Chinese Aviation and the WTO: A Brief
Author: Stephen Yin
Editor: Brandon Hughes
Date Published: November 20, 2017
Introduction
This article reviews the rising competitiveness of Chinese firms in civil aircraft manufacturing. This article also addresses why Western countries, such as the United States (US), should leverage the World Trade Organization (WTO) mechanism to ensure competitiveness with growing Chinese aviation industry. Western firms risk losing their competitiveness if Beijing continues use state support to prop up its aviation firms. Using the WTO as a method to address these concerns in an international setting ensures fairness in the aviation industry and encourages competitive development over disproportionate support. The conclusion reflects on the importance of China in global aviation and the rules-based system that governs this space.
US Industry Dominance
US companies currently dominate the small and medium-sized aircraft market in China. Gulfstream and Cessna occupy more than 50 percent market share.[i] The general aviation (GA) industry indirectly affects a number of other industries because of the raw materials needed to make products such as avionics, the fuselage, and engines.[ii] For instance, Boeing maintains out sized influence in the aerospace and defense industry because of its $3.5 trillion impact on the US economy, including its suppliers and third-party vendors.[iii] While its operations in the GA industry are relatively small, it has a strong interest in the US maintaining its preeminence in the civil aviation space not just as a source of national pride, but also to ensure access to profitable emerging markets, including China. The subject matter expertise that US firms can provide the Chinese market not only enhances the growth, but allows for transfer of best practices in aviation over time.
Opportunity and Challenges in the China Market
China’s growing number of aviation passengers presents an opportunity for US companies to capture greater market share. A recent Boeing report indicates how passenger demand in China will grow at the fastest rate in the Asia-Pacific region despite the country’s GDP growth cooling off.[iv] The International Trade Administration (ITA) agrees with this conclusion, as it estimates China to be the world’s largest aviation market in the next 20 years and also predicts rapid expansion in the GA industry.[v] However, these trends also foreshadow emerging threats from local Chinese competitors shouldering state-owned support. In order to mitigate these threats to industry growth, the US government should continue to use the WTO’s panel capacity, especially the appellate body, to maintain non-discriminatory trade policy in the rules-based system that governs global commerce.
The same ITA paper points out that China’s ambitions in aircraft manufacturing “may lead to increased competition from domestic Chinese firms as well as policies that favor domestic manufacturers.”[vi] As recently as October 27th, the Federal Aviation Administration (FAA) effectively lifted a regulatory barrier that would allow the selling of Chinese-made airplane parts in the U.S. This policy change directly links to Dispute Settlement No. 501, in which the US Trade Representative alleges China unfairly violated the General Agreement on Trade and Tariffs (GATT) III: 2 and III: 4 by exempting the 17 percent value-added tax (VAT) to give domestic plane makers an unfair advantage over foreign companies like Gulfstream. This matters because regional jets and single-aisle body aircraft, both of which fall under the GA category, will occupy a combined 76% of the total new aircraft demand by 2034.[vii] While the VAT applies only to sub-25 ton aircraft, Beijing may expand this to include aircraft that Boeing produces.[viii] The long-term impact of this policy is likely to be detrimental to US aircraft manufacturers’ ambitions to expand their operations in China.
Critics argue that Chinese-made planes such as the ARJ-21 and C-919 have not been certified for broad use in civil aviation and have technologies at least one generation behind their Western counterparts.[ix] While these models may not be currently competitive, they may threaten US primacy because the focus of the Chinese is to “elevate comprehensive aviation industrial capabilities and research levels” to reap long-term economic benefits.[x] Concurrently, the Chinese government is able to pressure state-owned airlines to purchase domestically made aircraft through mechanisms; such as taking away loans to finance their operations.[xi] This relationship may unfairly target US aircraft suppliers, making a panel request necessary in order to adequately protect against such treatment.
