WEPZA XX International Conference
Taiwan, September 25, 2001
No. 6 Ver. 1
Copies of this booklet may be obtained from:
WEPZA Secretariat
P.O. Box 986
Flagstaff, Arizona, U.S.A.
Tel: (520) 779-0052
Fax: (520) 774-8589
E-Mail: wepza@aol.com
WEPZA Website: http://www.wepza.org
© The Flagstaff Institute, 2004
It is extremely important that all EPZ managers understand the impact of the World Trade Organization's (WTO's) Agreement on Subsidies and Countervailing Measures (ASCM) on their zones. Many EPZs will have to change their rules in order to comply in a timely fashion with the ASCM or their countries could face serious trade disputes in the WTO. Managers of EPZs may even have to initiate changes in their national legislation if their programs are to remain secure.
Given the seriousness of this situation, it may come as a surprise to learn today that many governments, which are members of the WTO, are not taking advantage of their right to sit on the Committee for Subsidies and Countervailing Measures which is implementing the new rules. Individuals who are not familiar with the EPZ programs of their country often represent those that do attend the meetings. Members have a right to have an input into the process, and it is time EPZ managers make sure that diplomats who understand your issues represent your countries. WEPZA has a specific proposal to assist you in doing this, which we will talk about at the conclusion of this paper.
Coverage of ASCM
The Agreement is a multilateral agreement among countries that deals with subsidies that are specific in nature and are given to an enterprise or industry, or group of industries that affect trade. The Agreement authorizes the use of countervailing measures (i.e. punishments for violations), which are caused by such subsidies. It permits special and differential treatment for some countries. That means that some of the poorer countries may be treated a bit better than more developed market countries. Finally, it requires notification, which means that countries must reveal their specific subsidies to the WTO.
What are not covered are economic processing zones, export processing zones, free trade zones, and special economic zones and the like. There is no special treatment in this Agreement, or, in fact, anywhere in the WTO or in prior GATT Agreements, that mention these organizations specifically. ASCM does address some of the subsidies, or incentives that EPZs commonly use, and that is why it becomes important to you. In a quick review we did of countries listing incentives on the Internet, it appears that 20 of the 25 countries we examined are potentially in violation of their WTO commitments by 2003, and some may be already in violation of these commitments.
Importantly, the Agreement does not cover incentives which are not both subsidies and specific. Subsidies that are not specific and specific policies that are not subsidies are not covered. This is an important distinction, and will be discussed in detail later.
The Agreement also does not cover agriculture or services because subsidies in agriculture are extremely complex and are dealt with in other agreements more specific to that industry. Also, the Agreement is located in the section of the WTO Agreements dealing only with goods, and thus, by implication, does not cover services. This is important since the managers of strictly commercial zones, such as the Colon Free Zone in Panama, may not need to take extensive action to comply with this agreement.
Treatment of Specific Subsidies
The treatment of specific subsidies is that they may be prohibited, actionable, or non-actionable, and in all cases need to be notified to the WTO.
If they are prohibited they must be eliminated. Prohibited subsidies are subsidies that are either based on exports performance or to the use of domestic material.
An actionable subsidy is a subsidy that may be taken to a dispute, meaning it may involve a country in a dispute with another country at the WTO. That does not necessarily mean that actionable subsides can't be used, but there is a certain vulnerability in relying on them too much to develop industry. There are certain situations where a country may want to use actionable subsidies, for example if the country is a minor player in the industry. Actionable subsidies make up the vast majority of specific subsidies. Unlike prohibited subsidies, some other country must complain about an actionable subsidy, and be able to show injury before a country needs to change or eliminate the specific subsidy.
A non-actionable subsidy may not be taken to dispute. This used to be a larger and more important category, but now largely consists only of those subsidies that are not specific.
Lastly, a country that offers a specific subsidy needs to report or notify the WTO about the existence of the subsidy program. The offering country must bring it to the attention of WTO and provide some details about the program's size and operation. If the subsidy is not specific, it doesn't need to be notified.
Timetable
Most WTO member countries must eliminate prohibited subsidies, but this is done under a timetable in the Agreement. Developed countries were supposed to eliminate all prohibited subsidies by January 1, of 1998, while less developed, least developed, and transition economies all have different time frames and requirements.
