Employee espionage steps onto the world stage

A news story caught my eye this morning. It is about a Chinese researcher who worked for Dow Chemical. He is accused of taking technology from Dow Chemical, and using it to start a company in China, with the financial support of the Chinese Government.

Technical espionage has been going on for years, but in the past, it has focused on weapons technology, which was of interest to foreign governments.

Now, emerging economies have a rapidly-growing industrial focus, supported by huge direct government investment. In this innovative environment awash in money, almost any leading-edge technology that can be used to develop a profitable new business is of interest.

As the Chinese industrial base grows, almost every Western company with a sophisticated technology base, and the manufacturing expertise to translate their new discoveries into a reliable finished product, is at risk of having not only their base technology exposed to world view, but also their manufacturing processes, giving any new company in another part of the world a huge leg-up into the industry. More troubling, in many cases, this kind of knowledge theft is being encouraged by some foreign governments, which gives the thieves immunity in their new, foreign, corporate environment.

China now has a killer combination: an industrial base big enough to take advantage of these kinds of illegal technology transfers, and the funding to expedite them. And the rest of the world is catching on. Now there is China India, and a bunch of other Asian countries who are making big Government investments in new companies, and they are looking for "ideas".

In the past, the world attitude has been to let American companies do the heavy hauling on the R&D and manufacturing innovation, and then buy the products from the US. Now that these foreign countries are getting into new product innovation for themselves, they are taking ideas from anywhere, and funding the new companies that are formed to use them, with no questions asked.

Some 20 years ago, it used to only be military secrets that were of concern to the US Government, and much of the law is designed to combat military secrets leaks. Accordingly, the law as it stands is entirely inadequate to protect Western companies from intellectual property depredation.

From the New York Times:

The Justice Department lost a case involving two California engineers. The government focused on documents showing that the engineers were working with a venture capitalist in China to seek financing for a microchip business from China’s 863 program, which supports development of technologies with military applications.

But the men were arrested before they filed the grant application. The judge in the case concluded in May that the government had needed to prove that the men had “intended to confer a benefit” on China, “not receive a benefit from it.”

This underlines the problem. There seem to be inadequate protections under the law for personal enrichment from technology theft. The law protects against another country's gain from technology theft, which is in line with protecting military secrets. But it seems to offer no protections in the area of industrial espionage, where the thieves are entrepreneurs attempting to enrich themselves in an industrial market.

It also raises interesting questions that must make us revisit the fundamental US approach of keeping Government at arms-length from business investment. It seem that the Chinese experiment, which involves very large Government participation in industry, seems to be a successful one.

However, in the US, Government involvement in industry is relegated to assisting industry, either by developing new technologies, or providing subsidized loans to new companies in desirable industries, and leaving the private investors to reap all the benefits.

The National Institutes of Health spend tens of billions of dollars on research every year. They have no industrial income that defrays these expenditures in a meaningful way, and often their discoveries languish for lack of private investment, which would need to develop manufacturing techniques and corporate structure to exploit these new discoveries.

There are many other US government research departments that likewise develop a huge library of new discoveries that are not industrialized.

Now, it seems the Chinese government is prepared to bite this bullet, and they stand to benefit from their direct ownership of the companies they invest in to bring the technologies to market. They are also prepared to use their universities and government research institutes to develop the technology that these new companies will employ, because their shareholdings in the companies that will exploit their research will directly benefit them in the future.

It is logical (maybe not ethical) in this environment to steal as much technology as possible, because it saves repeating the costly research. And if such theft is protected by the Chinese government (which is easy, because they control the investigations inside China, where all the evidence is, in the factories that are employing the stolen technology).

So America needs to do two things immediately.

First, revisit the law, and ensure that laws are passed that give US companies adequate protections against intellectual property theft.

The second is to examine how technology can get from US government research organizations into the hands of consumers in a more efficient manner. In the past, the US has been looked to as the country that is the innovator, with Japan being regarded as the second fall-back.

The world has changed. The US economy is faltering, and I see no improvement in the US economy on the near horizon. It is time for a complete re-examination of US government participation in business, and the changes that need to be made to dramatically improve American efficiency in technology exploitation.

But then, I could be completely wrong. And maybe it simply doesn't matter. Or the problem is unfixable. Give it some thought, and leave a comment.

China now moves into second place.

