Evan Soltas
Apr 5, 2012

Technology Take-Out

Are Chinese policies hurting American innovation? A response to Noah Smith

Bustling Beijing
Noah Smith asks a great question: "Why should China bother with innovation when it can just steal technology?" His view, and I agree, is that it's in China's national interest to continue its tolerance of corporate espionage and intellectual property theft. To summarize, as long as China knows there's no credible threat of retaliation from its trading partners and that it will benefit from theft and imitation more than innovation, then it will continue playing the game with such a strategy.

Noah also worries about the effect of China's actions on innovation:

[I]n a world where China just steals everything, companies might as well just not innovate. Since companies are responsible for a substantial portion of the innovation in the world, this would be bad for China, since it would slow global economic growth, reducing demand for China's exports, investment into China, etc. It would also "kill the goose," forcing China to either rely on domestic innovation or accept slower productivity growth.
This weekend, I linked to a study about how patent law influences innovation, and said I'd want to come back to the topic soon. So here we are. The study says, in short, that patent law is vitally important to growth in mature economies -- not just in the quantity of innovation, but in the direction of innovation. "[I]nventors in countries without patent laws focused on a small set of industries where patents were less important, while innovation in countries with patent laws appears to be much more diversified," writes economist Petra Moser. Moser also writes that patent laws "may alter existing the patterns of comparative advantage between countries."

Moser's work suggests that the influence of Chinese intellectual property theft may be more complex than simply killing innovation. If we consider it similar to the repeal of patent laws, then history suggests that American innovators may shift resources out of any fields where patents are essential to covering the costs of research and development. Given firms which innovated efficiently -- i.e. to maximize firm profit -- before the change in patent enforcement, I see a rather strong case that the rate of technological progress, productivity growth, and the trend of real output growth could all be reduced.

Another way limited patent protection may direct innovation is based on where imitation is rapid and cheap. One older study which I found estimated that 36 percent of research and development expenditure would have not occurred without patent protection. The effect of patents on innovation, it also suggested, is highly concentrated -- in most industries, imitation occurs within months; in 15 percent, though, it can take up to 4 years. It is in those sectors where we should worry most about China hurting innovation in the United States.

In May 2011, the U.S. International Trade Commission published a report I found online entitled "China: Effects of Intellectual Property Infringement and Indigenous Innovation Policies on the U.S. Economy":

Based on U.S. border seizure statistics, China has become the primary source of IPR-infringing imports entering the United States...For example, U.S. receipts from royalties and license fees, which represent payments for U.S. intellectual property and technology, yielded a $64.6 billion trade surplus in 2009. However, receipts from China represent a small share of this surplus. Industry and academic sources report that this is in large part due to weak IPR enforcement...Despite the fact that IPR infringement in China and China’s indigenous innovation policies have been central themes in the  recent U.S.-China trade policy dialogue, no studies to date appear to have focused on estimating their impact on the U.S. economy.
The Commission's report went on to estimate the direct cost of Chinese policy at $48 billion in 2009, with confidence interval between $14 and $90 billion. 76 percent of these losses came from lost sales, whereas 24 percent came from unpaid royalties, license payments, and other related costs. The commission also said that the sectors which faced the highest costs were information and high-tech and heavy manufacturing, at $27 and 19 billion in 2009 respectively. The bulk of these losses -- $24 billion -- came from copyright infringement, and not in trademarks or patents, or trade secret theft. We're talking, largely, about Chinese distributors copying illegally Western movies and other media for distribution in China. Trademark infringement was strongest in consumer goods. High-tech, chemical, and heavy manufacturing were most concerned about how China's "indigenous innovation policy," which facilitates IPR infringement.

I'm hopeful, though, that intellectual property theft won't be the best strategy for China much longer. Noah pointed out that the returns to theft should diminish as China's level of technology approaches that of the United States.

China has been able to more or less compel American firms to let them steal, due to the low wages and production costs there in the 2000s. Now that that advantage is vanishing, I wouldn't be surprised to see a lot more multinationals exercising discretion, and not investing in China when the threat posed by intellectual property theft is a significant cost.

Other studies, too, suggested that lax protection of intellectual property may be a "middle-income country thing," as such countries become more innovative through imitation. This seems to be the case in China, with foreign direct investment working as a vehicle of technology transfer "via spillover channels such as reverse engineering, skilled labor turnovers, demonstration effects, and supplier–customer relationships." One caution to the emergence of Chinese innovation is that much of it seems very superficial -- the study notes the rise is limited to only "minor innovation" in external design patents -- and very much dependent on continued FDI. One study, published in 2008, reports that patent laws are being strengthened and that patent filings in China are soaring -- but it's not clear whether this will remedy the concerns of American firms.