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How costly is Chinese IP theft?

Christian List directed me to some studies of the costs of IP theft.  The first link was to an AEI report on the subject, which criticized the US definition of IP theft:

The leaders of the IP commission, Admiral Dennis Blair and General Keith Alexander, penned an opinion piece last year that not only points the finger directly at China but also illustrates confusion as to just what the US should target. They stated: “Chinese companies, with the encouragement of official Chinese policy . . . have been pillaging the intellectual property of American companies.” They listed a large array of US economic sectors as examples, including automobiles, chemicals, aviation, pharmaceuticals, consumer electronics, and software, among others.

But even these two highly knowledgeable leaders then went on to confuse the US case against Beijing’s “pillaging” by adding a list of military IP thefts, including plans and designs related to the F35 fighter, the Patriot missile system, the Aegis Combat System, thermal imaging cameras, and unmanned underwater vehicles, among others, as examples of Chinese spying operations. The problem and confusion to the reader here is that such military espionage is considered fair game by all nations, including the US. And one hopes that US intelligence agencies have been equally diligent in ferreting out Chinese (and other nations’) advanced military designs and equipment.

Chinese theft of US military secrets is certainly something that the US should be concerned about, and try to prevent.  But perhaps the moralistic tone one sees is a bit inappropriate, given that the US government does the same thing.  I’m all for trying to prevent this sort of espionage, but here I’ll focus on commercial theft, which seems to be the bigger issue.  The AEI piece linked to a 2017 US government report on IP theft.  Indeed the term ‘theft’ is used right in the subtitle of the report:

THE THEFT OF AMERICAN INTELLECTUAL PROPERTY: REASSESSMENTS OF THE CHALLENGE AND UNITED STATES POLICY

I was thus surprised to see the report discuss activities that cannot possibly be regarded as “theft”:

China continues to obtain American IP from U.S. companies operating inside China, from entities elsewhere in the world, and of course from the United States directly through conventional as well as cyber means. These include coercive activities by the state designed to force outright IP transfer or give Chinese entities a better position from which to acquire or steal American IP.

I.e., we’ll let you invest in China if you share technology.  In fairness, most of the report does focus on three types of outright IP theft:

We estimate that the annual cost to the U.S. economy continues to exceed $225 billion in counterfeit goods, pirated software, and theft of trade secrets and could be as high as $600 billion.

Wait until you see where they got these numbers:

Counterfeit and pirated tangible goods.

In 2016, the OECD and EUIPO used worldwide seizure statistics from 2013 to calculate that up to 2.5%, or $461 billion, of world trade was in counterfeit or pirated products.23 By applying this percentage to U.S. trade, we estimate that in 2015 the value of these goods entering the U.S. market was at least $58 billion.

The United States, however, is a much larger market for imports than the average market. It is nearly equivalent in size to the European Union, where the OECD/EUIPO study determined that approximately 5% of imports are counterfeit or pirated tangible goods. By using 5% as a proxy for the proportion of counterfeit and pirated tangible goods in U.S. imports ($2.273 trillion),25 we estimate that the United States may have imported up to $118 billion of these goods in 2015. Thus, anywhere from $58 billion to $118 billion of counterfeit and pirated tangible goods may have entered the United States in 2015. This represents the approximate value of counterfeit and pirated tangible goods (not services) entering the country.

With respect to counterfeit and pirated tangible U.S. goods sold in foreign markets, the OECD/EUIPO study found that they accounted for nearly 20% of the value of reported worldwide seizures. In 2015, estimated worldwide seizures of counterfeit goods totaled $425 billion, meaning that as much as $85 billion of counterfeit U.S. goods (20% of worldwide seizures) entered the world market (including the U.S. market).

Certainly, in the absence of counterfeit goods some sales would never take place, and thus the value of illegal sales is not the same as the sales lost to U.S. firms. The true cost to law-abiding U.S. firms in sales displaced due to counterfeiting and pirating of tangible goods is unknowable, but it is almost certain to be a significant proportion of total counterfeit sales. For purposes of aggregating the total cost to the U.S. economy of IP theft, we have estimated that 20% of counterfeits might have displaced actual sales of goods. When applied to the low-end estimate ($143 billion) of the total value of counterfeit and pirated tangible goods imported into the United States and counterfeit and pirated tangible U.S. goods sold abroad, the conservative estimate of the cost to the U.S. economy is $29 billion. When applied to the high-end estimate ($203 billion), the cost to the U.S. economy is estimated at $41 billion.

