The China question: IT concerns

Breaking down the barriers to doing business with China has long been a priority of U.S. technology companies. Recent tension over the spy plane collision, however, may make them the next victim of political fall-out.

Just months after celebrating a hard-fought congressional vote to expand trade with China, technology and Internet companies now fear they could be the next victims of the political fallout from increasing tensions over the spy plane collision and President George W. Bush's offer to sell Taiwan a huge arms package.

In this story, you will find:
  Hard won gains
  Losing grounds
  Mother lode for future growth
  Fastest growing market
  Tough battles ahead?

Lawmakers next month must decide whether or not to continue China's preferential trade status. Many computer, electronic commerce, software and telecommunications companies see China as a key and largely untapped market. And, as anti-China sentiment grows, they worry that gains they have made in recent years could be set back.

"We're very nervous going into June," said Grant Seiffert, vice president for government relations at the Telecommunications Industry Association.

Is U.S. technology firms at risk of losing the Chinese market? YES

A worst-case scenario would be an all-out trade war that impacts technology companies' ability to compete in the huge and growing Chinese market, and inflates the costs of Chinese-made information technology (IT) and electronics products.

"Our sales would evaporate immediately and there would be significant costs, not just in terms of lost exports, but on the import side as well," said one technology company lobbyist who would comment on the tenuous situation only on condition of anonymity.

Although such a turn of events is still considered unlikely, anti-China forces may take aim at legislation dealing with export controls over encryption, powerful computers and other technology.

And the increased rhetoric in Washington alone could make it more difficult for American companies doing business in a country already rife with poorly defined rules and regulations on everything from telecommunications to advertising to content.

Breaking down the barriers to doing business with China has long been a priority of U.S. technology companies. Over the past few years, the industry has made gradual but substantial progress in opening trade and loosening export controls on technology.

The Clinton administration, in a series of executive actions, loosened restrictions on exports to China and other countries of so-called dual-use technologies - strong encryption and powerful computers that traditionally were used only for military and intelligence, but are now increasingly used for business and consumer applications.

Then last year, after intense lobbying by the technology sector, Congress narrowly voted to grant China permanent normal trade relations, which would eliminate the need for an annual vote by Congress to provide China with the preferential trade treatment the U.S. grants to most countries. PNTR, as it is known in Washington, was the only concession the U.S. had to make in order to enjoy the benefits of the landmark bilateral trade agreement it negotiated with China as part of China's entrance into the World Trade Organization.

Getting Congress to approve PNTR, however, was tough for Clinton and its supporters, and it won't take effect until China finalizes negotiations on the terms of its WTO entrance.

That's not expected to happen until later this year, which means Bush must notify Congress by June 3 if he intends to renew China's normal trade relations (NTR) status for another year, a move he is expected to make. Congress will then have 90 days to try to pass legislation to block the move if it so chooses.

Computer, software and telecommunications companies are eager to resolve all the issues so they can enjoy much greater access to the world's most populous nation and narrow the huge trade deficit the U.S. has with China.

In 1999, China shipped $19.8 billion in IT and electronic products - such as computers, telecommunications equipment and consumer electronics - to the U.S., compared with $3.3 billion in such exports from the U.S. to China, according to AeA, formerly known as the American Electronics Association. Besides driving up the cost of imports from China, denial of NTR could spark a retaliatory response against U.S. products.

China is already one of the fastest-growing markets for technology goods - it increased 40 percent between 1999 and 2000 - and is expected to become one of the top markets for computers and cell phones.

"Our relationship between China and the U.S. is of paramount importance," said John Chen, president and CEO of software maker Sybase, which has extensive operations in China. "It's not only important to Sybase, but it's definitely important to the entire software industry."

But many worry that these hard-won gains could be threatened by the political dispute that has erupted in the wake of the April 1 collision between a U.S. spy plane and a Chinese jet fighter.

Although China released the crew after 11 days, its refusal to release the plane itself has given new ammunition to members of Congress critical of China. Tensions could be exacerbated by Bush's decision last week to approve the sale of a large arms package to Taiwan. Also at issue is China's recent detention of some U.S. residents - intellectuals visiting their homeland.

"Generally these geopolitical disputes are potentially going to have a negative impact on important trade relations from both sides," said Harris Miller, president of the Information Technology Association of America. "Clearly, people in the U.S. Congress, and even some in the administration, are not real comfortable getting real close to China, and people in the Chinese government and military . . . have similar [concerns] with the U.S. We have to realize our relationship with China is always very tenuous."

Critics of China have already signaled that they will mount a new effort to deny China its annual NTR extension.

"This situation is indicative of the regard in which the Communist regime in China holds our government," said Rep. Duncan Hunter, R-Calif., in early April after he introduced a bill that would repeal normal trade relations for China. "The fact is, while we trade with China, they prepare for war."

Industry lobbyists said they are confident they can rebuff such moves as Hunter's. But they are bracing for anti-China amendments to other legislation.

Given the size of the market and the amount of modernizing to be done in the Chinese communications sector, U.S. technology companies have been eager to expand their reach in China.

