Tag: huawei

Do New Cybersecurity Restrictions Amount to Regulatory Protectionism?

Protectionism masquerading as regulation in the public interest is the subject of an excellent new paper by my colleagues Bill Watson and Sallie James.  As tariffs and other border barriers to trade have declined, rent-seeking domestic interests have turned increasingly to regulations with noble sounding purposes – protecting Flipper from the indiscriminating nets of tuna fishermen, fighting the tobacco industry’s efforts to entice children with grape-flavored cigarettes, keeping U.S. highways safe from recklessly-driven, dilapidated, smoke-emitting Mexican trucks, and so on – in order to reduce competition and secure artificial market advantages over you, the consumer.

The paper documents numerous examples of this “bootleggers and Baptists” phenomenon, where the causes of perhaps well-intentioned advocates of health and safety regulation were infiltrated or commandeered by domestic producer interests with more nefarious, protectionist motives, and advises policymakers to:

be skeptical of regulatory proposals backed by the target domestic industry and of proposals that lack a plausible theory of market failure. These are red flags that the proposal is the product of privilege-seeking special interests disguised as altruistic consumer advocates.

After reading this incisive paper, you might consider whether a new law restricting U.S. government purchases of Chinese-produced information technology systems in the name of cybersecurity fits the profile of regulatory protectionism.  A two paragraph section of the 574-page “Consolidated and Further Continuing Appropriations Act of 2013,” signed into law last week, prohibits federal agency purchases of IT equipment “produced, manufactured or assembled” by entities “owned, directed, or subsidized by the People’s Republic of China” unless the head of the purchasing agency consults with the FBI and determines that the purchase is “in the national interest of the United States” and then conveys that determination in writing to the House and Senate Appropriations Committees.

Huawei, ZTE, and the Slippery Slope of Excusing Protectionism on National Security Grounds

Those who would give up essential Liberty, to purchase a little temporary Safety, deserve neither Liberty nor Safety. —Benjamin Franklin

Chinese telecommunications companies Huawei and ZTE long have been in the crosshairs of U.S. policymakers. Rumors that the telecoms are or could become conduits for Chinese government-sponsored cyber espionage or cyber attacks on so-called critical infrastructure in the United States have been swirling around Washington for a few years. Concerns about Huawei’s alleged ties to the People’s Liberation Army were plausible enough to cause the U.S. Committee on Foreign Investment in the United States (CFIUS) to recommend that President Bush block a proposed acquisition by Huawei of 3Com in 2008. Subsequent attempts by Huawei to expand in the United States have also failed for similar reasons, and because of Huawei’s ham-fisted, amateurish public relations efforts.

So it’s not at all surprising that yesterday the House Permanent Select Committee on Intelligence, yesterday, following a nearly year-long investigation, issued its “Investigative Report on the U.S. National Security Issues Posed by Chinese Telecommunications Companies Huawei and ZTE,” along with recommendations that U.S. companies avoid doing business with these firms.

But there is no smoking gun in the report, only innuendo sold as something more definitive. The most damning evidence against Huawei and ZTE is that the companies were evasive or incomplete when it came to providing answers to questions that would have revealed strategic information that the companies understandably might not want to share with U.S. policymakers, who may have the interests of their own favored U.S. telecoms in mind.

Again, what I see revealed here is inexperience and lack of political sophistication on the part of the Chinese telecoms. It was Huawei—seeking to repair its sullied name and overcome the numerous obstacles it continues to face in its efforts to expand its business in the United States—that requested the full investigation of its operations and ties, not anticipating adequately that the inquiries would put them on the spot. What they got from the investigation was an ultimatum: share strategic information about the company and its plans with U.S. policymakers or be deemed a threat to U.S. national security.

Now we have the House report—publicly fortified by a severely unbalanced 60 Minutes segment this past Sunday—to ratchet up the pressure for a more comprehensive solution. We’ve seen this pattern before: zealous lawmakers identifying imminent threats or gathering storms and then convincing the public that there are no alternatives to their excessive solutions. The public should note that fear imperils our freedoms and bestows greater powers on policymakers with their own agendas.

