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By Elizabeth M. Lynch, May 16, 2019

The Chinese government makes it really hard to believe that its detention – and now arrest – of Canadians Michael Kovrig and Michael Spavor is anything but politically motivated. It adamantly protests the charge that Kovrig and Spavor’s detention is somehow related to the troubles Huawei Technologies is facing in North America; it denies that this is tit-for-tat diplomacy.

But it’s actions reflect otherwise.  The initial detention of Kovrig and Spavor on December 10, 2018, came only days after Meng Wanzhou, Huawei’s Chief Financial Officer and the founder’s daughter, was arrested by Canadian authorities in preparation for extradition to the United States. And now, the formal arrest of the two Canadians – after 5 months in detention without access to a lawyer – came only hours after U.S. President Donald Trump signed an executive order prohibiting U.S. telecom companies from purchasing foreign equipment from companies deemed a national security threat and the United States Commerce Department officially listing Huawei as such a threat.  Not only does this lock Huawei out of the U.S. market, by being listed as a security threat, Huawei will also no longer be able to purchase key component parts from U.S. tech companies such as Intel, Qualcom, Broadcom and Google; parts that are integral to the future success of its business.

On Thursday morning, less than 12 hours after the U.S. government issued its announcements, the Chinese government announced that Kovrig and Spavor had been formally arrested on charges of stealing state secrets, Article 111 under China’s Criminal Law (translation courtesy of China Law Translate). Kovrig is suspected of “gathering state secrets for transmission outside of China” and Spavor is suspect of “stealing and providing state secrets for transmission outside China.”  Although the prosecutors are required to issue an arrest warrant upon arrest, it is unclear if this was done or to whom it was given (see Article 93 of China’s Criminal Procedure Law (CPL), Art. 93 –  translation courtesy of China Law Translate).  Professor Maggie Lewis does a great analysis of what the world can expect at this stage of the case.

But here is the rub that makes it increasingly hard to believe that the Chinese government’s actions against Kovrig and Spavor are not retaliation for what is happening to Huawei. The Chinese government decided to arrest Kovrig and Spavor one month earlier than they had to.  Because Kovrig and Spavor were being detained under Residential Surveillance at a Designated Location (RSDL), under Chinese Criminal Procedure Law, the public security authorities had up to six months – or until around June 10, 2019 – before they had to request the official arrest of the two (CPL Art. 79). Once the prosecutors formally arrest the suspect, the time frame to investigate becomes much tighter.  As a result, it is a rare occurrence for China’s public security bureaus not to take full advantage of these six months. But it appears that announcing the arrest of these two only hours after the U.S. declared Huawei a threat to national security was more important.

This isn’t to say that the U.S. is innocent of gaming the Huawei situation as a way to gain leverage against China in the current trade battle. But what is different here is that Chinese government is dealing with two lives; two people who could end up in a prison for a very long time basically as pawns in this game.  Trade disputes can be settled.  But the criminal justice system is a body on to itself. And once it is engaged, especially in China, it’s hard to turn back. 

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By Elizabeth M. Lynch, January 8, 2019

Pollyanna, ever the techno-optimist!

By now, most people have heard of One Belt, One Road (“OBOR”) – the Chinese government’s program to build up the infrastructure in developing countries across Asia, Eastern Europe and Africa. OBOR has largely been seen as a brick-and-mortar type of operation – building railroads, ports, pipelines. But in 2017, President Xi Jinping announced a new initiative within the government’s OBOR – promotion of a digital silk road.

And on Monday night, the China Institute hosted a discussion of that ambitious new program featuring Winston Ma, Managing Director and Chief Investment Officer of China Silkroad Investment Corporation, and moderated by Clay Shirky, a professor at New York University Arthur L. Carter Center of Journalism.  But, while the event was advertised as to be a lively, thought-provoking one that would confront pressing issues such as whether China’s digital silk road will lead to China’s domination of global internet standards and whether China’s technology will actually help emerging economies, Ma and Shirky’s conversation ended up being shallow and, as one audience member stated, blindly “techno-optimistic.”

Camal on the Digital Silk Road

For sure, the event did highlight some of developments that the rest of the world should wake up and take notice of. Going from building physical infrastructure in the developing world to cyber infrastructure unmaksks the Chinese government’s grand ambition to open those markets to its companies and become a  global superpower. And in some ways, as a country that developed simultaneously with the internet, China is uniquely situated to do that.  As Shirky pointed out, China was more of a blank slate to develop, and continuously modernize, its internet infrastructure.  The United States on the other hand, is saddled with the infrastructure of earlier telecommunications. Ma noted that this structural freedom enabled 800 million people to access the internet largely through mobile devices.  In fact, China has by-passed the use of credit cards – moving from a cash-based economy to a mobile payment one. Cash is often not an accepted form of currency, even by street vendors. Instead, the only way to pay in many places is with the swipe of your phone. What happens to those 600 million people without phones – and thus access to this economy – was not addressed.

But Ma further noted that it is this type of technology – and way of thinking – that China is also seeking to export to emerging economies.  The Taobao Villages – where farmers in rural areas can open an online “shop” and sell their produce or local crafts – is a model that could be replicated in other emerging economies. But is this good for the farmers in these other countries – to be dependent on exporting their craft goods to richer individuals?  Is it even good for the Chinese farmers? Instead of demanding that their government do more for them – such as provide quality education, health care, and social benefits that are on par with east coast cities – they must settle for peddling their goods in a virtual mall.  Unfortunately, these questions were not answered.

Surveillance in Xinjiang

Instead, both Shirky and Ma were unshaken in their commitment to the good that the internet and mobile devices can bring to all societies. Even when an audience member asked a pointed question about the use of this technology in surveilling and unlawfully detaining a million Muslims Uighurs in Xinjiang province, Ma evaded answering the question, instead re-focusing on antitrust issues. Shirky fared no better; he neither pressed Ma on the question nor rescued Ma from it by addressing it himself.

