U.S. trade report blasts China over high-tech policies

The U.S. International Trade Commission report on China trade practices was requested by the U.S. Senate Committee on Finance

The U.S. and other countries are getting slammed by China’s intellectual property rights infringements and standards-setting processes, according to an investigative report issued by the U.S. International Trade Commission (US ITC) this week.The US ITC’s report, which goes by the unwieldy title “China: Intellectual Property Infringement, Indigenous Innovation Policies, and Frameworks for Measuring the Effects on the U.S. Economy,” portrays China as a country where the government unabashedly pushes its own agenda of “indigenous innovation” to boost homegrown Chinese tech companies over foreign ones, all while rampant software piracy in China shortchanges the the U.S. software and music industries.

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The report also alleges the Chinese standards-setting process in the high-tech arena largely shuts out foreign input and acts as a market barrier. In addition, demands by Chinese government agencies that some foreign firms turn over intellectual property, such as source code, for review is all working to the disadvantage of foreign firms wanting to do business in China.“The policy is if you want to sell information security products to the government, it has to be certified by a Chinese lab. And to certify it, you have to transfer technology and share code,” says David Ohrenstein, director of public policy and emerging markets at the Business Software Alliance (BSA), the Washington, D.C. trade group. Ohrenstein calls the US ITC report “a very comprehensive bill of particulars on problems facing companies in terms of both intellectual property infringement and market-access restriction.”

To BSA’s knowledge, most software companies with roots outside China are balking at this demand from the Chinese government to turn over intellectual property for review, if only because these companies aren’t sure what the Chinese labs might do with the intellectual property they might be given.

Here are some of the issues tackled in this week’s US ITC report related to China and high-technology:

The Chinese TCM: “One issue is China’s strategy of developing closed, national standards for trusted computing through Trusted Cryptography Modules (TCM) rather than through participation in the ISO and Trusted Computing Group. The Chinese TCM requires that cryptographic algorithms and protocols used to perform specific security tasks, such as verifying that only authorized codes run on a system, be based on Chinese technology. U.S. industry representatives have raised concerns that Chinese development of TCM technology is motivated by the desire to reduce royalties for patents embedded in TCG technology standards and that it will negatively affect interoperability and globally integrated supply chains.”

Encryption source code requirements: “Concern about leakage of data by regulatory agencies has also surfaced for software encryption companies operating in China. The government has recently begun requiring software companies to submit certain source codes to the government in order to obtain China Compulsory Certification approval before they can market software encryption products in China. U.S. industry representatives have voiced concerns that their intellectual property could be subject to leakage from china’s Office of Commercial Code Administration or from the government-owned computer software laboratories that perform product tests for the government.”

China’s Multi-Level Protection Scheme (MPLS), which is described as “a set of rules for computer security certification that apply to government agencies, state-owned enterprises and Chinese infrastructure companies, including financial and transportation institutions. The MLPS could significantly affect U.S. sales of information security technology products, such as network firewalls and digital identity systems in China. The MLPS classifies computer systems into five tiers of increasing sensitivity and requires that security technology for the top three tiers be supplied by a Chinese-owned company and that core technology and key components be based on Chinese Intellectual property.”

China’s plans for developing Time Division Long Term Evolution (TD-LTE), a fourth-generation mobile telecommunications technology based on the TD-SCDMA standard, are said to “shift some royalties to Chinese firms.” In addition, Chinese WAPI, the “Wired Authentication and Privacy Infrastructure” standard with its “undisclosed encryption algorithm has hampered its acceptance by the International Organization for Standardization as an international standard,” according to the report, and “inclusion of WAPI technology adds costs for manufacturers, who must work with local companies to make the hardware as well as pay royalties for the Chinese technology.”

Industrial espionage through computer hacking originating in China. The attack against Google disclosed earlier this year, for example, is said to be traced to “computers at two educational institutions in China: Shanghai Jiaotong University and the Lanxiang Vocational School. The latter reportedly was established with military support and continues to train computer scientists for the Chinese military.” The report acknowledges there’s no full clarity yet on the “true attacker.”

