Back to Basics: Subsidy Wars
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- Authors: ELIZABETH VAN HEUVELEN
- Published: June 1, 2023
Overview and context
- A ramping up of subsidies by some of the world’s largest economies has contributed to a significant increase in global trade tensions.
- New subsidies, countervailing duties, and legislation such as the US Inflation Reduction Act, the EU Green Deal Industrial Plan, and the Made in China 2025 strategy have raised concerns about the potential for subsidy wars—subsidy competition that leads to a race to the bottom.
- Subsidies adopted by one major trading bloc have spurred others to enact their own subsidies within just six months.
- Subsidy disputes and countervailing duty investigations at the WTO have increased steadily since 2010.
Why governments subsidize
- Subsidies are a transfer of resources from a government to a domestic entity without an equivalent contribution in return and can take many forms, including direct grants to domestic companies, tax incentives, or favorable terms for financing.
- Motivations for subsidies:
- Achieve a national strategic objective or gain a competitive edge in international markets (example: production subsidies in high-tech industries such as aerospace and telecommunications to ensure predictable or guaranteed supply chains or to protect other national security interests).
- Respond to lobbying or political pressure without a clear rationale.
- Pursue public policy objectives, such as correcting market failures or responding to national emergencies (example: subsidies for COVID vaccines to address capacity constraints).
Economic and cross-border problems caused by subsidies
- Market distortion and resource misallocation:
- Subsidies cause a misalignment between prices and production costs, distorting markets and preventing efficient outcomes.
- They can divert resources to less productive uses and reduce overall productivity.
- Competitive and structural harms:
- If subsidies benefit some firms over others, they can snuff out innovation and force efficient firms to contract out work or exit the market altogether.
- Subsidies create opportunities for rent-seeking behavior and harm smaller economies that cannot afford to subsidize.
- Environmental and public-health harms:
- The world could have cut global carbon emissions by 28 percent and air pollution deaths by 46 percent had policymakers agreed to replace fossil fuel subsidies with an efficient carbon price.
- Trade and investment distortion across borders:
- Discriminatory provisions (for example, requirements that manufactured goods use components made exclusively or primarily within the country) can lead manufacturers to reconfigure supply chains, cause foreign producers to relocate production, and alter consumer preferences.
- Subsidies can undercut benefits from past tariff and market-access negotiations, increasing perceptions that trade is unfair and reducing public support for trade.
- Trading partners may impose countervailing duties or introduce their own subsidies in response, potentially triggering escalating subsidy wars.
International rules and shortcomings
- The WTO Agreement on Subsidies and Countervailing Measures (SCM agreement) and its Agreement on Agriculture provide a foundation for rules governing subsidies that affect trade in goods.
- The SCM agreement defines subsidies, including prohibited subsidies (such as export subsidies and local-content subsidies) and those that can be challenged because they have adverse effects on another country.
- The agreement requires governments to notify the WTO of certain subsidies and establishes procedures for unilateral and multilateral remedies, including countervailing measures and WTO dispute settlement.
- Shortcomings and gaps:
- Some forms of state intervention, including subsidies to and provided by state-owned enterprises, are not automatically counted as “subsidies” in the current WTO definition.
- Intervention can include providing favorable financing for land or equipment to state enterprises that produce goods for export.
- Some countries are concerned about how subsidy rules apply to state enterprises and have incorporated measures in recent trade agreements to limit market-distorting behavior (examples: the Comprehensive and Progressive Agreement for Trans-Pacific Partnership and the agreement between the United States, Mexico, and Canada).
- Countries have sometimes failed to notify the WTO when they introduce subsidies, contributing to a lack of transparency and sowing mistrust.
- There is no comprehensive analysis of subsidies and their effects internationally, and little guidance on how subsidies can be improved and how to minimize negative cross-border spillovers.
Paths to defuse subsidy tensions
- Key measures proposed to mitigate subsidy wars:
- Enhance transparency on subsidies.
- Provide better analysis of subsidies and their cross-border effects.
- Strengthen cooperation to improve the design of subsidies and limit their harmful effects.
- A recent joint paper, “Subsidies, Trade, and International Cooperation,” by four international organizations, including the IMF, proposes ways to enhance transparency, provide better analysis, and strengthen cooperation.
- Cooperation and common understanding are emphasized as ways to dial back tensions and contribute much-needed openness and predictability to global trade.
Elizabeth Van Heuvelen, F&D Magazine, June 2023.
Content in this bundle
- anea2022001 - Executive Summary
- Back to Basics: Subsidy Wars