Meeting the Challenge of China’s State-Owned Enterprises

February 15, 2012
Elizabeth J. Drake

China’s state-owned enterprises (SOEs) play an increasingly important role in the Chinese market and in economies around the world. SOEs are key players in sectors ranging from energy to automobiles and chemicals to information technology. Many SOEs are also present in the seven “Strategic and Emerging Industries” in which China aims to become a world leader by 2030, in part through the investment of $1.5 trillion in government resources over five years.
The competitive challenges posed by Chinese SOEs are the focus of hearing to be held in Washington D.C. today by the U.S. – China Economic and Security Review Commission. Elizabeth J. Drake, a partner at the Law Offices of Stewart and Stewart, will present testimony to the Commission reviewing the policy options available for addressing these challenges.
The testimony outlines three areas in which the U.S. can take steps to help level the playing field between American industries and Chinese SOEs:
1)  confronting Chinese government subsidies to SOEs, including subsidized loans, export credits, debt forgiveness, grants, equity infusions, and preferential access to key inputs such as land, utilities, and raw materials;
2)   challenging Chinese SOEs’ use of purchasing and joint venture agreements to favor domestic suppliers, goods, and services over foreign suppliers, goods, and services or to leverage technology transfers and other concessions from U.S. firms; and
3)   addressing anti-competitive and unfair trade practices by SOEs, including in China’s own market as well as in countries that are increasingly targeted for overseas expansion by SOEs.
On the issue of subsidies, the testimony highlights tens of billions of dollars that have been provided to Chinese SOEs through concessional export credits and export credit guarantees, and argues that a strong case can be mounted against these programs under WTO rules that prohibit subsides which are contingent on export performance. Other subsidies such as cut-rate bank loans and land concessions can also be challenged at the WTO if they are depressing prices and impeding sales for U.S. exporters. Ms. Drake notes that when China joined the WTO, it also agreed to specific rules prohibiting SOEs from providing inputs to one another at discounted prices – a successful case under these rules would not require any showing of injury to U.S. firms. Finally, the testimony emphasizes the need to correct a recent U.S. court decision, GPX International Tire Corp. v. United States, Nos. 2011–1107, –1108, –1109, slip op. (Fed. Cir. Dec. 19, 2011), that prevents the application of the countervailing duty law to offset the severe injury subsidized imports from China impose on U.S. industries and workers.
The second challenge posed by Chinese SOEs is their use of purchasing contracts and joint venture agreements to discriminate against U.S. suppliers and demand concessions such as the transfer of critical technologies. The testimony cites examples of such practices that have been documented in recent reports by Stewart and Stewart on China’s support programs for high-tech industries and for the automotive and auto parts sector. Fortunately, China is bound by fairly robust rules in its WTO Accession Protocol that directly address these issues. The rules require China to ensure its SOEs act consistently with commercial considerations and in a non-discriminatory manner when making purchasing and sales decisions, and the rules prohibit China from influencing the commercial operations of SOEs or requiring local content or technology transfers as a condition of investment approvals. Unfortunately, these provisions have never been tested, as no WTO member has challenged China to comply with these important commitments. Vigorous enforcement of these rules could go a long way towards reining in some of the most egregious practices in this area.
Finally, the testimony reviews gaps in competition and unfair trade policies that permit SOEs to gain an unfair advantage over commercial competitors. In China, for example, competition law treats SOEs separately from other firms, and it is still unclear whether the law will be fully enforced against SOEs. Gaps exist in U.S. policy as well. The OECD has noted that U.S. jurisprudence on predatory pricing, for example, may be inadequate to constrain anti-competitive conduct by SOEs operating in the U.S. market. Additional improvements may be needed in the screening process for foreign investment, SEC reporting rules, and domestic trade remedy laws. The testimony points to the OECD’s SOE guidelines as well as the on-going negotiations towards a Trans-Pacific Partnership Agreement as sources for new rules that could guarantee competitive neutrality between Chinese SOEs and commercial actors.
The Government of China’s aggressive support policies create an unfair advantage for Chinese SOEs in the Chinese home market, in the U.S. market, and in third country markets. The Commission’s hearing provides an important opportunity to explore the nature of the problem and debate possible solutions. Ms. Drake’s testimony concludes that the scope of the challenge requires a comprehensive U.S. response, one that combines elements of trade policy, investment policy, and domestic competition policy. In many cases, stronger enforcement of existing rules can address the worst of the abuses; in other areas, policymakers may need to consider new rules to ensure that U.S. firms and workers can compete on a level playing field with China’s growing state-owned sector.

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