Progressive adoption of rules ensuring competitive neutrality in a manner that is compatible with China’s economic model will be an important part of the EU’s attempt to revive the World Trade Organization, writes Renato Antonini.
Yi Gang, the governor of the People’s Bank of China, concluded his speech at the Group of 30’s International Banking Seminar 2018 on 14 October by saying: “To solve the structural problems in the Chinese economy, we will accelerate domestic reform and opening up, strengthen intellectual property protection, and consider treating state-owned enterprises with the principle of ‘competitive neutrality’.”
That was the first time the recently appointed central bank governor publicly and directly referred to the still relatively unknown principle of ‘competitive neutrality’ in the framework of the domestic reform of China’s state-owned enterprises.
Competitive neutrality is generally considered to mean that privately owned and state-owned enterprises should compete on a level playing field. The principle holds that no actor operating on the market should be subjected to unwarranted competitive advantages or disadvantages.
The Organisation for Economic Co-operation and Development sees competitive neutrality as a regulatory framework within which public and private enterprises face the same rules and where no contact with the state brings competitive edge to any market participant. This principle includes various elements – such as tackling subsidies and adopting transparency requirements – to ensure that public undertakings are not treated more favorably than their private counterparts.
We will increasingly hear about this principle in the coming years, and it will play a very important role in the framework of attempts to reform the World Trade Organization.
EU is longtime critic of aid that distorts trade
The European Commission has consistently held that distortive subsidies harm the global economy and should be avoided. In this context, the commission advocates competitive neutrality as the foundational basis of basic values of global trade relations. It is continuously calling for the advancement of competitive neutrality in international fora and trade negotiations.
The European Union has a keen interest in fighting subsidies, as the bloc has a unique internal regime of subsidy control. This strict state aid regime aims to limit distortions in the EU market as much as possible (in other words, to ensure competitive neutrality).
The EU state aid system greatly limits member states’ ability to provide financial support to companies. These rules go well beyond the WTO subsidies regime. EU governments can only grant subsidies under certain conditions, notably,if the aid contributes to well-defined policy objectives of common EU interest without unduly distorting competition between enterprises and trade between member states.
Importantly, aid deemed illegal must be recovered.
The EU’s state aid system is a key tool in the proper functioning of the internal market, as it helps ensure a level playing field in the bloc. However, the rest of the world lacks a similar system of state aid control, and this may disadvantage European enterprises. Non-EU rivals can receive certain types of subsidies from their home country and use them to compete with EU enterprises, both inside and outside the internal market.
Until recently, to address what it viewed as harmful government subsidies, the EU seemed to rely on trade defence measures and use bilateral negotiations to promote state aid controls in third countries.
For instance, EU competition chief Margrethe Vestager and He Lifeng, chairman of China’s National Development and Reform Commission, signed a memorandum of understanding in June 2017 to start a dialogue on state aid control. This dialogue created a mechanism of consultation, cooperation and transparency between China and the EU on state aid control.
WTO crisis gives EU ammunition
The recent WTO crisis opened another important door in the EU’s continued fight against subsidies. In its June concept paper on WTO reform, some of the EU’s objectives are clearly derived from the principle of competitive neutrality.
First, the EU recommends improving transparency and subsidy notifications. In this framework, the commission proposes to create a general rebuttable presumption that if a subsidy is not notified or is counter-notified, it would be presumed to be a subsidy or even be presumed to be a subsidy causing serious prejudice.
Second, the EU wants to amend WTO rules on aid to better capture state-owned enterprises. It seeks to do this primarily by addressing the concept of ‘public body’, which it believes has been too narrowly interpreted, allowing many SOEs to escape the application of the WTO agreement on subsidies.
Third, to more effectively capture the most trade-distortive aid, the EU calls for an expanded list of prohibited subsidies or to create a rebuttable presumption of serious prejudice. Subsidies that could be subject to such stricter rules include, for example, unlimited guarantees, subsidies given to an insolvent or ailing enterprise with no credible restructuring plan, or dual pricing.
US and Japan share EU concerns on SOEs
Other important WTO members share the EU’s concerns.
In their 25 September statement on industrial subsidies and SOEs, the EU, the US and Japan said ministers “highlighted the importance of securing a level playing field given the challenges posed by third parties developing state-owned enterprises into national champions”.
They noted that ministers recognised “the continued need to deepen their shared understanding, on the basis for strengthening rules on industrial subsidies and state-owned enterprises, including how to develop effective rules to address market-distorting behavior of state enterprises and confront particularly harmful subsidy practices”.
These include “state-owned bank lending incompatible with a company’s creditworthiness, including due to implicit government guarantees; government or government-controlled investment fund equity investment on non-commercial terms; non-commercial debt-to-equity swaps; preferential input pricing, including dual pricing; subsidies to an ailing enterprise without a credible restructuring plan; and subsidies leading to or maintaining overcapacity”.
The WTO crisis provides the EU with an opportunity to secure results from its long fight against subsidies. Because of China’s economic model and the importance of the country’s trading share, the principle of competitive neutrality has taken on particular importance for the EU as well as various other WTO members.
Renato Antonini (@rantoninibrux) is a government regulation partner at Jones Day and leads the law firm’s Brussels international trade practice.
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