EU-China investment accord fails to resolve subsidy disputes

March 10, 2021 7:00 AM
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Soon after the European Union and China reached an investment agreement at the end of 2020, members of the European Parliament, which must ratify the agreement, voiced concerns that China had not gone far enough to open its economy. Sabine Weyand, director general for trade at the European Commission, has been on the defensive about its shortcomings. “What is your yardstick?” she asked of her critics. “Is it an ideal world, where we transform…China into a liberal democracy and open market economy? Or should we use a yardstick to decide whether the EU has gotten the best it could?”

At least in one area, subsidies, the agreement falls short. The EU negotiating team clearly views the Comprehensive Agreement on Investment (CAI) as a high-standard agreement in terms of “transparency, level playing field, market access commitments and sustainable development.” China does for the first time prohibit forced technology transfer, and it accepts a broader definition of state-owned enterprises and promises to ratify International Labor Organization (ILO) conventions on forced labor. But the CAI does little to address disputes between China and the European Union over subsidies of exported goods, which can distort trade. In fact, Chinese subsidies are likely to be addressed, if at all, in a plurilateral setting, but only if the United States, the European Union, and their allies can persuade Beijing to embrace meaningful disciplines.

The World Trade Organization (WTO) disciplines industrial subsidies but only modestly restrains agricultural subsidies and does nothing to restrict service subsidies. The Agreement on Subsidies and Countervailing Measures (ASCM) governs industrial subsidies, the Agreement on Agriculture regulates agricultural subsidies, and the General Agreement on Trade in Services commits WTO members to negotiate limits on subsidies to service activities, but nothing has ever been agreed.

The CAI adopts the same subsidy definitions as the ASCM but enlarges coverage by subjecting service sectors to new transparency obligations. Similar to the WTO, but more lenient, the CAI exempts agricultural and fisheries subsidies.[1]

The CAI echoes notification rules set out in Article 25 of the ASCM. As well, the CAI requires notification of subsidies to specified service sectors.[2] The transparency obligations kick in no later than two years after the CAI takes effect, probably late 2023. However, WTO experience suggests that timely compliance and quality of subsidy notifications could be poor.

Over past years, the United States and the European Union have consistently expressed concern at the WTO’s SCM Committee over China’s non-notification of its possible subsidy programs in sectors such as steel and aluminum. Attempting redress, a January 2020 US-EU-Japan trilateral proposal on strengthening industrial subsidy discipline in the WTO pushed for meaningful incentives to ensure proper notification. The trilateral group recommends that, when a subsidizing WTO member does not notify, but another member counter-notifies the measure, the subsidizing member’s subsidy will be treated as prohibited, unless the required information is provided within a short deadline.

Apart from foreseeable difficulties with compliance and notification requirements, the CAI article on subsidies (Section III Subsection 2 Article 8) is weak on enforcement. Hence the European Union will have little recourse to seek remedies under the deal. If a subsidy has or could have negative effect on the other party’s investment interests, the two sides can only consult in an effort to reach a mutual solution. Any solution should be “considered feasible and acceptable by both parties.” The CAI’s dispute settlement mechanism outlines meaningful remedies, including the suspension of obligations, but does not apply to the subsidies section. Nor do most favored nation (MFN) and national treatment obligations apply to subsidies (Section II Article 1.4). Looking at the bright side, increased notification may enable the European Union to challenge some Chinese subsidies with countervailing duties imposed by Brussels or dispute settlement cases brought in the WTO.

Brussels and Beijing are obviously aware of WTO discussions on strengthening subsidy disciplines. The CAI leaves the door open for the two parties to update their agreement to reflect upgrades to the WTO rulebook, especially on the possible expansion of subsidy definitions.

One grievance among advanced economies is that the scope of prohibited subsidies under the ASCM is too narrow and does not capture several distorting practices. Hence the trilateral group proposed adding four new types of prohibited subsidies covered under Article 3.1 of the ASCM: (1) unlimited guarantees; (2) subsidies to an insolvent or ailing enterprise in the absence of a credible restructuring plan; (3) subsidies to enterprises unable to obtain long-term financing or investment from independent commercial sources, when those enterprises operate in industries plagued by overcapacity; and (4) certain direct forgiveness of debt. Needless to say, the CAI does not reflect this ambitious proposal, but the door is open if the WTO ever adopts the proposal.

In light of its multiple shortcomings in the realm of subsidy discipline, the best that can be said of the CAI subsidy article is that it makes a small step along a very long road. Taken together, Trump’s failed US-China phase one agreement and the CAI show that neither the United States nor the European Union alone has sufficient leverage to sway Beijing to accept effective discipline on subsidies. That is not surprising, since the power to dispense subsidies is the lifeblood of the Chinese Communist Party. The United States and the European Union will need to join forces, working with other countries in the WTO and regional trade groups, to have any hope of curing China’s subsidy addiction.

Notes

1. The WTO Agreement on Agriculture covers agricultural subsidies, but with a light touch, and negotiations on fisheries subsidies launched in 2001 at the Doha Ministerial Conference remain to be concluded.

2. Covered sectors include business services, communication services, construction and related engineering services, distribution services, environmental services, financial services, health-related services, tourism and travel-related services, and transportation services.