A 10-Point Plan to Grow Your Economy Through Innovation Mercantilism (Part 1)

By Robert D. Atkinson

To the commerce minister of a developing nation:

I write to you today from International Institute for Innovation Mercantilism to send my congratulations! Your party has just gained power and you have been appointed commerce minister in your developing nation’s cabinet. Your prime minister has just charged you with growing your nation’s technology economy. She complains that too much tech is the province of U.S. firms and that for your country to develop you need to find a way to grow tech industry jobs. She has given you one week to come up with a plan. What should you do?

You have three choices: 1) tell the prime minister that the best way to grow jobs and income is to encourage all sectors to be innovative and that it’s a mistake to focus principally on tech jobs per se; 2) say that you can do this, but that she shouldn’t expect immediate results because growing innovation industries through investments in science, education, infrastructure, and related areas takes a number of years to pay off, but when they do, the growth is sustainable; or 3) say, “Yes, prime minister.”

If you don’t mind risking getting sacked you should answer number one because, as the scholarly evidence shows, for most nations, more than 90 percent of economic growth comes not from tech production, but from the broad-based use of technology by all sectors. Moreover, many tech-development policies, such as tariffs on high-tech imports and government domestic procurement preferences, actually reduce the use of tech in other sectors and slow growth. You might answer number two because for many fast growing technology economies — such as those of Ireland, Israel, and Singapore — these “framework” policies laid the groundwork for strong, sustained growth.

But unfortunately your PM wants a high-tech sector pronto! So what are you going to do? Well, here’s a 10-point plan based on global best-in-breed innovation mercantilist strategies and policies. Only one or two downsides. One is that it involves systemically violating the principles and in some cases the rules of the World Trade Organization (WTO), which your trade ministry is committed to. But don’t worry, if you play your cards right you can probably get away with an aggressive innovation mercantilist strategy, in part because the international community is pretty toothless when it comes to enforcing WTO rules, and, the United States, your main tech competitor, “speaks loudly, but carries a small stick.” A second downside is that tech mercantilist strategies often fail and even when they succeed they come at a high price, both from government spending and restricted growth in other parts of the economy. But I wouldn’t worry, you and your PM will likely be out of office long before people notice.

So if you ready, let’s get started.

Key components for an innovation mercantilist strategy

Let’s face it, your economy lags in innovation. And it lags largely because of a knowledge problem. Your firms don’t possess the kind of cutting-edge technological know-how that leading tech firms have spent years and often billions of dollars building up. You can work to build these capacities by encouraging foreign direct investment, expanding funding for science and engineering, improving your research universities and the like, but as noted, your PM wants results now.

So what do you need to do? The short answer, regardless of whether you want to go down the innovation mercantilist path or the more legitimate innovation policy path, is that you need to boost tech knowledge and learning. As Harvard economic historian Alfred Chandler writes in Inventing the Electronic Century, competitive advantage in innovation industries comes from developing a continual “learning base.” As he writes, “the initial first movers who created their learning bases had competitive advantages by being the first in developing their technical and functional capabilities that provided barriers to entry.” In other words, it’s hard to create a biotech, computer, or software industry from scratch, especially when the leaders have a big head start. So if you are all in on your innovation mercantilist strategy, the key organizing principle needs to be to beg, borrow, or steal, by hook or by crook, all the technological knowledge and information you can get. Here are ten easy steps:

1) Keep foreign firms out so your domestic firms can develop their own learning bases.

Since you are focused not on the companies and citizens in your economy that consume technology, but on the relatively small number of companies that produce it, you want to do all you can to help the latter. A key is to reduce access to your markets by more efficient and innovative foreign tech firms. Don’t worry that you are hurting overall growth because you are limiting imports of best-of-breed global technologies; most voters won’t notice.

There are lots of ways to limit foreign market access. The easiest (and most profitable, at least to your treasury minister) is to slap high tariffs on technology imports. Unfortunately, this can be risky, as it can get you hauled up before a WTO tribunal in Geneva. But still, you ought to be able to get a good five or so years out of this form of protection before you are forced to stop, and by then, hopefully, you will have gained some learning and the treasury will have raked in a lot of revenue.

If tariffs aren’t an option, you can always require firms in your country to use national technology standards. But don’t forget to claim that your standards process is open and transparent and that your government-picked standards are better than the global standards developed by engineers in an open, consensus-based process. That pretty much gets you a pass in Geneva at any potential WTO tribunal. You might want to take a trip to Beijing and ask the masters how they have done it, for the Chinese government has imposed scores of domestic technology standards generated precisely for the purpose of giving their domestic firms a leg up and foreign firms some lead weights. But be forewarned, developing your own standards can land you into a “Galapagos Island syndrome“ where your domestic tech companies have the protection of national standards but the hindrance of not building products to shared global standards. Your PM didn’t actually say she wanted your domestic firms to export did she? If so, oops, as Japan had to learn the hard way from the 1970s to early 2000s when it went with domestic mercantilist standards, before it more recently went with industry-led, global standards.

