Along with Jim Bacchus and Huan Zhu, I have a new Cato paper out today on using the WTO to make China more market-oriented. Some of the main points are:
-- China's economic ambition is good. The world is better off with a wealthier China.
-- However, China does need to play by the rules that everyone else is playing by.
-- There is an assumption that China does not play by the rules, but when we looked at all the WTO complaints against China (41 at the time of writing), its compliance record is actually pretty good.
-- So one thing governments should start doing right away is bringing more WTO complaints against China. 4 possible areas are: general IP protection, trade secrets, forced tech transfer, subsidies. But with all the allegations against China, there are sure to be many other possible complaints as well.
-- In addition, there are gaps in the rules, and we should look to expand existing rules, eg, on state-owned enterprises.
-- In contrast to relying on the WTO, the Trump administration's approach is unilateral tariffs to push China to change. This approach makes it politically difficult for China to do so.
But here's the part I really wanted to run by readers of this blog. What do you think of this argument for an "adverse effects" SCM Agreement claim against certain Chinese subsidies?
... [SCM Agreement Article 5(b)] sets out a potentially broad, but mostly unexplored, type of actionable subsidy claim. There has been a long-standing GATT/WTO remedy for “nullification or impairment” that occurs even in the absence of a violation, generally referred to as a “non-violation” claim. These claims have a higher burden of proof, which makes them difficult to win, and they also have a weaker remedy, which makes winning them less valuable.69 However, by incorporating the nullification or impairment language into SCM Agreement Article 5(b), the WTO drafters may have given this remedy more teeth. There is little existing precedent for such claims, but the language is broad enough to make it worth exploring creative complaints under it.
As an example, China recently introduced tax exemptions and tax reductions for Chinese semiconductor producers, to last for a period of 10 years. For the first two to five years, the taxes will be eliminated completely.70 Subsequently, the taxes will be cut in half, through the 10th year.71
These tax exemptions and reductions clearly constitute “specific subsidies” under Articles 1 and 2 of the SCM Agreement, since they target a particular Chinese industry. The more difficult question is whether they cause “adverse effects to the interest of other Members” under Article 5. There is an argument that, because of their substantial size and the overall design of China’s policies in this sector, the tax exemptions and reductions given by China to its semiconductor industry cause adverse effects under Article 5(b).
According to footnote 12 to Article 5(b), nullification or impairment is “used in this Agreement in the same sense as it is used in the relevant provisions of GATT 1994, and the existence of such nullification or impairment shall be established in accordance with the practice of application of these provisions.” Where a measure is inconsistent with a provision of the GATT, Article XXIII:1(a) applies, and nullification or impairment is presumed. In addition, however, Article XXIII:1(b) gives rise to a cause of action when a member, through the application of a measure, has “nullified or impaired” “benefits” accruing to another Member, “whether or not that measure conflicts with the provisions” of the GATT 1994 (so-called non-violation complaints). The concept of nullification or impairment as an independent basis for a claim, even where there is no violation, has been elaborated in only a few GATT/WTO disputes. One panel offered detailed explanations, and the Appellate Body discussed the issues briefly, which can be summarized as follows.
The text of Article XXIII:1(b) establishes three elements that a complaining party must demonstrate in order to make out a claim under Article XXIII:1(b): (1) application of a measure; (2) a benefit accruing under the relevant agreement; and (3) nullification or impairment of the benefit as the result of the application of the measure.72
In the case of the Chinese tax exemptions and reductions, the application of the measure is clear and the benefits accrue on the basis of the tariff concessions made by China as part of its accession and through further commitments made under the recent Information Technology Agreement (ITA) expansion with regard to semiconductor products.73
The issue here is whether the semiconductor tax exemptions and reductions nullify or impair the benefits of China’s tariff concessions. There is a strong argument that this is the case, due to the fact that the competitive relationship between Chinese chipmakers and U.S. chipmakers has been upset by a very substantial subsidy.
Importantly, in order to prove an Article 5(b) adverse effects claim, there is no need to show lost sales. In this regard, the GATT EEC–Oilseeds I panel concluded: “In the framework of GATT, contracting parties seek tariff concessions. . . . The commitments they exchange in such negotiations are commitments on conditions of competition for trade, not on volumes of trade.”74 Instead of an effect on the volume of trade, a claim of “nullification or impairment” is based on “upsetting the competitive relationship” between domestic and imported products.75 Thus, in the present case, even though the immediate effects of the subsidy on trade flows between the United States and China are not known, the United States may still argue that its producers have been put at a competitive disadvantage relative to their Chinese competitors.