A least developed country is one of 42 countries listed by the United Nations, plus 20 countries that are specifically listed in the WTO Agreement on Subsidies and Countervailing Measures which generally have GNP per capita of less than US$1000 per year. Transition economies are those that are moving from a command economy to a market economy. Less developed countries, are those not in either of the two other groups which are also not recognized by the WTO has being developed. Developing countries include both less and least developed countries.
An export subsidy is a subsidy that requires export performance in order to be given. If getting the subsidy is contingent in some way on export performance, it is a prohibited export subsidy. For example, a country that provides a tax holiday for all companies that export some percent of their production has a prohibited export subsidy. Transition economies, have until January of 2002 to eliminate such subsidies, less developed countries have until January of 2003, and the least developed countries do not have to eliminate prohibited export subsides until their yearly GDP per capita exceeds US$ 1,000.
Prohibited domestic content subsidies require the use of domestically sourced material in order to qualify for benefit. India, and a number of other countries, uses such incentives in their automobile industry. India has just been taken to a dispute on the issue. India, being a less developed country, had until the beginning of 2000 to get rid of subsidies based on domestic content. Least developed countries have until 2003 and transition economies have until 2002 to eliminate prohibited domestic content subsidies.
The agreement does provide for developing countries and transitional countries to request an extension of these dates on a year-to-year basis. The discussion for developing countries must begin at least one year before the expiration of these time limits, i.e. during 2001.
Incidentally, an actionable subsidy may be maintained until somebody complains about it. Countries are supposed to eliminate prohibited subsidies before anyone complains.
Notifying
WTO members are required to notify the WTO about any specific subsidies that they have, whether they are prohibited, actionable, or non-actionable. They also need to notify the WTO if they believe they do not have any specific subsidies. If a member feels that another WTO member has a specific subsidy that has not been notified, it may ask for information on such a subsidy, and request them to notify the WTO about it. If they don't notify the WTO, then the country may notify the WTO itself. So, in the tradition of the WTO, it is a self-regulating process. Members regulate themselves and regulate other members.
Many developing countries, and some developed ones, have not been candid in their notifications. This has been due to both intentional disregard of their obligations and in many cases a lack of the administrative capacity to comply. The US, EU, and sometimes Japan, have asked pointed questions of other members about their EPZ programs.
What is a subsidy?
Now let's get into some more details as to what is a subsidy, what is specific, and what is prohibited, actionable and non-actionable.
There is a common sense view of what a subsidy is. If a government, public body, or a private sector organization enabled by a government, makes a financial contribution, it is a subsidy. If there is an actual or potential transfer of funds - a grant is given; insurance is given at below-market rates; or a loan is guaranteed for below-market rates - then there is an actual or potential to transfer funds. If revenues due the government are not collected it may be a subsidy. For EPZs a tax holiday is a subsidy. The provision of goods and services other than general infrastructure at below market rates, or the purchasing of goods at above market rates is a subsidy. For example, if one buys a company's products at above market rates or rents or sells a building at below market rates, it is a subsidy. Price, income or support programs, which are not covered in the agricultural agreements, are also considered to be subsidies under this WTO Agreement.
Let's be even more specific. Cash payments are subsidies. Full or partial exemption, deferral or allowances of direct taxes or social welfare charges are subsidies. Income, wage, profits, rents, royalties and other similar types of taxes, or those taxes based on the ownership of real property are direct taxes. If the government gives back or provides exemption from any payroll-based taxes or social welfare charges such as Social Security or Provident Fund, it is a subsidy.
Indirect taxes are treated differently from direct taxes. Indirect taxes, which include taxes on value added (VAT), sales, turnover, franchise, stamp transfer, inventory, personal property etc., could be rebated without being a subsidy. If a company gets back the value added tax it has paid, that's not a subsidy. However, if it gets back more value added tax than it paid, the excess is a subsidy. (There's a technical exception to this, but we don't need to deal with that right now.) Generally, if a company gets back more than it paid of an indirect tax, it is a subsidy. Of particular importance to EPZs is that remission of duty equal to, or less, then that paid is not a subsidy. What most EPZs allow in terms of duty-free entry and exit is not a subsidy. Remember, to be actionable in the ASCM it needs to be both specific and a subsidy.
Internal freight rates mandated or provided by the government at less than market rates are a subsidy. Similarly, rents, electricity, or other utilities mandated or provided by the government at less than market rates are subsidies. If the EPZ negotiates with a freight company that all shipments from the zone are at a lower rate due to volume, it is a commercial transaction and not a subsidy. However, if Government, or someone empowered by government, has mandated it for non-commercial reasons and below market rates it is a subsidy.
