Diffusing the Conflict Around Industrial Subsidies

The US is accusing China of distorting international competition through industrial subsidies to private and state-owned enterprises. This is one of the core elements of the trade conflict between the two nations. Multilateral rules disciplining the use of industrial subsidies are currently not very far developed – but could be a key feature in assuring a level playing field amongst trading nations. In two new publications, GED looks into whether multilateral disciplines on subsidies are indeed needed and if yes, how the trade community should go about negotiating them.

The Global Trade Alert database lists subsidies are one of the internationally most widespread sources of distorting trade outcomes. It’s not just China; many countries make use of subsidies, including developed economies. And there can be a good economic reason to make use of subsidies, and they can help to address market failures and help to proper economic development in areas – such as climate-friendly technologies, for example. But subsidies can also be harmful, for example, when they are used to keep unprofitable enterprises alive or when they lead to overcapacity in certain sectors. Dealing with the subject of subsidies requires a subtle approach, not quick and easy, hard, and fast rules.

As this is one of the main bones of contention, GED has looked into this matter in three publications.

• The first – by Bernard Hoekman and Doug Nelson – take stock of existing multilateral rules on industrial subsidies and discusses options to introduce improvements.
• The second, by the same authors, builds on the first paper but develops in greater detail, which approaches to subsidies make economic sense, which ones are politically viable, and how dialogue on subsidies should be structured.
• The third – by Robert Wolfe – refers to a similar debate about agricultural subsidies in the 1980s and distills policy implications on that basis.

Let’s look into these three publications in more detail. After documenting the widespread use of subsidies, the first publication discusses the current state of multilateral rulemaking on subsidies and state-owned enterprises in the WTO. While there are rules that cover partial aspects if subsidies, such as in agriculture or on ways to use countermeasures against their possible negative effects, a large share of WTO membership agrees that existing rules are insufficient.

In order to address this, the first logical step is to improve the data on the use of subsidies. Currently, notifications of member states are often incomplete, and there is a lack of transparency and analysis on the impact of subsidies. Once transparency has been improved, the analysis of the use of subsidies could, for example, be included in the trade policy review mechanism so that there is an institutionalized routine, analyzing and scrutinizing subsidy practices.

For rulemaking, the paper makes two broad suggestions: First, EU regulation of state-aid could be a source of inspiration. The EU has defined clear criteria that allow it to classify certain state-aid as permissible or not. Within the EU system, there are also areas in which subsidies are generally allowed as they are deemed to have positive horizontal effects – for example, in the areas of research or environment.

It is also possible to draw on experiences from agricultural subsidies. Not all kinds of subsidies have similar competitive effects. Depending on how competition distorting an effect is, it is placed within a green (generally permissible), amber, or red box. This approach could also be applied to different types of industrial subsidies. The paper also calls for bringing in various stakeholders and not only leave this debate to trade policy negotiators: the involvement of officials of national competition authorities and finance ministries could help to overcome national silo thinking and to set the ground for a more constructive policy dialogue at the WTO.

The second paper begins with a look into economic theory and political practice regarding subsidies. Based on that, it outlines which economic approaches have been chosen to deal with negative spillovers of subsidies and which of those would be politically viable in the context of international cooperation. Based on this, the authors discuss ways to move forward, which criteria should be looked into, and which international fora should be participating in this work.

The third paper looks closer into how transparency and analysis can help to develop better rules. It does so by looking closer into the PSE (Producer Subsidy Equivalent) – an index developed by the OECD to analyze agricultural subsidies – that helped develop rules in this area in the course of the Uruguay Round. The PSE was developed in the context of severe clashes over agricultural subsidies in the early 1980s.

It computes the impact of different kinds of subsidies on producers and customers, thus creating better transparency. Interestingly, this approach was pushed by finance ministries, not trade ministries, further underlining the point of the first paper that a multi-stakeholder approach is needed. In the Uruguay Round and subsequently, trade negotiators could rely on the analysis based on the PSE when they developed disciplines for agricultural subsidies.

However, there are also limitations to what extent the PSE-approach can be applied to industrial subsidies. In agriculture, it is relatively easy to compute the gap between the domestic price for a good and the world price – which is necessary to infer the effect of a subsidy. Because industrial production is much more integrated through global value chains – different production steps take place in different locations, it is much harder to compute such a difference between world and domestic prices for industrial goods.

These new two papers are part of GED’s project on reforming global trade governance. Industrial subsidies are a key issue of concern that ought to be addressed. Over the next few weeks, further papers dealing with trade governance and the WTO will be published, including improving working practices in WTO committees, finding more flexible ways of rulemaking within the WTO, and further contributions on WTO reform.