China: The Benefits of Software IPR Protection In China

Last Updated: 23 January 2012
Article by Joe Tsang and Steve Lo

Introduction

While the use of unlicensed software in China has fallen in recent years, and is expected to continue decreasing in the near future, the situation remains a focus in China. In recent years, Chinese legislators have made advances in the protection of software intellectual property rights (IPR). However, infringements of software IPR can be further reduced if greater software IPR protection were available.

This paper looks into the economic and non-economic benefits that developing countries, such as China, can experience from an increase in software IPR protection. In comparison to China's GDP, economic impacts from increased software IPR protection may be deemed relatively minor. However, China can potentially benefit from the resultant non-economic benefits.

In addition to increasing software IPR protection, other avenues can also be explored in order to derive these economic and non-economic benefits. This paper gives an overview into these avenues as well.

1.An overview of IPR protection in China

In a bid to adopt an "Open Door" policy to welcome foreign businesses in the late 1970s, China's market economic system and reformed legal framework gave rise to China's new responsibility of increasing intellectual property protection. China gradually increased its IPR protection by joining international IPR treaties such as the World Intellectual Property Organization (WIPO) Convention, Paris Convention for the Protection of Industry Property and the Berne Convention for the Protection of Literary and Artistic Works.

In 2001, China was accepted as a member of the World Trade Organisation (WTO) and by virtue of its membership, accepted the responsibility to adhere to the Trade Related Aspects of Intellectual Property Rights (TRIPS) Agreement dictated by the WTO.

To ensure that a coordinated and efficient system is in place to protect IPR in China, a variety of entities are involved in fighting IPR infringement, including the People's Court and the various governmental administrative authorities. These entities primarily include the following:

  • State Intellectual Property Office
  • State Administration for Industry and Commerce
  • National Copyright Administration
  • Ministry of Industry and Information Technology
  • General Administration of Customs
  • Supreme People's Court and Supreme People's Procuratorate
  • Administration for Quality Supervision, Inspection and Quarantine

To date, China's current IPR legal framework consists of three laws: the Patent Law, the Trademark Law and the Copyright Law. These are complemented and supplemented by related regulations, judiciary interpretations, administrative measures, and local regulations or measures.

Enforcement of any form of IPR in China can be undertaken by way of the administrative enforcement procedure or judicial procedure. Under the administrative enforcement procedure, the IPR owner files a complaint at a local administrative agency. Even though they cannot award compensation to the IPR holder, administrative agencies have the authority to issue penalties, fines and injunctions. Under the judicial enforcement procedure, legal proceedings are initiated at courts where possible compensation and damages may be awarded to the IPR owner. The judicial enforcement procedure supports both civil and criminal approaches, with the criminal procedure focused largely on channel infringements 2 (vs. end-user infringements) to date.

The administrative enforcement procedure has been more widely employed as it provides an effective yet inexpensive method for adjudicating IPR disputes. However, even with efforts working towards more enhanced IPR protection in China, enforcement remains a challenge. There are factors that may contribute to the challenge, such as:

  • a need for further resources to control and monitor nationwide IPR violations, as well as to impose enforcement policies
  • costs incurred to fund and train IPR experts and judicial expertise

In addition, investigation of infringement cases can require a great deal of effort, as details of the suspected companies are often hard to track due to China being a sizable country with a large number of companies.

Despite China's growing efforts to increase IPR protection through its legal system, IPR owners can at times encounter perceived variation between the quality of the laws and the outcome of the enforcement of the laws. As a result, IPR infringement remains a focus in China across a range of industries, such as consumer goods, entertainment, pharmaceuticals and software.

