Much political analysis concerning the rise of China has centred on the country's development into an increasingly formidable political power in the international arena. Conversely, less study has been devoted to China's developing market power resulting from its increased confidence and growing ability to shape policies relating to liberalized trade, both in the Asia-Pacific and increasingly across other regions. In the space of a decade, China has transformed itself from a sceptic of liberalized and preferential trade into one of their strongest proponents. Moreover, it has been better able to match words with deeds by actively engaging in negotiations to create stronger bilateral and multilateral preferential trade ties well beyond the Asia-Pacific region, including increasingly in Europe. China's admission to the World Trade Organization (WTO) in December 2001 gave Beijing a sturdier platform from which to negotiate more select forms of liberalized trade.Footnote ¹ Growing international concerns about the viability of the ongoing Doha Round of global trade negotiations has galvanized many counties into seeking alternative agreements and Beijing has made use of this development in seeking bilateral and sub-regional preferential trade agreements (PTAs) with selected states.

In addition to short-term economic gains which China has realized through these negotiations, PTA talks have become an important foreign policy tool for Beijing in its pursuit of what has been termed “commercial diplomacy” (shangwu weijiao 外交商务). This refers to the strategic use of commercial power, including the offering of preferred market access, to influence decisions related not only to trade but also to diplomacy and strategy. Various international commerce issues, including tariffs, services, competition policies and privatization, may factor into the definition of commercial diplomacy. In addition, while much strategic-related diplomacy frequently involves zero-sum outcomes, commercial diplomacy demonstrates a preference both for multilateralism and for win-win, positive-sum results.Footnote ² This fast-developing branch of China's expanding foreign policy is well in keeping with post-cold war Chinese diplomacy, permitting Beijing to make extensive policy inroads well beyond the Asia-Pacific region.

However, China's attempts at developing preferential trade deals with Europe have been hampered by the increasingly strained economic and political relationships between Beijing and the European Union. While trade between the two sides continues to grow and trade strategies remain co-ordinated, European concerns regarding China's market structure and its dedication to fair trade along with Beijing's concerns over increasing politicization of Chinese trade in Europe have created frictions and have prevented significant movement towards a specialized trade deal between the two. Therefore, China has instead turned its European focus towards non-EU economies, beginning with that of Iceland (Bingdao 冰岛). In late 2006, Reykjavik became the first European government and first non-Asia Pacific advanced economy to initiate formal preferential trade negotiations with China. Should the talks reach a successful conclusion, Norway and the rest of the European Free Trade Association (EFTA) may enthusiastically follow suit.Footnote ³ The preferential trade negotiations between Iceland and China represent a significant evolutionary step in China's commercial diplomacy and watershed changes in Beijing's thinking about PTAs. These changes include a greater willingness to incorporate service sectors into liberalization talks, China's commitment to cross-regional economic ties, including with small and medium states, and its determination to increase its visibility in the European economy, if necessary through a “side-door” (bianmen 边门) approach to commercial diplomacy there.

The Icelandic banking crisis which began in September 2008 has significantly slowed the pace of the talks, with the eventual outcome far from certain. These events have illustrated another potential challenge to Beijing's free trade policies in the form of negotiating liberalization with states which have been adversely affected by the recession. However, the successful completion of the China/Iceland talks and/or possibly others with the EFTA could propel the much larger European Union into re-examining its views on liberalized trade with Beijing. This would provide China with further knowledge of, and a presence in, the European market through a secondary but still lucrative approach rather than through a direct path to the European Union. These negotiations and the effect of the global recession on them will also provide a critical test of China's evolving policy towards building “partnerships” with select countries based on mutual interests rather than solely on strategic thinking. Finally, the Iceland case study further underscores Beijing's ambitions of moving beyond great power politics by seeking PTAs with smaller states, even when China's economic gains may initially be relatively minor, and demonstrates China's increasing confidence and adroitness with cross-regional commercial diplomacy.

