January 2, 2018 9:51AM

Chinese Intellectual Property Policies Demand a Smart U.S. Trade Policy Response – One President Trump Doesn’t Appear to be Considering

By Scott Lincicome

Rumors abound that the Trump administration will soon pursue “significant” retaliatory actions in response to alleged Chinese intellectual property rights (IPR) violations, pursuant to “Section 301” of U.S. trade law. While Chinese government IPR policies are indeed cause for concern and while Section 301 does permit the U.S. executive branch to act unilaterally in response to certain foreign trade actions, there is a smart and a not-so-smart approach to these issues, with the latter likely to be unintended by Congress, inconsistent with U.S. trade agreement obligations, ineffective, harmful for U.S. consumers and exporters, and met with a legitimate rebuke from not only China but also other U.S. trading partners. The alternative, on the other hand, would present the President with a golden opportunity to pursue a smart U.S. trade policy response to a serious issue that could achieve the same objectives as the other option, but in a more strategic and effective manner.

If reports are to be believed, the President is unfortunately not inclined to take the smart approach.

Section 301 of the Trade Act of 1974 provides the U.S. executive branch with the authority to enforce U.S. rights under international trade agreements and to respond to certain foreign “unfair” practices not covered by trade agreements. Section 301 is the principal statutory mechanism under which the President may unilaterally (1) determine that a foreign country has violated existing trade agreements or has engaged in acts that are “unjustifiable” or “unreasonable” and burden U.S. commerce; and (2) take retaliatory action to enforce U.S. rights under a trade agreement or to obtain the elimination of the foreign country act in question. The United States Trade Representative (USTR) makes determinations, initiates and conducts investigations, and implements any retaliatory action under Section 301.

Prior to the advent of the World Trade Organization (WTO) dispute settlement system in 1995, USTR frequently invoked Section 301 to seek to eliminate “unfair” foreign government trade practices. The mechanism’s frequent use was in large part due to the fact that the WTO’s predecessor – the General Agreement on Tariffs and Trade (GATT) – provided for less coverage and less accountability than the new WTO system. With the WTO now online and with new WTO rules against Members’ unilateral retaliation (more on this below), Section 301 fell into disuse, with only a few actions since the late 1990s.

In August of last year, however, USTR initiated an investigation of China under Section 301, which sought “to determine whether acts, policies, and practices of the Government of China related to technology transfer, intellectual property, and innovation are unreasonable or discriminatory and burden or restrict U.S. commerce.” USTR’s notice of initiation lists four types of conduct that were to be examined in the investigation (emphasis mine):

  1. The Chinese government reportedly uses a variety of tools, including opaque and discretionary administrative approval processes, joint venture requirements, foreign equity limitations, procurements, and other mechanisms to regulate or intervene in U.S. companies’ operations in China, in order to require or pressure the transfer of technologies and intellectual property to Chinese companies;
  2. The Chinese government’s acts, policies and practices reportedly deprive U.S. companies of the ability to set market-based terms in licensing and other technology-related negotiations with Chinese companies and undermine U.S. companies’ control over their technology in China;
  3. The Chinese government reportedly directs and/or unfairly facilitates the systematic investment in, and/or acquisition of, U.S. companies and assets by Chinese companies to obtain cutting-edge technologies and intellectual property and generate large-scale technology transfer in strategic industries; and
  4. The investigation will consider whether the Chinese government is conducting or supporting unauthorized intrusions into U.S. commercial computer networks or cyber-enabled theft of intellectual property, trade secrets, or confidential business information.

USTR’s findings are officially due by August 2018, but various media outlets report that the Trump administration’s USTR has already completed the Section 301 investigation and is now considering whether to impose steep tariffs on a large swath of Chinese imports. Inside U.S. Trade[$] says that “the 301 remedies against China would include what some called ‘significant’ tariffs covering retaliatory action in the trillion-dollar range,” with USTR arriving “at such a high number by calculating the cumulative damage the U.S. believes China’s IP and tech transfer policies have caused over the past 10 years.” Private groups are expecting tariffs because, as one source put it, “[Trump] seems to like tariffs, not because they’ll do much good.” Axios generally agrees, noting that it’s likely Trump in January will “put tariffs on Chinese consumer electronics as retaliation against the country's widespread theft of American companies' intellectual property.”

