Trump Should Take Aim at China’s Joint-Venture Rule

(Bloomberg Opinion) -- Some are wondering whether President Donald Trump will end his trade war against China with a fizzle, accepting more Chinese purchases of U.S. agricultural goods, rather than pushing for deeper, more lasting changes. Meanwhile, Trump's top trade representative, Robert Lighthizer, says he still wants “significant structural changes” to the Chinese economy.

What could those structural changes be? A big appreciation of the Chinese currency against the dollar is one possibility, making U.S. exports cheaper and Chinese imports pricier. Another obvious point of contention is intellectual property, which Chinese companies and the government steal with regularity. But enforcing any Chinese promise to curb IP theft will be difficult; by definition, the activity is done in a clandestine manner and hard to know about in advance.

Yet there is one simple, observable rule change that would reduce appropriation of U.S. technology while also making it easier for American companies to sell their goods in China. This is to insist on elimination of the joint-venture requirement for international investors operating within Chinese borders.

Joint-venture investment into China has fallen as a percent of the total, but is still very substantial:

Multinational companies in most high-value industries now are required to create a joint venture with a local company in order to build factories or offices in China. The government recently announced its intention to lift the rule for foreign automakers by 2022, and will eliminate it for electric cars and aerospace manufacturers immediately. This is a positive development, but the U.S. should push for a complete end to the requirement in all industries.

Why? Because these joint ventures are one conduit by which U.S. companies lose their intellectual property, and with it, their competitiveness. Joint ventures allow Chinese companies to work in close contact with American ones, giving the former a chance to learn the technologies of the latter. The Chinese company is then free to create its own products using the techniques it has learned, eventually competing with and pushing out its former partner, the U.S. company.

How important joint ventures are to this process is an open question. Sometimes, multinational companies agree explicitly to transfer their technology in exchange for access to the Chinese market, such as when European conglomerates Siemens AG and Alstom SA gave away their high-speed train technology to Chinese state-owned companies that proceeded to outcompete the Europeans.

But joint ventures are also probably central to tech transfer. This is the implication of a recent paper by economists Kun Jiang, Wolfgang Keller, Larry Qiu and William Ridley.

Jiang et al. used detailed data collected by the Chinese government to look at the consequences of multinational joint ventures. They examined the Chinese companies that form the partnerships, and evaluated their subsequent performance along a number of measures -- productivity, patenting, new product launches and exports.

Based on these metrics, Chinese companies did better after they formed a joint venture with a multinational. They were more productive, more innovative and expanded more aggressively into markets both domestic and overseas. Furthermore, Jiang et al. found that similar effects spilled over to other Chinese companies in the same industry, suggesting that Chinese companies somehow share the know-how they glean from foreigners.

How does this sharing work? It isn't clear, but one possibility is that the government has a hand in the process. Jiang et al. found that foreign companies tended to team up with companies that are heavily subsidized by -- and thus probably have close ties to -- the Chinese government. It seems very possible that the government pushes multinationals into joint ventures with state-affiliated companies precisely so these companies can appropriate the foreigners' technology and spread it to a variety of competitors, so that China rapidly comes to dominate the industry. Jiang et al.'s paper didn't prove this story, but it's certainly suggestive.

So one objective of U.S. trade policy should be to force China to immediately drop the joint-venture requirement for foreign investors in all industries. Joint-venture requirements are a particularly effective type of trade barrier, and the IP transfer they engender reduces American companies' incentive to innovate.

But even as the U.S. pressures China to drop joint-venture requirements, it should encourage joint ventures with U.S. allies in the developing world. India, for example, is at a much earlier stage of development than China, and thus needs foreign technology more than China (which could do much of its own innovation at this point if it was willing to make the effort). Because Indian companies have a more arms-length relationship with the government, they pose less risk of competing unfairly with the U.S. private sector. India is also a democracy and an important U.S. ally, so the U.S. has an interest in boosting growth there. Other poor countries in Africa and Asia, such as Ethiopia and Bangladesh, could also benefit from joint ventures with U.S. multinationals.

Joint ventures have proven to be an effective way of transferring technology across international borders. In the case of China, the U.S. has done more than enough transferring, and now needs to stop. But when it comes to U.S. allies with low-income levels, tech transfers should be seen as beneficial and pursued more aggressively.

To contact the editor responsible for this story: James Greiff at jgreiff@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Noah Smith is a Bloomberg Opinion columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.

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