Jonathan C. Spierer serves as Chairman/CEO of DistanceVision, Inc., a collaboration technology corporation, and is Principal of OtherVision Strategic Services, a strategy consulting practice. The help of five Harvard summer school students who performed as researchers on work which led to this project is greatly appreciated: Anis Ahmed, Daniella Arredondo, Wei Yeei Emily Lai and Thomas Zolezz.

Intellectual property issues loom large in the international arena. As the world becomes more technology-oriented, it is important to develop laws that reflect this orientation with solid protection for intellectual property rights that will encourage exchange, trade, and some level of international technology transfer. In its entry into the Chinese software market, however, the US software industry reported that up to 98% of the copies of US software products sold in the PRC were unlicensed or "pirated" copies. Rampant piracy of intellectual property in China has undermined foreign confidence in the Chinese market's ability to absorb foreign technology and copyrighted material without cannibalizing it.

The Chinese government has recognized the importance for its long-term growth of protecting foreign investments in intellectual property and has developed copyright laws modeled on international standards as a first step towards effective protection of intellectual property rights (IPR). On their face, China's laws meet or exceed the standards of the principal international IPR treaties. The implementation of these laws has proven lacking, due largely to ambiguities in the law and difficulties in enforcement. Market factors such as a the lack of an established domestic software industry, Chinese cultural biases, low public awareness of intellectual property issues, and deficiencies in China's education system have also encouraged high rates of software piracy. Nonetheless, other market factors and recent Chinese court decisions suggest prospects for improvement in Chinese intellectual property protections in the long run. Given these circumstances, it may be a good time for large software companies to establish themselves in the Chinese market through relations with domestic partners and infrastructure-based projects. However, smaller companies that depend heavily on one product which can be easily duplicated should typically wait until more fully-enforced IPR protection of knowledge, trademark and invention is present before entering the Chinese market.

Intellectual Property Rights Law in China

International Agreements

China has patterned its IPR laws on international treaties: the Berne Convention and the World Trade Organization's 1995 Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) Agreement. The Berne Convention for the Protection of Literary and Artistic Works (Berne Convention) requires signatories to provide protection, under law, for works of foreign nationals that is at least equal to the standard guaranteed to national citizens. In signing the Berne Convention in 1992, China pledged to develop more stringent intellectual property protections and to assure foreign intellectual property rights holders equal treatment under those laws.

In January 1992, China and the US signed a Memorandum of Understanding (MOU) on key intellectual property matters. Further exchanges in 1994 helped avert the imposition of US trade sanctions against China. In the late 1980s and early 1990s, the US threatened to effectively close US markets to Chinese imports through Section 301 tariffs. From 1984 to 1994, annual Chinese imports from the US rose from US$3 billion to US$8.8 billion while exports to the US rose from US$3.1 billion to almost US$38 billion. In 1995, facing the prospect of more court decisions that were solid in judgment but lacking adequate penalties,US Trade Representative Mickey Kantor threatened 100% tariffs on US$1.08 billion of Chinese exports to the US. The penalties were in retaliation for the US$1.1 billion in sales that U.S. companies claim to lose to Chinese piracy annually. The tariffs imposed under the US Trade Act's Special 301 provision would have been the largest in history. In response, the Chinese government in 1994 enacted stronger IPR enforcement laws and raided pirating factories as a display of its intentions to improve intellectual property rights in China.

As a further display of good faith, the PRC might soon sign the Agreement of Trade-Related Aspects of Intellectual Property Rights (TRIPs Agreement). This agreement prescribes minimum national standards of IPR laws/protection, enforcement standards, and a binding dispute settlement process. Were China to become a Member of the World Trade Organization, it would need to phase these provisions into enforcement. China largely sees signing on to TRIPS as a necessary step towards becoming a member of the WTO, which would open markets and remove the threat of future United States trade sanctions.

