China s quest for market economy status

Transcription

1 May 2004 China s quest for market economy status Stephen Green Summary China is not recognised as a market economy by any major trading partner, a status that makes it easier for its firms to be found guilty of dumping goods on overseas markets. Unsatisfied by what it sees as discriminatory treatment and fearful that this status could make it vulnerable to western protectionism, the People s Republic has embarked on a comprehensive campaign to gain market economy status (MES). It has lodged a formal request for MES with the European Union (EU) and the topic, alongside the EU s embargo on weapons sales to China, will be among the things Premier Wen Jiabao discusses with European leaders during his visit in May. Although the picture is mixed, there is much about China s present-day economy particularly its export sector that means it deserves MES. The competitiveness of its goods is mainly based on low cost, productive labour rather than subsidies, easy finance or controlled prices. In addition, the unfair methods for judging Chinese exports introduced by the current nonmarket economy and economy in transition classifications for China, are also good reasons for extending MES. A re-classification by the EU will probably, however, be delayed and informally linked to China committing to better implementation of its WTO accession agreements. Instead of offering a re-classification in June, the EU might offer a transparent framework for what is needed for MES to be extended. The likelihood, however, is that sooner or later the EU will recognise China as a market economy and will do so before the United States. Alongside the possible end to the EU s embargo on arms sales to China, transatlantic tensions on how to deal with China appear inevitable. While a move to end the arms embargo would currently be a mistake, extending MES would support China s transition to a market economy and help nudge the United States away from its current protectionist instincts when it comes to China. It is therefore a step which, carefully managed, that would be worth taking.

2 Introduction China s private sector is booming, its Communist Party oversees one of the most liberal trade regimes of any developing country and the provinces are privatising their assets at a rate that would cause Margaret Thatcher to blush. In short, China is fast becoming a market economy. Clearly though, the transition has some way to go. The government has not given up its ambition to nurture dozens of state firms into globally-competitive giants, banks continue to prefer to lend to state firms, and the bankruptcy regime is still not very effective, particularly when it comes to the state s own firms. China is in the midst of a dynamic, and messy, transition it is no longer a plan economy, and neither is it yet a mature market one. Being somewhere in-between, the question of whether China is or is not a market economy resists a simple, one-word answer. Unfortunately for policy-makers in Europe, United States and Japan, a one-word response is required. Why? Because Beijing has made a yes response a central objective of its trade policy. Being formally given market economy status (MES) by the members of the World Trade Organisation (WTO) has become, for good or for bad, a matter of national pride for Beijing. Getting it would be, like the 2008 Olympic Games, a stamp of international approval. Another reason is more pragmatic MES would change how anti-dumping actions against Chinese firms are judged. This might seem to be a marginal issue, but it goes to the heart of how Beijing views its position in the world trading system and underpins its fears about western protectionism. As a result, a huge diplomatic offensive has been launched to gain MES. Since the WTO itself does not classify countries itself this is left to its individual members China s trade officials have to lobby individual governments. The first minor victory came in April when New Zealand announced it would recognise China as a MES. Premier Wen Jiabao stated that this move amounted to an objective recognition of China s tremendous achievements in reform and opening up. 1 Australia has also been reported to be reconsidering its classification of China. 2 Europe, however, is the first major target. Premier Wen has declared that 2004 should be China s Year of Europe, and a Foreign Ministry White Paper in 2003 outlined China s ambition to build a comprehensive partnership relationship with Europe. 3 There are two things on China s wish list: MES and an end to Europe s 15-year old embargo on weapons and high-end information-technology sales to China. China deserves the first one, as rest of this Briefing Note argues. Market economy status and the anti-dumping framework In Europe trade policy is administered by the Commission for External Trade (CET) and is ultimately determined by the member governments. A formal request for recognition as a market economy was made by China in June 2003, and Pascal Lamy, the EU s Commissioner for External Trade, promised a preliminary verdict at the end of June this year. 1 New Zealand plans to start negotiations on a Free Trade Agreement with China later in See China appreciates New Zealand's recognition of market economy status, April 16 th 2004, Foreign Ministry Release, Sourced from May New Zealand Gives China Market Economy Status, China Daily, April 16 th 2004, sourced from May See Willy Lam, European embargo tops Wen's agenda, CNN, May 3 rd, 2004, Sourced from 2

