Saturday, November 9, 2013

Industrial Subsidies and the AEC

I recently successfully defended two subsidy cases, an EU investigation on biodiesel from Indonesia, and a US investigation on shrimp from Malaysia.  After having also participated in subsidy cases involving other ASEAN members, including Indonesia, the Philippines, Singapore and Thailand, I thought this would be an appropriate occasion to reflect on subsidies in the ASEAN context.

ASEAN member states have been understandably reluctant to include subsidy issues on the ASEAN Economic Community agenda.  They are primarily focused on attracting investment, both foreign and domestic, into their countries.  Tax breaks and investment incentives are major tools used in these efforts.  Furthermore, government-owned or government-linked companies have significant roles in the ASEAN member states.  Thus any member raising such issues would be subject to counter-criticism within the bloc.  Subsidy issues tend to be raised only when they indirectly affect other aspects of trade and investment, such as when ASEAN member states apply border measures to prevent the outflow of subsidized commodities, i.e., agricultural goods or basic consumer products. 

The AEC’s primary focus on the single production base and secondary focus on the single market also means that the market distortive effects of subsidies are currently of lesser concern to ASEAN’s leaders.  This differs from the EU, where a single market and a single production base were created at the same time, meaning that subsidies, such as state aid to industries, that could distort the single market are subject to close scrutiny by the European Commission.  The absence of strong antitrust powers or coordination in the AEC is also unlike the role of the European Commission in the EU, and reflects ASEAN’s lesser emphasis on creating a true single market by 2015, despite the rhetoric from its leaders.

Thus, the major scrutiny of subsidies in ASEAN comes in the context of anti-subsidy (also known as countervailing duty) investigations conducted by ASEAN’s trading partners, namely the EU and the US.  Such investigations are allowed by the World Trade Organization, and permit the investigating countries to impose duties to offset subsidies benefitting imports from other countries.  Imposition of duties requires that the subsidies be “specific” to particular industries and regions or that they be export-oriented. The subsidies also must have caused material injury to the domestic industry of the importing country.  The EU and the US are the most prolific users of anti-subsidy laws, although Thailand and the Philippines have conducted their own anti-subsidy investigations.

ASEAN countries get targeted in anti-subsidy investigations primarily due to their policies to attract investments.  Reduced income tax rates or tax credits for foreign investors may be standard practice in ASEAN, but if the investors export to the EU or the US, they could be targeted in an anti-subsidy investigation.   For example, the tax holidays provided by the Thai Board of Investment for investing outside of the Bangkok region have been deemed to be countervailable subsidies by the EU and the US. The EU has found that the Philippines’ application of a reduced tax rate for large corporations is a subsidy, even though the reduced rate applies to gross revenue instead of net profits.  The US found that Malaysia’s Pioneer program provided a subsidy in the form of tax holidays for qualifying industries.  Borrowing from government export-import banks at reduced import rates can also confer a subsidy.  Less commonly investigated are outright grants by governments or debt forgiveness (such as the loans restructured following the 1998 Asian financial crisis). 

One major difference between the EU and the US is that the EU is more skeptical of free trade zones and bonded warehouses than the US is.  Such facilities enjoy duty-free status due to their operating outside the principal customs territory. The EU is of the view that without proper safeguards, manufacturers can receive excessive import duty exemptions, which constitute a subsidy.  The EU has been more aggressive in finding ASEAN customs authorities lacking in such safeguards, whereas the US has not (although in a recent case on shrimp from Vietnam the US questioned the reliability of Vietnam’s administration of its duty-free zones).

Vietnam, which is viewed as a “non-market” economy (NME), presents another set of issues.   In an NME, the government has such influence over the economy that the lines between the private and public sectors become irretrievably blurred. Purchases of raw materials from government linked companies can be deemed as subsidies, particularly when the sales are made at prices below international levels. In cases involving NMEs, this can become a major issue because every domestic supplier could be considered as government linked.

The most worrying trend comes from the EU, where the European Commission recently investigated the export tax system applied by Indonesia on the palm oil and palm oil derivative industries.  After conducting anti-dumping and anti-subsidy investigations on biodiesel from Indonesia manufactured from palm oil, the EU found that the export tax system did not constitute a countervailable subsidy and terminated its anti-subsidy investigation.  However, it then went on to find that the same system had distorted raw material prices in Indonesia and warranted the imposition of higher anti-dumping duties on biodiesel.  The worrisome aspect is that the EU has elected to use the anti-dumping duty laws to deal with the purported distortive effects of a government policy, when the WTO agreements clearly state that this should be dealt with by the anti-subsidy laws and their accompanying set of legal understandings and disciplines.  If this trend continues, ASEAN exporters could find themselves subjected to anti-dumping duties not because of their pricing practices, but because of the policies of their home governments.

Subsidies in ASEAN will thus continue to be the subject of external analysis by the EU and the US in their trade remedy investigations, as well as by the WTO’s trade review procedure. This will remain the case until the single market envisioned by the AEC matures and comes into fruition, requiring scrutiny for subsidy and antitrust issues, such as is the case in the EU.  Like other aspects of the AEC, this too requires strengthening the ASEAN institutions’ authority to monitor, oversee, implement, and sanction transgressions against the AEC.  Hopefully ASEAN’s leadership will take the first steps to making those improvements soon.