Ma was right to note that the global, technology infrastructure is the future and largely that future is still unwritten. That is why – as Shirky noted – it is dangerous for the United States to be backing out of so many global treaties and alliances when, as Ma stated, the world is on the cusp of writing “new norms for a new game.” Not only will the United States’ retreat from the global stage mean that U.S. businesses will be at a disadvantage for decades to come, but China will be the one writing those norms.  And given how easily Ma ignored the question on surveillance and mass detention in Xinjiang and how quickly Shirky acquiesced, the question is, is this a good thing?

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By Elizabeth M. Lynch, December 23, 2010

Yesterday, the White House announced that President Hu Jintao will make a State visit to the U.S. on Wednesday, January 19, 2011.  President Hu’s visit is long overdue; at the end of President Barack Obama’s State visit to China in November 2009, it was expected that President Hu would visit the U.S. by the summer of 2010.

Needless to say, President Hu’s visit will come at an interesting time.  The State visit was not the only China-related news that the Administration announced on Wednesday; the Obama Administration also supported the United Steelworkers’ contention that China is illegally subsidizing its wind turbine industry by filing a suit in with the World Trade Organization.  And as trade issues continue to plague U.S.-China relations, North Korea’s recent bellicose actions against the South reflect the importance of China in maintaining peace in Asia while North Korea undergoes a leadership change.  Given the importance of the two nations to each other as well as to the rest of the world, a one-day State visit seems a bit short.  It will be interesting to see what deliverables emerge from the visit.

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By Elizabeth M. Lynch, October 7, 2010

This past September, the world watched as the centuries-old feud between China and Japan reached epic proportions over a little-known chain of uninhabited islands in the East China Sea.  Known as the Diaoyu Islands in Chinese, the Senkaku Islands in Japanese, both China and Japan claim them as their own and each seeks control of the oil-rich seabed that potentially lies beneath. 

 As Marcy Nicks Moody writes in Foreign Policy Digest (reprinted below), at stake with these islands is more than just a pile of rocks. 

DEVELOPMENTS
Last month, a Chinese fishing boat collided with two Japanese coastguard patrol ships off the coast of a small chain of uninhabited islands in the East China Sea.  Japanese authorities took the boat’s crew into custody, and prosecutors debated whether to press charges against the boat’s captain for obstruction of justice.  Demanding the captain’s release, Beijing made strenuous arguments invoking Chinese sovereignty and human rights.  Chinese Premier Wen Jiabao refused to meet with Japanese Prime Minister Naoto Kan during a recent United Nations Summit meeting in New York and insisted that the conflict be resolved through diplomatic channels, while simultaneously suspending all mid- and high-level political contact between the two countries.  When the fishing boat captain was released, Beijing responded by insisting that Japan issue a formal apology and provide financial compensation.   Japan, in turn, argued that China should compensate Japan for the damage done to its naval ships.  Whether the collision was intentional is unclear, and it is unlikely that further light will be shed on the subject.

BACKGROUND

If the scale and particularly bitter nature of the diplomatic denouement following this small maritime accident strikes readers as odd, it should.   These events put into sharp relief the changing security landscape that both Asia and the United States face today in the Asian maritime.  They may also provide some insight into how China intends to conduct its increasingly forward facing maritime and energy security policy.

The islands near which the collision occurred are a matter of ongoing dispute between China and Japan that dates back for at least 40 years. Although the Senkaku Islands (called the Diaoyu Islands, in Chinese) are effectively a pile of uninhabitable rocks, it became known in the 1970s as an area potentially rich in oil and gas deposits in the surrounding waters, control of which could improve either country’s energy security dramatically. At present, the islands are controlled by Japan, but claimed by China. Although both have legitimate grounds for their claims, there is no foreseeable end to the dispute in sight. As Japanese authorities held the Chinese fishing boat captain on the basis that they might charge him with a violation of Japanese law, they were implying that these waters are, indeed, Japanese. For this reason, it is not entirely surprising that China would respond with such vociferous complaints as it did. What was surprising were the unannounced measures that China also took.

In addition to arresting four Japanese citizens in China for spying, which may have been coincidental, China appears to have suspended the export of rare earth minerals to Japan. Rare earths are elements in the Earth’s crust. Although they exist in miniscule concentrations, they are crucial to a range of modern technologies, including car batteries, wind turbines, and many other electronics. China mines approximately 97 percent of the world’s rare earths and, given the relative importance of electronics manufacturing to the Japanese economy, this move has the potential to be extremely damaging to Japan. No one from the Chinese government announced the suspension, and officials from the Chinese Ministry of Commerce (MOFCOM) have denied any sort of embargo. Chinese officials have, however, made public that they are contemplating fining Toyota Motor Company’s Chinese operations for various violations, including illegal rebates to Chinese car dealerships. While it is possible that the dispute with the trawler captain, the suspension of rare earths exports, the arrests, and the Toyota fines are all coincidental, it seems more likely that China is manipulating its economic and commercial relationship to gain leverage in its dispute with Japan over the Diaoyu/Senkaku Islands.

China has similar ongoing disputes over other chains of islands in the South China Sea with its Southeast Asian neighbors—in particular, Vietnam. Like the Senkaku/Diaoyu Islands, the waters surrounding the Spratly and Paracel Islands are believed to be rich in oil and natural gas, in addition to their valuable proximity to busy shipping lanes. The U.S. government inserted itself into the dispute in July, when Secretary of State Hillary Clinton announced that the United States would be willing to facilitate multilateral talks on the issue. She insisted upon U.S. neutrality, but argued that the United States has a strong interest in preserving free shipping in the region. Not surprisingly, a number of Southeast Asian countries welcomed the announcement, while China, caught off-guard by the announcement, maintained that the talks should be undertaken in a bilateral format.

