eu china trade sustainability impact assessment: final...

EU China Trade Sustainability Impact Assessment: Final Report Page | 2

Contributors

The consortium would like to thank the following project contributors from Emerging Markets Group, DEVELOPMENT Solutions, and third parties:

Dr Willem van der Geest Dr David Evans Dr Li Qingzhang Dr Christian Fischer Dr Cheng Guoqiang Dr Sherman Robinson Dr Pan Jiahua Mr Clive George Dr Gunter Festel Dr Dagmar Wassmuth Dr Long Guoqiang Mr Christoph Daniel Jia Mr John Collins Mr Paul Ranjard Mr Andras Lakatos Mr David Kelly

Mr Michael van der Meer Mr Brian Jackson Mr Steven Chaytor Mr Luc Verscoore Ms Kalyani Iyer Mr Paul Pierrot Mr Jairo Isaza Castro Mr Pierre Thieriot Mr Giles Henley Mr Alexander van Kemenade Ms Yifei Wang Ms Philippa Kelly Mr Thomas Mayr Mr Azim Lila Mr Eric Eneme Bindjeme Mr Richard Hughes Ms Sandra Bo Wang Mr Jason Walker


Table of Contents

1. Executive Summary ............................................................................................................................................ 8 1.1 Overview .................................................................................................................................................. 8 1.2 Sustainability Impact Assessment ............................................................................................................ 9 1.3 Recommendations and Policy Proposals ............................................................................................... 13 1.4 Concluding Remarks .............................................................................................................................. 14

2. Introduction ...................................................................................................................................................... 16 2.1 Methodology ......................................................................................................................................... 16 2.2 The GLOBE Regional CGE Equilibrium Model ........................................................................................ 16 2.3 The TAPES PE Model .............................................................................................................................. 17 2.4 Consultation Process ............................................................................................................................. 17

2.4.1 Public Meetings and Workshops .............................................................................................. 18 2.4.2 Key Expert Consultation ........................................................................................................... 19 2.4.3 Online Consultation ................................................................................................................. 21

3. Global Analysis .................................................................................................................................................. 22 3.1 Overview ................................................................................................................................................ 22 3.2 The EU-China Partnership and Cooperation Agreement ....................................................................... 24 3.3 Context .................................................................................................................................................. 25

3.3.1 Economic .................................................................................................................................. 25 3.3.2 Social ........................................................................................................................................ 26 3.3.3 Environmental .......................................................................................................................... 27

3.4 Horizontal Issues .................................................................................................................................... 28 3.4.1 Intellectual Property Rights ..................................................................................................... 30 3.4.2 Government Procurement ....................................................................................................... 31

3.5 Sector Selection ..................................................................................................................................... 32 3.5.1 Machinery Sector ..................................................................................................................... 34 3.5.2 Environmental Goods & Services ............................................................................................. 35 3.5.3 Banking Services ....................................................................................................................... 36 3.5.4 Chemicals Industry ................................................................................................................... 37 3.5.5 Agriculture Industry ................................................................................................................. 38

4. The GLOBE Model ............................................................................................................................................. 39 4.1 Overview of the Globe Model and Results ............................................................................................ 39 4.2 The Globe Model and Application to the EU-China SIA ......................................................................... 40

4.2.1 The GLOBE Model .................................................................................................................... 40 4.2.2 Structural Characteristics of China’s Place in the Global Economy ......................................... 45 4.2.3 Scenarios .................................................................................................................................. 47 4.2.4 Empirical Results ...................................................................................................................... 48

4.3 Emissions and Poverty Effects ............................................................................................................... 50 4.4 Scenario Implications ............................................................................................................................. 51 4.5 Figures and Tables ................................................................................................................................. 53 4.6 Regional Impacts in China and the EU ................................................................................................... 63

4.6.1 China Regional Results ............................................................................................................. 64 4.6.2 EU Regional Impacts ................................................................................................................ 65

4.7 Modelling Conclusions ........................................................................................................................... 67 5. Sector and Horizontal Studies .......................................................................................................................... 68

5.1 Machinery .............................................................................................................................................. 70 5.1.1 Sector Background ................................................................................................................... 70 5.1.2 PCA Scenarios ........................................................................................................................... 76


5.1.3 Policy Recommendations ......................................................................................................... 80 5.2 Environmental Goods and Services ....................................................................................................... 85

5.2.1 Sector Background ................................................................................................................... 85 5.2.2 PCA Scenarios ........................................................................................................................... 90 5.2.3 Policy Recommendations ......................................................................................................... 93

5.3 Financial Services ................................................................................................................................. 107 5.3.1 Sector Background ................................................................................................................. 107 5.3.2 PCA Scenarios ......................................................................................................................... 111 5.3.3 Policy Recommendations ....................................................................................................... 121

5.4 Chemicals ............................................................................................................................................. 126 5.4.1 Sector Background ................................................................................................................. 126 5.4.2 PCA Scenarios ......................................................................................................................... 131 5.4.3 Policy Recommendations ....................................................................................................... 133

5.5 Agriculture ........................................................................................................................................... 137 5.5.1 Sector Background ................................................................................................................. 137 5.5.2 PCA Scenarios ......................................................................................................................... 142 5.5.3 Policy Recommendations ....................................................................................................... 145

5.6 Government Procurement ................................................................................................................... 149 5.6.1 Sector Background ................................................................................................................. 149 5.6.2 PCA Scenario .......................................................................................................................... 152 5.6.3 Policy Recommendations ....................................................................................................... 156

5.7 Intellectual Property Rights ................................................................................................................. 159 5.7.1 Sector Background ................................................................................................................. 159 5.7.2 PCA Scenario .......................................................................................................................... 162 5.7.3 Policy Recommendations ....................................................................................................... 163

6. TAPES/Partial Equilibrium Model for Commodity Sector Studies .................................................................. 167 6.1 About the model .................................................................................................................................. 167 6.2 Data Sources and Base Data ................................................................................................................ 170 6.3 Experiments Run .................................................................................................................................. 174 6.4 The Results ........................................................................................................................................... 175

6.4.1 Environmental Goods and Services Results ........................................................................... 176 6.4.2 Agriculture Results ................................................................................................................. 179 6.4.3 Chemicals Results ................................................................................................................... 181 6.4.4 Machinery Results .................................................................................................................. 182

6.5 Reading the Results ............................................................................................................................. 183 Modelling Bibliography ....................................................................................................................................... 186

List of Figures

Figure 1: China Regional Analysis – Map of Regions ................................................................................................................ 64 Figure 2: EU Regional Analysis – Map of Regions .................................................................................................................... 66 Figure 3: EU and China Energy Label Schemes ...................................................................................................................... 101 Figure 4: Financial Services - Baseline Scenario - Growth of Total Banking Assets, Foreign Participation (RMB Trn) ........... 111 Figure 5: Financial Services Modest Liberalisation Scenario Growth of Total Banking Assets, Foreign Participation (RMB Trn) ............................................................................................................................................................................................... 113 Figure 6: Financial Services Ambitious Liberalisation Scenario - Growth of Total Banking Assets, Foreign Participation (RMB Trn) ........................................................................................................................................................................................ 117 Figure 7: Provincial Distribution of Gross Industrial Output Value (State-Owned vs. Private Sector Output) ....................... 119 Figure 8: EU Agricultural Exports to China ............................................................................................................................. 137 Figure 9: Trade Activity in Grain Sector following Modest Liberalisation (millions) .............................................................. 143


Figure 10: Chinese Employees by Area (x 10,000) ................................................................................................................. 144 Figure 11: EU Malt and Barley Exports to China .................................................................................................................... 147

List of Tables

Table 1: GLOBE Scenarios .......................................................................................................................................................... 9 Table 2: Sector Scenarios ......................................................................................................................................................... 10 Table 3: Sectors, factors and regions in the GLOBE model ...................................................................................................... 53 Table 4: Structure of Trade and GDP 2001 .............................................................................................................................. 53 Table 5: Factor Shares in Selected World Regions ................................................................................................................... 54 Table 6: Value-Added Shares by Sector for Selected World Regions ....................................................................................... 54 Table 7: Output Shares by Sector for Selected World Regions ................................................................................................ 55 Table 8: China Tariffs and Non-Tariff Barriers by Sector .......................................................................................................... 56 Table 9: EU-25 Tariffs GTAP 2001 and Non-Tariff Barriers by Sector ....................................................................................... 57 Table 10: Baseline Projections GDP, Factors and TFP 2001-7 .................................................................................................. 58 Table 11: GLOBE Baseline Scenarios ........................................................................................................................................ 59 Table 12: GLOBE Trade Policy Scenarios .................................................................................................................................. 60 Table 13: Key to GLOBE experiments ....................................................................................................................................... 61 Table 14: GLOBE Macro Results for China from Experiments - % Changes on Baseline 2007 ................................................. 61 Table 15: GLOBE Macro Results for EU from Experiments - % Changes on Baseline 2007 ...................................................... 62 Table 16: GLOBE - Change in Bilateral Trade between China and EU (%) ................................................................................ 62 Table 17: Emissions and Poverty Indicators ............................................................................................................................. 63 Table 18: China Regional Impacts – GLOBE Results ................................................................................................................. 64 Table 19: EU Regional Impacts – GLOBE Results ...................................................................................................................... 65 Table 20: Impacts Summary Table Legend .............................................................................................................................. 68 Table 21: Sector Scenario Parameters ..................................................................................................................................... 69 Table 22: Chinese Structural Change used in Projection Scenarios ......................................................................................... 69 Table 23: PCA Summary Impacts Table – Machinery (China) .................................................................................................. 80 Table 24: PCA Summary Impacts Table – Machinery (EU) ....................................................................................................... 80 Table 25: Classification of OECD Environmental Goods Subsectors ........................................................................................ 85 Table 26: PCA Summary Impacts Table – EGS (China) ............................................................................................................. 93 Table 27: PCA Summary Impacts Table – EGS (EU) .................................................................................................................. 93 Table 28: PCA Scenario Impacts Table – Financial Services (China) ....................................................................................... 118 Table 29: PCA Scenario Impacts Table – Financial Services (EU)............................................................................................ 118 Table 30: PCA Summary Impacts Table – Chemicals (China) ................................................................................................. 133 Table 31: PCA Summary Impacts Table – Chemicals (EU) ...................................................................................................... 133 Table 32: Domestically Produced Supply under a Modest DDA ............................................................................................ 142 Table 33: Ambitious Liberalisation Accounting for High Projected Growth in Demand and Productivity ............................. 144 Table 34: PCA Summary Impacts Table – Agriculture (China) ................................................................................................ 145 Table 35: PCA Summary Impacts Table - Agriculture (EU) ..................................................................................................... 145 Table 36: PCA Summary Impacts Table – Government Procurement (China) ....................................................................... 155 Table 37: PCA Summary Impacts Table – Government Procurement (EU) ............................................................................ 156 Table 38: Social Accounting Matrix of Environmental Goods ................................................................................................ 169 Table 39: Chinese EGS Trade Figures by Partner (values besides tariffs/NTBs in US$ Millions) ............................................ 171 Table 40: Chinese EGS Market Figures (US$ Millions) ........................................................................................................... 172 Table 41: Chinese Agriculture Trade Figures by Partner (values besides tariffs/NTBs in US$ Millions) ................................. 172 Table 42: Chinese Agriculture Market Figures (US$ Millions) ................................................................................................ 172 Table 43: Chinese Chemicals Trade Figures by Partner (values besides tariffs/NTBs in US$ Millions) .................................. 173 Table 44: Chinese Chemicals Market Figures (US$ Millions) ................................................................................................. 173 Table 45: Chinese Machinery Trade Figures by Partner (values besides tariffs/NTBs in US$ Millions) ................................. 173 Table 46: Chinese Machinery Market Figures (US$ Millions) ................................................................................................ 173 Table 47: Initial Elasticities Used in TAPES/PE Models ........................................................................................................... 174 Table 48: Sector Scenario Parameters ................................................................................................................................... 175 Table 49: Chinese Structural Change used in Projection Scenarios ....................................................................................... 175


Abbreviations

aveNTB Ad Valorem Equivalent Non-tariff Barrier

BSI Banking Strength Indicator

CBRC China Banking and Regulatory Commission

CCCMC Chinese Chamber of Commerce of Minerals and Chemicals of Importers and Exporters

CDM Clean Development Mechanism

CECPA China Environment Culture Promotion Association

CES Constant elasticity of substitution

CET Constant elasticity of transformation

CGE computable general equilibrium

CIRC China Insurance Regulatory Commission

CO2 Carbon Dioxide

CSRC China Securities Regulatory Commission

DDA Doha Development Agenda

EET Established Environmental Technologies

EGS Environmental Goods and Services

EHS Environmental, Health, and Safety

EPA Environmental Protection Agency

EPP Environmentally Preferable Products

ESF European Social Fund

EU European Union

FAO Food and Agriculture Organisation

GAMS General Algebraic Modelling System

GATS General Agreement on Trade and Services

GDP Gross Domestic Product

GP Government Procurement

GPA Agreement on Government Procurement

GTAP Global Trade Analysis Project

HSBC Hong Kong Shanghai Banking Corporation

ICT Information and Communications Technology

IFC International Finance Corporation

ILO International Labour Organisation

IMF International Monetary Fund

IPR Intellectual Property Rights

MENA Middle East and North Africa

MEP Ministry of Environmental Protection

MFN Most Favoured Nation

MNCs Multinational Companies

MOFCOM China’s Ministry of Commerce

NAFTA North American Free Trade Agreement

NGO Non-governmental Organisation

NOK Norwegian crowns

NPL Non-performing Loan

NTB Non-tariff Barriers

OECD Organisation for Economic Co-operation and Development

PBDEs Polybrominateddiphenyl Ethers

PBOC People’s Bank of China

PCA Partnership and Cooperation Agreement

PCBs Polychlorinated Biphenyls

PRCEE Policy Research Centre for Environment and Economy


R&D Research and Development

REACH Registration, Evaluation Authorisation and Restriction of Chemical Substances

RMB Ren Min Bi

ROW Rest of the world

SACU Southern Africa Customs Union

SAFE State Administration of Foreign Exchange

SAM Social Accounting Matrix

SAT State Administration of Taxation

SEPA State Environmental Protection Administration

SIA Sustainability Impact Assessment

SME Small and Medium-sized Enterprises

SOCB State-owned Commercial Bank

SOEs State-owned Enterprises

SWF Sovereign Wealth Fund

TAC total allowable catches

TAPES/PE Model Partial Equilibrium Model

TECA Trade and Economic Agreement

TFP Total Factor Productivity

TORs Terms of Reference

TRIPS Trade Related aspects of Intellectual Property

UBS Union Bank of Switzerland

UNCTAD United Nations Conference for Trade and Development

UNEP United Nations Environment Programme

WB World Bank

WITS World Integrated Trade Solution

WTO World Trade Organisation


1. Executive Summary

1.1 Overview This Final Report of the EU-China Trade Sustainability Impact Assessment provides an in-depth analysis of the potential impacts of the successful completion of ongoing negotiations for a Partnership and Cooperation Agreement between the EU and China. It complements the Global Analysis Report undertaken for the present EU-China SIA, which identified sustainability issues, including social, economic and environmental challenges and which is summarized in Section 3 of this report.

The SIA methodology includes both qualitative and quantitative analyses to determine key baseline trends within economic, social and environmental themes, as well as potential impacts within these themes. Following the identification of key impacts, in accordance with the SIA’s terms of reference, a series of policy recommendations are made which intend to either enhance positive impacts (such as welfare gains) while mitigating negative impacts (such as environmental degradation resulting from increased economic activity).1

With regards to quantitative analysis, two forms of economic modelling have been utilised to ensure identification of potential economic impacts. Initially, the impacts of a comprehensive, economy-wide potential PCA agreement were assessed on a global scale using the GLOBE computable general equilibrium (CGE) model, utilising a database developed by the Global Trade Analysis Project (GTAP). This model was updated by the project’s expert modelling team to ensure inclusion of the most recent data to ensure the highest relevance to the PCA negotiations. The report provides a series of modelling scenarios covering anticipated trade policy reform, structural adjustments and continued supply and demand growth.

While global modelling was ongoing, the project team also undertook screening of key sectors in the European and Chinese economies which were particularly important in the context of the PCA negotiations. These sectors were selected based on their relative importance to the overall pillars of economic, social and environmental impacts. Relevance to each pillar was determined using a number of variables, such as economic output and employment, labour conditions and pollutant emissions.

Strategic Sectors: 1. Machinery 2. Environmental Goods and Services 3. Financial Services 4. Chemicals 5. Agriculture

Following selection of sectors, partial equilibrium (PE) modelling, using the TAPES model, was undertaken to assess the impacts of modest and ambitious liberalisation scenarios specific to these sectors. The use of global, economy-wide and region and sector specific quantitative analyses was undertaken to strengthen the assessment of both baseline conditions and potential impacts to

1 See European Union’s Handbook for Trade Sustainability Assessments


better inform the negotiations. In addition to the five sector case studies, two strategic horizontal issues were also selected for assessment.

Horizontal Issues: 1. Government Procurement 2. Intellectual Property Rights

With regards to qualitative analysis, the study incorporates causal chain analysis wherein cause and effect links between trade and economic activity, and resulting socioeconomic, social and environmental impacts complement quantitative results. This form of analysis has ensured economic modelling includes key economic variables in its output (e.g. production, trade, prices) and several socioeconomic variables (e.g. real wages, employment); whereas to assess variables in other key themes under the social and environmental pillars (e.g. labour conditions, gender issues, air pollution, energy efficiency) qualitative assessment is used as a more appropriate and reliable means of analysis. Quantitative economic models that include CO2 emissions estimations (as with this project’s global model) are increasingly common with the rising awareness of global climate change and have been included. Feedback and interactions between the vast number of pollutant emissions in the mediums of atmosphere, land (solid waste), water and others (such as noise, energy usage and efficiency) has resulted in qualitative analysis being used to measure all relevant variables. Under the pillar of social impacts, certain themes such as wages and employment can feasibly be modelled, however, other key topics such as labour rights, workplace safety, and basic human rights do not have associated quantitative data available and are measured using qualitative analysis.

1.2 Sustainability Impact Assessment Within this trade sustainability impact assessment a number of scenarios have been formulated and analysed to simulate probable scenarios of trade liberalisation under the potential PCA. Within the global analysis, using GLOBE, 9 scenarios of liberalisation have been provided, simulating the successful completion of varying configurations of tariff cuts or tariff cuts equivalent through the reduction of non-tariff barriers (as within a PCA), as well as the effects of multilateral tariff cuts as had been offered within the scope of the July 2008 package of the Doha Development Agenda (DDA), although these are unlikely to be realised in the near future given the impasse at the 2008 Geneva WTO Ministerial meeting. Additional scenarios have been also formed which include significant reductions of China’s current account surplus which has increasingly been noted as unsustainable.

Table 1: GLOBE Scenarios Scenario Tariffs / NTBs Reduction China Current

Account Surplus

China World

1. Current account adjustment 0% 0% - US$ 60 bn 2. Modest Liberalisation 1 (factors immobile) 25%/0% 0% No change 3. Modest Liberalisation 2 25%/0% 0% No change 4. Modest Liberalisation 3 25%/25% 0% No change 5. Ambitious Liberalisation 1 75%/0% 0% No change 6. Ambitious Liberalisation 2 75%/75% 0% No change 7. DDA Modest Same -> 25% No change 8. DDA Ambitious 1 Same -> 75% No change 9. DDA Ambitious 2 Same -> 75% - US$ 60 bn


Within sector scenarios the baseline has been established as the conclusion of a basic DDA, which has been assumed as a 10% reduction in tariff and non-tariff barriers multilaterally. Building on this, DDA modest and ambitious scenarios include multilateral cuts of either 25% or 75%. To add strength to the scenarios, a high growth projection has been forecast based on sector and sub-sector supply and demand curve growth rates within China and applied to modest and ambitious scenarios.

Table 2: Sector Scenarios

Tariffs and NTBs reductions

(Multilateral)

Demand Growth

Production Growth

Exchange Rate

Baseline with DDA 10% - - - DDA Modest 25% - - - DDA Ambitious 75% - - - Structural Change Only -

See Table 49 for subsector specific change

- DDA Modest with Structural Change 25% 10% DDA Ambitious with Structural Change 75% 10%

Economic Impacts

Global analysis reveals that trade liberalisation in the context of the PCA largely brings with it economic gains to both the EU and China. With regards to impacts on Europe, China’s appreciating RMB, coupled with rising imports in a large number of commodity goods sectors, is expected to benefit both European exporters as well as European terms of trade. Notably, service sectors in China are shown to be highly sensitive to exchange rate appreciation. Modelling scenarios using a China current account surplus reduction reflect growth in service imports into China. Across all sectors besides agriculture, multilateral liberalisation results in the strongest export growth for Europe as well as the sharpest balancing of China’s current account surplus.

With regards to the impacts on China under the global analysis, absorption (indicative of welfare gains) grows steadily under the progressively liberal scenarios, as does import demand for goods. Chinese export growth is dependent on the level of liberalisation, with the most ambitious levels of multilateral liberalisation causing an overall decline in export supply. This will happen within an environment of increased imports and absorption, and the effect on the average Chinese citizen remains positive. China’s productivity will also rise across the board in land, skilled labour and capital, signifying the gains from both a liberalised, competitive market as well as increased investment. Natural resource productivity rises in all scenarios, with the exception of the final two most ambitious scenarios. It is also expected that unskilled employment will also increase.

Within sector modelling which simulates liberalisation on a sector by sector basis, economic impacts are not as clearly positive. Within the Machinery sector, Chinese imports grow at over ten times the rate of exports, providing a growing market for European sales, but potentially reducing China’s sector’s production (and employment).

In the Environmental Goods and Services sector, China’s production again falls, slightly, although high absorption growth in air pollution control and wastewater management reflects the currently latent Chinese demand for these goods and services able to be satisfied through falling trade


barriers. Under the proposed scenarios, China’s imports of environmental goods and services are expected to surge by up to 44.5%, with a 57% increase in imports of European produced air pollution control goods and services.

In the Financial Services sector as a result of liberalisation under the PCA, greater competition will result from increased trade in goods and services between European and Chinese banks and insurance companies. Alongside increased access to a wider variety of products and services, an increase in real income will occur. A more productive and transparent financial services system will further promote China’s next stage of growth and development.

In the Chemicals sector, China’s exports and imports will both rise, although China’s imports will grow by up to 9 times compared to exports. This will result in a reduction of overall Chinese production of chemicals, although the slight rise in exports indicates that inefficient chemical plants will decrease while productive facilities expand. For Europe, the impacts are expected to be positive, with exports to China growing at over 34% in each subsector in the ambitious scenarios, resulting in increased production output in Europe.

In the Agriculture sector, China’s exports will grow by 8-90% by subsector, while imports grow rapidly at 10-50% by subsector, except in Dairy and Grains and Cereals which experience remarkable growth of over 100%. Within agriculture it is important to note possible impacts to third countries, given the tone of current negotiations within the Doha Development Agenda. In the event of a successful ambitious DDA both Europe and third countries experience growth in their exports to China, generally at even levels. However, in the Grains and Cereals subsector, Europe would experience declining exports to China while the rest of the world enjoy export growth to China of up to 343%. It is also important to note that under a DDA, European exports are expected to grow on average, highlighting that multilateral liberalisation in any of the sectors will benefit European producers overall.

Social Impacts

The social impacts of a PCA between the EU and China are complex and depend on the means of analysis. When analysing liberalisation via the GLOBE model, growth in productivity of skilled labour implies a likely rise of skilled wages, while increased employment of unskilled labour in China will likely be absorbed in less developed provinces where jobs, either skilled or unskilled, are in high demand. It should be noted that unskilled labour has a higher likelihood of labour exploitation, and while the jobs may be welcomed, they may also come with poorer labour conditions. Growing employment is complimented by growing rates of absorption, or welfare gains, wherein more affordable foreign goods raise competition for Chinese markets and ensure increased consumption by Chinese citizens. For Europe, social impacts are again expected to be positive. Positive gains in exports to China are predicted to feed into production methods and increase profitability and employment.

Within the sector studies where liberalisation occurs on a case by case basis, social impacts are expected to be mixed. Within the Machinery sector, declining production in China is expected to reduce sector employment, and exacerbate equity (income disparity) and health concerns among the sector’s significant workforce, based primarily in coastal China.


In the Environmental Goods and Services sector, declining production and increasingly competitive labour conditions among Chinese manufacturers may lead to a situation in which labour conditions erode. However, growth in demand for environmental services may lead to labour intensive manufacturing job losses being replaced by jobs in environmental services when appropriate vocational training is in place. Health effects are expected to improve dramatically – currently air pollution and water pollution are significant public health concerns in China, with up to 750,000 premature deaths annually attributed to these forms of pollution by the World Bank. Not coincidently, these areas are also where the highest environmental goods and services demand growth is estimated.

As the demographics of China’s population changes due to increased wealth accumulation, a greater variety of Financial Services and products will fulfil the consumption, investment and savings needs of the population. Changes in the employment structure of the financial sector and other related fields may also cause a widening of the urban-rural divide, which could result in a number of challenges relating to access to education and health.

In the Chemicals sector, declining Chinese production will create an environment wherein labour conditions and equity must be closely monitored to ensure that labour conditions are not permitted to decline in a more competitive market environment. Declining domestic production may ease ongoing tensions between facilities operators and local populations who at times live in very close proximity and who have previously been exposed to health risks through contamination of water supplies.

In the Agriculture sector, increased competition from European producers could lead to a decline in China’s agriculture sector, which may place pressure on low income, rural farmers who are faced with the risk of unemployment. Moreover, a more open trade regime may undermine China’s stated policy of self-sufficiency in food, as fallow crop land is converted to purposes which are more efficient and therefore more wealth creating. When coupled with the PCA impacts the Chinese government’s “Sunshine Project”, which aims to assist rural Chinese transition to urban jobs, may lead improvements in income distribution.

Environmental Impacts

Within the SIA a number of positive and negative environmental impacts are expected following completion of the PCA. In the Machinery and Chemicals sectors declining domestic production within China is expected to lead to lower environmental impacts, particularly in air and water pollution from the manufacturing processes. However, surging import demand of these goods may undermine the environmental benefits of lower Chinese production. While machinery goods from Europe may have more stringent standards in their production, end use practices will importantly affect their ultimate environmental impact in China. Similarly, chemicals may be produced in Europe with relatively lower emissions of water pollutants per unit, however, the safety management practices of industrial consumers in China will still largely determine their impact.

The Financial Services industry has little direct involvement in the environment, though a number of new initiatives suggest an increasing trend towards support to environmentally conscious projects. It remains to be seen how and whether environmental issues could be better aligned with core business areas.


A decline in Agriculture, one of China’s more inefficient water users, will see inefficient water use similarly decline, with the potential for water capacity to possibly improve. Unfortunately, improper land use and injudicious application of agrochemicals in the sector has resulted in rapid soil erosion and desertification. While marginal declines in agriculture may slow these trends, they may be difficult to combat even with imports relieving some of the pressure.

Liberalisation of the Environmental Goods and Services sector is expected to result in broad improvement of both prevention and remediation of pollution. Liberalisation and resulting demand rises in environmentally preferable products (EPP) such as renewable energy technologies and efficiency-related goods will substitute relatively dirtier alternatives such as coal-based energy and energy intensive goods. Additionally, dramatic increases in the demand for goods and services under the banner of established environmental technologies (EET) will see problems such as poor air quality due to emissions, declining water quality, low collection, treatment and utilisation of solid wastes, among others, all improve as both the goods and services related to these problems become increasingly competitive and efficient.

The PCA is expected to bring positive environmental benefits. Some of the positive and negative impacts occur in overlapping areas and the ultimate magnitude of the impact is difficult to predict, highlighting the need for ex-post monitoring to ensure that positive impacts are maximised.

1.3 Recommendations and Policy Proposals Within the trade sustainability impact assessment methodology a key component is the provision of policy recommendations to address, and indeed enhance or mitigate, the impacts assessed. Within this trade SIA, policy recommendations have followed several clear themes: assistance to restructuring of unproductive sectors or regions of the economy, including provision of social security programs; an improvement of standards and their harmonisation within regions, be they technical or environmental in nature; improvement of institutional capacity to both establish regulations as well as enforce them; assistance to business in ensuring their regulatory compliance and environmental stewardship; and importantly, improving environmental stewardship across all sectors of the economy.

The policy recommendations presented highlight the importance of China’s environment and its currently precarious situation. In all sectors the environment has been identified as either needing increased attention, or as a possible beneficiary with the correct policy approach. In the Machinery and Chemicals sectors standards for both production processes as well as end user consumption processes could provide significant reduction to environmental impact. As the EU is currently amongst the leaders for efficiency in these areas, sharing of best practices, particularly in the area of policy enforcement, will assist China in strengthening its own domestic policies. Inefficient water use in the Agriculture sector will require a delicate balancing of multiple priorities by China, including self-sufficiency, improved land use and water efficiency, and a reduction of the urban-rural income gap.

The use of ‘green’ Finance practices is viewed as a possible means to assist all sectors in meeting their environmental, and possibly social, responsibilities. As a next step to greater engagement between European and Chinese banks and insurance companies, a gradualist reform agenda that addresses system-wide changes, while also tackling specific issues is vital. Furthermore, an open and


transparent sector that promotes reciprocity between the two regions is necessary for both parties to realise the benefits of liberalisation under the PCA.

Ultimately, the most significant benefits to China’s environmental and social situation will result from significant liberalisation of the Environmental Goods and Services sector. While environmental and social benefits will be primarily realised in China (as well as indirect economic benefits), economic benefits are expected to accrue in Europe, making this sector’s liberalisation strongly mutually beneficial. These gains can be furthered through a number of policies and tools, such as a firm Chinese commitment toward internalisation of environmental externalities, improvement of pollution emitters’ responsibilities in China, and the expansion of powers of the Ministry of Environmental Protection with stronger enforcement abilities. European best practices could serve to provide guidance of this new ministry’s capabilities, whether in monitoring and analysis, legislation or enforcement.

Additional institutional shortcomings are identified in the horizontal studies on Intellectual Property Rights and Government Procurement, where improved institutional capacity is suggested to improve both market access for foreign companies as well as ensure a positive business environment for Chinese business and consumers. Within IPR, measures have been suggested to further improve the regulation of patents and copyrights in China for the benefit of all economic operators. The creation of independent regulator(s) and systems of deterrence to violators and incentivised compliance is also encouraged. To address concerns of the possible adjustment needs within China’s business community to more stringent IPR enforcement, initiatives to bolster research and development in cooperation with European actors has been suggested. Within government procurement, increased implementation of social safety nets is encouraged to help combat possible unemployment as government projects shift from being non-competitive. To enhance procurement benefits, it is suggested that the procurement processes in China be upgraded in crucial areas such as transparency, ICT-based procurement systems and adherence to recognised best practices which maximise the value-added of government procurement. Moreover, the need to emphasise the concept of environmental stewardship throughout the procurement process is viewed as a key policy to extend benefits accrued through liberalising this market.

1.4 Concluding Remarks The possibility of a more balanced and sustainable trade regime between the EU and China, and indeed the world and China, is a desirable pursuit. As the most populous, and among the fastest growing economies in the world, China’s economy and its impacts on Europe and the world are increasingly exemplified. Both anecdotal and scientific evidence continues to mount regarding the impacts of China’s economic development on its own environment and society and that of the rest of the world, as pollution caused by unrestrained economic activity indiscriminately crosses borders, both by air, water and via man-made mediums (in the case of solid waste). Moreover, social norms and standards are being placed under pressure by an increasingly competitive global economic environment, fuelled by the growth of several large, previously impoverished countries. Economic competition has raised concerns about the potential employment and output impacts in developed


countries and at the same time increasingly lower priced imports have benefitted consumers globally as prices on goods have dropped rapidly and purchasing power has increased.2

Within this Trade SIA, GLOBE CGE and sectoral modelling underscores the gains derived from an ambitious PCA or potential future agreements which reduce barriers to trade. Across most GLOBE scenarios, total Chinese imports are predicted to rise. While the total growth is minor at generally less than 1%, imports from Europe are expected to range from 1.92% to 14.77% by sector, with export growth across all sectors in Europe averaging 7.21%. Conversely, European total imports are expected to remain flat or grow marginally by at most 0.72%. This will result in an improvement in sustainability of the EU-China trade balance. The project’s quantitative and qualitative analysis reveals that as trade liberalisation leads to economic efficiency it also holds opportunities for the reduction of CO2 emissions, both in absolute terms and per unit of GDP (particularly in the most liberal multilateral scenarios). This highlights the potential economic and social benefits which trade liberalisation may have between the EU, China, and third parties and is extrapolated through the report’s sectoral and horizontal analysis. Finally, results indicate that welfare gains within China may be as high as 2.09% (in terms of employment growth), underscoring that increased trade is a valuable tool to combat poverty. The PCA is an important step towards improved economic efficiency that can assist in the realisation of import social and environmental benefits, when accompanied by the mitigating and enhancing policy recommendations included in this report.

2 Fallows, James. The $1.4 Trillion Question. Atlantic Monthly, January-February 2008


2. Introduction

2.1 Methodology By analysing the significant cause-effect links between a proposed change in trade policy and its economic, social and environmental impacts, this trade sustainability impact assessment combines qualitative and quantitative approaches and uses established sustainability indicators. The indicators have economic, environmental and social components and include variables such as average real income, employment, net fixed capital formation, equity and poverty, health and education, gender inequality, environmental air quality, water and land, biological diversity and other natural resource stocks.

Based on the principle of proportionate analysis, the aim of the report is to analyse the economic, social and environmental impact of a potential Partnership and Cooperation Agreement (PCA) between the EU and China. The four steps used in the assessment of the five sectors - agriculture, banking, environmental goods and services, machinery and chemicals, and two horizontal studies of intellectual property rights and government procurement, were based on screening, scoping, assessment and flanking measures. Further details as to the methodology used in sectoral selection can be found in Section 3.5 Sector Selection.

2.2 The GLOBE Regional CGE Equilibrium Model The basic tool for the economy-wide analysis of trade, social and environmental scenarios is the comparative static GLOBE Regional CGE model centred on China. The GLOBE model is a multi-region descendant of the single country CGE models developed in the 1980s. The first GLOBE Regional CGE model was developed to evaluate NAFTA. The GLOBE model therefore has a long pedigree with well known properties. The GLOBE Regional CGE model uses as its primary data base a Social Accounting Matrix (SAM). It is constructed so that the GLOBE model generates an updated SAM with every model solution. The present GLOBE Regional CGE model uses a SAM representation of the Global Trade Analysis Project (GTAP) v6 dataset for 2001. The GLOBE Regional model is, in effect, a series of single country/region CGE models that are linked by commodity trade in which domestically produced and consumed commodities are imperfect substitutes for both imports and exports. The SAM representation of the 2001 GTAP dataset has 87 regions/countries, 57 commodities and five factors of production. The regions, commodities and factors can be aggregated as desired in any particular application. The regions covered include all of China’s main trading partners including those in the EU27. To ensure maximum relevance to the PCA negotiations, the project modelling time has undertaken an internal review and update of the GTAP dataset to create a 2007 baseline.

This methodology is well suited to the simulation of the economic, social and environmental impact of basic trade policy reform and can also be used to study the impact of trade induced technical change where suitable data is available. The social aspect will concentrate on measures of economic welfare, levels of employment, income distribution, poverty and more generally the Millennium Development Goals. Modelling of environmental stress or potential stress can be accomplished using estimated emission coefficients that accompany the GTAP dataset, augmented where possible by direct estimates from sector experts.


In assessing trade policy integration and liberalisation, it is important to consider the impact of policies and trends affecting both “shallow” and “deep” integration. Shallow integration involves the lowering or elimination of barriers to the movement of goods and services across national borders within the region. Deep integration involves establishing or expanding the institutional environment in order to facilitate trade and relocation of production irrespective of national borders. Importantly, while the CGE model described above is suitable in exploring the degree of shallow integration, it will not capture the full extent of deep integration on a disaggregated sector-specific level.

For further details on the model used for global analysis, its strengths, weaknesses, and data sources please see Section 4.

2.3 The TAPES PE Model The strength of the GLOBE Regional CGE model is its capacity to capture economy wide impacts in a regional context. However, the GLOBE Regional CGE model cannot be disaggregated for targeting highly disaggregated sectoral analysis. The TAPES PE model is well suited for this purpose, to ‘drill down’ to uncover sectoral characteristics relating to tariff and aveNTBs and, where possible, to deep integration. The TAPES PE model used for this Trade SIA builds on recent work conducted using the TAPES PE model to quantify the impact of market obstacles on EU-China trade for the Competitiveness Study.3

There are a number of reasons why the TAPES PE model was chosen for the deeper sector analyses, and for exploratory work with new aveNTBs:

• At the most disaggregated level, the TAPES PE model can work with HS6 trade, tariff and aveNTB data available from WITS and from secondary sources such as the World Bank.

• The data requirements are less demanding because the TAPES PE model requires only sector and not economy-wide data.

• The TAPES PE model can be run for the recent years that WITS trade and tariff data are available, compared to the GLOBE Regional CGE model which uses the GTAP dataset.

• Sectors can be chosen to fit the sector case studies, including the sub-sectors in the sector studies where data is available.

• The loss of general equilibrium interactions can be partly compensated for by careful interpretation of results and sensitivity testing.

For further detail on the model used for sectoral analysis, its strengths, weaknesses, and data sources please see Section 6.

2.4 Consultation Process All Trade SIA’s include a process of ongoing consultation with civil society, which is inclusive of NGOs, industry associations and sector experts. Information on the project workshop has been available since Phase 1 at www.euchina-sia.com, while feedback has been encouraged both online and at

3 For more details see: Evans, H.D, et al (2007) “Market Access into China: Tariff and Non Tariff Barriers in Selected Sectors”, IDS & CARIS (University of Sussex) Joint Working Paper (Forthcoming)


workshops via the dedicated feedback email address, @euchina-sia.com. Additionally, five meetings have taken place in Brussels and Beijing between November 2007 and May 2008.

2.4.1 Public Meetings and Workshops Date & Place: 6 November 2007, Charlemagne Building, room , 170 rue de la

Loi, 1040 Brussels (15.00 – 17.00)

Subject: Civil Society Dialogue Meeting #1 – Phase 1 Global Analysis Report

The first Civil Society dialogue meeting for the SIA was held in Brussels on 6 November 2007. This meeting, organised by DG Trade, was attended by civil society stakeholders and offered a comprehensive update on the current status of the EU-China Partnership and Cooperation Agreement discussions. The Global Analysis Report, the central document for Phase 1 of the EU-China Trade SIA, was presented by the Implementing Consortium; feedback and discussion from attendees was encouraged and this input was incorporated when choosing the sectors for in-depth analysis in subsequent stages of the SIA. The dialogue proceedings were led by: ,

; ; and

.

Date & Place: 12 December 2007, Delegation of the European Commission,

Beijing (09:15-12:30)

Subject: EU-China Trade SIA Beijing Roundtable Workshop

Shortly after the Civil Society Dialogue, the Implementing Consortium organised a preliminary EU-China workshop which was held in Beijing 12 December 2007. The workshop offered an early opportunity for Chinese stakeholders to present their views on the sustainability of the EU-China trade relationship as well as the formal introduction of the Trade Sustainability Impact Assessment that will inform the PCA negotiations. The workshop also encouraged feedback from Chinese stakeholders on the identification of additional sustainability issues and other areas of cooperation within the context of the PC Chief Economist from the Policy Research Centre for Environment and Economy (PRCEE) and Lead WTO Expert at the EU-China Trade Project offered their views on China’s perspective of the EU-China bilateral trade relationship, followed of the Delegation of the European Commission to China who presented the EU’s perspective of the relationship. The roundtable featured 18 attendees from both Chinese and European public sector, NGOs and academic organisations. Date & Place: 20 February 2008, Asia Hotel, Beijing (09:10-14:30)

Subject: EU-China Trade SIA Beijing Stakeholder Workshop


Date & Place: 19 February 2008

Subject: Regional modelling within China

Expert: Local Chinese Expert

(Institute of Geographical & Natural Resources Research)

The purpose of this meeting was to establish the availability of regional production data within China, likely parameters and potential sourc g also elaborated the most appropriate means of aggregating China’s 31 provinces and municipalities, following a regional classification used by the central government’s 11th Five Year Plan which groups these areas into Northeast, Eastern/Coastal, Central and Western regions.


Subject: Poverty data

Attendees: Local Chinese Expert

Centre for Agricultural Trade Policy, Chinese Academy of Agricultural Sciences)

was consulted regarding the availability of data related to poverty which could be used within the GLOBE model to quantitatively assess social impacts of the PCA. informed the project team that the 2004 Household Economic Survey would be the most recent data appropriate for inclusion within the GLOBE model. was further consulted regarding the data’s availability, which later provided.


Subject: State-Owned Enterprise data

Attendees: Local Chinese Expert

(Chinese Academy of Social Sciences, Institute of Quantitative & Technical Economics, Economic Model Division)

was consulted regarding a prior paper she had published which discussed the economic performance of the different types of enterprises in China (state-owned, privately owned, foreign invested), as well as prior CGE models based on China to which she had contributed. provided a number of data sources for State-Owned Enterprises as well as feedback on how this data could be incorporated into the project both quantitatively and qualitatively.


3. Global Analysis

3.1 Overview The Global Analysis Report was the first in a series of stakeholder focused reports of the Trade Sustainability Impact Assessment (Trade SIA) for a new Partnership and Cooperation Agreement (PCA) currently being negotiated between the EU and China. The economic opportunities and challenges arising from increasing trade and investment with China have been well documented in recent studies by DG Trade.4 This Trade SIA, however, explores the economic impacts of further trade liberalisation in the context of the PCA and widens the scope of analysis to the possible social and environmental impacts. The purpose of the Global Analysis Report was to develop the baseline context in which the trade-related negations of the PCA will take place, and identify an early set of horizontal and industry sector-specific priority sustainability issues that are likely to emerge as the negotiations progress.

China’s emergence will continue to define the character of globalisation in the 21st century. The rapidly growing competitiveness of China’s fast growing economy ensure the impacts of a new trade agreement are felt on a global scale. The immense social changes of China’s integration into the world trading system continue to bring about an increasing global environmental impact. This will result in the EU-China Trade SIA being different from other Trade SIAs conducted to date. The impacts of trade liberalisation will require the analysis to focus on Europe as much as on China, as well as on higher value added and emerging sectors.5 The launch of the EU-China PCA negotiations reflects the strong intention for both partners to broaden and deepen their relationship. Although bilateral trade and investment between the EU and China has brought with it immense opportunities, increasing challenges have already started to emerge for the partnership.

Early Sustainability Issues Identified by the Global Analysis Report Although the China’s economy continues to experience impressive growth rates, important economic imbalances remain. The economy remains reliant on exports and investment-driven growth over domestic consumption. Over-investment in products which have no outlet in the domestic market has led to Chinese export-surges and dumping of Chinese products in overseas markets. This has been a major contributor to increasing trade frictions between China and some of its trading partners. Although the EU-China trade dialogue remains constructive, both parties now agree that the EU’s trade deficit with China, which increased to €159bn in 2007, is unsustainable.6

The entrenchment of China’s current growth model stems from the omnipresent social challenge of finding employment for the estimated 20 million new jobseekers entering into the labour market each year. Although gradually changing, this surplus of labour has traditionally contributed to the downward pressure on wages and labour standards. Faced with the multitude of risks associated

4 See e.g. DG Trade (2006) ‘Global Europe: EU-China Trade and Investment Competition and Partnership’ and DG Trade (2007) Study on the Future Opportunities and Challenges in EU-China Trade and Investment Relations 2006-2010. Available at: http://ec.europa.eu/trade 5 Previous Trade SIAs mainly dealt with a trading partner which is relatively less developed (or less ardently competitive) than China. These Trade SIAs therefore focus primarily on the impact of a trade agreement on the trading partner with whom an agreement is being sought. This also means that whereas previous Trade SIAs have focussed on relatively traditional industries such as agriculture, textiles, fisheries and automotives, the EU-China SIA will focus on higher value added and emerging industries such as machinery, banking services and the environmental goods and services sector. See http://www.sia-trade.org/ or http://www.sia-acp.org/ for other examples of recently conducted Trade SIAs. 6 Eurostat


with economic reforms, which in the short-term could derail growth and cause further localised employment pressures, continuous job creation remains a priority for the Chinese government. The deepening of the EU-China trade relationship is bringing to the forefront long-held concerns among European stakeholders that social and labour standards could suffer under a new trade agreement. Since enlargement in 2004 and 2007, Europe’s own regional differentials have become an important consideration for EU policymakers. Whilst the comparative advantage of Europe’s most advanced economies is well matched to the emergence of the Chinese economy, other member states, notably those in Southern and Central Europe, are relatively worse placed and at a higher risk of a delocalisation of jobs as a result of low-cost Chinese imports.

The costs of China’s priority on economic growth are becoming increasingly apparent, through increasing environmental challenges. Statistics show that an estimated one-third of China’s 1.3 billion people live in areas where the air is polluted, and around 700 million Chinese do not have access to drinking water that meets minimum purity standards. The scale of China’s environmental pollution has global consequences. By some estimates, China is the world’s largest contributor to global warming, while polluted water from its rivers has ended up in neighbouring countries.7 There are concerns amongst European civil society groups regarding the environmental impact of China’s further integration into the world economy. These concerns focus on the high levels of pollution caused by China's industries and the growing consumption of natural resources derived from unsustainable sources. China’s trade in environmental technologies could be expected to increase further if intellectual property was properly protected, royalties paid and technology transferred on a consensual basis.

Alongside concerns in Europe, China is experiencing its own domestic debates on the merits of further reforms and the opening up of its economy. Some policy-makers are wary of continuing at the current pace of economic reform, as the cost of liberalisation for households may outweigh short-term gains leaving people disenchanted with the broader economic policy. Besides this, Chinese policymakers point to an increasing number of domestic policy initiatives that are being undertaken to address not only international, but also increasing domestic concerns, to address social and environmental challenges.

Despite these challenges, the broad scope of the PCA provides a unique opportunity to integrate trade policy goals with wider cooperation objectives. These objectives range from energy efficiency, the preservation of biodiversity and natural resources, and a host of social issues at a time when many of China’s social infrastructure and institutions are being shaped. There is particular scope for cooperation between the EU and China on environmental and energy efficiency. China has already adopted a number of EU-inspired environmental standards and bilateral technical cooperation between Europe and China is expected to further increase in the future. European suppliers of environmental goods and technologies leveraging their ‘green competiveness’ are already well

7 According to the Netherlands Environmental Assessment Agency China became the largest emitter of carbon dioxide in 2006. The World Resources Institute estimates that the country will become the largest emitter in 2008 or 2009. The International Energy Agency estimates that China became the largest emitter of CO2 in 2007. The United Nations Statistics Division only provides data through 2004, which lists China as closely following the United States in total emissions. China now no.1 in CO2 emissions; USA in second position, Netherlands Environmental Assessment Agency, 5 December 2007 Envrionmental Trends to Watch in 2008, World Resources Institute, 18 December 2007 World Energy Outlook 2007, International Energy Agency, 2007 Environmental Indicators – Climate Change, United Nations Statistics Division, September 2007


previous EU-China summits. The new PCA will cover all components of the EU-China relationship and provide a comprehensive management framework. The prospective PCA is expected to lay the foundation for enhanced cooperation, including the enforcement and, where possible, the upgrading of environmental, social, labour and safety standards. It will also hold comprehensive dialogues on over 20 ongoing sectoral dialogues with a view to promote cooperation in all sectors, including on economic and financial matters, in both bilateral and multilateral forums. With regard to these existing sectoral agreements, the PCA will complement rather than replace these agreements.

In general, the PCA will be negotiated on the basis of a commitment to the principles of good governance, the rule of law, effective multilateralism, the fight against corruption and improved transparency. As such the PCA will contain a standard clause on human rights. The PCA will foster cooperation to find international solutions to global issues such as climate change, including energy cooperation, by stimulating energy efficiency and the promotion of renewable energy. Increased cooperation will also be sought in education, culture and science. It is envisaged there will be increased grass-roots level peer-to-peer exchanges of unions, students, academics, business associations, non-governmental organisations and other areas of cooperation.

Trade Provisions under Negotiation for the PCA

An important component of the PCA will be further progress on the trade liberalisation agenda to facilitate trade and investment flows by removing market access obstacles. The PCA, however, is not a preferential agreement, and tariffs will not be discussed. The PCA negations will take place within the framework of the World Trade Organisation’s (WTO) rules and obligations and will cover important provisions such as the protection of Intellectual Property Rights (IPR), trade in natural resources, the liberalisation of capital movements, investment, non-tariff trade barriers and competition in goods and services. The focus of the PCA will be to reach a sustainable trade agreement, including a commitment aimed at ensuring that environmental or social standards are not reduced in order to artificially attract investment or enhance trade. In addition, the possible impacts on third country partners, particularly least developed countries, will be taken into account. The broad scope of the PCA provides a unique opportunity to integrate trade policy goals with wider cooperation objectives, such as in the areas of sustainability, energy efficiency, social issues and the preservation of biodiversity and natural resources.

3.3 Context

3.3.1 Economic By some measures China is now the world’s second largest national economy after the United States.8 The European Union’s combined single market surpasses the size of both these countries.9 The economic impact of any trade agreement, between what are notionally the world’s first and third largest economies, will therefore have an impact beyond the confines of the bilateral trading relationship. Beyond their sheer size, however, the Chinese and European economies have arguably little in common. While China is an emerging economy which has experienced double-digit growth 8 Rank Order – GDP by Purchasing Power Parity, CIA World Factbook, 15 May 2008

9 In terms of GDP by purchasing power parity - Rank Order – GDP by Purchasing Power Parity, CIA World Factbook, 15 July 2008


for the last few years, the mature European economy has only recently started to recover after a period of low growth. Behind the impressive headline figures of China’s economic rise, the Chinese economy suffers from a number of substantial imbalances which are causing increasing domestic and international friction.

