China

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Centro do Comércio Globale Investimento

IS CHINA A MARKET OR A NON-

MARKET ECONOMY?

Implications for the rules of the WTO and the textile sector of Brazil

Center for Global Trade and Investrnents - EESP/FGV

Coord ination: Prof. Vera Thorstensen

Research Assistaitis:Daniel Ramos

Carolina Mül!erJosé Stucchi

Thiago NogueiraFernanda Bertolaccini

juIy, 2012

INDEX

1. INTRODUCTION . 7

II. TEXTILES AND CLOTHING SECTORS TARIFF OVERVIEW . ................................................ II

l.Brazil .........................................................................................................................................12

2. Argentina ......... . ......................................................................................................................... 14

3. China .........................................................................................................................................15

4. Mexico .... . .................................................................................................................................. 17

5. United States .............................................................................................................................20

6. Conclusioris .................................................................................. . ............................. ...............22

III. COMPETITION WITH CHINESE PRODUCTS ...................... . .................................................... 23

111.1. THE ISSUE OF EXCHANGE RATES ...................................................................................23

1. Irnpacts of Exchange Rates on Tariffs ......................................................................................25

1.1. Effects ofexchange rate rnisalignments on market access obligations ...... . ....................... 27

1.2. Effects of exchange rate misalignments on exporters' compctitiveness.............................14

1 .3. Coriclusions ......... . ....................................................................................... . ...................... .38

2. Legal Aspects of Exchange Rate on Trade ................................................................................19

2.1. Exchange rate and the WTO ..............................................................................................40

i. Exchange rales and IMF - Are exchange rales an exclusive matter ofthe IMF? ... . ........ ..40

ii. Exchange rale inipacts on the Multilateral Trade Systeni. ................................................ 41

2.2. WTO Agreements and the exchange rate issue .............. . .... . ......................................... . .... 49

1. Article XV ................... . ...................................................................................................... 49

ii. Article XXIII .......................... ... ... . ................................................................... . ................ .52

iii. Trade defense reniedies .................................................. . ................................................. .54

iv. Article II: 1 .........................................................................................................................59

v. Article 11:6.. .................................................................................................. . .................... 61

2.3. Conclusions .......................... . ................................ . ............................................................ 62

111.2 THE ISSUE OF SUBSIDIES .... . .......................................................................... . .................... 64

1.WTO rules: GArI'. SCM and the Protocol of Accession of China ..........................................65

1. 1 WTO rules ........... . ........... . .................................................. . ................................................ 65

1.2 Protocol of Accession of China lo the WTO: conirnitments on subsidies ..........................68

2. Main characteristics of the Chinese Textile Industry ............................................. . ................ ..71

2.1 Adjustment and revitalization plan for the Textile Industry ...............................................78

2.2 Chinese Textile Industry: private and puhlic enterprises ....................................................80

3. A suhsidizedeconoiriy ..............................................................................................................82

3.1 Two rnodelsofdeveloprnent .............. . ......................................................... . ...................... 82

3.2 Chinese subsidies programs potentially applicahle to the Textile and Apparel Industry.... 87

i. Specific textile and clothing industry subsidies programs .................................................87

ii. United States and European Union countervailing investigations .................................. ..90

iii. US Counter notification and the 200-11st Chinese subsidy programs ..............................93

4.Conclusions. 97

111.3. TI-IE ISSUE OF STATE OWNED ENTERPRISE . 100

1. Definition of SOEs....................................................................................................... 100

2. Overview of SOEs in Chinese Economy ..................................................................... 102

3. Chinese commitments at the WTO .............................................................................. 104

3.1. Subsidies ............................................................................................................... los

3.2. Governrneiit Procurement ..................................................................................... 106

3.3. State influence over SOEs governance ................................................................. 107

4. SOEs and China WTO niles compliance ..................................................................... 107

4.1. State influence over the Economy......................................................................... 108

4.2. Governmental support and competitiveness ................................... ....................... 110

4.3. Chinese outward foreign direct investment........................................................... III

4.4. Government procurement...................................................................................... 113

5. Conclusions ................ ... .... . ........................................................... ............................... 114

IV. WTO AND CHINA: TI-IE ISSUE OF NON-MARKET ECONOMIES ........................... lis

IV. 1 DEFINITION OF MARKET AND NON-MARKET ECONOMIES ......................... 116

1. International definitions ............................................................................................... 116

2. National definitioris .................. . ............................... .................................................... 121

3. Conclusions.................................................................................................................. 128

IV.2 NME AT THE MULTILATERAL TRADING SYSTEM .......................................... 130

1. Tile GATT era.............................................................................................................. 130

2. The WTO era................................................................................................................ 135

3. The accession of China to the WTO ............................................................................ 136

4. Conclusions... ........................................................................... .................................... 137

IV.3 IMPACTS OF NON-MARKET ECONOMIES ON THE WTO SYSTEM ............. ... 139

1. Irnpacts on Multilateral Trading Systein instruments .................................................. 139

2. China's obligations....................................................................................................... 144

3. Conclusions ............................................................. . ..................... . ..... ......................... 150

IV.4. NME AND ANTIDUMPING: LEGAL CONSEQUENCES OF 2016 ...................... 151

1. Tile regular system of normal value determination...................................................... 151

2. The special system of normal value determination ...................................................... 153

3. 2016— Is it the end 7 .................................................................................................... 155

4. Is the NME concept in the Ad Note itupossible to reach? ........................................... 158

5. Conclusions... .................................... . ..... ..................................................................... 160

IV.5 CONCLUSIONS ON TH NME ISSUE....................................................................... 162

V. ARGUMENTS TO BUILD A CASE AGAINST CHINA ............................................. 164

1. Exchange rate misalignments ................................................................ . ........... ........... 164

2. Commitments on subsidies, state owned enterprises and other NME features............ 167

3. Conclusions .................................................................................................................. 169

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VI. SUMARY AND CONCLUSIONS . 171

I3IBLIOGRAPHY...............................................................................................................................178

ANNEX 1 - Table - Main Indicators of Industrial Enterprises above Designatcd Size - TextileIndustry(2009)....................................................................................................................................190

ANNEX 2 - Table - Chinese Textile Provinces Economic Indicators (2007-2010)..........................191

ANNEX 3 - AD/CVD Investigations against the PRC ......................................................................192

ANNEX 4 - European Union AD Investigations Against China by Sector .......................................193

ANNEX 5 - Remaining List of Subsidies Programs notified by China to the Comniittee on Subsidiesand Countervailing Measures in 2011 .................................................................................................195

ANNEX 6— NCTO Iist of 28 subsidies prograrns for Chinese textile sector.....................................198

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ACRONYMS

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AB - Appellate Boc/y (WTQ)148C - Agricultura] Bank of chinaAd Note - Second Ad Note to Paragraph 1 of GA TTAriicle VIilDA - Agreeinent on Implenientation of Article VI of die General Agreement on Tariífs ande

• Trade 1994 ('Agreement on Anliduniping)4SEAN - Association ofSoutheast Asian NationsBenelux - Belgiuzn, lhe Netherlancls, and Luxembouig

• BOC - Bank of china• CAMEX - câmara de Comércio Exterior ('C'hamber ofForeign Trade - Bí'azii,)

CB - China Constriiction BankCEMAP - center foi' Applied Macroeconomics froni FG V São PauloCGTI - Center for Global Trade and Investznent - EESP/FGVSão PauloCNTA c - china Nationai Textile and Apparel C'ouncilCNTEX - chiiia Textile Network coinpaiiyConiecoii - council foi' Mutual Economic AssistanceCTEI - China National Textile and Apparei couricilC VD - Countervailing DutiesDECOM - Depariaiziento de Defesa Comercial (Department of Trade Defense - Brazil)DoC - US Departmenl of cominerceDSB - Dispute Seuiement Boc/yEC - European CominunitiesEEC - European Economic CommunityEU - European UziíonFDI - Foreign Direci Ir, vestínen!FIE - Foreign Invesied enterprisesGDP - Cross Domestic ProduciGPA - Agreenient 0,, Governineni ProctirementGA TI' - General Agreement on Tariffs and TradeLIS - Harnionized Coi;iniodity Description and Codirzg System1CBC - Industrial and Coininerciale Bank aí chinaICTSD - Internadonal Centre for Trade and Siistainable DevelopinentIi'vfF - Iníernational Monetary FundITO - International Trade OigaiiizationLDC - Least Developed CouniriesMDIC - Ministério do Desenvolvimento, Indústria e Comércio Exterior ('Ministry o!Development. Industíy and Foi'eign Trade - Brazil,)Mercosur - Mercado C'oiizún dcl Sur (Conunon Soutlzern IVíarkei)MFN - Most Fa vored Natioii Principie (GA 71 Article 1)MOFCOM - Chinese Ministiy of ComínerceATCTO - National council of Textile Ozganizations (United Siaes)NEM - New Economic MechanismNME - Non-markct economyNPL - Non-Performing LoansOECD - Organization for Economic Co-operation and DevelopmentPTA - Preferential Trade AgreemeniRAM - Recentiy Acccded Members

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L INTRODUCTION

China acceded to the World Trade Organization (WTO) ia 2001. aftcr 15 years ofnegotiatiOnS. lts membcrship aI the Multilateral Trading System allowcd the country tobenefit from non-discriniinatory trealment by ali WTO rnembers, including acccss to theirinarkcts.

The hcnefits accruing from China's accession [o the Organization, cornbined with the highlycompetitive prices ol' Chinese products have hclped to boost the country's exports and itsdevclopment. la 2009, China becarne the World's leader cxporter (excluding intra-EU trade).In 2011. China's exports amounted to US$ 1,9 trillion'. In 2010, exports from the textilesector alone amounted to US$77 billion, placing China also as thc major textile exporter, witha share in World exports of 30.7%, followed by the European Union (EU), with a 8.3% share(considering only extra EU trade) and India, with a 5. 1% share.

This rapid growth of China represents a major chalienge for Brazil and its textile sector. Ia2010, Brazilian textile imports arnounted to US$ 3,78 billion, against VSS 2,58 biliion in2009, while the imports from China ia the sector amounted to USS 1,49 hillion, againstUS$0,90 billion ia 20092, showing a significant incrcase ia inlports that couid affect theBrazilian textile industry.

Thc accession of China to the WTO lias brought opportunities and chalienges hoth to Chinaand to other WTO members. ia one hand. China would he obligcd to comply with the rulcs ofthe Multilateral Trading System, thus protecting other memhcrs froni unfair trade pract icesthat couid be promoteci by thc Chinese governnient or producers, whiic it wouid he assuredthat China did aol receive any discriminatory treatmcnt against its products or un!'air barriersto its trade. On the othcr hand, the significant weight of Chinese cconomy and thc fact that thecountry was still ia transition from a state-capitalism economic model towards a markct-oricnted one hrought inipacts to other menibers' econoniic activities and uncertainlies aboutthe application of WTO ruies.

Thc Multilateral Trading System was created ia the 1940's with the GATT, which containedcicar objectives to liberalize trade and to promote trade as an instrument oU economicdcvclopment. The system was estahlished hy market ccononiies, based ia niarket CcOnoiriyprincipies and rules. Airning to be multilateral, it gavc support and incentives to other marketand non-market econoniics (NMEs) to participate ia its activities, as a way to develop auniversal trading systcln. During its history, GATT gave little consideration to the impacts ofNMEs to Lhe systeni, once such cconornics were cilher small or in transition to marketoriental jon.

With thc cstahlishnient oU lhe WTO in 1995, this little conccrn was transformcd into a clearpresuniption that ali acccding countries - in transition or NMEs - would transformthcniselvcs mio niarket economies, accepting lhe principies and the ruies guided hy a inodeiunder niarkct orientalion.

Thc analysis prcsented in this research ciearly shows that thcse presumplions were negotiatedand acccpled ia ali accession processes. Ali eCOnomiCS invitcd to participatc in the WTO

\V'I'O Statistic Database - Tiuw S''ries on inwiijaíionnl Trach'V'FO. Inwn,ationa/ liade S'aiistics 2011.

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negotiate and agree to the conimitment of undertaking Lhe necessary reforms to migrate tomarket Ccofl01flCS, with the objective oU participating fuliy in lhe Multilateral TraclingS ystern.

China was Lhe first major hybrid econorny containing NME features to accede to lhe WTOand was followed by Viet Nam. The recent accession oU Russia4 and olhei- fonner ccntrally-planned economies is attracting attention Urom other WTO members and renewing lhediscussion ou the issue of NME features at the WTO.

When acccding, China cornmitted to undertake several reforms, regarding, e.g., governinenisubsidies and the management of state-owned enterprises (SOEs), and liberalization oU itsbanking system which would assure a levei playing fieid between China and other economiesunder Lhe WTO system. This purpose is cleariy stated in tis Protocol of Accession5.

Nevertheless, there is strong evidence that. ten years after accession. China sull lias notcompleted its transition process. A recent study about China puhiished by the World Bankchina 2030 - affirms that the governrnent continues to dominatc key sectors and that dose/inks between lhe governineni, big banks, and state enlerprises have crealcd vested interestsibat inhibil refoi'ms and contribute (o contiiuied ad lioc state interventions iii lhe econom.

Furtherinore, the report states that

China's transition to a rnarket economy is incomplete in niany arcas. A mix of market and non-marketmeasures shapes incentives lbr producers and consumers. and there remains a lack of clarity iiidistinguishing lhe individual roles of government state enterprises, and lhe private sector. It is imperative.therekre that China resolve these issues, acceleiate structural ret'orms and develop a market-bascd systemwith sound foundations in which lhe state focuses 011 provi(ling key puhlic goods and services - while avigorou,, private sector plays lhe more important role ol driving growth7.

The report of flue World Bank cxpressly states that China is stili not a market economy,despite thc reforms it lias aiready undertaken, and that there are distortions on its economythat impacts on the Uairne.ss of competition 8 . China still relies heavily Upon SOEs toimplement public policies conceived by the Communist Party. Considering the internalopposition to furthcr Jiberalization and privatization reforms, some commcntators are startingto douht tliat China could ever complete iLs transfornlation into a fu!l market economy, given

'lhe Working Party Report on lhe Accession of China constantly refers (o lhe Chinese econornic model as iiitransition lowards a Socialist Markei Economy. 'l'he detinition ol' a Socialist Market licoiiomy is 1101 given. biitMemhers siiinal to lhe fact that lhe Chinese economy hears characteristics of both market and non-marketeconomies. In this sense. Chinese economy could be considered as a hybrid economy. Sce \VTO. Reporto! t/wft'oi'king P;uiy on lhe Accession o! China. l47721C( '/CHiV/49. October 2001. para. 4Russia had ratitied lhe WTO Agreemeni under its national Law in July 2012 and became a fuIl niember of Lhe

WTO.See. inter alia. provisions concerning Lhe liberalization of the Right tu 'I'rade (Article 5). Non-Tarit'f N'leasures.

especially paragraph 3 (Article 7). Price Controls (Article 9) and Price Comparability in Determining Subsidiesand Dumping (Article IS) in WTO. Protoco/ o! Accession of the People is Republic of China. WT/1J432, 10Novembei' 2001. Julian Qin refers tu these obligations as being "obl igations to practice market economy" and"oblieations concernino domestic L'overnance". See QIN. Julia Ya. "China. India and WTO Law". iaSORNARAJAH. Muthucumaraswamy: WANG, Jiangyu. China. índia and lhe ínternational Econondc Order,Carnhride University Press. 2010,1)1) 172-173

WORI .1) BANK. china 2030 -- Buildin,g a Modera, IIar,nonious, and Creative iligh-Jncoine Society.Conf'erence Edition. Washington. l)C. 2012. p. 25.'Ibid.. p. 255 lbid.. p. 120

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the intrinsic political Iinks bctween thc Cornrnunist Party, SOEs and the means by whichpubi ic policies are implemented.

Thcsc NME features o[ China bring several irnpacts to the Multilateral Trading System. Sincelhe Multilateral Trading System was nol designed to regulatc trade practices of NMEs, neitherto force thcm to transforrn their economies towards rnarket ones, lhe WTO is unabie toproperly supervise China's internationai trade, failing to prevenI unfair trade such as thepractice of subsidies, the promotion of SOEs and exchange rale misalignrnents to subsidize itsexports.

Some relevam questions can he proposed:

• Is the WTO au organization created under markct economy principies and mies or does itprovide rules for both market and NMEs! If lhe laner is acccpted. are the rules of Ad Note toGATT Article VI (ou antiduiriping for NMEs) and GATT Arlicle XVII (state-owncdenterprises) sufficient? íU O• Can ii he assumed that, by acccding lhe WTO. China, Viet Nam, Russia and olher countriesto the WTO committcd to transform themselves mio inarket economies, or can two economicsystems he allowed! 'y

• Is the WTO properly cquippcd with mcchanisms to supervise for fair trade bctween statc-Iedand market-ied economies? Are the principies and rules established by lhe market econoniiesin the WTO efficient to regulate state-led economies?

• Is it possible to foresee a negotiation of a set of rules to deal with NMEs or hyhrideconomies when the transition processes are paraiyzed?

• \Vith growing impacts of iarge NMEs participating in thc WTO and no ciear progrcss intheir transition processes, what can he done to answer this new chailenge: a panei, a newround, a China Round. a NMEs Round? TJ j \ØJ c'/J 1,

• Should some preIiminry steps be taken such as a Working Party on NMEs to disct s tiissuc 2 JOc() fj

uu& uUJiWith thc impasse oU lhe Doha Round and thc lack of political will to unbIok ii. either WTOmeinbers take the chailenge to their hands and negotiate new niles to accommodate thischailenge, om, once again, this expiosive issue wili go to the Dispute Settienient Body (DSB).l'he diplomatic-juridical —tribunal- of the WTO will have the task of soiving a disputethrough ruiings of lhe Appcllate Body (AB). hased on amhiguously old articies. Once again,negotiation and diplomacy will be surpassed by conflicts that wili force lhe adaptation of rulescreated to iinforesccn situations.

The research

This research work airns to discuss the participation of NMEs in the WTO. The case to be(Iiscussed is China, nol only due to its preeminence as an exportcr but also because of itsimpacts ou lhe principIes and rules of the Multilateral Tmading System and on the fair tradeproinotedi by the Omganization.

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The report will, firstly, presem an outlook of markct access rules for the textile sector inseveral countries. In the foliowing. it shall analyze the main features of China's econorny thatcan have an impact on international trade and its legal consequences to the WTO systeni. Thel'irst feature is the misaligiiincnt of the Chinese currency that gives an incentive to Chineseexports and crcates new tariff barriers to its imports. Tile second feature is thc massivegranting of subsidies to thc Chinese indusiry. resulting in unfair trade practices. The thirdfeature is the large presence of SOEs iii the Chinese cconomy. Since SOEs are closely linkedto the government, it is difficult to assure that they act under rnarket conditions and are notintiuenced by siate intervention. Ali these features can constitute violations of the WTO rulesand of China' s cornrnitments and could be addressed through negotiations or hy lhe WTODispute Seulement Systeni.

Finaily, the issue of NMEs participation aI the WTO will be discussed. The section willanalyze whether lhe presence oU NMEs such as China can be conipatible with the WTO rulesor if the spccificities of such econornic niodel allow the country to bypass thesc rules, turningineffective multilateral tradc rules. Tile section will also discuss which instruments of theWTO agrcements are affected hy NMEs and what are the possihle solutions to Lhe NMEissue.

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II. TEXTILES AND CLOTHING SECTORS TARIFF OVERVIEW:Braziis main partners

Textile production is a traditional industrial sector iii rnost countries. lts profits and capitalaccwnulation were the main componenis of the Uirst Industrial Revolution. Ever since, itsindustry occupies a key role in many countries' strategic growth pianning. In 2010, thetextiles and clothing global exports ainounted to US$ 602,1 hillion, and global imports totaledUS$ 632,6 billion9.

In thc GATT era (1948 - 1994), international trade niles harely affcctcd the sector, sincernany exceptions were negotiated among export and import countries, through quotas andcontrolled growth rates. Laler on, during the negotiation of the Uruguay Round (1986 - 1994)and the estahlishinent oU thc WTO (1995), international trade on textiles was liberalized,prcssed by lhe development of international trade and lhe globalization of production. Thecconomic interdependence oU commerce was significantly increased and stimulated, pressingfor lhe negotiation of a ncw agrecmcnt, the Agreernent on Textiles and Clothing, with aprogressive disniantlement of quotas and barriers to trade. The rules negotiated incorporatelhe textile and clothing sectors in the GATT/WTO framework imposing general rules to thesectors in a period of 10 years. Among these rules: bound tariffs, prohihition of quantitativercstrictions, antidumping, countervailing measures and general safcguards, ali of themsuhmitted to Lhe mechanism of dispute settlemcnt, the juridical-diplomatic-tribunal- of theWTO.

By GATT/VVTO rules, ali developcd inernbers and the majority of developing oncs houndtheir tariffs, including textiie and clothing sectors, classified in the Harinonized CommodityDescription and Coding System under chapters 50 to 60 for textiles and 61 tu 63 for inade ups.

Through lhe rounds of negotiations, each member liberalizes these sectors following (lifferentsirategies and hargaining paths, rcspccting different reduction goals. The result is ihat,l)resefltly, developed and developing countries have different tariff profiles, with developingcountries prescnting significantly highcr tarifís than thosc of devcloped ones. In contrast,rccently acccdcd members (RAM), such as China and Russia, 1)resent lower tariffs than othcrdeveloping nicmbers, since they had to negotiate their acccssion after lhe end oU thc UruguayRound.

Ii is relevam to ernphasize that thcrc are sectors ainong lhe 1-IS chapters 50 to 60 that areconsidered agriculturai goods and SO subject to lhe Agrccmcnt on Agriculture and subject toLhe rules oU this Agreeinent, including higher bound tariffs. Those are: raw silk and silk waste,(lIS heading 5001 to 5003). wool and animal hair (HS heading 5101 to 5103), raw cotton,waste and cotton carded or combed (1-IS heading 5201 to 5203), raw Ilax (HS heading 5301)and raw Ilemi) (HS heading 5302), also known as fiber crops.

The following pages will analyzc the tariff protiles of the textile and clothing sectors forBrazil and four of its main trade partners: Argentina, China, Mexico and lhe Unitcd States.Tile objective is to highiight the main charactcristics of ihese profiles, since they are nol oniydevclopcd countries and developing ones, but also acccded GATT/WTO in different periods,which explain importam differences of tariff policies.

WTO. Tim( Sedes Database. Available at:<hup://stat.wt.orStatistieaIProerarn/WSDBViewData.aspx?Laiwtiuic=E>. Viewcd at: 1 3 Januaiy 2012.

IU

• Bound AVG

hÉ Applied AGV

This aiialysis kvill he Uurther revieved vhen Lhe study ot Lhe impacts of exchange ratemisalignments is introduced, to explain why Brazilian competitiveness is heing uridermined.

1. Brazil

Brazii's tariffs on textiles and clothing sectors are compietely bound and present ad valoremrates. According to the WTO Tariff Profile 2011, applied tariff averages are lower than thebound tariffs for textiles, but appliecl rates were increased to Lhe bound leveis for Lhe clothingsector.

Brazil's Tariff Profile

Textile sector CIottung sector

Source: WT() Tariíf Protile 20110AVG = average

There is au historical debate ou Lhe issue of high differences between bound rates and appiiedones. Developing countries have deíended these differences for Industrial Policy reasons,since tariffs are the only ailowed protectioil under GAYI'f'vVTO Law, and offer an importantfiexibility to deal with ternporary terms of trade iosses. This called "policy space" liasrcceived many criticisms from developed countries, that ciaim non transparency from theirdeveioping partners.

According to WTO data, in 2010, from 108 textile subsectors in HS 4 digits, 63 (58%) haveapplied MFN tarifí.s varying from 4% to 18%. Some products, such as carpets and 43 of the44 clothing subsectors have appiied tariffs exactly at Lhe stipulated bound limit of 35%, asshown beiow:

WTO. i'iuu' Seii's Di ibase - Brazi/. Available ai:<hu p://stat.wto.orgrrarifmfileAWSDRTarifFview.aspx?Language=E&country=BR>. Viewed ai: 29Febniary 2012.

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40,0%

35,0%

30,0%

25,0%

20,0%

15,0%

10,0%

5,0%

0,0%

Brazil Applied and Bound Tariffs...,. II1 ,..,WTO1D

Coltan

40%

20%

Source: WTO Tariff Data. Eiaborated by CGTI.

(ornrI. H€.)

Bund Tvff

tripk avere)

-4 li '0 o - io G -4 '0 O m r'. n ,'. .i A m - -4 iA 0' N o o -4 0' 0' 'i N. 0' 4 '0 fl P.

0' li 0'0'0'0'0'0'0'0'0'0'0' AiA 0 0'0'0'0'0' ' '0000' '000'

Considering average tariffs under lhe HS 4 digits classification, bound tariffs are consoiidatedai 35% with some products presenting bound rates at higher leveis, such as cotion ai 55%, orai lower rates, such as nonwovens ai 28.3%.

Proclucts whose appiiecl tariffs are above 25% are included in lhe clothing sector such aswoven fabrics: silk, wool, animal hair, cottoii, fiax,jute, yarn, siaple fiber, felt, chenilie, terry,gauze, tulle, plastic fibers, hand-woven tapestry, knitted or crocheted and metal thread,summing 35 items under textile sector and 49 items under clothing sector.

The higher rates are given to raw cotton, cotton waste and cotton, carded or combed,presenting a 55% bounded tariff. Nonetheless, the respective applied tariffs are relatively lowai 6% and 8%. This is the largest difference in Brazilian 50 - 63 4 digil 1-IS profile. Theabove-the-average bound tariff of 55% reflects the treatment given to cotton as a sensitiveagricultural product in Brazil, in respect to the Agreemeni on Agriculture.

Apart from carpets, the appiied tariffs of textile products are subject to tariff escaiation: tariffson raw materiais and their scraps are around 6%, yarns and sewing tlireads are near 15% andwoven fabrics are near 25% while tariffs in the clothing sectors are applied at the bound rateof 35%. Tu general, tariffs do not vary from these four tariffs leveis.

Brazilian's tariff profile is very similar to Argentina's: bound tariffs have some slightdifferences, but Lhe applied tariffs, apart from the products on Mercosur's Exception List,follows lhe Mercosur common external tariffs. Furthermore, they hotli protect carpets and lhe

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40,0%

35,0%

30,0%

25,0%

20,0%

15,0%

10,0%

5,0%

0,0%

clothing sector by applying tariffs at bound rates leve!, and both app!y higher tariffs to goodswith higher value added. In general, both rnarkets present relatively high tariffs (23,2% MFNapplied rates average on textiles and 35% on clothing) and are subject to tariff escalation,from !ower to higher added va!ue products.

It is relevant noting that Brazil and Argentina are both part to the Mercosur - MercadoCorniínde/ Suz' (Cornrnon Southern Market) and have, in general, the sarne applied tariffs. TheMercosur's Cornrnon Externa! Tariff (TEC) accepts sorne exceptions that each country canpresent to their Lists, aliowing thern to apply different tariffs. Regarding textile and appare!sectors, Argentina lias included products in three 4 digit HS headings: synthetic filament yarn(5402); narrow woven fabrics (5806); and tyre cord fabric of nylon (5902). Brazil liasinc!uded one 4 digit HS heading: Cotton, not cai ded or cornbed (52.01).

2. Argentina

Argentina's tariffs on textiles and clothing sectors are cornpletely bound and ad valorein.According to Lhe WTO Tariff Profile 2011, the bound average of the textile sector presentsthe sarne level for clothing. But applied average for textiles is lower than the ones forclothing.

Argentina's Tariff Profile

•BoundAVG

• Applied AGV

Textite sector Clothing sector

Source: Wi'() TarjO PinOte 2011AVC = average

'lhrough textile and clothing sectors tarifï analysis, it cai) l.)e ol)served that Lhe hound íaiiffsare consolidated aL ai'ound :35%. Also according to WT() Data ou Argentina, iii 2010, itsapplied MFN tarifís were, ou average, 23.1% for textiles and 35% ffir clothiiig. Someproducts tariífs, such as CarpetS and the clotliing sector, are closer or cxactly aI tlie stipulaledbound lim it , as showii below:

\'VT(), /i,,u' 5ei ,i's I)i I,,e,i - Available at:<hnp://siai.wto.urgíl'ariflPiofik'/WSI )UTariffPFView,aspx?I .angua '=F&Couniry=AR>. Vicwed aI: 29Fehriiary 2012.

14

40%

35%

25%

20%

15%

10%

0%

0%

—*--AppIldTffs

(rnpte .ere),uiidTff

ãmpte crge)

Argentina Applied and Bound Tariffs15C43 .oc.WTO.2l

e

e

e

e

e

e

e

e

e

O O O O - O O O O O .4 O O O O 4 .4 O O O O O O O O .4 O O O O .4 -40 O -4 -40 O004 .1 44Nr4,n LA LA '1 LaLaLALaO w N o LALAL OS 0444-1-4 NtI S14 LALAlIS La La (A La La La La La La La La LA La LA La lIS IA La LA La 5/5 IA La O O 'O 'O 'O 'O 'O 'O 'O 'O 'O 'O

Source: WTO Tariff Data. Elaborated by CGTI

At 1-IS 4 digits ciassification, products whose tariffs are above 25% are woven íabrics: silk,voo1, animal hair, cotton, flax, jute, yarn, staple fiber, felt, chenilie, terry, tuile, hand-woventapestry, knitted or crocheted and metal thread, as well as ali clothing sectors, reaching anamount of 35 items under textile sector and 49 items under clothing sector.

Apart from carpets, the applied tariffs of textile products are subject to tariffescalation: tariffson raw materiais and its scraps are around 6%, yarns are near 15% and woven fabrics are near25% while tarifl's in the clothing sectors are applied at the bound rate of 35%. In general, theproducts do not vary much from these four tariffs leveis. Nonetheless, in Argentina's tariffproflie, the higher the value added in a textile or clothing product is, the higher are the appliedtariffs.

Although they have the sarne overail external applied tariffs, each Mercosur member liasnegotiaed their bound tariffs separately. In this sense, it is worth to also anaiyze Brazi1s tariffprol IR'.

3. China

China's tariffs on textiles and clothing sectors are 100% bound and aí! valorein. According tothe WTO Tariff Profile 2011, there is a minimum space between the consolidated tariffaverage for thc textile and clothing sectors and those applicd (lhe so-caiied "poii(-y space"):

15

• Bound AVG

• Applied AGV

18,0%

16,0%

14,0%

12,0%

10,0%

8,0%

6,0%

4,0%

2,0%

0,0%

Chinas Tariff Profile

Textile sector Clothing sector

Source: WTO l'ariff Profile 201112AVG = average

Also, according to WTO data on China, in 2010, of the 108 textile subsectors in HS 4 digits.104 (96%) had applied MFN tariffs varying frorn 4% to 15%. The only textile sectors whichpresented appiied tariffs above 15% were: wool, fine or corse animal hair (HS 5101, 5103 and5105) and cotton (HS 5201 and 5203). Regarding the clothing sector, China's appiiecl tariffrates range from 14% to 20%. Almost ali products have appiied tariffs dose to or exactly atlhe stipulated bound limit, as shown beiow:

2 \'VTO, Time Se,ie Dalnise - AviilabIe at:<hup://stat.wto.oi'gfrarifíProfi1e/WSDBTariffPFView.aspx?Languav= 1&(;oufltr y=cN>. Vicwd dt: 29February 2012.

16

China Applied and Bound Tariffs—pi. po ,t HS 4 ditt, SO-$3 , WTO IZ 0101

45%

Cotion40%

::LI IIC•dwooIj

25% 31.1 aramllh -

20% - -

15% - Wo& Cotton Flax and

fabric lutofabrc

fi é,

Sntth&tknbpi* Car!ct - -- _iinum

fibõnflb,k

Sp,dl fob,,

Apphtd Tu iff o

(mpk n,crogc)

• BounJT.ffo

(ornpI rC.)

ov,roa. Cuts

DIoue, shirts, suts,underpan.

0%"4 41% ('400 'lIA 01.-4 '00#fl?.. 'O (.-44fl'O(.. (4.1 IA 0% "4 00 4'. .1 LA 0(01'. CO "4(01'. NO O O O .4 O O O O O -1 O O O O .1 .4 O O O O O O O O -4 O O O O .1-40 O .4-4 O O0 0 .4 -4 .4 (4 (1 (4 CO CO CO 't 't IA IA IA IA oO 1'. CO CO CO CO CO O O .-4 .4 .4 .1 .4 (4 (4 (4 ((4 CO CO

Source: WTO Tariff Data. Elaborated by CGT!

In the textile sector, the bound and appiied tariffs for raw materiais and its scraps are around

9%; for yarns and sewing threads, arouiid 6%: and for woven fabrics. near 11%, tariffs in the

clothing sectors are appIied at around 15%. As seen, China's appiied tariffs, except for raw

materiais and its scraps, are subject to moderate tariff escaiation.

'Fhe products witl'i tariffs above 25% are: vooI and cotton, carded or combed, with 38% and

40% applied duties respectively, revealing clear interest in protecting those specific

agricultura! sectors (HS sectors 5101, 5201 and 5203). Also in the textile sector, a !ess

accentuated tariff peak is uoted on synthetic stap!e fibers, carpets and linoleuni. The clothing

sector's tariff peaks, concentrateci Ou overcoats and suits, vary from 18.8% to 20%, not very

distant from the sector's 16.0% MFN applied duties average.

la general, China's market access presents mecliunl tariff rates (9,6% MFN appiied rates

average on texti!e and 16% ou clothing) and are suhject to moderate tariff escalation, froni

lower to higher added value products.

4. Mexico

Mexico's tariffs ou textiles and clothing sectors are also 100% bound and ad valoreiii.

According o the WTO Tariff Profile 2010, there is a significant difference between the

consoiidated tariff average and those appiied for textile and less for the clothing sectors, just

as other developing WTO members that are not recently acceded rnenibers:

17

• Bound AVG

Applied AGV

Mexico's Tariff Profile


Source: WTO Tariff Profile 2011AVG = average

Also accordiiig to WTO data, in 2010, ofthe 108 textile subsectors in HS 4 digits. 19 (17,6%)were duty-free, while other 88 subsectors (81,5%) had app!ied MFN tariffs varying from 2%to 15%. Regarding the clothing sector, Mexico's applied tariff rates range from 15% to 30%,with 39 ot' the 44 clothing subsectors (88,6%) presenting applied tariffs of 30%.

Tile textile items present a difference of approximately 20% between bounded and appliedtariffs wliile the clothing sector has an average oU 5% difference, as illustrated below:

e

1

1

01

' \' TO. Ti,ijt Seiie.s Datalxist - ifr.vico. Available ai:<http ://stat.wto.orTT'ariffPrnflIeAVSflBTarjffPFVjevaspx?Language=E&Cotiinry=MX>. Viewed ai: 29Fc'bniary 2012.

18

40,0%

35,0%

30,0%

25,0%

20,0%

15,0%

10,0%

5,0%

0,0%

st_

25%

20%

15%

10%

50%

Wool (otto.,45%.

LI35Lit

30% 1--lU-i II- --

Wotneh shM,, juta,undetpanh, onrcoal,. —*—AppliedT&lffs

I t (sampre

'Boundi,riffs(mpIe avtre)

Tntil. Fabrica

Knitt,d Fabrica ,nd

Mexico Applied and Bound TariffsãnpIeanrctnt 1G1d11u(3043)-nurtemolzaoa)

'O O - G - 0 Offi,%M..iI,a,P-t1e4 Ia o, ri 'O 0'O,.I'Oo'MI'. fl 'O tI 'O0t400 000 t100 00t1 t1000 0000 CrI 0000 ti rIOOttti 00

Data Plahnratd hv

In spite of the 35% MFN bound tariff rate average for the textile sector, raw materiais and itsscraps have applied Lariffs of 0%, demonstrating an incentive to import such inputs. Theaverage applied tariffs for yarns, sewing threads and woven fabrics are around 15%. Even Lhetariff peak of terry toweling and similar woven terry fabrics, at 18,8%, is not lar from the13,9% MFN applied duties average on textiles.

In lis turn, apparel and clothing have 30,0% MFN applied duties average, with Lhe exceptionof bags and sacks and seis consisting of woven fabric and yarn for making rugs and tapestries,both at the tariff of 15%.

The protection on cotton, wool and fiber cultures can be justified by their ireatment assensitive agricultural products, condition which is under the rides of the Agreernent onAgriculture.

In general, Mexico's market access presents medium tariff rates for the textile sector (13,9%IMFN applied rates average) and high tariff rates for Lhe ciothing sector (30% MFN appliedrales average). The applied tariffs are subject to tariff escalation, from lower to higher addedvalue products.

[k

• Bound AVG

•Applied AGV

S. United States

United States' tariffs on textiles and clothing sectors are 100% bound and ad valorem.According to the WTO Tariff Profile 2010, there is almost no difference between boundtariffs and applied ones for the textile and clothing sectors.

United States Tariff Profile


Source: WTO Tariff Profile 201114AVG = average

Also according to WTO Data, in 2010, of the 108 textile subsectors in HS 4 digits, 20(18,5%) were duty-free, while other 68 subsectors (63%) had applied MFN tariffs varyingfrom 0.5% to 10%. Regarding Lhe clothing sector, United States' apptied tariff rates rangefrom 0% to 20%, with 20 of lhe 44 clothing subsectors (45,5%) presenting app!ied tariffsfrom 4% to 10%.

For both the textile and clothing sector, the applied tariffs are very dose to the bound limits,as shown below:

14 WTO, Time Series Database - UidtedStates. Available at:<http ://stat.wto.orgfFariffProfile/WSDBTarjfPFVjew.aspx?Lanuage=E&CuflryU5 > Viewed at: 29February 2012.

20

14,0%

12,0%

10,0%

8,0%

6,0%

4,0%

2,0%

0,0%

USAAppIied and Bound TariffsmpI. .nnp,flRI4dIØL$5O4-aouintWT0{200)

25%

r20%

stipIofibro yrn

wool fabrFc wid fabrlc

15%fflain,,t M.talk ya,n ICnittod(abrk and fabrk fabrk.

cottonya'nwooÇwasto andtabrk 1and cai

10% --- -

BIouseç dilit;. sult%und*rant,, avercoat.

Kiiitted 0Jac*eto 1 " Knittod

and 1 tratk,ujt,•hirts BahWi

1 /• Doundtwiff,

(simple averoge)

4-Applied TNiHS(sinple avtraje)

ti Ino,,ioomNmN,-iIAmNn,1Lnonwo,,1u.,nN o o ri00 - 00000 '40 0004'4 0000000 0'4OOOO ,4-00-00

.0 'A (A A 'A A (A A A 'A A A

nÍIrr WTfl T,rifffl.ta Vl,ü,nr,rpd hv

What can be noted from USA tariff profile is that the pattern of increasing tariff rates forhigher value added products presented in the other analyzed couritries profiles are not sosignificant. Also, duty-free is not restricted to the fiber crops agricultural producis and not aliagricultural products are duty free. In general, woven fabrics' tariffs are higher than the sarnematerial's yarn. According to WTO Tariff Profile, in 2010 the MFN applied duties averagefor the textile sector was 7,9%. There are, nonetheless, tariff peaks, such as the 15,1% appliedto woven fabric of combed wool or of combed tine animal hair, or the 14,9% apptied towoven fabrics of metal thread and woven fabrics of metalized yarn.

Also according to WTO Tariff Profile, in 2010 the MFN applied duties average for theclothing sector was 11,7%. It reflects the higher protection rate for clothes and apparel incomparison to the textiles 7,9% average. Also, the clothing sector can have its tariffs clearlydivided between knitted or crocheted and not knitted or crocheted articles of apparel andclothing accessories, Éhe first having higher tariffs than the latter. Specifically, the tariff peaksmade of knitted or crocheted are shirts, at 16,5%, babies' garments and clothing accessories, aL16,7%, and track suits, ski suits and swimwear, at 19,5%. The tariffs for not knitted orcrocheted items, such babies' garments aiid clothing accessories at 15,2%, and brassiàres,girdies, corsets, braces, suspenders, garters and similar articles and parts thereof, at 15,1%, aresignificantly !ower. There are no tariffs, bounded or applied, above 25%.

21

6. Conclusions

At first, it can be observed that ali studied countries have tariffs on textiles and clothingsectors 100% bound and ad valorem. In addition, it can be noted that the United States has theiower bound and applied tariffs for both textile and clothing sectors:

.)UUI ÇC. VV 1 J t aLui LJOLd. L.laIJuLaLcu UJ

AVG = average

When analyzing the frequency distribution of the countries' tariff tines and import values, it isciear that the United Siates have the lowest MFN applied tariff average on non-agriculturalproducts: 74,4% of ali its tariffs are below 5%. Brazil, in contrast, have the higher MFNapphed tariff average on non-agriculturai products: 40,4% of ali lis tariffs are above 15%.

In comparison to Argentina, Brazii, China and United States, Mexico's tariff profile ontextiles and clothing presents the higher difference average between bound and applied tariffs.China and the USA have applied tariffs dose to their bound timits.

Except for the USA textiie profile, ali other countries present ciear pattern of tariff escalation.li also app!ies to the clothing sector, for which ali countries appiy higher tariffs.

22

III. COMPETITION WITH CHINESE PRODUCTS

There are some important features of Chinese economy directly affecting international tradeand distorting the competition of Chinese products. This Chapter will present an outlook ofthese main features and the legal consequences under the WTO system.

The first issue to be analyzed is the misalignxnent of Chinese exchange rate. Calculationsshow that the rerzminbi is substantially devaluated, which can represent an incentive toChinese exports and an additional barrier to its imports.

The second issue is the granting of subsidies by the Chinese government. The WTO has strictrules on the granting of subsidies, which can Iead to unfair trade. There are several subsidyprograms that may be affecting international trade and may be inconsistent with WTO rules.

Finaily, the third issue is the management of SOEs. These companies, present in the Chineseeconomy in a very large number, can be influenced by state policies instead of acting undercommercial considerations, causing distortions to trade.

111,1. THE ISSUE OF EXCHÀNGE RATES

Since the GATT, the International Monetary Fund (IMF) and lhe World Bank were created inthe 1940s, a strict division of functions was established: the GATT would be responsible forinternational trade liberalization, the IMF would maintain the stability of exchange rates andbalance of payments, and the World Bank would provide funds to Europe's reconstruction,after lhe Second World War. At that time, lhe multilateral trade system was created based onlhe dollar/gold standard, and even after it was changed to the flexible exchange system in lhe1970s, the exchange rate issue remained controlled by the IMF, not being incorporated neitherby lhe GATT nor the WTO.

Whi!e the World was under lhe US and EU (Lhen, EEC) economic leadership, wheneverexchange rate misalignments affected trade relations, the issue was discussed and negotiatedby only a few parties, as demonstrated by lhe Plaza Agreement, in 1985. This agreement wasreached by the US, lhe UK, Germany, France and Japan, and lhe main purpose was todevaluate the doilar. This kind of "agreement amongst a few" began to be challenged aftersome developing countries reached a more active position in lhe international trade arena,especial!y after China's accession to the WTO and its prominence as Lhe World's biggestexporter.

It is importam toto clarify how lhe WTO has been dealing with the exchange rate issuethroughout the years. Since 1947, Article XV of lhe GATT has estabtished rules on exchangearrangements: Article XV.4 states that contracting parties shall not, by exchange action,frustrate the intent of the provisions o! this Agreernent, nor, by trade action, the intent of theprovisions o! the Articles o! Agreerneril af the Internationai Monetary Fund.

Furthermore, lhe exchange rale concept is both menlioned in Lhe Agreements on Antidumpingand in the Agreement on Custonis Valuation, bul only with the purpose of indicating lhat lheofficial exchange rates informed by governments are the ones to be considered in lheinvestigations. Due to lhe escalation of exchange rate misalignments, which is responsibte foropposing lhe US and China, as well as other Asian countries, several experts are examining

23

the issue concerning the exchange rate irnpacts over international trade regulatory system, inorder to define whether these misalignments could represent a violation of Lhe WTO mies.Although many attempts of using trade remedies, such as antidumping and countervailingmeasures, to offset the exchange effects have been made, the results appear to be legailyquestionable, since trade remedies were not negotiated or agreed as mechanisms to inhibit theuse of exchange rates as unfair trade.

In other words, the issue conceming how exchange rate variations affect trade has never beenincorporated to the WTO mies. The oniy consensual rule was that exchange rate is an IMFmatter. Any attempt to raise this issue inside WTO rooms would fail.

The problem is that the IMF is an international organization which does not have anenforcement mechanism such as the WTO's DSB. It decides the relevant issues through anagreement amongst the most influential parties (those who own more voting power), in apolitical way. Unlike the WTO, which decides by consensus, the IMF does not have anegotiation nature.

Due to the intensificatiori of the debate on the effects of exchange rates on trade since the2008 financial crisis, the subject has been addressed to the 0-20. Howevcr, in the presentphase of multilateral crises, as expected, developed and emerging countries have failed to finda solution to the matter.

While experienced diplomats debate on how to raise the issue and trade iawyers attempt tofind a legal solution, economists have been proposing methodologies to calculatemisalignments of exchange mates in relation to some equilibrium rates. There are severalmodels for calculating equiiibrium exchange mates: the purchasing power parity, theequilibrium of Lhe current account, the equilibrium of assets and tiabilities fiows of a country,or the exchange mate based on the unit ef labor costs. Banks also estimate the levei ofexchange misalignment with the purpose of anticipating future fluctuations. When reviewingali these studies, it becomes quite evident that the magnitude and the extension in time ofthese exchange mate misalignments for Lhe main currencies are so significant that ignoringtheir effects on trade might undermine the objectives of the whole Multilateral TradingSystem.

V

The argument that different exchange methodoiogies produce different resuits cannot beaccepted any ionger. The main target is not to search for an estimate with absolute degree ofprecision, since this is the task of IMF, but to discover limits wh salignments can causetrade distortions. What reaily matters is to find out a threshold from where trade poticy

trumenecome ineffective and the WTO ruies might be nullified.

In sum, arguing that exchange rate is a matter exclusively of the IME's responsibility and thatir does not affect the WTO is to ignore Lhe obvious, that, indeed, exchange rates deeply affecttrade. The WTO cannot continue to ignore the effects that exchange rates have on the tradesystem and its rules, at risk of iosing touch with reality and transforming the organization imojust a sophisticated juridical. fiction!

Nevertheiess, after the financial crisis of 2008, persistent misalignments of exchange rateraised Lhe concemu of some WTO members that the issue should not be left unattended. Braziipresented a submission to the Working Group on Trade, Debt and Finance (WGTDF) in Aprit2011, suggesting a work program consisting in an academic research on the reiationship

24

between exchange rates and international trade (WT/WGT13FIW/53). In September 20th,2011, Brazil prcsented to the sarne Working Group a second proposai on the therne,suggesting the exam of available tools and trade rernedies in the Multilateral Trading Systemthat might allow countries to redress the effects of exchange rate misalignrnents(WTIWGTDF/W/56).

The WTO Secretariat presented its Note on a Review of Economic Literature in September2701, 2011. (WT/WGT13F/W/57), as mandated by the Working Group. Although an extensiverescarch, this work, encompassing the effects of exchange rates on economic fiows, did nottouch the issue of the irnpacts of exchange rate misalignment on WTO principies, mies and itsinstrurnents: tariffs, antidurnping, subsidies, safeguards, rules of origin, GATT Articles 1, 11,III, XXIV, just to name some of the mies that are certainiy being affected by exchange rates.In sumrnary, the WTO Secretariat Notes speaks "IMF language", not "WTO ianguage".

This first part of this section wiiI study the irnpact of exchange rates misalignments on themost traditional WTO instrurnent - tariffs.

The second part wiii undertake a legal anaiysis of the issue to identify potential deviationsfrorn the Multilateral Trading Systern rufes. li includes the effects of exchange ratemisalignments on tariffs, mainly on GATT Article II and GATT Article 1 (MFN).

1. Impacts of Exchange Rates on Tariffs

To better understand lhe effects of exchange variation on tariffs, one can inake sirnuiationsbased on values of rnisaiignrnents present in lhe literature.

There are different methodologies to estimate misahgnment. Some of thern are presented inTHORSTENSEN, V., MARÇAL, E. and FERRAZ, L.'5.

To caicuiate lhe effects of lhe misalignments on tariffs, these authors estimate adjusted tariffsthrough an exercise of misalignrnent "tariffication". The sarne methodoiogy is applied here.

The misalignment values for Brazii, US and China were estirnated by CEMAP - Center forApphed Macroeconomics from FGV São Paulo. This Center is currentiy caicuiatingrnisalignments for ali G-20 members. Credit Suisse in 201116 also made estirnates for someemerging markets. The results for Argentina and Mexico exchange rate rnisalignments areused here. Both CEMAP and Credit Suisse estimates use similar methodologicai approaches.

For the present exercise the following values, for 2010, were assiimed:Brazil: + 30%, China: - 20%, US: - 10%, Argentina: + 4%, Mexico: - 3%

Note:After lhe completion of this stud y, CEMAP published misaii gnrnents for 2011:Brazil: + 40%. China: - 15%, US: - 12%, Ar gentina: + 20%, Mexico: - 8%With these numbers the conclusions presented in the present stud y are the same.

' 5THORSTENSEN. Vera; MA.RÇAL, Ernerson; FERRAZ. Lucas. lmpacts of Exchange Rates on InternationalTrade Policy Instruments: the case of tariffs, Journal o! World Trade, 46-3, July 2012.Available at: <hnp://www.uncrad.ori/meetings/en/SessionalDocuments/ditc dir 201 2d Ia Vera.pdf>. Viewedat: 2 April 2012."6CREDIT SUISSE. "2011 - Valuation of Ernerging Markets Currencies." Debc TradingMonthly, January 2011.

25

In July, 2012, after the Central Bank of Brazil intervention in the Exchan ge Market, theevaluation for the "real" misalignment is still 15%. Again, the "real" is overvalued and theconclusions are preserved.

It is important to emphasize that for our exercise the precise value of the misaiignment is notrelevant. The aim is to search for Lhe Lhreshoid above which the efficiency of trade mies isundermined.

The next question to be raised is how such misaiignments affect the internationai trade policyinstruments negotiated by the GATT/WTO over the Iast 60 years.

It is possible to develop a methodology to analyze the effect of exchange rate misalignmentson either bound tariffs, negotiated by a country as a compromised ceiling for the tariff of eachproduct, or on applied tariffs, used by such member as a protection levei determined by itsTrade Policy.

Tariffs are a GATT's historical instrument for trade protection and one of lhe mainnegotiating subjects inciuded in multilateral rounds. lis purpose is to ailow an objective andtransparent protection for agricultural and non-agricuitural goods, and to be reduced overtime, as a restdt of trade iibera!ization. The difference between bound and applied tariffsrepresents an important space avaiiabie for industrial poiicy purposes, the so calied poliçyspace, strongiy defended by developing countries and highiy critized by developed countries.

The concepts of tariff and tariffication are the core of the GATT/WTO iogic. Endless hourshave been spent in ali negotiation rounds to estimate the ad vaiarem equivaient rates ofseveral duties expressed on a monetary basis, such as specific rate duties and variable levies.Even in the cases of antidumping, countervailing measures and safeguards, the duties areequiva!ent to tariffs. According to this iogic, exchange rate misaiignments can aiso be tariffiedthrough Lhe calcuiation of a tariff equivalent. Just like tariffs, the effect of the exchange ratecan be transferred to imported and exported goods' prices'7.

To bettcr demonstrate the effects of exchange rate misaiignments on tariffs, two exerciseswere conducted.

The first exercise focuses on the effects of exchange rate misaiignments over a country'stariffs. Depending on the overvaluation or devaluation of its currency, each country ana!yzed(Brazil, OS and China) will present a stimuius to imports or extra-tariffs above the leveibound at Lhe WTO, respectively. This exercise demonstrates the effect of each countryexchange rate misaiignment on the levei of market access negotiated at Lhe WTO.

The second exercise conducted in the present study aims at demonstrating the perspective ofBrazilian exporters facing the effects of different exchange rate misaiignments in selectedmarkets. Argentina, Mexico, liS and China markets were depicted and the competition wíthChinese exporters was anaiyzed. It will be possible to identify lhe chailenges faced by eachexporter to be competitive in the seiected markets.

' Tlie exchange rate misalignment tariffication methodology is developed ia Section III of THORSTENSEN,V.. MARÇAL, E and FERRAZ. L. in Impacts of Exchange Rates on International Trade Policy Jnstruments: thecase of tariffs. Journat of World Trade , 46-3. July 2012, and São Paulo School o[Econoxnics (EESP), PC V SãoPaulo (Brazil), September 2011.

26

The tariffs used for Argentina, Brazil, China, Mexico and US were obtained in the WTOdatabase (Tariff Arialysis Online) and dated from 2008 to 2010. A comparison is presentedusing:

- bound tariffs - simple average at HS 2 digits- applied tariffs - simple average at HS 2 digits

In this sirnulation, the effects of exchange rates were calculated at HS 4 digits simple averagesto iliustrate the direct impact on tariff rules and are restricted to Textile and Clothing sectors(HS sectors 50 to 63). Sirnulations using 2 and 6 digits and weighted averages were alsoanalyzed, but they are not presented in this study since their results show the sarneconclus ions.

1.1. Effects of exchange rate misalignments on market access obligations

A quite realistic picture of each WTO member tariff protection's frarnework can be given by agraphic showing tariff averages for each chapter of the HS.

In this exercise Brazil, US and China's bound and applied tariffs were examined afterapplying the rnisalignments of their exchange rates. The effects of tariffied exchange rates canbe visualized on the variation of both bound and applied average tariffs for these threecountries.

The results of the simulations show that the effects of exchange rate rnisalignments on tariffaverages are considerable.

Brazil - for a valuation of its exchange rate at + 30%, its bound and applied average tariffsbecome negative, representing an incentive to irnports.US - for a devaluation of - 1.0%, their bound and applied average tariffs increase abovethe current levei, representing an extra-tariff to imports.China - for devaluation of - 20%. its bound and applied average tariffs significantlyincrease, representing an extra-tariff to irnports.

Impacts of Exchange Rates on Tariffs for Brazil, US and ChinaMisalignmcnts: Brazil 30% overvaluation: China 20% devaluarion; LIS 0% devaluation

Tariffs Brazil China US

Simple average bound rales (2009) 31,4% 10% 3,5%

Adjusted simple average bound rales -8,0% 32% 13,9%

Simple average MFN applied rales (2009) 13,6% 9,6% 3,5%

Adjusted simple average MFN applied rales -20.5% 31.5% 13,9%

Trade weighted average applied rales (2008) 8,8% 4,3% 2,0%

Acljusted trade weighted average applied rates - 23,8% 25,2% 12,2%So=e: Tariff Profile - WTO. Elaborated by CGTI

27

Brazil's textile and clothing adjusted tarittproflle

When we analyze the effects o!' exchange rate rnisalignments on Brazii's textile and clothingiariff profile, the resuits are lhe foliowing:i) For a 30% overvaluation of Brazil's exchange rate

- Brazil's average bound tariffs, which currently vary from + 25% to + 55%, with anovervaluation of+ 30% will vary from - 12,5% to + 8,5%, most of them presenting negativevaiues.

- Brazil's average applied tariffs, which currently vary from + 4% to + 35 %, due to itsexchange rate overvaluation, wiil vary from - 27% to - 5,5%.

In surnmary, exchange rale overvaluation at a + 30% levei, represents not only a nuilificationof Brazii's bound tariffs, but also au incentive to irnports, since lhe applied tariffs are reducedto negalive leveis.

In this scenario, to ask for any significant cut ou bound tariffs, as in the Doha Round, wouldmean imposing larger distortions to the already negotiated tariff levei. The sarne observationcan be made in the context of negotiations in preferentiai trade agreements.

ii) Considering a devaluation of 10% for liS' exchange rate, lhe effects ou Brazil wouid belhe foiiowing:

- Brazil's average bound tariffs, currently varying from + 25% to + 55%, when adjusted to theliS devaluation will vary from + 13% to + 40%.

- Brazil's average appiied tariffs, currentiy varying from + 4% to + 35%, will vary from- 6,5% to + 21,5%.

28

iii) Considering a devaluation of 20% for China's exchange rate, the effects on Brazil wouldbe the foliowing:

- Brazil's average bound tariffs, currently varying from + 25% to + when adjusted toChina devaluation will vary between 0% and + 24%.

- Brazil's average applied tariffs, currently varying from + 4% to + 35%, will vary from—17%to+8%.

iv) Combining Lhe 30% overvaluation of Brazil's exchange rate with Lhe 20% devaluation ofChina's exchange rate, Lhe effects in Brazil wou!d be Lhe foliowing:

- Brazil's average bound tariffs, currently varying from + 25% to + 55%, when adjusted toboth devaluations will vary frorn - 37,5% to - 22,5%.

