On May 12, the European Parliament made a surprising vote, refusing to recognize China’s market economy status. China’s status as a non-market economy (NME) regularly causes political tension between China and its main trading partners. This move immediately generated lots of speculation on EU-China relations, which have been intensifying since several European states decided to join the China-led Asian Infrastructure Investment Bank (AIIB).
Political Battle for China’s Market Economy Status
China’s market economy status (MES) was a pending issue when China entered the WTO in December 2011. Concerned that China may not fulfill its commitments to WTO, many member countries decided not to grant MES outright to China. Instead, they introduced a non-binding deadline to do so by December 2016. More than 30 countries have recognized China’s MES long before the deadline, but its key trading partners — the EU, the US, Canada, Japan, India, and Mexico — all hold a legal presumption that China is a NME, and maintain legal discretion in determining when this presumption will be lifted. As the deadline is approaching, all these countries will need to make a decision soon. The EU’s move has set an example for other countries.
How important is the MES? From a legal perspective, there is only one area of trade law in which the MES has practical significance: antidumping law. A country can launch an antidumping investigation against any imported product, but the NME status imposes disadvantages on Chinese exporters facing antidumping investigations. Instead of using Chinese export prices as the benchmark, the importing country can use price information from an appropriate surrogate market economy to construct the normal value of the imported products, which typically leads to much higher dumping margins. Since 1995, China has been the world’s biggest target for antidumping investigations, accounting for more than one-third of all newly initiated cases. Between 1995 and 2014, the EU initiated 119 antidumping proceedings and issued 85 antidumping measures against Chinese goods.1 Granting the MES to China means that the EU would have a more difficult time imposing anti-dumping duties on Chinese goods because Chinese imports have to be treated with regard to a determination of normal value in the same way as imports from any other WTO members.
Despite being treated as a NME by its major trading partners, China has become the largest trading nation in the world. Over the last 15 years, its total trading volume has increased 8 times (from USD 510 billion to USD 4300 billion). China’s trade surplus has jumped more than 15 times (from USD 22 billion to USD 384 billion) whereas its average tariff rate has dropped by half (from 15.39 percent to 7.74 percent).2 The NME status seems to have had little to no effect in holding back China’s rapid trade growth.
If the MES does not seem to matter much in the trade relationship, why does the EU still hold the card? Was the EU’s decision based on economic rationales or driven by political considerations? According to the European Parliament, the EU determines a country’s MES based on five criteria, including (1) a low degree of government influence in the allocation of resources and in decisions of enterprises, (2) an absence of distortion in the operation of the privatized economy, (3) the effective implementation of company law with adequate corporate governance rules, (4) effective legal framework for the conduct of business and proper functioning of a free-market economy, and (5) the existence of a genuine financial sector.
The criteria-based assessment of MES might provide a clear legal framework for the EU’s decision, but how to interpret the criteria can be quite arbitrary. According to the EU’s recent evaluation, China fulfills just one of the five criteria. The rejection essentially reflected EU’s concern over China’s lack of transparency, particularly on the role of state-owned enterprises (SOEs) in the economy.
In terms of almost all economic indicators, SOEs are no longer the dominant player of the Chinese economy. The state’s presence in the economy has declined enormously in the last 15 years. SOEs’ declining role in the national economy does not mean that their overall size is shrinking in absolute terms. Rather, the private sector has outgrown the state sector by a large margin. Between 2000 and 2012, the total revenue of SOEs increased by three times whereas the private sector increased by 58 times. Indeed, subsidies still make up a significant portion of SOE profits. In 2011, the Unirule Institute of Economics, an independent think tank, estimated that the benefits SOEs received from discounted loans and subsidies exceeded their total profits by 40 percent.
These facts might partly justify EU’s decision, but political attitudes in Europe on further economic integration with China are more divided than what the dominant rejection votes suggest. European governments are split over the trade relationship with China. The UK supports freer trade with China whereas France is more concerned about the negative consequence of Chinese imports on its labor market.
The rejection essentially reflected EU’s concern over China’s lack of transparency, particularly on the role of state-owned enterprises (SOEs) in the economy.
China is EU’s largest importing and second largest exporting country. Between 2000 and 2015, the EU-China trade grew rapidly, as was the EU’s trade deficit with China, from EUR 48.8 billion to EUR 182.8 billion. The trade imbalance with China has cost millions of jobs in the EU. Aegis Europe, an alliance of 30 European manufacturing industries, estimates that granting MES to China would put between 1.7 million and 3.5 million EU jobs at risk.3 The steel industry, for example, has been actively lobbying the European governments not to grant MES to China, arguing that more than 85,000 jobs have been cut since 2008 due to the surge in Chinese imports.
Given European manufacturing industries’ strong opposition to Chinese exports, these figures might be exaggerated. The European Commission has a more modest estimate: potential job losses are less than 210,000 if the EU were to grant China MES.4 Moreover, despite the rising trade imbalance, the EU and China are deeply engaged in global value chains with complementary production structures. In 2009, Chinese exports created 1.1 million jobs in the EU whereas EU exports supported 5.5 million jobs in China.5 As such, the EU and China have vested interests in a close trade relationship.
It is clear that the long-term benefits of granting MES will outweigh the short-term costs, but the disputes across countries and industries make it difficult for the EU to reach a consensus. Job losses, no matter how small the figure, are taken seriously by politicians as they might trigger public backlash. Therefore, this rejection is fueled more by political than economic motivations.
