Trade Policy Concerns: Non-

Tariff Measures - Subsidies

Lecture 4
 What are the Major NTMs?
• Not direct tariffs, but other form of policies / barriers
• Set of import restrictions (e.g. Quota) / local preferences (e.g.
DCR) and supports to local players (e.g. Subsidies) / non-
transparent rules, regulations with possibility of multiple
interpretation (e.g. Standards, Reciprocity)
– Subsidies
– Domestic Content Requirement
– Dumping
– Export Quota / Voluntary export restraint (VER)
– Import quotas
– Government Procurement policies
– Environmental standards
– Technical standards
– Entry regulations at the foreign factor market
What is the Effect of providing
Subsidies?
 1. Subsidies
• Government funding to domestic producers for improving their trade
position
• Coverage: tax concession, low interest loans, insurance arrangement & cash
disbursements
• Effect: allows producers to sell goods for a lesser price
• Domestic subsidy – granted to producers of import competing goods
• Export subsidy – granted to producers of goods that are to be sold in
other countries
• Sectors: Agriculture, Fishery, Iron and Steel, Chemical, Automobile,
Aerospace, Electronics etc.
• WTO discussion to curb subsidies
• Actionable – subsidies for enhancing production
• Non-actionable – research and infrastructure-related subsidies, the
importance of specificity
• Do research grant necessarily form harmless subsidies? Random
Access Memory Hard Drives dispute involving US and South Korea
• National Pride: A case of Airbus and Boeing
Input and Output Subsidies

Free Electricity MSP

S1
S1

Leakage effect in case of Input Subsidies?

What is the Effect of a Domestic
Subsidy?
 1A. Domestic Production-Welfare Effect
• The subsidy is being provided to The initial Supply and Demand curves
import-competing manufacturers are SUS,0 and DUS,0 respectively.
• Equilibrium: $ 430 / ton.
Free Trade
• Assume the domestic market is
relatively small in relation to the
world, and free trade does not
affect world price ($ 400 / ton).
• Consumption: 14 tons; Domestic
Production: 2 tons; Imports: 12 E
tons.
• Consumer surplus substantial
because of the lower price
caused by free trade
• Producer surplus is a small area
for the same reason
 Domestic Production Subsidy-Welfare
• The Supply shifts to SUS,1 Suppose the US government provide
• Consumption: 14 tons; Production: 7 a subsidy of $ 25 / ton of steel.
tons; Imports: 7 tons.
• Market price does not change, but
for the steelmaker net price is $
425 ($ 400 + $ 25).
• Producer surplus increases due to
greater sales
• Subsidy revenue effects:
• Part of it is redistributed as
producer surplus.
• b is the protective effect
/deadweight loss
• Result: subsidies do not decrease
welfare as much as tariffs or
quotas, as domestic demand is not
distorted c
d

• Since there is no
distortion of
consumption (14 tons),
the consumer welfare
loss does not take place
• Better than tariff?
 Why Production increases after Subsidy?
• Consider the per unit cost structure of domestic producers:
• Suppose, World Price: Rs. 100
• Government providing a Rs. 5 input subsidy

Producer Actual Subsidy Cost Production Production

Cost After (Without (With
Subsidy Subsidy) Subsidy)
1 99 5 94 Yes Yes
2 100 5 95 Yes Yes
3 102 5 97 No Yes
4 105 5 100 No Yes
5 107 5 102 No No
 EU Domestic Subsidy in Agriculture: CAP
EU DOMESTIC GREEN BOX BLUE BOX AMBER BOX TOTAL SUPPORT
SUPPORT (Amount & %) (Amount & %) (Amount & %) NOTIFIED
NOTIFIED
TO THE WTO
(in EUR million)
Period 2011/2012 70 976.8 2 981.1 6 858.9 80 816.8
(G/AG/N/EU/20) 87.8% 3.7% 8.5% 100%

