The European Union-China’s Trade Relationship

This chapter provides a background to the study, discusses the research problem, explains the general purpose of the study, highlights the research objectives and questions, describes the research approach, and gives an overview of what each chapter will contain.

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General Introduction and Background

Success in global economic development hinges on several mutually dependent factors, with international trade playing an important role (Bhagwati 1994, p. 280). Governments in both developed and developing nations are striving for economic supremacy and so the need to identify different resource avenues to sustain economic growth is imperative. International trade has played an essential role in not only shaping national rapport but also in strengthening economic growth within nations. Resource distribution and their diversity differ between regions and nations, which underscores why there is a need for nations to engage in international trade to share these resources. Since the Second World War, international trade has gradually expanded, and nations have been engaging in different forms of it through unilateral, bilateral, and multilateral trade agreements such as Free Trade Agreements (FTAs), Preferential Trade Areas (PTAs), and Regional Economic Blocs, which have all proliferated in the second half of the 20th century (Ornelas 2005, p. 1482).

Industrialization and globalization have enhanced international trade by opening up channels for different countries and regional economic blocks to cooperate in a bid to strengthen their economies (Dent 2003, p. 11). This aspect is demonstrated by the relationship that exists between the European Union (EU) and The People’s Republic of China (China). Upon joining the World Trade Organisation (WTO) in 2001, China opened itself up for international trade, and in the last decade, has grown to become the world’s largest exporter, the EU’s largest trading partner in goods, and the fourth largest trading partner in services (Geest 2008, p. 13). This implies that China’s accession within the WTO gave it freedom of global trade and economic liberalization, which has facilitated its current numerous bilateral and multilateral trade ties (Breslin 2009, p. 820).

China initially prioritized trade and international business with the United States, Japan, and other Asian countries, rather than with European countries (Garcia 2010, p. 500). Close trade ties between the then European Commission (EC) and China grew during the 1970s and 1980s (Leal-Arcus 2010, p. 229); as China’s growing economy became attractive to many European traders. This led to both partners, that is, the EC and China establishing diplomatic relations that involved mutual trade and related trade agreements, which continue to exist to date. By 1985, the EC-China Trade and Cooperation Agreement emerged and it has remained a significant agreement between the two trade partners. According to Mungenast (2007, p. 10), since the signing of their first trade agreement, the EU-China trade partnership has grown exponentially, albeit with incessant challenges that are typical in such arrangements. Nonetheless, China and the EU have endeavored to remain connected economically through their trade partnership, which has been strictly commercial (Baldwin 2006, p. 1453).

The EU-China relationship

China is currently among the global economic giants and its rapid industrialization, urbanization, and globalization efforts have sustained economic growth since 1978 (Gill & Murphy 2008, p. 34). This has led to numerous countries engaging in mutual trade with China (Garcia 2010, p. 503); the European Union has remained one of its closest trade partners. Europe’s interest in China has also motivated other nations to engage in bilateral trade partnerships (Bhagwati 1994, p. 281). This implies that China does not only handle regional and international trade, but its ties encompass several tripartite trade agreements with nations all over the world, with great interdependence existing among them (Chaban & Holland 2008, p. 19). The rapport between US-China, EU-China, and EU-US or even an inclusion of other partners is interconnected and interdependent (Men & Balducci 2010, p. 116). This means that the mutual understanding between any of the parties involved in economic or trade agreements can significantly affect the overall relationship chain and may contribute to misapprehensions among nations.

The relationship between the EU and China has remained a commercial one, with trade and investment being key aspects of their agreements (Garcia 2010, p. 509), which currently amounts to €1 billion daily (Xin 2009, p. 7). The major EU imports from China are a consumer and industrial goods such as clothing, footwear, machinery, and furniture (Garcia 2010, p. 510). In China, the main imports coming from the EU include machinery, aircraft, motor vehicles, and chemicals, where trade in services is ten times lower than the trade-in goods (Leal-Arcus 2010, p. 229). Since China acceded to the WTO, much has transpired within the relationship between China and EU, raising concerns over the future of their relationship, especially considering the level of economic integration both entities have reached (Winkler 2008, p. 469).

Vogt (2012, p. 105) asserts that recent Chinese policies are affecting the EU-China trading partnership, as the EU encounters trade barriers while attempting to utilize the full potential of the Chinese market. Before the EU-China bilateral trade was strengthened, China had already begun imposing restrictions on various products from the EU in its domestic market (Zeng 2010, p. 640). This could be detrimental to the further development of the relationship; yet the relationship is of great importance, not only to the two partners but also to other countries and regional economic blocks that indirectly benefit from on-going worldwide relationships. This means that the EU-China trade ties are of global importance.

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Problem statement

Cordial diplomatic relations between countries are a prerequisite for success in trade partnerships, (Francová & Breveníková 2012, p. 558) such as the EU-China trade partnership. The EU appreciates this importance and it has endeavored to formulate policies that encourage free trade. This premise is plausible, as the EU has increasingly engaged foreign governing bodies in free trade talks and agreements. For example, at the 2006 EU-Latin America Summit held in Vienna, an agreement was reached to negotiate a free trade agreement with Central America, which had been under consideration for a long time (Woolcock 2007, p. 4). This agreement came due to several other initiatives by the EU to establish free trade agreements with other countries and regional economic blocks such as India, South Korea, and the Association of Southeast Asian Nations (ASEAN) (Manea 2008, p.370). Although the motives behind every such agreement may vary considerably, it is clear that the EU is fully aware of the importance of international trade to its economic development and consequently the importance of developing cordial relationships with its trade partners.

For China, there has been significant improvement in its foreign and international trade policies since becoming a member of the WTO in 2001. By doing so, they were obliged to make improvements that aim to meet the threshold by WTO statutes (EU Commission 2011, p. 2). Over a decade after accession to the WTO, China is still procrastinating on implementing key WTO principles that are supposed to eliminate trade discrimination and enhance transparency (European Commission Trade, 2011). According to the European Commission (2011) trade report, “China appears to have developed interventionist industrial policies aimed at the substitution of imports, forced transfer of technology and giving local producers preferential access to raw materials” (p.26)

This has raised concerns over the future of the economic integration between the partners, within the EU and other parts of the world because of the economic importance of this relationship to the global economy. The concerns arise because contemporary studies undertaken to examine the rapport between the EU and China have indicated the presence of difficulties in the EU-China bilateral trade relationship. For instance, Bagwell and Staiger (2001, p.300) show that the trade rapport between China and the EU is currently under pressure, as each partner has raised concerns over each other’s conduct. The trade partners have reached a point where they consider each other as unappreciative and treat each other with suspicion (Young & Peterson 2006, p. 800). There is a general feeling among EU member countries that the EU has contributed to China’s phenomenal economic growth, and even though China benefits more from the trade arrangement, it does not treat the relationship with caution. In contrast, China considers itself important to the EU and it has shifted its trade focus to other nations, including extensive trade agreements with the USA and numerous African countries instead of improving its relationship with the EU (Bond & Park 2004 p. 380).

The positions taken by both partners are concerning as even though each partner has contributed to the development of the other, trade partnerships need to remain amicable due to their mutually beneficial nature. The EU-China economic ties have grown to the extent where the two partners cannot profit effectively without each other and if severed, the global economy would suffer devastating effects. It is thus important to examine this relationship, despite the complexity of the inherent factors, to understand the challenges perpetuating tension. It is anticipated that this will help in gaining insight into the sustainability of the trade relations between the EU and China.

Aim and objectives of the study

The main aim of this research is to explore the bilateral trade relationship between China and the European Union, with a specific focus on the current challenges that are being faced, and proposing possible ways of sustaining the relationship. Before investigating the background of the constrained business relationship, a closer examination of various trade agreements signed between the two trading partners is undertaken. This will help to unveil various breached policies, to understand why the EU-China relationship is marred with tension. To achieve its main aim, the study hinges on the following specific objectives:

  • To investigate the various trade-related agreements consented to by both China and the EU.
  • To explore the prevailing challenges and problems in the bilateral trade agreements between China and the EU

Research Questions

For the aforementioned objectives to be achieved, they must be formulated into questions. The research questions that this study seeks to answer are therefore as listed below.

  • What agreements underpin the trade ties between the EU and China?
  • What challenges do the EU-China trade agreements face?