Trade Imbalance and Economic Prowess
Regardless of the economic or political motivations, the EU’s controversial decision touches upon a classic debate on economic integration and political conflict. The 19th century French economist Frederick Bastiat once said, “If goods cannot cross borders, armies will.” The underlying logic is that extensive economic interdependence may discourage interstate conflicts and constrain the likelihood of dispute escalation, but it may also give rise to trade conflicts, particularly if the trade relationship is unbalanced.
The latter scenario appears to be the case now. China’s growing trade power has been accompanied with rising trade conflicts with its major trading partners. The United States, China’s largest trading partner, has placed 98 antidumping duty orders against China, accounting for 37 percent of all US antidumping cases.6 India has also frequently used antidumping investigations against Chinese products. Japan, though more constrained in using this policy tool, is unlikely to grant the MES to China by the end of 2016.
It is ironic that the world’s largest trading nation still needs other countries to judge its trade status, an indication that China has a long way to go to transform its economic prowess into political power. Of course, China does not have the capacity to compel other countries to do what they otherwise would not, but can China exercise its economic weight to win more political support?
China’s economic prowess in past decades has been driven by its manufacturing and exports. China hopes to transform itself from a labor-intensive low-skilled manufacturing workshop into the headquarters of advanced industries. Initially concentrated at the bottom rung of the global value chain (GVC), China has gradually moved upwards. Thanks to the structural transformation fueled by trade and investment liberalization, Chinese exporters now buy more domestic intermediate inputs and rely less on imports. The share of domestic content in Chinese processing exports has risen from 46 percent in 2000 to 55 percent in 2007.7
China’s dominance in the downstream processing export sector is crucial to the rapid growth of “Factory Asia,” but as China moves up the GVC, the Asian regional production chain has gradually lost momentum. Asia’s trade growth has slowed faster than world trade due to the slow expansion of regional production chains. Although some new emerging economies such as Vietnam and Cambodia have attracted manufacturing multinational corporations to migrate from China, they don’t have the economies of size and production capacity to fill the vacuum left by China. The trade imbalance between China and its main trading partners has also been growing. China’s trade surplus surged by 55 percent in 2015, to USD 595 billion, primarily as a consequence of sharp declines in imports.
China’s new initiatives such as the AIIB, the New Development Bank (NDB), and the One Belt One Road (OBOR) plan are driven by the desire to export excess capacity and boost political support. There is a tendency that China focuses, at least in the short run, on strengthening its position as the source, not the destination, of the regional supply chain. These initiatives look similar to what Japan did in promoting regional integration in the 1980-1990s when Japan faced the similar pressures of economic slowdown and industrial overcapacity. Despite the expansion of its regional production network, Japan failed to improve its relations with other Asian countries. This was because the Japan-led regional production network helped Japan export its products to other countries rather than help other Asian countries use Japan as the destination for their exports. As a result, the trade imbalance between Japan and other Asian countries continued to grow, which heightened tensions between Japan and its Asian neighbors.8
China’s Real Economic Prowess Comes More from its Market than Products or Capital
Rather than replicate the Japanese experience, China should aim to build a complete regional production cycle that not only treats other Asian countries as the destination for Chinese products and capital, but also regard them as an integrated part of the production chain with China being the primary market for the final products. In other words, China would need a demand-side reform in trade policy to address the rising trade imbalance with its major trading partners.
Will the China-initiated regional integration continue to boost its economic potential in Asia, or will it lead to greater rivalries in the region and impede growth? Promoting economic integration may not necessarily facilitate political trust, but creating a balanced trade relationship is critical to ease economic tensions. In the short run, moving excess industrial capacity abroad will do little to alleviate the trade imbalance, which has come under fire by its major trading partners. The challenge China now faces is to find a better balance between expanding the international market for its products and boosting domestic demand to absorb more imports. In order to generate the positive effects of economic integration, China should use these new initiatives not just to transfer excess capacity, but also to promote foreign products made through Chinese investment to be re-exported to China. Investing Chinese capital abroad should contribute to a more balanced trade relationship as other countries may benefit from a more integrated regional market.
1. Puccio, L. (2015). Granting market economy status to China: an analysis of WTO law and of selected WTO members’ policy. The European Parliament Research Service. Retrieved from http://www.europarl.europa.eu/RegData/etudes/IDAN/2015/571325/EPRS_IDA(2015)571325_EN.pdf
2. China Trade Summary 2001 Data. Retrieved from http://wits.worldbank.org/CountryProfile/en/Country/CHN/Year/2001/Summary
3. Scott, R. and Jiang, X. (2015). Unilateral grant of market economy status to China would put millions of jobs at risk. EPI Briefing Paper 407, Economic Policy Institute.
4. Alexe, D. (2016, February 3). EU Commission minimizes job losses from China dumping and MES. New Europe. Retrieved from https://www.neweurope.eu/article/eu-commission-minimises-job-losses-from-china-dumping-and-mes/
5. European Commission’s Directorate-General for Trade. (2014). China-EU global value chain: who creates value, how and where. Retrieved from http://trade.ec.europa.eu/doclib/docs/2014/january/tradoc_152123.pdf
6. Hufbauer, G. C. and Cimino-Isaacs, C. (2016). The outlook for market economy status for China. Peterson Institute of International Economics. Retrieved from https://piie.com/blogs/trade-investment-policy-watch/outlook-market-economy-status-china
7. Kee, H. L. and Tang, H. (forthcoming). Domestic value added in exports: Theory and firm evidence from China. American Economic Review.
8. Bernard, M and Ravenhill, J. (1995). Beyond product cycles and flying geese: regionalization, hierarchy and the industrialization of East Asia. World Politics, 47, 171-209.