EU’s new anti-foreign-subsidies tool likely to invoke new wave of protectionism

_ Yuri Kofner, junior economist, MIWI Institute. Munich, 13 July 2020.

In June 2020, the European Commission presented a white paper on how to effectively prevent and counteract potential unfair competitive advantages, which extra-EU companies might have on the European market by receiving state subsidies from foreign governments. This move came largely as a reaction to fears over Chinese state-aided companies, but it could also affect exporters and investors from other regions. And they, in turn, are likely to react with “an eye for an eye”.

Box 1. Foreign subsidies According to the white paper, a foreign subsidy is any financial contribution by a government or public body of a non-EU State to an undertaking in the EU: ·         An interest-free loan ·         Unlimited guarantees ·         Capital injections ·         Preferential tax treatment ·         Tax credits ·         Grants

The EU’s new instrument (hammer)

The European Commission’s directorate for competition ensures that public support granted by EU member states does not lead to competitive distortions in the union’s common market. However, so far there is no international or European instrument sufficiently addressing unfair advantages caused by extra-EU state aid. For this reason, the commission proposed three new instruments to complement existing tools and fill the regulatory gap. The new legal instrument(s) might come into force as early as 2021.

The new instruments to counteract market distortions caused by foreign subsidies cover three specific areas – takeovers, public tenders and more generally when European companies are threatened by price dumping in the EU:

Module 1. A screening mechanism for foreign subsidies facilitating the acquisition of EU companies, prescribes a compulsory notification for subsidised acquisitions triggered by a threshold EUR 200 thousand; a preliminary review; if needed – an in-depth investigation if a market distortion is suspected; and finally – should the supervisory authority find that the acquisition is facilitated by the foreign subsidy and distorts the common market, it could either accept commitments by the notifying party that effectively remedy the distortion or, as a last resort, it could prohibit the acquisition.

Module 2. A screening tool for foreign subsidies in public procurement procedures, includes a compulsory notification mechanism of potential foreign subsidies for bidders; then a preliminary review; an in-depth review where necessary to establish the existence of a foreign subsidy with a decision on a  potential distortion of the procurement procedure; and finally redressive measures: exclusion from the procurement procedure and possibly even from future procedures.

Module 3. A general instrument to capture distortive effects of foreign subsidies, also includes a preliminary review; an in-depth investigation if a market distortion is suspected; and, if a market distortion is confirmed, then measures such as redressive payments and structural or behavioural remedies can be applied. However, the supervisory body could also consider that the subsidised activity or investment has a positive impact, which outweighs the distortion, and thus not pursue the investigation further. This would be the so-called “EU Interest Test”.

Jürgen Matthes, head, Research Unit International Economics and Economic Outlook, IW Cologne, supports the commission’s initiative, also for the following reasons:

• In theory, the rules should apply equally to subsidies granted by all non-EU countries and ought not to be discriminatory towards any specific country
• Contrary to the previous proposal, the new proposal is not only targeting state-owned companies. It generally focuses on all subsidies from third countries with which, in addition to state-owned companies, also private companies can undercut competition in the EU.
• The proposal enables complaints from market participants themselves. This will enable the commission to have a more detailed understanding about the market situation.
• A low subsidy threshold of EUR 200 thousand is planned over three years, so that small and medium-sized companies can also be protected.

The commission also hid an ace in the small print. Because, if the EU can take a closer look at a company and examines it for potential subsidies that might distort competition, it can at the same time request information on how the company is financed. If the company does not comply with this, there is a risk of severe penalties. Brussels thus cleverly reverses the burden of proof: For trade defence measures, the EU has so far had to prove to third countries, such as China, that subsidies have been granted to give an artificial price advantage. This is rarely possible because the Chinese subsidy bureaucracy is difficult to see through. Thus, protective instruments against unfair import competition often remain blunt. With the new anti-subsidy tools, the EU would now have a lever to get more information from China itself about the subsidy jungle, at least if Chinese companies want to be active in the EU. Here Brussels is playing out the size and relevance of the internal market.

Evening out the playing field vis-à-vis China?

As already mentioned, deliberations to introduce a legal tool to address foreign subsidies came over ongoing concerns that China’s economic rise paired with its model of state-capitalism could give it unfair competitive advantages and strategic influence in the European market.

China is the EU’s second largest trade partner after the USA, accounting in 2018 for 10.7 percent (USD 209.8 billion) of the union‘s exports and for 13.5 percent (USD 268.1 billion) of its imports. Yet, China owned only 4.2 percent of  foreign enterprises on the EU market, ranking 6^th place among foreign actors.

Yet the question is, how large governmental Chinese subsidies really are and how important they are in artificially fostering the export performance of Chinese companies abroad. As with non-tariff barriers, it is very hard to find estimates on total financial subsidies and equivalent quantifications of non-financial state aid. Moreover, estimates that do exist vary widely depending on the object and the unit of measure.

