China's Approach to Negotiating Trade Agreements

August 5, 2015International Tradeby East Asia Forum

The international trading system is at a crossroads.

The international trading system is at a crossroads. While the Doha Round of WTO negotiations remains deadlocked, new trade rules are being called for to adjust for new realities, such as the expansion of global value chains (GVCs). This means for the first time since the establishment of the WTO in 1995, regionalism has prospered over multilateralism, with the parallel emergence of three mega-regional trade negotiation platforms. With this in mind, China must reconsider its approach to negotiating trade agreements.

At home, China’s reliance on export-oriented growth faces an unprecedented challenge in the face of shrinking global demand. The global financial crisis (GFC) of 2008 hit developed countries — China’s key export markets — hard. The recovery of the US economy, halting though it may be, is somewhat positive news for Chinese exporters, but a slew of challenges are preventing Europe from rebounding as a major importer. The share of exports in China’s GDP fell from a peak of 35 percent in 2007 to 23.3 percent in 2013 and it continues to decline. In the post-GFC world, exports are evidently no longer the engine of China’s economy.

In the face of these and other challenges, official figures suggest China’s growth in 2014 was 7.4 percent — the lowest since the 1990s. This slowdown could ultimately benefit China in the long run if it is used as a springboard for reforms that shift the country’s growth model. The ‘new normal’ requires adjustments in domestic economic policies and externally oriented trade policies and strategies. Trade strategies that are compatible with China’s domestic conditions will help China achieve a stable shift to the new normal.

Plugging into GVCs and Asia’s regional production network has been a big part of China’s economic growth. Now, with demand for low-value-added products sluggish, China needs to figure out how to add more value and move up the chain. Part of the answer lies in innovation and overseas direct investment (ODI) to narrow technological and management gaps in Chinese firms.

With the Doha stalemate, the international trading system is struggling to provide new trade rules that take into account the way GVCs have changed the shape of global trade and investment. Today production lines are split across countries with the location of each process based on comparative advantage. Facilitating GVCs is the leading cause of the proliferation of regional and mega-regional trade negotiations, including the Trans-Pacific Partnership (TPP), the Transatlantic Trade and Investment Partnership (TTIP) and the Regional Comprehensive Economic Partnership (RCEP).

In the Pacific Rim, while RCEP and the TPP complement each other in terms of their membership scope and issue coverage, they are in competition to offer the first update to the international trade rules of the WTO. In turn, the outlook for the international trade rules varies greatly.

Despite its increasing trade power and enthusiasm to join international trade rule making, China is currently excluded from TPP negotiations. Chinese high-level officials have expressed interest in joining the negotiations to deepen China’s integration with other economies. However, it appears that China will not be allowed to join.

At the same time, some new sensitive issues — such as SOEs, the environment and labour — pose challenges for China in 21st century trade negotiations and joining the TPP. Handled badly, they can also be impediments to genuinely free trade. The environment was once an area in which Chinese standards once diverged from most developed countries, but today Chinese standards in many areas exceed those of even some TPP member countries.

RCEP serves as an alternative for China, though negotiating countries have a long way to go to reach an agreement. RCEP’s rules will not be as ambitious as the TPP’s but could serve as a middle ground toward consensus on a more ambitious trade package. Another accelerated track lies in China having started negotiations with ASEAN on an upgraded version of the China–ASEAN Free Trade Agreement, at the top of Beijing’s negotiation agenda. China has also picked up the originally US-proposed FTA for the Asia Pacific (FTAAP).

At the bilateral level, China has signed 15 FTAs as of April 2015. Since 2008, the coverage of services and domestic regulation has become more vigorous and comprehensive than in earlier negotiations.

As China becomes an increasingly important outbound investor, it is shifting its negotiation stance on bilateral investment treaties (BITs). China has signed 145 BITs, many of which were drafted with the aim of protecting China’s inbound investment recipient interests. More recent BITs — signed in the last decade — offer more balance between investor and recipient protections, including more fully-fledged dispute-settlement provisions, as well as progress on national and most-favoured nation treatment.

Under the umbrella of the One Belt, One Road initiative, the negotiations for BITs or for investment, chapters within FTAs will be a priority in China’s future trade negotiations. All this will also help to ensure China’s successful transition from government-led to private-led overseas investment. With China’s advantage in providing cheap labour diminishing, the potential for a boom in services trade will also drive it to embark on negotiating services agreements with trade partners.

The mega-regionals could either turn out to be a stumbling block for genuinely global free trade or pave the way to reaching a multilateral deal within the WTO’s framework. Divisions among trading blocs, as reflected in the shape of these mega-regional negotiations, pose uncertainty for the international trading system and suggest there could be delays in adapting to these trading dynamics.

Though geopolitical concerns could justify such divisions, large traders need to work together to converge on a trade deal that makes progress on the goal of establishing the new trade rules that are needed for 21st century prosperity and economic security. The internal reform of the Chinese economy and its changing role in the global economy provide common ground for China, a large developing country, and developed countries to work on their divergence and to agree to a new set of rules.

China’s negotiation strategies at the crossroads of international trade is republished with permission from East Asia Forum

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