Chinese National Law

Similar to the United States, the PRC has chosen to protect software under copyright law rather than trade secrets, patent, or contract law. The 1990 PRC copyright law, developed with assistance from the World Intellectual Property Organization (WIPO), legal experts, and business consultants, provided for the following: protection of copyright-related interests of literary, artistic and scientific works (akin to the Berne objectives); encouragement of works that promote the development of socialism in its material or spiritual values; and promotion of the development of the scientific aspect of the socialist state (a basic reason for enacting the law in the first place). During this time, foreigners were required to comply with the "first published in the PRC" rule; works would not be protected if first published abroad, except by special bilateral or multilateral treaties.

In 1991, China's first software-specific law, the "Computer Software Protection Rules," established principal rights for software authors. Software, defined as "the computer and the supporting files," was protected in its direct form, while exercises leading to development of the code, including mental exercises, concepts and algorithms, were excluded. Software authors enjoyed the right to publish their work (including the choice of whether or not to publish the author's name), the right of acknowledgment, and rights of sale, usage, licensing, and assignment. These rights could be exercised for a period of twenty-five yearsmore than adequate when software has an average commercial life cycle of far less than five years. Also, new "work of a foreigner" provisions afforded protection to foreigners equal to that given to domestic firms (under the Berne Treaty). Finally, it was specified that a written contract was required for joint venture development.

China's National Copyright Administration, under the Ministry of News and Publication, is responsible for the implementation of copyright laws, investigation of infringement cases, administration of external copyright relations and guidance for local authorities. The People's Courts hear complaints, make decisions and recommend penalties. Possible penalties (specified in Article 51 of the 1991 law) include fines of RMB 10,000 to RMB 100,000, civil damages equivalent to two to five times the value of the infringing copies, and two to seven years of prison depending on the specific case. The second of these penalties is more in line with international standards, allowing both for recovery of real damages and for deterrence.

Legal Implementation: Issues and Problems of Enforcement in China

Ambiguities Within the Law

Though intended to protect intellectual property rights, the Computer Software Protection Regulations and the Copyright Law contain ambiguities which, in some contexts, might be as harmful to foreign investors as the lack of legislation. The Chinese government can easily broaden its discretionary powers under ambiguous provisions of the law. One important ambiguity is the "knowingly" standard in Article 32 of the Computer Software Protection Regulations, which states:

Where the holder of software does not know or has no reasonable grounds for knowing that the software is infringing (upon an existing copyright), liability for infringement shall be borne by the supplier of the infringing software

This could become a major loophole, as any user could falsely claim that she was unaware of infringement of other copyrighted products. This is not in accord with the strict liability provisions of international standards; under Chinese law, ignorance of infringement is a defense.

Another dangerous provision permits production of a small number of copies of copyrighted material for "non-commercial objectives." The "non-commercial objectives" explicitly listed include classroom instruction, scientific research, and conduct of official duties by state agencies. It is important to note that the authors are not entitled to remuneration for such copies, and the term "non-commercial objectives" might as well be manipulated by the parties as well as by government officials to encompass a very wide variety of purposes.

The Copyright Law stipulates that works "banned from publication" shall receive no copyright protection, but does not clearly define "banned" works. As a result the government might ban publications after the fact to suit its particular needs. If banned by the government for "public interest," a large black market could result for works legal else where in the world but illegal in China.

Finally, Article 31 of the Rules permits the government to exempt certain software products from liability for any copyright infringements if the software is developed to implement relevant "state policies, laws, rules, and regulations." This rule could unfairly be used by the government to obtain source code or programs for its own use.

Enforcement of the Law

The civil penalties, however explicit in the letter of the law, are not enforced in actual practice. Although criminal penalties have been introduced, sentences vary between vaguely-defined grades of infringement. For example, "huge amounts" of illegal income, "especially serious" circumstances or "relatively large amounts" of illegal income are factors that distinguish between small violations and large illicit operations. Naturally, this vague language has discouraged foreign firms from pursuing criminal proceedings. Further, the introduction of criminal penalties has not resulted in any noticeable deterrent effect because the People's Procuratorate has been unwilling to prosecute IP-related criminal activity.