"For a number of U.S. companies, particularly those in the high-tech area, China is the mother lode for future growth, and that's not going to change," said Ed Rice, president of the Coalition for Employment Through Exports and a former senior aide to the House International Relations Committee. "So it's extremely important that we make this work."

While most U.S. companies stand to gain from the bilateral trade deal that lowers tariffs and removes some distribution and other barriers to selling goods directly in China, technology companies in particular would benefit greatly from the agreement.

For example, China has agreed to sign the Information Technology Agreement, which would eliminate tariffs on things like computers and semiconductors by 2005. Tariffs on such products coming into China currently average about 13 percent.

Under the WTO deal, foreign companies will be able to provide a broad range of telecommunications services, including cellular and Internet services, and be allowed to invest directly - up to 50 percent for some services - in Chinese telecommunications and Internet service companies.

As a member of the WTO, China also will be subject to an agreement that sets minimum standards for intellectual property enforcement. While industry officials said China has made much progress in tackling the problem, in 1999 the country had a piracy rate of 91 percent for business software.

In addition, China will allow foreign companies to market their products directly to potential customers and has agreed to stop such practices as requiring companies to share technology with the government.

As the economy in the U.S. and other parts of the world cools, China's remains strong. The government recently reported that China's economy grew by 8 percent in the first quarter of 2001. Some of the growth is due to domestic spending by the government aimed at helping to insulate China's economy from the global downturn.

For American companies suffering from the tech slowdown at home, China is among the bright spots on the global horizon.

"To the extent that other markets are growing faster, it does make it even more important," said Jim Whittaker, director of international public policy at Hewlett-Packard. "It's one of the advantages of being able to operate on a global basis."

Some of the bigger and older technology companies, like HP, IBM and Motorola, have had research, sales and manufacturing operations in China for years, but are looking forward to having some of the restrictions and barriers removed or relaxed once China joins the WTO. HP, for example, employs 1,800 people and runs 14 sales offices and three manufacturing facilities; it makes some components in China that are shipped to the U.S.

William Reinsch, head of the National Foreign Trade Council and a former Commerce Department undersecretary for export administration, said China is particularly important for the technology industry because "that's the stuff they want."

Industry officials cite a plethora of statistics to back up their optimism. China's is the fastest-growing telecommunications market, and only 5 percent of it has been tapped, according to the Telecommunications Industry Association. The number of wireless phone users is expected to grow from about 50 million in 2000 to 170 million in 2005, according to the eAsia Report released by eMarketer, an Internet statistics and analysis firm, in February.

China is expected to be the third-largest market for personal computers by 2003 and the second-biggest market for semiconductors by 2010, technology industry analysis firm IDC predicted last year.

Despite its efforts to control the type of content Chinese citizens can access on the Internet, the government has encouraged the development of its communications sector and growth of the Internet, according to Nina Hachigian, a senior fellow at the Pacific Council on International Policy in Los Angeles.

Earlier this month, Zeng Peiyan, who heads China's State Development Planning Commission, was quoted by China's state-controlled Xinhua News Service as saying: "We believe that the rapid development of China's network economy and speedier process of informatization [sic] will inevitably create enormous business opportunities for both Chinese and foreign investors."

Total online revenue in China is projected to grow from an estimated $818 million in 2000 to $23 billion in 2004, according to eMarketer. Internet penetration is growing rapidly as well, up from fewer than 1 million users in 1997 to 22 million in 2000, according to figures provided by the Chinese government, though some private figures say the number of users is lower.

"I think there is a lot of B2B [business-to-business e-commerce] potential," Hachigian said.

Yet Hachigian and others are quick to note that a number of obstacles must be overcome if China is to reach such potential.

Several companies and analysts said one of the primary barriers to doing business in China is a lack of transparency in its regulatory system. They also point to unequal application of China's value-added taxes and requests for multiple testing of products and certifications by various ministries. For example, HP's Whittaker said, the Chinese now impose tariffs on his company's computers of between 9 percent and 15 percent, which inflates the costs of his products to Chinese consumers.

"The No. 1 problem in doing business in China is they have rules and regulations and interpretations that seem to change from day to day," Sybase's Chen said. "That's why we want to build up a relationship with them . . . [so they will] interpret them in your favor. That's always an issue for an American company."

Sybase has a major operation in China with 300 employees focused on selling to the government, and the railroad and tax agencies. Chen said his company has 28 percent of the database software market in China. But one of the reasons the company has not set up a manufacturing plant in China is concern over the protection of intellectual property, which Chen said he hopes will improve once China joins the WTO.

PricewaterhouseCoopers released a survey in January measuring "opacity" - the lack of "clear, accurate, formal, easily discernible and widely accepted practices in the world's capital markets." China finished last on indexes examining the opacity of the regulatory and legal environments of 35 countries.

"Anyone who has done business over there knows it is very diff-icult," Reinsch said. "You're dealing with people who are arbitrary under the best of circumstances. They don't have a lot of standards. When an incident comes along, it makes everyone nervous."

