Trade Reform: Focus on Reducing Chinese (and U.S.) Domestic Subsidies

On both sides of each good or service traded internationally, people and firms prosper. That is, the buyer of a good or service expects to be better off from the exchange, as does the seller. People don’t exchange goods and services of equal value. Value is subjective, and unless both the buyer and the seller expect to be better off, they won’t buy or sell.

Trade across international borders works the same way, and every good and service that happens to be exchanged across a border increases wealth on both sides. But that’s not to say everyone benefits. When Chinese students who want to learn debate skills in English, pay U.S. debaters for Skype sessions, debate instructors in China lose an opportunity to earn that income. When U.S. students pay someone in China for Chinese Skype sessions, Chinese instructors in America don’t share in that exchange.

Governments obstruct international trade in many ways. The U.S. has passed a quota on imported sugar to “protect” U.S. sugar producers, which leads to U.S. sugar consumers paying twice world prices. And high sugar prices led Coke to use corn syrup in their cola instead of sugar. Economist Diana Thomas explains in this Learn Liberty video (at link and below).

Congress and the Executive Branch, under pressure from special interests, have passed thousands of tariff, quotas, and regulatory barriers to foreign goods and services, and so have the governments of Japan, China, South Korea, and Taiwan. Subsidies to domestic companies facing foreign competition serve as another kind of costly trade barrier.

Dismantling these trade barriers would benefit consumers in all countries, and would benefit most companies and employees.

For the case of subsidies, the U.S. could agree to reduce subsidies to U.S. firms in a trade agreement where Japanese, Chinese, South Korea, or Taiwan government would also reduce subsidies to domestic firms.

The study below suggests trade reform start, in the case of China, with agreements to reduce domestic subsidies. Reducing payments government make to favored domestic firms reduces government spending and saves taxpayers money.

Derek Scissors, Senior Research Fellow for Asia Economics at The Heritage Foundation, argues in his 2012 Congressional testimony, that though the Chinese government restricts and distorts trade with the U.S. in many ways:

It will thus be more productive to focus on Chinese subsidies, which are just as important to bilateral trade but more tractable. Concerning subsidies, the focus has been on artificially cheap Chinese exports flooding the U.S. In this case, however, American consumers benefit. Where subsidies are entirely harmful to U.S. interests is exports to the PRC. There, American goods and services are effectively blocked by subsidies, benefiting no one but certain Chinese firms. American efforts should focus on reducing barriers to the Chinese market created by subsidies.

Scissors note problems with PRC’s Intellectual Property Rights system and with industrial espionage, but argues that PRC subsidies offer a more strategic target for trade reform. PRC subsidies, most to wasteful and heavily-polluting State-Owned Enterprises (SOEs), harm the people of China as much or more than U.S. exporters.

… The PRC is far from alone as a subsidy abuser, but it stands out in the size and nature of subsidization. Subsidies are both huge and directed almost entirely to state-owned enterprises (SOEs). The status of SOEs (in any country) is itself at issue under the WTO, making it that much harder to come to grips with the subsidies these enterprises receive.[6] 

China has multiple sources of genuine competitive advantage, but these are often suppressed to ensure the dominance of SOEs, whose advantages are not market-based. Subsidies take the form of below-cost land, energy, and other inputs, implicit financial transfers, and regulatory protection. Because it is not financial in nature, regulatory protection is barely touched by WTO rules. It is also hard to measure. Yet it is the most important subsidy that Chinese SOEs receive because it suppresses competition, including competition from imports. 

Most SOEs, from large and centrally controlled to the many smaller provincial firms, can never be outcompeted because they cannot go bankrupt. They have effectively no obligation to creditors or any non-state shareholders. When failing, they are typically merged with other SOEs, with no downsizing and therefore no market share made available to non-state entities.[7] [Source]

Pressure for trade reforms that reduce domestic subsidies applies to other U.S. trading partners (all listed in the NCFCA topic), and to the U.S.:

Sustained American demands for the smallest possible role for Chinese SOEs translate into the largest possible share for American goods and services. The U.S. so far has failed to act along these lines. Congressional legislation aimed at Chinese trade barriers should focus on curbing the regulation that enables SOEs to avoid competition. The first step is to document the effects of this regulation.It should be said that the principle of reducing regulation to encourage competition plainly does not apply only to China. It can apply to a wide range of American partners that create regulations with one eye on disadvantaging foreign products. 

It also applies to the U.S. itself. The U.S. should be ready to reduce our own regulatory barriers to competition. This will not only establish our credentials in negotiation with foreign partners, but also make American companies more competitive against Chinese SOEs and everyone else. Congress obviously has a key role to play here.  [Source]