Difficulties with Administration of the Laws

Given China's vast geography and population, it would be an awesome task for the central government to police pirating activities throughout the entire country. Therefore, as in the United States, intellec tual property laws are chiefly enforced at the local level. In 1993, the Chinese government established special courts in the major cities China specifically handle intellectual property cases. Divisions have been set up in provincial and municipal courts throughout the country to adjudicate intellectual property disputes. Since then, some twenty other specialized courts have been set up throughout China. Although this is a step towards the provision of a proper system of protection for copyrighted material, implementation of such measures is still inconsistent and inefficient. However, due to lack of resources, the lack of judicial expertise, and the unpredictability of trial outcomes, litigation in Chinese courts remains a risky and expensive response to Chinese copyright violations.

Another administrative difficulty arises from the increasing decentralization of the Chinese government. Much of China's copyright enforcement takes place at the provincial and local levels; the national government lacks the resources and control to effectively monitor nationwide pirating activity and to impose national enforcement policies.

Investigation of infringement cases is difficult, as details of the suspected companies are often hard to trace. Other shortcomings such as poor telecommunications, inadequate infrastructure and the sheer size of the country compound the investigators' problems. Furthermore, the counterfeit goods may not necessarily be located at specific sites it is not uncommon for pirated material to be moved around several areas ("mobile stores," often located in a peddler's suitcase) in attempts to stay one step ahead of the enforcement officials. The National Copyright Administration in China, the body responsible for nationwide enforcement, is severely under-funded and understaffed; it reportedly employs as few as five members to tackle the task. It has also been reported that, in an effort to pursue enforcement actions, some rights holders are compelled to help subsidize transportation and other enforcement expenses.

Factors Affecting Software Piracy in China

Several market factors exacerbate the software piracy problem in China. First, the Chinese software industry remains in its infancy, which explains the low level of resistance from local manufacturers to the high levels of piracy. Nonetheless, it is recognized that continued piracy would only harm the development of software in China., and there are increasing signs that piracy is not limited to foreign-produced software. The Business Software Alliance, a software piracy watchdog group comprising leading American software firms, has reported that Chinese officials recently seized 700 illegal CD-ROMs in a series of raids, both Chinese and American-made. The Chinese computer industry grew 56 percent in 1996 and is expected to have grown another 50 percent in 1997 and 1998 according to China's Ministry of Electronics Industry. The domestic packaged software industry is valued at US$1-1.5 billion and is growing at 32 percent per annum. As violation (and resulting losses to Chinese rights-holders) of Chinese IPR increases, so will domestic pressure for better IPR protections.

The widespread disregard of intellectual property rights can also be partly attributed to historical factors, events and cultural characteristics. Chinese culture has long emphasized learning by copying in all aspects of life; the emulation of works of almost any kind has for centuries been regarded as honorable and necessary. Under the traditional Chinese education system, attainment of the highest academic qualification was demonstrated by faultless reproduction of the classical works of the past. These principles strongly influence contemporary education in China. In the environment where children are taught "right" and "wrong" answers as opposed to creative problem solving, it often follows that originality is not prized and "copying" is widespread. Finally, public awareness is a major obstacle; the idea of intellectual property, active before the Cultural Revolution, has only resurfaced recently.

Another major factor is the ease of consumer access to counterfeited computer software. It is simple for private consumers or business users to locate vendors of pirated computer software. Further, products of major software brands, such as Microsoft and Lotus, are available for a fraction of the price of licensed copiessometimes for as little as 1% of the legitimate price. Export consumers further expand the demand for pirated software. Without the need to obtain licenses to sell pirated copies, many vendors can accumulate a vast stock of pirated software. Some pirated products include modifications or improvements on the original copies to tailor to the needs of Chinese and other people.

The involvement of corrupt officials also contributes to high levels of software piracy in China. American trade officials estimated that there are over twenty plants in China producing as many as seventy-five million pirated CDs per year, and that many of these plants are state-owned. These counterfeiting operations are usually owned or run by Chinese businessmen who are well connected to the local officials who are, ironically, also responsible for monitoring pirating activities. 

Judicial Decisions Affecting Markets

Following the enactment of new laws, Chinese courts and enforcement authorities have increasingly acted to enforce intellectual property rightincluding the rights of foreigners. These actions show promise for more effective IPR protection in the future.

