Multiple Reasons for Optimism: China's IP Picture Continues to Evolve

Watch carefully as China now prepares new policy guidelines, expected by the end of this year, for its semiconductor industry. Policy-makers and economists say, no doubt correctly, that China has identified semiconductors as a core part of its high-tech and overall business strategy. Tax exemptions and tax reductions will be major components of the emergent strategy, as will direct subsidies for R&D. Such tactical economic initiatives are expected to affect foreigners, including American expert technicians and corporate partners, as well as domestic interests.

It will also be interesting to see what, if any, intellectual property provisions are included in the new guidelines to both protect indigenous semiconductor manufacturers and assure non-Chinese companies as to the protection of their own products. At the most general level, any formal commitments by the Chinese in this area can only reinforce increasingly optimistic prognostications regarding their overall willingness to respond to global IP concerns ' a willingness that has fast become a matter of Chinese self-interest, if nothing else.

The economic and IP dimensions are more interrelated than might at first seem apparent from the ongoing dialogue on semiconductors so far. IP has not yet been all that publicly conspicuous a part of this particular dialogue. But there's some very relevant history related to China, and its aspirations for its semiconductor industry, which suggests that the forthcoming guidelines may well have multifaceted implications on numerous fronts.

In 2000, China made a major push to develop its semiconductor and software industries. At that time, however, plans for a value-added tax (VAT) reduction angered the U.S., Japan, and the European Union as unfairly competitive. Indeed, it would have meant a 14% advantage for domestic manufacturers over semiconductor imports. The issue remained on the table for a few years and has been resolved in private consultations, but the U.S. government did bring the dispute to the brink of litigation.

As China returns to the strategic drawing board, World Trade Organization (WTO) principles are presumably very much on the minds of its ministerial planners. At the very least, the sense of relative urgency with which the Chinese are now hoping to grow semiconductor production will provide foreign negotiators with some leverage to obtain additional IP assurances. We may even see the Chinese themselves put such assurances on the table, without being asked to, when they roll out the new guidelines.  

Reinforcing a Trend

If so, it will support a recent pattern of heartening behavior. We see China more willing than in the past to sign international conventions on IP protection, while a series of laws and regulations on patent rights has also been enacted.

For instance, Beijing is now enforcing copyrights with disclaimers on file-sharing websites. Chinese police are said to have recently solved around 7000 criminal cases involving counterfeiting and commercial intelligence theft. The total IP equity of these cases involves approximately $321 million.

China has a recidivist tradition in that it tends to relax controls once outside pressure subsides. Yet it's a different market now, and the Chinese know that. Those outside pressures won't subside because the volume of product trade and manufacture will continue to reach epic dimension.

In that regard, consider too the Chinese position vis-'-vis the WTO. If they backed down over semiconductors in 2000 ' before they were members of the WTO ' consider their predictable openness to fair dealing, on the IP as well as the trade front, in light of all that has happened since then. Four years after joining the WTO, China's imports from the U.S. alone increased more than 80%. Meanwhile, China's exports to the U.S. are six times greater than that. In fact, the 2005 imbalance hovered at $200 billion.

It is therefore altogether in China's interest to continue assuaging global fears ' and overall trade figures suggest they are doing just that. Tariffs were down in 2005 by 6% while IT tariffs, which have averaged 13.3%, were completely eliminated after China joined the WTO. In the last two years, 18 Chinese cities were opened to local-currency transactions by foreign banks, which is actually faster than what the WTO action plan called for.

To be sure, in all of this, progress has been slowest on IP compliance. During Q1 and Q2 of 2005, 70% of pirated goods seized at Americans borders were Chinese. The amount of loss for non-Chinese business is easily in the billions. According to the U.S. Chamber of Commerce, a minuscule percentage of provincial enforcement actions ever wind up in court for criminal investigation.

There are two ways to interpret the lower marks China has earned for IP than, say, tariffs or competition. It may be that Beijing figures it's done enough to comply with the WTO; that membership is a done deal, that China's place in the organization is secure, and that it can and must now backtrack to protect native businesses.  

More likely, as has often been observed, the nub of the problem may be that there are simply too many administrative departments in China handling IP violations and that proper enforcement is therefore vitiated. Yet, if we focus on one key industry like semiconductors, it becomes clear what can be achieved at the enforcement level as well. We're not talking about ladies' purses, after all. We may learn by the end of 2006 that, if an industry is important enough to their future plans, the Chinese can accomplish just about whatever they want.

What Does the Litigation Really Mean?

Now, let's measure these hopeful prognostications against some evidence that we are possibly being too optimistic.

Throughout 2006, the U.S. has been playing a cat-and-mouse litigation game, confirming the possibility of a major lawsuit against China for failing to protect intellectual property as required by trade agreements. It would be brought before the WTO and encompass a broad array of product and industry areas, from movies and music to software and patented drugs.

