China Makes A Big Play In Silicon Valley

17 hours ago
Originally published on October 7, 2018 11:43 am

A year ago, Chinese President Xi Jinping stood before the 19th Communist Party Congress and laid out his ambitious plan for China to become a world leader by 2025 in advanced technologies such as robotics, biotechnology and artificial intelligence.

It was seen as a direct challenge to U.S. leadership in advanced technology. James Lewis, a specialist in China and technology at the Center for Strategic and International Studies, says China recognizes that technological superiority helps give the United States an edge in national security and wants in on it.

"The Chinese figured out that technology is the key to wealth and power, and the source of technology is still the West for China," says Lewis. The question is: "How do they get their hands on that Western technology?"

The Chinese government has been forming global partnerships with Western think tanks, recruiting key talent at networking events sponsored by the Chinese government and working with U.S. universities, says Michael Brown, managing director of the Pentagon's Defense Innovation Unit in Mountain View, Calif. The unit was set up in 2015 to help the U.S. military capitalize on emerging commercial technologies.

"I'd say they're very systematic, very long term in their approach and very well-funded," Brown says.

And, he notes, there is serious concern in Washington that China could acquire too much sensitive U.S. technology and transfer it back home.

"They don't play by the same rules that we do. So cybertheft is on the table; industrial espionage is on the table," Brown says.

Just this past week, Bloomberg Businessweek magazine reported the United States was investigating whether China had infiltrated the Pentagon and major companies such as Apple and Amazon by building spy chips into server motherboards. The motherboards were manufactured in China. The companies deny the allegations.

Chinese companies also troll bankruptcy courts, looking for failing U.S. firms, and target small enterprises making valuable technology, such as semiconductors. Chinese companies are also pumping millions of dollars and other resources into tech firms in Europe and the U.S. as a way to capture innovation and know-how.

That's illustrated in Sunnyvale, in the heart of Silicon Valley, where U.S. tech giants including Microsoft, LinkedIn and Yahoo have a presence. Right next to a Google complex is a building housing the offices of Baidu — China's largest Internet provider and Google's rival.

Baidu opened its innovation center, called the Institute of Deep Learning, four years ago, with a focus on a self-driving vehicle called Apollo. Other Chinese tech powerhouses — Alibaba, Tencent and Huawei — also have Silicon Valley research and development centers.

Instead of buying an existing U.S. business, these Chinese tech giants come to the U.S. and build new companies from the ground up, in what's known as "greenfield" investments. Lewis says these Chinese tech companies hire away a lot of U.S. employees who might otherwise work for American businesses.

"People change jobs frequently in the tech industry. And [Chinese businesses] say, 'I'll pay you a little bit more than the market rate.' You'll get a lot of talent," he says. "This is a way to acquire know-how."

Chinese venture capital has helped fuel a surge of minority investments in U.S. tech startups over the past few years. These startups could be working on breakthrough technology.

Adam Lysenko, a senior analyst at Rhodium Group, an economic research firm, says American entities represent the largest venture capital investment in startup technology companies, but Chinese investment accounts for about 15 percent of the deals. In the past eight years, there were more than 1,300 rounds of funding for U.S. startups with at least one Chinese investor, Lysenko says, totaling about $11 billion of Chinese investment.

"It is very common for Chinese firms to have some sort of ties to the government," Lysenko says. "And those ties can be in many different forms. It might just be because they have to answer to the government and party leaders back at home. And that [confers on] the state some level of control essentially over every Chinese firm."

After a record 2017, Rhodium Group predicts 2018 will be another record year for Chinese venture capital into U.S. startups. Lysenko says this has become a concern in national security circles because the nature of emerging technology is inherently dual-use: The artificial intelligence algorithms that help speed up your smartphone could also be applied to weapons on the battlefield.

Lysenko says he is not aware of any "smoking gun" case where Chinese venture capital has plundered sensitive technology from the U.S. with malicious intent. But, he adds, "That being said, I think it's become increasingly acknowledged that this risk exists, that venture capital and other minority investments provide Chinese investors to ... access potentially sensitive technologies, particularly ones that are in ascent, in an early stage where U.S. government, military and other security individuals haven't had a full chance to evaluate the implications of those technologies."

American venture capital still far surpasses Chinese funding. But many American tech startups depend on Chinese investment to stay afloat, says Chris Nicholson, the CEO of Skymind, a San Francisco-based startup that makes open-source artificial intelligence tools for businesses and employs about 30 people in the U.S., Canada and Asia.

Nicholson helped create Skymind in November 2014. He says the company, like many startups, was fragile in the beginning — until it got its first investment of $200,000 from Chinese consumer tech powerhouse Tencent.

"We got that 200K check and nobody else followed, but it allowed us to survive. And that's just, like, the whole trick of startups, is just surviving," he says. "Buy yourself enough time until you can realize your idea and test it on the market."

Nicholson says Skymind now has funding from some major American venture capitalists and a few smaller Chinese ones. He says no investor has ever asked Skymind for confidential technical information.

