Trade War or Growing Pains?
Gary Horlick
The most highly-regarded trade and customs lawyer in our research analyses China's new trade policies, their effect on international relations and possible implications for the future.
Gary Horlick
China’s new trade policies spark furious debate among the ‘Big Three’ and holds important implications for the future, especially with regards to climate change and coming out of the global recession. The recent controversy over China’s “indigenous innovation” policy illustrates the challenges to US and EU trade policy involving investment, intellectual property, government procurement, and competition rules in China. It also illustrates the increased willingness of US, European and Japanese businesses with investments in China to raise these issues publicly because they are well-aware that they need to be successful in China to remain successful in the global market.
In 1986, when China began its negotiations to join the GATT (now WTO), no one in China or outside foresaw that China’s economy would grow from a GDP of US$951 billion in 1986 to US$4.9 trillion in 2010 (calculated at the 2010 dollar rate). At that level, enough Chinese can afford the material possessions of modern civilisation so that China in 2009 – already the world’s largest market for mobile telephones, shampoo, and refrigerators – became the world’s largest market for automobiles (and seems likely to remain so even after the US market recovers). Obviously, there is no guarantee that China will continue to grow as it has. All economies are subject to external price shocks, financial collapses, and dithering governments. But, notably, China’s growth rate barely dipped during the 2008 to 2009 recession, so for planning purposes, businesses (and their lawyers) have to include a scenario of continued Chinese growth
As China’s internal market grows, manufacturers with large market shares will achieve larger and larger economies of scale, making them more and more competitive against their rivals without access to a similarly large market. For any product where demand correlates roughly with number of people, China is or will be the largest market in the world, even though its economy measured by GDP is only one-quarter the size of the US. This is also true for services – China is or will be the largest market for X-rays and MRIs, for example, and Hong Kong in 2009 led the world in IPOs (initial public offerings).
Put most directly, in products where China is the biggest market, US, European and other countries’ companies that are not number one, two or three in China may well become irrelevant even if they are successful in their home markets. In numerical terms, if the Chinese market for widgets is four times larger than the US market for widgets (perfectly plausible, as China’s population is more than four times that of the US), and Chinese company A has 50 per cent of its own market and 25 per cent of the US market, and US company U has 50 per cent of its own market and 25 per cent of the Chinese market, Chinese company C will have 45 per cent of the combined markets, and US company U will have 30 per cent of the combined markets. In the many industries where economies of scale matter (for example, the ability to do more research and development, or to buy components more cheaply), that gap could be fatal. And if US company S had 25 per cent of the US market and 0 per cent in China, it will disappear as an independent company.
So what matters for US and EU trade law and policy and that of many other countries for the future is to ensure that their companies are competitive in the Chinese market. This analysis is not solely China-targeted, of course. It will be just as true for India if India continues to grow and also true for a US or EU company with 50 per cent of the Chinese (or Indian) market.
China’s policymakers are well-aware of this impact of China’s growth, and they are – logically enough – trying to use China’s large internal market as a competitive advantage, especially as China is increasingly not the lowest-wage site for manufacturing (China’s policymakers do not want its workers earning low wages). This is not necessarily bad news for non-Chinese economies. The “supply chain” has disaggregated production, so that it is plausible that a non-Chinese company, “manufacturing” and selling a large volume of product in China, could well generate a large number of jobs in the US. A 2007 study of the Apple iPod suggests that, of the US$299 retail price, more than US$130 (and the jobs that go with it) stayed in the US, while less than US$10 stayed in China, where the product was “manufactured”. As suggested above, Apple would not be able to continue making iPods if it sells one million in the US and a Chinese competitor sells five million of a comparable product in China. The Chinese competitor would have enormous economies of scale and be able to out-compete Apple quite “fairly” worldwide, so Apple has to be able to sell large amounts in the Chinese market as well as the US market. But if it does, it will generate jobs and profits in the US more than in China.
None of this is really news, of course. Non-Chinese companies are well aware of China’s use of its large internal market as leverage, and have pressured their governments to complain vigorously about China’s “famous brands” subsidies (the subject of a WTO case), and the more recent “indigenous innovation” programme. What is new is the growing consciousness of the need to re-think priorities in trade policy. The US and EU spent enormous amounts of their negotiating clout with China from 1999 to 2006 to limit imports from China into the US and EU of ladies’ clothing. The textile quotas imposed by the US on other countries ended in 2005, so there are many other suppliers, and well under 4 per cent of all clothing sold at retail in the US is manufactured in the US, so there was no real possibility of growing a US industry making women’s blouses. In the abstract, it may have made sense politically to protect that industry, but the effort may have been much better spent on ensuring US and the EU companies’ access to the “government procurement” market in China, a market where possibly as much as 50 per cent of all purchases are by the government or state-owned enterprises. Of course, it is easier to close one’s own borders than seek changes in the larger market, but that will only make it too easy to focus policy on the smaller of the two markets.
