Talking Point

Hacked off with Americans

China retaliates against US tech firms over cyber-espionage indictments

People arrive at the launch event for Microsoft Windows 8 operating system in New York

In the crossfire: the latest Microsoft operating system has been banned from Chinese government computers

In the early nineteenth century, Francis Cabot Lowell managed to talk his way into a number of British textile mills. The American businessman had just one purpose in mind: to memorise the Cartwright power loom, an advanced piece of weaving technology. When Lowell got back to the US, he built his own version, becoming a successful industrialist.

This is one of many examples of intellectual property theft recounted by historian Doron Ben-Atar in his book Trade Secrets. He notes that American industrial spies routinely roamed Britain in the nineteenth century in the hunt for plant and machinery. “The United States emerged as the world’s industrial leader by illicitly appropriating mechanical and scientific innovations from Europe,” writes Ben-Atar, the head of Fordham University’s history department.

Ben-Atar even points out that Founding Father Alexander Hamilton was a big encourager of intellectual property theft (in 1791 in his ‘Report on Manufactures’ the Secretary of the Treasury called for the state to reward those who brought “secrets of extraordinary value”).

Thus the New Yorker magazine also points out there’s a certain historical hypocrisy when America’s current Attorney General Eric Holder claimed last month that China was stealing trade secrets to propel its own companies to “success in the international marketplace”.

As the magazine’s James Surowiecki wryly observed: “The United States should know. That’s pretty much how we got our start as a manufacturing power.”

In late May Washington indicted five Chinese military officers for cyber-espionage. They were charged in absentia by a Pennsylvania court for hacking into confidential information from six companies, the most prominent being Alcoa.

China’s Foreign Ministry was predictably furious at this ‘naming and shaming’ exercise, threatening retaliation for an “overbearing and hypocritical” act.

That threat would be made good within 24 hours…

What happened next?

The timing of the indictment was somewhat ironic. Exactly one year before, former NSA staffer Edward Snowden had fled America for Hong Kong, revealing the existence of a programme called Prism. This cyber-spying exercise was gathering vast amounts of data for the US government. As Snowden pointed out, a lot of the hacking was targeted at Chinese computer systems. The revelations about Prism also made plain that American tech companies were assisting Washington with its snooping.

After Snowden made Prism public, Beijing immediately cast itself as the victim in the hacking war. As the website Silicon Angle points out: “Snowden with his stories of NSA spying allowed China to take the moral high ground and claim that it, too, was a victim of spying. This prompted Chinese officials to announce an investigation into IBM, Oracle and EMC back in August 2013, citing ‘security concerns’ as the reason.”

The top echelons of the Chinese government has made plain its concerns about US technology in other, sometimes subtler ways. For example, in late March it was noted that First Lady Peng Liyuan had ditched her iPhone for a locally made smartphone. Xi Jinping’s wife, identified as an iPhone user when she took a photo with an Apple device on a state visit to Mexico last June (see WiC197), was seen instead with a ZTE handset.

But the sense of resentment post-Prism hasn’t subsided. “It’s really amazing some people still believe they have the moral high ground and credibility to accuse others, if we consider the Snowden revelations,” China’s ambassador to the US, Cui Tiankai, told CNN in an interview last month.

Cui has also rebuked Washington’s claim that it draws a distinction between spying for national security and for the advancement of domestic business, pressing the Americans to explain why it targeted Chinese companies, universities and even individuals for cyber attacks.

“I don’t know how they can make a distinction between such activities. How do they explain the attacks on Chinese companies, universities, and even individuals? Is that for national defence? Or is that for other purposes?” Cui said.

In this context the decision to go back on the public relations offensive and charge the five Chinese army officers with cyber-espionage was always likely to be inflammatory.

And so it proved. A day after the Justice Department announced the indictment, the Chinese responded by stating its government departments were forbidden from installing Windows 8, on concerns it could be used to undermine national security (see WiC239).

State broadcaster CCTV followed up with a 10-minute slot on its lunchtime news show attacking the Windows 8 operating system and saying that Chinese users were vulnerable to having information like their bank accounts snooped on.

