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China’s Internet Services Industry: A Strategy for Legal Reform

Tiffany Tompkins
tiffany.tompkins@miis.edu

Master’s Project
Commercial Diplomacy
Monterey Institute of International Studies

Advisors:
Professor William Arrocha
Professor Geza Feketekuty
Professor Bill Monning

May 1, 2002

This project was completed by Tiffany Tompkins to fulfill a requirement for a Master’s Degree in Commercial Diplomacy from the Monterey Institute of International Studies.

Scenario:

For the purpose of this project, I assume the fictitious role of a representative for the American Chamber of Commerce—People’s Republic of China (AmCham—China). After receiving numerous complaints from member companies about investing in China’s Internet services market, I have been asked to develop a plan to persuade the Chinese government to amend current laws and procedures to decrease regulatory risk.

Table of Contents

Executive Summary
Background

I. Industry Development

1. State-owned Telecom Enterprises
1a. China Telecom
1b. China Unicom
1c. Jitong Communications
1d. China Mobile
1e. China Netcom
1f. China Railway Telecom

2. Internet Access

2a. State-owned Commercial ISPs
2a-1 China Public Computer Network
2a-2 China Golden Bridge Network
2a-3 China Unicom Public Computer Network
2a-4 China Netcom Communication Network

2b. Bandwidth

II. Policy Background

III. Political Background

1. Central Government
1a. Central Committee
1b. National People’s Congress
1c. NPC Standing Committee
1d. State Council
1e. Ministries
1e-1 Ministry of Information Industry
1e-2 Ministry of Foreign Trade and Economic Cooperation
1e-3 State Administration of Radio, Film and Television
1e-4 Ministry of Public Security
1e-5 Ministry of State Security
1e-6 Ministry of Education
1e-7 Ministry of Health
1e-8 State Press and Publication Administration
1e-9 State Drug Administration
1e-10 Ministry of Culture
1e-11 State Council Information Office

2. Regional Governments

Box 1 State-Owned Enterprises

2a. Development Strategies
2a-1 Beijing
2a-2 Shanghai
2a-3 Guangdong
2a-4 Shandong
2a-5 Gansu
2a-6 Yunnan
2a-7 Sichuan
2a-8 Shaanxi

IV. Industry Laws

1. Telecommunications Regulation of the PRC

2. Measures for Managing Internet Information Service
2a. Content Providers
3. Notice Regarding Relevant Issues For Handling the Licenses to Operate
and Filing for the Record of Internet Services

4. State Secrets Protection Regulation for Computer Information Systems
on the Internet

5. Provisional Regulations on Governance of Internet-based News
Providers

V. Rule of Law

1. American Chamber of Commerce definition of Rule of Law
2. China’s Rule of Law Initiatives

VI. WTO

1. Value-added Services
2. Basic Agreement on Telecommunications Services
3. Transparency
4. Rule of Law

VII. Commercial Background
1. Role of Foreign Investment
2. US Perspective
3. IT Sector
4. Internet Users

Analysis Section

I. Commercial Analysis

Commercial issue #1: How will these reforms help AmCham member
companies?

1. Internet Access Services
1a. Investment Opportunities
1a-1 Prices
1a-2 Connection Speed

Box 2 US-China Broadband Comparisons

2. Internet Content Services
3. IT Products
4. Effects of Reform
5. Provincial Government Perspective

II. Policy Analysis

Policy Issue #1: How far is the Chinese government willing to open up?

1a. National security argument
1b. Protecting domestic industries

Policy Issue #2: How will liberalization contribute to China’s economic growth?

2a. Modern telecommunications system
2b. Spillover effects
2c. How are current policies hindering this economic growth?

Policy Issue #3: How will these reforms accommodate WTO obligations?

III. Economic Analysis
Economic Issue #1: How will boosting investor confidence in Internet services
Help China reach its broad economic goals?

