Caixin
Dec 25, 2020 06:32 PM
WEEKEND LONG READ

Weekend Long Read - Opinion: If China Is to Join the CPTPP, Its SOE Rules Are Not an Obstacle

Formerly lead private sector development specialist at the World Bank Group, Dr. Zhang Chunlin is an academic member of Caixin Insight and an editorial board member of Comparative Studies magazine.

Editor’s note: The Chinese leadership has stated this year that China will actively consider joining the Comprehensive and Progressive Trans-Pacific Partnership(CPTPP), a 11-country high-standard trade pact in Asia Pacific. However, questions and doubts have been raised over whether China could meet the CPTPP requirements on some sensitive areas such as state-owned enterprises.

Zhang argues in a detailed analysis that CPTPP SOE rules won’t be obstacles for Beijing to join, mainly because they are highly consistent with China’s existing commitments under the WTO; meanwhile, he also argues none of the new CPTPP SOE disciplines constitutes unacceptable concession for China to accept. However, China still needs to make necessary reforms to survive those challenging requirements of the CPTPP.

The Chinese government has maintained a positive and open stance regarding whether to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), and there is widespread view among researchers that supports China to join. However, there also is a view both at home and abroad that the CPTPP rules on SOEs are too difficult for China to accept and, therefore, constitute a major obstacle if China is to join. This view may have overestimated the difficulty of the problem.

It is important to note that over the past two decades China's SOEs have been subject to the disciplines of the World Trade Organization (WTO). In joining the WTO in 2001, China not only accepted the WTO rules related to SOEs, including Article XVII of the General Agreement on Tariffs and Trade (GATT) on “state trading enterprise” and the Agreement on Subsidies and Countervailing Measures (SCM Agreement), but also made several further commitments in two documents, Protocol of the Accession of the People’s Republic of China, and the Report of the Working Party on the Accession of China. They include:

• Commercial considerations and non-discrimination: to ensure that all state-owned and state-invested enterprises would make purchases and sales based solely on commercial considerations, and that the enterprises of other WTO Members would have an adequate opportunity to compete for sales to and purchases from these enterprises on non-discriminatory terms and conditions.

• Independence of commercial decision-making: not to influence, directly or indirectly, commercial decisions on the part of state-owned or state-invested enterprises, except in a manner consistent with the WTO Agreement.

• Specificity of SOE subsidies: to view subsidies to SOEs as specific for purposes of applying Articles 1.2 and 2 of the SCM Agreement.

• Notification obligations: to notify the WTO of any subsidy granted or maintained in China including subsidies to SOEs.

An analysis of CPTPP's SOE rules in comparison with disciplines China has accepted under the WTO shows that, despite many differences, they are highly consistent. If China is to join the CPTPP, it will certainly need to accept some new disciplines and make some new commitments, but none of them constitutes unacceptable concession. With further deepening of the SOE reform, CPTPP's SOE rules should not become an obstacle to China's accession.

CPTPP is the first free trade agreement that devotes one chapter (Chapter 17) to the issue of SOEs. The chapter comes from Chapter 17 of the Trans-Pacific Partnership Agreement (TPP), which was put together under the leadership of the United States during the Obama administration. There was no change after the United States withdrew itself from the TPP.

A chapter (Chapter 22) was also devoted to the issue of SOEs in the United States, Mexico and Canada Agreement, a free trade agreement the Trump administration renegotiated with Mexico and Canada. The chapter is largely a modified version of the chapter of CPTPP. To a large extent, therefore, the CPTPP’s SOE rules reflect the position of the United States.

CPTPP's SOEs disciplines include four parts: non-discrimination and commercial considerations; courts and administrative bodies, non-commercial assistance (NCA), and transparency. Among them, the rules on NCA (i.e. subsidy) receive the most attention and are the most complicated. Drawing on existing studies, this article provides a brief comparative analysis of them with their WTO counterparts.

