Crossing the Line: Transnational Subsidy

China’s economic model of “state capitalism” is often a central feature of prevailing tensions in the rules-based framework of international trade. While most of the problems concerning China are not new, it has been increasingly accused of acting contrary to the letter and spirit of the World Trade Organization (WTO) rules. During its Trade Policy Review in October 2021, the United States and other WTO members criticized China for undermining the global trading system through its massive use of industrial subsidies that skew the playing field against foreign competition and result in excess capacity.

In January 2020, a joint statement issued by the United States, European Union, and Japan identified how existing WTO rules on industrial subsidies could be strengthened. The trilateral group suggested amendments to the Agreement on Subsidies and Countervailing Measures (SCM) that would expand the list of prohibited subsidies, reverse the burden of proof in case of “excessively large subsidies,” and tackle through litigation subsidies that contribute to overcapacity. Soon after, in February 2020, the United States tabled a Draft General Council Decision to rein in non-market economy practices.

Further complicating these tensions is the relatively new issue of cross-border or transnational subsidies. China’s policy of “going global” as part of its Belt and Road Initiative (BRI) has brought this issue to the fore. As countries grapple with how best to address this concern, here is a look at what these transnational subsidies mean from the perspective of WTO norms and how countries can counter these transnational subsidies leveraging domestic policies.

Q1: What is a transnational subsidy? Why is it relevant?

A1: Industrial subsidies are regulated under the WTO’s SCM agreement. According to Article 1.1 of the SCM agreement, a subsidy exists if two distinctive elements are present: (i) financial contribution by a government or any form of income or price support; and (ii) conferral of benefit to the recipient. The language of the article further specifies that a subsidy is deemed to exist if there is a financial contribution by a government or any public body “within the territory of a Member.” On first glance, it is unclear whether the phrase “within the territory” describes the public body or the location of the recipient of the financial contribution.  

Depending on the interpretation of this phrase, the applicability of the SCM agreement would affect certain practices adopted by the Chinese government in the past few years. China has developed special economic zones in some of the countries along the BRI and has plans to build more. In particular, the Chinese government has provided various types of financial assistance to enable Chinese companies to establish themselves in these industrial zones in third countries. Consequently, the export of products from these industrial zones that have benefited from assistance from the Chinese government has resulted in calls for anti-subsidy investigations.

Q2: Are transnational subsidies regulated under WTO rules?

A2: There has been no WTO dispute directly interpreting the phrase “within the territory of a Member” in Article 1.1 of the SCM agreement. In the context of discussing development aid, a note by the WTO secretariat on the Expert Group Meeting on Trade Financing observes that it is not entirely clear whether the SCM agreement applies where the subsidizing entity is not within the territory of the member whose goods are allegedly being subsidized.

Commentators have taken divergent views on this. Gary Horlick points out that the territoriality criterion was intended to exclude from the subsidy disciplines items such as World Bank loans and U.S. Marshall Plan aid paid to European countries. Hence, it was decided not to treat as countervailable those subsidies given by the government outside of its territory.

On the other hand, Gustavo Hernandez argues that the SCM agreement does not stipulate that the government’s contribution must be in the territory of the member that gives the subsidy or for the companies located in its territory. Therefore, measures that are destined to the territory of any member can be considered as subsidies by the SCM agreement. Supporting this view is Lorand Bartels, who argues that “‘within the territory’ in Article 1 does not refer to the location of the recipient of the subsidy, and ‘within the jurisdiction of the granting authority’ is not limited to territorial jurisdiction, but could extend to personal jurisdiction based on nationality.”

Somewhat finding the middle ground, Crochet and Hegde interpret the SCM agreement as imposing a territorial limitation only in the case of actionable subsidies as a result of some provisions such as the specificity requirement under Article 2. In their view, a transnational prohibited subsidy may have a remedy under the SCM agreement, whereas a transnational actionable subsidy may not be countervailed.

This discussion highlights that the applicability of the SCM agreement to transnational subsidies will remain unclear until specifically clarified by the WTO members or adjudicated in a dispute. Capitalizing on this uncertainty, the European Union and the United States are attempting to counter Chinese transnational subsidies using existing ambiguities.

Q3: What has been the European Union’s approach toward tackling transnational subsidies?

A3: In 2019, the European Commission (EC) initiated three anti-subsidy investigations targeting Chinese subsidies provided to exporters of glass fiber fabrics and filament glass fiber from Egypt and hot-rolled stainless steel flat products from Indonesia. The steel products case was terminated as a result of the withdrawal of complaint by the EU producers.

