A Mouse Sleeping Next to a Dragon: New Twitches and Grunts

Stephanie Carvin from the Norman Paterson School of International Affairs presented her paper, A Mouse Sleeping Next to a Dragon: New Twitches, at the Public Policy Forum’s second roundtable with the Consultation Forum on China in 2017.

Context

At the outset it is important to recognize that China is not a unitary actor — there are competing interests, factions and a division between moderates and hyper-nationalists within the Communist Party of China (CPC).[1]Nevertheless, it is clear that CPC leadership is unified around one goal: survival of the party-state. This purpose sits above all things, including the rule of law, and reflects a de facto pact made by the last 30 years of Chinese leadership — increasing prosperity for stability and continued CPC rule. To maintain its end of the bargain, the CPC must deliver and continue to deliver a rising standard of living.[2]

As such, the Chinese government has announced several major policies aimed at facilitating resources extraction, but also creating more markets for Chinese goods. This includes the “One Belt, One Road” that will enhance interconnectivity in Asia. Further, the “Indigenous Innovation” and “Made in China 2025” strategies are aimed at using the technology of other countries to upgrade and enhance China’s manufacturing capabilities, bolster innovation and establish the dominance of key technological sectors. The intellectual property (IP) to enable these policies is being obtained through a series of mergers and acquisitions. As one China analyst observes, “the long-term economic benefit and future scalability of what is being acquired is thought to be a bargain.”[3] However, national security threats arise when this IP is obtained through means that challenge current trading rules (forced technology transfers) or clandestine means (as discussed below).

Geoeconomics

Geoeconomic statecraft is the use of economic instruments to accomplish geopolitical objectives.[4] It is a form of economic statecraft involving the intentional manipulation of economic interaction to capitalize on, reinforce or reduce the associated strategic externalities.[5] Since the end of the Cold War, rising powers that cannot challenge the United States and its allies conventionally are increasingly turning to geoeconomics to achieve their political ends.

This, of course, is not new. For a long time states have used economic instruments such as sanctions to make a political point or to achieve a specific end. But we are now seeing states, especially China, use a combination of legitimate (ambitious merger and acquisition strategies), grey area (sudden health and safety bans) and clandestine (cyber espionage) means to effectively achieve state ends on an unprecedented level. In just one example, China has successfully used foreign direct investment (FDI) to persuade other countries to adopt certain policies; within five years of China’s first investments in Africa, the number of African states to recognize Taiwan fell from 13 to four.[6] Beyond investment policy, China is also using financial and monetary measures, as well as polices related to energy and commodities and trade.[7]

As noted above, one of the trade strategies China uses is forced technology transfers, which are imposed on any company that seeks to do business there. This includes Canadian firms. For example, as a precondition of entering the Chinese market Bombardier reportedly had to transfer i) significant amounts of technology on its trains to two Chinese rail companies and ii) the design authority on major supplied parts for its CSeries jets to the government’s aircraft manufacturing company.[8] The end result is the creation of relationships where Chinese manufacturers are simultaneously partners and competitors with Canadian businesses. That competition is not only occurring domestically within China, but internationally. In May 2017 one of Bombardier’s strategic partners, CRRC Corporation, beat the company in a bid to make rail cars for the Montreal regional commuter rail service. (CRRC Corp, owned by an SOE, was able to cut the price from $103 million to $69 million.)

Canada’s former ambassador to China, David Mulroney, argues that Western companies, including Bombardier, have concluded that this is the price of doing business in China and that it is worth doing so.[9] Yet, as the above example shows, China’s “Indigenous Innovation” strategy is aimed at undermining and replacing Western firms. If successful, this policy undermines Canadian companies and could potentially result in significant job losses. In short, there is a real threat that certain geoeconomic strategies will skew the economic landscape in countries like Canada, rendering it difficult for our firms to succeed in the long run domestically and internationally.

