Foreign technology transfers to China

China is getting more innovative by the day, but still needs foreign technologies.

In recent years, China has made the headlines worldwide for some of its achievements in terms of science, technology and innovation. Chinese companies filing record numbers of patent applications, making waves in the digital sector with numerous unicorns, China landing a robot on the far side of the Moon etc. ? It’s about time! ? should we all probably think, as China’s authorities and companies have spent billions and billions of dollars in R&D in recent years and continue to do so (see Innovation in China: Risks and Opportunities for foreign companies)

Many are also appropriating foreign technologies via technology transfer contracts, as attested by the huge amount of royalties transferred abroad. China's external payments of IPR royalties rose 24 percent year on year in 2018 to 35.8 billion USD, resulting in a deficit of 30.2 billion dollars, the latest data from the State Administration of Foreign Exchange (SAFE) showed. This marked an average annual growth of 22 percent from 1997 to 2018 in the IPR royalty payments.

A growing uneasiness

Spillover is always a challenge for foreign players, but in the heydays of the “opening policies’, fascinated by the market potential, many shrugged off China’s policies bias, less than respectful behavior of local partners, and indelicate employees (31.4% of German companies interviewed in the latest German Chamber Business Confidence Survey expressed fear of IP theft by employees). In the past couple of years, the view has changed, or at least, the issues have become more visible. The Chinese government has made clear it does not want to be dependent on foreign technologies in many (all?) sectors, putting in place policies in favor of “indigenous innovation”, and even plans to be a dominant player worldwide, as quite explicitly stated by the Made in China 2025 policy.

This new attitude came with the realization that some local competitors have caught up, as shown in the 2017 Business Confidence Survey (BCS) of the EUCCC. Then, ? over half of respondents expect Chinese firms to have closed the gap in terms of their capacity for innovation by around 2020 – while this catching up is most likely to occur in services, with breakthroughs in industrial goods taking longer”. This movement increased in the following year, as the 2018 BCS indicates: “Although European industrial goods and services firms have been relatively skeptical about Chinese innovation capacity int he past, their perceptions drastically changed over the past year. Nearly double the share of respondents in this sector said that local firms are more innovative in products/services compared to 2017 ?.

Attesting how problematic this issue has become, the BCS had for the first time a section about ? Unfair Technology transfers ? in which it noted that ?19% of respondents have felt compelled to transfer technology in exchange for market access. Up until now, China has pursued an implicit strategy of trading domestic market share for new foreign technology in order to improve its technological capacity ?.

This is very much in line with the findings of the US-China Business Council 2017 Business Survey, which indicates that “Tech transfer to gain market access is an acute issue for those who face it; nearly 20 percent have been asked to transfer technology during the past three years. JV requirements and government approvals provide leverage to China.”

This new market condition also goes hand in hand with the growing realization that technology advance is not necessarily a key competitive advantage in a country that is still not that developed, and where price sensitivity is a very important factor. It is also the case when it comes to the Belt and Road Initiative, where most of the projects do not need the most advanced technologies, and what the Chinese companies are offering is “good enough” for the local conditions, not to mention favored by the Chinese financing institutions.

Forced technology transfers?

A recent study of the OECD tells us that “While there are clearly questions of degree, forced technology transfer can involve situations in which the owner of a technology (e.g. an investor or licensor) is required to transfer technology either to be permitted to operate under the same conditions as local firms or to access the market at all. Therefore, although the transferor of technology might choose to transfer technology to overcome serious obstacles, and a degree of consent might therefore be involved, the obstacles may still be viewed as forcing the owner’s choice to give away proprietary technology”.

This issue has taken the center stage as one of the main reasons for the commercial conflict between the US and China, since the USTR 301 report published on March 22, 2018 which detailed the US administration findings about it, and imposed increased tariffs on certain goods of Chinese origin in several tranches. In June 2018, the European Union challenged in the World Trade Organisation (WTO) “the systemic practices that force European companies to give up sensitive technology and know-how as a precondition for doing business in China”.

As explains Dan Prudhomme in his recent article “Forced technology transfer” policies: Workings in China and strategic implications, these policies are not always successful. They can even have the opposite effect, foreign companies refusing to invest because of them, and shying away from China. Indeed, we learn from the Amcham 2019 China Business Climate survey report that for 13% of its members, “Intellectual Property localization requirements and/or technology transfer requirements prevent them from increasing innovation in China”.

New regulatory developments

Recently, perhaps as a way to appease the US and EU, some regulatory changes have been adopted.

- New foreign investment law and in particular its Article 22:

Its second paragraph states: “The State encourages technological cooperation to be conducted in the course of foreign investment and on the basis of the principle of voluntariness and business rules. The conditions for technological cooperation are to be determined through consultation by the various parties to the investment on the basis of equality and the principle of fairness. Administrative organs and their employees must not force the transfer of technological through administrative measures.”

This seems to address a longstanding involvement of the authorities (but not only at the local level), as echoed by US- China Business Council members who, to the question “Who asked for your technology to be transferred?” answered: 67% Company, during negotiations; 33% Central government entity; 25% Local government entity. As I pointed out in a previous article (“Is article 22 of the new Foreign Investment Law a game changer for IPR owners?”), it actually won’t have much impact, if any.

- Amendment of the TIER regulations

On 18 March 2019, the State Council released the Administrative Order 709 which introduces in its paragraph 38 different amendments to the Regulation on the Administration of the Import and Export of Technologies (“TIER“) with immediate effect. Three articles in the import section of the Regulation were removed, namely Article 24(3), Article 27, and Article 29 (for details, see https://www.wipo.int/edocs/lexdocs/laws/en/cn/cn125en.pdf).

As Mark Cohen explains, TIER has been a subject of debate for nearly 20 years, and recently the TIER was itself part of ongoing WTO disputes already mentioned in this article. De facto, these changes re-equilibrate the relationship between foreign licensor and licensee, letting the market play its role with the Contract Law taking center stage.

A new era?

Technology transfers contracts should be (a bit) easier to negotiate from now-on, but companies wishing to avoid the still numerous legal hurdles (as well as some local business practices which might be somewhat surprising to a foreign player) would do well to retain the services of a reputable law firm to advise them during the different steps and aspects of the negotiation.

Furthermore, what the past 10 years experience should illustrate is that a technology transfer to China is not a simple business deal. Decision taken today may have long lasting effects. It is more important than ever to assess the short term benefits versus the mid/long term risks. The railway industry might be a cautionary tale in this regard. After having massively transferred technologies since 2004, the market opportunities promised in China never really materialized. Furthermore, the now technology savvy Chinese (state-owned) conglomerate is competing abroad with the foreign makers, with the added (unfair) competitive advantage of a strong backing from the Chinese authorities (massive subventions, very competitive financing for projects by Chinese banks etc.). As a result, according to the representative of the Rail Security Alliance (a coalition of North American railcar manufacturers, suppliers, unions, and iron and steel interests), as some American cities consider buying Chinese equipment, factories in the US are closing down and workers let go...