Testimony of

Senior Associate, The Henry L. Stimson Center

Before the

Hearing on

SD-124, Dirksen Senate Office Building

Washington, DC

The US-China economic and security relationship is undergoing fundamental, structural change due to global economic forces. As a result, China may witness much more rapid development of its commercial –and, indirectly, defense industrial– capabilities than demonstrated by other developing economies. To meet this challenge, respond effectively, and avoid potential negative side-effects, US policymakers require better, more timely, and comprehensive data and analysis of emerging global trade dynamics and China’s efforts to exploit these trends. In particular, the rise of global R&D in commercial high-tech industries and the growing level of foreign R&D investment in China warrant greater US Government attention and resources.

As barriers to international trade and foreign investment are lowered under world trade rules, the very nature of international trade and investment is changing. Increasingly, multinational corporations (MNCs) are able to exploit foreign markets, labor pools, infrastructure, communications systems, and supply chains. As a result, numerous MNCs are expanding (and, in many cases, shifting) production lines overseas. Moreover, multinationals competing in these overseas markets are beginning to move up the value chain of production, which is leading to the distribution of more advanced manufacturing processes worldwide. This growing trade dynamic has begun to generate many questions and concerns –particularly during the current economic downturn– as more and more manufacturing jobs and related services move offshore, many of them to China.

But there is an additional dynamic that has emerged as a result of growing global trade that has yet to receive the attention it deserves: the increasingly global nature of commercial high-tech research and development (R&D). While the United States continues to enjoy an overall net inflow of R&D dollars, US companies in the year 2000 invested almost $20 billion in overseas commercial R&D (up from about $5 billion in the mid-1980s). This trend mirrors developments in other Western economies, which are also witnessing increased levels of inward and outward commercial R&D investment. Today, the percentage of foreign-funded R&D in the United States (15%) and in the U.K. (16.8%) is about double that of two decades ago (up from 6.2% and 8.7%, respectively, in 1981); similarly, Canada and most other OECD states have experienced a rise in commercial R&D investment from abroad.

In large part, the driving force behind the globalization of R&D is the need for commercial ventures to increase the value-added quality of the goods or services they are manufacturing and selling abroad. For this purpose, research, design, and development work is often best done (at least in terms of cost concerns) near to one’s production base. Thus, as manufacturing moves offshore, so too is industrial R&D. Generally, the R&D assets being added or moved abroad is not the most advanced or basic type of research work, which is for the most part still undertaken at the high-tech company’s home base. More often R&D conducted overseas involves various forms of technology development or applied research work. Other reasons MNCs establish offshore R&D ventures include the need to set up "listening posts" in other high-tech business centers (i.e., Silicon Valley and its equivalents abroad), for localizing foreign products to match local tastes, for training and marketing purposes, and in the China market, for improving guanxi (generally, building connections or relationships) and/or to meet continuing (if now less formal) technology transfer demands.

An important aspect of the global R&D dynamic, however, is its expanding international scope. R&D investments by multinational corporations are no longer limited to industrialized economies in Europe and Asia (or to close US allies). Today, the world’s leading high-tech companies are establishing commercial R&D centers in many parts of the developing world as well. Although the data concerning levels of foreign R&D investments abroad is very limited (even with regard to Western economies), it is becoming clear that countries in the developing world too, particularly China and India, are experiencing a rapid rise in the level of foreign R&D investment. According to a recent Stimson Center study, high-tech multinationals in the information communications sector have established over 200 separate R&D centers on the Mainland over the past dozen years (1990-2002). Other estimates place the overall number in China today at somewhere between 100 and 400 foreign-funded R&D sites. This growing trend represents a new stage in economic globalization, yet, its overall implications for US economic and security interests and US relations with China have not yet been fully explored. Meanwhile, China and other recipients of this potentially more advanced form of technology transfer are encouraging further R&D investment from abroad in hopes of accelerating the development of their own domestic high-tech industries and "knowledge-based" economies.

Finally, the ongoing revolution in information communications has helped fuel the growth in offshore manufacturing, services, and commercial R&D. In particular, high-tech industries that are heavily reliant on communications technologies (such as telecommunications or computer software development) have been able to take advantage of an increasingly global marketplace by employing the internet or other communications platforms to increase productivity while reducing costs and expanding their worldwide presence. For example, research teams connected electronically and collaborating on a single R&D project may be located in two or three or more different sites around the world, making it possible to conduct commercial research on a continuous 24-7 work cycle. Under this model, different research centers generally focus on select segments of the overall research project based on the particular skill set or other advantages and resources specific to each researcher or center. Oftentimes, the result from this type of collaboration is in intangible or electronic form (for example, computer software code), meaning it can be easily and rapidly transferred almost anywhere around the world.

