SHANGHAI, China — In China, government leadership is essential to the rise and fall of any and every industry. When it comes to luxury goods, this leadership has fallen short of expectations, allowing a massive trade in counterfeits to grow.

According to US Chamber of Commerce estimates, Greater China is the source of 86 percent of the world’s counterfeit goods, a portion valued at a staggering $397 billion.

Even e-commerce giant Alibaba, itself a major target of anti-counterfeit critics worldwide, has called on the Chinese government to do more to fix its "ambiguous" efforts. A statement released last year by the company appealed to the government to step up its approach: "Counterfeiting is damaging, not only to consumers and legitimate merchants, but also to innovation and the long-term economic development of our nation, hindering China's growth as a responsible economic power," read the statement.

Prompted perhaps by these attacks on its record as well as the prospect of driving more tax revenue by encouraging legitimate luxury spending in China, the government finally seems to have made its anti-counterfeiting drive a focus of more attention and energy.

At the 13th National People’s Congress earlier this year, Premier Li Keqiang said that law enforcement had been playing, and would continue to play, a bigger role in cracking down on counterfeits, adding that making or selling fake goods was “the enemy of fairness and innovation, and [goes] against social ethics.”

Major brands have largely welcomed the recent wave of policies emanating from Beijing, sounding optimistic about the future of long-standing issues, such as intellectual property (IP) infringement and enforcement.

China has created a "much improved environment for brands" compared with a decade ago, said Valerie Sonnier, global intellectual property director at Louis Vuitton Malletier, speaking at the China International Import Expo in Shanghai last month. "Much more than some other countries," she added.

Consumer confidence is key

A crackdown on counterfeits is expected to buoy China's economy as domestic consumption accounts for a bigger slice of the 1 trillion yuan ($145.37 billion) that Chinese shoppers are expected to spend on luxury by 2025, according to data from McKinsey & Company. But winning the trust of consumers is critical.

At the start of this year, the government’s Ministry of Industry and Information Technology established the China Luxury Authentication Centre, a sub-department tasked with training a government-licenced army of luxury authenticators to battle the increasingly high-quality fakes being manufactured and sold in the Middle Kingdom.

At an interview in its non-descript offices directly next door to Beijing’s SKP luxury shopping mall — a symbolic location steps from a multitude of international luxury brand flagships — secretary general of the centre Peng Lei outlines its goal to train 100,000 professional luxury goods authenticators throughout the country.

Dressed in a Gucci sweater and sneakers, certainly not the norm for a Chinese government employee, Peng explained the increasing need for standardisation and oversight of luxury goods as spending on the sector booms and spend shifts away from overseas flagship stores to local purchases often made via e-commerce or, increasingly, second-hand retailers.

“Luxury product profit is quite big, but it’s not just about protecting the brands, it’s also about protecting the consumers, they both need a standard,” he said, adding that his centre is working closely with international brands, foreign luxury associations and all the major domestic e-commerce platforms to communicate data points for spotting fake goods, and identify counterfeiters.

Regulation nation

E-commerce is a major battleground in the fight against counterfeits and the Chinese government plans to implement the country's most comprehensive e-commerce regulation legislation to date on January 1, 2019. In the works since 2016, the new law aims to extend legal protections for both consumers and brand owners.

Platform operators, third-party vendors selling online and online sellers, including so-called “micro-businesses” that traditionally fly under the legal radar in China, will be subject to the law and will all be required to obtain official business licences from the country’s State Administration for Industry and Commerce.

This will make it harder for the plethora of small fish in China’s online ocean to avoid penalties for misleading consumers or infringing on IP. Platforms will also be legally required to respond to reports of fake goods in a timely manner, or face penalties of up to $30 million.

Luxury product profit is quite big, but it's not just about protecting the brands, it's also about protecting the consumers, they both need a standard.

Though most experts agree on the need for more legal regulation over China’s e-commerce sector, not everyone is happy about the final product. “This whole law is just a conglomeration of existing practices, regulations and laws, it’s not actually covering a whole lot of new ground,” said Joe Simone, founder and partner of SIPS, advisors to companies on intellectual property rights in China since the mid-1980s.

According to Simone, IP experts lobbied for the law to go much further in requiring platforms to be pro-active in policing counterfeits, rather than just responding to complaints. Also, he argues, what constitutes adequate “response” under the law may not actually require what he sees as meaningful action on the part of the platforms.