Despite the Chinese leadership’s declared intention to promote slower and more sustainable growth, progress on this front has been slow. The risk of overheating in key sectors ranging from real estate to steel production, and the overhang of a large stock of (potential) non-performing loans in the banking sector, continues to seriously threaten the overall health of the economy. The most serious of these imbalances are caused by the over-reliance of economic growth based on investment-driven industrial manufacturing, which unless the current rate in export growth continues, is in many sectors economically unviable. In combination with a low value currency, this makes China’s economy particularly vulnerable to external developments in the global economy.

China’s pattern of growth has been at the expense of domestic consumption, reflected by the relatively small role which the services industry plays in the economy. Over-investment in products which have no outlet in the domestic market has led to export surges and dumping of Chinese products in overseas markets. Such imbalances are an important contributing factor to rising trade friction between China and its trading partners. Although the EU-China trade dialogue remains constructive, both parties now agree that the EU’s trade deficit with China, which reached €159bn in 2007, is unsustainable. The EU-China High Level Economic and Trade Dialogue Mechanism has been set up to address this and a number of other issues, having most recently met in April 2008 to discuss issues such as energy, technology cooperation, IPR protection and trade facilitation. The challenge remains how to formulate policies to address economic challenges within the trade realm which are in many ways rooted in domestic social concerns.

3.3.2 Social The challenge of rebalancing the Chinese economy, and the entrenchment of the current growth model, stems from the day-to-day reality of an estimated 20 million new entrants coming into the labour market each year. A multitude of risks associated with economic reforms could in the short-term derail growth and create unpalatable employment pressures. Continuous job creation, particular in a number of regional hotspots, remains the priority for the Chinese government.

China’s rapid economic growth has certainly already brought about far-reaching social implications. Reform has brought better living conditions to millions and China no longer has any province or autonomous region classified as "low human development" according to the United Nation’s Human Development Index. Despite this impressive achievement, China’s rapid new economic wealth has not been spread equally over the entire population and social inequalities have rapidly increased. The greatest inequalities exist between China’s urban populations (located on the eastern seaboard) and rural populations (located in the central and western regions).

The urban population earns on average three times more money than their rural counterparts - an inequality factor double almost all other Asian countries and one of the highest in the world. Urban populations live six years longer than those in the countryside; and have better access to clean water, sanitation, education and medical treatment. This makes China a difficult country to compare in an


international perspective. Whereas cities like Shanghai are similar in terms of human development to Greece, rural areas in Guizhou Province have more in common with countries such as Botswana.

Since enlargement in 2004 and 2007, the EU’s own regional differentials have become a far more important consideration for policymakers than previously. Average EU income is estimated at €24,600 in 2007, but new member states such as Romania and Bulgaria have less than half the EU average with a per capital income of only €9,700 and €9,400 respectively. Whilst the comparative advantage of Europe’s more advanced economies is well matched to the emergence of the Chinese economy, other member states, notably those in Southern and Central Europe, are relatively worse placed and at a higher risk of seeing a delocalisation of jobs as a result of low-cost Chinese imports.

3.3.3 Environmental Globally, environmental degradation can be traced back thousands of years. However, it is during China’s more recent history that rapid economic growth has led to an unprecedented demand for natural resources. The damage to the economy and public health due to environmental pollution are increasing. Statistics demonstrate that an estimated one-third of China’s 1.3 billion people live in areas where the air is polluted, and around 700 million Chinese do not have access to drinking water that meets minimum purity standards.

The central government has become progressively aware of the problem and has promulgated a multitude of policies and regulations in an attempt to control the deteriorating situation. In 1998, the State Environmental Protection Administration (SEPA) was officially upgraded to a ministerial-level agency, and an increasing number of laws pertaining to environmental protection have been passed. In early 2008 the agency was further upgraded to the Ministry of Environmental Protection, with full ministerial powers, underscoring the government’s continued efforts to address environmental degradation. The enforcement of these laws is being expanded but remains problematic.

Not all environmental initiatives by the central government have so far been whole-heartedly adopted by local governments. Many local authorities continue to place economic growth and job creation ahead of all other considerations. At the same time, low pricing policies for key commodities such as water and energy means production and consumption patterns remain wasteful. Although China is one of the most water-deficient countries in the world, low-pricing means that water is used inefficiently. Moreover, water pollution has contributed to China’s water shortage worsening in recent years. Concern’s about water supplies and efficient use are not unique to China, with countries such as Spain dealing with similar issues exacerbated by recent draughts.10 China’s continued reliance on coal combined with high energy intensity, almost four times the level for the EU, means that harmful emissions have continued to increase. The scale of China’s environmental problems has global consequences. China is set to become one of the world’s largest contributors to global warming, while polluted water from its rivers has ended up in neighbouring countries. China is one of the world’s twelve richest countries in terms of biodiversity, but also contains one of the world’s highest number of threatened species.

There is considerable scope for cooperation between the EU and China on the environment and energy efficiency. China has already adopted a number of EU-inspired environmental standards.

10 Haslam, Chris, Rain doesn’t end draught forecast for Spain, Times Online, 18 May 2008


Bilateral technical cooperation between Europe and China is expected to further increase in the near future. European suppliers of environmental goods and technologies are already well established within the Chinese market. With the Kyoto Protocol’s Clean Development Mechanism expected to gain momentum in China, business-level cooperation is expected to continue in the future.

3.4 Horizontal Issues The increasing intensity of contemporary EU-China relations is reflected by over twenty sectoral dialogues under the EU-China relationship. Although the PCA will complement rather than replace existing sectoral agreements, many of these policy dialogues will have a bearing on PCA negotiations. With regards to the trade-related aspects of the PCA, over half of the ongoing dialogues, ranging from energy to competition policy, will be impacted. Following the EU’s 2004 enlargement, the EU-China trading relationship is now the largest in the world. The launch of negotiations on a new PCA, which will include an upgrade of the 1985 Trade and Economic Cooperation Agreement, reflects a desire on both sides to broaden and deepen the relationship. Numerous studies have shown that there are substantial benefits to be reaped by deepening bilateral trade and that a number of complementarities between the two economies can be exploited.11 The opportunities presented by increased bilateral economic ties are substantial but have not come about without important new challenges emerging.

Challenges in the past few years have progressively come to the forefront of EU-China trade relations. The challenges are most visibly embodied by China’s growing trade surplus with the EU. There is a rising perception among many European business representatives that progress on the reduction of market access obstacles to the Chinese market has been slowing. A range of policy instruments still exist to place foreign operators at a disadvantage, varying from selective public procurement, state sanctioned dissemination of unlicensed foreign intellectual property, restrictive investment rules, local content requirements, complex technical standards, subsidies and other forms of financial incentives for Chinese companies. A recently released study commissioned by DG Trade quantified the cost of these non-tariff barriers to European exporters at over € 21.4 billion.12

Nonetheless, there remains a common pledge to continued openness and constructive engagement in recent communications from both sides. Compared to US-China trade relations, which tend to be more confrontational and prone to unilateral offensive actions,13 EU-China trade negotiations continue to take a more cooperative approach. To some extent, however, this is due to objective reasons such as the EU’s trade deficit with China being far smaller than that of the US.14

In addition to economic challenges, the deepening of the EU-China trade relationship is bringing to the forefront long-held fears in Europe that social standards will suffer under a new trade agreement.

11 DG Trade (2007) Study on the Future Opportunities and Challenges in EU-China Trade and Investment Relations 2006-2010 12 ibid 13 Two US Senate committees have already approved legislation that aims to equip the US Treasury with new tools to pressure China into letting the RMB rise faster in value. A stronger bill is currently being debated in Congress that would allow US companies to seek countervailing duties against China's undervalued exchange rate. 14 According to DG Ecfin, the euro area enjoys a trade surplus (+ US$ 15.9 bn), while the EU 27 as a whole has a trade deficit mainly due to the UK (- US$ 155.8 bn) far below that of the US (US$ - 823.4 billion). In addition, the current account deficit of the EU as a whole is in far better shape than that of the US.


The concerns voiced by stakeholders range from the perceived threat of lowering labour standards15 to increased gender inequality.16 There are particular concerns attached to the perceived lack of workers’ rights in China, the low level of wages and the increasing number of industrial accidents and product safety recalls due to enforcement of health and safety requirements, despite a increasingly stringent regulatory regime.17 There is an ongoing debate about whether the increasing integration of emerging economies such as China and India into the world economy, which is a social imperative for these countries, can be sustained and made compatible with the desired labour market outcomes in the world’s more advanced economies.18

There are also concerns amongst European civil society groups regarding the environmental impact of China’s further integration into the world economy based on the continuation of resource-intensive development.19 These worries focus on the high levels of pollution caused by China's industries and the growing consumption of natural resources derived from unsustainable sources, including coal and oil, as well as wood derived from rainforests.20

Alongside concerns in Europe, China is experiencing its own domestic debates of the merits of further reforms and the further opening up of its economy of what has been widely perceived as a tough reform measures implemented as first steps in meeting WTO accession obligations.21 Some commentators have even described China as ‘trapped in transition’, particularly in the lower levels of government.22 Chinese policymakers point out, however, that an increasing number of new initiatives are being undertaken to address international as well as increasing domestic concerns. At the 22nd EC-China Joint Committee held on 12 June 2007, the two parties agreed for the first time that the current trend of the trade imbalance between China and the EU is unsustainable. On the domestic front new measures have been taken to reduce the social and environmental impact of economic reforms. On the social front, China has taken steps to improve standards, exemplified by the adoption on 29 June 2007 of the Labour Contract Law which was duly welcomed by European trade unions and other stakeholders.23 Domestically, China’s new emphasis on a ‘harmonious society’ seeks to re-direct the economic growth focus towards overall societal balance. In particular, this focus is designed to address the income inequalities between urban and rural areas which have emerged alongside rapid economic reforms. Simultaneously, China has taken a substantial number of steps to increase environmental protection. The 11th Five Year Plan and a host of supporting laws and regulations24, such as China’s new Renewable Energy Law, contain important policy guidelines

15 Response to the public consultation of the European Commission by the European Trade Union Federation (ETUC) available at: http://www.etuc.org/IMG/pdf/China Consultation 150606rev.pdf 16 WIDE Network (2007) Fair and Unfair Competition: The EU-China Trade Race and its Gender Implications, available at: http://www.igtn.org/pdfs//EU-China07.pdf 17 According to Chinese Statistics, in 2006 alone, industrial injuries disabled nearly 700,000 people, mostly migrant rural workers. WHO chief praises China’s efforts on food safety. AFP, 31 October 2007 18 For a comprehensive overview of this debate see Singh (2007). The central issue of discussion is Freeman’s (2005) contention that the “doubling” of the global labour force resulting from China and India’s recent integration with the international economy, may have profoundly unfavourable repercussions for workers in advanced economies. The relevance to this important discussion to the PCA will be returned to in the following stages of this Trade SIA. 19 WWF (2007) Re-think China’s Outwards Investment Flows http://assets.panda.org/downloads/wwf re think chinese outward investment.pdf 20 DG Trade (2006) ‘Consultation of civil society on the forthcoming communication on China’ http://trade.ec.europa.eu/doclib/docs/2006/october/tradoc_129853.pdf 21 Naughton (2005) ‘Waves of Criticism: Debates over Bank Sales to Foreigners and Neo-Liberal Economic Policy ‘ China Leadership Monitor 22 Pei (2007) ‘Is China’s Transition Trapped and What Should the West do about it?’ available at: http://www.fljs.org/images/Pei_pb1.pdf 23ETUC (2007) ETUC welcomes new Chinese Labour Contract Law http://www.etuc.org/a/3792 24 The draft of new environmental regulations and their increasingly strict application is discussed further in the overview of the Environmental Goods and Services industry in Section 6.


to reduce waste and enhance energy efficiency. These steps highlight the enormous potential of China’s leadership role in addressing global environmental challenges.

Within this context, Trade Commissioner Mandelson on several occasions has highlighted the importance of ‘getting China right’ and has more recently described the EU-China relationship as being at a ‘cross-roads’.25 The broad scope of the PCA provides a unique opportunity to integrate trade policy goals with wider cooperation objectives in the areas of sustainability, such as energy efficiency, the preservation of biodiversity and natural resources, as well as social issues. In particular, the horizontal issues of Intellectual Property Rights and Government Procurement have been identified as priority areas for future progress. The following sections provide more detailed overview of each of these issues and are examined in light of sustainability concerns.

3.4.1 Intellectual Property Rights China remains the main source of counterfeit goods. Chinese goods comprised about 58 percent of all articles seized at EU borders in 2007.26 The lack of enforcement of IPR is a growing concern and is rapidly reaching an impasse. In many sectors, European industry complains that poor enforcement and non-payment of royalties is causing the erosion of the value-added created by their R&D investments from which they derive competitiveness. This concern is exacerbated by China’s rapidly increasingly competitiveness in key segments of the value chain, and its increasing propensity to produce goods that are typical of those from countries whose per capita incomes are much higher.27 Observers have noted that in addition to unlicensed technologies being used in the domestic market, foreign operators are finding that their technologies are being sold by Chinese firms in other developing country markets. The result is not only the eroding of the value of foreign firms’ intellectual property but also their legitimate markets.28

China has on many occasions reiterated its determination to crack down on IPR infringement pointing out that it has an inherent interest to foster an environment in which investment in domestic innovation can take place.29 Enforcement in practice, however, has made very limited progress. The situation is exacerbated by overlapping and conflicting institutional legal frameworks, as the courts share similar functions to administrative bodies. There are overly burdensome requirements concerning the legal status of court documents, several interpretations exist for the valuations of infringements, and relatively light sentences for infringements make for weak deterrents. On 10 April 2007, these apparent shortcomings led the United States to file a WTO complaint against China, charging that, despite China being a signatory to the TRIPS (Trade Related aspects of Intellectual Property) Agreement, it is tolerating the continuation of IPR violations. The European Communities joined the consultation process and panel as a third party and has not ruled out taking its own action under the auspices of the WTO.

In the context of sustainable growth, the IPR issue is a complex one. Clearly, non-enforcement of IPR is unsustainable in the long run as technological progress is crucial to long term economic growth. Some studies on IPR in developing economies argue that a stringent enforcement regime can be

25Speech by Peter Mandelson (Strasbourg, 10 July 2007) http://trade.ec.europa.eu/doclib/docs/2007/july/tradoc_135226.pdf 26 Statistics recorded at the external borders of the EU at: http://ec.europa.eu/taxation customs/customs/customs controls/counterfeit piracy/statistics/index en.htm 27 Song & Ee (2005) ‘China’s Changing Economic Structures and Its Implications for Regional Patterns of Trade Production and Integration’ Paper No. 23-2005 https://mercury.smu.edu.sg/rsrchpubupload/5946/China_regionalcooperation.pdf 28 DG Trade (2007) Future Opportunities and Challenges in EU-China Trade and Investment Relations 29 In 2005, China had 2,452 patent applications under the PCT (OECD, 2007)


harmful to economies with low innovative capacity and can actually result in stifling innovation.30 Moreover, in countries where infringement is as rampant as in China, the infringing industry can be a large source of employment. As a country currently with medium innovative capacity, China falls in between, and the question facing the leadership is not whether to get serious about IPR, but rather when. Currently, China ranks 24th in the world in terms of patent filings per capita and ninth in the world in terms of patent filings per unit of GDP. However, seen as a whole, China is increasingly emerging as a global player in innovation. It now ranks third in the world in terms of total patents granted and has the highest patent filing growth rate in the world (+32.9%).31 Many Chinese businesses are also complaining of being forced to pay a premium on purchases because supplying companies price-in the likelihood of counterfeits of their products appearing after the sale. Stronger trademark protection will undoubtedly also build brands which consumers trust. Economic concerns aside, rampant counterfeiting of food and pharmaceuticals leads to an untold number of deaths each year. Faulty counterfeit components in everything from cars to DVD players have resulted in a number of accidents.

Technology transfer of environmental technologies is a key aspect of promoting sustainable development in developing countries, as envisaged by Agenda 21 and the Clean Development Mechanism (CDM) under the Kyoto Protocol.32 Under the current situation where the dissemination of transferred intellectual property cannot occur in a controlled fashion, this reduces the scope for cooperation in this area is reduced. The EU will likely look for new commitments by China in this area to ensure that environmental technologies can be transferred without compromising rights holders.

3.4.2 Government Procurement Compared to competition law, the regulation of procurement practices has so far not been a policy priority for China’s leadership. One only needs to look at the conflicting objectives of the country’s fragmented legal framework for confirmation. One the one hand, procurement laws emphasise the need for economic efficiencies in procurement. On the other hand, preference for domestic suppliers is an important element of the legal framework. Moreover, the scope and coverage of the two procurement laws is unclear and overall policy is governed by two distinct regulators.33 Discriminatory and opaque procurement practices create difficulties for foreign entities operating in China. Corruption is a common theme running through foreign operators’ complaints of unfair procurement, as is poor planning and the lack of capacity in technical aspects. When foreign companies do win large bids, it is usually because they have agreed to provide training and technology transfers to local companies.

While some Chinese officials have argued that opening up the procurement contracts to foreign competition may have a detrimental effect on infant industries and jobs, the WTO Government Procurement Accession (GPA) allows for developing countries to reserve certain privileges for vulnerable sectors. In addition, overall transitional privileges are also available. Competitive and

30 World Bank (1990) Strengthening Protection of Intellectual Property in Developing Countries: A Survey of the Literature http://www-wds.worldbank.org/servlet/WDSContentServer/WDSP/IB/2000/01/06/000178830 98101903544215/Rendered/PDF/multi page.pdf 31 http://www.wipo.int/ipstats/en/statistics/patents/patent report 2007.html p. 12 32 Article 34.7 of the Agenda 21 states: “The availability of scientific and technological information and access to and transfer of environmentally sound technology are essential requirements for sustainable development.” 33 While the Ministry of Finance (MOF) governs the Government Procurement Law, the National Development and Reform Commission (NDRC) governs the Bidding Law.


transparent public procurement increases value for money for governments and taxpayers. A lack of competition, or even corruption, results in the use of second-rate materials and inadequate designs which are not environmental or economically efficient and sometimes dangerous.34 The Chinese government is increasingly recognising this issue and has recently launched Government Procurement Accession (GPA) negotiations following their expressed commitment in late 2007. While it may take several years between the launch of the negotiations and the conclusion of an agreement, GPA accession will undoubtedly be a positive step forward in procurement reform for China on economic, social and environment grounds.

3.5 Sector Selection An initial list of twelve potential sectors to be considered for in-depth analysis in the Trade SIA was drawn up in consultation with the European Commission. These sectors were subsequently ranked along the four themes explored in the Trade SIA (economic, social, environmental significance, as well as relevance to the PCA). This assessment was qualitatively supported by quantitative indicators. The sectors where thereafter given a score in inverse proportion to their ranking. These scores were subsequently averaged35 to gain their ‘overall balanced sustainability score’.

Following this rationale, five sectors were selected to be taken forward for more in-depth analysis in the proceeding stages of the Trade SIA. These are:

1. Machinery (including power generating machinery); 2. Environmental Goods and Services (or ‘Eco-Industry’) 3. Financial Services (including insurance); 4. Chemicals (including pharmaceuticals36); and 5. Agriculture (including processed food);

The flowchart below provides a visual overview of how sectors were selected for in-depth analysis using their relative ranks within the three sustainability themes and PCA relevance. The tables on the following pages go through the rationale of ranking and scoring each sector.

Continued on following page…

34 A bridge collapse in China's Hunan Province on 14 August 2007 which killed over 30 people illustrates the dangers and has again raised questions about substandard building practices and possible corruption between the officials and contractors. China Daily (15 August 2007) available at: http://www.chinadaily.com.cn/china/2007-08/15/content 6028404.htm 35 In this instance a sector’s economic, social and environmental scores were determined with reference to the indicators provided in the Handbook for Trade Sustainability Impact Assessment (DG Trade, 2006), pages 52-56, as well as noted additional indicators. The scores in the three sustainability themes were then averaged and combined with the sector’s PCA score, determined by the likelihood of inclusion or progress of the sector under the PCA negotiations. The rational for this approach is to ensure that sectors to be analysed should be chosen based on both their potential impacts as well as the likelihood of progress within the PCA. Subsequently, the sectors which scored above the overall average score of 12 (i.e. of moderate relevance “6” in both sustainability themes and PCA relevance) were selected for in-depth analysis. 36 Please note, that although the Pharmaceutical industry was not selected for in-depth analysis on its own merit, it was deemed appropriate that it should be analysed as a sub-sector of the Chemicals industry.


4. The GLOBE Model

4.1 Overview of the Globe Model and Results The GLOBE regional CGE model is designed to assist in the analysis of economy wide and global issues. The focus is strongly on the economy wide and global issues, leaving sector issues largely to the analysis with Partial Equilibrium models as discussed elsewhere in this report (see Section 6). The Globe model is used to analyze the impact of further trade liberalisation in China, the impact on China of involvement in multilateral trade policy liberalisation and reductions in China’s current account surplus. As evidenced from the height of tariff and NTB protection in China and the EU, low average levels of tariff and NTB protection conceal a number of sectors with high ordinary and NTB protection. Of the five sector studies where sector models were used to assist in the quantitative analysis, four coincide with areas of moderate to high protection in China, namely Agriculture, Chemicals, Machinery and Financial Services. In the fifth case, Environmental Goods and Services, there is rapid structural change suggesting that a sector model is more appropriate.

The organisation of the report on the Globe model is as follows: Section 4.2.1 describes the GLOBE CGE model. Section 4.2.2 describes how a set of hypothesised exogenous macro economic reforms in China impact on the exogenously specified current account balances in the model and key endogenously specified variables such as the real exchange rates. The regions, sectors and factors specified in the model are described in section 4.2.3. In section 4.2.3, three sets of scenarios are also developed - baseline, current account surplus reform, and trade policy reform are described together with their interaction. Section 4.2.4 discusses key aspects of the macro and sector results from the nine experiments reported. Structural characteristics of the global economy and China’s place therein are described in section 4.2.4. Concluding remarks are made in Section 4.4.

Key Findings from Part I below

• Ordinary tariffs in China have fallen by over 50% from 2001 to 2007. • The average rate of NTBs that apply to the early 2000’s are estimated to be approximately

the same as average tariffs in 2001. • Further potential Chinese tariff reforms have small efficiency impacts. Potential DDA

multilateral reforms have much greater effects, particularly through the lowering of barriers to China’s exports.

• Relatively small lowering of the current account balance leads to a substantial appreciation of China’s real exchange rate and a potentially large trade adjustment effect on China and China’s main trading partners.

• Mixing a multilateral trade policy reform with a lowering of the current account balance shifts the efficiency effects away from the export side to the import side, increasing adjustment problems on China’s import side.

• A key idea behind the results is that trade policy is an inappropriate instrument alone for dealing with the perceived problem of bilateral current account imbalances.


4.2 The Globe Model and Application to the EU-China SIA

4.2.1 The GLOBE Model Modelling Trade Policy Reform

The GLOBE multi-country CGE (Computable General Equilibrium) model is described in McDonald, Robinson and Thierfelder (2005)37 and the model has the following key characteristics: GLOBE models agents’ micro economic behaviour in consumption and production in the economy, treating tradable goods as imperfect substitutes for domestic production. GLOBE allows for a choice of how key markets operate (closure rules), allowing for different assumptions about the behaviour of markets and actors to be examined. Given base data, key parameters and policy variables such as tariffs, GLOBE provides for real values of production, consumption, economic welfare, real exchange rates and changes in the employment of unskilled labour; a good indicator of the poverty impact of the various scenarios.

The GLOBE model is a member of the class of multi-country, computable general equilibrium (CGE) models that are descendants of the approach to CGE modelling described by Dervis et al., (1982). The model is a SAM-based CGE model, wherein the SAM serves to identify the agents in the economy and provides the database with which the model is calibrated. The SAM also serves an important organisational role since the groups of agents identified in the SAM structure are also used to define sub-matrices of the SAM for which behavioural relationships need to be defined (Pyatt, 1987). The implementation of this model, using the GAMS (General Algebraic Modelling System) software, is a direct descendant and extension of the single-country and multi-country CGE models developed in the late 1980s and early 1990s (see McDonald et al. 2007 for a more detailed description of the GLOBE model).

International Trade

Trade is modelled using a treatment derived from the Armington “insight”; namely domestically produced commodities are assumed to be imperfect substitutes for traded goods, both imports and exports. Import demand is modelled via a series of nested constant elasticity of substitution (CES) functions; imported commodities from different source regions to a destination region are assumed to be imperfect substitutes for each other and are aggregated to form composite import commodities that are assumed to be imperfect substitutes for their counterpart domestic commodities. The composite imported commodities and their counterpart domestic commodities are then combined to produce composite consumption commodities, which are the commodities demanded by domestic agents as intermediate inputs and final demand (private consumption, government and investment). The presumption of imperfect substitutability between imports from different sources is relaxed where the imports of a commodity from a source region accounts for a ‘small’ (value) share of imports of that commodity by the destination region. In such cases the destination region is assumed to import the commodity from the source region in fixed shares: this

37 McDonald, S., Robinson, S. and Thierfelder, K., (2005). ‘A SAM Based Global CGE Model using GTAP Data’, Sheffield Economics Research Paper 2005:001. The University of Sheffield.


is a novel feature of the model introduced to ameliorate the terms of trade effects associated with small trade shares.

Export supply is modelled via a series of nested constant elasticity of transformation (CET) functions; the composite export commodities are assumed to be imperfect substitutes for domestically consumed commodities, while the exported commodities from a source region to different destination regions are assumed to be imperfect substitutes for each other. The composite exported commodities and their counterpart domestic commodities are then combined as composite production commodities; properties of models using the Armington insight are well known. (de Melo and Robinson 1989, Devarajan et al., 1990). The use of nested CET functions for export supply implies that domestic producers adjust their export supply decisions in response to changes in the relative prices of exports and domestic commodities. This specification is desirable in a global model with a mix of developing and developed countries that produce different kinds of traded goods with the same aggregate commodity classification, and yields more realistic behaviour of international prices than models assuming perfect substitution on the export side.

Agents are assumed to determine their optimal demand and supply commodities as functions of relative prices, and the model simulates the operation of national commodity and factor markets and international commodity markets. Each source region exports commodities to destination regions at prices that are valued free-on-board (fob). Fixed quantities of trade services are incurred for each unit of a commodity exported between each and every source and destination, yielding import prices at each destination that include carriage, insurance and freight charges (cif). The cif prices are the ‘landed’ prices expressed in global currency units. To these are added any import duties and other taxes, and the resultant price converted into domestic currency units using the exchange rate to get the source region specific import price. The price of the composite import commodity is a weighted aggregate of the region-specific import prices, while the domestic supply price of the composite commodity is a weighted aggregate of the import commodity price and the price of domestically produced commodities sold on the domestic market.

The prices received by domestic producers for their output are weighted aggregates of the domestic price and the aggregate export prices, which are themselves weighted aggregates of the prices received for exports to each region in domestic currency units. The fob export prices are then determined by the subtraction of any export taxes and converted into global currency units using the regional exchange rate.

There are two important features of the price system in this model that deserve special mention. First, each region has its own numéraire such that all prices within a region are defined relative to the region’s numéraire. A fixed aggregate consumer price index is specified to define the regional numéraire. For each region, the real exchange rate variable ensures that the regional trade-balance constraint is satisfied when the regional trade balances are fixed. Secondly, in addition, there is a global numéraire such that all exchange rates are expressed relative to this numéraire. The global numéraire is defined as a weighted average of the exchange rates for a user defined region or group of regions. In this implementation of GLOBE the basket of regions approximates the OECD economies.

Fixed country trade balances are specified in “real” terms defined by the global numéraire. If the global numéraire is the US exchange rate and it is fixed to one, then the trade balances are “real”


variables defined in terms of the value of US exports. If global numéraire is a weighted exchange rate for a group of regions, as in this case, and it is fixed to one, then the trade balances are “claims” against the weighted average of exports by the group of regions in the numéraire.

Production and Demand

The production structure is a two-stage nest. Intermediate inputs are used in fixed proportions per unit of output—Leontief technology. Primary inputs are combined as imperfect substitutes, according to a CES function, to produce value-added. Producers are assumed to maximise profits, which determines product supply and factor demand. Product markets are assumed to be competitive, and the model solves for equilibrium prices that clear the markets. Factor markets in developed countries are also assumed to have fixed labour supplies, and the model solves for equilibrium wages that clear the markets. In developing countries, however, we assume that the real wage of unskilled labour is fixed and that the supply of unskilled labour is infinitely elastic at that wage. So, labour supply clears the market, and aggregate unskilled employment is endogenous rather than the real wage. In this specification, any shock that would otherwise increase the equilibrium wage will instead lead to increased employment.

Final demand by the government and for investment is modelled under the assumption that the relative quantities of each commodity demand by these two institutions is fixed—this treatment reflects the absence of a clear theory that defines an appropriate behavioural response by these agents to changes in relative prices. For the household there is a well developed behavioural theory; and the model contains the assumption that households are utility maximisers who respond to changes in relative prices and incomes. In this version of the model, the utility functions for private households are assumed to be Stone Geary functions; for the OECD countries they are parameterised as Cobb Douglas functions, i.e., there are no subsistence expenditures.

Macro Closure

All economy-wide models must incorporate the standard three macro balances: current account balance, savings-investment balance and the government deficit/surplus. How equilibrium is achieved across these macro balances depends on the choice of macro “closure” of the model. The scenarios report this exercise as “neutral” or “balanced” set of macro closure rules. This macro closure ensures the model is focused on the effects of changes in relative prices on the structure of production, employment and trade. Analysis of the impact of trade liberalisation on, for example, asset markets and macro flows is better studied using macro-econometric models which incorporate asset markets rather than using a CGE model which focuses on changes in equilibrium relative prices in factor and product markets. The strength of the multi-country CGE model is that it incorporates the features of neoclassical general equilibrium and real international trade models in an empirical framework, but also abstracts from macro impacts working through the operation of asset markets.

Current account balances are assumed to be fixed for each region (and must sum to zero for the world). Regional real exchange rates adjust to achieve equilibrium, as discussed earlier. The underlying assumption is that any changes in aggregate trade balances are determined by macroeconomic forces working mostly in asset markets, which are not included in the model, and these balances are treated as exogenous. This assumption ensures that there are no changes in future ‘claims’ on exports across the regions in the model, i.e., the net asset positions are fixed.


In the scenarios reported, changes in aggregate absorption (imports and domestic production used in household consumption, government and investment expenditure) are assumed to be shared equally (to maintain the shares evident in the base data) among private consumption, government and investment demands. The underlying assumption is that there is some mix of macro policies that ensures an equal sharing of the benefits of any increase in absorption or the burden of any decrease among the major macro “actors”: households, government and investment, i.e. final demand allocations are distributionally neutral. To satisfy the savings-investment balance, the household savings rate adjusts to match changes in investment. Government savings are held constant; direct income tax rates on households adjust to ensure that government revenue equals government spending plus government savings. The tax replacement instrument e.g. when import tariffs are lowered, direct taxes on households, is likely to be less distorting than the trade taxes that it replaces but there are reasons to be sceptical about its appropriateness in the context of many least developed economies (see Greenaway and Milner, 1991). One potential consequence of this assumption is that the results for the least developed economies may be more positive than otherwise.

Factor Market Clearing

The implications of two alternative factor market clearing conditions were investigated. In the first, the assumption of full employment and full factor mobility in all factor markets can be viewed as an archetypal free market model; but the presumption of full employment in all economies, used in the baseline scenario, is questionable. Hence a structuralist alternative is used in the comparative static scenarios where there are excess supplies of unskilled labour at a fixed baseline wage in developing regions (China, India, Other East Asia, Rest of South Asia, SACU, and Rest of sub-Saharan Africa). When there is unemployment, the real wage is held constant and the supply of unskilled labour adjusts following a policy shock. In the case of the current account balances, allowance was made for China to alter exogenously given current account surplus whilst maintaining a global current account balance. The reason for doing this and the way in which this was done is described below.

Exogenous Macro Policy Reform: Impact on Current Account and Real Exchange Rates

Economists agree that it is macro-economic preferences and policy, not trade policy that influences the pattern of global current account surpluses and deficits. The latter are determined by preferences for savings and investment over current spending, foreign capital flows and other macro policies.38 Since any changes in aggregate trade balances are determined by macroeconomic forces working mostly in asset markets which are not included in the GLOBE model, the question arises as to how best to introduce exogenous changes in current account balances into the GLOBE model that proxy exogenous changes in macro economic policies so that their impacts on the endogenous variables of the GLOBE model such as real exchange rates and trade flows can be analysed, and how the changes in current account balances impact on trade policy reform.

One route developed by Liu, Robinson, Wang, and Noland (1998) used in an earlier version of the EU-China GLOBE modelling supposed China had an exogenous current account balance and an

38 For a dynamic model with endogenous macro policies see McKibbin, W. J. and P. J. Wilcoxen (1999). "The theoretical and empirical structure of the G-Cubed model." Economic Modelling 16: 123-148.


endogenous real exchange rate. On the other hand, China’s trading partners were assumed to maintain exogenous real exchange rates vs. each other and endogenous current account balances. With this closure rule for the foreign exchange constraint, an exogenous lowering of China’s current account surplus lead to an appreciation of China’s real exchange rate against all of her trading partners. China’s trading partners’ endogenous current account balances adjusted mainly according to the size of their bilateral trade flows with China and the GLOBE model constraint that total current account changes sum to zero was maintained.

In the foreign exchange closure used here, the real exchange rates for all countries and regions were set endogenously, and the current account balances were set exogenously. For any exogenous change in China’s current account balance, base year trade weights were used to estimate a vector of changes in current account balances of China’s trading partners of equal to but of opposite sign to the change in China’s current account balance thus maintaining the GLOBE model constraint that total current account changes sum to zero. The use of base year trade-weights to adjust current account balances in China’s trading partners to exogenous changes in China’s current account balances provides a simple but effective framework for the analysis of the impact of hypothesised macro economic reform in China on trade policy reform. Thus the strategy used in the GLOBE model to reflect the real world effect of China’s policy of linking the RMB to an (unknown) bundle is to exogenously change China’s current account balance. The size of this exogenous change is chosen so that the endogenous changes in China’s real exchange rate in the GLOBE model mirror the size of changes in China’s exchange rate observed in the real world over the medium run.

Regions, sectors, factors and households in the GLOBE Model

For its base data the GLOBE model uses a global SAM derived from the GTAP 2001 dataset which contains 87 countries or regions, 57 sectors, five factors of production and one household. Each country or region is linked by bilateral trade flows. Regions and sectors can be aggregated in GLOBE as desired. For the EU-China Trade SIA GLOBE model there are 14 regions and 22 sectors, and a dummy regions globe that is the global supplier of trade and transport services for international trade.

Domain of Applicability of the GLOBE model and Comparison with TAPES/PE model

The GLOBE CGE model is based on country and regional models connected by bilateral trade flows. It can model Shallow Integration on a global scale; that is the reduction of barriers to trade without institutional change. It can also model some structural change such as bringing unemployed unskilled labour into employment. Suitable datasets and econometric evidence to model, for example trade induced technical change, is not widely available.39 GLOBE model however is not suited to modelling the effects of Deep Integration e.g. FDI induced productivity change, service

39 In the work reported in the Sussex report on regional integration the presence of suitable datasets and econometric evidence on trade induced technical change made it possible to incorporate trade induced technical change in a GLOBE model focussing on MENA countries. The presence of trade induced technical change in the GLOBE model based on econometric evidence greatly increased the quantitative estimates of the welfare effects of trade policy reform and added a new dimension to the policy environment within which the reforms took place. See Evans, H.D., Gasiorek, M., McDonald, S., Robinson, S. (2006) “Trade Liberalisation with Trade Induced Technical Change in Morocco and Egypt,” in Topics in Middle Eastern and North African Economies, Volume 8, September. www.sba.luc.edu/orgs/meea/volume8/


regulation, SPS and TBT measures. The GLOBE model dataset is very large, and is re-estimated on a three year cycle. This tends to make GLOBE model applications inflexible.

The TAPES/PE model described in detail in Chapter 6 is based on supply and demand at the sector level. It uses the most recent data in a flexible way and can model rapid structural change. Thus a natural division of labour between the GLOBE and TAPES/PE models exists, whereby GLOBE is used for modelling economy wide and global issues, while the TAPES/PE model is used for modelling sector specific issues, especially when there is rapid structural change.

4.2.2 Structural Characteristics of China’s Place in the Global Economy Some aspects of China’s place in the global economy and the importance of China’s trade are shown in Table 4. As can be seen from this table, China has one the highest trade dependence ratios. Although China’s share of global GDP was just over 4%, the fact that its GDP growth is so high (until recently, about 10% pa) combined with a high trade dependence ratio means that China’s impact on the global economy is very large. Equally, China’s high trade dependence ratio and rapid growth means that the trade also interacts strongly within the Chinese economy. This report draws out some of the important aspects of this two-way interaction in the discussion of trade policy reform and the impact of lowering China’s current account surplus.

The Globe model can be thought of as a multi sector multi commodity and multi region version of the standard Heckscher-Ohlin trade model. It is therefore important to see how well the GTAP dataset reflects the underlying factor endowments of the regional trading partners. In the GTAP dataset, factors are measured in constant US$ 2001 prices using the Atlas method so that factor shares across different countries and regions reflect the underlying measurement of factor endowments. As expected, China shows a higher share of unskilled labour compared with other Asian economies and NAFTA and the EU. Since the informal sector is not captured in the GTAP dataset, the shares of unskilled labour in China and India are lower than they would be if a more adequate measure of unskilled labour were available. More generally, the lack of differentiation of the countries/regions shown by factor endowments should be borne in mind when interpreting the reported results of experiments.

Table 6 and Table 7 show the shares of total output for selected world regions. China’s high share of output and value-added is no surprise, but the high shares of output and value-added in traditional sectors such as textiles and apparel, and in heavy industry sectors such as basic metals and machinery, when combined with extremely low shares of services, reflects in part the heritage of state planning.

China’s accession to the WTO has meant that trade policy has been a major area of economic policy reform. This can be seen in Table 8 for China. Overall levels of tariff protection weighted by 2001 imports have fallen by more than half over a six year period. The remaining sectors with modestly high tariffs are in agriculture, food products and motor vehicles. The frequent observation that NTBs remain high is also borne out for China. Here, the ad valorem equivalents measured by Kee et al 2004 at the World Bank at the HS 6 digit level centred around 2002 were aggregated to the GLOBE sectors using 2004 trade weights. The average height of the NTBs at 7.8% for agriculture and industry is similar to the average height of the tariffs in 2001. Interestingly, the peaks of the NTBs do


not generally coincide with the tariff peaks in 2006. In Table 9, the 2001 GTAP tariffs on EU imports from China used in the present scenarios are shown. The associated estimates of the EU NTBs against imports from China are also shown but have not been used in the present calculations which have a slightly lower EU average than the 2001 estimated tariffs from the GTAP dataset. It should be noted that the use of the 2001 GTAP tariffs does not take into account substantial changes in the external tariff of the EU since 2001. As noted in the discussion, a possible preferential arrangement between China and the EU, it is possible some of the results are sensitive to the use of the 2001 GTAP tariffs.

It is well known that using ad valorem equivalents of NTBs is not independent of the structure of output and trade at the time of estimation. In the case of China, it was found that some of the World Bank NTB estimates were at variance with observations of sector experts. The use of the ad valorem equivalents of the NTBs in this study is not meant to be definitive, but providing a useful first estimate of the height of NTBs. For this reason, the estimates of the NTBs have only been used in trade policy reform for China and have not been used in scenario calculations for the EU.

There is a difference in the average tariff for all China reported in Table 8 compared with the WTO TPR for 2006 for China. The difference is that Table 8 uses trade-weighted average tariffs whereas Table III.I Structure of MFN tariff in China, 2001-05 of the TPR uses a simple average of the tariffs, which is roughly double the all-China trade-weighted tariff reported in this report. There is a powerful accounting reason why the weighted average applied tariffs are used by modellers: it is the applied weighted average tariff that generates customs revenue, and the accounting relationships in CGE models requires the weighted average of applied tariffs generating observed customs revenue. The same rule also applies to the PE models, but the data base and accounting relationships are not quite so strictly applied in these models because they are sector rather than economy wide models. Since trade-weighted applied tariffs are much lower than the simple average tariffs, modellers tend to use lower Armington elasticities in their models as a counter-balance. There are very few examples in the literature where marginal tariff rates have been used that are different from the average rates. The rule is that modellers use the weighted average tariffs which, in the case of China, are about half of the rate of tariffs measured by simple averages. In Table 9 the 2001 GTAP tariffs are shown for the EU and the non tariff barriers estimated from the World Bank study on NTBs.40

Measuring NTBs and distinguishing them from indicators of Deep Integration

The World Bank methodology used in constructing the ad valorem equivalents of NTBs is based on a trade restrictiveness index constructed from TRAINS which includes the presence of price and quantity control measures, technical regulations, as well as monopolistic measures, such as a single channel for imports. The trade restrictiveness index is then used in a comparative advantage regression equation to estimate trade flows and the elasticity of demand for imports. The predicted trade flows are then compared with actual trade flows, and the difference attributed to NTBs. The ad valorem equivalent estimated from such residuals using the estimated price elasticity of demand for imports. The NTB estimates based on the World Bank study are only used as a first indicator of

40 Ideally the EU tariffs would have been updated in the baseline to 2005 or 2006, as was done for China from the TRAINS dataset so that the major change in agriculture tariffs in the EU would be captured in the baseline tariff estimates. However it was found that, while the average GLOBE sector tariffs estimated from TRAINS 2006 looked reasonable, when the TRAINS dataset was used to estimate the bilateral tariffs with the EU’s trading partners some entries were in the 100s of %. It was therefore decided not to model explicitly changes in EU tariffs from 2001, or changes in the indicative AVE of the non tariff barriers estimated from the World Bank.


the presence of NTBs. As far as possible the sector specialists were asked to verify the size of these indicative measures.

A standard objection to the use of the World Bank indicators of NTBs is that they are dependent on the particular equilibrium prices and outputs observed at the time of estimation. More generally the components of the TRAINS indicator of the presence or absence of NTBs cannot be easily distinguished from indicators of deep integration discussed in the sub-section on the domain of applicability of the models.

4.2.3 Scenarios The Baseline Scenario

The baseline scenario is designed to update the model base year from 2001 to 2007. This was done by first projecting GDP and factor growth over this period and estimating Total Factor Productivity (TFP) growth as the difference between GDP growth and factor growth. The second step entailed combining the TFP and factor growth projections with an estimate of tariffs on traded goods in 2007 and running the model with the Baseline Scenario for the year 2007. The model solution for 2007 was then used as a new base for the subsequent scenarios. Total factor productivity or TFP is estimated for each region by first estimating a weighted average of the annual factor growth and subtracting this from the estimated average growth rate of GDP over the period 2001-6. The annual average estimates of factor growth and TFP are then used to update the 2001 base factor supply and TFP to 2007, the new base year for the GLOBE model. The final step in the baseline scenario is to apply the tariffs for China obtained from TRAINS for 2006. The methodology behind the baseline scenario extends the analysis of growth differences between rapidly growing South and East Asian countries and their trading partners in the global economy used by McDonald et al. 2007. The results of GDP, factor and TFP estimates used in the baseline scenario 2001-2007 are shown in Table 10 below.

The baseline growth projections used are the average growth for the period 2002-2006 from the IMF World Economic Outlook, where the country estimates of GDP growth in current $US PPP are deflated using a $US GDP deflator. The advantage of using the $USPPP data is that aggregation into regional groups is much easier. A slight inconsistency is involved in the $US GDP deflator used for constant price estimates is based on the Atlas method. Also, the PPP estimates have a higher weight for non-traded goods, but these should not matter significantly over a four-year time period. In all, the disadvantages of using the PPP data were judged to be of lesser importance than the accessibility of the PPP data. The changes in China’s tariffs and NTBs to 2007 are in Table 8.

Ordinary tariffs can be readily modelled because they are recorded in the national accounts that form the basis of the measurement of the difference between domestic and world prices. Table 8 shows the measure of the rate of the NTBs but there is no corresponding accounting entry of the rents generated. By putting the NTBs into the baseline scenario, a distortion occurs because the NTBs induce some import substitution and there is no re-distribution of the rents generated in the model at present. The advantage of proceeding in this manner is that in subsequent experiments, the impact of changing the NTBs can be estimated by the model. The details of the model closures used in the baseline scenario are set out in Table 11.


The Trade Liberalisation Scenarios

Medium and long run trade policy scenarios or experiments are described in detail in Table 12. The medium run context for trade policy reform was modelled by making capital sector specific and immobile, and in the long run fully capital mobility was assumed. As with the currency scenarios, the unskilled wage was fixed and the employment of unskilled labour was endogenous in the developing countries including China. Alternative tariff cuts of a “modest” 25% and “ambitious” 75% in China were considered. The same was done for experiments with cuts to China’s NTBs. An experiment where China’s current account surplus is reduced is carried out with no trade policy changes, and in conjunction with trade policy changes. The final experiment combines elements of a global DDA tariff cut of 25% with a PCA inspired 50% tariff cut on bilateral trade between China and the EU, that is, a total of 75% tariff cut over baseline 2007 for bilateral trade between China and the EU.

4.2.4 Empirical Results In all, the 4 experiments were performed with the 2007 baseline estimated by the model used as the new base year described in detail below.

The experiments fall into three groups:

1. Experiments involving reduction of China’s current account surplus as a result of exogenous changes in macro policy in a multilateral context. The changes in China’s current account surplus are then combined with multilateral trade policy reform.

2. Experiments involving tariff reform in the medium and long run of 25% and 75% in China. 3. Experiments involving NTB reform in the long run 25% and 75% in China.

Experiment 1, China’s current account is reduced by $US60B, with compensating trade-weighted current account adjustment by the same amount in China’s trading partners. The change in absorption of over 4% (domestically produced and imported commodities for private and government consumption plus investment) is large for a comparative static calculation. It has no welfare or efficiency implications because the changes on the capital account that allow for the current account reduction is not included in the welfare function. However, lowering China’s current account surplus has major economy wide implications, starting with the appreciation of the real exchange rate (the price of domestic goods over foreign goods) of slightly over 6%. Some of the increase in imports of slightly over 5% and decrease in exports of 6.8% is accounted for by the change in current account surplus itself, and some by the effect of the real exchange rate appreciation on exports and imports. This is the over-all trade adjustment that takes place when the current account surplus is reduced. The anti-trade bias from the reduction of the current account surplus increases the returns to land and skilled labour increases whilst the returns to capital and natural resources fall. The demand for unskilled labour increases by nearly 0.4%. The terms of trade also improves slightly as a result of the anti-trade bias of the policy change.

The effects on the EU are much smaller but generally of opposite sign. Absorption and imports fall by 0.32%, imports, exports rise by nearly 0.6% and the real exchange rate depreciates by 0.2%. There is little effect on the returns to unskilled and skilled labour and capital, but the returns to land fall by nearly 0.4% and the returns to natural resources rise by just over 0.9%. The change in the pattern of


trade requires less adjustment than in the case of China and the rise in exports does not appear to involve agricultural products.

The changes in the overall level of trade for China and the EU hides the effects of lowering China’s current account surplus on the composition of bilateral trade. These effects are shown in Table 14 below which reveal a number of sectors where the change in imports or exports is over 10%. For example, China’s imports from the EU increase by more than 10% in wearing apparel, transport equipment, machinery and equipment and other manufacturing. Conversely, EU imports from China fall by more than 10% in textiles, wearing apparel and electronic equipment. There is no particular trade policy issue involved in these changes in the composition or levels of bilateral trade as a result of the lowering of China’s current account surplus, but the changes in sector trade shown in Table 14 suggest that there may be a trade adjustment issue to be monitored.

Tariff reductions and equivalent non-tariff barrier reductions in China are shown in experiments 2 to 6. Taking the long-run results in experiments 3, 4 5 and 6 it is striking that the impact on absorption in China is at most a little over 0.3%.This makes the point, that by 2007, the average rate of China’s tariffs was less than 4% and estimated NTBs was a little less than 8% and the overall impact on the economy of further trade policy reduction is minimal, even for 75% tariff reductions. Where there are substantial effects on GDP as in scenario 6 when NTB reductions of 75% are included, arising from the large increase in employment of unskilled labour, these benefits are lost in welfare terms by the adverse terms of trade response of over 2% from the expansion of exports and imports. The strong adverse terms of trade effects in scenario 6 are a reminder that China is big enough to affect its own terms of trade and therefore limit the benefits of Chinese trade policy reform.

The results of experiment 2 aimed to capture short to medium run impacts of trade policy reform where Chinese tariffs are cut by 25% but capital is fixed in each sector. In this case, the impact on absorption of nearly 0.5% is markedly higher than in the long run experiments. The reason for this apparent paradox is that the lack of capital mobility is highly constraining when tariffs are cut. But the tariff cut induces an increase in imports that has to be financed by export expansion requiring much larger real exchange rate depreciation than in the long run cases. As can be seen by the strong increase in the employment of unskilled labour, the constraints on capital mobility induce export expansion, increasing the employment of unskilled labour by nearly 2% and resulting in the increase in absorption and welfare of over 0.5%.

The importance of multilateral vs. unilateral tariff reduction for China is illustrated in experiments 7 and 8. When China joins the multilateral trade round, here a “super” Doha Round or DDA round with global tariff cuts of 25% and 75% respectively, the welfare response in China is strong because of improved market access for Chinese exports into partner markets. There are no adverse terms of trade effects, a strong increase in the demand for unskilled labour, especially in the Ambitious case and a real exchange rate appreciation. Multilateral trade policy reform is good for China. For the EU, the overall effects on absorption of the multilateral trade policy reforms in scenarios 7 and 8 are very low.


