A trade showdown is looming between the U.S. andChinese governments, and the flashpoint issemiconductors.

American chipmakers are deeply unsettled by arecent Chinese mandate that they must link up withChinese companies by June 1 if they want to sell Wi-Fi, or wireless local area networking, chips into thelocal market. The kicker: China wants the U.S. firms toshare technological know-how with the local outfits,in a country renowned for theft of intellectualproperty.

If that weren't enough to raise hackles on bothsides of the Pacific, late last week the U.S.government filed a World Trade Organization complainton a separate front, objecting to the heavy taximposed on semiconductors imported into China.

That the chip trade disputes have become so heatedand public shows that China will be anything but a passivecustomer for advanced American technology. Indeed, the wrangling speaks to Beijing's ownambitions to push the Chinese economy further alonginto high-tech areas like semiconductors.

Though the WTO complaint garnered more press,chip leaders say they're more worried by the Beijingmandate on Wi-Fi chips, which requires them to joinforces with one of two dozen Chinese companies versedin a domestic Wi-Fi security standard known as WAPI, or wired authentication and privacy infrastructure. Toget access to the WAPI protocol, U.S. chipmakers saythey are being asked to divulge details of their owntechnology to Chinese counterparts.

"The way in which the Wi-Fi encryption technologyhas surfaced has been more disconcerting than the taxdispute and portends a future standards issue," saidDebbie Leilani Shon, a former assistant U.S. traderepresentative in the Clinton administration whocurrently teaches international trade policy at the Universityof Southern California. "This is a technical barrierto trade, and the way it has evolved is very blatant."

The situation has aroused consternation among U.S.chipmakers angling for a share of the fast-expandingChina semiconductor market. China is expected tobecome the second-biggest chip market in the world by2010, according to IDC, up from its current third-place ranking. Last year, Intel ( INTC) claimed $3.7 billion worth of sales intothe market, amounting to a sizable 12% of its totalrevenue and making it the lead chip supplierinto China.

China still imports about 80% of the chips itneeds, but the country's own semiconductor supplierbase is growing quickly with help from both itsgovernment and overseas partners. U.S.companies are therefore wary of handing over details of theirchip technology that emerging Chinese competitorscould adapt and use to sell their own semiconductors.

"It's clear China must be viewing Wi-Fi as avery large market and therefore they want to establishtheir own market, which in and of itself is not anissue," said George Scalise, president of theSemiconductor Industry Association, the trade groupleading the opposition to the rule. "Where theviolation comes in is in requiring foreign companiesto provide intellectual property to a limited set oflocal Chinese companies."

The WTO says countries can't require technologytransfers in exchange for allowing access to theirmarkets, trade experts say.

Shifts Behind the Wall

In fact, Beijing's stance on Wi-Fi chips marks astriking shift. Over the past few years, the Chinesegovernment has sought technical input from the likesof Texas Instruments ( TXN) and Nokia ( NOK) to help develop China'sown cell-phone standard, known as TD-SCDMA, or timedivision synchronous code division multiple access.

The recent change of tone thus comes as anunwelcome surprise. Intel haspublicly balked at Beijing's demands, no doubt asource of frustration after the chip giant has alreadyspent some of last year's $300 million Centrino adbudget in China. Visitors to a Shanghai computer mallin December saw corridors bedecked with hangingpromotional posters for Centrino.

Meanwhile, the WTO dispute over taxes filed by the Bush administration last week centers onthe fact that China slaps a tax of 17% on importedsemiconductors but, after rebates, only 3% ondomestically designed and produced chips. The U.S.Trade Representative Robert Zoellick reckons that the import tax costU.S. chipmakers $344 million last year.

"It certainly looks illegal," said J. DavidRichardson, professor of economics in the MaxwellSchool of Syracuse University. "But subsidies likethese are a gray area."

Beijing argues that the tax doesn't discriminate,since foreign companies can become eligible for thefull tax rebates if they agree to design andmanufacture chips in China. Yet many chipmakers remainleery of moving advanced work to China, given that country'sspotty record on intellectual property protection. Inany case, the SIA maintains that China's tax policyviolates its commitments as a member of the WTO, whichprohibits countries from favoring domestic business.

U.S.-based trade experts and tech officials seemtaken aback by the surge of protectionist feeling fromChina, given that many had believed the new generation of Beijing leaders was more supportive of open trade.

Yet the political situation in Beijing is far fromstraightforward, given apparent differences of opinionwithin China's sprawling bureaucracy. Last summer theChinese seemed to be leaning toward quietly resolvingthe U.S. complaint over taxes, according to Scalise.One of China's government agencies hadconcluded that the higher tax in imported chips wasunfair, he said. But in an unexpected shift, the governmentthen backed off a decision that would have favoredU.S. chipmakers.

Talks to resolve the chip trade dispute will getunder way as early as this week, when the SIA meetswith Chinese officials in Geneva. More formalgovernment discussions will take place in Washingtonon April 21.

At least U.S. chipmakers are in a much betterbargaining position with Beijing than theircounterparts in more commodity markets, say tradeexperts. Intel and other Wi-Fi purveyors havesomething the Chinese want: advanced technology.That's not true for U.S. companies in the textileindustry, for example, where trade tensions have alsosurfaced. Textile makers have already lost substantialbusiness to China but can only compete on cost, wherethey operate at a disadvantage to low-cost Chineserivals.

In contrast, "high-tech issues are ripe fordiplomatic resolutions, because technology is anexpanding pie," said Richardson. "There are enough gains in high-techtrade to spread between both parties and make everyoneinto a winner."

For Intel and other U.S. chipmakers that see Chinaas a huge market for high-end fare like Wi-Fi, aresolution to the trade disputes can't come fast enough.

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