The Coming Trade War
Henry C.K. Liu

Part I:   The Coming Trade War and Global Depression
Part II:  Dollar Hegemony Against Sovereign Credit
Part III: Trade in the Age of Overcapacity
Part IV: Scarcity Economics and Overcapacity

Part V: Trade Related Aspects of Intellectual Property Rights (TRIPS)

This article appeared in AToL on August 5, 2005

Property rights are a social institution, not a natural phenomenon.  Intellectual property is an invention of the knowledge-based economy. Both free traders and protectionists in the US agree on the need to protect US intellectual property (IP) rights globally in general and in China especially. Of course a protectionist regime has less, if any, leverage at its disposal for combating the violation of intellectual property rights outside its borders. The Uruguay Round in 1986 produced the WTO Trade Related Aspects of Intellectual Property Rights (TRIPS) agreement.  It is supposed to be an attempt to narrow the discrepancy in ways these rights are protected in different countries around the world, and to bring them under common international rules. It establishes minimum levels of protection that each government has to give to the intellectual property of fellow WTO members. In doing so, it attempts to strike a balance between the long term benefits and inevitable short term costs to global society at large. Society benefits in the long term when IP protection encourages creation and invention, especially after the limited period of protection expires and the creations and inventions enter the public domain. National governments are allowed to reduce any short term costs through various exceptions, for example to tackle critical time-sensitive public health problems. The WTO dispute settlement system is designed to settle international trade disputes over IP rights before such disputes translate into political tension.

Yet ideas and knowledge are increasingly important, even dominant, parts of trade. Because technological underdevelopment in many countries is traceable to the historical legacy of Western imperialism, TRIPS can be viewed as condoning hidden trade-restricting tariffs imposed on the world by the technologically-advanced economies to perpetuate cultural imperialism. Prices of goods that carry IP rights invariably enjoy astronomical margins of profit over production cost. This high margin is rationalized by the claim that most of the cost of new medicines and other high technology products lie in the amount of invention, innovation, research, design and testing involved, not production cost.

The current high margin is designed to not only repay past research and development costs, but to finance on-going such costs to sustain an uninterrupted future stream of inventions. This means the technology gap between rich and poor economies will be widened with time under TRIPS. Only established mega drug companies operating with a de facto economic monopoly through astronomical price mark-ups can afford to develop new drugs. With all the talk about the need for competition policy, IP rights protection is shaping up to be the most anti-competitive regime in world trade. Further, in many advanced economies, such research and development costs are subsidized by government funding or tax deductions, paid for by the general public. Yet patent earnings seldom, if ever, flow back into private bank accounts of individual taxpayers in the form of tax rebates.

Films, music recordings, books, computer software and on-line services are bought because of the information and creativity they contain, not because of the plastic, metal or paper used to make them. The cost of material and printing is a miniscule part of the price of these products.  The bulk of the price goes to pay for advertising, distribution and only finally fees for licensing IP rights of the creators. Much of the revenue from IP rights goes to middleman organizations rather than original creators, weakening the argument that its protection encourages invention

Many products that used to be traded as low-tech goods or basic commodities now contain a higher proportion of invention and design in their value - for example brand-name clothing or genetically-modified new varieties of plants and produce. Creators are given the right to prevent others from using their inventions, designs or other creations - and to demand payment in return for others using them. These “intellectual property rights” take a number of forms. For example, books, paintings and films come under copyright; inventions can be patented; brand names and product logos can be registered as trademarks; and so on. Governments have given creators these rights as incentives for producing ideas that will benefit society as a whole.

But often, intellectual property rights are abused to protect trade-restraining monopolies. In such cases, both the definition of intellectual property and the enforcement of its protection can be unjust and oppressive. When copies of Louis Vuitton bags of same quality can be sold at a fraction of the price of the original at a profit, it is empirical evidence that the profit margin of the original is excessive. If the copies are of inferior quality, then they are caricatures and arguably not a violation of intellectual property rights. Fakes that are sold as fakes do not qualify as theft of the original. It is not illegal in any country to sell copies of the Mona Lisa as copies. The reason behind widespread intellectual property rights violation is because unjust and oppressive laws invite popular resistance.