Clandestine Activities

As noted above, a further geoeoconomic strategy being employed by China, one with direct national security implications, is the enhanced use of clandestine tools and methods to obtain IP from Western companies. In particular, this includes the use of:

1. Cyber-espionage;
2. Insider threats;
3. Clandestine foreign influence; and
4. State Owned Enterprises.

The goals of economic espionage are to obtain any information that is deemed to provide an advantage in an economic setting. Generally, this can be divided into three categories. First, there is data that can provide insight into a company’s position in negotiations, mergers, acquisitions and bidding wars. Second, states that may have weak research and development cultures seek the valuable IP of Canadian firms. Finally, states seek information from private businesses that allow them to develop insider threats such as human resources policies (to sneak individuals into companies) and records (to find individuals that can be targeted with bribes and blackmail). Open-source information suggests that China has engaged in the following techniques to obtain this information.

Cyber-espionage

China’s use of cyber-espionage against Western firms has been well established. However, it is worth noting that the information being obtained is believed to be directly assisting Chinese companies and SOEs that are in direct competition with Western firms or are investing in Western countries. In 2014, the FBI indicted five Chinese military officers for cyber-attacks who stole millions of dollars in IP from six American firms in the U.S. nuclear power, metals and solar products industries.[10] Although Canadian authorities have not been as aggressive about these types of activities against Canadian firms, there is no reason to believe that Canadian companies are immune to Chinese cyber-attacks. The fact is that no one in Canada, not even our security services, is aware of the true scale of Chinese hacking. We do know that Chinese hackers are likely behind a series of attacks into the Canadian government, including areas that deal with business and IP. This includes a series of attacks on the Department of Finance, Treasury Board and Defence Research and Development Canada in 2010/2011 and the 2014 hack into the National Research Council, which, taking into account several factors, reportedly cost “hundreds of millions of dollars”, including $8 million to replace compromised computers as well as lost productivity and time to rebuild.[11] Moreover, the fact that the Canadian government felt it was necessary to have an agreement with China on the matter suggests such activities have been going on for some time. While this new agreement may reduce the number of Chinese-sponsored cyber-attacks on Canadian business, there is no reason to believe the risk has been eliminated entirely. In June 2016 Cybersecurity group FireEye noticed a drop in the amount of activity by “advanced persistent threats” (APTs) associated with China conducting IP-theft against the US following the US-China cyber agreement and after being publically called out by then-President Barack Obama. However, they observed that harmful cyber activities continued on a more limited scale.[12]

Insider Threats

There is ample open-source evidence that China is using insider threats and or theft in order to steal valuable secrets and intellectual property. Indeed, during a 17-month period between April 2013 and July 2014 there were four reported cases of Canadians and/or Chinese nationals with links to Canada attempting to steal intellectual property or industrial secrets to China — two directly involving insider threats. In April 2013, Klaus Nielsen, a former lead researcher with the Canadian Food Inspection Agency and his colleague Wei Ling Yu were charged with trying to smuggle pathogens out of Canada to develop and sell testing kits in China against bacteria affecting cows.[13](While his accomplice is believed to be in China, Nielsen pleaded guilty in 2014.[14]) In December 2013, naval engineer Qing Quentin Huang was charged with trying to pass along classified Canadian shipbuilding techniques to China.[15]

Clandestine Foreign Influence

All states seek to influence one another, but typically these activities are carried out in a manner that is transparent, or at least with the knowledge of the governments to whom foreign policies are aimed. A national security threat emerges, however, when these activities are clandestine. Due to its very nature, clandestine foreign influence is one of the hardest threats to define, analyse and counter. Nevertheless, it is possible to identify at least two ways Chinese clandestine foreign influence poses a threat to Canada.