- Brazil's average applied tariffs, currently varying from + 4% to + 35%, wili vary froni- 48% to - 32,5%.

BrSI Applledtadffsx Adjusted taflffs . Effettof BRA + 01 Exchange Bate Oevtatlons.-WO0t

40%Çia

10%ApSt1flt(*rç

20%

- SA4lSfffi.tff*dofeM • 04 dn4aqlon, -(tia s0%

0o,jffihlhfl*m*

20%

40%

In summary, liS and China's exchange rate devaluations, which represent a subsidy to theirexporLs, not only nullify Brazil's negotiated bound tariffs, but also transform Brazil's apphedtariffs into a stimulus to US and China's imports.

The overvaluation of Brazii's currency virtually nuilifies Lhe tariff instrument, representing astimulus to imports in general. When faced with devaluated currencies, Lhe WTO's negotiatedtariff leveis can be further affected, which shows that Brazii is offering a much larger marketaccess that Lhe one negotiated at WTO.

29

US textile and clothing adjusted tariff profile

Unlike Brazil's tariff proifie, US bound and applied tariffs present dose values. This meansthat any valuation of actually appl.ied tariffs have a high probability of piercirig the boundLariffs at the WTO. When we analyze the effects of exchange rate misalignments on OStextile and clothing tariff profile, the results are Lhe following:

i) Considering a devaluation of 10% in the liS' exchange rate:

- The effect of a 10% exchange rate devaluation on tariffs currently varying from 0% to +20%, will result in tariffs varying from + 10% to + 31,5%. Therefore, tariffs will become wellabove the bound values negotiated by the US at the WTO.

ii) Considering a devaluation of 20% in the China's exchange rate:

- The effect of China's 20% exchange rate devaluation, will result ia OS tariffs currentlyvarying from 0% to + 20%, ia tariffs varying from - 20% to -4,5%.

iii) When the effects of both deviations are calcu!ated simultaneously, the effects ia Lhe OSwill be the foliowing:

- Considering Lhe effect of Chinas 20% exchange rate devaluation and US's 10% exchangerate devaluatiori, those tariffs currently varying from 0% to + 20%, will vary from - 10% to +7,6%.

30

25%

10%

15%

10%

USAAppIIed rariffs x Adjusted Tariffs - Effects of China + USA Exchange Rate Deviations

-*—Appliedtariífs IsIrrle

-ffectoi 1

• 9OVI6TaTØI CsMwleele rege)

In surnmary, lhe devaluation of Lhe exchange rale not only represenls a stirnulus to devaluatedcurrency countries' exports, but also creates an extra-lariff to other countries' imporls. Due tolhe fact that bound and applied rales are almosl the sarne for some countries, the adjustedtariffs became values well above lhe WTO's bound tariffs.

One could queslion whether lhose countries are violating the WTO's rules, especially GATTArticle II, which establishes thal lhe conlracting parties shall not apply tariffs in excess to lhebound tariffs.

On Lhe other hand, the offset effect of Lwo different exchange rale devaluations - theirnporling country's devaluation having lhe effect o!' increasing 115 tariffs while lhe exportingcountry's devaluation lowering lhern - demonslrates lhe potential "race to lhe boltorn"consequence of competitive exchange rate devaluations.

China's textile and clothing adjusted tariff profile

China's average bound and applied lariffs also present dose values. This rneans that anyvaluation o!' actually applied lariffs have a high probability o!' piercing lhe bound lariffs aI (heWTO. When we analyze lhe effecls of exchange rale misalignrnenls on China's lextile andclothing tariff profile, lhe resuils are lhe foliowing:

i) Considering a devalualion o!' 20% in China's exchange rale:

- Wilh an exchange rale adjustrnent of 20% devaluation, those Lariffs currenlly varying from4% to + 40%, will vary from +24,8% to +68%. Therefore, these tariffs are also well aboveLhe bound values negotialed by China at the WTO.

31

70%

60%

s0%

40%

20%

I0%

China Applledrarlffs ii AdjustedTariffs- Etfects of china Exchange Rato DevaluationÍo4.ro.I .gsun.WTÕiltta

..- Apç*i,d 11.61kÉ-)

• Oo,ad Ttb

.Adj,nted Ap14kdrdç, t,cPge.R_091.10%

ii) Considering a devaluation of 10% in the US exchange rate:

- China's average bound and applied tariff, currently varying from 4% to 40%, will vary from- 6,5% to + 26%.

iv) When Lhe effects of both deviaLions are catculated simultaneously, the effects in China willbe the foliowing:

- Considering the effect of China's 20% exchange rate devaluation and liS 10% exchange ratedevaluation, those tariffs currently varying from 4% to 40%, will vary from + 14,5% to +54%.

32

50%

40%

50%

20%

10%

alnaApptkdTarlfh *Adjusted Tariffs - Éffects ofcttlna + USA Exchange Rato Devaluatlon.wsMIfl4#t,00-% ..,nflfltfl

ADOSS r.av,fiI,DIs awrtl

• Iosnd TatU's(--ri-)

MIisted fali?, -tifeciofool tWA

*10%

In summary, as shown in the liS case, the devaluation of the exchange rate not onlyrepresents a stimulus to devaluated currency countries' exports, but also creates an extra tar!ffto other countries' imports. As the values are also above the WTO's bound tariffs, one couldonce more raise the question of whether those countries are violating the WTO's rules,bearing in mmd that GATI' Article II establishes that the contracting parties shall not applyexcess tariffs to the bound tariffs.

Some authors argue that China's devaluation, which represents a subsidy to its exports, iscompensated by Chinese imports, which are penalized with higher tariffs. Nevertheless, as asignificam share of Chinese imports comes from countries which China has preferential tradeagreements (ASEAN) or are imported to processing zones where they are re-exported, thoseextra tariffs are partially nullified, transforming the misalignment into yet another stimulus toChinese exports.

Some conclusions

In conclusion, the coexistence of exchange rate misalignments, with significant overvaluedcurrencies and with significant devaluated ones, when applied for extended periods of time,represerits a serious distortion for many international trade policies, especially for tariff policyinstruments, which are essential for efflcient and transparent rules and practices.

The possible simulations on exchange rate misalignments on countries' tariffs are limitlesssince each country will have a different set of adjusted tariffs for each bilateral traderelationship, considering both countries deviations. The problem is, thus, systemic, affectingpotentially every contracting party, with different degrees of distortion. These distortions willbe greater where the differences between each country's exchange rate deviations are wider.

33

1.2. Effects of exchange rate misalignments on exporters' competitiveness

With the enactrnent of the most favored principie, the GATT and, later, the WTO, sought tolevei the piaying field between exporters froni different countries when disputing the sarnenational rnarket. The idea was that each country should face the sarne tariff rales in a givenrnarket, independently of where the products carne frorn. In this sense, comparativeadvantages wouid be the main reason for rnarket accession to be acquired by an exporter indetrirnent of other, fostering better productivity and rewarding cornpetitiveness - two of thernain benefits of open trade.

Nonetheiess, exchange rate misalignrnents add a new element to the equation. Exchange raternisalignrnents frorn different countries have an irnpact on the competitiveness oU exportsfrom these countries to the sarne rnarket. Since each country presents different leveis ofexchange rate rnisalignrnents, their exporters wilil face different tariff rates when adjusted toeach particular misalignrnent. In practice, the export price will be affected, along with theircornparative advantage against other countries' exporters.

When we analyze the effect of severai exchange rate rnisahgnments on a particular country'stariff profile, a complex picture of cornparative advantages is drawn. The more exchange raternisaiignments are added, more compiex is the cornpetitiveness frarnework in lhe market. Onecouid, arguably, consider ali different exchange rate misaiignments from ali WTO rnembersthat produce a particular product and iliustrate it in a singie graphic, dernonstrating the chaotictariff profile and rnarket access in a single rnarket.

For the purpose of this study, 3 markets of interest for the exports of Braziiian textíle andclothing products were analyzed: Argentina, Mexico and US. In these rnarkets, the adjustedtariffs faced by exporters from the US and frorn China are depicted in comparison to theadjusted tariffs faced by exporters frorn Brazil.

Aiso, thc Brazilian market is portrayed in order to dernonstrate its market access situation,with adjusted tariffs frorn the perspective of foreign exporters. Once again, only the tariffrates from textiie and clothing sectors were depicted, at 4 digits HS.

In surnmary, for each country considered, the cornbined effects of exchange raternisalignment on applied tariffs, wifli present different tariff profiles for the sarne country. Inother words, considering the new "adjusted tariffs", each exporter wili face a different marketaccess situation depending which country he exports his products from.

The first rnarket anaiyzed is Argentina and exports from China and Brazii are depicted. Thesecond one is Mexico and the third the US. China's rnarket is also analyzed and exports frornthe US and Brazii are depicted. By the MFN principie, each of these exports shouid be facingthe sarne tariff treatment to reach each rnarket, which is not the case.

34

Argentina Market

The graphic shows the applied tariff rates of Argentina (depicted iii green). Since Brazil andArgentina are both part of the Mercosur free trade agreement, there are no tariffs applicab!efor textile and clothing exports from Brazil to Argentina - this is depicted by a bright yellowune at the base of the graphic.

For Chinese exporters, if Argentina has its currency overvalued by 4 %, it has the effect oflowering Argentina tariff rates. If China's exchange rale is devaluated by 20%, it has theeffeci of towering further the tariffs applied by Argentina. When both misalignments areconsidered, as they bear the sarne effect, the result is around 24% lowering effect of Argentinatariffs when faced by Chinese exporters (depicted in red).

For Brazilian exporters, if Argentina has its currency overvalued by 4 %, it has the effect oflowering Argentina tariff cates. If Brazil's exchange rate is overvalued by 30%, it has lheeffect of raising lhe tariffs applied by Argentina. When both misalignments are considered,Argentina's overvaluation offsets, partially, Brazil's rnisalignrnent effect. Since exports fromBrazil do not pay irnport tariffs when entering Argentina Market (because of the MercosuragreernenQ, the practical resuil is barrier of around 26% across the border faced by Brazilianexporters due to the combined exchange rate deviations effect (depicted in yetlow).

As can be seen in the graphic, even though exports from Brazil to Argentina should have acomparative advantage when cornpeting with exports frorn China, due to the Mercosuragreernent, the actual situation is the opposite. Considering exchange rate misalignments,exporters from Brazil face a 26% barrier to enter Argentina Market while exporters fromChina face, in average, negative tariffs, i.e. incentives.

35

- UlvaOIMU • OM deVOtIØM

33%

Apptd lrM'. t*nç8et.eraceI

AdMlvdIwIlh . olIvaSMU • 04 detiMil80- 37%

80%

70%

60%

50%

10%

30%

20%

10%

40%

Mexico Market

The graphic shows the applied tariff rates of Mexico (depicted iii green).

For Chinese exporters, if Mexico has its currency devaluated by 3%, li has the effect ofraising Mexico tariff rates. If China's exchange rate is devaluated in 20%, it has the effect oflowering the tariffs applied by Mexico. When both misalignments are considered, Mexico'sdevaluation offsets, partially, the Chinese misalignment effect. The upcoming resuli is arounda 17% lowering effect of Mexico tariffs when faced by Chinese exporters (depicted in red).

For Brazilian exporters, if Mexico has its currency devaluated by 3%, it lias the effect ofraising Mexico tariff rates. If Brazil's exchange rate is overvalued by 30%, it has the effect ofraising the Lariffs applied by Mexico. When both rnisalignments are considered, as they bearthe sarne effect, Lhe result is an effect of around 33% raise of Mexico tariffs when faced byBrazilian exporters (depicted in yellow).

MexlcoApplled ibrtffs x Adjusted hriffs - Effects of $elected Countries Exdiange Rate DeviationsWa*t* 4, Øe4*n.wt0001%

c,e

Once again, Brazilian exporters face signiflcantly higher tariffs Lhan their Chinesecompetitors.

US market

The graphic shows the applied (depic(ed in green) and bound (depicted ia blue and redcircies) tariff rates of the liS.

For Chinese exporters, if the US has its currency devaluated by 10 %, it has the effect ofraising liS tariff rates, If China's exchange rate is deva!uated in 20%, it has the effect oflowering the tarifís applied by Lhe US. When both misalignments are considered, Lhe liSdevaluation offsets, partially, the Chinese misalignment effect. The upcoming resuli is arounda 10% lowering effect on liS tariffs when faced by Chinese exporters (depicted in red).

KY

For Brazilian exporters, if the US has its currency devaluated by 10%, ir has the effect ofraising US tariffs rates. If Brazil's exchange rate is overvalued. by 30%, it has the effect ofraising the tariffs appiied by the US. When both misalignments are considered, as they bearthe sarne effect, the result is an effect of around 40% raise on US tariffs when faced byBrazilian exporters (depicted in yeliow).

It is clear from the flrst three graphics that Chinese exporters, due to the combination ofbilateral exchange rate misalignments, including its own undervaluation, face significantlylower tariff rates than Brazilian exporters.

Brazil Market

The graphic shows the appiied (depicted iri green) tariff rates of Brazil. This is the levei ofmarket access decided by Brazilian Trade Policy as sufficient to protect its home induslrywhile aliowing a regular trade flow in the textiie and clothing sector. The effect of differentexchange rate misalignrnents, however, demonstrate that the market access levei conceded isnot only dependent upon trade policy measures, but by Brazil's own exchange ratemisaiignrnenl as well as other countries' misaiignnients. In this sense, the protection grantedto the sector will vary according to which country the exports come from.

For Chinese exporters, if Brazil has its currency overvalued by 30%, it has the effect ofreducing the tariffs applied by Brazil. If China's exchange rate is devaluated by 20%, it hasthe effect of lowering the tariffs applied by Brazil. When both rnisalignments are considered,as they bear lhe sarne effect, the result is around a 50% lowering effect of Brazil tariffs whenfaced by Chinese exporters (depicted in red).

For American exporters, if Brazil has its currency overvalued by 30%, it has lhe effect ofreducing the tariffs applied by Brazil. If the US exchange rate is devaivated by 10%, II has the

37

effect of also lowering Brazil tariffs. When both misalignments are considered, as Lhey bearLhe sarne effect, the result is around a 40% lowering effect of Brazil Lariffs when faced byAmeilcan exporters (depicted in blue).

Brazil AppfledTariftsxAdjostedhriffs - øfectsofselected Countries Eschange RateoeviationsseIe.Ø04% .*Wl0

40%

va ----ri TdlfltIc30%

253%20%

rats flMaT1ffs

20% —I

.A4ndTaiffs-qffeaS

•I0% 40%

Adjugod rnVk .ff,csaftA • 04 de,bdns -50

40%

40%

Since each export country is facing a different tariff proflie, one can wonder about Lheeffectiveness of Lhe MFN principie established by GATI' Articie 1. "that any advantage, favor,privilege or imrnunity granted by any contracting party to any product originating in ordestined for any other country shall be accorded imrnediately and unconditionafly to Lhe likeproduct originating in or destined for Lhe territories of ali other contracting parties".

The sarne sirnuiation can be done for any other chosen rnarket. Each market will present adifferent Lariff profile for each commercial partner. The adjusted Lariff rates will vary widelydepending on the exchange rate rnisalignrnenLs considered.

1.3. Conciusions

Tariffs are stilil an iinportant international trade policy instrurnent for many WTO rnernbers.They are the single instrurnent allowed for market protection in accordance with WTO rules.For decades, negotiations on Lariffs were Lhe main objective of Lhe GATT rounds.

The exchange rate issue and iLs impacts on international trade policy instruments have beenignored, by consensus of Lhe parties, not only by Lhe GATT but by Lhe WTO as weil.Although being present in some Articles af Lhe GAFI' and in sorne agreements of Lhe WTO,Lhe effects of exchange rate rnisalignrnents on trade reguiation were never Laken mioconsideration, insLitutionally, by lis merubers. The main GATT Article to foresee Lhe effect ofexchange rates, Article XV.4 has never been Lested neither by the CATT nor by Lhe WTOdispute settiernent bodies.

However, Lhe rnisalignments of exchange rates have significant irnpacts on Lhe application oftrade principies and instruments: iL can affect rnarket access concessions. They can affect the

38

balance of tariff negotiation achieved through several multilateral trade rounds. Their effectson tariffs can represent commercial advantage gains for countries with devaivated currencies.

A more accurate analysis about the effects of exchange rates on tariffs demonstrates that thisissue can no longer be ignored by the WTO. Tariffs, that were, for decades, the basicinstrument iii trade negotiations, end up being nuliified by the effects of exchange ratemisalignments. More than that, exchange rate misahgnments affect directly the levei ofconcessions offered in negotiations and the extent of market access bound aL the WTO.

GATT Article II, the legal rule guaranteeing the levei of negotiated market access, has neverbeen raised at the DSB under exchange rato terms, despite the potentialiy violating effects ofthose misaiignments.

Furthermore, misaiignments can bring unpredictability to the multilateral trade system andundermine one of the main piilars of the WTO: the MFN principie (GATT Articie 1). Thesimulations above demonstrated that due to exchange rate misaiignment, exporters fromdifferent countries will each face different access conditions in any particular importingmarket, contrary to what the MFN (GATT Articie 1) principie seeks.

With the progressivo tariff rate reduction throughout the negotiation rounds, and due to thehigh levei of exchange rate misaiignments maintained by several important countries, theexchange rato rnisa!ignments end up having a greater reievance than tariffs themseives.Moreover, for devaluated exchange rate countries, (bis misaiignment not only converts itseifinto an export subsidy, but also imo an import surcharge, and, thus, imo a much moreeffective trade barrier than applied tariffs.

Several questions can be raiscd when observing that Doha Round negotiations are blockedbecause members such as the US and the EU are demanding more concessions from emergingcountries. One can ask about lhe real levei of market access offered by these members, giventhat their exchange rato policies are cieariy nuilifying ali their offers in Lhe negotiations. Thelevei of market access granted by members who practice long term exchange rate devaluationcan be put in doubt. How largo were in reaiity the tariff cuts offered in the last few years ofnegotiations?

Flistorically, until the 1.970s, Lhe GATT's contracting parties accepted the renegotiation ofspecific tariffs of some countries which faced exchange rate misahgnments. During theserenegotiations, the threshoid provided by Article II was used so that exchange ratemisahgnments would aHow the renegotiation of specific bound Lariffs. The question is: whynot reconsider the exchange rate issue and negotiate a new threshold?

Regarding market access, only by the introduction of the concept of adjusted tariffs for theexchange rate effect, would the WTO members be abie to analyze the real leveis of marketaccess negotiated and guarantee the levei of Lhe market access protection committed in thenegotiation.

2. Legal Aspects of Exchange Rate on Trade

After Lhe analysis of the impacts caused by rnisaligned exchange rates in countries' tariffs, itis importam to consider these impacts on trade ruies, more specifically, the provisions of theWTO Agreements.

39

The first part of this section will present the legal impacts of exchange rate on WTOinstruments and principies, whiie the second section wifl analyze the provisions of the WTOagreements in order to search for possible mechanisms that could address Lhe exchange rateproblem.

2.1. Exchange rate and the WTO

i. Exchange rates and IMF - Are exchange rates an exclusive matter of the IMF?

Exchange rate and currency issues were historically considered as rnatters of the IMFcompetence. Accordingly, at Lhe time of the creation of the Bretton Woods system in 1945,maintaining an international fixed exchange rate system based at par values to the doliar wasthe main objective of the IMF.

As the economist and IMF historian James Boughton stales, Lhe economic impacts ofexchange rate manipuiations on international trade fiows were very much in the minds of thepoliticai parties in the negotiations of Lhe Bretton Woods agreements' 8 . The chaoticconsequences to trade of the practice of competitive currency devaluation in the years beforethe World War II were sUtil very present and an international effort was sought to restrainthese mutually damaging "beggar thy neighbor" practices.

The fixed exchange rale system was anchored at the Articie IV of the IMF Agreement, whichdetermined that every country should maintain their exchange rates within a 1% band of a parvalue to the doliar established by the IME. This meant that the Multilateral Trading System,created a couple of years later, would not have to focus on the issue of exchange ratemanipulations, nor elaborate mechanisms to counter it.

That is Lhe reason behind the fact that exchange rate manipulation and other currency issuesare not present but in a few Articles of Lhe GATT. The problem seerned surpassed, with Lhecreation of the IMF, and the GATT could be roughly silent about it.

Concems about the impacts of exchange rate misalignments on internationai trade, however,would resurface after the end of the par value system in Lhe 70s. The fali of the gold standardrequired major modifications of the IME practice in the corning decades, a process that carneto be known as the organization's "silent revoiution"9.

The extent and depth of such rnodifications had direct impact on the IMF mies, particularlyon its Article IV, which was transformed from a rigid control to a flexible surveiliancemechanisrn. Andreas Lowenfeld argues that, after the fali of Lhe par value system and thecreation of the new surveillance mechanism, "[1]! lhe Fund Agreement no longer described,leI alone controlled, lhe interna (tonal inonetary system, then 11 seerned reasonable that lheArticles should be rewritten ". No such resurfacing, however, was done and "[tJhe institution

BOUGHTON. Limes M., "The IMF and Lhe Force of History: Ten Events and Ten ideas That Have Shapedtbe Institution," LMF Working Paper WP104175. PolicyDevelopineritandReviewDepannient, IMF, 2004, p. 6.'9 BOIJGHTON. James M., Si/ent ievolution; tbe [aternational Monetary Fund, 1979-1989, IMF, 2001, pp. 1-50.

RC

was preserved - that is, the skeletori; but 11w fundamental rule was replaced by a non-rule,and the mission gradually changed"o

The new mission of the IMF was then focused on guaranteeing the balance of payment ofendangered countries in a World of floating exchange rates. The objective of restrictingexchange rate manipulations was al.located to lhe new surveil!arice mechanism. However, dueto a change in the Economic Theory that relaxed concern over exchange rate manipulationsand the expansion of Lhe IMF's surveiliance mechanism in order to include several othereconomic factors, lhe objective was never completely attained.

On that, Lowenfeld further states that:

Article IV did not accomplish the objectives that the drafters had in mmd. Governments were reluctant toanswer inquiries put by the Fund, and had no real incentive to do so. ( ... ) The idea that the IMF. or theiriternational comrnunity through the IMF, could prescribe conduct under amended Article IV comparablewith what the Fund prescribed under Articte V did not prove viable. if indeed it was ever serioustyconsidered21.

The consequence was that Lhe IMF no longer had the mechanisms, or even the objective, ofexerting a rigid control over exchange rate manipulations. A!though this reality fitted well thenew Fund role in international economic governance, it striped the Multilateral TradingSystem of its safe-net against competitive currency devaluations.

In this sense, current argurnents defending that exchange rale issues should be dealt withsole!y at lhe IME are outdated. As IMF History has demonstrated, the JMF cari no longer bethe main forum where the impacts of currency issues on trade should be discussed, especiallynot when the control of exchange rate manipulations is Lhe main focus of discussion. Tt IacksLhe mandate and the mechanisms to do so.

ii. Exchange rate impaets on the Multilateral Trade System

Although Ieft unguarded since Lhe mid-70s, lhe Multilateral Trading System would not fee!Lhe consequences of exchange rate deviations until Lhe 2008 crisis. The tensions that havearisen concerning the relationship between trade and exchange rale have been dealt with,during this period, outside of lhe scope of either Lhe IMF or Lhe GATTJWTO, norma!lythrough political agreements between the concerned countries. The Plaza and lhe Louvreagreements are examples of negotiations that sought to rebalance depreciated or overvaluedcurrencies causing diversion oí trade fiows.

In Lhe present political landscape, however, such accords are harder to be reached. After the2008 financial crisis and the political choice of some of the biggest economies to devaluatetheir currencies in order to stimu!ate economic recovery and growth (notab!y Lhe USA, Chinaand some other Asian countries), the problem has again arisen and the Multilateral System hasfound itself unprepared to offer solutions.

Even after the creation of the WTO and the considerab!e enlargement of Lhe MultilateralTrading System scope, the exchange rale issue was not incorporated imo Lhe Marrakesh

20 LOWENFELD, Andreas E.. "The Internalional Monetary System: A Look Back Over Seven Decades",bania! o! Jaternational Econornic Law. v. 1 3. n.3, 2010. p. 582.21 fb1d. p. 585.

41

00

agreernents. The Uruguay negotiation round focused on tackling non-tariff trade barriers that• were becoming a much greater concern to international Lrade than the traditionai• barriers. Even though the importance of a closer cooperation between the IMF and the• was highuighted in the resulting agreernents (Deciaration ou the relationship between Lhe

WTO with the IMF - Umguay Round Declarations), no specific rnechanism was created todeal with exchange rate manipulations.

• The case of tariffs and frade remedies

O. As shown above, however, in the first exercise ou tariffication, persistent exchange raternisalignrnents do have significant distortion effects on ad valoreni applied and bound tariffs

• negotiated in the WTO, being at the sarne time au incentive to exports from a countrymaintaining an undervalued currency as well as raising additional barriers to the entry ofimports into its rnarket. However, irnport tariffs are um the only trade instrurnents affected.

Since Lhe creation of the Multilateral Trading System, with the GATT, the contracting partieshave sought to restrain protectionist measures to border tariffs. This wouid provide Lhe system

• with better transparency and predictability. The notion of tariffs or "tariffication" of other

• trade instruments is of great importance for the Multilateral Trading System and has been on

•its base since its beginning. Many trade diversion studies make an effort to "tarifficate" trade

. restrictive measures in order to assess their impact on trade flows. The distortion effects ofpersistent and deep exchange rate rnisalignrnents are not, in this sense, to be taken lightiy.

Trade remedies such as antidumping and countervailing ineasures are thernselves tariffs thatare applied in amount to import tariffs at Lhe border. Exchange rate misalignmenLs can either

. strengLhen or weaken the effect of trade rernedy measures applied - in Lhe case of aconsiderabie variation between the currency used to levy the duty and the currency of the

• intemationai price of Lhe product after the investigation. That would mean a potential• violation of Lhe objectives of trade rernedies.

. If Lhe airn of trade remedies is to curb a deterrnined unfair trade pracLice, iLs effectivenessdepends on accuraLeiy accessing and countering such practice. Antidurnping andcountervailing nieasures, which both are ievied, in general, as specific Lariffs, will be distortedby exchange rate variations and will not accurately address the pracLice identified as unfair

• during the investigations, to Lhe detrirnent of either the exporters or the affecLed sectorinvolved. The measure would, possibly be recalibrated afLer its review. In Lhe meantirne,however, Lhe exchange rate issue brings instability and unpredictability to yet Lhis instrument.

In Lhe sarne manner, the invesLigations prior to the application of Lrade rernedies arethemseives also affected by deep exchange rate rnisalignrnents. A counLry facing particularly

Ødeep devaluations can suffer additional antidurnping duLies if no proper consideration is donoduring investigations. The normal price construction and the price comparability both can be

• affected. The problem lies in that Lhe rules governing such investigations are silent about theØ issue, demanding oniy general respect to particular rnarket situations and fair price

eomparison, while prescribing no specific obligation concerning exchange rate variations.

0 The issue was raised in a GATT panei brought by Brazil against EC's appiication of• anLidurnping measures ou cotton-yarn frorn Brazihan producers (EC-Emposition of AD Duties• on Imports oU Cotton-Yarn from Brazil - ADP/137, 4 July. 1995). Brazil argued that the

• had violated its obligation under Lhe Tokyo Round Antidurnping Code (the predecessor of the

• 42

O0•

0

Uruguay Round Antidumping Agreement - ADA) by not taking imo consideration lhe• particular volatile situation of Brazilian exchange rate concurrent with high inflation.

•In early 1989, facing very high inflation, lhe Brazilian Govemment froze lhe exchange rate

. one Cr$ ("Cruzeiro") to one US$ in an attempt to decrease rnoney supply and controlinflation. The exchange rate freeze continued for a period oU three months. During this period

• domestic infiation continued to grow. Receipts from export saies (which were paid in US$),

• when converted imo Cr$, remained stabie. Foliowing lhe unfreezing of lhe exchange rate,Cr$ depreciated. Brazii argued that this combination of a fixed exchange rate and dornesticinflation led to a gross distortion in lhe comparison between domestic prices (when used aslhe basis of normal vaiue) and export prices, and this resultcd in an inflated dumping margin.

• Brazil argued that lhe phrase "particular market situation" in Article 2:4 (presently Articie 2:2

• of lhe ADA) inciuded lhe relevant situations external to lhe domestic rnarket, such as

eexchange rates, which affect price comparabiiity. Furthermore Brazil argued that Article 2:6(presently Article 2:4 of ADA) required lhe EC to consider lhe particular exchange rate freezesituation in Brazil at lhe moment o!' export in order to respect lhe "fair comparison"

• requirement in lhe Article. The panei so summarizes Brazil's position:

e• Brazil emphasized that the overriding principie of Articies 2:4 and 2:6 of lhe Agreement, reiterated

throughout lhe text ai' the Agreement, was that the methodology adopted should permit a propercomparison. Brazii beiieved that this fundamental principie had been violated in this case. Brazil argued

• that to ensure a proper comparison between normal vaiue and export price, lhe EC shouid have takenfurther steps by acknowledging lhe particular market situation prevailing in Brazil and basing normalvalue on saies to third countries, or adjusting lhe normal value based mi domestic data, or adjusting the

• exchange rate used. ( ... ) li was not possible to make such a comparison without using an exchange rate,and lhe selection ai' the exchange rate, particuiariy in lhe iight o!' domestic inflation, was criticai for lhecomparison. Article 2:4 therefore recognized lhe tink between lhe establishment of normal vaTue and

.

evolution aí' exchange rates. (EC-Jmposition of AD Duties mi Imports o! Cotton-Yarn from Brazil -ADP1137, 1" July 1995, p. 77-81)

e

• Although reiating to a fairiy specific situation involving exchange rate issues, lhe case was an• opportunity in which both parts had to discuss particularly differcnt views of lhe impact of

exchange rate variations on antidumping investigations. Even more broadly, lhe concept oUneutraiity of exchange rates was discussed by lhe parts.

•

• Brazii was of lhe view that lhe EC's refusa] to adjust the exchange rates used ininvestigation violated a fundamenta] principie o! the Agreement, considering as "pricedumping" what was, in fact, the weII-known phenomenori o! 'exchange durnping'.

• Furthermore, Brazil argued that in so doing, lhe EC had rehed on certain principies such as• 'monetary neutraiity' that were not vaiÉd in the context of antidumping proceedings. (EC-

• Imposition o! A Duties on .[rnports o! Cotton-Yarn from Brazil- ADP/137, 41h Juiy, 1995,

•118)

• The EC, on lhe other hand, argued

The calculation ai' duniping margins had to be marte mi lhe basis of objective and verifiable information,and not on lhe basis of arbitrary and subjective aspects. Accepting Braziis arguments in this regard would

O amount to introducing considerabie amount of subjectivity and uncertainty imo lhe system. It wouid gofar heyond lhe scope of lhe Agreement, lhe possibitities and lhe competence of the investigatingauthorities, and lhe interests aí' lhe signatories to have security and predictability in internationai trade.

• (PC-huposition o!' AD Duties on Imports o! Cotton- Yarn froin Brazil - ADP1137. 4" July, 1995. p. 119)•

O

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43

The EC was, in this sense, concerned with lhe potential consequences to the system ofintegrating exchange rate considerations imo antidumping investigations. Brazil disagreedthat the clear intent of the negotiators was to leave "monetary aspects of dumping" outside lhescope of lhe Agreement. Rather, the intent of lhe negotiators would have been to exciude lhedepreciation of exchange rate (the so called exchange rate dumping) from the scope of lheAgreement. In other words, since exchange cate dumping was not part of lhe Agreement, dueconsideration to exchange rate situations should be done in order to respect normal price andprice comparability, as well as to avoid considering such a phenomenon as "regulardumping".

Ir absoiutely wrong to infer from this specific fact lhe general statement that "monetary aspects ofdumping" were outside the scope of the Agreement. In any event, even if such a principie couid berelevam to lhe interpretation o! the Agreement, Brazil did not consider that it couid be appiied in a way tofrustrate the fundamental objective of tbe Agreement, i.e. the requirernent that there be a proper and faircomparison between normal value and export price. (EC-Imposiuon o!AD Duties on Irnports oíCbtton-Vara from Brazil - ADP1137. 41h July, 1995, p. 280).

Both countries agreed that lhe present ruies governing antidumping investigation exc!uded lhepossibility of considering exchange rate dumping ia the "price dumping margin". Brazilhowever argued that compieteiy exciuding monetary aspects of dumping wouid do exactiy lheopposite, since it would open up lhe possibility of counting exchange rate dumping as regulardumping, whiie lhe EC feared the possible consequence of bringing unpredictability to lhesystem if it considered such arguments.

The panel in lhe case did not render specific answers to lhe overarching question of whethermonetary aspects of dumping were intended to be exciuded or not from the ADA. It iimitedits anaiysis to lhe practicai question posed by Brazil of whether lhe EC had violated theagreement by using lhe official exchange rate in its investigation. The panei thus conciudedthat Brazil had not proved that lhe particular exchange cate situation at the time of lhe seusaffected directiy lhe prices practiced in its local market insomuch to render it inadequate as abasis for normal price consideration. On that, lhe Panei further stated that:

Even assuming arguendo that an exchange rale was relevant under Article 2:4, ir would be necessary, ir,Lhe Panei's view. to estabiish that it affects the domestic saies themseives in such a way that they wouidnot permit a proper comparison. Brazil had asserted that exchange raies were capabie of affectingdomestic saies and prices, because for example, the cost of raw materiais couid be affected byfluctuations in lhe exchange rate. In particular, domestic saies and prices couid be aífected if importedraw materiais were used in domestic production. However. Brazii had not argued that the costs of rawmateriais used in manufacture of cotton yarn were in fact so affected. For the Panei to engage in such anexercise, it would have to exceed irs scope of review. (EC-Iinposition of AD Duties on Jmports o[C'otton-Vara from Brazil - ADP1137, 4rn July. 2995, p. 479)

In this sense, Lhe panei did not exclude completely Lhe infiuence exchange cate misaiignmentscouid have on antidumping investigations. Actually, were imported inputs considerabie costsin cotton-yarn production, and provided that Brazil presented this argument, exchange ratecould be a reievant aspect in lhe investigation. In lhe Panel's view, there is no a prioriexciusion of exchange cate considerations ia the application of lhe antidumping rules.

Considering price comparability and Article 2.6 of lhe Antidumping Cede, lhe Panei reacheda narrower interpretation, li considered that exchange cate misalignments wouid not affectprice comparability since, if lhe prices compared (export price and normal price) had been

44

rightfufly se!ected, the only purpose of exchange rate would be to transiate these princes intoa cornmon currency:

e. The exchange rate in itself is not a differenée affecting price comparabitity. It is a mere instrunient for

transiaring mio a common currency prices that have previously been rendered comparabie ia accordancewith the second sentence of Article 2:6. In the view of Lhe Panei, an exchange rates function is to rnake it

• possibie to subsequently effect an actual comparison on a common basis as provided under the otherrelevant provisions of the Agreement (EC-Iniposition o! AD Duties on Tmports of Cotton-Yarn from

• Brazil - ,4DP1137, 4" Julji 1995, p. 494)

. It is interesting to note that the practice of zeroing by the EC and whether it affected pricecornparability was also discussed in Lhis panei. The panelists reached the conclusion that the

• practice of zeroing did not affect price cornparability in the case. More recent cases, however,• have further analyzed the issue and considered such practice as incongruent with Article 2:4• of Lhe ADA (the equivalent of Art. 2:6 of the Antidumping Code analyzed ia this case). It is,

in a sense, a more developed interpretation that could well be transposed to exchange rateconsiderations.

• In any sense, the EC-AD duties ou Cotton-Yarn case offered the possibility to discuss Lheirnpacts exchange rate misalignments can have on important multilateral rnechanisms. It also

•exposed the lack of specific provisions to deal with the issue ia the Antidumping Code.absence remained in the foliowing Uruguay round ADA. The sarne overail staternent can be

• made in relation to the Subsidies and Countervailing Measures Agreement (SCM).e

• Other aspects of the Multilateral Trading System are potentially affected as well since they

•are based on tariffs in their functioning, The Dispute Settlement Mechanism itself can be

. deep!.y affected ia its efficiency since its most praised characteristic - the possibility ofenforcing decisions through Lhe allowance of retaliatory measures - would be softened were a

• country to maintain its currency persistently undervalued, weakening measures airned at

• curbing its violating conduct. Naturaily, different rneasures such the suspension of

• rules wouid be immune to such effects, but a considerable part of the System could bejeopardized.

• Furthermore, rules of origins can be distorted as weli, since rnany ruies depend on accurateiy

• assessing the value added to a product ia differcnt moments of the production chain.dealing with severely distorted exchange rates, it becomes hard to determine the exact value

. added by a particular production stage. The assertion can be compromised, making it hard toguarantee the fulfillrnent of the objectives sought with rules of origin. This is particularly

• important in the context of Preferential Trade Agreements (PTAs), potentially being a cause• of trade diversion and circumvention of the

. The Director-General to the WTO, Pascal Lamy, has already brought to the attention thedifficulties modern production chains present to Lhe traditional view of rules of origin and

• international trade negotiations ia general. The "made ia the world" initiative 22 launched bythe WTO to support measuring and analyzing international trade in terms of value added, can

• be severely impacted by exchange rate misalignments.

e

• 22 WTO. Macle tu the world. Avaiiable aL: <http://www.wto.org/enghsh/res_e/statis_e/miwi_e/miwi_e.htm>,• Viewed at: 31 January 2012.

• 45

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The overarching principies

A more disturbing picture can be drawn if one considers Lhe impact of persistent exchangerate rnisaiignrnents on some of the piliars of the Multilateral Trading System. One of thesystem's principies most hit by the different exchange rate fluctuations is the Most-FavoredNation (MFN) present in Articie 1 of lhe GATT. It reads as foliows:

I. With respect to customs duties and charges of any kind imposed on or in connection withimportation or exportation or imposed on the internationai transfer of payments for imports or exports,and with respect to lhe method of levying such duties and charges, and with respect to ali roles andformalities in connection with importation and exportation, and with respect to ali matters referred toin paragraphs 2 and 4 of Articie 1IJ, any advantage, favour, privilege or immunity granted by anycontracting party to any product oriinating in or destined for any other country shall be accordedimmediateiy and unconditionaily to the like product originating in or destined for the territories of aliother contracting parties. (Emphasis added)

tinder Lhe MFN principie, each contracting party is broadiy obiiged to concede the sarne tarifftreatrnent to every other contracting party. Furthermore, any kind of advantage or privilegeone contracting party shouid have in reiation to imports and exports with another contractingparty should be "immediateiy and unconditionally" extended to ali other contracting parties.This principie aims at bringing two mam benefits to lhe system.

Firstiy, it guarantees that no particular country wili have a cornmerciai advantage in its tradewith another contracting party, which otherwise coutd raise tensions and divert trade. This is abroad guarantee, encompassing any kind of benefit a particular country could have in its tradewith another country pari to lhe system. The aim here is to avoid arbitrary and iess-than-optirnai aliocation of trade fiows between contracting parties, which could harm lhe benefitsbrought by internationai trade competitiveness.

The other benetit is the stabiiity of the system. Since a producer knows he wiii face the sarnetariff barrier to export to a particular country no rnatter where he exports from, he wili be ableto decide where to produce without taking appiied tariffs into consideration. Ir also bringspredictabiiity and provides a better environrnent for production to seek whichever countrypresents better comparative advantages. In this sense, the MFN principie stands as one of lhemain piflars of the Multilateral Trading System established after the Second World War andthe econornic turmoii of the 30s enhanced by protectionist and arbitrary measures in theperiod.

The misalignrnent (and possibie manipuiation) of exchange rates, however, brings anothervariabie to the equation, with no direct connection to fair competitive features. The particularexchange rate of a country, and its variation from a levei considered of medium termcquihbriurn, could represent an "advantage or privilege" in bilateral commercial reiationsbetween a set of countries when compared with other exchange rates portraying differentleveis of variation from their equihbrium. This is due to the effects exchange ratemisaiignrnents have on tariffs appiied by each country.

After the fali of the fixed exchange rate system under the auspices of lhe IMF during lhe 70sand its substitution with a floating exchange rate system, lhe CONTRACTING PARTIES tolhe (IATT have manifested theír concern with its consequence to the multilateral tradesystem. In particular, the impact on market access actualiy faced by exporters was highlightedin a floating exchange rale system:

46

1. The CONTRACTLNG PARTIES. while not questioning Lhe floating exchange rate system and thecontributions it has made, acknowledge that in certain circumstances exchange market instabilitycontributes to market uncertainty for traders and investors and may iead to pressures to increasedprotection; these problems cannot be remedied by protective trade action (Exchange Rate Flucwationsand their Effect on Trade - Fortieth Session o! the CONTRA CTING PARTIES, Action taken on 30Afoveínber 1984 - ff5761)

When exchange rate misalignrnents are "tariffied" and apphed to a country's tariff, a betterpicture of the uncertainties brought to Lhe system by the exchange market instability and thelevei of tariff barriers actualiy faced by exporters from a particular country can be perceived.

As shown before, in the second exercise on tariffication, each particular exporter, dependingon where he exports from, will have different tariff treatments and privileges, meaningdifferent market access leveis, contrary to what the MFN principie states. The greater theiength and persistence of such exchange rate misalignment, Lhe greater the consequences forthe most-favored nation treatment.

The absence of specific consideration to the broad and persistent exchange rate misaiignmentsof WTO members means potentiaHy infinite different tariff treatrnents between any set ofanalyzed countries. This situation is directiy the opposite of what the Multilateral TradingSystem sought with the estabiishment of the MFN principie.

Not only the MFN principie is affected but, with ir, the principies of transparency andpredictabiiity. After the end of the fixed exchange rate systetn, Lhe GATT contracting parties,concerned with the negative effects of exchange rate fluctuations on intemational trade fiows,made a statement urging the IMF to improve its system in order to take into account "thereiationship between exchange market instability and internationai trade"23.

In response, the IME pubiished in 1984 a study describing Lhe ways by which such exchangerate instabiiity could affect internationai trade fiows24 . The acadernic and empiricai evidenceswere inconciusive and no systemic adjustments were made by the contracting parties to LheGATT in order to address the uncertainty and potentiai negative effects of exchange ratefluctuations. No particular study was commissioned by the GATT, however, to analyse theimpacts of exchange rate manipulations on the instrumerits of the Multilateral Trade System.

Aid for Trade and Quota-Free-Duty-Free Initiatives

Finaily, a crucial aspect of the WTO is also potentiaiiy affected by persistent exchange ratemisaiignments. Considered by many as the "social" aspect of the multilateral trade system, theAid for Trade Initiative seeks to help least-developed countries to fight poverty and attaineconomic development through the insertion of their economies in Lhe internationai market.Through material, and know-how aid, it seeks to develop the trade-related skilIs andinfrastructure that is needed to irnplenient and beneflt from WTO agreernents and to expandtheir tra de25.

23Exc/;ange Rate Fluctuations and (heir Effect on Trade - Fortieth Session of Lhe CONTRACTINO PARTIES,action taken on 30 November 1984— 1J5761.241MF. "Exchange Rue Votatility and World Trade," WT/GC1444. IMF Occasional Paper 30, 1984.25 WTO. Ajd for Trade (WTO dedicated website pane for Lhe program). Availabte at:<http://www.wto ,org/english/rratop e/devei e/a4t e/aid4trade e.htm>. Viewed at 25 March 2012.

47

The outlaying idea is that through lis insertion in lhe international market, small economiescould get better prices for their products and better prospects for local producers. Thevolatility of exchange rates and, especially, the possibility of competitive devaluation of bigeconomies currencies, bring deep instability and insecurity to such "export-Ied" and openeconorny strategies.

At the 1984 Declaration, lhe contracting parties had already identified the particularly fragileposition that small trading countries would face in a floating exchange rate situation. AtParagraph 2 of the Declaration, it is stated that:

The CONTRACTING PARTIES also recognize that adjustrnent to uncertainty over exchange marketinstability could be more difticult for smatt traders when hedging opportunities are limited, and for smalltrading countries and developing countries, inter alia when the geographical distribution aí their tradecannot be easily diversified. Exchange Rale Fluctuations and their Effect on Trade - Fortieth Session ofthe CONTRACTINO PARTIES, action taken on 30 November 1984 - L/576 1)

The foliowing study by lhe IMF also acknowledge that small trading economies would bemore vuinerable to intense exchange rnarket instability since traders would have fewerhedging options26.

In this sense, Marc Auboin states that:

Of particular concern to LDCs is the dilemma created by regular periods of tosses in the terrns of tradeand

ar lhe sarne time the need to keep the nominal exchange rate relatively siable for domestic monetary

policy reasons. In periods of terrns of trade tosses, this dilemrna results in a constam realreal appreciation ofdomestic currencies, and hence an inducement to irnport, with adverse effects on the current accountbalance and debt to l3retton-Woods institutions.27

A recent OECD study has put renewing Iight into the subject, further strengthening suchfears25 . The paper examined lhe impact of sharp exchange rate misalignments in two smaHopen economies - that of Chile and New Zealand. It proved that small economies tend to bemore impacted by exchange rate misalignments than larger econornies such as the EU, lheUS, China or even Brazil. The authors sirnulated misalignments, eitlier upwards ordownwards, of 10 per cent of these countries' exchange rates and analyzed the impact on theirbilateral trade with bigger econornies. Small trading countries have to bear lhe "fuiladjustrnent of exchange rate changes", as they have less diversified production and exportbase, being less in a position to move into economic sectors Iess affected by intemationaltrade. Bigger economies, when facing lhe appreciation of their currencies, are abie to limit lhedamage done to their export position by moving up their production imo sectors where pricee!asticity is wider. The sarne does not occur with smaller, more concentrated econornies. Onthe other hand, when facing depreciations, lhe number of dornestic producers is sma!ler andhence insufficient to substitute for imports when prices increase. The study demonstrates,then, that smalier economies will be hit harder by exchange rate rnisalignments, either of theirown currencies or of their bigger trading partners. Price elasticity and lhe structure of theirproduction chains are also iinportant, helping (or hindering) to rnitigate negative effects.

261fv1F "Exebange Rate Votatility and World Trade," WT/GC1444, IMF Occasional Paper 30, 1984." AIJBOIN. Marc, Fufflhling lhe Marra kesh Mandate on Coberence: Ten Years o! Cooperation between lheWTO. IMF and World Bank. WTO. 2007. p. 26.28 OECD, To What Extent Do Exchange Rates and Their Volatility Affect Trade? The Case o! Two Sinal] OpenEconornies, Chile and J'Jew Zealand, TAD/TCÍWP(20 1 1)17.

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• The WTO has already acknowledged such problem. In a recent publication entitled "Aid for• Trade ar a Giance — 2011, showing results", published in conjunction with lhe OECD,

• authors recognize

If a currency is overva!ued, trade liberalization can triger rising imports and declining exports - becauseof the damage to cost competitiveness - with the excess demand for foreign exchange resulting iabalance-of-payments problems. In addition. domestic economic activity usuatty declines andunemp!oyment rises because the contraction in iniport competing sectors is not offset by an expansion of

S the export sector. Governments then face Lhe choice of either adjusting the exchange rate or reversingtrade reform. ( ... ) the impact of supportive macroeconomic policies is ofien larger than Lhe impact ofreducing binding export constraints through aid for trade29.

• This brings enormous chailenges to lhe objective by the WTO to promote economic

• development of LDC through their insertion in lhe international market. Thesewould depend on a very narrow band of export products, without any real space to divert theirproduction or climb up lhe production chain. With whole economies dependent on such a

• small economic structure, exchange rate variations of any particular trade partner could have• serious impacts to such

•In lhe sarne manner, the Quota-Free-Duty-Free Initiative, which the WTO Secretariat andsome WTO members struggle to rescue out of lhe stalled Doha Round, could be offset by

• sharp variations of lhe exchange rates of either the conceding countries or of lhe•• The Quota-Free-Duty-Free initiative consists in an agreement between WTO members, in

2005, to make it mandatory for developed countries, and optional for developing countries, togive duty- and quota-free market access to ali exports from Ieast-developed countries.

• Members were allowed, nonetheless. to exciude up to 3% of tariff lines from this initiative,• order to protect sensitive sectors30.

•2.2. WTO Agreements and the exchange rate issue

• Considering the huge impacts that misaligned exchange rates have 011 trade, one might ask• lhe existing provisions under lhe WTO agreements cannot address, at least partially, to lhe• matter. This section will anaiyze lhe main provisions of lhe WTO that couid give rise tu

complaints under lhe WTO Dispute Settlement Mechanism or could provide mechanisms torebalance lhe impacts caused by misaiigned currencies.

• 1. Article XV

• The mam Article of the GATT to deal with exchange rates and its impacts on trade is ArticleØ XV. li establishes the cooperation between lhe GATT/WTO and lhe IMF for matters such as

monetary reserves, balances of payments and exchange arrangements, denying the idea of acomplete separation between WTO and IMF subjects.

• The Article exphcitly encourages WTO members to seek policy coordination on questionswithin lhe jurisdiction of lhe IMF that affect trade measures, recognizing lhe intrinsic relation

• ______________• 29WT0, OECD. Md For Trade ar a Glance 2011: showing results, 2011. Available at:. chttp:f/dx.doi.org/10 . 17871978926411747 1-en>. Viewed at: 20 December 2011. p. 99.

30 LABORDE. David. "Looking for a meaningful Duty Free Quota Free market access initiative in the Doha• Development Agenda". ICTSD, Issue Paper n. 4. December 2008. p. 14.

• 49

•

between trade and finance and assuring the coherence of the international economic system asa whole, as designed aL Bretton Woods.

Concerning the specific issue of exchange rates, Article XV.4 states that:

Contracting parties shall not, by exchange action, frustrate the intent of the provisions of this Agreement,nor, by trade action, the intent ai' the provisions of the Articles of Agreement ai' the InternationalMonetary Fund.

It puts on evidence the negative impacts that trade and exchange rate measures can have onone another, recognizing that exchange rate issues can affect international trade. The Articlestresses the need to WTO members to take imo consideration the relationship between theinternational trade and monetary systems and to avoid trade or exchange rate measures thatcould harm any of the purposes of both agreements.

Nevertheless, despite the clear aim of this Article to enhance coherence between suchsystems, its enforcement is uncertain, due to the lack of precise definition of expressions suchas "exchange action" and "trade action" and due to the need to engage mio consultations withIMF. There are no examples, in the WTO, of the application of the Article XV.4, no memberhaving ever questioned another's exchange rate arrangements at the WTO Dispute SettlementSystem.

To declare a violation of Article XV.4, it is necessary to determine that a member is taking anexchange action which is having consequences on trade and, furthermore, is frustrating theintents of WTO.

The notion of exchange action is unclear and was never tested by the WTO DisputeSettlemerit Mechanism on a policy of currency devaluation. Although the expression has awide meaning, one would still have to argue that policies of currency devaluation can beclassified as exchange actions. It would be necessary to prove the existence of specificmeasures taken by a government that directly impacts on the devaluation of its exchange rate.The simple devaluation of a currency, independent to government's actions, cannot bechallenged under Article XV.4. A distinguishable govemmental measure that results incurrency devaluation must be identified.

A second step to apply Article XV lies on the proof that the exchange action is frustrating theintent of the provisions of GATT. The nieaning of the word "frustrate" is given in the Notesand Supplementary Provisions (Annex 1) of Article XV, which explam that its intention is:

( ... ) to indicate, for example, that infringements of the Ietter of any Article aí this Agreement byexchange action shall not be regarded as a viotation aí that Article ii'. ia practice, there is no appreciabledeparture from the intent aí the Article. ( ... )

Exchange actions operated in accordance with the Articles of Agreement of IMF will not bedeemed to contravene GATT Articles because there is no departure from the intent of thoseArticles. In order to find a violation of Article XV.4 ii is, thus, necessary to find a violation ofArticle IV of IMF's Articles of Agreement, which specificaily deais with exchange rate. Suchinterpretation is in accordance with the exception imposed by Article XV.9, which establishesthat nothing in the GATT can preclude members to exchange controis or exchange restrictionsin accordance with IMF's Articles of Agreement.

50

As mentioned hefore, Article IV has !ost its primary goal in stabilizing a fixed exchange ratesystem. Under a context of free floating exchange rates, the Fund on!y has a feeblesurveillance role and members have a wide choice of exchange rate policies. Due to thesefactors, it becomes more difficult that an exchange rate policy is considered by the Fund as aviolation of its Articies of Agreement.

Nevertheless, the IMF, in its Article IV Consultations has already noted the substantialdevaluation of the Chinese currency, advocating for stronger exchange rates, whích couldindicate that those currencies were not fully consistent with the Articles intent3t.

It is a!so irnportant to recali that Article XV.2 states that WTO mernbers shal! consuit IMFwhen dealing with problems conceming foreign exchange arrangements. Consultations withIMF would, therefore, be required in any dispute concerning Artic!e XV.4.

However, the status of this consultation shou!d be as of ainicus curiae. The WTO DisputeSett!ement Understanding states iii its Artic!e 13 that: Each panei shall have lhe right to seekinformation and technicai advice from any individual or body which il deems appropriate.t4onetheless, the conc!usions provided by this third party - the azuicus curiae - shall not bemandatorily accepted by the panei, which has thc competence to make its own findings andreject those made by a third party. In this sense, the AB has stated that the panel shali notsimply accept IMF findings when consulted under Articie XV.2, but to criticai!y access thosefindings32.

Finaily, in order to determine a violation of Articie XV.4, members must identify whichprovision of GATT has had its intent frustrated. Concerning currency devaluations, Article IIof GATT that deais with market access could be cha!ienged. This interpretation wiii bedeveioped beiow.

Despite its relevance to the issue of misa!igned exchange rates, the changes suffered by IMFduring the years, which have resulted on the weakening of the Fund's control and surveilianceover exchange rates have had a significant impact on the provisions of the GATT over theis sue.

The whole Article XV reiied on the control by the Fund over its members' exchange rates.When the IMF stopped exerting such control and allowed members to have either f!oating orpegged exchange rates, the determination of an exchange rate policy inconsistent with its IMFArticles of Agreement became harder, despite the ímpacts that those policies might have ontrade. The application of GATT Articie XV.4 became more difficult while the risks ofdistortions to trade caused by misaligned exchange rates became grater, since the maininstitution responsible for the issue no longer exerts any form of control.

Nevertheless, the application of Article XV on exchange rate issues is stil! possible: IMFArtic!e IV was weakened but it sUfi provides a guideiine for exchange rate policies. At thesarne time, GATT Articie XV remains in force, and li cannot be made ineffective.Furtherrnore, Artic!e XV is relevant for the fact that it puts in evidence thc risks brought by

31 2011 - Councry Report People s Republic of China: 4rtic1e IV Consulsation, Staff Report, July 2011, p.18.

WTO, AB, Judia - Quantitative Restrictions, DS90. AB Report, 23 August 1999, paras. 149-150.51

exchange rate policies to the WTO system and the need to regulate it ia order to avoiddistortions on the multilateral trade system.

ii. Article XXIII

One of the most unique rules of the WTO system is Article XXIII, which deals with non-violation issues: measures that affect a member's benefits, gained through negotiations,although they do not violate any of Lhe WTO rules.

GATT Article XXIII:I (b) states that, if a member considers that a benelit accruing to it isbeing nullifled or impaired as a result of the application by another member of any measures,whether or not it conflict with the provisions of GATT, the member may take the issue to theDSB. The disputes arising from Article XXIII can therefore be either violation or non-violation complaints.

The logic of this provision is that competitive opportunities, legitimately expected from tariffconcessions, can be frustrated by both measures inconsistent and consistent with GATT33.Therefore, it is necessary to protect the balance of concessions under the WTO, by providingmeans to redress any actions that impairs member' s legitimate expectations from tariffnegotiations. In this sense, the Panel for Japan - Rim considered that:

( ... ) the safeguarding of the process and Lhe results of negotiating reciprocal tariff concessions underArticle II is fundamental to Lhe balance of rights and obtigations to which ali WTO memberssubscribe(Pane! Report on Japan Fi]rns, DS44, para. 10.35).

The possibiiity to pursue a complaint under Article XXIII based on misaligned currencies wasaffirmed in a Working Party of the GATT. During the discussions, in 1979, about theapp!ication of Article 11:6 (a), which allows the adjustment of specific duties by members withdevalued currencies, under the new context of floating exchange rates, a question was raisedabout the possibility of application of that Article in the opposite situation: whethercontracting parties with appreciated currencies should be required to rcduce their specificduties, ia order to maintain the negotiated levei of market access. The working party agreednot to pursue the matter, noting that contracting parties could resort to Articles XXII andXXIII of GATT if they considered that the currency depreciation impaired in a particular casethe value of specific duty concessions34.