Research Approach

The subject of the EU-China bilateral trade is extremely diverse and internationalized beyond the scope of this study to apply any level of primary data collection. It thus exclusively depends on reviewing and analysis of secondary data in the form of well-documented information on this subject matter. To achieve a level of analysis that is appropriate for the level of this study, a review of the existing literature is conducted. Past studies are analyzed to establish any trends within this trade relation between the EU and China, to discover any changes that emerged by the state of the relationship. Reviews by other scholars are also examined to determine whether the perception of others captures what is transpiring between the trading partners. This includes a chronological account of the development of the relationship since its inception up to its current state. It is envisaged that this will delineate the new aspects that have been added to the trade relationship and any possible additional aspects that the partners are considering.

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To accomplish this, the researcher will use sources of information from a range of scholarly articles including journals, books, government reports, and organizational reports (such as the EU and WTO reports).

The study will seek information from an assortment of existing scholarly documents from the following databases; the European Union database, the Eurostat database, and the Market Access Database (MADB). These databases are full of EU related literature and they will provide a great deal of relevant literature

Chapter outline for the dissertation

This dissertation comprises five chapters. Chapter 2 examines a selection of existing theories, among them being the Theory of Economic Integration and the Political Economy Theory of Trade Agreements, which are considered relevant for this research. The chapter specifically focuses on the Theory of Economic Integration because the EU-China trade relationship is examined in light of this theory during the later chapters. Besides, the chapter provides a comprehensive theoretical literature review. Chapter 3 presents the findings of the study, whilst the fourth chapter forms analysis and discussion of these findings. The final chapter sums up the dissertation in a conclusion.

Theoretical Literature Review

As articulated in several studies, trade has always played an important role in determining economic growth among countries at different stages of development (Freund, Ornelas & Estevadeordal 2010, p. 22). Changes within socio-political and economic paradigms across the world have led theorists and researchers to investigate numerous trade theories and concepts. Theories about trade relationships existed long before international trade began expanding (Morgan & Katsikeas 1997, p. 73). In this section, the study examines four trade-related theories that are relevant to understanding the issues underlying the EU-China trade relationship. These theories include the Theory of Economic integration, the Political-Economy Theory of Trade Agreements, the theory of Mercantilism, and the Absolute Advantage Theory.

These four theories are considered relevant because the relationship between the EU and China is multifaceted as it involves China as a country on one side and the EU as a regional economic bloc on the other side and the theories are relevant to both kinds of relationships. The EU is an umbrella body through which the European countries seek to strengthen their position in the global landscape and discussions concerning the economic welfare of Europe. In practice, each of the European countries engages with China as an individual country but under the statutes outlined by the EU. This implies that at the European level, the EU is a regional economic bloc that is governed by statutes relevant to such arrangements. Therefore, this sort of arrangement is captured by all four theories. At the EU-China level, the trade relationship that exists is captured by the Theory of Economic integration, and the Political-Economy Theory of Trade Agreements. Despite all these theories are relevant to the topic, more emphasis is placed on the Theory of Economic Integration.

Theories of International Trade

Mercantilism

The main principle underlying the theory of mercantilism is that the world is endowed with a fixed amount of wealth thus for any country to grow its wealth; it has to take the wealth from other countries by exporting more of its domestic products while importing less form those countries (Mcdermott 1999, p. 71). This theory was the inspiration behind the European nations’ bid to colonize other territories around the world in the 19th and 20th centuries (Johnson 1994, p. 150). Through such arrangements, the colonial powers could cheaply produce raw materials for their domestic industries then they would export the final products to the world market including the territories from which the raw materials originated. Mercantilism was popular in the period between the sixteenth and eighteenth centuries. At this time, Great Britain and its European counterparts such as France and Germany among others endeavored to control as wide a territory as possible to provide a cheap source of raw materials as well as a destination for their products and consequently grow their economies (Mcdermott 1999, p. 72). Their focus was to export to and not import anything from these territories.

The arrangement did not only work against the territories from which the raw materials were extracted but also against the populace of the colonial powers. According to (McDermott 1999, p. 56), “it was a system by which the government and certain favoured organisations jointly extract income from the population.” The government worked out ways of ensuring that such organizations existed as monopolies within the economy and organizations, in turn, paid tribute to the government in the form of taxes, non-repayable loans, bribes, or dividends. To ensure that the status quo was maintained, the organizations endeavored to keep the knowledge about their production activities limited to their competitors and the public and completely abandoned leaked production techniques. Therefore, in this economic system, countries completely closed their economies to the external market and even within the country; organizations struggled to ensure that they stayed closed to outsiders at all costs.

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Mercantilism remained a powerful economic ideology until the Industrial Revolution shifted focus to other theories such as the comparative advantage theory and the absolute advantage theory to guide international trade. Some governments continued to pursue it behind the scenes, a move that led to the development of what is today known as Neo-Mercantilism (Men 2008, p. 8). Both in its traditional form and its later form, mercantilism involves a protectionist approach towards trade in which the focus for governments was to develop their own at the expense of their rivals’. The main difference between classical mercantilism and neo-mercantilism hinges on the premise that classical mercantilism focused on military development while neo-mercantilism focuses on economic development (Bramall 2000, p. 88). A close examination of the fiscal and economic policies of countries, which are perceived as neo-mercantilists, reveals that their governments reserve the sole right to make crucial decisions on currency matters and control capital in addition to controlling imports (McDermott 1999, p. 59), which is done without considering the welfare of other countries or the global economy.

Neo-mercantilism is reportedly existing in some Asian states among them Japan, China, Singapore, and Korea (Freund & Ornelas 2010b, p. 143). Only China is of interest here since its mercantilist policies have a direct bearing on its trade ties with the EU. China has been accused by several scholars of pursuing mercantilist policies, which have the potential to jeopardize the current post World War II world economic structure. Among these scholars are Wang and Zou (2011, p.3) who note that China’s mercantilist policies have a negative on the world economy.

The Absolute Advantage Theory

The theory of absolute advantage was postulated by Adam Smith. It holds that an entity has an absolute advantage if it can produce more of a good or service than its competitors with a similar amount of resources (Snorrason 2012, p. 24). Adam Smith introduced this concept to international trade in a bid to refute mercantilism, which had deeply taken root in the eighteenth century. According to Smith (Abrenica 2007, p. 10)., all countries cannot simultaneously develop wealth using mercantilist principles thus only free trade can foster simultaneous development of say, two countries engaged in trade. This theory thus espouses free trade as observed in the tenets of the economic integration theory and the political economy theory of economic integration. It encourages nations to focus on what they can produce best and most cheaply and leave what is expensive to produce to others who can do the same more efficiently.

To help in understanding the theory and its relevance to international trade, Smith used the analogy that even though a tailor may be deft at producing clothes, the same tailor cannot efficiently produce shoes yet s/he needs them (Schumacher 2012, p. 55). This necessitates the division of labor in which the tailor concentrates on the production of clothes and a cobbler takes care of the shoes. While explaining the division of labor and specialization, Smith employs an example of a pin factory in which

While one worker can make a pin a day, ten workers, each of them specialized in two or three operations can make 48,000 pins a day. Due to specialization, the output grew from one pin per worker to 4,800 pins per worker. In that way, the division of labor produces an increase in the quantity of work, which the same number of people [is] capable of performing. Smith emphasizes that the division of labor leads to increased returns (Schumacher 2012, p.56).

The main point was that if every country specialized in what it can produce most efficiently through the application of specialization and division of labor, goods would be produced at the least possible costs. This would bring about cost benefits for local consumers as well as consumers in any country to which the goods are exported without export charges. Due to this, country A for instance should concentrate on production areas where it can more efficiently produce and then seek to establish trade relations with other countries, which require what country A has to offer and have what country A needs. This way, all the parties involved will reap the benefits of international trade and the growth of their wealth.

This line of the argument matches what is espoused in the theory of economic integration. A country that has focused on what it can produce best will most likely eliminate trade barriers for the importation of what it needs from other countries. In this manner, the attainment of Pareto efficiency in international trade seems feasible. This means that just like the other two theories that are, the theory of trade arrangements and the political economy theory of economic integration, it seeks to eliminate impediments to trade and deliver an environment in which trade can be freely carried out to the benefit of all.

The theory of absolute advantage is plain and simplistic but international trade is increasingly abandoning it for the very principles that it was formulated to refute. The trends noted in the EU-China trade ties are an embodiment of the occurrences in many PTAs around the globe yet the participants in the PTAs are fully aware of the benefits of free trade. It is absurd to note that the benefits of the PTAs are often the driving force behind their formation but after their formation, many countries deviate from the initial agreements to take advantage of their partners.

