metadata: authors: 0: author: Wang, Yan
1: author: Zhao,Longyue
count: United States,China
docna: 0: docna: Trade remedies and non-market economies :
            economic implications of the first US countervailing duty
            case on China
docty: Policy Research Working Paper
subtopic: Public Sector Economics,Disease Control & Prevention,International Trade and Trade Rules,Trade and Services,Public Finance Decentralization and
            Poverty Reduction,Crime and Society
teratopic: Law and Development,Private Sector Development,Macroeconomics and Economic Growth
abstracts: cdata!: In 2007, the United States Department of
            Commerce altered a 23-year old policy of not applying the
            countervailing duty law to non-market economies, and
            initiated eight countervailing and antidumping duty
            investigations on Chinese imports. The change brings heated
            debate on trade remedy policies and issues of non-market
            economies. This study focuses on the first countervailing
            duty case on imported coated free sheet paper from China and
            analyzes the implications of this test case for United
            States-China bilateral trade, and industrial policies in
            transitioning market economies. The paper also provides a
            brief review of the economics of subsidies, World Trade
            Organization rules on subsides and countervailing measures,
            and United States countervailing duty laws applied to
            non-market economies. While recently acceded countries
            should review their domestic development policies from the
            perspective of economic efficiency and comply with the World
            Trade Organization rules, it is also important to further
            clarify the issues of non-market economies under the
            multilateral trading system, and pay keen attention to the
            rules negotiations in the current World Trade Organization
            Doha Development Round.
geo_reg_key: 119228,517198,119225,517191
repnme: repnme: Trade remedies and non-market economies :
            economic implications of the first US countervailing duty
            case on China
display_title: Trade remedies and non-market
            economies : economic implications of the first US
            countervailing duty case on China
listing_relative_url: /research/2008/03/13896462/trade-remedies-non-market-economies-economic-implications-first-countervailing-duty-case-china
topicv3: Trade m1326924 698,Trade in Services m1326928 780,Criminal Justice m1326993 1014,Treasury m1327009 1045,Injury m1327524 1428
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Law and Development,Private Sector Development,Macroeconomics and Economic Growth
no_of_pages: 50
author_keys: 0: author_key: 715608
model_extractions: WPS4560 Policy ReseaRch WoRking PaPeR 4560 Trade Remedies and Non-Market Economies: Economic Implications of the First US Countervailing Duty Case on China _Longyue Zhao Yan Wang_ The World Bank World Bank Institute Poverty Reduction & Economic Management Division March 2008
Policy ReseaRch WoRking PaPeR 4560

# **Abstract**

In 2007, the United States Department of Commerce altered a 23-year old policy of not applying the countervailing duty law to non-market economies, and initiated eight countervailing and antidumping duty investigations on Chinese imports. The change brings heated debate on trade remedy policies and issues of non-market economies. This study focuses on the first countervailing duty case on imported coated free sheet paper from China and analyzes the implications of this test case for United States-China bilateral trade, and industrial policies in transitioning market economies. The paper also provides a brief review of the economics of subsidies, World Trade Organization rules on subsides and countervailing measures, and United States countervailing duty laws applied to non-market economies. While recently acceded countries should review their domestic development policies from the perspective of economic efficiency and comply with the World Trade Organization rules, it is also important to further clarify the issues of non-market economies under the multilateral trading system, and pay keen attention to the rules negotiations in the current World Trade Organization Doha Development Round.

This paper—a product of the Poverty Reduction & Economic Management Division, World Bank Institute—is part of a larger effort in the department to synthesize and develop the most up-to-date materials on trade policy and WTO related issues for training and capacity building. Policy Research Working Papers are also posted on the Web at http://econ. worldbank.org. The author may be contacted at ywang2@worldbank.org.

_The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent._ Produced by the Research Support Team
# **TRADE REMEDIES AND NON-MARKET ECONOMIES: ECONOMIC IMPLICATIONS OF THE FIRST US COUNTERVAILING DUTY CASE ON CHINA**

Longyue Zhao and Yan Wang* _______

*Consultant and Senior E conomist, World Bank, r espectively. This paper – a product o f the Poverty Reduction and Economic Management Division, World Bank Institute – is part of a larger effort in the institute to develop and synthesize materials for capacity building on trade policy and WTO.   The authors w ish to th ank Roumeen Islam and Gianni Zanini for encouragement, and Will Martin, Bert Hofman and Louis Kuijs, John Jackson (Georgetown U) and Zhi Wang (US ITC) and participan ts of a meeting at the Ministry of Commerce, August 16 2007, for comments and suggestions; Bintao Wa ng for research assistance.

The views expressed here are entirely those of the authors, they do not represent the views of the World Bank.
TRADE REMEDIES AND NON-MARKET ECONOMIES: ECONOMIC IMPLICATIONS OF THE FIRST US CVD CASE ON CHINA

# **Table of Content**

- I. Introduction

- II. Subsidies and CVD under the WTO Agreement

- A. Definition of a Subsidy and Specificity

- B.  Classification of Subsidies

III. The Economics of Subsidies and Countervailing Duties

- A. Economics of Subsidies

- B. Rationales for Countervailing Duties

- IV. The NME Issues under the GATT/WTO System

- A. Non-Market Economy Status

- B. Criteria of Market Economy

- V. The US Trade Remedy Laws with respect to NMEs

- A. Anti-Dumping (AD) Law and NMEs

- B. Countervailing Duty (CVD) Law and NMEs

- VI. The First US CVD Case on China

- A. CFSP Case Review: A Chronological Description

- B. Subsidies Existence and Calculation

- C. Implications for China and Other NMEs

VII. Policy Implications: A Preliminary Discussion VIII. Conclusion References Tables Table 1. Global AD and CVD initiations (1995-2006) Table 2. US AD and CVD investigations on China’s Imports (by October 20, 2007) Table 3. Classification of subsidies in the WTO SCM Agreement Table 4 Comparison of legal criteria for market economy treatment in four countries Table 5. The U. S. statutory timetables for CVD investigation Table 6. CVD and AD duties on CFSP imported from China Table 7. Subsidies, as defined by the US Department of Commerce Table 8. Adverse Facts Available Subsidy Rate for Chengming Figures Figure 1. Partial equilibrium model of an export subsidy Figure 2. Partial equilibrium model of a production subsidy with trade Appendix Appendix 1. Top ten countries cited in US AD cases, fiscal years 1980-2005, cumulative Appendix 2. Global AD initiations and initiations against China (1995-2006) Appendix 3. Percentage of total initiations targeting to China (1995-2006) 2
TRADE REMEDIES AND NON-MARKET ECONOMIES: ECONOMIC IMPLICATIONS OF THE FIRST US CVD CASE ON CHINA

# **I. Introduction**

In 2007, the United States Departm ent of Commerce (USDOC) altered a long standing policy of not applying the countervaili ng duty (CVD) law to non-market econom ies (NMEs), and initiated eight countervaili ng and antidum ping duty investigations on Chinese imports. The change brings heated debate on trade re medy policies and NME issues.

Trade remedies mainly include antidumping, countervailing, and safeguards. The World Trade Organization (WTO) permits certain responses from importing nations which can prove that they suffered material injury due to unfair trade practices. So far, antidumping is the m ost popular trade rem edy measure in the worldwide trade disputes. Countervailing duties are less common than antidumping measures. From January 1, 1995 to Decem ber 31, 2006, a total of 3048 antidum ping and 19 1 countervailing initiations were notified to the WTO by reporting members (See Table 1).

The United States did not apply CVD to China until recently as China has been classified as a “non-market economy” since 1981.<sup>1</sup> This policy rests on two principles advanced in 1984 and confirm ed by a federal appeals court. 2 On Novem ber 21, 2006, the US Department of Commerce announced its decision to initiate an antidum ping and countervailing duty investigation on imports of coated free sheet paper from China. This decision changed the long standing precedent that the “non-market economies” could not be subject to the U.S. CVD investigations, on the basis that the extent of such subsidies cannot be accurately identified or measured.

In the case of coated free sheet p aper, the USDOC has found several coun tervailing subsidies provided by the Chinese governm ent, but no injury to the U S industry was found by the International Trade Comm ission (USITC). Thus the first case was concluded in November 2007 without CVD orde r. Nonetheless, th e change in USDOC policy has opened the gate for m ore CVD cases on China. By the end of 2007, eight AD and CVD investigations against Chinese im ported goods have been filed and m ore cases are expected (Table 2).

Today, policymakers from developing countries argue that antidum ping measures have been increasingly used as preferred means by which industries in industrial countries seek protection from their governments. Countervailing measures are a matter of even greater concern as they can be m ore easily abused due to am biguous rules. Developing and

> 1 From January 1, 1995 to December 31, 2006, the United States has initiated 373 antidumping and 75 countervailing cases (reported to the WTO), of which there are 64 AD initiations against China.  The Website of the WTO, visited on June 15, 2007.

> 2 GAO, _US-China Trade: Commerce Faces Practical and Legal Challenges in Applying Countervailing Duties_ . GAO-05-474, Report to Congressional Committees, Washington, D.C.: June, 2005.

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administering disciplines on the use of subsid ies seems to be one of the m ost difficult works of international econom ic policy and rule making. As a m atter of fact, both AD and CVD m easures are extrem ely costly and ineffective as shown in the follo wing sections.

The change of the U.S. CVD policy has broa d trade po licy implications for China, Vietnam, and other NME countries. Several technical issues may be of great concerns by developing countries: How to distinguish between legitim ate governmental industrial policies and distortion trade subsidies in a developing and transition econom y? Are American trade rem edy policies consiste nt with the W TO Agreements and its commitments? What are implications of the United States changing its policy of not applying CVD laws to NME countries? How to clarify the rules on antidumping, countervailing, and NME issues in the WTO negotiations?

This study intends to shed light on the a bovementioned questions by providing a revie w of the economics of subsidies, WTO principles on subsidies and countervailing measures, and US antidum ping and countervailing duty laws and criteria for subsidies in nonmarket economies. The paper will focus on th e first completed CVD case on coated free sheet paper from China; analyze the implications of this unprecedented case for trade and industrial policy implementations in China and other transition economies.

The rest of the paper is organized as follows . The section II gives a brief overview of the definition and classification of subsidie s under the W TO Agreement on Subsidies and Countervailing Measures (SCM). The econom ic impact of subsidies and countervailing duties is discussed in section III. In section IV we trace th e evolution of NME issues under the GATT/WTO system, and compare the different criteria for a market economy between the U.S. and EU. Section V discusses how the U.S. trade remedy laws treat nonmarket economies. Section VI presents an analysis on the first U.S. CVD and AD investigations on the Chinese imported CFSP, and discusses the main controversial issues and implications for China’s public policies. We also provide a preliminary assessment of China’s related subsidies, and discuss va rious challenges facing China, Vietn am and other NME countries in this section. It is our view while acceding countries should revise their domestic development policies in the pe rspective of econom ic efficiency, social welfare, and comply with the WTO rules, it is also important to further clarify the NME issues under the WTO system, and pay keen attention to the rules negotiations on the use of trade remedy measures in the current WTO Doha Round.

# **II. Subsidies and CVD under the WTO Agreement**

Based on the GATT 1979 Tokyo Round Subsidies Code, the W TO Agreement on Subsidies and Countervailing Measures (SCM ) has further strengthened disciplines on the use of subsidies and countervailing measures by the WTO Members. This section will give a brief overview of the definition and classification of subsidies under the WTO SCM Agreement.

4
The WTO SCM Agreement improves on the Tokyo Round Code by: (1) defining certain key terms, such as “subsidy” and “serious prejudice”; (2) prohibiting export subsidies and subsidies contingent on the use of domestic instead of imported goods, including _de facto_ export subsidies that are tied to exports or e xport earnings in practice though not in law; (3) creating a special presumption of serious prejudice for certain egregious subsidies; (4) defining and significantly strengthening th e procedures for showing when serious prejudice exists in im porting markets; (5) establishing a category of governm ent assistance that will be non-actionable and non-countervailable only when strict conditions and criteria are satisf ied; (6) requiring all developing countries, other than th e least developed, to phase-ou t export su bsidies and import substitution subsidies, and to accelerate the phase-out of export subsidies in situations where a developing country has achieved global export competitiveness in a p articular product sector; and (7) app lying the rapid, effective WTO dispute settlement mechanism.