1. Prices
2. Wages/Incomes
3. Trade
4. Productivity
5. Production
6. Consumer Welfare

IV. Political Analysis

Political Issue #1: Analysis of Chinese Stakeholders

1. Central Government
1a. Central Committee and State Council
1b. NPC Standing Committee
1c. State Council
1d. Next Generation of Leaders
1e. Ministries

1. Local Governments

Box 3 Beijing Olympics 2008

Political Issue #2: Analysis of Foreign Stakeholders

1. United States Trade Representative

V. Legal Analysis
Legal Issue #1: How will current regulations be affected by reforms?

1. Internet Access
2. Internet Content
3. Central government’s commitment
4. The end result

VI. Recommendations

VII. Comprehensive Strategy Paper

1. Chinese Political Strategy
1a. Build consensus among members within the Central Committee,
NPC Standing Committee and State Council
1b. The Ministries
1c. Regional government momentum
1d. Coalition building
1d-1 Coalition with USITO

2. US Political Strategy

3. Chinese Legislative Strategy

4. Media Strategy

5. Timeline

6. Budget

Appendices

Appendix 1 Project Map
Appendix 2 Ministry of Information Industry’s Thirteen Departments
Appendix 3 AmCham Companies
Appendix 4 Listed Chinese IT & Telecom Companies
Appendix 5 USITO Members
Appendix 6 White Paper to Chinese Government
Appendix 7 Sample Letter to USTR
Appendix 8 White Paper to USTR
Appendix 9 Talking Points, Q&A’s
Appendix 10 Sample Leave-behind for USTR
Appendix 11 Sample Press Release
Appendix 12 Timeline
Appendix 13 Budget
Appendix 14 BATNA Chart
Bibliography

Endnotes

Executive Summary

To: Michael Furst, Executive Director, American Chamber of Commerce- PRC
From: Tiffany Tompkins, Chief Consultant, AmCham Internet Services Lobbying Team
Re: Strategy to decrease regulatory risk in China’s Internet services sector
Date: April 30, 2002

Issue:

The American Chamber of Commerce - China celebrated China’s accession to the WTO in December 2001. US businesses may, for the first time, legally invest in the highly anticipated Internet services sector. This sector has enormous market potential, including:

• 33 million Internet users
• The largest Internet user base by 2006
• Fastest growing PC market
• 100 million broadband connections by 2004

The conditions and schedules arduously negotiated with China’s WTO Working Group were breakthroughs in the liberalization of China’s Internet services market. China now allows up to 30 percent foreign investment in Beijing, Shanghai and Guangzhou. By December 2002, foreign investment will increase to 49 percent with an additional fourteen cities added to the geographic scope. By December 2003, foreign investment will be allowed up to 50 percent with no geographic limitations. However, while this schedule of concessions seems impressive, many barriers still need to be addressed in China’s telecommunications sector.

China’s Internet services industry is dominated by high regulatory risk, which is impeding the American investor’s willingness to invest in the industry. This high regulatory risk is a direct result of the following problems:

• Complex licensing procedures for Internet content providers, resulting in discretionary interpretations by various ministries
• Nontransparent drafting procedures for all Internet-related regulations. Thirteen ministries are allowed to draft their own regulations without consulting other government entities or affected businesses. The current nontransparent legislative system directly violates China’s WTO commitments specifically addressed in the Accession Protocol under Transparency, section 1.
• The promulgation of Internet regulations inconsistent with China’s economic goals. This causes investment risk when Internet service providers depend on economic growth to increase telecommunications infrastructure and its subscriber base.
  

Background:

The Chinese government has been developing the Internet services sector and the related supply-chain industries. Both central and provincial governments believe the Internet will diversify the economy, and aid in the development of a modern telecommunications system, necessary for attracting businesses. Provincial governments, however, have received little investment in Internet services.

As part of China’s WTO accession package, China has promised to create a concrete, comprehensible and more transparent telecommunications legal framework that increases competition and improves the investment environment. The government aims to complete these new regulations by the end of 2002. However, this timetable seems unrealistic since consensus has been reached on none of the ten plus drafts circulating in the State Council.

Recommendations:

As Chief Consultant for the American Chamber of Commerce–PRC, I propose that AmCham lobby the Chinese government to accept the following recommendations:

• Consolidate all ministerial regulatory powers to the Ministry of Information Industry
• Create more transparency in the drafting procedures for Internet regulations by opening the drafting process to industry professionals and all affected parties. They need the opportunity to comment at a meaningful stage prior to promulgation
• Establish an appeals process to hear public opposition to draft laws and regulations
• Establish a body within the State Council to pass all Internet-related regulations
• Reduce the complexity of licensing procedures for ICPs by amending current articles under the Telecom Regulation of PRC. Create a less confusing, one-stop shopping system for those seeking approval.
• Reduce discretionary interpretation from the ministries by clearly defining national guidelines for content and licensing approval.
• Give advance public notice before a regulation or law goes into effect
• Implement and enforce prompt publication of new regulations
  

Outlook:

Now is the appropriate time to forward new ideas for improving China’s Internet regulations. These proposed reforms aim at increasing American investor confidence in this potentially highly profitable sector. AmCham, a coalition of companies who have invested or anticipate investing in China’s Internet services market, wants to ensure that China’s new Internet laws create a competitive business environment.

