Counterfeiting in the People's Republic of China

Contents

  List of Tables  iv

  List of Figures  v

  List of Abbreviations  vi

1  Introduction and Preliminary Remarks  1

2  Definition and Delimitation of Relevant Terminology  4

3  Impact of China’s Counterfeiting Problem  8

3.1  Negative Impacts of Counterfeiting in China  8

3.1.1  Introductory Remarks  8

3.1.2  Costs to the Right Holder  8

3.1.3  Costs to Consumers and Potential Users  11

3.1.4  Social Costs  12

3.2  Positive Impacts of Counterfeiting  14

3.2.1  Positive Impacts to Consumers and Local Economies  14

3.2.2  Positive Impacts for Development and Innovation  16

3.2.3  Positive Impacts for China’s Political Environment  17

3.3  Summary of Main Impacts and Evaluation  17

4  Analysis of economic, legal and political environment  18

4.1  Insights of Contemporary China  18

4.2  Drivers for Counterfeiting  19

4.2.1  China’s Transition Process and Economic Framework  19

4.2.2  China’s Enforcement Institutions and Legal framework  20

4.2.2.1  Enforcement Institutions  20

4.2.2.2  Legal Framework  25

4.2.3  China’s Political Framework  28

4.2.3.1  Attitudes of the People’s Government of PRC  28

4.2.3.2  Local Protectionism and Development  30

4.2.4  Summary  32

Contents ii

4.3  Containment Options concerning Environmental Determinants  32

4.3.1  Extensive Legal Protection  33

4.3.2  Reforming China’s IPR Enforcement System  33

4.3.3  Improving China’s IPR Legislation  35

4.3.4  Lobbying and Encouraging Political Commitment  35

4.3.5  Summary  37

5  Analysis of Suppliers on the Counterfeiting Market  38

5.1  Attributes of China’s Counterfeiters  38

5.2  Drivers for Counterfeiting  40

5.2.1  Unawareness of Statutory Provisions  40

5.2.2  Financial Incentives  41

5.2.3  Enabling Resources and Technical Knowledge  41

5.2.4  Historic Insights and their Influence on the Perception of IPRs  43

5.2.4.1  Attitude towards the “West  43

5.2.4.2  The Communist Era and the Perception of IPR  44

5.2.5  Cultural Traits and their Impact on Contemporary Counterfeiting  45

5.2.5.1  Confucianism  45

5.2.5.2  Collectivism and other Cultural Dimensions  47

5.2.6  Summary  50

5.3  Containment Options  51

5.3.1  Innovation and Constant Change of Product Attributes  51

5.3.2  Anti-Counterfeiting Technologies  51

5.3.3  Education and Deterrence of Counterfeiters  53

5.3.4  Securing the Value Chain  54

5.3.5  Co-Opting Preeminent Offenders  55

5.3.6  Passive Measures  56

5.3.7  Summary  57

Contents iii

6  Analysis of Consumers on the Counterfeiting Market  58

6.1  The Consumer of Counterfeited Goods  58

6.1.1  Introductory Remarks  58

6.1.2  Attributes of Chinese Consumers who Buy Counterfeits  58

6.2  Drivers for Counterfeiting  61

6.2.1  Increased Consumer Rent  61

6.2.2  Impact of Availability of Counterfeits on Purchase Intention  62

6.2.3  Cultural Traits and Consumer Behaviour  62

6.2.4  Sophistication of Chinese Consumers  65

6.2.5  Perception of Wrongdoing and Unethical Behavior  66

6.2.6  Anti-Big Business Attitude  67

6.2.7  Novelty Seeking and Risk Avoidance  68

6.2.8  Summary  69

6.3  Containment Options  70

6.3.1  Matching Consumers’ Needs  70

6.3.2  Communication and Education  72

6.3.3  Summary  75

7  Conclusions and Outlook  76

7.1  Conclusions  76

7.1.1  Recommendations for Companies  76

7.1.2  Recommendations for the People’s Government of PRC  78

7.1.3  Recommendations for Chinese Consumers  78

7.2  Outlook  79

7.3  Concluding Remark  80

8  Bibliography  81

9  Appendix  96

  - A Tables  96

  B - Figures  102

  D - Short interview concerning counterfeiting in the PRC  106

  E - Table of Chinese terms used in the paper  109

Contents iv

  List of Tables  

  Tab. 1 : Overview of counterfeiting concepts  6

  Tab. 2 : Estimated trade losses due to piracy (in millions of U S. dollars) and levels of  

  piracy in the PRC (1999 2002 )  9

  Tab. 3 : China’s IPR legislation  26

  Tab. 4 : Famous distribution and manufacturing centers of counterfeit goods in China  39

  Tab. 5 : Overview about anti-counterfeiting technologies  52

  Tab. 6 : Frequency of buying pirated or counterfeit goods - bivariate analysis  60

  Tab. 7 : Methods for identifying pirated clothing and accessories  66

  Tab. 8 A: Trademark enforcement activity, 1997 2000  96

  Tab. 9 A: Domestic and global anti-Counterfeiting organizations  96

  Tab. 10 A: List of industrial organizations engaged in anti-counterfeiting work  97

