China’s continued development and geopolitical rise, though impressive and seemingly globally-minded, serve as a reminder that its dual economic and security-focused interests remain a threat undermining both competitors and trading partners.
In May of this year, the US Department of Defense released its annual report on China’s military capabilities, entitled, “Military and Security Developments Involving the People’s Republic of China 2012.” The report outlines a growing and emerging Chinese military focused on obtaining Western dual-use and military technologies by any means. The report asserts, “Chinese actors are the world’s most active and persistent perpetrators of economic espionage.” Adding, “Chinese attempts to collect U.S. technological and economic information will continue at a high level and will represent a growing and persistent threat to U.S. economic security.”
Unsurprisingly, China vociferously objected to the report’s contents and being labeled a “growing and persistent” threat. Nevertheless, a more accurate depiction is not that China is a threat to the US but it is also a threat to any foreign nation state possessing technology China lacks.
China’s Automobile Industry
China’s modernization and economic exports remain fundamental to its growth strategy, however, efforts to both supply products to domestic consumers and prevent foreign companies from establishing a foothold at home are a priority-no matter how welcoming the Chinese appear on the surface. Enhancing the development and quality of domestically built automobiles falls under the strategic domestic priority category. Chinese firms, though, lack the technological know-how to ensure reliability and purchasing loyalty.
China’s domestic automotive industry has experienced a tremendous boom in the past few years. As disposable income continues to rise, so has demand for automobiles. In 2008 alone, for example, the state-owned Chinese firm, Beijing Automotive Industry Holding Company (BAIC), saw an increase in profits by more than 700 percent. Annual production of automobiles doubled and the production outlook suggested that by 2015, BAIC will be manufacturing nearly 4 million cars. China’s export-base for automobiles is relatively small relative to the global market.
Nevertheless, in April of this year, Chinese automobile exports approached 900,000 units, an increase of 50 percent from 2010. Continued growth is projected, as Chinese firms continue to build low-cost trucks and cars often priced from $6,000 to $15,000.
Growth expectations supporting an increase in exports continue to garner foreign direct investment. In fact, adding capacity in China is increasing with some analysts expecting exports to go from 18.5 million units in 2011 to 30 million by 2020. With cheap labor, low production costs, and Beijing welcoming economic insourcing, global auto manufactures are seeking the economic advantages of production in China, even as domestic demand for automobiles in China appears to be teetering downward.
Western Auto Technology Targeted
Western auto industry manufactures, including General Motors (GM), Ford Motor Company, and Volkswagen have all claimed to be commercially sabotaged or victims of Chinese economic and industrial espionage, citing that vitally important hybrid and electric car technology has been siphoned away. While a significant portion of Chinese economic and industrial espionage efforts have recently been conducted in the cyber realm, it is important to point out that not all efforts are technically sophisticated or exclusively reliant on connectivity for execution and penetration.
In GM’s case, two Chinese employees were found photocopying thousands of documents on hybrid technology of which many were destroyed before the perpetrators were caught. The sum total of the breach remains unclear, as when authorities interceded documents regarding hybrid technologies were the only ones found. The accused were indicted in July 2011. According to the charges, from December 2003 to May 2006, Shanshan Du conspired to obtain trade secrets about GM’s hybrid vehicle technologies, successfully passing that information to her spouse, who then approached Chinese car manufacturer, Chery Automobile Company, attempting to sell the hybrid technology. In Ford’s case, engineer Xiang Dong (“Mike”) Yu was sentenced to six years in prison in 2011 for trying to smuggle 4,000 documents, including design specifications, from the US to China. Yu pleaded guilty to stealing trade secrets, was fined, and received more than 5 years in prison.
The Volkswagen Veneer
Volkswagen too has become a victim of Chinese economic and industrial espionage. However, the case is slightly different, as Volkswagen itself established the sieve of Chinese technology recipiency. Volkswagen established a joint partnership with the Chinese automobile company, First Automobile Works (FAW), in 1991. The partnership provided Volkswagen a 40 percent ownership stake in its Chinese subsidiary, Volkswagen-FAW Company. The decision to create such a partnership was an effort to properly enter and hopefully establish a dominant foothold in the Chinese domestic automobile market. In order to do so and under current Chinese law, Volkswagen utilized manufacturing plants in China. China’s domestic market was rapidly expanding at the time and continues to be seen as extremely lucrative for foreign car companies like Volkswagen. By 2011, the importance of the Chinese domestic market was clear, as Volkswagen was delivering more than 2.2 million cars to China.
A domestic foothold may have been lucrative and all too clear in the short-term, however, the consequences of a partnership also became clear in July of 2012. A July report claimed Volkswagen’s partner had perpetrated a “systematic and planned” campaign to steal proprietary trade secrets and Volkswagen engine designs. An unnamed Volkswagen manager is reported in the press admitting that the loss was “quite simply a catastrophe.”