The Theory of Economic Integration

Economic integration is a multifaceted concept due to the dynamics involved in achieving it. After the Second World War, countries increasingly realized the need for the development of trade ties to boost their economic recovery from the adverse effects of the War. For instance, the European Community (EC), which was formed in 1957 by the then West Germany, Luxembourg, the Netherlands, Italy, Belgium, and France sought to unite the participants’ economic efforts to achieve a faster recovery. In the same period, a framework of the WTO started taking shape as the General Agreement on Trade and Tariffs (GATT). The development of theories such as The Economic Integration Theory was aimed at analyzing trade relationships to predict their future.

In its initial state, this theory was underpinned by two fundamental questions relating to trade liberalization and the formation of Preferential Trade Areas (PTAs), which it sought to answer (Hosny 2013, p. 141). The two questions were; what the welfare impact of trade agreements, whether free trade areas or customs unions, was on each member state, the entire bloc, and the rest of the world and whether two or more countries could form a trade bloc that could make the situation of the rest of the world worse off (Hosny 2013, p. 141). The theory of economic integration thus provides a construct within which trade agreements, their type, and nature notwithstanding, can be evaluated to find out if they are beneficial or non-beneficial to the participants and the rest of the world (Bagwell & Staiger 1999, p.238). This assertion holds as the theory’s fundamental principle is to enhance the welfare of both the participating and non-participating countries.

Balassa (1962) defines economic integration from two different perspectives, that is, as a process and a state of affairs (Giovanni 2007, p. 66). As a process, it entails the elimination of trade discrimination between states while as a state of affairs; it defines the extent to which trade barriers have been removed between states. From this definition, both the process of removal and the resultant environment is captured. Consequently, Robson (1987) perceives economic integration as being primarily concerned with achieving efficiency in resource utilization by focusing on spatial aspects (Gao 2011, p. 231). This means that he believes that once there is a free flow of goods and factors of production across borders, economic integration has been achieved.

In his analysis of this theory, Jacob Viner outlines two key concepts of international trade, that is, trade creation and trade diversion (Hosny 2013, p. 142). These two concepts provide a rudimentary understanding of the dynamics underlying the economic integration process. Trade creation occurs when two or more countries form a free trade area in which they eliminate all trade barriers amongst themselves and unify their tariffs on goods and services from non-member countries (Edwards & Lederman 2002). This results in an increase in trade activities amongst the member countries based on every member’s comparative advantage, thereby leading to an increase in revenues for all member states. Critics of the concept argue that in such arrangements, every member state is often compelled to focus on what it can produce more efficiently and this leads to the death of other industries, which cannot favorably compete within the arrangement (Popa 2007, p. 75). Trade diversion on the other hand embodies a situation that arises when members of a free trade agreement are compelled to stop trading with more efficient non-member states to start trading with non-efficient member states. This bears negatively on the economy of such countries. Viner’s conclusion from his analysis of economic integration was that PTAs do not necessarily add to the welfare of member countries due to the possibilities of contracting partners experiencing trade diversion (Honsy 2013, p. 145).

This analysis provided a ground for more scholars such as Mead (1955), Mundell (1964), and McMillan & McCann (1981) among others to advance the analysis of the theory to addresses the second question because Viner’s analysis only addressed the first question (Honsy 2013, p. 145). This means that the theory has undergone lots of improvement to make it capture the entire economic integration process. Viner’s analysis of economic integration was static in the sense that it only considered the static effects of the processes thereby failing to incorporate important aspects of economic integration, which include economies of scale, investment creation, and investment diversion, private sector participation in economic integration, services, and foreign direct investment (FDI) (Honsy 2013, p. 147). These factors are instrumental in facilitating economic integration in the current business environment; for instance, in the formation of the North American Free Trade Agreement (NAFTA), the US Chamber of Commerce and the Canadian manufacturers Association played a pivotal role in ensuring success in the formation of the PTA (Honsy 2013, p. 146). In another example, Trade (2007, p.56) notes that the formation of the Latin American Free Trade Association (LAFTA), led to an increase of 1.09% in the GNP of Latin American countries in 1977 via the dynamic effects of economic integration (Honsy 2013, p. 147).

Harold Mead (1955) shifted the focus of the economic integration theory from simply considering trade creation and trade diversion to including trade costs in welfare analysis. In his model known as General Equilibrium Analysis, trade creation is assessed in terms of the reduction of trading costs while the trade diversion is assessed by focusing on the increase it causes on trading costs. Three major principles are underlying Mead’s approach to the economic integration theory.

The first principle is the Theorem of Second Best, which posits, “If a constraint is introduced into a general equilibrium setting and it prevents the attainment of one of the Pareto conditions, other Pareto conditions, although still attainable are in general, no longer desirable” (Snorrason 2012, p. 19). Pareto conditions are the conditions that are essential for Pareto efficiency or optimality to exist. Pareto optimality refers to the allocation of resources such that there is no other way of reallocating the resources without reducing the welfare of some and increasing the welfare of others (Popa 2007, p. 73). The conditions necessary for Pareto optimality include allocative efficiency, technical efficiency, and production-allocative efficiency (Popa 2007, p.74).

According to the theorem of second best, if any impediment prevents any of these three conditions, the general equilibrium will be upset. When that happens, striving to achieve other conditions does not affect welfare. The impediments are thus considered distortions to an otherwise Pareto efficient free trade environment, which according to Adam Smith and David Ricardo, is the first best policy that all should strive to achieve (Honsy 2013, p. 148). It is not easy to achieve Pareto efficiency thus all trade agreements that exist are considered the second-best options that members settle for as they strive towards eliminating all impediments in their trading environments. The economic integration process is thus a continuum of sub-optimal situations in which countries or trade blocs find themselves. The gradual elimination of trade barriers only moves countries from one sub-optimal situation to another.

The second principle of the general equilibrium analysis is the Transfer of Payment Principle. It states that if it were possible to deploy international lump-sum transfers of payment, it would be possible to identify barriers to Pareto efficiency across the world (Snorrason 2012, p. 19). Transferring lump sum payments across borders is not realistic, which makes this principle only applicable at the national level.

According to Snorrason (2012, p. 20), a government is capable of taxing gainers and transferring the income to losers in an economy but without affecting the behavior of either of the groups. In any economy, there are three major players, that is, producers, consumers, and the government (Snorrason 2012, p. 20). Each of the three plays an important role in moving an economy forward but it is the role of the government that is of interest.

The government plays three key roles in an economy. These include taxing and or subsidizing various economic services, redistribution of income, and production and consumption of products on its own (Honsy 2013, p. 150). In its income redistribution function, the government can collect taxes in a lump sum fashion from those who gain in trade and transfer the income, in a lump sum fashion, to those who lose in a trade. In this manner, the government can identify the barriers to Pareto optimality. Once this is done, achieving this state in which everyone gains from trade is feasible. It requires the government to have elaborate information on each individual’s consumption patterns (Snorrason 2012, p. 20). Though not entirely impossible, it is a daunting task for the government to determine each individual’s consumption details. From this perspective, it is difficult enough to achieve Pareto efficiency at the national level using the transfer of payment principle. This makes it more challenging within the constructs of a trade arrangement that involves two or more countries.

The third element of the general equilibrium analysis is the comparison of welfare in economic integration. Under equilibrium analysis, economic integration is perceived as the transition from one economic situation to another to achieve Pareto efficiency. To evaluate the changes that occur in terms of trade costs and policy due to the transitions, it is necessary to conduct welfare comparisons. An economic model that enables welfare comparisons has gradually developed under the influence of Ohyama (1972), Wong (1991), and Krishna (1998) among others (Snorrason 2012, p. 21). The comparison is done from the perspective of consumers over given periods to determine if any changes occur during the transition from one economic situation to another in the integration process. The primary purpose of trade is to increase welfare; thus, the welfare measurement process employs welfare economics, which makes it possible to determine the desirability of one economic state over another (Snorrason 2012, p. 21). This mechanism is used to evaluate trade-related policies at the national level and can be applied within trade blocs. Three different approaches can facilitate welfare evaluation.