Period 2012/2013 71 140.0 2 754.2 5 899.1 79 793.3

(G/AG/N/EU/26) 89.1% 3.5% 7.4% 100%

Period 2013/2014 68 697.8 2 663.6 5 971.7 77 333.1

(G/AG/N/EU/34) 88.8% 3.4% 7.8% 100%

Period 2014/2015 65 256.8 2 878.8 6 642.3 74 777.9

(G/AG/N/EU/43) 87.3% 3.8% 8.9% 100%

Period 2015/2016 60 828.5 4 331.1 7 101.8 72 261.4

(G/AG/N/EU/46) 84.2% 6.0% 9.8% 100%

Period 2016/2017 61 696.1 4 641.2 6 944.5 73 281.8

(G/AG/N/EU/55) 84.2% 6.3% 9.5% 100%

Period 2017/2018 65 845.8 4 795 6 532.8 77 572

(G/AG/N/EU/61) 84.8% 6.1% 8.4% 100%

https://www.europarl.europa.eu/factsheets/en/sheet/111/wto-agreement-on-agriculture
 No Trade Scenario
• The domestic price is quite high.
• Quantity availability is low.
• Unhappiness among the electorate.
• Free trade?
SM

E
Pd

DM

Xd
Free Trade Scenario
• Lower output, Producers unhappy.
• Lobbying for protection.
• Import: CF - XF

SM

E
Pd

PW

DM

XF Xd CF
 Production Subsidy
• Per unit production subsidy.
• Rise in domestic output.
• No change in consumption.
• XS – XF is the additional production.
• Fall in imports. SM

SM, Subsidy

E
Pd

F
PW
G

DM

XF XS Xd CF
 Welfare Implications: Subsidy to Newcomers
• CS Change = 0 Government Revenue Change
• PS Change = j + k = Per Unit Subsidy X Additional Production
• PS Change, owing to rise in output = k = Vertical difference between the two
• Government Revenue change = - (c + d) Supply Curves * (XS – XF)
• W = δCS + δPS + δGR
• W = 0 + k – c – d (as k and c are similar
triangles)
• W=-d SM

SM, Subsidy

Pd
b h

e
c g
d f
PW
i k G
j
DM

XF XS Xd CF
 Global Evidence
• Rice Subsidy in Thailand (2007-08): Any permanent benefit?
Electric Vehicle subsidies across countries: Implications
• US Practice:
• “Federal tax credit for EVs will remain at $7,500

• Timeline to qualify is extended a decade from January 2023 to December 2032

• Tax credit cap for automakers after they hit 200,000 EVs sold is eliminated, making
GM, Tesla and Toyota once again eligible”

• Support by price ranges

• Indian Practice: Subsidy linked with battery capacity

• Food security argument: Case for agri-subsidies in India
• Hidden subsidies by State-Owned Enterprises in China?
Can the Domestic Subsidy be Actionable?

• Consider: Sugar MSP in India and Brazil’s move to WTO.

• Why Australia and Guatemala also lodged disputes?
What is the Effect of an Export
Subsidy?
 Export Subsidy to Which type of Entity?

Subsidy to Whom?

Natural Importer Natural Exporter

Primary Industrial Final Final

Products Intermediate Manufacturing Manufacturing
Products – Low- Products – High-
tech tech
Export Subsidy in a Natural Importer Country?

SM

E
Pd

PW

DM

XF Xd CF
Export Subsidy in a Natural Importer Country?

SM

SM, Subsidy
E
Pd

G
PW
Pds F
H
DM

XF Xd CF Xds

Will any government try this kind of a subsidy policy?

 Export Subsidy in a Natural Importer Country?

• What if the subsidized

product is:
• Primary Product?
• Intermediate for
manufacturing sector?
• Finished manufacturing
product?
• Experience across
countries
SM, Subsidy

PW
Pds

DM

CF/S Xds XF/s

If a country is a natural importer, then usually government subsidy

unlikely to make it exporter, at least in the short or medium runs.
Subsidy and World Price: Small Country