3 In its WTO accession agreement, China agreed that other WTO members could treat it as a non-market economy until This classification is vital to one area of trade policy dealing with dumping allegations against Chinese firms. When a firm in the United States, or any other WTO member, believes that a Chinese exporter is dumping its goods in its market, it can complain to its local trade authorities. 5 In the case of the United States this is the Department of Commerce, which investigates the complaint to find whether the goods are being sold at less than fair value. 6 There are a number of ways of determining this. The home and export prices of the goods might be compared. This is the normal methodology for market economies, where home prices reflect the true costs of production. If the overseas prices are below domestic prices, it is likely that they will be found to be less than fair value. In the case of China, an economy in which some input prices might be below real market cost, its trade authorities agreed that other WTO members could use the surrogate country approach. Investigators find a comparable firm in, say, India or Japan, to see what the real market costs of producing those goods are. If the Chinese firm is selling its exports for less than the Indian or Japanese firm s costs suggest it should, then it can be found to be selling goods for less than fair value. 7 In the United States, if a less than fair value finding is made, then the complaint goes to the International Trade Commission, which determines whether the domestic industry is suffering material injury because of the imports. If its decision is affirmative, dumping is found to occur. Punitive import tariffs (counter-veiling duties) can then be levied. In the EU, national governments make initial investigations and then, if they determine the matter has merit, they pass the accusation of dumping to the CET to investigate. The commission then determines whether goods are being sold at less than market value and whether injury has occurred. The Chinese authorities believe that this treatment is unfair for a number of reasons, including: 1. Increasing numbers of Chinese firms especially those in the export sector are operating within market environments with inputs purchased at their real cost and finance raised on a commercial basis. 2. It is a comparative advantage in labour costs that is primarily responsible for China s export dynamism, not cheap credit, state support or manipulation of the currency. No surrogate country has China s cheap pool of labour, a key component of the price of its manufactured goods. Any surrogate countries costs will be higher, making it likely that dumping can be judged to have occurred when it has not if the surrogate country method is used. 4 This classification was agreed in the US-China 1999 bilateral agreement and was multilateralised as part of China s WTO entry protocol. The relevant articles of the Accession Protocol are provided in Appendix A. 5 For a detailed account of the WTO s anti-dumping regime see Douglas Irwin, Free Trade Under Fire, Princeton University Press, Irwin notes that the Department of Commerce usually finds dumping to have occurred. The methodology is not fair: if any individual price in the United States is found to below the average home price, then dumping can be found to be occurring, a system which clearly biases the investigation since it makes dumping very easy to prove. 7 Finding a surrogate firm is hard. Those firms in developing countries are likely to be direct competitors of the firm under investigation. It is in their interest to refuse to be used as surrogates, forcing investigators to use developed country firms. Since the latter s costs are high, this increases the chances of dumping being found to have occurred. 3

4 3. Chinese trade officials point out that Russia, a country hardly known for its transparency and openness, is recognised by Europe as a market economy. The Chinese also feel that, despite having agreed to the 2015 NME status in talks with the Americans, that this was ultimately an unfair demand to which they had no choice but to agree. No other country is subject to a time limit on the status of its economy. 8 With China subject to 232 separate anti-dumping measures by the end of June 2003, the most of any country and with the fear of more being filed as Chinese export volumes rise over the decade there is good reason for Beijing to want better protection. If China obtained MES from the EU and the United States then any anti-dumping investigation would have to use Chinese prices, making dumping much more difficult to prove. China s Accession Protocol does allow it to gain recognition as a MES if it can prove to the satisfaction of other WTO members that it is in fact a market economy. This is what has occurred in the case of New Zealand. Alternatively, if China can persuade other members that market conditions prevail in a particular sector or industry then their anti-dumping investigations will use a market methodology when dealing with these areas. 9 For their part, China s trading partners are not entirely happy with China s MES ambitions. Trade officials feel hard done by that China is trying to re-negotiate something to which it willingly agreed only three years ago. They feel that the sometime emotional accusations of discriminatory behaviour by Chinese trade officials are not fair China did voluntarily sign up to this agreement, and there are good economic reasons for the classification. These include: 1. Some firms in China can still get preferential access to bank credit. Despite increasingly commercial lending practices, local state banks still come under pressure to lend to important state firms. This will impact on the prices at which they can sell their produce overseas. 2. The bankruptcy framework is still not effective, particularly for state firms, meaning that their products can be sold at below cost. 3. A number of important prices in the economy, particularly those of commodities and the price of money (the interest rate) are controlled, despite price liberalisation in most sectors. This introduces important distortions in the cost of production. 4. Russia is not a valid comparison. Its export profile heavily dependent on raw materials is very different from that of China. China s exports are more diverse and concentrated in manufactured goods, a profile that threatens European firms much more. The EU s current compromise The EU unlike the United States re-classified China as an economy in transition in This means that it considers complaints on a case-by-case basis, using five tests to judge whether the Chinese firm against which the dumping complaint has been filed is operating within a market environment. 10 These criteria are: 8 Rumours circulate that former premier Zhu Rongji, desperate to bring the WTO accession talks with the Americans to a successful close, gave away the 2015 deadline when the Americans were ready to accept a much earlier date. Others report that the United States initially requested a 20-year period, and that the Chinese successfully negotiated this down to 15 years. 9 The United States trade regime has the capacity to classify on a sector-by-sector approach, but the EU only classifies countries as market, non-market or market in transition. 10 The Chinese firm, once it receives notice of the complaint against it, is given the opportunity of applying to be considered to be operating in a market environment. 4

