China Export Policy Chokes on Vitamin Verdict

Internet cafés covered by the city of Wuhan’s Internet Café Association agreed to set minimum prices for online access nearly a decade ago. And more than one hundred coking coal company-members of the Coke Association of Shanxi Province each agreed in 2005 to cut production up to 40 percent.

These are two examples of the market power wielded by tens of thousands of quasi-government trade associations in China, which were formed in the late 1980s to control production and prices on behalf of government policymakers.

Trade groups have helped China shift away from central government planning toward a market economy. They’ve survived major changes for domestic companies wrought by China’s 2001 entry into the World Trade Association (WTO). And they’re safely entrenched, since every Chinese exporter must join a trade group to qualify for a government license to sell goods abroad.

But a recent U.S. court ruling, which followed an eight-year legal battle between Chinese and American vitamin producers, is threatening to rock the trade associations as well as the government’s export-control system.

A jury for the U.S. District Court for Eastern New York found the companies guilty of conspiring to fix prices of vitamin C made in China and sold in the United States. Court documents said their business, worth hundreds of millions of dollars, affected “products found in almost every American household” between 2001 and 2005.

The court in March ruled against two of the plaintiffs—North China Pharmaceutical Group Corp. and Hebei Welcome Pharmaceutical Co. Ltd. They were ordered to pay US$153 million in damages to U.S. rivals Animal Science Products Inc., The Ranis Co. Inc., and Magno-Humphries Laboratories Inc.

The Chinese companies, which have appealed, are members of a trade group called the China Chamber of Commerce for Import & Export of Medicines & Health Products (CCCM). Court documents said the group helped coordinate export prices for its vitamin-maker members.

Lawyers for the U.S. companies argued CCCM crafted a unified pricing strategy for vitamin C exporters, in violation of U.S. trade rules.

Tao Jingzhou, a managing partner for Asian practice at the American law firm Dechert LLP, said the defendants lost the lawsuit because they were subject to a “macro control” that the Chinese government considers normal for its trade associations.

The impact of the decision is expected to reach far beyond the vitamin industry. For example, a similar lawsuit against a metal and minerals products trade group called the China Chamber of Commerce of Metals, Minerals & Chemicals Importers & Exporters and seventeen magnesite clinker companies is also in the pipeline in the United States.

The legal challenges could affect China’s bid for winning official WTO designation as a “market economy.” Also at stake is the future of the trade association system.

Pricing Power

Business practices labeled as cartel behavior and prohibited by anti-trust laws in many countries are allowed in China for companies that export their products abroad.

China’s anti-trust law, in place since 2008, bans coordinated price-fixing and production controls among competitors if they affect the domestic market. But exporter cartels, supported by trade associations, are permitted.

Exporters are excluded from China’s rules against cartels because their business comes under the jurisdiction of importing countries, each of which has its own set of anti-trust laws, according to a 2008 media interview with Mei Yuxin, a researcher at the Ministry of Commerce’s International Trade Research Institute.

As a result, said Beijing-based anti-trust lawyer Huang Yong, exporters worldwide find themselves at the mercy of the laws in individual countries where they do business.

“Every country’s anti-trust law can apply to foreign companies,” Huang said. “As long as Chinese exports have an impact on the American market, it can be punished by American anti-trust law.”

China’s vitamin exporters may have overlooked this risk of violating U.S. laws when they worked through CCCM to fix prices.

CCCM is one of six major trade groups formed in the 1980s to support member exports and encourage decentralization of state-run companies. Other trade associations focused on agricultural products, textiles, light manufacturing, electronics, and mineral and chemical products.

Under Chinese law, a domestic manufacturer that wants to export products must join a relevant trade association.

Under each association are branches in charge of business niches, such as CCCM’s vitamin office. Thus, about 60,000 trade groups are operating today across the country, with no more than one group per business sector in any given city or province.

Each group enjoys strong government backing via a specific government agency that functions as an official sponsor.

Thus, if government policymakers deem a product too expensive or too cheap for the domestic or export market, a relevant trade association calls on leading manufacturers in the sector to make the necessary customer price adjustments.

Moreover, government agencies subsidize many of the associations and sometimes appoint their leaders. For example, the commerce ministry put Qiao Haili, a retired military officer, in charge of CCCM’s vitamin division.

Legal Tension

Between 2005 and this year, Qiao flew frequently between Beijing and New York for court hearings, where he led the defense team fighting for the vitamin producers against anti-trust charges.

