Counterfeiters Will Win the Trade War

The trade war between the United States and China continues to spiral, with mutual tariffs now hitting $34 billion worth of goods on either side after Trump began his spate of protectionist measures in March. Many analysts, such as Mark Muro, have argued that the tit-for-tat tariffs will hit certain U.S. industries hard, whereas others have pointed to the huge damage that could be done to the global trading system. But there’s another issue so far overlooked: The trade war will be a boon to China’s counterfeiters.

Counterfeiting was one of the many charges laid by U.S. President Donald Trump and his trade team at China’s door. They’re not wrong; the Chinese fake goods industry is enormous. Mainland China is the world’s largest producer of counterfeits, accounting for 63.2 percent of seized goods in 2013, followed by Chinese-ruled Hong Kong at 21.3 percent. Products from the United States, Italy, France, and Switzerland have been the main targets.

As legitimate Chinese brands have become more famous, the counterfeiting has turned domestic, with fake Huawei phones appearing on the market and many innovative Chinese companies also being targeted. Clothes, phones, and handbags once dominated the counterfeiting market but it’s now spread into more specialist industries; lookalike wines imitating famous Australian vineyards have been spotted on Pinduoduo, a large online retailer.

According to the International Anti-Counterfeiting Coalition, the industry has a global value of more than $1.7 trillion, making it many times more profitable than the global drug trade. Frontier Economics, a consultancy based in Europe, predicted in a report commissioned by the International Trademark Association and the International Chamber of Commerce that the global counterfeit industry will have a value of $2.3 trillion by 2022. The report estimates that another $1.9 trillion be lost on larger social and economic impacts, including displaced economic activity, criminal enforcement, and public fiscal losses.

The growth of e-commerce, which makes it even harder for consumers to distinguish genuine from counterfeit goods, has fueled the industry. Counterfeit goods not only stick the consumer with a lesser product, they cause reputational damage to companies. Due to a lack of resources, small and medium enterprises are less likely to respond to their goods being counterfeited.

Yet China is not the only state where fake goods are rife. In recent years, counterfeiting has grown tremendously in Southeast Asia, as has the scope of the industry. In part, this is spillover from China, with Chinese firms often looking for cheaper labor in neighboring countries. According to the Vietnam Association for Anti-Counterfeiting and Trademark Protection, counterfeit goods are produced in 30 product categories. Free trade zones, which are exponentially more prevalent today than four decades ago, now exist in 130 countries and are often plagued by poor governance, contributing to the expansion of the counterfeit industry, according to a study by the Organisation for Economic Co-operation and Development.

Globalization has created the conditions for the counterfeiting industry to boom, but protectionist measures will cripple attempts to solve the problem. While protectionist measures may decrease the level of trade between states, they will not inherently decrease the trade of counterfeit goods. In fact, the reverse may be possible.

Tariffs will lead to higher costs of imports for both U.S. and foreign companies. The business-to-business counterfeit industry is also large, often involving machines, chemicals, and spare parts. Six U.S trade associations stated in a joint letter to the chairman and ranking member of the Ways and Means Committee, the chief tax-writing committee of the U.S. House of Representatives, that the increased industry costs will impact on resources used to fight the counterfeit industry.

Further, unless companies decide to pass on the increased costs of imports to the consumer, they will have to absorb the costs or look for cheaper imports. It’s not just consumers that fall for fakes; Chinese counterfeit electric parts have been found in U.S. military equipment. The trade war could also prompt Chinese businesses to move some of their production to neighboring countries, making it even more difficult to identify counterfeit goods being exported to the U.S. based on a growing number of source countries.

Buyers will also be affected by the tariffs. The increased cost of imports are likely to trickle down to consumers, who are increasingly purchasing goods from foreign markets through e-commerce suppliers, directly or indirectly. In their letter, the six U.S. trade associations stated that: “Rather than pay more for legitimate goods, we fear that consumers might seek cheap counterfeits as a replacement, whether knowingly or unknowingly.” Higher costs will push people toward cheaper options. According to University of Arkansas at Little Rock economist Vincent Wenxiong Yao, counterfeiting rises as the price of legitimate goods soars, and counterfeiters can be even more adaptive to the needs of markets than their legitimate counterparts—not least by cutting even more corners.

