November 13th, 2008

Remedying the trade imbalance with China

Posted by John Carroll @ 9:19 am

Categories: Economic Policy, Intellectual Property, Microsoft

Tags: China, Microsoft Windows, Tools & Techniques, Operating Systems, Software, Management, John Carroll, Henry Paulson, Intellectual Property, Piracy

Microsoft has been grappling with the problem of piracy in China in an unusual way. Over 90% of proprietary software used in China is pirated, and for Microsoft Windows, some estimates put the figure much higher. Microsoft’s recent approach uses public shaming as a tool by which to curb the actions of people who use their software illegally. Most bootleg versions of Windows connect to the normal Windows update site to receive fixes. One of those fixes causes the background of illegal copies of Windows to turn completely black every hour.

The brilliance of this approach is that it doesn’t suddenly deny users the ability to access and use their computer. That would somewhat merit the hue and cry raised by Chinese users in response to Microsoft’s moves, as Microsoft would have denied them access to their own data. It just makes it obvious to everyone else that a particular computer uses pirated software. How well that works depends on a culture’s sensitivity to individual perception by others. I have it on good authority that it wouldn’t matter so much in Mexico, but China is a different story.

Whether the new policy changes piracy levels very much is an open question. Until it does, as Ballmer recently noted:

“China’s not really very important to our business right now. I’d like it to be but it’s not because of the high rate of piracy of intellectual property. We need some IP reform in China for it to be important to our financial results.”

Though the problems faced by Microsoft in China might give its opponents a certain spring in their step, it isn’t a problem confined to Microsoft. Henry Paulson, US Secretary of the Treasury, recently wrote an article for “Foreign Affairs” magazine where he discusses the importance of top-level engagement with China, noting some of the successes achieved thus far. One really can’t disagree with the general thrust of the article. Anyone who thinks we can accomplish anything of global consequence without the input of China has demographics working against them. Ensuring that China’s interests align with those of the rest of the world is one of the single biggest tasks of the next president (which, from a task list standpoint, is starting to look worryingly long;  you must be crazy to want to be president).

America’s trade imbalance with China is a particular bone of contention. Paulson did note that a rather large part of the imbalance is due to the fact that Chinese consumers spend so little of their income, maintaining savings rates of between 30-40%. Combined with America’s lack of a credible savings rate (which can even be negative, depending on how it is measured), it shouldn’t surprise anyone that America runs a large trade deficit with China.

However, a rather large part of the imbalance is due to the modern character of the American economy.  The United States is a nation whose GDP is largely driven by knowledge industries. Knowledge products (the stuff normally covered by copyright) is the category of goods that relies so heavily on copyright. As Paulson explains:

A real issue is the inadequate protection of intellectual propery rights in China, which has been an obstacle to increased US trade with and investment in China and has prevented a reduction in the bilateral trade imbalance. This and the theft or pirating of goods are big problems for many US companies operating in China and a reason others are reluctant to do business there.

Paulson believes China’s self-interest align with better copyright enforcement. A culture of intellectual property protections is a culture that cultivates local knowledge industries:

As China pursues its quest to develop a modern economy focused on technology, the Chinese government and Chinese companies will increasingly recognize the need to reward the creativity of their own firms and entrepreneurs by strengthening and enforcing intellectual property laws and regulations. It is by improving and enforcing its intellectual property laws that China will accelerate the development and competitiveness of its economy and also open up new market opportunities in China for companies around the world.

Clearly, knowledge products need to be priced at levels that citizens in developing markets can afford. There is a large and growing middle class in China, at least in the booming coastal cities, but they are much more resource constrained than citizens in western nations. Prices need to be country-flexible, in other words, which shouldn’t seem jarring to anyone who understands that multi-level pricing is a perfectly normal part of a company’s profit maximization strategy. If you have ever bought cheese in a supermarket (just to cite one inconsequential example), then you have experienced multi-level pricing.

But, something has to change in China’s approach to copyright. Heck, even fans of open source should agree with that. It’s hard to compete on price when the price of your biggest competitor - Windows - is artificially forced close to the price of your products.