5 1. Does the government influence the company s operations? 2. Does the legacy of the plan economy, in terms of public ownership, barter trade, etc. affect the firm? 3. Does the firm operate under an effective company law? Does it have decent accounting standards? 4. Does the firm operate under an effective bankruptcy framework and property rights protections? 5. Does the firm convert currency at standard market rates? 11 The EU sends out a team from its Trade Defence Unit to investigate each case. A firm has to meet all the five criteria to be classified as operating in a market. 12 According to the CET, about half of the Chinese firms they investigate are found to be operating in market environments. 13 Since 1999 some Chinese firms have claimed to be operating in market environments, though the numbers of complaints and accompanying investigations has declined in recent years. Since 2001, only some 25 cases have been investigated. Europe s case-by-case approach is clearly superior to the United State s blanket definition of China as a non-market economy. But should the EU go further and grant China MES? The report on its technical investigation into China s economy due in June 2004 will tell a hugely complex and finely balanced story. It will provide evidence of China s rapid movement to a market economy, but will, of course, also provide evidence of some non-market economy behaviour. Although Pascal Lamy has said that the MES decision will be entirely technical, given the complexity of the picture that will inevitably emerge, and the political significance of the decision for EU-China relations, it is likely that the final judgement will be take into account a range of other factors. These nudge the argument in favour of re-classifying China as a market economy. 1. The majority of China s exports come from foreign-invested joint venture firms and indigenous private firms, which operate in mostly market environments. The EU s economy-wide investigation will find more evidence of non-market activity than if the investigation focused solely on the export sector. 2. Making investigations into individual firms is a time-consuming and costly process, both for the Commission and the firms involved. Many firms can not cope with the detailed financial and operational data requested by the EU. The case-by-case approach also places the burden of proof squarely on the accused Chinese firms. Fail one of the EU s five criteria, and the firm is classed as operating in a non-market environment. 3. While a firm might fail one of the tests, the reason for its failure might not be a factor in determining the price of its exports. The fact that its accounts, for instance, are unclear to EU investigators is likely not a legitimate enough reason to find it guilty of dumping. 4. There are other safeguards that can be used to protect Europe s and others markets from unfair trade practices. Anti-dumping cases could still be filed against Chinese firms if the country was re-classified with MES, but instead of using the highly doubtful surrogate country approach, Chinese firms would be judged on the basis of more realistic costs. 11 The EU does not consider whether the exchange rate floats or is set administratively, but rather if individual firms can use preferential rates of exchange. 12 A parallel set of five tests are apparently being levied at the macro-level to determine whether the economy as a whole warrants MES, although the details of the tests have not been released. 13 Interview, April 1 st The Commission does not report any obvious trends in firms across industries and geographical areas. Neither is it clear that firms in more recent cases are more likely to be found to be operating in markets. 5

