The Coming Showdown Over China’s Status in the WTO as a Non-Market Economy

By Justin Kirschner

The “mother of all trade issues” will come to a head by the end of this year: is China a market economy under the WTO and who gets to make that decision? The answers to those questions have far-reaching economic and political ramifications.

Though the purpose of the WTO is to facilitate a reduction of trade barriers between its members, the WTO explicitly permits its members to levy anti-dumping duties. An anti-dumping duty is a temporary duty on imported goods imposed on a foreign firm when the foreign firm “dumps” products on the importing member’s market. A product is dumped when it is “introduced into the commerce of another country at less than its normal value” so as to cause or threaten to cause material injury to the domestic industry in the importing country. The consequent anti-dumping duty an importer may impose can be as high as the dumping margin, which is the difference between the actual price of the imported good and the normal value of the good. Generally, a product’s normal value is equal to the value of the product in the ordinary course of trade in the home market of the exporting country. 

However—and this is the heart of the issue with China—under the addendum to GATT Article VI, when the exporting country is a non-market economy, normal value may be calculated by other means because the state-controlled nature of the home market would create a normal value that is not “normal” but is artificially low. The resulting higher normal value creates a higher dumping margin, which in turn permits the importing country to slap the exporting firm from a non-market economy with a higher anti-dumping duty.

When China acceded to the WTO in 2001, its accession protocol contained a unique provision that allowed other members to treat it as a non-market economy and made it hard for that designation to change. While exporters generally enjoy a presumption of market economy status until the importer can prove otherwise, China is presumed a non-market economy unless it can prove otherwise for a particular industry. And while other members may only be deemed a non-market economy under a strict definition, China will remain a non-market economy unless the importer’s “national law” deems China a market economy. In other words, for China, the importer subjectively determines the definition of market economy and subjectively decides whether or not China meets the criteria. Those definitions tend to be restrictive. For example, under U.S. law, a country must satisfy six criteria in order to be a “market economy” and the executive branch has wide discretion to decide if the standards are met. Under EU law, there are five requisite criteria. So while for most WTO members, the door to the market economy club is wide open and the space inside is expansive, for China, when it comes knocking on the market economy club, it is met at a small door by large bouncers.

Market economy distinction from some of its largest trading partners is economically important to China because it could help solve the manufacturing over-capacity problem that plagues its economy. Because Chinese manufacturers operate within a non-market economy, they may be reticent to export to countries that do not recognize China as a market economy because of the resulting threat of exposure to a large volume of higher anti-dumping duties. Receiving market economy status without any actual change in domestic economic conditions will be like releasing a pressure valve because the threat of anti-dumping duties will decrease, thus freeing Chinese exporters to sell more goods abroad. This could ease the problems of over-capacity by bringing demand in line with supply.

And it is not just about economics for China. Indeed it might be as much or more about the positive political symbolism that comes with market economy status.

China says the bouncers have already agreed to let it into the market economy club on a certain date. It argues that section 15(d) of its accession protocol is a sunset provision on its non-market economy status. Fifteen years after China’s accession—that is, on December 11, 2016—the provision that permits importing countries to calculate the normal value of imported goods based on something other than a “strict comparison with domestic prices” will expire. China says this means that on that date, other members must recognize China as a market economy.

WTO members are inconsistent in their current treatment of China and in their interpretation of its accession protocol. Some members, like Australia in 2003, voluntarily recognized China as a market economy as part of negotiating a free trade agreement. The European Commission’s official position appears to be that China’s accession protocol does not require it to recognize China as a market economy, though the Commission nonetheless plans, at some point this year, to recommend to member states whether or not to vote to recognize China as a market economy. German Chancellor Merkel appears cautiously amenable to the idea, while Italy and big manufacturing interests are opposed, fearing that Chinese market economy status will kill European industries.

The US maintains that it need not and will not recognize China as a market economy in December 2016, plotting instead a plan of inaction that would force China to challenge its non-market economy status through the WTO dispute settlement mechanism.

Because of the subjective freedom for the executive branch, especially in the U.S., to deem China a market economy, this arcane legal issue has become a complex diplomatic game. If the EU and U.S. do not recognize China’s market economy status, they will have foregone potential Chinese concessions they could have elicited in return for the greater market access that market economy status would grant. But if negotiations were held, concessions might not materialize. China may hold the stronger negotiating position because it thinks it would win a case at the WTO, thus making a “no deal” acceptable to them.

The U.S. apparently is willing to roll the dice and punt this issue to the WTO dispute settlement mechanism. Europe’s conclusion is harder to read, though it points toward eventual market economy recognition. Massive trading partnerships with China are at stake for both. Between now and December, the international trade world will watch to see how this legal, economic, and political showdown is resolved.