Domestic International

S1
S2 S1
S2

6
5
5

Q1
Export Subsidy: China as a Large Country

SWOR
SWOR / Subsidy in China

5 PW

4.5 P *S

DWOR

• Suppose, original world price: Pw = $5

• Now, China provides a subsidy of S = $1
• As an outcome of the increased export supply from China, a large country, world price falls.
• P*S / P’w = $4.5
 4B. Export Subsidy – Welfare Effects
The Domestic demand and Supply curves
• Free Trade - No Subsidy for US are DUS and SUS respectively.
• Domestic equilibrium occurs at
a price which is lower than
Free Trade
world price ($5)
• Assuming the domestic market
is relatively small in relation to
the world, free trade will raise
the price in this case
• Consumer surplus is relatively
limited because of higher price
f
associated with free trade
E
• Producer surplus is a large area
for the same reason
• With provision of subsidy
however, terms-of-trade
effect and export-revenue
effect will set in.
Production: 8 units;
Domestic
Consumption: 4 units;
Exports: 4 units.
 Export Subsidy – Welfare Effects
• Export subsidy increases the net Now Suppose Export Subsidy is being
price for domestic producers (world
provided by the US (US $ 1 / bushel)
price + subsidy), US $ 6 ($ 5 + $ 1).
• Consumer surplus is decreased
further because of higher price (a + Export Subsidy
b)
• Producer surplus increases for same
reason (a + b + c)
• Taxpayer cost: b + c + d
• Deadweight loss of welfare to society:
(b) and (d)
• Provide employment and sales growth
to domestic industry in short run
• Cost to taxpayers – domestic
consumers end up paying greater price
for the goods they help subsidize
• Large Country: TOT declines as more
exports reach the international
market.

Production: 10 units;
Domestic
Consumption: 2 units; W = PS + CS + GR
Exports: 8 units. W = (a + b + c) - (a + b) – (b + c + d)
W=-b-d
 The New Price Line: Implication
• China domestic Price = $4
• World Price = $5
• Price is equated at $5, in both China and world when trade takes place.

• Chinese firm export 10 ton of iron and steel product.

• World Price = $5 / ton.
• Revenue for the Exporter = $5 X 10 = $50

• Chinese government is providing $1 per unit subsidy.

• Post-Subsidy Revenue for the Exporter
• Export Revenue = Revenue from World Market + Government Support
• = $5 X 10 + $1 X 10 = $60

• Revenue per ton by the exporter = $60 / 10 Ton = $6/Ton = $(5 + 1) / Ton
 Effects of an Export Subsidy:
Large Country Case

Price, P

PW
• Exporting country is a
large country.
• Government decides to
offer subsidy to secure
PD rise in exports.

D
X0
Quantity, Q
CS CF XF XS
Exports
 Effects of an Export Subsidy:
Large Country Case
• Government subsidy leads to rise in exports.
• Greater supply in the world market, hence the
price in world market falls to P*S.
Price, P

PS • Suppose, Chinese
Government Subsidy = PS
PW a b c – P*S = $1
Subsidy d
• Suppose, Original World
P *
S e f g Price: Pw = $5
• Pd = $4
• S = $1
PD • Pw + s = $5 + $1 = $6
• New World Price: P*S =
P’w = $4.5
• PS = P’w + s = $4.5 + $1 =
D $5.5
X0
Quantity, Q
CS CF XF XS
Exports
 Effects of an Export Subsidy:
Large Country Case
• Greater supply in the world market, the price in
world market falls to P*S.
Suppose, Pw = $5
Price, P Pd = $4
S = $1
Pw + s = $5 + $1 = $6
S P’w = $4.5
Ps = P’w + s = $4.5 + $1 = $5.5
PS

PW a b c
Subsidy d
= Producer Gain
P *
S e f g (a + b + c)
= Consumer Loss (a + b)
PD
= Cost of
Government Subsidy
(b + c + d + e + f + g)
D

Quantity, Q
Exports
 Effects of an Export Subsidy:
Large Country Case
• Net Welfare = PS + (-) CS + (-) GR
• Net Welfare = (a + b + c) – (a + b) – (b + c + d + e + f + g)
Price, P • Net Welfare = - (b + d + e + f + g) = - (b) – (e + f + g) – (d)
S

PS

PW a b c
Subsidy d
= Producer Gain
P *
S e f g (a + b + c)
= Consumer Loss (a + b)
PD = Cost of
Government Subsidy
(b + c + d + e + f + g)
D

Quantity, Q
Exports

Why Export Subsidization in China then?

 Subsidy and Terms of Trade Effect
• Export Price before Subsidy = 5
• Import Price before Subsidy = 4
• TOT = 1.25
• Export Price after Subsidy = 4.5
• Import Price after Subsidy = 4
• TOT = 1.1

• War over Lithium-Ion Batteries (850760) – who wins?

