TWN Info Service on WTO and Trade Issues (June 07/16)

18 June 2007

US proposes new WTO ban on five types of industrial subsidies

A new controversy has arisen in the WTO over a recent US proposal to ban several types of industrial subsidies as part of the Doha Round.

Many developing countries make use of the practices which the US now seeks to ban.

Experts and diplomats fear that the suggested ban will severely constrain the ability of developing countries to industrialise.

They also decry the double standards in the proposal.

First, the developed countries have used these subsidies, particularly when they were at their development phase.

Second, the US seeks to ban these subsidies only in the industrial sector, while exempting the agricultural sector, where the developed countries give massive subsidies.

Below is a report of the US proposal.  It was published in SUNS on 6 June.

Future issues of TWN Info will give more reports of experts' views and of the WTO meeting that discussed this issue.

Best wishes
Martin Khor

US proposes new WTO ban on five types of industrial subsidies

By Martin Khor (TWN): Geneva, 5 June 2007

The United States has proposed that the World Trade Organization prohibit several types of subsidies that governments provide to their firms in the industrial sector.

The proposal was submitted by the US on Monday (4 June) to the Negotiating Group on Rules as part of the overall Doha Work Programme.

If eventually adopted, the proposal will have significant implications for industrial development, since many developing countries make use of the practices which the US now seeks to ban.

It is already generating serious concern among trade analysts and experts from developing countries, who fear that the suggested ban will severely constrain the ability of developing countries to industrialise.

"The proposal is very much against the interests of developing countries, which will lose the flexibility of making use of these subsidies," said Bhagirath Lal Das, an international trade expert who was formerly UNCTAD's Trade Director as well as a former Indian Ambassador to the GATT. (See comments at end of article).

The developed countries have also been making use of these types of subsidies, particularly when these countries were at their development phase. Now that the US has become the world's most economically powerful country, it is seeking to prohibit practices in other countries that it also used as part of its industrial policy.

Moreover, the US seeks to ban these subsidies only in the industrial sector, while exempting the agricultural sector. In agriculture, the US is providing massive domestic subsidies in many forms, including some of the varieties that it seeks to prohibit in the industrial sector.

The US, together with the European Union, are also resisting proposals by developing countries to place disciplines on the Green Box subsidies in agriculture. The major subsidizing developed countries want to preserve their ability to continue providing Green Box subsidies without limits and with few conditions, even though there is evidence that many of these subsidies are trade distorting.

The US proposal is being made in the Negotiating Group on Rules, which is working under the Doha mandate to clarify and improve existing trade rules, including those on anti-dumping, an area in which the US has been criticised for protectionist purposes.

The proposal seeks to amend the WTO Agreement on Subsidies and Countervailing Measures (SCM) by adding five new types of subsidies onto the current list of subsidies that are prohibited.

The SCM Agreement presently prohibits two types of subsidies: export subsidies, and subsidies that promote import substitution, i. e. the use of domestic goods over imported goods.

Several studies (including one recently by UNCTAD) have made the point that developing countries are disadvantaged by the SCM Agreement because they are prevented from making use of subsidies that the industrialized countries and the newly industrializing countries used when they were in their industrialization phase of development.

This disadvantage will worsen if more categories of subsidies are added to the prohibited list, as is now proposed by the US.

Besides expanding the list of prohibited subsidies, the US paper also proposes to introduce a new provision under Notifications (Article 25). The proposed provision requires WTO members to notify the WTO of details of government or public-sector ownership of an enterprise.

The information to be notified includes: (1) any changes in such ownership or provision of equity capital, as well as explanations whether the government investment is consistent with the "usual practice of private investors" in the country; and (2) the percentage of government or public-body ownership in the enterprise and terms and conditions of any government financial contribution to the enterprise (including government revenue foregone or not collected).

The proposed notification is presumably to assist the WTO and its members to monitor and track down any practice of governments providing the prohibited subsidies to enterprises.

However, the US makes clear that its proposal is only for the industrial sector. "In light of the ongoing agriculture negotiations, the proposed new subsidy rules are not intended to apply to the agriculture sector," says a press release of the US Trade Representative.

The US proposal would prohibit the subsidies if they are "specific" (i. e., are only given to a particular company or industry) and if they benefit a product that is exported or competes with imports.

The five types of subsidies are: (1) government payments to companies to cover operating losses; (2) forgiveness of government-held debt; (3) government lending to "uncreditworthy" companies; (4) government equity investments in "unequityworthy" companies; and (5) other financing, such as "royalty-based" financing that is not commercially available.

US Trade Representative Susan Schwab said that stronger WTO rules will rein in the use of industrial subsidies, and that in an increasingly global economy, foreign government subsidies provide a distinctly unfair competitive advantage.

"The subsidies we want to prohibit maintain inefficient production capacity in industries ranging from steel to semiconductors. Stronger rules for these types of subsidies would address significant trade-distorting practices of many of our trading partners that often lead to unfair trade."

However, some trade experts of developing countries see the US move differently.

"The United States wants to preserve the use of subsidies that it continues to use, especially in agriculture where it is refusing to even discuss changing the rules to limit and discipline the Green Box subsidies," remarked Chakravarthi Raghavan, Editor Emeritus of the SUNS and a veteran analyst of the GATT/WTO trading system.

"The US proposals could nullify the effect of some of the WTO rulings against the United States, and enable without challenge its plans for ethanol production from agricultural food crops.

