CHINA SEEKS MARKET ECONOMY STATUS WHEN SECTION 15 OF ITS PROTOCOL OF ACCESSION INTO THE WORLD TRADE ORGANIZATION EXPIRES ON DECEMBER 11, 2016

Author: Ryan Kenny, Associate Member, University of Cincinnati Law Review

On December 11, 2001, China formally joined the World Trade Organization (WTO).[1] The WTO develops policies aimed at promoting global integration of member-states’ economies.[2] When China was inducted into the WTO, §15 of China’s Protocol of Accession (POA §15) allowed WTO members to designate China a non-market economy (NME). NME status allows WTO members to assess the true cost of production in China by using any fair method, rather than just the nominal price of production in the Chinese market.[3] These methods are used to determine countervailing duties (CVD) and anti-dumping laws (AD) for imports from China. With the POA §15’s expiration on December 11, 2016, the debate is whether its expiration automatically grants China market-economy status (MES), or whether national law makes such a determination. POA §15’s expiration does not grant China automatic MES status, and the United States is unlikely to grant China MES at the end of

I. Legal Framework Surrounding China’s MES.

China argues that the POA it signed in 2001 will grant it immediate MES after its expiration. Mei Xinyu, a researcher with China’s Ministry of Commerce, said, “[POA §15] is very clear and it’s unconditional” to this effect.[4]  However, there is no language in the POA that suggests that MES is automatic upon the expiration of the clause. Rather, each WTO member nation will determine individually whether or not China has liberalized its economy enough to earn MES.

A. POA §15 Language Does Not Indicate that MES Shall Be Granted to China Automatically upon the Provision’s Expiration this Year.

POA §15 determines how WTO members can impose CVDs on Chinese imports.[5] POA §15(a) states that if China can show that it operates a truly MES economy, then the domestic Chinese prices or costs should be used in determining price comparability.[6] Until then, the importing WTO member can use its own methodology so long as it does not violate the WTO’s goal of preventing discrimination against China.[7] The clause of POA §15 that has raised the issue is §15(d). §15(d) states:

(d) Once China has established, under the national law of the importing WTO Member, that it is a market economy:

(i) the provision of subparagraph (a) shall be terminated provided that the importing Member’s national law contains market economy criteria as of the date of accession. (ii) In any event, the provisions of subparagraph (a)(ii) shall expire 15 years after the date of accession.[8]

China argues that (d)(ii) shows that regardless of MES, WTO members cannot use their own methodologies in determining CVD on Chinese imports after its POA expires. This means that when a Chinese exporter is shipping widgets to the United States, when calculating the cost of production to determine CVD or if AD laws have been violated, the United States must use the Chinese production price, rather than any other methodology, to determine the “fair” cost of production. This would give China a significant competitive advantage when the Chinese government keeps the production cost artificially low by subsidizing the industry or having industries over-produce to drive prices down.

China’s interpretation of POA §15’s provisions is incorrect. The purpose of the POA was to provide China with adequate time to liberalize its economy, allowing market forces to determine the price of production, rather than the central or local governments.[9] This is evidenced by §9 of the POA concerning price controls. POA §9(1) states that China must allow market forces to determine the prices of goods, with some exceptions.[10] Furthermore, §15(d) specifically states “Once China has established, under the national law of the importing WTO Member, that it is a market economy . . .” it obtains MES.[11] (emphasis added). Moreover, §15(a)(ii) applies when a producer or producers are seeking MES and is limited to that application. This does not apply to consideration of MES or NME status across China’s entire economy. Finally, the WTO protocols do not grant MES, nor do they identify any criteria for determining MES.[12]

The correct interpretation shows that POA §15’a expiration does not automatically grant China MES. Therefore, China’s accession to MES in the United States will depend on the criteria for MES as set out by the Department of Commerce (DOC).

B. The DOC Sets Out Several Guidelines for Determining MES.

The law defines a NME generally as “any foreign country that the administering authority (the DOC) determines does not operate on market principles of cost or pricing structures, so that sales of merchandise in such country do not reflect the fair value of the merchandise.”[13] This means that market prices are determined by the government directly or indirectly (such as subsidies), rather than by principles of supply and demand. Therefore, when applying CVD and AD laws, using that markets price as the market value is inappropriate, because it may not reflect the market cost of the product in the global market.