Beijing's Changed Views on Preferential Trade

China's increasing success in drawing its neighbours into free trade negotiations is a strong indicator not only of its growing economic power, but also of its capabilities and self-assurance in channelling this power into improving its regional authority in matters related to interregional trade. China's support for free trade following the turn of the century was enthusiastically welcomed by many states in the Asia-Pacific region. Beijing has been able to acknowledge shifts in regional preferences for free trade as a result of regional wariness towards older, larger free trade regimes such as the regional Asia-Pacific Economic Co-operation Forum (APEC) and the WTO,Footnote ⁴ as well as the need to create a greater number of economic “parachutes” to prevent or mitigate a region-wide economic downturn such as that which occurred during the Asian Financial Crisis (AFC) in 1997–98. Thailand, Hong Kong and Macao were the first bilateral PTAs negotiated and completed by Beijing in 2003–04, agreements with Chile and Pakistan were struck in 2005 and 2006 respectively, and PTA talks with New Zealand were completed in January 2008 and with Peru in November of that year.Footnote ⁵ Today, preferential trade talks are under way with other Asia-Pacific states – Australia and Singapore – and with others outside the region, including Brazil, the Gulf Co-operation Council, the South African Customs Union, Mexico and Iceland. Furthermore, China has expressed interest in initiating PTA talks with India, Costa Rica and the membership of the Shanghai Co-operation Organization, and it was a testament to Beijing's growing influence in liberalized trade that in May 2009 Japanese Prime Minister Taro Aso took the extraordinary step of publically advocating a Chinese PTA despite ongoing political differences between the two states.Footnote ⁶ Although large and medium economies are not missing from Beijing's free trade agenda, one segment of China's trade diplomacy suggests a preference for talks with smaller developed states.

In order to understand Beijing's newfound capabilities in developing and influencing the proliferation of preferential trade agreements cross-regionally, it is important to examine China's reversal of its traditional antipathy towards free trade commitments, openly calling for increased trade liberalization. This takes into account growing domestic-level recognition of the country's economic power and the attractiveness of the Chinese “big market” (da shichang 大市场) factor, and shifting economic power levels in the Pacific Rim which have positioned Beijing much more favourably to influence regional trade discourse, a situation which China has been very adept at turning to its advantage. At the same time, however, those who have expressed concerns about Chinese economic hegemony in the region may be reassured by Beijing's attempts to link its push for increased regional and bilateral free trade with its determination to become a co-operative great power, acting within partnerships rather than creating a network of economic subaltern nations.

The after-effects of the AFC included serious reconsideration of the benefits of PTAs among Asian states, including China. Moreover, Chinese conduct during the crisis all but ensured that the country would be able to assume a commanding role in the development of smaller-scale economic arrangements. After the crisis spread from Thailand into South-east and then North-east Asia between the summer of 1997 and the beginning of the following year, China was faced with tough economic questions. While its still partially closed economy and lack of a fully convertible yuan, as well as other factors such as low deficits, shielded Beijing directly from the AFC's effects, the country still faced the pressures being put on Hong Kong as well as the spectre of Chinese exports suddenly losing their comparative advantage. China attempted to cement its role as regional partner to South-east Asia further by providing an unprecedented US$4 billion to assist in the international bailouts of the stricken Thai, Indonesian and South Korean economies.Footnote ⁷ This created much diplomatic capital for China, which became known as an oasis of stability in Asia, while galvanizing support for both bilateral and sub-regional economic co-operation.

The aftershocks of the AFC and the ongoing problems in bringing the latest WTO trade talks to a close have produced much support in East Asia for developing alternative trading arrangements in the form of PTAs. This resulted from the requirement further to strengthen regional political and economic ties in Asia and beyond as well as responding to the torpid pace of global multilateral trade liberation.Footnote ⁸ These overlapping trade agreements have been viewed as a potential spring-board for larger-scale trade agreements such as the WTO and APEC, but other analysts have expressed concern that this “PTA proliferation” will erode support for these larger regimes and fragment the Asia-Pacific trading system into overlapping and contradicting regimes, otherwise known as the “spaghetti-bowl effect,”Footnote ⁹ an increasingly complex tangle of PTAs on various levels. However, PTAs do have an advantage of being faster to negotiate and implement,Footnote ¹⁰ as well as to update or enhance. Finally, bilateral and sub-regional agreements are viewed as providing an alternative layer of trade liberalization should the Doha Talks end unsatisfactorily, something which is increasingly being seen as a risk as the talks have progressed at a torpid pace since their start in 2001 and have not been helped by the post-2008 “credit crunch” which has adversely affected many global markets.

The WTO has also been especially vulnerable to criticism as a result of its perceived slowness in responding to regional-specific grievances, a factor which was magnified after the sudden halt of member talks in Cancun in September 2003, largely due to deadlock between developed and developing area representatives.Footnote ¹¹While the WTO and other international-level financial regimes such as the International Monetary Fund have been magnets for anti-globalization protests and critical scrutiny, PTAs, by contrast, are not only viewed as more congenial alternatives but the fewer number of actors involved has often resulted in faster and more efficacious deal-making. The search for safety nets to deal with future regional or international economic downturns provided a powerful motivator for seeking alternative trade arrangements and by the beginning of the 21st century many new PTAs had either come into being or were under negotiation. Within the Asia-Pacific region the number of PTAs completed or under negotiation rose dramatically after 2002.Footnote ¹²