A devalued currency that reduces or nullifies other members tariffs cou!d, thus, affect thenegotiated levei of market access, and give rise to a compiaint, regard!css of the violation ofany WTO rule, if three elements are met: application of a measure by a WTO member; abenefit accruing under the GATT; and nuliification or irnpairment of this benefit as result ofthe application of the measure35.

GATT, EEC paynients and subsidies paid to processors and producers of oi/seeds and related anirnai-íeedproteins, Panei Report adopted 011 25 January 1990. BISD § 37S186 (Thirty-seventh Supplement, Forty-sixthSession, 1989-1990), 116627, July 1991, para. 144: and WTO. AB. European G'omrnunities - MeasuresAffecting Asbestos and Products Containing Asbestos, DS 135, 12 March 2001. para. 185.

GArI'. Report ofthe Working Party ou Specific Duties, 114858. 2 November 1979. p. 6.35WT0, DSB, Japan - Measures Affecting Consumer Photographic Rim and Papei-. DS44, 31 March 1998,para 10.41.

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The word "measure" has a broad definition which encompasses bindinê government action aswell as measures that have an effect similar to a binding one 3 . Regarding currencymisalignments, one can argue that governmental policies that aim to keep exchange rates in acertain levei below or above its fundamental equilibrium could be considered as a measureunder the meaning of Article XXIII. It is importam toto notice that the Article requires an actionby a government, which resutts on the misalignment. The misalignment itself cannot be objectof a complaint under Article XXIII. Therefore, misalignments deriving from instability in theglobal economy, which express only the floating character of some exchange rates could notbe charged under a non-violation complaint.

Regarding the benefit, it is usually considered as legitimate expectation of irnproved marketaccess. In a market with devalued currency, other members will face a more restricted marketaccess, with higher tariffs, once considered the effects of exchange rates, which can easily beclassified as an impairment of the legitimate expectation of improved market access. Theopposite reasoning can also be done: when members with devalued exchange rates exporttheir products, they are, by giving an incentive to their exports through devalued exchangerates, making other members concede a larger market access than the one that was negotiated,irnpairing expectations of a balanced levei of concessions between these mernbers.

An important aspect of those expectations of a benefit is that, in order to it to be legitimate,the measures must not have been reasonably anticipated at the time of the tariff concessions.This can be a problem when dealing with longstanding policies of currency devaluation. Itcould be argued that this specific situation couid have been foreseen during the negotiationsof tariff concessions and, therefore, there is no misbalance to be addressed to.

In the other hand, in the case of China, for example, the government had affirmed that Chinahad adopted a inanaged floating exchange rate system, based on supply and demand 37 . If onecan prove that the devaluation of Chinese currency is due to government management basedin other criteria than supply and demand, it is possible to claim that renminbi devaluation38could not be reasonably anticipated, since China affirmed that it was adopting a more flexibleexchange rate system.

At last, one is required to prove the existence of a nuilification or impairment of that benefit.Such nullification or impairment should be understood as upsetting the competitivereiationship between domestic and imported products, clearly caused by the measure at issue.When dealing with policies of cunency devaluations, such nuilification is evident, since it cangive a significant competitive advantage to products, nullifying the protection performed bytariffs and further causing trade diversion.

Article XXIII can, thus, be a usefui remedy to some cases of distortions caused by exchangerate misahgnments. li does not directly address the issue but it couid provide countriesinstruments to redress the negative impacts caused by exchange rate rnisalignments.

36Jb1d.paras. 10.47-50.37WT0, Report o!the Working Party on the Accession o! China, WT/ACC/CHN/49, 1 October 2001. para. 31.381n this sense. see IMF, 2010 . Country Report Peopie s Republic o! China: Articie IV Consultation, StaffReport, July 2010, p. 4.

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iii. Trade defense remedies

Another instrument that would be able to provide mechanisrns to address distortions causedby misi1igned exchange rates would be the trade defense remedies. Antidumping rights andcountervailing measures are the two WTO instruments that cmi be used unilaterally againstunfair trade. Those instruments allow countries that are importing products with unfaircompetitive advantage, due to the practice of dumping or the concession of subsidies, toimplement duties up to the margin of this advantage, rebalancing the competition in itsrnarket. Considering the competitive advantages accorded by devalued currencies, iii amanner that distorts many of the WTO instruments and principies, one can ask if there is anapplicable trade defense remedy.

The Antidumping Agreement has very few dispositions on exchange rates. The UruguayRound Agreement was based in the concept of dumping and the practices made during theGATT period, which, by its tum, was created under a context of par value system ofcurrencies, where exchange rate misalignrnents where not a worry.

The concept of dumping is the practice of an export price below the comparable price of suchproduct, in the ordinary course of trade, in the internal market of the exporting country(normal value). The concept of durnping, as presented above, is based on the difference ofthe mo prices of a product (ADA, Article 2.1) and not on the comparison of the export pricepracticed and Lhe export price that the product should have if the currency was not misaligned.This competitive advantage that products from countries with devalued currencies may haveis not addressed under the Antidumping Agreement.

Under this "price dumping" concept, the issue of exchange rates appears only during the pricecomparison, when the normal value, in a local currency, must be converted imo the sarnecurrency used for the export price. Article 2.4.1 states that the conversion shall be made onthe date of saie. During negotiations, such provision was proposed due the fact that (..) lheamount oíthe durnpinç margin may differ significantly, depending on lhe exchange rate to beused on speciíic case3 . An exception is made to fluctuations in exchange rates, which shall beignored. Finaily, exporters shali have at Ieast 60 days to adjust their export prices to reflectsustained movements in exchange rates during Lhe investigation.

The Article reflects some of the impacts of exchange rate tiuctuations on trade, aliowingrnechanisrns to adjust the calculation of dumping margins to sudden variations of exchangerates during the period of investigations, which could lead to an inadequate comparisonbetween the export price and normal value. Nevertheless, it does not consider Lhese variationsafter the implementation of antidumping rights nor it considers the effects of exchange raternisalignments on Lhe determination of the injury.

Usualiy, exchange rate misalignments can affect antidumping rights in two differentmoments: during Lhe investigation, when determining the injury caused by Lhe dumpedproducts and during the application of antidumping rights when there is variation of exchangerates.

JAPAN/GATF, Subrnission o[ Japan ou lhe Amendments to lhe Antidumping Code, Multilateral TradeNegotiations - The UruguayRound, MTNNG/NGS/W148. 3 August 1989, p. 5.

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When the conversion of the normal price is made in accordance with Articie 2.4, there shouidbe no impact of exchange rates on the determination of the margin of the durnping, since thesarne rate would be used for the estabiishment of the export price by the producer(consjdering the costs of production in its local cunency) and for the normal value, asconverted to the export currency on the date of the saie. Since fluctuations shali be ignored,both rates should be the sarne, regardless of its misalignment.

The problem arises when determining the injury caused by the dumped products on theimporting country's market. When a dumped product comes from a country with devaluedcw-rency, besides the unfair competitive advantage arising from the price dumping itself, iralso has an advantage frorn its lower price due to the currency conversion at favorabie rates.This second factor can increase significantly the injury caused by the imports of such productat the domestic industry of the importing country, which cannot compete with theseartificialiy low prices. The amount of injury, used for the determination of the antidumpingrights (Article 9.1), will be much greater than the injury that wouid be caused oniy by thedumping. This is relevant because the injury is essential to the application of antidurnpingrights. If no injury is caused by the dumping, but an injury is found due to currencydevaluation, antidumping rights may be implemented in contradiction with its original airn ofavoiding harmful price dumping.

In the case of antidumping, a devalued currency rnay facilitate the application of antidurnpingrights. This demonstrates the importance of addressing the issue of exchange rates under theWTO, since it distorts rnany trade instruments, in different manners. The correction of suchdistortions interests ali countries, since countries with both overvaiued and devaluedcurrencies are being affected by exchange rate misaiignments.

The second unaddressed impact on antidumping rights occurs after the investigation.Misahgnments will affect the antidumping duties, frequently charged as specific duties inforeign currencies. This distortion will oniy be adjusted at the sunset review, untii then, theproducers may be charged of a much higher or lower antidumping duty.

To address the cornpetitive advantages of a product arising from currency devaluation,another instrument would have to be created, since the Antidurnping Agreement has noprovisions over the issue, except for the few ones mentioned above. This new instrumentwould be based on the cornparison between the export price and the export price that wouidbe practiced if the currency was in its mediurn term equilibrium. It is a concept of "currencydumping".

Negotiations of the Havana Charter have considered this possibility, within a proposai ofcreation of four kinds of dumping, which couid be object of antidumping measures: price,service (freight), currency and social durnping40.

The proposal was rejected possibly because in a par vaiue system the idea of a currencydumping seemed a remote risk since the IMF would aiready provide enough guarantees toavoid countries manipuiating their currencies to get competitive advantages. Nevertheiess, ina floating exchange rate systern, the concept of a currency dumping rernedy seems very

° UN. ECOSOC. Report o! me Drafting Gornmittee o! ffie Preparatory Cornrnittee o! ffie United Nationsconference on Trade and Einpioyrnent, UN ECOSOC, E/PCJT/34, 5 March 1947. p. 13.

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plausible, creating a trade defense mechanism Lhat would allow countries to offset lheadvantages acquired by imported products due to exchange rate misalignments.

Despite Lhe lack of prevision of a currency durnping, GATT states, in its Second Ad Note toparagraphs 2 and 3 of GATI' Article VI, that:

Multipte currency practices can iii certain circunistances constitute a subsidy to exports which may be metby countervailing dutics under paragraph 3 or can constitute a forro dumping by means of a partialdepreciation of a country's currency which may be meL by action under paragraph 2. By "multiplecurrency practices" is meant practices by governments or sanctioned by governments.

This provision was included at lhe behest of South Africa request that stated that:

Mr. Chairman, ibe South African delegation raised this matter of multiple currency rates in relation tewhat we temi "exchange dumping duties", We had these expressions of opinion and we withdrew ourendeavours to get the proposed new paragraph 741 written into this particular Articte, by virtue of the factthat this commentary was te be included in Lhe notes of this meeting.42

The provision shows that although no specific instrument to counter currency dumping wascreated and although lhe IMF would exert control over exchange rates, some currencypractices were considered by members as a form of countervailable subsidy or dumping.

Indeed, another trade defense instrument that should be analyzed when dealing with exchangerates is lhe countervailing measure. The SCM regulates lhe granting of subsidies and aliowsmembers to charge countervailing duties iii order to offset lhe effects of subsidies on importsthat are found to be hurting domestic producers.

Economically, a devaluation of a country's exchange rale can be considered as a subsidy,since it is a governmental policy, that includes the buying of foreign currency in order to keepits own currency at artificially Iow rates, and it has an effect of lowering lhe prices ofexported products, granting them a competitive advantage in other markets. One can ask ifthis economic concept can be framed under lhe concept of subsidy under lhe WTO, aliowinglhe use of countervailing measures.

The SCM has a much more restricted concept of subsidies:

1. For Lhe purpose of this Agreement, a subsidy shatl be deemed to exist if:(a)(l) Lhere is a financial contribution by a government or any public body within Lhe Lerritory of aMeniber( ...);or(a)(2) there is any form of income or price support in the sense af Article XVI of GKfl' 1994;and(b) a benefit is thereby conferred.

In lhe case of devalued exchange rate, lhe conferred benefit is evident, as a devalued currericyaliows a product to have a lower price at the externai market than it would have with anexchange rate at its equilibrium. The benefit could be recognized by lhe fact that Lhe

41 Paragraph 7 of Articte 17 of the Havana Charter would have created the concept of currency dumping.42 IJN, ECOSOC. Verbatim Report o! the Twentieh Meeting o! Commission A to the Second Sessiori o! thePreparatory Coinrnittee o! the Unitcd Nations Conference on Trade And Employrnent, UN ECOSOC.E/PC/T/A/P V/ 20, 28 June 1947, p. 34.

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beneficiary would be piaced in a "better position than it would be in the absence of thesubsidy"43.

A greater difficulty arises from the identification of a financial contribution. This requirementwas intended to ensure that not ali governrnental measures that conferred benefits could bedeemed to be subsidies. That indicates that the expression "financial contribution" cannot beunderstood in a wide sense, including ali governmentai measures that confer a benefit. Afinancial contribution is au act or an omission invoiving the transfer of money or theprovisiori of certain goods or services45.

In order to classify a devalued currency as a subsidy, first of ali it is necessary to prove thatthe government is taking action to maintain its currency artificiaily iow. The devaluationcannot be a result of an extemal economic context, there must be a governmentai act oromission. Nevertheless, even if a government is deliberately manipuiating its currency, onehas yet to identify the money trans Ler between the government and the beneficiary. It coud beargued that this transfer lies in the act of converting a currency, by buying a foreign exchangecate at a lower price than the regular market price, or what should be the market price, sincethe official exchange cate would be the misaiigned one.

Once again, the Second Ad Note to Paragraphs 2 and 3 of GATT Article VI states thatmuitiple currency practices can in certain cases constitute a form of subsidies. As the Articlesof GATT shail be read together with lhe SCM, this implies that, in some circumstances, onecan identify a financial contribution - that would constitute a subsidy - in certain currencypractices. The provision foresees, thus, that some currency practices might be deemed assubsidies by the contracting parties and should be object of countervailing measures.

To be actionable under the WTO, a subsidy must also be specific. A specific subsidy is eithera prohibited subsidy (contingent upon export performance or upon the use of domestic overimported goods), or a subsidy specific to an enterprise or industry or group of enterprises orindustries (Article 2). In the case oL multiple currency practices, the specificity was evident,since a lower exchange rate would be accorded only to some sectors, and thus an Ad Notewas included under GATT Articie XVI, in order to ailow muitiple cates in accordance withIMF.

lii the case of a sinale devaluated exchange rate, it seems difficult to consider as specific adevalued exchange cate that should be available to ali exporters, investors, etc. Nevertheless,if one can prove that the exchange rate is directly linked with the volume of a country'sexport, varying when this volume raises or diminish, it is possible to argue that the subsidyarisen íorm a devaivated exchange cate is contingent upon exports, and thus, a prohibitedsubsidy under SCM Article 3 - which couid be object of a fast track panei.

WTO, AB. Canada - Measures Affecting ffie Export o! Civilian Aircraft, DS70, AB Report adopted on 2August 1999, para. 161.

WTO, DSB, US - Measures Treating Export Restraints as Subsidies, DS 194, Panei Report adoptcd on 29 June2001, para.8.65.

WTO, DSB, lIS - Prelirnirxary Determinations with Respect to Certain Softwood Lamber from Canada «TI,),D5236. Panei Report adopted on 27 September 2002, para. 7.24.

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Furthermore, by lhe provision 011 SCM Article 2.3, this prohibited subsidy shall alsoconstitute a specific subsidy, actionable by countervailing duties if it is proved that it causesinjury to the domestic industry of another member46.

A proposal dealing with trade defense remedies as a mechanism to address the effects causedby misaligned exchange rate is lhe "Currency Exchange Rate Oversight Reform Act of 2011".The American Act, still pending on approval, seeks to address to lhe effects caused byfundamentaliy misal.igned exchange rates through negotiations or by implementing tradedefense remedies.

The Secretary of Treasure shall submit to lhe Congress an annual report on monetary policyand currency exchange rales, which will include a lisi of currencies designated asfundamentally misaligned. Some of those currencies will be designated for priority action,according to factors such as: market interventions protracted in Lhe currency exchange market;accumulation of foreign reserves; and restrictions on lhe inflow or outflow of capital, forbalance of payment purposes.

The Secretary of Treasure shall seek bilateral consultations with countries with rnisalignedcurrencies, so these countries can adopt measures to address Lhe issue, and also seek theadvice of Lhe IMF, in case of currencies designated for priority action. In this Iast case, if nopolicy is adopted by Lhe respective country, antidumping initiations taken by Lhe USA shalltake into consideration Lhe exchange rate effect, by adjusting lhe price used to establish exportprice to reflect the misalignment of Lhe currency of Lhe exporting country. The USgovernment shall also: prohibit procurement by Federal Government of products and servicesfrom lhe cowty, if iL is not party to Lhe Agreement on Government Procurement; request LhaLlhe IMF consuit the country with misaligned currency under Article IV of IMF Articles ofAgreement; and not approve any financing of projects located in Lhe country.

One year after Lhe designation of a currency for priority action, if no measure is adopted, thegovernment of lhe US shall: request consultations at Lhe WTO with such country; andconsider undertakiig remedial intervention in the international currency markets.

The draft hill also proposes an amendment to lhe Tariff AcL of 1930, in order to allow Lheinitiation of investigations to determine whether currency undervaluation by the governmentof a country is providing a countervailable subsidy. The initiation of the investigation shafl bemandatory for currencies designated as for priority action. The proposal also presents aprovision that states that "Lhe fact that a subsidy may also be provided in circumstances thatdo not involve export shall not, for that reason alone, mean that the subsidy cannot beconsidered contingent upon export performance".

The Act proposes, thus, both the creation of a currency dumping, that should be implementedtogether wiLh regular price dumping, and the use of countervailing duties to address toexchange rate issues, altering the definition of a subsidy contingent upon export, in order toallow lhe classification of a currency misalignment under this concept.

Even though, trade remedies appear to be an interesting solution to Lhe exchange rate issue,they require a negotiation under lhe WTO, in order to adapt Lhe existing mies to lhe matter.

46 For a deeper analysis, sec LIMA-CAMPOS, Aluisio de; GIL, Juan Antonio Ouvir ia, A case for n;isalignedcurrencies as councervailable subsidies. unpubl ished

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Even though, trade remedies appear to be an interesting solution to the exchange rate issue,they must be used carefully. In order to impiement countervaiiing duties, one would also haveto prove in the concrete case that the exchange rate policy cmi be considered as an exportsubsidy. The concept of currency dumping does not exist under the Agreement ouAntidumping. t4ew negotiations would be required to adapt the Multilateral System to theconcept of currency dumping and to create specific trade remedies such as currencyantidurnping. Another possibility would be the negotiation of speciai bilateral safeguards tooffset the impacts of exchange rate misaligaments.

iv. Article II:!

The basic ruies for market access in the context of the GATTIWTO are in GATT Articie II.Article 11:1(a) estabhshes that:

Each contracting party shall accord to the commerce of the other contracting parties treatmenl no Iessfavorabte than that provided for in the appropriate Part of the appropriate Schedule annexed to thisAgreement.

The paragraph states that the levei of market access, determined by tariffs and other barriers,shall not be less than the negotiated levei under each country"s schedule of concessions.

The provision aims, thus, to assure that thc negotiations made through GATT and WTOrounds are not impaired by any treatment imposed by a member that might increase or imposenew barriers to international trade, reducing the market access. There is a worry ofguaranteeing the respect of concessions in order to aHow an increasing access to countries'markets. Under this trade liberahzation logic, the expression "iess favorabie treatment" shouidhave a wide meaning, inciuding aii measures piaced by a member that reduces the negotiatedmarket access. Such is the understanding of the EC - IT Products case (DS377) that hasstated that a iess favorable treatment should be understood as a measure that adverseiy affectsthe conditions of competition for a specific product (Panei Report, para. 7.757).

Article 11:1 (b), on its tum, states that products described on Scheduies shaH:

"( ... ) be exempt from ordinary eustoms duties in excess of those set forth and provided therein. Suchproducts shalt also be exempt from ali other duties or charges of any kind imposed on tor in connectionwith the iniportation in excess of those imposed on the date of this Agreenient or those dircctly andmaridatorily rcquired (o be imposed thereafter by legislation in force in the importing territory on thatdate"

In other words, countries have to keep their applied tariffs in an equai or lower levei than theirbound tariffs and shaH not impose any other kind of duty connected with importation thatexceeds the negotiated duties under the WTO. It should be noted that paragraph 1(b) is morespecific than paragraph 1(a) and its vioiation automaticaliy means a violation of paragraph1(a).

When considering exchange rate rnisalignments, one can tariffy its effects, by caiculating thepercentage by which prices of products are increased or decreased due to the misalignment, asshown in the first exercise of the previous chapter.

When dealing with converting currencies, the tariffication process can indicate distortionscaused by misaligned exchange rates ou prices. When this effect of misahgnments is applied

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onto tariffs charged at the frontier, one can analyze the real barriers irnposed by a country toimported products and compare it to its WTO commitments.

In the case of devalued currencies, Lhe final barrier imposed to irnported products (tariffsadjusted to exchange rate rnisalignment) may be greater than the bound tariffs under thecountry's Schedule, reducing the market access and resulting on a less favorable treatrnent.This effect clearly impairs the aim of Articte II, which is the maintenance of Lhe negotiatedmarket access, ia a perspective of trade liberalization.

The provision requires, nevertheless, that such less favorable treatment is accorded by thecountry which is irnporting the products. In other words, the treatment must be attributable togovernments. It cannot be a result of external circumstances. If one considers Lhat themisalignment is a result of a countrys policy, regardless if the devaluation was the aim ofsuch policy or just a side effect, it is possible to argue that it is according a less favorabietreatrnent than the one negotiated under the WTO, in violation of Article 11:1(a).

One could argue that since the provision makes reference to a treatment provided on amember's Schedule, this could only comprise tariffary treatrnent. This interpretation isincorrect for two reasons: first, Article II: 1 (b) has specific provisions on customs and duties.If paragraph (a) was restricted to tariffs, both Articles would have Lhe sarne exact purpose.The difference in the wording of both provisions should be taken into consideration. Thesecond reason is found in Article 5(b) of the SCM, which states that a subsidy is actionable ifit nuilifies or impairs the benefits of concessions bound under GATT Article II. This meansthat a subsidy, which is not tariffary, can be considered a treatment less favorable than the oneprovided in the Schedule. Therefore, Article II: 1 (a) can also apply to other non tariffarytreatments.

Furthermore, tariffs adjusted to the exchange rate rnisalignment may be considered as chargedin excess of the ordinary customs duties settled on the country's Schedule. The exchange raternisalignment distorts the applied tariff and rnay increase it over the bound tariffs, especiallyia deveioped countries and countries that have recently acceded to the WTO, that have a verynarrow margin between applied and bound tariffs. This Lariff in excess of the bound tariffwouid constitute a de facto violation of Article 11:1(b) - and consequently of Articie 11:1(a),reducing the market access and disrespecting the negotiations of tariff reduction through LheGATT and WTO rounds47.

The impacts of exchange rate rnisalignrnents on GATT Article II: 1 are of great worry, sincethey directly affect the guarantees of the WTO systern on Lhe respect of market accesscornrnitnients made by its members. The distortions caused by those misalignments on marketaccess are undeniable and musi be considered under Lhe WTO, under the principies laid outon Article II.

Even if one considers that there is no violation of the letter of Article 11:1, is still possible toargue Lhat its intent has been frustrated, since rnisaligned exchange rates can reduce Lhenegotiated market access. In this case, the frustration of such airn may give rise to a chailengeunder GATT Article XV:4, cornbined with Article II, as explained above.

See also HUDSON, O.; BENTO de FARIA, P. and PEYERL. T.. "The Legality Of Exchange RateUndervaluarjon Under WTO Law, The Graduate Institute of Geneva. Trade and Investrnent Law Cliniccoordinated by Professor JoostPauwelyn, June 2011, elaborated upon request by the CGTI.

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It is interesting to note that despite the lack of specific provisions of the reduction o!' marketaccess caused by devalued currencies of exporting countries, GATT Article 11:6 provides aninteresting mechanism of adjustment of specific duties, caused by importing countries'currency devaluations. This providos an evidence of the impacts of exchange rates on tariffsand market access, strengthening the argument of the impairment caused by devaluedcurrencies in Article 11:1.

v. Article 11:6

The idea that exchartge rato misalignrnents can affect the negotiated levei of market access isevident under Article 11:6. The Article aliows the adjustment of tariffs in order to reestablishthe negotiated market access affected by misaligned exchange rates in one specific situation:

The specific duties and charges included in Lhe Scheduies relating to contracting parties members of LheInternational Monetary Fund, and margins of preference in speciflc duties and charges are maintained bysuch contracting parties, are expressed in Lhe appropriate currency at Lhe par value accepted orprovisionaily recognized hy the Fund at Lhe date o! this Agreernent. Accordingly, in case this par valueis reduced consistentty with the Articles of Agreement of lhe International Monetary FunU by motethan twenty per centum, such specific duties and charges and margins of preference may beadjusted to take account of such reduction; provided that Lhe CONTRACTINO PARTIES (i.e., Lhecontracting parties acting jointly as provided for in Article XXV) concur Lha( such adjustments wili notimpair Lhe value of Lhe concessions provided for in Lhe appropriate Schedule or elsewhere in thisAgreement. doe account being taken of ali factor which may influence the need for, or urgency o!, sueiadjustment. (Eniphasis added)

A devalued currency has an effect of lowering the relative value of specific duties, enlargingthe negotiated rnarket access. It has Lhe exact opposite effect of ad valorem tariffs, which havetheir relative value raised by a devalued currency, diminishing the market access. The Articleallows. thus, countries to reestablish their negotiated market access that was unduly enlargedby the efíects of the devalued currency, by negotiating a raise on their specific duties. Thisnegotiation has occurred nine times during GATT era, between 1950 and 1975, ailowing theraise o!' bound specific tariffs of Benelux, Finland (3 times), Israel, Uruguay (twice), Greeceand Turkey.

Nevertheiess, the provision encompasses oniy one of four possibilities of the effects ofexchange rates on tariffs, the other three being: (i) overvalued currencies raise the relativovalue o!' specific duties, restringing the market access; (ii) devalued currencies raise Lherelative value of ad valorem duties, restringing the market access; and (iii) overvaluedcurrencies diminish the relativo value ol' ad valorem diities, enlarging the negotíated marketaccess. If the Article recognizes the need that countries may have to adjust their tariffs inorder to address to Lhe impacts of currency misalignments, why not to aliow this adjustment inali four cases, ínstead ofjust one o!' them?

A second interesting issue raised by Article 11:6 is the change in the intemational monetarysystem, from a par value to a floating exchange rate system. Initially, any devaluation thatcouid give rise to the application o!' Articie 11:6 would be defined by the IME, according withLhe par value system managed by the Fund. With the end o!' Lhe gold standard, it would benecessary to adapt the Article, so misa!ignments couid still be caicuiated, despite the lack of apar vaiue.

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The GATT contracting parties created a Working Group whose objective was to adapt theexisting mechanism in Article 11:6 to the new reality of floating exchange rates. From 1978 to1980, the Working Group met and adopted, in January 29 1980, the Guidelines for Decisionsunder Article 11:6(a) of the General Agreement (L14938, 27S/28-29). This documentreaffirmed the importance of maintaining the mechanism in order to neutralize the effect ofexchange rate devai.uation ou specific tariffs of contracting parties and created a methodologyfor the calculation of the currency depreciation, which shail be performed by the IME. Thecalcuiation takes into consideration the import-weighted average exchange rate during theprevious six months, and the depreciation shall be based ou currencies of trading partnerssupplying at least 80% of the imports of the concemed eountry. This Guidelines have beenincorporated under GATT 94, as established by its Article 1(b)(iv), and can be rightfuiiyinvoked by any WTO member.

It is also worth noting that, unlike Articie 11.1 and other GATT provisions that rnay deal withthe exchange rate issue, the provision of Article 11:6 is focused on the misalignment itself andnot on a governmentai action that results in a currency misaiignment.

Another relevant element of Article 11:6 is the threshold of a 20% devaluation, to enabiecountries to adjust their tariffs. This is importam asas it shows that only large misalignments canhave a significam impact on the levei. of market access, justifying an adjustment ou tariffs.Under a iloating exchange rate system, this threshold is even more necessary, since smailvariations and peaks in exchange rates occur often, but are not suffíciently grave to affectmarkets access. Oniy long standing misalignrnents, for the past six months, for instance, asestablished by the Guidelines, should be taken into consideration when evaivating the leveisof market access. The Guidelines kept the threshoid of 20% of exchange rate misalignment asa base for Lhe renegotiation, but it should be noted that this threshold was consideredreasonable based ou the levei of the tariff rates ar that time. Due to Lhe decrease of tariff ratesleveis, a new exchange rate misaiignment threshold could be negotiated in order to aHow atariff renegotiation of Lhe current systems of fioating or administrated exchange rates.

Finally, iL must be stressed that the negotiation mentioned in Article 11:6 had the objective toassure that Lhere has been au enlargement in the country's market access Lhat surpass thenegotiated levei and thaL Lhe tariffs are not adjusted in such way as to restrain bis accessfurther than the original negotiated levei. It is different, thus, of Articie XXVIII, which altowsmembers to withdraw its concessions, at the condition Lhat iL provides other compensations tomaintain Lhe general levei of concessions. In the case of Article 11:6, no compensation isrequired since the adjustment aiready aims to reestablish Lhe levei of concessions.

Of ali the impacts of exchange rate on trade instruments, the impact on market aecess is themost reievant one, since iL may impair the main aim of Lhe WTO: to liberalize internationaltrade, based on a balance negotiation of concession on market access. Article II alreadyprovides some mechanisms to address the issue, but in au incomplete manner. Negotiationsare essentiai to adapt the Articie in a way iL can fully prevent the distortions created bymisaligned exchange rates on market aecess.

2.3. Conclusions

The issue of exchange rates was never properly addressed under the Multilateral TradingSystem, mostly due to the initial responsibility of IMF over the subject. Iinder Lhe logic of theBretton Woods system, of a coherent financial and trade regulation, Article IV of Lhe [MF

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Articles of Agreement should be sufficient to address to most of the impacts of exchange rateson trade. Nevertheless, with the deep change caused by the end of the pair value system, therules ou exchange rates became inefficient at avoiding such negative impacts.

On the other hand, atthough the GATT and, in the foliowing, the WTO, have a few provisionsou exchange rates, proving the direct relation between this and international trade, a moreconsistent regulation over the issue was never a primary concern, since the matter was alreadyaddressed by the IMF, with which the WTO should cooperate in order to achieve greatercoberence (Marrakesh Agreement Establishing the World Trade Organization, Article 111:5).However, the changes uridergone by the IMF were riot talcen into consideration by theGATT/WTO and the lack of regulation arisen after the end of the pair value system was neverproperly analyzed.

Nonetheless, there are a few provisions under the WTO agreements that could be applicableto the exchange are issue, although insufficient to address the rnatter under a systemicmanner, avoiding the negative impacts of misaligned currencies on mernbers' trade. A casestudy is required in order to conclude on the possibility to chalienge a specific WTO memberunder the Dispute Settlement System, based on violation (and non-violation) of WTOprovisions due to its currency misalignments.

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111.2 THE ISSUE OF SUBSIDIES

China is estimated to become the most important economy ia the World in the next few years.1-lowever, its model of economic development is raising concems from several intemationalpartners. Since China acceded to the WTO, in 2001, it has been called to compiy with aliinternational trade mies and had to accept a more trans parent manner to implement its reformsand other changes required by its Protocol of Accession.

As the iargest exporter in the World and a fast growing economy, with rates varying from 7%to 1.0% per year, China is identified by many countries as a threat to their international marketpositions and also to their nationai industries.

The core of this chapter is to anaiyze one of the piilars of the Chinese Economic DevelopmentModei - subsidies. The maia objective is not to present a whole picture of the issue, but onlyto show some evidence of the importance of subsidies in the Chinese economy.

International mies on subsidies are established by WTO, in Article VI of the GATT and theSCM. The issue of Chinese subsidies is so sensitive, that a speciai clause was introduced inlhe Protocol of Accession of China on the subject.

WTO does not prohibit ali kinds of subsidies programs, butjust those that are contingent uponexport or upon the use of national content (Article 3, SCM).

The 5CM defines subsidy as a financial contribution made by (or on behalf oO a governmentor public body, or any kind of income or price support, which confers a benefit to therecipient, as of Article 1.1., Article 1.2 and Article 2 of SCM rule that subsidies limited to aspecific firm, industry or group of firms or industries shall be actionable under the WTO, bythe imposition of countervailing duties or by a compiaint under the DSB, in accordance withthe requirements of the 5CM.

The Protocol of Accession of China to the WTO determined special mies regarding subsidies.Article 10.2 states that: For purposes o! applying Articies 1.2 and 2 o! the SCM, subsidiesprovided to SOEs will be viewed as specific if inter alia, SOES are the predoniinantrecipients of such subsidies or SOEs receive disproportionate/y largo amounts of suchsubsidies.

Furthermore, Article 10.3 of the Protocol cails upon China to eliminate ali subsidy programsfailing within the scope of Article 3 (prohibited subsidies) of the 5CM.

In order to understand Chinese policy regarding subsidies it is necessary to address somepecuharities of its economic development system, which can be summed up by two modeis: astate-oriented model (e.g. Shanghai province) and an entrepreneurship model (e.g. Zhejiangand Jiangsu provinces).

As an example, this study wiil show the differences amongst these three Chinese regions,where proportionaily there are more SOEs in Shanghai than in Zhejiang or Jiangsu. Also, it isworth to take note that the economic model applied to each region has interfered on itsdevelopment and GDP por capita performance through the years.

Chinese SOEs began to pay in since 1985. After that, SOEs started to make tosses and had tobe covered by the government. For this reason, those enterprises were granted subsidies iaorder to reverse the situation. lii 1999, China and the United States signed an agreemeat priorto the Chinese accession to the WTO, where China agreed to cut its subsidies to Ioss-makingSOEs progressivety. Nevertheiess, up to 2008, this kind of subsidy remained as part of theChinese strategy to develop its textile industry.

Concerning the textile industry, if it was possibie to estabtish a pattern, it coutd be said thatthe IOth Five-Year Pian (2001-2005) was a start towards a global market competitiveness ofChinese textile industries. It is possibte to note a risc on subsidies leveis in order to permitcompanies to enhance their competitiveness in the global market. Also, it is possible to verifythe privatization of small SOEs because of the deficit amount, affecting Chinesegovernment' s budget.

The 1 lth Five-Year Plan covered Lhe years from 2006 to 2010 and the incentives were stillbased on the uprising of Chinese exports and companies' competitiveness. In this period, theEastern Region of China, where the textile provinces are tocated, experienced a strong rise onminimum wages, social security bitts and reiated costs. For that matter, the Chinesegovernment, especialty the provinces, created some programs focused on financing and loansto those companies, at low rates.

The 12th Five-Year Plan (2011-2015) is focused on innovation and R&D. In Lhis sense, theChinese government is still working te enhance the quaiity of the textiie products andmachinery produced in China and exported ali over the Wortd.

In the meantime, the Chinese government opted not to notify its known subsidies programs tothe WTO, as required by Lhe SCM The United States, in 2011, introduced a Request frorn theUnited States to China pursuani to A rticle 25.10 of the Agreernent (C/SCM1Q2/CHN142 - 11October 2011); listing 200 subsidies programs that China was in default to report to theCommittee on Subsidies and Countervaiting Measures.

This chapter is structured te introduce some aspects related to subsidies on Chinese economy,especiaiiy in the textile industry sector. Firstty, the regulatory framework on subsidies ofGATT, SCM and Lhe Protocoi of Accession of People's Repubiic of China to the WTO ispresented. Secondly, the mam characteristics of Chinese textile industry based upon Lheavailabie data are examined. Thirdly, a brief anaiysis of the economic devetopment modeis iaChina: state-oriented and entrepreneurial is summarized. Fourthiy, Lhe subsidies programsinvestigated by the United States and submitted to the Committee on Subsidies andCountervailing Measures in the WTO are iisted. Last but not leasi, our conciusions, presents abrief legal analysis comparíng the mie in force and Lhe practices of Lhe second iargesteconorny in the World.

1. WTO rules: GATT, SCM and the Protocol of Accession of China

1.1 WTO rules

The Agreement on Interpretation and Application of Articles VI, XVI and XXIII of GATT1947, negotiated ia Tokyo Round, was built on in the Uruguay Round by the SCM, as a partof the Marrakesh Agreements.

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The bases of the concept of subsidies are: GATT Article VI that established lhe rules forantidumping axid countervailing measures; GATT Article XVI that presents more rules forsubsidies; and GATT Article XXIII regarding nuilification of impairment. The Code onSubsidies of lhe Tokyo Round introduced new rules but was not able to produce a definitionof subsidy. A definitive deíinition was only introduced in lhe SCM of lhe Uruguay Round asper Article 1 (Definition of a Subsidy):

1.1 For lhe purpose of this Agreenient, a subsidy shall be deenied to exist if:(a)(I) there is a financial contribution by a government or any public body within the territory of aMember (referred to in this Agreement as "government'). i.e. where:(i) a government practice involves a direct transfer of funds (e.g. grants, loans, and equity infusion),potential direct transfers of funds or liabilities (e.g. loan guarantees);(ii) government revenue that is otherwise doe is foregone or not collected (e.g. fiscal incentives such astax credits)48;(iii) a government provides goods or services other thari general infrastructure, or purchases goods;(iv) a government makes payments to a funding mechanism, or entrusts or directs a private body to carryout one or more of ifie type of functions illustrated in (1) to (iii) above which would normally be vested iiithe government and the practice, in no real sense, differs from practices normally followed bygovernments; or(a)(2) there is any forro income or price support ia lhe sense of Article XVI of GATT 1994; and(b) a benefit is thereby conferred.1.2 A subsidy as defined in paragraph 1 shall be subject to lhe provisions o! Part II or shall be subject tothe provisions o! Part III or V onty 1f such a subsidy is specific in accordance with the provisions o!Article 2."

The 5CM determined three categories of subsidies: prohibited, actionable and non-actionablesubsidies. However, the category of non-actionable subsidies was riot renewed ia 2000 andexpired. As determined by Article 1 above a subsidy is defined by a financial contribution orany forra of incotue of price support that confers a benefit. Unlike dumping definitions,subsidies are performed by lhe government, even though lhe beneficiary may be a privateentity.

In accordance with Article 3 of SCM, lhe following subsidies shall be prohibited:

(a) Subsidies contingent, in law or in fact, whether solely or as one of severa] other conditions, uponexport perforniance ( ... )

(b) Subsidies contingent, whether solely or as one of severa] othcr conditions, upon the use of domesticover imported goods.

Prohibited subsidies may be object of a complaint under the DSB, foliowing lhe proceduresestablished in Article 4 of the 5CM.

PART III of the SCM regulates Actionable Subsidies. Article 5 determines that

No Member should cause, through the use of any subsidy referred to in paragraphs I and 2 o! Article 1,adverse effects to lhe intercsts o! other Members. i.e.:(a) injury to the domestic industry of another Member;(b) nuilification 0v impaivment of benefits accruing directly or indirectly to other Members under GATF

1994 in particular ifie benefits of concessions bound under Article 11 o! GATT 1994:(c) serious prejudice to lhe interests o! another Member.

48 "In accordance with the provisions o! Article XVI o! CAI]' 1994 (Note to Article XVI) and the provisions o!Annexes 1 through III o! this Agreement, the exemption of an exported product from duties or taxes borne by thelike product when destined for domestic consumption, or the remission of such duties or taxes in amounts not iaexcess of those which have accrued, shall not be deemed to be a subsidy."

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This Articte does not apply to subsidies maintained on agricultural products as provided in Articte 13 oflhe Agreenient on Agriculture.

Actionable subsidies can be challenged through the DSB, or through countervailing action ifiL causes injury to the dornestic industry of another member.

The SCM also presents some specific rules for countervailing investigations such as period ofLime, reviews, sunsets, de minimís clause. It is also importam toLo mention that Lhe SCMrecognizes Lhe positive use of subsidies in economic development programs, especially fordeveloping countries, and in Lhe transformaLion of centrally-planned economies to rnarketeconomies (SCM Articles 27.1 and 29.1).

Under this concept, China should be considered an economy in Lransition. However, despiteof few moves in transition to a market economy, several observers have recognized Lhat Chinahas not continued its reforms towards thís kind of system.

As a consequence, iL is being held a new debate on how to apply Lhe SCM on NMEs as China.It is been. argued Lhat iL would not make much of a sense to appty anti-subsidy measuresagainst China because it is treated as a NME. As a non-rnarker economy, subsidies cannot bequantified; price and cost are artificia!ly set by a centrally-planning authority49.

The US faces a challenging dilemma: in 1983, Lhe US Department of Commerce had reachedthis sarne conclusion about Lhe impossibitity to apply CVD againsL NME. This decision isnow being challenged by the US Presidency50who claims the very opposite, arguing that aCVD rnusL be imposed when identified, even againsL NME counLries51.

TROMMER. Sitke Metanie. "Special Market I3conomy: Undermining lhe Principies of WTO?" In: ChineseJournai o! International Law. v. 6, n° 3, 2007, pp. 597-598. The author also suggests a possible solution on thematter: "If one considers that no WTO inember upholds a classical non-market econorny with complete Statemonopoly over alt Lrade-related aspects of lhe econorny today, and that Lhe administrative practice addressingthis issue in antidumping proccedings is ledious and produces frustrating outcomes for ali parties invotved, onemay ask wheiher anti-subsidy investigations could not be conducted in cases of State interícrence, just tikeagainsl any other wo member. Arguably. lhe prolection value of the domestic industry against unfair tradingpractices is the sarne, since antidurnping duties theoreticalty can only be upheld before lhe Dispute SettlementBody if they are irnposed in tine with Articte VI of GATT and lhe Antidumping Agreernent, that is to say if theunderlying catcutations are adequate and the industry of the importing counlry suffers material injury caused bydumping. A survey of interested parties of EC Trade Defence Instruments in 2005 has shown that this view isshared by severat EC industries which suggesled that the anti-subsidy inslrument should be used in the case ofeconomies in transition."° In its 2011 Report to Congress on China's WTO Conipliance. the LJSTR slates that "The Commerce

Departmenl began applying U.S. CVD taw to China after finding lhat reforms to China's economy in recentyears had removed the obstacles to appiying Lhe CVD taw that were present in Lhe 'Soviet-era economies' atissue when the Commerce Department first declined to appty Lhe CVD Iaw to non-rnarket economies in lhe1980s." tn: USTR. 2011 USTR Report to Congress on China 's WTO Coruplíance, December 2011, page 46.

Reccntly, on lhe case GPX Internationat Tire Corp. v. U.S., case n° 08-CV-0285. of 19 December 2011, theU.S. Court of Appeals for lhe Federal Circuit stated lhat "Commerce appealed to our court, arguing that asubsidy is 'a device used by governrnents to dislort the signals that the markel gives to firms,' and that bydetinition. subsidies do not exist in NMEs" (page 6). On pago II, Lhe Court reveals that "Cornmerce's primaryargument is that lhe piam statulory tanguage mandating that a countervailing duty 'shatl be imposed' requires itto inipose countervailing dulies when il is able to identify a subsidy, even in an t'IME counlry". Finally. on page17. lhe Court explores the Depariment of Commerce decisions uphetd in 1983, arguing that "Commerce flrstconsidered imposing counlervailing duties on NME imports in 1983. when a countervailing duty subsidy wascalled a 'bounly or grant,' 19 U.S.C. § 1303 (1988) (repeated 1994). In 1984. Commerce deiermined that 'a'bounty or granl, within the rneaning of the countervailing duty law, cannot be found ia an NME' because 'Lhenotion of a subsidy is, by definition, a rnarket phenornenon.' Wire Rod, 49 Fed. Reg. at 19.372, 19.374. This

67

The United States Court of Appeals, recently, has upheld the understanding of the OSDepartment of Cornrnerce, dated as of 1983, in the case CPX International Tire Corp v.United States (GPX), which means that the OS Departrnent of Commerce cannot applycountervailing duties to ariy merchandise from any country that the sarne departmentconsiders a NME aiming at antidumping law. For that matter many countervailing ordersagainst China shall bè revoked and the US Department of Cornmerce will not be able toinitiate any countervailing duty investigations against NMEs. This is why the USTR urges theCongress to pass the bili "clarifying that Lhe CVD law can be applied to subsidized goodsfrom NME countries"52.

It is also important to notice that Article 27.13 of the 5CM itself, applicable to developingcountries in a process of privatization is not applicable to China, as of its accession'scommitments (RWP, paragraph 171).

1.2 Protocol of Accession of China to the WTO: commitments on subsidies

On the matter of subsidies there are some specific rules in the Protocol of Accession of Chinato the WTO, which China has agreed to uphold by its accession time in 2001.

In a general basis, China has comprornised to notify the WTO of any subsidy within themeaning of Article 1 (definition of a subsidy) of the SCM, including subsidies under Article 3(prohibited subsidies) of the sarne Agreement, in accordance with SCM Article 25.10. In2001,. upon its accession, China submitted, tinder Annex 5A, Notification Pursuant Article 25of lhe SCM, describing subsidies applied by the central and local governments until theaccession.

Nevertheless, after its accession, China has notified its subsidies only twice (2006 and 2011.Dite to the lack of subsidy notifications, the United States has adopted as one of its actions inthe Committee on Subsidies and Countervailing Measures of the WTO to press China tosubmit new and fuli notification listing its subsidies programs 53 . However, China did notsubmit its notification until the United States adopted a more intense measure, by filing acounter notification on the matter in October 2011.

In addition to the commitments of notification, China has agreed to be subrnitted to aTransitional Review Mechanism in which it was determined, as of Article 18.1 of its Protocolof Accession, to have its subsidy prograrns annually analyzed. This rnechanism expired in2011, afler 10 years of the Chinese accession to the WTO (Article 18.4).

On lhe matter of specific subsidies (Articles 1.2 and 2 of the 5CM), it is settled that they willbe viewed as specific if SOEs are the predominant recipients of such subsidies or if SOEsreceive disproportionately large arnounts of such subsidies 54.

rneans that the US Couri of Appeals for the Federal Circuit upheld Cornmerce's opiniori on the incompatibilityofanti-subsidy measures against NMEs.2 KIRK, Ronald. 2011 Annuai Report ofthe President ofthe United States ou 11w Trade Agreements Program,

Oftice of lhe United States Trade Representative, March 2012, page 181-182.KLRK, Ronald. 2010 Aunual Report o! the Fresident o! tbe United States ou the Trade Agreerneuts

Prograín.Office oF lhe United States TraJe Representative, March 2011, pagcs 34-5.54wTO. Protocol ofAccession o17!se People sRepublic of Clima. WT1U432. lO November 2001. p. 7.

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Article 15(b) of lhe Protocol of Accession of China to Lhe WTO establishes that for a matterof comparability issues ia determining subsidies, when addressing subsidies described iaArticles 14(a), 14(b), 14(c) and 14(d). (calculation of lhe amount of a subsidy ia terms of thebenefit to Lhe recipient) lhe SCM shall apply unless lhe importing WTO member finds somespecial difficulties ia that application, iii which case, members may use other methodologieswhich take imo account lhe possibility that prevailing terras and conditions ia China may notalways be available as appropriate benchmarks. When applying these methodologies, theimporting member shall, ia lhe first place, adjust such prevailing terras and conditions beforeusing terras and conditions prevailing outside China 55.

Furthermore, China provided a list of prohibited subsidies, with a timetable for Lheir elimination,in Annex 58 of Lhe Protocol, As provided in Article 10.3 of Lhe Protocol of Accession, it shoutdeliminate ali export subsidies, within the meaning of Article 31(a) of the SCM Agreement, by thetime of accession56.

Amongst the subsidies listed ia Annex 5B were Lhe subsidies provided to certain SOES whichwere mnning at a loss. The graphic below shows lhe evolution of subsidies from centralbudget provided these SOES 57:

SUBSIDIES FROM CENTRAL BUDGETPROVIDEDTO CERTAIN STATEOWNEDENTERPRISES WHICH ARERLJJNINGA1A LOSS (ICOmI RMØ)

£4

L.

£999

-----------

9± J9Z -990 -094

1990 ±999 ±997 1990

o1

Source: Prowcol of Accession of People's Republic ol' China - Annex 5A —2001.

The graphic shows that Lhe subsidies from central budget provided to certain SOES whichwere running at a loss experienced a substantial growth from 1996 to 1998.

The China Statistical Yearbook (2007) provides another picture of this kind of subsidies. Thegraphic below shows Lhe percentage from the total amount of government reveriues that isdestined to SOES running at a loss. The graphic also presents lhe variation of this percentageia each year58:

55 1bd p 956 Sce also WTO, Report of me Working Pan)-' cm the 4ccession oí China, WT/ACC/CHN/49, 1 October 2001.çaras. 166 and 167.

See also WTO, Protoco/ of/lccession o! People 's Republie o! China, WTILJ432, lO November 2001, p. 68.li shall be mentioned that China Statistical Vearbook series (years 2008, 2009. and 2010) do not show the

figures of subsidies to loss makingcnterprises. If the reduction margin were between 6.8% to 13,5%. it is unclear69

SUBSIDIES TO LOSS MAKING ENTERPRISES (1985-2006)

— --------. -

30.rt'°•°

15-o'

1o.r

o_o.----19:5

40.0%

J50%

5nc..chinastsIcjS—+— VwlstJon 1%) —e—I!I G ovt,n,nnt Rev*nut 0,1%

Source: China Statistical Yearbook (2007).

The graphic above shows that the amount of subsidies to loss making 59 enterprisesexperienced a consistent low since 1985 in percentage of central governrnent revenue. In Lhesarne year, SOEs started paying taxes and, a few years later, those enterprises transferred thecoss with social security to the local govemrnents, in order to decrease their negativerevenues 60. Paying taxes reverted in massive loss to SOEs, which might be an explanation forlhe 25% participation of subsidies to loss making enterprises on the government revenues in1985 and its consistent decrease, after changes ia social security system.

The graphic also demonstrates that the share of these subsidies in the central governmentrevenue diminished, even though in absolute amounts, there was an increase in some years.Since China Statistical Yearbook 2008 lhe data on lhe arnount of subsidies to loss makingenterprises has disappeared. Although there was a consistent reduction in the arnount ofsubsidies since 2001, in relative and absolute nurnbers, it is not possible to know if LheChinese government has eliminated the remaining 0,5% of subsidies to loss making SOEs invalues of its revenue or if there was only a change ïn the statistics published in its Yearbook.

whether those subsidies no longer exist. In China's Trade Policy Review (WTO) of 2010, there is no informationon lhe matter.59Sourafel GIRMA eta/estimate that 11w subsidies to Ioss making State Owned Enterprises has reached a total ofUSSI09.8 billion troto 1995, and Lhe variation remained between 4.4 to 2.4 billion from 1996 to 2005,annualiy. GIRMA, Sourafelet ai. "Can production subsidies expiam China's expor( performance?", 8 July 2008.Available ai: <http:f/www.voxeuorgfindexnh p?g=node/1373> Viewed at: 18 February 2012. p. 2.a LIN, Shuanglin. "The Risc and Fali of Chinas Governrnent Revenue". £41 Wo.rking Paper a. 150, 2009, p.14. The author also says: "Over lhe years. Lhe government has privatized many smali loss-making SOES. Also,Lhe government has transferred SOES' social securlty burden to Lhe society. In Lhe past, SOES took care of Lheretirement and healthcare of their workers, and now, local governments Lake cate of the social security ofernployees of the SOES. Ali flrms must join the social security program. New firms without retirees actuailysubsidized (he SOEs."(p. 14, foornote 17).

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2. Main characteristics of the Chinese Textile Industry

China's share in lhe Global Market of textiles rose from 38,8% (2001) to 47,1% (2005) but ithas seen no progress since then. 1-lowever, if considered only markets of the United States andlhe EU, China's share was of 71,3% (2006), experiencing a declining to 66,8% (2008). Interms of US apparel import market, China's share rose from 19,9% (2003) up to 35,9%(2009) and its share of the EU apparel import market rose from 21,8% (2001) to 42,8%(2008)61.

After Lhe creation of the WTO, members reached an agreement to the liberalization of lhetextile and clothing sectors by lhe approval of the Agreement on Textile and Clothing thatdetermined the mIes for the integration of these sectors to general WTO rules, by aprogressive enlargement of the preexisting quotas on textiles until their removal in 2005. Thistransition agreement expired in 200562. After this date, lhe United States and the EU,individually, agreed upon with China to extencl lhe quotas until 2008 and 2007, respectively.

The WTO World Trade Report of 2006 concluded that the elimination of quota restrictions ontextile and clothing did not have considerable impact on demand or domestic marketconditions in lhe United States and EU market, what has perceptibly changed, however, is Lhecomposition of inarket shares among exporting countries" indicating that "Lhe competitivesitua tion of the textiles industry in Europe and Lhe United States is more favourabie than thato! Lhe clothing industrjP 3 . Despite that, lhe Report concludes that the impact of restrictions onChinese exports was limited and tied to lhe market seasons64.

Textile and apparel industry has been an importam sectorsector for lhe development of Chinese exportssince lhe 1978 economy opening. By that time, lhe textile and clothing industry was chosen by lheChinese Government as one of its national industries to be promoted. This choice can be explained hy

61 McCANN. Jack. "China's Textile and Apparel Inctustry and the Global Market: Five Competitive Forces.' ittSAMAdvancedManagernenrfournal, Winter 2011, p. 33.62 More information cm WTO's website on Textiles: chttp:f/www.wto.or/english/tratop eltexti eitexti e.htm>.63 WTO. Exploring the /inks between subsidies, frade and the WTO. World Trade Report 2006. 223 pages.Available at: <http://www.wto.org/english/res e/booksp e/anrep e/world trade reportoó e.pdf>. Viewed ar: 12January 2012, page iii and 17.(i4Jbid pages 13-16.

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two main factors: basic infrastructure and experience in the field 65 and lhe fact [hat Lhis field did notrequire any advanced technology as from lhe start point66.

The Chinese Government established the pillars of its strategy to the sector in the 1980's bylhe Congressional approval of the "Six Priorities" to the Textile and Apparel Tndustry, whichincluded favorable treatments in the foilowing areas: supply of raw materiais, fuel and power;innovation and its transformation and infrastructure construction; bank ioans; foreignexchange, imported foreign advanced technology and transportation67.

Accordingly to Larry QIU, China is the largest producer of total textile and apparel productssuch as cotton yarn, cotton fabric, silk fabric, wool fiber, chemical fibers, garments, andknitted goods68

MA and YANG state that Chinese textile industry is even more dependent on global markets.Despite of its rapid growth, some textile sectors are deficitary such as wool, fabrics,bombazine, worsted, high grade textiles and apparel69 . There are some factors to benefit theChinese textile products such as lower labor costs or the famous Chinese silk, which is around75% oU lhe silk manufacturing in lhe World70.

Concerning trade defense instruments, several countries, including the United States and EU,are using more frequently antidumping duties then anti-subsidies, because China is notconsidered a market economy by the majority of WTO members, which allows the use of thesurrogate country methodology, in accordance with the provisions of China's Protocol ofAccession. However, there is enough evidence to support that several subsidies could becountervailed.

65 QIU aIso determines that 'China's modera textile and clothing industry began in lhe 1870s. Chan Qi YuanbLIilt up Lhe first textile factory caIled Ji Chang Long Reeling Miii in China. During lhe foliowing years until1949, lhe textile industry developed slowly as lhe society was very unstable and China had witnessed many warsover many years."(QIU, Larry. "China's textile and clothing industry. (2005)". Available at:<http:11s3.amazonaws.com/zanran stor ,,ipe/www.bm.tist.hk/ContentPaQes/18112599.pd . Viewed at: 12February 2012). In addition. lhe Departnient of Commerce of Lhe United States determined lha( "Nantong'stextile industry has a long history - dating from 1895 - and China's famous modern industrialist Zhang Jianestablished lhe nation's first self-run textile mil! (presentiy lhe No 1 National Cotton MIII). For example,Nantong has aiready deveioped into one of China's textile bases. The City uses 450.000 spindles and 26,000cotlon machines. It has Lhe complete equipment to produce lhe 'tive fabrics' (cotton, silk. linen, wool andchemical tibers) and lhe 'six synthetic fibers' (polyester, acrylic, polyvinyl chloride, poiyamide, poiypropyleneand polyvinyl alcohol). In Lhe past few years, Nantonf has used more than US$ 60miliion in tbreign investrnents,and most of this investment has been used in lhe light and textile industries. It has greatiy increased lhe strengthof the Iight and textile industries and has laid down an excelient base for íiture deveiopment."(US DoC, NTIS.China Report: Econornic ,4ffaírs, Springfield, VA: FBIS. 1985, p. 6).66 QIU, Larry. "China's textile and clothing industry. (2005)". Available ar:<http:/1s3.amazonaws.comlzanran storage/www.bm.ust.hklContentPages/i 811 2599. ydf>. Viewed aL: 12February 2012, p. 3.67 SFIAOÍ-IUA, Ma, Govermnent-Industry Relatíons after Decentralization: Froni ffie Five- Year P/an to theWorld Trade Organization.PhD thesis, 2010. Available at:<http://scholarbank.nus.edu/bitstreamJhandle/I 0635/27502(MaSH.pdt7sepuence= 1>. Viewed ar: 23 Fcbruary2012, p. 86.