6 The political impact of a change in China s economy classification China has a right to be protected from an anti-dumping framework that is too easily abused. Extending China MES, even if it does not yet host a perfect market economy, would be a legitimate move. This is both because of the market environment inhabited by most Chinese exporters and because the current classification of the EU, and even more so that of the United States, means that the methodologies used to investigate allegations of dumping are stacked against the exporters. In a world of trade real politick, however, a re-classification by the EU will probably be delayed and informally linked to China committing to better implementation of its WTO accessions. Trade officials complain that China is using capital requirements and other instruments to undermine the commitments it gave in financial services, is insufficiently active in defending intellectual property rights, and is going slow on opening up the internal distribution and logistics markets, to name but three current complaints. Instead of offering a re-classification in June, the EU might offer a transparent framework for what is needed for MES to be extended. At present its methodology for judging economy status is unclear and China s Ministry of Commerce would welcome more substantive criteria. The likelihood, however, is that whether it is in 2004 or later, the EU will move before the United States in recognising China as a market economy. When this re-classification takes place, it will clearly create pressure on Washington to follow particularly, of course, from the Chinese who will have a marvellous lever. Alongside the fact that it also appears possible that the EU s embargo on arms sales to China could be dropped, serious transatlantic differences of opinion on how to deal with the rise of China appear inevitable. 14 China s foreign affairs strategists deny such an objective, but they would clearly welcome such tensions. China s current Year of Europe campaign is plainly targeted at prising Europe away from the United States on both trade and security policy. In general, Europe does not share America s worries about China s growing economic dominance and political influence in Asia, nor its military ambitions, and Europe s industrial and labour lobbyists are apparently less concerned with the impact of China s economic rise than in America and less well organised. This makes Europe a more attractive place for China to pursue its foreign policy ambitions. Although the end of the arms embargo has a strong supporter in Jacques Chirac, many remain uneasy, viewing China s still problematic human rights record, its one-party political system and its uncompromising stance on Taiwan as matters of concern. The United States is extremely uneasy about the possibility of the arms embargo going, an unease that is shared by many across the political spectrum in Washington, not just those in the current administration. Europe should be extremely careful about opening up a breach in security policy with the United States on such an important subject as China. It is, however, progressive policy to encourage China s economic development and integration into the global economy and an international trading system based on fair rules. By extending MES to China, Europe would be making it harder for the anti-dumping framework to be abused for protectionist ends. and so would support this broader objective. Such a move might also nudge the United States away from its current protectionist instincts when it comes to China. If carefully managed, such a breach in China policy between Brussels and Washington would be progressive. 14 Axel Berkofsky, EU unlikely to lift China arms embargo soon, Asia Times, May 1 st 2004, sourced from May 4 th

7 Appendix: Section 15 of the accession agreement of the PRC to the WTO 15 Section 15. Price Comparability in Determining Subsidies and Dumping Article VI of the GATT 1994, the Agreement on Implementation of Article VI of the General Agreement on Tariffs and Trade 1994 ("Anti-Dumping Agreement") and the SCM Agreement shall apply in proceedings involving imports of Chinese origin into a WTO Member consistent with the following: (a) In determining price comparability under Article VI of the GATT 1994 and the Anti-Dumping Agreement, the importing WTO Member shall use either Chinese prices or costs for the industry under investigation or a methodology that is not based on a strict comparison with domestic prices or costs in China based on the following rules: (i) If the producers under investigation can clearly show that market economy conditions prevail in the industry producing the like product with regard to the manufacture, production and sale of that product, the importing WTO Member shall use Chinese prices or costs for the industry under investigation in determining price comparability; (ii) The importing WTO Member may use a methodology that is not based on a strict comparison with domestic prices or costs in China if the producers under investigation cannot clearly show that market economy conditions prevail in the industry producing the like product with regard to manufacture, production and sale of that product. (b) In proceedings under Parts II, III and V of the SCM Agreement, when addressing subsidies described in Articles 14(a), 14(b), 14(c) and 14(d), relevant provisions of the SCM Agreement shall apply; however, if there are special difficulties in that application, the importing WTO Member may then use methodologies for identifying and measuring the subsidy benefit which take into account the possibility that prevailing terms and conditions in China may not always be available as appropriate benchmarks. In applying such methodologies, where practicable, the importing WTO Member should adjust such prevailing terms and conditions before considering the use of terms and conditions prevailing outside China. (c) The importing WTO Member shall notify methodologies used in accordance with subparagraph (a) to the Committee on Anti-Dumping Practices and shall notify methodologies used in accordance with subparagraph (b) to the Committee on Subsidies and Countervailing Measures. (d) Once China has established, under the national law of the importing WTO Member, that it is a market economy, the provisions of subparagraph (a) shall be terminated provided that the importing Member's national law contains market economy criteria as of the date of accession. In any event, the provisions of subparagraph (a)(ii) shall expire 15 years after the date of accession. In addition, should China establish, pursuant to the national law of the importing WTO Member, that market economy conditions prevail in a particular industry or sector, the non-market economy provisions of subparagraph (a) shall no longer apply to that industry or sector. 15 Sourced from Decision of November 10 th

8 With thanks to David Wall, and several trade officials who spoke on the condition of anonymity, for their help in the preparation of this paper. The Royal Institute of International Affairs is an independent body which promotes the rigorous study of international questions and does not express opinions of its own. The opinions expressed in this paper are the responsibility of the author. Royal Institute of International Affairs Chatham House 10 St James s Square London, SW1Y 4LE United Kingdom Contact: Stephen Green, Head of Asia Programme, sgreen@riia.org RIIA All rights reserved. 8