Growing Pains: The Evolving U.S.-China Trade Relationship

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U.S. actions toward China in early 2007 seem to signal a newtrade policy tack for the Bush administration. After havinginitiated just two formal complaints against China within the WorldTrade Organization during that country's first five years as amember, the U.S. trade representative (USTR) has initiated threecases in the first four months of this year alone. In addition, theU.S. Department of Commerce ended its 22-year moratorium onapplying the U.S. Countervailing Duty law to imports from so-callednonmarket economies when it imposed preliminary duties againstallegedly subsidized imports of Chinese coated paper in lateMarch.

The recent flurry of activity has caused angst and raisedquestions on both sides of the Pacific. Has the Bush administrationchanged course with respect to China? Will its actions ameliorateor exacerbate tensions in the relationship? Will it lead toresolution of the underlying U.S. complaints and deter Congressfrom doing something rash? Is a trade war likely? This brief paperoffers answers, along with some of the context and perspective thathas been absent from many news reports.

In the final analysis, the administration's trade actions of2007 do not represent a departure from its longstanding China-tradepolicy but rather the next phase in a logical evolution. By usingthe WTO dispute settlement system to convey U.S. seriousness aboutachieving resolution, the administration should be able to keepCongress on the sidelines. If so, lingering issues are likely toget resolved and a trade war avoided. All bets are off, however, ifCongress short-circuits the WTO process and passes punitivelegislation that violates U.S. WTO commitments.

Recent U.S. Actions in Perspective

For more than six years, the Bush administration has been abulwark against an impatient, trigger-happy Congress, whichcontinues to threaten provocative, anti-China trade legislation.China agreed to undertake massive economic reforms when it joinedthe WTO in December 2001, and the Bush administration reckoned thatit would take some time to implement those commitments. Better tonot bludgeon China over slow-going reforms, as long as steadyprogress was evident. Otherwise China's taste for the multilateral,rules-based trading system might sour.

In its reports on China's record of compliance over the past fewyears, the USTR has acknowledged good overall progress alongsidelagging implementation in some areas. But the administration hastaken a big picture approach to the bilateral relationship,refusing to indulge every protectionist whim--although its recordis not perfect, particularly with respect to U.S. textile andclothing restraints.

As the commercial value of the bilateral trade relationship hasnearly tripled in a mere five years, from a substantial $121billion in 2001 to an immense $343 billion in 2006, the space fordisputes has expanded.1 When the relationship is characterized by a largeand growing current account imbalance (to which many policymakersattach exaggerated meaning) the spats can become politicallycharged, as they have.

Since the beginning of 2006, the USTR (and other agencies) hasmade it quite clear to its Chinese counterparts that the honeymoonperiod following China's accession was over and that it would soonendeavor to resolve disputes with China as it does with other majortrade partners, through WTO dispute settlement procedures, ifnecessary. In theUSTR's "Top-to-Bottom Review" of U.S.-China TradeRelations, the year 2006 marks the beginning of "Phase 3" of therelationship:

Now [2006] that the deadline for phase-in of most ofChina's WTO obligations has passed--and China has developed aninitial track record as a new WTO member--we are entering a thirdstage in our bilateral trading relationship. At this point, theeasiest obligations for China to meet have largely been fulfilled,and the hardest obligations are those that are still outstanding,precisely because their full implementation has proven especiallydifficult. Successfully addressing these remaining implementationissues will require serious attention and deliberate action by bothgovernments.2

Consistent with its report, the USTR initiated a WTO complaintthe following month (March 2006), alleging that certain Chinesepolicies discriminate against imported automobile parts andencourage consumption of domestically produced parts in themanufacture and assembly of automobiles in China. That complaintremains unresolved, as a dispute panel was convened in late 2006,and a report of its findings is expected later this year.

The auto parts case was only the second WTO dispute broughtagainst China. In 2004 the United States contested a Chinesevalue-added tax on integrated circuits that was allegedly appliedin full to imports only. During the consultations phase of thedispute, the Chinese agreed to change their law in a manner thatwas agreeable to U.S. negotiators, and the dispute was officiallyresolved.

In early February 2007 the United States filed its third WTOcomplaint against China, alleging that certain Chinese taxprovisions amount to subsidies for Chinese exporters and encourageconsumption in China of domestic products at the expense ofimports.