First, is the social welfare approach in which Bergson and Samuelson posit that the welfare function is best defined by considering the utility levels of individuals (Snorrason 2012, p. 22). Second, the social utility approach, which dictates that all aggregate consumption bundles be evaluated concerning a well–behaved social utility function, which according to Samuelson (1956), exists only if a social welfare function exists (Snorrason 2012, p. 22). This approach is advantageous because it considers the economy as a single consumer thereby making it easier to evaluate welfare. Third, the compensation approach, which holds that the transition from one economic situation to another is deemed preferable only if all losers are compensated and at least an individual is also made better off (Snorrason 2012, p. 23). Snorrason (2012, p. 23) notes that if country A and country B are in a state of initial equilibrium, where their policies are not coordinated, but at some point decide to coordinate their policies, the welfare gains attained are often defined by the difference in pre-integration producer prices between country A and country B (Honsy 2013, p. 151). Therefore, the larger the difference in producer prices the larger the welfare gain, and the smaller the difference, the smaller the welfare gain.

Political-Economy Theory of Trade Agreements

The other theory that is of relevance to the EU-China trade ties is the Political-Economy Theory of Trade Agreements. In this theory, Maggi and Rodriguez-Clare (2005, p. 6) present a model that incorporates the political dimension into the factors that drive the formation and development of trade agreements among countries. The theory holds that trade agreements lead to deeper trade liberalization if the governments engaging one another in the agreements have a stronger political motivation that can permit free mobility of capital across all their sectors (Krishna 1998, p. 221). This theory is relevant to the EU-China trade relationship because Dreyer and Erixon (2008, p. 4) note that the trade ties between the EU and China have over the years remained strictly commercial. The theory can aid in understanding how adding a political integration dimension to the agreement could influence its future development. Maggi and Rodriguez-Clare (2005, p. 23) break down their political-economy model into two sections.

In the first section, the two-period model, they outline three mainstays of the model. Firstly, Maggi and Rodriguez-Clare (2005, p. 23) assert that the extent to which capital is mobile in an economy determines how deeply trade liberalization can be achieved, which is to say that if some sectors in the economy experience limited capital mobility, the extent of trade liberalization in such sectors shall, in turn, be limited. In countries where economic integration is advanced, sectors such as the agricultural sector still lag in trade liberalization relative to other sectors such as the financial and manufacturing sectors (Grant & Dayton 2008, p. 770). The lackluster performance of the agricultural sector in trade liberalization is attributable to the that the sector is intensive in resources that are immobile like land. Maggi and Rodriguez-Clare (2005, p. 24) also argue that trade agreements often take two forms, that is, there are agreements, which allow capital readjustment across the sectors of an economy and those that do not allow such dynamics after the agreement has been signed. In the case where capital readjustment is allowed after the agreement is signed, capital escapes from the limited-mobility sectors to high-mobility sectors where losses are uncommon due to favorable domestic prices (Freund 2010, p. 125). Limited capital-mobility sectors, therefore, tend to resist trade liberalization if the trade arrangement is such that there is no room for capital reallocation after the agreement has been signed (Freund 2010, p. 125).

Secondly, the trade becomes more liberalized in the presence of political motivation, as compared to when it is lacking or when minimal (Maggi and Rodriguez-Clare 2005, p. 25). This contrasts with Acemoglu, Simon, and James (2005, p. 550) who argue that economic integration goes simultaneously with political disintegration. This theory differs with standard theories of economic integration such as the comparative advantage theory on the basis that here, “…motive for trade agreements is directly determined by the presence of politics, whereas in standard theory politics affects trade agreements only indirectly through trade volumes” (Maggi & Rodriguez-Clare 2005, p. 3).

Thirdly, it explains why, in trade agreements, which allow flexibility in tariff setting, countries opt for setting tariff ceilings rather than identifying specific tariff rates to be used (Grossman & Elhanan 1995, p. 689). Most trade agreements do not allow any further tariff negotiations after a trade agreement has been signed. This motivates countries to only set a tariff ceiling so that when the trade agreement takes effect, the participating countries can find an optimum tariff that will favor them within the arrangement. The implication is that countries seeking to establish trade agreements will always endeavor to ensure that some room for post-agreement lobbying remains. Horn, Maggi & Staiger (2006, p. 19) note that this reason explains why existing trade agreements are often incomplete contracts.

The second section of the model goes into depth to explain the reason behind the gradual development of trade ties despite those governments, after signing trade agreements, would naturally want them to take effect immediately. The importance of capital owners in an economy is thus highlighted in the model. Maggi and Rodriguez-Clare (2005, p. 25) note that capital owners often find themselves on a conflicting path with the government since at the time of the implementation of trade agreements, their capital is still held up in some sectors where capital mobility might be low therefore, they need some time to transfer their capital to other sectors. The need to consider their concerns and interests forces governments to relent in their efforts to affect trade agreements expeditiously. Mitra (2005, p. 11) notes that Chile is a typical example of the extent to which ideas from influential groups such as capital owners can affect trade policy. In Chile, the government has always tried to factor in the interests of the powerful interest group when considering trade agreements and this has led the country to advance above the level of its neighbors in Latin America in terms of trade liberalization (Mitra 2005, p. 12)

The gradualism in the liberalization of trade is perceived by Chisik (2003, p.397), Bond and Park (2004), and Conconi and Perroni (2005) because of the self-enforcing characteristic of trade agreements (Maggi & Rodriguez-Clare 2005, p. 24). These generally hold the view that if trade agreements could be perfectly enforced and that the participants could be patient enough with the agreements, then trade agreements would be able to take effect at once. This contrasts with the political economy model since, in its approach, gradualism in trade liberalization comes about Due to the abrasive relationship between capital mobility and the battles the capital owners engage the government in to get their interests catered for (Hasan, Quibria, & Kim 2003, p. 13). The political economy model is therefore a departure from the conventional way of looking at international trade and all the arrangements that are undertaken to enhance it.

Case Study

This chapter describes the development and current state of the EU-China trade relationship. It also outlines the policy framework that underpins this relationship both at the contracting partners’ level and within the WTO.

The European Union

What is today referred to as the EU took shape after the Second World War when European nations sought to unify their efforts to hasten their recovery from the ravages of war. The organization started as a move to bring Europe’s coal and steel industries together to develop a European Coal and Steel Community under the auspices of the Treaty of the European Coal and Steel Community (ECSC) (Bordchardt 2010, p. 11). There were only six-founder states; Belgium, Germany, Luxemburg, Italy, France, and the Netherlands, which committed to the treaty in April 1951 in Paris, France (Bordchardt 2010, p. 11). The treaty took effect a year later; it had been established to last fifty years.

Five years after the ECSC came into effect, in 1957, the six partners agreed to sign two additional treaties, which established the European Economic Community (EEC) and the European Atomic Energy (Euratom) both of which took effect in January 1958 (Furusawa & Edwin 1999, p. 346). These new treaties, known as the Rome treaties ran concurrently with the initially established ESCS. Matters of trade liberalization were thus at the discretion of the EEC. About ten years later, in 1968, the EEC became the European Community after the ratification of the merger treaty (Bagwell & Staiger 2010, p.223). This marked the beginning of a stronger move towards deeper economic integration of the contracting members. In 1973 three more countries, that is, the United Kingdom, Denmark, and Ireland joined the EC making it stronger and more prosperous (Bordchardt 2010, p. 13).

The European Commission, which is one of the institutions of the EU and comprises government leaders of the members of the EC, was established in 1974 to incorporate political integration within the EC agenda. In 1977, another institution, the European Court of Auditors was established in Luxemburg paving the way for the European Monetary System, which came into force in 1979. These institutions were aimed at ensuring that the EC grew stronger and was more efficient at achieving its objectives for its member states. In the same year, the citizens of the EC member states were given the mandate to elect representatives to the EC directly (Bordchardt 2010, p. 13).

In the decade from 1980 to 1990, three more countries joined the EC making the total number of contracting partners to be twelve. During this time, another important event occurred, the Single European Act was signed to pave the way for the total integration of the economies of the participating countries and standardization of their policies in the health, environment, and employment sectors. Despite these key events in the development of the EC within this decade, the most important event to the development of the EC was the falling of the Berlin wall in 1989 (Bordchardt 2010, p. 12). This allowed the unification of East and West Germany into a single state thus enlarging the EC further.

