requiring a foreign business to transfer its technology to a Chinese company as a prerequisite for approval to invest.

Restricting access to the rare earth minerals that are critical for nearly all high-technology products. (China controls more than 97 percent of the current global production.)

Discriminating against imported goods and products manufactured by foreign firms in China by imposing local-content requirements and domestic-company manufacturing requirements.

Subsidizing domestic businesses with free or reduced rent, all with an eye on lowering these companies costs of doing business so they can be more competitive around the globe.

The Chinese indigenous innovation industrial policies threaten important Washington state sectors in particular, including software, aviation, telecommunications equipment and electric cars. As Washington state firms continue to seek greater opportunities in China, leaders in these industries must put resources into strategic planning so the full cost of doing business there can be accurately assessed.

China will remain an important market for many of the worlds, and Washington states, companies for years to come. A business cannot be willing to pay whatever price of admission is asked, especially if that price is handing over innovative technology that provides a competitive edge. Otherwise, the repercussions will be irreparable and long lasting. Despite seeing short-term gains, such a business could very well end up competing against its own technology wielded by Chinese interests in other markets.

Fraser Mendel is a shareholder in the Seattle office of Northwest law firm Schwabe, Williamson & Wyatt. He co-chairs the firms China practice, and is a director of the Washington State China Relations Council. He lived and practiced law in Beijing for 12 years and returns frequently. He can be reached at [email protected].