Multilateral Trade Liberalisation with China’s Current Account Surplus Lowered

The traditional comparative static Swan-Solow context for the analysis of unilateral trade policy reform treats the current account surplus or deficit as exogenous and unchanging and the real exchange rate as endogenous. A lowering of tariffs or NTBs generates at the initial set of prices and exchange rate a negative change in the current account balance. The final equilibrium normally includes a devaluation of the real exchange rate. In this story, the devaluation of the real exchange rate is important because it provides a stimulus to exports which, together with the stimulus to import competing production, work together to restore the current account balance. The normal efficiency and welfare implications follow, even if CGE models typically show a small % increase in welfare, but the direction of change of trade flows and real exchange rates is predictable.

As already noted when comparing scenarios 5 and 8, the direction of change of the real exchange rate is influenced not only by the changed access of China’s import suppliers into China’s markets, but also the improved access of China’s exporters into foreign markets. This effect is vividly illustrated by the real exchange rate depreciation of 1.6% in scenario 5 and the real exchange rate appreciation of 1.2% in scenario 8. It was also noted in the discussion of scenario 1 that lowering China’s current account surplus by US$60 bn leads to an appreciation of the real exchange rate of slightly over 6%. Thus, the ambitious multilateral trade policy reform combined with a reduction of the current account surplus of US$60 bn leads to a real exchange rate appreciation of nearly 7%. The combined scenarios lead to a strong increase of imports of over 8% and an expansion of exports of nearly 4.7%. The increase in absorption in the combined experiment of 5.5% is roughly the same as the changes in absorption from experiments 1 and 8 taken separately. The contradictory effects of the combined multilateral trade policy reform and the reduction of China’s current account surplus arises because the benefits to China’s exporters from better access to export markets is blunted by the appreciation of China’s real exchange rate. On the other hand, the impact of lowering China’s tariffs on China’s import is enhanced by the appreciation of China’s real exchange rate. For the EU, in the case of the combined lowering of China’s current account surplus and multilateral trade policy reform in scenario 9, the welfare effect is in fact negative reflecting the fact that in trade-weighted allocation of a change in current account balances to China’s trading partners, there is a small increase in the EU’s current account surplus which lowers absorption.

4.3 Emissions and Poverty Effects In a comparative static context, estimates of the CO2 emissions of each of the scenarios reported is of interest primarily for emissions per unit of a measure of production such as GDP. In the case of scenarios involving a lowering of the current account surplus, the results must be interpreted in the context of the capital account transactions required for the current account total but which are not included in the GLOBE model welfare function. In effect, the GLOBE model results for these sectors can be thought of as the first period of a dynamic recursive model in which capital reserves are run down in order to finance the lowering of the current account surplus. Obviously since such running down of stocks is not sustainable in the long run, the results of scenarios 1 and 9 should be interpreted with care.

The question arises: are scenarios that are more economically efficient better custodians of the environment as measured by total CO2 emissions estimated per unit of GDP? To carry out these calculations, the CO2 emissions associated with the 2001 GTAP dataset, reported in the GTAP-E part


of the GTAP website, were estimated as coefficients per unit of gross output. In the case of household expenditure on goods emitting CO2, namely Coal, Oil and Gas, Petroleum and Coal products and Utilities, coefficients per unit of household expenditure on these items were also calculated. The results of these calculations are reported in Table 17 below.

The findings in Table 17 reveal that Chinese and multilateral tariff cuts, whether or not associated with cuts in NTBs, are associated with falls in emission per unit of GDP, i.e. Scenarios 2 to 8,suggest that economic efficiency is also “emissions friendly”. Of course, this contribution of lower emissions of CO2 is small relative to that produced by faster growth, but important nevertheless. In contrast, scenarios 1 and 9 show an increase in emissions per unit of GDP. This increase in emissions per unit of GDP is entirely associated with a rise in emissions from household consumption associated with the appreciation of the real exchange rate. In the case of scenarios 1 and 9 it is quite possible for increased emissions from increased household consumption to dominate the beneficial effects of lower emissions per unit of GDP from production.

An associated observation can be made about poverty reduction from Table 17, using changes in unskilled labour employment as the poverty indicator. Outside of scenarios with a reduction in current account surplus (Scenarios 1 and 9), the same more economically efficient scenarios have the highest contribution to poverty reduction. As previously discussed Scenario 6 has a large beneficial effect on poverty reduction, but in overall terms most of the welfare benefits are lost by the adverse terms of trade effects of the Chinese trade policy reform. This can be seen by the very small increase in absorption compared with the effect on GDP. Scenario 9 is also beneficial for poverty reduction, but on account of the efficiency of the tariff reform, not of the reduction in the current account surplus. Scenario 9 is also beneficial for poverty reduction in the short run. On balance, Scenario 9 which combines a multilateral trade policy reform with the real exchange rate appreciation maintains a high rate of poverty reduction and has a neutral effect on emissions and is an attractive scenario.

4.4 Scenario Implications • Scenarios 2-6 suggest that there is little over-all gain from general Chinese trade policy reform, except in the short run where capital immobility between sectors may open the possibility of greater gains from trade policy reform because the associate real exchange rate depreciation is larger, stimulating exports and expanding the employment of unskilled labour. • Scenarios 7 and 8 suggest that there is likely to be substantial mileage in multilateral trade policy reform, principally because it helps open markets to China’s exports. • Scenario 1 explores the impact of an exogenous macro reform that lowers China’s current account surplus. Lowering China’s trade policy surplus by $60B leads to a substantial appreciation of the real exchange rate and large trade adjustments both for China and the EU. Scenario 9 combines the lowering of China’s current account surplus by $60B and the Ambitious multilateral trade policy reform in scenario 8. The resultant combination of large trade adjustments from the reduction of the current account surplus and the responses of imports and exports to the multilateral trade policy reforms leads are blurred by mixed signals. On the side of China’s exports, the strong appreciation of the real exchange rate hinders the adjustment of exports to trade policy incentives, particularly those arising from the opening up of export markets. On the import side into China, the appreciation of the real exchange rate sharpens the impact of lower tariffs and enhances the


efficiency gains. There is a possible win-win aspect to scenario 9 if China embarks on macro reform, linking a lowering of the current account surplus to multilateral trade policy reform, and thus reduces pressures towards the use of restrictive trade policy measures to attempt to deal with the perceived bilateral trade deficit between the EU and China. • From the sections on CO2 emissions and poverty, the general result was that the more economically efficient policy is also “emissions friendly” in that CO2 emission per unit of GDP fell most in these cases. These same scenarios also tended to show a larger reduction in poverty. The exception was scenario 2 in which capital was assumed to be immobile domestically. This scenario is both environmentally friendly and leads to strong poverty reduction.


4.5 Figures and Tables Table 3: Sectors, factors and regions in the GLOBE model

Sectors Regions

Crop agriculture Electronic equipment China

Animal agriculture Machinery and equipment Advanced East Asia

Coal Other manufacturing Middle East Asia

Oil and gas Utilities Other East Asia

Other minerals Construction India

Meat products Trade and transport Rest of South Asia

Other foods Business services NAFTA

Textiles Other services MERCOSUR plus

Wearing apparel Rest of the Americas

Wood and paper products Factors European Union

Petroleum and coal products Land Middle East and North Africa (MENA)

Chemical rubber and plastic products Unskilled labour Southern Africa Customs Union (SACU)

Basic metal and mineral products Skilled labour Rest of sub-Saharan Africa

Motor vehicles and parts Capital Rest of the World

Other transport equipment Natural resources

Model dataset, based on GTAP v.6.

Table 4: Structure of Trade and GDP 2001

Share of Total

Imports Exports GDP Trade Dependence

China 5.80 6.85 4.14 0.71 Adv East Asia 12.80 14.28 17.21 0.37 Middle East Asia 2.25 3.08 0.76 1.64 Other East Asia 1.72 1.84 1.04 0.80 India 1.03 0.88 1.49 0.30 Rest of S Asia 0.50 0.40 0.46 0.46 NAFTA 23.37 18.86 36.69 0.27 MERCOSUR 1.97 1.94 2.93 0.31 Rest of the Americas 1.98 1.57 1.45 0.57 EU 39.87 41.53 28.00 0.68 MENA 4.59 4.54 3.23 0.66 SACU 0.51 0.65 0.39 0.69 Rest of SSA 1.10 0.89 0.61 0.76 Row 2.51 2.70 1.61 0.76

Total 100.00 100.00 100.00 Model dataset, based on GTAP v.6.


Table 5: Factor Shares in Selected World Regions

China Advanced East Asia India NAFTA

European Union

Land 4.04 0.51 9.97 0.52 0.62

Unskilled labour 42.55 35.48 35.71 34.51 28.70

Skilled labour 12.06 21.87 10.80 23.69 19.74

Capital 39.76 41.87 42.56 40.91 50.53

Natural resources 1.59 0.27 0.96 0.36 0.41

Total 100.00 100.00 100.00 100.00 100.00

Table 6: Value-Added Shares by Sector for Selected World Regions


European Union

Crop agriculture 10.8 1.6 18.5 1.3 1.6

Animal agriculture 5.8 0.6 6.8 0.4 1.1

Coal 0.5 0.2 0.5 0.2 0.1

Oil and gas 1.0 0.1 1.2 0.5 0.5

Other minerals 1.6 0.3 0.5 0.2 0.1

Meat products 0.3 0.3 0.2 0.7 1.0

Other foods 2.6 1.9 3.6 2.2 2.4

Textiles 3.0 0.5 2.1 0.6 0.5

Wearing apparel 3.0 0.6 0.7 0.5 0.7

Wood and paper products 2.3 1.9 0.9 2.8 2.3

Petroleum and coal products 0.6 0.3 0.2 0.1 0.1

Chemicals, rubber and plastics 4.0 2.7 2.6 2.9 3.2

Basic metal and mineral products 5.4 2.3 2.0 1.6 2.1

Motor vehicles and parts 0.9 1.7 0.7 1.1 1.8

Other transport equipment 0.7 0.5 0.7 0.8 0.5

Electronic equipment 2.2 3.2 0.4 1.4 1.7

Machinery and equipment 6.1 3.1 1.7 3.8 3.3

Other manufacturing 4.3 1.9 2.3 1.5 2.6

Utilities 2.4 3.0 3.6 2.2 2.3

Construction 7.3 6.9 5.5 6.0 5.9

Trade and transport 18.9 22.0 20.6 20.8 20.0

Business services 5.4 14.8 7.2 20.4 16.8

Other services 10.6 29.5 17.7 28.1 29.4

Total 100.0 100.0 100.0 100.0 100.0


Table 7: Output Shares by Sector for Selected World Regions


European Union

Crop agriculture 5.6 1.1 12.1 0.9 1.0

Animal agriculture 3.7 0.7 5.0 0.6 1.0

Coal 0.4 0.1 0.4 0.2 0.1

Oil and gas 0.6 0.1 0.7 0.5 0.3

Other minerals 1.7 0.3 0.4 0.2 0.1

Meat products 0.6 0.8 0.6 1.5 1.9

Other foods 4.4 3.5 5.2 3.0 3.4

Textiles 4.6 0.8 4.0 0.9 0.9

Wearing apparel 3.7 0.9 1.2 0.8 1.0

Wood and paper products 2.8 2.5 1.5 3.6 3.3

Petroleum and coal products 1.8 1.2 2.3 0.9 0.9

Chemicals, rubber and plastics 6.3 4.6 5.8 4.1 5.2

Basic metal and mineral products 8.0 4.0 4.4 2.3 3.6

Motor vehicles and parts 1.4 3.7 1.2 2.9 3.4

Other transport equipment 1.0 0.7 1.0 1.1 0.7

Electronic equipment 3.6 5.7 0.8 2.1 2.5

Machinery and equipment 7.9 4.4 3.3 4.4 4.9

Other manufacturing 4.9 2.5 4.1 2.0 3.5

Utilities 2.0 2.7 4.4 2.1 2.0

Construction 8.6 7.9 7.1 7.4 7.0

Trade and transport 15.3 19.3 18.3 19.8 17.6

Business services 3.8 12.2 5.1 17.9 14.1

Other services 7.3 20.3 11.1 21.1 21.4

Total 100.0 100.0 100.0 100.0 100.0


Table 8: China Tariffs and Non-Tariff Barriers by Sector

GTAP6 2001 Tariffs 2007 Tariffs

Non-tariff Barriers

Crop agriculture 43.5% 9.3% 14.2%

Animal agriculture 4.1% 11.8% 15.0%

Coal 0.9% 1.1% 83.7%

Oil and gas 0.0% 0.0% 0.0%

Other minerals 0.6% 0.3% 20.3%

Meat products 8.5% 3.3% 0.1%

Other foods 10.5% 7.9% 16.4%

Textiles 15.0% 5.1% 14.8%

Wearing apparel 3.9% 1.6% 0.5%

Wood and paper products 6.9% 1.7% 17.5%

Petroleum and coal products 6.2% 3.9% 8.8%

Chemicals, rubber and plastics 11.0% 5.8% 6.8%

Basic metal and mineral products 6.3% 3.1% 26.8%

Motor vehicles and parts 11.0% 14.1% 4.3%

Other transport equipment 30.2% 2.1% 0.3%

Electronic equipment 4.7% 0.3% 3.3%

Machinery and equipment 7.3% 4.6% 3.8%

Other manufacturing 8.7% 3.3% 1.0%

Utilities 0.0% 0.0% 0.0%

Construction 0.0% 0.0% 0.0%

Trade and transport 0.0% 0.0% 0.0%

Business services 0.0% 0.0% 0.0%

Other services 0.0% 0.0% 0.0%

Total all 7.5% 3.0% 6.5%

Total excluding services 8.9% 3.6% 7.8%


Table 9: EU-25 Tariffs GTAP 2001 and Non-Tariff Barriers by Sector

2001 GTAP Tariffs

Non-tariff Barriers

Crop agriculture 21.7% 28.6%

Animal agriculture 3.0% 25.3%

Coal 0.0% 1.2%

Oil and gas 0.1% 0.9%

Other minerals 54.1% 0.0%

Meat products 22.2% 44.1%

Other foods 8.9% 40.1%

Textiles 9.8% 21.5%

Wearing apparel 0.5% 9.7%

Wood and paper products 0.2% 0.1%

Petroleum and coal products 1.8% 0.1%

Chemicals, rubber and plastics 4.6% 0.5%

Basic metal and mineral products 0.9% 0.1%

Motor vehicles and parts 0.5% 0.7%

Other transport equipment 1.3% 0.9%

Electronic equipment 0.8% 0.0%

Machinery and equipment 3.7% 0.2%

Other manufacturing 21.7% 0.2%

Utilities 3.0% 0.0%

Construction 0.0% 0.0%

Trade and transport 0.1% 0.0%

Business services 54.1% 0.0%

Other services 22.2% 0.0%

Total all 8.9% 6.5%

Total excluding services 9.8% 7.8%


Table 10: Baseline Projections GDP, Factors and TFP 2001-7

Average Growth GDP % pa

Average Growth Factor Supply % pa

Average Growth Total Factor Productivity % pa

China 8.89 4.38 4.51

Adv East Asia 2.38 1.57 0.81

Middle East Asia 4.83 3.64 1.19

Other East Asia 5.08 3.63 1.45

India 6.70 4.06 2.65

Rest of S Asia 5.04 3.33 1.70

NAFTA 2.25 1.83 0.42

MERCOSUR 3.44 2.53 0.90

Rest of the Americas 4.10 3.13 0.98

EU 1.90 1.39 0.51

MENA 4.71 3.73 0.98

SACU 3.78 5.05 -1.27

Rest of SSA 4.71 3.60 1.11

RoW 5.97 2.51 3.46


Table 11: GLOBE Baseline Scenarios

Exogenous Variables and Policy Variables

Baseline 2007 Scenario Baseline Sensitivity Tests

Model Specification

Update in long-run mode 2001-2007 Possible sensitivity tests of experiments based on 2007 to:

Model Closure

Factor Markets Update in long-run mode 2001-2007 size of non-tariff relative to tariff barriers

all factors supply fixed returns endogenous, mobile between sectors

elasticities of substitution used in GLOBE model

estimates of aggregate factor growth and GDP projections

Macro closure

-private consumption

balanced and investment led closure for China, other countries/regions balanced closure


-govt consumption balanced and investment led closure for China, other countries/regions balanced closure


- investment balanced and investment led closure for China, rest balanced closure

balanced and investment led closure for China, rest balanced closure

Foreign exchange

- current account current account exogenous current account exogenous

- real exchange rate

real exchange rate endogenous real exchange rate endogenous

Tariffs

Effective Tariffs on Trade (overall)

TRAINS effectively applied tariffs 2006 applied to 2007

Non tariff barriers Included in baseline scenario from World Bank estimates at HS6 level centred on 2002 and applied to baseline 2007

Technical change assumptions

GDP projected for all regions for 2001 to 2007 together with total factor supply. TFP estimated as a residual from GDP growth less factor supply growth

GDP projections simulated as neutral technical change with no factor change. Factor growth estimated and residual neutral TFP estimated.


Table 12: GLOBE Trade Policy Scenarios Exogenous Variables and Policy Variables

Modest Trade Liberalization Highly Ambitious Trade Liberalization

Remarks

Model Specification Medium Run Adjustment Long Run Adjustment Key assumptions: Factor Markets Key assumptions: - land Supply fixed returns

endogenous, mobile between sectors

Supply fixed returns endogenous, mobile between sectors

Medium and long-run simulated by varying the degree of capital mobility

- unskilled labour Wage fixed supply endogenous, Developing countries. Supply fixed and wages endogenous Developed economies, mobile between sectors.

Wage fixed supply endogenous, Developing countries. Supply fixed and wages endogenous Developed economies, mobile between sectors.

Unemployed unskilled labour in developing countries only in longer run scenarios

- skilled labour Supply fixed returns endogenous, mobile between sectors.

Supply fixed returns endogenous, mobile between sectors.

- capital Supply fixed returns endogenous, immobile between sectors.

Supply fixed returns endogenous

- natural resources Supply fixed returns endogenous, mobile between sectors.

Supply fixed returns endogenous, mobile between sectors.

Macro closure - private consumption Balanced and investment led

closures for China, other countries/regions balanced closure

Balanced and investment led closures for China, other countries/regions balanced closure

China has balanced and investment led closures. All other countries/regions have balanced closure.

- govt consumption Balanced and investment led closures for China, other countries/regions balanced closure


- investment Balanced and investment led closures for China, other countries/regions balanced closure


Foreign exchange - current account Current account exogenous Current account exogenous

- real exchange rate

Real exchange rate endogenous

Real exchange rate endogenous

Tariffs

Effective Tariffs on Trade (overall)

DOHA Development Round Commitments or reduce 25% (if unclear)

Reduce 75% across all sectors All tariffs variation from Baseline 2010.

Non-tariff Trade Barriers reduction

Modest reduction 25% Major reduction 50%

Non-tariff Trade Barriers reduction in selected sectors of interest to EU

Modest reduction 25% Major reduction 50% Sensitivity Analysis for EU – interest : not necessarily identical to US, Japan or ASEAN

Technical Change assumptions

No change No change Scenarios with and without TFP change will be required


Table 13: Key to GLOBE experiments

Note: all experiments have mobile factors except 2. Unskilled wage fixed in developing countries including China except in the baseline scenario. Description of experiments: Baseline Scenario Other Scenarios: 1. Current account surplus China reduced $60B. Trading partners adjust current account In proportion to bilateral trade flows in opposite direction. 2: Modest Trade Liberalisation Scenario: China tariffs reduced 25% - capital immobile but Other factors mobile. 3: Modest Trade Liberalisation Scenario: China tariffs reduced 25%. 4: Modest Trade Liberalisation Scenario: China tariffs and non-tariff barriers are reduced 25%. 5. Ambitious Trade Liberalisation Scenario: China tariffs reduced 75%. 6. Ambitious Trade Liberalisation Scenario : China tariffs and non-tariff barriers Reduced 75%. 7: Modest Trade Liberalisation Scenario: Global tariffs reduced 25%. 8: Ambitious Trade Liberalisation Scenario: Global tariffs reduced 75% 9. Scenarios 1 and 8 combined.

Table 14: GLOBE Macro Results for China from Experiments - % Changes on Baseline 2007

China 1 2 3 4 5 6 7 8 9

Absorption 4.43 0.48 0.02 0.13 0.05 0.33 0.35 1.33 5.44 Import Demand 5.19 0.91 0.38 1.32 1.16 4.22 1.01 3.26 8.38 Export Supply -6.76 1.29 0.60 1.85 1.85 6.03 0.63 1.95 -4.67 GDP from expenditure -0.01 0.64 0.11 0.37 0.34 1.13 0.23 0.70 0.66 Real Exchange Rate -6.11 1.68 0.51 1.30 1.57 4.17 -0.34 -1.19 -6.94 Returns to: - Land 2.49 2.27 0.12 0.53 0.36 1.60 1.68 6.15 8.28 - Skilled labour 1.30 1.83 0.22 0.75 0.68 2.35 0.46 1.45 2.71 - Capital -0.03 - 0.26 0.85 0.80 2.72 0.44 1.37 1.32 - Natural resources -4.20 1.15 0.77 1.67 2.40 5.28 0.60 1.91 -2.17 Change in Unskilled Labour Employment 0.37 1.60 0.26 0.88 0.81 2.80 0.56 1.79 2.11 Terms of Trade index 1.007 0.994 0.997 0.991 0.990 0.973 1.001 1.003 1.010


Table 15: GLOBE Macro Results for EU from Experiments - % Changes on Baseline 2007

European Union 1 2 3 4 5 6 7 8 9

Absorption -0.32 0.12 0.00 0.01 0.01 0.03 0.02 0.06 -0.25

Import Demand -0.32 0.21 0.01 0.03 0.04 0.08 0.23 0.71 0.40

Export Supply 0.58 0.01 0.00 0.00 0.00 -0.01 0.17 0.55 1.12

GDP from expenditure -0.01 0.05 0.00 0.00 0.00 0.00 0.00 0.01 0.00

Real Exchange Rate 0.19 0.12 0.00 0.01 0.01 0.05 0.00 0.01 0.19

Returns to:

- Land -0.40 -2.08 0.01 0.08 0.04 0.27 -0.20 -0.50 -0.87

- Unskilled labour -0.02 0.53 0.00 0.00 0.01 0.01 0.16 0.49 0.48

- Skilled labour -0.07 0.00 0.00 0.01 0.01 0.02 0.15 0.46 0.39

- Capital -0.07 0.00 0.00 0.00 0.01 0.02 0.15 0.47 0.39

- Natural resources 0.92 10.14 0.03 0.17 0.11 0.58 -0.37 -0.95 0.00

Terms of Trade index 0.999 1.002 1.000 1.000 1.000 1.001 1.000 1.001 1.000

Table 16: GLOBE - Change in Bilateral Trade between China and EU (%)

China imports from EU EU imports from China

Crop agriculture 6.27 -5.25

Animal agriculture 4.63 -3.51

Coal 6.92 -5.91

Oil and gas 9.56 -0.18

Other minerals 2.01 -1.52

Meat products 10.10 -9.83

Other foods 5.38 -3.18

Textiles 7.03 -10.62

Wearing apparel 15.06 -10.88

Wood and paper products 8.06 -7.59

Petroleum and coal products 4.19 -3.64

Chemical rubber and plastic products 6.12 -8.43

Basic metal and mineral products 8.01 -6.75

Motor vehicles and parts 6.57 -5.60

Other transport equipment 11.99 -8.77

Electronic equipment 5.08 -13.13

Machinery and equipment 10.34 -9.65

Other manufacturing 11.42 -9.20

Utilities 7.35 -7.18

Construction 6.74 -0.90

Trade and transport 5.85 -3.72

Business services 5.19 -3.35

Other services 6.71 -1.32


Table 17: Emissions and Poverty Indicators

1 2 3 4 5 6 7 8 9

Emissions from production (1) 3496811 3494793 3509405 3499493 3503206 3505104 3516711 3500946 3509347 Emissions from household consumption (1) 338433 352739 339929 338268 338527 337890 338634 339303 341246 Total Emissions 3835244 3847531 3849333 3837761 3841732 3842994 3855345 3840249 3850594 GDP (2) 1620 1619 1630 1621 1626 1625 1638 1623 1631 Emissions/GDP 2368 2376 2362 2367 2363 2365 2354 2366 2361 % change on baseline Emissions from production 0.0 -0.06 0.36 0.08 0.18 0.24 0.57 0.12 0.36 Emissions from household consumption (1) 0.0 4.23 0.44 -0.05 0.03 -0.16 0.06 0.26 0.83 Total Emissions 0.0 0.32 0.37 0.07 0.17 0.20 0.52 0.13 0.40 GDP (2) 0.0 -0.01 0.64 0.11 0.37 0.34 1.13 0.23 0.70 Emissions/GDP 0.0 0.33 -0.27 -0.05 -0.20 -0.14 -0.59 -0.10 -0.30 Poverty Indicator (3) 0.0 0.37 1.60 0.26 0.88 0.81 2.80 0.56 1.79 (1) Emissions from GTAP-E Dataset (2) GDP by Expenditure from Table 14 (3) Change in Unskilled Labour Employment from Table 14.

4.6 Regional Impacts in China and the EU In order to give the results of the GLOBE model a spatial dimension, the Chinese economy was divided into the four main regions used by the Chinese central government in the 11th Five Year Plan: North East, Coastal, Central and Western. For 19 of the 23 sectors of the GLOBE model output estimates were made of the gross output by sector across regions. We were not able to obtain a breakdown of gross output by regions for sectors 20 to 23 using production data by province from the Yearly Industrial Database of the China Data Centre. Four scenarios were chosen to map the gross output changes to regions based upon the descriptive allocation described. A further refinement was made from the GLOBE model, noting that there are fixed proportions between gross output and value added (or GDP at factor cost). Using the value added to gross output conversion ratio and the regional share coefficients described for each sector, an allocation of GDP at factor cost to China’s four regions for sectors 1 to 19 of the GLOBE model was obtained. The 19 sectors cover agriculture, mining, manufacturing and utilities.

The scenarios selected for the regional analysis were:

• Baseline, which gives the initial GDP at factor cost by region, and the base against which each change in regional GDP at factor cost by scenario is measured.

• Scenario 1 – lowering the current account balance by $60bn, which induced a real exchange rate appreciation of nearly 7%.

• Scenario 8 – a multilateral tariff reduction of 75%.

• Scenario 9 – a combination of scenario’s 1 and 8.


4.6.1 China Regional Results Table 18: China Regional Impacts – GLOBE Results

% change on baseline GDP at factor cost (by region) Baseline Shares Scenario 1 Scenario 8 Scenario 9 Northeast 7.22 -0.96 0.36 -0.58 Coastal 67.57 -1.69 0.84 -0.85 Central 14.05 -0.77 0.61 -0.16 Western 11.17 -0.64 0.46 -0.17 China 19 sectors (excluding services) 100.00 -1.39 0.73 -0.66 China all sectors (including services) 0.16 0.75 0.89

Note: North-east – Heilongjiang, Jilin, Liaoning East (Coastal) – Tianjin, Jiangsu, Zhejiang, Fujian, Beijing, Hebei, Shandong, Shanghai, Guangdong, Hainan Central – Anhui, Henan, Hubei, Hunan, Jiangxi, Shanxi Western – Gansu, Tibet, Qinghai, Xinjiang, Yunnan, Sichuan, Ningxia, Inner Mongolia, Shaanxi, Chongqing, Guizhou, Guangxi

Figure 1: China Regional Analysis – Map of Regions

Table 18 shows the impact on GDP at factor cost by region and scenario for China. The final row provides the total change in GDP at factor cost for each scenario, for all sectors.

Column 1 indicates the baseline shares of GDP at factor cost for each region. It confirms the well known fact that the coastal region dominates economic activity for all of China. Column 2 shows the impact on GDP at factor cost of reducing the current account surplus by $60bn, the first period impact of a dynamic process. Overall GDP at factor cost improved in this sector by over 0.1%, rather less than the increase in absorption because the real exchange rate appreciation leads to a decline in exports. However, of the real exchange rate appreciation associated with scenario 1 and because the 19 sectors identified in the regions (except utilities) are traded goods (except utilities), GDP at factor cost declines, especially in the coastal region. The inland regions do not experience such a strong decline in GDP. This result is a simple consequence of what in another context might be called the


Dutch disease effect of real exchange rate appreciation. In contrast, the multilateral reduction in tariffs (column 3) has a positive impact on GDP at factor costs across all regions. The improvement of GDP at factor cost in the coastal region dominates over all other regions, with the strongest positive occurring improvement. Finally when the reduction of the current account surplus is combined with the multilateral tariff reform (column 4) the pattern is closer to the case of the current account reduction without trade policy reform (Scenario 1).

4.6.2 EU Regional Impacts The same exercise was carried out for the European Union, using a slight variation on the methodology used for China. First the EU results were disaggregated by country using gross output shares from the GTAP dataset and adjusted for the value added to gross output ratios obtained from the GLOBE model. The country data were then aggregated to regions (see Table 19 for regional aggregations of countries).41 Table 19 shows the change in GDP at factor cost by experiment for the EU. Compared with the impact on China the overall effects are small. However it is of interest to note that there is a clear regional pattern of gains and losses across the EU. For example the greatest gains form Scenarios 1, 8 and 9 are experienced by the Eastern Region and while the greatest losses are in the Western region. The Northern region experiences very small but mixed effects whilst the Mediterranean region has very small negative effects.

Table 19: EU Regional Impacts – GLOBE Results % change on baseline GDP at factor cost (by region) Baseline Shares Scenario 1 Scenario 8 Scenario 9 Western 48.33 -0.009 -0.007 -0.016 Northern 25.07 -0.001 0.011 0.010 Mediterranean 21.85 -0.003 -0.006 -0.009 Eastern 4.74 0.037 0.026 0.063 EU all Regions 100.00 -0.004 -0.001 -0.004

Note: Western - Austria, Belgium, France, Germany, Luxemburg, Netherlands Northern - Denmark, Finland, Britain, Ireland, Sweden Mediterranean - Greece, Italy, Portugal, Spain, Cyprus, Malta Eastern - Czech Republic, Hungary, Poland, Slovakia, Slovenia, Estonia, Latvia, Lithuania

41 The GLOBE model dataset covered 25 countries for the EU whereas the recent expansion increases the number of EU countries to 27. Elsewhere in this analysis efforts have been made to qualitatively assess impacts on Romania and Bulgaria.


Figure 2: EU Regional Analysis – Map of Regions


4.7 Modelling Conclusions A number of conclusions emerge from the GLOBE model analysis. First, multilateral trade policy reform is beneficial for China and other countries in comparison with unilateral reform as in WTO accession for China. Secondly, unilateral NTB reform should not be avoided where it can be shown to be gainful – such reforms create a better atmosphere for the reform process. Thirdly, the sectoral trade policy reform issues discussed in chapter 6 should not wait for the outcome of the wider multilateral reform process before they are implemented, even if carried out on a unilateral basis, especially where initial tariffs and indicative NTBs are high.

The background to the trade policy reform process is the appreciation of the RMB relative to a bundle of currencies. This was modelled in GLOBE through a reduction of the current account surplus, creating a significant appreciation of China’s real exchange rate. This altered the way in which trade policy reform works, switching the efficiency gains from the export side to the import side and increasing the adjustment challenges for China on the import side. It was also determined that the appreciation of the real exchange rate created a significant trade adjustment challenge for the EU in certain sectors. It was argued that an appreciating real exchange rate for China was not a valid reason for using trade policy to alter perceived bilateral trade imbalances.

The key finding for carbon emissions is that scenarios that generated improved economic welfare as measured by changes in absorption also resulted in lower emissions per unit of output required to produce the GDP. Whilst China’s major contribution to CO2 emissions is from the economic growth process itself, it is of interest to policy makers that further trade policy reforms that improve economic efficiency are consistent with lowering emissions per unit of GDP.

Estimates in the change in the level of employment associated with each scenario is a good indicator of the overall changes in poverty as measured around a poverty line, reported in Table 17. Generally the strongest impacts on lowering poverty are achieved by the most efficient trade policy reform scenarios.

Finally, the allocation of GLOBE results to regions in China highlighted the dominance of China’s coastal region and the importance of Dutch disease effects when the current account surplus is lowered and the real exchange rate appreciates. In the case of the EU, the individual impacts were dispersed across a large number of countries, however, it was noteworthy that Eastern European countries gained most from multilateral trade policy reform.


5. Sector and Horizontal Studies Note: The following sector studies are composed of three sections: a background, impact analysis of liberalisation scenarios and policy recommendations arising from the analysis. The background section is a summary of a more extensive series of sector reports completed in the prior phase of this Trade SIA which focused primarily on the EU-China historical and current trends within each sector, as relevant to EU-China trade. These reports below condense the background reports considerably. Interested readers are encouraged to further explore the issues raised through the full sector studies available at the dedicated project website.

The studies in this section build considerably on the prior reports with the addition of quantitative modelling results, which are then used to qualitatively assess the impacts of a PCA between the EU and China within the themes of economics, society and environment. These impacts are then addressed with an early provision of possible flanking measures, i.e. policy recommendations, which provide negotiators and stakeholders alike with a number of potential options to address both positive and negative impacts. Finally, summary tables provide a visual guide to the overall economic, social, and environmental impacts of liberalisation specific to each sector and should be read using the legend provided in Table 20.

Table 20: Impacts Summary Table Legend () (Strong) positive impact

Negligible impact

() (Strong) negative impact

Mixed impacts

(+)+ (Strongly) positive existing conditions

0 Neutral existing conditions

(-)- (Strongly) negative conditions

Localised impacts

Moderately diffuse impacts

Highly diffuse impacts

L Low capacity to change via policy

M Moderate capacity to change via policy

H High capacity to change via policy

Liberalisation Scenarios

While the PCA is not designed to be a means of traditional trade liberalisation, i.e. of bilateral or multilateral tariff reductions, it is possible that it may include provisions which assist with the reduction of behind the border barriers, with benefits accruing multilaterally. To simulate the impacts of this liberalisation six scenarios of tariff cuts or tariff cuts equivalent to the reduction on non-tariff barriers have been devised and applied to each sector.

Three types of medium-run experiments were run. Medium-run is taken to be a three year period during which the assumed structural changes take place and the effects of changes in the policy environment on protection and the real exchange rate apply. The first three experiments relate to shallow integration under the multilateral liberalization with an unchanged real exchange rate. The three experiments shown in Table 21 were DDA Baseline (10% cut), DDA Modest (25% cut), and DDA


Ambitious (75% cut). Secondly, and more speculatively, a set of medium run projections of domestic demand growth and possible supply curve shift for import competing production and export production were run to obtain a consistent set of projections of imports, domestic production and domestic demand. The same supply curve shifts were applied on the export side. Table 21: Sector Scenario Parameters

Tariffs and NTBs reductions Exchange Rate Multilateral

Baseline with DDA 10% - DDA Modest 25% - DDA Ambitious 75% - Structural Change only (see Table 49) - - DDA Modest with Structural Change 25% 10% DDA Ambitious with Structural Change 75% 10%

Table 22: Chinese Structural Change used in Projection Scenarios42

Environmental Goods and Services Supply Demand Air Pollution Control 43% 54% Wastewater Management 13% 61% Solid Waste Management 40% 48% Remediation and Cleanup 50% 53% Noise and Vibration Abatement 51% 59% Environmental Monitoring, Analysis and Assessment 36% 70% Cleaner Technologies 36% 35% Water Supply 3% 3% Renewable Energy 33% 74% Heat and Energy Savings Management 54% 56%

Agriculture Supply Demand Dairy Products 38% 37% Meat Products 20% 20% Fish and Aquaculture 15% 18% Grains and Cereals 0% 0% Fruit & Vegetables 9% 11% Beverages, Wines & Spirits 23% 23%

Chemicals Supply Demand Commodity 43% 48% Specialty 28% 30% Fine 33% 34%

Machinery Supply Demand Power-generating machinery and equipment 75% 68% Machinery specialised for particular industries 60% 53% Metalworking machinery 66% 66% General industrial machinery and equipment 66% 65% Electrical machinery 65% 64%

42 For details on structural change figures please see Section 6


5.1 Machinery

5.1.1 Sector Background

Economic Significance

The machinery sector is of keen importance to both China and the EU. This sector alone contributed over US$385 billion to China’s economic output in 2006. General industrial machinery and electrical machinery together accounted for close to 60% of that output.

Power-generating equipment

Power-generating equipment includes steam boilers, turbines, non-electrical engines and motors, and rotating electric plants. Industry is the biggest consumer of machinery products; thus this sub-sector plays an important role in powering production in the economy as a whole. While “power-generating equipment” is a minor sector in EU-China trade in machinery, ranking next to last before metal working machinery, the indirect role it plays in the functioning of the economy and society is of strategic importance. In the case of the power-generating equipment, the main customer is the power industry,43 which produces energy for the whole economy.

Efficiency remains a consistent challenge for machinery producers in China. China’s booming growth fuels demand for quality power-generation equipment, however, a number of factors hinder efficiency in this sub-sector, particularly poor management, inefficient structures and imbalanced distribution.44

China’s growing demand for energy has captured the attention of government officials and highlighted the need to support its development of this sector. Sales of power-generating equipment in China have experienced significant and uninterrupted upward trend recently, to reach US$73.1 billion in 2006. Domestic consumption is slightly higher at US$73.3 billion, with China a net importer of power-generating equipment. 45 China’s Ministry of Commerce (MOFCOM) in its ‘Catalogue for the Guidance of Foreign Investment Industry’46 reinforced the importance of power-generating equipment by classifying the sector as an “encouraged industry”. Chinese production of power-generating equipment has not been able to keep up with domestic demand; as a result, the market is turning increasingly towards third countries to satisfy demand.

Historically, the nature of the EU-China bilateral trade in this sector has been erratic. Historically, the EU has consistently maintained a trade surplus in this sector, however, both the magnitude of the surplus and the growth rates of the trade flows have varied significantly. The EU has been lagging behind China in terms of export growth in this sector; in fact, the EU has overtaken China in this category only briefly in 2004. Still, the EU has gradually reduced its trade deficit and raised its bilateral export/import ratio to 91% in 2006 compared to 55% in 1999.

43 The removal of the SITC category 713, “Internal combustion piston engines” resulted in making the power industry a customer of SITC category 71, “power-generating machinery and equipment”. 44 Ibid. 45 Sales in 2006 are estimated figures based on first quarter year-on-year growth rates. 46 www.zjgftz.gov.cn


Non-Electrical Machinery

The non-electrical machinery (or mechanical engineering) sector consists primarily of machinery goods that are not captured in the power-generating equipment or electrical machinery sub-sector.47 Mechanical engineering is critical to the supply and value chain of other industries, driving innovation and productivity for industries such as food production, textiles, furniture, automotive, shipbuilding, materials handling, agriculture, construction, electronics, aerospace and defence. It also provides services related to its products, such as improvement of existing processes. Moreover, the industry participates indirectly to the economy as a customer of the primary and services sectors.

Boasting close to 24,000 companies, mechanical engineering is one of the largest sectors in Europe, accounting for 8% of the total manufacturing output with sales totalling €459 billion in 2006 (up by 8.6 % from 2005 and expected to grow by 4.5% in 2007).

Europe enjoys higher output productivity levels in this sub-sector; output per employee averaged €176,501 in 2006, compared to US$43,000 per employee (2006 estimates) in China.48 Moreover, the mechanical engineering sector requires a high level of innovation – an area in which the EU is particularly strong – resulting in a competitive advantage in customised machinery and niche markets. Despite high labour costs, high regulatory requirements and threats from increasing global competition, European operators have invested assiduously in R&D, enabling them to face the challenge of declining product life cycles and maintain their position as world leader in technical production.

In contrast to companies in the power-generating equipment sector, companies producing non-electrical machinery in China are relatively ‘small’, both in terms of workforce and sales, and in particular private domestic enterprises (US$4.9 mn sales and 155 employees on average in 2005).

Between 2001 and 2006, the trade deficit in non-electrical machinery has narrowed, both in absolute and relative terms, however, the benefit of this evolution is entirely attributable to the last three years. Until 2003-04, Chinese imports of non-electrical machinery were increasing considerably faster than its exports, resulting in a two fold increase of the trade deficit in absolute value. After 2004, imports stalled while exports surged at a significantly higher rate of 21% per year on average. As a result, Chinese imports of non-electrical machinery from the rest of the world were only 30% higher than its exports in 2006, compared to 150% in 2001. Until recently China has been dependent on imports of certain high value added goods, including “general machinery” where its trade deficit turned into a surplus in 2005.

The non-electrical machinery sector accounted for one half of the bilateral trade in machinery between EU and China in 2007, amounting to €22.8 bn, with an average growth rate of 19.5% over the last decade. While EU exports stalled in 2004, the rise of imports from China continued, increasing by €1 bn per year to reach €9.4 bn in 2007, up from only €1.4 bn in 1999. This resulted in a narrowing of the trade surplus.

Concerning general industrial machinery, in the last eight years EU exports to China have multiplied by 3.5 and Chinese exports to the EU by almost seven. Until 2006 the EU enjoyed a trade surplus in

47 Notably by the EC’s DG Enterprise and Industry. 48 Source: China General Machinery Association database


general industrial machinery, but in 2007 incurred a €1.2 billion trade deficit, revealing a growing comparative advantage of China in this segment with the most probable explanation being Chinese producers increasingly turning towards emerging foreign markets in this sector.49

Electrical machinery

The list of goods included in the electrical machinery sector refers to electric power machinery; electric circuits apparatus; insulated conductors and equipment; electrodiagnostic and radiological apparatus; household equipment and small electrical machinery (like batteries, lamps, tools, etc).50 Unlike the first two sub-sectors of machinery – power-generating equipment and non-electrical machinery – the electrical machinery sector comprises equipment for professional and consumer products.

The electrical machinery industry in Europe, with some 11,315 companies, has a 4% share in the total manufacturing output, and sales amounting to €251 bn in 2006 (up by 7% from 2005).51 75% of production is sold within the EU (40% in national markets) and the remaining share (25%, or €63.3 bn) is exported to third countries. The main producing countries, classified by their share of European output, are: Germany (34%), Italy (14%), France (12%), Spain (8%) and the United Kingdom (7.5%). Electrical machinery is also an important sector in the Netherlands52 and Sweden, and a promising one in Central and Eastern European countries such as Czech Republic, Hungary (growing faster than the EU average), Slovak Republic (contributing to strong growth in the workforce).53

Companies operating in the electrical machinery sector are not as large as the power-generating equipment sector, but they are relatively large compared to the average companies manufacturing non-electrical machinery, both in terms of workforce and sales (US$10.9 mn sales and 245 employees on average in 2005). Unlike other machinery sectors, overall average output productivity in the electrical machinery industry has stagnated in recent years, despite a slight increase in 2005 to US$43,000 per worker. The domestic private sector recorded the highest output productivity ($96,136 per worker), considerably above average, while SOEs and FIEs lag far behind, the latter – quite surprisingly – ranking last with an output productivity of US$40,039. Electrical machinery is the only machinery sub-sector where China enjoys an overall trade surplus (US$19 bn in 2006). Both imports and exports recorded a strong and steady growth over recent years, respectively +27% and +29% per year on average; figures that are consistent with domestic production’s growth rate.

In total, the electrical machinery sector accounted for 43% of the bilateral trade in machinery between the EU and China with €19.5 bn in 2007, up from €6.2 bn in 1999. It is the most important share in the machinery sector. The trade balance is strongly in favour of China, with a trade surplus of €10.5 bn in 2007, after a peak of €11.2 bn the year before. The trade balance is also stable, with the EU’s imports-to-exports ratio remaining at around 3.5 over the years. In six categories, the EU only enjoys a (modest) surplus in one, ‘Electro diagnostic and Radiological Apparatus’ (SITC 774). The sectors in deficit are, in order of scale, household equipment (SITC 775), accounting for 39 % of the total deficit with €4.2 bn in 2007; small electrical machinery (SITC 778) with €4 bn (or 37 % of total

49 Study on the Future Opportunities and Challenges of EU-China Trade and Investment Relations, Study 1: Machinery, 2006 50 Other than rotating electric plants 51 Source: www.bara.org.uk/EAMA/press%20info%20economic%20outlook%20-%20spring%202007.doc 52 Xinhua, 17 December 2004 53 Vienna Institute for Economic Studies, March 2007.


deficit); electric power machinery (SITC 771) with €1.2 bn (or 11% of total deficit); insulated conductors and equipment (SITC 773) with €935 mn (or 9% of total deficit) and electric circuits and apparatus (SITC 772) with €444 mn (or 4% of total deficit).

Social Significance

This study will focus on employment and existing workforce trends in the EU and China, as well as their sensitivity and resilience to change in determining social interactions and impacts. While it is important to analyse the primary ‘social significance’ of the industry (i.e. employment), this analysis also addresses other areas such as labour standards, issues related to gender, and overall social cohesion.

Employment

Jobs in the machinery industry are generally more concentrated in specific geographic areas rather than dispersed over the entire territory as in service sectors. Infrastructure, transportation routes, access to markets and local institutional frameworks determine the location of industrial facilities and are the main factors explaining the concentration of industrial output. This concentration often results in the industry being a major employer in the specific regions where it is located, with other local employers often depending directly on this activity.

Employment in the machinery sector in recent decades has tended to decline, despite improving economic performance which has featured vigorous growth in output (and exports for mechanical engineering) as well as advances in productivity and profitability. Remaining competitive is critical for European manufacturers, who face pressure from modernising production processes and reducing manufacturing costs. Boosting productivity helps maintain or grow markets. Reduction in the workforce despite growth in output—particularly in electrical machinery—is explained by the drive to reduce labour costs.

The sector’s impact on individual EU member states ranks differently compared to the classification by “size of output”, which reveals gaps in productivity but also the social significance of the machinery sector for each country. The biggest producers – Germany, Italy, France and the United Kingdom – have the biggest workforce, which is understandable given their major share in both sectors of the EU machinery output. Sweden and Spain are emerging big players as well, where strong economic growth may lead to larger ‘social significance’ in the future. For low performers, ‘social significance’ corresponds to a ‘social exposure’, i.e. the vulnerability of these countries’ employment to international competition. Romania, Poland and the Czech Republic are indeed the most ‘sensitive’ regions within the EU27, with large workforces and low output productivity levels (particularly in Romania). While Hungary and Slovakia have significantly smaller workforces specialised in electrical machinery, a field where emerging producers are becoming increasingly competitive. Despite its larger workforce, Hungary may be in a better position than its northern neighbour due to relatively strong output productivity of €45,000 (versus €30,000 in Slovakia).

In China, both the “general machinery” and “electrical machinery” workforce enjoyed, during the period for which data is available, an enviable annual average growth of 15%. While the specialised


machinery workforce declined in 2004, its situation reversed in 2005 with 4.8% growth. It is expected that the workforce in specialised machinery will continue to grow, supported by favourable economic indicators (growing production and exports, decreasing imports).

Sizable labour productivity gains have been achieved at a rate exceeding overall employment growth (compared to a workforce decline in Europe), highlighting the economic gains of the sector in China. However, a main factor behind this performance – the availability of low-cost labour – may lose significance in the near future. Recent trends point towards acute labour shortages in the manufacturing sector in Guangdong province, where a large number of workers have not returned after the 2008 New Year holidays due to growing discontent with low wages and poor working conditions.54 In response factories have raised wages and improved working conditions in order to secure a stable employment base. In 2006 wage growth in Guangdong was as high as 46% in individual cities, with a provincial average of 17.8%.55

Environmental Significance

The machinery industry has a complex inter-relationship with the environment. Like all industries, it impacts the environment through its production processes. Furthermore, machinery produces goods used by other industries as inputs to their own production processes. The quality of the equipment produced therefore has an impact on the environment through contribution to these industries’ output. Additionally, as a consumer good, machinery’s impact on the environment is felt through the use of the product by the consumers.

The most direct impact the machinery sector has on the environment is through its production processes. For China, it is possible to quantify the CO2 emitted by the machinery industry through recent studies that have highlighted the share of pollution in China that is linked with the production of goods imported by European countries.56 In the case of Norway this price was estimated for machinery at 0.291 Norwegian crowns (NOK) (€0.036) per kilogramme CO2, which placed machinery in the category of “CO2-intensive products”.57 Utilising a similar methodology reveals that the CO2 emitted by the machinery industry in China has grown rapidly since 2001, exceeding 10,000 tons of CO2 annually by 2005.

The machinery industry also has upstream impacts on the environment, through its demand for inputs. Heavy demand for raw materials such as iron, copper, aluminium and high-quality special materials has been triggered by fast economic development of the sector.58 The environmental impact of mining and metal-processing industries can be partly linked with (if not attributed to) the development of the machinery industry.59

54 Between 11% (Guangdong Labour Ministry) and 30% (other estimates). Source: China Briefing, 17 March 2008. See also “Where is everybody? Manufacturers struggle in southern China's industrial belt,” The Economist, 6 May 2008. 55 Zhu, Yan. A Substantial Increase in China’s Minimum Wage, Fujitsu Research Institute, 11 Jan 2007 56 Reinvang & Peters; Norwegian consumption, Chinese pollution; Industrial Ecology Programme at the Norwegian University of Science and technology, January 2008. 57 This definition of machinery differs slightly, including “standard machinery and equipment, plus electric appliances, computers, office equipment, and so on” See their study for more details on the methodology used and the assumptions made. We used the following exchange rate to calculate CO2 emissions per US$ in 2001: 1 US$ = 8.9 NOK (www.oanda.com). 58 Draft Global Analysis Report on Trade SIA, Emerging Market Group (EMG) & Development Solutions, August 2007 59 The machinery industry represents 26% of the Chinese industrial output. Source: Draft Global Analysis Report on Trade SIA, Emerging Market Group (EMG) & Development Solutions, August 2007.


The European Union historically produces machinery goods and equipment more efficiently than in other parts of the world, encouraged by higher technical standards and by increasingly demanding consumers. Within the EU, Germany—the biggest producer of machinery—leads in the design and production of more energy-efficient products.