1

 

Non-Discrimination and Commercial Considerations

CPTPP's rules on non-discrimination and commercial consideration include two main requirements. One is that SOEs must act in accordance with commercial considerations in their purchase or sale of a good or service when engaging in commercial activities (Article 17.4.1.a). The second is that SOEs must accord “no less favorable” treatment to goods, services and enterprises from another Party (Article 17.4.1.b). Although the concepts of "national treatment" and "most-favored-nation treatment" are not used, the expression of "treatment no less favorable than..." means granting national treatment and most-favored-nation treatment. The two requirements have their origin in Article XVII of the GATT. In addition to an extension of the scope of application to service trade and foreign direct investment (the so-called "covered investment"), they have gone further in two aspects.

The first has to do with the relationship between "non-discrimination" and "commercial considerations" in Article XVII of the GATT, which was explained by the WTO Appellate Body in 2004. Simply speaking, the Appellate Body clarifies that the requirement of commercial considerations is aimed at preventing certain types of discriminatory behaviors, and cannot be interpreted as imposing "comprehensive, competition-law-type obligations”(WT/DS276/AB/R, Article 145). But in the CPTPP, non-discrimination and commercial considerations are presented as two independent requirements.

Although in accordance with Article 17.4.3, differential treatment in accordance with commercial considerations is not considered discrimination, whether purchases and sales that do not comply with the requirement of commercial considerations are in violation of the CPTPP depends on how Article 17.4.1.a is interpreted. If it is interpreted that the CPTPP is violated as long as an SOE does not act in accordance with commercial considerations in purchases and sales even if it does not engage in any discrimination, there can be inconsistency with the above mentioned interpretation of Article XVII of the GATT by the WTO Appellate Body.

It will also be in conflict with Article 17.2 of the CPTPP itself, which states that its SOE rules apply with respect to the activities of SOEs that affect trade or investment between Parties within the free trade area. If an SOE fails to comply with the requirement of commercial considerations but does not violate the principle of non-discrimination, it does not necessarily affect trade or investment between CPTPP Parties within the free trade area.

Secondly, the non-discrimination and the related commercial consideration requirements of the GATT apply only with “state trading enterprises”. The CPTPP extends the scope of application to cover all SOEs.

However, the two requirements of the CPTPP that are inconsistent with their WTO counterparts do not constitute any new commitment to China, because China already committed in its WTO accession to ensure that all SOEs make purchases and sales based solely on commercial considerations and afford enterprises of other WTO Members adequate opportunity to compete on non-discriminatory terms and conditions.

Courts and Administrative Bodies

Compared with others, CPTPP's rules for courts and administrative bodies are very simple and have not attracted much attention from researchers. First of all, Article 17.5.1 requires each Party to provide its courts with jurisdiction over civil claims that meet two conditions: against a foreign SOE and based on a commercial activity carried on in its territory. Second, Article 17.5.2 requires each Party to ensure that any administrative body that regulates an SOE exercises its regulatory discretion in an impartial manner.

These two rules appear to have no WTO counterparts and, therefore, may constitute new commitment for China. Their implication to China deserves more research, but they should not be unacceptable. To put it simply, an SOE operating on the territory of another country is not a diplomatic mission. It is only natural that any litigation arising from its commercial activities on the territory of that country be subject to the jurisdiction of its court. As for impartiality of regulation, it is of course also a principle that China upholds. The only thing that needs to be confirmed is that the requirement for impartial regulation be consistent with Article 17.2. In other words, unless the activities of the SOE involved have an impact on the trade and investment activities among CPTPP Parties in the free trade area, the regulatory impartiality of a Party’s administrative bodies do not fall within the scope of the CPTPP.

Non-Commercial Assistance: An Overview

The core requirement of CPTPP’s NCA rules is that no Party should grant any NCA to its SOEs that causes “adverse effects” to the interests of another Party, including “injury” to its domestic industry. The NCA is effectively the same as a subsidy in the WTO SCM Agreement. Although CPTPP does not use the term subsidy, its rules on NCA are essentially consistent with those on subsidies in the SCM Agreement. A subscription to CPTPP's NCA rules will mean some new commitments for China, but none of them is unacceptable.