For example, according to the Financial Times, Chinese subsidies given to 3,500 state owned enterprises amounted to USD 22 billion in 2018. However, these estimates do not include private companies, which account for the bulk of China’s economy. An estimate by Jiang Chao, analyst, Haitong Securities, put the total value of subsidies to Chinese companies in 2017 at US 61.4 billion. Another study by Zero2IPO Research Center says, that subsidies to China’s electronic industry alone, funnelled through “government-guided funds”, amount to a total of USD 570 billion. Along a monitor, conducted by the OECD, total financial and non-financial state support given to Chinese agriculture amounted to USD 204.3 billion in 2017.

However, recent research by the Kiel Institute for the World Economy and the Munich ifo Institute for Economic Research, raises the question, whether Brussels’ new initiative is really justified by the desire to maintain  a free market, or whether it is a modern protectionist measure in a new era of “managed trade”. A recent study by (Görg and Stepanok 2020) looking at 170,000 Chinese firms that accounted for ~ 85-90 percent China’s manufacturing industry, came to the conclusion that “it is questionable whether […] production related subsidies have a large role to play in explaining Chinese firms’ export performance”. (Knoerich and Tina Miedtank 2018) argue: “[…] it is unwise to appear overanxious and exaggerate a phenomenon that is far from dominant in Europe’s economic landscape. After all, the USD 86 billion of Chinese FDI stock in the EU in 2017, as estimated by MOFCOM, is dwarfed by US FDI in the EU, worth an estimated USD 3.6 trillion”. Rolf Langhammer, research fellow, IfW Kiel, in an article from 2016 puts it even more bluntly: “Concerns of a “sale out” of German technology to Chinese foreign investors are based on fears not on facts”.

Give Trump another excuse?

If the European Union is honest and will indeed persecute all foreign subsidies, and not just those coming from “illiberal” economies based on Western geopolitical views, then not only Chinese companies might incur costs from this new screening mechanism.

The EU‘s number one trade partner still is the USA, accounting for 29.8 percent (USD 407.0  billion) of European exports in 2018 and for 19.9 percent (USD 394.6 billion) of its imports. The USA ranks also 1^st place in terms of FDI: in 2015 it controlled 28.3 percent of foreign enterprises active in the EU and employed almost half of European citizens working for foreign companies in the EU.

Yet even the alleged home of laissez-faire capitalism is no stranger to state aid: according to American Transparency, between 2014 and 2017 US companies listed under Fortune 100 received at least USD 3.2 billion in federal grants. Energy related tax preferences amounted to USD 18.2 billion in 2016. And in 2017, according to the OECD, cumulated governmental financial and non-financial support to American farmers totalled USD 39.6 billion.

This raises two justified questions: Firstly, would Brussels be willing to invoke redressive anti-subsidy measures against the United States? Secondly, would the EU do it even at the price of potential retaliatory tariffs from the Trump (or Biden) administration? The ongoing trade dispute over subsidies for Airbus and Boing shows that this no arbitrary issue.

EU state aid: “he that is without sin”

As the New Testament verse goes: “he that is without sin, let him first cast the first stone”. In other words, the EU should think twice, before blaming and charging its trade partners for market distortions through state aid. After all, these countries are very likely to soon respond to Europe with the same logic, which is sure to be another unnecessary nail in the coffin of free trade. According to the EU state aid scoreboard for 2018, the union member states spent USD 142.8 billion (0.76% of GDP), on state aid, excluding aid to agriculture, fisheries and railways. That year, the EU budget officially supported European farmers with another USD 69.5 billion. According to the OECD, total non-financial and financial government support for European agriculture amounted to USD 93.2 billion in 2017.

Summary

In June 2020, the European Commission came up with a new legal instrument to address potential market distortions, i.e. “unfair competitive advantages” in trade and investment in the European common market allegedly had by foreign companies through receiving state aid from their respective home countries. The initiative came mainly over concerns that China, as the world’s largest illiberal and state-capitalist economy, would outcompete European businesses and thus could pose a threat to European economic sovereignty, values, and security.

Although the initiative surely has some merit to it and is greeted by some German economists, e.g. from the IW Cologne, there remain important issues to be considered.

Firstly, other German economists, e.g. the IfW Kiel and the ifo Institute, doubt the importance of Chinese economic influence over the European market as a whole, and in particular that industrial subsidies have indeed improved the export performance of Chinese companies.

Secondly, if Brussels wants to be honest, it has to use its new foreign subsidies screening mechanism not only against players deemed as “systemic rivals”, such as China and Russia, but also against all third parties, including the United States. Is the commission willing to risk likely further retaliatory tariffs from its main trading partner?

Thirdly, in terms of state aid, the EU is no less guilty than the rest of the world.  Thus, if the above discussed initiative is executed, other regions are likely to implement their own anti-foreign-subsidy mechanisms – this time directed against European companies. In the end, this will add unnecessary momentum to the already ongoing tit-for-tat protectionist spiral, which has been harming free trade and globalization for a decade now.

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