The rise of China is underlined by the news today that the Chinese economy has just become the second largest in the world, moving ahead of Japan, the old number 2 (well behind the US, the undisputable number 1) in the past quarter.

This blog entry is conjecture on the future of the world. Conjecture is based on hunch, and my hunches have always served me well, an integration of the information I have accumulated through directed and casual information gathering. Hunch takes thousands of factoids, and our resulting opinions are not always cognizant of all of the influences. Little pieces of information, their sources unremembered, play a role in forming our opinings.

But I will try to outline the major current elements that are part of the news. You, dear reader, can look back at the history of these elements, with the internet at your fingertips, and explode this conjecture, or expand on it. With a little luck, and some debate, the differing conclusions that our opinions lead us to might help us converge on something closer to an expectation of future reality.

Why is this important? I have found in the past that studying success stories, and the issues that are raised by that success, are very helpful in figuring out what has been lost in the striving for success, and determining the elemenbts that we are prepared to sacrifice for future success.

And there is no doubt that China is a success story. With double-digit percentage growth for the past 30 years, the power that China has become today is beyond the most wild forecasts that could have been made with a straight face in 1980.

Today, China has the most valuable bank in the world (stock market valuation), globally determines the price of raw materials, and has become a powerhouse in the invention and application of new technologies.

The Chinese totalitarian state is still intact. For sure, lots of growing pains. The Chinese Government has made strategic investments in every industrial sector. Their high speed rail system is fast becoming the envy of the industrial world. With the invitation extended to the rest of the world to participate in their very aggreesive program, the Chinese have been able to dramatically expand their knowledge base in high speed rail by technology transfer from almost every industrial player in the world, all of whom want to participate in the Chinese market.

China is rapidly buttressing its own ability to develop the new technologies it sees as essential. While they grow their educational system (China now graduates about 5 times as many engineers as the US), they have been dependent in the past for technology transfer from a mature Western engineering sector. In the next few years, I can see this changing, as China builds on acquired technology with a new army of fresh graduates in every area of engineering and material sciences.

We are also seeing a trend in the brain-drain department. In the past, many of China's best and brightest migrated to the west for greater opportunity. Now, they are beginning to see their long term opportunities in China as brighter and better, with the advantage of living in their own country, where they understand the culture and the language better.

In my opinion, this can only accelerate China to the forefront of every area of scientific research.

But the most important lesson here is not that they have the raw science, but they have developed a better working paradigm to translate that science into practical products. Their high speed rail ("HSR") network is a good example, and one I will expand on, because more efficient transportation is probably the greatest determinant of future growth.

Back in the day, when I was studying economics, I recall being amazed that approximately 70% of the cost of everything is transportation. From the farm equipment that harvests the wheat, the trucks to get the wheat to the silos, and the ongoing distribution process (trucks, trains, ships). Including the transportation of people to and from work, the mechanical transportation of coal from underground to its final destination, the transportation of products into a local supermarket ---- the list goes on and on.

This cost of transportation does not include the cost of electricity distribution, or information distribution, just the physical movement of people, commodities, and products.

In many cases, transportation costs are often an unitemised expense, buried in cost of materials or distribution. When the U.S. Department of Commerce publishes its Statistical Abstracts, they provide detailed information on the Transportation sector of the economy, the figures account for the transportation sector, which they define as "civil air transportation, including inland waterways, oceanborne commmerce, the merchant marine, cargo, and vessel tonnages". They further report on the employment in the transportation sector, details on licensed drivers (some 200 million licensed drivers in 2005), but the total economic cost is not aggregated.

An economist will include, as part of their cost analysis, the "opportunity cost", or added expense/foregone income of such things as transporting the kids to school, and the time spent getting to work.

Now if transportation costs are 70% of GDP, then efficiencies in transportation provide a much greater boost to national productivity than any other investment.

China is implementing high speed rail for passengers, which will ensure that people can get to work much faster, and as a reult, put in more productive work hours for the same total travel/work day.

More importantly, the Chinese HSR network is going to move freight, on faster freight trains. As well, moving passenger trains to a dedicated rail network is allowing them better specialised use of older rail for freight purposes.

In the US, passenger systems (freeway, rail) are running at the same speed, or slower than they did 50 years ago. Freeway rush-hour congestion, combined with longer commutes, have contributed greatly to decrease in efficiency (often embraced by consumers because of the perceived benefit of a more desirable home in a preferred location).