In addition, as the US ITC report notes, the Chinese government is expected to soon publish a so-called “National Indigenous Innovation Product Catalog” that’s supposed to be based on intellectual property developed and owned in China. Some local catalogs identified with Chinese regions and cities are said to already be cropping up.

The belief is “it will be used as a preference for government procurement,” Ohrenstein says.

The U.S. and Europe have formally objected to this policy. China’s push for “indigenous innovation,” which the U.S. ITR report says is the translation of the Chinese phrase “zizhu chuangxin” introduced four years ago, is making it ever more uncertain for international firms trying to do business in China.

“As part of the push for indigenous innovation, China has developed national standards specifically to compete with existing international standards, and in some cases, mandated the use of the new standards in Chinese markets,” the US ITR report states. “These standards act as market-access barriers and force foreign companies to adopt Chinese technologies to conduct business in China.”

The report says the standards-setting process in China works differently than in the U.S., where standards generally originate in the private sector. “Standards development in China occurs through a top-down system, and U.S. and other firms are often entirely excluded from the process or are permitted to participate only as observers,” the US ITR report points out.

The long-standing and universal problem of outright piracy related to software or entertainment products in music and film is further cause for complaint when it comes to China. How any of this impacts the U.S. economy and jobs is expected to be summed up in a second US ITC report to be published this spring, and it could trigger political friction between the two countries. (Both US ITC reports on China trade practices were requested by the U.S. Senate Committee on Finance).

Legitimate sales of music in China in both online and physical formats was just $75 million in 2009, says Michael Schlesinger, attorney with the D.C.-based International Intellectual Property Alliance, a coalition of seven trade associations in the film and music industries as well as the BSA.

The music industry believes a huge amount of music is pirated online in China, with Chinese search engine Baidu suspected of playing a role in that by offering a linking service to pirated music. “They actually have a linking service that lets people get music illegally,” Schlesinger says. The U.S. ITC report also includes a complaint about Baidu.

Schlesinger says the film industry is irritated about what’s called the “20-film quota” in China, in which China has agreed to allow 20 foreign films into China on a revenue-sharing basis. Not only is that number of films considered low, but the films undergo state review, and the film industry usually finds the contracts limit them to about 15% of revenue while the Chinese get 85%. “The piracy, the market access barriers and the industrial policies essentially shut out software and entertainment,” Schlesinger says.

Software piracy is also a troubling issue. BSA’s Ohrenstein says the estimate now is that 79% of software loaded on PCs in China is pirated. All told, that’s a collective commercial value of $7.6 billion that software firms are shortchanged. Historically, the piracy rate in China is actually dropping slowly as a raw percentage, but because Chinese citizens are now acquiring PCs in greater numbers, the problem of unlicensed software is still growing rapidly overall.

The U.S. ITC report discusses the topic of “underlicensing,” which occurs when a business installs legitimate software on more computers than is legally permitted under the terms of its license. The report says persuading the business to purchase software licenses through consultation is one approach. End-user piracy “generally is not viewed as a crime in China,” the report notes, but a copyright holder might decide to pursue a civil case.

“Microsoft, for example, won a 2010 civil case against Dazhong Insurance Company,” the report notes. “In that case, a Shanghai court ordered Dazhong to pay $318,000 in damages to Microsoft for use of its approximately 900 unlicensed copies of Windows and office software.” The report adds Microsoft called the case its “biggest legal victory in China.”

Foreign companies are often required to participate in joint ventures with Chinese firms to do business in China, and the tide of high-tech-related trade back and forth between China and the U.S. keeps surging stronger. The US ITR report specifies that “advanced technology products” pertaining to high-tech and intellectually property reached $17 billion from the U.S. to China in 2009, concentrated in aircraft, electronics products, computers and semiconductors. From China to the U.S. last year, that number was $90 billion, mainly in computers and cellular phones.

The report concludes it’s difficult for foreign companies to compete on a level playing field in China. IIPA attorney Schlesinger says what’s fundamentally occurring is a clash between two very different approaches to trade, the more free-market approach the U.S. embraces in contrast to the state-controlled, content-reviewed approach of China’s communist government. “This is absolutely not a free market,” he says.

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Copyright © 2010 IDG Communications, Inc.

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