A Test For China

For the first time, the World Trade Organization has issued a major ruling against China. According to the AP report:

The WTO found that China was breaking trade rules by taxing imports of auto parts at the same rate as foreign-made finished cars, according to a copy of the ruling's conclusions obtained by The Associated Press.

In the sweeping decision, the three-member WTO panel found against China on nearly every point of contention with the U.S., the 27-nation EU and Canada.

The three trade powers argued that the tariff was discouraging automakers from using imported car parts for the vehicles they assemble in China. As a result, car parts companies had an incentive to shift production to China, costing Americans, Canadians and Europeans their jobs, they said.

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China, which will still be able to appeal, claims the tariffs are intended to stop whole cars being imported in large chunks, allowing companies to avoid the higher tariff rates for finished cars. It argues that all measures are fully consistent with WTO rules and do not discriminate against foreign auto parts.

But the U.S. and the EU say that China promised not to treat parts as whole cars when it joined the WTO in 2001.

China's accession to the WTO was a vital component of the US strategy of engagement, in which economic relations with China are pursued as part of a two-pronged strategy. The first goal of economic development is to transform China's domestic economy into a middle-class, capitalist-style market which, it is argued, will in turn create domestic pressure for political reform. The second strategy of engagement is to make China increasingly dependent on the international community so that adherence to the status quo is more valuable than challenging it.

The WTO is an excellent forum for the latter strategy, as it requires countries to alter their domestic laws and economic rules to comply with international free trade requirements. As protection of domestic status is, more or less, the raison d'etre of national governments, agreeing to alter those arrangements for the sake of international free trade is a powerful signal of adherence to the status quo. How China reacts to the first negative ruling will be a meaningful statement of how China understands its own preferences vis-a-vis the status quo and the international system. If it agrees to comply with the ruling, which will certainly harm a sector of China's domestic economy that it desires to protect, it will be a strong sign that engagement is working.