State-Owned Enterprises and the TPP

My Cato trade policy colleagues and I recently released a Working Paper analyzing the Trans-Pacific Partnership (TPP). We find that the agreement is “net liberalizing,” and that despite its various flaws, the agreement will improve people’s lives and should be ratified. Some aspects of the agreement were obviously good (like lower tariffs) and others were easy to condemn (like labor regulations); but for many of the TPP’s 30 chapters, our opinion is more ambivalent. 

The TPP’s chapter on “state-owned enterprises” (SOEs) is one of those. The TPP’s SOE rules are good rules, but they’re not nearly as ambitious as we wish they’d be. We gave the chapter a minimally positive grade of 6 out of 10. Here’s some of what we had to say in our report:

Concerns about the role of SOEs have grown in recent years because SOEs that had previously operated almost exclusively within their own territories are increasingly engaged in international trade of goods and services or acting as investors in foreign markets. The chapter represents the first ever attempt to discipline SOEs as a distinct category through trade rules.

The provisions include three broad obligations meant to reduce the discretion of governments to use state-ownership as a tool for trade protectionism. These obligations are that SOEs and designated monopolies must operate according to commercial considerations only, must not give or receive subsidies in a way that harms foreign trade, and must not discriminate against foreign suppliers.

While the privatization of public assets is an important part of economic liberalization, the State-Owned Enterprises chapter does not attempt to eliminate or prevent government ownership. Instead, it is intended to reduce the economic distortions caused by direct government ownership of prominent firms. The chapter’s three main obligations make an excellent contribution to international economic law. The rules are simple and well-tailored to address the problem of protectionism conducted through management of SOEs and the granting of special privileges to them….

On the down side, the chapter provides for numerous exceptions to the basic rules, which will have the effect of diminishing the impact of these otherwise market-oriented disciplines. Each party maintains detailed lists of exemptions, allowing the bulk of existing SOEs to continue operating without paying much heed to the SOE disciplines. Most members have carved out specific SOEs from the chapter’s disciplines, particularly in the energy and finance sectors. The extent of these exemptions significantly limits the chapter’s practical impact. Moreover, by requiring a controlling interest, the definition of an SOE leaves out a great number of enterprises that receive special treatment by the state due to inappropriate government involvement through ownership.

It’s good that the TPP has rules for SOEs and that the rules in the TPP are good ones, but the agreement isn’t going to do much, if anything, to reform existing SOEs in the 12 member countries. 

Even so, the TPP’s SOE rules are not a total wash. They have real value in the long run, because they will provide a blueprint for future negotiations involving China.

Any trade negotiations between the United States and China, whether it’s China’s entry into the TPP or the formation of a larger agreement including both economies, will surely be contentious. The U.S. business lobby has a lot of complaints about various Chinese policies that disadvantage foreign companies, and SOEs are near the top of the list. At the same time, the Chinese government continues to rely on state-ownership in key sectors, especially banking and finance, not simply as a tool for protectionism, but also as a way to manage its economy more broadly. They will be reluctant to give up that control in a trade agreement. 

Ultimately, the greatest benefit from SOE liberalization will be enjoyed by the Chinese people, who currently suffer from rampant cronyism, mismanagement, and misallocation of investment in SOE-dominated industries.

It’s impossible to know at this point precisely how future U.S.–China trade negotiations will go or how much influence the TPP’s SOE rules will have on them. But those rules do provide an encouraging step in the right direction. Despite its practical weaknesses, the SOE chapter is a positive component of the TPP and is one of many reasons why advocates of free markets should support the agreement.