ANALYSIS

China has not been the positive, productive, and cooperative international partner that the Obama administration seems to have been expecting two years ago. On the security side, cooperation on the North Korean question has disintegrated; Beijing has refused to move forward on sanctions against Iran; and U.S.-China military-to-military relations are increasingly strained. On the economic side, meanwhile, China has not allowed its currency to appreciate materially; it has recently placed steep tariffs on some U.S. exports, and the business environment is widely acknowledged to have become increasingly hostile to non-Chinese enterprises. If nothing else, Secretary Clinton’s July announcement is a mechanism for registering U.S. frustration with the current trajectory. Like China, Washington is also willing to play the zero-sum game.

The disputes over the Senkaku/Diaoyu, Spratly, and Paracel Islands are all based, at least in part, in China’s quest for greater energy security. At the same time, Beijing has taken an increasingly aggressive stance in a range of its foreign policy dealings, both with the United States and with its Asian partners. Given the trend of global economic interdependence that relies more and more heavily on China’s mammoth economy, Beijing’s recent behavior could forecast some serious struggles in the future, as China manipulates its growing commercial influence to leverage its position in the Asian security landscape.

Marcy Nicks Moody writes about China. In 2007-08, she was a Fulbright Scholar in China, where she was also a Research Fellow with the U.S.-Asia Law Institute. She received an M.A. in East Asian Studies from Columbia University and graduated from Brown University.

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By Elizabeth M. Lynch, August 2, 2010

As promised, on July 9, 2010, China submitted its proposal to join the World Trade Organization’s (WTO) Agreement on Government Procurement (GPA).  China’s government procurement market – in which the government purchases supplies and services to keep it running –is larger than the GDP of many small nations, accounting for $500 billion by some estimates, a size that makes many western companies salivate.  But China has no legal obligation to open its government procurement market to global competition.

Needless to say, the inability for foreign companies to access such a huge market has been a sticking point for many foreign governments in its dealings with China.  During May’s Strategic & Economic Dialogue (S&ED), Secretary of State Hillary Clinton raised the government procurement issue often.  By the end of the S&ED, China promised to submit an application to the GPA in July, its first submission since 2007 when China’s application was resoundingly rejected by other GPA member nations for being over-protectionist.  But the U.S. is not the only country with issues concerning government procurement.  German Chancellor Angela Merkel visited China in the beginning of July and market access was number one on her list of discussion topics with the Chinese leadership.  Even the U.S. Congress is threatening action, proposing the adoption of the “China Fair Trade Act of 2010” if China does not open its government procurement market.

So with all that pressure, will China’s 2010 revised offer to join the GPA open its markets to foreign corporations?

Don’t hold your breath.  While China responded to some of the criticism lodged against its 2007 application – it shortened the implementation period from 15 years to 5 and significantly lowered the monetary values of the projects and purchases covered to be more in line with other member states – its 2010 application does little to actually open its government procurement market.

In Annex I of China’s 2010 application, a larger number of central government agencies are covered compared to China’s previous application – 61 to be exact.  But the largest market – namely government procurement on the local level – is completely absent.  Annex II, which is to list those sub-central government agencies covered by the agreement, is left blank.  Additionally, China’s state-owned enterprises (SOEs) are also not covered by the GPA

More high rise aparment buildings in Shanghai

application.  Although a hybrid between a government-run organization and a private corporation, SOEs maintain good ties with the government, especially on the local level.  As Monday’s New York Times pointed out, many SOEs whose businesses are completely unrelated to housing development, such as the Anhui Salt Industry Corporation, have been the biggest players in China’s real estate construction boom.  This is largely due to the SOEs huge amounts of cash and their ability to endless borrow from government-run banks.   But under China’s 2010 GPA application, these SOEs would be allowed to ignore competitive bids from foreign companies.

Although this is a disappointment for foreign corporations looking to crack into China’s government procurement market, China’s current 2010 GPA application is at least honest in admitting to the fact that the central government might have a lot less control over the provinces than many thought.

This is especially true if central policies seek to disrupt the symbiotic relationship that exists between local governments and local SOEs.  As Reuters notes in its report on China’s GPA application, China’s provinces have had a long history of preferential treatment of local provincial industries, even at the expense of Chinese corporations from other provinces.  These local SOEs – like the Anhui Salt Company – employ hundreds if not thousands of local workers, and local SOEs are often more willing to partake in a “I-scratch-your-back-you-scratch-mine” economy.  Take for example the real estate auction mentioned in the New York Times article.  At a government-run public auction, Anhui Salt put in an offer that far surpassed other offers, unnecessarily bidding up the price that it would eventually pay for the land.  But that inflated price goes directly to the coffers of the local government.  And in some provinces, where the government’s balance sheets are more of charade than actual accounting, this extra income is important.  Needless to say, provincial governments are inherently protectionist of its local industries and the system the two have created.

While many believe that the Chinese central government, with it authoritarian rule, can force provincial level governments to act a certain way, China’s 2010 GPA application reflects that there are actually limits.  It also hints that China might be more of a federalist system than originally thought.  Although the U.S. is a member nation of the GPA, because the federal government cannot mandate state government behavior when it comes to government procurement, states have to affirmatively agree to the join the GPA.  In the U.S., only 37 states are signatories to the GPA; the federal government can’t force states to comply with the GPA.  Similarly, China’s 2010 application and the fact that the central government apparently cannot force provinces to sign on to the GPA, raises the question if China is in fact a de facto federalist system.

At any rate, given the absence of SOEs and local governments from China’s GPA application, expect the 2010 offer to be rejected again.  What will be interesting is how loudly the U.S. will object when 13 states have yet to sign on to the GPA.