"Right now, we have a board of two people — me and my co-founder — and we're both American," he says.

For decades, funding for U.S. tech firms like Nicholson's often came through the Defense Department, whose support helped create technological breakthroughs that led to things like semiconductors and miniaturized GPS.

But that Pentagon funding over the years has become slow and cumbersome, while private sector technology creation moved much faster. The Pentagon recognized the problem and, in 2015, set up the Defense Innovative Unit to speed up funding to American startups, says Lt. Col. David Rothzeid, a spokesman with the DIU.

"We're trying to grow the defense industry base by enticing these companies that traditionally wouldn't work with us, and honestly don't need to work with us, but have a great capability that we would all benefit from," he says.

Rothzeid says the DIU has awarded about 80 projects to private commercial tech startups since August 2015. They were able to get those contracts finished in two to three months — "remarkably faster than the traditional procurement system," which could take years, Rothzeid says.

Even as the Pentagon tries to reignite relations with the commercial tech world, Congress is working to curtail Chinese investment. It is broadening the authority of the Committee on Foreign Investment in the United States, an interagency committee based at the Treasury Department that examines national security risks of foreign investments in the U.S.

CFIUS can make recommendations to the president on whether to block deals based on national security concerns — something President Trump has done five times, including blocking a Chinese state-backed company's attempt last September to buy Lattice Semiconductor for $1.3 billion.

In August, Trump signed into law reform of the foreign investment committee, allowing it to more closely scrutinize all sorts of Chinese inroads in the U.S. tech sector, says Mario Mancuso, who leads the international trade and national security practice at Kirkland & Ellis, an international law firm, and is the author of A Dealmaker's Guide to CFIUS.

Mancuso says not everyone in the U.S. business community is happy with the new law. "I think some deals where there are Chinese investors will be a lot harder. More deals will get a lot more scrutiny, and some deals just are not going to happen," he says.

Many U.S. tech companies have pushed back against tougher laws on foreign investment, saying it could strangle innovation. It can take weeks and cost an investor thousands of dollars to do a CFIUS investigation, which can scare off potential investors.

Skymind's Nicholson believes there are legitimate national security interests around technology that deserve legislation, but technology is moving fast in a lot of countries. He warns that the U.S. could be left behind.

"In Washington, D.C., people think innovation is an American monopoly — they think that people can't go anywhere else for innovation," he says. But, he emphasizes, that's not true. "So if we shut the door here, that capital is just going to flow through another door. And it's going to be outside of U.S. jurisdiction."

That's the conundrum now for Washington: how to balance U.S. national security concerns with a drive to be the leader in advanced technology.

Copyright 2018 NPR. To see more, visit http://www.npr.org/.

LULU GARCIA-NAVARRO, HOST:

There is a trade war underway between the U.S. and China, and it is a big concern to the global economy. But there's another deeper rift brewing between Washington and Beijing. And that stems from China's effort to unseat the U.S. as the global leader when it comes to technology and innovation. In the next installment of our series on China's growing role in the world, we turn to the U.S., where NPR's Jackie Northam reports Washington is pushing back.

JACKIE NORTHAM, BYLINE: The U.S. is unquestionably the leader in advanced technology - think artificial intelligence, robotics, sophisticated weaponry. It's what's helped give the country a national security edge. That's something China has recognized and wants in on, says James Lewis, a specialist in China and technology at the Center for Strategic and International Studies.

JAMES LEWIS: The Chinese figured out that technology is the key to wealth and power. And the source of technology is still the West for China. So how do they get their hands on that Western technology?

NORTHAM: Three years ago, Beijing unveiled its Made in China 2025 strategy, which calls for the country to become a world leader in advanced technologies, including artificial intelligence, AI. As part of that, China is forming global partnerships, pumping massive resources into tech firms at home, in Europe and here in the U.S.

MICHAEL BROWN: I'd say they're very systematic, very long term in their approach. And it's very well-funded.

NORTHAM: Michael Brown is with the Pentagon's Defense Innovation Unit in Silicon Valley. He says there's serious concern in Washington that China is acquiring too much sensitive U.S. technology and transferring it back home.

BROWN: They don't play by the same rules that we do. So cybertheft is on the table. Industrial espionage is on the table - which could include recruiting key talent at networking events that are sponsored by the Chinese government, working with U.S. universities.

NORTHAM: Just last week, Bloomberg reported the U.S. was investigating whether China allegedly infiltrated the Pentagon and major companies, such as Apple and Amazon, by building spy chips into server motherboards. The motherboards were manufactured in China. The companies deny the allegations. But there are other ways China is making inroads to capture American innovation.

There's a quiet leafy part of Silicon Valley called Sunnyvale, and a lot of the tech giants have a presence here. There's Amazon Labs, LinkedIn, Yahoo. And I'm coming up now to a Google complex. And I can actually see some of the workers sitting at picnic tables and enjoying the fine weather. Just behind the Google complex is a Chinese company called Baidu. And it's Google's rival.