“Displaced”?  So let me get this right. If my wife buys a Coach handbag for $100, and it’s a counterfeit from China, and she enjoys the handbag, then the “cost” to America is $100?  I’m guessing that no actual economists participated in the writing of this government report.

Update:  Bob Murphy pointed out that my wording was wrong.  I should have said; “So let me get this right. If my wife buys a Coach handbag for $100, and it’s a counterfeit from China that displaces the sale of an American handbag, and she enjoys the handbag, then the “cost” to America is $100?”

Otherwise, my point is the same.

You might argue that my handbag example trivializes the problem, and that the real problem is patent infringement, which slows innovation.  I agree.  But how big a problem is patent infringement?  Again, the US government:

The same OECD/EUIPO study found that while 95% of counterfeit goods seized by customs officials were protected by trademarks, only 2% were counterfeits of patent-protected goods.

Here is the summary data for all three types of IP theft:

Totaling It All Up

In summary, we estimate that the total low-end value of the annual cost of IP theft in three major categories exceeds $225 billion, or 1.25% of the U.S. economy, and may be as high as $600 billion, based on the following components:

• The estimated low-end value of counterfeit and pirated tangible goods imported and exported, based on a conservative estimate that 20% of the cost of these goods detracts from legitimate sales, is $29 billion. The high-end estimate for counterfeit and pirated tangible goods imported and exported is $41 billion.

• The estimated value of pirated U.S. software is $18 billion.

• The estimated low-end cost of trade secret theft to U.S. firms is $180 billion, or 1% of U.S. GDP. The high-end estimate is $540 billion, amounting to 3% of GDP.

The software estimates are flawed in much the same way as the pirated goods estimates.  But it really doesn’t matter, because the total estimated cost of IP theft is almost entirely driven by the third category (trade secret theft), especially when you consider that the first two categories use methods that exaggerate the costs by at least an order of magnitude—indeed it’s not obvious that there are any net costs at all.  So where does the trade secret data come from?  The report doesn’t provide any methodology, merely citing a PriceWaterhouseCoopers study.  The following graph summarizes the methods employed by PWC:

Screen Shot 2018-12-08 at 2.20.54 PMPWC have done the following.  They start with the admission that they have no idea how to directly estimate the losses from trade secret theft.  Instead, they look at 8 other types of (mostly) illegal activities, which are also extremely difficult to measure.  Then they notice that 4 of these 8 activities involve between 1% and 3% of GDP.

Where to begin?

1.  Why assume that the estimates for other activities are accurate?

2. Why assume that the loss from trade secret theft is typical of other activities?

3.  If this is indeed the right method, then why not include other illegal sectors, such as the smuggling of tropical birds into the US?  Why just pick the large activities?

4.  Why assume that the size of an illegal activity like drug smuggling is a proxy for the cost of that activity to society?

5.  Why include R&D, which is 2.7% of GDP?  It’s not an illegal activity.  And does it seem plausible that the losses from trade secret theft exceed the total amount spent on R&D? But the high end of their range is 3% of GDP. As an analogy, is it plausible that losses from shoplifting exceed total revenue for retail sales?

6.  Notice that the most similar activity (software piracy) has a far smaller cost than the other 7.

The bottom line is that there is no there there.  No matter where you look, there is no reliable estimate of the cost of IP theft to the US (much less the cost in foregone utility to the entire world.)

In fairness, it’s quite plausible that the losses in this area are pretty large in dollar terms, certainly in the billions, or even tens of billions.  But that view is not based on any of these near worthless studies; rather it’s my intuition given two facts:

1. Information is a more and more central part of the global economy.  Commodities are an increasingly small share of the economy.

2. Information is easy to steal, and can be almost costlessly replicated.

Given these facts, IP theft will almost inevitably be an increasing problem.  Not just with China, but with India and many other countries as well. (Recall the slogan, “information wants to be free”) For fans of IP protection, this theft is a valid concern.

But this perspective also suggests that as with drug smuggling, the problem will be almost impossible to stop.  Consider the 2017 US government report’s discussion of China’s new communication satellite technology:

Perhaps the most recent case is China’s development of the Micius satellite, considered the world’s first quantum communications satellite, which China launched into orbit in 2016. Scientists at national laboratories and academic institutions around the world have been working on developing technology based on quantum mechanics to create a communications system that is considered to be completely secure from penetration. China is eager to develop this technology to protect its own communications from potential adversaries like the United States. However, perhaps ironically, China was able to develop quantum communications technology ahead of its rivals by incorporating their research findings. In an interview with the Wall Street Journal, Pan Jianwei, the physicist leading the project, was quoted saying, “We’ve taken all the good technology from labs around the world, absorbed it and brought it back.” This may be just an innocent quip about how scientists share their basic research findings with one another across borders. However, it has been demonstrated that the Chinese government systematically collects information and secrets from abroad to further its technology development goals, as illustrated by the cases discussed above.