# **A. Definition of a Subsidy and Specificity**

The SCM Agreement begins by defining a subsidy in Article 1. A subsidy requires two elements: (1) “a financial contribution” by a government or any public body within the territory of a Mem ber; and (2 ) consequent conferral of “a benefit.” In order to be actionable either under W TO dispute settlement procedures or in a dom estic countervailing duty (CVD) proceeding, a subsidy also m ust be “specific” in accordance with the SCM provisions of Article 2.

**Financial Contribution** : SCM Article 1 spe cifies five categories of practices that constitute a financial contribution: (1) a direct transfer of funds ( _e.g._ , grants, loans, and equity infusions) or potential direct transfers of funds or liabilities ( _e.g._ , loan guarantees); (2) government revenue othe rwise due that is fore gone or not collected ( _e.g._ , fiscal incentives such as tax credits); (3) governm ent provision of goods or services (other than general infrastructure) or purchase of goods ; (4) governm ent payments to a funding mechanism or entrustm ent of or direction to a private body to carry out a function identified in (1) to (3) above ( _i.e._ , delegating a function normally vested in government); and (5) income or price support which operates di rectly or indirectly to increase exports of any product from , or to reduce imports of any product into, the territory of a WTO member ( _see_ Article XVI:1 of GATT 1994).

**Benefit** : While the SCM Artic le 1 identifies the practice s that cons titute a “f inancial contribution,” it does not define “benefit” or set out criteria for measurement of whether a benefit is conferred, or its amount.  The SCM Article 14 sets guidelines for methods used to calculate benefit. Thes e guidelines follow the benef it-to-the-recipient methodology used in U.S. CVD proceedings. Subsidies are generally v alued as th e benefit to the recipient rather than the cost to the government.<sup>3</sup>

**Specificity** : The SCM Article 2 provides that to be actionable a subsidy must be specific to “certain enterp rises” ( _i.e._ , to an enterprise or industry or group of enterprises or

> 3 WTO, “Canada-Measures Affecting the Export of Civilian Aircraft.” WT/DS70AB/R, Appellate Body Report adopted by the DSB on August 20, 1999.

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industries) within the jurisdiction of the granting authority. Government assistance that is both generally available and widely and even ly distributed throughout the jurisdiction of the subsidizing authority is not an actionable subsidy. Howe ver, Article 2.1 makes clear that a subsidy is specific not only when th e subsidy is limited to certain enterprises by law _(de jure)_ but also where, desp ite the exis tence of neutral and ob jective eligibility criteria, the subsidy is provided in fact _(de facto)_ only to certain enterprises. U nder Article 2.3 all expo rt subsidies and import substitution subsidies within the m eaning of Article 3 of the SCM Agreement are automatically deemed to be specific.

However, there are some argum ents about th e “jurisdiction of th e granting authority.” The United States argues that Article 2.2 is sim ilar to the US CVD practice, w hich recognizes that subsidies gran ted by a state or province on a generally available basis within a s tate or p rovince ( _i.e._ , not limited to certa in enterprises within a s tate or province) are not specific, and therefore are not actionable. However, central government subsidies limited to a region (including a province or state) are specific, even if generally available throughout that region. The EU opposed this interpretation.

# **B. Classification of Subsidies**

The SCM Agreem ent establishes a three-cl ass framework for the categorization of subsidies and subsidy remedies: (1) prohibited subsidies; (2 ) actionable subsidies, which may be c hallenged in W TO dispute set tlement proceedings and dom estically countervailed if they cause adverse trade effects; and (3 ) non-actionable subsidies. A brief summary of subsidies is listed in Table 3.

**Prohibited Subsidies.** Prohibited subsidies are also term ed as red subsidies. The SCM Article 3 lis ts two types of subsidies that are prohibited under all circum stances. (1) Export subsidies: subsidies contingent, in law or in fact, whether so lely or as one of several other conditions, on export perform ance; and (2) Import substitution subsidies: subsidies contingent, whether so lely or as one of several other conditions, on the use of domestic rather than imported goods.

An illustrative list of export subsid ies is set out in Annex I to the SCM Agreem ent. To challenge such a subsidy success fully in WTO dispute settlem ent proceedings, a complaining country need only prove that th e subsidy exists; there is no need to demonstrate that the subsidy has had adverse trade effects. If a pa nel or the Appellate Body finds that a government is maintaining a prohibited subsidy, the Dispute Settlement Body of the WTO (DSB) must authorize countermeasures if the subsidy is not withdrawn expeditiously. The US CVD action under dom estic law also m ay be taken against prohibited subsidies, but an affirmative injury determination still must be made.

**Non-Actionable Subsidies.** The SCM Article 8.2 sets out the criteria and conditions under which three types of subsidies m ay be non-actionable or green light subsidies: (1) Research and developm ent: government assistance for industrial research and precompetitive development activities; (2) Disadvantag ed regional development: government assistance to disadvantaged re gions; and (3) Envir onmental adaptation:

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government assistance to adapt existing pl ant and equipm ent to new environmental requirements.

Non-actionable subsidies must meet some strict conditions and criteria. The SCM Article 8 establishes procedures designed to ensu re that governments do not abuse the lim ited right to use these types of subsidies. In addition, Article 9 provides a rem edy that is available if a non-actionable subsidy causes se rious adverse effects to the industry of another WTO member. Finally, under Article 31, Articles 8 and 9 automatically expired on December 31, 199 9, and not yet ren ewed due to the delay o f the new round negotiation.

**Actionable Subsidies.** The SCM Agreement refers to two kinds of actionable subsidies against which action can be taken in the W TO or in dom estic CVD proceedings if adverse effects are identified. They are also termed as dark a mber subsidies and yellow subsidies based on their extent on distorting trade. Article 5 se ts out three types of adverse effects: (1) injury to the dom estic industry of another W TO Member; (2) nullification or im pairment of benefits accruing directly or indir ectly to othe r WTO Members under GATT 1994 in particular the be nefits of concessions bound under article II of GATT 1994; and (3) serious prejudice to the interests of another Member.

_Dark Amber Subsidies_ : The first type actionable subsidy is listed in Article 6.1. Those are presumed to cause serious prejudice. Where serious prejudice is presumed, the burden is placed on the subsidizing government to demonstrate that serious prejudice did not result from the subsidiz ation in question. The f our "dark am ber" subsidies are: (1) total subsidization of a prod uct exceeding five percent _ad valorem_ , which is calculated in accordance with Annex IV on a cost-to -the-government basis; (2) s ubsidies to cover operating losses sustained by an industry; (3) subsidies to cover operating losses sustained by an enterprise other than one-time measures that are non-recurrent and cannot be repeated for that enterprise an d that are given m erely to provide time for the development of long-term solutions and to av oid acute social problem s; and (4) direct forgiveness of government-held debt. Under Article 31, A rticle 6.1 also autom atically expired on December 31, 1999, but not y et renewed due to the delay of the new ro und negotiation.

_Yellow Light Subsidies:_ The second type is yellow li ght subsidies, which are any subsidies causing injuries that ar e not otherwise dealt with by th e Agreement as prohibited or non-actionable subsidies. Under the Agreement, a determination of serious prejudice must be based on m easurable, verifiable data. Serious prejudice arises where the effect of a subsidy is m anifested in: import displacement or impediment in either the subsidizing-country or third-country m arkets; significant price unde rcutting, significant price suppression, price depressi on or lost sales in any m arket; or an increase in world market share. Articles 6.4 through 6.6 provide more detailed guidance on the criteria set out in Article 6.3.

The SCM Article 7 and Annex V establish e xpeditious and effective procedures for resolving disputes regarding “dark amber” a nd “yellow light” subsidies. The procedures 7
are virtually identical to those for other WTO dispute s ettlement proceedings. Onc e a member requests consultations regarding such a subsidy, the Agreem ent allots 180 days for completion of the panel proceedings and the issuance of a decisio n by the Dispute Settlement Body (DSB). The Agreem ent provides an additional 60 days for appeals of panel findings. The losing party cannot block adoption of an adverse panel or Appellate Body (AB) report and the DSB must authorize countermeasures where a signatory has not either withdrawn a subsidy found to be ca using serious prejudice or eliminated its adverse effects within six months.

# **III. The Economics of Subsidies and Countervailing Duties**

While the WTO SCM Agreement strengthens disciplines on trade distorting subsidies, there are still disputes on governm ent subsidies and countervailin g duties. The m ost difficulty issues still related to the probl em of distinguishing between “legitim ate” government activities and trade-distorting subsidies. The governm ents of the m ajor developed trading nations continue to m aintain divergent views o n the role of government involvement with industry, and ev en more disagreement is found when the policies of developing countries are considered. 4 This section review s the econom ic impact of subsidies and countervailing duties on trade and welfare, and what countervailing duties are appropriate.

# **A. Economics of Subsidies**

Three types of economic assets are crucia l for the long run grow th of an economy: physical capital, human capital, and natural capital. Physical capital has traditionally been the focus of attention since it directly contributes to growth, which in turn affects s ocial welfare. However, human capital, which includes knowledge accumulation, technological innovation, and health, along with natural capita l directly affect social welfare and growth. The three assets are subject to market failures in varying degrees, som e more, some less. Ideally, gov ernment should m itigate the effects of m arket imperfection by regulation and providing incentives to invest in assets that are under-provided especially public or semi-public goods. The optim al government policy would be im plemented to ensure that the social returns to the three assets a re equal.<sup>5</sup> However, this is not necessarily the case in reality.

In reality, we often see governm ent policies including subsidies that have caused overinvestment in certain sectors, and under-investment in sectors affected by market failures, such as education and health, rural infrastructure; and ove r-exploitation of the n atural resources. Trade subsidy is considered one of the subsidies that are distortionary, leading to inefficiencies and welfare loss. Now let’s review the details.

There are two types of subsid ies in the international trad e parlance: the export subsidy and domestic or production subsidy. The expor t subsidy is paid to an industry only on

> 4 Jackson, H. John, William J. Davey, and Alan O. Sykes, Jr. _Legal Problems of International Economic Relations: Cases, Materials and Text_ , Fourth Edition, West Group, St. Paul, Minnesota, 2002.

> 5 This framework is based on a World Bank Institute study on _The Quality of Growth_ , World Bank 2000.

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products that are exported. The dom estic subsidy is granted to an industry on all of its production of a product, regardless of whether that products are exported. There is a big literature to show the impacts of subsidies on trade and welf are. Some subsidies can correct market failures and enhance econom ic welfare; other subsidies can distort resource allocation and reduce economic welfare.<sup>6</sup>

**Export Subsidy.** Export subsidies take on m any forms in the real world. These include tax rebates conditioned on export (excluding VAT rebate), subsidized loans to exporters or foreign purchasers, insurance guarantees, gu arantees against losses, and direct g rants or subsidized loans.<sup>7</sup> The econom ic effects of export subsidies are symmetrical with those of import tariffs. Just as tariffs cau se import-competing sector to expand, export subsidies lead to an expansion in the exportable production.

We now assume that there are two large countries trading a particular product in a partial equilibrium model. The expor ting country A is assum ed large enough to influence the world price in this particular product. Initially, consumption and production in country A 0 0 0 0 are qd , qs , and consumption and production in country B are q* d , q*s , respectively. After the exporting co untry introduces a per-unit export subsidy, it will lead to an increase in the supply of export, which redu ces the world price of the good and the price in the importing country from Pw0 to Pw1, and raise the price of the good in the exporting 1 0 country Pd relative to the free trade price Pw , as more products are exported rather than sold domestically for consumption. Consumers in exporting countries lose. See Figure 1.

Figure 1. Partial equilibrium model of an export subsidy <!-- Start of picture text --> Country A (exporter) World Country B (importer)<br>ES 0 S*<br>Pd1 S σ<br>Pw0 ES 1<br>Pw1<br>D*<br>ED 1 ED0<br>D<br>qd1 qd0 qs0 qs1 X 0 X 1 q * s1 q*s0 q * d0 q * d1<br><!-- End of picture text --> Source: Kathy Baylis, 2005.

> 6 Alan O. Sykes. 1989. “Countervailing Duty Law: An Economic Perspective.” _Columbia Law Review_ , V. 89 No. 2.

> 7 Husted, Seven, and Michael Melvin. 2004. _International Economics_ , sixth edition. Pearson AddisonWesley.  VAT rebate is considered trade-neutral, see Grossman 1980.