The defense strategy, however, revolved around a dilemma for China’s export trade policy and trade associations: In hopes of winning the lawsuit, Qiao’s team admitted Beijing ordered companies to fix prices for exports, and argued the companies had no choice but to comply with the laws of China’s sovereign government. In so doing, though, the defense opened China to foreign governments and other challengers who might say these price-fixing rules violate the country’s WTO commitments.

“I hope this case won’t set a precedent for Western governments and companies to claim that China is not a market economy and the Chinese government intervenes in the market,” said Tao, “and use that to launch a wave of anti-monopoly investigations.”

But Tao’s fears already may be coming true.

William Isaacson, a New York-based lawyer who led the fight against the Chinese vitamin companies, recently told the Reuters news agency that in the wake of his court victory, he has started investigating other suspected export cartels in China.

Isaacson had helped U.S. vitamin companies win a US$1 billion anti-monopoly lawsuit against European and Japanese vitamin producers in 1999. A few years later, one of the companies asked Isaacson to bring the case against Chinese producers who had taken over the American market.

The Chinese producers seized the opportunity and quickly moved into the American market after Isaacson had contributed to the breakup of a cartel tied to Swiss, German, Canadian, and Japanese firms. The companies were fined more than US$875 million combined, setting the stage for CCCM to coordinate its members to break into the U.S. market.

By 2004, according to court documents filed by Isaacson’s team, 68 percent of the world’s vitamins came from China. And CCCM members controlled 85 percent of the American market.

The dominance came three years after CCCM organized a meeting with China’s four major vitamin producers. Minutes from that meeting, which were offered by Isaacson’s team as trial evidence, said the companies agreed to restrict production and set a lowest price of US$3.35 per kilogram of exported vitamins.

Price-setting conferences organized by CCCM became an annual event for the vitamin companies. They set basement limits of US$3.80 per kilo in 2002, US$11 in 2003, and US$9 in 2004.

The strategy proved wildly successful. By the first quarter of 2002, several Chinese vitamin producers reported revenues had at least doubled from the same period in 2001.

Qiao defended CCCM’s coordinated effort to help Chinese vitamin companies win American market share. He noted that some of the companies actually strayed from the trade group’s order and set higher prices.

The pricing rules “were simply [a] formality only honest fellows followed,” he told the court.

Defense Crumbles

When the case was initially filed in 2005, the chairman of defendant Shijiazhuang Pharmaceutical Co., Cai Dongchen, called the allegations “baseless, reckless, and unreasonable.” His company was later dropped from the case after settling out of court.

Nevertheless, in the course of their defense, the Chinese companies admitted to price-fixing. They argued that since the Chinese government had required them to set prices, the U.S. court should defer the entire legal dispute to Chinese authorities.

The defense strategy was originally supported by the commerce ministry, which during the eight years of litigation sent three letters to the court as amicus curiae, or friend of the court, to confirm that the companies were required to follow the government’s pricing rules.

Ministry officials wrote that CCCM was set up to circumvent WTO rules against government export controls. They said a vitamin producer that failed to follow CCCM’s price limits would be denied an export license.

The practice is designed “to ensure orderly markets during China’s transition to a market-driven economy, and to promote in this transition period the profitability of the industry through coordination of pricing and control of export volumes,” according to the ministry’s correspondence.

Rather than help the vitamin companies, the ministry’s explanations provided perfect ammunition for Washington’s U.S. Trade Representative, who in 2009 launched a WTO complaint against China. It said the Chinese had violated WTO commitments by imposing export quotas and minimum export price requirements.

The complaint was eventually voided, but a WTO panel agreed, partly based on the commerce ministry letters, that the Chinese government indirectly imposed export restraints through trade associations.

The WTO complaint forced commerce and CCCM officials to rethink their involvement in the vitamin lawsuit. Qiao actually changed his testimony about the companies following government price requirements and instead told the jury as it was nearing a verdict in March that CCCM’s minimum price was voluntary and not binding on vitamin producers.

Qiao, according to an anti-trust expert close to the case who spoke with Caixin, was caught between a rock and a hard place: He wanted to convince the jury that government controls exist, but doing so exposed the Chinese government to accusations that it violates WTO regulations.

In the future, particularly if the vitamin companies lose their appeal, the Chinese government may be forced to choose between WTO rules and controlling exports through trade associations such as CCCM.