China was not absent from this process, as its economic power had become increasingly attractive to both Asian and non-Asian economies as demonstrated by the number of Asian economic actors seeking preferential deals with the country. Indeed, Beijing rapidly became the driving force in Asian PTA development, buoyed by government support and increasingly favourable attitudes among the Chinese public towards enhancing freer trade. For example, a Pew Global Attitudes survey released in October 2007 suggested 91 per cent of respondents in China favoured free trade, compared to 59 per cent of those polled in the United States.Footnote ¹³ Thus far, China's approach to PTAs has reflected a preference for selective inclusion of goods and services, almost a buffet-style approach, as well as the settlement of disputes via informal consultation rather than formal mechanisms,Footnote ¹⁴ a stance clearly reflected in the Iceland talks. In addition to bilateral negotiations, Beijing's commitment to liberalized regional trade was well illustrated by the call by then-Premier Zhu Rongji 朱镕基 in 2000 for a PTA with the Association of Southeast Asian Nations (ASEAN). The end result, the ASEAN–China Free Trade Area, was codified via a framework agreement in November 2002 and debuted in 2010.Footnote ¹⁵ Beijing has now begun to turn its attention to developing PTAs outside its immediate periphery, and the opening of the PTA talks with Reykjavik is an illustration of China's tactical approach to cross-regional free trade policy development.

The increasingly pro-free trade stance of Chinese President Hu Jintao and his government has signalled Beijing's quest to maintain its commercial diplomacy based upon what has been called a “system maintaining” approach, upholding the stability and legitimacy of the international trade regime, including the WTO, as well as regional regimes such as APEC. At the same time, however, China is developing a “system exploiting” set of policies,Footnote ¹⁶ taking greater advantage of the more congenial international stance towards PTAs by developing them to suit the country's expanded trading strategies. This provides an important illustration of China's expanded engagement with international economic regimes on several levels, a development considered crucial not only to China's continued economic prosperity, but also to its ongoing foreign policy of regional and now greater cross-regional engagement. Moreover, Beijing has recently attempted to portray itself as a developing great power through the doctrine of “peaceful rise” or more commonly “peaceful development” and “harmonious world.” At the 17th Party Congress of the Chinese Communist Party in October 2007, Hu Jintao's keynote speech noted the necessity for improved international economic relations as a means of further strengthening global harmony.Footnote ¹⁷ At the same time, Beijing has used its growing economic power to forge political and economic partnerships with states much further abroad to underline its desire to be a responsible great power making positive contributions to the development of the global economy.

The Genesis of the Sino-Icelandic Negotiations

As Europe began the gradual process of regional integration, its potential as an alternative Chinese economic partner to the United States became more evident. Deng Xiaoping remarked to former British Prime Minister Edward Heath in 1985 that Europe was becoming increasingly important to Beijing's nascent reformist trade policy both as a source of higher technology and as a developing trade conduit. Deng concluded by noting: “For the past three years we have been considering how to increase economic ties with Europe. It is our policy to do so.”Footnote ¹⁸ Since the European Union's creation and expansion, it has developed into Beijing's largest trade partner, with overall trade increasing by a factor of 60 between 1975 and 2005 to €210 billion,Footnote ¹⁹ and the number of institutional relationships between the two has also grown. The Asia–Europe Meeting, created in 2006, links the EU with the largest Asian economies (including China) and via various mechanisms, including biannual leadership summits, promotes cross-regional dialogue on political, economic and cultural areas.Footnote ²⁰ In May 2004 the EU–China Trade Policy Dialogue was developed with the aim of holding more formalized dialogue on trading issues, especially in the sensitive area of textiles, a sector which China had grown to dominate.Footnote ²¹

At the September 2006 China–EU conference in Helsinki, Chinese and European representatives agreed to launch talks to create a Partnership and Co-operation Agreement, and negotiations commenced the following January.Footnote ²² However, these talks have so far fallen well short of a feasibility study in developing a preferential trade agreement, and instead the focus of the Agreement has been on intellectual property rights, natural resources, product standards and non-tariff barriers as well as other peripheral issues. Even for that, progress has been slow and points of contention have included the status of Taiwan as well as Beijing's reluctance to negotiate in some sectors beyond WTO rules.Footnote ²³ As such, the negotiations have yet to address the more central issues related to tariffs and investment, nor has the Asia–Europe Meeting acted as a viable incubator thus far for Sino-EU preferential trade negotiations.