  Tab. 11 A: Foreign Direct Investment in Selected Non-Member Countries in billion  97

  Tab. 12 A: Gender and attitude toward piracy  97

  Tab. 13 A: Seizures of counterfeits of Chinese origin by U S. costumes from  2001

  to 2004 (excluding Hong Kong)  98

  Tab. 14 A: Seizures of counterfeits of Chinese origin by U S. costumes from  2001

  to 2004 (including Hong Kong)  98

  Tab. 15 A: Results of regressing intention to buy pirated CDs on attitude toward  

  piracy and demographics  98

  Tab. 16 A: Evaluation of government actions and market environment changes  99

  Tab. 17 A: Overview of affected industries and losses due to counterfeiting in China  

  and the World  100

  Tab. 18 A: Overview of China’s anti-counterfeiting enforcement institutions and its  

  competencies  101

Contents v

  List of Figures  

  Fig. 1 : Methodological structure of the present study  3

  Fig. 2 : Drivers for counterfeiting within the political, economic and legal  

  environment  32

  Fig. 3 : Drivers and containment options within the political, economic and legal  

  environment  37

  Fig. 4 : Drivers for supply based counterfeiting  50

  Fig. 5 : Drivers and containment options for supply based counterfeiting  57

  Fig. 6 : Drivers for demand based counterfeiting  70

  Fig. 7 : Drivers and containment options for demand based counterfeiting  75

  Fig. 8 : Corporate strategies against counterfeiting  76

  Fig. 9 A: Relationship between Software piracy and Income  102

  Fig. 10 A: Relationship between Software piracy and Education  102

  Fig. 11 A: Geographical position of counterfeiting hot-spots in China  103

Contents vi

  List of Abbreviations  

  A see Appendix  

  ACG The Anti-Counterfeiting Group  

  AIC Administration of Industry and Commerce  

  AmCham American Chamber of Commerce  

  BTK “Born to Kill Vietnamese Gang  

  CIB Counterfeiting Intelligence Bureau  

  CIPR Commission on Intellectual Property Rights  

  EC European Commission  

  EU European Union  

  FBI Federal Bureau of Investigation  

  GATT General Agreement on Tariffs and Trade  

  GDI Gross domestic income  

  GDP Gross domestic product  

IACC  International Anti Counterfeiting Coalition  

ICC  The International Chamber of Commerce  

IFPI  International Federation of the Phonographic Industries  

IHK  Industrie- und Handelskammer  

IIPA  International Intellectual Property Alliance  

INTA  International Trademark Association  

IP  Intellectual property  

IPR  Intellectual property right  

IRA  Irish Republican Army  

ITA  International Trademark Association  

  MNC Multi national corporation  

  MSA Mercado Solutions Associates  

  NBS National Bureau of Statistics of China  

  OECD Organisation for Economic Co-operation and Development  

  PR Public relation  

  PRC People's Republic of China  

  PSB Public Security Bureau  

  R D Research and development  

Contents vii

  SID Source Identification Code  

  SIPO State Intellectual Property Office  

  SME Small and medium sized enterprise  

  TRIPS Agreement on Trade-Related Aspects of IP Rights  

  TSB Technical Supervision Bureau  

  US United States  

  WIPO World Intellectual Property Organization  

  WTO World Trade Organization  

1 Introduction and Preliminary Remarkss 1

1 Introduction and Preliminary Remarks

Since the proclamation of the opening up policy (gaige kaifang) in the 1980’s by Deng Xiaoping and the present economic growth, Chinas economy is expected to become the world’s number one within the next 20 years. With the focus on surpassing growth rates, trade surpluses and an increasing domestic demand from 1.3 billion consumers, many decision makers ignore the fact that China has already become one of the worlds leading country: China is the number one of global counterfeiting.

Observers and researchers agree upon the fact that the scope, magnitude and impact of Chinas counterfeiting is unique in world history. The range of imitated products has no limits; China’s counterfeiters copy everything from sunglasses and sport shoes to elevators and aircraft parts. At a visit in February 2006, Germany’s foreign minister Steinmeier broached the issue of German maglev technology which is assumed to be used in the new Chinese maglev train (Wetzel, Muscat, 2006). This and other examples show that there is scarcely any industry or technology which is not threatened by China’s counterfeiters. The impact is alarming. Chinese official sources estimate the damages due to Chinas counterfeiting to exceed 16 billion U.S. Dollars a year. They admit that in the Chinese market, three genuine products oppose seven counterfeits (Mocek, 2005, p. 30). Eight percent of China’s gross domestic resort to counterfeiting (Chow, 2004, p.1). The negative consequences are concerning: tax revenues vanquish, legal businesses are disrupted, consumer safety is threatened, genuine producers are confronted with loss and shrinking credibility, innovation and investments are constricted and organized crime is promoted.