A massive unilateral tariff response by the United States would be a big mistake rife with legal and economic problems. This is unfortunate because there is widespread, bipartisan agreement in the United States that Chinese IPR practices are a problem – a concern shared by many U.S. trading partners – and because, as noted below, there’s a far smarter approach to this problem under Section 301.

On the other hand, tariffs of the sort mentioned above raise at least four serious concerns:

  • First, they could defy the will of Congress, which has delegated through Section 301 its constitutional authority over U.S. trade policy but has expressly directed USTR to take unilateral action under Section 301 for only those foreign trade barriers that fall outside of the WTO Agreements. The binding Statement of Administrative Action (SAA) for the Uruguay Round Agreements Act, which implemented the WTO Agreements into U.S. law, states that USTR “will” (not “may” or “could”) invoke the WTO’s dispute settlement procedures for any “alleged violation of a Uruguay Round agreement or the impairment of U.S. benefits under such an agreement”; the SAA adds that “[n]either section 301 nor the DSU will require the Trade Representative to invoke DSU dispute settlement procedures if the Trade Representative does not consider that a matter involves a Uruguay Round agreement.”

    The SAA thus makes clear that USTR cannot act unilaterally against foreign trade policies falling under the WTO Agreements and instead must bring a WTO dispute (and, if necessary, retaliate after receiving the WTO’s agreement that a trade violation indeed exists). This is precisely what the Obama administration did in a 2010 Section 301 investigation of China’s green energy subsidies, which resulted in a WTO dispute (subsequently joined by the EU and Japan) and China’s voluntary elimination of the subsidies at issue. The SAA also list certain policies, such as anti-competitive practices and IPR actions that “fall outside the disciplines of [the applicable WTO] agreements,” for which unilateral Section 301 retaliation would remain viable.

    USTR retains the sole discretion as to whether an issue falls under the WTO Agreements – a potential excuse for the Trump administration’s unilateralism in the current case. However, USTR’s decision may be subject to challenge at in U.S. courts, and there is a very strong argument that most of the Chinese practices that USTR has targeted are actually covered by the WTO – either through the WTO Agreement on Trade Related Intellectual Property Rights (which the U.S. successfully invoked in a 2007 WTO dispute that, again, led to China’s voluntary elimination of the IPR measures found to be inconsistent with the Agreement) or through the “WTO-plus” commitment that China made as part of its accession to the WTO. In particular, China’s WTO Accession Protocol (Article 7.3) requires China to ensure that “the distribution of import licenses, quotas, tariff-rate quotas, or any other means of approval for importation, the right of importation or investment by national and sub-national authorities, is not conditioned on…performance requirements of any kind, such as local content, offsets, the transfer of technology, export performance or the conduct of research and development in China.” USTR could attempt to argue that China’s technology transfer or licensing requirements (i.e., allegations 1-3 above) don’t implicate this commitment, but the breadth of Article 7.3 (and USTR’s own characterization of the investigation as focusing on “technology transfer”) would make that a real stretch – one that Congress or U.S. companies might not be willing to accept.

  • Second, and relatedly, broad retaliatory tariffs under Section 301 would almost certainly be challenged by China at the WTO and could actually result in a WTO panel ruling that both the tariffs and the law itself were inconsistent with the United States’ WTO obligations. A core tenet of the WTO, carried out in the SAA, is that each Member will not act unilaterally in response to a foreign trade action that supposedly violates the WTO Agreements and instead will pursue formal dispute settlement through the WTO. In the late 1990s, the EU challenged Section 301 as inconsistent with this fundamental rule, but a WTO Dispute Settlement Panel found that, although unilateral action taken by the United States pursuant to Section 301would constitute a prima facie violation of the WTO Agreement, the SAA and representations by the U.S. government during the dispute removed the threat of a violation and thus the aforementioned inconsistency. If the Trump administration were to depart from the U.S. representations made to the Panel by unilaterally adjudicating Chinese IPR practices that fall under the WTO Agreements and by imposing remedies (i.e., tariffs) that also fall under the WTO Agreements, this finding of consistency may no longer be warranted.

