The state handouts that get out of control

When Joe Biden announced sweeping import tariffs against Chinese electric vehicles, solar panels and batteries two days ago, he was very clear about the original sin. Chinese companies could charge such low prices, Biden said, because its government “subsidised them, and subsidised them heavily”.

Biden has also attempted to respond with his own handouts. The US’s Inflation Reduction Act (likely fiscal cost over $1tn) — and other industrial policy interventions worldwide — have rapidly elevated subsidies’ political salience.

There’s a very good environmental reason to subsidise green technology, namely to internalise negative externalities, that is to raise the price of high-emission relative to low-emission goods to reflect their true environmental cost. There are also wasteful and trade-distorting reasons for doing so — such as to promote economic nationalism.

This would be an excellent time to have a robust and widely respected set of international subsidy rules to distinguish between the two. Sadly, we don’t. The multilateral subsidy control regime is weak, and the prospects for strengthening and greening it are dim. Absent spontaneous increases in political will, public subsidies worldwide will be constrained more by governments running out of money than running foul of global rules.

To start with, it’s not always clear what a subsidy is. The guardian of the concept is the World Trade Organization, whose subsidies agreement defines it as a financial contribution for a specific purpose by a government or other public body via spending, forgoing revenue (such as tax breaks) or providing goods and services. A handout to solar-panel manufacturers is a subsidy: a public information campaign on renewable energy is not. The rules also determine how certain subsidies distort trade and what aggrieved governments can do about them.

This seems clear enough, but there is always a risk that the concept expands and creates confusion. A few years ago, a drive to reduce government handouts for the use of fossil fuels led to discussions inside the WTO and the OECD, two institutions with deep expertise on subsidies. The debates were usually based on measures of explicit subsidy on the WTO definition, made by the OECD and the International Energy Agency, which currently total $1.5tn a year. 

But unhelpfully, the IMF began pushing a much broader definition, including the “implicit subsidies” of simply failing to internalise external costs including air pollution and road-traffic accidents. By this measure, annual global fossil-fuel subsidies are a massive $7tn, nearly three times as much as worldwide spending on defence.

This has caused considerable consternation in policy circles: old subsidy hands correctly point out that these estimates of implicit subsidies are highly uncertain and hence cannot practicably form the basis of international rules. They also often lead to a misleading idea — unfortunately propagated by the fund itself, its sister organisation the World Bank and the UN — that trillions of dollars are being spent on fossil-fuel subsidies and could be redirected elsewhere. In reality the public money that supposedly funds implicit subsidies does not yet exist: it’s notional revenue from a tax the IMF thinks ought to be levied but isn’t.

Second, even sticking to the classic definition of explicit subsidies, it’s not clear how big they are. Governments are supposed to declare their subsidies to the WTO but this often happens late and is incomplete, an accusation the US in particular makes against China.

Under China’s vast and complex apparatus of state capitalism, many companies and banks exist in a netherworld between government and private sector. Measuring distortions is restricted by a series of rulings by the WTO’s dispute settlement system, which took a narrow view of what constituted a “public body” whose spending might count as subsidy.

Finally, there’s no comprehensive way of disciplining subsidy regimes, certainly the industrial rather than agricultural kind. The WTO framework isn’t entirely impotent: the nearly 17-year-long EU-US litigation over subsidies to Boeing and Airbus did cause both sides to redesign and constrain trade-distorting handouts. But it’s had much less success in restraining China. Governments generally resort to unilaterally applying anti-subsidy duties on imports — or, in the EU’s case, also acting against procurement bids, mergers and sales by foreign-owned companies inside the EU.

Attempts to expand multilateral rules have largely failed. The EU, Japan and the US in 2017 launched a trilateral initiative to create broader definitions of subsidy, but it failed to reach consensus. WTO members have tried to negotiate a global deal on restraining fishing subsidies, but India has blocked progress, as it frequently does in the WTO, claiming the rules would be unfair to its fishing fleet.

An independent initiative led by academics and lawyers has created the “Villars Framework”, a plan including reform of subsidy rules based on sustainability as well as trade distortions. But the likelihood of getting consensus on such a fundamental change is very small, especially as it attempts to address implicit as well as explicit subsidies.

To sum up: we all agree subsidies are very important and can be destructive. But we don’t agree on exactly what subsidies are, and even if we do agree we don’t know how to measure them, and even if we can measure them we don’t know how to deal with them. Apart from that, the global governance of this hugely important subject is doing just fine.

alan.beattie@ft.com