The extent of protection and enforcement of intellectual property rights varies widely around the world according to varying stages of economic development in different countries.  As intellectual property became more important in trade, these differences became a source of tension in international economic relations. New internationally-agreed trade rules for intellectual property rights are supposed to be a way to introduce more order and predictability, and for disputes to be settled more systematically before they translate into political tensions. But they can also be viewed as a new form of rule-based knowledge imperialism.  There exist an inherent inconsistency and conflict of interest for an industrial standard to claim protection of intellectual property rights because the condition for being accepted as industry standard is that all in the industry can use it freely. An industry standard that demands payment of fees for its use is a monopoly.

The argument that protection of intellectual property rights is indispensable for economic growth has no basis in history. The socio-economic and political history of the US was shaped by the widespread piracy of a simple pattern held by Eli Whitney (1765-1825) on the cotton gin, the widespread use of which had immense socio-economic and political repercussions. Little cotton had been produced in America prior to 1793. During the colonial period, the main crop was tobacco, but tobacco farming had ceased to be profitable as a result of soil exhaustion. The tedious process of separating short cotton fiber from the seeds had to be done by hand and took too much time to be profitable even in a slave economy. A few planters grew a long-staple strain called Sea Island cotton that was easier to separate, but this only grows in coastal areas, not inland, where only short-staple cotton can be grown. Whitney’s cotton gin made it possible to grow short-staple cotton inland for profit. The cotton kingdom then stretched quickly over a vast area from Georgia and South Carolina westward as far as Texas. With the growth of the British textile industry, cotton growers in the US were assured of a market for all they could produce. But cotton growing was labor-intensive, which perpetuated the south's slavery economy, which until the arrival of the cotton gin was fading as an economic institution because of a dwindling need for cheap labor. Also, cotton, unlike rice and sugar, was a more democratic crop, being equally profitable for large landowners with hundreds of slaves and for small farmers with a couple of hundred acres and two or three slaves. Right up to the Civil War, half of the cotton was grown by small farmers with fewer than six slaves each. The widespread piracy of the cotton gin pattern created a socio-economic condition that became one of the key causes of the Civil War.  Thus for the South, the civil war was in essence a people’s war against the big business interests of the North.

In recent years, the US judiciary and some highly-placed US government economists have been claiming that in the knowledge-based economy, antitrust laws may threaten economic liberty, turning antitrust on its head. The US Appeals Court’s decision (District of Columbia circuit) on Microsoft in July 2001 raised the issue with timely urgency. The justices acknowledged that tying browsers (Internet Explorer) or other add-on programs to computer operating systems (DOS-based Windows) may not be bad for economic freedom. The court, while upholding a lower court’s finding that Microsoft had engaged in unlawful monopolistic acts, said broadly that it is unclear how the “current monopolization doctrine should be amended to account for competition in technologically dynamic markets.” And given these conditions of uncertainty, courts must demand “considerable experience with certain business relationships,” such as software packages that bundle services together, before jumping to the conclusion that they are unlawful. The court said that in the future, all cases of tying involving platform software (upon which other computer programmers build) should be judged by a higher standard of proof.

Existing antitrust law requires only the "per se" test, which merely requires proof of the existence of a tie involving a dominant producer. But the court now says that platform-software cases must be judged by the “rule of reason,” which requires courts to balance the pro-competitive aspects of the tie against the anti-competitive ones. The new standard will almost certainly make it harder for government regulators to prove illegal tying in platform-software cases. This may make it easier for software firms to defend themselves when they bundle services together and offer them as one product. Thus whichever firm manages to establish an “industry standard” in one module can force the market to accept its bundling in a clearly anti-competitive manner.

The court defended its deliberate indecisiveness at least partly on the grounds that no one else had yet decided how the monopolization doctrines of the old economy should apply to the new. It feared that a ban on bundling, unless carefully considered, might “stunt valuable innovation.” And in general, the court noted, “we decide this case against a backdrop of significant debate among academics and practitioners over the extent to which ‘old economy’ monopolization doctrines should apply to firms competing in dynamic technological markets characterized by network effects.”

