Trans-Pacific Partnership negotiations and rulemaking to regulate state-owned enterprises

Tsuyoshi Kawase

The regulation of state-owned enterprises in international trade dealings has been cited as a major stumbling block to progress on the Trans-Pacific Partnership negotiations. This column explains the issues of contention, and argues that state-owned enterprises require an explicit and deliberate regulatory treatment. Given their unique properties, a coherent approach to state-owned enterprise regulation would promote progress in negotiations better than the piecemeal of overlapping rules currently considered.

Trans-Pacific Partnership (TPP) negotiations progressed slowly during the first half of 2014. Marathon negotiation sessions held from mid to late February in Singapore failed to show any signs of an agreement being reached. At the Japan-US Summit held in Tokyo in April, even a fancy sushi dinner couldn’t produce a substantial agreement on the liberalisation of Japan's five key agricultural products and the elimination of US tariffs on Japanese auto imports. While market access issues are a major impediment to the successful and prompt conclusion of the TPP, intellectual property rights and rules on state-owned enterprises (SOEs) have been cited by the media as among the most difficult areas to agree upon. In particular, negotiations on the issue of SOEs are expected to be contentious because the negotiating positions of the US and state-capitalist countries like Malaysia and Vietnam are quite confrontational.

At the latest meeting in July, held in Ottawa, the chief negotiators agreed to fend off some complicated issues, seemingly starting to abandon the prospect of reaching a conclusion by the end of this year. The SOE issue is of course a major one. The group negotiating on this issue reportedly ended up merely stocktaking the status quo in each country’s SOEs, without going into the details of substantive rules (Sankei 2014).

Why are SOEs a problem?

Certain elements of SOEs are problematic for other countries with market economies. SOEs:

are supported by government subsidies and cheap loans,

take advantage of preferential regulatory treatment, and/or

are not subject to scrutiny by shareholders on a short-term basis because of being under state ownership.

For these reasons SOEs are prone to engage in economically irrational behaviour such as dumping and excessive capital investments or anticompetitive business practices, thereby disrupting the order of fair international competition.

In the area of trade in goods, a significant portion of recent trade remedy cases by the US, as well as of recent US complaints to the WTO, concern Chinese SOEs. Affected industries encompass a range from the natural resources to high-tech industries, while a broad array of government support measures for SOEs and anticompetitive behaviour by SOEs have been pointed out as being problematic (Kawashima 2012).

In the area of investment, SOEs have been demonstrating competitiveness in acquiring interests in mineral properties and exploration rights in third world countries. For instance, China has been investing aggressively in natural resources in Africa – even in countries with high political risks – driven by its desire to secure energy resources for the motherland, gain access to newly emerging markets, and challenge the Euro-American hegemony in the world (JETRO 2009). Huge sovereign wealth funds (SWFs) have been making massive investments using revenue from exhaustible natural resources or foreign reserves as a financial source. On the part of host countries, there is a great deal of suspicion about the true political and strategic intentions behind such investments.

Sources of SOEs' competitive advantages that enable them to engage in economically irrational behaviour while maintaining control and strength in the market can be classified as follows (Capobianco and Christiansen 2011):

Outright subsidisation

Concessionary financing and guarantees by the government and/or governmental financial institutions

Preferential treatment in the application of regulations (e.g. exemption from information disclosure requirements, exclusion from the application of monopoly law)

Monopoly power and advantages of incumbency

Captive equity

Exemption from bankruptcy rules and information advantages

In all aspects of trade in goods and services as well as investment activities, private-sector companies from advanced market economies are being forced to compete with their SOE rivals equipped with all of those advantages. Thus, the OECD has been calling for ensuring a level playing field, or competitive neutrality between SOEs and private-sector companies. In essence, these terms represent the idea that SOEs should not have advantage over their private-sector counterparts solely because of their state ownership status (Capobianco and Christiansen 2011, OECD 2005).

Coverage and limitations of existing rules

In ensuring a level playing field with SOEs and private-sector companies, existing international economic laws and regulations can be applied as follows.

