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2005

CHINA’S HIGH TECHNOLOGY DEVELOPMENT

HEARINGS

BEFORE THE

U.S.-CHINA ECONOMIC AND SECURITY 

REVIEW COMMISSION

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

APRIL 21 AND 22, 2005

Printed for the use of the 

U.S.-China Economic and Security Review Commission 

Available via the World Wide Web: http://www.uscc.gov
U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION

Hon. C. RICHARD D’AMATO, Chairman 

ROGER W. ROBINSON, Jr., Vice Chairman 

CAROLYN BARTHOLOMEW, Commissioner 

GEORGE BECKER, Commissioner 

STEPHEN D. BRYEN, Commissioner 

JUNE TEUFEL DREYER, Commissioner 

THOMAS DONNELLY, Commissioner 

Hon. PATRICK A. MULLOY, Commissioner 

Hon. WILLIAM A. REINSCH, Commissioner 

Hon. FRED D. THOMPSON, Commissioner 

MICHAEL R. WESSEL, Commissioner 

LARRY M. WORTZEL, Commissioner

T. SCOTT BUNTON, Executive Director 

KATHLEEN J. MICHELS, Associate Director

The Commission was created in October 2000 by the Floyd D. Spence National Defense Authorization Act for 2001 sec. 1238, Public Law 106–

398, 114 STAT. 1654A–334 (2000) (codified at 22 U.S.C. sec. 7002 (2001)), 

as amended, and the ‘‘Consolidated Appropriations Resolution of 2003,’’ 

Public Law 108–7, dated February 20, 2003. Public Law 108–7 changed 

the Commission’s title to U.S.-China Economic and Security Review Commission. 

The Commission’s full charter is available via the World Wide Web: http:// 

www.uscc.gov. 

The Commission’s Statutory Mandate begins on page 334. 

(II) 
iii

1The Commerce Department defines approximately 500 product codes as ATP. These products 

fall into 10 categories: biotechnology; life sciences; opto-electronics; information and communications; electronics; flexible manufacturing; advanced materials; aerospace; weapons; and nuclear 

technology.

U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION

JUNE 29, 2005

The Honorable TED STEVENS, 

President Pro Tempore of the U.S. Senate, Washington, D.C. 20510

The Honorable J. DENNIS HASTERT, 

Speaker of the House of Representatives, Washington, D.C. 20515

DEAR SENATOR STEVENS AND SPEAKER HASTERT:

On behalf of the U.S.-China Economic and Security Review Commission, we are pleased to transmit the record of our April 21–22, 

2005 public hearings held in Palo Alto, California. The hearing entitled ‘‘China’s High Technology Development’’ provided revealing 

insights into China’s advancement as both a technology producer 

and innovator, and into the related challenges to U.S. technology 

leadership. The Commission examined how these developments 

may affect the U.S. economy, standard of living and national 

security. 

This venue was chosen because of Silicon Valley’s role as the epicenter of the U.S. technology industry. The Commission heard from 

representatives of California technology and venture capital firms, 

leading trade associations for the electronics, semiconductor, and 

information technology industries, and specialists on China’s technology development strategies and U.S. technology trends. The 

Commission also heard from senior officials from the State Department and the National Science Foundation who presented their 

agencies’ official assessments of China’s science and technology trajectory. Lastly, the Commission discussed China’s ongoing weaknesses in protecting intellectual property rights (IPR) and the implications for U.S. industry and China’s technology development 

with representatives of the California-based U.S. entertainment industry and observers of China’s IPR developments. The Commission was honored that former Secretary of Defense William J. 

Perry began the hearing by offering his analysis of the close link 

between U.S. military superiority and U.S. technology leadership. 

Over the two-day hearing, the Commission heard extensive testimony highlighting the following:

• China has become central to the global supply chain for technology goods of increasing sophistication, and its technology research and development activities are steadily and substantially expanding. 

• China’s production and export of advanced technology goods 

have produced a fast-growing surplus in trade with the U.S. in 

advanced technology products (ATP) 1 that reached $36 billion 

in 2004. 
iv

• Advances in China’s technology infrastructure and industries, 

along with similar advances in other developing countries, pose 

a significant competitive challenge that has begun to erode 

U.S. technology leadership. 

• Maintaining U.S. technology leadership is vital to both U.S. 

global economic leadership and long-term U.S. military 

superiority. 

The Importance of Technology Development to U.S. Economic 

and Security Interests 

Panelists testified about the critical importance of technology development and innovation to the U.S. commercial and defense base, 

stating that technology improvements drive about half the U.S. 

GDP and two-thirds of its productivity gains. 

Former Defense Secretary Perry expressed his concern about the 

decline in Department of Defense (DOD) spending for technology 

research and development (R&D), characterizing this as a national 

security concern that also adversely affects our commercial competitiveness. Dr. Perry noted that basic research (creating new 

technologies rather than applying existing technologies in new 

ways) is critical to generating future technological advances, but 

that nearly all R&D currently undertaken by industry is focused on 

product development. He recommended enhanced federal funding 

of basic research in order to maintain a strong national basic research environment. 

U.S.-China Trade and Investment 

In 1998, U.S.-China trade in items with the highest R&D and engineering content was roughly in balance. However, by 2004, the 

U.S. had amassed a trade deficit with China in ATP items of $36 

billion. In the information technology and communications sector, 

the deficit was $39 billion, offset by small surpluses in semiconductors and commercial aircraft. The level of technology in China’s exports also is increasing. Panelists testified that from 1995 to 2004, 

China’s high and medium-high technology exports increased from 

33 percent to 52 percent of overall technology trade, while low and 

medium-low technology exports were down from 67 percent to 48 

percent. 

The Commission was told that foreign investment in China continues to grow markedly, much of it drawn to technology sectors. 

Panelist Ernest Preeg of the Manufacturers Alliance advised the 

Commission that:

‘‘[F]oreign direct investment (FDI) in China was relatively 

low during the first stage of labor-intensive industrial 

growth, less than $5 billion per year through 1991. FDI 

then increased sharply, related to wide-ranging incentives 

for advanced technology investors, to $38 billion in 1995 

and $62 billion in 2004. Seventy percent of FDI is in manufacturing, with heavy concentration in export-oriented 

companies and advanced technology sectors. In 2004, 57 

percent of total Chinese exports were by foreign investors.’’

Dr. Preeg testified that Taiwan remains the largest foreign investor in China, accounting for about half of total FDI in China. 
v

The U.S. moved to fourth place in 2003 behind South Korea and 

Japan. Last year, South Korea invested $6.2 billion in China, 

Japan invested $5.5 billion, and the U.S. invested $3.9 billion. 

Private equity investments in China are also rising. Over the last 

two years, U.S. venture capital firms made over 100 investments 

in China. One panelist testified that venture capital in China will 

exceed $2 billion in 2005, with an additional $5 billion to $10 billion being raised for buyout funds and other forms of private equity. Gary Rieschel of Mobius Venture Capital testified that this 

type of investment is beginning to pour into China, as Chinese 

engineering talent increasingly demonstrates viable innovation 

capacity. 

China’s High Technology Strategies 

According to several panelists, and consistent with the Commission’s finding in its 2004 Report to Congress, the Chinese government continues to pursue a coordinated, sustainable vision for 

science and technology development. Official Chinese government 

statements at the highest level make clear the government’s view 

that the primary drivers of economic growth and national strength 

are science and technology. 

Panelists testified that China’s technology advancement is derived from technology transfers achieved via foreign trade and obtained from the over 600 foreign-owned R&D centers in China and 

also from the growing innovative capacity of indigenous Chinese institutions. In recent years, the Chinese government has been undertaking extensive reforms in its R&D system in order to create 

a modern national system of innovation (NIS), a defining characteristic of which is the central role played by industrial enterprise in contrast to the controlling influence of government research institutes in the past. China’s R&D expenditures have now 

reached 1.3 percent of GDP and it is now the third largest R&D 

spender in the world. Additionally, China is making great strides 

toward advanced technology power status by developing indigenous 

firms that have global brand recognition, reputations for producing 

quality products, and leading-edge R&D programs. Many Chinese 

technology firms have become globally competitive. 

China is using strategic policies to achieve its technology advancement goals. For example, in the area of software, China 

maintains a policy that only domestic software or ‘‘qualifying foreign software’’ may be used by government entities. The criteria for 

receiving the designation of qualifying foreign software have yet to 

be defined. The absence of such criteria has inhibited U.S. manufacturers from securing government business and appears intended 

to exclude U.S. firms from this lucrative market. Because the rates 

of software piracy are so high for the Chinese market as a whole, 

cutting off foreign software suppliers from the Chinese government 

market—in which the piracy rates are at least slightly lower than 

in the Chinese markets as a whole—essentially cuts those suppliers off from the China market altogether. 

Panelists told the Commission that the U.S. intelligence and defense community is not devoting sufficient resources to monitoring 

and analyzing China’s technological growth, and the derivative 

benefits for its military. Current National Intelligence Estimates 
vi

on China, and DOD reports such as its annual report to Congress 

on China’s military power, do not include an assessment of China’s 

technological development. This failure is particularly noteworthy 

when it is contrasted to the tremendous effort the U.S. and its allies exerted during the Cold War to ascertain the nature and extent 

of Soviet technological development. The Commission also was told 

that, although China has recently made high-level breakthroughs 

in nanotechnology, computer chip and semiconductor design, satellites, and supercomputing, the U.S. government does not currently produce an assessment of the implications of these advancements for China’s overall technological development or its military 

growth. 

Technology Standards 

Developing technology standards is an important part of China’s 

technology growth strategy. Industry participants identified China’s use of technical standards as a serious and growing barrier to 

trade. The Commission heard testimony that, unlike most international standards, China’s standards often do not reflect market 

competition, industry preference, or consumer choice, but rather 

are based on priorities of the Chinese government that often include the development and protection of domestic technology firms. 

Moreover, China has been able to use the leverage of access to its 

huge consumer market to promote its unique standards. 

Additionally, analyst Kathleen Walsh of the Stimson Center testified that ‘‘emphasis on technology standards developed to Chinese 

specifications is expected to help reduce China’s vulnerability to 

foreign supply, enhance China’s competitiveness, and limit opportunities for possible hacking, backdoor programming, or sabotage by 

foreign agents.’’ As commercial technologies are increasingly used 

in defense applications, the process of developing indigenous technology standards could also aid China in overcoming the hurdle of 

advanced systems integration, traditionally an obstacle for China’s 

defense development efforts. 

Challenges to U.S. Technology Leadership 

The Commission heard dramatic testimony from leaders of the 

U.S. technology industry that the economic challenges posed by 

China and other developing countries may well erode the current 

position of the U.S. as the world’s dominant technology innovator, 

absent a refocusing of attention and resources in the United States. 

William T. Archey, President and CEO of the American Electronics Association, stated:

‘‘Let me be clear: it isn’t that the United States is in decline. It’s that others are advancing quickly from behind, 

putting all their economic resources into moving their 

countries forward. The problem is that even if the United 

States were doing everything right, the world still poses an 

unprecedented competitive challenge. Unfortunately, we 

aren’t doing everything right, and this compounds the 

challenges that we face.’’
vii

George Scalise, President of the Semiconductor Industry Association, said:

‘‘Given the critical importance of semiconductors in driving 

U.S. economic growth and ensuring our national security, 

maintaining a competitive semiconductor manufacturing 

capability and supporting ecosystems must be an important priority for America’s federal and state governments. 

. . . [T]he U.S. needs a coordinated strategy to reduce the 

cost differential created by foreign government tax and incentive policies. . . . The investments and policy changes 

needed to allow U.S. manufacturers to compete in the face 

of foreign incentives designed to lure investment offshore 

are neither easy nor inexpensive, but it is vital that we 

make them.’’

Panelists testified that the keys to remaining a leader in high 

technology are strong investment in basic research, a steady supply 

of skilled scientists and engineers, a competitive investment and 

tax environment, and effective intellectual property (IP) protection. 

Dr. Perry and others also noted a need to review current U.S visa 

policy to find a better balance between the nation’s security interests and the national need for foreign scientists and engineers in 

R&D sectors. Some panelists indicated that in technology sectors, 

tax policies rather than lower labor costs are often the key factor 

in corporate decisions to invest abroad, given the high capital intensity required for technology production, and therefore the U.S. 

needs to enact tax reforms that would enhance the competitiveness 

of domestic production. There was a general view that when the 

U.S. has faced a competitive challenge in the past, the federal government marshaled the vision, leadership, and money to address 

that challenge—such as when, in the post-Sputnik era, it took 

strong steps to encourage technology innovation and to rebuild the 

nation’s educational system—and that such a national effort is 

needed to address today’s challenge. 

Ongoing Weaknesses in Protection of Intellectual Property 

Rights 

China’s failure to protect IPR remains a serious concern. The 

Commission heard testimony that China has made virtually no 

measurable progress in this area. While China has taken steps to 

build a legal framework for protection of intellectual property, enforcement remains ineffective. The Chinese government attitude 

appears complacent toward the huge losses to U.S. industry. Panelists testified that Chinese piracy rates for software are 90 percent, 

and for the motion picture industry they are 95 percent. The Business Software Alliance estimates that losses to the U.S. software 

industry due to Chinese piracy were $1.47 billion in 2004. The U.S. 

motion picture industry estimates its losses between 1998 and 2004 

at over $1 billion. Furthermore, panelists testified that China is 

now exporting its pirated goods, which are reaching markets such 

as the U.S. and the United Kingdom. 

While China’s domestically produced films also suffer from piracy, there is considerable evidence that when the Chinese government has chosen to do so, it has been able to control piracy in cer-
viii

tain areas. One panelist testified that in the case of domestic films 

where the government has a financial stake in the films or the theaters showing them, the government has been able to control piracy so the films can be viewed only in theaters, resulting in a 

large theater viewer ship that pirated films are unable to realize. 

This strongly suggests that the Chinese government has considerably more power to enforce IP protections than it has exerted to 

date. 

Failure to protect IP can be a double-edged sword in the technology sector. While, initially, pirated IP provides cheap inputs to 

fuel further technological growth, as China develops its own technologies, domestic pressure will require better IP protection. But 

some analysts worry that as China’s domestically designed technologies grow, the government may selectively protect domestic IP 

while providing inadequate resources to protect foreign IP. 

Future Hearings 

Given the issues and concerns raised in the hearing, the Commission intends to conduct an annual hearing in consultation with 

the White House Office of Science and Technology Policy, the Department of Defense, and the National Science Foundation, in both 

classified and unclassified sessions, on China’s advancements in 

science and technology (S&T). Such a hearing will include an assessment of both commercial and military technology, the contribution of foreign investment to China’s technological growth, and an 

analysis of implications for U.S. economic and national security. 

Recommendations 

1. As recommended in the Commission’s 2004 Report to Congress, the U.S. government must develop a coordinated, comprehensive national technology competitiveness strategy designed 

to meet China’s challenge to U.S. scientific and technological leadership. America’s economic competitiveness, standard of living, and 

national security depend on such leadership. The Commission 

therefore recommends that Congress charge the Administration to 

develop and publish such a strategy in the same way it is presently 

required to develop and publish a national security strategy that 

deals with our military and political challenges around the world. 

Such a strategy should:

• Identify future technology base goals; 

• Recommend policies for directing funds toward maintaining 

the U.S. technology base; 

• Initiate a national educational program, similar to the programs developed in the post-Sputnik era to enhance the level 

of math and science education at the ‘‘K-through-12,’’ undergraduate, and graduate levels in the U.S.; 

• Recommend appropriate tax and investment policies to encourage high-technology-related research, development, and manufacturing activities in the U.S.

2. In establishing a national technology competitiveness strategy, it is critical to incorporate input from the U.S. technology industry to better align private-sector goals with national interests. 

To this end, the Commission recommends that the Congress create 
ix

a task force including representatives from the Office of Science 

and Technology Policy, the National Science Foundation, and the 

Departments of Education, Defense, State, Energy, Labor, and 

Commerce to consult on a regular basis with select private-sector 

leaders in key science and technology industries, and investment 

leaders, particularly venture capitalists, regarding development 

and implementation of the national strategy. The intent in initiating such a task force is to create a permanent structured dialogue between the federal government and the private sector on 

technology base issues that have a direct effect on U.S. economic 

and national security. The task force should be required to report 

its findings and recommendations to Congress on an annual basis. 

3. Congress should increase intelligence community resources for 

collection and analysis focused on China’s technology development. 

It is crucial that U.S. policy makers have access to current, 

accurate, and complete information on China’s technological 

development. 

4. Given the lack of progress to date in curbing IPR violations 

in China, the Congress should press the Administration to develop 

and pursue a series of discrete cases in the WTO aimed at addressing the most egregious violations of U.S. intellectual property 

rights in China. 

5. The Commission recommends that a review of our nation’s immigration policies regarding student visas and business travelers 

take place immediately. The review should be conducted with full 

recognition of the importance of promoting interaction and exchange as a way of enhancing U.S. values and interests in the 

world and also of promoting U.S. economic interests. Many business travelers who wish to expand trade relationships have experienced difficulty in traveling to the U.S. Foreign student participation in our nation’s education system has declined. Both these 

trends facilitate the movement of innovation and economic capabilities offshore. At the same time, protecting our technological and 

economic base as well as our security interests is vital to our national interest and must be integrated into this policy review. 

6. The Bureau of Economic Analysis currently compiles international trade data for each ATP product. Congress should direct 

the Department of Commerce to present more detailed ATP trade 

data in a user-friendly format in its monthly publication, U.S. 

Trade in International Goods and Services. The data should be presented in a table that quantifies U.S. trade in each of the ATP 

products with the U.S.’s top ten ATP trading partners (of which 

China is one). This table should present, for each of the ten countries: (1) the value of U.S. imports of each ATP product from the 

country; (2) the value of U.S. exports of each ATP product to the 

country; (3) the country’s trade balance with the U.S. for each ATP 

product; and (4) the percentage of total U.S. imports of each ATP 

product accounted for by imports from that country. These data 

will facilitate analysis of the import dependency of the U.S. on spe-
x

cific ATP products and, more precisely, on specific ATP products 

from specific countries.

Sincerely,

C. Richard D’Amato Roger W. Robinson, Jr. 

Chairman Vice Chairman
(XI)

CONTENTS 

Page

THURSDAY, APRIL 21, 2005

CHINA’S HIGH TECHNOLOGY DEVELOPMENT 

Opening statement of Chairman C. Richard D’Amato ......................................... 1

Prepared statement .......................................................................................... 2

Opening statement of Vice Chairman Roger W. Robinson, Jr. ............................ 4

Prepared statement .......................................................................................... 4

Opening statement of Commissioner Patrick A. Mulloy, Hearing Cochair ........ 115

Prepared statement .......................................................................................... 116

INTRODUCTORY REMARKS—CHINA’S GROWING GLOBAL PRESENCE

Statement of the Honorable William J. Perry, Senior Fellow, Stanford Institute for International Studies, Stanford, California ......................................... 5

Introductory Remarks: Discussion, Questions and Answers ............................... 10

PANEL I: CHINA’S GLOBAL TECHNOLOGY COMPETITIVENESS I

Statement of James C. Morgan, Chairman of the Board of Directors, Applied 

Materials, Inc., Santa Clara, California ............................................................. 19

Prepared statement .......................................................................................... 23

Statement of George M. Scalise, President, Semiconductor Industry Association, San Jose, California .................................................................................... 27

Prepared statement .......................................................................................... 30

Statement of Alan C. Wong, Senior Counsel, Nvidia Corporation, Santa Clara, 

California .............................................................................................................. 35

Prepared statement .......................................................................................... 39

Statement of Gary Edward Rieschel, Executive Managing Director, Mobius 

Venture Capital, Palo Alto, California ............................................................... 42

Prepared statement .......................................................................................... 46

Statement of G. Carl Everett, Partner, Accel Partners, Palo Alto, California ... 50

Prepared statement .......................................................................................... 53

Panel I: Discussion, Questions and Answers ........................................................ 54

PANEL II: CHINA’S HIGH-TECH DEVELOPMENT STRATEGIES

Statement of Richard P. Suttmeier, Professor of Political Science, University 

of Oregon, Eugene, Oregon .................................................................................. 70

Prepared statement .......................................................................................... 73

Statement of Michael Pillsbury, Senior Fellow, Atlantic Council of the United 

States, Associate Fellow, Institute for National Strategic Studies, National 

Defense University, Washington, DC ................................................................. 81

Statement of Denis Fred Simon, Provost and Vice President for Academic 

Affairs, Levin Graduate Institute of International Relations and Commerce, 

State University of New York, Albany, New York ............................................ 84

Prepared statement .......................................................................................... 89

Statement of Kathleen A. Walsh, Senior Associate, Henry L. Stimson Center, 

Boston, Massachusetts ......................................................................................... 99

Prepared statement .......................................................................................... 101

Panel II: Discussion, Questions and Answers ...................................................... 107
Page

XII

PANEL III: DYNAMICS IN THE U.S.-CHINA HIGH-TECH RELATIONSHIP

Statement of Henry S. Rowen, Professor Emeritus, Graduate School of Business, Senior Fellow, the Hoover Institution, Emeritus Director, the Asia 

Pacific Research Center, Stanford University, Stanford, California ................ 117

Prepared statement .......................................................................................... 120

Statement of John Zysman, Co-Director, Berkeley Roundtable on the International Economy, Professor, University of California, Berkeley, California . 123

Statement of Ernest H. Preeg, Senior Fellow in Trade and Productivity, 

Manufacturers Alliance/MAPI, Arlington, Virginia .......................................... 126

Prepared statement .......................................................................................... 128

Statement of Eamonn Fingleton, Economic Author, Unsustainable: How Economic Dogma is Destroying American Prosperity, Tokyo, Japan ..................... 132

Prepared statement .......................................................................................... 134

Panel III: Discussion, Questions and Answers ..................................................... 141

PANEL IV: CHALLENGES TO U.S. HIGH-TECH LEADERSHIP

Statement of William T. Archey, President and Chief Executive Officer, American Electronics Association (AeA), Advancing the Business of Technology, 

Washington, DC ................................................................................................... 153

Prepared statement .......................................................................................... 156

Statement of John Ciacchella, Vice President, A.T. Kearney, Santa Clara, 

California .............................................................................................................. 158

Prepared statement .......................................................................................... 162

Statement of Rhett Dawson, President and Chief Executive Officer, Information Technology Industry Council (ITI), Washington, DC ................................ 164

Prepared statement .......................................................................................... 166

Panel IV: Discussion, Questions and Answers ..................................................... 168

FRIDAY, APRIL 22, 2005

CHINA’S HIGH TECHNOLOGY DEVELOPMENT

Opening remarks of Commissioner Patrick A. Mulloy, Hearing Cochair ........... 180

PANEL V: CHINA’S GLOBAL TECHNOLOGY COMPETITIVENESS II

Statement of John Gage, Chief Researcher and Director of the Science Office, 

Sun Microsystems, Inc., Santa Clara, California .............................................. 180

Statement of Mark FitzGerald, Managing Director and Senior Research Analyst in the Technology Group, Banc of America Securities LLC, San Francisco, California .................................................................................................... 186

Prepared statement .......................................................................................... 190

Panel V: Discussion, Questions and Answers ....................................................... 201

PANEL VI: CHINA’S SCIENCE AND TECHNOLOGY TRAJECTORY

Statement of Anthony F. Rock, Principal Deputy Assistant Secretary of State, 

Bureau of Oceans and International Environmental and Scientific Affairs, 

Washington, DC ................................................................................................... 210

Prepared statement .......................................................................................... 213

Statement of Larry H. Weber, Acting Deputy Director, Office of International 

Science and Engineering, National Science Foundation (NSF), Washington, 

DC .......................................................................................................................... 219

Prepared statement .......................................................................................... 222

Panel VI: Discussion, Questions and Answers ..................................................... 228

PANEL VII: CHINA’S IPR PROTECTIONS AND THE U.S.

ENTERTAINMENT INDUSTRY

Statement of John G. Malcolm, Senior Vice President and Director, Worldwide Anti-Piracy Operations, Motion Picture Association of America, 

Encino, California ................................................................................................ 237

Prepared statement .......................................................................................... 239

Statement of Darcy Antonellis, Executive Vice President, Distribution and 

Technology Operations, Senior Vice President, Worldwide Anti-Piracy Operations, Warner Bros. Entertainment Inc., Burbank, California ....................... 244

Prepared statement .......................................................................................... 247

Panel VII: Discussion, Questions and Answers .................................................... 253
Page

XIII

PANEL VIII: CHINA’S IPR PROTECTIONS AND IMPACT ON

TECHNOLOGY DEVELOPMENT

Statement of Pat Choate, Co-Director, Manufacturing Policy Project, Author, 

Hot Property: The Stealing of Ideas in an Age of Globalization, Sperryville, 

Virginia ................................................................................................................. 260

Prepared statement .......................................................................................... 262

Statement of Ted C. Fishman, Author, China Inc.: How the Rise of the 

Next Superpower Challenges America and the World, Chicago, Illinois .......... 270

Prepared statement .......................................................................................... 272

Panel VIII: Discussion, Questions and Answers .................................................. 276

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Statement of Oded Shenkar, Ford Chair, Fisher College of Business, the 

Ohio State University .......................................................................................... 281

Report provided by William T. Archey, President and CEO, American Electronics Association (AeA), Advancing the Business of Technology, entitled 

‘‘Losing the Competitive Advantage? The Challenge for Science and Technology in the United States,’’ dated February 2005 .......................................... 283

Letter provided by Rhett Dawson, President and CEO, Information Technology Industry Council, to Lin Jie, Ministry of Finance Treasury Department, and Chen Ying, Ministry of Information Industry Electronic Products 

Management Department, dated April 8, 2005 ................................................. 315

Article provided by Rhett Dawson, President and CEO, Information Technology Industry Council, entitled ‘‘Potential Scenarios for a WTO Case 

Against China’s Mandatory Implementation of the WAPI Standard’’ ............. 319

Article provided by Larry H. Weber, Acting Deputy Director, Office of International Science and Engineering, National Science Foundation, entitled 

‘‘Graduate Education and the National Science Foundation’’ .......................... 320

Paper provided by John G. Malcolm, Senior Vice President and Director, 

Worldwide Anti-Piracy Operations, Motion Picture Association of America, 

entitled ‘‘White Paper on IPR Protection’’ .......................................................... 322

(1)

CHINA’S HIGH TECHNOLOGY DEVELOPMENT 

THURSDAY, APRIL 21, 2005

U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION, Washington, D.C.

The Commission met in Stauffer Auditorium, Hoover Institute, 

at Stanford University, Stanford, California at 9:00 a.m., Chairman 

C. Richard D’Amato, Vice Chairman Roger W. Robinson, Jr., and 

Commissioner Patrick A. Mulloy (Hearing Cochair), presiding. 

OPENING STATEMENT OF CHAIRMAN C. RICHARD D’AMATO 

Chairman D’AMATO. Good morning and welcome to the U.S.-

China Economic and Security Review Commission’s hearing on 

‘‘China’s High Technology Development.’’ Today’s hearing in California’s Silicon Valley continues our series of sessions around the 

country to take the pulse of how China’s economic rise presents 

both opportunities and challenges to particular sectors and regions 

of the United States economy. 

We are particularly interested in the views of the many firms, organizations and individuals in Silicon Valley who are in many ways 

on the front lines of this developing relationship with China, and 

whose insights and recommendations we value very highly. 

We are grateful to Stanford University, particularly the Hoover 

Institution for its help in bringing the Commission to Northern 

California and to our former Commission colleague Ambassador 

Robert Ellsworth for his inspiration and guidance for this event. 

This hearing will assess how far China has come as a center for 

technology manufacturing and, perhaps more importantly, as a 

center for research and development and technology innovation. 

We will also be examining the role China plays in the global supply chain for technology goods and the contributions that U.S. and 

other foreign investment have made, and continue to make, to China’s scientific and technology advancement. China is clearly focused on acquiring great economic power status as soon as possible. 

What strategies and practices does China use to entice the transfer 

of technology by U.S. and other firms to China, and how important 

is the accomplishment of superpower high technology status to her 

overall strategy? 

These questions are essential to understanding the long-term 

challenges China pose to U.S. economic interests and go to the 

heart of our congressional mandate: To annually investigate the 

depth and breadth of U.S. technology and R&D transfers to China 

and the implications for U.S. economic and national security policy. 

Following our hearing we will present to Congress the key findings 

and policy recommendations on this issue. 
2

We are honored to have former Secretary of Defense Dr. William 

Perry lead off our hearing today. Dr. Perry has a unique understanding of the geopolitical and security implications of China’s 

economic and scientific trajectory. Indeed, I do not think it’s an exaggeration to say there is probably no American more qualified to 

evaluate and understand China’s technology, technological developments, America’s role in that phenomenon, and the vulnerabilities 

and challenges we face as China grows into what one witness this 

afternoon will call a new technological superpower. 

Dr. Perry has served in high positions in DOD in dealing with 

science and engineering and is himself a mathematician. He took 

upon himself the challenge of engaging the Chinese while he was 

Secretary of Defense. When he was Undersecretary in 1980, he led 

the first U.S. military delegation to China and established a military-to-military relationship with the PLA. He continues to speak 

and write prolifically and wisely on these issues. 

Last week his op-ed piece (April 13, 2005) in the New York Times

on the shortfalls in technology research in the current DOD budget 

submission was required reading for our Commissioners in preparation for this hearing. Dr. Perry is currently a Fellow at the Hoover Institution, a Professor at Stanford, and Co-Director of the Preventive Defense Project, a collaboration between Stanford and Harvard. 

Before proceeding I’ll turn the podium over to Vice Chairman 

Roger Robinson. 

[The statement follows:]

Prepared Statement of Chairman C. Richard D’Amato 

Good morning and welcome to the U.S.-China Economic and Security Review 

Commission’s hearing on ‘‘China’s High Technology Development.’’ Today’s hearing 

in California’s Silicon Valley continues our series of sessions around the country to 

take the pulse of how China’s economic rise presents both opportunities and challenges to particular sectors and regions of the U.S. economy. We are grateful to 

Stanford University, particularly the Hoover Institution and Stanford Law School, 

for all of their logistical help in bringing the Commission to Northern California and 

to our former Commission colleague, Ambassador Robert Ellsworth, for his inspiration and guidance for this event. 

Our last hearing outside of Washington, DC was also on the West Coast. This 

past January we were in Seattle to assess the impact of U.S.-China trade on Pacific 

Northwest industries, including aerospace, software, agriculture, and shipping. The 

Pacific Northwest region is one highly reliant on trade with Asia, and we had expected to hear testimony on the significant benefits that this region was receiving 

from its trade with China. However, the Commission heard witness after witness 

testify to both the immediate and long-term competitive challenges to regional industries from China, ranging from the advanced fields of technology and software 

to timber and horticulture. 

This hearing will assess how far China has come as a center for technology manufacturing and, perhaps more importantly, as a center for research and development 

and technology innovation. We will also be examining the role China plays in the 

global supply chain for technology goods and the contributions that U.S. and other 

foreign investment has made, and continues to make, to China’s scientific and technology advancement development. These questions are essential to understanding 

China’s long-term challenges to U.S. economic interests and go to the heart of our 

congressional mandate to annually investigate the depth and breadth of U.S. technology and R&D transfers to China and the associated implications for U.S. economic and national security. Following today’s discussion, we will present Congress 

with key findings and policy recommendations on this issue. 

A central question is to what extent and in what ways have the transfers of manufacturing capacity, R&D, and investment into China impacted the American economy? Is it possible to measure such impacts? Finally, what policy prescriptions 
3

should we recommend to Congress to deal with imbalances or shortfalls in R&D, 

education and other aspects of the U.S. economy central to our national health? 

The nature of globalization has made these questions much broader than the 

issue of direct technology transfers. For example, what is the critical level of knowledge or technology that enables the U.S. to have an advantage in certain technology 

sectors? Once knowledge or technology at that level is shared, is there a risk the 

U.S. will lose its lead in that sector? This question becomes key, when one considers, 

what industries are necessary to maintain national security. Once identified, what 

is the critical level of employment to maintain the industries in the United States? 

What research and development positions need to remain in the U.S. in order to 

ensure that science and engineering college graduates are able to enter the field? 

The February 2001 Report of The United States Commission on National Security/21st Century identified the declining condition of pre-college education in the 

United States as a critical national security problem. The National Science Foundation has echoed this concern in its reports as well. It is now 2005, what has been 

done to address this issue? We, here today, have the critical task to understand the 

scope of this concern and recommend to Congress actions that can be taken now to 

move the long-term trends into a positive direction. 

The scope of our inquiry goes beyond the private sector to include governmentto-government contacts. In 2002, this Commission recommended the establishment 

of a comprehensive inventory of official government-to-government science and technology (S&T) programs with China and a biennial report to Congress on the work 

being conducted under such programs. Congress adopted this recommendation and 

the latest report to be produced as a result was issued last week by the State Department. We look forward to hearing, tomorrow, from a representative of the Department about their conclusions as well as their assessment of all the avenues 

through which China gains access to U.S. technology. 

We are honored to have former Secretary of Defense William Perry lead off our 

event today. Dr. Perry has a unique understanding of the geopolitical and security 

implications of China’s economic and scientific trajectory. Moreover, we note that in 

a recent New York Times editorial, Dr. Perry cited concerns about the impact of declining funding for defense-based technology research and development. He stated 

that ‘‘If the Pentagon does not make the required investments today, America will 

not have dominant military technology tomorrow’’ and that ‘‘tech based activities 

have yielded advances in scientific and engineering knowledge that have given 

United States forces the technological superiority that is responsible in large measure for their current dominance in conventional military power.’’

Following Dr. Perry, we will hear testimony from U.S. corporate and investment 

leaders in the Silicon Valley region. James Morgan, Chairman of Applied Materials, 

George Scalise, President of the Semiconductor Industry Association, and Alan 

Wong, Senior Council for Nvidia Corporation are here to give their assessments of 

China’s advancement as a technology leader. We are privileged to have their on-theground perspective of the U.S. corporate relationship with China. We also have with 

us Gary Rieschel of Mobius Venture Capital and Carl Everett of Accel Partners here 

to discuss both China as a destination of venture capital and the rise of U.S. micromultinational start-ups. 

In our second panel today, we will hear testimony from four scholars who have 

examined China’s high-tech development strategies in depth. We are pleased to 

have Drs. Richard Suttmeier, Michael Pillsbury, Denis Simon, and Ms. Kate Walsh. 

This afternoon, we will hear from Stanford’s Henry Rowen, Ernest Preeg of the 

Manufacturers Alliance, Eamonn Fingleton, and Berkeley’s John Zysman. These 

four panelists will discuss the U.S.-China high-tech relationship and larger implications of globalization on U.S. high-tech sectors. 

Our last panel of the day will specifically examine challenges to U.S. high-tech 

leadership. We are pleased to have Bill Archey of the American Electronics Association, John Ciacchella of A.T. Kearney, and Rhett Dawson of the Information Technology Industry Council. 

Tomorrow we’ll hear from John Gage of Sun Microsystems as well as representatives from the State Department and National Science Foundation. We will then 

move to an important discussion of how China’s continuing weak protections for intellectual property impact the U.S. entertainment industry in particular and may 

act as both a driver and inhibitor of its technology development. We’ll have with 

us John Malcolm of the Motion Picture Association of America, Darcy Antonellis of 

Warner Bros., Pat Choate of the Manufacturing Policy Project and Ted Fishman, author of China Inc. 

We look forward to a highly informative event.
4

OPENING STATEMENT OF VICE CHAIRMAN ROGER W. ROBINSON, JR. 

Vice Chairman ROBINSON. Thank you, Mr. Chairman. 

As the Chairman indicated, we’re very pleased to be in California 

today to explore a topic of great importance to both our national, 

economic, and security interests. I also join the Chairman in extending the Commission’s appreciation to all those who helped 

bring together such an esteemed group of panelists, particularly 

Ambassador Ellsworth for his continued support of the Commission’s work. 

We have before us two days of panels laid out to provide an 

array of perspectives on China’s progress toward developing its 

technology production and innovation capabilities. We’ve assembled 

representatives of leading U.S. technology firms; industry associations; prominent venture capitalists; analysts of China’s technology, 

development strategies, and policies; seasoned observers of U.S.-

China high-tech trade; and senior officials of the State Department 

and the National Science Foundation. 

The State Department and NSF have both been monitoring and 

reporting on China’s technology advancements, and we’re pleased 

to have them represented here today. Tomorrow we’ll also hear 

from industry and outside experts on how China’s poor and—some 

would even call them—pathetic intellectual property rights protections affects technology development and trade. 

As we assess China’s technology advancements, we must also remain mindful that they pose both military and security challenges 

in addition to economic ones. As the Commission noted in its 2004 

Report to Congress, China has historically channeled high-technology research and development to the benefit of its defense industrial base. We made clear in that Report our view that ‘‘what 

China does with its growing technology capabilities—whether it 

converts them to military uses—is of direct national security concern to the United States.’’

Moreover, we in the United States must nurture our own technology base in order to maintain our defense capabilities, an argument, as the Chairman pointed out, eloquently presented by former 

Secretary of Defense Bill Perry, who we’re honored to have with us 

today, in his New York Times piece of last week. 

Accordingly, the assessments we’ll be hearing today and tomorrow from U.S. industry leaders about the trends affecting U.S. 

technology competitiveness and the government policy changes 

needed to preserve and promote such competitiveness are vitally 

important. 

I look forward to two days of rich and important testimony and 

will now turn over the proceedings to the hearing Cochairs, Chairman D’Amato and our colleague Commissioner Mulloy. Thank you. 

[The statement follows:]

Prepared Statement of Vice Chairman Roger W. Robinson, Jr. 

The Commission is pleased to be in California today exploring a topic of great importance to both our national economic and security interests. I join the Chairman 

in extending the Commission’s appreciation to all those who helped bring together 

such an esteemed group of panelists, particularly Ambassador Ellsworth for his continued support of the Commission’s work. 

We have before us two days of panels laid out to provide an array of perspectives 

on China’s progress toward developing its technology production and innovation ca-
5

pabilities. We have assembled representatives of leading U.S. technology firms and 

industry associations, prominent venture capitalists, analysts of China’s technology 

development strategies and policies, seasoned observers of U.S.-China high-tech 

trade, and senior officials of the State Department and the National Science Foundation. The State Department and NSF have both been monitoring and reporting 

on China’s technology advancements, and we are pleased to have them represented 

here today. Tomorrow we will also hear from industry and outside experts on how 

China’s poor intellectual property rights protections affects technology development 

and trade. 

As we assess China’s technological advancements, we must also remain mindful 

that they pose military and security challenges in addition to economic ones. As the 

Commission noted in its 2004 Report to Congress, China has historically channeled 

high-technology research and development to benefit its defense industrial base. We 

made clear in that Report our view that ‘‘what China does with its growing technology capabilities—whether it converts them to military uses—is of direct national 

security concern to the United States.’’

Moreover, we in the United States must nurture our own technology base in order 

to maintain our defense capabilities, an argument eloquently presented by former 

Secretary of Defense William Perry, who we are honored to have with us today, in 

a New York Times editorial last week. Accordingly, the assessments we will be hearing today and tomorrow from U.S. industry leaders about the trends affecting U.S. 

technology competitiveness, and the government policy changes needed to preserve 

and promote such competitiveness, are vitally important. 

I look forward to two days of rich and important testimony and turn the proceedings over to my colleagues and the hearing’s Cochairs, Chairman D’Amato and 

Commissioner Mulloy.

Chairman D’AMATO. And thank you, Commissioner Robinson. 

Dr. Perry, welcome. We look forward to your remarks. 

I think the Secretary said he will be talking for ten or so minutes 

and then would be delighted to take questions from the panel. 

Thank you very much, Dr. Perry. 

INTRODUCTORY REMARKS—CHINA’S GROWING GLOBAL 

PRESENCE 

STATEMENT OF THE HONORABLE WILLIAM J. PERRY, SENIOR FELLOW

STANFORD INSTITUTE FOR INTERNATIONAL STUDIES

STANFORD, CALIFORNIA 

Dr. PERRY. Thank you very much, Mr. Chairman. It’s a pleasure 

to be here to speak to this Commission on these very important 

issues. I’m going to focus my comments today on information technology. I’m doing that because that’s a field I know something 

about. That’s where my experience is. 

I will start with a caveat, though, that the comments I make will 

not necessarily be applicable to other fields. 

I want to start with a historical observation. Many years ago 

when I was the Undersecretary of Defense—this was in the late 

1970s—as Undersecretary for Research and Engineering, we were 

faced with a major threat from the Soviet Union. That seemed like 

a long time ago, but it seemed like a very real problem then. At 

that time the Soviet Union was just beginning to equal us in strategic weapons and nuclear weapons. We had to face the fact that 

they had about a three times advantage in conventional weapons, 

three times as many tanks, three times as many men in their 

army, and so on. 

So we were faced with an issue of what to do about that. The 

President at that time, as his predecessors all the way back to 

President Eisenhower, concluded we could not deal with that by 

trying to equal the Soviet Union in the number of men in their 
6

army. That would bankrupt our economy as, in fact, it eventually 

bankrupted their economy. But we saw it as a major problem. 

So we set about to do something which we called the ‘‘Offset 

Strategy.’’ The use of American technology to offset the quantitative advantage of the Soviet forces. 

As the Undersecretary of Research and Engineering at the time 

it became my responsibility to try to implement that Offset Strategy. And I elected to use information technology as the primary 

tool for doing that because we had then, as we have now, a commanding lead in that field. 

The key three items of the Offset Strategy were: 

Developing greatly improved sensors so that we could locate 

enemy tanks, vehicles anywhere on the battlefield at any time. 

The second came to be called Smart Weapons, was developing 

precision-guide munitions. Once we located an enemy unit a smart 

weapon could destroy it with one attempt, which is a dramatic difference from the firing accuracy, which had existed at that time 

and had been relevant in all earlier wars. 

The third part of the Offset Strategy was to develop what came 

to be called Stealth, so that our vehicles, our airplanes, and our 

ships, and so on, would not be subject to the same kind of precision 

attack that we were inflicting on others. 

So those were the three components of the Offset Strategy. All 

of them were embedded deeply in information technology, and our 

success depended on leadership in information technology. Those 

systems were developed in the late 1970s and the early 1980s. 

They saw their first use in warfare in Desert Storm, a decade after 

they were started, and they proved to be enormously successful. So 

they were developed in the late 1970s, and were applied for the 

first time in the late 1980s. 

In the late 1990s they were used again, this time in Kosovo. It 

was interesting then, and I want to make this point very specifically, that even though the world had known for a full decade by 

then about not only what we had done but how effective it had 

been, by that time even our allies, even the industrial nations of 

the United Kingdom, and Germany and France were not equal to 

that capability. That turned out to be a disadvantage in Kosovo because we had to carry most of the burden of precision strikes ourselves because that capability did not exist in other countries to the 

same extent. 

So that has been a real success story, but it did depend from the 

beginning and even to this day on our leadership in information 

technology. 

I make this point so that I can underscore the appropriate question that you were asking here, and certainly in the information 

technology field at least there is very good evidence that our leadership in information technology played a key role in our national 

security. There is also ample evidence it’s played a key role in bolstering our economy. That’s another story that I’m not as qualified 

to talk about, but I think both of those points are well understood 

in the world. 

Now the second story I would like to share with you that I think 

is relevant to this topic deals with a visit that I made to Shanghai 

a few years ago. I went over to visit a new company called The 
7

Semiconductor Manufacturing International Corporation located in 

Shanghai. 

They had been in business then one year, 12 months. I went over 

to tour their new factory, the factory for making semiconductor wafers that were close to the state of the art in semiconductor technology. The thing that amazed me was this plant was in operation, 

actually delivering product only 12 months after they started, only 

12 months from when that same site had been a green field. 

I was wondering how they were able to do this, so I asked a lot 

of questions. To oversimplify a rather complicated picture I will say 

I learned that the investments that had been made in that company had been one-third from the United States, one-third from 

China, and the other one-third, interestingly enough, was from Taiwan. The people who worked at that factory were about the same 

ratio: About a third came from Silicon Valley, about a third from 

Taiwan, and a third from China. 

So this illustrates how technology transfer really occurs and the 

benefits of technology transfer to a country like China. It also illustrates why the American companies and engineers invested in this 

operation is because they wanted a major part of the Chinese, the 

burgeoning Chinese cell phone market, and that’s what this factory 

was supplying, primarily. 

Now having started with those two anecdotes that I think are 

relevant to the issues you’re discussing, I want to make an observation and that is what I consider an existential reality that bears 

profoundly on this question. And that is that information technology is the ultimate global market. It is a global market, not a 

national market, to a much greater extent I think than any other 

industry. 

I would illustrate that by observing this laptop here or any other 

laptop you may have. It will have a name on the front and this 

name is Sony, which suggests it’s a Japanese product. But it might 

be IBM or it might be Samsung, suggesting it’s an American or Korean product. But if you take the cover off and look inside of it, regardless of the name on the front, you will find components from 

Silicon Valley; you will find components from Taipei, from Tokyo, 

from Singapore, from Seoul, from Shanghai. It is a global product. 

And no company could make their laptops without buying products 

and components from all over the world. 

Now in this global market then the United States is certainly a 

leader in the market, but we are not dominant and we are not able 

to control the market. That I consider is the existential reality that 

needs to be considered in dealing with the issues you are talking 

about today. Indeed, the United States information technology 

could not function effectively in isolation from other countries and 

from other markets. 

So the question that is sometimes asked is whether the U.S. 

should control the flow-out of its technology in this industry or the 

flow-in of investments. I think my answer to that question would 

be there is no practical way we can do that. 

So to me it’s not an interesting question because there’s no way 

of implementing it, even if you decided that you wanted to do. 

Nevertheless, having said that, I want to also say that it is the 

very great interest of this nation, both from a national security 
8

point of view and from an economic point of view, for us to maintain a leadership position in information technology. 

So the question then is: How do we maintain that leadership. 

And if we cannot do it by controlling the market, what should our 

strategy be for maintaining the leadership. 

Now I think there are three components to doing that, and I’ll 

comment briefly on each of them. The first is to do everything we 

can to maintain the efficiency of our companies in this industry. 

Second, to do everything we can to maintain the advantage we 

now have in technology innovation. 

And the third is do everything we can to protect the intellectual 

property of our companies. Those to me are the three issues. And 

I think every company that works in this industry in the United 

States tries to focus on those three issues. 

And the government’s role in this, it seems to me, should be to 

try to facilitate the companies’ success in achieving those three objectives. I have a very brief comment about each of the three of 

them. 

In terms of maintaining the efficiency of our companies, I think 

the main role of the government in to not restrict their ability to 

make an optimum exploitation of the international markets. They 

live on the international markets. And to the extent the government restricts their ability to deal in those markets, you are going 

to be impeding their abilities to succeed. 

And, secondly, you should not restrict their ability to make an 

optimum exploitation of international capital. They need capital 

flowing in to run their business. Some of this comes from international sources and, therefore, they need to be able to access foreign direct investments in U.S. companies. 

So from the government’s point of view, then, it seems to me that 

the laws and the regulations dealing with those issues should put 

minimal restrictions on our companies if we want them to have 

maximum success. 

The second point has to do with maintaining the advantage we 

have in technological innovation. This is really the mother’s milk 

of Silicon Valley. 

We have competition in all of these fields, in all of these products 

that we are developing today. In most of them, though, the competition is in what I would call a ‘‘tail chase,’’ to use a term from 

the military. The competition is following us. They’re trying to 

catch up. There’s always a philosophical issue of what you do when 

you look back and you see somebody chasing you. And there’s a 

temptation to try to find some way of slowing him down. And I’ve 

always believed that’s the wrong approach. The right approach is 

to run faster. 

And so we should focus on the laws and regulations that allow 

our companies to run faster, not try to find ways, which are usually 

ineffective, of trying to hobble the person who’s trying to catch us. 

The third issue is one of protecting intellectual property, about 

which I have less to say but which I believe is a very important 

issue. And I want to end by making a few comments about how we 

might do some of the things that I’m talking about, particularly in 

the area of technological innovation, which I think is the key to 

success here. 
9

I start off by observing that you are sitting here in Stanford University, and it is typical of the reason Silicon Valley enjoys leadership role in the information technology industry. The United States 

has the best technological universities in the world today, and that 

has been a very key part of our success. 

So one key thing we have to do, if we recognize that fact and 

want to maintain our leadership position, clearly you want to maintain the technical universities as being the best in the world today. 

So we have to find ways of sustaining the success of these universities. I’ll be happy to entertain questions on that. I’ve spent a good 

many years of my life in this particular university. And when I was 

in the government I observed carefully quite a few other universities. 

The U.S. Government plays a key role in these universities, by 

the way. And, in particular, it is one of the primary supporters of 

the research and development done at universities. So it’s really 

quite important how the government interacts with universities in 

terms of our being able to maintain the leadership position we have 

today. 

The second and a related point to that is the United States has 

traditionally made the largest investment of any country in the 

world in what I would call technological base. 

Mr. Chairman, you referred to the op-ed piece that Dr. Deutch 

and I wrote in the New York Times last week. That is what we 

were talking about—is maintaining the technological base. I want 

to separate that from R&D. 

People argue that we need to do more R&D. The companies in 

this country have a lot of R&D, but their R&D is focused almost 

entirely on product development, on the D part of R&D. They develop new products and those products make them successful in 

the market. But all of that product development draws on some 

base of technology. It’s technology-based. 

Most of the companies in this area, even the very enlightened 

companies like Hewlett-Packard, do not spend much of their dollars 

on increasing the technology base. This is the seed corn on which 

the new products are developed. That technology base has been 

supported traditionally in the United States by the United States 

Government and, for better or for worse, in the information technology at least mostly by the Defense Department. That was my 

basis for writing the op-ed piece. 

I saw a decline in the spending for the technology base by the 

Department of Defense. That to me is more than a national security issue because, in fact, our commercial industry depends on 

that same technology-based development. 

There was a time in this country when much of our technology 

base was done by the great research laboratories, like the Bell Laboratories and IBM. But if you haven’t noticed, let me point out to 

you, those days are gone. IBM and Bell Laboratories no longer play 

that role in the nation today. We are still very much dependent on 

the Department of Defense for providing the technology base, and 

it’s done primarily but not exclusively through our technical universities. 

The third feature in maintaining our technological innovation is 

that we have in this country, not just in Silicon Valley but in the 
10

country what I would call a cultural advantage in innovation. I do 

not think the government can or should do much to try to influence 

that. That’s an advantage we have that we should cherish and observe, but I don’t think there’s much we can do to affect it. 

And, finally, we have developed the necessary support system for 

technological innovation. It is in many parts of the country, but it 

certainly developed first and most prominently here in Silicon Valley. The support system is such things as the venture capital, 

which provides the risk capital for new innovations, the legal, and 

the accounting work. All of those particular support systems are 

brought together uniquely in Silicon Valley and they have been 

modeled in other parts of this country. And that’s a key part of our 

ability to do technological innovation. Now that’s not duplicated to 

the same extent in any other country in the world. What do we do 

from a legislative point of view to facilitate that? I think what we 

are doing, in fact, is probably tending to hobble it, that the changes 

that are being undertaken now in accounting principles, particularly those that affect the ability to give company stock options is 

probably a step backwards in that direction. 

So the things we could do to foster innovation, most of them are 

not things that the government can do, but the government can do 

some things to hobble innovation. And I think the regulation now 

underway in the accounting field is an example of that. 

The final point, which is a very important point about which I 

do not have much to say, is intellectual property. I recognize the 

importance of maintaining intellectual property. I recognize the 

fact that it’s being systematically abused in many countries in the 

world, not limited to China but certainly including China. 

I do not have the expertise to advise you on what to do in that 

area except to suggest that this is such an important problem that 

I think the American Trade Representative ought to have as one 

of his highest priorities taking the actions that he can to try to protect the intellectual property of American companies in information 

technologies and in other fields as well. 

This is an issue in China, it’s an issue in other countries, but it’s 

a particular issue in China. It’s one that I’m sure your Commission 

will be addressing. 

Now those are the opening comments I was going to make. Mr. 

Chairman. I would be happy to entertain questions or comments. 

Introductory Remarks: Discussion, Questions and Answers 

Chairman D’AMATO. Thank you very much, Mr. Secretary, for 

the very, very thoughtful presentation. A lot of the issues you discussed are issues that we are grappling with. 

On the IPR question that you mentioned, we have looked at that 

extensively. And we recommended that the Trade Representative 

and the President take the Chinese to the dispute settlement mechanisms in WTO, which would use the very tool available to us in 

that organization. Let’s use it and see what happens. That’s the 

best that we can come up with at the moment. 

I have a question on the technology questions that you mentioned. Your article in the op-ed piece in the New York Times last 

week with Mr. Deutch emphasized R&D funded by DOD. You also 

recognized the synergies between the commercial center and DOD. 
11

My question is: Are we doing enough outside DOD that, if we 

were to bring the budget of DOD up in technology, robotics, 

nanotechnology, and so on, is that enough for us, or are we not investing enough as a nation in the research and development on 

high technology now? We have 700 or 750 commercial R&D centers 

that have been moved from the United States to China, for example. Does that have an impact on our technological base and our 

ability to innovate in the long run? 

The question is: Do you have specific thoughts about what we 

might do beyond what we’re doing today to maintain the long-term 

leadership of this country in technology and innovation in the base? 

Dr. PERRY. The first point I would make is the one that we made 

in the op-ed piece, namely: Do not move backwards on the DOD 

support for technological base, because that has been an absolutely 

crucial element. I think you could get a hundred witnesses here 

who are in the informational technology industry and who are actually developing products and ask them that question, they will tell 

you how important that has been, starting back from the days 

when the Defense Department program called ARPA Net——

Chairman D’AMATO. Yes. 

Dr. PERRY. —became the predecessor to the Internet today. 

So I might say parenthetically on that that I was in the Defense 

Department back in the ’70s when we were developing that. We 

had no idea that the Internet was going to develop from this. We 

were developing it for entirely different reasons. We wanted to provide a more effective means for Defense scientists around the country to communicate with each other. That was the purpose for setting up ARPA Net. 

So I would like to say we had some sort of prescience on this, 

but we did not. We were doing it for a different reason. And it just 

stumbled out of the ARPA Net that we were doing. But without a 

doubt it was the DOD funding of that and carrying it through its 

infant years that allowed the Internet to develop first in this country, not in any other country. So that is very important. 

Now there’s no reason, there’s no logical reason why we could not 

provide that kind of technological base support, particularly for the 

commercial field, in agencies other than the Department of Defense. And 10 to 15 years ago we set out to try to develop other 

government agencies for doing that. They have never been as successful as the Defense Department. 

Chairman D’AMATO. No. 

Dr. PERRY. So I don’t argue that it has to be done in the Defense 

Department. I argue it is being done in the Defense Department. 

And until or unless we come up with a successor organization for 

providing that technological base for our commercial fields, we 

ought not to kill the goose that’s laying the golden eggs. 

I think the reason that it has been—it’s just difficult to do this 

right. And through the years the Defense Department has evolved 

a system including ARPA, which does it right. Until, as I say, until 

we have set up in another organization, a civil organization, a way 

of demonstrating that we can successfully provide the technological 

base support, we should continue to do it in the Defense Department and we should not decrease the level of support in the Defense Department. 
12

I would also like to see the environment created which would 

allow great scientific commercial laboratories like the Bell Laboratories, like the IBM Laboratories, being revivified. I don’t know 

quite how to do that, and I don’t know what the government can 

do to create the conditions where they can make that happen. But 

it is a fact that today that nearly all of the R&D that’s being done 

in industry today is product-development oriented and very little of 

it is there to support the technology base. 

And if we let that technology base go, you won’t notice the difference this year or next year, but you’ll notice a big difference five 

and ten years from now. 

Chairman D’AMATO. Thank you. 

Commissioner Wortzel. 

Commissioner WORTZEL. Thank you very much, Secretary Perry. 

I focused on your statements about the need to let companies get 

in international capital and to be able to with minimal restrictions. 

I want to ask a question about how one might craft appropriate restrictions. 

There are times when it’s very difficult to know, particularly if 

we’re dealing with China, but I can envision it with other countries, at times it’s very difficult to know just who the partner is. 

Doing due diligence in China is a very difficult task and sometimes 

it means simply figuring out who’s got the best relationship to the 

nearest Communist Party secretary. So should we be concerned 

that suddenly capital flows in and, lo and behold, our venture capitalist happens to be some clandestine research institute of the People’s Liberation Army? 

Dr. PERRY. I don’t have a good answer to that question, Mr. 

Wortzel. I have had concerns in the past for outside investments 

in the U.S. technological industry way back in the early ’90s when 

Japan was making heavy investments in the United States. I have 

a distinct recollection in the early ’90s of being convinced that the 

Japanese investments in the United States industry were going to 

cause them to take over our industries. It did not happen. Indeed, 

most of those Japanese investments turned out to be bad investments for them. 

I can still remember when we were so concerned about a different field but a related issue, about some of the Japanese investments in real estate in this country, thinking that they’re taking 

over the country. It turned out to be a pretty good deal for us and 

not for them. Based on that experience, I would be reluctant to try 

to set up some sort of controls on this issue. 

I don’t mean to dismiss it. I think it’s an issue that requires serious consideration. But on my own experience I haven’t seen any 

reason for arguing that it’s something that ought to be a major concern. 

I do know from seeing the various companies around here that 

they’re happy to get the capital from wherever they can get it. 

There’s a lot of capital flowing into this country from China and 

East Asia, as you know better than I. 

Chairman D’AMATO. Commissioner Robinson. 

Vice Chairman ROBINSON. Yes. Thank you, Mr. Secretary. You 

have provided some very illuminating remarks. 
13

Staying with the China side of the equation for a moment, you 

know that one of the principal mandates of our Commission is to 

look at some of the downside risks associated with the technology 

development dynamism of China, particularly its military relevance, which is your specialty. 

And, as you also know, China has its own offset strategy, whether you call it asymmetric warfare, or the somewhat more colorful 

term, ‘‘assassin’s mace.’’ The bottom line being is that they have a 

very focused effort on some key regional objectives, one of which, 

of course, is to be able to prevail quickly in any kind of conflict in 

the Taiwan Strait. The other objective akin to it is the ability to 

successfully interdict any U.S. force that should try to intervene in 

that blitzkrieg-type conflict. 

Now your Shanghai factory example I think is a good one, and 

the question is: Are the Chinese effectively closing that gap in information technology and other militarily-relevant capabilities to 

such a degree that in the next two or three years, when many estimate that they may feel confident in this kind of Taiwan scenario, 

that, the Chinese may be able to effectively pose not only a threat 

but a clear danger to our effort to defend Taiwan. What I’m getting 

at is the effectiveness of their own offensive power projection capability because of the rapidity with which they’re able to close some 

of these key military technology gaps. So that’s one question. 

I think the effort to lift the EU arms embargo is relevant here 

and if you have an observation on that, I’d be interested. 

A second question involves just a matter of broadening the lens 

a little bit, but you’ve been very visionary I think on the nuclear 

crisis on the Korean Peninsula. 

China is a pivotal player in this crisis because of its unique leverage. And you also, I think, are aware that things aren’t going 

very satisfactorily now as North Korea develops more and more nuclear weapons and ever longer-range ballistic missiles to deliver 

them. Frankly, it already looks like containment to me. I’m interested in your present feelings about whether we lost the bubble, so 

to speak, on the North Korean crisis when those 8,000 spent fuel 

rods were reprocessed? 

Dr. PERRY. There are a lot of different questions inside that, all 

of which are interesting to me. If I don’t answer all of them, please 

call me on it. 

Let’s take North Korea first since I just came back from Korea 

last week and I was there specifically to explore whether there is 

any possibility of bringing the allies, at least, together on how to 

deal with this issue. 

When I worked this problem as a North Korea policy review in 

1999, the first thing I did was go to Japan and go to South Korea 

to try to bring the three of us together. We have very different 

views on the problem, very different issues, and it was hard to get 

us together, but we finally did that. 

So when I finally went to Pyong Yang in 1999 I went with a letter, not just from President Clinton but from President Kim Dae 

Jung and from Prime Minister Obuchi, saying, ‘‘Dr. Perry represents our countries as well as the United States.’’ So we had a 

united front when we approached them. And the North Koreans 

were not able to drive wedges between us for that reason. 
14

Now today that’s not true. Today South Korea and the United 

States could not be further apart on this issue. And, of course, 

North Korea is busy driving wedges, but they don’t have to. We’re 

already far apart on that. I think it’s going to be very difficult to 

get a successful strategy with North Korean when even the allies 

are not together, much less China. 

So on the specific question of have we lost the bubble on that, 

I’m not quite sure what that means, but I think probably the answer is, yes. It was a major, major defeat for U.S. policy, I think, 

when the North Koreans reprocessed those fuel rods and made plutonium out of them. 

When we dealt with this problem in 1994 we made reprocessing 

of plutonium a red line. We said to the North Koreans, ‘‘If you 

cross that line, you’re going to be facing the United States in very 

serious ways.’’ And we were busy reinforcing our troops in South 

Korea to make the point to them. 

That led to the negotiation, which resolved that problem for a 

time. And the so-called agreed framework certainly did not solve 

the problem, but it delayed action on the problem for a good eight 

years, during which time the North Koreans could have made 

about 50 nuclear bombs, so it gained us something. 

But they have now reprocessed those fuel rods. They made the 

plutonium. We have no idea where that plutonium is. It’s very unlikely it’s a Yongbyon. So even one of the strategies which was 

open to us in 1994, which is going in and taking out the facility, 

is no longer a relevant strategy because the plutonium’s gone now. 

I think it was a major setback, allowing that to happen. 

I have not given up, by any means, on this problem. I think it’s 

such a serious threat to the United States, I think it’s very important to us we resolve that problem. And I have recommended to the 

Administration the action I think they could still take and might 

have some chance of success on it. But I must say that the key 

here, if we look in a diplomatic negotiation that involves carrots 

and sticks, the United States really only has one carrot that it 

might be willing to use. And that carrot is the willingness to make 

some a statement of no hostile intent to North Korea, which is 

meaningful. I think we have the ability to do that if we choose to 

do it. And that is a carrot that I think is meaningful to North Koreans. 

There’s also an important stick. The American stick, the only one 

we have is a military power, and that’s the one we really do not 

want to use. But the Chinese have a very big stick. They are responsible for more than 20 percent of the energy flow that goes in 

and much of the food that goes into North Korea today. And they 

have used that stick just once in a temporary way. Trying to get 

the talks going again, they reported they were having logistical 

problems delivering the fuel to North Korea, and they stopped the 

flow for about a week. And that had some remarkable effects on 

getting talks going again. 

So there’s no doubt that the Chinese have a stick if they choose 

to use it. So far they have not chosen to use it. So my view on getting those talks focused into action again is it requires the Americans being willing to use their big carrot and the Chinese willing 

to use their big stick. I think all of the other aspects in this prob-
15

lem are pretty incidental. But if those two things were to happen 

I think we, as a minimum, we could test whether or not the North 

Koreans are really willing to make a serious agreement on that. 

Vice Chairman ROBINSON. Is that statistic on the Chinese supply 

of North Korean oil correct? We’ve been hearing as high as 90 percent dependency on Chinese fuel. You had 20 percent. 

Dr. PERRY. Yes. I don’t trust any percent figures, I must say, but 

I do believe that if they were to cut off the supply of fuel that it 

would strangle. That’s the important point. 

Vice Chairman ROBINSON. Yes. We agree on that perception. 

Dr. PERRY. Thank you. 

Vice Chairman ROBINSON. Thank you. 

Chairman D’AMATO. Commissioner Reinsch. 

Commissioner REINSCH. Thank you. Thank you for your statement, Dr. Perry. I hope we all take it to heart. It seems to me if 

you look at it historically you have the great gift that not very 

many people in Washington have, which is that you’ve been right 

more often than you’ve been wrong. And we ought to take your 

words to heart precisely for that reason. 

On a personal note, I am particularly pleased to have your comments this morning because I invariably quote you when I give 

speeches on export controls. And you’ve given me some new ammunition, so I’m grateful for that. 

I do have two questions. One, on the innovation issue, let me ask 

you about intellectual capital. The Administration has adopted a 

series of policies that have made it more difficult for students to 

come here from other countries, China. And also for foreign professional workers to come here, engineers and the like, to work here 

for two or three years. 

Has this affected our ability to maintain innovation leadership? 

Dr. PERRY. The short answer to that is yes. I’m sympathetic with 

the reasons that the Administration is paying stricter attention to 

and making more complicated the immigration. I think to the extent it’s a response to 9/11, I understand why they’re making that 

response. But the net effect of it has been to keep out of this country many people we would like to have in the country. I don’t know 

that it has been successful in keeping terrorists out, but I do know 

it’s been successful in keeping out some very bright students and 

some very good scientists. And I think that hurts us. 

So I would like to find ways of doing what we need to do to restrict the flow of terrorists in this country and at the same time 

allowing the students and these scientists who want to visit here 

for conferences and come here for education to be able to do that. 

This university is a very good example of that. In our Engineering School, Graduate School of Engineering, about half of the students are foreign. Most of those from Asia. Some of our best students. And they enrich the university by their being here. 

I might comment parenthetically that we get in our Graduate 

Engineering School some of the best and brightest Americans in 

the country, but some of them come here just a little bit lazy. That 

is, they always were the best students in their high school, didn’t 

have to work very hard. And they come here and they think they’re 

not going to have to work very hard either, but then they come and 

they meet these Chinese students and Japanese students and Ko-
16

rean students, who work around the clock, and they—it just raises 

the bar for everybody. Everybody has to work harder. So I think 

it has enhanced the quality of our education by their being here. 

Now many of them go home when they’re done. Some of them 

stay, and the ones that stay also enrich our industry as well. Even 

the ones that go home end up working with American companies 

back here, and so I think we get benefits all around. 

There’s also the additional qualitative benefit that I don’t know 

how to make much out of but I think is important, is that thousands of students who come to American universities, when they 

go home they go home with some American ideas and some American values. And over a longer period of time I think that’s going 

to do a lot towards making modest transformations in China as 

well. 

So for all those reasons I think the foreign students who are here 

in this country are a net benefit to the United States economy, to 

the United States security, and I would encourage that. And, therefore, to go back to your point, I am concerned when our visa complications, for example, not wanting to make it difficult for students to come, but have discouraged many of them from coming at 

all. So we’re not starting to see a major shift of students from 

China, from Japan, from Korea to other countries, and I think 

that’s not good for us. 

Commissioner REINSCH. Which other countries? 

Dr. PERRY. European countries, other Asian countries, too. But 

European countries primarily. 

Commissioner REINSCH. Something you mentioned gave me a 

further thought, Dr. Perry. You referred to the Japanese real estate 

and investment issue. I think in the late 1980s and early 1990s we 

all shared the same concern that you articulated. 

One of the things that Washington debates these days is the extent to which that model is applicable now to the Chinese. There 

are a number of people who will say, well, it’s going to be the same 

thing. Why are we worried about the Chinese because we’re going 

to have the same experience we had with the Japanese? 

I think the sense of a lot of people in the Commission is that the 

analytical model isn’t the same, and this case is different. Do you 

have a comment on that? 

Dr. PERRY. No. I would not profess to be an expert in that field. 

I observed that history and I think about that, and I think you 

ought to look at that history when you consider it, but I will not 

argue that history is decisive. 

Chairman D’AMATO. Thank you. 

Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thank you very much. And thank 

you, Secretary Perry. It’s always an honor and a privilege to listen 

to you. And thank you also for your many years of service to our 

nation. 

Dr. PERRY. Thank you. 

Commissioner BARTHOLOMEW. I worked for Congresswoman 

Pelosi for many years. And as we were trying to get the funding 

for the KEDO, I sat and listened to you many times over that experience. 
17

I’m also struck by innovation. We are seated here in the birthplace of so much of this technological innovation. Ms. Pelosi always 

likes to say that the entrepreneurial spirit in Northern California 

is in the air that people breathe and the water that they drink. 

And how we move forward on that, I’m very interested also to hear 

your comments about FASB and the stock options. 

One comment on Commissioner Reinsch, which is I think the 

reason there is concern about this model of Japan and China is 

that the Japanese government is a democratic government and the 

Chinese government is an authoritarian regime 

And how the scenarios play out with different governments. But 

along those lines I’m interested in what you had to say about cultural innovation, too, sort of the cultural advantage that we have. 

There is not freedom of speech in China The restrictions on 

Internet usage, restrictions on freedom of speech, how much will 

that restrict the ability of the Chinese people to do the kinds of innovations that would move IT forward, for example? 

Dr. PERRY. I can only give you a judgment on that, subjective 

judgment. My judgment is it’s decisive. It’s a decisive factor. The 

free spirit we have here, the freedom we have I think is an integral 

and indispensable factor in the innovation area. That’s what I 

meant when by speaking about the cultural advantage we have. 

And it’s not just the difference in a country like China with an 

authoritarian government. Even in Japan, which is a democracy, 

there is not the same encouragement to innovate; there is not the 

freedom to innovate. When a Japanese engineer leaves his graduate school here at Stanford and goes back to Japan, he’s expected 

to go into a large company and fit a cog in that company. The 

thought that he would go out and start his own company is 

countercultural, really. 

So there’s a very big difference. And we didn’t do anything in the 

industry to create that difference. We just took advantage of it. We 

just exploited it. And as I say that’s not anything I think the government can do anything about, but we should cherish that difference and we should recognize it. And I do not think that we’re 

going to have any substantial competition in technological innovation in the very early—from China or, for that matter, much from 

Japan either. 

Commissioner BARTHOLOMEW. Interesting. Mr. Chairman, just 

one quick question, which is: 

Secretary Perry, do you share the concerns of many of your colleagues about the state of our public school systems and what it 

means for our ability to do technology, do innovation 10, 15, 20 

years down the road? 

Dr. PERRY. I do on an abstract basis. I don’t experience it. I’m 

here at Stanford and the students we get here from the public 

school system are amazingly bright and gifted and very well educated. So we get a very selected group of kids here, who have managed to rise up in spite of, I guess, the public school system. 

Also the public school systems here in the Palo Alto and Los 

Altos area are much better than the average, so I don’t experience 

the problem here. But I read about it, I study about it, and I very 

much believe that unless we can get the K to 12 right that we’re 

not going to be a great nation over the long-term, yes. 
18

Commissioner BARTHOLOMEW. Thank you. 

Chairman D’AMATO. Thank you, Mr. Secretary. I have two quick 

questions; I think a hardball and a softball. 

The hardball is: We’re going to have someone testify here who’s 

about to publish a book called ‘‘The Emerging Chinese Technological Superstate.’’ And the question is when we read all of this 

assessment on technology development, the number of firms moving FDI and R&D into China, and are we really seeing technology 

development or product development? To the extent that the Chinese are being competitive with us, to what extent are they actually doing the basic research, the real research, the kind of research that brings the ten years of product development later? 

I think the jury’s out on that. We’re getting conflicting testimony 

on that. I think it’s easy to confuse product development with real 

basic research. To what extent do you think the Chinese are really 

getting into this kind of basic research? 

The second question I have is: There are a number of people who 

are going to be testifying who come to the same conclusions on the 

inadequate relationship between Silicon Valley and the Federal 

Government. I’ll just read you one comment by a panelist: ‘‘One 

recommendation I would have to leave you with is: The Federal 

Government must do a better job of engaging with Silicon Valley. 

And the two should work together to move beyond unbridled engagement with China toward an alignment of private sector business interests with national interests.’’

‘‘Apart from hearings such as today’s, the Federal Government’s 

visibility in this region is surprisingly limited, particularly given 

that much of the technology subject to export controls giving rise 

to concerns about long-term competitiveness and proliferation originates within a 50-mile radius of this meeting. Except for the few 

individuals responsible for export control compliance within each 

company, there’s very little appreciation in the private sector for 

the competitive, strategic, and national security threats inherent in 

technology transfer. For the U.S. to maintain scientific and technological leadership, strategists and policymakers in Washington 

must win the cooperation of Silicon Valley.’’

You’ve seen it from both sides, from obviously your long experience in Washington and now here at Stanford in Silicon Valley. Do 

you think that there needs to be a more structured kind of dialogue 

between the individuals and organizations, and Silicon Valley with 

the policymakers in Washington to try and come to some kind of 

a better mutual understanding and perception of where we’re 

going? 

Dr. PERRY. I think the answer to that question is yes. I’m not 

sure I could advise you on how to structure that, but I think it has 

to be a benefit. 

On your first question, what I see from China today is product 

development. I have looked carefully in my various visits to China 

for examples of technology-based development. I don’t find it. I 

don’t think they have it. So I think they’re deficient in two respects. First of all, they lack the technology base we have. And, secondly, they do not have the culture that supports the innovation 

that we have. I think that’s going to be a fundamental problem 
19

that is going to hold them back. So if I’m right in that, they’re always going to be in what I call a tail chase on the new products. 

Chairman D’AMATO. So they’re not going to be running as fast 

as we are, hopefully? 

Dr. PERRY. They’re not going to be running as fast as we are. I 

don’t think there’s much we can do to hobble them, but I think 

there is a lot we can do to make sure we keep running faster. 

Chairman D’AMATO. Thank you, Mr. Secretary. You’ve been very 

generous with your time this morning. 

Dr. PERRY. Thank you. 

Chairman D’AMATO. We really appreciate it. Thank you very 

much. 

We’ll take a five-minute break. 

[Recess.] 

PANEL I: CHINA’S GLOBAL TECHNOLOGY COMPETITIVENESS I 

Chairman D’AMATO. Our first panel this morning after Dr. Perry’s presentation will be an attempt and evaluation of China’s global technology competitiveness. We have a very full and interesting 

panel. From the left, James Morgan, Chairman, Board of Directors 

of Applied Materials; Mr. George Scalise, President of the Semiconductor Industry Association; Mr. Alan Wong, Senior Counsel from 

Nvidia Corporation, Santa Clara; Mr. Gary Rieschel, Co-Executive 

Managing Director, Mobius Venture Capital; and Mr. Carl Everett, 

Partner in Accel Partners, again from the Valley here. 

The way we’ll do it, we’ll start from the left. Mr. Morgan will go 

first. And if each panelist would then summarize their remarks in 

about seven minutes, we’ll go right down, and then we’ll open it up 

to questions and answers. And we should have enough time to have 

a full series of questions and answers. 

Mr. Morgan, go ahead. See if you can confine your remarks to 

about seven minutes. Thank you. 

STATEMENT OF JAMES C. MORGAN

CHAIRMAN OF THE BOARD OF DIRECTORS

APPLIED MATERIALS, INC., SANTA CLARA, CALIFORNIA 

Mr. MORGAN. Thank you, Mr. Chairman and Members of the 

Commission. I prepared a copy of my testimony to submit, so I’ve 

got a few remarks. 

Chairman D’AMATO. We’ll include the full testimony in the 

record from each of you. 

Mr. MORGAN. So mostly I want to focus on how I see the competitiveness of the U.S. semiconductor equipment industry in regard to 

the rise of China, because I think it characterizes some aspects of 

the relationship that we have economically and in a broader sense 

with China. 

I believe your topic is a good topic, particularly to hold hearings 

here in Silicon Valley. The emergence of China as a key player in 

the electronics industry is a topic on the minds of every CEO I 

know, and not just CEOs of American companies. When I travel in 

Japan, throughout Asia, or in Europe the topic of China consistently comes up. 

As Vice Chairman of the President’s Export Council I can tell 

you that China has been a large part of our focus in discussing 
20

strategies to help promote and develop export opportunities for 

American goods and services. Last year we even took the step of 

conducting a special trip to China for Commission Members led by 

Secretary of Commerce Don Evans. 

The PEC has produced a number of letters of recommendation to 

the President regarding China. And I would respectfully suggest 

that the Commission Members review those recommendations as 

part of your work. I’d be glad to make them available to the Commission. They’re available online as well. And we can get more information for you on that subject if you want. 

One difficult issue we’re struggling to address at the PEC is the 

answer to the question posed to us by China’s Vice Premier Wu Yi. 

When we met with her in Beijing she assigned homework to PEC 

members. She had a reason for that. She noted that, according to 

her government figures, China’s overall trade was roughly in balance and U.S. imports to China accounted for only 8.2 percent of 

the total. This is a smaller figure than that of Japan, Korea, or Europe, and she asked the PEC why. 

Part of the answer can be linked to deficiencies in our U.S. export promotion activities versus those of our foreign competitors. 

Part of the answer can also be found in the barriers from the Chinese side, including undervalued currency, lack of regulatory and 

standard setting, transparency, rule of law, inadequate protection 

of intellectual property rights, discriminatory tax policies, subsidies, sectorial exclusions, and other derogations from WTO. National treatment rules places U.S. exporters at a disadvantage in 

the Chinese market. 

The PEC analysis found that Minister Wu’s basic proposition, 

however, was correct. European Union companies sell over 50 percent more goods and services in China than U.S. companies. Japanese companies sell over a hundred percent more than U.S. companies. 

What I find interesting that among high-tech products the U.S. 

is doing better in penetrating the China market. American semiconductor equipment firms have been moderately successful so far 

in the China market, selling about 51 percent of the equipment in 

the front-end market with things like wafer fab, mask and radicals, 

wafer manufacturing, and factory automation equipment. 

The situation’s not as good in the back-end segment, i.e., what 

we call test and assembly, as U.S. firms account for only 29 percent 

of sales. 

By way of background, Applied Materials is the world’s largest 

supplier of manufacturing systems and related services to the global semiconductor industry. We supply wafer-fabrication systems 

that perform many of the steps in the manufacturing process to 

make semiconductor chip circuitry. We also manufacture systems 

to produce flat-panel displays, develop and sell manufacturing execution software, and provide a variety of other manufacturing-related services to the industry. 

We are one of approximately 2,200 companies in the worldwide 

semiconductor equipment and materials industry represented by 

our trade association, Semiconductor Equipment and Materials 

International, or SEMI as it’s frequently known. 
21

About 1,000 of these companies are headquartered in the United States. Although Applied Materials had sales of just over $8 billion 

in our last fiscal year, about 85 percent of U.S.-based equipment 

and materials companies are small, privately-held companies with 

annual sales of less than 25 million. Many of these firms are part 

of a wide network of suppliers to largely publicly held companies 

such as Applied Materials that serve the global semiconductor industry. 

SEMI companies spend an average of 15 percent of annual revenues on R&D, and I think that’s a very important number for the 

Commission to keep clearly in mind. Applied Materials alone has 

spent $5 billion on R&D over the past five years. 

To fund these R&D investments every sale is important. Increasingly, this means sales to markets outside the United States. Export revenues now account for more than 70 percent of sales for 

most leading U.S. companies in the semiconductor equipment industry. For Applied Materials in fiscal year 2004 it was even higher. 

With so much of the semiconductor industry investment outside 

the U.S., maintaining a high market share in regional markets 

around the world is essential to ensuring the resources to fund continued R&D, innovation, and competitiveness. Thus access to overseas markets and the ability to compete in those markets with 

leading edge technology is absolutely vital to the long-term health 

of the U.S. semiconductor equipment and materials infrastructure. 

Asia, including Japan, now comprises almost 70 percent of the 

world’s market for semiconductor equipment and materials. 

Within the Asian market China is the fastest growing, growing 

about 130 percent from 2003 to ’04, but part of the impressive 

growth stems from the fact the market’s still relatively small: Less 

than three billion out of a global market of more than 43 billion. 

Though still a relatively small market investment trends indicate 

China is a key strategic market and early access to the China market is crucial for downstream success. For a company like Applied 

Materials that make products for manufacturing plants, it’s hard 

to overstate the importance of gaining the tool-of-record designation with a customer, since this means you have a good chance of 

being chosen to supply equipment for future manufacturing facilities over many, many years. 

If the U.S. can gain that market share early in the development 

of China’s semiconductor industry, we can defend that market 

share against erosion by foreign competition as the market grows. 

If we allow foreign equipment to be designed in at the early stage, 

displacing those competitors can be extremely difficult. 

One of the lessons we learned in the ’80s, when the U.S. faced 

stiff competition from Japan, is that competing effectively means 

competing for every customer in every market. Ceding market presence anywhere makes it that much more difficult to gain the margins to afford the R&D to stay competitive. 

Applied Materials has been engaged in China for a long time. I 

made my first trip there in 1984, and this past year we celebrated 

our twentieth anniversary. From a handful of service center workers at the outset of ’84, and at that time we weren’t allowed to even 

hire our own employees, we’ve grown to more than 300 employees 

in five offices around the country. For the first 15 years revenues 
22

from China was negligible, but in 2000 as it became part of the 

global economy in earnest, we saw significant growth with almost 

750 million from China in 2004—with the growth of the electronics 

industry in general and semiconductor, in particular, in China, we 

anticipate further market potential, driving a fivefold increase in 

semiconductor production over the next five years as a host of new 

fibs are built. The majority of these facilities are not anywhere 

near the cutting edge, but they don’t need to be. 

Currently, as China tries to increase their production of chips—

they produce only 25 percent currently—they are going to try not 

to depend so heavily on imports, which is typical of almost all these 

countries. 

So let’s look at what’s happening in the fact that only a small 

percentage of China’s population has been touched by technology. 

They have several serious problems, most of these have been articulated. There are rural and urban dislocations; banking, finance; 

inefficient state enterprises, just to name a few. 

The ability to generate genuine innovation in the absence of effective intellectual property protection is another real barrier to the 

ability to be a global technology leader. And while China’s growing 

economic power, it also has a lot of competitors, who will not likely 

cede their economic or technological leadership. Applied, like many 

other companies, has strategies for engaging in China and remaining competitive for the future. 

The key, I believe, is to focus really on the competitiveness of 

U.S. companies. In the end this is the only way we’re going to win 

the high-tech industry. We can open markets and attract new consumers by bringing down the cost, and we’re under intense cost 

pressure in our industry. That’s why your cell phone today does 

twice as much and costs half of what you’re old phone did. But with 

this in mind I think we see more and more companies exploring investment and partnerships with companies in China. In the end, 

America needs this kind of engagement in order to make sure we 

stay ahead of the curve. 

So where do we go? Any policy response I think to China or anywhere else should target an overreaching goal: To make the United 

States a preferred place for investment from around the world. 

There is a China-oriented component of this strategy that largely 

involves enforcing China’s WTO commitments, particularly its continued shortcomings in intellectual property and realignment of the 

currency. I’ve outlined some policy priorities in my written statement, so I won’t repeat them here. 

I think the semiconductor equipment industry, being technologyintensive, high value net exporting American success story is an industry where we can achieve a leadership position. And we intend 

to keep that hard-won place of international competitive leadership 

if we have the policy framework in the U.S. to do that. 

I think collectively we must work diligently to make sure the 

U.S. is the top of the list of attractive places around the world in 

which to do business. This is the best way to assure job growth in 

the U.S. and the resulting income and taxes to invest in U.S. competitiveness. 

Thank you very much. 

[The statement follows:]
23

Prepared Statement of James C. Morgan

Chairman of the Board of Directors

Applied Materials, Inc., Santa Clara, California 

Background 

Applied Materials, Inc., is the world’s largest supplier of manufacturing systems 

and related services to the global semiconductor industry. The company supplies 

wafer fabrication systems that perform many of the steps in the manufacturing 

process to make semiconductor chip circuitry. We also manufacture systems to 

produce flat-panel displays, develop and sell manufacturing-execution system software, and provide a variety of other manufacturing-related services to the industry. 

We are one of approximately 2,200 companies in the worldwide semiconductor 

equipment and materials industry represented by our trade association Semiconductor Equipment and Materials International (SEMI); about 1,000 of these companies are headquartered in the United States. 

Although Applied Materials had sales of just over $8 billion in our last fiscal year, 

about 85 percent of U.S.-based equipment and materials companies are small, privately-held companies with annual sales of less than $25 million. Many of these 

firms are part of a wide network of suppliers to larger, publicly-held companies—

such as Applied Materials—that serve the global semiconductor industry. 

Applied Materials, like most companies in the industry, was once simply a provider of tools built to specifications handed to us by our customers. Today, our research and development (R&D) generates many of the strategic process advances 

that increase chip information density, reliability and yields. As a result, SEMI companies spend an average of 15 percent of annual revenues on R&D; Applied Materials alone has spent $5 billion on R&D over the past five years. 

To fund these R&D investments, every sale is important. Increasingly, this means 

sales to markets outside the United States. Export revenues now account for more 

than 70 percent of sales for most leading U.S. companies in the semiconductor 

equipment industry. For Applied Materials in fiscal 2004, the figure was 83 percent. 

With so much of the semiconductor industry’s investment outside the U.S., maintaining a high market share in regional markets around the world is essential to 

ensuring the resources to fund continued R&D, innovation and competitiveness. 

Thus, access to overseas markets and the ability to compete in these markets with 

leading-edge technology is absolutely vital to the long-term health of the U.S. semiconductor equipment and materials infrastructure. 

The Emergence of Asia 

As the chart below indicates, Asia has emerged as the largest market for semiconductor equipment and materials manufacturers. First came Japan, then Korea, Taiwan (as well as smaller markets in Singapore and Malaysia), and now China. As 

a result, the Asia market now comprises almost 70 percent of the world’s market 

for semiconductor equipment and materials. Within the Asia market, China’s is the 

fastest growing. But part of the impressive growth rate (130 percent from 2003–

2004) stems from the fact the market is still relatively small: not quite $2.7 billion 

in 2004.
24

Though still a relatively small market, investment trends indicate that China is 

a key strategic market and early access to the China market is crucial for downstream success. It is hard to overstate the importance of gaining the ‘‘tool of record’’ 

designation with a customer, since this means the supplier companies likely will be 

a part of future manufacturing facilities. One of the lessons we learned in the 1980s 

when the U.S. faced stiff competition from Japan is that competing effectively 

means competing for every customer in every market. Ceding market presence anywhere makes it that much more difficult to afford the R&D to stay competitive. 

American firms have been moderately successful so far in the China market, selling 51 percent of the equipment in the ‘‘front-end’’ market (i.e., wafer fab, mask/reticle, wafer manufacturing and factory automation equipment). The situation is not 

as good in the ‘‘back-end’’ segment (i.e., test and assembly), as U.S. firms account 

for only 29 percent of sales. In sum, U.S. producers face strong competition from 

Japan, Taiwan, Korea and Europe in markets around the world, and China is proving itself no different. 

Applied Materials and China 

In November 2004, Applied Materials celebrated the twentieth anniversary of our 

presence in China. From a handful of service center workers at the outset in 1984 

(and at that time we were not allowed to even hire our own employees in China), 

we have grown to more than 300 employees in five offices around the country. For 

the first 15 years, revenues from China were negligible. It was not until 2000—as 

China became part of the global economy in earnest—that we really saw significant 

market growth. In 2004, Applied Materials had revenues in excess of $750 million 

from China. With the growth of the electronics industry in general, and of the semiconductor industry in particular, in China, we anticipate even further market potential. The chart below illustrates where we expect China’s electronics industry to be 

in five years.
25

Driving the nearly five-fold increase in semiconductor production in China over 

the next five years is a host of expected new semiconductor fabrication facilities 

(‘‘fabs’’):

It is important to note that the majority of these facilities are not at the cutting 

edge of technology, largely because they do not need to be. For every customer such 

as an SMIC building a 12-inch (300mm) facility, there are several others building 
26

8-inch or even smaller wafer-size production facilities. Currently, China produces 

only about 20 percent of the chips its domestic electronics industry consumes. China 

is aggressively moving to increase this figure, which has led to a building boom. As 

a result of this building boom, the percentage of consumption derived from domestic 

production will rise to about 45 percent in 2010, and the market for semiconductor 

chips is expected to double. 

Despite China’s impressive growth in some sectors, it is important to keep that 

country in perspective. Only a small percentage of China’s population has been 

touched by technology, and several serious problems face the country: rural/urban 

dislocations and unemployment, scarce water resources and growing pollution, energy consumption and rising prices, an unstable banking/finance system, inefficient 

state-owned enterprises, and others. China’s ability to generate genuine innovation 

in the absence of effective intellectual property protection is another real barrier to 

its ability to be a global technology leader. Given this host of looming challenges, 

it is not surprising that China was ranked 24th in the 2004 IMD ‘‘World Competitiveness Scoreboard’’ and 46th in the World Economic Forum’s 2004 rankings. (The 

United States ranked 1st and 2nd, respectively, in these ratings.) The point is, while 

China is a growing economic power, it also has a lot of competitors around the world 

who are not likely to cede economic or technological leadership easily. 

Applied Materials, like many other companies, has strategies for engaging with 

China and remaining competitive as China emerges as a significant semiconductor 

manufacturing player. On the one hand, it is a vibrant and growing market; on the 

other hand, we face the prospect of a domestic semiconductor equipment industry 

emerging to challenge us. Another issue we face is cost pressure from our customers. As some components and technologies become commoditized and prices 

drop, increased operations in China are often viewed as a solution to staying profitable and funding further R&D in the U.S. This raises the issue of intellectual property protection, which is haphazard at best in China. We spend considerable time 

and effort to safeguard our technology and corporate knowledge. 

Policy Responses 

Any policy response to the rise of global competition from China or anywhere else 

should target one overarching goal: to make the United States the preferred place 

for investment (of all types) from around the world. There is a China-oriented component of this strategy, which largely involves enforcement of China’s WTO commitments (particularly its continued shortcomings in intellectual property protection) 

and a realignment of China’s currency. 

For the most part, however, the U.S. policy response should be focused less on 

China and more on challenges at home to our overall competitiveness. There are numerous elements that comprise this comprehensive policy program, few of which are 

easy, inexpensive or near-term. They include, but are not limited to:

• Education—We cannot expect to be an innovation- and technology-based economy if our students are deficient in math and science skills. This is true at both 

the grade level (e.g., No Child Left Behind) as well as college and graduate levels (National Science Foundation funding). 

• Immigration/Visas—With pipeline shortages of scientific and engineering talent, we should make it easier to attract and keep students from around the 

world in the United States. 

• R&D Funding—Except for military and health sciences, Federal R&D spending has been stagnant for 15 years. The United States cannot coast forever on 

our R&D investments from decades gone by. The physical sciences are key drivers of an innovation-based economy and we are under-investing in those areas. 

• R&D Incentives—The on-again, off-again R&D tax credit (not to mention its 

increasingly archaic structure and difficult compliance) is less and less of an incentive to perform R&D activities here in the United States. 

• Regulation—The recent battle over stock options accounting (which will likely 

seriously diminish the use of this form of employee incentive) is a good example 

of how knee-jerk regulation with insufficient consideration leads us into blind 

alleys to no good purpose. The Gordian Knot of telecom regulation that retards 

broadband deployment in the United States is another type of entanglement 

that hamstrings U.S. competitiveness. 

• Export Controls—There are multiple sources for everything these days, and 

making it more difficult for U.S. exporters to compete and gain market share 

does not advance our national security since technology companies require sales 

in all regions to have the financial return necessary for continued R&D funding 

to stay in the lead.
27

These and other issues will determine the macro-environment that will drive investment decisions in the years ahead. The economic reforms started by Deng 

Xiaoping and accelerated under Jiang Zemin were marked by a high degree of pragmatism and flexibility. This flexibility is one of the reasons that China has been 

able to achieve the surprising economic growth it has. We would do well to be as 

pragmatic in seeking and implementing our own policy solutions. 

The U.S. semiconductor equipment industry is a technology-intensive, high valueadded, net-exporting American success story. As an industry, we achieved a leadership position through a lot of hard work by a lot of smart people over a long time. 

And we intend to keep this hard-won place of international competitiveness leadership—if we have a policy framework that enables us to do so. We must work diligently to make sure the United States is at the top of the list of attractive places 

around the world in which to do business. This is the best way to assure job growth 

in the U.S. and the resulting income and taxes to invest in U.S. competitiveness. 

Thank you.

During his testimony at the Commission’s hearing on April 21, 2005, Mr. Morgan 

made the following additional statement:

‘‘As Vice Chairman of the President’s Export Council, I can tell you that 

China has been a large part of our focus in discussing strategies to help 

promote and develop export opportunities for American goods and services. 

Last year, we even took the step of conducting a special trip to China for 

Commission Members—led by Secretary of Commerce Don Evans. The PEC 

has produced a number of letters of recommendation to the President regarding China, and I would respectfully suggest that the Commission Members review those recommendations as part of your work.’’

He submitted, for the record, copies of the following PEC documents: 

THE PRESIDENT’S EXPORT COUNCIL

Select Letters of Recommendation to the President of the United States 

December 17, 2004 Letter on Export Control Legislation

August 19, 2004 Report on the President’s Export Council Trip to China

August 19, 2004 Annex to the Council Letter on China addressing 

U.S. Competitiveness in China

September 29, 2004 Letter on Export Controls

October 1, 2003 Letter on China 

Copies of these letters of recommendation can be accessed

on the webpage of the President’s Export Council 

http://www.ita.doc.gov/TD/PEC/letterspage.html

Chairman D’AMATO. Thank you very much, Mr. Morgan. 

Mr. Scalise. 

STATEMENT OF GEORGE M. SCALISE, PRESIDENT

SEMICONDUCTOR INDUSTRY ASSOCIATION, SAN JOSE, CALIFORNIA 

Mr. SCALISE. Thank you, Mr. Chairman. I’m George Scalise, 

President of the Semiconductor Industry Association, which represents the bulk of the industry here, about 85 to 90 percent of the 

industry in the U.S. 

I also happen to be on the President’s Council of Advisers on 

Science and Technology, and recently chaired a study dealing with 

information technology, manufacturing, and innovation. It deals 

with some of the concerns that you have here. 

I, too, have submitted a written statement that will be a part of 

the record. 

Again, I think this hearing is a good opportunity to deal with 

some of the important challenges that we’re facing with regard to 

China. As a consequence, the Commission can help build a con-
28

sensus among the U.S. policymakers to develop an effective response to this challenge. I think if there’s one goal I would like to 

see you folks have is developing that effective response. 

But before I begin I want to note that China can and should pursue its desire to have a strong microelectronics industry. We have 

no problem with that. They are developing a compelling and a very 

large market within the country. In fact, it’s the fastest growing in 

the world and it’s home to some very strong competitors or at least 

evolving strong competitors. We favor that competition. 

We know that China will play the same role as Japan, Europe, 

Korea, and all the others that have come into this market. Net robust competition is what drives the investment, drives the technology development that has been the hallmark of this industry for 

the last 50 years. And, as a consequence, has enhanced the standard of living of peoples all around the world, not just here in the 

U.S. but all around the world. 

Just a couple of notes that make this largely possible. Number 

one is that we reduce our prices every year. This is one of those 

industries where on average the price declines 25 to 30 percent a 

year. To just underscore that, if you look at the cost of a bit of 

memory in 1995 it would cost $1—and look at that same price 

today it would be about two cents. So we’ve reduced it by 98 percent over those years. As Jim just mentioned, it’s for those reasons 

that you find greater and greater functionality, lower and lower 

costs for all kinds of products. Whether they’re consumer or industrial or military, all of these things are being enhanced by this 

technology. 

I’d like to also dispel a couple of myths that I think are floating 

around these days. First of all, that lower labor costs drive the decision to invest in China. That is probably true in some industries 

that are very labor-intensive, but when you look at the high-tech 

industry this is not true at all. 

When we look at the cost structure in China versus here in the 

U.S., there is about a billion dollars’ difference in the earnings that 

one can generate over 10 years—and you can define this in two different ways, but I’ll just define it in one way for now, using a net 

present cost calculation. 

Over a ten-year period you will generate about a billion dollars 

more in earnings in China than you will here in the U.S. for about 

a three-and-a-half-billion-dollar investment in a fab facility. Now 

the reason for that is not that their cost structure is better. It’s because they have some very aggressive policies dealing with tax 

treatment, incentives, subsidies, grants, and a whole host of things. 

The tax policy alone provides about 70 percent of the difference: 

Tax holidays, things of that nature. Another 20 percent is based on 

the grants and subsidies that are applied to the equipment that is 

purchased. Then there’s ten percent left that is a variety of other 

things, and a part of that then is labor. So I think it’s important 

to recognize that labor is not the issue when it comes to semiconductors. 

The second myth is that China lags in terms of technology in a 

significant way. They certainly do lag. We in the U.S. certainly are 

the leaders. We continue to be the leaders. We think we can be for 

some number of years. If we do the right things. But China is be-
29

coming better and better and better. And they’re narrowing the gap 

each and every month, so I think it’s important to recognize that 

we have a very real competitor that is coming along behind us. And 

they are going to be innovators. They are going to be very effective 

as they go forward. 

So what are the implications of all of this and what do we do 

about it? One of the key trends that’s happened as a consequence 

of these incentives and this investment shift that is taking place, 

two-thirds of the new 300 millimeter factories, which are the most 

advanced wafer fabs that Jim was just alluding to, will be built in 

Asia by 2007, two-thirds. That projection is almost ten percent of 

the global semiconductor industry in China at that stage, starting 

out from zero just a very few years ago. And it’s going to now continue to escalate at a very, very rapid rate. 

Last year the foundry capacity in China doubled to approximately 500,000 wafers a year. That’s a very sizable manufacturing 

capability. 

There is a critical need to make certain that not all of that investment goes to China. We have no problem with whatever percentage of it, whatever reasonable percentage goes to China, or 

Taiwan, or Korea, or anywhere else. What is critical is that we 

maintain a critical mass here in the U.S. so that we can maintain 

the ecosystem that starts with the R&D in the universities that Dr. 

Perry was talking about a few minutes ago, moves on to the 

precompetitive research that takes place in consortia. And we, 

through the SIA, fund about $80 million a year of university research that is a combination of very basic research as well as 

precompetitive research that is somewhere between basic and commercialization. 

Then we also invest about $15 billion a year here in the U.S. in 

commercialization research, and that is then backed up by the 

manufacturing that is a critical part of that ecosystem. 

So the point we want to make here is that—and we’re going to 

focus on this as opposed to some of the larger issues that could be 

addressed here today—maintaining that ecosystem and the manufacturing element of it is critical to our maintaining the leadership 

in technology that we enjoy today. 

We have been leading the technology revolution that came upon 

us shortly after the Second World War, and semiconductors have 

driven it for the last 50 years. We can maintain it throughout the 

rest of what we call the ultimate CMOS era, which is about another 10 to 15 years, and into the nanotechnology era, which is 

going to be the successor to this technology. It will evolve starting 

about 15 to 20 years down the road. 

But it is important to recognize that China is investing very 

heavily in the innovation ecosystem. And it’s important that we 

recognize what they’re doing. I think to the extent that they are 

WTO compliant, that’s fine. When they’re in violation of the WTO, 

then we have to do something about it. We did that last year with 

regard to their handling the value-added tax and WAPI, and we 

got those sorted out. We give them credit for having addressed 

those issues. 
30

But now we have to address issues that are WTO compliant. I 

think that’s the issue that needs to be addressed by the Commission as it hears testimony not only here but also in other venues. 

When we look at the policies that they are applying and, therefore, what we should do about it, I think that it’s very clear that 

if we can just address those policies and neutralize them, then we 

can deal with whatever we have to contend with. 

Our manufacturing capability here in the U.S. is equal to anyone 

in the world—and probably better than anyone in the world. 

Whether it’s cost, technology, innovation, product development, you 

name it, we are the best in the world. And we can compete with 

anyone on a cost basis. 

So what are our recommendations? The recommendations that 

we would suggest to you to take a very hard look at: First of all, 

at the tax holidays to match the tax holidays offered by overseas 

competitors. Now if it isn’t exactly that, something that is equivalent to that that allows that to be neutralized. 

Make the R&D tax credit permanent. Enact enhancements to 

make it more effective. And, again, this is something we’ve talked 

about for a long time. 

Allow companies to expense high-tech manufacturing equipment 

in order to improve cash flow and stimulate investment in new 

equipment. 

Re-examine international taxation rules and consider alternatives to the current rules on taxing foreign-source income so that 

there is an incentive to invest here at home as opposed to leaving 

it overseas and invest money over there. 

Enact significant tax rate reductions to make manufacturing 

costs in the U.S. more competitive with costs in other countries. 

And, again, a recent study shows us to be kind of at the bottom 

of the list when it comes to the taxes that companies are paying. 

If we’re going to be at the bottom of that list, it’s just that much 

harder to compete. 

Free up the 20,000 H–1B visas that were part of the appropriations bill that was passed last year that has now come into question and, as a consequence, is being used for other things than the 

advanced degree holders who are coming out of our universities 

with technology and science degrees. That’s what they were, this 

20,000 visas, were designed to provide the opportunity for those 

folks to stay here. Again, as Dr. Perry talked a few minutes ago, 

we have to make sure that those visas are used for that. 

Finally, enact the House bill on tax treatment of stock options, 

H.R. 913, the Broad-based Stock Option Transparency Act. Again, 

I think this is something that Dr. Perry talked about. We have to 

have the opportunity to hire these young people, provide them the 

incentives, the benefit that is afforded through stock options. 

So I’ll stop there. Thank you very much. 

[The statement follows:]

Prepared Statement of George M. Scalise, President

Semiconductor Industry Association, San Jose, California 

Introduction 

Mr. Chairman, Members of the Commission, my name is George Scalise, I am 

President of the Semiconductor Industry Association. SIA represents the largest 

U.S. headquartered semiconductor companies. I also serve on the President’s Coun-
31

cil of Advisors on Science and Technology—the PCAST—where I recently chaired a 

Subcommittee on Information Technology and Manufacturing Competitiveness. 

I want to start by thanking you for inviting me to testify here today. I think this 

hearing—with its focus on the opportunities and challenges that face the U.S. high 

technology industry vis-a`-vis our Chinese competitors—is very timely. As I will explain in my testimony, Chinese government policies, and not lower labor costs, are 

the major contributor to 10 year, a $1 billion cost differential, between building and 

operating a semiconductor plant in China compared to the U.S. This Commission 

has a responsibility to help build the consensus among U.S. policymakers to develop 

an effective response to this challenge. 

I would like to begin with a brief overview of the U.S. semiconductor industry and 

the mission of the SIA before going into more detail on the challenges presented by 

Chinese policies. 

First, though, I want to note that China can and should pursue its desire for a 

strong microelectronics industry. China is a very compelling market for U.S. companies, and it is home to some very strong competitors. SIA has since its inception 

favored free and open trade, and the case of China is no exception—robust competition is what drives the industry to invest ever higher amounts in research and technological advances in order to stay ahead. 

U.S. leadership in advanced technology is not guaranteed, and foreign competition 

is intensifying. Many other countries—including China—are aggressively pursuing 

policies to build technical capabilities and to attract semiconductor and other high 

tech investments. The issue before us today is to understand the competitive factors 

influencing our industry, ensure that competition is fair and unencumbered by government barriers or market distortions that prevent the best company from winning, and develop policies that will help us retain our leadership position in the 

years ahead. 

Overview: The U.S. Industry 

Today, the U.S. semiconductor industry is the most competitive in the world in 

terms of market share. U.S. chip companies account for almost half of the world 

market in terms of sales—more than any other country. Over three quarters of U.S.-

owned wafer capacity is in this country despite the fact that three quarters of our 

sales are outside the U.S.; almost 80% of the U.S. industry’s total labor compensation is in the U.S., while only 55% of our labor force is here. 

The U.S. also has the lead in terms of technology and manufacturing capacity. 

U.S. semiconductor firms as a whole still account for the largest percentage of purchases of semiconductor manufacturing equipment, but that lead is diminishing. 

Purchases by American companies have gone from just over 43% in 2001 to roughly 

25% last year. Chinese companies’ share of equipment purchases grew from about 

2.6% to over 8% over that same period. The second metric we look at is the geography where the equipment will be located. In terms of leading-edge capacity, the 

U.S. has declined from a high of 36% in 1999 to just over 20% in 2004, and that 

trend is continuing. Two-thirds of the world’s new 300 mm fabs will be built in Asia. 

These numbers represent a geographic shift, and also a structural shift from socalled integrated device manufacturers to foundries. Foundries manufacture product 

designed by others—Taiwan built its industry on the foundry model, and China appears to be following suit. 

A large part of the reason for this dramatic shift, though, is cost based. As I mentioned previously, there is a $1-plus billion 10-year cost difference between building 

and operating a fab in Asia versus the U.S. About 70% of the cost difference is due 

to tax benefits, 20% due to capital grants, and only 10% due to lower labor costs. 

Operating costs such as lower utility costs or cheaper logistics are also slightly lower 

overseas. 

As taxes represent 70 percent of cost differential, it is instructive to compare tax 

rates in specific countries. In the U.S., the Federal income tax rate is 35%, and state 

and local taxes typically equate to an additional 6% rate (after adjusting for the 

Federal deduction). In contrast, China offers a five-year income tax holiday, and an 

additional five years at half the tax rate. Singapore and Malaysia offer five- to 10-

year tax holidays. Ireland has a 12% tax rate, which is still a third of the U.S. rate. 

Taiwan’s tax holiday and accumulated tax credits have resulted in Taiwan chip companies reporting higher net profitability after rather than before taxes. These tax 

benefits often also apply for research, development, and design centers. 

The mission of the SIA is to ensure that the U.S. retains its lead in terms of both 

market share and technology. Chip manufacturing, corporate R&D, product design, 

semiconductor equipment and materials producers, and university research are all 

key elements of the semiconductor technology ecosystem, and erosions in any one 

part affects the other parts. The data I’ve just shared with you makes clear that 
32

while we have a solid lead today, we face significant competitive threats that I believe must be dealt with quickly and forcefully if we are to retain our lead in the 

future. 

China’s Market 

China’s semiconductor market was estimated at $25 billion in 2003, with annual 

growth rates ranging from 15–20%. China today is the third-largest country market 

worldwide, and is predicted to become the second-largest overall market by 2010. 

China is already the world’s largest mobile phone market, and second largest personal computer market. The demand for chips is driven by China’s increasing role 

as an electronics manufacturing hub, producing everything from PCs and cellular 

phones to flat panel displays, digital cameras, and DVD players. Semiconductors exports to China in 2003 were $2.4 billion and $2 billion for the 

first nine months of 2004—making them the second largest manufactured export 

from the U.S. to China. These figures may actually under-report the full value of 

U.S. semiconductor products exported to China, as the distributed nature of assembly and final testing in third-countries is not captured in U.S. export figures. 

Chinese Government Incentives 

This very rapid market growth is accompanied by a very ambitious policy agenda 

to foster the semiconductor industry in China. These policies range from direct incentives to manufacture in China to support for R&D, coupled with a willingness 

to utilize the standards setting process quite aggressively to favor specific firms. 

Some of these policies represent an effort to make rapid progress in an important 

industry. Others, unfortunately, represent violations of World Trade Organization 

(WTO) rules. 

In 2004, the Office of the United States Trade Representative (USTR) brought the 

first WTO case against China on that country’s Value Added Tax (VAT) rebate on 

semiconductors. In summary, that policy provided for rebates of 14% of the 17% 

VAT paid to companies who manufactured their semiconductors in China, while imposing the full 17% VAT on imported chips. This created a substantial incentive for 

Chinese chip purchasers to utilize domestically made product. The WTO case was 

always about more than fair market access—it was about making sure that investment decisions will be based on sound market factors and not government interference. The policy was very effective in skewing investment decisions and led to 

substantial increases in manufacturing capacity in China. In July 2004 the case was 

settled, and on March 31, 2005, all remaining elements of the program were halted. 

To its credit, the Chinese government implemented in full and on time all of the 

commitments made as part of the settlement agreement. 

Following resolution of the VAT case, it appears that the focus is shifting to R&D. 

At the point in time the VAT replacement policy was to be announced, China issued 

‘‘Temporary Measures of Special Funds in R&D in the Semiconductor Industry’’—

these measures will reportedly go into effect on April 30, 2005. The policy was 

jointly announced by the Ministry of Finance (MOF), the Ministry of Information 

Industries (MII) and the National Development and Reform Commission (NDRC). 

The notice itself does not indicate funding amounts, although press reports indicate 

that the fund may pay up to 50% of a firm’s R&D costs. Press reports also indicated 

additional income tax breaks for semiconductor makers, reportedly lengthening tax 

breaks to five years exemption and five years at half rate, up from the current twoyear exemption and three years at half rate that is granted to preferred companies. 

The SIA is actively seeking additional details regarding this policy, and would be 

happy to share them with the Commission when they become available. 

In addition to these direct subsidies, the Chinese government has also shown an 

interest in utilizing the standards setting process to impact the market. I’m not 

going to spend much time on this issue here today, but would be happy to answer 

any questions you may have at the conclusion of my testimony. 

Chinese Manufacturing Capacity and Technology Trends 

The combined impact of China’s compelling market opportunities and Chinese 

government subsidies has been noticeable. By 2007, the projection is that almost 

10% of global semiconductor capacity will be in China—up from barely 2% only a 

few years ago. 