    WTO rulings against the Trump administration’s Section 301 action could provide China with authorization to retaliate against American exports – but unlike the U.S., under the cover of international respectability and lawfulness (cover that might also obscure the Chinese government’s own, more “creative” unilateral retaliation against American companies). Even worse, other WTO Members would likely join China in condemning the United States’ chest-thumping unilateralism, perhaps even joining in on the underlying WTO dispute challenging the overall lawfulness of Section 301. So, in one fell swoop, the Trump administration could expose its exporters to WTO-consistent foreign retaliation, kill the remaining legitimacy of Section 301, and paint the United States as a global scofflaw (and China as the law-abiding victim). That’s a trifecta of bad, totally-avoidable outcomes.

  • Third, if history is any guide, these Section 301 tariffs probably won’t result in actual changes in Chinese Government policy. As I wrote last summer, past (pre-WTO) efforts to remove foreign-trade barriers unilaterally through Section 301, produced, at best, mixed results: U.S. negotiating objectives were “successfully” achieved less than half the time (35 cases, or a 48.6 percent “success ratio”), most often when the targeted country was dependent on the U.S. market. Even more damning, retaliation (tariffs, suspension of preferential access, etc.) under Section 301 achieved U.S. negotiating objectives only 17 percent of the time it was used.  These dismal results stand in stark contrast to the United States’ impressive (well over 80 percent) success rate at the WTO – and, as indicated by the examples above, China’s eventual compliance in response to U.S. WTO challenges. It beggars belief that, given China’s domestic political situation and the fact that the United States accounts for only 18.3 percent of all Chinese exports, Trump’s loud unilateralism under Section 301 would actually push China to change course on IPR.

  • Finally, it must be noted that U.S. tariffs “in the trillion-dollar range” could impose significant costs on American families and businesses. As I wrote for National Review in 2016:

    The consumer gains from trade disproportionally accrue to America’s poor and middle class. A 2015 study by Pablo Fajgelbaum and Amit Khandelwal finds that these groups, because they concentrate spending in more-traded sectors such as food and clothing, enjoy almost 90 percent of the consumer benefits of trade. These benefits are even more concentrated for Chinese imports, since poor and middle-class American consumers are more likely than their richer counterparts to shop at “big box” stores such as Target and Walmart that carry a lot of made-in-China goods.

    American businesses, of course, also benefit. More than half of all imports (including those from China) are inputs and capital goods consumed by other American manufacturers to make globally competitive products. Raising these firms’ costs via tariffs would mean fewer employees, if not outright bankruptcy — a particularly bad outcome given that downstream industries (e.g., steelmakers) typically employ far more workers than their upstream counterparts (e.g., steel users). Non-manufacturers benefit, too — whether they be retailers such as the Gap, transportation and logistics companies such as FedEx, or multinational firms such as Apple, which assembles iPhones in China but generates most of their final sale price through marketing, design, engineering, and even manufacturing done in the United States. (Chinese manufacturers themselves earn only a few dollars from an iPhone’s assembly.)

If Trump does indeed slap high tariffs on a large swath of consumer electronics from China, that means pain for lower-income Americans (right before the Super Bowl and peak HDTV season!), U.S. companies involved in the targeted products’ supply chain, and struggling U.S. retailers. Ouch.

In sum, broad retaliatory tariffs under Section 301 in this case would likely impose high political, economic and legal costs, while likely failing to achieve needed policy changes in China. These problems do not mean, however, that the Trump administration is powerless to act here. Instead, a smart course of action could entail both unilateral and multilateral responses that would be more consistent with U.S. law and WTO rules, more likely to achieve Chinese policy changes, and less likely harm U.S. economic and geopolitical interests. In particular: (1) a broad WTO dispute following the procedures set forth in Section 301 and the SAA and joined by other WTO Members with similar complaints against Chinese IPR practices; and (2) a targeted unilateral response for those Chinese government acts (e.g., allegation 4 above on state-sponsored hacking) that clearly fall outside the WTO Agreements. The first U.S. action would reassert the United States’ leadership on an important global trade issue and deny China that same position, while the second U.S. action would let President Trump brag about his strong unilateral response to Chinese “economic aggression” (though he’d need to use something other than tariffs to be perfectly consistent with WTO rules).

If the latest reports are to be believed, however, it’s unlikely that the President will pursue this course and will instead demand big, broad tariffs. If so, the costs will likely be significant – not just for U.S. consumers and exporters, but for the future of U.S. trade policy more broadly.

The views expressed herein are those of Scott Lincicome alone and do not necessarily reflect the views of his employers.