1. Scope

Compared with the SCM Agreement of 1994, CPTPP covers not only trade in goods but also trade in services and foreign direct investment. In other words, Chinese SOEs involved in trade in goods have been already subject to the disciplines of the SCM Agreement. Acceptance of the CPTPP will mean SOEs involved in trade in services and outbound direct investment will be subject to similar rules. WTO rules governing subsidies in service trade and trade-related investment are still to be established. If China is to join the CPTPP, coordination with its negotiation positions regarding subsidies in service trade and trade-related investment will be necessary. However, at least in principle, rules that are acceptable to SOEs involved in trade in goods should not be unacceptable to SOEs involved in service trade and outbound direct investment.

2. Providers and Recipients

As far as recipients of NCA are concerned, there is no substantial difference between the CPTPP and SCM Agreements, except that SOEs that are covered for investment (SOEs operating on the territory of another Party) are included. However, in terms of providers, major difference exists. According to the CPTPP, the provision of an NCA to an SOE can take place in three situations, namely, when it is (i) directly provided by the government of a Party; (ii) indirectly provided by the government of a Party that “entrusts or directs” a non-SOE to do so (footnote 17.18); (iii) provided by another SOE (including state-owned financial institutions).

The first and second are consistent with the SCM Agreement, with the one about non-SOEs being NCA provider coming directly from Article 1.1.a1.iv of the SCM Agreement. The third, however, represents a major departure from the SCM Agreement and WTO Appellate Body’s ruling. Nonetheless, a focused analysis in the next section shows that, while undoubtedly an important concession, it is not completely unacceptable to China.

3. Definition of the NCA

The basic definition of the NCA is an "assistance to an SOE by virtue of that SOE’s government ownership or control” (Article 17.1). This definition has two core elements, “assistance” and “by virtue of government ownership or control”.

One important difference between CPTPP's definition of "assistance" and the SCM Agreement’s definition of subsidy is that it does not use the term "benefit". The existence of a benefit is a key element of the SCM definition of subsidy. A financial contribution of a government or a public body is considered as a subsidy only when “a benefit is thereby conferred”. Article 14 of the SCM agreement defines the existence of benefits in various situations. The NCA definition does not require a determination of whether a benefit is conferred. Rather, it goes straight to a list of types of assistance. Nonetheless, the two approaches are consistent in spirit.

The types of assistance listed by the CPTPP fall into three groups. The first are those that are obvious in terms of benefits being conferred, such as grants and debt forgiveness. The second are those that enable recipients to obtain loans, loan guarantees, or goods or services other than infrastructure on "terms that are more favorable than commercially available", which of course means a benefit is conferred. The third comprises equity capital provision. Instead of referring to "terms that are more favorable than commercially available", the CPTPP adopts the concept of Article 14 of the SCM Agreement to define it as equity capital provided “inconsistent with the usual investment practice, including for the provision of risk capital, of private investors”. In other words, the recipients obtain equity capital on more favorable terms than available to them in the market, which of course means a benefit is conferred as well.

Therefore, although the term benefit is not used, CPTPP's definition of "assistance" is consistent with the SCM definition of subsidy. The only difference is that the SCM Agreement (Article 1.1.a1.(ii)) mentions “government revenue that is otherwise due is foregone or not collected”, which does not appear in the CPTPP. But this obviously does not mean that CPTPP allows subsidies to be provided in the form of tax foregone. How this can be handled in actual enforcement may have to wait for specific explanations and cases.

There are two other important concepts in the SCM Agreement that have not appeared in the CPTPP, one is "specificity" and the other is "actionable." To put it simply, specific subsidies are subsidies that only specific companies and industries receive; actionable subsidies means those against which Members can take actions such as litigation. According to the SCM Agreement, a subsidy becomes actionable only if it is specific. Article 2 of the SCM Agreement defines the criteria for determining specificity. CPTPP does not use the concept of specificity. However, an assistance is an NCA only when a SOE receives it "by virtue of” its government ownership or control.

How to determine whether an SOE receives an assistance by virtue of its government ownership or control? The CPTPP sets forth four criteria, which are all the same as found in Article 2 of the SCM Agreement. In other words, as long as an assistance meets the CPTPP's definition of NCA, it must also meet the SCM's definition of specific subsidy. The two are consistent. In addition, Article 10.2 of China's WTO Accession Protocol also states that "for purposes of applying Articles 1.2 and 2 of the SCM Agreement, subsidies provided to SOEs will be viewed as specific if, inter alia, SOEs are the predominant recipients of such subsidies or SOEs receive disproportionately large amounts of such subsidies." Therefore, the provisions of CPTPP do not go beyond what China has committed to in its WTO accession.