9
In the importing country, the consumer surplus increases but producer surplus decreases, the total welfare increased as the gain in c onsumer surplus is greater than the los s in producer surplus. However, in the exporting country, economic waste is created because the cost of increasing o utput to ex pand export exceeds th e revenue earned from the export. (If this is not the case, manufacturers would prod uce more even without the subsidy.) Consumers /households lose signifi cantly because (a) the consum er surplus declined, and (b) consumers have to bear the b urden of additional taxes that are required to finance the export subsidy. In the cas e where the country does not have the comparative advantage in a product which, for e xample, is resource-intensive, this will lead to f urther inefficiency due to m isallocation of resources and depletion of na tural resources.

In the cases where countries are relatively small and cannot influence world prices, the consequence would be different. Exporters are price takers in this case. Providing export subsidies will not influence the price in the world market, but, still, the consumer surplus increases but producer surplus has no change in im porting country; consum ers in exporting countries would have to bear the fiscal burden of export subsidies.

**Production Subsidies.** Now assume the exporting country provides a per-unit production subsidy on a tradable good. We assume that two large countries trade a particular product in a partial equilibrium model. The expor ting country is assum ed large enough to influence the world price in this particular product. Initially, consumption and production 0 0 0 0 in country A are q d , qs , and consumption and production in country B are q* d , q*s , respectively. After the expor ting country introduced a pe r-unit production subsidy, the domestic supply curve will shift down to the right from S to S’ by the amount of subsidy, reflecting the lower costs the industry now faces. This shif t increases the export and drives down the prices in both expor ting and importing countries from P w0 to P w1.  See Figure 2.

Figure 2. Partial equilibrium model of a production subsidy with trade <!-- Start of picture text --> Country A (exporter) World Country B (importer)<br>WS 0 S*<br>S 0<br>0 WS 1<br>Pw S<br>Pw1 S 1<br>D*<br>WD0<br>D<br>qd0 qd1 qs0 qs1 X 0 X 1 q*s1 q*s0 q*d0 q*d1<br><!-- End of picture text --> Source: Kathy Baylis, 2005.

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In the exporting country, consum ers and producers are both better-off. Howe ver, taxpayers in the country must bear the burden which is equal to the per-unit subsidy times the total production, an am ount that is grea ter than the summation of consum ers and producers surplus. The exporting country as a whole loses in this model. The effect of the production subsidy on the im porting country is the sam e as that of the export subsidy, the consum er surplus increases and the producer su rplus decreases, but the total welfare of th e country as a whole increases as the gain in consum er surplus is bigger than the loss in producer surplus in this case.

# **B. Rationales for Countervailing Duties**

As shown above, the exporting country usuall y loses in welfare when subsidizing the production of a good, while the importing count ry gains. W hy should an im porting country use countervailing dutie s to stop the gains com ing from subsidized imports? In fact, a considerable body of economic literatu re suggests that such a response is unwise. The importing country-or at least its consum ers-should be grateful, and send a “Thank8 you note” to the subsidizing country. However, from a global perspective, som e subsidies may distort international producti on and trading patter ns, leading to the misallocation of resources and a reduction in world welfare.<sup>9</sup> This is the most important economic rationale for banning or regulating distortion subsidies. But, can countervailing duties help to achieve that goal?

Most of the rationales for importing nations to apply countervailing duties originate from competing producer groups. One of the tradit ional arguments stresses the adjustm ent costs for dom estic industry to go out of bus iness due to the subs idized imports of a foreign country. Another possible argum ent notes that subsidies can be used f or trade policy strategy, or for “predatory purposes.” Some rationales on CVD are unrelated to economic welfare but are quite relevant to national security, employment, social stability, or political considerations. Finally, ther e may be some policie s with r egard to subsidization and CVD that ar e connected to national governm ent’s general approach to its economic system.<sup>10</sup> Countervailing duties are not effective in pr eventing various distortionary effects of subsidies. Subsidization may have at least three effects, and countervailing duties can not provide a remedy for all. For example, subsidization in country A allows A to expand its export into importing country B. In such a case, country B m ay wish to respond with countervailing duties. Second, subsidization of country A may enhance the expansion of

> 8 Jackson, H. John. The World Trading System: Law and Policy of International Economic Relations. Second Edition, the MIT Press, Cambridge, Massachusetts, 1997.

> 9 Alan Deardorff and Robert M. Stern, “Current Issues in Trade Policy: An Overview,” in U.S. Trade Policies in a Changing World Economy, Robert M. Stern, ed. Cambridge, MA: MIT Press, 1987. Cited from John H. Jackson, Ibid.

> 10 Ibid.

11
its export to a third country C, where A com petes with similar products that are exported from B. In such a case, country B does not have easy recourse to a response. A third effect is that the presence of dom estic subsidies in a product m ay restrain the import of the same product into the subsidizing country. The subsidy in this situation has becom e an import barrier with the eff ect similar to a tariff. Country B may need to respond with other measures for such subsidies.

# **IV. The NME Issues under the GATT/WTO System**

# **A. Non-market Economy Status**

NME issues can be traced back as early as the bilateral trade agreement in 1935 between the United States and the Sovi et Union. It provided that in exchange for m ost-favorednation treatment the Soviet Union would accept an obligation to import products from the United States worth at least $30 m illion a year. In the post-war period, while addressing the non-market phenomenon, both official docum ents and economic texts employed the term “State Trade Countries.” This was due to the overwhelm ing role that the State played in the foreign trade of a group of countries, predominantly in Eastern Europe.<sup>11</sup> GATT was designed by market economies and for market economies. The market-based nature of the GATT stems from the drafting history of the so-called Havana Charter, the legal foundation of the abortive Internationa l Trade Organization (IT O), and from the early years of GATT operation. 12 As has been extensively discussed elsewhere, selfinterested policies such as im port quantitative restrictions, prohibitive tariffs, the manipulation of currency exchange rates an d frequent changes in import regulation pursued by many governments in the 1930s had dr amatic consequences for international trade and the world economy in general.<sup>13</sup> In addition during the Second World W ar, the necessity of strictly controlling im ports and exports resulted in an expansion of State trading into countries that normally based their economy on the private sector. Driven by those developments, at the first session of the United Nations Econom ic and Social Council (ECOSOC) in 1946, the United States put forward a “Suggested Charter for an International Trade Organization” that was designed to deal with the factors im peding international trade, including State trading. The “Suggested Charter” served as the basis for negotiations in the Preparatory Comm ittee for the ITO that, by 1948, finally led to drafting of the Havana Charter.<sup>14</sup> The “Suggested Charter” initially had three articles in the section on State trading. One of them was entitled “Expansion of Trade by Co mplete State Monopolies of Import Trade.” The article proposed a methodology for dealing with countries possessing a State f oreign trade monopoly similar to that which had been included in the bila teral trade agreement

> 11 Alexander Polouektov, _“The Non-Market Economy” Issue in International Trade: In the Context of WTO Accessions,_ United Nations Conference on Trade and Development, UNCTAD/DITC/TNCD/MISC.20, October 9, 2002.

> 12 John H. Jackson, _World Trade and the Law of GATT_ , Indianapolis: Bobbs-Merrill, 1969. 13 Ibid.

> 14 Polouektov, supra note 11.

12
between the United States and the Soviet Union in 1935. It provided that a State-trading country member should negotiate with other member countries on “an arrangement under which, in conjunction with the granting of tariff concessions by such other Members, and in consideration of the other benefits of this Chapter, it shall undertake to im port in the aggregate over a period products of the other Me mbers valued at not less than any amount to be agreed upon.”<sup>15</sup> Although the Soviet Union voted for the establishm ent of the ITO at the ECOSOC session, it repeatedly declined, for political reasons, to participate in deliberations of the Preparatory Committee, and did not show any interest in the parallel negotiations that led to the formation of GATT. Eventually, the provision was dropped from the final text of the General Agreement. In the course of the Preparatory Committee deliberations it was also considered appropriate to reduce Stat e-trading provisions c oncerning that “m ixed economies,” to a large extent, were a passing phenomenon of the post-war period. At last, the General Agreem ent preserved only one of the proposed articles, which became Article XVII obliga ting State-trading enterprises to abide b y the gener al principles of non-discriminatory treatment.<sup>16</sup> Following progressive liberalization of foreign trade relations and a related dilution of an absolute State monopoly on foreign trade tran sactions, the emphasis of economists and politicians shifted to another feature of th e non-market economic systems, namely the central planning system. Accordingly, there em erged the term, “centrally planned economy”, which has superseded the statetrading economy. In the United States Customs Regulation of 1973, the term “controlled-economy country” first appeared. At the same time, on the other side of the ideological world, the term “socialist country” was preferred. With the start of profound market reforms in al most all centrally planned economies in the late 1980s and early 1990s, this phen omenon became universally known as “transition to a m arket economy.” However, along with the rather definite notion of “transition countries” the term “non-market economies” has been used, which appears to have a philosophical connotation rather than an economic or legal one.<sup>17</sup> Within the WTO fra mework, the NME issue has its roots in paragraph 1 of the _AD Article VI_ of GATT 1994. “It is recogni zed that, in the case of imports from a country which has a com plete or substantially co mplete monopoly of its trade and where all domestic prices are fixed by the State, special d ifficulties may exist in determining price comparability for the purposes of paragraph 1, and in such cases im porting contracting parties may find it necessary to take into account the po ssibility that a strict com parison with domestic prices in such a country m ay not always be appropriate.”<sup>18</sup> Through this provision, WTO Members explicitly recognize that non-mark et economy countries m ay need to be treated differently than m arket economies in antidum ping cases. This provision dates from the 1954-55 Review Session of the GATT and has its origins in the

> 15 “Report of the First Session of the Preparatory Committee of the United Nations Conference on Trade and Employment”, London, 1946, p. 59.

> 16 For a more detailed discussion on origins of GATT, see Jackson, supra note 12.

> 17 Polouektov, supra note 11.

> 18 GATT 1994.

13
consideration of issues rela ting to the W orking Party on the Accession of Poland. The Agreement on Im plementation of Article VI of GATT 1994 has carried through the provision to the current Antidum ping Agreement. The provision allows discriminatory treatment in the case of countries that ha ve a com plete or substantially complete government monopoly over international trade and where all domestic prices are fixed by the state.

Authorities administering antidumping legislation and investigations have generally taken advantage of this provision to reject inform ation on costs and prices provided by those countries considered to be non-m arket economies. As an alternative to the use of such price and cost information, they make their decision based on cost and price inform ation from third party surrogate countries with market economic systems. In each case, the market economy country chosen is to be at a level of developm ent comparable to that of the non-market economy that is subject to th e antidumping investigation. In some cases, these investigating authorities have deve loped and used synthetic cost and price information.<sup>19</sup>

# **B. Criteria of Market Economy**

“GATT (General Agreement on Tariffs and Trade) was designed by market econom ies for market economies.”<sup>20</sup> However, there is not a standa rd criterion for the m arket vs. non-market economy distinction. A comparison of legal criteria for m arket economy treatment in US, EU, Mexico and Malaysia is listed in table 4.

**UNCTAD Criteria.** In the Glossary of Customs Terms of the United Nations Conference on Trade and Development (UNCTAD), UN CTAD defines a market economy and nonmarket economy in the following ways:<sup>21</sup>

A national economy of a country is a m arket economy that relies heavily upon market forces to determine levels of production, consumption, inve stment and savings without government intervention.<sup>22</sup> A national econom y is a non-m arket economy in which the government seeks to determine economic activity largely through a mechanism of central planning, as in the former Soviet Union, in contrast to a market economy, which depends heavily upon market forces to allocate productive resources. In a “non-market” economy, production targets, prices, costs, invest ment allocations, raw m aterials, labor, international trade and most other economic aggregates are manipulated within a national economic plan drawn up by a central planning au thority; hence, the public sector m akes the major decisions affecting demand and supply within the national economy.<sup>23</sup>

> 19 John H. Jackson, William J. Davey, and Alan O. Sykes, p.721-722, supra note 4.

> 20  Polouektov, supra note 11.

> 21 UNCTAD’s Glossary of Customs Terms can be found in the Automated Systems for Customs Data (ASYCUDA). The ASYCUDA is developed by UNCTAD, and takes into account the international codes and standards developed by ISO (International Organization for Standardization), WCO (World Customs Organization) and the United Nations. See www.asycuda.org in details.

> 22 Ibid, see ‘market economy’.

> 23 Ibid, see ‘non-market economy’.