Problem Formulation and Delimitation

Although Chinas counterfeiting issue makes headlines in the economic world, only few research examined the problem in a comprehensive way. Many journalists focus on legal issues and thus mainly on the supply side of counterfeiting. Other researchers simply blame Chinas cultural heritage to be the main cause. Most papers lack a broad approach, which is inadequate regarding the magnitude and scope of Chinas counterfeiting. The objective of the present paper is to give a comprehensive overview about counterfeiting in the People’s Republic of China. Comprehensive shall mean that all aspects of counterfeiting are subject to analysis. In the following, supportive drivers for counterfeiting

1 Introduction and Preliminary Remarkss 2

and possible enforcement strategies against counterfeiting are identified and discussed. Since, the paper focuses on China, cross border counterfeiting, impacts in other countries or global approaches are only mentioned in few cases to highlight similar issues in China. The final objective is, to introduce possible strategies against: Counterfeiting in China. A closer definition for the term “counterfeiting” is given in chapter two. “China” in this case refers to “Mainland China”, which excludes Taiwan as well as the former colonies Hong Kong and Macau. The expressions: “China” and “People’s Republic of China” are used interchangeable although there is no question that Hong Kong and Macau are part of the PRC. The reasons for this introductory delimitation are legal and economic differences ¹ with the former colonies as well as the political debates and differences with Taiwan.

Methodology and Structure

Since counterfeiting is an illicit business, quantitative approaches are limited. Additionally comprehensive quantitative research faces problems such as the high level of heterogeneity within the Chinese environment or political restrictions. Most counterfeiting research is based on personal interviews, observations, official records and data as well as publications of interest groups. Qualitative evaluation therefore seems the more effective methodological approach. Although the present study shows the results of quantitative research, the general methodology follows qualitative trajectories.

The structure is divided into five main parts (Chapter 3 to Chapter 7) which combine descriptive and in the following, normative research. Chapter three introduces the impact of counterfeiting to highlight the up-to-date facts and importance of the issue. Chapter 4 to 6 represent the common market structure. They systematize the study into three main categories of research: environmental (economical, legal, political), supply side (“the counterfeiter”) and the demand side (“consumers”). Each research category is examined towards: relevant drivers, attributes, and containment options. Chapter seven gives a final summary and analyses future prospects.

¹ “one country - two systems” (yiguo liangzhi) means, that Hong Kong and Macau stay capitalistic oriented market economies for 50 years after the reunification with Mainland China. China’s economic system remains socialistic oriented. Since, the IPR legislation of Hong Kong is based on British case law, this paper focuses on Chinese legislation.

1 Introduction and Preliminary Remarkss 3

Introductory remarks concerning data

Although many authors mention detailed numbers on counterfeiting, the basis of their calculations stays often unclear. One crucial example is the share of counterfeiting in world trade. The share is estimated to be “somewhere between 4% and 8%”. Since official sources cite these numbers, many researchers transfer these assumptions and consequently they became common sense. Similar problems are the notations by newspapers, enforcement groups and industrial speakers concerning the amount of lost revenues (cf. IACC, 2005; Balfour et al., 2005; ACG, 2003). It is outstanding that most authors mention “estimated” losses. Due to the illicit nature of counterfeiting there is no scientific data to deal with. Chow (2000, p. 12) states that:

”There is no scientific method for determining the exact size of the counterfeiting problem”.

Also OECD sources doubt the existence of accurate statistics (OECD, 1998, p. 3). A possible solution may be to examine statistics of custom authorities, but they are also random samples and may not be appropriate. Summarizing, all numbers, cited in this study are understood as relative approximate values and are used in a descriptive way.

4

2 Definition and Delimitation of Relevant Terminology

Defining and delimitation of counterfeiting (weizao) is complex, because terms and definitions are often used interchangeably. Most authors divide into four different counterfeit categories: (1) Counterfeiting, (2) Product piracy, (3) Imitation, (4) a grey area (McDonald, Roberts, 1994; Lay, Zaichkowsky, 1999; Hung, 2003; Cheung, Prendergast, 2004a).

(1) Counterfeiting: Originally counterfeiting is restricted to trademark infringement (OECD, 1998). Usually counterfeiting is defined as unauthorized imitating of a products appearance in a way the consumer can not recognize if the product is an original one (OECD, 1998, p. 5; Hung, 2003, p. 59). Relatively speaking, it is an infringement of intellectual property rights of another party, like the infringement upon copyrights and trademarks (OECD, 1998, p. 5; Hung, 2003, p. 76; Bloch, Bush, Campbell, 1993, p. 27). One main attribute is the intension to deceive the customers (Bamossy, Scammon, 1985, p. 334; Kay, Zaichkowsky, 1999, p. 180). The process of counterfeiting includes the replication of brand names and trademarks as well as imitation of packaging, labelling and other product characteristics (Hung, 2003; OECD, 1998, p. 5).

(2) Product piracy: Product piracy is often used substitutional with counterfeiting which shows that the concepts are hard to differentiate. In the TRIPS agreement pirated products are defined as:

“…any goods which are copies made without the consent of the right holder or person duly authorised by the right holder in the country of production and which are made directly or indirectly from an article where the making of that copy would have constituted an infringement of a copyright or a related right under the law of the country of importation” (OECD, 1998, p. 5).