In June 2020, the EC proceeded to impose countervailing duties (CVDs) on imports of certain glass fiber fabrics produced by two Egyptian subsidiaries of a Chinese state-owned enterprise (SOE), located in a special economic zone in Egypt. Subsidies under consideration included loans by Chinese banks, loans and capital investments by the parent company in China, as well as direct subsidies provided by the government of Egypt. In order to skirt around the territorial limitation of the SCM agreement, the EC examined if Egypt could be held accountable for having “actively sought, acknowledged and adopted such subsidies for the benefit of the products made therein.” Concluding affirmatively, the EC relied on principles of state responsibility under international law to argue that Chinese subsidies had been adopted by the Egyptian government and, therefore, were essentially Egyptian subsidies. Following a similar line of reasoning, the EC also imposed CVDs on imports of filament glass fibers originating from Egypt but benefiting from Chinese subsidies. Experts have questioned the legality of this finding and argued that the SCM agreement excludes the possibility of attributing the conduct of one member to another. However, neither China nor Egypt have filed a complaint against the imposition of these CVDs with the WTO.

Coinciding with the imposition of CVDs on transnational subsidies, the EC introduced a “White Paper on levelling the playing field as regards foreign subsidies.” The white paper attempts to tackle situations where foreign subsidies are provided directly or indirectly to an entity established in the European Union, as they may distort competition within the EU single market. The European Union proposes three modules to address such foreign subsidies. Module 1 envisages a general instrument to capture distortive effects caused by foreign subsidies. This involves an ex-post scrutiny of such subsidies. Module 2 provides for an ex-ante review of distortions caused by foreign subsidies facilitating the acquisition of EU companies. Module 3 concerns government procurement and the harmful effects caused by foreign subsidies on such procedures. Additionally, the white paper also addresses ways to deal with foreign subsidies in the context of EU funding.

Following the replies received on the consultations of the white paper, the EC has put forth its legislative proposal to tackle foreign subsidies distorting the EU internal market. If approved by the European Parliament and the European Council, this broad proposal would have far-reaching consequences on foreign investments and public procurement.

Q4: What is the U.S. position on transnational subsidies?

A4: A proposal to regulate cross-border subsidies using the U.S. CVD law was first introduced in the Senate in April 2021 by Senators Rob Portman (R-OH) and Sherrod Brown (D-OH). Following this, more detailed legislation, H.R. 6121, was proposed by U.S. representatives Terri Sewell (D-AL) and Bill Johnson (R-OH)  in December 2021. An important aspect of this legislation is the proposed modification to the U.S. CVD regulations to address transnational or cross-border subsidies. The bill also contemplates enabling the Commerce Department to respond to serial violators of U.S. trade law and expedited tariff decisions in cases involving repeat offenders.

According to the proponents of this bill, China is subsidizing production in countries outside its territory as a result of expansion of the BRI. They propose giving the Department of Commerce the authority to apply CVD law to subsidies provided to a company operating in a different country. The proposed bill defines “transnational subsidy” as a subsidy “conferred by a country that is not the country in which the class or kind of merchandise is produced, exported, or sold (or likely to be sold) for importation into the United States to the producer, exporter, or supplier of the producer or exporter, of the subject merchandise.” Any such subsidy is to be treated as a subsidy having been provided by the government or public entity of the country facilitating the provision of such subsidy. In other words, the proposal advocates that transnational subsidies provided directly or indirectly be subject to CVDs.

Noting the application of CVDs by the European Union on transnational subsidies, a recent Congressional Research Service report suggests that the United States may take a similar approach by reviewing U.S. CVD laws and regulations or take an alternate approach. Based on the legislative proposals, it appears that there is support for modification of the CVD laws. Industry’s response to this approach has been varied. The U.S. Chamber of Commerce has indicated its opposition to the earlier version of the bill in the Senate. However, the American Iron and Steel Institute has expressed its support, highlighting the growing problem of Chinese steelmakers subsidizing export-oriented steelmaking facilities in some Asian countries in the BRI.

Given the uncertainty around the WTO compatibility of such an approach, the United States should consider addressing this issue at the multilateral level. In November 2021, Chinese president Xi Jinping indicated openness to negotiations on subsidies to industrial firms and SOEs. The United States, which has renewed its trilateral partnership with the European Union and Japan, should utilize this opportunity to address the potentially trade-distortive effects of China’s BRI and economic model.

William Reinsch holds the Scholl Chair in International Business at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Sparsha Janardhan is an intern with the CSIS Scholl Chair. 

Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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Sparsha Janardhan

Intern, Scholl Chair in International Business