Yet a few sidebars from U.S. officials should put this and all similar litigation in better perspective. In July, Timothy Stratford, assistant U.S. trade representative for China, told a conference in Seattle that trade cases, far from being hostile, often keep trade relationships healthy.

According to Stratford, Chinese leaders are starting to see the benefits. 'What better way to help them understand this than to start suing them?” Stratford said, a day or so after Congress approved $50 million for the U.S. Trade Representative to, inter alia, increase surveillance of Chinese compliance with trade agreements.

Stratford's comments offer a priceless insight into the wrangling over both trade and IP, especially with respect to a country that may someday dominate global trade and literally own most of the world's legitimate IP. Understood this way, litigation is not evidence of backsliding or of chronic insoluble problems. Quite to the contrary, it is the best way to define limits to infringement, and to better define the Chinese government's response to infringement, even as sufficient flexibility remains to satisfy, or at least reach acceptable compromises with all key players.

In that sense, it is also significant that Stratford's remarks were made in Washington state, which does more per capita trade with China ($20 billion per year) than any other state. There are indeed many interested parties to every litigation and every threatened litigation! A litigation strategy designed to edify rather than punish will keep Seattle's merchants happy even as it supports the interests of other non-Chinese players hard-pressed to protect the family jewels against piracy, theft, and counterfeiting.

Of course, IP presents myriad problems that are beyond the strict pale of trade relations negotiations. Infringers and counterfeiters presumably operate outside the sphere of government influence, or at least enough outside that sphere to provide the government with excuses for failing to enforce in areas like consumer goods counterfeiting. The additional problem is that Chinese infringers themselves know a lot about IP law, and can expertly fake trademarks or apply separately for the legal right to manufacture what they've already stolen.

Solid Markers

At some point, though, we need to view Chinese infringers are just infringers ' rather than marketplace weathervanes. The real weathervanes are the legal and institutional steps that the Chinese have already taken and which, as we've tried to emphasize, can only grow stronger every time the government embarks on just such an initiative as its current efforts on behalf of its semiconductor industry.

Consider:

' There are now 15,000 IP cases in Chinese courts. There were 1,076 prosecutions in infringement cases. Each new strategic business push forward ' like this year's focus on semiconductors ' can be predicted to inspire more cases against infringers and pirates.

' China, through its State Intellectual Property Office (SIPO), has issued its first Action Plan on IPR Protection. The very fact that it would do so at this juncture in history is as important as the content of the plan itself.

' China's Administration for Industry & Commerce (AIC) seizes goods and imposes damages equivalent to $100,000 U.S. dollars per offender. One Australian IP specialist, Alicia Beverley, has observed that her country has no such comparable entity.

' China will be taking unprecedented measures to avoid embarrassment during the 2008 Olympics, which it is hosting.

' Public officials are now subject to punishment for failure to enforce IP rights.

There are also current and predictable trends among foreign businesses that may further ameliorate China's IP problem:

' China is a 'first to file' country. As more foreign companies understand that they therefore need to file before they set up shop in China, more domestic infringers will look to greener pastures for dishonest gain that has nothing to do with IP rights.

' More foreign companies are designing products that are harder to knock off. It may be cold comfort to businesses that have suffered losses as a result of IP violations in China, but there is a perceptible trend toward greater innovation by foreign companies as they continue to refine their products in order to stay one step ahead of violators.

' Private investigators represent a growing professional service in China, and they will need to compete effectively for foreign clients. In other words, they'll have to help catch more infringers.

Meanwhile, the marketplace has sent powerful signs of its increased confidence:

' U.S. companies filed more than 13,000 patent applications in the first half of 2006, according to SIPO. This number represents a 20% increase over the same period last year.

' This year's 20% increase almost exactly mirrors similar increases from year to year over the past three years.

' China opened its 50^th IP service center. If nothing else, this expansion shows that China, at some level at least, is no longer making excuses for or hiding its IP deficiencies, but is instead marketing its attentiveness to IP as an actual drawing card to attract foreign business.

' Solicitation by China of comments from U.S. companies and the U.S. government has increased significantly.

While the rise in patent applications is currently driven by large corporations, China expects midsize companies to follow suit in the very near future. If that is their goal, they will naturally be taking steps to make it happen. Increased patent filings by midsize companies will, in turn, decisively reflect on China's IP regimen, since these smaller companies cannot afford a lawless environment to the extent that Fortune 100 companies can live with it as a cost of doing business.

Right now, in other words, one might argue that the burst in legitimate IP activity in China is a direct reflection on the dizzying prospects for business growth, not on tangible improvements in China's IP system. But when that high-volume IP activity begins to include foreign companies of ever greater size variety, the skeptical argument will no longer hold water. China will have then come of age as a marketplace for everyone.

