INTERNATIONAL TRADE LAW

Assignment on as how export competitiveness

SUBMITTED BY – ANKITA SUBMITTED TO - DR.

DIGVIJAY SINGH KATOCH

ASSISTANT PROFESSOR OF LAW

R.N. -1020161753

BA LLB 7th Sem.

Explain, how export competitiveness determines legality and

Export subsidies are incentives provided by the government to producers who export their goods
to foreign countries. These producers could be anyone ranging from huge firms to cottage
industries to poor farmers with small land holdings. Due to these subsidies the producers have
some motivation to produce more goods which leads to increase in the stockpile. The
government either buys the surplus from this supply by itself or provides concessions on tax or
factors of production. After this the surplus amount is exported to other countries to strengthen
the foreign exchange reserves. Therefore subsidization encourages production activities and also
helps in alleviating poverty among small producers. Thus, to see that how the practice like export
competitiveness affect the actionable subsidies.

Statement of problem

To look on to concept of export competitiveness and its effect on the legality and illegality of
actionable subsidies which are incentives provided by the government to producers who export
their goods to foreign countries. These producers could be anyone ranging from huge firms to
cottage industries to poor farmers with small land holdings. Due to these subsidies the producers
have some motivation to produce more goods which leads to increase in the stockpile. The
government either buys the surplus from this supply by itself or provides concessions on tax or
factors of production. After this the surplus amount is exported to other countries to strengthen
the foreign exchange reserves. Therefore subsidization encourages production activities and also
helps in alleviating poverty among small producers.

Research methodology

Based wholly on doctrinal research this assignment covers various aspects under it. .
Websites, dictionaries and online articles have also been referred to gather more knowledge on
the perspectives of the title and providing a superstructure to make the assignment structural and
organized.
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Introduction

The trade practices of giving subsidies are normally defined as financial support in cash or in
kind, if made in favour of an undertaking by the state. This support can either be direct or
indirect in form, for the goods or services that any such industry produces. Trade-subsidy
supported by the national government often leads to the distortion of efficient and competitive
market system or can either be a protectionist measures, and hence, violates the underlying
principles of fair-trade. Fair trade principle although not emphasized as the main trading
principles of governing free trade, however is effectuated as a regulatory measure through the
SCM Agreement provisions.
Actionable subsidies can be defined as any form of subsidies other than those mentioned in
Article 3 of the SCM Agreement. Article 5 and Article 6 of the SCM Agreement covers
substantive obligations for the Member States to follow while adopting such policies. These
subsidies are justifiable to the extent that they are not profit-making. Question arises, when do
they take the form of non-justifiable state support and therefore are liable as actionable subsidies.
Actionable subsidies can be objected to if they cause injury to the domestic industry of another
Member State country. 1
Two categories of subsidies are prohibited by Article 3 of the SCM Agreement. The first
category consists of subsidies contingent, in law or in fact, whether wholly or as one of several
conditions, on export performance (“export subsidies”). The second category consists of
subsidies contingent, whether solely or as one of several other conditions, upon the use of
domestic over imported goods (“local content subsidies”). These two categories of subsidies are
prohibited because they are designed to directly affect trade and thus are most likely to have
adverse effects on the interests of other Members.
The scope of these prohibitions is relatively narrow. Developed countries had already accepted
the prohibition on export subsidies under the Tokyo Round SCM Agreement, and local content
subsidies of the type prohibited by the SCM Agreement were already inconsistent with Article
III of the GATT 1947. What is most significant about the new Agreement in this area is the
extension of the obligations to developing country Members subject to specified transition rules
(see section below on special and differential treatment), as well as the creation in Article 4 of

1
TREBILOCK AND HOWSE (2002)
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the SCM Agreement of a rapid (three-month) dispute settlement mechanism for complaints
regarding prohibited subsidies. 2

WTO principles
The World Trade Organization (WTO) emerged in 1994 from the General Agreement on Tariffs
and Trade (GATT), established in 1947. The GATT and the WTO are founded on a number of
basic principles  :

 The « Non-discrimination principle » has two components : the most favoured nation
(MFN) clause (Article I) and the National clause (Article III) of the GATT. It requires
that imported goods from WTO members on crossing a border and payment of customs
duties must be treated on the same terms as national products.

 The main trade policy instrument is an import tariff which have been « bound » in the
course of negotiations and included in the schedules of concessions .
Gradual reductions in tariffs in the course of negotiations were intended for further trade
liberalization.

 Member countries are required to observe the principle of reciprocity, which, however,
has not been explicitly defined .

 The principle of « fair competition ». It includes inter alia the right to impose
countervailing duties on imports that have been subsidized and anti-dumping duties on
imports that have been dumped.

Actionable subsidies

Most subsidies, such as production subsidies, fall in the “actionable” category. Actionable
subsidies are not prohibited. However, they are subject to challenge, either through multilateral
dispute settlement or through countervailing action, in the event that they cause adverse effects
to the interests of another Member. There are three types of adverse effects. First, there is injury
to a domestic industry caused by subsidized imports in the territory of the complaining Member.

