Subsidies and Countervailing Measures Agreement

The Subsidies and Countervailing Measures (SCM) Agreement deals with two important issues:

• It establishes multilateral rules or disciplines regulating the provision of subsidies. Specifically, it describes the various situations where countries are allowed to give subsidies to their industry, where subsidies are actionable and hence could be challenged by other countries. The SCM Agreement determines whether a country can extend a particular subsidy or not, and if it can, then what are the conditions under which it can do so.
• It provides for the use of countervailing measures or duties by countries to counter illegal subsidisation by another country. Countervailing duties are another form of trade-remedial measures like antidumping and safeguard measures. Countervailing duties are also used in situations where there is distortion caused to the domestic industry of one country due to a practice (illegal subsidisation) followed by another country. Hence, the SCM Agreement provides another trade-remedial measure in the multilateral trading regime embodied in the World Trade Organisation (WTO).

Regulating subsidies

At this stage it is pertinent to understand the need to regulate subsidies. Subsidies are generally described as benefits given by governments to their industries, or agriculture, or other sections of the economy. This benefit by the government may take different forms such as direct cash transfers or foregoing revenue, ie not collecting revenue from a particular industry that is otherwise due, etc.

Once such a benefit is conferred on a particular industry that is involved in international trade, it gets an unfair advantage over the other industries of other countries. For example, let us assume that the steel industry in the US has cost of production of 10 units and hence it sells its product at 12 units in the international market and earns a profit of 2 units. Assume that there is an Indian steel manufacturer whose cost of production is 7 units owing to better efficiency or reaping economies of scale. This Indian steel manufacturer sells its products at 10 units, which is less than the price at which the US steel manufacturer is selling. However, it earns a higher profit.

Now, if the US steel manufacturer is given a subsidy by the US government in the form of a cash grant of, say, 5 units, then the US steel manufacturer can sell its products at less than 10 units (the price at which the Indian steel manufacturer is selling) notwithstanding the fact that its cost of production is much higher than the Indian steel manufacturer’s. This is possible because of the subsidy that it is getting.

Hence, the subsidy is extending an unfair advantage and distorting international trade. Such subsidisation goes against the very basics of the free and fair international trading regime where every country is entitled to a level playing field. Therefore, such subsidisation needs to be countered. In order to counter such subsidies it is pertinent to have multilateral trade rules. The SCM Agreement provides these trade rules.

Structure of the SCM Agreement

The agreement is divided into 11 parts.

Parts I to IV of the agreement provide the multilateral disciplines to regulate the subsidies. Part I provides that the agreement applies only to subsidies that are specifically provided to an enterprise or industry or group of enterprises or industries. It defines both the term “subsidy” and the concept of “specificity” (discussed later in this article). Parts II, III and IV divide all specific subsidies into one of three categories: prohibited, actionable, and non-actionable, and establish certain rules and procedures with respect to each category, including specific dispute settlement rules and procedures for each category.

Part V establishes the substantive and procedural requirements that must be fulfilled before a country applies a countervailing measure against subsidised imports. Parts VI and VII establish the institutional structure and notification or surveillance modalities for the implementation of the agreement. Part VIII contains Special and Differential Treatment rules (S&DT) for various categories of developing country members. Part IX contains transition rules for developed country and former centrally-planned economy members. Parts X and XI contain dispute settlement and final provisions, ie how to settle a dispute that may arise between two countries on the issue of subsidisation or imposition of countervailing duties.

The concept of subsidy under the SCM Agreement

In order to understand the multilateral disciplines on subsidy it is pertinent to understand the concept and definition of a subsidy. According to the SCM Agreement, a subsidy shall be deemed to exist if there is a financial contribution by the government or any public body within the territory of a country, and a benefit is thereby conferred. Hence, the definition of a subsidy contains three intrinsic elements:

• It must be a financial contribution.
• The financial contribution must be made by a government or any public body within the territory of a member.
• The financial contribution must confer a benefit.

All three of these elements must be satisfied for a subsidy to exist. In other words, if the government of country ‘A’ gives a financial contribution to its steel industry, and this financial contribution does not confer any benefit to the steel industry, then the financial contribution made by the government of country ‘A’ will not qualify as a subsidy, although the contribution has been made by the government.

Similarly, there may be a financial contribution that may confer a benefit on a particular industry, but if this financial contribution has not been made by the government, then it will not be called a ‘subsidy’ under the SCM Agreement.

Let us examine all three intrinsic elements or components in the definition of a subsidy, as stated above.

Financial contribution

During the Uruguay Round, the concept of ‘financial contribution’ was included in the SCM Agreement only after lengthy negotiations. There were two different views. According to one view that supported the concept of ‘financial contribution’, there could be no subsidy unless there was a charge on the public account.