Watch carefully as China now prepares new policy guidelines, expected by the end of this year, for its semiconductor industry. Policy-makers and economists say, no doubt correctly, that China has identified semiconductors as a core part of its high-tech and overall business strategy. Tax exemptions and tax reductions will be major components of the emergent strategy, as will direct subsidies for R&D. Such tactical economic initiatives are expected to affect foreigners, including American expert technicians and corporate partners, as well as domestic interests.

It will also be interesting to see what, if any, intellectual property provisions are included in the new guidelines to both protect indigenous semiconductor manufacturers and assure non-Chinese companies as to the protection of their own products. At the most general level, any formal commitments by the Chinese in this area can only reinforce increasingly optimistic prognostications regarding their overall willingness to respond to global IP concerns ' a willingness that has fast become a matter of Chinese self-interest, if nothing else.

The economic and IP dimensions are more interrelated than might at first seem apparent from the ongoing dialogue on semiconductors so far. IP has not yet been all that publicly conspicuous a part of this particular dialogue. But there's some very relevant history related to China, and its aspirations for its semiconductor industry, which suggests that the forthcoming guidelines may well have multifaceted implications on numerous fronts.

In 2000, China made a major push to develop its semiconductor and software industries. At that time, however, plans for a value-added tax (VAT) reduction angered the U.S., Japan, and the European Union as unfairly competitive. Indeed, it would have meant a 14% advantage for domestic manufacturers over semiconductor imports. The issue remained on the table for a few years and has been resolved in private consultations, but the U.S. government did bring the dispute to the brink of litigation.

As China returns to the strategic drawing board, World Trade Organization (WTO) principles are presumably very much on the minds of its ministerial planners. At the very least, the sense of relative urgency with which the Chinese are now hoping to grow semiconductor production will provide foreign negotiators with some leverage to obtain additional IP assurances. We may even see the Chinese themselves put such assurances on the table, without being asked to, when they roll out the new guidelines.  

Reinforcing a Trend

If so, it will support a recent pattern of heartening behavior. We see China more willing than in the past to sign international conventions on IP protection, while a series of laws and regulations on patent rights has also been enacted.

For instance, Beijing is now enforcing copyrights with disclaimers on file-sharing websites. Chinese police are said to have recently solved around 7000 criminal cases involving counterfeiting and commercial intelligence theft. The total IP equity of these cases involves approximately $321 million.

China has a recidivist tradition in that it tends to relax controls once outside pressure subsides. Yet it's a different market now, and the Chinese know that. Those outside pressures won't subside because the volume of product trade and manufacture will continue to reach epic dimension.

In that regard, consider too the Chinese position vis-'-vis the WTO. If they backed down over semiconductors in 2000 ' before they were members of the WTO ' consider their predictable openness to fair dealing, on the IP as well as the trade front, in light of all that has happened since then. Four years after joining the WTO, China's imports from the U.S. alone increased more than 80%. Meanwhile, China's exports to the U.S. are six times greater than that. In fact, the 2005 imbalance hovered at $200 billion.

It is therefore altogether in China's interest to continue assuaging global fears ' and overall trade figures suggest they are doing just that. Tariffs were down in 2005 by 6% while IT tariffs, which have averaged 13.3%, were completely eliminated after China joined the WTO. In the last two years, 18 Chinese cities were opened to local-currency transactions by foreign banks, which is actually faster than what the WTO action plan called for.

To be sure, in all of this, progress has been slowest on IP compliance. During Q1 and Q2 of 2005, 70% of pirated goods seized at Americans borders were Chinese. The amount of loss for non-Chinese business is easily in the billions. According to the U.S. Chamber of Commerce, a minuscule percentage of provincial enforcement actions ever wind up in court for criminal investigation.

There are two ways to interpret the lower marks China has earned for IP than, say, tariffs or competition. It may be that Beijing figures it's done enough to comply with the WTO; that membership is a done deal, that China's place in the organization is secure, and that it can and must now backtrack to protect native businesses.  

More likely, as has often been observed, the nub of the problem may be that there are simply too many administrative departments in China handling IP violations and that proper enforcement is therefore vitiated. Yet, if we focus on one key industry like semiconductors, it becomes clear what can be achieved at the enforcement level as well. We're not talking about ladies' purses, after all. We may learn by the end of 2006 that, if an industry is important enough to their future plans, the Chinese can accomplish just about whatever they want.

What Does the Litigation Really Mean?

Now, let's measure these hopeful prognostications against some evidence that we are possibly being too optimistic.

Throughout 2006, the U.S. has been playing a cat-and-mouse litigation game, confirming the possibility of a major lawsuit against China for failing to protect intellectual property as required by trade agreements. It would be brought before the WTO and encompass a broad array of product and industry areas, from movies and music to software and patented drugs.