These problems have also developed within an atmosphere of increasingly frosty relations between Beijing and Brussels over a variety of economic issues. Perceptions of China by many large EU members have become more negative in recent years as a result of increased concerns about job outsourcing, intellectual property rights abuses and closed access to some Chinese economic sectors. In addition, by 2007 elections in the largest EU states, including the United Kingdom, France and Germany, had introduced new governments which are sceptical about China's rise as a political and economic power.Footnote ²⁴

This mistrust has manifested itself in an increasing number of policy differences. Beijing ran afoul of the Union's anti-dumping laws in recent years and has complained that it is being singled out by the EU for this as well as being subject to unfair EU trade barriers. Beijing was also incensed at being refused the designation of “market economy” by the Union in its report on the subject in June 2004, an omission interpreted by China as being both unfair and politically motivated, especially in light of Russia, a non-WTO member, successfully achieving that status. There was also lingering frustration in Beijing with Europe's refusal to remove the arms embargo on China as a result of both internal EU differences and American pressures.Footnote ²⁵ This has been viewed as a significant impediment to increased political and economic dialogue. More recently, the EU has been concerned about its growing Chinese trade deficit, €128 billion in 2006 and reaching €160 billion by the end of 2008, as well as the allegedly undervalued Chinese yuan, which both the United States and EU would prefer to see raised to a level better reflecting the increasingly powerful Chinese economy. The 50 per cent jump in China's overall trade surplus in 2007, to US$262 billion, added more fuel to arguments that China's trade policies were creating unfair distortions.

The EU, along with the United States and other economies, was critical of a series of incidents involving quality control failures in exported Chinese goods during 2007.Footnote ²⁶ From a political viewpoint, China has had scrapes with Western European government over issues such as the protest-plagued Olympic torch relays in London, Paris and Athens during the first half of 2008, and the decision by Beijing to call off an EU summit in December 2008 in the wake of a European tour by the Dalai Lama.Footnote ²⁷ In short, these political-economic disputes together with lingering Chinese unease with seeking a PTA with such a large and complex entity as the European Union, which still lacks a common foreign policy, will be likely to prevent the short-term launch of Sino-EU preferential trade negotiations.

Thus, it was Iceland, not an EU member but nevertheless well-integrated within the Union's economy, which became the first European state to enter formally into negotiations with China in December 2006 with the goal of finalizing a free trade agreement. The formal process began with a bilateral meeting between foreign ministries in early 2005 which ended with a call for a PTA feasibility study. The government of Iceland first approached Beijing with the idea of starting talks and both sides recognized the compatibility of their economies despite their considerable size differential.Footnote ²⁸ The Iceland negotiations permitted Beijing to engage a European economy in PTA talks while bypassing the complexities of the EU itself. The small island state's role in the European economy is distinct, as while Iceland remains hesitant to join the EU, it is a member of the European Economic Area, a single market for European goods and services as well as labour. Reykjavik also implemented the EU's Schengen Agreement in 2001, which abolishes border controls with most Union members.Footnote ²⁹ Iceland therefore has acted as a useful window, or as one Reykjavik official termed it, an “icebreaker,”Footnote ³⁰ for China's commercial diplomacy in Europe without committing Beijing to complex deals with the European Union. At the same time, the conclusion of a PTA with Iceland would offer Beijing a lofty vantage point from which to view the rest of the European economy, providing greater understanding of the Union's liberalized trade preferences while discovering the potential challenges to greater Chinese engagement with the EU economy.

Another obstacle to commencing the Sino-Icelandic talks was removed in 2005 when Iceland agreed to apply the “market economy” designation to China, noting that Beijing had achieved the minimum WTO standards for that level of recognition.Footnote ³¹ As with other PTA partners, including Chile and New Zealand, Beijing had pressed for that designation within the framework of the negotiations as a way of moving beyond what it saw as the unfair application of “non-market economy” as a legal, WTO method of constraining Chinese trade.Footnote ³² The start of the China–Iceland PTA negotiations was in many ways a result of the growing bilateral trade relationship which began after Iceland recognized Beijing in 1971, eight years before the United States, and later when Iceland established its embassy in Beijing in 1995. The actual catalyst for the PTA talks came in May 2005 when China and Iceland signed a memorandum of understanding which recommended the initiation of free trade negotiations in short order. It was initially suggested by Reykjavik that talks should comprise Beijing and the entire EFTA, but Beijing requested the talks be solely between itself and Reykjavik, further reflecting a conservative, pro-bilateralist methodology on China's part.Footnote ³³

The advantages of an “Iceland first” approach rather than a multilateral policy towards the EU or EFTA were numerous for both sides. Despite the small number of economic goods Beijing would derive from an Iceland deal, the island's comparatively small economy (it is the smallest state in the Organization of Economic Co-operation and Development) meant that fewer sectors would be under negotiation and that both sides would have more room to explore liberalizing ideas beyond trade in goods. Moreover, Iceland has been termed a “norm entrepreneur,” along with other states in Scandinavia, meaning that Reykjavik is often able to exercise diplomatic power well in excess of its size.Footnote ³⁴ A successful deal would allow Iceland to demonstrate further its abilities to negotiate trade with much larger economies, while China would have its first PTA opening into the European economy. From a wider geo-strategic viewpoint, an Iceland deal would result in China having a liberalized trade deal with a member of the North Atlantic Treaty Organization (NATO), as well as an integral part of the northern Atlantic corridor linking North America with Europe.Footnote ³⁵ Thus, the ideas of symbolism and prestige are very much present in these negotiations along with hard political-economic considerations.