First, the Chinese government and linked individuals have been known to intimidate individuals and (particularly expat) communities in Canada. There have been allegations that the Chinese government has sought to silence critics in the Chinese Canadian press through campaigns of harassment and intimidation.[16] Such campaigns threaten the rights of individuals to free speech and peaceful dissent in Canada. Second, there are reported allegations that the Chinese government has targeted politicians in ways that go beyond normal lobbying efforts, possibly recruiting them for espionage or to use their insider status to achieve policies that are favourable to Beijing, such as downplaying Canadian or provincial relations with Taiwan.

State Owned Enterprises

Although seen as a source of much needed investment, there are a number of reasons why SOEs are problematic for Canada. It is widely accepted that SOEs are far less efficient than private sector firms. Their profitability continues to fall and the returns are about half those of their non-state peers.[17] Despite their large presence in China, by 2017 they account for less than a fifth of output.[18] While this is a risk for the Chinese economy, there are risks that these giant SOEs could distort global markets through their inefficiencies, hurting the potential for growth worldwide as they become dominant forces in the international economy.[19] Moreover, recent attempts at SOE reform have been to make them bigger, not smaller. And to bring them even further in line with Beijing’s priorities.[20]

Perhaps most importantly, what differentiates SOEs from typical private sector firms is that they have access to resources that their private sector peers (domestically and internationally) do not, including clandestine (discussed above) and financial support. Despite their low productivity, SOEs take about half of all bank loans in China and are responsible for that country’s large increase in corporate debt.[21] In short, Chinese SOEs are not obliged to follow normal business practices because essentially they cannot fail. Backed by the world’s largest economy they can enter markets, altering them with large corporations that do not have to follow the laws of sound business management. Indeed, Beijing arranges so much support to its SOEs because they are seen and treated as national champions, serving the interest of the party-state. At best the outcome may be reduced efficiency of the market, at worse this could lead to the collapse of domestic industries.

The Risk of Retaliation

Combined, these three economic risks show the challenge of dealing with China, particularly on a Canada-China FTA. The idea that Canadian national security will be protected because Chinese firms will be forced to comply with Canadian domestic business practices and laws is short-sighted. Chinese SOEs are intrinsically linked with the Chinese party-state. As such, any attempt to level the playing field or punish SOEs will likely provoke retaliation in ways that Canadian laws cannot address. Frivolous “health and safety” claims are frequently used when Beijing is displeased. The repeated bans on canola products, often just before a high-profile meeting between Canadian and Chinese authorities, is telling; China manufactures a crisis in order to extract more concessions from Canada, while giving up little, if anything, in return.

But the threat goes beyond this obvious and now predictable negotiating tactic. China is not afraid to use its economic might to send signals (if not extremely blunt messages) to states. Norway suffered China’s wrath when it awarded the Nobel Peace Prize to dissident Liu Xiaobo, sparking a sharp fall in Norwegian imports such as salmon.[22] China has ham-fistedly tried to use agricultural policy to woo Taiwanese voters in the south of that country to vote for pro-Beijing parties.[23] It has even retaliated against economically powerful Japan over its stance on the Senkaku/Diaoyu island group. After days of non-stop anti-Japan coverage in the media, two thirds of Chinese citizens voluntarily agreed to boycott Japanese products. Further, it has regularly used rare earth mineral bans against Japan that target its high-tech industries. As two observers of geoeconomics note, “That boycotting Japanese goods and suppressing Japanese investment in China hurts Chinese workers, however, only underscores Beijing’s tolerance of pain when it comes to accepting domestic costs for its geoeconomics policies.”[24]

In short, as we increase the ties between our economies, any attempt by Canada to respond or retaliate against a Chinese company in a core-interest area could very well result in a very harsh economic punishment. For example, China delisted the University of Calgary as an accredited foreign school after the Dalai Lama spoke on its campus.[25] (With an estimated 600 Chinese nationals paying around $36,000 each, this move was a costly one for the university.[26]) As Mulroney notes:

China seems to be the only country in the world that can have its feelings hurt… Senior Chinese officials claim to be wounded, deeply and personally, by criticism from the media, local communities or NGO groups…

Some SOE managers appear to confuse the SOE and its interests with China itself, allowing any bump in the road of negotiation to be transformed into an insult to the nation.”[27]

When China (or its SOEs) are hurt, it lashes out using whatever instruments it has at its disposal, including its many geoeconomic tools as well as the SOEs themselves.