The Schengen Agreement was signed in 1990 and thus it enabled people to travel freely across the member countries without the need to show passports at border posts. In 1992, the agreement that led to the formation of the ESCS matured, and the body was integrated into the EC (Bordchardt 2010, p. 12). The Treaty of Maastricht, which created the EU, was signed in the same year, but it only came into effect in 1993 (Irwin & Tervio 2002, p. 15). This treaty also required the member states to adopt a single currency, the euro, by the end of the decade. Three more countries, Austria, Sweden, and Finland also joined the organization. By the close of the 20th century, the EU had become a strong economic and political force that comprising fifteen countries (Meunier & Kalypso 2006, p. 910). In 2002, twelve more countries joined the EU bringing the membership to twenty-seven countries. By that time, twelve of the participating countries abandoned their currencies and adopted the euro.

The EU as currently constituted is a result of the alteration of the initial treaties by the treaties of Maastricht, Amsterdam, and Nice. It operates several institutions including the EU Parliament, The Council of the European Union, the European Commission, a court of justice, and a court of auditors. These institutions play different roles in ensuring the collective agenda of the EU is advanced. The body, therefore, oversees the economic welfare of its member countries, political welfare in the form of advancing democracy, and controls almost all sectors of the member countries.

This makes it an important body when it comes to international trade matters between its member countries and the rest of the world. It acts as the umbrella body, which negotiates with prospective trading partners on behalf of its members and any agreements reached are legally binding to all members (Maur 2005, p. 1571). This means that the members have ceded some elements of their sovereignty to the organization. The political and economic influence it commands grants the EU a bargaining power that the individual states would not achieve as independent states. Although each of the member states gets to carry out trade directly with the EU’s trading partners, the trading activities have to be carried out under the auspices of the EU guidelines and agreements.

In the recent past, the economic outlook of the EU has not been impressive. The European Commission (2013, p. 2) notes that towards the end of the year 2012, there was low economic performance within the EU. The forecast for the GDP of the EU for 2013 estimates that the GDP of the euro area is shall contract by ¼%. This percentage translates into a huge financial figure due to the size of the EU GDP. Additionally, not all EU member countries’ economies perform similarly, as some are more adversely affected by the economic challenges the EU faces than others are.

For instance, a study conducted by Pew Research Centre in May 2013 shows that the French are increasingly discontented with the effect of the EU on their economy with a decline of 19% of support for EU and only 9% of the citizens pleased with the state of the economy (Pew Research Centre 2013, p. 1). In contrast, 75% of Germans are pleased with the current state of their economy and the decline in support for the EU is only 8% (Pew Research Centre 2013, p. 1). This shows that some European countries benefit more from the deals that the EU signs with trading partners across the world than others do. In overall terms though, citizens of all member countries are declining in their support for the EU due to the perception that it is hurting their economies instead of improving them.

China

Before 1979, China was operated on policies, which kept its economy very poor and stagnant (Morrison 2013, p. 1). Its economy was centrally controlled, largely inefficient, and non-influential on the global economy. This led to it being referred to as a sleeping giant. Foreign trade back then was only left for goods that could not be manufactured in China. The government-controlled about ¾ of industrial production through state-owned enterprises (Ramjerdi 2007, p. 259). Private enterprises and foreign investments were barred from operating within the Chinese economy. This left all matters concerning economic development strictly under the control of the government.

A leadership change in which Deng Xiaoping took over the reins of leadership after the death of Mao Zedong in 1976 altered all these and set China on a positive economic growth path, which has led to its exemplary economic performance over the last three decades (Morrison 2013, p. 2). The framework for opening up China’s business environment and massive economic reforms was initiated and by 1979, it was implemented. China started giving incentives to farmers and encouraged them to sell their products on the free market; it also established four economic zones in a bid to lure foreign investors into its economy (Morrison 2013, p. 2). Coupled with this, the Chinese government put in place measures aimed at boosting exports and imports. Gradually, the government started adopting policies, which decentralized functions that were initially under government control to various sectors.

Since the beginning of the economic reforms in China, its growth has been impressive, averaging at 10% for over three decades. This was a departure from the previous era where analysts report that from 1953 to 1979 the growth in China’s GDP was only about 6.7% (Staiger 1995, p. 99). The figure is disputable because unscrupulous government officials were capable of manipulating the production figures due to political reasons (Morrison 2013, p. 3). This means that the figure could have been lower. The growth it has realized in the last three decades means that since China implemented economic reforms, it has been able to double its economy every year or thereabout (Morrison 2013, p. 3).

The impressive performance heightened with China’s accession to the WTO in 2001. This opened its economy up for the world market and with nations getting interested in trading with China due to the growth it was witnessing, its trade circles expanded. For it to join the WTO China was compelled to reform its economic policies further to meet the threshold of the WTO requirements. Some of the requirements have been successfully implemented by the Chinese government but others are yet to be implemented. This has not impeded China’s economic progress because in the last decade after China joined the WTO, it has grown to become, “the world’s largest manufacturer, merchandise exporter, and holder of foreign exchange reserves” (Morrison 2013, p. 1). It is the EU’s second-largest trading partner and the largest source of imports. Similarly, China is America’s second-largest trading partner and the largest source of imports (Morrison 2013, p. 1). In the last decade, China’s foreign exchange reserves amounted to $ 3.2 trillion, a figure that was way above any other economy in the world.

Despite these impressive credentials held by China in the global trade scene, some issues have been raised over the extent of its willingness to open up completely to the outside world. Vogt (2012, p. 105) notes that recent Chinese policies are affecting the EU-China trading partnership, as EU traders have encountered impediments in their endeavors to exploit the full potential of the Chinese market. About twelve years after China’s accession to the WTO, it is still procrastinating on implementing key WTO principles, which would eliminate trade discrimination and enhance transparency in the Chinese business environment, especially on matters such as tendering and resource allocation to manufacturers (European Commission Trade, 2011). According to the European Commission 2011 trade report (p. 26), “China appears to have developed interventionist industrial policies aimed at the substitution of imports, forced transfer of technology and giving local producers preferential access to raw materials.”

The EU-China Trade Relationship

In the recent past, the EU-China trade relations have been characterized by increasing discontent from both sides but mostly from the EU. Since the beginning of the trade partnership between the EU and China, member states of the EU have had differing ideas and opinions on how the EU should develop the relationship with China (Mitra 2002, p. 475). This assertion holds as the different EU member states have differing interests in China and sometimes the country-specific interests conflict with the overall position taken by the EU. This aspect is not good for the global economy especially considering the premise that this relationship has become the most valuable in the world (Huang 2010, p. 41). The EU is China’s largest trading partner and largest export destination while China holds the position of EU’s second-largest trading, the largest importer, and third-largest export destination (Huang 2010, p. 41). The EU and China Currently trade over € 1 billion every day (European Commission 2013). By the end of the year 2012, the EU’s imports from China stood at 289,915 million euro and exports stood at 147,874 million euro (European Commission 2013). This brings the total trade in the year 2012 between the two to 437,789 million euro.

These figures make the relationship very important for the stability of the global economy. Despite this importance, the trade relationship continues to experience increasing friction due to claims of departure from the guiding principles that underpin the relationship.

The agreements and Policies Underlying the EU-China Trade Relationship

The trade relationship between the EU and China began to develop in May 1975 when the sides officially established diplomatic ties. The diplomatic ties were antecedent to the trade agreements that were established later on and they continue to exist to date. The first among the numerous legally binding trade agreements between the EU and China was the 1978 EEC-China Trade Agreement that was signed on April 3rd, 1978 (Baldwin 2006, p. 1455). This agreement formed the basic skeletal framework that led to the formulation of a more comprehensive trade cooperation framework by a joint committee that was established when the agreement was signed. The comprehensive trade cooperation framework was unleashed between May 21st to 23rd 1985 as the Agreement on Trade and Economic Cooperation (ATEC) (Garcia 2010, p. 499). This trade agreement remains the primary guideline for the trade activities between the two partners to date. There have been additional legally binding additions aimed at augmenting this agreement, nonetheless, it remains the main framework within which trade between the EU and China is conducted.

Agreement on Trade and Economic Cooperation (ATEC)

This agreement was signed between the European Economic Community (EEC) and the People’s Republic of China (China) between the 21st and 23rd of May 1985 to guide the commercial and economic relations that were budding between the two partners (Garcia 2010, p. 501). This move was informed by the satisfactory application of the trade agreement signed in April 1978 between the two partners. Both sides had expressed interest in advancing the trade relations to a higher level. ATEC, therefore, incorporated the following as its mainstays.