"Say I am Gucci and I file a takedown request, if the pirate makes an argument saying they bought the item from a legitimate source or saying the brands are not similar, that it's clearly labelled Cucci and not Gucci, the platform can just say, 'Well, it's up to you guys to duke it out in court.' They just need to do one quick assessment, notify the parties and their job is done," he explained.

Shrinking the grey area

The new law will impact China’s million-strong legion of daigou agents, or parallel importers who buy and resell goods from overseas, bypassing China’s traditionally higher price tags for product categories such as beauty and luxury. That’s because the new requirements for business licencing and taxation apply not only to those selling goods through platforms and e-commerce websites, but also those selling through social media and live-streaming platforms, as daigou agents commonly do.

Neilson figures put overseas purchases of foreign goods being brought back into China without paying locally mandated tariffs at $100 billion in 2017, with a significant percentage of these (figures from Bain & Company released in 2016 suggest as much as half) coming from professional daigou agents, as opposed to regular tourists shopping for themselves.

And yet, the golden era of easy money and little oversight once enjoyed by daigou who exploited hefty differentials between luxury goods price tags in Europe and China is over. The past two years has seen round after round of government tariff cuts work to bring prices for luxury goods in China more in line with the rest of the world, lessening the demand for daigou consumption. At the same time, brands, notably Chanel, have worked to normalise their prices across global markets.

In 2011, luxury items sold overseas were 68 percent cheaper on average than the same products sold in China. By the end of 2017, the difference was just 16 percent, according to research from China’s Fortune Character Institute.

Since then, China’s Ministry of Finance announced its latest round of tariff cuts on May 31, applying to 1,449 categories spanning across luxury, fashion, beauty and other sectors and prompting brands such as Louis Vuitton to cut their Mainland China pricing by a further three to five percent.

“China has lowered the tax and duty on 8,000 product categories so far,” said Peng Lei. “The Chinese government is adjusting the market, because it knows that if it doesn't, they won’t be able to manage and control a market that is growing so significantly.

These tariff cuts have, naturally, created some pain for China’s bottom line. According to Deloitte, recent reductions in import tariffs has cut 60 billion yuan ($8.7 billion) from the country’s budget. But the Chinese government seems to be betting that the long-term gains of repatriating luxury spending, as well as eliminating parallel grey market imports will be worth the short-term pain.

If they want to do something, they do it... When it comes to fake markets, they could do much more... they can be much more strong in stopping it.

“The result is the rate of Chinese people going overseas to buy [luxury goods] will become less and less, it will get rid of daigou, then the money can come home. So, China can support many more stores, service more customers. This all represents the core of China’s normalisation of the luxury market,” Peng added.

Any shift in the aforementioned $100 billion from off-the-books imports to official transactions in mainland Chinese will also serve to narrow China’s trade surplus — a potentially helpful side-effect for a government facing ongoing trade conflict with the US. If just a third of the annual total could be made official, the surplus would shrink by 10 percent, according to Bloomberg analysis.

Global luxury companies have welcomed the clampdown, even as it has also initially caused them financial pain. Luxury stocks shuddered in October as Chinese customs officials cracked down on these grey market imports, searching bags at the country’s major international airports and slapping those bringing in more than the individual import limit of 5,000 yuan ($728) worth of duty free goods with hefty fines.

But LVMH chief financial officer Jean-Jacques Guiony said on the conglomerate's most recent earnings call that stricter enforcement from Chinese officials was welcome, as "[Daigou] is not something that we welcome or that we try to promote… The Chinese [authorities] moving in the same direction is good for us."

A long way from perfect

Recent moves may have made China a better partner for the luxury industry increasingly dependent on spending from its citizens, but there is still plenty of room for more leadership from policy makers here.

"I think there is a little more attention on this point [of legitimising the local luxury industry]," said Giovanni Pungetti, chief executive for Greater China of OTB Group, parent company of Diesel, Marni and Maison Margiela, though he is quick to add that they are such a powerful entity that they could be much more effective against counterfeits, for example, if they made it a serious priority.

“If they want to do something, they do it. We have seen this with [crackdown on] corruption. When it comes to fake markets, they could do much more. If they would like to be, they can be much more strong in stopping it,” he said.

Though almost certainly driven by self-interest, a thriving legitimate luxury industry is a net-positive for China’s economy as it shifts more and more from a manufacturing to consumption-led economy, and though there is doubtless more that can be done, there is an air of confidence that 2018 will mark a turning point in China’s official attitude to grey and black market luxury.

This is good news for consumers and the industry at large, and bad news for the dark underbelly of China’s luxury industry that has been allowed to thrive unchecked for far too long.

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