With the enactment of the U.S. Inflation Reduction Act (IRA) and the announcement of the European Union (EU) Green Deal Industrial Plan, there is now a full-fledged subsidy war between the United States and the European Union. While these subsidies are meant to encourage green technologies, incentivizing firms to produce locally would seem to be an almost as important policy goal. And it is not limited to the U.S. and the EU. Global Trade Alert recently reported that, in 2022, production subsidies accounted for half of all trade-distorting measures, making it the mostly commonly used harmful trade policy measure.1
By: Alan Yanovich
While subsidies can be appropriate policy tools to overcome market failure, they create significant distortions and can create a never-ending cycle of subsidization. Subsidies distort the allocation of resources among countries and within them. Firms will invest in the jurisdictions that provide the highest subsidies and will produce the goods to which governments have chosen to direct the subsidies. Already there are numerous reports in the press that firms are redirecting investment to the U.S. to take advantage of the IRA subsidies and that the EU is trying to slow this down by increasing its own subsidies. This U.S.-EU subsidies competition does not only impact their firms, it also adversely affects the rest of the world. Other countries will find it more difficult to retain investment, let alone to attract more of it, in the face of the U.S. and EU subsidies. The fact that the EU is responding to U.S. subsidies with its own subsidies compounds the problem for everyone else. The choice for other countries is to offer their own subsidies or risk losing investment to the U.S. and the EU. If other countries respond with their own subsidies, the distortions will multiply. Obviously, this cycle poses a greater challenge to countries with less resources, as the World Trade Organization (WTO) Director-General recently noted.2
Is there anything that can be done to stop the subsidy war? Litigation is one option, even if it is not always the ideal one. Subsidies conditioned on the purchase or use of locally-made goods are clearly prohibited by the Agreement on Subsidies and Countervailing Measures (SCM). Prior panels have consistently found against local content requirements even when they were purportedly tied to green policies. In addition, production subsidies that have no local content requirement can be challenged in the WTO if they cause “adverse effects” to other WTO members. This includes situation where the effects of the subsidy have not fully materialized, but rather threaten harm to the economic interests of other WTO Members. Some will argue that a WTO challenge is futile at present because the subsidizing countries, like the U.S., can appeal an adverse panel ruling “into the void” while the Appellate Body is not operational. This is too narrow a view. Adverse panel rulings have reputational costs. It may get more difficult for the U.S. to accuse other members of subsidizing their domestic industries and pursuing industrial policies when WTO panels are actually finding that it is the U.S. that is in violation of the SCM Agreement. Furthermore, if the subsidizing country appeals an adverse finding by a WTO panel into the void, the WTO member who brought the initial complaint may feel it can legitimately resort to unilateral retaliation.
There are multiple options beyond litigation. More transparency on the subsidies that are being provided is fundamental to understand their potential effects on other trade partners and to ensure consistency with the rules. Transparency requirements are already embedded in the SCM Agreement, but compliance can improve. Transparency must be towards everyone. A recent press article suggested European ministers visiting Washington, D.C. had obtained a commitment from the U.S. to provide full transparency over the level of subsidies being provided under the IRA. Although this commitment to transparency is welcome, the information must be made available to all WTO members.3 There are no sound policy reasons to discriminate when it comes to transparency.
Ideally, one would also want to see a commitment to refrain from providing distorting subsidies. But that is unlikely to happen. A more realistic option is for WTO members to agree on guidelines that ensure that subsidies are narrowly directed at environmental objectives, are non-discriminatory, and are the least trade-distorting possible.
In the absence of such agreement, or a sudden shift towards restraint, members that are affected by the subsidies will have to give serious consideration to ways of increasing the costs on subsidizing members. Countervailing duties are an option when the subsidies flow to products that are exported to other markets. Perhaps it is time to reconsider the WTO-consistency of the distribution of the proceeds from the countervailing duties to affected domestic industries. Since they are affected by subsidies given to their competitors in the other jurisdiction, why not compensate them by giving them the proceeds of the countervailing duties? However, countervailing duties are only effective in terms of remedying the effect of the subsidies in the importing country but they do not address the effects in other markets.
Some countries may eventually consider that they should have a right to impose immediate retaliation as a remedy for lost exports to the subsidizing country. This would be similar to the existing right in the Agreement on Safeguards to suspend concessions when a safeguard is considered to be inconsistent with that Agreement. However, this type of suspension of concessions would not address the effects in third country markets. Only WTO litigation addresses those effects.
Each of these options has its own drawbacks. They would reduce trade, which is the opposite of what the multilateral trading system pursues, and each introduces its own distortions. Nevertheless, without anything to counter the current impulse to subsidize, there is a risk of a prolonged subsidy war and that trade tensions will increase more and more. That scenario isn’t in anyone’s interest.
