China is currently considered to be an NME in which the government controls pricing and production decisions. In other words, according to the U.S. government, the Chinese economy does not operate on market principles, which means that cost and pricing structures in the Chinese market are regarded as unreliable and are therefore not used for calculating dumping margins. Instead, the DOC selects the prices of inputs and the expense and profit percentages from a surrogate market economy (e.g., India) to determine a theoretical price that would be charged in the mainland if China were a market economy. This methodology constitutes a major disadvantage for Chinese exporters because the use of surrogate input prices prevents the Chinese manufacturers' comparative advantage from being demonstrated.

To add to the problem, the choice of which country's economy to use as a surrogate may strongly affect the calculation of dumping margins. For instance, the input prices for the manufacture of a given product may be very different, so much so that if one country is chosen as the surrogate dumping may be found not to exist, whereas if another country is chosen a substantial dumping margin may be generated. Because the results may vary greatly as a result of which country is chosen as a surrogate, the results generated by the methodology carry an unavoidable and sometimes large element of arbitrariness, opening the process to charges of manipulation by the DOC.

For these and other reasons, the Chinese government has sought to change China's NME designation in the U.S. and other countries. Beijing's international diplomacy on this issue has been fairly effective over the past two years, with such countries as Argentina, Australia, Brazil, Chile, Iceland, Russia, South Korea and the member nations of the Association of Southeast Asian Nations granting market economy status to the mainland during that period. However, much to the chagrin of Chinese officials, the U.S. and the European Union have not yet been persuaded to recognise China as a market economy.

By law, the DOC must consider six criteria in determining whether to change a country's NME status: (i) currency convertibility; (ii) free bargaining for wages; (iii) restrictions to foreign investment; (iv) government ownership or control of the means of production; (v) government control over the allocation of resources and the price and output decisions of enterprises; and (vi) other appropriate factors. The 15 May memorandum acknowledged the significant reforms that the Chinese government has implemented to date but concluded nonetheless that the limited extent to which market forces and institutional reform have taken root in critical sectors of the Chinese economy preclude China's designation as a market economy. The memorandum identified several specific impediments to this designation, including the absence of private land ownership, the lack of effective rule of law and protection of property rights and the continuing leading role played by China's state-owned enterprise sector.

The DOC's Office of Policy decided to postpone its assessment of China's compliance with the six statutory market economy criteria for the final memorandum, limiting most of its preliminary analysis to an examination of China's banking sector. In essence, the memorandum concluded that "the continued significant government involvement in China's banking sector reflects an assumption that the state, not markets, should determine the growth sectors or individual companies that deserve access to credit." In the opinion of the Office of Policy, the continuing collective influence of the Chinese government over the domestic banking sector is a "critical element" of China's NME designation, given the "importance of the banking sector for investment and, thus, resource allocation in the economy."

MOFCOM called the DOC decision "unfair and untimely" at a time when U.S.-Sino trade relations are progressing steadily. According to MOFCOM, China has established a market economy system that has been recognised by "many countries" (according to recent estimates, nearly 50 countries have granted market economy status to China). MOFCOM also urged the U.S. to treat fairly and objectively the market economy application filed within the context of the on-going AD investigation of lined paper products from China.

The DOC decision not to grant market economy status to China is hardly surprising and will most likely be confirmed in the final memorandum. China has generally gained the support of Latin American and Asian countries on this issue by offering attractive investment deals and increased market access for exports in return for market economy designation. However, this strategy is unlikely to work in the case of the U.S., where domestic public perceptions tend to play a more decisive role than in other countries and reliance on Chinese investment is minimal and often viewed with apprehension. In fact, Congress is likely to stall any potential overtures in this area unless the Chinese currency is allowed to rise substantially against the dollar and/or there is a significant reduction in the size of the bi-lateral trade deficit. At present, the EU appears somewhat more likely than the U.S. to grant market economy status to China, although not this year. In fact, several EU members, including most notably the United Kingdom, favour granting market economy status to China. Should the EU decide to take this step, there would be a lot more pressure on the U.S. to follow suit.