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By Elizabeth M. Lynch, June 15, 2010

China's rare earth mine in Inner Mongolia

Last November, China Law & Policy reported on an obscure-sounding group of minerals found at the bottom of the periodic table: rare earth minerals.  While you may never have heard of them, you likely use them.  With their lightness in weight and resistance to heat, rare earths have been instrumental in many technological innovations, from color television, to laptops, to the iPhone.  Rare earths are also essential to any company that wants to succeed in the green technology revolution.  Rare earths are needed to create batteries for electric cars and for wind turbines.  Expect demand to increase.

But while demand increases, the global supply will decrease.  Why?  China currently produces 95% of the world’s rare earth minerals and in the beginning of June, the Chinese government announced that it was considering nationalizing its rare earth industry.  As China becomes a leader in green technology, its own domestic demand increases, leaving less to export.

Monday’s PBS Newshour did a 10 minute analysis of the rare earth dilemma, China’s demands and what it means to the U.S. as it seeks to catch up in the green technology revolution.  To watch the video or read the transcript, click here.

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By Elizabeth M. Lynch, June 11, 2010

Government Procurement - Shopping Spree for the Government

On Tuesday, China Law & Policy published an insightful interview with attorney Brett Gerson concerning China’s Government Procurement Law, China’s new policy to promote “indigenous innovation” in the Chinese technology sector, and China’s agreement to submit a proposal to the World Trade Organization’s (WTO) Government Procurement Agreement (GPA).

The very next day, what was the talk on Capitol Hill?  China’s government procurement policies!  Before a congressional hearing on China’s trade obligation under the WTO, China’s government procurement policies took center stage.  Which leads us to wonder – are members of Congress busy reading China Law & Policy?

Given the lack of depth in some of the Senators’ comments, we hope not.  In a rare show of bipartisanship, both Republican and Democratic senators united in their attacks on China, demanding that China sign on to the GPA.  Senators Debbie Stabenow (D-MI) and Sam Brownback (R-KS) were the leaders of the pack, calling for China to behave like every other WTO member and join the GPA and stating that China’s indigenous innovation policy is just a way for China to steal foreign patents.

But if the Senators had read Tuesday’s China Law & Policy interview, they would know that “signing up” is just not an option for the GPA.  China has to submit a proposal stating its new government procurement policy and the GPA member countries choose to accept or reject that proposal.  It’s like the Miss America pageant and China’s proposal is its version of the bathing suit competition; even if you wear your nicest two-piece, it’s still the judges who ultimately decide.  As Brett noted in his interview, China submitted such an application in 2007 and, because the GPA member countries did not like China’s proposal, it was rejected it.  China has promised to submit another proposal in July

Sen. Debbie Stabenow (D-MI)

2010.  Once China submits it, the decision to “sign up” for the GPA is out of its hands.  But Congress missed this important procedural distinction and the fact that China has actually promised to move forward.

And not all WTO countries are also members of the GPA.  Senator Stabenow just got that wrong.  A simple Google search would show that actually, plenty of WTO members, including countries like Australia, India and Turkey, are not parties to the GPA.

As for the accusation that China’s indigenous innovation policies are a way to steal foreign intellectual property, here’s a wake-up call – getting China to change this one policy is not going to solve the problem.  Chinese companies do illegally use foreign intellectual property and the Chinese government often turns a blind eye toward enforcing intellectual property rights and laws.  But China’s indigenous innovation policy is just one tool that China uses.  As Jim McGregor pointed out in his Washington Post op-ed, the Chinese government has created a complicated structure seeking to benefit its domestic technology industry:  “a foreign-focused anti-monopoly law, mandatory technology transfers, compulsory technology licensing, rigged Chinese standards and testing rules, local content requirements, mandates to reveal encryption codes, excessive disclosure for scientific permits and technology patents;” discriminatory government procurement policies is just one piece of the puzzle.

Congress needs to see this problem holistically – not something that can be solved merely by getting rid of a discriminatory government procurement policy.  And as McGregor notes in his piece, part of the problem is on the U.S.-side.  Although China has been building its economy for the past 10 years and the China “threat” to U.S. competitiveness has been obvious for the past five, the U.S. has done little offensively to battle this threat.  The U.S. government has not created any kind of economic planning for technology start-ups as  Tom Friedman noted in his New York Times op-ed, and the one piece of legislation that could provided something of a lifeline to the U.S.’ technology sector, the Climate Change bill, has been stalled in the Senate for a year now.  Furthermore, the U.S. still retains a behemoth bureaucracy that is ineffective to deal with the complexities of the China relationship and hires individuals with little to no China background to do this work.  Congress’ sole focus on attacking China on Wednesday ignores the other half of the equation – developing the U.S. tech sector to better compete with China and a government bureaucracy that actually protects U.S. industry.

China is an economic threat to the U.S, especially in the technology sector.  But Wednesday’s hearing showed a Congress not willing to actually solve the problem.  Instead, Wednesday showed a use of rhetoric designed to win upcoming midterm elections.  The only losers are the American public and the millions of Americans who are still out of work.

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By Elizabeth M. Lynch, June 8, 2010

Last month’s Strategic and Economic Dialogue (S&ED) featured many thorny issues that have been plaguing U.S.-China relations for the past few months: North Korea, currency manipulation, Iran….and government procurement?  Yes, government procurement. Not what one would think of as a controversial topic worthy of a major dialogue between two of the world’s leading powers.  So to help us understand the addition of government procurement to the S&ED agenda is Brett Gerson, an associate in the international trade and public procurement practices at Reed Smith and co-author of the recent article “Can China’s Government Procurement Market be Cracked?” in this month’s The China Business Review.