Much of the investment going into China today is in the foundry area. In the year 

2004 alone, foundry capacity in China doubled to approximately 500,000 wafer 

starts per month—revenues earned by Chinese foundries also doubled from 2003 to 

2004 to approximately $1.8 billion. By 2006, Chinese foundry capacity at the 0.18 

um node will be approximately 28% of world total. 

While much of the capacity in China today is 200 mm and in some cases employs 

used equipment, experts project that there will be up to five 300 mm fabs oper-
33

ational in China by 2007. While the majority of Chinese capacity in 2004 continued 

to be at 0.5 um, the capability and capacity are rapidly expanding for more advanced nodes up to 0.13 um—and one foundry even announced that it will soon 

have available 90 nm (0.09 um) process technology. 

Most Chinese foundries have entered into—or are in the process of entering into—

process technology licensing agreements with leading semiconductor companies in 

Taiwan, U.S., Japan and Europe. Foreign companies also represent the bulk of the 

customer base for these foundries. Last year, foreigners accounted for approximately 

80% of Chinese foundries revenues. However, Chinese fables companies are growing 

rapidly—their revenues are expected to quadruple between 2003–2008, to $1.2 billion. Although this is still a relatively small number, Chinese foundries expect that 

local design houses will drive demand for advanced manufacturing capabilities in 

the future. 

Semiconductor technology has been making rapid strides in China by virtually 

any metric one can imagine. The determined resolve of the local authorities to build 

a strong local semiconductor industry, coupled with the attractiveness of China as 

a market, is acting as a powerful accelerator. 

The decision to locate new capacity in China is not driven primarily by low labor 

costs—semiconductor fabs are capital and technology intensive and even an 80% differential in wage rates results in barely a 10% difference in final costs. The difference lies mainly in government incentives such as favorable taxation and other 

benefits. 

Although China has chosen the low end of the foundry business as their entry 

vehicle into the global semiconductor industry, Chinese foundries are advancing rapidly to becoming world-class in leading-edge process technology. In addition, the 

Chinese government proactively supports an entire local ecosystem including fabless 

design houses, integrated device manufacturers (IDMs), contract manufacturers 

(EMS) and designers (ODMs), test and packaging houses, venture capital and startup firms. The rapid growth of the Chinese electronics ecosystem is likely to make 

the global environment far more competitive than ever before. 

Steps the U.S. Must Take: Technology Policy 

Again, I believe that China can and will have a competitive semiconductor industry, and we welcome it as a competitor. That said, my concern is what the United 

States must do to ensure that we do not lose our position as technology leaders 

going forward. We must recognize that what is true for us in industry is true for 

the country as a whole—retaining our lead in this newly more globally competitive 

era will require a focused effort, and significant investments. 

As I mentioned, I serve on the President’s Council of Advisors on Science and 

Technology—the PCAST—and I recently chaired a Subcommittee on Information 

Technology and Manufacturing Competitiveness. We delivered our report to President Bush in January of last year. Among our key findings were:

• Manufacturing share of U.S. GDP and employment fell by half over 50 years, 

but productivity increases allowed output to remain steady. 

• Technology improvements drive approximately half of U.S. GDP, and two-thirds 

of productivity gains. While IT-producing industries generate less than 5% of 

GDP, they accounted for nearly half the surge in productivity growth since 

1995. Continued advances in information technology are the key to continued 

economic growth. 

• There is growing international competition for leadership in high-tech fields—

our foreign competitors aren’t content to be low cost commodity suppliers anymore. 

• Many of our competitors have low labor costs, and benefit from significant foreign government incentives; and finally, and I think most importantly, 

• U.S. leadership is not guaranteed.

Retaining our technological leadership depends on the existence of a healthy innovation eco-system, and that in turn relies on a number of key components, including 

among other things:

• Strong investments in basic R&D 

• Skilled scientists and engineers 

• Laws and regulations that support domestic investment 

• A competitive investor and tax environment 

• A level playing field with effective IP protection

There are a number of government policies that support and help strengthen this 

eco-system. A cornerstone is supporting a strong and vibrant university R&D capability. Our university system is the best in the world, and Federal investment in 
34

university research is critical to retaining current leading-edge industries and also 

creating new ones. 

Before addressing what I believe the government should do, let me make clear 

that the U.S. semiconductor industry invests heavily in this area. In recent years, 

semiconductor firms have invested between 19–22% of sales in R&D, for a total of 

$16 billion in 2004—more as a percentage of sales than virtually any other industry. 

Although much of this investment is on the product development side, basic university research and consortia activities represent important components, especially as 

we reach the physical limits of CMOS. Exclusive of consortia such as the SIA affiliated Semiconductor Research Corporation (SRC) and the SIA-founded Focus Center 

Research Program (FCRP), semiconductor companies contribute $50–60M annually 

to university research. In addition, industry consortia contributions to universities, 

SEMATECH and other programs totaled $320 million in 2003, tripled the level from 

$110M in 2001. 

Federal funding for R&D as a percentage of GDP, though, declined from 1.2% in 

1985, to only 0.7% in 2003. While the downward trend was slightly reversed from 

2000–2003, it is important to return to the levels of the mid-1980s as a percentage of GDP. In addition to overall funding levels, we need to think about balance. 

Within university R&D, the physical sciences have remained largely flat, and engineering only recently showed modest increases. In 2005, overall Federal R&D investment was $132.2 billion, a 4.8% increase from the previous year. The Department of Defense (DoD) accounted for 80% of the increase. 

The National Science Foundation Authorization Act of 2002 called for doubling 

the NSF budget over 6 years, but appropriations have not followed. In FY 2003, a 

10.1% increase was a good start, but a 5% increase in FY 2004 fell well short of 

the goal—I believe this year it is imperative that the NSF receive at least a 7% increase in funding to keep up with technology demands. This would lead to doubling 

by 2014. 

SIA has firsthand experience with the Federal funding challenge. The Focus Center Research Program (FCRP), jointly funded by SIA companies, equipment suppliers and DoD, sponsors university-based research across the country. Federal 

funds are leveraged through matching industry contributions. Due to budget constraints, the Administration has not been requesting its share of funding for this 

program in the last two years. Congress has added money to fund the program. Government funding for FY 2006 should be $20M, to be matched by $20M by industry. 

It is important to the continuity of research that this program has a predictable 

funding mechanism from our Federal partners. 

These investments in R&D are as much economic policy as they are technology 

policy. It is not in our national interest to try to compete as a low labor cost supplier, and even if we did choose to compete on this level we could not compete 

against China. Our goal must be to create high wage jobs, which can only be 

achieved with higher productivity and products that command a premium in the 

marketplace. 

A perfect emerging example can be found in the area of nanotechnology. The 

worldwide annual industrial production in the nanotechnology sectors is estimated 

to exceed $1 trillion in 10–15 years from now, which would require about 2 million 

nanotechnology workers. Recognizing the importance of this new area, the President 

signed the 21st Century Nanotechnology Research and Development Act in December 2003. Since FY 2001, Federal spending on nanotechnology has more than doubled, to a total of $1 billion in the FY 2005 request. In 2004, U.S. nanotechnology 

investment was estimated at nearly $1B. Yet, the EU, Japan, the combined total 

of Korea, China, and Taiwan, each invested at nearly the same levels, and their investments are growing. 

SIA has proposed the Nanoelectronics Research Initiative to find the next foundation for information technology—the successor to CMOS—by the year 2020. The 

NRI will be a collaborative effort between the U.S. Government, industry, and academia. This year, SIA gained significant understanding of existing government programs in this area, and the NRI will continue to augment, link and accelerate these 

efforts. 

Steps the U.S. Must Take: Tax Policy 

In addition to technology policy, America’s Federal and state governments need 

a coordinated strategy to reduce the cost differential created by foreign government 

tax and incentives policies. This strategy should include several elements, including 

competitive Federal tax policies, a permanent R&D tax credit, and other elements. 

The Federal Government should match the tax holidays offered overseas and it 

must correct many of its misguided policies that discourage investment in the U.S. 
35

and consider other measures to close the tax gap with our trading partners. Specifically Congress should:

• Make the R&D tax credit permanent, enact the Alternative Simplified Credit 

and other R&D credit enhancements such as those included in the Senate bill 

last year, and increase the credit rates so that the foreign tax cost differentials 

are eliminated. The credit is currently scheduled to expire at the end of 2005. 

Equally important, many companies invest significant sums on R&D yet cannot 

use the credit as currently structured. • Allow companies to expense high technology equipment and thereby improve its 

cash flow and its ability to invest in new high technology equipment. • Rethink international taxation rules and consider alternatives to the current 

rules on taxing foreign source income. Many of the companies that compete 

against the U.S. operate under territorial tax systems, or otherwise more favorably treat foreign income. The move toward contract manufacturing, a result of 

the escalating cost of chip factories, puts an additional burden on U.S. companies because their offshore income may be treated under Subpart F rather than 

as deferred income. Taxes on repatriated funds make it more likely that these 

funds will be reinvested overseas. • Consider significant rate reductions to allow manufacturing to remain in the 

U.S. SIA is encouraged by last year’s FSC/ETI resolution that will effectively 

reduce the rate for domestic production to 31.85 percent over five years. As a 

result of recent reductions in Europe, U.S. corporate tax rates also even now 

exceed most European nations.

State and local governments also have a role to play. They must ensure that their 

tax policies must take into account the capital intensity of the semiconductor industry. Sales and property taxes fall disproportionately on businesses that provide their 

workers with the expensive tools that drive productivity. To counter foreign tax holidays, states that have succeeded in attracting new facilities or retooling of existing 

fabs have adopted policies such as sales tax exemptions for machinery and equipment, property tax caps, R&D tax credits, business tax apportionment and ad valorem tax abatements. Successful states have also emphasized prompt and flexible 

environmental permitting to reduce cost and respond to the short product life cycles 

in the chip industry. 

Conclusion 

The question posed to me today by the panel was two-fold: the state of China’s 

manufacturing and technology capabilities, and what the U.S. can do to address 

these challenges. 

As noted, I believe the state of China’s technological and manufacturing capabilities are rapidly increasing. They are able and talented competitors, who will increasingly pose a challenge to the U.S. I believe it is incumbent upon us not to seek 

to dampen this competition, but to embrace it fully while at the same time making 

the investments needed to retain the U.S. competitive lead. It is not in our interest 

to try to compete as a low labor cost supplier—our goal is to pay high wages which 

can only be justified with higher productivity and products that command a premium in the marketplace. 

The U.S. competitive lead is ours to keep—or ours to lose. The investments and 

policy changes needed to achieve this goal are neither easy nor inexpensive, but it 

is vital that we make them.

Chairman D’AMATO. Thank you, Mr. Scalise, for that detailed 

testimony and recommendations. 

Now we’ll move on to Mr. Wong. 

STATEMENT OF ALAN C. WONG, SENIOR COUNSEL

NVIDIA CORPORATION, SANTA CLARA, CALIFORNIA 

Mr. WONG. Thank you, Mr. Chairman. Let me begin by thanking 

the Members of the Commission and its staff for holding these 

hearings. I believe that the focus of this Commission is vitally important to the economic and strategic future of the United States. 

In my view, apart from terrorism and other violent threats, there 

is perhaps no greater long-term geopolitical challenge to this nation 

than the question of how to address, and co-exist and work with, 

the rising power of China. 
36

I should preface my further remarks by saying that my views 

today are my own, and not those of my past or present employers. 

In one of my past work lives as a State Department Foreign 

Service Officer, I often found myself an informal watcher of China. 

While posted in India and Japan, political and economic developments in China were of great strategic interest to both of those nations, as well as to the United States. 

Today, my interest is more practical, and conditions in China impact my professional life on a daily basis. As in-house counsel at 

a large semiconductor company, I spend the bulk of my time managing legal matters overseas. In China, that has meant setting up 

several operating units to support market expansion and offshore 

research and development efforts. 

One initial observation is that offshoring cutting-edge technology 

to China creates a Catch-22 situation. In an effort to reduce costs, 

find new engineering talent, and reach new markets, Western companies are inevitably creating greater competition for themselves. 

By transferring technological know-how and fueling demand for 

new technology and products, we are not necessarily creating new 

market opportunities solely for ourselves. 

Take, for instance, the mobile phone industry, of which much has 

been said today already. The introduction of cellular technology 

into China has been stunningly quick in fueling demand that outpaces that of the United States. Yet that introduction of technology 

has also enabled a native Chinese cell phone industry that now accounts for over 40 percent of sales in China. 

Likewise in the computer software and hardware industries, all 

bets are off. When major software, hardware, and PC makers first 

took their wares and know-how to China, it is likely they were hoping for a billion new customers. There is no denying that there remains plenty of market upside in China, and that Western companies continue to grow their business there. But it is also true that 

the demand for computer software and hardware, including advanced semiconductors, is increasingly filled by local Chinese producers. 

It is becoming increasingly apparent that Chinese technology 

manufacturers will not be satisfied with the China market. Many 

are already working towards plans to, somewhat ironically, expand 

globally beyond China, perhaps starting first with other Asian markets, but no doubt with sights set on long-term goals that likely include Western markets. 

Another aspect of offshoring technology work to China that’s 

been touched on today is the problem of intellectual property risk. 

It is true that, at least on paper, there has been change for the better in Chinese legal structures for intellectual property protection 

and enforcement of patents, copyrights, and trademarks. But such 

progress is incremental, and in some instances meant mainly to 

mollify the concerns of foreign investors. 

When it comes to keeping trade secrets secret, or enforcing nondisclosure agreements, there is little hope of credible recourse. 

From an information security perspective, companies can take precautions, including use of cameras in their facilities, firewalling 

computer systems, and encrypting data, but the risks remain high 

in an environment where encryption methods must be acceptable 
37

to the Chinese authorities and the host government must be given 

the encryption keys. The bottom-line is that companies going to 

China must be cautious, and they must limit and compartmentalize 

the technology they take there if they are to retain competitive advantages. 

Getting started in China has required long lead-times and presents practical challenges on a daily basis. Procedures are always 

multilayered and complex, with little insight into the approval 

processes, and uncertain motivations on the part of the Chinese. 

Most Western companies have been fortunate in that interests on 

both sides are apparently in sync. My experience is that offshoring 

has been welcomed in China because we have offered technology, 

expertise, employment, and overall investment deemed to be of 

high value to local and central government authorities. 

In most instances government and quasi-governmental actors 

have been extremely helpful to us. To our advantage, entities such 

as technology parks and quasi-governmental promotion units are 

often stakeholders extremely motivated to assist and guide foreign 

companies through the maze of official and private requirements. 

We cannot, however, lose track of the reality that China is a centrally-controlled playing field where much of what goes on is allowed simply because it is deemed to be of benefit to China’s longterm goals, whatever those may be. 

From our position as a democracy with a multitude of conflicting 

motivations within and outside of government, and in a post-Soviet 

era, when the idea of central control is becoming a dim memory in 

many parts of the world, it is sometimes difficult to keep in mind 

that central government control continues to exist, particularly in 

a country like China where every day brings greater and seemingly 

freer engagement at the business level. But at times, reasons for 

concern become clear. 

For example, in an effort to assure Western companies that 

power sources and road access to a given site will be plentiful and 

well-maintained, Chinese promoters sometimes let slip that infrastructure in the area will receive consistent support and priority 

because the government wants to attract certain technologies that 

can be used in the Chinese defense and military industries. 

So when the Commission’s Report to Congress of last year asked 

‘‘whether [China] converts [growing technology capabilities] to military uses and/or to control the free flow of information to its population,’’ it seems to me that the question should be considered rhetorical and the answer more than clear that some interests at play 

are not in our national interest. 

It seems that China is becoming master of the game of attracting 

foreign investment and technology, creating jobs, and rapidly raising standards of living for its own people. One visit to Shanghai is 

enough to convince most people that China lives in the modern age 

and is a force to be reckoned with. The very modernity one is greeted with adds to a sense of comfort for foreign investors. But while 

China welcomes foreign investment and marketeers, it does not 

really give up its domestic markets, and it retains complete control 

over regulations, market access, labor supply, and infrastructure. 

Foreign companies create new markets within China, but, once 

demand is established, in almost every instance native Chinese 
38

producers take back a large chunk of that demand. So rather than 

a billion new customers for foreign companies, China presents only 

the market that China wants it to be. 

Even for cutting-edge technology, open markets in China may be 

illusory and temporal. What China may really want is technology 

and know-how to take advantage of its own market potential, and 

in preparation for competition in and perhaps dominance of foreign 

markets. 

In parallel, China seems to be getting its ducks in a row for the 

future, engaging internationally and creating channels of influence 

and resources in far-flung parts of the globe. One has to give China 

credit—it has created a winning strategy of attracting our investment, technology, and jobs, while for the most part placating fears, 

and simultaneously developing its own capabilities and resources. 

U.S. technology companies need to also keep in mind that the 

cost benefits of offshoring and investing in China may at least in 

part be illusory. It is a challenge to find skilled and experienced engineers in China and then have to compete for them against other 

U.S. companies and multinationals. Though on a yearly basis 

China continues to produce many times the number of engineers 

as the U.S., demand, competition, and salaries for those individuals 

are rising at tremendous rates. By some accounts, salaries for 

skilled employees are rising as much as 20 percent per year, making retention all the more difficult, and steadily eroding cost advantages with respect to technology labor. 

For the most experienced personnel, salaries and incentives such 

as stock options are already on a par with the U.S. Real estate 

costs are also rising, with rental rates per square foot in cities such 

as Shanghai already exceeding current rates here in the Bay Area. 

All of which is to say that the total cost of doing business in China 

is now much higher than anticipated. 

I’m flattered that Chairman D’Amato has already stated some of 

my recommendations. I’ll repeat them briefly. I believe the Federal 

Government must do a better job of engaging Silicon Valley, and 

that the two need to work together to move beyond unbridled engagement with China towards an alignment of private sector business interests with national interests. 

We need to educate each other on an ongoing basis. Again, apart 

from hearings such as today’s, the Federal Government’s visibility 

in this region is surprisingly limited. I’m sure it’s high for many 

of the people in this room today, but in general I would say it is 

not. Except for a few individuals responsible for export controls at 

each company, there is in my experience very little appreciation in 

the private sector for the competitive, strategic, and national security threats inherent in technology transfer and offshoring activity, 

particularly with respect to China. 

For the U.S. to maintain scientific and technological leadership, 

strategists and policymakers in Washington must win the cooperation of Silicon Valley. Developing and publishing a national policy 

and strategy towards China, in itself, will not likely change or affect the views and behaviors of the private sector, particularly here 

in Silicon Valley. But moving beyond a D.C.-centric Federal Government and establishing a visible, ongoing, sophisticated, and 

non-threatening presence in this region could help. 
39

To have effect beyond Washington, the dialogue must go beyond 

this forum—through the media, among corporate management, and 

at the level of technology workers, not just among the people in 

this room. The government will need to demonstrate that it understands what is driving companies overseas to places like China, 

and that it has insights to offer that can help companies make better decisions—insights not only with respect to risks, threats, and 

national security, but also at the practical level, by discussing overall return on investment, competition risk, long-term scenarios, and 

by counteracting hype and naivete ́. By working more in concert, the 

Federal Government and the private sector can together encourage 

more deep thinking and discussion on the issue of China—leading, 

hopefully, to a more sophisticated normative understanding of what 

China means to the United States and to each business’ competitive position. 

Thank you. 

[The statement follows:]

Prepared Statement of Alan C. Wong

Senior Counsel, Nvidia Corporation, Santa Clara, California

China’s Global Technology Competitiveness:

Recent Company Experience in China

• The Catch-22 of off-shoring to China: to stay competitive we enable our competitors; technology transfer and IP risk • Getting started in China: multilayered complexity and lack of transparency, 

government control, regional variations, long lead-times • Uncertain motivations: helpful actors in a black box; mutual interests apparently in synch; some interests against our national interests • Masters of the Game: China’s rising standards of living; creating a comfort zone 

for foreign investment • The possibility of illusory benefits: competing for China’s labor supply, rising 

wages, site challenges, stock options, total cost of doing business, temporal market opportunities • Weighing the upside: shifts in policy, uncertain financial and legal structures; 

playing only in the market China wants it to be • Moving Silicon Valley beyond engagement: alignment of business interests with 

national interests

Good morning. It’s a pleasure to be here. Let me begin by thanking the Members 

of the Commission and its staff for holding these hearings and for inviting me to 

participate. I believe that the focus of this Commission is vitally important to the 

economic and strategic future of the United States. Apart from terrorism and other 

violent threats, there is perhaps no greater long-term geopolitical challenge to this 

nation at the beginning of this century than the question of how to address, and 

co-exist and work with, the rising power of China. 

I should preface my further remarks by saying that my views today are my own, 

and not those of my past or present employers. 

In one of my past work lives as a State Department Foreign Service officer, I often 

found myself an informal watcher of China. While posted in India and Japan, political and economic developments in China were of great strategic interest to both of 

those nations, as well as to the United States. Today, my interest is more practical, 

and conditions in China impact my professional life on a daily basis. As in-house 

counsel with primary responsibility for international legal affairs at a large semiconductor company, I spend the bulk of my time managing legal matters overseas. In 

China, that has meant setting up several operating units to support market expansion and off-shore research and development efforts. My recent experience may be 

of interest in the context of these hearings. 

The Catch-22 of Offshoring to China: To Stay Competitive We Enable Our 

Competitors 

One initial observation is that offshoring cutting-edge technology work to China 

creates a Catch-22 situation. In an effort to reduce costs, find new engineering talent, and reach new markets, Western companies are inevitably creating greater 
40

competition for themselves. By transferring technological know-how and fueling demand for new technology and products, we are not necessarily creating new market 

opportunities solely for ourselves. Take for instance the mobile phone industry. The 

introduction of cellular technology into China has been stunningly quick in fueling 

demand that outpaces that of the U.S. Yet that introduction of technology has also 

enabled a native Chinese cell phone industry that now accounts for over 40% of 

sales in China. 

Likewise in the computer software and hardware industries, all bets are off. When 

major software, hardware, and PC makers first took their wares and know-how to 

China, it is likely that they were hoping for a billion new customers. There is no 

denying that there remains plenty of market upside in China, and that Western 

companies continue to grow their business there. But it is also true that demand 

for computer software and hardware, including advanced semiconductors, is increasingly filled by local Chinese producers (not to mention pirated software). And it is 

becoming apparent that Chinese technology manufacturers will not be satisfied with 

the China market—many are already working towards plans to, somewhat ironically, expand globally beyond China, perhaps starting first with other Asian markets, but no doubt with sights set on long-term goals that likely include Western 

markets. 

Another aspect of the enablement of Chinese competition that results from 

offshoring technology work and technology transfer is the problem of intellectual 

property risk and blatant IP theft. It is true that, at least on paper, there has been 

change for the better in terms of legal structures in China for intellectual property 

protection and enforcement of patents, copyrights, and trademarks. But we need

to keep in mind that such progress is incremental, and in some instances, meant 

mainly to mollify the concerns of foreign investors. When it comes to keeping trade 

secrets secret, or enforcing non-disclosure agreements against entities or individuals, there is little hope of credible recourse. From an information security perspective, companies can take precautions, including use of cameras, firewalled computer 

systems, and encrypted data, but the risks remain high in an environment where 

encryption methods must be acceptable to the local authorities and the host government must be given the encryption keys. The bottom-line is that companies going 

to China must be cautious, and they must limit and compartmentalize the technology they take there if they are to retain competitive advantages. 

Getting Started in China: Multilayered Complexity and Lack of Transparency 

Getting started in China presents practical challenges on a day-to-day basis. Setting up a new wholly-owned company is not the 7–10 day task that we take for 

granted in the U.S. Outside legal counsel and consultants typically recommend allowing at least 6 months to locate a site and come to terms on a lease, negotiate 

with government officials over scope of allowed business and incentives, prepare 

documentation, and obtain government approvals. Our experience is that timeframes can be shorter (though at other times they have taken as long as predicted), 

but the processes are always multilayered and complex, with little insight into the 

approval processes. Businesses entering China need to understand that approval 

processes are government controlled and lack transparency. Decisions can be arbitrary and unpredictable, and even private party processes such as lease negotiations 

may be subject to government approvals, and influenced by motivations we can only 

begin to guess at. 

Procedures also vary considerably from region to region, and between technology 

parks in the same region. In Shanghai, Chinese and English versions of important 

documents are carefully crafted to closely match in meanings and may carry equal 

validity. In South China, only Chinese versions may be valid—English translations 

may be prepared by a company’s own advisers, but may carry no legal weight. In 

some cases, the latter, more opaque situation may actually lead to quicker approvals, but with more uncertainty over exactly what the terms are and how they will 

be enforced. Additionally, the problem of transparency is heightened when a company considers engaging in a joint venture, licensing arrangement, or acquisition 

involving a Chinese entity. Performing due diligence will in almost all cases be 

difficult and will result in far fewer satisfactory answers and far less clarity than 

hoped for. 

Uncertain Motivations: Interests Apparently in Synch; Some Interests 

Against Our National Interests 

I’ve touched on the idea of uncertain motivations on the part of the Chinese. Most 

Western companies today are fortunate in that interests on both sides are apparently in synch. Central and local government actors find our presence beneficial in 
41

terms of technology and capital transfers, job creation, and increased supplies of 

goods and resources, all contributing to generally heightened standards of living. My 

experience is that offshoring and market outreach efforts in various regions have 

been welcomed because we have offered technology, expertise, employment, and 

overall investment deemed to be of high value both to local and central government 

authorities. In most instances, government and quasi-governmental actors have 

been extremely helpful to us. To our advantage, entities such as the technology 

parks and certain quasi-governmental promotion units, and most importantly individuals within those organizations, are often stakeholders who are extremely motivated to assist and guide foreign companies through the maze of official and private 

requirements. Individuals themselves are often paid bonuses for successfully recruiting foreign companies. On the surface at least, interests on all sides are finding 

common ground. 

We cannot, however, lose track of the reality that China is a centrally-controlled 

playing field, where much of what goes on is allowed simply because it is deemed 

to be of benefit to China’s long-term goals, whatever those may be. From our position as a democracy with a multitude of conflicting motivations within and outside 

of government, and in a post-Soviet era when the idea of central control is becoming 

a dim memory in many parts of the world, it is sometimes difficult to keep in mind 

that central government control continues to exist, particularly in a country like 

China where every day brings greater and seemingly freer engagement at the business level. But at times, reasons for greater concern become clear. For example, in 

an effort to assure Western companies that power sources and road access to a given 

site will be plentiful and well-maintained, Chinese promoters sometimes let slip that 

infrastructure in the area will receive consistent support and priority because the 

government wants to attract certain technologies that can be used in the Chinese 

defense and military industries. So when the Commission’s report to Congress of 

last year asks ‘‘whether [China] converts [growing technology capabilities] to military uses and/or to control the free flow of information to its population,’’ it seems 

to me that the question should be considered rhetorical and the answer more than 

clear. That we have at times seen the overt and covert transfer of dual use items, 

including turbine designs, precision machine tools, and other technology useful for 

the development of WMD and related delivery systems, makes it even clearer that 

some interests at play are not in our national interest. 

Masters of the Game: Creating a Comfort Zone for Foreign Investment; 

Temporal Market Opportunities 

It seems that China is becoming master of the game of attracting foreign investment and technology, creating jobs, and rapidly raising standards of living for its 

people. One visit to Shanghai is enough to convince most people that China lives 

in the modern age and is a force to be reckoned with. The very modernity one is 

greeted with adds to a sense of comfort for foreign investors. At the same time, 

China appears to have given up very little in terms of its own resources and markets. It continues to export finished goods at rates that far exceed imports. It welcomes foreign investment and marketeers, but it does not really give up its domestic 

markets, and it retains complete control over regulations, market access, labor supply, and infrastructure. Foreign companies create new markets within China—but, 

once demand is established, in almost every instance, native Chinese producers take 

back a large chunk of the demand. In some cases, the nature of demand may also 

be manipulated through the adoption of state-dictated standards in areas such as 

wireless technology and software. So rather than a billion new customers for foreign 

companies, China presents only the market that China wants it to be. Even for cutting-edge technology, open markets in China may be illusory and temporal. Some 

might argue that, rather than new goods, what China really wants is technology 

and know-how to take advantage of its own market potential, and in preparation 

for competition in and perhaps dominance of foreign markets. In parallel, China 

seems to be getting its ducks in a row for the future, engaging internationally and 

creating channels of influence and resources in far-flung parts of the globe. One has 

to give China credit—it has created a winning strategy of attracting our investment, 

technology, and jobs, while for the most part placating fears, and simultaneously developing its own capabilities and resources. 

The Possibility of Illusory Benefits: The Rising Total Cost of Doing Business 

U.S. technology companies need to also keep in mind that the cost benefits of 

offshoring and investing in China may at least in part be illusory. It is one thing 

to find cheap manufacturing labor and materials, it is a different challenge to find 

skilled and experienced hardware engineers in China, and then have to compete for 
42

them against other U.S. companies and multinationals. Though on a yearly basis 

China continues to produce many times the number of engineers as the U.S., demand, competition, and salaries for those individuals are rising at tremendous 

rates. By some accounts, salaries for skilled employees are rising as much as 20% 

per year, making retention all the more difficult, and steadily eroding cost advantages with respect to technology labor. For the most experienced personnel, salaries 

and incentives such as stock options are already on a par with the U.S. Real estate 

costs are also rising, with rental rates per square foot in cities such as Shanghai 

already exceeding current rates here in the Bay Area. All of which is to say that 

the total cost of doing business in China is now much higher than anticipated. 

Weighing the Upside: Focusing on the Short-Term Rather Than the End 

Game 

For better or worse, however, there does not seem to be a noticeable decrease in 

corporate plans to move more operations offshore. Despite election year battles over 

offshoring and outsourcing of U.S. jobs, it seems that boards, management, and institutional and individual investors continue to see offshore strategies in a positive, 

rose-colored light. Companies will continue to weigh the perceived upside against 

the risks of shifting economic and political policies in China, uncertain financial and 

legal structures, controlled markets, and rising costs. In my view, companies seem 

overly focused on short-term strategies and market potential, without imagining the 

end game and the possibility that they will lose their competitive advantage and/

or be taken advantage of. How this will play out I leave to others more skilled at 

gaming the variables. 

Moving Silicon Valley Beyond Engagement: Alignment of Business Interests 

With National Interests 

The one recommendation that I would like to leave you with is this: that the Federal Government must do a better job of engaging with Silicon Valley, and that the 

two should work together to move beyond unbridled engagement with China towards an alignment of private sector business interests with national interests. To 

start to do that, we need to educate each other on an ongoing basis. Apart from 

hearings such as today’s, the Federal Government’s visibility in this region is surprisingly limited, particularly given that much of the technology subject to export 

controls and giving rise to concerns about long-term competitiveness and proliferation originates within a 50 mile radius of this meeting. And except for the few individuals responsible for export control compliance within each company, there is in 

my experience very little appreciation in the private sector for the competitive, strategic, and national security threats inherent in technology transfer and offshoring 

activity, particularly with respect to China. For the U.S. to maintain scientific and 

technological leadership, strategists and policymakers in Washington must win the 

cooperation of Silicon Valley. Developing and publishing a national policy and strategy towards China, by itself, will not likely change or affect the views and behaviors 

of the private sector, particularly here in Silicon Valley. But moving beyond a DCcentric Federal Government and establishing a visible, ongoing, sophisticated, cooperative, and non-threatening presence here could help. If the Commission agrees 

with some of these observations, and if it wants to have effect beyond Washington, 

the dialogue must go beyond this forum—through the media, among corporate management, and at the level of technology workers. The Commission will need to demonstrate that it understands what is driving companies overseas to places like 

China, and that it has insights to offer that can help companies make better decisions—insights not only with respect to risks, threats, and national security, but 

also at the practical level, by discussing overall return on investment, competition 

risk, long-term scenarios, and by counteracting hype and naivete ́. By working more 

in concert, the Federal Government and the private sector can together encourage 

more deep thinking and discussion on the issue of China—leading, hopefully, to a 

more sophisticated normative understanding of what China means to the U.S. and 

to each business’s competitive position. Thank you.

Chairman D’AMATO. Thank you very much, Mr. Wong. 

And now we’ll have Mr. Rieschel who is with Mobius Capital. 

STATEMENT OF GARY EDWARD RIESCHEL

EXECUTIVE MANAGING DIRECTOR

MOBIUS VENTURE CAPITAL, PALO ALTO, CALIFORNIA 

Mr. RIESCHEL. Yes. Good morning. Thank you for inviting me to 

present to the panel and the Commission. 
43

The area that we’ve been asked to comment on today is the venture capital community impact on China’s global technology competitiveness. There are three areas that I want to address. 

One was China’s competitiveness relative to the outsourcing of 

jobs from the U.S., Europe, and Japan. 

Second, China’s competitiveness as it relates to creating true 

technology innovation and becoming a world leader in establishing 

technology standards. 

And, finally, China’s competitiveness as it relates to access to 

capital, which I believe is absolutely critical to the achievement of 

real innovation. 

A brief context for my comments is appropriate. I’ve been fortunate enough to be able to establish business operations in Europe, 

Japan, China, and India, as well as other countries during my career. I lived in Japan from ’89 to ’93. And I was two years as the 

head of the American Electronics Association’s Industry Committee. At that time there was great concern in the U.S. technology 

sector, in the ranks, that the Japanese were going to overtake U.S. 

leadership in semiconductors, consumer electronics, large-scale 

computing, and ultimately software. Various projects such as the 

famous 5th Generation Computer Initiative and TRON were 

trumpeted with great fanfare by the Japanese ministries. All were 

unsuccessful commercially. I would make the statement that if 

China depended on central control for innovation and technology, 

we would have nothing to be concerned about. 

It’s important to put the development we see in China over the 

last 25 years in the proper historical context. There are numerous 

historical references to China’s innovations through the centuries 

that we don’t need to recreate here. But suffice it to say that Chinese culture and society have consistently been world leaders in 

the creation and adoption of technology. And there’s absolutely no 

reason to believe that with unlimited access to risk and human 

capital this won’t continue for the foreseeable future. 

As relates to outsourcing, virtually all computers, cell phones, 

televisions, DVD players, tool and die equipment, and simple chemical reagents used in the U.S. today are now manufactured offshore. And if involves silicon, the odds are it’s manufactured in a 

Chinese facility. 

The first wave of manufacturing outsourcing worldwide has been 

estimated to total over $400 billion and represents the value associated with primarily labor-intensive items. China and India have 

been the most talked about beneficiaries of this wave, which is motivated primarily based on a country’s cost competitiveness on labor 

and an available talented pool of workers. The return on equity, 

which dominated the equation, was a return on financial equity. 

Many U.S. companies have taken advantage of this wave and 

they were clearly thinking initially of cost savings. They were originally driven to compete by the highly efficient Japanese manufacturing combines of the late ’80s and early ’90s. And they helped put 

into business the companies such as Flextronics, Solectron, Quanta, 

TSMC, among others, as manufacturing partners that are really 

becoming dominate players today. 

Those players were not satisfied with just low level manufacturing operations and began to look at what the next level of inno-
44

vation was for them. And that entered the world of design. Today 

throughout the manufacturing plants in Szhenzen, Hangzhou, 

Shanghai, and Fujian, there’s not only simple manufacturing but 

also a significant amount of real original design work. This is obvious when you look at the current key designers of laptop computers, Quanta in Taiwan; cell phones in China; and digital television chips. 

The dollars associated with the next wave of outsourcing will be 

measured in trillions. It will focus on skill-intensive manufacturing 

and return on intellectual capital. It will be marked by reducing 

the time to market of new products and services and even tighter 

integration across the supply chain. 

What enabled these companies to so rapidly evolve into leading 

design houses in China was an extremely aggressive focus by the 

Chinese government in the 1980s to establish world-class technology education centers across the university system. 

Second, technology markets have evolved from being driven by 

enterprise buying to being driven by consumer buying. China will 

be for the foreseeable future the largest consumer market in the 

world for technology products. 

Technology product cycle times have decreased from 18 to 24 

months in the 1995 timeframe to nine to 12 months today. This has 

serious implications for design efficiency and time to market of new 

products. 

Standardization of products. A larger and larger percentage of 

products are based in the technology sector have become standard 

based, which facilitates design at the edge of a product or technology around a standardized core. The standardized core becomes 

available very rapidly worldwide. The design tools are also now 

available on a worldwide basis. The Internet has been a powerful 

enabling force. 

China and India both have basically had a free ride on billions 

and billions of dollars on a massive telecommunications overbuild 

to give them basically free access to moving bits around the world, 

whereas having to do that on their own nickel would have been 

prohibitively expensive. 

And, finally, the economics. It’s just very attractive to move up 

the value chain from simple packaging and assembly to design. 

Another major difference between China and other countries, as 

we address these issues, is that the other countries that have developed a strong contract manufacturing base, is that that China 

itself a large and attractive market, which creates great incentives 

for Chinese firms to pursue the domestic market directly. 

The Chinese domestic market is large enough to provide an extraordinary base for companies in the consumer market to leverage 

that base into a leading global competitive position. Haier is doing 

this in consumer electronics with over $10 billion in sales; Huawei 

is doing this in telecommunications. And the acquisition of IBM’s 

PC business by Lenovo is an excellent example of a Chinese manufacturing powerhouse now extending its brand overseas. This is 

just the tip of the iceberg. 

When you then address major investments by U.S. and European 

companies in China, you have to focus on their R&D investments 

that they’re making. Philips will have 1,300 R&D staff in China by 
45

the end of 2006. General Electric will have 1200 global R&D engineers in China by the end of ’06 and another 1,000 by ’08. These 

are not people doing designs for the Chinese market. These are 

global R&D facilities leveraging their overall channels worldwide, 

but much of the core development in those companies is moving 

into the Chinese market. 

In total, over 700 R&D facilities exist today in China funded primarily by the U.S., Japan, Europe, and Taiwan. These R&D centers will employ over half a million researchers and engineers 

when fully operational. 

So to recap you have the following ingredients in China to foster 

innovation: A strong history of technical innovation; an excellent 

educational infrastructure; a strong base of companies that grew 

up in a brutally competitive cost-driven market; and huge financial 

incentives to establish—to expand the value chain from brand to 

brand from design and manufacturing. 

You have many technologies becoming more standard based, enabling greater innovation off that base, and rewarding rapid time to 

market. You have a very rapid domestic market. And you have Chinese companies now accepted as brands in the technology market 

worldwide, which was definitely not the case ten years ago. 

It is worth commenting further on education and its impact on 

China’s increasing competitiveness. There have been a lot of articles, comments made already this morning. I think one of the key 

issues we do have to address is that the U.S. is losing its position 

as being both the employer of choice after foreign students come 

here for school and also not becoming the place where foreign students would like to go to school. We’re making it difficult for them, 

and that’s a terrible mistake for us. 

If you look at just the engineers, as Alan mentioned, China’s 

going to graduate 325,000 engineers this year: Five times the number in the U.S. 

The education is not just in the technical area. One of the most 

surprising things for me has been to discover that 250 million Chinese study English as a foreign language. This is not in school. 

They’re paying money to study English as a foreign language, 

which puts us in the position of there will be more English-speaking people in China than the United States within a few years. 

The final catalyst to real innovation is access to capital, particularly venture capital. Venture capitalists do not invest in me-too 

products. What we do is we look for places where you really can 

find innovation. And the real innovative products that have been 

created over the years, whether you look at Intel, whether you look 

at Cisco, Microsoft, and so on, many of those companies were funded with venture capital. 

Venture capital is now flowing into China at an increasingly 

rapid rate. There will be several billion dollars raised this year, 

specifically on China’s specific funds to invest in the Chinese market. And that’s not because all of us look at China as a me-too 

manufacturing market. We look at it from the standpoint of the engineering talent and the infrastructure that’s been built up from 

the outsourcing base that is now really capable of doing some interesting innovation. So that’s why the dollars are now flowing to 

China in a very large scale. 
46

Finally, to not run over the time too much, the issue of intellectual property I think is a very real issue. And it’s something that 

we take to heart in looking at any investments; something that 

does need to be addressed by China, has not been addressed satisfactorily to date. But it’s also instructive to look back at—historically countries typically didn’t really embrace intellectual property 

until they created it. 

And so I think that what you will see over time is you will see 

over time China becoming more focused on protecting intellectual 

property, but largely because it will be developing it internally and 

the local business people are the ones who are driving the real 

adoption of intellectual property protection, because it’s starting to 

impact their own businesses. 

Thank you very much. 

[The statement follows:]

Prepared Statement of Gary Edward Rieschel

Executive Managing Director, Mobius Venture Capital, Palo Alto, 

California 

Thank you for inviting me to present to you this morning. 

The area that we have been asked to comment on today is China’s global technology competitiveness. This is a daunting subject to tackle in any bounded way, 

so I decided to summarize my thoughts on three main areas of China’s competitiveness.

a. China’s competitiveness relative to the outsourcing of technology jobs from the 

U.S., Europe and Japan to China, particularly in manufacturing. 

b. China’s competitiveness as it relates to creating true technology innovations 

and becoming a world leader in establishing technology standards. 

c. China’s competitiveness as it relates to access to capital, both foreign direct 

investment and liquidity in the local financial markets. This is absolutely critical to the achievement of real innovation.

I will address each of these in turn. First, let me provide you a brief context for 

my comments. 

My career in the technology industry dates to 1979, and I have been fortunate 

to be able to establish business operations in Europe, Japan, China, India, and other 

countries during my career. While I lived in Japan from 1989 to 1993, I spent two 

years as the head of the American Electronics Association’s Industry Committee. At 

that time, there was great concern in the U.S. technology ranks that the Japanese 

were going to overtake U.S. leadership in semiconductors, consumer electronics, 

large-scale computing, and ultimately software. Various projects such as the 5th 

Generation Computing Project and TRON were trumpeted with great fanfare by the 

Japanese ministries. 

It is instructive to look at Japan, if only to understand the clear differences between the threat to U.S. competitiveness that Japan represented in 1990 and that 

China represents today and in the future. The Japanese threat was primarily due 

to an extreme level of vertical integration in huge corporations such as NEC, 

Hitachi, Fujitsu, Sony, Matsushita, and their excellence in driving costs down in 

areas such as semiconductor memory, storage devices, display screens, as well as 

a very large market in Japan based entirely on proprietary computer architectures. 

This was still a world where technology existed in ‘‘walled gardens’’ that a large 

company (IBM, Fujitsu, and DEC) could dominate vertically with proprietary systems. While this helped the large Japanese companies in Japan, it greatly limited 

their ability to export many of their complex products and systems. 

Clearly, the Japanese did not come to dominate the world’s technology landscape, 

although many Japanese companies today are major players in technology. The 

overall growth of the technology markets and their rate of change made it difficult 

for the Japanese companies that specialized in large-scale process manufacturing to 

be nimble enough to respond to market changes. As the technology sector has become more consumer-driven and less enterprise-driven, you are now seeing the resurgence of several of the large Japanese technology providers, but again, primarily 

in complex process-driven market segments. 
47

Fifteen years later, the ‘‘walled gardens’’ of the computer industry have largely 

been torn down. While there are certain technology franchises that continue to 

dominate a particular area (Microsoft, Intel are the classic examples), the vast majority of the rest of the technology industry now must innovate around a series of 

‘‘standards’’ established by either standards body (IEEE), or the market (Apple’s 

Ipod). The market today favors the nimble and the ability to take a standard and 

relentlessly innovate at the edge of that standard. Many of the factors that lead to 

the original form of outsourcing were in response to Japanese advantages in largescale production and cost efficiencies. The next wave of outsourcing, product design 

and development, is driven by the dramatically reduced cycle time that a company 

has today to make a product profitable. 

Now let’s turn to China specifically. 

First of all, it is important to put the rapid development that we see in China 

over the last 25 years in the proper historical context. There are numerous historical references to China’s innovations through the centuries that I will not attempt 

to recreate here. Suffice it to say that the Chinese culture and society have consistently been world leaders in the creation and adoption of technology and there is absolutely no reason to believe that with unlimited access to risk and human capital 

this won’t continue for the foreseeable future. 

China’s Competitiveness in Outsourcing 

As it relates to the outsourcing of technology jobs, virtually all of the computers, 

cell phones, televisions, DVD players, tool and die equipment, and simple chemical 

reagents used in the U.S. are now manufactured offshore, and if it involves silicon, 

the odds are it is manufactured in a Chinese facility. The first wave of manufacturing outsourcing worldwide has been estimated to total over $400 billion and represents the value associated with primarily labor-intensive items. China and India 

have been the most talked about beneficiaries of this wave which was motivated primarily based on a country’s cost competitiveness on labor and an available, talented, 

pool of workers. The return on equity which dominated the equation was a return 

on financial equity. 

The many U.S. companies that have taken greatest advantage of this wave were 

clearly thinking initially of cost savings, many of them driven to compete with 

highly efficient Japanese manufacturers as mentioned above. They actually helped 

put into business the companies such as Flextronics, Solectron, Quanta, TSMC, 

among many others, as manufacturing partners. The idea was that these ‘‘partners’’ 

would focus on cost reduction and that the large brand name companies such as 

IBM, Compaq, HP, and Cisco would continue to create original reference designs 

and transfer those designs to these ‘‘partners’’ for manufacturing. But these partners did not stand still and were not satisfied with the low gross margins and price 

competitiveness of historical contract manufacturing. They began to identify other 

places in the value chain of the technology world where they might best add value. 

The answer was product design. 

From Manufacturing to Design and Ultimately—Brand 

Today, throughout the manufacturing plants in Szhenzen, Hangzhou, Shanghai, 

and Fujian, there is not only simple manufacturing, but a significant amount of real 

original design work. This is obvious when you look at the current key designers 

of laptop computers (Quanta in Taipei, Taiwan), cell phones (Cellon—China, 

Flextronics—China, Bird—China), digital television chips (Grace, SMIC—China), 

among dozens of other industries. The dollars associated with the next wave of 

outsourcing will be measured in trillions and will focus on skill-intensive manufacturing and return on intellectual capital. It will be marked by reducing the time to 

market of new products and services and even tighter integration across the supply 

chain. 

The reasons for this should not be a major surprise. The traditional contract manufacturing companies operate at gross margins between 2 and 8%, depending on 

their product mix and efficiency. Design work yields gross margins between 7 and 

14%, again depending on the product line and market. The migration from contract 

manufacturing to product design is inevitable due to the much better economics. 

A couple of examples here are instructive. Quanta, a Taiwanese company, started 

life as a motherboard manufacturer. Over time, Quanta evolved to an integrated 

supplier of laptop computers, estimated to manufacture nearly 25% of the world’s 

laptop computers. Quanta moved up the value chain into design, with over 1,500 

designers in Taiwan and China and plans to go to over 7,000 within a few years. 

The laptop computer ‘‘brands’’ of IBM, HP, and Dell (for computers sold under the 

Dell label in China) are examples of the laptops that Quanta produces. 
48

Another excellent example of a major company that those outside of the technology industry are not familiar with is Flextronics. Flextronics has evolved from 

a pure U.S-based contract manufacturer in the 1980s to a global force in the design 

and manufacture of cell phones and other high value consumer devices. Over 2,000 

design engineers work in the Flextronics facilities in China, designing products for 

companies such as Motorola, Sony, Ericsson, and Siemens. For the first time this 

year, Nokia has begun to outsource both design and manufacturing of a portion of 

its cell phone line. It is estimated that Flextronics is now the second largest manufacturer of cell phones and the third largest designer of mobile devices in the world. 

What enabled these companies to so rapidly evolve into leading design houses 

from a base in contract manufacturing? Several key factors were critical for this, 

not necessarily listed in priority order:

a. An extremely aggressive focus by the Chinese government in the 1980s to establish world class technology education centers across the Chinese university 

system. 

b. Technology markets have evolved from being driven by the enterprise to being 

driven by consumers (this has huge further implications for China’s competitiveness that will be discussed later). 

c. Technology product cycle time has decreased dramatically causing firms to release new products into the market on 9 to 12 month cycles from what was 

every 18 to 24 months in the 1995 timeframe. This has serious implications 

for design efficiency and time to market of new products. 

d. Standardization of products. A larger and larger percentage of products in the 

technology sector have become standard-based products which facilitates design at the edge of a product or technology around a standardized core. 

e. Increasingly sophisticated design tools. The increasing capability of CAD/CAM 

design tools and their ubiquity has allowed many organizations to quickly 

come up the curve on design. The larger branded companies have perfected design transfer to their supply chain which also facilitates the ability of new 

players to add value in the design process. 

f. Internet. The Internet has been a powerful enabling force. China and India 

were able to leverage the massive telecommunications overbuild into a ‘‘free 

ride’’ on the modernization train, since the Internet broke down and eliminated many geographic barriers for human collaboration. 

g. Economics. The attractive economics of moving up the value chain to design 

from simple packaging and assembly drove job creation and influenced government policy.

Now that you have these companies participating in the design and manufacturing phases of the value chain, the end user brand becomes primarily a marketing 

and sales channel organization. Again, this is where a great deal of value exists, 

and so it should be no surprise that we see a number of companies moving from 

manufacturing and design to marketing their own brands and creating their distribution channels. We have started to see the first major Chinese companies establish global brands from an initial base in contract manufacturing. Haier, the leading 

Chinese consumer electronics firm, is the best example. They started as an OEM 

manufacturer for several Japanese electronics firms, evolved into TV and DVD design, and are now marketing as a branded entity in the U.S. and Europe. They have 

become the world’s fifth largest supplier of consumer electronics equipment from a 

cold start in 1984. 

The major difference between China and other countries that have developed a 

strong contract manufacturing base is that China itself is a large and attractive 

market which creates great incentive for the Chinese firms to pursue the domestic 

market directly. The Chinese domestic market is large enough to provide an extraordinary base for companies in the consumer market to leverage that base into 

a leading global competitive position. Haier is clearly doing this in consumer electronics, and Huawei is doing this in telecommunications. The acquisition of IBM’s 

PC business by Lenovo is an excellent example of a Chinese manufacturing powerhouse now extending its brand reach overseas. This is just the tip of the iceberg. 

In addition, there have been major investments by leading U.S. and European 

companies in China, focused not on local R&D specific to the Chinese market, but 

rather global R&D. Philips Electronics will have 1,300 R&D staff in China by the 

end of 2006. General Electric will have 1,200 global R&D engineers in China by the 

end of 2006 and another 1,000 by 2008. Dow Chemical has launched a 2,500 person 

global R&D facility in the Shanghai area for completion in 2007. In total, over 700 

foreign R&D facilities exist today in China, funded primarily by the U.S., Japan, 

Europe, and Taiwan. These R&D centers will employ over 500,000 researchers and 

engineers when fully operational. 
49

So to recap thus far, you have the following ingredients in China to foster innovation:

a. A strong history of technical innovation. 

b. Excellent educational infrastructure with a heavy emphasis on technical skills 

(as an anecdote, Bill Gates of Microsoft will say that if you want to find the 

smartest people in Microsoft you have to visit Microsoft’s Beijing research center). 

c. A strong base of companies that grew up in a brutally competitive cost-driven 

market. 

d. Huge financial incentives to expand in the value chain to brand from design 

and manufacturing. 

e. Many technologies becoming more standards-based enabling greater innovation off that base and rewarding rapid time to market. 

f. A domestic market that is fast growing and wealthy enough to create and sustain world class companies. 

g. Chinese companies being accepted as ‘‘brands’’ in the technology markets 

worldwide.

It is worth commenting further on education and its impact on China’s increasing 

competitiveness. There is no end of articles detailing the high percentage of Chinese 

and Indian students in technical studies in U.S. universities. Many of the leading 

U.S. companies today would be lost without the foreign students that came to the 

U.S. to study and then stayed to start careers and seek their fortunes. For the first 

time the U.S. has real competition in being the most attractive market for those 

graduates to pursue their dreams. This is a profound change in how the best and 

the brightest graduates of the U.S. university system see their futures. 

More important is the impact of the sheer numbers of talented, highly trained 

technical graduates leaving Chinese universities. In 2005, China will graduate over 

325,000 engineers, roughly five times the number in the U.S. There are currently 

more than twice as many researchers in Chinese national laboratories as in the U.S. 

equivalent institutions. 

But the educational advantages that China is leveraging are not only in the technical areas. China today has over two hundred and fifty million people paying to 

take English-as-a-second-language coursework, a number that is expected to grow 

to three hundred and fifty million people by 2008. Every Chinese student studies 

English from first grade through high school. It is somewhat ironic that there will 

be far more English-speaking people in China than in the U.S. within several years. 

A comprehensive discussion on the ills of the U.S. education infrastructure is beyond the scope of this paper. However, it must be recognized that without addressing how we educate our children in the U.S. that our global competitiveness will 

inevitably decline, and far more rapidly than we would like to believe. 

The Final Catalyst—Access to Venture Capital 

There has been a great deal written about the Chinese culture and its tolerance 

for risk and failure, attributes that have been lauded consistently in the U.S. for 

the past 50 years. The U.S. has certainly benefited from this in the technology area, 

as initially there was no particular reason why so many breakthrough technologies 

were created in the U.S. instead of in Europe. However, the great flexibility of the 

U.S. markets, and their tolerance for risk were unique and really stood apart on 

the world stage. Other countries that offered this tolerance of risk such as Singapore, Taiwan, and Israel, were simply too small to have a major impact on the 

world’s technology markets, with relatively few exceptions (such as foundries in Taiwan such as UMC, TSMC). 

China is different. It is a very large country with vast intellectual resources and 

a middle class that by some estimates now totals over 100 million Chinese families 

which places it second only to the U.S. In addition, the impact of the overseas Chinese populations ability to provide capital, jobs, and inspiration, cannot be overestimated. The educational infrastructure that has been created in the last 30 years 

alone is impressive. Nearly 1.2 million Chinese students applied in 2004 to take the 

national examination for graduate programs in China. It is estimated that over 

200,000 graduate students will complete their coursework this year in China’s universities. 

The supply of intellectual capital combined with a huge and growing domestic 

market makes for an intoxicating mix. With the entry to WTO, China has also been 

making significant improvements to its financial markets and accounting transparency, which is enabling the final major ingredient to an explosion of innovation 

to come into China—Risk Capital. 
50

Risk Capital, or Venture Capital, has been one of the U.S.’s secret weapons for 

several decades. Other countries have tried to create incentives for a similar capital 

structure, focused on the ‘‘cult of the entrepreneur’’ to flourish, but with very few 

exceptions, this has failed. It will not fail in China. 

Total Venture Capital raised for investment in China will exceed $2B in 2005 representing approximately 10% of the total amount of venture capital expected to be 

raised this year. This does not include the additional $5 to $10 billion being raised 

to invest in buyout funds and other forms of private equity in China. This also 

doesn’t include the very robust amount of capital from overseas Chinese that is 

being transferred back into investments in China. The Venture Capital dollars will 

continue to increase for the next few years. To put these numbers in context, in 

1995, the total Venture Capital raised for investments in U.S. companies in the 

technology area was approximately $10B. We expect to see the investment level of 

venture capital funds for China reach 1995 U.S. levels within 10 years. Venture 

Capital has funded many of the innovative technologies that we take for granted 

today. Intel, Cisco, Apple, Microsoft, Oracle, PeopleSoft, Juniper, Qualcomm, Yahoo, 

Google, AOL, Verisign, Network Appliance, and Broadcom would not exist without 

venture capital financing. The external source of capital and the internal granting 

of ownership through stock options in these companies is what have attracted the 

best and brightest in U.S. industry to the technology sector during the past 30 

years. 

This money is now being targeted toward creating the next generation of great 

Chinese companies, using U.S. pension and endowment dollars. Over 300 U.S. venture capitalists visited China in 2004, and over 100 investments have been made 

by U.S. venture firms in Chinese companies (mostly through offshore entities) in the 

last two years. The ‘‘China story’’ has been well accepted by the U.S. capital markets with 20% of the NASDAQ IPOs last year being Chinese companies. However, 

now many Chinese companies are considering initial listings on the Hong Kong or 

Shanghai Stock Exchanges. This is another area that is beyond the scope of this 

paper to thoroughly discuss, but there are significant implications for the U.S. capital markets should a credible alternative to the NYSE and NASDAQ emerge in 

China. 

This does not mean to imply that it is either easy to raise money to invest in 

China at this time, or to successfully deploy the capital into local Chinese companies. What the capital flows do reflect is a growing appreciation for China’s ability 

to innovate at a global level and increasing comfort with both the financial risk in 

the market and the execution risk of the business. The financial risk is being mitigated by the efforts of the Chinese government, and the execution risk by the large 

number of Chinese returning from overseas to either start companies or join the 

management of existing Chinese companies. This now numbers in the thousands of 

highly experienced Chinese executives each year. 

It is my opinion that China must be encouraged to continue to make reforms and 

move toward being a full member in word and action of the global technology market. We have to acknowledge that given the size of the domestic Chinese market 

that they will want to have a say in establishing standards for that market. We 

should expect this and simultaneously encourage their participation in standards 

bodies around the world. We can also expect over time for the Chinese to have 

greater appreciation and adherence to intellectual property laws as they begin to 

create their own proprietary intellectual property and their local entrepreneurs push 

the government to enforce the laws. 

In summary, China sits at the first table of the world’s innovators today. The 

combination of the market opportunity, the education system and extremely talented and well-trained workforce, and the emerging access to virtually unlimited 

venture capital and private equity dollars, guarantees that China will become a 

major innovative force in the global economy. 

Thank you again for the opportunity to present to this panel.

Chairman D’AMATO. Thank you very much, Mr. Rieschel. 

Mr. Everett. 

STATEMENT OF G. CARL EVERETT

PARTNER, ACCEL PARTNERS, PALO ALTO, CALIFORNIA 

Mr. EVERETT. Mr. Chairman, Members of the Commission, I’m 

pleased to submit my response to the four questions asked by the 

Commission. I really appreciate the opportunity to comment on this 
51

important topic here today. It’s an honor to appear before you with 

my fellow panelist here. 

The first question was: What role does foreign investment, particularly venture capital, play in the expansion of advanced technology research and development in China? What technology sectors are garnering the most private capital? 

Last year venture capital investment and investors outside China kicked in nearly $1.3 billion into 253 Chinese companies, according to a report by Zero2IPO, a Beijing-based data service that 

is focused on the venture capital industry in China. 

I’ve included a copy of their survey with my testimony today. 

The funds invested rose 28 percent in 2003, and the number of 

deals surged 43 percent. Semiconductor investments attracted onethird of the dollars, and the leading city by a wide margin was 

Shanghai. To date, China has contributed very little in terms of advanced R&D breakthroughs. There simply are not many, if any, 

new technologies that can claim their genesis in China. In semiconductors, networking, and computing technology China has been 

expert in cost down and mass volume production of existing products, enabling lower price points and market expansions. 

An example of a new product from an advanced research product 

would be IBM’s recent announcement of the CELL processor, a 

multicore microprocessor aimed at the consumer space. The home 

of the IBM project is Austin, Texas. I would also note that for the 

last 12 years, since 1993, IBM Corporation, a worldwide R&D development activity, has led the U.S. in patent filings and all countries in the number of patents filed at the U.S. Patent Office. 

There was an interesting article recently in the New York Times

about IBM’s new intellectual property strategy, which I would reference to you for further information. China has yet to produce 

such an event, and there’s no doubt that China will play a key role 

in delivering mass volumes of the CELL-based computers to the 

world marketplace. 

Private venture capital and corporate investment in design and 

development activities in China lend important support to directing 

the vast resources available toward creating new and larger markets for knowledge-intensive products. The intellectual resources 

available in the world to work on information-processing products 

are in an oversupply status. A short 20 years ago Silicon Valley 

leaders regularly opined that there was a permanent shortage of 

electrical engineers to do the work necessary to advance the computing industry. It should be no surprise that someone listened and 

responded to the call. 

This new generation of Chinese engineering talent will use the 

crucible of ‘‘cost down’’ and high-volume manufacturing as their 

training ground to hone skills that will enable China to contribute 

breakthrough product advances in the future. We have to have the 

confidence that the overcapacity can be soaked up by larger world 

markets. We have only history to reference in support of the markets materializing. However, I can assure you anyone in our industry during 1985 who would have dared forecast a PC market approaching 200 million units in 2005 of a semiconductor market valued at 200 billion this year would have been dispatched to run a 

factory in Milpitas. 
52

The next big bet is China will step up to become a U.S.-caliber 

marketplace for knowledge-intensive consumer and business products. 

The second question was: To what degree is the Chinese government directly involved in technology ventures. Well, rather than to 

just look for a dollar amount invested by the Chinese government, 

my opinion is the direct aid to technical ventures by China is amplified by enabling investments in kind to help bootstrap a new 

venture. 

Examples of investments of kind I’m referring to are: 

Free office and factory space in the regional science parks and 

technology development areas located in the various provinces; 

Providing priority access to university professors and the ability 

to recruit top-notch students into particular projects; 

Preferential access to state-controlled telecom marketplace providers, is also readily available; 

Finally, another example is interest-free loans with no term and 

unsecured that are being granted to support strategic projects in 

China. 

These attributes go hand in hand with low cost for employees to 

make a very competitive company. In many ways investments in 

kind deserve more credit to the success of a company than just the 

absolute dollars plowed into the treasury of a company. This soft 

dollar resource infusion helps ensure a return on the hard dollars 

invested. 

The third question was: What role does venture capital play in 

the growing trend of multinational start-ups in China? 

The venture industry adds its own value to the China effort. In 

addition to bringing capital, each firm brings its own particular 

value-add to a project. This is important in the multinational marketplace that our companies compete in. Since R&D capital is not 

the resource in short supply today, it comes down to the people, 

contacts, and the building of the investor-entrepreneur trust relationship during the investment process the development of a company that makes a difference in value creation. Because of this reality, China will also make the venture industry more competitive 

over time. The good venture capitalists must also make investments in kind, not just capital. 

The fourth and final question was: What are the trends with regard to return on investment for venture capital investments in 

Chinese technology sectors? And what is the degree of risk of such 

ventures? 

I expect the returns will be good where investments are 

leveraging Chinese capabilities. Early results are already visible at 

SMIC, for example. SMIC quickly became the number three wafer 

foundry company in the world with advanced technology in wafer 

costs projected lower than what we see from the traditional foundry 

leaders in Taiwan. SMIC created the largest share value at IPO for 

a 2004 offering by a factor of 6X at over $600 million and, therefore, presented the opportunity for venture returns. 

In addition to all the traditional risk of a new venture, China 

presents many additional risks and operating challenges of its own. 

The first risk is the first rule. The government can change the 

rules suddenly and without recourse. China is a communist coun-
53

try. Even Sarbanes-Oxley does not wield such a return changing 

force as being on the wrong side of a public policy shift in China. 

Respect for this reality is a front-of-mind issue when investing in 

any particular sector. What will the government position be? What 

will their position be during the life of the investment? 

It is also very important to achieve transparency on the structure 

and the financial hygiene of the venture. Setting in place excellent 

operating people and controls from the start is key to achieving a 

return on any investment in China. 

And, finally, until intellectual property respect becomes a value 

important to the China technology community as well as the Chinese government, the current environment is an extreme risk to 

building knowledge-intensive products that are unique and defensible. 

Thank you. 

[The statement follows:]

Prepared Statement of G. Carl Everett

Partner, Accel Partners, Palo Alto, California

Mr. Chairman, I am pleased to submit my response to the questions asked by the 

Commission. I appreciate the opportunity to comment on this important topic. It is 

an honor to appear before you as a panelist.

1. What role is foreign investment, particularly venture capital, playing in 

the expansion of advanced technology research and development in 

China? What technology sectors are garnering the most private capital?

Last year venture capital investors outside China kicked in nearly $1.3 billion 

into 253 Chinese companies according to a report by Zero2IPO, a Beijing based data 

service focused upon venture capital in China. The funds invested rose 28% from 

2003, while the number of deals surged 43%. Semiconductor investments attracted 

one-third of the dollars and the leading city by a wide margin was Shanghai. 

To date China has contributed very little in terms of advanced R&D breakthroughs. There simply are not many of any new technologies that can claim their 

genesis as China. In semiconductors, networking and computing technology China 

has been expert in ‘‘cost down’’ and mass volume production of existing products enabling lower price points and market expansion. An example of a new product from 

an advanced research project would be IBM’s announcement of the CELL processor, 

a multicore microprocessor aimed at the consumer space. The home of the IBM 

project is Austin, TX. China has yet to produce such an event however there is no 

doubt China will play a key role in delivering mass volume of CELL based computers to the world market. 

Private venture capital and corporate investment in design and development activities in China lend important support to directing the vast resources available toward creating new and larger markets for knowledge intensive products. The intellectual resources available in the world to work on information processing products 

are in over supply status. A short 20 years ago Silicon Valley leaders regularly 

opined there was a permanent shortage of electrical engineers to do the work necessary to advance the computing industry. It should be no surprise that someone 

listened and responded to the call. The new generation of Chinese engineering talent will use the crucible of ‘‘cost down’’ and high volume manufacturing as their 

training ground to hone skills that will enable China to contribute breakthrough 

product advances in the future. We have to have the confidence that the overcapacity can be soaked up by larger world markets. We have only history to reference in support of the markets materializing; however I can assure you anyone 

in our industry during 1985 who would have dared to forecast a PC market approaching 200 million units in 2005 or a semiconductor market valued at $200 billion this year would have been dispatched to run a factory in Milpitas. The next 

big bet is China will step up to become a U.S. caliber marketplace for knowledge 

intensive consumer and business products.

2. To what degree is the Chinese government directly involved in technology ventures?

Rather than just look for a dollar amount invested by the Chinese government, 

my opinion is the direct aid to technology ventures by China is amplified by ena-
54

bling investments in kind to help bootstrap a new venture. Examples of investments 

in kind are:

Free office and factory space in the regional science and technology parks located 

in the provinces. 

Priority access to university professors and the ability to recruit top notch students into a project. 

Preferential access to the state controlled telecom marketplace providers. 

Interest free loans with no term and unsecured are being granted to support strategic projects.

These attributes go hand in hand with low cost for employees to make a very competitive company. In many ways investments in kind deserve more credit to the success of a company than just the absolute dollars plowed into the treasury. The soft 

dollar resource infusion help insure a return on the hard dollars invested.

3. What role does venture capital play in the growing trend of multinational start-ups in China?

The venture industry adds its own value to the China effort. In addition to bringing capital each firm brings its own particular value add to a project. This is important in the multinational marketplace our companies compete in. Since raw capital 

is not the resource in short supply today it comes down to the people contacts and 

the building of the investor entrepreneur trust relationship during the development 

of a company that makes a difference in value creation. Because of this reality 

China will also make the venture industry more competitive over time. The good 

venture capitalist must also make investments in kind, not just capital.

4. What are the trends with regard to return on investment for venture 

capital investments in Chinese technology sectors? What is the degree of 

risk of such ventures?

I expect returns will be good where investments are leveraging China’s capabilities. Early results are already visible at SMIC. For example, SMIC quickly became 

the number 3 wafer foundry company in the world with advanced technology and 

wafer cost projected lower than what we see from the traditional leaders in Taiwan. 

SMIC created the largest share value at IPO for a 2004 offering by a factor of 6X 

and therefore presented the opportunity for venture returns. 

In addition to all the traditional risk of a new venture China presents many additional risks and operating challenges of its own. The first risk is the first rule. The 

government can change the rules suddenly and without recourse. China is a communist country; even Sarbanes Oxley does not wield such a return changing force 

as being on the wrong side of a public policy shift in China. Respect for this reality 

is a front of mind issue when investing in any particular sector. What will the government position be? What will their position be during the life of the investment? 

It is very important to achieve transparency on the structure and the financial hygiene of the venture. Setting in place excellent operating people and controls from 

the start is key to achieving a return on the investment. Finally until intellectual 

property respect becomes a value important to the China technology community and 

the Chinese government the current environment is an extreme risk to building 

knowledge intensive products that are unique and defensible.

Panel I: Discussion, Questions and Answers 

Chairman D’AMATO. Thank you very much, Mr. Everett. 

Now we’ll open up to Q&A, and try to limit your questions to five 

minutes for the Q&A. 

Commissioner Reinsch. 

Commissioner REINSCH. I have two questions. 

I think Mr. Rieschel’s testimony, in particular, was interesting 

because he essentially said in looking at this maybe we ought to 

follow the money. And you’re suggesting that venture capital 

money is going to China and not because they perceive the development of me-too products, as you put it, but they see it becoming 

an innovation center. 

The first question is: Do the rest of you agree with that? Not 

with respect to the money. Do the rest of you agree that China is 
55

going to within some medium term timeframe become an innovation center of its own? 

George is shaking his head yes. Anybody want to comment? Mr. 

Morgan is shaking his head maybe yes. 

Mr. MORGAN. I think kind of the bottom line is, is that you’re 

rapidly moving to where you can do almost anything that you do 

elsewhere in China in terms of the level of capability. It’s not exact, 

but in limited quantities you can get almost anything done effectively there. 

Commissioner REINSCH. Okay. George. 

Mr. SCALISE. I think there is another point to this that is very, 

very unique. And I have established a lot of operations around the 

world. And typically you would establish it with anywhere from 

two to five ex-patriots coming in to help get it established and then 

use local talent. 

Some of the investments in China, to get them off the ground, 

have had as many as 25 percent of their employees that have been 

trained, worked here in the U.S. by and large; some of them came 

from Europe and some from Taiwan, other places. But the number 

of ex-patriots in one company I know, I’ve seen them talk with the 

manager, they have 3,000 employees, 700 of them are ex-patriots, 

which is phenomenal. 

So when you talk about how quickly they can come up the learning curve and become leading-edge innovators, in large part it’s because of this. Now I don’t minimize for the moment the indigenous 

capability that’s evolving. It’s going to become very good, but a lot 

of that capability is because of the ex-patriots that have gone over 

with this great reservoir of understanding that helps to make that 

happen. 

Commissioner REINSCH. Okay. Let me ask the second question 

before my time is up, because it’s related to this. And that is for 

those of you that were here early enough to have heard Dr. Perry 

this morning. He made a distinction between basic research and essentially R&D on product development. 

I think from the D.C. point of view you were really focusing on 

the latter rather than the former, which is what investors would 

do. But Dr. Perry’s other point was, at least as far as the United 

States was concerned: Don’t look at companies to be the source of 

basic fundamental research, but look to the government, in this 

case, primarily the Defense Department to provide that foundation 

on which companies will then build. 

From the Commission’s point of view, from a national security 

point of view, that’s sort of a very important issue. If the Chinese 

become the world’s leader in cell phone manufacture, that’s one 

thing, which may or may not be a good thing. But if they become 

an innovation leader in fundamental research that leads them to 

a whole set of defense innovations, that raises a whole set of other 

implications. 

My assumption has been, and maybe—correct me if I’m wrong—

that’s part one, is that if there’s going to be a groundswell, if you 

will, of basic research in China, that too may be led by the government or by government-sponsored think tanks, the Academy of 

Science, whatever it is, as opposed to companies. So one part of the 

question is: Is that right? 
56

But second, more important: Is it likely that the Chinese government is going to be smart enough to figure that out and undertake 

to spend a significant part of its resources to do that kind of thing 

or not? 

Mr. EVERETT. I think there’s a good likelihood it’s well underway 

today in the government, to focus on the research efforts. My sense 

is there’s a careful balance between research and development 

that’s important from a political and economic standpoint in China. 

From a development standpoint, the product development engine, 

there’s a cost-down structure that’s there, is a very important contributor to employment of the Chinese people, which is a political 

issue. They want to maintain a low unemployment rate, which 

would be very desirable. And there are all kinds of economic structure that’s put in place in support of that, the tying of the R&D 

to the dollar, and so forth, that you can go look at. Those are development-oriented activities. 

On the other hand, the university system is well cultivated, well 

financed, well funded, well directed by the Chinese government in 

a very efficient and focused area. And they’re putting in those capabilities. So I think they have probably broke the code, if you will, 

on what they need to do to run both development-oriented activity 

and a research-oriented activity. 

Commissioner REINSCH. Mr. Rieschel. 

Mr. RIESCHEL. If I could comment in one particular area that has 

been an area of focus for me for the last couple years. In the area 

of energy there’s probably 30 fuel cell projects right now in the Chinese national universities and labs. 

And I know of about 50 solar and other energy-related projects. 

And they’re really at fundamental levels of research. These are not 

product-oriented. These are really fundamentally improving underlying material science for the energy market, which makes sense, 

given China’s somewhat insatiable demand for electricity and other 

sources of energy, but that area is absolutely one where I haven’t 

seen quite the same level yet in the U.S. educational infrastructure 

that I’ve actually seen in China. 

Commissioner REINSCH. Mr. Wong. 

Mr. WONG. Yes, I’d like to add also that there’s a crossover point 

between product development and basic research, particularly 

when you’re looking at something like semiconductors. If you’re 

meeting or exceeding Moore’s Law, you’re coming very close to 

doing something dramatic in terms of research when you’re just 

trying to develop the next generation product to remain competitive 

with your competitors. And that really ups the capability of semiconductors. It also ups the capability that it offers for doing something like nuclear modeling or something like that, as you well 

know. 

So I do think that they are innovators in the sense that, as they 

develop products that are at the high end, they’re necessarily going 

to be getting closer to the cutting edge of research and development. 

Plus I would say that I’ve noticed, when we’ve been out there, 

that the government and the technology parks are really making 

an effort to create what they call incubation spaces for small innovative Chinese technology companies—where these guys are rent-
57

ing time on design tools so they don’t have to invest in them themselves, trying to get them to ramp up and be very innovative and 

entrepreneurial. So I think that everything is going on—Statesponsored big projects as well as little projects. 

Commissioner REINSCH. Thank you. 

Chairman D’AMATO. Thank you. I have two quick questions. 

Mr. Rieschel, mentioning alternative energy sources, do you notice Chinese venture capital—I’m not talking about American venture capitalists, but Chinese venture capitalists—going into things 

like alternative energy investments and research? 

Mr. RIESCHEL. Yes. 

Chairman D’AMATO. You do? 

Mr. RIESCHEL. And there are two primary sources. There is a 

great deal of informal venture capital there that’s—we would call 

it here ‘‘angel money.’’

Chairman D’AMATO. Yes. 

Mr. RIESCHEL. And there it’s primarily the large family institutions that literally have hundreds of millions of dollars of assets. 

And those groups have been quite aggressive in starting the seed 

financing of a number of these projects. And there’s also a great 

deal of Taiwanese money that is now not really investing that 

much in Taiwan but is really moving into the mainland from an 

investment perspective quite aggressively. So I think there is quite 

a bit of capital there. 

Chairman D’AMATO. You’re citing about $2 billion in U.S. venture capital going in this last year. How would you compare the 

macro? Is there a way that you could have a feel? 

Mr. RIESCHEL. It’s much larger than what the institutional venture capital investments have been, but I can’t give you a calibration on whether it’s twice as large or five times as large. 

Chairman D’AMATO. Thank you. 

Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thank you, Mr. Chairman. And 

thank you to all of our panelists. This is very interesting. It’s always useful for us to hear from and talk to people who are actually 

doing things on the ground. We get a better understanding of the 

complete picture. 

I keep thinking about the tail-chasing metaphor that Secretary 

Perry used this morning. I’m not sure if you all heard, but it’s apt, 

but it also talks about the world in a particular way. And I wonder 

whether the world exists that way anymore. 

In other words, if you are chasing some other dog’s tail in front 

of you but, as Mr. Everett said, that there’s a government, for example, that can change the rules at once. So if you end up leashed 

in a way, the person who’s chasing after you can get to you sooner 

or the rules of the road might not be what they have always been 

before. I think that’s one of the things we’re always trying to understand in terms of dealing with the Chinese government. Are 

they playing by the rules, want to comply, all of these issues. 

In that context I’m really trying to understand the issue about 

the training of foreign students here. If we acknowledge that part 

of our competitive edge has come from our universities, and I’ll 

stipulate by saying that I believe in the free flow of ideas, and the 

free flow of people is very important to the free flow of ideas. But 
58

how is it in our U.S. national interest, not so much the interest of 

your individual companies or your individual sectors, if we are 

bringing the best and brightest from other countries here and 

training them, and then they’re going back home to work competitively with the companies that we have here for American workers; 

how does that ultimately advance our economic interests and our 

national security interests? I’m just having a little bit of trouble 

understanding that. 

Mr. SCALISE. Well, let me just take a cut at that. 

First of all, one of the recommendations we have is that we staple a green card to every advanced degree in science and technology that comes out of our universities and give those students 

the opportunity to become a citizen now. 

Commissioner BARTHOLOMEW. That’s right. 

Mr. SCALISE. Yes. And I think it’s a very good idea, but beyond 

that we have always had a very open attitude. As I say, we fund 

a lot of research. We have no requirements with regard to those 

students, where they go to work. The challenge is for our people, 

our companies to work as mentors, be a part of those university research efforts, and to make it attractive for those young people to 

come here. We get about 70 to 75 percent of those students to come 

into our companies. The other 25 have other ideas, and that’s fine. 

So I think it’s a good idea to have that free flow of students coming in. And we should get our share, more than our share, if we 

just do the right things to engage with them as they’re going 

through the programs and make it attractive for them to come and 

work with us. 

Commissioner BARTHOLOMEW. Mr. Scalise, just a question on 

that. When you say 75 percent of the people come into your companies, are these people who are based here in the United States 

doing work of American companies? As U.S. companies become 

more multinational, and that is what it is, again, you have a set 

of looking after the interests of your companies, but there are people who need to be looking at what are the economic interests of 

American workers and what is happening here in the United 

States. 

Mr. SCALISE. No. We have over 75 percent of our employees here 

in the U.S., even though 70 to 75 percent of our sales are outside 

the U.S. The vast majority of our employees, and especially the 

high-technology folks, the ones we’re talking about here, are based 

here in the U.S. 

Now some of them are overseas, and there are things happening 

where we’re developing more of that activity, but it’s by and large 

here. We think it will stay here as long as we have the leadingedge technology being developed at our universities and those students coming out of our universities want to stay here and work. 

We can be competitive, as I pointed out earlier. That’s not an issue. 

Commissioner BARTHOLOMEW. Mr. Morgan. 

Mr. MORGAN. Can I just add one thing? I think I agree with everything that George said. I think it goes back to the key point, 

and I think even Bill made it, too, this morning, is the investment 

climate in the U.S. has to be attractive, because if they come here 

to get the education, they stay here because there’s good opportunities here. But as we discourage opportunities in the U.S., then they 
59

got better opportunities elsewhere in the world. And so they go 

back to those places, whereas they would stay. So the thing I think 

that we have to focus on as far as staying ahead is our investment 

climate. 

Commissioner BARTHOLOMEW. And I’d note, of course, that Secretary Perry was talking about how having the foreign students 

here makes our own students more competitive because they have 

to work harder to keep up. 

Mr. Everett, did you have a comment? 

Mr. EVERETT. Yes. I strongly believe we should never waste a 

mind. And I think by embracing the concepts that Mr. Scalise is 

talking about here and providing opportunities and the government 

stepping up and making the investments in kind to keep American 

companies or Americans fully employed in new technology ventures 

is probably the right thing to do here. 

It’s immaterial in my opinion where the intellectual talents 

comes from as long as it’s deployed toward growing the marketplace for knowledge-intensive products. 

Commissioner BARTHOLOMEW. Mr. Wong. 

Mr. WONG. Yes, one thing that I wanted to add was that I agree 

with what George said about creating a good environment here in 

the U.S. for keeping businesses here. But at the same time I think 

there is a perception on the part of companies still that they cut 

costs in terms of labor by going overseas, even at the high end. I 

mean I have to hear this all day long—that we can hire three 

heads for every one that we hire in Silicon Valley. 

So with respect to your question, I think one of the ironic things 

is that we now often see people encouraging U.S.-trained students 

and engineers to go back and start offshore operations. So we’re actually encouraging them to go back to their countries, and there’s 

no guarantee we’re going to retain them more than a year, or two 

years, or whatnot. 

Commissioner BARTHOLOMEW. Thanks. 

Mr. Chairman, just one comment and that is, of course, here we 

are in the home of all of this technology. Although we’re not really 

talking about nanotechnology very much or biotechnology, I think 

we also need to visit the implications of some of the social restrictions that are being put on technology and what that means for future innovation here. Thanks. 

Chairman D’AMATO. Thank you. 

Commissioner Dreyer. 

Commissioner DREYER. I was interested in what Secretary Perry 

had to say about not being particularly concerned because the Chinese intellectual climate does not favor technological innovation. I 

seem to hear you all saying something different. Is that correct? I 

see you nodding collectively. 

It occurred to me that Secretary Perry is assuming that the climate at the top, which he correctly characterizes, also characterizes 

the climate at the bottom. I think that’s where I would disagree 

with him. The Chinese have a saying that heaven is high and the 

emperor is far away, meaning that at ground level one can do what 

one wants, so long as the emperor is unlikely to find out. 
60

It seems to me that I see a good deal of technological innovation 

happening at the lower level. So far, I see three people nodding and 

two people not saying—do you want to expand on this? 

Mr. EVERETT. Yes. I’ll make a comment on that. I do believe that 

there’s a pattern to recognize here, and it’s probably really apparent in the semiconductor industry. If you’d roll it back to the late 

’70s or mid ’70s, a lot of people came here on visas, got educated, 

and learned the business. One of the more prominent examples 

was Morris Chang who spent a considerable amount of time at 

Texas Instruments and went on to found TSMC. 

Commissioner DREYER. But he’s Taiwanese. 

Mr. EVERETT. He’s Taiwanese. But I would just want to point to 

a pattern here of how things develop and how I project things may 

develop in China in the future. So it takes a period of time for this 

knowledge to accumulate, be transferred, taken back, and planted 

in an industry to bloom. 

So my prediction, and it’s simply that, is in the future China will 

provide a substantial amount of innovation to our industry because 

they are being trained today, okay, just as the Taiwanese were 

trained in the ’70s and went back. So I think this is the process 

and a pattern to recognize. It’s also been healthy for our industry 

and our business because it’s enabled huge markets for goods and 

services and been a great deployment of the intellectual talent 

those people were born with. 

Mr. SCALISE. One comment that I think is relevant to this: If we 

continue to fund the university research programs at the levels we 

are today, we will begin to lose ground relative to our competitor 

universities across the world, and especially those in China that 

are becoming aggressive to become good research universities. 

However, if we address that issue, get back to where we were 25, 

35 years ago and fund at the levels we must to maintain robust research at our universities—and, incidentally, the way we see that 

today, we are not going to create a new Bell Labs or a new Xerox 

Park. What we are doing now and the way we’re working it, as I 

say, we fund about $80 million of research at universities, we’re 

doing it through a consortia arrangement and it’s a virtual research laboratory. We have five of these across the country: One at 

Berkeley, one at UCLA, Carnegie-Mellon, Georgia Tech, and MIT. 

But we also engage another 35 universities as a part of that consortia to do basic research. We’re funding basic research here. 

As long as we do that we will still attract a very large percentage 

of the very bright students from outside the U.S. and many of 

those will want to stay here. And I think we ought to continue to 

focus on that: Fund the research at the universities; make sure 

we’re at the leading edge so if there is something that attracts 

these young people, why they want to come here as opposed University A, B, and C in some other part of the world; and then we’ll 

get our share of them here if we have the right investment policies 

and programs that make it a viable opportunity to run a business 

here. 

Mr. RIESCHEL. If I could have one comment. I think there’s an 

interesting example of how and why you need to separate the ideology and the value system that people appreciate. So I think Mr. 

Scalise’s comments on people coming here and getting an education 
61

having the ability to stay here, even if they choose not here, is absolutely—is absolutely huge. 

If you look at the fact that my family’s currently living in the 

Shanghai area, there’s 700,000 Taiwanese nationals living in 

Shanghai in one metropolitan area. They’re not there because they 

embrace the culture and value system of the Chinese government. 

They’re there because they can make money. 

And so, as these students come here, if they don’t have the incentive and if we aren’t allowed to structure the companies in such a 

way to provide the incentives, to keep the best and the brightest 

people that come out of our educational system here, they will go 

someplace to start that career. And that’s just fundamentally, fundamentally at the very basis, I think, of everything that we have 

to do. 

Chairman D’AMATO. Mr. Wong. 

Mr. WONG. Well, one thing that I’ve been struck by is that we 

seem to be giving a lot of credit here and making assumptions that 

everything’s always aboveboard. I don’t profess to have any particular great secret knowledge here, but I mean one thing we need 

to keep in mind is that not everyone’s happy about the way things 

have gone. 

For instance, we laud the fact that the Shanghai foundry industry has come up so quickly, maybe not up to the best wafer fab 

technology they can do in Taiwan or at IBM, but very quickly, 

within a year’s time. But at the same time TSMC last year sued 

SMIC because they alleged that they stole all their trade secrets, 

and that’s how you could do it in a year. They didn’t win, but they 

settled it for $175 million. So there are some very interesting 

pleadings in that case that are publicly available, and I would recommend that people look at those, because it’s certainly something 

that, whatever the truth is there, you need to be aware of when 

you’re a U.S. company and you’re going overseas, not only with 

your own operations but also in terms of who you’re partnering 

with. 

Chairman D’AMATO. Yes. 

Mr. MORGAN. I want to add a point. I think it’s very important 

that our ambassador and consul capabilities in a place like China 

be quite strong, and we have some good people there. I’m not sure 

we have enough of them and enough of a charter, but I found in 

Japan, let’s take as a example in the ’80s when there was a lot of 

issues, intellectual property, getting squeezed out, different things. 

The government people there, by their ability to communicate with 

their government people, you don’t want to go court in Japan nor 

do you want to go to court in China, but you can get a lot accomplished if your government understands your challenges and the 

issues that you have and can weigh in with you, so it’s important 

to have good people involved in these things, and it helps a lot. I 

don’t want to underestimate how helpful that is. 

Chairman D’AMATO. Thank you. I have two quick questions. 

Mr. Rieschel, this whole question of IPR theft, doesn’t that put 

a chilling effect on some of the activities of venture capitalists that 

are worried about going in there and, Wild West, and you come out 

with nothing and somebody else owns your stuff? Isn’t that a big 

factor and a chilling effect, or is it not? 
62

Mr. RIESCHEL. I think it is and so you don’t invest in areas 

where that’s easily accomplished. I don’t think we would be making 

any investments in the package software business in China, whereas you would invest in a software company where the software is 

hosted on the cellular infrastructure and it’s an application that 

people are buying and selling through the cell phone; because then 

what you have to do is you—there’s no package to actually replicate. There’s nothing to steal. It also puts you on the wrong side 

of trying to steal from China Telecom, China Unicom, and China 

Mobile, who the government’s far more likely to be supportive of. 

And so I think you have to pick the areas that you’re going to 

invest in. If it’s a product—software, in particular, has been a challenge. The more complex the software the less theft. But at the 

same time, the more complex the software the less successful it’s 

been in the market. That is not at all been a successful market for 

large complex applications over the last 20 years or so. 

Chairman D’AMATO. Thank you. 

And I have another question on the question of deterrent and 

chilling effects. There are some people who argue that essentially 

what Mr. Wong calls the Chinese government or Chinese are master of the game of attracting foreign investment, but once you’re in 

there you have this very nationalistic government which has certain very—they’re very centrally directed toward building a strong 

China and building strong Chinese industries. 

Now you’ve been in there 20 years. So I think it would be interesting to hear your perception of to what extent you can survive 

in China despite the fact that the Chinese obviously want to train 

and build their own domestic industries with the technologies that 

you’re bringing in. How do you cope with that? 

Mr. MORGAN. Well, you know a lot of that was also true in 

Japan. I was a venture capitalist at one time and had a very small 

company in the ’70s that grew quite a bit over the years. You know 

one of the problems with intellectual property was right here in the 

Valley. Now you do have a court of law that can help you in that 

sense, but you didn’t have that in Japan. 

But you have to take a really proactive stance to protect your 

technology. That just has to be a strategy from the beginning. 

There’s going to be some leakage. You have to assume that. So you 

pick and choose your fights. 

You use all your resources and the resources are potential legal 

characteristics where most of these markets aren’t for—a lot of 

products are global markets nowadays, so you can sometimes protect yourself in another marketplace because they have to go outside to build their business. PR, I mean the ability to have bad 

publicity is not a good thing for a lot of these companies trying to 

get started there. 

The third thing is the government. In other words, your government is there asking questions, concerned about this sort of thing. 

In a lot of cases their government will respond. Now they’ll drag 

their feet and they’ll do all the sort of normal things that people 

do to do what they continue to do, what they want to do. But if 

you really have your focus on it and they know that, then they’re 

going to work—they’ll help more or they’ll help solve some of those 

problems. 
63

So I think it’s just a major part of your whole strategic and tactical day-in and day-out effort to protect your property. 

Chairman D’AMATO. Thank you. 

Commissioner Mulloy. 

Cochair MULLOY. I want to thank you all for taking time to be 

here today. Mr. Wong, I particularly enjoyed reading your testimony, which I found very interesting. S one who began his own career in the Foreign Service, I welcomed your insights very much. 

Mr. Scalise, you say in your testimony that it’s not in our national interest to try to compete as a low-cost supplier because then 

there aren’t high-paying jobs for our people, right? Our goal must 

be to create high-wage jobs here, which can only be achieved with 

higher productivity, and products that command a premium in the 

marketplace. But what worries me from what I’m hearing here and 

from other testimony, the Chinese have a clear sense of national 

mission of what they’re about in building this high-tech strategy. 

I don’t see any vision in the United States about what we’re doing. 

Mr. Wong tells me you can hire three R&D people in China for 

what you can get here. I’m told that some of our own Americanborn students are less inclined to go into these fields because they 

sense that, too, that this is moving, and that why should they go 

into a profession that may be moving. Yet it’s essential for us that 

we have our own students get into this field. 

We had testimony last year that the Chinese offer incentives to 

bring the Chinese-trained students that we have trained and 

brought up and invested in, taxpayer money invested in, give them 

a good education, the Chinese government is offering them real incentives to bring them back to China. 

So when you look at all of that you begin to say, we’ve got to 

bring more and more foreign students in and educate them. I was 

here in the 1950s when Sputnik went up and we put a lot of money 

and we had American students who learned science and math and 

could do it. Is there something inherently wrong with our own students, or is it that we don’t give them the proper incentives? We’re 

not telling our people what is really going on here and what’s the 

inevitable conclusion if we stay on the road that we’re presently on. 

That’s what I’m hearing and that’s what I’m getting. I’m hearing 

the venture capitalists are now moving the money that might be 

invested here, hiring people here. It’s now going there. With a $700 

billion current account deficit, I say where is all this headed and 

what does it mean? 

So I just throw that out for anybody who wants to make an observation. 

Mr. SCALISE. Let me make a comment on that. First of all, when 

you go back and look at the period after the Second World War—

remember, we were the last country standing. 

Cochair MULLOY. Yes. 

Mr. SCALISE. Everyone else was flat on their flat back trying to 

figure out where they were going to go next. We had a 15-year advantage on the rest of the world to get the technology into place, 

get our university research programs. We established the National 

Science Foundation. We did a lot of very visionary and creative 

things at that stage. And we’ve led that parade now for 50 years. 
64

Today we have a number of competitors out there, and they’re 

getting better. Their universities, their research universities are 

not up to our standards. There are probably some around the world 

that are close to being competitive, maybe even competitive, but 

when you look at the full complexion of the U.S. university research system, it’s by far the best in the world. 

As long as we maintain that and we maintain the student-flow 

through those universities and get our share of the students, wherever they come from in the world, it doesn’t matter. We need the 

best and the brightest, wherever they come from. But then we have 

to have, as I said a few minutes ago, the investment policies here 

that allow those young people to then exercise that capability that 

they’ve taken from these universities, that knowledge that they 

have accrued and put it to work here as opposed to somewhere else 

where they’re trying to make it more attractive. 

That’s why we focused on just one element of this thing today, 

and that is the manufacturing part of it, because when it comes to 

the research—our research is still the best. The innovative products we’re coming out with, yes, there are competitors, but we still 

have, by and large, the best innovative products around. And we 

can maintain that as long as we keep that best and brightest coming through our university system. 

So if this ecosystem that needs to be nurtured, you can’t look at 

just a piece. We’re not worried about how much we pay these very 

bright people, the payback is very, very high. Our average income 

here in the U.S. is $96,000 for each employee, and we have about 

75 percent of our labor compensation here. We pay on average, yes, 

25,000 or 26,000 overseas. So Alan’s comment about three to one, 

that’s true. But they are not necessarily quite the same engineer 

as this engineer we’re talking about that’s coming out of MIT and 

Stanford and a whole host of other great research universities. 

They’re good. 

As they come out of IIT in India in certain specific areas, they 

are exceptionally good. So it’s not a one-in-zero here. It’s a very 

complex set of issues. But when you look at it in its broadest context, we can be very, very competitive with very good jobs and all 

the second- and third-order effects that flow through that if we 

maintain leadership in these technologies that are evolving, no 

question. 

Cochair MULLOY. Mr. Morgan, you’re involved on the President’s 

Export Council and in a science and technology program with the 

President? 

Mr. MORGAN. No, just the Export Council, but I’ve been on the 

previous President’s Trade and Export Commission and Semiconductor——

Cochair MULLOY. Do you sense, from your contacts around the 

Administration, that they understand what is really going on here 

in terms of China having a national vision? 

Mr. MORGAN. Yes, frankly, I do. The problem is there are only 

a few people in any part of the government that has much of an 

appreciation, is one of the challenges. We had really an excellent 

trip with Secretary Evans last June and met with the top leaders 

there. Of course, I’ve watched this for 20 years, known closely some 
65

of the key people there. They just have an experience that we don’t 

have. 

Most of their political leaders have run cities. Many of them have 

run industrial operations. Now they’re a communist kind of plan 

set, kind of mindset in the old days that’s changing, but they understand what it takes to make an organization and a strategy 

work. It’s not quite as political in that sense. 

Where we have difficulty I think is we don’t have enough people 

in the supporting areas throughout the government, particularly in 

the legislative side, to have spent time in these places and understand the issues. Most of them are pretty focused on their locale, 

and I think that’s just the way it is. I’ve thought about how to 

change that. I’ve actually gone and spent dinners, offered to invite 

the staff and spend an evening with some of their staff, but you 

know most of them have other issues that they’d rather spend time 

on than China and Japan most days. So they’re just ahead of us 

in that sense. 

Cochair MULLOY. Thank you. 

Chairman D’AMATO. Let’s see. We have Commissioner Wortzel. 

Commissioner WORTZEL. Gentlemen, thank you very much for 

being here and sharing your time with us. 

Mr. Wong, I would like to draw you out, if I could, on a particular aspect. On page 2 of your testimony you talk about ‘‘the 

risks remaining high in an environment where encryption methods 

must be acceptable to the local authorities and the host government must be given the encryption keys’’ when you’re dealing with 

software, and that creates particular risks. 

As I look ahead, Professor Henry Rowen later today is going to 

talk to us about central government, ownership, and involvement 

in technology and technology development. He says and he’s 

quoting someone—1950 to 1978, the Chinese Academy of Sciences 

owned all the technology, and since reforms, post 1978, 40,000 

products were passed on to companies. By 1987 the Academy had 

spun out several dozen high-tech companies, including computer 

companies, Legend or Lenovo, and China Daheng, information 

technology. So we’ve got this situation where the central government is at a certain point really doing all the research and parsing 

out things to go into development, where it wants it to go for the 

reasons it wants. 

Now supposedly this is all changed and there are private companies, foreign investment. But you seem to imply that there continues to be collusion between parts of the central government and 

local governments and private companies to actually gather technology and to bypass technology controls as part of this government 

effort. Is that what you’re implying? 

Mr. WONG. Well, I wouldn’t say that I’m implying it as something that I know. It’s something that I fear. With respect to 

encryption, what I am worried about is not software encryption, 

we’re worried about our own information. When we want to be connected here, we want to have our server, all the data in it, 

encrypted and sent back to here or through our other servers somewhere else in the world. 

Commissioner WORTZEL. A business practice. 
66

Mr. WONG. Exactly. And this is what our information security 

people would want typically, whether we were in France or wherever. Well, here you would just use whatever you feel like, whatever system you feel is most secure. And, of course, you would feel 

that, as long as you have a high level of confidence in it, it’s not 

vulnerable to attack by your competitors or by any authorities. 

Well, there we were told that you could use certain methods and 

that you needed to give them the key to it. So my assumption is 

that anything you put in there they can have if they want, at least 

as far as the authorities go. So to what extent they do, I don’t 

know, but it makes us concerned that you better be darned careful 

of what you put in there. And we are. Other companies are too. 

There are companies where all the printers in a facility are in 

a locked room and only two people have the key. There are no USB 

ports. There are no disk drives to copy anything. In many cases, 

I mean you really just have to think—where am I going to locate 

the data? Are the people onsite there only going to be able to enter 

data, can they get data out, to what extent can they get data out? 

As far as collusion goes, I don’t have any hard facts. I’ve worked 

for the government before. I mean I’ve heard things. You’ve all 

heard things, I’m sure. But one thing I think is public knowledge 

is that we keep making a comparison between Japan and China. 

I think it’s publicly known, although not that often talked about, 

that there are in excess of 2,000 front companies here in the 

United States that are either run by or affiliated with the PLA. 

Those are companies that are trying to deal with, partner with 

U.S. companies, and get around export controls. My assumption 

would be that if you’ve got that many here in the U.S., that the 

level of involvement with companies in China would be higher. 

Which companies those would be, I don’t know. Whether there’s 

anything covert, I don’t know. But our assumption is that it’s a different environment here—if there’s a venture-driven company and 

the government wants something, they’re going to basically tell 

them to go away unless they invest in them. 

But in China, if you’re a company and the government comes to 

you and says, ‘‘We’d like some information either on your partner 

or on what you’re doing,’’ what do you say to them? Sure, it’s an 

environment where I think more and more people are happy living 

good lives. They want to make money. They want to own nice cars, 

which they do in Shanghai obviously, but I don’t think it’s the kind 

of environment where you can say ‘‘no’’ to the government. 

Chairman D’AMATO. Thank you. 

Commissioner Robinson. 

Vice Chairman ROBINSON. Thank you, Mr. Chairman. 

Well, we’re still trying to get a handle on that issue of the Chinese PLA or defense industrial base companies. We learned the 

hard way that if you ask the question the wrong way to our intelligence community, you get a very different type of answer. 

In any event, we are impressed that some of the better known 

Chinese companies that have sustained remarkably large growth 

rates, such as Huawei, are to some of us on the Commission questionable. This is not just because of the nature of their activities 

with the military and intelligence services of China, which in some 

cases is a formidable one. It also involves their overseas activities, 
67

whether it’s building a command-and-control and air defense system for Saddam Hussein or whether it’s doing similar work on a 

communications network for the Taliban in Afghanistan. 

In other words, we’re alert as part of our mandate to look at 

some of the downside risks associated with firms like Huawei that 

are popular partners for some of America’s largest telecommunications companies. 

I was impressed by Commissioner Mulloy’s intervention earlier. 

We are grappling with a big picture issue here and Mr. Scalise and 

Mr. Morgan have talked to this. We certainly buy the notion that 

we need to retain, in effect, our share of the brightest and best students moving through our advanced university research facilities. 

And I think we’re likewise impressed by the extent to which 

China is trying to foster an environment and an incentive system 

to recapture that talent and to ensure that it’s, to the extent possible, retained by them. 

I have at a visceral level the same kind of reservations that Commissioner Mulloy and others have along the lines of ‘‘What the 

hell’s going on here?’’ In other words, this does not smack of fairness and an even playing field. China has a national program to 

do this. 

The question posed to you, Mr. Morgan, was, do we have something comparable. Do we even have a national recognition of the 

problem, much less a set of our own incentives that compete head 

to head with a country like China to ensure that we retain this 

kind of talent, including the stapling of a green card on their diploma or something along those lines. I happen to think that’s a 

good idea. 

But what I’m really trying to get to here is that we’re trying to 

fashion a set of recommendations for the Congress. I think one of 

them should be how we might bolster national recognition of the 

fact that this is not just an economic matter and a competitiveness 

matter but it’s a national security issue for the U.S. 

And, second, how we can perhaps build a database on what other 

nations are doing to retain or to capture this talent versus ourselves and see if we can, on some systematic basis, determine how 

we can bring up our incentive system to match those of other nations more effectively. I think this is an urgent matter and we 

would value your help if you have additional thoughts on the 

crafting of a recommendation from this Commission to the Congress. And I don’t guarantee that all of my fellow Commissioners 

are going to agree with this, but I think that we would very much 

like to review, at minimum, how the Congress could play a constructive role in, in effect, fixing this problem because the stakes 

are so high. 

You know if we get this wrong we are going to lose that technological scientific lead that has been the lifeblood of this country’s 

competitiveness both economically and militarily. 

So anything you might offer in terms of a dialogue with the Commission would be greatly appreciated. And if you’d like to react to 

whether I’m exaggerating this concern or whether you think that 

it is possible to get our arms around achievable recommendations 

of this kind, I’d be interested in your views. 
68

Mr. WONG. Commissioner, one thing that goes back to a question 

I think Commissioner Bartholomew had mentioned before—and I 

think it’s very important to your focus here—is that we need to invest more, I think, in public grade school and high school education, because at the higher level we are always going to be competitive—at MIT, at Stanford, CalTech, whatnot. But more and 

more of those students are going to be foreign students at the top 

level if you don’t have students with the capabilities to get in there. 

And we take for granted that we just innately have the ability 

and that’s all we need, but it’s not true. I grew up going to grade 

school here in California in the ’60s. At that time it was one of the 

best public educational systems in the nation, in the world. I don’t 

think I’d want to go to my grade school or my high school today. 

I’d be more worried about my safety than anything else. I mean it’s 

different if you go to school in Palo Alto, but I didn’t. 

So I would say that if you really want to look at the long-term, 

it may seem like a remote issue, but it really is tied in closely to 

the future of our competitiveness and our national security. 

Mr. RIESCHEL. Let me make one comment. 

Chairman D’AMATO. Mr. Rieschel. 

Mr. RIESCHEL. I think the observation that you just made is really important and also Secretary Perry’s comments this morning. If 

we try to prevent someone else from doing what’s really in their 

best national interest or actually in the interest of their people, because one of the problems that China’s dealing with is the broadest 

spectrum or the broadest disparity between poor and wealth of any 

country in the world, two orders of magnitude greater than the 

United States, and we get criticized for that fairly broadly. 

So if you’re focused on preventing that, then I think that’s a terrible mistake. So the spirit of the conversation on what do we need 

to do proactively to maintain that is such a refreshing thing to hear 

and it’s not something that comes across in the press and the 

media very often, because it’s always about how do you prevent 

someone from being successful. And as long as—the global pie has 

a lot of room to grow if we get ourselves together with the right 

partners to make that happen. And I just want to comment that 

that’s such a refreshing feeling coming across from the panel this 

morning. I really appreciate that. 

Mr. SCALISE. I would just add one comment here. When we did 

the study for the President’s Council of Advisors on Science and 

Technology on IT innovation and manufacturing, we went back and 

looked at what we did in the 1940s to set the stage for this great 

revolution that we have been the beneficiary of. And you know 

Vannevar Bush laid out some very, very insightful and courageous 

thoughts. And that vision was the foundation for a lot of the things 

that happened. 

But in addition to that the Congress then had the will to go 

ahead and invest in it in a way that allowed it to unfold. I think 

that’s something that needs to happen again, and it has to be a bipartisan thing. It can’t be squabbling about every word in every 

sentence in every document that comes out. It has to be a decision 

on the part of the Congress to say: This is something we must do 

and we’re going to come together and do it, and allow the National 

Science Foundation to have the funding that it needs, a doubling 
69

of the science and technology. The physical sciences part of the National Science Foundation is critically important today. We’ve allowed that to lag for so long. 

We’re doing a wonderful job on the other side of the equation as 

far as the research is concerned through the NIH and so on, but 

the physical sciences, we’ve just let it lag far behind. We can’t 

allow that to continue. So getting the vision, getting the leadership, 

and having the Congress come together and say: We’re going to be 

the ones that are going to make this happen now, is what really, 

in my view, has to occur. 

Mr. MORGAN. I just might make one point. I really appreciate the 

opportunity to participate, and I was glad to see the perspective of 

many of the Commission Members. 

I would encourage you, as I think many of the people have, is 

that really the investment climate in the U.S. is the key, in addition to building the support issues that we’ve talked about, is the 

key to keeping the jobs and opportunities here. 

The things that, of course, all of us know in the past few years 

that are going against that, we really I think need to highlight that 

early in your report, that it’s important to look at it from that way. 

That leads you to several conclusions that you’ve got better research than I have to do, but if you take it as a way that we’re 

going to somehow block the development of China, I think you got 

a disaster. You got a train wreck. So that’s my major point. 

Chairman D’AMATO. I think that’s what Dr. Perry was saying 

this morning about running faster, running faster in place. We also 

appreciate your recommendations on the tax side, because that’s an 

area that we think we need to look at again. 

Cochair MULLOY. May I just make the request, because I know, 

Mr. Scalise, you gave us some very good recommendations, if any 

of you in light of this talk about a national vision or strategy if it 

strikes you that there’s something that we ought to think about, we 

would invite you to submit those to us in writing. That would be 

most helpful. 

Commissioner BARTHOLOMEW. Mr. Chairman, I’m sorry. Just one 

more comment, which is it’s interesting to hear—I can’t resist this 

one—at the same time we have people talking about reducing taxes 

and increasing spending. And, of course, this is a terrible set of priorities that our entire fiscal situation has gotten into, where we 

have had reductions, tax cuts in certain places, increases of spending in other places. We have the largest deficit that we are confronting. I couldn’t let that opportunity pass, that it’s not an easy 

thing to do, is it, to cut——

Mr. EVERETT. It is a huge challenge, but I have one final recommendation to make in this, and it’s right to your point, Commissioner. The Administration had promised an increase in the funding of the National Science Foundation, which directly addresses 

the K-through-12 program in science in our schools. That’s a small 

amount of money in the grand scheme of things, but it is yet to be 

done. 

And if there is any single action that would put us on a path to 

get to a plan that Commissioner Mulloy talked about, that would 

be a great beacon to see that National Science Foundation funded 

by the government, as it should be. 
70

Chairman D’AMATO. Thank you very much. 

That will conclude this panel. We’ll take a five-minute break. 

[Recess.] 

PANEL II: CHINA’S HIGH-TECH DEVELOPMENT STRATEGIES 

Chairman D’AMATO. The Committee will come to order. 

Our next panel this morning will look at the question of China’s 

development strategies, high-tech development strategies, what 

they’re trying to do. We have a number of experts here. From left 

to right: Dr. Richard Suttmeier, Professor at the University of Oregon; and on his left Dr. Michael Pillsbury from Washington, D.C.; 

and to his left Dr. Denis Simon, Provost of the State University of 

New York in Albany; and then on his left Ms. Kathleen Walsh, 

Senior Associate at the Henry Stimson Center in Boston. 

We’ll go from left to right. And if you would try to confine and 

summarize your remarks, your presentations will all be in the 

record in full, to about seven minutes. And then we’ll have time for 

Q&A. Why don’t we go ahead left to right and start with Dr. 

Suttmeier. 

STATEMENT OF RICHARD P. SUTTMEIER

PROFESSOR OF POLITICAL SCIENCE

UNIVERSITY OF OREGON, EUGENE, OREGON 

Dr. SUTTMEIER. Thank you, Mr. Chairman. It’s a pleasure to be 

here with you today. Seven minutes doesn’t give us too much time 

to cover a big subject. As a result I want to just make a couple 

quick remarks. I think they’ll come up in other presentations as 

well. 

I’d like to start, borrowing from Charles Dickens with the observation that China is experiencing ‘‘the best of times and the worst 

of times,’’ with regard to its science and technology. As the previous 

panel pointed out, yes, indeed we do have national purpose and national programs in China. But I think that we have to remember 

is national programs of that sort both accomplish things but also 

don’t accomplish things and produce lots and lots of problems. 

So part of my position here today is to be a little bit dissenting 

about the China juggernaut phenomenon and point to some of the 

weaknesses that I see as a result of years of looking at these 

issues. 

So in terms of the best of times, this we can see fairly easily. In 

many ways the Chinese are reaping the achievements of 25 years 

of planning, reform, major changes in their national system of innovation, very significant increases in funding in the last five or six 

years in terms of funding of R&D with some impressive consequences: increasing publications in leading scientific and engineering journals, the creation of a high-quality manpower pool and 

a very good educational system, and now the commitment to a 15-

year science-and-technology development plan, which will shape 

S&T to the year 2020. 

But I also want to call attention to the ‘‘worst of times,’’ as these 

are perceived by a number of officials and scientists and others in 

China. And these I’ve tried to address under the general rubric of 

China’s ‘‘technology trap.’’
71

The idea here is that so much of China’s rapid economic growth, 

its rapid movement up the value-added chain, has been the result, 

basically of technology coming in from abroad. And, as a result, 

there is a growing sense of frustration in the Chinese technical 

community with the fact that so much of what China produces 

doesn’t incorporate Chinese intellectual property, Chinese innovations. And that, in turn, has consequences for the overall performance and profitability of Chinese industry. 