In principle, the act of pirating products is similar to the act of counterfeiting. A copy or imitation is made of the genuine product. But in contrast to counterfeiting, pirated products are not necessarily sold as genuine ones (Cheung, Prendergast, 2004a, p. 5; McDonald, Roberts, 1994, p. 58; Chow, 2000, p. 9). The costumer is aware that a pirated, non-genuine product is offered.

Pirating often refers to the act of copying content from books, films and software. The content or the main utilizable product attribute of a pirated good is often similar to the genuine

2 Definition and Delimitation of Relevant Terminologyy 5

product. The packaging and labelling may differ (Chow, 2000, p. 9). Main affected industries are Software, Film, Music, and Publishing industries as well as arts-and-crafts (Chow, 2000, p. 9; Lay, Zaichkowsky, 1999, p. 180).

(3) Imitation: Imitation refers to the manufacturing of a product which has a very similar appearance compared to the genuine product (McDonald, Roberts, 1994, p. 58). The main peculiarity is that the product is not advertised and distributed as the genuine one. Imitated products are also known as “knock-offs” (Bamossy, Scammon, 1985, p. 334; McDonald, Roberts, 1994, p. 58). Bamossy and Scammon (1985, p. 334) introduce a fine example:

“…a Mexican made champagne uses the same name and label used to identify premier French champagne, but adds enough Spanish words so that it is only imitating the French label, not counterfeiting it”.

The appearance of imitated products is very similar to that of genuine products, and for the consumer hard to distinguish between the both (McDonald, Roberts, 1994, p. 58). Lay and Zaichkowsky (1995, p. 180) state, that substance, name, shape and form look alike but through closer inspection differences are visible. Imitated products mask their origin and try to deceive the costumer but they are not sold as genuine products (Bamossy, Scammon, 1985, p. 334; McDonald, Roberts, 1994, p. 58).

(4) Grey area activities: The grey area includes all other forms of counterfeiting like “parallel trading” and “over-runs”.

Parallel trading as explained by an OECD sources refer to situations where products are legally bought in one country and diverted for sale to another country. The right holders restrictions are evaded (OECD, 1998, p. 6). In general it means that original goods are distributed in markets which are not authorized by the right holder. “Over-runs” are goods which are unauthorised and manufactured by legitimate suppliers (Bamossy, Scammon, 1985, p. 335). The other contracting party manufactures more goods than stipulated in contract and sells it on own account on the black market (OECD, 1998, p. 6). Also low-quality and second choice productions do refer to “over-runs” problem. Especially in China “over-runs” is a practise used by Chinese Joint Venture partners and contractors (Hung, 2003, p. 63; Sieren, Kamp, 2004, S. 58; Roberts et al., 2000, p. 20f.; Uchatius, 1999, p. 24). The product sold to the costumer is a genuine product which has no limitations apart from lacking after sales service and lacking warranty. In the case of second choice productions, the quality level is substandard. Enforcement institutions often do not take

2 Definition and Delimitation of Relevant Terminologyy 6

forms of the “grey area” for serious counterfeiting. In consequence right holders need to find own strategies for prevention (OECD, 1998, p. 6).

All four concepts are only slightly different and are often used substitutive. They all have in common that they infringe another party’s intellectual property rights ² (zhishi chanquan). Table 1 gives an overview of the discussed concepts and highlights its differences.

Source: compiled by the author

In practice a clear distinction is difficult. Cases of property right infringement often include several forms of counterfeiting (OECD, 1998, p. 5). McDonald and Roberts (1994, p. 57) argue that the different concepts of counterfeiting are all illicit actions and that the differences arise from the intention to deceive the costumer. Consequently they highlight the ethical question of counterfeiting. Other authors like Wee, Tan and Cheok (1995, p. 19) use broader definitions, because the substantial impact of all forms are quite similar and enforcement strategies never focus solely on one of the explained forms (cf. Shultz, Saporito, 1996; Chaudhry, Walsh, 1996; OECD, 1998).

² “Intellectual property” refers to all creations of the mind: such as inventions, literary and artistic works, and symbols, names, images, and designs which are used in commerce (WIPO, 2005).

2 Definition and Delimitation of Relevant Terminologyy 7

Literature review gives evidence, that counterfeiting in China has various forms and often includes several forms of infringement. To achieve a comprehensive overview about all aspects of China’s counterfeiting, a broader definition of counterfeiting will be used. Based on OECD (1998, p. 5) terminology counterfeiting will be explained as: “…any making of a product which closely imitates the product of another. Hence, it may also include the unauthorised production and distribution of a product that is protected by other intellectual property rights, such as copyright and neighbouring rights.”

Consequently, the present paper the term “counterfeiting” will include all additional concepts like product piracy, imitation and the grey area.

The product manufactured through the action of counterfeiting is named: “counterfeit” (jiahuo). The terms: counterfeit, counterfeited good, fake, fake product are used interchangeable, they are replaceable.