The agreement was signed as a bilateral trade arrangement between the EEC as a single entity and China. This implies that even though the actual trading activities that take place between China and the member states of the current EU, the states carry out all their trading activities within the guidelines provided by the EU. This agreement, since it was more comprehensive, it replaced the 1978 agreement in totality. The main issues in the agreement were for both sides to continually strive to foster trade and economic cooperation between them, to maintain “the most favoured nation” status in their trade relations as stated in the 1978 agreement and an encourage industrial and technical cooperation between them.

The agreement provided a detailed outline for the trade relations between the contracting partners from then on, maintaining the initial agreement and giving room for expansion in areas that had initially not been captured by the 1978 trade agreement. The agreement embodied two countries that had realized the potential mutual benefits that could accrue to either side if serious trade relations were pursued between them. The EU has since become “China’s greatest trade partner in the world while China is the EU’s second largest trade partner” (EU Commission 2011, p. 3).

This growth has been realized amid several additional agreements woven into the main framework provided by ATEC. Key among the additional agreements include the human rights dialogue launched in 1995, EU-China dialogue on Small Arms and Light Weight weapons, an agreement on Science and Technology cooperation signed in 1998, a comprehensive strategic partnership launched in 2003, and a partnership on energy and climate change, which was signed in 2005 (European Union 2005, p. 2).

Under the human rights agreement, the partners agreed to hold biannual sessions in which ideas on pertinent human rights issues are shared. Past sessions have been able to cover topics such as media freedom, the death penalty, ratification of the International Convention on Civil and Political Rights (ICCPR), minority rights, and the rule of law among others (European Union 2005, p. 2). This shows a clear commitment by the EU and China to transcend the boundaries set by trade relationships to establish comprehensive cooperation that incorporates social matters as well.

The EU-China dialogue on Small Arms and Light Weight weapons was launched in a bid to foster international security cooperation between the partners. It allows the experts from the two sides “to hold consultations on non-proliferation and conventional arms exports and due to this initiative, the partners launched a joint effort to fight piracy in the Gulf of Aden” (European Union 2005, p. 3).

The science and technology cooperation agreement signed in 1998 spells out the guidelines for joint research between the partners. Since its launch, China currently stands as the EU’s third-largest research partner behind the US and Russia. Over 150 Chinese researchers have participated in joint research ventures with EU researchers including the 7th Framework Programme and the flagship Galileo project (European Union 2005, p. 3).

The most important additional initiative aimed at improving the EU-China trade relations is the 2003 comprehensive strategic partnership. It was further reinforced by a 2006 communication entitled “EU-China: Closer Partners, Growing Responsibilities” and a policy paper on trade, which aimed at charting the way forward for a comprehensive partnership between the partners. The idea of establishing a comprehensive partnership prompted “China to release a white paper on its relations with the EU, the first and only one of its kind released by China on a foreign partner” (European Union 2005, p. 3). Generally, these two partners have in the past stayed true to their initial agreement on commercial and economic cooperation because they have both strived to develop and expand their relations.

Other Frameworks Governing the EU-China Trade Relations

Free trade agreements, regardless of their level of operation, are expected to operate within the constructs of the globally accepted statutes outlined by the global trade organization, WTO (Maggi 1999, p. 200). All unilateral, bilateral and multilateral trade arrangements established in the past or are in the offing have to seek approval from the WTO before they are officially established (Kishore, Krishna & Robbins 2006, p.566). This implies that there are threshold criteria, which they must meet before approval and after the approval, they still have to operate in observation of key provisions of the WTO, which govern PTAs. These provisions include the General Agreement on Tariffs and Trade (GATT) Article XXIV, The General Agreement on Trade in Services (GATS) Article V, and The Enabling Clause.

GATT Article XXIV

This article was incorporated in the General Agreement on Trade and Tariffs (GATT) in 1947 when the organization was formed to regulate international trade (Matsushita 2010, p. 4). Even though GATT was relinquished to form the WTO in January 1995, the provisions, which had been in place such as GATT Article XXIV remained in force to date. This implies that this Article is the main framework that governs trade in goods. It is thus perceived as the guideline for countries engaged in FTAs all over the world. Its key provisions as Matsushita (2010, p. 4-5) outlines include the following.

Article XXIV paragraph four (4) states that the principal reason behind the formation of FTAs should be to ease trading activities between countries or regions and not to erect trade frontiers between such countries, regions, or third parties that have trade dealings with the contracting partners.

Article XXIV paragraph five (5) sets out the provisions that have to be observed when forming FTAs at varying levels where. 5(a) sets out the requirements for the formation of a customs union, 5(b) sets out the same conditions for the formation of a free trade area and 5(c) points out the necessity of such agreements falling within the specified time duration for their formation as outlined in other sections of the GATT.

GATT Article XXIV also sets out the safe limits within which trade remedies can be applied between contracting parties in FTAs. The trade remedies covered include anti-dumping measures, countervailing duties, and safeguards (Charnovitz 1995, p.46). It gives the conditions under which a partner may choose to apply any of the listed remedies against its partner without going overboard in terms of breaching the key guidelines of FTAs. Also, the Article gives the procedure to be followed in resolving disputes, which may arise in the course of trade between contracting partners. Dispute resolution is first left for the FTA to handle through its framework since all such organizations must have a dispute resolution procedure in place. They are therefore referred to the WTO only when the FTA cannot handle it successfully.

The GATS Article V and the Enabling Clause are not directly relevant to this study and will therefore not be considered in detail. The GATS Article V deals with trade in services between territories that are engaged in a trade partnership. The Enabling clause, on the other hand, governs the relationship between developing countries when they form their own FTAs. This study thus chose to elaborate only the GATT Article XXIV because the trade relationship between the EU and China is largely merchandise oriented.

EU-China Disputes at the WTO

Following diplomatic relations established in May 1975, between China and the EEC and a trade agreement reached three years later, trade has existed between the two partners. It has emerged that entering into agreements does not guarantee that the two parties involved in the agreements will work harmoniously and mutually. Commitment between the two trading partners to the agreements and policies governing their bilateral trade relationship has been a critical issue because the WTO has had to arbitrate between the partners on several occasions.

In 2006, the EU lodged a complaint against China for imposing measures that were perceived by EU member states as adversarial to the exportation of automobile parts to China (Huang 2010, p.44). China had devised some charges on imported automobile parts, which when compared with the locally manufactured parts would render the imported parts more expensive than necessary (Huang 2010, p.44). The dispute was taken through the dispute resolution process at the WTO and China was found to have violated the guidelines that underpinned their trade relations. China thus ceased to levy the charges, which were considered unfair.

In 2008, the EU logged another complaint again China. The complaint was related to trade in services where according to the EU; China had bestowed upon Xinhua News Agency the responsibility of being the regulatory authority for foreign news agencies and foreign financial news providers (Huang 2010, p. 46). The reason for this complaint was that Xinhua News Agency is China’s state news agency and it gave its subsidiary, China Economic Information Service (CEIS), the mandate to grant and renew foreign financial information suppliers’ licenses. The EU claimed that this made it very difficult for foreign players to get fair treatment since the CEIS made the issuance of licenses conditional to foreign financial information suppliers. China was once again found to have violated the WTO guidelines.

In a separate case, the EU raised alarm over China’s imposition of export restrictions on bauxite, coke, fluorspar, silicon carbide, and zinc as well as export duties on most of these raw materials, which the EU considered improper and in violation of China’s Accession Protocol (Huang 2010, p. 48). This dispute is similar to the freeze on exports of rare earth metals that China recently imposed on the EU, US, and Japan for 10 days causing huge losses for hi-tech industries, which are heavily dependent on these raw materials (Lackner & McEwen-Fial 2011, p. 4). The freeze was targeted at the three economic entities due to varying reasons, but the lesson learned in all three cases was that China could use its economic might to seek political gain. This observation is a clear indicator that the country can opt to violate WTO and FTA guidelines to make its case heard not considering the consequences of such actions. For instance, the freeze on rare earth metals was imposed even though about 95% of the world’s supply of these raw materials comes from China (Lackner & McEwen-Fial 2011, p. 4).

The EU also requested a consultation with China at WTO in 2009 over China’s imposition of provisional anti-dumping duties on iron and steel fasteners imported from the EU. The EU perceived this move as discriminatory and sought the intervention of the WTO in resolving the dispute. This dispute was unique in the sense that all the other disputes that had been filed with the WTO were done in conjunction with other complainants who also had trade disputes with China but in this one, the EU stood alone against China. That is an indicator of how seriously the EU took the issue.

