Is China a market economy, what’s happening in 2016, and what’s written about it in China’s Protocol of Accession to the WTO? A blog posted on the VOXEU website in November 2011 addressed the misconception that market economy status for China was automatic. Since then new misconceptions have emerged. This note seeks to address those misconceptions. It looks at what the issue is all about. Why it’s important. And why it’s all much ado about nothing.

The problem lies in understanding Article 15 of China’s WTO Protocol of Accession. Article 15 is not very long. It has four paragraphs. Paragraph (a) deals with price and cost comparison methodologies in dumping investigations. Paragraph (b) deals with the calculation of benefit in subsidy investigations. Paragraph (c) deals with notifications to the WTO and finally, paragraph (d) addresses the status or nature of China’s market. Article 15 was negotiated by China and the US and then accepted by all other WTO members.

The background to the debate is the nature of the Chinese economy. Is China a market economy as understood in Europe or the United States and many other countries? Or is it still a socialist market economy as China declared itself to be when it joined the WTO in 2001.

What’s the difference and why is it important? It's commercially important because local companies in China, producing within the socialist market economy system as developed by China, have advantages by being based there, that companies based in the EU or the US simply don't enjoy. The advantages in the Chinese model of a socialist market economy are: state ownership and disposition of key industries and resources; restrictions on foreign ownership; restrictions on foreign investment; currency manipulation; lack of open competition; little or no enforcement of IP law; distortions of costs and prices; government management of markets; government management of market players.

The effects of these advantages, only available in China, are spilling over into the global market and distorting competition outside China. This means that companies in normal markets, subject to strict competition and state aid rules, bankruptcy laws, open competition in public markets and the like, suffer. They suffer by not being able to participate equally in China's market and they suffer in the global market from unfair and statemanaged competition originating in a distorted market. The China market model is a China company only model.

What does WTO law say about the nature of China’s market? Article 15 does not define it. However, paragraph (d) of Article 15 sets out the steps to be followed to legally change its classification from non-market to market economy. There is no date or deadline. Paragraph (d) gives China the right to establish, at any time, either that the whole country is a market economy or that a particular industry or sector is operating under market economy conditions. How must China establish that it is a market economy? It must do so according to the law of the importing WTO member. In other words, for the EU, under the terms of EU law. In the EU there are five criteria that a country needs to meet to be considered a market economy. And China does not meet them. It's that simple.

Article 15 (d) is recognition that China accepted that it was not a market economy when it joined the WTO in 2001. It accepted it was, as China clearly stated at that time, a socialist market economy.

What happens if China can show that it is a market economy? Paragraph (d) provides that all the provisions in paragraph (a) in relation to the choice of methodologies in specific anti-dumping investigations no longer apply. In other words, if China can show it is a market economy then the price and cost methodologies used for market economies, with all the exceptions and complications, must be used in specific antidumping investigations against Chinese imports.

If this is so clear, where do the misconceptions come in? There is a sentence in paragraph (d) which provides that one part of paragraph (a), namely paragraph (a)(ii), will expire 15 years after China joins the WTO. China joined the WTO in December 2001 so add 15 years and you get December 2016. The provisions of paragraph (d) or the other provisions of paragraph (a) do not expire.

Paragraph (a) has three parts: a chapeau (an introductory or explanatory section) and then two other sections numbered (i) and (ii). The chapeau is addressed to anti-dumping investigating authorities. It provides that, in one situation, the prices to be used are Chinese prices and costs and, in another situation, the investigating authority can use a methodology not based on a strict comparison with domestic prices and costs in China. So paragraph (a) provides the investigating authority with an unlimited choice of methodologies to use in anti-dumping investigations in the period prior to China being able to clearly show it is a market economy.

In the first section, numbered (a)(i), the producers under investigation are given the right to show (independent of what China as a whole can show under paragraph (d)) that market economy conditions prevail in their specific industry. Section (a)(ii) deals with what is to be done when those same producers cannot substantiate a claim that market economy conditions prevail. So the two sub-sections of paragraph (a) are detailed rights given to the producers under investigation during an investigation while China is still a non-market economy. If the producers can show that market economy conditions prevail, then the prices and costs to be used shall be the prices and costs for the industry under investigation. A successful claim by producers under section (a)(i) determines how the investigating authority must exercise the choice it is given in the chapeau of paragraph (a).

Paragraph (a)(ii) deals with the situation in which the producers under investigation cannot show that market economy conditions prevail in their industry. In this situation the investigating authority can use a methodology that is not based on a strict comparison with domestic Chinese prices and costs. Paragraph (a)(ii) does not mandate any one particular methodology. It merely provides that the investigating authority can choose a methodology different from the methodology in (a)(i). 

The text of paragraph (a)(ii) does not currently impose on investigating authorities the methodology to be used when market economy conditions do not prevail. It leaves the choice of methodology to the investigating authority. And the different methodologies that can be used is theoretically infinite.