Additionally, the term “counterfeiter” (weizaozhe) stands for the originator of counterfeiting. This can be an individual or an organizational structure such as a company or a crime syndicate. Since, some counterfeiters are legal companies and other counterfeiters are private, illegal operating groups, a sharp delimitation is impossible. Beside the term counterfeiter is the term “infringer” is used substitutional.

3 Impact of China’s Counterfeiting Problem 8

3 Impact of China’s Counterfeiting Problem

3.1 Negative Impacts of Counterfeiting in China

3.1.1 Introductory Remarks

The following chapter deals with negative impacts caused by Chinas counterfeiting. Even though the present paper mainly focuses on counterfeiting in China, the impacts must be evaluated on a cross-border perspective. The problems caused by Chinese counterfeiting do not only affect China. Through export and transnational trade the problems are also present in other countries and economies. Consequently, it is necessary to leave the regional level and embrace non-Chinese subjects as well. As a result, the following chapter will also include a few examples, numbers and problems from other affected countries to highlight the broad range of negative impacts.

3.1.2 Costs to the Right Holder

All industries and all types of products even in markets outside China may be affected by China based counterfeiting (cf. Tab. 17-A and Appendix D). Consequently the range of right holders is various. Every company in the market is a potential target for counterfeiters this includes domestic Chinese companies as well (Balfour et al., 2005, p. 1; Sisci, 1997, p. 1.; Chow, 2000, p. 16). There is clear evidence from literature that some industries are more affected, than others. The Green Paper on counterfeiting in the EU (1999, p. 5) states:

“There was fairly general agreement that the industries most severely affected were software, textiles, clothing, toys, music, perfumes, publishing, pharmaceuticals, phonographic/CD recordings, videos, car parts, and sports goods; but the list was long, over fifty items, and went as far as garden gnomes and CAT scanners.”

The specific costs to right holders vary greatly. There are financial losses, brand erosion or decreasing goodwill as well as additional enforcement costs or lawsuits initiated by consumers concerning product liability (IHK, 2004, p. 2).

(1) Direct pecuniary losses: Pecuniary loses have various reasons. The first, sales of genuine products decrease and returns drop. The scale of losses is various and hard to verify ³ . Some spokesmen of certain industries and promoters even exaggerate their losses. In general, most

³ See chapter one, methodology restrictions concerning the possibility of measuring counterfeiting activities.

3 Impact of China’s Counterfeiting Problem 9

losses cited by experts are substantial. The following examples give an impression about the variety and magnitude of the financial losses:

Foreign companies estimate a loss of 20 percent of their overall sales due to counterfeited products (Porteous, 2001, p. 28). Hung (2003, p. 59) cites Chinese government sources, who conservatively estimate the total value of counterfeited goods in 1998 to about 16.2 billion U.S. dollars. Wölfel (2003, p. 37) also defines Chinese counterfeiting a: “16-billion-Dollarindustry”. Ho (1995, p. 2) says that the software industry lost half a billion U.S. dollars in China in 1994. OECD (1998, p. 12) states a number of 120 million U.S. dollars lost sales for U.S. motion picture industry in 1997 in China.

Tab. 2: Estimated trade losses due to piracy (in millions of U.S. dollars) and levels of

Numbers form the automotive industry come from Daimler-Chrysler which claims a damage of more than ten million U.S. dollars from counterfeiting. In 2001, over 4,000 windshields and 60,000 brake pads were confiscated by corporate investigators (Wölfel, 2003, p. 46). In 1998, Unilever has detected over 100 factories which have produced fake Unilever products. In 1999 they mentioned 213 fake factories (Wölfel, 2003, p. 38). The Germany based, chemical company Henkel estimates that over 30 % of all soaps and creams in Chinese supermarkets are faked (Wölfel, 2003, p. 38). In 1989, even before the tremendous distribution of easy copying technology and private computers, Lotus Development Corporation assumed a loss of 200 million U.S. dollars annually from Taiwanese counterfeiters alone (Swinyard, Rinne, Kau, 1990, p. 655). Ang et al. (2001, p. 221) mention that in urban areas of China, over 90% of daily-use products are counterfeits. Bottenschein (2005, p. 121) assumes that 15 % to 20 % of all marketed brands are counterfeited.

3 Impact of China’s Counterfeiting Problem 10

All these examples, give evidence that genuine manufactures face substantial losses due to counterfeiting. Additionally, the lost sales and revenues ⁴ which were mentioned, lead to social costs which are discussed in 3.1.4.

(2) Brand Erosion: Another basic problem for genuine manufactures is the loss of goodwill and reputation (INTA, 2004, p. 2; Chow, 2000, p. 10; Wee, Tan, Cheok, 1995, p. 19). Basically brand owners are more affected than copyright owners (Chow, 2000, p. 11). In this case, there are three main concerns.

Consumers are worried about buying a product if they can not be sure that it is a genuine one. Brand acceptance shrinks which lead to brand switching. Also the value of status goods will drop if too many people wear the same brand, which was explained by the Rolex example (Wölfel, 2003, p. 43; Grossman, Shapiro, 1988, p. 98). Consequently sales and return will decrease.

