China’s currency regime is legitimately challengeable as a subsidy under ASCM rules

John Magnus, Timothy Brightbill

16 April 2010

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In the US and in many other countries, economists and policymakers generally agree that the Chinese government undervalues its currency. Opinions on the amount of misalignment vary, but experts at the Petersen Institute for International Economics recently estimated that the renminbi is undervalued by 25% on a trade-weighted average basis, and by about 40% against the dollar (Bergsten 2010b).

There is also general agreement on the mechanism used to accomplish this: the Chinese government prohibits all dollar-to-renminbi exchanges except those to which it is a party (either directly or through official forex banks) and requires authorised exchange transactions to occur at a government-determined, administered rate. Apart from these tightly-controlled circumstances – reportedly involving about $1 billion daily (Bergsten 2010b) – there is no place on earth where willing suppliers and demanders of renminbi can connect, and where economic forces that might otherwise drive up the market-clearing price for renminbi can find expression.

There is also broad consensus that this undervaluation meets at least the lay definition of a “subsidy,” in that it makes exported Chinese products more competitive (less expensive) than they otherwise would be. Nobel-winning economist Paul Krugman has gone further, terming China’s exchange-rate policy “mercantilist” and “predatory,” and opining that it gives Chinese manufacturing a large cost advantage and causes huge trade surpluses (Krugman 2010).

However, there is a less robust consensus on whether China’s policy meets the narrower, legal definition of a “subsidy” applicable under the WTO Agreement on Subsidies and Countervailing Measures (ASCM) and under national countervailing duty (CVD) laws. We address this important question, starting with the context of US CVD cases where the issue has most squarely arisen.

Should the US Commerce Department investigate currency subsidy claims?

The US Commerce Department began applying the US CVD law to Chinese products in 2007. Since that time, US industries have filed numerous petitions asking Commerce to include Chinese currency practices among the investigated subsidy programmes. Although the standard for initiating with respect to an individual subsidy programme alleged in a CVD petition is relatively low, Commerce has each time refused to investigate currency subsidies. In the first few China CVD cases, Commerce simply said, without detail, that the currency subsidy claims were inadequately pleaded. Yet the petitions did allege, with reasonably available supporting information, all the required elements: financial contribution (which exists any time a government and a company trade one thing for another, even currencies), benefit (the petitions adequately alleged, although one could not say that they fully proved, undervaluation), and specificity (more on this below). So Commerce was wrong, but there was no way to tell where it went wrong.

In a more recent case on coated paper, Commerce at last named the required element that in its view had been pleaded insufficiently: specificity.1 In particular, Commerce stated: “Petitioners have failed to sufficiently allege that the receipt of the excess renminbi is contingent on export or export performance because receipt of the excess renminbi is independent of the type of transaction or commercial activity for which the dollars are converted or of the particular company or individuals converting the dollars."2

By basing its decision on specificity, Commerce seems to be accepting (or at least assuming) that the currency subsidy claim meets the “financial contribution” and “benefit” requirements – in other words, that China’s currency regime involves “subsidies,” but not necessarily countervailable subsidies. There would be no point analysing the specificity of a programme that does not involve financial contributions, or that involves financial contributions but no benefits.

In any event, Commerce’s statement on specificity has some superficial plausibility since tourists and foreign investors receive the same exchange rate as Chinese exporters when converting dollars to renminbi; if there is any excess, it is made available to “dollar sellers” in all three categories. However, those familiar with US and international law on specificity regard Commerce’s position as indefensible. Among other things, the vast majority (reportedly at least 70%) of the subsidy goes to companies who can receive it only by exporting. This is precisely the fact pattern that led the WTO to decide in 2002 that the US’ extraterritorial income regime constituted a countervailable subsidy. In particular, the WTO Appellate Body found that the subsidy conferred by the extraterritorial income regime – an interim measure promulgated en route to full repeal of the earlier foreign sales corporation scheme – was export-contingent.3 Export-contingent subsidies are automatically specific.

Under WTO precedent, in other words, China’s currency regime qualifies as export-contingent, and therefore as specific. The US standards on export-contingency and specificity are no harder to satisfy than the WTO standards, which makes it particularly surprising that Commerce has refused even to collect and analyse data on the specificity of this alleged subsidy. Moreover, binding US legal authority makes clear that the specificity test is only intended to avoid absurd results like countervailing the benefit arising from truly public goods provided by governments (such as police protection and public highways).4

In short, while Commerce appears to be trying to defer to the Treasury Department on currency matters, it faces great difficulty in justifying its failure to investigate what industry experts have called “the greatest subsidy of them all” (Bergsten 2010a). This difficulty seems likely to increase, as Congress is displaying growing impatience.5

This is not to say that Commerce, if it investigates, will necessarily find and countervail a currency subsidy. The financial contribution and specificity elements should pose no significant hurdle, but that still leaves the question of benefit. Commerce might be unable to conclude confidently that a benefit exists (that the exchange rate provided by the Chinese government is misaligned in the relevant direction), or – more likely – to quantify precisely the amount of such a benefit. However, both in practical terms and within the unique atmosphere of US administrative law, Commerce can only sort out these difficult issues by investigating.