While Iceland's economy is small compared to other Western European states, it had become increasingly diversified with its finance, insurance and real estate sectors together comprising 26 per cent of total Icelandic GDP in 2006,Footnote ³⁶ sectors within which Beijing has been anxious to develop greater international exposure. The overall trade volume between Reykjavik and Beijing grew from 1.7 billion ISK (US$28.1 million) in 1995 to 23.2 billion ISK (US$380 million) in 2006, small in absolute terms but impressive in light of Iceland's small size (with a population of 313 million). There was, however, an ongoing trade deficit, with Chinese exports to Iceland totalling US$77.7 million in 2006 versus US$40 million for Icelandic exports to China. China's major imports to Iceland include textiles, clothing, coke and ships, while Iceland's primary exports to China include fish and related products, machinery and electronic goods.Footnote ³⁷ Tourism is also an important selling point for China–Iceland ties, as in 2006 alone an estimated 10,000 Chinese tourists visited Iceland.Footnote ³⁸ There was also talk of closer co-operation between Iceland's increasingly-globalized financial institutions and those of China, as was demonstrated by two major Icelandic banks opening offices in China, Glitnir in Shanghai in December 2006 and Landsbanki in Hong Kong in November 2007.Footnote ³⁹ With China increasingly interested in internationalizing its own banking sectors, this is another source of potentially increased co-operation between the two countries. As one Icelandic bank representative noted, before the country's financial institutions went into crisis in 2008, the island's exposure to North American entrepreneurial practices while still being closely in contact with EU institutions also set Iceland financial institutions apart from others in Europe,Footnote ⁴⁰ making them more receptive to cross-national negotiations, including with China.

In addition, China has sought Iceland's assistance to fuel its rapidly growing economy by developing thermal energy capabilities in order to divert its energy consumption away from coal, which is both inefficient and a major contributor to Chinese pollution. At present about 70 per cent of China's energy comes from coal, with alternative sources such as nuclear, hydroelectric and geothermal very much underdeveloped. At the same time, China's growing dependence upon foreign oil and gas supplies has also sparked initiatives to diversify sources and make better use of indigenous supplies.Footnote ⁴¹ A joint project in geothermal energy development, begun in 2005 and completed in December 2006, has been supported by the Shaanxi Green Energy Geothermal Development Corporation, co-administered by Iceland's Enex Kina and the Shaanxi Geothermal Energy Corporation and supported by China's Sinopec energy company and Glitnir Bank.Footnote ⁴² Construction of a thermal heating infrastructure was begun in the city of Xianyang in Shaanxi province in central China and is expected to be at full capacity by 2015. It is likely that this pilot project will be duplicated elsewhere in China. Other Chinese provinces have shown interest and approximately 90 Chinese students have participated in training programmes at the United Nations University Geothermal Training Programme in Reykjavik, more students than from any other country.Footnote ⁴³ There are many other potential outlets for exchanges of technical expertise in this area as China continues to seek modernization of its energy capabilities. This may include development in the Pearl River Delta adjacent to Hong Kong, as suggested by Icelandic President Ólafur Ragnar Grímsson when he visited the region in October 2007.Footnote ⁴⁴

One recent study of why China has engaged specific PTA partners noted that one category of potential bilateral links which Beijing has sought, in addition to neighbouring states and selected regional groupings, include smaller, resource-rich states such as Australia and New Zealand.Footnote ⁴⁵ Iceland definitely falls into this small-economy category when looking at the potential cost/benefit ratio for China. As a result of these sector-specific building blocks which allowed for increased levels of bilateral economic contact between Beijing and Reykjavik, the stage was set for formal negotiations. The official Sino-Icelandic trade talks began in Beijing in April 2007 with a second and third round of negotiations completed in June and October of that year, and a fourth round undertaken in March 2008 in Reykjavik. Both sides were hopeful of a completion of the PTA by August of that year, before China turned its attention to the 2008 Beijing Olympics.Footnote ⁴⁶ The first round examined the major issues while the second looked at more specific areas such as agriculture, fishing and other foodstuffs. Between rounds, Reykjavik consulted representatives of major industries, including fishing, aviation, shipping and banking, for their views. The talks so far have produced much optimism on the Chinese side. After a meeting with President Grímsson in October 2007, Hu Jintao called for an acceleration of the negotiations as well as an increase in co-operation in areas relating to medicine, finance, engineering and food industries. In addition, both leaders agreed to increase the level of dialogue on thermal energy and clean energy development as well as cultural ties.Footnote ⁴⁷