QIU, Larry, "China's textile and clothing indLlstry. (2005)". Available at:<http://s3.amazonaws.com/zanran storage/www.bm.tLst.hk/ContentPaees/18112599.pd Viewed at: 12February 2012.p. 4,69 MA, Jing. VANG, Weiquan, "On Trade Barriers to China's Textiles Industry," in: International Journal ofBusiness and Managernent. v. 5, n°9, September 2010, p. 127.701b1d.. P. 129,

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Recently, China has created several programs on green technoiogy subsidies 71 , which mightbe seen as a change on China subsidies policy provided by central and local governments.Moreover, regarding Lhe textile and clothing industry, lhe 2008 international financial crisisstarted the trigger to a new stimulus package for lhe Chinese manufacturers.

The idea of subsidizing green technology initiatives is related to lhe core of Lhe Chinesedevelopment: exports and foreiga direct investment. According!y to Rohit Aggarwal, lhemain objective is to increase lhe market influence in lhe global textile markets, and, for thatmatter, it is crucial to gather more advanced techno!ogies, innovation, and to operate inharmony with lhe environment. Also, consumer concerns and some health issues are at stake,if considered that lhe textile and apparei industry invo!ves in theír processes several chemicalformula and chemical proceedings that may affect consumers and workers if an appropriatetechnology is not available72.

The main instrument to promote development in China was provided by lhe Five-Year Plan.Provinces have specific plans and Lhe central government as well. The 1001 Five-Year Planestablished that the textile industry was to be stimulated and lhe focus was on the exportsleveis.

The ii" Five-Year P!an (2006-2010) was also concerned with lhe exports !evels but it startedchanging paradigm by introducing lhe need to develop advanced technologies. Thus, lhe 11 h

Five-Year P!an determined that:

To strengthen lhe technological capability of lhe textile industry and increase ibe number of Chinese-owned brand names; to devetop high-tech, high-performance, differential, and environrnentaL-friendly andrenewable fibers, and to enhance the development and utilization of textiles for industry use, silk and non-cotton tibers; to advance the gradient shitï of the textile industry.

Each Five-Year Pian focuses on some sectors to explore. In this sense, lhe economicintervention is noticed by privaLe actors and lhe proper taxes incentives to be given in thispolicy. The results are remarkable.

lu 2010, textile investments responded for 38,55% and 9,27% of total invested in central andwestern regions in China, compared to 19,13% and 2,66% of 2006. This means that lhetraditional textile provinces have been experiencing a decrease of its participation oninvestments made on lhe textiie sector 73. 5h11, lhe Textile Tndustry Chamber of Commerceinforms thal, in 20 1.0, lhe exports in lhe sector have returned to lhe figures verified before2008 financial crisis, amounting US$206,5 billion (up 75,72% from 2005).

The figures are remarkable and they demonstrate that Lhe Five-Year P!ans of lhe Chinesegovernment have had a great impact. By Lhe time of 2008 financial crisis, lhe Chinesegovernment also approved a plan to revitalize lhe textile industry: Top Ten Industry

USÍWTO, Request froni the Unired Stares to China pursuant to ,4rticle 25.10 o! the Agreement,G/SCMJQ2/CHN/42. II October 2011, p. 2.72 CTE!. 12 July 2011. The declaration was made by RohitAggarwal, vice-president, strategic marketing andplanning, TI-LE, in an interview to htty://english.ctei.gov ,cn, an official public body of central Chinese

overnment.'China Textile Industry Report 2010-2011. Textíle Industry Chamber o! Comínerce - The Sub-Coundll o!Textile Industry, CCPITAvailabIe aI: <http:/fwww.ccpittex.coni/engfnews/44937.html>. Viewed at: 28 February2012.'4ldib.

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ma

Promotion Pianninj'5. The 11th and 12' t` Five-Year Plans are very important as well ondictating Lhe priorities of Lhe Chinese government invesLment and policies towards textile andapparel industry.

Geographical arca

The China National Textile and Apparel Council (CNTAC), in 2008, included Lhe bases,chies and towns where Lhere were textile industry activities. Also, determined which area oftextile and apparel sectors those entities were entitled for. The map below shows lheprovinces where it can be found any textile and apparel economic activity:

China's Provinces on Textile and Apparel Industry

Source: CTEI.

The figure shows that lhe textile and apparel industries are located mostly in East China(Shandong, Jiangsu, Shanghai, Zhejiang, and Fujian), Central-South China (Hubei andGuangdong), and also in the Northeast (Liaoning).The majority has a high levei o!' privateenterprises, with lhe exception of Shanghai.

SINOMACU, Top Ten Revitalization Industries Announced by Chinese Government to Cope with FinancialCrisis,' On 26.3.2010. Available at:<http://www.sjnoniachcomcpJtemp ]atesfr nem eWcontent.asøx?nodejd=320&parze=Con(entPage&contentid=Çfi> . Viewed at: 29 February 2012.

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Zhejiang, Guangdong, Jiangsu and Shanghai are, together, the traditional provinces where thetextile and apparel industries can be found. Thus, these provinces are of main concern when itcomes to the analysis of eventual local subsidy program and also the functioning of theirbanking system for investments and loans. However, the main objective here is to provide theinformation needed to identify the most relevant subsidy programs and the relation with thoseprovinces.

The Communist Party itself endorsed a study which details the division of work andspecialization in each rural provinces also leading to a rapid urbanization process. Accordingto it the production is coordinated in single product lines under the yicunyi pin system (whichis one item per viliage) or yixlangyl pin (one item per township)76.

The sarne study adds that this system not only increased the levei of industrlallzation inZhejiang 's countryside and rural sector, but also contrlbuted to speedlng up the process ofurbanlzation, prompting me reorganization of the population 77. B y adopting this system theviliage and towns are well-known by specific products and sectors as the table belowdetails78:

76 LI, Xingshanet aL. —lhe Successfut Practice and Implementation of the Socialist Market Economy: AnInvestigative Research Report on Zhejiang's Econorny - Part 1," translated by M.E. Sharpe. In: The ChineseEconomy. v. 35. n. 4, July-August 2002. p. 16."Ibid., p. 16.78 OnIy main chies and towns are related on the table, the list, for that matter. is not exhaustive.

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The CTEI, an official organ of the Chinese governrnent commissioned by China NationalTextile and Apparel Council (CNTAC) and operated by China Textile Network Company(CNTEX), is the most influential network for those who need information on the Chinesetextile and apparel industry. Besides data and simple reports, CTEI maintains a doserelationship with local governments, local textile clusters and local enterprises. li wasmanaged to catalogue thcir data in order to provide a complete list (dated from 2008) of thetextile sector and the producing province, Furthermore, it was possible to link Lhe provinceproduction to the specific industries established in their cities and townships as well.

1

sProvinces: Textile and Apparel Sectors

Source: Ci'EI.

Guangdong and Zhcjiang are lhe leading provinces in diversity of textile and apparel sectorsfollowed by Jiangsu, as it can be inferrcd from lhe table above. This diversity might be aconsequence of an entrepreneurial economic model. Zhejiang, arnongst ali industry sectors,has 11% of textile and apparel industry participation and, actually, lhe most irnportantprovince for that industry sector.

Both Zhejiang and Guangdong are very large and have huge economic indicators. Asdemonstrated before, entrepreneurial provinces have better statistics if it is considered otherelements but foreign direct investment and GDP growth.

Shanghai had a historical importance to textile and apparel sectors before Mao ZedongRevolution in I949. After that, Shanghai has been experiencing a planned economic

Accordingly to Jack SHEPI-IERD, 'Increasingly strict and burdensome regulation of the cotton industry athome iii the period immediate!y preceding the outbreak of the present hostilities also hclped to inspire manylarge Japanese texti!e concerns to transfer part of their activities to China. The Japanese seemed determined to(um the three poris of cities of Tientsin, Tsingtao and Shanghai into strongholds from which to conquer theChinese texti!e markct, using Chinese labor and Chinese raw cotton for that purpose. ( ... ) The principal lossessuffered by Chinese textile interests through destruction and damage to mill properties during the course ofhostilities were in the Shanghai arca. Of the 2.500,000 spindles in operation before the war. no less than 44%were concentrated in and around Shanghai, while 23% were scattered in the Province of [Jjiangsu, along theYangtze and the Shanghai-Nanking Railway.' ("Sa!vaging the Textite Industry in China." Par Eastern Survey.v. 8, n° 15, 19 July 1939, p. 172-3).

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tnode1 80, notably new paths since the Revolution, probably forcing Chinese entrepreneurs tomove their business to Zhejiang or Jiangsu Province.

2.1 Adjustment and revitalization plan for the Textile Industry

After lhe financial crisis of 2008, which affected mainly the United States and the EU,Chinese textile exports experienced a decrease compared to 2007. For that matter, ia 2009, thegovernment launched the Top Teri Jndustry Promotion Plari in order to prevent the crisis tospread on the Chinese productive sector. It included automobile, iron and steel. electronicinformation, petrochemicals, nonferrous metal industry, shipbuílding industry, logisticsindustry, light industry, equipment manufacturing, and textile industry.

Accordingly to LONGBAO, ali industries included in the aforementioned plan (logisticsindustry excluded) are responsible for 80% of industrial added values or for 25% of China'sGDP81.

The core of the plan could be summarized in this way: ensure the demand and adjust thesupply. This plan had three-year duration and was focused on balancing lhe dornestic demand(which ap rose) and the extemal demand (slightly diminished ia 2009). Thus, newopportunities of investments were launched and that so-called adjustment, the incentives totechnological innovation, measures to achieve global competitiveness and other minor issueswere taken imo account82.

This revitalization plan counted on a US$586 billion stimulus package to promote theadjustment of industrial structure, the restoration of market confidence and prevent theeconomy to experience a trend of a fast slide down. Regarding the textile industry, the planwas sumrnarized by SINOMACH (China National Machinery lndustry Corporation), a SOEapproved by the Chinese State Council83 , in verbis:

Markct funetions should be brought imo ptay to stimulate demands. White efforts are to be made tostabilize lhe international markets, hard efforts have to be made to stimulate lhe domestie demand topromote lhe economie growth. The government will deploy dedicated investments to support thetechnical progress of the textile industry in Lhe hope of supports have to be augmented for Lhe textileindustry, inctuding Lhe increase of lhe export tax rebate and lhe credit and loan support.s extended to Lheenterprises which are in fundamental good conditions, but are experiencing temporary operating and

80 HUANO. Yasheng. Capitalísin with C'hinese Characteristics - Entrepreneurship ano dia StataCambridge:Cambridge University Press. 2008. p. 176-9.SI LONGBAO. Wei. "Regional Economic Development and Entrepreneurship in China," Paper prepared for theconference. In: US-China Business Cooperation in die 21 Century: Opportuniiíes and Chalienges forEntrepreneurs. Indianapolis (IndianalUs), Indiana University, April 15-17, 2009, p. 14.82 Tbid.. p. 14.83 According to SINOMACH's website, "established ia January 1997, China National Machinery IndustryCorporation (SINOMACH) is a targe state-owned enterprise approved by lhe State Council and directtyadministered by Lhe State-owned Assets Supervision and Administration Commission. ( ... ) SINOMACH is atarge state-owned group with the targest scale, widest diversification. most comprehensive lines of business andthe strongest R&D capabilities ia lhe Chinese machinery industry. The Group has under irs portfolio 50 wholly-owned and holding subsidiaries, including 7 tisted companies and more than 70 overseas services branches,employing 100.000 stafís globatly. For years, SINOMACH has sustained annual growth rates over than 30%,with operating revenue reaching RMB 155 billion in 2010. The group was ranked among lhe Global 500 for Lhefirst time in 2010 and has remained No. 1 among lhe top 100 Chinese machinery enterprises for years and hasbeen rated class A in the performance evaluation for state-owned enterprises conducted by the State-ownedAssets Supervision and Administration Commission." Available at:chttD://www.sinomach.com ,c&temDtateslT common en/index.aspx?nodeid=147>. Viewed at: 12 March 2012.

78

financial difflcultics. The central and local governments and enterprises should expand their efforts in theprocurenient of cotton and silk materiais. Efforts shouid be made to guide textile and garment enterprisesto move to central and western part of Lhe country.

The government established a plan to expand textile and apparel industry to the Western partof China and in lhe recovery of the export levei prior to lhe 2008 financial crisis. The portalSINA inforrned that in 2008 lhe export çrowth were lO percent iess than lhe previons year,causing a profit decrease to 1.77 percent8

Public authorities estimated that lhe plan could imply in an average production 10% growtheach year untii 2011 (last year of lhe pian) and an 8% export growth, to reach US$240 billion.The maia measure adopted by lhe government was lhe tax rebate increases. Beijing increasedthem by five times since 2008. The measures wouid be implemented in order to achieve amore advanced technoiogy to increase technology, aiso improving domestic consumption andlhe extension of ioans tepayment deadlines to help lhe textiles enterprises experiencing a siicedown on their businesses86.

The transparency on lhe measures adopted in lhe use of the amount established in lhe packagestimuius remained unclear: China has shown a limited compromise to disciosure essentiaiinformation to allow an accurate analysis of lhe effects of this sort of action.

The Il° Five-Year Pian provided stimulus for the growth of production, saies and exports ofChina textile industry. The domestic demand was a pivotal issue in lhe achievements ofChinese textile industry under lhe 1 11h Plan. Also, foreign direct investments andexports leveis were part of lhe pian, increasing opportunities for independent innovation.However, lhe quai.ity leveis need to be improved. Whiie lhe quantity of investments wasreached, there is an uncertainty if lhe quality goais foilowed the sarne path.

The 12' h Plan is concerned about those quaiity goais, and iii Chapter 9, one canread:

09 Textile - Promote the industriatization and application of hi-tech ftbers. and new-generation functionaland differential fibers. Accelerate the devetopment oí industrial textite prodticts. Promote Lhe localizationof high-end looms and accessories. Support tbe recycling of otd and waste textile products.87

At the present time, Chinese authorities are to shift lhe course of lhe current deveiopmentpohcy. Despite lhe export and foreign direct investrnent goais, they are aiming at lhediversification of lhe industry and to enhance lhe quahty of those investments, providingfunding for high-tech research and assuring that lhe textiie industry of China wiill remam

84SLNOMACH. "Top Ten Revitalization Industries Announced by Chinese Government to Cope with FinancialCrisis," On 26.3.2010. Avaitable ar:<http://www.sinomach.com.cn/templatesTr news enlcontent.aspx?nodejd=320&yape=Contentpage&contentid=3028>. Viewed aL: 29 February 2012, p. 2."China hikes tas incentive for textile exporters: state media. SINA. Beijing, 4 February 2009. Availabte at:chtty :/Ienglish.sina.corn/business/2009/020412 1 5949.html>. Viewed at: 02 March 2012.86China- Three- year textite otan targcts export groMh.Just-Style. 29 April 2009. Available at: chttp://www.iust-sty1e.comJnews/three-year-textile-plan-tarets-export-growth id 1 04000.as px>. Viewed at: 02 March 2012,

CHINA, NPC & CPPCC, "12 Five-Year Plan (China);' 17 March 2011, p. 14. Available at:<htty ://ec.europa.eu/redonal policy/international/pdffchina draft 1 2th 5yearplan 17032011 .txlf>. Viewed aL: 02March 2012. On page 11 one can also see that regarding the tight textile industry: "The light textile industryshould strengthen environmentat protection and quatity safety, strengthen corporate brand building and improvetechnologicat equipment levei."

79

competitive and will start exporting not only becatise of its lower costs but also because of itsquality of practices and quahty of products.

The course of action Laken in the past five years included the optimization of the industrialstructure, the control of industrial inefficiency specially related to the consumption ofexcessive amounts of energy, and to enhance the independent innovation and to improve well-known global brand names, amongst others.

However, Chinese textile industry has its own problems such as the high labor costs, lheimprovement of environmental protection laws and measures, rise iii the cost of raw materiais,reverting to an increase on consumer prices, slightly growth of inflation and unernployment inemerging niarkets88.

China textile industry will remain as largest and as competitive as now, and it will experiencesignificant growth ia the next years, amongst all incentive programs formally introduced bythe central government, and, as it will be demonstrated beiow, by a strong subsidization of itsmarket.

2.2 Chinese Textile Industry: private and publie enterprises

li is not one of Lhe goals of this stud.y to anaiyze Chinese economic framework. Neverthelessit is useful to understand some policies upheld by the central govemment ia international fora.

The mainland Chinese government cornpromised to an econom.y opening, in 1978. Despitethis comprornise, China has not agreed to overtake its socialist market economy system. In the1980's, coliective-owned enterpríses were a successful example of the triumph of the Mao'smodel.

[-lowever, since 1985, SOEs have been paying taxes to the government, and, for that rnatter,what was profitable before became deficitarian. Thus, the government revenue started tostiffer some downs, as seca . in the previous item.

lii Lhe 1.990's, as I.ong as it can be checked in China SLatistical Yearbooks, SOEs were highlystibsidized and export subsidies were part of the Five-Year Plans elaborated by the ChineseGovernment.

Between 1999 and 2000, China and the United States initiated negotiations to speed upChinese accession to the WTO, and one of iLs specific compromises can be seen ia item 10.3ou subsidies, in which China agreed to eliminate ali prohibiLed subsidies.

Since 1999, as a first step of China's Lransition towards a market economy, the Chinesegoveniment privatized ali small SOEs or rnerged SOEs amongst themselves or SOEs withother Icind of enterprises ia Chinese Law such as those of the private sector.

For Lextile and apparel industries, it is relevam toLo mention again the 10tE\ 1 and 12 Five-Year P1an89. In 2001, the 1 01 Five-Year Plan was still concerned about exporL volume. In

88 YENER, Entre, "China textile industry Booming." Nome textÜe, 16 Septeniber 2011. Available at:chtLp://www.hotnetextjle.com (r/haberde(ay.asø?ID=203>. Viewed ar: 27 February 2012.89 Provinces, themselves. have their own Five-Year Plan with specitic goa]s for the region and also by sector.

80

2006, the poiicy was to invest and to maintain ali incentives given to the textile industry.However, China estabhshed the Adjustment and Revitalization Plan of Textile Industry in2009, aiming to protect the domestic production, and increase exportation figures. In 2011,the 12th Five-Year Pian determined (hat Lhe main concern should be investments in R&D andinnovation, in order to enhance the quality of the Chinese textiles and of their national brands.

The legal implications of (hese pians can only be understood when Chinese economic rnodelsof deveiopment are examined. In China, there are two main econornic models co-existing: thestate-oriented and the entrepreneurial ones. The graphic beiow shows China's Pubiic andPrivate Industrial Sector before accession tili 2009, year of the international crisis and year ofthe new Chinese package for textiies, by number of enterprises (public and private) and byamount of their revenues (in renminb4:

Source: China Statistical Yearbook (201.0).

It is evident from the graphic Lhe augmentation of the private sector as whole in China after lIsaccession to lhe WTO. However, despite the increase of private enterprises, there is astalistical problem, because enterprises whose ownership belongs to Lhe government areclassifled as "non-public" as collective-owned enterprises. The question now is - who owns acollective enterprise.

Secondly, the gross industrial output value of SOEs is slightiy better performed than theprivate enterprises; despite that private enterprises outnumber the public ones. The graphicalso shows that the gross industrial output of private enterprises just outnumbered the SOEs'by 2009, even though since 2003, private enterprises are Lhe large majority of the Chineseregistered enterprises. This comparison demonstrates Lhe nurnber of registered SOEs is not theonly data to be verified. There is evidence to believe that Lhe SOEs have a very importampolitic role and a support from the government that wouid be very hard to be foliowed byprivate enterprises or, as Chinese classification, "non-public enterprises".

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3. A subsidized economy

3.1 Two modeis of development

A brief historical approach and explanation of some of Lhe Chinese formal plans to enhancelis industry development are relevam toto understand what is absent from official reports of theChinese government. The incentives and priorities established by Lhe government can only beunderstood if associated to the aggregation of several subsidies programs.

Before the Chinese accession to Lhe WTO Lhe socialisL market economy was based on publicownership and export subsidies. In order to be part of the multilateral trading system, ChinaunderwenL several economic reforms. Since its accession to Lhe WTO, though, there is !essevidence of plans to bring China imo a market economy model. This is Lhe main conc!usionof Lhe China - 2030 report issued by the World Bank recently90.

Fotiowing Lhe examinaLion of the textile sector, two economic development mode!s coexistingin China become clear: one entrepreneurial and the other state-oriented. Zhejiang, Shandongand Jiangsu are considered entrepreneurial provinces since they present a much highernurnber of private enLerprises relatively to SOEs. Also, privaLe enterprises yie!d biggerparticipation in Lhe provinces' econonlies. On the oLher hand, Shanghai and Hubei areconsidered as state-oriented provinces because Lhe participation of SOEs in Lheir econornies isbigger than that of private enterprises. These features can be seen in Lhe graphic be!ow (innumber of enterprises and renminbfl:

China's Public and Private Industrial Sector - Textile Industry Provinces45000

40000

35000

30000

15000

420000

15000

10000

3000

0

Sbar,giial

c.,..........a.na.. SOE

03.000.00

2.500,00

02.000.00

1.300.00

2o

c

O 1.000,00

500.00

00,00ZIoefParg Olangsu Fujian Shandor,g Hubel Guar,gdong Llaonlng

51,fic l—b.Pdv,ite Crsterprhe. ~SOE Grou Ir,el,'strial OijIput VaI,re -..- Prlvate Entprise Gros, ndue?rIaI Oiirp.itVahie 2010

Source: China Statistical Yearbook (2010).

00 WORLD BANK. China 2030: Buliding a Modem, Harmonlous, and Creative High-Jnconze Society.Conference Edition, 2012, p. 25.

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The differences between lhe two main economic development modeis are clear: in Shanghailhe gross industrial output value of SOEs is higher than lhe private one, despite lhe fact thatthere are more private enterprises than public ones. It is interesting to note lhe discrepancybetween private and public sectors, which can be noticed in Shanghai where lhe rnajority ofenterprises are considered private but lhe gross industrial output value of SOEs outnumberslhe private ones. The graphic above shows that SOEs have a very strong position under lheChinese government, even though their nurnbers have been dirninishing every year, and thattheir gross industrial output value is kept higher than private enterprises in state-orientedprovinces. This is another evidence how information on lhe subsidization of Chineseindustries are contradictory.

When it comes to the entrepreneurial provinces, such as Jiangsu and Zhejiang, lhe privategross industrial output value outnumbered lhe SOU by a large margin. For that matter, itcould be fair to conclude that private enterprises performance is better prornoted iaentrepreneurial provinces than in state-led ones.

Indeed, these two econornic development models have been considered by governrnent andanalysts alike as translating two opposite plans applied by regional governs in China. Theyare viewed as two different alternatives to developing China's economy, both presentingsuccesses. However, in practice, it is often hard to distinguish between these two models bylhe perspective of state interference in lhe economy.

Entrepreneurial provinces have experienced some reforms leading to a change ia theirenterprises profiles. Private enterprises were encouraged while public enterprises dirninished.SOEs were substituted by TVEs (townships and villages enterprises) 91 , enterprises withprivate coilective investments and public ownership 92 , which seem very similar to a publicbody. In any case, several SOEs continue to exist in entrepreneurial provinces. This is one oflhe reasons explaining lhe persistence of subsidies in these provinces since public enterprisesdo not follow lhe sarne policies of private ones, and since lhe issue of public ownership isdisputable. In this sense, and along with lhe unclear statute of TVEs, private collectiveinvested enterprises and public ownerships, it is difficult to assess how rnuch theentrepreneurial model differentiates itself froni lhe state-oriented one regarding prívateownership.

The WTO Trade Policy Review of China (2009) considered, in its footnote 82 that "collectively ownedenterprises usually take lhe forra township-village enterprises (TVEs) as most were founded by town orviliage governments or village-coliective economic organizations. Some TVEs have been transformed imoprivate enterprises and belong to the 'non-public' sector: those that continue to be owned by town or vilIlagegovernments or village-coliective organizations belong to the 'public' sector" (WTO, Trade Policy ReviewBody, Guria - Report by ffie Secrecariat, WTÍTPRJS1230, 26 April 2010, p. 54).92 Despite lhe positive panorama drawn by the Comniunist Party, lhe adaptation process imo entrepreneurial leddevelopnient has proved to be challenging: "Most entrepreneurs displayed a passive type ol' entrepreneurship, inparticular in the levei of innovation capability. For exarnple. oniy 0,03% of domestic enterprises ownindependent intellectual property righls. More than 99% of entrepreneurial businesses didn't apply for patentsand more than 60% doesnt own a trademark. It can be said that the current entreprencurial activity thatsupported China's economic growth are still at a relative low levei." LONGBAO. Wei. "Regional EconomicDevelopment and Entrepreneurship in China," Paper prepared for lhe conference. in: US-China BusinessGooperation in the 21' antury: Opportunities and Chal/enges for Entrepreneurs. Indianapolis (Indiana/US),Indiana University. April 15-17, 2009, p. 16.

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e

e

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Furthermore, lhe entrepreneurial model has Iimits to which extent ir can rely on privateownership and entrepreneurship to direct its deveiopment. Chinese economy is considered bylhe Communíst Party to be a socialist market economy and to follow several economicprincipies as to guarantee it is a peop!e-based economy 93 , including lhe foflowing:

Characteristics of a 4 peopie-based economy':1. Subject to the parameters and conditions of a market economy - stiniulate, encourage, and even goadthe coinmon peopie in society to be entrepreneurial and autonomousiy create new businesses andenterprises. to develop their own strength, to exercise appropriate self-restraint, and to have a leveipiaying field for equal and fair competition;2. Property rights are cleariy dehneated, and so is lhe distinction between responsibitity and power orauthority. "people-based economy" = "ownership by the whole people".3. This is an economy in which the government of a socialist state exercises macroeconomic regulatoryinfluence or 'control' ( ... ), Lhe socialist nationat government serves as a powerful shield and providesfundamental guarantees.4. Finaily, this would also be an economy that emphasizes efficiency hut also pays attention to fairnessand justice ( ... ) whose most fundamental guidelines are to operate in accordance with Lhe law.

As can be noted from Lhe abstract above, the Chinese economy presents characteristics both ofa private-Ied economy and also of a government-!ed economy. The difference betweenentrepreneurial and state-oriented development is, thus, dim. As Xingshan statcs, "If one werecompelled to say whether Zhejiang's economy was 'public' or 'private' in the traditionalsense, it would be very difficult"94.

In suminary if lhe entrepreneurial model is not exact!y entrepreneuriai in lhe westerneconomic sense, what is lhe state-oriented economic model, hereof rcpresented by Shanghai?

Shanghai has oniy 0,1 percent of Chinese territory and 5,4 percent of national GDP and yet6,9 percent of lhe total national industrial output va!ue 95 . In lhe begimiing of lhe 20° Century,lhe Iargest textile firms and banks headquarters were in Shanghai. After 1949, Shanghaineseindustrialists moved on to Hong Kong and, in lhe 1970's, Shanghai entrepreneurs controlledlhe massive majority of textile industries and factories in Hong Kong. For that matter, YI andYASHENG conclude that "lhe Hong Kong miracle was a Shanghai miracle in disguise"96.

Despite of its magniticent bui!dings and alleged prosperity, what has been ca!led as "Shanghaimiracle" is not we!1 proven. YASHENG suggested, then, another approach to understandShanghai's economic development model: rural and urban household surveys; private-sectorsurveys on larger and more establ.ished private enterprises; and a professionally managedpatent database°7.

' LI. Xingshanet aL. "rhe Successful Practice and Implementation of the Sociaiist Market Economy: AnInvestigative Research Report on Zhejiang's Economy - Part II," translated by: M.E. Sharpe, in: The ChineseEconomy, v. 35, n. 4. JuIy-August 2002, pp 40-42.94Ibid. p. 49.

These figures can be found ia Shanghai government's website, available at:<ht(p://www.shanghai.gt)v.cnlshanp,hai/node271 1 8/index.htmi>.96 YI, Qian; YASI-TENG. Huang, "Is entrepreneurship Missing in ShanghaiT In: International Difíerences i,Entrepreneurship, edited by Josh Lerner and Antoinette Schoar. Chicago: Chicago University Press. May 2010,p. 326.

p. 176, 'They [study's chosen micro datal have another distinct advantage over GDP and FDI data: GDPand FDI data are exphcit benchmarks used by Lhe Chinese politicai system to promote and demote officiats. TheIikelihood that the Micro data 1 report are politically tainted is mttch less and they thus reflect more accuratelyLhe economic dynamics on Lhe ground."

84

YASHENG estabiishes three key elements in Shanghai's economic deveiopment modei:

1) a heavy-handed intervention by lhe siate in most micro affairs of Lhe economy;2) lhe rnost biatant anti-rural bias in its policy orientation in lhe country;3) a biased liberalization that privileges foreign capitalists and restricts and

discrirninates against indigenous capitaiism98.

These multiple economic developrnent models in lhe sarne country lcd China to a verycomplex administrative structure, essential to anaiyze subsidies prograrns and industrialpolicies. China's government budget is rnanaged separately by governments at differentleveis99 . There are five leveis of governments in China: central government, provincialgovernments (including autonomous regions), prefecture governments, county governrnents,and township governments. Each levei of government has its own budget. The nationaibudget is composed of central and local government budgets.

Discussing econornic development modeis, SOEs and interactions between pubiic and privatesectors are essential to introduce lhe subsidies applicd by Chinese authorities, considering thatlhe most distorting ones are those related to lhe SOEs.

As argued above, China offers several kinds of subsidies and fiscal exemptions in order toguarantee its industries' performances. From 1985 to 2005, Chinese subsidies arnounted toUS$310 biiiion, which US$151 billion were to SOEs. Innovation funds and science &technology prornotion funds accounted for Lhe other 50% of lhe given subsidies, whichtranslates Lhe Chinese governrnent objective to invest in high-tech products in order toenhance Lhe industry structure and, then, improve their export performance - these subsidiesare availabie both to state and non-SOEs. The SOEs share is composed by 95% of subsidiesto cover ioss making'°°.

Some authors believe Lhat lhe subsidies to ioss making SOEs were decisive for lhe wholeChinese economic system, as stated by ECKAUS:

The mariy stories about lhe inefficiencies and excess labor of lhe SOEs impty that their production costsare retatively high. Were lhe SOEs dumping their production abroad and taking tosses doing so? Thesubsidies would have heiped make it possible for them to do se and survive. It would be imrossible to bemore definitive without having much more information about costs of productions in SOEs'

98 Ibid..p. 178.People's Republic ol' China states as following: "Article 30. The administrative division of Lhe Peoples

Republie of China is as follows: (1) The country is divided imo provinces, autonomous regions andrnunicipatities directly under lhe Central Government: (2) Provinces and autonomous regions are divided imoautonomous prefectures, counties. autonomous counties and cities: (3) Counties and autonomous counties aredividcd imo townships. nationality townships and towns. Municipalities directly under lhe Central Governmentand other large cities are divided into districts and counties. Autononious prefectures are divided into counties,autonomous counties, and cities. Ali autonomotis regions, autonomous prefectures and autonomous counties arenational autonomous arcas." CHINA, Constitution (1982). Constirution o! the People s Republic o! China;Chapter 1. General Principies. Avaitabte at: <http://engtish.people ,com.cn/constitution/constitution.htmi>.Viewed at: 29 January 2012.' GIRMA. Sourafelet aí, "Can production subsidies expIam China's export performance? — 8 July 2008.Available at: chttp://www.voxeu.org/index.php?g=node/l 373> Viewed aI: 23 February 2012, p. 2-3. In addition.lhe study argues that the resu/ts show that a doubling of production subsidies Ieads, on average, to a 2.1%increase ia the levei o! exports (p 3).'°' ECKAIJS. Richard 5., "China's exports, subsidies to state owncd enterprises and lhe WTO," in: ChinaEconornicReview, 17(2006) - 1-13. p. 12.

85

The author suggests that the subsidies to loss making SOEs could have contributed todumping practices by the sarne Chinese enterprises and the effect around the globe could havebeen massive. However, the lack of information and transparency turns the issue yetunresolved. It is worth noting that China has agreed on elirninating subsidies to loss makingSOEs, ia accordance with its Protocol of Accession to the WTO. Those subsidies have beenmarked as expenses and negative revenue in the Chinese national budget. Allegedly, in 2008,those subsidies no lonqer existed in Chinese Statistical Yearbooks, despite the diminishingcurve of its elimination 02 Also it is difficult to identify this kind of data - since they are notindicated as subsidies but as expenses - in provinces' budgets.

Another sign of the relevance of subsidies to Chinese economy can be drawn from thecountry's answer to the 2008 financial crisis. According to the US Trade Representative andthe US Department of Commerce, it is estimated that ali fiscal stimulus packages to counterthe 2008 crisis in OECD countries was equivalem toto 3.5% of their coilective GDP. On theother hand, China's stimulus package (both fiscal and financial stimulus) was the largest iarelative terms, amounting to around 13% of its GDP'°3.

Since China has become a WTO member, China has agreed to change some of its econornicpolicies moving towards a market-based econorny. However, the reforms reached its peak in2005, when the fiscal reforrn and the privatization of enterprises were managed by thegovemment and the subsidies to Ioss rnaking SOEs slight!y decreased. After that, the Chinesegovemment did not keep the pace of reforms. A recent World Bank Report on China's futurealerted its authorities about the risks of stopping reforms'°4.

Furtherrnore, some reforms undertaken by China seern to not change the underlyingsubsidized aspect of its econorny, nor the place of SOEs in its developrnent. After the issue ofsubsidies to loss making enterprises was settled, and new brands of incentives were beingdiscussed ia the DSB, another kind of subsidy was being implemented: non-performing loans(NPL).

It is undisputed that China financial systern is mainly forrned by state-owned commercialbai*s, so-called the big four: Industrial and Commercial Bank of China (ICBC), AgriculturalBank of China (ABC), Bank of China (BOC), and China Construction Bank (CCB).

The Big Four are responsible for the largest financial projects and also responds for the SOEsfinancial loans'°5 . Over 50% of market share (by assets) corne from. the Bi.- Four'° 6 . Some of

102 See graphics on pages 78 and 80.103 USTR; US Department of Commerce, Subsidies Enforcement - .4nnual Report to the Congress. February,2010,p. 14.'0'See WORLD BANK, China 2030: Building a Modem, ffarmonious. and Creative Nigh-Inco.rne Society,Conference Edition, 2012.' 0'BIHONG. Huang, "Non-Performing Loan of China's Banking System." ia: The Bulietin o! Institute forResearch iii Busirzess and Econonncs. Meiji Gakuin University, no. 23, p. 130.106 BURZYNSKA, Katarzyna, "Financial Developnient and Economic Growth: The Case of Chinese BankingSector," Master Thesis, Department ei' Economics. School of Economics and Management, Lund University,September 2009. Available at: chtty://www.nek.Iu.se/NEjKfngfFjnancialdevclopmentandeconomicgrowth.pdf>.Viewed at 29 November 2011, p. 16 Recently. according to B11IONO Huang, "Chinese Banks traditionallyadopt the 4-category system to classify loans as pass, past due, idle and Ioss. As of 2004, China's wholly state-owned commercial banks (SOCBs) and joint shareholding commercial banks (JSCBs) started to adopt theinternational 5-category loan classification system. The 5-caregory system categorizes bank loans according totheir inherent risks as pass, special-mention, substandard. doubtful and Ioss" (ibid., p. 134).

86

these programs are in the form of NPL, which are highly criticized for their lack ofcommercial viability, especially loans granted to SOEs without interests or that require norepayment. In this sense HIJANG states that:

"Chinese NPLs is mainly Lhe result of extensive policy lending. low efftciency of SOEs, weak corporategovernance and poor operation skills of Lhe banks, and lhe business cycles. ( ... ) Although NPL ratio ofSOCBs has been reduced significantly, Chinese banks continue to make astounding numbers ofquestionable loans atop lhe existing pile with Lhe economic overheating initiateci in 20)2. The Chineseregulators must, therefore, go beyond merely fixing 'stock' problem of NPLs in Lhe financial system (oconfront an addi(ional source of instability: a flow of new bad debt"107.

China financial system is also under questioning due to Lhe decisive role of its state-ownedcommercial banks. In this sense, China accepted, in its Protocol of Accession, that other WTOmembers use foreign or other market-based criteria to verify Lhe benefit of the loan and itsterms, interfering in preferential policies to SOEs'°8.

3.2 Chinese subsidies programs potentially applicable to the Textile and ApparelIndustry

This section. will Iist ali the programs potentially applicable to the textile and clothing sectorsas pointed out by several reports, investigations and official documents subrnitted to the WTOas well as individual members' reports.

1. Specfflc textile and clothing industry subsidies programs

In 2007, Lhe National Council of Textile Organizations, an American association, elaboratedLhe NCTO China Subsidies Review, regarding the textile industry. The 72 subsidy programslisted were divided by the name of Lhe program, its relevance (specific or applicable), a briefdescription, and financial implications. Some of lhe subsidies programs are listcd below, byrelevance'°9:

1) Specific:a. Export Incentive Program (Government Assistance to increase fabric exports);b. Export Incentive Program (l-Iangzhou City of Zhejiang Province);c. Export Incentive Program (Ningbo City of Zhejiang Province);d. Go Global (One of special funds for brand development);e. Technology Incentive Program (Assumption of Interests on Loans for

Technology Upgrade);f. Value Added Tax (Special Refund).

2) Applicable to Lhe Textile and Apparel Industry:a. Value Added Tax (Refund);b. The "Two Free, Three Haif" Programt10;c. Technology Grants (High-tech project support grants);

' °7 íbid.,p. 151.08 See article 15.b of Lhe Protocol of Accession of China. See also USTR, 2011 USTR Report to Congress onChina 's kVTO Compliance. December 2011. p. 44.109 Further information can be found at NCTO. "Government of China lndustry Subsidies (Applicable to Textilelndustry)," in: NCTO China Subsidies Review. 6 pages. Available at:chttp://www.ncto.orgfNewsroom/chinesesubsidies.ydf>. Viewed at: lo March 2012.

°Listed in the 2009-2010 US CVD investigation C-579-953, as it can be inferrcd from Lhe next item.87

d. Technology Development Fund (Ningbo City Key Industry TechnologicalDevelopment);

e. Subsidies (SOES) 1;

1'. Subsidy (energy)' 12;

g. Land Grant Program;h. Income Tax Program (Refund, Reduction, Rate or Exemption) (10);i. Foreign Trade Development Fund (Central Foreign Trade Development);j. Foreign. lnvestment (Free Land);k. Export Incentive Program (Subsidy Fund);1. Export Incentive Program (Interest Subsidy);

By that time the main concerns about Chinese subsidies programs were related to SOEs,"GoGlobal" (in order to make the textile enterprises global), rural Funds promotion, landprograms, tax incentives, and local incentives and subsidies programs" . The famous brandsprograms and incentives were subject to a WTO dispute requested by the United States(DS387 - Grants, Loans and Other Incentives), questioning severai programs, specially theChina World Top Brand Programme and the Chinese Famous Export Brand Prograrnme"4.The dispute never reached the panei phase because China agreed to end the questionedsubsidies' IS

Recently, in October 2011, the Chinese Delegation to the WTO submitted a notification withsubsidies applied between 2005 and 2008 116 . The docuinent can be seen as a response to thecounter notification submitted by the linited States Delegation one week before, as it is goingto be seen later in this section.

However, the United States still considers that the Chinese notification to lhe Committee onSubsidies and Countervailing tvleasures in the WTO "was far from complete" '7.Readingthrough Lhe referred Chinese notification, one can highlight the following programs asrelevant' 1.8:

1) Preferential tax policies for foreign-invested enterprises (2005-2008): "Two Free,Three Hall" - any foreign invested enterprises may participate in this program,which main objective is to guarantee profits in the five initial funetioning years:mo years of fuily exemption of the enterprise income tax and pius three years ofreduction by haif. The enterprise rnust stay in the country for, at least, ten years.

This kind of subsidies does not appear in China Statistical Yearbook since 2008; however. it is not clear thatthis program is inoperative doe to the lack of transparency and accurate information.112 The US Qovernnient included this program in the counter notitication submitted in 2011 with Chinesesubsidies programs not presented to the Commiftee on Subsidies and Countervailing Measures.II) STEWART. Terence P.. "China's Support Programs For Se!cctcd Industries: Textiles and Apparel," TradeLawyers Advisoury Group, Report of June 2007, pp. 5 to 17.114 See WTO. DSB. China - Grant, Loans ano Other Incentives, DS387. 2008."' See USTR, United States Wins End to Chinas 'Farnous Brand' Subsidies alter Chailenge ai WTO:Agreernent Leve/s Piaying Fieid for American Workers in Eveiy Manufacturing Sector, Press Re!ease, December2009. Avai!ab!e ar: chttp://www.ustr.gov/about-us/press-officefpress-releasesí2009fdecember/united-states-wins-end-china%E2%80%99s-%E2%80%9Cfamot,s-brand%E2%80%9D-sub >. Viewed at: 23 February 2012.116 Programs extracted from CHINA/WTO.New and Fuji NotiíYcation Pursuant te Article XVI?! ofthe G.477'1994 and Articie 256 of the Agreenient cm Subsidies and 2ountervai.ling Ivfeasures. Committee on Subsidies andCountervai!ing Measures (G/SCMINI!55ICHN and G/SCMIN/186/CHN), 21 October 2011." 7 IJSTR, 2011 USTR Report to Congress ai Chinas WTO Coznp/iance, December 2011, p. 43.

For lhe fui] Iist, see Annex 6.88

2) Preferential tax policies for foreign-invested export enterprises: If an enterprise has70% or more of its output value of export products it will pay only haif of theenterprise income tax, after the five initial years of the program 1.

3) Preferential tax policies for advanced technology enterprises with foreigninvestment: Advanced technology enterprises with foreigri investment, after theexpiration of Program 1 (five initial years) may continue to pay haif of theenterprise income tax.

4) Preferential tax policies for enterprises with foreign investment recognized as highor new technology enterprises established in the state high or new technologyindustrial development zones: 15% reduction.

5) Preferential tax policies for enterprises with foreign investment established in Lhecostal economic open arcas and in the economic and technological developmentzones: 15% reduction.

6) Preferential tax policies for enterprises with foreign investment established in theThree Gor-es of Yangtze River Economic Zone: 24% reduction of enterpriseincome tax.

7) Preferential tax treatment for projccts for environmental protection, water andenergy conservation: exemption for the first three years and half reduction for theuext three.

8) Preferential tax policies for enterprises making little profits: VAT refund fromintegrated utilization of resources as electric power produced from urban waste.

9) Preferential tax policies for enterprises making little profits: qualified smallenterprise income tax reduction of 20%.

10)Preferential tax policies for township enterprises: "10% of the enterprise incometax payable by township enterprises may be exempted to subsidize their socialsecurity expenses."

11)Preferential tax policies for Lhe research and development of enterprises (2): "Theactual expenses of domestic industrial enterprises, regardless of the ownership, onresearch and development of new products, new technologies and new craftswhich have increased 10 per cent (included) or more from the previous year shallbe deducted by 150 per cent from the taxable income of the year of theenterprises."

12)Fund for supporting technological innovation of the technological small andmedium-sized enterprises (SMEs): it includes government grants, interest discountand capital investment.

13)Fund for international market exploration by SMEs: it is provided to SMEs orenterprises and organizations which provide services to SMEs for internationalmarket exploratiori (RMB 1,08 billion in 2008).

1.4) Fund for promoting the trade of agricultural, light industry and textile products(2007 to 2008): "The fund is provided for projects promoting the development ofquality system certification, registration of marks of origin and the training andexchange of new technology, new design and new market concepts" (RMB 500million ia 2007 and RMB 100million in 2008).

15) Preferential tax policies for foreign invested enterprises and foreign enterpriseswhich have establishments or place in China and are engaged in production orbusiness operations pitrchasing domestically produced equipment: 40% reductionincome tax of the expenses on purchasing domestically produced equipmentswithin the total investrnent of the project (1999 to 2007).

89

16) Preferential tax policies for doinestic enterprises purchasing domestically producedequipments for technology upgrading purpose: 40% reduction on the sarne basis ofProgram 15 above.

This list shows that the subsidies programs enacted by China have been changing along theseyears as a WTO member. Before its accession the main problem was export subsidies and thefavorable treatment given to SOEs. Nowadays, WTO members are deeply concemed aboutthis subsidies nature change, focusing on new technologies and energy instead of loss makingSOEs.

Despite the fact that some rernainirig subsidies programs from the 2006 Iist provided by Chinaare still in the list, such as those ones related to foreign invested enterprises' 19 the previouslist submitted by China did not include any provincial and local government subsidies or anystate-owned banks subsidies 120

, failing to make any commitment to withdraw ifiem.

ii. United States and European Union countervailing investigations

Anothcr way to examine the Chinese subsidies programs is to study the United States and theEU countervailing investigations. They are chosen in this analysis because of their relevancein the intemational trade, especially, in the textile md apparel sector.

The WTO World Trade Report of 2006 reported that, in 2005, China market share in theAmerican textile industry was US$27,2 billions of US$102,6 billions, meaning an increase of43% compared to the previous year. In the EU (25 members to that date), the Chineseparticipation rose 44%, reaching US$24,2 billions of a total of US$77,8 biltion, while the risein imports in the American textile market as whole was only 6% and in the EU market it wasonly 7%121• This means that China has been increasing its position as a trade partuer in thetextile industry and, as per •an international trade perspective, the most affected ones arenecessarily third countries which are traditional trade partners in this sector, which are• constantly los ing their competitiveness.

The United States are more pro-active in the use of countervailing duties (CVD) againstChina than any other country. By a brief analysis of their official data:

AD!CVD

EU

Source: European

estigations by the US and EUD-CVI) Trw. (PRC) CVDIAJ)

144 56,69% 1 -

110 43,31% 21 -

254 100,00% 22 -id the US International Trade Commi

China

128 3

89 O

217 1 3 1n (IJoC) (JuIy/September 2011).

"' See CHINA/WTO, New and Fui) Notificatian Pursuant to Articie XVI:) aí the CÁ Ti' 1994 and ,4rticle 25 o!the SCM Agreement. Committee on Subsidies and Countervai!ing Measures, GISCM/N1123/CHN, 13 April2006.20 China also could have included preferential loans, debt forgiveness andothers. USTR, 2011 USTR Report toCongress on Chinas WTQ Cornp!iance, IDecember 2011, p. 44.121

WTO, Expioring the Jinks between subsidies, frade and the WTQ, World Trade Report 2006. Available at:<hftw11~.wto.org/endishIres e/books p elanrep elwor!d trade report06 e.pdf>. Viewed at: 12 January2012,pp. 14-15.

;tit

The table above shows that if considered only the (Jnited States and the EU investigations, lheEU is accountable for 56,69% of ali investigations, but only initiated one CVD investigation,while the United States are accountable for 22. In lhe Annex 3 it is detailed the sectorsaffected by those investigations.

The EU investigation concerned the wireless wide arca networking (WWAN)' 22 submitted tolhe European Commission in 2010. The sole enterprise to operate in this market is the OptioNV, the complainant' 23 . The investigation request was withdrawn by the complainant iaMarch 2011 because it signed a cooperation agreement with a producer in China. TheEuropean Commission closed lhe investigation, since there was no intercst of lhe EU on thematter124.

The United States investigations show a variety of subjects. In a general basis, lhe USTRstates that the subsidy allegations investigated lia ve involved preferential loans, incorne taxand VA T exemptions and reductions, the provision of goods and services on non-cornrnercialterrns125 , amongst other subsidies programs, central, provincial or local ones. For the purposeof this study, only the investigation concerning lhe textile sectors where the InternationalTrade Commission and lhe US Department of Commerce were able to find somecountervailable subsidy programs are presented below.

These subsidies programs were identified by lhe US Department of Comrnerce ou lheInvestigation C-579-953 - Narrow Woven Ribbons with Woven Selvedge from PRC, as ofDecember 14, 2009 (FR V. 74, a° 238, p. 66090 et seq). The Department of Commerceinvestigated two Chinese companies: Yama Ribbons and Bows Co., Ltd. and ChangtaiRongshu Textile Co., Ltd. The merchandise under investigation is classified under lheHarmonized System Classification 2007 sectors 58 (Special Woven Fabrics; Tufed TextileFabrics; Lace; Tapestries; Trirnrnings Embroidery), 59 (Impregnated, Coated, Covered orLaminated Textile Fabrics; Textile Articles of a Kind and Suitable for Industrial Use), and 63(Other Made up Textile Articles; Sets; Worn Clothing and Worn Textile Articles; Rags),respectively 13, 05, 01 IO-digit subheading in HTSUS statistical categories.

In this investigation, lhe US Department of Commerce list several subsidies and categorizethem as follows'26:

1) Loan Programs'27:

122 Corresponding to the Harmonized System 2007 sectors 84 (Nuclear reactors, bollers. machinery andmechanical appliances; parts thereoQ and 85 (Electrical machinery and equipment and parts thereof; soundrecorders and reproducers, television image and sound recorders and reproducers, and parts and accessories ofsLlch articles). In the European t.Jnion system, lhe 1 0-digit sectors are: 85176200 and 84718000.123 See Ofílcial Journai ofEuropean Línion, C24917-11, 16,9.2010.p. 7124 See 011k/ai Joumal o! Huropean Union. L58136-38. 3.3.2011. pp. 36-7.' 25USTR, 2011 USTR Report to C'ongress on China 's WTO Cornpliance, December 2011. p. 46.

- Department of Cornmerce.International Trade Administration.Narrow Woven Ribbons with WovenSelvedge froni the People 's Republic o! China: Prelirninary A!flrniative Countervaiiing Duty Determination andAiignrnent o! Final Countervailing Duty Determination with Final Antidumping Duty Determination (C-570-953). Federal Register, v. 74, n°238, December 14. 2009 (Notices), pp. 66090 to 66096.127 Itenis 1, 2. 3. and 4 were considered programs preliminarily determined to be not used by Yama or to notprovide benefits during lhe period ol' investigation. Ir worth noting that the progranis were analyzed inaccordance with lhe investigated sector and the investigated enterprises, which rneans that the programs existedbut werc not used by the specitïc enterprise under investigation.

91

a. Policy Loans to Narrow Woven Ribbon Producers from State-Owned CommercialB anks.

2) Grant Programs:a. The State Key Technology Renovation Project Fund;b. Famous Brand Program;c. Export Assistance Grants;d. Export Interest Subsidy Funds for Enterprises Located iii Zhejiang Provincee. Technology Grants for Enterprises Located in Zhejiang Provirice.

3) Indirect Tax Credits and VATfTariff Reductions and Exemptions:a. Import Tariff and VAT Exemptions for FIEs Using Imported Technology and

Equipment;b. lmport Tariff and VAT Exemptions for Certain Domestic Enterprises Using

lmported Technology and Equipment;c. VAT Rebate for FIE Purchases of Domestically Produced Equipment;d. Corporate Income Tax Refund Program for Reinvestment of FIE Profits in Export-

Oriented Enterprises;e. Preferentia! Tax Policies for Township Enterprises.

4) Foreign-Invested Enterprises (FIE) Income Tax Rate Reduction and Exemption Programs:a. Preferential Tax Policies for Enterprises with Foreign lnvestrnent ("Two Free,

Three HaIf") Program;b. Preferential Tax Policies for Export-Oriented FIEs;c. Tax Program for High or New Technology FIEs;d. Preferential Tax Policies for Research and Development for FIEs;e. Tax beriefits for FIEs in Encouraged Industries that Purchase Domestic

Equipment.5) Preliminarily Determined To Be Countervailable

a) Tax subsidies to FIEs (Foreign Invested Enterprises) iii Specially Designated Arcas'28;b) Local Income Tax Exemption and Reduction Programs for "Productive" FIE'29;

Those programs were Iisted iii the preliminarily affirmative countervailing dutydetermination. In 2010, lhe IJS Department of Commerce issued its final affirmativedetermination maintaining countervailing subsidies to the investigated enterprises' 30 . Afterthat, in September 2010, the Department of Cornrnerce issued the Countervailing Duty Ordermaintaining the countervailing subsidies as of the previons determination and, also, lhetermination of Lhe suspension of liquidation'31.

The United States Trade Representative holds hearings on China 's Compliance with WTOCommitments, in which several American organizations are invited to speak. Recently, onOctober 15th 2011,. the National Council of Textile Organizations (NCTO) delivered a speechand submitted a written statement to this hearing.

28 Yama received a counrervailable subsidy of 0,24 percent ad valorem under this program (FR 66095, v. 74,no. 238).129 Yama received a countervailable subsidy of 0,05 percent ad valorem under this program (FR 66095, v. 74,no. 238). The other investigated enterprise, Changtai, received a countervailable subsidy of 118,68 percent advalorem (FR 66094. v. 74. no. 238). The other enterprises investigated received a countervailable subsidy of59,49 percent ad valorein under this program (FR 66096. v. 74. no. 238).130 Yama recejved cot,ntervailable subsidy of 1,56 percent ad valorem. no longer ar de ,niníniis rate; Changtaireceived countervailable subsidy of 117,95 percent ad valorem; and ali others 1.56 percent ad valorem (FederalRegister v 75, no. 137, July 19, 2010 2 p. 41804).' See Federal Register, v. 75, no. 169, 1 Septernber 2010. pp. 53642 and 53643.

92

The written statement listed over 30 different policy initiatives from the Chinese central orprovincial governments aimed at supporting lhe Chinese textile sector. The document showsthe subsidies programs that are injuring the American textile sector, and also the connectionbetween Chinese textile imports to the United States and the decrease ofjobs in the Americantextile sector.

NCTO believes that subsidies and grants are responsible for a 5 to 30 percent benefit forChinese textile producers. Alongside there is a 5 percent benefit from the increased VATexport tax rebate and another 25 to 40 percent from currency manipuiation. Thus, the benefitsgranted by the Chinese government would range from 35 to 75 percent132.

In accordance to the NCTO, the rnost significant subsidies are being offered in terms ofpreferential lending, preferential land use rights and reduced costs for cotton and man-madefibers' 33. In addition, NCTO informs that income tax reductions, indirect tax programs,discounted electricity and grant prograrns are in effect but have a minor influence on theChinese textile sector performance.

The NCTO lists 28 subsidies programs, the tax rebate and the currency manipulation. For thepurpose of this chapter on!y those subsidies programs that are considered WTO prohibited bythe NCTO (ali 28 programs are listed in Annex 6) are reproduced below:

Prohibited Subsidies:1) Tax reductions for Export-Oriented FIEs: Program available after the "Two Free,

Three Haif Program" and if the enterprise exports account for 70 percent of theenterprises' saies: Export Subsidy (Article 3, SCM - Prohibited);

2) Tax reductions for FIEs and other Foreign Enterprises Purchasing Chinese-madeEquipment: National content over imported (Article 3, SCM - Prohibited;;

3) VAT rebates on FIE purchases of domestically-produced equipment: Nationalcontent over imported (Article 3, SCM - Prohibited);

4) Export Interest Subsidy Program (Shenzhen and Zhej iang Provinces): ExportSubsidy (Article 3, SCM - Prohibited);

5) Funds for "Outward Expansion" of industries in Certain Provinces (Jiangsu, Zhejiang,Shandong, Guangdong): Export Subsidy (Article 3, SCM - Prohibited).

iii. US Counter notification and the 200-Iist Chinese subsidy programs

In the Protocol of Accession of People's Republic of China there was an obligation to notifythe Comrnittee on Subsidies and Countervailing Measures, every year, the subsidies prograrnsissued by the government. Those obligations are determined by Article 25.1 of the SCM(Notifications) and by Paragraph 173 of the Report of the Working Party on the Accession ofChina.

However, China has only notified lhe Cornmittee on Subsidies and Countervailing Measuresin 2006 and, after that, in 2011, as a response to the counter notification submitted by theUnited States Delegation at the WTO.

32 NCTO. Statenient to me hearing Record U 5. Trade Representative - China 's £'on?pliance with kVTOCornrnitinents, submitted by Mr. Cass Johnson (President of NCTO) in 5 October 2011, p. 3.' 33 Ibid.p. 1.

93

The Chinese notification with subsidies programs from 2005 to 2008 has already beenstudied. Now, it is importam toto take a look in lhe United States Counter notification tocomplete lhe list of Chinese subsidies programs.

The United States alieges that more than 100 sub-central government measures were nolnotified, and 83 of them are related to the central govemment initiative "famous exportbrands".

The document suggests that the subsidies are divided as foliows:

China Subsidies Progranis by Sector (US Counter Notification 2011)

Green Technology

Famous Brand Ex

Source: US Counter

Central

37

88

79

2011. WTO, G/SCM/Q/CHN/42,

Sub-Central

6

83

1623

tilable at: www.wto.org .