The obvious candidates for highest priority for future US and EU trade law and policy include (but are certainly not limited to):
- investment rules in China, to ensure that foreign companies have the same opportunities as Chinese ones (which, of course, implicates Western attempts to stop or limit Chinese investment in their countries);
- intellectual property rules to make sure that companies can sell their trademark, patented, or copyrighted products without facing competition from direct copies. It becomes extremely important in a global market to prevent production and sale of unauthorised copies of one’s products. This could be copyrighted, trademarked or patented goods, or any other type of intellectual property (and without ignoring the controversies about appropriate access to and protections for certain types of intellectual property products, such as medicines) and is the subject of ongoing WTO litigation between the US and China, so the topic is not new, but in this new context becomes even more important.
VAT rebates:
- China already uses differing VAT rebate rates for differing points in the supply chain to provide an incentive to locate perceived “value added” functions in China. So far, this has been limited to some fairly obvious industrial processes and products. What if other major markets start doing the same thing on the same products, leading to VAT “rebate wars”, (but always within the total amount of the VAT, thus creating difficulties for a WTO challenge.)
Standards:
- the EU and, to a lesser extent, US insistence on “policy space” to use unique standards often assumes that the EU and US are the largest markets. If China or India become the largest markets, do we want to continue to advocate the same relatively loose interpretation of WTO, SPS and TBT matters? This will be particularly true for climate-change issues, where the US and EU have relatively strict standards for factory emissions, and relatively quite high emissions per capita. Or do we prefer the approach advocated for TPP of greater binding use of internationally-agreed standards?
- subsidy rules, so that Chinese companies do not receive larger subsidies than their non-Chinese competitors (which may require some discipline in the West as well – the recent WTO panel reports on large commercial aircraft contain long lists of subsidies to industrial enterprises in the West, and they are not limited to aircraft producers);
- services rules, notably the WTO General Agreement on Trade and Services (GATS), must be substantially rethought and redrafted. The current GATS focuses on relatively narrow and separate categories and focuses on enterprises that are primarily services providers. But almost all “manufacturing” enterprises in developed and developing countries in practice are a bundle of “service” functions (from designers through production and shipping schedulers, and many others) rather than solely direct physical human manufacture (is tending or repairing a machine a “service” function?). This mixed nature is recognised in the WTO “bananas case”, but within a narrow services category of “wholesale distribution”. There is GATS language which permits a much broader interpretation, but so far the tendency has been to require that an activity fit within a specific relatively narrow service sector in which a commitment has been made. That approach does not recognise that an individual company may be performing a wide range of services (and manufacturing functions) along a very long supply chain. For example, manufacturing automobiles requires, among many other service functions, the operation of a test track. The current GATS does not recognise that reality.
- access to government procurement markets becomes exceedingly important, as the two largest future markets, China and India, have very large state and state-owned sectors. With perfect hindsight, some of the energy spent on other topics in, for example, the negotiations for China’s accession to the WTO could better have been spent on government procurement.
- trade remedies (anti-dumping, countervailing duties, and safeguards), to date championed in negotiations by the US and the EU in alliance to protect their home markets, may look ill-advised if bigger markets decide to use them to keep out US and European imports from the US and Europe of final goods or, perhaps even more daunting in a supply chain world, key imported inputs, (thus, forcing transfer of manufacturing that might have stayed in the US or EU.) China has an active trade remedy programme of its own, with 16 anti-dumping (AD) cases (number five in the world) and three countervailing duties (CVD) cases (number three in the world) initiated in 2009. Little attention has been paid to the possibility that China is using these cases in a more tactical or strategic sense than other countries. For example, EU cases against imports of metal fasteners and of goods scanning systems from China were met not only with a sweeping WTO challenge to the results of the EU metal fasteners case, but also by parallel cases in China against imports of EU metal fasteners, X-ray scanners, in addition, China stopped soy bean imports from Argentina to protest AD cases there. Most strikingly, China initiated three CVD cases against US exports in 2009 and to date has issued a final ruling that the US “buy American” government purchasing preferences are a subsidy to US industry and a preliminary determination that US government subsidies to corn and soybeans subsidise US exports of poultry, and presumably, beef and pork (China does not complain about the allegedly subsidised US corn and soybean which it buys in massive quantities), and China is poised to declare that the US auto bail-out was a subsidy to the Big Three.
This does not mean that the US and Europe have to abolish trade remedies, they are welcome to keep them as they are, if they are willing to pay the price.
This should not be viewed as a “trade war” with China, but rather as “growing pains” as the world adjusts to a player the size of the US and EU or larger, with US$2.5 trillion in reserves. The need for this adjustment is clear, both in terms of the current disputes and also in terms of management of future global issues, moving out of recession and into possible arrangements on climate change.