November 18, 1997

written_testimonies of Anne Craib

Director, International Trade and Government Affairs

Semiconductor Industry Association

Before the

U.S.-China Economic and Security Review Commission

Hearing on China’s WTO Compliance and U.S. Monitoring Efforts

February 5, 2003

The Semiconductor Industry Association (SIA) represents the $70 billion U.S. semiconductor industry. SIA member companies comprise approximately 85% of U.S.-based semiconductor production. Collectively, the chip industry employs a domestic workforce of 255,000 people. U.S. semiconductor firms are leading global competitors, commanding a 50 percent world market share.

Semiconductors are the building blocks for American competitiveness in a broad range of high technology goods – from computers to medical technology. A strong and vibrant semiconductor manufacturing industry is a key part of a healthy information technology ecosystem – it supports everything from research and development to a robust university capability in microelectronics. U.S. semiconductor makers have facilities around the world, as needed to serve the global IT industry. While such a global span is necessary to remain competitive, the members of SIA also believe it is vital to retain leading edge manufacturing capabilities here in the United States – our policy objectives are aimed at supporting that goal.

Today, China is the third largest country market in the world today for semiconductors, and enjoys the world’s highest growth rate. By 2010, China is predicted to be the world’s second largest country market for semiconductors, behind only the United States. Semiconductors are the second largest U.S. export to China and China’s number one import. China can and should have a major role in the global semiconductor market – however, we believe that China must build these capabilities based on fair, transparent and WTO-consistent policies.

Over the past decade, SIA was a strong supporter of China’s accession into the World Trade Organization (WTO) and of legislation to provide Permanent Normal Trade Relations for trade with China. We are also pleased that the Chinese government has taken a number of positive steps in implementing its WTO obligations. China signed the Information Technology Agreement (ITA), and eliminated tariffs on a range of information technology products when it joined the WTO -- this was a very positive step not only for those selling into China, but for China’s own economic development. SIA has long supported the elimination of semiconductor tariffs, beginning with the suspension of U.S. tariffs in 1985, because tariffs increase the costs to consumers of not only semiconductors but also finished information technology products. The spread of IT products fuels benefits in the economy.

Despite progress in some areas, the Chinese government needs to take additional steps to fulfill the commitments it made under WTO accession. My written_testimonies will focus on those issues of special relevance to American semiconductor producers, including China’s value-added tax (VAT) rebate for domestically produced chips, unique standards development, and inadequate intellectual property protection.

VAT Rebate

China imposes a VAT of 17% on sales of all imported and domestically-produced semiconductors and integrated circuits. However, current Chinese government policy provides for a rebate of the VAT burden in excess of 3% for certain integrated circuits manufactured within China.[1] This discrimination against imported semiconductors through the VAT rebate is inconsistent with China's WTO obligations.

GATT Article III (on “National Treatment”) states that a WTO member cannot impose taxes on imported products that are greater than those imposed on domestic products. By rebating the amount of the VAT burden over 3% for local products, while continuing to impose the full 17% VAT on imported semiconductors, the current policy violates this most basic GATT/WTO obligation.

The semiconductor industry is a tremendously competitive business – a fraction of a percent can make the difference in winning or losing a sale. A 14% differential created through WTO inconsistent tax policy is a burden that foreign companies simply can’t overcome in selling into the Chinese market.

In addition to market access concerns, the VAT policy is severely skewing investment patterns. China's IC industry attracted $3.6 billion of new investment from 2000 to 2002, with investment projected to reach $12 billion by 2005 and $25 billion by 2013. This is an unprecedented amount of investment that cannot be justified on commercial terms and is likely to lead to severe overcapacity in the industry in future years. We have done quite a bit of research in this area, and it is clear that the VAT rebate is a major factor in these investment decisions. This investment flow makes the VAT a very time-sensitive issue – if the problem is not solved and all slated investments are made, the bulk of cutting edge capacity will be in China.

