How the U.S., the EU, and Japan Are Trying to Rein in China’s State Capitalism

By Matt Dallisson, 21/11/2018

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On November 12, the United States, European Union, and Japan will submit a package of proposals to the World Trade Organization’s Council on Trade in Goods that would significantly help curb China’s practices of heavily subsidizing its state-owned enterprises. They are also discussing ways to prevent China from forcing Western companies to transfer technology to Chinese firms. Hopefully, the Trump administration’s threat to escalate the tariffs war with China will persuade China to accept such reforms.

Subsidies. China announced it planned to provide $350 billion in subsidies to 10 key industries of the future such as robotics, electric vehicles and EV batteries, advance computers, and mobile devices under its ‘Made in China 2025’ policy. (Unlike economy-wide supports such as an R&D tax credit, WTO rules prohibit subsidies to specific companies because of the competitive advantage they confer.)  But under WTO rules, no country can obtain any remedy such as duties to offset the subsidies without hard evidence documenting these subsidies.

Although WTO members are obligated to give “notice immediately” when each subsidy program is created, the reality is many don’t. China has disclosed only a small fraction of its subsidies, usually several years after they were created. Moreover, China’s subsidies are shielded by unpublished government budgets, internal instructions, oral directives, and a law that allows commercial information to be treated as “state secrets.”

The U.S., EU, and Japan have already agreed to propose two changes aimed at pressuring abusers to disclose the subsidies:

• Revise the rules to stipulate that a failure to give to give timely notice of subsidies would result in a presumption that the subsidy causes injury, which would make it far easier for the affected country to seek damages in a much shorter time frame
• Introduce a system of escalating administrative sanctions that would reduce the offending member’s influence in the WTO and its access to information

The three have also agreed to seek an expansion of the WTO’s existing list of prohibited subsidies to state-owned enterprises (SOEs) to include the unlimited guarantees of financial obligations, subsidies to insolvent or failing companies with no credible restructuring plan, and preferential pricing for inputs such as raw materials and components.

Although the U.S., EU, and Japan are still trying to agree on the details, they also intend to seek “targeted remedies against subsidies to maintain or expand capacity beyond commercial consideration.” These subsidies are a major problem. For example, China is the largest producer and exporter of steel and the largest source of excess steelmaking capacity. Itsexcess capacity alone exceeds the total U.S. steelmaking capacity and, in an average month, China’s steel output equals total annual U.S. production.

SOEs themselves frequently provide subsidies to Chinese companies in the same manner as the government does. The U.S., EU, and Japan want to make such practices subject to the same rules as government subsidies to SOEs and to private firms but are still trying to reach a consensus on the best ways to do that.

The EU is proposing a clarification of the WTO rules to determine what constitutes a “public body,” which would help establish whether an SOE is performing a government function or is furthering a government policy, and the adoption of criteria for establishing whether a member country exercises meaningful control over an SOE.

The U.S. is suggesting rules that would force SOEs to provide detailed disclosures that could facilitate challenges by injured members. These include a listing of all SOEs on a public website and disclosure of the percentage of government shareholding in the SOE, titles of government officials who are officers or on the board of the SOE, annual SOE revenues, and detailed facts on any policy or program that provides subsidies to the SOE.

Either option would significantly increase opportunities to restrain SOE abuses.

Forced technology transfers and theft. The U.S., EU, and Japan are also tackling steps inside and outside the WTO to combat forced technology transfers both in China’s domestic market and, through mergers and acquisitions, abroad.

For the Chinese market, the group favors limits to requirements that foreign companies form joint ventures with a Chinese partner, foreign equity caps, administrative reviews based on unclear rules with wide discretion, and pressure on foreign companies to license their technologies to Chinese companies on bargain terms.

Because WTO rules on cross-border investments are limited, the U.S. is sharing information with the EU and Japan on U.S. laws for screening foreign investments. For example, the Foreign Investment Risk Review Modernization Act (FIRRMA), which became law last August, mandates that the U.S. government conduct far-reaching inquiries into the impact of such investments on national security. Twelve of the European Union’s 28 member states currently lack any system for reviewing foreign investments.

The EU has recently proposed a new screening mechanism that would clarify the scope of each member’s review of incoming investment. It would help spot SOE investments that are problematic.

These measures would be useful steps.

Now let’s turn to the forced transfers or theft of digital technologies. In May, the U.S., EU and Japanese trade ministers issued a strong statement condemning “government actions that support…theft from computer networks of foreign companies of commercial information and trade secrets” to use them  for commercial gain. The three also agreed to seek a rule that would stop WTO members from requiring companies to disclose their source codes, highly competitive core technology that is produced at great expense. While the ministers have not yet agreed on tools to achieve these goals, their accord to pursue them is promising.

Expansion. The U.S., EU, and Japan agree that the expansion of their group is essential. The most likely candidates to join soon are Australia, New Zealand, Canada, and Mexico. Among the many reasons I think the Trump administration should ease up on its attacks on the WTO is the fact that they are making it more difficult to recruit developing-country members, even though many share U.S. concerns about China. Indeed, China has missed no opportunity to use the U.S. attacks to portray itself as a defender of the WTO trade system.

The U.S., EU, and Japan should also lobby China to join their reform process. That might seem like a wild idea, but given that any single WTO member can block proposed rule changes, it would be far better to involve China early in these efforts.

Why would China ever agree to such reforms? One reason is it cannot afford to be isolated from the major industrial economies: It depends on access to their technology to achieve its Made in China goals. Another is increased isolation could kill the trade goose that enables China’s leaders to produce the prosperity on which their legitimacy depends.

China’s subsidies and tech-transfer practices pose a major threat to the global trade order. They must be reined in. If ultimately adopted by the WTO, the proposals that the U.S., EU, and Japan have agreed to or are hammering out would represent a big step toward achieving that end. As one savvy senior EU trade official recently told me, the U.S. should exploit the leverage from the tariffs war to bring China to the table.