Granted, I’m no expert in cyber espionage or cyber security and one or both of these Chinese companies may be bad actors. But the House report falls well short of convincing me that either possesses or will deploy cyber weapons of mass destruction against critical U.S. infrastructure or that they are any more hazardous than Western companies utilizing the same or similar supply chains that traverse China or any other country for that matter. And the previous CFIUS recommendtions to the president to block Huawei acquisitions are classified.

Vulnerabilities in communications networks are ever-present and susceptible to insidious code, back doors, and malicious spyware regardless of where the components are manufactured. At best, shunning these two companies will provide a false sense of security.

What should raise red flags is that none of the findings in the House report have anything to do with specific cyber threats or cyber security, but merely reinforce what we already know about China: that its economy operates under a system of state-sponsored capitalism and that intellectual property theft is a larger problem there than it is in the United States.

And the report’s recommendations reveal more of a trade protectionist agenda than a critical infrastructure protection agenda. It states that CFIUS “must block acquisitions, takeovers, or mergers involving Huawei and ZTE given the threat to U.S. national security interests.” (Emphasis added.) What threat? It is not documented in the report.

The report recommends that government contractors “exclude ZTE or Huawei equipment in their systems.” U.S. network providers and systems developers are “strongly encouraged to seek other vendors for their projects.” And it recommends that Congress and the executive branch enforcement agencies “investigate the unfair trade practices of the Chinese telecommunications sector, paying particular attention to China’s continued financial support for key companies.” (Emphasis added.) Talk about the pot calling the kettle black!

Though not made explicit in the report, some U.S. telecom carriers allegedly were warned by U.S. policymakers that purchasing routers and other equipment for their networks from Huawei or ZTE would disqualify them from participating in the massive U.S. government procurement market for telecom services. If true, that is not only heavy-handed, but seemingly strong grounds for a Chinese WTO challenge on the grounds of discriminatory treatment.

Before taking protectionist, WTO-illegal actions—such as banning transactions with certain foreign companies or even “recommending” forgoing such transactions—that would likely cause U.S. companies to lose business in China, the onus is on policymakers, the intelligence committees, and those otherwise in the know to demonstrate that there is a real threat from these companies and that they—U.S. policymakers—are not simply trying to advance the fortunes of their own constituent companies through a particularly insidious brand of industrial policy.

Despite Huawei’s Experience, America Is Open to Chinese Investment

After several days of defiance, Chinese telecom equipment manufacturer Huawei announced Monday that it would abide a recommendation from the Committee on Foreign Investment in the United States (CFIUS) that it divest of U.S. technology company 3-Leaf. CFIUS is an inter-agency group charged with reviewing the national security implications of proposed foreign investments in U.S. companies and assets and advising the president about whether or not he should block those transactions on security grounds. CFIUS is composed of representatives from 16 different U.S. government departments and agencies and is chaired by the Secretary of the Treasury.

Last week, CFIUS issued a recommendation that the president block Huawei’s $2 million purchase of assets—including certain patents—from 3-Leaf on the grounds that the transaction presented a risk to national security. (Technically, the recommendation was for the president to compel Huawei to divest of 3-Leaf, since the transaction was consummated in May 2010, before CFIUS was made aware of the deal). Apparently, CFIUS was concerned about Huawei’s ties to the Chinese government—specifically the Chinese military.

Despite assurances from Huawei’s vice president of government affairs, William Plummer, that the company “is 100 percent employee-owned and has no ties with any government, nor with the PLA,” Huawei’s ownership structure is opaque. A letter submitted to administration officials from U.S. Senators Jim Webb (D-VA) and Jon Kyl (R-AZ) alleged that Huawei has a “history of illegal behavior and ties with the People’s Liberation Army, Taliban and Iranian Revolutionary Guard.” The letter also accused Huawei of various patent and trademark infringements and suggested that the small scale of Huawei’s acquisition ($2 million) was designed to enable the transaction to avoid scrutiny—a theory that is lent credibility by Huawei’s decision not to inform CFIUS of its intention to purchase 3-Leaf.

