SINGAPORE (July 22): Microchips, smartphone-testing robotic arms, wind turbines, solar cells, experimental glass made from crushed diamonds, Star Wars toys, chemical formulae for food colouring, data storage systems, firewall software — these are just some of the things Chinese companies have been accused of stealing from their Western counterparts.

As long ago as 1992, the George H W Bush administration persuaded the Chinese government to create laws to protect US companies’ intellectual property (IP). But copyright piracy remained rife and, over the last two decades, Chinese appropriation of Western innovations has become a major geopolitical issue. It is one of the key sticking points in the current trade negotiations between Washington and Beijing.

The issue is not clear-cut. Many foreign firms have been able to thrive in the lucrative Chinese market without giving up their most prized technology. In areas such as 5G networks and artificial intelligence (AI), Chinese technology is already superior to the Western equivalents.

But given the nexus of connections between Chinese companies and the state, along with the growing geopolitical tensions between China and the US, it seems likely technology will continue to cause friction between the two superpowers. So, what are the implications for investors in Chinese firms and their foreign competitors?

As China is such a powerful economy, the extent to which it can dominate every technological sector is a germane concern for companies, governments and investors. There are some things China is very good at and there are others where it is going to struggle without technology transfer. As investors, we have to treat it very much on a case-by-case basis.

The US government has become more vociferous in its criticisms of China in recent years and Chinese companies are regularly accused of taking Western technology. A recent CNBC poll found that one in five US companies believe Chinese firms stole their IP over the last year. More often than overt theft, appropriation of foreign ideas occurs via the officially sanctioned practice of “forced technology transfer” (FTT).

According to Dan Prud’homme, associate professor at EMLV Business School in Paris and the co-author of a forthcoming book on China’s IP regime, FTT takes various forms. “Lose the market” policies, for example, effectively outline a quid pro quo whereby foreign firms must agree to transfer technology or give up access to the Chinese market. Others leave foreign companies active in China with no choice but to relinquish their IP, through policies such as unfair IP civil litigation rulings and certain requirements to excessively disclose trade secrets directly to the state or state-organised panels as a precondition for regulatory approvals.

Needless to say, FTT is unpopular among foreign businesses and policymakers. A 2018 report by US trade representative Robert Lighthizer, which looked into FTT, cyber hacking and state-directed acquisitions of US firms by Chinese rivals, formed the basis for a round of sanctions imposed on Chinese goods by US President Donald Trump’s administration last summer. The European Commission is also taking action against FTT via the legal mechanisms of the World Trade Organization.

Beijing has already ceded some ground. IP courts and tribunals have been established across China in recent years, providing both domestic and foreign companies with a way of seeking redress for IP theft. And China’s foreign investment law was revised in March; it now requires Chinese government officials to keep confidential any trade secrets they learn during regulatory approvals, under the threat of criminal proceedings.

Governments and investors alike are keeping a close eye on the trade talks between US and Chinese representatives, which could result in further agreements on FTT. But while it may make some concessions, Beijing tends to bristle at the suggestion that it merely steals all its ideas — and with good reason.

China has invested heavily in high-quality education, and now produces 2.8 million science and engineering graduates, five times as many as the US (although the US still leads on a per-capita basis). Many of these graduates end up at leading tech companies such as Baidu, Alibaba Group Holding and Tencent Holdings — the so-called BATs — which are developing products and services to match anything on offer in the West, especially in so-called “online-to-offline” booking systems and integrated mobile payments.

In areas such as the internet, AI and payment systems, China is already more advanced than most Western countries. “Deep learning” and AI were first discovered in the US, but implementation and product development are being led by China. Chinese tech companies tend to be much more efficient than their Western rivals at building on existing discoveries and bringing new products to market, from mobile phones to LCDscreen televisions to consumer drones. This is partly because they have access to a vast population of tech-savvy consumers who are comparatively more willing to try out products and services compared with their peers in the West.

With US companies increasingly looking to China for inspiration — dockless bicycle sharing is just one idea that has crossed the Pacific from Guangzhou’s bustling tech scene to the start-ups of Silicon Valley — Chinese companies are beginning to defend their own IP as vigorously as their Western rivals, at home and overseas. The legal framework is improving, although work still needs to be done.

Western governments and companies routinely complain about the practice of FTT in China, but are these grumbles justified? And beyond the trade war, what does the future hold for Chinese tech innovation?