This, it seems to me, centers particularly on what I’ve called in 

the paper China’s ‘‘enterprise problem.’’ And the enterprise problem is basically the problem of not having your national innovation 

system being centered in industrial organization, industrial corporations or companies. The enterprise sector coming out of the 

traditions of the Soviet model has been, in fact, quite weak as a 

center of innovation and arguably still is—although we’re seeing 

lots and lots of very contradictory data on that point, something we 

could talk about a little bit further if you want to in Q&A. 

But I think that most of the Chinese policy analysts would conclude that you don’t look to Chinese enterprises as the source of 

technological innovation in China. Instead you have to look at what 

had been the traditional strengths of the innovation system, i.e., 

government research institutes—especially the Chinese Academy of 

Sciences and, more recently, universities. 

These research institutes and universities have, I think, done 

very well in the course of the reform era. Enterprises somewhat 

less so. In my written testimony I give you a little bit of data on 

these questions, for instance, on R&D intensity in industry. 

If you look at where Chinese R&D intensity in enterprises is, as 

one measure of innovative activity, it lags notably behind that of 

most of the OECD countries. As a result, as Chinese enterprises, 

I think, as they face this new world of market competition and 

globalization are themselves becoming increasingly interested in 

outsourcing R&D. In other words, they are outsourcing a great deal 

of their innovation activity, rather like the way that Mr. Scalise 

was referring to, I think, in terms of the creation of virtual innovation networks in this country. That is, enterprise-research institute, and enterprise-university relationships I think have become 

more important and are going to become even considerably more 

important in the future. 

I would urge the Commission not to be taken in by talk of Chinas as the new technology superpower and to remember that there 

are a number of the very significant vulnerabilities, as well as 

achievements, that we can see in the Chinese innovation system. 

Now, of course, the Chinese government is aware of these and attempts to do something about them through its technology policy. 

There are many different things we could talk about with regard 

to a Chinese technology policy. I will just focus on one, which the 

staff had asked me to address: the question of China’s initiation of 

a national standard strategy. 

As one looks at this strategy, there is some literature cited in the 

footnotes for your reference, we can see that the initiation of this 

standard strategy comes very much out of either the consequences 

of WTO membership and the sense that Chinese industry is disadvantaged in relative gains terms as a result of its deeper integra-
72

tion into the international economy. In other words, Chinese industry has done very well in a lot of ways, but relative to many of its 

multinational partners maybe not as well as it thinks it should. 

Now as a result of we have begun to see a growing attention to 

standards starting in the late 1990s and on up to the present. And, 

of course, this all broke into our consciousness last year as a result 

of the WAPI issue, which I think Mr. Dawson will also address a 

bit. 

But again, if we look at this national strategy, it appears in the 

first instance to be rather troublesome. It appears to be the working out of a big national industrial policy with all kinds of techno 

nationalist overtones. However, I think as one begins to look at it 

more carefully, it’s considerably more complex. There are a large 

number of actors involved, and they do not all have the same preferences and the same interests in it. There is also considerable variation in the politics of standard setting from standard to standard. 

We were learning in the work that we’ve been doing on this is 

that for a variety of reasons it’s been very difficult for China to actually pull together a cohesive national strategy. China is now 

working on a national strategy document that many foreign companies have commented on; a review of that document reveals many 

of the problems they are having. 

Let me point out that the standards area is one where recommendations to Congress from the Commission might be warranted, especially in light of what the EU is doing with China with 

regard to standards. Everybody understands, I think, that standards have become very, very important in the global economy; the 

EU has become very aggressive in trying to win the Chinese over 

to their views. They’ve put money into it, and so forth. 

On the U.S. side there has been a response as well, documented 

a little bit in my testimony, but I think everybody who has looked 

at this issue would agree that considerably more can be and should 

be done if the U.S. is going to try to engage China on standards 

issues in ways that will gradually take China’s formative mentality, or formative culture of standards, which is where it is in 

China at the moment, and turn these more towards a U.S. view 

how to approach standards rather than have the European view 

prevail. 

In conclusion, let me just note that there’s no question—as we 

look down the road—that China’s importance in the science-based 

industries of the future is growing rapidly. The R&D strategies 

that are now in course will make China, or and has already has 

made China, an important player in some areas of science-based 

industry. 

That said, one also has to recognize continuing fundamental endemic institutional problems that identify in my written testimony 

as limitations on what China can achieve. 

I would just conclude with one final thought, because I was interested this morning in the extent to which we may be seeing a growing divergence of interest in the United States on how science in 

China and in the U.S. fit together in the international economy and 

its global innovation networks. Increasingly, from my point of view, 

after looking at these issues for a number of years, but certainly 

in the last five or eight years, it seems as if American universities, 
73

higher education systems, American high-technology companies in 

general, and the technical agencies of the U.S. Government have 

all done serious assessments of what China means for them. They 

have all taken China very, very seriously in an informed way and 

I think have incorporated ‘‘the China factor’’ into their longer-term 

sense of strategy and projections of their future. 

One gets the sense, however, that political authorities in the 

United States haven’t quite gotten it, and that they increasingly 

see the world differently from the institutions, above, who are the 

major sources of American innovation. If true, I think it is a very 

worrisome development to have the nation’s political authorities 

seeing the world so differently from the nation’s innovation leaders. 

I would encourage the Commission to give this some thought: Is 

there, in fact, a very serious divergence of interest between those 

who are doing the research, the scientific discoveries and the innovation in American society, and the American state which is understandably concerned about security and shorter term economic 

issues? Are the latter leading to government actions which work 

against the more innovative sectors of the society such that effective coordination at the national level to advance the nation’s competitiveness being lost? 

Thank you. 

[The statement follows:]

Prepared Statement of Richard P. Suttmeier

Professor of Political Science, University of Oregon, Eugene, Oregon

China’s ‘‘Technology Trap’’ and the

Reconstruction of the Chinese National Innovation System

‘‘The Strategy for Technological Innovation Determines the Future of China’’

In a series of revealing commentaries in China’s official People’s Daily this January, some of the most critical issues affecting its China’s technological aspirations 

for the 21st century were brought to the attention of Chinese readers. A brief review 

of the claims made is a suitable point of departure for our discussion. 

Entitled ‘‘Giving Full Play to Scientific, Technical Progress,’’ the five-part series 

begins with a critique of China’s rapid growth experience, emphasizing in particular 

its failure to break fully with an ‘‘extensive growth’’ model characterized by overinvestment and inefficient resource utilization. While movement towards a more 

‘‘intensive growth’’ approach (based on technological innovation, efficient resource 

utilization and productivity gains) has been an objective throughout the past 25 

years of reform, success has been slow, with the lack of progress becoming more evident as the environmental costs of growth have soared and the relative scarcity of 

resources and environmental services have become more alarming. While the solution to the problems of extensive growth are not simply technological, the commentary calls for a refocusing of Chinese science and technology policies to address 

the critical challenges of resource availability and environmental degradation which 

threaten the course of Chinese modernization. 

In the second installment, attention is called to the problems of indigenous innovation in China, in both industry and agriculture. Reiterating themes that have appeared in Chinese policy discussions since China’s accession to WTO, and in recent 

foreign studies of Chinese industry, the commentary bemoans the fact that domestic 

technological innovation has been disappointing, and has tended to make Chinese 

industry subordinate to global technology leaders. In the words of the commentary,

‘‘We should . . . understand that the overall size of Chinese industry, and 

the overall scale of China’s economy are big, but China’s industries’ technological level and their abilities in self dependent innovation are still low. 

. . . Chinese companies lack core technology, depend on foreign companies 

for crucial parts, are at the lower end or the middle range of the global industrial chain, rely on multinational companies for technological support 

and rely on the global sales chain. . . .’’
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1While this Chinese assessment is consistent with that of foreign observers, recent work by 

Ping Zhou and Loet Leydesdorff examining Chinese publication trends points to a notable 

growth in citations to Chinese-authored papers. Ping Zhou and Loet Leydesdorff. ‘‘The Emergence of China As a Leading Nation in Science.’’ Available at http://www.leydesdorff.net/

ChinaScience. 

To remedy this situation, the commentary calls for a strengthening of the nation’s 

research and development and the need to ‘‘. . . support enterprises in developing 

self-owned crucial technology, in creating famous brands and in improving their 

abilities in research and development.’’

The importance of industrial enterprises as centers of innovation is the theme of 

the third part of a series. China has become very interested in the problems of technological innovation in recent years and in the concept of a national system of innovation (NIS). It has undertaken extensive reforms in its R&D system in order to 

create what it believes to be a modern NIS, a defining characteristic of which is the 

central role to be played by industrial enterprises, rather than government research 

institutes (GRIs), as had been the case under the central planning system of the 

past. The development of an industrial innovation tradition, especially effective industrial R&D, in an economy which lacked such a tradition, has become a major 

challenge for reforms in science and technology. Central objectives have included extensive reforms in the GRIs and the building of R&D capabilities within Chinese 

companies, one important approach to which (which has had mixed success) has 

been the marrying of GRI and enterprise. The central message of the commentary 

is that the building of an effective national system of innovation, which will be necessary for launching China on the path to intensive growth and allow for China to 

control the technological terms of its participation in the global economy, are tasks 

of cardinal importance at the moment, and that the key to an effective NIS is to 

have industry playing the lead role. A sense of the urgency of all of this is captured 

at the end of this third part in the assertion that ‘‘The strategy for technological innovation determines the future of China’’ (emphasis added). 

Two other matters affecting China’s technological development are taken up in 

the final two parts of the commentary. In part four, the discussion turns to the importance of human resources and the effective cultivation, utilization, and rewarding 

of technical talent. The commentary notes that China’s technical community is already quite large by international standards and is growing in quality and quantity. 

It also notes the growth in output from this technical community as measured in 

publications in international journals, but also recognizes that the originality of this 

output has been disappointing and that even though the number of Chinese publications is growing, citations to them have not (‘‘. . . the number of significant original 

achievements is still small and China’s international scientific and technological 

competitiveness is still mired at the lower-middle level.’’).1 On a funding per researcher basis, the Chinese contingent of professional manpower is still supported 

at low levels by international standards and there is much that members of the 

technical community must learn about the importance of interdisciplinary cooperation in the face of exciting new research challenges which cross disciplinary and 

organizational boundaries. 

The final installment takes up an especially sensitive issue that has been a central part of technology policy debates since the initiation of the open-door policy of 

the late 1970s—the role of foreign technology in China and the consequences of 

technology transfers from abroad for the development of the domestic NIS. China 

has imported vast amounts of foreign technology over the past 20 years and this 

has contributed in no small way to the quality and rapidly increasing technological 

sophistication of Chinese exports. This technology transfer experience, though, has 

affected the NIS negatively in two ways. Unlike Japan, and later Korea, China has 

devoted considerably less energy towards assimilating foreign technology, with the 

result that the technological dependency bemoaned in part two of the commentary 

has, if anything, worsened. In addition, foreign technology has enjoyed a privileged 

position in Chinese industry relative to domestically developed technology due both 

to the often superior performance characteristics of the foreign technology, the failures of the domestic technology diffusion system, and psychological and cultural orientations reflecting the belief in the superiority of foreign technology. Whereas Chinese manufacturers have approached the use of foreign technology pragmatically, to 

improve business performance, the commentary laments the fact that there has not 

been a strong tradition of using technology imports for technological learning. As 

the commentary puts it, ‘‘we should not pay attention only to increasing manufacturing capacity and neglect technological innovation . . . the target for (technological) 

imports is innovation and the creation of new self-owned technology.’’
75

2Growing an average of 17.35% per year since 1998, China’s GERD/GDP reached 1.31% in 

2003. In 2003, China ranked 5th in the world in terms of publications catalogued by SCI, EI, 

and ISTP. Ministry of Science and Technology. 2004 STS DATA BOOK. 3These have included attempts to reform several hundred GRIs by merging them with enterprises, or by having them become enterprises themselves. There are number of indications that 

these reforms have not gone smoothly. 

Best of Times/Worst of Times? 

In spite of the People’s Daily’s laments, there is no question that there has been 

great progress in Chinese scientific and technological development. Taking advantage of an unusual 25 years of political quiescence—long by the standards of 20thcentury Chinese political history—the Chinese government has put in place a series 

of policies and reform measures which have allowed it to reconstruct the national 

innovation system into one intended to make Chinese science and technology internationally competitive during the 21st century. Over the past decade, the quality 

of higher education has improved dramatically, expenditures on research and development have been rising rapidly, and Chinese researchers have captured a notably 

increasing share of publications in international science and engineering journals.2

China’s successful entry into the world of manned space flight symbolizes the possession of a concentration of technological capabilities which have attracted international attention, and plans are in course to significantly enhance China’s profile 

as a power in science and technology by the year 2020 with the initiation of an important new 15 year science and technology development plan. While these and 

other such developments can be taken as evidence that Chinese science and technology are experiencing ‘‘the best of times,’’ anxieties and frustrations about Chinese 

technological capabilities are also growing, as alluded to above, even as the best of 

times are savored. It might be appropriate, therefore, to suggest (borrowing from 

Charles Dickens) that for China’s science and technology, these are ‘‘the best of 

times and the worst of times.’’ 

Following the People’s Daily, we can locate the source of these anxieties and frustrations in what can be described as China’s ‘‘technology trap.’’ Thus, in spite of 

progress on a number of dimensions of scientific and technological development, 

China finds itself struggling to escape from a series of enduring conditions which 

have long frustrated its hopes for indigenous technological progress. There are a 

number of indicators of the problem. China’s patenting activity is disappointing and 

it is rare that Chinese products incorporate indigenous intellectual property. Instead, China’s remarkable growth as a center of manufacturing, and its emergence 

as a significant exporter of high technology goods, have involved a dependence on 

foreign technologies which seemingly has deepened as a result of its accession to 

WTO. A number of factors contribute to this condition. 

First, the legacy of the pre-reform era has not been completely overcome. Inspired 

by the Soviet system, Chinese institutions for research and innovation were characterized by the centralization of R&D in government research institutes (GRIs), with 

little attention given to developing R&D capabilities within enterprises. In spite of 

beliefs that effective coordination between the activities of GRIs and enterprises 

could be effectuated by central planning, the organizational differences between the 

two were rarely overcome. Great efforts have been made since the beginning of the 

reform era to rectify the situation, but the results have been mixed.3

As economic reforms have taken hold, and as China has become more integrated 

with the global economy, the need for technological innovation in Chinese enterprises has risen and has created a demand for new technology in Chinese enterprises that was rarely in evidence under the old central planning system. The creation of this demand might be expected to stimulate China’s domestic R&D system 

and lead to expanded industrial research and more intimate relations between Chinese enterprises, and GRIs and universities. While there have been changes in this 

direction, as discussed further below, problems remain. 

Chinese enterprises have long tended to regard technology originating from the 

domestic research system as immature and, when available, have preferred foreign 

technology. In a number of industries, therefore, Chinese firms wind up paying substantial license fees for this know-how, payments which cut into already rather slim 

profit margins. At the same time, this bias towards foreign technology does nothing 

to stimulate the domestic research system. These interacting factors—weak enterprise R&D capabilities, relatively strong government research institutes with weak 

connections to industry, a high degree of dependence on foreign technology, and the 

unattractive terms required to pay for that technology set the conditions for China’s 

‘‘technology trap.’’ Unfortunately, market oriented enterprise responses to life in the 

trap are often characterized by the widespread pirating of intellectual property, a 

response which weakens China’s efforts to build a strong IPR regime. As a result, 
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4 Anne Stevenson-Yang and Ken DeWoskin. ‘‘China Destroys the IP Paradigm.’’ Far Eastern 

Economic Review. V. 168, #3 (March 2005). Pp. 9–18. 5 Cf., Erik Baark. ‘‘Hype and Hope: Evaluating China’s Science and Technology Future.’’ Available at http://www.axess.se/english/currentissue/themelbaark.php#top and Cong Cao. ‘‘Challenges for Technological Development in China’s Industry.’’ China Perspectives 54:4–16 (2004) 

with Albert G.Z. Hu and Gary H. Jefferson. ‘‘Science and Technology in China.’’ Unpublished 

paper prepared for the conference on ‘‘China’s Economic Transition: Origins, Mechanisms, and 

Consequences.’’ Pittsburgh, PA, November 5–7, 2004. 6 Baark reports that enterprises have become increasingly active in China’s national programs, participating in 10,000 of the 14,202 projects carried out under the six major Chinese 

research programs in 2003, including participation as prime contractor for 14% of the projects 

conducted under the 863 Program, for example. Baark. ‘‘Hype and Hope. . . .’’ 7 China’s 2003 High-Tech Industry Almanac, compiled by the National Development and Reform Commission reports a R&D/value-added ratio of 7.1% in 2002. 8Ministry of Science and Technology, various. 

the efforts of China’s indigenous innovators to lift China out of the technology trap 

are compromised by a lack of intellectual property protection, thus perpetuating the 

trap.4 Structural biases in the financial system make the funding of new ventures 

difficult, and unresolved problems in China’s social safety net also work against indigenous innovators, which also makes it difficult to escape the trap. 

The Enterprise Problem 

Efforts to make the industrial enterprise the center of the national innovation system, as in the developed capitalist countries, have been strenuous over the past decade. Understanding the consequences of those efforts, however, is not easy. The 

changing nature of industrial R&D in China, for instance, is poorly understood and 

has led to a variety of often conflicting interpretations.5 As recently as 1996, industrial enterprises accounted for only 37% of the nation’s R&D. This had risen to 60% 

in 2000, and has remained above 60% since then (it was 62.4% in 2003). While there 

is widespread agreement that there is much more innovation related activities occurring in Chinese enterprises, the extent and significance of it remains somewhat 

puzzling. The rapid rise in the share of national R&D performed by industry must 

therefore be interpreted with care. It is difficult to see how the enterprise sector of 

the national R&D accounts could change so dramatically in four years without considering the effects of the transformation of several hundred government research 

institutes into enterprises (thus counting their research activities in the ‘‘enterprise’’ 

category rather than the ‘‘government’’ category), the consequences of changing definitions of innovation related activities within enterprises as these affect the reporting of statistics, and an increase in support from government for industrial R&D.6

Problems with indigenous innovation in Chinese enterprises is also evident in considering the relatively low research intensity of Chinese firms as measured by R&D 

expenditures as a percentage of value added. Although research intensity is increasing, for Chinese high technology industries as a whole, this percentage stood at only 

4.2% in 2003 (up from 3.6% in 1999) which was notably below the average of over 

20% in selected OECD countries (22.5% in the U.S. in 2000).7 It was only in the 

aerospace industry (15.8%) that this measure of research intensity approached that 

of high tech industries in the OECD countries. The sector reporting the largest single amount of R&D expenditures, electronic and telecommunications equipment, had 

an R&D intensity of only 5.39% in 2003. When the R&D/value added measure is 

applied to Chinese industry as a whole, and not just to the high-tech sector, the percentage falls to 3.4% in 2003 (up from 2.3% in 1999, in contrast to the 8.2% in the 

U.S. in 2000).8

The discussion above indicates that the building of a strong industrial R&D tradition in Chinese enterprises will be a long-term affair. This suggests that Chinese 

firms will continue to seek new technologies from sources outside the firm, which 

implies that technologies from abroad (when available) will continue to be important, but also that relations with Chinese GRIs and universities need to be reconsidered. It is useful in this context to compare China with some of the more technologically advanced OECD countries. Increasingly, industrial enterprises in such 

countries no longer seek sources of talent and ideas for high technology and science 

based industrial innovations solely from within the boundaries of their own firms. 

Instead, with regard to research and innovation, ‘‘the boundary of the firm’’ has become quite porous with many different kinds of relationships with other centers of 

knowledge creation—other companies, government research institutes, and universities—becoming common. As we know, this ‘‘outsourcing of innovation’’ extends 

beyond national borders as well, and is one of the main characteristics of ‘‘the 

globalization of innovation.’’

We have noted above that persistent problems between Chinese enterprises and 

government research institutes and universities have been a defining feature of Chi-
77

9The Academy’s ‘‘Knowledge Innovation Program’’ over the past 6 years has strengthened and 

reoriented the work of CAS institutes in ways that will make it an especially important part 

of the changing Chinese NIS. 10Kazuyuki Motohashi and Xiao Yun. ‘‘China’s Innovation System Reform and Growing Industry and Science Linkages.’’ University of Tokyo, Research Institute of Economy Trade and 

Industry (RIETI). RIETI Discussion Paper Series 05–E–011. 11Motohashi and Yun. ‘‘China’s Innovation System. . . .’’ 12 Chen Jin. ‘‘R&D Internationalization and the Reconstruction of China’s R&D System.’’ 

Paper presented at the conference on ‘‘Globalization and China’s Development in Science and 

Technology,’’ East Asian Institute, National University of Singapore, November 5, 2004. 13For instance, as China attempts to build new science based industries, the extent and quality of its basic research will become more important. At the moment, its basic research expenditures (only about 5% of its national R&D total) are rather low in comparison with OECD countries. Although this is expected to grow towards 15–20% during the course of the 2005–2020 

planning period, there is a growing debate inside and outside of China about the effectiveness 

of China’s large national R&D spending programs for stimulating truly creative and original research. 14This subject is treated in greater depth in Richard P. Suttmeier and Yao Xiangkui. China’s 

Post-WTO Technology Policy: Standards, Software, and the Changing Nature of Techno-Nationalism. NBR Special Report. Seattle. National Bureau of Asian Research, May 2004. 

na’s ‘‘technology trap.’’ Clearly, however, incentives on both sides of the enterpriseresearch center divide have changed, and the capabilities of many GRIs (especially 

the institutes of the Chinese Academy of Sciences) 9 and universities have been notably enhanced as a result of the infusion of highly trained research staff from both 

foreign and domestic graduate programs, significant increases in funding for research, and major, modernizing institutional reforms. In addition, with such new 

policy instruments as the 1996 Technology Transfer Promotion Act and the 1998 

Regulations on Technology Transfer for GRIs, the Chinese government is encouraging new approaches to overcoming this important feature of the technology trap.10

It is thus quite possible that China’s still evolving NIS will be characterized less 

by the centrality of the enterprise than by active GRI-industry and university-industry relations. The ways in which Chinese enterprises approach the ‘‘boundary of the 

firm’’ issue and the outsourcing of research and innovation are likely to become 

increasingly important factors in the future Chinese high technology, and thus 

warrant our careful attention. Studies which have been conducted on the subject 

suggest that outsourcing to domestic research centers (GRIs and universities) is increasing,11 but so is interest in outsourcing to more scientifically and technologically 

advanced venues outside of China.12

Standards 

There are a number of other important aspects of China’s technology policy, and 

strategy for escaping the technology trap, but time and space do not permit our 

pursuing them here.13 Instead, I would like to address one particular aspect of 

technology policy in which the Commission has expressed an interest, i.e., China’s 

growing interest in technical standards.14

China’s efforts to develop a national standards strategy nicely illustrate the various influences which converge in contemporary Chinese technology policy. The 

interest in standards, in the first instance, is rooted in long-held aspirations for Chinese technology and the belief that through technological development, China can 

reclaim a position of wealth and power lost to technologically superior countries over 

the course of the past 150 years. As a great country, in this sense, China should 

of course have its own technical standards. 

The experiences of the past two decades with domestic reforms and integration 

into the international economy constitute a second source of influence. In subjecting 

Chinese industry to market forces, these experiences have illustrated the significance of technological progress for sustained market success. Along with other players in the global high technology economy, China has become intensely aware of the 

increasing importance of technical standards in corporate strategy and national industrial well-being. Its entry into the WTO is a third influence which, by facilitating 

the business operations in China of multinational corporations who often control 

standards and international standard setting, has reinforced the lesson that standards matter a great deal. In addition, though, China’s obligations under WTO include the modernization of its own domestic standards regime to bring it into 

conformity with international norms, a process still in progress. Thus, the deeper 

integration with the international economy resulting from WTO accession has both 

obligated China to redesign its own domestic standards regime, but has also provided incentives to pursue distinctive Chinese technical standards in its technology 

policy as a way of managing the increasing competition from foreign firms. Efforts 

to integrate these two objectives are now in course within the Chinese government 
78

15 Under the leadership of the Standards Administration of China (SAC), the strategy paper 

has gone through preliminary drafts (the latest being in September 2004) which have been circulated to domestic and foreign stakeholders for comment. The final draft has not yet been made 

public. 16 China’s effort to establish WAPI (Wireless Authentication and Privacy Infrastructure) 

standard in 2004 led to a major dispute with its international partners which led to a remarkable government-industry ‘‘stop WAPI’’ coalition in the U.S. and to the escalation of the issue 

into a matter of high diplomacy reaching the Vice President’s office. Although the Chinese government eventually relaxed its position, and thus avoided even more serious conflict, the WAPI 

story continues to unfold. 

as it prepares the final draft of a Chinese standards strategy document.15 As we 

try to interpret the challenges posed by China’s use of standards in technology policy, it will be useful to keep in mind the following points: 

—Motivations. In devising a national standards strategy, the Chinese have had 

to reconcile a variety of considerations stemming from the different functions 

of standards in modern societies and a diversity of motivations at work as we 

move from standard to standard and technology to technology. For instance, 

with regard to technical standards in particular, these include concerns over information security—evident, for instance, in the controversial WAPI case 16 and 

in the promotion of Linux based alternatives to Windows—while economic considerations figure more prominently in other cases, especially in consumer electronics. As noted in the People’s Daily series cited above, China is unhappy with 

the royalties its firms must pay for licensing technologies and the impact these 

have on profits. Unhappiness vis-a`-vis specific products is reflected in a broader 

dissatisfaction with the relative gains coming to China from its participation in 

the global economy as a result of its position in the value chains of various industries. In other cases, finding standards that make possible technologies 

which are more congenial to Chinese language, cultural preferences and tastes 

may be an issue. More generally, China’s growing technological capability, and 

the belief that it is now in a much better position, technologically, to set standards, motivates standard setting initiatives, and resonates nicely with a deeper 

techno-nationalism which has its roots in modern Chinese history. We should 

recognize, therefore, that within a still inchoate, vaguely defined national standards strategy, there is no single motivation which drives standards development 

in all technologies. —Puzzles. The incorporation of a standards strategy into Chinese technology policy warrants our close attention, and the WAPI case certainly elicited it. However, WAPI may not be typical of Chinese standards initiatives and it, along 

with the strategy as a whole, present us with a series of puzzles about China’s 

approach to standards. In the first instance, China’s standards system is still 

quite new, as is interest in using standards as a technology policy tool. The 

game of standards, thus, is a new one for China, and there are a number of 

signs that neither the rules, nor the skills needed for winning, are entirely 

clear. While there is a growing confidence in China’s ability to set standards, 

it remains to be seen whether China has the capabilities, technologically, to set 

standards which will be winning on performance grounds. This then points to 

a second, but related puzzle—that of the role of market power in Chinese thinking. While appeals to market power might compensate for technological deficiencies, they also carry their own uncertainties. Foreign observers remain 

puzzled whether China is mainly interested in establishing Chinese standards 

for the Chinese market, or whether it wants to use Chinese standards in the 

Chinese market in order to lead to the propagation of Chinese standards in 

international markets. There is clearly a danger, in spite of China’s market size, 

that the promotion of standards for the Chinese market, without due regard to 

international markets, runs the risk of reducing the relevance of Chinese standards internationally. 

—Actors. A third puzzle, again, relating to the consistency of motivations at work 

concerns the variety of actors involved in the standards strategy and the diverse 

sources of initiatives for standard setting. Among these actors are government 

agencies, government research institutes, Chinese companies and industrial associations (as well as players from the international community) and it sometimes appears that there is no simple or consistent identity of interest among 

them making the harmonization of preferences on standards initiatives quite 

difficult. For some Chinese companies, for instance, financial success has been 

found by working within an architecture of standards that has already been established internationally. New government supported initiatives for distinctive 

Chinese standards may not be welcomed by such firms. Even within govern-
79

17 Interviews with Chinese familiar with the WAPI case, for instance, reveal that there is 

considerable dissatisfaction with WAPI, technologically, and in terms of advancing Chinese 

standards, many feel that it was the wrong case for testing the standards strategy which was 

promoted in the wrong way. 18The U.S. has become more active in addressing the challenges posed by Chinese approaches 

to standards (seen as one of the most serious market access questions faced by U.S. exporters). 

In August 2004, the U.S. and Chinese governments sponsored a large workshop in Beijing on 

standards and conformity assessment (and a follow-on meeting is planned for this year). American standards organizations, working through the American National Standards Institute 

(ANSI) have now established a presence in Beijing, and ANSI is considering a formal representative office in the Chinese capital. In addition, the Foreign Commercial Service will be posting 

a standards attache ́ to the U.S. Embassy in China. 

ment, there are signs that different ministries, or parts of ministries, may have 

rather different views on the desirability of promoting particular standards. 

Hence, if pursued without finesse, a national standards strategy could increase 

domestic policy conflict, and could actually retard technological development.17

A lack of finesse, as seen in the WAPI case, can also induce conflict internationally leading to significant costs and an interruption of technological progress. 

—Foreign Participation. Another curiosity about the current state of China’s efforts to promote a national standards strategy is the role to be played by MNCs. 

Foreign companies, in general, have not been happy with the access they

have been given to Chinese standard setting forums, and continue to lobby for 

greater participation and transparency from the Chinese. That said, MNCs have 

been active players in helping to provide technology for Chinese standards development; the role of Siemans in the development of TD CDMA comes readily 

to mind. More generally, in most of the more prominent cases of Chinese standards initiatives, foreign know-how has been an important component in the 

development of the Chinese standard. Indeed, in spite of the suggestion of 

techno-nationalist motivations which are evident in some cases, overall, Chinese 

standard setting initiatives provide further evidence that technological development is increasingly an international, if not global, exercise, and that a narrow 

techno-nationalism is likely to be self-defeating. This is a lesson which many—

though not all—leaders of the Chinese technology policy community understand 

quite well. 

—Implementation and Institutional Models. Another series of interesting questions turn on Chinese strategies for implementing standards. Among these is 

the extent to which China will embrace market driven approaches to standard 

setting as opposed to the setting of standards by government, or by formal 

standards bodies. This question is closely related to the very important issue 

of whether European approaches to standards, more closely associated with the 

latter approaches, will have greater influence with the Chinese than U.S. approaches (favoring market forces and action through voluntary associations). 

Europe has been actively working with China to promote its vision of a standards regime, and although the U.S. has also taken initiatives with China for 

bilateral cooperation, intending in part to promote the U.S. vision, its efforts 

may require additional resources.18 Implementation issues also extend to 

whether China’s regulatory capacity and ability to enforce standards is sufficiently developed. Such questions all suggest that China’s standards strategy 

faces many uncertainties and is not necessarily guaranteed success. 

—The Challenge. Nevertheless, there is no doubt that China is quite serious about 

developing a standards strategy and is committed to becoming an important 

player in standard setting. It brings to this commitment a growing technological 

sophistication, considerable market size and thus market power for promoting 

its standards, and a variety of cultural preferences which are also likely to help 

shape an indigenous standard setting tradition. As the discussion above indicates, however, China is considerably less monolithic in the pursuit of its standards strategy than its initial stance on WAPI might have suggested. Ongoing 

engagement with China on standards, therefore, is not only possible but will be 

both necessary and desirable. The transitional nature of China’s standards regime suggest that there are still a variety of ways in which the evolution of that 

regime can be shaped through various forms of cooperation and dialogue. Denying visas to Chinese technical personnel who plan to attend standards meeting 

in the U.S. is not one of them.

It will be very important for the U.S. Government and the U.S. corporate sector 

to monitor trends in the Chinese standards scene and deepen their analyses of those 

trends. This will require, in particular, that we differentiate among cases, that there 

be understanding of who the actors are in different cases and what their motiva-
80

19For a fuller account, see Richard P. Suttmeier. ‘‘Science and Technology: A New World in 

the Making?’’ In Ashley Tellis and Michael Wills (eds.). Strategic Asia 2004–05: Confronting Terrorism in the Pursuit of Power. Seattle. The National Bureau of Asian Research. 2004. 

tions might be. It is especially important to understand the underlying organizational interests and politics involved, as well as underlying economics of the cases. 

The U.S. should be supportive of the development of more market oriented standard 

setting and internationalist, or techno-globalist, orientations in China, and should 

strive to make WTO provisions with regard to standards more robust in the Chinese 

setting. An especially important target of activities may be the formative cultures 

of China’s emerging industrial associations. 

Given the fact that China will be playing an increasingly important role in the 

corporate technology strategies of American corporations, it is important for the 

public and private sectors in the U.S. to cooperate in engaging China on standards 

and to develop an informed and deft approach which recognizes China’s long-term 

commitment to becoming influential in technical standard setting and the many 

problems and uncertainties it faces in pursuing that commitment. There is considerable potential for a misguided strategy, and misguided responses to that strategy, 

and thus for costly economic conflicts and technological frustrations and dead ends. 

A degree of wisdom will be required on all sides. 

Conclusion 

Over much of the past 25 years, China has attempted to enhance its technological 

capabilities by relying heavily on technology transfers from abroad while slowly reforming and improving its domestic institutions for research and higher education. 

As entry into the WTO loomed larger in the late 1990s, the Chinese realized that 

much more attention would have to be given to domestic research and indigenous 

innovation; following WTO accession, Chinese enterprises would face considerably 

stronger competition from MNCs; MNCs reluctance to transfer more advanced technology would increase; and China would be forced to give up policy tools used in 

the past to encourage, if not coerce, MNC technology transfers as a cost of doing 

business in China. Faced with these contingencies, China began to take the task 

of building its national innovation system much more seriously and initiated a series of policies to support that effort, including a significant expansion of R&D 

spending, a series of measures to move the enterprise sector to the center of the 

NIS, and the promotion of a technical standards strategy. 

While many of these initiatives have been successful, a careful look at them also 

reveals a number of problems—many clearly related to the inherent limitations of 

a national system of innovation in an age characterized by the global production of 

knowledge and innovation. We should therefore not become excessively alarmed at 

the more techno-nationalist themes associated with the building of a Chinese NIS, 

nor taken in by facile accounts of China as a rising technological superpower. In 

this connection, it is instructive to recall the many voices in the 1980s warning of 

a rising East Asian techno-nationalist power and of a coming Japanese technological 

domination, to ask why so many of these voices were wrong in such important ways, 

and to reflect on why so many of us seemed to want to believe their message. 

Clearly, there are ample indications that Chinese scientific and technological capabilities are improving, and in some cases improving rapidly. China does loom 

large in the emerging world of science based industries, a world in which knowledge 

production in such fields as information technology, biotechnology, and nanotechnology is both globally distributed and concentrated in local innovation clusters.19 U.S. companies, U.S. universities, and many agencies of the U.S. Government have already recognized this fact and have incorporated ‘‘the China factor’’ 

into their institutional plans and objectives. Unfortunately, U.S. public policy has 

at times reflected a serious misinterpretation of this ‘‘new world in the making’’ and 

China’s role in it. As a result, we may be seeing a worrisome growing divergence 

between a public policy orientation shaped by those in Congress, in the Administration, and in certain advocacy groups having a deep distrust of China and the increasingly intimate relations with China in science and technology being pursued 

by U.S. firms, institutions of higher education, and government technical agencies 

who have identified China’s role in this new world as critical for their own futures. 

China’s efforts to promote scientific and technological development inescapably 

touch upon the economy-security nexus which is the concern of this Commission. 

The Commission is to be congratulated for taking this subject seriously and for convening this hearing. As we go forward, we will be forced to rethink our relations 

with China in science and technology, and the starting point for this must be an 

accurate assessment of Chinese capabilities and intentions vis-a`-vis its science and 

technology. As the discussion above points out, and as the expert literature on the 
81

subject of Chinese technological development makes clear, there are many puzzles 

and contradictions shaping China’s emergence as a country with internationally recognized scientific and technological capabilities, and many inconsistencies in trying 

to discern its intentions. A major study now underway at the University of Oregon 

with support from the NSF, (see, http://darkwing.uoregon.edu/∼xyao/USlChina/

index.html) seeks to better understand these puzzles and their implications for the 

role of science and technology in U.S.-China relations. I invite the Commission to 

avail itself of this work and to call upon us if we can be of service. It is terribly 

important that we get the story of China’s scientific and technological development 

right. Assessments of the security implications of this story which overlook its puzzles, contradictions, and inconsistencies, and which reject justifiable nuances, can 

become highly misleading and detrimental to long-term U.S. interests. 

Thank you.

Chairman D’AMATO. Thank you, Dr. Suttmeier. 

Dr. Pillsbury. 

STATEMENT OF MICHAEL PILLSBURY, SENIOR FELLOW

ATLANTIC COUNCIL OF THE UNITED STATES

ASSOCIATE FELLOW, INSTITUTE FOR NATIONAL STRATEGIC STUDIES

NATIONAL DEFENSE UNIVERSITY, WASHINGTON, DC 

Dr. PILLSBURY. Members of the Commission, I have been in and 

out of the Defense Department for 30 years and so what I say 

today has got nothing to do with any affiliation I have with the Defense Department or any part of the U.S. Government. I’m just 

going to give you the results of a research project done for the Commission that really had six topics to examine. 

The first one was the statement by Chinese leaders in the past 

six months or so about their national strategy for innovation in 

science and technology. I want to contrast what they say with the 

American approach. 

The American approach to science and technology I think is what 

Secretary Perry said, it was part of the Defense Department’s business. Companies benefited from that, but I don’t think you can find 

any statement from any American president that’s anything like 

the Chinese leadership has been saying for the past 25 years, in 

particular the past year. 

The Chinese statements say: The source, the primary source of 

economic growth and national strength is science-and-technology 

policy. You cannot find that in any American White House collection of documents. It’s not our strategy. We like science and technology. We spend a lot of money on it, but no one anywhere that 

I know of says in a kind of almost religious matter these are members of the Communist Party who have certain views on religion 

and what moves history, and they’re saying to each other: Chairman Mao, Mao Zedong had it wrong. He did not see science and 

technology as the primary force of production and national 

strength; Deng Xiaoping did. 

Now the current president of China’s best university some would 

say, Tsinghua, has taken it one step further. He and his prime 

minister in the past six months to a year have been repeating 

something new about innovation: Our national strategy is based on 

innovation here in China. We must not be tail-chasers. We must 

innovate at home. 

Now this is serious. When a Communist Party chairman says to 

a country of 1.3 billion, ‘‘This is our new national strategy,’’ pardon 

my saying this—it’s not like a Member of the House of Representatives making a speech back home during recess, it’s very serious. 
82

So section 2 was: What does this mean? Because if this has been 

China’s strategy for 25 years we ought to see something by now, 

and they ought to be very proud of it. So I did a search of the Chinese press for their claims for their biggest accomplishments in 

science and technology in the last year. I list 16 of those you. And 

I would ask you, especially those of you who are like I am, I was 

a beneficiary of the National Science Foundation Dissertation 

Grant Program and also the Sputnik shock, of course, caused a new 

program called the National Defense Education Act, which was responsible for my Ph.D., so I should be very pro science and, in fact, 

I am. I have been bought by the National Science Foundation you 

might say. I benefited from the Sputnik shot. 

So as I read through these 16 accomplishments I called friends 

of mine in the scientific community to say, ‘‘Is this something impressive or is this just nothing new?’’ I don’t think I have time to 

read all 16 to you, but I encourage you to go through some of these 

things. 

It is not easy to have cloning technology to produce a live buffalo; 

the Chinese just did it. It’s not easy to have a supercomputer that 

operates at one teraflop, that is one trillion calculations per second. 

The fastest one is in Japan at 36. We have one at about 36. They 

now claim that they can scale up the new one that they’ve just 

begun operating in Shanghai to 50, and perhaps higher to 64. Is 

this something new and startling? My friends in the computer community say, ‘‘We never imagined China would do this 20 years ago.’’

There’s something, I won’t bore you, but it’s called the amino 

chip nanogram detector for Staphylococcus enterotoxins. The Chinese Academy of Military Medicine has one of these in operation. 

It is going to improve it even more. It’s a great thing, frankly. It 

helps detect things that should not be allowed into your borders. 

I’m not saying it’s a bad thing, but it’s impressive. It’s state of the 

art. 

There’s something called ‘‘pebble-bed reactor technology.’’ It 

means to have your nuclear fuel inside a graphite ball so there cannot be a meltdown. It can change the safety of nuclear reactor design so that nuclear power becomes feasible once again. We haven’t 

built any, as you know, in America for 35 years. Not one reactor 

built here for 35 years. The Chinese just announced that they want 

to build 40 reactors, and the implication is, using this technology, 

which is being developed in a military area just outside of 

Tsinghua University. 

They’re quite proud of this. Other countries are seeking to work 

with China to obtain access to pebble-bed nuclear reactor technology. 

Taiwan just opened up its first tailor design center in Shanghai 

for circuits, after having said, in fact, to this Commission that it 

would not do so. And this is one of many design centers being 

opened up in the Shanghai area. 

The Pentium-equivalent chip that China is claiming is going to 

be patented in China so they will no longer have to pay any fees 

for a computer chip technology that goes into PCs. They announced 

this just quite recently. They are modest. They say it’s only Pentium III quality, but the key point it’s the claim for the patent that 

it’s Chinese-owned intellectual property. 
83

The mini satellite project and the announcement that 100 satellites will be launched by 2020. Packetized optical switching at 

10,000 times the current rate, in cooperation with Fujitsu, using 

nanotechnology. I gave four examples in here of joint projects with 

Japan in the area of nanotechnology that the Chinese have announced. 

By the way, when these announcements are made the Politburo 

usually shows up, or some of them do. They give a national science 

and technology award. What’s rather amusing to me is the PLA 

Central Military Commission also shows up. Pictures are taken. It 

would be like the Secretary of Defense and the President and Vice 

President Cheney and the leadership of the Congress all getting together to award prizes every year for innovation. Actually it’s not 

a bad idea. There’s quite a few things the Chinese do that are not 

bad ideas for us to copy, including these massive tax breaks for 

R&D. 

Particle accelerator joint research. Okay. New router for the 

Internet—won’t go into this. 

I then say to you, Mr. Commissioners and Madam Commissioners, do you want to ask the National Science Foundation, the 

White House Office on Science and Technology Policy, others who 

study foreign science, others who study foreign science in our executive branch to give you a new assessment on the rapidity of Chinese progress? Because if you do I suggest 20 indicators that have 

not been looked at before that might provide a finer-grained analysis of just how dramatically improving the Chinese are, the operation is, especially in the last year or two. So that when you hear 

someone say, ‘‘Oh, the last five years,’’ ‘‘Oh, the last ten years,’’ 

you’ve got to immediately think to yourself—this gets into my final 

point about the old paradigm versus the new paradigm on the 

progress of Chinese science and technology. 

The old paradigm is still the dominant paradigm. And I quote to 

you in my executive summary from the current issue of The Economist. The Economist starts out, its article on China, talking about 

800 million people living in poverty. You have to understand all 

this, they say, to understand the future of China, and that China’s 

leaders only dream of joining the ranks of the world’s leading 

economies. 

The image of China we’ve had for 30 years under what I call the 

old paradigm is: They are poor, they are backward. Sometimes it 

eases into racism: They’re not very bright. Yes, they can learn if 

we show them how and we, nice white boys go over there and teach 

them something, but they really can’t ever innovate on their own. 

There are about ten points of the old paradigm. 

The old paradigm also has a national security angle to it, which 

is that China is our friend. More than our friend, our quasi-ally, 

is the term often used. Now when I was an undergraduate 200 

yards from here in the ’60s, I remember reading speeches by Secretary of State Dean Rusk that China was basically the greatest 

threat to the world and that we should all go to Vietnam, we undergraduates at Stanford should all go to Vietnam and fight—and 

he actually was quite explicit—to stop the expansion of Chinese 

communist power into Southeast Asia. China was considered 

crazier than the Soviet Union, if not as powerful. 
84

A little bit later in the ’70s and ’80s we transformed ourselves 

from that paradigm, China as the greatest enemy, to China as our 

quasi-ally. And the DOD, frankly, and I’m sorry to say, in many 

ways I was there, took the lead. The DOD provided China technology of an extremely sensitive nature beginning when Dr. Kissinger offered it in 1973 in a meeting that was only declassified a 

few months ago. Early warning technology and improvement of 

their radar and linkages to our satellite-detection system was offered in 1973. 

By the time Secretary Perry was Undersecretary we were doing 

surveys of just exactly how we could help the Chinese military 

technology base the quickest and the best. 

In the ’80s one of your Commissioners was involved in this, I believe. In the ’80s Ronald Reagan, who we all know is seen as a conservative against communism, Ronald Reagan approved six weapon 

systems for sale to China. There was a vote on one of them in 1986. 

Only one senator voted against. Only one Senator voted against the 

transfer of a program to upgrade the Chinese fighter system, fighter aircraft. It was Jesse Helms. He still believed in the old paradigm, that we shouldn’t help Chinese defense technology. 

So then in those days: Poor, backward, and a quasi-ally. Now I 

would submit to you we may be getting into a period where there’s 

another paradigm beginning to take shape. We’re hearing about it 

from Silicon Valley and from the Japanese and from the Indians. 

But we Americans, generally speaking, especially our China expert 

community, I would submit, are still stuck in the old paradigm: It’s 

a poor, backward, friendly quasi-ally, and therefore any discussions 

of improving our own science education programs, improving the 

NSF budget, all the list you heard about in the first panel, most 

American China experts would think ‘‘What’s that got to do with 

China? They’re not a challenge. They’re not a reason to be cited for 

this.’’

So it’s kind of sad that China is going to deny us a Sputnik kind 

of shock that, according to President Bush’s Science Advisory in 

Colorado, in February of this year, I put his speech in here, he puts 

up figures of what caused the rise and fall of U.S. science budget 

funding over a 50-year period, and he makes the point, quoting another person’s paper he says, but he agrees with it he says, he 

makes the point that it’s external factors outside the community of 

scientists that determine budget increases and improvements in 

our ecosystem of scientific innovation. We need challenges from the 

outside. We need a tail chaser who is ruthless closing in on us and 

threatens to surpass us. And according to the old paradigm we certainly don’t have that in China. 

Thank you. 

Chairman D’AMATO. Thank you, Dr. Pillsbury. 

Dr. Simon. 

STATEMENT OF DENIS FRED SIMON

PROVOST AND VICE PRESIDENT FOR ACADEMIC AFFAIRS

LEVIN GRADUATE INSTITUTE OF

INTERNATIONAL RELATIONS AND COMMERCE

STATE UNIVERSITY OF NEW YORK, ALBANY, NEW YORK 

Dr. SIMON. Good morning. I also want to thank the Commission 

for organizing this panel and also for focusing on the issue of Chi-
85

nese science-and-technology development. I believe it’s one that has 

not been given sufficient attention. Today, I’d like to excerpt part 

of my remarks to you as a way to hopefully generate an interesting 

discussion about where, indeed, China is headed. 

China’s emergence as an increasing significant player in the 

global economic and technology system raises a number of important challenges for the United States. These challenges stem from 

the fact that the rapid changes occurring in China’s international 

role are part of a broader set of fundamental changes in the structure and operation of the world science-and-technology system, 

engendered in large part, by the onset of the process of globalization. 

Since the last decade of the twentieth century no less than five 

major continental-size economies have expanded their participation 

and deepened the nature of their involvement in the international 

economic and science-and-technology systems: China, India, Russia, 

Mexico, and Brazil. Add to this mix, the growing technological capabilities of the so-called four Asian tigers plus Japan, and we 

must recognize that the world science-and-technology order is already in the midst of a paradigm change of immense consequences 

for our country. 

Simply stated, there is no turning back the clock insofar as the 

evolving landscape of global economic and technology affairs is concerned. As new competing centers of technological excellence 

emerge, the U.S. will no longer be the sole or even leading rule 

maker or trendsetter in everything ranging from scientific breakthroughs to the setting of technical standards. 

Accordingly, it is incumbent upon the United States—the business, academic, and government communities, to take stock of the 

features of this new playing field, to alter many of our existing operating assumptions about key success factors, and to prepare ourselves for a world of more intense competition and perhaps greater 

turbulence in the coming decades. 

Just as we have witnessed important changes associated with 

the globalization of product and capital markets, we are also witnessing critical changes associated with the globalization of technology. Technological advance has been upgraded to a national priority among many countries. New centers of pronounced technological capability have started to appear outside the United States, 

Europe, and Japan. As the world’s leading multinational firms seek 

to take greater advantage of critical knowledge and skill complementarities that now exist across a range of different economies, 

the processes of technological exploration and exploitation have become further globalized. 

In many instances globalization has led to more rapid movement 

of technology know-how overseas at an earlier point in their socalled lifecycle. The new core competency for success in this demanding environment of technological globalization is the ability to 

identify, harness, and manage the forces for transborder innovation 

and technological advance. The hallmark of competitive advantage 

in a world of globalization is knowing how to link and leverage 

knowledge, information, and people expertise across borders and 

cultures. 
86

At the forefront of the changes associated with globalization 

stands China, a nation whose political leaders and technical community have placed great faith in the development of science and 

technology as a tool to enhance their country’s modernization and 

international role. China’s growing technological prowess has become an increasingly important catalyst in the evolving reconfiguration of the world’s manufacturing and knowledge networks. 

Currently the most critical manifestations of China’s technological advance lie in the steady quality improvements that already 

have occurred with regard to the country’s human resource base 

and its physical infrastructure. In short order, the payoffs from ongoing economic reforms and structural change in the science-andtechnology system are likely to be more consistently realized as 

well, thus further drawing China into the mainstream of international science-and-technology competition and cooperation. 

I would argue that the key issue for the United States regarding 

China’s technological advance has less to do with how to respond 

to a potential Chinese technological threat or how to deal with 

China as a possible competitive adversary, and much more to do 

with how we engage China as a strategy partner in a world where 

scientific progress and technological advance are no longer simply 

within the purview of one nation. 

More specifically, the real questions are: First, whether as a 

country we can truly grasp, in both political and technological 

terms, and take advantage of the unique opportunities for our 

country and the world, that derive from the emergence of a more 

technologically capable China. 

And, second, whether we have the political will and the commitment to prepare, educate, and train enough people, senior and junior professionals, in science, engineering, and management, who 

can interact and work effectively across borders and cultures with 

their Chinese counterparts. Our strategic goal as a nation vis-a`-vis 

China should be to capture potential technological synergies, take 

advantage of evolving scientific and technological complementarities, and collaborate successfully to push out the frontiers of 

science and the boundaries of technology for the mutual benefit of 

American and Chinese citizens. 

China’s leadership sees ongoing progress in science and technology as critical to addressing three of the most important policy 

problems facing their country: China’s in the global economy, national security, and the creation of the conditions of a sustainable 

development model. 

It is clear to me that China has entered an important watershed 

period in terms of the operation and performance of its science-andtechnology system. After two decades of structural reform that 

began under Deng Xiaoping, the Chinese science-and-technology 

system is positioned for an important takeoff. The question is no 

longer if this will happen but, rather, when. 

The evidence for suggesting that China has reached such an important milestone comes from a broad array of data points across 

the Chinese science-and-technology system. First and foremost, it’s 

apparent that the inputs contributing to the formulation and implementation of science-and-technology policy in China have become more sophisticated and globally oriented. 
87

China is now focused on creating and perfecting a fully integrated national system of innovation with the goal of bridging together those critical components needed to enhance the overall 

yield from growing investments by government and industry in research and development. Overall R&D expenditures have now 

reached 1.3 percent of GDP, reflecting a rapid acceleration in 

spending on R&D over the last five years. 

China is now the third largest R&D spender in the world, trailing only the United States and Japan. And while there are still 

considerable differences in the magnitude of spending on R&D between China and the U.S., it should be realized that increases in 

science-and-technology spending have grown faster than the 

growth of the overall Chinese economy. 

Of course, we must be careful not to mistake quantitative growth 

with qualitative improvements, as large components of the Chinese 

science-and-technology system still remain inefficient and ineffective users of some of these available funds. 

Second, China is engineering the formation of a new technological architecture, one that is helping to redefine the rules, structures, and standards that have been in place over the last several 

decades. This does not mean that government has disappeared 

from the science-and-technology landscape. The most compelling 

example of continued government leadership is embodied in the 

State Council Document Number 18 which was issued in mid-2000 

and recently revised, which continues to provide direction for the 

growth of the software and semiconductor industries. 

Nonetheless, like a gradual but steady volcanic eruption, the old 

elements of the planned Soviet-style system are now progressively 

being pushed aside as the core features of a new science-and-technology system emerge. 

Third, there has been appreciable improvement in the Chinese 

university sector. Not only has the system grown in terms of its capacity, only a few years ago only three to four percent of high 

school graduates could enter university. Today that number has 

jumped to approximately 17 percent. China now graduates more IT 

engineers than India, some 350,000, compared to India’s 300,000 

and about 50-to-60,000 in the United States. 

Major investments by universities have been made in new 

equipment and related resources, and the problems of nepotism

and faculty inbreeding are being attacked as the Chinese take on

the challenge of creating a number of truly world-class universities. 

Finally, and most relevant for purposes of this hearing, China 

has stepped up its interests in the further internationalization of 

its science-and-technology system. Most profound are those developments on the commercial side of the equation. China continues 

to have a voracious appetite for acquiring foreign technology. And, 

as noted by Business Week, unlike Japan there is no ‘‘not invented 

here’’ syndrome in the PRC. 

Estimates today now are that there are well over 600 foreign 

R&D centers—I recently heard someone say 750—with the number 

increasing steadily every six months. 

We must remember that it was not too far in the past when 

many foreign firms remained skittish about doing business in 
88

China and were skeptical about the staying power of China’s reform program. Today, however, that situation has changed. China 

is now deeply embedded in the framework of global business and 

commerce. And, those companies striving to position themselves 

globally will not be successful unless they have a significant presence in China; not simply in manufacturing and marketing but increasingly, as suggested, in research and development. 

Let me make a couple comments about the growth of foreign 

R&D in China for us to better understand what’s actually taking 

place. 

Like many other critical transitions in Chinese economic modernization drive, the growing role of foreign R&D is being driving 

by a confluence of government and market forces. First, as indicated, the Chinese government has emphasized the importance of 

strengthening the country’s technology base. And, in April 2000 

new regulations to formally establish foreign R&D centers in China 

were issued by MOFCOM, formerly MOFTEC. In 2002, MOFTEC’s 

foreign investment legislation was also modified to change R&D activity from a ‘‘permitted’’ to an ‘‘encouraged’’ form of foreign investment, which made it eligible for all of these different kinds of incentives we’ve heard about this morning. 

Chairman D’AMATO. Please summarize. 

Dr. SIMON. Okay. Let me look at the implications for the United 

States then. 

Coming to a better understanding of the prospects for future Chinese scientific-and-technological development is of considerable importance for evaluating and managing the consequences of China’s 

political, economic, and technological evolution in the coming decades. 

Globalization, complemented by economic reforms, has changed 

the playing field for China. The Chinese leadership, once seemingly 

daunted by the forces of interdependence and globalization, now 

see enhanced opportunities for China to gain unencumbered access 

to advance technology and know-how. Thinking about Chinese behavior in terms of tension between the forces of techno-nationalism 

and techno-globalism actually creates a false and somewhat inaccurate dichotomy for understanding China’s current international 

orientation. These two seemingly contradictory constructs are really part of the same behavior, with techno-nationalism and technoglobalism intertwined in a single synergistic relationship with one 

another. 

The United States Government must take a new look at the tremendous opportunities to be derived from Chinese scientific 

progress and technological advance, and work to enhance our ability to tap into the steadily growing and improving human resource 

and technological assets in China, from universities to government 

think tanks to new technological enterprises. In the final analysis, 

only by pursuing this path will we help to enhance our own country’s innovative potential. 

Thank you. 

[The statement follows:]
89

Prepared Statement of Denis Fred Simon

Provost and Vice President for Academic Affairs

Levin Graduate Institute of International Relations and Commerce

State University of New York, Albany, New York

Overview 

I would like to thank the Commission for organizing this special hearing and for 

taking up the issue of China’s technological development. China’s emergence as an 

increasingly significant player in global economic and technology affairs raises a 

number of important challenges for the United States. These challenges stem from 

the fact that the rapid changes occurring in China’s international role are part of 

a broader set of fundamental changes in the structure and operation of the world’s 

S&T system—engendered, in large part, by the onset of the process of globalization. 

Since the last decade of the 20th century, no less than five major continental-size 

economies have expanded their level of participation and deepened the nature of 

their involvement in international economic and S&T affairs—China, India, Russia, 

Mexico, and Brazil. Add to this mix the growing technological capabilities of the socalled ‘‘Asian four tigers’’—South Korea, Taiwan, Hong Kong, and Singapore, plus 

Japan, and we must recognize that the world’s S&T order is already in the midst 

of a paradigm change of immense consequences for our country. Simply stated, there 

is no turning back the clock insofar as the evolving landscape of global economic 

and technology affairs is concerned; as new competing centers of technological excellence emerge, the U.S. will no longer be the sole or even the leading ‘‘rulemaker’’ 

or trend-setter in everything ranging from scientific breakthroughs to the setting of 

technical standards. Accordingly, it is incumbent upon the U.S.—the business, academic and government communities—to take stock of the features of this new playing field, to alter many of our existing operating assumptions about key success factors, and to prepare ourselves for a world of more intense competition and perhaps 

greater turbulence in the coming decades. 

Just as we have witnessed important changes associated with the globalization of 

product and capital markets, we also are experiencing critical changes associated 

with the globalization of technology. Generally speaking, there is a more general 

awareness around the globe today regarding the strategic role of technology in driving both economic progress and international competition. In fact, technological advance has been upgraded to a national priority among many countries. Facilitated 

by the revolution in communications and transportation, the liberalization of economic and trade policies, and a combination of both increased domestic and foreign 

investment, new centers of pronounced technological capability have started to 

appear outside of the U.S., Europe and Japan. As the world’s leading multinational firms seek to take greater advantage of critical knowledge and skill complementarities that now exist across a range of different economies, the processes of 

technological exploration and exploitation have become further globalized. In many 

instances, globalization has led to the more rapid movement of technology and 

know-how overseas at an earlier point in their so-called life cycle. The new core competency for success in this demanding environment of technological globalization is 

the ability to identify, harness and manage the forces for transborder innovation 

and technological advance. This holds true for universities as well as the commercial 

world. As Ghoshal and Bartlett have demonstrated in their seminal book Transnational Management (McGraw Hill), the hallmark of competitive advantage in a 

world of globalization, is knowing how to link and leverage knowledge, information 

and people expertise across borders and cultures. 

According to a business survey published in September 2004 by the Economist

among 104 senior executives from the world’s leading multinational corporations 

(Scattering the Seeds of Invention: The Globalization of Research and Development), 

52% of the firms indicated they had plans to expand their overseas R&D activities 

over the next three years. The most crucial imperative among multinational firms 

is to shorten the time it takes to commercialize new innovations. The key to success, 

in this regard, is fully mining the global talent pool, which involves effectively tapping into ‘‘the new centers of scientific and technical excellence that are mushrooming around the world.’’ In fact, it might not be too far fetched to suggest that, 

somewhat akin to the patent wars of the 1980s and 1990s, the United States is 

about to find itself in the midst of a global war for talent. Interestingly, in this regard, China was named the top destination for future R&D growth among 39% of 

those interviewed, closely followed by the U.S. (29%) and India (28%). 

As indicated above, at the forefront of the changes associated with globalization 

stands China, a nation whose political leaders and technical community have placed 

great faith in the development of science and technology as a tool to enhance their 

country’s modernization and international role. China’s growing technological prow-
90

ess has become an increasingly important catalyst in the evolving re-configuration 

of the world’s manufacturing and knowledge networks. Cities such as Dalian, for example, are now being touted as emerging centers of excellence for providing software services for both regional and global markets. Currently, the most critical 

manifestations of China’s technological advance lie in the steady quality improvements that already have occurred with regard to the country’s human resource base 

and its physical infrastructure. In short order, the payoffs from ongoing economic 

reforms and structural change in the S&T system are likely to be more consistently 

realized as well, thus further drawing China into the mainstream of international 

S&T competition and cooperation. I would argue that the key issue for the United 

States regarding China’s technological advance has less to do with how to respond 

to a potential Chinese technological threat or how to deal with China as a possible 

competitive adversary, and more to do with how we engage China as a strategic 

partner in a world where scientific progress and technological advance are no longer 

simply within the purview of one nation. More specifically, the real questions are 

first, whether, as a country, we can truly grasp—in both political and technological 

terms—and take advantage of the unique opportunities for our country and the 

world that derive from the emergence of more technologically capable China; and 

second, whether we have the political will and commitment to prepare, educate and 

train ample numbers of junior and senior professionals—scientists, engineers, and 

managers—who can interact and work effectively across borders and cultures with 

their Chinese counterparts. Our strategic goal as a nation vis-a`-vis China should be 

to capture potential technological synergies, take advantage of evolving scientific 

and technological complementarities, and collaborate successfully to push out the 

frontiers of science and the boundaries of technology for the mutual benefit of American and Chinese citizens as well as the rest of humankind. 

Stocktaking of Science and Technology in China 

To understand China’s growing role in global science and technology affairs, it is 

essential to appreciate a number of the critical changes that have taken place across 

the Chinese S&T system over the last 5–10 years. The decision of many foreign companies to establish substantial R&D centers in China is closely linked to the recent 

evidence of progress in a number of key areas. 

China’s leadership sees ongoing progress in science and technology as critical to 

addressing three of the most important policy problems facing the country: national 

security, competitive success in the global economy, and the creation of the conditions for ecologically sustainable development. As someone who has been working 

professionally on the study of S&T advance in the People’s Republic of China (PRC) 

for about 25 years, it is clear to me that China has entered an important watershed 

period in terms of the operation and performance of its science and technology system. After undergoing two decades of structural reform that began under the leadership of Deng Xiaoping, the Chinese science and technology system is positioned for 

an important take-off—the question is no longer if this will happen, but rather 

when. In many ways, it appears as if 20+ years of preparation for national scientific 

and technological distinction are beginning to come to fruition, with China poised 

to become a major international player in science and technology if not, in the long 

run, a scientific and technological superpower. 

The evidence for suggesting that China has reached such an important milestone 

comes from a broad array of data points across the PRC’s S&T system. Let me discuss several of the most recent positive developments, all the time recognizing that 

China’s S&T system is not some sort of unstoppable juggernaut that knows no limits; nor is it an example of a failed experiment in structural reform. China’s recent 

progress cannot be ignored as the following two examples indicate: (a) the development of the Dawning-4000A computer, running at a speed of over 10 trillion operations per second (10 Tflops) and ranked tenth in the world in 2004 on the list of 

the world’s top high performance computers and (b) the launch of Phase II of the 

Qinshan Nuclear Power Plant (Zhejiang) in May 2004, which marks the operation 

of the first large-capacity nuclear power station independently developed by Chinese 

engineers. There are others involving space as well as biotechnology and the human 

genome. At the same time, it should be realized that there still are numerous structural hurdles and resource constraints that China must overcome before it can begin 

to approach the comprehensive scientific and technological strength of countries 

such as the U.S. and Japan. 

First and foremost, it is apparent that the inputs contributing to the formulation 

and implementation of science and technology policy in the PRC have become more 

sophisticated and globally oriented. China is now focused on creating and perfecting 

a fully integrated ‘‘national system of innovation,’’ with the goal of bridging together 

those critical components needed to enhance the overall yield from growing invest-
91

ments by government and industry in research and development. Overall expenditures on R&D have now reached 1.3%, reflecting a rapid acceleration in spending 

on R&D over the last five years. Based on country data from the AAAS for 2003, 

China is now the third largest R&D spender in the world, trailing only the U.S. and 

Japan. And, while there are still considerable differences in the magnitude of spending on R&D between China and the U.S., it should be realized that increases in Chinese S&T spending have grown faster than the growth of the overall PRC economy 

according to statistics provided by China’s Ministry of Science and Technology. Of 

course, we should be careful not to mistake quantitative growth with qualitative improvements as large components of the Chinese S&T system remain inefficient and 

ineffective users of available funds. Nonetheless, it also is safe to say that current 

Chinese policymakers and experts recognize that as they devote more resources into 

the S&T system, they also must attack, with great vigilance and steadfastness, the 

problems of bureaucratic red tape and organizational inertia that remain in numerous parts of the system. 

Second, driven by a combination of economic reform and globalization, China is 

engineering the formation of a new technological architecture, one that is helping 

to re-define the rules, structures, and standards that have been in place over the 

last several decades. This does not mean that government has disappeared from the 

S&T landscape; through continuing state-sponsored high technology promotion and 

commercialization programs such as 863, 973, Climbing, Torch and Spark, the central government remains a major force behind China’s effort to catch up with the 

West. The most compelling example of continued government leadership is embodied 

in State Council Document #18 issued in mid-2000, which continues to provide direction for growth of the software and semiconductor industries. That document was 

followed by a MOST initiative published in November 2003 called the China Offshore Software Engineering Project (COSEP), which has provided much of the impetus behind the further expansion of outsourcing activities, especially those targeted 

at the United States and Europe. 

Nonetheless, like a gradual but steady volcanic eruption, the old elements of the 

planned, Soviet-style system are now progressively being pushed aside as the core 

features of a new science and technology system emerge. A good example of the Chinese willingness to be bold and even provocative is reflected in the Knowledge Innovation Project (KIP), a major reform initiative that has been introduced by the Chinese Academy of Sciences. The KIP project involves a significant restructuring effort 

inside the CAS organizational framework, leading to the closing down of a number 

of non-productive research institutes, the merging of others, and the introduction of 

new commercial incentives to ensure that CAS research activity is more closely 

linked to the needs of the economy. While we have not yet seen the full impact of 

the KIP project on R&D activity inside the CAS and there still are an assortment 

of obstacles to overcome, it is clear that there has been a major shake-up and the 

changes are anything but modest in terms of moving away from the often rigid 

modus operandi of the past and establishing new financially-oriented metrics and 

performance drivers for promoting a more innovative culture. 

Related to the changes occurring in the CAS is the growing role of the enterprise 

as the major source of R&D spending in China. Chinese enterprises accounted for 

over 60% of the money spent in 2004 on R&D in China, a major change from the 

situation that existed when the S&T reforms were introduced in 1985. Chinese 

firms such as Huawei, Legend, Haier, Founder, etc. are now joining foreign-invested 

firms in helping to define the cutting edge for technological advance in China. Foreign investment has served as an important ingredient in helping to stimulate 

rather than constrain local technological gains, though the short-term focus of many 

Chinese companies does inhibit the creation of a real ‘‘culture of creativity’’ inside 

many PRC enterprises. George Gilboy, Edward Steinfeld and others have argued 

that we have yet to see firm evidence of true innovative performance coming out 

of Chinese industry. This is no doubt reflected in a close scrutiny of Chinese data 

regarding increases in high technology exports. The overall level of these exports indeed may be growing, especially in the IT and telecom fields, but still largely 

(though not exclusively) on the basis of products generated by foreign invested firms 

or through the assembly of parts, components and sub-assemblies imported from 

abroad. Nonetheless, I would argue that there also is discernible evidence of real 

progress taking place—as a result of new competitive pressures associated with 

WTO commitments, the continued opening up of the Chinese economy to competitive forces, and the expanded return of larger numbers of PRC nationals from 

abroad. The bottom line is that we are beginning to see an important convergence 

of critical success factors that will only enhance innovative performance inside Chinese industry. The path for China’s technological future has been spelled out quite 
92

well in the following quote in Murtha’s discussion of LCD technology in South 

Korea:

‘‘Stepping forward into ongoing, knowledge-driven competition begins by 

taking a step back, recognizing that the point of entry is not a teacher’s position, but that of a student. Follower companies can often take advantage 

of equipment, materials, licenses, process recipes, and consulting services 

that encompass important elements of the knowledge created by predecessors who have started from nothing. Creating the vital resources needed 

to succeed in a knowledge-driven industry, however, does not begin with 

purchasing state-of-the-art technology, but rather with creating a basis in 

people for learning how to use it. Often this means entering the industry 

with current generation technology, achieving commercial yields, and running at efficient scale to build up the knowledge foundations necessary to 

seize a leadership position as the next generation emerges. Substandard returns or losses that come with late entry in current technology amount to 

tuition, reimbursable through timely entry to the next [technology].’’ From: 

Thomas Murtha, et. al., Managing New Industry Creation: Global Knowledge Formation and Entrepreneurship in High Technology (Stanford, 2001)

Third, there has been an appreciable improvement in the university sector in 

China. Not only has the system grown in terms of its capacity to produce larger 

numbers of university graduates—only a few years ago, only 3–4% of high school 

graduates could enter university in China—today that number has jumped to approximately 17%. China is now graduating more IT engineers than India; the Chinese churned out about 350,000 IT graduates in 2004 compared to 300,000 in India 

and 50,000 in the U.S. In addition, there is appreciable evidence from discussions 

with a broad range of foreign-invested firms in China that the quality and skill levels of graduates in the fields of science and engineering also have risen, though not 

necessarily evenly across the education system. Major investments have been made 

in providing new equipment and related resources to upgrade university laboratories and associated facilities. This enhancement of the physical infrastructure has 

been complemented by the steady improvement in the quality of the faculty. Problems of nepotism and faculty ‘‘inbreeding’’ are being attacked as the Chinese take 

on the challenge of creating a number of truly world class universities. Here again, 

these improvements admittedly have not been homogenous throughout the system, 

with university campuses in the West generally lagging behind those situated along 

the coast. There also are a large number of graduates that remain unemployed after 

graduation; estimates are that between 750,000–900,000 will have difficulties finding work this year. Nonetheless, China’s universities have shown some remarkable 

progress that cannot be ignored when looking at the country’s human resource endowment, particularly as the demand for higher skilled individuals increases in the 

years ahead. 

Based on data from MOST, China now claims to have the second largest stock 

of scientists and engineers in the world, with the U.S. still holding the number one 

position. That number reached approximately 1.3 million in 2004. Of course, on a 

per capita basis, the Chinese situation still reflects a comparatively weak position, 

with China being significantly behind Japan, Germany, France and Russia as well 

as the U.S. The highest quality professionals remain concentrated in Beijing, Shanghai, and Shenzhen, a situation that must be changed if scientific and technological 

progress is to diffuse to the country’s Western regions and lesser developed areas. 

Experienced research managers and project leaders also remain in short supply, a 

fact that continues to be one of the key drivers behind recent PRC efforts to court 

more Chinese who hold positions in industry and academia in the U.S., Europe and 

Japan to return home to take on leadership roles. There is solid demographic evidence in various scientific and technical fields that China still continues to experience a ‘‘talent fault,’’ that is, the after-effects of the damage to the country’s talent 

pool wrought by the Cultural Revolution, with shortages in the numbers of senior, 

experienced technical and managerial talent still quite apparent. 

Finally, and most relevant for purposes of this hearing, China has stepped up its 

interest in further internationalization of its science and technology system. From 

the perspective of bilateral science and technology relations, while the Sino-U.S. 

S&T relationship continues to grow in several areas, it continues to under-achieve 

in many others. One reason is that the S&T component of our relations with China 

frequently has been treated as the icing on the cake in the face of other larger U.S. 

foreign policy concerns; from the Chinese perspective, however, access to U.S. 

science and technology resources has been the cake itself! The unfortunate demise 

of the U.S.-China cooperative program in management because of inadequate funding is just one example of a failure on the part of the U.S. to fully appreciate key 
93

ways to reap benefit from as well as shape the evolution of the Chinese system. On 

the other hand, China’s S&T relations with the European Union have become especially strategic; the European Union sees the net addition of Chinese scientists and 

engineers to their own S&T programs as a key asset in its competition with the 

United States. China sees Europe as an alternative partner to the U.S., with the 

Europeans seemingly being more willing to place political considerations on the back 

burner while they focus on the mutual benefits of enhanced S&T collaboration with 

the PRC. More broadly speaking, Chinese scientists and engineers are becoming important participants in international science and technology affairs and are contributing an increasing share of papers to the world’s technical literature, with there 

being growing evidence that the work of Chinese researchers is being cited in Western journals with increased frequency in fields such as nanotechnology, biotechnology, etc. 

Even more profound, however, are developments that have occurred on the commercial side of the equation. China continues to have a voracious appetite for acquiring foreign technology, and as noted by Business Week, unlike Japan, there is 

no ‘‘not invented here’’ syndrome in the PRC. While financial constraints made it 

necessary for the Chinese to rely heavily on foreign investment during the first 

twenty years of the open policy, there clearly is now a stronger emphasis on securing access to know-how rather than equipment and process technologies to support 

manufacturing. The PRC government has introduced legislation over the last several years to make it attractive for foreign firms to bring not only manufacturing 

and distribution to China, but also to fill out the value chain and engage in R&D 

activities as well. Estimates are now that there are over 700 foreign R&D centers 

in China, with the number increasing steadily every six months or so. 

We must remember it was not too far in the past when many foreign firms remained skittish about doing business in China and were skeptical about the staying 

power of China’s reform program. Since the early 1980s, Chinese leaders have been 

quite forthcoming in declaring their intentions regarding the import of foreign technology and equipment to support China’s modernization efforts. At that time, China 

lacked a growing market as well as a normalized business environment to attract 

many foreign firms, especially when it came to the transfer of high technology. And, 

to the great frustration and chagrin of Chinese leaders during this period in SinoU.S. relations, COCOM and U.S. export controls further diminished Chinese access 

to state-of-the-art know-how, especially in the telecom, computer and microelectronics sectors. Today, however, that situation has changed in a fundamental way. 

China is now deeply embedded in the framework of global business and commerce. 

In the 1980s, management gurus such as Peter Drucker argued that American companies had to have an appreciable presence in Japan to be a true global player; 

today, those companies striving to position themselves globally will not be successful 

unless they have a significant presence in China, and not simply manufacturing and 

marketing, but increasingly, as suggested, research and development. Similarly, in 

the 1980s, Japan specialists such as James Abegglen and others suggested that the 

Japanese would continue to be the principal economic and technological force in the 

Pacific Rim for the foreseeable future. Today, however, we can say that a fundamental shift has occurred in the Pacific Rim technological order; Japan’s once 

untouchable position as the premier technological power in the region is steadily, 

albeit gradually, being challenged by the continued rise of China. 

There appears to be an increasing level of coherence as well as serendipity 

between the imperatives driving Chinese science and technology strategy, international competitive trends, and globalization. The need for new, expanding markets among multinational firms seems to fit nicely with the timing of China’s 

increased market openness along with the growing prosperity and sophistication of 

Chinese consumers. More specifically, the Chinese value proposition—market access 

for technology transfer—has become a meaningful attraction for many of the Global 

Fortune 500. In addition, the ability of multinational firms to tap into China’s labor 

pool and take advantage of the rapidly upward learning curve among many Chinese 

enterprises fits well with the Chinese desire to sustain high levels of employment 

and to expand technology-intensive exports. Gaining higher and higher levels of 

technological mastery has allowed China to assume a more central role in the global 

supply chain across key industrial sectors, including telecommunications, electronics 

(consumer and industrial), and information technology. Moreover, the growing desire among multinational companies to capture China’s knowledge assets to enhance 

their local and global competitive position dovetails nicely with the PRC’s objective 

of gaining expanded access to foreign know-how in design, product development, engineering, etc. Many multinationals now see it in their strategic interest to have a 

substantive R&D presence in the PRC. In essence, China has become the new battleground for the playing out of U.S.-Japan-EU-Korea competition. Winning or los-
94

ing in China now has global implications in terms of international competition in 

everything from pharmaceuticals to telecommunications. This means that newer, 

more advanced technologies are steadily being brought into China as various multinational companies seek to leverage their core technological strengths for competitive advantage in the PRC and abroad. 

The rapidly expanding flow of foreign R&D into China has been complemented 

by a steadily growing, albeit much smaller, flow of Chinese R&D investment abroad. 

These investments are largely focused on establishing technological listening posts 

overseas to further facilitate the upgrading of China’s technological base. Huawei, 

the leading Chinese telecommunications equipment manufacturer, has over ten such 

listening posts across Asia, the U.S. and Europe. Along with helping to support 

Huawei’s global aspirations, these operations also serve as a magnet for recruiting 

Chinese talent abroad, especially among those who are not yet ready or willing to 

return to China after living and working in the U.S. for several years. The vibrancy 

of the Chinese technology networks around the world is one of the most dynamic 

elements in helping to explain the progress that has been made since the mid-1990s. 

In fact, Chinese information networks, which increasingly are linked to vibrant capital networks, already have become a steadily potent mechanism for helping to steer 

China onto a more innovative path. In this regard, the strategic role that Taiwan 

has played cannot be ignored, especially with respect to the IT sector and recent 

progress regarding development of the Chinese semiconductor industry. 

To more fully encapsulate the impact of globalization on China’s technological trajectory, I would like to offer four key hypotheses that we ought to consider as we 

contemplate how far and how fast the Chinese S&T system may progress in the 

coming years.

1. Unlike a number of other developing countries that have felt threatened or 

under attack by the forces of globalization, China seems to have embraced the 

onset of globalization. Globalization is now viewed as a strategic process for obtaining increasingly unencumbered access to state of the art technologies and 

know-how. 

2. More and newer technologies are flowing into China at an earlier point of time 

in their life cycle than has occurred in any other developing economy since the 

end of WWII. The product life cycle, and associated technology life cycles, have 

been turned on their head in the Chinese case, even as complaints have proliferated and continue to abound regarding the leakiness of the PRC system 

for protecting and enforcing IPR. 

3. The real strategic value of China for the majority of multinational firms lies 

not in simply gaining access to cheap labor, but rather in accessing China’s 

higher end brainpower, that is, the cadre of heretofore under-utilized or inefficiently utilized scientists and engineers who are now part of a ‘‘global’’ talent 

pool. 

4. More and more multinational firms will not only be setting up R,D&E activities in China, but they will be looking at the PRC as a strategic partner within 

their overall global innovation system, leading to even greater technological 

sharing, e.g. Alcatel Shanghai Bell.

I want to stress once again that the picture I am painting is not either of an infallible China or of a Machiavellian China surging forward at the expense of the rest 

of the world. Rather, what we are seeing in the Chinese case are the results of 25 

years of knowledge absorption and learning starting to kick in. Traveling to China 

4–5 times a year for the last 20+ years, I continue to be impressed by the inherently 

more open and sophisticated nature of the discourse that is taking place across Chinese policymaking, business and academic circles. And, I also have been impressed 

by the growing transparency of the debates regarding science and technology issues. 

Foreigners, once largely isolated from policy discussions in China, are now asked to 

render opinions and conduct investigations about the degree to which progress has 

been made. The recent invitations provided to a broad range of foreign experts to 

offer their ideas regarding China’s 15 Year Comprehensive Long-term Science and 

Technology Plan is just one such example.

‘‘Grabbing the China Market By Harnessing the Chinese Wisdom’’

Foreign R&D in China 

In the last part of my presentation, I would like to discuss some of the features 

of foreign R&D in China as a way for us to better understand where the future 

might take us in terms of the interrelationship between the U.S. and Chinese S&T 

systems. In the late 1970s, as part of the so-called ‘‘new international economic 

order,’’ many multinational firms set up R&D centers in developing countries as a 

way to exhibit their commitment to technology transfer and Third World economic 
95

development. In the majority of cases, however, these R&D centers were largely 

‘‘hollow’’ operations, with little of substance—research or training—taking place inside except for some local product adaptation. Today, we see somewhat of an opposite picture emerging in the case of China. While clearly not all of the 700+ foreign 

R&D centers are engaged in state-of-the-art research—basic or applied—and most 

have eschewed a focus on basic research, there are a growing percentage of foreign 

companies who are filling out their complete value chain in China by deepening 

their R&D activities as part of a strategic global re-positioning of their business. 

Like many other critical transitions in China’s economic modernization drive and 

its relationship with the outside world, the growing role of foreign R&D in the PRC 

is being driven by a confluence of government and market forces. First, as indicated 

earlier, the Chinese government has emphasized the importance of strengthening 

the country’s technology base and upgrading the innovative potential of PRC enterprises. Accordingly, in April 2000, MOFTEC (now MOFCOM), issued Circular 

Waijingmaozifa #218, which basically formalized the status of foreign R&D centers 

in China by providing guidance and details on the rules for their establishment. In 

April 2002, MOFTEC’s foreign investment legislation was modified to change R&D 

activity from a ‘‘permitted’’ to an ‘‘encouraged’’ form of foreign investment. These 

new policies complement a series of related changes that have taken place with 

regard to the importation of foreign technology. Moving away from the restrictive 

regulatory regime of the 1980s and 1990s, in 2002, Beijing radically revised the 

existing legislation regarding foreign technology imports. In essence, the spirit and 

intent of these revisions has been to promote smoother and faster movement of technology and know-how into China by shifting the PRC government emphasis toward 

approval rather than tight control. 

Under the new rules for foreign R&D centers, ownership structures can vary from 

equity joint ventures to wholly-owned enterprises. To qualify for formal R&D status, 

however, 80% of the staff must hold a college degree and be involved in actual R&D 

activities. Two types of R&D activities are permitted under the legislation: (1) an 

R&D center whose main purpose is to engage in the general transfer of know-how 

to any entity; and (2) an R&D center that is controlled by a parent firm and is involved in research for which it will be reimbursed expenses plus a reasonable profit. 

In the latter case, the expectation is that the IPR belongs to the parent sponsor. 

R&D centers, however, cannot engage in so-called ‘‘technology trade’’ that is not the 

product of their own research and development efforts. These foreign R&D centers 

are eligible for a range of tax incentives as well as tax relief for equipment imported 

to support the R&D activities. In addition, the Chinese government has committed 

itself to easing visa requirements to enable entry and exit to/from China for both 

locals and foreign nationals employed at the center. Moving beyond the preferences 

offered by the central government, both Beijing and Shanghai have issued their own 

regulations to further encourage foreign companies to set up R&D operations in 

their respective cities; some of these regulations are aimed at attracting expertise 

from outside China’s coastal areas by awarding residency permits, etc. 

A second driver behind the growth of foreign R&D centers in China revolves 

around the issue of technical standards. Since the mid-1990s, Chinese government 

policy has placed a greater emphasis on acquiring technical know-how to enable 

local industry to gain a greater percentage of the revenues associated with licensing 

and technical standards. In January 2005, XU Jianguo, Vice Director of MOST’s Development and Planning Department, announced that the Ministry will provide a 

new injection of funds into R&D for the purpose of establishing 29 international 

technical standards. The original program, which began in 2002, now involves more 

than 2,100 scientists and experts working in such fields as environmental protection 

indicators, trace element examination, textile safety, broadband local area networks, 

and RFID. Given the steadily expanding size of the Chinese domestic market and 

the potential weight of Chinese market power on an international level, foreign 

firms have been anxious to shape or influence China’s decisions regarding which 

standards are being adopted in telecommunications, software, computers, pharmaceuticals, etc. Perhaps no area better illustrates how the competition for standards 

setting has drawn in foreign R&D investment than mobile telephony. Siemens, 

Nokia, Ericsson and Motorola have all made substantial investments in building out 

R&D operations in China in this highly competitive sector. Nokia, for example, used 

its R&D capabilities as leverage to secure a position in the CDMA handset market 

in China, while at the same time hoping to secure an advantaged position by working with its Chinese counterparts on further development of CDMA technology. As 

the requirements and sophistication of Chinese consumers continue to rise in the 

highly dynamic mobile phone market, local R&D is needed to get new products into 

the market quickly and reliably, thus helping to set trends and win market share. 
96

Cost-cutting considerations are clearly a third driver for attracting foreign R&D 

to China. The data seems to vary from city to city and from province to province, 

but the fact remains that the loaded costs of employing and supporting an engineer 

in China run about 20–25% of a U.S. counterpart. The issue, however, is not always 

one of cost-based substitution. In many instances, the movement of R&D to China 

by foreign firms also reflects a desire to create a critical mass of talent, at affordable 

rates, that can be utilized to focus on an auxiliary problem or alternative technical 

solution that otherwise might be ignored and bypassed due to lack of available staff 

and funds in the U.S. Moreover, the presence of an advanced technical team in 

China, especially with local language skills and cultural familiarity, gives the foreign firm a better chance to work with local suppliers and vendors to ensure that 

domestically manufactured parts and components meet required levels of quality 

and performance. Once local Chinese R&D teams can be integrated culturally and 

operationally within the global R&D infrastructure of a large multinational firm, 

they are ready to service global markets as well as the local Chinese marketplace. 

This is clearly the intention of firms such as Microsoft, IBM and GE—all of whom 

have steadily grown their research presence in China. 

Professional services companies in the human resources field, more commonly 

known as ‘‘headhunters,’’ have found that the demand for their services has substantially increased over the last 2–3 years. In the 1980s and 1990s, the major 

headhunters, mostly based out of HK and Singapore, spent the bulk of their time 

finding appropriate expatriates to take top managerial assignments in China. 

Today, they have expanded their operations to Beijing and Shanghai, and their principal focus is largely on identifying experienced PRC nationals in China and abroad 

who wish to return home to assume a leadership role in these types of foreign-invested R&D centers and technical organizations. Chinese scientists and engineers, 

at home and abroad, are drawn to working in foreign R&D organizations because 

of the nature of the projects, the opportunities for training and travel overseas, 

better salaries (though not always), and more varied career opportunities. As the 

staffing needs for these foreign R&D operations have grown, the result has been the 

creation of an emerging internal brain drain problem, with some of the best and 

brightest Chinese talent forsaking opportunities with domestic companies and government labs for the seemingly more exciting career path in foreign-invested organizations. 

Fortunately or unfortunately, depending on one’s perspective, this problem may 

be short-circuited by the further growth of technological entrepreneurship in China. 

There is a saying in Chinese, ‘‘it is better to be the head of a chicken than the tail 

of an ox’’ [ning wei ji tou, bu wei niu wei]. The high turnover rate for junior- and 

mid-level talent in both foreign-invested and domestic R&D operations reflects their 

apparent willingness to further ‘‘jump into the sea’’ and embark down an entrepreneurial path that increasingly involves starting their own firms. This is not much 

different than what happened in Taiwan in the late 1970s and 1980s in Hsinchu 

Park, when many local engineers left employment with foreign companies such as 

Motorola and General Instruments to open their own firms—sometimes with indirect government support and even encouragement. One particular difficulty that has 

already arisen in China from the rapid circulation of such technical talent, however, 

deals with the security of IPR and adherence to confidentiality agreements contained in employment contracts with their foreign employers. With many foreign 

firms utilizing trade secrets and not always patents to protect their IPR, it is sometimes hard to prevent critical know-how from being used inappropriately in some 

of these start-up firms. This also is the case with some returnees from abroad, who 

have left positions with U.S.-based firms to begin an entrepreneurial journey in 

China. 

There are a range of other drivers that account for the step up in the number 

of foreign R&D centers being established in China. Some of these factors exist on 

the ‘‘push’’ side rather than the pull dimension. They include tax and visa policies 

at home in the U.S., the growing pressures on compensation and benefits packages, 

and overall problems regarding the availability of well-trained technically-oriented 

individuals. Most critical, however, remains the imperative of global competition, 

which continues to be creating more pressures for more sustained innovation, 

greater customer responsiveness, and more rapid commercialization of new products 

and services. China’s role in this regard promises to be anything but passive. PRC 

government policies are distinctly based on the notion that the expanding number 

of foreign R&D centers will serve as a catalyst for sparking new innovative behavior 

throughout the economy. 

Heretofore, it is safe to say that the contributions from foreign R&D activities in 

China still remain limited, though this has much to do with the fact that the phenomenon is still in its early stages of development. A number of important questions 
97

remain, nonetheless. For example, will foreign R&D in China become an integral 

part of the PRC’s national innovation system? Is there a formal capture strategy in 

place or being conceived by the Chinese government to ensure that the contributions 

from R&D can be absorbed? And, is China’s national innovation system structured 

and developed to the point that it can maximize the benefits from being steadily 

embedded in a comprehensive web of global knowledge networks in world science 

and international engineering? At the present time, the response to these three key 

questions would seem to be, ‘‘stand by, the answer is yet to be fully determined.’’ 

That said, from both a policy and organizational perspective, there has been growing 

evidence that the Chinese S&T system is indeed pointed in the right direction as 

it seeks to optimize the growing presence of foreign R&D activity. While the direction of China’s technological progress may not be always linear, aided and abetted 

by the development of continuously more cohesive relationships with the world’s 

leading technology-based corporations, the pace of progress will likely be more rapid 

than we might anticipate. 

To get more specific, so far, the identifiable contributions from foreign R&D in 

China seem to lie more in the world of intangible benefits rather than concrete ones. 

Nonetheless, they still are critically important as a precursor to more rapid Chinese 

technological advance. They fall into the following areas, many of which in the past 

have been areas of major weakness for the PRC:

• Training: technical training, cross-functional/cross-cultural teaming, and product and process design methodology, esp. electronic design automation for shortened design cycles; • Technology transfer: the diffusion of ‘‘uncodified’’ trade secrets rather than specific patented information; • Standards: best practices, industry standards, performance metrics, and quality 

requirements; • Software: programming methodologies, software design architectures, systems 

integration techniques, and overall testing procedures and quality assurance; • Management: project management, business management, and management of 

knowledge workers; 

• Networks and information resources: participation in global knowledge networks; 

• Spin-offs: new business ventures and entrepreneurial activity; and 

• Spillovers: technical assistance to vendors and suppliers.

In the final analysis, however, as Chinese policymakers fully recognize, the R&D 

activities of foreign firms in China are driven by the strategic agendas of these companies. To gain a deeper, longer term commitment from foreign firms in the R&D 

area, China will have to improve its overall enforcement of IPR protection. This also 

is true with respect to China’s efforts to develop its software industry, especially if 

the country hopes to move beyond basic, low-end outsourcing activities. The need 

for better IPR enforcement is often affirmed by many academic, business and legal 

observers of the Chinese scene, though with little expectation that much will be 

done in the short term. Strong IPR enforcement also is necessary for MNCs to be 

willing to engage in more extensive basic research in China. Securing this type of 

scientific-oriented research is very much coveted by China’s S&T leadership. Venture capital will be hesitant about supporting technological entrepreneurship if 

there continues to be pervasive apprehension that IP rights cannot be made secure. 

Based on the experience of other Pacific Rim economies, the key to solving the IPR 

problem in China actually lies in the degree to which the roots of local technological 

entrepreneurship take hold. With locally created IP at risk, the appropriate conditions will exist for local government and enterprise stakeholders to make progress 

in cracking down on those who violate foreign and domestic IP rights.

Implications for the United States

At the beginning of this presentation I raised two critical questions: (1) whether 

we fully grasp the ramifications of the new globalized technological environment of 

the 21st century—in which China is becoming a key player; and (2) whether as a 

nation, we have the will and capabilities to prosper as new rules kick in and new 

success factors are defined. Coming to a better understanding of the prospects for 

future Chinese scientific and technological development is of considerable importance for evaluating and managing the consequences of China’s political, economic, 

and social evolution in the coming decades. There are those that would discount the 

importance of China’s emergence in the realm of science and technology simply because they do not see ample evidence of substantial Chinese progress at this time. 

In this group, are those whose analysis of China’s S&T system tends to emphasize 

the shortcomings of Chinese R&D performance and the continued lags in innovative 

capability. At the other end of the spectrum are a range of analysts who tend to 
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be alarmists about China’s emerging technological capabilities, raising, at times, exaggerated concerns about China’s ability to acquire—through legal or illicit means—

as well as absorb and assimilate all types of know-how and equipment from abroad. 

In reality, both perspectives suffer from the same weakness—they fail to capture the 

complexity and dynamism of the rapid pace of change both inside and outside of 

China. 

Globalization, complemented by economic reforms and structural changes in the 

S&T system, has changed the playing field for the PRC. The Chinese leadership, 

once seemingly daunted by the forces of interdependence and globalization, now sees 

enhanced opportunities for China to gain access to advanced technology and knowhow. Thinking about Chinese behavior in terms of a tension between the forces of 

techno-nationalism and techno-globalism actually creates a false and somewhat inaccurate dichotomy for understanding China’s current international orientation; 

these two seemingly contradictory constructs are really part of the same behavior, 

with techno-globalism and techno-nationalism intertwined in a single, synergistic 

relationship with one another. Techno-nationalist imperatives drive Chinese technoglobalist behavior, fostering expanded economic reforms and greater openness—both 

of which, in turn, facilitate more foreign involvement in the PRC economy through 

FDI, technology transfer, and the establishment of foreign R&D centers. Technoglobalist actions support Chinese techno-nationalist goals and objectives as broader 

and deeper engagement with the international science and technology system serves 

as an enabler for strengthening domestic technological capabilities. While not completely devoid of their old penchant of seeking technological self-reliance, China’s 

current leadership seems to grasp the tremendous utility that comes from embracing (rather than attempting to thwart) the opportunities for cross-border cooperation 

and collaboration generated by increased globalization. 

The United States must take a new look at the tremendous opportunities to be 

derived from China’s scientific progress and technological advance. An enhanced 

ability by the United States to tap into the steadily growing and improving human 

resource and technological assets inside of China—from universities to government 

think tanks to high tech enterprises—will only help to enhance our own country’s 

innovative potential. In spite of some noise in the U.S. media, the good news is that 

American firms are at the forefront of understanding the meaning of China’s new 

global economic and technological posture, though in concert with the recent NII report by the Council on Competitiveness, they also seem to grasp the dangers ahead 

if the United States does not expend the resources needed to upgrade our own education system and support critical research activities in both academic and commercial settings. A growing number of American universities as well are re-positioning 

themselves to take advantage of the opportunities for cross-border research collaboration created by recent S&T progress in the PRC and several other countries. It 

will not be long before a large percentage of American universities enter the borderless world, with the walls surrounding traditional academic departments coming 

down and departmental faculty being dispersed around the world instead of being 

physically co-located in one geographic venue. 

As things currently stand, however, there simply does not seem to be enough appreciation in Washington, DC for how we ‘‘win’’ in the changing globalized world of 

the 21st century. The United States Government needs to invest more in the training of a whole new generation of future leaders who are, at the same time, more 

cross culturally aware, more managerially adept, and more technologically savvy 

than their predecessors. To be sure, we must be more expert in our ability to monitor and analyze developments in the Chinese S&T system; we currently lack sufficient numbers of faculty and graduate students who are preparing for careers that 

would have them delving deeply into the emerging pockets of scientific and technological excellence in places such as China. Moreover, we also must have a cadre of 

individuals who are adept at seeking out opportunities and working on team-based, 

collaborative projects with relevant counterparts from around the world whose 

names may be even more difficult to spell than pronounce. America’s technological 

future is not simply tied to protecting and advancing our own national system of 

innovation, but rather in creating and developing a global system of innovation, 

with the U.S. in a leadership role by virtue of our enhanced global awareness

and cognition. The rise of China gives us a unique chance to test the efficacy of our 

global commitment. If we simply envisage China as a foreboding technological 

threat—potential and real—we are more likely to adopt behaviors towards the PRC 

that will increase the chances of that becoming a reality. Or, we can view China 

as an increasingly capable strategic partner that affords us critical opportunities for 

seizing upon real and potential technology synergies and complementarities. As the 

Chinese look on, our actions will clearly set the tone. The final choice remains ours 

to make.
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Chairman D’AMATO. Thank you very much, Dr. Simon. Ms. Walsh. 

STATEMENT OF KATHLEEN A. WALSH

SENIOR ASSOCIATE

HENRY L. STIMSON CENTER, BOSTON, MASSACHUSETTS 

Ms. WALSH. Well, thank you very much. I’m pleased to be here, 

once again, to talk about this very important issue. I commend the 

Commission for taking it on and having such a cross-section of experts explore this issue. I am particularly pleased to be on such an 

esteemed panel. I’ve been reading and exploiting the works of my 

colleagues here for many years, so. 

I’d like to just talk about one issue in particular that I probably 

know the most about which is the foreign R&D presence in China. 

There have been some new developments and some interesting dynamics that I think merit the Commission’s attention. 

As my colleague mentioned, there seems to be a growing number 

of foreign R&D centers appearing in China. I think, more importantly, the Chinese have seen this themselves as an important 

issue, warranting their research and analysis. The Ministry of 

Commerce think tank recently put out a report. I haven’t seen it 

myself. I’ve only seen excerpts in the Chinese and international 

press, but it does cite the number of 700 overall foreign R&D centers in China. 

To my understanding, based on my past research, this seems to 

be a very fast pace of R&D investment. Frankly, I question these 

statistics. I don’t know how they were measured and the process, 

and I know too that the number of 600 was used in June 2004. 

So we have to dig deeper into that area to find out what is causing this rate of growth and whether they really are experiencing 

a rate of growth of 200 new R&D centers a year. If so that would 

be phenomenal. If not, I think it’s still important because there is 

a lot of activity going on in China and it’s concentrated in urban 

areas that are increasingly becoming clusters around China’s east 

coast areas. So it’s a growing trend, clearly, and one that the Chinese themselves find to be important to their own developmental 

efforts. 

Its impact which the Commission is interested in is still unclear 

in my view, what impact this foreign investment is having on China’s own developmental capabilities. The data is, as Dr. Suttmeier 

mentioned, hard to interpret. And you can interpret it two different 

ways, the glass is half full, or half empty, and we’re in the process 

still of doing that. But to my mind I think earlier studies on the 

phenomenon of technology transfer, in particular, about the elevation from production to R&D, tends to show in China and beyond 

that there is a transfer of technology and learning from these foreign R&D centers. The data is hard to come by, but the phenomenon seems to be playing itself out repeatedly. And we can assume I think at least some of this is happening in China as well. 

But more recent data that I think the Commission should definitely take a look at, if they haven’t already, is some research done 

by Gary Jefferson at Brandeis and some of his colleagues. He’s 

working with the Chinese Ministry of the National Bureau of Statistics, and Ministry of Science and Technology to try and interpret 

the data that they themselves have collected. I think it’s very important work. 
100

I look at it and I say it shows that there is not only the technology transfer from the foreign R&D centers, but his research 

seems to indicate that the Chinese themselves are becoming more 

innovative, that if you look at Chinese high-tech exports and hightech manufacturing, that not all of this can be attributed to foreign 

investment, that the Chinese themselves are becoming more innovative and even more efficient in terms of their R&D productivity 

when contrasted with international statistics. 

So I think this is very important work and it provides some statistical evidence for the phenomenon that we’re looking at. It’s not 

clear exactly where this trend is headed. Certainly Dr. Suttmeier’s 

suggestions that this could have some two steps forward, one step 

back characteristics, I think is a very important consideration as 

we look at China’s potential. But his research, too importantly 

points out that China is moving ahead technologically very quickly. 

According to both the internationally-recognized and comparative 

S&T statistics, China is moving ahead quickly, continues to do so; 

and the data suggests perhaps that China could experience a rapid 

acceleration of capabilities, moving from the developing world to 

more online or on par with developed countries and the world’s 

most advanced economies. 

Looking at the R&D intensity, the R&D spending-per-our-GDP 

statistic, you can look at it in different ways, but I think that it 

rings true to me that China could potentially achieve a rapid acceleration in the science-and-technology capabilities, which I think 

begs the question not of whether China will do this, but as Dr. 

Simon has said, when and how sustainable China’s growth will be. 

I think that’s an important question for the Commission to take a 

look at, and what this will depend on. Obviously it will depend on 

continued FDI, but can China achieve this rapid advance and then 

sustain it and, what are the implications of that—I think this is 

an area that bears greater attention. 

But I think, my view is that China has put in place the infrastructure and the education and the resources that it needs to develop a more innovative system of its own—if Dr. Jefferson’s analysis is correct; that the Chinese enterprises themselves are becoming more innovative and that the spillover from foreign R&D centers in China is more indirect or intangible than it is tangible—

which rings true with my research—then that says a lot about China’s capacity down the road. If they are in fact doing this more 

themselves than via a direct transfer of know-how from the foreign 

R&D centers, this is an important indicator. 

One other issue I’d like to raise just briefly. I raise it not fully 

understanding the phenomenon at all but having learned that this 

is a new dynamic happening in the China market. I raise it as an 

area of future research, which is, as I mentioned in my testimony, 

the CJK model, ‘‘CJK’’ standing for or shorthand for China, Japan, 

and Korea. 

In addition to the techno nationalist and techno globalist phenomenon we’ve discussed, there appears also to be a more techno 

regional approach to technology development in R&D, akin, of 

course, to the greater China dynamic that we saw in southern 

China, Hong Kong, and Taiwan as well in an earlier era; that there 

may be a broadening today of this regional collaboration. The Chi-
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* The author is a consultant on China and international security policy, currently directing 

the Project on Post-Conflict Border Security and Trade Controls at the Henry L. Stimson Center. The views outlined here are those of the author alone and do not reflect an official position 

or view of the Stimson Center. 1Much of this discussion is taken from material included in a paper entitled, ‘‘China’s S&T 

Strategy: Drivers, Dynamics, and New Directions,’’ prepared for a conference on ‘‘Chinese Military Modernization and East Asian Security: Political, Military, and Defense Industrial Responses’’ (Maui, Hawaii, Center for Strategic & International Studies, May 19–20, 2005). 

nese, Japanese, and Koreans have signed agreements in the IT sector to collaborate to develop new technologies. 

I mention one example that I found in the press, this Linuxbased system called Asianux that has been co-developed by companies from these three countries. In conversations in Beijing, both 

with industry analysts and representatives of each of these countries—although I didn’t speak to the Japanese about this—this is 

a trend that they all are fostering, that is, the complementarity of 

their technological and economic structures nationally and as well 

as industrial interests, that they see that this complements each 

parties’ interest in collaborating. And so whether the U.S. will have 

a role in this in the future I think is a very important question that 

the Commission may wish to take a look at. 

I’ll stop there and look forward to the questions. Thank you. 

[The statement follows:]

Prepared Statement of Kathleen A. Walsh

Senior Associate, Henry L. Stimson Center, Boston, Massachusetts 

Thank you Commissioners D’Amato and Mulloy and other Members of the Commission. It is my distinct pleasure to speak before you once again, particularly in 

the company of this very esteemed panel.* 

It is particularly fitting that this meeting be held at the heart of U.S. high-tech 

innovation. That Silicon Valley and other technology centers around the United 

States remain home to the world’s most successful and competitive technology 

innovators is in America’s strategic and economic interest. China’s recent science 

and technology (S&T) advances and growing innovative capacity present a new challenge to U.S. innovation, but not yet one that is overtly threatening nor insurmountable. It is emerging quickly, however, and requires vigilant monitoring and constant 

analysis. Improving our understanding of China’s S&T objectives, capabilities, and 

future plans will aid U.S. industry, if supported by the Executive and Legislative 

Branch initiatives, to maintain our competitive edge. So, I commend the Commission on holding this hearing and focusing on this vital issue. 

In your invitation, you laid out several questions related to China’s S&T efforts 

and issues related to funding, standard-setting, foreign investment, and foreign corporate R&D in China. Let me take each of these issues in order. 

China’s Science and Technology Policy: Current Priorities and New Directions 1

The PRC government continues to play a central role in Chinese science and technology development as well as in promoting high-tech industry innovation. As is 

PRC government practice, Beijing continues to outline the nation’s long-term priorities and plans for S&T development. The latest of these—the 10th Five-Year Plan 

(FYP) for 2001–2005—is coming to a close. Among the plan’s objectives were to double GDP by the year 2010, to increase overall spending on research and development (R&D) to 1.5% of GDP (a goal carried over from the earlier 9th FYP), to 

prioritize spending on ‘‘pillar industries’’ and key strategic technologies (including 

information technology and electronics), and to reform China’s state-owned enterprise R&D system in order to provide China with a capacity to leap ahead in its 

economic development. Foreign investment, as discussed later, plays an important 

role in China’s plans and continuing S&T development efforts. 

While a full account of the success (or failure) of this latest FYP plan must wait 

another year, it does appear that China has made strides toward its stated goals. 

Most measures of China’s S&T input and output show continued growth, distancing 

China further from the developing world and toward levels common in more developed, Western economies. For instance, Beijing’s spending on R&D reached 1.3% of 
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2For data on China’s S&T progress, see National Bureau of Statistics (NBS) of China, Chinese 

Statistical Yearbook 2003, no. 22 (Beijing: China Statistics Press, 2003); and National Science 

Board, Science & Engineering Indicators—2004 (Arlington, VA: National Science Foundation, 

2004). For context, see Albert Hu and Gary Jefferson, ‘‘Science and Technology in China,’’ Prepared for Conference 2: ‘‘China’s Economic Transition: Origins, Mechanisms, and Consequences,’’ 

Preliminary Draft (29 October 2004), accessed online at http://people.brandeis.edu/∼jefferso/

res.html. 3 According to Jefferson’s analysis: ‘‘S&T takeoff is defined here as an abrupt increase in a 

country’s ratio of research and development (R&D) spending to GDP from less than one percent 

to more than two percent. For these large, high-income economies, this remarkable acceleration 

in the ratio of R&D spending to GDP occurred on average within the span of a single decade.’’ 

See Gary H. Jefferson, ‘‘R&D and Innovation in China: Has China Begun Its S&T Takeoff?,’’ 

Prepared for the Harvard China Review (August 11, 2004), p. 1. 4The first case involving China’s Wireless Authentication Privacy Infrastructure (WAPI) data 

encryption technology is well-known and initially required foreign invested enterprises to collaborate on development with a select set of domestic firms. This case was resolved, at least 

tentatively, with China’s agreement at the 2004 Joint Commission on Commerce & Trade to indefinitely rescind it’s policy. Another case recently reported in the media suggests that foreign 

pc makers will be expected to collaborate in some fashion with China’s leading pc company, 

Lenovo, if interested in competing in China’s future pc terminal market. Fiona Chou, ‘‘China’s 

WAPI Evokes Foreign Protest,’’ Telecom Asia (March 2004); Lenovo Launches China’s First Security Chip, SinoCast China Business Daily News (April 12, 2005). 5See, for instance, Mure Dickie, ‘‘Beijing reviews rules on foreign software buying Procurement Policy,’’ Financial Times (April 12, 2005). China is also reported to be favoring domestic 

firms to the detriment of foreign investors in other sectors such as semiconductors. See ‘‘ChinaIC-Policy,’’ China Business News Online (April 7, 2005). 6See, for instance, articles on outsourcing to China and elsewhere appearing over the past 

year in Business Week, CIO Magazine, Technology Review, among other venues. Pete Engardio 

and Bruce Einhorn, ‘‘Outsourcing Innovation,’’ Business Week (March 21, 2005), pp. 84–94; 

Christopher Koch, ‘‘Innovation Ships Out,’’ CIO Magazine (January 15, 2005), online at

http://www.cio.com/archive/011505/outsourcing.html; Corie Lok, ‘‘Where’s My Job?,’’ Technology 

Review (April 2004), pp. 74–75, online at http://www.technologyreview.com/purchase/pdfldl.asp? 

79juh=337948&hy6f0=16564. 

GDP in 2003, putting the stated 2005 goal of 1.5% within reach. Attaining this goal 

would be an important achievement, placing the PRC on a fast-paced, upward trajectory and closer to the sustained level of R&D spending of about 2–3% that characterizes the world’s most developed and technologically advanced economies.2 In 

fact, statistical analysis of China’s latest S&T output has led some to suggest that 

China could be in the early stages of an ‘‘S&T takeoff,’’ which would have the PRC 

joining the ranks of the world’s top-tier advanced economies within a decade.3

Yet, even if this comes to pass, a nagging question for both PRC policymakers and 

foreign analysts alike is whether China’s success will be sustainable and how dependent it will be on continued high levels of foreign investment. There is no clear 

answer to these questions and much will depend on China’s approach to high-tech 

development and foreign investment in the coming years. There are both worrisome 

signs ahead and indications of progress that might ease the way for China’s hightech development to be viewed as a win-win scenario by domestic and foreign investors. (It should also be noted here that China’s economic failure would risk a troubling lose-lose situation due to the rising level of global economic interdependence, 

particularly in innovative, IT-based industries). 