2) Whatever you do, don’t let your fellow ministers buy high-tech goods and services from foreign firms.

Remember, the goal is to build up your own domestic firms’ learning capabilities and you can help this by simply refusing to buy from foreign firms. And don’t forget that you probably control or at least influence not just government ministries, but a lot of sectors, such as state-owned enterprises and a whole slew of firms that owe the government favors. You can enlist them in the buy-domestic cause. Japan led the way with domestic procurement preferences in the 1970s and 1980s. China is doing even more today. So what if you are raising the price or lowering the quality of what the government buys, it’s helping your national champions.

This works best if you are not a signatory to that pesky WTO Government Procurement Agreement that requires you to buy goods and services based on best value to government, regardless of the nationality of the company. But if you are, there’s an option: For IT goods and services, simply claim that you need to buy local for cybersecurity reasons, and don’t forget to invoke the Edward Snowden revelations as a pretext. Milk this one for all its worth, saying that you just need to make sure that foreign tech products don’t have U.S. intelligence backdoors in them, as the Chinese are doing with their Integrated Circuit Promotion Guidelines. Even though foreign tech is just as, if not more, secure than any domestic tech you can procure, if you use this excuse the WTO won’t stop you.

3) Don’t let foreign firms sell unless they agree to give domestic firms technology.

It almost always makes sense to encourage foreign firms to invest in your nation. After all, they pay higher wages than domestic firms and have access to more global knowledge. But don’t despair; unless you are a small and poor country like Zimbabwe, or a socialist nation like Venezuela where no foreign firm will invest, you have some leverage. For if there is one thing technology firms want, it’s to sell their products and services. So simply say no domestic sales or investment unless they agree to a joint venture with one of your domestic champions.

If you want to learn how to do this right, get on the first jet to Tokyo because the Japanese were the first nation to master this strategy. For example, in the 1950s the Dutch electronics firm Phillips, seeking to break into the Japanese market, agreed to establish a joint venture with the Japanese firm Matsushita (maker of the Panasonic brand) whereby Phillips provided the core technology to make light bulbs, radios, and other electronic components. Ten years later, the Japanese used the same tactic to get access to new semiconductor technology, forcing Texas Instruments, one of the leading semiconductor firms, to enter a joint venture with Sony and to license its technology not just to Sony, but to all Japanese electronics firms that wanted it. It was either that or no market access. The Japanese did this time and again over the years, including with firms like IBM where they refused to let IBM sell mainframes in Japan unless IBM formed a joint venture and gave its technology to Japanese firms. Unlike other firms, IBM held firm and was able to sell direct in Japan, having to make just the one teeny concession of sharing its patents with Japanese electronics firms.

Today, with an economy bigger than the Japanese economy, the Chinese are going to town with this strategy, pressuring scores of leading U.S. technology firms to share valuable technology with their Chinese competitors as a condition of market access. It’s either their way or the highway. And since the U.S. government won’t exert real pressure on the Chinese government to protect U.S. firms, U.S. firms have little choice but to deal.

By the way, if the prior government was so clueless as not to do this in the past, perhaps out of some idealist notion that being in the WTO meant the country had to follow its rules, it’s not late to fix it. Get a few of your other ministers to collectively tell foreign firms that if they don’t sell out to domestic champions then their life will be, shall we say, difficult. The Japanese government was a master at this, like when they pressured RCA, the world’s leading TV firm at the time, to sell its wholly owned Japanese operation, JVC, to a Japanese firm, which ended up being bought by Matsushita.

4) Enlist other government agencies to weaken foreign firms.

If you want to win, it’s easier if your competitors are weakened. So get your assistant to set up a meeting with your justice minister and press him to launch an antitrust investigation into some of the leading foreign tech firms in your economy. This is right out of the Chinese, European, and Korean play books. Europe has long used antitrust to try to hobble U.S. tech firms like GE, Microsoft, and now Google and Facebook. Korea hasn’t been bad at this either, bringing mercantilist-inspired cases at the behest of the domestic tech firms against U.S. tech firms like HP, Microsoft, and Oracle. But the unrivaled master is China, as it is able to use its “anti-monopoly” law and politicized court system as a bludgeon, successfully going after U.S. firms like Microsoft, Qualcomm, and Western Digital, and extracting all kinds of valuable concessions, like big fines, reduced prices for Chinese firms, and the ability to have their firms buy equity stakes in the U.S. tech companies.

