In its latest report, the Appellate Body made several important rulings under the SCM Agreement. Simon has already posted on the double-remedy issue. A while ago, I posted on the Panel report in this case, asking whether the Panel had painted a wrong picture of China's economy. The post has generated numerous comments from our readers. See here. Now it is time to examine where we are after the AB decision.
1. SOEs as "public bodies" under Article 1 of the SCM.
The AB overturned the Panel's decision that all SOEs are "public bodies" by virtue of the government ownership control. Instead, the AB defined "public body" as one that is vested or entrusted with authority to perform a government function. Applying this standard, the AB found that China's SOE input suppliers in this case (i.e., state-owned steel mills) are not "public bodies", whereas the state-owned commercial banks (SOCBs) are. (To be more precise, applying the appropriate standard of review, the AB held that the United States is permitted to treat SOCBs as public bodies).
The AB also indicated that whether an entity is vested with authority to perform a government function should be examined by referring to the legal order of the relevant member. In deciding that SOCBs are "public bodies" in China, for example, the AB cited the provision in the Commercial Banking Law of China that requires Chinese banks to "carry out their loan business upon the needs of [the] national economy and the social development and under the guidance of State industrial policies". (AB Report, para. 354) (The AB also cited the fact that the government appoints the banks' management. But this factor should be part of government ownership control.)
Bottom line: (a) A company that has purchased goods or services from SOEs will not automatically be deemed as having received government "financial contribution". (b) SOCBs are government agencies for SCM purposes. Hence, all borrowers from SOCBs have, by definition, received government "financial contribution" in the form of loans.
2. Price distortion under Article 14 of the SCM
The Panel had ruled: (i) the domestic prices of a product produced in a state-dominated sector are distorted, hence cannot be used as market benchmarks to calculate benefits under Article 14(d); (ii) because there is no private land ownership in China and government controls allocation and pricing for all land use rights, all prices for land-use rights in China are distorted, hence cannot be used as benchmarks under 14(d); and (iii) because the state controls the banking sector, all interest rates in China are distorted, hence cannot be used as benchmarks under 14(b).
The AB affirmed the Panel on (i) and (iii). Since China did not appeal the Panel's decision regarding (ii), the Panel's ruling on land prices stands valid.
Significantly, in contrast with its "public body" analysis, the AB simply equated SOE producers with the government in its price distortion analysis under 14(d). The AB found in this case that China's domestic steel prices are distorted because SOEs account for 96% of the market share in China. Although China had argued that its steel industry consists of numerous SOE and non-SOE producers and competition is fierce, the AB did not take into account these factors in its analysis. (According to a US Congressional study in 2010, there are more than 1,000 steel producers in China, and China's domestic steel market is so highly fragmented and competitive that the government is having a hard time to rein in the industry.)
Thus, the AB has not only affirmed, but also further expanded, its position in US-Softwood Lumber IV that in-country prices may be rejected if the government has a predominant position in the industry. This interpretation is rather radical, since Article 14(d) explicitly provides that in-country prices are to be used for calculating benefits arising from the provision of goods and services. The AB ruling in this case expands its original interpretation in that it has found dominant government ownership of market actors alone is sufficient to reject the prices in the sector as distorted. In other words, it is the government ownership of market actors, rather than the competitive conditions of the market, that will determine whether the prices are legitimate.
What is the bottom line? The big picture about China's economy and market conditions remains as outlined in my original post:
- Any company that has purchased products or services from a sector dominated by SOEs (e.g., steel, telecommunications) is potentially being subsidized, since domestic market prices for all such products and services are distorted.
- Every economic actor in China is potentially being subsidized as it has to exist on some land, since all prices for land use rights are distorted.
- Any company may be subsidized if it borrows money in China, or buys input from another firm that borrowed money in China, whether from Bank of China or HSBC, since all interest rates in China are distorted.
As a result, all such prices can rejected, and instead third country prices will be used to calculate the benefits of Chinese subsidies.
The AB's rulings under Article 14 SCM will have a long-lasting impact on China subsidy cases. Unlike the doubt remedy issue, which presumably will cease to exist once China "graduates" from its NME status in 2016, the price distortion issues will persist as long as China practices its state capitalism (or a "socialist market system with Chinese characteristics"). Thanks to the AB rulings in this case, WTO members may want to switch to CVDs as the main weapon against Chinese exports, since it is so easy to find government subsidies in China, and virtually all Chinese products can be targeted.