Such an investigation would admittedly be dramatic, and perhaps even traumatic. It would push Commerce to the centre of the political spotlight concerning a difficult international issue on which the Treasury Department has led for many years. And merely preparing, much less actually sending to the Chinese Government, a CVD questionnaire aimed at eliciting information that would be needed to make a “benefit” determination on currency would create diplomatic shockwaves. However, despite these acknowledged political risks, such an investigation is in fact the correct result from a legal perspective.

We are convinced that however much it wishes to avoid (or others wish it to avoid) doing so, Commerce should and eventually will investigate currency subsidy claims in China-CVD cases. It will conclude by making a professional, evidence-based determination on the fundamental legal issue at stake: whether the exchange rate provided by the Chinese government during the relevant investigation period resulted in giving Chinese companies a countervailable benefit in the form of too many yuan when they converted dollars earned by exporting.

Would a direct ASCM-based claim be viable for the same reasons?

The US and other countries have a second alternative – a direct challenge of China’s currency regime as a subsidy, filed under the ASCM. ASCM Article 4 allows challenges to “prohibited” subsidies – including (as defined in Article 3) those that are export-contingent – and ASCM Article 7 allows challenges to other subsidies that can be shown to cause adverse effects.

Such a direct challenge would be viable. That does not mean it would necessarily succeed, either in producing a legal victory or in prompting actual changes in China’s behaviour. But the claim could be legitimately asserted, and has more merit than many other WTO claims that have been fully litigated.

A direct challenge would most likely allege that China’s exchange regime results in export-contingent, and therefore prohibited, subsidisation. The financial contribution and export-contingency elements of this claim would have a strong chance of success for the reasons stated above. The key difference would be that in this scenario, the WTO panel (rather than the Commerce Department) would have to decide in the first instance whether the Chinese government’s financial contributions confer a “benefit.”6

Some would say this is the smartest strategy, at least in terms of securing a favourable result in dispute settlement. Historically, the WTO dispute system has tended to favour plaintiffs and find that challenged measures violate one or more WTO provisions; the system has also shown a pronounced pattern of ruling against trade remedy (antidumping and countervailing) measures. Accordingly, the US (or another WTO Member) might be better off appearing in Geneva as a complainant, rather than seeking to defend a CVD measure. Others would argue the opposite: the WTO rules assign the burden of proof to a complainant, and a China currency challenge is precisely the kind of difficult case where the burden of proof might well dictate the outcome. It would be better, under this view, to act first under national law and then be prepared to defend (if necessary) a challenge of the resulting CVD measures.

Is WTO litigation desirable?

The fact that a colourable WTO claim exists does not mean, for some, that WTO litigation is an acceptable scenario. In a recent Wall Street Journal article, former Appellate Body chair James Bacchus advised against both a direct WTO challenge and application of CVD measures that could then trigger a WTO complaint (Bachus 2010). His argument has three broad themes – none of which survive close examination.

First, Bacchus asserts, such a case would cause grave harm to the WTO. “Whether the US or China prevailed, a WTO case would be self-defeating for both countries and disastrous for the global trading system. … The strain of dealing with [such a] case would stretch the political limits of the WTO. Both China and the US depend daily on the existence and the reliability of a rule-based global trading system. Do they really want to risk it over this issue?”

We disagree. Contending that the WTO Dispute Settlement Body (DSB) system is not robust enough to process a prohibited subsidy claim (or a challenge to a CVD measure) is an odd thing for a former Appellate Body chair to do. Commentators have said the same thing about other difficult cases – from Japan-Film and EU-Beef in the 1990s to the Large Civil Aircraft cases more recently. Concerns that individual cases would swamp the system have always proved to be unfounded; the system has proved to be remarkably durable, even when it has produced questionable results.

In fact, use of WTO dispute settlement is desirable where there is a legitimate disagreement about a Member’s compliance with obligations, where substantial trade effects appear to be present, and where efforts to negotiate have stalled to the point where they need a boost from a DSB -adopted decision. Funnelling commercial disputes with China into this system was, after all, a key rationale for facilitating China’s WTO accession nine years ago.