2
SCHMITTOFF, EXPORT TRADE: THE LAW AND PRACTICE OF INTERNATIONAL TRADE, (Sweet and Maxwell)
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This is the sole basis for countervailing action. Second, there is serious prejudice. Serious
prejudice usually arises as a result of adverse effects (e.g., export displacement) in the market of
the subsidizing Member or in a third country market. Thus, unlike injury, it can serve as the basis
for a complaint related to harm to a Member's export interests. Finally, there is nullification or
impairment of benefits accruing under the GATT 1994 3. Nullification or impairment arises most
typically where the improved market access presumed to flow from a bound tariff reduction is
undercut by subsidization4.

The creation of a system of multilateral remedies that allows Members to challenge subsidies
which give rise to adverse effects represents a major advance over the pre-WTO regime. The
difficulty, however, will remain the need in most cases for a complaining Member to
demonstrate the adverse trade effects arising from subsidization, a fact-intensive analysis that
panels may find difficult in some cases.

Export Subsidies as Signals of Competitiveness

With incomplete information, the domestic government would like the foreign firm to believe
that the domestic firm has low costs since then the foreign firm would reduce its exports, and
thus increase the profits of the domestic firm. Hence, the domestic government has an incentive
to give its firm a larger export subsidy than under complete information so that the foreign firm
will infer that the domestic firm has low costs. Therefore, the export subsidy in the signalling
equilibrium under incomplete information will be larger than the profit-shifting export subsidy
under complete information. The game of incomplete information described in Section II has
many perfect Bayesian equilibria (pooling, partial-pooling and separating equilibrium), but this
section only considers the unique signalling (separating) equilibrium of the game. In a signalling
equilibrium the domestic government's export subsidy is a one-to-one function of the marginal
cost of the domestic firm, and the foreign firm correctly infers the marginal cost of the domestic
firm from the export subsidy set by the domestic government. The existence and uniqueness of
signalling equilibrium in games of incomplete information with a continuum of types has been
considered by Mailath (1987)5. He shows that if the signalling agent's payoff function satisfies

3
http://www.imf.org/external/pubs/ft/weo/2017/update/01/ (accessed on Nov 16, 2019 at 9:30pm)
4
Subsidies And Countervailing Measures, https://www.wto.org/english/tratop_e/scm_e/subs_e.htm
5
Tancu p.7.http://pure.au.dk/portal/files/12176/mt84715_thesis.pdf. (visited at 9:35pm on 17 Nov 2019)
 INTERNATIONAL TRADE LAW

certain regularity conditions (most importantly belief monotoncity, type monotonicity, and single
crossing) then there exists a unique signalling equilibrium. In the game of Section II, the
domestic government's welfare (payoff) function satisfies all these conditions. Belief
monotonicity is satisfied since a 1W l/ac3 < 0. This says that the lower the domestic marginal
cost, then the larger the gain to the domestic country from using an export subsidy, which is
obviously related to the result of de Meza (1986). Single crossing, which is a technical
condition, is also satisifed since (a W1 lae, )/(a W1 /la C) is monotonic in domestic marginal cost
for any positive export subsidy. Hence, the game of incomplete information in Section II has a
unique signalling equilibrium.

The Airbus-Boeing Dispute

One of the key trade disputes between the United States (US) and European Union (EU) arises
from the rivalry between Boeing and Airbus in the highly competitive large civil aircraft (LCA)
industry. After intensifying in the late 1970s and early 1990s, the dispute over government
subsidies paid to their respective commercial airplane companies has again escalated since 2004.
This time, however, the stakes are much higher since both the US and EU filed complaints at the
World Trade Organization (WTO) Dispute Settlement Body (DSB). On 30 May 2005, the Office
of the US Trade Representative (USTR) requested the establishment of a panel of the WTO DSB
to move forward with a trade dispute case against the EU. The EU responded on 31 May 2005 by
filing its own case against the US6. This is a complicated case, and both sides have very long-
held claims and arguments as to why the other side has been breaking WTO rules.The Airbus-
Boeing conflict has followed a familiar path of trade disagreements between the EU and US,
with each side symmetrically accusing its opponent of breaking the rules. There are three reasons
for the significance of the current state of the dispute. First, the LCA industry is of critical
importance to both parties in terms of its impact on technological development, trade balances,
economic growth, well paid employment, national prestige and national defense. Second, the
dispute is a test of whether WTO mechanisms/ rules can successfully manage a broad conflict
between two great trade powers concerning an industry that both parties consider to be strategic.

6
“The Airbus Global Market Forecast for 2009-2025”and “2008 Annual Review”,
<http://www.airbus.com/en/airbusfor/
analysts(visited at 9:35pm on 17 Nov 2019)
 INTERNATIONAL TRADE LAW

Third, more importantly, from a long-term perspective, the dispute indicates “a fundamental
tendency in global trade negotiations and world politics for economic globalization to reach its
limits in the harsh realities of multi-polar power politics” (Weinstein, 2005).

