Issue No.02 - March/April (2005 vol.22)
Published by the IEEE Computer Society
DOI Bookmark: http://doi.ieeecomputersociety.org/10.1109/MS.2005.41
<div>Enter the Protectionist Dragon? China's software and standards policies stir debate and reflection</div> <div>Greg Goth</div> <p>To encourage the domestic software industry's development, Chinese policy makers have written a series of regulations in the past five years. These give Chinese software developers tax incentives and mandate that government buyers give preference to domestic software. These regulations also encourage the development of open source software over proprietary software. These policies have precipitated concern and criticism from China's trading partners.</p> <p>At the heart of the debate lie two perceptions of how to achieve market equilibrium. The rules of the game are changing fast, and the entrenched bureaucratic way of running the Chinese economy is butting against the imperatives of the global marketplace.</p> <p></p> <p>The Software Drain: Outdated Software Costs Companies Millions <div>Benjamin Alfonsi</div></p> <p>While it might sound like an IT urban legend, the "software drain" is a very real phenomenon according to a recent report by the Business Performance Management Forum. The report is based on a survey of 226 US-based IT professionals and C-level executives (CEOs, CFOs, CIOs, CTOs) conducted in the third quarter of 2004. Respondents ranged from small and mid-market businesses to global corporations; about a quarter were companies with revenues of US$500 million or more.</p><p>Among the findings, seventy percent of the respondents reported having redundant or outmoded software applications, and 73 percent said they have no mechanism in place to combat the problem. Of these, 44 percent estimate that such applications consume more than a tenth of their company's IT budget.</p>
China's economy holds perhaps the greatest opportunities in the world in the coming decades. The makers of all sorts of goods, from soda pop to software, are positioning themselves to take advantage of the projected phenomenal growth of the Chinese marketplace.
Since its economic reforms of the late 1970s, China has made huge strides in becoming a strongpoint for manufacturing and assembling goods to be sold worldwide. However, it has struggled to join the world's software development leaders. To encourage the domestic software industry's development, Chinese policy makers have written a series of regulations in the past five years. These give Chinese software developers tax incentives and mandate that government buyers give preference to domestic software. These regulations also encourage the development of open source software over proprietary software.
Two of the most notable of these regulations are State Council Document Number 18 ( www.csia.org.cn/chinese_en/index/No18Document.html), published in 2000, which expressly addresses the software industry, and the Government Procurement Law of 2002, which pertains to an overall government procurement agenda.
These policies have precipitated concern and criticism from China's trading partners. Two of the latest flash points in this continuing disagreement occurred late in 2004. On 8 November, the Ministry of Information Industry (MII), which oversees the software sector, and the Ministry of Finance drafted implementation rules for government software procurement. The document is a sector-specific reinforcement of the wider procurement law, reportedly worded so as to compel public-sector software purchases to be domestically produced. Just three weeks later, the Beijing municipal government canceled a US$3.5 million contract with Microsoft after central government officials and senior members of the Chinese computing community complained.
The Balancing Act
At the heart of the debate lie two perceptions of how to achieve market equilibrium. On the one hand, China's foreign trading partners claim that the rules mandating government offices "buy Chinese" violate the contemporary technology-neutral spirit of a level playing field. On the other, scholars and business leaders intimately involved in the Chinese market say the Chinese government might also believe the playing field has been tilted in favor of deep-pocketed multinational firms for too long, and this is a way to level it.
"I think each side is aware of the problems the other side faces, and is sympathetic to them, but we have two different sets of constraints," says Anne Stevenson-Yang, managing director of the Beijing-based US Information Technology Office (USITO), a private, nonprofit organization representing six US industry trade associations and advocating trade policies that open China to US-based high-tech firms. "The way the Chinese government is constructed, its officials are responsible for specific industries and for particular industry targets, often expressed in revenue amounts. So you have a kind of apple-and-orange situation, where bureaucrats are being rewarded for creating revenue growth in an industry, and it's kind of irrelevant whether that growth is really healthy for the industry or not."
Yet one Chinese software executive says perceiving the Chinese software market as a monochrome slate that a central ministry dictates to is erroneous. From what he can see, official policy and reality aren't always in sync.