14
UNCTAD has also used the State T rading Nations and Group D to differentiate a nonmarket economy from a m arket economy. Prior to their 1989-199 1 conversions to market-oriented policies, Group D consisted of the socialist countries of Eastern Europe participating in UNCTAD, excluding Rom ania and Yugoslavia (which were considered members of the Group of 77) and Albania (which did not activ ely participate in UNCTAD and other elements of the United Nations system). Group D countries showed a particular interest in the division of the UNCTAD Secret ariat concerned with “Trade between Countries with Different Econom ic Systems.”<sup>24</sup> However, today few countries have an absolute central planning system, and there are a number of ways to measure the market orientation of a transition economy.

**European Union.** In the Council Regulation (EC) No 905/98 of 27 April 1998,<sup>25</sup> the EU allows Chinese respondent enterprises to appl y for the status of m arket economy in antidumping investigations and stipulates five crit eria for determining the status of a market economy, namely:

(1) Decisions of fir ms regarding pri ces, costs and inputs, including for example, raw m aterials, cost of technology and labor, output, sales and investment, are made in response to market signals reflecting supply and demand, and without significant State interference in this regard, and costs of major inputs substantially reflect market values; (2) Firm s have one clear set of basic accounting records that are independently audited in line with international accounting standards and are applied for all purposes; (3) The production costs and financial si tuation of firms are not subject to significant distortions carried over from the former non-market economy system, in particular in relation to depreciation of assets, other write-offs, barter trade and payment via compensation of debts; (4) The firm s concerned are subject to bankruptcy and property laws which guarantee legal certainty and stability f or the operation of firms; and (5) Exchange rate conversions are carried out at the market rate.

**The United States.** From the adoption of the Antidum ping ACT of 1921 until the passage of the Trade Act of 1974, the appli cation of AD law to non- market economies was devised and im plemented exclusively through administrative agency action. In the 1960s, the United States Department of Treasury developed and used what was known as the “surrogate country” approach fo r applying AD law to non-m arket economies.<sup>26</sup> This approach was adopted and codified by C ongress in the Trade Act of 1974. Congress adopted also Treasury’s another m ethodology, known a s the “factors of production”

> 24 Ibid, see Group D.

> 25  OJL 128, 30.04.1998, p.18. Council Regulation (EC) No 905/98 of 27 April 1998, amending Regulation (EC) No 384/96 on protection against dumped imports from countries not members of the European Community.

> 26 At that time, the US Treasury Department was the agency with responsibility over domestic trade remedy laws until the passage of the Trade Agreement Act of 1979, which transferred administrative authority from Treasury to the Department of Commerce.

15
approach, in the Trade Agreement Act of 1979 as an alternative to be used in NME cases where there was no available surrogate country.<sup>27</sup> In the Omnibus Trade and Competitiveness Act of 1988 (OTCA), US Congress enacted numerous reforms to the AD laws, starting with a definition of a NME, as well as a set of standards that the DOC was to take into consideration when determ ining whether a specific country is a non-m arket economy. According to the OTCA, a non-m arket economy is a country that “doe s not operate on m arket principles of cost or pricing structures, so that sales of merchandise in such country do not reflect the fair value of the merchandise.” The Act requires that the USDOC shall take six criteria into account when making a determination. The six criteria are the following:

- (1) The extent to which the currency of the foreign country is convertible into the currency of other countries. (2 ) The extent to which wage rates in the foreign country are determ ined by free bargaining be tween labor and management. (3) The extent to which joint ventures or other investm ents by firms of other foreign countries are permitted in the foreign country. (4) The extent of governm ent ownership or control of the m eans of production. (5) The extent of governm ent control over th e allocation of resources and over the price and output decisions of enterprises. (6) Suc h other factors as the administrating authority considers appropriate.<sup>28</sup>

In addition, the OTCA provides the USDOC with significant administrative discretion for determining when a foreign country is a non-market economy. Determinations of nonmarket economy status made by the USDOC ar e not subject to judi cial review in any antidumping investigation.<sup>29</sup> It is obvious, that the criter ia of market economy defined by the U.S. and EU are based on the factors that may affect fairness of trade in anti-dumping actions. The U.S. criteria have directly raised the issue for a country to be a market economy as a whole, while the EU mainly targets the criteria of m arket economy of an enterprise and an industry. Furthermore, these criteria form an integrated system, any one single criterion should not be applied independen tly. The European c ountries and the U.S. will not m ake their judgment just according to one criterion, but su m up the results of investigations in all aspects covered by these criteria in d etermining whether or not enterprise or the industry has reached the critical point of a market economy, so as to reach a con clusion whether the country, the industry, or the enterprise in question has achieved the status of a market economy. In an actual treatm ent of an anti-dumping case, the defending party will have to be prepared in line with the standards of the country that is initiating the anti-dumping action.

> 27 Tatelman, B. Todd. “United States’ Trade Remedy Laws and Non-market Economies: A Legal Overview,” CRS Report for Congress, Order Code RL 33976, April 23, 2007. 28 19 U.S.C. § 1677(18) (B) (2000).

> 29 Jackson, Davey, and Sykes, supra note 4.

16
However, the current lack of precisely de fined rules in the U.S. and EU leaves considerable discretion in the hands of those officials who apply the rules. As a result, they may use the rules only when appropriate to effectuate the real purpose of the rules. Their exercise of discretion will be difficult to review, however. And, of course, it presents serious problem s of potential abuse. The problem s themselves m ay be magnified, since those seeking pr otection from the officials ar e constituents of sorts of the officials, while those who will be adversely affected are foreigners.<sup>30</sup>

# **V. The U.S. Trade Remedy Laws with Respect to NMEs**

In the United States, there are two m ajor forms of dom estic trade remedy laws, antidumping law (AD) and countervailing duty law (CVD), whic h are designed to counteract foreign “unfair” trade. Antidumping laws provide relief to domestic industries that have been, or are threatened w ith, the adverse impact of imports sold in the U.S. market at prices less than the fair m arket value (LTFMV). CVD give a sim ilar kind of relief to domestic industries that have been, or are threatened with the adverse impact of imported goods that have been subsidized by a foreign governm ent or public entity. The relief provides an additional im port duty placed on the dumped or subsidized imports. Both of these rem edies are available to the imported goods from market economy countries, but until recently CVD law had not been applied to those imported goods from “non-market economies”.<sup>31</sup>

# **A. Antidumping Law and NMEs**

The antidumping regulatory fram ework is currently embodied in Subtitle B of Title VII of the Tariff Act of 1930, as added by the Trade Agreem ents Act of 1979, and subsequently amended. Prior to the Tokyo Round U.S. AD law was not entirely consistent with GATT Article VI, principall y because it required do mestic producers to show only injury, not m aterial injury.<sup>32</sup> It also granted a great deal of discretion to the administrators of the law, the Department of Treasury (DOT) and the International Trade Commission (ITC), who exercised that discreti on in a way that seldom resulted in the imposition of AD duties, which caused m any in Congress to believe that the Executive Branch did not take the enforcem ent of the AD laws seriou sly enough. Since 1980 the administration of the U.S. AD law has b een split betw een the International Trade Administration (ITA) of the U.S. D epartment of Commerce (DOC), which de termines whether dumping has occurred, and the ITC, which determines whether U.S. industry has demonstrated sufficient injury due to the dumped imports.<sup>33</sup> The Tariff Act directs the DOC to determ ine whether foreign merchandise is being sold in the United States at LTFMV. For dum ping that is a lleged from market-based

> 30 Ibid, p. 681.

> 31 Vivian C. Jones. “Trade Remedies: A Primer.” CRS Report for Congress, Order Code RL 32371, Updated June 14, 2006. Todd B. Tatelman. “United States’ Trade Remedy Laws and Non-market Economies: A Legal Overview.” CRS Report for Congress, Order Code RL 33976, April 23, 2007.

> 32 Jackson, Davey, and Sykes, supra note 4.

> 33 See 19 U.S.C. §1677(2000).

17
economies, DOC has applied a standard m ethodology for determining whether a foreign manufacturer’s goods were sold in the Unite d States at LTFMV by comparing the U.S. price of the product (identified as either the “export price” or “constructed export price”) with the “normal value” of the subject merchandise, which is typically measured as either the price at which the m erchandise is sold in the exporter’s or m anufacturer’s home market, or a “constructed price” if there are no sales of the targeted product in the home market.<sup>34</sup> The AD law is applied to NME countries in a m anner different than that applicable to market economies. It assumed that domestic prices and costs are not based on m arket factors in NME countries and are thus ina ppropriate for comparison with the producer’s prices in the United State. The DOC is inst ead statutorily authorized to employ a quite different price com parison methodology for NME im ports, which has gone through several transformations of its rules to handle this particular problem and the United States Court of International Trade (USCIT) has continuously reviewed these actions.

In the 1960s, the DOT developed and began using what was known as the “surrogate country” approach for applying A D law to NMEs. Under this approach, com parable prices and costs from similarly situated third market-bas ed economies were substituted for the NMEs to determine fair market value.<sup>35</sup> This approach was adopted and codified by Congress in the Trade Act of 1974. The ad ministration had adopted an alternative methodology, known as “factors of production,” which was used when an appropriate surrogate could not be located in 1975. The “factor of production” approach required that the amount of each factor input be taken from a market economy country selected to be at a comparable stage of econom ic development.<sup>36</sup> In 1979, Congress passed the Trade Agreements Act, which further refined the computation of fair m arket value for nonmarket economies, and transferred administrative authority from the DOT to the D OC. According to the DOC, m arket value should be determined on the basis of either (1) the home market prices or export prices of such or sim ilar items in a s urrogate market economy, or (2) the constructed value of those items in a surrogate market economy.

In 1988, the U.S. Congress again reversed AD provisions for dealing with NMEs in the Omnibus Trade and Com petitiveness Act of 1988 OTCA). 37 The OTCA enacted numerous reforms to the antidum ping laws, starting with a definition of a non- market economy and a set of s tandards for determ ining whether a specific nation is a NME country. The OTCA also provide the DOC w ith significant administrative discretion for determining when a foreign country is a non- market economy, which is not subject to judicial review in any antidumping investigation.<sup>38</sup>

> 34 19 U.S.C. §1677b(a) (2000) and 19 U.S.C. §1677b(e) (2000).

> 35 Department of Commerce, _Bicycles from Czechoslovakia_ , 25 Fed Reg. 6657 (1960), cited from Tatelman, supra note 27.

> 36 Department of Commerce, _Electric Golf Cars from Poland_ , 40 Fed Reg. 25497 (1975), cited from Tatelman, Ibid.

> 37 Luke P. Bellocchi, “The Effects of and T rends in Executive Policy and Court of In ternational Trade Decisions Concerning Antidumping and the Non-Market Economy of the People’s Republic of China,” 10, _New York International Law Review_ , Winter 1997.

> 38  19 U.S.C. §1677 (18) (C) and (D) (2000).

18
The United States first classified China as a “nonmarket economy” country in _Preliminary determination of Sales at Less than Fair Value, Greige Polyester Cotton Print Cloth from China_ in 1982,<sup>39</sup> and recently reaffirmed the determination by ITA on May 15, 2006 ( and m ore comprehensively on August 30, 2006) in the context of an investigation on certain lined paper from China.<sup>40</sup> Since 1982 the US employs a special NME methodology to calculate AD duties on pr oducts from China. This m ethodology results usually in duty rates that are signifi cantly higher than thos e applied to m arket economy countries. The United States Gove rnment Accountability Office (GAO) has found that Commerce applied duties to the same product from both China and one or more market economies on 25 occasions fr om 1985 to 2004, and AD duties on Chinese products were on average over 20 percentage points higher than those applied to m arket economies. China country-wide AD duties were over 60 points higher than com parable market economy rates.<sup>41</sup>

# **B. Countervailing Duty Law and NMEs**

The United States has h ad some form of c ountervailing duty legislation in place since 1897. It was strengthened and elaborated in the Tariff Act of 1930, se ction 303, which authorized the Treasury Department to impose duties on imported merchandise to offset any subsidies. This applied only to dutiabl e imports, but was extended to non-dutiable imports in the Trade A ct of 1974. The Trade Agreem ent Act of 1979 im plemented the Tokyo Round Subsidies Code under U.S. la w, changed the count ervailing duty law dramatically and created procedures m uch like those applicable to antidum ping cases. The authority to investigate allegations of subsidization was transferred from DOT to DOC, International Trade Administration (ITA).<sup>42</sup> The CVD laws are designed to provide relief to U.S. industries that have been, or are threatened with, the adverse impact from imported goods that have been subsidized by a foreign government or public entity. Similar to AD law, f or an industry to obtain relief, both the ITC and the DOC must make affir mative conclusions. The DOC must find that the targeted imports have been subsidized, and the ITC must find that the industry has been materially injured or threatened with material injury due to the subsidized imports. Investigations are to be subjected to tight time limits. Both ITA and IT C determinations are made appealable to the Court of Intern ational Trade (CIT), and subsequently to the Federal Circuit.<sup>43</sup>

> 39 48 Fed. Reg. 9897 (1982)

> 40 ITA, _The People’s Republic of China (PRC) Status as a Non-Market Economy (NME)_ , Memorandum, May 15, 2006, and _Antidumping Duty Investigation of Certain Lined Paper Products from the People’s Republic of China (‘China”) – China’s Status as a Non-Market Economy (“NME”)_ , Memorandum, August 30, 2006.