So what are the consequences?

With no improvements to U.S. transportation, Chinese productivity improvements will go unmatched in the U.S. Already, Chinese business is a substantially lower-cost manufacturer than U.S. business, Their next target will be "last mile" deliveries in the U.S., to sidestep the overhead of U.S.-owned distributors.

Meanwhile, the greatest fear in the US economy is deflation, or shrinkage of the economy. In fact, we have been watching this process for many years. For example, computers halve in cost (or double in performance), about every 18 months. But overall, consumers have spent more on computing devices, because demand has risen faster than the prices have dropped. For example, if people purchase twice as much computing horsepower every 18 months, then the computer market remains at the same annual dollar sales. the fact that it has been growing indicates that demand is higher than the rate of cost reductions.

You have heard the arguments for Peak Oil, no doubt, which say that the amount of oil in the world is finite, and we will get to a point where the amount of oil available to be pumped will decrease every year.

Now think about the concept of Peak Computer Spending, which will be reached when cost reductions in computer production outstrip the increase in demand. there will be a shrinkage in the gross dollars spent on computers in the U.S.

This is only one of the possible areas of economic shrinkage. But to compete with the rest of the world, the US is going to have to match global prices with its exports, and this will mean vast new efficiencies that will be thrust upon us.

The U.S. has not had any serious technological challengers for well over 50 years. But now, we are seeing a race in Asia that is not threatening to overtake us, it is actually doing so. And it is not just China. India, Japan, Singapore, Malaysia, and Taiwan are all vigorously competing now, and Europe is playing in that world very happily.

And the U.S. continues to fall further behind the technological innovation curve.

OK, so what is my take-away message from this?

I am not happy about the Chinese social model, which will be empowered by their growing economic clout. I will expand on this in a later blog.

China ascendent.

The US is clutching to its tattered financial philosophies as anxiously as grandma clutched her tattered shawl, hoping that Belief will trump reality, that somehow, if Belief is strong enough, it will keep out the howling winds of financial glaciation.

The philosophy I have heard for so long is that private investment will do the job, and business should self-regulate, and the US Government should just reduce taxes and get out of the way.

Despite this talk of free enterprise, it has actually been massive US Government spending that has laid bare new technologies, then developed the manufacturing expertise to reliably translate the technology into a product.

Only when this is complete can US invention take over, using corporate models to exploit the technology in a market-driven environment. No opportunity left unexamined!

Quick examples. Alexander Fleming 'discovered' penicillin in 1928. When America joined WW II, there were about three teaspoons of penicillin in the entire US. The US Government that took over all the patents early in WW2, got the USDA on a heavy-duty R&D bender, and figured out the best technology and manufacturing techniques. As a result, by late 1942, every soldier's ration pack contained penicillin.

US Government expenditures during WW II likewise refined management, design, and manufacturing techniques in every single industry in the US. At the end of WW II, the US had the most efficient manufacturing industry in the world. With Europe in ruins, and all pre-war competition destroyed, it was Spring time for the American economy.

Likewise, huge US Government spending during the race to put a man on the moon in the 1960's spawned the US medical equipment industry (life support systems) and the US micro-computer industry (integrated circuits).

For the past 20 years, US industry has done everything it can to prevent Government investment in new, disruptive technologies, while they aggregated their power, and gobbled up smaller companies. The end result is uncompetitive markets comprised of a few huge players, who deliver services to consumers and industry at inflated prices, while preventing any innovation unless they own it directly.

Over the past 20 years, the Chinese have taken this opportunity to really move ahead. Now, the huge innovator in the world has become the Chinese Government, and the industry it expedites.

The infrastructure that supports any given industry is called "the Commons". The Commons are made up of all the elements that an industry relies on to expedite their business. The most basic Commons are transportation, energy, water, people, and real estate. Then, depending on the industry, there will be other companies that supply raw material, intermediary products, sub-assemblies, security services, and the like.

In the past, US industry has been able to take rapid improvement in the Commons as part of their environment. Much of this improvement has been financed by Government. For example, the US freeway system, started in the 1950's, may have been funded by Government to enable the rapid movement of troops and defense materiel around the US, along the lines of Hitler's autobahns, but the benefit to industry was huge, giving much greater mobility to both freight and people at lower cost, saving both time and money.