China, for its part, has also had its turn at the WTO raising complaints against the EU over trade-related issues. It has only raised two cases against the EU so far. The first case was raised in 2009 on anti-dumping measures taken by the EU on iron and steel fastener imports from China. China’s position was that the EU had breached the established Anti-dumping regulations; thus, the measures amounted to discrimination of Chinese iron and steel fasteners.

On a different case, China filed a case with the WTO against the EU over anti-dumping measures on certain footwear from China. Again, like in the iron and steel fasteners case, China’s main grievance was that its products were being given unfair treatment by the EU. Based on the two examples of cases that China filed with the WTO against the EU, it faces anti-dumping restrictions as the main trading challenge whereas the EU faces a myriad of varying challenges.

The complaints so far discussed are those that were adequately substantial to stand the WTO dispute resolution process. They are not the only examples of trade disputes between the EU and China as other numerous cases of discontent have arisen. For instance, China pursues an indigenous innovation policy in which the public procurement process is designed to favor local Chinese firms (EU Commission 2011, p. 4). Also, there is the intellectual property rights infringement for foreign companies seeking to establish in China because such companies are forced to disclose vital information concerning innovation during registration with IPR China (EU Commission 2011, p. 4). The Chinese government is also increasingly imposing specific Chinese standards, which make it difficult for foreign firms to compete with local firms favorably.

The trade relations between China and the EU are therefore increasingly facing difficulties. Although both sides raise issues repeatedly, a close analysis of the relationship shows that instead of benefiting from the trade agreement, Europe is hurting from the trade. China strives to raise its exports to the highest practical levels while lowering the imports to end up with a huge balance of trade in its current account. In as much as this approach may be good for China’s economic development, it is not good for its trade partners and the global economy. Atkinson (2012, p. 5) notes that the last decade alone saw China accumulate US$ 3.2 trillion in terms of foreign exchange reserves giving it the world’s largest current account balance. While this was happening, its trading partners are facing acute trade deficits. For example, according to Atkinson (2012, p.5), in 2012, trade between China and the EU yielded a trade deficit of €145.8 billion for the EU. He adds (2012, p.5) that in the same year, China had a trade surplus of US$ 276.5 billion with the US. China strives to ensure that its exports as much as possible while at the same time trying to minimize imports to the least possible levels.

The EU has been accused of exhibiting mercantilist characteristics in its trade policies as well. In 2009, barely a month after the G20 Summit, Europe was accused of retracting from the salient resolve of the summit when it announced that it would charge up to 60% import tariffs on Chinese candles (Blakeney 2012, p. 101). The need to avoid erecting trade barriers took center stage in the G20 Summit due to the global economic meltdown that was being experienced at the time. Trade was thus seen as a means of fast tracking of global economic recovery. Major players in international trade, that is, the G20 Summit members were expected to foster a more enabling trade environment.

Although the decision by the EU to charge tariffs on Chinese candles was not the only one of its kind around the world, it elicited many reactions due to the timing. The world bank touted it as an anti-free trade decision, which had the potential of escalating tit-for-tat protectionism such as was witnessed during the great depression of the 1930s (EU Committee 2008, p. 7).

The EU also imposed anti-damping taxes on other imports including Chinese wire, iron and steel pipes, and aluminum foil from Armenia, Brazil, and China (Ferreira & Rossi 2003, p.1397). These measures were taken to protect local industries against highly subsidized imports, which local industries could not favorably compete with. Other countries such as the US, India, and Russia have similar measures on similar commodities; thus, they are perceived as espousers of mercantilist policies. The theory of mercantilism is still in use by many economies in the world, due to the notion that economic power goes together with political power. Countries, therefore, strive to attain economic prosperity via trade hurting avenues to position themselves in politically influential standings on the global scene.

Analysis

Application of the Trade Theories to the EU-China Relationship

The theory of economic integration extensively considers the issues encountered by countries during the economic integration process. The most important point that it puts forward is the need for all participating countries engaging in trade agreements to strive towards eliminating all economic frontiers to enable a Pareto optimum trading environment because without this, they may fail to realize the desired results.

It emerges that at the beginning of the EU-China trade relations and a good portion of their development process, the relations followed the model outlined by the theory of economic integration. The key idea espoused in the theory is that the economic integration process involves the elimination of trade barriers between integrating partners. This was the main idea behind the formation of the trade relations between the EU and China. This premise is plausible due to its establishment, the agreement between the EU and China gave each partner the “most favoured country” status in matters of trade (Shi 2008, p. 9). In addition to this, several other agreements signed between the EU and China focused on eliminating more of the tariff and non-tariff trade barriers that remained between the partners.

Apart from its elimination of trade barriers, the agreement also took on the path outlined in the theory of economic integration where due to the inability of the partners to achieve Pareto efficiency between them, they settled for a series of second-best options as elaborated in the theorem of second best. However, the theorem of second-best asserts that without all the conditions of Pareto efficiency, contracting partners may not necessarily realize welfare in their trade relations, the case was different with the EU-China trade relations because Pareto efficiency is yet to be realized between the partners but there have been acknowledged economic benefits on both sides. EU Commission (2011, p. 5) notes that the two economies have already integrated to the extent where it is not possible to imagine one without the other.

This development causes the relationship to deviate from the constructs of the theory of economic integration and its key principles. The transfer of payment principle is also not practically applicable in the relationship between the EU and China due to the complex nature of this relationship. Additionally, it is difficult enough to apply the transfer of payment principle at the national level; this means that attempting to apply it to the EU-China trade partnership is not a practically viable undertaking. This makes it difficult to identify the barriers to Pareto efficiency in the trade relations between the partners using the theoretical guidelines provided by the theory of economic integration. At this point again, the theory of economic integration does not add to the advancement of the trade relationship between the EU and China. From this analysis, it emerges that the EU-China relationship does not perfectly follow patterns of the theory of economic integration and its predictions even though most of its principles apply to the relationship.

Careful consideration of China’s approach to trade agreements reveals that it prefers strictly commercial trade arrangements. In the strictly commercial trade agreements, China opts to deal in goods only (Gao 2011, p. 44). Considering this approach in the light of the main principle underlying the political-economy theory, if this theory holds, then China’s trade relations with its partners cannot realize their full potential. The EU Commission (2011, p. 4) notes that China limits the realization of the full potential of trade activities between the two partners. It has chosen to erect some frontiers in its trade environment especially in the services sector and access to raw materials. Foreign manufacturers complained of a discriminatory approach in the allocation of resources with local producers being given priority over foreign producers (EU Commission 2011, p. 3).

In the EU-China trade relationship, many activities that have been witnessed can be explained through this model. For instance, according to Gao (2011, p. 51), all the trade agreements that exist in the world today are broadly classifiable into two groups, that is, those that incorporate economic as well as political integration such as the EU and those that focus only on economic integration such as NAFTA in North America. He adds (2011, p.51) that in the NAFTA type of integration, there is a further subdivision, which gives rise to Economic Partnership Agreement (EPA), which espouses trade in goods, services, a joint approach to addressing environmental concerns and matters relating to intellectual property rights (IPRs) and another approach, which focuses on trade in goods only. Careful consideration of China’s approach to PTAs reveals that the country prefers the latter approach.

This premise is underpinned by several examples among them the PTA between China and Pakistan in which trade in goods started in 2005 but trade in services only came to be incorporated in 2009 (Gao 2011, p. 52). A similar case is seen in the FTA between China and ASEAN in which trade in goods commenced in 2004 while trade in services followed only in 2007 (Gao 2011, p. 53). The most explicit example of China’s approach towards FTAs was witnessed in its talks with Australia, which have protracted given that Australia’s position was that liberalization of services is antecedent to the liberalization of goods (Gao 2011, p. 53). This turned out to be the opposite of China’s approach to FTAs thus, it took China along to find a solution to the stalemate. The EU Commission (2011, p. 4) concurs with Gao (2011, p. 53) on the idea that China allows liberalization of trade in goods to take pre-eminence in its FTAs. It notes that trade between the two partners has done well in the recent past.

Overall, exports from the EU to China have more than doubled (121%) between 2005 (first 11 months) and 2010 (11 first months). However, this level of EU exports remains below potential, and better market access would allow EU exporters and investors to contribute to, and take a full part in, China’s phenomenal economic growth (EU Commission 2011, p. 3).

