Trade Trilateral Targets China's Industrial Subsidies

January 22, 2020

Last week, the trade ministers of the United States, the European Union, and Japan met and agreed on proposed reforms to the World Trade Organization (WTO) rules governing subsidies. Announced a day before the U.S.-China “Phase One” agreement, these reforms target trade-distorting subsidies, including those used by Beijing to support strategic industries, which were notably left out of that deal . Further, this proposal and the trilateral group that negotiated it represent a promising example of cooperation between the United States and the European Union at a time where other trade issues threaten to disrupt the transatlantic relationship.

Q1: Why was this trilateral group formed?

A1 : For years, advanced economies, led by the United States, have criticized China for its unfair trading practices and the shortcomings of existing WTO rules to resolve these issues, especially industrial subsidies. To spur WTO reform and rein in those practices, in December 2017, U.S., EU, and Japanese trade ministers announced they would “enhance trilateral cooperation” to address several “unfair market distorting and protectionist practices,” including subsidies and forced technology transfer. The three parties later formalized the grouping to focus primarily on “non market-oriented policies and practices that lead to severe overcapacity” by developing stronger WTO rules to govern industrial subsidies. The group has since met five times, finally reaching an agreement on initial reform proposals last week.

Q2: What did the United States, the European Union, and Japan agree to in their January 14 announcement?

A2: The three governments agreed on the outlines of changes to the WTO Agreement on Subsidies and Countervailing Measures (ASCM), which sets rules regarding subsidies and countervailing duties to offset subsidized foreign goods. The three officials—U.S. Trade Representative Robert Lighthizer, EU Commissioner for Trade Phil Hogan, and Japanese Minister of Economy, Trade, and Industry Hiroshi Kajiyama—suggested amendments to the ASCM aimed at capturing trade-distorting subsidies that have slipped through the cracks of international trade rules.

The trilateral group agreed that the list of subsidies prohibited under the ASCM should be expanded. Prohibited subsidies are those devised to be trade distortive and are subject to accelerated dispute settlement at the WTO. Currently, the agreement bars subsidies conditioned on export performance and subsidies contingent on the use of domestic over imported goods. The three ministers proposed that the ASCM also prohibit subsidies that are unlimited guarantees, subsidies to “insolvent or ailing” enterprises that lack a “credible restructuring plan,” also known as “zombie” companies, subsidies to enterprises that “cannot obtain long-term financing from independent commercial sources operating in sectors or industries in overcapacity,” and certain direct debt forgiveness.

The three ministers also proposed changes to the ASCM to make it easier to impose countervailing duties on actionable subsidies. Currently, a country must show that a foreign subsidy has harmed or threatens to harm its interests for a countervailing duty to be imposed. The trilateral group has proposed that the burden of proof be reversed when certain subsidies are subject to a trade remedy investigation. Those subsidies include “excessively large subsidies,” subsidies to uncompetitive firms, subsidies that create overcapacity without commercial participation, and subsidies that lower domestic input prices for exports. When pursuing countervailing duties against these subsidies, the subsidizer would have to prove that the subsidies under review do not distort trade.

The three also proposed some changes around the edges of the ASCM. They agreed that subsidies that contribute to overcapacity should be explicitly challengeable via litigation at the WTO. They also proposed that if a WTO member does not notify a subsidy as required by the ASCM, and that if a subsidy is counter-notified, it be considered a prohibited subsidy. Counter-notification occurs when a WTO member submits information on measures, such as subsidies, imposed by another WTO member but not notified to the WTO by the offending member.

Finally, the governments suggested that the ASCM prescribe a separate methodology in instances when the domestic market of the subsidizing member is distorted. This appears to suggest that non-market economies be treated in countervailing duty cases similar to how they are treated in antidumping cases. In antidumping cases involving non-market economies, such as China, the responding government may throw out prices from the home market from which the dumped product originated and instead construct a price to establish the antidumping duty rate. The three governments here have suggested that the ASCM be amended to allow for domestic prices to be rejected in instances where that market is distorted and that a new price be constructed to establish the countervailing duty rate.

