The WTO and Subsidies

For most of last century, governments had a great deal of leeway in deciding who they could give subsidies to and how much they could give. The growth in international trade in the latter part of the 20th century, and the emergence of the World Trade Organization, brought about a momentous change in subsidy policy. Governments realized that their benefits from trade agreements they’d signed to lower tariffs and free trade would be lost if other members were allowed to freely subsidize companies or industries. A trade-off had to be made: to ensure members competed on an equal footing, governments agreed to abide by a body of rules that allowed certain kinds of subsidies and prohibited others — what economists call ‘disciplines’.

By and large, these rules prescribe what kinds of subsidies a country can hand out and how. The first sectors of the economy to come under these disciplines were agriculture and the cross-border trade in goods. In the future, these disciplines are expected to extend deeper into agriculture and into the trade in services such as banking and tourism. That will make the WTO’s role in governing subsidies even bigger than it is now. Any debate over subsidies, such as the emerging one over biofuels, will increasingly have international dimensions that will require an understanding of the WTO rules on subsidies and how these rules are developed.

What Are Subsidies For?

Subsidies are a means for governments to promote the growth of particular industries or regions, to correct market failures, or to enhance social welfare. Billions of dollars — roughly 1% of a country’s GDP — are spent each year by governments to supplement the incomes of farmers, help unemployed workers find new jobs, fund research into new technologies, defray the costs of exploration and research in the energy industry, assist companies to invest in eco-friendly technologies, lower the cost of education and medicine to the public, and nurture nascent manufacturing industries. These subsidies usually achieve one of four objectives: economic and industrial development, research and innovation, redistribution and environmental protection.

Of course, in practice, governments also hand out subsidies to curry favor with political constituents and powerful interest groups. That is one of the dangers of subsidies — that they entrench recipients who have a vested interest in perpetuating them even once the subsidies are no longer needed — if they ever were. In a closed economy, as was more common in the past, a government contemplating which individuals or industries it wanted to subsidize only needed to consider the demands of its domestic constituencies and interest groups, and try to convince the public that its subsidies to one region or one sector of the economy were justifiable on the grounds of economic development or social welfare. But in today’s more open global economy, while governments still need to do this, they also have to ensure their subsidies adhere to the WTO rules they’ve agreed to follow. This entails ensuring that their subsidies do not distort international trade and harm the competitiveness of producers in other member economies.

This globalization of trade and the creation of the WTO to govern it has led to growing numbers of confrontations between governments over subsidies, of which the most prominent has been the debate over American and European agricultural subsidies. Take the case of U.S. subsidies to cotton farmers. The United States has unsuccessfully fought a three-year court case against Brazil and a handful of West African countries, which claimed that American subsidies hurt cotton producers in Brazil and West Africa because it made them unable to compete with U.S. subsidized cotton on the world market. The case has dragged on for five years without a clear resolution. Brazil still contends that U.S. reforms to its subsidies have not gone far enough, and another case is wending its way through the WTO court system.

The deadlock in the Doha round of negotiations also can be understood in the context of this shift towards international disciplines on subsidies. Subsidies are not the only reason why the Doha Round has twice run past its self-imposed deadlines. But it is fair to say that agricultural subsidies have been the biggest stumbling block to a deal. Critics blame the massive subsidies by the United States and the EU for creating huge distortions in trading, pumping up output by uncompetitive producers and putting a squeeze on more competitive ones, many of them in developing countries. But the United States, the EU and Japan have been reluctant to agree to stricter limits on the amount and types of agricultural subsidies. This is not just a story of these countries being beholden to powerful lobbying groups at home, though to some extent that is true. It is also an ongoing debate over how much freedom a country has to use subsidies to promote its own values. The EU, for instance, takes the view that subsidies are not just an economic support — though they are useful to supplement low-income farmers — but they also provide food security to EU countries and help preserve the region’s landscape. The costs of the subsidies, according to this argument, outweigh the benefits to EU citizens.