Huawei’s decision this week to abandon the deal spares the president from issuing a formal opinion on the matter, and in all likelihood spares Huawei the added humiliation of a formal rejection from the U.S. president. Meanwhile, Huawei and officials of the Chinese Ministry of Commerce are lambasting the CFIUS decision as further evidence that the United States is closed to Chinese direct investment, and implying that U.S. investors might expect similarly shoddy treatment in China. What to make of all of this?

First, as I’ve argued before (e.g., here, here, and here), the United States should be open to foreign direct investment from all countries and the rules and regulations governing investment should be transparent, consistent, straightforward, and applied equally to suitors from all countries. That being said, state and local governments should be aggressively courting Chinese investment, for the reasons I gave in a paper published 14 months ago:

If it is desirable that China recycle some of its estimated $2.4 trillion in accumulated foreign reserves, U.S. policy … should be more welcoming of Chinese investment in the private sector. As of the close of 2008, Chinese direct investment in the United States stood at just $1.2 billion—a mere rounding error at about 0.05 percent of the $2.3 trillion in total foreign direct investment in the United States. That figure comes nowhere close to the amount of U.S. direct investment held by foreigners in other big economies. U.S. direct investment in 2008 held in the United Kingdom was $454 billion; it was $260 billion in Japan, $259 billion in the Netherlands, $221 billion in Canada, $211 billion in Germany, $64 billion in Australia, $16 billion in South Korea, and even $1.7 billion in Russia.

Some of China’s past efforts to take equity positions or purchase U.S. companies or buy assets or land to build new production facilities have been viewed skeptically by U.S. policymakers, and scuttled, ostensibly over ill-defined security concerns. But a large inflow of investment from China would have an impact similar to a large increase in U.S. exports to China on the value of both countries’ currencies, and on the level of China’s foreign reserves.

In light of China’s large reserves, its need and desire to diversify, America’s need for investment in the real economy, and the objective of creating jobs and achieving sustained economic growth, U.S. policy should be clarified so that the benchmarks and hurdles facing Chinese investors are better understood.

Since 2008, Chinese direct investment in the United States has increased from $1.2 billion to perhaps as much as $6.5 billion last year. If only President Obama’s speech last week at the Chamber of Commerce exhorting U.S. business to invest and hire were given at the Guandong Business Club…

Second, I am no security expert, so I cannot comment on the credibility of CFIUS’ concerns or the senators’ allegations about Huawei. But I think it is entirely reasonable to have a process, like that conducted by CFIUS under the Foreign Investment and National Security Act, to vet transactions to ensure that those presenting risks to national security are brought to the attention of the president, who can then exercise his discretion to block them. Like some prospective export transactions, some prospective purchases of U.S. assets present legitimate security risks that may warrant intervention. Is the process completely apolitical and immune from insider maneuvering? No. Is there scope for politically driven decision making? Yes. Can the process be used to steer a transaction away from the foreign suitor and toward a politically favored domestic entity? Sure. But so far there have been few accusations of that nature, so why make the perfect the enemy of the good?

Finally, in the immediate case, Huawei acted clumsily, if not irresponsibly, and in defiance of a process with which it should by now be quite familiar. In 2008, Huawei had to withdraw its bid for American company 3Com after CFIUS found national security problems, some of which could have been resolved had Huawei been more forthcoming about its ownership structure and business dealings. Likewise, Huawei was excluded from participation in a major network upgrade by Sprint Nextel over similar concerns about the company’s ties. That the company thought it could just circumvent CFIUS carrying that kind of historical baggage and quietly purchase 3-Leaf last May speaks to a profoundly amateurish decision making process at Huawei, or an imperative to conceal something.

Despite the sour grapes expressed by Huawei and its patron, the Chinese Ministry of Commerce, the United States is open and ready to welcome Chinese investment