Bailouts may render WTO principles inoperable
An interview with Julius Sen, a research associate at the London School of Economics' International Trade Policy Unit

In the midst of the current financial crisis, many developed and some developing countries have turned to bailout packages to resuscitate stricken businesses.

These government measures could potentially violate the World Trade Organisation (WTO) rules on subsidies. In fact, some countries, such as Brazil, have already threatened to launch WTO claims against countries that implement them. The Global Subsidies Initiative has spoken to Julius Sen, a research associate at the London School of Economics’ International Trade Policy Unit, for his view on whether the bailout packages violate WTO commitments, and if so, how governments may respond.

GSI: Since the financial crisis began last fall, certain governments such as those in the United States, Canada, Japan and Germany, have offered their banks and/or automobile industries financial bailouts, usually in the form of soft-loans and credit guarantees. Generally speaking, are these bailouts consistent with WTO rules?

Julius Sen: The short answer is no. But there are several issues to be taken into account when analysing the specifics with reference to the application of WTO principles of non-discrimination, broken down into Most Favoured Nation and National Treatment obligations. First of all, what are the specific obligations or commitments of the member concerned? This question is particularly important in the area of financial services, which are subject to the rules of the General Agreement on Trade in Services (GATS) agreement and thus slightly different from the General Agreement on Tariffs and Trade (GATT) which would apply to the auto sector.
Second, governments can take emergency action for the restructuring of specific sectors, under Article XIX Safeguards, which can include financial assistance of various sorts, but they have to negotiate compensatory concessions with trading partners during the safeguard period, which I don’t think anyone has done.
Third, any grants, concessional loans or other forms of state aid have to be applied in a non-discriminatory fashion (that is for everyone in the market - which obviously has not been the case); should not be trade distorting (which of course they are); and should not have any local content obligations, which would violate the TRIMS agreement on investment conditionalities. And finally, there are European Union rules on State Aid and Competition policy that will also apply to the cases of anyone operating in the EU market, which of course includes U.S. and Japanese automakers and banks. I am not sure what the discussions have been in this area within the EU, but I doubt whether any have actually taken place.
There is an additional possibility that would take state actions completely out of WTO jurisdiction, and that is if these countries treated these rescue packages as part of national security (Article XXI). The concept of legitimate security considerations has never been defined, and is thus flexible to national interpretation.

GSI: In particular, the U.S. government’s 19 December bailouts of automakers Chrysler and G.M. have been criticised for violating WTO subsidies rules. What is your analysis of this view?

JS: I agree that these actions would appear to violate WTO rules at a number of levels, but I am not aware of the full details of how these bailouts were done. Normally, a sector can be identified for restructuring under Article XIX, and during the period of restructuring, concessions have to be offered to all trading partners to make up for their loss of income in that market. In this case, I doubt whether there was any discussion with other WTO members, so there would have been no Article XIX process.
The other level of violation is that this package was only offered to U.S. automakers, not to foreign automakers within the United States. This would appear to violate the rules of non-discrimination and national treatment. And of course these financial concessions will give these automakers an advantage in export markets, including NAFTA markets, so would amount to export subsidies in such cases, which are prohibited under GATT rules. At the same time, the question of whether subsidiaries of U.S. automakers in other countries (such as Vauxhall in the UK, Saab in Sweden and Opel in Germany - all subsidiaries of GM) are entitled to U.S. bailouts, also arises. At present they are not, which has led Saab to file for bankruptcy protection. But it begs the question of how WTO rules apply to complex multinational structures with more or less autonomous subsidiaries.
Furthermore, if new technical standards are introduced to encourage energy efficient models for the U.S. market, and if select U.S. automakers alone are given money to help re-engineer their plants to meet these new standards, and the same concessions are not given to others within the U.S. or that export into the U.S., then this too would probably be a violation of WTO rules.

GSI: WTO Director General Pascal Lamy recently commented that it was too early to tell what impact these measures would have on trade but warned that some “may eventually have negative spill-over effects on other markets or introduce distortions to competition between financial institutions.” Do countries need to wait for these spill-over effects and distortions before commencing WTO claims?

JS: First of all, I’m not sure I agree with the phrasing ‘eventually’ and ‘spill-over’. The situation is in the here and now and is not a remote possibility. For instance, many countries are offering state assistance to meet trade financing requirements for exporters. This would appear to be a prima facie violation of WTO rules under the TRIMS and other agreements, which also has a very real (trade distorting) impact on the competitiveness of global exports, even now. But of course the response is also fully understandable from the perspective of managing the crisis!
WTO rules do not enforce themselves. Member States have to initiate action. At the moment everyone seems prepared to operate a general ‘ceasefire’ in this respect, which means national governments (who alone can bring cases) recognise that everyone is in difficulty and confronting violations will only complicate efforts to find global solutions to the crisis. There are precedents for this, most notably in the Agreement on Agriculture which built in a ceasefire provision for the first decade of its life, precisely to avoid trade wars in an area of extreme sensitivity and complexity.
The problem will arise, most likely, in the United States, where the U.S. government has to take action under law to investigate private sector complaints and to respond through disputes or other policy instruments (such as anti-dumping actions). These are mandatory provisions that could trigger global mayhem in trade. Unfortunately, the U.S. Congress loves to adopt an assertive position on trade issues, which can make life difficult. And remember, under the U.S. Constitution, foreign trade is within the competence of the U.S. Congress alone. The president only exercises negotiating power on behalf of Congress.

SW: The Brazilian ambassador to the WTO, Roberto Azevedo, recently said that his country may contest the eventual trade distortions that will result from bailouts being offered throughout the world. According to Mr. Azevedo, artificial incentives in one country could be hazardous to companies in other countries. What do you think about this assessment?

JS: He is absolutely correct. But given the scale of the crisis, everyone is now bailing out their economies and protecting domestic markets, though of course emerging economies don’t have as much money and therefore can only offer small bailouts compared with the U.S., EU, Japan and China. As mentioned above, perhaps some sort of ceasefire in taking disputes to the WTO is needed, provided everyone agrees to apply their stimulus and recovery packages in a non-discriminatory fashion. This is, however, an exceptionally complex issue and no one is likely to formally agree, because every stimulus package will apply differently and there will be domestic winners and foreign losers in all cases!

SW: Do you think Brazil may have a claim, in particular, against the U.S. for its financial and auto industry bailouts?

JS: Yes. But they would be wise to wait a while before reacting formally. Perhaps negotiating with the United States and others would be more productive because it is probably more important, at this stage, to keep U.S. markets open for imports than it is to fight individual cases.

SW: Some experts suggest that claims such as these will probably never happen. Given the number of countries that have and will be offering bailouts, it has been argued that negotiated settlements are more likely. What’s your opinion?

JS: In a sense I agree. But the problem is the bailouts are not all the same and there are clear winners and losers, and so the burden and benefits will be distributed unevenly. One option is to have a general ceasefire, but the danger is that protectionism and discrimination would revive to an extent that it renders WTO principles inoperable. The second is to fight every violation, but this will only irritate the U.S., EU, Japan and others, making a final solution more difficult. The third option is to negotiate a new WTO provision providing for non-discriminatory bailouts, stimuli, etc. This is possible, but no one really understands the implications in terms of scale of money or market effects, or would know how to start negotiating and how long it would take.
Bilateral negotiations would seem to be the most viable alternative at the moment, but this will work against the weakest countries for which multilateralism offers the best hope. In brief, the whole system is in such a mess at the moment that we will be lucky to escape a trade war, and really anything short of that will look like a success. But of course it will come at a price: the severe erosion of WTO principles.