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At a time of rising protectionism, China is sending a signal of liberalization by lowering its import tariffs on cars. The unilateral move is only a first step if China wants to prove its commitment to the multilateral trading system. Sacrificing outdated protections can also help China’s transition towards a higher value-added economy.

Car sales

Right before German chancellor Angela Merkel’s trip to Beijing, China has doubled down on its pledge to save the global trading system from a wave of protectionism. In the wake of Xi Jinping’s promise given in Davos in 2017, China has taken a few steps such as dropping the requirement that forced foreign investors to enter into joint ventures with Chinese partners. But by and large, the international business community remained unconvinced of China’s true commitment to further liberalize access to its markets.

This may be about to change. By reducing import tariffs for cars from 25 to 15 percent by July 1, the Xi leadership has started to tackle one of the biggest obstacles to China’s credibility as a global leader on trade: the country’s highly selective and distorted tariff structure. The move delighted the shareholders of German carmakers such as Audi, BMW, Daimler, and Porsche that export their premium models to China. The overall effect on these companies’ profits may be limited however, since the lower import tariffs will also lead to lower prices for the middle-class models they produce in China.

As for China, allowing cheaper car imports may seem courageous, but it is in China’s own interest. The change in tariffs will be felt in the Chinese economy, but in the long run, it will facilitate the transition to a higher value-added economic model.

 China’s current production model is rooted in the time when the country’s focus was on being the world’s extended workbench. The combination of low labor costs and high tariffs on finished products such as cars induced international companies to move their assembly lines to China. But due to China’s lower technological level many critical components were imported (at lower tariff rates), meaning that most of the value-added remained abroad. The cost of importing intermediate products was offset by the savings in labor costs during the assembly stage in China. For Chinese companies as well as for international companies willing to produce in China, the high import tariffs on finished or downstream goods also meant that their assembly stages were then strongly protected from international competition in the Chinese market.

China’s tariffs are high and inflexible

Even compared to other emerging economies, China’s tariff structure has been rigid. First, China maintains a tariff level for non-agricultural products (9 %), which is considerably higher than that of its two main trading partners, the United States and the European Union (both below 4%). Especially in the upper ranges (between 15 and 25 %), the Chinese level is far higher than that in the world’s other two large trading blocks. Second, China has been less willing than countries like India or Brazil to unilaterally lower tariffs from the maximum level allowed under WTO rules (“bound tariffs”). Since its WTO entry in 2001, this rigidity explains why China’s “applied” tariffs on non-agricultural products have been almost identical with the “bound” tariff rates.

This behavior no longer serves China’s own economic interests. It has cemented a production structure in cross-border supply chains in which China’s role is often reduced to that of a finishing-touch assembler of inputs. The current tariff structure discriminates against the production of upstream products such as battery production or data technologies for e-mobility that are defined as central sectors in the “Made in China 2025” industrial policy strategy and that the Chinese government supports with generous subsidies.

Lower tariffs would help China’s transition

If China continues to lower the high import tariffs on finished products, this would increase competition with producers abroad. Especially in combination with rising wages, China would likely end up losing many low-skilled manufacturing jobs in assembly to less developed countries. This is true for the car industry, but also for a number of other industries that have been overproportionately protected, from textile and clothing to several food industries.

Yet all of these industries can no longer be a backbone of China’s industrial structure as China charges ahead with its industrial upgrading plans laid down in the Made in China 2025 strategy. China will have to sacrifice a number of processing stages and even entire low-tech industries, which had been symbols of China’s transformation in the reform era.

This overdue transition would be a necessary step in China’s development towards an advanced economy. The competition created through lower import tariffs would incentivize domestic investment in the production of those intermediate products that so far had less chance to compete with products from abroad than the downstream stages of production. Changing the tariff structure might therefore one day result in China becoming a competitive producer of intermediates instead of only a finishing touch producer.

A series of deep unilateral cuts of tariffs below the bound level would bring a double dividend to China. It would help the country’s economic transformation while enhancing the global standing of its leadership – as a leader in global trade, if not as the savior of the WTO.