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Are we headed for a Subsidy War? – A new front has opened as de-globalisation marches on

30 November 2022 | Insight
Legal Briefings

With geopolitical tensions rife and countries retreating behind economic barricades, subsidy policies have become weaponised

Crises provoke government action and governments often react to crises with subsidies. Consider recent history. It barely needs stating that widespread subsidisation occurred throughout the world in response to the financial crisis, the Covid-19 pandemic, the resulting supply chain disruption and the more recent energy emergency.

The traditional view in trade circles has been that countries can subsidise domestic companies to promote their own policy objectives but other countries are allowed to defend themselves against the adverse effects based on their own interests. While subsidies can be legitimately limited exclusively to a country’s own companies, they should not discriminate against imports or be confined to exports.

The traditional means of defending against foreign subsidies was to impose countervailing duties on imports of subsidised products to offset the subsidy. However, this has long been a source of disputes. Countries normally do not admit their own interventions are subsidies but rather label them as “support” or “incentives” or otherwise legitimate responses to perceived problems; they therefore resent being told to cease such measures. In addition, responding to a foreign subsidy can often be a good opportunity to exaggerate the required remedy to advantage or protect one’s own industry. That has also been a fertile source of trade disputes.

As a result, the World Trade Organization (WTO) provides definitions of what may be deemed a subsidy, what degree of injury or adverse effect may justify offsetting or retaliatory action and the permissible extent of that offsetting or retaliatory action. Indeed, the WTO Agreement on Subsidies and Countervailing Measures (SCM Agreement) goes further and expressly prohibits, at least as regards trade in goods, any action in response to a subsidy that goes beyond what is permitted by that agreement.

This consensus appears to be breaking down.

One of the reasons for the US neutering of the WTO dispute settlement system has been that the definition of a subsidy in the SCM Agreement does not cover much claimed subsidisation by state-owned enterprises in China. The EU now appears to have accepted that the WTO is “broken” and is joining the US in calling for reform, including further action against Chinese subsidies.

The WTO Agreement is increasingly perceived as out of date and inflexible. Thus, it took over 20 years for WTO Members to agree to designate subsidies for illegal fishing as prohibited and subject to retaliatory action. The WTO abandoned its attempt to designate certain meritorious subsidies as “non-actionable” by allowing Part IV of the SCM Agreement, that would have protected them from retaliation, to expire in the year 2000. The prospect of reaching an agreement in the WTO to allow subsidies in support of climate action, for example, seems so remote that no country proposed it (although its Director General would like the WTO to have a role on climate action).

In short, all countries consider it important to preserve their own policy discretion to respond to the challenges they face, including with financial assistance, while at the same time regularly objecting to the market interventions of others.

The recent trends

The US:

The tariffs of up to 25% imposed by the Trump administration on imports of Chinese goods were said to be justified among other factors by Chinese subsidies under the ‘Made in China 2025’ policy that involved state support to modernise the Chinese economy. A WTO panel has held these US tariffs to be contrary to WTO obligations but the US has appealed this finding “into the void” — that is, to an Appellate Body that does not currently function due to US refusal to appoint new members. Pending the appeal, the panel report cannot be adopted and become binding. In the meantime, China has adopted unilateral and unauthorised retaliation against the US, which is maintaining its tariffs and has not brought dispute settlement action against China. In other words, both parties have stepped outside the multilateral system to wage this particular subsidy war.

The US has also recently adopted a so-called Inflation Reduction Act that includes $369 billion of support for energy and climate action (it does not use the word “subsidy”) including a payment of up to $7,500 for the purchase of any electric vehicle provided it is assembled, and its batteries originate, in North America. This generous but discriminatory subsidy is claimed as justified by the need to combat climate change.

The US, however, countervails imports of products from the EU where the manufacturer has benefited from the grant of free emission trading allowances in the region within the framework of the EU’s action against climate change (the EU ETS).

When the EU threatened WTO action against the contentious elements of the Inflation Reduction Act, the US Trade Representative brushed off the threat and suggested the EU should respond instead with its own subsidies — something its Member States are actively considering.

The EU:

The EU is unique in the world in having developed an internal mechanism for objectively assessing whether the subsidies of its Member States (State Aids) have negative effects on competition that outweigh their positive effects and should therefore be prohibited. It is a sophisticated system of which the EU is proud — and that the UK is also trying to replicate.

The EU is attempting to transpose its system of subsidy control to the rest of the world with its new Foreign Subsidies Regulation on which we have written separately. It is an ambitious attempt to level the playing field by subjecting foreign subsidies that distort the EU internal market to similar controls to those that EU companies are subject to. It will certainly cause trade conflicts if it should be applied to the subsidies of other WTO Members that they consider should be exclusively addressed under the WTO SCM Agreement or any applicable bilateral trade agreement. It is part of the trend in the EU to resort increasingly to “autonomous” instruments rather than be restricted to agreed disciplines. Other recent proposals for autonomous measures following this trend are proposed regulations on the protection of the Union and its Member States from economic coercion by third countries, on prohibiting products made with forced labour on the Union market and the proposed Carbon Border Adjustment Mechanism responding to perceived imbalances between EU measures to counter climate change and those taken by other countries. Another measure illustrating the EU’s new willingness to act autonomously where multilateral efforts have failed is the recently adopted International Procurement Instrument, which allows the EU to restrict the access of economic operators, goods or services from third countries to Union public procurement procedures where such third countries do not provide access to their procurement markets.

A striking gap in the system, however, is that subsidies granted by the EU itself or by its Member States when implementing EU measures are not subject to EU State Aid control. For example, the EU Commission is proposing a European Chips Act to promote semiconductor production in the region that will involve financial support (referred to as the Chips Fund) and the creation of a European Sovereignty Fund. The EU is also able to authorise Member State support through use of a special exception to State Aid rules for Important Projects of Common European Interest. A more established example of EU-backed State Aid is the policy choice of the EU to grant of free emission trading allowances under the EU ETS to avoid “carbon leakage". In such cases, there is no balancing of benefits to the EU against adverse effects on other countries. Thus, as mentioned above, the US has taken countervailing action against the grant of free allowances under the EU ETS.

Conclusion

Subsidies can generally be considered good for the countries that grant them (otherwise they would be a waste of money) but often bad for other countries that are adversely affected.

In our deglobalising and crisis-prone modern world, we are likely to see increased use of subsidies and indeed subsidy races combined with increased use of retaliatory measures against them and reduced availability of mechanisms to resolve the disputes.

In other words, we are headed for subsidy wars.