All of these global trends –the growth of offshore manufacturing, global R&D, and the information communications technology revolution– present substantial potential economic and investment opportunities for US companies. At the same time, however, they present serious challenges to US trade and security policy, particularly in the area of export controls. Moreover, the still-limited data available on these global trends points to the need for a much closer examination of how they are impacting US interests at home and abroad.

The PRC has been a prime beneficiary of all of the above-described global trade phenomena due to its enormous market potential, expanding role in the world economy, and the Mainland’s many policies, programs, and incentive plans designed to take advantage of these new international dynamics. In fact, China may be uniquely positioned to benefit from today’s increasingly globalized marketplace. As a very large, generally stable, but still under-developed market, the PRC presents not only plentiful opportunities for foreign investment but also actively seeks high-tech investment from overseas, becoming in 2002 the world’s most popular site for foreign direct investment. In addition, China enjoys the advantage of a very large labor force that is not only comparatively cost-efficient but also includes an impressive and growing generation of skilled scientists and engineers (many of whom receive their degrees from US universities). These assets plus China’s own investments in infrastructure, market-oriented economic reforms, and the government’s emphasis on developing strategic high-tech industries has placed the PRC in an exceptional position to exploit the global trends outlined above – which is exactly what China has been trying to do.

The PRC’s selection of "pillar industries", its strategy of "picking winners" among China’s emerging high-tech or industrial enterprises, its incentive programs for certain high-tech industry and R&D investments (including tax credits, favorable land-lease terms, preferential loan programs, etc.), and other regulatory practices that affect both domestic and foreign investors are all part of an effort to reap the benefits of an increasingly global economy. Thus, it is likely, in my view, that China will continue to utilize these types of strategies in the future, at least as long as they are able to do so without incurring substantial costs in terms of foreign investment or international reputation.

Yet, while US attention is rightly focused on creating a more fair trade environment in the PRC and making sure that China lives up to its considerable commitments under the WTO, our attention should also be focused on (and we should be preparing for) the potential for China to advance far more quickly in terms of developing its own high-tech industry –and, indirectly, it defense industrial capabilities– than has been demonstrated by other developing economies in the past. Because China is so well-positioned to exploit the global dynamics described above and has adopted development strategies designed to do so, already there are Mainland competitors emerging in critical high-tech industries such as computer software development, telecommunications, and low-end semiconductor manufacturing. There is no doubt that much of this capacity is due to foreign investment and technological input (which could conceivably be withheld if deemed necessary, but would be extremely costly in many ways). But it is also clear that a number of Chinese enterprises have already moved beyond their dependence on foreign partners and are gaining substantial market share in critical high-tech sectors in China and beyond long before many would have predicted. Therefore, it arguably makes greater sense to focus our resources on trying to prevent possible technological surprise in the case of China than on trying to obstruct China’s technological advancement (an increasingly difficult prospect). For if we are better able to gauge China’s high-tech trajectory, the United States can continue to trade with China armed with a growing confidence that we understand the impact US technology transfers may be having on China’s development, while ensuring that we remain ahead of the curve (with the added benefit of economic growth at home). But if we are to run faster, we need to know how far, how fast, and in what direction.

Added to this dynamic is the growing influx today of foreign scientific and technological know-how and equipment to China (and other parts of the world) that is integral to conducting high-tech commercial R&D, whether at home or overseas. This could serve as an important, additional accelerant in China’s plans to modernize its economy, industry, and military (although China’s past efforts at assimilating foreign technology demonstrate that this is by no means certain). The best evidence of this potential is the United States, which emerged as a bona fide world power following World War II mainly due to the enormous federal investments made in basic science and engineering as well as the increased collaboration that took place among industry, academia, and government researchers during and after the war. This lesson has not been lost on China or other nations that aspire to create more advanced industrial and knowledge-based economies such as ours. Today, however, it is likely to take far less time to achieve; such is the advantage of late developers. Once again, the challenge it poses for US policymakers is not how to prevent China’s technological advancement, but how to stay ahead of it.

• Realize that changing global trade dynamics are already impacting US-China relations.

• Conduct a US innovation survey to aid assessment and monitoring of America’s high-tech edge.

The global economy presents the United States with great opportunity to enhance our economic and security interests as well as serious, long-term challenges. According to recent remarks by China’s Foreign Minister, Li Zhaoxing: "China is willing to step up dialogue and cooperation with the US side in economy, trade and finance with a view to continuously propelling the stability and growth of the economies of both countries and the world in general." The United States should take China up on this offer.