"It's much more complex than that," says CEO Gus Tsao of Evermore Software, based in Wuxi City, near the central Chinese coast. Evermore's integrated office suite is a "strong second" to Microsoft in sales and number of users in China. "On one hand, they want to attract foreign investment. On the other hand, the Chinese government—some of the people, not all of the people—thinks the development of the domestic software industry is vital. Some others don't think it's that important. It depends who's in which position and they all do things differently. That's why the market is really chaos right now."
Richard P. Suttmeier, a University of Oregon political science professor who has published extensively on the Chinese technology economy, says the rules of the game are changing fast, and the entrenched bureaucratic way of running the Chinese economy is butting against the imperatives of the global marketplace.
Suttmeier says the high-tech Chinese economy today is a mixture of state-owned firms, research institute spinoffs, and domestic and multinational private-sector players. This mix is far removed from the centrally planned structure on which modern China's political economy was based.
"You see a place very much in transition," Suttmeier says. "You have lots of diversity there, and that is changing the nature of government–industry relations."
History Is Key to Understanding
A comparison of the history of the US and Chinese computer industries might help explain the situation's complexities. The US-based computing infrastructure was building its base in the 1960s with groundbreaking architectures such as the IBM System 360 and with legal precedents such as the Justice Department's antitrust suit forcing IBM to unbundle its applications, languages, and systems software. China, meanwhile, was undergoing years of political upheaval in the advent and aftermath of the Cultural Revolution, roughly from 1958 until 1976.
Suttmeier, in a coauthored article published by the National Bureau for Asian Research in May 2004, argued that the wellspring of China's emergence as a potential global technological competitor didn't occur until 1978, when Deng Xiaoping announced policy commitments at the National Science Conference ( www.nbr.org/publications/specialreport/pdf/SR7.pdf).
In the intervening years, China's new emphasis on technology has yielded impressive results when compared to what existed prior to the 1978 initiatives. For example, according to statistics compiled by Liu Xielin of the National Research Center for Science and Technology for Development in Beijing, the Chinese software industry accounted for sales of just half a billion yuan in 1991. By 2002, those figures had increased to 110 billion yuan, or about US$13.3 billion. Yet on a percentage basis, China still lagged far behind the US. In 2002, the Chinese software industry accounted for just 1.9 percent of the global software market, compared with 40 percent for the US-based industry ( www.iipi.org/activities/forums/softwareconference/Liu%20Paper.pdf).
Suttmeier says that the argument over state-controlled policies versus a market-based approach might split Chinese officials and technologists who look back on their country's earlier military and strategic research advances from opposite points of view—either as indicators of China's ability to "go it alone" or as a mistake that focused innovation too narrowly with little societal benefit.
Suttmeier contends that comparative analysis of the Chinese and Japanese electronics industries over a 40-year period would show many of the Chinese advances occurred in almost exclusively military and strategic programs. These programs, he says, showed no economically beneficial diffusion into nonstrategic or civilian arenas and actually hindered the industry's wider development.
LATE TO MARKET, RUNNING TO CATCH UP
Once China opened its borders to global partnerships, it rapidly became a center for low-cost manufacturing of high-end goods. Yet this success also taught Chinese leaders that an assembly shop, no matter how skilled, didn't produce the most lucrative rewards possible. Those are reserved for the companies that have either capitalized on global standards by capturing the largest share of the market or those that have produced a proprietary technology that became a de facto standard, such as Windows. Suttmeier cites one report estimating 50 to 70 percent of the manufacturing costs of a Chinese-made PC go to license fees paid to Intel and Microsoft.
In reaction and in an effort to bolster Chinese products' value in the huge domestic market, the Chinese technology community has also tried to create its own standards—ranging from wireless LAN security to perhaps a Chinese-specific Linux kernel—that differ from their global counterparts. In the case of the wireless LAN security standard, which differed from the globally accepted technology for the 802.11 protocol, Chinese policy makers pushed the matter to the limit before agreeing to delay deploying their standard indefinitely under intense pressure from the US government in April 2004.
Like Suttmeier, Mark Bohannon, senior vice president and general counsel at the Software and Information Industry Association, believes that a handful of private Chinese developers are exploiting the "buy Chinese" drive and separate-standards approach to create a sizable market wedge for themselves. Both Suttmeier and Evermore CEO Tsao say an attempt to create separate Chinese standards could backfire. Instead of compelling global competitors to develop either a unilateral Chinese standard or separate products for the Chinese and global markets, the policy could force Chinese companies to abandon cost-efficient global development and marketing efforts.
