EC wins right to slap $4 billion sanctions against US

The WTO has authorized the EC to impose trade sanctions against the US to the tune of $4 billion as retaliation for the latter’s provision of prohibited export subsidies to its corporations. However, the EC appears to be in no hurry to enforce the sanctions, and the two trading powers may yet strike a deal that could ultimately harm developing-country interests in ongoing WTO negotiations.

by Chakravarthi Raghavan

GENEVA: The European Union has been given authorization to retaliate against the United States by slapping up to100% ad valorem tariffs on some products imported from the US up to a maximum of $4.043 billion a year, as a countermeasure against the US’ continued violation of WTO obligations in providing export subsidies through its tax treatment for “foreign sales corporations.”

The panel of arbitrators - the original WTO dispute settlement panel that ruled the US law in question to be a violation of the US obligation not to provide prohibited subsidies - in giving the ruling and fixing the maximum amount of authorized countermeasures, accepted the EC contention that in the case of a prohibited subsidy, the appropriate countermeasure is the extent of the prohibited subsidy provided by the US government, and not the trade damage that could be caused to the EC from such subsidies.

On the basis of its estimation of trade damage, using some economic models and elasticities of supply and demand relating to its own market (as a proxy), the US had suggested an authorization of about $1 billion.

The arbitrators turned down the US view, underscoring the point about “prohibited” subsidies and the provisions on appropriate countermeasures in the WTO Agreement on Subsidies and Countervailing Measures (SCM), as different from violations that are “actionable” and where the relief is intended to counter the damage caused to trade partners.

Jungle-law of retaliation

The retaliation authorization that the EC has got has once again shown up the biggest weakness of the much-flaunted WTO Dispute Settlement Understanding, which has been claimed to be the “jewel in the crown” of the WTO. For, the enforceability of members’ rights and obligations in the so-called rules-based WTO system depends on the jungle-law of retaliation, an instrument that could cause as much harm to the user as to the other party and at best an instrument that could only be used by the powerful against the weak. It is thus something that can never be resorted to by any developing country or weaker trade partner without hurting itself.

Like all sanctions, whether in the trade or other fields, the instrument is only useful as a threat; but when exercised, it never achieves the end objective of making the other party yield. In fact it puts up the backs of the other side.

The authorization granted to the EC is the biggest for retaliation provided by the WTO so far. Earlier authorizations by arbitrators have been for Canada against Brazil (over aircraft export subsidies) for $220.5 million; for Ecuador against the EC over the latter’s banana import regime ($200.1 million); for the US against the EC over the banana regime ($191.4 million); and for the US and Canada against the EC over the ban on beef hormones ($116.8 million and $7.2 million respectively).

In none of these cases have sanctions been useful to secure compliance with the offending member’s WTO obligations. In the aircraft-subsidy case, Canada has not actually used the sanctions to retaliate: if it had, the retaliation would have put an end to all Brazil-Canada trade. Ecuador, which got the authority to retaliate against the EC over bananas, also did not apply any sanctions, not even in allowing copyright violations, since the Ecuadorian authorities were concerned about the wider repercussions to their trade. They merely sought to use the sanctions authorization to pressure the EC to change, but did not really succeed.

The US did take retaliatory actions against the EC over beef hormones, but could not force the EC to comply. The EC consumers were not ready to accept hormone-treated beef, and the sanctions, while hurting some exporters and producers, were just shrugged off. The banana sanctions imposed by the US did not achieve their purpose either of ‘persuading’ the EC to change its banana import regime to comply fully with the US demands.

In winning this award from the arbitrator, the EC is thus put in a dilemma since slapping of such countermeasures would increase the costs for its own consumers and would worsen the already strained transatlantic trade relationship.

Holding off on sanctions

All indications from Brussels are that the EC will be in no hurry to impose the countermeasures though it will be publishing the list of possible products that could be hit with the retaliatory duties to create some pressures within the US for the modification of the law to comply with the WTO.

The EC’s Trade Commissioner Pascal Lamy has indicated in comments and remarks at Brussels that he will be in no hurry to get the EC ministers to agree on and impose the sanctions, but would give time to the US to comply, and that it expects the US to do so soon.

The US Trade Representative Robert Zoellick has also said that he does not expect any sanctions to be imposed at all, and expects the US Congress to act in adopting the necessary legislation.