Recommendations

Despite these challenges, the reality is that, as a middle power, Canada cannot afford to ignore a state with a sixth of the world’s population. Our prosperity depends on trade — but also a stable world order, including the rule of law. Given its size, Chinese instability or collapse would have devastating consequences on the global economy and regional stability. Therefore, as a nation, we have a stake in one of the most pressing questions of our times: will a rising China be integrated into a liberal economic order, or will it seek to replace our current system with its own institutions?

On the one hand, it is clear that no state has benefitted more from the current world order than China. In this sense, all states have an interest in preserving that which has allowed for its dramatic growth and lift millions to rise out of poverty. On the other, through forced technology transfers and clandestine activity, China has demonstrated that it is willing to go its own way when the rules do not fit its interests, specifically relating to the preservation of its party-state.

As a middle power, Canada only has so much leverage with China and we should understand it will use its geoeconomic might to achieve its ends. If the government decides to proceed with an FTA, Canada must be prepared to lessen the impact of these very real security risks. It also must be prepared to walk away from a deal, with all of the blowback that will entail.

In light of the various considerations related to Canada’s future engagement with China, as outlined above, this paper makes six recommendations for going forward:

1. If Canada is to enter into an FTA with China, it should do so on a very slow, rolling basis. Until Canada can learn more about how China behaves within an FTA, caution should prevail. Moreover, once a concession is made to China it will likely expect that same concession in future negotiations. What will happen if Canada wants to say “no”?

2. Recognize that not all SOEs are alike, but it is important that ownership, as well as behaviour, remains a criterion for Investment Canada Act national security reviews. China is increasing its control over large SOEs and they must be considered instruments of the state. There are over 150,000 SOEs in China, and we can recognize that some will pose more of a security threat than others. Further, China/Chinese SOEs may attempt to circumvent different ownership policies the government puts forward with hidden or clandestine ownership schemes. As such, Canada is better off maintaining the current national security review process.

3. Canada should enhance its diplomatic presence in China. Diplomacy will be the key to solving numerous issues raised in this paper, including the negative externalities of geoeconomics and retaliation. Reflecting on his time as ambassador to China, David Mulroney has argued that Canada should better coordinate its policies among our embassies and consulates there, as well as across government.[28] There can be little doubt that a comprehensive, synchronising strategy would be beneficial when dealing with such a complex country, and enhance good work already being done.

4. Not all of the security challenges China represents can be handled by diplomacy alone. On the military front, Canada is taking steps to reinvest in its armed forces. As we do, we should be looking at enhancing cooperation with our Asia-Pacific allies. With regard to national security, the government must remain aware that China is likely to continue to engage in espionage and other clandestine activities regardless of our diplomatic initiatives.

5. Improve information sharing with the private sector. Given that national security threats are likely to continue, it is vital that both government and business get a better understanding of the threat. Making it easier to share information with the private sector, and working to create channels where the private sector can share its security concerns is an important step. The recent announcement that the Canadian Security Establishment (CSE) will be working with the Canadian Cyber Threat Exchange is a welcome development. More of these kinds of initiatives should be encouraged.

6. The Canadian government should invest in a robust Chinese studies program at the secondary and post-secondary levels. In many cases Canada’s Chinese culture and language programs are being managed by the Chinese-controlled Confucius Institutes.[29] Whatever path Canada chooses to take with an FTA with China, we cannot ignore this rising power. Investing in enhancing our capabilities now will pay dividends later. It will better prepare us for addressing the challenges and key policy questions Canada will have to wrestle with in the coming decades.