By Professor Peter Draper, Executive Director and Dr Naoise McDonagh, Lecturer, Institute for International Trade, The University of Adelaide
The distorting effects of state-owned enterprises (SOEs) and industrial subsidies on global market competition has become a topic of increasing importance for many World Trade Organization (WTO) members in recent years. There is growing pressure from key actors for WTO reform. The U.S., EU and Japan have jointly outlined a reform agenda for the WTO’s Agreement on Subsidies and Countervailing Measures (ASCM)1 , focusing on market distorting effects of state capitalism. China has offered a different reform agenda that seeks greater recognition of the role of subsidies in pursuing legitimate social and development goals, as outlined in a recent WTO communication. Subsidy usage is therefore a key development issue.
A lack of reform may lead to growing use of subsidies by developed and advanced developing countries with deep pockets in ways that ultimately widen the economic gap between countries. This is because many developing economies will not have the capacity to leverage subsidies to build their industrial bases.
“The distorting effects of state-owned enterprises (SOEs) and industrial subsidies on global market competition has become a topic of increasing importance.” #DevMattersTweet
For example, a recent Bloomberg report on the booming hydrogen energy sector suggested ‘a global race to stake claims in what could be a $700 billion business by 2050’ had emerged in a contest of ‘countries going against countries to lock in market share’. The EU alone is reported to be earmarking up to EUR 470 billion to ensure market leadership in the sector.
While we cannot yet assume these subsidies will be in violation of WTO rules, there is a real possibility that growing contestation for market share involving use of subsidies will benefit those who can afford to spend the most. Furthermore, while subsidies may result in cheaper imports of technology for non-subsidisers, these gains can be erased later once pricing power is established by market leaders.
This article does not offer a solution to the complex issues at hand, but engages a more humble endeavour to do two things. First, we lay out some core organizing principles which we argue should guide reform – since without agreement on core principles any negotiation process runs the risk of becoming unfocussed and unproductive; second, we identify a potential process through which reform discussions can constructively proceed.
Given the wide scope of proposed reforms that key players have placed on the table, there should be plenty of interest from the broader WTO membership. However, due to divergences in interests core principles will be required to guide reform discussions. We propose the following:
- Focus reform efforts on subsidies that cause large negative cross-border spill-over effects on trading partners, since these generate the greatest political and economic tensions.
- Policy space for subsidies aimed at implementing legitimate social and other policy objectives should be formalized, particularly for subsidies generating positive cross-border spill-over effects. Subsidies for infectious disease vaccines or carbon emission reduction are obvious examples here.
- Allowing for certain policy space carve outs and tailored special and differential treatment for developing countries, the principle of competitive neutrality should still be central to reform, to ensure the integrity of market competition that underpins healthy economic development.
- Governments should agree on a capped limit for the growth in subsidies allowed under arrangements such as the aggregate measure of support in agriculture. Also, special and differential treatment should be phased out as countries meet agreed upon development milestones, based on objective graduation criteria.
- The rules should be orientated by a view that permissible subsidies are always temporary, based on regular review processes backed by predictable and enforceable phase out schedules.
- Reform and clarify rules governing security exceptions to enable transparent and objective application where reasonable, and to prevent misuse when not.
Having outlined the core principles we view as appropriate for guiding a reform process we next turn to contours of a possible reform process.
“A lack of reform may lead to growing use of subsidies by developed and advanced developing countries with deep pockets in ways that widen the economic gap between countries.” #DevMattersTweet
First, given the oppositional nature of the policy recommendations a broader reform package will be needed to enlarge the scope for negotiating trade-offs. This would provide the basis on which a reduced but still worthwhile set of reforms could be negotiated. A potential architecture for a deal on industrial subsidies should draw on the Agreement on Agriculture’s colour-coded ‘boxes’2, corresponding to a spectrum of non-trade distorting subsidies to most trade distorting subsidies.
This would most likely focus on the ASCM, by expanding the coverage of prohibited subsidies, while re-establishing the expired permissible subsidies such as those supporting regional development, research and development, and environmental management. At the same time tighter disciplines governing the usage of countervailing duties will need to be on the table.
Second, if proposed reforms are to result in new WTO rules more players need to be brought into the process. The G20 is arguably a good starting point, as it contains the systemically important economies of both developed and developing status, and allows avoidance of the current gridlock in the WTO.
That said the goal is to establish a plurilateral process that can eventually feed into a broader WTO reform agenda. Two steps are envisaged as follows3:
- The G20 should establish a subsidies reform sub-committee. This would be comprised of senior trade and finance ministry officials, as these officials have responsibilities to cover trade and industrial policy, financing of such policy, as well as the wider policy dimensions that arise with subsidies. The remit of the sub-committee needs to be multi-year and not tied to the Presidential rotation of the G20 since working through reform packages that are technically complex, as well as economically and politically sensitive, will be slow. The aim here would be to devise a plurilateral path forward that could eventually feed into a WTO reform agreement.
- To stay connected to an eventual WTO reform agenda, intra-G20 meetings should be replicated in Geneva. Here G20 members based in their respective WTO delegations would have regular meetings with regard to the subsidies reform agenda. The benefits of this approach are twofold. First, it will ensure that G20 discussions are informed by broader WTO reform considerations being worked out in Geneva. Second, informal liaisons with non-G20 WTO members who are interested in subsidies reform negotiations can be engaged in an ongoing manner, with an eye towards eventual broader reforms.
In sum, we hope the above provides constructive ideas for a path towards reform for a number of key inter-related issues in the multilateral trade system that have major implications for developing countries. Furthermore, given the gridlock at the WTO it is suggested that the G20 plurilateral initiative should progress irrespective of broader WTO buy-in. Instead, willing WTO members could agree to a ‘joint statement initiative’ that could be incubated by the G20 process.
1.↩ Three joint statements can be found here (January 9, 2019), here (May 23, 2019) and here (January 14, 2020).
2.↩ Green, blue, and amber, respectively. For more context consult the World Trade Organization’s explainers, available at https://www.wto.org/english/thewto_e/whatis_e/tif_e/agrm3_e.htm.
3.↩ These are drawn from a longer policy brief the authors have previously written on the topic: ‘Industrial Subsidies, State-Owned Enterprises and WTO Reform: Prospects for Cooperation’, Institute for International Trade, PB08, 2020, https://iit.adelaide.edu.au/news/list/2020/09/02/industrial-subsidies-state-owned-enterprises-and-wto-reform-prospects-for