What this illustrates is that there is no widespread agreement on the role subsidies play in economic development and social welfare, or on the possible distortive impacts they have on international trade. There is, for example, a longstanding debate over how important subsidies were in the meteoric rise of East Asian countries. The other key point to keep in mind is that the rules governing subsidies at the WTO are not set in stone. While there is a basic agreement on how to treat subsidies for traded goods, it is the general framework that is subject to negotiations during the Doha Round. So the debate on subsidies is very much up in the air.

A Short History of the WTO Agreement on Subsidies

The WTO is essentially a forum where rules governing international trade in goods and services are negotiated and enacted into law. At 12 years of age, it is one of the youngest international organizations. About 151 countries are WTO members; Russia is the biggest country not yet a WTO member, although it will soon be admitted to the club. By joining the WTO, Russia will, like all other members, be bound to honor the commitments it made in its accession agreement and to adhere to the regulations stipulated in the WTO’s many agreements, the first of which dates back to 1947.

The general principle underlying the agreements — and the WTO — is trade without discrimination. Codified in the first article of GATT as Most Favoured Nation treatment, or MFN for short, this requires a member to treat all other members equally. Another general principle is National Treatment, which requires a country to treat imported and domestic goods and services alike. The various agreements on goods, services, investment, intellectual property and other issues provide rules and guidelines for members to follow.

In the case of subsidies, that agreement is the Agreement on Subsidies and Countervailing measures. The ASCM applies to goods. Services are treated under the Agreement on Services, although a detailed framework for services has not yet been developed and is supposed to be negotiated in the current Doha negotiations. Agricultural subsidies are treated on their own in the Agreement of Agriculture. When negotiating the SCM agreement in the Uruguay round, members decided agriculture was too sensitive to be bound by the ASCM’s more stringent subsidy disciplines. And looking at how fraught the Doha round has become with recriminations and deadlocks over agricultural subsidies, that judgment seems prescient.

A good taste for how flammable subsidies are is to consider the fact that the SCM agreement is believed to be the agreement WTO members violate the most. The SCM agreement was negotiated 14 years ago, but came into effect with the WTO. Prior to that, subsidies were dealt with under the 1947 General Agreement of Tariffs and Trade, which was fairly tolerant of subsidies, and the “Subsidies Code” negotiated at the Tokyo Round during the 1970s. The SCM agreement went far beyond the "Subsidies Code" and its limited subsidy disciplines, and for the first time provided a legal definition of a subsidy, which has become crucial in settling subsidy disputes. Disputes usually tend to play out with the accusing country trying to prove a challenged payment scheme or policy qualifies as a subsidy, while the defending country tries to show it does not. It can be a time-consuming and costly process.

Under the ASCM definition, a subsidy exists if it meets the three following criteria: it is a financial contribution by the government or a government-related agency; it confers a benefit to those who receive the subsidy; and it is specific, that is the subsidy is targeted to an industry or a limited group of producers.

Red, Yellow and Green

Fitting these criteria though, doesn’t necessarily make a subsidy prohibited. The SCM agreement divided subsidies into three categories in a traffic light schema: prohibited ‘red light’ subsidies, actionable or ‘yellow’ light subsidies, and non-actionable ‘green light’ subsidies. (The non-actionable category expired after five years and no longer exists.) The important thing to understand here is that these categories were created to recognize that subsidies can have detrimental or beneficial effects depending on how they are structured, and that they play an important role in economic development, redistributing growth and, it can be argued, protecting the environment.

Prohibited subsidies are not allowable under any conditions because they highly distort trade. Two types of subsidies are prohibited: export subsidies and domestic-content subsidies; in short, subsidies contingent upon the export of a good or service, or that requires the subsidized producers to use domestic inputs.

Actionable subsidies are subsidies that are not prohibited but can be challenged by other members if one member believes that another member’s subsidy has injured a domestic producer or group of producers. To be actionable, the subsidy should be targeted to a specific producer or group of producers; if it is deemed to be "non-specific" it is automatically permissible.

