Bumpy ride on the Silk Road

The old Silk Road, Gansu, China (Jonathan Kos-Read, CC BY-ND)

The last year’s visit of President Andrzej Duda in China launched a discussion on Poland's greater involvement in the development of the New Silk Road. While estimating the benefits from this project, no-one should pretend that there is no risk involved.

The goal of the One Belt, One Road (the so-called New Silk Road) project is to create a network of countries linked with transport infrastructure, preferential customs tariffs and simplified import and export regulations, which are to serve the free movement of goods between China and its trade partners. The facilitation in the movement of goods is to apply in both directions. However, it brings not only benefits, but also risks for European markets, including the Polish economy.

Chinese foreign policy is largely determined by domestic factors and created for internal needs. The stalling economic growth, so far driven by investments, was largely based on exports. This development model has led to overproduction and crisis in many industries. Chinese authorities are now attempting to transform the current model into a new one focused on consumption, but for political and societal reasons they are still protecting and supporting unprofitable enterprises through subsidies, support in the acquisition of new markets and a number of other legal and illegal measures.

Convincing the EU Member States, including Poland, to strengthen cooperation and to actively participate in the project of the New Silk Road would facilitate the export of subsidized Chinese overproduction to Europe. China also hopes that closer cooperation with the EU will mean that Brussels will be more willing to recognize China as a market economy on behalf of the member states.

China as a market economy country

Obtaining the status of a market economy is extremely important for the Chinese authorities. The European Union has launched a public consultation that will help it decide whether to grant China market economy status. If the European Union takes a negative decision in this matter it will be poorly received in China and may have adverse political and economic consequences. On the other hand, the recognition of the Chinese economy as a market economy carries a serious risk for the EU Member States – a significantly facilitated influx of cheap, often subsidized, Chinese products is a threat to European producers. After the recognition of China as a market economy, anti-dumping duties will be imposed on the basis of comparing the export prices with the prices on the internal Chinese market, which are artificially low due to grants and subsidies.

In light of the studies conducted by European think tanks, such as  Think!Desk, China’s economy still does not meet the conditions of a market economy.

The long list of reasons includes, among others, the widely used state programmes of subsidizing individual companies or entire sectors (especially those dominated by state-owned enterprises), tax breaks, preferential loans, complimentary or preferentially priced transfers of land use rights, and a number of other instruments. These programmes in conjunction with state regulation of the factors of production, such as land prices, energy prices and – to a slightly lesser extent – the costs of labour and capital, mean that the prices on China’s domestic market are not shaped by market mechanisms and are artificially suppressed in the case of a broad range of products. The use of such prices as the basis for assessing the necessity of applying anti-dumping duties is pointless. Giving China the status of a market economy without the existence of functioning market mechanisms significantly weakens the ability of importing countries to combat unfair trade practices.

China is the undisputed leader in the WTO with regard to the number of allegations of price dumping and illegal subsidies. Meanwhile, Franciso Urdinez and Gilmar Masiero, from the University of São Paulo, have indicated that the recognition of China as a market economy would reduce the number of anti-dumping investigations initiated against China by almost 78 per cent.

Risks for the UE

The steel industry is one of the most important sectors in which Chinese imports have been subjected to anti-dumping restrictions. In 2014 China’s production surplus amounted to nearly 340 million tons, and in 2015 to about 300 million tons. By November 2015 China had exported more than 100 million tons – which was still not enough to offset the decline in domestic demand. The only chance to quickly mitigate the situation is to increase exports, which is openly acknowledged by the representatives of the Chinese authorities, trade associations and the management boards of companies. It is estimated that over two years the imports of Chinese steel to the EU increased from 3.5 million to 6.5 million tons, despite the fact that it is inhibited by import duties. A similar situation exists in many other industries.

The Economic Policy Institute (EPI) estimates that granting China the status of a market economy and limiting anti-dumping procedures within 3-5 years would cost the European Union 1.7-3.5 million jobs in industries directly competing with imports from China, among others, the electronics industry, clothing industry, furniture industry, electrical industry, manufacture of metals and metal products, plastics industry and machinery production. An estimated 2.7 million people could be laid off in import-sensitive industries, such as the paper industry, ceramics industry, steel industry, glass industry, and the automotive industry. The GDP could drop by 1-2 per cent compared with 2011.

These risks apply to Poland as well. In the analysis prepared by EPI, Poland took fifth place in the ranking of risk – between France and Spain. Poland is threatened with the loss of 145,000 – 290,000 jobs.

Potential benefits for Poland

On the other side of the equation, however, are the potential benefits of Polish involvement in the Chinese business initiatives. Lobbyists supporting closer cooperation with China emphasize that the increasingly affluent Chinese society will, after all, spend more and more, including on goods from abroad. This in turn opens up opportunities for Polish exports. Recent analyses, such as the report of The Demand Institute indicate, however, that this market is not growing as fast as has been anticipated.

