Subsidies Under the SCM Agreement

Introduction

Undoubtedly, the law relating to the development and administration of the use of subsidies developing is one of the most difficult areas of international economic policy and rule making. It is also one of the most pervasive problems in international trade. All the governments around the world in some way or the other intervene in order to achieve the industrial or social policy goals. Subsidy is one such method. In the simplest of terms, Subsidization occurs when a government provides its producer(s) with financial contributions that give the producer(s) an advantage in the market place.

Subsidies acquire greater importance when it comes to developing countries and least developing countries. It is crucial or the sustenance and maintenance of their economies at whatever stage of development these economies are..

There are theories both for and against the use of subsidies in International Trade. Economists in favor of subsidies argue that it would be unwise on the part of the importing country to take any action any against subsidization. Subsidies do not distort as much as other classic trade and commercial policy instruments, viz. quantitative restrictions and tariffs. In fact, they argue that subsidies an instrument, whereby governments, at least in a perfect competition model, subsidize foreign consumers: a reduction in the marginal cost of foreign firms (which may be the consequence of a subsidy) would, in general, reduce prices in domestic firms. On the other hand, those against it argue that subsidies tend to distort international production and trading patterns, and reduce efficiency and thus reduce world welfare.

However, determination of analysis of impact of subsidy of international trade is another discussion altogether which the researcher shall refrain from discussing as it beyond the scope of the paper.

The WTO- Agreement on Subsidies and Countervailing Measures aims to compromise these two positions. The compromise between the possibility for governments to apply subsidies and restrictions imposed by international trade law fits well into the general picture of the WTO legal system’s overall structure. WTO law primarily imposes restrictions on governments only insofar as it is necessary to ensure the functioning of the principles of non-discrimination and open markets in order to ensure optimal economic welfare. However, this does not imply that the WTO members have unrestricted freedom with regard to their trade and economic policies. Economic activity pursued within the ambit of their regulatory freedom is also subjected to the restrictions by WTO law.

For the purposes of the present paper, the provisions relating to subsidies are codified under two multilateral agreements, viz. General Agreement on Tariffs and Trade, and the Agreement on Subsidies and Countervailing Measures.

The SCM Agreement took effect with establishment of the World Trade Organization on January 1, 1995 and was brought into existence in order to plug the loopholes of GATT with respect to the use of subsidies in international trade. The GATT permitted an importing country to impose countervailing duties to offset public subsidies for the manufacture, production, or export of merchandise, and set out the basic obligations of a GATT member country with respect to the use of subsidies. However, these provisions were found lacking in two respects. First, the rights and obligations were laid down in broad terms, and secondly, concepts like subsidy, export subsidy, material injury and domestic industry were defined in terms susceptible to a wide range of interpretations. SCM intended to bring about greater uniformity in the interpretation of these concepts and lend precision and predictability to the rights and obligations.. The SCM agreement contains disciplines on both the subsidizing government and on the actions taken by the government in the importing country against another government’s subsidies. But unlike its predecessors, it defines subsidy and introduces the concept of ‘specific’ subsidy for the most part, a subsidy available only to an enterprise or an industry, or a group of industries within the jurisdiction of the authority granting the subsidy; only specific subsidies are subject to the disciplines set out in the Agreement. Further, the SCM Agreement also defines three categories of subsidies: prohibited, actionable, and non-actionable.

Historical Background

The problem of subsidies has always been a subject of intense debate. There has been a continuous evolution of the provisions relating to subsidies in the four decades of the operation of the GATT 1947 till the Uruguay round.

There were a number of independent national rules that provided for remedy in cases of imports being subsidized by the foreign states which can be traced back to the 19th century. However the elaborate development of multilateral international rules concerning subsidized trade began primarily with the GATT.

The original GATT agreement of 1947 did not provide for exhaustive substantive rules of subsidy practices. In the original GATT agreement of 1947, there was very little discipline on the question of subsidizing except for the permitted response of countervailing duties. There was a fairly general reporting requirement in Article XVI of the original GATT, plus a general obligation in Article II, paragraph 4 against the use of new subsidies to inhibit imports into the subsidizing country when that country had “bound” its tariff on the product concerned.