In late March, the U.S. Commerce Department levied preliminarycountervailing duties against imports of Chinese coated paper,breaking with its informal 22-year policy of not applying the U.S.Countervailing Duty (CVD) law to imports from so-called nonmarketeconomies.

Then, in April, the United States launched two new WTO cases,one alleging inadequate protection for American intellectualproperty rights holders under Chinese laws and the other concerningmarket access barriers for copyright industry products.

The administration's actions have been criticized by tradesupporters and critics alike, but for different reasons. Some whosupport trade suggest that the U.S. actions are unwarranted,hypocritical, and likely to provoke retaliation from China.Meanwhile, trade skeptics suggest that WTO dispute settlement takestoo long and often fails to resolve the underlying complaint, andthat unilateral measures are warranted. Neither assessment iscorrect.

Defense in Principle of U.S. Actions

One misconception that permeates media accounts of the recentU.S. actions is that, by bringing these WTO cases and by applyingthe U.S. CVD law, the United States is acting provocatively,unilaterally, and in a manner that somehow violates China's rightsunder the WTO. A recent Washington Post column wronglyequates the U.S. CVD action to pre- WTO unilateralism:

Today such bashing is relatively rare, because suchsanctions run afoul of WTO panels. But the unilateralist urgeremains: Look at the imposition of trade sanctions Friday onChinese paper.3

A unilateralist action would be one that is not sanctioned bythe WTO. The duties levied against Chinese coated paper, inprinciple, do not run afoul of WTO rules. Even if one findsfault with the countervailing duty law or other laws that can leadto higher import duties (as this author does), trade remedy dutiesare, unfortunately, explicitly sanctioned exceptions to the mostfavored nation principle that underlies the WTO system.

About the CVD decision, a Los Angeles Times editorialwent so far as to say "the decision to impose a10â€ââ'¬Å"20%import penalty could be the opening shot in a trade war between theworld's largest economy and its fastest growing." 4 Again, this is a bit dramaticgiven that, under WTO rules, trade remedy restraints are permittedand unilateral retaliation is not.

Counseling the administration that alternatives would "do moregood than starting a trade war," a recent New York Timeseditorial misled its readers about the implications of the recenttrade actions:

The [decision to launch WTO cases on intellectualproperty and market access for copyright industries] came less thantwo weeks after the Commerce Department said it would impose dutieson two Chinese paper makers that it says got an unfair boost fromChina's government. Experts say such duties could expand to steel,plastic and beyond unless China reins in subsidies. In February,the U.S. opened another subsidy case at the W.T.O.5

True, other U.S. industries can petition for relief fromsubsidized competition under the countervailing duty law, but thereis nothing automatic about it. Those industries have to demonstratethat they are materially injured by reason of subsidized imports,which would be a stretch for many industries in the highlyprofitable U.S. manufacturing sector, particularly steel. And thesubsidy case brought to the WTO in February is not a U.S. CVD case,but is actually a complaint challenging certain Chinese tax lawsthat allegedly discriminate against U.S. producers. Seekingresolution of trade issues through the multilateral WTO is acommendable alternative to unilateral sanctions.

There is nothing especially provocative in the Bushadministration's assertion of U.S. rights in its WTO complaints.This is how WTO members resolve their differences after informalnegotiations prove unsuccessful and domestic political pressure forresolution builds. Although some characterize the U.S. turn to theWTO as demonstrative of a new strategy of litigation andenforcement, the fact is that WTO dispute settlement encouragesdialogue and favors negotiated settlement over formal adjudication.And when disputes require formal adjudication from a dispute panelor the Appellate Body, resolution is almost always achieved withouttrade sanctions.

Bringing formal complaints at the WTO and invoking measuresunder permissible domestic trade laws really are not extraordinaryactions demanding extraordinary conclusions. WTO members haverights and obligations according to their domestic laws andinternational treaties. Diverging views about those rights andobligations have inspired 363 formal complaints to the WTO DisputeSettlement Body since 1995 (about 30 per year).6 Retaliatory actions have beenauthorized in only six cases.

The three recent U.S. WTO actions are all about encouragingChina to open its market further in accordance with its commitmentsand are not complaints on behalf of importcompeting interestsseeking to frustrate Chinese access to the U.S. market. In thatregard, the WTO cases are progressive; they seek to liberalize realor perceived barriers to trade. Whether the United States succeeds,either through formal consultations or dispute adjudication,remains to be seen.

