Will China Scuttle Its Pirates?

American trade officials in Beijing earlier this summer were treated to an unusual bit of street theater. Knowing the officials would be watching, 23 Chinese police and judges garbed in green military uniforms assembled in front of the hotel complex where the U.S. delegation was preparing for talks on intellectual-property rights. Then the posse split off into motorcades and set off on raids on alleged software pirates. "It was like having a mariachi band serenading you below the balcony," says Stephanie Mitchell, vice-president of the U.S. Business Software Alliance (BSA).

But that's not going to be enough to satisfy the Americans. They are gearing up for a crucial round of talks with the Chinese in August. It will be the first since June 30, when the U.S. launched a probe of Chinese intellectual-property abuses that could result in multimillion-dollar trade sanctions against Beijing. Acting in harmony with Washington, U.S. business is joining the fight. In late July, Microsoft, Lotus Development, and Autodesk filed suit in a Beijing court against five retailers that the software companies claim were selling computers loaded with pirated programs. Walt Disney Co. is suing in another case.

ONLY A START. Now that President Clinton has ended the annual debate about China's most-favored-nation trade status, issues such as intellectual property are moving to the top of the U.S.-Chinese trade agenda. And while the Administration has been ineffectual with Japan, the U.S. has some real clout with China. Until Beijing acts, Washington is threatening to withhold support for China's effort to boost its international stature by entering the General Agreement on Tariffs & Trade. As a carrot, the U.S. is holding out the prospect of much higher-profile official contacts.

Raids on retailers of pirated goods are a start. Clinton Administration officials are insisting that China shut dozens of factories that churn out illicit software, videotapes, compact discs, and books--costing U.S. business more than $800 million last year (table).

China does have laws on its books to protect patents and copyrights. But authorities rarely enforce them. In late July, Science and Technology Minister Song Jian vowed the government would do more, including a nationwide crackdown on copyright piracy. That hasn't impressed Washington. "It's a question of political will," says a U.S. trade official. "They have ample resources to find these people and put them in jail."

Some U.S. companies aren't waiting for official action. Singly or through industry trade groups, they are testing the waters of China's newly formed intellectual-property courts. The first such case to come to trial is Disney's suit against a Chinese bookstore, printer, and distributor. Disney acted after it found books in Beijing using Disney characters. Company officials decline to discuss the case. The International Federation of Phonographic Industries has filed three other cases on behalf of music producers. China's CD pirates cost American producers $345 million a year.

But China's judicial system moves slowly at best. The BSA presented evidence of stores selling pirated goods back in March on behalf of Microsoft, Lotus, and other software companies. But it took Chinese authorities four months--and the Administration's threat of sanctions--to respond with sweeps of the target stores. Based on the evidence seized, Microsoft, Lotus, and Autodesk filed their suit. But all the software companies fear that such delays could give suspects time to destroy incriminating evidence.

When foreign companies do win redress in the courts, the resulting fines can be paltry. Microsoft sued state-owned Shenzhen Reflective Materials Institute for trademark infringement in 1991 after determining that the institute had made at least 650,000 fake holograms similar to those Microsoft uses on its packages. Microsoft says those holograms were used on counterfeit software packages sold overseas, at a value of between $20 million and $150 million.

In 1993, the court awarded Microsoft a mere several hundred dollars in damages and fines. The penalties were later raised to $5,000. In an appeal, Microsoft is requesting $20 million. Microsoft has seen several types of its programs copied, including its Excel spreadsheet, one of its biggest sellers. During a visit to China in March, William H. Gates III complained personally to President Jiang Zemin about China's intellectual-property record.

The problem for U.S. companies isn't just that violations of intellectual-property rights in China undermine sales there. As Microsoft discovered, much of the counterfeit production is exported, so it eats into sales from Asia to Latin America. Take music. U.S. officials say 26 CD factories in southern China produce up to 80 million copycat CDs annually, of which around 75 million are exported. "It has just killed our legitimate business in Hong Kong," says Jay Berman, chairman of the Recording Industry Assn.

U.S. trade officials are counting on the threat of sanctions, and the threat of blocking China's entry into GATT, to force it to crack down. "We try to set it up so that they don't have a choice," says an Administration trade official. American negotiators are laying out a step-by-step enforcement regimen similar to get-tough tactics the U.S. has pressed other Asian nations to adopt. The Administration, for example, wants China to form strike teams to stage well-publicized raids and shut down offenders with crippling fines and jail terms.

NO FLOOD. It's a program that has worked in other markets once rife with copyright violations. In the late 1980s, 85% of videocassettes sold in South Korea were pirate versions. But under stiff pressure from the U.S., Seoul has been zealously rooting out counterfeiters.

Even if China closes the pirate factories, no one expects sales of the U.S. originals to flood the market. Americans still face informal quotas and other barriers. Authorities in Beijing say they want to ease those curbs and combat piracy but can't control all the myriad illegal outfits in their sprawling market. Moreover, their power over the booming coastal regions has greatly diminished. "The question is whether the central government can muster the political clout to make the provinces come to heel," says Eric H. Smith, executive director of the International Intellectual Property Alliance.

Indeed, it's no secret who the offenders are. U.S. officials have given Chinese authorities the names, addresses, and telephone numbers of the biggest counterfeiters. The problem, U.S. officials say, is that the Trade Ministry is politically weak--while some of the pirate plants are run by people with ties to the military. Says a U.S. official of one such plant: "We've been told privately by the trade minister that it's untouchable."

The Americans respond that better policing of intellectual-property rights is also good for China. "To be a player in the high-tech arena, China must have more enforcement, stronger laws, and stronger penalties," says David Curtis, associate general counsel at Microsoft. As the American pressure increases, that's a message that Chinese officials will be hearing more often.

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