Icelandic officials involved with the talks noted that Reykjavik has had much recent experience in negotiating free trade, including with much larger states and other organizations such as the EU, and that despite the disparity of size of the Chinese and Icelandic economies there is much compatibility. Chinese representatives have also stressed that Beijing has approached the talks not with economic size differences in mind but as negotiations between two equal partners.Footnote ⁴⁸ More crucially, what makes this potential agreement distinct is that it not only covers the abolition of tariffs on trade in goods but also services, such as banking, for which Iceland is becoming increasingly known.

The May 2005 Beijing–Reykjavik memorandum of understanding which preceded the talks noted the compatibility of service sectors including education, tourism and financial services, and suggested that services be added to the PTA negotiations, an inclusion improved by the fact that upon joining the WTO, China accepted global baseline rules governing services trade as specified by the General Agreement on Trade in Services.Footnote ⁴⁹ The fact that both goods and services are under negotiation for this specific free trade agreement means that a successful Sino-Icelandic PTA deal would be a “sector expanding” bilateral trade agreement, a PTA designed to take advantage of having only two actors involved in the process and delving into areas, such as services, not normally covered by multilateral agreements because of their complexity.Footnote ⁵⁰ They have included negotiations on some of the so-called “Singapore issues,” service sectors which have been a longstanding headache for the WTO talks to incorporate into an international trade liberalization agreement.Footnote ⁵¹ This potential PTA, especially if services are incorporated within it, also has much strategic value for China, as its success would demonstrate to other European economies, and especially to the EU, Beijing's determination to liberalize trade with the continent and that it is prepared to negotiate preferential trade beyond goods alone.

Not surprisingly, the major sector under consideration on the Icelandic side has been fishing, as that comprises the majority of Icelandic exports. Thus far the response from fisheries industries to the talks has been positive, and there are no plans to have the final agreement affect quotas despite some concerns that Chinese requirements might do so. China is interested in maintaining trade in Icelandic seafood both for local consumption and processing for trade with other countries. Since over the past few years China has maintained a 10–12 per cent tariff on imported seafood and demand for seafood in China has grown considerably in keeping with the country's developing consumer base and more varied culinary tastes since the beginning of the 1990s, free trade in this area would accomplish much in boosting Icelandic seafood exports to China.Footnote ⁵² As China's consumer class continues to expand rapidly, there has been an accompanying demand in the country for greater varieties of imported foodstuffs.

There are, however, some serious issues to be addressed before this PTA can be successfully completed. Some actors such as the Association of Icelandic Industry have voiced concerns about competition with China, while others including labour unions have expressed worries about the negative effects of free movement of persons under a deal. However, while open borders, it has been stressed, are not on the agenda, there has been talk of including recognition of professional credentials and qualifications by each state.Footnote ⁵³ There have also been recent concerns about labour rights in China and scandals in the West over the quality of Chinese goods. To address the latter point, there has been talk of a mechanism to be established between the two states to examine these issues. There is also the matter of the trade deficit between China and Iceland, but its exact nature is open to interpretation since many Icelandic products sold to China, such as seafood, are processed and re-exported.Footnote ⁵⁴ In short, the focus of the talks has been primarily to achieve trade fairness on both sides, while downplaying the substantial size differential between the two participants.

Thus far, the European Union has paid only marginal attention to the Sino-Icelandic talks, at least officially, but other states in the EFTA are watching matters more closely. Switzerland announced in April 2007 that it too was interested in initiating free trade negotiations and a PTA feasibility study with Norway was completed in December of that year. Switzerland was the third European state, after Iceland and Norway, to recognize China as a market economy.Footnote ⁵⁵ With these events, Beijing has not ruled out the possibility of an eventual round of trade negotiations with the EFTA. Success with the Iceland talks, however, may well dictate how and when this might occur, as for now China prefers to approach the North Atlantic region bilaterally. From a European viewpoint, a Sino-Icelandic PTA may be sufficient to begin a “domino effect”Footnote ⁵⁶ of PTA proliferation with the other EFTA states which could ultimately result in the regional deal which was first proposed.