Click here to listen to the interview with Brett Gerson or read below for the entire transcript.
Length: 19 minutes (audio will open in another browser)

In the interview, Brett mentions three laws and regulations pertaining to government procurement in China. They can be found through these links:

• 2002 Government Procurement Law of the PRC (official PRC translation)
• January 2010 Draft Government Procurement Law Implementing Regulations (Unofficial translation courtesy of the U.S.-China Business Council) – link to be updated soon
• May 2010 Draft Administrative Measures for the Government Procurement of Domestic Products (Unofficial translation courtesy of the U.S.-China Business Council)

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Potentially a $90 billion Procurement Shopping Spree

EL:  Just to begin, what exactly is meant by government procurement and how does this involve U.S.-China relations?

BG:  Well, essentially government procurement is the process whereby governments or government ministries or agencies can purchase goods or services at a large-scale to provide for use in the carrying out of government processes.  So for example, this could, as an example of goods, a government agency could purchase in bulk a large number of, let’s say, printers or staplers or another good.  It could also be services.  The government could enter into an agreement with an IT company to provide some type of computer services or internet maintenance or something like that.

It’s becoming a very big issue between the U.S. and China because like many other areas of China’s market, there is immense potential for companies – both Chinese and foreign – to get into China’s procurement market.  Obviously the Chinese government is huge, they have a wide array of ministries and agencies both at a, sort of, federal level coming from Beijing, and at a provincial level.

EL: And how big is this market, this potential market, in U.S. dollars?

BG:  It’s hard to say exactly.  Most estimates hover around $90 billion which is really huge.  But it is tough because it is hard to say exactly which entities are state-owned enterprises, so which are entirely private and which are sort of public in nature.  But most estimates hover around $90 billion and I have seen a couple where in 2010 that’s expected to reach $100 billion.

EL: Currently, does China have any policy or laws in regards to government procurement of foreign companies’ goods or services?

BG: Yeah.  In 2002, China promulgated the Government Procurement Law.  It’s somewhat controversial in nature but it basically just states that Chinese government agencies and entities must purchase domestic goods, works or services except where those goods, works or services can’t be obtained within China under reasonable commercial terms.  Those reasonable commercial terms are defined as 20 percent more than imports.  Now, the problem with the Government Procurement Law is that it never defined what is “domestic.”  So companies, particularly foreign companies, had a hard time cracking that market because it was so easy for the Chinese government and Chinese government agencies and entities to just simply purchase products – goods or services – from Chinese companies.

Since 2002, there has been a lot of international pressure on China to better define what is domestic.  They finally did this in January 2010, just about six months ago, the Chinese government issued what’s called the Implementing Regulations.  These aren’t exactly law, but they define how the Chinese government is suppose to carry out the Government Procurement Law.  The Implementing Regulations set forth that….it better defined domestic.  It says that essentially domestic manufacturing costs that exceed a certain threshold, those products will be defined as domestic.  Now in the implementing regulations, they didn’t actually set the threshold.  We were able to look at some other guidance that the Chinese government issued recently and we were able to guess that they probably meant 50 percent.  Now, just a few weeks ago, right before the high-level meetings in China that you discussed, the Chinese government again issued another sort of policy guidance paper that did clarify that the threshold for a product to be considered domestic is 50 percent of domestic production costs.

EL:  So if they have clarified this recently and this law has been in place since 2002, why is this now becoming such

China's Government Procurement Laws - Trade Protectionism?

an issue? What has caused government procurement to become almost the centerpiece of the Strategic and Economic Dialogue last month?

BG:  There’s two main reasons and they sort of come together.  The first is that in the World Trade Organization, there is an agreement called the Government Procurement Agreement [GPA].  It’s a plurilateral agreement meaning that some but not all of the World Trade Organization members are a part of this agreement.  It basically just states that if you’re a party to this agreement, you cannot favor products or services from your country against those from a foreign country.  China, when they first came on to the World Trade Organization in 2001, they promised that they would join the Government Procurement Agreement as soon as possible.  Now, they have submitted a proposal before, back in 2007, but it didn’t quite come to the level of international best practices.  The member countries essentially rejected it.  Since that point, the United States as well as major European countries and other members to the GPA, have pressured China to resubmit a proposal that do come up to the standard that the member countries expect.  Finally, China agreed just recently at the high-level discussions in China that they were going to submit a new proposal in July of this year.  Right before the time the World Trade Organization Government Procurement Committee meets.  So I think that is one of the issues that is really bringing it to the forefront, is that there is a lot of pressure on China to join the GPA agreement.

The other issue, and this was also discussed and mentioned by Hillary Clinton and Timothy Geithner, is China has set forth a very controversial policy called indigenous innovation policies.  And basically these are policies that direct provincial governments and agencies and ministries to buy only from certain product catalogs.  These catalogs are primarily made up of high-tech and IT goods and traditionally it’s been extremely hard for foreign companies to get their products onto these catalogs.  For example, and I mention this in the article, out of the Shanghai-based catalog, there are over 500 products that are listed on this catalog, and foreign products make up only two of these products.  Of those two, they are not entirely foreign entities, they’re joint ventures between a foreign company and a local Chinese company.

So I think those two issues, one that China has been slow to join the World Trade Organization Government Procurement Agreement and two, these indigenous innovation polices that make it very difficult for foreign companies to get their high-tech products listed on these procurement catalogs.

EL:  But in terms of China favoring its domestic products over foreign products, is China really acting any differently than from any other countries in terms of government procurement?  Doesn’t in the U.S., isn’t the U.S. government required to purchase U.S. products?  How is China any different from that?

BG:  Well there’s a couple of differences.  The U.S. and other countries that are members of the GPA do have policies that direct or allow their own domestic government entities to purchase only domestic products.

There’s a couple of differences.  One, here in the U.S. we have what is called the Buy American Act.  The Buy American Act essentially says that federal agencies can only procure unmanufactured articles that have been mined or produced in the U.S. or manufactured articles that were made substantially of articles or materials mined or produced in the U.S.  But there are several exceptions.  One is you can waive that if it would be consistent with public interest or if observing that preference would be inconsistent with the public interest.  Second, where the cost of buying the U.S. good is, sort of, unreasonably higher than would you purchase them from a foreign entity.  The third exception is where the products in question are in too short of a supply in the U.S. to make that purchase feasible.