While the first results of recent proactive environmental industrial policies may soon be realised, energy efficiency is distressingly low in Chinese industry, where 3.5 times more energy is still needed to produce the same quantity of output in Europe; and there is no clear downward trend.60 Chinese industry is dominated by large state-owned enterprises (SOEs) despite reforms and restructuring they remain inefficient and highly polluting. According to the China Sustainable Energy Program, Chinese industry emits “the bulk of China’s pollution” and consumes 70% of the country’s primary energy, with almost half caused by the 1000 most energy intensive companies.61 It is reasonable to assume that the equipment used is partly responsible for this problem, with some machinery equipment showing relatively low energy consumption performance.62

Most of the goods included in the machinery sector are inputs used by other sectors. A certain number of them, however, are final goods: household appliances like washing-machines, refrigerators, dishwashing machines, shavers, lamps, batteries and accumulators.

In the EU, energy demand resulting from household products accounts for 25% of final energy needs, with electricity used for domestic appliances showing the largest growth.63 Higher living standards, multiple purchases of electric appliances and a growing demand for air-conditioning devices drive this upward trend. The quality of equipment is also important: the use of obsolete and energy-inefficient appliances has a heavy environmental cost, with at least 44 Terawatt hours of energy waste per year in the EU due to inefficiency.64

While its share of household equipment may not yet reach EU levels, China represents the largest growth market in the world in this segment, remaining far below saturation level. Rising incomes and a boom in the housing market have resulted in soaring demand for refrigerators, air-conditioners and water heaters, with a great majority produced by local manufacturers.65 Energy efficiency regulations for household appliances have existed since the late 1980s and have been expanded to cover more products and raise the stringency of performance levels. However, even the most recent energy efficiency requirements standards implemented in 2007 still lag significantly behind developed countries.

The environmental footprint of China’s household appliances is particularly heavy, a problem that stronger regulations and standards could prevent. As a leading exporter of household appliances worldwide, China exports their environmental impact as well. Boosting efficiency could, it follows,

60 Depending on the methodology employed for measurement energy consumption in China is rising or at best stabilising 61 Fact Sheet: China Emerging as New Leader in Clean Energy Policies; The China Sustainable Energy Program, 2007. 62 In 2000, according to the 2004 Medium and Long-Term Energy Conservation Plan, “average energy efficiency of medium and small sized motors was 87%, the average design efficiency of fans and water pumps was 75%, all being 5 percentage points lower than that of advanced world level, with the system operating efficiency nearly 20 percentage points lower” 63 European Commission, DG for Energy and Transport. 64 “Eco-efficiency of Household Appliances”; Presentation by Luigi Meli, Director General of CECED 27 March 2006 65 “Mitigating Carbon Emissions: the Potential of Improving Efficiency of Household Appliances in China”; Jiang Lin; Environmental Energy technologies Division; Berkeley National Laboratory; July 2006


have major (positive) spill over effects. Conversely, increased Chinese exports of inefficient products would induce a greater impact on the environment in recipient countries.66

5.1.2 PCA Scenarios PCA Impacts

The five machinery sub-sectors (power-generating machinery and equipment, specialised machinery, electrical machinery, metalworking machinery and general industrial machinery and equipment) are expected to be affected by liberalisation of the machinery sector in China. The degree of impact between the sub-sectors will not vary greatly, suggesting that they are closely related and affected similarly by liberalisation policies.

The scenario assumptions made are that barriers will be reduced by 10%, 25% and 75% under the baseline, modest and ambitious liberalisation scenarios. The effects on the machinery sector will be more evident in the long-term, building on the general trends that may be visible in the immediate period after liberalisation efforts. The results also suggest that the overall economic benefits in the short-term at least, are more pronounced for the EU compared to China.

Given the increasing demand for machinery and equipment in China, and the EU’s comparative advantage in manufacturing sophisticated and innovative machinery and equipment, China will gain from access to these commodities. As demand increases for machinery and equipment made in the EU, it will gain from greater access to a large and growing market.

Economic Impacts

Across the five sub-sectors, liberalisation will increase domestic demand in the Chinese market (by up to 17%). The domestic supply of machinery is negatively affected, as a result of increased foreign competition in the sector. All five sub-sectors will be affected to a similar degree, though the metalworking machinery sub-sector may be affected slightly more with ambitious liberalisation resulting in up to a 5% decline in Chinese production. In an economy of China’s size these numbers are significant, especially given major increases in machinery imports from EU countries. Electrical machinery imports from the EU for example are forecast to increase by up to 63% under ambitious liberalisation. These figures are substantially larger than the decrease in local supply in China. When combined with the imports from NAFTA and the rest of the world (RoW), the supply in China is outstripped by the level of imports from elsewhere. This will cause pain for some in the Chinese economy, particularly local manufacturers and suppliers of machinery and equipment.

It remains to be seen whether rapid expansion of domestic demand will drive China’s machinery sector strongly in the future, or provide opportunities for international companies. China’s productivity in machinery currently lags behind a number of European countries. For example, the Netherlands, Finland, Sweden and Italy, which are the most productive amongst the EU countries in this sector, out-produce China by more than five times. However, China shows immense potential as its productivity is increasing rapidly. The Chinese economy is going through a ‘Heavy and Chemical

66 Ibid


Industrialisation Era.’67 It is anticipated that the pace of this expansionary period will be one of the fastest in the world in the next 15 years.

The impact on the EU inflows of machinery from China would be dwarfed by the corresponding benefits. China would become much more dependent on imports from the EU at the expense of its local industries. This would have a negative impact on the country’s national accounts. China’s economic structure could itself be restructured as labour and resources now in the machinery sector are transferred to other sectors. Currently, private domestic companies control about 50% of the sector, in terms of productivity. SOEs have the smallest share with around 12% and FIEs about 30%. If China’s productivity is affected by liberalisation of the sector, FIEs can be expected to gain a larger share of the market.

As exports from the EU increase as a result of liberalising the sector, trade between China and the EU will increase. Based on the figures, it appears that the trade gap will be in favour of the EU. In an ambitious liberalisation scenario, China imports from the EU will grow 65%, whereas, in the same scenario, exports to the EU will grow by only 1.5% for power-generating machinery and equipment. However, an unfavourable import-export ratio does not provide a definitive picture of the impact on the economy, as the significant levels of import growth indicates that there is a strong demand for these goods due to growth in China’s economy. Given that a variety of other industries, such as textiles and construction are dependent on the machinery sector, losses in the machinery sector may be offset by growth in other industries, which require machinery and equipment. Thus, the direct productivity gains in other sectors could compensate for the losses in the machinery sector itself.

If the EU and China focused on specific sub-sectors, liberalisation would not necessarily lead to competition between the two. They could indeed become more complementary. Assuming they are both are part of the global production supply chain, China’s strengths will be focused on low-end machinery; the EU’s comparative advantage is in high-end machinery and equipment. Such a vertical division of labour would allow each region to build on its expertise without reducing the other’s market share.

Social Impacts

Social equity recently became a policy issue in China, with major statements made in Hu Jintao’s report to the 17th National Party Congress in 2007, and in Wen Jiabao’s Government Work Report at the National Peoples Congress in March 2008. These interpreted the previously vague core objective of social harmony in terms of “giving increased attention to social equity and justice.” Within this, rebalancing the vital indicators of China’s urban and regional, and coastal and regional sectors is to be a high priority.68

67 Wang Mengkui, ed. Major Issues of China’s Mid-long term Development (2005-2020), China Development Press, 2005 Liu Shijin, China Entered into the Period of Heavy & Chemical Industrialization Period and its Impacts on Macro Economy, on Economics Trends, 11th issue, 2004 68 Wen Jiabao, “Report on the Work of the Government” (Address to the 11th National People’s Congress, 5 March 2008; available at http://www.chinadaily.com.cn/china/2008-03/19/content_6549442.htm. (In Chinese), “Government work report paints road map of promoting ‘social justice’,” China News Net, 7 March 2008 (http://www.chinanews.com.cn/hr/ozhrxw/news/2008/03-07/1184866.shtml).].


As part of this emphasis, the Chinese leaders signalled that as well as redistributive mechanisms such as a social security net, the state should ensure social equity, and not just efficiency, in primary distribution. “Primary distribution” is a traditional category from the planned economy era, covering salaries and other direct incomes (secondary distribution covers housing, medical and other welfare-type arrangements). It is understood that different sectors of the economy have widely different salary levels for similar job classifications. These discrepancies are now acknowledged to be a major source of inequity.69 All industry sectors under review will increasingly be required to monitor such social justice impacts in a policy setting similar to the social democratic frameworks of Europe. There will be a move towards increasing the share of wage incomes in the national total.

At some point with liberalisation some cuts in production of machinery and equipment are likely, thereby undermining sector employment. Job losses will follow, especially for low-skilled labour. While jobs are lost in all three scenarios, the change is less than 1%; given the size of China’s economy and population, this is substantial.

Job losses aside, increased competition from the EU may also result in a downward adjustment of wages and labour standards in China’s machinery sector. This will have serious consequences, especially given the currently high levels of inflation. Lowering of labour and social standards has long-term implications which will particularly affect the poor.

Furthermore, when the labour force and its wages suffer, the rural-urban divide will be exacerbated because a large part of the labour force in China that contributes to the sector is from rural areas. The EU may offer its technical assistance with mechanisms to compensate for potentially disruptive consequences of these changes.

Unemployment is a crucial problem with far-reaching consequences. Over the long-term, it reduces literacy and security. Health indicators, such as nutrition status and mortality are also depressed by job losses and reduced wages, especially for low-skilled labourers struggling to find employment in other sectors. The hukou or household registration system, which regulates population movement, is a major employment barrier, and coupled with a slow-down in the machinery and equipment sector, a variety of social problems in China may be exacerbated.

Among EU countries, Poland and Bulgaria, which had diminishing employment levels in the machinery sector, may benefit from the increased advantage of EU exports to China. Overall employment levels in the EU in this sector will improve, while the opposite will occur in corresponding Chinese regions such as Heilongjiang, which has historically been a region with substantial activity in the machinery sector.

Increased EU-China engagement affects society through the transfer of technology. Given the EU’s relative strength in innovative, high quality machinery and equipment, China’s technology would be upgraded through importing advanced technologies. The figures suggest an optimistic level of imports into China from the EU, ranging from 2-45% across the three scenarios. By adopting advanced technologies, China’s competitiveness in the sector would improve, and in the long term, a level-playing field between the two regions could offset any initial loss of profit by Chinese machinery producers. Technology transfer into China thus offers social and economic benefit for

69 Hu Jintao, “Accelerating Social Development with the Focus on Improving People's Livelihood,” Part 8 of Hu Jintao's report at 17th Party Congress, October 2007; available at http://english.people.com.cn/90001/90776/90785/6290145.html.


both regions. The mounting trend for Multinational Companies (MNCs) to relocate R&D facilities to developing countries is one way in which technology and investments in this sector will enter China—already identified as a top destination for MNCs to relocate their R&D.

There is a potential barrier to importing advanced technologies due to China’s relatively lax intellectual property rights protection. Could the appeal of advanced technologies propel the Chinese government to ensure stringent IPR laws and enforcement and stop exerting disguised forms of pressure to transfer technology, without which the transfer of advanced technologies into China may be deterred? This remains a key issue and is further examined in this report’s Intellectual Property Rights Horizontal Study.


One benefit of reduced manufacturing of machinery and equipment in China is that the energy use entailed by it would also be reduced. Given that China is known for its inefficient use of energy, slower manufacturing growth would be good from an environmental perspective. In the three scenarios, China’s local production is anticipated to reduce by at most 5% per subsector. However, such a reduction would not necessarily mean that the volume of machinery usage in China will be reduced, as figures suggest that import levels into China will be substantial (between approximately 1.5-17% in the three scenarios). As long as China’s economy grows at the current rate and demand for machinery and equipment increases, the use of machinery and equipment will be substantial. Depending on the type and quality of machinery, it is possible that the impact on the environment will be adverse. Increasing trade volume between the EU and China in the machinery sector may entail environmental practices adopted in the EU being incorporated in China.

As a consumer good, the impact on the environment by machinery usage is also felt through the specific use of the product. For instance, machinery used in construction facilities is bound to affect atmospheric quality, with both short and long term implications. This is especially true of power-generating machinery. However, with appropriate flanking measures, such as cleaner processes and high quality equipment, it is possible to mitigate environmental degradation.

As income levels in China increase, changes in consumption patterns will affect the environment. With increasing consumption of household appliances— refrigerators, dishwashing machines and air-conditioners, for instance—energy demand will increase. Unless measures exist to drastically improve the energy efficiency of this equipment, China could face increasing environmental problems due to increasing economic growth and income levels.

Environmental regulations in the EU have generally been of a high standard. Consumer demands helped improve production processes and end products. Environmentally conscious policies relating to the machinery sector in the EU could enhance China’s environmental standards, as a result of increased trade between the two regions. Given higher environmental standards in the production processes and usage relating to machinery and equipment, China would also be a more attractive destination for foreign investment as the issue of climate change becomes a priority and a determinant of business and investment decisions.


A summary of impacts is provided below. Please note that the impacts are derived from policy only scenarios, while projections scenarios help determine the feasible reversibility and capacity to change within a sustainable development theme. Refer to Table 20 for key explanation.

Table 23: PCA Summary Impacts Table – Machinery (China)

Table 24: PCA Summary Impacts Table – Machinery (EU)

5.1.3 Policy Recommendations

Mitigation measures

Support businesses’ restructuring and workers’ adaptability to foreseeable change in low-performing Member States

Overall the machinery sector in Europe is globally competitive, but several Member States record relatively low performance, particularly in the electrical machinery sector. Production in Romania, Slovakia, the Czech Republic and Poland face the threat of being displaced by cheaply manufactured foreign products, especially from China. These countries have not yet fully modernised their machinery sector during their market economy reforms, and may have to downsize utilities and workforce when faced by increasing competition from Chinese exporters. The European Union has a certain number of tools it can use to address social and economic consequences of economic restructuring. One is the strengthening of the European Social Fund (ESF), whose objective is to “foster a balanced economic and social development” in order to support Member States’ policies

Indicator Existing Conditions

Scenario Impacts Policy Options

Overall Direction Magnitude

Equity Reversibility Capacity to change

Economic Production (machinery)

++ Y L

Economic Structure - Y L Consumption and Production Patterns

-- Y H

Social Equity 0 Y H Health -- Y M Labour - Y M Environmental Atmosphere -- Y M

Indicator Existing Conditions


Overall Direction Magnitude


Economic Exports & Production

+ Y L

Social Labour - Y M


towards a full employment.70 The ESF provides funding under two Structural Fund objectives: “Convergence” (for less developed regions) and “Regional competitiveness and employment” (to anticipate economic change and promote adaptability). Main priorities of these objectives are: a pro-active approach to adaptability among businesses and workers through innovation and education/training; improvement of access to employment (focus on modernisation of employment services); and combat social exclusion.

Support flanking measures to address economic and social consequences of the economic reform / liberalisation process in China

China also faces risks from liberalisation of the machinery sector. As highlighted, the machinery sector in China faces fierce competition and low profitability, with more than a quarter of the companies suffering losses. The consequences of reforms and liberalisation could be potentially more serious for State-Owned Enterprises, which are artificially supported by the government through subsidies and easy loans from state banks. The government is already committed to address economic and social aspects of restructuring, by supporting SOE reforms and SMEs promotion, and taking actions in specific industrial sectors. In June 2008, the China Banking Regulatory Commission urged State-owned commercial banks to adjust their loan structure to provide more capital to finance Chinese SMEs which had been adversely affected by the global credit shortage. As an incentive, the CRBC proposed offering partial tax-relief on income from SME loan interest.71 It is anticipated that the Chinese government simultaneously sets up accompanying measures focused on social security to further reduce social impacts. A symposium hosted by Peking University in April 2008 discussed practical ways to improve China’s social security system. Wang Yijiang, an economics professor at Tsingtao University, stated China’s social spending is “highly insufficient”. The Chinese government has already set aside 156.1 billion yuan for social security spending and job creation in 2008; such expenditures should be encouraged to further bolster worker security.72 SOEs should receive special attention, through support and capacity building to adapt to changes and cope with the financial shortages resulting from lower government subsidies. It is suggested that the EU encourage ongoing reforms of the social security system and integrate these conditions and developments into its trade policy negotiations.

In previous PCAs, the EU has lent support to technical assistance programs aimed at constructing the legislative framework conducive for improving the competitiveness for domestic SMEs. There were also provisions for assistance in creating targeted funding to assist in the restructuring of these SMEs in anticipation of the increased competition brought on by greater liberalisation and foreign competitors. Currently in China, there is already the China International Cooperation Association of Small and Medium Enterprises (CICASME) which facilitates communication, commercial exchange and technological advancement of Chinese SMEs. In the machinery sector, both regions could benefit from an exchange of best practices between the ESF, one of its key objectives being improving regional competitiveness and employment, and CICASME, which is tasked with facilitating international and domestic business exchange, promoting the restructuring of SMEs in both regions 70 The European Social Fund from 2007; Summaries of legislation; http://europa.eu; 02 January 2006. 71 Hongjiang, Wang. "China Launches Projects to Help Children of Migrant Workers." 10 May 2008. www.chinaview.cn. 4 June 2008 <http://news.xinhuanet.com/english/2008-05/10/content_8142387.htm>. 72 Xu, Wang. "Call to Increase Welfare Spending." 22 April 2008. China Daily. 5 June 2008 <http://www.chinadaily.com.cn/bizchina/2008-04/22/content_6634585.htm>.


to hasten standards harmonisation and bolstering international competitiveness. This could yield policies and solutions that would assist companies that stand to face stiffer competition from more liberalised machinery trade to position themselves to compete more vigorously.

Enhancement measures

Achieve further progress in the field of technical barriers to trade in China

The liberalisation process linked with the PCA should be supported by flanking measures on technical barriers to trade that may not fall under the scope of the agreement, but remain crucial for European businesses (such as industrial safety requirements). Dialogue platforms have been set by the EU and China on technical regulation issues for industrial safety (for each sector, including machinery), however, this has not led to noticeable improvements on the ground. Given the high political sensitivity of the issue on the Chinese side, existing projects aimed at improving the Chinese administration’s capacity to enhance its conformity assessment system and achieve progress on standards harmonisation should be supported by an intensive political dialogue. Such cooperation should be held in a constructive manner and build upon past experience within the EU, in order to provide the Chinese side with concrete answers to the probable opposition of local manufacturers and conformity assessment bodies (such as testing laboratories, certification agencies and inspection bodies).

Support to improvement and enforcement of work safety regulations in China

Work safety, and decent work in general, are serious issues for China. The booming economy, fuelled by cheap and abundant labour, has not been accompanied by development of effective work safety frameworks. Both Chinese and foreign producers, all engaged in fierce competition and expected by consumers to ensure the lowest manufacturing costs possible, have invested minimally in work safety, decent work or workers’ well-being. Central laws and regulations have been issued but lack proper enforcement. 73 Therefore, a liberalisation process that would result in a greater market share for EU producers should be accompanied by measures – both in Europe and China – ensuring that these companies, as well as their subsidiaries and suppliers, comply with ILO standards. Furthermore, support should be provided under the “Governance” umbrella to the Chinese authorities to enhance the enforcement capacity of existing legislation and the issuance of new ones.

China has more deaths per capita from work-related illnesses each year than any other country, according to the ILO. In 2005, the most recent year for which data is available, 386,645 Chinese workers died of occupational illnesses, according to Chinese government data compiled by the ILO and cited in the 14 July 2006, Journal of Epidemiology. The number of workers living with fatal diseases does not include those who suffer amputations. Primitive, unsafe machines with blades that lack safety guards have caused millions of limb amputations since 1995, according to lawyers for Chinese workers.74

As policy makers work towards strengthening labour safety standards in China’s machinery sector, existing guidelines promoted through international organisations, such as the World Bank, can be

73 Yuchao Zhu, Workers, Unions and the State: Migrant Workers in China's Labour-intensive Foreign Enterprises, Development and Change, Volume 35 Issue 5 Page 1011-1036, November 2004 74 Pulitzer Centre for Crisis Reporting http://www.pulitzercenter.org/openitem.cfm?id=701


helpful in shaping policies to suit China. For instance, updated versions of the World Bank Group Environmental, Health, and Safety Guidelines (known as the 'EHS Guidelines') since 30 April 2007, highlight specific guidelines pertaining to occupational health and safety standards. These guidelines set broad standards and can be incorporated into China’s machinery industry. An overview and specific details are provided in the ‘EHS Guidelines’. The EHS Guidelines document suggests measures to ensure machine and equipment use and safety. For instance, proper drill benches and wagon drills are stated as preferable to hand-held drilling equipment. Similarly, the document also provides guidelines for the use of hydraulic jacks, breakers and hammers amongst a variety of other machinery types.75

While China ratified the ILO’s Occupational Safety and Health Convention 1981 (No 155) in 2007, there still remains a large scope to further reduce hazards in the machinery industry.76 Notably, a number of significant ILO workplace safety conventions have yet to be ratified by China. These include the Occupational Health Services Convention (No 161), which seeks to provide preventive health services to workers, and the Promotional Framework Occupational Safety and Health Convention (No 187), which aims to build comprehensive national policies that further promote, implement, and enforce an environment of improved worker safety through preventative health services. In addition to these broad conventions, a number of issue-specific ILO Conventions also exist whose ratification may improve the safety of workers within and beyond the machinery sector. These include the Radiation Protection Convention, 1960 (No. 115), the Occupational Cancer Convention, 1974 (No. 139), the Working Environment (Air Pollution, Noise and Vibration) Convention, 1977 (No. 148), and Asbestos Convention, 1986 (No. 162). Given the importance of worker rights and safety in Europe, and the frequent incidence of workplace accidents in certain sectors in China, China and Europe’s agreement in ratifying and fully implementing these conventions would be an important first step in the pursuit of greater workplace safety. 77 Furthermore, the framework provided by the World Bank’s EHS Guidelines, alongside initiatives by the ILO, may be informative and useful for taking China’s labour safety standards to the next stage.

Support for greener production

European companies currently must adhere to some of the highest environmental, safety and quality standards in the world to maintain their competitiveness in the European market. The EU has in fact set itself apart as the benchmark for product standards. Among the comparative advantages of the European production of machinery equipment are its environmentally friendly features, in particular improved energy efficiency. Liberalisation that would lead to a reduction of trade barriers of all kinds should logically result in a higher penetration of European machinery into the Chinese market. As a result, the machinery equipment field in China should become more environmentally friendly, especially since China has a great need to reduce the enormous energy demands of its industry. However, EU standards on emissions and pollution are not binding for producers who sell their products outside the EU. It may thus happen that they produce the same equipment with two different standards, in order to be able to sell at a cheaper price and therefore to remain competitive in third markets.

75 “IFC Environmental Health and Safety Guidelines” at http://www.ifc.org/ifcext/policyreview.nsf/Content/EHSGuidelinesUpdate 76 See ILO Database 2006 for further details. 77 Various EU member states have ratified all of the ILO conventions discussed, with the highest frequency of ratification in Sweden, Finland, Luxemburg and Germany.


While firms in developing countries may enjoy a significant competitive advantage from operating in markets that, generally, have more relaxed production and quality standards, they will face substantial obstacles entering the European market. Further, as incomes in the domestic market increase, tastes and preferences will likely change as well. Thus, companies with the capability to produce the superior product will see their market share grow. Companies that can match European standards would thus enjoy a competitive advantage in a maturing market. European companies would likely be eager to retain their position in this sector of the market rather than sacrifice brand image to cut costs and capture short-term gains in market share. To further spur a switch towards high efficiency production and machinery goods in China (and, indeed, in Europe) it is suggest that EU-China negotiations pursue an agreement which provides trade in certified environmentally friendly goods with preferential tariffs, investment rules and other financial and regulatory incentives. A number of detailed examples and suggestions are further provided in Section 5.2.3 Policy Recommendations for Environmental Goods and Services.

The positive outcomes of liberalisation in the machinery sector could be further enhanced by supporting high environmental standards for EU exports to China. Strategies on a fair and transparent transfer of greener technologies should also be pursued, seeking a way to support Chinese producers toward greener machinery, while respecting the interests of EU producers (i.e. without endangering their intellectual property). A set of measures should support the drive of China’s energy industry towards energy efficiency and environmental friendliness (through the power-generating equipment sector). Priorities could be set on the development of renewable energies and the modernisation of coal plants and the development of modern coal-fired power technologies.78

78 Considering the immense coal reserves of China, thermal power is likely to have the lion share in China’s energy mix for a long time, rendering unavoidable the development of new technologies for coal-fired power.


5.2 Environmental Goods and Services

5.2.1 Sector Background Overview

It is estimated that global trade in environmental goods and services exceeded US$613 bn in 2006, up from US$200 bn in 1990, with an average annual growth of 15% since 2000.79 Within this, developed countries have traditionally accounted for 90% or more of market share, however, saturation of developed markets since 2000 has lead to increasing growth rates in developing countries such as China and India.80 Between 2000 and 2001 sector growth was a mere 1.6% in developed countries, while it grew at an average of 7.5% in developing countries.81

The environmental goods and services sector at times presents conceptual difficulties to analyses, due to its relatively recent definition by the OECD in the late 1990’s and subsequently shorter history of data. Moreover, recent negotiations between the European Union, the United States, and third countries both in bilateral and multilateral forums have focused strongly on the ambitious expansion of the sector, from approximately 160 current goods and corresponding services under 10 subsectors to approximately 450. These new expansions are primarily due to the inclusion of a wide number of goods which reduce carbon emissions; a new subsector which previously played a much smaller role in the historical EGS sector compared to other goods and services related to more overt forms of pollution mitigation.

Due to the wider depth of literature based on the OECD definition, 160 goods and 10 service subsectors, that definition was used to analyse the baseline economic situation in the sector between the EU and China.82 Within this definition, six subsectors relating to traditional pollution monitoring, prevention and cleanup fall under the broad heading for Established Environmental Technologies, while another four which seek to reduce the environmental impact of a number of sectors, either in production processes or consumer use, fall under the banner of Environmentally Preferable Products (see Table 25).

Table 25: Classification of OECD Environmental Goods Subsectors

Established Environmental Technologies (EET) Environmentally Preferable Products (EPP) - Air Pollution Control - Wastewater Management - Solid Waste Management - Remediation and Cleanup - Noise and Vibration Abatement - Environmental Monitoring, Analysis and Assessment

- Cleaner Technologies - Water Supply - Renewable Energy - Heat and Energy Savings Management

79 USTR Schwab to Announce New Climate Initiatives for WTO. United States Department of State. Nov 30, 2007. Available at: http://www.state.gov/g/oes/rls/or/95967.htm Alavi, Rokiah. Tariff and Non-tariff Measures on Exports of Select Environmental Goods. ICTSD Programme on Trade and Environment, 2007 80 Alavi, Rokiah. An Overview of Key Markets, Tariffs, and Non-tariff Measures on Asian Exports of Environmental Goods. ICTSD Programme on Trade and Environment, 2007 81 UNCTAD (2003) Report of the expert meeting on definitions and dimensions of environmental goods and services in trade and development. 82 Please see the full Environmental Goods and Services study for a more thorough baseline analysis at



Due to the historical emphasis on the sector, developed countries such as those of the EU have traditionally held a strong trade advantage in the subsectors of EET goods, whereas developing countries typically have a stronger position in the relatively new sectors of EPP goods. Within the EU-China trade relationship a similar trend occurs, that until 2006 saw a consistent trade surplus for the EU. Overall bilateral trade in the sector has grown from € 2.6 billion in 1999 to € 12.3 billion in 2006, at an annual growth rate of 18.8%. In 2006, EET goods comprised approximately 86% of the trade compared to EPP’s 14%. Confirming global trends, subsectors where the EU holds a trade advantage are primarily in the EET goods, and include Solid Waste Management, Air Pollution Control, Environmental Monitoring, Noise and Vibration Abatement, and Cleaner Technologies.

Again confirming global trends, subsectors where China has performed well are primarily in the EPP category of goods, although wastewater management and remediation and cleanup goods are noted as two EET categories of Chinese strength with regards to trade. It should be noted that the Chinese surplus of € 555 million in 2006 is comprised of approximately 52% renewable energy goods, and within that 99% of these goods are in solar photovoltaic cells.

The EU’s large deficit in this sector, where bilateral trade has grown at 62.3% annually since 1999, is in fact believed to be largely the result of domestic policies within EU member states such as Germany and Spain which aggressively subsidise renewable energy in order to reach renewable energy goals – therefore the result is attributed to excess demand created by (German and Spanish) subsidies and the insufficient supply of EU renewable energy goods and technologies (given that Europe, and particularly Germany, has the highest solar energy capacity in the world). When viewing global production of solar cells, Europe produced approximately twice the number of photovoltaic cells than China in 2006, and was only outpaced in this figure by Japan in 2006, which has also pursued aggressive policy measures to ensure high uptake of solar energy. Notably, China’s rapid growth in production since 2005 led it to become the top global producer in 2007.83

Another import sector to explore further is Heat and Energy Savings Management, where below-market priced Chinese energy efficient light bulbs (CFL-I’s) have been a previous source of controversy. From 2001 a 66.1% anti-dumping tariff was imposed on CFL-i’s originating in China and from specific producers, on the grounds that government manipulation of the Chinese market was placing European producers at a disadvantage . It has been noted, however, that the EU is likely to be able to meet only 25% of its demand for energy saving light bulbs through domestic production and imports into the EU are required to meet Europe’s stringent RoHS standards which prompted the European Commission to recommend “in the Community's interest” to discontinue in 2008 the antidumping duties on Chinese light bulbs.84 Furthermore, a vast number of these goods are manufactured by European companies or their subsidiaries operating in China, further complicating analysis of the true economic benefits accrued through this policy.

83 Eco-Economic Indicators: SOLAR POWER, Earth Policy Institute, 27 December 2007 Report: Chinese solar cells swamping subsidized German market, The Earth Times, 28 March 2008 84 “European Commission proposes end to anti-dumping duties on energy saving lightbulbs in one year”, IP/07/1261


Social and Environmental Significance

Within China numerous health risks have been raised by the staggering level of pollution that has resulted from the countries rapideconomic growth. Across every environmental subsector the costs of inaction, and thus the accumulation of further pollution and environmental degradation, are staggering.

Air pollution continues to be an area of high concern, with the average Chinese city experiencing PM10 levels of two-to-three times that of larger European capitals. In 2005 only 22 cities in China, or 4.2% of those polled, met Grade I air quality standards which are derived from a mix of PM10, SO2 and NOX ratings. Notably, Chinese standards in all indicators do not necessarily meet the minimum environmental standards established in Europe, with Grade II (out of V) including PM10 levels which would be considered a high health impact by European agencies. High levels of SO2 pollution have also lead to acid rain at endemic levels across the country. It is estimated that in 2003 acid rain was the cause of over 80% of agricultural crop losses nationally, at a total cost of RMB 30 billion.85 Additionally, acid rain also causes material damages to buildings, at a cost of over RMB 7 billion the same year. Epidemiological research has found a consistent and coherent association between air pollution and medical conditions such as reduced lung functions, respiratory symptoms, chronic bronchitis, cardiovascular and cerebrovascular diseases and premature death. World Bank studies have indicated that the costs of healthcare due to diseases incurred by poor air quality in China may have been as high as RMB 520 bn in 2003, or 3.8% of GDP.86

Water pollution is another area of concern. In 2008 SEPA reported that 25% of all waterways in China were unfit for even limited human contact, failing to meet standards for even SEPA’s lowest water rating, Grade V.87 In recent years pollutants to waterways, historically composed primarily of industrial discharge, have increasingly originated from ‘nonpoint’ sources, particularly agriculture where use of nitrogenous fertilizer has grown by 40% and use of chemical pesticides has doubled from 1990 to 2004.88 Approximately 38% of China’s rivers and 75% of its lakes are severely polluted, while only 20% of water waste is treated in China, compared to 80% in most developed countries. Exacerbating the severity which pollution has on water resources is an increasing scarcity of water supplies. China’s per capita volume of water resources is small at only 2,170 cubic meters, equivalent to less than 28% of the world average. By 2030, when China’s population is expected to reach 1.6 billion, this figure will drop to 1,760 cubic meters, dangerously near the international water-shortage benchmark of 1,700 cubic meters.89 Around 700 million Chinese do not have access to drinking water that meets minimum purity standards, leading to a high prevalence of cholera and other waterborne diseases. Furthermore, between 300 and 500 million rural residents lack adequate sanitary facilities, aggravating the risk of contracting these diseases.90 Biological and chemical pollutants, which continue to contaminate China’s limited water supplies, have a number of major health implications to those who consume untreated water, including a variety of birth defects, cancers and other terminal health risks. It is estimated that in 2003 health complications raised by

85 The World Bank and State Environmental Protection Agency of the P.R.C., Cost of Pollution in China, 2007 86 The World Bank and State Environmental Protection Agency of the P.R.C., Cost of Pollution in China, 2007 87 Graham-Harrison, Emma. China says pollution goals low as unveils ministry. Reuters, 11 March 2008. Available at: http://uk.reuters.com/article/idUKSP25601120080311?sp=true 88 China Statistical Yearbook 2004 89 People’s Daily (5 June 2002) ‘Water Resources Set to Reach Critical Levels’ 90 The World Bank and State Environmental Protection Agency of the P.R.C., Cost of Pollution in China, 2007


water contamination cost Chinese citizens up to RMB 66 bn, although this figure notably excludes costs of cancer treatment.91

In 2005 China produced over 155 million tons of waste, surpassing the US’ 133 million tons, and well above the EU’s 114 million tons, to become the world’s largest producer of solid waste. 92 Urbanisation, urban population growth and increasing affluence are seen as the key determinants of China’s already significant growth in waste output and will continue to contribute to future solid waste growth. Solid waste is considered a multi-generational environmental problem due to the long decomposition time of many modern consumer goods, which coupled with growing waste production imply a potential solid waste crisis in the future if more efficient disposal patterns are not established. Within China, electronic waste is rarely disposed of in a responsible manner from a human health perspective. Because this re-collection is done in such a crude manner, workers are exposed to a variety of carcinogenic chemicals, such as lead, cadmium, phosphorus, polychlorinated biphenyls (PCBs) and polybrominateddiphenyl ethers (PBDEs). These chemicals are capable of causing stomach disease, lung disease, miscarriages, birth deformities and premature deaths.

Related to all forms of waste is the cost of cleanup. By the end of 2005 an estimated 40,000 square kilometres of land had been destroyed by unsustainable mining practices in China, prompting regulators in the Ministry of Land and Resources to establish new remediation funds in 2007, which will be composed of mandatory contributions from operators. 93 New regulations, which are currently available in draft form, raise fines on polluters by up to 2000%, with businesses expected to pay up to 30% of remediation costs.94

While China to date has been able to fuel its energy appetite primarily through increasing utilisation of coal, which rose by 350% between 1978 and 2005, energy supply shortfalls have become more frequent in recent years. In the summer of 2004, 24 of China’s 27 provinces experienced rolling blackouts, darkening first tier cities such as Beijing and Shanghai.

CFL-i light bulbs consume approximately 1/5 of the energy of a traditional incandescent bulb, although consumption patterns in Europe currently favour incandescent bulbs, which dominate about 80% of the European market, with more than 2 billion sold annually compared to 270 million CFL-i’s, primarily due to cost differences.95 Studies indicate that a replacement of incandescent bulbs with CFL-i’s would result in a reduction in European emissions of CO2 by 23 million tons per year, or 0.5% of annual European emissions, although European production is predicted to be capable of meeting only 25% of future demand.

Given China’s aforementioned environmental challenges, many of which are rooted in high energy consumption practices, energy efficiency and clean energy production are increasingly viewed as necessary pursuits by policy makers in China. Between 1978 and 2005 coal and oil’s contribution to overall electricity generation has declined from 94% to 89%, while energy from alternative sources rose from 3.1% in 1978 to 7.7% in 2005. 91 The World Bank and State Environmental Protection Agency of the P.R.C., Cost of Pollution in China, 2007 92 United States Environmental Protection Agency; China Statistical Yearbook 2006; Eurostats 93 Hornby, Lucy. China to require environmental deposits from mines. Reuters UK, 16 Nov 2007. Available at: http://uk.reuters.com/article/environmentNews/idUKPEK14536720071116 94 Xinhua. China’s environmental watchdog plans to raise fine on water polluters. 26 Nov 2007. Available at: http://news.xinhuanet.com/english/2007-11/26/content_7147127.htm 95 World Wildlife Fund. EU keeps unfair market barriers on energy-saving lamps. 29 August 2007. Available at: http://www.panda.org/about wwf/where we work/europe/news/index.cfm?uNewsID=112120


Legislation

In the absence of successful bilateral or multilateral liberalisation in the coming years, such as through the EU’s PCA mechanism or the WTO, change which will significantly affect the business climate in China’s EGS sector, from trade to investment to technical regulation, will be based upon unilateral, or domestic legislative changes.

In China’s 11th Five Year Plan (2006-2010) an entire chapter is devoted to resource conservation and the reconfiguration of society towards increased “environmental-friendliness”.96 Within the plan are numerous calls for reform, both institutional and market oriented, to reach these goals. With regards to air pollution a number of specific goals exist, including: the elimination of small (under 20 ton) coal boiling broilers; desulphurisation, de-nitrogenation, and dust reduction projects at remaining coal plants; increased vehicle emission standards; and reduction of dust originating from construction sites.97 In the area of water use, the 11th Five Year Plan again lists a number of substantive goals, among which are: restrictions on establishment of high water use industries, reduced agricultural water use through methods such as micro-irrigation and dripping irrigation, improving industrial water usage through adoption of high-technologies and liberalise the water pricing system to encourage conservation. With regards to solid waste, the 11th FYP calls for the construction of 21 new solid waste disposal facilities in Beijing alone. More broadly, similar centres are expected to be constructed as necessary in newly established cities, towns and villages nationwide, with an emphasis on using advanced research and development to boost the rates of industrial utilisation (i.e. recycling of wastes). The plan also requires an improvement of energy efficiency of 20% by 2010; however, this goal lacks clear steps to its realisation. SEPA has recently stated that due to poor compliance and missed goals in the first two years of the 11th Five Year Plan reductions in energy intensity would have to be raised by 5% annually, a highly costly and ambitious goal, to meet the 2010 target.98

Another key piece of legislation which will shape development of the environmental sector in China during the coming years is its newly released white paper on energy policy, ‘China’s Energy Conditions and Policies’. The paper reinforces a number of previous laws such as the Renewable Energy Law of 2005 and the Energy Conservation Law of 1997. China’s high dependence on coal, which accounted for 69.4% of energy resources in 2006, is targeted for diversification over the coming years towards a balanced energy composition from alternative sources, such as renewables.99 Under the 2006 Renewable Energy Law these goals are also outlined – in recent years wind power has received a majority of investment, with US$1 bn between from 2003 to 2008. Under the law, wind power generation capacity is expected to expand tenfold between 2006 and 2020.100

China has also enacted a number of efficiency enforcing laws. The China National Institute of Standardisation has passed regulation requiring a reduction in energy consumption by white goods,

96 The Outline of the 11th Five Year Plan. National Development and Reform Commission. Available at: http://en.ndrc.gov.cn/hot/t20060529 71334.htm 97 Beijing’s 11th Five Year Plan. Translation by Beijing Association of Enterprises with Foreign Investment, 29 March 2006. 98 Graham-Harrison, Emma. China says pollution goals low as unveils ministry. Reuters, 11 March 2008. Available at: http://uk.reuters.com/article/idUKSP25601120080311?sp=true 99 China’s Energy Conditions and Policies. Information Office of the State Council of the People’s Republic of China, Dec 2007. 100 Brent, Willam. Cleantech Boom… or Bust?. China Business Review, July/Aug 2007


televisions and lighting which will reduce residential power consumption by 10% by 2010.101 Building standards enacted in 2006 require buildings in Beijing, Chongqing, Shanghai and Tianjin to reduce energy consumption of new buildings by 65% and in other cities by 50%. Under the State Council’s Energy Conservation Law, 25% of buildings are expected to be renovated by 2020 to meet efficiency standards. The Ministry of Housing and Urban and Rural Construction has noted that on average Chinese buildings consume 2 to 3 times more power than equivalent buildings in other countries; an estimated 10% reduction in residential electricity demand would offset construction of some 30 coal fired power plants.102 Ongoing Ministry of Construction research indicates that only 53% of new building projects meet national energy standards, while 99% of existing building infrastructure fails to meet standards.103

5.2.2 PCA Scenarios Impacts of PCA Scenarios

Economic Impacts

Within the liberalisation scenarios, growth in China’s environmental goods and services sector is expected to be robust over the following 3 years (see Section 6. TAPES/Partial Equilibrium Model for Commodity Sector Studies). Within the theme of Economic Structure, trade flows are expected to change significantly under the various scenarios. Notable features of trade flow adjustment under the scenarios include: significantly faster growth of imports into China of goods and services in the subsectors of Air Pollution Control, Wastewater Management, Noise and Vibration Abatement, Cleaner Technologies, Water Supply, and Heat and Energy Savings Management. Meanwhile, under trade policy only scenarios, Chinese export growth to both the EU and rest of world is expected to be positive, although growth will be far milder than imports, resulting in an overall decline in the Chinese trade balance. In the ambitious liberalisation scenarios with fast growth, Chinese exports also continue to grow, but again to a lesser degree than imports, resulting in a reduction of the Chinese trade surplus. Notably, trade diversion appears to occur in the environmental goods sector under the ambitious scenario, with previously balanced trade between China and the rest of world now being increasingly dominated by reduced tariff goods from the EU. While this creates a more affordable environmental sector for consumers within China and the EU, this trade diversion may come at the cost of implementation of environmental services in third countries, as well as the use of more efficient environmental goods from elsewhere.

With regards to Consumption and Production Patterns, patterns of energy use and waste generation and management will improve within both the EU and China under the first three policy scenarios. These estimate that overall levels of production will decline throughout the sector in China, while overall demand (and thus usage) of solid waste management and renewable energy goods will climb slightly under the ambitious scenario. Within the ambitious scenario with structural change a more ambiguous picture is created – renewable energy goods and solid waste management goods enjoy even large growth in demand in China, although this is met to a larger extent through Chinese supply, which may imply increased manufacturing activity of a lower

101 Ibid 102 Ibid 103 Fu, Jing, Yu, Tianyu. Half of new buildings fail energy standards. China Daily, 14 Jan 2008. Available at: http://www.chinadaily.com.cn/bizchina/2008-01/14/content 6391282.htm


environmental standard in China than under policy scenarios where goods are increasingly manufactured in European factories. Given the large changes in (i) import growth, (ii) Chinese demand growth, and (iii) Chinese production growth in these sectors, it is difficult to determine which change will have a greater effect; the confidence intervals on any estimates are very broad.

Social Impacts

Although the beneficiary of environmental goods and services is obviously the environment itself, and hence human welfare, a number of knock-on effects exist in the realm of social impacts. With regards to Equity within the trade policy only scenarios, overall production within the sector in China is expected to decline, while total imports into China will rise significantly and total exports from China will rise only marginally. This implies that under these scenarios an increasingly competitive market environment will emerge, wherein reduced market distortions from tariff and non-tariff barriers allow the most competitive actors in both the EU and China to operate more freely. Within this environment, overall production may contract in China as less efficient operators go out of business, placing pressure on effected workers. Simultaneously, access to and quality of environmental services is expected to increase dramatically, with many effects felt across all levels of society. Many environmental services are managed through government procurement and have basic universal service requirements (e.g. water). Further, the nature of their implementation produces broadly felt effects (e.g. a reduction in air pollution in an urban area). Hence, the increased demand and market access of these goods and services is expected to enhance welfare widely, accompanied by possible positive feedbacks in the areas of gender equality, which has previously been found to improve with higher energy availability and security as it reduces the amount of time required on basic survival activities in the household (gathering burning fuel, fetching water, etc).104 Moreover, China census data indicates that in the environmental services sector of the economy women contribute 40% of the labour force.105 This is notable as localised environmental services are expected to expand with the increased availability of internationally traded environmental goods, and may have positive employment effects for female workers.

With regards to Health, a number of positive effects are expected to result from any of the proposed policy scenarios. With growth in goods and services related to air pollution and waste water reduction expected in the Chinese market, mortality from air and water pollution as estimated by the World Bank to decline in relative terms. Water supply and waste water treatment facilities will expand in their capacity and areas of coverage, leading to improved access to sanitary sources of water. Notably, a change in the current regime of subsidisation of water prices in China may be a double edged sword which both spurs private investment in infrastructure while also excluding low income earners from basic water rights. Increasing use of solid waste management goods and services, through the increased use of recycling, land-filling, and incineration, is expected to improve overall sanitation in the country; although notably certain lucrative niche sectors such as e-waste processing may remain in the black market, unless there is an increased regime of legislative oversight and enforcement.

104 Gender, Poverty and Environmental Indicators on African Countries 2008, African Development Bank Group. Available at: http://www.afdb.org/portal/page? pageid=473 18884240& dad=portal& schema=PORTAL 105 Employment by sex and detailed occupational groups, International Labor Organisation, Labor Stats, Accessed 15 July 2008


In the area of Labour, impacts are again mixed in their direction, although magnitudes are perceived to be relatively small. With production in China experiencing slight declines in the trade policy only scenarios, pressure is expected to increase on labour markets which are already in a state of flux in China’s manufacturing sector, possibly leading to increased unemployment and a decline in job stability in manufacturing. Meanwhile, increasing use of labour intensive environmental services, such as solid waste collection, will likely see employment rise, however the average skill level of these jobs and therefore their wage opportunities is unclear.


With Chinese domestic demand (absorption) of environmental goods growing in all sectors, even in modest scenarios, the environmental impact of any PCA including the sector is expected to be largely positive. Under the theme of Atmosphere, more affordable and available air pollution control goods will lead to improved urban air quality conditions in key areas such as particulate matter (PM10), sulphur dioxides, and nitrogen oxide, and as defined by the WHO, an area where China is currently in dire need of improvement. With Chinese demand and imports growing in this sector under all scenarios, these benefits are expected under all scenarios but to varying degrees. With regards to CO2 emissions a positive or negative impact is not certain. Under the trade policy only scenarios, Chinese production (which is known to be particularly energy inefficient) is expected to decline, while absorption of renewable energy goods is expected to climb. Within such a change it is likely that overall CO2 emissions will decline in China, although the opposite may be true in Europe as production increases to expand into new markets in China. Under the more optimistic growth scenarios, however, Chinese production will grow in all sectors while implementation of renewable energy goods will increase dramatically, making it difficult to assess which impact – CO2 emitting production or CO2 reducing renewable energy – will have a greater overall influence. Here it is necessary to recognise that a key component of reducing CO2 emissions will be ensuring a lower CO2 footprint not only in alternative sources of energy production (i.e. renewables) but also in future production processes using conventional technology.

In the Fresh Water theme, improved waste water treatment systems are expected to reduce the need to draw water from fresh sources, such as ground water and river systems, while also helping reduce the amount of algal blooms and other chemical related ecological disasters which have occurred regularly in China in recent years. If growth in the water supply subsector follows a path of efficiency, it is probable that the reversal of currently wasteful water use and distribution methods in key sectors, such as the agriculture sector, will contribute to a lower overall demand for water per capita. It is also possible, however, that access to improved technologies and services in the subsector of water supply will speed the implementation of major water transfer projects within China (from wet Southern regions to dry Northern regions), which could exacerbate already existing international tensions with regards to water rights for key transnational water systems in China, such as the Mekong River System (China’s Nu River). These effects combined could possibly slow or even halt the falling of water tables in key sensitive regions. In the environmental theme of Land, mitigation of ongoing desertification is a likely knock-on effect of improved stewardship of water resources, although the degree to which improved water use efficiently can counter a growing population’s water use is uncertain. Overall, the mitigation of key emissions and ecosystem erosion


may lead to a more secure level of Biodiversity, however these effects again are difficult to predict with a large degree of confidence.

A summary of impacts is provided in Table 25.Please note that impacts are derived from trade policy only scenarios, while projections scenarios help determine the feasible reversibility and capacity to change within a sustainable development theme.

Table 26: PCA Summary Impacts Table – EGS (China)

Existing Conditions


Indicator Overall Direction Magnitude


Economic Economic Structure + Y M Consumption and Production Patters

-- Y H

Social Equity -- Y L Health -- Y H Labour - Y M Gender Equality - Y M Environmental Atmosphere -- Y M Land -- Y L Fresh Water -- Y M Biodiversity -- Y H Table 27: PCA Summary Impacts Table – EGS (EU)

Existing Conditions




Economic Economic Structure - Y M Consumption and Production Patters

+ Y H

Social Equity 0 Y L Labour 0 Y L Environmental Atmosphere + Y H

5.2.3 Policy Recommendations Brief on EU internal policy measures

Environmental standards and policies in EU member states are harmonised through an extensive body of European legislation (the environmental acquis communautaire), comprising approximately 100 directives, 50 regulations, 250 decisions and 200 other relevant texts.106 All EU directives are binding on member states, with flexibility in their implementation in national law. Framework

106 Commission of the European Communities (2008) Directory of Community legislation in force, Chapter 15.10 Environment, 1.03.2008, http://europa.eu.int/eur-lex


directives set out general principles, procedures and requirements that must be complied with by subsidiary directives and laws. EU regulations apply directly in all member states and supersede any conflicting national laws. EU decisions are binding on the parties to whom they are addressed, and generally specify detailed administrative requirements or technical aspects of regulations or directives.107

Horizontal legislation relating to general environmental management issues includes directives on access to environmental information, environmental impact assessment and strategic environmental assessment. Specific legislation covers: air quality; waste management; water protection; nature protection; industrial pollution control and risk management; chemicals and genetically modified organisms; noise from vehicles and machinery. Legislation in some of these areas excludes those aspects covered by other areas (e.g. air quality and water protection for industrial plants are covered by the legislation on industrial pollution).

EU environmental law either implements or promotes four main types of instruments in pursuit of environmental goals:

• Command and control (or regulatory) instruments prohibit certain activities and place constraints on others. These include regulations related to pollution control, the designation of protected species and controls on their exploitation. Pollution prevention and control instruments include many thousands of detailed standards covering production processes and permissible levels of pollutants in emissions, discharges and wastes.

• Planning instruments complement regulatory instruments, and deal in particular with non-pollution types of impact. They include designation of protected areas, land use or spatial planning, minerals planning, water resource planning, environmental impact assessment and strategic environmental assessment.