Total

43

928

34

Some relevant subsidies programs to lhe textile industry are 134:

1) Central Government Measures:

a. Renewable Energy Law of People's Republic of China, adopted by theNational People's Congress on 28 February 2005, Order No. 33 1120051 of lhePresident of Lhe People's Republic of China, and amended by lhe NationalPeoplc's Congress on 26 December 2009.

b. Notice of the National Development and Reform Commission on ProvisionalMeasures on Administration of lhe Price and Expense Apportionmenl ofRenewable Energy Power Generation, NDRC Price [2006] No. 7 (4 January2006).

c. Equipment Manufacturing Industry Restmcturing and Revitalization Plan,approved by the State Council on 4 February 2009.

d. Several Opinions of the State Council on Expediting lhe Rejuvenation of theEquipment Manufacturing Industry, GuoFa [2006] No. 8 (13 February 2006).

e. Loans and lnlerest Subsidies Provided Pursuant to lhe NortheastRevitalization: Liaoning Provincial Bureau of Foreign Trade and EconomicCooperation and Department of Finance of Liaoning Province Notice onPrinting and Distributing lhe Provisional Administrative Measures onNortheast Old Industrial Base Foreign Trade Development Fund, Liao WaiJing Mao JiZi No. 559 [2004] (18 November 2004).

f. Income Tax Exemption for Investmenl in Domestic "TechnologicalRenovalion': Technological Transformation of Domestie EquipmenlInvestment Credit Management of Enterprise Income Tax Audil, adopled byState Tax Administration, No. 013 (17 January 2000).

2) Sub-Central Governmenl Measures:

134 The complete !ist can be found in WTO, Request from ffie Uriked States to China Pursuant to Article 25.10 ofthe Agreement. GISCMIQ2/CFINI42. Committee on Subsidies and Countervailing Measures, 11 October 2011.

94

a. Opinions Regarding Accelerating lhe Development in the EnvironmentalProtection lndustry, issued by the Hunan People's Provincial Government,Xiang ZhengFa [2009] No. 36 (11 November 2009).

b. Plans for a New Round Technological Renovation of Ningxia Industry (2008-20 12), issued by the Peopl&s Government of Ningxia Hui Autonomous Region(25 December 2008).

c. Opinions on Promoting Fast and Healthy Development of CharacteristicManufacturing Industry through lmplementing Industrial Upgrading Projects,QWF [2007] No. 20.

d. Circular of the Provincial Department of Commerce, Deveiopment and ReformCommission, Economic Commission, Department of Finance, Department ofScience and Technology, Bureau of State Tax, Administration for Industry andCommerce, Bureau of Quality and Technical Supervision, and Entry-ExitInspection and Quarantine Bureau of Heilongjiang Province and HarbinCustorns ori Printing and Distrihuting lhe "Guiding Opin.ions of HeilongjiangProvince on Supporting the Development of Farnous Export Brands, HeiShang LianFa [20061 No. 1.

e. Incorne Tax Exemption for FIEs Located in Jiangsu Province: Income TaxLaw of the People's Republic of China for Enterprises with Foreign Investmentand Foreign Enterprises, adopted by the Fourth National People's Congress n.45 [19911 (9 April 1991); Industrial Structure Adjustment Guideline Catalog,Jiangsu Commerce & Trade Commission (26 January 2007); NanjingChemical Industry Park, Preferential Policies, sponsored by Narijing MunicipalGovernment (2004); Xuzhou Economic Development Zone, Policies forEncouraging Investments in Xuzhou Economic Development Zone (14 July2004); "China Through A Lens: Taxation Regulations and Tax Incentives,"available at http://www.china.org.cn/eng1ish1features/62665.htm.

f. Notices on Publícation of Interim Procedures on Management of ZhejiangProvince Export Brands Fund, ZCQZ [20061 No. 207.

g. Income Tax Programs for FiEs in Guangdong Province "Preferential Policiesfor Foreign Investment": Investment Guide to Guangdong, available athttp ://www.invest gd.com/main/tzdg/tzzn enI04.html.

h. Funds for Outward Expansion of Industries in Guangdong Province:Implementing Measures of Guangdong Province on Supporting theDcvelopment of Outward-Oriented Private Enterprises, Yue Ban Fa No. 1.7(2003).

L Intemational Market Development Fund Grants for SMEs: Xiamen TradeDevelopruent Bureau pursuant to SMEs International Market Exploiting Fund(Trial) Method, Cai Qi n. 467 [20001; Circular of the Ministry of ForeignTrade and Economic Cooperation and the Ministry of Finance ori Printing andDistributing the Detailed Rules for the Implementation of the Measures for theAdministration of International Market Developing Funds of SmalI- andMedium-sized Enterprises, Wai Jing Mao JiCaiFa No. 270 [2001] (13 June2001.).

j. Direct grants in Guangdong Province: lmplementing Measures of GuangdongProvince on Supporting the Development of Export-Oriented Enterprises (29September 2003).

k. Preferential loans and interest rate subsidies in Guarigdong Province:Implementing Measures of Guangdong Province on Supporting theDevelopment of Export-Oriented Private Enterprises (29 September 2003).

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1. Income Tax Programs ia Huimin Industrial Park in Zhejiang Province: JiashanEconomic Development Zone (12 May 2004); "Welcome to Jiashan:Preferential Policies" (2004), available at htt://www.jszsj .com/en/epp.htm;"Huimin Industrial Park: About 1-luimin," available athttp://www.hrnjszj.cn/huimin.asp.

m. Income Tax Offsets andlor Refunds for FIEs Purchasing Domestic Equipmentin Qingdao Municipality: "Local Preferential Policies," Chinese Govemment'sOfficial Web Portal (29 August 2005); "Zhejiang China: l-Iangzihou Economic& Technological Development Zone" (10 May 2004); "China Investment:Hangzhou Economic & Development Arca" (undated), sponsored by theManagement Commission of HEDA.

n. Income Tax Programs ia the Hangzhou Export Processing Zone in ZhejiangProvince: "Zhejiang China: Hangzhou Economic & TechnologicalDevelopment Zone" (10 May 2004); "China Investment: Hangzhou Economic& Development Arca" (undated), sponsored by the Management Cornmissionof HEDA.

o. Income Tax Prograrns for Export-Oriented FIEs in Dongguan City iaGuangdong Province: "DongGuan: Preferential Policies," available athttp://english.dg.gov.cn/Prferential%20Policies.htm.

p. Export-Based "Reward" Subsidies for Enterprises in Huimin Industrial Park inZhejiang Province: "Jiashan Economic Development Zone" (12 May 2004),available athttp://www.zhejiang. gov.cnlgb/node2/node 161 9/node 1624/1 644/userobiect 1 3ai6580.htm; "Welcome to Jiashan: Preferential Policies" (2004), available athttp://www.jszsj.cornlenlepp.htm ; "Huimin Industrial Park: About Huimin;Preferential Policy" (For Foreign Invested Enterprises), available athttp://www.hmiszi.cri/huimin.asn.

q. Export Interest Subsidies from the Liaoning Provincial Govemment: LiaoningProvincial Bureau of Foreign Trade and Economic Cooperation Circular onPrinting and Distributing the Provisional Administrative Measures on High-Tech Products and Equipment Manufacturing Products Export FinancialInterest Assistance of Liaoning Province Liao Cai Qi No. 671 [2004 .] (16December 2004).

r. Reduced Income Taxes Based on Geographic Location (Zhejiang andShandong Provinces): Income Tax Law of the People's Republic of China forEnterprises with Foreign Investment and Foreign Enterprises, Article 7,adopted by the Fourth National People's Congress n. 45 [1991] (9 April 1991).

s. Import tariff and VAT refunds and exemptions for FIEs in. Zhejiang:Preferential Policies, the Peoples Government of Zhejiang Province (29 March2006), available athttp://www.Zheiiang. gov.cnlzj foreignlenglish/node577/node578/node58 1/userobiectlai557 1 .html; Yuhang Economic Development Zone, People'sGovemment of Zhejiang Province (4 August 2006), available aLhttp://www.z p .gov.cn/zb/zinew/node428/nodel 848/node 1 854/node 1 857/userobjectlai6491 .html.

t. Import Tariff Refunds and Exemptions for FIEs in Guangdong: Regulations onSpecial Economic Zones in Guangdong Provirice, Approved by the IsthSessionof the Standing Cornmittee of the Fifth National People's Coagress (26 August1980); DongGuan Tax Administration, DongGuan Website.

u. Exemption from Real Estate Tax and Dyke Maintaining Fee for FIES inGuangdong Province: Invest in Shunde, Shunde Investment Promotion Bureau,available at www.investshunde.org/English/zn 3.html.

v. Land-related subsidies to companies iocated in specific regions of GuangdongProvince: lmpiementing Provisions for Encouraging Foreign lnvestment inGuangdong Province, People's Government of Guangdong Province (26 April1987); Shunde Investment Policy availabie athttl)://www.shunde.cnlgb/040801/68.htm.

w. Exemption from Land Development Fees for Enterprises Located in IndustrialCluster Zones: "Preferential Policies" availabie athttp:www.lunjiao.gov.cii/zsyz3.htm; "Preferential Policies on Investment inZhongshan" available athttp://www.zs.gov.cnlenglish/governmentiview/index.action?did=849&id=39 108; "Policies and Regulations, Rules, Industrial Parks" - Zhongshan IndustrialParks.

x. Income Tax Programs for FIES in Dongguan City iii Guangdong Province:"DongGuan: Preferential Policies," available athttp://english.dg.gov.cnlPreferential %2øPolicies.htm.

y. Technology Grants for Enterprises Located in Zhejiang Province: PreferentialPolicies of Zhejiang Province (7 December 2006).

z. Technologicai Innovation Funds Provided by Zhejiang Province: PreferentialPolicies of Zhejiang Province (7 December 2006); Certain Opinions RegardingStrengthening Independent Innovation, Speeding lJp Establishment ofMunicipality of Technology and Innovation, Wenweifa [2006] No. 86.

The list of ali these subsidies programs are here included as evidence how China isimplementing its Industrial Pohcy and using subsidies as one of its main instruments.

4. Conclusions

After analyzing several subsidies programs provided by China, it is possible to surnmarizesome coriciuding remarks.

A recent USTR Report coinplained about Chinese compliance to lis WTO commitments onsubsidies. It notes that China has agreed to use a single official journal to publish its trade-related laws, to transiate its trade-related legisiation, courts to review administrative actions,the uniformization of the application of lis laws and regulations. The report affirms thatChina's publications in the MOFCOM Gazette concerning ali trade related measures was "far[mm complete ". The report also states that China has a poor record of compliance with itstransiation commitment. Furthermore, a significant number of departmental rules are sulissued without [irst having been published for public comment on me State Council 'swebsite!135.

According to the USTR, China has implemented only mo commitments from its Protocol ofAccession: the adoption of Lhe enquiry points, where any individual might obtain information,operated by the MOFCOM, named as "WTO Enquiry and Notification Center"; the secondcommitment refers to the notice-and-comment procedures regarding the proposition of new

t33EJSTR 2011 USTR Report to Congress on China 's WTO Cornp/iance. December 2011. pp. 109-112.97

laws or by lhe time of their revision, which aliows lhe public to make comments on these newor revised laws136.

The research performed showed that lhe Chinese govemment (central or local) providesincome tax refund grant, for many years. Local govemment usually refunds lhe investment oflhe enterprise in buying Iamd to instail its units. Some subsidies are granted to building inorder to facilitate lhe construction of lhe piam. Several programs deal with technology andothers with the construction sector. Finaily, financial supporting fund associated with interest-free loans (or NPLs or non-repayable loans).

Ali these programs running at lhe sarne time can introduce significant disruption to themarket, creating an unfair competition environment, due to lhe amount of subsidies and lhediversity of funds. The participation of SOEs in thís process makes lhe practice even moreunfair because of its political role' 37.

As stated above, China has five administrative leveis and several shared competences. Someof them reports to budget issues, tax and government revenue issues, and development andincentive programs. Accordingly to ECKAUS, by 2003, lhe central governrnent wasresponsible for 17,6% of ali subsidies and lhe local government respondcd for 82,4%. Inaddition, lhe IJSTR affirms that around 20% of China's investment in industries comes fromprovincial and local governments' 38 . This is relevant to understand why studying Chineseprovinces, countïes, cities, and towns is crucial to learn lhe whoie process of subsidizationand find out measures that can be considered inconsistent with WTO Law that might be risenupon lhe respective government and piead for anti-subsidy measures or, in specific cases, apanei to settle the matter139.

One important conclusion to be taken is that lhe Chinese economy is strongly subsided. Theprograms I.isted in this chapter show a significant list of subsidies programs. Furthermore, thesubsidies notificati.on submitted by China last October did not include any provincial or localgovernment subsidies, disregarding lhe fact that, in July 2011, lhe Chiriese govemment shouldhave submitted its subsidies notification for lhe period 20092010I40. The current notificationpresented by China has only covercd subsidies programs for the period 2005-2008 and, onceagain, it has failed to make commitments on lhe ending of those subsidies.

China had to impiement several reforms to accede to lhe WTO. Therefore, since SOEs and lheprivatization movement in lhe early 2000's, there is no evidcnce of a consistent process of

136 1b1d., pp. 11.0-111.M Thc 2012 Report of the World Bank on China: "In Lerms of political costs, it is irnportant to remember thatlhe political economy of policy reform is complex and difficult in alt countries. including China. Every subsidycreates its own lobby, whether the subsidy takes lhe form of preferential access to land and credit, or access tocheap energy and resources. State-owned enterprises have political power and lobbying capacity, and energy-intensive export industries will also lobby for subsidies to maintain their competitiveness. Governrnent will needto balance lhe wider social benetits of reforms with lhe losses of those adverse!y affected. Saíety net policies forthose likely to be negatively affected may include income support. and access to alternative eniploynient,retraining opportunities, and relocation assistance. Such policies will go a long way in mobilizing the politicaland workplace-based support for lhe changes that are needed (ILO 2011) . WORLD BANK, China 2030:Buliding a Modern. Harrnonious, and ('reative High-Jncoine Society. Conference Edition, 2012, p. 266.38USTR, 2011 USTR Report to C'ongress on China 's WTO Coinpliance, December 2011, p. 44.

' 39ECKAUS, Richard S., "China's exports, subsidies to state owned enterprises and lhe WTO," in ChinaEco!) ornic Revjew. 17 (2006) - 1-13, p. 4. Table 1,40 USTR. 2011 USTR Report to Congres.s on China 's WTO Compliance, December 20!!, page 45

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reforrns. After 2008, there is no information that lhe Chinese government did continue itsprocedures towards a market-based econom.y. Despite of revoking some subsidies programs,China just gaveto them a new profile and use.

There is also evidence that either the socialist or the entrepreneurial development modeis arenot exactly private and ruled by market law. The China Statistjcal Yearbook 2010 estimatethat there are over 20 Lhousands SOEs registered, which means Lhat the disappearance ofsubsidies to loss making SOEs from its official notifications and data rea!ly intriguirig.

The texti.Ie industries have been part of the Five-Year Plans for many periods. The three lastones have been given speciat attention to textiles and to industry iii general.

There are several tax competences that be!ong to the provinces and local governments makinglhe research on subsidies even more complicated' 41 . Moreover, WTO members, businessmen,and acadernics complain about lhe lack of transparency of Lhe Chinese government.

The current course of action includes tax incentives, rebates, and non-repayable loans, by themeans of bank credit and budgetarian rubrics' 42 . The 12° Five-Year Plan focuses on raisingLhe quality and design standards of textile and apparel producis in order to help Chinesebrands to compete in lhe international market. For that matter, ir will be necessary strengthennational brands and to build a positive image.

The main fact to be considered is if Lhe Article 27.13 of lhe SCM is applicable to a NME, in asense that it was written for market economies and perhaps it will need amendments or anevolutionary interpretation to fit in China's characteristics. Neverthe!ess, China has agreed notto invoke this Article143.

Lastly, the lack of transparency from lhe Chinese govemment is a great concern.

China will have to submit more information on the role of private sector, the role of the BigFour, lhe subsidies to SOEs, lhe credit !ines, the budget division, and the available data.

141 MENDES, Marcos J., "Os Sistemas Tributários de Brasil, Rússia, China, Índia e México: Comparação dasCaracterísticas Gerais," Texto Para discussão 49, Consultoria Legislativa do Senado Federal/Centro deEstudos,Brazil. October 2008, p. 49.112 VÁ QIN, Jul ia, "WTO Regulation of Subsidies to State-Owned Enterprises (SOEs) - A Critical Appraisal ofthe China Accession Protocol," in Journal o! Internationa! Economic Law, v. 7, n 4, 2004, p. 875.143 WTO, Report o! the Working Party on the Accession o! China, WT1ACC/CHV149, 1 October 200!. p. 34,para. 171.

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111.3. THE ISSUE OF STATE OWNED ENTERPRISE

Since the late 1970's, the Chinese Government has been undertaking important refonnstowards economic liberalization and openness. Some of the main pillars of this strategy havebeen the attraction of foreign irivestments, promotion of exports and an increasingly activeindustrial policy. With its accession to the WTO, in 2001, China took an unequivocal step inthe direction of submitting its trade policy to a complex framework of multilateralagreements. Although Lhe constraints to its policy space appeared to be excessivelyburdensome, the potentíal gains China were about to obtain appeared to be far moresignificant.

Amongst ali the critical points of the Chinese accession to the WTO, one of the most relevantwas state's influence over the economy, more specifically the key role played by SOEs in itseconomy and how this scenario could be brought into conformity with the multilateral rules.Changing structural fundamentais of the Chinese economy obviously represents a huechalienge and Beijing committed itself to doing so, by means of its Protocol of Accession 'and several declarations contained in the Report of the Working Party on the Accession ofChina ("RWP")'45.

Several implications of the Chinese state prominence in the country's economy through SOEsjustifies WTO members' concerns regarding non-market oriented trade practices.Subsidization, a promising government procurement market and the influence over outwardand inward fiows of investments can decisively affect intemational trade beyond Chineseborders. For those reasons, the analysis of the Chinese levei of compliance with its WTOcommitrnents regarding SOEs and its activities reveals the economic impacts of Chinese tradepolicies and how the WTO members are impacted by state presence iii the economy.

1. Definition of SOEs

The first chailenge when discussing the issue of SOEs is the precise meaning of suchexpression. As discussed above, the activities of SOEs can have multipie implications overChinese economy and global trade, regarding for instance subsidies, investments andcompetition, what suggests that a singie definition of SOEs can hardly fit in every possiblecontext.

The Chinese Statistical Yearbook 146, published by the Chinese governmental press, definesSOEs as non-corporate econornic entities where ali asses are owned by the siate, includingSOEs, state-funded enterprises and state-owned joint-operation enterprises. Furthermore, itcreates a second category of state-holding enterprises which have mixed ownership and wherethe percentage of state assets is iarger than any other single shareholder of the sarneenterprise, giving state control over it.

The WTO has also expressed its understanding about the meaning of the expression SOEs indifferent occasions. The report prepared by the Secretariat for the third Trade Policy Review

44 WTO, Protocois of accession for new rnembers since 1995, including cornrnitments in goods and services, IIFebruary 2012 (last update). Available aL: <http://www.wto.org/engIish/thewto e/acc elcornQlcteacc e.htm>.Viewed at: 5 January 2012.'4'Jbid.146 CHINA, National Bureau of Statisties of China. C'hinese Statistica/ Yearbook 2010, Chinese Statistic Press,2011. Available at: chtt://www.stats.gov ,crVtjsj/ndsj/20I0/indexeh.htm>. Viewed at: 22 IDecember 2011.

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of China (2010) (TPR of China) contains a definition of SOEs for general purposes, statingthat SOEs consist of wholly state-owned enterprises, and enterprises in which the State hascontrolling shares (state-controlled enterprises) 147 . State-controlled enterprises are those inwhich Lhe state, or another SOE, holds more than 50% of equity or, if the share of the equityis less than 50%, the state or another SOE has controlling influence on its management andoperation.

When it comes to the DSB, the AB has established itself a definition of "public body", whichis closely related to SOEs, wheri it comes to the SCM. On the case United States - DefinitiveAntidwiiping and Countervaíiing Duties on Certain Products from China (DS379), filed byChina against the United States of America (US), the AB reversed the Panel's understandingthat a public body is any entity controlled by a government' 48 . Differently, it concluded that apublic body is ao entity that possesses, exercises, or is vested with, governmental authority.

The definition of public body is thus narrower than the concept of SOEs, which Ieads to theinterpretation that only the SOEs that are under govemment control may be considered as apublic body.

The consequences of such a definition were crucial for the outcome of such case, as the ABconciuded that Lhe (iS had acted inconsistently with the SCM when its authorities found thatcertain Chinese SOEs that supp!ied steel, rubber, and petrochemical inputs te investigatedcompanies constituted "public bodies", a key element for lhe verification of a stibsidy, as perArticle 1.1 (a) (1) of the SCM.

This definition was particularly relevant because its main criterion for the determination of apubhc body is the role played by the entity and not the percentage of shares owned by thegovernment. The 2011 - Report to Congress of the U.S.-China Economic and SecurityReview Commission' 49 (Report of the VCESRC) alerts to the difficulty to trace the realownership of any enterprise in China due te lhe lack of transparency of Chinese regulatorysystems. Considering this point, the AB definition appears to have adopted an adequatecriteria in its report for DS379, obliging the US to revisit its double remedies approach and itspublic body determinations relating to SOEs.

Nevertheless, Lhe role played by the entity is also of difficult determination and should beunderiaken on a case by case basis, following a pmper evaluation of the core features of meentity concerned, and its re/ationship with governrnent ia the narrow sens»o.

This initial approach te Lhe controversial nature of such concept is fundamental for thecomprehension of the Chinese commitments regarding SOEs and its implications in differenteconomic leveis.

WTO, Trade Policy Review Body, China - Report by the Secretariat. 26 Api! 2010, p. 54.' WTO, AS, US - Antidurnping and Countervai/ing Duties (China), WT/DS379/AB/R, AS Report adoptcd ouII March 201!. pp. 124-125, para. 322.149UCESRC, 2011 Report lo Congress. Washington, D.C.: 112" Congress, I' Session, November 2011. p. 40.'5° WTO. AS, US - Antidumping and Countervailing Duties (China), WTIDS379/AB/R, AB Report adopted onII March 2011. p. 124. para. 319.

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2. Overview of SOEs in Chinese Econoiny

The incorporation of SOEs rnay have multipie objectives. Such enterprises may respond topolitical, social, or cultural, or income redistribution purposes. Many of them were createdoriginally to pursue publ.ic policy objectives and this appears to fit perfectly to the Chiriesecase. These aspects complicate the understandíng, in comparison with private companies, ofhow SOEs operate, the way they are governed and how their relationship with the state playsoutt51.

The participation of SOEs in Chinese economy is particulariy remarkable but it is worth-noting that the number of such enterprises has been decreasing since 2000, accordïng to theReport of the 1.JCESRC' 52 . Although the number of SOEs in China tends to be quite unclearand hard to precise, there are some estimates which provide a picture of the whole scenario, inthe central and local leveis.

A study by the Brooking Institution 153 , a public policy think tank based in Washington, DC,estimates that in 2003, there were approxirnately 159,000 SOEs, including both centratly andlocally administered enterprises. This number would have been reduced to 1.14,500, in 2010,according to the sarne research. On the other hand, the statistics of the China StatisticsYearboolc 2010154 show a inuch lower number of such enterprises, as demonstrated in thetable below:

Number of SOEs in China

Year Number of SOEs1998 64,7371999 61,3012000 53.4892001 46,7672002 41,1252003 34,2802004 35,597

2005 27,477

2006 24,961

2007 20,680

2008 21,313

2009 20,510Source: China StatisticsYearbook 2010

Apart from making efforts to promote reforrns to downsize the state sector through thequantitative reduction of SOEs, China pursues the strategy called "grasp the big, let go of thesmali", since 1997, which implies privatizing, filing bankruptcy of small SOEs in rnost

151 Unctad World Investinent Report 2011. Non-Equity inodes o! international production and developinent, NewYork and Geneva, 2011, p. 34.' IJCESRC, 2011 Report to Congress. Washington. D.C.: 112" Congress. ISI Session, November 2011. p. 42.' LI, Cheng. "China's Midterm Jockeying: Gearing Up for 2012 (Part 4: Top Leaders of Major State-OwnedEnterprises)," China Leadership Monitor, n. 34. February 2011, p. 3.'' CHINA. National Burcau of Statistics of China, Chinese Statistical Yearbook 2010, Chinese Statistic Press,2011. Available at: chttp://www.stats.ov.cn/tjsj/ndsj/20I0/indexeh,htm >. Viewed at: 22 December 2011.

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competitive sectors. According to an articie published by the World Bank' 55 , another commonsolution found by the Chinese Govemment is merging those small enterprises to createstronger firms. Those strategies are claimed to be a huge success, in terms of creating largeSOEs.

The administration of the largest 121 nonfinancial companies owned by the centralgovernment is supervised by Lhe state-owned Assets Supervision and AdministrationCommission (SASAC)' 56 , a kind of a holding company which reports to the State Council.The SASAC also extends its supervision to SOEs in the provinces or central SOEs'subsidiaries, by means of its local state-owned assets management authorities. The scope ofeconomic activities developed by SOEs in China is, however, much bigger than SASACcompanies and its supervision is in charge of other governmentai entities. According to theReport of the UCESRC, the Chinese central SOEs can be categorized in 3 major groupings'57.

The first one, the SASAC companies, consists of the companies which provide public goods,such as defense, communications, transportation and utilities, as well as firms related tonatural resources (oil, minerals and metais, for example). In 2003, the enterprises of this firstgrouping accounted for 196 enterprises and, in 2010, it has been reduced to the abovementioned 121 enterprises, which are the largest Chinese SOEs.

The second grouping includes companies of sectors such as banking, finance, and insurance,under the administration of the China Bariking Regulatory Commission and the ChinaEnsurance Regulatory Commission. The companies of the third group are those specialized inbroadcast media, publications, culture and entertainment, which are administrated by variousagencies, controlled by the Chinese Communist Party.

Another important implication of the activities of SOEs in China is related to Chinese foreigninvestments abroad. According to the Report of the UCESRC, SOEs in the energy, rawmateriais and metais have been major participants in the "going out" pohcy' 58 . The WorldInvestment Report 20l.1', elaborated by the Unctad, demonstrates Lhe prominent role piayedby transnational Chinese SOEs in outward investment fiows, which account for 50enterprises, a number considerably higher than other countries, such as Brazil, India orRussia, as stated at the table below:

'55 XU, Gao, "State-Owned Enterprises in China: How big are theyT' East Asia & Pacfflc on 11w rise (WorldBank Blogs), 19 January 2010. . Available at: chttx//bIogs.worIdbank.orgieastasiapacific/state-owned-enterprises-in-china-how-big-are-they>. Viewed at: 19 December 2011.56 See the State-Owned Asseis Supervision and Administration Commission (SASAC) official website aLchttp://www.sasac.gov.cn/n2963340/index.html >

UCESRC. 2011 Report to Congress. Washington, D.C.: 112 b Congress, 1 ` Session, Novernber 2011, p. 44.' 5t Ibid..p. 58.' 59Unctad. World Investrnent Report 2011: Non-Equity niodes of international production and de velopinent. NewYork and Geneva, 2011.p. 31.

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A study by the Rhodium Group'°°, an American company which analyzes investmentmanagement, concluded that between 2003 and 2010. 74 percent of the number of investmentdeals originated from private firms, which the authors ciassify as companies having 80percent or greater nongovernment ownership. On the other hand, in terras of total deal value,the picture is reversed, as SOEs account for 65 percent of the total.

It is hard to precise, however, the total participation of SOEs in Chinese economy, given alithe considerations above regarding the problematic definition of SOEs, public bodies and thecontroversial criteria to classify such entities as private or public ones. The difficulty to traceownership in China is also a significant obstacle for more accurate estimates. However, thedata analyzed herein is instrumental to a more comprehensive understanding of the roleplayed by SOEs in Chinese economy.

3. Chinese commitments at the WTO

li is a wide consensus that the WTO relies on the functioning of market-oriented economies.For this reason the Chinese accession to the Multilateral Trading System demanded specialconditions to conform the dyïiamics of a NME to WTO rules. WiLh the purpose of benefiting

160 ROSEN, Daniel li.; HANEMANN, ThiIo, An Anierican Open Door? Maxinnizing the Beneíits of ChineseForeign Direct luvestinent, Special Repor(, New York, NY: Asia Society, May 2011. p. 33.

104

from the opportunities offered by the multilateral agreements, China assumed firmcommitments to implement, for example, importara legal and regulatory reforrns and specialsafeguard mechanisms to protect other members' domestic industries against surges ofimports from China.

In regard to SOES, China committed itself to several obligations which are related, in general,to a liberalization process, and contained either in its Protocol of Accession or in the RWP.Most of those commitments are related to subsidies, government procurement and theindependence of the decision making process within SOES.

3.1. Subsidies

Discussing SOES in the context of subsidies is crucial, mainly considering Articles 1.. 1. and1.1 (a)( 1) of the SCM, which prov ide that (..) a subsicly shali be deerned to exist tE there is afinancial contribution by a go vernment or any public body within the territory o! a Member(emphasis added). Keeping in mmd the numerous possible definitions of a SOE, as statedabove, it is fundamental to assess, in each case, whether such enterprises constitute or notpublic bodies, for the purposes determining whether a financial contribution made by a SOEcan be considered a subsidy.

As a matter of fact, SOES shall also be analysed as potential recipients of subsidies and notonly as providers, due to its commonly dose relationship with governments and publicbodies. This logic applies to the debate involving the Chinese government and Chinese SOES,which are claimed to be disproportionately supported by the state.

The Protocol of Accession does not contain comprehensive provisions regarding China'scommitmerits related to SOES and subsidies. However, it brings a key mie regarding theSCM, when dealing with subsidies provided to SOES and the determination of specificity,according to Articles 1.2 and 2 of the 5CM. This Protocol of Accessiori provision states thatwhen applying such Articles, subsidies provided to SOES shalt be deemed to be specific if,inter alia, SOES are the predominant recipients of such subsidies or SOES receivedisproportionately large amounts of such subsidies (Protocol of Accession Paragraph 15).

The determination of specificity is particularly important for the purposes of determining if asubsidy is either prohibited or actionable under the DSB. The specificity of any such financialcontri.butions is also a requirement for the imposition of countervailing measures provided forin Article 10 of the SCM, according to Article 1.2., as follows:

A subsidy as defined in Paragraph 1 shall be subjeer to the provisions of Part II [Prohibited Subsidies] orsha]l be subject to the provisions of Part III [Actionable Subsidies] or V [Countervaiting Measures] onlyif such a subsidy is specific in accordance with the provisions of article 2 [Specificity].

Another relevant provision contained in the Protocol of Accession concerns the prohibition ofintroduction or maintenance of any export subsidies on agricultural products. Agriculturalexport subsidies are regulated under WTO Agreement on Agriculture, and their limits areusually established under each members Schedule of Concessions. In the case of China, thereis no atlowed margin for export subsidies on agricultural products.

On this matter, the Protocol of Accession dedicates special attention to fiscal and othertransfers between or among SOES in the agricultural sector and other enterprises that operate

1.05

as state trading enterprises in lhe agricultural sector, which sha!i be notified to lhe WTO. Thepossibiiity that a SOE figures as a subsidies provider or recipient justifies lhe ratio of this ruleand lhe need of transparency on those transfers.

Likewise, the RWP expresses general concerns about subsidization provided by ChineseSOEs, mainly the financial contributions made by state-owned banks, which wou!d be doingSO as govemment actors. The Chinese representative stated, however, that China is committedto lhe objective that SOEs, ineluding banks, should be rim on a conimercial basis and beresponsible for their own profits and Josses 161 . Moreover, lhe Chinese representativereinforced that China would progressively work towards a fuil notification of subsidies, asprovided for by Articie 25 of the SCM.

3.2. Government Procurement

The Chinese SOE sector represents a considerab!e percentage of China's economy, giving riseto strong economic interests amongst WTO members, more specifically in regard to China'sadhesion to lhe WTO Government Procurement Agreement (GPA). Upon Chinese accession.to lhe WTO, lhe members of lhe Working Party stated that China shouid immediateiy becomean observer to lhe GPA and shouid initiate negotiations for membership in lhe Agreementwithin mo years of accession.

China is an observer to such agreement since its accession to the WTO in 2002 but lhedeadline for its entry in lhe GPA remains open, as lhe country committed itself to initiatenegotiations for membership "as soon as possibie". This open term has motivated severalconcerns by other members, which have been urging China to adopt lhe UPA framework,given lhe remarkabie business opportunities offered by such market.

On Lhe other hand, lhe Chinese committed to lhe adoption of fundamental principies of beingopen, fair, equitable, efficient and acting in pubiic interest when carrying out governmentprocurernent. The RWP aiso brings lhe Chinese commitment that until lhe country becomes aparty to lhe UPA,

ali government entities at Lhe central and sub-national levei, as weli as any of its public entities other thanthose engaged in exciusiveiy commerciai activities, would conduct their procurement in a transparentmanner, and provide ali foreign suppliers with equal opportunity to participate ia that procurementpursuant to the principie of MFN treatment'62.

The commitment to Lhe adoption of lhe most favoured nation principie means that aii lheprocurements which are opened to foreign suppliers sha!i offer lhe bidders equal opportunitiesto participate in the procedures. With regards to transparency, China committed itseif tosubject its pubhc entities' procurements only to iaws, regu!ations, judicial decisions andadministrative ruhngs of general app!ication and procedures which had been pub!ished andmade avaiiab!e to Lhe public. For this purpose, lhe Protoco! of Accession imp!ies Lheobiigation of notifying to Lhe Council of lhe Trade in Goods !aws, reguiations and proceduresreiated to the Chinese government procurement system.

61 WTO, Report ofthe Working Party on the Accession of China. I'VT1ACC/CHN/49. October 2001, p. 34. para.172.' 621b1d., p. 70, para. 339.

106

In this context, China confirmed that, without prejudice to its rights in future negotiations inLhe GPA, ali laws, regulations and measures relating to the procurement by SOES ofgoodsand services for commercíai saie, production of goods or suppiy of services for commerciaisaie, ar for non-governmentai purposes wouid not be considered to be laws, reguiations andmeasures re/ating (o governinent procurenient' 63 . Therefore, it wouid be subject to Lheprovisions of Articles II (MFN Treatment), XVI (Market Access) and XVII (NationaiTreatment) of the General Agreement on Trade in Services and Article Ill (NationaiTreatment) of the General Agreement on Tariffs and Trade 1994.

3.3. State influence over SOEs governance

Most of the Chinese SOES are major players in its respective markets and have strongeconomic power due to such condition. Entering an organization which privileges market-oriented trade practices required a significant modification of the relation between theChinese government and the its SOES in the context of establishing a modern enterprisesystem. The Working Party on Lhe accession of China to the WTO reported severa! Chineseobligations in this regard. The RWP contains the statements o!' the Chinese representativerelated to the commitments and objectives to be achieved by China upon its accession to theWTO.

The representative o!' China stated that the country's SOES basically operated in accordancewith mies o!' market economy and thus the government would no longer directly control Lhehuman, finance and material resources, and operational activities such as production, supplyand marketing.

The content of this commitment is that prices of, for example, commodities produced byChinese SOES, or the allocation of resources in operationai arcas would no ionger be decidedby the govemment and shall be determined by Lhe market, which means that it shali be basedon commercíai considerations. Chinese SOES which operate as financial institutions, such asbanks, wouid have to offer its ioans to other SOES exclusively under market conditions.

A more modern and independent system o!' enterprises is an important element o!' marketeconomies and the Chinese transition to such stage wiii hardly be achieved withoutconcluding this reform. The growing reievance of foreign invested enterprises in Chinademands a clear and market-oriented competition between ali the players and gives risc toseverai concems by WTO members. Furthermore, Chinese private companies also Lend to bein disadvantage due to governmental support to SOES.

4. SOEs and China WTO rules compliance

As expiained above, Chinese WTO commitments demand deep economic reforms whichmight impiy structural changes in the role o!' SOES in the country's economy. A goodcriterion to assess Lhe progress made by China regarding this aim is the analysis of economicdata, such as the evolution of Lhe effective participation of SOES in Chinese markets. Whenevaluating Lhe whole scenario, WTO members and observers in general can only partially reiyon officiai data pubhshed by the Chinese government.

63 WTO, Report o! me Working Party on the Accession o! China, W'T1ACC/CHN/49, October 2001, p. 9, para.47.

107

A study by the (3.5.-China Economic and Security Review Commission' 64 reveals theparticular difficulties to evaluate the levei of China's compliance with its liberalizationcommitments, when making use of lhe Chinese government's indicators.

TEie Chinese government publishes severa[ statistical rneasures which can be used to assess lhe size 01'

state-owned enterprises relative to orher fornis of ownership aecording to various dimensions. In manycases. Lhe measures of SOE activity consider only whotty-owned SOEs. That is, these SOE measures donot treat entities in which the state ownership share is less than 100 perceni. but greater than 50 percent,as being state-owned. Further, the official estimates otïen do not track ultimate ownership, therebyignoring enterprises that are not registered as SOEs or state-controtled enterprises even when indirectstate ownership is present. (Emphasis added)

As presented before, lhe Chinese Government divides SOEs in two categories: fully SOEsand state-holding enterprise. Nevertheless, many statistics disregard the latter, providing onlya partial picture of Lhe issue, since several business structures, such as joint-ventures or share-holding corporations whose majority shares are owned by the Chinese government, publicbodies or other SOEs, are excluded from lhe official statistics.

In order to address a more accurate measurement and study of the Chinese SOE sector,observers have to resort to other sources than official ones. The Report of the IJCESRC'65makes reference to some estimates made by observers or intemational organizations, such asthe OECD, which take into consideration more comprehensive criteria. Those estimatesindicate a participation of between 27,9 and 50 percent of the SOE sector in Chinese grossdomestic product, with due consideration to Lhe fact that lhe remaining percentage does notnecessarily corresponds only to the private sector, but also to other forms of governmentownership much more difficult to trace.

4.1. State influence over the Economy

li appears to be a wide consensus that China took remarkable steps towards economicliberalization ten years after joining lhe WTO. The need to meet its several obligationsresulting from its accession scems to have motivated such an important shift. However, thisprocess is claimed to have been reversed in the last years, as the Chinese Oovernmentindicated that iii does not intend to give up direct command of large portions of the economy.

This important guidcline has led to lhe retention of control over a large number of SOEs andto lis strengthening by means of Lhe use of subsidies and other policies to create dominantdornestic and global competitors, as reported by Lhe (3.5.-China Economic and SecurityReview Commission 166 . As reported by Lhe WTO Secretariat through the TPR of China '6SOEs have been retreating from some of the more competitive industries, concentrating itsactivities in other industries with a state monopoly, which are related to national security andoverali economic development, according to lhe Chinese authorities.

With those purposes, in December 2006, lhe State Council issued the Cuiding Opinions onPromoting Lhe Adjustment o! State-owned Assets and Lhe Restructuring of State-ownedEnterprises (Guiding Opinions). Aiming particularly the Iargest Chinese SOEs, according to

"SZAMOSSZEGI, Andrew: KYLE. Cole, "An Analysis of State-Owned Enterprises and State Capitalism inChina." Washington. D.C.: Capital Trade. Inc. and UCESRC. 26 October 2011. p. II.165 UCESRC, 2011 Report to Congress. Washington, D.C.: 112 Congress, I' Session, November 2011, p. 40.1661b1d., p41.67

WTO, Trade Policy Review Body, China - Report by the Secretariat, 26 April 2010. p. 54.108

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the 2011 Report to Congress On China 's WTO Compliance (Report to the US Congress) suchmeasure calis on SASAC to

enhance the state-owned econoniy's controtling power", "prevent the Ioss of state-owned assets,"encourage "state-owned capital to concentrate in major industries and key fieids relating to nationalsecurity and national economie lifelines" and "accelerate the forniation of a batch ol' predominamenterprises with independent intel!ectuat property rights, famous brands, and sirong internationalcompetitiveness.'68

The economic global crisis of 2008 seems to have intensified such policy and the Law onState-owned Asseis o! Enterprises, which becanie effective in May 2009, provided lhe legalmeans of putting lhe governmental guidelines in practic. Some strategic industries, in whichthe state must hold control by means of SOEs, and five heavyweight industries, in which thestate must remain heavily involved, are identified by the Chinese government. The chartbelow shows the elected sectors:

Industries that the Chinese Cosrernment Has iclent.ifled. as "Sirategie"and "Heavyweight"

Strategic Industries:1)Arrnaments2) Power Generation and Distribution31 011 and Petrochernicais4) Telccornrnunications5) Coai6) Civil Avíation7)Shipping

Source: Report of the UCESRC

As stated by SASAC's chairman Li Rongrong. State capital mustplay a leading role in thesesectors, whích are the vital arteries of the national economy and essential to nationalsecurliy' 70. Important consequences derive from such governmental decision, as foreigncompanies are not permitted to engage in lhe sectors reserved for strategic industries. Besides,foreigners are submitted to very strict regulations iii those sectors designated as heavyweightindustries, confining competítion and creatíng state-controlled markets.

Inward foreign direct investment fiows are often contingent on de facto transfer oftechnology, given that in some sectors foreign investors are not allowed to have a controllingshare in enterprises. This issue is demonstrated by the Report to the US Congress, thatmentions lhe case of the iron and steel sector, which is classified as a heavyweight industry'71.It is important to note that this kind of requirement is in conflict with lhe commitrnent inChina's accession agreement not to condition investment on the transfer of technology.

Finaily, lhe control by the state has relevant consequences regarding corporate governance ofsuch SOEs and appears to be inconsistent with the liberalization commitments reported by LheRWP. The power to decide the composition of lhe corporate boards and SOEs' management

' 68 USTR. 2011 Report to Congress 011 China 's WTO Cornpliance. Washington D.C.. December 2011, p. 61.Available at: chtt://www.ustr.govIwebfm send/3189>. Viewed at: 23 January 2012.69 UCESRC. 2011 Report to Congress. Washington. D.C.: 112 Congres, 1 Session, November 2011, p.48.

170 HUANXIN. Zhao, "China names key industries for absolute state control." China Daily. 19 December2006.Available at: <htty://www.chinadail y .comcn/chinaJ2006-12/19/content 762056.htm'. Viewed at: 18December 2011,' 71 IJSTR. 2011 Report to Congress on China 's WTO Corapliance, Washington DC., December 2011, p. 72.Avaitable at: chttp://www.ustr.gov/webfm send/3 89>. Viewed at: 23 Jantiary 2012.

109

Ileavvweight Industries:1.) M ahi nery2) Autornobites3) Inknnation Technologv4) Construction5) Iran. Steel. and Nonferrous Metais

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teams are not part of the modernization China is expected to accomplish as a result of itsWTO comrnitments.

4.2. Governmental support and competitiveness

One of the most controversial aspects for observers of the activities of Chinese SOEs is thegreat levei of governmental support which is provided by the state, either by subsidization,more favorable regulatory treatment or other forms of disruptive practices. This situationleads to a distorted competition environment and is potentially harmful for foreign enterprisesand domestic private companies.

A!though the Chinese Government alieges that it has always supported Lhe development ofenterprises of ali ownership structures equally, the WTO Secretariat has already reported thissituation, which has been intensified after the 2008 global crisis which motivated a stimuluspackage by the Chinese government:

However. SOEs have been benefiting disproportionately from the Government's recent measures to boostthe economy, particularly the economie stimulus. At the sarne time, dornestic private enterprises arefinding it more difficult to access credits from banks. ( ... ) (Ernphasis added)

When discussing Chinese subsidization, a preliminary rnatter arises from the lack oftransparency of such governmental practices iii China. Article 25 of the SCM provides for theobligation of notifying subsidies granted or maintained within the territory of each member,so as the WTO can evaluate the trade effects of such measure. Nevertheless, since itsaccession to the WTO in 2001, China has done se only once and the list presented by Beijingwas judged by Chinese trade partners to be incomplete.

Inadequate transparency in several areas places an excessive burden on other WTO membersseeking to better understand China's trade policy measures A great evidence of howproblematic has been the Chinese notification of subsidies was the notification submitted bythe Office of the United States Trade Representative identifying approximately two hundredsubsidy programs, which China failed to notify'72.

The list provided by the US indicates that China favors the state-owned sector with a varietyof direct and indirect subsidies. In addition to that, although China notified several subsidiesthat appear to be prohibited, it did so without making any commitrnent to withdraw them, andir failed to notify other subsidies that appear to be prohibited, according to the Report to theUS Congress'73.

An example of the more favorable treatment granted to SOEs is expressed by the fact that, in2009, 85 percent of Lhe total amount of bank loans in China (9,59 trillion yuan or 1,4 trillionArnerican doliars) has been assi.gned to SOEs. Most of those loans were granted by state-owned banks, which are China's largest banks, confirming that SOEs benefits from the doserelation with the governrnent. On the other hand, private companies, which absorb nearly 85

172United States details China and India subsid y prorarns in submission to WTO, Press Release. WashingtonD.C.: USTR, October 2011. Available aI: <http://www.ustr.gov/about-us/press-offlce/press-releases/201 l/october/united-states-details-china-and-india-subsidy-prol>. Viewed aI: 19 December 2011.173USTR, 2011 Report to Congress on China 's VYTO Coinpliance, Washington D.C., December 2011, p. 44.Available at: chttp://www.ustr.gov/webfm sendf3 189>. Viewecl aI: 23 January 2012-

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China outward foreign direct investments

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The Unctad has recently reported that state-owned transnational companies are aii importantemerging source of FDI and, although they represent less than 1 percent of transnationalcompanies worldwide, they represented about 11 percent of global foreign direct ínvestmentin 2010179. In the context o!' energy, raw materiais and metais sectors, Chinese SOEs played amajor role in the "going out" strategy. As stated above, a study by the Rhodium Groupconcluded that betweeri 2003 and 2010, in terms of total deal value, SOEs account for 65percent of lhe total, demonstrating the great influence of state initiative in relation to outwardforeign investments.

Besides having signiflcant government direct or indirect support, SOEs are also claimed to beadvantaged when getting governmental approval to invest abroad, in relation to Chineseprivate companies O The table below shows the remarkable participation o!' only fourChinese SOEs in total outward foreign direct investments, approximately 52 percent:

' 78Unctad. World !nvestnzent Report 2011: Non-Equlty niodes of internationaiproduction and development, NeYork and Ceneva, 2011, p. 9.' 79fbid..p. 1.' 80USTR, 2011 Report to Congress o,; China 's WTO C'ompliance. Washington D.C., December 2011, p. 59.Available at: <httn://www.ustr.gov/webfni send/3189>. Vicwed at: 23January 2012.

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Participation of only four Chinese SOEs

Entity Global Iuvestment (U.S.$ biIlion

CNPC *34.48

Sinopet 32.21

China lnvestrnent Corporation tCIC) 25.67

Chinako (Alaminum. Corporation oíChi•na) 20-62

Subtotal [12.98

Chinese total Ff1 since 2005 5215.9rce: Revort of the UCESRC'8'

The ownership and governance of state-owned transnational companies generate multipieconcems in host countries regardin, among others, the levei playing fieid and nationaisecurity, as reported by the Uncta& 8 . As discussed above, the Chinese Government electedstrategic sectors where SOEs shall prevail and be administered according to governmentalpurposes. It is widely known that Chinese Government guides outward foreign directinvestment imo those sectors it intends to see grow and develop. Due to the dose ties betweenthe Chinese Government and Chinese SOEs, acquisitions of firms with sensitive technology,inteliectual property or in sectors reiated to natural resources a major source of concern, in theoutward foreign investments context.

When operating abroad, Chinese SOEs also pose a great competitive chalienge for the hostcountry's dornestic enteTrises. The United States-China 2010 Business Council MemberPriorities Survey Resuits' named competition with SOEs as one of the top three concerns forits members.

However, these issues suggest a chalienge for host countries, which shall seek regulatoryways and diplomatic understandings with the Chinese Government so as to direct investmentsflows with a more constructive approach for both sides. It is important to remark that in areaswhere there are no national security considerations, Chinese FDI has the potential to createjobs and enhance economic growth of the host country, reason why this matter shall inspireglobal leaders towards negotiation and conciliation.

4.4. Government procurement

As discussed above, upon its accession to the WTO, China committed itself to becoming amember of the GPA as soon as possibie, but it is so far an observer of the agreement. Thissituation also tends to favor Chinese SOEs because China's Government Procurenient Lawdirects central and sub-central government entities to give priority to "local" goods andservices, with iimited exceptions, as China is permitted to do, because it is not yet a party tothe GPA'84.

' 81 USTR, 2011 Report to Congress on Chinas WTO Compliance, Washington D.C., December 2011, p. 58.Available at: <http://www.ustr.ovJwebfm send/3 189>. Viewed at: 23 January 2012.' t2Unctad, World Investmenr Report 2011: Non-Equity modes of international production and development, NewYork and Geneva. 2011. p. 1.83 USCBC, USCI3C 2010 Meniber Priorities Survey Resu/ts, Washington D.C.: USCBC, 2010, p. 2.

184USTR. 2011 Report to Congress on China 's w'ro Conipliance, Washington DC., December 2011, p. 65.Available at: chttp://www.ustr.gov/webfm send/3 189>. Viewed aL: 23 January 2012-

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Thus, to a certain extent, SOEs' procurements market can be lawfully reserved to Chinesedomestic producers. Likewise, those measures provide Chinese Oovernment with a hugepolicy space. 50 that SOEs and other public entities in China can act as important tools forindustrial policy purposes.

With this purpose, the Chinese Government issued catalogues aiming aL qualifying"indigenous innovation products". A second measure adopted by China was the issuance ofthe Administrative Measures for Governnient Procurement of Imported Products, whichimposes several restrictions for government procurement of imported foreign products andtechnologies. In addition, China inc!uded "Buy China" polices in its stimulus projects in2009. 185

This kind of measures runs counter to the liberalization path expected of a WTO memberseeking to accede to the OPA.

5. Conclusions

The Chinese liberalization reforms have progressed, mainly after its WTO accession. TheWTO membership implied several coinmitments which motivated, for example, importantlegal and regulatory reforms, remarkable tariff reductions and special safeguard mechanismsto protect other members' domestic industries against surges of imports from China.

In other arcas, China appears to have made little progress and the frequently debated low leveiof compliance in those arcas has been raising WTO members' concerns. Governmentalintervention in the economy, by means of direct or indirect subsidization of SOEs, distortiveguidance of inward and outward foreign direct investment are some of the top listed criticalaspects of China's WTO compliance.

The Jack of transparency about Chinese firms', mainly SOEs', relation with the centralgovemment, regarding financial support or decision making and corporate governance, is amajor problem. Considering Lhe huge Chinese SOEs' economic power in both national andglobal levei, ir is reasonable to assume that any Chinese nade distortive practices or publicpolicies may have enormous impacts worldwide.

The discussion about the problematic role played by Chinese SOEs is closely related to thetransition from a NME to a market-oriented one, which is a necessary step when gettingengaged in an organization deeply compromised with international trade liberalization.Moreover, its members have negotiated rules precisely designed for market economies andChina needs to demonstrate it is willing to play by the rules it accepted when it acceded to theWTO.

' 851b1d., p. 66.

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IV. WTO AND CHINA: THE ISSUE OF NON-MARKET ECONOMIES

China has acceded to the WTO in 2001,. after 15 years of intense negotiations. AlthoughChina has greatly benefited from iL, Lhe presence of such a big NME has brought up Lensionsand uncertainty to the Multilateral Trading Systeni.

During the second haif of the 20th century, it was a common perception that the GATTsystem, along with the OECD, was Lhe club of market economies in contrast to Lhe Councilfor Mutual Economic Assistance - Comecom - that would be the club of sociaiist-plannedeconomies t86 . In this sense, its rules, tailored for market-economies, have riot envisageddealing with the different aspects of planned-economies, or NMEs.

The issue of NME in the Multilateral Trading System is noL a new one. Ir has been presentsince Lhe negotiations of Lhe United NaLions Conference on Trade and Employment, inHavana, which were organized to create the InternaLional Trade OrganizaLion (ITO). TheHavana Charter had provisions aimed aL making Lhe necessary legal adjustments to enable fairtrade between market and non-markeL economies alike. As Lhe ITO was never created, Lheonly article present in Lhe remaining GATT to deal wiLh NME was its Articie XVII, on sLaLe-trading enterprises.

Nevertheless, throughouL the hisLory of GATT development, and especially after Lhe creaLionof the WTO, Lhe accession and presence of NME countries in Lhe Multilateral Trading Systemhas heen constam. The systemic response to the chailenges brought by the conLrast beLweenLhe lack of specific rules to deal with NMEs and their economic singularities has variedgreatly from Lhe GATT to Lhe WTO eras. The accession of China, a hybrid economy wiLhNME features, to the WTO has broughL new iighL to Lhe issue, increasing Lhe stakes of acoherent integration of NME feaLures imo Lhe Multilateral System.

This section will discuss Lhe systemic chalienges of integrating NMEs in Lhe WTO. IL willanalyze how Lhe Multilateral Trading SysLem has dealt differently with the issue during theGATT and during Lhe WTO era. IL will then discuss Lhe impacts of a NME on the principiesand rules of Lhe Multilateral Trading System and how Lhey mighL be affected. This analysis isimportauL to understand the meaning of the systemic changes imposed on China's economyupon accession to Lhe WTO. The economic measures present in China's Accession ProLocolhave, Lhus, a broader meaning and iLs fulfillment is indispensable for Lhe welI-funcLioning ofthe multilateral system.

Finaily, it will discuss the NME methodology for calculating normal price in antidumpinginvesLigations and whaL the legal consequences are for the 2016 deadline for thismeLhodology.

FirsL of ali, however, Lhis secLion will iook imo the available definitions of NME ia Lhecontext of intemaLional Lrade and whether iL offers adequaLe criLeria for inLegraLing NMEs intothe multilateral Lrading system.

See, e.g., KASER. Michael. "Comecon and the new muttilateralisrn'. The World Today, Royal Institute ofInternational AtTairs, Vol. 28. No. 4, April, 1972

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IV.! DEFINITION OF MARKET AND NON-MARKET ECONOMIES

China joined the WTO in 2001 through the Protocol of Accession WTIL/432, in which Chinacommitted to a series of obligations that should theoretically Iead it imo a market economy.China's status of NME is also referred to in a few provisions of the Protocol, as, for example,in Article 15, where concerns are raised about the difficulties arisen from the absence ofmarket economy conditions for the determinatiort of dumping and subsidies. Nevertheless,there is no definition, under the Protocol, of the expression "non market ecoriomy". Theprovisions of Article 15 only presume that China is a NME, but give no further ciarificationon the expression, leaving the matter to members' domestic legislations.

China's Accession Working Party Report, when referring to Articte 15 of the ChineseAccession Protocol, states that:

Several members of the Working Party noted that China was continuing the process of transitiontowards a fui] market econorny. Those members noted that under those circumstances, in the case ofimports of Chinese origin imo a WTO Member, special difflculties could exist in determining cosi andprice comparabiiity in che context of anti-dumping investigations and countervailing dutyinvestigations'87.

The Working Party thus evidenced some NMEs' effects mi the WTO system, especiaily onthe proper functioning of its mechanisms, but did not give a definition of what precisely isdeemed to be a NME or a "fuli market economy". In this context, one can raise the questiori:what is a market economy and how to define it?

Although the main concem with the concept of NME focuses on dumping investigations, asshown by China's Protocoi of Accession, such definition is crucial to shed some iight on otherNME chalienges to the mies of the Multilateral Trading System, and to fully understand theparticipation of China, as well as that of other NMEs in the WTO.

1. International defmitions

There are a diversity of economic parameters and subtie gradations between a centrallyplanned and a market economy. Hence, the difficulty of legaily defining a market economy(or a NME). Apart from the United Nations Conference on Trade and Development (Unctad),a legaily detailed description has still not been produced among influent internationaiorganizations, though there are punctual official statements that, together, form an officialstructure of what is needed for a country to be considered as a market economy.

Unctad

Unctad defines 188 market economy as "a nationai economy of a country that refles heavilyupon market forces to determine leveis ofproduction, consumption, investment and savingswíthoutgovernment intervention

Likewise, Unctad's definition of a NME is as follows:

A national economy in which the government seeks to determine econoinic activity largely

'v WTO. Report oíthe Working Party on me Accessior; o! china, WT1ACc/GHN149. October 2001. para. 15088 tinctad's Glossary of Customs Terms, available at

http:J/www.asycuclaorg/cuglossa,asp?tcrm=inarket+ccononiv. Last viewed on 3 1 st January 2012.116

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through a mechanism of central planning, as in lhe former Soviet lJnion, in contrast to amarket economy which depends heavily upon market forces to aliocate productive resources.In a "non-niarket' economy, production targets, prices, costs, investrnent allocations, rawmateriais, labour, internationai trade and most other econoniic aggregates are manipulatedwithin a national economic pian drawn up by a central planning authority; hence, the publicsector makes the major decisions affecting demand and supply within lhe national economy.