This anecdote reveals more than the US government might have intended.  It suggests that it will be almost impossible to prevent scientific and technical information from rapidly spreading around the world.  The US should still crack down on IP thieves on a case-by-case basis, when they are caught, but we should not assume that this “war” is any more winnable than the drug war. Our pharma companies have basically accepted the fact that they are innovating for the high price American market, and the Europeans and Canadians will (legally) free ride.  Our other companies need to accept that there will be a lot of (illegal) free riding in IP intensive products, and there’s only so much we can do about it when it occurs in other countries.  Starting a trade war is a particularly inappropriate response.

I’m going to end with a comment left by Dallas Weaver after an earlier post on this topic:

You can divide IP into “real deep knowledge based IP” such as detailed scientific inventions and “fluff stuff” like “mickey mouse” or the business methods or “single click” IP.   The latter is obvious and easy to “borrow” and the owner could and do object.  I don’t care that much as the outcome is usually just rent-seeking with little contribution to humanity.

However, in the case of “real IP”, if you don’t have the knowledge base you can’t even steal it.   You could give the detailed IP for the F-35 to all the countries in the world and only a very few could, even, in theory, make the plane.    You can’t steal what you don’t understand.

If you have the ability to steal and utilize “real IP”, you also have the ability to create your own inventions.   Why copy the obsolete designs of others rather than creating improvements.   If you copy, you are always behind the curve.

Modern technology is so complex that the associated IP is all about people who understand the technology and China produces more STEM graduates in two weeks than we do in a year.  Guess who will win the real IP game?   Meanwhile, we demand that the new Ph.D. STEM graduates from our universities who are from China go home after graduation.

Most of the discussions about IP theft are by people who don’t have a strong enough STEM background to really understand what they are talking about.  Even Tyler with his deep understanding of economics doesn’t understand that the “tree of knowledge” is producing more fruit than ever in history, but to reach it requires “standing on the shoulders of giants”.

To even be able to stand on the shoulder of giants requires being able to read primary references in the area and I would like to drop the challenge to the readers to pick up the Reports section of Science Magazine (AAAS Journal) and see how many refereed articles they could read and understand.   When you stand on these shoulders you can see tons of what appears from your lofty perspective “low hanging fruit” for the picking.

PS.  I’m pretty sure that Tyler does understand the amazing fruits produced by the “tree of knowledge”, but I thought his comment made some interesting points.

PPS. I have a related post at Econlog.

The loudest apologists for global neoliberalism

Back in 2016, the Trumpistas told us that the economy was a disaster.  Trump himself talked of economic “carnage” in his inaugural address.  When people pointed out that unemployment had recently fallen from 10% to 4.6%, they said those numbers were meaningless, and that the actual unemployment rate was as high as 30% or more.  We were told that the real issue was the huge trade deficit, which was decimating the American economy.  Those who pointed to “phony unemployment data” and ignored the trade deficit were nothing more than apologists for global neoliberalism.

Today the Trumpistas insist that the economy is in superb shape even though, as Tyler Cowen points out in a recent post, imports are surging and the trade deficit is getting larger.

I actually don’t have any big problem with Trumpistas saying the economy is in good shape, as long as they acknowledge that they have become the loudest apologists for global neoliberalism.  If they aren’t willing to acknowledge that fact, then what basis do they have to insist that the economy is in great shape?  RGDP growth?  It was just as fast around 2014-15.  Unemployment?  It fell from 10% to 4.6% even before Trump was elected.  Stocks?  They soared dramatically higher under Obama.  The big Trump issue is and always has been the trade deficit.  That’s how he wants to be judged, and that’s how I’ll judge him.

So Trumpistas should either take credit for continuing Obama’s policy of selling out to global neoliberalism with a policy of big trade deficits, falling unemployment, and soaring stock prices, or else keep their mouths shut.

PS.  The Financial Times makes the following claim:

Even if Mr Trump were gone tomorrow, nobody today in the US could run for president and win on a “let’s go back to the 1990s” platform. Laissez-faire trade and globalisation in general are under fire in the US (as well as in Europe and any number of developing countries).

