Is China a market economy?

Authors: Gary Clyde Hufbauer and Cathleen Cimino-Isaacs, PIIE

There’s a potential mega-battle brewing over trade rules and the provision of market economy status for China that could reach the World Trade Organization (WTO) in 2016.

Whether particular countries grant China market economy status has important implications for the adjudication of anti-dumping cases. In international trade, dumping occurs when a country exports a product at a price below the normal cost of production or price paid in the exporting country.

China anti-dumping case

When China joined the WTO in 2001, Article 15 of China’s Protocol of Accession to the WTO generally allowed other WTO members to disregard Chinese prices and costs in anti-dumping cases and instead base the calculation of dumping margins using external benchmarks. An exception was made if Chinese producers could ‘clearly show’ that market economy conditions prevailed in the industry. Article 15 essentially authorised ‘nonmarket economy’ methodologies long used by the United States and the European Union in anti-dumping cases against communist countries.

Taking advantage of this provision, authorities in the United States, the European Union, Japan and Canada, among others, almost always use surrogate prices and costs to calculate Chinese dumping margins. Rarely are the authorities satisfied that market economy conditions prevail in Chinese industries.

This comparison with surrogate prices and costs typically leads to much higher dumping margins and thus much higher penalty duties imposed to bring the delivered price in the importing country closer to ‘normal value’. Since China is a leading target of dumping cases worldwide, the non-market economy methodology is a sore point with Chinese officials. A decade ago, China mounted a vigorous diplomatic campaign asking trade partners to accord it market economy status. The campaign succeeded with New Zealand, Singapore and Malaysia in 2004 and Australia in 2005, among others, but it did not persuade the United States, the European Union, Japan, Canada and several others.

All this brings us to the prospect of controversy come December 2016. Article 15(a)(ii) of China’s Protocol states:

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.

But buried in Article 15(d) is the critical sentence: ‘In any event, the provisions of subparagraph (a)(ii) shall expire 15 years after the date of accession’.

Chinese officials strongly argue that this sentence requires all countries to accord China market economy status on 11 December 2016, 15 years after China’s accession, and that WTO members can no longer use surrogate costs and prices in anti-dumping cases.

Some US and EU lawyers read the text differently. While they agree that Article 15(a)(ii) will effectively disappear, they do not agree that the Protocol confines WTO members to a binary choice between market economy (with its strict comparison of export prices with Chinese prices or costs) and non-market economy status (which allows comparison with surrogate prices or costs). They point to the opening language in Article 15(a), which states:

[T]he 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.

To be sure, under Article 15(d), the whole of Article 15(a) potentially disappears, but only ‘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’.

Come December 2016, the United States and European Union might well argue that China has not established that it is a market economy. They could modify their current surrogate practices and instead use ‘mix-and-match’ approaches — claiming that some Chinese firms or industries operate under market conditions and others do not. For those that do not, they could use surrogate prices or costs.

Whether the United States takes a hard-line mix-and-match approach, rather than grant China market economy status across the board, could well turn on policy considerations rather than legal parsing. Among these considerations will be the general atmosphere of commercial relations with China in 2015 and 2016, including the evolution of the renminbi exchange rate (devaluation would inspire a hard-line approach) and the outcome of the US–China Bilateral Investment Treaty negotiations (success would have the opposite effect).

With that observation from the economic text of realpolitik, we recommend that the United States should adopt a rebuttable presumption of market economy status in post-2016 anti-dumping cases. If a US petitioner can show that the Chinese firm accused of dumping is state-owned or state-controlled, does not publish financial accounts in accordance with international standards, or in other ways ignores commercial considerations in its business dealings, then the US Commerce Department could revert to surrogate prices or costs.

This approach would have two benefits: it would encourage Chinese state-owned and state-controlled firms to publish financial accounts and operate according to market principles, and it would answer fears by some US firms that they are being forced to compete with the Chinese Ministry of Finance.

If something like this mix-and-match approach is adopted, China might well initiate WTO litigation in response to an affirmative anti-dumping decision. But 2018 seems the earliest date for a final decision by the WTO Appellate Body. And even if China prevails in the WTO, the targeted Chinese firms would not receive retroactive refunds for anti-dumping duties collected prior to the ruling. Again, this hard commercial reality would encourage Chinese firms to publish accounts and operate according to market principles.

Answering these questions is of grave importance. The market economy battle, along with another potential battle over currency manipulation, has been spurred by the politically charged belief in the United States that China does not play fair — a legacy of many years of US trade deficits. These disputes could shape future trade rules, disputes and remedies for years to come.

Gary Clyde Hufbauer is a senior fellow and Cathleen Cimino-Isaacs is a research associate at the Peterson Institute for International Economics (PIIE).

This article is based on a previous post published here by the Trade and Investment Policy Watch blog of PIIE.