We are not alone in finding this policy quite alarming. The World Semiconductor Council (WSC), representing industry from the U.S., Europe, Japan, Korea, and Taiwan, condemned China’s VAT rebate policy in the following joint statement issued in May 2003:

Discrimination [due to the VAT policy] has the effect of limiting market access, distorting patterns of trade and investment, and negates the benefits China promised to provide when it joined the WTO. The WSC calls for China to lower its VAT rate to 3% for all semiconductors, regardless of origin.

SIA continues to work with our counterpart associations in Europe, Japan, Korea, and Taiwan on this issue.

The same public policy reasons that caused China to decide to join the ITA and eliminate its tariffs on semiconductors apply with equal force to a decision to lower the VAT rate  raising the cost of access to information technology harms economic development. A substantial portion of the growth of the American economy has been attributed to information technology and the productivity enhancements made possible by advances in semiconductor technology and production. Just as it was in China’s interest to eliminate all import tariffs on semiconductors, significant reduction in the VAT rate imposed on all semiconductors would contribute to the growth of the Chinese IT market and would benefit the Chinese economy in general. In addition, reports indicate that China’s elimination of semiconductor tariffs (formerly 6-12%) has succeeded in reducing smuggling of semiconductors into China. As the high VAT rate on semiconductors provides an incentive for smuggling, this runs counter to the high priority the Chinese government has placed on eliminating illegal entry of goods.

We have worked closely with USTR, Commerce and others in the U.S. Government to try to seek a solution to the VAT issue. Last summer, the Chinese government gave indications that it was willing to explore the WTO implications of the VAT rebate policy, and a working group reportedly was formed to examine the issue. However, SIA is disappointed that recent discussions with the Chinese government demonstrate a lack of flexibility in bringing this policy into compliance with WTO rules.

The best solution for U.S. export interests and the development of China's information technology market is for China to reduce the VAT rate to a level of 3% or eliminate the VAT for all semiconductors and integrated circuits, regardless of origin. Clearly, a diplomatic solution to this issue would be preferable for all parties involved. However, the time sensitive nature of the problem dictates that a solution must be found sooner rather than later, and if we expect to retain a competitive industry here in the U.S. we must resolve this issue soon. If the issue cannot be resolved through diplomatic means, we believe USTR will have no recourse but to file a WTO case – we stand ready to fully support that effort if and when USTR makes such a decision.

Standards

SIA notes with concern an increasing use of unique national standards in China that are designed to favor domestic suppliers. The wireless LAN issue is one vivid example. In May 2003, China issued two new WLAN standards (that define a requirement to use Chinese encryption technology) which the Chinese government said were needed for national security reasons. However, established international efforts exist through the Institute of Electrical and Electronics Engineers (IEEE) to address multilevel security schemes for wireless networks. The new Chinese standards differ significantly from and are incompatible with internationally-recognized protocols, and would require creation or adaptation of products solely for the Chinese market. Country unique standards won’t benefit China in the long run. New technology standards evolve rapidly and are continuously improved and modified by international standards groups and as a result of innovations of thousands of companies. The losers are proprietary technologies that attempt to compete with the global standard – however, ultimately they cannot compete with the cost/benefit that a successful global standard delivers. Moreover, proprietary standards that are not widely adopted can lead to problems with product interoperability. In fact, past experiences illustrate that proprietary standards often become obsolete in fast paced global industry, leaving those who adopted them to fall behind or simply go out of business.

This requirement would affect a range of technology products with wireless LAN capability, including chips, wireless cards, computers, printers, and scanners.

The standards became effective on December 1, 2003, even though the technical details for implementation of the Chinese requirements are still not readily available to non-Chinese companies[1]. Through extensive U.S. industry effort and bilateral discussions led by the U.S. Department of Commerce, USTR, and the State Department, a six-month grace period was enacted – through June 2004. Reports now indicate that Chinese authorities will require foreign firms to engage in value-added production with a select list of 24 local firms to obtain import permits in order to sell wireless LAN equipment in China. Products already in-country will also be required to obtain permits. The so-called co-production requirement will require U.S. and other foreign companies to share an unprecedented amount of intellectual property with – in effect – their Chinese competitors. Those competitors will also be responsible for certifying whether or not foreign companies are compliant with the standard before they can sell in China.