4. Adverse effects and injury

The core requirement of CPTPP’s rules on NCA is that no Party should grant any NCA to its SOEs that causes “adverse effects” to the interests of another Party. This is consistent with Article 5 of the SCM Agreement. However, since CPTPP covers service trade and direct investment, the specific provisions on adverse effects and injuries in these two areas, including identification criteria and methodology, are not covered by the SCM Agreement. Joining the CPTPP will mean accepting them.

But as far as trade in goods is concerned, CPTPP's provisions on adverse effects are essentially consistent with the SCM Agreement. Simply put, adverse effects in CPTPP can occur in two ways. One is "displace or impede from", and the other is price "undercutting" and related price "suppression", "depression", and "lost sales". For example, if the production and sale of a product of an SOE that benefits from an NCA displaces or impedes from the Party’s market the import of similar goods from another Party, or results in a significant price undercutting or price suppression, price depression, or sales loss, the NCA is considered to have caused adverse effects. These provisions are in line with those of Article 6 of the SCM Agreement, especially Article 6.3. Regarding injury, the specific provisions of Article 17.8 of the CPTPP on its determination methodology are consistent with Article VI of the GATT and Article 15.1 of the SCM Agreement.

2

Non-Commercial Assistance: SOEs as Providers

According to the SCM Agreement, a subsidy is a financial contribution by a government or a public body that confers a benefit. Before Chinese SOEs entered the international market on a large scale, the specific meaning of "public body" in this definition did not attract much attention. When China joined the WTO, western incumbents focused on subsidies received, instead of provided, by SOEs. But in 2011, in the case of “United States – Definitive Antidumping and Countervailing Duties on Certain Products from China” (the DACD case), China and the United States had disputes over the definition of "public body".

In short, the U.S. view is that a public body referred to an entity controlled by the government. According to this interpretation, state-owned and state-controlled enterprises and financial institutions are all public bodies. China’s view is that a public body is an entity vested with government authority to perform governmental functions, which implies that SOEs and state-owned financial institutions are not public bodies unless they are vested with government authority to perform governmental functions.

The WTO’s Panel for this case supported the views of the United States, but its position was rejected by the Appellate Body. According to the Appellate Body (WT/DS379/AB/R), a public body within the meaning of Article 1.1.(a)(1) of the SCM Agreement must be an entity that possesses, exercises or is vested with governmental authority. As for what constitutes “possesses, exercises or is vested with governmental authority”, the Appellate Body believes that the mere fact that a government is the majority shareholder of an entity is not enough. What is important is the evidence that the entity performs governmental functions as “a sustained and systematic practice”. However, if the evidence shows that the formal indicia of government control are manifold, and there is also evidence that such control has been exercised in a meaningful way, then such evidence may permit an inference that the entity concerned is exercising governmental authority.

CPTPP does not use the concept of public body. According to its rules, any assistance provided to an SOE by its government, another SOE (including financial institution), or a non-SOE entrusted or instructed by the government, as long as it meets the NCA definition, is regulated by the NCA rules. In other words, it does not matter whether or not an SOE that provides assistance is a public body within the meaning of the SCM Agreement. Because the CPTPP defines an SOE by its government ownership or control, this is consistent with the U.S. position in the DACD case mentioned above. After the CPTPP, this position has been further strengthened in the United States, Mexico and Canada Agreement, which includes assistance provided by an SOE to a non-SOE as NCA.

So, is this provision of CPTPP acceptable to China? If China considers joining the CPTPP, is it an obstacle?

Theoretically speaking, the issue deserves further discussion. When the SCM Agreement puts public body together with the government, the objective is to prevent the government from indirectly and covertly providing subsidies through public entities under its control. For the same consideration, even if a private enterprise is "entrusted and instructed" by the government and meets certain other conditions, the financial contribution it provides to other enterprises that meets the definition of subsidy should be regarded as a subsidy.