A post on the official microblog at the People’s Daily then labelled American tech firms as “pawns of the villain”. It further vowed: “For anyone who steals our information, even though they are far away, we shall punish them!” (The warcry was subsequently deleted.)

Is the setback just for Microsoft?

No, it would seem to be a broader attack after Xinhua announced that the Chinese government will be vetting all major tech products. Details of how this will be achieved were unforthcoming although the vetting was said to be aimed at preventing suppliers from controlling, disrupting or shutting down their clients’ systems or gathering, storing and processing client information.

Companies that fail the vetting process will be prevented from supplying their products and services in China, the official statement said.

What was much clearer was that the focus seems squarely targeted at US tech firms, which was again made evident when news emerged from Bloomberg that the central bank had told Chinese banks to switch from using IBM servers.

“This is certainly going to impact US technology providers,” said Ben Cavender, an analyst with China Market Research Group. “Replacing some of the foreign providers will be difficult but at this stage there are more and more home grown solutions that China can rely on,” he told Silicon Angle.

One Chinese server firm that’s made ground since Snowden’s outing of Prism is Inspur. It grabbed headlines late last month on news that 80 IBM staff in China had been lured across to its own operations.

Coupled to the story about the central bank’s directive, Inspur stock surged, hitting its daily trading limit for three consecutive days as investors speculated it would be the main beneficiary.

Tencent Technology reports that the server maker is becoming more aggressive in its sales tactic. It has launched the ‘I2I programme’ (which stands for IBM to Inspur) and the company has told domestic media that it has already made inroads in replacing IBM as a key partner to China’s financial services firms. Apparently, Postal Savings Bank piloted the use of Inspur’s servers last year, and other big banks such as China Construction Bank have also began testing its products.

Though hardly a household name, Inspur has been growing at a rapid clip. In the first quarter, it sold more than 80,000 servers, accounting for 19% of the Chinese market. That ranks it first in China, and fifth globally. It’s year-on-year sales growth was 288%.

By comparison, IBM, HP and Dell saw their market share fall in the first quarter from 49% of China’s server business to 38% (with IBM’s server sales declining by a quarter).

This matters commercially because China is the market where server sales are seeing the most dramatic growth. Research firm Gartner points out that global server shipments rose just 1.4% in the first quarter, but grew 29% within China.

Inspur started out as a state-owned firm in Shandong, but today is 61%-owned by its employees. Nor is it the only domestic player benefiting from the post-Snowden localisation trend. Huawei’s president of strategic marketing William Xu says Agricultural Bank of China has also become a client recently and that Huawei’s network products are being used in 36 ABC branches and three of its data centres. Xu adds that other banks have approached it for “big data” solutions too.

Another beneficiary could well be Lenovo. It has been gaining share through sales of its own servers. However, its market clout will be boosted after it acquires IBM’s X86 server business, a purchase first announced in January (see WiC224). “This deal moves forward our aspirations in the server market by five years,” Peter Hortensius, president of Lenovo’s Think Business Group told the Financial Times at the time.

The $2.3 billion acquisition will vault Lenovo from ninth in the global server market to third.

Is it all part of a broader strategy?

Few now doubt that the Chinese government wants to lessen the nation’s reliance on America’s tech companies.

“China’s blistering attacks on US tech firms is more than a quid pro quo over cyberspying charges,” writes Computerworld, an online news site. “It’s a signal of China’s growing confidence in its own technology capabilities.” It adds that the country has demonstrated its growing prowess by symbolically building the world’s fastest supercomputer – a machine capable of speeds approaching 34 petaflops.

According to a report released last year by the Congressional Research Service, Beijing has plans to reduce its dependency on foreign technology from about 50% of products and networks today to 30% by 2020.

There have already been some successes. Take routers, switches and other network equipment. Domestic manufacturers, primarily Huawei, have been able to replace many foreign manufacturers in the Chinese market.

In application software, domestic products have gained ground on foreign products too. A survey by Hapi Research found that medium-sized Chinese companies were increasingly opting for business management software made by firms like Kingdee and UF rather than global leaders SAP and Oracle. The international brands only retained their dominance in larger companies such as Sinopec and Shougang Group, the report added.