This conclusion was reached after a comparison between the trade in goods and trade in services between the EU and China. The trade-in services are according to the report, ten times less than the trade in goods, and its growth potential is constrained by China’s domestic trade policies.

The political economy model developed asserts that politics play an important role in international trade, efforts made by China to alienate political integration from its FTAs is not in the best interest of its economic development. A higher level of political motivation in FTA talks has the potential of eliminating the most delicate trade frontiers because, in the presence of political goodwill, partners can approach each other with a substantive level of trust (Miyagawa 2006, p. 330). The case has been different with FTAs that involve China. Its choice of trade partners and its negotiation objectives, as noted by Gao (2011, p. 54), often place it in a position where it can afford to ignore its partners while its partners cannot ignore it. For example, considering China’s trade ties with Pakistan, Costa Rica, and Macau, none of these countries form part of China’s major trade partners yet for these countries, China is a very important trade partner (Gao 2011, p. 54).

This gives China an upper hand in bargaining with such partners on further trade development. In its relationship with the EU, a similar scenario is gradually taking shape. Bagwell and Staiger (2005, p. 475) note that the EU member countries have raised complaints that China seems to be taking its trade relationship with the EU for granted yet it (China) benefits more from that trade relationship. Although the diplomatic relations between China and the EU member countries are cordial, there appears to be no political goodwill to advance the relationship largely because China has chosen to keep its political and social welfare issues out of its trade ties with the EU. The failure of the relationship to show any indications of developing into a free trade area makes it possible to conclude that the EU-China trade relationship truly follows the political economy model.

The EU has been reported to raise import duty on certain products from China to protect local industries of member countries. A recent example is the EU’s raise of the tariffs on candles from China by up to 60% to protect the candle industry in Germany and Poland (EU Commission 2011, p. 5). Whether this was a tit-for-tat move by the EU to counter China’s increasingly closed market remains a speculative line of thought. The candles in question were not necessarily cheaply produced in China but were highly subsidized by the Chinese government (Atkinson 2012, p. 31). Again the motive behind subsidizing production and exporting the products to foreign markets as cheaply produced goods is not in the spirit of absolute advantage. China produces goods at artificially cheap prices to make them competitive on the world market when; it does have an absolute advantage in most of the goods it produces. This means that it does not follow the principles of absolute advantage and opts for mercantilist approaches. ‘…China’s policies represent a departure from traditional competition and international trade norms. Autarky, not trade, defines China’s goal,’ (Atkinson 2012, p. 5). China’s current trade approaches refute all conventions of trade and appear to indicate that China aims to achieve autarky.

Deviation from the Guidelines of International Trade in EU-China Relationship

As outlined by the few disputes described in Chapter Three, trade between the EU-China has been marked with cases of deviation from the guiding principles. For both partners to report each to the WTO means that at some point, the accused partner had breached the guiding principles of the global organization.

The dispute over automobile spares that were reported by the EU to the WTO in 2006 was duly resolved and China was found to have violated the WTO statutes. China conceded and ceased to levy the charges that were causing the conflict. Another example of the violation of the statutes guiding the trade relationship between the EU and China occurred after the EU reported to the WTO that China had bestowed upon its state news agency, Xinhua News Agency, the responsibility of being the regulatory authority for foreign news agencies. The contention was that foreign players would not get fair treatment in the issuance and renewal of financial information supplier licenses. It was again established that China had gone against the WTO statutes, which espouse free trade, and thus it rectified the issue. There are examples such as those in which China accused the EU of unfairly imposing anti-dumping restrictions. The WTO did not successfully resolve these disputes thus the two countries formed a committee that eventually negotiated them out of the disputes. Notwithstanding the mechanism of resolving the disputes, the concept that they occurred shows that both sides have at one time violated the guidelines of the agreements signed by both as well as WTO guidelines.

These instances delineate the cases in which the EU and China have deviated from the guidelines that define the existence of their trade relationship. Apart from breaching WTO statutes, the instances also go against their agreement on treating one another as the most preferred trade partner. There are cases of creation of trade barriers on both sides, which have not been reported to the WTO but are addressed within the partner’s dispute resolution mechanism. An example of this aspect is when the EU decided to charge up to 60% import duty on Chinese candles to protect local industries of its member countries. The move caused a lot of tension between the two partners but was eventually resolved. The latest dispute between the two is the solar panel dispute in which China was accused of dumping cheaply produced solar panels in the EU market (European Commission 2013). The EU complained as an umbrella body but its member states were divided on the issue because some of them benefited from the cheap panels and did not consider the move by China as negative. This means that China’s behavior has the potential to jeopardize the relationship with the EU member states.

The rest of the world does not appreciate all these instances of trade disputes are because they bear negatively on the global economy. When the EU imposed a 60% tax on Chinese candles, the World Bank referred to the move as one that could lead to tit-for-tat trade wars. (Dollar & Kraay 2004, p.45).

Conclusion and Recommendations

Conclusion

The study set out to explore the trade relationship between the EU and China with a focus on the existing challenges to find out if there are possible ways of making it sustainable. The concern over the sustainability of the trade relationship between the EU and China stemmed from disputes have been reported between the partners with the more serious ones finding their way to the WTO for resolution, which is happening at a time when the trade relationship is currently reported as the most valuable in the world. This means that it holds a lot of importance to the global economy. Despite this importance, the contracting partners in a bid to protect their interests, have in the past taken measures, which indicate a departure from the norms of trade and placing self-interest above the welfare of the global economy.

The theory of economic integration, which was adopted to analyze the trade relationship between the EU and China, encourages any economic entities that participate in trade partnerships to carry out their trade without affecting the welfare of other countries across the world. The relationship follows the model to some extent but deviates from the predictions of the model in other areas. For instance, agreeing to treat each other as the most preferred country when the first trade agreement was signed between the two was within the constructs of the model as it encourages members to eliminate all trade barriers to enable free trade between members. The study established that countries that enter trade agreements are often only willing to cede ground for economic integration up to some extent. Governments are often unwilling to let go of the lucrative source of income, that is, import and export duties and other tariff barriers.

The EU-China trade relationship exists under the auspices of several treaties that if closely observed by the partners, can facilitate smooth trade between them. The relationship is marred with challenges, which are caused by policies pursued by each partner albeit at varying levels. China has been accused of artificially lowering the production costs for its local industries via inappropriate subsidies, which prompts its trade partners such as the EU to take anti-dumping measures against such merchandise. Unnecessarily subsidizing production costs is not good for trade because it has the potential of killing industries, which could otherwise produce the same products more cheaply if the subsidies were not issued. The EU has also met criticisms from China and other players in the global economy for its trade restricting behavior, which breaches the free trade agreements it is a party to.

These two partners are the best placed to resolve their disputes and advance their trade relationship and make it sustainable. As it is, they have proved that the signing of agreements does not necessarily mean that they will be observed. In cases where each of the partners was reported to go against the agreements that guide trade between them, no identifiable punitive measure was taken against the offending partner other than asking it to desist from such behavior in the future. It is therefore in the best interest of trading partners to observe the trade agreements they get into to ensure that they exploit the full potential of the relationships. As it is, the EU and China lost track at some point in their trade relationship. The relationship is still sustainable if the partners take time to reconsider their commitment to the trade agreements by carefully evaluating the benefits that have accrued to both sides due to this trade relationship.

Recommendations

Based on the researcher’s assessment of the conflict causing reasons in the EU-China relationship, it emerges that a few adjustments in the conduct of the two can alter the course of the trade relationship. The researcher recommends the following as measures that could set the relationship on a smooth path once again and ensure the sustainability of the relationship.

  • Political goodwill is a vital component of any trade relationship but largely lacks in the relationship between the EU and China. If both partners could cede some more ground in the political dimension of their relationship, it can overcome obstacles that have impeded its further growth because as it is, analysts predict no likelihood of its further development.
  • Reaffirming commitment to the existing statutes of their relationship and those within the WTO and observing them to the letter is also a good way of ensuring the sustainability of the EU-China trade relationship. China has been accused of delaying implementing all the requirements of the WTO. This seems to favor the existence of non-standard policies, which impede free trade with its trading partners. If both partners meet all the requirements of guiding agreements and WTO and operate strictly within their auspices, the sustainability of the relationship would not be a farfetched idea.

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