• Economic instruments include licensing charges for pollution permits, application fees for planning approvals, fines for non-compliance, taxes, subsidies and emission trading schemes.

• Voluntary codes and practices promoted through EU legislation and policy include product labelling schemes, certification schemes for sources of supply, cleaner production technology and environmental management systems.

The requirements of regulatory instruments and planning instruments generally create economic incentives for environmental stewardship by producers, consumers or both. For example, the EU directive on landfill of waste banned landfill disposal for certain types of waste and required considerable reductions for others, thereby creating economic incentives for recycling and for the use of preferable methods of disposal. These and other instruments which create economic incentives include:108

• licensing charges for pollution permits

• financial liability legislation e.g. for contaminated land

• application fees for planning approvals

• fines for non-compliance with command and control or land use regulations

• taxes on the use or disposal of polluting products

107 Commission of the European Communities (2003) Guide to the Approximation of European Environmental Legislation, SEC(97)1608, updated December 2003 108 Ravetz J, George C and Roberts P (2008 forthcoming) Environment and the City, Routledge, London


• environmental protection subsidies and grants

• government spending on environmental improvement

• emission trading and other impact trading schemes

All of these instruments cause changes in costs or prices and hence influence producer and consumer preferences. Some contribute directly to remediation. Fees charged for industrial discharges into the public sewage network are typically at least equal to the cost of removing the pollutants in a municipal treatment plant. The cost of the necessary monitoring may also be recovered through the fees charged.

Subsidies can be an effective way of easing the transition to a new regulatory control (e.g. when a particular activity is banned), or of stimulating the development of new technologies or techniques. They can, however, have perverse effects if applied beyond short term intervention.109 The EU’s biofuels directive has been subjected to considerable criticism on these and other grounds.110

Market-based economic instruments such as emissions trading can be an economically efficient way of reducing pollution, by allowing the most efficient producers to sell their emission rights to less efficient ones. The US has used such instruments effectively for the reduction of sulphur dioxide emissions. The EU Emissions Trading Scheme has been described as the centrepiece of European efforts to reduce greenhouse gas emissions, although the scheme is still in its infancy and has yet to achieve significant emission reductions.111

Brief on policy measures in China

Compared to other developing countries, China possesses an extensive legal regulatory system with more then 2000 laws issued in the area of environmental protection, which in theory, should safeguard the environment. Provisions for environmental management are included in the regulations at state, provincial and local levels with more than 30 environmental administrative regulations, more than 70 rules, and about 400 national environmental standards.

The regulatory and enforcement framework developed in China for industrial pollution is quite comprehensive as it includes command and control, economic, and other instruments. The system has been continuously updated and expanded to improve effectiveness and cover priority issues. Experimentation in pilot projects has helped improve the design of new approaches. However, the system suffers from a number of shortcomings.

In principle, China’s laws on environmental protection contain general requirements with which the regulated community should comply. They are not, however, supported by implementation regulations which further define the responsibilities of various parties and make detailed implementation provisions. For example, environmental protection departments cannot enforce the law effectively, as the legal basis for their actions is lacking. In some cases, such as in the pollution levy system, fees are established by administrative order rather than by higher level laws approved by the State Council. This leaves regulations open to challenge by enterprise managers, given the

109 Global Subsidies Initiative, http://www.globalsubsidies.org/ 110 Doornbosch R and Steenblik R (2007) Biofuels: is the Cure Worse Than the Disease? Report SG/SD/RT(2007)3, OECD, Paris 111 Stern N (2006) Stern Review on the Economics of Climate Change, Cambridge University Press, Cambridge, Chapter 15


lack of appropriate binding legal status. In addition, related instruments, such as permits and pollution levies, are not always consistent, which makes the system difficult to administer.

A further issue relates to the opaqueness of the enforcement system and the discretionary application of environmental standards. Whilst in principle all firms are required to meet national standards of pollution discharges, which are subject to environmental regulations, environmental protection enforcement personnel must exercise discretion consistent with local government‘s policies and priorities. Although the environmental protection agencies issue notices to collect discharge fees, the amounts of fees is generally negotiated rather than calculated using formulas detailed in regulations. In fact, the choice of enforcement action has more to do with the particular case at hand than the strict compliance with environmental rules.

A related issue is that although Chinese laws and regulations provide environmental agencies with some administrative powers, such as the authority to issue warnings and impose an administrative fee in cases of minor non-compliance; they do not have adequate instruments to address serious non-compliance. For example, they cannot shut down production lines or whole enterprises, suspend accounts of enterprises, or order people to be detained for serious breach of environmental regulations leading to casualties. This is in contrast with the taxation, commercial and industrial government departments that do possess such powers. It is not yet clear that the growth-at-all-costs mentality set in place by China’s original reforms has been replaced by the logic of sustainability, especially at the working level of bureaucracy. The two continue to coexist.

Finally, in China there is limited involvement of courts in addressing conflicts and penalizing non-compliance. Civil society, in the form of the media, the legal system and NGOs, has not been encouraged to help hold local officials accountable for wrongdoing.112

Mitigation

A. Measures related to trade negotiations, bilateral agreements and international mechanisms

Water resources

The assessment of the PCA scenario indicates that EGS liberalisation will contribute to improved efficiency in water resource utilisation, but with potential adverse social and environmental effects. A change in China’s water subsidy regime associated with liberalisation could lead to the exclusion of low income earners from basic water rights, while access to improved technologies and services may stimulate water transfer projects that exacerbate international tensions over transnational water systems.

Parallel measures for cooperative action within the PCA may be developed both to counter the adverse effects and enhance the beneficial ones. Such measures may for example include:

112 Elizabeth Economy, “China Vs. Earth,” The Nation, 21 April 2007. Available at: http://www.thenation.com/doc/20070507/economy.


• Joint action in developing regional cooperation on the environment, with particular emphasis on transnational water resources.

• Joint programmes in collaboration with EU and Chinese industries to apply improved EGS in areas of high water stress.

• Technical assistance with revising China’s water subsidies and regulatory regimes with the specific objectives of maintaining and improving supply to low income earners while achieving greater utilisation efficiency.

• Phasing of EGS liberalisation to coincide with appropriate revisions to subsidies and regulatory regimes.

Employment levels and labour conditions

The impact assessment for the PCA scenario has indicated a decline in overall levels of production in several EGS sub-sectors in China, at least in the short term. Less efficient operators may contract or go out of business, placing pressure on affected workers.

In services such as solid waste collection a rise in employment is projected, but with wage opportunities that are unclear.

Any adverse impacts on employment levels and conditions are expected to be relatively small and short-lived in the context of China’s rapid industrial growth, through which many new employment opportunities are being created. Nonetheless, cooperative measures may be developed which would counter any adverse effects of EGS liberalisation while at the same time promoting improved labour standards throughout Chinese industry. Such measures may include:

• Reinforce existing cooperative programmes on employment, labour legislation, social dialogue, social protection and social cohesion (including the Decent Work initiative).

B. Internal policy measures

Improve regulatory oversight

In many ways China has already begun a progressive overhaul of its environmental laws over the past decade. Notably, however, its primary regulatory body, the State Environmental Protection Agency, is often noted as underfunded and understaffed given the sheer size of China coupled with the extent of environmental issues to be tackled. For comparative purposes the United States EPA, which oversees approximately the same amount of land, employs approximately 17,000 full time employees involved in research, formulating policy, monitoring and enforcement.113 SEPA currently employs approximately 200 employees, and is expected to grow to perhaps 400 during 2008.114 To China’s credit, however, following the 11th National People’s Congress, SEPA was officially granted ministry status in a move to strengthen enforcement across the country, with experts noting that a

113 China’s green eyes focus on protection. BBC, 5 Dec 2006. Available at: http://news.bbc.co.uk/1/hi/world/asia-pacific/6157451.stm 114 Sanderson, Henry. China Environment Agency Gets More Power. Associated Press, 1 March 2008. Available at: http://ap.google.com/article/ALeqM5icPw8BwDs4EYOrcM2Xe3KOGqPw5gD8V44VN01


number of environmental goals in the 11th Five Year Plan, such as pollutants and energy intensity reductions, were falling behind schedule and would need significantly higher enforcement.115 While the upgrade of SEPA’s official role in the government hierarchy is welcomed, it is noted that no concrete plans have been stated as to expansion of the new ministry’s manpower or operating budget, both seen as critical in improving oversight. There also remains inconsistency of environmental regulatory enforcement at regional and local levels. European best practices could be transferred to the newly empowered regulator, the Ministry of Environmental Protection (MEP), through a series of capacity building programs that would couple European institutions, such as national environmental regulators, with Chinese stakeholders.

Work should be undertaken to improve the technical capacity of the Ministry of Environmental Protection’s Bureau of Environmental Supervision, the MEP’s regional centres, and provincial Environmental Bureaus.116 Training should be geared towards enforcement of existing laws, which are quickly improving in design but lacking in implementation.117 Where possible, manpower should be increased, or alternatively ICT should be leveraged to better improvement the enforcement capabilities of current staff. Indeed, SEPA and the new MEP have identified the need for a country-wide, integrated system of pollution monitoring and reduction to combat current problems with ‘defective statistic[s]… [and a] weak monitoring capability’. Within this the MEP has noted a need to improve ‘hardware capabilities’, such as online monitoring systems, direct supervision capabilities at key sites of pollution, and an improvement in statistical methods and information distribution. ‘Software capabilities’, i.e. management methods, have also been identified as needing improvement.118

Appropriate compliance assurance strategies should be developed which enable strict and timely response to non-compliance, while creating fair incentives to improve compliance and reward for better environmental behaviour. At the same time, however, the discretion of enforcement personnel should be limited and described precisely in regulations.

Raise public awareness

More use could be made of engaging Civil Society to achieve compliance with environmental regulations. Implementation of such a policy would require awareness-raising campaigns and capacity building efforts. The China Environment Culture Promotion Association (CECPA), previously under SEPA, has conducted public awareness surveys in major Chinese cities annually since 2005. Early 2008 results revealed that public awareness rated 42.1, public action 36.6, and public satisfaction 44.7 on a 100 point scale, with only 13% of respondents indicating they felt they personally were playing a role in improving the environment.119 The survey revealed that Harbin, Guangzhou, Shenyang, Changsha and Changchun rated lowest in public satisfaction; Chongqing, Chengdu, Xining, Lanzhou, and Yinchuan lowest in public action; and Hefei, Wuhan, Beijing, Jinan,

115 Graham-Harrison, Emma. China says pollution goals low as unveils ministry. Reuters, 11 March 2008. Available at: http://uk.reuters.com/article/idUKSP25601120080311?sp=true 116 About MEP Internal Departments, Ministry of Environmental Protection, 12 July 2007. Available at: http://english.mep.gov.cn/About_SEPA/Internal_Departments/200707/t20070712_106638.htm 117 Vice Minister Zhang Lijun, To establish monitoring and evaluation system for pollution reduction and strictly enforce accountability system and veto system, 4 December 2008. Available at: http://english.mep.gov.cn/Ministers/Speeches/200801/t20080121 116577.htm 118 Ibid 119 Interview with Secretary General Wang Panpu, 8 January 2008 Sun Xiaohua, Public yet to read the green of environment, China Daily, 8 January 2008. Available at: http://www.chinadaily.com.cn/cndy/2008-01/08/content 6376520.htm


and Lanzhou lowest in public satisfaction. Cooperation could be fostered with the MEP’s Department of Education and Communications to improve public awareness and dissemination programs.120 Campaigns which educate consumers of the impact of their consumption choices, such as the FAO’s ‘Virtual Water’ educational posters, are particularly recommended by this report.121

Encourage market restructuring

For an improved trade regime in environmental goods and services to be fully utilised and environmental stewardship to more meaningfully take hold in China, it is important to further increase the already rising requirements on China’s most notoriously polluting industries. In many ways this is already taking place, evidenced by changes in encouraged and restricted investment, chemical plant closures following public health disasters, and the growing influence of SEPA. While restrictions and fines are one key means of discouraging new polluters from setting up factories, it is important to also encourage current polluters of all sizes to adopt more efficient technologies which will significantly reduce their environmental footprint. Prior studies have shown that China’s industry is approximately 4 times more energy intensive than Germany’s, with efficiency gains of up to 50% expected should the most environmental sound technologies and practices be implemented.122

In addition to encouraging clean energy and efficiency improvements through feed-in tariffs and subsidies, it is also important to eliminate subsidies to currently polluting industries. In the areas of energy, steel, water and agriculture high pollution or intense resource use is partially encouraged by current subsidy regimes.123 Furthermore, China’s quantitative limits on foreign trade and investment in the segment of renewable energy can be viewed as a disincentive to providing environmental services. For example, since 2005 a number of measures have been taken to increase local content in wind projects, including a minimum requirement of 70% domestic ownership, 3% tariffs on individual turbine parts, 8% tariffs on imported assembled parts, and 17% tariffs on pre-assembled turbines, essentially requiring domestic assembly or production to remain cost competitive.124 While quantitative barriers such as this are designed to improve local capacity, this report observes that they may ultimately slow the rate of renewable energy growth.

Within Europe, many programs which encourage clean technologies and discourage dirty industries are already in place. Indeed, Germany is home to what is viewed as the world’s most successful feed-in tariff on solar electricity, which has played a significant role in the country installing the highest amount of solar capacity since 2003, ahead of the world’s number two, Japan, by a factor of 3 in 2006 and 2007.125 Market pricing options for water consumption and trading also provide

120 About MEP Internal Departments, Ministry of Environmental Protection, 12 July 2007. Available at: http://english.mep.gov.cn/About SEPA/Internal Departments/200707/t20070712 106640.htm 121 ‘Virtual water’ represents the total amount of water (generally in litres) that a end product required in its production processes. The FAO’s program uses graphical posters to highlight the water requirements for basic consumer goods which are not normally in the public consciousness. Water Development and Management Unit, Food and Agriculture Organisation. Available at: http://www.fao.org/nr/water/index.html 122 Environmental sector China. Deutsche Bank Research, 28 February 2006. 123 Environmental sector China. Deutsche Bank Research, 28 February 2006. Haley, Usha. Shedding Light on Energy Subsidies in China: An Analysis of China’s Steel Industry from 2000-2007. Alliance for American Manufacturing, 8 Jan 2008. 124 Steenblik, Ronald, Liberalisation of Trade in Renewable-Energy Products and Associated Goods: Charcoal, Solar Photovoltaic Systems, and Wind, OECD Trade Directorate, December 2005 Pumps and Turbines, 125 Dorn, Jonathan. Solar cell production jumps 50 percent in 2007. Earth Policy Institute, 27 December 2007. Available at: http://www.earth-policy.org/Indicators/Solar/2007.htm


encouragement mechanisms for productive and efficient water usage by industry and households. This should be analysed for further application in both the European and Chinese context.

Adopt standards appropriate to regions

Many of China’s environmental problems are nationwide or require national initiatives, e.g., in energy production, solid waste disposal or air pollution control. However, in the case of water access, the dry north faces significant challenges in the coming decades which are not relevant to the comparatively wet south. In the north, water conservation and efficiency programs are viewed as crucial in tackling this problem, especially with the likely rapid decline of water tables with climate change.126 Studies show that public awareness and education are critical to solving such problems, while researching and adopting increasingly efficient water technologies, both for industrial, agricultural and home use, is equally important.127

126 Wang, Jinxia, et al. Can China Continue Feeding Itself?. The World Bank Development Research Group, January 2007. 127 Ibid


Enhancement

A. Measures related to trade negotiations, bilateral agreements and international mechanisms

Improve the Classification and Recognition of Environmentally Friendly Goods

Within the Doha round of WTO negotiations, a number of countries have proposed various means of classifying environmental goods for the purpose of reducing or eliminating tariff and non-tariff barriers, including a proposal from China on establishing two lists, one for all, comprised of all environmental goods to be (“Common List”) and one for developing and least-developed countries

comprised of sensitive goods (“Development List”). Overall, however, implementation of such lists has proven divisive, as many developing countries allege that developed countries with strong EET industries will enjoy a majority of the gains under liberalisation using the current Harmonised System. Countries such as India have proposed alternatives to the rigid list of goods method, such as the project scheme whereby individual ‘green’ projects are to be granted better market access and reduced tariffs. However, as well as being highly subjective, some find this scheme to be no different from current government abilities.

A proposed alternative is to grant preferential market access to EET and EPP in the PCA context using clear, objective criteria. Significant differences between the two product categories, especially in their end use, make it necessary to establish different sets of criteria in order to remain both objective in ensuring open trade with environmental benefits and address concerns about broadly grouping non-environmental goods in tariff reductions. In the case of EET, it is generally infrastructure projects that package engineering services with their construction. These EET goods and projects also often include products, such as piping or chemicals, whose environmental user-friendliness is hard to identify in customs checks. EPP goods on the other hand are primarily end use consumer goods which achieve environmental goals through reducing the resources used in day to day activities. Notably, in this proposed methodology, renewable resource management goods, such as solar cells and related products, typically considered an EPP, will be grouped with EET due to their similarities as large, infrastructural projects as opposed to individual

Figure 3: EU and China Energy Label Schemes


consumption.

In the case of EPP goods, it is suggested that a bilateral dialogue establish clear guidelines whereby energy efficient products would enjoy increased market access between the EU and China. Under each countries’ current energy labelling scheme, which are similar in execution, products warranting the highest efficiency (dark green) would enjoy tariff free market entry (see Figure 3). Furthermore, guidelines could be established where lesser ratings (i.e. light green through yellow) would receive ad valorem tariff reductions between 25-75%. Finally, products considered to be energy inefficient (orange through yellow) could face increased tariffs, albeit on a small scale (e.g. a 5-15% ad valorem equivalent increase). This would encourage both EU and Chinese producers to compete for ever higher efficiency ratings to the benefit of consumers in both the EU and China, and bring the two regions to conform more closely in standards and testing.

In the case of EET (including renewable energy plants), intermediate input goods face the definitional difficulty of often having multiple uses. One such example is piping, which could be used in either a polluting chemicals factory or in a wastewater treatment facility. The same issues exist for many of the goods in similar industries, such as turbines for renewable energy, chemicals and incinerators for solid waste treatment, and measuring equipment for environmental monitoring. In all cases these goods could be used either for environmentally beneficial purposes or in more conventional, industrial applications. As opposed to granting free market access on a project by project basis, it is proposed that in both the EU and China environmental industries are granted licenses designating them as providing environment improving infrastructure and related engineering. This license could be granted as part of the development application process. Those licensed industries would enjoy free movement of certified project engineers, allowing foreign operators from both the EU and China to bring best practices to target markets, ensuring both high quality and cost-effective service provision.

Climate change

The trade liberalisation measures in the PCA are expected to have mixed impacts on climate change, with greater use of energy efficient and low carbon technologies accompanied by greater economic growth and increased energy demand. The major role that EGS can play in reducing greenhouse gas emissions will be only partly facilitated by the liberalisation measures under negotiation. Their contribution may, however, be enhanced by joint measures within the PCA for EU-China cooperative action on climate change, with particular emphasis on the development and application of appropriate EGS.

Any such cooperative action should address greenhouse gas emissions in both the EU and China, and take full advantage of their respective strengths in the development and provision of EGS. Such measures may for example include:

• Cooperative development of energy efficiency policies in the EU and China which maximise the use of each other’s strengths in the provision of EGS.

• Joint funding in collaboration with EU and Chinese industry of R&D technology projects for carbon capture and storage and other innovative low carbon or energy saving initiatives.


• An agreement on technology transfer which provides stronger enforcement of intellectual property rights along with preferential access to specified EGS related to climate change, based for example on the WTO provisions for access to medicines.

• Cooperation in the development of EGS standards and technical regulation, with particular emphasis on EGS related to climate change.

• Consider developing a joint approach to including China in the EU’s Emissions Trading Scheme, with special provisions for each party’s emissions in the production of goods supplied to the other.

• Develop joint approaches to international agreements and action under the United Nations Framework Convention on Climate Change.

Urban environmental quality

The trade liberalisation measures for EGS in the PCA scenario are expected to have strongly beneficial effects on efforts to improve the urban environment in China, in regards to air quality, water quality and the minimisation and disposal of solid waste. In itself, however, the impact of EGS liberalisation is unlikely to be sufficient to counter the growing pressures on the urban environment resulting from China’s rapid industrialisation and economic growth.

Parallel cooperative measures within the PCA may be developed to further enhance the contribution of improved EGS to improving the Chinese urban environment. Such measures may for example include:

• Technical assistance with streamlining China’s environmental legislation and regulatory bodies, with the specific objective of increasing the cost-effectiveness of regulatory personnel, with particular emphasis on their promotion of better use of EGS.

• Technical assistance with the development of information technology systems to support a streamlined and strengthened environmental regulatory regime.

• Programmes for exchange of personnel between EU and Chinese regulatory authorities to promote improved knowledge and experience of efficient and effective regulatory systems, including standards and approaches for regulating the use of EGS.

• Joint research programmes on the development and application of EGS to the specific needs of the Chinese environment.


Adopt international environmental standards

As previously noted SEPA’s environmental standards are often weaker than international standards. One such example is air quality ratings, where grade I and II, often considered acceptable through their grouping, are actually significantly weaker than similar ratings in Europe. Under the EU’s Ambient Air Quality standards PM10 levels may not exceed 50 um for more than 35 days in a year, or an average of 40 um over one year.128 SEPA standards, on the other hand, considers PM10 levels

128 Environment – Air Quality. Europa, 6 December 2007. Available at: http://ec.europa.eu/environment/air/quality.htm


under 100 um as ‘good’ or ‘excellent’, while ratings under 200 um are considered only slightly or lightly polluted, with no stipulation of the maximum number of occurrences permitted in one year.129 In order to foster a business environment where environmental stewardship is valued, it is not only important to reduce the cost of such actions but also mandate them by adopting standards in all waste categories which maximise benefit to the environment. A joint World Bank-SEPA report notes the staggering healthcare costs of pollution, which provides ample reason for a more preventative stance on environmental pollution.

This report acknowledges that much progress has been made in the areas of environmental protection in China in recent years, with growth in the scope and power of SEPA into the MEP, improved environmental standards in areas such as chemicals management,130 a reduction in the growth rate of pollution, and an improvement in the regulations restricting high impact industrial activities.131 Unfortunately, some environmental standards in China are over a decade old and reflect the institutional capacity of a China very different from today’s.132 This report suggests that China’s environmental standards be made compatible with international standards, such as those outlined by the World Bank or World Health Organisation, in order to ensure that enforcement of regulations provides citizens an environment conducive to public health. 133

Internalising environmental costs

Previous studies have indicated that in order to fully enjoy the benefits of a liberalised EGS sector, market mechanisms that include historical externalities in the price of goods, utilities and services must be put in place.134

Environmental standards and policies in China are in part similar in principle to those in the EU, employing a similar range of instruments. One difference lies in China’s considerably smaller Gross National Income per capita, which results in correspondingly smaller government expenditure per capita, and correspondingly underfunded regulatory capacity. A recent OECD review reports that China has a much stronger regulatory regime than many other developing countries and has made

129 Technological Rules Concerned "Ambient Air Quality Daily Report”. National Environmental Monitoring Centre, State Environmental Protection Agency. Available at: http://www.sepa.gov.cn/english/airqualityinfo.htm 130 At least 10 new chemicals management regulations, circulars, or guideline documents were released within 2007, with new programs integrating international chemicals management best practices with the assistance of Japan and South Korea. Chinese Chemicals Management Regulations, Ministry of Environmental Protection. Available at: http://english.mep.gov.cn/special reports/chemical regulation/ 131 Ministry Zhou Shengxian, Minister Zhou Requested to Guide Environmental Protection Work with Scientific Outlook on Development and Make All out Efforts to Promote Historical Transformation for Environmental Protection, 22 January 2008. Available at: http://english.mep.gov.cn/Ministers/Speeches/200802/t20080219_118305.htm 132 For example, national standards for ambient air quality were last revised in 1996 and as noted elsewhere in this report vary significantly from those established by the EU and international bodies. Standards and Reports, Ministry of Environmental Protection. Available at: http://english.mep.gov.cn/standards_reports/ 133 Standards such as those outlined for water quality by the WHO, or the comprehensive environmental health standards set out by the International Finance Corporation with the technical assistance of the World Bank. Programmes and project, World Health Organisation. Available at: http://www.who.int/entity/en/ Environmental, Health, and Safety Guidelines, International Finance Corporation. Available at: http://www.ifc.org/ifcext/enviro.nsf/Content/EnvironmentalGuidelines 134 Eco-industry, its size, employment, perspectives and barriers to growth in an enlarged EU. European Commission DG Environment, Sep 2006.


considerable progress in strengthening it further.135 Nonetheless these efforts have not kept pace with the environmental pressures created by the country’s rapid economic growth.

China’s effort to improve its environmental performance with limited funds draws on a wide body of experience that has been accumulated internationally, in both industrial and developing countries. Development assistance from the international community has contributed to this performance. Assistance within the PCA might fruitfully be directed towards strengthening these efforts, particularly by helping to adapt some of the European lessons to the Chinese situation.136

In addition to increased absolute fines and enforcement related to pollution abatement, it is also suggested that mechanisms be put into place which encourage adoption of renewable energy technologies, through policy instruments such as feed-in tariffs (China in fact has a feed-in tariff system regulated similarly to the EU, which is poorly implemented).137 While China has stated ambitious goals for increasing renewable energy’s contributions in the 11th Five Year Plan, little progress has been made. Through 2007 energy intensity continued to grow, following annual energy demand growth of 13% between 2002 and 2006. Experts estimate that to meet the 11th FYP goals energy demand growth would have to slow drastically to 3% annually until 2010, a reduction most unrealistic.138

While China has adopted new objectives to reduce energy intensive industries in its 2007 Catalogue on Foreign Investment in Industry through restricting many of the most energy-hungry industries, a mix of policy options with both ‘push’ and ‘pull’ mechanisms should be utilised to reach the 11th Five Year Plan’s ambitious goals. For example, aggressive feed-in tariffs, which benefit both domestic and foreign firms, would accelerate already ongoing efforts. This is especially needed in areas such as solar photovoltaic cells, where as much as 90% of Chinese production is estimated to be produced solely for export, primarily to European countries.139

Improve financial support for environmental infrastructure

Within the environmental goods and services sector, there is a heavy dominance of infrastructure related projects. Water and solid waste treatment plants, hydropower dams, wind farms and solar are significant investment projects relying on long term returns. These realities may cumulatively stifle the interest of private business in providing such goods and services.140 Financial incentives should be designed which encourage early adopters of new, environmentally friendly technologies. Coupled with internalised environmental costs, this move could enable interested firms to considerably improve their ability to offer environmental goods and services to wider segments of the population. SEPA’s recent partnership with the International Finance Corporation to establish

135 OECD (2006) Working Party on Environmental Performance: Environmental Performance Review of China, OECD, Paris 136 Personal communication – Dr Clive George, Impact Assessment Research Centre, Institute for Development Policy and Management, School of Environment and Development, University of Manchester 137 Xiao Shu, “China’s winds of change,” China Dialogue, 8 November 2007. Available at: http://www.chinadialogue.net/article/show/single/en/1461]. 138 Rosen, David and Houser, Trevor. China Energy – A Guide for the Perplexed. Center for Strategic International Studies and the Peterson Institute for International Economics, May 2007. 139 Dorn, Jonathan. Solar cell production jumps 50 percent in 2007. Earth Policy Institute, 27 December 2007. Available at: http://www.earth-policy.org/Indicators/Solar/2007.htm 140 Eco-industry, its size, employment, perspectives and barriers to growth in an enlarged EU. European Commission DG Environment, Sep 2006.


environmental criteria, based partly on the IFC’s Equator Principles, for a new type of ‘green’ loans to environmentally beneficial business ventures is an encouraging development.141 ICBC surveyed its 59,000 corporate clients last year to assess environmental performance. About 78 percent were cleared for green loans of more than RMB 200 million, accounting for about 80 percent of the total. SEPA will work with the financial sector to bring in an international benchmark on green credit based on a deal signed with the International Finance Corporation (IFC) in Beijing in January 2008 to introduce the Equator Principles in China.142

As this project is still in its developmental stages, its effectiveness is as of yet uncertain, however, it is noted that the guidelines adopted here may be instrumental in establishing similar guidelines for the EET sector as defined above. Furthermore, it is suggested that companies which qualify for ‘green’ loans are also provided access to reduced-tariff imports to further improve the ability of such companies to improve the environment. In a separate study, 44 percent agree (and 37 percent agree to some extent) that loans should be granted only to those companies that guarantee no damage would be done to the environment. These were the main findings of a nationwide survey conducted by the China Environmental Culture Promotion Association, under the State Environment Protection Administration (SEPA).143

141 Liu, Yingling. Analysis: China Uses Green Loans to Tackle Environmental Problems. Worldwatch Institute, 11 Feb 2008. Available at: http://www.worldwatch.org/node/5604 142 see http://www.equator-principles.com/chinadaily012508.shtml 143 See http://www.chinadaily.com.cn/china/2008-01/08/content 6376451.htm


5.3 Financial Services


The financial sector, comprising banking and insurance goods and services is fundamental to a country’s economic growth and development. The substantial cross-border capital movements that exist today have been created through the liberalisation of financial sectors, underpinned by technological advancements coupled with financial innovation. Pooling and market-based pricing of credit and other types of risks (and, in an international context, benefitting from access to world financial markets with increased economies of scope and scale), improves the allocation of savings. This in turn is a significant aspect of sustainable development.

China officially opened its banking sector to foreign banks in early 2006. Anticipating this, foreign banks invested over US$11 billion in 2005. Following the sub-prime mortgage crisis which started in the US in late 2006, the entrance of foreign players and the transition to a more market-based mechanism in China now takes place in an atmosphere of heightened concern.

The Chinese banking system consists of three tiers. The State Development Bank, the Import and Export Bank and the Agricultural Development Bank are policy banks, which were created in 1994. The second tier comprises what are known as the four state-owned commercial banks (SOCBs); the third tier consists of joint stock commercial banks, city commercial banks, rural credit cooperatives and foreign banking institutions. China’s continued economic boom is reflected in the growth and increasing profitability of its financial sector.

Foreign insurance companies have also grown their presence within the Chinese market. China reported that by the end of May 2007, there were 46 foreign insurance companies in China with 130 operational branches reaching profit levels of over RMB 14.21 billion (€ 1.42 bn) in 2006, which was 4.24 times higher than it was at the time of China’s accession.

In comparison to China’s financial sector, European banks and insurance companies deal with a wider variety of products and services, reflecting more experience and greater reliance on more sophisticated and innovative products and services. European banks and insurance companies, however, face a number of obstacles and market access barriers. As part of China’s WTO commitments, these barriers should have dropped gradually in the past few years. Below are a list and description of key barriers that European banks and insurance companies face in China:


Differentiation of branches of foreign banks vs. locally incorporated subsidiaries of foreign banks

While in principle foreign banks are now allowed to do RMB business, there is a new differentiation between “branches of foreign banks” and “locally incorporated subsidiaries of foreign banks”. “Branches of foreign banks” cannot:

- provide RMB loans to Chinese citizens (individuals) - offer retail deposits to Chinese citizens – they can only offer time deposits to Chinese

citizens of at least RMB 1 million (approx. €95,000) per deposit, and are thus practically barred from the RMB deposit business with (non wealthy) individuals

- cannot offer card business Locally incorporated subsidiaries of foreign banks are not subject to these restrictions, and thus in their RMB business are basically treated like Chinese banks.

Branch/ Sub Branch Network Expansion

Foreign banks continue to face difficulties due to a complex system of administrative submissions required to expand their branches and sub-branches network. This process is made particularly time consuming as foreign banks are currently barred from making simultaneous multiple branch and sub-branch submissions.

License Requirements for New Products and Services

There are no clear implementation guidelines for introducing new financial products such as credit and debit cards. All banks with local incorporation are still required to seek approval of local authorities for all such initiatives. As products become more complex this prevents consistent and efficient launches of new financial products.

Capital Requirements For locally incorporated subsidiaries of foreign banks, the capital requirements have again been set higher than before, from RMB 300 million (€28.5 million) to RMB 1 bn (€95 million). On the other hand, once established, locally incorporated subsidiaries of foreign banks can open new branches with less branch operating capital – RMB 100 million (€9.5 million) instead of previously RMB 300 million (€28.5 million). While local banks are subject to the same rules as foreign banks according to Chinese banking regulations, 144 ‘second-tier’ sub-branches of SOCBs are often exempted the same RMB 10 million capital requirements. In contrast, € 5 million capital is required for banks to operate throughout Europe.

Foreign Debt Quota Most foreign invested enterprises (FIEs) do not have sufficient debt quotas. These foreign debt quotas hamper the ability of FIEs to source funding from their relationship bank in China, many of whom are foreign banks.

Ownership Restrictions Foreign banks are not permitted to hold more than 20% individually (25% collectively) of a Chinese bank.

Securities and Fund Business Despite China’s accession to the WTO this sector remains largely closed to foreign competition. Currently no foreign majority-owned securities firm or fund management company exists in China. The amount of securities business done by the seven foreign invested joint-venture securities firms145 remains small. Foreign companies are not allowed to hold majority control in fund management companies.

Bond Underwriting Foreign banks currently may only buy/sell domestic bonds on a proprietary basis and are barred from selling on to end investors.

Prudential Requirements (Very Low Maximum Loan-to-Deposit Ratio)

Among rules which apply both to local and foreign banks, is a very low maximum loan-to-deposit ratio of 75%, implying that a bank with 100 units of deposits cannot have more than 75 units of loans outstanding. This in principle is a “prudential regulation” to ensure the liquidity of banks, and permissible under WTO rules. But given that foreign banks find it hard to gather significant RMB deposits, this is a curb on their lending business. Since the regulation need not be met fully until 2011, however, how well foreign banks adopt it (how much RMB deposits they manage to attract) remains to be seen. Given the slow regional expansion and branch office opening procedures already mentioned, it is difficult for foreign banks to fulfil this ratio in time. If the loan-to-deposit ratio had applied to foreign banks by early 2007, foreign banks would have had only about half the volume of deposits required to cover for their then existing loan portfolio – in other words, they had a loan-to-deposit ratio of around 150%. The maximum ratio of 75% is an incentive to transform branches of foreign banks into locally incorporated subsidiaries (with higher capital requirements), in order to have better access to the retail/individual deposit market.

144 Administrative Rules of Commercial Banks Outlets 11/March/2002 promulgated by the People’s Bank of China 145 As of end 2007: http://www.csrc.gov.cn/n575458/n4001948/n4002195/n4003695/n4003770/n4003830/9430854.html



As the Chinese economy continues double-digit annual growth, the banking sector plays a crucial role in maintaining and handling such growth, amidst fears of overheating and inflation. While the four state-owned banks in China have substantial assets, they compete with the biggest European banks—UBS, HSBC, Credit Agricole and BNP Paribas, amongst others, which have a substantial market share in Europe.146

One of the drains on China’s economy and banking system are State-owned enterprises (SOEs) and their high levels of non-profitable loans (NPLs). Through their historical links to the state banks, SOEs consume much of China’s capital, though they produce little or no returns on their loans. By providing non-performing loans (NPLs) with little regard for repayment or risk, the portfolio of non-profitable loans has been as high as 25% in 2001. Large volumes of NPLs place a substantial burden on the balance sheets of at least half the banks in the financial system. Fears of displacing employees in SOEs are one of the reasons that regulators have resisted changes in the sector.

In the long term, a more efficient and market-based system is necessary to ensure stability and higher levels of employment.147 Net losses of jobs are likely to be counterbalanced to an extent by the booming private sector market will be able in part to offset job losses in SOEs.

Instead of maintaining the status quo which perpetuates government control and ownership, a genuinely commercial banking sector that is rules-based will not only help reduce the burden on the banking sector caused by NPLs, but will also align China’s financial system with that of the needs of an emerging and dynamic private sector. Against this, the international sub-prime crisis has raised claims in China that foreign financial frameworks are too weak. China’s current rate of economic growth provides a fertile ground for the further development of small and medium-sized enterprises (SMEs) requiring banking services. SMEs are predicted to be vital to China’s growth and further incentives in the form of greater access to financial products and services will be essential for realising this potential.

Social Significance

Corruption poses a significant problem for China's banking system because loans are often made on the basis of political connections. In many cases, bank branches extend loans to firms controlled by local officials, even during periods when the central government has attempted to limit credit, due to inflation concerns.

The effect of China’s rapid growth has not been equal, with urban and rural classes affected differently. By liberalising the financial sector, it is not only SOE employees in the urban and middle classes who will be affected by reforms, but the rural population which stands to gain from services provided by foreign banks in rural areas.

Despite the large market for rural financing, due to China’s large rural population, the low profitability of rural financial institutions has slowed down the development of rural finance. Where

146 ‘Thinking Big’, The Economist, May 18, 2006 147 ‘How Financial System Reform could Benefit China’, McKinsey Quarterly, 2006 Special Edition


Chinese banks have been traditionally apprehensive about entering the rural market, more recently rural financing by banking institutions in China, in particular by rural commercial banks and rural cooperative banks, seems to have accelerated.148 The prospect for further development of rural financing seems promising. Since the radical reform of the rural credit cooperatives in 2003, significant strides have been made in the reform of the property rights system and corporate governance.149 The government is increasingly trying to make loans more accessible for China's more than 700 million rural population to combat a widening wealth gap and boost output of grain and pork after recent price increases.150

Due to higher levels of employment and corresponding wages, lifestyle patterns in China are also undergoing changes as a result of trends in urbanisation, mechanisation and industrialisation. It is feared that the failure to deal with the ensuing inflation could incite political and social tensions. Further, there are signs of labour shortages in the manufacturing sectors due to inadequate human resources with management skills and experience, and fading demographics in the age range of 18-25 year olds as a result of China’s One Child policy.151 Demographic and corresponding changes in China’s wealth accumulation patterns suggest that China is experiencing greater concentration of wealth. Today more than 300,000 Chinese have a net worth over US$1 million. 152 Further, a growing middle class with higher disposable incomes increase the need for more sophisticated financial services. A distinguishing factor of the Chinese retail banking sector is the typical 40 percent personal savings rate. In a society characterised by significantly high savings, financial services that are stable and profitable for local investors should provide the necessary incentive for higher spending and consumption. As China prepares itself for inevitable changes in the social and economic environment as a result of a liberalised banking sector, the provision of complex financial services and products that cater to the current phenomenon of China’s new middle class is necessary for the next step of development and growth.


Direct environmental impact of the banking sector is hard to identify. Despite the increasing focus on sustainable development and environmentally-friendly initiatives globally, banks still lag behind in their responses. There does, however, appear to be increasing commitments to socially and environmentally responsive practices by engaging in specific national and global environment-related projects by financial institutions.

148 Xinhua, “Rural credit cooperatives generate 44 bln yuan in profit”, 7 March 2008, http://en.chinagate.com.cn/povertyreduction/2008-03/07/content_11902513.htm. 149 “The reforms of rural credit cooperatives have achieved significant progress,” China Banking Regulatory Commission, 3 June 2008 http://www.cbrc.gov.cn/english/home/jsp/docView.jsp?docID=1494; 150 Philip Lagerkranser, “China to Relax Rules on Foreign-Owned Rural Banks,” Bloomberg, 27 May 2008. Available at: http://www.bloomberg.com/apps/news?pid=20601080&sid=aCIucSDgXu7I&refer=asia. 151 Cai Fang, “How to deal with the future labor shortage?” China Daily, 9 March 2007; available at http://www.chinadaily.com.cn/bizchina/2007-03/09/content_823785.htm 152 Merrill Lynch (2007)


approximately 2.4 percent by 2010, up from 2.11 percent in 2006. However, benefiting from strong growth in China’s banking sector will mean that overall foreign assets will increase by almost 50 percent to RMB 1.49 Trn (€ 149 bn) by 2010, up from RMB 927 bn (€ 92.7 bn) in 2006. As foreign banks are not able to compete on an equal footing, in the longer term it is expected that the share of foreign banks will be restricted to niche markets and continue to remain below 3 percent. It is expected that European bank’s market share among foreign banks will remain stable at 35 percent.

In the insurance sector, non-life insurance has been largely liberalised compared to banking and life insurance. The remaining restrictions on foreign operators relate to compulsory cover lines. These will continue to block foreign provider entry from the large market for motor vehicle third party insurance. Absent any new restrictions, foreign insurance companies operating in China will be able to set up their branch networks and distribution channels with insurance agents. Previous studies154 estimate that under baseline trends European insurers will gain a market share (estimated premiums earned) in the non-life insurance market of 5 percent by 2010 (or € 1.1 billion), up from their current share of 0.4% (€ 44 million). In life insurance, current market share of European operators is at roughly 0.8%. Due to practical limitations on market access, the share of European insurance companies in the Chinese market is expected to grow to only 8% market share by 2010 although strictly indirectly (i.e. through investments with Chinese companies or in joint-ventures). 155 In the long-term, as in the banking sector, this market share is expected to level off should baseline conditions remain in place as current market access obstacles remain for foreign investors.

Modest Liberalisation Scenario

It is assumed in this scenario that licensing restrictions for the opening of new branches are liberalised, while ownership restrictions on foreign financial institutions remain, both in the banking and insurance sectors. In practice, however, discrimination against foreign banks will remain, and China notably continues to apply ownership caps on foreign shareholdings in Chinese banks – despite no foreign equity caps being listed in China's GATS schedule. It is assumed that any concessions made to European financial institutions will be made to other foreign institutions as well.

Liberalised Licensing Requirements means that banks would be able to offer new services ….

If licensing requirements were further relaxed, foreign banks would as a result of increased administrative efficiency, enjoy more straightforward access to the market and reduced cost-structures. This would allow for a more competitive expansion of their branch network than under baseline conditions. Foreign banks would be able to tap into RMB deposits more easily; but this would be restricted mainly to wealthy individuals in large cities. An important area that foreign banks are expected to focus would be lending to SMEs, leaving China’s larger banks to focus predominantly on SOE-lending. European banks are relatively experienced in this complex field, which requires well-developed credit analysis and risk management capability. European financial institutions would be in a good

154 DG Trade (2007) ‘Future Opportunities and Challenges in EU-China Trade and Investment Relations’ Study 7: Financial Services 155 Ibid


of foreign banks this is expected to have a positive impact on total banking assets in China (Figure 5). By 2015 foreign banks could reach a market share of 8 percent. 159 Although in the long-run total banking assets of foreign banks are expected to increase in line with the overall banking sector this trend will level off once sufficient levels of market saturation occur.

Although total assets growth is expected, in the longer term foreign banks might even lose relative market share to domestic banks. The Banking Strength Indicator (BSI), which measures the financial strength of Chinese banks benchmarked to the fifteen top international banks, already suggests that Chinese banks have strengthened due to increased capitalisation and earnings in 2006.160 Between 2005 and 2006, the index went up by 33.5 percent.161 It is expected in both the moderately optimistic and ambitious liberalisation scenarios that with increased competition Chinese banks will increase their capabilities in the long term and are expected to regain market share.

The insurance industry will perform better, but in the long-run will face similar constraints…

For foreign life insurance providers it is unlikely that current ownership restrictions will be reduced under a modest liberalisation scenario. Like foreign banks, foreign insurance providers face challenges in registering branch offices, although to a lesser extent than under a modest liberalisation scenario. Chinese-Foreign life insurers will continue to face difficulties in obtaining licenses to operate in new provinces. Similar to the banking sector this means insurers are effectively prevented from creating national distribution networks under their control and will therefore be unable to operate with the same speed as domestic insurers.

Expected Impacts - Modest Liberalisation

An opening up of the financial sector in a modest liberalisation scenario is expected to have an overall positive impact on the economy. Foreign financial institutions would be a cornerstone of China’s institutional framework. International best practices would ‘spill-over’ from foreign financial institutions who operate on a more efficient allocation of capital. Financial institutions are important when opening up capital markets, and reducing legal and administrative barriers will create long term positive impacts on economic indicators. Notably, this moderate scenario will have only a limited impact on increasing capital formation as limitations on foreign investment results limits the amount of assets which can be accumulated by foreign operators operating locally. Overall social indicators are also likely to improve in the long term under the modest liberalisation scenario, although the picture is more mixed than in the optimistic liberalisation scenario discussed below. In the short term, Chinese banks are likely to have to close down a number of inefficient branches and increase automation to compete with foreign banks.

159 This compares to an average 10.9% share of banking assets which foreign banks have obtained in Korea, Malaysia, Thailand (data from Bankscope) 160 The Banking Strength Indicator is based on the CAMELS rating of the Chinese banks relative to top fifteen non-Chinese banks, which are ranked according to their Tier-1 capital. Each CAMELS component is also based on underlining variables, including, but not limited to: capital asset ratio, Tier-1 capital ratio; the ratio of nonperforming loans to gross loans; loan-loss coverage ratio; the cost-to-income ratio; return on assets; return on equity; the ratio of liquid assets to deposits; and the ratio of non-interest-based revenue to total assets. (See http://www.milkeninstitute.org/chinaindicators) 161 http://www.milkeninstitute.org/chinaindicators


In the longer term, the effect on the wider economy is expected to be more positive as more efficient lending practices will promote sustainable private sector growth, which in turn, will have a positive effect on employment levels. Such impacts, however, may only be discernable in and around large commercial cities where large-scale private sector activities are focused. The impact on the environment is expected to be negligible.

Economic Impacts

Based on scenario assumptions that measure the effects of reductions in non-tariff barriers (NTBs) and changes in Total Factor Productivity (TFP), the main and obvious changes are in the import and export levels of financial services.162 In a modest scenario that assumes a 30% reduction in NTBs, there is a 16.46% increase in imports of financial services. The corresponding change in the export levels of Chinese financial services is -0.63%, which may appear negligible, but in a market the size of China’s the number is substantial enough to suggest that such a decline in exports due to a cut in the NTBs alone because of the general equilibrium effect, will result in capital and labour moving out of the sector. Where Chinese banks and insurance providers may lose out due to increased access to the Chinese market of European banks and insurance companies, the latter will gain substantially. Under the modest liberalisation scenario highly localised economic benefits are expected due to improved fund and asset management, where foreign banks have better access to the segment of wealthy individuals who require sophisticated financial services and products within cities. This clientele are willing to pay for better services, reputation and international contracts. By catering services to a niche crowd, the involvement of European banks will improve the quality of financial services in China, however, this only pertains to a narrow stratum of Chinese society, so the economic impact will probably be very concentrated amongst wealthy individuals. This could have a negative impact on income inequality as the widening wealth gap in urban and rural areas is precipitated by unequal access to banking services. Similarly, due to the growing financing requirements of private enterprises, albeit not as dramatic as in the field of consumer financial services, the demands for corporate client and SME business is expected to increase. This means that the effective credit supply to SOEs is reduced and will help the restructuring of the Chinese economy. Although this will have substantial positive economic impacts by improving bank profitability and reducing the number of NPLs held by banks in China, this will also cause localised shift in employment patterns away from the state-owned sector. A similar trend is seen in an ambitious PCA liberalisation scenario, where the imports of European financial services will increase to 36.55%, and export levels of Chinese financial services will drop further to -1.23%. When the issue of TFP is introduced in addition to reduction to NTBs, the positive incentives to export are enough to overcome the transfer of factors out of the sector so that exports increase.

162 Modelling for Section 3 of the Financial Services Study was done using Globe. Please refer to the Globe technical appendix for further details.


Additionally, a small depreciation of the real exchange rate will result from variations in the export and import levels.

Social Impacts

As is explicitly recognised in China’s 11th Five-Year Plan (5YP), a modern financial system promotes better and more job opportunities, especially as young and qualified locals enter the job market. By liberalising the sector, both basic and complex banking skills are developed, with effects on the short and long term overall structure of the industry, job opportunities and comprehensive competitiveness.163 A liberalised banking sector may in the interim displace a large number of workers from state-owned enterprises. For instance, as the volume of loans to SOEs is reduced due to more competitive loan requirements, current trends in SOE layoffs are likely to continue unabated. However, in the long-term, a more competitive financial sector should produce more employment opportunities in the private sector, particularly SMEs. The Chinese government is aware of the impact that SMEs as job-creators can have on forestalling potential social unrest resulting from unemployment. SMEs can potentially be more important for preserving social stability than the social security system. Local experts have offered an important caveat: many workers laid off from SOEs are in their 40s and 50s who lack the new skills needed to succeed in more competitive private ventures.164


It is increasingly recognised that the lending decisions and influence on client behaviour of financial institutions may indirectly affect the environment.165 In addition, international financial institutions are increasingly aware of the risks associated with environmental issues and are developing more stringent environmental policies to minimise these risks.166 Given that foreign financial institutions are more involved in environmental initiatives than local counterparts, it is assumed that best practices in this area would likely be more widely shared should foreign participation increase. Any such beneficial impact of a modest increase in the participation of foreign banks is likely to be minimal given the still limited, though increasing, recognition the role of financial services in environmental sustainability.

Ambitious Liberalisation Scenario

The ambitious liberalisation scenario considers the same conditions as an agreement in which foreign financial institution would be able to acquire a majority controlling stake in local banks and insurers. Substantial reduction in formal obstacles improvements are also assumed in a number of 163 China Internet Information Center (2006), Key Points of the 11th Five-Year Guidelines, http://www.china.org.cn/english/2006/Mar/160397.htm 164 US Embassy Economic Report, http://www.usembassy-china.org.cn/econ/smes2002.html 165 UNEP (1998) Industry and Environment, Vol. 21, No 3, July-September 166 An example of this is The Carbon Disclosure Project, of which a large number of international financial institutions are members. This organisation aims to take a pro-active stance on carbon emissions abatement as a recognition of the risks of inactivity on climate change, while also responds to a range of pressures- from customers, competitors, investors and global regulators


increase in non-life insurance premiums for European operators in China from about €44 million in 2004 to about €2.5 billion in 2010. European operator’s market share of life insurance could rise from approximately €300 million at present to up to €18 billion by 2010, with their market share growing from approximately 0.8 percent to 12 percent.169 Like the banking sector it is expected that Chinese life insurance will continue to dominate the market. The three largest Chinese life insurers (China Life Insurance Company, Ping An Life Insurance Company and China Pacific Life Insurance Company) account for 83 percent of premiums, with only Ping An having a foreign investor (HSBC) holding a 19.9 percent ownership stake. These companies will continue to leverage their substantial branch network and local name recognition to their competitive advantage.

