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Issue 19, 2006 (21 September)
 Feature Article

China to Remain Non-Market Economy for AD Purposes

The Department of Commerce's Office of Policy sent a memorandum to Assistant Secretary for Import Administration David Spooner on 30 August providing the full analysis underlying its 15 May determination that China will remain a non-market economy for purposes of U.S. anti-dumping law. The respondents in an AD investigation of lined paper products from China had requested that the DOC re-evaluate this status, a request supported by China's Ministry of Commerce.

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 expenses and profit percentages from a surrogate market economy 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 market data prevents Chinese manufacturers' comparative advantage from being demonstrated.

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 on 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 memo concludes that while China has made some progress in these six areas, "market forces in China are not yet sufficiently developed to permit the use of prices and costs in that country for purposes of the Department's dumping analysis." The memo recognises that China has a dynamic, albeit constrained, private sector but also finds that the state retains for itself considerable levers of control over the economy.

The memo identified several specific impediments to a market economy designation, including restrictions on the foreign exchange market and capital account transactions, factors limiting the impact of market forces on wage formation, a privileged role for state-owned enterprises in core industrial sectors, and the Chinese government's ownership or control of the domestic commercial banking sector. Some of the more relevant findings of the memo are summarised below.

Currency Convertibility. China maintains significant restrictions on both the inter-bank foreign exchange market and capital account transactions, which appear to interfere with the ability of market signals to impact the exchange rate. At the same time, the yuan is convertible into foreign currencies for trade purposes, important reforms have been made to the currency regime, the foreign exchange market is being developed, and initial moves to liberalise both inward and outward capital flows have been made. As a result, while China's reforms to date cannot ensure that the yuan is market-based, the currency is not completely insulated from market forces.

Wage Rates. Wages between employers and employees in China appear to be largely negotiated, as opposed to government-set, as evidenced by the variability in wages across regions, sectors and enterprises. Workers have certain rights with respect to compensation and choice of employment. While there are a number of institutional and administrative constraints that limit the extent to which market forces influence the formation of wages - the lack of independent unions, the prohibition on the right to strike and significant restrictions on labour mobility - employers are generally free to make independent decisions regarding labour.

Joint Ventures. China permits all forms of foreign investment, such as joint ventures and wholly-owned companies, in most sectors of the economy. Foreign investors are free to repatriate profits and investments and are protected from nationalisation and expropriation. However, China still manages foreign investment to a significant degree; e.g., by guiding foreign direct investment toward favoured export-oriented industries and specific regions, shielding certain domestic firms from competition and relying on industry-specific foreign direct investment rules and regulations.

Government Control of Production. In essence, the Chinese government continues to combine market processes with continued state direction. China has made progress in privatising SOEs and introducing limited market practices to state-owned firms. The government has made a decision to recede from direct state control over certain parts of the economy but intends to maintain and bolster state control in other areas (including finance, energy and "core" industries). While property rights in a market economy should be secure, administered according to law and accompanied by a reasonable degree of freedom of alienation, property rights in China remain poorly defined and weakly enforced.

Government Control over Resource Allocation and Price/Output Decisions. The era of China's command economy has receded, the majority of prices are liberalised and there is evidence of some market-based resource allocations at both the micro and macro level. The state-owned sector is shrinking in relative terms and a limited number of state-owned enterprises are profitable and competitive. The growing private sector is productive, profitable and increasingly driving economic growth. Nevertheless, the Chinese government remains deeply entrenched in resource allocation at all levels. The government's continued role in the allocation of financial resources indicates that it exerts significant leverage over the allocation of resources in the economy as a whole. In particular, enterprises in the state-owned industrial sector have required significant capital merely to sustain operations, distorting the operating environment for the private sector.

Other Factors. China faces a myriad of major challenges in overcoming institutional weaknesses regarding the rule of law, property rights and bankruptcy.

In general, the memo appears to leave a window open for an eventual change to China's NME status, provided additional progress is achieved. However, 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. Paradoxically, the European Union could break the status quo in this area if it grants China market economy status (the EU currently requires Chinese companies to prove they are operating under market economy conditions in order for them to be afforded that status in AD investigations). Such an action would probably put some pressure on the U.S. government to follow suit.