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Why China Is Making The Valley Fret


A trade dispute that has been quietly festering for months burst into the open on Mar. 10. That's when Intel Corp. (INTC) announced it wouldn't comply with a looming deadline that the Chinese government has set for so-called Wi-Fi chips, which let PCs and other electronic devices connect wirelessly to the Web. By June 1, Beijing wants component makers to incorporate its own standard for wireless security into any chips sold in China. The problem: Complying could mean turning over proprietary technology to one of 24 government-sanctioned companies.

Intel's announcement underscores growing fears in Silicon Valley that Beijing's motive is to boost its nascent chip industry. Beijing denies that, saying its main aim is to ensure that the Wi-Fi technology used in China is secure. But U.S. tech companies aren't buying it, and they're lobbying Washington to step in. If the rule is allowed to stand, U.S. tech execs fear Chinese companies will use their Wi-Fi technology to build the expertise needed to grab a big share of the growing market for chips in China. And later, as they achieve economies of scale, Chinese chipmakers could become global rivals. Says George M. Scalise, president of the Semiconductor Industry Assn. (SIA): "Once you start down this path by giving in, you open the door for more demands and end up having a whole bunch of competitors using your technology."

A RISK OF BEING SHUT OUT

How much technology should be shared with Chinese partners? The issue been debated for years. On one hand, tech outfits don't want to give away trade secrets that will spawn low-cost rivals. But if they turn down the government's demands, they risk being shut out of a fast-growing market. "The Chinese are customers at the end of the day," says Colin L.M. Macnab, vice-president of marketing at Atheros Communications Inc., a Sunnyvale, Calif., chipmaker. "Telling customers they can't have things isn't good for business."

Still, it's easy to see why U.S. tech companies have misgivings about Beijing's Wi-Fi policy. Over the years, numerous foreign tech businesses claim they have suffered from China's weak protection of intellectual property -- from Microsoft Corp., which alleges that its software has been widely counterfeited, to Cisco Systems Inc., which last year sued a Chinese hardware maker over allegations that it copied and used Cisco networking software. And while Beijing has reined in some of the worst excesses since joining the WTO two years ago, much remains to be done. Most important, say legal experts, Chinese legislation to protect intellectual property is vaguely worded and difficult to enforce. "It has been half measures," says Joseph Simone, a partner at Baker & McKenzie in Hong Kong. "They haven't done the full job."

What's more, the moves to force foreign chipmakers to share their Wi-Fi technology come as China is plainly trying to ramp up its domestic chip industry. That's an enormous undertaking, of course, and the Chinese remain years behind the U.S., Europe, and other Asian nations. For now, the budding industry is churning out low-end semiconductors, including commodity memory chips, for relatively simple goods. To help get things going, however, the Chinese have levied a 17% value-added tax on all chip imports. By contrast, domestic chipmakers pay the equivalent of a 3% tax. U.S. tech companies have been lobbying Washington to file a WTO complaint, and the U.S. was expected to do so on Mar. 18.

With the Chinese starting to move into microprocessors -- the guts of everything from PCs to telecom networking gear -- the move to force foreign chipmakers to cooperate with and possibly turn over their Wi-Fi technology to local partners is setting off alarms. Intel and others fear that if they do, Chinese rivals will move into more complex manufacturing over the next 10 years. Intel could be particularly vulnerable, since Centrino integrates a Wi-Fi transmitter with a microprocessor. The U.S. giant might have to hand over key knowhow to make the Chinese standard work.

China says U.S. companies are over-reacting. Beijing says -- rightly -- that current Wi-Fi security is weak; it argues an improved standard will instill greater public confidence in the technology. It also argues that it is far more efficient to set one national standard, so as to avoid the confusion that can occur when multiple standards flourish. And behind those reasons lies a deeper national security concern: Fearful of their vulnerability to spying, the Chinese simply don't want to depend on foreign suppliers for crucial encryption technology. "The Chinese have adapted a lot of American standards for network and communication equipment," says Liu Jiren, chairman and CEO of Neusoft, a software developer based in the northeast of China, and one of the 24 companies named to work on the new Wi-Fi standard. "China is really an open country. The purpose of this is really to make [Wi-Fi] safer and create confidence so people will use the mobile network."

AN ESCALATING DISPUTE?

But chipmakers point to what has happened in the cell-phone industry. In the late 1990s, nearly all the handsets sold in China were foreign-made. Then Beijing awarded licenses to local companies and closed the market to new foreign players. To gain entry, such newcomers as Samsung and LG Electronics teamed up with those Chinese companies. While both Samsung and LG say they shared technology for a piece of the Chinese market, it has cost many rivals dearly. Today, Chinese companies such as TCL Corp. and Ningbo Bird produce tens of millions of handsets a year -- many for export.

Will the Wi-Fi dispute escalate? The Information Technology Industry Council, National Association of Manufacturers, and SIA all contend that Beijing's policy violates WTO rules. U.S. trade experts tend to agree. Alan William Wolff, a trade lawyer at New York-based law firm Dewey Ballantine, says China's mandated technology transfer could be illegal under WTO rules because governments are not allowed to treat foreign companies differently from domestic ones. Moreover, chipmakers have already agreed upon improved international standards to address many of the Wi-Fi security issues China raises.

That view is hardly unanimous, however. Because the WTO rules give governments some flexibility over national security concerns, some believe Beijing has a case. What's more, WTO rules also allow governments to set standards so long as they promote market efficiency. But while that argument is valid, lawyer Simone says, "national security is an even bigger trump card."

In truth, the chipmakers hesitate to involve the WTO. Understandably leery of alienating China, they are working behind the scenes to convince Beijing to kill the standard -- or at least allow chips using the international standard to be sold. The U.S. government has also written to China, while trade officials have pressed the industry's case in Beijing.

The dispute could drag on for months, pressuring chipmakers to fold their cards. Analysts say Intel has the least to lose by refusing to cooperate with the Chinese, at least for now, since Centrino represents a fraction of its sales. Atheros and Broadcom Corp., on the other hand, rely heavily on Wi-Fi technology in their chips. If the Chinese won't compromise, say analysts, they may find it tougher to remain out of the market. How the issue is resolved may depend on whether U.S. chipmakers remain united. By Cliff Edwards, in San Mateo, Calif., with Jim Kerstetter in San Francisco, Bruce Einhorn in Hong Kong, and Paul Magnusson in Washington


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