EU-China: Win-Win Trade Liberalization and Stimulus Scenarios?

This paper presents three clusters of original simulation exercises, dealing respectively with: i. modest and ambitious bilateral and multi-lateral trade liberalization and its impact on the EU-China trade relation; ii. global current account adjustment scenarios, where China sharply reduces it current account surplus, necessitating symmetric adjustments elsewhere, in particular in the deficit regions such as the North American Free Trade Area (NAFTA); and iii. stimulus of the domestic Chinese economy through implementing a huge stimulus package in the context of rapidly falling global demand brought about by the global financial crisis and its severe demand implosion. One scenario super-imposes on the crisis context a sharp reduction of China’s accumulated capital reserves in an attempt to escape the ‘dollar trap’. The EU-China Partnership Cooperation Agreement (PCA) negotiations presently do not include a focus on a free trade agreement between the EU and China. In this sense, the EU-China PCA is distinctly different from e.g. the 2002 EU-Chile agreement, as well as the ongoing negotiations between the EU and ASEAN, India, Korea and the Economic Partnership Agreements between the ACP countries and the EU. One of the key reasons for this is that the EU's trade deficit with China has been growing very fast, in particular since WTO accession in 2001and it has reached historically unprecedented levels in absolute and relative terms. It is widely held that a free trade agreement between the EU and China would further accelerate the growth of the deficit, and that such a growth in the bilateral EU-China trade deficit is undesirable. However, amongst trade economists, it is the over-all impact of trade policy reform on economic welfare in the EU and China that matters, and changes in the bilateral trade balances that result from such policy changes are of importance in relation to trade adjustment costs and benefits. In the case of a free trade agreement between the EU and China, the core of the economic analysis of the impact on economic welfare follows well known lines from Customs Union theory. In the empirical analysis of a free trade agreement between the EU and China, conducted for this paper, trade policy reform includes both tariff and non-tariff trade policy instruments. The application of Customs Union theory is complicated but not superseded by the more complex empirical reality than originally considered by Viner. Section 2 of the paper provides an overview of the GLOBE model: a regional Computable General Equilibrium model in which China and the EU are identified as separate regions (countries). This paper uses an updated version of GLOBE (Evans et al (2008). The section describes the modelling approach, the structural characteristics of China and its place in the global economy and presents the baseline-scenario, against which the three clusters of counter-factual scenarios are compared. Section 3 presents the 17 scenarios which analyze key issues of i) EU-China trade liberalization scenarios, ii) Chinese current account reforms; and iii) the impact of crisis and stimulus. Section 4 present the empirical results at the macro-level, while Annex I provides details at the sector level for imports and exports for the trade liberalization scenarios. The paper argues that for EU-China trade to achieve win-win outcomes in terms of economic welfare, a substantial and asymmetric reduction of non-tariff barriers (NTBs) in the Chinese economy may be necessary. Fresh estimates of the levels of Chinese NTBs are included in the paper and used in the simulations, drawing on research undertaken by Evans et al. (2006) as well as for van der Geest, Evans et al. (2008). The impact of current account adjustments in the Chinese economy on the macroeconomic and trade balances of partner countries and regions is analyzed. Crisis and stimulus – both in OECD and China – are simulated in the context of the global financial crisis and demand contraction. A sharp and sudden reduction of primary factor incomes in OECD economies is analyzed, which reverberates throughout the global economy with a multitude of consequences for the Chinese economy. The conclusions draw out the tentative policy implications for EU-China trade relations in terms of economic welfare and trade adjustment impacts. Liberalization scenarios with a strong focus on the reduction of NTBs in China as well as standard tariff reduction may be the best option towards the much desired win-win scenarios for EU-China trade. However, growth and absorption losses due to the crisis are much larger than any potential gains from trade-liberalization. The current global stimuli do not change that result, indeed it is crucial that the Chinese stimulus package is ‘trade-neutral’ and avoids a bias towards import substitution as well as export subsidization measures. The huge stimulus package implemented within the Chinese economy is part of a win-win scenario, including GDP gains in China and other regions. Preliminary remarks on an emerging research agenda are included.