China’s Quest For Market Economy Status

China is not recognized as a market economy by any of its major trading partners, making 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 makes it vulnerable to western protectionism now and in the future, the People’s Republic has embarked on a campaign to gain recognition as a market economy. It has, however, met with little success so far. Given this failure, Beijing’s trade strategists might want to rethink their tactics.

China claims to be a market economy, despite having agreed – only five years ago – to be recognized as a non-market economy for 15 years by the other members of the World Trade Organization (WTO). After winning over New Zealand, Singapore, Malaysia and Thailand, hopes were high that the European Union would follow this summer by giving China market economy status (MES). This would have left the United States the odd man out.

However, in June 2004, the EU’s “preliminary assessment,” found that China was still not deserving of MES. The EU pointed to a number of problems, including state interference in the economy through industrial policy and pricing restrictions; uneven compliance with corporate governance and accounting standards; an ineffective bankruptcy framework and intellectual property rights abuses; and biased capital allocation by financial institutions. It was quite a list.

The reaction from Beijing? It simply re-iterated its claim. Its strategy has been based on some reasonable and some flimsy economic arguments about the extent of market reform in China, blunt and often passionate assertion, and a sense that MES is somehow owed to China as a reward for its (admittedly impressive) reforms. This strategy looks set to stay. For their part, trade officials in both the EU and United States need hardly leave the comfort of their desks to point out the many non-market distortions in China’s economy.

The “yes, we are” “no, you’re not” game look sets to run until such time that China has really become a full MES, which will probably happen some time around 2015 anyway. But Beijing would be better served by shifting the focus of the debate. It might consider doing four things.

First, it needs to be clear about what MES is – and what it is not. It needs to get clear that MES, a grand-sounding concept, is only meaningful in the context of anti-dumping investigations. This is how MES works. In the case of the United States, the Department of Commerce investigates any complaint from a U.S. firm that a Chinese firm’s imported goods are being sold at “less than fair value.” Since China is classified as a “non-market economy” by the U.S., and therefore the export price might be below real market cost, a “surrogate country” approach is used to determine fair value. Investigators find a comparable firm in, say, India or Japan, to see what the “real” costs of producing those goods are. If this price is more than the Chinese export price, then the goods are being sold at “less than fair value.”

If this 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 be occurring and punitive import tariffs can then be levied. A similar process occurs in the EU, though here individual countries do the initial assessment.

However, instead of staying focused on the small print (and this is where the devil is), Beijing appears to be intent on dragooning MES into wider attempts to gain recognition as a global player, a country worthy of equal status with others in the international economy. It is unclear what is motivating the spinning of the issue in this way, but it clearly harms trade officials’ ability to deal with the issue strategically. It means Beijing is buying into the whole MES framework, rather than questioning it.

The second thing to do is exactly that – openly question the whole MES framework. The PRC leadership should admit the distortions that exist in their economy, but question the fairness of tarnishing all China’s exporters with the non-market economy brush.

Of course, exporters have backward linkages into China’s domestic economy, but in many sectors these are very limited. Many export-oriented firms operate in near-market conditions. This appears to be the case in the preliminary finding of dumping against shrimp imports into the U.S. from China and Vietnam. The big four shrimp exporters investigated in the suit proved to the satisfaction of the Department of Commerce that they were private firms. However, the surrogate country approach meant that Commerce used another country’s prices (in this case India’s) to determine “normal value.” It is not clear that Indian prices fully capture China’s competitiveness.

Many of China’s exporters are funded by capital borrowed at market rates from informal financial institutions. They do not benefit from government support. Their financial accounts may not be transparent, but that is the same in any emerging market, particularly one where government preys on private firms. As China increasingly exploits its comparative advantage in labor-intensive goods (including fruits, vegetables and fisheries), its exports in these sectors will rise. If they fall victim to anti-dumping duties legitimized by distortions in a completely different part of the economy, China’s people will rightly feel unfairly treated.

Third, China should question to what extent any distortions in the economy, even those that affect its exporters, actually impact on export prices. It might employ an international audit firm to assess whether the Chinese firms that have already been found guilty of dumping have actually been dumping. At present we simply do not really know. The audit firm would dispense with the substitute country approach, would attempt to cost all of the inputs actually used in each firms’ products, and work out which ones were distorted by non-market factors and which were due to China’s cheap labor and often great infrastructure.

The likelihood is that many firms, if not the majority of them, would be found not to have been “dumping” at all, in that any distortions in their operating environment were not significant enough to make the export competitive in overseas markets. This would provide substantial and detailed evidence that the MES framework is being manipulated by China’s trading partners to derive unfair advantage for their domestic firms.

Fourth, Beijing might want to call for the wholesale revamping of the anti-dumping framework. This would be in the national interest but would also garner support among other developing countries – as well as most trade economists. Such a reform could involve giving a WTO body the power to investigate complaints (currently, it is governments who investigate actions and they come under pressure from domestic lobbies to find dumping). Introducing a requirement of cause, i.e. that the distortion is the factor which causes the exports to be competitive abroad, may also be useful.

Such a move would be in the long-term interest of China, since even after its 15 years are up and it gains MES, it will still be vulnerable to anti-dumping actions. Though these actions will use China’s own prices, they will still likely be prejudiced in favor of the filing firm.

Would this strategy attract support in Beijing? There are some obvious short term costs. First, there is the loss of face inherent in tacitly admitting that one’s previous position was untenable. Second, China is getting the hang of using anti-dumping measures itself. According to Scott Kennedy at Indiana University, it had announced 51 measures by the end of 2003. It might not want to give these up. Third, reforming anti-dumping is no easy task. Winning over the United States Congress to re-legislate the current anti-dumping framework would be a Herculean task, and would require considerable support from within the United States, which is clearly lacking at the moment.

Moreover, given the current state of U.S. law, it seems unlikely that the U.S. could recognize China, as the Europeans do, as an “economy in transition.” This allows the European Commission to judge Chinese firms on a case-by-case basis as to whether they are operating in a market environment. If so, their prices are used; if not, the surrogate country scenario kicks in. Although imperfect, there is something to be said for this approach, given the mixed state of China’s economy.

But would a change of strategy ultimately support China’s national interest? Perhaps not. The one great thing about the whole MES fuss – for both China and the United States – is that it diverts protectionists’ attention away from other matters and allows pro-trade politicians to appear to be tough on China. Setting up commissions and sending over investigators allows members of the Administration and Congress to blow off some steam and to show that by refusing China MES they are defending U.S. interests and preventing the manipulation of trade. The big picture is that trade keeps expanding.

In fact, put the MES debate aside, and one finds that the United States is generally behaving responsibly over trade with China. Despite the calls for protectionism, President Bush has almost wholly resisted exploiting the special safeguard measures he has at his disposal for dealing with China’s exports. Most disputes have mostly been resolved without recourse to the WTO. In the latest spat over China’s subsidizing of computer chips, the U.S. had to file an action with the WTO, but this was justified by the clear illegality of the subsidies. China backed down when its lawyers told it so.

All in all, trade ties are growing. China’s non-market economy status might be one of the prices that must be paid for that to occur. Creating noise about the issue takes the fight to Europe and the U.S., and creates a phony war that China can afford to allow the U.S. and EU to win. Ultimately, it might be for everyone’s benefit.