Expected Impacts - Ambitious Liberalisation

As argued in the modest liberalisation scenario, the wider Chinese economy will benefit though the reduction of regulations and greater access to financial products and services. In the ambitious scenario, reforms will take place less gradually, which could lead to greater and more rapid benefits being accrued. Such immediate reforms could also provide less of a buffer or adjustment period, leading to challenges, which may only be overcome in the medium-long term.

Table 28: PCA Scenario Impacts Table – Financial Services (China)

Existing Conditions



Equity Potential for Reversibility

Capacity to change

Economic

Real Income - Yes L

Inflation -- Yes H

Capital Formation + Yes M

Regulatory Environment

- Yes H

Products & Services - Yes H

Social Employment (Direct) + No L

Employment (Indirect) 0 No M

Class Inequality -- No M

Poverty - No M

Environmental

Pollution (Indirect) -- / Yes H

Table 29: PCA Scenario Impacts Table – Financial Services (EU)

Existing

Conditions



Equity Potential for Reversibility

Capacity to change

Economic Service Exports - Y L Market Access -- Y L

169 Ibid


Economic Impacts

The economic benefits of financial reforms tend to accrue in the long run; and costs tend to accrue in the short-term. Substantial lay-offs can be expected in the short run as finance under a more liberal and competitive environment is redirected from the state sector towards the private sector. Figure 7 highlights the provinces where SOEs still play an important role in the economy. With more stringent loan-processing methods, less productive SOEs would either have to improve their operational standards, change capital management structure or shut down. Provinces marked in red would therefore be relatively highly affected by ambitious financial sector reforms. Figure 7: Provincial Distribution of Gross Industrial Output Value (State-Owned vs. Private Sector Output)

Source: China Statistical Yearbook (2006)

In the long term, however, strong economic and employment benefits are likely to be felt across China. Previous studies have argued that financial reforms that direct more funds to private companies could raise GDP by as much as 17 percent, or US$320 billion a year, stimulate mass job creation in the strongest areas of China's economy, and raise tax revenues to finance social programs.170 China’s productivity would rise sharply if a larger share of funding went to SMEs and other private enterprises, as a result of increased access to loans through competitive means from foreign banks.171 The credit policies of local and provincial banks currently makes it very difficult for the central government to use monetary policy to fight inflation without causing major disruptions to the economy. Wider economic benefits are likely to be felt from the substantially improved ability for policy makers to control. Deeper, more liquid, broad-based and transparent markets with greater participation of sophisticated institutional investors markets, which are more representative and reflective of strong underlying economic fundamentals, means China will benefit from less volatility,

170 How Financial System Reform could Benefit China’, McKinsey Quarterly, 2006 Special Edition 171 Ibid


better dispersion of risk and greater stability.172 The wider availability of products and services tailored to the needs of customers will also have important welfare effects, not only for businesses, but also for consumers in both urban and rural areas. In addition, substantial beneficial spill-over effects accrue as areas such as trade finance continue to grow further underpinning China’s increasing importance as exporter and importer on international markets.

Social Impacts

Over the past decade, Chinese households have earned only 0.5 percent a year on their real savings compared to 1.8 percent for households in South Korea.173 Given demographic changes in China, where there is a growing middle class and wealth accumulation amongst the wealthiest Chinese, varied asset management and investment products and services would not only utilise household savings more efficiently and facilitate better long-term investments, but also promote more consumption, boosting social welfare and economic growth. In an ambitious scenario, a liberalised insurance sector would allow foreign insurance companies with expertise in providing both life and non-life insurance in their home markets, to access the growing Chinese markets. Such changes would have strong implications for social security in China, previously such services were provided by SOEs, but in this ambitious scenario, market competition will have a positive effect on the development of China’s social security policies. As China transitions to a liberalised economy, a more forward-looking social security system created as a result of greater market competition is more befitting and holds more prospects for the welfare of Chinese households.


As analysed above, currently the majority of loans go to SOEs and often in energy intensive industries. By boosting consumption, a liberalised financial industry will help to develop a number of alternative industries in the private sector, notably less energy intensive services industries. Such changes will have a positive impact on the environment, while simultaneously diversifying China’s economy. In addition, if current trends in the international banking sector continue, the increased participation of foreign banks might aid to instil a so-called ‘race to the top’, where best-practices in socially and environmentally responsible lending is integrated into core business models. In the insurance sector, China’s Insurance Regulatory Commission (CIRC) recently issued the Guidelines on Environmental Pollution Insurance which defined the establishment of a roadmap for an environmental pollution insurance system in China by 2015.174 Foreign insurance providers, familiar with similar systems in other countries and specialist knowledge on risk assessment, loss evaluation, responsibility claim, dealing with accident and compensation etc, would be able to contribute to the establishment and commercial viability of such a system.

172 DG Trade (2007) ‘Future Opportunities and Challenges in EU-China Trade and Investment Relations’ 173 How Financial System Reform could Benefit China’, McKinsey Quarterly, 2006 Special Edition 174 China ushers in "green insurance system" to curb pollution,” Gov.cn, 18 February 2008. Available at: http://english.gov.cn/2008-02/18/content 892569.htm.


5.3.3 Policy Recommendations Increased investment by European financial institutions can play an important role in underpinning the deepening of the EU and China’s trade relationship in a PCA. High-level discussions within the PCA negotiations that target specific issues (e.g. licensing requirements and ownership restrictions) will allow both parties to directly deal with existing hurdles to long-term engagement. Policy recommendations in the social area are especially significant on social equity grounds and are important for protecting the more vulnerable segment of the workforce. Effective policy changes need to address three main aspects: standardisation, simplification and equal treatment.

Reform Measures should be Consistent with a Gradualist Approach but Need to be Balanced with the Business Interests of Foreign Operators

Financial reforms are crucially dependent on how well they are planned and implemented. Badly planned and too hastily implemented financial reforms tend to produce particularly bad outcomes.175 Both liberalisation scenarios presented in this study are consistent with a gradual approach to the further opening up of China’s banking sector. There is a diverse range of reform initiatives which can be undertaken, each of which has different benefits and costs characteristics. Some of these may yield small benefits, but are not costly to implement. At the same time it is important that the financial sector is opened up to an extent that it gives foreign operators sufficient incentive to apply their full home grown expertise. Although such reform measures yield great benefits, they can be costly in the short run. All reform measures carry risks but the involvement of foreign capital to some extent offsets these risks and has important spill-over benefits in introducing expertise into the economy which upgrades capabilities. This will help to ensure the success of more costly reform measures that have larger benefits. In regards to the insurance industry, government interest in developing China’s financial sector has resulted in the role of foreign banks and insurance companies being limited. The CIRC could further encourage the development of the insurance sector by allowing open competition between local and foreign operators, instead of delegating the latter to a relatively assisting role. Discriminatory treatment has also limited foreign banks’ access to offshore debts, which as a result has reduced available funding for legitimate transactions such as trade finance and projects and infrastructure lending.176 Such projects are essential to China’s growth, and where the resources and expertise exist, unequal policies should not serve as an impediment.

Make Gradual Reforms Pareto-Efficient, and Put in Place Integrated Social Provisions Where this is Not Possible

Financial reforms should wherever possible be Pareto-efficient177 with any losers compensated. As shown in previous sections, localised pockets of short term costs, mainly in the form of

175 Lee, Jisoon (2006) Financial Reforms: Benefits and Costs, Seoul Journal of Economics, Winter 2006 Issue 176 AmCham-China 2008 White Paper 177 Pareto Efficient: A change in the status quo that makes at least one person better off, while making no one else worse off. See http://en.wikipedia.org/wiki/Pareto_efficiency.


unemployment occurring from a shift in financing away from the state sector, is more or less inevitable as domestic reforms continue. Under any liberalisation scenario, substantial up-front funding will be necessary to develop the existing social security system to adapt to the changing economy and Chinese demographics. This situation may be exacerbated if the government delays in providing adequate social care.

Strengthening social security to contain severe localised social pressures places state budgets under fiscal pressure. State owned banking sector reform should coincide with the further development of the insurance sector. Importantly, an efficient social security system, as a result of a more developed insurance sector, would also help mitigate the problems relating to the privatisation of China’s healthcare. Basic pensions for enterprise retirees were raised three years in a row beginning in 2005. A total of 329.5 billion yuan was allocated for old-age insurance programs from the central government budget in the form of subsidies over the last five years.178 Bilateral cooperation initiatives such as the EU-China Social Security Reform Co-operation Project, in which the EU has committed €20 million to aid the construction of a sustainable social security system in China, display the EU’s knowledge and experience in this area. These initiatives would be further strengthened by the active participation of European insurance companies which, given the insurance industry’s increasingly important future role as a substitute for social security, holds high market potential for these companies. When limited to work as minority shareholders with Chinese partners, neither products nor procedures of European insurers can be protected, nor will European insurers develop the ownership incentives of investing in expertise to facilitate the development of China’s social security system.

Reforms and Liberalisation Measures need to be System-wide and Deal with Specific Issues

Liberalisation measures need to on-going, with a long term road map towards substantial mutual benefit to both parties. This roadmap must stay relevant over the long term. Financial sector reform, often lumped under the rubric of general reform measures, should form a coordinated, system-wide and specific program. Policies need to address specific issues to make it easier to estimate any costs of change, while simultaneously facilitating the transition process by setting out a clear set of objectives. Allowing faster network expansion by foreign banks and by employing a more transparent process, complexity and difficulties prevalent in business planning can be avoided. The current approval system for investing insurance funds overseas should be simplified, for example,179 benefitting all parties by removing unnecessary red tape. Initially, European banks and insurance companies should be able to fill any demand gaps that currently exist in the market. However, in the long term, the Chinese financial system should to gain substantially from the presence of European banks in China, as administrative and legal barriers are

178 —. "Report on the Work of the Government." 19 March 2008. Xinhua. 5 June 2008 <http://www.chinadaily.com.cn/china/2008-03/19/content_6549442_6.htm>. 179 AmCham-China 2008 White Paper


reduced. As the Central European transition process suggests, domestic banks and institutions also stand to gain from greater competition in the market.180

Build on WTO Common Ground and Reduce Remaining Obstacles to Trade and Investment

EU negotiators for the “financial sector chapters” of the PCA should negotiate on issues where “practical” or “prudential” obstacles remain significant for European operators, seeking both to enhance compliance and expand upon China’s current WTO commitments. These include branch or subsidiary opening procedures for financial institutions and the maximum loan-to-deposit ratio of 75%, which severely hampers EU banks’ business opportunities in China. Since foreign banks with limited branch networks are and will remain dependent on borrowings instead of deposits for financing their growing loan portfolio, foreign banks should be allowed to fulfill the 75% ratio by a maximum outstanding loan volume of 75% of deposits and borrowings from financial institutions.

These negotiators should impress upon China the benefits of further financial sector liberalisation. Target issues include: (a) the possibility of foreign insurance providers providing both life and non-life services from one company, therewith better catering for EU insurers’ industrial organisations; and (b) the possibility of EU insurers obtaining majority stakes in life insurance ventures in China.

Reciprocity

Reciprocity remains a guiding principle in trade and investment liberalisation, and the PCA is no exception. For an effective reciprocal relationship, instead of targeting specific areas, such as the insurance sector, a broader approach which covers those of special interest to both parties should be addressed. Such an approach would help ensure a balanced set of mutual advantages.

In recent developments, Chinese state vehicles—be they sovereign wealth funds (SWFs) or State Banks—have become significant equity investors in financial institutions abroad, including the EU. In order to further develop a mutually beneficial trade and investment regime with China in the PCA framework, the EU could:

a) Come to a joint, preferably liberal policy towards SWFs (as recommended by the OECD); b) Ensure that, matching the EU’s liberal approach to SWFs (including those from China),

remaining market access obstacles for European operators in Chinese financial markets be removed.

c) Standardise requirements, e.g. in reinsurance deals between domestic and foreign companies; and relax the 80 percent rule on the amount ceded to a single re-insurer. Such steps help establish a level-playing field allowing both the EU and China to benefit from trade with each other.

Given that the main concern with SWFs gaining more control in the assets of the other countries is a related to the notion of foreign governments gaining have controlling stakes in strategic corporations where commercial decisions may be driven by political and not commercial rationale. Annual or more frequent sovereign wealth fund reports on portfolio composition and investment

180 Bonin, John P. and Huang, Yiping (2004) "Foreign Entry into Chinese Banking: Does WTO Membership Threaten Domestic Banks?" The World Economy, Vol. 25


strategies could help mitigate fears and risks.181 A broad agreement on a ‘code of conduct’ for sovereign wealth funds, negotiated through the OECD or IMF, would help ensure a regulatory system that supervises the activities of SWFs.

In terms of specific policies that would address the market access obstacles mentioned throughout this study:

• Ownership restrictions- Currently, foreign banks are only allowed to hold 20% individually or 25% collectively in local Chinese banks. These ownership restrictions should be increased to reflect the competitiveness of foreign banks in an equal system based on open market principles. Similarly, Joint-Venture restrictions should be lowered so that shared ownership is accessible to interested foreign parties.182

• Coordination of regulatory processes within China would be the first step towards harmonising Chinese and EU standards. By formulating policies and guidelines that pertain to the various regulatory bodies in China (e.g. People’s Bank of China(PBOC), State Administration of Foreign Exchange (SAFE), State Administration of Taxation (SAT), China Securities Regulatory Commission (CSRC), China Insurance Regulatory Commission (CIRC). Through a coordinated and standardised regulatory system, not only will local banks and insurance providers benefit from greater efficiency, but foreign banks seeking access into China’s market will not face excessive red tape and the process of being integrated into the Chinese banking system will be expedited.183

• As China restructures its regulatory standards internally, it will also be better prepared to adopt international standards that are pertinent to the financial sector. According to Liu Mingkang, Chairman of the CBRC, some Chinese banks will carry out the Revised International Capital Framework (also known as Basel II) from 2010 onwards.184 Basel II is to be phased in globally from 2008 onwards with the aim of strengthening capital adequacy and risk management through better bank supervision. Some have suggested that the Basel II framework is better suited for the G10 countries, but as an emerging economy with a large market and signs of improvement in its banking capital adequacy, the Chinese government should promote the adoption of this framework amongst its financial sector with more rigour with plans of aligning its entire financial sector along standards set internationally.

• Capital requirements: Locally incorporated banks should be allowed to take 30% capital deposits from other banks so as to be on equal standing as local banks. In the case of specialty insurance companies, insurers with proper international rating should have access to appropriate market access in the form of reduced minimum capital requirements.

Achieving significant progress in all of the above issues may be highly ambitious, and will require a high degree of cooperation between negotiators. The following considerations may aid the ongoing processes and further spur liberalisation in the sector:

• Strengthening various high level economic and financial dialogues between China and European countries, particularly the annual meeting of the EU-China Economic and Financial Dialogue, which has been held annually since 2005. Through these dialogue mechanisms, both sides will be more

181 ‘Sovereign Wealth Funds’, Richard Portes in VOX, October 17, 2007 182 EUCCC 2007/08 China Position Paper 183 See EUCCC 2007/08 China Position Paper for more details 184 TMCnet.com. April 12, 2006


aware of the importance of liberalisation of the financial services sector, and accordingly put the openness of the financial sector into the policy priority of their relevant negotiation agenda.

• The EU and China should endeavour to initiate the negotiation of a bilateral investment agreement as soon as possible. As an institutional arrangement, such an agreement would be instrumental in the progressive liberalisation of the financial sector of both parties. The concept of reciprocity, such as welcoming transparent investment via sovereign wealth funds in exchange for increased access to the Chinese market, should be stressed. Furthermore, Chinese investment via SWFs may dampen the global ‘liquidity crunch’ rooted in the current US sub-prime crisis.

• In order to mitigate possible financial instability following removal of restrictions on internationalisation of financial services and cross-border capital movement, the EU and China should strengthen the collaboration on financial surveillance and regulation by pursuing bilateral agreements in this regard, particularly related to joint monitoring of speculative capital flows and the collaboration on regulating financial derivatives.

Negotiation approach

While China has become an important global player and strong exporter in many sectors of consumer and investment goods, EU competitiveness in most internationally “traded” service sectors is still prominent. The full range of issues to be discussed in the PCA should proceed on the basis that EU concessions or market opening offers towards China extract Chinese concessions in reciprocity, also across sectoral borders. Any potential attempts to separate the goods and services chapters or aspects of the PCA negotiations should be avoided. Important to liberalisation is that further engagement of EU financial actors would take place mainly in China, and thus almost automatically create the technology and knowledge spill-overs China requests from its international partners. Financial sector liberalisation can thus be considered a win-win-approach.

Trade and investment activities between China and the EU are growing ever more, benefiting China with a huge surplus and growing foreign currency reserves. As a counter balance, the PCA should facilitate the EU bringing comparative advantages into play as well, and have European financial operators participate with their supportive services, e.g. financing or insuring such trade and investment activities, without being hampered by over-prudential or discriminatory regulation.

Finally, several EU countries are strengthening their legislative power controlling the investment activities of Sovereign Wealth Funds (SWF). The respective laws coming into place, e.g. in France and Germany, will allow for a rather discretionary action. The Chinese partners should remain cognizant of the fact that such discretionary powers can be employed more or less stringently vis-à-vis Chinese planned investment, just as China’s regulatory authorities can rule on foreign investments more or less stringently in a case by case approach. With this in mind, it is recommended that principles regarding investment and SWF established by the OECD be adhered to within the PCA negotiation, ensuring that progressive liberalisation and improved transparency allay the concerns which have spurred investment related legislation in select member states.185

185 Sovereign Wealth Funds and Recipient Country Policies, OECD Investment Committee Report, 4 April 2008


5.4 Chemicals


The global chemical industry, with over 70,000 different products, is one of the most wide-ranging and complex of industries. Chemical products range from basic commodity chemicals, derived from initial processing of organic and inorganic raw materials, to specialty and fine chemicals that are characterised by consumer products such as pharmaceuticals, soaps, cosmetics, toothpaste and other basic household goods. In terms of absolute output the chemical industry is dominated by commodity and related intermediate chemicals that are crucial inputs into a vast array of other industries such as electronics, machinery and the aforementioned consumer goods. Despite its crucial role in a number of other industries, the general public knows little of this industry’s products besides final consumer goods.

As a rule, commodity manufacturing in Asia is for the regional Asian market only, and the huge investments are driven by the strong growth of local customer markets. Asia’s imports from Europe and other regions will thus decrease when new local production facilities go on-stream. Hence it is important to realise that the chemical industry has a distinctly multiregional character in the sense that there are limited trade flows between the three main manufacturing regions of North America, Europe and Asia. Only about 10% of total output is shipped between these three regions. Not surprisingly, interregional trade is particularly limited for volume/commodity products which are relatively expensive to transport. The limited interregional trade has not, however, decoupled prices and industry cycles in the different regions. The prices of commodity plastics, for example, moved in remarkably close harmony in all three regions. Unlike interregional trade, trade within the regions is very strong.

Viewing the chemicals industry by its linkages to other sectors of the economy displays its relationship to the overall economy and its operations. More intuitive categories exist, however, that allow for more general analysis. These are commodity chemicals, specialty chemicals, and fine chemicals. Commodity chemicals are comprised of upstream products that are generic in nature and produced in large scales for input into other industrial processes, requiring significant economies of scale as well as a large dependence on petroleum. 186 Specialty chemicals are intermediate substances, inputs into other industrial processes rather than end products. Specialty chemicals are generally of higher value than commodity chemicals and have specific applications as both intermediate and end use products, for example in the electronics manufacturing and construction materials industries, although generally still not as specialised as fine chemicals. Additionally, specialty chemicals also constitute consumer products, such as household chemicals and cosmetics. The final category, fine chemicals, represents the highest value-added segment of the chemicals industry, with unique performance characteristics playing a much more important role than bulk production or price, as in commodity chemicals. Examples include pharmaceuticals, special coatings, inks and photographic chemicals. Each subsector follows significantly different business models, so it is important to differentiate them.

186 In addition to organic and inorganic basic chemicals, commodity chemicals in this study will include generic rubber and plastic, as these products are primarily manufactured by companies specialising in the commodity chemicals sector.


The global chemical sector has shown modest growth in recent years, with output reaching €1.86 trillion in 2006, up 9.4% from 2004.187 Within this developed economies have held their historical strength, with the EU leading with approximately a third of global output. While major players are still based heavily in developed nations (Japan claimed the major share of Asia-Pacific output in 2006), a rising competitive environment globally has prompted massive industry restructuring since the early 1990s.


Although global output of chemicals is relatively dispersed geographically, in terms of trade the EU is unquestionably dominant, claiming over 58% of global chemical exports in 2006. Within its surplus growth the EU’s restructuring strategy has focused on the evolution of its export composition, where commodity chemicals and specialty chemicals combined share of exports has dropped from 68% in 1999 to 63% in 2007, corresponding to a rise in fine chemicals’ share of exports from 31% to 37% over the same period.188 The rise of fine chemicals has been led by Europe’s pharmaceuticals industry, which accounted for over 83% of fine chemical exports in 2007. The rising prominence of fine chemicals, including pharmaceuticals, in the EU’s export composition highlights both the global competitive environment in the relatively lower value, high quantity commodity chemicals as well as Europe’s innovative strengths in higher value, knowledge and service based markets.

As a whole the chemicals industry is of strategic importance to other industries in most developed economies, due to the complex inter-industry interactions discussed above. It comes as no surprise that, with China’s overall economy and industry output growing by over 10% for several years, its chemicals industry has also experienced rapid growth. In fact China’s chemical sector has experienced growth in excess of national growth during this period, with annual growth in output of major chemical goods as high as 23% since 2000. In absolute terms, chemical goods production reached US$ 372 billion in 2006, cementing its importance to the domestic economy. Approximately half of this resulted from the commodity chemicals sector, composed of crucial upstream inputs into other industrial sectors, while fine and specialty chemicals split the remaining half.

EU-China trade in commodity chemicals accounted for over €14 billion in 2007, growing at approximately 16% annually since 1999. The EU has maintained a deficit in the sector throughout this period, reaching €5 billion in 2007. As a portion of total sector trade, however, the EU’s deficit has declined from 52% in 1999 to 33% in 2007, signifying growing competitive strength and/or increasing market access for EU companies. The EU’s continued deficit in the sector is not surprising, given its restructuring towards fine chemicals in recent years. This has provided a niche for new, relatively inexperienced producers such as those in China to fill. Furthermore, China’s reputation as a low cost labour centre as well as the ‘world’s factory’ for basic manufactured goods has made close placement of petrochemical plants, along with related downstream plastics and rubber manufacturing, an ideal choice, thus reducing transport costs for primary and intermediate inputs into China’s many manufacturing industries. As a result, commodity chemicals accounted for 79% of Chinese chemical exports to Europe in 2007, essentially the same proportion as in 1999.

187 Global Industry Profile. American Chemistry Council 188 Eurostat


In 2007 EU-China trade in specialty chemicals reached €2.7 billion, growing strongly at 17.5% since 1999. Prior to China’s WTO ascension, when tariffs on chemical exports averaged 14.7%, the EU held a slight deficit to China in specialty chemicals, amounting to less than €52 million, or 4.8% of total trade at its peak in 2001. Following WTO ascension and the corresponding tariff declines the EU’s sector trade balance improved marginally, reaching €102 million in 2004 after three years of 16% annual export growth. In 2005, however, China’s tariff reductions in the sector halted, and with the Chinese RMB declining vis-à-vis the Euro (due it it’s managed float vis-à-vis the declining US dollar) European chemical exports faced increasingly difficult price competitiveness from Chinese producers. Nonetheless, European exports remained more or less on par with Chinese imports, resulting in a relatively minor Chinese surplus of €116 million in 2007, representative of less than 4.2% of bilateral trade in the sector. Within the EU deficit in specialty chemicals in recent years there has been an overwhelming dominance by generic household chemicals such as detergents, waxes and soaps as well as cosmetics. While cosmetics feature several luxury lines, on the whole goods in this category are generic in nature and competition is highly based on price as opposed to product performance.

In 2007 EU-China trade in fine chemicals reached €2.6 billion, following average annual growth of 13.6% since 1999. European producers have been particularly strong in the subsector since increased market access following China’s WTO ascension in 2001; maintaining a growing trade surplus which reached €382 billion in 2007. The EU’s strength has been primarily driven by robust pharmaceuticals exports, which constituted 50% of bilateral trade and, when considered a subsector to their own, a €602 million trade surplus for the EU in 2007. Although only in the fine chemicals market for just over a decade, by 2004 China had reached 13.1% market share in the pharmaceuticals market.189 European producers have also performed well in fertilizers, although to a lesser extent than pharmaceuticals, with that group of goods experiencing a minor EU surplus of €31 million in 2007.

Social Significance

With over 10 million employees the chemical industry accounted for 10.98% of China’s total industrial sector employment in 2004.190 Despite this high level, reports indicate that many local governments in China are keen to further encourage investment and expansion in the chemicals sector (among others) as a means to bolster overall employment figures.191 Employment may cause Chinese officials to hesitate when considering increased market liberalisation, as state owned industries account for a large share of jobs in the sector, despite constituting only one-tenth of total enterprises. State-owned enterprises employ 601 employees each on average, compared to 223 in foreign invested enterprises or just 109 in private invested enterprises.

On average, throughout all of China’s industries, labour productivity in 2005 was approximately RMB 104,000 per worker annually. The chemical industry average was approximately RMB 102,000 per worker annually, implying a minor misallocation of labour, because labour productivity within the chemical industry in Europe is much higher compared to other industries. Within the chemical

189 Chemical Engineering News, October 10, 2006 190 Main economic indicators of all industrial sectors (2004). China Statistical Yearbook 2006, National Bureau of Statistics. 191 China Insight – Chemicals. Broadwin China Strategy Consulting. Available at: http://www.chinastrategy.com.cn/industry_insight_chemical.htm


industry, however, vast disparities exist in labour productivity between enterprises under different ownership schemes. Within enterprises with foreign investment, worker productivity is approximately 50% greater than the industry-wide average, at RMB 154,000 per employee. In the state-owned and domestic private enterprises, however, labour productivity is well below the national average at RMB 88,000 and RMB 95,000 per worker respectively.

Risk of unemployment through elimination of inefficient or redundant enterprises in the chemical sector is further exacerbated by the high concentration of China’s chemical industry. The seven provinces of Jiangsu, Shandong, Sichuan, Zhejiang, Hubei, Yunnan and Henan account for approximately 53% of its output.

There are more disturbing social impacts. In 2006, SEPA acknowledged that environmental accidents had reached alarming levels, occurring at a rate of every other day in 2005, with 76 major incidents, and causing over 510,000 social ‘disputes’.192 Due to China’s high population densities in areas of commerce it is inevitable that industrial facilities and residential neighbourhoods overlap. In recent years social awareness of the risks posed by large industrial facilities, particularly chemical processing plants, has risen, leading to grassroots movements and organised protests against new plant construction, in a similar essence to the ‘not in my back yard’ movement surrounding the heavy industry construction in developed countries. The biggest of these, in Xiamen, Fujian province, led to plans for a major plant for the manufacture of paraxylene (PX) being abandoned.193


The effect of the chemical industry on China’s environment has been an area of rising concern in recent years, especially considering the breadth of its impact in the case of large spills on waterways. Due to water pollution, China’s water shortage is getting worse every year. In 2003, over six million kilograms of organic water pollutants per day were released. This has led to approximately 38% of China’s rivers and 75% of its lakes to be severely polluted, while only 20% of waste water is treated in China, compared to 80% in most developed countries. Within all industries, approximately 90% of organic water pollutants from industry originate from the food and beverages, primary metals, chemicals, textiles, and paper and pulp sectors. The chemicals industry is estimated to account for 14.8% of total emissions in China, compared to 9.1% in Europe. Concurrently the chemicals industry in China was accountable for approximately 20.1% of total industrial wastewater emissions nationwide in 2005.194 Further exacerbating the chemical sector’s contributions towards emission of pollutants is the fact that in 2005 it accounted for 21.5% of industrial energy demand, and 12.3% of total energy demand in China.195 The above-mentioned action to stop construction of the PX plant in Xiamen was at the same time effective in bringing poor environmental monitoring standards to public attention.

Legislation

192 China sees environmental accident every other day: SEPA. Gov.cn, 19 April 2006. Available at: http://english.gov.cn/2006-04/19/content 257882.htm 193 Li Li, “Power to the People,” Beijing Review, 28 January 2008; http://www.bjreview.com.cn/nation/txt/2007-12/27/content_92763.htm. 194 China Statistical Yearbook 2006. China National Bureau of Statistics 195 China Statistical Yearbook 2006. China National Bureau of Statistics


Although lacking extensive provisions regarding the chemicals industry, China’s 11th Five Year Plan does include legislation relevant to the chemicals industry. Between 2006 and 2010 emissions of total pollutants are planned to decrease by 10%, while energy consumption per unit of GDP is planned to decrease by 20%, particularly relevant given the chemical industries’ 30% contribution to total industrial power consumption.196 The plan also calls for a structural adjustment to the layout of the chemicals industry, although no specific goals are described. The plan calls for promotion of China’s biopharmaceuticals industry and revitalisation of ethylene production industry, despite the fact that national ethylene production grew by 9.6% annually between 1999 and 2005.197

In late 2007 the National Development and Reform Commission’s Catalogue for the Guidance of Foreign Investment Industries, which classifies different types of encouraged, restricted and prohibited investment was updated. In the revision a number of polluting industries were removed from the encouraged category and in some cases restricted or prohibited, however, the chemical industry still largely benefits from its inclusion on the encouraged list. With over 30 specific goods markets listed for encouraged investment in the chemicals market and over 15 in the pharmaceuticals market, investment is likely to continue to grow significantly in the coming years. Notably, a number of ‘green’ goods are included on the list, including at least nine goods with environmentally sustainable production processes or end-use applications

On 1 March 2007, the Ministry of Information Industry of China began its new hazardous waste restriction program, often referred to as China RoHS for its conceptual similarities to the EU Restriction on Hazardous Substances directive. While not specifically targeting the chemicals industry, because of its effects on downstream producers, China RoHS has a high relevance to both EU and Chinese chemicals producers. Similar to the original EU RoHS, the regulation is designed to reduce hazardous wastes through elimination of pollutants in consumer products and packaging as well as enforced recycling programs.198 The program takes a ‘cradle-to-grave’ approach, placing requirements on input producers (such as commodity chemicals producers) down to final sellers. These requirements include: the use of non-toxic, biodegradable or recyclable packaging; labelling which indicates the environmental friendliness of a product throughout its supply chain and its recyclability; listing of potentially harmful substances involved in its production; and the dates for which its chemical ingredients are active (i.e. not degraded). Notably, in addition to these agreed upon hazardous substances, the Chinese RoHS also mentioned the banning of “other toxic and harmful substances” without qualification, placing a degree of uncertainty on the chemical industries and their downstream purchasers.199 Also differing from the EU RoHS, all producers along a supply chain are legally responsible for compliance, including for products which are not on the market.200

196 The Outline of the 11th Five Year Plan. National Reform and Development Commission. Available at: http://en.ndrc.gov.cn/hot/t20060529_71334.htm 197 China Statistical Yearbook 2006. China National Bureau of Statistics Beijing’s 11th Five Year Plan. Beijing Association of Enterprises with Foreign Investment, 29 March 2006. 198 China RoHS Answers to Frequently Asked Questions. Design Chain Associates, 27 February 2007. Available at: http://www.chinarohs.com/faq.html 199 Franklin, Ray. China RoHS and China WEEE. RoHSwell.com, 28 October 2008. Available at: http://www.rohswell.com/News/Genl006.php 200 In the EU RoHS goods are only required to comply when they are ‘put on the market’, i.e. available for sale. Within China RoHS a subtle difference is that goods must comply once they have left production facilities. While this definition is only slightly different it has raised concern among suppliers about ambiguity as to when one must comply, particularly in intermediate goods whose toxicity may vary significantly from the final, end use product.


Producers in both the EU and abroad have raised concerns to the new EU REACH regulation, which is scheduled to be actively enforced from 1 December 2008. In China the Chinese Chamber of Commerce of Metals, Minerals and Chemicals of Importers and Exporters (CCCMC) has noted a high level of concern with Chinese producers, who may face certification and licensing fees as expensive as US$399,558, with total registration costs expected to add 5% to overall business operating costs.201 These cost pressures are expected to hit small and medium enterprises who operate on thin margins. The CCCMC predicts a decline in overall chemical industry employment by up to 200,000 workers. Furthermore, manufacturers who utilise downstream chemicals in their production processes are expected to suffer losses as well, as chemical producers based in Europe will experience rising compliance costs that will be reflected in overall commodity prices. The EU REACH regulation is designed to provide considerable improvements in environment and consumer safety for chemical products manufactured and imported into Europe.

5.4.2 PCA Scenarios PCA Impacts

Economic Impacts

Within the policy only scenarios the economic impacts are expected to be mixed. Within China’s Economic Structure, low export growth coupled with significantly high (41% from the EU) import growth will lead to an overall balancing of China’s current account surplus. Notably, while Chinese production will decline absolutely, Chinese exports will expand marginally, implying that the economic performance of sector actors will become more competitive and efficient in an environment of reduced trade barriers. With production declining it is also possible that material consumption will be reduced marginally, however significance of this reduction is difficult to assess without further analysis into upstream supply chain affects.

China’s Consumption and Production Patterns are also expected to experience a positive effect, with declining chemicals production leading to both a decline in energy use and waste generation, although these factors may be offset by the transport costs of higher trade flows between the EU and China under more ambitious scenarios. As the chemical sector is estimated to account for over 30% of industrial energy use in China, a production decline of 3% may mean significant shifts in overall energy use. A decline in production may also lead to a decline in hazardous wastes, where the chemical sector produces approximately 14% of Chinese total output.

Social Impacts

The social impacts of a PCA between the EU and China are mixed, with both positive and negative effects felt across different social themes. Within the theme of Equity, a decline in overall production in China may lead to unemployment and an aggravation of existing poverty conditions.

Within the theme of Health, declining water pollution from domestic sources as a result of reduced chemicals production in China will likely lead to better access to safe water, and also reduce the

201 Reach to severely impact China’s chemical industry. PlasticNews, 22 October 2007. Available at: http://www.plastemart.com/plasticnews desc.asp?news id=11083&P=P


occurrence of chemical disasters which contaminate major water sources for extended period of time, such as in the case of the eutrophication of Lake Tai. Growth in fine chemicals, inclusive of pharmaceuticals, will also reduce the cost of medicines to Chinese consumers.

Housing may expect to benefit, as actors in the market narrow in the face of declining chemicals production. Chemical plants located on the suburban fringes, a source of serious social unrest in recent years, will in future be fewer.

Labour is an area of significant likely impact. With production declining, a rise in unemployment appears likely in China, although the opposite would occur in Europe. This may aggravate China’s already inequitable income distribution. As a result employment opportunities within China may decline, leading to increases in unacceptable work practices and a decline in job stability during the period of analysis. A decline in chemicals production, however, may also lead to a decline of industrial accidents, with the overall growth or decline in industrial accidents difficult to accurately assess.


The environmental baseline for the chemicals sector presents a variety of problems to China. With regards to the Atmosphere, with the chemicals sector accounting for over 12% of total energy demand in China it is also understood to be a significant contributor to the country’s currently rising CO2 emissions. A decline in production under the trade policy only scenarios would presumably lead to marginal declines in energy demand as well, thus reducing CO2 emissions from the sector.

Within the Land and Freshwater themes, increased access to chemicals from abroad may lead to high levels of pollution by domestic consumers, in spite of reduced emissions from domestic production. In particular, greater access to agrochemicals may allow farmers to use these vital inputs in an even less environmentally sound manner than in the past. Chemicals runoff previously has lead to eutrophication of major bodies of water, such as rivers, lakes, and coastal areas, where abnormally high levels of chemical nutrients from fertilizers leads to an explosion in certain types of algal growth, which subsequently unbalances the overall ecosystem and also makes water unfit for human consumption. The conflicting impacts of reduced domestic output and increased use of foreign agrochemicals makes it difficult to determine a definite outcome, making this a key area for attention in the period following a PCA. Impacts of potential pollution would also impact on Oceans, Seas, and Coasts as well as Biodiversity, although the impacts again are uncertain.

A summary of impacts are provided below. Please note that impacts are derived from policy only scenarios, while projections scenarios help determine the feasible reversibility and capacity to change within a sustainable development theme.


Table 30: PCA Summary Impacts Table – Chemicals (China)

Existing Conditions




Economic Economic Structure + N L Consumption and Production Patterns

-- Y H

Social Equity 0 Y H Health -- Y M Housing - Y H Labour - Y M Environmental Atmosphere -- Y H Land - Y M Fresh Water -- Y H Oceans, Seas, and Coasts -- Y M Biodiversity -- N M

Table 31: PCA Summary Impacts Table – Chemicals (EU)

Existing Conditions




Economic Production & Exports - N L Social Labour - Y M

5.4.3 Policy Recommendations Within the chemicals industry in China which is already relatively open to foreign investment and trade, the impacts of EU-China relations on the sector are more concentrated in regulatory areas concerning trade and the environment as opposed to purely economic. In addition to the overwhelming importance of the sector’s regulation in both countries, it is also the sensitive issue of employment in provinces of China and European member states which are more susceptible to further industrial restructuring.

Mitigation

Resources to Address Shifting Employment

While increased trade and investment liberalisation will foster efficiency in the sector and greater overall productivity in each side’s respective subsectors, providing market mechanisms with greater autonomy will also cause structural adjustment challenges for localised labour forces as old, inefficient plants are forced to close down and new ones open. Policy makers need to incorporate employment outcomes into their scenarios. Policy makers should provide resources to those who


experience structural and cyclical unemployment through regulatory liberalisation. A variety of measures can be utilised to this effect, including relocation assistance, employee retention programs, industry restructuring incentives and re-education assistance.

Relocation assistance and employee retention programs both aim to aid workers who have lost jobs in no longer efficient chemicals firms by providing appropriate incentives to new, innovative chemical companies to first hire from this pool of workers before new industry entrants. Relocation can be both financial and emotionally traumatic, especially under the circumstances of a firm closure. Relocation assistance facilitates this by partly subsidising workers who have recently lost jobs in the chemicals industry to find employment in other areas. Employee retention programs aim to encourage new chemicals companies to first select new employees from existing industry labour pools before competing in other domestic or foreign labour markets.

Industry restructuring incentives and re-education aid seek to facilitate rapid transition from older, inefficient or labour intensive subsectors towards new chemicals subsectors or entirely new industries. Within China, over a third of employment in the chemicals sector is within SOEs which operate at approximately 2/3 the productivity level of foreign enterprises, implying that increased competition could marginalise these workers. SOEs are also cited as among the chief violators of environmental regulations and oversight, and the leading cause of environmental disasters as described above.202 Under a regime of more stringent regulations and a strong environmental agency, these less efficient companies will likely require restructuring. Within Europe, while Germany commands nearly a third of chemicals industry employment, new member states are viewed as more vulnerable due to their legacy SOEs which still operate using non-competitive business models.203

Improve Environmental Stewardship

Given the severity of China’s environmental problems, particularly those related to the chemicals industry, growth in demand due to trade may be interpreted by some as a precursor to further environmental degradation wherein some production facilities continue to put gross output above environmental safety.204 This is particularly relevant in the chemicals industry, given its large share of overall wastewater emissions in water-scarce China. While SEPA’s influence has recently been boosted with its transformation to the Ministry of Environmental Protection (MEP), little is known in regard to any lift in capacity in policy formation, monitoring or enforcement, either in manpower or financing terms. With only an estimated 200 employees currently, compared to the German Federal Environmental Ministry’s 1,800, MEP still counts as understaffed and underfunded, especially given China’s vast size and the abundance of environmental issues.205 Thus, priority should be given to improving the regulatory powers of those responsible for China’s environment.206

202 McElwee, Charles. China Environmental Law and the Chemical Industry. Squire Sanders Legal Counsel Worldwide. 203 Milmo, Sean. Chemical industry employment levels continue to decline in the US and Europe. ICIS Chemical Business, 28 February 2008. Available at: http://www.icis.com/Articles/Article.aspx?liArticleID=9104613 204 The cause of accidents such as the 2006 Songhua River spill are frequently cited to operators ‘recklessly discharged chemical waste water’. Accident page, China Chemical Reporter, 9 June 2006 205 Sanderson, Henry. China Environment Agency Gets More Power. Associated Press, 1 March 2008. Available at: http://ap.google.com/article/ALeqM5icPw8BwDs4EYOrcM2Xe3KOGqPw5gD8V44VN01


Assist SME’s in Regulatory Compliance

A host of new regulations affecting the chemicals industry both directly and in downstream markets are in the process of being phased in the EU and China. These include the EU’s REACH, RoHS, and WEEE, as well as China’s RoHS and WEEE counterparts. Notably, despite the similar names (as used by industry), industry associations have noted differences in the legislation between China and Europe, which may lead to large differences in enforcement and compliance costs. In China, the cost of compliance with the EU’s REACH is estimated at 5% of total revenues, with licensing alone costing nearly US$400,000. It is feared that these operating costs will be felt most significantly on small and medium sized enterprises which are particularly common in the private chemicals sector in China (where employment is on average 110 employees per enterprise compared to 601 in state-owned enterprises), with some industry associations estimating the costs of compliance at 200,000 jobs.207

To help encourage both regulatory compliance and a market environment open to SME operations it is suggested that a single body be made responsible for assisting SMEs in REACH compliance. No less than 6 government bodies in China have wide-reaching obligations in this regard. The creation of a single office which coordinates all of these bodies in their roles would help reduce overlapping and possibly competing initiatives as well as provide Chinese SMEs with a obvious single contact point who would then aid them in compliance through internal projects or via liaison with one of the agencies or ministries. The establishment by the China Chamber of Commerce of Metals, Minerals and Chemicals Importers and Exporters (CMCCC) of a representative office in Helsinki will assist Chinese companies’ compliance with REACH and further develop an industry based compliance approach encouraged by the EU regulation. Greater international compliance with REACH will have a correlating and positive impact on improved environmental and consumer safety in the EU.

Enhancement

Foster “Green” Production

Tariff incentives (from the EU) or tax incentives (from China) are suggested for those companies both meeting their necessary regulatory compliance as well as hold ISO14000 environmental management systems certification. While this internationally recognised certification does not place sector-by-sector guidelines for environmental management, it does provide a framework which encompasses identification and mitigation of a company’s environmental impact through both internal management as well as external consultation with stakeholders, including customers, local communities and regulatory bodies.208 These monetary incentives, available on a sliding scale wherein SMEs are eligible for the largest relative benefits (represented as a percentage of tariff or tax reductions), will both help recoup the cost of licensing, certification and compliance while

Info - The Ministry. German Federal Environmental Ministry. Available at: http://www.bmu.de 206 For more details please also see 5.2 Environmental Goods and Services 207 China Statistical Yearbook Reach to severely impact China’s chemical industry. PlasticNews, 22 October 2007 208 ISO 14000 Essentials. International Organisation for Standardisation. Available at: http://www.iso.org/iso/iso 14000 essentials


encouraging improved stewardship in one of China’s most publically known environmental-disaster-prone industries.209

Improve Industry Best-Practices through Bilateral Cooperation

It is suggested that the industry be encouraged to create independent external review boards with responsibility and authority to address complaints from the public or other industry members. This would demonstrate that code compliance is a high priority and that all members are held to reasonably consistent standards. In general, there is a need for stricter controls of Chinese chemical companies exporting products out of China, especially those producing and exporting pharmaceutical ingredients. Close co-operation between the EU and China’s standard bodies should be supported to ensure compliance with EU standards and REACH chemical regulations. There is still a need for more openness and transparency in China’s standards development process, and organisations should be fully open to foreign participation.

A code of conduct for chemical producers and governmental authorities should be formulated based on the already established regulations and initiatives. The aim of this document would be to communicate a clear and transparent set of rules and best practice examples for public communication. Companies should be encouraged to report against the code’s standards.One very important point for this code is that, according to the TRIPs agreement, China is required to protect undisclosed information submitted to Chinese agencies in obtaining regulatory approval for pharmaceutical and chemical entities from disclosure or unfair commercial use. China’s State Drug Administration and Ministry of Agriculture oversee the marketing approval of pharmaceuticals and agricultural chemicals, respectively. Although the IP protection has improved with new laws, there remains a strong demand for the enforcement of claims and a centralised authority in China could further assist foreign companies enforce their rights.

Additionally, anti-dumping remains a major issue in the chemicals sector. Within the PCA it is suggested that a dialogue with China be established to implement an anti-dumping agreement in line with the EU anti-dumping regulation.

Thos study also supports a framework for new collaborations through dialogues built on existing co-operations between the EU and China to ensure that the Chinese chemical industry works towards international standards in health and safety. Importantly, this should be complimented with further bilateral discussions regarding a chemical sector deal within the Doha Round in which all major chemical producing countries should participate. Should the EU and China reach an early consensus in this area it may serve to build momentum towards an eventual way forward under the current round of multilateral negotiations.

There is also a need for advocacy programmes to promote the importance of effective and broad based research dissemination. Awareness campaigns should be accompanied by the development of effective case studies to provide working examples of how research dissemination can positively benefit the industry.

209 The China Chemical Reporter’s Accident Page reported that at least 45 environmental accidents occurred between January and September 2007


5.5 Agriculture

5.5.1 Sector Background Economic Significance

While both the EU and China are major actors in global agricultural trade, trade in agriculture between them is relatively small. This suggests that it has significant potential for growth.

The EU and China are huge players in the global agriculture market, both as producers and consumers. China and the European Union are both among the top five exporters and importers in the world. The EU remains a net food importer and China's ability to remain self-sufficient in food production faces greater hurdles. Liberalisation on both sides could reduce prices for consumers and increase market penetration for producers in both regions. Rising incomes offer more opportunities for EU firms to expand their market presence in China, either through investment in local producers or increased exports. Such opportunities are particularly strong in grains, dairy, meat, and wine and beverages sub-sectors.

Agricultural trade volume between the EU and China represents just over €4 billion. Although trade in agriculture between them is relatively small, the EU and China are major actors in global agricultural trade. In terms of overall trade activity in the agricultural industry, both imports and exports have been steadily rising since 2002. Trade habits in these two regions are especially important given that China is one of the biggest consumers and producers of grain in the world and the EU is one of the largest consumers of food products in the world. There are five sub-sectors that play an important role in the EU-China trade

relationship, and are given specific focus in this study (see Figure 8):

• Fish and aquaculture sub-sector represents the largest proportion of EU imports from China as well as a substantial proportion of agricultural exports to China.

• The grains and cereals trade will be of keen importance as agflation and biofuel technology persist as important policy concerns. Trade policy in this sub-sector will also have a direct impact on environmental protection issues as well as development in rural areas.

• Meat and dairy products hold great potential for European food producers as a means of boosting investment in the Chinese food market.

• Wines and spirits represents an expanding market in China that offers lucrative opportunities for investment and modernisation for producers in both regions.

Figure 8: EU Agricultural Exports to China


Fish and Aquaculture

China is the world’s largest exporter of seafood. In 2005, China produced over 45 million tonnes of fish and in 2004 was the source of close to 70% of total worldwide aquaculture production.210 A great deal of this production is consumed domestically, yet fish remains the largest agricultural export of mainland China and China’s aquaculture and fishing industry employs 13 million people. 211 The biggest concerns for producers and consumers, both domestic and international, are safety and sanitation.

In 2007, fish, molluscs and other aquatic products represented 26% of Chinese agricultural exports to the EU. Of those aquatic exports, 69% consisted of frozen fish fillets. Overall, fish fillets represent 18% of agricultural imports from China. The demand for Chinese fish products contributes to the EU trade deficit, however, consumer safety concerns could impact on this level of trade. Fisheries in Fujian province are suffering from water shortages and water contamination from sewage and agricultural runoff. The pollutants in the water the fish farms occupy pose a serious threat to the fish and could potentially reduce the output of these farms. To counteract the risks of the tainted water, fish farmers are known to add veterinary drugs and pesticides. This extends the life of the fish, but these additives remain in the fish even after they have reached the market. These chemicals are known carcinogens and can cause serious liver damage. In 2007, the US banned several species of fish imports from China after discovering trace elements of these chemicals in shipments. Despite recent scrutiny China has faced concerning food safety, seafood is likely to remain a lucrative export for China.

Grains and Cereals

In Europe, grain production is increasing while stocks are steadily decreasing. The main reason for declining grain stocks and rising food prices is the increasing intersection of the food and energy markets due to rising interest in biofuel technology. Ethanol, made from corn and other traditional food crops, is being pursued as an alternative liquid fuel for automobiles. On the upside, engines that run on biofuels are significantly cleaner than fossil fuel alternatives; and carbon dioxide emissions are greatly reduced. Recent studies suggest, however, that the fossil fuels burnt to produce biofuel alternatives cancel much of the promised emission reduction which further pushes up prices in this sector as speculative transactions. Prices are expected to remain high for at least another year or so (enough time to observe two full crops and replenish global stocks), and investors aim to secure grain supplies and farmland, resulting in grain and farmland prices soaring upwards.

In China, grain prices have also seen a marked increase, though there are number of different factors at work. One factor involves increased domestic demand for meat and dairy products. Dairy farmers and livestock owners are increasing herd numbers to increase output of meat and dairy products. Among other factors impacting grain prices in 2007 include the pork shortage resulting from an unexpected outbreak of blue-ear pig disease. The outbreak decimated the pig population, leading farmers to accelerate breeding, increasing demand for feed and resulting in grain price increases. As 210 FAO - Fisheries and Aquaculture Department. The State of World Fisheries and Aquaculture - 2006. Rome: Food and Agriculture Organization of the United Nations, 2006. 211 Food and Agriculture Organization of the United Nations. "Fishery and Aquaculture Country Profile - China." www.fao.org. 03 June 2008 <http://www.fao.org/fishery/countrysector/FI-CP_CN/en>.


grain prices began their initial rise, Chinese exports of staple grains increased substantially. Exports of corn in 2007, for instance, rose 41.4% over exports in 2006. Another factor is the decrease in grain production due to environmental issues. Encroaching deserts in the west are threatening the already scant acreage available for crops and farming; coupled with rapid urbanisation, limited water supplies, and reforestation efforts aimed at slowing desertification. China’s ability to remain self-sufficient in grain production is in jeopardy. Food security is of high importance to the central government and intervention in the grain market is likely as officials attempt to buttress farmers and encourage the continued planting of grains.