Therefore, the crux of the issue is whether a financial contribution or assistance (such as a debt exemption) provided by an SOE (including financial institution) to other enterprises that meets the definition of subsidy (NCA) in other aspects should invariably be considered an indirect subsidy (NCA) provided by the government?

The answer implied by the U.S. position is affirmative, and an affirmative answer is reasonable in two senses. First of all, since an SOE is state-owned by definition, the financial contribution it provides to other enterprises boils down to a free transfer of government funds to other enterprises. For example, debt exemption offered by an SOE will eventually be reflected in a decline in government dividends it distributes, or a depreciation of its equity owned by the government. Secondly, since the SOE is controlled by the government, even if its offer of financial contribution is not instructed by the government, it is at least allowed by the government. Therefore, in terms of its impact on market competition, there is no difference between such financial contributions and subsidies directly provided by the government.

However, the second reason mentioned above may not always hold. SOEs can be independent in commercial decision-making, which is in accordance with commercial considerations and not subject to government direction. In fact, when China joined the WTO in 2001, the United States already made China commit that the government would not directly or indirectly influence the commercial decisions of SOEs.

The free trade agreement between the United States and Singapore that came into effect in 2004 also requires the Singaporean government not to directly or indirectly influence or direct the decisions of its government enterprises, and to ensure that the way it exercises its voting rights in government enterprises does not conflict with the agreement. The CPTPP did not make such a requirement, as if it does not expect SOEs to be independent in commercial decision-making.

But it did not completely rule out the possibility either. Its Article 17.2.6 stipulates that its SOE rules do not apply to independent pension funds and enterprises controlled by them, with the exceptions of direct NCA to them provided by the government, or NCA to others indirectly provided by the government through them. The definition of the so-called "independent pension fund" includes two core elements. The first is fiduciary duties they owe to contributors and beneficiaries; the second is independence of investment decision-making, that is, not under the direction of the government, although investment “direction” from the government does not include general guidance with respect to risk management and asset allocation and is not demonstrated, alone, by the presence of government officials on the enterprise’s board of directors or investment panel (footnote 17.3). This provides basis for the exemption of many Malaysian SOEs.

Therefore, ideally, those SOEs that are independent in commercial decision-making should be treated differently from others. Financial contribution (assistance) with the presence of benefit transfer provided by an SOE that is considered independent from the government in commercial decision-making by certain criteria should not be regarded as subsidy (NCA), unless the SOE is entrusted or instructed by the government to do so. Of course, making such a judgment is never easy, may be impossible when transparency is lacking. But if it can be done, those SOEs that do have independence in commercial decision-making can be granted more freedom and the government that acts as a commercial shareholder can be encouraged.

However, the CPTPP has no room for renegotiation. China can only consider joining or not joining. If it joins, it has to accept the U.S. position on this issue. This will undoubtedly be an important concession, but such a concession is not unacceptable. The fundamental reason is that China does not need to maintain a system of indirect provision of subsidies through SOEs, and such an approach is not good for China itself. As mentioned earlier, when an SOE ignores commercial principles to provide subsidies (such as debt exemption) to other enterprises, what it does is no more than giving away government owned resources to others free of charge. This kind of behavior distorts market competition and damages the government's fiscal discipline more than direct provision of subsidies by the government itself. Even without CPTPP, it should not be allowed.

Of course, the provisions of the CPTPP may be abused. Normal transactions between state-owned financial institutions and SOEs, as well as between SOEs, may be suspected or sued as NCA. This problem is particularly prominent considering the large number of SOEs in China, which mostly operate in the upstream part of supply chains. But the risks in this regard are not as serious as often perceived. First of all, the CPTPP (footnote 17.4) has excluded transactions within enterprise groups and arm’s length commercial transactions between SOEs from its NCA definition. Secondly, as long as sufficient transparency is maintained, attempts to abuse the rules will be checked by the CPTPP's dispute resolution mechanism.

Deepening reform is of course critical. The key is to take actions to ensure that transactions between state-owned financial institutions and SOEs conform to the principle of competitive neutrality and are recognized by the market. At the same time, at least in non-strategic areas, state shareholders must complete the transition to a role of financial investors in accordance with the principle of "managing state capital instead of SOE" established by the government as soon as possible, and hand over corporate business decision-making to the board of directors while exercising shareholder rights. However, considering all aspects of the issue, the CPTPP rules on SOEs as NCA provider are not unacceptable, although it is certainly an important concession from China’s position in the DACD case.

