After a long and exhausting negotiation process, China joined the World Trade Organization (WTO) in 2001. Its accession implied the acceptance of different treaties regulating tariffs, services, and intellectual property rights. The latter agreement, referred to as TRIPS (Trade Related Aspect of Intellectual Property Rights) established a harmonization of the patent system across the globe requiring all member states to adopt a stronger regime for the enforcement of intellectual property rights (IPRs). It was strongly pushed forward by a handful of large US multinational companies, supported by European and Japanese ones, in order to extend the patent regime in force in rich countries to all signatory states.
A number of aspects of TRIPS were severely criticized at that time. Some scholars claimed that the US and its multinational companies, whose comparative advantage depended on advanced technology, would be the main beneficiaries. TRIPS would have paved the way for multinational corporations of rich countries to extend the coverage of their vast patent portfolios to the developing world. As a result, the rise of a sharp dualism within emerging markets was predicted, with foreign advanced companies monopolizing hi-tech sectors, leaving domestic firms with the low-tech slice of the cake and therefore unable to imitate advanced technology. In other words, the acceptance of the western patent system by developing countries would have triggered an increase in the polarization in the international division of labour, with companies in developing countries stuck with low-productive industries and only limited possibilities for development through the use of advanced technology.
Now, ten years after the agreement entered into force, it is time to take stock and assess whether TRIPS did indeed have the predicted implications. In retrospect, who gained and who lost from the implementation of the agreement?
What Tom White and Tom Blue in the US have to do with offshoring in China
Let’s start by considering the effects on western citizens. Substantial tariff reductions, the dismantling of most nontariff barriers, as well as the gradual elimination of quotas on textiles and apparel following the WTO accession increased China’s presence in western markets. The share of advanced country imports accounted for by China has risen significantly, with particularly sharp increases in Japan, the United States, and the European Union, thereby allowing their citizens to benefit from cheap imported goods. However, this came with costs in terms of unemployment, the main culprit being offshoring.
Over the last decades, the transfer of production activities (manufacturing or services) abroad has increased substantially mainly accounted for by significantly lower costs of production, above all labour costs. For this reason a distinction has to be made between western citizens working in the manufacturing sector at the lower end of the value chain, who we will henceforth call Tom Blue, and the high skilled worker, henceforth Tom White, employed in research and development (R&D) or the services-to-business sector.
Empirical research shows that Tom Blue has experienced serious losses due to the transfer of most low-skilled labour-intensive parts of production to countries with lower labour costs. Among the OECD countries the US lost over 2,6 million jobs in manufacturing over the 1995-2005 period, while the United Kingdom and Germany lost 755,000 and 701,000 jobs in this sector, respectively. The only OECD countries showing a significant increase in employment in the manufacturing sector are Mexico and Turkey. The reduction in employment in the manufacturing sectors has gone hand in hand with a decline in Tom Blue’s wage, as well as a deterioration in labour and health protection.
More recently, offshoring has been extended to companies in the service sector. The rapid development of information technology, the standardization of infrastructure and the decrease in data transmission costs have overall lowered barriers to trade in different categories of services-to-business, including R&D, and thereby an increasing number of such tasks could be offshored and carried out by high-skilled workers residing abroad. Firms and especially multinational enterprises (MNE) are now more prone to offshore activities which involve technology and innovation, not only to adjust their products to local markets, but also to boost state-of-the-art technology and tap into global centers of knowledge. However, in these cases evidence suggests that the job losses due to offshoring are largely offset by the creation of new jobs at home. This implies that Tom White may not have lost much from the increasing employment of foreign high-skilled workers. Moreover, offshoring processes located in the upper part of the value chain requires coordination at home, leading to rising demand for high-skilled workers.
However, the overall worsening conditions and job opportunities for Tom Blue have not been offset by a considerable increase in employment for Tom White. In other words, the increase in jobs in the knowledge economy has not been sufficient to compensate for the losses in the manufacturing sector. The idea of an international division of labour in which workers in advanced economies are employed in knowledge-related industries, while emerging economies specialize in the production of manufactured products to the benefit of all is a myth.
The great lobbyists: multinational corporations
As outlined earlier, western multinational corporations strongly pushed for the ratification of TRIPS. They claimed that the agreement, by impeding developing countries’ companies from copying their products without restraints was essential to guarantee ‘fair’ trade. This would have stopped the continuous deterioration of trade surpluses in advanced countries thanks to a resurge in exports. The story developed differently though.
Thanks to the TRIPS agreement, MNEs could extend their patent portfolios to all WTO member states obtaining adequate protection of their rights and preventing counterfeiting. This made MNEs more comfortable in moving their technology-based activities, such as R&D labs abroad. A study carried out by the European Commission, based on a survey of 158 European firms, found that 70 per cent of the companies had increased R&D offshoring over the period from 1999 to 2004, confirming potential benefits of offshoring R&D.