Not all sectors have been equally affected by FTT and research by Prud’homme shows that “lose the market” policies proved particularly effective in high-speed rail during the 2000s. He noted that foreign firms that participated in FTT during that time — Siemens, Alstom, Kawasaki and Bombardier — unintentionally helped create CRRC Corp, the Chinese company that now dominates the global high-speed rail industry.

But, in other sectors, Western companies have been able to use joint ventures with local partners to their own advantage. Take, for example, the car industry: Over the past 10 to 20 years, Western automotive companies have sounded alarms over technology transfer in China. In reality, they have benefited a lot from the opening and widening of the Chinese market, to a much greater degree than Chinese companies have benefited in terms of gaining technology. Since the financial crisis hit auto sales a decade ago, big US and European car manufacturers have sought access to the fast-growing Chinese market. For the most part, they have done so while successfully protecting their technology.

As part of its recent package of reforms, China has announced it will lift the 50% cap on foreign ownership of joint ventures; BMW says it plans to increase its half share in a venture with Shenyang-based Brilliance China Automotive Holdings to 75% when the law change comes into effect in 2022. Other car manufacturers such as Daimler are expected to follow suit.

The change in the rules signals the Chinese government is willing to see how domestic companies fare without the support of foreign branding and marketing expertise. Unlike Japan or South Korea, China has struggled to create a “national champion” auto manufacturer that can compete on the global stage, although companies such as Geely Automobile Holdings, which acquired Volvo in 2010, are fast progressing in electric car technology. Other Chinese firms have spied opportunities to make inroads in the global supply of auto parts, such as airbags.

China’s domestic auto parts industry is developing quickly — not so much because of FTT but through targeted investment and acquisitions. Shanghai-based Ningbo Joyson Electronic Corp, for example, has been on a buying spree, acquiring German and Japanese suppliers. It aspires to be a credible global competitor to Robert Bosch, Continental and Aptiv, although it has yet to prove it can make a serious impact beyond China.

The complaints over technology transfer have a sharper edge in industries such as IT, robotics and semiconductors, which have been prioritised by the Chinese government.

China is keen to upgrade its current manufacturing base, and as the country develops, it is aware of the risk of getting caught in the middle of the value chain between countries that offer low-cost outsourced labour and nations where manufacturing is of better quality, such as the US and Germany.

In particular, China wants to curb its reliance on foreign technology such as computer chips; it currently spends more on importing semiconductors than it does on oil. It has been unable to close the gap through foreign acquisitions, which tend to be blocked by wary Western governments. The US, along with South Korea, enjoys a commanding lead in chip technology and is fiercely resisting China’s attempts to buy expertise to catch up.

One consequence of such protectionism is that leading dynamic random-access memory chip makers have gained a defensive moat against fast-growing Chinese rivals, at least in the short term. Chinese companies, such as state-owned Fujian Jinhua Integrated Circuit, had been catching up with the biggest DRAM producers amid allegations of IP theft from Micron and others. But in 2018, the US government banned American companies from supplying it with parts, which made it impossible for Fujian Jinhua to operate.

Faced with these political obstacles, China may have to develop the requisite semiconductor expertise the hard way, through long-term investments in training and R&D (it has reportedly earmarked US$100 billion to US$150 billion of public and private funds for this goal).

Creating market-leading semiconductors has become harder as chips get physically smaller, which is slowing the progress of the leaders and may yet give China an opportunity to catch up. And emerging industries such as the Internet of Things do not require cutting-edge chips, only the kind of middling semiconductors China is already adept at developing.

What is more, the power of the US to maintain its lead through punitive measures on foreign companies is somewhat constrained by the intricate global supply chain for semiconductors — each chipmaker relies on several thousand specialised component suppliers. Consider Trump’s move to ban US firms from supplying Chinese telecoms company ZTE Corp, which had been accused of violating sanctions in Iran and North Korea. This brought the Chinese company to its knees — but so many US firms were caught up in the economic fallout that the ban was quickly reversed.

Gunpowder, paper, movable type, the compass, the mechanical clock, alcohol, silk, tea drinking, porcelain and toothbrushes: China has a long history of inventions that are copied by other nations. As it rediscovers its knack for world-changing innovations, the arguments over technology protection could soon become a two-way street.

This article is jointly written by Aviva Investors’ Alistair Way, head of emerging market equities; Alessandro Rovelli, senior corporate analyst; and Xiaoyu Liu, emerging market equities fund manager

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