Intellectual property and the trade deficit

While I was preparing the Carnival of the Liberated this morning I stumbled across this interesting morsel from Najma of A Star from Mosul:

Windows, Office, Norton AntiVirus and all of the other famous software that are expensive for normal people to buy are bought with what equals one dollar here.. No one buys an original copy, it’s only for the shop from which we buy the copies. I have nothing original at home among 100s of CDs, except for some drivers installations which are usually provided with the driver.

Lots of Americans aren’t aware of it but in much of the world—particularly in the Middle East and Asia—a CD store is a place where CD’s are copied for re-sale.

You don’t have to look too far to read articles whining about the U. S. trade deficit with the rest of the world. Here are two articles from today alone. The Reuters article has a typical comment:

“A currency revaluation cannot solve the trade deficit problem. The deficit is there because wages in China are $5 per day and in the U.S. $200 per day including benefits,” Duncan said ahead of the publication of an updated edition of his book.

We are running a trade deficit because our wages are too high; we are running a trade deficit because their wages are too low; we are running a trade deficit because our currency is overvalued; we are running a trade deficit because their currencies are undervalued; we are running a trade deficit because we’re buying too many foreign products. These would all be great answers if they were true. Let me add another explanation: we are running a trade deficit because we re-directed our economy away from producing hard goods and towards services and the production of intellectual property and the world is just full of people who don’t believe that intellectual property makes any sense. It’s like leaving a twenty dollar bill in the middle of the street—somebody is bound to come by and pick it up.

Take my favorite example, China. Almost all software in use in China is pirated:

Sell one operating system to every citizen in China and you could make some real money. But in China software is pirated, not sold legitimately. What’s a producer of intellectual property to do?

The future of business in China–and why it is both tantalizing and troublesome–is on display in Beijing at the bustling Hailong market, an elbow-your-way-in set of hundreds of stalls peddling computers and software. Just a ten-minute drive from the offices of Microsoft China, the market sells everything from ready-to-go laptops to motherboards, monitors and “mice” for the boldest shoppers bent on building a PC on the cheap.

At one busy table a Chinese-language version of Windows XP, Microsoft’s latest operating system, comes in a shrink-wrapped box with the familiar logo. The price–$245–amounts to four months’ salary for an average Chinese worker. Too steep? No problem. At a nearby stand a woman reaches under the counter to a tall stack of CDs on which XP has been illegally copied. Gentle bargaining brings the bootleg price down to $5.50.

That is the paradox of China for Microsoft (nasdaq: MSFT – news – people ). Like many U.S. companies, Microsoft is mesmerized by the dream of capturing its share of business here–if only it could overcome some rather monumental barriers. Piracy is rampant: More than 90% of the application software used here comes from illegal copies. It has been only 13 years since the nation adopted its first copyright law, and it later tightened the rules only reluctantly, mostly to win support for its admission to the World Trade Organization. Comfortably in WTO now and enjoying a $30.4 billion trade surplus with the U.S., China scarcely bothers to enforce the laws.

Nearly all music CD’s and movie DVD’s sold in China are pirated:

Rampant piracy in the Asia-Pacific region cost Hollywood’s leading studios more than $896m (£475m) in 2004, according to official figures just released.

Studio lobbyist the Motion Picture Association of America (MPAA) coordinated more than 12,000 raids of illegal DVD burning labs and other outlawed facilities in more than 13 countries last year, including China, Malaysia and Hong Kong.

In fact those three countries are regarded as the worst offenders when it comes to sales of bootlegs, disc burning machines and the like.

Official data reveals that more than 50 million pirate VCDs, DVDs and recordable CDs were seized, while more than 3,156 optical disc burners were confiscated last year.

Integrated circuits, pharmaceuticals,

An estimated 97 percent of Western drugs sold in China are fake. Many genuine products are not sold here simply because manufacturers fear they will be copied. Inadequate IP protection also discourages drug companies from spending on research and development (the cost of developing a new drug: about US $800,000).

movies, DVD’s, software: there is very little that the United States produces other than agricultural products (which they put import quotas on) and munitions (which we put restrictions on) that the Chinese can’t and won’t pirate.

So what’s the scope of the problem?

WASHINGTON – The United States could bring a World Trade Organization case against China for piracy of copyrighted material, such as music, software and films, a top Bush administration official said on Monday.

“I think we would take a serious look if we could bring the evidence together to make that case to the WTO,” U.S. Deputy Secretary of State Robert Zoellick said during remarks at the Heritage Foundation, a conservative think tank.

The U.S. Chamber of Commerce has estimated U.S. companies lose more than $200 billion in China each year because of sales of counterfeited and pirated goods.

Yes, $200 BILLION. Our trade deficit with China in 2004 was $162 billion or, said another way, if China were playing fairly and honestly all other things being equal we’d be running a $48 billion dollar surplus with China. And nobody (except for the Chinese) would be talking about revaluing currencies or Americans consuming too much.

That’s money that should be going into research and development, hiring more software developers and engineers (some of whom would surely be hired here), and producing more intellectual property but instead $162 billion dollars per year is going into Chinese banks.

I don’t see any real likelihood of this situation righting itself, the Chinese are unlikely to take anything but show measures to correct things, and I don’t believe that any outside agency (like the WTO) will actually do anything to correct the situation.

So, what can be done? As I see it there are several alternatives:

1. We can impose import duties equal in amount to the estimated amount of pirated materials on the goods of the violating countries. I can hear the economists screaming “Riccardian comparative advantage” from here. Not to mention the WTO.
2. We can negotiate with the various violating nations to induce them to enforce U. S. intellectual property rights. That, as Roosevelt’s vice president “Texas Jack” Garner said of the office of the vice president, would be worth a bucket of warm spit.
3. We can abolish intellectual property laws here (and refuse to honor other countries’ intellectual property laws). That would induce investment here in hard product-producing industries rather than intellectual property-producing industries. The dislocation would be enormously difficult (probably more difficult than the dislocation that produced the economy we’re living in now back in the 1980’s) but at least we’d have something to trade.
4. We can impose a consumption tax (as so many economists e.g. Brad DeLong, Gary Becker have urged). Our standards of living would fall. And overseas pirates would take over every new industry that arose from the increased investment. It’s a helluva lot easier to reverse engineer than it is to engineer.
5. We can do nothing and keep buying and borrowing until the flywheel comes off.

I’m betting we’ll adopt the last alternative.