In its jump into global wealth, China has focused on its Commons. With heavy Government participation in industry (in most companies, the Chinese Government is a major shareholder), the Government funds the Commons projects, both short- and long-term, that will expedite Chinese industry to the forefront of global industry in the future.

Some examples.

Transportation. China is now building a high speed rail system. To a lot of Americans, this is news. The Chinese and high speed rail? OK, go scare the crap out of yourself and read this current assessment on Wikipedia. 11,000 miles of rail are currently under construction, and 33,000 miles expected to be built by 2020. And they have been working on this since 1993. They have experimented with every practical high speed technology, and are on their fourth generation of train design. their objective is to have the slow trains moving freight at speeds around 165 mph, and passenger trains moving at 225 mph. I compare this to San Francisco Bay Area Rapid Transit, which has no amenities, is incredibly rattly and noisy, and travels at an average speed of 33 mph. America: Fail!

http://en.wikipedia.org/wiki/High-speed_rail_in_China

Energy. The Pew Trust published their renewable energy summary for the world in 2009 in March, 2010. Chinese investment in renewable energy was $34.6 billion to the US's $18.6 billion. Even more revealing, China's output, at 52.5 Gigawatts (GW) was only just behind the US's 53.4 GW. In the past 6 months, China has taken the lead in output. China is also positioned to dominate in the global manufacture of both solar and wind technology. If there are going to be jobs, China will scoop up most of them.

http://www.pewtrusts.org/uploadedFiles/wwwpewtrustsorg/Reports/Global_warming/G-20%20Report.pdf?n=5939

And in a further stunning integration of high speed rail and clean energy, China has just brought the largest single photo-voltaic array online. http://inhabitat.com/2010/07/21/worlds-largest-integrated-photovoltaic-bipv-project-online/

Raw materials. China is actively pursuing raw material acquisition around the world. They are no longer mixing their financial interests with their political philosophies as their business model. As well, they are aggressively looking to their own resources within their own territories, and have dramatically expanded their iron ore mining in the past year. Tibet also offers a lot of promise for mineral resources. They are entering Africa with a fairly clean slate, and are able to say "Yeah, we were screwed too" when the issue of past Western Imperial mauling gets raised.

Water. China has fresh water problems. The cost of clean freshwater supplies is already recognized as a problem. Although the problem will not become critical for years, it is already being addressed by the Chinese Government as an issue that needs to be addressed now, not when the crisis hits.

Education. China has a huge focus on education. They are graduating about 5 times as many engineers a year as the US.

Labor. Do I really need to say anything here? One point four billion people, people.

Investment. The investment environment encourages those international investors who do not have a political agenda. Right now, with the Chinese economy growing rapidly, international investment is looking at Chinese business opportunities as probably the best in the world.

Manufacturing commons. Suppliers of special services and skills to industry have grown in the crevices of the growing financial success of China. Software, security, sub-assembly manufacturing, and any area where companies have a need that can be better met by outsourcing than direct employment, Chinese business is flourishing.

Summary. Chinese Gross Domestic Product (the total output of all goods and services in the economy) has grown by more than ten times since the 1980's. Currently, China's GDP growth is still above 8% per annum, making it a very attractive place for investment.

Combine this with the Chinese Government's efforts to ease the path for business by creating more efficient infrastructure, and a better trained workforce, it is likely that China is going to continue to be a very desirable place to create new businesses, and will be the lowest cost manufacturer in the world.

Money has no Beliefs. Investment will go where the returns are, and it is likely that China will continue to grow into their new shoes exponentially, partially using capital and expertise from around the world mixed with Chinese Government and industrial investment..

Not moved by the necessity to produce great quarterly financials, the Chinese have their eyes firmly on the long term prizes, and one of them is the reduction in the US' ability to mess in the South China Sea. To get there, they have to pull America's economic teeth, and this final bit of extraction will be achieved when there is a new global reserve currency that replaces the dollar.

The final coup can be achieved by dumping some US treasuries, which China has in their pocket as loose change.

If Europe is waiting for America to right this situation, then they will be looking in the wrong direction when the axe falls.

"The things that kill you are the things you never saw coming" is a phrase I quote frequently. Americans are not aware of the fundamental reasons for their success. Now, their philosophy is blinding them to the reasons for the rise of China.

It is also fairly certain that the Republicans will further paralyze the system if they get the opportunity. The British paper, the Financial Times, published this commentary on their expectations: an American financial winter.