In addition to that, government agencies may purchase foreign-made information technology equipment.  So that’s sort of a big issue and that sort of touches upon the China indigenous innovation policies – there is sort of a cut-out for U.S. government agencies to waive the Buy American requirements for sort of high-tech, IT goods.

Also, the Buy American Act doesn’t include services which the Chinese government procurement policies will.  As you know, services is a huge sector for foreign companies in China: legal services, accounting services, IT services, things of this nature.

In addition to the Buy American Act, we also have the Trade Agreements Act and this is a pretty big issue because the Buy American Act will be waived where we have a trade agreement act, an agreement with another country.  These include all the countries that are signatories of the WTO Government Procurement Agreement that we mentioned before that China is not a signatory to; these also include all countries that we have free trade agreements with ; all these developed countries and also the Caribbean basin countries.

You are right in that the U.S. does have certain policies like the Buy American Act that on their face appear somewhat discriminatory.  But I think that the differences between China’s policies and the U.S. policies is that we have so many carve-outs for our Buy American Act: exceptions and instances where the Buy American Act requirements will be waived where we have agreements in place with other countries.  China is not one of them.

EL:  Just to go back to the indigenous innovation policy of China, because that was something that Secretary of State Clinton did mention specifically as a problem.  I guess just examining the equities of it.  Given that the U.S. and other countries were largely able to develop their technology sector before our current global trade system, and before there was competition from other countries, shouldn’t China also be permitted this luxury?  Don’t they have an opportunity to catch up?  Isn’t China’s indigenous innovation policy just a way to allow its small but growing technology sector to really flourish?

BG:  There is no question that China should be allowed to sort of foster the growth of their high-tech services but I

Investing in R&D in China might bring more benefit than an indigenous innovation policy

think, and Secretary Clinton and Secretary Geithner both mentioned this, that there’s ways to do this that are less discriminatory for foreign firms.  Rather than link the indigenous innovation policies to government procurement – which they are trying to do – we think that there are other ways such as using tax incentives or research and development support programs that can sort of achieve the same goals without the discriminatory effect.  We think that generally China grow this area by including foreign firms rather than excluding them.  Like I said, there are certainly sort of high-tech tax status programs that they can enter into and R&D programs.

One of the big ways that their policies discriminate against foreign firms is, initially when they released the indigenous innovation policies, they required that to get on these catalogues that I mentioned before, the company has to…the trademark of the product has to be owned by a Chinese company and they also had to have full ownership of the products IP [intellectual property] in China.  This was really stringent, this was tough.  Thankfully, just a couple of months ago in April actually, the Chinese government again released sort of guiding, implementing regulations memo.  Now, this doesn’t have the force of law but they’re proposing to relax these requirements by saying that instead of having full ownership of the trademark in China, the company need only have exclusive rights to the product’s trademark in China.  Instead of having complete ownership of the intellectual property in China, you only have to have a license to use the intellectual property in China.

So this is definitely a step in the right direction.  But ultimately, I think ideally foreign companies, U.S. companies, would want to de-link the indigenous innovation policies from government procurement.

EL:  Just getting back to the Strategic and Economic Dialogue, do you know what it was that the U.S. side was seeking to achieve in terms of government procurement and indigenous innovation policy.  I know that you had mentioned a little bit before but can you just summarize that the U.S. wanted out of it?

BG:  Sure.  I think the first thing they wanted is to urge China to submit an additional proposal, a new proposal, to the World Trade Organization Government Procurement Agreement, which they have agreed to do by mid-July so that’s definitely is a step in the right direction.  We don’t know exactly what that is going to say but we are think that it is going to be a step closer to international best practices and the other proposals that the member countries have agreed to.

Second, I think that, the U.S. delegates really wanted the Chinese government to relax the indigenous innovation policies and de-link them from the government procurement policies.  As it stands right now in the Implementing Regulations, Article 9 says that Chinese government entities and agencies should favor indigenous innovation products which are only listed on these catalogues like I mentioned.  So I think what the U.S. government would like to see is getting rid of the indigenous innovation article from the Government Procurement Law.  It is unclear that the Chinese government is going to do that.

EL:  Even though it seems like there was some progress at the Strategic and Economic Dialogue and that China has agreed to submit a new proposal, do you really see though China, I guess, even if it submits a new proposal, do you see that proposal to the WTO to join the Government Procurement portion of the WTO, do you see that as actually being something that other member countries would agree to?  Do you see China acquiescing to a lot of the foreign pressure and is it really in China’s self-interest to do that at this stage in its development?

BG:  It’s hard to say at this point.  I think we’ve seen that, in other areas, in strategic and economic areas, China has certainly refused to acquiesce to international pressure to do certain things or not to do certain things.  So it is hard to say without seeing their proposal.  I think that the GPA member countries would reject a proposal that is not up to standard.  They’ve done it before and I think they might do it again.  And I’m not sure that would be in China’s interest.  I think China at this point would have to understand what the member countries expect, what the parameters would be.  And it’s unclear to me that they would submit something that would be any less than that.  So it’s hard to say.  I don’t know.

Generally it seems that China doesn’t acquiesce.  However if the international community is successful in persuading them that it is in their best interest, to relax their indigenous innovation policies and to de-link them from government procurement, then I think they will go ahead and submit a proposal that’s up to par, that’s in line with international best practices.

Over the last several months, in January, since they issued their Implementing Regulations, there has been significant international backlash and they have sort of watered down some of the more strict discriminatory provisions in the Implementing Regulations.  So there’s been progress.  I suppose they only have another six, seven weeks before they’re going to submit their proposal to the Government Procurement Committee so it is unclear how much further they are going to go in watering those items down.