Chen and others said they expect the regulatory and legal environment will improve with China's accession to the WTO. China will be subject to the organization's rules, and other members will be able to bring a complaint before the WTO should China fail to live up to its obligations.

As China is "increasingly exposed to Western business methods and international competition, it will put increasing pressure on China to address all these issues, to remain competitive and attract foreign investment," said Timothy Bennett, AeA's senior vice president for international affairs and former senior official at the office of the U.S. Trade Representative.

Still, others noted that U.S. companies should not expect instant solutions and that the Chinese market should not be seen as an immediate cure for U.S. economic woes. For example, while many think of China as a giant market with more than 1.2 billion people, the true market is probably only 350 million, said Eddie Cheung, Asia analyst at eMarketer.

And those who followed the 1999 launch of the Chinese-language portal got a glimpse of how difficult launching in China could be. While optimistic about his company's fortunes, Daniel Mao, chief operating officer at Sina, said his firm faced several obstacles when it set up operations in China.

Given China's strict controls over content, Sina knew it needed a license for its site based in Beijing. But China had yet to develop regulations covering the Internet. Company officials didn't know where to go to obtain a license until China imposed some regulations in late 1999. Sina encountered a similar problem when it wanted to post advertising on its site. Chinese law requires advertisers to obtain a license, but there was no regulation that addressed online ads. To get around the problem, his company set up a separate ad company.

Mao said such inconveniences are understandable, and those who choose to set up shop in China must learn to be patient.

"It is a developing nation. While the infrastructure is improving, it's not to a level that the average American can enjoy," Mao said. He, like other executives of foreign-based companies doing business in China, was reluctant to directly criticize the Chinese government. "My take is very simple. If you don't want to make money there, you stay home."

Other obstacles to e-commerce in China include the lack of fixed telephone lines, the lack of credit cards and other payment methods for online purchases, and the lack of transportation. Cultural differences also hamper e-commerce, such as a desire by many Chinese to see a product before they buy it, Hachigian said.

"That's been the story - that it will be big market," said Jim Lucier, vice president and senior analyst at Prudential Securities. "The problem with that is poverty. There is still tremendous underdevelopment in central parts of the country."

Given the importance technology companies are placing on this market, however, it's no wonder business leaders are concerned about the potential fallout from any deterioration in U.S.-Chinese relations.

Some say there is reason to worry. PNTR only passed the House after months of lobbying by the business community and arm-twisting by the Clinton administration and Republican leaders in Congress, in the face of stiff opposition from labor, environmental and human rights groups.

Supporters argued that China's accession into the WTO provides an opportunity to level the playing field for U.S. companies currently denied the access to the Chinese market that Chinese products enjoy in the U.S.

With approval of PNTR under their belt, supporters of expanded trade with China were optimistic that they would have little trouble gaining support for a one-year extension of China's NTR status. In fact, Rep. Robert Matsui, D-Calif. - a senior member of the House Ways and Means Committee, which handles trade issues - said he had hoped that China's critics could be persuaded against offering a motion to block NTR this year.

Now, Matsui and others worry that some lawmakers who reluctantly voted for PNTR will switch sides.

"I thought before it would be easy and it would pass rather handily," Matsui said. Now he believes the House could actually vote against a one-year extension of NTR. He said it is essentially a "free vote" for House members because even if the House votes against NTR, it is highly unlikely the Senate will follow suit. And even if it does, Bush would most likely veto such a measure.

"It certainly stirred up some concerns . . . that some members of Congress had before they took a vote on China PNTR," Seiffert said.

Matsui and others said they are worried about the message such a vote would send to China.

"It throws a wrench in the entire trade negotiation process," said Dave McCurdy, a former Democratic member of the House who now heads the Electronic Industries Alliance.

While they expect a tougher fight, McCurdy and others said that at the end of the day they do not believe Congress will block an extension of NTR.

"There are plenty of things we can do to annoy [China] short of trade," such as pushing to deny Beijing's bid to host the 2008 Summer Olympics, said James Lewis, director of technology policy at the Center for Strategic and International Studies.

Still, China's detractors may have other targets, such as legislation to reauthorize the Export Administration Act, which is moving through the Senate. The bill outlines procedures for placing export controls on products that have both commercial and military uses, and could become a magnet for anti-China amendments.

"There's no question that this latest incident has provided fresh fodder for the people in Congress who are viscerally anti-China," said Rice of the Coalition for Employment Through Exports. "I think it's inevitable that we will see anti-China amendments pop up later this spring and into the summer."

Senate Intelligence Committee Chairman Richard Shelby, R-Ala., was one of a handful of senators who blocked the export bill from coming to the Senate floor last week, saying it was the wrong time to bring this measure to the floor given the heightened tensions with China. "I'm sure the Chinese leaderhship can't believe its luck," Shelby said. "The Senate is now rushing to open the floodgates for technology [China] needs to upgrade its military."

"Is it one more arrow in the sling of those who say you can't deal with China?" Yes, McCurdy said. But he added: "Do I believe it will stop them [the Export Administration Act or NTR]? No."