While the market has decidedly punctured the myth of the new economy being exempt from laws of financial gravity, the court appears to be still a willing victim of self-delusion. Microsoft's operating system, the cumbersome and memory-gluttonous DOS, aside being a long way from the most innovative, became the industry standard by its dubious grafting on to Windows, which was not an original Microsoft innovation but somehow became Microsoft’s legal intellectual property. Moreover, the fee charged by Microsoft for Windows is outrageously excessive compared with typical pattern fees. Microsoft does not merely demand a copyright fee for the use of its pattern, it forbids all others from manufacturing Windows, which must be bought from Microsoft as a product, additional copies of which Microsoft can produce with no significant additional cost.

In some markets, customers might in fact want one company to dominate because if it does, it will set a standard everyone can follow and that will make the product more valuable to all. The court's difficulty was that no one knew how to apply antitrust principles to such markets. But an industry-standard operating system for computers is very similar to an industry-standard gauge of railways. Should the company that adopted a gauge that became the industry standard be permitted to prevent other firms from manufacturing rolling stock of the gauge without paying the company a fee?

The court cited the overused example of the traditional telephone system. The more people who subscribe to it, the more calls all consumers may make or receive. Each individual phone user thus benefits from the network in proportion to the number of other people who use it. Once a product like that, or a standard, achieves such wide acceptance, consumers definitely want the supplier of that product to be bigger rather than smaller. Under those circumstances, antitrust laws should intervene only cautiously, to avoid making matters worse for the consumer. But this is a confused argument. The issue is not that industry standards are themselves anti-competitive. The issue is that a single firm’s ownership of industry standards is anti-competitive. The law should recognize that the benefits of being an industry standard must be balanced by responsibilities and obligations to the industry and the community at large.

For example, the Queen’s English has become the international language of finance. Should all bankers and financiers pay a fee to the Queen of England for the use of her language in loan documents? Industry standards imply socialization. It is a very sound principle that if a standard is adopted industry-wide, that standard is owned by all users and must be freely available to all. Microsoft can bundle all it wants to serve the public better, but it should then make Windows free to all users and charge only for its new add-ons to compete with those offered by other firms.

The court concluded, amazingly, that in the end, the goal of US competition law is not to promote competition for its own sake but to promote efficiency. This is a very peculiar attitude for an US court, for the whole US argument against monopolistic planned economy is its alleged inefficiency. Larry Summers, former US Treasury secretary and now president of Harvard University, when he spoke to antitrust lawyers at a 2001 meeting of the American Bar Association was at pain to stress the point that monopolies may be good. “First, do no harm,” he advised, borrowing from the Hippocratic Oath. Where the need for common standards naturally leads to monopoly power, he argued, antitrust enforcement actions may divide those markets in ways that will harm efficiency and the consumer. “We shouldn’t jump too quickly to the conclusion that because something increases competition it is necessarily good,” he said. But that is a socialist argument against a competitive society versus a cooperative society. Funny he did not say anything against the deregulation of airlines and energy. “The nature of competition is going to shift in the knowledge-based economy. The real question is whether there will be an enduring monopoly in something that is inferior,” he said, adding that the history of the software market made that seem unlikely. Unlikely? The DOS-based Windows software is universally considered by programmers as a grossly inferior product; the only advantage in using it is that it is an industry standard.

For neo-liberals, the only time a monopoly is good for the consuming public is when the entire industry has become uneconomic by deregulation, such the rail industry. Unfortunately, this is becoming commonplace in energy, air transportation, health services, telecommunications and the entire new economy. There is no data to support the contention that Microsoft bundling has been good for consumers. It has been good only for Microsoft.  Microsoft has spent more than $3 billion in recent years settling lawsuits by rivals, including a $1.6 billion deal with Sun Microsystems Inc. in 2004 and a $750 million truce with America Online, now part of Time Warner Inc., in 2003.  In a settlement announced on June 30, 2005, IBM will get $775 million in cash and $75 million worth of software from Microsoft to settle claims still lingering from the federal government’s antitrust case against Microsoft.

