Dumping with Chinese characteristics

Richard Malish is an attorney in the New York office of Mayer Brown LLP who specializes in investments into and from China. He can be contacted at rmalish@mayerbrown.com

The views expressed do not reflect the views of Mayer Brown LLP or any of its clients.

For decades Chinese exporters have been easy targets for dumping penalties under special rules for nonmarket economies (NMEs). The US Department of Commerce (DOC) is currently debating whether it should rationalize its antidumping review by recognizing individual Chinese companies as “market-oriented.”  

This would be good news for foreign direct investors in China, and the free-market bastions they control.

An antidumping review is generally initiated when US producers representing at least 25% of a domestic industry ask the DOC to review whether a Chinese product is being dumped, i.e. sold at less than the “normal value” of the price charged in China or below its cost of production. Upon a finding of dumping and injury, the Customs Service will assess duties against that product equal to the margin between the price (or cost) in the foreign market and the price in the US market.

Unfortunately for Chinese exporters, China is considered a NME – and will likely be for at least 15 years under the terms of its WTO accession. As NMEs are deemed to lack market prices necessary to calculate a product’s normal value, the DOC obtains cost and price information from surrogate countries with market economies considered to be close to the same level of development.

Surrogate values, however, provide considerable scope for interpretation of data that could result in firms being charged with dumping. Furthermore, such calculations are harder to challenge under the WTO’s dispute settlement mechanism. Faced with such uncertainty, many Chinese exporters choose to settle with US domestic competitors for a percentage of their profits in order to keep their name out of any antidumping procedure.

The burden of proof

At present, the only way around this is to prove that market economy conditions prevail in the relevant industry. The test for such a “market-oriented industry” (MOI) requires that there be virtually no government involvement in production or pricing, the industry is marked by private or collective ownership and producers pay market-determined prices for all major inputs.

However, in the 15 years the MOI test has been in existence, no Chinese industry has met the test’s high standards as it ignores market realities.

Where competitive free markets exist, prices and costs are typically on a company-specific, rather than on an industry-specific, basis. Therefore, the normal value of exports needs to be calculated on a company-specific basis as well.

The MOI test also ignores the varied characteristics of China’s modern economy. As the DOC has stated, China’s economy features both “private initiative as well as significant government intervention” and “market forces now determine the prices of more than 90% of products traded.”

Recognizing this incongruity, in May 2007 the DOC requested comments on whether, and on what grounds, it should consider granting market-economy treatment to “market-oriented enterprises” (MOEs) in antidumping proceedings involving China. The idea is revolutionary in its ability to rationalize the potentially distorted treatment caused by the current blanket policy.

The proposal has received stiff resistance from some in the US industry who see the change as further deteriorating their competitive advantage. In addition, the US Senate is already proposing a US$3 million increase in DOC funding for staff to meet the backlog created by the added workload of applying the countervailing duty law to China. Critics of the MOE proposal argue that investigating Chinese companies individually would involve a tremendous additional cost.

However, these issues could be mitigated by adopting a clear threshold for MOE review. The key to successful and efficient implementation is to focus on the most palpable bastions of free markets in China – foreign-invested enterprises (FIEs), and especially wholly foreign-owned enterprises (WFOEs). Recognition of the role these corporate forms play in China seems to have lagged within the trade world.

FIEs most clearly demonstrate de jure private ownership, a requirement under the current MOI test. While the ownership of private Chinese domestic companies may not always be clear, FIEs have shareholding structures which are generally more transparent, and the added layer of foreign corporate formalities allows for greater scrutiny.

Recently passed laws to crackdown on “round-tripping” of domestic investment through offshore special-purpose vehicles, including the removal of most FIE-specific tax incentives, have been hailed as important steps in eliminating the potential for fraud.

FIEs typically establish all selling prices, and incur costs in accordance with market-driven considerations. They are also better than their domestic counterparts at taking advantage of inputs and market instruments outside China. Indeed, a common provision in Sino-foreign joint venture contracts is that the foreign party will help the joint venture import equipment and supplies from overseas and arrange foreign-based financing.

In 2000, the foreign investment laws were amended so that FIEs could source raw materials and equipment freely instead of giving priority to domestic suppliers. Currently, FIEs in certain sectors are more likely to purchase inputs from foreign sources or other FIEs which are based in, or controlled by companies in, market economies. In fact, even in resource-intensive industries such as the furniture industry, companies are known to source higher-quality wood from places as far as Finland.

A big opportunity

The US has been one of the most active investors in FIEs and the biggest beneficiary of the opening of investment opportunities and broadened business scopes for such companies. Bringing the antidumping analysis down to the company-specific level is a timely recognition of China’s reforms and will help many US and other foreign investors make more rational investment decisions.

It will also help remove one important thorn in the often problematic trade relationship between the two countries.