EL:  Well I guess only time will tell what happens in July.   Thank you.

BG:  It will be interesting; hopefully we can follow up and discuss what happened.

EL:  That would be great.  Thank you so much for your time.

BG:  Thank you.

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By Elizabeth M. Lynch, November 8, 2009

Last Wednesday, November 4, the European Union, the United States and Mexico filed a complaint with the World Trade Organization (WTO) against China for its quotas, export duties and minimum export prices for raw materials essential to the manufacture of steel and aluminum.  Noticeably absent from the complaint though, is any mention of China’s restriction on rare-earth elements.

Rare Earth - Much More than a Band from the 70s.

The raw materials at issue in the WTO complaint, while important to key manufacturing industries in the US and the EU, in many ways represent the economy of old.  Rare-earth elements, which China also heavily restricts export of, represent the economy of tomorrow; many of these rare-earth elements are indispensable for a greener, more environmentally-friendly world.  The magnetic properties of rare-earth elements like dysprosium and terbium are important for wind turbines and essential for the production of long-lasting, light-weight batteries for electric cars.

China, and its rare-earth enriched Inner Mongolia, account for 93% of the global production of rare-earth elements and 99% of the world’s dysprosium and terbium.  While countries have sought to expand green technologies, thus increasing the demand for rare-earth elements, China has continued to restrict the amount exports of rare-earth materials.  This past September, China, for the third year in a row, lowered the amount of rare-earth materials allowed for export by 6% overall, double-digits though for certain rare-earth materials .

China wants not just the monopoly on the production of rare-earth materials, but also on the more profitable business of producing down-stream products like electrical cars and wind turbines.  Japan, which is the largest importer of rare-earth materials because of Toyota and Honda’s drive to expand the market for hybrid and electric cars, feels the biggest pinch of all.  In fact, Japan purchases from a fifth to a quarter of its rare-earth materials on the black market, a black market where Chinese sellers thwart their own government’s restrictions.

In addition to its own domestic production, China, with its large foreign reserves to spend, has attempted to be a controlling share holder in other countries’ rare-earth industries.  Last spring, Chinese government-controlled mining companies purchased a 25% share of Australian rare-earth mining company Arafura.  China’s offer to purchase 51% of another Australian rare-earth mining company, Lynas, was likely going to be denied by the Australian government because of the Chinese government’s mishandling of the Rio Tinto case and the detainment of Australian citizen.  The Chinese mining company pulled out of the deal before it could be denied by the Australian government.

After China’s CNOOC’s failed bid to purchase California oil company Unocal in 2005, CNOOC  made overtures to purchase a single asset of Unocal’s: Mountain Pass, the U.S.’ only rare-earth mine.

Thus, the future of some green technology is beholden to China.  But Japan, instead of investing in China’s rare-earth elements industry, is looking to invest elsewhere – likely because of the danger in investing in a country with a fickle commitment to rule of law.  Japan has signed a deal with one of Kazakhstan’s largest mining companies for rare-earth excavation and is looking to Australia, Canada, Vietnam and the U.S. as alternate suppliers.  However, it will take at least 10 years before any of these new mines will produce rare-earth materials.  Until then, anticipate delayed development of green technologies and hopefully a WTO complaint.

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By Elizabeth M. Lynch, September 29, 2009

Originally posted on the Huffington Post

President Obama, with President Nicolas Sarkozy and Prime Minister Gordon Brown on Friday, Sept 25 at the G-20 Summit

China remained noticeably mum on Friday as other member nations of the U.N. Security Council stood before the world and accused Iran of developing a secret nuclear enrichment site.  Flanked by Prime Minister Gordon Brown of the U.K. and President Nicolas Sarkozy of France, President Obama promised to take strong action against Iran if the country did not fully disclose its nuclear ambitions and open all sites to international inspectors.   Such strong action would include crippling sanctions on all trade to and from Iran.  Even Russia appeared willing to consider sanctions if Iran failed to cooperate, breaking with Russia’s long opposition to such action.

China, on the other hand, prefers a different route.  Stressing the need for diplomacy and negotiations, China announced that “sanctions and pressure should not be an option” in dealing with Iran.  Although not completely ruling out sanctions, China desperately hopes that the upcoming talks with Iran scheduled to begin this Thursday satisfy the U.S. and obviate the need for sanctions.

Why is China so hesitant to support sanctions against a country that is secretly developing nuclear capabilities?  History, geo-politics and economic ties are what set China apart from its Security Council brethren in dealing with Iran.  But China’s growth as a world power has caused it to become a stakeholder in the current system.  With this new-found power, China has begun to realize its actions, or lack of action, does in fact shape the world’s future course and as a result, its own global prospects.

History, History, History

China has long been an outsider to the western world order.  Even after mainland China’s return to the U.N. Security Council in 1971, China was still largely considered a pariah state, a Communist country with severe human rights violations.  China’s violent crackdown on the 1989 Tiananmen protests rolled back any international good will it was amassing and subjected China to crippling economic sanctions.  It has only been in the past few years that China has become a significant voice in the international arena and respected by Western powers.

But for China, its past is far from forgotten.  While it has significantly benefited from the current world order, China understands that other countries, either rightly or wrongly, are marginalized because of alleged human rights violations or nuclear development.  As a result, China has developed a philosophy of “non-interference” in other country’s domestic affairs and has largely stuck to that attitude in dealing with countries that the U.N. or the U.S. might consider rogue.  This is not to say that China condones such behavior; in fact China has been an ardent supporter of various global nuclear non-proliferation efforts and supported sanctions against North Korea for its nuclear development.  However, with its sense of history, China will be slow to agree to sanctions against Iran, even if sanctions are in its long-term self-interest.