The 1955 review session amendments to the GATT introduced the first substantive obligations regarding subsidies into the GATT (paragraphs 2 through 5 of Article XVI). However, this portion of GATT was confined only to export subsidies and did not apply to general, production or domestic subsidies. In addition, the GATT rules were divided between applications to “primary” and “non-primary” products. Furthermore, paragraph 4 of Article XVI of GATT, which imposed an obligation for non-primary goods proved troublesome as not all countries were prepared to adopt the declaration implementing the same. Because of these lacunae, the GATT treatment of subsidies proved to be controversial and the disciplines weak.

Thereafter, negotiations leading to a code concerning subsidies and countervailing duties were begun in the Tokyo Round, resulting in 1979 in an agreement on that subject. This agreement, the Subsidies Code, was the first general comprehensive multilateral discipline of the use of subsidies in international trade and the first elaboration of the subsidy rules since the 1955 GATT amendments. Moreover, unlike the 1955 agreement, this code explicitly provided for domestic subsidies and was not restricted to just export subsidies.The Code also established two-track approach to disciplining subsidies. Track I dealt entirely with countervailing duties and ways for the country to implement their countervailing duty rules and provided for elaborate definitions of material injury. Track II of the Code is devoted to the substantive obligations under international rule regarding how governments should refrain from granting subsidies that affects goods in international trade.

The Subsidies Code, however, did not provide an express definition of ‘subsidy’ except an illustrative list of export subsidies, which should not be granted. The interpretive notes of the Subsidies Code also did not provide any further assistance, which left the definitions of ‘subsidy’ remained unclear. Furthermore, in practice, the Code has been characterized by numerous disputes and lack of agreement between signatories on various issues. Ultimately the Subsidies Code proved lacking in the clarity and effectiveness to resolve the problems posed by subsidies in international trade.

Next came the Uruguay Round text on subsidies, mandatory for all members, which was not only a substantial change from the Tokyo Round Subsidies Code, but also a substantial improvement. This text, officially entitled ‘Agreement on Subsidies and Countervailing Measures’ is sufficiently extensive and detailed that for most purposes it seems to supersede the text of GATT Articles VI and XVI. Similar to the 1979 Subsidies Code, the SCM Agreement addresses both the issues of international obligations (1979 Track I) and the issues of application of countervailing duties (1979 Track II).

There are eleven parts of the SCM Agreement. Part I contains “General Provisions” circumscribing the scope and coverage of the Agreement. It defines what is a “subsidy” for the purposes of the Agreement as well as precise rules on “specificity”. Part II contains strict disciplines on “Prohibited Subsidies”, which are subsidies contingent upon export performance and subsidies contingent upon the use of domestic over imported goods. Part III provides multilateral disciplines on “Actionable Subsidies”, which are subsidies that cause adverse effects to the interests of other WTO members. Finally, Part V stipulates the substantive and procedural conditions that must be satisfied in order for countervailing duties to be imposed by a Member on subsidized imports that are causing injury to a domestic industry.

Subsidies Under The Scm Agreement

Article 1.1 SCM Agreement provides for a more or less, precise definition of subsidy. Art. 1.1 SCM Agreement provides that a subsidy under this Agreement essentially requires 1) a financial contribution by a government or any public body within the territory of a Member, and 2) that a benefit is thereby conferred.

The SCM Agreement contains an exhaustive list of measures that are deemed to be a “financial contribution”. The list identifies government practices that range from grants and loans to equity infusions, loan guarantees, fiscal incentives, the provision of goods or services and the purchase of goods. Even Measures carried out by a private entity, provided that a government has “entrusted” or “directed” the private entity to carry out one of the enumerated practices normally followed by governments, also fall under the ambit of financial contribution.

However, the agreement also provides that a benefit should be conferred on the recipient and therefore mere financial contribution by a government does not constitute subsidy The SCM Agreement fails to provide an extensive guidance on the question of what constitutes a “benefit”. In fact, the concept of whether or not a benefit has been conferred to the recipient in the definition of subsidy under Article 1 is one of the most difficult concepts in the entire Agreement.

However, the views on the necessity of conferring of benefit have not been unanimous. in the Negotiating Group on Subsidies and Countervailing Measures conflicting views were put forward on the question whether a necessary condition for the existence of countervailable (domestic) subsidy is that the practice in question confers a net benefit to the recipient and adversely affects the conditions of normal competition. The importance of this concept is further evident from the large number of disputes that have come up for consideration before the Panel and the Appellate Body, primarily involving the interpretation of the phrase “benefit is conferred”, crucial in the determination of whether a subsidy exists or not.