Regarding trade in goods, the most effective set of rules is the WTO Agreement on Subsidies and Countervailing Measures (ASCM). US—Lead and Bismuth II (DS 138, 2000), US—Countervailing Measures on EC Certain Products (DS 212, 2002) and EC—Large Civil Aircraft (“Airbus”, DS 316, 2011) are the notable cases where the Appellate Body considered “actionability” under ASCM of loans, capital investments, and other financial contributions for SOEs from their governments. Furthermore, in Canada—Renewable Energy/Feed-in Tariff (DS412/426, 2013), the Appellate Body effectively restricted SOEs' discriminations between domestic and foreign firms in procurement as a violation under Article III:4 of GATT (national treatment principle). GATT Article XVII (state trading enterprises) and the recently revised WTO Agreement on Government Procurement (GPA) can be also used as a tool to restrict discriminatory purchasing and sales activities by SOEs.

Regarding trade in services, the Financial Times' Global 500 ranking of companies by market capitalisation in 2013 shows that four Chinese banks and China Mobile were among the top 50. As seen in China—Electronic Payment Services (DS413, 2012), SOEs' competitive advantage can be contained by means of a member's commitments to the national treatment and market access under the WTO’s service agreement, GATS, but only in areas where the member has made specific commitments. GPA also can oblige SOEs to comply with the principle of non-discrimination in procuring and purchasing services. No substantive rules on service subsidies are available other than specific commitments included in each WTO member’s schedule.

Regarding outward direct investments, some international investment agreements (IIAs) concluded between home and host countries contain provisions exempting subsidies (e.g. Article 14 (5) (b) of the 2012 U.S. Model Bilateral Investment Treaty). Other preferential treatment for SOEs that is discriminatory and anticompetitive in nature by host countries may be found to be in non-compliance, for instance, with the principle of national treatment or that of fair and equitable treatment. Furthermore, a foreign investor can bring a claim against the government of its host country for the reason of SOEs' misconduct under the investor-state dispute settlement (ISDS) provisions of the relevant IIA. Emilio Agustin Maffezini v. The Kingdom of Spain (ICSID Case No. Arb/97/7, 2000) is a good example of the wrongful acts and omissions by an SOE acting on behalf of the host country being condemned by an ISDS tribunal. Article 2 of the 2012 U.S. Model Bilateral Investment Treaty comprises a similar principle.

On the other hand, regarding inward direct investments, when a host country deals with strategic investment activities and anticompetitive business practices by foreign SOEs and SWFs, it is effective to apply mutatis mutandis and, within the purview of the OECD Code of Liberalisation of Current Invisible Operations, domestic investment review and blocking processes for the reason of protecting national security and public interests. Leading examples include Articles 26 and 27 of the Foreign Exchange and Foreign Trade Act of Japan and the Exon-Florio amendment of the US. Many IIAs basically do not restrict such investment reviews without liberalisation commitments on investment. And most IIAs provide for national security and public order exceptions. The IMF's Santiago Principles and the OECD Declaration on SWFs and Recipient Country Policies can be cited as relevant international soft law.

Regarding international enforcement of competition law, the European Commission's antitrust investigation since 2011 into Gazprom (the Russian state-controlled gas company) has opened a new possibility for regulating foreign SOEs' behaviour by means of competition law. Gazprom is suspected of having divided up markets and maintaining unfairly high gas prices in the Czech Republic and other countries in Central and Eastern Europe. While preparing a compromise proposal as a possible option, the European Commission was expected to release its investigation findings, which would confirm effectively the illegality of Gazprom's anticompetitive business practices. Due to the recent developments in Ukraine, the European Commission likely will delay its decision on the case (Bloomberg News, 6 March 2014; Radio Liberty, 11 February 2014).

In search of effective SOE rules: The TPP's challenge

As such, the SOE rules currently in place are a mere patchwork of various international and domestic rules on trade, investment, and competition, rather than being a set of rules established specifically for the purpose of regulating SOEs with their characteristics taken into account, and there exist no established uniform principles by which to regulate SEOs. Consequently, the transparency of information such as the description of business and financial standing – which is a prerequisite for the effective regulation of SOEs – is outside the realm of the existing international law. Also, there exists no regulatory scheme to control outright government subsidies paid into an SOE’s investment and operations in the third country market. Person-oriented SOEs’ strengths (like close relationships with influential politicians) would be next to impossible to capture. Given all of these points, there is no doubt that a new set of SOE rules needs to be established. Now the US’ attempt to regulate SOEs ranges from the TPP negotiations to TTIP negotiations with the EU and the Trade in Services Agreement (TiSA) at the WTO. Needless to say, China is the future target in mind.