In this paper, we focus on the economic benefits that would be expected from reducing IPR infringements in the software industry in China. We aim to address the following questions around the impact of improving software IPR protection in China:

  • Why do software users continue to use unlicensed software?
  • How does insufficient software IPR protection affect a country?
  • What economic benefits would result from further improving software IPR protection?
  • How useful are the other benefits that result from improvements in software IPR protection?
  • Aside from improvements in software IPR protection, what avenues can be explored in order to derive these benefits

2. China's situation, and types of software IPR infringements

While the software IPR infringement rate remains a focus in China, it has shown a marked improvement over the last five years. The historical software IPR infringement rates as defined by the Business Software Alliance (BSA) and Chinalabs can be seen in Figure 3.

The BSA and Chinalabs figures are fairly different due to the derivation methodologies employed by the respective organizations. BSA commissions IDC, a market intelligence company, to perform annual surveys on unlicensed software usage on personal computers (PC) in China. The BSA-commissioned surveys focus on all packaged software products running on PCs, but do not include other forms of software, e.g., those running on servers or mainframes. These survey results are then used to determine the software IPR infringement rate . Chinalabs derives its figures from the results of sample surveys commissioned by the State Intellectual Property Office (SIPO) and takes into account PC software, embedded software, software services and software exports.

While the software IPR infringement rates reported by BSA and Chinalabs are different, the important point to note is that both organizations agree that software IPR infringement has seen some reduction in China over the past five years.

The table below presents a list of the various types of software IPR infringement, in no particular order.

In general, internet download and software counterfeiting are the most common forms of software IPR infringements found in China. With the proliferation of download sites hosting unlicensed software, the anticipated increase in internet access speeds and the increase in the number of internet users in China, internet unlicensed usage is expected to become the leading form.

3. Why software users continue to use unlicensed software

For a software user, the use of unlicensed software occurs for many reasons. Reasons can range from the perceived value of the software, to relatively less stringent penalties that can result from using unlicensed software, to the ease of obtaining unlicensed software for use. The following is a list of possible reasons that drive users to use unlicensed software, and a brief discussion on each.

  • Perceived fair value: The affordability of a licensed version of software (when compared with a country's average disposable income) can be a significant factor in a user's decision to purchase licensed software. If a software product is priced at a higher price point than its perceived value to users, users are less likely to purchase the licensed version of this software. This tends to be more prevalent amongst the consumer segment, particularly consumers with lower income levels, but can also be a factor in purchasing decisions for small-and-medium enterprises (SMEs) and some large enterprises. Some global software companies have started campaigns to increase the awareness of the value of licensed software and the risk of counterfeit and employed country-specific pricing in a bid to address this issue.
  • Level of penalties: Consistently stiff penalties (e.g., financial penalties and incarceration) can be a deterrent to using unlicensed software. In general, countries with stiffer penalties have lower software piracy rates (as illustrated in Figure 5). More importantly, the penalties for software IPR infringement in China have varied significantly in terms of the size of the penalty.

  • Ease of obtaining unlicensed software for use: Another factor in the use of unlicensed software is the ease of obtaining such software. Given the accessibility of unlicensed software today, particularly online, it may be more convenient to obtain unlicensed software than to search for a legal avenue to purchase the software (e.g., through retail stores). This factor may be less of an issue if the software is available for purchase online. However, the perceived fair value of the software product will still come into play; for example, if a software product is available online, but is still perceived to be too pricey, users are still unlikely to purchase the licensed version of the software product.
  • Restrictions in genuine software: Advanced and expert users have indicated that genuine software tends to contain restrictions such as copy protection, activation or a restricted length of license. For these users, such features that help prevent piracy are instead regarded as inconvenience. In their view, the lack of restrictions present in unlicensed software gives them greater flexibility in how they can use the software.
  • Hive mentality / existing culture of unlicensed software usage: If unlicensed software usage is relatively rampant within a user's social circles, or a user feels that it is prevalent amongst other computer users in the society, the user may be more likely to use unlicensed software.

4. Issues arising from insufficient software IPR enforcement

Several issues arise if insufficient levels of software IPR enforcement exist in a country.