3

Transparency

CPTPP’s requirements on transparency (Article 17.10) fall in three categories: one is to regularly publish a list of SOEs; the second is to provide information on specific SOEs upon request from other Parties; and the third is to provide NCA information at the request of other Parties. They are largely the adoption or modification of rules in Article 25 of the SCM Agreement. The main difference is that the SCM Agreement requires Members not only to provide information on a regular basis, but also to do so at the request of other Members. In comparison, CPTPP only requires the regular publication of a list of SOEs, while the focus is put on information to be provided at the request of other Parties.

However, the content of the information that must be provided upon request is much the same as that of the information to be provided regularly in the SCM Agreement. For example, regarding subsidy information, the SCM Agreement lists five aspects (Article 25.3), namely, form, amount, policy objectives, duration, and statistical data of the subsidy. CPTPP has two differences. The first is an addition of the providers and recipients of NCA; the second is an addition of four more dimensions with regard to the amount of NCA, namely, amount of NCA in trade in services, provision of loans and loan guarantees, provision of goods or services, and provision of equity capital. There is obviously nothing unacceptable about these differences.

Conclusion

Based on the above analysis, although there are many differences between the CPTPP's rules on SOEs and the relevant WTO rules, rulings and commitments made by China, if China is to join the CPTPP, the new commitments or new disciplines that potentially have substantial significance to China are only the following three:

1) An SOE operating on the territory of another Party is subject to the jurisdiction of the court of that Party for civil claims against it on the basis of its commercial activities on the territory of that Party.

2) The rules on NCA apply not only to SOEs involved in trade in goods, but also to those involved in trade in services and outbound direct investment.

3) Any assistance provided by an SOE (including state-owned financial institutions) to other SOEs, as long as it meets the definition of NCA, is considered NCA, regardless of whether or not the provider is a “public body” within the meaning of the SCM Agreement.

The analysis in this article shows that none of the above constitutes unacceptable concession. Two points also follow. First, when China joined the WTO, western incumbents understood the challenges the entry of Chinese SOEs into the global market might bring to the global trading system and prepared well for it. With the possible exception of the role of SOEs as subsidy provider, the strictness of disciplines they made China accept is broadly comparable with that of the requirements of the CPTPP. Second, the view that CPTPP's SOE rules are designed to discriminate against and suppress Chinese SOEs is unfounded.

Of course, this is not to say that Chinese SOEs can easily survive the requirements of the CPTPP. On the contrary, the necessary reforms will be very challenging if China joins. In particular, it is necessary to clean up and eliminate any anti-competitive subsidy provided by state-owned financial institutions and SOEs to other SOEs. But they are consistent with China’s own reform agenda.

The pessimistic view that these reforms are too difficult to implement is mostly based on a judgment that the international competitiveness of Chinese SOEs is highly dependent on anti-competitive subsidies and discriminatory measures that would not be permitted by the CPTPP. This is not backed up by evidence and not necessarily true. In fact, a large number of well-performing SOEs are fully capable of competing with others in the international market on equal footing. As for those that cannot survive without government subsidies, they should have already exited the market. At the same time, it is also important to realize that adequate compensation for the cost of public service obligations carried out by SOEs should not be confused with anti-competitive subsidies. If China is to join the CPTPP, this needs to be clarified through negotiation.

At the time of China’s WTO accession, there were many very pessimistic projections about the ability of SOEs to survive. However, history has shown that as long as the determination to reform is firm enough and the measures are strong enough, difficulties can be overcome. The extent to which Chinese SOEs have adapted to market competition today is completely noncomparable with that of two decades ago. If they could accept the WTO disciplines two decades ago, there is no reason to believe that they cannot rise to the challenges of CPTPP rules today. The key is to turn the determination of market-oriented reform and institutional opening into action.

 Read More 
Opinion: China Might Be Able to Reform Its Way Out of SOE Restrictions in CPTPP Trade Pact

The views and opinions expressed in this opinion section are those of the authors and do not necessarily reflect the editorial positions of Caixin Media.

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