Where is the evidence for this claim?  Why can’t we go back to the 1990s?  Polls show that support for free trade agreements is stable over time, and that young people and minorities are far more supportive of free trade than older people.  Why is it assumed that our future is inevitably more protectionist?  Aren’t the young and minorities our future?

Screen Shot 2018-06-10 at 3.51.00 PM

Commodities are fungible

Here’s the Financial Times, discussing recent trade negotiations with China:

They said that after two days of “constructive talks” China had agreed to “significantly increase” its purchases of US goods and services and on the need for “meaningful increases” in US agricultural and energy exports to China.

Beijing had agreed, they said, to amend relevant laws and regulations, including its patent law, to address US intellectual property complaints that have fuelled Mr Trump’s recent threats to impose tariffs on up to $150bn in imports from China. They also pledged to continue engagement to resolve their differences.

In recent years we’ve heard a lot of complaints about a “China Shock”, the idea that a surge in Chinese exports to the US has cost jobs in manufacturing.  And now the US is pushing China to import more US food and energy, which would create an even bigger China shock, if it were successful. That’s because any trade policy that leads more food and energy exports also tends to lead to more imports of manufactured goods.

On the other hand, the policy is not likely to be successful.  If the Chinese buy more corn and oil for the US, they will buy less corn and oil from Brazil.  Brazil will send those goods to the countries that previously were buying the US corn and oil that are being redirected to China.  The bilateral deficit with China will shrink, but the overall US trade deficit with the rest of the world will not change.  Commodities are fungible.  All that will happen is that trade patterns will be rearranged, imposing more transportation costs.  A deadweight loss for the global economy.  And of course Trump’s fiscal policy will make the trade deficit “worse”.

The Chinese surely understand this, but I suspect the Trump administration does not.  Or perhaps people like Larry Kudlow do understand, but are keeping quiet because they wish to avoid something much worse.

Saturday’s vague statement did not mention telecommunications company ZTE and its lack of firm targets highlighted a continuing gap between both sides’ priorities.

The apparent failure came as political reaction forced the Trump administration to back away from a presidential commitment to resolve a dispute over ZTE, which was forced to suspend business operations after being banned from buying US components. . . . Mr Trump’s tweet provoked a backlash from both Republicans and Democrats in Congress who pointed to US intelligence agencies’ longstanding security concerns about ZTE. Politicians across the US political spectrum warned the president on Friday not to cave in to China.

Trump’s negotiating has been so ineffective that both Dems and Republicans are complaining he’s too weak on China, not nationalistic enough.  ROFL.

Trump is discovering that trade is like health care, much more complicated than he imagined.  It’s already clear that the Bannon wing of the GOP has lost on trade; there will be no meaningful actions to reduce the US trade deficit.  Indeed Trump’s policies will likely widen the deficit.  The alt-right has successfully transformed the GOP into an alt-right party in terms of rhetoric.  You see mainstream GOP politicians like Mike Pence heaping praise on criminal, racist, right-wing extremists like Sheriff Arpaio.  The alt-right can also take comfort in the fact that we have despicable, stupid, bigoted preachers represent the US at the Jerusalem embassy opening.  But the alt-right is losing on policy.  They failed to get an alt-right foreign policy, they failed to get a Mexican wall or a sizable cut in immigration (except refugees, a tiny portion of immigration), they failed to get a big increase in infrastructure spending, and they will fail to get an alt-right trade policy.

The one signature success of Trump—big tax cuts for corporations—is not an alt-right policy. It’s from the traditional Mitt Romney GOP playbook.

How would consumers feel about the Federal government tripling the gas tax?

Even the previous 4-cent increase in the gas tax was controversial.  Now suppose the federal gasoline tax (currently 18.4 cents) was tripled.  I’d expect consumers to freak out over the news.  And yet even a 37-cent increase is relatively small compared to some of the wild gyrations in gas prices that we’ve seen in recent years.  So why would the reaction be so strong (assuming that I’m correct?)

I think the answer is that consumers know that gas prices gyrate up and down, but also that a gas tax is permanent.  Thus future gyrations would be around a trend line that is 37 cents higher than before.

Commenter Plucky directed me to a very good Tax Foundation article on the proposed border tax.  This caught me eye:

Another consequence of dollar appreciation is that debts denominated in U.S. dollars will become more expensive in foreign countries. This is because a foreign country or business would need to raise money in the local currency and convert it into more expensive dollars to pay the debt. Emerging markets may be hit hardest by this.[33] However, many policy changes in the United States and natural movements in the market have impacts on the value of the U.S. dollar that could impact dollar-denominated debts.[34] It isn’t clear why a border adjustment would be a special case.

