China’s failure to make more rapid progress in protection of intellectual property is adversely affecting its economic relations with the U.S. as well as its own economic development.

By Chloe Reum

Scope of the IPR Issue between China and the U.S.

A source of economic tension between the United States and China relates to the assertion by American business executives and U.S. government officials that Chinese companies illegally appropriate large amounts of intellectual property from U.S. companies. IPR infringement in China diminishes market opportunities and the profitability of U.S. companies when sales of technologies and goods are undercut by competition from cheaper counterfeits. Intellectual property is often the most valuable asset that a company holds, however, many firms lack the resources and skills necessary to protect their intellectual property in China.

Since 1979, China has progressively made efforts to pass a variety of laws designed to encourage greater public awareness of the piracy problem and to periodically control the piracy issue by publicly shutting down knock-off markets in cities like Shanghai and Shenzhen. China has also joined international IPR conventions and organizations, including the Universal Copyright Convention and the World Trade Organization. By taking part in these IPR conventions and organizations, China has been able to incorporate more IPR laws based on global standards into its system, including patent, copyright, trademark, and technological laws (e.g. the Trademark Law of the People’s Republic of China (1982), the Patent Law of the PRC (1984), the U.S.-China Intellectual Property Rights Enforcement Promise (1995), etc.). As a result, current objections concerning China piracy no longer apply to its laws, but about the way China enforces these laws, which has proved not to be sufficient to prevent IPR infringements. Because China is still a developing country and doesn’t have enough funds or allocated resources to pursue every case of IP infringement, most pirates steal, share, and sell copyrighted information without consequence. Additionally, China’s inability to rid themselves of their communist culture and cultural roots in Confucianism - two ideologies very distinct from liberal western economic theory - has made it difficult for the country to resolve IPR violations. As stated by Donald P. Harris, a professor at the Temple University Beasley School of Law specializing in international intellectual property, “the Chinese culture subordinates individual interests to group interests, in stark contrast to the protection of individual property rights. Therefore, protection of IPRs is not a primary concern.”

The Importance of IP Reform in China

The scope of the IPR infringement and piracy problem in China has become a very significant issue in relation to the U.S. From movies and music to books, designer apparel and accessories to software, one can find counterfeit copies of just about anything a typical consumer uses in daily life. Counterfeit products amount to 15-20% of China’s total GDP – totaling up to $20-25 billion in counterfeit products sold in China per year according to the U.S.-China Business Council. Additionally, in a 2011 U.S. International Trade Commission study, U.S. businesses experienced $48 billion in losses due to infringement in China in 2009. Organized, large-scale production and exporting of pirated optical discs and other media is especially common and problematic in the southern Chinese cities of Guangzhou and Shenzhen. Because infringing products can be distributed digitally through decentralized global networks, they can quickly reach consumers in markets around the world, contributing to the growth of digital piracy as a concern for copyright-intensive companies. Various U.S. copyright holders and the State Council’s Development Research Center estimate 90-99% of all software used in China is pirated, resulting in a $1.8 billion dollar U.S. sales loss that continues to exceed annually. The enforcement against piracy has become a very concerning and challenging issue for smaller companies situated in the U.S. because they don’t maintain a physical presence in China. As a result, the U.S. has placed China on its “priority watch list of countries failing to protect IP rights and significantly reduce infringement levels”, threatened to impose trade sanctions against China, and brought suits against China through the WTO.

However, China lacks the will and the legal structures to enforce its IPR laws due to several factors that account for their ineffectiveness. First, its administrative system and national strategies to deter piracy ultimately fail due to local protectionism, in which local officials hinder enforcement efforts because illegal companies generate profits that are central to the success of the local economy. Because there’s a continuing demand by consumers around the globe for cheaper knock-off versions of luxurious and expensive items, the incentive for piracy keeps growing. At the same time, China’s court fines and sentences aren't severe enough to limit the incentive for the continuation and growth of piracy.