Exchange risk insurance at rates not expected to cover insurance risks and business costs is a subsidy.
A loan or export credit given at below the rates paid for funds is also a subsidy unless it is part of a multinational program organized by at least 12 original members. It appears that the ASCM bases this subsidy on rates for the cost of funds to the lender and not on market rates to the borrower. So if the government of India goes out, using its superior credit, to borrow funds at the low London Inter-Bank Offer Rate (LIBOR), and makes these funds available to companies at a rate below which the companies would be able to borrow funds, but above the government's costs of funds and administration, those loans are arguably not subsidies. This makes some economic sense, as the capital markets in many developing countries are inefficient. Domestic interest rates are too high and inhibit investment in productive assets. This may allow a type of incentive that is not a subsidy that provides funds to companies at more than the government cost of funds, but less than the local market rate.
What is Specific?
Now let's get on and point to what is specific. Any subsidy that is based on export performance or domestic content requirements is specific. Therefore, if you are going to base an incentive on exports or domestic content, you are going to have to make sure that the incentive is not a subsidy. Clearly, tax holidays that are based on exports are a subsidy. Many zones use these implicitly because a company cannot get into the zone without being an exporter and one only gets the tax holiday if one operates from the zone. That is decidedly a specific subsidy based on exports even though it is somewhat indirect.
A subsidy is also specific if access to the subsidy is limited to specific enterprises, or industries, or groups of such. If a subsidy is given to the semiconductor industry, it is a specific subsidy. However, if the regulations give a subsidy to every company that employs one engineer for every ten workers, then it is not defining a specific industry. If it says that the country will give a subsidy to every company that employs more than 100 new workers, it is not a specific subsidy, because the ASCM also says that if the industry is defined in law or regulation by objective criteria that are economic in nature and horizontal in application it is not specific. The agreement gives the examples of firm size or number of employees. This is an important exception for countries trying to adjust their development programs to be compliant.
The following rule is a potential problem for EPZs. A subsidy is defined as specific if eligibility is limited to designated regions of the WTO member. If special incentives are given to every company located within a specific 50 hectares, such as an EPZ, then it is specific, unless, it is done by a level of government that is entitled to set or change rates for all enterprises within its jurisdiction. Typically this exception permits towns, cities, states and provinces to have individual tax policies. The ASCM is not about tax harmonization, so if the state of Colorado wants to have a lower tax than the state of New York, the difference between Colorado's tax rate and New York's is not a subsidy. There are some countries that are looking at creating special economic districts that are Primary Taxing Authorities, which would be turning the taxing structure of the country upside down. It appears that making the local districts the Primary Taxing Authority with perhaps a portion of their revenue going to the national authority, that the local districts might be able to give a substantial tax holiday. To do this you might have a taxing authority authorized to set or change rates for every company within its jurisdiction. Done carefully, and including the whole country in such districts, it may not be specific.
Here are some hypothetical examples.
Ireland lowers its corporate tax rate from 40 percent to 12 percent. Germany and France, with 40 percent corporate tax rates, object and say Ireland is subsidizing companies. Are they? No. It is not a subsidy, and it is also not specific. It may be providing benefits, it may be harming the domestic industries of Germany and France, but it is not covered by this Agreement. It is not actionable.
Kuwait provides expensive desalinated seawater at below production costs to all industry. Is this a subsidy? Yes, it's a subsidy, but it's not specific. It's not covered by this Agreement.
Oman provides U.S. $500 million in port improvements to a port operated by a private company. The grant allows the port to maintain lower rates. Specific subsidy? No, infrastructure is not a subsidy, and the rates charged for using the port are not specific.
Disputes
If you are maintaining a prohibited subsidy and somebody complains about it, the normal dispute settlement mechanism of the WTO is conducted at an accelerated pace. Countries will have less time to respond, and if the panel finds the country has a prohibited subsidy, the panel "shall recommend" its elimination. For a country that has based its development programs on such a subsidy, the results could be disastrous. For this reason, WEPZA recommends that EPZs in all countries move away from reliance on prohibited subsidies as incentives.
A country may file a dispute; take action, against countries that have specific subsidies that cause injury to its domestic industry. How injury is defined is quite complex and will result in complex disputes. Specific subsidies that cause the nullification of benefits under GATT 1994, or serious prejudice to the domestic industry of another member may also involve a member in a dispute. Serious prejudice is a different standard than to cause injury but neither is well defined. First, though, another member must complain. A complaining member must demonstrate injury, nullification or serious prejudice beyond minimum amounts, and the time frame is the normal time frame of the dispute settlement mechanism. So it is treated very differently. There is also plenty of opportunity to negotiate a settlement in the process.
