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Don’t rush into granting Market Economy Status to China

26 February 2016

By Jan Gaspers and Mikko Huotari

The economic and political costs of granting Market Economy Status (MES) to Beijing without extracting concessions in return would be too high. In addition to economic interests, political and strategic considerations should also guide the EU’s decision.

When China became a member of the World Trade Organization in late 2001, the expectation was that by 2016 its economy would be based on market principles. This turned out to be an illusion; hardly anyone doubts that China is still operating as a fundamentally state-driven economy.

But the wording of China’s WTO accession protocol is now putting the debate over China’s market economy status (MES) at the top of the EU’s agenda. Beijing argues that the expiry of a key provision of Article 15 at the end of 2016 obliges other WTO members to automatically accept China as a market economy. This status would make it more difficult for China’s trading partners to impose anti-dumping duties on cheap Chinese imports.

European decision-makers are under increasing pressure to develop a stance on the issue, which addresses both Chinese demands and unfair competition between China and the EU. However, as we argued in our recent China Policy Brief, Brussels should not rush into proactively granting MES to China but rather seek a better deal for the Union and its member states at the negotiating table.

Economic risks are difficult to quantify

Seen by many as the European Commission’s preferred course of action, granting MES to China would pose significant economic risks. These risks are difficult – if not impossible – to quantify and are also unlikely to be fully clarified by the forthcoming European Commission impact assessment.

Preliminary findings from the Commission suggest that Chinese imports in sectors with existing anti-dumping measures will increase between 17 and 27 percent. Job cuts across Europe will be significant, if not as bad as claimed by some industry lobbyists. Currently, the European Commission expects the loss of 79 percent of the 234,300 jobs in manufacturing industries covered by anti-dumping measures in Italy, Germany, Spain, France, Portugal and Poland.

We think that Rolf Langhammer (“Yes to MES!”) might be overly optimistic when he claims that the trade defence toolbox of the EU against dumped exports from China will still be effective. The anti-subsidies instrument in its current shape will be insufficient to guard against unfair competition from Chinese producers.

But most of all, proactively granting MES to China would come at the expense of Brussels’ political credibility both at home and abroad. Domestically, the EU would almost certainly lose political capital with Europe’s business community and citizens if it failed to strike a settlement with Beijing that yields more favourable economic results for European industries.

Engagement with China on the issue of MES also constitutes an important litmus test for the EU as an international actor. Failure to define collective EU interests as a basis for MES negotiations with China and the proactive granting of MES on legalistic grounds would reaffirm the Union’s image as punching below its weight in international affairs.

At this stage, by proactively granting MES the EU would also lose its leverage over China when it comes to promoting open markets and fair competition.

Three different approaches: US, Canada and Australia

Current developments put additional pressure on the EU to enter into negotiations with China. Due to the stagnation of economic reforms, Beijing’s negotiating position is weakening. At the same time, the economic slowdown in China is heightening the prospects of a trade war with the EU. Increasing exports of excess production combined with a further devaluation of the Chinese currency will add to tensions.

When they develop their negotiating position vis-à-vis Beijing, EU policy-makers could draw inspiration from some of the EU’s most important strategic partners with similar economic systems, namely the US, Canada, and Australia.

The US administration’s current rhetoric suggests that it is intent on pursuing a confrontational approach by simply not granting MES to China. While its stance is likely to soften over time, the US views MES as one of the few remaining issues through which China might be pushed towards accepting and implementing Western standards on key economic issues.

Canada continues to use the WTO accession protocol as a legal basis for effective anti-dumping measures. In contrast to the US approach, Canadian authorities have backed up their non-granting of MES by removing the automatic expiry dates for so-called ‘prescribed countries’, including China, from Canada’s ‘Special Import Measures Act’.

Unlike the US or Canada, Australia has already granted MES to China. However, Canberra attempts to legitimise and to continue using effective anti-dumping measures by taking recourse to existing WTO law beyond the accession protocol.

Brussels should strike a compromise with China

Given the EU’s legalistic nature and the diverging interests of its member states when it comes to China, none of these approaches constitutes a perfect match for the EU. But a possible EU strategy could include a mix of the following elements:

  • Brussels could seek to strike transitional and sectoral bargains with China. The EU could grant MES in steps, taking into account determinations of whether or not specific industries in China operate according to market principles.
  • The EU could aim for package deals, encouraging Beijing to make concessions in exchange for MES. Such concessions could include output and export self-restrictions or establishing a more level playing field for European and other foreign companies in China.
  • At the very least, the EU should push China toward better compliance with its WTO commitments and to push China towards joining the WTO agreements on government procurement and OECD rules for export credits.

No matter what the EU’s eventual strategy will look like, its success will depend on close coordination among EU institutions, European leaders and key allies. Perhaps even more importantly, the EU should seek pragmatic solutions by working with reformers in China. Seeking ways to contain the current steel crisis in a mutually tolerable way might be a good starting point. Nevertheless, the EU needs to brace itself for retaliation and WTO litigation from China.

Now is the time for the EU to defend the core economic interests of its member states and to set its long-term relations with China on the right track. If it fails to do that, it risks losing its credibility as an international actor, active rule-maker and standard setter in the global economy.

This is the slightly modified version of an article that was previously published in the EU Observer on 11 February 2016.

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The  Mercator Institute for China Studies (MERICS)is a Stiftung Mercatorinitiative. Established in 2013, MERICS is a Berlin-based institute for contemporary and practical research into China.

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