WTO

The Multilateral Trading System's first discussion on the subject happened during lhe ReviewSession of General Agreernent on Tariffs and Trade (GATT 1947), on 1954-1955. Article VI,which contains dispositions on subsidies and dumping rnatters, was arnended through lhesecond Supplementary Provision to paragraph 1 (Ad Note):

Ad Article VI

Paragraph 1

2. Ir is recognized that. in lhe case of irnports from a country which has a complete orsubstantiaily complete monopoly of its trade and where ali domestie prices are flxed bythe State, special difficulties may exist ia determining price comparability for the purposes ofparagraph i ( ... ).(Emphasis added)

Point 2 of the Ad Note refers to lhe determination of price comparability between market andcentrally planned economies. But is it a WTO definition of a NME? Evidence in that sensecan be found in the reference to lhe Ad Note present in Article 15 of Lhe Tokyo RoundSubsidies Code, paragraph 1, which states:

Article 15

Speciai situations

1. In cases of alleged injury caused by imports from a country described in Notes andSupplementary Frovisions to Lhe General Agreement (Annex 1, Articie VI, paragraph 1,point 2) Lhe importing signatory may base its procedures and measures either: (...) (Emphasisadded)

Through that indirect reference to lhe Ad Note, the Panei on IJS — Antidurnping andCountervailing Duties (WT/DS1379). paragraph 14.119 declared that:

(T)he predecessor to lhe SCM Agreement - lhe Tokyo Round Subsidies Code - contained a provisionthat expiicitly addressed the concurrent use of NME [non-market economies] methodologies inanti-dumping investigations, and of countervailing duties, in respect of imports from NMEs. Whereimports from non-market economies were at issue, Article is of that Code imposed upon lheimporting Member a choice between the use of anti-dumping measures or of countervailing duties.(Emphasis added)

The presurnption that Lhe inferred Article deals with imports from NMEs can also be found inParagraph 578 of the Appellate Body's decision on the sarne case, which states that:

Article IS of lhe Tokyo Round Subsidies Code imposed upon an importing signatory a choicebetween the use of anti-dumping duties and the use of countervailing duties against importsfrom NMEs' 89 . (Emphasis added)

189 WTO, US - Antiduniping and Countervailing Duties, Apelate Body Report, WTIDS/379, II March 2011,para. 14.1 19.

117

The reference to the Ad Note in lhe heading of Paragraph 1 is explicit, and therefore it seemsreasonable to infer that lhe definition of lhe Ad Note is, for lhe Dispute Settlement Body(DSB), a definition of a NME. This interpretation is confirmed by lhe Appellate Body in lhecase EC — Fasteners, in a footnote to its decision:

We observe that the second Ad Note to Article VI:! refers to a "country which has a complete orsubstantially complete monopoly of its trade" and "where ali domestic prices are fixed by lhe Stat&'.This appears to describe a certain type of NME, where thc State monopolizes trade and sets alidomestic prices' 90 . (Emphasis added).

However, lhe Appellate Body continues:

The second Ad Note to Article VI:1 would thus not on its face be applicable to lesser fornisof NMEs that do not fuiflil both conditions, that is, lhe complete or substantially completemonopoly of trade and the fixing of ali prices by Lhe State' 91 . (Emphasis added)

This leads to Lhe interpretation that, although lhe Ad Note provides a definition of a NME, itdoes not cover lhe whole meaning of Lhe expression. As lhe Appellate Body stated, there areolher forms of NMEs bes ides a country which has a complete or substantíally completemonopoly of lis trade and where ali domestic prices are !lxed by lhe State. Even though LheAd Note may not be applicable to such other forms of NMEs, they could be recognized as so.

The matter of NME was also addressed in the Agreement on Subsidies and CountervailingMeasures (SCM). Article 29, Paragraphs 1, 2 and 3, approaches lhe rnarket economy issuewhile dealing with time-frame extensions for countries in transition to market economies:

Article 29: Transformation imo a Market Economy

29.1 Members in Lhe process of transformation from a centrally-planned into a market,free-enterprise economy, may apply programmes and measures necessary for such atransformation.

291 For such Members, subsidy programmes falling within the scope of Article 3, and notifiedaccording to Paragraph 3, shall be phased out or brought imo conformity with Article 3 within aperiod of seven years from lhe date of entry imo force of the WTO Agreement. In such a case,Article 4 shail not apply. ( ... )

29.3 Subsidy progranimes falling within lhe scope of Article 3 shall be notified to Lhe Conimitteeby lhe earliest practicable date after the date of entry imo force o! the WTO Agreement. Furthernotifications of such subsidies may be made up to two years afler the date ofentry imo force o!the WTO Agreement. (Eniphasis added)

Article 29.3 determines that countries considered to be in lhe proeess of transformation from acentrally-planned imo a market-oriented economy (Article 29.1) shall notify lhe Committeeon Subsidies and Countervailing measures of subsidies to which Article 3 of lhe SCMAgreement would apply. The lack of a legal definition enables Lhe WTO and its members todecide politically on Lhe matter to some extent. Notifications under Article 29.3 of lhe SCMAgrcement were submitted by countries that were transitioning to a market economy, such as1-lungary (1995), Poland (1996) and Romania (1996)192193.

9° WTO EC - Definitive Anu-Dumping Measures on Certain Iron or Steel Fasteners froin China (13S397).WT/DS397/AB/R, Appellate Body Report adopted on 15 July 2011, para. 285, footnote 460.

Ibid.192 14UNGARY/WTO, Notifications under Article 29.3 of the Agreenient on Subsidies and CountervaüingMeasures, G/SCM1N19/HUN, 22 November 1995; POLAND/WTO, Notifications under Article 29.3 o! theAgreernent on Subsidies and Countervai/ing Measures, GÍSCMIN19/POL. 23 February 1996; ROMANIA/WTO,

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The Agreement ori Trade Related Inteilectual Property Measures (TRIPS) also handies lhemarket economy or NME condition in order to mie over measures that may arise from lhetransitional situation:

Article 65

Transitional Arrarigements

1. Subject to lhe provisions aí Paragraphs 2,3 and 4, no Member shall be obliged to apply theprovisions of this Agreement before lhe expiry of a general period of one year foliowing the dateof entry imo force of Lhe WTO Agreement.

2. A developing country Member is entitled to delay for a further period of four years Lhe date ofappiication, as defined in paragraph 1, of the provisions of this Agreement other than Articles 3,4 and 5.

3. Any other Mernber which is ia lhe proccss of transformation from a centrally-planned intoa market, free-enterprise cconomy and which is undertaking structural reform of ltsintellectual property system and facing special problems in the preparation and implementationof inteliectual property laws and regulations, may also benefit from a period oU delay asforeseen in paragraph 2. (Emphasis added)

However, one can affirm that those Articies are no ionger valid in view of lhe fact that thesetransitory provisions have aiready expired. it is comrnon practice in lhe accession of newmembers to lhe WTO that their Accession Protocois wiflI inciude a provision stating that anyobligation in lhe Multilateral Trade Agreements annexed to lhe WTO Agreement that wouldbe impiemented over a period of time starting with the 'entry of force of that Agreement'should be impiemented as if lhe new member had accepted such Agreement on lhe date of itsentry into force. This has been lhe case of China 194 and other recently acceded members. Inany case, it is expected that by lhe time new members acquires fuil membership, they havealready adjusted ia accordance with most WTO provisions. lu other words, the new membersrnust observe lhe mies frorn lhe date of their WTO accession.

The Anti-Dumping Agreement (ADA) is more cautious. In its Article 2.2, there is a vagueconcept that is not further explored:

2. Deterniinalion of IDumping

2.1 For the purpose of this Agreement, a product is w be considered as being dumped, i.e.introduced mio lhe commerce of anolher country at Iess than its normal value, if Lhe exportprice of the product exporled from one country to another is less lhan lhe comparable price, inthe ordinary course aí brade, for the like produel when deslined for consumption in theexporting country.

2.2 When there are no saies af lhe like product in the ordinary course of trade in lhe domestic

Notifications under Article 29.3 o! me Agreement on Subsidies and Countervailing Measures,G/SCMIN19/ROM. 31 October 1996, respectively.193 Olher countries also submitted notifications under Article 29.3 of Lhe 5CM Agreement. However. lhosenotifications referred to lhe fact lhat either they had no subsidies programs under lhe scope of this article or thalLhe Articie 29.3 was not applicable la ihem. Those counlries are: Czech Repubiic (GISCMINI9ICZE. 24 July1995), Jordan (O/SCMÍNI9IJOR. 12 July 2000), Oman (G/SCMJN/9/OMN, IS January 2001), and Saudi Arabia(G/SCM!N/9/SAU, 12 Ocbober 2006).' WTO. Protocol o! Accession of People s Republic o! China to the World Trade Organization, WTÍL/432, 23November 2001, Article 3, p. 2. See also, inter alia. WTO. Protocol otAccession o! Socialist Repvblic o! VierNam to 11w World Trade Organization, WT/L/662. IS November 2006, Article 3. p. 2; WTO, Protocol o!Accession o! Ecuador to the World Trade Organization. WT/ACCIECIJ/6, 22 Augusl 1995. Article 3, p. 2

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rnarket of Lhe exporting country or when, because of the particular market situation or lhelow volume of lhe saies ia Lhe domestic market of lhe exporting country, such saies do notpermit a proper comparison, Lhe margin of dumping shall be determined by comparison with acomparable price of lhe like product when exported to an appropriate third country, providedthat this price is representative, or with the cost of production ia lhe country of origin plus areasonable amount for administrative, selling and general costs and for protits. (Emphasisadded)

Paragraph 2.7 of the sarne Article asserts that its provisions are without prejudice to thesecond Supplementary Provision to paragraph 1 o! Article VI iri Annex 1 to GATI' 1994.These specific clauses were never discussed in the DSB with a view to determine theirrelationship, and there is, up until now, no clear definition as to what a particular rnarketsituation is, although it seems to have a rnuch wider meaning than a NME, since such amarket situation can also prevail in a specific sector of a market economy, e.g. a naturalmonopoly.

The Agreement on Agriculture in its preambie only points out to a rnarket-orientedagricultural trading system:

Recalling thaL their Iong-term objective as agreed at lhe Mid-Term Review of lhe UruguayRound "is to establish a fair and market-oriented agricultural trading system and that a reformprocess shotild be iniLiated through lhe negotiation of commitments on support and protectionand Lhrough Lhe establishment of strengthened and more operationally efíective GATI' roles anddisciplines". (Emphasis added)

Ali other agreements of lhe IJruguay Round are silent on lhe rnatter.

World Hank

Like other international organizations, lhe World Bank has not explicitly defined what amarket econom.y is. However, in lis reports and studies, especially on countries in transition tomarket economies during the 1990s, sorne standards were defined. Those reports provide anoverview of lhe economy and discuss policy reforms and institutional changes deernednecessary for achieving a quick transition from a centrally planned to a rnarket economy, aftersorne members have appiied for membership.

Czechoslovakia had reapplied mernbership in 1991 and requested lhe World Bank and IMF'sassistance into changing to a market economy. On the country report cal!ed Transition to aMarket Economy, from 1991, lhe World Bank rnakes lhe following staternents:

A market economy requires a modero banking system with a clear division of labour between lheCentral Bank in charge of monetary ?olicY and bank supervision on Lhe one hand, and lhecommercial banking sector on lhe other °.

The state must play an active role to promote competition and avoid monopolies. Theimplenientation of anti-trusL legistation and regulaLions are the most obvious requirements, butnot lhe only ones. Thus. Lhe sLaLe also needs to avoid controis and regulations that may be used tostrengthen inonopoly powers (for example, controis on lhe establishment or expansion ofeconomic activities notclearlyjustitied by necessary zoning, health and safety considerations; orthe aliocation of import licenses for essential-inpuLs to a favoured group of producers). There

195 World Bank. "Czechoslovakia: TransiLion to a Market Economy", The World Bank Courztry Studies,Washington, 1991, p. xx.

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may also be a need for a positive program to encotirage new entrants in to particular activitiest96.

The World Bank also points at price controls as a relevant issue when assessing lhe properfunetioning of a market economy. Such controls are admitted only in extraordinarycircumstances:

( ... ) (A) market econorny cannot function properly without competition and lhe freedom to setprices and that, eventually, price controis will remain for onty few activities, such as naturalmonopolies like water, electricity, and gas, and social services like health care. as in otlicr marketeconomíes'97.

2. National definitions

Complementing Lhe internatiortal provisions on market economy or NME, some countrieshave more speciflc legal definitions and procedures whieh often become reference to othercountries' domestic legal system.

United States

The United States (liS) legal system is based on common law, and some acts are eompiledunder lhe US Code (USC). lis Tome 19 treats Customs Duties issues and regulations anddefines what a NME is under lhe Section 771(18) of lhe Tariff Aet of 1930 and, as amended,under 19 USC § 1677(18)198:

(18) Nonmarket econoniy country (A) In general

The term "nonmarket economy country" means any foreign country that the administeringauthority determines does not operate ou market principies of cost or pricing structures, sothat saies of merchandise in suei country do not reflect the fair value of the merchandise.(Empbasis added)

(8) Factors to be consideredIn making determinations under subparagraph (A) Lhe administering authority shali take imoaccount-

(i) lhe extent to which lhe currency of lhe foreign country is convertible imo lhe currency ofother countries;

(ii) lhe exteni to which wage rates in lhe foreign country are deterrnined by free bargainingbetween labour and rnanagement.

(iii) lhe extent to which joint ventures or other investments by firms of other foreign countriesare permitted in lhe foreign country,

(iv) Lhe extent of government ownership or control of lhe means of production,(v) Lhe extent of governmcnt control over lhe aliocation of resources and over lhe price and

output decisions of enterprises. and(vi) such other factors as lhe administering authority considers appropriate.

(C) Determination in effect(i) Any determination that a foreign country is a nonmarket economy country shall remain in

effect until revoked by lhe administering authority.(ii) The administering authority may make a determination under subparagraph (A) with

respect to any foreign country at any time.

'96 Ibid. p. 43.Ibid. p. 56The Titie 19 of Lhe US Code was consulted at September 9 as currently published by lhe US Government

and refiects lhe laws passed by Congress as of Feb. lst, 2010. Until this date no officiai changes were made bylhe Office of lhe Law Revision CounseL.

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If the Department of Commerce (DoC) has designated a country as a NME, this determinationremains in effect until revoked by lhe administering authority, pursuant to USC Section771(18)(c)(i). For lhe DoC to conduct a review of a country's NME status, the country'sgovernment must make a formal requcst for a review, or support a respondent's claim in anantidumping case, that the country has a market economy. After receiving a formal request,the DoC begins an analysis of lhe six factors outlined above to determine whether to treat lhecountry in question as a NME.

If a country has not been formally designated as a NME, it is presurned to be a marketeconomy. If an interested party alleges that the country is a NME and documents its allegationwith respect to each of lhe factors listed above, the DoC will initiate a formal inquiry todetermine whether the country should be treated as a NME or not.

Apart from that, lhe USC still carnes legislation from the Cold War period that refers to lhesubject. Also under the customs titie, there is the provision that, if a NME limits the freedomof eniigration in east-west trade, ir will be eligible to sanctions, such as not receiving the non-discrimination treatment for the duration of the limitation (12 U.S.0 §2432)'.

Even more sunpnisingly, lhe Titie 12 that regulates banks and banking bríngs. under 12 USC§635, the definition of what is a Marxist-Leninist country:

(B) Marxist-Leninist country defined.-

(1) In general—For purposes of this paragraph, the term "Marxist-Leninist country" meansany country that rnaintains a centraiiy pianned economy based on the principies ofMarxism-Leninism, or is economicaiiy and militarily dependeni on any other such country.

(ii) Specific countries deemed to be Marxist-LeninisL—Uniess otherwise determined by thePresident in accordance with subparagraph (C). the foliowing countries are deemed to beMarxist-Leninist countries for purposes of this paragraph:(1) Cambodian People's Republie.(II) Democratic People's Republie of Korea.(III)Democratic Republic of Afghanistan.(IV)Lao Peopies Democratie Republie.(V) People's Republic of China,(VI) Republic of Cuba.(VII)Socialist Federal Repubhc of Yugoslavia.(VIII)Socialist Republic of Vietnam.(IX)Tibet. (Emphasis added)

As for a market economy, there is an open-ended definition under 19 USC §2703a (d), whichcontains conditions for Haiti to receive economic aid:

(d) Eligibility requirements(1) In generalHaiti shafl be eiigible for preferential treatment undcr this section if the Presidem determinesdetermines andcertifies to Congress that Haiti:

(A) has estahlished, or is making continuai progress toward establishing:(i) a market-based economy that protects private property rights, incorporates an

' This disposition has been the source of much debate concerning lhe accession oU Russia to the WTO. For aslong as this Article remains applicable, the US wilil not be entitled to market access and non-discriminatorytreatment from Russia, neither Russia from the OS. The political process to modify this article is, however,delicate and has provoked ample politicai debate in the country. See CLINTON. Hillary, Trade With Russia Is aWin-Win, Wall Street Journal. 20June 2012. accessibie arhttp:/Ionline.wsj.çorn/article/SB i000l42405270230383640457747506i 208876588.htnil?rnod=goo g lenews wsj.last access in 25.06.2012.

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open rules-based trading system, and minimizes government interference in the economythrough measures such as price controis, subsidies, and government ownership ofeconomicassets;

(ii) the role of Iaw, potiticai pluraiism, and the right to doe process, a fair iria[, andequal protection under lhe Iaw;

(iii) lhe elimination of barriers to United States trade and investment, including by:(1) lhe provision of national treatment and measures Lo create an environment

conducive to doniestic and foreign investment;(II) lhe protection of inteliectual property; and(III) te resolution of bilateral trade and investment disputes; (Emphasis added)

Regarding lhe Russian Federation, lhe United States recognized Russia as a market economyon June 7. 2002200.

European Union

The European Community (EC) had defined market economy on lhe Council Regulation No384196 of 22 Decernber 1995 on protection against dumped imports from countries notmembers o! lhe European Community, in its Art. 7(c). Due to lhe paradigm change on NMEdiscussion caused by size of China's economy, the Council Regulation EC 1225/2009repealed that document and added new and more specific clauses 201 . About NMEs, its legaltext determines, on Article 7, that:

(b) In anti-dumping investigations concerning imports from lhe People's Republie of China.Vietnam and Kazakhstan and any non-market econorny country 202 which is a member of lheWTO ai lhe date of Lhe initiation of Lhe investigation, normal value shait be deterrnined inaccordance with paragraphs 1 to 6, if it is shown, on the basis of properly substantiated ciainis byone or more producers subject LO Lhe investigation and in accordance with Lhe criteria andprocedures ser OUL ia subparagraph (c). that market economy conditions prevait for this produceror producers in respecL of Lhe manufacture and saie of lhe like product concerned. When this isnoL the case. lhe roles set ouL under subparagraph (a) shait appty.(e) A claim under subparagraph (b) must be made in writing and contam sufficient evidence thatthe producer operates under market economy conditions, that is if:- decisions of ftrms regarding prices, costs and inpuLs, inciuding for insLance raw materiais. costof Lechnology and tabour, output, saies and investment, are made in response to market signaisretlecting supply and demand, and wiLhout significant State interference in this regard, and costsof major inputs substantiatiy retlecL market values,- firms have one clear sei ol' basic accounLing records which are independently audited in tinewith international accounting standards and are applied for ali purposes.- the production costs and financial situation of firms are not subject to significant distortionscarried over from lhe former non-market econotny sysLem, in particular in relation todepreciaLion of assets, other write-offs, barter Lrade and payment via compensation of debts,- lhe firms concerned are subject to bankruptcy and properLy iaws which guarantee legalcertainty and stability for Lhe operaLion ol' firms, and- excharige rate conversions are carried out aL lhe market rate. (Emphasis added)

200 As provided by Pub. L. 107-246, § 2, Oct. 23, 2002, 116 Stat. 1511201 This legisiation was subject to the WTO Dispute Settiement because of its Individual Treatment clause(WT/DS397), which provided for the possibility of applying a country-wide durnping margin and anLi-dumpingduties for companies from NME. This possibihty was considered contrary to lhe rules of the Anti-dumpingAgreemenL. See WTO, European Communities - Defiziitive Anti-Dumping Measures on C'ertain Jron or SteelFasteners froin China, Appeilate Body Report, WTIDS397/AB/R, 15 July 2011,275 p202 Including Albania, Armenia, Azerbaijari, Belarus, Georgia, North Korea, Kyrgyzstan, Motdova, Mongotia,Tajikistan, Turkmenistan and tizbekistan.

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The EC 1225/2009 also provides lhe procedure for the market economy status verificationwith respect to a specific sector:

A determination whether Lhe producer meeis lhe abovenientioned criteria shall be made withinthree months of the initiation of the investigation, after specific consultation of lhe AdvisoryCommittee and after lhe Community industry has been given an opportunity to comment. Thisdetermination shail remam in force throughout Lhe investigation.

The conditions to be fulfilled by countries acceding to lhe European Union (EU) shed somefurther iight on lhe matter. According to lhe Treaty on European Union, Article 49, anyEuropean State that desires to join lhe European Union shall be welcorne to do so as long as itrespects the European Union principies stated at Article 6 of lhe sarne treaty 203. Also, a broadanalysis of the institutionai and systemic reforms required for an acceding member to be abieto respect such principies wili be done by lhe EU.

In June 1993, during lhe European Council rneeting at Copenhagen, lhe conditions forcountries aiming to accede to lhe EU were further developed imo a series of criteria: theCopenhagen Criteria204 . These criteria list necessary attributes for a country to be able to joinlhe European Union and were so resumed by lhe European Cornmission:

- stable institutions that guarantee democracy, the rute of law, human rights and respect for andprotection of minorities;- a functioning market economy, as welt as lhe abitity to cope with Lhe pressure of competitionand lhe niarket forces a( work inside the Union;- lhe abitity to assume the obligations of membership, in particular adherence to lhe objectives ofpoliticat, economic and monetary union 05 . (Emphasis added)

Concerning lhe accession of forrner USSR members, a more specific descrtion relatingte acceding countries of Central and Eastern Europe to lhe EU was outlined 206.

ii) The European Council welcomed lhe courageous efforts undertaken by lhe associatedcountries to modernize Lheir economies, which have been weakened by 40 years of centralptanning, and to ensure a rapid transition to a market economy. The Conimunity and itsMember States ptedge their support to this reform process. Peace and security in Europe dependon the success of those efforts.

iii) The European Council today agreed that lhe associated countries in Central and EasternEurope that so desire shall become members of lhe European Union. Accession will take placeas soon as an associated cotintry is able to assume lhe obligations of membership by satisfyingthe economic and political conditions required.

Membership recjuires that the candidate country bus achieved stability of institutionsguaranteeing democracy, lhe rute of law, human rights and respect for and protection ofminorities, the existence of a functioning market economy as weti as the capacity to cope withcompetitive pressure and market forces within the Union. Membcrship presupposes Lhecandidates ability to take on the obligations of membership including adherence to Lhe aims ofpolitical, economic and monetary union. (Emphasis added)

203 These are lhe principies of tiberty, democracy, respect for human rights and fundamental freedoms, and lherule of taw. See EU. Treaty on Evropean lJnion, Maastricht, 7 February 1992, Articie 6.204 See EU, European Counci! Meeting, Copenhagen, 21-22 June 1993. D0C19313.205 As stated on httn://eceuropa.eu/cnlanzenlentithe-I)olicv/conditions-fbr-enlan!ementiindex en.htn1. iast accesson 25.06.2012.206 See EU, Eurnpean Council Meeting, Gopenhagen, 21-22 June 1993, D0C19313. point 7A,

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Hence, the EU regards as market economies ali its 27 members, including the former sociaiiststates, as expressly declared in their Protocois of Accession 207 . Similarly, lhe EU established aframework for EU negotiations with lhe Western Baikan countries (also comprising financingprograms): the Stabilization and Association Process 208, to be followed and updated until thecountries' eventual accession. The Process has tliree aims: (i) stabilizing the countries andencouraging their swift transition to a market economy, (ii) promoting regionalcooperation, and (iii) promoting eventual membership of lhe EU.

This kind of EU initiative demonstrates the weight it gives to the existence of a marketeconomy in order for a country to be part of the Union and for it to function properly. There isno single recipe, however, for which reforms are needed in order to achieve a functioningmarket economy as the EU will work with acceding members in a case-by-case manner,addressing each country's specific needs.

Australia

Austraiia's Customs Act also handies lhe NME issue. First created in 1901, its dispositionshave protected and regulated Australia's market ever since. In recent years, when somesectors faced difficulties to counter the flood of Chinese products, the Australian Parliamentfound the need to reform its 1901 Custom Act, Article 269TAC(4). This Article, which dealswith normal value of goods, had to be altered because it established methods for deterininingnormal value of goods in anti-dumping investigations involving command econornies onlywithin a very specific definition: lhe Government of the country of export had to have at Ieasta substantial monopoly of all o!the frade of the country - not just conceming the goods underinvestigation, and also had to substantially influence lhe domestic pn'ce of ali goods in thatcountry. The govemments of states in trans ition from a command economy to a marketeconomy may still control or greatly influence the domestic sefling prices of a significantnumber of sensitive products, but ir is unclear whether the extent of this control would faliwithin the scope of subsection 269TAC(4).

Because of that, lhe Australian Congress amended lhe law in order to include the transitioneconomy concept, through Customs Legislation Amendment Act (No. 1) 2003. These normsamended subsection 269TAC(1) to include a definition of economy in transition, presently atthe new subsection 269T(5C):

A country has an economy in transition ata time if:(a) before the time, Lhe Governrnent of the country had a monopoly, or a substantial nionopoly.of Lhe trade of that country and deterniined, or substantially influenced, the domestic price ofgoods in that country; and(b) ar the time, that Government does nor:

207 See EU. "Commission Opinion on Lhe applications for accession to the European Union by the Repubtic ofBulgaria and Romania (22 February 2005)," Qificia/Journal ofthe European Urjion, L1I57, 21 June 2005. pp.3-4; and European Union, European Commission, "Commission Opinion on the applications for accession to theEuropean Union by the Czech Republic, lhe Republic of Estonia. Lhe Republic of Cyprus, lhe Republic of Latvia,the Republie of Lithuania, the Republic of Hungary, Lhe Republie of Malta, the Republic of Poland. Lhe Republicof Siovenia and the Slovak Republic (19 February 2003)," Official Journai of ffie European Union, 23September 2003. pp. 3-4.208 Europeari Community Commission, Cominunication troa, tlie Cornrnission to [he Evropean Council andParliarnent, Brusseis, 26 May 1999, COM(1999)235. See also. European Council, C'onciusions ou 11wDeve Jopment of a Cornpre/iensive Policy Based on the Coininission Communication on "The Stabiiisadon andAssociation Process for Countries o! South-Eastern Europe, 2192" Council meeting, General Affairs,Luxemburg, 21-22 June 1999.

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(1) have a monopoly, ora substantial monopoly, of the trade of that country; or(ii) determine, or substantially influence, lhe domestic price of goods in that country.

In this sense, lhe countries which have economies in transition are those countries whichpreviously had centrally-planned economies and which are moving towards market- basedeconomies in which lhe price of goods is basically determined by supply and demand 209. The1901 Customs Act now contains, when normal value of goods cannot be determined, standingformulas for both NMEs and transition economies:

269 TAC Normal Vatue oí Goods(4) Subject to subsections (6) and (8), where lhe Minister is satisfied that it is inappropriate toascertain the normal value of goods in accordance with the preceding subsections because theGovernment of the country of export:

(a) has a monopoly, or substantial monopoly, of the trade of the country; and(b) determines or substantially influences the domestic price of goods in that country;

(...)(5D) The normal value of goods (the exported goods) is the amount deterniined by lhe Minister,having regard to ali relevant information, if lhe exported goods are expurted to Australia and lheMinister is satisfied that the country of export has an economy in transition and that at Ieastone of the following paragraphs applies:

(a) both of the foliowing conditions exist:(i) lhe exporter of the exported goods seus like goods in the country ofexport;(ii) market conditions do not prevail in that country in respect of lhe domestic sellingprice of those like goods;

(b) both of the foliowing conditions exist:(i) lhe exporter of the exported goods does not sell like goods ia lhe country of exporthut others do;(ii) market conditions do not prevail in that country in respect of lhe domestic sellingprice of those like goods; (Emphasis added)

In spite of the legislation on transition economies, Australia's Foreign Affairs Departmentrecognized China as a market economy in 2005, by the time lhe Free Trade Agreementbetween lhe two countries was concluded. The Memorandum of (Jnderstanding between lheDepartment of Foreign Affairs and Trade of Australia and the Ministry of Commerce of lhePeople's Republic of China on the recognition of China's fuil market economy statusestablisbes that:

Paragraph 2-

Recognising that Australia and China should negotiute on na equal basis, Australiaacknowledges China as un equal WTO trading partner by recognising China's fuli marketeconomy status by permanently not seeking recourse to Sections 15 and 16 of the ProtocolofAccession of the People's Republic of China to the WTO and Paragraph 242 ofthe WTOReport of the Working Party on the Accession of China. (Emphasis added)

Brazil

Brazil also has specific norms on lhe matter of determining NMEs in lhe context ofantidumping !egislation. The Decree 1.602. dated 23 August 1995, enacts administrativeprocedures of anti-dumping investigation and states:

Art.7 In finding difficu!ties in determining lhe normal value in case of imports from notpredominantly market oriented economies, where doniestic prices are mainly fixed by lhe state,lhe normal value can be determined using lhe actual amounts incurred and realized by lheexporter or producer in question or can be a constructed value of a like product in a third marketeconomy country, or lhe export price to other countries, exclusive Brazil, or, whenever that is not

209 See, Australia, Custorn.s Legislation Arnendment BiI/ (No. 2). 2002, Item 2, p. 6

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possible, lhe normal value can be based on any other reasonable method. inciuding Lhe price paidor price to pay by the similar product on Brazilian market, dully adjusted, if necessary, in orderto inciude a reasonable profit margin.

Circular N. 59, dated 28 November 2001, clarifies some provisions of lhe aforementionedDecree. Article 3.2 defines economies in transition:

3.2Considering the transformations undergone by severa[ countries with economies Lhat aretraditionally non-market orientated economies, which reached (he stage of economies in transitionhaving impiemented important measures with a view to removing state monopolies and the controland state intervention on domestic prices, lhe foliowing understanding wiii be adopted:

3.2.1 The foliowing countries are considered as economies in transition: Bulgaria, lhe SiovakRepublic, Siovenia, Hungary, Poland, Romania and fite Czech Republic.3.2.2 As regards the initiation of the investigation involving Lhe countries mentioned inparagraph 3.2.1, the provisions oí' Article 7 of Decree 1.602, of 1995, shall not appiy. However, ifduring the investigation it is verified that the market rules do not prevail in the sector where theproducerfexporter under investigation operates, the provisions of Article 7 may be applied for thecalcuiation of the normal value. (Emphasis added)

Although there are no longer any countries under transition economy status 210, 22 countries2'were Iisied as NMEs in lhe former Dumping Analysis Petition Form of lhe Ministry ofDevelopwent, Industry and Foreign Trade (MDIC). This form, however, has been replaccd bya newer form, as provided by Portaria N. 46/2011 of lhe Secretariat of Foreign Trade(SECEX) of MDIC. The new form does not list any country as a NME.

The Circular 59/2001's Article 3 also states:

3.3 For the assessment of the existence of market economy conditions, lhe foilowing elements,"inter alia". wili be observed:

(a) lhe degree of government controi over the companies or over the means ofproduction:

(b) lhe levei ol' state control over lhe ailocation of resources, over prices and over LheproducLion decisions by companies;

(c) lhe tegisiation to be appiied in terms of ownership, investment, taxation andbankruptcy:

(d) the degree of freedom ia Lhe determination of wages in negoLiations betweenemployers and employees:

(e) Lhe levei ai which distortions inherited from the centraiized economy system persistin relation to. inter alia. assets amortizaLion, other asseLs deductions. direct swap ofassets and payments in the forro debt compensation; and

(f) the levei of state interference on currency exchange operations. (Emphasis added)

This Article is open-ended and means that, among other things, a country is onl.y would berated as a market economy if it fulfils, to some extent, those six conditions. How lhe Chamberof Foreign Trade (CAMEX) and lhe Departmerit of 'Frade Defence (DECOM) of SECEXinterpret the above market economy criteria is also relevant to lhe present study.

During an antidumping investigation involving ímports of High Carbon Iron Chromium(Charge Chrome) from South Africa, Kazakhstan and Russia, in 1998, DECOM had toconsider the characteristics of lhe sector in each of this countries in order to determine normal

210 The countries present ai Circular N. 59 were later recognized as market economies by Circular N. 32, of loJune 2009, and by Circular N. 89, of IS December 2008.211 They were: Albania, Armenia, Azerbaijan, Beiorussia, Bosnia-Herzegovina, KazakhsLan, China, North Korea.Croatia, Cuba, Georgia, Serbia, Montenegro, Lithuania, Macedonia. Moidavia, Mongoiia. Kirgizstan, Tajikistan,Turkmenistan, Uzbekistan and Vier Nam

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value for price comparability purposes 212 . It is interesting to note that DECOM consideredSouth Africa to be, a priori, a rnarket economy, while asking for the investigated producersfrom Kazakhstan and Russia to provide evidence of the degree of State interference ia theirrespective sectors. Only the degree of State interference was considered and no previousanalysis on the overail characteristics of these economies was made in order to determine if,broadly, they were NMEs. In this sense, the investigations did not offer any further clue onDECOM's arguments to consider those mo particular economies as non-rnarket ones, sincethe burden of proof was allocated into the producers' side of the dispute. The producers didnot respond and the argument could not be developed.

More recently, CAMEX has limited its analysis during antidumping investigations toprovisions stating the temporary presumption of NME status of the concerned countries. Thishas been the case in CAMEX Resolution 08/2011 on definitive anti-durnping for glassproducts from Argentina, Tndonesia and China, where CAMEX stated that for cornrnerciaidefense purposes, China is not considered to be predominantly a ínarket CCOflOfflY (4'alluding to the presumption present in article 1.5 of China's Accession Protoco12 1 . Thedocuments available do not deepen the concept neither the pararneters used for such anassessrnent. In a superficial analysis of CAMEX's database from 2008 to 2011, otherResolutions follows the sarne pattern, such as Res. 1412010, Res. 20/2011, Res. 23/2010, Res.2412010, Res. 3712010, Res. 48/2010, Res. 74/2010, Res. 212009, Res. 3/2009, Res. 14/2009,Res. 1912009, Res. 33/2009, Res. 48/2009, Res. 49/2009, Res. 5312009, Res. 80/2009, Res.5112008, Res. 79/2008.

Ia any case, companies from NMEs countries may request market economy treatment fortheir specific rnarkets, for the purpose of dumping investigations. For exarnple, theXinanchem Company requested the rnarket econorny treatrnent for the sector underinvestigation of dumping, but could not substantiate its request and was convicted of durnpingpractices (CAMEX Res. 312009).

The NME treatment of China is under discussion in Brazil. In 2004, Brazil signed the"Mernorandum of linderstanding on Trade and Investment Cooperation Between the People'sRepublic of China and the Federative Republic of Brazil", recognizing China as a rnarketeconomy.

However, such declaration of market econorny recognition, to have effect on the dornesticlegal system, must bc intemalized, through an act of thc Executive Power, specificallythrough a Circular passed by SECEX of MDIC, as it happened in other instances (Russia,Uksaine, Siovakia, Slovenia, Estonia, Hungary, Latonia, Lithuania, Poland, Czech Republic,Bulgaria and Rornania). No Circular on China has been enacted yet, meaning that, for internaipurposes, China is still considered a NME.

3. Conclusions

The definition of a NME is irnprecise, especially when it attempts to cover multiple economicsituations in which a country requires international assistance or relies upon different degreesof government interfcrence ia its econorny. The case of transitional econornies is particularlydifficult to comprehend. During a transitional period in which the economy will neither becentrally planned nor a rnarket econorny, the Governrnent is required to intervene on behalf of

212 Sce, MD!C, Portaria lntcrniinisterial No. 19. dated 7 October 1998. point 4.1.3.213 WTO. ProtocolofAccession o! the Peopie 's Repuhiic o! China. WTIL/432, lO November 2001.

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the consumer, and anti-competitive behavior may arise from the possible distortions to themarket. To assist countries in that endeavor, assistance is granted in the form of specialconditions and periods extensions to fully abide by the WTO norms whi!e reforms take place.

From the WTO normative system and Accession Protocois, it can be inferred that the mainlegal provisions to deal with the presence of NMEs in Lhe WTO are related to thedetermination of normal value for dumping investigations, and Lhat the supporting treaties aredeliberately vague due to the difficulty of regulating such complex economic feature.

This explains why Um definitions of NMEs, both under the WTO and several nationallegislations can only be found in the limited context of durnping investigations. A morecomprehensive discussion over Um issue was seldom undertaken under the MultilateralSystem. Nevertheless, as it will be discussed below, NMEs' impact on the WTO system goeswell beyond antidumping rules.

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IV.2 NME AT THE MULTILATERAL TRADING SYSTEM

1. The GATT era

At the end of World War 2, nations aimed aL ereating an international economic frameworkwhich would regulate economic relations of ali countries, capitalists and socialists alike, inorder to avoid a repetition of the economic turmoil of the 1930s214. The so-called BrettonWoods system would have included, in addition to the hilernational Monetary Fund (IMF)and the World Bank, an Intemational Trade Organization (ITO).

The founding document for lhe ITO, the Havana Charter, drafted by the United NationsConference on Trade and Employment, contained provisions enabiing the participation ofNMEs in the projected trading system. Nevertheless, both because Lhe USSR, the mainsocialist economy at the time, decided not to participate in the negotiations and because of Lhestrengthening of the Coid War rivalry between the US and the USSR, these provisions onNMEs were graduaily weakened. In the GATT, initialiy seen as a provisional agreement tothe creation of the ITO, only one of those provisions deahng with NME subsisted: GATTArticle XVII, on staLe-trading enterprises (STEs).

The ITO never carne imo force and Lhe GATT was the main source of mul.tilateral traderegulation for aimost 50 years. The GATT did not concentraLe in finding ways to adaptsocialist economies to its framework, partly because of its provisional status and also becauseof the lack of interest of the USSR in the emerging Multilateral Trading System. ThLLS, theissue of NMEs was overiooked for some time.

Even the applicability of Article XVII to NMEs was questioned: Grzybowski affirms Lhatwhen Lhe Article binds state-trading enterprises to make transactions solely in accordancewith commercial considerations, it theoretical!y exciudes ornei' molivations, which seerns to

contradici lhe basic tenets of economic planning in a socialist country of lhe soviet typ e215.

The first difficulties of applying GATT rules to NMEs arose during the 1950s with thetransition of Czcchoslovakia, a GATT founding member, towards a centrally-plannedeconomy. One of the first issues brought up was the calculation of dumping margins and thedetermination of normal value216.

Czechosiovakia argued that the alternatives foreseen in GATI were not proper to calculateLhe normal value in centraily planned economies. The country affirmed thatno comparisor; ofexport prices with prices in lhe dornestic market o! 11w exporting country is possible when

such doinestic prices are not esta blished as a result ol'fair competition in that market, but are

214 Sce LOWENFELD, Andreas F., "'Lhe InternaLional Monetary System: A Look Back Over Seven Decades",Joui'nai ofhuernational Economic Law, vol. 13(3), pp. 575-59521$ ORZYBOWSKI, K., "Socialist Countries in OATT," lhe Amerícan Journal o! C'oinparative Law. v. 28, n. 4,Autumn, 1980, p548.216 In accordance with GArI' Article VI, durnping occurs when a product is exported to a country at a lowerprice than the sarne product is solcl ia the domestic market of the exporting country. In the absence of anacceptable domestic price to calculate the dumping margin, Lhe normal value of Lhe good could be derived from(1) the highest comparable price for the product for exporL to any Lhird counLry or (ii) the cost of production ofLhe product, plus a reasonabte addition for selling costs and profit.

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fixed by the State27. The main problem was that, since the prices inside the country werefixed, they could otEten be higher than export prices, which led to the determination ofdumping by other countries and consequent applicatiort of antidumping rights.

Czechoslovakia proposed, thus, an amendment to Article VI, by which lhe margins ofdumping should be calculated using the comparable price on the domestic market of Lheexporting country or, in lhe absence of such domestic price or when prices iri the domesticmarket were fixed by the State, (1) the "average comparable prce for the Jike procluct forexport by third countries tu the irnporting country iii question iii the ordinary course of trade"should be used, ou (ii) in the absence of such price, lhe average comparable price for the likeproduct for export by the exporting country to third countries, or (iii) the cost of productionplus a reasonable addition for sciling cost and profit2.

The GATI Contracting Parties did not accept the proposal, but agreed on adding anInterpretative Note on Article VI, affirming that in lhe case of imports from a country withcomplete or substantially complete nionopoly of trade and where domestic prices are fixed bythe State, special difficulties may exist in determining price comparability based on pricespracticed on the domestic market, and members may find that such strict comparison may notal1ways be appropriate219.

This Note, though acknowledging lhe lack of price comparability for products trem NMEs,did not provide any alternative methodology for determining normal value in antidumpinginvestigations involving such countries. Legally, GATT members had a large margin ofmaneuver when dealing with dumping from centrally planned econornies. Czechoslovakiarequested further stud, to achieve a more specific antidumping rule for NMEs, but lhe issueremained untouched22

In practice, however, the use of a third country, as proposed by Czechoslovakia, became thecommon alternative methodology and was later explicitly rneritioned at the Working Party onthe Accession of Potand.

The transition of Czechoslovakia (to a NME) also brought difficulties in the application ofother GATT rules, in particular with respect to balance of payment provisions iri ArticleXV:6. The provision deals with the membership of the contracting parties at the IntemationalMonetary Fund, stating that parties that fail to join the Fund shall enter into special exchangearrangements with the CONTRATING PARTIES. The Article aimed to avoid parties to adoptexchange rate policies incompatible with the rules of the multilateral financial system thatcould impact on international trade.

It is worth noting that the international monetary system established at Bretton Woods, basedon a dollar-gold standard and par values, relied upon the IMF maintaining a strict control over

217 GATT, Article VI - Proposais b,y ffie C'zechoslovakia Delegation - Revision, W.9186/Rev. 1, Review WorkingParty 11 on Tariffs, Schedules and Customs Administration, Contracting Parties Ninth Session, 21 December1954. W.9186IRev. 1218 Ibid.219 GATL Report o! Review Working Party III on Barrjers to Trade other than Restrictions or Tariffs,Contracting Party Ninth Session, U334, 1 Mareb 1955.220 GATT, Anti-Dumping and Countervailing Duties - Memoranda received from the Governrnents o!Czechoslovakia and Sweden. U943,26 Novernber, 1958.

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its members' exchange rale policies 221. In this sense, the members of the IMF were consideredto practice trade-neutrai exchange cate policies and Lhe GATT thus required its own membersto also participate ia lhe IMF.

Czechoslovakia claimed that a country with complete monopoly of foreign trade could changethe par value of its currency without affecting international commerciai transactions andwithout impairing any concessions made under Lhe GATT. Therefore, there was no need toapply lhe provisions under Articie XV:6 to centraliy planned economies. It proposed anamendment in the Article, with lhe inciusion of an exception of its application for thosecountries222 . The amendment was not accepted, but a waiver from lhe obhgations underGATT Articie XV:6 was accorded to Czechoslovakia 223 . This exemption was extended tosome other NMEs when they acceded to lhe GATT, as well as to Cuba, when it withdrewfrom lhe IMR.

The case of Czechoslovakia is relevant because it shows that its transition to a centrallyplanned economy was never regarded, neither by other contracting parties, nor by itself, asincompatible with its obligations in lhe Multilateral Trading System. Aithough lhe GATT wasgenerally seen as being based ou capitalist principies, aiming at market iiberalization, Lheparticipation of NMEs in such system was not thought to threaten its principies. The partiesconsidered lhe need to adjust some of lhe rules, in order to adapt to the particularities ofcentrally planned economies (as some ITO provisions had been drafted to accommodate lheparticipation of lhe USSR), but the core of the system would remam intact.

Uniike Czechoslovakia, lhe second NME acceding to Lhe GATT, Yugoslavia, was already acentrally planned economy 225 . In that case, GATT contracting parties formally requested fromYugoslavia some changes in its commercial policies, in order to make it able to participate inlhe GA1T.

In lhe accession of Yugoslavia, lhe compatibility of GATT rufes with the country's economywas analyzed. The Working Party examined:

( ... ) Lhe economic and íoreign trade system of Yugoslavia in Lhe light aí Lhe requirementsaí the provisions of Lhe General Agreement, particular attention was paid te Lhe institutionalset-Lip. Lhe nature oí lhe business enterprises. Lhe relationship between Lhe public authoritiesand these entities, the process af business decision-making, Lhe method of price forniation,the problem of lhe elimination of export subsidies, and. in general, Lhe extent to whichforeign products could enter and compete on the Yugoslav market.226

221 IMF members were ohligated to mainrain their currencies aL an established par-value to the doliar, not varyingmore than L% ftom it. This system collapsed in 1971 after the "Nixon Shock". when the U.S. declared that theywould no longer guarantee lhe convertibility aí US dollars to gold. See BOUOHTON. James M., The IMF andthe Force aí 1-listory: Ten Events and Ten Ideas That Have Shaped (he Institution, IMF Working PaperW1,104175. Policy Deve!opment and Review Department, IME, 2004-222 GATL Arnendinent to Article XV. 6 - Mernorandum oíthe Czecboslovak De/egation, W.9/142, ContractingParties Ninth Session. 14 January 1955.223 GATF, Waiver granted to Czechoslovakia of the provisions o! Article XV:6 Decision o! 5 Marc!; 1955,SR9145. Contracting Parties Ninth Session, IS March 1955.224 GA'rr, Article XV.-6 - Waivergrantedto Cuba. Decision oí7August 1964. L/2254, 14 August 1964.225 Although Yugoslavia had already been promoting some economic reforms that distanced itself from theSoviet model, it continued to be a NME aL lhe time of its accession.226 GATL Report o!the Working Party on lhe Accession o! Yugosla via, , LJ2562. 24 February 1966.

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The 1959 Decision on relations with Yugoslavia affirms that lhe go vernment o! Vugosla via isnot aI present in a posítion to assume ali lhe obligations involved in accession to lhe GeneralAgreemenr'27 . Parties agreed, thus, that Yugoslavia would endeavor, ID the development ofarrangements affecting lIs commerciai policies, to move progressively lo ward a position inwhich it can give fuil effect to lhe provisions o! lhe General Agreemen? 28 . Also, the WorkingParty on the Accession of Yugoslavia affirmed that in 1959, the Yugoslav Parliarnent hadcreated conditions for lransforming lhe economy from one based on slrict central planning toone reiying essenlially on market forces for lIs regulation229.

Yugoslavia did not becorne a market econorny, but it undertook some important changeswhich allowed its provisional admittance to the GATT in 1962230. Such reforrns included: theelimination of state intervention in Lhe activities of individual enterprises and businessdecision-making; the adoption oU customs tariffs; the promotion of a reform in the pricingsystem, allowing free pricing for a range of commodities and removing certain price limits forbasic industries; and lhe decentralization of investment resources, reducing the role ofgovernment in investment financing.

Finally, in 1966, despite the fact that Yugoslavia clearly was yet a NME, the Working Partydetermined that the changes undertook by the country were enough to allow a hillparticipation in the Multilateral Trading System23 L It can however be argued that the entry ofYugos!avia in the GATT under "market conditions" owed more to political than economicreasons, to reinforce Yugoslavia's non-alignment with the USSR and thus further restrainsoviet influence over the region232.

The foliowing NME to accede to the GATT was Poland, in 1967. Its accession contrasts withYugos!avias, because some special provisions were devised for application to Poland thatdiffered from the obligations of ali other GATT contracting parties. No change was requestedfrom Poland's econornie system; this time the adaptation lied on the rules applicable to thecountry.

The adjustments proposed by Czechoslovakia - a reserve from the obligations in ArticleXV:6 and the application of the Interpretative Note on Article VI - were also applied toPoland233 . Regarding the application of the Second AD Note to Article VI:!, the WorkingParty Report acknowledged the possibi!ity of using the surrogate country methodology (theconstruction of the normal value based on the prices of the sarne product produced in anothercountry), which was not expressly foreseen in the Note.

Since Poland did not have any customs tariff, its concessions were based on importcommitments: Poland committed to increase the total value of its imports from the territoriesof the contracting parties by no less than 7% per annum. Also, to counter any sharp increase

227 GArE, Decisiou ou Relations with the Federal People s Republic o! Yugosla via, U986, Contracting PartiesFourteentb Session, 16 May 1959.228 Ibid229 GArI'. Report oídio Working Party on the Accession o! Yugosla via, 112562, 24 February 1966.230 GATT, Provisional Accession o! Yugos/a via, 111939, Contracting Parties Twentieh Session, 13 November1962.231 GArE. Report o! lhe Working Parly ou lhe Accession o! Yugoslavia, 112562. 24 February 1966.232 See POLOUEKTOV, Alexander. The Non-Market Econoíny Issue ia Internationa! Trade in lhe Context o!WTüAccessions, Unctad/DITCITNCD/MISC.20, Unctad Report, 9 October 2002, p. 39.233 GATT, Accession oíPoland, 112851, 19 September 1967, para. 8; and GATT, Accession o! Poland Reporto!the Working Party, 112806, 23 JLIne 1967, para. 13

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on imports of Polish products under non market conditions, a specific safeguard mechariismwas created aliowing GATT contracting parties to impose restrictions to the import ofproducts from Poland that were being imported in such increased quantities as to cause orthreaten serious injury to domestic producers.

Furtherrnore, members were permitted to maintain quantitative restrictions against Poland,even if these were inconsistent with GATT Article XIII, provided that the discriminatoryelemeni of the restriction was not increased and was progressively relaxed.

The accession of Poland became a modei for future NME accessions to the GAYT 234. In thecase of Romania, which acceded in 1971, the only significant difference was in its Scheduleof Commitments, where it committed to "increase its irnports from the contra cting parties asa whole at a rate not srnaller than the growth o! total Rornanian imports provided in its Five-Year Plans" 235 . This provided some flexibiiity to its obiigations on imports, if compared toPoland.

The accession of Hungary, in 1973, presented a few more differences: the country already hada customs tariff and had recently undertaken a reorganization of the central management of itseconomy, which, according to Grzybowski, would have introduced market relations 236 . Theeconomic changes did not alter the pianned character of the country's economy, but it ailowedHungary to negotiate concessions under a tariff base and not through quotas. Nevertheless, itremained subject to quantitative restrictions and special safeguards by other contractingparties. The country also reserved its position wíth res?ect to Article XV:6 and was subject tothe application of the Interpretative Note on Article V1237.

The GA'fl' made, therefore, oniy few adaptations in order to accommodate NMEs into itsframework. The draft charter of ITO had intended to be open to ali economies, even though anumber of its mies were considered "market oriented". The GATT, although not having thedispositions of the ITO that dealt with NMEs, never fuily closed itself to the participation ofsuch countries, despite its clear aim of trade liberalization, consistent with market orientedgovernments. According to Jackson, as the sole "offspring" of the failed ITO, the GATTattempted to accommodate different market siructures, not only NMEs, but also countrieswith different leveis of industrial development and with policies of economic deveiopmentnot fuily consistent with market oriented principies 238. Ali those adaptations of GATT ruieswere made in order to allow a better functioning of the Multilateral Trading System underthose specific circumstances.

The accessions of Poland, Romania and Hungary show the range of adjustments aliowed inGATT rules. According to FIUANG, such approach, in contrast with general rules:

234 While Yugoslavia had a more "pro-market" orientarion, Poland followed a much stricter model of socialistecononiy. See POLOUKTOV, Atexander, "The Non-Market Econorny" Issue in International Trade in meContextofWTOAccessions, UnctadIDITCITNCD/MISC.20, Unctad Report, 9 October 2002, p. 39.235 GATF. Protocol for ffie Accession of Rornania to ffie GA 77', BISD § 1 8S/5 (Eighteenth Supplement, Twerity-Seventh Session. 1969-1970), April 1972236 GRZYBOWSICL, K., "Socialist Countries in GATF," The Arnerican Journal o! ('oraparative Law. v. 28, n. 4,Autumn, 1980, p549237 GATIT, Protocol for the 4ccession o! I-Iungary to me GATT. BISD § 20S13-8 (Twentieth Supplenient,Twenty-Ninth Session, 1971-1972), January 1974.238 JACKSON, John H.. Restructuring the GATTSystem. Royal Institute of International Affairs, London. 1990.pp. 81-82

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(..) was to be based on silent recognition of the special status of the planned economysystem in the GArI' and of the provisory character of these arrangements. The accessionprotocois, though also constituting binding obligations, impiy an exceptional tolerance ofplanned economies within the organization. The GArI' rules, based on market principies,were the norm of the organization. Planned economy features were exceptions which werespecially granted te state-trading countries in the accession protocols239.

These adjustments were referred by Jackson as the "interface principie". The idea was tocreate mechanisms that would mediate between lhe different economie structures, providingrules to reduce the incompatibilities among them240. The negotiations of quotas instead oftariffs and the creation of specific safeguard mechanisms in NMEs accessions to the GATTare vivid examples of that approach.

But Jackson also strcsses that the NMEs participating iri the GATT system were relativelysmall and the accession of China or the USSR could create much more significant impacts,demanding either a more complex interface system or a decision to revert GATT to being afortim designated primarily for market oriented economies241.

2. The WTO era

With the coilapse oí communist regimes in Eastern Europe, a number of countries werewilling to promote significant economie reforms in order to transform their systems towards amarket oriented economy. The accession of such economies in transition to the WTOtriggered a change of direction in how the Multilateral Trading System approached NMEs:instead of adapting WTO rules to integrate NMEs, the main eoncern was to promote a moreefficient transition of such economies.

Interestingly, the accession of Yugoslavia to the GATT became the main reference in thatnew approach, to a certain degree. In the sarne way as Yugoslavia had been required toundertake reforms such as the adoption of custorns tariff, the transition economies had topromote economic reforms in a much deeper way than the ones required during GATT era tobe granted membership in the WTO.

Acceding members, such as Mongolia, Bulgaria, the Kyrgyz Republie, Latvia, Estonia,Albania, Croatia, Georgia, Lithuania and Moldova, were required to commit to obligations inthe fields of: foreign exchange; state ownership and privatization; pricing policies; tradingrights; subsidies; industrial policy; state-trading enterprises and transparency 242 . Clearly, theaim was to approximate these economies to a more inarket oriented model, aliowing the fuilfunetioning of the Multilateral Trading System.

The WTO agreements provided a few rules specifically devoted to transition economies (e.g.,Article 29 of the 5CM and Article 65 of TRIPS), mostly granting them more time to enforcetheir obligations, but there were no material changes in the WTO mies in order to aliow a

239 HUANG, Chien. "Non-market Economies Accessions to the WTO: Ao Empire is Rising?" ISA AnnualConvention, San Francisco, CA, March 23-26, 2008, p. 5240 JACKSON, John II., Restructw'ing ffie GA 17 System, Roya] Institute oí International Affairs, London, 1990,pp. 84-85. See also HUANG. Chien, "Non-market Economies Accessions te the WTO: An Ernpire is Rising?"ISA Annual C'onvencion, San Francisco, CA. March 23-26, 2008. p. 6.241 Ibid. p. 82.242 POLOIJEKTOV. Alexander. "The Non-Market Economy' Is.sue in International Trade in the C'ontext o!WTOAccessions, UnctadIDITC/TNCD/MISC.20, Unctad Report, 9 October 2002, p. 26.

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better participation of these economies. The commitments undertaken in the protocois ofaccession related to changes in these countries' economic systems rather than to specificchanges in the WTO rules.

A different approach to the integration of NMEs into the Multilateral Trading System wasalso a consequence of the evolution of lhe System itseif over time. With the successful GATTrounds of negotiation, tariff leveis had been significantly reduced and non-tariff measures hadbecome the major perceived obstacle to trade liberalization. The WTO extended its scope toineasures once considered of domestic competence, bringing the organizatiorYs influence intodomestic policy makirig243.

