Despite shelving WAPI, China stands firm on chip tax

The fuss over China's plans to implement a national standard for wireless LANs (WLANs) came to a quiet end Wednesday during bilateral trade talks between U.S. and Chinese officials in Washington, D.C. But the outcome of the talks was far from being a complete victory for the U.S. side, which had raised several areas of concern.

The announcement that implementation of WAPI (WLAN Authentication and Privacy Infrastructure) will be delayed indefinitely was generally hailed as a victory for U.S. companies that had opposed the measure. However, the Chinese side yielded no ground during the talks on a value-added tax (VAT) rebate given to some domestically produced semiconductors.

The VAT rebate, which is not offered for chips produced outside of China, lies at the heart of a lingering trade dispute between the two sides. U.S. firms exported about US$2 billion worth of chips to China in 2003, according to the Office of the U.S. Trade Representative. China's tax policy cost the purchasers of those chips an additional $344 million, it said.

"The Chinese have more to gain from the VAT on chips than they do from WAPI," said Duncan Clark, managing director of market analyst BDA China Ltd. in Beijing. Clark noted that the Chinese government has made the development of the company's semiconductor manufacturing industry a strategic priority.

Bilateral discussions on the chip VAT will continue next week in Geneva, Switzerland, U.S. Trade Representative Robert Zoellick said.

Although no agreement was reached on the chip VAT, China agreed to shelve indefinitely plans to require all WLAN equipment sold in the country after June 1 to support WAPI, a homegrown security protocol. WAPI is not compatible with the security protocol used by the 802.11 wireless networking standard developed by the Institute of Electrical and Electronics Engineers Inc. (IEEE).

If the Chinese WLAN standard had been implemented, sales of 802.11-based WLAN equipment would not have been permitted in China after June 1. To licence WAPI, foreign vendors would have been forced to share their technology with Chinese companies under a provision that required foreign vendors to license through coproduction agreements with one of more than 20 designated Chinese companies.

In addition to shelving plans to implement WAPI, Chinese officials agreed during the talks to step up their enforcement efforts against intellectual property piracy and said they support technology neutrality in the adoption of 3G (third-generation) standards for mobile phones.

The move to shelve WAPI was not completely unexpected. Analysts in China had been predicting for months that China would find a way to back down from requiring vendors to support WAPI.

"I'm not surprised. WAPI was ultimately an indefensible policy," Clark said.

Lenovo Group Ltd., China's largest PC maker and one of the companies granted the rights to license WAPI, had also hedged its bets against the implementation of the Chinese WLAN standard with the development of a prototype laptop, called Vela, that is based on Intel Corp.'s next generation Centrino platform, code named Sonoma.

While publicly supportive of China's plans to implement the Chinese WLAN standard, Lenovo -- formerly known as Legend Group Ltd. -- was quietly prepared to consider production of the Vela prototype if the Chinese government decided to permit the sale of 802.11-based WLAN equipment in China, a company source indicated ahead of Wednesday's trade talks.

The decision to postpone indefinitely the mandatory implementation of WAPI was welcomed by U.S. companies and analysts.

China's decision on WAPI "demonstrates its commitment to leadership in the IT industry," said Chuck Mulloy, a spokesman for Intel, which had announced in March it would not support the technology.

"This is good news for consumers globally, not just in the U.S.," said Chris Kozup, an analyst at Meta Group Inc., in Cambridge, Massachusetts. Having more than one standard would have dampened the effects of economies of scale and slowed price declines for WLAN equipment, he said.

One immediate result of the Chinese announcement to suspend the implementation of WAPI will be increased sales of WLAN equipment in China, said Karl Feilder, the chief executive officer (CEO) of U.K.-based Red-M Communications Ltd., a provider of network intrusion detection systems.

Uncertainty over the implementation of WAPI had led many Chinese users to put off purchases of WLAN equipment, Feilder said, noting that Red-M sales in China had slowed to "a trickle" in recent months. With the implementation of WAPI now suspended, Red-M is already seeing a surge in interest from potential Chinese customers, he said.

However, while the Chinese government will no longer require vendors to support WAPI or ban the import of 802.11-based WLAN equipment after June 1, WAPI is unlikely to go away completely, Feilder said. Red-M has licensed WAPI through a coproduction agreement with a Chinese partner and intends to continue development of WAPI-based products.

Looking ahead, Feilder expects to see demand for WAPI, or derivatives of the technology, emerge in certain vertical markets within China, such as in government. Suspicion of foreign encryption technology will create demand for WAPI or derivatives in areas where security is considered particularly important, he said.

That market, if it does emerge, would be very small compared to the overall market for WLAN equipment, Clark said. He does not see much of a future for WAPI, noting that Chinese end users prefer to purchase products based on international standards whenever possible.

"Bad standards never die, they just fade away," he said.

(Stephen Lawson in San Francisco contributed to this report.)

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