"An operating system is a standard platform," Tsao says. "For example, we had to test 38 operating systems two years ago when we were readying our product for market, counting criteria such as languages, versions, and then the different systems themselves, such as Windows and Linux. Our testing problem is growing exponentially. If they don't abide by the international standards, we will have [quite] a problem to work with the office system." Of course, anecdotal advice such as Tsao's might not convince state policy makers of the perilous direction a separate standards and development track could lead to.
A domestic-preference approach clearly runs counter to both the spirit and the letter of the contemporary global marketplace. This sentiment is written in the World Trade Organization's Government Procurement Agreement. China, although a WTO member, has yet to sign the agreement and can thus escape official censure for promulgating the domestic-only policy—for the near term, at least.
Laura DiDio, senior analyst for the technology consulting firm Yankee Group, says the Chinese reluctance to sign the global procurement agreement might not win them popularity votes but has enabled them to establish their policies without too much hindrance.
"From their standpoint, I think it's been wise because it's worked for them so far," she says.
THINGS AREN'T ALWAYS WHAT THEY SEEM
Despite the concern the domestic-preference policies have caused, China's software market remains a picture of ambiguity and improvisation.
Tsao, whose company recently landed five lucrative contracts for provincial-education deployments, says Beijing's recent cancellation of the Microsoft contract shouldn't be read to mean Windows is no longer an option for the Chinese public sector.
"The MII, according to our knowledge, has a recommended software list, and Microsoft products are listed," Tsao says. "So that has confused local government agencies. And that's really to Microsoft's advantage. A lot of people we talk to said before they received the list, they knew to buy domestic software, but now they're confused because of this."
Tsao says Microsoft still holds an advantage over Chinese competitors despite official policy. The reason, according to Tsao, is the years of investment and effort Microsoft has spent in the Chinese market. This effort has paid off with valuable connections, or guanxi.
"Microsoft is very well known, and they have lots of people and money," Tsao says. "They have developed a relationship over the longer term; we have not."
For example, he says, the CEO of Microsoft's China operations, Tim Chen, was once president of Motorola China and has extensive resources and relationships Tsao can't match.
"He can literally go to any provincial governor's office and see the governor if he requests it, and I can't," says Tsao. "You can tell there's a difference there."
To illustrate how complex and confusing the situation is, no one outside the MII has been able to deconstruct the most recent regulations point by point, as the draft itself hasn't been released. The ministry has released only a summary.
"Even that they were very anxious about," USITO's Stevenson-Yang says. "They gave us a brief summary of key points and they didn't want it to get to the press. Actually, this has been a more transparent process than you normally get. In the Chinese system, having any input into regulations is a privilege, not a right. So they consider that they're already being pretty nice to us. They're kind of stuck between a rock and a hard place. It's reasonable for the government to want to make a procurement policy that would promote their own industry, but they can't figure out a way that will work."
In the interim, multinational firms are bolstering their Chinese investments to meet the government criteria already in place. Just three days after the MII drafted the procurement regulations, the Chinese government recognized US-based Computer Associates as the first multinational vendor to be granted official "Software Enterprise" status for 2004. The designation will grant CA benefits under Document 18's rules. Those benefits refund a portion of the 17 percent value-added tax, give the company priority consideration for government agency purchasing, and refund income taxes for senior management and technical employees to bolster recruiting and retention efforts. Agnes Wan, CA's director of marketing in China, says the designation recognizes the company's concerted efforts to improve China's software industry.
"We established ourselves in China in 1995 and registered locally in 1998," Wan says. In 2003, the company opened an R&D facility, the China Technology Center. It's also a member of the China Software Industry Association.
"We see ourselves as a local company. We are committed to the Chinese market," Wan says. "We will try our best to support government initiatives."
Those with a stake in the discussion should bear the complexities of the Chinese market in mind, Suttmeier says, and not look for a sweeping clear-cut agreement. Mutually acceptable equilibrium will be achieved in a series of small steps, he says.
"That will be an ongoing conversation, and it's probably going to work itself out in different ways at different times."