  • Direct economic impact on the software industry: In terms of economic issues, these would include issues such as the devaluation of software products and the negative revenue impact to software vendors. Additionally, efforts and resources being put into the software industry would unnecessarily be expended. Direct economic impacts on the software industry will be discussed in greater detail further on in this paper.
  • Potential cyber security threats: Unlicensed software may include malware and typically does not receive the latest updates or patches. Some of these updates and patches are meant to address potential security issues, which, if left unaddressed, may result in a user's PC being vulnerable to security threats. In turn, a large-scale attack assisted by these vulnerabilities can present a serious threat to a country's information infrastructure, and is capable of seriously crippling any country dependent on its information infrastructure to function. Cyber-attacks have become increasingly common, with recent cyber-attacks occurring in Estonia, the United States, South Korea and Israel.

  • Stifling of creativity and innovation: The proliferation of unlicensed software products may result in a lack of creation and innovation from the software industry, particularly in developing products for the consumer segment. As domestic developers and vendors realize that their products (targeted at the consumer / mass-market segment) are likely to be illegally duplicated for use, it may result in a lack of incentive to develop new consumer products. Software developers may then decide to focus instead on enterprise or customized products which may be less likely to be reproduced illegally

5. Further improvements in software IPR protection in China can lead to economic benefits for the country

Economic benefits are often touted as the key factor for increasing software IPR protection in a country. Here, we take a look at the details of the tangible economic benefits that can arise from increasing software IPR protection (which in turn is expected to result in a reduction in the unlicensed software usage rate). These tangible economic benefits are measured and reflected in the economic impact model that was developed in conjunction with this paper.

  • Direct software sales revenues: A clear, direct economic benefit of software IPR protection would be the revenues directly generated from legal software sales. With an increase in software IPR protection and enforcement, a greater number of consumers and enterprises would purchase software for use legally, hence increasing the revenue generated from software sales.
  • Revenues from adjacent industries: As the software industry sees a positive revenue impact from the increase in software IPR protection, adjacent industries are also expected to benefit due to the "halo effect".
  • Job creation: Job creation can arise in either a direct or indirect fashion, both of which contribute directly to the economy. In the direct fashion, as software IPR protection increases, jobs are created to support not only the software industry (e.g., from sales personnel selling legal software, or software developers creating new software), but also in areas such as IPR enforcement and IPR education. Indirectly, an increase in software IPR protection is also expected to affect adjacent industries such as those in service provision and consulting. Hence, as software IPR protection increases, adjacent industries are also expected to create more jobs to cope with the demand generated as a result of the increase in software IPR protection.
  • Taxation revenues: Taxation revenues can be broken down into two categories, namely, corporate tax revenues and consumer tax revenues. For the former category, as enterprises move towards utilizing legal software, IT spending on legal software would increase, and hence corporate IT spending revenues would increase. As corporate taxes are derived from the revenues generated by these enterprises, the increase in IT spending revenues results in a greater volume of tax revenues. In terms of consumer tax revenues, the government would generate more sales tax from consumers as a result of greater software sales from consumer purchases of legal software. In addition, taxation revenues are also linked to the quantum of job creation – as jobs are created as a result of lower software piracy (e.g., in order to support the software industry) additional personal taxation revenues are generated in the economy.
  • Foreign investment: Foreign investment would be expected to increase as companies realize that an increase in software IPR protection would be beneficial to their companies' presence in the country, both in terms of revenue and branding. This would directly impact the amount of investment into the country's economy, making it a tangible economic benefit.
  • Domestic investment: Similar to foreign investment, domestic investment is likely to increase. An increase in software IPR protection would result in higher barriers to imitation, giving domestic companies added incentive to invest in the software industry. For example, domestic software companies that have shied away from developing new consumer products, due to the proliferation of unlicensed software usage in the consumer segment, may consider investing in software research and development (R&D) if software IPR protection were to increase.