Moreover, these successes may place much strain on the EU to avoid being left out of privileged access to the Chinese market enjoyed by non-EU states, prompting a rethinking of its own Chinese trade policies. As one European Commission representative noted, the commencement of Sino-Norwegian and Sino-Swiss FTA talks would definitely attract more attention in Brussels as these two EFTA members are more integrated with the EU economy.Footnote ⁵⁷ A Chinese PTA with Berne, an economy embedded both geographically and economically with EU states, would be especially difficult for the Union to ignore. An open question is whether Chinese deals with EFTA states, and possibly with the entire Association, would be enough to galvanize the initiation of a Sino-EU preferential trade study despite the current economic differences between Beijing and Brussels.

The Icelandic Banking Crisis and Its Aftermath

The events which began in late September 2008 made Iceland one of the most visible casualties of the growing global financial crisis.Footnote ⁵⁸ In a matter of weeks, the country's three largest banks fell into government receivership after accruing massive debts and being unable to pay their creditors. The value of the Icelandic krona went into free fall as global confidence in the nation's economy quickly evaporated and business failures and unemployment increased. The coalition government of Prime Minister Geir H. Haarde attempted to address the mounting crises but was ultimately dissolved in January 2009.Footnote ⁵⁹ The Chinese offices of both Glitnir (now Íslandsbanki)–Shanghai and Landsbanki–Hong Kong were subsequently shut down as the banks attempted to consolidate and Reykjavik was placed in the uncomfortable position of having to request loans from other states as well as the International Monetary Fund. There was some initial talk of Beijing contributing to a loan package, but a targeted commitment did not materialize. Instead, Iceland received a US$2.1 billion loan from the International Monetary Fund and was promised another US$3 billion from an assortment of governments including fellow Scandinavian states, Russia and Poland.Footnote ⁶⁰ However, Beijing did gain much goodwill in December 2008 when a Chinese fireworks provider agreed to defer payment for their annual shipment to Reykjavik, thus allowing the renowned Gamlárskvöld (New Year's Eve) pyrotechnics displays in Iceland to proceed as scheduled.Footnote ⁶¹

The Icelandic crisis, or to use the local term, “kreppa,” cast the free trade talks into considerable doubt, appearing in the wake of delays caused by both the Wenchuan earthquake in Sichuan in May 2008 and the Beijing Olympics three months later. While the negotiation rounds had made significant progress until then, there was much work to be completed especially in the area of free trade in services.Footnote ⁶² A brief series of talks, short of a formal round, took place in March 2009 with some progress reported and there were hopes that the next formal round could take place in October.Footnote ⁶³ However, adding to the level of uncertainty is the developing debate within Iceland over whether the country should commence negotiations with the European Union despite its longstanding antipathy towards the EU in the past.

Following elections in April 2009, the government of Prime Minister Jóhanna Sigurðardóttir confirmed it would seek to commence talks with the European Union regarding membership in the organization and the ability potentially to abandon the krona for the euro. However, there remains concern in the country over the status of the island's natural resources, especially its fishing industries. At the same time, the governments of Britain and the Netherlands have tied Iceland's membership talks to Reykjavik's repayment of funds that both countries lost after the collapse of the Icelandic online savings firm Icesave in October 2008, a situation complicated by Reykjavik's January 2010 decision to hold a referendum on the repayment scheme.Footnote ⁶⁴ Should Iceland successfully begin talks with Brussels, this would place Beijing in the difficult position of proceeding with their negotiations despite the risks that EU membership may nullify the terms of the China PTA. As a result, Beijing's attention would turn to the other non-EU candidates of Norway and Switzerland. In a February 2009 interview with Xinhua, Swiss Economy Minister Doris Leuthard expressed hopes that Berne would be the first government to complete a free trade deal despite the head start of Reykjavik and Oslo. The feasibility study for a China–Switzerland PTA began in November of that year.Footnote ⁶⁵

Iceland's Role in Chinese Commercial Diplomacy

China is in many ways trying to catch up with its own trade successes, especially since much of its attention over the past five years was focussed on addressing a sensitive leadership transition and ensuring that economic reform stayed on track, while preventing a high degree of backlash in terms of protests against closures and restructuring which have benefited many but have also created significant losses in certain sectors. In addition, the Chinese government has only relatively recently acknowledged the phenomenon of globalization in an official capacity and has had less time to gauge what closer economic and technological linkages will to do the role of Chinese state–society relations.Footnote ⁶⁶ Despite much ink spilled on the subject of the new Chinese market, there is no consensus as to how much economic sovereignty Beijing is willing to transfer to free trade regimes, especially larger ones, in the name of participating in liberalized trade. Turning towards bilateral PTAs, especially when seeking economic partnerships outside its immediate region, has reflected these concerns.

