As the global financial crisis continues to worsen, many developed and some developing countries have turned to bailout packages to resuscitate stricken businesses, which could potentially violate the World Trade Organization (WTO) rules on subsidies.  In fact, some countries, such as Brazil, have already threatened to launch WTO claims against countries that implement them.

In most cases, determining whether a given bailout package and the possible subsidies contained therein is WTO compliant begins with the Agreement on Subsidies and Countervailing Measures (SCM Agreement). The SCM agreement governs subsidies when they involve a financial contribution on the part of a government that confers a benefit on specific enterprises or industries.

WTO procurement provisions are another area of WTO rules that may be infringed by bailout measures. One recent such measure that has received a lot of recent attention recently is the controversial “Buy American Clause” included in the American Recovery and Reinvestment Act signed by President Obama on 17 February 2009. This clause requires public work projects funded under the Act to use U.S. iron, steel and manufactured goods.

After intense international criticism, the U.S. Senate softened the measure by adding that it must be applied in accordance with U.S. obligations under international agreements. Even so, the measure may lead to questions within the WTO framework, as well as other international commitments entered into by the United States.

Subsidy Watch has spoken to three experts on the WTO for their views on whether the certain government bailout packages violate the commitments governments have made at the WTO, and if so, whether wide-spread litigation through the WTO’s dispute resolution mechanism is to be expected.  Professor Julius Sen is a Research Associate at the London School of Economics’ International Trade Policy Unit.  Arvind Panagariya is a Professor of Economics at Columbia University, a Non-resident Senior Fellow at the Brookings Institute and former Chief Economist of the Asian Development Bank.  Ken Shadlen is a Senior Research Fellow, Global Development and Environment Institute (GDAE), Tufts University and a Senior Lecturer in Development Studies at LSE.

Interview with Julius Sen:

SW: Since the financial crisis began last fall, certain governments such as those in the United States, Canada, Japan and Germany, have offered their banks and/or automobile industries financial bailouts, usually in the form of soft-loans and credit guarantees.  Generally speaking, are these bailouts consistent with WTO rules? 

The short answer is no. But there are several issues to be taken into account when analysing the specifics with reference to the application of WTO principles of non-discrimination, broken down into Most Favoured Nation and National Treatment obligations. First of all, what are the specific obligations or commitments of the Member concerned?  This question is particularly important in the area of financial services, which are subject to the rules of the General Agreement on Trade in Services (GATS) agreement and thus slightly different from the General Agreement on Tariffs and Trade (GATT) which would apply to the auto sector.

Second, governments can take emergency action for the restructuring of specific sectors, under Article XIX Safeguards, which can include financial assistance of various sorts, but they have to negotiate compensatory concessions with trading partners during the safeguard period, which I don’t think anyone has done.

Third, any grants, concessional loans or other forms of state aid have to be applied in a non-discriminatory fashion (that is for everyone in the market—which obviously has not been the case); should not be trade distorting (which of course they are); and should not have any local content obligations, which would violate the TRIMS agreement on investment conditionalities. And finally, there are European Union rules on State Aid and Competition policy that will also apply to the cases of anyone operating in the EU market, which of course includes U.S. and Japanese automakers and banks. I am not sure what the discussions have been in this area within the EU, but I doubt whether any have actually taken place.

There is an additional possibility that would take state actions completely out of WTO jurisdiction, and that is if these countries treated these rescue packages as part of national security (Article XXI). The concept of legitimate security considerations has never been defined, and is thus flexible to national interpretation.

SW: In particular, the U.S. government’s 19 December bailouts of automakers Chrysler and G.M. have been criticized for violating WTO subsidies rules. What is your analysis of this view?

I agree that these actions would appear to violate WTO rules at a number of levels, but I am not aware of the full details of how these bailouts were done. Normally, a sector can be identified for restructuring under Article XIX, and during the period of restructuring, concessions have to be offered to all trading partners to make up for their loss of income in that market. In this case, I doubt whether there was any discussion with other WTO members, so there would have been no Article XIX process.

The other level of violation is that this package was only offered to U.S. automakers, not to foreign automakers within the United States. This would appear to violate the rules of non-discrimination and national treatment. And of course these financial concessions will give these automakers an advantage in export markets, including NAFTA markets, so would amount to export subsidies in such cases, which are prohibited under GATT rules. At the same time, the question of whether subsidiaries of U.S. automakers in other countries (such as Vauxhall in the UK, Saab in Sweden and Opel in Germany—all subsidiaries of GM) are entitled to U.S. bailouts, also arises. At present they are not, which has led Saab to file for bankruptcy protection. But it begs the question of how WTO rules apply to complex multinational structures with more or less autonomous subsidiaries.

