China, climate and COVID-19: Managing subsidy spillovers

Bernard Hoekman, Douglas Nelson 08 May 2020

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The Global Trade Alert, an independent initiative that compiles data on trade policies, has documented that subsidies account for more than half of the 20,000+ measures affecting trade taken by G20 members since 2009 (Evenett and Fritz 2019). The COVID-19 pandemic has greatly increased the use of subsidies while changing the balance of traditional trade policies towards restricting exports and reducing import barriers (as countries seek to maximise domestic availability of medical supplies). These subsidies are mainly directed at supporting firms and workers directly affected by the Great Lockdown. While these measures are important and appropriate responses to the pandemic, they can give rise to very similar competitive spillover concerns as those that underpin trade tensions with China. In the EU such worries pertain to the asymmetric capacity of national governments to grant subsidies, and the consequent impact this may have on competitive conditions of the EU market (Motta and Peitz 2020). More generally, large increases in subsidies for firms already facing competitive challenges may sow the seeds for a further worsening of already significant existing trade conflicts.1   

The need for international cooperation to manage such tensions is evident. In a recent paper prepared for a Bertelsmann Stiftung-supported project on WTO reform (Hoekman and Nelson 2020), we argue for revisiting current approaches to addressing subsidy conflicts. The main WTO instrument for non-agricultural subsidy-related policies, the Agreement on Subsidies and Countervailing Measures, has important gaps and is outdated. While it prohibits export subsidies and local content requirements, and regulates what WTO members may do to use trade policy to offset injurious effects of foreign subsidies on domestic producers, the rules were crafted in the 1980s, before the rise of global value chains, the emergence of China as a major trading nation, and the growth in trade in services and the digital economy.  Investment incentives and subsidies for services activities are not covered. The rules leave unclear how to treat the activities of state-owned enterprises and whether such entities are a ‘public body’ or whether input subsidies or differential taxes, that lower domestic prices of inputs, are covered (Wu 2016). There are gaps in regulation of export support provided through export credit agencies (Dawar 2019).

Unlike tariffs, subsidies are appropriate instruments for many policy goals, but like tariffs they will generally have spillovers via effects on trade. Any subsidy policy can have spillover effects on other sectors and on other countries.  Some of these spillovers may be positive, while others may be negative. To be successful, any revision of the international subsidy regime must rest on a clear understanding that the economics and politics of subsidies differ across polities; it must consider the goals that motivate their use and the nature of cross-border spillovers they create.  If the goal is to discipline policies that give rise to spillovers, the focus of attention must be on effects as opposed to narrowly defined policy instruments.

The optimal response to spillovers will vary depending on the objective functions of both (all) national policymakers. WTO rules pay no attention to the objectives of governments using subsidies. There is no notion in the WTO of what constitutes a ‘good’ subsidy. This contrasts with the EU and some recent trade agreements that recognise the legitimate role of certain types of subsidies and establish a presumption these are not objectionable. In Hoekman and Nelson (2020), we describe an economic approach that can be used to assess whether a subsidy effectively addresses a market failure or objectives of common interest, balanced against associated negative effects on competition in the relevant market. An important feature is a shift away from rigid ‘hard law’ rules to focusing on the effectiveness of subsidies in attaining economic and non-economic objectives and their effects on markets.

The international subsidy regime can move in this direction through application of relatively simple, robust rules of thumb derived from the theory of economic policy. These recognise the right of nation states to engage in a wide range of domestically warranted subsidy policies, but also the possibility of conflicts emerging over modalities and levels of acceptable competitiveness spillovers. Making such conflicts the subject of technical discourses focused on establishing the goal of a subsidy, whether it addresses a market failure or pursues a legitimate domestic goal in a plausible way, and whether trade spillover effects are necessary to achieve the goal, may deflect much of the political heat associated with conflicts over inherently domestic issues.

A revamped subsidy regime requires participation of the US, the EU, and the People’s Republic of China – the three global trade powers. The rules must be seen as supporting the generalised gains from open trade and global production, not an attempt to isolate or ‘reform’ China. At the same time, China should accept that it has a leading role to play in the regime. The three majors should recognise that their political economies are consistent with a broadly liberal international regime even though they are, and will remain, profoundly different from one another.

Accommodating systemic differences will be facilitated by distinguishing between competitive spillovers arising from policies to address global collective action problems and market failures, and those stemming from national industrial policies. The former should be treated differently from the latter. A corollary is that governments must elucidate their policy goals. A rule of thumb creating a presumption in favor of national treatment can narrow the range of conflict, as nondiscrimination will be more efficient in attaining noneconomic objectives. Conversely, if a subsidy does not address a collective action/market failure problem, countries should be able to use countervailing duties or bring disputes alleging adverse effects.