1 See https://www.globaltradealert.org/global_dynamics.
2 See https://www.wto.org/english/news_e/news23_e/igo_20jan23_e.htm
3 G. Chazan, “France and Germany claim assurances from US over green subsidies”, Financial Times, 7 February 2023.
While subsidies can be appropriate policy tools to overcome market failure, they create significant distortions and can create a never-ending cycle of subsidization. Subsidies distort the allocation of resources among countries and within them. Firms will invest in the jurisdictions that provide the highest subsidies and will produce the goods to which governments have chosen to direct the subsidies. Already there are numerous reports in the press that firms are redirecting investment to the U.S. to take advantage of the IRA subsidies and that the EU is trying to slow this down by increasing its own subsidies. This U.S.-EU subsidies competition does not only impact their firms, it also adversely affects the rest of the world. Other countries will find it more difficult to retain investment, let alone to attract more of it, in the face of the U.S. and EU subsidies. The fact that the EU is responding to U.S. subsidies with its own subsidies compounds the problem for everyone else. The choice for other countries is to offer their own subsidies or risk losing investment to the U.S. and the EU. If other countries respond with their own subsidies, the distortions will multiply. Obviously, this cycle poses a greater challenge to countries with less resources, as the World Trade Organization (WTO) Director-General recently noted.2
Is there anything that can be done to stop the subsidy war? Litigation is one option, even if it is not always the ideal one. Subsidies conditioned on the purchase or use of locally-made goods are clearly prohibited by the Agreement on Subsidies and Countervailing Measures (SCM). Prior panels have consistently found against local content requirements even when they were purportedly tied to green policies. In addition, production subsidies that have no local content requirement can be challenged in the WTO if they cause “adverse effects” to other WTO members. This includes situation where the effects of the subsidy have not fully materialized, but rather threaten harm to the economic interests of other WTO Members. Some will argue that a WTO challenge is futile at present because the subsidizing countries, like the U.S., can appeal an adverse panel ruling “into the void” while the Appellate Body is not operational. This is too narrow a view. Adverse panel rulings have reputational costs. It may get more difficult for the U.S. to accuse other members of subsidizing their domestic industries and pursuing industrial policies when WTO panels are actually finding that it is the U.S. that is in violation of the SCM Agreement. Furthermore, if the subsidizing country appeals an adverse finding by a WTO panel into the void, the WTO member who brought the initial complaint may feel it can legitimately resort to unilateral retaliation.
There are multiple options beyond litigation. More transparency on the subsidies that are being provided is fundamental to understand their potential effects on other trade partners and to ensure consistency with the rules. Transparency requirements are already embedded in the SCM Agreement, but compliance can improve. Transparency must be towards everyone. A recent press article suggested European ministers visiting Washington, D.C. had obtained a commitment from the U.S. to provide full transparency over the level of subsidies being provided under the IRA. Although this commitment to transparency is welcome, the information must be made available to all WTO members.3 There are no sound policy reasons to discriminate when it comes to transparency.
Ideally, one would also want to see a commitment to refrain from providing distorting subsidies. But that is unlikely to happen. A more realistic option is for WTO members to agree on guidelines that ensure that subsidies are narrowly directed at environmental objectives, are non-discriminatory, and are the least trade-distorting possible.
In the absence of such agreement, or a sudden shift towards restraint, members that are affected by the subsidies will have to give serious consideration to ways of increasing the costs on subsidizing members. Countervailing duties are an option when the subsidies flow to products that are exported to other markets. Perhaps it is time to reconsider the WTO-consistency of the distribution of the proceeds from the countervailing duties to affected domestic industries. Since they are affected by subsidies given to their competitors in the other jurisdiction, why not compensate them by giving them the proceeds of the countervailing duties? However, countervailing duties are only effective in terms of remedying the effect of the subsidies in the importing country but they do not address the effects in other markets.
Some countries may eventually consider that they should have a right to impose immediate retaliation as a remedy for lost exports to the subsidizing country. This would be similar to the existing right in the Agreement on Safeguards to suspend concessions when a safeguard is considered to be inconsistent with that Agreement. However, this type of suspension of concessions would not address the effects in third country markets. Only WTO litigation addresses those effects.
Each of these options has its own drawbacks. They would reduce trade, which is the opposite of what the multilateral trading system pursues, and each introduces its own distortions. Nevertheless, without anything to counter the current impulse to subsidize, there is a risk of a prolonged subsidy war and that trade tensions will increase more and more. That scenario isn’t in anyone’s interest.
1 See https://www.globaltradealert.org/global_dynamics.
2 See https://www.wto.org/english/news_e/news23_e/igo_20jan23_e.htm
3 G. Chazan, “France and Germany claim assurances from US over green subsidies”, Financial Times, 7 February 2023.
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