John Conroy, Chairman of the Executive Committee, Baker & McKenzie, LLP


Your Excellency, Mr. Mayor, Members of the Council, Ladies and Gentlemen,
I would first like to thank you for the opportunity to participate in the International Business Leaders Advisory Council.  This is my third opportunity to address the Council and I consider it a distinct honor to contribute to an event filled with such distinguished peers.

During my many visits to China and through the work that I have shared with my colleagues in the Beijing office of our firm, I am continually impressed with the vibrancy of your great city and its importance as the center of science, technology and innovation in China.  It is clear that Beijing now has the prerequisites to lead China’s national development strategy and its quest to strengthen capacity for indigenous innovation.

Given its highly-educated population, first-rate university and research systems, and relatively developed hi-tech business and production capacity, Beijing is ideally suited to be the most active center of innovation in China.  To establish and maintain its position in this regard, the government will need to consider bold measures, and to sustain those measures over an extended period.

Foreign investment in China and transfer of technology to Chinese companies over the past three decades has been one of the great success stories in China’s development and has led to localization of vast amounts of technology and development of many new products for China.
The development of new technologies and local enterprises that can create and commercialize them is critical to China’s future. 

China has already established itself as the “Factory to the World”, but China’s ability to generate sustainable and stable growth now depends on the ability of its citizens and enterprises to create new and advanced inventions and brands. The capacity of China to create truly advanced and world-class technology is now readily apparent, and this technology is already beginning to bring benefits to businesses and consumers worldwide.

Your government is already fully aware of the need for bold measures to promote indigenous innovation, incentives designed to promote greater foreign investment in high-tech sectors, and the establishment of new platforms for international cooperation.

With the forgoing in mind, I would like to make a few remarks regarding the specific challenges that our firm believes should be considered by municipal authorities as it pursues medium and long-term objectives for promoting indigenous innovation.

Technology Transfer

Before looking forward, it is instructive to look back on exactly how China and other developing countries have benefited from technology transfer regimes.

Previously China limited the duration of technology licenses to ten years, after which the licensee was free to use the licensed technology.  These durational limits were dropped in connection with to China’s accession to the WTO, and as a consequence, foreign companies have been much more willing to introduce higher-level technology to their joint ventures, OEM factory suppliers and other licensees in China. 

Increasing the flow of high-technology to China—whether through licensing or the establishment of R&D facilities—is of course good for China.  But the benefits do not arise from the high-technology itself.

Since China’s Open Door policy was introduced by Deng Xiaoping, the most valuable transfers of technology have arguably not been in the form of patented or other particularly advanced proprietary technology. Rather, the real benefits have been realized through the transfer or more basic know-how, including non-proprietary technology, management know-how and plain old “experience” which is transmitted as a part of technology licensing activity.

Chinese employees of  foreign invested enterprises have been able to bring this sort of non-proprietary—but critical—know-how with them to domestic enterprises, including start-up small and medium-sized enterprises (SMEs), thereby greatly accelerating the growth of high-tech domestic industries. 

Meanwhile, foreign companies have for many years been establishing R&D centers in China, in part to “localize” their products for the local market, but more generally to promote the creating of world-class new inventions by their Chinese partners and employees.  While these investments are continuing, query whether the Beijing government can attract even of such investments—both from abroad as well as from Chinese investors themselves—by developing more effective incentive and support programs.

Government Policies Favoring Domestic Indigenous Innovation
Beijing can benefit by bolder policies for encouraging indigenous innovation and related investment.  Such policies can be tailored to incentivize and reward innovation in a manner which does not appear to stifling competition from foreign enterprises. 

Just as Chinese companies should be free to invest in overseas enterprises, policies relating to innovation should have no borders.

As appropriately summarized by a speaker at a recent meeting of the Quality Brands Protection Committee , “…innovation is an important driver of economic growth, but it requires an environment where entrepreneurs, independent thinking and information exchange and cooperation are encouraged.”

Since 2006, new policies have been pursued by the Beijing government to encourage and support indigenous innovation, in part to make China less dependent on licensed foreign technology.  This push includes procurement rules which favor local enterprises as well as new financing schemes.