The other problem arises from low product quality. If a consumer buys a counterfeit for a genuine and the product is flawed, he/she will think the genuine producer is accountable. (Bloch, Bush, Campbell, 1993, p. 27; OECD, 1998, p. 27). Especially in China this is a problem because the ability to identify authentic brands is low (Lay, Zaichkowsky, 1999, p. 180). If costumers are not satisfied with a new brand, brand loyalty may not evolve. In early and developing markets like in China, this may have strong influences on long-term sales (Lay, Zaichkowsky, 1999, p. 181). In contrast, one may not forget that the scope of brand erosion is lower throughout consumers who knowingly buy a counterfeit. They do not expect a high level of quality so the distance between expected product attribute and real product attribute is not that high. Dissatisfaction thus does not arise.

A last issue is that the consumer gets the impression that the genuine product is much too expensive. If the genuine product is for example ten times more expensive, the consumers get the impression that the genuine producer is cheating on costumers because they do not perceive the high price as a fair offer. This may lead to the consumer’s attitude being put off big businesses (see 6.2.4) and a shrinking product loyalty (Wölfel, 2003, p. 43).

⁴ While discussing lost sales or lost revenues, it is important to distinguish between the conscious buyer and the unconscious one. When the consumer unconsciously buys a counterfeit the genuine manufacturer certainly faces lost sales. If the buyer is conscious, it may be possible that he/she would not have bought a genuine product anyway. People who knowingly buy a fake Rolex are usually no potential costumers for a genuine Rolex because prices are much too high. Consequently, dealing with numbers of potential losses, there is a need to keep in mind that sales of counterfeits would not consequently be potential genuine sales.

3 Impact of China’s Counterfeiting Problem 11

(3) Other costs: There are several other negative impacts for genuine manufacturers. First of all, a market undermined by counterfeiters is less attractive for foreign and local companies. Growth or entry strategies need to be reviewed (OECD, 1998, p. 22). A high scope of counterfeiting may even led to market exit.

Increased counterfeiting requires enforcement strategies which bind capital and other resources (OECD, 1998, p. 22). Chinese and foreign SMEs often lack the resources to fend an attack by aggressive counterfeiters (Chow, 2000, p. 16). Additionally, transaction costs increase.

Research and development as well as production costs may increase because anticounterfeiting technologies need to be developed and implemented (OECD, 1998, p. 22). If the call for legal and administrative support is too hard to deal with, companies may suffer from resentments from local or national authorities in China (Chow, 2000, p. 47). Faked and phony products may danger consumers and consequently led to lawsuits initiated by consumers (IHK, 2004, p. 2).

3.1.3 Costs to Consumers and Potential Users There are two main problems caused by counterfeiting.

(1) The consumer surplus shrinks when an inferior product is bought at a comparatively high price (OECD, 1998, p. 23; Bamossy, Scammon, 1985; p. 335). If the customer is not aware, that the bought good is counterfeited, he or she pays a price which is far too unjustifiable. This is a form of asymmetrical information and leads to market failure (cf. Arrow, 1963). A more simple fact is that; conscious cheating leads to dissatisfaction of the buyer. Additional, a decrease in consumer surplus arises in an increased price level for genuine products caused by enforcement costs of the original manufacturer (Bamossy, Scammon, 1985, p. 335).

(2) The other and most problematic impact of counterfeiting towards consumers is the threat of consumer’s health and safety caused by low-quality products (OECD, 1998, p. 23; CIB, 2004, p. 8; Wölfel, 2003, p. 41). This affects the conscious and unconscious buyer. He/she faces the risk that ingredients and preliminary products are not identifiable and may face safety risks. Counterfeits are not only cheaper because of savings for brand management and R&D. Counterfeiters usually use unskilled labor, child labor, inferior materials, cheap machinery and they usually do not have safety inspections or a quality management. The aim of counterfeiters is to produce merchandise and commodities as cheap as possible. In consequence, the products are often of poor quality and thus a risk to consumer’s health

3 Impact of China’s Counterfeiting Problem 12

(Wölfel, 2003, p. 42). The number and the scope of casualties and accidents caused by unsafe counterfeit products are distressing. The following examples highlight some recent cases which can be seen as the tip of the iceberg.

In 2004 by the province of Anhui, 12 infants died after being fed with fake milk powder. More than 229 other babies were injured (cf. Li, 2004). In 2001, a China based factory was discovered which had produced and distributed fake windshields, lacking safety elements like shatterproof features (“GM, Ford, and DaimlerChrysler”, 2001). Oster (cf. 2000) cites Chinese officials who state that every year dozens of people die from unsafe bottles and “lead-tainted” beverages. The last source indicates that in 2001, 192,000 people died by taking fake drugs in the whole of China, which shows the magnitude of the problem (Godman, 2002).

Although, these examples are outstanding in terms of impact it can be assumed that “smaller” impacts such as toxicities in faked clothing, malfunctions of fake electronics or hazardous toys are a threat to consumer’s health and thus cause substantial losses to consumers.