“Benefit”

The term benefit has been analyzed in Canada-Measures Affecting the Export of Civilian Aircraft, where the WTO Appellate Body decided that the existence of a “benefit” has to be determined by comparison with the market, that is to say, by comparing what the recipient of the financial contribution received from the government with what it would have received on the market. The issue came up for consideration before the Appellate Body as Canada contended that the Panel had erred in concluding that the existence of a “benefit” should be determined on the basis of the commercial benchmarks applied in Article 14. Instead, in Canada’s opinion, account must be taken of the “cost to government” of a subsidy and that, therefore, the Panel’s focus on Article 14 to the exclusion of “cost to government” amounted to an error in law.

Brazil opposed the same saying that the meaning of the term “confer” clearly implies action by the grantor upon someone else and thus implies “benefit to the recipient”. It also argued that Canada’s contention that with respect to the “cost to government” standard does not focus on the recipient of the contribution and is only concerned with the effect of a government contribution on the government itself.

The Appellate Body however confirmed the Panel’s focus on the recipient of a subsidy in determining the existence of a benefit, stating:

Logically, a “benefit” can be said to arise only if a person, natural or legal, or a group of persons, has in fact received something. The term “benefit”, therefore, implies that there must be a recipient. This provides textual support for the view that the focus of the inquiry under Article 1.1(b) of the SCM Agreement should be on the recipient and not on the granting authority. Accordingly, we believe that Canada’s argument that “cost to government” is one way of conceiving of “benefit” is at odds with the ordinary meaning of Article 1.1(b), which focuses on the recipient and not on the government providing the “financial contribution”. Furthermore, the marketplace provides an appropriate basis for comparison in determining whether a “benefit” has been “conferred”, because the trade-distorting potential of a “financial contribution” can be identified by determining whether the recipient has received a “financial contribution” on terms more favorable than those available to the recipient in the market.

Further, In the Brazil-Export Financing Programme for Aircraft, the Panel was established to consider a complaint by Canada with respect to certain export subsidies granted under the Brazilian “PROEX” on sales of aircraft to foreign purchasers of “Embraer”, a Brazilian manufacturer of regional aircraft. As per the Appellate Body ruling, the Panel made an error in finding that the “financial contribution” in the case of PROEX subsidies is not a “potential direct transfer of funds” by reasoning that a letter of commitment does not confer a “benefit”. The importance of this decision lies in the overruling of the Panel view by the Appellate Body as in the interpretation of Article 1.1 (a)(i). The appellate body held that Panel had imported the notion of a “benefit” into the definition of a “financial contribution”, whereas a “financial contribution” and a “benefit” are two separate legal elements in the definition which together determine whether a subsidy exists.

“Recipient Of The Benefit”

Another important finding in the Canada-Aircraft decision was that the “recipient” of a “benefit” is not limited to the single firm exporting subject merchandise , but may include a “group of persons” and even the shareholders of such a firm.

Furthermore, the Panel on United States-Imposition of Countervailing Duties on Certain Hot-Rolled Lead and Bismuth Carbon Steel Products Originating in the United Kingdom, in its interpretation of the term “benefit”, subsequently upheld by the Appellate Body, considered that the existence or lack thereof of benefits has to be decided by drawing a comparision with the other potential recipients or beneficiaries and whether the beneficiary in question has received it on more favourable terms. The Panel referred to Articles VI:3 of GATT 1994 and footnote 36 to Article 10 of the SCM Agreement:

The existence or non-existence of ‘benefit’ rests on whether the potential recipient or beneficiary, which ‘logically’ must be a legal or natural person, or group of persons, has received a ‘financial contribution’ on terms more favorable than those available to the potential recipient or beneficiary in the market. Moreover, in the particular context of countervailing duties, we believe that consideration should also be given to Article VI:3 of the GATT 1994, and footnote 36 to Article 10 of the SCM Agreement.

In United States-Countervailing Measures concerning Certain Products from the European Communities, the United States contended that “the SCM Agreement regards subsidies as bestowed upon legal or natural persons” and argued that this finding of the Panel contradicted the findings in Canada – Aircraft and in US – Lead and Bismuth II. On the other hand the European Communities submitted that, according to Article 1.1(b) of the SCM Agreement, a “financial contribution need not be directly provided to its recipient” and “the recipient of a financial contribution need not be the same as the recipient of the benefit conferred thereby, as long as the required causal relationship between the contribution and the benefit is established.” In its decision, the Appellate Body held that there is nothing to indicate that the “benefit” of a financial contribution, as contemplated in Article 1.1(b) of the SCM Agreement, should necessarily be “received and enjoyed” by the same person or, put differently, there is nothing indicating that the “benefit” cannot be “received and enjoyed” by two or more distinct persons.

