Monday, April 16, 2012

The regulation Vs subsidy debate and international trade law

Consider the three scenarios.

In the first, the government of Regulationland promulgates a law that prescribes certain domestic content requirement for equipments used in domestic solar power generators. It ensures that the local manufacturers are directly favored over imports under all conditions. It involves no direct subsidy by the government, though the entry barrier erected is an implicit subsidy protection. This is the classic pre-WTO domestic industry protection strategy.

In the second, the government of Subsidyland provides a large direct subsidy to its equipment manufacturers. This enables these manufacturers to beat off competition from their external competitors and imports. Alternatively, it also helps them outbid foreign manufacturers in their own markets. This strategy requires that the government of Subsidyland incur huge subsidy expenditures. China has been following this policy in many sectors, including renewables.

In the third, the government of Tariffland offers to purchase the output from the solar industry - generated solar power - at a (higher) concessional tariff, provided the generator meets certain local equipment sourcing requirement. This indirectly promotes local manufacturers over their external competitors. This approach is a mix of regulation and subsidy, and it reduces the huge upfront subsidy burden on governments. Canada has adopted this strategy under its FIT Program and India under its Jawaharlal Nehru National Solar Mission.

Substantively, in all the three cases, the issue involved is the same. National governments have deployed various strategies to favor their domestic solar equipment manufacturers over their foreign competitors. The objective is to promote domestic industry and prevent them from being swamped by foreign competition. Any international trade law that seeks to promote trade discrimination has to necessarily address the issues raised by all the three strategies in an equitable manner.

Why do countries adopt these different strategies? Individual nations adopt these strategies based on their respective national strengths and weaknesses - fiscal balance, strength of local industry, nature of national renewables program etc. Those unwilling or unable to spend public resources prefer the first, while those with deep pockets prefer the second. The third alternative is deployed by countries with limited fiscal space.

The international trade law provisions that regulate such measures by national governments are covered in the Article III: 4 of Trade Related Investment Measures (TRIMS). This "national treatment" rule prohibits protectionism and discriminatory treatment against imported products and in favour of domestic products. This effectively means that the regulatory restrictions of Regulationland and Tariffland are illegal.

However, and very interestingly, Article III 8 allows for payments of subsidies to domestic producers and consumers. This means that it is permissible for governments to subsidize their manufacturers by offering them direct subsidies or to subsidize consumers by providing power at concessional rates. Accordingly, the action of the government of Subsidyland and that of the Tariffland authorities in providing tariff concessions are permissible. Now there is something clearly amiss with this differential treatment.

The principle of fairness in any law demands that for any particular objective, the law should not be path dependent and should constrain or promote all sides equally. In other words, the mechanics of its implementation should not favor one country over another. In this case, given the specific objective of ensuring that foreign manufacturers of solar equipments are not discriminated against, any law should ensure that none of the three - Regulationland, Subsidyland, and Tariffland - are discriminated against or left less well-off than the others.

This effectively means that the law should equally neutralize the ability of governments to either regulate or subsidize away foreign competition. Regulation and subsidy are two sides of the same coin - a regulation is a negative subsidy (or tax) on the foreign competitor while a fiscal concession to domestic manufacturers are direct positive subsidy to them. In other words, any WTO regulation to restrict trade discrimination can itself be fair only if the degree of restraints imposed on regulation is the same as that imposed on subsidies.

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