Outside of subsidies, the trilateral group discussed “possible elements of core disciplines” to prevent forced technology transfer but did not release any specific text. The ministers reiterated their opposition to forced technology transfer and agreed on the need to build support among other WTO members on the need to address the issue, including through non-WTO means, such as export controls and national security investment screening regimes.

The three agreed to continue cooperation in several areas, including special and differential treatment, notification obligations, and electronic commerce negotiations at the WTO. Each of these areas is under discussion at the WTO and may see some material progress at the upcoming Ministerial Conference slated for June. Apparently left out of the trilateral meeting was discussion of the U.S. blockade on the WTO Appellate Body, which has rendered the WTO’s dispute settlement function inoperable. Tokyo and Brussels would like to see new appointments to the Appellate Body to restore the required quorum of three judges and allow the body to get back to work; they have been frustrated by the lack of clarity on what Washington would need for that to happen. Last, the governments agreed to continue cooperation in other international forums that deal with steel excess capacity and the global semiconductors market.

Q3: Does the trilateral statement entirely address complaints over Chinese subsidy and technology transfer practices?

A3: While the proposed changes to the ASCM make headway in better defining a subsidy, one crucial gap remains: the definition of “public body.” For a subsidy to fall under the ambit of the ASCM, and therefore be subject to WTO challenge and countervailing duties, it must be provided by “a government or any public body” within the territory of a member. The blurred line between state-controlled and private companies in China has frustrated U.S. efforts to impose remedies on certain subsidized Chinese imports. In a number of WTO cases, China has successfully argued that the entity providing a discounted input or cheap loan, for example, did not meet the definition of a “public body,” and, therefore, the alleged subsidy being provided did not meet the WTO definition of a subsidy.

Washington, Brussels, and Tokyo agree that the WTO Appellate Body’s interpretation of “public body” erodes the utility of WTO rules on subsidies because it is overly narrow. The three governments, however, have yet to agree on a new definition of “public body.” Absent a new definition that covers Chinese companies that are short of technically being state-owned but are still state-directed or heavily influenced by the government, the value of the other proposed changes to better counter subsidies will have limited impact. In other words, the trilateral group has made progress in defining bad behavior but still has work to do in identifying who can or cannot engage in that behavior.

Q4: What happens next?

A4: Since the WTO is consensus-based, an agreement among all 164 members is necessary before reforming existing subsidy disciplines. The trilateral group will now try to get other countries to support the proposed rules before formally submitting them to the WTO. The three sides are aiming to announce progress at the twelfth WTO ministerial conference (MC12), scheduled for June 8-11 in Nur-Sultan, Kazakhstan. While there are many other critical issues on the agenda for MC12, including reviving the Appellate Body, EU Commissioner for Trade Phil Hogan said the trilateral group plans to “strike while the iron is hot” and push for broader support on new subsidy rules, beginning at this week’s World Economic Forum in Davos, Switzerland. Despite this optimism, broad agreement, especially from large subsidizers that the rules are aimed at like China, is unlikely by MC12.

As an alternative, the trilateral partners may try to get the proposed rules approved by the Group of Seven (G7) at its June summit in Camp David, which is scheduled to overlap with MC12, before bringing the proposal to the Group of Twenty (G20) summit in November. A G20 agreement on subsidy disciplines between the world’s largest economies would help the chances of formal WTO reform. Given China’s membership in the G20, Washington, Brussels, and Tokyo will have to make a concerted diplomatic effort to get the other G20 members on board with the proposal in order to build pressure on China to agree to the new rules.

Alongside efforts to multilateralize the new proposal, the three ministers will continue to work on a stronger definition for “public body.” This will likely be a contentious issue in light of U.S. suspicions that the European Union would like to find a definition that covers China’s state-affiliated companies but not its own. The three sides will also continue to cooperate on other important WTO reforms, including disciplines to prevent forced technology transfer, improving compliance on existing notifications, self-declaration of developing economies, and setting rules for global electronic commerce.

Dylan Gerstel is a research assistant with the Simon Chair in Political Economy at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Jack Caporal is an associate fellow with the CSIS Scholl Chair in International Business.

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).