Geo-strategic Considerations

Iranian President, Mahmoud Ahmadinejad at last week's U.N. Security Council

Iran plays an important role in China’s aspiration to become a regional power.  With its rise, China has sought to create political alliances and economic ties with other countries in Asia and reduce the influence of the U.S. in the region.  One such effort is the Shanghai Cooperation Organization (SCO).  China leads the organization which has created greater economic interdependence among Russia, China and the Central Asian states.  Iran, although not a member, currently holds observer status.  China, along with Russia, has used the SCO to reduce the U.S. military presence in Central Asia when in July 2005, its members signed an agreement to push the U.S. to set a deadline for troop withdrawal from the region (Library of Congress Report, p. 68).

The SCO is beginning to function as a multilateral alliance system allowing China to exert its influence in a region where western powers are largely absent.  To move too quickly in calling for sanctions against Iran, a country within the SCO’s domain, China could jeopardize its current leadership role in the region.

Economic Ties

China’s strongest reason to oppose sanctions against Iran lies with its current economic ties to the country.    In 2008, 12% of China’s crude oil imports were from Iran; the first five months of 2009 have seen an increase and China is on target to import 15% from Iran (Energy Information Administration Country Analysis Brief) .  Furthermore, Chinese oil companies have invested heavily in Iranian oil fields.  In December 2007, China’s Sinopec signed a $2 bn contract with Iran to develop the Yadavaran oil fields; in January 2009, CNPC, China’s largest oil and gas company signed a $1.7bn oil contract to develop the Azadegan oil fields.  Although these investments are large, many question whether the Chinese companies have in fact moved forward with developing these fields.  In the past, Chinese oil companies have signed deals with countries but have waited, even as much as ten years, for geopolitical issues to settle (According to the Brookings Institute, CNPC signed a contract with Iraq in 1997 but did not begin to the develop the oil fields until 2008, after threats of sanctions were over).

Similarly, China has looked to Iran for its large quantities of natural gas.  In March 2009, the L.A. Times reported that Iran and China signed a $3.2 bn deal for natural gas development. But like the oil contracts, it is unclear if China intends to follow through with this agreement given the current politically-sensitive climate.

More real though is Chinese oil companies’ sale of gasoline to Iran.  Although Iran has the second largest crude oil reserves in the world, it has little capacity to refine that oil and make it into usable gasoline.  In fact, Iran imports 40% of its gasoline, mostly from European countries but also from China.  Because of China’s increasing economic ties with Iran, sanctions that impact all trade with Iran could be particularly damaging to China.

China’s Countervailing Interests

On Sunday, it seemed as though everyone on the political talk shows called for China to join the U.S., France, Britain and Russia in condemning Iran and agreeing to join sanctions if need be.  But China has not wavered on its stance of trying diplomacy first.  At the same time, it has also not stated that it will oppose sanctions if the October 1 talks fail.  And while political pundits, the media and elected officials in the West are currently criticizing China for not throwing its weight behind sanctions, it is China’s current silence on the issue that gives the October 1 talks the best chance of success.  Without China’s commitment for or against sanctions, Iran is left guessing what its trading partner will do, and could acquiesce to U.S. demands to show blueprints of the new nuclear site and open its country to inspectors.

But if the October 1 talks fail, expect China to agree to sanctions, but likely not the ones that will be proposed by the U.S., France and Britain.  In December 2006 and March 2007, in response to Iran’s nuclear development, the U.N. Security Council unanimously agreed to sanctions.  However, through China and Russia’s insistence, these sanctions were substantially watered down and merely limited the sale of nuclear equipment and technologies to Iran and froze the assets of key individuals involved in Iran’s nuclear development.

The Obama Administration has already realized that a total embargo on gasoline shipments is not in the cards.  Not only would Chinese companies be negatively impacted, but so would European oil companies that sell gasoline to Iran.  Many E.U. countries have already come out against a total embargo.

But other measures, such as eliminating investments in Iran, might have more traction with China and could be something it agrees to in this round of sanctions.  China has a lot to lose if Iran becomes a nuclear power or appears to be a nuclear power.  First, while 12% of China’s crude oil imports are from Iran, 20% are from Saudi Arabia, a country that has already reprimanded Iran for its nuclear aspirations.  Will China jeopardize that relationship by opposing sanctions?

Second, Israel’s response to an unchecked Iran could potentially lead to such instability in the region cutting off not only oil from the Middle East, but also key shipping lanes for China’s oil imports from other countries.  China cannot afford to be cut off from any oil shipments since currently it only has 25 days worth of oil reserves.

Third, a nuclear Iran threatens the Central Asian strategic alliances that China has worked hard to create through the SCO.  Arguably, the other Central Asian countries might begin to take their cues from Iran, dissipating China’s leadership role in the region.

Fourth, it remains unclear if China’s investments in Iranian gas and oil fields actually exist.  If not, then China could easily agree to stop its investments in Iran.  Even if China has already begun to develop these oil and gas fields, it is only at the start of these investments and under its contracts with Iran, China does not receive a return on the investment until development is completed.  Any of China’s current contracts have a long way to go before completion.

Finally, China does want to become a responsible world player.  It has actively sought membership in various international organizations and largely abides by their rules.  Last year, during the North Korean missile crisis, China was on board in issuing a harsh reprimand of Kim Jung-Il’s actions.

If the situation with Iran further disintegrates and sanctions become necessary, the Obama Administration should push China to agree to sanctions that include a cut-off of investments in Iran.  China might hesitate at first, but for the reasons stated above, they could agree to such measures.  Getting China to stop importing crude from Iran could prove harder.  Although interestingly enough, Iran’s largest importer of its crude is Japan, a strong U.S. ally, and Japan might actually be the strongest opponent of such measures.  Including an embargo on sales of gasoline to Iran would be impossible.  But asking China to join sanctions that limit investment in the region, is doable.