In this case, the benefits in question accrued to the United States on the date of China’s original tariff schedule taking effect after accession, and the date of the ITA expansion being incorporated into China’s schedule. The subsidy (i.e., the tax exemptions and reductions) was announced on March 30, 2018, and was to be effective from January 1, 2018. Since the tax exemptions and reductions were announced on a date subsequent to the tariff concession, the United States is entitled to rely on a presumption that it did not anticipate the introduction of the subsidy and its consequent upsetting of the expected competitive relationship between U.S. and Chinese chipmakers.76
Elaborating on this standard, in EEC–Oilseeds I, a GATT panel considered that nullification or impairment would arise when the effect of a tariff concession is “systematically offset by a subsidy programme”:
The Panel considered that the main value of a tariff concession is that it provides an assurance of better market access through improved price competition. Contracting parties negotiate tariff concessions primarily to obtain that advantage. They must therefore be assumed to base their tariff negotiations on the expectation that the price effect of the tariff concessions will not be systematically offset. If no right of redress were given to them in such a case they would be reluctant to make tariff concessions and the General Agreement would no longer be useful as a legal framework for incorporating the results of trade negotiations.77
This standard was reiterated by a WTO panel in the U.S.–Offset Act dispute: “This would suggest, therefore, that the EEC–Oilseeds panel considered that non-violation nullification or impairment would arise when the effect of a tariff concession is systematically offset or counteracted by a subsidy programme.”78
Examining the semiconductor tax exemptions and reductions under the standard of “systematic offsetting/counteracting” makes clear that the measure has caused nullification or impairment, for the following reasons.
First, the amount of subsidy provided is of great importance. Here the amount of subsidy is the amount of government revenue forgone, which is a complete rebate from a corporate income tax of 25 percent, for two to five years, covering a wide swath of semiconductor manufacturers, plus a 50 percent rebate from income tax through to the 10th year. This large tax rebate serves to completely undermine the promise of lower tariffs, which was a substantial concession that could have been of great benefit to foreign producers, and indicates that the subsidy is counteracting the competitive benefit accruing to the United States under China’s promises.
The U.S. semiconductor industry is the leading global provider of semiconductors and semiconductor manufacturing equipment, accounting for 50 percent and 47 percent shares of the world market, respectively. More than 80 percent of U.S. production is exported, with China its biggest export market. Moreover, China’s growing demand for semiconductors is met mainly by imports, including 56.2 percent from the United States.79 These trade figures make it clear that the United States will be hit hard and put at a competitive disadvantage by these Chinese subsidies relative to what it enjoyed previously. Any competitive edge that U.S. chipmakers had because of tariff reductions on their exports to China will be offset by the Chinese grant of subsidies in the form of tax breaks to domestic Chinese chipmakers.
Secondly, the systematic nature of the Chinese measures can be seen through the broader context of the measure. The Chinese government, motivated by economic and national security goals, has publicly asserted its desire to build a semiconductor industry that is far more advanced than today’s and less reliant on the rest of the world.80 The strategy aims at making China the world’s leader in Integrated Circuit (IC) manufacturing by 2030.81 Therefore, the intention of the Chinese government is clear: it wants to promote domestic production, either for domestic use or export.
Thirdly, the effect of the tax exemptions on U.S. manufacturers must be viewed in light of China’s broader strategy. The stated aim of Chinese policy is for China to be at an “advanced world-level [semiconductor capability] in all major segments of the industry by 2030.”82 China has set goals to promote its IC sectors and is supplementing these specific policies with a series of complementary policies that are applied across the IC sector. According to public reports, it places conditions on access to its market to drive localization and technology transfer.83 All these measures taken together have the potential to (1) force the creation of market demand for China’s indigenous semiconductor products; (2) gradually restrict or block market access for foreign semiconductor products as competing domestic products emerge; (3) force the transfer of technology; and (4) grow non-market-based domestic capacity, thereby disrupting the global semiconductor value chain.
Summing up, while China promised to reduce semiconductor tariffs as part of its accession and under the ITA, and has therefore made commitments under Article II benefiting its trading partners, including the United States, it has nullified or impaired those benefits through the use of specific subsidies, resulting in adverse effects under SCM Agreement Article 5(b).