- Economic Consequences of CVD Laws
- Countervailing Duties from 1890 to the Present
- The Future of CVD Laws
Countervailing duties (CVDs) are tariffs imposed by a country to offset a foreign subsidy. The General Agreement on Tariffs and Trade (GATT) has permitted the imposition of CVDs since 1947 to offset ‘‘actionable’’ subsidies if the government determines that these subsidized imports are causing or threatening to cause injury to the domestic industry. Actionable subsidies are subsidies that are not explicitly prohibited under the GATT but are subject to challenge if they cause adverse effects on another country.
CVDs are similar to anti-dumping duties, the tariffs imposed to protect domestic industries from products imported at unfairly lowprices, in that both seek to counteract the ‘‘unfair’’ trade practices of a foreign trade partner. Anti-dumping duties aremuch more prevalent than CVDs in the world today, however. Between 1995 and 2005, World Trade Organization (WTO) members imposed 1,804 antidumping duties compared to just 112 CVDs. As a result, countervailing duties have provoked significantly less research and debate than anti-dumping duties.
Some economists emphasize that importing countries should welcome subsidized imports rather than punish the exporting country through the use of CVDs because foreign subsidies lower import prices and increase domestic welfare at the expense of the foreign government. Other economists and lawyers stress that CVDs can improvewelfare by eliminating economic distortions caused by subsidies and discouraging the future use of these subsidies. It is unclear whether current CVD regulations are solely used to offset foreign subsidies; some empirical evidence suggests that CVDs are often geared more toward imposing additional trade protection rather than eliminating economic distortions that arise from foreign subsidies. In order to understand the current debate over CVDs, it is important to understand the economic arguments for and against the use of countervailing duties, the evolution of CVD regulations and their worldwide use, and how future international trade negotiations could alter the use of CVDs.
Economic Consequences of CVD Laws
Economists generally agree that CVDs can improve global economic welfare, at least in principal. Consider, for example, Canadian lumber exports to the United States.Trade theory suggests thatCanadian subsidies would lower the price of Canadian lumber exports to the United States. The United States would benefit from these lower prices as long as it is a net importer of lumber. In otherwords,U.S. consumers of lumber would gain more from the lower, subsidized prices than U.S. lumber producers would lose from lower prices and the loss of market share to Canadian producers. In this situation, the imposition of a CVD would increase the importprice, restore thewelfare of U.S. lumber consumers and producers to their presubsidy levels, and transfer money from the Canadian government to the U.S. government.
The imposition of the CVD causes total U.S. welfare to fall in this scenario because the gain to the U.S. government and U.S. lumber producers does not offset the loss that U.S. consumers experience from the higher prices. Even in this situation, however, the imposition of the CVD could result in an increase in global economic welfare. If the subsidy allows Canadian producers to export lumber to the United States even though U.S. producers harvest lumber more efficiently, then it creates an economic distortion. A countervailing duty that offsets this subsidy should eliminate the unnatural advantage and the distortion, thus improving total economicwelfare. By imposing the CVD, however, the U.S. government improves world welfare at the expense of a net decrease inU.S. economic welfare.
Since the late 1980s, most economists have agreed that under certain conditions CVDs can improve domestic welfare. Assume that there are two firms serving the world market for aircraft, one in the United States and a second in the European Union. Both firms, taking the output of their foreign competitor into consideration, choose output levels to maximize their profits. European production subsidies will artificially lower the cost of production, causing theEuropeanproducer to increase its output. The U.S. producer will react by cutting its production level to try to maintain a higher price. The subsidy lowers the world price of aircraft, although not by the fullamount of the subsidy as in the lumber example. It also increases European profits and lowers U.S. profits. The production subsidy can increase total European welfare as long as the gain to European consumers and producers offsets the cost to the government. In contrast, the subsidy may decrease U.S. welfare if the loss of profits to the domestic aircraft producer is greater than the gain to U.S. consumers.
Using theoreticalmodels, both Dixit (1988) and Collie (1991) show that the optimal response of the U.S. government in a situation like this is to retaliate with a CVD that partially offsets the subsidy. The CVD increases European production costs, thereby increasing the price of aircraft and transferring some of the profits of the European producer to the U.S. government and the U.S. producer. The CVD can increase U.S. welfare in this case because the gain to the U.S. producer and government will offset the loss to the U.S. consumer.
Collie also shows that a foreign country should be deterred from subsidizing exports when a domestic country uses CVDs. This theoretical prediction implies that the threat of the imposition of CVDs should be enough to eliminate subsidies. The continued use of subsidies and countervailing duties, however, reveals that this is not the case.Qiu (1995) develops amodel to show that the coexistence of subsidies and CVD regulations canbe explained by things such as lengthy delays in the imposition, and restrictions on the level, of CVDs.
Countervailing Duties from 1890 to the Present
In 1890, theUnited States enacted the first CVD law, which applied only to certain grades of sugar. Belgium enacted the first CVD law targeting all subsidized imports in 1892, and the United States expanded its CVD coverage to all imports in 1897. By 1921, nine additional countries had passed CVD legislation.
The 1947 GATT formally sanctioned the use of CVDs to counteract foreign subsidies. The countervailing duty portion of the 1947 GATT was largely based on the U.S. law at the time, with one important exception. The GATT allowed for the imposition of CVDs only if subsidized imports were causing or threatening to cause injury to a domestic industry. The United States was granted a grandfather provision and thus did not require proof of injury until 1974. International rules governing the imposition of CVDs remained largely unchanged until the 1979 Tokyo Round GATT Agreement on Subsidies and Countervailing Measures and the 1994 revision of this agreement that resulted fromtheUruguay Round of trade negotiations.