While use of domestic trade remedies laws tends to raisebarriers to trade and is thus ill-advised, WTO members arepermitted to have and to apply them. The United States did notviolate any WTO obligations by applying the countervailing duty lawto Chinese goods, as long as that process complied with itsobligations under the WTO Agreement on Subsidies and CountervailingMeasures.

What is unusual about this case and perhaps explains the vastmedia speculation about a trade war is that the CVD law has notbeen applied to so-called nonmarket economies since 1984. While theCommerce Department has always had the discretion to apply the CVDlaw to Chinese companies, it has foregone doing so because even theDOC appreciates the absurdity of attempting to measure the benefitsof a subsidy in an economy where the government is deemed tocontrol the means of production and prices and costs are presumedto be fictitious. How can Commerce calculate a subsidy benefit tocountervail by comparing numbers that it officially deemsmeaningless? What is the meaning of a government subsidy initself?

The change in policy might have been inspired by any number ofdevelopments. First, the Chinese economy has become much moremarket-oriented, and thus prices and costs in many sectors now arereflective of supply and demand. Second, until recently China hadnot fulfilled its obligation of notifying the WTO of its subsidyprograms. Now that it has largely complied and done so, there ismore information available to U.S. industries and the CommerceDepartment to conduct a reasonable (by their standards) assessmentof the accruing benefits of those subsidies. Third, U.S. industrieshave been complaining about competition from subsidized Chineseindustries for a long time, and that message is having an impact onCapitol Hill. The timing of the administration's action may havebeen intended to head off legislation that would remove executivebranch discretion and mandate application of the CVD law tononmarket economies.7

The trade remedy laws are problematic in that they raisebarriers to trade. But there is nothing especially objectionableabout subjecting China to the U.S. CVD law. Imports from all othercountries (that are not deemed nonmarket economies) are subject tothe law, and China should be treated like all other major tradingpartners. But if China is to effectively be considered a marketeconomy for purposes of the CVD law, then it should be treated as amarket economy under U.S. antidumping law. China's current de factostatus as a market economy under CVD law alongside its explicitstatus as a nonmarket economy under the antidumping law isinternally inconsistent, is punitive, and likely violates the termsof China's WTO accession protocol. HR 1229 would mandateapplication of the CVD law to China, but it would also make itharder for China to receive market economy status under theantidumping law. As such, HR 1229 would be unlikely to withstandWTO scrutiny.

Trade War Is Unlikely

Although some suggest that recent U.S. actions will spark atrade war with China, such an outcome is unlikely. For starters,tit-for-tat trade wars between WTO members are unheard of. The WTOwas created, in part, so that trade wars would be relegated tohistory. Under the rules-based system of trade, members canretaliate in response to an action or inaction of another memberonly when such a course has been authorized by the DisputeSettlement Body, and only in measured proportions.

Despite complaints about the three U.S. WTO cases, the UnitedStates hasn't done anything that is even challengeable within theWTO. The United States has not suspended concessions with respectto Chinese imports. It has merely notified the WTO that it believescertain Chinese policies create a disadvantage to U.S. exporters ina way that violates China's obligations.

Only the CVD action against Chinese coated paper can bechallenged by China in the WTO. Although no such challenge has beenissued, it wouldn't be surprising if the Commerce Department, inits zeal to combat import competition, violated U.S. law or U.S.WTO obligations.8

Barring improper application of the law, China (as a WTO member)has no legitimate recourse to retaliation. Ultimately, China couldretaliate legitimately only if it went through the formal channelof challenging the U.S. action and convinced a WTO panel (or,eventually, the WTO appellate body, if the case were appealed) thatthe United States violated its WTO obligations and then refused tomake proper amends. And, even though the WTO dispute settlementsystem sanctions retaliation under certain circumstances, membersdon't reach for their billy clubs every time they feel they've beenwronged--a fact that seems to elude rabid China-bashers in theCongress. Picking battles judiciously and engaging in dialogue isthe essence of WTO dispute settlement.

Furthermore, China would be foolish to retaliate against U.S.actions unilaterally. If China were to retaliate without a greenlight from the WTO, it would be in violation of its own WTOcommitments. Such actions, apart from being economically damaging,would render China a WTO renegade. And, given the growingtemptation in other countries (see, for example, legislativeproposals in the 110th U.S. Congress) to ignore WTO rules to hammerChinese imports without limit, that is a precedent China does notwant to set.