We understand that the national government is about to introduce further guidelines to promote indigenous innovation by giving preference to companies that create patented technologies in China.   These policies have met with deep concern among foreign industry associations and governments, and our clients have been pleased to note that the original proposals are being reconsidered.   Specifically, on April 10, 2010 the Ministry of Science and Technology, the National Development and Reform Commission and the Ministry of Finance jointly issued the Notice on Carrying out the Work of Determination of 2010 National Indigenous Innovation Products. This Notice revised the previously issued accreditation rules for indigenous innovation by requiring only that companies have the rights to use IP for the products produced in China rather than mandating full domestic ownership of IP.  This notice has addressed some of the concerns of foreign investors that China’s policy could discriminate against foreign invested enterprises and it is a step in the right direction, but it needs to be combined with proactive policies on non-discriminatory tax incentives and R&D support.

Though well-intended, the earlier proposals were perceived almost universally as a form of discrimination that could very well have a range of undesirable and even unintended consequences. It is therefore important that any future rules and policies seek to avoid the impression of discrimination—particularly where those rules and policies are not likely to bring the short and long-term benefits originally intended.

While domestic content requirements are a normal part of the government procurement policies of the US and many other countries, requiring domestic IP content is extremely unusual, and if pursued further in China, there is a risk that other governments and legislatures, including the US Congress, will seek to retaliate, thereby putting Chinese exporters at a significant disadvantage, and perhaps sparking a wider disputes over trade policies.

In the global economy foreign and Chinese companies need to have the ability sell products globally, so it is not practical to require domestic ownership of IP as a precondition to indigenous innovation status. These new indigenous innovation requirements could slow down the introduction of innovative products into China which in past years has mainly happened through the licensing of foreign technology. And this would have the effect of inhibiting rather than spurring domestic innovation.

Encryption Requirements for Software

Other government policies such as the planned implementation of new rules regarding encryption disclosure would also have a negative effect on innovation.  This is an area of proprietary commercial secrets and very few owners of valuable encryption items are comfortable entrusting their key products and technology (including software in source code form) to government agencies.

International Best Practices for Encouraging Innovation

Domestic industries have expressed concern about only being able to obtain certain technologies by means of licensing them from foreign technology providers and it appears that this is one of the main drivers behind China’s push for indigenous innovation.  But it is instructive to look at international best practices used to encourage innovation in other countries.  According to an overview of these practices prepared by the US-China Business Council , most countries use a combination of non-discriminatory tax incentives and R&D support to encourage innovation. 

In other developing countries there have been policy initiatives similar to those currently being contemplated by China and many countries have mandated local content norms for government procurement. But the key difference is that these initiatives don’t include the requirement that IP ownership be vested in the developing country.

Progress in Consolidating Rule of Law

A strong reputation for the “rule of law” is critical for attracting and retaining investment over the long term.  Hong Kong is one example in China where the rule of law is well-regarded.  Consequently, many investors establish their operations there and rely on the Hong Kong law, the courts and arbitration organs to deal with disputes.

Beijing courts have gradually improved their reputation for their ability to deal fairly and independently with complex disputes, thereby providing greater predictability for investors and traders and encouraging further investment. Query though what steps might be taken by the Beijing municipal government to further strengthen the reputation of Beijing courts.
Protecting Beijing’s Reputation for IP Protection

Perhaps the most important aspect of the rule of law that is relevant for indigenous innovation and investment is that relating to intellectual property (IP).  And experience suggests that the lack of faster progress in protecting IP rights will have a larger impact on Chinese products and brands than they will on foreign products and brands.

Even now, it widely understood that Chinese high-tech companies consciously invest less in R&D due to fears that trade secrets cannot be effectively protected, for example, in the context of employees that take secrets from their employer and exploit them elsewhere.

