November 15, 2017 9:46AM

Can the WTO Handle China?

By Simon Lester and Huan Zhu

We often hear arguments that the World Trade Organization cannot handle an economy like China's, with its heavy state intervention. Trade rules are just not up to this task, some people say. Here's a recent example from a Wall Street Journal article entitled "How China Swallowed the WTO":

Rather than fulfilling its mission of steering the Communist behemoth toward longstanding Western trading norms, the WTO instead stands accused of enabling Beijing’s state-directed mercantilism, in turn allowing China to flood the world with cheap exports while limiting foreign access to its own market.

“The WTO’s abject failure to address emerging problems caused by unfair practices from countries like China has put the U.S. at a great disadvantage,” Peter Navarro, a trade adviser to President Donald Trump, said in an interview.

China has a wide range of policies that make up its industrial policy, and we can't address them all in a short blog post. However, we will describe one recent example, and explore briefly whether WTO rules can help. This is also from the WSJ:

Batteries have emerged as a critical front in China’s campaign to be the global leader in electric vehicles, but foreign auto makers and experts say it is rigging the market to favor domestic suppliers.

Tianjin Lishen Battery Co. here in eastern China recently agreed to sell its battery packs to Kia Motors for the EVs the South Korean company makes in China and is now in talks to supply General Motors, Mercedes-Benz and Volkswagen, a supervisor for the Chinese company said.

But that is largely because Tianjin Lishen has little foreign competition.

Foreign batteries aren’t banned in China, but auto makers must use ones from a government-approved list to qualify for generous EV subsidies. The Ministry of Industry and Information Technology’s list includes 57 manufacturers, all of them Chinese.

Foreign battery companies declined to discuss their absence. But analyst Mark Newman of Sanford C. Bernstein said the government has cited reasons such as paperwork errors to exclude foreign suppliers.

“They want to give their companies two to three years” without foreign competition to secure customers, achieve scale, and improve their technology, Mr. Newman said.

The ministry didn’t respond to questions.

So, if we accept the conventional wisdom, nothing can be done about this battery policy, right? There's no way to prove that the policy is protectionist, so we just have to give up on the WTO as a solution here, right?

We disagree. In fact, the WTO has rules to deal with this exact kind of subtle, disguised protectionism. The WTO's Agreement on Subsidies and Countervailing Measures prohibits subsidies that are contingent on the use of domestic goods, even where the contingency is not specified in law. If a complainant can show that the connection between the subsidies and the use of domestic goods exists on a de facto basis, the measure will be found in violation. Whether a challenge succeeds will depend on the specific facts of the case. In the electric vehicles example described above, the complainant could look for, inter alia, evidence that the electric vehicle companies which have received subsidies only use batteries on the government list, or that they switched to using the batteries on the lists after the lists were published. 

Of course, proving a case here is not going to be easy. A single WSJ article is not enough. The complainant will need to go gather some evidence and build its case. But that's how litigation always works, and does not suggest any great flaw in the WTO.

The key point here is that what China is doing is not some novel approach to industrial policy that no one has ever seen before. Rather, it is classic protectionism that WTO litigation has handled for years. Governments do this sort of thing all the time, and many WTO cases deal with this exact kind of disguised protectionism. (As an example, in a 1999 decision examining whether certain Canadian subsidies to the aircraft industry were contingent on export, the WTO courts took into account "sixteen different factual elements" before concluding that the subsidies at issue violated the prohibition on export subsidies.) Thus, governments who are concerned with China's policies should try to work within the WTO system to address their complaints.