> 41 GAO, _US-China Trade: Eliminating Non-market Economy Methodology Would Lower Antidumping Duties for Some Chinese Companies_ . GAO-06-231, Report to Congressional Committees, Washington, D.C.: January 2006.

> 42 Jackson, H. John, William J. Davey, and Alan O. Sykes, Jr., supra note 4.

> 43 Ibid.

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There are five stages in the overall investigation process fo r countervailing duty cases, each ending with a determination by either DOC or ITC: (1) initiation of the investigation by DOC; (2) the prelim inary phase of the ITC’ s investigation; (3) the preliminary phase of DOC’s investig ation; (4) the f inal phase of DOC’s investigation; and (5) the final phase of the ITC’s in vestigation. W ith the exception of Commerce’s p reliminary determination (stage 3), a negative determination by either the DOC or the ITC results in a termination of proceedings at both agencies. The statutory deadlines relating to the five stages are listed in Table 5.<sup>44</sup> Unlike the AD law, the U.S. CVD law requires an internal market-oriented benchmark to determine whether, an d to what extent, subsidization has occurr ed. Since it has been argued that in nonmarket economies there are no such internal m arket-oriented benchmarks,<sup>45</sup> the U.S. CVD law has not been tr aditionally applied to non-m arket economies. This is largely as a result of a 1984 determination by the DOC that there is no adequate way to m easure market distortions caused by subsidies in NME countries. In order to have a clear background on this determination, we will review som e CVD petitions in the 1980s.

In September 1983, the counter vailing duty petition agains t the People’s Republic of China (PRC) was filed with the USDOC pursuant to 19 U.S.C. §1303 (1980) on behalf of the American Textile Manufacturers Institute (ATMI), the Am algamated Clothing and Textile Workers Union (ACTWU), and the In ternational Ladies’ Gar ment Workers’ Union (ILGWU). This petition represented the first time that the USDOC has been called upon to evaluate the countervailability of a lleged producer subsides in an NME country. The subsidy alleged in the petition was the PRC’s dual exchange rate system whereby one particular yen conversion rate is offered to producers of certain non-export goods and another more generous rate is offered to producers of goods keyed for export. The keyed goods in this case were textiles, apparels and related product s. After the hearings were held in Washington, D. C. in November 1983, USDOC Secretary Baldrige convinced the Textile producers to withdraw the CVD petition and promised to rein state the investigation if later requested by the industry.<sup>46</sup> In November 1983, the appellees, Georgetown Steel Corporation, Raritan River Steel Company, and Atlantic Steel Company (collectively, Georgetown Steel), and Continental Steel Corporation (Continental Steel), filed two countervail ing duty petitions with the Administration on behalf of dom estic producers of carbon steel wire rod. They alleged that carbon steel wire rod im ported into the United States from Czechoslovakia and Poland, respectively, was "subsidized" and th erefore subject to countervailing duties under section 303. The Administration instituted countervailing duty investigations based upon those complaints. After the hearing, the International Trade Administration of the

> 44 ITC, _Antidumping and Countervailing Duty Handbook_ , Twelfth Edition, April 2007. Available on website at: <u>www.usitc.gov/trade_remedy/731_ad_701_cvd/handbook.pdf.</u>

> 45 See Barshefsky, Charlene. “Non-Market Economies in Transition and The US An tidumping Law: Remarks on the Need for Reevaluation,” Boston University International Law Journal v.8 (Fall 1990). 46 “Countervailing Duties and Non -Market Economies: the Case of the People’s Republic of China”. Syracuse Journal of International Law and Commerce, v. 10 (Fall/Winter 1983), p. 405-20.

20
Department of Commerce (Adm inistration) issued final negative determinations. It held that the Czechoslovakian and Polish exports of wire rod had not received any "bounty" or "grant" under the terms of section 303, so that counterva iling duties on those items were not applicable.

The Administration concluded that, as a m atter of law, section 303 was inapplicable to non-market economies.<sup>47</sup> The Court of International Tr ade reversed, holding that the Administration's determination was contrary to law. The su bstantive issue in this case, here on appeal from the Court of Internati onal Trade, is whether the countervailing duty provisions in section 303 of the Tariff Act of 1930, as amended, _19 U.S.C. §1303_ (1982), apply to alleged subsidies gr anted by countries with so-called non-market economies for goods exported to the United States. The Ad ministration held that section 303 does not apply to non-market economies. The Court of Appeals for the Federa l Circuit reversed the ruling of the Court of Internationa l Trade and upheld the Adm inistration's determination that U.S. countervailing dut y laws should not apply to im ports from NMEs.<sup>48</sup> The U.S. Uruguay Round Implementing Act of 1994 did not explicitly change the U.S. jurisprudence described above, but Article 29 of the Subsidies Agreem ent concerns “Transformation into a Market Econom y,” and provides for a grace period of nonapplication for some subsidy rules, after which it seems the normal subsidy rules will apply.<sup>49</sup> A recent study analy zed the im pact of fore ign subsidization on the US steel in dustry (Blonigen and Wilson, 2007). The study covered data on 37 different steel products from 22 different foreign countries to the US market from 1979-2002. T he results provide strong evidence of both cyclical and structural excess capacity effects for exports to the US market. However, the effects are confined to such a narrow rage of country-product combinations that is un likely that such e ffects were a significant factor in the misfortunes of US steel firm s over the past deca des. The US steel indu stry fought hard and filed 241 CVD cases during 1980-2003, among which 78 cases (32 percent) were considered affirmative, and countervailing duties were charged. However, these duties only affected a small percentage of the total imports to the US steel market (Blonigen and Wilson, 2007).

# **VI. The First U.S. CVD Case on China**

# **A. CFSP Case Review: A Chronological Description**

On October 31, 2006, the NewPage Corporation of Dayton, Ohio, a U.S. manufacturer of glossy paper, filed a petition with DOC and ITC alleging that an industry in the United States is materially injured or threatened with m aterial injury by reason of subsidized a nd less than fair value (LTFV) imports of CFSP from China, Indonesia, and Korea. In the petition, NewPage

> 47 49 Fed. Reg. 19370, 19374 (1984).

> 48  Georgetown Steel Corp. v. United States, 801 F 2d 1308 (Fed Cir 1986).

> 49 John H. Jackson, p. 336, supra note 8.

21
alleged that several Chinese paper com panies were recipients of governm ent subsidies such as grants, policy loans, and tax breaks. 50 NewPage’s petition m arks the first CVD investigation against C hina since 1991 when a U.S. company for mally requested the DOC to initiate a CVD investiga tion of _Ceiling and Oscillating Fans Imported from China_ .<sup>51</sup> According to the DOC statistics, from 2005 to 2006, imports of CFSP products from China increased by approxim ately 177 percent in volume, and were valued at an estimated $224 million in 2006.<sup>52</sup> On November 20, 2006, the DOC announced its decision to initiate CVD and AD investigations against China, Indonesia and Korea with re spect to “coated free sheet paper,” which altered its longstanding policy of not applying the countervailing duty law to NME countries.<sup>53</sup> Then the ITC issued its af firmative preliminary determination on December 29, 2006, considered that there is a reasonable indication that an industry in the United States is materially injured by reason of allegedly subsidized import of CFSP from China, Indonesia, and Korea.<sup>54</sup> The case was delayed when the Chinese Gove rnment and one of the Chinese exporters filed in the U.S. Court f or International Trade (CIT) arguing that the DOC lacked the legal authority to levy CVD against Chin a and should cease its in vestigation. The Department of Commerce m aintained that the 1986 court decision m erely affirmed its authority to determine whether to apply c ountervailing duties to non-m arket economies. The U.S. CIT formally rejected China’s motion on March 29, 2007.

On March 30, 2007, the U.S. DOC announced its preliminary decision to apply U.S. CVD law t o imports from China. This is the first tim e countervailing duties will be imposed on i mports from a non- market economy. The decision alters a 23-year old bipartisan policy of not applying the count ervailing duty law to non-m arket economy countries.<sup>55</sup> The prelim inary decision determined that Chinese producers and exporters of coated free sheet paper received ac tionable subsidies ra nging from 10.90 to 20.35 percent (Table 6).

There have been several reactions to th e DOC’s prelim inary decision. Som e U.S. Congress Members welcomed the Commerce Department’s decision to impose duties on certain kinds of Chinese paper imports, an d adhered that Congr ess should still pass

> 50 ITA, “Commerce Initiates Countervailing Duty Investigation on Coated Free Sheet Paper from the People’s Republic of China,” <u>http://www.ita.doc.gov/press/press_releases/2006/paper_china2_112106.asp,</u> November 21, 2006.

> 51 56 Fed. Reg. 57616 (1991). The petitioner claimed that China’s fans sector was a market-oriented industry (MOI) and the CVD law should be applied. However, the ITA concluded that the PRC fans industry was not a MOI, and issued final negative determination in the case. See 57 Fed. Reg. 24018 (1992).

> 52 Commerce News, United States Department of Commerce, “China CVD Fact Sheet,” March 30, 2007.

> 53 DOC, _Notice of Initiation of Countervailing Duty Investigations: Coated Free Sheet Paper from the People’s Republic of China, Indonesia and the Republic of Korea_ , 71 Fed. REG. 68546 (November 27, 2006).

> 54 ITC, Coated Free Sheet Paper China, Indonesia, and Korea, 71 Fed. Reg. 78464 (December 29, 2006). 55 Commerce News, United States Department of Commerce, “Commerce Applies Anti-Subsidy Law to China,” March 30, 2007.

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legislation to cement the department’s authority to impose countervailing duties on all non-market economies, not just China.<sup>56</sup> Changing the law will rem ove any doubt or court challenge to m ake certain th at every in dustry can file a cas e if they have been harmed.<sup>57</sup> Even the industries have been supportive of the DOC’s prelim inary announcement. The National Association of Manufacturers says that it is great news and an im portant step toward balancing trade with China. The Blue Green Alliance, Sierra Club, and the United Steelworkers have been supported as well.<sup>58</sup> The American Forest and Paper Association (AF&PA) is the most supportive of the DOC’s preliminary decision in this case. AF&PA also endorses its continued support for legisl ation that would m ake the application of CVD against China and other non-market economies. NewPage Corporation is a member of AF&PA, however AF&PA was not a petitioner in the CFSP case. 59 However, the Printing Industries of America (PIA), the primary consumer of glossy paper in the United States, opposed the paper producer’s petition.<sup>60</sup> On October 18, the U.S. Department of Commerce announced its affir mative final determinations in the co untervailing and antidumping duty investigations on coated free sheet paper from China, Indonesia, and Kor ea. The final determ ination reaffirmed the March 30th preliminary decision. The DOC determined that Chinese producers/exporters received countervailable subsidies ranging from 7.40 percent to 44.25 percent, and sold CFS paper in the United States at 21.12 perc ent to 99.65 percent less than fair value (Table 6).

A tariff order will be issued onl y if the ITC will have a final affirmative determination in injury investigation. However, on November 20, 2007, United States International Trade Commission finally determined that the U.S. industry is neither materially injured nor threatened with m aterial injury by reason of imports of c oated free sheet paper from China, Indonesia, and Korea that the U.S. Department of Commerce has determ ined are subsidized and sold in the United States at less th an fair value. As a re sult of the Commission's negative determinations, no antidumping or countervailing duties will be imposed on imports of this product from these countries.<sup>61</sup> While the U.S. ITC has m ade a negativ e final determination, the af firmative determination of the U.S. DOC in the count ervailing and antidumping duty investigation on CFSP from China has opened the gate to apply the counterva iling duty law to nonmarket economies.