First a few words on issues of concern. From a U.S. perspective, China’s recent 

efforts to pressure foreign high-tech investors to collaborate with leading Chinese 

firms in developing advanced technology (e.g., wireless data encryption, computer 

software, and secure personal computer terminals) are disturbingly reminiscent of 

pre-WTO Chinese regulations.4 Other PRC government policies favoring domestic 

firms and technologies over, or to the exclusion of, foreign brands are also of continuing concern, particularly repeated stories of China’s policy on software to be procured for government use.5 Not only do such policies undermine the confidence of 

foreign investors in China’s long-term market potential, but they risk China’s continued high-tech development being viewed abroad as threatening to regional and 

global interests. Already, there is a rising level of alarm evident in industry and 

government circles over the rapid pace of international outsourcing and the movement of advanced R&D assets to China and other developing economies; implementing techno-nationalistic, protectionist policies such as these is likely only to 

reduce the level and type of foreign investment available to the Mainland over time 

and on which China’s long-term S&T plans depend.6

Another, related area of concern is China’s efforts to develop indigenous-design 

technology standards. While China’s interest in doing so is obvious and represents 

a goal shared by many states, Beijing’s approach to developing home-grown technology standards and their potential application to military technologies poses serious concerns for U.S. economic and security interests. The PRC is pursuing new, 
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7 Richard P. Suttmeier and Yao Xiangkui, ‘‘China’s Post-WTO Technology Policy: Standards, 

Software, and the Changing Nature of Techno-Nationalism,’’ NBR Special Report, no. 7 (May 

2004). 8The report also notes that creating new technology standards was highlighted recently as 

an overall strategy outlined by the Science & Technology and Education Leading Group (which 

falls under China’s civilian State Council) in a draft report published in 2004 entitled ‘‘Study 

on the Construction of National Technology Standard System.’’ The AmCham report also notes 

that the PRCG plays a ‘‘key role’’ by funding most and approving all national standard projects. 

See American Chamber of Commerce in China, ‘‘White Paper on American Business in China’’ 

(2004). 9Deloitte Touche Tohmatsu, ‘‘Changing China: Will China’s Technology Standards Reshape 

Your Industry?’’ (July 2004), available online at <http://www.deloitte.com/dtt/cda/doc/content/

DRlChangeChinalJuly2004%281%29.pdf>. 10 China’s spin-on approach has evolved since Deng Xiaoping first announced the strategy of 

‘‘Combining the Military and Civilian Sectors’’ (junmin jiehe). Today, the emphasis is less on 

defense conversion than on spin-on activities by civilian and defense industry enterprises for, 

or in concert with, China’s military (the PLA or People’s Liberation Army). China’s emphasis 

on ‘‘coordinating military and economic development’’ is noted in Beijing’s most recent Defense 

White Paper. See Information Office of the State Council, ‘‘China’s National Defense in 2004’’ 

(December 2004). See also Tai-Ming Cheung, ‘‘Harnessing the Dragon: Civil-Military Integration 

and China’s Defence Modernisation,’’ Richard H. Yang, ed., CAPS Papers No. 36 (Taipei: Chinese Council of Advanced Policy Studies, January 2004), particularly pp. 4–5. 11On the commercial side, see Kathleen Walsh, Foreign High-Tech R&D in China: Risks, Rewards, and Implications for U.S.-China Relations (Washington, DC: Henry L. Stimson Center, 

2003); and, for instance, ‘‘China, EU, and Galileo,’’ GPS World (September 1, 2003). Regarding 

the defense sector, see Richard D. Fisher, ‘‘The Impact of Foreign Weapons and Technology on 

the Modernization of China’s People’s Liberation Army,’’ commissioned report for the U.S.-China 

Economic and Security Review Commission, January 2004; and Eugene Kogan, ‘‘Russo-Chinese 

aerospace cooperation on the up: over 100 joint defence programmes are believed to be in 

progress; joint development of a commercial transport could be on the way,’’ Interavia Business 

& Technology, no. 669, vol. 58; p. 17 (1 January 2003). 

indigenously developed technology standards in a number of areas, primarily in the 

information technology sector, in an effort to become more competitive nationally, 

regionally, and across the globe.7 Unlike most other markets, however, China’s technology standards are often not the result of market competition, industry preference, or consumer choice but of PRCG priorities. Moreover, as reported in the latest 

report by the American Chamber of Commerce in China, ‘‘. . . member companies 

note a growing influence of standards working groups that either preclude foreign 

participation or attach certain technology sharing conditions. This is especially common where there is government-funded or encouraged R&D, or in sectors where 

strong resistance to foreign competition exists (e.g., construction and building materials).’’ 8

While it is true that foreign investors not interested in abiding by Chinese standards have the ability to opt out, the reality is that the China market has become 

such an influential and integral part of the global economy that whatever standard(s) prevail on the Mainland is likely to have global impact as well. There are 

few companies, including multinationals, willing or able to compete against such a 

force.9 Consequently, many foreign investors in the China market are quietly hedging their bets by developing new product lines compatible or interoperable with new 

or expected PRC standards. 

Indigenously designed technology standards are also intended to aid China’s military modernization efforts. PRC defense industrial modernization increasingly relies 

on commercial technology spin-on to defense applications.10 As with the U.S. military, China is seeking to exploit the ubiquitous nature of dual-use technology in a 

global economy and the move toward modular production in both commercial and 

defense industrial development. The emphasis on technology standards developed to 

Chinese specifications is expected to help reduce China’s vulnerability to foreign 

supply, enhance China’s competitiveness, and to limit opportunities for possible 

hacking, backdoor programming, or sabotage by foreign agents. The process of developing indigenous technology standards could also aid China in overcoming the hurdle of advanced systems integration. Though normally considered an important 

chokepoint in China’s development efforts (particularly on the defense side), systems 

integration could be less of an obstacle for China than generally presumed given ongoing R&D collaboration at foreign-invested R&D centers in China that often involve systems integration activities with, by, or for PRC partners.11

In fact, the number of foreign-invested R&D centers in high-tech industry sectors 

in China continues to rise, apparently rapidly. The latest statistics emanating from 

China’s own studies of this phenomenon list the total number of foreign high-tech 

R&D centers in China at 750 (as of the end of 2004). China’s statistics have varied 

widely over the past few years, with the most recent tally suggesting a one-year rate 
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12 Excerpts from China’s Ministry of Commerce’s think tank, the Chinese Academy of Foreign 

Trade and Economic Cooperation, 2005 Report of Transnational Corporations in China, cited in 

‘‘Overseas Investment on the Up,’’ China Daily (February 1, 2005). 13For information on foreign R&D centers in the ICT sector, see Walsh, Foreign High-Tech 

R&D. 14See ‘‘China is #1 for R&D Investments,’’ Economist Intelligence Unit (October 2004). 15Suttmeier and Yao; Martyn Williams, ‘‘Major Asian IT Groups to Collaborate on Open 

Source,’’ InfoWorld (November 14, 2003), http://www.infoworld.com/article/03/11/14/HNasianit 

groupsl1.html. 16See Ministry of Public Management, Home Affairs, and Posts and Telecommunications 

(MPHPT), Communications News, vol. 12, no. 22 (February 4, 2002), online at

http: // www.soumu.go.jp/joholtsusin/eng/Releases/NewsLetter/Vol12/Vol12l22/Vol12l22.html; 

MPHPT, Communications News, vol. 13, no. 14 (Oct 2002), online at http://www.soumu.go.jp/

joholtsusin/eng/Releases/NewsLetter/Vol13/Vol13l14/Vol13l14.html#3; and MPHPT, ‘‘Results 

of the Second China-Japan-Korea ICT Ministerial Meeting,’’ Communications News, vol. 14, no. 

12 (September 26, 2003) online at http://www.soumu.go.jp/joholtsusin/eng/Releases/NewsLetter/

Vol14/Vol14l12/Vol14l12.html#3. 17 Research conducted in Beijing (May 2004). Kathleen Walsh, ‘‘Sino-Korean IT Industry Cooperation and Regional Security Implications’’ paper commissioned by the Center for Strategic 

and International Studies (CSIS) International Security Program (June 2004). 18 ‘‘Asianux Gains Strength as Oracle Pledges Support,’’ ITNetCentral (26 July 2004) accessed 

online <http://www.itnetcentral.com/article.asp?id=13764&icontent=17147>. See also joint news 

release, ‘‘Official Signing Redflag Software, Miracle Linux and Haansoft for Co-development of 

‘Asianux’ ’’ (October 6, 2004), accessed online <https://www.miraclelinux.com/english/press/2004/

102601.html>. 19 China is planning to cooperate with Indian software companies to form an industrial alliance, according to the Sino-India Cooperative Office, which was established in December 2004. 

See ‘‘China and India join forces in software,’’ Sina.com (March 10, 2005), online at http://

tech.sina.com.cn/it/2005–03–10/0342546148.html. 

of growth of 200 new R&D centers in the 2003–04 period alone.12 This would seem 

extraordinary. While the measures used in determining this and previous totals are 

unknown (and thus their accuracy uncertain), indicators elsewhere also show the 

rate of overseas high-tech R&D investments rising at a fast clip. Statistics from the 

U.S. Bureau of Economic Analysis show that U.S. R&D investments in China have 

risen exponentially (from $7m in 1994 to over $500m in 2000), achieving the 11th 

spot overall in 2000 in U.S. overseas R&D investments (up from 30th place just six 

years prior). Given the rapid acceleration of foreign-invested R&D in China in the 

years since, it is likely that the Mainland holds an even higher place in overseas 

U.S. R&D investment today.13 In addition, a recent survey on the ‘‘Globalization of 

R&D’’ conducted with 100 senior high-tech executives by the Economist Intelligence 

Unit found that the majority (39%) favored China as the site for future overseas 

R&D investments over the next three years; the U.S. trailed at 29% and India at 

28%.14 Thus, foreign R&D investments in China represent an important trend and 

likely key, contributing factor to China’s high-tech development. Beijing supports 

this trend by continuing to provide attractive investment, tax rebate, and other financial incentives to foreign investors. 

Lastly, another interesting trend, though still in an early stage of development, 

is an emerging ‘‘techno-regional’’ approach to high-tech development. In the IT sector, China, Japan, and South Korea have signed agreements to collaborate on developing new technologies primarily, though not exclusively, for the Asian region.15

The three ‘‘CJK’’ parties have agreed to co-develop products in at least seven areas 

of IT technology, including 3G and next-generation mobile communications, nextgeneration internet (IPv6), digital TV and broadcasting, network and information 

security, open source software, telecommunications service policies, and the 2008 

Beijing Olympics.16 This model of development was recently applied in developing 

a new Linux-based computer operating system (‘‘Asianux’’) developed for the Asia 

market by China’s Red Flag Software Co., Japan’s Miracle Linux Corporation, and 

(since the product’s debut) Korea’s Haansoft software company.17 Asianux was 

developed in cooperation with the U.S. firm Oracle, through joint work reportedly 

conducted at Oracle’s China-based R&D center.18 While the political issues and 

challenges surrounding this model of development are significant, this apparent new 

regional approach to collaborative high-tech R&D could yield interesting and impressive results if these issues can be overcome. This model might also be applied 

with other neighboring states in Northeast, Southeast, and South Asia, as suggested 

by recent statements promoting increased Sino-Indian high-tech collaboration.19 If 

so, in these relationships, China is likely to continue to serve as the hub for regional 

high-tech investments, development efforts, and exports, particularly as China focuses on developing the central and western parts of the country, which are hungry 

for foreign investment akin to that witnessed along China’s east coast. 
105

20See, for instance, recent work by economist Gary Jefferson of Brandeis University on R&D 

in the China market, available online at http://people.brandeis.edu/∼jefferso/res.html. Also, see 

Maximilian von Zedtwitz, ‘‘Managing Foreign R&D Laboratories in China,’’ R&D Management, vol. 34, no. 4 (September 2004), pp. 439–452. 21 United Nations Conference on Trade and Development, ‘‘Investment and Technology Policies for Competitiveness: Review of Successful Country Experiences,’’ Technology for Development Series, UNCTAD/ITE/IPC/2003/2 (New York, NY: UNCTAD, 2003), p. 12. 22 Jefferson, ‘‘R&D and Innovation in China: Has China Begun Its S&T Takeoff?’’ 23For copies of these reports and supporting materials, see http://www.futureofinnovation.org, 

http://www.compete.org/pdf/NIIlFinallReport.pdf; and http://www.eia.org/docs/innovationl

playbook.pdf. 

This leads to your question: Is China successfully integrating R&D and know-how 

from foreign companies into the development of competitive domestic technology 

firms? The answer is probably, yes. Anecdotal evidence and ongoing studies of the 

impact of foreign technology transfer and R&D in China and elsewhere suggest this 

is the case.20 A recent U.N. analysis describes the typical process this way: 

. . . while the innovation function of TNCs [transnational corporations] is the 

slowest to relocate from the home country, particularly to developing countries, it does shift to affiliates over time. Given the availability of the highlevel skills and infrastructure (including R&D institutions and universities 

of sufficient quality), affiliates in developing countries do start to conduct 

R&D. They initially start with simple adaptive tasks, move on to process 

development, then move to product development and finally to basic (‘‘blue 

sky’’) research. Only a few economies have reached this stage, for example 

Singapore, Brazil, India, the Republic of Korea and Taiwan Province of 

China (China is catching up fast), and the amounts involved are small relative to TNC R&D in advanced economies, but the trend is clear.21

Additionally, recent statistical analysis of foreign and domestic high-tech R&D 

firms in China finds that China’s own enterprises appear to be more innovative, efficient, and profitable than many foreign-invested firms operating on the Mainland.22

Nevertheless, hard and compelling data on the R&D phenomenon in China are hard 

to come by and may only become available once a large number of PRC high-tech 

firms have emerged as competitors in the China market and beyond (which might 

be interesting from a historical perspective, but would come too little, too late for 

U.S. industry). The prudent course, therefore, is to assume, based on past experience in other developing countries, that PRC firms will learn from this dynamic, 

which if anything has been accelerated by recent globalization dynamics, and will 

become more competitive and innovative more quickly than imagined. This also 

places the emphasis where it belongs: on what the U.S. approach will be to an increasingly high-tech Chinese economy. 

U.S. Policy Response to Rising High-Tech Competition from China 

Several studies have been published over the past year or so examining the impact that globalization—and China’s economy in particular—are having on the U.S. 

high-tech industry. Among these is the recently published Task Force on the Future 

of American Innovation, the Council on Competitiveness’ Innovate America, and the 

Electronic Industries Alliance’s Policy Playbook on Innovation and Global Competitiveness.23 The common denominator among all these efforts is that U.S. technology 

policy is lacking in its response to the growing challenges posed by China and other 

developing countries in a global economic environment conducive to increasingly advanced forms of transnational research and development. As the evidence mounts 

that this trend is growing and likely to be a lasting phenomenon, U.S. policy must 

keep pace. 

Among the suggestions made in these reports and that make sense in the context 

of the U.S.-China trade relationship are the following:

• Increase funding for basic or fundamental research, which remains the 

key driver of innovation, development, and market competitiveness. U.S. Government funding of basic, non-defense R&D has declined over a number of years 

as China and other states are increasing their funding levels. Although U.S. 

funding overall far outpaces China’s, basic R&D funding represents an investment in America’s future and must remain a priority and be sustained over 

time if the U.S. economy is to maintain its competitive edge. 

• Work more closely and regularly with industry to analyze this complex 

challenge and to devise appropriate policy responses. Industry is on the 

front lines of this global phenomenon and the best situated to identify new and 

important challenges to U.S. economic competitiveness. Whatever policy pre-
106

24 Xu Binglan, ‘‘Plan Ponders Most Pressing Issues,’’ China Daily (6 April 2005), http://

www.chinadaily.com.cn/english/doc/2005-04/06/contentl431623.htm. 

scriptions are decided must also ensure that these measures aid rather than impede U.S. business and investment. Regular meetings of a high-level body comprising leading high-tech industry representatives, U.S. Government officials, 

and academic experts would benefit each community in keeping track of, and 

responding to, emerging challenges posed not only by China but by ongoing, 

fast-moving economic forces having an impact around the globe. The National 

Academies’ Government-Industry-University Research Roundtable (GUIRR) 

serves this purpose in part. However, such meetings would ideally involve a 

larger cross-section of experts, be conducted even more frequently, and be free 

and open to the public. 

• Work more closely with PRC counterparts. Chinese and American officials 

as well as analysts are trying to get a better read on overseas R&D investments 

and other aspects of globalization. While scientific and governmental exchanges 

occur regularly on a bilateral and multilateral basis in official and informal settings, these could be expanded further, if backed by U.S. Government funding, 

to improve cooperation on collecting data and discussing data collection techniques in the context of changing global economic dynamics. This is a common 

problem and could be addressed more effectively through enhanced cooperation 

and transparency. 

• Finally, the re-constitution of a resource such as the former Office of 

Technology Assessment (OTA) would be highly beneficial in gathering the 

interdisciplinary expertise that is needed to confront the challenges outlined in 

this hearing. The problem is too large and fast-changing for any single analyst, 

team, or even institution to monitor, much less analyze while taking into account the United States’ myriad economic, political, and security interests. An 

OTA-style research and analysis unit, particularly located in the Legislative 

Branch, would be a welcome asset and reserve in effectively confronting the ongoing challenges posed by globalization.

In Beijing, meanwhile, officials have begun to formulate the goals to be set out 

in the next or 11th Five-Year Plan, which will guide Chinese S&T efforts over the 

period 2006–2010. This plan will no doubt include further lofty objectives to which 

China’s S&T community will aspire. It is likely that among these goals will be to 

reach an R&D per GDP spending rate of 2%. Another focus, according to press reports, will be on enhancing domestic development efforts, particularly in China’s 

central and western provinces, in part to alleviate the widening disparity in income 

between coastal and inland areas. Also, in the next phase of China’s technological 

development, Beijing is seeking to move China from an imitation to an innovative 

stage of production or, put more colloquially, from ‘‘made in China’’ to ‘‘made by 

China.’’ Beijing’s strategy of pursuing ‘‘informatization’’ in civil and military development and the promotion of indigenously developed high-tech standards are designed to further this ‘‘made by China’’ goal. 

But perhaps more important than China’s stated goals in the upcoming plan will 

be how PRC officials seek to achieve these objectives. The upcoming FYP may be 

telling in this regard. If, as recent press reports suggest, the next strategic plan focuses more on establishing guidelines than on outlining a detailed ‘‘blueprint’’ and 

specific targets for S&T development, it may reflect a new and more successful approach to enhancing China’s S&T capabilities.24 That is, the plan could more resemble long-term development strategies followed in technologically advanced economies 

than the PRC’s own traditional planning documents. If so, this would suggest a new 

understanding of modern S&T development and innovation policy and could prove 

more successful than past plans, which have not fared particularly well against the 

historical record. In this case, we could witness a more S&T-advanced industry on 

the Mainland than previously expected, perhaps within the next five or so years. 

PRC officials have of late also shown greater flexibility in planning and their approach to S&T development, demonstrating a willingness to review funding programs, alter course if necessary, and experiment on an interim basis. China is also 

becoming more transparent in its S&T statistics and analysis, in other words, willing to admit some failings as well as successes. As a result, efforts to engage PRC 

experts and officials on what are sometimes sensitive issues are becoming easier 

and bearing more fruit than in the past. This presents a potential new opportunity 

for U.S.-China relations. 

I thank you for your time and consideration of these remarks. I look forward to 

any questions you may have.
107

Panel II: Discussion, Questions and Answers 

Chairman D’AMATO. Yes. Thank you, Ms. Walsh. 

Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thank you very much, Mr. Chairman. Thank you to all of our witnesses who I hope will indulge me 

on a question that’s a little bit off of the R&D but I think has an 

impact. 

Last week our Commission had a hearing on the Chinese government’s control of media and access to information, including particularly the Internet. During the Q&A, one of the issues that came 

up was concerns about the impact of what I would call and other 

people sometimes call, the ‘‘long arm of Chinese censorship on 

American scholarship about China.’’ Academicians, graduate students here cannot ask certain kinds of research questions. They 

have to be careful about the topics they pick because if they pick 

the wrong thing or ask the wrong question they find that they don’t 

have access to China, they don’t have access to the information 

that they need. And, in fact, it seems to be having an impact on 

a younger generation of scholars who are choosing other topics, 

which I think has consequences for us in terms of how we understand China as we move forward. 

Dr. Pillsbury, you mentioned that no Sputnik moment, which 

strikes me as quite similar to the Chinese strategy of intelligence 

gathering, which is a grain of sand here, a grain of sand there, and 

you keep everything underneath the proverbial radar screen so 

there’s no ah-ha moment. And by the time people have figured out 

what’s going on, they’ve got what they need and they move on. 

Ms. Walsh, you talked a little bit about this. What I’d like some 

sense of is: How complete and how thorough do you think our understanding is of what is going on in terms of Chinese R&D? 

We’ve heard conflicting things already. Some people believe that 

they have the capacity to do innovation. Some people believe that 

they don’t have the capacity to do innovation. It gets to what Secretary Rumsfeld has said: We know what we know. We know some 

of what we don’t know, but we don’t know what we don’t know. I 

just wondered if you could give us an honest assessment of the 

body of information, how accurate is it, how thorough? Thanks. 

Dr. SUTTMEIER. Well, I’ll take a crack at that. You know some 

of us started in this business a long time ago, and there wasn’t 

much to go on at all. So we kind of pulled together little bits of 

pieces of information here, there, so forth, and so on. That has 

changed dramatically. 

I think of these days as as some wags have put it, the problem 

is not getting access to data, it’s being able to process all that there 

is. Now for sure, I think you always have to regard Chinese statistics and other kinds of data with due caution, but there’s just an 

enormous amount there. 

With regard to statistical data pertaining to research and innovation, the system is still coming into being. It’s not perfect yet. So 

if we look at, for instance, the standard science-and-technology indicators that China now produces, these are the result of a slow 

process of 15, 20 years of normalizing Chinese approaches to that 

with international approaches. But there is quite a lot of data out 

there. 
108

I made reference in my written testimony to recent work by Albert Hu and Gary Jefferson which uses a new source of data that 

really wasn’t available to foreign researchers until very recently, 

primarily data that is used by the State Statistical Bureau in its 

compilations of national statistical reports. 

So I would say that in general, while there are still data problems, there is a world of difference from the past. China has become a fairly open place and not only in terms of data but in terms 

of other kinds of access. 

I and others have been invited to serve as consultants to Chinese 

government organizations on matters of science and technology. 

This has involved visits to institutes, discussions with high-level 

leaders, and so forth. Such activities would have been unimaginable in the recent past. 

For instance, we have served as commentators on the preparation of China’s long-term R&D plan, now in the final stages of 

preparation. Inviting foreigners into something like this is a sea 

change; in the past, such plans were guarded, very closely held by 

the government. 

So to me I think that there’s an enormous openness with regard 

to data as long as you kind of understand what the continuing constraints really are. 

Ms. WALSH. Could I just add to that? I agree completely with 

what Dr. Suttmeier said, but I also notice that it’s by the invitation 

of the Chinese to come and cooperate. That says to me two things. 

One, that I think we should be exploiting this and that there’s an 

opportunity there to push the Chinese for more of this kind of information. They’ve become more transparent. 

I just downloaded their statistical yearbook, all one thousand 

pages of it, from the Internet, which I thought was phenomenal 

too, because you used to have to troll through the library to go find 

these things. So I think this is a real opportunity then that we, the 

government, the U.S. industry should be pressing China to do more 

of in order to have a better understanding of their statistics, how 

they’re changing their own statistical-collection methods, and what 

are the issues that they’re interested in. I think it’s an opportunity. 

It would be a plus for us as well as for the Chinese who are obviously interested in these issues. 

Dr. SIMON. I think one of the most promising areas is this decision by the National Science Foundation now to open up an office 

in Beijing. And, in short order, there will be someone I think that’s 

going to take residence or has already taken residence. I think that 

will help to provide some better insights into what’s going on. 

What we really need more of is a marrying together of expertise 

on China with people who have science and engineering backgrounds, and having people basically who understand something 

about the culture and the social science dimensions of life and organization in China and somebody who understands what it takes 

to put through a biotech project or someone who understands what 

it takes organizationally and structurally to successfully manage a 

nanotech project. 

Around the United States, there are an assortment of scientists 

and engineers who on their own are working on projects, are working on cross-border innovation and collaboration. The problem is 
109

that we have never really pulled these things together to come up 

with a more complete comprehensive picture, so we get anecdotal 

information. We get a story in the Chinese press, but what does 

that really mean? How good is that chip? How good is that computer? Has IBM and Sun, et cetera, gone in and looked at the new 

so-called supercomputer that the Chinese have developed and what 

is their assessment of it? 

We need to be doing more of these kinds of things to really understand how fast the Chinese R&D system is able to put out such 

kind of new innovations. 

Commissioner BARTHOLOMEW. Dr. Pillsbury. 

Dr. PILLSBURY. I agree with my three fellow panelists, but I 

would add a twist to it based on my own experience in DOD. The 

Chinese are the most open to the United States in areas where 

they want help from us. They can be remarkably open. 

I have been into very sensitive Chinese military factories, one of 

which they make ICBMs. I was just kind of poking around and I 

saw they also made air conditioners and other things. I said, there 

doesn’t seem to be even any line, and I got a long explanation 

about why that is. 

A lot of Americans from DOD, some in uniform, have been into 

very sensitive Chinese military installations, going back 20 years 

ago—when they wanted our help in that area. However, where I 

would disagree, I’m afraid, is that any area which would tend to 

give us a sense of threat from China that they’re going to be competitors, there was one Congressman said a couple of months ago, 

will eat our lunch in science, that’s quite difficult to get in. You 

suddenly discover that that person isn’t in town this month or it’s 

not convenient to take you out to see that particular facility. 

So I tend to be a little bit cynical that our own—I’m not sure the 

Commissioners know this yet. We still help China a great deal in 

science and technology to many other areas of competition and the 

U.S. Government takes the lead. It’s not the private sector. This 

Commission’s concern about currency manipulation led to a Treasury Department mission of many people to go into China last year 

and help them improve their banking system, in extremely helpful 

ways to them. They’re very grateful. The system of giving loans, 

the system of how to check credit rates, the system of how our 

banking system works. 

Those who practice this inside the U.S. Treasury and Federal Reserve and the banking examination system all went to China to 

help them improve what they have been saying for several years, 

is one of the greatest areas of competitiveness that they face, their 

banking system. 

The Department of the Treasury helped them a lot last summer, 

and do you know the reason for this mission? Because of Congressional concern and this Commission’s concern with currency manipulation, and the Chinese had given the reason why they can’t repeg 

or float is because our banking system is in so much trouble. So 

what did the U.S. Government do? We’ll help you improve your 

banking system. 

Now we did this with their airliner program. I remember visiting 

the factory in Shanghai in the ’80s where there were four FAA GS–

15s embedded in the McDonnell Douglas factory helping them get 
110

the precision making of the parts correct. And I said, ‘‘Excuse me. 

Why are you doing this? You’re Federal employees from the FAA?’’

They said, ‘‘You don’t understand. It’s our policy to help the Chinese airline industry get going, airplane manufacturing industry 

get going. If they don’t manufacture their parts to specifications, 

they can’t sell these airliners on the international market,’’ which 

that makes sense to me. 

When the Tiananmen sanctions were put on, the DOD stopped 

various programs. That one didn’t stop. And China just recently 

announced selling its first 50 airliners overseas made in that factory. So not only morally does the U.S. Government help China become more competitive but also it’s a matter of national policy. 

So I go back to your comment this morning, Commissioner Bartholomew, about the tail-chasing metaphor. The tail-chasing metaphor is not right. It’d be as though we’re reaching back and giving 

food to the tail-chaser and say, come on and not perceiving the tailchaser that way at all. So I think we need a better metaphor to 

capture what is going on. 

Chairman D’AMATO. Thank you. I have a quick followup question 

to that broad inquiry that Carolyn Bartholomew made on the level 

of understanding what we know. During the Cold War, as I remember, we had a very substantial, robust intelligence community collection process dealing with Soviet science and technology. 

My question is, Dr. Pillsbury, within the limits of an open hearing, what is your impression of the depth and quality of U.S. intelligence analysis to collect and monitor foreign science-and-technology developments, particularly with regard to China? Has that 

capacity atrophied or do we still have a substantial and robust capacity to evaluate Chinese S&T? 

There might have been an ‘‘NIE’’ on Chinese S&T in the past, 

but I don’t remember it. Can you shed any light on that? 

Dr. PILLSBURY. Are you addressing this to Dr. Simon as well as 

me? 

Chairman D’AMATO. Dr. Pillsbury. 

Dr. PILLSBURY. I would say, in the first place, that our intelligence community suffered massive cuts as part of the end of the 

Cold War, so everything got cut drastically. 

Secondly, the intelligence community as I’ve always understood 

it needs clients. It wants the President and the Cabinet to demand 

information and analysis on a topic, so you’d have to ask yourselves 

just rhetorically how much of a client base has there been for studies of Chinese science and technology? I would submit almost zero. 

And so if the intelligence community is doing its budgeting job 

properly, and I have no reason to believe that they’re not, I would 

expect their capacity to analyze science and technology would be 

quite low. 

Thirdly, I would say there have been a number of academic seminars, Princeton has had some of them, on NIEs done against the 

Soviet Union and one recently at the Wilson Center on the NIEs 

against China. I noticed, as you say, Mr. Chairman, the effort on 

the Soviet Union focused a lot on their science and technology, 

their R&D, and their new weapon systems. 

I notice when the Chinese NIEs were released by the intelligence 

community a few months ago there’s almost nothing on Chinese 
111

science. It’s what Dr. Suttmeier referred to—I forgot the exact 

phrase—but how 20 or 30 years ago there was almost nothing to 

go on. So those three indicators suggest to me that there’s very little, if anything, on Chinese science by the intelligence community, 

that they believe this is a good thing, that there’s simply no clientbase concerned about it. It’s back to the Sputnik shock, is simply 

not there and the old paradigm that they’re poor and backward and 

our quasi-allies. So who would want to do an assessment of how 

a quasi-ally’s science and technology is going unless you wanted a 

national competitiveness strategy. 

If you want to build the kind of thing that your Commission recommended last year, that long section in the Report on the National Competitiveness Strategy, you would need to compare American efforts over the next ten years with what China’s is likely to 

do. 

And my suggestion in my paper is we simply don’t have the—

despite the work of Dr. Suttmeier, I don’t mean to criticize him, 

but—and Dr. Simon—we don’t really have the kind of knowledge 

that would lead Members of the House and Senate to say, ‘‘Oh, my 

God, we need a National Chinese Strategy. What a challenge we 

face from China.’’ We don’t have that today. In fact, we have quite 

the opposite: Everybody stressing that, oh, they’re pretty backward 

still except for a few small exceptions. 

Thank you. 

Chairman D’AMATO. Thank you. 

Ms. Walsh. 

Ms. WALSH. Can I just add two cents on that? I think that’s correct, but I think a lot of the prejudice perhaps has been that the 

interest, of course, has been on China’s military modernization and 

defense industrial capabilities, which of course lag the commercial 

side. But today they’re learning from the commercial side. So this 

is generating new interest today in looking at the commercial sector for lessons learned and what they may mean for China’s military modernization. So I think this is starting to happen. But I 

think that also explains why there’s been less interest in China’s 

S&T because on the defense side China has obviously shown much 

less capacity. 

Chairman D’AMATO. Thank you very much. 

Dr. Suttmeier, yes. 

Dr. SUTTMEIER. Well, just on the point that Dr. Pillsbury made 

about viewing China as sort of a poor—I didn’t mean to myself in 

this testimony say that there is no progress here. This is going to 

be a major, major player, no question about that. 

But I think what’s very important is to begin to get a sense of 

balance. Consider the issue of comparisons with Japan from an earlier period. I think the issue is not does China compare with Japan, 

it’s more do our perceptions of China in the twenty-first century, 

how do they compare with our perceptions of Japan in the late ’80s 

and the early ’90s, and what were the knowledge bases for the 

judgments we made then and the judgments we make now. 

And I think that in many ways we made lots and lots of 

misjudgments because we didn’t look as carefully as we might have 

at underlying vulnerabilities. So I think that what I’m trying to 

argue here is that I think we need to pay attention to both, because 
112

otherwise you will get these wild swings over very, very exaggerated claims about China and its potential without looking at any 

of the weaknesses, or you’re going to wind up with the China as 

the poor, underdeveloped quasi-ally. I mean it’s neither, and I 

think it’s important to get that right. 

Chairman D’AMATO. Thank you. 

Dr. SIMON. Just a quick point. It not only deals with the intelligence community but also the role of science attaches in our embassies and consulates around the world. 

A number of years ago, there was an effort through the State Department and through the Foreign Service to basically create a formal career track for the training and positioning of people abroad 

who really did have science and engineering backgrounds and for 

them to become Foreign Service officers and therefore to be astute 

observers of what was going on. 

That went through a tremendous amount of effort to get that 

going, but it never got any traction. The National Academy of 

Sciences has made recommendations about this, in the sense of 

putting more of these kinds of people out, out in the field and creating a more professional track. That still hasn’t happened. And 

then the Foreign Service Institute has pulled back on its training 

of people particularly in those areas. 

It is very clear that we need more people who can understand 

what is nanotechnology all about when they’re out in the field. 

They don’t need to have a deep necessarily, totally scientific Ph.D.-

level understanding, but we need to have more people out who are 

professionally trained and aware of what’s going on in these fields 

so that they can report back. And also, on the other side, that there 

are customers. 

It’s no good to report on nanotechnology in China in a very sophisticated technology report if there’s nobody in the State Department and the intelligence community, et cetera, who’s going to read 

the report. 

Chairman D’AMATO. Well, they could report to the Commission. 

Dr. SIMON. They could report it to the Commission, that’s true. 

But that’s the point——

Chairman D’AMATO. A new client. 

Dr. SIMON. No, but we do need to, I mean that problem is part 

of a larger issue that we need to face up to. 

Chairman D’AMATO. Thank you. 

Commissioner Mulloy. 

Cochair MULLOY. Dr. Simon, I see that you’re with the Levin Institute at State University of New York. Is that named after Neil 

Levin? 

Dr. SIMON. Yes, it is. 

Cochair MULLOY. I had the great pleasure of working with Neil. 

And I believe, Blanche and I, when he was on the staff of the Senate Banking Committee. 

Dr. SIMON. Oh, okay. 

Cochair MULLOY. He was a wonderful young man, and you’re fortunate to be working in that institute. 

Dr. SIMON. Thank you. 

Cochair MULLOY. He was killed on 9/11 in New York, so I just 

wanted to mention that. 
113

Dr. SIMON. Thank you. 

Cochair MULLOY. Dr. Suttmeier, you said, and I want to get this 

because I think it’s an important one, that the scientific community 

and the corporate community all think it’s good to be doing what 

you’re doing in terms of interacting science and technology with 

China, et cetera, but that the politicians perhaps don’t fully appreciate this and you asked us to be a channel or something. 

Do you ever think that the politicians are in touch with the people and that they’re transmitting signals back to the policymakers 

that the people aren’t benefiting from all this way or have some 

concerns about it? And maybe the reverse signal should be given 

to the scientific community and the corporate community that 

there are some concerns that need to be addressed here? 

I worked for the Congress for a number of years, and these people are out there and they’re picking up signals and then they try 

to transmit to the policymakers. 

Now Dr. Pillsbury has told us at the highest levels of the Japanese government, they’re seized with science and technology——

Dr. PILLSBURY. Chinese government. 

Cochair MULLOY. —Chinese government, they’re seized with 

science and technology as the way to move the country forward 

both standard of living wise and I think national strength wise, 

which means expanding influence, et cetera. 

I’m not sure that we’re fully grasping that among our policymakers, understanding that this is a national mission that these 

folks are engaged in. Then you read this nice testimony by Alan 

Wong, who is in the business community. He says, ‘‘It seems that 

China is becoming master of the game of attracting foreign investment and technology, creating jobs, rapidly raising standards of living for its people.’’ And God bless them, fine. If I were them, I’d 

be doing the same. But then we have to say: What is the impact 

on us? What is the impact on our standard of living? 

Mr. Wong goes on to say, ‘‘China appears to have given up very 

little in terms of [market access or] its own resources’’ or anything 

else. It may be getting a lot, not giving very much in terms of benefiting us. 

Does anybody think that Dr. Pillsbury has put his finger on 

something quite important that we should focus on and look at this 

with a little more caution and critical eye? I would ask Dr. Simon 

and any of the others to comment. 

Dr. SIMON. Maybe I’ll take a quick crack. First of all, it’s not that 

all of a sudden we’ve discovered some deep secret among Chinese 

leaders, that they’ve had this stated policy. Since the early ’80s the 

Chinese government under Deng Xiaoping and under subsequent 

leaders have all articulated the same message: Our goal is to close 

the technological gap between China and the rest of the world, to 

do it rapidly and to do it utilizing a combination of foreign technology and foreign investment. It’s been the stated policy. 

We haven’t paid much attention to it. I would make the argument that the reason why it didn’t have much meaning for us early 

on is because the Chinese didn’t have any leverage in order to 

make that happen. As we moved from the 1980s to the mid 1990s 

and beyond, the Chinese market itself became a form of leverage, 

manifested in the increasing appearance of consumers who had dis-
114

cretionary incomes to buy things, first some basic things like nice 

clothes and then moving up to cars and computers. They used to 

talk about the ten or eight most precious gifts that everyone had 

to have, from a digital watch to a VCR. And today, we talk about 

cars and computers and houses, multiple houses for some Chinese. 

So the fact that we’ve got these active consumers, 250 to 300 million out there, is a tremendous amount of leverage in the marketplace that wasn’t there. So, I think that’s the first and most important thing, that the Chinese now have something to leverage out 

in the market. 

Second of all, the next thing that they’ve got going for them now 

is what we’ve all talked about, that is, they’ve got a steadily improving science-and-technology human resource base. And that 

human resource base, largely in many cases under utilized or unutilized scientific and technical personnel, they are a very critical 

asset if you look at the new models of innovation that are occurring. 

And we’ve heard from people this morning that they are working 

in transnational, multicultural teams. We’ve heard about virtual 

teams. That’s the world of innovation for the twenty-first century. 

And China now can play in that game; where before it was just a 

marginal player, it’s now becoming more of a central player. 

Cochair MULLOY. Anyone else? 

Dr. SUTTMEIER. I would substantially agree with that. I would go 

back even further. I think that the importance of being competitive 

in science and technology has been a founding principle of the People’s Republic of China. One of the things to remember is how 

much of an effort was made in the 1950s. We talk about 1.3 percent of GDP now being spent on R&D. In the 1950s the Chinese 

were spending more like two, two and a half. So there’s a lot of 

background in all of that. 

I think that going back to the other part of question, Commissioner, about under estimating the judgment of the political community, perhaps I am. I think what I’m really saying is that I 

would like to see more leadership from the political community 

that is smart. 

We’ve heard various points in the course of the discussion this 

morning about one kind of policy and another kind of policy that 

we should be doing that we’re not doing. I think that’s my fundamental bottom line, is that we may not be as far apart on that as 

possible. But if you’re going to do that, if you’re going to have an 

effective national strategy, then I think you focus on, first of all, 

some of the things that the innovative parts of the community are 

involved with, their knowledge of this China. Then you don’t do the 

kinds of things that are going to work directly against it. 

I think the message that I kept hearing this morning is the extent to which government in some cases really is working against 

national well being in terms of our own innovative capability, and 

that’s my concern. I think that what I’m really arguing for is attention to this potential divergence and much more of a bipartisan, integrated national strategy to begin to address this kind of thing 

with China as a reference point. 

Chairman D’AMATO. Thank you very much. 
115

This concludes the morning session. We’re going to adjourn for 

lunch. Thank you. 

[Whereupon, at 1:21 p.m., the hearing was recessed, to reconvene 

at 2:15 p.m., this same day.] 

AFTERNOON SESSION, 2:15 P.M.

THURSDAY, APRIL 21, 2005

OPENING STATEMENT OF COMMISSIONER PATRICK A. MULLOY

HEARING COCHAIR 

Cochair MULLOY. I want to join the Chairman and the Vice 

Chairman in expressing the Commission’s appreciation to Stanford 

University, our former colleague Ambassador Ellsworth, and all the 

others who have helped in making this event possible out here 

these next two days, today and tomorrow. 

The issues we are discussing are of vital long-term economic and 

national security interests of the United States. It is important 

that we discuss them here in Silicon Valley, the nation’s hub of 

technology development and innovation. 

I think what Americans need to understand is that the fastest 

growing sector of our trade deficit with China is in high-technology 

goods. So policymakers in Washington need to understand what is 

driving the rapid advance of China’s technology sectors. While 

some observers see this as just the inevitable result of global market forces, there appears to be more to it than that. I don’t think 

it’s just market forces. I think there are things going on here. 

As the Commission’s past work has documented, the Chinese 

government is following a coordinated and comprehensive strategy 

coupled with policy incentives to build up its technology capabilities 

and foster the emergence of globally competitive companies. I don’t 

fault China for having a well-thought, thorough, well-coordinated 

strategy to build up its technology competitiveness as long as that 

strategy does not violate its WTO or other international obligations. 

I am concerned that our own country has not recognized our current situation and has no strategy to deal with the emerging challenges. That is why we’re here, to try and get from the witnesses 

an understanding of what is really happening out there and what 

we as a nation should be doing. 

This afternoon we continue our discussion with a panel of renowned observers of the U.S.-China high-tech trade and investment relationship. We have Dr. Henry Rowen from here at the 

Hoover Institution; Mr. Ernie Preeg of the Manufacturers Alliance, 

a longtime public servant of the United States Government; Mr. 

Eamonn Fingleton, author of Unsustainable: How Economic Dogma 

is Destroying American Prosperity; and Professor John Zysman of 

U.C. Berkeley and Co-director of the Berkeley Roundtable on the 

International Economy. He has authored, among other books, one 

that we read at least ten years ago, Manufacturing Matters: The 

Myth of the Postindustrial Economy. 

I’m delighted to have all of you here today. Let’s proceed from 

left to right, Mr. Rowen, Dr. Zysman, Dr. Preeg, and Mr. Fingleton. 

[The statement follows:]
116

Prepared Statement of Commissioner Patrick A. Mulloy

Hearing Cochair 

I would like to join the Chairman and Vice Chairman in expressing the Commission’s appreciation to Stanford, our former colleague Ambassador Ellsworth, and all 

the others that have made this event possible. The issues we are discussing today 

are vital to the long-term economic interests of the United States, and it is important that we discuss them in Silicon Valley, the nation’s hub of technology development and innovation. 

The realities of China’s rapid economic advancement are well known. What is perhaps less well understood, however, is the broad spectrum of industries, including 

advanced technology sectors, for which China poses competitive challenges to the 

U.S. economy. A recent report prepared for the Commission by the Economic Policy 

Institute concluded that ‘‘China’s exports to the United States of electronics, computers, and communications equipment, along with other products that use more 

highly skilled labor and advanced technologies, are growing much faster than its exports of low-value, labor-intensive items such as apparel, shoes, and plastic products.’’ The report further found, remarkably, that the United States is now running 

a $32 billion trade deficit with China in goods classified by the U.S. Department 

of Commerce as Advanced Technology Products. 

The U.S. technology industry is clearly taking note of these dynamics. In it’s 2005 

report, entitled Losing the Competitive Advantage, the American Electronics Association, whose president, Bill Archey will be testifying later this afternoon, made 

several key findings: First, ‘‘America needs to recognize that future innovation is not 

predetermined to occur in the United States’’ and that ‘‘even if we were doing everything right, we still face unprecedented competition from abroad.’’ Second, that 

‘‘China is already the world’s manufacturing hub and now is moving up the production line to promote higher end technology firms, creating sobering competition for 

companies and workers around the world.’’

Policymakers in Washington need to understand what is driving the rapid advancement of China’s technology sectors. While some observers see this as the inevitable result of global market forces, there appears to be more to it than that. As 

the Commission’s past work has documented, the Chinese government is following 

a coordinated and comprehensive strategy, coupled with policy incentives, to build 

up its technology capabilities and foster the emergence of globally competitive companies. 

As highlighted in the Commission’s 2004 Report to Congress, the two key components of China’s technology strategy are (i) to encourage foreign investment in areas 

where domestic capabilities are lacking and (ii) to limit foreign access to markets 

where domestic industries are gaining economies of scale. One such policy is the requirement that only domestic software or ‘‘qualifying foreign software’’ may be purchased by government entities. The criteria for qualifying foreign software have yet 

to be defined. The absence of such criteria has inhibited U.S. manufacturers from 

entering into government business and appears intended to shut foreign firms out 

of this lucrative market. 

A second example is China’s development of unique technology standards. By creating such standards, China has attempted to use its market leverage to promote 

standards that it controls, such as for wireless communication and digital music, 

rather than internationally recognized standards that are already in wide use. We 

will hear extensive testimony on this practice during the hearing. 

I do not fault China for having a well thought-through, well-coordinated strategy 

to build up its technology competitiveness. Instead, I am concerned about the U.S. 

response. Technology competitiveness and innovation is a signature of our economic 

well-being and we cannot allow our competitiveness to wane. As we recommended 

in our 2004 Report to Congress, ‘‘the U.S. Government must develop a coordinated, 

comprehensive national policy and strategy designed to meet China’s challenge to 

the maintenance of our scientific and technological leadership,’’ along the lines of 

the national security strategy that is currently developed to address our global military and political challenges. 

This afternoon we continue our discussion with a panel of renowned observers of 

the U.S.-China high-tech trade and investment relationship: Henry Rowen, from 

right here at the Hoover Institution, Ernest Preeg of the Manufacturers Alliance, 

Eamonn Fingleton, author of ‘‘Unsustainable: How Economic Dogma is Destroying 

American Prosperity,’’ and Professor John Zysman of UC Berkeley who authored, 

among other books, ‘‘Manufacturing Matters: The Myth of the Post-Industrial Economy.’’

They will be followed by a panel examining the challenges China poses over the 

long-term to U.S. technology leadership. We are pleased to have with us Bill Archey, 
117

President of the American Electronics Association, Rhett Dawson, President and 

CEO of the Information Technology Industry Council, and John Ciacchella, Vice 

President at A.T. Kearney. Mr. Ciacchella conducted two studies this past year; one 

exploring the economic impact of offshore outsourcing on the Bay Area, and another 

(due out soon) consisting of interviews with 300 high-tech leaders assessing their 

competitiveness in today’s market. 

Thank you all for being here today, I look forward to this afternoon’s panels and 

tomorrow’s session.

PANEL III: DYNAMICS IN THE U.S.-CHINA HIGH-TECH 

RELATIONSHIP 

STATEMENT OF HENRY S. ROWEN

PROFESSOR EMERITUS, GRADUATE SCHOOL OF BUSINESS

SENIOR FELLOW, THE HOOVER INSTITUTE

EMERITUS DIRECTOR, THE ASIA PACIFIC RESEARCH CENTER

STANFORD UNIVERSITY, STANFORD, CALIFORNIA 

Mr. ROWEN. Thank you, Chairman. It’s a privilege to be invited 

to appear before this group. I attended some of this morning’s session and so I will not dwell on topics that I know you’ve already 

discussed today. I’ll say a little bit about a few of them. 

The four topics I want to touch on very briefly, the place that’s 

been called China’s Silicon Valley—a lot of places get called as Silicon Valley—this place in Beijing is one of them. In China it’s actually in competition with Shanghai. Shanghai’s more silicon, but 

that’s a detail. 

The importance of international linkages, which has come up, 

certainly a lot this morning. The concept of value added and some 

indicators of the rise of Chinese science. 

Now Zhongguancun. There are a lot of letters there. ‘‘ZGC’’ for 

short. It has the largest concentration of high-tech companies. 

12,000 is the nominal number. There are not 12,000 real companies. At most there are maybe 8,000, and some of the 8,000 are 

questionable, if you really properly identify what’s a company. About 400,000 workers. Total revenues in year 2002 of $29 billion which is rather less than the Intel Corporation, so just to put 

it in scale. But it’s grown enormously. 

In 1998 there were only 527 companies, by the count there, with 

10,000 workers. So in a quite short period of time it’s just grown 

enormously. This region, by the way if you know Beijing which I 

imagine you do, is the west side of Beijing. It’s a big area. It’s 

where the major universities are located, the research institutes, 

and now all these companies. 

It’s an officially designated science park, but the place began to 

take off before it was called a science park, designated a science 

park, and it took off for an obvious reason: The government ministries are in Beijing with the research institutes there. As soon as 

the economy began to be liberalized, it was just natural for people 

to start setting up companies there. And some of the leading companies, in fact, came out of the Academy of Sciences, Legend, 

Lenovo, Founder, and others, out of universities as well. And they 

stayed where they were. 

And for telecommunications companies, in particular, as is in 

this country, it pays to be near the seat of power, political power. 

That’s why you see in the beltway so many telecommunications 

companies. It’s the same thing in Beijing, be where the action is 

and where the money is. 
118

So the environment that was there, especially before the creation 

of this science park idea, had pluses and minuses. And the pluses 

were significant: Well-educated, talented people. These research institutes. Governments applied finance. You can say that’s a negative, maybe a positive, but under the circumstances it was a positive because otherwise there was no way of getting money. 

The negatives were very substantial: Inadequate legal system—

still is. Weak financial institutions—still true. Micromanagement 

by government bureaucrats—maybe there’s less of that now, I’m 

not sure. And isolation from world markets—well, that has certainly changed. Less isolation. 

By the way, Mr. Wortzel, this morning—is he here? He quoted 

from my paper this estimate of 40,000 products coming out of the 

research institutes to the market. That’s not my estimate. That’s 

an estimate of the Zhongguancun Park Administration. I have no 

idea what those 40,000 products are. 

Well, helping greatly with some of these difficulties was the arrival of foreign firms into ZGC. China gets most of its technology 

from overseas and multinational companies are the main source. 

So in 2002 in ZGC they accounted for 43 percent of total revenues 

and 78 percent of exports, a very huge proportion. But what’s being 

acquired, what these companies are bringing in is not just technology. It’s a package and it’s the package that matters. And the 

package includes management skills, products, obviously the product inputs, talent, and ideas. All of the above comes with the 

money. The capital is the least important part of it, and technology 

is certainly an important part of it, but it’s the other stuff as well. 

As I’m sure this Commission knows and undoubtedly has discussed China’s poor protection of intellectual property causes these 

foreign companies to try and restrain the transfer of advance technologies to China because they have the feeling it will be lost. But 

a lot flows, a lot of less advanced technology certainly flow. 

Another kind of capital that’s flowing is human capital, of which 

there’s a great deal of it flowing. And in ZGC by 2002, 4900 returnees had started 1800 companies. During 2001 and 2002, it was 

about two per working days, two new companies per working day 

by the returnees, which is kind of impressive. 

Now I don’t know the fate of these companies but, judging from 

the Silicon Valley experience, it would not be surprising if a lot of 

them failed, but maybe a lot of them succeeded, too. 

University business links. These have been very important there. 

Unlike anything seen in the U.S. or really any other place in the 

world, the university linkages with business. 

For various reasons universities founded and they own many 

companies. The estimate for Tsinghua University and Beijing University is each about 200 companies. And you might ask why did 

this happen. Well, historically it made a great deal of sense for this 

to happen. But in the view of the university leaders now in these 

places, those relationships are problematical and they need to find 

out a way to disentangle this ownership of companies. I imagine 

that this will be changed in the years ahead so that have more of 

a separation of the universities from these companies. 

The big obstacle for China’s high-tech future, and others have 

mentioned this, particularly Professor Suttmeier this morning, the 
119

future is bright, there’s no question about that, but the challenges 

are very substantial. And it’s essentially on the building of institutions: Institutions of law; finance; management skills; and learning 

how to create technology. Viewing it from the perspective on research, which has been on information technologies, we don’t see 

anything very impressive coming out of China so far. It’s quite 

unimpressive. But that doesn’t mean it’s not going to be, but so far. 

Foreign links has been mentioned. All I will say is it’s enormously important. I’m struck by one fact. I think it’s a fact: 81 percent of the members of China’s Academy of Sciences have studied 

abroad. 

Cochair MULLOY. Eighty-one? 

Mr. ROWEN. Eighty-one percent, mainly in the United States. 

That’s extraordinary. It’s like 81 percent of the U.S. Academy of 

Sciences, say a hundred years ago, having studied in Germany. I 

mean I’m sure that many did, but probably not 81 percent. 

Value added. Most of the numbers that you see and I see and 

that everybody see quoted widely are almost everywhere, the statistics, press, everywhere, are gross numbers, revenues, total revenues, total sales, et cetera. Well, they’re relevant, but they can be 

very misleading. 

In the first quarter of 2005 exports were reported at $156 billion. 

That’s a huge number. But what does it mean? What’s missing in 

such reporting is how much of that value was created inside of 

China. The best estimate that I know of was an estimate, it’s actually for the year 1995, which is some time ago. It’s very hard to 

do this, but Chen, Cheng, Fung and Lau did a paper several years 

ago using Chinese data, it took a lot of work, and estimated that 

the value added within China for a category of electronics and telecommunications, which is pretty close to high-tech, was 20 percent. 

So you export a hundred yuan of goods, China had to import from 

somewhere, source from the United States, maybe not from the 

United States, from somewhere, 80 just to be able to do that. 

It’s not a wild distortion to think, at least in the high-tech world 

especially, as a big processing zone, not a place that’s really originating all that much. Gives it a little bit different perspective on 

some of this stuff. 

Progress in science, I’ll just summarize very briefly. It’s very significant in certain areas, very substantial. There are indicators of 

this, the rate that is measured by papers, international referee 

journals going up. Citations still pretty low, citations in these articles and journals still pretty low, but growing. So the trend is really very substantial. 

I like to look at it from two angles: From the science end it’s really impressive progress. If you view it from the other end, to the 

commercial R&D end, not so impressive so far. And in between is 

kind of a big gap or a big challenge in between, which is the institutional set of obstacles I had mentioned before. This is the legal 

system, the financial system, and management skills, all of the 

above that make it a challenge, which will be overcome. But how 

quickly it will be overcome is very hard to determine. 

Thank you. 

[The statement follows:]
120

Prepared Statement of Henry S. Rowen

Professor Emeritus, Graduate School of Business

Senior Fellow, the Hoover Institution

Emeritus Director, the Asia Pacific Research Center

Stanford University, Stanford, California

Some Key Factors in China’s Remarkable Rise in the

Technologies of Information

I will touch on four topics today: One is the leading center of high tech companies 

in China, Zhongguancun Science Park. Second is the importance of international 

linkages in China’s high tech rise. Third is the importance of domestic value-added 

in understanding the economic significance of China’s export numbers. Fourth, is 

some indicators of the rise of science. 

Zhongguancun Science Park (ZGC For Short) 

This park, located northwest of the center of Beijing, has the largest concentration 

of high tech companies in China. It had 12,000 of them in 2002 with over 400,000 

workers and revenues of $29 billion. Sixty-four percent were in the information 

technology (IT) industry with the rest in advanced manufacturing, bio-medical, materials, and energy sectors. An understanding of its history and present status helps 

us to understand how China has made giant strides in high technology industries. 

Its high tech strategy has been to train many technologists, to help scientists and 

engineers in research institutes and universities form companies, to make stateowned one more market-focused, and to encourage foreign firms to bring technologies via direct investments. Taiwanese companies and foreign MNCs are responsible 

for a large proportion of China’s IT exports. Large investments in telecommunications have been a core part of the strategy. The ZGC cluster in Beijing has made 

a remarkable transition from a set of government research institutes, state companies, and universities in a non-market system to a more dynamic, market-driven 

place with many new companies. 

Shortly after China’s reform movement started, in 1980, a researcher, Chen 

Chunxian, left the nuclear laboratory of the Academy of Sciences to set up the first 

privately funded research and technology institute in Beijing. He was followed by 

other entrepreneurial scientists and technicians. According to Adam Segal (in Digital Dragon; High Technology Enterprises in China), from 1950 to 1978 the Chinese 

Academy of Sciences ‘‘which owned all the technology . . . in all that time did not 

sell one product. Since the reforms, 40,000 products have been passed to companies 

and have been put on the market.’’

By the end of 1987, the Academy had spun out several dozen high-tech enterprises, including the computer companies Legend (now called the Lenovo Group) 

and China Daheng Information Technology. Most were PC-related. By the end of 

1987, hundreds of enterprises were crowded along a ten-kilometer long street called 

Zhongguancun Electronics Street. 

During this period, Tsinghua University and Peking University also established 

their own high-tech enterprises. There were two main motives: one was to supplement low salaries and enable them to keep the best people; the other was to move 

technology from laboratories to the market. University-funded enterprises have 

played an important role in Zhongguancun’s development. 

In 1988, the Beijing Experimental Zone for Development of High and New Technological Industries was set up with the power to try new rules and institutions on 

a small scale before moving them nationwide. It became known as the 

Zhongguancun Science Park. It was small, with only 10,000 workers in 1989, but 

about to take off. Waves of start-ups in ZGC coincided with, and depended on, the 

rapid growth of China’s IT industry. The domestic market was greatly aided by 

large government investments in telecommunications while paralleling this was 

China’s rapidly growing participation in the global IT market. Essential to this 

strategy has been an openness to foreign goods and direct investments. 

At the beginning the region had important assets and daunting liabilities. The 

main assets were many scientific and academic institutions, a well-educated and talented group of scientists, and a willingness to experiment, and supportive governments, both at the national level and locally. The liabilities, also substantial, included poorly defined laws, including those for intellectual property rights, an array 

of state-owned companies, bureaucrats micro-managing state-owned enterprises, 

weak managerial skills, isolation from world markets, and an underdeveloped financial system, especially for risk capital. 

Essential to the successes that followed were networks of relations that connected 

families, the new entrepreneurs, the institutes from which they had come, universities, local governments, and national ministries. The institutes supported their 
121

spun-off entrepreneurs in several ways, including financially; local officials for the 

most part worked to reduce regulations, arranged for finance usually in the form 

of loans, and did not interfere excessively in the inner workings of enterprises; universities set up enterprises and maintained close ties to their graduates; and national ministries kept research money flowing to institutes and universities. 

From 1988 to 2002, the number of its companies grew from 527 to over 12,000 

(of which perhaps 4,000 are not really viable) with total employment going from 

10,000 to 420,000. In 2002, fifty-five of these companies were listed on an exchange 

and thirty-three had sales of over U.S. $12 million per year. ZGC firms have 40 percent of the market for software applications and 50 percent of the PC hardware 

market. It has the No. 1 Chinese portal, Sina.com, and the top online game firm 

in China, ourgame.com. It is the leading place in biotechnology, new medicines and 

new materials, but these industries are still small. 

At the small end of company sizes, 4,300 had sales of less than $120,000. This 

is far from an equilibrium situation. For example, 82 percent of the 4,300 small 

companies lost money in 2002. The number of firms in ZGC is likely soon to shrink. 

Today, China gets most of its technology from overseas with multinational companies as the main source. In ZGC, they account for 43 percent of the Park’s total revenues and 78 percent of its exports. Actually, what is being transferred is not only 

technology in a narrow sense but also design techniques, know-how and managerial 

skills, including knowledge about how to solve problems and how technologies are 

related to each other. Investments made by multinationals are a kind of package 

that combines money, products, technology, talent, managerial skill and ideas. Many 

are establishing research centers; for example, Intel, Microsoft and Novozymes (a 

Danish enzyme company), have set up such centers there. China’s poor protection 

of intellectual property discourages the transfer of advanced technologies but it has 

not prevented a large and sustained flow of direct investment by foreign firms. 

Another major source of ‘‘capital’’ is the human kind embodied in returnees from 

overseas. It is remarkable that the total of 4,900 such people (3,500 since 1999) had 

started 1,800 companies in ZGC by 2002. In two years they had started two companies each working day on the average. 

ZGC has both advantages from being in the capital city and disadvantages. On 

the advantages, there is a large flow of money from government ministries both directly for procurement and indirectly through support of institutes and universities 

and it benefits from the idea incorporated in the Beijing Experimental Technology 

Zone, ‘‘What is not forbidden by the law is not against the law.’’ Two examples: one 

is that a venture capital limited partnership can be established; the other is that 

the scope of a business need not be clearly defined. On the disadvantages, from the 

vantage point of Silicon Valley—or Shanghai or Shenzhen—there are benefits in 

being far from the Emperor, whether he is seen as being in Washington or Beijing. 

On ZGCs human resources, about half the workforce has at least bachelors degrees. There are over 30 online job service web sites and 42 percent of workers find 

jobs through them. The job market is a classical free market one: employment at 

will by both the employee and the employer; those who don’t measure up are dismissed, an especially effective measure in the early development stage when other 

enterprises had lifetime employment. Worker mobility is high; two-thirds of employees working for less than three years have changed jobs. (A rate this high may be 

dysfunctional.) 

The ZGC system has changed. Tax advantages were reduced in 1993 and the 

Academy of Sciences ended its support for many successful firms in order to support 

new ones. Competition has been encouraged among domestic firms and has intensified with the arrival of foreign ones. Corporate forms were adopted with ownership being expressed though stock issuance, appointment of general managers and 

boards of directors. 

Close university links to business are also under pressure to change. Universities 

and research institutes within ZGC run their own ventures, often holding 100 percent of their equity. Problems inherent in these connections have become evident. 

Legal unclarity in ownership makes it impossible to share it with other investors, 

a barrier to raising capital. Efforts are underway to clear up enterprise ownership, 

to enable university-founded enterprises to operate independently, and to set rules 

so that teaching, research and operation of university-founded enterprises can be 

mutually beneficial and not in conflict. This requires a separation of the teaching 

and research missions of universities from commercial activities that may be socially 

useful but that can detract from their core missions. 

China’s financial system, especially for risk capital, remains underdeveloped. Despite the fact that the Beijing Municipal People’s Congress enacted the first local 

law allowing limited partnership venture capital firms, this organizational form has 

yet to be adopted and a mergers and acquisition market has yet to emerge. High-
122

tech companies are listed in Hong Kong or, ideally, on NASDAQ. (A recently established NASDAQ-like second board at the Shenzhen exchange might provide a 

domestic market listing for young firms in a few years.) In 2002, 21 ZGC start-ups 

received RMB 830 million (U.S. $100 million) of venture investments. Foreign investors are still dominant; 12 local institutions supplied 29 percent and 7 foreign ones 

supplied 71 percent. 

In little over 20 years ZGC has come a long way. Its future depends on that of 

China, which faces challenges in building institutions, including those of law, finance and those for the creation of technology. Given its record, it will overcome 

them. 

It is hard to miss the high proportion of scientific and technical papers published 

in the leading scientific and technical journals that have Chinese authors, many of 

them at American universities. Increasing numbers are returning home. This was 

a major source of talent for Taiwan in the 1980s and 1990s and now there is a growing flow back to China. They return not only with scientific and technical skills but 

also know-how on organizing and conducting research projects and building companies. It is remarkable that the total of 4,900 such returnees (3,500 since 1999) had 

started 1,800 companies in ZGC by 2002 and that by 2003, 4,300 returnees to 

Hsinchu had created 119 companies. Foreign nationalities constituted over onefourth of Singapore’s professional IT manpower in 1995–97 and is likely to have increased since then. 

Whether among Silicon Valley, Hsinchu, ZGC, or Bangalore, linkages have been 

critical. Some of these places have become hubs, such as Silicon Valley, linked 

through flows of goods, people, capital and technology into a global network. 

International Linkages 

The story of ZGC reveals many important foreign connections: People, direct investment, technology, markets. Martin Kenney and Kyonghee Han (in ‘‘The Venture 

Capital Industries in Five Asian Nations’’) describe three types of people links between Silicon Valley and Asia. The first was the human linkage provided by Asian 

students who stayed in the United States and worked in Valley firms and elsewhere 

in the U.S. such as Bell Labs. They soon began launching their own start-ups while 

they kept close relationships with friends and families in Asia. Second was Asian 

students and seasoned managers who returned to their various nations, either joining the Asian operations of Silicon Valley firms or setting up companies that contracted with Silicon Valley ones. The third link was Asians trained at home who 

then joined the overseas operations of Silicon Valley firms. Each link was a conduit 

for information transfer and learning. The repeated interactions that occurred on 

many levels created awareness of what was occurring in Silicon Valley, not only in 

terms of the technical and managerial skills but also of its entrepreneurial character. 

According to Marguerite Gong Hancock, Jen-Chang Chou and Ming Gu, a new 

and prominent international network example is the Semiconductor Manufacturing 

International Corporation (SMIC), a silicon foundry whose headquarters are in 

Shanghai. It has three fabs in Shanghai, one in Tianjin, and three being built in 

Beijing. Ninety percent of its output is exported. Almost all of its early management 

team were veterans of the semiconductor industry and had spent most of their professional careers in leading semiconductor companies worldwide before they joined 

SMIC. Chief Operating Officer Marco Mora, for example, had more than 18 years 

of management experience at STMicroelectronics N.V., Texas Instrument Italia 

S.p.A, Micron Technology Italia S.p.A and WSMC (a Taiwanese foundry). Of its 

4,400 workers, 500 came from Taiwan, 300 from the U.S. and 200 from other places 

outside of China. Significantly, all but one of its initial management team started 

out in Shanghai. 

Its funding was also global: from H&Q Asia Pacific, Walden International, New 

Enterprise Associates, Oak Investment Partners, Vertex, Goldman Sachs, and four 

Chinese state banks. 

In short, it is hard to imagine anything like the present global IT industry without these many kinds of connections. In the present post-bubble era, it is common, 

almost a rule enforced by venture capitalists, that Silicon Valley start-ups establish 

a part of their operations from the outset in some place in Asia. Costs are lower 

and able people can be recruited. 

Putting China’s Export Numbers in Perspective 

The common practice of reporting gross revenues from exports can lead to a misinterpretation of their economic significance. Almost always missing in such reporting is the value created domestically associated with these exports. This is often 

modest. Thus, according to Wong Poh Kam, in Singapore, 25 percent of the value 
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1Kathleen Walsh, ‘‘Foreign High-Tech R&D in China: Risks, Rewards and Implications for 

U.S.-China Relations, the Henry L. Stimson Center, 2003. 

of its exports of disk drives in the mid-1990s was added domestically and, according 

to Chen, Cheng, Fung and Lau, China’s domestic value added to its electronics and 

telecommunications exports to the U.S. in 1996 was about 20 percent. These numbers imply that for every dollar of exports, goods costing 75 cents or 80 cents had 

to be imported. So, if China exported, say, $50 billion of high-tech products to the 

United States, it had to import around $40 billion of goods (although not necessarily 

from the U.S.) for that to be possible. 

Doubtless, the value being added domestically in China to its high-tech exports 

is growing but it is growing from a modest level. 

Some Indicators of Progress in Science 

There is a growing belief in scientific and technical circles worldwide that Asia, 

and especially China, will become not only a place for making things but also—perhaps soon—will become a creator of technology. They have able, well-trained people, 

have or are developing needed institutions, and are connected to the world of ideas. 

One indicator is the large and growing numbers of well-educated scientists and 

engineers. According to Diana Hicks, the number of Ph.D.’s granted in China from 

1986–1999 increased by about 50 times (from 100–200 to over 7,000). Others are 

increased spending on research and development; the growth in scientific publications and in their quality measured by citations. Still another is the setting up by 

high-tech foreign firms of R&D centers in China—about 200 in number. Today, 

these centers seem to be doing more ‘‘D’’ than ‘‘R’’ but that mix will surely shift towards doing more research. 

China has great ambitions in science and technology and given its accomplishments they are likely to be realized—although the timing is uncertain. Between 

1995 and 2000, its spending on R&D more than doubled. It was still only one percent of GDP but it was growing at ten percent a year and the government says it 

wants to increase that share.1 According to Kathleen Walsh, by the year 2000 China 

ranked eighth in the world in scientific papers contributed by Chinese authors 

(three percent of the world total) compared with it being 15th in the world five years 

earlier. This is not to assert that China’s capacities are up to those of the industrialized countries. This will not likely happen soon but it is on the move. 

The rise of China in innovativeness will have mixed impacts on others. The generation of new ideas can benefit everyone. It also gives their creator an advantage—

as Silicon Valley has demonstrated. What should not be in doubt is that the U.S. 

and everyone else will face a large challenge coping with the rise of an innovative 

China.

Cochair MULLOY. Thank you, Dr. Rowen. 

Let me just tell the panelists: Your full statements will be included in full in the record of the hearing. If you could limit yourself to seven to eight minutes, and then we’ll open it up to Commissioners asking questions. Thank you. 

Dr. Zysman. 

STATEMENT OF JOHN ZYSMAN, CO-DIRECTOR

BERKELEY ROUNDTABLE ON THE INTERNATIONAL ECONOMY

PROFESSOR, UNIVERSITY OF CALIFORNIA, BERKELEY, CALIFORNIA 

Dr. ZYSMAN. Thank you very much. Many of you may know the 

degree to which the international economy was really formed 

around the U.S.-China trade struggles. I emphasize that because I 

wasn’t exactly known as soft on, shall we say, foreign economic 

challenges. And I want to set some of what I’m going to say here 

today in that regard. 

One of the great moments for me was having one of the friends 

from BRIE take me into his office and point out that I had been 

moved off of the Japan enemy’s list, which they actually had with 

a big target. And many of my friends had been moved to the sidelines. 
124

BRIE has also worked some on U.S.-China relations on the issue 

of China’s entry to the WTO. But when speaking with Members of 

the Commission and speaking with the staff, when I was invited 

to speak here I asked myself: What could I, who’s not really a great 

expert on China, add to the conversations that friends like George 

Scalise, John Gage and the industrial side, Barry Naughton on the 

academic side, wouldn’t say otherwise. 

There were really three things that I wanted to say that I 

thought were worth taking your time. 

The first, I usually like these to come up as a whole, so let me 

just simply say: Let me list the three points I’d like to make very 

quickly—is that China’s not the first great new economic power to 

enter the world scene. We could go back a century and remark on 

Germany, even the United States. Japan is obviously something 

we’ve dealt with. 

We’re not going to stop China’s entry. We may shape the character of China’s entry, but we’re not going to stop it. And the great 

question is the nature and character of our own adaptation, our 

own adjustment, our own successful response to the character of 

the economic and security challenges that that poses. 

The second point that I want to make is that the key issue is the 

nature of our adaptation and our adjustment. The third is that the 

core of that is going to be an emphasis on innovation, not simply 

technical innovation, but in fact innovation in business models, innovations in fundamental business strategies. 

Now having said that let me run through these slides fairly 

quickly, and I’ll put, as you’ve asked the core points in the record. 

The first, as I say, is that China’s not the latest story. Really the 

term ‘‘globalization,’’ if you actually count it really emerges with 

Japan. We had a bilateral world. Bilderberg was the center of the 

universe until the Trilateral Commission emerged with the emergence of Asia as a real challenge. And Japan was really the first 

instance of that Asian challenge. In a certain sense globalization is 

a sequence of national stories, told on a larger stage. 

When I emphasize that China is not the only story I suspect that 

Motorola would pick a different national story as its big threat. It 

might choose Finland. It might choose the character and strategy 

that the Finnish adopted that led them from being on the periphery of the Soviet empire to a core player in the communications 

era. 

As I say, the core issue that matters for the United States is the 

nature of our adjustment. Now obviously we need to enforce appropriate rules and negotiate the best possible international agreements. Nothing that I’m saying suggests other than that nor that 

I don’t take that very seriously, but I do. But I think as in the 

Japan era, much of what was, in fact, lost sight of was the character of the American adaptation that was required. 

In the Japan story we had a story of closed markets, radical domestic expansion, and then production innovation and managerial 

innovation. It was a very straightforward story. In some ways Jim 

Martin, who spoke to you this morning, the great—it was Korea’s 

expansion that complicated that story as it became a player in the 

semiconductor industry that in some ways made the story more 

complicated. 
125

China’s, as Barry Naughton and others have told us, is a story 

of FDI as an instrument of development; of manufacturing; of 

outsourcing; of the effort to try and capture R&D and higher valued-added activities; of local networks built out, around and underneath FDI. It’s a struggle for standards, and IP is a strategic game. 

As my friend Stu Feldman at IBM suggested, that what we really 

are looking at is a game of three-dimensional Go played on what 

most people understand is a two-dimensional chess board, but the 

game that is being played is much more complicated and much 

more serious than we conventionally understand. 

It’s not going to be the last story. This Commission will reconvene in a few years about India, I’m sure, and which the story is 

one about service outsourcing, a less concerted national strategy 

perhaps, but managerial innovation and outsourcing service. 

Now as an instance, because I want to use the Indian story as 

an instance of what I mean by adaptation here. Part of the problem 

that we face is that when we face challenges, we respond with old 

lessons and old tools. 

If you look at the outsourcing story, which is different than the 

offshoring story since you can offshore without outsourcing and you 

can outsource without offshoring, the question becomes: Why does 

a company like Wipro suddenly show up in my backyard as an 

outsourcer in this area? And the answer is that certainly part of 

the story was about low cost labor being able to be outsourced to 

India. 

Another part of the story was that they clearly learned managerial lessons about how to organize outsourcing that permitted them 

to come back into this area with a new managerial innovation and 

begin to organize outsourcing onshore. The question we have to 

keep track of is what are the real challenges and how is business 

going to respond. 

Since time is limited I will put in the record my arguments about 

what the character of the nature of the business challenge really 

is, which is finding the spot of differentiated assets that prevent 

you from being caught in a commodity, that much is blurring. Commodities become products become commodities. Internal functions 

such as R&D become products. Services become products. And 

product companies like IBM become service companies. It’s not 

very stable. 

And, in fact, there’s an endless search for new positions, and the 

real search is for new business models and an experimentation to 

allow that to happen. 

Now in the last minute of overtime that I’ll permit myself is the 

question is what ought we to do? Now I would emphasize that obviously we have to pursue the best possible international arrangements. We have to defend international appropriate global rules of 

intellectual property and the like. But others will emphasize that. 

Domestic adjustment and adaptation is for me the key. Innovation in the end is going to be the key to that adaptation. I look at 

the fact that in China we see massive network build-outs in communications networks. And we ask the question as Korea builds 

out significant networks in high-speed telecommunications networks, Internet networks, if the leading edges of usage are outside 

the United States, will our companies be able to follow? 
126

So the question becomes: What do we do? Government policy has 

to be aimed at sustaining the U.S. as a driving source of innovation, as a source of R&D to assure that we maintain ourselves as 

a technology pump, that we remain on the leading edge of infrastructure and technology exploitation and education, education, 

education. 

Corporate strategy has begun to be imaginative, identifying the 

shifting markets and understanding the innovation in business 

models, not just technology to understand what the new opportunities are in this set of challenges. And then I’ve put up a few things 

that I think might be useful to the Commission that I’ll be glad to 

submit later that might be helpful in thinking through some of the 

choices that are before us. 

Thank you. 

Cochair MULLOY. Thank you very much. Dr. Preeg. 

STATEMENT OF ERNEST H. PREEG

SENIOR FELLOW IN TRADE AND PRODUCTIVITY

MANUFACTURERS ALLIANCE/MAPI, ARLINGTON, VIRGINIA 

Dr. PREEG. Thank you. I’m also delighted to be here today and 

talk about what is a highly dynamic U.S.-China relationship in the 

high-technology industry. I’m just completing a heavy study on the 

subject, it will be out in June with the title: ‘‘The Emerging Chinese 

Advance Technology Superstate.’’

And the principal conclusion is that China, indeed, is an emerging super state in this context and this poses a serious challenge 

to the longstanding U.S. leadership in technology innovation and 

related production exports. And if the gap continues to narrow, as 

it is now, there will be major implications for U.S. commercial, national security, and geopolitical and other foreign policy relationship, could be a very fundamentally changed international order. 

My written statement does summarize both my analytic and policy conclusions. So I will just use my time here to tick off what I 

consider the essential ingredients to achieve such advance technology super state status, and a few issues that need to be watched 

in terms of China getting from here to full status with the U.S. and 

Europe being the other established broad super states in this area. 

I see six essential ingredients for super state status, and I see 

China meeting all of them. Much of this has been talked about already. First there has to be a very large internal market for these 

new products to be marketed first at home. China with 1.3 billion 

people, nine-percent growth clearly has the market. And more and 

more investment is directed toward the domestic as well as export 

market. 

Second, we talked a lot about R&D, a major commitment to R&D 

resources. This really started in 1995. There were key decisions of 

the Chinese government that really put this up as the top priority. 

From 1995 to 2002 their R&D grew 22 percent a year versus six 

percent for us. They’re passing Japan by this year to be the second 

largest R&D commitment. I should also say it’s much more heavily 

directed toward manufacturing industry where the new technologies are being developed, whereas our public R&D certainly is 

much more heavily in the health sector compared with NSF, for example. 
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The third ingredient is, again, we’ve talked about education: A 

tripling of their college program and graduates since ’95, from one 

to three million graduates. They are now somewhat higher than 

U.S. graduates. 

There’s a tendency to look at doctorates in science and engineering. This year roughly doctorates in engineering will be about 9,000 

there versus 5,000 in the U.S. The educational system is much 

more heavily oriented towards science, math, engineering. 

The fourth ingredient is investment in infrastructure. And here 

again their resource commitment in terms of savings, environments 

is really quite extraordinary. And certainly for the advance technology sector, when it comes to transportation, communications, 

electric power, and other supporting infrastructure they have been 

keeping up and it’s quite impressive. 

The fifth and sixth ingredients are linked. One is to have a very 

fiercely competitive, if you will, private sector or relationship 

among these companies who have to keep moving ahead quickly. 

And, second, you have to have a very open trade and investment 

policy. These are linked, and China has both of them. Certainly everything we read about the advance-technology sector between 

multinational companies and China companies coming on-stream 

and rather rapidly is intense competition. And this really creates 

the incentives to move ahead in these areas. 

In fact, the whole process of these last ten years, take the last 

four or five, has been driven very much, as we know, by foreign direct investment. Very export oriented. The foreign direct investment up to ’95 was quite low because labor-intensive industry, textiles and such, doesn’t need much foreign direct investment, but it’s 

gone up from five billion in ’91 to 38 billion FDI in ’95 to 62 billion 

last year. Again, mostly, 70 percent in the manufacturing sector 

and very export oriented. The percentage of total of Chinese exports by foreign companies last year was 57 percent. I think that’s 

without precedent. And it would be much higher if you limit it to 

the advance-technology sectors, because that’s where the FDI is so 

concentrated. 

And this is related to the extraordinary trade performance: 35 

percent growth in exports in ’03 and ’04. It’ll probably be at least 

that much this year. In fact, I’m predicting that their global trade 

surplus will go up from 40 billion last year to maybe a hundred billion this year, just taking off. Partly apparel and textiles, but it’s 

also semiconductor, steel, and the information technology sectors. 

So very trade oriented. And this is where the trade, the high-tech 

trade is the bottom line in international Chinese in these areas. 

And here the Chinese trade structures change dramatically in the 

last three or four years. Over half of Chinese exports are now in 

the so-called high-tech sectors, as defined by the OECD. 

Apparel, textiles, and footwear, they’re down to 18 percent. It’ll 

be a little bump this year, but it’s just going down. So they’re a 

high-tech exporter, for the most part. 

When it comes to U.S. trade, we have this trade category: Advance-technology products. These are the ones that have the most 

deeply embedded, the highest content of R&D and engineering 

input. It’s about 30 percent of our manufacturing sector. Globally 

our advance-technology industry in this ATP trade has gone from 
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a surplus of 20 billion in ’98 to a deficit last year of 37 billion. And 

the shift has been almost all China. We were in trade balance in 

’98. Last year the deficit with China was 37 billion, accounted for 

the entire global. 

That’s the overall picture of the ingredients. Let me just tick off 

four of the things we should keep watching to get to the if you will 

status. One, will there be Chinese companies coming on to achieve 

multinational status in terms of competitiveness. Ex companies are 

coming on fairly quickly in almost every advance-technology sector. 

They want to establish a brand name, quality, a reputation, and a 

big R&D capability. 

A second point to look at was raised earlier: The export platform 

relationship where they import components and then export. This 

is almost entirely an East Asian relationship with Taiwan, South 

Korea, and Japan. I think it’s changing rapidly. I think on average 

in the information technology, telecommunications sector probably 

now, but we don’t have good data, probably over half of the content 

on average is Chinese. And it goes up because there’s more and 

more going to Chinese sourcing and trying to upgrade. But it’s an 

important relationship and we certainly need more information. 

Thirdly, there is a need for structural reforms: The banking, financial sector shifting from industry to other sectors. But, again, 

if you say how, this can have adverse impacts on disruption, but 

probably not relatively as much so for the advance-technology sector. This—this sector’s financed not by the big Chinese banks. It’s 

overseas’ financing by the foreign companies and even the Chinese 

companies. They’re not having to turn to the internal banking sector. 

So I think although there are big problems and challenges here, 

it’s unlikely to really slow down the advance-technology momentum. 

Finally, there is the process of political change. I believe it’s almost inevitable there will be some form of democratization, without 

saying how or what pace. It can be disruptive, it need not be. Certainly South Korea, Taiwan have went through it without disruption from authoritarian, but it could be disruptive. The question is 

how will this impact on the advance-technology sector. Again I 

can’t predict that, but it’s unlikely that they would really do things 

that would undermine the sector, but this is certainly something 

that needs the scrutiny. 

That’s it. And on the policy response, as I say, the conclusions 

are listed in my written statement, and we might want to get into 

those during the question period. 

Thank you. 

[The statement follows:]

Prepared Statement of Ernest H. Preeg

Senior Fellow in Trade and Productivity

Manufacturers Alliance/MAPI, Arlington, Virginia

The Emerging Chinese Advanced Technology Superstate

China is an emerging advanced technology superstate, which poses a serious challenge to longstanding U.S. leadership in technology innovation and related production and exports. A further relative advance in Chinese advanced technology 

performance will have important impact on U.S. commercial, national security, and 

foreign policy interests. 
129

An advanced technology superstate is defined in terms of economic, technological 

and financial power, leading to political power in international affairs and to becoming a military super power as well. The essential ingredients for superstate status 

are a very large internal market, correspondingly large public expenditures for research and development (R&D), education, and infrastructure, a highly competitive 

private sector, and an open trade and investment policy. China meets all of these 

conditions, although further market-oriented reforms are needed, especially in the 

financial services sector. 

These are the central conclusions of my study, The Emerging Chinese Advanced 

Technology Superstate, scheduled for publication in June. More specific conclusions, 

grouped in terms of the analytic assessment and the recommended U.S. policy response, are as follows: 

Analytic Assessment 

(1) Deng Xiaoping’s ‘‘Four Modernizations,’’ put forward in 1978, have led to 25 

years of 9 percent annual GDP growth in China, and a fivefold increase in per capital income. This rapid growth, however, has been in two distinct stages. The first 

stage, from 1980 to 1995, centered on export-led growth in low technology, laborintensive industries, while only during the past 10 years has advanced technology 

industry development become the top priority. 

(2) The two principal ‘‘resource’’ indicators of advanced technology development 

are R&D expenditures and science and engineering graduates. Chinese R&D expenditures grew by 22 percent per year from 1995 to 2002, compared with 6 percent 

in the United States. Projected to 2005, Chinese expenditures will be higher than 

those of Japan, more than 60 percent of the EU level, and about 40 percent of the 

U.S. level. Chinese R&D is more heavily concentrated in manufacturing than is U.S. 

R&D, with 60 percent of the Chinese R&D performed by enterprises, 28 percent by 

government research institutions, and 10 percent by universities. 

(3) Chinese science and doctoral degrees increased by 14 percent per year from 

1995 to 2001, compared with minus 1 percent in the United States. Projected to 

2005, annual Chinese doctoral degrees will be half that of the U.S. level. Chinese 

doctoral degrees in engineering grew 18 percent per year from 1995 to 2001, compared with minus 2 percent in the United States. Projected to 2005, Chinese engineering doctorates will be 70 percent higher than the U.S. level. 

(4) Two performance indicators are patent applications and technical article authorship. Chinese patent applications increased annually by large double-digit percentages from 1995 to 1999, as did technical article authorship from 1995 to 2001, 

but from very low base levels. More up-to-date figures would be revealing, and the 

National Science Foundation is urged to provide more current figures. 

(5) Foreign direct investment (FDI) in China was relatively low during the first 

stage of labor-intensive industrial growth, less than $5 billion per year through 

1991. FDI then increased sharply, related to wide-ranging incentives for advanced 

technology investors, to $38 billion in 1995 and $62 billion in 2004. Seventy percent 

of FDI is in manufacturing, with heavy concentration in export-oriented companies 

and advanced technology sectors. In 2004, 57 percent of total Chinese exports were 

by foreign investors. 

(6) Taiwan is the largest foreign investor in China, accounting for up to half of 

total FDI, but there are no precise figures because most of it comes indirectly 

through Hong Kong and other sources. The United States was the second largest 

foreign investor through 2002, but in 2003 and 2004, South Korea and Japan pulled 

ahead of the United States. In 2004, South Korea invested $6.2 billion, Japan $5.5 

billion, and the United States $3.9 billion. 

(7) Taiwanese investment is concentrated heavily in the information technology 

sector, including the semiconductor sector. China plans to build up to 18 semiconductor plants by 2005, and there are now about 400 chip-design companies in China, 

about one-third of which are foreign. 

(8) American investment in China is broader in industry scope, although with 70 

percent in manufacturing. China provides tax incentives and exerts coercion on 

American companies to do R&D and upgrade the technology level of production in 

China, and many companies are doing so. There is also a trend to work with Chinese suppliers and thus increase value added within China. Ingersoll-Rand employs 

20 engineers to train Chinese suppliers to meet quality standards. Cisco CEO John 

Chambers predicted that ‘‘China will be the IT (information technology) center of 

the world.’’

(9) Chinese exports grew 35 percent in both 2003 and 2004, and will probably 

come close to that again in 2005. China passed Japan in 2004 to become the third 

largest exporter after the United States and Germany, with most of German exports 
130

within the EU, and on current course China will be the number one exporter within 

three years. 

(10) Chinese high and medium high technology exports are growing the fastest 

and their share of total manufactured exports increased from 33 percent in 1995 to 

an estimated 52 percent in 2004, while low and medium low technology exports 

were down from 67 percent to 48 percent. In 2004, less than 20 percent of Chinese 

exports were in textiles, apparel, and footwear. 

(11) The U.S. merchandise trade deficit with China increased from $57 billion in 

1998 to $162 billion in 2004. For advanced technology products (ATP), which have 

the highest R&D and engineering content, the United States was in rough trade balance with China in 1998, but had a deficit of $36 billion in 2004. The ATP deficit 

was $39 billion in the information technology and communications sector, offset by 

small surpluses in semiconductors and commercial jet aircraft. 

(12) The ‘‘export platform’’ issue involves Chinese exports of advanced technology 

products with large import content of high technology components. There are no precise figures for the extent of this relationship, and the import content varies widely 

by plant and industry subsector. The overall degree of export platforming is probably relatively small and declining steadily as the share of Chinese value added 

increases. The very large majority of export platforming is by Taiwanese, South Korean, and Japanese companies, and very little is by American companies. 

(13) The net assessment is that China, indeed, is an emerging advanced technology superstate, in terms of its domestic market size, the resource commitment 

to R&D, engineering, and infrastructure, the rapidly growing and highly competitive 

investment sector, and the spectacular export performance. 

(14) One indicator for final arrival as an advanced technology superstate will be 

the emergence of internationally competitive Chinese firms, with brand recognition, 

quality product reputation, and a leading edge R&D program. A number of large 

Chinese firms in several sectors are approaching this stage of multinational competitiveness. 

(15) China nevertheless will have to make important structural adjustments to 

maintain its high rate of growth in advanced technology development. Financial sector reform is most important, and significant steps are underway. A sectoral shift 

from export led to domestically generated growth needs to be made, which should 

include a greater resource commitment within China to health care, infrastructure, 

and environmental improvements. 

(16) Political change in China is difficult to predict, but disruptive change that 

would undermine advanced technology industry is highly unlikely. A process of democratization within China, whatever the pace and modalities, is almost inevitable 

as China progresses toward being an affluent, more highly educated, informationbased society, with a rapidly growing middle class and a highly productive private 

sector. 

(17) One geopolitical consequence of the Chinese rise to advanced technology 

superstate status is that it is becoming the economic hegemon in East Asia. China 

is or will soon become the principal trading partner of all other East Asians, including Japan and South Korea. China is the largest recipient of FDI by far, and an 

outward flow of Chinese FDI to Southeast Asia is gathering momentum. Once the 

yuan becomes a convertible, market-based currency, Shanghai, Beijing, and Hong 

Kong will soon become the financial centers of Asia. As a result, China will have 

the dominant economic influence within the region, with corresponding growing policy leverage. 

(18) One geostrategic consequence of the Chinese rise to advanced technology 

superstate status is that Chinese internally generated military modernization is 

moving ahead much faster. A fundamental restructuring of Chinese defense industry in 1997–1999 shifted control of defense enterprises from the military to the civilian government, and integrated their operations with commercial advanced technology enterprises, including competitive bidding for defense contracts. In effect, 

China shifted from the discredited Soviet model toward the U.S. model for weapons 

development and production. 

(19) The result has been a more rapid rate of military system modernization, particularly for the navy and defense electronic systems. During the 1990s, the U.S. 

Department of Defense (DOD) consistently assessed the Chinese military capability 

as being at least 20 years behind the United States. The 2004 DOD annual assessment was that China will have uneven success in its goal of catching up with the 

industrialized nations within 5 to 10 years, and the 2005 assessment will likely indicate an even faster narrowing of the gap. 
131

The U.S. Policy Response 

(1) China is the most important U.S. bilateral relationship. A new relationship, 

resulting from China’s emergence as an advanced technology superstate, centers on 

a deepening economic engagement of wide-ranging mutual benefit, together, up to 

this point, with a far less engaged set of mutual national security interests. The 

most important medium to longer term U.S. interest in play is to maintain U.S. 

leadership in advanced technology industries, which is importantly related to relative military force capabilities. 

(2) The political relationship is troubled, but likely to move in a positive direction 

over time through democratization within China, largely as a result of the deepening economic engagement, which can be helped through targeted U.S. diplomacy. 

Deepening ethnic and cultural ties between the two countries, including through 

study and travel, will also help. Confrontation over Taiwan should be avoided as a 

mutual interest, but this can become more difficult as Chinese military modernization proceeds at a faster pace. 

(3) The recommendations here focus on the economic relationship, beginning with 

the most important immediate problem, Chinese currency manipulation. The Chinese yuan is estimated to be at least 40 percent lower than a market-based exchange rate, as a result of massive purchases of foreign currencies, over the past 

four years, by the Chinese central bank. Others, particularly Japan, South Korea, 

and Taiwan, have followed suit, which has had a substantial overall adverse impact 

on U.S. trade, particularly the manufacturing sector, including advanced technology 

industries. The U.S. trade deficit is in the order of $150 billion larger as a result 

of such currency manipulation, which is in violation of IMF and WTO obligations. 

The United States should act vigorously against all four East Asians to cease the 

practice, initially through direct consultation, but making clear that the United 

States is prepared to pursue IMF and WTO dispute settlement procedures if necessary. 

(4) Once China moves to a convertible, market-based exchange rate, which is its 

stated objective, the international financial system will soon take on a new structure 

oriented around three key currencies, the dollar, the euro, and the Chinese yuan. 

The IMF system will also change fundamentally, with few if any large IMF loans, 

the policy focus on how floating rates are managed, and possible initiatives for currency unions. The most challenging financial relationships will be within Asia and 

across the Pacific with the dollar. The United States and China will thus take on 

principal leadership responsibilities and need to structure their bilateral financial 

collaboration more effectively. 

(5) The U.S.-China trade and investment policy relationship has bilateral, multilateral and regional dimensions. The bilateral dimension centers on implementation 

of Chinese WTO accession commitments and involves negotiations on a wide range 

of issues. Protection of intellectual property rights (IPRs) is the biggest problem 

area, with serious adverse impact on U.S. advanced technology industries. Other 

issues of particular interest to U.S. advanced technology industries which need to 

be addressed include investment policy, standards and technical regulations, taxation, subsidies, telecommunications services, and biotechnology regulations. 

(6) The multilateral dimension currently involves the WTO Doha round, which is 

bogged down largely over the issue of nonreciprocity for developing countries. The 

United States and China could go a long way to breaking the impasse through a 

jointly supported formula for tariff reductions in the nonagricultural (almost all 

manufacturing) sector, in which China would make a fully reciprocal offer in view 

of its strong export competitiveness in manufactures. 

(7) The regional dimension of trade policy is now focused most importantly on 

East Asia, in view of the China/ASEAN free trade agreement (FTA), with Japan and 

South Korea following in the wake. Such an East Asian preferential trading bloc 

would have further substantial adverse impact on the U.S. trade deficit in view of 

the high tariffs throughout East Asia, and would also have a negative geopolitical 

consequence as a high visibility Asian grouping in an adversarial position vis-a`-vis 

the United States. 

(8) The only practical way the United States can head off an East Asian preferential trading bloc, which excludes the United States, is through initiatives to create an Asia-Pacific free trade agreement, as agreed at summit level in Bogor in 

1994. The centerpiece of such an agreement would be U.S.-China free trade, which 

although not feasible at this time, should be addressed through the formation of a 

high level U.S.-China study group to examine the economic costs and benefits of free 

trade between the United States and China within the Asia-Pacific context. 

(9) In parallel, the United States should undertake or complete FTA negotiations 

across the Pacific with Thailand (negotiations under way), South Korea (official 

talks under way), and Taiwan (informal talks under way). This ‘‘three spoke’’ initia-
132

tive, in addition to existing U.S. FTAs with Singapore and Australia, would definitively move the United States into the trans-Pacific free trade relationship, and 

would be incorporated as part of a proposed formal APEC review of progress toward 

the Bogor objective. Such trans-Pacific FTA initiatives, moreover, could well lead to 

a multilateral free trade agreement for the nonagricultural sector. 

(10) A U.S. domestic economic policy response to the Chinese challenge to U.S. 

leadership in advanced technology industry is essential. In broadest terms, the U.S. 

manufacturing sector is the engine for technology-driven economic growth and needs 

to be more competitive internationally. The $552 billion trade deficit in manufactures in 2004 was one-third the size of U.S. production, which greatly reduces the 

domestic revenue and employment base for continued innovation. The trade deficit 

needs to be greatly reduced or eliminated, which involves two principal domestic 

policy areas. 

(11) The first macro-policy area is the need to increase domestic savings so as not 

to have to borrow abroad to finance investment which, in turn, drives up the trade 

deficit. Greater incentives for private and business savings, and the reduction or 

elimination of the Federal budget deficit, are the policy vehicles. 

(12) The second remedial policy area involves various specific policies that place 

cost or other disadvantages on U.S. manufacturing industries compared to major 

trading partners, and to China in particular. Specific proposals and conclusions are 

offered for tax policy, education, R&D, tort reform, health care, regulatory policies, 

and the Sarbanes-Oxley law. 

(13) The current U.S. domestic policy response to the Chinese advanced technology challenge is disturbing and points to an increasingly difficult road ahead for 

American companies. To remedy this, there is a need for better public communication about the relationship between the advanced technology engine for growth 

phenomenon and U.S. international as well as domestic interests. What is lacking 

most of all is a sense of national purpose in responding to a rapidly changing world, 

driven most importantly by the development and application of wide-ranging new 

technologies on a global scale. 

(14) The final conclusions extrapolate the Chinese advanced technology experience 

over the past 10 years into a broader historical perspective ahead. Prevailing paradigms about the post-Cold War world are found inadequate. A revised and updated 

new order of international relationships will center on political, economic, and military power relationships increasingly dominated by three advanced technology 

superstates—the United States, the EU, and China—each a regional advanced technology hegemon within the North America/Caribbean, European, and East Asian regions, respectively. The three regions together include 52 percent of global population, 79 percent of GDP, and 85 percent of merchandise exports. India may rise 

to advanced technology superstate status within 10–20 years, as the South Asian 

advanced technology hegemon. Relationships among the three advanced technology 

hegemons are not yet well defined, however, and other regions of the world will face 

important adjustments as well.

Cochair MULLOY. Dr. Preeg, thank you very much. 

I want to give a special thanks to Mr. Fingleton for getting here. 

He flew from London to New York yesterday and got up and took 

a 6:15 flight out of New York to be here with us today. So, 

Eamonn, thank you so much. We really appreciate it. 

How do you feel? 

STATEMENT OF EAMONN FINGLETON, ECONOMIC AUTHOR

UNSUSTAINABLE: HOW ECONOMIC DOGMA IS

DESTROYING AMERICAN PROSPERITY

TOKYO, JAPAN 

Mr. FINGLETON. Thank you for that introduction. I think my 

head is at twelve o’clock at this stage, 12:00 midnight. 

I’d like to address a fundamental misunderstanding in the 

United States about the rise of China. Most Americans seem to 

think that other countries must give way, must sacrifice their industrial workforce and their manufacturing base to accommodate 

China’s rise. 

I think this is an America-specific point of view. Few other nations take this view. And this should be clear from the fact that 
133

although China runs a huge surplus with the United States, it actually runs a deficit, a large deficit with the rest of the world. 

Certainly in East Asia other East Asian nations do not take the 

view that they have to sacrifice their manufacturing bases because 

China is suddenly rising. I’ve lived in Japan for 20 years and I 

think that the Japanese example is particularly relevant. 

Wages in Japan are very high and Japanese imports from China 

are growing very rapidly. Yet on balance it’s very clear that Japan 

has benefited from China’s rise. 

Let’s go through some of the facts of the situation. 

Japan’s imports from China have risen 263 percent in the last 

ten years. Chinese goods now account for nearly 21 percent of Japan’s total imports. Now how big is that number? Well, by comparison Chinese goods represent a mere 13 percent of America’s total 

imports. 

Outsourcing has clearly been a big factor in the rise in Japan’s 

overall imports in recent years. Japanese companies outsourcing 

from China. Thus if any nation should be hollowed out by China’s 

rise it should be Japan, particularly as Japanese wages are actually higher than American wages. They’re about 20 to 30 percent 

higher than American wages. 

Yet now look at Japan’s trade position overall. Japan’s trade position has not been weakened by the rise of China, quite the reverse. Japan’s current account surplus last year was $181 billion, 

$181 billion. That surplus was three times the surplus earned in 

1989, which was the last year of the financial boom in Tokyo. It 

was also the peak year of American awareness of the Japanese juggernaut. So Japan in the time of China’s rise has increased its current account surplus three times. 

How has it done this? What is Japan doing that the United 

States is not doing in relation to its policy with China? 

Unlike the United States, Japan manages its trade. It manages 

its trade with all nations, but particularly these days with China. 

It manages the trade relationship in two very important ways. 

One, it avoids the hollowing out of the Japanese industrial sector, 

and two, it avoids the transfer of key technologies to China. There 

are many policies that support these objectives. A key one is Japanese labor policy. 

As we know, Japan has an unusual labor system known generally as the lifetime employment system. That’s a misnomer. ‘‘Permanent employment’’ is a better way of describing it, but the basic 

point of the system is that layoffs are not allowed for healthy, large 

corporations. There are some exceptions, and they get publicity in 

the American media so that people get the impression that the system is breaking down. It’s not breaking down. 

Basically in Japan for major corporations payroll in domestic operations is a fixed cost. That completely transforms the way that 

management in Japan views their responsibilities. The basic responsibility of a Japanese CEO is not to please the stock market. 

It is to ensure the long-term viability of the jobs in the Japanese 

operations of that corporation. 

It falls almost automatically that top management in corporate 

Japan will align themselves with the objective of the nation’s overall economy. Japanese companies do not shift work overseas until 
134

they find better work for their people at home. When I say ‘‘better 

work,’’ I mean more capital-intensive work, more know-how intensive work, much more capital-intensive work, typically much more 

know-how intensive work. 

So when a company like Toshiba, for instance, finds that it wants 

to outsource assembly of television sets to China, it already has 

much more interesting, much greater value-added work for its people at home to do. Typically such work is making components, very 

often maybe ten times more capital intensive with an enormous 

amount more know-how involved in the production process. 

The labor policy in Japan also supports the Japanese government’s policy objective of avoiding the transfer abroad of key technologies. From a Japanese corporate perspective there is absolutely 

no point in shifting high technology processes abroad. You want to 

keep those processes for your home workforce to maintain their 

productivity edge and to maintain their competitiveness in world 

markets. 

All this adds up to a pattern that is very different from the 

American pattern of trade with China. Japanese corporations import a lot of assembled goods from China. That’s as in the American case. But they export a vast number of key components, thus 

Japan has a broadly balanced trade relationship with China. In 

this sense, a classic example of the division of labor. Japan has 

shifted abroad low quality work and has redirected its own workforce into much more high quality work, thus for a relatively small 

increment of the total costs it has received a big increase in unit 

volumes. And much more could be added, but I see I’m pretty much 

out of time. 

If it were of interest, I’d be happy to discuss why Americans have 

not understood this point in the past. It seems to me that it’s a 

question of how the media approach the subject of——

Cochair MULLOY. Why don’t you take another minute or so and 

finish. 

Mr. FINGLETON. Yes. Well, it seems to me that the American 

media have completely misunderstood the East Asian economic 

phenomenon. And you see that in so many ways. The media described Japan as having collapsed in the 1990s. There was no collapse in Japan in the 1990s. That’s obvious in the trade figures of 

Japan. 

People who don’t go to Japan very often don’t realize it, but consumers in Japan are among the wealthiest consumers in the world. 

They increased their living standards very dramatically in the 

1990s. In every way that you look at an economy like Japan, if you 

look at what is actually happening as opposed to what people are 

saying, you find that Japan has done well. So, as I say, this is a 

question for the media. It’s also probably a question for academics 

that study Japan. 

[The statement follows:]

Prepared Statement of Eamonn Fingleton, Economic Author

Unsustainable: How Economic Dogma is Destroying American Prosperity

Tokyo, Japan 

For more than a decade now we have been told that it is inevitable that highwage nations like the United States will be hollowed out by a rising China. This 

is dangerous nonsense that has already done untold damage to the United States. 
135

Although China has every right to aspire to become rich, other nations should not 

be expected in response to have to weaken their industries, let alone impoverish 

their manufacturing workforces. If this point is not understood in the United States, 

it is well understood elsewhere, not least among China’s richest trading partners 

in East Asia. In varying degrees, South Korea, Taiwan, Singapore and Japan have 

cooperated with China’s desire for export-led growth yet they have done so without 

compromising their own fundamental economic interests. 

The experience in Japan, where I have lived for nearly twenty years, is particularly instructive. It is a little known fact that wages in Japan are actually higher 

than in the United States—about 20 to 30 percent higher measured at recent market exchange rates. Yet even as Japan has rapidly increased its imports from China, 

it has shown no evidence of being hollowed out. Quite the reverse. Japan’s industrial strength has, on balance, actually been considerably enhanced by trade with 

China in recent years. Certainly Japan’s trade surpluses have continued to burgeon. 

Japan’s current account surplus last year, at $181 billion, was not only the largest 

of any nation in world history but it was more than three times Japan’s current account surplus in 1989, the last year of the Tokyo financial boom. 

It is interesting to note that China supplied full 20.7 percent of all Japan’s imports in 2004, compared to a mere 13.4 percent of America’s. Measured in yen, Japan’s imports from China increased by 263 percent in the ten years to 2004. 

Just as in the case of the United States, outsourcing from China has played a 

major role in the rise in Japan’s imports in recent years. There the similarity ends. 

Unlike the United States, Japan believes in managing its trade. Although Japanese 

officials recognize, of course, that consumers can benefit considerably from trade, 

they also recognize that people need jobs and incomes before they can consume. 

Thus where imports would pose a significant threat to jobs, the Japanese government generally acts to minimize the damage. It does so typically by issuing guidance to key players in, for instance, the Japanese distribution system to minimize 

their purchases of the relevant imports. 

Where outsourcing is concerned, a second key concern for Japanese policymakers 

is to keep tight control of the nation’s key production technologies, thereby maximizing Japan’s productivity edge. It is taken for granted in Japan that production 

technologies are as much the nation’s property as they are the property of the corporations that developed them. Thus individual corporations are not permitted unilaterally to transfer advanced technologies to foreign operations. The sense that the 

technologies are national property is enhanced by the fact that they are typically 

developed jointly by Japanese corporations in industry-wide research cartels. It is 

assumed by all concerned that the latest technologies will be applied in the first instance in factories at home, thereby giving Japanese workers a vital edge in global 

competition. Any decision to move the technologies abroad will be the result of a 

government-guided industry consensus. Thus although corporate Japan has transferred significant production technologies to China in recent years, it has never 

given away the crown jewels. 

Much of the control of Japanese trade stems automatically from the nation’s distinctive labor regulation. A basic principle is that employers should avoid making 

layoffs. This principle is applied flexibly—in the Japanese way, bureaucrats are entrusted with extraordinary case-by-case discretionary powers. Thus exceptions to the 

no-layoff policy are permitted, particularly in the case of small firms and corporations in near-terminal financial difficulties. But for large, solvent corporations, layoffs are generally not permitted. 

In practice therefore the operating assumption in corporate Japan is that payroll 

is a fixed cost. This profoundly alters how Japanese top managements see their responsibilities. Thus whereas in corporate America, profits come way above jobs in 

a CEO’s priorities, in corporate Japan the ranking is exactly reversed. It is useful 

to see the world as the chief executive of a major Japanese corporation sees it. 

Whereas his American counterparts are much concerned with pandering to the 

whims of securities analysts and micromanaging quarterly earnings flows, a Japanese CEO is necessarily focused on long-term production planning. His principal 

concern is to create new and ever more productive work for his Japanese colleagues 

at every level in the organization. Not the least of his concerns will be to ensure 

the viability of the jobs of the thousands of young workers recruited this year, workers who can be expected to be still on the payroll thirty years hence. Towards this 

end he will want to make sure that the corporation spends heavily on research and 

development and that this spending is directed principally towards developing new 

production technologies intended to give his workers a productivity edge in world 

competition for decades to come. 

All this means that a Japanese CEO’s attitude to outsourcing will almost automatically be closely aligned with the Japanese national interest. Because he cannot 
136

easily shed labor at home, he will move production activities abroad only after he 

has already lined up new and better work for his domestic workers. By new and 

better work is meant work that is either more capital intensive or more know-howintensive or both. 

By way of example, a Japanese television manufacturer might move assembly operations to China only after it had first determined to redeploy its domestic assembly workers making sophisticated components such as liquid crystal displays. The 

significance of this shift is apparent when you realize that the manufacture of components is often ten or even twenty times more capital intensive than assembling 

television sets. It also often involves an enormous amount of secret production 

know-how that can give Japanese workers an enormous edge in global competition. 

In the case of liquid crystal displays, the importance of production know-how can 

be readily demonstrated. A liquid crystal display consists of perhaps as many as a 

million separate dots each controlled by a separate transistor. If the display is to 

be a saleable product all the dots and transistors must work perfectly. If there is 

any deviation from perfect conditions in the factory, there will be a significant number of dysfunctional transistors and the resulting displays will have to be scrapped. 

By dint of learning by doing over thirty years or more, Japanese LCD manufacturers have so honed their production technologies that they can secure a yield of perfect products of as much as 90 percent in a typical production batch. By contrast 

any new entrant into the field—say a Chinese company or an American one—would 

probably be lucky to get a yield of as much as 10 percent. In other words, Japanese 

workers by dint of their employers’ superior production know-how can readily 

outproduce workers abroad by a factor of nine to one. For Japanese CEOs, the availability of cheap Chinese assembly labor has on balance been a major plus because 

it has made possible a highly efficient division of labor. Released from labor-intensive assembly functions, workers at home increasingly concentrate on making sophisticated components. 

Thus the rise of outsourcing in China has enabled Japanese corporations, (1) to 

increase greatly their total unit output, (2) to redeploy their home workers in ever 

more productive work, (3) to cut unit costs and unit prices, thereby expanding ever 

further the global market for their products. All this helps explain the fact that 

though Japan has now been ostensibly eclipsed by China in exports to the United 

States, the Japanese are not complaining. In reality much of the most sophisticated 

value added in China’s exports originates in Japan. 

Below is an article, which will be published in May in The American Prospect.

Rediscovering Asia’s Real Powerhouse

By Eamonn Fingleton

For those who claim an above average knowledge of the global economy, here’s 

a question: which East Asian economic powerhouse recently announced the largest 

current account surplus in world history? 

The answer is, of course, Japan. Not that readers of the American press would 

have noticed. Given the press’s obsession with China, little about East Asia’s other 

economic powerhouse makes it into print these days. Yet in most of the ways that 

matter to current American economic policy, Japan is far more important than 

China. 

To be sure China is growing very fast. But all misinformed American commentary 

to the contrary, China remains a long way from displacing Japan as Asia’s largest 

economy. Still less is China any sort of benchmark against which a high-wage economy like the United States should be measuring itself. 

Japan by contrast is avowedly such a benchmark. A fact utterly lost on the American media is that Japanese industrial wages are now among the world’s highest. 

They are not only far higher than in China—about four to fifteen times higher depending on the region of China—but they are actually 20 to 30 percent higher than 

in the United States. Yet Japan’s export industries have not only survived but also 

thrived. 

The largely untold story of Japan’s extraordinary manufacturing successes of recent years should inspire a radical reappraisal of fundamental American economic 

assumptions. Certainly Japan’s trade performance stands as a stunning rebuke to 

those who hold that high-wage nations can no longer compete in manufacturing. 