"Even more, the US is making some of the current import and export subsidy practices, that are now hit only under Art. 6.1 of the SCM (serious prejudice to exports), to be 'prohibited subsidies' and thus 'illegal'. The United States blatantly is seeking to prevent other countries, and more so the developing countries and their enterprises from emerging to challenge the dominance of the US companies. What they practised before they now want to prohibit others from doing.

"The developing countries would do well to summarily reject the US proposals and refuse even to discuss them."

In its paper, entitled "Expanding the Prohibited Red Light Subsidy Category", the US proposes revised text for Article 3 (on prohibited subsidies) and Article 25 (on notifications) of the SCM Agreement.

It states that this submission is "made without prejudice to subsidies rules developed in the agriculture negotiations. In light of the ongoing agriculture negotiations, the proposed new disciplines discussed in this paper are not intended to apply to the agricultural sector".

The paper proposes that five types of subsidies are to be added to the subsidies that are prohibited under the SCM Agreement.

Two of these subsidies are now considered "Actionable Subsidies" in Part III of the Agreement. They are currently not prohibited, but members cannot use actionable subsidies which cause adverse effects on other members.

The US now proposes to move these two types of subsidies from the "actionable" section (Part III) to the "prohibition" section (Part II) of the Agreement.

The two types of subsidies are: (1) subsidies to cover operating losses sustained by an industry, or by an enterprise; and (2) direct forgiveness of debt.

The paper then proposes that three additional types of subsidies (which are presently not prohibited nor actionable subsidies) which it says represents "the most extreme forms of government economic intervention" be included in an expanded prohibited category. These additional subsidy types include: (1) loans to uncreditworthy companies; (2) the provision of equity capital in a manner inconsistent with the usual investment practice of private investors; and (3) other forms of financing that a company would be unlikely to receive from commercial sources.

Two other proposed provisions are: (1) a requirement that the product that benefits from the new class of prohibited subsidies be exported or competes with imports; and (2) if the subsidizing Member can demonstrate that the subsidy provided does not have a positive effect on the capacity and sales of the subsidy benefit recipient, the prohibition will not apply. The US says that these provisions are to ensure that subsidies that have no trade-distorting effect will not be subject to the new prohibition.

The draft text put forward in the US paper that adds new categories to the types of subsidies that are prohibited by the SCM Agreement is as follows:

"Except as provided in the Agreement on Agriculture, and provided that such subsidies are specific, and the subsidized product is exported or competes with imports, the following subsidies within the meaning of Article 1 above, shall be prohibited:

(a) the direct transfer of funds to cover operating losses sustained by an enterprise or industry;

(b) forgiveness of debt, i. e. forgiveness of government-held loans or other instruments of indebtedness, and grants to cover repayment of government-held loans or other instruments of indebtedness;

( c) loans and other instruments of indebtedness provided directly to enterprises that are uncreditworthy;

(d) provision of equity capital where the investment decision is inconsistent with the usual investment practice (including for the provision of risk capital) of private investors in the territory of that Member; and

(e) other financing (i. e., "royalty-based" or "sales-contingent" financing or other similar financing) to an enterprise or project that otherwise would be unlikely to receive such financing from commercial sources.

The draft text also contains several footnotes that give details, explanations and interpretations of the five types of subsidies.

The draft text also states that subsidies in the above paragraph shall not be prohibited if the subsidizing Member demonstrates that the subsidies have not had a positive effect on the capacity and sales of the subsidy benefit recipient.

It states further that the following are not prohibited under the above paragraph: paragraph 3.2: (a) subsidies provided pursuant to small business programs; (b) subsidies to public utilities (e. g. publicly-owned enterprises that supply electricity and water); and ( c) subsidies necessary to ensure the provision of arms, ammunition or war materiel indispensable for national security or national defense purposes.

Another proposed new article in the US paper deals with Notifications. It requires WTO members to notify the Committee of the following information regarding ownership of an enterprise by a government or public body:

(a) with respect to the provision of equity capital by any government or public body: the date and terms of the transaction; and an explanation of the consistency of the investment with the usual practice of private investors in the territory of that Member;

(b) with respect to any government majority-owned, as well as government-controlled enterprises: the percentage of direct and indirect ownership that the government or any public body holds in the enterprise and the terms and conditions of any financial contribution by any government or public body to the government majority-owned or controlled enterprise, excluding non-specific instances in which government revenue that was otherwise due was foregone or not collected.

The notification requirement does not apply to a publicly-owned utility or financial institution.

The US proposal is already generating concern among policy makers and analysts from developing countries.

"This new proposal of the US seeks to expand the scope of the 'prohibited subsidy' substantially and it will constrain the countries, particularly the developing countries, in providing support to their industrial units that sometimes face temporary problems," commented Bhagirath Lal Das, the international trade expert.

"At present, the prohibited subsidies are export subsidy and import substitution subsidy. Thus, they are directly linked to export and import. Provision of subsidy for production is currently permitted except if it causes injury or serious prejudice to some other country," added Das.

"Hence, a country can go on providing subsidy for production until some country comes up with a complaint that such a subsidy is causing injury or serious prejudice to it, for example, by harming its domestic production by the import of such subsidised products or constraining the export of its own product into the subsidising country.

"The developing countries can use this flexibility to provide subsidy to their industry until some other country comes forward with a complaint or grievance.

"This flexibility will be lost if the US proposal is accepted. The proposal is mainly targeted at ailing industries/units, a situation that can be quite prevalent in the developing countries. While facing competition from the firms of the developed countries, they may sometimes need support for survival. And the new proposal will stop the support from the government in such cases.

"The proposal is very much against the interest of the developing countries. They should certainly oppose it."