China's bianmen approach to cross-regional bilateral (kua quyu shuangbian 跨区域双边) PTAs, entering potentially large markets through smaller and medium-sized economies, is very much in keeping with its diplomatic initiatives of the 1990s in developing strategic partnerships (huoban 伙伴) with select states based not on military ties but rather on a mutual willingness to treat one another as equals, work towards mutual benefits and tolerate differences between themselves. China began this process by approaching large states such as Russia, Britain, France, Egypt and Saudi Arabia in the 1990s, and also signed a partnership agreement with the European Union in April 1998. Medium-sized states such as Canada, Mexico and South Africa also penned agreements with Beijing during that decade.Footnote ⁶⁷ More recently, China has shown willingness to sign more multifaceted agreements with small and medium states well outside the Asia-Pacific region, creating an increasingly intricate hub-and-spoke partnership configuration for Beijing.

The underlying goals of China's “partnership” approach with various economies have included the maintenance of a peaceful international environment in order to allow for ongoing stable domestic reform and an increase in the number of diplomatic ties with large and small powers in recognition of China's status as an imminent great power. In addition, Beijing wishes to promote multi-polarity and improve China's image in the international system, and more recently to develop Beijing's commercial diplomacy in keeping with its big market status. Although China is currently much more comfortable with larger institutions, such as the European Union and the EFTA, there remains a preference for seeking bilateral relations before multilateral ones, particularly in regions where China has less of a diplomatic history. Being a latecomer to the table of liberalized trade policies, it has had to learn about the trade preferences of many countries very quickly. A 2007 article in the People's Daily in Beijing noted the successes which China had marked in diversifying its trade partners, especially in terms of overall trade growth in the country, over the past decade.Footnote ⁶⁸ With increasing confidence in its economy and its diplomacy, Beijing has launched what many have called a “charm offensive” (meili gongshi 魅力攻势) in many parts of the world well beyond Asia, offering diplomatic deals which combine access to China's market with increased political ties.Footnote ⁶⁹ This has led to the looming question, unthinkable five years ago, as to whether China is now developing “soft power” beyond Asia to other parts of the world, including Europe.

The development of preferential trade regimes will have the ability to place China in a stronger economic role in areas outside Asia, with the Sino-Icelandic free trade talks a vital component of Beijing's emerging commercial diplomacy in Europe and elsewhere. A successful deal with one EFTA member, Iceland or another, will undoubtedly set the stage for a domino scenario among other Association members and the possibility of a Sino-EFTA multilateral agreement with the European Union, with the EU probably having to revisit the possibility of a China PTA of its own. Thus China's preferential trade agreement strategy in Europe could be considered a variation on the Maoist strategy of focusing on small and medium villages before turning attention to the cities.Footnote ⁷⁰ However, there is the question of whether Beijing might be going too far, too fast, in its race to join and develop PTAs, launching itself into the proliferation process so soon after joining the WTO and perhaps not having enough time to absorb fully the economic advantages and disadvantages of membership. Several sectors, especially those of agriculture and manufacturing, have found themselves under strain as a result of WTO commitments, and with both the WTO and increasing Chinese engagement with free trade regimes, the benefits to the state's economy will be spread very unevenly, at least during the short term, according to both sector and location.

Nevertheless, the diversification of China's trade interests invites greater examination now that the leadership transition has been completed. At the same time, should the Doha Round of WTO ultimately fail, economic agreements on the regional and cross-regional levels will be seen by Beijing as backup tools necessary to ensure that the process of trade liberalization continues to move forward. Concerns about Doha were also very much on the minds of representatives in Iceland when the PTA talks were first considered.Footnote ⁷¹ Although one author noted that the primary incentive for China to pursue a PTA with Iceland is to gain “a foothold in Europe,”Footnote ⁷² the motivations for both sides are much more multifaceted, involving not only mutual economic benefits but also gains in political and persuasive power well outside their home regions.

China has largely mitigated its concerns about loss of sovereignty as a result of economic regime engagement, a factor which, as has been argued, explained its cautious approach to liberalized trade pacts throughout much of the 1990s. What the Iceland case has demonstrated as well, however, are the potential side-effects of the global financial crisis on China's trade liberalization agenda. As many small states have found themselves especially vulnerable to economic contagion, this will also present a challenge to Beijing's pattern of engaging smaller markets for potential trade deals. Regardless of the outcome of the Iceland talks, it is unlikely that Beijing will be deterred from its side-door approach to further engagement with the European economy. China's growing support for preferential trade agreements along with a growing comfort-level with cross-regional bilateral talks may end up creating a much more intricate network of trade co-operation for Beijing reaching well beyond the Pacific Rim. With the Iceland negotiations and other potential European preferential trade negotiations to follow, a new area of study is being opened on the subject of the contributions of cross-regional PTAs to Chinese foreign policy and the country's increasing commercial diplomatic capabilities as well as its developing interdependence within the global economy.