Experts, including professors, police and prosecutors in Beijing, have shared their views on the problem of trade secret protection with our firm’s lawyers and with industry associations in which we participate, and we understand the difficulty in pursuing more effective criminal enforcement relates to high standard of proof in the PRC Criminal Code.  Relevant provisions in the Code and judicial interpretations of the Supreme People’s Court require that, to pursue a case, evidence of harm to the trade secret owner exceeding RMB 500,000 must be proved.  By contrast, in most other countries, the mere theft of a trade secret can attract criminal as well as civil liability, thereby making it easier to pursue cases cost-effectively, and increasing the deterrent impact of the law.
While this points to a problem with national legislation which the Beijing city government may not be able to resolve, I wonder whether the Beijing government and representatives from Beijing at the NPC could take the lead in organizing research on these issues and submitting it to the NPC for its further consideration.

Addressing Perceived Weaknesses in IP Protection

The efforts over the last few years of the Beijing government and judicial authorities with respect to IP have also attracted public acclaim.  But as we all know, there is always more that governments and industry can do together to strengthen IP enforcement. 

Beijing administrative and judicial authorities are doing tremendous work in gradually improving IP protection for domestic and local inventors and brand owners.  Our firm’s clients have been particularly heartened by the innovative approaches to enforcement that have emerged from the Administrations for Industry and Commerce (AICs), Public Security Bureaux (PSBs), and courts in the Haidian District and the Chongwen District. There is a clear sense among our clients particularly in Haidian – China’s Silicon Valley – that local authorities understand the close link between IP protection, innovation, and economic development.

But the progress that is being made is being undermined by continuing blatant IP violations in retail and wholesale markets—including in the main shopping centers of Beijing, such as the Silk Market.  These problems do not relate to goods associated with high technology, but rather consumer goods such as mobile phones, fashion, footwear, cosmetics and other related items.  But the high profile of these violations—which are reported quite regularly in the Chinese and international press—undermine investor confidence in IP protection and the rule of law in Beijing.   

It must be acknowledged that counterfeiting of fashion and other consumer goods exists in many countries, including the United States.  But rarely does it occur in a major city, such as Beijing, on such a large and relatively organized scale. 

I appreciate that the government and the judiciary are applying a great deal of time and attention to these problems, and our clients in the consumer goods industries are increasingly confident that additional progress will be realized soon.  But accelerating efforts to control the problem would provide a much-needed boost to Beijing’s reputation among foreign as well as local investors regarding the seriousness of the municipal government towards IP protection.
Partnering with Industry

As the Beijing government develops new policies and action plans to promote investment in innovation and strengthen IP protection, foreign companies and law firms, such as Baker & McKenzie, are prepared to provide their experiences and recommendations as part of this policy making process.

As you know, foreign companies rely heavily on industry associations, including many with offices in China, to work cooperatively and transparently in gathering information, research and recommendations for government. Baker & McKenzie lawyers are involved in many such associations on a pro bono basis.

Conclusions

Just to sum up:

*To establish and maintain its position as the most active center of innovation in China the Beijing government will need to consider bold measures, and to sustain those measures over an extended period.

*Rather than relying on government mandated regulations, Beijing should encourage more true innovation by enterprises by providing more support to educational institutions and to high-tech industries.

*Consistent with international practice, efforts to promote innovation and investment in new technologies should be based on policies that set out a level playing field—one which encourages cooperation and alliances between Chinese and foreign technology companies, rather than dividing them..

*Beijing should also consider bolder steps to improve the rule of law, particularly with respect to IP protection, and to deal with enforcement challenges—such as those posed in small commodity markets in Beijing—which undermine the city’s reputation for IP protection. If more effective IP protection enforcement environment would be established, not only indigenous innovation but also introduction of innovative technologies from abroad would be encouraged.

*The role of foreign as well as local industry associations and experts should be harnessed more effectively to promote the goals of indigenous innovation.

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I present these comments in my capacity as an advisor to this council.  It will be my honor to assist the Mayor and the Beijing Municipal Government in any way I can to help ensure that my firm and the clients it represents do their part to help build up the city’s capacity for indigenous innovation and help Beijing further develop into a world class center of science, technology and innovation with international influence.

Our firm and the associations we work with would be pleased and honored to provide further information regarding the suggestions outlined above, including more detailed relevant information on international best practices.