China’s resolute retreat from the market economy model: Reactions from the West and implications for the rules-based trading system
On 15 September 2020, China’s Communist Party Central Committee published a plan entitled Opinion on Strengthening the United Front Work of the Private Economy in the New Era. According to this plan, which includes over a hundred prescriptive measures, entirely privately-owned Chinese businesses of every size will be expected to recruit Communist Party members in management and other key positions, work towards fulfilling Communist Party objectives, and be held accountable by reporting back on progress under the plan.
These “guidelines” do not come out of nowhere. They are just the latest in a series of plans and guidelines over the past few years directed at establishing a “united front” by government and the private sector for a “new era” of economic expansion. By these means, the Chinese government/the Communist Party have sought to exercise ever greater control over China’s economy and specifically over private business operators. In so doing, China is moving further away from market economy aspirations, with significant implications for the rules-based trading system. These changes in China will further fuel the efforts of leading Western economies, including the UK, to reform the WTO and its rules on subsidies, and will have a lasting impact on China’s trade relations with its major trading partners.
China’s failed bid for recognition as a market economy and adaptive strategy
For those who came of age during the Cold War, this level of state control by a Communist country may seem familiar. But it sits uneasily with China’s own long-term external trade strategy. When China acceded to the World Trade Organization (WTO) in December 2001, it requested and obtained a right to be treated as a market economy country by other WTO members after 15 years. Concretely, this meant that other WTO members with developed anti-dumping arsenals, such as the EU, US, Canada and Australia were expected to abandon, as of December 2016, their long-established non-market economy country criteria and methodologies when calculating protective anti-dumping duties on Chinese exported goods.
These non-market economy country methodologies were originally developed to target exports by the Communist bloc countries. They gained prominence when China and Russia began to expand their industrial exports in the 1990s and early 2000s, when the West began imposing systematically very high and often prohibitive anti-dumping levies on their exports (and particularly on those from China).
However, with December 2016 approaching, those WTO members maintaining non-market economy country criteria and methodologies were not prepared to grant China market economy country status (MES). There are two main reasons for this. First, China remained governed by its Communist Party, while gradually but convincingly becoming the world’s heavyweight industrial exporter, undercutting cost structures in the Western economies. Second, in becoming an expansive foreign investor and technology powerhouse, China emerged as a genuine economic superpower. In 2017 the US declared China to be a ‘strategic competitor’, and in 2019 the European Commission described China as a ‘systemic rival promoting alternative models of governance’.
From China’s perspective, Western countries have failed to deliver on their WTO promise made in 2001. Accordingly, from the Chinese point of view, there is no inconsistency in China’s adaptive economic and foreign trade strategy. Anticipating and adapting to the West’s attitude towards itself, China had begun developing its foreign economic expansion strategy at least since 2013. Around that time, the widely commented One Belt, One Road Initiative was announced, and later became part of China’s constitutional policy, in 2017. Moreover, China’s systemic efforts to expand industrial and technology investments in the EU and third countries have facilitated China’s access to and establishment in protected Western markets.
In short, the Communist Party’s recent plans to reinforce state and party control over the Chinese private economy are likely to be both evidence of a new long-term assertive economic and trade strategy in response to the West’s broken WTO promise, and a reaction to the recent abrupt change in Western geopolitical and trade policy attitudes.
The West’s counter-reaction
China’s increasing government and Communist Party control over the private domestic and exporting sector, coupled with Chinese outward economic growth strategy, are already making waves across the world. Western countries have recently deployed a range of unilateral or regional measures demonstrating the intensity and scale of the response to China’s state-run economic expansion model. For example, in January 2020 the US-EU-Japan issued a trilateral statement calling for reforms to WTO subsidy rules and other WTO reforms. In addition, both the US and the EU have adopted unilateral measures targeted at China.
The US has not only maintained its non-market economy methodologies in trade remedy investigations but has also convinced Mexico and Canada to agree to a special “anti-China” clause in NAFTA 2.0, the US-Mexico-Canada FTA (USMCA), in force since July 2020. Article 32.10 of this agreement prevents any state party to the agreement from engaging in and concluding free-trade negotiations with a non-market economy country (i.e. China), on pain of expulsion from the agreement. With China’s new Communist Party initiatives targeting the private sector, the US can be expected to include an “anti-China” clause in other free-trade agreements under negotiation, as well as in future initiatives for agreements with trade partners.
For its part, the EU has amended its anti-dumping legislation, by introducing in late 2017 a unilateral new concept of “significant distortions”, which operates in a similar way to the former non-market economy criteria and methodology, and results in even higher dumping margins and duty rates on Chinese goods entering the EU. The EU has also intensified its anti-subsidy actions against China in recent years, by imposing a range of countervailing measures on Chinese industrial goods and value added products, including hot-rolled steel (2017), coated paper (extended in 2017), tyres for buses and lorries (2018), electric bicycles (2019), solar glass (extended in 2020) and glass fibre fabrics (2020). There is currently a new and ongoing countervailing duty investigation into stainless steel, as well as two ongoing sunset review investigations with a purpose to extend older countervailing duties for a further period in future.
