The China Challenge

By John Paul Quinn

China’s immense size and its history as a closed society have made it the subject of a number of urban legends and fanciful speculations. However, there are some current, verifiable statistics about China that should be believed—they are about counterfeiting and intellectual property rights (IPR), and they’re alarming.

According to U.S. Customs and Border Protection (CBP), China—out of all U.S. trading partners—accounted for 85 percent of the total value of counterfeit products seized, valued at $96.7 million at midyear 2008. This was up 9 percent from a year ago.

CBP also notes that overall, consumer electronics/electrical articles represent 9 percent of the total value, or $9.7 million. And 11 percent of the safety and security hazard seizures were electrical/¬electronic goods, valued at $2.8 million. The report further notes that almost 90 percent of seizures that pose a safety and security risk to the United States were of Chinese origin.

“China remains a special challenge for us,” said Wayne Paugh, who heads an interagency task force called the National Intellectual Property Law Enforcement Coordination Council (NIPLECC).

“Last year, the U.S. filed two World Trade Organization (WTO) cases against China for violations of their obligations as a permanent WTO member,” he said. “One involved impeding market access, the other IPR violations. As we proceeded with the litigation, our negotiations on trade issues with the Chinese broke down at the leadership level, with little being accomplished. Recently, we have re-engaged with them, but this is symptomatic of the nature of this issue.”

Many believe the situation will only deteriorate because too many politicians around the world have held back too long on taking aggressive actions to effectively combat Chinese counterfeiting.

Speaking off the record at an intellectual property rights conference in Brussels earlier this year, a leading official of the anti-counterfeit section of the World Customs Organization (WCO) made a sobering observation.

“It would be a bit naive to expect China to do anything serious about counterfeiting when some 30 percent of its citizens are involved in making products that are questionable from the IPR standpoint,” he said. Do the math.

A worsening situation

The consensus in the European Union (EU) and the United States is that the China situation continues to get worse. This is especially frustrating in Europe, where the EU is currently involved in a 15 million-euro three-year project to train judges and prosecutors in China on IP protection law. The EU is contributing 12 million euros; China is paying 3 million euros.

But some observers are guardedly optimistic that things may begin to improve.

“IP laws are in place in China,” said Candice Li, external relations manager for anti-counterfeiting at the International Trademark Association (INTA) in New York. “But prosecution and enforcement are hindered by the size of the country and the rapid growth of the economy. We believe that, overall, the Chinese government is opposed to counterfeiting and is trying to cooperate and engage the problem.”

The argument for possible gradual improvement is based on the belief that the global economy may, to some extent, curtail the proliferation of counterfeiting in China.

As the country’s economy continues to expand, there is a likelihood of ongoing rising inflation that will not be limited to legitimate trade.

As counterfeiters see their costs rising, they may weigh the risks involved in pursuing their clandestine operations.

Reportedly, the Chinese government has already started to feel pressure from its own manufacturers, who are also being victimized by fakes.

Couple this with the arguments by the WTO and other international bodies that protecting IPR is a prerequisite for attracting foreign investment capital, and enlightened commercial self-interest may gradually kick in.

Political priorities

Others are less sanguine about any consistent improvement in China.

“China could do more if they wanted to,” said David Dossett, chief executive of the British Electrotechnical and Allied Manufacturers’ Association (BEAMA), based in London. “The problem is that they tend to shift their priorities and juggle their varying and political and economic interests, so at times they’re tacitly pro-counterfeiting and at times con.

“At this time, the Chinese authorities are very good if we take them evidence that a factory is making counterfeits. They’re efficient and helpful and raid the location and seize the products. But they’re not allowed to be proactive and do their own investigation and close an operation down of their own accord.”

BEAMA has been engaged in anti-counterfeiting activities in China since 2001. Working with local authorities, it has focused annually on two areas: Wenzhou, the country’s electrical manufacturing center, and the Canton Fair, where association members hit the purveyors of counterfeit articles.

The Canton Fair operators learned from experience and went undercover, so BEAMA shifted its attention this year to another exhibition at Yiwu, a massive distribution and consolidation center for both domestic and overseas markets, where export shipments are containerized.

