China’s goals of international recognition during the last decade, in addition to accession to the World Trade Organization (“WTO”), include most prominently acceptance by the United States as a market economy. There have been at least two motivations: to have its creation of a market, “with Chinese characteristics,” recognized and approved around the world; and to be liberated from the trade remedy methodology tailored specifically for non-market economies. The former is more psychic; the latter is pragmatic.
Non-Market Economy Status
World trade rules are built around principles of free trade. Free trade as an ideal type refers to unimpeded private market transactions where governments, monopolies, and state enterprises do not have enough influence to distort the conduct or outcomes of private enterprise competition. The free private enterprise system assumes, as did Adam Smith, that the selfish private acts of individuals and their organizations will yield, out of their competition and interaction, a greater public good. The market, not government, defines and produces the public good. It also assumes that governments and monopolies, when regulating or controlling private transactions, distort markets and thus are harmful to the public good.
The role of government in the ideal free private enterprise system is limited, mostly to regulating anticompetitive behavior and breaking up excessively large conglomerates and monopolies that prevent free competition. Of course, such limited government is a fiction. Governments have many roles in civil society, and all impact the economy.
All governments raise revenue through taxes. They make judgments about who most can afford to pay. Despite the periodic calls in the United States for a “flat tax” imposed on everyone equally, taxes everywhere are “progressive,” graduated according to the perceptions of what can be afforded and by whom, including business enterprises as well as individuals. Taxes on transactions – sales taxes or value added taxes – are also common. The form of taxation, the extent to which taxes are graduated, and the taxpayers (corporate or individual) all express public policies favoring some over others. A core public policy in the United States favors private home ownership, which has produced special tax provisions affecting everything from bank loans to construction materials. All such government interventions and taxes distort markets in one way or another. Yet, like death, taxes are inevitable and are the most obvious form of government intervention in markets.
Governments play additional roles. Every free market system assigns governments a role in forbidding the formation and operation of anticompetitive monopolies and trusts. Governments may regulate to protect the health, safety, and welfare of citizens. Such regulations typically raise costs of production for private enterprise, and impose certain manufacturing methods and ways of doing business. Hence, despite the ideal type, governments everywhere intervene in the free market.
Corporations rhetorically champion free enterprise, but in practice they seek competitive advantages that inevitably translate into limitations on competition. Governments regulate to limit or eliminate such corporate behavior. The nature of competition is to seek an advantage and a superiority over others. Such advantages are defined by reducing the competitive abilities and positions of others. Individuals and corporations idealize competition only to the extent that competition can improve their situations, which by definition requires the degrading of the competitive positions of others. Consequently, free private enterprise systems foster competitors whose objective is always to reduce competition. Governments overseeing such systems endeavor to maximize competition, while protecting against the release into the stream of commerce of products and practices inimical to the health and safety of individuals and society.
This ideal type of free enterprise system is the theoretical antithesis of a state-controlled or command economy. In the ideal type, government intervenes only as required, reluctantly, and while trying to guarantee free competition. In a command economy, government seeks to direct all economic activity, deciding what needs to be manufactured, to whom it should be distributed, and at what price. Government extracts rents from this production and, therefore, in control of the entire economy, can raise revenues anyway it likes. Markets function only to the extent that governments permit, in any particular sector, the interaction of willing buyers and willing sellers. Mostly, demand is regulated by supply, the latter controlled entirely by the government.
The United States, since the ascension to power of Mao Tse-Tung, has treated China, dominated by state-owned enterprises and with a tax system dictated by government (rather than negotiated among competing interests), as a non-market economy. However, China, since the “opening” of Deng Xiaoping, no longer regards itself as a non-market economy. Instead, China thinks of itself as a capitalist, market economy, albeit with “Chinese characteristics.”
There are many indicia supporting China’s self-image because substantial competition has grown up in China. Capitalist goods are everywhere and are sold competitively throughout the country. There are advertisements promoting different prices for the same or comparable goods. People decide what to buy, from food to cars, such that supply does not control demand, and the government does not control supplies. Labor has become mobile, with people moving from one part of the country to another, from one kind of job to another, from one corporate entity to another making or selling the same product. Prices vary with supply and demand, not dictated by government.
