Worldwide: Subsidies And Overcapacity: Recent Developments At The G20 And The WTO

Last Updated: 12 September 2017
Article by Edward Borovikov, Xiaoyi Tang and Laurens Engelen

Introduction

Overcapacity occurs when industrial capacity exceeds production levels, so that the supply of the good in question exceeds its demand. By lowering incentives for research and development, high levels of unutilized capacity reduce overall competitiveness. Domestically, emerging and innovative industries are impeded by the misallocation of economic resources. Abroad, competing industries are harmed by having to compete with artificially low priced exports. Because of these stymying effects, overcapacity is regarded as one of the major factors threatening global trade stability.

Cyclical overcapacity occurs for example when a sudden decrease in demand causes excess capacity. However, unutilized capacity can also be structural, for example when industrial production is fueled by political, rather than economic considerations. Because the production level is not determined by supply and demand, structural overcapacity often requires economic policy reform and is therefore more intractable than cyclical overcapacity.

Overcapacity in the Steel Industry – High Level Political Discussions at the G20 and the WTO and EU's Position

One particular industry where unutilized production capacity vastly exceeds global demand is steel. China has been blamed to have subsidized its steel manufacturers, by adopting various beneficial policies, in order to strengthen a strategically important industry. In contrast, Chinese governmental officials reject this blame and argue that the Government does not subsidize steel exports and on the contrary, "China introduced a series of measures to control steel exports starting from 10 years ago".

While disagreements on who are the main contributors to overcapacity continue, this issue in the steel industry has been on the forefront of global high-level political discussions for several years. In September 2016 and July 2017, respectively, the G20, the informal economic forum consisting of 20 major economies, acknowledged the problem of overcapacity, recognized its negative impacts on production, trade and workers, and called for the removal of market-distorting subsidies and other types of support by government, adding that a collective action was required to reduce steel excess capacity1.

In the meantime, the European Union ("EU"), joined by the United States ("U.S."), Canada, Japan and Mexico, responded to this call to action by submitting several proposals in the World Trade Organizations' ("WTO")2 Committee on Subsidies and Countervailing Measures ("SCM Committee"), which stated that the SCM Committee "could usefully look more closely at the extent to which subsidies contribute to overcapacity and how they could be further disciplined in the interest of providing a level playing field for traders and an environment where trade and resource allocation is not distorted."

In order to provide a basis for a more extensive discussion on the issue of overcapacity and its consequences for global trade and the global economy, these proposals3 launched the following questions:

  • To what extent have subsidies contributed to the creation of excess capacity?
  • What are the specific governmental or business practices that have contributed to the creation of excess capacity?
  • In what areas are current SCM Agreement disciplines incomplete or inadequate to address these practices?

During recent SCM Committee meetings, the EU clarified its position on the questions set out above with regard to structural overcapacity due to subsidization4.

Concerning the first question, the EU stated its view that subsidization is a significant, if not one of the main drivers of overcapacity. Without government support, normal market forces would prevail and the systematic discrepancies between supply and demand on world markets would not be sustainable.

As regards the second question, the EU clarified that this government support was provided in the form of many different policies, including but not limited to (i) providing easy financing to companies, (ii) preventing bankruptcies, and (iii) keeping prices of input products artificially low to support production levels.

In connection with the third question, the EU pointed out three main deficiencies in the SCM Agreement, which prevented a forceful reaction against subsidization and the resulting overcapacity.

First, it was unclear whether its definition of subsidies under the SCM Agreement included government policies and programs going beyond import or export subsidization, such as government financing and so-called "sham" purchases. The EU noted however that such programs are likely to contribute to the creation of excess capacity. Moreover, other terms in the SCM Agreement, such as what constitutes a "public body", were said to be lacking in clarity as well.

Second, the European Union remarked that the lapsing of the provision setting out the definition of a "serious prejudice" had raised the legal standard as regards actionable subsidies, rendering these provisions difficult to apply. Consequently, subsidies not directly prohibited under the SCM Agreement5, had become more challenging to respond to. It was however clear that economic policies not falling under this definition could also have the effect of creating excess industrial production capacity. The EU again pointed to examples of providing below-cost financing and favorable treatment of the industry concerned. The inability of governments to effectively counter actionable subsidies destabilizes the international global trade system and results in a lose-lose situation, as structural overcapacity obstructs innovation in the subsidizing country, and leads to decreasing profitability and increasing unemployment in its trade partners.

Lastly, the EU pointed to the notification, surveillance and transparency provisions of the SCM Agreement, which it deemed insufficient to tackle the problem of excess capacity. By not generally enforcing the notification and reporting duties, the SCM Agreement does not sufficiently force countries to comply with the transparency level to properly monitor subsidies and their effects on industrial production capacity. This problem is exacerbated by the fact that even countries abiding by their reporting obligations often submit incomplete or irrelevant information.