Capitalism with Chinese Characteristics
To add insult to injury, FAW now plans on going out on its own and competing directly against Volkswagen. FAW will replace engines once provided by Volkswagen with a Russian substitute. Officially, Volkswagen is downplaying the issue in hopes of finding some sort of resolution. A Volkswagen spokesperson explained in July, “We’re examining the issue very closely…we’ve always worked together with FAW very successfully and very trustfully in the past.”
FAW has effectively stolen the designs for the Volkswagen EA 111 engine, and it is highly probable it will use it to develop an FAW engine, eventually to be sold in China as part of a standalone product. At present, FAW already maintains the industrial infrastructure and manufacturing capacity necessary to become the dominant provider and direct competitor to Volkswagen, with a major factory in Changchun, China, and a vehicle output which exceeded 2.3 million units, in 2011, making it one of the top three Chinese vehicle producers.
The Market Consequences
The Chinese propensity to illegally acquire automotive technology will continue to have huge implications for the market as a whole. Industries and individual companies are having profit margins and growth projections upended by the nefarious, calculating, and criminal activity of numerous Chinese state-run companies. The examples mentioned demonstrate a wanton disregard for normative economic and competitive behavior, while demonstrating that acquisition through theft is simply fair game.
American Superconductor Corporation (AMSC) had been selling most of its turbine controller technology to China’s wind power company, Sinovel, since 2005. In March, Sinovel stopped purchasing turbine technology from AMSC. In July, it was discovered that the Chinese firm had stolen the technology and built its own factory to produce the controllers without AMSC involvement. Apparently, AMSC employees found that one of its power converters had been switched for a near exact replica. The part had been manufactured by Dalian Guotong Electric Company, founded by Han Juliang, the President of Sinovel. On further inspection, it was found to contain AMSC’s main control system software that had apparently been reversed engineered. By September 2012, and as a direct result, AMSC’s shares dropped 84 percent.
The Western Long March Home
Chinese economic and industrial espionage leveraging various operational venues, including insider threat, profit motive, honeytraps, and bureaucratic regulations to achieve quasi-economic warfare is unlikely to stop. In fact, it will likely continue to grow across the board, across industries, and include any means possible, especially when opportunities for low-hanging fruit emerge even outside the cyber realm.
The US and the EU can prosecute individual actors in the commercial espionage schemes, as it has before in the DuPont theft of TiO2.The five DuPont defendants conspired to sell information on DuPont’s trade secrets to Pangang Titanium Industry Co, a Chinese state owned company, so it could develop a large-scale titanium-oxide factory in Chongqing, China. The company began building the plant in 2010, with the first phase scheduled to be commissioned at the end of this year, according to Pangang’s website. The five employees are awaiting trial. Even so and as the outcome of the case is pending, the damage has already been done, and sending a few individuals away doesn’t deter, detract, or dissuade the strategic priorities of a state whose developments and progress are based on the advances and breakthroughs of others.
Whether or not China is pushing for state-sponsored economic and industrial espionage, particularly in the manufacturing and automobile industries, is secondary only to the loss-benefit calculation the activity engenders. Pointing a finger at China is easy and warranted, however, it’s a much more complicated situation than a simple finger waggle. Western companies are simply unable to directly and explicitly link the industrial and economic espionage efforts back to the Chinese government. All indications suggest that there is a massive and directed effort by the Chinese state to support efforts by national companies to illegally acquire technology and trade secrets. However, without a smoking gun, China maintains a certain degree of deniability.
China’s continued rejection of insinuations or direct accusations that recognize the Chinese government of complicity in illegality indicates the first moves of a bureaucratic chess game the Chinese are masters at playing. If China was sincerely interested in slowing illegal business activity, bureaucratic measures could be the impetus to reform. Specifically, Chinese law mandates that foreign automobile manufactures are required to build their own cars but that companies must do so under the guise of a partnership or joint venture with domestic Chinese entities. In doing so and since such Chinese partners are required to maintain a majority share of the joint venture, it seems patently obvious that such regulations are aimed at ensuring China acquires technology, expertise, and know-how in exchange for allowing foreign firms access to its lucrative domestic market.
Of course, access and profitability can happen only if foreign firms are able to operate without the fear of being pilfered. Companies signing such joint ventures are walking themselves into dangerous territory, as they know full well they are sacrificing long-term competitive advantages for short-term profits. The US and Western nations are engaged in an unofficial but ongoing industrial and economic war with China. At present, it appears that China is winning. However, it is one thing to be able to mimic technology; it is another to invent it. A parrot’s cage is the mind of the one it copies.