> 56 “Baucus Applauds Commerce Decision to Fight Chinese Subsidies,” March 30, 2007.

> 57 “Rangel and Levin Respond to Commerce Subsidy Investigation,” March 30, 2007.

> 58 “Administration Responds to China Trade Subsidies, Fair Trade Advocates Welcome First Step, Call for Further Action,” March 30, 2007.

> 59 “American Forest and Paper Association Announcement,” March 30, 2007.

> 60 PIA Comments to Application of the Countervailing Duty Law to Imports from the People’s Republic of China submitted to US Department of Commerce, January 16, 2007.

> 61 The US ITC, Coated Free Sheet Paper from China, Indonesia, and Korea (Investigation No. 701-TA-444446 (Final) and 731-TA-1107-1109 (Final), USITC Publication 3965), December 2007.

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# **B. Subsidies Existence and Calculation**

In this section, we discuss in detail how th e DOC determined the existence of a subsidy and calculated the scale of subsidies in CFS paper imports from China. This is a summary of documentation based on what the DOC published in its m emorandum on the preliminary affirmative countervailing duty determination in March 30, 2007. From learning point of view, a summ ary of how s ubsidies are determined and calculated is useful. We provide no judgm ent or discussion on whether these subsidies exist or not, and if they are actionable subsidies or non-actionable.<sup>62</sup>

**Existence of Countervailable Subsidies.** In the original filed petition, NewPage Corporation alleged that 13 Chinese C FSP producers/exporters have received countervailable subsidies from the Government of China ( GOC). The DOC selected the two largest of them , Gold Ea st Paper (Jiangsu) Co., Ltd. (Gold East) and Shandong Chenming Paper Holdings Ltd. (Chenm ing) as mandatory respondents. The alleged subsidies include government grants, policy loans, tax exemption, export refunds, equity infusion, currency m anipulation, and others , which num ber more than 17 kinds of subsidies. The DOC has denied the invest igation on the currency m anipulation program from the very beginning.  In stead, it found that there are si x kinds of program s to be countervailable in its preliminary determination:

**1. Grant Program:** There are two grant programs that relate to this allegation: the State Key Technology Renovation Fund (“Key Technology Program”), and the Clean Production Technology Fund. The DOC has identif ied that the former program provides countervailable subsidies, and the latter not to be used.

1.1. The Key Technology Program was created by the former State Economic and Trade Commission (SETC) in 1999 and aim ed to promote: (1) technological renovation in key industries, key enterprises, and key products ; (2) facilitation of technology upgrade; (3) improvement of product structure; (4) improvement of quality; (5) increase of supply; (6) expansion of domestic demand; and (7) continuous and healthy development of the state economy. The recipients of these funds will ma inly be selected from large-sized stateowned enterprises and large-sized state holding enterprises. While this program has not operated since 2003 due to the Administrative system reform, the DOC finds that these grants are a direct transfer of funds providi ng a benefit in the amount of the grant. These grants are s pecific because the pro gram is limited to c ertain enterprises. Chenming applied and was approved to have fundi ng under the Key Technology Program in 2000, and that the funds were disbursed in 2001. The DOC used the standard grant methodology determining the countervailable subsidy to be 1.28 percent _ad valorem_ for Chenming.

1.2. The Clean Production Technology Fund is a program to provide incentives and rewards (monetary or nonmonetary) to encourage enterprises to conduct clean

> 62 In the following discussion, all materials come from _Coated Free Sheet Paper from the People’s Republic of China: Amended Preliminary Affirmative Countervailing Duty Determination_ , Department of Commerce, March 31, 2007.

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production inspections, with the goal of protecting the environment. The program entered into force in October 2004, and any paym ents under this program are made at the local level. Chenming did not receive any grants under this program during 2004 and 2005. Gold East reported that it received a grant under this program, but any potential benefit to Gold East under this program is less than 0.005 percent. W here the countervailable subsidy rate for a program is less than 0.005 pe rcent, the program is not included in the total countervailing duty rate.

**2. Government Policy Lending Program.** In order to determ ine whether the policy lending program alleged by th e petitioner confers counterva ilable subsidies on the producers and exporters of the subjected merchandise, the DOC ascertains first that the GOC has a program in place to sup port the development of the paper industry, and then these policies were carried out by the central and local gove rnments through the provision of loans extended by GOC polic y banks and state-owned commercial banks (SOCBs).

The DOC preliminarily determined that the GOC has a specific and detailed policy to encourage and support the developm ent of th e domestic forestry and paper industrybased on the following GOC documents: (1) “The Outline of the 10<sup>th</sup> National Economic and Social Five-Year P lan.” One of the goals of 10 th Five-Year Plan is to “accelerate reform and renovation” of certain industr ies, including the “wood pulp, high quality paper and paperboard” industry; (2) “The 10<sup>th</sup> Five-Year and 2010 Special Plan for the Construction of National Forestry and Papermaking Integration Project.” In this plan, the GOC established specif ic pulp pro duction capacity targets of “ more than 2.15 m illion ton” after 2010, and policy m easures to pr ovide “appropriate fina ncial support to the construction of forestry and paperm aking integration in its early phase by ways of infusing capital in cash or loans with discount;” (3) “The 10<sup>th</sup> Five-Year Plan in the Paper Production Industry” released by the SETC. A key policy recommendation is to increase the industry’s access to financial resources; a nd (4) other administrative measures of the GOC.

The DOC determined that the abo ve policies were carried out by the central and local governments through the provision of loans extended by GOC policy banks and S OCBs. (1) According to the 1979 _Law of Local People’s Congresses at Various Levels and Local People’s Government at Various Levels of the PRC_ , as a mended, local governments must follow the laws and regula tions made by the central governm ent, and Five-Year Plans should be considered a central government policy or program that local government adopt and im plement through SOCBs; (2) Loans provided by governm ent policy banks are co nsidered government loans, and constitute direct financial contributions; (3) Loans by SOCBs are also gov ernment loans in China, because of: a) the current law, Article 34 of the _Commercial Bank Law of the People’s Republic of China_ states that banks are required to adhere to the PRC’s “national industrial policies;” b) the near-complete state ownership over these banks enables the GOC to utilize SOCBs as policy instruments; c) local governments continue to guide and direct the allocation of credit through their local bank branches; and d) the chief executives of the head offices of the SOCBs are government appointed and the pa rty retains significant influence in their 25
choice; and (4) the above-m entioned Five-Year Plans are im plemented by paper companies. Chenming’s 2005 Annual Report states that, “all of the projects the Company had launched were those which satisfying the national industrial policy,” and will k eep studying “to m ake sure the Com pany’s development is com plying with the national policy on the industry.” Chenming, Gold East, and a certain num ber of Gold East’s cross-owned com panies had outstanding loans under this program during the period of inve stigation. The DOC preliminarily determined that a countervaili ng benefit of 3.15 percent ad valorem exists for Chenming and 14.02 percent for Gold East for this program.

**3. Income Tax Programs.** Four tax exem ption programs are related to this allegation, which are considered as countervailabl e subsidies by the DOC’s prelim inary determination.

3.1. The “Two Free, Three Half” Program. According to Article 8 of the _Foreign Invested Enterprises and Foreign Enterprise Income Tax Law_ , FIEs that are “productive and scheduled to operate not less than 10 years are exempt from income tax in their first two profitable years and pay half of their applicable tax rate f or the following three years.” The intent of this law is to attract foreign investment to China. The DOC determined this program is a subsidy and specific as th e program is lim ited to c ertain enterprises, “productive” FIEs.

3.2. Reduced Incom e Tax Rates for FIEs Based on Location. F IEs located in the designated coastal economic development zones, special economic zones, and economic and technology development zones pay corporate income tax at a reduced rate either 15 or 24 percent in China.<sup>63</sup> 3.3. Local Income Tax Exemption and Reduction Program for “Productive” FIEs. The governments of the provinces, the autonom ous regions, and the centrally governed municipalities have been delegated the authority to provide exemptions and reductions of local income tax for FIEs.

3.4. Income Tax Credits on Purchases of Domestically Produced Equipment by FIEs.

**4. VAT and Duty Exemptions.**<sup>**64**</sup> Two programs are related to this allegation, which are considered as countervailable subsidies by the DOC’s preliminary determination.

4.1. VAT Rebates on Purchases of Domestically Produced Equipment.

4.2. VAT and Tariff Exemptions on Imported Equipment.

> 63 A new Enterprise Income Tax Law will come into effect on January 1, 2008, in which the income tax will be levied at the same rate of 25% regardless of domestic or foreign owned enterprises.

> 64 It is well accepted that VAT refunds to exporters are trade neutral and non-distortionary in the economic literature. See Grossman, Gene M. 1980. “Border Tax Adjustments: do they distort trade?” Journal of International Economics, 10 (1980) 117-128.

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**5. Domestic VAT Refunds for Companies Located in the Hainan Economic Development Zone.** One of Gold East’s cross-ow ned companies was a qualifying manufacturing enterprise in the Economic Development Zone of Hainan.

**6. Other Subsidies.** Chenming reported four additional programs in which it participated. Due to Chenming’s request that the DOC treat information about these four programs as business proprietary, and determ ine that these four programs constitute countervailable subsidies.

**Benchmark and Subsidies Calculation.** As discussed in the proceeding section, the DOC determined that loans receiv ed by the pa per industry from Chinese banks, either policy bank, SOCBs, or foreign banks, constitute countervailable subsidies. According to U.S. law, the benefit for a preferential loan is the “difference be tween the amount the recipient of the loan pays on the loan and the am ount the recipient would pay on a comparable commercial loan that the recip ient could actually obtain on the m arket.” Normally, the DOC uses com parable commercial loans reported by the com pany for benchmarking purposes. However, the DOC argued that the Chinese banking sector does not operate on a commercial basis, and that the interest rates of the Chinese domestic banking sectors do not provide a suitable ba sis for benchmarking. Then the DOC created a market-based benchmark outside of China by a simple average of the national len ding rates for countries with comparable gross national income with China.

**1. Domestic Benchmark.** The DOC determ ined that th e Chinese dom estic banking sector does not provide an appropriate be nchmark because the Chinese banking sector dose not operate on a commercial basis and is su bject to significant distortions, primarily arising out of the continued dominant role of th e government in the sector. (1) The GOC’s ownership: the GOC continues to c ontrol the vast m ajority of financial intermediation in the banking sec tor; (2) SOCBs: they continue to be plagued by functional and operational problem s, and fund s continue to be a llocated in a m anner consistent with the government policy; (3)  Foreign banks: foreign investment in banking sector is tightly constrained, and foreign banks are subject to the same restrictions as the SOCBs. Therefore, foreign bank lending does not provide a suitable benchmark.

**2. External Benchmark.** The DOC uses a cross-country average lending rate as the external benchmark in this proceeding. Th e countries are select ed based on sim ilar income levels to China: (1) China is a lo wer-middle income country according to the country classification of the World Bank, 37 countries have been selected; (2) The DOC computed a sim ple average of these 37 lend ing rates from _International Financial Statistics_ in 2005, as the external benchm ark for short-term loans; (3) The DOC developed a ratio of short-te rm and long-term lending for 2005, by using the short-ter m lending drawn from London Interbank Offered Rate (LIBOR) data and long-term interest rate from the interest rate swap market reported by the Federal Rese rve, to transfer the short-term lending rate into long-term one.

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**3. Subsidies Calculation.** Once a subsidy identified in each program , the DOC calculated its impact on the firms’ sales and translated this into a countervailable benefit. Add them all up, and o ne gets an individua l final duty rate for each exporter of the subject merchandise. In total, the count ervailing duty is 10.90% for Chenm ing, and 20.35% for Gold East. The all other rate is 18.16%, competed by a weighting average (see Table 7).

**Final Determination.** The prelim inary determination brings several dispute issues between the Government of China (GOC) and the United States. Some major issues will be discussed in the following:<sup>65</sup>

**1.  The Authority to Apply the CVD Law to China.** The GOC argues that the US DOC does not have the authority to apply the CVD law to China as long as the DOC continues to consider China as a NME country, since _Georgetown Steel_ remains a contro lling precedent. The GOC also claim s that the US Congress made it clear that its inten tion of using the NME methodology for calculating AD duties is to fully cover the distortionary effect of subsidies. The Uruguay Round Agr eements Act (URAA) contained eight major changes to the AD law and six cha nges to the CVD law, but no chang es to the ru les applying the CVD law to NMEs.