There are many indicia that China remains a command economy. The government owns and controls the supply and prices of natural resources and public utilities. The government controls banks and insurance, lends money through the banks according to government policy and rates, controls the currency and its value. The most important economic sectors, such as steel production, are dominated, when not exclusively captured, by state-owned enterprises. Through the control of money and loans and prices, the government dictates the supply and demand for the most important products and services.
The global economic meltdown with the fall of Lehman Brothers in September 2008 made the United States look more like China than the other way around. The U.S. government took effective control of major banks and insurance companies, bought out one of the leading economic sectors – automobile manufacturing – and shaped subsidy programs throughout the economy designed to assure the success or survival of enterprises chosen by the government. Yet, while insisting that it is the world’s leading capitalist economy, the United States denied China’s claim to be recognized as a market economy.
Symbolism Of Market Recognition
China, as a matter of national pride and self-respect, has resented the American insistence that massive American subsidies and market intervention preserved a capitalist, market, free enterprise system, while identical conduct in China guaranteed that China would be considered outside the mainstream, along with Cuba and Vietnam and North Korea, as a non-market economy. The more China has insisted that the United States should recognize it as a market economy, the more the United States has resisted. Excuses have become cumulative, most prominently in the American complaint over China’s refusal to float fully the value of its currency, notwithstanding that U.S. currency did not float freely until 1971, and the United States certainly was not considered a non-market economy before then.
Recognition as a market economy has come to mean, for China, fulfillment of a promise it perceives was made in 2001 when China acceded to the WTO. Even though the WTO agreement projected recognition as a market economy by 2016, and then only upon the satisfaction of various criteria, China’s Commerce Minister now insists that the United States agreed to recognize China’s market economy status by 2010 and offers a sense of betrayal that recognition has not happened.
The Practicalities Of Market Economy Status
In only one significant respect does recognition as a market economy matter: when complaints are brought that Chinese goods are dumped in the United States, the methodology for determining whether there is dumping, and if so, how much, is different for non-market economies. This distinct methodology gives the United States Department of Commerce more discretion and flexibility to find dumping, and to inflate the dumping “margin,” the measure of how much dumping and consequently how much duty will be owed for the merchandise to be imported into the United States.
Dumping is determined in one of two ways: either a good is sold abroad for a price lower than the price at home, or the costs to produce the good exceed the price at which the good is sold abroad. When Chinese goods are subjected to this second measurement, the cost of production, the non-market economy methodology becomes critical.
Non-market economy status presumes that, in the absence of markets, there are no market prices. It is then theoretically impossible to determine the cost of production because it is impossible to determine the costs of any of the inputs. There are no market wages; no market rents; no market utilities. Raw materials have no market prices, nor do any component parts.
When the inputs are imported from a market economy, dumping analysts use the price the Chinese manufacturer has paid for those inputs. But when the inputs are domestic products, analysts assume there is no market price for them. The analysts then seek and apply “surrogate” prices – prices of the same input in a “market” economy that, supposedly, is at a similar level of development as China. Surrogate values may come from many different countries, but American official analysts have favored (for China) India, Bangladesh, Indonesia, and occasionally other countries.
The selection of surrogate values is highly contentious and is decided, in the end, by U.S. government officials. They have decided that freight costs, for example, could not be used if derived from a Chinese-flag ship. They have chosen, instead, some of the highest shipping rates in the world.
Subsidies And Market Economy Status
Until November 2006, treatment of China as a non-market economy did have advantages for China. A “subsidy” in international trade is a financial contribution from a government that is market-distorting. Where there is no market, there is nothing to distort. Therefore, until November 2006, the United States had never brought a subsidies (countervailing duty) case against China. Subsidies could not be alleged; they had to be treated as costs of production susceptible to the application of surrogate values.
It was always thought that China could not and would not be exposed to countervailing duty allegations unless and until it might be recognized as a market economy. The Chinese Government, consequently, stayed out of trade remedy disputes, as dumping is the business of business, not government. Dumping is determined by prices, and companies, not governments, set prices. Moreover, it was exceedingly difficult to address some of the “inputs” this way for a cost-of-production analysis.