The other view argued that there may be cases of government intervention that may not involve an expense or there may not be a public charge, but it would nevertheless distort competition and confer an undue advantage on a particular industry. Hence, according to this view, cases where there is no ‘financial contribution’ made by the government but a benefit is conferred should be included within the ambit of a ‘subsidy’ in the SCM Agreement. The SCM Agreement finally adopted the first view and made ‘financial contribution’ a part of the definition of ‘subsidy’.

The SCM Agreement contains a list of types of measures that represent a financial contribution. Some of these measures are:

• A government practice that involves the direct transfer of funds (for example, grants, loans and equity infusion), potential direct transfers of funds or liabilities (for example, loan guarantees).
• Government revenue that is otherwise due is foregone or not collected. This would include fiscal incentives such as tax holidays or tax credits.
• A government provides goods or services other than general infrastructure, or purchases goods. This would include government providing intermediate goods or raw materials free of cost or at concessional rates.

Financial contribution made by government

The second important concept involved in identifying a subsidy is that the financial contribution should have been made by the government or at the behest of the government or any public body within the territory of the country. Thus, the SCM Agreement applies not only to measures of national governments but also to measures of sub-national governments and of public bodies like state-owned companies. In the context of India, payments made by state governments or payments made by public sector companies would also fall under financial contributions made by the government.

Conferring a benefit

The third important component in the definition of a subsidy is ‘benefit.’ A financial contribution can only be called a subsidy if it confers a ‘benefit’. However, the difficulty here is the definition of ‘benefit’. In many cases, as in the case of a cash grant, the existence of a benefit and its valuation will be clear. However, there may be other cases where the issue of benefit will be more complicated and difficult to ascertain. For example, when does a loan or an equity infusion, or the purchase by a government of a good, confer a benefit? The SCM Agreement is silent on this. In the context of multilateral disciplines, the issue of the meaning of ‘benefit’ is not fully resolved.

Specificity: What if a subsidy is deemed to exist?

Assuming that a measure is a subsidy within the meaning of the SCM Agreement, it will not automatically be subjected to the SCM Agreement. It can be subjected to the SCM Agreement only if it has been specifically provided to an enterprise or industry, or to a group of enterprises or industries. This brings us to the principle of ‘specificity’ given in the SCM Agreement. According to this principle, unless there is specific recipient of a subsidy, such a subsidy will not become the subject matter of the SCM Agreement.

The reason behind this is that only if a subsidy is specific does it lead to misallocation of resources. In cases where a subsidy is openly or widely available, there may not be a misallocation of resources and hence no need to discipline the use of such a subsidy. Thus, only ‘specific’ subsidies are subject to SCM Agreement disciplines. The SCM Agreement describes four types of ‘specificity’:

• Enterprise specificity: A government targets a particular company or companies for subsidisation.
• Industry specificity: A government targets a particular sector or sectors for subsidisation.
• Regional specificity: A government targets producers in specified parts of its territory for subsidisation.
• Prohibited subsidies: A government targets export goods or goods using domestic inputs for subsidisation.

Different categories of subsidies

The SCM Agreement creates two basic categories of subsidies: those that are prohibited, those that are actionable (ie, subject to challenge in the WTO or to countervailing measures). All specific subsidies fall into one of these categories.

Prohibited subsidies: Two categories of subsidies are prohibited. The first category consists of subsidies contingent, in law or in fact, whether wholly or as one of several conditions, on export performance. These types of subsidies are ‘export subsidies’. Hence, any subsidy whose payment to the recipient is directly linked to its export performance is a ‘prohibited subsidy’. Examples of such subsidies are as follows (Annex 1 of the SCM Agreement):

• The provision by governments of direct subsidies to a firm or an industry dependent upon export performance.
• Currency retention schemes or any similar practices which involve a bonus on exports. In other words, some reward being given by the government on export performance.
• Internal transport and freight charges on export shipments provided or mandated by governments, on terms more favourable than for domestic shipments.
• The full or partial exemption, remission or deferral specifically related to exports of direct taxes or social welfare charges paid or payable by industrial or commercial enterprises.
• The allowance of special deductions directly related to exports or export performance over and above those granted in respect of production for domestic consumption, in the calculation of the base on which direct taxes are charged.

The second category of prohibited subsidies consists of subsidies contingent, whether solely or as one of several other conditions, upon the use of domestic over imported goods. These subsidies are referred to as ‘local content subsidies’. In other words, any subsidy that gives preference or encourages the use of domestically-produced goods, either as intermediate goods or for any other purposes, over imported goods, is a prohibited subsidy under the SCM Agreement. Such a subsidy will discriminate against the imported goods and hence impair the benefits that may have accrued to an importing country.