The state of the TPP negotiations is not revealed due to their highly secretive nature. However, it has been reported that, in the Lima round of negotiations in May 2013, Australia proposed an internal audit-like mechanism under which each country would examine and ensure the aforesaid competitive neutrality between private-sector companies and SOEs within its own economy (Inside US Trade, 7 June 2013). This approach, originating in Australia’s own domestic system, is premised on the penetration and acceptance of the basic concept of the market economy. It also involves significant administrative know-how for the implementation of laws and regulations similar to competition laws. Given this, it would be difficult for Vietnam and Malaysia to introduce the same or similar system immediately.

In contrast, the US proposal put forward in another round in Lima held in October 2011 calls for, inter alia, regulating a broader range of enterprises including those that are effectively government-controlled, eliminating all preferential measures granted to SOEs that would nullify or impair market access, prohibiting financial support to SOEs, and ensuring non-discriminatory treatment between SOEs and their private-sector competitors. Also, by calling for the enforcement of all of those measures by means of an effective dispute settlement system, this is a very ambitious proposal (Inside US Trade, 29 September 2011).

Reportedly, Australia effectively gave up on its proposal last summer partly due to strong opposition from the United States (Inside US Trade, 8 August 2013). As seen over the past few months, TPP countries have indeed narrowed their differences over the basic mechanism of regulation and the scope of application. As the actual draft text is not disclosed, questions remain concerning the detailed design of the regulation mechanism. For example, if it were to simply regulate subsidies and loans, ASCM-like rules would be sufficient. However, how should we quantify preferential treatment in environmental regulations for SOEs or SOEs’ lax corporate governance in order to access their competitive advantages? The definition of an SOE is another difficult issue to agree upon. Should the term ‘state-owned’ be taken literally as meaning 100% government ownership? Or should more than 50% of its voting shares held by the government be sufficient? Furthermore, treatment of enterprises owned by sub-national governments – which would be sensitive for federalist countries such as the US – is seemingly another reason for splits among the negotiators.

Meanwhile, full consideration should be given to the positive roles of SOEs, as observed in some network industries where a monopoly generates efficiency (e.g. electricity, water) as well as in areas where significant spillover effects can be expected but private-sector investment is not forthcoming because of the huge amount of capital and high risks involved (e.g. high-tech, aeronautics) (Chang 2007, Kowalski et al. 2013). SOEs can also play an important role in promoting economic development, particularly in developing countries, for various economic and social reasons (Gillis 1980). Thus it seems superficial to seek stricter restrictions merely due to a single-minded assumption that SOEs must be inherently evil as insisted by American industries. Rather, we should explore an ideal code of conduct that can effectively regulate SOEs based on a thorough understanding of their anti-competitive nature as well as of their positive social and economic functions.

Editor’s note: The full version of this column is available on the website of the Research Institute of Economy, Trade and Industry (RIETI) of Japan

References

Kawashima, F (2012), "Chugoku ni okeru Shijo to Seifu o Meguru Kokusaikeizaiho-jo no Hogensho to Kadai: Jiyushijo-koku to Kokkashihonshugi-koku no Tairitsu? [Legal Phenomena and Challenges in International Economic Law concerning the Relationship between Market and Government in China: Conflict between Free-Market Countries and State-Capitalist Countries?]," Phenomena of International Economic Law and Challenges of the Market and Government of China: Confrontation between free market countries and state capitalist countries?]," in the Japan Association of International Economic Law Yearbook, No. 21.

Japan External Trade Organization (JETRO) (2009), China in Africa: A Strategic Overview.

Capobianco, A and H Christiansen (2011), "Competitive Neutrality and State-owned Enterprises: Challenges and policy options," OECD Corporate Governance Working Papers, No. 1.

Chang, H-J (2007), State-Owned Enterprise Reform, UNDESA.

Haley, U C V, & G T Haley (2013), Subsidies to Chinese Industry: State Capitalism, Business Strategy and Trade Policy, Cambridge University Press.

Kowalski, Przemyslaw, M Büge, M Sztajerowska, and M Egeland (2013), "State-Owned Enterprises: Trade Effects and Policy Implications," OECD Trade Policy Paper, No. 147.

Gillis, M (1980), "The Role of State Enterprises in Economic Development," Social Research, Vol. 47(2).

OECD (2005), OECD Guidelines on Corporate Governance of State-owned Enterprises, OECD Publishing.

Skovgaard, P, and N Lauge (2013), "Investment Treaties and the Globalisation of State Capitalism: Opportunities and Constraints for Host States," in R Echandi & P Sauvé (eds.), Prospects in International Investment Law and Policy, Cambridge University Press.

The Economist (2012), "Special Report: State Capitalism," 21 January 21.