If enforced, such requirements would set a dangerous precedent by imposing technology transfer and local content requirements that China committed to eliminate with WTO accession.[2] The issue remains active, and SIA appreciates the continued efforts of the U.S. government to encourage China to adopt internationally-recognized standards.

We will work with USTR to carefully monitor China’s standards development in the electronics area to ensure it is not used as an industrial policy tool to foster China’s information technology production goals by creating market access barriers. China committed to abide by the WTO’s Technical Barriers to Trade (TBT) Agreement, including publication of notices of adopted and proposed technical regulations, standards, and conformity assessment procedures.[3] China must notify standards development activities that affect imports to the WTO’s TBT committee as early in the process as possible.

If these types of practices continue, they will have a real and significant negative impact on U.S. electronics firms, to the detriment of U.S. economic interests. Moreover, such forced cooperation measures have a negative effect on China, as they discourage the investment necessary to develop a local Chinese electronics industry on a commercially-sound basis.

Intellectual Property Protection

SIA would like to underscore the importance of China’s full compliance with its commitments to improve intellectual property (IP) protection. Adequate IP protection is critical not only to U.S. firms doing business in China, but is also in China's self-interest, as it will encourage the high technology foreign investment China seeks in order to promote the development of its economy, while simultaneously encouraging local entrepreneurs to engage in innovation.

Accession to the WTO required China to enact specific legislation to extend intellectual property protection to semiconductor layout designs (maskworks) consistent with TRIPS. On March 28, 2001, China’s State Council passed the Regulation on Integrated Circuit Layout Design Protection as part of its preparations to join the WTO. The regulation took effect October 1, 2001. This legislation also covers discrete semiconductors, as confirmed to the WTO by the State Intellectual Property Office (SIPO).

Intellectual property protection is of great importance to U.S. semiconductor producers, as China’s capabilities in the semiconductor sector are rapidly advancing. The intellectual property contained in the design of a maskwork remains one of the highest value-added components of chip manufacturing. SIA is aware of at least two cases where maskwork violations have occurred in China.

In addition to observing the TRIPS obligations, China should take steps to strengthen trademark enforcement. While Chinese intellectual property laws are generally sound, and Chinese administrative agencies have been cooperative in taking action against trademark counterfeiters, trademark protection laws could nonetheless be improved. China should also strengthen its judicial system to ensure consistent and effective patent enforcement. Courts have not had much experience in highly technical cases, such as semiconductor or electronics patent cases. Finally, general transparency in the courts should be improved so that all cases (including patent cases) are handled openly and fairly.

Given the short life-cycle of products in the semiconductor industry, illegitimate products can severely damage a U.S. firm’s ability to reap the legitimate results of its intellectual and capital investment. SIA has discussed with USTR the idea of a “fast-track” mechanism to address IPR violations in an expedited manner. In addition, the World Semiconductor Council is developing a code of conduct for producers, which China would benefit from once it becomes a WSC member.

Conclusion

China is growing into a major force in the information technology arena – both as a customer and as a competitor. Given the size, growth, and potential of the Chinese market, it is essential that U.S. semiconductor firms have the chance to compete fairly. China has made notable progress with respect to its WTO commitments, but its government must make additional efforts to bring all policies into full compliance. The elimination of the discriminatory value-added tax, increased use of international standards, and improved protection of intellectual property are key areas where SIA will continue working with USTR, Commerce, and State to insist on fulfillment of China’s WTO commitments. I must stress that these issues are time sensitive – they must be resolved in a short period or the damage to the U.S. industry could be considerable. SIA appreciates the opportunity to appear before the Commission today to testify on these important issues.

[1] The Chinese government has not released the encryption algorithm, the interface for the encryption, nor the testing requirements.