The counterfeit industry will also be more inclined to take advantage of transshipping, referring to the shipment of goods via an intermediate destination. In April, the European Union and Italy announced an investigation into tax fraud by illegal Chinese companies shipping counterfeit goods into Europe through Greece’s largest port, Piraeus. The New York Times has also reported on how tariff evasion is openly advertised by Chinese brokers, who offer to hide the evidence that goods were produced in China by exporting through countries such as Malaysia.

Beijing’s own public-relations campaign has responded to the U.S. tariffs. China’s Ministry of Commerce released a press statement that claimed China was taking legal means to fight the trade. Further, the statement claimed that in 2017, $28.6 billion in royalties was paid to foreign firms, 15 times the amount that China was paying in 2001 when they joined the World Trade Organization. Last week, the State Administration of Market Regulation in China also announced new measures in response to the proliferation of counterfeit goods.

Chinese e-commerce companies are also attempting to fight the counterfeiting trade—even though it was a massive contributor to their own initial success. Alibaba also annually spends more than $14.5 million conducting annual spot-checks on 100,000 products identified at risk of being counterfeit. Similarly, Pinduoduo claimed it would increase its product vetting. A potential new law would also make online retailers liable for the sale of counterfeit goods advertised on their sites.

The Made in China 2025 initiative is also attempting to upgrade domestic industry by enhancing the output of its manufacturing, turning the country into a high-tech powerhouse that could not only challenge the important role the United States plays in the export of technologies, changing the priority of domestic industry away from easily counterfeited goods.

In 2016, the United States and China pledged to strengthen cooperation on combating the counterfeit industry through working with big data and new information technologies. The partnership sought to enhance joint efforts to work with copyright holders and e-commerce platforms to better protect U.S. and Chinese small- and medium-sized enterprises from intellectual property theft. But the vehemence of the trade war puts these measures under threat.

In email correspondence with Foreign Policy, William Zarit, the chairman of the American Chamber of Commerce in China (AmCham), stated that the organization “urges a ceasefire in the tariff duel and hold serious results-oriented negotiations to find a mutually beneficial and sustainable solution within an acceptable timeframe and based on fair and reciprocal treatment.” AmCham also acknowledged the significant progress China has made to protect intellectual property.

But relations between the United States and China have reached new lows, endangering cooperation efforts as U.S. experts are frozen out. And with China’s own exports endangered, internal government pressures to keep the economy growing may lead to a lack of enthusiasm for enforcing intellectual property rights and other anti-counterfeiting measures, as happened in 2009 after the global downturn. National protectionism often leads to local protectionism by provincial or county-level officials determined to guard their own industries, even fake ones, as economist Daniel Chow has demonstrated.

Zarit said that most AmCham member companies still want the United States to push for a level playing field and reciprocal treatment to boost market access. However, according to AmCham, in China the “counter-productive import tariffs are not the most effective way to bring about desired changes in China’s discriminatory industrial policies. Instead, this approach damages healthy and open trade dialogue. It also hinders Chinese and US experts’ collaboration to tackle counterfeiting in China since you can’t work together if you don’t communicate.”

International solidarity would be one way to put more pressure on China to enforce legitimate manufacturing, but the United States has ignited trade wars with key allies that have blown up existing relationships. The EU-China relationship may be enhanced by the growing number of trade wars initiated by the United States, but they may have to focus on boosting trade instead of disrupting the counterfeit industry. The battle against the counterfeit industry requires international cooperation, but instead of working alongside its allies, the Americans have opted to work alone.

The solution to the counterfeiting problem isn’t competition, but cooperation. The trade must be recognized a mutual threat—to the rights of brands in the developed world, like the United States, and to the reputation and legitimacy of Chinese trade.

Governments and companies need to work together by sharing best practices on tackling the counterfeit industry. Washington stands a better chance of fighting fakes by working with Beijing, not against it.