Most subsidies fall within the actionable category. In a dispute over an actionable subsidy, a challenge has to prove that the subsidy does one of three things: that it causes harm to the domestic industry; that it impairs or nullifies the benefits derived from its WTO membership, such as when a subsidy deprives a member of market access because its goods are priced out of the market; or that it causes ‘serious prejudice’ to the member. Serious prejudice can be claimed if a domestic producer or producers are negatively affected by the subsidy in the subsidizing country or in other countries, for example, when they lose market share. None of these are easy to prove and can involve complex and lengthy determinations.

The green-light subsidies were inserted into the text by members during the SCM Agreement negotiations. A research and development clause was inserted into the text — at the behest of the United States — which allows governments greater scope in providing assistance to industries or universities to finance research. An environmental clause, put forward by Mexico, was also established to allow subsidies to companies or industries to adapt to stricter environmental regulations. Mexico’s concern stemmed from its dispute with the United States over American policies to restrict imports of tuna that were caught using nets that harmed dolphins. Lastly, a regional-development clause was also included to allow governments to provide redistributive assistance to regions that are not as developed.

Green-light subsidies belonged to a provisional category that laid out conditions under which subsidies without any risk of being challenged by other members. Officially this category expired in 2000 after members could not agree to its extension. Unofficially, members are still providing subsidies under this category with little fear that they will be challenged. A reexamination of green-light subsidies is being conducted during the Doha Round, although little progress has been made.

Some developing countries whose GDP per capita is less than $1,000 are exempt from the prohibition on export subsidies, and also receive different treatment under the ASCM. The rationale for this exemption is that subsidies can be useful for countries to develop nascent, uncompetitive industries.

Besides establishing the traffic-light subsidy schema, the SCM Agreement also outlines what measures members can take to counteract another member’s subsidy. Any actions, such as a duty on imports from that member country, can only be taken if the country successfully proves to the WTO that the other member’s subsidy is impacting a domestic company or industry. If the subsidizing member does not agree with the WTO’s findings and does not stop or reform the challenged subsidies, the other member can apply a countervailing duty to annul the benefits of the subsidy.

All trade disputes, including ones over subsidies, are settled by the WTO's Dispute Settlement Body (DSB), which must deliver a judgment within six months of receiving a complaint. Appeals are handled by an Appellate Court. A recent subsidy case that wound its way through the system right up to the Appellate Court, and is still ongoing five years later, was United States–Upland Cotton, which found that some subsidies provided by the United States caused serious injury to Brazil or were prohibited export subsidies.

One last important article in the SCM Agreement is subsidy notification. Information on subsidies is notoriously scarce and, when available, it is difficult to compare on a country-basis. The SCM Agreement requires all members to notify the WTO of all the subsidies it provides on a bi-annual basis. This requirement should improve statistical evidence and assist countries in analyzing any impacts of the subsidies on their domestic industries. However, the requirement has rarely been met in practice. In any given year, up-to-date subsidy data are available for less than half of WTO members. For some members this may be due to an undeveloped administrative system; but for many the silence reflects the unwillingness of members to submit their subsidies to the scrutiny of other members.

Doha: Agriculture, Fisheries and Services

The Doha Round was launched in 2001 and was widely billed as "the development round". For subsidies, the Doha mandate called for negotiations to “clarify and improve” the subsidy rules for agriculture, services and fisheries.

Agriculture was chosen because it is one of the biggest recipients of subsidies and the trade-distorting impact of these subsidies is believed to be substantial. At the moment, the EU Common Agricultural Policy represents just under half of the EU’s budget. The United States spends an estimated $11 to $19 billion a year on agricultural subsidies. As mentioned above, agricultural subsidies are treated under subsidies agreement because they are a much more sensitive and protected sector that’s been resistant to change. Longstanding arguments over food security, entrenched agricultural interest groups with powerful lobbying groups, and new arguments over ‘multifunctionality’ all complicate the negotiations. As a result, the subsidy regime for agriculture has been much looser: export subsidies, for instance, which are prohibited under the SCM Agreement because they highly distort trade, are still allowable under the current Agreement of Agriculture. In the ongoing Doha Round of negotiations, export subsidies are slated to be phased out. But the disciplines for agriculture still will not be as strict as the SCM Agreement’s.