Non-Actionable Subsidies
Non-actionable subsidies are a third class of subsidies defined by the agreement. Among other things they are any subsidy that is not specific. One thing you must learn from this presentation is that, to be covered by this Agreement, it must be both specific and a subsidy. By definition in the Agreement, any subsidy that is not specific is non-actionable. The Agreement also created 3 specific subsidies that were non-actionable. These included research and development, assistance to disadvantaged regions, and the adaptation of existing facilities for environmental compliance. They may have been useful, but they were subject to a review after 5 years to consider extending their applicability (Article 31). The review was not done, so these categories of non-actionable subsidies have been eliminated. This does not eliminate the defense of a subsidy as being non-actionable because it is non-specific, for that is a fundamental part of the entire agreement.
Summary and Program
The WTO Agreement on Subsidies and Countervailing Measures is important to EPZ operators and developing countries. The Agreement has more flexibility for development policy than what is apparent. EPZ managers need to know what that flexibility is, and how to use it.
The WTO is a rule-based trading system. Countries have to pay careful attention to what the rules say, and what they don't say. Most printed pages have about 95% white space and 5% ink. With the WTO Agreements, countries need to learn to operate in the white space. Countries need to look at their development programs and create subsidies that meet policy objectives that are non-specific. That is, perhaps, the easiest course of action. Secondly, countries need to create and promote incentives that are not subsidies. There are a lot of these - education, infrastructure, political stability, standards labs, efficiency of service, and clean customs are but a few examples. All those are incentives that are not subsidies.
In general countries ought to amend prohibited subsidies to make them actionable or non-actionable subsidies. I suggest that even a least developed country, ought to look at using subsidies in more creative ways, and stop focusing development on what will become a prohibited subsidy just as the economy is taking off. At US$ 1000 per year GDP income is still just over US$ 3.00 a day, and wage rates are often still below US$ .40 per hour. The poorest countries are years away from this level, but when they reach it they will have had years of successful economic development. It would be a poor time to have to implement a major change in industrial incentives.
Adjusting to this agreement is not the only course of action. Developing countries need to get together with other developing countries to develop a positive agenda to change portions of this agreement. In many ways it is biased against developing countries in that the incentives they offer to investors to overcome the high costs of doing business in poor environments are more likely to be actionable subsides than the incentives offered by the developed countries. In this positive agenda the countries should ask for more time to eliminate prohibited incentives, higher income levels before subsidies become prohibited, and more options for non-actionable subsidies. Countries might try to reinstate and expand the exceptions to the rules on specificity, such as allowing the creation of economic zones that do not violate the rules of specificity.
Finally, EPZ managers ought to work with us at WEPZA to understand the effects of this agreement on their operations, and on what they and their countries must do to comply. The obligations many countries have undertaken in joining the WTO mean that a great deal of time, effort and resources must be devoted to compliance issues. The burden of many countries can be reduced if WEPZA can do more research and analysis of this agreement, and others, in order to develop more specific and innovative policy options for the 100 countries with EPZs, and the 130 without. For some EPZs the time for action is less than a year away. EPZ managers ought to help provide opportunities and resources for WEPZA staff to work with their governments, WTO representatives, legislators, scholars, business community, and media to increase the understanding of these organizations on what this and other international agreements mean to their EPZ programs and what the EPZs mean for their national development.
But this is not enough. EPZ managers should help WEPZA find funding and other resources for research on this and other EPZ issues. Few are compassionately addressing development from the EPZ prospective. EPZs have proven to be dynamic engines of industrial development when they are honestly managed with reasonable goals and expectations. For many of the poorest countries in the world, they may represent the best hope for diversifying their economies away from commodity products, and benefiting from globalization and the expansion of trade. The concepts of EPZs have been changing and growing since the creation of the modern EPZ in the 1960's. This change is still going on, and WEPZA-directed research is needed to show government leaders, economists, banks, multinational organizations and the world community at large just how EPZs create sustainable development, and why world trade rules should be supportive of them.
Only when such work is done will your EPZ program be secure, and only when your EPZ program is secure will sustainable national development be possible for all countries. You must do your part for your country and the world.