The bill to change the particular US legal provisions to bring them into compliance with the WTO obligations is in the works, but has so far taken shape in such a manner as to continue to provide the tax breaks to the US corporations but without offending the WTO by express linkages to exports. However, the bill is also caught up in disputes over some proposed provisions on some unrelated tax issues, including denying corporations any benefits if they incorporate outside the US to avoid taxation.

There is also some intense lobbying by major corporations (like Boeing, General Electric, Microsoft, etc.) to which the US law has provided the gravy train of annual tax largesse, which the US Treasury itself has estimated at $4.025 billion in 2000.

In any event, with the biennial Congressional elections due in November, it seems unlikely that any bill can be enacted before then.

Other indications, and past experience, also suggest that the EC is most likely to keep wielding this threat of sanctions to cut a deal with the US in the new WTO round of multilateral trade negotiations and get the trade rules changed to suit their mutual interests - and at the expense of the developing world.

Developing countries, under the rubric of implementation issues and rules issues, have flagged some of their concerns and calls for changes in the SCM Agreement (as well as the Agreement on Agriculture) to ensure a level playing field for themselves. But it is not at all clear or certain that they could play their cards to use this opportunity to change the rules in their favour.

While the US and the EC have some major trade rivalries, the interlocking of their corporations is such that the two often join together against the developing world to further the interests of their corporations.

By and large, trade negotiators of developing countries, even those few delegations which have some familiarity with and technical expertise in trade rules and trade, are handicapped in terms of development political economics, and their capitals seem unable to take an overall perspective.

History of illegality

The EC-US dispute over subsidies to US corporations for their exports has a long history. It is tied to the US method of taxation where its nationals and corporations are taxed on their global incomes. Most of the rest of the world use a territorial system for taxation.

In 1971, the US enacted the Domestic International Sales Corporation (DISC) Act purportedly to remove the handicaps of its corporations. The EC brought a complaint against this law in 1972 in the old GATT, and a ruling was handed down in 1976, with a GATT panel holding the DISC law to be an export subsidy. However, in the old GATT, dispute settlement panel rulings could not be automatically adopted, and the US DISC law and its subsidies continued till 1984, when the law was replaced by the Foreign Sales Corporations (FSC) Act.

In the Uruguay Round negotiations, the US and the EC joined in elaborating the SCM Agreement under which most of the targeted subsidies for exports provided by developing countries were prohibited, even as the major industrial countries were enabled to provide large general subsidies through support for R&D, etc.

The new US Foreign Sales Corporations Act was enacted on the view that it was a taxation law and thus exempt by a footnote to the SCM Agreement. It enabled US corporations to set up subsidiaries which were in fact offshore shell corporations (mostly incorporated in the Virgin Islands, Guam and Barbados) which had at best a room and a fax machine to receive and send out messages. Such offshore corporations can be established for as little as $2,000 and used to be advertised as such on the Internet.

The exports of the US corporations were on paper channelled through their offshore shell corporations, and the income and profits were exempt from US taxation. The offshore corporations, wholly owned by the US corporations, got more favourable tax treatment for their earnings from goods exported and containing no more than 50% in value of imports. There was no requirement (as under ordinary tax) for arm’s-length relationships between the parent and the subsidiary.

After the WTO came into being (and partly aggrieved by the aggressive way the US began challenging the EC’s banana regime and other such regimes), the EC raised a dispute at the trade body in 1997 over the FSC law. The case meandered its way through the dispute settlement proceedings, and in 2000 a ruling was handed down that the FSC law, and the favourable tax treatment for exports, was a prohibited subsidy and the US was asked to comply without delay.

The FSC law was then replaced by the FSC Repeal and Extraterritorial Income Exclusion Act 2000 (ETI Act), which the EC challenged on the basis that it still continued to provide the prohibited export subsidies and the US was thus not in compliance. The WTO compliance panel, and the Appellate Body in appeal, indeed held the ETI Act to be providing prohibited subsidies in violation of the US’ obligations under the SCM Agreement, the Agreement on Agriculture, as well as the GATT and GATS provisions for non-discrimination and national treatment between imported and domestic like-products.

The US said it would comply and change the ETI Act, but the amending legislation has been caught up in Congress, and the major beneficiary corporations have been lobbying intensely to ensure its continuance in one form or another. (SUNS5184)                                

From Third World Economics No. 288 (1-15 September 2002)