Yet a few sidebars from U.S. officials should put this and all similar litigation in better perspective. In July, Timothy Stratford, assistant U.S. trade representative for China, told a conference in Seattle that trade cases, far from being hostile, often keep trade relationships healthy.

According to Stratford, Chinese leaders are starting to see the benefits. 'What better way to help them understand this than to start suing them?” Stratford said, a day or so after Congress approved $50 million for the U.S. Trade Representative to, inter alia, increase surveillance of Chinese compliance with trade agreements.

Stratford's comments offer a priceless insight into the wrangling over both trade and IP, especially with respect to a country that may someday dominate global trade and literally own most of the world's legitimate IP. Understood this way, litigation is not evidence of backsliding or of chronic insoluble problems. Quite to the contrary, it is the best way to define limits to infringement, and to better define the Chinese government's response to infringement, even as sufficient flexibility remains to satisfy, or at least reach acceptable compromises with all key players.

In that sense, it is also significant that Stratford's remarks were made in Washington state, which does more per capita trade with China ($20 billion per year) than any other state. There are indeed many interested parties to every litigation and every threatened litigation! A litigation strategy designed to edify rather than punish will keep Seattle's merchants happy even as it supports the interests of other non-Chinese players hard-pressed to protect the family jewels against piracy, theft, and counterfeiting.

Of course, IP presents myriad problems that are beyond the strict pale of trade relations negotiations. Infringers and counterfeiters presumably operate outside the sphere of government influence, or at least enough outside that sphere to provide the government with excuses for failing to enforce in areas like consumer goods counterfeiting. The additional problem is that Chinese infringers themselves know a lot about IP law, and can expertly fake trademarks or apply separately for the legal right to manufacture what they've already stolen.

Solid Markers

At some point, though, we need to view Chinese infringers are just infringers ' rather than marketplace weathervanes. The real weathervanes are the legal and institutional steps that the Chinese have already taken and which, as we've tried to emphasize, can only grow stronger every time the government embarks on just such an initiative as its current efforts on behalf of its semiconductor industry.

Consider:

' There are now 15,000 IP cases in Chinese courts. There were 1,076 prosecutions in infringement cases. Each new strategic business push forward ' like this year's focus on semiconductors ' can be predicted to inspire more cases against infringers and pirates.

' China, through its State Intellectual Property Office (SIPO), has issued its first Action Plan on IPR Protection. The very fact that it would do so at this juncture in history is as important as the content of the plan itself.

' China's Administration for Industry & Commerce (AIC) seizes goods and imposes damages equivalent to $100,000 U.S. dollars per offender. One Australian IP specialist, Alicia Beverley, has observed that her country has no such comparable entity.

' China will be taking unprecedented measures to avoid embarrassment during the 2008 Olympics, which it is hosting.

' Public officials are now subject to punishment for failure to enforce IP rights.

There are also current and predictable trends among foreign businesses that may further ameliorate China's IP problem:

' China is a 'first to file' country. As more foreign companies understand that they therefore need to file before they set up shop in China, more domestic infringers will look to greener pastures for dishonest gain that has nothing to do with IP rights.

' More foreign companies are designing products that are harder to knock off. It may be cold comfort to businesses that have suffered losses as a result of IP violations in China, but there is a perceptible trend toward greater innovation by foreign companies as they continue to refine their products in order to stay one step ahead of violators.

' Private investigators represent a growing professional service in China, and they will need to compete effectively for foreign clients. In other words, they'll have to help catch more infringers.

Meanwhile, the marketplace has sent powerful signs of its increased confidence:

' U.S. companies filed more than 13,000 patent applications in the first half of 2006, according to SIPO. This number represents a 20% increase over the same period last year.

' This year's 20% increase almost exactly mirrors similar increases from year to year over the past three years.

' China opened its 50^th IP service center. If nothing else, this expansion shows that China, at some level at least, is no longer making excuses for or hiding its IP deficiencies, but is instead marketing its attentiveness to IP as an actual drawing card to attract foreign business.

' Solicitation by China of comments from U.S. companies and the U.S. government has increased significantly.

While the rise in patent applications is currently driven by large corporations, China expects midsize companies to follow suit in the very near future. If that is their goal, they will naturally be taking steps to make it happen. Increased patent filings by midsize companies will, in turn, decisively reflect on China's IP regimen, since these smaller companies cannot afford a lawless environment to the extent that Fortune 100 companies can live with it as a cost of doing business.

Right now, in other words, one might argue that the burst in legitimate IP activity in China is a direct reflection on the dizzying prospects for business growth, not on tangible improvements in China's IP system. But when that high-volume IP activity begins to include foreign companies of ever greater size variety, the skeptical argument will no longer hold water. China will have then come of age as a marketplace for everyone.