Background on the China-U.S. Intellectual Property Rights Dispute: Pre- WTO

For over 30 years, the United States has urged China to improve enforcement of U.S. intellectual property rights and allow for more expansive market access to intellectual property-related goods (like CDs and computer software) through threats of trade sanctions and WTO legal proceedings. The history of the China-U.S. Intellectual Property Rights Dispute began in 1979 through the U.S.-China Trade Agreement, which specified that both countries would “afford each other equal national treatment in protection of patents, copyrights, and trademarks.” Prior to this agreement, Section 182 of the U.S. 1974 Trade Act (otherwise known as Special 301) was used to protect American IPR in foreign markets by determining countries that have inadequate IPR protection and instigating negotiations with these “priority foreign countries.” However, in U.S.-Chinese Joint Commission on Commerce and Trade talks and market access negotiations of 1985, U.S. officials began expressing their concern in regards to Chinese IPR protection enforcement (involving inadequate levels of copyright, patent, and trade secret protection). As a result, these concerns led to the USTR designating China as a “priority foreign country” under its Special 301 watch list beginning in 1989 and the U.S. to threaten China with trade sanctions and prohibitive tariffs. Despite efforts to provide greater market access to U.S. products, establish mechanisms to ensure long-term enforcement of IPR laws, and begin a “Special Enforcement Period” to take actions against large-scale producers and distributers of pirated goods in 1995, China was once again designated a “priority foreign country” in 1996 and has remained with that title for intellectual property infringement ever since.

The state of the U.S.-China dispute in 1996, in which enforcement was executed at the retail level rather than at the source of production and trade/ investment barriers to U.S. IPR-related products prevented Chinese individuals from purchasing products freely in the market, has remained very similar to the IPR dispute between the U.S. and China today in terms of the key issues. Failure to rectify the IPR violations has several consequences for both countries. Imposing sanctions on either side reduces economic relations and opportunities and could lead to a trade war, and the lack of IPR enforcement discourages future foreign investment in China (having economic repercussions for both China and the U.S.).

The Effect of IPR Enforcement on the Chinese Economy

As China’s free market advances, the repercussions of lax IPR enforcement will affect not only foreigners but also legitimate Chinese businesses. Legitimate businesses will find it difficult to build national brands, invest in research and development, and find incentives to create new products. Consequently, China’s chances of emerging more successful in the global marketplace will be reduced if it loses crucial tax revenues, foreign investors, and the ability to develop new industries due to its poor IPR enforcement.

China is in the midst of a transition from an export-oriented economic growth model to one more consumer-driven, encouraging innovation, and, per its new leader, Xi Jinping, free of corruption (note the substantial drop in China’s exports last month (March 2015)). Indeed, China’s three largest technology companies, Alibaba, Tencent Holdings, and Baidu, have in turn spawned potential start-up businesses led by former employees turned entrepreneurs seeking investments from wealthy Chinese. However, the lack of IP enforcement combined with tight government control over the Internet may thwart domestic economic development. As stated by Antoine van Agtmael, President of the Emerging Markets Investors Corporation, “China is making it harder to innovate in China precisely when rising labor costs in China and more flexible, open innovation in America, together with cheap energy costs, are prompting more companies to build their next plant in the U.S., not China.” Therefore, the future will belong to companies that can make things smartest, not simply cheapest, and China’s IPR enforcement policies may be a significant factor in determining how well it succeeds.

The Effect of IPR Enforcement on the U.S. Economy

Despite rapid economic growth and success in the Chinese market, many U.S. firms have reported that intellectual property rights infringements (involving stolen trade secrets, reduced sales and royalty/license fees, and damaged brand names and product reputations) have weakened their competitive positions. IPR violations of copyrights, patents, trademarks, and trade secrets in China reduce market opportunities and profits of U.S. companies since they have no other choice but to compete with the sales of illegal, cheaper imitations. In 2009, the result of this was $48.2 billion in global losses for U.S. IP-intensive firms. Copyright infringement in 2009 accounted for approximately $23.7 billion in U.S. company losses due to the low costs of digital replication, market access restrictions, and the convenience of the internet as a medium of exchange. Trademark infringement, the most reported form of IPR infringement in 2009, affected nearly 92% of firms in the consumer goods manufacturing sector.

IPR infringement particularly affects the U.S. economy since innovation and intellectual property play a crucial role in driving employment, productivity, and overall growth. The United States International Trade Commission estimates that an improvement in IPR protection/enforcement to “levels comparable to the U.S would likely increase employment by 2-5%” and result in as much as a “10-20% increase in sales, royalties, and license fees earned in China.” In other words, there would be a gain of 922,588 new U.S. jobs in IP-intensive firms. Additionally IPR protection-related improvements could lead to an estimated $107 billion gain in U.S. exports and sales, particularly benefitting the service, software, paper-products, and publishing sectors.

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