How to persuade China to trade fairly

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Since its accession to the World Trade Organisation, China has been widely criticised by US and European technology companies for replacing import taxes and customs barriers with new forms of protection. Against this backdrop, Beijing's actions over the past six months might appear positive.

China has stepped back from plans to use technology standards, uneven taxes and government procurement policies in a way that would have restricted the competitiveness of foreign wireless, semiconductor and software makers. But it is too early to assume all will proceed smoothly in China's technology sector.

Although it seems committed to its WTO obligations, Beijing is worried about the relatively low technological level of Chinese manufacturing and is seeking ways to protect its own technology industries. These factors create a pattern of policy making that is likely to define the technology sector in China for several years. The technology industry around the world should prepare for cycles of tough protectionism, foreign reaction and Chinese backtracking.

China first retreated from the use of standards in April. This followed its decision last year to ban the import, manufacture and sale of wireless equipment that did not use China's own security encryption standard - known as the WAPI standard. As only Chinese companies had access to the algorithms needed for the encryption, foreign companies entering the Chinese market would have had to find local partners. Yet many potential partners were also potential competitors, raising fears among foreign companies about the transfer of proprietary knowledge to rivals. The ban would also have imposed higher costs on foreign manufacturers trying to meet the new standard, forcing them to produce one product for China and others for elsewhere. In March, the US administration wrote to the Chinese authorities expressing concern about the ban. A month later, Wu Yi, China's vice-premier, announced the indefinite suspension of the implementation of China's wireless encryption standard.

Beijing stepped further back last month, rescinding a value-added tax rebate on semiconductors for domestic manufacturers after the US threatened to file its first WTO case against China, over VAT. The tax was designed both to foster domestic integrated circuit (IC) production and lure advanced IC producers to the mainland from Taiwan and elsewhere. Some domestic manufacturers received a rebate of all but 3 per cent of the 17 per cent VAT on their locally produced ICs, while Beijing imposed the full 17 per cent VAT on imported ICs unless they were designed in China.

In another welcome move, a Chinese official told Reuters last week that new regulations would require government offices to buy legally produced software rather than pirate it and to favour locally made products. The expectation had been that China's State Council would announce this summer a requirement that a proportion of software bought by government ministries and state-owned companies - as much as 70 per cent, according to some reports - be made by Chinese companies.

As Microsoft, SAP and other foreign companies with research facilities in China can conceivably claim local status, the new regulations signal a shift in the official effort to distinguish between Chinese and foreign software.

The strategy of technology standards and other non-tariff barriers emerges from a fundamental reality of Chinese technology development: China's basic innovative capacity has improved in step with its involvement in the international economy, but Chinese companies remain followers, not leaders, in developing new technologies. Beijing's bureaucrats, fearing that China will remain a low-technology, labour intensive manufacturing workshop to the world, are likely to develop other policies designed to protect the domestic market.

But foreign policy makers and technology executives should not overreact. Consistent pressure will work better than hastily enacted counter tariffs. When push comes to shove, China will choose market-oriented policies over more nationalist attempts to favour domestic companies.

In addition, individual foreign technology companies involved in the Chinese market must maintain a unified front and not try to reach separate side agreements with Beijing. The west cannot avoid conflict over technology issues with China. But, properly handled, these conflicts can help push China further toward more market oriented development.

The writer is a senior fellow in China studies at the Council on Foreign Relations

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