Blog Post

What can the EU learn from the China-Switzerland free trade agreement?

The US-China trade war has placed EU trade relations with China under the microscope. Should the EU challenge China’s trade practices and employ trade defence measures? Or should they be diplomatic and embark on negotiations, perhaps paving the way to a Free Trade Agreement? Close examination of the 2013 agreement between China and Switzerland suggests much will have to change for trade negotiations between China and the EU to succeed.

By: and Date: March 3, 2020 Topic: Global Economics & Governance

China and Switzerland signed a free trade agreement (CSFTA) in 2013 after only two years of negotiations. The agreement came into force on July 1st 2014. The speed with which the CSFTA was signed is a reflection of the political support for the deal in both nations. Switzerland, a neutral nation among the least encumbered by security concerns regarding China, was keen to gain access to the Chinese market and establish its presence before the EU. China saw Switzerland as a gateway into Europe and viewed the trade agreement as an important test case, and one that might soften the EU’s traditional reluctance to negotiate with China.

Six years on and the CSFTA provides interesting insights. Even though the EU is far from considering its own trade agreement with China, the CSFTA serves as an indicator of concessions that the EU could hope to obtain from China and those it would have to concede in return. That said, the CSFTA sets a low bar of ambition for the EU’s negotiators. After all, even post Brexit, the EU is a vastly more important trading partner for China than Switzerland (trade between the EU27 and China was $670 billion in 2018, over ten times that between Switzerland and China).

In this post, we examine how trade between China and Switzerland has evolved in the brief time since the CSFTA came into force. We then review the parties’ concessions on tariffs, services and intellectual property, and attempt to extrapolate what similar concessions would imply for the EU. Even as Switzerland and the EU are economies that differ in size, they have similar negotiating offensive interests, such as professional services, intellectual property protection and advanced machinery, and defensive interests, such as agriculture.

Trade Outcomes

Although it is too early to make a definitive assessment, the CSFTA’s discernible impact on trade between China and Switzerland has so far been modest at best. China and Switzerland trade relatively little with each other. Their mutual trade intensity index as computed by the World Bank WITS shows both have a mutual value of under 100, meaning they do not fare well when compared to their overall importance in world trade. While trade has increased since the agreement came into effect, it has been highly volatile and dominated by a couple of key sectors (namely jewellery and pharmaceuticals). China attracted 7 per cent of Swiss goods exports in 2019, up from 5.8 per cent in 2013. However, Swiss exports to China grew most in the period immediately preceding the agreement (at an annual rate of 49 per cent between 2010 and 2013); export growth slowed down immediately after it came into effect, to 3.1 per cent annually in 2014-19.

Switzerland’s exports to China are dominated by jewellery, which accounted for 60 per cent of the total in 2018 and are highly volatile. Swiss jewellery exports to China grew at an average annual rate of 221 per cent between 2010 and 2013, and slowed dramatically to 2.7 per cent a year between 2014 and 2019. The slowdown occurred despite tariff cuts on gold and jewellery products under the CSFTA, and complete elimination of tariffs on many such items. A crackdown on corruption in China may account for these trends, as gifts of Swiss jewellery and watches are reportedly a common form of bribery in China. The contraction in these exports from Switzerland to China primarily accounts for the slowdown in exports and the volatility seen. In contrast, exports of pharmaceutical products, which accounted for 20 per cent of Swiss exports to China in 2019, saw annual growth of 16.4 per cent since the FTA came into effect (2014-19). For context, EU jewellery exports grew faster in the period following the Sino-Swiss agreement than that preceding it, perhaps supporting the corruption crackdown in Switzerland narrative. However, EU pharmaceutical exports slowed down markedly following the CSFTA, indicating some trade diversion may have taken place.

China’s total goods exports to Switzerland have also slowed down since the agreement came into force, from an average annual growth rate of 7.8 per cent between 2010 and 2013 to 3.8 per cent in 2014-18. However, the slowdown in exports to Switzerland is less pronounced than the overall deceleration in Chinese exports: from an annual average growth rate of 16.8 per cent in 2010-13 to 2.7 per cent in 2014-18.[1]

Tariff Cuts

The effect of tariff cuts under the CSFTA is smaller than meets the eye. If they were applied to the EU’s exports to China, they would result in only partial savings for the European exporters, who in 2018 paid $17.5 billion euro in tariffs to China. According to China’s tariff schedule from the CFSTA, tariffs on most Swiss goods are immediately reduced to zero or eliminated over 5 to 15 years, but remain unchanged on a large group of products. The difference in treatment is applied at a high degree of granularity (6-digit UN Harmonized Commodity Description and Coding Systems (HS)). We can evaluate the effect that such a tariff reduction would have if China’s tariff schedule as agreed under the CSFTA was applied to the EU’s exports to China, exhibited in the table below.

Source: Bruegel based on WITS

Tariffs would be immediately eliminated on about 1/3 of EU exports. However, nearly all these goods already benefit from very low or zero MFN tariffs. At the same time, those goods that will benefit from a phased reduction have quite high tariffs: for around 1/3 of those eliminated in 5 years, the MFN tariff is 10%, even as is it lower for the bulk of the remaining products. Similarly, goods that will see full elimination in 10 years largely have an MFN tariff between 4-15 per cent (90 per cent of the total).

