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China regularly forces us to check our assumptions about how the world works. The country’s return to regional and global prominence challenged preconceived notions (in the West) about leadership. Then, there was the stubborn defiance of expectations that one-party communist rule would give way to democracy. Sharpening tensions between China and the West (and its neighbors) reflect a whole series of inaccurate priors about ways that Beijing’s policies would evolve.

Now, China is forcing us to reassess how capitalism works and how the world should adjust to its refusal to mimic Western corporate and business practices. These differences assume great significance in the race to catch up with and overtake the West in the development of leading-edge technologies. Make no mistake: China is in many important ways a capitalist country; but Chinese capitalism is a very different animal from that practiced in the West.

Let’s start with some shibboleths and misperceptions. First, there is a belief that China can’t innovate and its technological progress is the product of massive intellectual property theft from the West. Proponents of this theory either rely on simple prejudice or China’s use of administrative provisions to force companies that want to do business in the country to turn over technology.

They are wrong. Historically, the Chinese were extraordinary innovators, inventing paper, printing, the compass and gunpowder. Lee Kai-fu, former head of Google China and now a venture capital investor in China, argues that “Chinese companies are innovating as much as the American ones.” They “use their scale, spending, and efficiency at the grunt work level, … (burning) cash like crazy and (relying) on armies of low-wage delivery workers to make their business models work,” he said. This “alternate internet universe” befuddles “analysts entrenched in Silicon Valley orthodoxy.”

Lee concedes that “the Chinese culture does not frown upon copycatting as much as Americans do,” but adds that “that is more of a cultural issue, not a business one.” Dubious of Lee’s conclusion? Then listen to Eric Schmidt, former chair of Google. He worries that China is poised to overtake the U.S. in key fields such as artificial intelligence in a few years.

Second, the charges that China illegally acquires all its technology are wrong as well. While theft is an issue, every credible economic historian acknowledges that China’s behavior is no different from that of other developing countries. (Be wary of the often-cited claim that China has “stolen” $600 billion in intellectual property from the U.S. It’s exaggerated and inexact.) Laggards, the U.S. included, always engaged in industrial espionage. Capable governments — Japan and South Korea prime among them — imposed limits on foreign direct investment that capped ownership of domestic companies and obliged investors to share their intellectual property.

And while virtually every poll of companies operating in China has a significant number complaining about pressure to transfer technology in exchange for market access — about 20% in both American and European surveys — purists counter that “forced” transfer is nothing of the sort: Companies chose to do business in China and they accept deals that include tech transfer or ownership limits.

Still, “defensive” efforts to protect the domestic market and national competitors are worrying. An April 2021 report from the European Council on Foreign Relations explains that they create “a vast yet protected base for Chinese firms to grow unimpeded by the pressure of foreign competition — and, in turn, to enter foreign markets from a position of strength.” Protected companies generate revenue and can invest in future innovation, grow in scale and technical proficiency. They are shielded from foreign demand shocks. This shelter means more in network economies in which first movers enjoy tremendous advantages.

China has truly innovated on the offensive side of the equation, particularly with the deepening integration of the Chinese Communist Party (CCP), and subsequently the state, into the business sector. The first, somewhat traditional, expression of this tendency is the role of state-owned enterprises (SOEs). Once thought to have been doomed by the economic reforms of the ‘90s — those expectations again — China is now determined to create national champions. Rather than being pruned, those behemoths are expanding: According to one report, the average size of the largest 100 conglomerates in China increased from 500 companies to more than 15,000 between 1995 and 2015.

With executives, directors and managers appointed by the party, these organizations are often viewed as extensions of the government. In many cases, top executives are party officials. While they sometimes make decisions that reflect corporate rather than state interests, there are boundaries on discretion, limits that have tightened in recent years. Just ask Jack Ma.

The reach of the party/state is not restricted to SOEs. The PRC corporation law calls for Communist Party cells in private companies too, and there is no transparency regarding the power and influence of these groups in the management and operation of those businesses.

Jude Blanchette, China chair at CSIS, the U.S. think tank, argues that “changes to the political, regulatory, and financial architecture that underpin China’s state capitalist system have been so pronounced that it is time to replace the existing ‘China Inc.’ framework with ‘CCP Inc.’” He added, this “dizzying mix of public, private, and hybrid-ownership firms” makes it “almost impossible” to say “with any precision where CCP influence ends and where firm autonomy begins.”

For Hao Peng, party chair of the State-owned Assets Supervision and Administration Commission of the State Council, which oversees all state-owned companies, the rules are simple. “Regardless of whether state-owned or private enterprises, they are all Chinese enterprises. (We) will firmly promote the upstream and downstream integration of firms of various ownership structures, the integration of large, medium, and small, and the coordinated and innovative development of various market entities to jointly build a group of world-class enterprises.”

Trey McArver, a business advisor, bluntly told the Financial Times a few years ago, “No company, private or state-owned, gets ahead in China without aligning itself with the party’s larger goals and strategies. That is more the case than ever in Xi’s China.”

That impact of the alignment is increasingly clear. A study by the Office of the U.S. Trade Representative concluded that “private companies’ overseas investment decisions are… strongly influenced by the Chinese government’s decision to encourage or restrict a given overseas investment sector in line with the country’s industrial policy.” The study went on to say this is “a wide-ranging, well-funded effort to direct and support the systematic investment in, and acquisition of, U.S. companies and assets to obtain cutting-edge technology, in service of China’s industrial policy.”

Much of this, it must be stressed, is not illegal — or wasn’t. That is why governments in Washington, Tokyo, London and Berlin (among others) have revised laws regulating foreign investment or created regulations to scrutinize university research.

There is a more basic issue, however. Chinese companies are practicing a different form of capitalism. Their decisions are not guided by the same impulse to maximize profit or shareholder value as are those of their counterparts. The protections and support they enjoy from the Chinese government are somewhat familiar — and in some cases subject to regulation by bilateral and multilateral trade and investment regimes — but the guiding principles are alien. How does that gap in perspectives and intentions transform the fundamental bargain at the heart of a business deal?

Legal scholars Jeffrey Gordon and Curtis Milhaupt conclude that “the multilateral trade and investment regimes that took shape in the postwar period simply do not contemplate this type of actor.” They’re optimistic about the prospects for reform of those institutions, however. Mark Wu, a Harvard law professor who is now an advisor to the USTR, is not. He believes that “China’s distinctive economic structure” poses a “systemic challenge” to the global trade regime and fears that governments will increasingly resort to megaregional trade agreements, like the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), instead. The collapse of the WTO regime, he warns, is a real danger.

One option is inclusion of chapters on corporate governance in bilateral trade and investment deals. The Japan-European Union Economic Partnership Agreement is one example. But any deal — bilateral, minilateral or multilateral — requires Chinese acquiescence. That is a long shot when Chinese companies benefit from the status quo. Recognition of the inequities that exist and the need for a remedy is a critical first step.

Brad Glosserman is deputy director of and visiting professor at the Center for Rule-Making Strategies at Tama University as well as senior advisor (nonresident) at Pacific Forum. He is the author of “Peak Japan: The End of Great Ambitions” (Georgetown University Press, 2019).

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