Consequently, lhe nature of governance under lhe WTO is dramatical]y different from theGATr in lhe sense that lhe power to regulate certain domestic policies has transferred frommember countries to lhe WTO Agreements. ( ... ) With regard to new member's accessions,this signals that lhe accession negotiations under lhe WTO request countries to niakeremarkable commitments in relation to their capability to undergo ali reforms necessary tomeet WTO obligations. The candidate rnust not only familiarize themseives with the newrules with respect to services and inlellectual property but are also under an obtigation tobring their regulatory, judicial and administrative framework ia compliance with lheWTO2

The position of WTO members vis-à-vis lhe transition process from non-market to marketeconomy evoived from "adaptations and incentives" to "obligations", since NMEs practicesbecame incompatibie with a more integrated Multilateral Trading System. The interfaceprincipie was no longer sufficient to allow the functioning of the roles: new members wererequired to undertake deep economic reforms towards a market oriented modei in order tofully compiy with WTO ruies.

3. The accession of China to the WTO

The Chinese accession in 2001, and Viet Nam's accession in 2007, followed this new pattern,and represent interesting exampies of the new approach.

China was the first iarge NME to integrate the WTO system. While other NMEs had littieweight in international trade and, thus, any distortions to competition could be easilyoveriooked by other members, China had a much iarger economy, which couid cause greaterimpact on other members' economies. The accomniodation of China in the system wouidnecessarily be more compiex than other NMEs, as every NME feature could give risc todisruptions in other markets.

In its accession process, China committed:

• to estabiish judicial review of administrative actions;• to accord non-discriminatory treatment at lhe procurement of inputs and goods and in respectof the prices and avaiiability of goods and services supplied by governmentai authorities;

243 An interesting exampte of lhis extension of the WTO scope is Articte 27.13 o. lhe 5CM. The provision statesthat forgiveness of debts and subsidies to cover social costs related to a privatization program in a developingcountry shalt not be actionable. This is a clear incentive to privatization of companies in developing countrieswhere SOEs were an importam part of their economies.244 HUANO. Chien. "Non-market Econornies Accessions to the WTO: An Empire is Rising?" ISA AnnoalC'onvention. San Francisco. CA. March 23-26, 2008. p. ti

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• to liberalize lhe availability and scope of lhe right to trade;• to refrain from taking measures to influence or direct state-trading enterprises, except inaccordance with WTO Agreements;• to allow prices for traded goods and services in every sector to be determined by marketforces;• to eliminate export subsidies ori agricultural products, amongst others.

China's Protocol of Accession 245 also has provisions ou:

• a progressive elimination of quantitative measures imposed by other members that areincompatible with WTO Agreements;• the application of transitional specific safeguards;• the use of alternative methodology for lhe determination of normal value in the calculationof dumping margins;• a special safeguard for textiles;• special methodologies for identifying subsidy benefits.

In one hand, China's Protocol has a series of obligations that should lead China Lowards amarket oriented economic system, an essential feature for lhe smooth functioning of the M/TOsystem. On the other hand, lhe Protocol contains interface mechanisms, some of provisionalcharacter, similar to those used for NMEs during the GATT era. Members considered at themoment of its accession that China was not yet a market oriented economy and that memberswould retain some buffer mechanisms while China implemented the comrnitments that wouldtransform its economy, aliowing for lhe participation of China

ar lhe WTO.

China's accession to lhe WTO was not only a chailenge for China that explicitly opted fortransforming its economy into a market economy; it was also a huge chailenge for the wholeMultilateral Trading System to adapt itself to China. In particular, there is today evidence thatChina has not performed a fuil transition towards a market economy, which raises uncertaintyabout the compatibility of such economic model with the WTO.

4. Conclusions

The failure to establish Lhe Intemational Trade Organization (ITO) Ied to a lack of specifictrade afies applying to international trade between planned and market economies. ArticleXVII of the GATT dealt with only a minimal spectrum of the chalienges posed by the subject.The process of accession of NMEs to the GATT, during lhe subsequent years, put on viewsome of these chalienges and how they were dealt with in lhe protocois of accession - mainlythrough buffer mechanisms and import obligations.

Even if lhe economic adaptations then required were minimal, there was already theperception that they might not be sufficient 24 . In this sense, when referring to the adaptations

245 WTO, Protocol ofAccession ofthe Peop/e s Repubiic o! China. WT/U432, lo November 200!.246

Some authors reler to this low levei of liberal requirements during GATT as the "embedded !ibera!ism" SeeRUGGIE, John, "International Regimes. Transactions, and Change: Embedded Liberalism in the PostwarEconomic Order", International Organízation. volume 36(2), Internationat Regimes, Spring, 1982. Also, John.Jackson argues that GATT operated as an interface between market and planned economies, not exertingpressure unto the laLter boi enabling their interaction. See a!so JACKSON. John 1-!.. Restructuring the GAT7'Systein, Roya! Institute of Internationa! Affairs, London, 1990-

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made in lhe accession of sociahst economies to lhe GATT, in 1980, Grzybowski affirmedthat:

With this general formula GAFI' was satisfied. ( ... ) Whether Poland with her price policies andinvestment prograíns can really adhere, not only ia Ietter but also ia spirit. to provisions of Art.XVI! of GATT. is another matter247.

As lhe Multilateral Trading System gradualiy changed its focas, from import tariffs to non-tariff barriers, and started to supervise internal policy measures from its members in order toguarantee a levei playing field, so did lhe adaptations required for lhe accession of NMEs.With lhe creation of lhe WTO, there was a substantiai change in lhe nature of obligatiorisimposed on acceding NME countries in order to preserve lhe weli functioning of lhe system.They now focus on a systemic approach, requ ring deep economic changes and an adaptationof lhe development model of lhe acceding NME.

The accession of China to lhe WTO brought new chaHenges, because of its size and aiso dueto lhe partiai reforms perforrned ort its system.

247 GRZYBOWSKI. K., "Socialist Countries in GATT", The Arrierican Jowwal o! Co;nparative Law, vol. 28, no.4. Autumn, 1980, p 548

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IV.3 IMPACTS OF NON-MARKET ECONOMIES ON THE WTO SYSTEM

The shift in the treatment of NMEs when acceding to the WTO, as outlined above, derivednot oniy from the faet that members perceived that they had aiready conceded considerableleveis of market access through the negotiation rounds and should now ask equivalentconcessions from acceding countries; lhe economie ehanges now required rather attempt torespond to the practieal difficulties brought by eompetition on the international market withproducts from NMEs, whose weight in some eeonomic seetors can have an important tradeimpact. In a series of recent Articles ou the subject, The Economist highiighted some of thefears of market economies:

Another concern is Lhe impact of the model ou the global trading system ( ... ). Ensuring that trade isfair is harder when some companies enjoy the support, overt or covert, of a nationai government.Western politicians are beginning to lose patience with state-capitalist powers that rig the systemin favor of Lheir OWTI companies. For emerging countries wanting to make their mark on theWorld, state capitalism has au obvious appeal. li gives them the clout that private-sectorcompanies would take years to build24t.

In light of these concerns and considering the impact that the Chinese accession has had to theMultilateral Trading System, it is worth analyzing what exactiy are the trade rules andinstruments that are not adapted or wouid not be fit to deal with trade from NMEs. There aretwo ways of addressing this analysis and both will be undertaken in this section. Firstly, abrief theoretical analysis of lhe economie and legal instruments of Lhe WTO will offer insightsabout which of these would not offer sufficient solutions to dealing with NME economies.The second approach, empírica!, is to analyze recent accessions of NME countries to theWTO and understand which adaptations were deemed necessary by WTO members. In thiscase and due to Lhe scope of this study. China's Accession Protocol will be analyzed.

1. Impacts on Multilateral Trading System instruments

First of ali, it is importam toto stress that, after the end of the socialist biock and the gradualtransition of planned economies to market-oriented ones, it is hard to determine, today, awhole economy as planned or as NME, i.e., where government is Lhe sole or predominantvector of resources aliocation. Nevertheless, one can identify NME characteristics or "formsof NMEs" (as stated by the Appellate Body of the WT0249) with different leveis ofgovemment interference in the economy. This central planned interference can attain differentleveis and might indicate NME features that may cause difficulties in the application of WTOrules.

These NME features were identified in the first part of this article and are Lhe basis for thepresent anaiysis. Particulariy some NME features in some economies are indications thatstructurai reforms might be required for their integration in Lhe Multilateral Trading System. Itis also interesting to indicate that these features are not exclusive to socialist or transition

248 The rise of state capitaIism. lixe Econornise. 21 January 2012. Available at:chttp:/Jwww.economistcornfnodc/2 1543160>. Viewed at: 27 January 2012-249 In Lhe case EC - Fasteners. Lhe Appellate Body argued the existence of severa] fornis of NME, varying intheir levei of government interference, and that the one Lhat oniy a narrow one fitted the requirements of thesecond Ad Note to Artcle VI of Lhe GAfl. WTO, AB. EC - DeíYnitive Anti-Duinping Measures on Certain Ironor Stee/ Fasteners (rom China (DS397). WT,DS397/AB/R, AB Report adopted on 15 July 2011, para. 285,footnote 460.

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economies, being identifiable, aibeit in lesser leveis, in western market economies in differentmoments of their history250.

As seen above, during the GATT period, the CONTRACTING PARTIES were mainlyconcerned with two aspects of NME inconsistencies with Lhe Multilateral Trading System:governments had the monopoly of international trade; and internal prices were fixed by Lhegovernment.

The monopoly of international trade dictated that import tariffs, the main trade instrument tomeasure market access and the base of multilateral negotiations, were either inexistent orirrelevant. The inadequacy of import tariffs was overcome by import commitrnents fromacceding NMEs (Poland and Romania). This so!ved the immediate problem of market accessbut could not be extended to ali acceding members since it created another market distortionby forcing artificial leveis of import rather than regular market forces to dictate trade betweenthe contractirig 251.

The real probiem underlining the initiative was how to reconciie market access negotiationsand obligations with the state control of market decisions. The multilateral negotiations werebased under the premise that, apart froin the barriers to trade imposed by countries, econornicagents wouid be free to seek products from whiehever market offered the best prices andconditions, thus favoring competitive advantages and better productivity - a pular of liberaleconomics (even of "embedded liberalism"). The fact that imports were aetually centrailydecided undermined this principie and was irreconcilable with the dynamics of multilateralnegotiations. In this sense, high leveis of government interference on import decisions byeconomic agents might undermine the carefui!y negotiated market access conditions. Even ifone considers that only some economic sectors would be centrally controlied by the state in aNME, this couid bring chaiienges to the way multilateral negotiations are conducted and,particuiarly, to market aecess obligations under GATT Article II.

In fact, the GATT already acknowiedged lhe difficuities brought by import controi by theState, through import monopoiies. !ts Articie 11.4 estabiishes that:

If any contracting party estabiishes, maintains or authorizes, formaiiy or iii effect, a monopoly ofLhe importation of any product described ia the appropriate Schedule annexed to this Agreement,such monopoly shall not, except as provided for ia that Schedule or as otherwise agreed betweenthe parties which initially negotiated the concession. operate so as to afford protection on Lheaverage lo excess of the amount of protection provided for in that Schedule. The provisions ofthis paragraph shall not limit Lhe use by contracting parties of any form of assistance to domesricproclucers permitted by other provisions of this Agreement. (Emphasis added).

In this sense, the GATT sought to restrain the domestie market protection afforded throughimport monopoiy to the limits estabiished in each party's Schedule of Coneessions. These,however, transiated market access obligations into import tariffs. It is thus hard to imagine apractical and efficient way to translate the market access granted through a given bound tariff

250 Huang argues that the difference ia Lhe levei of government intervention in western countries was the cause of"crisis" periods during GATT/WTO existence. See HUANG, Chien. "Non-market Economies Accessions to theWTO: An Empire is Rising?". ISA Aunual C'orivention, San Francisco, CA, March 23-26, 2008. p. 17251 As Polouektov argues, ir also brought a considerable levei of economie distress to Poland, since iL wasobligated by its accession commitments to raise its inports by not iess than 7 per cent annuaily. ScePOLOUEKTOV. Alexander, "The Non-Market &onoiny" Issue in Iriternational Trade in the C'ontext o! WTQAccessions. Unctad report, 9 October 2002, UNCTAD/DITC/TNCDIMISC.20, p. lO.

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rate imo import obligations, especially considering the development of international trade andof terras of trade. Considering these difficulties, an Interpretative Note to Article 11.4 wasadopted stating that:

Except where otherwise specifically agreed between the contracting parties which initiallynegotiated Lhe concession, the provisions of (his paragraph wilil be apptied in the Iight of theprovisions of Article 31 of lhe Havana Charter.

The relevant part of Article 31 of the Havana Charter for this analysis is its Paragraph 5 thatrequires the contracting party that has imposed an import monopoly over a product to importand offer for saie such quantities ofthe product as will be sufficient to satisfy the fui] domesticclemand for the irnported product. This interpretation has been confirmed by two GATTpaneis 252 . Once again, the definition of what wouid satisfy the fuJi doniestic demand for theimportedproduct is hard to establish.

In any case, the direct reference of the Interpretative Note to Article 11.4 to an Article of theHavana Charter highlights the difficulties imposed by the non-creation of the ITO for thepurpose of intcgrating NMEs in the Multilateral Trading System. The Havana Charter had awhole section - Section D: State Trading and Related Matters - dedicated to deahng withsuch issues. li is interesting to note that during the GATT Review Session of 1954-55, theReview Working Party on Other Barriers to Trade considered proposals for amending thestate trading provisions of the General Agreement either by consoiidating them or by adoptingArticles 29-31 oU the Havana Charter, but these proposais failed to gather unanimous approvaiand were abandoned.

Another reaction to state moriopoly of internationai trade was the possibility of contractingparties to apply special safeguards, specifically aimed at imports from the acceding NMEcountries. Also, the existing quantitative import restrictions could be maintained regardingthese countries as long as they were progressively relaxed, although no final term wasprovided. The justification was thc fear that, due to the weight of the State when comparedwith individual enterprises, a decision by a NME country to export a particular product wouldcause considerable damage to some sectors of market economy countries. The competition ofprivate owned enterprises with state backed ones was considered unfair and would justifythese "buffer" mechanisms. In this sense, in order to promote a fair competition betweenmembers of The Multilateral Trading System, a separation between state and privateproducers would be required.

GATT Articles

There are many chalienges in appiying the Multilateral Trading System rules, as they are, toNMEs. Some of them are highiighted here.

Article XVII of the GATT regul.ates the participation of SOEs in the economy of thccontracting parties so as to limit potentiai negative effects on fair trade between private andSOEs. Ir states that:

252 GATI, lapa!? - Restrictions on Iínports o! Ceriain Agricultural Products, 116253. Panei Report adopted on 2February 1988, BISD § 358/163, paras. 5.2.2.1-5.2.2.2 and the three parailel Pane] Reports on Republic o! Koren -Rastrictions ou Jmports o! BeeI LJ6503. 116504, 1J6505, adopted on 7 November 1989. BISD § 36S1202,234 2 268

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1. (a) Each contracting party undertakes that if iL establisbes or maintains a state enterprise,wherever iocated, or grants to any enterprise. formally or in effect, exclusive or speciaipriviieges,* such enterprise shali, in its purchases or saies invoiving either imports or cxports, actin a manner consistent with the general principies of non-discriminatory treatmentprescribed in this Agreement for governmental measures affecting imports or exports by privatetraders.

(b) The provisions of subparagraph (a) of this paragraph shail be understood to require thatsuch enterprises shali, having due regard to the other provisions of this Agreement, make anysuch purchases or saies solely in accordance with commerciai considerations,K includingprice, quaiity, availabiiity, marketabiiity, transportation and other conditions of purchase or saie,and shali afford the enterprises of the other contracting paries adequate opportunity, in accordancewi(h customary business practice. to compete for participation in such purchases or saies.

(e) No contracting party shali prevent any enterprise (whether or not an enterprise describedin subparagraph (a) of this Paragraph) under itsjurisdiction from acting in accordance with lheprincipies of subparagraphs (a) and (b) of this paragraph.

2. The provisions of Paragraph 1 of this Articie shail not apply to imports of proclucts forirnrnediate or ultimate consumption in governmental use and not otherwise for resale or use in theproduction of goods* for saie. With respeet to such imports, each contracting party shail accord tothe trade of the other contracting parties fair and equitable treatment. (Emphasis added)

Article XVII establishes lhe principies under which ali enterprises should operate (private andstate-owned), i.e., act in a manner consistent with the general principies of non-discriminatorytreatment and make purchases or saies in accordance with commerciai considerations. In thissense, it seeks to obligate SOES to act as private enterprises so as to afford lhe enterprises ofother contracting parties adequate competition opportunity, guaranteeing fair trade. Atthoughanswering theoretically to the chalienges posed by competition between private and SOE,subsequent practice has shown the difficulties in analyzing whether purchases by SOES havebeen made in accordance with commerciai considerations253.

li is worth noting that the GA'VI' did not regulate government procurement and Article XVII.2exiends Ibis to government procurement made through SOEs. In this sense, another chaflengeis that one must separate purchases made for government purposes from those made inregular comrnerciai tradc while anaiyzing whether these have respected commerciaiconsiderations. Article XV11.3 seems to acknowledge these chalienges and lhe potentialdamage to fair trade of the abuse of SOES, stating that:

3. The contracting parties recognize that enterprises of the kind described in Paragraph i(a) of this Article might be operated so as to create serious obstacles to trade; thus negotiations ona reciprocai and mutualiy advantageous basis designecl to limit or reduce such obstacles are ofimportance to the expansion of internationai (fade

The solution proposed was that countries counting with SOES should negotiate speciaiagreements to iimit or reduce the obstacles posed by SOES. These special agreementsdemonstrate lhe exceptionality of state-controlled production in lhe Multilateral TradingSystem254 . Aiso, ii is interesting to note that lhe Interpretative Note paragraph 3 of Articie

253 The cases Korea - Various Measures 01? Beef and Canada - Wheat Exports and Graín Imports, in theWTO, both demonstrated the difficulties in analyzing the rationale hehind SOE irnport decisions and of theproof of whether they acted in accordance with commerciai considerations. To extend this ana]ysis to the numberof SOE present in NME wouid entail considerable chalienges.254 The existence per se of SOEs was not considered a negative feature of an economy during GATT time. Thiswas stated. in 1964, by the Committee ou the Legal and Institutional Framework of the GATT in Relation to

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XVII makes reference to lhe speciai agreements made under Article 11.4, which in turn refersto lhe dispositions present in the Havana Charter. Yet again lhe dispositions of GATT wereconsidered insufficient to deal with NME features and the recourse to the non-adoptedHavana Charter has been deemed necessary. The extent and economic presence of SOES inNMEs further enhance the chalienges posed by the subject and indicate the insufficiency ofGATT mies to discipline competition between private and SOES 255.

The second aspect of NMEs highlighted during GATT time was the fixing of domestic pricesby the State. This problem was mainly iinked to the difficulties in determining normal valuein anti-dumping investigations and lhe Ad Note to Paragraph 1 of Article VI of GATT wasconsidered as a suitable arrangement. Nonetheless, Lhe fact that internal prices were notdetermined by market forces, but rather by lhe govemment, made it hard to guarantee anylevei of market access for certain products deemed as "sensitive" by each NME country. If thegovernment decided, due to pohcy options, that, for instance, the price of a good shou!d notsurpass a determined levei, it would be, in practice, impeding any imports of that product inhigher prices than the one estabiished. This problem, keen in Lhe case of NMEs, was alreadyhighlighted by Lhe GATT, in its Article 111.9 that states:

The contractíng parties recognize that internai maximum price control measures, even thoughconforming to the other provisions of this Article, can have effects prejudicial to Lhe interests ofcontracting parties supplying imported products. Accordingly, contracting parties applying suchmeasures shall take account of Lhe interests of exporting contracting parties with a view toavoiding to lhe fullest practicable extent such prejudicial effects.

Although this practice has been used several times in Westem countries considered to bemarket economíes, lhe extent of its use and lhe economic justifications regarding NMEpractices brings further chailenges to lhe implernentation of lhe Nationai Treatment principie.

Exchange rates

Besides Lhe issues above already highiighted in lhe accessions of NME during GATT time, itis possible to identify other chailenges posed by Lhe presence of NME in lhe MultilateralSystem, considering its present structure and legal order.

The control over exchange rales and the constraints on free currency convertibility has beenindicated as of particular concern regarding some NME. The manipuiation of exchange ratescan be detrimentai to imports both b1 its impact on tariffs as for lhe difficuities for economicagents to deal in international lrade2 6 GATT Articie XV is Lhe logical reference to deai withthis issue, along with lhe surveiliance of lhe IMF. Nevertheless, this subject is under muchdebate nowadays and an effective remedy against exchange rate manipulations is stiil underdiscussion. This brings unpredictabiiity to lhe whole system, but is of particular concernregarding NMEs.

Less-Developed Countries in reaction to a proposal ol' the representative of Egypt seeking an interpretation ofAlicie XVII. In this sense, the presence of SOEs bring rather new challenges tu Lhe multilateral system thatrequire further attention by the contracting parties and better transparency.255 In light of lhe creation of lhe WTO, an Understanding on Lhe Interpretation of Article XVII of the GATT1994 was adopted. It sought to enhance transparency in SOE matters and created a working party to reviewnotifications and counter-notifications in the subject. Flowever, no substantial modifications to lhe discipline ofArticle XVII were promotcd and Lhe WTO provided no further development in the subject.256 See, THORSTENSEN, Vera, MARÇAL, Emerson, FERRAZ, Lucas, (2011)- Impacis o! Exchange Rates onfnternational Trade Po/icy Instnirnents: The Case o! Tariífs, Journal of World Trade, v. 46, i. 3. 2012

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Subsidies

The practice of subsidies in NME also presents special difficulties related to lhe inherentrelationship between lhe source of the subsidies - lhe government - and their mainbeneficiaries - SOE. The rules present in GATT Article VI and in lhe SCM do not solve alithese specificities, making it difficult to identify mechanisms that would allow for a clearseparation between subsidy beneficiaries and benefactors.

It is worth recalling that lhe reason why subsidies might be considered negative in lhe contextof international trade is that they are governmental stimulus to direct resources to a particularsector of lhe economy. In this sense, lhe government would be influencing in the aliocation ofresources that would otherwise be directed to whichever sector of Lhe economy presentedbetter comparative advantages and better efficiency. If one considers that a NME featurewould be precisely lhe aliocation of the resources of the economy by the govemment, lhe veryconcept of subsidies may not fit properly to this reality 257 . Nonetheless, the surveiliance anddiscipline of subsidy programs is an important part of lhe functioning of lhe MultilateralTrading System and it would be to Lhe detriment of the system's coherence to exclude NMEsfrom it.

Finally, the control over investments decisions/planning in NME can raise other kinds ofchailenges, which the narrow legal basis of Lhe WTO in the subject would not be apt toresolve.

2. China's obligations

The accessions of NMEs to lhe WTO have produced much more debate and specificobligations to the acceding country than those during OATT. One can argue that this is due tolhe change in Lhe nãture of WTO obligations compared to those of GATT 258 - being muchmore concerned today with policy aspects of members' international trade. Nonetheless, lheaccession of some countries to Lhe WTO, deemed to be NME, have entailed especialobligations, reproduced in their respective Accession Protocols 259. These obligations canserve as indications of which aspects of their economies were considered to be ia conflict withthe legal and economic order of the WTO.

The analysis of the Protocol of Accession of China and of its Working Party Report offersome indications of lhe structural economic adaptations required of a NME in order to

257 This is the reasoning behind lhe recent decision of lhe U.S. Court of Appeals (Federal Circuit) that reaffirmeda decision by the Department of Commerce of lhe U.S (DoC) from lhe 1980s, prohibíting the application ofcountervailing duties to countries considered to be NME. See GPX International Tire Corp. v. U.S., case ri' 08-CV-0285, ofDecember 19, 2011, lhe U.S. Court of Appeals for lhe Federal Circuit,258 Kent Jones demonstrates that lhe average Iength of time from application to accession for the 30 countríesjoining the GArI' was 62 months, while the elapsed time for WTO accessions among Lhe first 25 new membersaveraged 101 months. See JONES, Kent. "The Political Economy o! WTO Accession: The unfinished businessof universal membership", World Trade Review, vol 8:2, April, 2009, pp 292-293.259 It is worth noting that WTO niembers have expressly considered China Lo be "in Lhe process of transitiontowards a fuIl market economy". In this sense, they clearly considered China not yet to be a market econorny,bearing aL least some NME features. See WTO, Report of lhe Working Party on lhe Accession o! China,WT/ACC/CFIN/49, 1 October 2001, p. 29, para. 150.

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integrate itseif in lhe Multilateral Trading System. Some key obiigations 26° are highlightednext.

Uniform administration of WTO rufes over the territory

Iinder Article 2.A of Lhe Accession Protocol, China must apply WTO rules in a uniformmanner over ali its territory, including border trade regions and minority autonomous arcas,special economic zones, open coastal cities, economic and technical development zones. Thisis relevant since Lhe pianned-economy development model created severai special zones (ofwhich Lhe special economic zones are Lhe most often cited) in which trade rules could varysubstantialiy. The uniform application of trade mies represents a considerable adaptation. fromthis model.

Rufe of Law

Article 2.0 and 2.D requ res Lhe estabiishment of an official journal and of a judicial system,impartial and independent, with possibility of appeal. These two requirements can beinterpreted as being nccessary to implement Lhe rule of law in China. These obligations, ratherthan economie adaptations, relate to the manner by which obiigations are negotiated,monitored and implemented in Western countries. In this sense, these obligations areconsidered imperative in order to adapt the Chinese system to the legal functioning of lheWTO.

In this sense, Lhe Working Party Report on Lhe Accession of China (China WPR) states that:78. The representative of China confirmed that it wou!d revise its relevant laws and reguiations sothat its relevam domestic laws and reguiations would be consistent with Lhe requirements of LheWTO Agreement and Lhe Draft Protocol on procedures for judicial review of administrativeactions. He further stated that Lhe tribunais responsible for such reviews wouid be impartial andindependent o!' Lhe agency entrusted with adniinistrative enforcement, and would not have anysubstantial interest ia Lhe outcome of Lhe matter. The Working Party took note o!' thesecommitments261.

Non-discrimination - foreign capital and individuais

The Protocol of Accession, in its Article 3, estabhshes Lhe obhgation of China to concedenational treatment for foreign individuais, enterprises and foreign-funded enterprises.Aithough this obligation extends to ali WTO members, it has a special meaning for NME,since it implies Lhat ali foreign individuais and enterprises shaii be free to participate in theeconorny of Lhe country, aL Lhe sarne rate as nationais. This has particular implications to Lhetreatrnent conceded to foreign capital in NMEs.

260 Juha Qin refers to these speciai obligations as WTO-plus obhgations since they imposed stricter disciplinesthan rcquired by Lhe WTO Multilateral Agreements. Part of these WTO-plus obligations refers to what Qincharacterized as being "obligations to practice market economy" and "obligations concerning domesticgovernance". These are Lhe obligations object of Lhe present analysis. See QIN, Julia Ya. "China. India and WTOLaw", in SORNARAJAH, Muthucumaraswamy; WANG. Jiangyti. China, índia and the Intemationa! EconoinicOrder, Cambridge University Press, 2010 .pp 72-173.261 WTO, Report o! the Workíng Party on lhe Accession o! China, WT/ACC/CHN/49, 1 October 2001. p. 15

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Right to Trade - monopoly of international trade

The right to trade and the monopoly of international trade by lhe State are main concems forlhe well-functioning of lhe Multilateral Trading System. In this regard, China WPR statesthat:

80. Some members of Lhe Working Party noted LhaL China was in the process of liberatizing Lheavaitability of Lhe right to import and export goods frorn China, but that such rights were now onlyavailabte to some Chinese enterprises (totatling 35,000). In addition, foreign-invested enterpriseshad Lhe right to trade, aithough Lhis was restricted to Lhe importation for production purposes andexportation, according to Lhe enterprises scope of business. Those members stated their view thatsuch restrictions were inconsistent with WTO requiremenLs, ineluding Articles Xl and III ofOAYI' 1994, and welcomed Chinas commitment to progressively liberalize Lhe availability andscope of the right to Inicie so that within Lhree years after accession ali enterprises would have Lheright to import and export ali goods ()262

Articles 5 and 8 of lhe Protocol of Accession dealt with this subject. In order to conductinternational trade Li a manner consistent wi.th lhe WTO Agreement, China must progressivelyliberalize lhe availability and scope af lhe right to trade for both its nationai and foreigriindividuais and enterprises (Article 5). This adaptation shouid be done, generaily, in threeyears. Also import and export licensing shouid be Iiberalized and a justification by Chinawould be required for niaintaining the restriction ar its scheduled date of termina tion (Article8.b). In this sense, China undertook lhe obligation to:

83. The representative of China confirmed that during Lhe three years of transition, China woutdprogressivety liberalize Lhe scope and availability of trading rights.

(a) The representative of China confirmed thaL, upon accession, China would etiminate forboth Chinese and foreign-invested enterprises any export performance, trade batancing, foreignexchange balancing and prior experience requirernenis. such as in importing and exporting, ascriteria for obtaining or maintaining the righL to import and export.

(b) With respect to whotty Chinese-invested enterprises, the representative of China statedthat although foreign-invested enterprises obtained timited trading rights based on Lheir approvedscope of business. wholly Chinese-invested enterprises were now required to apply for such rightsand Lhe relevam auLhorities apptied a threshold in approving such appticaLions. In order toacceterate Lhis approval process and increase lhe availability of trading rights, the representative ofChina confirmed thaL China would reduce the minimum registered capital requiremenL (whichapplied only to wholty Chinese-invested enterprises) to obLain trading rights to RMB 5.000,000 foryear one. RMB 3,000,000 for year Lwo. RMB 1.000,000 for year three and would eliminate Lheexamination and approvai system at Lhe end of Lhe phase-in period for Lrading rights.

(c) The representative of China also contirmed that during the phase-in period. Chinawouid progressively liberalize Lhe scope and availability of trading rights for foreign-investedenterprises. Such enterprises would be granted new or additional trading rights based on Lhefoltowing schedule. Beginning one year afLer accession, joint-venture enterprises with aninorityshare foreign-investment would be granted fuil rights to trade and beginning two years afteraccession majoriLy share foreign-invested joint-ventures would be granted fuil rights to trade.

(d) The representative of China atso conl9rmed that wiLhin three years after accession, alienterprises in China woutd be granted Lhe right to trade. Foreign-invesled enterprises would not berequired to estabtish in a particular form or as a separate entity to engage in importing andexporting nor wouid new business licence encompassing distribution be required to engage inimporting and exporting263.

262 1bid.p IS.Ibid. p. 16

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The Working Party took note of these commitments.

Price controis

Article 9 of lhe Protocol of Accession regulates price controis in China. This subject has beenof key interest when dealing with NME. Article 9 states that China shall "allow prices fortraded goods and services in every sector te be determined by market forces" and provides forthe elimination of "multi-tier pricing practices". In this manner, WTO members sought teaddress the problem highlighted by Article 111.9 ef the GATT.

At lhe time of accession, Chinese representatíves recognized that:

52. There were present!y three types of prices: government price, government guidance price andmarket-regulated price. The government price was set by price administration authorities andcould not be changed without the approval of these authorities. Products and services subject togovernment pricing were those having a direct bearing on lhe national economy and lhe basicneeds of lhe peoples Iivelihood, including those products that were scarce ia China 264.

Regarding this issue, China WPR states that:

50. Some members of lhe Working Party noted that China had made extensive use ef pricecontrols, for example in lhe agricultura! sector. Those members requested that China undertakespecific commitments concerning its system of state pricing. In particular, those members statedthat China should a!Iow prices for traded goods and services in every sector to be determined bymarket forces, and multi-tier pricing practices for such goods and services should be eliminated.Those niembers noted, however. that China expected te maintain price controts on lhe goods andservices listed in Annex 4 to the Draft Protoco!, and stated that any such controls shoutd beniaintained in a manner consistent with the WTO Agreement, in particular Article lii o!' theGATT L994 and Annex 2. paragraphs 3 and 4, of lhe Agreement on Agricu!ture.

51. Some members of the Working Party expressed the view that price controis and state pricing inChina a!so encompassed 'guidance pricing" and regu!ation of the range of proftts that enterprisescould enjoy. Such policies and practices would a!so be subject te China's commitnients. In theirview, price controls shou!d be adopted only in extraordinary circumstances and shou!d be removedas soon as the circumstances justifying their adoption were addressed265.

China undertook the obligation to terminate, generaily, the price centrei systern, and tomaintain enly those contained at Annex 4 ef the Protocel ef Accession. In se, China alsoagreed net te implement price controis in such way as te provide further protection for itsdornestie market:

62. The representative of China further conftrmed that price controis would not be used forpurposes of affording protection to domestiu industries or services providers. The Working Partytook note of this commitment.

63.Some members o!' the Working Party expressed a concern that China cou!d maintain pricesbe!ow market-based ones in order to limit iniports.

64. In response, the representative of China confirmed that China would apply its current pricecontrols and any other price controis upon accession in a WTO-consistent fashion, and wou!d takeaccount of the interests of exporting WTO Members as previded for in Artic!e 111:9 of lhe GATT1994- He also confirmed that price controts would not have the effect of limiting or otherwise

264 !bid. p. 10265 1b1d.p. lO

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impairing Chinas market-access commitments on goods and services. The Working Party tooknote of these commitments2.

Subsidies and Countervailing Measures

Regarding lhe subsidisation of Chinese economy, the special characteristics of China'sdevelopment model bring further chalienges to lhe implementation of lhe SCM Agreement. Inthis sense, China WPR stated that:

171. Some members of lhe Working Party expressed concern that lhe speciai features of Chinaseconomy, in its present state ol' reform, still created lhe potential for a certain levei o]'trade-distorting subsidization; this could have an impact not only on access to Chinas domesticmarket, but also on lhe performance of Chinese exports in lhe markets of other WTO Mernbers,and should be subject to effective SCM Agreement disciplines. ( ... ) The representative of China( ... ) informed lhe Working Party of lhe efforts being undertaken, as part of its ongoing reformprocess, to reduce lhe avaiiability of certain types o]' subsidies 267.

Annex 5.A of lhe Accession Protoco! of China brought a list of 22 types ol' subsidies 268 , 3 ofwhich should be phased out after accession (Annex 53). Those are: subsidies provided tocertain state-owned enterprises which are running at a loss; lhe priority in obtaining loans andforeign currencies based on export performance; preferential tariff rates based on localizationrate of automotive production.

Also, due to the difficulties in identifying subsidies in NMEs and determining specificityduring countervailing duties investigations, Article 10.2 of the Protocol. of Accessionconsidered that subsidies provided to state-owned enterprises will be viewed as speci[ic if,inter alia, state-owned enterprises are the predominant recipients of such subsidies orstate-owned enterprises receive disproportiorzately large arnounts of such subsidies. Thissought to surmount lhe chailenges in determining specificity of subsidies ia NMEs asacknowledged by lhe Department of Commerce of lhe U.S (DOC) 269.

State-Owned Enterprises

The rate of participation of SOEs in lhe economy is considered one of the most importantfeatures of NMEs. This has deep implications in lhe case of China. In this sense, China WPRstated that:

44. In iight aí lhe role that state-owned and state-invested enterprises piayed in Chinas economy,some membcrs of lhe Working Party expressed concerns about lhe continuing governmentalinfluence and guidance aI lhe decisions and activities of such enterprises reiating to lhe purchaseand saie of goods and services. Such purchases and saies should be based sotety on commerciaiconsiderations, without any governmental intluence or application o]' discriminatory measures.

China undertook lhe obligation not to allow government interference in SOE commercialdecisioris, which would be dependent solely upon commercial considerations.

266 Ibid. p. 12

261 Ibid. p. 34268 These did not cover ali subsidies present in Chinese economy aI lhe time aí accession, doe to difficulties indata coltection, as acknowledge by lhe representative o]' China to lhe Working Party on its Accession. [bid, p. 34269 See GPX International Tire Corp. v. US., case n° 08-CV-0285. o]' December 19, 2011, lhe U.S. Court o]'Appeals for lhe Federal Circuit.

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45. The representative of China emphasizcd Lhe evolving nature of Chinas economy and Lhesignificant role of Fifis and Lhe private sector in Lhe economy. Given Lhe increasing need anddesirability of competing with private enterprises in Lhe market, decisions by state-owned andstate-invested enterprises had to be based on comnierciai considerations as provided in Lhe WTOAgreement,

46. The representative of China further confirmed that China wouid ensure that ali state-ownedand state-invested enterprises wouid make purchases and saies based solely on commercialconsiderations. e.g., price, quaiity, marketabiiity and avaiiabihty, and that Lhe enterprises of otherWTO Members wouid have an adequate opportunity to compete for saies to and purchases fromthese enterprises on non-discriminatory terms and conditions. In addition, Lhe Government ofChina wouid not influence, directiy or indirectiy, commerciai decisions on Lhe part of state-ownedor state-invested enterprises, inciuding on Lhe quantity, value or country of origin of any goodspurchased or soid, except in a nianner consistent with Lhe WTO Agreement. The Working Partytook note of these commitments.

Considering the chalienges posed by the separation between purchases made by SOE forcommercial purposes and ihose for govemment final use, China WPR stated that:

47. The representative of China confirmed that, without prejudice to Chinas rights in futurenegotiations in the Government Procurement Agreement, ali iaws, reguiations and measuresreiating to Lhe procurement by state-owned and state-invested enterprises of goods and services forcornmerciai saie, production of goods or supply of services for commercial saie, or for non-governmental purposes wouid not be considered to be laws, reguiations and measures relating togovernment procurement. Thus, such purchases or saies wouid be subject to Lhe provisions ofArticies II, XVI and XVII of Lhe GATS and Articie III of Lhe OATT 1994. The Working Partytook note of this commitrnent.

Transitional Product-Speciflc Safeguard Mechanism

Two "buffer" mechanisms were concejved to address WTO members' concerns about Lheimpact on their economies of China's accession to the WTO. The first one is lhe reference tospecial rules regarding price comparability in antiduinping and countervailing measuresinvestigations against imports from China. Due to Lhe high levei of controversy over Lhesubjcct, this first buffer mechanism will be analyzed more thoroughiy in lhe next section ofthis study.

The second buffer mechanism is the use of transitional product-specific safeguard mechanism- one general and another specific to Lhe textile sector. This is a common feature of NMEaccessions to Lhe Multilateral Trading System and has been reproduced in the Protocol ofAccession of China in its Article 16 and in China RWP Para. 242, respectively.

Transitional Review Mechanism

As a sign of the importance of ali the above-mentioned systemic changes required of China, aspecial transitional review mechanism was provided for in Article 18 of the Protocoi ofAccession of China. This mechanism would examine China's implementation of itsobligations both under WTO agreements and under China WPR and Protocol of Accession.China was subject to annuai reviews in the first eight years of its accession and to anadditional review by the tenth year (Lhe last one occurred ia 2011).

It is worth noting that the transitionai review mechanism operated in conjunction with Lheregular Trade Policy Review Mechanism to which ali countries are subject reguiarly. China issubject to reviews each two years tinder the regular mechanism (Lhe first was conducted in

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2006). The combination of both review mechanism made China's economy as the mostscrutinized since its accession, demonstrating the impact of its accession to the MultilateralTrading System.

3. Conchisions

There are several WTO provisions that are not adapted to NMEs. Core principies such as thenational treatment, as well as rules on market access, estabiished in GATT Articie II, facechalienges when appiied to NMEs. Furthermore, even Articie XVII, created to deal with theissue of state-Lrading enterprises show itself as irisufficient to regulate NMEs and to assuretheir compatibility with Lhe Multilateral Trading System.

The WTO members, therefore, decided to require new obiigations from acceding NMEs,imposing substantial economic changes and eiiminating aspects considered incompatibie withthe multilateral system. Considering ali these deep systemic obligations to which China had toadhere before acceding to the WTO, it is fair to argue that WTO members sought to guaranteethe adequacy of China's econorny to multilateral trading mies by demanding reforms thatwould curb Chinese NME features. In this sense, Juha Ya Qin states that "as a result oítheseobligations, whether China practices market econom4' is no longer a mete matter ofdomesticpolicy; instead, it has become a matter o! WTO Iaw"2 O

270 QIN, Julia Ya. "China. India and WTO Law". in SORNARAJAH, Muthucumaraswarny; WANG. Jiangyu.china. Ind/a and me International Econoinic 0Mev. Cambridge University Press. 2010. p 173

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IV.4. NME AND ANTIDUMPING: LEGAL CONSEQUENCES OF 2016

The concept of NME has been particularly important for lhe application of antidumpingduties. The concept has been widely used to justify the application of altemativemethodologies, e.g. third countries' export prices, for lhe determination of normal value inantidumping investigations, concerning exports from NME countries. In this sense, a countrythat has been identified as a NME for antidumping purposes will have the "NMEmethodology" of normal value calculations applied to him.

This methodology has been applied for a long time concerning planned and transition-economy countries, but the risc ol' China as lhe biggest global exporter and its accession to theWTO have shed new light to Lhe issue. It is thus relevant to understand lhe legal aspects of theNME concept in antidumping investigations.

1. The regular system of normal value determination

During an antidumping investigation, Lhe national investigating authority must determine themargin of dumping, i.e. the difference between the export price of a product and its 'normalvalue'. Article 2 of lhe ADA provides three methods to calculate a product's normal value.The main one is based on Lhe product's price in the exporter's domestic market (Article 2.1).

2.1 For the purpose of this Agreenient, a product is to be considereci as being dttmped, i.e.introduced into the commerce of another country at less than its normal value, if the export priceof Lhe product exported from one country to another is Iess than the comparabie price, in theordinary course of trade, for the iike product when destined for consumption in Lhe exportingcouritry.

In this sense, the investigating authority must use the price of the product in the domesticmarket of Lhe exporting country as lhe normal value. There are two possible deviations. Thefirst possibility is when Lhe saies of lhe product in the domestic market have not been made inlhe 'ordinary course of trade' and, thus, cannot be an appropriate basis for 'normal value'. Inthis regard, the AB has stated that:

( ... ) Article 2.1 requires investigating authorities to exclude saies not marte "in Lhe ordinary courseof trade", from Lhe caiculation of normal vaiue, preciseiy to ensure that normal vaiue is, indeed.the "normal" price of Lhe hke product, in Lhe home market ol' Lhe exporter. Where a saiestransaction is concluded on ternis and conditions that are incompatibie with "normal" commercia/pra ctice for saies ol' Lhe like product, in the market in question. at Lhe relevam time.time. the transactionis not an appropriate basis for caicuiating "normal" vaiue271.

The situations wherc lhe ,,ales in Lhe domestic market of Lhe exporting country are not made'in Lhe ordinary course of trade' are established by ADA Articie 2.2:

When there are no saies of Lhe like product in the ordinary course of trade in the domestic marketof the exporting country or when. because of Lhe particular market situation or Lhe iow volumeof lhe saies in Lhe domestic market of the exporting country, such saies do not permit a propercomparison ( ... ). (Ernphasis added).

In íEis case, two aiternatives are available: the price charged by Lhe exporter in a thirdcountry; or a constructed price based 011 the combination of the exporter's production costs,other expenses and normal profit margins. This would be Lhe regular system of normal value

271 AB report in US - Hot-Rolled Sreel (DS 184), para. 140, WT/DS i 84/ABIR151

determination, and any deviation from the use of the price in the domestic market must bemade in a case-by-case scenario and considering the particular market situation of a giveneconomic sector. Note that it is not uncommon for saies ia market-economies' domesticmarkets to be considered as not offering an appropriate basis for normal value considerations,thus entailing Lhe use of exports for third countries or constructed prices instead. This couidbe due, e.g., to low intemai saies volume when compared to the volume exported.

The second possibie deviation is not sector-specific or dependent upon a case-by-caseanalysis, but rather based on a consideration of the whoie economy of Lhe export country asnot offering conditions of "ordinary course of trade". It is established in Lhe Ad Note andrefers to NME countries.

It is interesting to note that there is no direct reference in lhe ADA to alternativemethodologies or lhe use of third countries' export prices in Lhe determination of normalvalue272. The possibility of using alternative methodologies for determining normal value inanti-dumping investigations is present in GATT Article VI, which establishes lhe generalmies under GA11T for anti-dumping and countervailing measures investigations. The Ad Noteto this article was introduced in 1955, at the request of Czechoslovakia, a NME, and statesthat:

2. li is recognized tha, ia Lhe case of imports from a country which has a complete orsubstantially complete monopoly of its trade and where ali domestic prices are rixed hy theState, special difticulties may exist ia determinirig price comparability for Lhe purposes ofParagraph 1, and in such cases importing contracting parties may find ir necessary to take intoaccount the possibility that a strict comparison with domestic prices in such a country may notalways be appropriate. (Emphasis added).

The Ad Note, thus, opens lhe possibility of moving away from lhe regular methods ofcaiculating normal value, since, in countries where lhe State has "complete or substantiallycomplete monopoly of its trade" and where "ali domestic prices are fixed by the State", Lhethree regular methods do not offer a plausible basis for price comparabihty, aithough the notedid not provide which should be Lhe alternative methodology.

Later, the use of lhe surrogate country method for the calculation of normal value in anti-dumping investigations regarding NME established itseif as lhe preferred altemative andstarted to be used by lhe contracting parties to the GATT273.

The appropriateness of this method to deal with lhe issue was reaffirmed subsequently ia theWorking Party reports on lhe accession of several NME countries that later joined lhe GAri'and lhe WTO, indicating lhe preference of lhe CONTRACTING PARTIES to it.

Ir is worth noting that the departure from the traditional methods of calculating normal valuewas inciuded in GATT at Lhe request of Czechosiovakia, which, at the time, was transitioningits economy to a socialist central pianned system. Czechoslovakia argued that the alternatives

272 Articie 2.2.2 (iii) refers to "any other reasonabie method" for Lhe calculation of profits when constructing Lheprice for normal value, but this must be done considering lhe proftt margin normalty realized by other exportersor producers in Lhe domestic market of Lhe country oforigin.273 According to Polouektov, the first anti-dumping investigation in the U.S. to consider a country as a NME wasia 1960, concerning lhe imports of bicycles from Czechoslovakia. See POLOUEKTOV, Alexander, "T/;e Non-Market Econoiny" Issue iii International Trade in the Context of WTO Accessions,UNcTADIDITC/TNCD/MIsc.20, Unctad Report, 9 October 2002. p. 8.

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foreseen in GATT were not proper to caiculate the normal value in centrally plannedeconomies. The country affirmed that "no comparison or export prices with prices in thea'omestic market o! (fie exporting cour#ry is possible when such domestic prices are notestablisbed as a result of fair competition iii that rnarket, but are fixeci by the State ". Themain problem was that, since the prices iriside the country were fixed, they could often behigher than export prices, even if those where based on market assumptions, which led to thedetermination of dumping by other countries and consequent application of antidumpingrights"75

The Ad Note was conceived, in this sense, as an exception to the regular systeni of normalvalue determination, aimed at addressing the possibility of, when deaiing with exports fromNME, finding a greater margin of dumping than would be found if the product's normal valuewas established considering market-economies prices. It was aimed at protecting NMEeconomies.

The GATT mechanism has since seen few developments and has been embodied by the ADA,ia its Article 27. No further adaptation, however, has been made to address the adequacy ofthe exception to the new rules established by the ADA. Furthermore, as the contracting partiesto the GATT had the autonomy to determine which countries would fit in the Ad Notedefinition, as well as the adequate alternative method, the concept gradually expanded toinciude ali NME countries, not only those that had a complete or substantially completemonopoly of its trade and where ali domestic prices were üxed by the State. Several countriesas the US, the EU and Brazii, started to compose lists of countries that would fit thedescription of NME and be subject of the surrogate methodology during anti-dumpinginvestigations. The majority of these countries would hardly fit perfectly in the 1955description of a NME, demonstrating the evolution of the concept nationally.

The regular system of normal value determination offers, ia this sense, two possibilities ofdeparting from the price of saies in the domestic market of the exporting country. The firstone may be applied when the domestic market does not offer "conditions that are compatiblewith "normal" commercial practice"276 (i. e. market conditions) for the particular product. Thesecond one is an exception provided for dealing with countries whose economies are deemedto, in general, not offer normal market conditions - the NME countries. The first must beanalyzed in a case-by-case context, while the second entails the application of the surrogatemethodology for ali anti-dumping investigations concerning the NME country.

2. The special system of normal value determination

The accession of NMEs to the WTO has created, however, another possibihty of usingalternative methodologies in determining normal value ia anti-dumping irtvestigations. In theaccession documents of Viet Nam 277 and of China278 a special system for the determination of

274 GArI', Article VI - Emposais by die Czechosiovakia Delegation - Revision, W.9/86/Rev. 1, Review WorkingParty 11 cm Tariffs, Schedules and Customs Administration. Contracting Parties Ninth Session, 2 1 Deceniber1954, W.9/86/Rev. 1275 GATI. Anti -Durnping and Countervailing Duties. A'íernoranda received from the governinents o!Czechoslovakia and Swenden, 26 November 1958, L/943. para. 8-11.276 WTO, AB, US - .4nti-Dumping Measures on ('ertain Hot-Rolled Steel Products froni Japan (DS184),WT/DS 1 84/AB/R, AB Report adopted on 24 July 200!, para. 140277 See WTO, Report oídio Working Party on the Accession o! Vier A tarn, WT/ACC/VNMJ48, II January 2007,para. 255.

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normal value is provided. Both are very similar and we will reter to the one present ia China'saccession protocol since it has been the source of much debate.

Article 15 of China's Accession Protocol establishes, in the relevant parts to this analysis,that:

IS. Price Comparability iii Deterrnining Subsidies and Duinping(...)(a) In determining price comparability under Article VI of lhe GAIT 1994 and lhe

Anti-Dtimping Agreement, the importing WTO Member shali use either Chinese prices or costsfor the industry under investigation or a methodology that is not based on a strict comparison withdomestic prices or costs in China based on lhe foliowing ruies:

(1) If the producers under investigation can ciearly show that market economyconditions prevail in the industry producing the like product with regard to themanufacture, production and saie of that product, the importing WTO Member shali useChinese prices or costs for the industry under investigation in determining pricecomparability:

(ii) The importing WTO Member may use a methodology that is not based on astrict comparison with domestic prices or costs in China if the producers underinvestigation cannot ciearly show that market economy conditions prevail in theindustry producing the like product with regard to manufacture, production and saie ofthat product.

The special systein created by Article 15 provides two alternatives for calculating the normalvalue in anti-dumping investigations concerning exports from China. The investigatingauthority can either use Chinese prices or costs for the industry under investigation or analternative methodology. In this sense it is similar to the regular systeni but to the fact that noreference is made to the use of export prices to third countries. In this case, however, the mainrnethod of normal value determination is not the use of the prices of the domestic market(China), but rather the alternative methodology.

Article 15(a)(i) and (ii) determines that in order for the investigating authority to use Chineseprices or costs, the producers of the industry under investigation must cicarly show thatmarket conditions prevail in their sector. This means that the burden of proof lies in theexporters side to prove that their sector offers market conditions and that, in this sense, thesaies made in the domestic market can be considered as in the 'ordinary course of trade'.Otherwise, Article 15(a)(ii) states that the aiternative methodology may be used. As seenabove, this alternative methodology has estabhshed itself in the practice of WTO members asbeing the use of surrogate countries' prices.

This special systern of caiculating normal prices ia anti-dumping investigations againstexports from China wiil be in place until one of two situations applies. Article 15(d) statesthat:

(d) Once China has established, under the nationai law of the iinporting WTO Member,that iL is a market economy, the provisions of subparagraph (a) shaii be terminated providedthat the importing Members nationai Iaw contains market economy criteria as of the date efaccession. In any event. the provisions of subparagraph (a)(ii) shall expire 1 5 years after the dateof accession. In addition, shouid China establish. pursuant to the nationai iaw of the importing

278 See WTO. Pmtocol o! Accession ofPeople s Republie o! C/zftza to the World Trade Organization, WT/L/432,23 November 2001. Article IS. p. 8-9

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WTO Member, that market economy conditions prevail in a particular industry or sector, lhenon-market economy provisions of subparagraph (a) shall no tonger apply to that industry orsector- (Emphasis added)

The first situation provided for in Article 15(d) is when China establishes itself as a marketeconomy under a WTO member national law, i.e., when a WTO member considers China tobe a market economy under its law. National laws of WTO members vary broadly in relationto NME concept and recognition. In any case, when this happens, ali the provisions of Article15(a) shall cease to apply. This means, in practice, that Lhe whole special system will beterminated. This is only logic since, whenever a country decides that China is a marketeconomy, there are no justifications for applying altemative methodologies that are based onthe inexistence of rnarket conditions. This recognition will also have impacts for Lhe regularsystem of normal value determination, as will be further explored below.

It is importam to note that, in order to this first situation to be valid, the importing rnember'snational law must have contained market economy criteria as of Lhe date of China's accession.This was included in the Article, presumably, to avoid political pressure by China to forcecountries that did not previously use the NME concept in their anti-dumping investigations toadopt such laws and recognize China as a market economy.

Note that under Lhe regular system WTO members are not obligated to apply the exceptioncontained in Lhe Ad Note or have national laws previewing the application of alternativemethodologies in anti-dumping investigations concerning imports from NME countries. Theymay do so. In Lhis case, countries Lhat do not have legal provisions concerning NME countrieshave only Lhe special systein to rely upon when applying alternative methodologies ininvcstigations concerning imports from China.

Another possibility is that China proves that market conditions prevail in a specific sector orindustry, but not for its entire economy. In this case, Lhe provisions of Article 15(a) will ceaseto apply, i.e. Lhe special system will be terminated, but only for Lhis particular sector.

The second situation, when Lhe special system wili cease to exist, is after 15 years of Lhe dateof China's accession to Lhe WI'O. In this case, however, Article 15(d) states Lhat only theprovisions of Article 1.5(a)(ii) will expire, talher than ali. Lhe provisions of Article 15(a)provided for in the first situation. This means that even after 15 years of China's accession,Article 15(a)(i) will continue to be applicable until China is considered by Lhe investigatingcountry as a market economy.

The precise meaning of this legal passage has been subject to increasing scrutiny and debate.A concrete legal analysis is due in order to fuliy understand Lhe meaning of 2016.

3. 2016—Is it the end?

As seen, there are two different systems for establishing lhe normal value in anti-dumpinginvestigations regarding exports from NME countries. In Lhe regular system, a country cancither apply one of Lhe three methodologies provided for in Lhe ADA or consider the countryof origin as a NME to apply Lhe Ad Note exception and use an alternative methodology, e.g.,Lhe surrogate country.

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The special system, provided for in Articte 15 of China's Accession Protocol, on the otherhand, does not require, necessarily, a country to consider China as a NME in the context ofthe Ad Note. On the contrary, the system reverses the burden of proof and establisbes thealternative methodology as the one to be applicabie to imports from China, as long as Chineseproducers do not prove that market conditions prevail in their sector or as long as China is notrecognized by the importing country as a market economy. Finaily, 2016 hangs as a deadlinefor the application of the special system.

Much debate has taken place about the 2016 deadline. Positions vary from the understandingthat no change has to be made by investigating authorities 279 to a broad objective recognitionby WTO law of the market status of the Chinese economy 220 . Although the Protocol ofAccession has been widely criticized for its lack of legal acuity, the mies of treatyinterpretation present in the Vienna Convention on the Law of Treaties can be of help to solvethis dilemma.

According to Article 31 of Vienna Convention lIa] treaty shall be interpreted in good faith inaccordance with the ordinary rneaning to be given to the terms o!' the treaty in their contextand iii me light of lis object and purpose. From this Article derives the principie of textualapproach in interpretation and that every term present in a treaty must be given an ordinarymeaning. In other words, there can be no term in a treaty that is void of sense28t.

The Protocoi of Accession makes a clear differentiation between the two situations where thespeclal system ceases to apply in its entirety. Article 15(d) states that, in the first situation, i.e.,when a country recognizes China as a market economy, ali the provisions of Articie 15(a)cease to apply, while in the second situation, i.e. in 2016, only Article 15(a)(ii) will cease toapply.

In this sense, in order to give fuli meaning to Article 15(d), iii 2016, the special system willpartially cease to exist and countries that relied only upon it to apply alternativemethodologies for normal value determination in anti-dumping investigations against exportsfrom China will have to discontinue doing so. This does not mean, however, that Lhe regularsysteni will also cease to exist. Members to the WTO wilt continue to be able to use theexception of the Ad Note to deal with normal value determination for products from NMEcountries, as long as they consider them to fit in Lhe Ad Note's quahfication.

Article 15(d), though, creates a special situation concerning China, since it establishes that,after 2016, Article 15(a)(i) wiill continue to be apphcabie. Article 15(a)(i) opens the possibilityfor Chinese exporters and manufacturers to prove that, in their respective sectors, marketconditions exist. This reminiscence of the special system wili create a possibihty for Chineseexporters which is not open for the exporters of other NME countries under the Ad Note'sregular systern.