Furthermore, in Canada – Aircraft Credits and Guarantees, the Panel considered whether a “benefit” is conferred on a company by virtue of a “benefit” being conferred on the customer purchasing the product of such company:

In examining Brazil’s claims in this case, we shall consider whether or not a ‘benefit’ is conferred on Bombardier by virtue of a ‘benefit’ being conferred on the airline customer purchasing Bombardier aircraft. … In our view, the fact that Bombardier may arrange financing in the form of government support does not necessarily confer a “benefit” simply because Bombardier is ‘relieved of the necessity of providing or arranging its own financing’. If that were the case, a ‘benefit’ would be conferred whenever Bombardier arranged external financing – even through commercial banks – since any external financing would ‘relieve it of the necessity of providing or arranging its own financing’. We find it difficult to accept that the existence of ‘benefit’ (in the context of financing) is determined on the basis of whether or not Bombardier provides internal or external financing. The existence of ‘benefit’ (in the context of financing) is determined by reference to the terms at which similar financing is available to the airline customer in the market.

“Is Conferred”

Since the definition employs the phrase “is conferred” with respect to the “benefit”, the interpretation of the same also forms an important part of a discussion on the definition of subsidy. In fact, since the SCM Agreement is completely silent on the timing of the conferral of benefit, the same has been a subject of contention in various disputes before the WTO.

A case in point is United States-Imposition of Countervailing Duties on Certain Hot-Rolled Lead and Bismuth Carbon Steel Products Originating in the United Kingdom, wherein the Panel was established to consider a complaint by the European Communities with respect to countervailing duties imposed by the United States on certain hot-rolled lead and bismuth carbon steel products originating in the United Kingdom.

The United States argued that an investigate authority must demonstrate the existence of benefit only at the time the financial contribution was made. An ongoing investigation to determine that the original benefit still constitutes an advantage to the relevant would make it nearly impossible to administer countervailing duty laws. On the other hand, the European Communities contended that the use of the present tense in Article 1.1 of the SCM Agreement does not indicate that the required determinations of financial contribution and benefit should only be made as of the moment a financial contribution was made. They further emphasized that under the countervailing duty law, the investigating authority must in all cases examine the existence of benefit during the period of investigation, and cannot irrefutably presume that a benefit conferred sometime in the past continues.

Thus the issue before the Appellate Body was whether an investigating authority would be required to make a finding of benefit in a (subsequent) review of the countervailing measure. The Appellate Body rejected the argument by the United States holding that “Article 1.1 does not address the time at which the ‘financial contribution’ and/or the ‘benefit’ must be shown to exist.” Therefore, it agreed with the Panel that while an investigating authority may presume, in the context of an administrative review under Article 21.2, that a “benefit” continues to flow from an untied, non-recurring “financial contribution”, this presumption can never be “irrefutable”.

Furthermore, the Panel on Canada – Aircraft Credits and Guarantees clarified that “to satisfy the ‘benefit’ element of Article 1 of the SCM Agreement for purposes of a challenge to [the programme at issue] as such, [the complainant] would have to show that the program requires conferral of a benefit, not that it could be used to do so, or even that it is used to do so.”

Therefore one can see that in order for a subsidy to fall under the definition of Article 1.1. of the SCM agreement it is important to show that there was some sort of benefit conferred besides the financial contribution. Besides this benefit, financial contribution alone cannot be considered a subsidy and the importing country cannot levy measures against the foreign country.

However, even today problem still remains with respect to the area of subsidies and need for clarification persists which should be adequately addressed. In the recently concluded Doha Round of Negotiations it was envisaged that the negotiations in the area of World Trade Organization (WTO) rules would be aimed at “clarifying and improving disciplines under the Agreements on Implementation of Article VI of the General Agreement on Tariffs and Trade (GATT) 1994 and on Subsidies and Countervailing Measures.” The Declaration enjoined that in this exercise “the basic concepts, principles, and effectiveness of these Agreements and their instruments and objectives” would be preserved and “the needs of developing and least developed countries” would be taken into account. However, this round of negotiations having collapsed, the problem still remains unsolved.

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