Indigenous Innovation: Technology Firms Tangle Again With China Over Contracts and IP Control

China is determined to inspire, fund and thereby create its own innovation industry, primarily in technology. One way the country determined to do this was to insist that if you wanted to sell in China, you had to make what you were selling in China. The assumption was that the Chinese would figure out how to learn what you were doing and take over the business eventually. This was not lost on western companies or governments, which protested, threatening to cut off China from their own markets. The powers that rule from Beijing agreed but it is not clear that the regions have gotten the message or that Beijing is all that concerned that they do. John Bussey reports in the Wall Street Journal:

"There's an old proverb in China: The mountains are high, and the emperor is far away—meaning, if you're a bureaucrat out in the hustings, you can pretty much forget about Beijing and do whatever you like.

U.S. companies are learning this the painful way.

Multinationals are again complaining to U.S. trade officials about a problem they thought was resolved months ago. When China's President Hu Jintao met with President Barack Obama in January, he agreed to cancel rules that required foreign companies to design their products in China if they hoped to sell to the government—essentially a forced technology transfer.

The government is still the big customer in China, and the rules, part of the country's new campaign to create "indigenous innovation," had caused great anguish in the foreign business community. No one wanted to give away technology just to win a contract.

Mr. Hu's decision to abolish the practice was a hallmark of the January summit. It won applause from companies in the U.S., Europe and Asia, which had been worried about an increasingly restrictive business climate in China.

But out in the provinces, far from the emperor, where many procurement decisions are made, the nobles apparently have a different idea.

"At the provincial level, funny that they haven't yet gotten the word," says an executive with a large U.S. technology company. He adds that he met recently with a number of companies operating in China and none had seen significant change on the ground. "This was a big issue."

"People in the tech community are happy with what Hu Jintao committed to," says John Neuffer, vice president of global policy at the Information Technology Industry Council, a trade group. "But like anything in China, it's whether it's implemented or not."

"They are letting provincial authorities do their own thing," adds an executive with a U.S. manufacturer. One province may accept his bid, he says, but another may reject it as not meeting China's requirement that innovation be done in China—the technology-transfer imperative. "You have to fight it in every province. It's like punching at a cloud."

Many of these U.S. companies are keenly dependent on China for their growth and see the country increasingly inclined to favor local companies. China's goal isn't surprising: It wants to build its own national and global champions.

Robert Hormats, the State Department's top economic official, says procurement "will definitely be a topic" at high-level meetings with China in coming weeks. "I don't want to prejudge it, but we've heard from a number of companies that they're still having difficulty selling to government entities."

Beijing has plenty of experience cracking down when it wants to. During phases of China's explosive growth, when inflation was on the rise, the government tapped the brakes by slowing bank lending. It did so by announcing rules requiring regional banks to place more of their deposits in reserve (a step it took again this week). And if the provinces didn't heed, Beijing used so-called administrative measures—phone calls directly to a bank's officers, a regulatory style akin to cracking heads. It worked.

Still, it is a big country, and President Hu's commitment was made only in January. Chris Murck, president of the American Chamber of Commerce in China and based in Beijing, says, "It's too early to say the bureaucracy is stonewalling." Existing regulations first need to be rewritten to accommodate the agreement.

The bigger issue, Mr. Murck adds, is that this is just one piece of China's broader industrial policy, a large array of mostly new rules designed to speed the growth of national champions and foster home-grown innovation.

The list is long: new patent laws that could make it easier to seize foreign innovation; the setting of standards that require products to be re-engineered to meet Chinese specifications; national-security initiatives that give preferential treatment to Chinese companies in several industries; limitations on market access for U.S. services companies; continued weak enforcement of intellectual-property rights.

"China is picking some of the wrong ways to innovate," says John Frisbie, president of the U.S.-China Business Council. "Companies will tell you they continue to grow in China. But at the same time, they are watching these trends and it's giving them concern."

Technology companies, where innovation is the stock in trade, are having a particularly rough slog. At the end of the day, China's slow-motion approach to enforcing the Hu-Obama agreement is just part of this larger trend, says an executive in Beijing with a U.S. tech company.

"China's interest in developing its own companies is just what it is," he concludes. "Everything else is on the fringes."