Second, Bacchus raises doubt about the viability of the likely US legal arguments, saying “it is one thing to make an assertion [about the facts here meeting ASCM requirements] as part of the political debate in Washington; it is quite another to prove it in an international legal proceeding before WTO judges in Geneva.” In the context of a Chinese challenge to countervailing duties imposed by the US, of course, it is China that would have to prove that the ASCM requirements were not met. And getting CVDs imposed in the first place would require a US petitioner to do far more than simply make “assertions” as part of the US political debate.

Third, Bacchus predicts one other undesirable outcome: “[T]he example of such cases could inspire still more WTO cases – against China and the US”. Again, it is unclear why additional WTO cases are necessarily a bad thing, particularly if they identify additional prohibited or actionable subsidies. The elimination of trade barriers in all forms is the primary mission of the WTO, and use of the dispute settlement system is a proper way of pursuing this goal. Mr. Bacchus concludes that “[o]n this issue especially, litigation should be the last resort.” Perhaps there really is something special about currency exchange transactions, in the universe of financial contributions, such that WTO litigation would indeed prove to be toxic. If so, China can act accordingly when deciding whether to challenge a US countervailing measure. And it is not as if exchange-rate behaviours were totally avoided by the drafters of the GATT and the other WTO agreements; these behaviours are even mentioned in the ASCM itself.

Conclusion

We believe there are strong legal and factual arguments that China’s currency regime meets not just the lay or economic definition of a subsidy, but even the narrower legal definition applicable in ASCM cases and CVD cases. While we cannot predict the outcome of a Commerce Department CVD investigation or a WTO complaint, there is a solid legal basis for both. And the fact that China’s alleged currency misalignment is a difficult, high-profile matter with profound economic and political implications is not a reason to shy away from using available legal tools in response to it.

Authors' note: Views expressed are personal, not necessarily shared by any client.

References

Bacchus, James (2010), “Don't Push the WTO Beyond Its Limits”, The Wall Street Journal, 25 March.

Bergsten, C Fred (2010a), “Jobs on Main Street, Customers Around the World: A Positive Trade Agenda for US Small- and Medium-Sized Businesses”, Statement at Office of US Trade Representative conference entitled, 21 January.

Bergsten, C Fred (2010b), “Correcting the Chinese Exchange Rate: An Action Plan”, Testimony before the House Ways and Means Committee, 24 March.

Krugman, Paul (2010), “Chinese New Year”, The New York Times, 1 January.


1 Certain Coated Paper Suitable for High-Quality Print Graphics Using Sheet-Fed Presses from the People’s Republic of China: Initiation of Countervailing Duty Investigation, 74 Fed. Reg. 53,703, 53,706 (Oct. 20. 2009).
2 Id. at 53,706.
3 See US – Tax Treatment For "Foreign Sales Corporations" -- Recourse To Article 21.5 of the DSU by the European Communities, WT/DS108/AB/RW (Jan. 13, 2002) at paras. 113-120. As the Appellate Body explained at para. 120, “the ETI measure grants a tax exemption in two different sets of circumstances: (a) where property is produced within the US and held for use outside the US; and (b) where property is produced outside the US and held for use outside the US. Our conclusion that the ETI measure grants subsidies that are export contingent in the first set of circumstances is not affected by the fact that the subsidy can also be obtained in the second set of circumstances. … The subsidy granted with respect to the property produced within the US, and exported from there, is export contingent within the meaning of Article 3.1(a) of the SCM Agreement, irrespective of whether the subsidy given in respect of property produced outside the US is also export contingent.”
4 See Uruguay Round Agreements Act, Statement of Administrative Action (1994), at 259 (specificity test is supposed “to function as an initial screening mechanism to winnow out only those foreign subsidies which truly are broadly available and widely used throughout an economy”); id. at 243 (“Consistent with longstanding US practice, government assistance that is both generally available and widely and evenly distributed throughout the jurisdiction of the subsidising authority is not an actionable subsidy.”) (emphases added).
5 On March 16, 2010, a bipartisan group of 14 US Senators introduced S. 3134, “The Currency Exchange Rate Oversight Reform Act of 2010,” which would, among other things, pressure Commerce to investigate currency subsidy claims in China-CVD cases.
6 It is also possible that “expert witness” inputs obtained by a WTO panel from the International IMF -- and perhaps also from the Permanent Group of Experts established under the ASCM -- would work differently in these two scenarios.
 

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Topics:  Exchange rates

Tags:  China, exchange-rate policy, subsidy

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