Supporters of the Policy
Supporters of the policy contend that China’s VAT scheme on imported aircraft is not discriminatory. They point out that Chinese GA manufacturers also pay the VAT by purchasing from foreign suppliers and receive a refund only if they export their product overseas.[xii] Other observers point out that US GA companies have known about the VAT since 2006 and coins it as a non-issue.[xiii] While these points may be accurate, many feel the true crux of the issue is on national treatment and transparency, not the VAT itself.[xiv] This article contends, such policy has failed. On these fronts, China has failed by A) not providing foreign companies the same refund opportunities should their products be exported by Chinese firms and B) not promptly publishing the taxes, even if they are non-discriminatory.[xv] Thus, these challenges still necessitate requesting a panel.
Moreover, supporters argue that this dispute does not deserve a panel because of its longtime existence. Indeed, the GA industry has known about the VAT since 2006, as Smith stated earlier. However, the US Trade Representative (USTR) should pursue this case in panel now in order to preemptively address issues in the government and public before both can act.[xvi] Given the inflammatory rhetoric towards Beijing in the 2016 US Presidential election, pursuing solutions through WTO litigation can uniquely diffuse political tensions that could detrimentally impact the long-term Sino-US relationship.[xvii] Thus, requesting a panel now is optimal to quietly mitigate the tough stances of President Trump while protecting politically influential US industries like GA. Even though the US withdrew its initial complaint from Dispute Settlement 501 in 2016, the initial filing showcases the seriousness of the reach that these policies have in both business and government circles.
Recommendation for the US
If current negotiations fail, it would be prudent for the US to request another WTO panel. Precedent in WTO court favors the US, and the panel option also offers a unique opportunity to establish the importance of transparency in the multilateral trading system. A recent Wall Street Journal analysis revealed that China has aggressively leveraged the WTO courts, participating in a quarter of all cases since 2007, reflecting Beijing’s desire to shape world trade rules. Washington can counter this trend and shape the global narrative by leveraging the WTO’s capacity to enforce the rules of global commerce. Despite the Trump administration’s skepticism toward the organization, the US Trade Representatives still litigates cases on a frequent basis. One recent example is the appellate court upholding an initial ruling that Indonesia’s import licensing regime for horticultural and animal products disproportionately hurts US producers. Litigating and winning would benefit not only the GA industry but ensure potentially discriminatory policies do not unfairly target commercial aircraft. Using WTO panels reinforces the notion that government officials will know such actions will have material implications for trade relations.
Conclusion
In conclusion, business and government can collaborate to ensure equitable market access in the long term, and as the global hegemon, the US continued to be in a position to lead free market-oriented countries in maintaining non-discriminatory trade policy even in the face of globalization’s potential retreat. China will likely continue to pursue domestically made and sourced aircraft for its burgeoning economy, making it imperative that the US continue to seek fair and impartial policies. Use of the WTO offers Washington an unbiased mechanism to address these issues further brings Beijing into the rules-based trade system.
About the Author: Stephen Yin is an analyst in the Corporate and Investment Banking division at Citigroup, where he covers industrial companies. He graduated from Georgetown University in 2017 with a degree in International Political Economy and a certificate in Jewish Civilization. A self described, foreign policy nerd, Stephen is always seeking to learn more about how business and government intersect and to engage in dialogue that leads to both constructive conversations and solutions. He can be reached via his Linkedin Profile here.
List of References & Notes
[i] See NYT writer Chris Horton, China’s Aviation Market is Taking Hold. In his article, Horton mentions how attracted Chinese clients are to American companies like Gulfstream and Cessna. In addition, China has mentioned GA in the past 5-year plans, showing the industry’s increasing significance in the eyes of the Beijing government.
[ii] Interestingly, during my phone conversation with Smith, he mentioned how USTR did not consult GAMA or the Aerospace Industries Association before requesting consultations. He said this move was an anomaly because complaints are filed in response to industry complaints.
[iii] See a blog maintained by Randy Tinseth, Vice President of Marketing for Boeing commercial airplanes: http://www.boeingblogs.com/randy/archives/2009/01/post.html
[v] See ITA 2016 Top Markets Report: “Aircraft Parts.” China Country Case Study. The ITA ranked this as no. 7 out of the top markets for US exporters, with related industries such as manufacturing in China occupying higher rankings (no. 3). In each report concerning China, a common theme of market access barriers and intellectual property challenges emerges.