The economic model developed in conjunction with this paper quantifies the various economic impacts of unlicensed usage on the software industry in China. The model builds a complete economic picture by considering the relevant factors driving GDP – including spending, investment and taxation. The model is underpinned by a granular analysis of the types of software in the market, and how unlicensed usage impacts the different revenues generated from the sale of software. In all, the model takes a deeper and broader view and seeks to provide an overall picture of the gains to be delivered from strengthening software IPR protection in China.

The results from the economic model show that a 10% decrease in unlicensed software usage could be worth US$ 15b over five years. This significant impact is built upon a cumulative increase in sales volumes of over 54m licences for PCs and servers across China. The model also shows that there would be wide-reaching impacts by increasing jobs in the IT sector by over 50,000 a year, as well as adding more than 1.5% to China's total IT GDP per year.

6. More importantly, further improvements in software IPR protection in China can lay the foundation for the country's drive towards the Knowledge Economy

Further improvements in software IPR protection would not only generate economic benefits for China, they would also result in intangible / indirect benefits that can impact the economy, and the country as a whole. Intangible benefits can manifest themselves in various forms, such as an increase in creativity and innovation, productivity gains, time savings and quality of foreign investments. These intangible benefits are explored in greater detail further on in this section.

While the value of these intangible / indirect benefits cannot be easily quantified, a key characteristic of these benefits is that they could contribute to China's transition to being a Knowledge Economy , which is a priority of the Chinese government. The government is keenly aware that China needs to continue building the foundations for a Knowledge Economy in order to remain sustainable and competitive in the global arena over the long-term.

With only 40% of China's 2008 GDP generated from tertiary industries , and the development of other low-cost manufacturing countries, the time is ripe for China to take greater strides through the Knowledge Economy transformation process. Other economic factors that are likely to accelerate China's transformation include the ongoing increase in buying power of Chinese nationals, fostering the increase in ability to obtain domestic and foreign higher education and foreign imports, and the continuing evolution and maturing of China's low-cost manufacturing sector.

In order to make the transition to a Knowledge Economy, China can design its transitional strategies based on the recommended "four pillars" framework. These four pillars are defined as :

  • Economic and institutional regime – an economic and institutional regime that provides incentives for the efficient use of existing and new knowledge and the flourishing of entrepreneurship
  • Educated and skilled population – an educated and skilled population that can create, share and use knowledge well
  • Efficient innovation system – an efficient innovation system of firms, research centers, universities, think tanks, consultants and other organizations that can tap into the growing stock of global knowledge, assimilate and adapt it to local needs and create new technology
  • Dynamic Information and Communication Technologies (ICT) infrastructure – ICT that can facilitate the effective communication, dissemination and processing of information

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Footnotes

1 Source: State Intellectual Property Office of China

2 Defined as the producers of unlicensed products

3 Source: IP rights regulations in China

4 Source: BSA; Chinalabs

5 Where the software IPR infringement rate is calculated as the number of unlicensed software units divided by the total of software units installed for that year

6 For its 2009 software IPR infringement rate derivation, Chinalabs conducted computer-assisted telephone interviews with 2,803 individual users and 1,834 business users

7 Source: BSA; SafeNet

8 Source: Legal publications of the listed countries

9 Source: Seventh Annual BSA/IDC Global Software 09 Piracy Study

10 For criminal cases

11 Source: Wired; various news sources

12 Tangible benefits are defined as benefits for which direct econmoic value can be measured.

13 Intangible / indirect benefits are defined here as the benefits for which direct economic value is difficult to quantify, but which nonetheless have an impact on the economy in a different form.

14 A Knowledge Economy is defined by The World Bank as one in which "organizations and people acquire, create, disseminate and use knowledge more effectively for greater economic and social development". A Knowledge Economy allows a country to develop more efficient ways of producing goods and services, which in turn results in more effective and affordable delivery mechanisms to a larger group of people.

15 Source: National Bureau of Statistics of China; compared to above 65% for countries with a higher Knowledge Economic Index ranking such as Japan, Australia, United Kingdom and the United States

16 Source: The World Bank

17 Source: The World Bank, Ernst & Young

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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