The US DOC insists that Congress granted to it the legal authority to apply the CVD law to any country, which is not lim ited only to market economies. In 1984, the Departm ent first addressed the issue of the application of the CVD law to NMEs. The Departm ent’s previous policy of not-applying the CVD law to NMEs is not a “rule” but a practice. In the _Georgetown Steel_ case, the court did not prohibit that the CVD la w be applied to NMEs, but it was the D epartment’s decision not to apply the law to N MEs based upon the language of the statute and the facts of the case. In contrast to the case of Soviet-bloc economies where both output and input prices were centrally administered, China has eliminated price controls on m ost products, and therefore the Departm ent is able to determine whether subsidies benefit imports from China.

**2. Countervailability of Bank Loans in China.** The US Departm ent found in its Preliminary Determination that loans from Chinese Po licy Banks and sta te-owned commercial banks (S OCBs), and even foreign curren cy-denominated loans from domestic and foreign banks constitute count ervailable subsidies. The GOC argued that information on the record does not support a conclusion that loans from Policy Banks and SOCBs constitute a financial contribution or that lending by these banks is specific to the forestry and paper industries. First, China established Policy Banks in the m id-1990’s to carry out government industrial policy, but by the year 2000, m ost of the lending from Policy Banks had shifted from policy loans to commercial loans.  Even now in m aking policy loans, these banks are operating on a commercial basis. Second, China’s SOCBs function essentially as comm ercial banks, independent from government influence. The banks must make their decisions based on commercial considerations, and government’s industrial policy is simply one factor that banks may take into consideration in analyzing

> 65 The US DOC, “Issues and Decision Memorandum for the Final Determination in the Countervailing Duty Investigation of Coated Free Sheet from the People’s Republic of China,” October 17, 2007.

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risk. The detailed loan appli cation and approv al processes are sim ilar to tho se in the United States and oth er countries. Third, SOCBs Loans do not cons titute a financial contribution although the GOC does have a m ajority stake in SOCBs. Fourth, Lendings of SOCBs and Policy Banks in C hina is not specific. Th e five-year plans and other related government documents do not serve as mandated preferences in relation to lending to the forestry and paper industries.

However, the US DOC disagreed with GOC’s responses. As discussed in the Preliminary Determination, the DOC continues to find that the GOC has a policy in place to encourage and support the growth and de velopment of the pa per industry through preferential financing initiatives, as illust rated in the five-year plans and industrial policies. In the DOC’s vi ew, loans provided by Policy Banks and SOCBs in China constitute a direct financial contribution from the government.

**3. Appropriateness of the Benchmarks.** The GOC disagrees with the benchm ark used by the DOC in the Preliminary Determination to calculate the benefit of the Government Policy Lending Program. The GOC argues th at the DOC should use the appropriate commercial benchmarks from China in the benefit calculation. Aft er the gradual liberalization of the financial markets in China, domestic interest rates can serve as an appropriate benchmark. If the DOC continues to reject inter est rates in Chin a as appropriate benchmarks, then it should consid er more than one factor in s electing “surrogate” countries.  In a ddition to gross national incom e (GNI), other factors should be taken into account such as national savings rate and inflation, as China is a country with a high savings rate and lo w inflation, as compared to c ountries in the same income group.

The US DOC argues that no interest rate in China could be used as a suitable benchmark for measuring the benefit of bank loans, and that it is appropriate to resort to an external benchmark. The DOC continues to construct a benchmark by using data from a group of lower-middle income countries, but agrees to change the m ethod of calculation. Instead of a simple average from these countries, the DOC used a more com plex method to take into account other factors that m ay drive in terest rate variation across income levels, including institutions, level of savings, market risk, and transaction costs. Benchmarks for loans denom inated in f oreign currencies and Chinese currenc ies were deter mined separately by using a regression of inflation-adjusted interest rate on a composite index of certain governance indicators that apply to all of th ese countries. These indicators reflect the quality of each country’s in stitutions across several dimensions, including political stability, government effectiveness, regulat ory quality, rule of law, and control of corruption.

4. **Application of Adverse Facts Available to Chenming.** During the final stage, Shandong Chenming Paper Holdings Ltd. (Chenm ing) withdrew from the investigation as one of the mandatory respondents due to reasons unknown to us. The US DOC based the net cou ntervailable subsidy ra te for Chenming on adverse facts available (AFA) methodology in the final determination. Since the AFA is not available, the DOC applied the highest calculated final subsidy rate s for income tax, VAT and policy lending programs of all the other producers/exporters in this investigation. That is why Chenming 29
received the highest C VD duty rate of 44.25 percent in the final DOC determ ination (Table 8).<sup>66</sup>

# **C. Implications for China and Other NMEs: A Preliminary Discussion**

Even though the US ITC found that no injury has been caused by im ports of CFSP from China, the US DOC CVD decision has opene d a flood gate of CVD petitions by U.S. manufacturing firms. By the end of 2007, there were eight CVD a nd AD cases against imports from China. Other NME countries will face broad challenges.

**1. Expanding CVD to Other Industries?** The application of CVD duties to CFS paper is likely to be followed by other com panies and industries to litigate the im ports from China. The sectors that the US has highligh ted as a concern on the subsidy front include steel, petrochemicals, high technology, fore stry and paper products, textile, hardwood and plywood, m achinery and othe r non-ferrous m etal industries.<sup>67</sup> The Am erican Iron and Steel Institute (AISI) and the Steel Manufactures Association (SMA) stressed their continued strong support for legislation that would require the DOC to apply CVD law fully to China and other NMEs. With regard to steel, they said that China has the world’s most heavily subsidized steel industry.<sup>68</sup>

Another possible sector is textile and appa rel industry. According to Inside US-China Trade report, the National C ouncil of Textile Organizations (NCTO) is having active discussions with lawyers about the possibili ty of filing its o wn countervailing duty case against imports of Chinese apparel. NCTO believes it is possible that a CVD case on apparel might lead to even higher margins than the 10 to 20 percent Commerce found in CFS paper case.<sup>69</sup> U.S. Department of Agriculture has recently released a Glo bal Agriculture Information Network (GAIN) Report. The report argues that China has implemented a variety of VAT exceptions for Chinese farmers and agricultural processors. China’s applied VAT rate to farmers and processors is 13 percent; the e ffective VAT actually collected is 5.8 percent, or less than half the official rate. There appears to be “a disparate impact” on imports. They also argue that China’s agricultural exporters are offered an effective export subsidy between 7.2 and 9.77 percent through VAT rebate s. The report says that these policies will continue to hurt U.S agricu ltural exports and are inconsistent with th e WTO principles of “National Treatment.”<sup>70</sup>

**2. Is Everything a Subsidy?** Since 1978, China has undertaken comprehensive reforms, which have progressively transform ed the central planned econom y into a m arket

> 66 Ibid.

> 67 US Trade Representative’s Office, “National Trade Estimate Report on Foreign Trade Barriers,” 2007. 68 AISI, “AISI and SMA Welcome Commerce Ruling against Chinese Subsidies; But Groups Say next Step Must be Prompt Passage of CVD/NME Legislation.” March 30, 2007. American Iron and Steel Institute. 69 Pete Kasperowicz, “NCTO Actively Talking to Lawyers about CVD Cases against China,” Inside USChina Trade, April 25, 2007.

> 70 USDA, “People’s Republic of China Trade Policy Monitoring VAT Protections: The Rest of the Story 2007,” GAIN Report CH7018, March 19, 2007.

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economy. However, the government is still playing a very important role in the economic and social developm ent. In order to achieve i ndustrial and social goals, China has adopted various incentive policies to introdu ce foreign direct investment, which support the new and high technology innovation and industrial development in various development zones. Western regions will en joy preferential tax po licy in the n ewly passed Enterprise Income Law. Som e of these policies m ay be subjected to U.S. countervailing duty investigations.

The second CVD case jointly filed recently by six U.S. steel tub e companies and the United Steelworkers (USW) identifies two “new types of Chinese subsidies” in addition to those cited in the first CVD case, accord ing to the June 7 petition. One new subsidy cited is the downstream export tax rebate program under which China gives companies a rebate on taxes paid for upstream goods if these are used to produce downstream goods for export, which encourages the producti on and export of goods like steel pipe. The second new subsidy is the provis ion of raw m aterials by government steel m ills to Chinese makers of circular welded carbon quality steel pipe (CWP) at a co st less than adequate remuneration. In addition to the hot-rolled steel which was provided at low cost, national and local governments offer electricity, natural gas, water and land at subsidized prices to CWP companies, according to the petition.<sup>71</sup>

**3. Is the Exchange Rate Countervailable?** In the original f iled petitions, th e US petitioners all argue that th e Chinese Government provided countervailable subsidies by “currency manipulation”. The D OC has re jected the investigation on “currency manipulation” in the case of CFS paper. Ho wever, there are two bills from the Senate Financial Committee (S. 1607) and the Senate Banking Committee (S. 1677) trying to connect currency issues with trad e remedy laws. They would target the alleged “undervalued Yuan” as a subsidy for purposes of the US CVD law or would use the “corrected” value of the Yuan to calculate the dumping margin in an AD case. This is a potential challenge facing China in the near future.

# **VII. Policy Implications: A Preliminary Discussion**

# **A. Reviewing and Adjusting Domestic Subsidy Policies**

Since China and Vietnam are both transition economies, there is a need to review their domestic policy regarding subsidies from a social welfare point of view: that is, who are the beneficiaries of these subsidies; how be nefits are distributed across incom e groups. There is a need to conduct an incidence analysis to see if this particular subsidy is propoor or benefiting the rich; and whether they compete with other p ro-poor subsidies for budgetary resources. In the light of increasing environmental pressure, and degradation in some areas, there is a need to exam ine the environmental impact of these subsidies and tax exemptions to see whether they have provided incentives for energy-intensive industrial development, wasteful use, or depl etion of natural resour ces. This review

> 71 Eric Nelson, “China Steel Pipe CVD Case Cited Two New Subsidies, Largely Follows Paper Case,” _Inside US-China Trade_ , June 13, 2007.

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would be good for re-balancing the dom estic economy and improving the quality and sustainability of growth.

China’s system of subsides is in th e process of dramatic transition. A recen t study on China’s subsidies (Wang, Yan 2007) exam ined three categories of subsidies, and found that: (1) C ategory I subsidies –including price subsidies and s upport to the state enterprises –rose in quantity, but the share in GDP has declined dramatically from a high level of 8 percent of GDP in 1985 to 0.7 perc ent in 2005. This represents a signif icant reduction in policy distortions, which may have contributed to rapid growth; (2) Among Category II -quantifiable subsidies re ported by the government to the WTO, 72 poverty reduction and the environment received greater attention in recent years. However, if one examines the duration of benefiting from subsidies and tax exemptions, exporters, foreign invested enterprises have enjoyed preferenti al tax treatment for a longer period of tim e. Enterprises and workers in the coastal regions have benefited longer than those living in inland regions; (3) The size of quantifiable subsidies seems to be comparable to those of other large developing countries, b ut the composition is a matter of concern. Category I and II subsidies rose from 131 billion Yuan in 2001 to 132 billion in 2004, but the shares in GDP declined from 1.19 percent in 2001 to 0.82 percent in 2004; (4) Many subsidies are not quantifiable. Among 80 kinds of both quantifiable and non-quantifiable subsidies, about 26 percent out of 80 seems to be discriminatory /inconsistent with WTO principles and hence, are likely to be challenged by trading partners. However, this is from an economic point of view, not from a legal perspective.

In the litera ture, it is quite clear th at the VAT tax rebate has been considered _tradeneutral_ as VAT is dei gned to tax final output, so that taxes paid on interm ediate transactions are rebated. According to Gene Grossman who analyzed the European VAT using the “destination principle” conclude d “According to current GATT rules the destination principle applies to all indirect taxes. The European VAT as adm inistered is, therefore, trade-neutral. All p roducers, whether producing for domestic sale or for export, claim credit for any taxes paid on inputs. A tax liability is calculated for domestic sales, while export sales are exem pt. This exemption is the adjustment requested by the destination principle of taxa tion. On balance, goods are e xported completely tax free. Imports are taxed, but if they are used as intermediate goods they qualify for the same tax credit as do domestically produced intermediates” (Grossman, 1980 page 126).

