The usual suspects

By the end of 2007, EU imports from China will have reached a new record high. Goods are also traveling in the other direction in record numbers but, with the size of the EU’s trade deficit with China poised to surpass America’s, the year-end headlines may make for glum reading.

This will set the seal on what has been an increasingly difficult 12 months for EU-China relations.

No matter what the problem, in recent years, the consensus in both Brussels and Beijing has been that it should be resolved through dialogue rather than megaphone diplomacy, threats and punitive actions. During 2007 there have been signs for the first time that the EU is beginning to have serious doubts about this approach to China.

The rising deficit is the stimulus for the shift. Although sound arguments can be made that the trade deficit itself is not so important in the wider context of EU trade, the fact is that the headline number gets attention. And it gives support to the increasingly common view that the relationship is not working.

Sharp words

A private letter written in October by Trade Commissioner Peter Mandelson to Commission President Jose Manuel Barroso, which somehow emerged into the public domain, hints at a potentially fundamental shift in thinking.

Although his language has hardened in recent months, Mandelson tends to fight for the middle way, seeking to bring about change in China through dialogue rather than protectionism. But his letter suggested that the policy of dialogue has failed, and the Chinese juggernaut is out of control.

As Mandelson went on to imply, this may mean embracing the US approach of trying to force concessions from China, for instance by using the WTO dispute resolution mechanism.

It is true that difficult issues are not being resolved. In 2007 the renminbi has become for the first time a contentious issue for Europe. China’s policy has been to allow a gradual appreciation against the US dollar. However, given the dollar’s accelerating decline against the euro this year, the renminbi would have had to undergo a major, and probably disruptive, appreciation against the dollar to rise against both currencies. This is something that China is unlikely to contemplate.

The best hope for the Europeans, and probably also for the Chinese, is that sometime in the near future the world’s money markets decide that the dollar is not a completely worthless currency.

The usual irritants, like dumping, continue. The EU steel industry has filed for anti-dumping actions against two types of steel imports from China. It is likely to apply for action against other steel products in the near future. Given the time that anti-dumping investigations take, this issue will certainly run into the coming year. It could also lay down a marker for other industries keen to take action against China.

Bra wars 27

In 2008 textiles are likely to return to haunt EU-China relations. The restrictions on imports imposed in 2005 are due to lapse, which means there could once again be a flood of textile shipments headed for the EU. Despite the deal the two sides have signed to monitor the situation, the real challenge will come if the Commission has to field complaints from manufacturers faced with surging Chinese competition.

Meanwhile, other European companies may file grievances about lack of access to the Chinese market. Exports to China may be rising, but consensus is mounting that, on many issues, Beijing is not playing by the rules set out in its WTO accession obligations.

These concerns should be addressed in a new EU-China partnership and cooperation agreement, currently in the early stages of negotiation. The new agreement, which replaces a 1985 document on trade and economic cooperation, is supposed to encompass every aspect of the EU-China relationship. However, economics will be a primary concern, and with Brussels looking for Beijing to commit to serious action on some of the outstanding problems, life won’t be easy for the negotiators.

All this is happening at a time of unprecedented volatility in the world economy, with sharp currency swings, rising inflation, collapsing asset bubbles and uncertain economic prospects. In the best of times, steering the relationship of two of the world’s biggest economies would be difficult, but the challenges are not about to get any easier.