The Agreement on TRIPS, the subject of Annex 1C of the agreement establishing the World Trade Organization, is the latest translation of cultural imperialism into economic imperialism on a global scale. The Schumpetrean "creative destruction" that US Fed Chairman Alan Greenspan tirelessly celebrates, is increasing distorted from the specific idea of a better mouse trap, to the systemic appropriation of the broad notion linking mice to traps. In the US, the self-proclaimed bastion of democracy, the creative destruction of economic democracy through the rule of law is in full force. Not only do the poor economies not have a fighting chance under TRIPS, even the people in the advanced economies are quietly put in technological servitude by the new patent regime.  The notion that an individual should be granted permission to stake a personal claim on a nation’s natural resource (such as gold, oil and other mineral rights) is undemocratic enough, but now intellectual property rights are defined way beyond any reasonable personal efforts, such as writing a book or a symphony (covered under copyrights), to thoughts while shaving that really amount to wholesale robbery from the public domain. On a corporate level, intellectual property rights has become an economic weapon of mass destruction, preventing creativity from ever seeing sunlight. US annual revenue from patent licenses now exceeds $100 billion, which is larger than the foreign exchange reserves of most countries.  Through TRIPS, US patents gain global status without the burden of sharing patent fees with other governments.

Patents originally were intended to protect the lone inventor, the pioneering genius in a garage, against the predatory exploitation of big companies. In today’s reality, the opposite is usually the case. As basic industries such as electricity, telecommunication and broadcasting developed in the 20th century, the great corporations learned to create arsenals of interrelated patents to use as sword and shield by systemic patent. The recent advertisement campaign of Mercedes-Benz in the Wall Street Journal is built around a theme that there is only one Mercedes, the car with 10,000 plus patents.  Patent battles have become a strong catalyst for mergers, reducing competition in many domains. The largest corporations, with gigantic patent portfolios, routinely enter into cross-licensing agreements with their largest competitors.   Companies without portfolios of their own have to pay cash, representing a hidden tax within the high-tech economy.  And the costs are skyrocketing.  Revenues in the United States for patent licenses were about $15 billion in 1990; eight years later they had soared to more than $100 billion. In 1999, IBM alone took in well over $1 billion from licensing and received a record 2,756 new patents. MSFT’s revenue would dwindle by 80% if its patent and copyrights are suddenly invalidated. A Boeing software engineer has patented a basic method of correcting the century in dates stored in databases and sent a threatening form letter to 700 of the nation's largest corporations (including The New York Times), demanding one-fourth of a percent of their total revenues, on the assumption that they probably have used the same method.

The four key elements in the issue of fair value in global trade are IP, technology, information and pricing.  In classical exchange theory, price is determined by cost and demand which under free trade conditions will reach equilibrium to provide the optimum price and the largest sales. But free trade is a myth, and the US is the leading opponent of it in practice while being the leading proponent of it in rhetoric.

The rationale for IP protection is that it is needed to subsidize the coming stream of new technology.  But as the Microsoft anti-trust case demonstrates, IP inhibits new technology more than it is generally recognized.  The same is evident in medical drugs.  The only arena this inhibition does not exist is in military technology where the technological imperative still governs at the expense of price sensitivity. The fundamental criterion for a free market is the equal availability of information to all participants.  When information is packaged and sold as commodities, free market becomes the casualty. When two economies of uneven stages of technological development trade bilaterally, the concept of countervailing trade surplus in favor of the less advanced economy is simple justice.  Otherwise it would be structural economical imperialism.  More and more developing nations are finally taking this view in their trade negotiations with more advanced countries.

As for intellectual pirating, this is a serious and controversial issue. The reason it is so widely practiced by most less-advanced economies is that there is a widespread view that the current intellectual property rights regime is not fair toward late comers. China is only the latest to join the club. The US as a young nation participated fearlessly in intellectual piracy until it became technologically matured. The same is true with Japan, Korea and Taiwan.  Europe was notorious for its brazen theft of early technology from other cultures. To be fair, China should be entitled to claim retroactive IP rights on the compass, gunpowder, paper making, silk production, printing, etc., for a period of 50 years starting now, to compensate for her loss due to the absence of an international IP regime during her epoch of high inventiveness. The Arabs should be compensated for Arabian numerals without which modern mathematics would not develop. When a law is unjust, it invites widespread violation. How about an international affirmative action program for IP or IP amnesty for the underdeveloped Third World for 50 years? It will speed up global development and the advanced economies will also benefit more than they will lose as a result.

Next: Trade Wars lead to Shooting Wars