Nonetheless, the US government made a request to WTO for consultation regarding VAT rebates in China. The US request to the WTO for consultation stated that these measures “appear to be inconsistent with Article 3 of the SCM Agreement”. And “to the extent the measures accord im ported products treatm ent less favorab le than that accorded “like domestic products”, they appear inconsiste nt with Article III: 4 of the GATT 1994 and Article 2 of the TRIMS Agree ment” (USA, 2007). So, this debate is not going to go away.

72 People’s Republic of China, 2006. “Subsidies: New and Full Notification Pursuant to Article XVI: 1 of the GATT 1994 and Article 25 of the SCM Agreement.” WTO Doc. G/SCM/N/123/CHN, 13 April 2006.

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There is a need for the governm ent of China to review all the subsidies based on the economic and social welfare point of view, a nd to make them comply with WTO rules. This includes how VAT rebate is adm inistered, and whethe r it is based on universal principles or discriminatory conditions.<sup>73</sup> Recently, the corp orate income tax has b een unified for domestic and foreign firm s, so the issue related to tax exemptions has been largely resolved. In June 2007, the governm ent has also elim inated the tax rebate for exporters in steel and other resource intensiv e industries. Furthermore, an export tax is levied on exports of steel, in order to lim it over-expansion in that industry and reduce resource depletion. It is perh aps the right tim e to re-evaluate all these policy m easures (tariffs, subsidies and export taxes) affecting prices and incentives, and reform them in a comprehensive manner.

# **B. Using the WTO Dispute Settlement System**

While the first US CVD case on China was co ncluded with no CVD order, the disputes still exist between the Chinese government and companies and the US. There are usually two options for the Chinese governm ent and Chinese companies to deal with the US CVD cases: they m ay sue the US DOC on its determ ination in the U.S. Court of International Trade, or file a complaint for consultation with the US to the WTO Dispute Settlement Body. Issues that can be resolved in the CIT are only those related to the U.S. trade law, such as, if the DOC’s findings are fair and in line with the U. S. trade law, and so on. If China files a com plaint to the WTO Dispute Settlem ent Body to ask a consultation with the U.S. government, the W TO can then establish a panel to exam ine the DOC’s findings and m ethodology, the cons istency with W TO Agreements, U.S. commitments, Chinese commitments, and other issues.

The likelihood of one or both of these happe ning is high. We thi nk the second option – consultation in the WTO DSB is a better channel to solve this dispute, because: (1) lots of issues are related to the WTO agreements; and (2) the implications of CVD cases are significant for development polic ies in China, Vietnam , and other developing countries. Indeed as we argued, the Chinese Governm ent raised the consultation request to the WTO DSB in Septem ber 14 on the US deci sion regarding charging antidum ping and countervailing duties on CFS paper. China char ged that the U.S. determ ination violated the SCM Agreement on three counts and the Antidum ping Agreement on one count.<sup>74</sup> Consultations were held on October 12, 2007. However, because the International Trade Commission issued a negative injury determination in the glossy paper investigation, it is unlikely that this matter will be pursued.

However, several CVD methodology issues are still disputable.

1. The DOC prelim inarily determined that the GOC has a specific policy to support the paper industry based o n the GOC’s docum ents: “The O utline of the 10 th National

> 73 A recent joint study by US ITC and Chinese researchers found that this tax rebate for exports has induced a “round-tripping of exports” and that is, Chinese firms “exports” to China itself. This is highly inefficient from China’s own development point of view (Ferrantino, et al 2007).

> 74 WTO, WT/DS368/1, September 18, 2007.

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Economic and Social Five-Year Plan,” “The 10<sup>th</sup> Five-Year and 2010 Special Plan for the Construction of National Forestry and Pa permaking Integration Project,” “The 10<sup>th</sup> Five-Year Plan in the P aper Production Industry,” and other adm inistrative measures of the GOC. Is this method reasonable to use for further CVD investigations?

2. Loans received by the paper industries from Chinese banks, either policy banks, stateowned commercial banks, or foreign banks in China, are all considered governm ent loans, constitute direct financial contributi ons, and considered subjects to countervailing duties.

3. The DOC determ ined that the C hinese domestic banking sector can not provide an appropriate benchmark because the Chin ese banking s ector doesn’t operate on a commercial basis, and a cro ss-country average lending rate was used as the external benchmark. In Article 15 (b) of China’s Prot ocol on the Accession, it requests that “the importing WTO Me mber should adjust such prevailing terms and conditions before considering the use of term s and conditions prevailing ou tside China.” Is the DOC’s methodology consistent with this provision?

4. In Article 10 of the Protoco l on the Acces sion of the People’s Republic of Chin a, it declared that “China sh all eliminate all sub sidy programs falling within the sco pe of Article 3 o f the SCM Agreem ent upon acce ssion,” but it is no t clear if it is countervailable if China had abolished such a program after its accession.

5. The application of both antidum ping and countervailing duties to China’s coated free sheet paper creates concerns about double co unting using current ru les. Article VI paragraph 5 of the GATT 1947 requests that members cannot subject an export subsidy to both AD and CVD duties, but it is not clear if a domestic subsidy can be double counted. This issue needs to be clarified.

Several recent studies point out that Am erican trade remedy laws have strayed far away from their original purpose, becoming little more than an e xcuse for special interests to shield themselves f rom competition at the ex pense of both Am erican consumers and other American companies. Harvard University Professor Gregory Mankiw, former Chair of the President’s Council of Economic Advisers from May 2003 to February 2005, has said, “Antidumping is the ‘third rail’ of U.S. trade politics, with few politicians of either party willing to point out its broadly negative impact.”<sup>75</sup> Countervailing measures will be even worse than antidumping, b ecause it is m ore easily abused due to the am biguous WTO rules. If the Chinese govern ment will file a com pliant with th e WTO Dispute Settlement System to consult with the Unite d States on these trade remedy issues, it will be possible to form a WTO panel to judge the disputed issues.

Fair and free trade is b eneficial and will continue to benef it the majority of consumers and companies in the United States. In contrast, trade remedy laws cover a small part of trade flows, and protect a sm all group people at the cost of bot h consumers and other

> 75 Mankiw, N. Gregory and Phillip L. Swagel, “Antidumping: The Third Rail of Trade Policy,” _Foreign Affairs_ , July/August 2005.

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companies. In the current CVD case, the petitioner, NewPage Corporation, which was founded in 2005, has 4000 e mployees, and $2 billion ou tput per year.<sup>76</sup> However, the primary paper consumers, the U.S. printi ng industry is com posed of approximately 40,000 plants employing 1.1 million workers and producing approximately $170 billion of output per year. The industry is primarily domestic, with exports exceeding imports on an annual basis.<sup>77</sup> According to Mankiw and Swagel, the US steel industry has long been the leading user of antidumping procedures: nearly half of anti dumping tariffs imposed since 190 have been on steel imports, and 158 of the 294 antidumping orders in force as of April 2005 were on steel products. Such tariffs continue despite strong performance by U.S. steel firms and a 45 percent jump in steel prices betw een December 2003 and March 2005. These higher steel prices help s teel producers, but they hurt the m uch larger num ber of firm s and workers that use steel. Whereas steel pr oducers employed just under 160,000 workers in early 2005, more than 1.5 million employees worked at firm s that m anufacture metal products, more than 1. 1 million at firm s that manufacture machinery, and nearly 1.8 million at firms that produce transportation equipment such as cars and parts. One recent study found that each job saved by steel tariffs cam e at the co st of three jobs in steelusing industries and caused economic distortion equal to some $450,000.<sup>78</sup>

# **C. Participating in the Rules Negotiation in the Doha Round**

While the WTO SCM Agreement contains a delicate balance of subsidy definitions and disciplines that were intended to be clear, predictable and enforceable, the application and enforcement of the SCM Agreem ent since 1995, however, has not been a resounding success. In the ongoing Doha Round Negotiations, most developing country members are very focused on agricultural issues, but we think the rule s negotiation is also v ery important. China, Vietnam, and other NME WTO members, might work together with other developing countries to use the Doha Round Negotiations to further clarify the coverage of governm ent subsidies, trade remedy rules, preferen tial treatment to developing countries, NME and other related issues.

1. Subsidies and development policies. There are a number of proposals in discussion in the current Doha Round Negotiations on SC M Agreement. Some proposals are about prohibited subsidies. The United States has proposed to expand the existing category of prohibited subsidies, and has suggested in cluding the “dark am ber” category. Som e developing countries have proposed m ajor reforms to Article 27 of the SCM Agreem ent and to provide special and differential treatment to developing countries.

2. Procedures for countervailing measures. Besides the categories of subsidies, it is very important to make clear procedures for i mposing countervailing duty m easures, and to

> 76 James C. Tyrone, Senior Vice President of Sales and Marketing, NewPage Corporation, Testimony before the Trade Subcommittee of the Ways and Means Committee of the United States House of Representatives, February 15, 2007.

> 77 PIA, supra note 61.

> 78 Mankiw, N. Gregory and Phillip L. Swagel, supra note 78.

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prevent abuses in the adm inistration of c ountervailing duty laws. The United States proposed to strengthen and expand the application of the CVD rules.

3. NME status for China and Vietnam. In regard s to China’s NME status, the Article 15 (d) of the Protocol on the A ccession of the People’s Republi c of China declared clearly that China will be treated as a m arket economy on December 11, 201 6 for antidumping investigations without any conditions. However, there is no such clear language written for countervailing duty investigations.<sup>79</sup> Vietnam has the similar situation about its NME status in the Report of the W orking Party on the Accession of Vietnam. It is good for China and Vietnam to make the provision m ore clear in this Doha round negotiation.<sup>80</sup> Furthermore, it would be better if China and Vietnam can negotiate an expedited entry to “market economy” status.

# **VIII. Conclusion**

Development experiences in the recent year s clearly show the we lfare-improving benefit of freer international trade. The world bene fits from developing countries like China, India, Brazil and Vietn am becoming more significant trading nations. The ostensible purpose of trade remedy policies is to help ensure competition by punishing exporters of various unfair trade practices, and to lessen the adverse impact on an importing country’s industries, producers and workers. In prac tice, however, trade rem edy measures have been increasingly used not only as trade policy instruments to mitigate the adverse impact of unfair trade, but also as the preferred m eans by which industries in many countries seek and obtain protection from their governm ents. Today, most developm ent practitioners have realized that antidumping has been a growing problem in international trade instead of dumping.

Countervailing duty is often considered as a less-evil brother to antidumping. In fact it is not the case -- as it is more easily abused due to ambiguous WTO rules. CVD cases are costly and ineffective. For exam ple, between 1980 and 2003, the US steel industry filed 241 CVD c ases with 7 8 cases (32 percent) considered affirmative and countervailing duties charged. However, these duties only a ffected a sm all percentage of the total imports to the US steel market (Blonigen and Wilson 2007). The March-30th decision by the US DOC opened the gates for more CVD cases against NMEs.

This study provides an exam ination on the first CVD cas e on coated free sheet paper from China, and finds that this case has strong implications for transition economies and developing countries. Extreme caution must be used when designing industrial policy and development policies to achieve econom ic and social objectives. Some subsidies m ay distort international production and trade patterns, and reduce efficiency and world welfare. Some subsidies in sectors wher e the country does not have a com parative advantage, for example, a resource-intensive product in a resour ce-scarce country, may lead to over-exploitation of nature resource and rapid depl etion. Many subsidies sim ply compete for scarce budgetary resources that could be better used in areas where there is a

> 79 W/L/432, Article 15 on page 8-9.

> 80 WT/ACC/VNM/48, paragraph 255 on page 66.

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market failure, such as in rural p rimary education and basic health; or where there is an urgent need for providing public services to the poor and vul nerable. More studies are needed on who benefits from subsidies and tax exem ptions, and whether these are consistent with the objective of building a “harmonious society”.

China, Vietnam and other transition econom ies should review their domestic policies on subsidies from the perspectives of econom ic and social welfare and ensure that they comply with WTO rules. They could reso rt to the WTO Dispute Settlement System to ensure that the applications of US CVD and AD applications are fully consistent with WTO Agreements, as they deem appropriate. And they could participate actively in the rules negotiations on the use of trade rem edy measures in the W TO Doha Round. Trade remedies for non-m arket economies have b ecome more com plex and challenging. In addition to complying with WTO Agreements and dealing with the technicalities of AD and CVD m easures for them , non-market economies would be even better off if an expedited entry to the “market economy” status could be negotiated under WTO.

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