Quieting the Provocateurs

Although cynics suggest that the administration is acting nowonly because it seeks to improve its chances of winning renewal oftrade promotion authority from Congress, the more likelyexplanation is that the administration believes the time has cometo treat China like any other major trading partner. Concern aboutthe possibility that Congress will ignite a powder keg by enactingprovocative, anti-Chinese legislation also factors into theequation. Keeping Congress on the sideline is a perfectlyjustifiable motivation given the items on the Congressionalagenda.

Some Members of Congress and sundry trade policy observers havestaked out the position that our disputes with China cannot beresolved in a timely and satisfactory manner within the WTO.Instead of submitting to that multilateral process, the UnitedStates would be better off fending for itself on its own termsaccording to its own timetable.

In accordance with that aggressive posture, several pieces oflegislation have been introduced in the 110th Congress, which aimto punish China. HR 1229 is one of those bills. While it containsseveral provisions that would likely violate U.S. WTO commitments,it is among the less rabid anti-China bills beforeCongress.9

HR 1002 is the House version of the Schumer-Graham bill from theprevious Congress, which would impose at 27.5 percent tariff on allgoods from China unless and until the Chinese currency appreciatesagainst the dollar by an amount deemed sufficient by the Congress.HR 571 would subject imports from China (and other "nonmarketeconomies") to higher rates of duty, while S. 571 would strip Chinaof its Permanent Normal Trade Relations status. Each of those bills(and other proposed legislation) would violate U.S. WTOobligations. The bills are so egregious that, despite the costs toboth economies, they could invite instant retaliation fromChina.

In other words, if the United States were perceived as blatantlyviolating its WTO obligations by passing provocative anti-Chinalegislation, China just might retaliate and a trade war ensue. Butthere is no good reason for the Congress to take this tack. Thereis no evidence that U.S.- China trade disputes cannot be resolvedunder the WTO dispute settlement system. The semiconductor taxissue was resolved during consultations in 2004 and the auto partscase awaits a dispute panel decision. It is quite possible thatagreeable solutions to the three recent cases can be reached duringbilateral consultations, as well.

Conclusion

The Bush administration has not changed its strategic assessmentof the trade relationship. Nor has it really changed course. Itsrecent actions are apropos of the logical next phase in a vitallyimportant relationship. And that should come as no surprise toChinese officials, who have been kept more than adequately apprisedof U.S. political developments and their tactical implicationsthrough highlevel exchanges with U.S. cabinet members.

Official anger and incredulity aside, this new phase of thetrade relationship is likely to lead to greater mutualunderstanding, a reduction in U.S. congressional pressure, and astronger trade relationship. The WTO dispute settlement system wasdesigned to foster resolution of trade disputes and to minimizeprospects for trade wars. Congress should refrain from enactingpunitive sanctions and give the WTO a chance to help resolveU.S.-China trade disputes.


1 U.S. Department ofCommerce, Bureau of the Census, Foreign Trade Statistics,http://www.census.gov/foreigntrade/statistics/highlights/top/index.html#2007;figures account for goods trade only.

2 United States TradeRepresentative, "U.S.-China Trade Relations: Entering a New Phaseof Greater Accountability and Enforcement, Top-to-Bottom Review,"February 2006, http://www.ustr.gov/assets/Document_Library/Reports_Publications/2006/asset_upload_file921_8938.pdf.

3 Sebastian Mallaby, "FreeTrade: Pause or Fast-Forward?" Washington Post, p. A15,April 2, 2007.

4 Los AngelesTimes, editorial, March 31, 2007.

5 New York Times,editorial, April 10, 2007.

6 For a list of WorldTrade Organization disputes, including complainants, defendants,and issues, see www.wto.org.

7 See HR 1229, TheNon-Market Economy Trade Remedy Act of 2007.

8 Commerce Departmentactions are no strangers to the U.S. courts or the WTO disputesettlement system. See Daniel Ikenson, "Abuse ofDiscretion: Time to Fix the Administration of the U.S. AntidumpingLaw," Cato Institute Trade Policy Analysis no. 31, October 6,2005.

9 For a good critique ofHR 1229, see Daniel L. Porter, partner, International Trade Group,Vinson and Elkins LLP, Testimony Before the Subcommittee on Tradeof the House Committee on Ways and Means, March 15, 2007,http://waysandmeans.house.gov/hearings.asp?formmode=view&id=5689.