Moreover, Chinese imports are weakening – with a 0.5 per cent decline in the GDP growth rate, for several months of the past year imports recorded much greater declines than exports, and the difference cannot be explained solely by the decline in commodity prices. Exporters operating on the Chinese market for years have been acutely affected. During the past year Taiwan recorded several double-digit declines in exports to China, with record drops of almost 20 per cent in November and over 16 per cent in February. In the first three quarters of 2015 German exports fell by 2.6 per cent year-on-year.

Whether the share of imported goods in the market increases or not depends on the attitude of the Beijing authorities towards foreign companies. The aforementioned report of Think!Desk identified many mechanisms for the protection of the domestic market from foreign competitors that were previously used by the Chinese authorities.

In the last months of 2015, the state-owned media published declarations of party dignitaries confirming that the manufacturing sector is and will remain the foundation of the Chinese economy, and that reforms are not intended to reduce its role, but merely to increase its competitiveness. China is to transform from the “world’s factory” to a world industrial power, which is to be achieved through special programmes, including the flagship project “Made in China 2025”.

Polish industrial production is currently more competitive rather than complementary in relation to the Chinese industry. Over the last five years, 10 of the 29 branches of the Polish industry surveyed by Merrill Lynch have increased their competitiveness at the expense of China, which was the best result in the region. Polish companies in the chemical industry, machinery industry, furniture industry, wood processing and others are increasingly effective in competition with the Chinese. Poland is more competitive as a place to invest in manufacturing in these sectors due to production costs and the proximity of the markets.

This trend is likely to continue, provided that the Polish authorities diligently and sensibly implement the promised reindustrialization, and that the European Union does not allow its market to be flooded with subsidized Chinese products. In light of the previous practices and declarations of the Chinese authorities and the list of industries threatened by Chinese imports presented by EPI, the window of opportunities for the Polish industry in China doesn’t seem to be wide open.

There are realistic chances for the success of Polish food in the Chinese market. However, if Polish fruit growers gain access to the Chinese market this year, they will face a big challenge. China is a huge producer of apples, some of which are exported in amounts giving the country a place among the world leaders. Imports, which had been growing in previous years due to price growth on the domestic market, decreased once again in 2015 and are still relatively small. Meanwhile, the competition is significant and includes the United States which is once more launching exports to China, Chile – the current leader – and the dynamic France.

China is also the world’s biggest producer of pork, while the Polish authorities have long been seeking to introduce Polish pork to the Chinese market. The Chinese government has been supporting domestic producers for strategic reasons and controls the level of imports, despite a deficit of pork on the market. The ratio of imports to domestic production is low and in the years 2011-2014 remained within the range of 1.2 – 1.6 per cent. In 2015 the export of pork from several countries to China increased, but that was mainly due to the sharp decline in the pig population in China. Competition from the United States, Denmark and Spain is very strong, and we should bear in mind that Polish manufacturers are not very competitive in terms of prices even in our domestic market. In the first three quarters of 2015, the imports of pork to Poland reached 619,000 tons, while exports amounted to only 478,000 tons. Poultry exporters are doing well, but the number of plants that have obtained the certificates required by the Chinese authorities is still small.

Milk manufacturers also have high hopes for the Chinese market. During meetings in China, OSM Łowicz signed a contract for the supply of milk. Other Polish dairy manufacturing brands are already available in Chinese stores, e.g. Mlekpol, Mlekowit, Łowicz, Rotr and Grajewo.

Chinese companies, however, are aware of the market potential and are increasingly willing to buy foreign milk processing plants, mainly in Australia and New Zealand, in order to reduce the purchases of goods.

The alcohol industry and sweets manufacturers  also have a large potential. Polish cosmetics are also waiting for their chance, but the changing regulations in China are hindering distribution.

The success of Polish enterprises in China is to a great extent dependent on the genuine opening of the Chinese economy to foreign companies and products, the limitation of the role of the state in controlling the market and influencing it using administrative methods and the illegal support for domestic enterprises, both in exports and in the domestic market. Bilateral Polish-Chinese relations are and will remain asymmetric. The equal partner for China is the European Union as a whole. Polish politicians should actively participate in the work of EU bodies and shape an EU policy towards China that is favourable to Poland through contacts with Berlin, Paris and other EU members.

The recognition of China as a market economy would have a significant negative effect on the condition of many Polish companies. Closer cooperation with China in the creation of the New Silk Road (One Belt, One Road project) and other initiatives and the efforts to open up the Chinese market for Polish products should not obscure the risks.

Łukasz Sarek is an analyst of the Chinese market. He studied law and sinology at the University of Warsaw, as well as the language and culture of China at Zhejiang University and Nanjing Normal University. He has lived and worked in China for many years.

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