3.1.4 Social Costs

Social costs are negative impacts on the society and the economy of a country. The character of counterfeiting and IPR infringement supports various negative aspects like: unemployment, substandard working conditions, dropping tax revenues, organized crime and decreased ability for innovation and national growth.

(1) Unemployment is a direct outcome of dropping revenues of original producers (OECD, 1998, p. 22; Bamossy, Scammon, 1985, p. 335). There are few concrete numbers in literature. The Anti-Counterfeiting Group estimates annual job losses of 4,100 in Great Britain (ACG, 2003, p. 2). The European commission published an estimated number of 200,000 annually lost jobs worldwide (EC, 1999, p. 4). Numbers about counterfeit based unemployment in the PRC are not available, but it is estimated that unemployment is a concern in China as well.

In contrast to the argument that counterfeiting supports unemployment, one may also argue that counterfeiting creates jobs as well. The problem is that these jobs are often based on substandard working conditions or child labour (OECD, 1999, p. 2).

(2) Tax revenues are lost if illicit businesses displace tax paying companies. There are few concrete numbers in literature, but most authors mention lost tax revenues as one of the main

3 Impact of China’s Counterfeiting Problem 13

problems (OECD, 1998, p. 23; Cohen, 2003, p. 5; IACC, 2005, p. 8). Chinese authorities estimate that they lose three billion U.S. dollars in tax revenues each year (“Une coalition internationale contre”, 2003). Other financial damages arise from increased costs for investigation and enforcement against counterfeiters (OECD, 1998, p. 23).

(3) Organized crime and terrorism are a disturbing and unpleasant concern of politicians worldwide. Counterfeiting has been identified as one of the easiest way for criminal syndicates and terror groups to finance their operations (cf. “Une coalition internationale contre”, 2003; INTA, 2004, p. 11; Roberts et al., 2000, p. 20f.; Wölfel, 2003, p. 21f.). Counterfeiting is less risky than smuggling, prostitution or drug trafficking. In other words, profit is higher and penalties lower (IHK, 2004, p. 3). Especially in China, a change from smuggling to counterfeiting is visible. In 1999 China’s central government launched a campaign against smuggling. (Ostrov, 2000, p. 44f.). Penalties became much higher. Even death penalties were imposed in the last few years (Ostrov, 2000, p. 47). Consequently many criminals switched to counterfeiting businesses.

The problem of terrorism is published in several papers (Union des Fabricants, 2003, p. 1f., IACC, 2003, 20f.; Wölfel, 2003, p. 21; Hudson 2003, p. 30ff.). The most famous example is the first bomb attack on the World Trade Center in 1993. In this particular case, the FBI found evidence that the activities of Sheik Omar Abdel Rahman and his henchmen were financed by counterfeited T-Shirts (IACC, 2003, 20.f). Baguioro (2003) cites EU authorities who report that the Muslim extremist group Hizbollah is involved in the distribution of counterfeit goods. The origin of the seized goods was China (Baguioro, 2003, p. 1). Wölfel (2003, p. 21ff.) mentions several international terror groups being involved in counterfeiting, such as the: BTK, IRA, Italian Mafia and Islamic fundamentalists.

(4) Innovation and national growth is an important and crucial factor for China as a developing country. Counterfeiting inhibits the capability to innovate and consequently the development of national growth. Furthermore it diminishes the competitive advantage of the economy and leads to a negative reputation as location for investments. In general, innovation is crucial for economic growth and prosperity (cf. Sodipo, 1997, p. 51ff.; Rapp, Rozek, 1990, p.77). Many authors found that there is a strong link between economic development and IPR protection (cf. Marron, Steel, 2000; Ginarte, Park, 1997; Rapp, Rozek, 1990). Rapp and Rozek (1990, p. 77ff.) state, that strong patent protection has a

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positive influence on economic development. Fink and Braga (2000, p. 3) describe the role of IPR protection as an:

“Effective way to foster the dynamic benefits associated with innovative activities.”

IPR assures that an innovator has incentives to innovate. Without an IPR regime, invested resources are not refunded. Consequently rational actors will not innovate and contribute to the welfare of an economy or society ⁵ . Practically, the rampant infringement of intellectual property rights in China restrains potential investors and entrepreneurs (OECD, 1998, p. 23; Shultz, Saporito, 1996, p. 20; Arayama, Mourdoukoutas, 1999, p. 63f.). With a stable IPR regime the inflow of FDI, latest technology and knowledge the process of transition and thus the growth of Chinas welfare is expected to be much faster and more extensive.

3.2 Positive Impacts of Counterfeiting

Most authors, institutions and lobbyist groups see counterfeiting basically as negative. Even in scientific literature there are no comprehensive discussions in a moral or economic way if counterfeiting may have positive aspects. Basically this seems coherent as the magnitude of negative aspects discussed in chapter 3.1 shows. Nevertheless positive aspects may exist. This paper has the aim to give a comprehensive overview on counterfeiting. Consequently, the following paragraph will provide an introducing excursus on positive aspects of counterfeiting.

