Talking Trade blog
China’s unfolding FTA strategy
Published 07 July 2015
The Chinese currently have 12 free trade agreements (FTAs) in place (listed below). Many of these agreements are with relatively minor players (with all due respect to countries like Costa Rica, Iceland, Chile and New Zealand). More recent agreements, between China and Australia and China and South Korea, are more substantial.
The South Korea-China deal was signed on June 1 and will enter into force once parliaments on both sides ratify the agreement. The Australian agreement was initialed in November 2014 and is also waiting for the completion of domestic procedures to start implementation.
China was hesitant to join the Asian rush to FTAs. This was, I would argue, partly because it was a late entrant to the World Trade Organization (WTO). As a newcomer, China's terms of accession to the WTO were quite challenging. China was required, for example, to drop tariffs on nearly all products entering China.
Further, it was required to create a legal ceiling on the amount of tariffs it can ever charge that is very low relative to many other developing economies. This has given China less room for maneuver between the ceiling and the amount of tariffs actually charged at the border (in other words, the difference between bound and applied tariffs is very small). This is certainly true relative to developing economies that joined the GATT/WTO decades ago.
China also had to quickly get in place the conditions to protect intellectual property rights at the level required by WTO membership. This included not just establishing and expanding offices to grant patents, but also training patent examiners and setting up a legal system to enforce IP rights.
Given the size and importance of China's market, other WTO members watched implementation very carefully. This is not always the case--many smaller developing countries (especially) have uneven implementation of existing commitments, but since the stakes are often not very high for others, these deviations are not of great concern. Few legal battles will take place over non-implementation of specific rules with smaller countries over limited markets. But China is a different story entirely--given its size and growing importance to the global economy, non-implementation is a big deal for other members. Hence China has faced many challenges in the dispute system at the WTO.
Given this recent history, China was reluctant to take on board any additional trade commitments in an FTA.
However, as more of the global economy is increasingly connected through FTAs, a stance of staying outside these bilateral and regional arrangements became harder to defend. Even for China, the competitive disadvantage of not getting benefits available to FTA partners in some markets started to look significant.
Thus, the Chinese government started negotiations with more significant trading partners, like South Korea. Sixteen percent of Korea's imports were from China and South Korea exported nearly a quarter of their total exports to China. This meant that a bilateral deal could be a useful foray into this world of more significant trade arrangements.
The headline figures on the China-Korea FTA sound relatively impressive. For example, the deal contains 17 chapters. It covers e-commerce (where China and Korea are both extremely strong) and includes some commitments on government procurement. It lets production out of Kaesong count as covered South Korean products.
The deal promises tariff reductions on 91% of goods trade. This is not too bad at all. Except for the details. It takes 10 years before China will reach tariff reductions on 71% of goods trade. Once the deal comes into force, it will be a decade before South Korea is supposed to cover 79% of goods trade. The agreement gives both sides 20 years to reach full implementation of tariff cuts.
Even then, this is actually less impressive than it appears. It turns out that China and Korea trade quite a bit with one another, but only in very few sectors like autos and auto parts or certain types of agricultural products. The Chinese import 852 tariff lines worth of products from Korea and Korea, in turn, imports just 637 tariff lines of items from China. Even after 20 years, it is very likely (and hard to confirm in the absence of the actual text) that many of these tariff lines will be in the 9% of trade excluded from the agreement.
The Australians appear to have received a more ambitious set of outcomes for their key sectors. For example, important agricultural markets like dairy, beef, sheep, horticulture products, and many processed foods are to be opened with the removal or reduction of tariffs over periods as relatively short as 4 years. For many manufactured goods and pharmaceutical products, some of the tariffs are reduced on entry into force. Some of the services market opening into China is quite helpful, including openings for Australian financial, telecommunications, and construction services.
The China-Australia FTA also includes a framework for e-commerce, and put into place plans for future negotiations on government procurement.
Note however, that some of these pledges with both parties could also be revisited in the ongoing Regional Comprehensive Economic Partnership (RCEP) talks that include both South Korea and Australia. The level of commitments in areas like e-commerce could potentially be more significant in this megaregional trade agreement than in the bilateral deals.
If you want to see whether China is serious about opening up its market to greater competition, I think there are two things to watch. First, are the continuing developments in the Shanghai Free Trade Zone. This was deliberately set up as a test bed for further liberalization. But businesses have, generally, been very disappointed with the results. The restrictions on coverage and small geographical size has meant that companies get relatively few benefits from being in the zone compared with being elsewhere in China (or even in Hong Kong). Slowly, slowly, the rules around Shanghai are being loosened. However, if this is intended to be a laboratory, much more will be needed before we can say with confidence that China is prepared to sign on to higher quality, higher standard agreements.
The second development worth watching is the ongoing negotiations with the Americans over the bilateral investment treaty (BIT). This has lots of potential, as the two sides have agreed to a radical shift in the way China handles inward investment. Under the BIT, all sectors are meant to be opened for American investment except for those explicitly listed. The two sides are swapped initial offers in mid-June in Beijing and followed up during the regular US-China Strategic and Economic Dialogue (S&ED) meeting later in the month in Washington. The next exchange of offers is scheduled for September.
Generally when a country switches to using a negative list, the inclination of government officials is to list every sector and subsector as closed to future investment. Future negotiations consist of a (probably tedious) process of peeling back and pruning the list to a much more manageable set of highly sensitive sectors that will remain closed. This suggests that the first exchange of offers is likely to look poor. Indeed, both sides appear to have emerged from the original meetings expressing disappointment. But what matters is how rapidly and how extensively future negotiations unfold.
In any case, for China's market to continue to grow, I would argue that it increasingly needs to make changes in domestic rules and regulations and allow greater competition. For example, as China's firms are investing heavily in research and development and are trying to make the leap from copying things to inventing things, they will increasingly demand protection of these new ideas. This will, I would suggest, mean that it is in China's interest to ratchet up its own IP protections. Doing so in the context of a good trade agreement with other benefits might be easier to get done than a unilateral approach.
Hence, the signs suggest that more ambitious, higher quality agreements around trade are likely to be coming to China in the near term. This includes offers in ongoing bilateral and regional agreements, such as RCEP.
China's Free Trade Agreements
Free Trade Agreements under Negotiation
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