This is not new ground for the WTO. An initial, time-limited effort was made to include a category of nonactionable subsidies in the WTO, but this expired in 1999. It was too narrow and did not distinguish subsidies that addressed (global) market failures from those that do not. It is past time that WTO members revisit what was started over 20 years ago. Preparing the ground requires a collective effort to measure and analyse the prevalence and effects of subsidies, using robust, transparent methodologies. A cooperative rather than adversarial approach is called for, centered on deliberation informed by a concerted data collection program and analysis.

Governments can identify distortions that seem to have been caused by subsidies offered by other countries, but they lack the data to illuminate that state support. A first step can be taken by launching a work program to compile information and analyse existing subsidy programs in systemically important economies, bringing together the epistemic community with expertise and interest in subsidies. At this point in time, no international platform exists that brings together cross-country national finance and economy ministries, national competition authorities, and international organisations concerned with the governance of subsidies. Building bridges across these groups can help provide a basis for mutually beneficial cooperation in this area.

Development of a body of professionally competent, peer reviewable, internationally balanced work will generate common ways of talking and thinking about the issue of subsidies.  For all the differences in national regimes, this may support agreement over time on good practice norms and standards.  As those become more widely accepted, national governments can legitimate subsidy policy internationally by adopting those standards. The more this is treated as a technical, not a political, endeavor, the greater the likelihood of an epistemic community on subsidy issues taking root. Disciplines on subsidies must begin with information, and this public good is under-supplied. Formal notifications may not be the best way to enhance understanding of policies that might be affecting the health of the trading system. Countries need to understand the incidence of subsidies before they can analyse the potential trade distortions, a necessary input into any negotiation on new rules of the game for subsidies.

Delegation of both measurement and analysis to a trusted, neutral and technically capable body is critical to support the needed deliberation by states. The OECD has played this role for decades in producing comparable analyses of subsidy regimes in agriculture. This work illustrates the importance of going beyond documenting policies to measuring the magnitude of interventions using well-defined indicators. Many international organisations collect information on and monitor the use of subsidy instruments. A joint initiative that spans the OECD and specialised international financial and development organisations in which the major emerging economies are members can provide the needed technical and analytical support. The G20 Trade and Investment Working Group is an existing mechanism that includes the major international agencies.

The WTO should provide a platform to members willing to invest resources into a work program to compile information and analyse existing subsidy programs in systemically important economies, bringing together the epistemic community with expertise and interest in subsidies. This could include organising regular thematic sessions of the WTO Committee, dealing with subsidies (Wolfe 2020) and a dedicated Working Party spanning different WTO bodies concerned with subsidy matters, including those where no rules exist presently but subsidies are an important policy instrument, notably services. Such efforts need not aim at a new multilateral agreement although that would be preferable. A plurilateral agreement among the major trading nations – China, the EU, signatories of the Comprehensive and Progressive Agreement on Transpacific Partnership and the United States – is necessary and may even be sufficient (Hoekman and Sabel 2020).

A call to launch an international work program on subsidies may be criticised as kicking the can down the road; it is not. WTO members simply do not have sufficient information to develop a common understanding of where new approaches are needed. Calling a time out on the recent focus on unilateral action and bi-/trilateral talks to establish new rules in order to develop such understanding is a necessary condition for managing the competitive tensions that arise from the use of tax/subsidy instruments. Such cooperation must recognise the important role tax/subsidy policies play in addressing market failures and global collective action problems – notably combating climate change and now the COVID-19 crisis. The need to manage the international competitive effects of COVID-19 pandemic economic support measures greatly increases the urgency of joint action to manage subsidy spillovers.

References

Dawar, K (2020), “Regulating under the radar: EU official export credit support”, VoxEU.org, 31 January.

Evenett, S and J Fritz (2019), “Going it Alone? Trade policy after three years of populism”, VoxEU.org, 23 December.

Hoekman, B and D Nelson (2020), “Rethinking International Subsidy Rules”, Bertelsmann Stiftung working paper.

Hoekman, B and C Sabel (2020), “Open Plurilateral Agreements, Global Spillovers and the Multilateral Trading System”, Bertelsmann Stiftung working paper.

Motta, M and M Peitz (2020), “EU state aid policies in the time of COVID-19”, VoxEU.org, 18 April.

Wolfe, R (2020), “Informal Learning and WTO Renewal: Using Thematic Sessions to Create More Opportunities for Dialogue“, Bertelsmann Stiftung working paper.

Wu, M (2016), “The ‘China, Inc.’ Challenge to Global Trade Governance”, Harvard International Law Journal 57(2): 261–24.

Endnotes

1 For example, Boeing and Airbus, already involved in long-running disputes over subsidies, are seeking additional subsidies in light of the economic conditions created by the Covid-19 crisis. See here and here.

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Topics:  Covid-19 Environment International trade

Tags:  China, climate, COVID-19, subsidy, trade

Professor and Director of Global Economics, Robert Schuman Centre for Advanced Studies, European University Institute; Research Fellow, CEPR

Professor of Economics, Tulane University

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