3.2.1 Positive Impacts to Consumers and Local Economies

(1) A main argument results from the price advantage. If a consumer consciously buys a counterfeit good, he or she can satisfy their own individual personal need; they also pay the price willingly and without reluctance (cf. Slive, Bernhardt, 1998). If the consumer is aware that the bought good is counterfeit, there will be no dissatisfaction after the purchase since the buyer did not anticipate a high standard and quality product. In a simple way: The consumer seeks a cheap product and gets it.

The counterfeited product offered fits the needs of the consumer, the genuine does not. From consumer’s point of view, there is thus a clear positive attitude towards counterfeited goods (cf. Slive, Bernhardt, 1998; Bloch, Bush, Campbell, 1993, p. 28). Counterfeit are seen as an extension of the product choice and legitimate buying options.

⁵ On the other hand, one can suggest other incentives for people to innovate. One example would be that innovators do not seek for financial success but for social status and prestige. Since, social status is important in some cultures, the innovator would have an interest to share his ideas for free just to enhance his/her reputation.

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Also the argument of reduced goodwill and shrinking brand awareness losses its impact, if one assumes that the buyer knows that the product is counterfeited. If the buyer does not expect a high level of quality he/she will not be unsatisfied with a lower standard. A negative effect on the genuine brand will not take place.

(2) Another aspect is mentioned by Schultz and Saporito (1996, p. 22). They state that a certain level of counterfeiting may arise by promotional influences. Throughout so called “wannabe” consumers, a demand and supply is created. This leads to higher brand awareness for the genuine brand, and may result in a broader range of potential consumers in the future (when the purchase power has increased).

Another argument comes from Slive and Bernhardt (1998) who recommend selling software without cost for private use, to promote sales to commercial users. McDonald and Roberts (1994, p. 63) argue the same way. They say:

“Pirate product buyers know of their deception and seek ultimately to trade up to the genuine product as they become more affluent.”

Especially in under developed economies this process is traceable (Shultz, Saporito 1996, p. 22). But also in China, as a developing country this may fit because the Chinese market is still nascent (Lay, Zaichkowsky, 1999, p. 181).

(3) In paragraph 3.1.4 social costs of counterfeiting like unemployment were mentioned. Of course these arguments can also be seen the other way round. It is known that in some local economies counterfeiting is the dominant business. Some villages or townships depend substantially on the returns generated by counterfeiting ⁶ (cf. CIB, 2004; Roberts et al., 2000, p. 20f.; Chow, 2004, p. 6). On a global perspective this is a major problem (cf. 3.1.4). On a local level, counterfeiting business fosters development, provides jobs and tax for local administration (Chow, 2004, p. 6). For the people in those regions counterfeiting has a positive impact. As a result, local authorities will protect counterfeiters and local people will protest or even demonstrate against enforcement measures to protect their jobs (see 4.2.3.2).

⁶ A colourful example is cited by CIB (2004, p. 19). A village near Shanghai is mentioned where over 10.000 people directly or indirectly work in the counterfeiting businesses, making handbags and leather goods.

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3.2.2 Positive Impacts for Development and Innovation

(1) History has shown, that counterfeiting and imitation was prevalent at a certain stage of development in nearly all developed countries (McDonald, Roberts, 1994, p. 61). McDonald and Roberts (McDonald, Roberts, 1994, p. 61) state that:

“Each country has resorted to imitation and piracy as one strategy on the road to home grown innovation.”

They argue, that the experience and the gained skills from producing counterfeits have supported or were even necessary constituents for the emergence of their own developments and innovations. Imitation is seen as a learning process.

The Commission on Intellectual Property Rights (CIPR, 2003, p. 6) introduces similar aspects. They cite the view of the developing world, which sees IPR as an obstacle for the development of their local industry and technology. In their view, the concept of property rights, only benefits the interests of the developed world and its MNC (cf. CIPR, 2003 and Steidlmeier, 1993). One of the main arguments is that innovation would not increase even with a sophisticated IPR regime, because fundamental human and technical capacity is absent (CIPR, 2003, p. 8). Zhang, G. (2005, p. 21) also mentions the problem of a missing scientific community, which makes innovation driven development difficult.

(2) Another point is that certain limitations of use, such as patents, increase the costs of medicine or fertilizers which are urgently needed by patients or farmers (CIPR, 2003, p. 8; cf. Steidlmeier, 1993). The CIPR comes to the conclusion that the protection of IPRs need to be adjusted to the specific circumstances and development level of a country. An IPR protection regime thus needs to be subordinated to fundamental human rights. Especially in the case of drugs and medicine preventative IPRs are problematic (CIPR, 2003, p. 10).

The remarks gathered have shown that the accumulation of knowledge by imitating products can be important to certain countries. Also the counterfeit e.g. the product itself may help to decrease certain problems. Since these findings may be an argument to ignore IPR infringement, they need to be examined towards transferability into the Chinese context. One main question is, if imitation and counterfeiting a necessary basis for development in China? On the one hand, other Asian countries like Japan, South Korea or Singapore had a period of increased imitation (McDonald, Roberts, 1994, p. 61). Consequently, one may suggest that China is currently at this stage.