The recent EU anti-subsidy investigations against Chinese exports are based on somewhat repetitive investigative processes relying on a permanent body of evidence, maintained by the European Commission and updated on an on-going basis. This body of evidence is contained in a technical Commission “staff working” document explaining and demonstrating China’s Government and Communist Party de facto control over Chinese industries and exporting enterprises. It explains the effects of the Chinese government’s five-year plans, general policy and Communist party plans, industry-specific plans as well as local plans in terms of providing “guidance” or de facto public direction for industrial subsidisation. This evidence “at hand” in any new investigation facilitates EU complaining producers in bringing complaints against Chinese competitors, and in establishing the existence of countervailable Chinese subsidy programmes at China’s nation-wide, provincial and local levels, allowing the calculation of countervailing duties in each case. The new Communist Party plan will add to this body of evidence and will likely prompt further EU anti-subsidy and countervailing duty actions and remedies against Chinese exports.
Nearly in parallel, the EU and the UK have initiated a process of elaboration and adoption of investment screening legislation, unprecedented for Europe but more common in other countries, including the US. The EU legislation provides for the security review, both at EU member states’ national level and by the Commission, of foreign direct investments in strategic sectors. Furthermore, the EU has recently announced the preparation of a competition/trade law instrument aimed at removing the distorting effects of foreign subsidies and foreign acquisitions in the EU’s internal market, which is likely to take shape in a Commission proposal in 2021. Both the security screening tool and the foreign subsidies instrument are likely to be triggered by China’s recent non-market reforms, as those are likely to lead to cross-border subsidies for Chinese foreign direct investments, subsidies to Chinese exporting service sectors, and to (not only strategic) subsidised acquisition investments.
The implications for the rules-based WTO system and WTO reform
China’s new assertion of control over private entities raises several questions under WTO law. The first is whether this would make these entities “public bodies” under the WTO Agreement on Subsidies and Countervailing Measures (SCM Agreement). If they are, it would be possible to target any financial contributions that they offer to other entities, without further evidence of Chinese government involvement, on the basis that these entities are in fact pursuing Chinese government policy. So far, it seems this is unlikely. While there is a significant debate on when entities can be considered “public bodies”, at least for the time being it is EU and US practice not to consider this term to cover entities without a significant state ownership stake. At most, the EU applies this term to Chinese state-owned or state-controlled entities (mainly banks) and its central export credit agency. Moreover, even for “state-controlled” entities, the EU applies a “control” test drawn from the area of competition policy, where relevant factors include a large governmental share in the ownership, government appointment of members of managing bodies, and formal references in statutory documents. And mere instructions from the Communist Party to private entities do not involve ownership, nor meaningful control pursuant to corporate and merger control tests. Nonetheless, practice may change.
This does not mean that China’s new policy will entirely escape subsidies control. The SCM Agreement also covers subsidies granted by private entities which have been “entrusted” or “directed” by a government to grant subsidies to other entities. Thus, a government might instruct a privately-owned bank to provide a loan on preferential terms to exporting enterprises. However, unlike subsidies granted by “public bodies”, which are treated as having been granted by the government, for subsidies granted by “private bodies” it needs to be proved, as an additional step, that the government has entrusted or directed the private entity to grant the subsidy in question. That is not easy to do. In the case at hand, China can be expected to argue that its plans only amount to advice and soft guidance, and therefore that they cannot meet the WTO’s legal standards for “entrustment” and “direction”. Whether that argument would be successful remains to be seen.
Should the current WTO rules on subsidies remain unchanged, one should expect a further worsening of bilateral economic relations with China, and a further decline in global trade flows due to heightened trade frictions between China and the Western economies. One can therefore expect further efforts to reform the WTO. Such reforms have already been declared as “necessary” by the G20, while “most” of the G20 consider that “market-oriented policies” are a basic principle of the multilateral system.
Elements of an ambitious WTO reform package include stricter transparency obligations and new multilateral rules on subsidies, which would facilitate WTO dispute settlement findings against Chinese subsidisation policies. There could be new proposed elements in those rules, focusing on facilitating the establishment of “entrustment” or “direction” beyond tangible legal relationships, possibly considering state-run economy specifics. Such a “West-favouring” WTO reform scenario, if successful, may not be China’s preferred outcome, but will ensure a predictable and more stable rule-based system which would ultimately benefit Chinese enterprises doing business globally.
Should WTO reform efforts fail, the outcome for the rules-based trading system will be much less optimal. Individual Western countries can be expected to continue to develop their own unilateral and regional approaches to (China’s) State-run economic model and subsidies, including prohibitive duties and draconian remedies against subsidised services and investments. Those may not necessarily be aligned between various Western jurisdictions and would be likely to create disarray in global commercial planning. This could in turn lead to a less predictable trading environment for Chinese companies wishing to expand globally, and to further damage to global trade and investment.
Edited by the Linklaters Trade Practice. The views and opinions expressed here are the personal opinions of the author(s) and do not necessarily represent the views and opinions of Linklaters.