Most relevant for this post is the examination of goods that would see no reduction in tariffs, which represent 14 per cent of EU exports to China. This is where tariffs are highest and some of the EU’s most important export interests lie. The MFN rate applied on these goods varies from 2 to 65 per cent but is 25 per cent for over 80% of exports in this category. Nearly all these goods fall under the category of vehicles (chiefly all vehicles other than railway or tramway, those principally designed for the transport of persons or goods). These goods represent 11.5 per cent of overall EU-China goods exports. This simple comparison underscores the importance of tariff reductions on vehicles for EU-China negotiations to yield meaningful results.  However, many European automobile companies are already well-established producers in China (such as Volkswagen or Daimler), so they may not be as interested in lowering China’s import tariffs in that sector as they would be otherwise.

Swiss tariff reductions under the CSFTA also cover a broad range of goods. Items where Chinese exporters may realise large savings include magnets, water heaters, vacuum cleaners, bicycles and electric motors. The Swiss watch industry gains access to duty-free intermediate parts from China. That said, Switzerland has also ensured continued protection of its agricultural and agri-business sectors, encompassing products such as milk and cheese, sugary products, fruits, cereals, specific animal products and certain types of wine.

Services

China’s concessions in services under the CSFTA have been even more limited than in trade in goods. The service schedule of the Sino-Swiss agreement largely mirrors the service schedule in China’s WTO accession protocol (where -it should be noted – China made major commitments compared to established WTO members). Only minor additional concessions are made in the CSFTA. Since the Swiss have major offensive interests in services, especially in financial services, their failure to extract more concessions from China, is indicative of China’s reluctance to further open its service sector. Services are also a key offensive interest of the EU. While the EU has a large goods trade deficit with China, it has a surplus in services.

A significant concession made by the Chinese is the relaxation of joint venture requirements in certain sectors. The conditions vary, but Swiss operators are allowed to control a larger share of joint ventures than other WTO members in order to provide certain services, and can in some sectors even establish wholly-owned subsidiaries. This represents limited progress on a major concern of foreign companies, and one at the top of the list of EU and US demands on China.

Concessions made by China under the CSFTA in financial services and insurance services – another important Swiss and EU interest – are small.  In insurance, there are no additional concessions to China’s accession protocol, although there is greater specificity on the provision of activities permitted by Chinese branches of Swiss companies. In financial services, additional concessions apply only to securities trading, allowing Swiss companies to trade on behalf of qualified institutional investors (QDII) in China, provide advisory services and overseas custody services. Swiss companies can also own 49 per cent of joint ventures which engage in certain trading and underwriting activities. Under its MFN WTO obligations, the maximum permitted ownership share of these joint ventures is 33 per cent. Swiss joint ventures are also allowed to engage in securities brokerage, proprietary trading and asset management if they obtain the required approval.

China’s additional commitments under the CSFTA on professional services and travel services – a key area for both Switzerland and the EU as such services each represent over 20% of EU service exports to China – are also small. With regards to travel services, the only difference between the CSFTA and China’s WTO accession protocol is greater specificity on the scope of service activity provision allowed. Regarding professional services, the main concession made relates to translation services: Swiss providers may establish wholly-foreign owned enterprises while other WTO members must participate in joint ventures (although majority ownership of these is permitted).

Implications

Switzerland and Iceland are the only two high-income economies outside China’s neighbourhood which presently have a comprehensive trade agreement with China. Though modest in scope, the CSFTA has been hailed as a milestone, with Swiss proponents describing it as their most important agreement since the 1972 FTA with the EU.

However, China’s concessions are primarily in areas where trade barriers were already low. In what are potentially the sectors of greatest interest for the EU such as high value-added manufacturing (primarily vehicles) and professional services the CSFTA registers little progress. The agreement hardly addresses other Chinese practices that draw the most persistent criticism by the EU and others. For example, while both parties commit to the ‘adequate and effective protection and enforcement of intellectual property rights’, the pledges remain vague and in line with past China-EU joint declarations. The bilateral dialogue on intellectual property rights and annual Intellectual Property Working Group meeting established by the CSFTA does not appear to have achieved much progress beyond the original statement of intention.

The EU is now China’s largest trading partner, and would certainly be more ambitious in its dealings with China than Switzerland could. However, a critical lesson from the US-China trade war and the truce agreed under the recent Phase-1 deal is that China has ample capacity to resist external pressure when the other party’s demands are not in line with steps it would like to undertake either way. The China-Switzerland agreement is much more comprehensive than the Phase-1 deal, and it is reciprocal, yet it confirms this pattern. That said, the EU will naturally have its own defensive concerns and red lines in any negotiations with China, in sectors ranging from agriculture to steel and many kinds of labour-intensive products (such as garments). Based on this examination of the CSFTA, we conclude that negotiations of an FTA between China and the EU would be arduous, to say the least. Even though the potential welfare gains from expanding trade ties between these two giant economies are far larger than those of any existing EU trade agreement, much will have to change before the conditions for a deal between China and the EU become truly propitious.

[1] This blog employs data on Chinese exports as reported by the World Bank’s World Integrated Trade Solutions (WITS). It should be noted that relevant discrepancies exists within the WITS database between data on Chinese exports to Switzerland (with China as the reporting party) and Swiss imports from China (with Switzerland as the reporting party).


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