Their argument has fostered an utterly unwarranted sense of inevitability about 

America’s manufacturing implosion. Just how much damage has already been done 

can be gauged from the fact that, at more than 5.6 percent of GDP, America’s current account deficit last year was proportionately the second worst of any major 

economy in history. It was exceeded only by Italy’s 7.7 percent deficit in 1924—
137

hardly a happy precedent given that Mussolini seized dictatorial powers in January 

1925. 

Let’s get Japan’s true economic standing into perspective:

1. Translated at market exchange rates Japan’s gross domestic product last year 

came to $5.1 trillion—three times China’s $1.7 trillion. 

2. Japan’s current account surplus last year, at $181 billion, was more than two 

and a half times China’s. Even more impressively it was more than three times 

what Japan earned in 1989, the last year of the Tokyo financial boom. (Full 

disclosure: Japanese officials are now worried that, thanks to higher oil prices 

among other things, the surplus could dip as low as $145 billion in 2005. But 

Americans need shed no tears. This would be a nice contrast moreover with 

the last time oil prices last seriously cramped Japan’s mercantilist style: in 

1980, after all, Japan incurred a ***deficit*** of more than $10 billion.) 

3. Despite the fact that the United States now buys about one-third more from 

China than from Japan, the Japanese are hardly complaining. On the contrary, 

Japan makes most of the high-tech components and materials in China’s exports. Japan’s know-how-intensive and capital-intensive factories are using 

China (as well as dozens of other nations) as an export pipeline to the United 

States. Judged by where the added value is really created, Japan is still a far 

larger source of U.S. imports than China.

How can all this be reconciled with the press’s account of a perennially ailing 

Japan? It can’t, of course. Japan is no basket case and never has been. Strange as 

it may seem, for many years Japanese leaders have—for very Japanese reasons—

been assiduously exaggerating Japan’s weaknesses and understating its strengths. 

Perhaps the biggest surprise is how rich Japanese consumers have now become. 

Their affluence is immediately obvious in how they dress. Already considered the 

world capital of fashion by such style mavens as Suzy Menkes and Amy M. Spindler, Tokyo was recently pronounced ‘‘the coolest city on the planet’’ by the editors 

of GQ magazine. 

As UCLA management professor Sanford Jacoby points out, Japan’s prosperity is 

also abundantly apparent on the roads, which are full of late-model cars, and in its 

electronics stores, which are perennially packed with free-spending males. Indeed 

the Japanese are so rich that many of the most advanced new products—everything 

from the latest game machines to the most spectacular new flat-panel television 

screens—are launched in Japan months or even years before they hit the United 

States. 

‘‘Japan is a very affluent country with an income distribution much less unequal 

than in the States,’’ says Jacoby, author of a new book on Japanese corporate governance. ‘‘Those in the bottom two-thirds of the income distribution enjoy a higher 

quality of life than their U.S. counterparts. As for the upper one-third, they too benefit from Japan’s high level of public services as well as the security that comes 

from a stable, cohesive society.’’

Even in the late 1990s, when commentators abroad were daily performing the last 

rites for the Japanese economy, the palpable prosperity on the ground in Japan 

stunned visiting Americans. A typical recollection is that of Nathanial (stet) 

Gronewold, a Minneapolis University graduate who studied economics in Hiroshima 

in 1997 and 1998. He says: ‘‘My time in Hiroshima went down in the record books 

as two of the worst years for Japan’s economy. But the affluence I witnessed in and 

around Hiroshima was a stark contrast to the scores of empty storefronts and offices 

in downtown Minneapolis, which was supposed to be booming at that time.’’

Although Japan’s real estate crash early in the 1990s has received plenty of attention, the veritable boom in construction that Gronewold witnessed in Hiroshima was 

no isolated phenomenon. As measured by the architectural website skyscrapers.com, 

80 skyscrapers were built in Tokyo in the 1990s, versus just 49 in the 1980s (skyscrapers being defined as buildings rising at least 35 meters). In Osaka the total 

was 56 versus 18; in Yokohama, 19 versus none. By comparison London’s total was 

33 versus 28. Meanwhile New York actually registered a decline: a mere 103 skyscrapers built in the 1990s versus 257 in the 1980s. 

Here are a few other examples of how well Japanese consumers have been doing:

• Car navigation systems. With 3 million systems sold annually, Japan is by 

far the largest market for these invaluable gadgets. (They use satellite technology to pinpoint a car’s position, suggest routes, provide alerts on traffic jams, 

and generally take much of the second-guessing out of getting from A to B.) 

• The Internet. As reported by London-based Total Telecom magazine, Japanese 

Internet connections are now not only the fastest in the world but the cheapest. 
138

Investing more heavily in optical fiber networks than almost any other nation, 

Japan now leads the world in so-called FTTH (fiber to the home). 

• Mobile phones. Japan has come from nowhere in the early 1990s to establish 

a lead of 25 percent over the United States in the rate of mobile phone ownership. Japanese mobile phone networks now lead the world in service quality. 

Thus camera-equipped phones took off in Japan as far back as 1999. Ditto for 

‘‘I-mode’’ service—the ability to access the Internet via mobile phone. Already 

by 2003, according to the Virginia-based consulting firm TMG, 29.5 percent of 

the Japanese population enjoyed I-mode service. Such access was still almost 

unknown in the United States. 

• Health care. Boasting one of the world’s better universal health care systems, 

Japan has cut its infant mortality by more than one-quarter since 1990 to just 

3.28 per 1,000 live births. Less than half the American rate and a mere oneseventh of China’s, this constitutes a world record low. And, despite the fact 

that the Japanese have been eating more and more unhealthy Western food, 

they are living longer than ever. Female life expectancy at birth is now 84.5 

years, an increase of 2.7 years since 1990. The Japanese now live four years 

longer than Americans, and eleven years longer than the Chinese.

If Japanese consumers have made remarkable progress in recent years, the advances in Japanese industry have been stunning. Thanks to consistently heavy investment, Japan has made huge strides in industrial productivity. Thus, as Fortune 

recently reported, Toyota Motor seems set to pass General Motors within the next 

two years to become the world’s largest automaker. By contrast in Japan’s ‘‘juggernaut’’ era of the late 1980s Toyota was still being out-produced more than two 

to one by General Motors and more than 50 percent by Ford. 

Japanese workers these days typically work with ten to twenty times the capital 

of their Chinese counterparts. For the most part therefore the Japanese and the 

Chinese are positioned at opposite ends of the manufacturing spectrum—a spectrum 

moreover that has never been wider. The Japanese worker’s huge productivity advantage is well illustrated by the fact that, on latest CIA figures, Japan is home 

to 57 percent of all the world’s industrial robots. 

Underlying all this has been a national strategy to out-invest all foreign competition. The result is that, utterly overlooked by the American press, Japan has established monopolistic leadership in more and more areas of advanced manufacturing, 

particularly in producers’ goods such as materials, components, and machine tools. 

Almost invisible to the consumer, such monopolies constitute ‘‘chokepoints’’ which 

give Japan control over ever-larger swathes of the global industrial landscape. 

One such chokepoint is Japan’s little noticed but geopolitically important lock on 

advanced lens-cutting. Leadership in lenses helps explain why Japanese companies 

dominate the world market in everything from television studio equipment to 

endoscopes. Lens technology even gives Japan a crucial inside track in semiconductors. The point is that advanced lens-cutting is the single most important technology 

in creating so-called steppers, the photolithographic machines that print minute 

electrical circuits on silicon chips. Japan’s champion lens-cutters, Nikon and Canon, 

make more than two-thirds of the world’s steppers. 

Japan also monopolizes such important semiconductor production equipment as 

photomasks, as well as key materials such as silicon, gallium arsenide, and epoxy 

cresol novolac resin (ever purer versions of which are needed for each new generation of computer chips). 

Elsewhere in the electronics industry Japan’s hidden chokepoints include charge 

coupled devices (essential in everything from home video cameras to guided missiles), high-tech batteries (vital in many portable devices, not least military equipment), and laser diodes (the enabling technology in, for instance, the ever growing 

CD/DVD family of gadgets). In miniaturized disk drive motors, Kyoto-based Nidec 

has 90 percent of the world market. Its highly precise, almost silent, motors are the 

enabling technology in the Apple iPod. 

In mobile phones, the Japanese are quietly dominant. Although Western brandnames like Motorola and Nokia appear to lead the industry, today’s sleek mobile 

phones would not exist without Japan. Japanese electronics makers embarked on 

a massive government-led effort in the 1970s and 1980s to miniaturize the various 

components. A survey by Deutsche Bank found that as of 2000 of 36 suppliers of 

the nine key components in mobile phones, 29 were Japanese. Japan also owns most 

of the world’s optical fiber production capacity. 

Even in the pharmaceutical industry, where the Japanese are generally regarded 

as also-rans, Ajinomoto supplies 60 percent of all amino acids. It also makes 70 percent of all threonine, a vital ingredient in animal feeds, as well as 40 percent of 

all aspartame. 
139

Perhaps the single most surprising area of Japanese industrial success has been 

aerospace. After decades of quietly capturing key chokepoints in avionics, carbon 

fiber, and titanium, Japan has now passed a fast declining United States in all but 

name. One indicator is that, as officially acknowledged by Boeing, Japanese contractors will build 35 percent of the new super-advanced Boeing 787, a big jump on their 

21 percent share of the Boeing 777. In the view of independent experts, the 787 will 

be more a Japanese plane than an American one. 

Although it is impossible in a few paragraphs to do full justice to Japan’s progress 

in recent years, it should be clear by now that the ‘‘lost decade’’ story was a hoax. 

In truth the Western media have been blindsided by a 180-degree reversal in Japan’s public relations program. Whereas in the 1980s Japan had aggressively emphasized its strengths (some real, others imaginary), it switched in the 1990s to a 

highly counterintuitive ‘‘bad news’’ strategy. 

The up-beat propaganda of the 1980s had been intended primarily as a defense 

in dumping suits. Hence, for instance, a bogus claim, much aired in the American 

media in the 1980s, that Japanese car-makers were supposed to be more than ten 

times more productive than their American peers. 

Japan’s propaganda needs changed abruptly once major American corporations 

laid off their factory workforces and switched to outsourcing. As companies like 

Hewlett-Packard and Motorola stopped competing with the Japanese and started 

buying from them, a new era of U.S.-Japan corporate partnership emerged in which 

the dumping suits disappeared. Meanwhile America’s trade deficits with Japan widened rapidly, prompting Washington to view Tokyo more and more as a power rival. 

In the new circumstances, Japan’s old super-economy image was not so much an 

irrelevance as a liability. 

Washington’s mood softened remarkably, however, after the Tokyo stock market 

crashed in 1990. Assuming quite wrongly that the crash signified fundamental problems in Japan, Washington began expressing gentlemanly concern for the ‘‘fallen 

giant.’’

Never slow to spot an opening, Japanese leaders soon found other sob stories to 

tell. In an early gambit, officials reversed Japan’s vagrancy policy. In the 1980s they 

had carefully kept Japanese cities miraculously free of vagrants, thus fostering a 

myth that Japan was immune to the pathologies of lesser societies. In reality, as 

James Fallows documented, down-and-outs had existed all along in Japan. Up to 

the early 1990s they had been kept hidden in special remote ghettos such as the 

Sanya district of Tokyo. The new ‘‘bad news’’ strategy called for a radical change: 

now down-and-outs were given carte blanche to camp out in Tokyo’s glitziest neighborhoods, such as the park opposite the toney Imperial Hotel. 

Another official gambit was to adopt highly conservative national accounting assumptions, which drastically choked back Japan’s apparent growth rate. Hence the 

fact that, though both Japanese living standards and exports have palpably boomed 

in the last fifteen years, annual GDP growth is officially stated to have averaged 

only about 1 percent. 

Meanwhile officials began beating their breasts about an apparently disastrous 

deterioration in public finance. One ‘‘footnote’’ has been omitted: Japan’s official foreign exchange reserves rocketed from $85.1 billion in 1989 to $840.6 billion at last 

count. In effect the Japanese government has been borrowing to prop up not the 

Japanese economy but the American one. 

Some of the sob stories had a basis in truth, but nonetheless greatly exaggerated 

the real trauma. Take the banking crisis. This present writer was virtually alone 

among Tokyo-based observers in the 1980s in predicting the banks’ problems. These 

duly emerged in the early 1990s but, pace all misinformed alarmism in the American press, Japan never came close to a domino-style banking collapse. 

Far from countering the alarmism, many prominent corporate chieftains compounded the jitters. In 1998, for instance, the president of Toyota Motor made world 

headlines when he suggested that a collapsing Japan could take the world financial 

system with it. This remark seemed on its face inexplicable. Certainly no one climbs 

to the top of a major corporation anywhere, least of all in Japan, by shouting ‘‘Fire!’’ 

in a crowded theater. Of course, if all the dramatis personae in the Japanese establishment knew that the fire was merely part of a kabuki act, that would be different. . . . 

What is clear is that nothing in Toyota’s own business experiences remotely justified the remark. In fact Toyota’s profits in 1998 represented a healthy 56 percent 

advance compared to 1989, a performance that put Ford and General Motors in the 

shade. The home market in Japan moreover had remained profitable as household 

car ownership increased by 2.2 million in the 1990s. The cars moreover had become 

much larger and more luxuriously fitted, with the svelte Toyota Lexus, for instance, 

replacing the dowdy old Toyota Century as the executive limousine of choice. 
140

If Japanese leaders put on a convincing impression of economic decline in the 

1990s, it has to be admitted that Western commentators made a gullible audience. 

Many press correspondents wailed about corporate Japan’s low profits. And sure 

enough profits are low in Japan. What the correspondents have not understood is 

that in the Japanese system—whose workings are consistently misunderstood by 

foreigners—profits are a secondary consideration. That may seem surprising but the 

fact is that even in the ‘‘juggernaut’’ years of the late 1980s Japanese corporations 

were notoriously unprofitable. 

In general the further people were from Japan the more extreme their statement 

of the ‘‘basket story.’’ Take New York-based Karen Elliott House, who in 1992 compared the Japanese economy all too gleefully to children’s toys called Shrinkies, 

which were advertised to ‘‘shrink right before your eyes.’’ In a similar outburst of 

misplaced schadenfreude, Paul Krugman recycled unchecked a myth that Tokyo had 

been reduced to building ‘‘bridges to nowhere’’ and ‘‘roads with no traffic’’ to stimulate the economy. Japan has no bridges to nowhere; and it is hard to build unnecessary roads in a nation with one of the highest ratios of cars to road space in the 

world. 

For sheer absurdity few observers came close to Michael E. Porter. In a book entitled ‘‘Can Japan Compete?,’’ Harvard’s competitiveness oracle persuaded himself 

that Japan had ceased to innovate by the mid-1980s. Thereafter its export drive had 

allegedly become increasingly dependent on industries so laughably low-tech they 

would embarrass an Afghanistan or a Peru. Among these were yeast, flaked cereal, 

and, most memorably, ‘‘raw bovine and equine hides’’! For some reason Porter’s list 

overlooked all the hundreds of high-tech products that were then—he was writing 

in 1999—driving not only Japan’s export boom but the world technology revolution. 

To be fair to Porter et al it has to be added that key members of the Tokyo foreign 

community had an agenda to mislead visiting Americans. It has always been so. As 

far back as the 1970s, Tokyo-based consultants were already describing the then utterly closed Japanese market as one of the world’s most open. In the 1990s key analysts pitched in to support Japan’s new ‘‘bad news’’ strategy. This may seem surprising but several of the key analysts in Tokyo have consistently shied away from 

invitations to debate their doom-and-gloom take on post-bubble Japan. 

If there is a moral in Japan’s hidden strengths it is this: it is past time Washington began to address the implosion of advanced American manufacturing. Any 

full consideration of the flaws in current policy is beyond the scope of this article 

but Washington could at least as a first step take a jack-hammer to Japan’s closed 

markets. 

In a chivalrous wish not to kick a man when he is down, American trade negotiators removed all pressure for Tokyo to open Japanese markets nearly a decade 

ago. Thus even Japan’s rice market is still tightly closed—and this despite the fact 

that the American press announced in banner headlines in 1993 that the market 

had supposedly been opened. (Database note: many of these reports seem to have 

been airbrushed from the permanent record.) 

For American trade policy, the most outrageous failure has been the Japanese car 

market. Detroit’s share in Japan last year was less than 0.2 percent. Of course, Japan’s trade lobbyists allege that Detroit does not make cars configured for Japan’s 

drive-on-the-left roads. Actually this is blatant propaganda. The Detroit companies 

have never had any trouble serving Britain, the world’s other major drive-on-theleft market. In any case, many Japanese car buyers prefer the steering wheel on 

the ‘‘wrong’’ side: in a country where imports tend to be egregiously expensive, this 

is a status symbol. 

The ultimate smoking gun here is the plight of the Korean car industry. Its products have made inroads all over the world—everywhere except Japan. While Japan 

has opened up in a token way to Korean electronics exports (Samsung in particular 

has become highly visible in Japan), Korean car-makers are still completely excluded. Thus their sales in Japan last year came to just 2,930 units—less than 0.04 

percent of Toyota’s output. 

If the Japanese car market is really so closed, why hasn’t Detroit pressed harder 

for access? Up to the mid-1990s Detroit did try but since then it has given up. The 

reason is clear: Japan holds the whip hand. The Japanese corporate establishment 

is noted for the alacrity with which it retaliates against American corporations who 

make trouble for its trade policy. Detroit used to be relatively immune from such 

pressure. Not any more. The American car companies are now heavily dependent 

on Japan for key materials like special steels, precision components like air conditioning compressors, and, most of all, for such vital machine tools as painting robots 

and body presses. In a word they are a prime victim of Japan’s chokepoint strategy. 

If they were to make more than a token effort to fight Japanese mercantilism now, 

they would face certain retaliation. 
141

All this prompts a question: if America’s largest manufacturing industry can’t 

stand up to Japan anymore, which nation is really the basket case?

Panel III: Discussion, Questions and Answers 

Cochair MULLOY. Thank you, Mr. Fingleton. 

We’ll open it up for questions. All of these trends and the movement of R&D and the large trade deficits and that sort of thing, 

this isn’t the inevitable part of technology and market forces and 

other things, this all is taking place within a public policy framework that officials of the United States and other countries put in 

place: The WTO and before that the GATT. 

In other words, if we didn’t have an average tariff and lock it in 

the WTO, and before China became a member of the WTO, they 

didn’t get as much investment. Once they get the market locked 

open through being a member of the WTO and locking our tariffs 

in, then the investment could flow because people could move and 

feel pretty sure they can send their goods back to this market with 

a very low tariff. 

I think this isn’t just historically inevitable. These are forces and 

a framework that’s been put in place. 

Secondly, when you were talking about the components going 

into China trying to assemble them, only 20 percent value added, 

it’s interesting that that whole East Asian block, though, when we 

talk about currency manipulation, it’s not just China. Japan’s in 

there, Korea’s in there, Taiwan is in there. They’re all massively 

intervening in currency markets to help manage this transfer of 

wealth from the United States across the Pacific Ocean. That’s my 

impression. And the third thing. 

When we talk about a national competitiveness strategy, Dr. 

Zysman, I don’t think we’re just saying China is the reason for 

this. I think we’ve thrown ourselves into a globalized economy with 

3.2 billion new people coming onboard with China, India, and Eastern Europe and others that we didn’t have 15 years. This has made 

an enormous difference. The fact that we have a legal framework 

that may have been put in place without fully understanding what 

we were doing, has driven some of these changes that we’re now 

witnessing. But I’d like to open that up for any comments. 

Mr. ROWEN. Let me pick up on one point. You mentioned R&D. 

Research involves ideas and ideas do not go through customs. Ideas 

move. And if there is talent, which heretofore has been untapped, 

but now it’s generating, it’s growing, it’s accessible. You can’t stop 

ideas, in some sense. You can try, but it’s hard. 

So one of the things that’s happening is that a lot of companies 

have discovered that there are people with talent whose wages are 

lot lower than they are in the United States or in Europe or in 

Japan, who can be accessed. That’s only one aspect of it because 

there’s quite a lot of other parts of to it, too. But that aspect is very 

important. You mentioned R&D, and that’s what it’s about. 

So in that sense it’s inevitable. It is truly inevitable that if there 

emerges, as there has, a place with talented people and with telecommunications costs having plummeted, for example, ideas really 

can move. Those people are now part of the global system. It is a 

globalization phenomenon. And that is not in itself a result of any 

change in policy. 
142

Cochair MULLOY. I agree with you on that. Let me just add one 

more thing. I think at the time that the policies were put into 

place, technologies were changing quite rapidly. The rise of the 

Internet, particularly in the services industry area, is an enormous 

development. 

Of course with public policy, you could change that. You could 

just put a tax on transactions for the Internet. So it’s not like it’s 

all inevitable. If you didn’t want it to happen there would be ways 

that you could do it. I’m just pointing that out. 

I think we fully didn’t understand what we were doing when we 

get into some of these arrangements. 

Yes, Dr. Preeg. 

Dr. PREEG. Well, you were groping toward a policy framework or 

explanation, but you also we talked about the manufacturing sector 

where it comes together. Manufacturing is ten times more engaged 

in trade and that’s where the innovation takes place. Two-thirds of 

commercial R&D in the U.S. is in the manufacturing sector, over 

90 percent of new patents come out of the sector. And here we’ve 

got a $600 billion trade deficit in manufactures, of 1.5 trillion value 

added. So 40 percent of the trade deficit; we’d have a 40 percent 

larger manufacturing sector or resource base for R&D and everything else if our trade were in balance in this sector. And I think 

that’s an orientation that makes the imbalance that is talked about 

by finance ministers much more qualitative in terms of it’s hitting 

directly into the advance-technology, the innovation of technologies 

when the brunt is all here. And that’s why there’s such a difference 

with East Asia where they’re all leaning the other way. 

The policy response is certainly is the currency issue. There are 

some trade issues. But we also have to have a domestic policy 

agenda. That’s why I would agree with all the comments this morning, that we really have to have a concept and we have to have a 

broad strategy and commitment as a nation to this issue, which we 

don’t have now and certainly the Chinese do. 

Cochair MULLOY. Commissioner Reinsch. 

Commissioner REINSCH. Thank you. I have two questions. 

Mr. Fingleton, I was looking at your written statement while you 

were talking, and you had a very intriguing beginning. And then 

I kind of got lost, and maybe you can clarify. 

You began by saying in your written statement we’ve been told 

that it’s inevitable that high-wage nations like the U.S. will be 

hollowed out by rising China, and then you suggest that this is 

nonsense and then proceeded to talk about Japan, which was very, 

very interesting. I was fascinated by your description of what’s 

going on in Japan, but can I draw you back to China for a couple 

minutes and ask you to tell us, A, why it’s nonsense and presumably, since I think Dr. Preeg essentially said the opposite and that 

we are being hollowed out, maybe you can tell us why he’s wrong. 

Mr. FINGLETON. Well, there’s no question that the United States 

is being hollowed out, but what I’m challenging is the idea that 

this is inevitable. Other countries don’t regard China’s rise as necessarily leading to their hollowing out. They have policies to take 

care of that, to balance out. 

Commissioner REINSCH. And what policies would you recommend 

that we adopt to achieve the same result? 
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Mr. FINGLETON. Well, clearly America has a problem in the sense 

that it cannot emulate the practices in East Asia where the official 

position is that all these countries are in favor of free trade, yet 

the unofficial reality is that they’re all highly mercantilist. The 

United States is not in the business of double standards, so it 

seems to me that the appropriate response is outright protection. 

It’s not a word that many people think favorably about these days, 

but what’s the alternative? Your economy is being completely gutted. A very drastic response is necessary. 

I don’t know whether people fully understand how weak the 

United States economy now is. The current account deficit last year 

was, what, 5.5 or 5.6 percent of GDP? 

Cochair MULLOY. Seven hundred billion. 

Mr. FINGLETON. Five point seven percent of GDP. That’s the second worst current account deficit in percentage terms of any nation, any major nation in the history of recorded trade. 

Dr. PREEG. Seven percent this year. 

Mr. FINGLETON. The only nation that ever had a worse deficit 

than that was Italy in 1924. And in 1925 Mussolini seized dictatorial powers. 

Commissioner REINSCH. Well, maybe we could pursue this for a 

minute with some of the other panelist. Dr. Zysman, do you agree 

with Mr. Fingleton’s prescription? Your testimony, I thought, was, 

as some this morning was, very helpfully focused on what the 

United States ought to do with respect to its own competitiveness. 

Mr. Fingleton suggested a slightly different route. Do you think 

he’s right? 

Dr. ZYSMAN. Well, I’m going to answer to the first question of 

what should we do and why. 

Commissioner REINSCH. You don’t have to be tactful. That’s all 

right. 

Dr. ZYSMAN. The first issue is the trade deficit as such doesn’t 

necessarily have its underpinnings in industrial or technological 

competitiveness as such. Any good economist, and I’m actually not 

an economist by formal training, would argue that it lies in domestic savings and expenditure structures, and I think we have to acknowledge that. If there is a problem, and I actually think there 

is in the long-term, it doesn’t translate into an argument about 

trade flows in that way. 

The second issue is, is how does one respond to the hollowing 

out, if you will, of the American industry. Having written a book 

some time ago arguing precisely that those issues mattered, our 

prescription at the time was not that we use protection, it was 

rather that we aggressively develop the capacity of American firms 

and industry to compete. One could choose sectors such as the 

automobile industry where clearly in response to the Japanese 

there’s been great progress made and at the same time not enough. 

And one has to ask the question of why companies such as General 

Motors and Ford are not effectively competing in auto sectors and 

what are the character of the choices that they are making. 

Cynics like myself who grew up in Nebraska would say maybe 

the reason is they design cars in Detroit rather than Los Angeles. 

And to some extent there are issues: Such as what the basic strategies here, what are the manufacturing issues here. 
144

The other questions that I would emphasize is what can we do 

in terms of developing the R&D and innovative capacity in this 

country, and that’s where I would put the emphasize. We’re not 

going to change—whether or not Eamonn Fingleton is right, and I 

don’t agree with the position as such, we’re not going to reverse 50 

years of American trade policy. That’s not going to happen. Therefore, the question is what do we do. And I think the question is we 

have to make sure that in leading-edge technology areas, such as 

telecommunications, our networks are leading edge so that our 

equipment producers have the targets to aim at that leading-edge 

users are really emerging in the United States, that we educate the 

population for a digital era as rapidly as the Chinese are trying to 

do. 

If we don’t do those kinds of things it won’t matter what we do 

with trade policy, because we’ll lose. 

Commissioner REINSCH. Ernie, you want to have the last word 

on this point? 

Dr. PREEG. A quick word, but just noting that there’s no single 

simple policy response. In my paper I list a comprehensive set of 

14 things that we should be doing, but I certainly think the two 

most important ones is the currency manipulation issue is huge. If 

it really is at least 40 percent under valued China and 20 percent 

or more in the other East Asians, this is a major cost difference. 

For automobiles 20 percent on the yen, Japanese yen, that’s $3,000 a car. That’s the whole difference between General Motors 

making a loss and Toyota making a profit. So that’s one big area 

and it’s finally being engaged, I feel, now in recent months after 

several years. And this has to be dealt with. 

The other is the domestic issue that’s been—we need not only a 

higher savings rate so we don’t have to borrow abroad, but there 

are a number of other measures, domestic policy measures that we 

should take from R&D expenditures to taxes to Sarbanes-Oxley, 

whatever, that are really putting U.S. companies at a disadvantage 

vis-a`-vis China and others. 

Commissioner REINSCH. Thank you. 

Cochair MULLOY. Yes. Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thank you, Mr. Chairman. Thank 

you to our panelists. I have questions for Dr. Zysman and Mr. 

Rowen. 

Dr. Zysman, the chart that you had up comparing Japan, China, 

and India, I was interested because the first two characterizations 

of Japan were closed market and rapid—was it rapid domestic 

growth? And I was interested, of course, that you didn’t include as 

the first two characteristics on the Chinese description because 

closed markets are still an issue, WTO-compliance problems, 

phytosanitary standards, all sorts of things American products 

aren’t getting. 

So I’m trying to understand your analytical framework of comparing and contrasting. 

Dr. ZYSMAN. You’re right. And as I looked at the slides I wish 

I had redone them. But let me make the point that I would make, 

which is what the Japanese did was use closed domestic markets 

and not banning foreign direct investment, as a mechanism of basically being able to extract technology abroad and develop it in rap-
145

idly growing markets at home. The Chinese obviously are using foreign direct investment and attempting to see how much technology 

can get transferred internally from local relationships with multinational corporations. 

There was a particular dynamic in the Japanese days, particularly evident here in Silicon Valley in the semiconductor wars in 

which you couldn’t invest, you couldn’t sell, markets would expand 

in particular products, and the first sales of American companies 

would go up. And the first Japanese product that would enter, 

sales would drop to zero or close to zero. So it was a different dynamic, and I should have characterized it as a different dynamic 

in that regard. 

Commissioner BARTHOLOMEW. And some of what we’re trying to 

do, at least I am, is understand the Japanese model, the Chinese 

model, how predictive. As you say, we have a tendency to fight our 

next battle based on the last war and whether that is always good 

or accurate or not. 

I think one of the characteristics we’re seeing is how rapidly 

things are changing. 

Dr. ZYSMAN. That’s right. 

Commissioner BARTHOLOMEW. That it’s picking up speed and 

tempo and size as we go along. And are our old models of changing 

within this society, within our economy going to work fast enough 

in order to make the changes that are necessary? 

Dr. ZYSMAN. I agree with that. 

Commissioner BARTHOLOMEW. Yes. Mr. Rowen, I was interested 

when you said you can’t stop the movement of ideas, which I think 

we’d all really like to believe. But of course the Chinese government seems to be predicating what it’s doing on the idea that you 

can’t stop the movement—well, that they can control the movement 

of ideas. 

As we’ve been hearing about science and tech, it’s quite clear 

that they want the science and tech ideas, but again last week we 

heard about the chokeholds they have on Internet service providers 

and the other kinds of ideas that they are blocking. I wondered if 

you could talk a little bit about economic reform leading to political 

reform, what you think about that, and how long China can continue to grow its economy based on the model that they’re using 

of only allowing certain kinds of information in, but blocking political change. 

Mr. ROWEN. That context was ideas affecting science and technology and commerce. 

Commissioner BARTHOLOMEW. Okay. 

Mr. ROWEN. That was the context. And it is remarkable, as was 

observed this morning by, I think it was, Suttmeier, how open they 

are in terms of the kinds of information. I mean Chinese statistics, 

people call—you can call some of our own, they are really worth 

looking at. I mean a lot of that material is very valuable, and that 

did not used to be the case. They are putting up vast quantities of 

useful information for their own purposes, and of course anybody 

can get that stuff. 

So in the context of commerce and science, science has to be 

international. If you try and make it national science, forget it. 
146

You’re going to lose. It has to be international to count, to be fruitful. So that’s really very clear. 

On the more political side that’s not really the subject of this 

particular area, my belief is that they’re fighting a losing battle, 

but that’s just a belief of mine. I’m trying to control information, 

generally speaking, this other kind of information. But for the 

science and commerce kind, they are really quite wide open. 

Commissioner BARTHOLOMEW. Thanks. Anyone else? Mr. 

Fingleton? 

Mr. FINGLETON. Yes, I’d like to address this question, the flow 

of ideas. I think that you have to make a distinction between different types of ideas. In general, in competitiveness we’re talking 

about production technologies. Production technologies can be kept 

secret for a very long time. I know that in the Japanese case, for 

instance, they are very, very protective of their production technologies. They license their technologies to the Koreans and to the 

Taiwanese sometimes, but many of the technologies they keep entirely to themselves. 

When, for instance, they have overseas operations using these 

technologies the technologies will be embedded in the machines—

in the settings and so on and are not obvious to the local workers, 

so that if a machine breaks down the local workforce will not be 

able to repair the machine. They’ll send somebody out from Japan 

to repair that machine, one of their own highly trained engineers 

who will be completely discreet and will make sure that no technology is transferred. So there are many, many areas where Japan 

has world monopolies in typically key components, key materials, 

in the jargon, ‘‘choke points.’’ Japan has been able to maintain 

these choke points for many years without the production technology leaking abroad. 

Cochair MULLOY. Commissioner Dreyer. 

Commissioner DREYER. Thank you. 

As I listen to people talk about this huge expansion and the 

number of engineers China is turning out, my concern is that it’s 

best not to interpret these statistics without knowing the context 

behind them. I think the context behind them has been misinterpreted here. 

The reason for the large increase in the production of Chinese 

engineers and, in fact, the Chinese educational system as a whole, 

is not increased demand from industry. It stems from the large increase in the unemployment rate. The Chinese educational system 

began a rapid expansion about 1999 with the object of keeping 

numbers of young people off the job market, since there were few 

jobs for them, and concern that unemployed young people would increase the potential for social unrest. 

As we found out in our own country when we had a rapid increase in the educational system at the time of the Vietnam War—

because many young people wanted the draft exemptions that attending college game them, this results in a dilution of the quality 

of education. The consensus in China is that these new graduates 

are not well trained. Another interesting factoid is that not many 

of these additional college graduates are finding jobs. This is even 

true of the students who’ve returned from overseas. 
147

There is a wonderful pun on this, which if you don’t know Chinese characters is hard to appreciate the humor of, but basically 

it depends on a homonym in which the characters for returned students are pronounced the same as those for sea turtles, which has 

a good connotation. But now they call themselves by another homonym, which translates as seaweed. The idea is that they have been 

washed up on shore and no one wants them. 

What I am wondering is if you see this as a temporary thing. Are 

these kids going to beef up their skills? Is the expansion of the system going to mean that some day these engineers are wanted? 

We saw this, in fact, with the Soviet Union. We were scared for 

years by scare-mongerers who said, ‘‘Oh, my God, look at how 

many more engineers they are training than we are; we have to 

train more engineers.’’ After the Soviet Union disintegrated many 

of them went to Israel to try to find jobs, and the Israeli authorities 

considered them unqualified. So perhaps we’re scaring ourselves 

too much or perhaps you think the industry is going to expand and 

absorb them all anyway? 

Mr. ROWEN. A comment on that. One indicator of employment, 

the demand for various skills is the wage rates. My impression is 

that for engineers and certainly electrical engineers, computer scientists, that’s one small category to be sure out of a much larger 

set, it’s going up rapidly. Rising rapidly. That suggests there isn’t 

a lot of unemployment, so much so that companies are moving activities or starting up activities increasingly in other parts of China 

than the east coast, going to Chengdu, going inland, to get access 

to people because they’re getting too expensive in Shanghai. That 

does not suggest unemployment. 

Now I don’t know about civil engineers, frankly. Maybe there are 

a lot of unemployed civil engineers, I just don’t know. But I’d be 

kind of surprised. By the way, this is a noble thing. I’ll bet the Chinese national income statistics have a category, which I haven’t 

looked at I must confess, at wage rates for various categories. Some 

day you ought to look at those wage rates. I’ll bet one would find 

in looking at them they’re going up for various categories. If that’s 

true then it is not about an unemployment problem. 

Commissioner DREYER. My source is Beijing Review, which rarely gives out unwanted bad news, and also the Chinese economist 

He Qinglian. 

Mr. ROWEN. Well, okay. Somebody ought to look at the numbers 

and see what’s happening to the wage rates. 

Dr. ZYSMAN. I think there are a couple of issues here. Let me 

deal with the secondary comments I have and then come to the 

core. The secondary comments are that some of the issues such as 

the inappropriately trained Soviet engineers can itself be somewhat 

misleading. 

I looked at one point at Hungarian engineers, who were great experts at dealing with variable flows of electricity because they were 

better than anyone in the world because the system, the electrical 

system didn’t work very well. And so they weren’t capable of building product that could accommodate that, they would fail. Suddenly 

they had stable electrical systems and a lot of those skills were irrelevant. 
148

One could say some of the same things about those trained in 

military technology areas in Southern California and the difficulty 

of their adapting to a commercial era. At the moment if you look 

at St. Petersburg it’s the mathematicians who are now sources of 

outsourcing, of heavy outsourcing of software activity and the like. 

So there were Soviet skills, they weren’t necessarily the engineers 

that people expected them to be. 

The comment I’d make, and I don’t know the statistics in China, 

but I do know the broader panorama, which is we should not discount the efforts that others are making to educate their populations in high-technology skills in very significant ways. That is, 

whatever is true of that set of statistics today, the Indians will 

make up for it tomorrow, and the Chinese in improving their own 

education system, the day after. So that the fundamental problem 

of an enormous abundance of skilled, technically-trained labor that 

we will confront in different ways will be there over time. And the 

question is how to assure that the best come through the United 

States, that we’re the technology pump. 

I would agree with Henry, we can’t hold on to the technology. We 

can only make sure that it passes through here and is developed 

in innovative ways. 

If you look at the Berkeley—I don’t know Stanford as well—Computer Science and Electrical Engineering Department the current 

chairman is Indian, the chairman before him was Indian, the chairman before him was also head of the DARPA Computer Science Division, came from Bangalore. The dean of engineering is from New 

Zealand. The leader in semiconductor design activity worldwide is 

Alberto Sangiovanni-Vencentelli, which suggests he might be 

Italian, and so on. It’s that flow-through, that technology pump 

that is absolutely critical. We have to keep it vibrant. We have to 

run away from the competition, not move back to it. 

Commissioner DREYER. Oh, without question. So I take it you 

would agree then with the idea that the economy will eventually 

absorb these people even though they may not be able to find jobs 

this year? 

Dr. ZYSMAN. I have no idea how well they’re trained, but if 

they’re not properly trained, the next generation will be. 

Commissioner DREYER. Thank you. 

Dr. Preeg. 

Dr. PREEG. This is a very important question and, as usual, it’s 

very hard to get hard facts. But my reading is somewhat different, 

and I make three points. 

One, I would doubt very much that the increase in college graduates of one million to three million every year over the last ten 

years, which was related to those decisions in ’95 and ’96 to put 

science and technology at the top, that this was to somehow offset 

the tens of millions of workers coming off the farms or the SOEs 

being—people put out of work. So it’s a very slow-moving and, I 

would think, very expensive way of dealing with these huge numbers of people that were unskilled and unemployed. 

Commissioner DREYER. Excuse me. 

Dr. PREEG. Yes. 

Commissioner DREYER. That isn’t what I said. 

Dr. PREEG. Oh, okay. 
149

Commissioner DREYER. This is a large number of people who 

turn, let’s say, 18 or 19——

Dr. PREEG. Yes. 

Commissioner DREYER. —and they’re not coming off the farms. 

They’re coming out of urban high schools. 

Dr. PREEG. Anyhow, that was not my reading of the buildup in 

the late 1990s. 

The second page is that I’ve seen in the recent press, I think it 

was in The Economist magazine, a long piece recently, that there 

is upward wage pressures, particularly in professional and skill 

labor jobs. There are some real problems of companies being able 

to hire enough people. And there’s a lot of competition of multinationals competing and taking away workers, trying to retain 

your workers without. So there appears to be some upward movement of incomes, at least in recent months. 

The third point is that though the engineers, and there’s been a 

lot written about this, the most detailed I’ve had is from the Taiwan relationship, which is so close. Incidentally, the U.S.-Taiwan 

Business Council puts out a lot of good material on this. All the 

experience in a lot of case histories is that these engineers, Chinese 

engineers, they have all the basic technical training and skills, but 

they’re not business related. That they have to be trained to do 

that. 

That’s why the Taiwanese, they come in, and very mixed about 

what this means for the future of Taiwan, and they set up in 

China. And they hire these engineers who have the basic training 

and then they need a few years of working in a competitive private 

sector company to really put it together and make them a much 

more valuable asset. So I think there is this building process, but 

I haven’t seen anything where they’re basically not competent in 

their engineering skill. So I would be more on the side that there 

may be some transitional ups and downs, but that they’re building 

a pretty solid basis of engineers and technically-skilled people. 

Commissioner DREYER. Thank you. 

Mr. Fingleton. 

Mr. FINGLETON. I don’t have knowledge of the detailed facts here, 

but surely if there is an oversupply of labor it’s simply a short-term 

phenomenon. If this labor is valuable labor it’s not going to go unused for long. 

Commissioner DREYER. Thank you. 

Cochair MULLOY. Thank you. 

Chairman D’Amato. 

Chairman D’AMATO. Thank you, Commissioner Mulloy. 

I wanted to pursue a couple of things. One, Mr. Rowen, in terms 

of the transfer and free flow of ideas, this question of flow of ideas, 

we had a hearing, and we’re required to look into the Internet, by 

statute, by Congress, so we’re looking into it. 

We had a hearing two weeks ago and a very comprehensive report was released by a group from Harvard, Cambridge, and Toronto working together. And their conclusion was very disturbing, 

that the Chinese had been, in fact, more successful than anyone 

had expected in terms of manipulating the Internet at various 

points, both the backbones and other nodes, and along with other 

techniques including thousands and thousands of people dedicated 
150

to intimidating Internet users if they get out of hand, closing of 

Internet cafes by the tens of thousands on big sweeps. 

I think that Dr. Perry was correct this morning in saying that 

the control of ideas through these techniques by the Chinese government has had an effect, negative effect on their development. 

When we passed the Chinese Most Favored Nation Treatment back 

in, what was it, 2000, which was the creation of this Commission, 

the Administration argued at that time that this creation of a market economy in China would ultimately bring democratization and 

political reform. That argument was used consistently throughout 

the debate, particularly by the Administration. 

So the question is to what extent has that actually occurred, and 

our conclusion is it hasn’t occurred at all. It hasn’t occurred at all. 

In terms of if the Congress had at that time been told that, yes, 

they’re going to be able to create a super state, economic super 

state and still be able to control the flow of ideas politically, and 

there will be no political reform and it will be a continued, highly 

brutal communist dictatorship, that vote might have turned out differently. 

Now the jury may still be out. It’s only five days down the pike, 

but the transfer of all these technologies by people like Cisco and 

Nortel have assisted the Chinese in being able to use sophisticated 

techniques to control the Internet. 

We’d like to send you the results of that hearing. I think that 

would be something we would be interested in getting a reaction 

on. Although there are some entrepreneurs in Silicon Valley who 

are able to penetrate the Internet through various techniques, it 

still seems to be very much on the margin and is not available. And 

the user has to be quite sophisticated to be able to plug into it, so 

the average Chinese is not going to be able to use these techniques 

to get the New York Times or the Washington Post. So that I think 

is something that we found very disturbing. We were wishing that 

it would not be that way, but the worry is that it will continue that 

way. 

So we will face a continually strengthening China that continues 

to control the ideas in its society and the ideas that may not be 

friendly to the United States, will be hostile to the United States, 

using nationalism to control thought in China. 

Anyway, just a comment I wanted to make on that. 

I don’t think it’s much of a mystery what we have done in the 

past when we have faced a competitive challenge. What we did in 

the post-Sputnik era was very simple: We marshaled a vision and 

leadership and money at the Federal level to hot house technologies and to rebuild our educational system and so on. 

It seems to me, maybe I’m missing something, but first the recognition of the problem and then the result of that recognition 

bringing leadership from the national level. Where else is it going 

to come from but the Federal Government in terms of producing 

more money for education, for technology development, and the vision to go with it. 

Does that make sense to you? I mean the fact is we don’t have 

the recognition of a problem. We have a leading editorial in the 

New York Times today that basically says there isn’t really a problem in manipulated currency, it’s all being made up by Congress, 
151

and that this is protectionism raising its ugly head that we would 

even talk about doing something with regard to punishing China 

for manipulating its currency. Right here in the New York Times, 

it doesn’t exist as a problem. When you don’t have a problem, you 

don’t have a solution. 

This is a very interesting article. Everyone should read this editorial about leadership in terms of fixing the currency problem. 

Anyway, that’s just my thought. Do you have any questions? 

Mr. FINGLETON. If you can give me ten seconds on that. It seems 

to me that if there were a truly free market on the dollar, the dollar would drop by 50 percent against most of the East Asian currencies overnight. 

Cochair MULLOY. That’s your judgment, Mr. Fingleton? 

Mr. FINGLETON. Yes. But put it like this, what level does the dollar have to fall to for the United States to balance its trade now? 

It doesn’t have the manufacturing capacity to increase exports, 

even if the dollar were down to 50 yen. It doesn’t have the capacity 

to take advantage of a cheap dollar anymore. 

Chairman D’AMATO. Well, the realignment of the currency, however, would have some effect, some say 15, 20, 25 percent, on the 

level of the deficit. So every little bit helps, and 20 percent is certainly an important percentage. 

Mr. FINGLETON. I agree, totally agree that the dollar is overvalued and that part of the solution is to reduce the dollar’s value 

against all the East Asian currencies, but it’s a matter of a very 

long time. In the short-term, a devaluation of the dollar would increase the trade deficit. In the long-term, yes, it would be beneficial, but it would be quite long-term, five, ten years ahead. 

Chairman D’AMATO. Yes. 

Dr. PREEG. Just a couple of points. There is the J-curve effect, 

that you would have a very short-term increase in trade deficit, but 

there are also time lags. It will take not ten but maybe one to three 

years to play out, to a very substantial improvement in the trade 

deficit position, as happened in the late ’80s. But there also has to 

be corresponding steps within the U.S. economy to shift resources, 

so it’s not simple and it does take time, but that is the basic solution. 

One other point, just to respond to you, it’s not just in the New 

York Times, the Wall Street Journal off on the right is just as bad 

on the currency-manipulation issue. But the saving grace here is 

these elite papers in New York City are kind of away from the 

countryside. It’s the Congress that has to go back to their constituents each weekend and who hear about it. Certainly on both sides 

of the aisle in the Congress there is very strong feeling about the 

currency-manipulation issue, and that’s driving the White House a 

little more than the New York Times is today. 

Chairman D’AMATO. Yes. That’s right where the action is. The 

Congress is reacting and, of course, the Congress will overreact, as 

it does, only because the Administration hasn’t acted on these 

issues. So you get these overreactions. That’s expectable. But without that you don’t have any action. 

Dr. PREEG. Just like financial markets, usually over react, too. 

Chairman D’AMATO. Yes. 
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Dr. ZYSMAN. If I could just suggest, it would seem to me that obviously part of the question is to ask how much of the currency 

problem is straightforward manipulation, but even—let’s assume 

that it is. I think this question of what the consequences of different levels of devaluation of the dollar would be at this point really needs to be looked at, because I don’t think it’s a solution. And 

that’s a serious problem. 

I know you don’t think it is, but I think in fact that it’s not going 

to solve the problem in and of itself. 

Chairman D’AMATO. That I don’t think what is——

Dr. ZYSMAN. That a devaluation of the dollar will, in fact, as you 

said, it would make some contribution to it——

Chairman D’AMATO. Yes. 

Dr. ZYSMAN. —but it wouldn’t solve the problem. 

Chairman D’AMATO. Right. 

Dr. ZYSMAN. And I think we shouldn’t convince ourselves that 

that would, in fact, solve the problem—make it go away. 

Chairman D’AMATO. I agree with that, but if you have multiple 

problems and you solve none of them——

Dr. ZYSMAN. Absolutely. 

Chairman D’AMATO. —you’ve got to start working on these 

things incrementally. Pretty soon you’re getting into the domain of 

solving the overall issue. 

Dr. ZYSMAN. That’s right. As long as we don’t think we’ve solved 

it by dealing with that one somewhat, in a certain sense, let’s just 

blame the currency problem. 

Chairman D’AMATO. Let me just say, I don’t think that we’re 

solving it by changing—we would not want to cause the currency 

you want to float, because the banking system is too fragile. But 

they can repeg it. Everybody agrees that a repegging of 25 or 30 

percent could be done by the Chinese without affecting their banking system. 

So the problem is that if we’re going to have an international 

system bound by rules and market action, or are we going to have 

one that’s being manipulated continuously. 

Cochair MULLOY. I’d like to finish up by noting that I agree with 

you, John that the currency is not a silver bullet, but it is one bullet. And it needs to be done. This Commission strongly recommended that and we have for over a year and a half been telling 

the Congress this is an important issue. 

I’m delighted that during the debate on these issues our reports 

are being cited by Congressional Members, and that’s why it’s so 

important for us now to move on to the broader vision. I think Congress needs and the nation needs to think about a more comprehensive look at what is going on here, and that’s why we’re in 

the business of trying to help them. And you have helped us very 

much and I want to thank all of you for being here this afternoon. 

If you have anything else that you feel we should know about, 

feel free to contact us because we’re going to now wrestle with this 

and try and distill some recommendations to the Congress. 

Thank you very much. 

Commissioner REINSCH. On those comments, I can just note for 

the record the Commission was not unanimous in that recommendation. 
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Chairman D’AMATO. It was almost unanimous. 

Cochair MULLOY. No, last year, on the Exchange Rate Report to 

the Congress, our Annual Report, that was a unanimous report, 

that we said China was manipulating its currency, and not just 

China but other countries in Asia like Japan, Taiwan, and Korea. 

The one that we sent up most recently more or less endorsing 

Senator Schumer’s bill was not a unanimous recommendation, correct. 

Thank you very much. We’ll take a five-minute break and then 

we’ll have our last panel of the afternoon. 

[Recess.] 

PANEL IV: CHALLENGES TO U.S. HIGH-TECH LEADERSHIP 

Cochair MULLOY. We’re going to start our final panel of the afternoon, in which we’re examining the challenge that China poses to 

the long-term U.S. technological leadership, upon which depends 

our standard of living and our national security. 

We are pleased to have with us an old and dear friend, Bill 

Archey, who has served the great Republic for many years in the 

public sector, but is now the President of the American Electronics 

Association. Thank you for being here, Bill. 

Mr. Rick Dawson, the President and CEO of the Information 

Technology Industry Council. And Mr. John Ciacchella, Vice President at A.T. Kearney. He has conducted two studies this past year, 

one exploring the economic impact of offshore outsourcing on the 

Bay Area and another which is, I understand, due out soon, consisting of interviews with 300 high-tech leaders, looking at assessing their view of their competitiveness in today’s world market. 

So I want to thank each of you for being here. We’re looking forward to your testimony. Any statement that you give us we’ll put 

in the record of the hearing and transmitted to the Congress. If you 

could limit your opening statement to seven or eight minutes, and 

then open it up for discussion, questions and answers. Thank you. 

Mr. Archey. 

STATEMENT OF WILLIAM T. ARCHEY

PRESIDENT AND CHIEF EXECUTIVE OFFICER

AMERICAN ELECTRONICS ASSOCIATION (AeA)

ADVANCING THE BUSINESS OF TECHNOLOGY, WASHINGTON, DC 

Mr. ARCHEY. Thank you very much, Mr. Mulloy. A pleasure to 

be here. 

First of all, I’d like to note just in February this year AeA released a report whose title probably says it all: ‘‘Losing the Competitive Advantage? The Challenge for Science and Technology in 

the United States.’’ I’d like to submit a copy of this report for the 

record, if that’s all right with you. 

Cochair MULLOY. It will be included in the record. 

Mr. ARCHEY. Thank you. 

I would also to note that the report is receiving a great deal of 

attention. I would like to believe it was because of its wonderful 

content, but it’s thanks to Tom Friedman for publishing his book. 

And we have discovered, as I discovered of Monday this week, I 

briefed three United States Senators at their request because their 

staff told them they didn’t have to read Friedman’s book, all they 

had to do was read ours and it was a little shorter. So I thank Mr. 
154

Friedman because next week I’m briefing ten Members of the Congress about competitiveness. 

And the thrust of our report is pretty straightforward. It is not 

that the United States is per se in decline but, rather, that our 

competitive edge is slipping. We are also—would argue that by almost every metric the United States is still the leader in most technologies in most economic areas, but the lead is clearly eroding 

and, most importantly, other countries the catching up. 

I think that one of the things that we talked about is, is that 

even if the United States were doing everything right, the competitiveness equation on the world stage has changed fundamentally. 

And we would still have a significant competitiveness challenge 

even if we weren’t doing everything right. Our problem is, is that 

we don’t believe we’re doing everything right, and I’ll talk a little 

bit about that. 

We basically hit on just five variables. The first is, is that economic reforms around the world are rapidly transforming economies. As all of you on this panel realize, for a number of years the 

United States has been seeking to persuade other countries to 

adopt market economic principles and practices. The good news is 

they did. The bad news is they did. And, as you know, if you look 

back to 1985 and if you county China as just being in the incipient 

and choate stages of its own economic development to a different 

system, 60 percent of the world lived under some sort of a command-and-control economic system. That’s now down to about 15 

percent or less, that are living under a command-and-control system. 

I look at, for example, India, when I was there in 1985 when I 

was with the government and an American company could not own 

a controlling ownership, all kinds of restrictions on foreign investment, et cetera. Now it hasn’t changed completely, but it’s changed 

dramatically from that period of time. 

The second thing that we talk about, which is something that I 

don’t think gets enough attention, is—and some of this also was 

referenced in a CIA report that came out last month that basically 

noted that you do not have to be the innovator of a technology to 

essentially be a leader in using it and in developing your own economic and technological system. 

Indeed the point they make is that the diffusion of technology 

now is so rapid that your ability to use it is almost as important 

as being the innovator of it. And I think that’s an important point 

in terms of the way the world is going. 

The third issue that we note is that if we’re going to be competing in this world, in what I would call a brave new world of 

competition, we had better do something about the issue you all 

have been talking about which is the whole issue of science and 

technology education in the United States. We say it in the report 

that we got to stop this stuff of, ‘‘Boy, math and science is terrible 

and it’s awful, and what are you having for lunch.’’ We’ve got to 

get to the point of acknowledging it’s a disaster. And I think there’s 

a lot of things that we could talk about, about that. 

By the way, Chairman Dryer made a mention of something about 

the fact of four to six times more engineers in China. I just got 

back from China on Friday night. We met with the plant director 
155

or the country manager of three American companies. And we put 

in our report some question about what the competence was of Chinese engineers, at least raising the question. I asked that of all 

three. The answer that all three gave is you’re talking about three 

or four years ago, not today. 

Chinese engineers are world class and they also made the point 

that the biggest problem they have now is keeping them, because 

the amount of competition for engineers in China is enormous for 

Chinese engineers. They said their biggest problem is the poaching 

by American companies of each other of engineers. 

This point about the increase in salaries, they were talking about 

how much that’s gone up in just the last two or three years. But 

in terms of competence and technical skills, their argument is these 

are really first notch. So I just make that as a matter of reference. 

The fourth point that we’re making is that if we’re not going to 

have our own engineers from the United States, the answer is not 

to keep high-skill talent from other countries from coming into this 

country. I would argue that the United States has been the beneficiary of the greatest influx of minds, of great minds, over the last 

50 years. What we are doing now is basically saying, ‘‘Well, you’re 

maybe not welcome.’’

I’d like to just give two anecdotes not in my papered statement. 

In China last week the chairman of the board of one of the companies, a member company of ours, was talking about the problem 

about immigration and visas. They have a fairly large facility in 

Court. They like to bring back their Chinese managers to their 

home office that’s based in Portland, Oregon. They could not get a 

single visa for one of their workers over the last two years, so they 

now have a training facility in Toronto, Canada, which the chairman of the board said that makes no sense at all, because the Toronto facility now is almost as big as their home office. But they’re 

doing all the training in Toronto because they can’t get the visas 

to come to the United States. 

The second one has to do with the problem of graduate schools 

in terms of the decline. You may have seen it. NSF has noted this. 

We’re looking at a 35-percent decline of Chinese graduate students 

applying to graduate schools of engineering in the United States. 

Gerry Van Eeckhout is one of the former founders of ACT Teleconferencing. It’s a national firm. He now teaches, after he retired, 

a course at the Fudan University in Shanghai for eight weeks a 

year. And I just saw him in Denver three weeks ago, in fact, talking about competitiveness. And he made note of the fact he just got 

back from his class. He had 22 students. These are seniors in college. He asked how many were going to graduate school. He said 

19 of the 22 were going to go graduate school. 

And he said, ‘‘Well, how many are going to a U.S. school.’’ Not 

one. And he asked, ‘‘Why not.’’ He said, ‘‘We can’t get the visa.’’

And, interestingly, the university or the country most benefiting 

from it was, Australia. About seven were going to graduate school 

in Australia. And, interestingly, two were going to Eastern Bloc 

countries, where they noted that the masters in engineering program was being taught in English at an Eastern European school. 

So what we don’t fully understand and appreciate and I don’t 

think the country understands is how much the immigration situa-
156

tion has changed dramatically. And I have a personal view about 

this because I happen to think that all of the foreign nationals who 

came to the United States, went to school here, worked here and 

may have gone back to their home country, I think they went back 

to their home country with an awfully positive view about this 

country. And I think we’re losing that now. And I think we’re going 

to continue to lose it. 

The fifth issue that we deal with in all of this has to do with the 

Federal funding that you talked about and in detail about R&D. 

My prepared statement makes mention of it. But I want to end my 

comments by saying something to the Chairman who made mention of something. 

We say in this paper that there’s a lot of things we got to do, 

but that’s not the pressing problem. The pressing problem is to acknowledge we got a problem. That has not happened. 

I would submit to you that official Washington’s view is: What 

competitiveness problem? There isn’t any. 

First of all, it’s America’s birthright to be number one. And if 

that doesn’t work God has ordained that we’re going to be number 

one. And my argument about that is until we, in fact, deal with the 

issue that the rest of the world is catching up, that this competitiveness issue is not the statement of a handful of elites, that it’s 

a real problem, I don’t think we’re going to get to any of these solutions that were talked about in the previously panel or maybe some 

panels this morning when I wasn’t here. We have got out raise a 

consciousness. 

Next November, we’ve got three or four major partners in it, 

we’re going to do a program in Washington entitled ‘‘Sputnik 

2005.’’ And it’s to take a look at the whole potpourri or panoply of 

issues, not just education, but to look at all of them; and to also 

talk about what have other countries done and where are they. 

Maybe they can raise a consciousness. Well see. Thank you very 

much. 

[The statement follows:]

Prepared Statement of William T. Archey

President and Chief Executive Officer

American Electronics Association (AeA)

Advancing the Business of Technology, Washington, DC 

Mr. Chairman and distinguished Members of the Commission, thank you for having me here today to talk with you about the topic of U.S. competitiveness. This 

is a very timely discussion as I just returned from a weeklong trip in China. This 

was my 22nd trip to China. My first trip was in 1981 to Beijing. I refer to that period as the ‘‘BT’’ period. Before Traffic. At that time, a trip across town took 10–

15 minutes. Today, it takes an hour or more. The traffic today is emblematic of what 

is happening in China, and especially Beijing. 

In February of this year, AeA released a report whose title says it all: ‘‘Losing 

the Competitive Advantage? The Challenge for Science and Technology in the 

United States.’’ I am submitting a copy of this report to the Commission for the 

record. 

The thrust of our report is that the United States is slipping. Yes, we are still 

the leader in nearly every way that one can measure, but that lead is eroding as 

other countries are catching up. 

Let me be clear, it isn’t that the United States is in decline. It’s that others are 

advancing quickly from behind, putting all their economic resources into moving 

their countries forward. The problem is that even if the United States were doing 

everything right, the world still poses an unprecedented competitive challenge. Unfortunately, we aren’t doing everything right, and this compounds the challenges 

that we face. 
157

Our report on competitiveness identified five themes, which the United States 

needs to address to prevent an impending slide in U.S. global competitiveness. 

First, the economic reforms around the world are rapidly transforming economies, 

making them dramatically more competitive. 

The United States has long urged the world to adopt free market principles. Well, 

the world listened. Major economic reforms have taken place in Russia, Eastern Europe, China, and India, to name a few. Indeed, if you look back just 20 years to 

1985, over 60 percent of the world lived under command and control economic systems. 

While many Americans are just now beginning to recognize how competitive the 

world has become, this change didn’t happen overnight. Just as the U.S. didn’t 

achieve its current leadership overnight. It takes years of investment in your innovation infrastructure. You need to invest in research and development, particularly 

basic research. You need to invest in your people, especially in science and technology education. You need to adopt a system that encourages investment, welcomes 

change, and promotes risk-taking and rewards it. 

Which brings us to our second theme, that other countries are adopting and utilizing technology to enhance their economic growth and competitiveness. And as a 

recent CIA report states, ‘‘the greatest benefits of globalization [will] accrue to countries and groups that can access and adopt new technologies.’’

Already many countries are using technology to leapfrog from behind. Technology 

allows countries to bypass traditional development paths and use the latest technology to bring themselves forward. The implications are far reaching for U.S. competitiveness; the stagnant economy of yesterday could be the competitive rival of tomorrow. There is no better example of leapfrogging than the development of China’s 

wireless telecommunications infrastructure. 

Other countries realize that the U.S. experience of the 1980s and 1990s is the 

model to be followed. Namely that the growth of the high-tech sector leads to wealth 

and job creation. But for that to happen, there is a need to build a high-tech infrastructure. 

To this end, many countries are making great strides. China now graduates four 

times the number of engineers as the United States. Japan graduates twice as 

many, and South Korea with 1⁄6 the population, graduates the same number of engineers as we do. 

The changes in China have led to massive injections of investment into the Chinese economy, and where investment goes, trade follows. In 2002, China surpassed 

the United States as the prime destination for foreign direct investment in the 

world. In 2004, China surpassed the United States as Japan’s largest trading partner. In the same year, China was the largest U.S. trading partner for technology 

products, surpassing the combined 25 countries of the European Union. 

China is not alone. Many countries are increasingly climbing the technology ladder. As with China, they are no longer satisfied simply to manufacture technology 

products. They are also striving to become creators and designers of the next generation of breakthrough technology products and services. 

This is my third point. If U.S. workers are to compete in a world economy that 

is increasingly knowledge based and driven by technology, the American education 

system must improve. 

A highly skilled workforce is the lifeblood of any successful company, industry, or 

national economy. Regrettably, the American K–12 system is failing to provide the 

math and science skills necessary for kids to compete in the 21st century workforce. 

Which in turn means that the U.S. higher education system cannot produce enough 

scientists and engineers to support the growth of the U.S. high-tech industry that 

is so crucial to our economic prosperity. 

We should be appalled and embarrassed that our 12th graders score at the bottom 

on international math and science tests. Far too often, our students shy away from 

engineering and tech programs because these are seen as careers for geeks and 

nerds. Interestingly in China, 39 percent of its college students are majoring in engineering while only five percent do so in the United States. 

This leads me to my fourth point. If we cannot produce enough domestic scientists and engineers, keeping out high-skilled foreign talent is not the answer. 

For decades, if not centuries, America has been the beneficiary of an influx of 

many of the most talented minds on this planet. Foreign-born individuals represent 

one of every five scientists and engineers in the United States. That is over 1 million workers. These workers are job creators. They contribute a tremendous amount 

of knowledge, talent, and innovation to the U.S. economy. People might be surprised 

to learn that almost half of the Nobel Prizes awarded to researchers in the United 

States between 1901 and 1991 were won by foreign-born individuals or their children. 
158

Unfortunately, immigration policy post 9/11 has deterred foreign nationals from 

coming to the United States to study or work at the very time that this talent has 

tremendous opportunities elsewhere. We literally cannot afford to lose their intellectual abilities. Indeed, last year we saw a 35 percent decline in Chinese applications 

to U.S. graduate schools of engineering. 

Finally, the U.S. Federal funding that spawned so many technology breakthroughs in the 20th century is faltering. Few people realize that Federal funding 

helped create the Internet, MRI scanners, the mouse, and GPS system—to name a 

very select few. 

So what has been happening to R&D funding? Well, federally funded research has 

declined as a portion of the economy, and the priorities have shifted away from technology. In 1981, half of all Federal R&D went to technology; by 2003 this dropped 

to one-third. 

In November 2004, the U.S. Congress even cut the budget of the National Science Foundation by $105 million, the first cut in 16 years. 

Government investment plays an indispensable role in building the foundation of 

a knowledge-based economy by investing in ventures, concepts, and ideas often 

years before a commercially viable product or service is available. When government 

provides the foundation, U.S. businesses convert these innovations into new products, services, and sometimes, new industries. Why would we want to break this 

cycle? 

Mr. Chairman, the United States is not preordained to lead the world in economic 

or technological advancement. We achieved this lead by the sweat of our brow and 

60 years of investments in our infrastructure. We understood that innovation—

taken in its broadest sense as the open acceptance of change and new ideas—is 

what fuels our economy. 

Yes, we are still in the lead, but I hope that everyone understands that it is a 

precarious one. While we are taking this lead for granted, others are rapidly moving 

up from behind. 

The world is a changed environment. It is intensely more competitive, and we are 

going to have to work harder to stay out front. Unless this realization hits home, 

our lead will continue to narrow, and at some point, we will be staring at someone 

else’s back. 

Mr. Chairman and Members of the Commission, thank you for having me here 

today.

Cochair MULLOY. Mr. Archey, thank you very much for that 

statement. It was very clear and very forceful, and we appreciate 

it. 

Mr. Ciacchella, please. 

Commissioner DREYER. Do you pronounce it c–h? 

Mr. CIACCHELLA. Yes, it’s like in c–h, Ciacchella. 

Cochair MULLOY. Thank you. 

STATEMENT OF JOHN CIACCHELLA

VICE PRESIDENT, A.T. KEARNEY, SANTA CLARA, CALIFORNIA 

Mr. CIACCHELLA. Thank you, Mr. Mulloy. I appreciate the opportunity to be here. 

I actually brought a small, short presentation. There were two 

studies was I submitted to the panel before that I think will add 

some slight context to what Archey presented, but in two different 

contexts. One is from a U.S. high-tech executive perspective and 

the other is from a Silicon Valley regional perspective. So I’d like 

to share those with the panel, and we’ll just walk through here. 

The two studies, one was focused on high-tech and telecom competitiveness. We surveyed 300 U.S. executives. This was done at 

the end of December and the beginning of January. The findings 

have gotten some pretty wide review. And really if you look about 

the overall finding there, U.S. tech companies, there is a lot of 

change happening on a global level. The feeling is that U.S. companies need to improve their competitive positioning, that they’re not 

doing enough, and I’ll go into a little bit more in detail on that. 
159

The second study was really looking at what I would call a very 

strategic region, which is the Bay Area, Northern California, and 

the impact of offshoring in jobs here. And here what we did is we 

took a look at really what are the capabilities that this region is 

competing on and how are those capabilities stacking up on a global level. Which capabilities are competitive in and which capabilities are we losing ground in. And that was based on a number of 

interviews, plus a lot of analysis of job postings and trying to understand where are jobs headed. 

Just to summarize some of the key results from the competitiveness studies of the U.S. executives, three major trends came out as 

driving this competitive intensity. One is, and as Archey mentioned, we have two mega markets that have come online: China 

and India. What’s interesting about these is they are both interesting markets, but they’re also generating their own global competitive players. 

The second thing is there’s been a pretty significant shift in 

where technology’s going. If you look at the major driver of technology over the past 20 years, it’s really been around the enterprise 

infrastructure. Last year was the first year that integrated circuits 

going into consumer applications exceeded those going into enterprise or defense applications. So technology is going into the consumer market. 

The consumer market is a very global market, plus you got a 

very big global economy that’s forming, a free market economy 

that’s forming. 

The other thing is it is a technology business, so you’re seeing 

a lot of proliferation of new technology. There are a lot of technologies that have very recently crossed the chasm, so to speak, 

that are being deployed very rapidly and very broadly. Everything 

from digital media, wireless type of capability, broadband capability, so technology is also proliferating on an infrastructure level 

as well. 

I think it’s important to note those because there’s some policy 

things that we may talk about in terms of technology. 

We asked the question: How prepared are U.S. high-tech companies. Most executives, a vast majority, 90 percent said, yes, they 

feel this competitive intensity. Things are more intense. The competitive playing field is getting harder. Only 15 percent rate themselves as being very prepared to deal with this; 70 percent actually 

rated themselves as fair to good; and less than 40 percent have any 

formal process at the company level to really start to look at competitiveness on a global level. 

A lot of high-tech companies tend to be organized by products or 

market segments, so they’re working very diligently in these product segments, but there’s a lot of bigger changes that are starting 

to happen that are changing market boundaries and changing traditional production boundaries. 

You have companies like Apple today, a big music company, so 

you’re getting a lot of these changes. Those are hard to pick up 

when you’re working at a product sort of level. 

U.S. companies aren’t standing still, but there were some key actions that seemed to be missing, from our point of view, when we 

looked at this. Company-level strategies for China and India were 
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very few and far in between. We found a lot of product level strategies, but really treating these as new markets that they needed to 

go into with the full power of their companies. 

Innovation was happening around product extensions, but in 

terms of making the bigger bets and really driving some of the 

newer types of innovation, companies that have been coming out of 

a recession are still in a little bit of a bunker mentality in terms 

of placing bigger bets and trying to make some bigger plays. But 

this is a time with these exploding new markets where that might 

be actually what needs to be done. 

And then there was just some comments about improving their 

consumer processes. 

If you think about it from a policy perspective, that’s were the 

comments and some of the things that I summarized out of the 

study. One is to balance a playing field between the U.S. and other 

mega markets. U.S. companies have the same access to the labor 

pools that are over there, so they have the access to the low cost 

labor pools. But the access to the markets, those consumer markets, that doesn’t seem to be a level playing field. 

Also some of the things regarding intellectual property protection, compliance type of issues, those are things that are unequal 

right now. So the challenge they have is, yes, we can access the talent, put our manufacturing there, but in terms of going into those 

markets and competing head to head with the companies that are 

over there, we’re playing under a different set of rules than they’re 

playing under. We need to get that rule base balanced out. 

There’s been a lot of discussion already about the foreign workers, especially the high-talent foreign workers. It’s especially important because high-tech companies are global companies. If you look 

at most of them, they have people who are working in multiple regions who are flying back and forth between here and China and 

India on a monthly basis, in some cases. We’ve interrupted that 

flow, is essentially what’s happened. And that’s a flow that’s been 

very positive for U.S. companies as well as, you’ll see later, U.S. 

regions. 

And then I think the point in terms of funding for science and 

technology and research, a key theme that came out, it wasn’t so 

much amount, but being steady about it. Having a steady policy 

around technology and science type of research, especially in critical technologies. The ability to be able to plan and to understand 

that the U.S. Government is actually working on these things and 

it’s not going to go through some sort of whipsaw procedures. 

I’m shifting gears here in terms of the Bay Area job study. In 

terms of offshoring. Offshoring is really not an issue. It’s an issue 

in the sense that it impacts people, but this is a practice that’s 

been done especially in the Bay Area for a long time, so it’s a wellestablished practice. 

The Bay Area is very well positioned in critical technologies: Bio, 

info, and nano—the three O’s. Archey mentioned that the U.S. in 

terms of its position on technologies is still pretty good, but the 

sense of erosion is what’s in there. 

When we looked at capabilities there were three that stood out 

of the five that we said the Bay Area was competitive in. Three 

that were pretty new—I mean entrepreneurship and research and 
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advance technologies, this area is pretty well known for that. But 

three that stood out that were a little bit newer and that are shining a little brighter and that other regions see this region actually 

driving is cross-disciplinary research, so this is bio and information 

technology. So this is where you’re taking chemical processes and 

electronic processes and bringing these together. 

Cross-disciplinary research is something that is actually very 

unique to this region. It’s something that’s harder to do in other 

places, so that was something that came out. 

The last one that I wanted to talk about is global integrated 

management. These are managers and engineering project type of 

managers who can actually manage projects that are actually going 

beyond company boundaries or beyond country boundaries and 

working those. We have a unique skill set in terms of managing 

very diverse, spread businesses. 

In terms of weaknesses: Mass production, back office operations. 

Those have been pretty well known at least in this area. It doesn’t 

mean that the U.S. can’t compete in some of those in some other 

regions, but the high cost here prevent some of those. 

But what’s interesting is product and process enhancement, and 

there’s been a lot of discussion about engineering. Engineering 

that’s associated with testing software, engineering that’s used to 

cost-down products for—as they mature out. Those engineering 

skill sets are easily duplicated. That’s a lot of what you’re starting 

to see being offshored from this area, that type of engineering. 

The net is there is a feeling that there will be job creation in the 

region. Keep in mind the region’s job growth is half of that of the 

U.S. So even the Bay Area has this reputation of being this job 

growth engine. Actually, if you look over the last 20 years, it’s been 

about half the U.S. job growth rate. But what is interesting is 

there’s a lot more churn here, so you’re getting quite a bit of churn 

that’s happening. 

In terms of policy implications, the key notes here are really investing in the capabilities that the region, and I would transpose 

this to the U.S., is what capabilities are we betting on? Because we 

can’t bet on supporting all the capabilities that we have, so where 

are we going to invest? And then promoting policies that fit those 

capabilities. 

There was also quite a bit of commentary around government 

being more innovative in terms of supporting a transitioning workforce. If you want to think about this, cycles are picking up. In fact, 

it’s interesting, if you look at the enterprise business market versus 

a consumer business market, the enterprise business market has 

a cycle or a cadence of about two to three years in terms of changing products and infrastructure. Where a consumer market is 12 to 

18 months. 

The world is speeding up and jobs are changing much quicker. 

Everybody’s going through jobs, but our ability to take health benefits and those kinds of things move them around with us is something that’s very difficult to do. There’s a need for innovation in restructuring some of the support processes that are underneath. 

So those are just a couple of prepared remarks. I know you have 

the reports. I just wanted to give you a quick summary. 

[The statement follows:]
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Prepared Statement of John Ciacchella

Vice President, A.T. Kearney, Santa Clara, California 

A.T. Kearney has recently conducted two studies on competitiveness that have intriguing policy implications when it comes to maintaining U.S. leadership in high 

technology. In this testimony I will review each study and its results, and then examine their policy implications. 

Tech Industry Competitiveness 

A.T. Kearney’s ‘‘Crunch Time: The Competitiveness Audit’’ finds an industry of rebounding opportunity but also increasing competitive intensity. The study was conducted in late 2004 and early 2005 in cooperation with the CMO Council and the 

BPM Forum, and it is based on a survey of 300 U.S. technology and telecommunications executives. 

The study finds three major trends impacting technology markets:

• New Mega Markets—China and India. In coming years, information technology spend growth from the Asia-Pacific region, for example, will be double 

that of the United States and Europe. Consumer spending growth for China, 

India, and Russia will also be double the domestic rates. These represent new 

mega-markets in which high-tech firms can sell their products. 

• Shift From Defense and Enterprise to Consumer. The consumer has become the main driver of the tech market, as illustrated by the eclipse of semiconductors going into consumer applications over those going into business or 

defense purposes. 

• New Technologies. Emerging technologies such as wireless and VoIP (voice 

over internet protocol) are fast becoming mainstream. The most significant fiveyear growth forecasts are for digital TVs, MP3 players, digital hotspots, and 

RFID.

Meanwhile, competition is increasing as companies become larger, more global, 

and more efficient than ever before. Whether it’s new players from China, Korea or 

India, or larger players resulting from domestic consolidation, the result is companies with a combination of greater size and increased agility. 

Where is this competition coming from? Respondents vote the United States as 

the number one geographic source, with China and India trailing close behind. 

When asked about factors influencing competitiveness, the top three responses are 

emerging technologies, industry consolidation, and new entrants into the market. 

So how prepared are U.S. high-tech companies? While 90 percent of our survey 

respondents expect competitive intensity to increase, just 15 percent rate their own 

company’s preparedness as ‘‘very good.’’ (Most gave themselves a ‘‘good’’ or ‘‘fair’’ 

grade.) Less than 40 percent have a formal function or process to assess competitiveness. Most drive their competitive planning and action within product and market groups—not at the company level. 

Why is this a problem? The mega-shifts discussed above are challenging traditional market and product boundaries. Leaders use innovative business models to 

exploit the intersection of new markets and new technologies; for example, Apple 

with music, eBay with auctions and Yahoo and Google with advertising. Among established players, EMC is moving from storage to ‘‘content management,’’ while IBM 

continues to migrate from hardware to software to outsourced services. In short, 

companies that want to position themselves to play globally and change markets 

with new technology must break out of their product business silos. 

In summary, the study shows that the U.S. technology industry is not standing 

still; it is taking key actions. However, given the significant market changes underway, companies may need to do more. The study identifies six dimensions to improving competitive positioning. The three most important, according to technology executives, are:

• Strengthening their companies’ strategic position in the marketing place, e.g., 

developing company-level strategies for emerging markets such as China 

• Enhancing product and service innovation, e.g., innovating not just through incremental improvements around core products, but in a few big bets on potential new technologies 

• Improving customer intimacy and experience, e.g., engaging customers and 

channels to improve customer processes and systems, strengthen account management, and shift sales focus from products to solutions.

Other key dimensions are managing operational complexity; managing organization, culture, and leadership; and optimizing governance and capital deployment. 
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Competitiveness of a Strategic U.S. Business Region 

‘‘The Future of Bay Area Jobs: The Impact of Offshoring and Other Key Trends,’’ 

undertaken in 2004 in partnership with three area nonprofits (Joint Venture: Silicon Valley Network, the Bay Area Economic Forum, and the Stanford Project on 

Regions of Innovation and Entrepreneurship), began as a rigorous examination of 

the much-discussed effects of global offshoring on the domestic jobs base. It soon 

found, however, that while the offshoring trend has actually been around for decades, other factors also drive changes in the job market. 

Based on 120 interviews, analysis of 9,000 online jobs listings, extensive review 

of secondary source materials, and in-depth examination of the semiconductor and 

software industries, the study’s analytical framework focused on four key components: trends, regional capabilities, the regional business environment, and the regional job market. 

Our study found that the Bay Area is overall well-positioned in three critical technologies: information technology, biotechnology, and nanotechnology. 

Analyzing the region’s capabilities—perhaps the most important component in 

companies’ choices to locate and invest in a region—the study found that the Bay 

Area is highly competitive in five key areas:

• Entrepreneurship/new business creation 

• Research in advanced technologies 

• Cross-disciplinary research 

• Concept and market development 

• Global integrated management

The Bay Area is less competitive in three areas: mass production, back-office operations, and product and process enhancement. Remember, however, that this study 

focused only on the Bay Area (where the cost of living is quite high), and other domestic regions may be competitive in these capabilities. It’s not that such operations 

are necessarily headed for China, or anywhere offshore—a call center in Nevada or 

a distribution center in Dallas, for example, will still have advantages over offshore 

locations. Further study of various pockets or regions within the country would help 

identify their competitive capabilities. 

But to return to the Bay Area, we found that its unique strengths should produce 

net job creation for the foreseeable future. The region should continue to incubate 

and grow new businesses; small and new businesses will keep most of their jobs 

local until their business processes and products mature. 

In addition to job creation, there will be job destruction. With the regional economy’s focus on innovation and strong link to economic cycles, an individual may find 

that after the creation and scale-up of a business, her job might move to another 

region of the country or world—and she’ll probably want to stay in the Bay Area 

and start with a new business centered around a new technology. But again, despite 

(and in part because of) the stress on any one individual, the macro jobs picture 

will be strong. 

Policy Implications 

From our competitiveness study, the primary policy implication of interest to this 

Commission concerns balancing the playing field for trade between the United 

States and China. China is a potentially huge market for U.S. products—but who 

will have access to it? Currently, Chinese firms have far greater access to U.S. markets than vice-versa. Part of the problem is maturity of infrastructure (retail, logistics, etc.). But part of it is market entry issues, including intellectual property protections. U.S. firms need government help to assure that they can grow globally just 

as Chinese firms do. 

Again, I’m speaking of markets to sell products. As the offshoring phenomenon 

shows, we do already have access to low-cost labor in China. But that labor is unregulated—which brings up another issue of balancing the playing field. We must 

ensure that Chinese firms are held to the same standard of compliance as American 

firms when it comes to the environment, labor, and accounting. U.S. policies on 

these issues reflect our society’s concern for the long-term sustainability of financial 

markets and the health and welfare of both workers and the world we all live in. 

We must call on the Chinese government to match our support for these ideals. 

We have also hampered our own competitiveness by limiting H–1B visas, the tool 

through which high-potential, highly talented foreign individuals can come to this 

country for work or school. The program suffered from some abuse in the late 1990s, 

and was justifiably examined in the aftermath of 9/11, but we should now reinvigorate the inflow of skilled immigrants who can power our economy. Many of these 

talented people end up staying permanently in the country where they study or 
164

work—and if we don’t bring them in, then Canada, the United Kingdom, and other 

countries will. 

The Bay Area jobs study generated recommendations for individuals, businesses, 

and all levels of government, but let me focus now on the government end. Primarily, the lesson is that we should invest in promoting the region’s competitive capabilities, including mechanisms such as:

• R&D tax credits • Funding for science in next-generation technologies, including bio, nano, and energy • Increased grants for higher education that supports our competitive capabilities.

Note that it is far more effective to use taxes and policies to maintain our leadership position in areas where we are already strong than to try to shore up areas 

where we are less competitive. 

The volatile nature of the Bay Area economy, our study found, has many benefits 

to business, although it frequently takes a toll on individual workers. As companies 

mature and move certain functions offshore, they can do so without calculating the 

total burden on their transitioning employees. That burden has traditionally fallen 

on the government (in addition to the employee himself). We should thus encourage 

businesses to ‘‘share the load’’ of job transitions. 

But since that volatile job market is nevertheless a robust one—good for national 

competitiveness—we as a society can also pursue innovative approaches for 

transitioning employees. A big concern for individuals considering leaving their jobs 

is maintaining their health insurance, so better portability of health accounts might 

allow them to take more chances in business creation. Likewise, leaving an established company for a startup generally requires new skills to apply to the new technologies that the emerging company is centered on. The 401(k) is a wonderful innovation that basically creates a portable retirement account; workers are calling for 

a similar approach to their continuing reeducation and retraining needs. 

Finally, policy should address the needs of the supporting business environment, 

such as housing and transportation. Current policies are in place to do so; however, 

has government demanded the same type of productivity and efficiencies from its 

suppliers and departments that businesses have gained from their suppliers and internal departments? 

Conclusion 

China’s high-tech development contributes to the intense competitive environment 

for U.S. high-tech firms—but at the same time it promises huge markets for those 

who succeed. With a level playing field in trade, and policies that invest in our competitive capabilities, the Federal Government can permit well-prepared U.S. companies to thrive in the challenging but promising years to come. 

I thank you for the opportunity to share our perspectives on these important 

issues.

Cochair MULLOY. Thank you, Mr. Ciacchella. 

Mr. CIACCHELLA. Thank you. 

Cochair MULLOY. Mr. Dawson. 

STATEMENT OF RHETT DAWSON

PRESIDENT AND CHIEF EXECUTIVE OFFICER

INFORMATION TECHNOLOGY INDUSTRY COUNCIL (ITI)

WASHINGTON, DC 

Mr. DAWSON. As the last speaker on the last panel on a very long 

day——

Cochair MULLOY. Of today. 

Mr. DAWSON. —of today, and I compliment all of you for your interest and participation. And I checked up there, and your chairs 

are no more comfortable than the chairs out here, so good for you 

for staying engaged. I’ll try to step through my little piece here 

quickly, but thank you for inviting me. 

I am going to take a case study, which is probably familiar to 

most of you, called WAPI, that has to do with the Chinese standard 

with the Wireless Local Area Network, that we went through a 

year ago, and use that as a case study to try to draw some broader 
165

understandings. More specifically, to try to come up with some prescriptions both for what industry can do and for what government 

can do in other cases, as they surely will arise in the future. 

First of all, just a word about standards. Standards, as you 

know, can create markets and they also can close markets. We are 

in the standards business up to our eyeballs and have been for a 

long time. The WAPI case was not as unusual as it appears to be. 

It has happened before. We have dealt with similar cases outside 

of China. But this one was unusual and unique because it pulled 

together a lot of different of the threads that I’ll describe to you. 

It started in May of 2003 when China issued a compulsory standard that would have gone into effect the following June. It was an 

incompatible standard but purposely so with every other international standard. 

In order to comply with the proposed regulation U.S. technology 

companies or any technology companies would have had to collaborate with their Chinese competitors and, effectively, turn over their 

technology to co-produce the products for that specific Chinese market for that standard. 

In the process, of course, they would have had to choose being 

sharing their valuable intellectual property with the Chinese competitor or abandon the Chinese market. These regulations, if they 

had gone into effect, would have excluded China from the world 

market for wireless local area network products or WiFi products, 

as they’re called, and it would have essentially split the world into 

two WiFi camps. 

One of the things that defines the IT production and services 

world is we like to have one standard around the world rather than 

having a proliferation of standards. 

Moreover, the Chinese in their regulation would have only provided this mandatory technical standard to selected domestic producers in China of wireless equipment and then designated those 

companies as the obligatory partners of any foreign manufacturer 

seeking to do business or bringing those products into China. 

Fortunately, the highest level of the Administration were engaged and the Congress, too, and the Chinese agreed to indefinitely 

suspend implementation of this mandatory standard and revise the 

standard based upon the comments from both foreign and domestic 

firms. They promised further to participate in the international 

standards body. 

This was an important result for the U.S. industry. And beyond 

just the simple product and market losses it would have been a terrible precedent that would have allowed China to discriminate 

against foreign firms through the standards process and it would 

have been an example to other countries. 

Moreover, we did all of this without going through the delays associated with the WTO dispute settlement procedures, which sometimes can drag on for years. So we are really pleased and impressed with what the Administration did in working together to 

coordinate with industry and allowing us to move forward. 

Let me just kind of skip to the end and tell you what four different prescriptions I have for government and four that I have for 

industry. 
166

First of all, we need to give policymakers in our government the 

tools to be able to understand and then turn around and explain, 

countries particularly in emerging markets about the importance of 

technologies and standards, and why it’s in their interest to adopt 

and deploy internationally recognized market-driven standards. 

Secondly, we have to give our government the ability to advocate 

and promote global market-led voluntary standards that support 

innovation and interoperability as opposed to government-mandated standards. 

Third, we have to press for market access so consumers, industry, and economies around the world can benefit from what we 

think are beneficial highly innovative technological advancements. 

Fourth, when China or any other signatory does not comply or 

play by the rules, we ought to be prepared to take the case to the 

WTO. 

Those are the four prescriptions for government. 

Now for industry I think we have to continue to promote the 

value of these voluntary standards that are both compatible or 

interoperable. 

Secondly, we have to work to gain an appreciation and a better 

understanding of intellectual property rights, how governments 

work on standards, particularly in China. And there I commend to 

you Pete Suttmeier’s prepared testimony, which was an extraordinary well-prepared piece of explication of the problems. We also 

have to understand the implications of our investments in China, 

as we heard about over lunch. 

Third, we have to increase the effectiveness of Chinese participation and leadership in a broad range of internationally-recognized 

standards, organizations. 

Finally, we have to engage in a private-sector dialogue, industryto-industry dialogue within China on the value of global standards. 

That concludes my statement. 

[The statement follows:]

Prepared Statement of Rhett Dawson

President and Chief Executive Officer

Information Technology Industry Council (ITI), Washington, DC

China, Standards and the U.S. High-Tech Industry

My name is Rhett Dawson and I am President and CEO of the Information Technology Industry Council, a trade association of 31 top high-tech companies. I have 

been asked here today to provide testimony on China’s use of standards and the impact this may have on the competitiveness of the U.S. high-tech industry, as our 

association has been working on technology standards for almost ninety years. 

To jump into that often complex set of issues let me illustrate that with a recent 

experience we had, one that I believe highlights many challenges the industry is facing, not only in China, but around the globe. The illustration I will use is the Chinese Wireless Land Area Network (WLAN) standard proposed last year as a mandatory one for selling these types of wireless products in China. It is better known by 

its acronym ‘‘WAPI.’’

In May of 2003, China issued compulsory ‘‘WAPI’’ security standards that would 

have gone into effect on June 1, 2004 and were incompatible with the international 

standards upon which most WLAN products are based. In order to comply with the 

proposed regulations, U.S. technology companies would have had to collaborate with 

their Chinese competitors to co-produce products for the Chinese market—and in 

the process potentially risk sharing their valuable intellectual property with their 

Chinese competitors—or abandon the Chinese market and its opportunities. 

These regulations would have excluded China from the world market for WLAN 

products as products made anywhere else in the world would not have functioned 
167

there, essentially splitting the world market for these products. Moreover, China 

only provided this mandatory technical standard to several of its domestic producers 

of wireless equipment, and designated these companies as the obligatory production 

partners of any foreign manufacturers seeking to market these products in China. 

ITI worked very closely with our industry colleagues around the world and also 

brought together the various groups in the U.S. to closely collaborate to maintain 

a strong industry voice on this issue. ITI worked hard to keep our government informed and to make sure this issue was on the Adminstration’s agenda. Facing pressure from the highest levels of the Bush Administration and the Congress China 

agreed to indefinitely suspend implementation of this mandatory standard, revise 

the standard based on comments from foreign and domestic firms, and participate 

in international standards bodies. 

This was an important result for U.S. industry. IT is a leading U.S. export to 

China, accounting for 26% of all U.S. exports to China in 2002. This amounts to 

several billion dollars per year of U.S. tech exports to China. Many of these and as 

yet to be designed U.S.-made products and components would have been affected by 

this standard, jeopardizing high-end U.S. jobs. The fast growing wireless market in 

China (forecast to grow by 25% per year) remained open to U.S. competition, and 

we avoided a terrible precedent that would have allowed China, and, potentially 

other countries who might wish to follow a similar path, to discriminate against foreign firms through the standards process. 

Furthermore, results were achieved immediately, without the delays associated 

with the drawn out legal process of the WTO dispute settlement procedures. The 

well-executed cooperation and coordination at a variety of levels within and among 

U.S. Government agencies was highly impressive and crucial in the success on this 

issue. This type of continued coordination will be necessary going forward as we will 

see similar issues from China and must be prepared, as industry and government, 

to address them. 

This example goes far in highlighting concerns that all sectors, but particularly 

the U.S. high-technology sector are currently facing in China. The precedent that 

may have been set in the above example, by a government—a signatory to the WTO 

agreement—mandating a technology and forced domestic production would have had 

significant implications, resulting in incompatible technologies across the globe. 

It is a well publicized fact that the Chinese government wants to develop a robust 

domestic high-technology industry. This is not unique to China, as many governments around the world including our own want to see healthy and competitive domestic industries. However, the challenge for China is balancing her efforts to promote a domestic industry with upholding its commitments and obligations to their 

trading partners, as agreed to in their accession to the World Trade Organization 

and through bi-lateral and regional agreements. 

The principles and policies that ITI and the U.S. and global IT industry are advocating for in China are consistent with China’s aims, and in fact, will ultimately 

provide for a more competitive and innovative high-tech industry around the world 

and in China. 

Interoperable standards are key to the success of the global ICT industry and to 

the benefit of users of technology. A unique technology standard in one economy, 

especially one as large and influential as China, isn’t a good solution for consumers, 

industry or governments. 

Requiring global companies which have invented, innovated, and developed the 

ideas for the technology to transfer that same technology to hand selected Chinese 

companies as a price of doing business amounts to a disinvestment to the benefit 

of a competitor. 

And if left unchecked, this technological protectionism has the strong potential to 

create dissension that would stifle innovation, prevent interoperability, and stunt 

the growth of the global information and communications technology infrastructure. 

Some of the lessons we have learned from this experience are:

• We need to engage on an ongoing basis at the policy level directly with our government and other governments, particularly in emerging markets, about how 

technology and standards can help grow their economies and why it is in their 

interest to adopt and deploy internationally recognized, market-driven standards. 

• We need to redouble our already considerable efforts promoting global, marketled, voluntary standards that support innovation and interoperability. 

• We need to encourage market access so that consumers, industry, and economies around the world can benefit from innovative technological advancements. 
168

• We must convince governments that forced technology transfer may look like 

a ‘‘short cut’’ to industrial modernization, but in a global market such short cuts 

are counter productive in the long run.

Some of the actions U.S. industry is taking or is planning to take to advance these 

objectives are:

• Aggressively promote the value of global, market-led, voluntary standards that 

are compatible and interoperable 

• Encourage greater appreciation for IPR and investments in R&D in China 

• Encourage more private and public sector capacity building efforts focused on 

Chinese participation in the international standards process 

• Increase effective Chinese participation in a broad range of internationally recognized standards development activity 

• Build strategic alliances with Chinese industry and other (non-PRC) industry 

groups 

• Continue efforts to educate key decisionmakers in Chinese and U.S. Government on standards issues

Thank you for this opportunity.

Panel IV: Discussion, Questions and Answers 

Cochair MULLOY. Thank you, Mr. Dawson. We were actually 

talking about something that you said in your testimony and we 

were clarifying our own thinking on it. 

Mr. DAWSON. That’s good to know, as opposed to when are we 

getting out of here. 

Chairman D’AMATO. Figure out your testimony. 

Cochair MULLOY. No, absolutely. 

Chairman D’Amato. 

Chairman D’AMATO. Thank you, Commissioner Mulloy. 

Mr. Archey, I was just taken with your perspective in your testimony, and the fact that you are briefing Members of Congress. We 

think you should brief all the Members of Congress and get around 

to see everybody on that, because I think you’re absolutely right. 

Dr. Pillsbury talked about the old paradigm and the new paradigm. And it’s increasingly occurring to me that the old paradigm 

does have a hangover effect and is dominating much thinking and 

writing here. And if you don’t have a sense that there is a problem 

your investigation is not going to get to aggressive solutions. 

Let me ask you: Have you looked at the Tax Code with the kind 

of recommendations that might be useful to revise the Tax Code to 

entice companies to stay in the United States or bring their earnings back from abroad? 

It seems to me there are a lot of pieces in the Tax Code that actually encourage companies to go abroad, the earnings-overseas 

provision, for example. Have you looked at that? Because it seems 

to me there’s some pay dirt in looking at how the Tax Code can 

be revised to encourage firms to invest in America. 

Mr. ARCHEY. Mr. Chairman, we have a tax committee that’s been 

within AeA for almost 30 years. It’s got anybody the 95 companies. 

That is, in fact, what they’re looking at right now. And probably 

will be another month or two before we’re going to have any final 

recommendations coming out of it. So I don’t want to really speculate as to where it’s going to come, but it’s being thoroughly looked 

at. 

The second item, I just want to make a comment that I should 

have made in my opening statement, because I’m kind of fascinating by it. 
169

I’ve been in Washington 31 years. In the 1990s, in an era of 

globalization, where globalization got lots of attention, I find it 

ironic and a great paradox that, in my judgment, the Congress of 

the United States became more insular in that last ten-year period 

than they were ten years earlier. And at a point in time when 

we’re talking about the world as the marketplace, all those kinds 

of things. 

So the fact that we’re having a difficulty with members acknowledging what’s going on in the rest of the world I guess shouldn’t 

be surprising. I can remember in the ’80s and ’90s when you’d hear 

all these people talk, ‘‘Oh, this is a protectionist Congress.’’ I used 

to laugh at that because it wasn’t at all, but I will say this: If this 

is not a protectionist Congress it’s pretty damn close to a neo-isolationist Congress. I’m just amazed at it because it’s happening at a 

point in time when the rest of the world is now so much more 

prominent in terms of who we are and how we act and all that, 

and yet I think we have become more introspective and more insular, and I think that’s the big problem. 

Chairman D’AMATO. I think part of the problem is Members are 

afraid to travel because the politics of assassination in this culture 

has gone through the roof. You go overseas and you’re an opponent 

in an election cycle, you’re going to get smeared. That’s a big part 

of this problem. 

Cochair MULLOY. Chairman, thank you. 

Vice Chairman Robinson. 

Vice Chairman ROBINSON. Thank you. 

Mr. Dawson, notwithstanding the case study you mentioned, as 

we prepared for this hearing—and I want to commend the Commission staff for a superb briefing book that was made available to us 

along with background papers—one thing that really struck me is 

that the Chinese seem to live for creating standards-related obstacles and, frankly, unfair barriers. 

Wherever they can find a standard or a different way to go to 

protect their industries or give advantage to their domestic companies, they’ll move in that direction. I wish I had on the tip of my 

tongue four or five different industry sector examples, but I think 

most of you know which they are. And even in the capital markets 

arena, you have a Chinese investment bank that has to be the 

partner for Goldman Sachs and Morgan Stanley and virtually everyone else, for large equity offerings on the New York Stock Exchange. 

I’m interested in your take on whether the Chinese are breaking 

the code slowly but surely, that this kind of barrier-building is not 

conducive to the kind of broader trade relationships that they want 

to enjoy with ourselves and others in the world. Also, that there 

is an increased resolve to do something about it and to mobilize our 

respective governments intervene aggressively and see what can be 

done. 

But I can tell you my take on it. I don’t think the Chinese get 

it and that they can’t resist the temptation to manipulate standards.Do you have a more optimistic view on that? 

Mr. DAWSON. I should have clarified my view that the experience 

at WAPI did not make me a Pollyanna. As a matter of fact, it made 

us much more vigilant and put us on our guard. Secondly, made 
170

us come up with a work plan that was going to go try to work with 

the Chinese to show them why it’s better to work another way. 

That plan is still in development. It’s going to be deployed this 

summer in China. 

But let me say two other things, one of which is you and I both 

talk about ‘‘they’’ when we’re talking about China. Well, Pete 

Suttmeier’s confirmed my view, actually, which is that there is a 

lot of ‘‘they’’ out there. There are the standards wonks that want 

to try to put a trap against any foreigner that might get in their 

way. 

Then there is a government official, like Madam Wu who came 

to deal with us in the JCCT, and found our arguments more compelling on balance; and went back and told standard organizations 

the directions they should take. So the ‘‘they’’ is a little bit more 

complex and it needs to be discriminated and it needs to be articulated fairly well. 

So I guess we’re not quitting. We’re going to go redouble our efforts to try to show them the error of their ways. I guess if I didn’t 

believe I was going to be effective in doing all that, I wouldn’t keep 

trying. 

Cochair MULLOY. Thank you. 

Commissioner Reinsch. 

Commissioner REINSCH. Thank you. 

On the standards issue, I appreciated the last point you made. 

We’ve had at the National Foreign Trade Council a standards expert, if you will, working with us for the last year and a half, who 

has produced three really thoughtful papers on this subject. The 

use of technical standards as a barrier to trade is a serious and 

growing problem. 

As a practical matter, the largest sinner, if you will, is the EU, 

not the Chinese. And they’re actually in the process of trying to 

persuade everybody else to be as bad as they are. That’s not by any 

means to excuse the Chinese but to suggest that it’s a pervasive 

and also a growing problem. Let the record show Mr. Archey is 

nodding his head yes. And it’s something that I think our trade negotiators really need to go after. There are WTO issues here in the 

technical-barriers-to-trade part of the agreement that can be mobilized. 

It’s nice that there’s the occasional happy ending, but your point 

that one shouldn’t be Pollyannish about that is very well taken. I 

think this is going to be a far more serious problem in the future 

even than it’s been in the past. 

I do have a question for Mr. Archey. As always, I appreciate your 

tactful way of presenting your views. We benefit from it enormously. And I was very happy with your comments about students 

and visas and travel because, as you know, I’ve been giving that 

speech for a long time. I think the damage that we’re doing to our 

economy long-term is enormous. 

I did want to ask you: And probably I know the answer given 

what you went on to say about the current Congress, but have you 

raised that issue with Members of Congress, the visa, business 

travel, immigration issues at all? And, if so, is there any ray of 

hope that you can share with us there? Because that’s really a larger part of the problem. 
171

Mr. ARCHEY. We have, in fact quite a bit in the last month. I’d 

also have to acknowledge that it gets caught up with the overall 

immigration issue and it gets intermingled with it. 

Commissioner REINSCH. Yes. 

Mr. ARCHEY. I find it sometimes very difficult in meeting with 

a Member to make that distinction between amnesty and all of 

those other kinds of issues about workers coming across from Mexico. But I would argue that right now, Mr. Reinsch, I would argue 

that I have never seen a Congress that the immigration attitude 

seems to be just: Don’t let them in. And that makes it fairly simple 

and straightforward and then easy to implement. I’m not being facetious. I think that really is the attitude. 

I just want to make one other point that you made about the 

standards issue. We wrote a paper about a year ago, and I think 

Mr. Dawson’s group is doing a very good job on those standards 

stuff, but I would just reinforce your point. We made a point about 

a year ago that the big nontariff barrier of the new century is going 

to be standards. 

And, in fact, we said that the European Union is the absolute 

leader in terms of that and we’re seeing it in the environmental 

area left, right, and center. I think we’re going to see it in about 

four or five more areas coming. I think the Europeans are feeling 

a lot of insecurity about their competitiveness. And standards are 

a great way to have a WTO-acceptable way of maybe lessening the 

competition. 

Commissioner REINSCH. I couldn’t agree more. 

Mr. Dawson, you had a comment. 

Mr. DAWSON. To your point about standards, we need to distinguish between the European Union as a government and the European industry or distinguish between the Japanese IT or CE industry and the Japanese government. Earlier this month I met with 

my Japanese and European counterparts on the TBT approach in 

Geneva we were all on the same page, so there wasn’t an argument 

among industry about what needed to be done in the IT and CE 

space on the nontariff barriers to trade. So I think we have to elevate it and make it clear to our governments that here’s what industries at least in the IT space wants to do. 

Commissioner REINSCH. Do you have a Chinese counterpart? 

Mr. DAWSON. I do and I have not met him or her. 

Commissioner REINSCH. Well, I guess my advice would be that 

perhaps you should. 

Mr. DAWSON. I intend to. 

Commissioner REINSCH. I’m sure you do. 

One of the things we’ve noticed is that industry in the other locations has been pretty much on the same page, although, as you 

well know and I’m sure Mr. Archey knows from past lobbying efforts, the American industry has been a lot more aggressive and I 

think effective taking on its government on an issue like this, than 

European companies, for example, have been taking on their government. And Japan is a whole different story. 

If there were a Chinese industry that was capable of mobilizing 

and approaching its government to explain how some of these 

things affect them, I think that would be worthwhile to develop, so 

I’d encourage you to do that. 
172

Thank you, Mr. Chairman. 

Cochair MULLOY. Yes. Thank you, Commissioner Reinsch. 

Commissioner Dreyer. 

Commissioner DREYER. Mr. Archey, now that we have you briefing all of Congress, I would suggest that you include some college 

presidents and educators in your briefing. They, too, are unwilling 

to confront the fact that we are losing the technological edge. They 

provide a lot of statistics about how SAT scores have gone up. But 

there are caveats to that which they don’t mention, which you and 

I can talk about separately some other time. 

The last thing on people’s minds at universities—I am a professor in my other life—is genuinely increasing the quality of students. 

Mr. ARCHEY. I don’t think I disagree, but I would say the heartening thing is that two university groups, which probably won’t announce for a couple of weeks, are going to be a partner in our Sputnik 2005 seminar. And one of the groups I can talk about, which 

is the group that’s doing the Workforce in the Twenty-First Century group, and I think that there are some others. 

I also would argue—here we are on the Stanford University campus—that four-year universities have a great tendency to not want 

to change. I would argue that some of the greatest changes in 

terms of dealing with technological jobs have been in the community colleges in the United States because they’re not hung up 

about the fact that they’re actually cooperating with business. And 

they’re rather quick to be able to move on some things, so. 

I don’t disagree, but I was heartened by the fact that we were 

solicited by a couple of groups who had read that report and said, 

‘‘Are you actually going to do that seminar?’’

And we said, ‘‘Well, what do you think?’’ And so we’re going to 

partner with them. 

Commissioner DREYER. If you don’t mind, we’d like to keep up 

with you on what you feel the progress has been, because this is 

potentially just very important. Of course, it’s also possible for universities to pervert exactly what you’re doing while telling you that 

they’re complying. So I’d be very interested in your assessment 

after, say, five years. 

Mr. Dawson, you made a very interesting comment. You said 

that we’ve got to press for better access. I’m wondering how, in 

practical terms one does that. Does one reason with Madam Wu Yi 

or somebody like that or point out the advantages for China? How 

do you leverage this? 

Mr. DAWSON. Well, you push every button on the elevator. You 

push the button that takes you to Geneva, you push the button 

that let’s you talk about these conversations at the JCCT, and you 

keep that agenda going. You make sure that industry stays on the 

doormat of the government so they know that when you bang on 

the door you really care. And you make sure that USTR knows that 

IPR matters, and you don’t stop. You become a pest and you push 

and keep pushing. And if you have any ideas about buttons on that 

elevator that ought to be pushed, I’ll push them, because we’re very 

interested. 

Commissioner DREYER. Thank you. 
173

Cochair MULLOY. I have a suggestion for another. You want to 

work with other countries—entities like the EU if they’ll be helpful 

in carrying out that agenda, then you ought to work with them 

pretty closely. 

Mr. DAWSON. Oh, we do. 

Cochair MULLOY. Yes. 

Commissioner Wortzel. 

Commissioner WORTZEL. Thank you. 

I appreciate all of you being out here. Your presentations were 

lively and right to the point. I have a question for Mr. Ciacchella. 

You’ve got a very interesting highlighted paragraph in here in 

the presentation that says that there’s a shift from defense and enterprise to the consumer, that the consumer is now, for the most 

part, the main driver of the high-tech market as opposed to defense; and that semiconductors are going into consumer applications versus business or defense purposes. I want to draw you out 

on that a little bit, if I could, because it strikes me that defense 

at one time clearly drove new research and cutting-edge research, 

which later found its way into the civil market. 

China’s high-technology strategy used your model: Find things 

that will work well in the consumer market, bring it in through import substitution, and then figure out how to use it in the defense 

sector. 

I guess now my concern is whether or not there are specific technology areas, either here in the United States or in China, sectors 

where defense remains the driver. If we had to say, okay, ‘‘Don’t 

worry about competitiveness, the United States will compete,’’ 

that’s part of your message, let technology go and float where it 

will. It will sort out the marketplace, and innovation will sort it 

out. But are there specific technology areas where defense is the 

driver because they are so unique to defense and then they then 

begin to affect the security of the United States? 

Mr. CIACCHELLA. There are a couple of things there, so let me 

comment. The first is I brought up the switch to consumer markets 

only because if you put it in context and you go back to the late 

1970s and 1980s, and if you think of high tech before the 1980s 

and into the 1970s, some of the companies that were around that 

were high tech didn’t make it through that transition from defense 

to enterprise. Because I think when applications going into enterprise exceeded those going into defense was about in the mid-’70s 

when that shift happened. That created a whole another group of 

companies and competitors, and there were a lot of other companies that they didn’t make the transition. 

So if you look at history as any indication, we’ve gone through 

an interesting trigger point now where if you go, if you project that 

forward to the next 20 years, there will be the similar shifts in 

companies. New companies are going to take over, where the companies who were wrapped up in the infrastructure areas are going 

to have a tough time. 

You see this quite a bit in the telecom industry, for instance, the 

Lucents of the world and some of those. It’s tough. You’re going to 

continue to see a lot of that. And this is a trend that’s probably 

going to go out for 20 years. 
174

So I bring that up because that is a trigger point that actually 

happened. And we have historical precedent to see that, okay, at 

that time that changed and churned a lot of the industry. 

Now if you start to look at it for, okay, let’s look at it from a defense perspective, for instance, and what does that mean. Well, if 

there are suppliers or if there are companies today that are providing critical path technologies to U.S. defense, U.S. security, they 

happen to be subsidizing a lot of into the enterprise market. 

They’re struggling to make the shift into the consumer market. The 

U.S. Government, U.S. defense agencies are going to have to find 

ways to either shift to suppliers who are going to make that transition or are going to have to find ways to help subsidize some of 

these companies who are doing that. 

So not knowing the specifics, if I’m looking long-term at my suppliers, so if I’m in the procurement function, for instance, who are 

the suppliers who are susceptible to the shift that are going on, 

and who are these suppliers that are giving me critical path technologies right now and are they vulnerable? I would start to put 

them on my radar screen, is what I would start to do. 

Commissioner WORTZEL. Thank you. 

Cochair MULLOY. Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thank you, Mr. Chairman. 

And thank you to our witnesses. It’s a long day, but we’ve actually had longer. 

Mr. Ciacchella, I’m interested in what you’re saying with this 

distinction. I want to take us full circle back to where Secretary 

Perry started us this morning. One of the issues he talked about 

was the distinction between the technological base, investing in the 

technology base versus what the companies are doing, which is 

product development. He drew a very clear distinction, and that’s 

what I hear you’re saying, that companies are moving away from 

what Secretary Perry called the seed corn on which the product development is based and moving directly into product development. 

I’m curious about where the role of the U.S. Government is and 

where it should be. I mean he seemed to clearly come down on the 

side of the government needs to be making sure that there is a 

strong basic research component that has traditionally come out of 

the defense and military sectors. And then almost in ways the private companies will take it from there and do what they’re going 

to do and do the innovation. Is that some of what you’re seeing or 

what you’re advocating? 