An additional factor is the promotion of biofuels, such as corn-based ethanol for industry applications, putting further strain on grain prices in 2007. The extent of the benefits of transitioning to biofuels is still under investigation and the future state of the grain market is tied to the fate of this bourgeoning industry. In light of the recent price increases in food, especially grains, the Chinese government has already put a freeze on approving any additional biofuel development or production projects, which has been in effect since 2006.

Economists are concerned that if the current trend of protectionist policies in the grain sector goes on undisturbed, the “agflation” afflicting developing countries will likely linger and could potentially worsen.

The major impediments to growing trade in the grain sub-sector are export duties, soaring fuel prices and increased domestic consumption due to the growth of biofuels. There has been a sudden downturn in EU exports of grain to China. Starting in 2006, exports dropped from a 10-year high of €80 million in 2005 to a 10-year low of €1 million.212 The farms and agricultural firms in both the EU and the US have been avidly pursuing biofuel technology as a way to simultaneously reduce dependency on foreign oil and reduce greenhouse gas emissions. The European Energy Council mandated in 2008 that EU member states substitute 10% of their transport fuel supply with biofuels by the year 2020. As a result, demand for biofuel crops will likely remain high and may continue to displace other food crops further contributing to higher food prices. This impact could be short-term if the commitment to biofuels as an alternative fuel decreases. There are already some indications that the benefits of biofuels may not be as high as once thought. In January 2008, an internal EU study on the benefits of biofuels, conducted by the EU’s Joint Research Centre warned that transitioning from fossil fuels to biofuels would be very costly while its environmental benefits are not assured.213 Researchers will continue to more closely scrutinise the benefits of substituting biofuels for traditional fossil fuels, however, current trends suggest that biofuels will likely continue to be pursued as a cleaner alternative to fossil fuels. EU-China grain trade would likely shrink in volume as more and more arable land is allotted to maize, soybeans and wheat for biodiesel production.

Dairy and Meat

The dairy sub-sector consists of the production of milk, dried milk powders and various milk-based products including yogurt, butter and cheese. Milk consumption in China has risen substantially in the last decade. Producers in China and exporters in Europe are anxious to fill the growing demand. 212 Note: Within Section 2 all Eurostats figures provided for 2007 (marked with +) are based on preliminary Eurostats data. All figures within Section 2 for 2008-2011 (marked with *) are projections based on established trends, representing ‘business as usual’ growth. 213 Bounds, A. Brussels' own scientists cast doubt on EU biofuel strategy. Financial Times, p. 1. January 18 2008


It is likely that as incomes rise and diets change, Chinese milk and dairy consumption will rise to levels similar to those in more affluent Asian countries such as Japan and South Korea. Though the EU’s share of world milk production has dipped somewhat since 2000, the EU remains the world’s largest producer of milk and dairy products.

Meat and meat-products include bovine and ovine meat, pork, poultry and products derived from these animals. The EU and China are both large producers of meat products, however, the EU is the net exporter in the EU-China trade relationship. Trade activity in this sub-sector is relatively small.

There is a substantial amount of volatility in the meat market, as illustrated recently by recent outbreaks of livestock disease and other food safety issues. The outbreak of foot-and-mouth disease in the UK, blue-ear disease in the pig industry in China, and the threat of avian influenza that threatens the poultry market in Asia are cautionary examples of safety and sanitary standards being absolutely crucial to establishing long-term markets for meat products.

Domestic dairy and meat production in China will continue to increase to meet growing demand. Exports of meat from China to the EU will follow a downward trend as the gap between domestic supply and demand begins to shrink. The pace of domestic consumption could slow in the short-term, however, as high levels of "agflation” are likely to cut into gains in annual income. This could have a positive impact on meat exports overall. The dairy sub-sector should experience an overall increase both in trade volume as well as foreign investment. The capital intensive nature of milk production, along with the quality and variety of dairy products available for export in the EU, makes it likely that EU producers will find a growing market for their dairy imports in China. Moreover, given the relatively underdeveloped state of dairy production in China, it is likely that foreign investment will also increase as foreign firms bid to enter China’s domestic dairy market.

Wine & Spirits

The alcoholic beverages market in China, on the other hand, is valued at approximately US$44 billion as of 2007. According to sales, demand is highest for beers, ciders and other flavoured alcoholic beverages. Wines, which represent a substantially smaller portion of the market, are nonetheless valued at US$4.5 billion dollars for 2006.214 Fortified wines represent the EU’s biggest export in this sub-sector. Production of wine and spirits in China is increasing; however, tastes and preferences in the market are changing. Domestic wine production in China is catching up with international producers, having grown by 81% between 1994 and 2005 while production in France (Europe’s largest producer) grew by less than 1%. Notably, however, absolute production in France exceeded China’s in 2005 by nearly 10 to 1.215 Flavoured and non-flavoured natural and mineral waters represent only a negligible proportion of the beverage trade between the EU and China.

Social Significance

A numerical majority of the population lives in rural Chinese society. So great is the impact of this area of policy that it is referred to as the sannong (“three dimensional agrarian”) issue, comprising

214 Industry Profile: Wine Market in China 2007, Datamonitor, November 2007 215 Winefacts, World Wine Production, Australian Wine and Brandy Corporation, July 2007


agriculture, rural politics and the peasantry. It is not confined to the economics of agriculture.216 Changes in the economic balance naturally have broad repercussions, for example on farm income disparities, off-farm employment, migration and rural poverty. The weak protection of farmer’s basic rights means that these social effects easily become political, as changes in relative wealth are amplified.

At the current rate of economic growth in China, income inequality between the rural and urban populations is predicted to increase. Typically, under competitive market economy conditions, income gaps between various sectors is the major cause of labour movement. Shifting its huge surplus of rural labour to the non-agricultural and industrial sector is a major challenge currently facing China. So far the state has been unwilling to relax the political “insurance system” represented by the rural urban divide. This policy, expressed in the household registration (hukou) system has contributed to increasing rural-urban tensions. Inflation is another high priority issue emerging at the rural-urban divide.217 It was initially triggered by rising food prices (for instance, pork prices increased by 63.4% in February 2008, while overall consumer inflation went up by 8.7% in the same month.218 Household incomes have not grown correspondingly impacting real wages. The government’s response has been to increase financial transfers to the rural sector and stimulating production in the market it is hoped to curb price rises.


Some agricultural experts point to certain farming practices that are unsustainable and may be doing irreparable damage to China’s supply of arable land. For instance, there are indications that goat herding practices by cashmere farmers in Inner Mongolia are accelerating the desertification process.219 The cashmere industry has been growing rapidly in the last fifty years and the particular breed of goat from which the most desirable material is shorn have an especially harsh impact on the grasslands and shrubbery that hold the nutrient-rich soils in place.

The accelerating growth in production in the agricultural sector, driven by the expanding meat and dairy sub-sector, and an increased demand for grain, is putting a serious strain on China’s water supply, especially in the north-eastern provinces where most grain production is centralised. The government’s insistence on grain self-sufficiency has pushed some areas of China to the verge of a water crisis, driven both by excessive overall water use as well as inefficient use of agro-chemicals such as fertilisers and pesticides.

Complicating the problems inherent in China’s current and expected water shortages are the consequences of ongoing global climate change as a result of sustained CO2 emissions. Studies have indicated that as temperatures rise across China and the world, current regions of arable land will shift in unpredictable ways, creating both winners and losers in agriculture. Modelling suggests that climate change without CO2 fertilization could reduce yields of rice, maize and wheat in China by up

216 Sannong is a category of China’s national statistics, and is also an entire division of the CPC’s Central Party School. 217 Pieter Bottelier, “The Long Term Risks of China's Inflation Problem,” China Brief, 28 April 2008 [http://www.jamestown.org/china_brief/article.php?articleid=2374132]. 218 ‘Breath-taking Inflation’, China Daily, 12 March 2008 219 Osnos, Evan. "The Price We Pay for China's Boom." The Chicago Tribune 17 December 2006: C1.


to 37% in the next 20 to 80 years. 220 By 2100 temperatures are expected to rise by up to 4°C across China, while increased CO2 in the atmosphere is expected to have a conflicting effect on agricultural output.221 The amount of CO2 which plants have available in the atmosphere is a key determinant in overall fertility in growth, leading to uncertainty from experts as to whether climate change via CO2 emissions will in fact bolster or reduce crop yields globally and in China. The impacts of climate change will thus create both difficulties and opportunities for farmers in China, and require holistic preparation and adjustment mechanisms to ensure that issues such as rural poverty, food security, income distribution and agricultural management are enhanced rather than diminished by climate change.

5.5.2 PCA Scenarios

Economic Impact

Overall, the results indicate that the agricultural sector in both the EU and China would receive a substantial boost from a PCA that deepens trade liberalisation. Liberalisation in the agriculture sector, specifically in the EU and in China, would entail the reduction or elimination of production quotas and export taxes as well as more transparent SPS and product certification enforcement. This would have an overall positive impact on both the economies of the EU and China. Economic gains would be made from liberalisation of trade between the EU and China, with demand rising for agricultural products even under a modest liberalisation scenario. Chinese production in the five key sub-sectors would see a nominal decline (less than 1%); however, there would be a substantial increase in EU-China trade activity following modest trade liberalisation. Chinese imports of EU products would increase an average of 15%, with the bulk of those gains would favour the dairy subsector. Export trends in the EU suggest that farmers in France and the Netherlands would see the biggest proportion of those

gains. EU imports of Chinese products would increase an average of 4.30% with the biggest increase being in the fruits and vegetables and grains subsectors.

If progress on the Doha Development Agenda continues as projected (this scenario is defined as a 10% reduction in tariffs and other non-tariff barriers), exports to the EU would increase across all agriculture sub-sectors by an average of 1.66%. However, a modest liberalisation of trade (which in the model is defined as a 25% reduction in tariffs

and non-tariff barriers) would, in almost every sub-sector, triple these potential gains. Imports of EU agricultural goods would see similar gains in trade. Dairy, fruits and vegetables, and wines and spirits would all see double digit growth with modest liberalisation; an ambitious liberalisation would more than double these gains. Dairy imports from the EU would see the most substantial improvement in this scenario. The meat and seafood subsectors would experience more modest gains but would still benefit from double digit growth in exports with ambitious liberalisation. EU exports under a

220 Investigating the impacts of climate change on Chinese agriculture, China-UK Collaboration Project, 2004 221 Ibid

Table 32: Domestically Produced Supply under a Modest DDA

% ∆ Domestically Produced Supply

Dairy Products -0.414

Meat Products -0.061

Fish and Aquaculture -0.302

Grains and Cereals -0.342

Fruit & Vegetables -0.035

Beverages, Wines & Spirits -0.037


assumption, production in an ambitious liberalisation scenario (scenario 5) rather than decreasing modestly increases rather dramatically (see Table 33). This has serious implications for Chinese government’s efforts to confront the water scarcity and land degradation issues.

Table 34: PCA Summary Impacts Table – Agriculture (China)

Existing Conditions




Economic 0 H Imports - N H Exports ++ N H Production + N H Demand 0 Y M

Social 0 M Employment in Ag Sector + Y M Self-Sufficient food production + Y H Income Distribution - Y M

Environment - H Water Supply - Y H Drinking Water 0 Y H Land Degradation - Y H

Table 35: PCA Summary Impacts Table - Agriculture (EU)

Existing Conditions

Scenario Impacts Policy Options Indicator Overall Direction

Magnitude Equity Reversibility Capacity to

change Economic + H

Imports + N M Exports ++ N H Production + N H Demand + Y L

Social + M Employment in Ag Sector + Y M

5.5.3 Policy Recommendations Mitigation Measures

Urban-Rural Migration

The most important role of government is to mitigate the impact of greater imports and heightened efficiency in the agricultural sector on the rural labour market. The Chinese government has spent over 66 billion yuan in the last five years on employment programs and job training for rural migrant workers to offset the job losses from SOE lay-offs.222 Encouraging or facilitating the migration of labour from rural areas to urban centres would improve the income disparity that has persisted between urban and rural citizens as well as improving overall real income growth. Further balancing of the rural-urban divide could dampen the impact of high food prices, as urban dwellers in China

222 "China to Create 10 Million Jobs in Cities in 2008." 5 March 2008. China Daily. 5 June 2008 <http://www.chinadaily.com.cn/china/2008npc/2008-03/05/content_6509495.htm>.


generally experience higher income growth rates, while rural dwellers sharply feel the knock-on effects on food prices from inflation (and experienced a higher rate of consumer goods inflation in 2007).223

Efficient Water Use

China is already taking action to head off a serious water crisis in the Northern provinces with the construction of the South-to-North Water Transfer Project. As this is not scheduled to be completed until 2050, the government will likely need to intervene in the meantime to exercise controls on farming and land cultivation. Furthermore, economic and social incentives to expand will be strong as trade barriers are reduced. Tighter controls on new land cultivated in conjunction with greater efforts to educate farmers in the northern provinces of the dangers of water scarcity and the importance of sustainable farming, would go a long way towards curbing the environmental threat of land degradation and water shortages. Initiatives suggested aim to improve efficiency of water delivery, including strengthening wastewater processing and reuse, and liberalise water pricing.224 The IFC and World Bank’s ‘Environment, Health, and Safety Guidelines’ provide a number of guidelines in all sectors discussed. Regarding terrestrial agriculture sectors, a number of parameters for the monitoring of water and pesticide use are recommended by those guidelines, with the need to establish and implement water use management tools among farmers highlighted.225 This report suggests that the IFC and World Bank guidelines for these industries be considered for adoption within China’s rural agricultural sectors and also advocates the use of the Food and Agricultural Organisation’s water management guidelines, which includes tools such as CropWat to increase efficiency of water use in agriculture.226

Sustainable Fisheries and Aquaculture

Given the strength of the EU-China trade relationship in the fish and aquaculture sector, stronger steps need to be taken by authorities on both sides to ensure sustainability of the fishing sector. On the EU side, authorities could increase efforts to see that all ports in member states are accurately reporting the catch volumes that are entering the EU. Moreover, authorities should ensure that staff and inspection capabilities at high volume ports such as the Canary Islands and Las Palmas can verify that total allowable catches (TAC) and national quotas are being enforced vigorously. Both China and the EU should make greater efforts to regulate commercial fishing vessels, ensuring that they are properly licensed and their catch origins are accurately reported.

To improve the state of China’s fishery and aquaculture industries, this report suggests the standards laid out by the IFC and World Bank’s ‘Environmental, Health, and Safety Guidelines’ for the Aquaculture and Fisheries industries and the FAO’s ‘Code of Conduct for Responsible Fisheries’ be adopted by relevant ministries and bureau’s within China, such as the Bureau of Fisheries within the Ministry of Agriculture, the Department of Nature and Ecology Conservation and the Department of Environmental Supervision within Ministry of Environmental Protection. The standards developed by the IFC and World Bank provide a number of key indicators (e.g. wastewater

223 Subler, Jason, China urban-rural income gap continues to widen, Reuters,24 January 2008 224 Also see 5.2 Environmental Goods and Services 225 Environmental, Health, and Safety Guidelines, International Finance Corporation. Available at: http://www.ifc.org/ifcext/enviro.nsf/Content/EnvironmentalGuidelines 226 Water Development and Management Unit, Food and Agriculture Organisation. Available at: http://www.fao.org/nr/water/index.html


rather than malting barley would have positive job and income effects for Europe’s malting industry and it would reduce the negative environmental side effect of exporting a bulky raw commodity over long distances. Since the malting process consumes considerable water, China could gain from the import of malt due to the water saved.


5.6 Government Procurement


Government Procurement (GP) is defined by OECD as the purchasing of goods and services by the government for consumption and investment, but not for resale.229 Effective procurement practices are transparent, reflect on the quality of public finances, and are essential for efficiency in public spending. The result of acquiring optimum quality goods and services for public consumption at competitive prices is improved value for taxpayers’ money and allocation of resources. 230 Government procurement worldwide accounts for a significant share of world merchandise and commercial services imports. Further liberalising purchasing by governments represents a major opportunity for international trade.

GP can be divided between consumption and investment expenditure. Consumption refers to a wide variety of purchases to support government activities such as purchases by public utilities, either publicly or privately owned, in sectors such as water, energy, transport and communications. Investment expenditure entails capital formation through construction of public goods such as infrastructure. Governments are increasingly outsourcing such work to the private sector. Limited access to data, as well as differences in policy, strategy and regulatory procedures in regards to government procurement in international markets, makes quantifying GP difficult. Differences in the needs for tradable and non-tradable purchases, such as defence expenditure, also complicate quantifying GP.

Since governments tend to favour domestic sources for GP, governments may restrict import competition, creating market distortions, inefficiencies and artificial price increases. Furthermore, developing countries tend to be less transparent in their procurement systems, compounding the problem of limited competition and slowing further development of procedures and practices. Open government procurement markets allow increased competition among suppliers, in turn leading to improved prices for public authorities. Evidence of such success in the EU single market highlights the increased opportunities in the area of government procurement as a result of eliminating trade barriers.

There are several trends in the development of EU government procurement. First, small and medium enterprises are encouraged and given more support to participate in government procurement in the EU. Second, the emerging e-procurement systems bring more transparency to procurement procedures and provide more efficient and just-in-time purchasing arrangements. Third, government procurement in the EU pays increasingly more attention to its environmental effects. Green procurement is increasingly entering the mainstream of government procurement; with the EU taking a leading role in the promotion of “green” government procurement. Fourth, the detection and elimination of corruption is a concern for all parties involved in the procedures of

229 “The Size of Government Procurement Markets”, OECD Journal on Budgeting, Vol 1. No.4 230 A Report on the Functioning of Public Procurement Markets in the EU: Benefits from the Application of EU Directives and Challenges for the future, 3 February 2004


government procurement. The OECD has increased focus on incorporating integrity and ethics in the area of government procurement.

China’s reform of the public procurement system is relatively new compared to that of the EU. In a command economy, there is sometimes little distinction between government and the market. Prior to reform, government procurement in China occurred in arbitrary, unregulated and a self-administered basis, with little or no structured policy or model.231 In 2006, according to the Ministry of Finance (MOF), China’s government procurement market was worth RMB 350 billion, and by 2007 that value had gone up significantly to RMB 381 billion (€36 billion), largely as a result of increased investments in fixed assets, such as construction works as part of Olympic related projects.232 Compared with developed countries, Chinese government procurement as a proportion of GDP is still low, but has the potential to increase gradually as government reforms are pushed forward.

As the EU strengthens its trade relationship with China, increased transparency and adaptation of China’s regulatory system to Government Procurement Agreement (GPA) standards will allow both parties to benefit from the exchange of goods and services for the public. China has submitted its application for accession to the GPA, and as the EU and China are currently negotiating a Partnership and Cooperation Agreement (PCA), which potentially covers several issues on government procurement, intensified cooperation between the EU and China could lead to benefits for both regions. China’s accession to the GPA, the most significant international agreement on government procurement, will open up China’s GP market to foreign companies by requiring transparency and the removal of national preference. China’s GP market amounts to approximately RMB 400 billion, and is of increasing appeal to foreign suppliers and services providers. For all parties to compete on a level-playing field, China will have to commit itself to free trade in the global market by expediting its accession to the GPA.

China potentially could reap the benefits of free trade and increased competition by simply removing any barriers to foreign bidders. Under the GPA, however, market access will only have to be guaranteed to foreign bidders to the extent that their home countries guarantee similar access to their GP markets for Chinese suppliers and contractors.


An open, liberalised GP system puts market pressure on suppliers to increase the quality of goods and services, while also leading to price reductions. A competitive and transparent GP system allows purchasing authorities to make more informed decisions, thereby ensuring procured goods and services are of the appropriate quality and ideally suited for their intended need. Furthermore, such a system allows suppliers to compete on an international level. In a fair and competitive procurement market, governments may purchase goods and services from both domestic and international suppliers and thus GP is of importance to international trade flows. In China’s case, such a GP system depends on the Chinese government’s willingness to allow market access and the

231 “Procurement Function and Government Procurement”, Cao Fuguo, ( Vol. 10, 1999) China Tendering 23 232 European Business in China Position Paper 2007/2008, Public Procurement Working Group


willingness of suppliers and contractors to compete. Key issues of reciprocity between China and the EU and the degree of transparency in the bidding process will determine future outcomes.

UK experience shows that the ideal “value for money” is achieved through selective competition (a restricted procedure, a competitive negotiated procedure or competitive dialogue in EU terms, a selective procedure with or without negotiation under the GPA, in each case open to all suitable candidates and conducted on the basis of objective selection and award criteria). A fully open, unregulated GP system may lead to too many bidders, increasing bidding and acquisition costs. Regulation should aim to be effective without imposing too many burdens and constraints on purchasers or providers.

EU rules have been brought into line with GPA, removing institutional barriers to cross-border or international trade in the field of GP. This cannot apply in China, however, unless and until China’s domestic regulation is brought into line with the basic requirements of the GPA and other signatories to the Agreement are willing to enter into reciprocal agreements.

Social Significance

A liberalised government procurement sector has broad social implications. The more transparent and fair the procurement processes are, the less the chances of corruption and rent-seeking on the part of domestic governments and suppliers. As a result of potential benefits of an open government procurement system, proponents of a multilateral GP framework consider the GPA to be part of a ‘good governance’ agenda, which will be of particular benefit to developing countries.233

If ‘governance’ is defined as the process of decision-making and the process by which decisions are implemented (or not implemented), fair and transparent decision-making processes are not only necessary for establishing international best practices, but by addressing problems such as corruption, greater levels of trust is generated between the citizens and their government.234

While the effect of liberalising GP should be to increase competition, improve value for money and assist the competitiveness of suppliers, its impact on employment is not straightforward. Though national preference would be precluded in GPA compliance, save for a short transitional period, governments may take it on themselves to decide which economic activities would be kept in the public sector.

Environment Significance

Environmental concerns are among the many considerations which Government purchasers need to take into account in meeting the needs they serve. Such concerns may be expressed as a matter of law, national or local policy, or simply as an aspect of best practice. Governments can strongly influence the development of environmentally-conscious initiatives by supporting greener 233 See, for example, WTO, "Moore welcomes Oxfam Report but cites Omissions and Errors," Geneva: World Trade Organization, 11 April 2002, [online: web] URL: http://www.wto.org/english/news_e/pres02_e/pr285_e.htm 234 See United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP) http://www.unescap.org/pdd/prs/ProjectActivities/Ongoing/gg/governance.asp


technologies and factoring other environmental considerations into their public procurement decisions. Governments ‘can provide a reliable market and encourage new investment, product development and competition’. 235 The concept of ‘best value’, which characterises public procurement, can extend to value for money, not only in terms of best price and quality, but also best environmental value. In areas where public authorities have significant purchasing power (In the EU, GP represents 16% of total GDP), authorities can use their market leverage to opt for goods and services that are environmentally conscious.236 This in turn translates into incentives for businesses to align their operations in line with high environmental standards so as to promote sustainable practices and mitigate adverse environmental impacts.

Furthermore, the increasing global trend to Corporate Social Responsibility, with an emphasis on environmental sustainability from various national and international constituencies, may lead to further liberalisation of GP policies. Various developed countries have sought greener products and services in their GP, while OECD countries have pledged to take into account environmental considerations in the public procurement of goods and services.237

5.6.2 PCA Scenario In 2004, the EU and China expressed a commitment towards strengthening their bilateral relations. The Partnership and Cooperation Agreement (PCA) has been under negotiation since January 2007, with the intention of upgrading the 1985 Trade and Economic Agreement (TECA). By expanding the scope and complexity of their cooperation, the EU and China are working towards a more strategic partnership framework which has the potential to impact a variety of key industries and business areas for both regions.

The Partnership and Cooperation Agreement (PCA) currently under negotiation seeks to open areas in trade and investments which go beyond the WTO obligations of the parties. Government Procurement is a significant area of economic activity which has social and environmental impacts and the potential to increase international trade. It sits outside the WTO but is the focus of a specific plurilateral agreement, the Government Procurement Agreement (GPA). The EU is a signatory to the Agreement and China has made an initial offer of the aspects of Chinese Government Procurement it is prepared to open up to suppliers and contractors from other signatories if reciprocal arrangements can be agreed.

The process for accession to the GPA is conducted in bilateral discussions between signatories and is facilitated by the WTO Secretariat in Geneva. China’s offer specifies the purchasing authorities that would comply, the types of goods and services that could be covered above proposed financial thresholds and various exemptions that would apply. As the opening proposal is a request and offer process, China’s initial offer falls short of existing coverage under the GPA, particularly in the EU, and seeks to take advantage of various derogations for developing countries. It seems likely, therefore, that discussions on China’s accession to the GPA will take some time.

235 Sustainable Procurement Group (2003), Report Recommendations of the Sustainable Procurement Group 236 European Commission, Green Public Procurement, http://ec.europa.eu/environment/gpp/background_en.htm 237 OECD Environment Programme (2004): Environmentally Sustainable Buildings: Challenges and Policies


EU-China dialogue on the reform and opening up of Chinese GP will, however, take place in the context of the PCA as well as that of the GPA. In context, the EU is well-placed to share experience to assist China to take forward the reforms already underway and to provide technical assistance for the development of human and institutional resources. In exchange, China should offer greater transparency as to existing opportunities for EU suppliers and contractors even though market access might not yet be guaranteed.

It is in any case in the EU’s interest that procurement practice in its trading partners is predictable, equitable and professional so that EU suppliers and contractors know where they stand, do not incur bidding costs in vain and can reasonably expect to be treated fairly.

Liberalising China’s government procurement system will have economic, social and environmental impacts. While the outcome is generally expected to be positive, in the short-term and as both parties adjust to new arrangements, some negative effects can be expected. These teething problems should not deter the two regions from achieving the mutual benefits of a more liberalised government procurement market.

Furthermore, EU experience has shown that, even in liberalised markets, local suppliers and contractors enjoy a competitive advantage. Local labour may well be employed with a consequent transfer of knowledge and skills; whereas foreign suppliers and contractors are more likely to form local alliances than to bid from abroad. Import penetration is unlikely to rise dramatically.

Economic Impact

As a developing country, the main concern for Chinese officials of opening up China’s government procurement market to foreign competition is the detrimental effect on state-owned enterprises and, consequently, employment. While the GPA provides certain ‘transitional’ privileges to vulnerable sectors in developing countries, the fear is that the EU as a developed country will gain more than China would as a developing country. The fact is, however, that China and the EU cannot be expected to sign up to anything less than a balanced package of rights and obligations.

Fair competition and transparent procurement ensure that corruption and preferential treatment are exposed and that second-rate materials and inadequate designs are not used for government funded projects. This serves to raise the quality and standard of goods and services procured, with both short and long term implications for both regions.

From an EU perspective, a liberalised public procurement system in China is beneficial to EU exporters, who can tap into a market that is just starting to open up. Given that government procurement represents at least 15% of world GDP, and governments and their various agencies are the major purchasers of goods and services, ranging from basic commodities to high technology equipment, a transparent and open procurement system offers substantial business opportunities for European service providers and manufacturers. However, European businesses must not get too optimistic as there are no proposals at present to open procurement by sub-central bodies or utilities, or in construction other than of residential and office buildings. China’s initial offer also excludes infrastructure and related supplies.


China also stands to gain from liberalised government procurement as it will benefit from the EU’s capital goods, technology and innovations. Currently, the EU represents more than 19% of China’s external trade, and by opening up its imports to high-value services and products, not only will EU companies enjoy greater global competitiveness, but Chinese businesses will also benefit from this move which will open doors to other markets. Evidence from China’s recent economic trends suggests that opening the economy to foreign goods and investment has brought tangible benefits in the form of unprecedented growth. Further liberalising the government procurement market has the potential to take China’s growth to the next stage through the development of its native enterprises and export of local goods and services.

An added benefit will be a general increase in the quality of public goods and services. A transparent, liberalised bidding process will encourage government officials to choose bids of the highest value and most competitive price. This will encourage greater efficiency without sacrificing environmental considerations.

An agreement on GP under the PCA will help improve the competition in China’s national GP market. The competition will take place not only among domestic suppliers, but also between the domestic and foreign suppliers. By making high value and quality purchases, the Chinese government will be the biggest beneficiary. Moreover, a competitive GP market can encourage domestic suppliers to improve the quality of their products and technology, so as to become increasingly competitive in a fast and dynamic economic environment.

Social Impact

The main social impact of a liberalised GP system is in the area of employment. China’s excess supply of labour in rural areas poses a challenge to a country with China’s industrial strength, especially given its current rapid economic growth. The government is under significant pressure to create employment as rural workers move to urban areas in pursuit of employment and better wages. If the GP market were to be opened, competition between foreign and Chinese suppliers would cause further challenges to employment in China. However, it is also possible that unemployment, as a result of a liberalised GP system may be a short-term problem as China’s domestic service and goods providers are able to compete with foreigners on a level-playing field.

Employment in state enterprises may be affected as private sector firms and foreign suppliers are able to bid for procurement projects in an open system. Unemployment can lead to a series of severe social problems, such as a wider income divide and increasing crime rates, due to social instability.

While opening up the economy may pose some socio-economic challenges, the long-term benefits will outweigh the initial challenges, as a mutual opening up of the GP market between the two regions will increase employment opportunities. In the meantime, dialogue in the context of the PCA should contribute to the continuing reform of Government procurement and enhance its capacity to deliver social objectives.


Environmental Impact

The environmental impact of broader GP liberalisation has the potential to be more positive than negative. Given that EU Member States are increasingly environmentally conscious, and have already proven to factor social and environmental considerations into their procurement policies and practices, it can be expected that with enhanced engagement between the EU and China, the EU will be able to influence similar standards in China’s procurement processes and decision-making. Compared to the EU, China’s environmental standards are relatively low. In fact, China’s environmental protection regulatory regime is incomplete, and through its 11th Five-Year Plan, China has set the target of achieving sustainable growth through increasing energy efficiency, investments in renewable energy and improving overall environmental protection.238 The PCA will provide a platform for the EU and China to engage on these issues and assist China in improving its commitments to environmental protection based on international standards and the example set by the EU.

If the EU is successful in influencing China’s use of Green procurement as a method to environmentally friendly and sustainable growth, China has the market size to shape production methods and consumption behaviour through its procurement practices. Green procurement, which promotes energy efficiency, has the potential to change China’s purchasing orientation by providing incentives to enterprises such that they produce environmentally conscious products. If green technology and low-pollution and resource-saving products and services become part of the norm of government procurement practices, the long-term effects on the environment in China are positive.

While opening up China’s GP system will reduce market access barriers for foreign competitors, it is important to note that environmental standards should not end up serving as non-tariff barriers (NTBs). Such an outcome would negate the positive effects of liberalising the sector. Environmental standards in China may need to be gradually improved, as sudden regulatory changes may result in domestic firms losing business opportunities to foreign enterprises as they adapt to changes in environmental standards requirements.

Table 36: PCA Summary Impacts Table – Government Procurement (China)

Existing Conditions




Economic

Economic Structure - N M

Transfer of technology 0 N H

Trade 0 N L?

Social Quality of GP (infrastructure, building standards, services)

-- N H

Labour ++ Y H

Environmental Environmental Standards & Efficiency -- N H

238 China’s 11th Five-Year Plan www.gov.cn


Table 37: PCA Summary Impacts Table – Government Procurement (EU)

Existing Conditions


Indicator Overall Direction Magnitude Equity Reversibility Capacity to change

Economic

Trade - N L?

Social

Labour 0 Y L

5.6.3 Policy Recommendations Mitigation Measures

It is improbable that a balanced package of liberalisation measures would lead to significant unemployment. If anything it should in the longer term lead to new employment opportunities as Chinese goods and services break into new markets. To avoid a domino effect of social problems as a result of unemployment, the Chinese government will in any case need to address China’s large and transforming population and labour market. The government may need to introduce business-friendly regulations that would allow smoother labour movement and encourage private sector growth and job creation. Social safety nets, such as adequate insurance coverage, unemployment benefits and basic healthcare provision, should be addressed by the government to mitigate any potential social problems in the short-term as a result of liberalisation.

Social safety nets potentially mitigate the negative effects of liberalisation if it is introduced incrementally, taking advantage of the transitional measures in the GPA. The contrary view, however, is that delaying the benefits of reform, increased transparency and liberalisation may have a negative effect overall. It is a matter for national consideration, therefore, whether measures to delay liberalisation, for example to protect non-competitive industries, should be allowed to postpone the creation of new opportunities for other competitive industries or to delay the benefits government purchasers might achieve from liberalisation and increased competition.

Enhancement Measures

Government procurement is one of the many areas that will be affected if a consensus were reached on the PCA. China’s accession to the WTO-led GPA will lay a basis for a predictable and legal foundation for EU-China trade in this field. Given that China has made an initial offer for accession to the GPA, the next step towards a PCA is for China to fulfil its commitment to open access negotiations in 2008.

Experience in the EU would suggest that the introduction of the EU’s internal regime on Government Procurement enhanced the status of procurement professionals in some member states, involving them in procurement procedures from which they were previously excluded and giving them an opportunity to demonstrate their ability to improve value for money in addition to their knowledge of the regulatory regime. The proposed introduction of international obligations in China might well have a similar effect.


Building capacity in the procurement process would also improve the quality and value of government procurement; for example investing in the development of an ICT-based procurement system that emulates those in South Korea and the Philippines might yield positive results, as might the wider use of electronic communications and supplier management systems.

Improving overall transparency in the procurement process would level the playing field for small and medium enterprises and provide more lucrative opportunities for foreign firms, particularly in areas outside the scope of the GPA.

Given EU experience under the GPA, it is recommended that China is well-advised to press on with reform with a view to liberalisation under the GPA as soon as reciprocal agreements can be reached and accession can be achieved. In the meantime China will no doubt want to take advantage of the GPA’s provisions for technical assistance to accession candidates.

Ensuring a Win-Win Outcome from the Negotiations

It is in the EU’s interest to assist China to complete the reform of Government Procurement, to formulate a more realistic offer for GPA accession and to seek bilateral understandings in the context of WTO discussions such as those on Trade in Services and a possible Transparency Agreement. To that end, the EU should continue sharing experience on procurement policy, the legislative and other means to give effect to the policy objectives and developments in best practice.

Discussions on matters relating to Government Procurement will inevitably take place in various forums. Overall the EU’s policy objectives should be:

• sufficient transparency to enable EU undertakings to identify opportunities open to them, to establish whether national rules apply and to enforce any rights they might have;

• reductions in existing barriers to EU undertakings;

• continuing reform to align more closely with international best practice, as an aspect of good governance and to pave the way for GPA accession;

• a much better offer for China’s accession to the GPA; and

• co-operation with China on securing future improvements to the GPA, in the light of developments in best practice, and encouraging greater participation by WTO Signatories including existing GPA Members.

It will benefit all Parties if China’s reform of Government Procurement and China’s accession to the GPA are completed as soon as politically and practically possible. For example:

• China will benefit from better governance, reduced scope for corruption and waste, better value for money taking into account environmental and social objectives, the increased competitiveness of suppliers, contractors and service-providers and new opportunities to supply into markets abroad.

• The EU will benefit from increased transparency and new opportunities to trade with China under bilateral agreements, multilateral trade negotiations under the WTO and the plurilateral Government Procurement Agreement.


• Other Signatories to the GPA will also benefit if China is able to negotiate a balanced package of rights and obligations.

• China’s success in gaining accession to the GPA is likely to establish a pattern which other emerging economies can emulate.

• China has the potential to be a major ally of the EU in seeking future improvements to the GPA, increased participation in the GPA by other WTO Signatories and multilateral agreements on procurement outside the scope of the GPA.

In particular the EU should promote:

• increased transparency on procurement policy and practice at the central, regional and local levels in exchange for shared experience and technical assistance;

• withdrawal of mandatory national preferences and measures of equivalent effect;

• technical specifications which do not discriminate on grounds of origin and which are proportionate to environmental and social objectives;

• agreement between the principal Chinese authorities on national procurement policy, the allocation of responsibilities at the central, regional and local levels, the removal of inconsistencies in existing legislation and the development of the institutional and human resources necessary for world class procurement;

• a revised offer to match existing EU GPA coverage (including all central and local authorities, non-commercial State Owned Enterprises equivalent to bodies governed by public law, targeted utility sectors, a wider scope of supplies, works and tradable service contracts, and comparable thresholds), with earlier implementation, fewer exceptions, shorter transitional measures and an effective remedies system; and

• common objectives for other WTO developments affecting Government Procurement.


5.7 Intellectual Property Rights


Intellectual property is divided into two categories: Industrial property, which includes inventions (patents), trademarks, industrial designs, and geographic indications; and Copyright, which includes literary and artistic works. These rights are granted to creators and inventors to regulate the use of their products. While Intellectual Property Rights (IPR) are still in early stages of development in developing countries, the move towards greater protection of intellectual property has been gaining momentum since the 1990s. One of the most prominent initiatives in intellectual property is the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs), which was negotiated during the Uruguay Round in 1994, and entered into force on 1 January 1995.

In the EU context, the legal basis for the intervention of the EC on intellectual property rights protection is set in Article 95 of the EC Treaty with the aim of harmonising the laws of the Member States on intellectual property and in Article 308 of the EC Treaty with the aim of creating a right that applies uniformly across the EU Single Market. This is the case for example with the creation of the Community Trademark and of the Community Design. Regarding patents, a single Community patent would mean that a patent granted one place in Europe would be valid in the entire community. In the EU particularly, progress has thus far been made in the areas of trademarks, designs and models, copyright and patents and geographical indications. More specifically, harmonisation has occurred in areas relating to computer programs. Amongst the key issues to be considered are outstanding questions on whether litigation in a national court relating to nationally granted patents would apply to other Member States as well.

Significant pressure from businesses and researchers to establish a uniform patent system has been a key cause for changes made in this field by the European Commission due to the strong link between IPR protection and investment and trade opportunities. A study published by the Commission in 2007 reported that approximately €20 billion in trade opportunities are lost every year to EU businesses because of market access barriers in China.239 The EU-China trade deficit was expected to rise above €170 billion in 2007, widening by more than €2.1 billion in the past year.

Intellectual Property in China underwent significant changes just prior and after China’s accession to the WTO in 2001. The State Intellectual Property Office (SIPO), which overlooks IPR issues in China, has been the main driver of initiatives in this area and the People’s Supreme Court has jurisdiction over the way courts administer IP laws. Amongst the variety of areas covered by IPR, copyright is a particularly contentious issue in China.

As a rapidly growing economy, IPR protection has strong implications for China, which possesses considerable competitive advantage in the production and export of computer hardware. As Chinese and international companies consider re-location or technology product development, the protection of IP will be directly related to growing their investment. For China, IP protection is a

239 “EU Trade Commissioner Mandelson in China November 23-28” EU Report, Brussels, 23 November 2007


central pillar to establish innovation orientated industries as national priorities point towards China moving from mere production to innovation.

Current trends indicate that there are an increasing number of Chinese patent and trademark filings overseas, and the need for increasing Chinese support mechanisms like hotlines and websites to help Chinese and foreigners navigate the system. While the government has started to take strong measures to improve its IPR protection system, it is alleged that China still has a long way to go before achieving international best-standards and practices in this area.

Two reasons explain why IPR violations remain rampant, despite existing initiatives to deter IP theft. First, the legal regime surrounding IPR is riddled with loopholes and ambiguities that facilitate virtually uninterrupted IP theft. Secondly, even where the laws are clear, enforcement has proved elusive. Official figures suggest that administrative and criminal authorities have increased their efforts to tackle IP violations in China.


IPR protection in developing countries has the potential to create dynamic and inter-related benefits.240 By increasing incentives for innovators, IPR improves productivity. While the increase in productivity may initially be in developed countries, the spread of new technologies will be faster to developing countries if legal mechanisms are in place to protect the rights of the innovator.

Developing countries tend to assume that developed countries are the main benefactors of strong IPR protection. However, this misconception overlooks the statistical evidence that in developing economies strong IPR protection is positively correlated with economic growth.

Technology is an important area that is affected by strong IPR laws and protection. Technological diffusion contributes significantly to the GDP growth of developing countries by encouraging research and development (R&D) where domestic innovation has previously been lacking. For greater R&D activities to be promoted, IPR protection is fundamental, especially as China has a lot to gain from the transfer of key technologies from developed countries.

Stronger IPR also has a positive impact on a nation’s level of exports and increases the probability of investments undertaken by multinational firms. 241 Improvements in IPR increase a country’s attractiveness for foreign investment, especially for sectors that rely heavily on IP rights.242 Multinational firms have been demonstrated to respond to changes in IPR regimes by significantly increasing technology transfer to developing countries.243

240 The Federal Reserve Bank of San Francisco (2004) “Can International Patent Protection help a Developing Country Grow?” www.frbsf.org/publications 241 Keith Maskus and Mohan Penubarti (1995) "How Trade Related are Intellectual Property Rights?" Journal of International Economics, 39, 227-248, and Edwin Mansfield (1994), "Intellectual Property Protection, Foreign Direct Investment and Technology Transfer," International Finance Corporation 242 Beata S. Javorcik, "Foreign Investment, Technology Transfer, and Protection of Intellectual Property Rights," The World Bank. http://www.wipo.int/documents/en/meetings/2003/wipo_wto/presentations/ppt/smarzynka.ppt 243 Lee Branstetter, Raymond Fishman and C. Fritz Foley, "Do Stronger Intellectual Property Rights Increase International Technology Transfer? Empirical Evidence from US Firm-Level Data," NBER Working Paper 11516 July 2005. weblog.ipcentral.info/IPRs%20&%20Tech%20Trans.pdf


Social Significance

By allowing new technology to enter the market faster, increased competition and productivity will promote economic growth, which in turn will create a variety of social benefits. As the economy prospers, there will be increased levels of employment and wage improvements. In the long term, an enhanced technological infrastructure, a strong economy and other resulting changes could lead to substantial changes in lifestyle patterns.

The obvious benefit of IPR protection is that it ensures that produced goods are of sufficiently high quality and meet set standards. Particularly in the area of pharmaceuticals, it is necessary to ensure that medical goods and services are adhere to strict standards, as poor quality can have serious and detrimental effects on consumers. Especially in China, low quality and cheap products should not be considered an alternative for poor people.


China's environmental products cover a large range and can basically meet the needs of environmental pollution control, though the technological level and reliability of the key equipment and core product still is not at par with those of the developed countries due to low levels of innovation, as a result of poor IP protection.

Due to the lax enforcement of IP laws in China, developed countries have been deterred from exporting their technologies to China due to the costs to their own economies. Such loss in opportunities, has an impact on China’s environment. A lack of transfer of knowledge and technology from the United States and other countries with more advanced and sophisticated anti-pollution technologies has had an effect on air pollution in China which annually causes 400,000 premature deaths and 75 million asthma attacks.244

Emissions from vehicles are stated to be the main cause for this health situation, and poor IP protection is the single major obstacle for the transfer of pollution-control technologies into China from abroad. If China were to strengthen its IPR laws and enforcement mechanisms, it would be able to assure its trading partners in developed countries of its ability to protect and promote their technologies in an environment that is respectful and responsive towards developments in technology which have strong impacts in various aspects of society.

244 “Beijing Car Ban Experiment Highlights China's Environmental Woes”, World Politics Review, 15 August 2007


5.7.2 PCA Scenario A focus of the Partnership and Cooperation Agreement in relation to Intellectual Property Rights should support the development of the institutional framework for IPR enforcement in China. The IP institutional infrastructure in China has progressively developed into a rule-based and increasingly open system, however, progress can be expanded in the areas of furthering transparency and strengthening predictability within the institutional infrastructure. Intellectual Property is administered by government regulations and government agencies are established to address IP violations. China’s government agencies that encourage reporting and connect with enforcement agencies are difficult to navigate for European companies. For example, of the fifty centres of China’s Service Centres for Intellectual Property Protection only three centres in Beijing, Jiangsu and Ningbo have websites in English.

Capacity building within the institutional infrastructure in China also remains a priority to encourage companies to report and utilise the legal remedies provided by Chinese law. Confidence in the enforcement of intellectual property laws is a key factor in foreign investment and market expansion activities. The positive implications for business growth and economic activity in both Europe and China should provide a clear incentive to support China’s institutional framework and institutional capacity as part of the PCA.

The lack of business confidence in China’s IPR framework will potentially have a long-term and negative impact on the EU-China trading relationship. Consistency in enforcement is required to prevent companies from placing limits to entering or expanding operations in China. An avoidance of market opportunities due to IPR concerns will limit opportunities for European companies to further grow their business in China and for China to move up the technology and productivity ladder essential for its long-term economic development. Inconsistency in the disposal and/or destruction of products that violate the rights of IP owners should be addressed to increase confidence levels.

Coupled with enforcement consistency is the limited level of deterrence provided by China’s legal system for IP violation. Damages paid in successful civil damages in China are often measurably below the loss incurred. Maximum penalties alone and the lax enforcement of penalties generally are arguably a non-deterrent to the profit potential from IPR infringement activities. In addition, the extent of the illegal activity required for commencement of criminal proceedings in China (threshold mechanism) is high in terms of the levels of severity or illegal gain received.

Intellectual Property Rights administration is fundamental to strengthening the EU-China trading relationship. Business partnerships, business promotion, sourcing, manufacturing, sales and distribution, research and development and licensing are all adversely impacted by ongoing IPR infringements. When business regards IPR issues as a liability on a balance sheet as opposed to an asset, trading relationships will be adversely impacted. The PCA has a clear role to play in supporting governance and institutional strengthening in China. The several high level EU-China dialogues and the EU-China Project on the Protection of Intellectual Property Rights (IPR2) funded by Europe and China have prioritised IPR measures in these areas, however, enforcement consistency and the correlating increase in business confidence is crucial to strengthening the economic relationship.

The role of technology in supporting sustainable development and a transition to a low carbon economy is well-established. Similarly well-established is the notion that countries cannot act in


isolation in achieving sustainable living standards. Investment in research and development is supported by IPR protection and a causal link exists between IP and innovation in environmental technologies. A two-speed IPR agreement for environmental technologies between developing and developed countries, similar to the two-speed agreement established for carbon reduction timetables, is unlikely to facilitate China’s transition to sustainable development. The two-speed carbon reduction timetable balances environmental impacts with other Millennium Development Goals associated with economic growth and poverty alleviation. The current stage of China’s development and the country’s public and private investment capabilities, positions IPR as an economic growth generator in China, supportive of research and development to support the role of technology in sustainable development. A two-speed IPR agreement on environment technologies will potentially impact adversely on innovation and investment in this sector in China and will potentially imbalance China’s attainment of Millennium Development Goals. The PCA should strengthen IPR cooperation to facilitate the government priorities in both Europe and China in the area of sustainable development.

Intellectual property protection encourages cultural development and awareness. The PCA negotiations should recognise the positive social impacts of growth in cultural knowledge and cultural industries. Investment risk in cultural industries is reduced by the assurances that an effective IPR system can provide protection against violations. The wider and long-term Europe-China relationship will benefit from strong cultural industries and the positive social impacts derived from accessing respective markets.

5.7.3 Policy Recommendations A. Measures related to trade negotiations, bilateral agreements and international mechanisms

Several key issues in the area of intellectual property could be appropriately discussed within the context of the PCA negotiations. Broadly, these issues fall under the improvement of intellectual property rights protection and enforcement as they concern foreign entities with registered intellectual property in China.

First, it was first signalled several years ago that European companies have at times been "forced" to transfer technology, against their will, through administrative procedures prior to marketing certain products, building certain factories or importing technology (that can be linked to imported equipment).245 Eventually, sensitive information (e.g. schematics) that has been submitted to the relevant authorities is provided directly to Chinese competitors, undermining the value of a foreign operator’s unique IP.

Secondly, with regards to the Chinese R&D Development centres in which European investment is encouraged, it should be noted that current development of legislation and regulatory framework(s) are moving towards stricter control to avoid information from being freely transferred to the foreign investor. While inward investment and contribution of technical expertise is warmly welcome,

245 European Business in China Position Paper 2007/2008, European Chamber of Commerce in China


getting out (the results of the research) is strictly controlled. In the process of such one-sided control, sensitive or confidential information may again be compromised, eliminating its value.

As a first step in addressing these issues the negotiators of the PCA could propose a clause that states, as a principle, that unless the vital interest of the parties (EU and China) are directly concerned by the subject matter of a technology (a general term including patentable or not patentable technical data), information must be able to flow freely between commercial partners as well as between businesses and the relevant authorities (i.e. to register IP) with full confidence in the absolute protection of their intellectual property, guaranteed and enforced by Chinese authorities, while reducing unnecessary administrative ‘authorisation’ procedures in transferring information from research centres to their investors and clients.

The negotiators should also make clear that if European companies are not absolutely guaranteed that they can enjoy the exclusivity of the results of their research and development efforts made in China, without restriction (other than those related to National Security, or limited and strictly defined exceptions in favour of the public interest), as a "trade policy" the European Commission may discourage the pursuit of such research and development efforts in China. Finally, it is suggested that the negotiators closely follow the activities of the State Council in the near future, as it is expected to release a National Intellectual Property Strategy in the near future that may alter the regulatory environment in the country and thus require revision of negotiating objectives.246


Foreign business associations have generally asked for greater transparency in China’s IPR regime. Given the broad range of IPR, policies that address the specific areas, such as copyright or patents would be most effective in helping to improve China’s IPR system. The key areas of concern to foreign businesses have been in the areas of copyrights and patents. Improvements in these two areas have the potential to increase the appeal of the Chinese market to European investors and businesses while allowing these businesses to operate in an environment conducive to intellectual property protection by local authorities. While there have been signs of overall legislative and operational improvements in China, the highly localised nature of enforcement would benefit from more specialised and focused policies.

