Truth finding: Do Subsidies Continue After Privatization?

• Author: Yu Wu
• Position: University of Aberdeen, Aberdeen, UK Law394@abdn.ac.uk
• Pages: 139-146

Key words: subsidy, privatization, fair market value, ASCM

Page 139

1. Introduction

A subsidy in ASCM¹ means a financial contribution or benefit thereby conferred by governments or any public body within the territory of a member country.

Subsidies exist in various forms. This article makes an attempt to address the continuity of subsidies especially after privatization. For example, a steel producer obtained a subsidy from the government while it was a state-owned enterprise. Aided by the provision of subsidies, the steel producer was encouraged to export and therefore made a great improvement in its produce. In the recent reform of this country, privatizing the steel producer was necessary, and then transferred to a new producer. A question arises here whether the privatized steel producer still enjoyed the benefit of subsidies, and accordingly would be subjected to countervailing duties ² from other countries upon its steel exports, only because the prior steel producer did receive the subsidy before privatization. Will a non-recurring financial contribution to the previous owners still confers a benefit to the new owners and therefore qualifies as a countervailable subsidy? ³

The WTO Panel, in many of its cases, ruled that "while Members may maintain a rebuttable presumption that the benefit from prior financial contributions (or subsidization) continues to accrue to the privatized producer, privatization at arm's length and for fair market value is sufficient to rebut such a presumption".⁴ The Appellate body clarified that privatization at arm's length and for fair market value may not result in extinguishing the benefit. However, how to define a fair market value varies and is not fixed because of the different places, time, and the methods of privatization.

In fact, the problem would become more complicated when the subsidy is offered during the process of privatization. The interplay between privatization and countervailing duties laws occurs at two main points: the treatment of past subsidies to enterprises (whether they are extinguished by the transfer of ownership), and the treatment of subsidies given in connection with the privatization process as incentives to private purchasers.⁵ The second treatment is directly concerned with privatization itself.

Privatization is the transfer of property or responsibility from the public sector (government) to the private sector (business). The term can refer to partial or complete transfer of any property or responsibility held by government. There are three main methods of privatization: (1) share issue privatization - selling shares on the stock market. Share issue requires a mature and sufficiently developed capital market, otherwise it is difficult to find enough buyers, and transaction cost would be high; (2) Asset sale privatization - selling the entire firms or part of it to a strategic investor, usually by auction. As a result of higher political and currency risk deterring foreign investors, asset sales are more common in developing countries; (3) Voucher privatization - shares of ownership are distributed to all citizens, usually for free or at a very low price. It has been mainly used in the transition economies of Central and Eastern Europe, such as Russia, Poland, the Czech Republic, and Slovakia. To judge whether a subsidy is transferred to the new owner after privatization, the choice of methods of privatization closely relates to the answer, because the standard to test the "transfer of subsidies" in privatization by an auction may no longer apply to the voucher privatization. Therefore, while the U.S. intends to lists the factors to proceed Page 140 to a consideration of whether the sale of privatization was at arm's length for fair market value, it needs to consider the method of privatization, but it appears not.

This article intends to analyze the basic standard set up by WTO Appellate body firstly. Pertinent to the proposed methodology and the factors that might be considered by U.S. government in the test of subsidies continuity, a clarification is made that some considered factors are not appropriate for judging whether subsidies are transferred to a new privatized entity. The article is divided into three parts: firstly, reviewing the WTO rules and cases, especially looking through the development of methodology to test the "transfer of subsidies" by U.S. government. Secondly, introducing and analyzing the new factors and possible standards of U.S. to test fair market value, in order to point out irrationality of some factors. Thirdly, identifying some unresolved problems during the process of test, and attempting to find the solutions for them.

2. The concerned WTO rules and findings

With respect to assessing the transfer of subsidies after privatization, the only rule in Uruguay Round Agreement on Subsidies and Countervailing Measures (ASCM) concerning this problem is Article 27.13

"The provisions of Part III shall not apply to direct forgiveness of debts, subsidies to cover social costs, in whatever form, including relinquishment of government revenue and other transfer of liabilities when such subsidies are granted within and directly linked to a privatization programme of a developing country Member, provided that both such programme and the subsidies involved are granted for a limited period and notified to the Committee and that the programme results in eventual privatization of the enterprise concerned."

In other words, in consistent with necessary conditions such as notification to the Committee, some partial subsidies can be not actionable if the subsidies encourage the privatization. As for this Article 27.13, there are three points needed to be clarified: firstly, this article only applies to developing countries, rather than the disputes between U.S. and E.C., since this article is part of Article 27 entitled with Special and differential treatment of developing countries members. However, the definition of "developing countries" is not clearly given in ASCM. Secondly, the subsidies that are only granted within or directly linked to a privatization might not be considered for countervailing duties by import countries. Virtually, the purpose of most subsidies offered during the process of privatization is to encourage privatization of entities rather than encourage exports or use of domestic over imported goods, thus such subsidies are not prohibitive subsidies. It also provides an answer to whether a concurrent subsidy with privatization, e.g. debt forgiveness, relinquishment of government revenue and transfer of liabilities, can be extinguished during the privatization, or a new subsidy to the new owners, provided the subsidies can just cover social costs. However, it only happens in privatization of developing countries instead of developed countries. Thirdly, due to the purpose of such subsidies offered to encourage privatization, they are not categorized to prohibitive subsidies, but actionable subsidies. If such subsidies are cover social costs or contingent upon export or use of domestic over imported goods, or happening before privatization, they should be actionable or even prohibitive.

Obviously, it does not answer the question of whether the subsidies offered before privatization would be extinguished in privatized entities. Nonetheless, the WTO Appellate Body in United States- countervailing Measures Concerning Certain Products from the European Communities, WT/DS212/AB/R (December 9.2002) recommended an option to assess the problem.

The Panel clarified that its findings apply only to changes in ownership that involve privatizations in which the government retains no controlling interest in the privatized producer and transfer all or substantially all the property.⁶ The Panel then stated that "while Members may maintain a rebuttable presumption that the benefit from prior financial contributions (or subsidization) continues to accrue to the privatized producer, privatization at arm's length and for fair market value⁷ is sufficient to rebut such a presumption" ⁸

While the Appellate Body clarified that privatization at arm's length and for fair market value may result in extinguishing the benefit. Indeed, we find that there is a rebuttable presumption that a benefit ceases to exist after such a privatization. Nevertheless, it does not necessarily do so. There is no inflexible rule requiring that investigating authorities, in future cases, automatically determine that a "benefit" derived from pre-privatization financial contributions expires following privatization at arm's length and for fair market value⁹.Privatization may, not must, result in extinguishing the benefit. The Appellate Body changes an irrebuttable presumption into a rebuttable presumption.

As for this case, the first question arising is why subsidies could be extinguished if the transaction of privatization is made at arm's length and for fair market value. Since a government grants a financial contribution to a pre-privatization entity, it is possible for the pro-privatization entity to get the benefit of the subsidy. The purpose of the countervailing duty law is to offset the competitive benefit enjoyed by subsidized firms. The mere Page 141 change of ownership of the shares from the government to the private company does not reduce the competitive benefit and therefore it is difficult to say the prior subsidies do not pass through to new entities. Before assessing whether the finding is reasonable, the following is an example:

Consider a person ("A") who is given £100 through a government financial...