Furthermore, if new technical standards are introduced to encourage energy efficient  models for the U.S. market, and if select U.S. automakers alone are given money to help re-engineer their plants to meet these new standards, and the same concessions are not given to others within the U.S. or that export into the U.S., then this too would probably be a violation of WTO rules.

SW: WTO Director General Pascal Lamy recently commented that it was too early to tell what impact these measures would have on trade but warned that some “may eventually have negative spill-over effects on other markets or introduce distortions to competition between financial institutions.” Do countries need to wait for these spill-over effects and distortions before commencing WTO claims?

First of all, I’m not sure I agree with the phrasing ‘eventually’ and ‘spill-over’. The situation is in the here and now and is not a remote possibility. For instance, many countries are offering state assistance to meet trade financing requirements for exporters. This would appear to be a prima facie violation of WTO rules under the TRIMS and other agreements, which also has a very real (trade distorting) impact on the competitiveness of global exports, even now. But of course the response is also fully understandable from the perspective of managing the crisis!

WTO rules do not enforce themselves. Member States have to initiate action. At the moment everyone seems prepared to operate a general ‘ceasefire’ in this respect, which means national governments (who alone can bring cases) recognise that everyone is in difficulty and confronting violations will only complicate efforts to find global solutions to the crisis. There are precedents for this, most notably in the Agreement on Agriculture which built in a ceasefire provision for the first decade of its life, precisely to avoid trade wars in an area of extreme sensitivity and complexity.

The problem will arise, most likely, in the United States, where the U.S. government has to take action under law to investigate private sector complaints and to respond through disputes or other policy instruments (such as anti-dumping actions). These are mandatory provisions that could trigger global mayhem in trade. Unfortunately, the U.S. Congress loves to adopt an assertive position on trade issues, which can make life difficult. And remember, under the U.S. Constitution, foreign trade is within the competence of the U.S. Congress alone. The president only exercises negotiating power on behalf of Congress.

SW: The Brazilian ambassador to the WTO, Roberto Azevedo, recently said that his country may contest the eventual trade distortions that will result from bailouts being offered throughout the world.  According to Mr. Azevedo, artificial incentives in one country could be hazardous to companies in other countries. What do you think about this assessment?

He is absolutely correct. But given the scale of the crisis, everyone is now bailing out their economies and protecting domestic markets, though of course emerging economies don’t have as much money and therefore can only offer small bailouts compared with the U.S., EU, Japan and China. As mentioned above, perhaps some sort of ceasefire in taking disputes to the WTO is needed, provided everyone agrees to apply their stimulus and recovery packages in a non-discriminatory fashion. This is, however, an exceptionally complex issue and no one is likely to formally agree, because every stimulus package will apply differently and there will be domestic winners and foreign losers in all cases!

SW: Do you think Brazil may have a claim, in particular, against the U.S. for its financial and auto industry bailouts?

Yes. But they would be wise to wait a while before reacting formally. Perhaps negotiating with the United States and others would be more productive because it is probably more important, at this stage, to keep U.S. markets open for imports than it is to fight individual cases.

SW: Some experts suggest that claims such as these will probably never happen. Given the number of countries that have and will be offering bailouts, it has been argued that negotiated settlements are more likely. What’s your opinion?

In a sense I agree. But the problem is the bailouts are not all the same and there are clear winners and losers, and so the burden and benefits will be distributed unevenly. One option is to have a general ceasefire, but the danger is that protectionism and discrimination would revive to an extent that it renders WTO principles inoperable. The second is to fight every violation, but this will only irritate the U.S., EU, Japan and others, making a final solution more difficult. The third option is to negotiate a new WTO provision providing for non-discriminatory bailouts, stimuli, etc. This is possible, but no one really understands the implications in terms of scale of money or market effects, or would know how to start negotiating and how long it would take. 

Bilateral negotiations would seem to be the most viable alternative at the moment, but this will work against the weakest countries for which multilateralism offers the best hope.  In brief, the whole system is in such a mess at the moment that we will be lucky to escape a trade war, and really anything short of that will look like a success. But of course it will come at a price: the severe erosion of WTO principles.

Interview with Arvind Panagariya:

SW: Since the financial crisis began last fall, certain governments have offered their banks bailouts. Generally speaking are these bailouts consistent with WTO rules?

Banking falls under GATS, which has no rules on subsidies. However, bailouts that favour domestic banks and discriminate against foreign banks can result in the violation of market access and national treatment commitments.  If the damaged parties bring cases to the WTO Dispute Settlement Body (DSB) related to the banking sector, it will be a new frontier for the WTO, since subsidies to service sectors are currently not subject to any disciplines. 