The Chinese government lobbying campaign will concentrate on how these reforms will help China reach its economic goals, benefit the sector’s industries and the economy as a whole. The key is improving the investment environment for Internet services.

Background

 I. Industry Development

During the late 1980s, the Chinese government built seamless Internet networks to connect academic institutions. Two public data networks were developed, connecting the capitals of 30 provinces. However it was not until 1994 when China officially logged on to the World Wide Web through an international gateway developed by SprintLink. This first Internet connection transmitted data from Stockton , California.

By this time three networks had been established with 2,200 dial-up users and ten leased line subscribers through China Telecom, the only state-owned telecommunications company providing Internet services. China Telecom was a part of the Ministry of Posts and Telecommunications until China Telecom separated from its regulator in 1998. At this time, the government created the Ministry of Information Industry to merge the Ministry of Post and Telecommunications and the Ministry of Electronics and Information. The MII now oversees telecommunications, multimedia, broadcasting, satellites, and the Internet and approves investors seeking telecom services licenses. As required by law, licenses are issued on the basis of the company’s investment strength, their ability to provide long-term services, their management expertise, and their technical strength. The Ministry functions as a policy and standards coordinator for the entire industry. Since 1998, the MII has overseen all basic and value-added telecom development, in addition to China ’s six state-owned telecom enterprises.  
   

1.  State-owned Telecom Enterprises

1a.  China Telecom

China Telecom (CT) is a de facto monopoly. Until the recent announcement of China Telecom’s north-south break-up, the company controlled the country’s largest fixed line infrastructure with a 120,000-kilometer network of trunk and branch lines. As the country’s dominant fixed-line operator, with over ninety-nine percent of the local service market and almost all international direct dial and domestic direct dial long-distance calls (144 million subscribers out of 144.4 million total subscribers)[1], China Telecom has retained an unassailable lead over its smaller and younger competitors and respectively stands as one of the worlds largest telecom companies[2]. Revenue for the first seven months of 2001 equaled $10.5 billion (87.3 billion Yuan).[i]

CT is the largest network operator in China with extensive voice and data networks, including switching centers and transmission lines. CT controls 85 percent of China ’s PSTN switching capacity and 80 percent of backbones and is one of two gatekeepers for all international voice and data transmissions.[ii] All access networks must use CT’s bandwidth to access the World Wide Web, and therefore CT (with the MII behind it) has been able to maintain majority control over Internet access and content. CT collects revenue by leasing its lines to ISPs and providing Internet services directly to consumers. On average, the leased-line charges account for almost 80 percent of a Chinese ISP’s costs—compared with just 6 percent in the US —indicating that CT has been able to maintain high prices.

1b.  China Unicom

In 1994, the government created China Unicom (CU) to initiate competition for China Telecom. China Unicom was the first company established to absorb the paging business but has since moved to become a prominent mobile service provider. China Unicom is the only state operator that offers a full range of services and has therefore benefited from annual revenue of nearly $3 billion.[iii] CU does provide some local and domestic long distance services but the service is considered inferior to China Telecom’s telephone service. Its telephone services are limited to a few large cities and total subscribers are .32 million.[iv]

In the Internet industry, most of Unicom’s services revolve around wireless Internet services and VoIP technologies. In August, China Unicom completed the second of three phases in its network build out, giving it the world’s largest VoIP network.[v] The company’s existing leased-line Internet service consists of a 55Mbps international Internet connectivity and has completed 20,000 km of a nationwide fiber optic backbone, providing cable Internet access for 25 cities. CU is the second largest ISP in number of cities covered, but its market share is low and operations are lacking in its Internet access and Internet data center services. Content delivery is also poor in the sense that Websites are unattractive in both content and presentati on.

The government has continued to restructure telecom services by creating four additional state-owned enterprises to introduce competition to the industry. Each of these companies, Jitong Network Communications (est.1994), China Mobile (est.2000), China Netcom (est.1999), and China Railway Telecom (est.2001) specializes in a variety of telecom services.  
 