In March 1992, Chinese authorities raided the Shenzhen Reflective Materials Institute, and found 650,000 Microsoft holograms for use in pirated copies of Microsoft software. By October 1993, the Chinese authorities determined that the Institute had infringed on Microsoft's trademark and fined the institute US$260 under China's strengthened laws. Microsoft estimated its losses at US$20 million. Finally, in August of 1993, China set up Intellectual Property Trial Chambers in the Beijing Intermediate People's Court.

In 1995, Chinese judicial courts heard 3,395 intellectual property cases, resolving 3,344 of these cases. During the first ten months of 1995, the government investigated 42,000 cases and seized hundreds of thousands of pirated items. In a landmark verdict on April 16, 1996 against Beijing Ju Ren Computer, the Beijing No.1 Intermediate Court delivered judgment in favor of the Business Software Alliance (BSA) upholding the plaintiffs' intellectual property rights and ordering the defendant to (1) publicly apologize to the plaintiff, (2) pay over RMB600,000 (US$70,000) in damages, including court costs and accounting costs, and (3) pay additional fines directly to the court. The court also ordered the defendant to undertake not to infringe intellectual property rights in the future, and the law enforcement officials to confiscate all computers and software seized during the raid on the defendant's premises. In another case, the same court rendered a judgment against Beijing Giant Computer Co. for software copyright infringement. These were the first cases decided in favor of a US plaintiff in a Chinese court.

Market Trends

The Chinese government took these steps to protect intellectual property for various reasons. First, China faced the threat of trade sanctions had agreement with the US in stopping piracy not been reached. Secondly, in the Chinese markets, fake and counterfeit products are sold openly and inexpensively. This, ultimately, hurts Chinese industry as well. Many customers purchase counterfeit goods at cheap prices with the intention of getting refunds from distributors of licensed goods for full value. Accordingly, shop owners face substantial losses when paying refunds for returned fake items, and the government also loses revenue.

Third, even legitimate business suffers under these conditions. Customers become confused about the origin of all goods, impairing sales of licensed products. This confusion prevents consumers from becoming more educated about the market regarding quality of goods and relationships of companies with those goods. This perceived loss of distinctiveness between products also creates a disincentive to Chinese citizens and Chinese firms from inventing new products, since even if they are success it is still more difficult to differentiate in the market or obtain market share.

Further, more generally, software is a key industry for China and the rest of the world both for prestige and current/future market opportunity. Software controls the world's key commercial, government and consumer electronic systems, bringing professional prestige to those developing the newest important commercial concepts. To the bottom line, according to International Data Corporation (IDC), packaged software was an approximately US$135 Billion global industry in 1998 (growing 14% through 2002), while the global IT products/services industry reached nearly US$800 Billion (growing nearly 10% through 2002). Many software moguls have classified China as "perhaps the world's most interesting market." As one of the world's largest countries both in terms of economy and population, it is not only a large purchasing market but also a large potential labor and entrepreneurial market for software development and service. Ultimately, as Chinese software pirates undercut international and domestic capabilities, China is robbed of its opportunity to play a significant role in developing capable products and people in this critical industry.

Industry Prospectus and Conclusion

The enactment and actual enforcement of new IPR laws and public embarrassment of pirating manufacturers suggests that there is a future for the software industry in China. Several of China's top universities, including Qinghua University in Beijing, have patent departments. The Chinese government has recognized that to encourage technology transfer, there must be protection for technology. "The rapid development of China's own software industry depends upon full protection for software producers under the law." According to Stephanie Mitchell, Vice President of the BSA, "The fact is, piracy is a form of stealing that hurts China and Chinese software producers as much as it hurts their foreign counterparts."

The waters among giants have always been perilous for smaller firms, and the software industry is no exception. In the United States, for example, larger software firms have typically dominated the largest categories (like basic infrastructure), and it has been challenging for smaller firms to bring capacity and talent to cover such enormous overall large categories. However, smaller firms have successfully developed niche markets in many areas or special advanced technologies, and their leadership in these areas was supported by ownership (short-term or long-term) of the invented product, technology and brand name. This ownership, leading to growth and profitability, has justified the company and its shareholders spending the time, effort and money for development. This ownership is protected by copyright/patent (for software products), trademark (for brand name) or patent (for specific technologies or inventions).