The move produced impressive results. In the six months from April to September of 2008, BEAMA seizures doubled over those of 2007, with 850,000 products valued at 1 million euros confiscated.

Counterfeit hub

Individual manufacturers tracking the China scene continue to be skeptical.

“I don’t see any improvement near-term in controlling the amount of Chinese counterfeit products entering world markets,” said Kevin Harris, international policy manager, Eaton Corp. “And I’m embarrassed because it seems that trade associations are taking more action than national governments, or WTO or WCO.

“Most observers agree that China is the hub of counterfeit manufacturing, but there doesn’t seem to be any coordinated political strategy to stop this. Aside from associations like BEAMA taking a stand, we don’t see any action being taken without our industry involvement.

“Many of the sites raided in BEAMA’s operations in southeast China are factories without names, unlicensed, operating illegally, and apparently previously unknown to the authorities,” he said.

In Eaton’s experience, there has been little penetration of its U.K. market by Chinese knockoffs of its products. The real threat lies in these products being introduced into the company’s export markets in Africa, the Middle East and Asia, where the company’s brand name, and those of many of its major competitors, could be seriously compromised if this situation is not controlled.

“There may be IP laws in place in China,” Harris said, “but the real issue has to do with the low level of enforcement and the lack of political will to ensure that there will be serious deterrent penalties to discourage counterfeiting.”

Meeting the challenge

Meanwhile, in the United States, manufacturers have had some heartening successes in facing up to the challenge of Chinese counterfeits.

Probably the highest profile and most successful anti-counterfeit litigation in the electrical equipment industry that has taken place in the United States has been a series of lawsuits instituted by Schneider Electric/Square D, Palatine, Ill., involving the company’s line of circuit breakers, and the back trail led to China.

According to Brian Lewis, outside counsel for Square D at Wildman Harrold in Chicago, who prosecuted these cases, in the course of the U.S. litigation and two raids conducted in China, a network of 33 unauthorized manufacturers, importers, and distributors was uncovered, more than 250,000 counterfeit products were seized or quarantined, and approximately 300,000 products are under recall by order of the Consumer Product Safety Commission.

“In one facility that was raided, with the assistance of the Chinese authorities, some 19,000 counterfeit breakers were seized, knockoffs of both Square D and other U.S. brands,” said Stephen Litchfield, assistant general counsel, Schneider Electric/Square D. “In the investigators’ opinion, this plant was geared up to manufacture 3 million pieces a year and had been in operation since 2004, meaning that before they were shut down they could have generated 9 million pieces of counterfeit and highly dangerous product.”

But the evidence continues to point to unabated production of counterfeit electrical/electronic products in China.

“Last year, we participated in a NEMA survey which covered many of the products we manufacture and sell,” said Dave Griffith, electrical distribution channel manager, GE Consumer and Industrial U. C. Division, Nela Park, Ohio. “This included lamps, power distribution products, motors, switchgear, relays and circuit breakers. If you tallied up our competitors’ and our input, it was estimated that 90 percent of all the counterfeits of these products entering the supply chain comes from China.”

Griffith also advises manufacturers to be careful with what lines they choose to produce in countries with a counterfeiting reputation, because that represents an ideal opportunity for reverse-engineering and copycatting.

In this ongoing confrontation, the Chinese government apparently perceives that its importance as a pre-eminent and sought-after emerging market will limit international sanctions against it, and other governments will constantly be reluctant to take a strong stance against them on an individual basis.

“The bottom line is that this is not a manufacturer problem, and it’s not an electrical industry problem. It’s the China problem,” Lewis said. “This is a multibillion-dollar industry for that country, and it has been established that this involves automotive, aviation, electrical and electronic, drug and food products.

“Until the United States and the European Union and other global bodies become more aggressive, it’s up to all of us in our industry associations and in our individual companies to be proactive in this anti-counterfeiting fight,” Lewis said.

QUINN reports on a wide range of business topics for journals in the United States and Europe. He can be reached at 203.323.9850 or at mirabel@snet.net.

Counterfits Can Kill