Baidu is China's largest Internet search provider. It opened this innovation center here in Silicon Valley with a focus on self-driving vehicles. And other Chinese tech powerhouses - Alibaba, Tencent, Huawei - also have their own research and development centers here. Instead of buying an existing U.S. business, the Chinese tech giants come in and build a new company from the ground up. These moves are called green field investments. And they hire away a lot of U.S. workers, says the CSIS' Lewis.

LEWIS: People change jobs frequently in the tech industry. And you say, I'll pay you a little bit more than the market rate. You'll get a lot of talent. This is a way to acquire knowhow.

NORTHAM: There's also been a surge of investments in tech startups through Chinese venture capital. Adam Lysenko, a senior analyst at Rhodium Group, an economic research firm, says there were more than 1,300 rounds of funding for U.S. startups with at least one Chinese investor over the past eight years.

ADAM LYSENKO: It is very common for Chinese firms to have some sort of ties to the government. It might just be because they have to answer to the government and party leaders back at home. And that infers the state some level of control.

NORTHAM: Lysenko says this has become a concern in national security circles because the nature of emerging technology is inherently dual use. In other words, the AI algorithms used to help speed up your smartphones could also be applied to weapons on the battlefield. Lysenko says while he's not aware of any smoking-gun case where a Chinese venture capital has plundered sensitive technology from a startup, it's widely acknowledged that a risk exists.

LYSENKO: That venture capital and other minority investments provide Chinese investors to access potentially sensitive technologies, particularly ones that are in, in a sense, an early stage where U.S. governments haven't had a full chance to evaluate the implications of those technologies.

NORTHAM: But for many American tech startups, Chinese investment can be critical.

CHRIS NICHOLSON: I think we got lucky. We got a beautiful office, right? It used to be an architectural consulting firm.

NORTHAM: Chris Nicholson is the CEO of Skymind, which makes cutting-edge artificial intelligence software. Daylight pours through the large windows overlooking San Francisco's Mission Street.

NICHOLSON: Mission between 9th and 10th is a little rough, which is not great when you're trying to impress clients.

NORTHAM: Nicholson helped create Skymind about four years ago. He says the company, like many startups, was very fragile in the beginning, until it got its first investment of $200,000 from Chinese consumer tech giant Tencent.

NICHOLSON: And nobody else followed. But it allowed us to survive. And that's just - like, the whole trip of startups is just surviving. Buy yourself enough time until you can realize your idea and test it on the market.

NORTHAM: Skymind now has funding from some major American venture capitalists and a few smaller Chinese ones. Nicholson disputes that venture capital investors automatically gain access to startups' research or knowhow. Later-stage investors putting in much larger amounts typically ask for things like information rights and board seats. Nicholson says no investor has ever asked Skymind for confidential technical information.

NICHOLSON: Right now we have a board of two people. And it's me and my co-founder. And we're both Americans.

NORTHAM: For decades, funding for firms like Nicholson's was through the Defense Department. It helped create technological breakthroughs that led to things like semiconductors and miniaturized GPS. But that funding over the years has become slow and cumbersome while technology has been moving much faster in the private sector. The Pentagon recognized the problem and, in 2015, set up the DIU, the Defense Innovation Unit.

(SOUNDBITE OF DRONE FLYING)

NORTHAM: A military engineer maneuvers a tiny drone as it buzzes above a tarmac at the DIU in Silicon Valley. Lt. Col. David Rothzeid says the Pentagon created the unit as a way to make it easier to get funding to startups.

DAVID ROTHZEID: We're trying to grow the defense industry base by enticing these companies that traditionally wouldn't work with us and don't honestly need to work with us but have a great capability that we would all benefit from.

NORTHAM: This alternate funding is one way Washington is trying to counter Chinese investment. The Trump administration has also been aggressive in blocking several large mergers and acquisitions of U.S. tech companies by Chinese firms. And Congress is beefing up laws on the books aimed at protecting U.S. technology from foreign governments. It will allow closer scrutiny of all sorts of Chinese inroads in the tech sector, says Mario Mancuso, a trade lawyer with Kirkland and Ellis.

MARIO MANCUSO: I think some deals where there are Chinese investors will be a lot harder. More deals will get a lot more scrutiny. And some deals just are not going to happen.

NORTHAM: Many U.S. tech companies push back against tougher laws on foreign investment, warning it could strangle innovation. Skymind's Nicholson again.

NICHOLSON: In Washington, D.C., people think innovation is an American monopoly. They think that people can't go anywhere else for innovation. That's not true. Tech is moving fast in a lot of different countries. So if we shut the door here, that capital is just going to flow through another door. And it's going to be outside of U.S. jurisdiction.

NORTHAM: And that's the conundrum for policymakers. How does the U.S. balance its national security concerns with its drive to be the leader in advanced technology? Jackie Northam, NPR News, Silicon Valley. Transcript provided by NPR, Copyright NPR.