Under the version of the agreement finalized in 1994, governmentsmay initiate a CVD investigation at the written request of the domestic industry. Prior to imposing a CVD, the government must determine that the imports from the country under investigation have (1) benefited from a prohibited or actionable subsidy, and (2) the subsidized imports have caused or threatened to cause ‘‘material’’ injury to the domestic industry. If the government makes a final determination that subsidized imports have injured the domestic industry, itmay impose a CVD up to the calculated amount of the subsidy per unit of imported product.
In general, the agreement does not detail how countries should measure either the amount of the subsidy or the degree of injury to the domestic industry. The agreement does specify, however, that the amount of the subsidy should be consistent with some generally accepted guidelines, such as:
- The difference between the amount paid by the firm on a government loan or a government-guaranteed loan and the amount the firm would pay on a comparable commercial loan obtained in the private market; and
- The difference between themarket price of a good and the price paid to the firm by the government in the purchase of goods, or the difference between the market price of a good and the price paid by the firm to the government in the provision of goods.
Injury determinations should be based on an examination of the volume of subsidized imports, the impact of these subsidized imports on domestic output and prices, and the subsequent impact of the imports on the domestic industry. In conducting this examination, the government should evaluate all economic factors associated with the industry, including the actual and potential decline in output, market share, profits, and capacity utilization, aswell as other factors that may be causing injury to the domestic industry. No CVDs may be imposed if the government determines that the amount of the subsidy is less than 1 percent of the import price or the volume of subsidized imports is negligible.
Investigations must be concluded within 18 months of their initiation. Countervailing duties should remain in force only for as long as necessary to counteract the subsidies causing injury. The duties must be eliminated after five years unless the government determines during a sunset review that revocation of the duties would be likely to lead to a recurrence of injury caused by the subsidies.
Countries have a great deal of latitude in the way they conduct countervailing duty investigations. Most countries have either a bifurcated approach, inwhich the injury and subsidy investigations are conducted by two different governmental entities, or a single-track approach, in which both investigations are conducted by the same entity. For example, in the United States, the International Trade Administration of the Department of Commerce determines the level of subsidies, while the International Trade Commission determines whether the subsidies have caused injury to the domestic industry. In contrast, the Trade Directorate of the European Commission makes both determinations in the European Union.
In 1956, 20 countries had CVD legislation, although only 8 actually used the legislation. The United States, which has historically made much greater use of CVDs than other countries, imposed only 62 CVDs between 1897 and 1959. Under the TokyoRoundAgreement,however, the use of CVDs by a small subset of countries rose dramatically. For example, the United States imposed CVDs in more than 90 cases between 1980 and 1988 alone. Between 1989 and 1993, 7 signatories to the GATT initiated 150 CVD investigations, of which the United States accounted for slightly more than 45 percent.
Since the completion of the Uruguay Round Agreement, more countries have imposedCVDmeasures, although its use is still highly concentrated among a few countries. Seventeen WTO members initiated 182 CVD investigations between 1995 and 2005. Of these, 61.5 percent, or 112 investigations, eventually resulted in the imposition of Countervailing duties. The United States and the European Union initiated 64 percent of all CVD investigations between 1995 and 2005.Half of allCVDinvestigations during this time period were filed against exports from India, Korea, Italy, Indonesia, and the European Union. Metals, particularly steel products, accounted for nearly 40 percent of allCVDpetitions; other leading industries targeted for CVD actions include food products and footwear.
Some economists argue thatmany of these CVDs were used primarily to protect domestic industries from targeted imports, whether subsidized or not. For example, Marvel and Ray (1996) find that U.S. CVD petitions tend to be made against multiple nations simultaneously and are closely linked with anti-dumping petitions. Moreover, most CVD investigations define any financial contribution to the foreign firm as a subsidy, regardless of whether it lowers the foreign export price and creates an economic distortion. Based on these characteristics, Marvel and Ray conclude that CVDs are used primarily to provide the domestic industry with protection from imports rather than to counteract subsidies.
Other researchers have found empirical evidence that political pressure may explain the imposition of some CVDs. As summarized in Blonigen and Prusa (2003), there is a large literature that tests the economic and political determinants of the injury decisions in both CVD and anti-dumping investigations. Most research in this area has analyzed U.S. investigation outcomes and found that although economic factors significantly influence outcomes, political pressure also positively influences the likelihood that a CVD or anti-dumping investigation will result in the imposition of duties.
The Future of CVD Laws
Stiglitz (1997) suggests that CVD laws can be beneficial as long as they are not used to protect domestic industries from import surges. He and others suggest that regulations be revised to include a higher standard of proof for establishing the existence of subsidies. In 2001, the members of the WTO agreed to ‘‘clarify and improve’’ CVD regulations during the Doha Round of trade negotiations, although the clarifications will not necessarily resolve the problems economists have with countervailing duty laws.Negotiators developed a long list of proposals to consider, including specific changes to regulations governing the calculation of the amount of the subsidy and the injury determinations.
In summary, a countervailing duty is a tool that countries can use to offset the unfair use of production subsidies by foreign governments. The use of CVDs is relatively rare today compared to other trade remedy tools such as anti-dumping duties. There is no clear consensus among economists on the impact of CVDs on the economy. Although traditional international trade theory predicts that the imposition of a CVD will increase global welfare at the expense of the imposing country, more recent theoretical models have shown that countervailing duties can improve domestic welfare under certain conditions. Empirical evidence suggests that CVDs may be geared more toward imposing additional trade protection rather than offsetting foreign subsidies; therefore some economists have urged the WTO to revise current regulations governing the use of CVDs. See also anti-dumping; Doha Round; fair trade; General Agreement on Tariffs and Trade (GATT); newtrade theory; subsidies and financial incentives to foreign direct investment; Uruguay Round; World Trade Organization