Ni Guangnan has been a prominent proponent of the trend. A researcher with the computing institute of the Chinese Academy of Sciences, Ni has encouraged the government to “take the lead in the use of domestic software and hardware” to “eliminate security risks”. In the past, the reason why so many Chinese haven’t wanted domestic tech was less to do with the product than “fawning on foreign stuff”, Ni laments. This lack of confidence has hurt Chinese suppliers, he says, although he admits that there are two areas where the domestic tech sector is still weak. The first is in database software, where there is no decent substitute for Oracle, he says. The second area where China is a non-player is operating systems, which Ni says is “monopolised’” by Microsoft, Google and Apple.

Beijing’s hopes of producing an alternative operating system faltered in February when its local champion Red Flag went bankrupt, firing all of its 150 staff (see WiC227). Its Linux-based OS had struggled to win customers since its launch in 2000 (the Changjiang Daily put Red Flag’s market share at less than 1%). Even Lenovo, China’s biggest PC maker, preferred to ship its computers with Windows installed.

In fact at least 200 million computers in China still run on Windows XP, a statistic that is causing consternation for other reasons. In the hope of persuading customers to switch to Windows 8, Microsoft has announced it will no longer offer support for XP. So the fear is that this will make computers running XP more vulnerable to viruses and cyber-intruders. That’s a particular worry for all those Chinese government PCs that are still using it.

In fact, one of the bizarre upshots of CCTV’s attack on Windows 8 was that the experts who were interviewed towards the end of the segment all said there was no good local alternative.

TIME magazine realised Beijing’s problem too. “It is not exactly clear, for instance, what government computers will use for an operating system if not Windows 8,” it noted.

Many local netizens scoffed at the government’s Windows 8 ban: “If Windows is abandoned, how will civil servants play solitaire?” one asked. Netizens also joshed that CCTV had inadvertently run what amounted to a 10-minute ad for Microsoft’s product – and made clear that all those Chinese PCs running XP would have little choice but to upgrade to Windows 8.

But IT analyst Sun Yonglie seemed to suggest to 21 CN Business Herald that the Chinese government knows this too. He reckons the bluster about the ban is deliberate. See it more as a negotiating tactic, Sun says, to force Microsoft to lower the prices that it charges the government procurement office for the software in future.

How are US tech firms reacting to events in China?

Microsoft was quick to rebut the security concerns about Windows 8. On its company weibo account it insisted that its operating system contains no ‘backdoors’ and that it has never assisted intelligence agencies by providing access to customer details.

It added that Chinese government computers would be “perfectly fine” if they deploy Windows 8.

However, American tech bosses are clearly concerned about the backlash from Prism and the concerns about data security it has stoked in China. Microsoft’s new CEO Satya Nadella was among nine signatories to a letter to the US Senate asking for more respect for data privacy (Apple, Google and Facebook also signed). It stated: “We understand that governments have a duty to protect their citizens. But the balance in many countries has tipped too far in favour of the state and away from the rights of the individual. It is in the best interest of the United States to resolve these issues.”

The letter also alluded to the fact that NSA activity was bad for business: “Confidence in the internet, both in the US and internationally, has been badly damaged over the last year. It is time for action.”

(Bloomberg reported on a new piece of research this week suggesting that Snowden’s revelations could lead US firms to miss out on as much as $35 billion in overseas revenues from the cloud computing space alone.)

However, Beijing’s new assertiveness on the tech front could have an unwelcome consequence for one of its own national champions. That’s after it emerged that Lenovo has asked for more time to complete its purchase of IBM’s server business. Washington’s politicians are yet to approve the deal and they might block it on national security grounds (since US government agencies use IBM servers). The China Daily cites Lenovo’s senior vice president Chen Xudong as saying that worsening Sino-US relations in cybersecurity could ultimately derail the deal.

Whether or not the purchase goes through, it seems likely that China’s reliance on ‘Made in America’ tech will lessen. By the same token, some of the American expertise will be hard to replace. That suggests that even if Beijing has a masterplan for using only homegrown technology products, it’s going to be five to 10 years before it becomes a realistic possibility.


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