Mr. CIACCHELLA. It’s something that we’re seeing and advocating. If you look at some of the—out of the U.S. high-tech study 

that we did, from a policy recommendation there was this theme 

about steady investment in science, steady investment in critical 

sciences and in emerging science areas. So biotechnology, for instance. Next generation energy. So it’s the underlying sciences in 

some of those things that came out as the—U.S. companies are not 

going to be investing in the basic research. But, again, if you look 

historically, if you look at the foundation for the Internet, for instance, that was a DARPA-funded thing that became—and what’s 

the Internet today and the web and everything else that was built 

around that. 
175

In a similar fashion the funding that was need for the human genome and the project is spawning this sort of thing. So it’s finding 

those, as you mentioned, what are these kernels, because most U.S. 

companies have shifted their R&D focus. You’re absolutely right. 

It’s into product development. In fact, this shift to consumer markets is going to require them to be much more adept at understanding what are really much more fragmented markets now. 

So R&D and development from being a technology development 

activity is going to become more to being almost an analytical type 

of approach. You’re going to have to understand multiple customers, multiple segments, and multiple geographies. That’s a lot 

of investment. That’s a lot of trying to understand what are the 

needs and how can we plug in technologies that already exist. 

What can I pull off the shelf. 

If you go—who’s going to be developing the sciences that are 

going to support those? A lot of U.S. technology companies are 

starting to—they’re looking to find it, not develop it anymore. 

That’s a different model. 

Commissioner BARTHOLOMEW. And I guess that’s my question, 

which is if they are focusing on consumer development at the same 

time that the government is reducing its investment in basic research, surely even somebody who’s thinking ahead in a business 

knows that their product development is dependent on basic research, where do they think the research is going to be coming 

from? 

Mr. CIACCHELLA. Well, that’s a good question. And I can tell you 

what some of them are saying, is they’ll go get it wherever they 

can. So if they’re not getting it here they’ll get it overseas. Or if 

they can’t get it here and if they can’t get it overseas but their competitor can, then we’re going to be losing the ability to develop an 

industry around that technology. 

Commissioner BARTHOLOMEW. Thank you. 

Cochair MULLOY. Thank you. 

I have a couple of comments and then a question. The issue of 

the Congress being more protectionist or isolationist—I can offer a 

couple thoughts, because I did work up there a long time. 

Going back to NAFTA, the Congress was told: This will help get 

exports to Mexico and it will help stop illegal immigration. It did 

neither. 

Congress was told: Support the WTO and it’ll help the U.S. trade 

position in the world. Our average tariff MFN rate is probably 2.5 

percent. We locked in an average tariff with India, probably 15 percent or so. So there are terrible inequities built into this system. 

I remember this clearly because I was in the Commerce Department in the Clinton Administration when they were trying to sell 

PNTR to the Congress, and they were doing list state by state of 

all the exports we were going to get to China, when they were selling that to the House. I remember the Wall Street Journal the day 

after the House voted to approve PNTR for China: Morgan Stanley 

Investment Bank has said ha-ha-ha. This wasn’t about exporting to 

China. This was about the multinationals investing in China. And then they look at a $700 billion current account deficit and 

they see no end in sight. We’re heading toward a trillion, they 

begin to say: Why would we listen to these folks anymore. There’s 
176

a lot of doubt because they’re hearing from their people: My God, 

okay, the blue-collar guys, your jobs are going to go. But we’re 

going to move up. And now we hear the people who are supposedly 

moving up, the white-collar guys, saying, ‘‘Our jobs are going out 

to India now.’’

So there’s a lot of concern in the Congress and no one has completely helped them understand what is happening here. I think 

that’s what really needs to be done. And it has to be that somebody 

feels like this is the national interest and, boy, if we don’t do this 

we’re really going to be in trouble. 

Now I’m hearing more and more students don’t want to go into 

fields that are a part of the internationally-competitive part of the 

economy because they say, ‘‘If I go into chemical engineering, or 

something, somebody can outsource that job to India, and I’m not 

going to go into that. I’m going to go into lawyering or investment 

banking or media or something like that,’’ so that’s a problem for 

us. 

I remember we had a guy named Ron Hira come out in Seattle. 

I read his testimony, and he said these H–B1 visas and other 

things, all we were doing was bringing in people, training them, 

and then they would go back, and it made it easier to outsource 

jobs here. That’s what this H–B1 program was about. So now the 

Congress is getting that in their head, so they’re reluctant to go 

down that road as well. 

So I think we have to speak the truth to Congress and tell them 

what is going on and help them understand. We cannot, even if it’s 

for the sake of a short-term goal, go up and there and oversell 

something without explaining what really is going to, or you’re 

going to get this kind of reaction. 

Now I know that we’ve all said we need to put more money into 

R&D. So this is the question I have: If the Congress were to follow 

this recommendation, is there any chance that we would put all 

this money into R&D, help our companies, and then that they 

would then transfer the R&D abroad as part of their competitiveness? How would we deal with that issue? How would you reassure 

the Congress in that area? 

Mr. ARCHEY. Just the last question or the other three? 

Cochair MULLOY. Anything you want to comment on. 

Mr. ARCHEY. Okay. First I want to comment about this point 

about kids don’t want to go into programs that are internationally 

competitive because they’re worried about the jobs. I would argue 

that it’s much more than that. 

I think if we’re going to increase young kids going into math and 

science we’ve got to do a fundamental change in the attitude and 

in the aura about those jobs, because in the 1990s the high-tech industry increased its employment by 50 percent. Engineering graduates dropped by six percent in the same period of time. Every 

study in the last ten years has indicated for a kid in high school 

who thinks about a career in high-tech, their view is that that’s for 

geeks and nerds and basic dorks. And it’s a interesting thing. It’s 

really got a very pejorative connotation about it. 

I used to say all the time in the days when L.A. Law was on that 

we needed a new situation program called ‘‘L.A. Geek’’ where we 

basically talk about how exciting a career in high tech is. 
177

We’ve got a report coming out Tuesday on high-tech jobs in all 

50 states and the national data. In 2004 the average salary for a 

high-tech worker was 84 percent higher than the rest of the private 

sector, so it’s not the issue of how much money are you making. 

It’s an issue of the aura and the status that is associated with it 

that I think is the problem. 

I think on the last one, in terms of would they transfer the technology if this were defense sponsored or government sponsored. 

Cochair MULLOY. Government sponsored. 

Mr. ARCHEY. I doubt they would, but I wouldn’t make it categorical that they wouldn’t. But I don’t think so. We talking about 

globalization, we talk about global companies. We talk about all 

that. We’ve always talked about, oh, the world citizen and all that. 

Hell, I think nationalism right now all over the world is more intense than it’s ever been. And that’s after this incredible period of 

globalization. 

I think that American CEOs and American executives are acutely aware of the fact that they’re American companies. They may 

have plants everywhere else in the world, but they also know from 

whence they came, and that matters a lot. And they also tend to 

be awfully good citizens. 

Cochair MULLOY. Thank you. 

Mr. Ciacchella. 

Mr. CIACCHELLA. On the workforce topic I just wanted to comment briefly and just substantiate what Archey said. We actually 

did a study for Joint Venture Silicon Valley about three, four years 

ago, and looked at K through 12, so high school was really the area 

that we focused on and interviewed quite a bit. The bottom line 

was tech was not cool. And this was done actually at the peak of 

the Internet revolution. 

And, as Archey mentioned, the jobs paid well. At the time it was 

a very respected kind of a profession. But the issue was it’s competing with MTV. It’s competing with entertainment and other 

kinds of video games and other types of media out there and impression. So there is an aura. It’s an education sort of thing. 

There are some programs, I don’t know if Stan Myer’s on any of 

your panels, he’s at the Semiconductor Equipment and Materials 

Institute. There, for instance, they have this technology day where 

they’re taking kids through fabs and showing them what it’s really 

like to work with technology, because it can be actually pretty cool. 

But the real question is how do you make technology, how do you 

make science cool again, because the kids of today don’t see it as 

a cool thing. And it’s more of a marketing issue than I think that 

any kind of—there’s something fundamentally wrong with the 

types of jobs that are out there. So I tend to put that that’s a marketing problem. And we’ve got to figure out how do we better market science and technology jobs to kids, because it’s competing 

against a lot of other occupations. We’ve got to do a much better 

job of doing marketing. Fashion, I mean you name it. 

Commissioner DREYER. CSI. 

Mr. CIACCHELLA. CSI, exactly. 

Cochair MULLOY. Yes. 

Mr. CIACCHELLA. On the topic of R&D investment by U.S. Government, and will that leave the country, through time that will 
178

happen. I mean that happens with all technologies as they mature 

out. But with the executives that I work with, there is a strong propensity to use and to develop technologies, the next generation 

technologies here. U.S. companies, their primary research centers 

for a lot of their next generation technologies are here, if you look 

at the evolution of a product and you look at the evolution of technology, it starts in a place and it migrates out. 

So I think it’s not an either-or situation, it’s an evolutionary 

process. Technology that we develop here that we fund here will 

stay here in the beginning, and the beginning’s an important period of time because that’s when a lot of the innovation and that’s 

when a lot of the margins and the profits from innovation come. 

Later you’re playing a very low-margin game. As technology proliferates and goes overseas, then it’s an okay thing. I think what’s 

important is to look at that beginning stage of when technology 

happens. 

Mr. DAWSON. To your first point about telling the truth about 

trade. We are up on the Hill every day of the week every week because we’re facing a vote on Central America free trade, Dominican 

Republic, and the truth about high tech in that agreement is it’s 

a one-way street. We have no tariffs. Several of those Central 

American countries do, so it’s a free ride for the high-tech industry. 

I don’t represent the sugar industry. I don’t represent the textile 

industry. I represent the high-tech industry. And for us, in truth, 

it is a good deal. 

Cochair MULLOY. Um-hum. 

Mr. DAWSON. Now I don’t know how I talk about sugar and . . . 

Cochair MULLOY. We ought to go back and have Mr. Wizard on 

television. I don’t know if you remember him, he used to do those 

science shows when I was kid and we all watched him learn how 

to do it. 

One last thought, if there are any ideas on how Congress could 

tie the money you put into R&D, at least that there’s some benefit 

maintained here, think about how to do that. 

Mr. Archey. 

Mr. ARCHEY. Well, all they got to do in the Congressional Research Service and everybody else on the Hill is we’ve got it, so just 

take a look at how many preeminent technologies over the last 25 

years in the world of technology came as a direct result of the sponsorship by the Federal Government of the R&D. It is the most unbelievable list. Many of you are familiar with it. 

I contend that that’s where if you’re going to start talking about 

increasing R&D budgets, just give them the list. By the way, these 

things came out of DARPA, these came out of NSF, these came out 

of NASA, et cetera, et cetera. I mean it’s in the story. 

You’ve got to remember one thing, too, on this. Until about the 

early ’90s there was a really intensive ideological debate over the 

role of the United States Government in funding R&D. And eventually it became this marvelous new term, ‘‘precompetitive research,’’ 

which made it okay for the government to invest in it. And that 

debate has pretty much ended, but that was really intense back in 

those days. And there were all kinds of folks who were the government shouldn’t be involved at all. 
179

But look at something like fiberoptic technology, the original 

work that was done on the basic materials aspect of it, which nobody was expecting was going to turn out to be a fiberoptic line, 

was done by the Federal Government. 

Cochair MULLOY. Thank you. 

Chairman D’Amato has a final question and maybe observation. 

Chairman D’AMATO. I want to thank you all for coming and staying and thank the audience for coming and staying. Mr. Dawson, 

this question about government procurements standards. Have we 

lost that battle with the Chinese government? 

Mr. DAWSON. No, it’s on the table. In fact, it’s on the JCCT agenda. We are pushing hard. It doesn’t mean we’re going to be successful. It doesn’t mean we’re going to get all the pieces, particularly 

software that we’re seeking, but we are certainly pushing to try to 

get that undertaking signed up and we’re not giving up. 

Chairman D’AMATO. Good. Good luck on that. 

Thank you very much. 

Cochair MULLOY. Thank you, all. 

[Whereupon, at 5:00 p.m., the hearing was adjourned.] 
(180)

CHINA’S HIGH TECHNOLOGY DEVELOPMENT 

FRIDAY, APRIL 22, 2005

U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION, Washington, D.C.

The Commission met in Stauffer Auditorium, Hoover Institute, 

at Stanford University, Stanford, California at 9:10 a.m., Chairman 

C. Richard D’Amato, Vice Chairman Roger W. Robinson, Jr., and 

Commissioner Patrick A. Mulloy (Hearing Cochair), presiding. 

OPENING REMARKS OF COMMISSIONER PATRICK A. MULLOY

HEARING COCHAIR 

Cochair MULLOY. Good morning. Today we’re going to continue 

with our hearing in which we’re trying to assess China’s high-technology development and its implications for the United States. 

In our first panel this morning we will hear testimony on what 

China’s technological growth means for U.S. companies and what 

trends we can expect from China in industries such as the semiconductor industry. 

On our first panel we have: Mr. John Gage, who’s the Chief Researcher and Director of the Science Office of the Sun Microsystems Corporation; Mr. Mark FitzGerald, who is the Managing 

Director of Equity Research for Banc of America Securities, is also 

on his way. I think he’s gotten lost somewhere on campus, but he 

will be here shortly. 

Mr. Gage, feel free to start your testimony. 

PANEL V: CHINA’S GLOBAL TECHNOLOGY COMPETITIVENESS II 

STATEMENT OF JOHN GAGE

CHIEF RESEARCHER AND DIRECTOR OF THE SCIENCE OFFICE

SUN MICROSYSTEMS, INC., SANTA CLARA, CALIFORNIA 

Mr. GAGE. Thank you very much. It’s a great pleasure to be here. 

I put this up on the screen just as a warm-up because I thought 

it would be interesting for us to recognize as we examine technology and its spread. 

This shows our laboratory in Beijing and where Tsinghua is. 

What I’m doing here is showing you an application. Google actually 

owns this. They bought this company and the companies named 

Keyhole, for those of you that have a Defense background. 

The company began with a number of Sun people and Silicon 

Graphics people that used to build command and control, and then 

realized that since PCs are pretty powerful, in ’98, ’99, they could 

do with the PC what you could do with a Sun or a Silicon Graphics 

machine, and they started a company. Twenty people acquire satellite data and they tried to make money of it for a while, and they 
181

haven’t made much money. Then Google bought them six months 

ago. Google feels rich these days, because they are. And they said: 

We’ll let you kids ride with this until we have 30-centimeter data 

for the entire surface of the Earth. 

Now 30-centimeter data is interesting data. I’ve used this in Beijing in other places to say to people, the Chinese: It’s really quite 

a narrow strait here. Why don’t we look. 

Then you fly over to the other side and there’s a Chinese air 

force base there. And the Chinese response to this is usually: You 

can’t do this. 

And you say: Oh, no, watch me. So you come down on the Chinese air force base and you look across the strait. And you say: 

That’s where Sandy Berger put the boat. See, right over there. And 

here’s the margin of error that you might have had, had you managed to have a slightly crocked takeoff with a missile. So it’s an interesting storytelling mechanism. I won’t launch into why we’re 

going to look at Antarctica, but I put that up just as an indication 

that I could as easily been sitting in Beijing watching this. It’s access to the data across the network and it would allow an examination at 30 centimeters of where your lawn furniture’s arranged in 

the backyard or where your car is parked. 

As the data becomes accessible from webcams, or I was in Seoul 

two weeks ago and held in my hand the old, the five-megapixel cell 

phone. And they said that’s the old one. The new one’s seven 

megapixels. So a seven-megapixel image from, let’s say, one of the 

350 million cell phones deployed in China at this moment would 

allow me to have tail numbers off of those planes parked on the 

Chinese—and it would just be data thrown up on the data. Lots of 

data’s being thrown up on the data. 

So I just thought I’d show this to let you get a feeling for the universality of access to information. I’ll turn this off now. 

This is what I wanted to talk about. You posed a variety of questions yesterday. Some went to the state of technology in China. 

Some went to the deployment of research done in the United States 

to entities in China that might use that information for defense 

purposes. Commissioner Wortzel asked: ‘‘Well, what if this stuff 

that’s just for defense things, what are they doing there. What are 

the barriers being put up, what’s the standards gambit going to be 

in China? What’s the frontier of all this. Where does the U.S. R&D 

go?’’

How do we know that when we bring the best and brightest from 

China to the United States, modular visa requirements, that it’s 

advancing our national interest. How do we really at the bottom 

get a grip on the impact on the balance in national security by 

looking at what’s going on in China. 

Let’s try this one first. This was two weeks ago. The Association 

for Computing Machinery has an annual contest for who’s the best 

programmer. And there are the world champions, Shanghai 

Jiaotong. 

Shanghai Jiaotong’s team, you see part of one of the team members there, the problem set’s there. The problem set, there are ten 

problems dealing primarily with things like how do you efficiently 

locate cellular telephone towers and so forth. The list of overall 

winners this year is here. 
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Now for an idea of where is the technology capability distributed, 

this is a pretty good list. Here they are. This is the compute crowd. 

Now this is not precision machinery. This is not aeronautics. But, 

notice, we start out with Shanghai and Moscow and St. Petersburg, 

Waterloo—perennial comer—Poland, and then there’s Fudan, and 

then there’s Beida, and Hong Kong, Tsinghua, Yonsei—well, that’s 

actually in Korea. Keep on going down through the winners here, 

there is CalTech lumped together. So in the top 30, MIT top 30. 

I was at Berkeley last week for the chancellors’ investiture. Richard Newton, the dean of engineering, who says Berkeley is the 

number one engineering school in the world, as the surveys all 

have showed now, I said, ‘‘Yes, but the last time Berkeley won this 

competition was seven years ago. Where are you guys?’’

So the competition for the world’s smartest people is now being 

won by, if I’ve got a really hotshot computer science faculty at 

Jiaotong, which apparently I do, I’ll go to Jiaotong. I might go to 

Moscow. It’s a little grim and cold. I might go to St. Petersburg. 

It’s colder. I might go to Waterloo, it’s cold. Why don’t I go to places 

like this or this or this or this, places where I’m able to get a world 

class education and I’m received warmly in an entity that is building a gigantic engineering enterprise throughout all of China. 

So the questions that you have posed about where is the talent 

and how good it is—I’ll leave the itsy-bitsy drone thing—well, actually maybe I’ll show that. When anybody can see how to make this 

sort of thing, which is just some power, some solar panels on top 

of a little propeller with big cameras underneath, that thing there 

will make the Earth viewer app. I showed you a few moments ago 

considerably sharper. 

So this is all relatively simple technology to do. I guarantee you 

people are making these things in China. And there’s a lot of effort 

that’s gone into that. 

So I thought I’d show you the talk I gave two weeks ago. We 

have a twelfth annual conference where we bring a thousand Chinese universities to Beijing with the Ministry of Education and we 

talk to them about the advances in the world’s fastest machines, 

what we’re doing. And this guy, Professor Wu, who directs 

CERNET, which now reaches almost 2,000 Chinese universities 

with bandwidths at a minimum of two megabits, but at a maximum gigabit, he’s built over 12 years the largest Internet in the 

world. He’s building the new one, CERNET2, that’s at Internet 2 

positions. And from their position there is a new protocol or 

there’s—actually ten years of development of this—that’s the next 

step for all of us doing Internet protocols. It’s called IP Version 6. 

One of the components of it is when you send a packet around 

in IPV6, it has a source address and a destination address that are 

known. We’ve run out of addresses at I Internet Version 4. So you 

give somebody an address and behind it are hidden thousands of 

addresses that are given. So when you browse the net you don’t 

know where the stuff is coming from. Well, now in IPV6. The Chinese government loves this. 

We’re going to know where the package is coming from and we’re 

going to know where they’re going. But it will also mean that the 

development of new applications in a world where for security you 

do want to know where source and destination IP authenticated, 
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this changes finance because it makes the entire Internet much 

more secure. 

So who’s going to be the first place that’s got access to a completely IPV6 large-scale network? China. It’s built; 200 universities 

are on it right now. And this is at gigabit to ten-gigabit speeds. 

These guys are moving. 

Now the minister in charge of all universities, Minister Wu, Wu 

QiDi, has a problem. She’s got to bring higher ed. everywhere. And 

so I put this up on the screen. It’s our ad. You know, hello, all of 

China. Sun is embedded in doing the sorts of things you want to 

do, but the statement of national purpose, about investment in the 

Chinese student body and finding the smartest people is her primary concern. 

If you’ve ever visited any of the golden high schools, that’s are 

the high schools in Beijing where the hotshot kids go, poor, backward Stanford. The high schools have better facilities than Stanford does. Not in machinery. They can’t make chips, and so forth. 

But, boy, the money has poured in to providing an environment for 

very smart, hard-working kids to do very serious work. 

So in answer to your questions yesterday about where is everybody in China, they’re moving right along. And the IBM challenge—IBM makes, from our point of view their machine is down 

60 percent of the time, so we don’t think much of it—but at the 

moment the fastest computer in the world is a pile of little relatively slow processors all jammed into a room that’s a parallel machine. And so for all Chinese kids, they’ll get access to a direct realtime competition called ‘‘IBM Eserver Blue Gene.’’ They will use 

the IBM power—that’s the name of a chip—power based parallel 

supercomputer—the Opteron chips are faster—which is used to 

solve some of the most difficult problems in physics, engineering, 

biology, geology, and university. And so this is for compete. Get on 

the supercomputer, one of the most powerful parallel—you can be 

anywhere. 

You can be in Chengdu, you can be places to get access, get your 

protocols, make them run—as long as the IBM machine is up, so 

the notion that there is some kind of a container in which we keep 

technology isn’t the right metaphor. And at the base, to get your 

instincts right, you’ve got to tune your metaphors, because you find 

over and over when you’re trying to make a quick decision you 

don’t think a lot about it. You base it on some metaphor that you 

believe captures the essence of the situation, but if you got the 

wrong one you don’t think clearly, and certainly not under pressure. 

So from our point of view as a technology company, we’re an 

open company. Actually I should have shown you this, but I’ll do 

it right now. Let’s look at the Ministry of Science and Technology 

in China and the standard—woops—software corporation. We made 

a deal last year with the Ministry of Science and Technology and 

with the Ministry of Information, MII, and we said to them—there 

they are—‘‘We’re going to give you the source code for the stuff that 

replaces Microsoft on the desktop.’’ You have a heavy-duty problem. 

Ninety percent of government offices are running stolen Microsoft 

software. Probably the case in the city government of Washington, 

D.C. And you have a way to take open source Linux and all the 
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stack above it that does the desktop stuff and put it out throughout 

all of China. 

Ninety percent of small and medium enterprises use stolen Microsoft software because it costs $5. Cost zero is better. And it 

allows everyone in China to add value. 

So we made that arrangement. And now several million desktops 

at the moment are running this stuff. It’s created a new place for 

employment for the smart kids coming out of Jiaotong because 

they’re going to go do innovative work, very Chinese-based work on 

the sorts of environments to read and write on people’s desktops. 

So our view of this is you’ve got to be there and participate. We 

have a research lab of about 300 people in Beijing. We have offices 

in about ten cities around China. Yesterday I sent mail to our Vice 

President of Human Resources saying the panel had some questions about how many bodies there are hither and yon in—how 

much of our workforce comes from China. 

So the response is, and I should probably pass this by the lawyers but it’s nonetheless real-time communicate here: ‘‘Unfortunately the way companies are required to collect university data 

only has themselves identify as people as Asian. So it’s very difficult to estimate numbers country by country. Theoretically the 

U.S. Government should know from L1 and H–1B visas, but 

haven’t seen any data.’’

Now that goes to the point of: Where is Washington in the Valley? Somebody ought to be coming around to us and saying we are 

looking at all this stuff, the Commission has asked us to be able 

to get clear numbers about who is where and what are they up to. 

And here’s our numbers. So to have our Chief Human Resources 

Vice President not have had any communication with anybody running the L1 and H–1—now maybe it’s just a phone call away, but 

it’s clear there’s no proactive mechanism for people to be building 

the date that the Commission needs to be able to give probing analysis of where we are. 

So I could give you offhand the guy that’s in charge of building 

Sun—all of Sun’s hardware except for the supercomputer—which is 

we’re building the world’s fastest machine for DARPA. He’s not in 

charge of that—is David Yen, born in Taiwan, spent many years 

in mainland Taiwan. Has no Taiwanese accent, but he does use 

Taiwanese slang when he speaks in Beijing, which is irritating to 

the PRC people, but he’s in charge of all of our hardware. 

Li Gong that runs the lab in Beijing created the security models 

for Java. Why is that important? Because almost two billion devices run Li Gong software as a security model in every cell phone 

from Motorola or Nokia or Samsung or anybody else. It’s all in 

there. 

So then I said, ‘‘Well, Bill Archey just said the quality of Chinese 

engineers, what do you think?’’

‘‘Yes, we agree on quality of people. Beijing is one of the six cites 

we, Sun, have targeted for growth. We’ve had an Austin lab, a Burlington lab, a Prague lab, St. Petersburg, and Bangalore. And right 

next to Tsinghua’’—oh, Beveridge has an odd spelling of 

‘‘Tsinghua,’’ but anyway, the phonetic spelling—‘‘and so we’re putting a lot of’’—woops—‘‘we’re putting a lot of money into this.’’ This 

is a response about do we have to do crypto. 
185

So now what—‘‘We’re recruiting every person we can.’’

So what’s our problem? 

‘‘Our multiple problems I think are affecting competitiveness. 

Visa restrictions are awful. They open up each year in October. The 

85,000-person quota is filled in a month. The Labor Department 

predicts by 2010, five years away, there will be a shortage of ten 

million workers in the U.S. It affects us disproportionately. In addition, the new government restricted-persons list limits the kinds of 

jobs we can give to Chinese nationals both here and in China. 

Don’t get me started on stock option expensing. Because of the restricted-persons issue, we have not yet seen Canada as a reasonable alternative’’—that would mean do we go train people in Canada. We can train people anywhere we want in the world. 

‘‘Is that’’—well, no, Crawford doesn’t think so. He says, ‘‘I’d at 

the moment rather move more engineering to China.’’ This is just 

to take advantage of quality and the depth of expertise and, in fact, 

the advances people are making in China that we aren’t at the moment making in the U.S. 

So then Crawford waxes global, ‘‘I fear between our legislators, 

our regulators, our lawyers, and our accountants we’re seeing the 

beginning of the end of American competitiveness, absent internal 

upheaval, which is’’—‘‘upheaval, which is possible, the Chinese are 

on their way with India, Brazil, and Russia to be massive economic 

forces. We need to engage more, not less.’’

So that’s essentially the sentiment that I think is shared in the 

Valley by everybody. And Intel, H–P, Motorola, all of us as we 

build our labs in a variety of places in China are attempting to 

make some—take advantage of that pool of expertise and knowledge. And since we’re global companies, as you saw this morning 

in the New York Times, the estimate that General Motors and 

Ford, hammered as they are, are going to suddenly be facing cars 

made completely in China at a quality asserted by the Hyundai 

guys as good as anything made in Korea, which is pretty good, 

we’re going to watch a major assault in all frontiers, technological 

frontiers. 

Now on the current state of affairs in the economy. The observation of the New York Times’ story this morning went one level 

deeper. The assault is not simply by making a cheap car. Making 

a car is not so much the metal, it’s the database. It’s figuring out 

what should be where at what point and how do you arrange the 

logistics chain so that you’re efficient. 

When people talk about how, oh, the cheap labor in China is 

really the problem we have, and you’ll hear these textile people say 

these things, the garment people, they’re flat wrong. If you go to 

look at a plant in China you will look at for a garment-manufacturing operation, a kilometer-and-a-half building completely computerized with the world’s most modern fabric and textile machinery run by a couple of people. They’re very good at the logistics 

supply chain work, you have to be if you’re going to start making 

something to compete globally, as they say, an automobile manufacturer, because you’ve got to integrate hundreds even thousands 

of components in your logistics chain. 

So it’s that other dimension of manufacturing capability. John 

Zysman wrote a book once called Manufacturing Matters, and it 
186

does because you learn how by doing. And every time you build a 

new plant you’re ten to 20 percent more efficient because of the 

stupid things you did on the first one, you get better on the next 

one. And if you capture that knowledge by doing it, then you’re on 

the road out making very serious inroads industrially. 

So I think I should stop with that, just as an overview of how 

we see the role of what we do globally and, in particular, with respect to China. 

Cochair MULLOY. Mr. Gage, thank you very much for that presentation. I see you must have stayed up late last night getting it 

ready, but we appreciate the effort you put into it. 

Mr. GAGE. In spite of the generous wine from the Commission. 

Cochair MULLOY. Mr. FitzGerald, I’m sorry we started prior to 

your getting here. I understood you got lost on campus. I did the 

same thing yesterday trying to find my way here, so we welcome 

you. I see that you must have spent some time in Montreal. I spent 

two years there. I’m glad we have a chance to talk. 

STATEMENT OF MARK FITZGERALD

MANAGING DIRECTOR AND

SENIOR RESEARCH ANALYST IN THE TECHNOLOGY GROUP

BANC OF AMERICA SECURITIES LLC

SAN FRANCISCO, CALIFORNIA 

Mr. FITZGERALD. Yes. I don’t speak French very well, though. 

Cochair MULLOY. Mr. FitzGerald, when I introduced the panel I 

noted that you were the Managing Director of Equity Research for 

Banc of America Securities. 

Mr. FITZGERALD. Thank you. While they get the presentation up, 

I think the message that I’d like to leave with the panel is that the 

outlook in the semiconductor industry in terms of competitiveness 

in China is not nearly as dire as in some other aspects of it. I think 

there’s very good news here, particularly for the U.S. because if you 

look at the semiconductor industry and some of the segmentations 

in it, the U.S. clearly leads and dominates in these areas. It’s going 

to be multiple years and billions and billions of dollars that China 

or, for that matter, any new entrant to the semiconductor industry 

is going to have to basically invest to even begin to rival some of 

the leadership. 

The problem is that the capital intensity of the semiconductor industry and the know-how that’s required is so high and so deep 

that no one simply walks into this business and is a supplier of 

semiconductors overnight. Simply put, you want to think about the 

semiconductor industry not as a monolithic industry but as subcomponents. Each one of these subcomponents has major technology, intellectual property associated with that. 

What I want to give you just is a brief overview of where that 

intellectual property resides today and how difficult it is to duplicate it. Basically the way we think about it, there’s three segments. 

There’s the semiconductor-equipment manufacturing industry. This 

is the very bottom of the food chain. Then there’s the semiconductor-chip production. This is the chip companies that have these 

large, expensive semiconductor plants that they build. And then 

there’s what we call the design or the intellectual property in terms 

of the designing of chips. 
187

If you look at these different segments, the U.S. clearly has a 

major leadership position in several of these. Two of them are really very difficult to attack at this point for any global competition, 

because we are so far down in the road in terms of developing the 

technology at this point. 

The capital equipment part of the business is already consolidated to the point that there are just two global leaders in this part 

of the business: It’s basically us with about 40-percent market 

share and Japan. There are a few pockets outside of those two regions in terms of some technology, but it’s in places like Europe. 

And someone like Israel actually emerges here as a factor. 

For someone like China to come in and duplicate the infrastructure, the know-how in this segment, I think is almost impossible 

at this stage of the industry’s development. We’ve even seen as 

other Asian countries have tried to pile into this semiconductor industry, Korea, Taiwan, Malaysia, it’s been impossible for them to 

duplicate the technology and the infrastructure that the U.S. and 

Japanese companies have basically put in place at this point. 

Then if you looked at the semiconductor-production side of the 

business, the U.S. has much smaller market share here. This is 

where a lot of the movement is happening in terms of Asia emerging. But, again, I think in this area it’s very fast coming down from 

our vantage point to about eight to ten companies globally who are 

going to dominate this business. And within that there is a handful 

of U.S. companies, a handful of Japanese companies, and a couple 

companies in Taiwan and Korea. 

Again this is where China is trying to enter the marketplace at 

this point, but again the technology hurdles are incredibly high. It’s 

going to be multiple years to see whether any of these companies 

can really emerge in China as a factor in terms of actual chip production. There’s a lot of money being spent in China, but I can go 

through Asia in the last ten years and show you billions of dollars 

that was spent on semiconductor-production technology in places 

like Korea and Malaysia, Thailand, that have just not ever produced anything and are basically shells of operations at this point. 

I think what you really need to appreciate, that leading-edge 

technology is really coming down to eight to ten companies globally. And you get companies like Intel, Samsung, Texas Instruments, who are really dominant in this area. There are clearly a 

handful of Japanese companies and there are companies in Taiwan, Taiwan Semiconductor I think emerges as a major player 

here. 

If you’re going to look at vulnerability, though, and where I think 

China has the biggest opportunity, it’s really in the design part of 

the area. This is where the capital hurdles and the hurdles in 

terms of having established technology are a lot lower. There are 

clearly many start-ups in this area that are happening, but ultimately these design companies are going to have to rely on the rest 

of the food chain for their technology, so you want to look at this 

as where they’re trying to enter is really going to engage them with 

the rest of the global semiconductor industry. 

Moving on, this is simply the way that a semiconductor factory 

is laid out. What we basically have here is multiple steps in terms 

of how we make semiconductors. It starts at the beginning there 
188

and then runs through this process. What I’ve highlighted is the 

individual equipment that each one of these accounts for a step in 

the semiconductor industry. 

What I wanted to show you, not so much getting hung up on the 

technology here, but if you take each one of these steps and then 

move to the next slide, which is a bit of an eye chart here, and look 

at the companies that dominate those steps. You will go through 

and see it’s a U.S. company or it’s a Japanese company. 

Again, this is where I think it’s going to be almost impossible for 

anybody to make an entrance into the global stage at this point because the customer base for these equipment companies is very 

rapidly shrinking, to about eight to ten companies at this point. 

If you look at the people who buy the semiconductor equipment—

so this is one step up—this is the capital spending that we’ve seen 

in the last five years. You can see there is a huge shift to Asia at 

this point. But what we’re seeing very rapidly happen is that the 

spending on semiconductor factories at this point, this is spending 

by companies like Samsung and Intel, Taiwan Semiconductor, is 

very rapidly getting concentrated in about the top ten companies 

at this point. 

What we’re talking about now is to build a new semiconductor plant, a two and a half to $3 billion investment. That’s getting to 

be a big problem even for countries that are pursuing industrial 

policy. And those $2 to $3 billion investments have to generate, on 

average, a year about $5 to $6 billion to justify, commercially justify those semiconductor plants. 

Well, if you do the math here, the total semiconductor business today, a $250 billion business, it’s not going to take too many of 

these semiconductor plants to basically justify the total global production. That’s why we’re seeing very rapidly this industry shrinking to a handful of companies. The next set of technologies is so 

difficult that if you haven’t had the learning curve of the last 20 

years, it’s incredibly difficult to enter the business. 

I cover one of the leading Chinese semiconductor companies, a 

company called SMIC. It’s had an incredibly difficult entrance into 

the semiconductor industry at this point. It came public a little 

over a year ago. Its reception on Wall Street and on the global markets has been somewhat of a disaster at this point. When you really look at the strategy of the company, it’s really difficult to see 

how this company’s going to emerge and really compete with a 

company like Samsung or Intel at this point. 

Bottom line: If you’re going to be a player in the semiconductorproduction industry, you have to have a commercially driven strategy. And that’s something that Asia has learned in a big, big way 

in the last ten years here, which is basically you can get all sorts 

of government funding. You can get government grants and free 

land, but ultimately if you are a semiconductor company and you 

do not have a commercially driven strategy, then you don’t have a 

long-term viable model and it’s just going to be a sinkhole for cash 

at this point. 

Again, when I look at the actual semiconductor-production technology I think China has an incredibly difficult challenge ahead of 

them. I don’t want to say that it’s impossible, but this is just a very 

steep hill to climb for China at this point. 
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Compounding the problem is that the industry is clearly starting 

to show aging—which we’re starting to see the semiconductor industry, the growth rate start slowing. It was a lot easier to enter 

the industry in the 1990s when we had the super high growth 

rates. It’s going to be that much more difficult to penetrate a slower-growth environment. 

Where I think the Chinese industry has the biggest opportunity 

ahead of it is basically in penetrating the application or the design 

side of the business. This is where you can get a lot of smart engineers. And, as Mr. Gates pointed out, China is clearly graduating 

a large number of engineers at this point. Where the capital intensity is low, you can do a start-up company, get a couple engineers 

together and design chips going forward. The success of that model, 

though, is really predicated on the applications that they’re focused 

on. 

What I think is the big challenge and the biggest opportunity for 

China is to become a leader in leading applications. That gives the 

semiconductor-design companies in that region of the world an opportunity to enter. 

So if I had to point out a weak link in terms of the strategy that 

China’s pursuing, it’s basically focusing on the lower end of the 

semiconductor food chain. If they really want to be successful, I 

think really focusing on the intellectual property or the design part 

of the industry and really developing applications, I think, will be 

the real key for China. 

I would point out today: The U.S. still leads in a major way here 

in terms of the design area. So it’s still a major strength, but it’s 

probably the area that is most vulnerable in terms of global competition at this point. 

[The statement follows:]
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Panel V: Discussion, Questions and Answers 

Cochair MULLOY. Thank you very much, Mr. FitzGerald. 

We’re going to have rounds of questions. Now each Commissioner 

will have an opportunity to ask questions of up to five minutes. 

Commissioner Wortzel. 

Commissioner WORTZEL. Thank you both very much for the illuminating presentations. 

I am fascinated with just how advanced you’ve characterized the 

Chinese as being in this area of technology, yet the obstacles they 

face. And I’m perplexed by what I see as big gaps in other areas, 

which you may not be able to explain, but you may be able to tell 

me whether these gaps can be filled through the application of programming skills, because they may be—Jiaotong may be number 

one in the world in programming, but—one of the top jet engine 

manufacturing companies in the world, Rolls-Royce Spey, went into 

China in 1978 with the idea of producing viable either military or 

commercial jet engines for the People’s Liberation Army. 

They worked very quietly in semi-secret in Xian from 1978 to 

1984. The first jet engines they were able to produce that worked 

came off that assembly line in 2004. And they almost adequately 

power the J10 aircraft that is a clone of our F16. 

If you visited the Northern Industries Corporation or Group 

plant south of Beijing near the Marco Polo Bridge, where on parallel lines they produce armored personnel carriers and Valdo 

buses, to this day the Chinese industrial sector cannot make a diesel turbine engine or a gas turbine engine or a diesel turbine tank 

engine. Can’t make it. 

Now I don’t understand how that’s possible, that you could be so 

advanced in one, this has perplexed me, why you have these wonderful on missiles, wonderful on telecommunications, wonderful in 

radar, world-class computer programming, and in 1978 to 2004 is, 

what, 30 years, you can’t make an engine for an aircraft. Thank 

God they don’t make really good engines for aircraft. Tank engines 

don’t bother me as much. 

But can the world-class capabilities you’ve described quickly 

begin to close that gap what are the great deficiencies in the Chinese military industrial sector? 

Mr. GAGE. That’s a great question. I’m certain I’m not qualified 

to answer this question. But as you watch a change in fundamental 

design—Daimler with this announcement about what they’re doing. 

Daimler’s stated for the last six years, what they make is a network on wheels. 

So you take the wiring harness out. All the complexity that you’d 

have in any car that you buy out here in the parking lot and replace it with a fiber optic link tying all the components in a car 

together and make everything a component on the network, given 

the automobile’s design cycles, people take not 30 years but they 

take ten years to get that kind of a change. But the fly-by wire or 

drive-by-wire vehicles, parts and component count drops significantly. 

So what we do, just the piece of the puzzle that the information 

technology guys put together, is changing fundamental design of all 

of these vehicles and planes, which means time to market becomes 

much shorter, design cycle’s faster. And a kid who started school 
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five years ago, say, at one of these great high schools who’s now 

finishing in graduate school at Tsinghua is learning about the control mechanism that could turn into an industry shift quite rapidly 

as you design new—I think of the cars in Malaysia, some of the 

other attempts. 

When Lotus moved, joined the manufacturing plant in Kuala 

Lumpur to help teach people how to make smarter designs, all of 

a sudden there was some shift in Proton’s manufacturing efficiency. 

So I think that translates immediately into these domains. 

On the battlefield in Iraq the devices that speak one to another 

use networking. It’s unfortunate with the fight we have with the 

music people, it’s all peer-to-peer communication so that a Howitzer is able to talk to a radar is able to talk a forward observer, 

all in a conversation that no human being’s involved in. That’s the 

stuff we do and that’s the stuff, which is generic technology that 

everybody learns how to do. 

So the U.S. dominates in space-based surveillance devices. It 

costs a lot to get them up there. But, as you see, when you’re able 

to combine them with this remarkable change in imaging technology that’s in your cell phone, you’re suddenly building a different mosaic of information that can be the transformative force 

we’ve all—network-centric warfare is the mantra, even since the 

failure in Desert Storm of Navy to speak with Army. Now that 

we’ve united in a battlefield management system based completely 

on networking, those that know about networks are a let up, wherever they may be. 

Chairman D’AMATO. Commissioner Dreyer. 

Commissioner DREYER. Thank you both for some really fascinating testimony. My question relates to something Mr. Gage 

started out his presentation with, these tantalizing photographs of 

areas with military applications in the Taiwan Strait. 

I also noticed that one of your top-scoring universities was 

Chung Shan, which is in Kaohsiung, in the southern part of Taiwan. I am wondering if you could expand a little on the relative 

military applications, for Taiwan versus China, in a scenario in the 

Taiwan Strait. 

Mr. GAGE. Move into fiction. Well, the fundamental technical 

change that’s occurring is the creation of sensor networks. We’ve 

all talked about sensor fusion. You can go to Berkeley at the moment. Berkeley makes about a cubic millimeter sensor with a radio 

built in. Smart dust would be—so the ability to make something 

that has not a loud signal, it peeps a little bit, but if you have a 

lot of them and they’re scattered around on the surface—on the 

ground, one talks to the next, talks to the next. You make a dynamic mesh, and suddenly you have a sensor network, which can 

be quite broadly deployed. And all these peer-to-peer discussions 

start going on. 

Did somebody step on you? Did a tank roll over you? Is it hot 

where you are? So this dream, in essence, for an intelligent, allsensor fusion environment is coming very rapidly. If you think 

about 350 million cell phones in China, they’re all in some sense 

capable of communicating each with the other. You can download 

something to all of them and make them play a symphony in unison right now. 
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So we’re entering some world where the boundary between 

what’s a piece of civilian technology, a handheld seven-megapixel 

camera, and what’s a military piece of technology, don’t you wish 

you had a seven-megapixel mobile camera. We’re watching the 

story of how the consumer-level stuff surpasses the capabilities of 

things we currently deploy to our armed forces. 

Your son knows better than—look at the generation. Ask the 20-

year-olds who are very good at doing things, they say, ‘‘Oh, my 

God, the 15-year-olds.’’ You ask the 15-year-olds and they say the 

real hotshot are the eight- or nine-year-olds that just are deeply 

into this. 

So we’re watching generations arrive that have a very different 

feel for technology and a different expectation of how to do things. 

And I suppose that’s a military application for that. 

Commissioner DREYER. Since it’s highly unlikely that Taiwan 

would attack China, could we imagine Taiwan deploying a ring of 

these sensors to let it know when a missile is headed this way? 

Mr. GAGE. They sure ought to be doing that, yes, if you can make 

the stuff. My view on this is: Anything we can dream up somebody’s doing. And the issues about how do radios work, we’re in 

some sense in an isolated world in the United States. 

When you think that 85 percent of Koreans have broadband, 

when you think that six million in Japan have ten megabits to 

their home back and forth for 20 bucks a month, we’re in a backwater in the United States at this moment. The feeling you have 

about what’s possible, if you’re in Korea and you’re walking down 

the street with your cell phone, which is receiving direct, full-bore 

video to the screen of the cell phone from satellite and from, in 

about a week, the terrestrial network, you have a very different 

sense about what’s possible; than here where you can barely 

make—in fact at this moment I’ll bet none of your cell phones work 

in this room because we’re sitting in a blackout area with very inefficient cellular telephone providers. 

The thought you’d be able to get full-bore video to your cell phone 

in this room is out of our perception. It’s happening at this moment 

in Korea and it’s happening for 60 percent of the population in 

Korea. Ninety percent have cell phones, some number like that. 

So maybe if we talked about how you make the universities receive more money for advance research, well, absolutely. But this 

other component about jabbing the American technology community to provide the environment inside the United States that stirs 

the imagination of the kids, that’s another component. We did say 

L.A. Law should have an ‘‘L.A. Geek,’’ well, there something to 

this. 

Finally, if I’m drifting off the subject so much, the disturbing 

thing is we are not focusing, as many people have said, on teaching 

science and mathematics in the elementary schools. 

And, just as a citation, the smartest person in this domain is a 

man named Alan Kay, who dreamed up Small Talk here in Palo 

Alto 25 years ago, a computer language that would let a ten-yearold do programming things that would beat the kids at Jiaotong 

today. And Alan has said why would we worry about how well the 

kids are doing on tests when the teachers that teach the stuff don’t 

understand math or science themselves and, therefore, we’re stuck. 
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Commissioner DREYER. Mr. FitzGerald, did you want to add anything to that? 

Mr. FITZGERALD. No, I can’t add anything to that. 

Commissioner DREYER. Thank you both. 

Cochair MULLOY. Chairman D’Amato. 

Chairman D’AMATO. Thank you, Commissioner Mulloy. 

Mr. Gage, you had on your screen there earlier the word ‘‘legislators.’’ Those are the people we work for. In fact, they’re the only 

people we work for. We report to the Congress. 

You also mentioned you thought it would be important for Washington, I think you said something about engaging the Silicon Valley in a more in-depth way. We’re interested in how we can do 

that, to develop a program for us to become more competitive. Obviously we have problems with our Tax Code. We have funding 

shortfalls, let’s say, in some new programs that need to be funded. 

We have regulatory problems. 

The question I have is: Have you thought about how would you, 

if you had the opportunity, structure a dialogue and recommend 

how we would become more competitive in these various areas? 

How would you do that? What is the first thing you would do to 

turn this competitive situation around? 

Mr. GAGE. Focusing on legislators or just in general the executive 

branch——

Chairman D’AMATO. In general. There may be things that legislators can do and things that they cannot do, but there’s a range 

of funding opportunities and changes in the Tax Code, for example. 

We think there are some things that have to be done there and 

maybe some regulatory questions. How does one engage Silicon 

Valley with the national legislature to try and make us more competitive? 

Mr. GAGE. Now that’s a great question. The standard way to engage Silicon Valley is to talk—Silicon Valley has very simple, repeated demands, which most businesses would say the same thing: 

Don’t regulate us, don’t tax us, leave us alone. We’re doing just 

fine, thank you. So you get that standard response. Every CEO you 

would put in front of the panel would say exactly the same thing. 

The answer is: We need tax credit. The answer is, don’t talk to us. 

Well, that’s not clearly the answer, because I think a separate 

conversation, and the forum for it could be the Competitiveness 

Council or a variety of places. Just take my own company, Sun. 

Named after the Stanford University Network, though all the software came from Berkeley. The Defense Advanced Research Projects 

Agency in the past put money into very advanced research, which 

had a high chance of failing. 

The Defense Advanced Research Projects Agency today has cut 

off almost every advanced computer science research project in the 

universities because they view themselves as delivering operational 

capability to the battlefield nine months from date start of grant. 

This is the stupidest thing we could possibly be doing. 

So you could get the chief technical officers or the chief scientists 

or the chief engineers, not the business crowd to say what we really need is a flow of the world’s smartest people, and that has to 

start by doing the sort of things you heard yesterday, about we 
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have to start the seed corn, because without that we simply have 

nothing four or five years down the road. 

So four or five years down the road for us there’s a shift from 

the kinds of computing we do now to new kinds of computing. 

We’re building the world’s fastest supercomputer because one guy’s 

invented a new way to bond chip to chip without wires in between 

so we can go a couple of thousand times faster, get rid of the heat. 

There is to be a change for optical and for quantum. That’s coming. So where do we have the optical and quantum research going 

on? We need to make sure that that’s funded now, and it’s not 

funded on one of these ‘‘write me a lot of reports every year about 

how far you’ve gone.’’ DARPA’s glory was in giving people three or 

five years worth of relatively burden-free funding so you could 

think about things. 

So if we had to make recommendations to legislators it would be, 

on the one hand, stop requiring that one of the most advanced researchers someplace submit a monthly report about how well 

they’re doing, because that’s just time taken away from thinking. 

This is not a good idea. And stop picking on some research area 

that may have a stupid name to present how we’re wasting Federal 

money. The amount of money we’re spending on these things is so 

small that it really doesn’t make any—it’s nice to grandstand, but 

it harms the research environment overall. There’s a longer talk 

about beefing up the armed service research capabilities, which we 

definitely need to do. 

As Negroponte takes his charge to try to do some integration of 

the agencies, I believe there will be an integration of research 

agendas. It would be a nice place to start, where people are able 

to say, ‘‘These are things we really need,’’ and have the voice come 

from Geospatial as well as from NRO as well as from—everybody 

has a way to express what should be done. 

I think in those domains, as we go through the oversight of the 

intelligence budgets, which is a necessary step to take, there needs 

to be pressure on the legislative side that the research agendas for 

the most advanced and most demanding applications turn into 

funding for those places where that kind of work takes place. We’re 

sitting in one of them, but also be sure it takes place all across the 

country in all sorts of institutions that then allow us to draw upon 

the smartest people around the world. That’s another component of 

national security. 

Chairman D’AMATO. Thank you very much. 

Do you have anything to add to that, Mr. FitzGerald? 

Mr. FITZGERALD. I would just emphasize that inasmuch as we 

lead in several of these technologies, feeding this semiconductor industry with the best and the brightest is absolutely critical. Clearly 

a lot of this talent, given that we’re not graduating the number of 

engineers we need to, is coming from overseas. The easier you can 

in terms of greasing that process of bringing people into the country, I think the better off we’d be. 

Chairman D’AMATO. So while we’re ahead in the semiconductor 

industry, let’s stay ahead. 

Mr. FITZGERALD. Exactly. 

Chairman D’AMATO. I think part of the problem is I’m not sure 

that there’s a national consensus that we do have a competitive-
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ness problem. One would assume that if we could establish that 

consensus, then the various funding flows to various technologies 

would be easier to marshal. Thank you very much. 

Cochair MULLOY. Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thank you, Mr. Chairman, and 

thanks to our witnesses. It’s a particular pleasure to hear from Mr. 

Gage, who I described to somebody last night as having iconic status here in the Silicon Valley. I had the pleasure and the luxury 

of peppering him with questions for three hours last night, so I 

won’t drag him through that again. 

But I am interested in this concept of free flow of information, 

which is what it’s all about. It’s almost as though there are two levels of information. There is the free flow of the scientific information upon which of this technology is based and the technology carries information. So it is the free flow of the content of the information that’s being carried. And of course the electronic frontier. All 

of these issues in some ways I think of as an anti-authoritarian 

move. 

So what I have trouble reconciling, as you mention CERNET 

and—is it—IPV6?—with the Chinese taking technological leadership on these kinds of initiatives? How do we reconcile the fact that 

the Internet is about the free flow of information with the technological leadership that is coming from a government that has demonstrated that it is not interested in the free flow of all kinds of 

information but only certain kinds of information? 

Mr. GAGE. Professor Wu, whose name I put on the screen, 12 

years ago had to keep his head down because the Minister of Telecommunications, also Wu, would have handed it to him if he realized exactly what was going on with the universities creating a 

fiber network throughout China without the permission of the Minister of Telecommunications by contracting with the Minister of 

Railroads, who didn’t like the Minister of Telecommunications, and 

the PLA that did the slave labor to put the fiber along the railway 

tracks, and suddenly there’s a fibernet all over China linking a 

thousand universities, and state council—everyone’s divided. 

What’s good, what’s bad, everybody just let this happen. Suddenly 

the network’s up and rolling. 

There is a bit of exaggeration, how we’re the only place doing 

this, the most advanced, because this is something we can do quite 

quickly or are, in fact, doing in a lot of places. But in a way it’s 

a statement of the sense of inevitability that’s in the hearts and 

minds of the kids who are studying late at night that, ‘‘We’ve been 

so backward we can’t even make a jet engine and now we’re at the 

forefront of things. And, oh, boy, this is an opportunity for China 

to assume its natural place of leadership in the world.’’

So there are many different—just as IP blocking and, I was in 

Shanghai. We had an 8,000-engineer conference in Shanghai a couple of months ago. It was at the moment of the Tiananmen Square 

anniversary, actually it was June, so the BBC announcer was 

blacked out. They’d watch BBC until they said, ‘‘And today in commemoration of,’’ and the screen would go black all over China. You 

could get the New York Times, but you couldn’t get the story about 

Tiananmen Square because it would block on content, so you can 

block on the source of where it’s coming or even down inside the 
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packets on what’s in the packets, but there are a lot of packets. So 

it’s a problem for anybody that wanted to try to really block things 

from blocking. 

So there’s a tension. There’s a constant tension. Will the conservatism of China—and Orville Schell phrases it: Will the Internet 

change China or will China change the Internet. And it’s a little 

bit of both. 

Then think on the other side, Samsung, a $68 billion company 

with—we buy so much stuff from them because—some memory and 

all these things. It’s one of the world’s greatest semiconductor companies. Samsung has a lot of dealings with the Chinese government because if moved to the West means they want to start putting in fabs and things in the West, so relationships that have 

nothing to do with what the U.S. is thinking it’s up to are shifting 

the technical ground underneath us. 

So a component of the Commission’s work could be to examine 

the relationships between Korea and even in Japan, in spite of 

demonstration, every one of the biggies, Toshiba, NEC, everybody’s 

going out to do business in China. That’s a significant technology 

transfer that’s—Asia backbone doesn’t concern us. The dream of 

Asia is to stop having the packets come to San Francisco to get rerouted so when you send mail from Shanghai to Beijing—it used 

to go through San Francisco, it doesn’t anymore. So these global relationships are really powerful. 

Because people really want to get the information around, the 

kids learning things that you wouldn’t believe they know. But the 

bloggers are active in China, millions of them. And we’re an open 

systems, share-the-code company, and it’s always been taken to my 

astonishment as some kind of a political statement in China. So 

ten years ago I’d talk about open systems, and they all viewed this 

as a challenge to the existing regime. So this is a mantra. People 

do believe they should have access to everything. I suppose in a 

way when the Chengdu Ph.D. student finds he can’t get a visa to 

get to the U.S., he writes off the U.S. because he doesn’t need it 

anymore. He’s got enough openness to be able to build something 

important in China. 

Commissioner BARTHOLOMEW. Thank you. 

Cochair MULLOY. Mr. Gage, you must have read your papers 

today because you talked about the articles in the Times and the 

Journal about China’s auto industry. I paid attention to those, too. 

We did a hearing on that area in Ohio in September, 2004, and got 

a picture of what is coming at us there. 

I don’t know whether you saw this other article in the New York 

Times about Mr. Portman who has been nominated to be head of 

USTR, and that he’s really getting a going-over. He’s promising to 

take a tougher line on China. 

But the problem is we have to be careful of what kind of line we 

take and why and understand more comprehensively what we do. 

Mr. Anthony Rock, who from the State Department is going to testify on the next panel, tells us: ‘‘China has used the lure of its enormous emerging consumer market to induce firms wanting to get 

into the Chinese market to sign investment agreements that systematically include some form of technology transfer.’’
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Secondly, he says, ‘‘Chinese investment policies encourage foreign investment in high-tech industries in particular with a system 

of preferential tariff and tax rebates designed to create incentives 

for high-tech industries, as contrasted with lower-tech industries.’’

From what you know, is that correct? If both of you could comment on that. And if that’s the case and we wanted to, how would 

we counter that as a nation? What should we be doing to deal with 

that situation? 

Mr. FITZGERALD. There are clearly incentives being given by 

China to attract technology companies, but I’ll tell you there’s one 

major hurdle that they face at this point that I don’t see any immediate resolution to, and that’s the protection of intellectual property. If you look at the global companies at this point, you have 

companies like Intel putting some manufacturing in China at this 

point. But it’s the lagging technologies, it’s the older technologies, 

it’s the non-critical technologies. 

People are so concerned about the protection of their assets at 

this point, because China does not have a good legal system at this 

point to protect them, that they are induced by the opportunity of 

the size of the marketplace. But none of the kind of family jewels 

is being placed in China at this point because of the lack of protection. I suspect that’s an issue whether you’re sitting running 

Samsung today or running Sony or Toshiba, you’re all looking at 

the opportunity there and being encouraged to invest. But it’s not 

the leading-edge technologies that are going in at this point. So I 

don’t see until that issue is resolved that China’s going to really 

be able to attract the best and the brightest in terms of the leading-edge technologies. 

Cochair MULLOY. Mr. Gage? 

Mr. GAGE. Yes. I’d say Tony Rock really knows what he’s talking 

about. I look at the agreements we have been entering. When we 

started in China, the oil crowd showed up with a contract typed on 

a 40-year-old typewriter where the ‘‘o’’ was so sharp it made holes 

in the paper. And it was one of these: We are going to be friends 

and everything will work out, and we’re going—and that was it, 

about three paragraphs. 

And we said, ‘‘Have you any clue about American lawyers? By 

the time we come back to you with a contract that says, ‘In case 

of hurricane, the deal’s off ’ or, ‘If you cheat and steal,’ you’re going 

to be so offended by our legal contracts you’re not even going to 

talk to us again.’’

Well, 15, 20 years later things are considerably different. But the 

Chinese style in general is a very sharp business. I shouldn’t say 

‘‘sharp,’’ a very standard business deal. ‘‘Hello, big phone companies, we’ll allow three of you to now serve Beijing. First all put 

your bids in. Oh, so the three get your prices way down. Oh, now 

that it’s you three, we expect to see a 50-percent reduction again 

if we’re going to keep doing business.’’

So it’s just, the lure, as Tony Rock says of a giant consumer market brings lots of people in. From our point of view, take an example like Huawei. Huawei makes machines that rival Cisco. It’s not 

too hard to make these machines. Andy Bechtolsheim, our Sun employee number one, built a machine ten times faster than anything 
209

Cisco did, and then Cisco bought, and he went over to Cisco for a 

few years, just making a chip. 

So Huawei has entered and is competing throughout Asia and is 

beating Cisco in country after country after country with lower 

prices. Northeastern University has some software from a professor 

and they started making MRIs and scanners. They beat Siemens 

and GE by, let’s say they’re at 30 percent of their price and the 

costs are almost nothing for these machines comparatively, so they 

make an enormous amount even beating American manufacturers. 

So there is a direct pull for companies that will begin to go global. 

Huawei is going global. 

In fact, in the United States the new smart washing machines 

and new smart laundry stuff, dryers and things, made in China, 

easy to put circuitry in that fixes the thing when the filter’s not 

been cleaned, reports home, in advance of a lot of the white goods 

manufacturers around the world. 

So we’re watching, just as he says, industry by industry, depending on how much advanced technology you need. Now semiconductor guys need an enormous amount of advanced technology, but 

white goods people don’t and can hit a market. Router-and-switcher 

people don’t. They can hit an immediate market with things that 

everybody knows. So it gets down to your commercial negotiating 

capability to stay in the game. 

From our point of view, since we sell to all these guys, China 

Telecom, and we run all the cellular operations in China, our goal 

is to just be in the game, stay there, participate deeply in the 2008 

Olympics, be part of the country. We ran Athens, we’ll run Beijing. 

It won’t be our face you’ll see, it will be Lenovo, but we are being 

pulled into China to bring all of our expertise to bear on this 

emerging large market. 

Cochair MULLOY. I want to thank you both. 

Are there any other Commissioners who have any followup questions? No. 

Thank you very much for your testimony here today. If you have 

anything that you want to submit for the record, we’ll be happy to 

package that in what we send up to the Congress. 

We’re going to take a five-minute break and then we’re going to 

have the panel with the State Department and the National 

Science Foundation. 

[Recess.] 

PANEL VI: CHINA’S SCIENCE AND TECHNOLOGY TRAJECTORY 

Cochair MULLOY. From the second panel this morning we will 

hear from representatives from the Department of State and the 

National Science Foundation. Anthony Rock is the Principal Deputy Assistant Secretary of State in the Bureau of Oceans and International Environmental and Scientific Affairs. Dr. Larry Weber is 

Acting Deputy Director of the Office of International Science and 

Engineering for the National Science Foundation. We appreciate 

very much both of you for being here and we look forward to your 

testimony. 

Mr. Rock, we’ll start with you and then go to Dr. Weber. 
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STATEMENT OF ANTHONY F. ROCK

PRINCIPAL DEPUTY ASSISTANT SECRETARY OF STATE

BUREAU OF OCEANS AND INTERNATIONAL ENVIRONMENTAL AND

SCIENTIFIC AFFAIRS, WASHINGTON, DC 

Mr. ROCK. Thank you, Mr. Chairman, and Members of the Commission. First of all, let me just start by saying I am frankly in awe 

of the speakers that have preceded me. This has been an excellent 

session overall. 

I wanted to also report to you that it’s cold and rainy this morning in Washington, D.C., so I’m delighted to be here on behalf of 

the Department of State and in particular the Bureau of Oceans 

and International Environmental and Scientific Affairs to talk to 

you specifically about the U.S.-China Science and Technology Report that we recently submitted to Congress. 

The U.S.-China Science and Technology Cooperation Report is a 

comprehensive review of U.S. Government civil science and technology activities during the period of 2002 and 2003, under the 

U.S.-China Science and Technology Agreement of 1979. I understand that the Commission worked closely with Congress in developing the reporting requirement, of course, for this. And, by the 

way, I have submitted the full text of my comments for the record, 

with your permission. 

Cochair MULLOY. It will be included in the record. 

Mr. ROCK. Thank you very much. 

The State Department of course coordinated the contents of this 

Report with numerous Federal agencies. The Report now, by the 

way, can be found on our website: http://www.state.gov/g/oes/rls/or/

44681.htm. Mr. Chairman, broadly speaking, the Administration takes a 

view that advancing a candid, constructive, and cooperative relationship with China is the key to achieving our long-term national 

security goals. As the President noted in the 2002 National Security Strategy, ‘‘[t]he United States’ relationship with China is an 

important part of our strategy to promote a stable, peaceful, and 

prosperous Asia-Pacific region.’’

So through governmental contacts, through scientific contacts, 

through academic contacts with a large number of Chinese officials 

and, frankly, everyday citizens, we do exert an influence over their 

views, their path toward the development of a market-based system and the policies that they take broadly with respect to the 

United States. 

Science-and-technology cooperation is a key component of any nation’s economic and social development. China like the United 

States has long endorsed this view. And they are on the move, as 

we have heard over the course of the past few days, and will continue to be so whatever occurs, whether or not there is a U.S.-

China government-to-government science-and-technology agreement. 

However, since China and the United States signed this bilateral 

agreement on January 31st of 1979, I think we’ve used this cooperation for a diverse and I believe mutually beneficial commerce 

of ideas, if you will. And it’s been accomplished through scientific 

cooperation. It’s been accomplished through education. It’s been accomplished through dialogue across a wide spectrum of human 

knowledge. 
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I want to emphasize that the U.S. agencies engaged in this activity carefully consider the critical importance of our national security, our intellectual property protection, our economic security as 

they weigh the costs and benefits of the kind of cooperation that 

they will undertake with China. 

The principal objective of the agreement is to provide broad opportunities for mutually beneficial cooperation. And U.S. agencies 

are engaged with their Chinese counterparts, essentially in seven 

major fields that we’ve discussed in the report itself. And those 

seven fields are: Agriculture, energy, space, health, environment, 

earth sciences, and engineering. 

The nature of the agreement provides for exchanges of people, 

scientists, scholars, specialists, and students. It also provides for 

the exchange of data and information and training. 

Just a quick word, if I may, about the agreement itself. The 

agreement is what we call an umbrella or a broad agreement that 

provides a general framework and conditions for cooperation. It 

cannot anticipate all of the subjects for cooperation that may arise 

over the years. So the U.S. technical agencies and their Chinese 

counterparts develop subsidiary, subject-specific agreements as 

part of the overall process. These are in the form of protocols or 

memoranda of understanding. And some of these protocols are specific with regard to the science-and-technology activities. Others 

are broader with regard to science and they themselves have subsections or subagreements for specific projects. 

So, all in all, we have 26 protocols and 60 annexes to the agreement across those seven fields of science-and-technology cooperation. 

So what are the benefits that we are achieving from these protocols and these annexes of this overall agreement? I’d just like to 

give a few examples of some of these benefits, and I would be 

happy to provide more details as we come back in the Q&A portion 

of the discussion today. 

There’s no question that access to a larger cadre of low-cost and 

well-trained and well-equipped researchers has helped our U.S. scientists to go more rapidly and more efficiently toward their scientific basic research goals. 

I’d just like to give one example of that, the access to a significant high-energy physics research facility in Beijing, built at Chinese expense, with technical cooperation from the United States 

has really helped ultimately for us to look at some very important 

elements related to particle physics, jointly, cooperatively, and advancing theoretical research in the high-energy physics area. 

The fact that we are working with China on clean coal and cleanburning fossil fuel technologies has opened huge potential markets 

for clean-energy technologies and equipment in which the U.S. is 

a world leader. And these collaborative projects set the stage for 

Chinese support for U.S. energy businesses more broadly. 

I think it’s critical that China works directly with the National 

Institute for Standards and Technology to help promote U.S. measurements and U.S. standards related to products and manufacturing. This is a major step towards supporting international trade 

and ultimately helping to increase U.S. exports. 
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Joint research with China on mineral resources including oil and 

gas helps both nations not only with alternatives to Middle East 

oil, of course, but helps to create additional potential markets for 

U.S. oil industry equipment suppliers as well as joint-venture opportunities for U.S. oil companies. These are activities that are well 

underway. 

When we look at the nuclear power industry in China we have 

an opportunity to understand the state of the technology better and 

we have the opportunity to open potential markets for advanced 

U.S. power technology as well. 

China has invested heavily in remote sensing and in mapping research, and a large number of Chinese scientists are now leaders 

in the field. The U.S. Geological Survey is working with these Chinese experts and leveraging that expertise to provide some very 

valuable global data that helps us monitor transboundary environmental phenomena and deal, in particular, with issues related to 

climate. 

I was particularly struck by the work that’s done in the health 

arena. One example, 250,000 women in China were studied, demonstrating conclusively that folic acid supplementation during early 

pregnancy can help to prevent neural tube defects. It’s an incredible study underway with HHS support. 

Mr. Chairman, as a Foreign Service Officer who grew up on the 

East Coast, I was particularly struck by some information that I 

learned from the U.S. Department of Agriculture, that most of the 

grass growing on U.S. rangelands throughout the United States is 

actually derived from Chinese varieties of grasslands that were acquired by the Department of Agriculture as part of these programs. 

Commissioner DREYER. When? 

Mr. ROCK. I’ll have to go back and look at the document to get 

the exact date. 

Similarly, in the agricultural area, issues such as the DNA sequencing of cotton and rice genomes increased rapidly the DNA sequencing data. It helped us take an active approach to crop breeding in the United States as a result. 

There is cooperation in the area of marine resources emphasizing 

large-scale fisheries, emphasizing aquaculture production and practices that have been very energetic in China as well. And, as I 

mentioned earlier, the data exchange with regard to climate has 

helped us look at improved predictive models for climate change 

and improve our climate science capabilities. 

I think it’s clear from the discussions we’ve heard so far that 

China is rapidly becoming a science-and-technology center throughout Asia. And there are some areas of the S&T base that are going 

to merit continued U.S. attention, areas such as information technology, software development, and the changes and developments 

in micro and nanotechnologies. 

Through basic research cooperation, such as what we are seeing 

in the government-to-government programs, we spur our own innovation and we monitor theirs, quite frankly. The win-win scenario 

of science-and-technology cooperation is not unique of course to this 

agreement or to this relationship. It’s part of a much larger trend 

in the way we are looking at science globally. 
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We’ve heard a lot about the activities of the multinational corporations, the fact that they are seeking to tap into emerging markets and low-cost, highly-skilled labor in the developing world and 

that this itself is leading to the internationalization of research and 

development worldwide. 

In China and in other countries it’s the rise of the Internet, it’s 

the mobility of humans, and it’s the mobility of financial capital 

that is resulting in this global dispersion of these well-educated scientists. With the free exchange of science information worldwide, 

the future of our technology leadership will depend not on our 

hoarding our capabilities but on managing our partnerships and 

diffusing the technology in a more appropriate fashion. 

I would simply like to say that I believe that under the Scienceand-Technology Agreement China has made enormous economic 

strides, but those are economic strides with respect to agricultural 

production, energy efficiency, reducing pollution, improving public 

health, and helping to develop their mining minerals and other industries. Even in those areas, in fossil energy technology, for example, when we look at their energy growth we also look at their climate-change impacts. 

We’ve talked about the real developments, the real causes of developments, the market-based reforms, the large supply of domestic 

research, and the foreign capital investment from multinational 

corporations, these are the drivers. 

[The statement follows:]

Prepared Statement of Anthony F. Rock

Principal Deputy Assistant Secretary of State

Bureau of Oceans and International Environmental and

Scientific Affairs, Washington, DC

Introduction 

Mr. Chairman and Members of the Commission, I appreciate the opportunity to 

appear before you today on behalf of the Bureau of Oceans and International Environmental and Scientific Affairs of the U.S. State Department to discuss the U.S.-

China Science and Technology Report, the contents of which we coordinated with 

numerous Federal agencies and recently submitted to Congress. This report satisfies 

the requirements of a provision of law that calls for a comprehensive review of activities under the U.S.-China Science and Technology Agreement of 1979. I understand that the Commission worked closely with the Congress in developing the reporting requirement. 

The Administration believes that advancing common interests in peace and prosperity with China is key to achieving our long-term national security goals. As noted 

in the President’s 2002 National Security Strategy, ‘‘[t]he United States’ relationship with China is an important part of our strategy to promote a stable, peaceful, 

and prosperous Asia-Pacific region. We welcome the emergence of a strong, peaceful, 

and prosperous China.’’ One of the requirements of this report is an ‘‘assessment 

of how the Agreement has influenced the foreign and domestic policies of the People’s Republic of China and the policy of the People’s Republic of China toward scientific and technological cooperation with the United States.’’ Through government, 

scientific, and academic contacts with a large number of Chinese officials and citizens, we are exerting a critical influence over their views, their path of development 

to a market-based system, and policies toward the United States. 

Turning to science and technology cooperation, a key component of any nation’s 

economic and social development is the effort to advance scientifically and technically. China has long endorsed the view that there can be no true economic or 

social growth without such advancement. Since January 31, 1979, China and the 

United States, under the S&T Agreement, have carried out a diverse and mutually 

beneficial commerce of ideas through scientific cooperation, education, and dialogue 

across the entire spectrum of human knowledge. Although there are areas where 

we likely will compete, as there are areas where we must protect both information 

vital to our national security and the intellectual property of our citizens, the bene-
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fits of our scientific and technological cooperation with China far outweigh the costs 

of this relationship. Achieving a candid, constructive, and cooperative relationship 

with China is the task set before our diplomatic and scientific communities by the 

President. In response, the goal of the Federal agencies now engaged in the efforts 

highlighted in the report is not only to tap into and help shape China’s growing scientific and technological resources, or to help China handle pressing problems like 

environmental damage or HIV/AIDS, but to influence China’s development into a 

country with whom we can share common interests that align our nations together 

against poverty, international crime and terrorism, and other global threats to 

human welfare, health, and dignity. 

The Science and Technology Agreement 

The principal objective of the Agreement is to provide broad opportunities for cooperation in scientific and technological fields of mutual interest, thereby promoting 

the progress of science and technology for the benefit of both countries and of mankind. Cooperation under the Agreement includes activities in the fields of agriculture, energy, space, health, environment, earth sciences, and engineering. The 

Agreement provides for exchanges of scientists, scholars, specialists and students, 

and of scientific, scholarly, and technological information and documentation. It also 

provides for joint planning and implementation programs, courses, conferences, seminars and projects, joint research, development and testing, and the exchange of research results and experience between cooperating U.S. and Chinese entities. Facilitation of scientist-to-scientist collaboration under this agreement has been a key to 

the success of the bilateral S&T relationship. 

The S&T Agreement itself is a broad ‘‘umbrella’’ agreement that provides for some 

of the more general conditions for cooperation, but which cannot anticipate all of 

the subjects for cooperation that may arise over the years. The U.S. technical agencies and their Chinese ministry counterparts therefore develop subsidiary, subjectspecific agreements for their cooperation that are ‘‘Protocols’’ or ‘‘Memoranda of Understanding.’’ Some of these protocols refer to single specific joint S&T activities, 

while other protocols cover a broader subject area and may contain a set of related 

sub-agreements (project annexes) to further define cooperation in specific areas. The 

number of protocols has grown over the years, and there are now more than 26 active protocols and over 60 annexes. 

Benefits of the Agreement to Both Countries 

Science and technology cooperation with China has benefited the United States 

in many areas. The following are examples:

• Access to an increasingly large cadre of low-cost, well-trained and well equipped 

researchers with whom U.S. scientists can do cooperative research to meet U.S. 

scientific goals. 

• Access to a significant high energy physics research facility built at Chinese expense, with much technical assistance from the U.S., and collaboration in its 

scientific program has resulted in many important measurements of elementary 

particle properties. 

• Obtaining current information on the evolution of the Chinese nuclear power 

industry and the state of its technology. Cooperation in the nuclear power industry opens potential markets for advanced U.S. nuclear power technology. 

• Adoption of clean coal and clean burning fossil fuel technologies in China opens 

a huge potential market for clean energy technologies and equipment in which 

U.S. industry is a world leader. Collaborative projects have set the stage for 

Chinese support of U.S. energy businesses. 

• Chinese exchanges with the National Institute of Standards and Technology 

(NIST) help promote the use of U.S. measurements and standards in China. 

The development of a measurement infrastructure is necessary to support international trade and help increase U.S. exports. 

• Joint research into Chinese mineral resources, including oil and gas, has given 

the U.S. an advantage in a number of areas. Increases in China’s oil and gas 

potential provide both nations with alternatives to Middle East oil. U.S. cooperation in discovering and developing China’s fossil energy reserves also creates large potential markets for U.S. oil industry equipment suppliers, as well 

as joint venture opportunities for U.S. oil companies. 

• China has invested heavily in remote sensing and mapping research and a large 

number of Chinese scientists are international leaders in the field. USGS-China 

cooperation leverages Chinese expertise to provide global data valuable in monitoring transboundary environmental phenomena. 
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• A multi-year U.S.-China study of almost 250,000 women in China demonstrated 

conclusively that folic acid supplementation during early pregnancy can prevent 

Neural Tube Defects such as spina bifida and anecephaly. • Cooperation brought substantial benefits to U.S. agriculture. Much of the grass 

growing on U.S. rangelands is derived from Chinese varieties acquired by 

USDA. • In projects of mutual interest, like DNA sequencing of the cotton and rice 

genomes, cooperation provides access to the DNA sequencing data in a shorter 

timeframe and at much less expense than if the U.S. were working alone. • Cooperation in marine resources benefits the U.S. scientific and commercial sectors by providing access to large-scale fisheries and aquaculture production 

practices used in China. • Cooperation has brought mutual benefits to both the U.S. and China with new 

data on climate to develop improved, predictive models for use in understanding 

how climate may change.

Some areas where China has gained include:

• Collaboration (mostly) with the U.S. has facilitated China’s becoming a participant in the worldwide high energy physics research enterprise. • The overall public health of China’s population has been improved through collaboration in the fields of medicine and public health. The U.S. Government 

funded Global Aids Program and Comprehensive International Program of Research on AIDS is but one example of this cooperation. • Safety of China’s growing nuclear power industry has been enhanced by cooperation with the U.S. Nuclear Regulatory Commission and the Department 

of Energy. • Chinese agricultural production has increased as a result of collaborative programs with USDA. New crops, new varieties, and improved irrigation and farming techniques were introduced through S&T collaboration. • China’s efforts to clean up industrial pollution and prevent further environmental degradation have been aided by cooperation with NOAA and EPA. • Access to U.S. labs has helped Chinese scientists address disease, genetic and 

biotechnology issues and develop environmentally-friendly fish farming techniques. • China has become more efficient in the use of energy. Alternative energy technologies have been introduced. • The development of China’s mining and petroleum industries has been facilitated by joint projects in mineral research, geology and deep-ocean drilling. • China’s efforts to investigate fusion as a potential energy source for the future, 

including participation in the negotiations to construct a major international fusion facility called ITER, have been aided through technical collaborations with 

Department of Energy sponsored laboratories and universities.

Assessment of the Influence of the Agreement 

The U.S.-China S&T Agreement has provided China with some benefits that have 

helped close some of its scientific and technological development gaps. At the same 

time, the Agreement has helped moderate the bilateral relationship, given the U.S. 

access to the Chinese market and labor pool, and supplied the U.S. with significant 

amounts of high-tech research talent and labor. As a result, both countries have 

benefited from the Agreement, though in different ways. The report’s analysis of 

various aspects of the Agreement’s implementation has not identified any signs of 

significant diversion of high-tech information that would be of use to China’s military and defense industries. 

The S&T Agreement has facilitated a deep and ongoing dialogue between the U.S. 

and Chinese science communities. This dialogue occurs between U.S. technical agencies and their Chinese ministry counterparts at the policy level, but is probably 

most intensive at the level of individual scientist-to-scientist communication, either 

face-to-face at conferences, meetings, and in the laboratory, or through the Internet. 

Such communication would undoubtedly occur regardless of the presence of a diplomatic agreement, but the cooperative activities undertaken as a result of agency 

memoranda of understanding (MOU’s), signed under the Agreement and its protocols, provide a structural basis for individual scientists to develop partnerships with 

colleagues living in other countries with similar research interests. 

The Administration also believes that U.S.-China S&T cooperation has played a 

consistent stabilizing role in U.S.-China relations. While the overall U.S.-China relationship may swing up or down as a result of political and economic developments, 

changes in leadership and other factors, the U.S.-China S&T relationship has remained a largely stable pillar of the bilateral relationship, allowing a continuance 
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of cooperative activities in science and technology at levels determined more by scientific accomplishment, interest and available budget than by geopolitical interest. 

In addition to promoting good will, trust, and openness, U.S.-China science and 

technology cooperation has contributed to PRC domestic policy reforms by providing 

the PRC government with information that helps guide the ongoing reform process. 

For example, in the area of remote sensing, cooperation between USGS and the Chinese Academy of Sciences has involved joint research and exchanges in the rectification, enhancement, classification, and interpretation of remote sensing images. As 

an example, using this information, the Chinese leadership concluded that China 

was losing cultivated land to development at a rate faster than previously thought. 

In response to this information, Chinese leaders ordered a one-year freeze on all 

agricultural land conversions not specifically authorized by the State Council and 

imposed strict new measures to intensify land management initiatives to protect 

China’s cultivated land. In another example, remote sensing information revealed 

that local governments, intending to maximize their disaster relief assistance, exaggerated the amount of land affected by the 1998 Yangtze flood by ten times. Both 

of these examples illustrate how U.S.-China cooperation in remote sensing can provide information that helps redress local government misreporting and corruption. 

China is a rapidly developing science and technology center in Asia. Several areas 

in China’s S&T base warrant close U.S. attention, including information technology, 

software development, and the budding biotechnology and nanotechnology sectors. 

As China progresses toward catching up with Western industrialized nations, continued U.S.-China research cooperation allows the U.S. to monitor China’s technological advancements. But U.S.-China cooperation can also help leverage U.S. 

research investments in key high-tech areas by using the contributions of Chinese 

scientists to attain U.S. research goals. China’s developing science and technology 

capabilities suggest that future U.S.-China cooperative activities could yield even 

more benefits to the U.S. than ever before. 

This win-win scenario of science and technology cooperation is not unique to the 

U.S.-China relationship, but is part of a much wider trend in the way science is advancing globally. Multinational corporations, seeking to tap into emerging markets 

and low-cost, highly skilled labor in developing countries, have led the internationalization of research and development worldwide. In China and other countries, the 

rise of the Internet and the increasing mobility of humans and financial capital 

have led to the global dispersion of well-educated engineers, scientists and researchers, laying the foundation for international research cooperation opportunities in 

both the private and public sectors. 

Now, more than ever, government-funded science has become a unified global effort. For the past two decades, the most challenging science and engineering problems have been tackled by international teams of researchers with common interests 

and complementary expertise. In an increasingly global world of open information 

and collaboration, scientific cooperation is not a zero-sum enterprise. Generally, scientists only cooperate if they share complementary resources that can be leveraged 

to achieve mutually beneficial goals. Today’s team-centered, global approach to 

science and technology provides tremendous potential for advances and discoveries 

in international ‘‘big science’’ cooperative projects. Bearing these trends in mind, tomorrow’s technological leaders will not be the countries that restrict the sharing of 

knowledge and technology, but those which can effectively use international scientific resources to create innovative new solutions through cooperation. 

An example of this global cooperation is the proposed ITER project whose mission 

is to demonstrate the scientific and technological feasibility of fusion as an energy 

source. Six Parties, including China and the U.S., are currently involved in negotiations for the construction, operation, and decommissioning of ITER. If these negotiations are successful and the project proceeds, all of the Parties will have excellent 

opportunities to work together on ITER construction and to share the benefits of 

such collaboration as well as the subsequent research results gained during operation. 

Four specific areas in science and technology development are of particular interest to the United States: information technology, software development, biotechnology, and nanotechnology. China’s information technology sector (IT) now forms the 

core of China’s S&T enterprise. China’s IT market is one of the fastest growing markets worldwide and is now the second largest in the Asia-Pacific region, behind 

Japan. The Chinese market for IT products and services was $22 billion in 2002, 

and is expected to exceed $40.2 billion by 2006. Chinese companies are matching 

most if not all of the current trend lines for advanced telecommunications systems 

and are providing the full range of telecommunications equipment. 

China could also become a significant player in software development. As of 1993, 

China already had more software professionals than any other country aside from 
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the United States. China’s Ministry of Information predicts that software and systems integration product sales from China’s 2,200+ software companies should climb 

30% in 2004 to reach U.S. $25 billion. With computer and communications hardware 

becoming increasingly complex, software developers worldwide are encountering 

severe problems devising reliable systems. According to experts, U.S.-China cooperation efforts to resolve some of these fundamental difficulties could be highly productive for both parties. 

China is making a significant effort in biotechnology, especially in the area of genetic engineering. The Chinese government has promoted biotechnology since the 

1980s through ambitious multiple research programs. Current Chinese research 

areas include agricultural biotechnology, genomic sequencing, biochips, leveraging 

leads produced by traditional Chinese medicine, bioinformatics, stem cell research, 

biomanufacturing, and toxicology testing. Biotech research, which was traditionally 

concentrated in universities and state research facilities, has also spun-off startup 

companies comprising a booming Chinese biotech market. China’s biotech market is 

currently about $3 billion, and is forecasted to grow at 13.5% annually to reach $9 

billion in 2010. 

While China is globally competitive in genome sequencing, agricultural biotechnology, and gene therapy, its biotech industry as a whole struggles to commercialize new products and produces relatively few exports. Experts predict that it will 

take at least a decade for China to develop a world-class biotech industry. Major 

barriers to commercialization include a weak venture capital industry, poor patent 

protections, and difficulties in adopting Chinese products to fit stringent regulations 

in major world markets. 

China is starting to become a global player in nanotechnology, which Chinese 

leaders view as one of the nation’s most important scientific fields for future research and development. While still a nascent industry, China is investing heavily 

in nanotechnology, with the central government budgeting approximately $240 million and local governments contributing $240–360 million from 2001–2005. China 

already ranks third in the world, behind the United States and Japan, in the number of nanotechnology patent application cases. Its 2,400 patents represent 12% of 

the world’s total. China is also seeking to establish a national nanotech infrastructure and has established the China Nanotechnology Center facility in Beijing, a center dedicated to nanotechnology research and development. China’s current research 

in nanometric materials and their applications, tunnel microscope analysis and 

monatomic control, has approached internationally advanced levels, but domestic 

studies in nanometric electronics and nanometric biomedicine still lag behind the 

developed countries. 

Advances in Chinese S&T capabilities in key research areas can provide important opportunities for the U.S. S&T enterprise. Using the expertise, initiative and 

money of foreign partners like China can help the U.S. retain its competitive advantage and technological superiority. The free exchange of scientific information and 

the growing S&T capabilities of developing countries will mean that the key to future U.S. science and technology leadership will not depend upon hoarding high-tech 

secrets from other countries. Instead, it will depend upon creating with foreign partners a distributed information network from which spring global innovation and discovery. 

China is rapidly developing and becoming a major user of fossil energy resources. 

The S&T Agreement has provided key data and training to Chinese scientists to understand how China’s energy growth may impact climate in the future. 

Assessment of Impact of S&T Activities on China’s Industrial Base and Economic Capabilities 

Over the period in which the S&T Agreement has been in force, China has made 

enormous economic strides. Certainly cooperative activities under the agreement 

have provided some economic benefit to China including helping to develop China’s 

minerals, mining and petroleum industries, increasing agricultural production, enhancing energy efficiency, reducing pollution and improving public health. Economic 

benefits to the U.S. derived from this cooperation and highlighted in an earlier section, have also been considerable. 

The extent to which cooperative S&T activities conducted under the Agreement 

may have contributed to China’s economic growth is difficult to assess. China’s dramatic economic transformation has been the result of macroeconomic decisions by 

the PRC that allowed market forces and capital to operate in China, and stimulated 

massive foreign and domestic capital investment. Advances in China’s science and 

technology capacity have also played a critical role in driving China’s economic 

growth. High-technology exports from China and Hong Kong exceeded $100 billion 

a year and 19% of China’s total exports are now high-technology products. Although 
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the high-tech industry has been the leading edge of China’s economic growth, the 

driving force behind China’s scientific and technological advances has not been technology transfer from the U.S.-China bilateral S&T activities, but rather:

• Market-based reforms of China’s science and technology infrastructure • The large supply of domestic S&T research talent • Foreign capital investment from multinational companies • Technology transfer from foreign companies • Chinese government investment in strategic high-tech technologies

A 1985 Chinese Communist Party Central Committee report on ‘‘The Reform of 

the S&T Management System’’ provided guidance for restructuring the Chinese 

S&T system. The restructuring reformed funding allocations and cut state budgets 

for research institutes and universities; it also encouraged them to launch their own 

commercial ventures. These initial reforms opened the door for many more institutional reforms that were modeled on the S&T policies of advanced nations, resulting 

in improved coordination between government bureaus, universities, research institutes, and companies. Following these structural reforms, China embarked on multiple long-term S&T research and development plans. These programs set national 

S&T targets, encouraged cooperation between research and production units, and 

significantly increased funding for the development of key technologies critical to 

economic development and national security. 

Foreign direct investment has been another significant factor in China’s scientific 

and technological advancement. In exchange for access to China’s growing market, 

foreign companies, many from the U.S., have poured capital, technologies and knowhow into China’s commercial sector. From 1994–2001 the cumulative investments 

of U.S. multinational corporations in China more than quadrupled, from $2.6 billion 

to $10.5 billion, growing at an average annual rate of 20.1%, adjusting for inflation. 

Multinational companies are encouraged to invest in R&D activities in China by 

attractive tax-based incentives. Many Chinese research institutes and companies 

now form joint ventures with multinational companies to achieve specific research 

or technology development objectives. 

Another important factor in China’s technology transformation is the availability 

of a large pool of cheap, technologically sophisticated workers. The lure of well-educated engineers, researchers and scientists has drawn many foreign companies to 

invest in research and development activities in China. What sets China apart from 

advanced nations is its ability to produce such large numbers of scientists, engineers, and researchers. Furthermore, while China has long suffered from a ‘‘brain 

drain’’ to the U.S., an increasing though limited number of China’s top students are 

choosing to return to China after receiving graduate degrees abroad. The Chinese 

government attracts talented, foreign-educated Chinese students by offering them 

higher salaries, generous housing packages and even putting entire research teams 

at their disposal. 

Supported by the government’s emphasis on technology commercialization, market-based reforms, strategic research programs and a highly-skilled S&T labor force, 

high-tech nongovernmental enterprises have flourished in the Chinese economy. 

While S&T Agreement-related joint activities may have provided some ancillary economic benefits to China, the trendlines of its economic transformation would have 

been largely in place regardless of whether an S&T Agreement with the U.S. had 

been in place during this period. Against the overall context of market-driven economic growth in China, the role of government-to-government cooperation appears 

to have had, at best, a minor and ancillary role in contributing to the build-up of 

China’s economic, industrial and military capabilities. It is clear that China’s remarkable economic development occurred largely independent of cooperative agreements with other governments. The U.S. S&T Agreement is only one of many that 

China has with advanced industrialized nations. 

Another factor in the rapid rise of Chinese S&T abilities is the PRC’s continuing 

effort to acquire technologies from the West. The Chinese have employed a variety 

of methods to accomplish this objective including attracting foreign investment, particularly in R&D areas; sending large numbers of students abroad to study scientific 

and technological disciplines; industrial partnerships; joint ventures and offset 

deals; placing significant numbers of Chinese scientists, technicians, and engineers 

in key private sector firms abroad; scientific and military cooperation with countries 

where advanced technologies are developed; and covert means. Another valuable 

source is information mined from open S&T journals and websites. 

China’s Investment Strategy 

The rapidly growing U.S. business investment in China is vital to the development of bilateral commercial ties, and reflects the eagerness of U.S. firms to position 
219

themselves in China. A Department of Commerce study highlights China’s policies 

concerning investment by overseas firms, American companies in particular. According to this report, China has used the lure of its enormous emerging consumer market to induce firms wanting to get into the Chinese market to sign investment 

agreements that systematically include some form of technology transfer. Chinese 

investment policies encourage foreign investment in high-technology industries in 

particular, with a system of preferential tariff and tax rebates designed to create 

incentives for high-tech industries as contrasted with lower-tech industries. Among 

the industrial sectors in which China is seeking investment are information technology, aerospace and electronics, including telecommunications. Some IT multinational companies have even agreed to transfer core technologies, such as source 

code, in order to gain market position. Although under the World Trade Organization (WTO) obligations, China is not allowed to require technology transfer as a condition of doing business, state-owned enterprises and local government bodies in 

particular are still widely believed to continue the practice. 

An increasing source of technology transfer from U.S. private sector companies is 

the increasing use of offset deals which include the creation of a laboratory, center 

or institute intended for joint research and development in key industries such as 

IT, telecommunications, electronics, chemicals, and automobile manufacturing. 

There are estimated to be more that 400 research and development branches of multinational corporations in China, including companies like Motorola, IBM, and GM. 

U.S. companies attempting to gain a foothold in the Chinese market are often reluctant to complain about the difficulties of doing business in China, the Commerce 

study reports. However widespread complaints have been received from U.S. firms 

investing in China about de-facto coercion by Chinese officials to transfer technology 

as the price of admission to the Chinese market. This Chinese investment strategy, 

designed to extract technology from American firms as a condition for entering the 

market, in State’s estimation has been the principal source of technology transfer 

from the United States to China. The minor transfers of technology that may have 

taken place within the context of S&T cooperation carried out under the Agreement, 

are in State’s estimation, inconsequential in comparison. 

Conclusion 

Examination of the S&T relationship between the U.S. and China under the 1979 

S&T Agreement, shows that cooperation undertaken in the context of this Agreement has been of significant value to both countries. The cooperation undertaken 

by the USG agencies is, as intended, in the benign civilian domain. Although it is 

impossible to rule out unintended benefits to the military sphere, such side effects 

are almost impossible to document or substantiate and any benefits to China’s military would have been small compared to the overall benefits of cooperation. As a 

vehicle for acquiring technology useful in the military or industrial area, the Agreement is of miniscule importance in the overall perspective of China’s abilities and 

means to gather scientific and technological information. The U.S.-China Agreement 

is useful, mutually beneficial, promotes stability in the bilateral relationship, and 

should be maintained. S&T cooperation under the Agreement brings significant benefits to both countries and should be continued.

Cochair MULLOY. Thank you, Mr. Rock. 

Mr. ROCK. Thank you. 

Cochair MULLOY. We’ll have some questions for you. 

Mr. ROCK. Please. 

Cochair MULLOY. Dr. Weber. 

STATEMENT OF LARRY H. WEBER

ACTING DEPUTY DIRECTOR

OFFICE OF INTERNATIONAL SCIENCE AND ENGINEERING

NATIONAL SCIENCE FOUNDATION (NSF), WASHINGTON, DC 

Dr. WEBER. Distinguished Members of the Commission, thank 

you very much for the invitation. I certainly second Mr. Rock’s observation about the quality of the witnesses yesterday and this 

morning. It’s been delightful to be here. 

Let me start with a brief overview of the National Science Foundation and the mission that we fulfill to provide some context. 
220

Then I’ll speak briefly to two sets of indicators relevant to today’s 

discussion: R&D and education. 

For more than 50 years the National Science Foundation has 

been a strong steward of America’s science-and-engineering enterprise. NSF’s five and a half billion-dollar annual budget represents 

only four percent of the total Federal budget for research and development. The agency supports half of the nonmedical basic research conducted at U.S. academic institutions. Support is given 

through a competitive, peer-reviewed grants process. 

In the Federal R&D structure the National Science Foundation 

is unique. We don’t have a mission-oriented research objective, 

such as health, agriculture, or space. Instead we keep all fields of 

science and engineering focused on the furthest frontier, recognize 

and nurture emerging fields and prepare coming generations with 

scientific talent. 

The agency is also congressionally mandated to collect and interpret data on key scientific-and-engineering indicators, and provides 

a biennial report to Congress entitled ‘‘Science-and-Engineering Indicators.’’

Let’s look at some key indicators relevant to today’s discussion. 

Overall trends provide the best story. 

By 2001 China accounted for nine percent of the world’s hightech exports. This reflects a threefold production increase by hightech industries in China between 1996 and 2001. 

Because the size and openness of the U.S. market provides incentives for foreign inventors to apply here for patent protection, 

trends in the number of U.S. patents issued to foreigners can indicate changes in patterns of inventiveness. Although a much higher 

number, the number of patents granted to U.S. inventors grew only 

42 percent from 1996 to 2002. Over that same time period patents 

granted to Chinese inventors increased fourfold. 

Funding invested by U.S. parent companies in R&D in their majority-owned affiliates in China is another key indicator. In 1994 

R&D expenditures at the 172 U.S.-majority-owned affiliates in 

China totaled only $7 million. By 2000 the number of affiliates had 

increased to 454, and R&D expenditures reached $506 million. This 

made China the eleventh largest host of U.S. R&D expenditures 

overseas. 

Gross expenditures for R&D are an indicator of overall capacity 

of a country for technological innovation. In 1996 China’s R&D investment totaled $20 billion in purchasing power parity. That was 

only ten percent of the U.S.’s investment at the time. By 2002 China’s investment reached $72 billion, representing 26 percent of 

U.S. expenditures and positioning China as the third largest investor in R&D, after the United States and Japan. 

The ratio of R&D to gross domestic product measures the share 

of the economy devoted to innovative activity and technological 

change. The U.S.’s R&D-to-GDP ratio has fluctuated between 2.4 

and 2.7 for many years. China’s R&D-to-GDP ratio more than doubled from 1996 to 2002, when it reached 1.3. 

What makes this rapid rise in R&D-to-GDP ratio more impressive is that it occurred against the backdrop of a rapidly expanding 

economy with an average GDP growth of almost ten percent per 

year. The Chinese government has stated a goal of increasing R&D 
221

expenditures to 1.5 percent of GDP this year and seems well positioned to do just that. 

On the education side, the human dimension of innovation, including education and workforce, offers another set of key indicators. 

Higher education policy in China has resulted in a dramatic shift 

from an elite-based education system to a mass-oriented education 

system. For example, only ten percent of Chinese 18- to 22-yearolds were enrolled in tertiary education as recently as 1999. The 

Chinese government then set a goal to increase that ratio to 15 

percent by the year 2010. The goal was nearly reached in just three 

years, with enrollments of 14.7 percent by 2002. 

From 1991 to 2001 China almost tripled its number of workers 

with associate degrees or higher, adding nearly 30 million collegeeducated workers to their labor pool. During the same period the 

U.S. increased its number of workers with associate degrees or 

higher by only one-third. 

The number of Chinese students getting bachelor’s degrees in 

science and engineering also increased dramatically, climbing 20 

percent in five years, to over 337,000 in 2001. Comparable data 

show only a four-percent increase in the United States. 

Even greater growth has occurred for science-and-engineering 

doctoral degrees in China, nearly doubling to over 8,000 from 1996 

to 2001. During the same period the number of U.S. science-andengineering doctoral degrees remained essentially flat at between 

25,000 and 27,000, of which approximately 40 percent were to nonU.S. citizens. China is now the largest producer of science-and-engineering doctoral degrees in the Asia region. 

It’s noteworthy also that while science and engineering account 

for only about one-third of all bachelor’s degrees in the United 

States, these fields account for nearly 60 percent of bachelor’s degrees in China. 

The Ministry of Science and Technology reports that as of 2003, 

five million students were enrolled in science-and-engineering programs at Chinese universities. Data on China’s science-and-engineering degrees over the next five years will be interesting, indeed. 

In summary, data on China’s science and technology show a trajectory of rapid expansion in commercial output, in research-anddevelopment investments, and in higher education. While the data 

only cover years up to 2001 or 2002, all trajectories are strongly 

positive. 

NSF will release a comprehensive report on Asia science and 

technology this summer that we hope will provide useful context 

for the Commission’s policymaking efforts. 

There are also important considerations regarding the role of foreign-born individuals in the United States, and much of that was 

discussed yesterday. I do want to note one point. At 33,000, individuals born in China accounted for nine percent of the doctoral degree holders employed in science-and-engineering occupation positions in the United States in the year 2000. 

Lastly, I’d like to refer to the question of visas, which has been 

discussed to some extent, and note that there has been considerable discussion on this topic. I would respectfully refer the Commission to an October 2004 Foreign Relations Committee hearing 
222

on the topic and a March 17th House Subcommittee hearing on 

Twenty-First Century Competitiveness and Select Education. 

Just two weeks ago on April 4th NSF participated in a congressional roundtable on the impact of U.S. visa policy on the U.S. research-and-scientific community. I will leave a copy of NSF’s testimony with you. Thank you very much. 

[The statement follows:]

Prepared Statement of Larry H. Weber

Acting Deputy Director, Office of International Science and Engineering

National Science Foundation (NSF), Washington, DC 

Chairman D’Amato, Commissioner Mulloy, Members of the Commission, and distinguished guests, I appreciate the opportunity to appear before you today on behalf 

of the National Science Foundation (NSF) concerning China’s science and technology 

trajectory. 

First, I’d like to set the broad context for my presentation with a brief overview 

of the NSF and the mission we fulfill. Then, I’ll speak briefly to two sets of indicators relevant to today’s discussion—R&D and education. 

For more than fifty years, the NSF has been a strong steward of America’s science 

and engineering enterprise. NSF’s $5.5 billion annual budget represents roughly 4 

percent of the total Federal budget for R&D. It’s an important 4 percent, supporting 

half of the non-medical basic research conducted at U.S. academic institutions. 

In the Federal R&D structure, NSF is a unique agency. We do not have a missionoriented-research-objective such as energy, health, agriculture, or space. Instead, we 

advance learning and discovery in all disciplines of science and engineering and foster connections among them. It is NSF’s job to keep all fields of science and engineering focused on the furthest frontier, to recognize and nurture emerging fields, 

and to prepare coming generations with scientific talent. 

NSF supports the best and brightest people, ideas, and tools in the nation through 

a peer-reviewed granting process. At present, NSF receives more than 40,000 proposals per year. NSF’s merit review system is widely imitated around the world, 

and numerous governments, including China, have created their own science foundations based on the NSF model. 

In addition to NSF’s day job of guiding science and engineering to the latest frontier, the agency is Congressionally mandated to provide a central clearinghouse for 

the collection, interpretation, and analysis of data on scientific and engineering resources, and provides a biennial report to Congress titled, ‘‘Science and Engineering 

Indicators.’’

Hence, I’m here today to highlight some important data indicators to support your 

policy discussion. 

It is important to note that not all of China’s data are fully internationally comparable. Because there are often questions about individual data points, it is most 

useful to look at overall trends. 

While China’s science and technology enterprise lagged significantly behind other 

countries in the early 1990s, the last decade has seen phenomenal growth in a number of key indicators. The Chinese government has instituted strategic policy initiatives intended to ‘‘revitalize the nation through science and education.’’ These policies have been articulated through a number of formal channels, including the 1995 

National Conference on Science and Technology and the tenth five-year (2001–2005) 

S&T plan. China’s Ministry of Science and Technology reports that the policies have 

boosted China’s overall high-tech development, R&D capacity, socio-economic development, and national security. 

A few statistics will highlight the rapid growth of China’s science and technology 

enterprise, including industrial advances and R&D investments, and education infrastructure and the workforce. 

By 2001, China accounted for 9% of the world’s high-tech exports. This is a reflection of the three-fold increase in production by high-tech industries in China between 1996 and 2001. It is notable that in-house production, characterized as ‘‘value 

added,’’ also grew at the same rate as total production (Appendix Table 1). 

Because the size and openness of the U.S. market provides incentives for foreign 

inventors to apply here for patent protection, trends in the number of U.S. patents 

issued to foreigners can indicate changes in patterns of inventiveness. The number 

of patents granted to U.S. inventors grew from 61,104 in 1996 to 86,973 in 2002, 

an increase of 42%. Over the same period, patents granted to Chinese inventors increased four-fold from 134 to 522. Because the review process leading up to the offi-
223

cial granting of a U.S. patent takes approximately 2 years on average, trends in the 

number of U.S. patent applications provide a more up-to-date, albeit less certain, 

indicator. For the period 1996 to 2001, the number of U.S. patents applied for by 

Chinese inventors increased by three and one-half times. 

Another indicator is the amount of funds U.S. parent companies invest in R&D 

in their majority-owned affiliates in China. In 1994, R&D expenditures at the 172 

U.S. majority-owned affiliates in China totaled only $7 million. By 2000, the number 

of affiliates had increased to 454, and R&D expenditures reached $506 million, representing 2.6% of total overseas R&D by U.S. companies, and making China the 

eleventh largest host of U.S. R&D expenditures overseas. Moreover, U.S. affiliates 

in China invest relatively more in R&D compared with U.S. affiliates in other countries, as measured by the ratio of their R&D spending to their value-added gross 

product. In 2000, this ratio was 9.2% for U.S. affiliates in China, compared with 

3.3% for the aggregate of U.S. affiliates in all host countries. 

Gross expenditures for R&D (GERD) are an indicator of overall capacity for technological innovation. In 1996, China’s R&D investment totaled $20 billion in Purchasing Power Parity dollars—only 10% of the U.S.’s investment. By 2002, China’s 

investment reached $72 billion, representing 26% of U.S. expenditures and positioning China as the third largest investor in R&D, after the United States and 

Japan. 

The ratio of Gross Expenditures for R&D (GERD) to Gross Domestic Product 

(GDP) is a measure of the share of the economy devoted to innovative activity and 

technological change. The U.S.’s GERD to GDP ratio has fluctuated between 2.4 and 

2.7 for many years. China’s GERD to GDP ratio more than doubled from 0.6 in 1996 

to 1.29 in 2002. What makes this rapid rise in the GERD to GDP ratio more impressive is that it occurred against the backdrop of a very rapidly expanding economy, 

with an average GDP growth of almost 10% per annum. The Chinese government 

has a stated goal of increasing R&D expenditures to 1.5% of GDP by 2005, and 

seems well positioned to do just that. 

The human dimension of innovation, including knowledge creation, education, and 

workforce, offers another set of key indicators. Several prominent trends regarding 

education in the U.S. and China have emerged. 

Higher education policy in China has resulted in a shift from an elite-based education system to a mass-oriented education system. During the 10-year period ending in 2001, China almost tripled its number of workers with associate degrees or 

higher, adding nearly 30 million college-educated workers to the labor pool. During 

the same period, the U.S. increased its number of workers with associate degrees 

or higher by only one-third. The trend suggests that China’s number of college-educated workers will soon surpass that of the United States. 

With 10% of their 18–22 year olds enrolled in tertiary education in 1999, the Chinese government set a goal to increase that ratio to 15% by the year 2010. The goal 

was nearly reached in just 3 years, with enrollments of 14.7% in 2002. 

The number of Chinese students getting bachelor’s degrees in science and engineering increased from 281,245 in 1996 to 337,352 in 2001, a 20% increase. Comparable data show a 4% increase for the United States, with 398,622 science and 

engineering bachelor’s degrees in the year 2000. There has been even greater 

growth for doctoral degrees in science and engineering in China, nearly doubling 

from 1996 to reach 8,153 in 2001. During the same 5-year period, the number of 

science and engineering doctoral degrees in the United States remained essentially 

flat at 25–27,000, of which approximately 40% went to non-U.S. citizens. As a point 

of comparison, at over 8,000, China is now the largest producer of science and engineering doctoral degrees in the Asian region. 

It is noteworthy that, while science and engineering account for about one-third 

of all bachelor’s degrees in the United States, these fields account for nearly 60% 

of bachelor’s degrees in China. The Ministry of Science and Technology reports that, 

as of 2003, there were 5 million students enrolled in science and engineering programs at Chinese universities. Data on China’s science and engineering degrees 

over the next 5 years should be interesting indeed! 

An indirect indicator of the development of a trained science and engineering 

labor pool is the number of individuals born in a country who are employed in 

science and engineering occupations within the United States. The number of individuals with college degrees who were born in China and employed in science and 

engineering occupations in the United States rose from 31,000 in 1990 to 124,000 

in the year 2000, constituting an increase from 1.2 to 3.1% of all tertiary-degreed 

individuals working in S&E occupations in the United States. During the same 

period, the number of doctoral degree holders employed in U.S. science and engineering occupations who were born in China increased from 5,500 to 33,000, rep-
224

resenting an increase from 2.6 to 8.7% of the total number of doctoral degree holders working in U.S. science and engineering occupations (Appendix Table 3). 

In summary, I hope this snapshot of data provides useful context for your policymaking efforts. China faces many challenges in developing its science and technology enterprise, including social, political, organizational and bureaucratic constraints. However, data show significant growth in China’s high-tech industries, and 

in their investments in R&D and education. Given their enormous reserve of human 

capital, and the increasingly global nature of science and technology in the 21st century, China appears poised for continued rapid growth in the future. 

The National Science Foundation looks forward to tracking future trends and to 

continued participation in such timely discussions. Thank you again for the opportunity to appear before the Commission. 
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Panel VI: Discussion, Questions and Answers 

Cochair MULLOY. Dr. Weber, thank you very much. 

Thank you both for some really good testimony and very helping, 

good information in there. 

Commissioner Wortzel. 

Commissioner WORTZEL. Thank you very much. 

I’m very interested in this agreement, Doctor, for a couple of reasons. You’re probably aware that in, I think it was, 1984 or 1985, 

under a very similar series of agreements the U.S. Geological Survey had linked to the Russian Soviet Academy of Sciences a set of 

computers that were really designed to do bathymetric and—metrology generally is the science of measurements, metrological studies. It seemed like a very innocent agreement that advanced 

science. And it turned out after a fairly extensive counterintelligence investigation that what had actually happened was the 

bathymetric data and geodetic data that would have permitted Soviet submarines to choose the best firing points to target American 

missile silos or bunkers or underground facilities. 

The salinity and geodetic data that would have allowed them to 

adjust the launch of that missile correct, to hit more accurately, 

was being automatically transferred to the Soviet armed forces. 

The effort to shut it down was strongly opposed by your Bureau, 

I would add. It’s a very reassuring report, but you acknowledge in 

your own annual report that at least in the area of nuclear physics 

there may have been some losses. The Cox Commission Report outlines some losses that may have improved China’s nuclear capability. 

I would imagine that if we looked into it, the same sort of bathymetric and geophysical data that was of concern with the Soviet 

Union in 1984 is now being transferred to the Chinese Academy of 

Sciences and could be used for this new nuclear submarine program. 

So I’m not as sanguine about all the activities that go on in 

there. Most of them I think are great activities and I would really 

support, but when you get into mapping and metrology and geodetics and when you get into nuclear physics, I think it requires 

more control. 

So question one would be: Could you describe to us the counter 

intelligence or security controls that accompany these agreements 

and how do we know that these scientists aren’t mishandling data 

or losing large spools of classified data? 

Second, you say in your testimony that the report’s analysis has 

not identified any significant diversion of high-tech information 

that would be of use to China’s—could you characterize for us the 

insignificant stuff that went over there? Who has that standard of 

what’s significant and what’s insignificant? 

So I’m skeptical. I support a lot of this. Are there 12 or 18 protocols? 

Mr. ROCK. There are 26 protocols. 

Commissioner WORTZEL. Twenty-six protocols. Well, of those I 

have expressed serious reservation about two, based on real serious 

problems. So I’d like to explore that and ask you to discuss those. 