I’d make two points here:

1.  A border tax would be relatively permanent.  The dollar would continue to fluctuate over the business cycle, but (so it is claimed) around a 25% higher trend line.  That’s a lot.  For instance it would give Canadian tourism a big advantage over American tourism.  Hawaii would find it harder to attract Asian tourists.  Ditto for Florida vs. the Bahamas.  It certainly won’t destroy our tourism industry, but don’t assume that 25% is not a big deal—it is.  How about our airlines?

2.  In the past, a strong dollar has often been associated with a relatively strong US economy.  Thus the pain of emerging markets having to repay dollar debts at a higher rate is partly offset by strength in EM exports.  This would be different, a sudden 25% jump in the cost of repaying debt, without the associated macro benefits.  Again, I’m not saying it would necessarily cause a debt crisis, but don’t assume that adding 25% to trillions in dollar debts is not a big issue.

PS.  I actually think the tax reform proposal has a lot of merit. Debt and equity would finally be on a level playing field.  But I still have a few lingering doubts about suddenly imposing an exchange rate shock of that size.  (Perhaps because I own some overseas mutual funds.  But then even US multinationals will see foreign profits translated back into US dollars at a considerably lower value, and yet the US stock market seems to be doing fine.  So who knows?)

Don’t confuse free trade and trade deficits

Here’s Benjamin Cole:

As David Glasner recently noted, no plank of orthodox macroeconomics is more sacred today than that international free trade is good, and that even large and chronic trade deficits don´t matter.

But an overlooked 2012 paper from the New York Federal Reserve, entitled House Price Booms, Current Account Deficits, and Low Interest Rates, raises serious concerns about chronic trade deficits, particular given the deeply entrenched ubiquity of property zoning.

This is not true.  The claim that large trade deficits do not matter is certainly not “sacred”, indeed many economists disagree.  But even if it were true, this makes no sense.  Trade deficits are one thing, and free trade is another.  Both the US and Germany have relatively free trade, but we have a large deficit (although much of that is measurement error) and Germany has a large surplus.  The cause of our current account deficit is saving/investment imbalances.  If you want a smaller deficit you do not install tariffs, you install pro-saving (or anti-investment) fiscal policies.  You encourage saving by lowering the tax rate on capital income, and you reduce government dissaving by making the budget deficit smaller.  Yes, tariffs could reduce the budget deficit by a tiny amount, but it’s an extremely inefficient way of doing so.

If you are worried about trade deficits, the last thing you should be doing is protectionist trade policies.

The paper posits, “One of the most striking features of the period before the Great Recession is the strong positive correlation between house price appreciation and current account deficits, not only in the United States but also in other countries that have subsequently experienced the highest degree of financial turmoil.”

The short story is this: When a nation consumes more than it produces, and imports the difference, it must sell assets to finance the shortfall. Foreigners are especially keen on the perceived security of real estate, and, of course, can leverage up with the ready assistance of domestic banks.  The term “commercial bank” has become a misnomer, as more than 75% of U.S. bank lending in is on property. Thus, huge trade deficits equal huge capital inflows into domestic real estate.

Property Zoning

The universal culprit in this trade-deficits-results-in-house-price-booms scenario is property zoning, a feature of modern economies deeply embraced by both the propertied and financial classes, but (consequently?) rarely a topic in macroeconomic discussions.

To mix metaphors, property zoning is the Achilles Heel of macroeconomic blind spots.

Without property zoning, nations such as Australia, Canada and the United States could produce more housing to soak up the foreign capital inflows, even after those flows are leveraged five-to-one by domestic banks. The U.S. runs about $500 billion a year in trade deficits.

But with ubiquitous zoning, house prices soar to equate supply and  demand, generating inflation and reducing living standards of the domestic population.

Ben is right that lots of people complain about foreigners snapping up real estate (more so in places like Sydney, Vancouver and London, than in the US.)  But he’s wrong about the economics.  Housing construction during periods of house price booms like 2005 is far higher than during house prices busts like 2009-12.  The irony here is that the very same protectionists who complain that foreigners don’t buy enough of our cars, thus depriving Detroit auto workers of jobs, also complain that foreigners buy too many of our houses, thus providing jobs to our construction workers.


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