The 2006 mid-term elections delivered a significant Democratic majority pressuring the Administration to get tough on China, especially as to alleged subsidies. A petition alleging subsidies to coated free sheet paper was pending. The Department of Commerce, soon after the elections, decided to initiate a countervailing duty investigation, while refusing, still, to recognize China as a market economy.
China protested the apparent anomaly – a non-market economy subjected to a countervailing duty investigation – but to no avail. Various legal issues emerged and several are still the subject of WTO proceedings initiated by China. None has been resolved by the WTO, and meanwhile the United States has found subsidies and imposed countervailing duties in 12 cases already. All of these cases were accompanied by antidumping petitions, and a cumulation of dumping and subsidies duties have been imposed in 26 cases since 2007. Petitioners complaining about unfair competition from China now routinely file simultaneously antidumping and countervailing duty petitions.
Why Non-Market Economy Status No Longer Has Practical Meaning
The decision to investigate subsidy allegations and impose countervailing duties while still treating China as a non-market economy rendered the non-market economy status practically meaningless. It is not as if, were China tomorrow to be recognized as a market economy, anything of practical value would change.
The United States has been applying surrogate values for subsidy allegations against China throughout the economy. For the allegation that China was not charging enough money for the commercial use of land in rural Shandong Province, the Department of Commerce used land values from suburban Bangkok. The Commerce Department ignored entirely expert testimony that the use of such values was nonsensical from the perspective of economics and land use. And Commerce treated any input supplied by a state-owned enterprise as a subsidy, the value of which was to be determined by selection of a surrogate value in a market economy.
The rationale for the application of surrogate values is based on Certain Softwood Lumber from Canada. Even though a WTO panel found the use of such values improper in the case of Canada and a NAFTA panel found it illegal, the Commerce Department dismissed the NAFTA panel as having no precedential authority and the WTO panel as ambiguous. Beginning with coated free sheet paper, the Commerce Department has cited its own administrative determination in the softwood lumber case as the basis for its treatment of China.
The Commerce Department argues that, even though Canada is indisputably a market economy, Canadian provincial governments own so much of the forests that any price for standing timber cannot be a market price. It did not matter that nearly twenty-five percent of the standing timber sold in Quebec is private, as is more than fifteen percent in Ontario. It did not matter that the pricing scheme for public forests in Quebec was based entirely on the prices in the private forest. The Commerce Department reasoned that the public sector was so large compared to the private sector that the private sector prices were driven by the public sector and therefore could not be used. It reasoned that the residual value methodology applied by Ontario, whereby the market price of manufactured lumber required certain pricing of the raw material, could not be used because most of the natural resource was in public hands. It did not matter that the NAFTA and WTO panels disagreed, as did a number of notable experts.
China, over the course of three years, has failed to successfully challenge any of the Commerce Department surrogate value applications in U.S. courts. [confirm] Consequently, the Commerce Department has been laying a foundation of subsidy findings as “administrative practice,” upon which it can rely for virtually anything that may arise in the Chinese economy. Bank loans, even from commercial banks, can be treated as non-market rates because of the alleged dominance of state-owned banks setting the market rates; prices for inputs from private companies can be set aside as long as there are state-owned enterprises in the same business. It will be very difficult for China to prove that the state is not dominant in one sector or another, and the burden of proof will fall on China.
The United States can recognize China as a market economy and continue to apply surrogate values and non-market economy methodologies in trade remedy disputes because China has focused on the issue of market economy status instead of on the methodology the United States developed in the softwood lumber dispute with Canada. The core issue remains not the nomenclature, but the predominance of state-owned enterprises.
The Strategic And Economic Dialogue
The Strategic and Economic Dialogue in Beijing in May 2010 seemed to produce only one Chinese headline: that the United States was going to recognize China as a market economy. The expectation was variously seen as fulfillment of a promise and as an essential American concession, a Chinese victory of sorts. The United States, as it happens, did not provide such recognition, only promising to continue a discussion about it. Consequently, the United States now knows it is holding something that China values highly, and yet is not worth very much, an enviable negotiating position. China, for its part, needs to recognize how little such recognition means, and move on to more meaningful discussions.