For example, just look at the Western Digital Corporation (WDC) case. In 2012, WDC, one of the world’s leading hard drive manufacturers, acquired a subsidiary of Hitatchi. While Australian, European, Japanese, and U.S. competition authorities approved the acquisition, China’s Ministry of Commerce (MOFCOM) refused, which prevented WDC from achieving $400 million in savings per year in China through rationalization with Hitachi’s Chinese facilities. But less than three weeks after the Chinese state-owned high-tech company Unisplendor bought into WDC, MOFCOM, the Chinese regulator, approved the integration of WDC and Hitachi. Western Digital is now the third global IT company to accept investments from Chinese government-owned corporations in order to win MOFCOM approval.

Just remember — and this is key — never admit that you are doing these things for mercantilist reasons; just keep repeating “our government is pushing for competitive markets that support consumer welfare.” The last phrase is especially important because if the antitrust bureau in the U.S. Department of Justice hears that they will just nod and smile in support. Case closed.

But make sure you tell your justice minister not to actually enforce competition policy on your own domestic firms. You want them to be able to collude and coordinate. Again, this is right out of the Japanese play book from the 1960s to 1980s, where firms coordinated pricing policies in the home market in order to be able to afford to price below cost in foreign markets, especially the United States. Don’t worry, your firms won’t have to do that for too long. Just long enough to drive out your foreign competitors, and then prices and profits can go back up.

And don’t forget your colleague in the justice ministry can also use government pressure to force domestic firms to merge, or at least divide up markets so that they don’t have to compete with each other. This can help if you want to avoid domestic competition. The French government did this in the 1960s to create Bull as a merger of several French computer companies to compete with IBM. The Japanese government-orchestrated strategy to challenge IBM in the mainframe market involved assigning firms particular niches (large mainframes, mid-size, peripherals, etc.) so they could specialize and compete against IBM. But be forewarned, this can fail miserably if you pick wrong (as the French and U.K. mainframe computer cases from the 1960s demonstrate).

5) Set up a weak patent system so your companies can file patent suits against western companies.

Along these lines, here’s another tactic: Work with your patent office and court system to allow domestic firms to get as many patents as they want, even if they are weak. They can use them against foreign firms who have the temerity of wanting to license their patented technology to your country’s firms. Again, when you take a field trip to Beijing, be sure to talk to the Chinese Intellectual Property Office as it has this down to a science. Supported by China’s recent anti-monopoly law, China has a perfect weapon. In particular, Article 55 states, “This Law is not applicable to undertakings’ conduct in exercise of intellectual property rights pursuant to provisions of laws and administrative regulations relating to intellectual property rights; but this Law is applicable to undertakings’ conduct that eliminates or restricts competition by abusing their intellectual property rights.” Abuse means charging market-based intellectual property (IP) licensing fees to Chinese companies. This provision has been used to take action against companies whose only “crime” is to be innovative and hold patents. Indeed, the Chinese law allows compulsory licensing of IP by a “dominant” company that refuses to license its IP if access to it is “essential for others to effectively compete and innovate.” And with Chinese courts largely rubber-stamping the government’s dictates, foreign companies have to comply. All too often complying means changing companies’ terms of business so that they sell to the Chinese for less and/or transfer even more IP and technology to Chinese-owned companies, often after paying substantial fines.

Moreover, under the Chinese patent system it is extremely easy for a Chinese firm to be granted “utility model and design patents” (as distinct from harder to obtain invention patents that are more akin to U.S. patents). In 2009 these “junk patents” constituted approximately three-quarters of Chinese patents issued to Chinese-owned firms. This weak patent system makes it easy for Chinese firms to countersue in response to infringement suits by foreign competitors. The Wall Street Journal reported that more than half of patents are filed with the sole intention of suing foreign firms for patent infringement. Chinese firms are able to take advantage of an intentional legal loophole whereby China does not recognize foreign patents.

China’s patent policy makes it easier for domestic retaliation by Chinese companies that face overseas intellectual property rights lawsuits from foreign competitors. One example was a case where the CHINT Group, a Chinese firm, sued the French electronics firm Schneider for a patent violation. Schneider had first filed suit against the CHINT Group for infringing on its patents and won some lawsuits in Germany and Italy. In China, the Chinese patent office granted the Chinese firm a weak utility model patent enabling it to counterattack and make the claim that Schneider was using its technology illegally. The Chinese Intermediate People’s Court fined Schneider about $50 million. The newest case involves the use of the Apple trademark name “iPad.” A Chinese company, Proview Technology, claimed that it owns the trademark to the name, even though Apple had previously bought the rights to the name. Apple ultimately settled for $60 million with Proview.

I can’t give you all the secrets now though! Check back tomorrow for the rest of the steps for how to grow your nation’s economy through innovation mercantilism.

Robert D. Atkinson (@RobAtkinsonITIF) is president of the Information Technology and Innovation Foundation, a think tank focusing on the intersection of technological innovation and public policy.