There are six factors the DOC considers when determining whether a country is a NME.[14] These factors are used to analyze a country’s entire economic system, which determine whether or not the DOC will deem a country a NME or MES. Once an economy is determined to be an NME, a company or industry can petition the United States government to make it an exception, and therefore treat its production prices as being determined by market forces, so long as the petitioner can show sufficient distance between its operations and government influence.[15]

II. The Chinese Government’s Involvement in the Economy Makes it Unlikely that China Will Obtain MES from the United States.

When China first began its open-door economy policy in 1978, the balancing goal between socialism and capitalism was aptly described by Deng Xiaoping, a statesman in the Chinese Communist Party at the time: “socialism with Chinese characteristics.”[16] Professor Cao adapted this phrase to more accurately describe what had happened in China since Xiaoping made that statement: “privatization with Chinese characteristics.”[17] Although China has rapidly introduced more free-market elements to its command-style economy, there is still heavy state involvement in the economy. This involvement is enough to affect supply and demand in such a way that China’s economy cannot be considered an actual market-economy, but rather a mixture of elements of capitalism still heavily influenced by command-style economics

A. China’s Economy is Not Predominately Driven by Market Conditions.

One Chinese industry that has come under particularly heavy scrutiny from the international community is the steel industry. Of the fifty largest steel companies in the world, twenty-six are Chinese companies, and nearly all of them are state-owned enterprises.[18] Currently, there is a huge oversupply of steel in the global market, which has had serious consequences on the trading price of steel in the New York Mercantile Exchange, which shows that contracts for steel are decreasing nearly forty percent year-over-year, meaning the demand for steel is rapidly decreasing.[19] This has been due in part to the overproduction of steel in China. Chinese steel companies, like the rest of the global steel industry, have not been profitable due to this oversupply that has driven the cost of steel so low that profitability margins have shrunk.[20] Only recently, with the slowdown in China’s economy, has the Chinese government expressed any goal towards cutting steel production.[21] However, none of the Chinese steel producers have gone out of business, despite these losses, earning the nickname “zombie companies”, meaning they continue to survive “despite bleeding red ink.”[22] This is due to propping-up by local governments, due to reasons surrounding domestic politics in China, all of which, until recently, had the implicit backing of the central government.[23]

The steel industry is one example showing that China still has a long way to go before becoming a market economy. Political goals have trumped common-sense business practice, which has seen the sparring between local governments and Beijing over steel production. Steel production should have been cut already, and it should not take directorates from the Chinese government to make this happen, but rather global market forces. This invokes two of the DOC’s factors in determining whether a country is a market economy or a NME: government control over production and government influence on pricing and output decisions.

Chinese involvement with industry can also be seen in technology-focused industries. Typically, in a market economy, one assumes that technological innovation comes from an environment in which ingenuity and creativity are fostered and allowed to develop, largely on their own accord in response to needs and demands with the economy for more efficiency. This can be referred to as a bottom-up approach. However, most bottom-up technological support in China for small, non-state-owned enterprises is subject to local and provincial governments’ self-interest and corruption.[24] Policy goals drive innovation from Beijing. Since 2006, the Chinese government has been appropriating technology from several technology-based industries, including air transportation, power generation, high-speed rail, and information technology.[25] The reason for this is industrial policies aiming to make China the next global tech hub to compete with other giants, such as Silicon Valley.[26] These industries either comply, or are shut-out of the Chinese market.[27] The target of these policies is typically foreign firms with joint ventures in China with domestic Chinese companies, which is one of the factors the DOC considers.

Conclusion

The Chinese steel industry and technology appropriation policies are just two examples of why China has not yet made the necessary reforms to be granted MES. These policies spill over into many industries and economy considerations. The Communist Party maintains control by ensuring rapid economic growth and large capital investments.[28] To do this, local officials are promoted based on the economic progress of their jurisdictions.[29] This has directly led to the overproduction and capacity issues that have affected export prices, which have an effect on companies all over the world.[30] This shows that political goals often trump business practical business in China.  The technological appropriation, which affects numerous industries, and the steel industry serves as just two of countless examples of how Chinese politics is controlling the Chinese economy. China has failed the DOC test for being granted MES. Therefore, China still has reforms that it needs to take before the United States is likely to grant it MES.

 

[1] China Joins the WTO – at Last, BBC News (Dec. 11, 2001 at 8:28 GMT), http://news.bbc.co.uk/2/hi/business/1702241.stm.