Patents & Trade Secrets

The current system requires companies to provide highly confidential information while applying for technical and/or regulatory approval. It is questionable whether the provision of highly confidential information is necessary as it could compromise the company’s business advantage in a competitive environment. Research has shown an ‘authentication report’ on whether the disputing business secret in the case is unknown by the public also known as a ‘Novelty Search’ is necessary to determine the outcome of cases.247 Lawyers and judicial organs need to work alongside experts to arrive at a conclusion on authentication. ‘IPR in China’ also provides further information and details

246 Outline of the National Intellectual Property Strategy, State Council of the People's Republic of China, 5 June 2008. Available at: http://english.gov.cn/2008-06/21/content_1023471.htm 247 ‘Constitutive Requirements of the Offense of Infringement of Business Secrets and Its Judicial Definition’, Zhong Yi, Attorney at Law - Shanghai Runhe Law Firm 05/12/2008


of the processes involving ‘Anti-Unfair Competition and Trade Secret’.248 There have been cases in China where authorities have made companies’ confidential information freely available on the internet. To build a trustworthy Principal-Agent relationship, companies that are registering patents in China should be guaranteed better at the early stages of the regulatory approval process to ensure a sustainable and long-term relationship built on trust between European companies and local authorities.

Copyrights

One of the reasons why counterfeiting is rampant in China is due to the lack of public awareness of the associated short and long term costs of IPR infringement. For awareness of IPR to move beyond the official level and spread across the masses, the use of public education campaigns and increased policing to discourage public consumption and sale of counterfeit goods educate is essential.

Independent Regulators

Currently, initiatives that are targeted towards IPR protection are administered through SIPO, a state agency. To prevent a conflict of interest and to ensure that European firms enjoy similar privileges as Chinese companies, an independent regulator is necessary. Only by separating the agencies from the state can there be accountability and greater transparency in China’s IPR system. A fair system is also necessary for instituting customs enforcement, where exports are controlled and assessed based on their authenticity.

Deterrence and Incentives

Stronger incentives and deterrence measures are vital for sending a clear message about the severity of IPR violations. Existing penalties are not considered severe enough by companies that are victimised by IPR infringements. It is not the law, but the lax enforcement that has so far allowed violators to continue with the production of illegal goods. In 2004, the Supreme People’s Court and the Supreme People’s Procuratorate jointly released a judicial interpretation decreeing that counterfeiters could be sentenced for up to seven years in prison.249 As Chinese authorities begin to take a more active role in helping to prevent IPR infringements, stricter penalties, with greater visibility, will serve as a stronger deterrence, especially if it affects their business reputation and profits. To achieve more stringent deterrence measures, it may not be sufficient to merely create harsher punishment measures. Strengthening the governance of related institutions will also be vital in ensuring a system of sustainable incentives and deterrence measures.

Research & Development (R&D)

Given China’s relative strengths in low-end technology and the EU strength in high-end technology, further encouragement of R&D activity in China is required. Currently, the lack of incentives and limitations in the current set-up of China’s IPR system has not helped to promote an environment conducive for R&D activity involving high-end technology. R&D requires large investments, which have no guarantee of returns even if the project is successful. In addition to the uncertainty and

248 See ‘IPR in China’ at www.ipr.gov.cn for more details. 249 “Stricter Penalties for IPR Violations”, 17 January 2007, China Daily, http://www.chinadaily.com.cn


volatility of the market, a climate that does not protect IPR means that newly developed products are copied and disseminated shortly after entering the market. Where goods are pirated, investors have little or no incentive to develop products. To overcome this hurdle, the Chinese government should provide incentives in the form of R&D tax breaks and a better guarantee of IPR protection. Such policies are essential for stimulating interest in R&D, which is important from a commercial aspect and for promoting enthusiasm and capital input from the private sector. Piracy and counterfeiting activities need to be effectively controlled through government policies so that developers of technology will be fully capable of pricing newly developed products, appropriately. Such an approach would help ensure returns for investors that back R&D projects.

Management of IPR

As European SMEs expand their businesses into the Chinese market, policies that enhance compatibility between their business practices and China’s IPR system are important. Increasing manpower that is involved in IPR issues in a foreign business climate with differing IPR standards is one way that businesses can adapt to the local market. Policies that are formulated in-house or through SME networks (e.g. China IPR SME Helpdesk a project of DG Enterprise and Industry) that are meant to support SMEs operating in China will assist in the assimilation process and the understanding of China’s complex business environment.


6. TAPES/Partial Equilibrium Model for Commodity Sector Studies

6.1 About the model The Environmental Goods and Services (EGS) sector was the first sector chosen for the application of a Partial Equilibrium (PE or TAPES) model to complement the descriptive and qualitative analysis in the sector report. The model used is the same as the PE model described in prior EU-China market access studies, import competing production and domestic demand.250 For Environmental Goods and Services and other sector models, an export sector was included for analysis to add depth to the impact analysis. In the version used in this report, there is no direct linkage between import competing production and exports. The key differences in the domain of applicability between the GLOBE regional CGE model and the TAPES/PE model are as follows. The GLOBE regional model consists of country/regional CGE models linked primarily through bilateral trade flows. As discussed in chapter 4 on the domains of applicability of the GLOBE and the TAPES/PE model’s, the domain of applicability of the TAPES/PE model is, at the industry or activity level and economy wide influences enter only through the exogenous real exchange rate. The TAPES/PE model is also useful when there is a rapid structural change, as in some of the sub sectors modelled.

The Armington Assumption in the TAPES/PE Model

In the standard partial equilibrium model, imports and domestic production are assumed to be perfect substitutes. This means that a change in domestic prices due to a change in tariffs is immediately translated into a change in the price of the domestically produced product and a change in consumer prices when markets operate competitively. In the TAPES/PE model the imported good is assumed to be imperfectly substitutable with the domestic product. In both the TAPES/PE model and in the GLOBE model, the substitution possibilities between the imported good and the domestically produced good are defined by what is known as the Armington Elasticity, after the seminal work of Armington 1969.251 Normally the Armington elasticity is assumed to be constant, specified by a constant elasticity of substitution, or CES function. In the normal case, which operates in both the TAPES/PE and the GLOBE models, the elasticity of substitution between domestic goods and imported goods in each sector is assumed to be larger than the elasticity of demand for the composite good that enters into the domestic demand function. This means that the changes in the domestic price of the imported good from changes in trade policy only passes through partially to the domestically produced substitute. For example in the initial situation the world price of the imported good is given and domestic prices of the imported good will be higher than world prices by the amount of the tariff. If the prices and quantities of the domestically produced good adjust such that the supply and demand for the domestic good are equated, and the price of the composite good made up of the imported and domestically produced goods clears the supply of the composite good from imports and domestic production, then the initial situation will also be an equilibrium situation.

250 Future Opportunities and Challenges in EU-China Trade and Investment Relations 2006-2010 251 Armington(1969)


In the normal situation when the Armington elasticity is greater than the elasticity of demand for the composite good, displacement from the initial equilibrium by lowering the tariff will increase the share of the imported good in the composite good and lower the price of the composite good, when the price of the domestic good is still its initial equilibrium price. Thus the price of the composite good falls, raising the demand for the composite good. The effect on the demand for the domestic good then depends on the relative size of two elasticities. When the elasticity of demand for the composite good is small and the Armington elasticity is large, the effect is for the substitution effect to outweigh the effect of the fall in the price of the composite good on the demand of the composite good and the demand for the domestic good falls. In the new equilibrium it will still be the case that the price of the imported good has fallen relative to the price of the domestic good but the final output of the domestic good is lower than in the initial situation. On the other hand, when the substitution effects are low and the elasticity of demand for the composite good is large, the demand effects outweigh the substitution effects and the demand and the price of the domestic good will rise. This second case is not dealt with in the calculations using the TAPES/PE model; it is always the case that the substitution elasticity is larger than the demand elasticity. Lowering tariffs therefore lowers the output of the domestic good.

Two sets of structural changes are considered in the application of the TAPES/PE model which involve shifts of the domestic supply curve and shifts of the domestic demand curve. These shifts could occur for a variety of reasons. In the case of the supply curve this could shift to the right due to increased employment, increased capacity utilisation, increased investment, especially increased foreign investment and technical change. The particular causes of a shift in the domestic supply curve behind the identified trends in Table 49 are fleshed out in the sector studies. In the case of shifts in the domestic demand curve these could occur from the general effects of economic growth, income effects, and the characteristics of particular sectors. The shifts in the demand curve in each of the sub sectors identified in Table 49 from historical trends are fleshed out in the sector studies.

The effects of shifts in the supply curve on the composition of imports and domestic demand in the standard case can be thought of as a variant of the impact of the change in tariffs, but of the opposite sign. A rightward shift of the supply curve from an initial equilibrium will increase the supply of the domestic good at the initial equilibrium price. The excess supply of the domestic good will lower the price of the domestic good and lower the price of the composite good. The share of the domestic good in the composite good will increase, and the final effects on imports will depend upon the relationship between the elasticity of demand for the composite good and the elasticity of substitution between the imported and domestic goods. In the standard case the rightward shift of the supply curve for the domestic good will increase the output of the domestic good and the demand for imports will fall. Finally, when the demand curve for the composite good shifts to the right the increased demand for the imported good will be available at the fixed price for imports and the fixed exchange rate. However, at the initial price for the domestic good there will be excess demand for the domestic good; When the new equilibrium is reached the price of the domestic good will have increased, and the share of the domestic good in the composite good will have increased. The final effect on the output of the domestic good will again depend on the elasticity of substitution between the domestic good and the imported good, and the elasticity of demand for the composite good. In the standard case, when the elasticity of substitution is large and the elasticity of demand for the composite good is small there will be an increase in the supply of the domestic good, and the price of the domestic good and the demand for imports will fall.


The Environmental Goods and Services Sector

Environmental goods typically have production technology and/or final product characteristics that provide environmental benefits. A schematic Social Accounting Matrix (SAM) is used to show how in an ideal world the data used for the EGS could be classified so that the PE model could be specified to exploit these characteristics of environmental goods. However, this was precluded due to data limitations. The environmental SAM is shown below with a brief discussion of the data sources and methods used for the TAPES/PE model.

The SAM provides a unique conceptual framework for analysis of the environmental goods sector (see Table 38). Whereas prior studies have established commodities (C) of established environmental technologies (EET) and environmentally preferable products (EPP) have associated activities (A), they also have non-environmental applications ((N)) which are important to differentiate when seeking environmentally sound policy. The conceptual SAM below is useful to clarify some of these issues prior to the application of a PE model to the EGS sector using available data.252

Table 38: Social Accounting Matrix of Environmental Goods Activities Commodities Primary Factors World

AEET AEET(N) AEPP CEET CEPP CEPP(N) VA ROW Total

AEET output total output

AEET(N) output total output

AEPP output total output

CEET inputs inputs inputs consumption exports demand

CEPP inputs inputs inputs consumption exports demand

CEPP(N) inputs inputs inputs consumption exports demand

VA VA VA VA total VA

ROW imports imports total imports

Total total inputs total inputs total inputs supply supply total consumption total exports

As prior studies have noted, data on the environmental goods and technologies sector is generally of a low quality besides the well defined trade data using the Harmonized System, the classification used for traded goods based on the characteristics of products, the rows in the SAM above. In the case of activities ISIC activity-based classifications should be used (the columns of the above SAM) e.g. as in the utilities sector. However, the however, OECD classification of Environmental Goods which is the starting point of this work is based on HS classifications. This blurred the environmentally desirable product and process characteristics of the sectors chosen for the EMG sector model. In the end, a heterogeneous group of 10 EGS products were included in the TAPES/PE model.

252 For illustrative purposes – renewable energy goods such as solar cells have no expected applications which are not environmentally beneficial, whereas the chemicals and piping materials used in wastewater treatment facilities could potentially be used in a number of other industries.


Agriculture, Chemicals and Machinery

Within the agricultural, chemicals, and machinery sectors, subsectors were selected based on previous trade studies, trade data methodology (using the Harmonised System or Standard Industrial Trade Classification), and authoritative trade sources such as the World Trade Organisation, Organisation for Economic Cooperation and Development, the World Bank and the United Nations Conference on Trade and Development.

Within the Agricultural sector, 6 sectors were identified as highly relevant to the PCA, and were defined using the Harmonised System at the 2 digit level to ensure relevance to possible future trade negotiations within the PCA.

Within the Chemicals sector, prior trade studies were consulted to reach the definition used, which includes 3 subsectors: Commodity Chemicals, Specialty Chemicals and Fine Chemicals. Again, the Harmonised System was used at the 2 digit level to ensure relevance to the forthcoming negotiations.

Within the Machinery sector an adequate disaggregation of subsectors could not be determined within the Harmonised System, which prompted the use of the Standard Industrial Trade Classification system at the 2 and 3 digit level to form 5 subsectors.

Financial Services

It was not possible at this time to assemble the necessary data to run a PE model of the Financial Services sector. A preliminary analysis of liberalisation in this sector using the GLOBE CGE model is reported using first estimates of NTB barriers and productivity impacts of reform.

6.2 Data Sources and Base Data A variety of sources were used to gather the required trade, production and tariff/NTB data for input into the models. Global trade figures were obtained via the World Integrated Trade Solution (WITS), maintained by the World Bank in collaboration with United Nations Conference on Trade and Development and including both the UN COMTRADE Database (with relevant trade flows) and the Trade Analysis and Information System (TRAINS), maintained by UNCTAD and containing relevant tariff and non-tariff barrier estimates. For the EGS sub-sectors, trade flows were broken down by sub-sector and regions, in this case the EU and ROW. For the agriculture, chemical and machinery sectors, the trade flows were broken down by sub-sector and EU, NAFTA and ROW. Ordinary tariffs were estimated from TRAINS and the Ad Valorem Equivalents of NTBs were estimated using the World Bank dataset on NTBs, assembled by Kee et al.253 Eurostat was also utilised to gather EU-China and EU-World trade figures, which were cross checked against values obtain from WITS for consistency. As noted in the discussion of NTBs in Chapter 4 the estimates used are only intended to be indicative of potential areas where NTBs may exist which require cross referencing with the detailed sector studies.

With regards to production data in the sectors, Chinese production data was gathered from a variety of statistical year books, particularly China Yearly Industrial Data, via the All China Data Centre, a

253 Olarreaga, Marcelo, Kee, Hiau Looi and Nicita, Alessandro, "Estimating Trade Restrictiveness Indices" (March 2006). CEPR Discussion Paper No. 5576


database certified by the China National Bureau of Statistics. Growth rates used to form scenarios wherein supply and demand curves shift significantly in China were determined from productivity, market size and market output figures for the period available on a sector wide basis for each commodity sector using the above data source as well as the freely available China Statistical Yearbook, primarily Chapter 14 on Industry.

For reference, summary tables of the base data used in each sector are provided below. Notably, the four sectors’ size, in terms of trade as well as total production output, vary significantly both in sector-wide terms as well as when comparing subsectors within a sector (e.g. wastewater management vs. cleaner technologies within EGS). In the case of Environmental Goods and Services, the definition as used by the OECD (comprised of approximately 160 HS Codes) is based upon the Harmonised System, a trade nomenclature. When seeking adequate equivalents in Chinese production of Environmental Goods and Services it was discovered that in certain subsectors available data was either aggregated at a much higher level or using a different definition, which led to several subsectors having a lower production output than total exports. This data deficiency in those subsectors is acknowledged, within the understanding of the configuration of the model (wherein an export model and import competing model operate independently).

Table 39: Chinese EGS Trade Figures by Partner (values besides tariffs/NTBs in US$ Millions)

Tariffs NTBs

on Chinese Imports

to Chinese Exports

on Chinese Imports

to Chinese Exports

China Imports

China Exports

Air pollution control EU 5.22% 1.04% 21.50% 0.07% 1122 199

ROW 5.85% 3.11% 13.04% 0.04% 2170 1236 Wastewater management

EU 7.00% 1.08% 0.40% 0.03% 2800 2030 ROW 7.62% 3.71% 0.28% 0.03% 5215 7399

Solidwaste management

EU 1.48% 3.45% 0.52% 0.04% 2153 404 ROW 0.77% 2.98% 0.26% 0.30% 5701 2210

Remediation and cleanup

EU 1.48% 1.15% 0.52% 0.04% 200 273 ROW 0.77% 1.57% 0.26% 0.30% 723 1400

Noise and vibration abatement

EU 5.28% 2.45% 0.00% 0.05% 483 115 ROW 5.65% 5.05% 0.00% 0.04% 1097 748

Environmental monitoring

EU 3.46% 0.00% 0.00% 0.11% 1637 242 ROW 3.49% 1.40% 0.00% 0.22% 3604 1093

Cleaner Technologies EU 10.00% 6.22% 0.00% 0.54% 30 1

ROW 9.99% 4.36% 0.00% 3.48% 104 32

Water Supply EU 6.46% 6.36% 0.00% 0.00% 20 15

ROW 5.91% 4.63% 0.00% 0.00% 36 55

Renewable Energy EU 0.20% 0.05% 0.00% 0.00% 69 607

ROW 0.77% 0.46% 0.00% 0.55% 2838 818 Heat and Energy Savings Management

EU 6.87% 2.09% 0.00% 0.04% 376 268 ROW 7.78% 4.25% 0.00% 0.08% 545 1133


Table 40: Chinese EGS Market Figures (US$ Millions)

Demand Exports Imports Production Air pollution control 6793 1435 4001 2792 Wastewater management 8908 9429 8634 274 Solid waste management 11536 2614 7955 3580 Remediation and cleanup 9131 1673 934 8198 Noise and vib abatement 3710 863 1668 2043 Env monitoring 5643 1335 5423 220 Cleaner Technologies 1036 34 147 889 Water Supply 7228 70 59 7169 Renewable Energy 5130 1426 2928 2202 Heat and Energy Savings Management 3696 1401 990 2706 Total 62812 20279.5 32740 30072

Table 41: Chinese Agriculture Trade Figures by Partner (values besides tariffs/NTBs in US$ Millions)

Tariffs NTBs

on Chinese Imports

to Chinese Exports

on Chinese Imports

to Chinese Exports

China Imports

China Exports

Dairy Products EU 6.78% 12.11% 28.95% 2.71% 129 9

NAFTA 7.55% 1.29% 14.44% 1.55% 90 43 ROW 9.94% 10.13% 35.33% 2.13% 347 170

Meat Products EU 12.01% 1.26% 0.00% 7.40% 75 7

NAFTA 11.79% 1.51% 0.00% 0.71% 391 14 ROW 12.31% 4.23% 0.00% 4.06% 220 475


EU 10.08% 1.25% 0.00% 11.86% 209 971 NAFTA 10.30% 6.28% 0.00% 11.71% 590 1818

ROW 9.37% 6.73% 0.00% 11.79% 2357 3117

Grains and Cereals

EU 3.37% 4.56% 0.21% 14.17% 3 9 NAFTA 27.01% 10.71% 5.34% 39.44% 154 40

ROW 34.53% 144.90% 40.96% 26.80% 663 884

Fruit & Vegetables

EU 28.13% 5.59% 0.00% 51.39% 37 587 NAFTA 9.83% 5.82% 0.00% 46.76% 204 525

ROW 2.78% 14.01% 0.00% 49.08% 1254 3265

Beverages, Wines & Spirits

EU 11.01% 1.58% 0.19% 5.54% 451 31 NAFTA 9.29% 2.69% 0.11% 4.65% 37 132

ROW 17.22% 13.00% 0.02% 5.09% 98 762 Table 42: Chinese Agriculture Market Figures (US$ Millions)

Demand Exports Imports Production Dairy Products 15005 223 787.996 14248 Meat Products 35289 495 767.889 34391 Fish and Aquaculture 25611 5906 3457.713 20731 Grains and Cereals 48760 933 1371.293 47509 Fruit & Vegetables 48134 4377 1559.239 46029 Beverages, Wines & Spirits 49971 925 656.633 48962 Total 222770 12859 8600.763 211870


Table 43: Chinese Chemicals Trade Figures by Partner (values besides tariffs/NTBs in US$ Millions)

Tariffs NTBs on Chinese Imports

to Chinese Exports

on Chinese Imports

to Chinese Exports

China Imports

China Exports

Commodity EU 7.54% 3.80% 6.20% 0.18% 6418 91487

NAFTA 6.93% 4.14% 6.05% 3.29% 7544 143822 ROW 7.75% 4.60% 6.83% 1.74% 57762 242432

Specialty EU 7.64% 2.02% 4.20% 0.09% 1846 12543

NAFTA 7.29% 2.19% 2.49% 7.02% 1667 12674 ROW 7.31% 4.48% 2.09% 3.55% 5161 39269

Fine EU 5.93% 3.20% 6.95% 0.50% 2063 11327

NAFTA 10.92% 4.22% 4.42% 8.33% 1647 13310 ROW 8.19% 3.46% 9.65% 4.42% 5368 37653

Table 44: Chinese Chemicals Market Figures (US$ Millions)

Demand Exports Imports Production Commodity 260781 477742 82086 178695 Speciality 95864 64486 9904 85961 Fine 118346 62291 10437 107909 Total 474991 604519 102426 372565

Table 45: Chinese Machinery Trade Figures by Partner (values besides tariffs/NTBs in US$ Millions)

Tariffs NTBs

on Chinese Imports

to Chinese Exports

on Chinese Imports

to Chinese Exports

China Imports

China Exports

Power-generating machinery and

equipment

EU 5.88% 1.83% 0.22% 2.03% 2579 1464 NAFTA 4.46% 3.51% 0.15% 3.71% 1536 2111

ROW 6.98% 3.77% 0.04% 3.97% 4167 6087 Machinery specialised

for particular industries

EU 5.73% 1.68% 2.72% 1.88% 7934 1272 NAFTA 2.68% 0.88% 1.80% 1.08% 1967 2537

ROW 3.88% 2.40% 2.57% 2.60% 14131 6062

Metalworking machinery

EU 8.98% 1.99% 34.13% 2.19% 1995 190 NAFTA 7.77% 4.01% 23.51% 4.21% 359 320

ROW 8.69% 2.18% 28.94% 2.38% 5165 876 General industrial

machinery and equipment

EU 9.92% 2.02% 3.86% 2.22% 10500 6252 NAFTA 6.55% 2.67% 2.88% 2.87% 3474 11545

ROW 7.78% 4.19% 4.36% 4.39% 13204 16244

Electrical machinery EU 14.61% 2.60% 3.54% 2.80% 11590 12998

NAFTA 10.77% 2.88% 4.15% 3.08% 3579 25053 ROW 5.05% 3.02% 7.44% 3.22% 34439 52278

Table 46: Chinese Machinery Market Figures (US$ Millions)

Demand Exports Imports Production Power-generating machinery and equipment 51471 1385 8460 43011 Machinery specialised for particular industries 80811 9662 9108 71703 Metalworking machinery 119921 9871 26001 93920 General industrial machinery and equipment 146629 34040 30061 116568 Electrical machinery 213658 90329 55061 158597 Total 612490.319 145287 128691.4 483798.9


Initial Elasticities Used

Table 47: Initial Elasticities Used in TAPES/PE Models

Imports Comment:

Armingtons - substitutability of imported and domestic goods 4 - High

Substitutability between import sources 2 - Low

Domestic supply 2 - Low

Domestic demand 2 - Low

Fixed world price imports Sector small with no terms of trade effects

Exports

Export Supply 3 - Medium

Fixed world price exports Sector small with no terms of trade effects

6.3 Experiments Run Three types of medium run experiments were run. Medium run is taken to be a three year period during which the assumed structural changes take place and the effects of changes in the policy environment on protection and the real exchange rate apply. The first set of three experiments relating to shallow integration under the DDA with an unchanged real exchange rate were run. The three experiments shown in Table 46 were DDA Baseline (10% cut), DDA Modest (25% cut) and DDA Ambitious (75% cut). Second, and more speculatively, a set of medium run projections of domestic demand growth and possible supply curve shift for import competing production and export production were run to obtain a consistent set of projections of imports, domestic production and domestic demand. The same supply curve shifts were applied on the export side. The medium run projections shown in Table 49 for supply growth rates were calculated from an industrial output dataset available in the China Statistical Yearbooks’ chapters on Industry, Environment, and Agriculture. Except in the case of environmental goods, output data was available from 1999 to 2006, allowing for a average annual growth in total output from Chinese production over the seven year period to be determined. In the case of environmental goods and services, this data was available from the year 2000. In all cases, output statistics were measured in units, e.g. tons of produce, units of types of machinery, etc. In the case of demand, growth rates were determined from growth in total imports by subsector over the period of 1999 to 2006. These trends were as far as possible estimated at constant prices. Second, using shares of imports and domestic production for each sub-sector, the trend rate of growth or annual constant price shift of the composite demand curve for each sub-sector was estimated. Finally, information from the trends, supplemented in some cases by judgement, was used to obtain estimates of structural change in domestic production and domestic demand for the medium run. No estimates of structural change of imports were required because imports were assumed to be available at a fixed price. The estimated medium run shifts of the domestic supply and demand curves used in the second set of policy scenarios are shown in Table 49.

Finally, the projected demand and supply curve shifts were used with the Ambitious DDA projections and a real exchange rate appreciation of 10%.


Table 48: Sector Scenario Parameters

Tariffs and NTBs reductions Exchange Rate Multilateral

Baseline with DDA 10% - DDA Modest 25% - DDA Ambitious 75% - Structural Change only (see Table 49) - - DDA Modest with Structural Change 25% 10% DDA Ambitious with Structural Change 75% 10%

Table 49: Chinese Structural Change used in Projection Scenarios

Environmental Goods and Services Supply Demand Air Pollution Control 43% 54% Wastewater Management 13% 61% Solid Waste Management 40% 48% Remediation and Cleanup 50% 53% Noise and Vibration Abatement 51% 59% Environmental Monitoring, Analysis and Assessment 36% 70% Cleaner Technologies 36% 35% Water Supply 3% 3% Renewable Energy 33% 74% Heat and Energy Savings Management 54% 56%

Agriculture Supply Demand Dairy Products 38% 37% Meat Products 20% 20% Fish and Aquaculture 15% 18% Grains and Cereals 0% 0% Fruit & Vegetables 9% 11% Beverages, Wines & Spirits 23% 23%

Chemicals Supply Demand Commodity 43% 48% Specialty 28% 30% Fine 33% 34%

Machinery Supply Demand Power-generating machinery and equipment 75% 68% Machinery specialised for particular industries 60% 53% Metalworking machinery 66% 66% General industrial machinery and equipment 66% 65% Electrical machinery 65% 64%

6.4 The Results Please find below the output of the TAPES/PE models in sections 6.4.1 to 6.4.4. Please note that the below quantitative results have been qualitatively analysed in detail within the DDA Scenarios segment of each sector study within.


6.4.1 Environmental Goods and Services Results Domestic Demand (Absorption)

Baseline with DDA

DDA Modest

DDA Ambitious

Structural Change Only

DDA Modest with Structural change

DDA Ambitious with Structural change

Air pollution control 2.49 6.502 22.819 52.225 89.518 120.774

Wastewater management 1.421 3.61 11.457 60.459 104.621 120.218

Solid waste management 0.198 0.496 1.504 47.065 74.765 76.616

Remediation and cleanup 0.036 0.09 0.274 51.713 57.359 57.734

Noise and vibration abatement 0.582 1.474 4.619 57.182 80.918 87.208

Environmental monitoring 0.658 1.657 5.101 69.528 111.837 119.066

Cleaner Technologies 0.366 0.939 3.075 35.4 356.081 47.33

Water Supply 0.014 0.036 0.115 3 1.821 3.475

Renewable Energy 0.1 0.25 0.755 66.749 94.787 95.886

Heat and Energy Savings Management 0.495 1.259 4.018 55.352 71.137 76.654

Domestically Produced Supply

Baseline with DDA

DDA Modest

DDA Ambitious




Air pollution control -0.816 -2.078 -6.622 47.144 36.779 29.994

Wastewater management -0.469 -1.175 -3.551 27.296 17.387 14.547

Solid waste management -0.066 -0.165 -0.496 42.919 34.93 34.457

Remediation and cleanup -0.012 -0.03 -0.091 51.419 49.586 49.468

Noise and vibration abatement -0.193 -0.487 -1.494 54.211 47.148 45.482

Environmental monitoring -0.218 -0.546 -1.645 46.637 36.142 34.627

Cleaner Technologies -0.122 -0.311 -1.004 35.532 175.642 31.77

Water Supply -0.005 -0.012 -0.038 3 1.379 2.842

Renewable Energy -0.033 -0.083 -0.25 47.541 40.092 39.83

Heat and Energy Savings Management -0.164 -0.416 -1.304 54.878 49.962 48.385


Quantity Imports

Baseline with DDA

DDA Modest

DDA Ambitious




Air pollution control 4.813 12.596 44.5 55.796 128.719 190.574

Wastewater management 1.481 3.763 11.942 61.542 107.576 123.835

Solid waste management 0.316 0.793 2.407 48.941 93.5 96.488

Remediation and cleanup 0.457 1.147 3.491 54.298 129.542 134.736

Noise and vibration abatement 1.534 3.889 12.228 60.839 124.527 141.664

Environmental monitoring 0.693 1.747 5.377 70.473 115.073 122.694

Cleaner Technologies 3.338 8.601 28.643 34.601 1791.821 150.002

Water Supply 2.321 5.929 19.164 3 58.623 86.43

Renewable Energy 0.2 0.501 1.512 81.566 138.684 140.937

Heat and Energy Savings Management 2.302 5.875 18.913 56.65 132.362 159.71

Quantity Exports

Baseline with DDA

DDA Modest

DDA Ambitious




Air pollution control 0.279 0.7 2.131 43 29.6 31.442

Wastewater management 0.307 0.772 2.356 13 2.485 4.096

Solid waste management 0.321 0.807 2.462 40 -5.644 29.102

Remediation and cleanup 0.173 0.434 1.315 50 -5.089 36.775

Noise and vibration abatement 0.455 1.145 3.518 51 37.456 40.681

Environmental monitoring 0.133 0.334 1.009 36 22.808 23.635

Cleaner Technologies 0.728 1.841 5.734 36 24.653 29.419

Water Supply 0.478 1.203 3.701 3 -6.184 -3.869

Renewable Energy 0.06 0.149 0.449 33 19.878 20.238

Heat and Energy Savings Management 0.377 0.947 2.9 54 39.913 42.619


Quantify of imports by region of origin

Baseline with DDA

DDA Modest

DDA Ambitious




Air pollution control EU 5.889 15.578 57.381 55.796 134.776 216.475

ROW 4.222 10.964 37.561 55.796 125.403 176.621

Wastewater management

EU 1.394 3.539 11.191 61.542 107.128 122.333

ROW 1.527 3.883 12.344 61.542 107.815 124.639

Solid waste management

EU 0.522 1.311 3.999 48.941 94.492 99.542

ROW 0.238 0.597 1.802 48.941 93.122 95.328


EU 0.679 1.707 5.23 54.298 130.814 138.679

ROW 0.395 0.99 3.008 54.298 129.188 133.641


EU 1.464 3.708 11.624 60.839 124.134 140.363

ROW 1.565 3.969 12.494 60.839 124.699 142.235


EU 0.687 1.731 5.326 70.473 115.039 122.586

ROW 0.696 1.754 5.4 70.473 115.088 122.742

Cleaner Technologies EU 3.34 8.607 28.668 34.601 1791.936 150.049

ROW 3.337 8.599 28.636 34.601 1791.788 149.988

Water Supply EU 2.418 6.184 20.052 3 59.005 87.82

ROW 2.268 5.791 18.685 3 58.417 85.681

Renewable Energy EU 0.036 0.09 0.268 81.566 137.709 137.985

ROW 0.204 0.511 1.542 81.566 138.707 141.008

Heat and Energy Savings Management

EU 2.157 5.495 17.588 56.65 131.528 156.818

ROW 2.402 6.136 19.821 56.65 132.933 161.694

Quantify of exports by region of destination

Baseline with DDA

DDA Modest

DDA Ambitious




Air pollution control EU 0.11 0.276 0.833 43 29.055 29.771

ROW 0.306 0.768 2.339 43 29.688 31.711

Wastewater management

EU 0.11 0.274 0.827 13 1.979 2.542

ROW 0.361 0.908 2.775 13 2.624 4.522

Solid waste management

EU 0.339 0.851 2.598 40 -5.603 29.273

ROW 0.318 0.799 2.437 40 -5.652 29.071


EU 0.118 0.296 0.893 50 -5.22 36.205

ROW 0.184 0.461 1.397 50 -5.064 36.886


EU 0.245 0.614 1.864 51 36.734 38.433

ROW 0.487 1.227 3.773 51 37.567 41.027


EU 0.011 0.027 0.081 36 22.433 22.499

ROW 0.16 0.402 1.215 36 22.892 23.887

Cleaner Technologies EU 0.637 1.608 4.984 36 24.368 28.5

ROW 0.732 1.851 5.765 36 24.665 29.456

Water Supply EU 0.602 1.518 4.695 3 -5.893 -2.947

ROW 0.444 1.118 3.43 3 -6.264 -4.12

Renewable Energy EU 0.005 0.012 0.037 33 19.715 19.745

ROW 0.1 0.25 0.755 33 20 20.604

Heat and Energy Savings Management

EU 0.11 0.276 0.833 43 29.055 29.771

ROW 0.306 0.768 2.339 43 29.688 31.711


6.4.2 Agriculture Results

Domestic Demand (Absorption)

Baseline with DDA

DDA Modest

DDA Ambitious




Dairy Products 0.458 1.253 5.282 37.461 42.34 49.704

Meat Products 0.071 0.183 0.614 20 21.259 21.962

Fish and Aquaculture 0.356 0.912 2.974 16.793 23.962 27.163

Grains and Cereals 0.362 1.034 5.377 -2.2E-12 2.426 8.267

Fruit & Vegetables 0.041 0.105 0.338 10.044 11.53 11.882

Beverages, Wines & Spirits 0.044 0.112 0.38 23 23.789 -32.538


Baseline with DDA

DDA Modest

DDA Ambitious




Dairy Products -0.152 -0.414 -1.701 37.512 35.922 33.656

Meat Products -0.024 -0.061 -0.204 20 19.583 19.353

Fish and Aquaculture -0.118 -0.302 -0.972 16.39 14.101 13.136

Grains and Cereals -0.12 -0.342 -1.731 -2.1E-12 -0.796 -2.613

Fruit & Vegetables -0.014 -0.035 -0.112 9.979 9.489 9.374

Beverages, Wines & Spirits -0.014 -0.037 -0.126 23 22.738 -32.208

Quantity Imports

Baseline with DDA

DDA Modest

DDA Ambitious




Dairy Products 11.657 32.526 149.007 36.541 169.682 400.96

Meat Products 4.322 11.251 38.881 20 101.732 151.461

Fish and Aquaculture 3.211 8.265 27.413 19.219 87.039 118.966


Fruit & Vegetables 1.656 4.24 13.852 11.964 75.701 91.742

Beverages, Wines & Spirits 4.392 11.449 39.813 23 107.837 -55.95

Quantity Exports

Baseline with DDA

DDA Modest

DDA Ambitious




Dairy Products 0.953 2.42 7.679 38 27.206 33.738

Meat Products 0.528 1.33 4.103 20 9.437 12.432

Fish and Aquaculture 1.451 3.711 12.044 15 7.341 15.966


Fruit & Vegetables 3.935 10.455 39.684 9 8.357 37.03

Beverages, Wines & Spirits 1.403 3.586 11.643 23 14.67 23.589



Baseline with DDA

DDA Modest

DDA Ambitious




Dairy Products

EU 10.983 30.414 134.462 36.541 165.385 371.698

NAFTA 8.169 21.915 83.778 36.541 148.091 269.731

ROW 12.651 35.6 169.159 36.541 175.938 441.502

Meat Products

EU 4.33 11.271 38.962 20 101.769 151.606

NAFTA 4.274 11.12 38.366 20 101.496 150.527

ROW 4.405 11.473 39.765 20 102.136 153.062


EU 3.338 8.602 28.663 19.219 87.622 121.114

NAFTA 3.395 8.753 29.225 19.219 87.883 122.079

ROW 3.153 8.111 26.846 19.219 86.774 117.992

Grains and Cereals

EU 4.6 10.625 -3.477 -1.10E-11 66.32 43.189

NAFTA 11.767 32.576 137.74 -1.10E-11 99.322 252.678

ROW 18.464 54.951 343.517 -1.10E-11 132.962 557.94

Fruit & Vegetables

EU 7.228 19.142 70.741 11.964 100.818 187.552

NAFTA 3.123 8.046 26.825 11.964 82.115 113.591

ROW 1.201 3.055 9.741 11.964 73.702 84.82


EU 4.163 10.825 37.286 23 106.673 -56.746

NAFTA 3.698 9.572 32.402 23 104.336 -58.285

ROW 5.638 14.853 53.731 23 114.186 -51.565


Baseline with DDA

DDA Modest

DDA Ambitious




Dairy Products

EU 1.307 3.334 10.716 38 28.341 37.51

NAFTA 0.277 0.696 2.118 38 25.065 26.831

ROW 1.104 2.807 8.92 38 27.686 35.279

Meat Products

EU 1.053 2.675 8.478 20 10.889 17.157

NAFTA 0.194 0.485 1.47 20 8.524 9.588

ROW 0.53 1.336 4.118 20 9.443 12.448


EU 1.56 3.993 13.017 15 7.632 16.973

NAFTA 1.161 2.953 9.416 15 6.557 13.245

ROW 1.587 4.065 13.275 15 7.707 17.239

Grains and Cereals

EU 1.603 4.105 13.418 0.00 -6.305 2.076

NAFTA 3.455 9.11 33.421 0.00 -1.801 20.079

ROW 6.746 18.763 90.102 0.00 6.887 71.092

Fruit & Vegetables

EU 3.777 10.008 37.54 9 7.918 34.927

NAFTA 3.559 9.398 34.72 9 7.32 32.161

ROW 4.024 10.706 40.868 9 8.603 38.192


EU 0.669 1.689 5.244 23 12.57 16.505

NAFTA 0.688 1.738 5.403 23 12.624 16.681

ROW 1.555 3.981 12.978 23 15.107 25.066


6.4.3 Chemicals Results

Domestic Demand (Absorption)

Baseline with DDA

DDA Modest

DDA Ambitious




Commodity 1.044 2.696 9.054 46.508 66.052 78.026

Specialty 0.264 0.677 2.222 29.14 34.849 37.516

Fine 0.368 0.957 3.321 33.563 39.467 43.673


Baseline with DDA

DDA Modest

DDA Ambitious




Commodity -0.346 -0.883 -2.848 45.137 39.204 36.01

Specialty -0.088 -0.225 -0.73 28.948 27.102 26.275

Fine -0.122 -0.317 -1.083 33.478 31.567 30.27

Quantity Imports

Baseline with DDA

DDA Modest

DDA Ambitious




Commodity 4.089 10.604 36.125 49.507 128.368 178.388

Specialty 3.444 8.886 29.746 30.866 109.397 148.427

Fine 5.409 14.215 50.91 34.438 126.271 197.008

Quantity Exports

Baseline with DDA

DDA Modest

DDA Ambitious




Commodity 0.588 1.483 4.589 43 30.608 34.607

Specialty 0.664 1.678 5.23 28 17.133 21.225

Fine 0.751 1.901 5.954 33 21.975 26.827


Baseline with DDA

DDA Modest

DDA Ambitious




Commodity

EU 3.943 10.209 34.567 49.507 127.552 175.202

NAFTA 3.759 9.711 32.624 49.507 126.524 171.229

ROW 4.148 10.763 36.75 49.507 128.696 179.667

Specialty

EU 3.915 10.148 34.519 30.866 111.823 157.565

NAFTA 3.389 8.738 29.183 30.866 109.113 147.35

ROW 3.289 8.474 28.197 30.866 108.604 145.461

Fine

EU 4.586 11.947 41.363 34.438 121.777 178.22

NAFTA 5.19 13.606 48.28 34.438 125.065 191.834

ROW 5.779 15.237 55.275 34.438 128.296 205.599


Baseline with DDA

DDA Modest

DDA Ambitious




Commodity

EU 0.384 0.966 2.956 43 29.944 32.505

NAFTA 0.697 1.761 5.474 43 30.966 35.745

ROW 0.6 1.513 4.681 43 30.647 34.724

Specialty

EU 0.207 0.519 1.575 28 15.798 17.014

NAFTA 0.851 2.154 6.753 28 17.681 22.979

ROW 0.749 1.894 5.906 28 17.382 22.004

Fine

EU 0.358 0.9 2.749 33 20.777 22.991

NAFTA 1.128 2.868 9.129 33 23.134 30.627

ROW 0.736 1.86 5.795 33 21.926 26.637


6.4.4 Machinery Results Domestic Demand (Absorption)

Baseline with DDA

DDA Modest

DDA Ambitious




Power-generating machinery and equipment 0.186 0.473 1.503 70.927 78.294 80.57

Machinery specialised for particular industries 0.383 0.974 3.105 55.456 68.042 72.237

Metalworking machinery 1.568 4.241 17.052 66 85.812 113.116

General industrial machinery and equipment 0.553 1.42 4.663 65.36 79.491 86.405

Electrical machinery 0.874 2.257 7.599 64.325 82.766 93.966


Baseline with DDA

DDA Modest

DDA Ambitious




Power-generating machinery and equipment -0.062 -0.157 -0.496 71.644 69.246 68.532

Machinery specialised for particular industries -0.127 -0.323 -1.014 56.797 52.781 51.53

Metalworking machinery -0.517 -1.375 -5.113 66 59.877 52.735

General industrial machinery and equipment -0.184 -0.469 -1.508 65.546 61.082 59.065

Electrical machinery -0.29 -0.741 -2.412 64.557 58.825 55.708

Quantity Imports

Baseline with DDA

DDA Modest

DDA Ambitious




Power-generating machinery and equipment 2.211 5.642 18.15 65.123 156.093 185.703

Machinery specialised for particular industries 2.253 5.749 18.504 50.582 126.715 153.104


General industrial machinery and equipment 3.419 8.813 29.401 64.641 155.129 201.489

Electrical machinery 4.154 10.784 36.918 63.675 154.093 211.359

Quantity Exports

Baseline with DDA

DDA Modest

DDA Ambitious


DDA Modest Structural change

DDA Ambitious Structural change

Power-generating machinery and equipment 0.9 2.285 7.237 75 61.099 68.899

Machinery specialised for particular industries 0.308 0.774 2.359 60 45.114 47.397


General industrial machinery and equipment 0.443 1.115 3.427 66 51.066 54.52

Electrical machinery 1.357 3.475 11.356 65 53.661 65.364



Baseline with DDA

DDA Modest

DDA Ambitious


DDA Modest with S-D Shift

DDA Ambitious with S-D Shift

Power-generating machinery and equipment

EU 5.513 17.695 65.123 155.779 184.603 5.513

NAFTA 4.434 14.007 65.123 153.163 175.685 4.434

ROW 6.158 19.935 65.123 157.343 190.02 6.158

Machinery specialised for particular industries

EU 6.793 22.155 50.582 128.953 160.902 6.793

NAFTA 3.975 12.421 50.582 122.913 140.113 3.975

ROW 5.395 17.266 50.582 125.957 150.461 5.395


EU 30.441 132.997 66 207.344 437.474 30.441

NAFTA 23.979 94.636 66 192.119 348.985 23.979

ROW 27.548 115.287 66 200.529 396.622 27.548

General industrial machinery and equipment

EU 8.813 29.399 64.641 155.129 201.485 8.813

NAFTA 7.879 25.92 64.641 152.939 193.379 7.879

ROW 9.055 30.309 64.641 155.696 203.605 9.055


EU 13.457 47.695 63.675 160.223 235.866 13.457

NAFTA 11.392 39.285 63.675 155.489 216.741 11.392

ROW 9.78 32.926 63.675 151.79 202.282 9.78


Baseline with DDA

DDA Modest

DDA Ambitious



DDA Ambitious Structural change

Power-generating machinery and equipment

EU 0.2 0.501 1.517 75 58.288 59.889

NAFTA 1.363 3.477 11.212 75 62.977 75.159

ROW 0.908 2.301 7.235 75 61.124 68.895

Machinery specialised for particular industries

EU 0.185 0.464 1.407 60 44.669 46.025

NAFTA 0.286 0.719 2.189 60 45.036 47.152

ROW 0.343 0.862 2.63 60 45.241 47.787


EU 0.215 0.54 1.636 66 50.206 51.845

NAFTA 0.405 1.019 3.122 66 50.923 54.064

ROW 0.233 0.584 1.773 66 50.273 52.049

General industrial machinery and equipment

EU 0.218 0.547 1.659 66 50.217 51.878

NAFTA 0.465 1.171 3.598 66 51.15 54.775

ROW 0.514 1.294 3.986 66 51.334 55.356


EU 0.296 0.743 2.262 65 49.603 51.86

NAFTA 2.065 5.328 17.891 65 56.412 75.069

ROW 1.282 3.267 10.486 65 53.351 64.071

6.5 Reading the Results For a first assessment of the results, it is useful to divide the four TAPES/PE case studies by height of protection. Taking 7.5% as the divide between high and low tariffs, it can be seen from Table 39 of the EGS base data that this sector has generally low levels of ordinary and NTB protection on the import side while there are few identified barriers to exports. The identified tariff and NTB protection for agriculture shown in Table 41 can be differentiated. On both the import and export side there are generally high ordinary tariffs. Some high NTB barriers are identified on the import side and a significant number of high NTB barriers were identified on the export side. In the case of chemicals shown in Table 43 the highest barriers are on the import side, with much lower tariff barriers identified on the export side. Most none tariff barriers identified were also low. In the case of machinery (Table 45) high tariff and NTB barriers were identified in metal working machinery on the import side. On the export side ordinary tariff barriers were low, but some very high peaks of NTBs were identified. The height of protection thus identified drives the results in the first three scenarios.


As a case in point, consider the case of air pollution control in the EGS results. This sector has an initial tariff of over 5% and an identified NTB of over 20%. Thus in the ambitious scenario with a cut in tariffs and NTBs of 75% there is a strong effect on domestic demand, and a strong increase in imports, replacing domestic supply by nearly 7%. On the export side there is a small expansion due to the very modest improvement in export market access. In the other EGS sectors there is a similar pattern in the results, but the orders of magnitude are very much lower because the initial trade barriers are so much lower, and the impact is therefore low even in the DDA Ambitious scenario.

The impact effects in the case of Agriculture are different. The high tariff and NTBs throughout the sector suggest that lowering the tariff barriers in all of the first three scenarios will have strong negative effects on domestic supply, however, this is not the case because the initial import shares are very low. Thus the displacement of domestic supply is relatively low, but the impact on imports is very large, especially for Dairy Products and Cereals. On the export side the stimulus from lowering barriers in export markets is small, except for Grains and Cereals and Fruit and Vegetables; the export response across the sector is relatively low.

The chemicals sector is characterised by relatively low levels of protection and except in the case of commodity chemicals the import share of the domestic market is relatively low. Thus the combination of low protection and low shares of domestic supply in total domestic demand means that the impact of the first three scenarios on domestic demand and domestically produced supply is low. In contrast, the impact on imports is modest to large, especially in the case of fine chemicals. On the export side the simultaneous of the first three scenarios from the reduction in market access barriers for exports is small and the export response is low.

The machinery sector is characterised by relatively low ordinary tariffs and low tariff barriers for China's exports. However for the metal working sector, high NTBs were identified for metal working machinery. Thus the effect of the first three scenarios is most evident in the fall in domestic supply for metalworking and electrical machinery, with large increases in the quantity of imports in those sectors. On the export side small increases result in the DDA ambitious scenario, except for electrical machinery.

Scenario four sets out the consequences of structural shifts identified in table 12. For example, in EGS for most sub-sectors there is strong import substitution and in most cases only modest export expansion. In contrast, in agriculture the identified structural changes are relatively small and the size of the domestic demand shift tends to be similar to the size of the domestic supply shift. In this case the impact of structural change is small. In the power generating machinery and equipment sector, the identified structural changes in domestic supply are stronger than the shifts in domestic demand. The model results show an increase in domestic supply which is larger than the increase in imports.

Interpretation of the results for the remaining chemicals and machinery sub-sectors will depend on both the level and difference between the identified structural shifts in supply and demand. When the shift in domestic demand is higher than the shift in domestic supply, the difference will be made up by imports. On the export side because the shift in the domestic supply curve has also been applied as a shift in the export supply curve, a low shift in the export supply curve will yield a low expected growth of exports. The export response will only be large when a shift in export supply is large. The results in scenarios 5 and 6 combine the effects of these structural changes with policy


induced changes. For sectors with low tariffs and low barriers to exports the impact on imports, domestic supply and exports will be dominated by the effects of the exchange rate appreciation in relation to structural change.


Modelling Bibliography

de Melo, Jaime, and Sherman Robinson. "Product Differentiation and Foreign Trade in CGE Models of Small Economies." The World Bank, 1989.

Devarajan, S., J.D. Lewis, and S. Robinson. "Policy Lessons from Trade Focused, Two-Sector Models." Journal of Policy Modelling 12 (1990): 625-57.

K. Dervis, J. De Melo, and S. Robinson. General Equilibrium Models for Development Policy. Cambridge, MA: Cambridge University Press, 1982.

Liu, Gang-Li, Sherman Robinson, Zhi Wang, and Marcus Noland. Global Economic Effects of the Asian Currency Devaluations: Peterson Institute for International Economics, 1998.

Nolan, Marcus, Sherman Robinson, and Zhi Wang. " The Continuing Asian Financial Crisis: Global Adjustment and Trade." Peterson Institute for International Economics, 1999.

Pyatt, Graham. "A Sam Approach to Modelling." Journal of Policy Modelling 10, no. 3 (1988): 327-52.

Thierfelder, Karen, Scott McDonald, and Sherman Robinson. "GLOBE: A SAM Based Global CGE Model Using GTAP Data." United States Naval Academy Department of Economics, 2007.

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