VoxEU Column International trade

Trade frictions with china: Do western policymakers have an end game?

If the US and EU continue down the path of confronting China directly, they will face a choice between piecemeal trade actions that highlights the divergence between their words and deeds, or the imposition of a blatantly WTO-illegal restriction on Chinese exports that would ruin their reputations as good WTO members.

Starting a fight is often a lot easier than ending one. Over recent months policymakers in the European Union (EU) and the United States have escalated their denunciations of Chinese trade practices, product safety, and currency regimes. Some measures against Chinese exports have been taken--and more have been threatened--if China does not respond. The facts of the situation are these: Recently it was announced that China's total trade surplus for the first 10 months of this year was $212.4bn, a 59 percent increase over the previous 12 months. The bilateral trade surplus with the United States alone was estimated to be $15.4bn in October 2007. The comparable monthly trade surplus with the EU was $13.9bn. It has been calculated that the latter surplus is rising by $20mn per hour. Meanwhile, the Chinese renminbi has slowly appreciated 11 percent against the dollar since its fixed peg was abandoned in July 2005.

In the US criticisms of China's trade and currency policies have been sustained over the past few years, especially from the United States Congress. As a result, the Bush Administration set up a cabinet level dialogue with their Chinese counterparts. This dialogue has not delivered reforms in China at the pace sought by Congress. Consequently, measures have been proposed in recent months in both houses of Congress that would permit the application of anti-subsidy measures to both "non-market economies" (of which China is one) and to trading partners found to be manipulating their currencies. The House bill had 113 sponsors from both political parties. It should be noted that previous proposals to levy large across-the-board tariffs on Chinese tariffs are not part of these bills, at least for now. Moreover, further legislative action on these bills is not expected in 2007. Action in 2008 is likely and this is a concern given its potential overlap with next year's US election campaigns.

There are two other noteworthy developments in the United States. First, in a 14 November 2007 letter to the Congressional leadership 100 chief executive officers of US corporations urged that "unilateral" trade measures against China should not be taken. Such US corporate pressure arises because so many Chinese exports are produced or transported by foreign investors operating in China, a political payoff that Beijing may not have originally en-visaged. Second, in October 2007 the US Department of Commerce recommended imposing anti-subsidy duties on imports of glossy paper from China. This is significant, not only because China had heretofore been exempt from anti-subsidy actions, but also because the form of subsidy relates to the terms upon which Chinese banks typically lend to Chinese firms. This widespread nature of this "subsidy" could put a broad range of Chinese exports at risk of high anti-subsidy tariffs in the US.

Before the recent appreciation of the euro the EU had tried a less confrontational approach to its trading relations with China. The EU's own Trade Commissioner, however, recently argued that Europe's approach "is no longer delivering sufficiently credible results," and proposed greater resort to anti-dumping, anti-subsidy, and safeguard actions against Chinese imports and to WTO Dispute Settlement procedures. Is the hardening of Mr. Mandelson's position due to a change of heart on his part (from a stance that has sought to keep Europe's borders open to foreign commerce) or to an attempt to assuage or even neutralise critics of Chinese commercial policies in the EU? The latter explanation is more likely and is probably tied to the euro's appreciation which has put EU exporters under considerable financial pressure. This pressure has persuaded EU finance ministers to publicly seek relief from somewhere. It is said that while the French and German governments are divided on the merits of the euro's appreciation (with the Germans non-plussed and the French very con-cerned), both could agree on the need for further renimbini appreciation.

The growing criticism of Chinese trade and currency practices has taken place precisely at a time when the Chinese leadership has indicated a shift in its development policies. At a recently concluded 17th Chinese Communist Party Congress and in the Eleventh Five Year Plan the Chinese government confirmed its move away from a growth-at-any-cost strategy towards one that emphasises sustainable development. This policy shift is said to reflect a desire to better balance economic growth with reduced environmental degradation and improved social conditions. This shift is said to reflect the leadership's understanding that pollution created by current production activities is holding back Chinese economic growth and by the strong view held by some party cadres that Chinese workers should no longer be cheap labour for foreign multinationals. It seems just how much weight is applied to each of these three elements, whether those weights will change in response to unanticipated events, and what the implications are for Chinese foreign economic policy have yet to be determined.

Given these developments how should the ratcheting up of Western criticism of trade and currency practices be interpreted? First, there are good reasons why the Chinese may decide that Western words may not be followed by that damaging deeds--at least not in the near-term. To the extent that the sharp recent euro appreciation is principally responsible for hardening European positions, then Chinese policymakers may delay making any concessions if they cannot discount either the possibility of a subsequent euro depreciation or that the fears of European exporters, which triggered EU policymakers' concerns, will be seen to have been exaggerated. With respect to the threat of harsh steps by the U.S. Congress, China might argue that its tough line to date has already seen the relevant Congressional bills watered down (to garner more support among US Congressional members) and that holding out further will obtain similar results. For different reasons, then, certain Western threats to Chinese exporters appear hollow.

Where Chinese exports are at risk is through the widespread application of trade defence instruments, especially anti-subsidy actions that target those subsidies that are thought to be persuasive in the Chinese economy. The recent U.S. duties on Chinese exports of glossy paper may be a harbinger of things to come. China's principal line of defence here is that tariffs on unfairly traded goods also adversely affect the profitability of Chinese investments and the supply chains that are operated by Western companies. These companies plus corporate buyers in the West will have a strong interest in opposing the application of trade defence instruments to many Chinese exports. Moreover, under WTO rules demonstrating that an export is subsidised doesn't alone allow tariffs to be imposed, a threshold level of injury to a domestic injury must be met before China's exports can be targeted for extra duties.

As far as WTO dispute settlement cases against China are concerned, much expert opinion is doubtful of a case against the Chinese exchange rate regime finding favour at the WTO. Cases concerning the implementation of China's accession commitments are another matter entirely. However, here no doubt China has learnt from the experience of Japan, which successfully defended itself against a number of controversial cases brought by the US in the early 1990s. Moreover, China will no doubt have learnt about how to delay compliance with WTO Appellate Body rulings from the very trading partners that are now criticising its trade and currency practices, namely, the EU and the US. So it is difficult to see much Western satisfaction in the near- to medium-term to bringing dispute settlement cases against the Chinese.

Given all of these considerations and potential dead-ends, where does this leave EU and US trade policymakers? Should they persist on their current path, they essentially face a choice between a rhetorically tough campaign against Chinese exports where the almost-inevitable piecemeal action highlights the divergence between their words and deeds or--through some (unwelcome) political convulsion--a blatantly WTO-illegal across-the-board restriction on Chinese exports could be imposed. These two choices amount to either Western policymakers shredding their credibility in front of the domestic interests calling for action against China or ruining their reputations as good WTO members. Given the end game's unpalatable consequences, some serious thought ought to be given in Western capitals as to how much political capital should be committed to escalating trade frictions with China in the first place.

Editors’ note: This is a revised version of an essay published in WTO News, November 2007 edition.

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