279 See O'CONNOR, Bernard. Market-econoniy status for China is not autornatíc. VoxEu 27 November 2011.Available ar hup://www.voxeu.or2/index.phc?cl=node/7345. Last access on 01.03.2012.280 See OAO. Henry, ffyou don 't believe Lo the 2012 rnyth, do you believe ia the 2016 myth?. WTO and China,20 Noveniber 2011. Available at lutp://wtoandcliina.blospot.com/20I 1/1 I/if-you-dont-believe-in-201 2-myth-do-yoii.html. Last access on 01.03.2012.281 For further analysis on the rules of treaty interpretation see BROWNLIE, lan, Prnciples o! PublicInternationalLaw, Fifth Edition, Oxford University Press, 2002, pp. 631 to 638.

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This interpretation makes sense if we look at the first situation, i.e. where a countryrecognizes China as a market economy. In this case, ali of the provisions of Article 15(a)cease to exist. If so, it would make no sense to maintain the application of Article 15(a)(i)since the rnentioned recognition will prevent the country from using the exception to theregular system provided for in the Ad Note. If it recognizes China under its national law to bea market economy, it will not be able to apply the alternative methodology provided for in theAd Note. This rationale links the two situations to the existing practice at the time of China'saccession negotiations. Furtherrnore, the direct reference in Article 15(d) to lhe national iawof lhe WTO mernbers relating to market economy recognitions supports this interpretation.

The alternative interpretation that iii 2016 there would be an objective recognition of China'smarket econorny condition wouid entail two legal inconsistencies. First, it would not give aproper ordinary rneaning to Article 15(d) since it provides for two different situations withtwo different legal consequences. By arguirig that, in 2016, the special system would cease toexist, this interpretation would consider void of meaning the fact that Article 15(a)(i) wouldcontinue to exist, while if the recognition was rnade under the national law of Lhe WTOmember, ali of Article 15(a) would be terininated. The legal consequences wouid be the sarnefor both situations, contrary to what establishes the textual approach to treaty interpretation.

Besides, the remaining Article 15(a)(i) would be void of purpose, since, if every WTOmember had to consider, from 2016 ou, China as a rnarket econorny, what would be thepurpose of Chinese exporters to prove that there are market conditions in their sector?

The second inconsistency is that, if WTO mernbers were obligated to recognize China as amarket econorny ipsis litteris and ad infinitum, for anti-dumping investigation purposes,China would be Lhe only country Lhat would be protected from the application of the Ad Note.Other NME' countries that do not have the sarne deadline established in their accessiondocuments (or were not subject to accession, i.e. original members) wouid be treateddetrimentaily.

On Lhe other hand, the interpretation that nothing wouid change after 2016, i.e. that therewould be no consequence for the national laws of WTO rnembers, also fails to give fulirneaning to Article 15(d).

2016 will be the end of the special systern of normal value deterrnination but will nol affectthe regular system and the Ad Note mechanisrn. Countries which already relied uponal.ternative methods provided for in the Ad Note to calculate normal values in anti-durnpinginvestigations regarding NME countries, such as Brazil, US and EU, will continue to be abieto do so.

Christian Tietje and Karsten Nowrot282, aithough stating a similar interpretation to the presentone, consider that it wouid be difficult for WTO Mernbers to continue to consider China as aNME and apply the Ad Note rnechanism to it, since its definition is hardly apphcable to anyexisting WTO Mernber. In this sense they state that:

For !awyers and governmentat officials clealing with anti-dumping law and practice. the IIDecember 2016 is certainly not a myth - it is reality. From that date onwards, it will be aíniost

2S2 TWTJE, Christian and NOWROT. Karsten, "Myth or Reality? China's Market Economy Status under WTOAnti-Dumping Law after 2016", PoJicy Papers on Transnational Economic Law. No. 34, TransnationalEconomic Law Research Center. December 2011.

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impossible - at Ieast from the perspective of WTO iaw - to make a determination of lhe normalvalue of products targeted by an antidumping proceeding on lhe bases of analogous third countrymethodology. The only possibitity to do so wouid be to make a positive, explicit determination ofChina's NME-status based on lhe second Ad Note to Art. VI: 1 GATT 1994. However, taking mb

acçount lhe high threshotd stipulated in lhe second Ad Note to Art. VI: 1 GATT 1994. chances toconvincingly and thus successfully do so are aimost non-existing283.

Although we dispute that in 2016 a renewed affirmative of lhe NME character of China wouldhave to be made by WTO Members that seek to continue to apply lhe alternativemethodology 284, there is a wide perception that such an affirmative would be difficult tosustain under WTO law. We further analyze lhe NME concept in the Ad Note and its scope.

4. Is the NME concept in the Ad Note impossible to reach?

As seen above, lhe Ad Note was conceived 57 years ago to address lhe particular case ofCzechosovakia. The concept included in lhe Ad Note has since evolved and was reaffirmedas a plausible alternative for normal value considerations in anti-dumping investigationsagainst NME countries in several accession documents. The national laws have also beenadapted, exploring different aspects of NME and the use of the surrogate countrymethodology.

The Ad Note however has not seen any such adaptation and has been integrated as it is imolhe ADA thus, into lhe WTO system. Until recently, there was no interpretation from lhe DSBthat would offer some clarification to whether the practice developed by WTO Members inlhe application of lhe Ad Note mechanism was in disrespect of lhe textual conditions. Thecase EC - Fasteners, however, offered such an opportunity, which was ceased by lheAppellate Body (AB). 1n a footnote to its decision on the case, Lhe AB stated that:

We observe that lhe second Ad Note to Artícle VI: 1 refers to a "country which has a complete orsubstantially complete monopoly of lIs trade" and "where ali clomestic prices are fixed by theState". This appears to describe a certa/a type of NME, where lhe State monopolizes trade and seIsali domestic prices. The second Ad Note to Article VI: 1 would thus not on its face be appllcableto lesser fornn of NMEs that do nol fulflil both conditions, that is. the complete or substantiallycomplete monopoly of trade and lhe fixing of ali prices by the State 5 . (Emphasis added).

In this sense, the AB argues the existence oU different leveis or fornis of NMEs. The ones thatwould entail lhe application of the Ad Note mechanism, i.e. alternative methodologies, wouldonly be those that fulfili both conditions entirely: complete or substantially completemonopoly of trade and the fixing of ali prices by lhe State. According to this statement by lheAB, it would indeed be highly improbable that any WTO member would fulfill, today, bothconditions.

The direct application of lhe 1955 concept to today's reality does not seem, however, to fullyapply lhe approach of interpretation provided by lhe Vienna Convention of the Law of

283 Ibid, p.l 1

There is no such obligation in lhe Accession Protocol and ir would be unto lhe interested part to seek disputesettlement if it feeis that the provisions of lhe Ad Note are being misapplied285 WTO, AB, EC - Definitive A nti-Dwnping Measares on Cèrtain Iron or Steel Fasieners from China (DS397),WT/DS397/AB/R, AB Report adopted on 15 July 2011, para. 285, footnote 460.

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Treaties, which has been more than once indicated by the AB as relevant 1aw 286 . Article 31,paragraph 2 of the Vienna Con.vention states that:

2. The context for the purpose of lhe interpretation of a treaty shall comprise, in addition to lhetext, including its preamble and annexes:(a) any agreement relating to Lhe treaty which was made between ali the parties in connection withLhe conclusion of lhe treaty;(b) any instrument which was made by one or more parties in connection with the conclusion ol'the treaty and accepted by Lhe other parties as ao instrument related to Lhe treaty.

In this sense, the Ad Note must be read in the context of other "agreement(s) relating to thetreaty". The Protocois of Accessions and Working Party Reports (WPR) of the NMEcountries that acceded to the GATT after the creation of the Ad Note in 1955, ali refelTed tothe concept in the Ad Note as being adequate to deal with the economies of the accedingcountries. The Ad Note was usually referred to in the WPR of NME acceding countries as aoadequate mechanism to deal with price comparabiiity probiems in Anti-dumping investigationsconcerning imports from these countries. The mention to the Ad Note was reproduced lo LheAccession of Poiand 287 '88

, Romania and Hungary 289 . In other words, the CONTRACTINGPARTIES considered that the definition present in the Ad Note fitted the acceding members'economies.

The Flungary WPR made a direct reference to the Ad Note, especially regarding the surrogatecountry rnethodology290. The case of Hungary, however, was different from the precedemNME accessions of Poland and Romania. Differently than those two countries, therequirements made by GATT contracting members in Hungary Protocol of Accession werelighter than those present in the accession of Poland and Romania. Hungary acceded in 1973but had already started major economic transformations through its New EconomicMechanism (NEM).

The NEM comprehended a series of reforms airned at decentralizing Hungary's economy andaflowing for market economy conditions to determine part of its internal prices. Also, therewas a relaxation of state monopoly of foreign trade as weB as the establishment of importtariffs. It was considered as the "most radical postwar change" of any Comecon country 29 ' andthose reforms were acknowledged by a GATT trade report Lhree years before the accession ofHungary to the a- 292

Notwithstanding Lhe differences between the 1-lungarian econoniy and Poland and Romania'seconomies at the moment of their respective accessions, the CONTRACTING PARTIESfound that the special provisions of the Ad Note would fit their economic situations alike. It

286 See WTO, AB. US-Standards o! Re!orruulated and Conventional Caso/me, WTIDS2/AB/R, AB Reportadopted on 29 April 1996, p. 23; See also WTO, AB, Japan - Taxes ou A/cobolic Beverages, WT/DS81ABIR,AB Report adopted on 4 October 1996, p. 12.287 GAIT. Accession o! Po/and, 19 September 1967, U285 1. para. 8; and GATT. Accession o! Po/and - Repono!the Working Party, L/2806, 23 June 1967, para. 13288 GATIT, Accession o! Romania to tbe CA7T- Repor o!the WorkingParty5 August 1971, L/3557, p.3289 Accession o! Hungary to flue CÁ TT - Report o! the Working Party, BISD § 205/34-38 (TwenticthSupplement, Twenty-Ninth Session, [971-1972), January 1974. p. 3290 Jbid, para. 18291 GRANICK David. vrhe Hungarian Economic Reform". World Politics, Vol. 25, No. 3., April, 1973. pp.414-429.292 GATT, Accession ofHungary - meinorandum ou Foreign Trade Regime, U330 1, 26 January 1970

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is, thus, difficult to retain a restrictive and crystal!ized interpretation of the concept of NMEpresent in the Ad Note.

If one was to apply this concept in lhe lines of Lhe AB decision, Hungary, which at Lhemoment of accession no longer fixed afi 0w prices ia its domestic rnarket, as acknowledgedby lhe CONTRACTING PARTIES thernselves, would not fit the definition and would not bea suitable country for the application of Lhe surrogate country methodology. Nevertheless, theCONTRACTINO PARTIES decided differently, clearly considering that the concept in theAd Note had evolved.

Even Poland, that followed more strictly the soviet economic model, did not fully fit Lhe strictdefinition of the Ad Note. In this sense, Horlicic and Shuman stated that:

The GATT Working Party, considering Poland's accession to the GArE, expticitly declared itsunderstanding that Lhe nonmarket exception to Lhe antidumping normal value test would apply toPoland. This is interesting in two respects. It suggests that in lhe eyes of Lhe GATI' one need nottake at face value lhe apparently slrict GATT rcquirement for application of lhe NME exceptionthat a country have "a complete or subslanlially complete nionopoly of its trade" and that "alidomestic prices [be] fixed by lhe State." Even ia 1967. Poland probably did not fit this test if itwere rigorously applied.293

This shows that, since Lhe beginning, Lhe CONTRACTING PARTIES took a f!exibleapproach on Lhe application of the Ad Note, allowing its application for severa! differentNMEs, differently to how iL was interpreted by Lhe AB.

In this sense, Lhe NME concept present in the Ad Note cannot be considered the sarne as whenli was created in 1955, thus aliowing for an evolutionary approach that takes intocotisideration the ways it has been applied by the contracting parties to the GATT during Lhesubsequent years, especially regarding lhe accession of NME countries. Due flexibility mustbe accorded to the concept's interpretation.

5. Conclusions

The subt!e distinction between the first and second phrase of Articte 15(d) of China's Protocolof Accession disguise an irnportant difference in lhe app!ication of alternative methodologyfor normal value determination in antidumping investigations against exports frorn Chinaafter 2016.

The 2016 deadline makes the special system to partial!y cease to exist. This means thatcountries that relied solely upon Lhe provisions of Article 15 of China's Protocol of Accessionto apply the alternative methodology wi!l have to cease to do so. Nevertheless, the regularsystem remains applicable: i.e. the exception present in the GATT Article VI Ad Note can stitibe used by WTO rnembers on investigations against NME countries, as tong as they considerthem to fit in Lhe Ad Note's qualification. Only if a country recognizes China as a marketeconorny, under lis national law, wi!l he be prevented from using lhe exception of lhe regularsys tem.

293 HORUCK, Gary; Shuman. Shannon. "Nonmarket economy trade and U.S. Antiduniping/CountervailingDuty Laws". Thc International Lawyer. v. IS, n. 4. 1954, p.834

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Here ir is important to recail the need to undertake an evolutionary interpretation of the AdNote, as ir was made by lhe Contracting Parties through GATT history, aliowing a moreflexible approach to the concept of NME.

A careful interpretation of Articie 15 (d) of China's Protocol of Accession shows that Lhedeadline of 2016 does not imply the end of the use of the aiternative methodology for thenormal vaiue determination in antidumping investigations against China. The Ad Note ofGATI' remains appiicabie, regardless of the provisions of the Protoco! of Accession and thedeadline shali only have effect over the special system created under the Protocol.

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IV.5 CONCLUSIONS ON THE NME ISSUE

The present study has anaiyzed lhe systemic chailenges posed by the integration of NMEsinto the Multilateral Trading System. The reiationship between market and plannedeconomies has seen an interesting evolution on how the GATT and the WTO dealt with thespecificities of trade between the two economie systems. The accession of China has, in thissense, required 15 years of intensive negotiations, including extensive economic and legalanalysis to conclude a set of systemic adaptations required of China so as to allow for itsaccession.

These systemic adaptations comprise obligations in the fields of: foreign exchange; stateownership and privatization; pricing policies; trading rights; subsidies; industrial policy; statetrading enterprises; investment; rule of law and transparency. These obligations wereconsidered by lhe members of lhe WTO as indispensable for the establishment of a leveiplaying field regarding trade with China and for lhe well-funetioning of the WTO legal order.

After 10 years of China's accession, however, trade disputes and tensions between China andsome of the most important members of the WTO, especially the US, have arisen overChina's compliance of WTO obligations. In the wake of the worst financial crisis since theGreat Depression, trade rows and resentment over China's trade and industrial policies havebeen present daily in international and local news. This study argues that much of the tensionexpressed by men1bers of the WTO is due to the fact that the Multilateral Trading System isnot apt to deal with NME features still present in China's economy.

By analyzing some key NME features of lhe Chinese economy - notably, the exchange ratemanipulation; the economic importance of SOEs and their relationship to the centralgoverument; and the subsidization of its economy - this study has demonstrated that Chinahas not, yet, promoted the reforms needed in order to completely adapt its economy to theMultilateral Trading System. Most alarming, the international press, experts andgovernmental offices are expressing their concerns that China has slowed the pace of reforrnand gives signs of not intending to move forward with the liberalization of its economy294.

The analysis of China's Accession Protocol and Working Party Report demonstrates thatthere was an expectation by WTO members that China would move towards a inarketeconorny by impiementing the systemic adaptations provided for in those documents. Thenon-fulfillment of this expectation, especially with the proximity to lhe symbolic 2016deadline, has paved the way for extreme ideas of how to deal with lhe situation, some evenproposing the revocation of China' s membership to the WTO.

The Multilateral Trading System, however, has provided for rnechanisms to deal with thebreach of trade obligations. A WTO member has lhe right to address the DSB if it believesthat another member is not complying accordingly with its obligations under WTO Law. Thisstudy analyzed briefly the options of WTO members regarding the fulfiliment of China'sobligations in relation to NME features. Further fact and data collection would be needed inorder to build a case against China, but the obligations toward a market economy that arepresent in its Protocol of Accession are judiciable in the same inanner as other WTO rules.

294See, inter alia, LJCESRC, 2011 Report to Congress of US-China Econornic and Securiy Review Corninission,112h Congress, 1 ` Session, November 2011.

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More broadly, however, the complex scenario of the presence of NMEs in the MultilateralTrading System is not a new one. Neither, as iL has been seen in the case of Czechoslovakia, isit impossible for countries to adopt NME features that would demand considerable adaptationof WTO law. The Multilateral Trading System, in its present state, does not offer thenecessary mechanisms to allow a leveled playing field in trade between market and NMEs.

Besides a cornprehensive adaptation of WTO rules, two more immediate solutions can beundertaken te deal with the tension concerning NME features in the WTO.

One possibility would be the creation of a special Working Party to analyze thoroughly theimpacts of NMEs te the Multilateral Trading System. The Working Party on NMEs wouldanalyze both economic and legal adaptations to trade niles iii order to allow for a fair tradebetween ali parties involved. It woutd also identify which NME features were the mostharmful to international trade and pressure for the end of such features in the economies ofevery WTO member.

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V. ARGUMENTS TO BUILD A CASE AGAINST CHINA

Reviewing the main features of China's participation in the WTO, in the presem moment,some concerns can be expressed about lhe compliance of China with lhe commitments madeupon its Protocol of Accession. Some of its policies, as it was presented in Chapters III andIV, can cause significant negative impacts on other members markets, by granting Chineseproducts some competitive advantages that were not or could not be foreseen ai the momentof lhe negotiation of its accession and, thus, result in a change in the equilibrium ofnegotiations on which the WTO is based.

Such imbalances could either arise due to a violation of China's commitments to the WTO orcould constitute a non-violation, which might nonetheless be subject to consultation and evena complaint under lhe DSB.

1. Exchange rate misalignments

The first concem related to unfair competitiveness of Chinese products is lhe one conferredby exchange rates. Several economctric estimates show that lhe Chinese currency isdevaluated &om 1.5% tili. 20%, causing advantages on Chinese exports and disadvantages toother members' exports, as shown in Chapter 111.1.1., having impacts both on Chinese importsand exports.

Regarding imports, the Chinese currency would represent a greater barrier to foreign productsthan lhe one that was negotiated at lhe WTO, in China's Schedule of Concessions. If thetariffs adjusted to the exchange misalignment surpass the bound tariffs, there will be alimitation on lhe country's market access.

Regarding exports, Chinese products would have an advantage equivalem toto the oneconferred by subsidies, since by the conversion of currency based on a devaluated exchangerale, these products will have a smaller price when exported to other countries than theywould have if lhe conversion was being made based on a exchange rate at its equilibrium.

Both these impacts could constitute a violation of some of WTO provisions, as presented in adeeper analysis made in Chapter 111.1.2.

There are a few provisions under lhe WTO agreements that can be applicable to the exchangerale issue. A more developed case study is, nonetheless, required in order to conclude on lhepossibility to chailenge China under lhe DSB due to its currency devaluation. Somearguments are developed here.

The above mentjoned limitation on lhe Chinese market access could constitute a violation ofGATT Article 11.1, which states:

(a) Each contracting party shall accord to the comnerce of lhe other contracting parties treatment noless favourable than that provided for in lhe appropriate Part of lhe appropriate Schedule annexed to thisAgreement.(b) The products described in Part 1 o! lhe Schedule relating to any contracting party. which are lheproducts of territories of other contracting parties, shall, on their importation into lhe territory to whichlhe Schedule relates, and subject to lhe ternis, conditions or quatifications ser forth in that Schedule, beexempt from ordinary customs duties in excess of those set forth and provided therein. Such productsshall also be exenipt from ali other duties or charges of any kind imposed on or in connection with lhe

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importation in excess of those imposed on the date of this Agreement or those directly and mandatorilyrequired to be imposed thereafter by legislation in force in the importing territory on that date. ( ... )

Paragraph 1(a) assures that the market access negotiations made at WTO are not impaired byany treatrnent imposed by a member that might increase or impose new barriers tointernational trade, reducing such market access. In this sense, a "!east favorable treatrnent"should be understood as a measure that adversely affects the conditions of competition for aspecific product On its turn, Paragraph 1(b) requires countries to keep their applied tariffs inan equal or lower level than their bound tariffs and to not impose any other kind of dutyconnected with importation that exceeds the negotiated duties under lhe WTO.

When lhe effect of lhe current Chinese devaluated exchange rate is applied on its tariffs, lhefinal barrier imposed to imported products will be greater than its bound tariffs at the WTO,reducing the market access, which negativety affects the conditions of competitiori resulting,thus, on a less favorable treatment. This effect c!early impairs the aim of Article 11.1.

To constitute a violation, however, one must prove that such less favorable treatment isaccorded by a measure of the Chinese government and it is not a resu!t of other externa!circumstances.

Furtherrnore, tariffs adjusted to the exchangc rate misalignment may be considered as chargedin excess of the ordinary customs duties settled on the Chinese Schedule. The renminbidevaluation increases all applied tariffs over the bound tariffs. This tariff in excess of thebound tariff would constitute a de facto violation of Article 11:1(b) — and consequent!y ofArticle 11:1(a), since thcre is a reduction on the market access.

Even if one considers that there is no violation of the lelter of Article 11:1, it is still possible toargue that its intent has been frustrated, since there are adverse effects on the conditions ofcompetition. In this case, lhe frustration of such aim may give rise to a chaflenge under GATTArticle XV:4, combined with Article II.

Artic!e XV:4 states that:

Contracting parties shalt not, by exchange action. &ustrate the intent of the provisions of this Agreement,by trade action, the intent of the provisions ol' the Articles of Agreenient of the International

Monetary Fund.

The provision recognizes that exchange rale issues can affect internationat trade and demandsWTO members to avoid exchange rale measures that could harm any of the purposes ofGATT.

In order to determine a violation of Article XV:4, it must identified that a provision of GATT(Article 11.1, in this case) has had its intent frustrated, even if there has been no violation ofthe letter of the Article. The meaning of lhe word "frustrate" is given in the Notes andSupplenientary Provjsions (Annex 1) of Article XV, which explain that its intention is:

(...) to indicate, for example, that infringemenls of the Ietter of any Article of this Agreement byexchange action shall not be regarded as a violation of that Article if, in practice, there is no appreciabtedeparture from the intent of the Article. ( ... )

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Exchange actions operated in accordance with the Articles of Agreement of IMF wi!l not bedeemed to contravene GATT Articles because there is no departure from the inlent of thoseArticles. In order to find a violation of Article XV:4 it is, thus, necessary to find a violation ofArticle IV of IMF's Articles of Agreement, which specifica!!y dea!s with exchange rate.

To declare a violation of Article XV:4, combined with Article 11:1, it is also necessary todetermine that China is taking an exchange action which is having consequences on trade,therefore frustrating the intents of WTO. One has to argue that China is implementing adistinguishable policy to devaluate the renminbi and that this policy can be c!assified asexchange action.

If a member can present evidence that the Chinese exchange policy is an exchange action andthat it is frustrating the intent of GATT Article II:!, there wili be a violation of Artic!e XV:4,that could be object of a complaint under the DSB.

Besides the instruments argued above, one can also resort to a non-violation comp!aint.GATT Article XXIII:! (b) states that, if a member considers that a benefit accruing to iL isbeing nuliified or inipaired as a result of Lhe application by another member of any measures,whether or not it conflict with the provisions of GATT, the member may take the issue to theDSB.

The reason.ing of a non.-violation comp!aint is Lhat some measures, even if consideredconsistent with. GATT, can frustrate competitive opportunities, legitimately expected fromtari.ff concessions. Therefore, it is necessary to provide means to redress the misbalancecaused by such measures, even though there is no direct violation of GATT provisions.

The currently devaivated reriminhi, which is presenting an impact of nullifying othermembers' tariffs, cou!d be considered as affecting the market access accorded by other WTOmembers. This couid give risc to a complaint of non-violation if three elements are met:appiication of a measure of currency devaluation by the Chinese government; the existence ofa heneíit accruing to WTO members, in the case, Lhe of balanced levei of concessionsbetween members, as weil as the benefit of the negotiated Chinese market access; andimpairment of these benefits (incentive to Chinese exports, that affect the balanced levei ofmarket access and the restrictions caused on its own market access by the devaluatedcurrency) as result of the application of the measure of currency devaivation.

First, one has to argue that there are govemmentai policies that aim to keep exchange rates ina certain levei be!ow its fundamental equi!ibrium and that those policies couid be consideredas a measure under the meaning of Articie XXIII. It is importam toto notice that the Articierequires an action by a government, which results on Lhe misa!ignment. The misaiignmentitself cannot be object of a complaint under Article XXIII.

Regarding the irnpairment of the benefit, it should be understood as upsetting the competitivere!ationship between domestic and imported products, c!early caused by the measure at issue.It is possible to argue that in a Chinese market with devalued currency, other members willface a more restricted market access, with higher tariffs, once considered the effects ofexchange rates, which can easi!y be c!assified as an impairment of the legitimate expectationof irnproved market access. The opposite reasoning can also be done: when China exports itsproducts using a devaluated exchange rate, it is, by giving an incentive its exports through adeva!ued exchange rate, making other members concede a !arger market access than the one

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that was negotiated, impairing expectations of a balanced levei of concessions between thesemembers and China.

An important aspect of those expectations on such benefits is that, in order to it be legitimate,lhe measure of currency devaluation must not have been reasonably anticipated at the time ofthe tariff concessions.

Article XXIII may be a useful action to redress the negative impacts caused by the devaluatedChinese exchange rate.

The provisions presented above are the possible tools that could be raised on an eventualcomplaint against China due to its exchange rate misalignments. Further analysis of Chineseexchange rate policies and measures is required in order to evaluate the concrete measuresapplied by China.

2. Commitments on subsidies, state owned enterprises and other NME features

China's Protocol of Accession provides a series of obligations to which China should commitregarding the functioning of SOEs and the granting of subsidies. As shown in Chapters 111.2and 111.3, these two features of Chinese economy are of great importance since they can causesignificant distortions on competition with Chinese products impacting on other members'imports and exports.

Considering severai commitments made by China and the current stage of transition ofChina's economy, especially relating to the massive granting of subsidies and theadministration of SOEs, one can ask if, ten years after its accession, China is complying withthe WTO.

Some difficulties arise to complete this analysis: the lack of transparency of Chinesegovemment regarding the disclosure of the list of its subsidies programs and the data aboutSOEs makes it difficult to obtain up-to-date and complete information. The considerationsmade hereinafter are only indications of possible violations of Chinese commitments. Adeeper analysis wouid be required in order to state that there is a violation of suchcommitments.

Regarding subsidies, China committed itself to eliminate ali export subsidies, including thoseon agricultural products (Protocol of Accession, Articles 10.3 and 12.1). Subsidies areconsidered by the WTO as unfair trade, as they can cause distortions on international trade.The SCM considers a subsidy as: (i) a financial contribution by a public body (such as loansand guarantees, fiscal incentives, provision of goods and services, etc) or any form of incomeof price support; and (ii) that confers a benefit (SCM Article 1). It is important to stress that asubsidy may be granted by any public body, including local govemments, central governmentand ali other administrative leveis.

The Agreement classifies subsidies imo two categories: export subsidies and subsidiescontingent upon the use of domestic goods, that may give rise to a complaint under the DSB,as specific subsidies. Specific subsidies that cause injury to the domestic industry of anothermember may be object of countervailing duties. Specific subsidies that nullify or impair othermembers' benefits accruing from the GATT or that cause serious prejudíce to the interest ofanother member may be chailenged at lhe DSB.

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China presents significant amounts of subsidization of its econorny. lis stimulus packagecalcu!ated in 2010 by the US amounted to 13% of its GDP, and included several kinds ofsubsidies295.

Several of these subsidies, once demonstrated their specificity, may be object ofcountervailing duties if they cause injury in other members' domestic industry. The specificsubsidies can a!so be taken to Lhe DSB if they impair another member's benefits accruingunder GATT or if they cause serious prejudice to the interests of another member, i.e. if it isaffecting other members' exports by an unfair competition at the domestic market of a thirdcountry.

Furthermore, it should be noticed that China's Protocol of Accession provides that subsidiesprovided to SOE will be viewed as specific if SOEs are the predorninant recipients or receivedisproportionate!y large amounts of such subsidies (Article 10.2).

Besides those actionabie subsidies. several subsidy programs that are oriented to boostChina's exports were identified. Those subsidies, such as tax reductions for export-orientedFIEs, tax reductions for FIEs and other foreign enterprises purchasing Chinese inadeequipment; VAT rebates on FIE purchases of domestically-produced equipment, exportinterest subsidy program, amongst others, as presented in Chapter 111.3, are likely to beconsidered as prohibit subsidies at the DSB, due to the elements of contingency to exports anduse of Chinese made products.

Another important Chinese commitment that has not been respected is the ob!igation to notifyannually to the WTO ali of its subsidy programs. China has made notifications to theCommittee on Subsidies only upon its accession, in 2001, in 2006 and 2011(SCM Article 25and China's Protocol of Accession, Article 10.1).

Regarding the issue of SOEs, China committed to not influence directly or indirectly oncommercial decisions on the part of state-owned or state-invested enterprises (Working PartyReport Para. 46). Neverthe!ess, as presented in Chapter 111.3, there is some evidence that theChinese government, in the past years, decided to retain direct command of key sectors of itseconomy, by the maintenance of control of several SOEs and enhancing the state ownedeconomy's controlling power. This direct controi aimed by the government and exertedthrough SOEs could indicate that China is not complying with ils commitment te notinfiuence such enterprises.

Furthermore, there are concems of other WTO members that SOEs are benefittingdisproportionate!y from governmental measures to boost the economy by granting subsidiesand providing iarger access to credit than it is granted to private companies. Such preferencescould indicate a vio!ation of GATT Article III that establishes that national treatmentprincipie, since private foreign companies would not be able to benefit of these preferences.

Arother issue is the direct investments contingent on de facto transfer of technology. Chinacommitted to only impose measures regarding such transfer that were consistent with theWTO Agreements (RWP, Para. 49). Nevertheiess, as presented before, stitdies have shown

295 IJSTR. US Department of Conimerce, Subsidies Enforcernent, Annual Report to the Congress, Fcbruary20I0,p. [4.

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that in some sectors foreign investors are not allowed to have a controiling share inenterprises, what would result ia a de facto obiigation oU transfer of technoiogy that might beconsidered inconsistent with WTO mies.

Finaily, one shouid analyze China's compiiance regarding its commitment of ensuring that aiistate owned and state-invested enterprises wouid make purchases and saies based solely oncommercial consideratioris (RWP, Para. 46). Considering the possibiiity of state infiuence onSOEs, as presented above, one can wonder if those enterprises are acting according to marketconditions or are making decisions based on other factors. China affirmed that ali laws andmeasures relating to Lhe procurement by state owned and state invested enterprises of goodsand services wouid not be considered to be iaws and measures relating to govemmentprocurement. Thus, these procurements cannot be influenced by state policies neither canbenefit from the exemptions of the principie of nationai treatment regarding governmentprocurement, foreseen ia QATT Article 111:8.

China aiso undertook commitments regarding: a uniform administration of WTO rules overits territory; Lhe estabiishment of an officiai journai and a judicial system; the concession oUnational treatment for foreign individuais and enterprises; the progressive hberalization of Lheright to trade; the determination of ali prices for traded goods and services by market forces.The compliance of China with ali those commitments, essentiai to its transition towards amarket economy, must aiso be evaluated.

More broadly however, the fact that China has stopped its transformation process imo amarket economy means a vioiation of other members legitimate expectations regarding thebenefits accrued from China's accession to the WTO. The anaiysis of China's AccessionProtocol and Working Party Report demonstrates that there was an expectation by WTOmernbers that China wouid move towards a inarket economy by implementing the systemicadaptations provided for in those documents. The non-fuifiliment of this expectation couidhave brought some impairment to other members benefits accruing from the WTOagreements, as presented in Chapter IV.3, and thus, could be brought before the DSB under anon-violation complaint concerning Articie XXIII.

3. Conclusions

As shown above, China is likely to be vioiating a series of commitments to the WTO, bothunder its Protocol of Accession and under the WTO agreements. The exchange rate issue, themassive granting of subsidies and the managernent of SOEs ali bring major negative irnpactsto other member's trade and seem to be inconsistent with the mies of WTO. It is possible toidentify specific vioiations of the country's commitments, which shouid be addressed at theDSB.

The WTO presents a consistent set of ruies that aims to reguiate its members tradingpractices, in order to prevent unfair trade. The negative impacts caused by China ia Lhe arcasof subsidies, SOEs and exchange rate constitute distortive practices that prevent a fair tradebetween WTO members and are inconsisteat with these WTO mies. The vioiation oU expresscommitments under China's Protocol of Accession and oU WTO mies should be raised at LheDSB, ia order to recommend China to bring the chalienged measures into compiiance, so asto eiiminate the distortions caused to internationai trade.

Ira

The study has presented the legal reasoning of the applicatiori of severai WTO instrumentswhich China is likely not to be complying with the analysis of the specificities of each ofChina's subsidy programs, the acts and mies regarding SOEs and the policies that affectexchange rates, one should be ready to submit to the DSB a complete compiaint againstChina.

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VI. SUMARY AND CONCLUSIONS

The astonishing growth of China's exports represents a major chalienge to Brazil and to thetextile sector. In 2011, China's exports amounted to US$ 1,9 triltiori In 2012, Braziliantextile imports amounted to US$ 6,6 billion. against US$ 6,2 biilion ia 2011, while theimports from China in lhe sector amounted to tJS$ 3,3 billion ia 2012, against US$ 2,9 billionin 2011. Apparei and made up articles represent a significant part of the Brazilian importsfrom China. In 2012, Brazilian apparei and made ap articles imports amounted to US$ 1,5billion, against US$ 1,2 billion in 2011297, showing a significant increase on Lhe country'simports that affected Lhe Brazilian textile industry.

China acceded to Lhe WTO in 2001, after 15 years of negotiations. The benefits accruing fromChina's accession to Lhe Organization, combined with Lhe competitive prices of Chineseproducts resulting from their extensive array of subsidies have heiped to boost the country'sexports and its deveiopment.

The accession of China to Lhe WTO has brought chailenges to otha WTO members. In onehand, China would be obliged to comply with the mies of the Multilateral Trading System,thus protecting other members from unfair trade practices, while iL would be assured thatChina did not receive any discriminatory treatment against its products or unfair barriers to itstrade. On the other hand, Lhe significant weight of Chinese economy and the fact that thecouritry was still in transition from a socialist economic model towards a market-oriented onebrought impacts to other member's economic activities and uncertainties about the applicationof WTO ruies.

The Multilateral Trading System was created ia Lhe 1940's with the GATT, with clearobjectives to liberalize trade and to promote trade as an instrument of economic deveiopment.The system was estab!ished by market econornies, based ia market ecoriomy principies andrules. Aiming to be multilateral, it gave support and incentives to other market and non-markets economies to participate in its activities, as a way to develop a universal trade system.During its history, GATT gave little consideration to the impacts of NMEs to Lhe system,once they were either small or in transition to market orientation.

With Lhe estahlishment of the WTO in 1995, this little concem was transformed in a clearpresumption that ali acceding countries - in transition or NMEs would transform themselvesin market economies, accepting the principies and the rules guided by a modei under rnarketorientation.

The anaiysis presented in this research clearly shows that these presumptions were negotiatedand accepted in ali accession processes. Ali economies invited to participate in the WTOnegotiate and agree to the commitment to transform their econornies to market economieswith Lhe objective to participate fully in Lhe Multilateral Trading System.

China was Lhe first major hybrid economy 298 containing NME features to accede to the WTOand was followed by others. In China's accession, iL committed to undertake several reforms,

296 WTO Statistic Database - Time Series on International Trade.297 Al ice web - Ministry oíDeveloprnent. Industry and Foreign Trade - Brazi/298 The Working Party Report on the Accession of China constantly refers to Lhe Chinese economic model as intransition towards a Sociatist Market Economy. The clefinition of a Socialist Market Economy is not given. butMernbers signal to the fact that the Chinese economy bears characteristics of both market and non-market

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regarding, for exampie, the granting of subsidies and Lhe management of SOEs, and toliberalize its banking system which would lead Lhe country towards a market-oriented system,assuring a levei piaying field between China and other economies under the WTO System ofinternationai trade rules.

Nevertheless, there is strong evidence to the effect that, after ten years from WTO accession,China still has not compieted its transition process. The World Bank has published in 2012 astudy about China - China 2030 - where it affirms that China is still not a market economy,despite Lhe reforms it has aiready undertaken, and that there are distortions on its economythat impacts on Lhe fairness of competition.

In truth, China stiil relies heavily upon SOEs to impiement public policies conceived by theCommunist Party. Considering Lhe internal opposition to further liberalization andprivatization reforms, some commentators are starting to doubt that China could evercomplete its transformation into a fuli market economy, given the intrinsic political linksbetween the Communist Party, SOEs and the means by which public policies areimplemented

These NME features of China bring several. impacts to the Multilateral Trading System. SinceWTO was not designed to supervise or regulate trade practices of NMEs, neither to force thento transform its economies toward market ones, it is unable to properly supervise China'sinternational trade, faihng to prevent unfair trade such as the practice of subsidies, SOEs andexchange rates.

As questioned at the beginning of this study, some relevant questions should then beanswered by WTO members:

• Is the WTO an organization created under market economy principies and rules?Or is this Organization providing rules for two systems: market and NMEs? If so, are theniles of Ad Note GATT Article VI and GATT Article XVII sufficient?

• The accessions of China, Russia and other countries to the WTO can be assumed as acommitment to transform themselves in market economies, or mo economic systems can beallowed?

• Is the WTO properly equipped with mechanisms to prevent NMEs to circumvent Lheprincipies and rules established by the market econornies in the WTO?

• Is it possible to foresee a negotiation of a set of rules to deai with NMEs or these rules wouldbe incompatible with WTO rules?

• With growing impacts of big NMEs participating in the WTO and no clear progress in theirtransition processes, what can be done to answer this new chailenge: A panel? A new round?A China Round? A NMEs Round?

• Shouid some preiiminary steps be taken such as a Worlcing Party on NMEs to discuss theissue?

economies. In this sense. Chinese economy coulci be considered as a hybrid economy. See WTO, Report o! theWor*ing Party ori the Accession o! China, WT/A Cc/cHN149, October 2001. para. 4

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With ti-te impasse of the Doha Round and no political will to unblock the System, either WTOmembers take the chailenge to their hands and negotiate new rules to accommodate thischalienge, or, once again, this explosive issue will go to the DSB to solve a dispute throughrulings of the Appeilate Body.This research analyzed three main issues of the Chinese competitiveness: exchange rate,SOEs and subsidies. Ali three issues point to Lhe conclusion that, after ten years from itsaccession, China has not complete its transition process to becom e an econorny based onmarket rules, and it is still a NME.

Considering those issues of China's participation at lhe WTO, some actions can be proposedon each of these themes:

The issue of exchange rate

As presented in Chapter 111. 1, due to the functional division between the WTO and IMF, thesubject of exchange rates was never dully incorporated in the WTO. Nevertheless, after thefinancial crisis of 2008, currency misalignments became, once again, a concern of countries.In 2011, Brazil presented two submissions to the WTO Working Group on Trade, Debt andFinance, with a work prograni of an academic research on the reiationship between exchangerates and international trade. including lhe examination of the available toois and remediesunder the WTO agreements that could redress the effects of exchange rate misalignments.

The WTO Secretariat has already produced a review of economic literature on the impacts ofexchange rate on trade and a WTO seminar on the topic took place in March 2012, althotigh itonly dealt with the impacts of exchange rates on trade, discarding the discussion of the effectsof currency in the existing WTO mies. New proposai is foreseen tilI the end of 2012.

The discussion of the issue at Lhe WTO is of most importance, since only through deepstudies and through the negotiation of new mies that directly deal with exchange rates can theissue be properly addressed. Therefore, a strong support to the development of discussionsunder the Working Group on Trade and Finance is fundamental to assure that the issueremains relevant at the international agenda and a positive outcome is found.

Despite the lack of provisions under the WTO abie to regulate the effect of exchange rates ontrade in a consistent manner, there are legal instruments that can be used to prevent some ofthe negative effects caused by misaligned exchange rates. GATT Articles II:!, XV:4 andXXIII provide the legal basis for a complaint under the WTO Dispute Settlement Systemabout the negative effects caused by devaluated currencies as the Chinese renminbi. A requestof consultations and a panei on exchange rates may be the only immediate alternative, sincenegotiations under the Working Group shouid be extensive before a solution is accorded.

The resort to the Dispute Settlement System wili aliow the AB to further interpret thisArticles under the perspective of exchange rates, which can provide more guidance on howthe effects of misaligned currencies can be addressed by the existing toois and remedies of theWTO, subject not yet on discussion under the Working Group.

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The issue of subsidies

Chapter 111.3 presented a list of subsidies granted to Chinese industry particularly textiles.Several of those subsidies are likely to be considered prohibited under the 5CM, due to theircontingency upon exports. It is important to further investigate those subsidies, which mayaffect the Brazilian industry, in order to gather the required information to pursue a complaintunder the DSB.

Furthermore, even the subsidies that are not considered prohibited can be actionable, if theyare deemed to be specific and it causes injury to another member's domestic industry. Here itis important to recail that China's Protocol of Accession has a relevant provision on thespecificity of subsidies granted to SOEs, that is broader that the requirements under the SCM.

An investigation on those specific subsidies that cause or threaten to cause injury to theBrazilian industry can lead to the application of countervailing duties against those subsidies.Trade defense measures are efficient instruments provided by the WTO to address unfair tradepractices and should be used in a more consistent manner by Brazil. The country has neverapplied a countervai!ing duty against China, despite the massive subsidization of Chineseindustry, as shown in Chapter 111.3.

The issue of state owned enterprise

The management of SOEs is very little regulated by the WTO Agreements. As presentedbefore, the only rule dealing with state trading enterprises is GATT Article XVII, which onlyhas superficial provisions on the obligation of state trading enterprises to act in anondiscriminatory manner and lii accordance with commercial considerations.

The provision is insufficient to regulate the several impacts to intemational trade that can becaused by SOEs. GATT Article XVII:3 already stated that: The contracting parties recognizethat enterprises of the kind described in Paragraph 1 (a) of tbis Article might be operaied so asto create serlous obstacles to trade; thus negotia dons cii a reciprocal and mui ual/yadvantageous basis designed te lirnit or reduce such obsta cles are af importarice to theexpansion of international trade.

The WTO system, that has created a comprehensive regulation of inteniational trade, cannotleave the issue of SOEs, so relevant after China's accession, to bilateral negotiations. The issuemust be regulated in a more consistent fashion, which allows a clearer determination of theactions that may be considered inconsistent with market considerations, giving morepredictability to the administration of SOEs and limiting its negative effects on trade.

Therefore, the negotiation of new rules, in order to deepen the provisions of Article XVII arethe only available solution to prevent, under lhe Multilateral Trading System, that SOEs mayconstitute a barrier to international trade.

NME and antidumping: legal consequences of 2016

The main discussion on antidumping investigations against China is the deadline of 2016provided by the country's Protocol of Accession. As presented in Chapter IV.4, in 2016, thespecial system of the Protocol will partially cease, and WTO members will have to resort tothe provisions of lhe GATT and ADA in order to justify Lhe application of alternative

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methodologies for the determination of the normal value in antidumping investigationsagainst China.

A relevant question is, therefore, if the Ad Note is applicable. The AB has stated that thedefinition of the Ad Note refers to a specific type of NME and the provision can only beapplied to it (EC-Fasteriers). Nevertheless, the Protocois of Accession of Poland, Romaniaand Hungary, that followed different non-rnarket economic modeis, none of them fully inaccordance to the definition of the Ad Note, made express reference to the applicability of theprovision to these countries. This is strong evidence that the CONTRACTING PARTIESinterpreted the concept of NME provided by the Ad Note in an evolutive manner, in order toaccommodate different kinds of NME, interpretation that was disregarded by the AB.

Therefore, despite the deadline of 2016, countries should still be allowed to apply thealternative methodology on anti-dumping investigations against China, if they fulfili therequirements of the ADA and the Ad Note, with due consideration to the evolutions on theinterpretation on the definition of NME.

Nevertheless, it is importam toto recali that Article 15(d) creates a special situation conceniingChina, since it establishes that, after 2016, although the application of Article 15(a)ii ofChina's Protocol of Accession ceases, Article 15(a)(i) will continue to be applicable. Article1 5(a)(i) opens the possibility for Chinese exporters and manufacturers to prove that, in theirrespective sectors, market conditions exist. This reminiscence of the special system wili createa possibility for Chinese exporters not open for the exporters of other NME countries underthe Ad Note's regular system.

Consequences of China being a hybrid economy with NME features

As shown through this entire worlc several features of Chinese economy create major impactsto the rules of the Multilateral Trading System, which are not able to assure a levei piayingfieid between hybrid and market economies. The negotiation of new mies to deal with thespecific concerns raised by NMEs is imperative. The concerns brought by Chinese accessionwili likely increase in the foliowing years, due the country's continuous economie growth.

After ten years of China's accession trade disputes and tensions between China and some ofthe most important members of the WTO, especia!ly the liS, have arisen over China'scompliance of WTO obligations. In the wake of the worst financial crisis since the GreatDepression, trade rows and resentment over China's trade and industrial policies have beenpresent daily in intemational and local news. This study argues that much of the tensionexpressed by members of the WTO is due to the fact that the Multilateral Trading System isnot apt to deal with NME features still present in China's economy.

By anaiyzing some key NME features of the Chinese economy - notably, the exchange ratemanipulation; the economic and political importance of SOEs and their relationship to thecentral government; and the subsidization of its economy - this study has demonstrated thatChina has not, yet, promoted the reforms needed in order to completeiy adapt its economy tothe Multilateral Trading System. Most alarming, the international press, experts andgovemmental offices are expressing their concems that China has siowed the pace of reformand gives signs of not intending to move forward with the liberalization of its economy.

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The concern over China's !ost appetite for economic reforms, especially with the proximity tothe symbolic 2016 deadline, has paved the way for extreme ideas of how to deal with thesituation, some even proposing the revocation of China's membership to the WTO. There aretwo possible ways to dealing with this growing tension without resorting to such extrememeasures.

Firstly, the Multilateral Trading System has provided for mechanisms to deal with the breachof trade obligations. A WTO member has the right to address the DSB if it believes thatanother inember is not complying accordingly with its obligations under WTO Law. Asshown above, China is likely to be violating a series of comrnitments to the WTO, both underits Protocol of Accession and under the WTO agreements, !inked to several of its NMEfeatures. The exchange rate issue, Lhe massive granting of subsidies and the management ofSOEs ali bring major negative impacts to other member's trade and seem to be inconsistentwith the mies of WTO. It is possible to identify specific vioiations of the country'scommitments.

Specifica!!y, some obiigations to irnplement economic changes to its system, present in ChinaAccession Protoco!, such as the ones reiated to SOEs and Subsidies, seem not to have beenfo!lowed through by China and cou!d give way to formal complaints under the DSB.

More broadly however, thc fact that China has stopped its transformation process imo amarket economy means a vioiation of other mernbers legitimate expectations regarding thebenefits accrued from China's accession to the WTO. The ana!ysis of China's AccessionProtocol and Working Party Report demonstrates that there was an expectation by WTOmembers that China wou!d move towards a market economy by impieinenting the systemicadaptations provided for in those documents. The non-fuifii!ment of this expectation cou!d bebrought before the DSB under a vio!ation complaint concerning Article XXIII.

Secondly, the negotiation of new provisions to reguiate specific features of China and otherNMEs, if the transition of those countries towards a market oriented model remainsincomplete.

The first action that should be taken is the creation of a Working Group under the WTO thatwould study the impacts caused by NME features to muhilateral trade ruies. The WorkingGroup would be able to evaluate the specific elements of NMEs that may be consideredincompatible with the Multilateral Trading System and which e!ements require an adaptationof the Multilateral Trading System in order to allow a better application of WTO mIes.

This study has already foreseen the urgent need to adapt the existing rules on trade defense:antidumping - especially the Ad Note, considered outdated, subsidies and safeguards. Specialattention must be given to GATT Article XVII on SOEs. A deeper study in this WorkingGroup couid reveai more provisions that wouid need to be discussed.

ft is essential to WTO members to deal with the concerns raised by NME's participation at theWTO. The rules of the Multilateral Trading System are no longer able to provide a consistenttrade regu!ation that assures the respect of the organization's core princip!es. The conflictsraised by the issue of NMEs between WTO members have the potential to undermine theWTO. Members must negotiate a solution urgent!y.

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Either WTO members take care of NMEs and hybrid economies or both NMEs and hybrideconomies will create a dual system of mies in the WTO, undermining the wholeIntemationa! Trading System.

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ANNEX 5 - Remaining List of Subsidies Programs notified by China to theCommittee on Subsidies and Countervailing Measures in 2011299

Preferential tax treatment to anti-HTV-AIDS medicine.

Preferential tax treatment to numericaliy controlled machine tool products.

Preferential tax treatment to dies products.

Preferential tax treatment for casting and forging products.

Preferential tax treatment for raw copper materiais.

Fund for high technoiogy R&D for packaging industry.

Fund for deveiopment of eiectrical information industry.

Fund for research and development of integrated circuit industry.

Preferential tax policies for integrated circuit industry.

Subsidy for scrapping oid vehicles.

Exemption of tariff and import VAT for the imported technologies and equipments.

Preferential tax treatment for endangered wiid animais and piants as weil as their

products returned by foreign governments, by the government of Hong Kong, China or

the government of Macao, China to China.

Preferential tax policies on irnports of seeds (seediings), breeding stock (fowl), fish fries

(breeds) and non-profit-making wild animais and piants kept as breeds during the period

of the "Eleventh Five-Year Plan".

Preferential tax policies ou imports of seeds (seediings), breeding stock (fowl), fish fries

(breeds) and non-profit-making wild animais and plants kept as breeds during the period

of the "Tenth Five-Year Plan".

Preferential tax treatment for imported products for the purpose of repiacing the

planting of poppies.

Preferentiai tax treatment for tea sold iii the border arcas.

Tnterest discount for pouitry industry.

Preferential tax treatment for pouitry industry.

Preferentiai tax policies for the reiief grain and disaster relief grain, compensation grain

for returning cuitivated iand to forests and to grossland, and the grain rations for the

migrants from the reservoir arcas.

Preferential tax policies for the imports of China Grain Reserves Corporation for the

purpose or rotation of grain reserves.

Preferentiai tax policies for enterprises of grain or oil reserves.

Subsidy for grass seed sowing by airpianes.

Subsidy for prevention from control of pest and disease in forestry.

Preferential tax policies for the enterprises engaged in forestry.

299 Programs extracted from CHINAJWTO.New and Fui! Notifica tion Pursuant to Article XVI:] of theGA TT 1994 and Article 256 ofthe Agreernent on Subsidies and Countervading Measures. Committee onSubsidies and Countervailing Measures, O/SCM/N/155/CHN and GISCM/N/I86JCHN, 21 October 2011.

195

SLrbsidy for national key construction projects on water and soil conservation.

Fund for iriterest discount of loans for the purpose of agricultural water-saving

irrigation.

Fund subsidizing agricultural industrial ization and agricultural products processing.

Fund for agricultural comprehensive development.

Direct subsidy to farmers.

Comprebensive subsidies for agricultural inputs.

Subsidy for purchasing agricultural machinery and tools

Subsidy for promoting superior strains and seeds.

Fund for subsidizing transformation of agricultural technology.

Fund fort popularization of agricultural technologies.

Fund for training of youngster farmers on science and technology.

Fund for subsidizing the training of rural rnigrant labour force.

Fund for specialized economic cooperatives of farmers.

Preferential tax policies for enterprises engaged in projects of preliminary processing of

agricultural, forest, animal and fishery products.

Preferential tax policies for key leading enterprises engaged in agricultural

industrial ization

Fund for promotion of coordinated development of foreign trade and economic relations

arnong regions.

Fund for optimizing the impori and export structure of mechanical and electrical

products as well as high-tech products.

Special fund for establishment of service system for SMEs.

Development fund for SMEs.

Research and development fund for industrial technologies.

Preferential tax policies for enterprises transferring technology (2).

Preferential tax policies for the research and development enterprises.

Preferential tax policies for scientific research institutions under transforrnation.

Preferential mx policies for enterprises which provide ernployrnent for unemployed

people.

Preferential tax treatment for products for the disabled people

Preferential tax treatment for imported products exclusively used by the disabled people

(2).

Preferential tax policies for enterprises that employ disabled people (4).

Special fund for the industrial ization of wind power equipment.

Preferential tax treatment for renewable resources.

Preferential tax policies for Clean Development Mechanisrn.

Special fund for the industrializatiori of wind power equipment.

Preferential tax treatment for renewable resource.

196

Preferential tax treatment for products produced with integrated utilization of resources

Preferential tax treatment for buiiding material products produced with integrated

utilization of resources.

Preferential tax treatment for building material products produced with integrated

utihzation of resources.

Preferential tax policies for enterprises wichi utilize the waste materiais.

Prefereritial tax treatment for public infrastructure projects that are particularly

supported by the State

Fiscal fund to alieviate poverty.

Preferential tax policies for enterprises established in the poverty stricken arcas.

Preferential tax policies for ewnterprises ia Binhai New Arca of Tianjin.

Preferential tax policies in the western regions.

Preferential tax policies for foreign-invested enterprises engaged in agriculture, forestry

or animal husbandry and foreign-investede enterprises established in remote

underdeveloped arcas.

Preferential tax policies for foreign-invested enterprises engaged in energy,

transportation infrastructure projects.

Preferential tax policies for Chinese-foreign equity joint ventures engaged in port and

dock construction.

Preferential tax policies for enterprise with foreign investment in the border cities.

Preferential tax policies for enterprises with forcign investment recognized as high or

new technology enterprises established in the State high or new technology industrial

development zones.

Preferential tax policies for high or new technology enterprises.

Preferential tax policies for enterprises with foreign investment established in Special

Economic Zones (excluding Shanghai Pudong arca).

Preferential tax policies for enterprises with foreign investment established in Pudorig

arca of Shanghai.

197

ANNEX 6 - NCTO Iist of 28 subsidies programs for Chinese textile sector 300

1) Income Tax Programs:

a. Tax Exemptions and Reductions for "Productive" Foreign Invested

Enterprises (FIES);

b. Provincial Income Tax Exemptions and Reductions for FIEs;

e. Tax Refunds for Reinvestrnent of FIEs;

d. Tax Reductions for FIEs in Designated Geographic Localions;

e. Tax Offsets for Research and Development at FIEs;

f. Tax Reductions for High and New Technology Enterprises (HNTEs);

g. Tax Reductions for FIEs that are also HNTES and are Located in

Development Zones;

h. Tax Reductions for HNTEs Located in Economic Zones;

i. Tax Reductions for Enterprises Located in Special Economic Zones;

j. Tax Reductions and Exemptions for Enterprises lnvested in Western

Regions.

2) Indirect Tax Programs30t:

a. Value Added Tax (VAT) and Tariff Exemptions on Iniported

Equiprnent;

3) Preferential LendinglDebt Forgiveness:

a. Preferential Lending, Debt Write-Off & Other Preferential Programs by

Chinese "Poliey" and "Commercial" Banks;

li Preferential Lending, Debt Wrtite-Off & Other Preferential Programs at

Regional and Municipal Banks;

4) Government Provision of Goods and Services:

a. Discriminatory Land Policies by the Government of China;

b. Discrirninatory Land Policies by Regional and Municipal Governments

in China;

e. Discounted Electricity Rates by Provincial Authorities for Textile

Producers;

d. Programs to Ensure Access to Lower Cost Cotton;

e. Programs to Ensure Access to Lower Cost Man-Made Fibers;

5) Grant Programs:

a. Special Textile Funds Authorized under the "Administration of Textile

Special Funds" Program and the "Circular on Relevant Policies to

'Ni CT0."Statement to the hearing Record U.S. Trade Representative - Chin&s Compliance with W'J'OCommitments", submitted by Mr. Cass Johnson (Presidem o! NCTO), 5 October 2011. pp. 4-7.301 VAT taxes are altowed under wTo rules, but not a discriminatory use of VAT taxes to develop"encouraged" industries.

198

Promote Chinese Textile lndustry to Shift to New Ways for Growth in

Foreign Trade and Support Chinese Textile Enterprises to 'Go Global".

According to reports. the funds available amounted to 1.36 bihion RMB;

b. State Key Technology Renovation Project Fund;

e. State Scienee and Technology Support Scheme;

d. "Famous Brands" awards;

e. Clean Production Technology Fund;

The tax rebate and currency manipulation programs were considered non-WTO, thus

they were not inc!uded in this list. The subsidies programs under Article 3 (Prohibited)

of the SCM are not Iisted here either because they were already listed in item 3.4. of this

chapter.

199

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