1c.  Jitong Communications

Jitong Communications provides data and voice communications services with its broadband Internet protocol-based network, serving approximately 700 customers, including government agencies, Chinese and foreign corporations, small and medium-sized businesses, and other Internet access providers. The company operates the national public Golden Bridge Network backbone infrastructure for Internet access and data communications and is the second company controlling the international gateways. Since 1997, Jitong has established branches in the following ten cities: Beijing, Shanghai, Guangzhou, Shenzhen, Wuhan, Dalian, Qingdao, Shenyang, Chongqing and Changchun.
  
1d.  China Mobile
China Mobile is the single largest provider of all mobile services, including mobile Internet services and VoIP to subscribers in China . It separated from China Telecom in 2000 as part of the government’s breakup of China Telecom’s monopoly. The company has twenty-five subsidiary companies, covering all cities and ninety-six percent of rural towns.[vi]  

  
  
1e.  China Netcom  
China Netcom was initially an Internet service company developed as a subsidiary to China Telecom. In 1999, however, China Netcom became an independent company comprised of four members. The China Academy of Sciences, State Administration of Radio, Film, & TV, Ministry of Railways and the Government of Shanghai created China Netcom to become an Internet services wholesaler, selling high-speed network capacity (broadband) and connection to other ISPs. The network provides service to 17 cities in eastern China . AT&T is one of its clients.
 

1f.  China Railway Telecom

The latest telecom company, China Railway Telecom, was established in March 2001 to diversify services and create additional competition for the entire industry. The state-owned company provides basic long-distance, local services, data transportation and Internet-related business but does not have the ability to provide mobile or international long distance services. Most of the Railway Telecom’s network is outdated. The company is in dire need of technology, specialists and capital.
  

2.  Internet Access

As more state-owned telecommunication companies developed and the Internet grew, the government initiated several laws to regulate the industry.

In 1996, the Ministry of Public Security issued the Circular Concerning the Recordal of Computer Information Systems Linked to Foreign Networks. The Cirular[vii] states that all Internet users are required to register with a local public security bureau within 30 days of establishing a link. It empowers public security authorities to warn and/or shut down computer networks that jeopardize the safety of computer information networks. Public registration forms are now included in applications for Internet service subscriptions.

In addition, two laws were initiated to regulate the actual Internet access process. These laws legally set forth the Internet services system by regulating international gateways and creating a four-tier system for domestic networks’ international access.[viii]
 

1. The Provisional Regulations of the People’s Republic of China Concerning

Administration of International Connections of Computer Information Networks (Provisional Networks) — developed by State Council 1996, revised in 1997. “This regulation lays out the basic organizational and administrative structure of China ’s information services network. The revisions of 1997 specifically addressed the issues relating to the establishment of interfacing networks and their connection to the international computer networks. Under the system, subscribers, whether individuals or legal persons, must connect their computer systems to connected networks operated by properly approved and registered domestic ISPs, which, in turn, are linked up with the so-called ‘interconnected networks’. At present, there are six authorized interconnected networks.”[ix]  
   

2. The Implementation Measures — issued in 1998, states that “all connections to overseas computer networks must go through the international gateways operated by the Ministry of Information Industries that can be connected to China’s domestic network for the purposes of commercial services. In this regard, no one can set up or use other channels for international access. Only interconnected networks or computer information networks that directly carry out international connections, and are actually China ’s backbone Internet operators, are allowed to connect directly to the Internet by going through the MII controlled gateways. The establishment of new interconnected networks is subject to the approval of the State Council.”[x]

The four-tier level consists of 1) Internet subscribers, 2) local/private ISPs, 3) national state-owned ISPs and 4) the international gateways[xi].

1)      The first level consists of the Internet subscribers.

2)      The second level consists of local/private ISPs, often referred to as Internet access networks. These service providers are not directly linked to China ’s Internet backbone but consist of local area networks. LANs are defined as “data communications networks which are geographically limited (typically to a 1 km radius) allowing easy interconnection of terminals, microprocessors and computers within adjacent buildings.”[xii] More developed ISPs also possess wide area networks extending over distances greater than one kilometer. However, all of these ISPs must subscribe to one of four commercial interconnected networks to access the Internet because private companies are not allowed to install their own phone lines or networks. The cost of leasing such lines usually accounts for 80 percent of an ISP’s total cost. Currently there are approximately 620 localized ISPs.