Thank you. 
229

Mr. ROCK. Thank you very much, Commissioner. And, first of all, 

I think I should simply state and I know you’re all aware of this, 

that what we are discussing today was the unclassified version of 

the document. And I know that you all have also had an opportunity to take a look at the classified version of that as well. 

Let me just first, if I may, talk about the overall monitoring and 

approval process for these agreements, because it sort of operates 

at four levels, if you will. The most macro level is the Joint Commission itself, the high-level commission that is chaired by the 

President’s Science Advisor and by the Chinese Minister of Science 

and Technology. It’s through that mechanism and a supporting Executive Secretariat process that we have regular meetings and we 

discuss the overall areas of cooperation, the projections for the future of where we would like to see that cooperation take place. 

And there are a range of interagency meetings that precede those 

JCM discussions. And in those interagency meetings we have the 

participation of all key agencies, including the Department of Defense and the intelligence community as part of that dialogue. 

There are then subsequent interagency working group meetings 

that occur after the JCM dialogue, so that we can get a sense about 

whether the areas that we are proposing are areas that we can, in 

fact, follow through on. 

That gets us to stage two in the evaluation. And if an agency 

says that they believe that they can follow through in an area of 

cooperation, they start something called the Circular 175 process, 

which is the process by which they design a proposed agreement 

that they intend to negotiate. Again that agreement goes through 

the entire interagency evaluation process and, in fact, it’s my bureau that has the responsibility of ensuring that each component, 

both within the State Department, which includes our nonproliferation bureaus and our intelligence bureaus and our regional bureaus 

alike, and the interagency community, again including DOD and 

the intelligence community, all participate in reviewing the draft 

agreement that’s the subject of negotiation. 

The third level is a bit of a postfactum but it is indeed the biennial report itself. We do circle back as a result of the efforts that 

you and the Commission have identified for us. We do circle back 

and see whether or not there has been progress toward the goals 

or whether there has been something that might suggest diversion. 

The fourth level is a little bit more diverse, but let me just say 

that individual agencies monitor their own programs. And this is 

true across all sectors. And I would point out, for example, that 

Health and Human Services has posts in Beijing right now. The 

Department of Energy will be putting in posts; the National 

Science Foundation will be putting representatives in Beijing. We 

of course have an Environment, Science and Technology Section 

within the Embassy in Beijing itself. 

The Department of Commerce reviews the U.S. agency activity 

on a regular basis. I would note NOAA, NIST, and NSF in particular that got recent reviews in these areas. 

All travel is reviewed across all of the agencies’ activities. All 

grants are reviewed. All of our NIH grants are reviewed. All of the 

visa applications for S&T personnel obviously are reviewed 

throughout the course of this process. 
230

So it is a fairly comprehensive evaluation I think at each stage 

of the game. 

What are we losing? What might be diverted? This export-control 

review is not a competitiveness review. It is not a review that examines whether or not the corporation that decides to assist in an 

R&D facility in China is doing the right thing or the wrong thing. 

It looks specifically at the Federal agencies and at their activities. 

If you look at something like nuclear safety, for example, it’s in 

our shared interests to ensure that we don’t have another 

Chernobyl. And so we look at plant aging. We look at security of 

materials. We look at all of these elements. 

Do we learn more about the materials? Do they learn more about 

the materials as a result of that? Certainly we are sharing information about all elements of that talking. Is the benefit greater than 

the costs? Certainly the security of the facility itself is of a far 

greater value to us overall. 

Cochair MULLOY. We have two other panels coming on, so we’re 

going to try and get in and out, each Commissioner five minutes, 

so try and give your answers crisply, short, so we can get moving 

through here. 

Chairman D’Amato. 

Chairman D’AMATO. I’m going to be crisp in my question. I have 

two quick questions, one for Dr. Weber. 

To what extent is your agency gearing up to do a major review 

of China’s S&T? I noticed we’re talking about an analysis that’s 

two, three, four years old, and they’re moving so quickly. I heard 

you say something about a study this summer. I don’t know whether that is on that level of criteria, but in your next budget submission, for example, which is now going through the appropriations 

process, the question is: Are there sufficient resources for the agency to go ahead and do a major new S&T assessment of China? 

Dr. WEBER. The Report on Asia Science and Technology that I 

referred to will come out this summer. It’s a fairly comprehensive 

report. Unfortunately in many ways it relies on vetted data that 

are internationally comparable. And, therefore, by their nature, 

will be several years old. So even in that report, using OECD and 

data from individual countries that have been fully vetted and comparable, the data will be from 2001 and 2002 generally. But it will 

be a comprehensive report that will provide good context and comparison. 

It is very important in these kinds of data to look at trajectories; 

the individual points are not as important. So the trajectory showing rapid increases, we can expect to continue. 

Regarding NSF’s efforts and budget for these purposes, we do the 

biennial report to Congress. It’s mandated. It’s part of our budget. 

There has been increasing activity internationally, not just with 

China. Several chapters cover various indicators on international 

activities. These have been included for several iterations now and 

that will certainly continue. 

Specifically for China, we sent an NSF staff member to the embassy in Beijing for about two months a year and a half ago. She 

went back last fall for another month looking at these kinds of 

data, interfacing with the Ministry of Science and Technology and 

other agencies. We’re beginning to develop that relationship. We 
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hope that the opening of our office in Beijing later this year will 

help move that process forward. 

Chairman D’AMATO. Thank you. It does seem to me like the time 

is ripe for another major review by the agency. We’d like to examine that a little further with you. 

I have a quick question for you, Mr. Rock. I understand you have 

an executive committee meeting this fall, as you do annually or biannually with the Chinese. I’m curious about how the agenda is 

set. 

For example, it seems to me that some of the problems that 

China has, particularly in the area of the environment, they need 

a lot of help on the environment before they wreck it, and some 

areas of health and that sort of thing. Are we proactive in establishing the agenda as to what we think should be going on or are 

we kind of on the receiving end from the Chinese? How does that 

dynamic work? 

Mr. ROCK. Thank you for that question because I think this is 

something we’ve really been looking at carefully. Our White House 

Science Advisor Jack Marburger is very engaged in this process 

overall. It’s his view that we should be doing much more to set the 

priorities. 

The Executive Secretariat meeting is really geared to look at the 

activities that the agencies already have underway and how we can 

extend those further. Going into the new areas is something that 

we do at the high level JCM discussions. We actually do a fair 

amount right now in the environmental area in particular. EPA 

has some excellent work that they’re doing, air quality work, water 

quality management, emissions work, that sort of thing. It’s excellent. 

The Executive Secretariat meeting will be looking at extension of 

those existing activities. The next JCM will take on the bigger new 

areas, and I know that Dr. Marburger will be on top of that. 

Chairman D’AMATO. When will the next JCM be, next year? 

Mr. DRAGNICH. That would be two years from last October. 

Chairman D’AMATO. Thank you. 

Mr. DRAGNICH. It’s a two-year cycle, and then the Executive Secretariat meets in the intervening year, so it will be October of this 

year that the Executive Secretariat meets. 

Chairman D’AMATO. So there’s plenty of time now to fashion an 

agenda that we think would be useful. 

Mr. ROCK. Absolutely. 

Chairman D’AMATO. Thank you. 

Cochair MULLOY. Sir, could you identify yourself for the record? 

Mr. DRAGNICH. Yes. I’m George Dragnich. I head the Office of 

Science and Technology Cooperation under Mr. Rock. I am the U.S. 

Executive Secretary for the Executive Secretariat. 

Cochair MULLOY. Thank you very much. 

Commissioner Dreyer. 

Commissioner DREYER. A question for Dr. Weber. I was interested in your statement that the Chinese educational system is 

moving away from elitism. I take it you got that from official numbers? 
232

Dr. WEBER. Yes, very much so. With more than 15 percent of 

their 18- to 20-year-old population now enrolled in higher education. 

Commissioner DREYER. Beware of the official numbers because 

they are belied by what the Chinese are saying to each other in 

their newspapers. There was a recent report on the nine-year-compulsory education system, which concluded that China was way, 

way, way far away from its goal. It also found a large number of 

cases in which schools lied about the number of students they had 

because they get paid per student. The dropout rate has actually 

increased in some areas. Furthermore, there are a lot of complaints 

in the Chinese press about the elitism of the system because kids 

in urban areas have many more educational opportunities than 

those in rural areas. In fact, the government seems to have embarked on a practice of practical triage. They all but forget the 

rural areas, and the rural areas are still where 70 percent of the 

population lives. 

You also have 120 million people with I don’t know how many 

children who are migrant workers. These children do not have adequate access to education. So I would just ask you to bear these 

in mind when you say the system is moving away from elitism, because if you read what the Chinese press is saying, they’re worried 

that it’s moving toward greater elitism. 

Cochair MULLOY. Thank you. 

Commissioner Reinsch. 

Commissioner REINSCH. Mr. Rock, I have a couple of questions 

for you. You referred to visa review in passing. Is that something 

that your Bureau participates in within the State Department for 

the people that are coming in pursuant to these agreements? 

Mr. ROCK. Mr. Commissioner, my bureau doesn’t do it directly, 

but I can give you a sense of how the process is done. 

Commissioner REINSCH. I know you do that. I just wanted to 

know if you participated——

Mr. ROCK. My Bureau does not do it directly, no. 

Commissioner REINSCH. Do you get involved at all in the departmental review of the Technology Alert List? 

Mr. ROCK. What my Bureau does is to pass the documentation 

to our Defense Trade Controls Office, which is in our Nonproliferation Bureau and to each of the other components of the Bureaus 

that are responsible for export control throughout the Department. 

Commissioner REINSCH. What documentation do you distribute? 

Mr. ROCK. The individual proposals. The agreements themselves 

and the——

Commissioner REINSCH. I see. 

Mr. ROCK. —proposals for each of the areas of cooperation from 

each of the Federal agencies. 

Commissioner REINSCH. I’m a step removed from that. The Department maintains a list of technologies that it cares about, and 

it reviews some visa applications in light of that list. It seems to 

me that if you are the Science Bureau, among other things, that 

you would want to have some role in determining what is on and 

off that list, but you don’t. 

Mr. ROCK. Well, on behalf of the agencies that we represent, 

NASA for example and NOAA and USGS and the like, we’re very 
233

interested in assuring that their programs can move forward as 

best as possible. But we realize the constraints, the technology constraints and the controls that need to be in place. So we are in the 

business of trying to move the cooperation forward as best we can, 

but we are not in the business of telling our export control people 

what should or should not be on that list, so it does create a certain 

tension between us and the other guys, as you imagine. 

Commissioner REINSCH. I’m trying to increase that tension and 

I’m encouraging you to increase that tension. It seems to me that 

your role is not to decide what’s proliferation sensitive and what 

isn’t. Somebody else does that and that makes sense. But it seems 

to me you can make a meaningful contribution in talking to those 

people about what technology is already widely disbursed and what 

is not and what technology is generally available. And I assume 

what you do too, which is to let them know when a project is particularly in the interest of the United States Government and have 

it go forward. 

Okay. Second question, if I may. You also mentioned in your testimony that one of the categories of the 26 relates to standards. 

Can you elaborate a little bit. Maybe this is not fair to ask you. 

Maybe I should ask somebody from Commerce, but can you elaborate or, if not, supply for the record what is covered by that, what 

actual activities are covered by that? 

Mr. ROCK. Commissioner, the best thing for me to do would be 

to supply you for the record the summary of the NIST activities, 

with the National Institute for Standards and Technology, it is a 

part of the——

Commissioner REINSCH. It’s all done by NIST? 

Mr. ROCK. It’s all done by NIST, yes. 

Commissioner REINSCH. Okay. 

Mr. ROCK. And it covers a wide range of activities. Most of it is 

exchange of personnel on the standard practices with regard to metrology and the standards measurement. These are not technology 

exchanges so much as they are information exchanges. 

Commissioner REINSCH. Right. Now that’s very important. This 

came up yesterday, if you recall if you were here, because a lot of 

us, including me, view standards as the next big trade barrier 

problem, not only with respect to China but primarily with respect 

to the EU. But to the extent that we can work with the Chinese 

to develop common standards or, more appropriately, our standards 

that really gives our exporters a leg up. 

Mr. ROCK. I’m actually glad to hear you say that because NIST 

is my prime customer in all of our science-and-technology agreements. We have just recently had a discussion with them to ensure 

that they’re as active as possible, specifically with the EU, since 

you mentioned it. This is an area that we think is particularly important. It’s obvious that the commercial impact is huge as a result. 

Commissioner REINSCH. Do you have some doubts about their enthusiasm? 

Mr. ROCK. Not one bit, sir. 

Commissioner REINSCH. Good. 

Mr. ROCK. I went and met with the director himself, and he is 

fully committed. 
234

Commissioner REINSCH. Good. Thank you. 

Thank you, Mr. Chairman. 

Cochair MULLOY. Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thank you very much, Mr. Chairman. 

Thank you to our witnesses and thank you both also for your 

service. It’s something that we all benefit from, so thank you. 

Mr. Rock, who decides what scientists participate in these exchanges in programs? Is it all government-to-government scientists? 

Mr. ROCK. I’m inclined to say it’s all government-to-government 

scientists, but that really wouldn’t be fair to the National Science 

Foundation and to Health and Human Services. 

Let me just emphasize that the entire agreement, if you look at the dedicated funds, the entire agreement really is less than $50 

million overall, over the past years of this study. And $38 million 

of that went to Health and Human Services, 28 million for NIH 

and another 5 million or so to CDC. Another 7 million goes to the 

National Science Foundation. 

So reaching out to the scientific community in the case of biomedical and in the case of NSF’s activity is far and away the bulk 

of the commitment in terms of resources under the agreement. Beyond that we are entirely driven by the priorities set by the Federal agencies themselves. And that’s why it’s a very important 

question about how we are pulling together what the Administration sees as priorities for cooperation as opposed to what each of 

the individual agencies feels they can achieve through a cooperative relationship with a Chinese counterpart. 

We are, to some extent, captive to that right now simply as a result of limited resources. 

Commissioner BARTHOLOMEW. And from the perspective of the 

Chinese government, it’s the government that’s deciding which scientists are participating? 

Mr. ROCK. Absolutely. 

Commissioner BARTHOLOMEW. This might not be the right question, but we’ve been hearing a lot about bringing students over, 

university students, graduate students. Do either of you know anything about the process by which those students are chosen in 

China who can go abroad to study? How they’re identified, how 

they’re chosen? 

Mr. ROCK. I can’t speak to the exact process. I can tell you that 

we processed 230,000 visas for the Chinese in 2004, and of those 

we issued 18,000 visas to Chinese students. It gives you a sense 

of the percentages. I have no doubt and all anecdotal information 

suggests that they are carefully selected for priority areas of 

science. 

As I believe I mentioned to some of the Commissioners yesterday, I don’t think that we do over-estimate how strategic that really is. I think there is a bit of letting a thousand flowers bloom, if 

you will, in getting the best and the brightest into U.S. university 

systems. 

Commissioner BARTHOLOMEW. But they need some sort of Chinese government sponsorship or support in order to go abroad and 

study in an American university or Australian university. Again, it 
235

might not be fair questions to ask you, but I’m trying to understand that process. 

Dr. WEBER. I can’t speak to the official process, but most of the 

Chinese students coming to the United States are not supported 

with Chinese government funds. They’re supported with family or 

private funds. 

Commissioner BARTHOLOMEW. Okay. All right. Thank you, gentlemen. 

Cochair MULLOY. A final question. I grew up in northeastern 

Pennsylvania and I grew up right around the post-Sputnik era, 

when there was a lot of Federal money that would help young people get educations, graduate educations. I got an NDA, a fellowship. One of my good friends got an NSF fellowship. 

He went on and got his Ph.D. in chemistry, taught chemistry, became head of the chemistry at a mid-size university, and I think 

is now dean of the science and engineering—or somewhere. So your 

money invested in him really went quite far. Now I know you have a $5.5 billion budget. And I think you still 

make grants for students to pursue graduate work. And we heard 

yesterday that more and more of the Chinese people who come here 

to get educated have incentives by the Chinese government to go 

back to China. 

In your testimony you tell us that right now 8.7 percent of the 

total doctoral degree holders working in U.S. science-and-engineering occupations are from China. Do the U.S. taxpayers through the 

NSF give money to educate Chinese students as opposed to American students? Because when you get one of these fellowships it 

makes a big difference in your life. You can contribute a lot to your 

society for generations. The people he’s trained have been assets 

for our society. 

Do we give the Chinese students or other foreign students those 

NSF and, if so, how much? What is the percent that goes to America and what is the percent that goes to foreign? 

Dr. WEBER. The support of graduate students is done in two 

ways by the National Science Foundation. One is through fellowships, which are given to individual students. And there is a citizenship or permanent residency requirement to apply for and receive those fellowships. 

Each year NSF gives about 1,000 graduate research fellowships. 

Those are all going to U.S. citizens. 

The other main mechanism for providing support for graduate 

students is through research grants. So a university professor will 

apply to NSF for a research grant. That budget can include support 

for postdoctoral or graduate student researchers. There is no citizenship requirement in that case. And so the NSF and, therefore, 

U.S. Government funds are in some cases being used to support 

foreign graduate students working at U.S. universities on projects 

led by U.S. researchers. 

Cochair MULLOY. Let me just further elaborate on this because 

I think it’s important. My son went to an elite university. He’s in 

medical school now. But when he started he had to take all these 

science courses and math. 

He would come back home and tell me, ‘‘Dad, they’re all taught 

by people from abroad, and I don’t understand what they’re talking 
236

about. It’s very difficult.’’ The people who apply for these research 

grants, they may be foreign citizens at the university, and they 

might then choose to bring other foreign students to benefit from 

that. Would that follow? I think that would follow. 

So is this of any concern to anybody, the fact that our systems 

are loaded with this makes it that the American students that 

might want to go into this and may stay here with their lives have 

less incentive or are not nurtured to go into this kind of stuff? And, 

if so, is that something we ought to address or think about how to 

address? 

Dr. WEBER. That certainly is a big concern. As was discussed in 

yesterday’s testimonies, one way of looking at this is we need to 

have a world-class, world-competitive higher education system that 

is advancing the frontiers of science and technology. We need to get 

good people from wherever we can. In that sense we’re, the United 

States, is benefiting tremendously from the foreign talent that 

we’re attracting here. 

Many, many faculty at U.S. universities are from abroad. The 

National Science Foundation does not require that they be U.S. 

citizens in order to apply. They have to be employed at a U.S. institution. NSF grants go to U.S. institutions. 

Cochair MULLOY. They go to a professor who applies. And then 

he can hire people with that grant, right? 

Dr. WEBER. Yes. Yes. 

Cochair MULLOY. So he may hire people from his home country? 

Dr. WEBER. If those individuals came to work with that researcher as a postdoc or a graduate student, certainly, yes, he 

could use that support——

Cochair MULLOY. Is there a debate among the scientific community on whether this is a problem or whether we should be rethinking what we’re doing here, or does everybody think this is the way 

it should go? 

Dr. WEBER. The other half of your question was whether or not 

we shouldn’t be encouraging and giving incentives to U.S. citizen 

students and researchers. The answer is absolutely, yes. It’s not a 

situation where we have a long line of U.S. citizens waiting to get 

into the graduate degree programs to be postdocs, to be professors. 

It’s a situation where there’s a large demand for that. Without the 

foreign talent coming in, we wouldn’t be able to fulfill that——

Cochair MULLOY. I just want to finish this up, because I think 

there’s something going on here. 

When I was in college the head of the history department encouraged me to take the Foreign Service exam, and that direction had 

an enormous influence on me. If a foreign professor is the head of 

some department, he may turn off the American kids who can’t understand him, or whatever. I think there’s some problem with nurturing our own students to go into this. I think people ought to be 

thinking about it in some way or another. Enough said, but I think 

there’s an issue here that needs further discussion. 

Thank you very much for being here, both of you. This has been 

enormously helpful. 

We’re going to take a five-minute break and then we have two 

other panelists, so thank you. 

[Recess.] 
237

PANEL VII: CHINA’S IPR PROTECTIONS AND THE U.S. 

ENTERTAINMENT INDUSTRY 

Chairman D’AMATO. In our last two panels of this inquiry into 

China’s high-technology development and what it means for U.S. 

economic and technological competitiveness, we will hear from experts on China’s intellectual property rights protection. 

On the current panel we have Mr. John Malcolm, Senior Vice 

President and Director of Worldwide Anti-Piracy Operations for the 

Motion Picture Association of America; and Darcy Antonellis, Senior Vice President of Worldwide Anti-Piracy Operations for Warner 

Bros. Entertainment, Incorporated. 

We look forward to this perspective from the entertainment industry and note that the entertainment industry together with 

aerospace, is really the leading signature industry in the United 

States. What happens to it is of great interest to this Commission. 

We’ll put your full testimony in the record if you would summarize it in seven or eight minutes and then we’ll go to Q&A. 

Mr. Malcolm. 

STATEMENT OF JOHN G. MALCOLM

SENIOR VICE PRESIDENT AND DIRECTOR

WORLDWIDE ANTI-PIRACY OPERATIONS

MOTION PICTURE ASSOCIATION OF AMERICA

ENCINO, CALIFORNIA 

Mr. MALCOLM. Mr. Chairman, fellow Commissioners, I’m very 

pleased to have the opportunity to appear before you today on behalf of the Motion Picture Association of America and its international sister organization the Motion Picture Association to discuss China’s progress in implementing effective intellectual property rights protection and enforcement, as well as its progress in 

opening its markets for legitimate film products. 

The 1995 USTR negotiated intellectual property rights agreement and the November 1999 U.S. Government-China Agreement 

for China’s entry into the World Trade Organization were intended 

to provide market access opportunities for American entertainment 

companies and to address the unchecked piracy of movies. 

Since 1995 American entertainment firms have invested heavily 

in the Chinese market, exporting films to China, co-producing films 

in China, distributing Chinese films abroad, investing in the construction of new theaters and the modernization of old ones, 

hosting Chinese film festivals in the U.S., and sponsoring training 

sessions. 

Despite extensive efforts and steady investments by the MPAA 

and its member companies in the audio/visual market in China, 

strong support from the U.S. Government, and continuous dialogue 

with Chinese authorities, we have only seen limited progress thus 

far with respect to both increased market access for American entertainment companies and the fight against movie theft, which 

still flourishes. 

Strict market access barriers and rampant piracy continue to 

thwart efforts to deliver legitimate entertainment products in 

China, hurting both the Chinese and American film industries. Although box offices revenues for U.S. films in China were up in 

2004, this did not begin to make up for the nearly 60 percent de-
238

cline in theatrical revenues that our members experienced in China 

from 1996 to 2003. 

As a result of Chinese-government-imposed trade barriers that 

limit the importation of legitimate film products, thereby giving pirates free rein to fill the great demand that exists in China for U.S. 

films, and an insufficient law enforcement response, piracy in 

China has reached levels not seen since 1995. 

In 2004 it’s estimated that our members lost $280 million due to 

piracy in China, an increase of over $100 million from the already 

deplorable losses that they suffered in 2003. As you no doubt are 

aware, the American motion picture industry is a vital component 

of our economy. The American broadcast and motion picture industries accounted for $108.4 billion to the 2001 U.S. gross domestic 

product. And the success of U.S. films abroad is a major facet of 

the industry’s revenue. 

While most U.S. industries struggle with trade deficits, the 

American motion picture industry has a trade surplus with every 

country with which we do business and directly employees approximately 500,000 U.S. workers. With respect to China, the reality is 

the trade in the theatrical market is essentially a one-way street. 

As the box office potential for U.S. films in China remains anemic because of access restrictions and piracy, U.S. companies are 

importing Chinese films into the U.S. and other markets, which results in considerable revenue for Chinese producers and which 

helps the Chinese economy. Chinese films have done very well in 

the United States, grossing tens of millions of dollars and benefiting enormously from strong marketing and wide distribution arranged by U.S. distributors. 

For example, in the U.S. alone Crouching Tiger, Hidden Dragon

grossed $125 million. Hero opened at number one in the box offices 

as soon as it was released and grossed of $50 million. And to date 

House of Flying Daggers has grossed over $10 million. 

In sharp contrast, the total box office generated in China for all 

U.S. films last year was about $60 million. And, by the way, U.S. 

companies are only allowed to receive 13 to 14 percent of that 

money, the precise amount to be determined by the Chinese government. From our perspective this is unacceptable. China must 

demonstrate its serious commitment to providing adequate market 

access for our film products and to effectively protecting them from 

being stolen on a massive scale. 

Market barriers that invite piracy and prevent the legitimate distribution of U.S.-filmed entertainment must be removed. 

I’ve outlined a number of specific proposals in my written submission about ways to eliminate restrictions on market access in a 

full and fair way and about ways in which the Chinese government 

could effectively combat piracy. They’re fairly straightforward, such 

as an end to government-imposed film quotas and theater blackout 

periods; an end to restrictions on foreign investment and revenue 

sharing; an end to strict limits on the number of foreign importers 

and distributors who are permitted to operate within China. 

They also call for increased enforcement efforts, the establishment of reasonable criminal thresholds, the imposition of deterrent 

sentences, and the dissemination of government-sponsored mes-
239

saging to the Chinese public about the illegality of and real harms 

caused by copyright piracy. 

I look forward to exploring some of these proposals with you 

today and to answering any questions you may have. Thank you. 

[The statement follows:]

Prepared Statement of John G. Malcolm

Senior Vice President and Director, Worldwide Anti-Piracy Operations

Motion Picture Association of America, Encino, California 

Dear Mr. Chairman and fellow Commissioners, 

I am pleased to have the opportunity to appear before you today on behalf of the 

Motion Picture Association of America (MPAA), and its international sister organization the Motion Picture Association (MPA), to discuss China’s progress in implementing effective intellectual property rights protection and enforcement, as well as 

its progress in opening its market for legitimate product. 

The Motion Picture Association of America represents seven major studios that 

produce and distribute filmed entertainment—theatrical motion pictures, home 

video entertainment and television programming—all around the world including 

China. Our members include Buena Vista International, Inc., Metro-Goldwyn-Mayer 

Studios Inc., Paramount Pictures Corporation, Sony Pictures Releasing International Corporation, Twentieth Century Fox International Corporation, Universal 

International Films, Inc., and Warner Bros. Pictures International, a division of 

Warner Bros. Pictures Inc. 

The 1995 USTR-negotiated intellectual property rights agreement and the November 1999 USG-China agreement for China’s entry into WTO were intended to provide market access opportunities for American entertainment companies, including 

our members, and to address the unchecked piracy of movies. Since 1995, American 

entertainment firms have invested heavily in the Chinese market: exporting films 

to China, co-producing films in China, distributing Chinese films abroad such as the 

recent U.S. releases of ‘‘Crouching Tiger Hidden Dragon,’’ ‘‘Hero,’’ ‘‘House of Flying 

Daggers,’’ and ‘‘Kung Fu Hustle,’’ investing in the construction of new theaters and 

the modernization of old ones, hosting Chinese film festivals in the U.S., and sponsoring training sessions. 

Despite extensive efforts and steady investments by the MPA and its member 

companies in the audiovisual market in China, strong support from the U.S. Government and continuous dialogue with Chinese authorities, we have seen only limited progress thus far with respect to both increased market access for American 

entertainment companies and the fight against the piracy of movies, which still 

flourishes. Strict market access barriers and rampant piracy continue to thwart efforts to deliver legitimate entertainment products in China, hurting both the Chinese and American film industries. Although box office revenues for U.S. films in 

China were up in 2004, this did not begin to make up for the 60% decline in theatrical revenues that our members experienced in China from 1996 to 2003. 

As a result of Chinese government imposed trade barriers that limit the importation of legitimate filmed products, thereby giving the pirates free reign to fill the 

great demand that exists in China for U.S. films, and an insufficient law enforcement response, piracy in China has reached levels not seen since 1995. In 2004, it 

is estimated that our members lost $280 million (USD) due to piracy in China, an 

increase of more than $100 million (USD) from the already deplorable losses suffered in 2003. 

As you, no doubt, are aware, the American motion picture industry is a vital component of our economy. The American broadcast and motion picture industries accounted for $108.4 billion of the 2001 U.S. GDP. The success of U.S. films abroad 

is a major facet of the industry’s revenue. While most U.S. industries struggle with 

trade deficits, the American motion picture industry has a trade surplus with every 

country in which we do business, and directly employs approximately 500,000 U.S. 

workers. 

With respect to China, the reality is that trade in the theatrical market is essentially a one-way street. At the box office potential for U.S. films in China remains 

anemic because of access restrictions and piracy, U.S. companies are importing PRC 

films into the U.S. and other markets, which results in considerable revenues for 

Chinese producers and which help the Chinese economy. Chinese films have done 

well in the United States, grossing tens of millions of dollars and benefiting enormously from strong marketing and wide distribution arranged by U.S. distributors. 

For example, in the U.S. alone, ‘‘Crouching Tiger Hidden Dragon’’ grossed over $125 

million (USD); ‘‘Hero’’ opened at #1 in the box office as soon as it was released and 
240

grossed over $50 million (USD); to date, ‘‘House of Flying Daggers’’ has grossed over 

$10 million (USD). In sharp contrast, the total box office generated in China for all 

U.S. films last year was about $60 million (USD), and, by the way, U.S. companies 

are only allowed to receive 13% to 14% of that money, the precise amount to be determined by the Chinese government. 

From our perspective, this is unacceptable. China must demonstrate its serious 

commitment to provide adequate market access for our filmed products and effective 

protection against piracy. Market barriers that invite piracy and prevent the legitimate distribution of U.S. filmed entertainment must be removed. 

Because China has, thus far, failed to make any of these changes, the MPA joined 

the rest of the copyright industry members of the International Intellectual Property 

Alliance (IIPA) in supporting the IIPA’s Special 301 recommendation that USTR immediately request consultations with China in the World Trade Organization, and 

that it place China on the Priority Watch List pending an out-of-cycle review to be 

concluded by July 31, 2005, at which time appropriate additional actions can be 

taken including the possibility of establishing a dispute settlement panel in the 

WTO. 

I would now like to briefly review the current situation and provide some specific 

recommendations on what needs to be done. 

MARKET ACCESS RESTRICTIONS SUFFOCATE LEGITIMATE MARKET 

As I stated above, current government imposed restrictions on the importation 

and exhibition of foreign audiovisual content deprives Chinese consumers of access 

to legitimate audiovisual content, thereby creating opportunities galore for pirates 

to fill that existing need by providing stolen media containing uncensored and 

untaxed content. Legitimate market potential in China continues to be impacted 

most severely by:

(i) lack of competition in the distribution of film because the Chinese government 

permits only one film importer and two film distributors, both of which are 

components of the same monopoly managed by the State Administration of 

Radio Film & Television (SARFT); 

(ii) a quota of 20 non-local films per year to be distributed on revenue sharing 

terms to be determined solely by the Chinese government; 

(iii) limits on the retail sale of legal home entertainment; and 

(iv) government-imposed restrictions on foreign investment, foreign channel carriage, and programming content in the television sector.

These restrictions on foreign audiovisual products tilt the market environment 

heavily in favor of pirates, who obey none of the government’s regulations and restrictions, while capturing at least 95% of the U.S. audiovisual industry market’s 

sales in China. The unchecked piracy of local and foreign films provides clear evidence that the current market access regime does not meet Chinese consumer demands and will cause the Chinese entertainment industry to suffer. 

I would now like to offer specific recommendations as to what we believe the Chinese government must do to strengthen the market for legitimate audiovisual products and to combat widespread piracy: 

Market Access 

• Set a fixed timetable for the removal of the limits, restrictions, and structural 

distortions on imported audiovisual products, and allow a free and competitive 

marketplace to develop in which Chinese consumers, not the Chinese government, are able to determine which films and other audiovisual products are 

most appealing to them. 

• Film: (1) eliminate the government imposed import monopoly; (2) eliminate the 

government imposed distribution duopoly; (3) remove film import restrictions 

and the unreasonably low quota (currently 20 films per year) on the number 

of revenue-sharing films that are permitted into China; (4) eliminate government determination of box office revenue percentage shares; (5) eliminate government determination of which films will be imported and when they will be 

released; (6) institute a ratings system with age classifications which will operate quickly, efficiently, and transparently; and (7) eliminate ‘‘black-out’’ periods 

when new releases of non-local films are denied screen time. 

• Home Video: (1) streamline and expedite the licensing process for retail outlets 

by designating one authority with the power to grant retail licenses; (2) ensure 

import duties are based solely on the value of the imported physical media, not 

on potential royalties which may never come to fruition; (3) remove restrictions 

on replication and home video licensing agreements; and (4) streamline and improve the censorship process. 
241

• Television: (1) permit foreign satellite channels to be carried on local cable systems; (2) streamline and expedite the censorship process; (3) reduce local content restrictions; (4) continue to reduce investment limitations; and (5) eliminate the local uplink requirement. 

• Internet/E-Commerce: (1) Designate one governmental body with administrative authority over matters relating to the Internet; (2) establish consistent, 

centralized, and transparent regulations of the Internet with policies that reflect and reinforce the provisions of copyright laws by protecting content and 

punishing infringers with stiff administrative criminal penalties, and which include potential liability for Internet service providers (ISPs) for piracy related 

offenses and satisfactory notice-and-takedown measures for websites offering 

pirated materials; (3) ensure guaranteed access to a secure environment for legitimate media suppliers to offer the products or services; and (4) implement 

prohibitions on registering, trafficking in, or using a domain name with badfaith intent to profit from the goodwill of a trademark belonging to another entity (commonly known as cybersquatting); and (5) clarify existing ambiguities 

and cure deficiencies in the Copyright Law pertaining to the circumvention, alteration or deletion of electronic rights management systems and to temporary 

copies so as to comply with the clear letter and spirit of the protections afforded 

in the World Intellectual Property Organization (WIPO) Copyright Treaty. 

PIRACY FILLS THE VOID 

Piracy is ubiquitous in China, filling the void created by strict limitations on foreign access to the legitimate market. China has the highest piracy rate in the Asia 

Pacific region, estimated at 95% in 2004, and adequate measures are not being 

taken to address the problem. No legitimate supplier of films, whether local or foreign, can compete with pirates who pay no taxes, endure no censorship obligations, 

and bear none of the costs of running a studio.

• Optical Disc Piracy: Optical disc piracy continues to be exceptionally high, 

the highest in the region. According to a 2003 article in The Hollywood Reporter, the legitimate home video market in China is only about 5% of the estimated total market of $1.3 billion (USD). Pirated DVDs of the latest U.S. theatrical titles are readily available within days, if not hours, of their initial release. 

Despite some efforts by local authorities, underground factories continue to operate around the clock producing thousands upon thousands of pirated discs.
242

There is an immense illegal optical disc manufacturing capacity in China, far in 

excess of domestic demand. China’s total optical disc manufacturing capacity from 

recognized and licensed replication facilities (not including blank CD–Rs) is 2.67 billion discs annually, which does not include the millions of discs that are produced 

in underground, unlicensed facilities. In addition to fulfilling the unmet demand for 

domestic consumption, huge numbers of these discs are illegally exported to other 

countries, thereby infecting those markets too. 

Understanding and Solutions estimated that in 2003, 69% of the VCD and 85% 

of the DVD discs manufactured in China were pirate product.

The abundance of pirate optical discs in China is evidenced by the low prices for 

those discs, lower than anywhere else in the region.

• Pirate Exports: The export and transshipment of pirate optical discs from and 

through China continues to grow at alarming rates. Exports of pirated DVDs 

from China to the U.S., the UK, and other countries have increased steadily 

over the last three years and show no signs of abating. Although MPA appreciates the assistance of Customs, the fines and penalties that are generally levied against pirates who are apprehended are considered low and not deterrent. 
243

• Television Piracy: There has also been a significant increase in cable and 

VOD piracy in China. Provincial television stations routinely make unauthorized broadcasts of MPA member company titles, often relying upon counterfeit 

‘‘letters of authorization’’ or ‘‘licenses’’ from companies in Thailand, Hong Kong, 

and Taiwan, which purport to convey broadcast rights. There are approximately 

1,500 registered cable TV operators in China and 45 digital TV operators, serving more than 100 million households, all of which routinely include pirate 

product in their programming. Very few enforcement actions have been taken 

to date. 

• Internet Piracy: Internet piracy involving illegal hard good sales and unauthorized downloading and streaming of MPA member company films is also on 

the rise. A large number of Chinese ISPs host these infringing websites. In 

2004, MPA sent out 3,905 cease-and-desist letters to ISPs in China, requesting 

the ISPs to ‘‘take down’’ infringing websites, compared with 444 such letters in 

2003. While overall compliance rates are difficult to discern, we do know that 

when such notices were sent to non-P2P targets (mostly streaming sites), the 

compliance rate was a very disappointing 17%. 

• Losses Due to Piracy: Theatrical feature films are released in a sequential 

pattern—first in cinemas, then in home video, and later in television. It is the 

hope of every film producer that the release pattern can generate revenues sufficient to recoup the investment in the film and, hopefully, return some profit 

for investors and for reinvestment into new projects. Piracy adversely affects 

every phase of the recoupment process. From 1998 to 2003, piracy-related losses 

to U.S. film companies topped $740 million (USD) in China. In 2004, piracyrelated losses in China are estimated to reach $280 million (USD). Piracy is not 

only stifling foreign importers, it is crippling the entire Chinese film industry—

studios and the cinemas. 

• Government Will: Government recognition of the piracy problem, although improving, still has a long way to go. The bottom line is that China’s actions have 

not produced substantial progress toward a significant reduction in copyright 

infringement levels, as had been promised by Vice Premier Wu Yi at the U.S.-

China Joint Commission on Commerce and Trade (JCCT). Moreover, China has 

not met its WTO TRIPS commitment to provide effective enforcement, particularly criminal enforcement, against piracy ‘‘on a commercial scale,’’ nor has it 

honored its continuing bilateral obligations as reflected in the 1995–1996 bilateral agreements and action plans. Although the MPA welcomed the 2004 announcement by Vice Premier Wu Yi of an IP protection campaign across China, 

and the establishment of a National IPR Protection Office (NIPO), and takes 

note of the fact that there has been a recent increase in raiding activity and 

better coordination of administrative enforcement efforts in various regions, 

those efforts, while welcome developments, have had little to no effect on the 

piracy situation. Criminal copyright cases against pirates are extremely rare in 

China, and there has been insufficient government messaging to Chinese consumers regarding piracy. 

• Lack of Deterrence: Current law in China does not contain deterrent penalties and contains inordinately high criminal thresholds, which preclude effective prosecution and sentencing (more than 99% of raids currently result in 

administrative fines, most of which are quite low and do not act as a serious 

deterrent). The recently-amended Supreme People’s Court’s ‘‘Judicial Interpretations’’ do little to help the situation, lowering only slightly the monetary 

thresholds (which continue to be calculated at pirate prices, rather than legitimate retail prices) that must be achieved before a prosecution can be undertaken. There are additional problems regarding the definition of distribution, 

penalties/criminality of importing and exporting of pirate products, the rules 

with respect to repeat offenders, and other areas of the Interpretations. Unfortunately, we believe that these minor changes to existing law are highly unlikely to result in a sufficient number of criminal cases being brought or high 

enough penalties being imposed which might otherwise send a real message of 

deterrence. Finally, criminal enforcement of copyright piracy continues to be 

burdened by the fact that Articles 217 and 218 of China’s criminal code require 

a demonstration that piracy is occurring for the purpose of making a profit, 

something very difficult to demonstrate in the online environment. TRIPS requires criminalization of ‘‘copyright piracy on a commercial scale’’—not just piracy for the purpose of making a profit.

In our opinion, the Chinese government should take the following steps to help 

curb the rampant piracy situation that currently exists:
244

• Fixed Timetable: Establish a fixed timetable to reduce piracy from its current 

level of over 95%, setting as an immediate goal reducing piracy levels to less 

than 50% by the end of 2005. 

• Criminal Threshold: Immediately reduce or eliminate the high criminal 

thresholds (and accompanying procedural hurdles) that prevent the effective application of the criminal law to audiovisual piracy—the only way to significantly 

reduce piracy in China. Sending major criminals to jail is key to bringing this 

form of large scale, criminal activity under control. 

• National Task Force: Under Vice Premier Wu Yi’s leadership, establish a national Anti-piracy Criminal Task Force to deter all forms of optical disc factory 

piracy, wholesale and retail piracy, and online piracy of software, books, music, 

games, filmed entertainment, and the like. This Anti-Piracy Task Force should 

engage in a transparent, well-publicized, and sustained national campaign to 

prevent and punish criminal acts of piracy occurring within the country and at 

its borders. 

• Criminal Code Amendment: Amend the Criminal Code to clarify its full and 

effective application to all piracy crimes (including enterprise end-user piracy 

of software), thus bringing it into compliance with TRIPS. 

• Administrative Fines: Significantly increase administrative fines for piracy 

and better utilize that process against all forms of piracy, including enterprise 

end-user piracy of software. 

• Copyright Law: Through amending its copyright laws or implementing regulations, China should correct the deficiencies in its implementation of the WIPO 

Copyright Treaty and WIPO Performances and Phonograms Treaty, and should 

ratify those two treaties. As stated above, although China revised its copyright 

law in October 2001, deficiencies remain, including the unreasonably high 

threshold of commercial piracy necessary to trigger a criminal prosecution, and 

penalties that are not deterrent. China’s failure to apply the criminal law to piracy is ‘‘in practice’’ a violation of TRIPS Articles 41 and 61 (requiring enforcement which ‘‘on the ground’’ deters further infringements, effective ex parte 

civil search orders, and specific deterrent ‘‘criminal’’ remedies). Further, China’s copyright laws should (1) criminalize end-user piracy; (2) add reference to

all the exclusive rights now provided in the law, particularly the new WIPO 

treaties rights and unauthorized importation; (3) add criminalization of violations of the anti-circumvention provisions and rights management information; 

(4) criminalize Internet offenses that are without ‘‘profit motive’’ but which have 

an adverse impact on rightholders ‘‘on a commercial scale’’; (5) eliminate distinctions between crimes of entities and individuals; and (6) increase the level of 

penalties overall. 

• Public Awareness: The government must make a much stronger effort to 

build consumer awareness of the dangers and penalties of engaging in piracy. 

Not only does piracy drain the national economy, it invariably fosters an expansion of other forms of criminal activity, including tax evasion and avoidance of 

censorship laws. All enforcement actions and prosecutions should be accompanied by heavy media coverage, spreading the message that the government 

considers piracy to be a serious offence. The Chinese government has demonstrated on innumerable occasions that, when it wants to do so, it can shape 

powerful forces in its society through enforcement efforts and extensive media 

coverage. It can do the same with piracy. 

CONCLUSION 

Mr. Chairman, on behalf of the Motion Picture Association of America, as well as 

the thousands of law-abiding people who work in the movie industry and whose livelihoods are threatened by piracy, I want to thank you again for inviting me to testify today. I would be happy to answer any questions you may have at this time.

Cochair MULLOY. Thank you very much, Mr. Malcolm. 

Ms. Antonellis. 

STATEMENT OF DARCY ANTONELLIS, EXECUTIVE VICE PRESIDENT

DISTRIBUTION AND TECHNOLOGY OPERATIONS

SENIOR VICE PRESIDENT, WORLDWIDE ANTI-PIRACY OPERATIONS

WARNER BROS. ENTERTAINMENT INC., BURBANK, CALIFORNIA 

Ms. ANTONELLIS. Thank you and good morning, Mr. Chairman 

and Commissioners. I’m honored to be here today on behalf of Warner Bros. Entertainment, one of the seven member studios that 
245

fund and work collaboratively with the Motion Picture Association, 

our trade organization. 

The Commission’s hearings over the last two days regarding 

China, its high-tech development, as well as its government’s views 

towards IPR and foreign-market access are important issues that 

must be understood and addressed if our industry, the filmed entertainment industry, can hope to build viable businesses and partnerships in China. 

While I know there are studio members who are experiencing the 

same level of frustration in the efforts to enter the China market, 

given Warner Bros. long history in the region, we hope to share 

some firsthand knowledge and experiences with you today. 

Warner Bros. was the first studio to establish distribution arrangements in China. We opened our first office in Shanghai in the 

’20s. And since the mainland was reopened to foreigners, we have 

been expanding our participation in all areas of the entertainment 

spectrum, providing local employment and utilizing local services. 

We were the first studio to film on location in the PRC with Steven Spielberg’s Empire of the Sun and to release an American 

blockbuster, The Fugitive, in 1994. Today our priorities include 

support of the local China film industry, investment in local production and support of a local creative community to preserve the 

industry’s art form. 

We have invested heavily in bringing state-of-the-art multiplex 

cinemas to more than 30 cities so that consumers can experience 

high quality movie going. We’ve recently partnered with a local distributor to expedite delivery of high-quality DVDs in the market at 

competitive prices. And our international television distribution 

group has partnered with CCTV for television in-country distribution. 

We have invested our resources and capital in China because we 

believe it has the potential to be a significant player in the filmed 

entertainment industry. 

Contrary to some beliefs, the Chinese consumer has not only 

money to spend but also the willingness to spend it. Of its 1.3 billion population, China boasts an urban population of approximately 

38 percent, which has been growing by one percent annually for 

the past decade. 

In the decade post 1989, China’s annual GDP growth rate had 

remained steadily high, between seven and 14 percent. The latest 

figure for 2004 was roughly 1.65 trillion. Consumer spending in ’04 

was up 13.3 percent over the previous year at 650 billion with disposable income increasing over 7.7 percent. 

Where is this money being spent? Seventy-four billion roughly on 

dining. Another 74 billion on travel and tourism. Thirty on IT 

items such as PCs and iPods. And 9 billion on cosmetics. 

Looking at the media space, 26 billion on cell phone usage and 

2.2 billion on cable TV. Yet with all of that disposable income, the 

filmed entertainment industry’s revenues are several magnitudes 

smaller, at a mere 180 million. That includes all releases both local 

and foreign. 

Based upon other foreign industries prospering in the market, we 

believe given proper market access as well as IPR support, filmed 

entertainment can prosper in China and its new economy. 
246

Philips, which has been allowed to make a hundred percent foreign investment in its China operations, saw its 2003 revenues rise 

11.9 percent from ’02 with China representing 20.6 percent of their 

worldwide revenues for 2004, or 7.5 billion. Likewise, Dell, Proctor 

and Gamble, Coca-Cola, and Yum Brands all have achieved similar 

acceptance and financial success in the China market. 

Coke’s China market share is now 10.7 percent of its global revenues. Clearly many industries have been allowed to flourish and 

have tapped into a very lucrative consumer base in China. 

Now let’s compare the situation to the filmed entertainment industry, as represented by the MPAA member companies. As John 

Malcolm testified earlier, our issues can be broken down into two 

components: Market access and Piracy. 

The two are closely coupled. To promote market stability, let 

alone growth, both areas must be addressed simultaneously to provide a proper foundation for business development. As one of the 

largest creators and distributors of content around the world, we 

continue to experience challenges in China to build viable cinemagoing, theatrical, home video, and television distribution businesses 

with restrictions that impede acceptable market access and continue to allow the piracy market to develop. 

Our competitors are the pirates. We accept that theft is always 

a component of our business plan. However, theft left unchecked 

and supported by new technology that facilitates the viral, illegal 

distribution of our copyrighted works makes it impossible to create 

a competitive strategy. 

What’s most encouraging based upon internal research conducted, was that Chinese consumers do recognize and are willing 

to pay for quality product. In fact, a statistically significant portion 

of those polled commented that if they knew that they could reliably purchase high quality DVDs that were available at cost-competitive prices, they would buy such product and avoid buying pirated product. 

Looking more specifically at our issues, market-access restrictions covering both investment options and business-development 

options continue to be severe. Investment restrictions limit our control to operate as we would within a free market and create risk 

profiles that simply make even minority investments challenging. 

Warner Bros. entered into joint ventures with the goal to construct high quality cinemas in several urban areas, to enable local 

citizens the ability to experience true cinema, versus the outdated 

and dirty theaters typically available. But to make these cinemas 

profitable and justify our construction costs, there must be a consistent flow of locally produced as well as foreign films available for 

exhibition. 

Current film quotas, as John mentioned earlier, are approximately 20 per year for all foreign films, which, by the way, the 

state is currently evaluating and looking to reduce further to 14, 

and an extremely cumbersome censorship or approval process 

makes getting product to the market on time almost impossible. 

As nice as these theaters are, by not having adequate product 

flow into the theatrical market on an expedited basis, we simply 

can’t compete with the 2.6 billion disc DVD-manufacturing capacity 

in the market that helps to fuel pirate product flow. For our theat-
247

rical-distribution business, there are issues that revolve around the 

following: Release approvals—we are given specific dates when we 

can release a title; the censorship process is very complex; the levies that we must pay for importing our features; and, last, strict 

prohibitions on media buying and direct contact with the media to 

even promote the film. 

Our home video distribution business in 2004 created a local 

joint venture intended to compete against the piracy market by offering DVDs for sale on an expedited basis and cost-competitively 

priced. These highly produced DVDs are made available in retail 

outlets identified to have the same goals as ours: Sell legitimate 

product at competitive prices and in a pleasing retail environment. 

Here too, inconsistent audio/visual licensing parameters, restrictions on foreign ownership, unofficial yet observed caps on foreign 

home video releases, and import duties all represent obstacles to 

making this business viable. 

And financially, on the piracy front, every title released in the 

U.S. is available in the pirate market in China. If a title is released 

first in the U.S., one can be assured that a pirated camcorded 

version was made and, via the Internet, downloaded in China to be 

used as the master for manufacturing pirated discs and are on the 

streets within 24 to 48 hours, all locally subtitled and locally packaged. 

This is one reason why we are grateful for the recent passing of 

the Family Entertainment and Copyright Act, which makes 

camcording in the U.S. a felony. 

Inconsistent enforcement activities and recently lowered yet potentially ineffective criminal thresholds make protection of our IP 

almost impossible. This lack of deterrence coupled with inconsistent messaging to consumers only facilitates piracy growth, both 

of hard goods and via the Internet. 

In closing, the filmed entertainment industry and certainly Warner Bros. is willing and able to take up the challenges associated 

with new market development, but to do so we need market reform 

and legislative reform that supports IP protection and increases enforcement. In China the consumer’s appetite for filmed entertainment is significant and increasing. Unfortunately without proper 

reforms and aggressive enforcement strategies, any new business 

scenario that we will offer is greatly compromised by an unrestricted and increasingly sophisticated piracy market. 

I thank you for your time and attention. 

[The statement follows:]

Prepared Statement of Darcy Antonellis

Executive Vice President, Distribution and Technology Operations

Senior Vice President, Worldwide Anti-Piracy Operations

Warner Bros. Entertainment Inc., Burbank, California 

China’s IPR Protections and the U.S. Entertainment Industry

Good morning, Mr. Chairman and Commissioners, 

I’m honored to be here today on behalf of Warner Bros. Entertainment Inc., a 

filmed entertainment creator and distributor and owners of one of the largest commercial theatrical and television libraries in the world. 

The Commission’s hearings over the last two days regarding China, its high-tech 

development as well as its government’s views towards IPR and foreign market access are important issues that must be understood and addressed if our industry, 
248

the filmed entertainment industry, can hope to build viable businesses and partnerships in China. 

While all Hollywood Studios are experiencing the same level of frustration and 

disappointment in our efforts to enter the China Market, given Warner Bros. long 

history in the region, we hope to share some firsthand experiences with you today. 

Warner Bros. was the first Studio to establish distribution arrangements in China. 

We opened our first office in Shanghai in the twenties and since the Mainland was 

reopened to foreigners, we have been expanding our participation in all areas of the 

entertainment spectrum, providing local employment and utilizing local goods and 

services whenever possible. We were the first studio to film on location in the PRC 

with Steven Spielberg’s ‘‘Empire of the Sun,’’ and to release an American blockbuster, ‘‘The Fugitive,’’ in 1994. 

Today, our priorities include support of the local China film industry. Investment 

in local productions and support of the local creative community preserves our industry’s art form. Today we’ve invested heavily in bringing state of the art multiplex 

cinemas to more than 30 cities so that consumers could experience quality moviegoing. We’ve recently partnered with a local distributor to expedite delivery of high 

quality DVDs into the market at competitive prices and our International Television 

Distribution group has partnered with CCTV, bringing American programming to 

the PRC and Chinese programming to an international audience. 

We have invested our resources and capital in China because we believe it has 

the potential to be a major market for the filmed entertainment industry. 

Contrary to some beliefs, the Chinese consumer has not only money to spend, but 

the willingness to spend it. Of the 1.3 billion people, China boasts an urban population of 38%, which has been growing by one percent annually for the past decade. 

In the decade post 1989, China’s annual GDP growth rate has remained steadily 

high, between 7 and 14%, the latest figure (for 2004) $1.649 trillion. Consumer 

spending in 2004 was up 13.3% over the previous year, at $651.8 billion. Disposable 

income has risen 7.7% for urban residents to $1,138.4 trillion and 6.8% for rural 

residents, to $651.8 trillion. 

And where is this money being spent? $74 billion on dining, another $74 billion on Travel and Tourism; $30 billion on IT items such as PCs, iPods, Digicams, etc., 

$9 billion on cosmetics and $2 billion on other luxury goods. Looking at the media space, the Chinese consumers have spent $26 billion on Wireless phone usage, $2.2 billion on Cable TV; $1.2 billion on newspapers, and 

$298 million on online gambling. Yet with all of this disposable income, the filmed 

entertainment industry’s revenues are several magnitudes smaller, at $180 million. 

This includes ALL releases, local and foreign. 

Based upon other foreign industries prospering in the market, we believe given 

proper market access as well as IPR support, filmed entertainment can prosper as 

well. Philips, which has been allowed to make a 100% foreign investment in its 

China operations, saw its 2003 revenues rise 11.9% from 2002 to 2003, and China 

represented 20.60% of their worldwide revenue for 2004 or $7.5 billion. 

Likewise, Volkswagen has done well in China, where it has been allowed to invest 

50% of foreign funds in its venture. Its revenues have grown more than 53% from 

’02 to ’03, in a year where total revenues only grew 4.9%. Dell, Procter and Gamble, 

Coca-Cola, Yum Brands—all have achieved similar acceptance and financial success 

in the China Market, and all those companies have been allowed to bring 100% foreign investment capital to do so. Coke’s China market share is now 10.70% of its 

global revenues. Yum Brands is as high as $13.35%. Clearly, many industries have 

been allowed to flourish and have tapped into a very lucrative consumer base in 

China. 

Now let’s compare this situation to the film distribution industry. The data available illustrates both a clear and compelling story. In 2004, worldwide box office revenues were approximately $25 billion yet, of that, China box office was approximately $62 million or four tenths of one percent of total box office (see appendix—

Table 1). Other statistics are encouraging and disheartening at the same time. 

While the GDP and Urban Per Capita Income has risen steadily, there has been 

a corresponding decline in box office revenues. While worldwide revenues have 

shown steady growth from 1998 through 2004, the China box office actually performed slightly lower in comparison to its 1998 level (see appendix—Table 2). 

As represented by the MPA member companies, our issues can be broken down 

into two components: Market Access and Piracy. 

The two are closely coupled. To promote market stability (let alone growth), both 

areas must be addressed simultaneously to provide a proper foundation for business 

development. As one of the largest creators and distributors of content around the 

world, we continue to experience challenges in China to build viable cinema-going, 

theatrical, home video and television distribution businesses with restrictions that 
249

impede acceptable market access and continue to allow the piracy market to develop. Our competitors ARE THE PIRATES. We accept this as most industry sectors 

do. Theft will always be a component of our business plan. However, theft left unchecked and supported by new technology that facilitates the viral, illegal distribution of our copyrighted works makes it impossible to create a competitive strategy. 

What’s most encouraging based upon research that Warner Bros. conducted to 

test the business plan to create a Home Video joint venture with a local partner 

was that Chinese consumers DO recognize and ARE willing to pay for quality product. In fact, a statistically significant portion of those polled commented that if they 

knew that they could reliably purchase high quality DVDs that were available at 

cost competitive prices, they would buy such product and avoid buying pirated product. Also, in some cases consumers today will buy the pirated feature, if they like 

it, they’ll actually seek out a better quality product for their home library and throw 

out the pirated DVD. Consumers are ready, willing and able to spend their disposable income for the quality they perceive in seeing a movie or buying a DVD, legitimately, when they are able. Consumers have shown us that there is a steady 

demand and disposable income they will dedicate to legitimate product, provided it’s 

available and cost competitive. 

Looking most specifically at our issues, market access restrictions covering both 

investment options and business development options continue to be severe. Investment restrictions limit our control to operate as we would within a free market and 

create risk profiles that simply make even minority investments challenging. 

China Film HG Corporation, the first-ever Sino-foreign JV entertainment company was created with the goal to construct high quality cinemas in several urban 

areas to enable local Chinese the ability to experience true cinema, versus the outdated and dirty theatres typically available. But to make these cinemas profitable 

and justify our construction costs, there must be a consistent flow of locally-produced as well as foreign films available for exhibition. 

Current film quotas (approximately 20/year for all foreign film imports and the 

state is currently evaluating a further reduction to 14) and extremely cumbersome 

approval processes (covering areas like censorship) make getting a feature to market 

untenable. 

As nice as these theatres are and using a release strategy that would release the 

title in China at the same time as the U.S., by not having adequate product flow 

out into the theatrical market on an expedited basis, we simply can’t compete with 

a 2.6 billion disc capacity piracy manufacturing market. 

For our theatrical distribution business, namely the entity that negotiates with 

exhibitors for screens and theatre access (which is state run), their issues revolve 

around:

• Release approvals—which includes specific dates that we are allowed to release 

a film 

• The Censorship Process—which by virtue of its complexities and inconsistent 

guidelines makes getting a film cleared a unique process each time 

• The Levies that must be paid for importation of the feature, which based on 

box office returns, renders almost all titles unprofitable 

• And finally, strict prohibitions on media buying and direct contact with the 

media to promote the film.

In 2004, our Home Video distribution business created a joint venture with a local 

distributor to distribute DVDs on an expedited basis and competitively priced ($2.60 

USD). These highly produced (not copies of camcordings with people walking 

through the frame) DVDs are made available in retail outlets that have the same 

goals as ours: to sell legitimate product at competitive prices and in a pleasing retail 

environment. 

Here too, inconsistent audio/visual licensing parameters for retail licenses, restrictions on foreign ownership, unofficial yet observed caps on foreign home video releases allowed, and import duties all represent obstacles to making this business 

viable. 

Finally, on the piracy front, every title released in the U.S. is available in the piracy market, uncensored, in China. When a title is released in the U.S., it is guaranteed that a pirated camcorder version will be posted onto the Internet triggering 

a massive supply chain with the title being downloaded in China and used as the 

master to manufacture pirated discs, complete with local subtitling and on the 

streets within 24 to 48 hours. This is one reason why we are grateful for the recent 

passing of the Family Entertainment and Copyright Act which makes camcording 

in the U.S. a felony. 

Inconsistent enforcement activities and a recently lowered yet potentially ineffective criminal threshold make protection of our IP almost impossible. This lack of 
250

deterrents coupled with inconsistent messaging to consumers only facilitates piracy 

growth, both of hard goods and via the Internet as broadband access rapidly expands. 

Our challenges are summarized as follows with recommendations for action:

Market Access—Market Reform

Challenges:

➢ The filmed entertainment industry is one of a few market segments yet to be 

reformed 

➢ Foreign investment restrictions (minority ownership) inhibit business development 

➢ Distribution of theatrical content is regulated by the state-run entities that 

maintain tight market access control and cumbersome regulations 

❍ These include: 

• Film quota of 20 titles for all foreign submissions (each Studio may get 

one or two titles a year) 

• Arbitrary ‘‘black-out’’ periods invoked without notice that restrict importation of foreign films 

• No documented and consistent censorship process (no ratings system 

available)

➢ Distribution of home video content is regulated by state-run entities that maintain tight market access control and cumbersome regulations 

❍ These include: 

• Audio/Visual license approvals are difficult to receive 

• Taxation levels can range from 50 to 75%

• No documented and consistent censorship process (no ratings system 

available) 

➢ Distribution of television content is limited by channel ownership restrictions 

and inconsistent distribution guidelines

Recommendations:

We have experienced first-hand that unless reform is endorsed at the highest levels of government within China, it is unlikely that the state-run agencies will 

change their current policies. Pressure must be applied for reform to support market 

access that will facilitate relaxing of restrictions that are listed above.

Piracy

Challenges:

➢ Massive Optical Disc Manufacturing Capacity (supports pirate market) 

❍ These include: 

• 2.6 billion disc capacity within China 

• Major exporter and supplier of pirated discs to key EMEA territories 

• Difficulty in tracing product for enforcement purposes

➢ Lack of Legal Deterrents 

❍ These include: 

• Highly profitable, often linked to organized crime 

• Criminal Threshold remains high even after modification 

• Low level fines 

• Little to no enforcement of TV or Cable piracy 

• No time limits on investigations 

• Enforcement training still requires support 

• Little to no government public relations messaging regarding IP respect 

and anti-piracy to consumers 

• Little use of government clout to control piracy yet test cases e.g. Hero 

show that government can curb illegal distribution

➢ Growing Internet Piracy 

❍ These include: 

• +90MM Internet users with +30% using broadband 

• No Internet regulations established to define legal code of conduct and 

ISP requirements 

• Rapidly increasing peer-to-peer file-swapping that is greater than Europe 

and the U.S. in absolute volumes 
251

• Growing number of websites selling content illegally—in some cases 

hosted by established Chinese service providers whose stock is publicly 

traded on U.S. Exchanges.

Recommendations:

Whether its film, software, games or the design specifications for making a new 

automobile, the issue of China’s acknowledgement and enforcement of intellectual 

property rights rest at the core of market access and growth. The U.S. must take 

a multi-tiered approach by addressing piracy on a legislative, legal or enforcement, 

market access, consumer awareness and business development perspective. Vice 

Premier Wu Yi, charged with Foreign Trade, IPR, and health, should be called to 

task on her publicly made commitments to curb piracy through multiple campaigns. 

At the 8th China International Fair of Investments & Trade in Xiamen, Vice Premier Wu Yi committed to crack down on IPR infringement. However, it is unclear 

if a strategy has been developed and plans put into action to support a long term 

and robust anti-piracy strategy. 

In closing, the filmed entertainment industry and certainly Warner Bros. Entertainment, is willing and able to take up the challenges associated with new market 

development. But to do so we need market reform and legislative reform that support IP protection and increases enforcement. 

In China, the consumer’s appetite for filmed entertainment is significant and increasing. Unfortunately, without proper reforms and aggressive enforcement strategies, any new business scenario that we offer will be greatly compromised by an unrestricted and increasingly sophisticated piracy market. 

APPENDIX
252
253

Panel VII: Discussion, Questions and Answers 

Chairman D’AMATO. Thank you both for your testimony and your 

written testimony is very detailed and complete. You lay out an extensive indictment of what’s going on in China vis-a`-vis our entertainment industry. 

We had a hearing on this I think two or two and a half years 

ago. There has obviously been absolutely no progress since that 

date. It’s an outrageous situation and cries out for some kind of 

U.S. Government action. 

You lay out what the Chinese should do. Unfortunately, you 

don’t give us what the United States Government should do to 

make this happen, because jawboning doesn’t work. 

And, by the way, I understand, Mr. Malcolm, on your Blackberry 

you just received a message about a new white paper on Beijing 

on this issue. Would you read the first section of that? 

Mr. MALCOLM. Yes. I just on my way here today, my regional director in the Asia-Pacific Region told me that there is some consternation within the Chinese government on this issue. And so 

they’ve issued a white paper on intellectual property rights for the 

first time in ten years, which I suppose is a welcome development. 

And I have not had a chance to study it, but I note that in the 

summary that while certainly disappointing and perhaps as expected, the document itself contains all kinds of qualifiers. 

For instance, one that leapt to my mind is one that says, quote: 

China has decided on a level of IPR protection appropriate for its 

own national situation. 

So essentially, the Chinese government does, as it seems to do 

in many areas, decides what it wants to do, and that’s what it will 

do and no more. 

Chairman D’AMATO. And we can break the code on that, how 

much they’re going to be doing. I guess the question I have is: It 

does not seem of course fair to the Chinese to curtail the importation of their film on this country. But, on the other hand, what do 

you do? Obviously the Chinese will not respond to anything unless 

it’s more painful for them not to respond. So we haven’t imposed 

any kind of pain in this area on the Chinese government. And certainly the Chinese government could do something in this area if 

it chose to, and it is not doing so. 

Ms. Antonellis, you mentioned also that you are constructing a 

series of film theaters in China. Could you elaborate a little bit on 

the problems that you’ve had with the Chinese government in that 

respect? 

Ms. ANTONELLIS. Certainly. Thank you. We created a joint venture for the purpose solely of constructing theaters, high quality 

theaters in a number of cities. As I mentioned, we have some 30 

locations now. 

And because it continues to be a volatile situation, in places 

where we have been given approvals for construction, with administration and commission changes within the state, what were approvals are now being questioned and in some cases construction 

progress has been stopped. And this has occurred literally within 

the last two weeks. 

Chairman D’AMATO. I know that other Commissioners have some 

questions, but I just have one general question for both of you. 
254

To what extent have you asked for assistance from the Federal 

Government, specifically in these areas, and what has been the response? 

Mr. MALCOLM. On behalf of the MPAA we ask for assistance 

from the Federal Government all the time. We do work with the 

U.S. Trade Representative. We have supported the National Intellectual Property Alliance’s recommendations to USTR that an outof-cycle review be performed for China. We have briefings all the 

time with representatives in both the legislative and executive 

branch. 

I am very heartened to see that, for instance, Congressman 

Portman has already come out with statements pending his confirmation hearing saying that China will be a priority. I know that 

there are some people of goodwill, such as Bill Lash at the Department of Commerce, that go over and use the bully pulpit. I would 

say that in many instances we are happy with the response we get, 

but Lord alone knows it’s a big problem. There’s a lot of work to 

be done. 

Ms. ANTONELLIS. From the commercial side, and as John just 

mentioned, a number of those efforts to the USTR are really driven 

through the MPAA trade association. 

From the commercial side from Warner Bros. we spend a large 

portion of our time dealing with the various state-run industry 

agencies on the China side, in constant negotiations. So whether 

it’s the China Film Group, which is a state-run entity, as well as 

SARFT, the film, radio and television entity, for approvals, we try 

to get some changes to policy. That’s where we’ve focused. 

Chairman D’AMATO. Have you considered asking the Administration to take the Chinese to the WTO on intellectual property here? 

Mr. MALCOLM. Yes. That’s part of the IIPA’s recommendation. It 

calls for an out-of-cycle review and then says, pending that expedited review or once the expedited review is completed, to take a 

look at the results and take appropriate action. And one of the possibilities, a distinct possibility, is to suggest setting up a dispute 

panel at the WTO. 

Chairman D’AMATO. Do you agree with that? 

Ms. ANTONELLIS. Yes. 

Chairman D’AMATO. Thank you. 

Commissioner Dreyer. 

Commissioner DREYER. I was very interested in Mr. Malcolm’s 

statement that the U.S. companies are allowed to receive only 13 

to 14 percent of the box office, the total box office money in China, 

the precise amount to be determined by the Chinese government. 

Who the dickens agreed to that and why? 

Mr. MALCOLM. Ms. Antonellis would probably know more about 

the history than I would. I’m not sure that it was something that 

we had an opportunity to agree to or not agree to, as opposed to 

having it imposed upon us, but she could provide a better answer, 

I’m sure. 

Ms. ANTONELLIS. Yes. Akin to our current licensing arrangements, if you would compare those to another territories, obviously 

similar scenarios exist. However, the percentage or the splits, as 

we like to call them, between what the studios net from a distribu-
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tion arrangement versus what is left for the local participants is 

somewhat skewed in our distribution in China. 

At the time it was a function of market access. It was the only 

way that we were going to be able to get distribution. And because 

we’ve looked at the market so strategically, being able to get a toehold into that arena was more important. 

Commissioner DREYER. I should say that many other industries 

have made the same mistake. So you’re not alone, but it’s nonetheless embarrassing. 

Ms. ANTONELLIS. Somehow it doesn’t make me feel better. Yes, 

I agree. 

Commissioner DREYER. Understandably. Thank you. 

Chairman D’AMATO. Thank you. 

Commissioner Mulloy. 

Cochair MULLOY. When we brought this issue up in 1995, you 

understand that China was not in the WTO. So when we complained about IPR violations then and they didn’t respond, we 

threatened to block access for some of their goods to our market, 

and then they signed an agreement. 

Now of course you can’t do that because we’re committed to have 

this open market in our WTO agreement with China, so our only 

solution would be to go to WTO, win the case, and then put on 

some barriers, whatever. Whatever the WTO would permit us to 

do. 

There’s another thing. I’ve been reading about the automobiles 

coming from China now. The big articles both in the Wall Street 

Journal and the New York Times. Just for the record, I think it’s 

important to note that the same people who negotiated, what do 

you get, 20 films into China a year, the same people who negotiated that negotiated an agreement with China, WTO legal, that 

they can keep a 25-percent tariff on cars going from the United 

States to China, but China can ship cars from China to the United 

States and face a 2.5 percent tariff. 

Now you wonder why people in Washington are finally beginning 

to wake up and say what is wrong with this system. Something 

isn’t right. 

But I think it’s important for you, Mr. Malcolm, to distinguish 

between what China’s failing to do with regard to what they 

agreed, which I think is mainly enforcement, these other things 

that you describe as market access, are they perfectly within their 

WTO agreement rights to keep those market access? 

The industry agreed 20 films, that’s all their obligated to do. Now 

the only way you can get that is if you offered them something else 

in a new round of negotiations, that they might give you more. But 

they’re perfectly within their legal rights to do that to you. Is that 

correct? 

Mr. MALCOLM. Mr. Commissioner, I’m on more comfortable 

ground with respect to the enforcement piece of this being in 

charge of global anti-piracy operation. So I don’t want to tread into 

areas in which I’m not an expert. 

Cochair MULLOY. Okay. 

Mr. MALCOLM. I can talk about WTO and compliance with respect to enforcement, which is deficient. 
256

Cochair MULLOY. Yes. It’s a huge, a huge issue. But when you’re 

talking market access, I think a lot of that is just the fact that we 

agreed that those market-access barriers could be in place, because 

our guys were bargaining for something else, I don’t know what. 

We haven’t seemed to have gotten a lot of access in any industry, 

but that’s my understanding. 

Do you have a different understanding, Ms. Antonellis? 

Ms. ANTONELLIS. I think it’s our understanding, though, with respect to some of those provisions that it is certainly, in our opinion, 

worth review. With respect to restraint of trade, there are some 

issues around those conditions dealing with actual the importation 

of our product to maintain a viable business, that again would warrant a review in terms of their WTO compliance. 

Cochair MULLOY. Thank you, both. 

Chairman D’AMATO. Thank you. 

Commissioner Wortzel. 

Commissioner WORTZEL. Appreciate very much both of you being 

here. I’m interested in a very limited aspect of this. I know it’s all 

very important, but when I worked in the embassy in China the 

biggest producer of counterfeit DVDs and tapes and everything else 

in China, the biggest two were Buy E Studios, the People’s Liberation Army movie studio run by the General Political Department 

of the People’s Liberation Army and the People’s Liberation Army 

Air Force Studio, I think in Shanghai. That earned them a lot of 

money. This is how they got a lot of their budget. We don’t know 

how much. 

So my question is: Are you able today to figure out who the counterfeiters are and where the money’s going? 

Mr. MALCOLM. Commissioner, in a number of instances, yes. I’m 

not going to say that some of it is not government, at least if not 

tacitly, approved or perhaps they derive funds from it. As Ms. 

Antonellis pointed out, approximately 2.6 to 2.7 billion disks are 

being produced, and that’s out of licensed replicators. There are 

dozens if not hundreds of unlicensed replicators where we see millions of disks. 

I’m sad to say that in the case of China a lot of it is going into 

the pockets of organized criminal figures who are quite dangerous 

and who pose security risks both domestically within China and 

internationally. 

Ms. ANTONELLIS. Along those lines within the last couple of years 

the industry has availed itself to some technology that’s actually allowed us to map the supply chain of the pirated market. And that’s 

allowed us to show where discs originate from and how they flow 

to different countries. And, very honestly, China with its manufacturing capacity is a huge exporter of pirated product into some primary territories. 

So our highest revenue-generating locations, like the U.K., for example, their production just from China accounts for 10 to 13 percent of all discs flowing in. So that’s kind of a secondary issue, 

servicing both the local market, the China market as well as transshipping it to other territories. 

Mr. MALCOLM. Commissioner, may I elaborate for just a moment? A lot of the disks both for domestic consumption and for export in China are coming out of replication machines. Replication 
257

machines are a million dollar plus piece of equipment. They’re 

being run out of labs that essentially employ slave labor by organizations that have two costs on their mind: One, keeping those 

slaves alive and, two, corrupting officials. When those disks are exported outside of the country, they are being distributed by 

snakehead gangs that are well organized within China. And the 

welcoming committee whenever raids are conducted frequently involves high-powered weaponry. These are highly dangerous, highly 

organized people that are well funded. 

Commissioner WORTZEL. But I take it that in the end what was 

once side money for the military has now turned into a big time 

organized crime business. Thank you. 

Chairman D’AMATO. Thank you. 

I seem to remember a couple of years ago we were told, yes, 

there’s a problem in China, but they’ve been successful in cutting 

off the exports. Obviously that’s been turned around if it ever was 

the case, and it’s as bad today as it ever was. We’re really at 

square one. 

Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thanks, Mr. Chairman. 

And thank you to our witnesses. My comment on the white paper 

is let’s hope that the U.S. Government response is not what it usually does, which is to negotiate yet another MOU that is not worth 

the paper that it’s written on. 

This is an issue that has been going on for so long. I’m flabbergasted to hear these numbers. It’s very frustrating for us to 

hear it year in and year out. I can only imagine how frustrating 

it is for all of you. It looks like there’s a change in strategy in your 

industry and I commend you for having the guts to stand up and 

start talking about it now. Because it’s quite clear that negotiating 

quietly is not getting anybody where they need to go. 

I was going to ask a version of Commissioner Wortzel’s question 

which was why do you think that getting market access is so much 

trouble? Is it because of concerns about freedom of expression and 

control over content or is it primarily because there are people who 

are benefiting financially from the piracy that’s going on? 

Ms. ANTONELLIS. All of the above. With respect to control of the 

market, to give you an idea, the local Chinese film market on average produces well over 200 films a year. Unfortunately only a small 

percentage of those films actually make it to theaters. The rest are 

put on shelves and exhibition is still extremely limited and state 

run. 

We think it’s a combination of factors. The first is to maintain 

tight regulation of just that sector, as well as, as you mention, it 

is big business and it is big business with money that resides and 

stays in country and with benefits that obviously we can’t directly 

view. But we always approach the issue of what is a mutually beneficial situation. And because the piracy market is so robust, the 

reality is that they’re seeing every one of our titles that the United 

States produces, so it’s a difficult proposition to say what’s in it for 

them. 

This really, in our belief, gets down to the core to what your feeling is about intellectual property. If you have no respect for copyright, well, then there’s the answer. And we’ve made a strategic de-
258

cision, a business decision to aggressively enter the market to the 

extent that we can on all of our distribution outlets and stay there 

for a period. You’re going to make a long-term investment and see 

what can be developed on the exhibition front. But that will only 

have limited success unless we can deal with the IPR side. 

Commissioner BARTHOLOMEW. Mr. Malcolm, anything to add? 

Mr. MALCOLM. Not really, Commissioner. 

Commissioner BARTHOLOMEW. It’s also interesting. Obviously we 

have huge economic interest in American cultural products being 

sold overseas, but we also know that people overseas love American 

cultural products. It’s one way that we can help promote American 

interests more broadly than just the economic interests. It has consequences for all of us when you can’t get your product in overseas. 

Just recently, the Marketplace on NPR covered a story about a 

bust that had taken place that was in cooperation between American officials and Chinese officials. One of the main targets of the 

bust was an American who was responsible. 

I’d love for you to comment if you can, and if you can’t, I’ll understand. I presume that the reason that was the case, that the Chinese authorities particularly cooperated on, was because it would 

be a way to come back and say, ‘‘But, see, it’s not our problem; it’s 

an American problem’’; am I accurate on that? 

Mr. MALCOLM. I’ll be delighted to comment on the case. I’m sure 

that they were not displeased that the first major pirate that was 

prosecuted under criminal copyright theft happened to be an American, but it was an individual named Randy Guthrie, who comes 

from, I gather, a lovely and well-to-do family——

Commissioner BARTHOLOMEW. Very prominent. 

Mr. MALCOLM. —and, for whatever reason, decided to strike out 

and make his fortune on his own and did it in a rather illicit fashion. It was an investigation that was a cooperative venture between 

ICE at the Department of Homeland Security and the Chinese authorities. It was successful. I applaud them for doing so. There’s 

still a lot more work to be done. 

Commissioner BARTHOLOMEW. Ms. Antonellis, anything to add? 

Ms. ANTONELLIS. No. 

Commissioner BARTHOLOMEW. Thank you. Thanks very much. 

Chairman D’AMATO. Thank you. 

Commissioner Reinsch. 

Commissioner REINSCH. Thank you. Just as an aside I have a 

feeling the problem is in part less their lack of respect for copyright 

than that it’s an alien concept. I think we’ve got a long way to go 

to persuade them that it’s relevant, which is no comfort. I have a 

lot of sympathy for your dilemma. 

I have just a narrower question. You mentioned I think in passing that the Chinese themselves produce some 200 films a year. Do 

they have a piracy problem with those? 

Ms. ANTONELLIS. Yes, they do. The difference is that we have a 

handful of cases for example Hero, a locally produced title and most 

recently Kung Fu Hustle, where the state has engaged in an advance campaign touting the film and directly or indirectly a message is basically sent out that it’s to be kept off the pirated market. 

And that’s evident recently in the Kung Fu Hustle case study. 
259

There were large revenues made in both cases from theatrical 

box office because market access was restricted on the piracy market to basically drive consumers to theaters. So they do have issues 

with local as well as foreign. 

Commissioner REINSCH. Well, that’s very interesting. You answered my next question, which was going to be whether there’s 

differential treatment, and you’ve essentially said yes. 

But it seems to me the implication of what you said is that the 

Chinese government is in a far better position to control this than 

they would suggest. 

Ms. ANTONELLIS. Yes, we believe so. 

Commissioner REINSCH. So when the money to be made is there, 

when it’s their film, they are able to send the right signal to these 

people, whom they apparently know better than perhaps we think 

they do. 

Ms. ANTONELLIS. Yes. 

Commissioner REINSCH. Ah-ha. Well, that’s very interesting. I 

think I’m not going to take it any further, though. We’re short on 

time. 

Chairman D’AMATO. Thank you, Mr. Reinsch. 

I think it’s sufficiently clear that the Chinese government if it 

doesn’t have outright control over this whole thing could exercise 

substantial control over it to get it under control. And I think we 

ought to tag the Chinese government with responsibility for not 

making some progress in this area. 

I want to commend Warner Bros. for your tenacity in staying in 

this market despite all this nonsense. You deserve more help than 

you’ve been getting from the U.S. Government. 

I have an old theory in the Chinese case, you need to have an 

apples for oranges strategy. If they don’t take our apples then we 

can keep their oranges out. They want to export cars into the 

American market. My sense is there shouldn’t be any cars coming 

into the American market until they fix this. Maybe we should take 

a look at some of the other products. That’s the only thing that gets 

their attention. 

The other thing is I think you should go to the WTO, and that 

would be of some help. 

I think that concludes this particular panel. Thank you very 

much for coming. 

We would be interested in seeing that white paper. 

Commissioner DREYER. Actually I downloaded it yesterday off 

the Internet and I gave it to Roger. 

Chairman D’AMATO. I would ask for the unanimous consent that 

we include that white paper in the record. 

Thank you very much. 

Commissioner DREYER. Very interesting. 

Chairman D’AMATO. Take a five-minute break. 

[Recess.] 

PANEL VIII: CHINA’S IPR PROTECTIONS AND IMPACT ON 

TECHNOLOGY DEVELOPMENT 

Chairman D’AMATO. For our last panel of the day and of this session at Stanford we’ll examine the role IPR protection plays in Chinese technological development. Dr. Pat Choate will present a com-
260

missioned paper on U.S.-China advance technology trade. By the 

way, Dr. Choate has also released a new book on Hot Property: The 

Stealing of Ideas in the Age of Globalization, right on point for this 

hearing. 

Ted Fishman will discuss how China’s strategy for IPR protection 

functions within China’s larger economic and technological technology goals. 

Why don’t we go ahead and take seven or eight minutes each and 

then we’ll go for questions. 

Dr. Choate. 

STATEMENT OF PAT CHOATE

CO-DIRECTOR, MANUFACTURING POLICY PROJECT

AUTHOR, HOT PROPERTY: THE STEALING OF

IDEAS IN AN AGE OF GLOBALIZATION, SPERRYVILLE, VIRGINIA 

Dr. CHOATE. Mr. Chairman, Members of the Commission, thank 

you very much. I’d like to note on the record my appreciation for 

Alfred Knopf and company sending copies of the book to the Commission. I would also note that the book comes out the middle of 

next week, so you’ve got about a five-day jumpstart on the public 

to get your copies up on eBay. 

I’d like to talk about a country that does the following or has 

done the following: That provides incentives to steal IP, including 

cash; that creating important barriers to guarantee local markets 

and keep out other technology products; that provided no domestic 

patents to foreigners; no grant of copyrights to foreigners; no protection of trade secrets; no protection of trademarks to foreigners; 

no prosecution of IP theft; no right for civil remedies for foreigners. 

That country is not China. That’s the United States. When we 

founded this country, America was at its creation the great pirating 

and counterfeiting center of the world. Now the truth is that’s how 

nations develop. America did it. Germany did it in the late nineteenth century. Japan did it in the middle twentieth century. And 

China’s doing it today. 

It’s really in the sense the way that business is done and it is 

for us to recognize that. And if we’re going to deny visas anyone 

we should deny visas to any foreign student that wishes to come 

here and study intellectual property history, because our forefathers devised ways to steal technology that others hadn’t even 

heard of let alone applied in the world. 

Now I would note in response to a question yesterday in which 

the President has said that innovation is the basis for national development. There was a President who said that and it was George 

Washington. His first message to Congress laid out his priorities 

for his Administration. They were: Industrial development, inland 

navigation. He called upon the Congress to create a patent and a 

copyright system, which they did 90 days after his message went 

forward. 

Moreover, what you found in that Constitution, in that provision, 

it was based upon a constitutional provision. It was one of the few 

constitutional provisions that was enacted unanimously at the Constitutional Convention. The Authors and Inventors Clause is the 

only place in the Constitution where the word ‘‘right’’ is mentioned. 

The Bill of Rights was passed 18 months after that provision. 
261

Moreover, it’s a right that is defined by the Congress, something 

that was reaffirmed in the recent Sonny Bono case that was taken 

to the Supreme Court, a ruling of 7 to 2. It’s a conditional right. 

So it’s very appropriate, I would think, to recommend to Congress how to define that right. And I have some thoughts on that 

that I will give you later on. 

Now I would also note that our challenge today is that China is 

the global epicenter of pirating and counterfeiting. As to the actual 

numbers there, the Chinese government estimates that domestically the cost is 19 to 24 billion a year. This is a gross under estimation. 

The real cost in China is somewhere in the range of six to eight 

percent, according to Interpol and in Europe, for example, it’s eight 

percent. The real cost of goods sold, of counterfeit and pirated 

goods is $140 to $180 billion a year. That does not count the value 

of the theft of the foreign technology nor of the exports. 

It’s important to the United States for a very simple reason. We 

are as a people a volcano of creation: 4.5 percent of the world’s population, we create half of the innovations. And according to the intellectual property creators in the last half of this century, we’ve 

created 90 percent of the major innovations, like the CAT scanner, 

et cetera. 

In effect our economy is based upon innovation. Innovation is our 

competitive advantage, which means that it’s imperative that that 

innovation be encouraged and it be defended. In my testimony I lay 

out the defenses and the way. Our forefathers set up a system that 

has worked remarkably well and it is that inside the United States 

inventors and copyright owners, authors and inventors, creative 

people, have the right of private action. They do not have to depend 

upon the government. They themselves can defend their rights. 

They can go to the court system and the Federal court system, 

which have integrity, and they can find justice. 

Alexander Graham Bell fought 600 lawsuits defending the telephone, including three that went to the Supreme Court, and he 

won every one of those cases. That right and that ability, at putting it in the hands of the inventor, is very important. But internationally we set those rights country by country. 

When we deal internationally it’s imperative that our government assist and defend our inventors and our creative people. They 

cannot on their own deal overseas if other countries do not put into 

place the right of private action and the means, such as a judicial 

system, that will make that possible. 

The second thing I would bring up on enforcement is that we are 

failing in this country to defend our inventors overseas. There has 

not been one single case brought by the United States on intellectual property matters since June of 2000 to deal with this issue. 

The Clinton Administration brought up 13 IP cases and prevailed 

on 13 cases. 

It is very clear that if we go to the WTO on the China, the 

United States will prevail on that case. It’s imperative that we do 

so. 

We’ve cut our domestic enforcement in this country. The Counter 

Espionage Unit that we maintain on economic counter espionage, 
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* Pat Choate is the author of Hot Property: The Stealing of Ideas in an Age of Globalization, 

from which parts of this statement are drawn. Alfred A. Knopf, Inc. will release this book on 

April 26, 2005. 

all of those agents have been assigned to the terrorism issue. We 

basically have nothing left on that. 

The second thing then that’s happening is at the same moment 

that we’re seeing this great crime wave, and this is the great economic crime of the twenty-first century, is intellectual property 

theft, and it’s particularly important to this country. What we’re 

seeing is now their efforts underway to weaken our own patent 

laws, to weaken our defenses here in this country. 

Congress I think made a great mistake in 1999. One of the 

things that they did is they began to try to harmonize the American patent system with that of Japan and Europe, not by raising 

their standards up but by lower our standards down. The most 

egregious thing there is we adopted something called the 18-month 

rule. When an inventor files a patent today, at 18 months the Patent Office is obligated to publish the application, including the details of how you replicate that patent on the Internet. It takes an 

average now of 27 months to run a patent. 

So suddenly you have a situation for nine months and in some 

cases longer than a year, the inventor has their stuff up in a world 

filled with pirates and copyright thieves, and they have absolutely 

no defense. And the only defense they have if someone steals their 

innovation, they can go to the other country and try to bring a lawsuit. Well, you know what happens there. 

This is stifling innovation. I can arrange with quite a number of 

inventors that are no longer seeking patents because to get a patent is to give it away. And then the problem that you have if you 

don’t have the patent you’re having trouble financing it. 

Microsoft, IBM, and a handful of other companies are now supporting legislation that would weaken that even further. I would 

hope the Commission could take a look at that and make some recommendations. 

I’ll end my testimony with that. 

[The statement follows:]

Prepared Statement of Pat Choate

Co-Director, Manufacturing Policy Project

Author, Hot Property: The Stealing of Ideas in an Age of Globalization

Sperryville, Virginia

Mr. Chairman and Members of the Commission: 

Innovation is America’s competitive advantage and intellectual property (IP) 

rights are the wellspring of that creativity. They underpin our economy and assure 

our national security. 

For more than two centuries, America’s unique system of intellectual property incentives and protections has fostered a volcanic outpouring of innovation and enterprise. Now, that creativity, and all that it makes possible, are threatened by other 

nations’ massive and blatant violations of U.S.-owned intellectual property rights, 

by well-funded efforts to weaken U.S. intellectual property laws and by ‘‘reform’’ legislation enacted in 1999 that forces the U.S. Patent and Trademark Office to reveal 

the vital details contained in a patent application 18 months after it is filed, long 

before most patents are granted. This premature disclosure of inventors’ most intimate secrets—while their creations lack the legal protections conferred by a patent— 

aids counterfeiters and pirates, penalizes U.S. inventors and discourages innovation. 

In effect, Congress unthinkingly legalized a major form of industrial espionage. 
263

My analysis of China’s protection of U.S. intellectual properties begins with an 

examination of the importance of those rights to the United States, the foundation 

and evolution of those protections, plus a review of the IP obligations that China 

willingly assumed when it joined the 148-member World Trade Organization (WTO). 

In sum, China is not meeting its WTO intellectual property commitments. Indeed, 

China is pursuing a national development strategy based on the uncompensated, 

unapproved stealing of other nations’ best ideas and technologies. China’s failure to 

fulfill its WTO intellectual property commitments is not just a U.S. problem: It is 

one of equal significance to Europe, Japan and all other nations that value innovation. Fortunately, as discussed later, powerful remedies exist.

Innovation and Progress

How important are technological advances to America’s development? They are 

vital. The cotton gin, interchangeable parts, the telegraph, electricity for the home 

and factory, mass production techniques, the airplane, television, computers, lasers, 

iPods, among millions of innovations, each profoundly changed the nature of work 

and life, not only in the United States but throughout the world. 

Economists have measured the effects of technology on the American economy. 

The studies are distinguished by the use of differing techniques, different periods 

and different parameters. The constant in most of these studies is they examined 

three basic factors—labor, capital and technology—apportioning to each its relative 

contribution. 

Nobel Economics Prize winner Robert Solow of Harvard University found that 

technological advancement, coupled with increased human capital improvements in 

the labor force, accounted for between 80–90 percent of the annual productivity increase in the U.S. economy between 1909 and 1949. Edward Denizen of George 

Washington University concluded that in the period 1929–1982 more than twothirds of the productivity gains were due to advances in science and technology. 

Whether the precise numbers of those two studies are correct, the important point 

made by each is that progress in knowledge and innovations were the primary factors behind the growth of America’s economic productivity. And while quarrels exist 

among economists, historians, lawyers, and politicians as to the details of the American system of innovation—that is, are patent terms too long or short, is copyright 

coverage too broad or narrow, are trademarks useful or not—the fact remains that 

the Founding Fathers of this nation and their successors created a system of innovation that has worked better than any other.

The Great Economic Crime of the 21st Century

Intellectual property theft is the great economic crime of the 21st century. The 

FBI estimates that pirating and counterfeiting costs U.S. companies up to $250 billion per year. The European Union estimates such theft bleeds its economy of more 

than $400 billion annually. 

Significantly, such theft is about more than money. Fake goods harm and kill people. Piracy and counterfeiting impede innovation. The result is fewer new medicines, 

fewer advances in science, fewer new products, fewer new music CDs, fewer new 

movies, less new software, and higher prices for whatever is created. 

Pirates and counterfeiters also frustrate creativity. Their actions deny incentives—whether it is money, recognition, fame, or power—to the creators of new 

ideas who do the work and take the risks required to challenge the old with something new, different and better. Fakes destroy good jobs and the reputations of legitimate producers and goods. 

Each year, the Office of the United States Trade Representative presents a listing 

of countries where intellectual property theft is blatant. That report (available over 

the Net at www.ustr.gov) reveals massive infringements of U.S.-owned intellectual 

properties by many nations.

A Constitutional Right in the United States

What is the legal foundation of U.S. patent and copyright protections? It is the 

U.S. Constitution. 

The American Revolution almost failed because the fledgling nation lacked the capacity to manufacture the materials of war. Those demands had to be fulfilled by 

European producers and then smuggled across the Atlantic. By the War’s end, the 

necessity for manufacturing self-sufficiency was so seared into the minds of George 

Washington and other Revolutionary leaders that when the Constitution was being 

drafted, they included a special provision to encourage domestic innovation and 

creativity. Article 1, Section 8 of The Constitution of the United States of America 

provides:
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‘‘The Congress shall have power to promote the progress of science and useful arts, by securing for limited times to authors and inventors the exclusive 

right to their respective writings and discoveries’’;

This is the only place in the body of the Constitution where the word ‘‘right’’ is 

mentioned explicitly. The Constitutional amendments that became known as the 

Bill of Rights were not ratified until almost the end of the third year of George 

Washington’s first Presidential term and almost 19 months after passage of the first 

copyright and patent acts in 1790. 

This twenty-seven-word clause is the legal basis for every patent and copyright 

ever issued in the United States. Congress may vary the terms and duration and 

thus render the contemporary definition of what is the proper balance between the 

public and private interests, but the Constitution guarantees every American’s right 

to such protections. The Commerce clause of the Constitution is the basis for trademark protection.

A Golden Covenant

Ideas are intangible, even ephemeral, things. Yet, they are the fountainhead of 

all advances in literature, science, technology, agriculture, music, medicine, designs 

and even better mousetraps. And although ideas cannot be owned, the right to exclude others from producing the creations that flow from them can be—at least for 

a set time. Intellectual property law is about classifying the form an idea takes, the 

right to exclude others from its use, the enforcement of that right, the penalties for 

any infringements of that right, the allocation of responsibility for imposing that 

punishment, and, equally important, the attendant obligation of the intellectual 

property owner to society. 

Although the protections take many forms, as a body they are called ‘‘intellectual 

property rights.’’ Fundamentally, such rights, wherever they exist, are a basic social 

contract between society and someone who creates an idea—a golden covenant—by 

which the public grants that creator the right to exclude others from using their 

creation for a set period in exchange for the disclosure of its details, and ultimately 

the surrender of that property right, allowing the creation to enter the public 

domain. The hope is that by giving the author or inventor a property right for a 

limited time, while also making public their creation’s most intimate details, the 

general state of knowledge will be advanced.

Four Types of Protection

Over time, four basic types of intellectual property protections have been created: 

copyrights, trademarks, patents and trade secrets. Each contains its own bundle of 

rights, backed by a body of law that is appropriate for specific types of intellectual 

products. Lawrence J. Siskind, a San Francisco intellectual property lawyer, has 

created a useful typology for distinguishing these four types of protection. 

Imagine, he says, that Thomas Edison wrote a book about the process of incandescence. A copyright would protect Edison’s literary or artistic creation, barring others 

from either copying or distributing his words or any illustrations in his book. But, 

a copyright would not forbid others from using the ideas in the book to create their 

own electric lights. 

If Edison held a patent, however, he would possess ‘‘the right to exclude others 

from making, using, offering for sale, or selling’’ his invention in the United States 

or importing the invention into the country. Thus, a patent would give Edison the 

right to exclude others from using his idea for a set period in exchange, of course, 

for publicly disclosing its details. Edison’s incentive is that he gets a chance to develop his idea and reap the financial reward during a prescribed period. The public’s 

incentive to make such a grant is that knowledge is advanced by Edison’s disclosure. 

If Edison wanted to label his light bulb as the ‘‘Edison Bulb,’’ he would seek a 

trademark. That could either be a word, a name, symbol or device to distinguish 

his idea or product from all others. While others could make and sell light bulbs, 

if they did not violate Edison’s patent, they could not call their product an ‘‘Edison 

Bulb.’’ That right would belong to him. Edison could also package his bulb in a distinctive way and that too would be protected as ‘‘trade dressing.’’ Thus, when others 

sold their bulbs, they could not make or package them to appear as the ‘‘Edison 

Bulb.’’

If Edison chose to keep secret the details of how he made his light bulb, his customer list, his manufacturing processes, and any special formulas or designs, laws 

on trade secrets would protect him. But as Siskind points out, if he marketed the 

product and someone independently took it apart and figured out how his creation 
265

was made or worked, Edison would probably lose any legal rights. Coca-Cola, for 

example, has kept its formula secret, but relying on trade secret protections is risky. 

Of course, there is much more to each of these basic protections. For instance, 

there are several types of patents—utility patents protect useful inventions, methods 

and processes. Design patents safeguard unique and ornamental shapes and designs. Patents also are given to those who invent or discover and asexually reproduce a distinct and new variety of plant. 

Congress sets the length of protection for intellectual property and it varies by 

type. Utility and plant patents are generally valid twenty years from the date of 

application. Design patents last fourteen years from the date of grant. Copyrighted 

works registered after 1978 are authorized for the life of the author plus 70 years. 

Those registered before 1978 are secured for 95 years from the date the copyright 

was originally secured. For works made for hire, the copyright endures for 95 years 

from publication or 120 years from creation, whichever is shorter. Trademark rights 

can exist indefinitely if the owner continues to use the mark and re-registers it 

every ten years.

Enforcement

The Founding Fathers created both a right for IP owners and the private legal 

means for them to defend those rights in the courts. Thus, most U.S. intellectual 

property owners rely on their own attorneys, not their government, to defend their 

IP rights in the United States. Foreign infringers fully understand this difference. 

Former U.S. Patent Commissioner Bruce Lehman notes that foreigners ‘‘are particularly freaked by (patent) litigation.’’ The reason is clear: U.S. Federal courts are far 

more difficult to subvert than U.S. politicians. 

In the United States, private lawsuits to defend patents, copyrights, trademarks, 

trade secrets, masks and plant varieties are potent because the decision to act resides with the IP owner and the Federal courts are strong judicial bodies that can 

impose massive penalties. The strength of the courts is the judges, whose qualifications are reviewed and approved by the U.S. Senate. For more than two centuries, 

America’s Federal judges have been capable, often brilliant and uncompromisingly 

honest. 

To further ensure fairness, the courts have a strong appellate system, which allows an impartial and competent review of lower court decisions by panels of other 

judges. To provide a knowledgeable review of complex patent and trademark cases, 

Congress created the U.S. Court of Appeals for the Federal Circuit, which is located 

in Washington, D.C. Created in 1982, this court hears all appeals on patent and 

trademark cases. 

Before the creation of this new court, the 11 appeals courts (now 12 in number) 

upheld only 40 percent of U.S. patents in litigation; afterward, the new Federal Circuit Court has upheld roughly 80 percent. 

America’s strong intellectual property laws and an equally strong judicial system 

are hazards for counterfeiters, pirates and infringers inside the U.S. The statistics 

of private patent suits illustrate why. Alexander I. Poltorak and Paul J. Lerner in 

Essentials of Intellectual Property estimate that only 1.1 percent of all patents 

are ever litigated. 

Of that one percent that are litigated, almost 76 percent settle before going to 

trial, generally after an expenditure of $1 million or more by each side. Only four 

percent of all suits filed eventually do go to trial. The other 20 percent are either 

withdrawn or dismissed. Thus, only about 4/100 of one percent of patents are litigated. 

Of cases where a patent’s validity is challenged, Poltorak and Lerner report that 

litigation upholds 67 percent. When infringement is litigated, patent owners win 66 

percent of their cases. These are very good odds for patent holders, and very bad 

ones for pirates, counterfeiters or infringers—at least in the United States. 

Such low litigation numbers, and such high success rates for patent owners, are 

a positive reflection on the U.S. Patent and Trademark Office, signifying that its 

examinations are thorough and the patents it issues are strong—again, at least inside the United States. 

When the first U.S. Congress created the first patent and copyright laws, they 

considered court-ordered civil sanctions sufficient to deter infringers. In 1909, Congress decided that civil sanctions were insufficient to stop some brazen copyright infringers, so criminal prosecutions were authorized as an additional deterrent. In 

1992, Congress broadened the law, making copyright infringement a felony offense 

under Federal law ‘‘if at least ten infringing copies or any type of copyrighted work 

with a value of $2,500 or more are made or distributed in a 180-day period.’’ The 

Economic Espionage Act of 1996 made the theft of trade secrets a Federal crime re-
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gardless of who benefits. Unlike copyrights, trademarks and trade secrets, no Federal law makes patent infringement a criminal act. 

In addition to the civil suits and Federal criminal prosecutions, U.S. IP holders have another means to keep infringing goods out of the United States. Under 

Section 337 of the Tariff Act of 1930, the U.S. International Trade Commission is 

empowered to investigate allegations of patent, copyright, and trademark infringements of imported goods, plus the misappropriation of trade secrets. The Commission is an independent, quasi-judicial Federal agency that analyzes the effects of 

imports on the economy and directs actions against unfair trade practices, such as 

intellectual property infringement. 

If an IP holder thinks that its rights are being infringed upon by unauthorized 

imports, it can file a formal complaint with the Commission. If the Commission 

votes to investigate, it appoints an Administrative Law Judge to preside over the 

proceedings and make an initial decision. Hearings are held and eventually the 

Commission makes a decision or a settlement is reached. Between the mid-1970s 

and January 2004, the Commission heard 505 cases involving alleged violations on 

items that range from integrated circuit chipsets to rodent bail stations (a better 

mousetrap). When the Commission finds there has been an infringement of a valid 

and enforceable U.S. patent, copyright, trade secret, or trademark, it orders the 

Customs Service to exclude that good from entry into the United States. 

Other Federal enforcement of U.S. intellectual property laws has been reduced to 

the point of vanishing since the 9/11 attacks, as most of its resources were transferred to the war on terrorism.

Foreign Protections

A distinctive feature of intellectual property protections is they are of national origin, issued country by country. Consequently, having the protection of a patent, 

copyright, or trademark in the U.S. does not automatically mean that a creation is 

safeguarded elsewhere. Rather, IP owners must generally seek protection country 

by country. 

Most important, many nations do not provide the legal means to enforce their 

trademarks, patents and copyrights. They have IP laws on the books, promise to enforce those laws, and then allow, even encourage violations. Their laws are niceties, 

as fake as the goods whose production they facilitate. 

The major problem faced by American intellectual property owners is not one of 

inadequate protection inside the U.S., but the absence of such means in most developing nations. In such instances, U.S. intellectual property owners are forced to depend on the U.S. Government to act on their behalf. Only the Office of the United 

States Trade Representative can initiate a U.S. intellectual property case against 

other governments at the World Trade Organization. 

Ironically, after leading the long, historic fight to put the WTO’s IP protections 

into place, Washington is now strangely unwilling to use them. Since June 2000, 

the U.S. has not filed a single intellectual property case at the World Trade Organization, although the Office of the United States Trade Representative documents 

each year, country-by-country, their IP infringements and how this theft is permitted, even encouraged, by the national governments.

The World Trade Organization and Intellectual Property Rights

In response to the massive international theft of U.S.-owned intellectual properties, the United States in the 1980s and 1990s championed the creation of a new 

body of international laws and protections, called the Trade Related Intellectual 

Property System (TRIPS), which is administered by the World Trade Organization 

(WTO), and sets minimum IP standards for WTO members. 

TRIPS came fully into force on January 1, 2005. The TRIPS agreement is the 

most significant intellectual property agreement of our time. It covers five broad 

areas: First, TRIPS defines the basic principles of how international intellectual 

property agreements will be applied. The main principle is national treatment—that 

is, governments will deal with foreigners and their own citizens equally. A corollary 

is called ‘‘most-favored nation’’—that is, all foreigners will be treated equally. If the 

U.S. gives a trade concession to Mexico, it must also be willing to give the same 

concession to Chili, Brazil and all other nations. This mandate prohibits discrimination among nations. 

Second, TRIPS ensures that adequate standards of protection are provided by all 

participating nations. To this end, TRIPS strengthened the provisions of the principal international agreements that existed before it was created, including the 

Paris Convention for the Protection of Industrial Property, which includes patents 

and industrial designs—setting new and higher standards. For copyrights, TRIPS 

included computer programs and databases. It expanded international copyright 
267

rules to include rental rights, thus taking pirates on directly. TRIPS also gave performers the right to prevent the unauthorized recording and use of their live performances for 50 years. With that, the WTO took on bootleggers. 

TRIPS gives international protection for trademarks, defining what is eligible, 

plus the minimum rights nations must provide. When place names, such as ‘‘Tequila,’’ ‘‘Scotch,’’ and ‘‘Champagne’’ are used to identify a product, TRIPS provides 

special protections for those products as well. Industrial designs are protected by 

TRIPS for a minimum of 10 years and patents for at least 20 years. Nations must 

provide patents for both products and production processes, though they can exclude 

diagnostic, therapeutic techniques, surgical methods, plants, animals and biological 

processes for the production of plants or animals. Plant varieties, however, have 

TRIPS patent protections. A process patent extends to the product directly created 

by the process. The TRIPS Agreement allows governments to issue a patent-holder’s 

competitor a compulsory license for a patented product or process, but only under 

strict and defined conditions. 

Integrated circuit layout designs are protected for a minimum of 10 years under 

TRIPS. Governments are required to take all necessary steps to protect undisclosed 

information and trade secrets of commercial value. Finally and most important, Part 

2 of TRIPS defines minimal standards. If any party to TRIPS wants higher standards and longer terms of protection for the intellectual properties, they can have it, 

provided they do not discriminate against or between foreigners. 

The third part of TRIPS is enforcement. The agreement requires all signatory governments to enact laws that ensure the enforcement of this agreement and provide 

penalties that are sufficient to deter future violations. TRIPS enforcement requirements are defined in detail, including rules for getting evidence, provisional measures, injunctions, damages and other penalties. Under TRIPS, governments must 

provide courts that can review administrative decisions and order the disposal of 

counterfeit goods. Governments are also required to make willful trademark counterfeiting and copyright piracy criminal offenses, punishable with jail sentences and 

to prevent the import of counterfeit and pirated goods. 

The fourth part of TRIPS is its dispute settlement procedures. If any nation 

thinks that any other nation is violating the TRIPS provisions, they can take their 

case to the WTO, where a three-person panel will hear the complaint. The loser in 

that complaint can file an appeal at the WTO and be heard by a new appeal panel. 

That decision is final. If a defendant nation loses the case, it must change its laws 

and practices or pay damages to the plaintiff nation. Those damages can be paid 

in cash, or the winning plaintiff nation can impose tariffs on a list of the defendants’ 

imports sufficient to pay an amount set by the TRIPS dispute panel. The WTO can 

impose costly penalties on those nations that fail to uphold their IP agreements. 

Fifth, the WTO provided special transitional arrangements while TRIPS was 

being introduced. 

The WTO dispute settlement procedure is a powerful tool. If the U.S. believes, for 

instance, that China is not fulfilling its TRIPS obligations to provide protections 

against piracy and counterfeiting of U.S. IP, it can take a case to the WTO. And 

if the U.S. can prove that this theft is costing U.S. authors, artists, inventors and 

other IP owners multiple billions of dollars annually, it can ask for annual compensation in that amount for as long as the theft and China’s institutional unresponsiveness continues. Moreover, the U.S. does not need China’s permission or help 

to collect the money once a WTO verdict is issued. Under the WTO, the U.S. can 

impose a small tariff on every good imported from China and then distribute those 

funds to the U.S. victims. Or, it can impose large tariffs on a few Chinese imports. 

All that is required is national political will and lawyers who can prove to a WTO 

panel what the victims allege. Most important, such action is legal and conforms 

to the TRIPS agreement signed by China.

China’s WTO TRIPS Compliance on Intellectual Property Protections

The Office of the United States Trade Representative’s 2004 Report to Congress 

on China’s WTO Compliance reveals that China is putting its framework of laws, 

regulations and implementing rules into compliance with the TRIPS Agreement. 

The problem noted in the report is ‘‘Enforcement of these measures, however, remained ineffective in 2004.’’ The USTR pointed out that nearly three years after 

China’s accession to the WTO U.S. right-holders uniformly say that intellectual 

property rights infringement in China is rampant. Witnesses also report that such 

violations are worsening. Although China has established three mechanisms for intellectual property rights enforcement, none is having a deterrent effect. Specifically, 

the USTR concludes,
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• Administrative Enforcement—‘‘Although the central government continues

to promote periodic anti-counterfeiting and anti-piracy campaigns, and these 

campaigns result in high numbers of seizures of infringing materials, they are 

largely ineffective.’’ • Criminal Enforcement—‘‘At present, criminal enforcement has virtually no deterrent effect on infringers. . . . Partly because of these weaknesses in China’s 

laws and regulations, China rarely pursues criminal prosecutions.’’ • Civil Enforcement—‘‘U.S. companies continued to complain in 2004 that there 

is still a lack of consistent and fair enforcement of China’s IPR laws and regulations in the courts. They have found that most judges lack necessary technical 

training and that court rules regarding evidence, expert witnesses and protection 

of confidential information are vague or ineffective. In addition, in the patent 

area, where enforcement through civil litigation is of particular importance, a 

single case still takes four to seven years to complete, rendering the new damages 

provisions adopted to comply with China’s TRIPS Agreement obligations less 

meaningful.’’

China’s failure to meet its WTO TRIPS obligations is dearly costing foreign IP 

owners. The Chinese government estimates that in 2001 the market value of bogus 

goods sold in China was between $19 billion and $24 billion. The technology stolen 

to produce many of these goods has a far greater value, as does the harm done to 

the reputations of IP owners, plus the value of bogus sales outside of China. This 

estimate is a vast understatement of the true costs of the IP theft emanating from 

within China’s borders. 

Despite intense attempts over many years, U.S. diplomacy has not persuaded 

China’s leaders to fulfill their TRIPS obligations. The result is a Chinese Potemkin 

village of protections—newly created national bureaucracies putting into place the 

forms, regulations and institutional mechanisms that real intellectual property protections systems have. 

