Browsing the blog archives for July, 2016.

Intellectual Property in China

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I’ve been discussing the free/fair trade debate in the last two blog posts. In this one I turn to the issue of intellectual property (IP) in China.

Microsoft in the classic example. Most computers run on Windows and use Office. In the US and most western nations you’ll pay to use this intellectual property. In countries like China, most do not. On paper, Chinese law protects intellectual property rights, but enforcement is spotty at best, and many Chinese simply don’t see it as a serious problem. Estimates of Microsoft losses in China are all over the board, with $60 billion as a good guess. These estimates might be inflated because they assume that all Chinese users of Microsoft products would have paid for them if pirated versions were not available. $20 billion is a conservative bottom line loss, and that’s a lot for one firm.

The Intellectual Property Commission Report estimates the total annual IP-related losses for US firms in Asia to be around $300 billion, about the same amount that US firms export to the continent. The report (http://www.ipcommission.org/report/ip_commission_report_052213.pdf) is worth reading if you have some time, as it chronicles the various problems, from patent and trademark violations to piracy and copyright infringement. The takeaway point is that IP is a very serious problem, especially in China.

There are two primary reasons why IP law is so difficult to enforce in China. First, the nation lacks the infrastructure and incentives to prosecute offenders. China has improved in this regard during the past two decades, but it’s got a long way to go.

Second, IP in China and the US is viewed very differently. Historically, Americans have championed creativity and individuality. But as a collective society, the Chinese tend to place less value on individual innovation; in their view, new ideas aren’t as important as production. Put another way, many Chinese see the value of an iPhone primarily in its production and distribution, not in its conception and original design. Hence, IP is largely a collective entity. It’s no secret that Chinese companies tend to focus on mimicking innovative global competitors, but with a lower cost structure.

I once discussed the IP problem with a group of undergraduates in Beijing and most of them just didn’t understand why I thought it was a serious issue. Why should you be concerned if millions of Chinese are using pirated copies of Windows and Word, they asked? These users wouldn’t be able to afford to pay for it anyway. Of course, if Microsoft pirates could be required to pay for the product in order to use it, many would find a way to do so, increasing the size of the market and driving down the price. I explained that innovation occurs because of property rights and incentives, but in the end most of the students were okay with Westerners sorting that out, leaving Chinese firms to use and reuse global technology as they wish.

While it’s unrealistic to eliminate IP theft in any country, but the Chinese government must develop the infrastructure necessary to enforce international standards. If they don’t, innovative Western firms must continue to overcharge for their new products to cover developmental costs while many Chinese firms and consumers get a free ride. Nobody in China has an incentive to do this without international pressure, which is why insisting on real action is so important.

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Manipulating the Currency

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Recently I’ve been asked if and how I can support Donald Trump when he appears to be opposed to free trade. My last post introduced some of the most important facets of free/fair trade. I will expand on one of them—currency manipulation—in this post.

Ten years ago, the exchange rate between the US dollar and the Chinese yuan (also called RMB) was about 8 RMB per dollar (see http://www.xe.com/currencycharts/?from=USD&to=CNY&view=10Y). Today, the rate is about 6.7 RMB per dollar. All other factors held constant, a product made in China and worth 800 RMB would have sold for $100 ten years ago, but would now sell for $119—a 19% increase—due to the strengthening of the yuan relative to the dollar.

From the Chinese perspective, this means that a $100 product sold in China would have cost about 800 RMB ten years ago, but would only cost 670 RMB today. In other words, the dollar as weakened relative to the RMB, resulting in an overall price reduction of 16%.

A weaker dollar is good for US companies but bad for US consumers. US producers will be able to sell products in China at lower prices in terms of their currency, while US consumers will have to pay more for Chinese products. Conversely, a stronger dollar is bad for US companies but good for US consumers, because it raises the price of American products abroad and reduces the price of Chinese products in the US.

So what is the problem with the Chinese currency? Exchange rates among major world currencies fluctuate naturally with their economies. However, the Chinese government pegs the value of the RMB to the US dollar, allowing only minor fluctuations except when central planners decide to make or allow more significant changes. In other words, the Chinese government can adjust the relative prices of its products in US markets by maintaining an artificial exchange rate. Historically, the Chinese have undercut US firms by keeping the RMB artificially weak. They sought to strengthen the RMB as Chinese industries strengthen and their companies are able to command higher prices abroad.

Chinese leaders claim that this controlled exchange is only temporary while Chinese firms “catch up” with more established global competitors. Moreover, some economists contend that maintaining a weak RMB isn’t really a problem for the US because it allows Americans to purchase products at lower prices. While this is true, it puts our companies at a competitive disadvantage and also creates long-term problems as some industries (electronics, for example) become dominated by Chinese manufacturers. Given that many Chinese manufacturers are government-subsidized and Chinese central planners can manipulate the currency at any time, their firms will maintain a decided global advantage.

Some economists claim that a free floating exchange rate—if permitted by Chinese authorities—would be about the same as the current controlled rate anyway. If this were true, then the Chinese would have already stopped pegging the RMB exchange rate to the dollar. It’s difficult to calculate what the free floating exchange rate would be between the dollar and the RMB, but I’m convinced the RMB would be stronger (less than the current 6.7 per dollar), which would be a boon for American firms.

US leaders have given lip service to this issue in the past, but all of them have been afraid to seriously confront the Chinese. Perhaps they fear a “trade war” if we push too hard. Nonetheless, Trump is right to argue that this is an issue that must be negotiated. To be free and fair, governments should not interfere in currency exchange markets. The prosperity of US firms lies in the balance.

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