Wednesday, January 18, 2012

"Subsidies" and the WTO Agreement

The Subsidies and Countervailing Measures (SCM) Agreement (overview here) of the WTO is an interesting document in many respects. It is also a reflection of the fact that no agreement can be frozen in time and should be dynamic enough to reflect the changing environment.

For the record, the SCM Agreement creates two basic categories of subsidies - those that are prohibited those that are actionable. The former consists of export subsidies (those subsidies contingent on export performance) and local content subsidies (those contingent on the use of domestic over imported goods), both of which directly affect trade and infringe on others interests. The later though not prohibited, can be challenged either through multilateral dispute settlement (in case of exports having to compete with subsidized products) or through countervailing duties (in case of injury to domestic industry due to imports from the infringing country).

Of great relevance to countries like India, especially in light of the recent controversies over trade in renewable power generation equipments, is the restrictive nature of the definition of subsidies within the SCM. Only a measure which is a "specific subsidy" within the meaning of Part I is subject to multilateral disciplines (or the rules regarding whether or not a subsidy may be provided by a Member) and can be subject to countervailing measures. I can see atleast three reasons why this definition is restrictive and comes in the way of achieving fairness in multilateral trade.

1. The agreement requires that any subsidy involve a "financial contribution" that involves a "charge on the public account". They include grants, loans, equity infusions, loan guarantees, fiscal incentives, the provision of goods or services, the purchase of goods. They do not include measures and policies of government that while are not explicitly subsidies, do end up distorting competition. This effectively means that any indirect subsidy by way of "revenues foregone" - lower (than cost-recovery) utility tariffs, low land prices, repressed labour market, artificially cheap capital and so on - are not prohibited. At the least, it is difficult to prove that they attract the provisions of the SCM.

2. The "specificity" provision is another restriction that effectively rules out making a case against universal, economy-wide distortion generating subsidies. The overview to the SCM Agreement makes this very clear,

Assuming that a measure is a subsidy within the meaning of the SCM Agreement, it nevertheless is not subject to the SCM Agreement unless it has been specifically provided to an enterprise or industry or group of enterprises or industries. The basic principle is that a subsidy that distorts the allocation of resources within an economy should be subject to discipline. Where a subsidy is widely available within an economy, such a distortion in the allocation of resources is presumed not to occur. Thus, only "specific" subsidies are subject to the SCM Agreement disciplines.

The underlying premise that a widely available subsidy is non-distortionary holds good only in the context of a closed economy. However, when seen in the context of an open economy facing international competition, such one-side subsidies end up unfairly favoring that side over its competitors.

3. The requirement that any subsidy provide a "benefit" also makes the definition of subsidies restrictive. Benefits, by implication, have a reference to the domestic market place. If the subsidies in that market are universal, then there is no specific "benefit" that adheres to any producer.

In simple terms, the definition of subsidy in the SCM agreement fits in nicely into the international trade strategy and national industrial policy followed by fiscally strong countries like China. It ensures that the sort of subsidies that China today provides to its manufacturers do not infringe the provisions of the SCM Agreement. Even if it do so, it would have been very difficult to establish that these are not permissible subsidies.

With regulatory restrictions (or tariff and quota barriers) prohibited by the national treatment condition of TRIMS and China-type manufacturer subsidies made impossible due to their weak fiscal positions, manufacturers from developing countries are left to fight a lop-sided battle. Their only strategy to combat such trade competition is to indulge in your own set of China-style economy-wide structural subsidies. However, countries like India, which do not have the deep pockets to support their domestic industries, are left with no means to fight such trade competition.

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