[vi] While the ITA does not cite specific justification regarding this line of reasoning, it does mention China’s history of suppressing competition in order to nurture its infant industries.
[viii] It is interesting (and noticeable) that the GA industry is currently the one most affected by DS 501, not Boeing. According to the company’s own market outlook, increasing demand for its aircraft provides the best market penetration opportunity by a large margin. However, if Chinese-made plans such as the ARJ-21 and C919 take up this share due to regulatory favors, then such ambitions may be stymied.
[ix] Source: Thomas Duesterberg, Can the Chinese Create a Competitive Commercial Aviation Industry? The Aspen Journal of Ideas, Jan/ Feb 2015.
[x] This comes from a 2012 interview with AVIC CEO Luo Zuoming, who also stated, “[The acquisition of foreign firms] is akin to the hiring of a foreign coach for “one-on-one” training to elevate our R&D level and capabilities. Therefore, the basic objective of foreign acquisitions is not the amount of economic benefits or profits that can be generated in the short term.”
[xi] Crane, Keith et. al. “The Effectiveness of China’s Industrial Policies in Commercial Aviation Manufacturing.” RAND Corporation 2014. The paper highlights 3 main reasons how the Beijing government can pressure domestic airlines to purchase domestically made aircraft: 1) Through the approval process, the Civil Aviation
Administration can pressure airlines to purchase Chinese-designed and manufactured airplanes 2) China’s three largest airlines are all state-owned companies, and these CEOs must be approved the Central Organization Department of the Chinese Communist Party 3) Three airlines have relied on financial support from the state to finance their operations and expand their fleets. For example, in 2009, China Southern received a $1.5 billion capital injection that helped cover procurement and other costs.
[xii] See Lachlan Wolfers et al., China: Country VAT/ Business Tax Essentials Guide 2015. KPMG Tax.
[xiii] Smith even went as far as saying that if the US won the case, then the US GA industry would not experience substantial benefits because no competition exists in China for companies like Gulfstream and Cessna. However, he did say that having the VAT being applied across the board or its elimination may boost exports to China.
[xiv] Even if the VAT were the main subject of debate, it still carries substantial weight. A March 2016 tax analysis by Deloitte argues, “VAT in China is far from neutral with sticking VAT, blocked input credits, cascading costs and other unique technical matters that can result in significant VAT-related costs hitting the bottom line.” See Chin et. al., Deloitte Tax Analysis: Issue 232/ 2016 – Mar 2016.
[xv] Moreover, critics charge that a WTO panel may not be cost effective because of the excess of $1 million in lawyer fees and lack of timeliness. While this and the threat of harming diplomatic relations are legitimate concerns, they have resulted in being non-issues in similar past cases. The GA industry has slow velocity in terms of business environment and relies on USTR to ensure that it participates in a fair and balanced environment. Timing is irrelevant because the purpose of pursuing the case is to gain long-term economic advantages that easily exceed the legal fees. Still, others are concerned that the outcome of such a case may result in precedent that may be used against the US, namely Washington giving preferential contracts to American firms. This is empirically false: multiple foreign companies have large government contracts, such as BAE Systems of the UK and Dassault Systèmes of France. Further, USTR has brought 14 cases against China since 2009, yet consistent increases in bilateral trade shows that diplomatic relations are not harmed by pending litigation.
[xvi] See Kennan J. Castel-Fodor. “Providing a Release Valve: The U.S.-China Experience with the WTO Dispute Settlement System.” Case Western Reserve Law Review 24.1 (2013): 201-38.
[xvii] Both Hillary Clinton and Donald Trump have attacked China on multiple occasions, with the dumping of steel and aluminum to depress prices being a prominent topic during the third presidential debate. Trump, in particular, has threatened to impose a 45 percent tariff on all Chinese imports earlier during the campaign season. With both candidates against TPP and the concept of freer trade, not standing up for American industries like GA may negatively impact the Obama administration’s attempts to paint a picture of trade enforcement and holding countries like China responsible for policies that may violate established international law.
