Are Chinese Tech Companies a Victim of Washington or of Beijing?

Bipartisanship in Washington is such a rare bird that when it takes flight, one begins to suspect that something is terribly amiss. Not surprisingly, when Congressmen join hands across the aisle and call for the US to get “tough on China,” skepticism is warranted.

Over the last decade, American politicians have raked Cisco over the coals for helping to build the “Great Firewall,” accused Beijing of currency manipulation, and even attacked China for “counterfeit” Apple stores. But no issue seems to animate as much hysteria in US politics as claims that Chinese electronics have “built-in back doors” that could be exploited by Beijing for purposes of espionage or warfare.

Lenovo, which is now the number one PC maker in the world, was one of the first Chinese companies to get hit with back door allegations, with Congress citing potential back doors as a reason to block the State Department’s acquisition of 16,000 Lenovo computers in 2006. The sale went through, though the State Department only used the computers for non-sensitive tasks.

More recently, in May of this year, computer chips manufactured by the Chinese firm Microsemi were discovered by researchers at Cambridge to have an unexplained hardware back door, which, depending on who one speaks to, is either a completely routine diagnostic measure or a malicious platform for cyberwarfare.

It is into this hostile milieu – intensified by the theatrics of an American general election year – that Huawei and ZTE made their doomed bid to help build the next generation of U.S. communication networks. Back doors were once again a major issue.

Before we continue, one must concede that back doors very well could exist in Chinese-built hardware. In our iPhones, for example, or in our new Dell netbooks. “But those aren’t Chinese companies!” one might protest. True, but China’s key position in the global supply chain means that any hardware vendors doing business in China could potentially be infiltrated. If the threat exists, it’s likely already on our desks or in our pockets.

For its part, the Obama administration reportedly downplayed the threat of espionage, telling Congress that there is no evidence of Huawei or ZTE spying on America. Since the White House can call upon more resources than Congress to verify the possibility of espionage, many observers will see the House Select Committee on Intelligence’s findings – as well as Chairman Rogers’ subsequent calls to blacklist Huawei and ZTE – as blatant protectionism. That said, if the allegations of spying against Huawei and ZTE are protectionism disguised as paranoia, does that make them innocent victims?

Victims, yes. Innocent, not so much.

Stan Abrams has detailed on his blog, China Hearsay, the Chinese firms were unable to reach the standard of transparency demanded by the US Congress, and gave evasive answers when pressed by investigators. Huawei refused to answer questions about the possibility of Chinese government ownership through Huawei stock and the nature of its interactions with Chinese regulators. Given their stonewalling tactics, Abrams rightly wondered whether Huawei and ZTE had actually followed the advice of their American lawyers.

Another point to consider is that a national communications network is a sensitive piece of infrastructure, and it’s neither nationalist nor protectionist to ask foreign vendors to be completely aboveboard about their business practices and ownership structure. Therein lies the rub, however, since even if Huawei and ZTE had wanted to be forthcoming, the Chinese government may not have allowed it.

Make no mistake, Huawei and ZTE are great companies fielding excellent products. As the biggest communications company in the world, Huawei has earned praise from Western media for its mobiles and 3G modems, while its market follower ZTE remains less flashy and consumer-oriented at the high end, yet omnipresent in Chinese homes and workplaces. Thanks to a combination of joint ventures with Western companies like 3com, a generous industrial policy from Beijing, and a fair degree of market savvy, both firms have developed into world-class telecommunications companies in a remarkably short time.

Getting to the top has required Huawei and ZTE to play by Beijing’s rules, which have sometimes included disincentives towards transparency, malleable contracts, and creative notions of IP protection. (In fairness, these rules are changing, but Huawei and ZTE, like Youku and Baidu, are still judged by the rules they followed while “growing up.”)  Although Beijing’s rules have enabled Huawei and ZTE to emerge as powerful brands within China, it has also slowed their expansion into Western markets, where the rules of the game are fundamentally different. Furthermore, given the Chinese government’s penchant for labeling information “state secrets,” chances are that neither Huawei nor ZTE will be able to fully comply with foreign regulators, especially those as tough-minded as Congressman Rogers.

Although Huawei and ZTE have stalled out in their bid to enter the American market in a big way, they previously made inroads into Canada, the UK, and other Western countries. Things changed this year. Australia took steps to effectively blacklist Huawei in spring, Canada suggested it might block Huawei from contributing to its National Broadband Network in October, and there’s a real danger that other Western countries may follow suit. If a “global blacklist” leaves Huawei and ZTE as vendors for developing countries only, China’s dream of becoming a high-tech exporter is in peril.

One thing is certain: Beijing will follow up on Washington’s moves against Huawei and ZTE with punitive measures against American businesses. Rather than conclude the first summit between China’s new President Xi Jinping and President Obama (or Romney) with the announcement of “diplomatic hongbao” in the form of big ticket contracts for American companies, Xi’s American counterpart is likely to return home empty-handed. Ironically, this stands to hurt many of the American firms who support the crackdown on Huawei and ZTE in the US.

Karma, as you know, has its own back doors.