SW: In particular the U.S. government’s December bailouts of automakers Chrysler and G.M. have been criticized for violating WTO subsidies rules. What is you analysis of this claim?

Regarding the auto industry, in so far as there is an element of subsidy in the credit offered under the bailout plan, a violation has definitely occurred. The real issue is whether the damaged parties will bring cases to the DSB. If no country brings a case, offending parties will get away with it.

SW: Under the terms of that bailout the Treasury Department agreed to loan up to US$13.4 billion to GM and up to US$4 billion to Chrysler at an interest rate of 3% percent above the London Interbank Loan Offered Rate (LIBOR).  What do these terms say about the legality of this bailout under WTO rules?

In principle, if the terms are better than what is available on the market, a subsidy exists and there is violation.

SW: The controversial “Buy American Clause” included in the American Recovery and Reinvestment Act signed by president Obama on 17 February 2009 has received a lot of attention, so much so that the Senate revised it to say that it must conform to U.S. international obligations. What is your take on this provision?

The final version agreed between the House and Senate requires WTO consistency.  But this may not be sufficient to rule out retaliation. For example, as a plurilateral agreement, the GPA (Government Procurement Agreement) allows the U.S. to discriminate against non-signatories such as Brazil and India.  If the U.S. does resort to this flexibility and discriminates against them, they could retaliate in a WTO-consistent manner. Brazil and India have bound tariffs on products exported by the United States that far exceed the corresponding applied tariffs.  They could raise the applied tariff rates all the way up to the bound rates without violating WTO rules.

Interview with Ken Shadlen:

SW: Do the government by bailouts by the major industrialized countries pose a particular threat to developing countries which lack the funds to compete in the bailout game?

Yes, developing countries are disadvantaged in that they have less funds available to subsidize and so on, though this is always the case. One could argue that the WTO rules, in particular the ASCM, were written in such a way as to permit the sorts of subsidies that are more useful in developed countries and prohibit the sorts of subsidies that are more useful in developing countries. So, yes, what you’re describing is really an accentuation of a pre-existing asymmetry in countries’ abilities to exploit the permissiveness of the WTO.

That said, one could argue that the subsidies and bailouts we are seeing now may actually benefit developing countries to the extent they generate recovery in their principal export markets, such as the United States, the EU, and Japan. After all, if OECD countries are in recession then demand for developing countries’ exports are low, which affects employment and debt-servicing capacities and so on, so developing countries have an interest in OECD countries doing what they can to prevent a long and deep recession or depression.

Ultimately, to get a sense of the effects, you need to look at countries’ export profiles, and the extent to which a given country exports goods are, or are not, affected by the interventions being put in place around the globe. Just to give an example, if a country exports steel and machine tools and transportation equipment to the United States, then the sorts of measures introduced in the U.S. might hurt as it loses exports in key sectors. However, if a country exports shirts and shoes it would probably be less negatively affected. In short, to say anything with any confidence, we have to look carefully at the details of the programmes being put in place and different developing countries’ industrial and export structures.

SW: Do you expect there will be a large number of disputes between WTO Members related to the recent government interventions?

In general I don’t expect there to be so many WTO-related disputes, given the number of countries involved. It is not at all clear what is and is not legal; and it is very difficult to demonstrate that another country’s subsidy is causing damage. 

There is, however, a more interesting (and probably overlooked) reason why there are unlikely to be disputes, and that regards the way the WTO dispute settlement system works, which is to order countries to stop violating an agreement and then authorize the injured country to retaliate if the violating country does not remove the illegal measures.

These bailouts or subsidy programs (whatever you want to call them) all seem to me like one-off and time-delimited interventions, not on-going changes to countries’ policies and practices. What this means is that by the time any country could prove that another country’s intervention is causing damage and violating some agreement, the money will have been spent and the program terminated. If I am correct in my non-lawyer’s understanding of how the WTO works and what these bailout-rescue-subsidy programs entail, then it would seem that, in addition to the reasons that I note above, countries will have little incentive to exhaust resources pursuing cases through the WTO’s dispute-settlement mechanism.

SW: The controversial “Buy American Clause” included in the American Recovery and Reinvestment Act signed by president Obama on 17 February 2009 has received a lot of attention, so much so that the Senate revised it adding that it must conform to U.S. international obligations. What is your take on this provision?

My sense is that the revision probably allows the United States to go about doing this in a way that does not violate commitments under the WTO’s GPA (Government Procurement Agreement) and also the government procurement provisions in the many regional and bilateral trade agreements the U.S. has signed (these also include government procurement regulations). The last-minute change to the U.S. Act, stipulating that it will be implemented in accordance with international obligations, likely means that government procurement will be done in a way that allows companies from GPA parties and Regional and Bilateral Trade Agreement partners to participate.