The Agreement on Agriculture has something similar to the SCM’s traffic light schema for agricultural subsidies. In the Doha round, WTO members have agreed to increase the number of prohibited subsidies and cap the level of amber-box subsidies. Large agricultural subsidizers, such as the EU, Japan and the United States, have been reforming their subsidies to keep in step with these commitments. This has led to a rapid increase in green-box subsidies, a trend that has raised concerns among other big agricultural producers. Green-box subsidies are any subsidies that are not linked to outputs or inputs, or have an impact on production. Among the subsidies classified as Green Box are those used for environmental management and conservation. The worry of other members is that these subsidies have been changed in name but not in substance, and the issue remains a sticking point in the current negotiations.

Subsidies to services

As mentioned above, trade in services like banking, medical services, tourism and telecommunications is governed by the General Agreement on Trade in Services. Little is said in the GATS about subsidies beyond stipulating that a subsidy to a service provider or industry must be in accordance with the most-favoured nation and national-treatment principles. In addition, it calls upon WTO members to develop a framework of rules suitable to services, since the goods agreement is unlikely to be an exactly applicable model. The negotiations are supposed to give special consideration to developing countries and the importance of subsidies in development.

But progress since negotiations began in 1996 and during the current Doha Round has been minimal. One problem is that services are much more complex since the GATS applies to four modes of trading services, rather than just the cross-border trade of goods in the SCM Agreement. These are: services supplied by one country to another, such as banking; the consumption of services in a foreign country, which would apply to services provided to foreign tourists; the presence of a company in a foreign country like a subsidiary; individuals travelling to another country to supply services there. No decision has been made on whether a one-size-fits-all solution or a mode-by-mode and sector-by-sector approach is needed. As well, calculating the adverse effects of one country’s subsidy on service suppliers in another — essential to settling any subsidy dispute — is quite difficult because financial transactions in the four modes of supply are not easy to quantify. A lack of data on subsidies for trade in services, and of studies on their trade-distortive impacts, has further hamstrung efforts to develop a framework.

These obstacles go a long way to explaining why members have shown little interest in developing subsidy rules for services. But it is likely that solutions will need to be found eventually. While members are supposed to improve market access in services in the Doha round, concerns that one country’s benefits can be nullified by another’s subsidies should force members to the negotiating table.

Fisheries Subsidies

Fisheries are a unique instance of where subsidy negotiations have focused not just on the trade-distortive impacts of subsidies, but also their environmental impacts. Partly this is because of the migratory nature of fish and because fishing stocks are shared resources. One member’s actions can quickly impact domestic fishing stocks or another member’s access to fishing stocks in the open seas.

The Doha mandate specifically called for negotiations on fisheries subsidies, taking into consideration that it is an important industry for developing countries. What has been negotiated since then is far more ambitious. The latest draft for negotiations shows members are focusing on prohibiting subsidies that contribute to overfishing, and allowing subsidies that improve fisheries management. The significance of this development is that fisheries will likely become a model for future negotiations over the environmental impacts of subsidies on shared resources.

Tips For Writing About Subsidies and the WTO

Any government handing out a subsidy today has to ensure that it doesn’t injure the trading interests of another member. When writing about subsidies, keep in mind both their domestic and international impacts. While domestically a subsidy involves a diversion of tax resources towards one sector, internationally that subsidy may be affecting foreign producers, who could dispute the subsidy.

WTO subsidy rules are not set in stone. What is allowable today as a subsidy may not be in the future. Negotiations in the Doha Round on subsidy rules for agriculture, goods, services and fisheries will have a significant impact on how trade will impact the environment or a developing country’s freedom to nurture young industries.

Useful contacts for subsidy stories, besides the recipients of subsidies, are government policy officials, WTO officials and negotiators, economists, legal experts, development and environmental research institutes.

Sign up for the WTO press reports that provide details of closed and open door negotiations in the Doha Round.

Data on subsidies are not easy to come by. The WTO collects subsidies data through trade policy reviews and member submissions. Most governments release data under their national accounts statistics. The IMF also complies subsidy data in its Government Finance Statistics Yearbook.