Smaller firms may be able to find creative service-based methods for entering the Chinese market, though it would certainly need to be a long-term investment. Over time, as China develops credible protections for intellectual property rights and begins penalizing violators, smaller foreign and domestic Chinese companies will be able to justify developing and promoting better products and services in the Chinese market.

In China's current software market climate, only larger firms such as Microsoft can enter on a major scale because they can afford to reap long term rewards (such as developing infrastructure and promoting standards) and secure a future presence while absorbing piracy-losses and other sacrifices. Setting standards and creating familiarity within a market often develops a future user bias: current users of software, whether pirated or not, will become accustomed to the larger firms' product features. As the products develop, the early entrants will have an educated and familiar public ready to buy their products.

The position of strength gained by market entrants is also changing due to industry shifts, including increased internet usage and related changes in legal and commercial practices. Programs (or, at minimum, upgrades) are now frequently distributed through "virtual" methods (from a distance over the Internet and through other alternatives to sales of physical CD-ROMs) because it brings lower costs of distribution to software inventors/manufacturers, while also giving these manufacturers more direct contact with the customer. By IDC estimates, worldwide software license and product distribution was achieved through electronic or online methods only 5-10% of the time in 1998, but it will become the preferred methodology in 2002-3 and will be utilized in nearly every case by 2008. This could effectively eliminate the "alleyway CD pirate," since the same software can be obtained more conveniently and cheaply over the Internet. As a result of this and other factors, firms that deal with these issues regularly explained that some of their IPR protection emphasis has moved from copyright to basic trademark laws to protect branded software and related products. Further, virtual distribution will put pressure on distributors in the markets to develop value-added services that will require the businesses or consumers to seek products offline. This trend toward value-added services supports increasing emphasis on technology services. Although most software revenue in the past has been generated by sales of software (on diskettes and CDs), software-related services, such as consulting, customization and support, are increasingly important sources of earnings.

Another method of differentiation for physical entrants such as major software developers is investment in China's software "market infrastructure." Microsoft invests heavily in such projects as Guangdong Education and Research Network, and the China Education and Research Network has donated hundreds of NT servers, MS Chinese Office and Windows 95 packages to Chinese organizations. Microsoft has also invested in four training centers in Beijing, Shanghai and Guangzhou, and has decided to make it easier for original equipment manufacturers to license the MS operating system software. These measures have helped consolidate the positions of MS DOS and MS Windows as the preferred operating systems.

Leaders enforcing both national and regional Chinese laws would be well-served by asking themselves what is more important for China's future: a pirating industry capable of stealing and undercutting other firms' innovations or a legitimate software industry capable of competing on an international level? As laws are better enforced to curb pirating and protect IPR, more opportunity will be provided for software product and person development. This will encourage Chinese and international firms of all sizes to benefit from the large market. Growth in industry in and importance of the US market allowed the United States to reform from the copyright offender it was to, as we witness today, a leading force for developing world standards of IPR protection. This is best accomplished for software and related areas through a level playing field that excludes pirates through means such as improved formal and informal protections embedded with well-enforced IPR protections.

Credits

Forney, Matt. "Now We Get It: Foreigners Aren't the Only Ones Railing about Copyright Theft in China: A Growing Class of Creative Chinese is Singing the Same Tune." Far Eastern Economic Review. February 15, 1996.

Kelly Inglis-San, Linda L. Laureate, Clement Au-Yeung and Tina M. Frow. Intellectual Property Protection in China. The Law. Asia Law and Practice, Hong Kong, 1996.

Lam, Philip H. "Copyright Protection of Foreign Computer Software in the People's Republic of China: Significant Progress in Two Years." Loy. LA Int'l & Comp. Volume 14, No.4, October 1995.

Wingrove, N. "China Traditions Oppose War on IP Piracy." Research - Technology Management. Vol. 38, No. 3. May 1995.