Yet, local officials have great power and often little connection with national authority. Viewed from their perspective, why should a local official take jobs away 

from neighbors, friends, family and constituents and give them to an unknown foreign corporation, inventor, author or artist whose operations may be elsewhere, 

maybe not even in China? 

As for private enforcement of intellectual property rights, the very idea of patents, 

copyrights, trademarks and trade secrets are as novel to China as are ideas of constitutional rights, religious freedom and civil law. China is an old civilization. To 

graft the U.S. system of intellectual property rights onto China’s ancient political 

culture may be as difficult and odd a task as trying to graft a grape vine unto a 

mature oak tree. 

Professor William P. Alford of Harvard Law School, captures the essence of the 

problem in To Steal a Book is an Elegant Offense. He writes,

‘‘A system of state determination of which ideas may or may not be disseminated is fundamentally incompatible with one of strong intellectual 

property rights in which individuals have the authority to determine how 

expressions of their ideas may be used and ready access to private legal 

remedies to vindicate such rights.’’

China’s culture, of course, can change, but to expect its political leaders to accept 

foreign notions of intellectual property laws, individual civil rights and private legal 

remedies as a central part of its political structure is not likely to happen soon, if 

ever. To expect the Chinese public to forego voluntarily the production or purchase 

of pirated and counterfeited products simply because some foreigner owns the exclusive use of an invention, trademark, trade secret or a copyright is too high a hope, 

at least in the near future. 

If China’s economy evolves as did Japan’s, the Chinese may become interested in 

intellectual property protection when they develop proprietary technologies that 

they want to secure in other nations. Until then, foreign intellectual property owners must regard China as the great threat to their creations that it is.

Intellectual Property Rights Under Assault Within the U.S.

The assault on U.S. intellectual property rights and enforcement extends into the 

U.S. In a protracted legislative patent war during the 1990s, several foreign governments and large corporate interests tried to weaken U.S. patent protections, and 

continue to do so. Among other proposals, these interests sought to:

• Remove the U.S. Patent and Trademark Office from congressional oversight, 

• Vest control of the patent function in a private corporation whose directors 

would be appointed by the President, 
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• Eliminate civil service protections for patent examiners, • Shorten the term for U.S. patent protections, • Award a patent to the first person to file an application rather than the person 

first to invent a new creation, • Allow competitors to challenge the claims in a patent while the application is 

still under review at the Patent Office, • Limit the ability of patent-holders to defend their rights in the courts, • Publish the details of a patent application eighteen months after it is filed, even 

if no patent has yet been issued.

The 18-month provision was enacted into law in 1999. Today, the details of a U.S. 

patent application are made public, via the Internet, eighteen months after it is 

filed. Only those applications for a U.S.-only patent are exempt from this rule. Yet, 

the U.S. Patent Office takes an average of 27 months to issue a patent. Thus, an 

inventor has a period of 9 months when the secrets of the innovation are made 

known to the world and no protections exist. An inventor can sue the infringer after 

being awarded a patent, but often requires filing a case in foreign courts—a costly 

process. One consequence of this rule is that U.S. creations are being stolen before 

inventors have the protections of a patent. Equally important, many inventors are 

keeping their creations as trade secrets, thus diminishing the general knowledge. 

The un-enacted proposed changes to U.S. patent protections remain a top U.S. 

lobbying priority of the Japanese government, the European Union and several 

transnational corporations and their business associations. 

In the 1990s, advocates of copyright change persuaded Congress to lengthen the 

duration of copyrights, legislation the Supreme Court later ruled constitutional. An 

unintended consequence of the copyright extension is that much of the knowledge 

created in the last 75 years of the 20th century is frozen in copyrighted works whose 

ownership is unknown, that produces few if any royalties, is not digitalized, and 

thus remains largely unavailable to most potential users. Were the commercially inactive portions of that copyrighted knowledge base released into the public domain, 

existing computer technology could easily deliver it to the fingertips of anyone connected to the Internet. One option for releasing this vast body of knowledge would 

be to alter the copyright laws in a manner that returns the term of a copyright to 

a short period, such as 14 years enacted by the first U.S. Congress, but allow owners to review indefinitely, as is now done with trademarks. Owners of commercially 

viable works would likely renew. By not renewing, owners of non-commercial works 

could speed their creations into the public domain.

Recommendations

China is unlikely to have an effective system of intellectual property protections 

any time soon. TRIPS is a legal way for the U.S. to address China’s failure to meet 

its WTO intellectual property obligations. 

I recommend that the U.S. initiate a WTO case against China for failing to meet 

its TRIPS commitments. A WTO finding and the U.S. collection of damages would 

provide the Chinese government a substantial incentive to fulfill its TRIPS obligation. I also recommend that the collected damages be divided among the damaged 

U.S. IP owners, rather than be deposited in the U.S. Treasury. The victims deserve 

the compensation. 

I also recommend that the USCC bring to Congress’s attention the unintended 

damage created by the 18-month patent application disclosure rule and urge it to 

revert U.S. policy to that followed for more than two centuries—that is, the U.S. 

Patent and Trademark Office is obligated to keep the details of a patent application 

totally secret until a patent has been issued. If no patent is issued, that Office is 

to vigorously guard the application, allowing the inventor to protect the innovation 

as a trade secret.

Conclusion

Innovation is America’s competitive advantage. U.S. domestic intellectual property 

protections must reflect that reality and our government must resist attempts to 

weaken the IP rights of its creative people. 

Globally, the U.S. led other nations in creating a body of IP protections at the 

WTO. The time has come to test whether those protections are real. An intellectual 

property case against China is the ideal check as to whether TRIPS can work. If 

not, the U.S. needs to know and then act accordingly and quickly. Passivity on such 

a far-reaching threat is the most dangerous policy.

Chairman D’AMATO. Thank you very much, Dr. Choate. 

Mr. Fishman. 
270

STATEMENT OF TED C. FISHMAN

AUTHOR, CHINA INC.: HOW THE RISE OF THE

NEXT SUPERPOWER CHALLENGES AMERICA AND THE WORLD

CHICAGO, ILLINOIS 

Mr. FISHMAN. Good afternoon. What an amazing day this has 

been. I wrote a book China, Inc., which came out in February, and 

now I have to revise every single page of it. 

I have a prepared testimony. It links so much on what other people have said today, that I thought I would veer from it and build 

on the remarks that I’ve heard this morning. So with your indulgence I will do that. 

First I want to thank the Commission. One of the experiences 

I’ve had in writing China, Inc. is that I’ve given a lot of talks 

around the country and a few hundred outings on the radio and 

television, too. I hear all kinds of voices on China and how people 

feel about China. 

When I made the rounds in Washington when I began this 

project, I went to all kinds of places. There’s a lot of intelligence 

about China in Washington, but it’s all very atomized. There are 

the guys who worry about strategy, the guys who worry about 

trade, the guys who do cultural exchange. But I think your Commission alone is one of the few places in this whole country where 

our government is trying to figure out what should be the general 

national consensus about China in this country. Unless we have a 

general view and we could put together all of the different hats 

that people wear on China and figure out what’s best for the 

United States, then we’re not going to have a useful policy. Instead 

it’ll be poached away bit by bit and we’ll be working against ourselves. 

That’s very much true on intellectual property, because this is a 

perfect case in which we wear two hats. We wear hats as consumers in which many ways we benefit enormously from China’s 

very loose, to use a charitable term, intellectual property regime, 

because it drives prices down for the consumers. I’ll talk about that 

in a bit. 

The first thing I want to say in general, though, is we should do 

a thought experiment which builds a little bit on what Dr. Choate 

said and that thought experiment is what we would do if we were 

making policy for the Chinese, what kind of intellectual property 

regime would we want for our country. 

All governments think about what is the best of the welfare of 

their people. Bad governments do this to some degree, good governments try to do it entirely. And if you were the leader of 1.3 to 1.6 

billion people—mostly poor people, desperately poor people—and 

you could give them the wealth of the world’s most advanced, industrialized economies in entertainment, in pharmaceuticals, in industrial goods, in technologies, what would you do? 

Would you say if there were no consequence to you—and there 

has been no consequence to the Chinese—would you enforce intellectual property laws or would you say, no, let all of this technology 

come here. I’ll entertain my people, I’ll keep them healthy, I’ll 

make them smart. 

There is a real logic in the Chinese position. If you are thinking 

about solutions on how to approach it that will benefit Americans 

you have to think that you are against a very mighty agenda on 
271

the part of the Chinese government. It is a policy of the Chinese 

government not to enforce intellectual property. It’s an industrial 

policy. It’s a welfare policy. It’s an entertainment policy. It’s a cultural policy. And any change that we want to make has to go 

against the full might of those agendas, of a government that fully 

sees itself acting in the interests of its people on this issue. 

You might have noticed in some of the recent news on Japan, for 

example, I was just noticing this in the paper yesterday, that one 

of the things Japan wants to talk about with China in the midst 

of all of these protests and demonstrations is intellectual property. 

I can’t help but think that one element of these demonstrations is 

a way to get the Japanese to back down on almost every item in 

their agenda. 

There’s quite a bit of vehement demonstration. The Japanese are 

being made to know that there are millions of people who can 

throw bottles and rocks at Japanese facilities and surround them 

any time they want should the Japanese press too hard on anything, including intellectual property. 

I got a call this morning, interestingly enough, from a man who 

came to one of my readings. His name is Ron Hollis. He runs a 

company called QuickParts. He said, ‘‘Mr. Fishman, I have to talk 

to you about my recent trip to six cities in China.’’ He’s a manufacturer who makes prototype-molded parts, kind of the nuts and 

bolts of American industry. They’re molded plastic, they’re formed. 

He’s got a laser machine that can create any kind of part on very 

short notice for a prototype. 

He said, ‘‘You know, American manufacturers do not understand 

what’s going on in China, that there is a very high level of sophistication.’’ We’ve heard about it at the universities and at the hightech firms of China, but in the mid-tech and the low-tech firm 

there’s a very, very virulent strain of intellectual property theft 

going on that affects American industry. 

He told me he couldn’t go to any of the factories that he had visited and not see knock-off parts copied from his customers. They 

were simply there. Not only that, but he would take a poll wherever he went. And he would say, ‘‘Well, how many computer stations do you have in this factory,’’ and there might be 40 or 50. 

He said, ‘‘Well, how much have you paid for software.’’ And it’s 

not just Windows software or database software; these are the advanced, industrial design software packages, which run American 

industry. 

Almost to a facility no one had paid anything for those factories. 

Now we just heard from the motion picture association and from 

Warner Bros. We know that their goods are pirated. We know that 

Microsoft goods are pirated. With apologies to them, it’s very hard 

to get American consumers to weep for Microsoft or the motion picture industry. 

In fact, when we have the opportunity to pirate from them without consequence, we do the same thing. That’s what Napster was 

all about. 

But if you think beyond the level of lost sales, which Dr. Choate 

was talking about, which is around an $80 billion calculus (China 

takes $80 billion worth of sales from companies that would sell 

them equivalent values of goods), if you go beyond that and you 
272

look at the competitive ramifications of it, that a Chinese factory 

working on a platform of counterfeit software or even an entire production line which counterfeited, is operating in an environment 

which they have no technology cost, competing against American 

manufacturers who have a very high technology cost. In these manufacturing facilities it can cost $50 to $60,000 a year on a single 

computer station to run some of the advanced costs. 

Do the math. If there are 50 engineers working on those stations, 

it’s already millions of dollars. But some of these places have hundreds. I went into an automobile factory in China, which with their 

200 workstations each with thousands and thousands of dollars of 

pirated software on it, they are competing against auto parts makers, American automotive makers who have high technology costs. 

This is part of China’s low-cost manufacturing machine. It’s something you can’t compete against. 

You might be able to find a way to save labor, but you can’t save 

on your technology cost. It’s simply a cost that they don’t have to 

bear, that we do, and it is kind of a competitive advantage, which 

is almost impossible to overcome. 

I talk about some more examples of this in this my written testimony, the main focus of which is the mismatch between our economy, which is a knowledge economy and knowledge-based economy, 

and China’s economy, which is a things economy. Some things we 

can talk about in the question and answer period are what are the 

remedies for this. You’ve talked about them in some ways already. 

I think the apples-for-oranges remedies are very, very important. 

You have to think, even rethink WTO. 

If the Chinese are pirating our movies, maybe we put their movies in the public domain on day two. That’s something that we 

ought to think about. And we ought to be very open-minded, working at the very top of our intelligence on this. Also figuring out how 

big a stick we’re willing to carry in this, because the situation is 

just getting worse. Pirating is creating multibillion-dollar companies in China, and they now will compete against Americans at the 

highest level. 

Thank you. 

[The statement follows:]

Prepared Statement of Ted C. Fishman

Author, China Inc.: How the Rise of the Next Superpower

Challenges America and the World

Chicago, Illinois 

First, I want to commend the Members of this Commission, and its staff, for attaching high importance to the issue of technology transfer to China. You are certainly correct in regarding technology transfer as one of the most crucial issues in 

our relations with China and in our economic futures. In reporting my book, China, 

Inc.: How the Rise of the Next Superpower Challenges America and the World, I 

came to see the transfer of technology and other intellectual property to China as 

one of the most urgent problems in our economy. Without swift and forceful action 

to reverse the free—and by ‘‘free’’ I mean ‘‘no cost’’—flow out of our knowledge economy into China, the United States will lose the heart of our economic strength and 

see a rapid diminution in our standard of living. I will come to some of the specifics 

of the argument further on. First, I would like to put my comments on technology 

transfer and intellectual property in context with a few general observations about 

China and the United States. 

China now informs nearly every big question about America’s future. Take your 

pick: the future of our financial system, the demands on our schools at every level, 

how we shop, how we make things, how we employ workers at home and around 
273

the world. Our national security, global prestige and persuasiveness are increasingly 

affected by China’s new-found economic might and confidence and, more importantly, by how we see China’s future prospects. Whatever China’s weaknesses—and 

it has many—it is folly not to acknowledge that its long-term prospects will most 

likely build on its considerable strengths, and that the country will go richer, 

stronger and far more influential over the coming decades. It is all but inevitable, 

for instance, that China will overtake the United States as the world’s largest economy. Simple math makes the point. With five or six times the U.S. population, 

China need only provide its people with one-fifth or one-sixth the average income 

of Americans to have the largest economic footprint in the world. There is much talk 

lately about the value of China’s currency, with some U.S. manufacturers suggesting 

that the yuan is 40 percent cheaper against the dollar than it ought to be. Should 

China take the single step of letting its currency float freely on the world market, 

the per capita incomes of the Chinese will increase from one-thirty-eighth of the 

U.S. average, to one-twenty-seventh. That is still low enough to keep China as a 

low-cost factory floor for the world, but it nonetheless offers an enormous boost in 

China’s economic footprint. 

To date, looking over the last twenty years and arriving at the present—the 

economies of the United States and China have acted as great complements to one 

another. China has proved more than able at manufacturing the physical things of 

this world, often at low costs no other countries can match. American consumers 

benefit. On average, the China price returns about $600 in savings every year to 

American consumers. Those who spend more, save more. In contrast, the U.S. Government’s recent tax cuts to individuals, designed to be an economic stimulus, returned half as much, and the country had to draw down from the treasury and add 

to our public debt to put that money in people’s hands. China simply delivers it. 

So when we talk about how cheap technology transfers contribute to the Chinese 

low-cost manufacturing machine, we should admit that on one level Americans, and 

the rest of the world’s consumers, benefit mightily. 

First, I want to stress that I see no point in demonizing the Chinese for their own 

practices. They have solid reasons for doing business the way they do, and many 

of us would act in much the same way were we in the position the Chinese now 

find themselves in. Here’s a simple thought experiment. Imagine you were the 

leader of between 1.3 and 1.6 billion people, most of them desperately poor and modestly educated. Suppose you could transfer to your people the jewels of the world’s 

advanced industrialized nations, paying nothing for much of it and pennies on the 

dollar for some more. Suppose, in other words, you could steal the best technology, 

copyrighted materials, brand names and top entertainment for your wanting people. 

And imagine further that you had little expectation of being held to account for that 

theft. In contrast, you would be rewarded for it. In fact, that theft would make your 

country an ever-more desirable home for the very international fashion, technology 

and knowledge enterprises you were so liberally borrowing from. Anyone here would 

make that choice—the choice which the Chinese government and people made and 

still do make every day. One of the precepts of good leadership is to make one’s people prosperous and capable, and the Chinese practices have followed that hands 

down. Remember, the incomes of the Chinese have risen four-fold in twenty years, 

the use of personal computers is widespread and expert and Chinese factories routinely run on the very same software that their competitors in America use. In all, 

China’s creation of an extremely loose intellectual property regime has paid off 

handsomely. And, we must admit, impressively. It has been a key element of 

China’s growth. Rather than fault the Chinese for the method of their progress, I 

suggest we offer admiration, grudgingly, but sincerely. Conceding their success, 

however, does not mean conceding. It is now time we exercise what means we have 

to enforce global rules that will also serve the American economy. 

To understand the deep threat to the U.S., it helps to understand the mismatch 

between the Chinese economy and ours. 

The U.S., and other rich industrialized countries, now bet our best dollars on the 

knowledge economy, the amorphously defined new world in which better ideas, not 

faster, cheaper hands, create jobs and wealth. Consider what an advanced economy 

like ours does best: make movies, produce television shows watched from Helsinki 

to Cape Town, turn out global pop stars. We design the software and processes that 

streamline the operations of giant retail chains and global high-tech manufacturers. 

We engineer advanced engines and the guts of the world’s computers. We devise 

brands, durable corporate identities and fashions. We conjure new ways to move 

money and put it to work. We turn the most basic tasks into knowledge work. Modern printers, to note one example, rely heavily on the most advanced automated 

presses, computerized design tools and management and shipping for delivering materials efficiently to consumers and are as dependent on the latest software and 
274

technological innovations as a biotech lab. And those 2.8 million American workers 

who in recent years have lost their factory jobs? They don’t learn new ways to use 

power tools. They are retrained in front of a computer; they learn to run the robots 

that do the jobs they used to do. You do not need to look at factory floors to see 

how deeply the knowledge economy reaches. Even that most ancient, and basic of 

all human tasks, farming, has been re-made by our knowledge economy. A farmer 

wakes in the morning to check weather and futures prices on PC with an Internet 

connection, he climbs into the cab of a $200,000 farm machine that makes its way 

through the fields using GSP navigational technology. Under the wheels grow crops 

that are as highly engineered as the most complex pharmaceuticals, and when they 

are harvested they move throughout the food distribution with an efficiency made 

possible by tracking, inventory and sales software. One American farmer, deploying 

the tools of our economy, developed in public and private laboratories and workshops can do the work of 20,000 Chinese farmers. Even when we produce the physical stuff of the world, we produce it most efficiently because of the knowledge products that emanate out of the 21st century American economy. 

The trouble with this apparently successful state of affairs is that the stuff we 

do best exists nowhere and everywhere at the same time. Some of our most valuable 

things—software codes, pharmaceutical processes, car designs, digital movie files—

weigh nothing and, as e-mail attachments, can move at the speed of light. To learn 

American ideas and procedures is all but the same as owning them. (Unless, of 

course, laws successfully prohibit their co-option.) In contrast, most of what China 

makes that finds its way into the world market is physical. The Chinese can borrow 

and steal the designs to our best products all they want. The statistics are wellknown to this Commission. Add them up and the Chinese economy itself looks like 

a counterfeit economy, one in which the vast majority of goods branded as one thing 

are made by someone else. Everything from simply copied commodity products such 

as household cleaners, fashions, consumer and business technology to goods higher 

up the economic and technical food chain such as biotechnology, automotive and 

aerospace products all have their unofficial knockoffs in China. Sometimes the copying affects only bottom lines, sometimes the stakes are much higher, as in the case 

of false pharmaceuticals. China’s drug industry is a complex mix of enterprises, 

some owned by the state, others private, and nearly all out of bounds of the licensing and quality control mechanisms of the world’s major drug companies, whose 

products the Chinese copy. Copied drugs are sometimes excellent, and sometimes 

deadly. Both pose dangers. Bad copies kill patients, they also have the potential to 

kill American companies because bad drugs are now finding their way into the mix 

of real medicines, so that a vial of 30 pills bought at a local pharmacy in Chicago 

might have one or two bad pills made in a back room in Guangzhou. The patient 

death is bad in itself, but bad medicines also threaten American jobs and wealth. 

The legal repercussions may one day drive a blue chip company into bankruptcy. 

If that sounds far-fetched consider what the recent spate of drugs removed from the 

market have done to the share prices and liabilities of the companies behind them. 

The amount of economic activity in China tied to pirating and counterfeiting is 

staggering. Stolen movies and software are the poster children of global piracy and 

in China they are everywhere. Hollywood’s Motion Picture Association estimates 

that 95 percent of all movies seen in China are pilfered and that its members lost 

$178 million in potential revenue. DVDs are only the most visible items in the pirate and counterfeit economy. Ninety percent of all software running on Chinese 

computers has been pirated and bought openly in stores for around $3 a copy. Using 

a lost-sales calculus, which measures the losses to foreign companies by tallying the 

value of the dubious goods sold, the U.S. Department of Commerce estimates the 

loss to American companies at between $20 billion and $24 billion. The Department 

says the Japanese now lose even more: $34 billion. Add in the European Union and 

the number approaches $80 billion. Thomas Boam, who until recently served as the 

Minister Counselor for Commercial Affairs at the U.S. Embassy in Beijing, argues 

piracy and counterfeiting account for between 10 percent and 30 percent of the $1.4 

trillion Chinese economy. Some estimates go much higher. I will explain further 

how these lost sales numbers undercounts the loss to the U.S. economy. We should 

also consider, however, how these calculations rest on a fiction, one which itself obscures the rationale the Chinese frequently offer for the intellectual property practices. In short, they argue that the real versions of the goods they copy are simply 

too expensive. With drugs it is a compelling argument. The Chinese government 

clearly believes that providing lifesaving drugs for a fraction of their American price 

is in the interests of its people. With things like DVDs the argument is a bit less 

compelling, but price is still the issue. Few Chinese would buy genuine goods if they 

had to pay the prices Americans do. At $20, a DVD movie in a U.S. store equals 

10 days’ wages for hundreds of millions of Chinese factory workers. 
275

And there’s the rub. What Americans make and what the world values moves 

very easily into the counterfeit economy. If Americans wanted to borrow and steal 

the physical stuff that China makes, we would have to march in with an army and 

commandeer Chinese factories and workers. Western powers and the Japanese tried 

that in the mid-19th and -20th centuries, respectively, and, happily, will not repeat 

the experiment. China, however, can in a sense colonize the developed world simply 

through careful study and a willingness to go its own way on intellectual-property 

protection. 

The most hopeful group looking at China’s prospects for reform are those that 

study the country’s growing body of laws. Quite often lawyers attend my talks on 

China and tell me that the country is serious about following international standards and that its volume of legal mechanisms to punish transgressors is growing. 

They even point to some high profile cases in which international parties found 

some redress in Chinese courts. Yet, to an observer in the street, and to those who 

talk to American businesses that face China’s version of enforcement, the story is 

not hopeful at all. Indeed, despite the proliferation of laws, the situation on the 

ground in China grows steadily worse. DVDs are everyone’s favorite example. They 

are so cheap in China that foreigners are every bit as eager to buy them as locals. 

They also are one of the most visible exports from China’s great counterfeiting machine. New laws have had no effect on the trade. Quite the opposite. The places they 

are sold no longer look like back-alley stalls but like Main Street retailers. Near 

Beijing’s diplomatic row, two outdoor markets once famous for knockoff fashions 

have been combined into a large, bright department store-like building with escalators, tailors on site and merchants with business cards, international shipping 

accounts and full stocks of fake fashions, designer tableware, brand-name musical 

instruments and, of course, thousands upon thousands of fake Swiss watches. The 

most common punishment counterfeiters face is the confiscation of whatever products they have in stock. Sometimes a pitiful fine is levied. China’s National Copyright Administration cites with much fanfare 52 raids on video shops in 2003, but 

the total fines amounted to $6,900, or an average of $132 for each offender. 

With apologies to some of the other presenters at this hearing, I offer one trivial 

observation on the way to a more important one. It is nearly impossible to get the 

general public to feel sorry for Hollywood when the Chinese pirate American films 

and movies. Likewise, few in the world weep when big software corporations, such 

as Microsoft, Oracle and Adobe lose sales to pirates and counterfeiters. Yet, nearly 

every time one hears about the dangers of China’s practices to the U.S. economy 

the story is told in terms of the lost sales to these sorts of companies. Missed entirely is the much bigger threat China’s loose intellectual property regime poses to 

our whole economy. American companies are not just creators of intellectual property, they are buyers of it. It can cost millions, or tens of millions of dollars to 

purchase and service the software to run an American company. Yet, Chinese competitors often pay nothing for the same technology, because it is simply stolen. Walk 

into the vast majority of Chinese firms that run computers and one will see one 

work station after another stuffed with $2 versions of software that costs Western 

competitors hundreds of dollars to run. 

China’s loose intellectual property rules also transfer to Chinese industry valuable 

intellectual assets that can take American companies years and cost significant 

sums to develop. American automobile makers can spend half a billion dollars developing and building a new car, and take two years to do it. As soon as the car hits 

the market, Chinese manufacturers study it and look at how to copy it. Chery Motors, the company which will soon introduce Chinese built cars into the U.S. market 

has been accused by General Motors of pirating an entire GM car and beating GM 

to market with the Chery copy. It is not unusual for whole assembly lines to get 

duplicated in China, where the copiers need not worry about the cost of developing 

and designing the lines. Big business in the U.S. is vulnerable, but so are smaller 

firms where often one good idea, patented or kept proprietary in some other fashion, 

is the only truly valuable asset the firm has. 

China’s failure to police its intellectual property rules often looks less like ineffective government than a conscious policy to shift the highest value goods from other 

economies into the country. It is, in essence, the largest industrial subsidy in the 

world, and brilliantly, it costs the Chinese nothing. In 2005, China will most likely 

be the world’s third-largest trading nation, and counterfeiters give the country’s increasing number of globally competitive companies the means to compete against 

powerful foreign rivals that pay for their use of proprietary technologies. In a 

broader geopolitical context, China’s counterfeiters deny the world’s advanced economies, especially in the U.S. and Japan, the opportunity to sell to China the valuable 

designs, trademarked goods, advanced technology and popular entertainment that 

the Chinese urgently desire but cannot yet produce on their own. For the U.S., this 
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mismatch is particularly punishing. Japan and Germany, which also suffer from 

China’s policies, do not have the huge trade deficits with China that the U.S. does. 

One reason is because our export economy is far more dependent on the sale of 

highly valuable, intangible and easily copied goods. Japan and Germany make the 

machines China needs to run. America makes the software that runs those machines. It is far more difficult for us to get paid by Chinese users for what we make, 

though most of the rest of the world pays handsomely for it. Until we can get paid 

for what we make and the Chinese use, our deficits will worsen, not improve. Say, 

for example, that the value of the dollar drops against the Chinese yuan. Economists predict our trade situation will level out, but do not take into account that 

no matter what our goods cost, the Chinese will most likely continue to pay nothing 

for some of the most useful goods we make. And, as a result, their factories will 

continue to be able to beat even the most efficient American factories on price. 

We now have a golden moment in which we can still use our power as China’s 

most important customer to enforce a change in its intellectual property regime. Action ought to be forceful and unequivocal. Our trade deficit with China alone—not 

counting the rest of our trade with the country—is more than ten percent of the 

entire Chinese economy. That is an astonishing figure, and in it we can find 

strength to exert rules over our trade with China. That may require a radical rethinking of past agreements, some brinksmanship with quotas and tariffs and other 

remedies. Without action, however, the U.S. is likely to find our entire economy copied in China and Americans paid little for the brainwork imported to make it run. 

Thank you.

Chairman D’AMATO. Thank you very much. Thank you both for 

your interesting testimony. 

Commissioner Mulloy. 

Panel VIII: Discussion, Questions and Answers 

Cochair MULLOY. I have a couple questions. First I want to salute Dr. Choate. It’s not often that we get a man who ran for Vice 

President of the United States to come and testify before the Commission. 

Dr. CHOATE. It’s not often that you get somebody who lost by 92 

million votes. 

Cochair MULLOY. How many votes did you get? 

Dr. CHOATE. Almost nine million. 

Cochair MULLOY. Nine million votes, all right. 

Dr. CHOATE. That’s definitely a mandate to stay in the private 

sector. 

Cochair MULLOY. So we’re delighted. 

Dr. CHOATE. Thank you very much. 

Cochair MULLOY. We did have this piracy problem in the United 

States when we started out, and domestically we protected it. 

Dr. CHOATE. Yes. 

Cochair MULLOY. It was foreigners. Maybe we were ripping off—

Dickens always used to complain, I remembered. But what you 

have to understand is later we had the Paris Convention dealing 

with patents and the Bern Convention dealing with—that was in 

the late 1890s, in that period. 

Dr. CHOATE. Right. 

Cochair MULLOY. Then when we decided to create a WTO and 

give these developing countries and India and China access to our 

market at an MFN rate 2.5 percent, part of the deal was we have 

IPR interest in your country. Part of the deal is you protect those. 

So we created an international agreement. We weren’t violating 

any international agreement when we were ripping of intellectual 

property rights in the 1800s. They are. They signed it. That’s the 

difference. They should be enforcing it. And they should be giving 
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Americans the intellectual property protection that they signed up 

to give them. That’s part of the deal. So that’s why I feel its important for people to understand that distinction. 

Dr. CHOATE. In my testimony, Commissioner Mulloy, I point out 

that we made a very explicit deal, as we did the GATT negotiations. And the explicit deal that we made, and we led the Europeans and the Japanese in getting this deal, is that the United 

States would withdraw all quotas on textile and apparel imports. 

We would end the old multifiber agreement in exchange for the developing world excepting TRIPPs, the Trade Related Intellectual 

Property Protections inside the WTO. 

Cochair MULLOY. Right. 

Dr. CHOATE. We set a ten-year phase-in. The end of the phase 

in was the 1st of January of this year. We’ve kept our part of the 

bargain. We have to have lost one million apparel and textile jobs 

in that ten-year period. We’ve gone from 1.6 down to barely 

650,000 workers. That is a heavy cost. Incidentally, half of those 

workers are not finding themselves back into the economy. 

It turns out that China, the largest beneficiary of that agreement 

on textiles is China. China now has 25 percent of our market. 

They’re projected by 2010 to have 75 percent of our market unless 

something is done. And they have made no compliance on the intellectual property. 

China promised us and China made a treaty with 147 other 

countries that it would adopt four sets of minimal standards and 

it would provide a judicial system that would operate. I think Commissioner Reinsch hit the point earlier. It is to try to impose on 

China a system of private rights, and private means to enforce 

those rights, that has no experience in the concept of a private 

right of speech, a private right of religion, a private right of politics. It’s in effect as though we’re trying to graft a grapevine on a 

redwood tree. 

Now what I’m urging and suggesting is that we stress the system. If this TRIPPs not going to work——

Cochair MULLOY. And we know it. 

Dr. CHOATE. —we need to know it. We need to stress the system 

and we need to stress it as quickly as we can. 

Cochair MULLOY. Mr. Fishman, how does the lack of IPR protection in China for American products, how does that diminish and 

make Americans less willing to go into math and science in our 

own country? 

Mr. FISHMAN. The lack of IPR protection in China influences almost any issue we have with China, and there are no small issues 

with China. On the education front, for example, if the value of 

your worldwide patents are diminished, then the value of the people who creates those patents is diminished. 

China right now is the only robustly growing large economy in 

the world. You might put India up there, too. For the large companies around the world, they see the United States, Japan, and 

Western Europe as mature, rather slow growing economies, compared to China’s robust ten percent—nine and a half, ten percent 

year over year. They are developing products for that market. 

The CEO of Motorola told me the other day they don’t outsource 

to China, they insource to China, which means they move innova-
278

tion to China to serve that market. In that market they pay engineers one-sixth to one-tenth of what they pay engineers in the 

United States. And they know that their intellectual property that 

they develop in China migrates into the design of products and the 

supply chain very, very quickly. 

If you’re going to pay your highest-paid engineers in 

Schaumburg, Illinois ten times as much, you probably want to push 

as much engineering as you can into more affordable employment 

markets, which right now happen to be very big markets. And how 

in their right mind is going to stick to their centers where they 

have the highest costs. 

I spoke to a convention of manufacturers and I just asked them 

how many of you would let your children do what you do? These 

were people who owned their own manufacturing businesses. In a 

room of about 200, only five hands went up. 

You might ask the same thing of engineers in this country, many 

of whom were represented in the ranks of those manufacturers. 

Who in their right mind would encourage their kids to go be an engineer if they knew that there was a very large chance that any 

company that their children worked for would be looking to pay 

somebody one-sixth or one-tenth of their wage overseas. 

Cochair MULLOY. Thank you both victim. 

Mr. FISHMAN. Thank you. 

Dr. CHOATE. Thank you. 

Chairman D’AMATO. Commissioner Dreyer. 

Commissioner DREYER. Dr. Choate, I hope you’re not letting 

China off the hook too easily here when you say they have no tradition of intellectual property rights, because of course you’re absolutely right historically. On the other hand, over the last ten years 

we’ve seen a fair number of suits of one Chinese citizen suing another Chinese citizen or a company for exactly that. If they know 

how to do it domestically and they know it’s a crime, then I think 

they know internationally. 

Additionally, the Chinese constitution does give citizens freedom 

of religion. 

Dr. CHOATE. Right. 

Commissioner DREYER. Albeit they find other ways to circumscribe it. 

I think it’s going to be very interesting to see these negotiations 

with the Vatican play out. I just hope the Vatican doesn’t do what 

we saw our representatives from the film industry admitting to and 

saying, well, this is a strategic plan; we want a toehold in the market. 

Dr. CHOATE. Um-hum. 

Commissioner DREYER. Because I consider the Vatican to have a 

number of very, very bright diplomats and I would hate to see 

them get mouse-trapped on the bishop appointed. 

But I do think we’ve been far too, ‘‘Oh, well, it’s not in their tradition,’’ forgiving of the Chinese. And I just wanted to be sure you 

didn’t mean that. 

Dr. CHOATE. No, no. On this issue I’m very unforgiving. Whether 

they have it in their constitution or whether they do it to their citizens, they made a commitment with us. They have taken the bene-
279

fits of that commitment, which is going to be worth about 30 million jobs for them. And we’ve paid an enormous price. They owe us. 

It’s up to our government to force that issue. If there’s any fault 

at this point, it’s our fault for not forcing and enforcing our—it is 

here. 

Mr. FISHMAN. Look, we have $170 billion trade deficit with 

China. That’s not even our total trade. That’s just our trade deficit, 

right. That’s 14 percent of the Chinese economy. That is a huge 

stick. 

Dr. CHOATE. Yes. 

Cochair MULLOY. A hundred and sixty-two last year. 

Mr. FISHMAN. Well, I’m projecting for this year, yes. 

Chairman D’AMATO. Nearly three times the size of their entire 

defense budget, even in the inflated terms we understand it to be. 

Mr. FISHMAN. We have this golden window now. 

Commissioner DREYER. Theoretically the defense budget. 

Mr. FISHMAN. We have this golden window that may not last forever, in which we are by far their most important customer. That 

window may close if we don’t act soon. 

Chairman D’AMATO. Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thanks very much, and thanks to 

our witnesses who have been sitting here for quite a while. I actually have a comment more than a question. Mr. Fishman, I think 

I probably disagree with your paradigm from the very beginning 

that the government is interested in the welfare of the people. My 

conception of the Chinese government is that it is these days interested in the welfare of the people only to the extent that bad welfare of the people threatens their hold on power. 

Mr. FISHMAN. Well, maybe they’re not incompatible. 

Commissioner BARTHOLOMEW. I was struck by what you said. I 

don’t know that the interests of the Chinese people are first and 

foremost in the minds of Chinese leaders when they’re making a 

lot of these decisions, and that helps to explain some of how the 

decisions can be made without a whole lot of costs. 

Mr. FISHMAN. Having said that, their per capita GDP has gone 

up fourfold in 20 years. 

Commissioner BARTHOLOMEW. Yes. There is another issue of 

course. You talk about the leverage that we have given the size of 

the trade deficit and everything there. At some point as American 

job loss continues and our economy goes down, one would hope or 

think that they need to be concerned about the fact that people are 

not going to be consuming at the level that they are in order to 

maintain the market that they have here. 

Mr. Chairman, the Cochairs did a great job in putting this together. 

Chairman D’AMATO. Well, thank you very much, Commissioner. 

I’d like to thank both of our panelists. This is an issue that really 

I find embarrassing as an American, the fact that our government 

is unwilling and has been unwilling to actually make any kind of 

moves that are credible and effective in protecting the rights, intellectual rights and the property rights, of our citizens. It’s really 

quite an embarrassment and it needs to be remedied; we’re going 

to try and push as much as we can to get it remedied one way or 

another. 
280

Go ahead, Commissioner Mulloy. 

Cochair MULLOY. Yes, I just asked Dr. Choate about bringing 

this case and using the WTO. We paid a big price to get them in 

there. We ought to use it. 

I’ll tell you what my impression is. I was in the Clinton Administration at the Department of Commerce at a political level. I saw 

the way the USTR behaves. I think they have a proprietary interest in making the WTO look good. I don’t think they are afraid that 

if we bring a case, it’s like the emperor has no clothes. Then if it 

doesn’t work, they’d be embarrassed or their creation doesn’t work. 

I personally think you bring the case and if you can’t win the 

cases, then your policy is clear that that group won’t work and 

we’re going to do something else. That’s my observation. 

Dr. CHOATE. It’s very much in our tradition to do that. The first 

patent act of 1790 turned out to be too uncomfortable. Thomas Jefferson worked. They changed it 1793. That didn’t work. They 

changed it again in 1836. This is part of democracy and it’s part 

of our tradition. If something doesn’t work, you find something else. 

But you deal with the problem. The problem in this case is it’s totally unacceptable to have our innovation stifled by another country violating an agreement and stealing it. 

Chairman D’AMATO. At the same time that they’re dependent to 

a large extent on their development on our economy, and we’ve allowed that to happen. 

Dr. CHOATE. And selling the goods back here to us. 

Mr. FISHMAN. Here is a provocative thought on that, which is 

how do American companies participate in the theft. When you go 

into a big box retailer and there’s a DVD player there that costs 

$29 and the license fee on that DVD player is $12, and those are 

stacked from floor to ceiling in those factories, there are American 

companies who are winking and nodding at their Chinese suppliers 

for stealing on their behalf. 

Cochair MULLOY. That’s a great comment. 

Chairman D’AMATO. I want to thank this panel for its testimony. 

I would also like to extend our appreciation as a Commission to the 

Hoover Institution; Stanford University Law School, in particular 

Julia Erwin-Weiner and Courtney Ewing for their assistance in arranging for the use of this facility. 

We would also like to express the Commission’s deep appreciation to Kareen Lambert, Wayne Fishburn, Heather Milnbarger, 

and Julie Wicklund of Cooley Godward and all the others who 

worked so hard to make this onsite visit possible. 

Finally, a special thanks to the Commission’s excellent program 

and administrative staff who worked long hours preparing the program and agenda. Thanks especially to Carmen Zagursky, who arranged for this hearing; our Associate Director, Kathy Michels; 

David Ohrenstein, our Trade Counsel; Scott Bunton, our Executive 

Director; M.L. Faunce, Davetta Vaughn and Romayne Houle, Staffing and Program Assistants; and Olivia Knight, Research Fellow, 

for their hard work. Lastly, thanks for the court reporters and the 

technicians for their help for these two days. 

This concludes the hearing. 

[Whereupon, at 1:00 p.m., the hearing was adjourned.] 
281

Statement of Oded Shenkar

Ford Chair, Fisher College of Business, the Ohio State University

Intellectual Property Rights

Honorable Members of the Commission, the infringement of IPR by China, which 

takes the form of piracy, counterfeiting (trying to pass a pirated product as a genuine article), and related practices, is at the heart of the U.S.-China economic relationship, since, simply put, China is the world’s number one violator while the 

United States pays the heaviest price of the infringement. The repercussions of IPR 

violations of are not merely economic, but carry over to the strategic, geopolitical 

and national security arenas. The problem has repeatedly featured on the agenda 

of U.S. trade negotiators, but in my opinion does not receive the attention it deserves. From the perspective of the U.S.’ national interest, IPR violation should top 

the list of bilateral and global trade issues, ahead of exchange rate alignment, which 

seems to be the current focus of the U.S. Administration efforts, or any other trade 

related items. IPR violations by China should also be of primary concern to U.S. policymakers, businesses, individual copyright owners, and U.S. taxpayers who have 

been funding a substantial portion of domestic R&D expenditure only to see a substantial portion ‘‘borrowed’’ without compensation. 

That China violates IPR is well known, but many do not recognize the scope of 

the problem. China is not the first or only nation to violate IPR, but it dwarfs other 

contenders, such as India and Vietnam, in the scale, scope and range of IPR violating goods. While U.S. media continue to showcase the bootlegging of DVDs (obviously 

a huge problem to the movie industry), Chinese outfits routinely copy anything from 

razor blades and cigarette lighters to pharmaceuticals, automotive components and 

even entire cars. China is able to do that because it possesses a unique combination 

of advanced production capabilities and widespread disregard for IPR. Typically, nations with advanced technological capabilities respect IPR to a reasonable (though 

variable) extent, while violating nations lack the capabilities and infrastructure to 

replicate technology- and capital-intensive products. China is the only nation which 

is able and willing to make high quality copies of complex industrial designs within 

a short time of accessing the necessary information (often by reverse engineering). 

Various estimates put IPR violating production at ten to twenty percent of Chinese output, though the phenomenon, by nature, defies accurate quantification. For 

example, China is the leading source of U.S. custom seizures of counterfeit imports, 

but it is obvious that the goods apprehended represent a mere fraction of the actual 

volume of infringing products coming into the country, and that similar products 

routinely make their way into other markets, sometimes in broad daylight. Numbers 

are also difficult to come up with since many U.S. and other multinationals do not 

want to offend the Chinese authorities and are also fearful of repercussions should 

legitimate customers come to suspect their products as not being genuine. 

The damage caused by IPR violations is enormous though often underestimated. 

Some of the costs include: 

1. The substitution of a genuine product by a fake creates substantial revenue 

loss. The loss is not limited to the Chinese market (where it is estimated that almost half of foreign multinationals lose upward of twenty percent of local sales to 

violating products) as counterfeit and pirated goods are now exported en masse to 

global markets, especially (but not only) to those where IPR protection is lax. For 

U.S. car makers, whose better margins on ‘‘after market’’ components compensate 

for very slim manufacturing margins, the damage can be quite salient. Obviously, 

the cost is born by stockholders, legitimate suppliers, employees, dealers and more. 

2. The violation of IPR allows competitors to undercut the prices charged by legitimate producers because they do not need to pay for development expense (for pirated and counterfeit goods) and/or trademark promotion (for counterfeit goods). Since 

development represents a substantial portion of final product cost in technology intensive industries, legitimate producers are placed at a significant disadvantage and 

may be pushed out of the market altogether. 

3. When counterfeit products malfunction, as they often do, the reputation of the 

company and the brand associated with them suffer what might be irreparable damage. The damage here is almost incalculable as a company loses its pricing power 

and its long-term competitiveness erodes. 

4. Pirated and counterfeit goods are often built to lower safety standards and understandably do not go through the rigorous standards required in the United 

States and other developed nations. The result is a substantial risk to consumers 

who might buy, for instance, a flammable toy, not to mention the risk represented 

by fake products such as pharmaceuticals, brake pads and the like. 

5. IPR violating products increase the cost of doing business of legitimate players 

by necessitating legal and administrative expense in going after violators, not to 
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mention the litigation risk involved in plaintiffs charging the legitimate producer in 

not preventing the sale of a counterfeit under its name. Legitimate players also 

spend considerable dollars in trying to engineer their products in a manner that will 

make copying more difficult. 

6. IPR violating goods compromise U.S. export controls because the technology 

transfer does not go through the documentation and certification oversight. The result 

may be that security related technologies will find their way into the wrong hands. 

7. IPR violating goods create an opening for criminal and terrorist activities, as 

the enormous profit margins available from their sale attract international crime 

syndicates and global terror groups who view this line of business as an ideal opportunity to fund their clandestine operations. 

All developed nations should be concerned with IPR violations, and to some extent 

they are. The United States is however the most vulnerable to IPR violations for 

a simple reason: It is the world’s leading owner of IPR assets, from patents to brand 

equity. The United States has a very substantial surplus in technology flows, that 

is, the payments it receives for technology owned by U.S. entities (e.g., as part of 

a licensing agreement by a foreign user) far exceed the payments U.S. entities pay 

for foreign technologies. This means that the U.S. is the most susceptible to Chinese 

IPR infringement. For the same reason, it will be difficult to build a global coalition 

to combat IPR violations as other developed nations suffer less and are more likely 

to sacrifice IPR on the altar of the promising Chinese market. 

Common wisdom suggests that the problem is temporary, that once China’s transitional economy matures and its legal system evolves, IPR compliance will naturally occur. I beg to differ. For two thousand years, legal responsibilities in China 

rested with the executive branch; today’s system is very much the same, with no 

separation of powers to speak of. It is naı ̈ve to assume that the system will change 

just because China is becoming a part of the global trading system. The country has 

already defied the economic presumption that it was impossible to attract substantial foreign investment without a proper IPR regime. The assumption that China 

will come to respect IPR because it will be in its interest to do so when it becomes 

an innovator may also be misplaced. I would argue that violating IPR rights enables 

Chinese companies to advance their competitiveness with minimal investment, in effect piggybacking on R&D investment made by foreign firms and governments (who 

in most countries carry much of the R&D expense directly, e.g., via government 

labs, and indirectly, e.g., via research funding). Put it another way, IPR violations 

constitute a direct subsidy enjoyed by Chinese manufacturers at the expense of U.S. 

taxpayers and stockowners. IPR violations are an oft neglected element in the socalled China price mystery, namely the ability of Chinese firms to price their products well below the cost of production in other locations. While labor cost, exchange 

rates and the like also play an important role in the ‘‘China price,’’ there is no question that especially for technology-intensive products, obtaining free technology confers a substantial discount. Finally, even if the problem is temporary, it may last 

long enough for many U.S. businesses to lose market share or go out of business. 

Why doesn’t the Chinese government do more to curb the practice? First, because 

the violations enable Chinese companies to climb the technological ladder despite 

modest R&D expenditure (China spends roughly 1% of GDP on R&D versus close 

to 3% in the United States). Second, a sudden halt of IPR violating production 

would trigger economic collapse in those Chinese localities that have become addicted to fake production, and the regime can ill afford the resulting unemployment 

and social unrest. Third, given the tenuous control of the central government in 

many rural areas, it may be argued that Beijing is incapable of putting an end to 

the practice even if it wanted to. As a result, the Chinese government would rather 

take its chances with the United States (and, to a lesser extent, other foreign governments), conducting occasional raids that don’t get to the root of the problem, 

rather than face angry local constituencies who may challenge its rule. 

The problem therefore may get worse before it gets better. Note, for example, that 

while most developing nations have shown incremental improvement in software piracy rates in recent years, China’s violation rates have actually been on the increase. Given the rapid globalization of fake production, the scope of the problem 

is expected to broaden, as bogus products make their way into more markets. Enhanced Chinese compliance, if it were to happen, may be directed at protecting nascent Chinese players rather than foreign multinationals, in effect strengthening 

their competitive advantage. Finally, with organized crime and terrorist groups getting into the game, the consequences of benign neglect of IPR violations by China 

and its trade partners can be ominous. It is my humble opinion that we cannot afford to look the other way. 
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Potential Scenarios for a WTO Case Against China’s Mandatory 

Implementation of the WAPI Standard 

Technical Barriers to Trade 

The WTO Technical Barriers to Trade (TBT) Agreement directs WTO members to 

ensure that mandatory standards do not have the effect of creating ‘‘unnecessary 

obstacles to international trade.’’ Further, the TBT Agreement mandates the use of 

international standards whenever possible and requires WTO members adopting 

standards that are inconsistent with international standards to notify other WTO 

members when such standards may have a significant effect on international trade. 

The proposed Chinese WAPI standards clearly create significant barriers to trade. 

In addition, as the Chinese standards differ in significant respect from the IEEE 

standards and will prohibit the importation of all existing Wi-Fi enabled equipment, 

China should have made the necessary notification through the WTO. To date, no 

such notice has been provided. 

National Treatment 

GATT Article III prohibits the adoption of any internal regulation that discriminates against imported goods. To the extent that foreign manufacturers are denied 

access to the details of the Chinese standards, are prevented from obtaining the certification necessary to sell their products in China, and/or are forced to obtain access 

to the Chinese market through a joint venture partner (with the likelihood of forced 

technology transfer), the implementation of the WLAN standards is inconsistent 

with the Article III national treatment requirement. Such a mandate is also inconsistent with commitments in China’s WTO Protocol of Accession not to condition the 

right of importation on performance requirements, including the use of local content 

or the transfer of technology. 

Trade-Related Investment Measures 

The WTO Agreement on Trade-Related Investment Measures (TRIMs) prohibits 

the use of local content requirements. To the extent that Chinese co-production requirement mandates the use of Chinese goods in producing WLAN products that 

may be sold in China, it would appear to be inconsistent with this requirement. 

Again, such a mandate is also inconsistent with specific commitments in China’s 

WTO Protocol of Accession not to condition the right of investment on performance 

requirements of any kind, including the use of local content or the transfer of technology. 
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1Science Resources Statistics INFOBRIEF, ‘‘Graduate Enrollment in Science and Engineering 

Fields Reaches Peak; First-Time Enrollment of Foreign Students Declines.’’ NSF 04–326, June 

2004. At http://www.nsf.gov/statistics/infbrief/nsf04326/start.htm. Accessed May 16, 2005.

Graduate Education and the National Science Foundation 

Graduate Student Enrollment in the United States 

The latest available data 1 (2002) pertaining to U.S. science and engineering (S&E) 

graduate student enrollment shows: 

• Graduate student enrollment in U.S. S&E programs reached a new peak at 

nearly 455,000 students in fall 2002. 

• Sixty-eight percent of these students, or 310,000—the second-largest numerical 

number in the last 20 years—were U.S. citizens and permanent residents in fall 

2002. 

• The increase of 15,500 U.S. citizen and permanent resident graduate students 

between 2001 and 2002 represented the largest numerical gain since 1992. 

• Thirty-two percent, or 145,000—all-time highs for both proportion and number—of U.S. S&E graduate students were temporary visa holders in fall 2002. 

• Fields with the highest numbers of temporary visa holders in fall 2002 included 

engineering (58,262), computer sciences (26,801) and social sciences (18,011). 

National Science Foundation Support of Graduate Students 

Although NSF’s $5.65 billion budget currently accounts for 4 percent of total Federal science and technology investment and nearly 50 percent of non-medical basic 

research conducted in academe, the agency supported only 26,500, or 6 percent, of 

the nation’s science and engineering graduate students in 2002. Based on available 

data, NSF estimates that about 70% of its supported graduate students are U.S. 

citizens or permanent residents. 

Support Through Education-Oriented Programs

Many NSF-supported graduate students receive support through programs designed specifically to catalyze graduate education and related activities in science, 

technology, engineering, and mathematics (STEM) fields. Activities funded through 

such programs range from direct support including fellowships to institutional 

awards that foster improved graduate educational experiences at host institutions. 

If applicable, fellowships provided through such programs total $40,500 annually—

$30,000 as stipend and $10,500 for educational costs, e.g., tuition or health insurance. Several of these programs have defined citizenship requirements. 

Examples of programs tailored to national STEM educational goals in which only 

U.S. citizens, nationals, and permanent U.S. residents are eligible to fully participate include:

• Graduate Research Fellowship (GRF) offers approximately 1,000 new graduate fellowships annually that provide three years of support for graduate study 

leading to research-based master’s or doctoral degrees. In FY 2004, GRF supported a total of 2,295 students. 

• Alliances for Graduate Education and the Professoriate (AGEP) supports 

alliances of Ph.D.-granting institutions to develop and implement innovative 

models for recruiting, mentoring, and retaining minority students in STEM doctoral programs and/or to develop strategies to identify and support underrepresented minorities desiring an academic career. During the 2003–04 academic 

year, 5,994 Ph.D. students were enrolled in AGEP alliances. In the same academic year, 702 Ph.D. students graduated from AGEP alliances. 

• Federal Cyber Service: Scholarship for Service (SFS) provides funding to 

academe to award scholarships to undergraduate or graduate students in information assurance and computer security fields as well as to improve the quality 

and increase the number of such professionals. SFS support the final two years 

of undergraduate study, two years of master’s-level study, or the final two years 

of Ph.D.-level study. Over 540 students have entered the SFS program. 

• NSF Graduate Teaching Fellows in K–12 Education (GK–12) provides fellowships and training to enable graduate students in STEM disciplines to acquire skills to prepare them for professional and scientific careers. Through 

interactions with teachers in K–12 schools, graduate students improve communication and teaching skills while enriching STEM instruction in K–12 schools. 

In FY 2004, GK–12 supported 947 students. 

• Integrative Graduate Education and Research Traineeship (IGERT)

supports STEM undergraduate and graduate students as well as host institutions providing research-based graduate education and training activities in 
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emerging STEM areas. The program catalyzes cultural change in graduate 

education by establishing innovative new models for graduate education and 

training in collaborative, interdisciplinary environments. In FY 2004, IGERT 

supported 1,386 students. 

• East Asia and Pacific Summer Institutes for U.S. Graduate Students 

(EAPSI) supports up to 175 fellowships to provide U.S. S&E graduate students 

firsthand research experiences in Australia, China, Japan, Korea and Taiwan, 

an introduction to the science and science policy infrastructure of the respective 

location, and an orientation to the culture and language. NSF’s counterpart foreign funding agencies coordinate with hosting universities and research institutes, arrange logistics, and provide about two-thirds of the funding for these 

programs. The China Summer Institute started in 2004, and NSF will send 30 

U.S. students to China this summer. 

Support Through Research-Oriented Programs

Other NSF-supported graduate students are funded through research programs, 

including individual and collaborative research projects, centers, or facilities awards, 

and assist principal investigators, senior researchers, or postdoctoral associates in 

performing research. In general, no citizenship requirements exist for principal investigators (PIs), co-principal investigators (coPIs), post-doctoral researchers, technicians, or graduate students on research awards. Currently, about 90% of PIs and 

CoPIs supported by NSF are U.S. citizens or permanent residents.

NSF Contact: Larry Weber; Acting Deputy Director 

Office of International Science & Engineering 

National Science Foundation 

703–292–8710

lweber@nsf.gov 
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WHITE PAPER ON IPR PROTECTION

The [People’s Republic of China] State Council Information Office published 

on April 21, 2005, a white paper titled New Progress in China’s Protection 

of Intellectual Property Rights. The nine-chapter report discusses the policies 

adopted and actions taken by the government to protect IPR during the past 

decade. The last white paper on this topic was published in 1994.

New Progress in China’s Protection of Intellectual Property Rights

Foreword 

I. Basic Situation of the Protection of Intellectual Property Rights 

II. Patent Protection 

III. Trademark Protection 

IV. Copyright Protection 

V. Intellectual Property Rights Protection for Audio and Video Products 

VI. Protection of New Varieties of Agricultural and Forestry Plants 

VII. Customs Protection of Intellectual Property Rights 

VIII. Public Security Organs Act on Criminal Infringement on Intellectual 

Property Rights 

IX. Judicial Protection of Intellectual Property Rights 

Conclusion 

Foreword 

The intellectual property system is a basic legal system that promotes mankind’s 

economic development, social progress, scientific and technological innovation, and 

cultural prosperity. As science and technology is developing rapidly worldwide and 

the pace of economic globalization is accelerating, the status of the intellectual property system in economic and social life has reached a historical high. The protection 

of intellectual property rights (IPR) has drawn wide attention of the international 

community. 

China is a country with a long history of civilization. Over the past several thousand years, vast numbers of outstanding Chinese scientists, inventors, men of letters and artists have made enormous contributions to mankind’s development and 

progress with their splendid intellectual achievements. The Chinese government 

and people are keenly aware of the value of inventions, creations, and science and 

technology. 

The IPR protection system was established at a comparatively late date in China, 

but has developed rapidly. Major progress has been made in IPR protection since 

the late 1970s, when China initiated the reform and opening-up policies. An IPR 

system has been gradually established, and is promoting healthy economic development and overall social progress. 

In order to help the international community have a better understanding of the 

real situation regarding China’s IPR protection and make a proper judgment, we 

hereby give a brief introduction to and explanation of related issues. 

I. Basic Situation of the Protection of Intellectual Property Rights 

China has always adopted a responsible attitude to actively promoting IPR protection. While adhering to the international rules on IPR protection, China has decided 

on a level of IPR protection appropriate for its own national situation, and made 

great efforts to balance the interests among intellectual property creators, users and 

the general public, so as to create a benign circle for the creation and use of intellectual property. 

Major progress has been made on IPR protection in China over the past years 

thanks to concerted efforts made by people from all walks of life.

—A relatively complete system of laws and regulations that covers a wide range 

of subjects and is in line with generally accepted international rules has been 

established and keeps improving. Since the 1980s, the state has promulgated 

and put into effect a number of laws and regulations covering the major contents in IPR protection. These include the ‘‘Patent Law of the People’s Republic 

of China,’’ ‘‘Trademark Law of the People’s Republic of China,’’ ‘‘Copyright Law 

of the People’s Republic of China,’’ ‘‘Regulations on the Protection of Computer 

Software,’’ ‘‘Regulations on the Protection of Layout Designs of Integrated Circuits,’’ ‘‘Regulations on the Collective Management of Copyright,’’ ‘‘Regulations 

on the Management of Audio-Video Products,’’ ‘‘Regulations on the Protection of 

New Varieties of Plants,’’ ‘‘Regulations on the Protection of Intellectual Property 

Rights by the Customs,’’ ‘‘Regulations on the Protection of Special Signs,’’ and 

‘‘Regulations on the Protection of Olympic Logos.’’ China has also promulgated 

a series of relevant rules for the implementation of these laws and regulations, 
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and their legal interpretation. As a result, the system of laws and regulations 

on IPR protection in China has been continuously improved. In 2001, around 

the time when China was admitted into the WTO, in order to provide effective 

legal protection to IPR, the country made comprehensive revisions to the laws 

and regulations regarding IPR protection and their legal interpretation. While 

more emphasis is given to promoting the progress of science and technology and 

innovation with regard to legislative intent, content of rights, standards of protection and means of legal remedy, the revisions brought the laws and regulations into conformity with the WTO’s ‘‘Agreement on Trade-related Aspects of 

Intellectual Property Rights’’ and other international rules on IPR protection. 

—A coordinated and efficient work system and a law enforcement mechanism 

have been established and improved. In its practice of IPR protection, a twoway parallel protection mode, namely, administrative and judicial protection, 

has emerged in China. Several departments in China are assigned with the 

duty to protect IPR. They include primarily the State Intellectual Property Office, State Administration for Industry and Commerce, Press and Publication 

General Administration, State Copyright Bureau, Ministry of Culture, Ministry 

of Agriculture, State Forestry Administration, Ministry of Public Security, General Administration of Customs, Supreme People’s Court and Supreme People’s 

Procuratorate. For many years these departments have done effective work in 

their respective fields. To further strengthen IPR protection, in 2004 China established the State IPR Protection Work Team headed by a vice-premier of the 

State Council, responsible for planning and coordinating the work regarding 

IPR protection throughout the country. Its office, located in the Ministry of 

Commerce, handles the routine work of the team.

In recent years, the state has increased work contacts between administrative law 

enforcement organs and public security organs and people’s procuratorates with respect to IPR protection. In October 2000, the relevant departments jointly issued the 

‘‘Notice on Strengthening Cooperation and Coordination in the Work of Investigating and Dealing with Criminal Cases that Infringe Intellectual Property 

Rights,’’ which contains clear provisions on relevant issues. In July 2001, the State 

Council promulgated the ‘‘Regulations on the Transfer of Suspected Criminal Cases 

by Administrative Law Enforcement Organs,’’ which includes clear provisions on 

how the administrative law enforcement organs should transfer suspected criminal 

cases to public security organs in a timely fashion. In March 2004, the relevant departments jointly issued the ‘‘Opinions on Increasing Work Contacts between Administrative Law Enforcement Organs and Public Security Organs and People’s 

Procuratorates.’’ A work mechanism involving the coordination of administrative law 

enforcement and criminal law enforcement has been established, creating a joint 

power to deal with IPR infringements. This ensures that suspected criminal cases 

enter the judicial process promptly. In recent years, the judicial organs have adjudicated a large number of IPR infringement cases according to law. In civil cases, 

the infringed parties have received timely compensation for their financial losses, 

and IPR-related crimes have been effectively combated.

—Administrative law enforcement has been strengthened in IPR protection. As 

gradual improvements are made in the legal system on IPR protection, China 

has shifted its focus from legislation to law enforcement. Administrative law enforcement has been enhanced through the combination of routine management 

and supervision with special crackdown campaigns. In August 2004, the Chinese government decided to launch a special one-year campaign to protect IPR 

across the country from September 2004 to August 2005. It was decided at the 

national TV and telephone conference on rectification and standardization of the 

market economic order convened by the State Council on March 31, 2005 that 

the campaign was extended to the end of 2005. With unified planning, the relevant departments have investigated and dealt with major IPR infringement 

cases, focusing on major fields in the protection of trademark rights, copyrights 

and patent rights, on major links in the import and export of goods, all types 

of exhibitions and wholesale markets of commodities, and on key places where 

producers and sellers of counterfeit goods were known to be concentrated. Their 

quick action and strict law enforcement efforts have dealt a blow on IPR offenders, achieving positive results. 

—Efforts are being made to heighten the awareness of the general public about 

IPR. The Chinese government attaches great importance to publicity concerning 

IPR. Beginning in 2004, the state designated the week from April 20 to 26 every 

year as the ‘‘week for publicizing the importance of IPR protection.’’ By making 

wide use of newspapers, magazines, television, radio and the Internet, and 

through holding seminars and knowledge contests, and making public interest 
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advertisements, the government carries out publicity and education among the 

general public regarding IPR protection. The aim is to create a social atmosphere in which labor, knowledge, talent and creation are respected, and heighten 

the awareness of the general public regarding IPR. 

—Actively fulfilling the international obligations to protect IPR. China has taken 

an active approach to joining major international conventions and agreements 

on IPR protection. Following its accession to the World Intellectual Property Organization in 1980, China joined in succession more than ten international conventions, treaties, agreements and protocols, such as the ‘‘Paris Convention for 

the Protection of Industrial Property,’’ ‘‘Patent Cooperation Treaty,’’ ‘‘Budapest 

Treaty on the International Recognition of the Deposit of Microorganisms for 

the Purposes of Patent Procedure,’’ ‘‘Locarno Agreement Establishing an International Classification for Industrial Designs,’’ ‘‘Madrid Agreement Concerning 

the International Registration of Marks,’’ ‘‘Nice Agreement Concerning the 

International Classification of Goods and Services for the Purpose of the Registration of Marks,’’ ‘‘Protocol Relating to the Madrid Agreement Concerning the 

International Registration of Marks,’’ ‘‘Agreement on Trade-related Aspects of 

Intellectual Property Rights,’’ ‘‘International Convention for the Protection of 

New Varieties of Plants,’’ ‘‘Berne Convention for the Protection of Literary and 

Artistic Works,’’ ‘‘Universal Copyright Convention,’’ and ‘‘Convention for the 

Protection of Producers of Phonograms Against Unauthorized Duplication.’’

While strictly executing its international obligations in IPR protection, China has 

devoted great efforts to adjusting and improving international rules regarding IPR 

protection in order to let all countries of the world share the fruits and benefits 

brought about by the progress of science and technology. In recent years, China has 

held talks, and engaged in exchanges and cooperation with other countries, international organizations and foreign-invested enterprises in the field of IPR. At the 

suggestion of the United States, starting in 2003, China and the U.S. have held a 

round-table conference on IPR every year, and reached agreement on many IPRrelated issues at the two round-table conferences. In 2004, China and Europe held 

their first round of talks on IPR in Beijing. Initial agreement was reached between 

the two sides on matters of cooperation related to IPR. Relevant Chinese departments have established good cooperative relations with corresponding departments 

in several countries, and international organizations such as World Intellectual 

Property Organization and International Union for the Protection of New Varieties 

of Plants. In September 2003, a mechanism was established for regular contact and 

coordination between relevant Chinese departments and foreign-invested enterprises. Under the mechanism, a meeting is held every three months to solicit comments and suggestions from the foreign-invested enterprises on issues related to 

IPR protection. 

II. Patent Protection 

With the establishment of the China Patent Office in 1980, China’s patent work 

has developed continuously over 25 years. On April 1, 1985, the ‘‘Patent Law of the 

People’s Republic of China’’ went into effect. Following that, China promulgated 

several patent-related laws and regulations, such as the ‘‘Rules for the Implementation of the Patent Law,’’ ‘‘Regulations on Patent Commissioning,’’ ‘‘Procedures for 

the Administrative Enforcement of Laws Concerning Patents,’’ and ‘‘Regulations on 

the Implementation of Customs Protection of Patent Rights.’’ China has twice made 

revisions to the ‘‘Patent Law’’ in the light of the requirements of social and economic 

development so as to enable it to improve continuously. 

By mainly relying on its own resources, China has established a relatively complete and independent patent examination system in a short period of time. On January 1, 1994, China became a member state of the ‘‘Patent Cooperation Treaty.’’ The 

China Patent Office is China’s agency dealing with cases involving the Patent Cooperation Treaty, performing international patent searches and preliminary examinations. Meanwhile, China has established a fairly comprehensive system for patent 

work. Relevant departments of the State Council and local governments have established patent administrative organs in accordance with the provisions of the ‘‘Patent 

Law.’’ China now has more than 5,000 people working in patent agencies, and a 

service system mainly providing patent commissioning, patent information, patent 

technology transfer intermediary and patent technology evaluation services has 

taken initial shape. 

China’s patent work has realized leapfrogging development. From April 1, 1985 

to the end of 2004, the State Intellectual Property Office handled 2,284,925 patent 

applications with an average annual increase of 18.9 percent. Of these, 1,874,358 

were domestic applications, and 410,567 came from other countries, accounting for 

82 and 18 percent, respectively. Patent applications in China had exceeded two mil-
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lion by March 17, 2004. It took China 15 years for patent applications to reach one 

million. But it took only four years for the number to double. In 2004, the State 

Intellectual Property Office handled 353,807 applications, an increase of 14.7 percent over the previous year, which saw 308,487 applications. Of these, 278,943 were 

domestic applications, accounting for 78.8 percent of the total and an increase of 11 

percent over the previous year, which saw 251,238 applications. Foreign applications 

numbered 74,864, accounting for 21.2 percent of the total and an increase of 30.8 

percent over the previous year, which saw 57,249 applications. From 1994 to 2004, 

the State Intellectual Property Office handled, in total, 7,131 international applications for patent rights, of which 1,592 such applications were handled in 2004. 

International patent applications that entered China via the channel of the Patent 

Cooperation Treaty totaled 157,770. Of these, 32,438 applications were submitted in 

2004. 

By the end of 2004, the State Intellectual Property Office had approved 1,255,499 

patents. Of these, 1,093,268 were domestic ones, and 162,231 were from other countries, accounting for 87.1 and 12.9 percent of the total number of approved patents, 

respectively. The numbers of invention patents, utility model patents and exterior 

design patents that had been approved were 185,412, 651,224 and 418,863, accounting for 14.8, 51.9 and 33.3 percent respectively. In 2004, the State Intellectual Property Office approved 190,238 patents, an increase of 4.4 percent over the previous 

year, which had 182,226. It approved 151,328 domestic patents, an increase of 1.2 

percent, compared with 149,588 in the previous year. At the same time, it approved 

38,910 foreign patents, an increase of 19.2 percent over the previous year, which 

saw 32,638. 

The ‘‘Regulations on the Protection of Layout Design of Integrated Circuits’’ went 

into effect in China on October 1, 2001. By the end of 2004, the State Intellectual 

Property Office had received 682 applications for the registration of layout design 

of integrated circuits. It registered 571 of them, and issued related public notices 

as well as certificates to the applicants. In 2004 alone, the State Intellectual Property Office received 244 applications for the registration of layout design of integrated circuits. It registered 205 of them, and issued related public notices as well 

as certificates to the applicants. 

In recent years, patent administration departments at all levels have strengthened administrative enforcement of the law in this respect. In particular, they have 

launched crackdowns on infringements of patent rights of food and medicines, which 

are closely connected with people’s health and lives. They have made great efforts 

to investigate and deal with cases that infringe upon the patent rights of key technologies and cases that had widespread repercussions. They have also conscientiously investigated and dealt with infringements and counterfeits of patent rights 

of inventions, utility models and exterior designs. Following the State Council’s unified plan, in August 2004, the State Intellectual Property Office issued the ‘‘Work 

Program on Strengthening Enforcement of the Laws on Intellectual Property Rights 

and Launching a Special Law Enforcement Campaign.’’ All subsidiary departments 

under the State Intellectual Property Office were mobilized to participate in the 

campaign. By the end of that year, local intellectual property offices had checked 

10,251 industrial venues and examined 2,081,537 commodity items. By the end of 

2004, local patent administration departments across the country had accepted 

12,058 cases involving patent infringement and patent disputes, and 10,411 of the 

cases, or 86.3 percent, were resolved. In 2004, local patent administration departments accepted 1,455 cases involving patent disputes, and 1,215 of them were resolved. They also dealt with 3,965 cases of patent counterfeits, and 358 cases of 

unauthorized use of others’ patents. 

III. Trademark Protection 

Great progress has been made in China’s trademark protection work since November 1, 1979, when China resumed the unified registration of trademarks. The 

‘‘Trademark Law’’ went into effect on March 1, 1983. The Chinese government promulgated the ‘‘Rules for the Implementation of the Trademark Law’’ in March 1983 

to help with the implementation of the law, and in 1988 revised it for the first time. 

In February 1993, the Standing Committee of the National People’s Congress (NPC) 

made the first revision to the ‘‘Trademark Law’’ to include service trademarks in 

the work of trademark protection, strengthen efforts to crack down on trademark 

infringement and counterfeiting, and improve the trademark registration procedures. In July 1993, the Chinese government made revisions to the ‘‘Rules for the 

Implementation of the Trademark Law’’ for the second time to bring collective trademarks and certification trademarks into the scope of legal protection of trademarks, 

and added to it provisions on the protection of ‘‘trademarks well known to the public.’’
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In October 2001, the NPC Standing Committee made revisions to the ‘‘Trademark 

Law’’ for the second time to include three-dimensional trademarks and color combination trademarks in the scope of trademark protection and offer greater protection to well-known trademarks. The revised ‘‘Trademark Law’’ also stipulates that 

the trademark system shall be used to protect geographical marks, judicial examination shall be added for the certification process of trademark rights, and greater efforts shall be made to crack down on trademark infringement and counterfeiting, 

thus bringing the relevant provisions of China’s ‘‘Trademark Law’’ in line with the 

principles of WTO’s ‘‘Agreement on Trade-related Aspects of Intellectual Property 

Rights.’’ In August 2002, the Chinese government again revised the ‘‘Rules for the 

Implementation of the Trademark Law’’ and renamed it ‘‘Regulations for the Implementation of the Trademark Law.’’

In accordance with the provisions of the ‘‘Trademark Law’’ and the ‘‘Regulations 

for the Implementation of the Trademark Law,’’ the State Administration for Industry and Commerce formulated or revised several administrative rules and regulations, including the ‘‘Trademark Assessment Rules,’’ ‘‘Provisions on the Recognition 

and Protection of well-known Trademarks,’’ ‘‘Procedures for the Management and 

Registration of Collective Trademarks and Certification Trademarks,’’ ‘‘Procedures 

for the Implementation of Madrid Agreement for the International Registration of 

Trademarks,’’ and ‘‘Procedures for the Administration of the Printing of Trademarks.’’

As improvements are made in the legal system concerning trademarks and as the 

general public’s awareness about trademarks is heightened, applications for trademark registration in China have soared in recent years. In 1980, applications for 

trademark registration were only a little more than 20,000. The number reached 

132,000 in 1993. In the five years from 2000 to 2004, applications for trademark 

registration quickly exceeded the key marks of 200,000, 300,000, 400,000 and 

500,000, and came to 1,906,000 finally. It means an additional 256,000 applications 

were submitted in these five years over the total submitted during the 20 years 

from 1980 to 1999. It accounts for 53.6 percent of the total number of applications 

submitted from 1980 to 2004. In 2004, 588,000 applications were filed for trademark 

registration, 136,000 more than the previous year and an increase of 30 percent. 

The number of applications in 2004 was 2.17 times that in 2001, when China joined 

the WTO. By the end of 2004, China had had 2,240,000 registered trademarks. 

As the investment environment in China is constantly improved, especially after 

China joined the WTO, both the number of applications for trademark registration 

from foreigners and the number of registered foreign trademarks have kept increasing. In 1982, there were 1,565 foreign applications for trademark registration in 

China. The number exceeded 20,000 in 1993 and exceeded 60,000 in 2004. Before 

1979, only 20 countries and regions had 5,130 trademarks registered in China. By 

the end of 2004, 129 countries and regions had had 403,000 trademarks registered 

in China. This represents almost an 80-fold increase over that in 1979, accounting 

for 18 percent of the total number of registered trademarks in China. 

China has actively fulfilled its obligations to protect internationally well-known 

trademarks since it joined the ‘‘Paris Convention for the Protection of Industrial 

Property.’’ In handling cases involving objections and disputes over ownership of 

trademarks as well as trademark management, the State Administration for Industry and Commerce has certified more than 400 well-known trademarks, effectively 

protecting according to law the legitimate rights and interests of owners of foreign 

and Chinese well-known trademarks. In 2004 alone, it certified and offered protection to 153 well-known trademarks, of which 28 were brand names of foreign enterprises. Meanwhile, administrative organs of industry and commerce at all levels 

regard the protection of well-known trademarks as their priority and have made 

greater efforts to protect them. They have severely cracked down on all kinds of illegal acts that have infringed upon the rights and interests of well-known trademarks. 

For years, administrative organs of industry and commerce at all levels across 

China have fully exploited their advantages in trademark administrative law enforcement—complete networks, simple procedures and high efficiency. Focusing on 

the protection of the right to exclusive use of registered trademarks, and dutifully 

carrying out their responsibilities, they have investigated and dealt with a large 

number of trademark infringement and counterfeiting cases, effectively protecting 

the right to exclusive use of registered trademarks of both foreign and domestic 

trademark owners, and safeguarding the legitimate rights and interests of consumers. From 2001 to 2004, administrative organs of industry and commerce at all 

levels across China dealt with 169,600 cases that violated the trademark laws and 

regulations. Of these, 113,000 cases involved trademark infringement and counterfeiting (12,000 cases involved foreign trademarks), and 56,600 cases were other 
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types of violations of trademark laws and regulations. They confiscated and destroyed 529 million pieces (sets) of counterfeiting trademark logos, and transferred 

286 cases involving 300 people to judicial organs to pursue their criminal responsibilities. In 2004, in accordance with the unified plan and arrangement of the State 

Council on IPR protection and that of the State Administration for Industry and 

Commerce on the protection of the right to exclusive use of registered trademarks, 

administrative organs of industry and commerce at all levels across China launched 

three special campaigns that focused on the protection of well-known and foreignrelated trademarks, and on dealing with infringements of trademarks of food and 

medicine. The campaigns effectively protected the right to exclusive use of registered trademarks. According to statistics, in 2004, administrative organs of industry and commerce across China investigated and dealt with 51,851 law-violation 

cases involving trademarks. Of these, 5,494 concerned foreign trademarks, a 2.6-fold 

increase of that in 2003. Of the 51,851 cases they investigated, 11,680 were common 

violations of the trademark laws and regulations. The rest of the cases, altogether 

40,171, involved trademark infringement or counterfeiting, an increase of 51.66 percent over 2003. They confiscated and disposed of 38,951,800 pieces (sets) of illegal 

trademark logos, confiscated 280,800 tools such as moulds and press plates used for 

the infringement, and confiscated and destroyed 5638.53 tons of items that had been 

used for the infringement. They transferred to judicial organs 96 cases involving 82 

people to pursue their criminal responsibilities. 

IV. Copyright Protection 

China’s legal system for copyright protection was gradually established in the 

1990s, with the implementation of the ‘‘Copyright Law’’ as a hallmark in this process. In recent years, China has made revisions to the ‘‘Copyright Law.’’ It has also 

promulgated a number of regulations with legal effect, such as ‘‘Regulations on the 

Protection of Computer Software,’’ ‘‘Regulations for the Implementation of the Copyright Law,’’ ‘‘Procedures for the Implementation of Administrative Sanctions Concerning Copyright,’’ and ‘‘Regulations on the Collective Management of Copyright.’’ 

The promulgation and implementation of these legal documents have laid a solid 

legal foundation for copyright protection. 

At present, China has formed a three-level copyright administrative management 

system: the State Copyright Bureau, copyright bureaus at the provincial level and 

the prefectural (city) level. Governments of various provinces, autonomous regions 

and municipalities directly under the central government have constantly consolidated their copyright administrative management departments and made improvements to the system of copyright administrative management and law enforcement. 

In recent years, China’s copyright administrative management departments at all 

levels have strengthened their administrative enforcement of the copyright law. 

They have increased cooperation with other government departments, such as the 

departments of public security, industry and commerce, the customs, press and publications, and cultural departments. As a result, a mechanism of law enforcement 

whereby different departments are coordinated in combating copyright infringement 

and piracy has gradually taken shape. The copyright administrative management 

departments have always maintained the pressure on copyright infringement and 

piracy. They have launched several campaigns to crack down on pirated discs, textbooks, reference books, software, illegal duplication and selling of audio-video products, selling of smuggled audio-video products and Internet infringement practices. 

Positive achievements have been made. According to incomplete statistics, from 

1995 to 2004, copyright administrative management departments at all levels confiscated 350 million pirated copies, accepted 51,368 cases of infringement and resolved 49,983 of them. In 2004, they accepted 9,691 cases of infringement, resolved 

9,497 of them and imposed administrative sanctions on the infringers in 7,986 cases. 

These included the investigation and punishment of two Chinese enterprises that 

had infringed upon the copyright of the Microsoft Corporation of the United States 

and other major cases. 

While establishing and improving its copyright legal system and strengthening its 

copyright administrative management, China also attaches great importance to the 

establishment of a copyright public service system. At present, China has established a copyright public management and service system consisting of copyright 

collective management organs, copyright agencies, copyright protection associations, 

professional associations and organizations of copyright holders. In 1988, the Copyright Agency of China was established. In 1990, the Copyright Research Society of 

China was established and its name was changed to Copyright Society of China

in 2002. In 1993 the China Copyright Society of Works of Music was established.

And in 1998, the Copyright Protection Center of China was established. At present, 

writers’ associations, such as China Federation of Literary and Art Circles, China 
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Writers’ Association and China Film Association as well as professional associations 

of book publishers, producers of audio-video products and software developers have 

established their own copyright protection organizations. Copyright societies have 

been established in more than 20 provinces (autonomous regions, municipalities directly under the central government) and some major cities. Preparatory work is 

under way to establish China’s collective copyright management organizations of 

works of the written language and of audio-video products. 

V. Intellectual Property Rights Protection for Audio and Video Products 

Persistent piracy of audio and video products in spite of repeated bans is a problem of international significance. The Chinese government attaches great importance to IPR protection for audio and video products, treats crackdown on piracy of 

audio and video products as an important task in IPR protection and has made continuous efforts to carry it out. In recent years, China has gradually established a 

whole set of systems for the management of audio and video products, which mainly 

includes an IPR protection system, audio and video business license system, exclusive publication right system, duplication authorization system, SID code system, 

censorship system for imported audio and video products, the system of awards for 

informants, the system of uniform anti-counterfeit labels for audio and video products, the system of registration and filing of audio and video products in storehouses, and the system of inspection of, report on and keeping the public informed 

of illegal audio and video products. 

In August 1994, the government promulgated the ‘‘Regulations on the Administration of Audio and Video Products,’’ and amended it in December 2001. In accordance 

with the relevant laws and regulations, including the ‘‘General Principles of the 

Civil Law,’’ ‘‘Copyright Law,’’ ‘‘Criminal Law’’ and ‘‘Regulations on the Administration of Audio and Video Products,’’ the Press and Publication General Administration, Ministry of Culture, General Administration of Customs and Ministry of Commerce respectively and jointly issued a series of administrative regulations, such as 

the ‘‘Regulations on the Administration of Publication of Audio and Video Products,’’ 

‘‘Measures for the Administration of Wholesale, Retail and Renting of Audio and 

Video Products,’’ ‘‘Measures for the Administration of Import of Audio and Video 

Products’’ and ‘‘Measures for the Administration of China-Foreign Cooperative Distribution Enterprises of Audio-Video Products,’’ providing both legal and administrative groundwork for the business and protection of audio and video products. 

In light of the rapidly developing audio-video market, the government has step 

by step readjusted its administration of the audio-video industry. The ‘‘Regulations 

on the Administration of Audio and Video Products’’ provides for the division of 

functions in the administration of the industry. In 1998, the State Council further 

sorted out the administrative system on the principle of ‘‘streamlining, efficiency 

and unification,’’ clearly assigning the administration of audio-video products’ production, publication and duplication to the Press and Publication General Administration; and that of wholesale, retail, renting, showing and import of audio-video 

products to the Ministry of Culture. Following the suit of the central government, 

the local governments have also readjusted their administrative systems in this 

regard. So far, China has initially established market management networks at

the central, provincial, prefectural and county levels. In most areas, investigation 

squads have been set up to keep watch on cultural markets, including the market 

for audio and video products. They sincerely perform the duties of supervision and 

administration on the audio-video market. 

Since the 1990s, the publication market supervision authorities and cultural administration authorities have cooperated closely with other relevant departments in 

making sustained efforts to enforce order in the audio-video market. As a result, the 

order of the audio-video market has been gradually improved, the number of pirated 

audio-video products clearly reduced, and the circulation of original copies greatly 

increased. According to incomplete statistics, from 1994 to 2004, nine CD duplicating enterprises had their duplication business licenses revoked, and 200 illegal 

CD production lines were discovered. In August 2004, under the unified arrangement of the special IPR protection campaign, the Ministry of Culture drew up an 

overall plan for an intensive crackdown on infringements in the audio-video industry, in accordance with which it guided and coordinated with key cities and areas 

in strengthening law enforcement, and discovering and closing down a large number 

of underground storehouses and distribution networks of illegal audio-video products. In 2004, cultural market inspecting and management authorities throughout 

the country inspected audio-video businesses on 555,368 occasions, confiscating 154 

million copies of audio-video works. On January 12, 2005, the Ministry of Culture 

and the Office of the National Working Group on Intellectual Property Rights Pro-
329

tection launched a nationwide campaign to destroy illegal audio-video products, during which over 63.35 million copies of such products were destroyed. 

VI. Protection of New Varieties of Agricultural and Forestry Plants 

Proceeding from the actual conditions of China and on the basis of earnestly summing up and borrowing from international experience, the Chinese government has 

set up and carried out a series of systems and measures for the protection of new 

varieties of plants, thus fully guaranteeing the legitimate rights and interests of the 

investment bodies involved. On October 1, 1997, the government began implementing the ‘‘Regulations on the Protection of New Varieties of Plants,’’ greatly expanding the scope of IPR protection in China. 

To supplement the implementation of the ‘‘Regulations on the Protection of New 

Varieties of Plants,’’ the Chinese government has in succession promulgated and implemented such regulations as the ‘‘Rules for the Implementation of the Regulations 

on the Protection of New Varieties of Plants (Agriculture),’’ ‘‘Rules for the Implementation of the Regulations on the Protection of New Varieties of Plants (Forestry),’’ ‘‘Regulations on Agency of New Agricultural Plant Variety Rights,’’ ‘‘Regulations on Handling Cases of Infringement of New Agricultural Plant Variety Rights,’’ 

and ‘‘Regulations of the Ministry of Agriculture on the Work of the Reexamination 

Board for New Varieties of Plants,’’ providing legal guarantees for the rapid development of new varieties of plants. 

In recent years, the government has set up the Office of Protection of New Varieties of Plants and the Reexamination Board for New Varieties of Plants at the Ministry of Agriculture and State Forestry Administration, respectively, forming an 

institutional protection system combining examination and approval agencies, lawenforcement organizations, intermediary service organizations and other rights protection organizations. Meanwhile, a technological support system has been established, which includes the Center for the Preservation of Breeding Materials of New 

Varieties of Agricultural Plants, Center for Testing of New Varieties of Plants and 

its 14 sub-centers, and the Center for the Testing of New Varieties of Forest Plants 

and its five sub-centers and two molecule determination labs. To ensure scientific 

and authoritative examination of plant variety rights, and drawing on the international standards for testing new varieties of plants, the relevant authorities have, 

based on the actual conditions of China, formulated guides for testing 57 new varieties of plants, including corn, rice, poplar and peony, of which 18 have been promulgated and implemented as national or industrial standards. 

The government has issued and implemented five lists of protected new varieties 

of agricultural plants and four lists of protected new varieties of forest plants, which 

cover 119 genera and species, including 41 agricultural plants and 78 forest plants. 

The numbers are far higher than the minimum numbers required by the ‘‘International Convention for the Protection of New Varieties of Plants.’’

By the end of 2004, the Ministry of Agriculture had handled 2,046 applications 

for plant variety rights. The number of applications handled in 1999 was 115, and 

by 2004 it reached 735, indicating an average annual increase of 44.9 percent. 

Among all the applications, there were 1,875 for field crops, 87 for vegetables, 52 

for fruit trees and 32 for decorative plants. A total of 2,174 applications were from 

scientific, technological and educational institutions, and 772 from enterprises and 

individuals, which included 32 from foreign enterprises and individuals. After examination, 503 applications were granted the variety rights. 

By the end of 2004, the State Forestry Administration had handled 305 applications for variety rights, including 64 from France, Germany, the Netherlands, Belgium and the United States, and granted 72 new plant variety rights. The involved 

plants included Chinese rose, peony, Christmas flower, azalea, poplar, Chinese 

chestnut, apricot, eucalyptus and walnut. Of them, 253 applications were for decorative arbors, accounting for 82.95 percent of the total. The applications were mainly 

from Chinese research institutions, foreign individuals engaging in breeding and 

Chinese universities, which respectively accounted for 50.2 percent, 14.4 percent 

and 11.1 percent of the total. 

Since 2001, the government began experimental law enforcement on the protection of new varieties of plants in 12 selected provinces and municipalities, and then 

gradually spread the work across the country. By the end of 2004, 17 provinces (autonomous regions and municipalities directly under the central government) had 

handled 863 cases of infringement of new agricultural plant variety rights and of 

faking new agricultural plant varieties. 

VII. Customs Protection of Intellectual Property Rights 

In September 1994, China began to carry out border protection of IPR. At present, 

the Chinese customs houses have established a complete system of IPR-related law 
330

enforcement measures, which includes such links as examination of customs declaration bills and certificates, inspection of imported and exported goods, detention 

and investigation of right-infringing goods, punishment of illegal importers and exporters, and disposal of right-infringing goods. 

In October 1995, China promulgated and implemented its first ever ‘‘Regulations 

on the Protection of Intellectual Property Rights by the Customs,’’ and began to establish its system of IPR customs protection in accordance with WTO rules. In 2000, 

the NPC Standing Committee amended the ‘‘Customs Law of the People’s Republic 

of China,’’ defining the functions of IPR customs protection from the legal perspective. In December 2003, the Chinese government promulgated the revised ‘‘Regulations on the Protection of Intellectual Property Rights by the Customs,’’ which 

strengthened the customs houses’ power in investigating and dealing with rightinfringing goods, reduced the burden on the proprietors of intellectual properties in 

seeking customs protection, and defined the functions of the customs houses, the judicial and other administrative organizations. Later, the General Administration of 

Customs formulated the ‘‘Measures for Implementation’’ of the revised regulations, 

which clearly provided for such issues mentioned in the revised regulations as keeping business secrets, filing of international registered trademarks, collecting and returning of security deposit, and the payment of relevant fees by the proprietors. In 

September 2004, the Chinese government promulgated the ‘‘Regulations on Implementation of Administrative Penalties,’’ which clearly provided administrative penalties for infringements on IPR in importation and exportation. The ‘‘Interpretations 

on Several Issues in Practical Application of Laws in Criminal Cases of Infringement on Intellectual Property Rights’’ was promulgated by the Supreme People’s 

Court and the Supreme People’s Procuratorate in December 2004, which further 

clearly stipulated the criminal responsibilities of agencies importing or exporting 

right-infringing goods. By then, a legal system for IPR customs protection geared 

to the needs of economic and social development had been basically established. 

China has established and improved its law enforcement mechanism for IPR customs protection. First, it has established a central filing system for IPR customs 

protection. As long as the IPR proprietors have filed their IPR with the General 

Administration of Customs, the port customs have the power to detain imported or 

exported goods that infringe on the filed IPR. By the end of 2004, the General Administration of Customs had confirmed 6,257 files of IPR for customs protection. 

Second, a model combining active protection with passive protection is implemented 

in law enforcement. Besides detaining import or export goods suspected of IPR infringement, the customs can also investigate and deal with illegal import and export 

of right-infringing goods within the scope of their powers and duties. Third, law enforcement organizations have been founded and improved, and the building of IPR 

law enforcement teams enhanced. By the end of 2004, all the customs houses directly under the General Administration of Customs had set up relevant departments for the management of IPR protection, and 11 of them had set up special 

organizations for IPR protection. Some customs houses with adequate conditions 

had stationed liaison officers on site. A system of IPR law enforcement has taken 

shape on three levels, namely, the General Administration of Customs, customs 

houses directly under it, and grassroots customs posts. 

To curb right infringements and piracy in import and export links, the port customs all over China focus law enforcement on import and export of fake and pirated 

products. From 1996 to 2004, the Chinese customs ferreted out 4,361 cases of right 

infringement in import and export, which involved 630 million yuan. Since 2000, the 

number of cases discovered by the customs has increased by 30 percent annually. 

The customs have effectively cracked down on the illegal import and export of rightinfringing goods, preserving order at ports, and safeguarding the interests of proprietors. 

In offering IPR border protection, the Chinese customs attach great importance 

to liaison and cooperation with proprietors and relevant organizations and associations of proprietors, and have enhanced their communication and coordination with 

IPR authorities and their cooperation and exchanges with foreign border law enforcement authorities. So far, the Chinese customs have signed memorandums of 

cooperation on IPR protection with such proprietors’ organizations as the Motion 

Picture Association of America, and have cooperated with them successfully. The 

Chinese customs have cooperated on many occasions in law enforcement with IPRrelated administrative and criminal law enforcement authorities, such as IPR management authorities and public security organs, effectively cracking down on illegal 

and criminal IPR infringement. The Chinese customs have signed agreements of 

mutual assistance in administrative law enforcement with the customs of the European Union countries, the United States and other countries, which contain the 

provisions on IPR customs protection. The Chinese customs have also actively con-
331

ducted information exchange and law enforcement cooperation regarding IPR protection with the customs services of other countries. 

VIII. Public Security Organs Act on Criminal Infringement on Intellectual 

Property Rights 

In recent years, the Chinese public security organs have adopted a series of measures to crack down on all kinds of criminal IPR infringement, continuously enhanced their law enforcement standards and abilities, and safeguarded the sound 

development of the socialist market economy. 

In 1998, to step up the fight against criminal IPR infringement, and in accordance 

with the provisions of the ‘‘Criminal Procedure Law,’’ the Ministry of Public Security 

established a specialized department to organize, guide and coordinate the fight 

against criminal IPR infringement, and supervise over the handling of serious cases. 

Local public security organs at all levels, from the top downward, have set up specialized investigation teams for receiving, filing and investigating such criminal 

cases. From 2000 to 2004, the Chinese public security organs cracked 5,305 cases 

of criminal infringement on IPR, which involved nearly 2.2 billion yuan, and arrested 7,100 suspects. Among them, there were 4,269 cases concerning infringement 

on the exclusive rights of trademark ownership, which involved 1.18 billion yuan, 

and 5,564 suspects were arrested. A number of suspects were found guilty of the 

production and sale of fake or inferior products and illegal business operation, and 

sentenced accordingly. 

Since November 2004, the Ministry of Public Security has launched a one-year national campaign against criminal infringement on the exclusive rights of trademark 

ownership, cracking some cases of criminal IPR infringement that were of widespread and baneful repercussions and involved large amounts of money. These cases 

included: production of fake Gillette razor blades cracked by the public security organs of Zhejiang Province, production of fake Adidas and Nike sports shoes cracked 

by the public security organs of Fujian Province, production of fake Cisco (USA) 

electronic products cracked by the public security organs of Guangdong Province, 

and production of fake brand name liquors, including Wuliangye, cracked by the 

public security organs of Sichuan Province. 

As more and more foreign companies are investing, selling their products and 

building enterprises and R&D centers in China, the Chinese public security organs 

have gradually established a system of regular communication and coordination 

with IPR proprietors, earnestly listening to their opinions and suggestions. Since 

December 2002, together with relevant associations of enterprises with foreign investment, the Ministry of Public Security has held three forums on ‘‘Protection of 

Intellectual Property Rights against Crimes’’ and published forum declarations, improving communication and coordination in this field. 

In view of increasing transnational and trans-border criminal cases of IPR infringement, the Chinese public security organs attach great importance to international law enforcement cooperation in the fight against IPR infringement, and 

have conducted cooperation with the law enforcement organizations of various countries in assistance in investigation and collection of evidence, exchange of information and judicial assistance. In July 2004, working together with the Immigration 

and Customs Enforcement of the Department of Homeland Security of the United 

States, the Chinese public security organs successfully cracked a serious case of suspected sale of pirated DVDs in Shanghai, arrested seven suspects headed by an 

American citizen, raided three places where pirated DVDs were hidden, and confiscated over 210,000 pirated DVDs. 

IX. Judicial Protection of Intellectual Property Rights 

In recent years, the Chinese procuratorial organs have earnestly exercised their 

duties of examination of arrests and prosecutions in cases of criminal IPR infringement, as well as legal supervision over relevant criminal lawsuits in accordance 

with law, handled a large number of cases of suspected criminal IPR infringement. 

From 2000 to 2004, the procuratorial organs at all levels approved the arrests of 

2,533 people suspected of criminal IPR infringement, and instituted prosecutions 

against 2,566 suspects. In 2004, the arrests of 602 people suspected of criminal IPR 

infringement were approved, and prosecutions against 638 suspects were instituted. 

In the same year, procuratorial organs around China launched a special drive to supervise cases involving production of fake products and IPR infringement, during 

which they urged relevant administrative law enforcement organs to transfer suspected criminal cases to public security organs according to law, supervised the filing of cases that should have been filed by the public security organs according to 

law, made sure that suspected criminal cases entered judicial proceedings in time, 

and investigated some criminal cases of conniving and covering up production and 
332

sale of fake products and of IPR infringement involving government functionaries 

abusing their powers. 

For many years, the Chinese people’s courts at all levels have continuously 

strengthened work in IPR-related civil and criminal trials under the principle of 

‘‘justice and efficiency.’’ Through handling a large number of IPR-related cases, they 

have protected the legitimate rights and interests of Chinese and foreign IPR proprietors equally, punished acts of IPR infringement and severely cracked down on 

criminal IPR infringements, making unremitting efforts to realize social fairness 

and justice. 

Since the handling of the first case of a technological contract dispute in 1981, 

the Chinese courts have continuously expanded the range of IPR-related trials to 

include cases concerning copyright, trademarks, patents, unfair competition, computer software, new varieties of plants and integrated circuit layout designs, thus 

establishing the status of court trials in the handling of IPR-related cases. From 

1998 to 2004, courts throughout the country concluded 38,228 IPR-related civil cases 

of first instance and 2,057 criminal cases of first instance involving IPR infringement in accordance with Section Seven, Chapter III of the ‘‘Specific Provisions’’ of 

the ‘‘Criminal Law,’’ handing down sentences to 2,375 criminals. Among these cases, 

in 2004, 8,332 civil IPR-related cases of first instance and 385 criminal cases of first 

instance involving IPR infringement in accordance with Section Seven, Chapter III 

of the ‘‘Specific Provisions’’ of the ‘‘Criminal Law’’ were concluded, and 528 criminals 

were punished. In the same year, the Chinese courts also concluded 932 criminal 

cases of production and sale of fake or inferior goods, punishing 1,453 criminals involved, and concluded 1,434 criminal cases of illegal business operation, punishing 

2,103 criminals. A considerable proportion of the above two types of cases also involved criminal IPR infringement. 

To correctly apply laws and make law enforcement standards coherent, and based 

on its experience in handling IPR-related cases, the Supreme People’s Court of 

China has formulated a series of relevant judicial interpretations in accordance with 

the law, and improved a series of important IPR-related law application principles, 

which have played an important role in the timely settlement of new problems 

emerging from the handling of IPR-related cases and in guiding the correct handling 

of IPR-related cases by the people’s courts at all levels. For example, the ‘‘Several 

Provisions on Law Application for Stopping Patent Infringement before Litigation’’ 

promulgated by the Supreme People’s Court in June 2001 provided judicial measures for stopping right infringements and effectively preventing more losses on the 

part of proprietors. The ‘‘Interpretation of Several Issues Regarding Specific Law 

Application in Handling Cases of Illegal Publications’’ promulgated by the Supreme 

People’s Court in December 1998 defined the standards of condemnation and penalty for criminal offences of copyright infringement. The ‘‘Interpretation of Several 

Issues Regarding Specific Law Application in Handling Criminal Cases of Intellectual Property Rights Infringement’’ jointly promulgated by the Supreme People’s 

Court and the Supreme People’s Procuratorate in December 2004 properly reduced 

the condemnation standards for the crimes of IPR infringement strictly in accordance with the provisions of the ‘‘Criminal Law’’ and in light of China’s actual conditions and judicial reality, increased the applicability of the relevant provisions of the 

‘‘Criminal Law,’’ and provided a concrete applicable legal basis for handling criminal 

cases of IPR infringement, and was thus of great significance for effectively cracking 

down on crimes of IPR infringement. 

The Chinese courts put special emphasis on the professional training of IPR 

judges. After many years of judicial practice and systematic training, a contingent 

has been formed of highly competent IPR judges who speak foreign languages, and 

have an intimate knowledge of the law, rich judicial experience and expertise in 

science and technology. Relatively complete IPR-related judicial departments have 

been gradually established, providing a strong personnel and organizational guarantee for effective IPR-related judicial work. 

The Chinese courts have continuously enhanced international exchanges and cooperation in the field of IPR-related judicature, learning and borrowing from the 

useful experience and successful practices of foreign countries. The Supreme People’s Court actively conducts friendly cooperation with the World Intellectual Property Organization and European Union, and has hosted several seminars and training courses on IPR, the results of which have been encouraging. These seminars and 

training courses have effectively promoted the enhancement of China’s IPR judicial 

protection, and continuously pushed the level of its IPR-related judicial work to a 

new high. 
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Conclusion 

Practice over the past two decades and more has shown that the Chinese government has made arduous efforts to protect IPR. China has achieved a noticeably 

great improvement in IPR protection, which took the developed countries several 

decades and even over a century to attain. However, the Chinese government is 

clearly aware that, in a large developing country with a population of 1.3 billion, 

relatively backward economy and low level of science and technology, a complete 

IPR protection system cannot be established overnight. China has a long way to go 

in this regard, and is faced with heavy tasks in IPR protection. 

At present, there are still IPR infringements in certain areas and fields in China, 

some of which are very serious. The awareness of the importance of IPR in Chinese 

society as a whole needs to be further enhanced. Meanwhile, China’s IPR protection 

work is facing new challenges in the course of economic globalization and rapid development of science and technology worldwide. In accordance with the requirements of the concept of scientific development, the Chinese government will adopt 

more effective policies and measures in the process of building a well-off society in 

an all-round way and developing a harmonious society, exerting efforts to raise its 

IPR protection work to a new level. 

For many years China has received active support and assistance from the international community in the establishment of its IPR protection system. In the future, 

the Chinese government will continue to earnestly execute its international obligations in this regard, enhance its cooperation with various countries and international organizations with a more active, open attitude, and join hands with them 

in promoting the establishment of a sound system and environment favorable for 

IPR protection worldwide. 
(334)

STATUTORY MANDATE OF THE U.S.-CHINA ECONOMIC AND SECURITY 

REVIEW COMMISSION 

Pursuant to Public Law 108–7, Division P, enacted February 20, 

2003

RESPONSIBILITIES OF THE COMMISSION.—The United 

States-China Commission shall focus, in lieu of any other areas of 

work or study, on the following:

PROLIFERATION PRACTICES.—The Commission shall analyze and assess the Chinese role in the proliferation of weapons of 

mass destruction and other weapons (including dual use technologies) to terrorist-sponsoring states, and suggest possible steps 

which the United States might take, including economic sanctions, 

to encourage the Chinese to stop such practices.

ECONOMIC REFORMS AND UNITED STATES ECONOMIC TRANSFERS.—The Commission shall analyze and assess 

the qualitative and quantitative nature of the shift of United 

States production activities to China, including the relocation of 

high-technology, manufacturing, and R&D facilities; the impact of 

these transfers on United States national security, including political influence by the Chinese Government over American firms, dependence of the United States national security industrial base on 

Chinese imports, the adequacy of United States export control 

laws, and the effect of these transfers on United States economic 

security, employment, and the standard of living of the American 

people; analyze China’s national budget and assess China’s fiscal 

strength to address internal instability problems and assess the 

likelihood of externalization of such problems.

ENERGY.—The Commission shall evaluate and assess how China’s large and growing economy will impact upon world energy 

supplies and the role the United States can play, including joint 

R&D efforts and technological assistance, in influencing China’s energy policy.

UNITED STATES CAPITAL MARKETS.—The Commission 

shall evaluate the extent of Chinese access to, and use of United 

States capital markets, and whether the existing disclosure and 

transparency rules are adequate to identify Chinese companies 

which are active in United States markets and are also engaged in 

proliferation activities or other activities harmful to United States 

security interests.

CORPORATE REPORTING.—The Commission shall assess 

United States trade and investment relationship with China, including the need for corporate reporting on United States investments in China and incentives that China may be offering to 

United States corporations to relocate production and R&D to 

China.
335

REGIONAL ECONOMIC AND SECURITY IMPACTS.—The 

Commission shall assess the extent of China’s ‘‘hollowing-out’’ of 

Asian manufacturing economies, and the impact on United States 

economic and security interests in the region; review the triangular 

economic and security relationship among the United States, Taipei and Beijing, including Beijing’s military modernization and 

force deployments aimed at Taipei, and the adequacy of United 

States executive branch coordination and consultation with Congress on United States arms sales and defense relationship with 

Taipei.

UNITED STATES-CHINA BILATERAL PROGRAMS.—The 

Commission shall assess science and technology programs to evaluate if the United States is developing an adequate coordinating 

mechanism with appropriate review by the intelligence community 

with Congress; assess the degree of non-compliance by China and 

[with] United States-China agreements on prison labor imports and 

intellectual property rights; evaluate United States enforcement 

policies; and recommend what new measures the United States 

Government might take to strengthen our laws and enforcement 

activities and to encourage compliance by the Chinese.

WORLD TRADE ORGANIZATION COMPLIANCE.—The 

Commission shall review China’s record of compliance to date with 

its accession agreement to the WTO, and explore what incentives 

and policy initiatives should be pursued to promote further compliance by China.

MEDIA CONTROL.—The Commission shall evaluate Chinese 

government efforts to influence and control perceptions of the 

United States and its policies through the internet, the Chinese 

print and electronic media, and Chinese internal propaganda. 

(I)

LIST OF WITNESSES, COMMUNICATIONS, AND 

PREPARED STATEMENTS

Page 

Antonellis, Darcy, Executive Vice President, Distribution and Technology Operations, Senior Vice President, Worldwide Anti-Piracy Operations, Warner 

Bros. Entertainment Inc., Burbank, California ................................................. 244

Prepared statement .......................................................................................... 247

Archey, William T., President and Chief Executive Officer, American Electronics Association (AeA), Advancing the Business of Technology, Washington, DC ............................................................................................................. 153

Prepared statement .......................................................................................... 156

Choate, Pat, Co-Director, Manufacturing Policy Project, Author, Hot Property: 

The Stealing of Ideas in an Age of Globalization, Sperryville, Virginia .......... 260

Prepared statement .......................................................................................... 262

Ciacchella, John, Vice President, A.T. Kearney, Santa Clara, California .......... 158

Prepared statement .......................................................................................... 162

D’Amato, Chairman C. Richard 

Opening statement of ....................................................................................... 1

Prepared statement .......................................................................................... 2

Dawson, Rhett, President and Chief Executive Officer, Information Technology Industry Council (ITI), Washington, DC ................................................ 164

Prepared statement .......................................................................................... 166

Everett, G. Carl, Partner, Accel Partners, Palo Alto, California ......................... 50

Prepared statement .......................................................................................... 53

Fingleton, Eamonn, Economic Author, Unsustainable: How Economic Dogma 

is Destroying American Prosperity, Tokyo, Japan ............................................. 132

Prepared statement .......................................................................................... 134

Fishman, Ted C., Author, China Inc.: How the Rise of the Next Superpower 

Challenges America and the World, Chicago, Illinois ....................................... 270

Prepared statement .......................................................................................... 272

FitzGerald, Mark, Managing Director and Senior Research Analyst in the 

Technology Group, Banc of America Securities LLC, San Francisco, California ..................................................................................................................... 186

Prepared statement .......................................................................................... 190

Gage, John, Chief Researcher and Director of the Science Office, Sun Microsystems, Inc., Santa Clara, California ................................................................ 180

Malcolm, John G., Senior Vice President and Director, Worldwide Anti-Piracy 

Operations, Motion Picture Association of America, Encino, California ......... 237

Prepared statement .......................................................................................... 239

Morgan, James C., Chairman of the Board of Directors, Applied Materials, 

Inc., Santa Clara, California ............................................................................... 19

Prepared statement .......................................................................................... 23

Mulloy, Patrick A., Hearing Cochair 

Opening statement of ....................................................................................... 115

Prepared statement .......................................................................................... 116

Opening remarks of .......................................................................................... 180

Perry, Honorable William J., Senior Fellow, Stanford Institute for International Studies, Stanford, California ................................................................ 5

Pillsbury, Michael, Senior Fellow, Atlantic Council of the United States, 

Associate Fellow, Institute for National Strategic Studies, National Defense 

University, Washington, DC ............................................................................... 81

Preeg, Ernest H., Senior Fellow in Trade and Productivity, Manufacturers 

Alliance/MAPI, Arlington, Virginia .................................................................... 126

Prepared statement .......................................................................................... 128

Rieschel, Gary Edward, Executive Managing Director, Mobius Venture Capital, Palo Alto, California ..................................................................................... 42

Prepared statement .......................................................................................... 46
Page

II

Robinson, Vice Chairman Roger W., Jr. 

Opening statement of ....................................................................................... 4

Prepared statement .......................................................................................... 4

Rock, Anthony F., Principal Deputy Assistant Secretary of State, Bureau 

of Oceans and International Environmental and Scientific Affairs, Washington, DC ............................................................................................................. 210

Prepared statement .......................................................................................... 213

Rowen, Henry S., Professor Emeritus, Graduate School of Business, Senior 

Fellow, the Hoover Institution, Emeritus Director, the Asia Pacific Research 

Center, Stanford University, Stanford, California ............................................ 117

Prepared statement .......................................................................................... 120

Scalise, George M., President, Semiconductor Industry Association, San Jose, 

California .............................................................................................................. 27

Prepared statement .......................................................................................... 30

Simon, Denis Fred, Provost and Vice President for Academic Affairs, Levin 

Graduate Institute of International Relations and Commerce, State University of New York, Albany, New York .................................................................. 84

Prepared statement .......................................................................................... 89

Suttmeier, Richard P., Professor of Political Science, University of Oregon, 

Eugene, Oregon .................................................................................................... 70

Prepared statement .......................................................................................... 73

Walsh, Kathleen A., Senior Associate, Henry L. Stimson Center, Boston, 

Massachusetts ...................................................................................................... 99

Prepared statement .......................................................................................... 101

Weber, Larry H., Acting Deputy Director, Office of International Science 

and Engineering, National Science Foundation (NSF), Washington, DC ....... 219

Prepared statement .......................................................................................... 222

Wong, Alan C., Senior Counsel, Nvidia Corporation, Santa Clara, California ... 35

Prepared statement .......................................................................................... 39

Zysman, John, Co-Director, Berkeley Roundtable on the International Economy, Professor, University of California, Berkeley, California ........................ 123