As for employment, from 1999 to 2009 US multinationals in manufacturing cut their US employment by 2.1 million, or 23.5 per cent, but increased employment in their foreign subsidiaries by only 230,000 (5.3 per cent). This suggests that US multinationals outsourced an increasing part of their production to foreign contractors. In sum, Western multinational companies took advantage of the enlargement of their playground brought about by China’s accession into the WTO, and the TRIPS agreement by remarkably expanding their activities abroad at the expense of production and employment at home.
Unintended consequences: is China the great winner?
Chinese economic performance since 2001 has been impressive: Gross Domestic Product (GDP) grew at an average annual 10 per cent over the last ten years and GDP per capita at constant prices reached $2,425 in 2010, 137 per cent more than in 2001. China is these days also the main attractor of Foreign Direct Investments (FDI) in the developing world, having received inflows of $106 billion in 2010.
As said, many scholars claimed that China’s accession to the WTO would exacerbate the dualism in the Chinese market. The hi-tech industries would have remained in the hand of foreign companies, with domestic firms confined to traditional low-tech sectors. A look at the figures contrasts this hypothesis. Data on foreign and domestic patents registered in China show quite the opposite trend. Examining patents grouped according to technological class over the period from 2003 to 2010, we find that i. in 2003, foreign patents were more numerous than domestic patents across all technology classes; ii. the opposite holds in 2010: domestic patents predominate across all technology classes, except for electricity.
This suggests that Chinese companies have been able to learn to a considerable extent how to promote innovation in hi-tech industries which were once dominated by foreign companies back at the beginning of 2000s. The prediction of a rising dualistic market in China as a result of WTO accession is thus invalidated. Today, the old stereotype about China being the low-wage producer is clearly outdated, and Chinese companies are pushing innovation forward to offer products with high margins and hi-tech content. A recent report in The Economist outlined the story of the Chinese firm Huawei, founded by a former military officer backed by local government, which now more closely resembles a western high-tech firm than a state-backed behemoth. In 2008, the company filed for more international patents than any other firm.
Two reasons may account for this development. Firstly, the assumption that patents prevent other firms from imitating and adopting patented technology, as suggested by most standard economics textbooks, is not confirmed by reality. A sizable body of research has shown that patents are rather ineffective tools in the prevention of imitation across all industries, with the important exception of the pharmaceutical sector.
Secondly, China has proved the importance of public policy for developing absorptive capacity, i.e. the capacity of a country’s business and public sectors to successfully adopt foreign technology. Absorptive capacity can be developed through investments in education and publicly funded research, along with the development of effective institutions. According to the latest OECD Main Science and Technology Indicators, China is today the fourth R&D spender among the OECD countries accounting for a share of 12.5 per cent, after the US, the EU and Japan, exhibiting double digit increases in R&D expenditure year after year. A similar trend can be observed regarding investments in education as well as specific projects such as science parks and technological infrastructure more generally.
Conclusions: the winners, the losers, and a lesson
There are few doubts that Tom Blue is among the losers in this game, suffering from a decline in employment and consequently a decline in income and labour conditions. So far, this has not been compensated by an equal increase in job opportunities in the more advanced sectors. A well-known lesson has been largely disregarded, that is, higher market integration always leads to substantial redistribution effects within the countries involved. Since the 19th century, decisions about free trade and market integration have ignited political campaigns and sparked fierce political debate. This has not been the case with the TRIPS agreement which was the outcome of a nondemocratic process driven by a small number of US lobby groups. Hence, the opportunity to publicly discuss the trade-off between cheaper goods versus higher unemployment was not granted.
Western multinationals have rather benefited from China’s entrance into the WTO. TRIPS has substantially enlarged their opportunity to expand activities abroad to exploit lower labour costs. This is at least partly reflected by the increase in profits and productivity of these firms. Ironically, multinational corporations pushed their governments to integrate the TRIPS agreement into the WTO by promising larger trade surpluses in advanced countries. On the contrary, however, the increase in offshoring and outsourcing has further broadened western countries’ trade deficits over the last decade.
Finally, China is by all means the great winner. Chinese companies have proven their ability to innovate and imitate technology not only in labour-intensive and low-tech industries, but also in hi-tech industries which ten years ago were monopolized by foreign companies. This has been significantly driven by impressive investments in research, innovation and human capital, providing a remarkable example to other developing countries. This strategy, however, requires a deliberate effort on part of the administration, considerable resources, and a long-term forward-looking vision of public management.