3)      The Implementation Measures identifies six network organizations[3] operating international network facilities that connect to the gateways. These are divided into educational and commercial ISPs.  
 

ISPs for Educational Purposes:

a.       China Education Network (CERNET) — a private network only used for academic and educational institutions in China and is administered by State Ministry of Education

b.       China Science and Technology Network (CSTNET) — the primary network for research institutions and scientists
 

ISPs for Commercial Services:

c.       China Public Computer Network (CHINANET)

d.       China Golden Bridge Network ( CHINA GBNET)

e.       China Unicom Public Computer Interconnection Network (UNINET)

f.        China Network Communication Network (CNCNET)

2a.  State-owned Commercial ISPs  
    

2a-1.  China Public Computer Network

Chinanet, the largest commercial ISP in China , offers services to all major cities. The service provider is operated by China Telecom. Therefore, China Telecom is the dominant ISP for Chinanet, which then leases lines to local/private ISPs. CT controls over 80 percent of the Chinese connection to the international gateways. CT’s high leasing fees have prevented smaller ISPs from becoming significant players.  
   

2a-2. China Golden Bridge Network

China GBNet was launched in 1996. Jitong Communications is the main ISP behind it. The GB project was developed in March 1993 to establish a computer information service system for government agencies and enterprises. The project connects 24 provinces and cities in central and eastern China , concentrating in coastal cities. Major subscribers are the State Information Center , the Ministry of Foreign Trade & Economic Cooperation, and the State Customs General Bureau. Through GBNet, Jitong provides commercial Internet services and controls thirteen international gateways.  
    

2a-3.  China Unicom Public Computer Interconnection Network

China Unicom’s Internet services operate through Uninet. Its primary network is located in southern China and provides Internet protocol applications like VoIP and fax over IP.  In 2000 China Unicom implemented access services to over 100 cities on a 20,000 km nationwide fiber optic backbone.
    

2a-4.  China Network Communication Network

China Netcom is the parent company of CNCNET, which had existing connections to broadcasting and railway networks before becoming a China Netcom company in 2000. CNCNET reduced its networking capacity when Railcom was developed in 2001. Many original CNCNET railway networks controlled by Netcom were given over to China Railcom.  

These four Internet backbones were interconnected on a broadband basis in April 2000 and have a significant advantage in providing users with services. As of July 2001, China ’s total bandwidth is 3013.  

At the apex of the system are the international gateways controlled by China Telecom and Jitong Communications. All networking traffic is funneled through the international gateways. This funneling system has caused congestion problems since there are few international gateways relative to the total number of Internet users.

The limited number of local/private ISPs results from state control of the international gateways and national backbones, and a general lack of investment. Higher rates have resulted from the lack of competition between the four national carriers and two gatekeepers. The Chinese government finds it very important to control the international gateways to censor Websites containing “objectionable material”. The government can block certain general sites, like foreign news organizations, that might contain unwanted information. CNN and BBC are just a few of the Web sites that have been blocked from entering the country. This censorship has become known as the “Great Firewall”.  

These regulations were some of the earliest government controls over Internet services. In September 1998, a Notice outlined detailed qualifications and procedural requirements for the establishment and operation of ISPs. The Notice on Relevant Issues Concerning Implementation of a Business Permit System for Operating International Connections of Computer Information Networks[xiii] requires that special business permits be applied under the auspice of MII. Applications can be filed at local MII branches for companies planning to engage in the ISP business. These local branches are authorized to approve and issue permits, and file and record the permits with the MII. Multi-province ISPs must apply directly to the MII for permits. This system established control over second and third level ISPs in the industry.  

Collectively, these four laws help demonstrate how Internet access works in China . Registered Internet users dial up access from their computers to local area networks. These networks then connect to a regional network, which in turn connects to one or more backbones. Most backbone and regional network traffic run over leased phone lines. Connecting to an international gateway finishes the process. At the moment, China is interconnected to the US , Canada , Australia , Britain , Germany , France , Japan , and South Korea .  

To give an example, a local ISP in Beijing that possesses local area networks (LANs) must lease lines from China Telecom’s Chinanet’s networking backbone to gain access to and from international gateways. China Telecom then makes money from Chinanet’s network because they own the lines and the data centers that make up the backbone.

2b.  Bandwidth

Over the years these networks’ bandwidth has increased with the increasing volume of processed information. The following is a chart of these increases.[xiv]

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