[2] What We Stand For, World Trade Organization, https://www.wto.org/english/thewto_e/whatis_e/what_stand_for_e.htm; policies include reducing trade discrimination, removing trade barriers, providing predictability in trade, fostering global competition, opening international markets to developing economies, and protecting the environment.

[3] Market Economy Status for China After 2016?, European Parliament Directorate-General for External Policies at 6 (March 2016), http://www.europarl.europa.eu/RegData/etudes/STUD/2016/535023/EXPO_STU(2016)535023_EN.pdf (citing Council Regulation No 1225/2009 Art. 2(7), Nov. 2009)

[4] Lucy Hornby and Shawn Donnan, China Fights for Market Economy Status, Financial Times (May 9, 2016), https://www.ft.com/content/572f435e-0784-11e6-9b51-0fb5e65703ce

[5] Both CVD and AD laws attempt to bring fairness to the markets for artificially-low import prices for different reasons. CVD target foreign government subsidies to industry, while AD laws combats exporters selling goods at such a low price, often intentionally losing money, in order put competition out of business. Difference Between Antidumping and Countervailing Duties, Customs Info (accessed on Oct. 21, 2016), http://www.customsinfo.com/industry-blog/difference-between-antidumping-and-countervailing-duties

[6] European Parliament Directorate supra Note 3 at 8 (citing POA §15(a)); POA §15(a)(i) allows Chinese companies to obtain MES treatment if they can prove that market conditions prevail in their industry. Id.

[7] Id.

[8] Id.

[9] Douglas Bulloch, China is Not a Market Economy Yet, Let’s Not Kid Ourselves, Forbes at 2 (May 17, 2016 at 12:27 am), http://www.forbes.com/sites/douglasbulloch/2016/05/17/granting-china-market-economy-status-will-make-the-whole-world-less-of-a-market-economy/2/#74a64e6b7f20

[10] Id. at 9

[11] Id. at 8

[12] Id. at 10 (commentary by Prof. O’Connor); Towards China’s Market Economy Status, Weber Shandwick at 2 (April 2016), http://webershandwick.be/wp-content/uploads/2016/03/Weber-Shandwick-Report-Towards-China-Market-Economy-Status_April-2016.pdf; Hornby and Donnan supra Note 5 (citing opinions of trade lawyers)

[13] 19 U.S.C. §1677(18)(A)

[14] 19 U.S.C. §1677(18)(B); factors: (1) the ease of converting the country’s currency into another currency, (2) the extent to which wage rates are determined by market forces, (3) openness to joint ventures and other forms of investment, (4) the extent of government ownership or control of the means of production, (5) the extent of government control over pricing and output decisions, and (6) any other factors the DOC deems appropriate.

[15] An example is the Silicon Carbide test: whether there is de jure state involvement, such as specific laws or proclamations; de facto, meaning that there is significant indirect state involvement; or the government is not heavily involved. Notice of Final Determination of Sales of Less Than Fair Value: Silicon Carbide from the People’s Republic of China, 59 Fed. Reg. 22585, 22587 (May 2, 1994) LEXIS

[16] Lan Cao, Chinese Privatization: Between Plan and Market, Law and Contemporary Problems Vol. 63, No. 4, William and Mary Law School *1 (Jan. 17, 2001), https://law.wm.edu/faculty/documents/cao-653-6431.pdf

[17] Id.

[18] Bulloch supra Note 9

[19] Luke Kawa, Steel is the Poster Child for Oversupplied Commodity Markets, and It’s in Shambles, Bloomberg Markets (Nov. 16, 2015 at 3:57 pm EST), http://www.bloomberg.com/news/articles/2015-11-16/steel-is-the-poster-child-for-oversupplied-commodity-markets-and-it-s-in-shambles

[20] Tadanori Toshida, China Struggles to Transition to Market Economy, Nikkei Asian Review (Sept. 13, 2016 at 7:00 pm JST), http://asia.nikkei.com/Politics-Economy/Economy/China-struggles-to-transition-to-market-economy?page=2

[21] Bulloch supra Note 18

[22] Id.

[23] Id.

[24] Thomas M. Hout and Pankaj Ghemawat, China vs. the World, THRIVING IN EMERGING MARKETS at 25 (Harvard Business Review, 2011)

[25] Id. at 25

[26] Id.

[27] Id.

[28] Id. at 38

[29] Id.

[30] Id.

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