Over the years, the WTO has ruled that both sides unfairly subsidized their aircraft makers. Last
year, the WTO's appeals body upheld a 2016 ruling that the EU had supported Airbus with
subsidized loans for the development of new aircraft — the A380 superjumbo and the A350
twin-aisle jet. The world body also found that the loans which were repayable on delivery
amounted to illegal assistance 7.

Earlier this year, the WTO handed the EU a victory in its counter case, saying America's
favorable contract terms and tax breaks to Boeing had hurt Airbus sales. Interestingly, both the
US and the EU claimed victory on hearing the decisions. The WTO is yet to rule on the harm
caused by the unlawful subsidies. That will determine the number of countermeasures the two
sides can impose. Ruling on the US sanctions request, the WTO has allowed the US to impose
tariffs on up to $7.5 billion worth of EU goods, well below the US request. The US trade office
had estimated the harm from the EU subsidies to Airbus at $11 billion in trade each year.

Conclusion

When the foreign firm has incomplete information about the marginal cost of the domestic firm,
it has been shown that the domestic government can use an export subsidy to signal the
competitiveness of its firm. A larger export subsidy leads the foreign firm to infer that the
domestic firm has lower costs, and in response it reduces its output which increases the profits of
the domestic firm. In the signalling equilibrium under incomplete information, the domestic firm
receives a larger export subsidy than it would under complete information. This assumes that the
domestic government has better information than the foreign firm about the costs of the domestic
firm. However, the domestic government may prefer not to acquire this information since
expected welfare may be higher in the pooling equilibrium than in the signalling equilibrium.
OThe editors of the Scandinav As noted in the introduction, the analysis can be extended to the
case where both firms have incomplete information about their competitor's marginal cost, and

7
Pavcnik, N. (2002): “Trade disputes in the commercial aircraft industry”, The World Economy, 25 (5): 733-751.
 INTERNATIONAL TRADE LAW

both governments can use an export subsidy.3 This would lead to a simultaneous signalling
game, similar to those considered by Mailath (1988, 1989), where both governments have an
incentive to use export subsidies to signal the competitiveness of their firm. Since both
governments simultaneously use export subsidies to signal the competitiveness of their firms,
there are now two effects: the direct signalling effect and the strategic interaction effect. The
domestic signalling equilibrium export subsidy is a function of the competitiveness of the
domestic firm, which now depends on the expected foreign export subsidy, e2. For a given value
of e2 the direct signalling effect leads the domestic government to use a larger export subsidy
than under complete information as in the proposition of Section IV. The strategic interaction
effect introduced by this extension arises because the direct signalling effect will also lead the
foreign government to increase its export subsidy. This will increase e2 which will lead the
domestic government to reduce its export subsidy, because domestic and foreign export subsidies
are strategic substitutes; see Collie (1991). Hence, the strategic interaction effect partly offsets
the direct signalling effect, so that the overall effect is smaller than in the one-sided signalling
game. Qualitatively, the proposition of Section IV still holds: The export subsidies in the
signalling equilibrium under incomplete information are larger than the profit-shifting export
subsidies under complete information. The signalling effect of an export subsidy is driven by its
profit-shifting effect and, in particular, by the fact that the more competitive the domestic firm,
then the larger the export subsidy given by the domestic government. Therefore the signalling
argument for an export subsidy is subject to the same criticisms as the profit-shifting argument,
and is likely to be equally sensitive to changes to the basic model. Dixit (1984) has shown that
when there are a sufficiently large number of domestic firms, then the optimal policy is an export
tax rather than a subsidy, because the usual terms-of- trade effect will dominate the profit-
shifting effect.8 Then the optimal export tax is increasing in the competitiveness of the domestic
industry and, under incomplete information, the domestic government would give a larger export
tax to signal the competitiveness of the domestic industry. For a Bertrand duopoly, Eaton and
Grossman (1986) have shown that the optimal policy is an export tax rather than a subsidy, and it
can be shown that the optimal export tax for the domestic country is increasing in the
competitiveness of the domestic firm. With incomplete information in a Bertrand duopoly, the
domestic firm would like the foreign firm to believe that it has high costs since then the foreign

8
MAVROOIDIS AND PETROS, TRADE IN GOODS, (Oxford University Publication, 2012)
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firm would set a high price which would increase the profits of the domestic firm. Hence, the
domestic government should reduce its export tax to signal that the domestic firm is
uncompetitive. However, with Bertrand competition, Mailath's conditions for existence and
uniqueness may break down and then there would be no signalling equilibrium. Since the use of
an export subsidy to signal competitiveness is costly, firms and governments may consider other
means of conveying cost information. Shapiro (1986) has shown that in a Cournot duopoly, there
is an incentive for the voluntary sharing of cost information by firms. However, this result
requires that the firms can make a binding agreement to share information before costs are
observed, and that there is a third party such as a trade association which can verify the cost
information. These assumptions seem especially strong for a duopoly consisting of a foreign and
a domestic firm. 9

9
RUBINI AND LUCA, THE DEFINITION OF SUBSIDY AND STATE AID: WTO AND EC LAW IN COMPARATIVE PERSPECTIVE,
(Oxford University Press, 2009)