USTR Report: Internal Issues Affecting Trade

Sunday, December 17, 2006 17:43
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The third part of the USTR report, and in many ways the most important (read dry) portion, relates to the internal policies that affect trade. It is the nuts and bolts, the rules and regulations, and it is where the roots of many problems faced can be traced back to.

As the title suggests, this section deals with China’s internal issues that are affecting trade.. i.e. “fair trade”.. and the USTR has a number of areas and a number of concerns. While all are legitimate to concerns to foreign companies entering the China market or competing with Chinese products on a global stage, these manufacturers/ service providers should not expect this report to be a quick fix, and instead should take the time to see where the issues are and plan accordingly.
The subsections of this portion are:

  • Non-discrimination
  • Taxation
  • Subsidies
  • Price Controls
  • Standards, Technical REgulations and Conformity Assessment Procedures
  • Other Internal Policies

Again, to gain a full understanding of the issues highlighted by the USTR report, readers should download the full report and review relevant sections.

The section sets the stage by defining Most Favored Nation status and the Rule of National Treatment, and that following WTO ascension, China must import goods with other MFN nations all the same. In addition, and in compliance with the Rule of National Treatment, once the goods are within the borders of China they must be treated in the same manner of domestic goods.

Obviously, it is the opinion of USTR that China has yet to meet their obligations fully in this area, and have highlighted after sales services, pharma, chemicals, and spirits as products and services that are still not treated fairly under MFN or Rule of National Treatment.

The report also states that the VAT system is one of the primary means by which China has been able to provide protection to Chinese manufacturers (is more fully explored in taxation section)


VAT: As stated above, the VAT system benefits chinese manufacturers (although, the report does not report how U.S. manufacturers in China are using the VAT system to their own benefit as well). Essentially, through VAT, Chinese manufacturers are receiving a subsidy (more on that in the subsidies section).

In this section fertilizers and semi-conductors were used as the primary examples where Chinese producers were protected through the VAT scheme as imported products were forced to use a higher cost basis from which to sell their products.

The report does concede that the problem is more enforcement rather than regulation based as local and provincial authorities overlook collection of taxes in order to support local manufacturers.

Consumption Tax: through various vehicles, imported items are taxed at much higher rates than domestic products resulting in higher prices – foreign electronics are often 20% more expensive in Mainland China vs. HK

Whether it is through preferential loans through state-owned banks, tax breaks in a special economic zone, or other government based benefits, local manufacturers are often allocated benefits that subsidize their efforts, and thus reduce their cost of goods sold.

These subsidies have a wider range than the domestic market as many exported products are leveraging these policies to ensure their goods are entering third markets at much lower levels than would otherwise be possible.

Price Controls:
In some areas, the government still enforces price controls (telecom, pharma, tobacco, etc) that can be lower than the manufactured costs of imported and thus preventing foreign manufacturers from entering the market profitably

Standards, Technical REgulations and Conformity Assessment Procedures:
China, upon ascension, was to meet the Agreement on Technical Barriers to Trade that “establishes rules and procedures regarding the development, adoption and application of voluntary product standards, mandatory technical regulations, and the procedures (such as testing or certification) used to determine whether a product meets such standards or regulations”.

Through this, China was to:

  1. Ensure the conformity assessment bodies operate transparently
  2. That these bodies apply the same technical regulations the same
  3. Same fees are applied towards domestic & imported goods
  4. Processing periods and complaint periods are same for domes vs. imported goods

In addition, China is obligated to:

  • Restructure the regulatory system and regulators
  • Provide transparency throughout the process
  • Bring standards into line with international practice
  • Provide uniform assessment procedures

Needless to say, there are a number of issues related to the above that are covered in the report.

Other Internal Policies:
State-Owned Enterprises: China agreed SOEs would make purchase and sales of goods/ service solely on commercial considerations

State Trading Enterprises: China was to open the books on companies that trade SOE goods, but to date this information has been released only in vague forms, and has yet to be released in details that are in line with the agreement.

Government Procurement: China has agreed that until it is party to the Agreement on Government Procurement, it will at the central and local level conduct purchasing in a transparent manner. Interestingly is that once they are party to the agreement, there is no requirements in how public works projects are tendered or bidded on.

In general, none of the findings of the USTR report are a big surprise. As pointed out in the previous post, the negotiators either did not fully understand or appreciate China’s position, or they did and knew they would not be able to clear the hurdles. To meet many of requirements china would literally have to restructure itself from the ground up in many areas, unwind the fiefdom culture found in Chinese politics, overcome the fact that many areas are still struggling to participate in some form or another (i.e. Just because investment in the East coast is saturated, does not mean that Chengdu has experienced the same growth).

One thing that really stuck out is in relation to the purchasing and trading activities of the SOEs. To think that the government would open up the books or provide a fair environment with regard to the purchasing and trading activities of SOEs is beyond me, and pressing for reform in the SOEs is a task that will be fruitless as the government will protect those organizations still controlled until.

In issuing this report, the USTR has done a great job of highlighting the areas that are still in need of further improvement, and no doubt, these areas will continue to see improvement. however, China already has its hands full with a bipolar economy (overheated in some areas vs. in need of reheating in others), and for the U.S./ E.U./ other agencies believing that compliance is going to occur in a specific time period will be disappointed. It will be a process, and will every process, delays will occur.

For foreign companies, what this section shows is that there is still plenty to consider when entering China. While at no time has it been easier to enter China, there are a number of systematic issues that may work against you in China, and that some of these issues may actually inhibit growth in third countries as Chinese manufacturers are able to leverage systematic inefficiencies in China to their benefit. It is nothing a U.S. company would not do, it is nothing to suggest the situation will change as a result of this document, and it is up to the strategic planners and market managers to properly assess the situation and develop sounds strategies.

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