More recently, the EU once again emphasized the importance of subsidies notification. In order to improve Members' compliance levels with the applicable notification obligations, the EU suggested to the WTO's Negotiating Group on Rules either to create a general rebuttable presumption which would treat all non-notified subsidies as actionable, or to instead create this presumption only for those subsidies which the subsidizing Member had been requested to notify but had failed to do so6.

Further Remarks on Reporting and Notification Duties Raised by Other WTO Members, in Particular the U.S.

The issue of structural underreporting was also raised by other WTO Members, in particular, the U.S, noting that 65% of WTO Members did not meet their reporting duties for 2015.

The U.S. has recently made use of its counter-reporting rights under the SCM Agreement to present China with existing government policies, asking to explain why these have not been reported. The U.S. observed that many of the programs in China were sub-central in nature, which was not separately reported. According to the U.S, this was especially problematic in situations where economic policy objectives are set at the level of the central government and then implemented at the sub-central government level, since sub-central governments are more likely to adopt so-called beggar-thy-neighbour policies aimed at serving their own interest rather than the general good. The U.S. noted that economic development goals are adopted in China at the central level by way of five-year industrial development plans. In their implementation of these five-year plans, sub-central governments then adopt subsidy programs, often without much control or oversight by the central government. Because of the need to properly monitor subsidies, both prohibited and actionable, the U.S. underscored the importance of regular and timely reporting.

The U.S. also pointed out that other government programs contributing to structural overcapacity had been acknowledged by China's own steel association. In this regard, the U.S. referred to the issue of so-called "zombie mills", referring to unprofitable steel producers kept alive by government support, effectively removing the possibility of them going out of business because are too important to the local economy and employment. Sub-central government levels, which usually adopt subsidy programs, thus have an incentive to preserve these zombie mills. It should however be noted that China's central government declared that in recent years they had provided funds to convert steel mills to produce other goods. The governor of China's biggest steelmaking province has also declared that it aims to close down the last of its zombie mills by the end of 2018.

Conclusion – the Need for Collective Action

These ongoing discussions make it clear that the issue of structural overcapacity in the global steel sector has yet to be resolved. However, it is equally clear that such a solution will necessarily have to come out of high-level political discussions and negotiations. It should therefore come as no surprise that the appropriate forum for these negotiations is currently the subject of debate between the main global players in this saga. While no one is disputing that these discussions should be held across various fora, China has questioned the choice for the SCM Committee as forum for launching these discussions and has consistently underscored the need to address these issues outside of the WTO framework, such as the G20. The complementarity between various global fora has been acknowledged by other WTO Members, who however have shown support for the SCM Committee to investigate the link between subsidies and the creation of overcapacity.

In the absence of an efficient solution, WTO members have reacted quickly to the overcapacity in the steel industry by shielding their domestic markets from low priced steel products. In the EU and the U.S, there have been no fewer than ten anti-dumping or anti-subsidy investigations in connection with steel imports7.

The various elements in this ongoing story make it clear that a definitive solution for the overcapacity problems facing the global steel sector should not be expected anytime soon. It is however clear to all parties involved that trade defense Instruments can only be a short term solution. The willingness of the main actors in this saga to address this structural issue can however be considered a positive development. It is in everyone's interest that this is now followed up by a structural solution to this problem and that international trade in steel products can be normalized.

Footnotes

1. See for example, G20 (Germany 2017) Leaders' Declaration: Shaping an interconnected world, Hamburg, 7/8 July 2017. LINK 

2. In order to provide a legal framework addressing subsidies, WTO members have adopted the Subsidies and Countervailing Measures Agreement ("SCM Agreement"), prohibiting subsidies contingent on export performance or on the use of domestic over imported goods. In addition, the SCM Agreement identifies so-called actionable subsidies, having an adverse effect on the interests of other members, for example by causing serious prejudice. When adopted originally in 1994, the SCM Agreement contained a provision defining serious prejudice. This provision expired however after a period of five years, and has not been renewed.

3. See WTO documents: G/SCM/W/569 and G/SCM/W/572

4. See G/SCM/M/99

5. Subsidies which are directly prohibited by the SCM Agreement include such measures as export subsidies and subsidies contingent on import substitution.

6. See TN/RL/GEN/188

7. In the EU, there have been recent investigations into rebar from China and Belarus, cold-rolled steel from Russia and China, hot-rolled steel from China, Brazil, Iran, Russia, Serbia and Ukraine, corrosion resistant steel from China, and seamless pipes and tubes from China. In the U.S, references could be made to the antidumping and countervailing duty investigations into steel wire rod from 10 countries, cold-drawn mechanical tubing from six countries including China, Section 337 investigation against carbon and alloy steel products from China, and section 232 investigation concerning the steel imports relating to the U.S. national security issue.

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