The implications of China getting ‘Market Economy Status’ from the European Commission

19th July 2016

Aidan Yao, Senior Emerging Asia Economist at AXA Investment Managers (AXA IM), discusses the significance of a possible decision by the European Commission to offer China full market economy status (MES).

“On the 20th July, the European Commission is due to discuss whether to grant China full market economy status (MES). What’s the significance of this decision? Why should China and the European Union (EU) care about it? And what could be the impact if China is granted this status? The below provides some quick answers to these (and other related) questions.

What’s the difference between having MES and a NME (non-market-economy), and why does it matter?

“The distinction between having MES and being a NME matters for determining the dumping margin in the anti-dumping process. A country is considered to be ‘dumping’ its products if it exports them at prices below those that are sold domestically. ‘Dumping’ is more easily determined for an NME, because their domestic prices are seen as controlled or manipulated by the government. The World Trade Organisation (WTO) hence permits its members to impose anti-dumping duties on products from an NME.

“When it joined the WTO back in 2001, China was still considered a ‘command economy’, but with an ambitious plan to reform. The WTO granted China its membership subject to China accepting a ‘temporary provision of the NME status’ for the next 15 years, which expires on 11th December 2016. The EU is currently in discussions with China on whether to grant it MES after this date.

Why does China care about this?

“The WTO allows for punitive tariffs to be imposed on products of an NME, and China has been the number one target of anti-dumping investigations over the years. Of the 3,240 cases reviewed by the WTO between 2001 and 2014, over 840 (or 26%) were against China (figure 1). While many emerging market (EM) countries have already granted China market economy status, countries which have not, still account for a larger share of China’s exports (figures 2 and 3). Hence, winning MES and lowering tariffs for its products in these markets can bring tangible benefits to the Chinese economy.

Yao1

Source: WTO and AXA IM

Yao2

Source: CEIC and AXA IM

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Source: CEIC and AXA IM

Has China made progress to gain MES?

“China has been actively promoting itself as worthy of MES, and has made significant progress over the years. Figure 4 shows that a large part of the EM world has already granted China early MES for different reasons, including: 1) having a Free Trade Agreement with China (Australia and New Zealand); 2) to attract investment (Brazil and Argentina); 3) to win China’s economic and political support (African countries); and 4) for mutual support among the NMEs (Russia and Vietnam).

Fig 4: Map of WTO members that granted MES to China vs. those that have not

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Source: EPRS and AXA IM

Will the EU and other developed markets follow suit (in granting China MES)?

“This was at the center of discussions at last week’s EU-China Summit, paving the way for the European Commission’s decision on 20th July. The topic will also be discussed at the September G20 meeting, as China tries to also win MES recognition from other developed market countries. As mentioned above, the NME status was temporarily imposed on China and will expire on 11th December. China believes that this will mean an automatic recognition of MES afterwards. However, this interpretation is challenged by others, who believe that it will come down to the individual WTO members to determine whether China is an NME or not, and set its trade policies accordingly.

“In May, the members of the European Parliament voted against granting China MES in a non-binding resolution to urge the European Commission to do the same in July. The vote reflected concerns of EU industries, trade unions and stakeholders regarding the potential negative consequences of cheaper Chinese imports. In 2013, then European Commissioner Karel De Gucht suggested that the EU would grant China MES from 2016. But his successors, Cecilia Malmstrom and the current Commissioner Donald Tusk, have taken a more prudent stance. Germany and the UK are reportedly supportive of China’s plea.

What are the criteria for MES set by the EU?

“The EU has laid out five criteria for MES:

1)     Little government influence in resource allocation and enterprise decision-making

2)     Absence of distortion in the operation of private economy

3)     Effective implementation of company law with adequate corporate governance rules

4)     Effective legal framework for business conduct, and proper functioning of the free market

5)     Existence of a genuine financial sector

“In its assessment back in 2008, China was seen as only meeting the second condition. China has since made significant progress on economic and financial market reforms, but no subsequent evaluations have been conducted.

What’s the economic impact – a ‘rule of thumb’ estimate?

Providing a precise assessment of the impact of removing China’s NME status (and the duty-imposing countries) is very difficult, and clearly beyond the scope of our simple analysis. One estimate from the Peterson Institute for International Economics puts China’s exports to the G20 that are exposed to ‘temporary trade barriers’ at around $100bn in 2013 or 7% of China’s total exports.

“We estimate that the amount would have grown to slightly below $108bn by the end of 2015. Figure 5 shows that China is by far the largest victim of anti-dumping measures (consistent with figure 1), with its exposure far exceeding the total amount of all other countries put together. Figure 6 shows where the levies were raised: more than 9% of China’s exports, or $43bn, to the US were subject to trade barriers in 2013 while nearly 28bn worth of exports to the EU were affected by China’s NME status.

Yao5

Source: PIIE and AXA IM

Yao6

Source: PIIE and AXA IM

“It is important to note that these estimates are not what China stands to gain if it is granted MES. This is true for two broad reasons: 1) if countries continue to impose trade restrictions on China, after it is deemed a market economy, the WTO may permit China to exercise retaliation. But the amount of that retaliation is subject to a complicated calculation (beyond MES recognition); and 2) the US and the EU have other tools at their disposal to impose barriers on Chinese goods, even after MES is granted (Australia, for example, still imposes levies on 3.5% of Chinese imports, even while it considers China as a market economy).

“For China’s trading partners, refusal to remove anti-dumping measures (after granting China MES) could provoke retaliation that leads to rising trade frictions among the largest trading nations in the world. In the absolute worst case, a trade war could break out that causes severe pains to an already fragile global economy. But more realistically, we consider this (MES negotiation) as another diplomatic/economic challenge for China, as opposed to a tangible threat for the global economy.”

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