Actionable subsidies: These subsidies are not prohibited; however, they are subject to challenge, either in the dispute settlement body of the WTO or through countervailing action (imposing countervailing duty). However, such an action against ‘actionable’ subsidies can be taken only if the following condition is satisfied: the subsidies cause adverse effects to the interests of another country. The SCM Agreement gives three types of adverse effects:

• There is injury to domestic industry caused by subsidised imports in the territory of the complaining country. This can be understood with the help of the following example. Let us assume that country ‘A’ subsidises its steel industry. As a result of this subsidisation, the steel exports of country ‘A’ to country ‘B’ displace the steel produced domestically in country ‘B’. Hence, there is an injury to the steel industry of country ‘B’ due to the subsidisation of steel in country ‘A’. This is a case of adverse effect being caused to the steel industry of country ‘B’. Hence country ‘B’ can challenge this subsidy of country ‘A’.
• There is serious prejudice. Serious prejudice usually arises as a result of adverse effects (for example, export displacement) in the market of the subsidising country or in a third country market. This can also be understood from the example given above. Let us assume that in the previous example, country ‘B' exports steel to country ‘A'. However, the steel exports of country ‘B' are not able to find adequate market access in country ‘A' because the latter subsidises its steel production. Thus, unlike injury, this kind of subsidisation serves as the basis for a complaint because it hurts or impairs a country's export interests.
• There is nullification or impairment of benefits accruing under the GATT 1994. Nullification or impairment arises most typically where the improved market access presumed to flow from a bound tariff reduction is undercut by subsidisation. For example, country ‘A' may lower its bound tariff rate on steel and hence country ‘A' may benefit from this as it will get more market access. However, country ‘A' may offset the advantage to country ‘B' by subsidising its domestic steel industry. This will qualify as nullification or impairment of benefits under GATT 1994.

The creation of a system of multilateral remedies that allows countries to challenge subsidies that give rise to adverse effects is a significant advancement over the pre-WTO-GATT era.

Countervailing measures

One of the most important components of the SCM Agreement is the provision to impose countervailing duties. This is given in Part V of the SCM Agreement. A countervailing measure is a kind of trade-remedial measure, just like antidumping duties or safeguard measures. The SCM Agreement defines the substantive as well as procedural requirements for imposing countervailing duties.

The SCM Agreement states that countervailing duties could be imposed if the following conditions are fulfilled:

• There is subsidisation of imports.
• There is injury to domestic industry.
• There is a causal link between subsidised imports and injury to domestic industry.

These three conditions are the same as given for the imposition of antidumping duties or for the imposition of safeguard measures. Hence, subsidisation (the manner in which it is defined in the SCM Agreement that has been discussed above) alone will not attract the imposition of countervailing duties unless there is injury to domestic industry and there is a casual link between subsidisation and injury to domestic industry.

Procedural rules for imposition of countervailing duties

The SCM Agreement also contains detailed rules regarding the initiation and conduct of countervailing investigations, the imposition of preliminary and final measures, the use of undertakings, and the duration of measures. A key objective of these rules is to ensure that investigations are conducted in a transparent manner, that all interested parties have the full opportunity to defend their interests, and that investigating authorities adequately explain the bases for their determinations.

Some of the more important innovations in the SCM Agreement are identified below:

Standing: The agreement defines in numeric terms the circumstances under which there is sufficient support from domestic industry to justify the initiation of an investigation. According to the SCM Agreement, domestic industry is defined as the producers as a whole of a ‘like product’. ‘Like product’ implies that the product is identical to the dumped product, or in the absence of such a product one that has characteristics closely resembling the dumped product. For instance, if country ‘A’ is subsidising ink pens in country ‘B’, then ink pens manufactured in country ‘B’ are the like product. If country ‘B’ does not produce ink pens, then ballpoint pens may be called a like product.

Preliminary investigation: The agreement ensures the conduct of a preliminary investigation before a preliminary measure can be imposed. This is the same as given in the Antidumping Agreement.

Sunset : The agreement requires that a countervailing measure be terminated after five years. However, the countervailing duty may be continued if it is determined that continuation of the measure is necessary to avoid the continuation or reappearance of subsidisation and injury. This is also a feature common to the Antidumping Agreement.

Judicial review: The agreement requires that members create an independent tribunal to review the consistency of determination of the investigating authority with domestic law.

Undertakings: The agreement places limitations on the use of undertakings to settle CVD (countervailing duties) investigations in order to avoid voluntary restraint agreements or similar measures camouflaged as undertakings. Hence, unlike the Antidumping Agreement, the SCM Agreement does not approve the practice of following undertakings..