In December 2016 section (a)(ii) expires. So the question is: does the investigating authority still have a choice as what to do? What prices and costs should be used? What methodologies can be used if China has not exercised its right under paragraph (d) to show that it is a market economy? Post 11 December 2016, WTO law will only set out what the investigating authority must do if the producers can positively show that market economy conditions prevail in their industry. The expiry of (a)(ii) means that the investigating authority is not told what methodology to use if the producers under investigation cannot positively show that market economy conditions prevail in their industry.

The expiry of (a)(ii) cannot be interpreted to mean that an investigating authority must use a particular methodology. Or, as some argue, that the investigating authority must use the methodology for market economy producers. That would be to render paragraph (d) requiring China to show that it is a market economy inutile or without sense.

So what happens after this provision expires? In simple terms, the expiry of (a)(ii) leaves a gap in the instructions to investigating authorities. A ‘nothing’.

When there is a gap in international law, what can a sovereign state do? Under general legal principles, when there is a gap (or lacuna) the sovereign state retains the discretion to decide how to act or fill the gap, so long as the solution does not infringe general international law.

What guidance does WTO law provide? The first guidance is that the chapeau of paragraph (a) remains. This clearly indicates that the authority continues to have a choice. The expiry of (a)(ii) does not limit that choice. The fact that the chapeau to the whole of Article 15 remains does not change the fact that not all of paragraph (a) expires. Both the chapeau and (a)(i) remain as well as the chapeau of Article 15 as a whole.

The second guidance is that there is a linkage between the use of domestic Chinese prices and costs and the showing that market economy conditions prevail. Thus, in principle, these domestic costs and prices should not be used when the producers cannot show that market economy conditions prevail in their industry or when China cannot clearly show that it is a market economy.

The third guidance is that paragraph (d) remains. To give continued meaning to this paragraph after 2016 there needs to be the possibility of treating producers from China differently from producers in market economies. 

The fourth guidance can be found in the fact the sub section (a)(ii) does not mandate any particular methodology to be used. The EU has based its analogue country methodology on this provision as well as paragraphs 150 and 151 of the Working Party Report on China’s Accession to the WTO. However the commitment in the Working Party Report by WTO members in relation to China regards sub section (a)(ii) only and not in relation to paragraph (a) as a whole.

The fifth guidance can be found in paragraph (b) of Article 15. This paragraph deals with calculating the benefit of subsidies. It provides that prices and costs from outside China can be used when the prevailing terms and conditions in China may not be considered a suitable benchmark. In other words, when the market is not a market economy. If Article 15 positively contemplated this solution for subsidies it chose positively not to exclude it for dumping investigations.

The sixth guidance can be found in Article 2(4) of the WTO Anti-Dumping Agreement. This provides that the comparison of prices must be fair. The WTO Appellate Body has held that there is no limit on what can be adjusted so as to ensure that the comparison is fair. Thus if export price is determined in relation to a market economy the normal value must be determined on the basis of market economy criteria.

The seventh guidance can be found in the practice of different WTO members. What do reasonable, unbiased and objective investigating authorities from different countries do? And what would be the consequences of the EU unilaterally interpreting Article 15 in one way, when the WTO might interpret it in another way in the future?

Finally there is the analysis of Article 15 by the Appellate Body from the 2011 EC-Fasteners case. The issue before the AB was whether producers from China should get a country wide dumping duty or individual treatment (paragraph 282). It was not about the consequences of the expiry of sub section (a)(ii) on the choice of methodologies. The AB concluded (paragraphs 290, 291 and 365) that the scope of application of Article 15 did not extend beyond the issue of the methodologies to be used to calculate normal value and thus was not relevant to its reasoning on the WTO legality of the EU’s basic Anti-Dumping Regulation on individual treatment. Thus the AB’s analysis is not directly directed at the consequences of the expiry of (a)(ii). In legal terms it is obiter dicta. In addition, care must be taken in reading too much into this report. The AB reads the second sentence of paragraph (d) to result in the expiry of all of paragraph (a) in 2016 and not just sub section (a)(ii). 

So, as Shakespeare might have said, to conclude this little tale:

  1. China agreed in 2001 when it joined the WTO that it was not a market economy.
  2. There is nothing in Article 15 giving China the status of a market economy in 2016.
  3. Rather, paragraph (d) of Article 15 shows that China must establish, according to EU rules, that it is a market economy.
  4. A gap in WTO law opens up after December 2016 as to what to do when producers from China under investigation in individual procedures cannot show that market economy conditions prevail in their industry.
  5. This gap will need to be filled in those investigations. The AB allows investigating authorities to choose methodologies where no particular methodology is imposed by the GATT or the WTO Anti-Dumping Agreement.
  6. Thus the emergence of a gap does not remove the legal basis for the use of non-market economy methodologies.
  7. The basic EU anti-dumping Regulation gives the EU Commission sufficient legal basis in how to fill the gap.
  8. No legislative change is therefore necessary (unless there is a need to introduce a system to evaluate the prevailing conditions in a particular industry) as a consequence of the expiry of sub section (a)(ii) of Article 15 of China’s WTO Accession Protocol.