• State subsidies in China – rise in export from Tesla, SAIC Motor
Corp. and BYD Auto Co.
• Share decline for South Korea, with modest performance of LG
Energy Solution, Samsung SDI and SK On etc. – growing demand
for supports
How can Governments enhance viability
of local players in domestic market?
 Strategic Intervention in Advanced Countries:
Market Failures (1)
1. Technological externalities
• Firms in an industry generate knowledge that other firms / later
entrants can also use without paying for it
• Marginal social benefit of knowledge – good case for subsidizing the
industry
• Hi-tech firms in the initial period are willing to make investments in R
& D activities – initial losses – need to be supported
• Argument against laissez-faire: firms never get full benefit out of the
investments as other firms reverse engineer their product and enjoy
the undue advantage (e.g. electronics)
• Problem 1: How to define hi-tech research / knowledge-intensive
industry, as strict policies would augment bureaucracy and help only
large firms and not smaller units capable of innovating?
• Problem 2: if domestic market size supports only one / two firms?
• Solution: Subsidize the activity with externalities, not all activities in
an industry (e.g. R & D)?

US practice of deducting R & D current expense against the

corporate profit tax
How can Governments enhance
viability of local players in
international markets?
 Strategic Intervention in Advanced Countries:
Economies of Scale (2)
2. The presence of monopoly profits in highly concentrated
oligopolistic industries
• Case of the industries where there are only a few firms in
effective competition
• The assumptions of perfect competition will not apply.
• Firms will make excess returns (profits), above what equally risky
investments elsewhere in the economy can earn.
• There will be an international competition over the excess returns.
• Brander and Spencer (1985) hypothesis – A subsidy from the
government to domestic firms can shift the excess returns from
foreign to domestic firms
• Implications: when firms are selling only in foreign markets, the
support raises national incomes at the expense of other countries.
 The Game-Theoretic Framework
• There are two firms in the world from two countries, say – Boeing
(US) and Airbus (EU).

• Say, the game (decision) is played over a particular choice, whether to

produce and export a 200-seat aircraft or not (Yes / No).

• The decision is taken by judging the expected profitability of the

venture.

• The expected profitability matrix can be summarized by collecting

business data, which helps the firms to arrive at their decisions.

• Following Brander-Spencer model, a notional pay-off matrix (measured

in US $ billion) is prepared.

• The rows correspond to a particular decision by Boeing (Green).

• The columns correspond to a particular decision by Airbus (White).

Within each box, the number in lower left end represents the
profit of Boeing, while the same in the upper right end represents
the profit of Airbus.
 7.1: National Interest Arguments for
Activist Subsidy Policy

Airbus Produce Don’t produce

Boeing
-5 0
Produce -5 100
100 0
Don’t produce
0 0
• If only Boeing produce, it earns a profit of $ 100 billion, and
Airbus can not enter the market (zero profit) and vice versa
• When both Airbus and Boeing enter the market, they both earn
losses because of imperfectly competitive nature of the
industry
• Industry leadership under this scenario is determined by the
historical accident, i.e., who enters the market first.
• Suppose Boeing gets a head start.
• Equilibrium outcome is A= 0 and B=100: Airbus does not produce
and only Boeing produces.
 What happens if EU decides to
subsidize Airbus operations to remove
Boeing from market?
 Effects of EU Subsidy to Airbus

Airbus Produce Don’t produce

Boeing
20 0
Produce -5 100

Don’t produce 125 0

0 0
• Suppose, now the EU governments decide to pay a subsidy of $ 25
Billion to Airbus, as that leads to generation of jobs and other
benefits to the EU citizens.
• The pay-off matrix is accordingly revised, with Airbus’s profit being
20 billion and 125 billion under the two options.
• Boeing now knows that irrespective of its decision, it now needs to
compete against Airbus’s higher profitability and will lose money. So
it decides not to produce.
• Equilibrium outcome is A=125, B=0: Only Airbus operates in the
Market after Subsidy is provided. WHY?
• The subsidy of 25 billion leads to a profit of 125 billion – the
strategic effect of the subsidy creates a deterrent for foreign
competition.
 7.2: Level Playing Field Argument

Airbus Produce Don’t produce

Boeing

Produce -20 0
5 125
100 0
Don’t produce 0 0

• Suppose Boeing enjoys an underlying cost advantage, so it earns a

profit of $ 125 billion when produce, while Airbus earns only $
100 billion in the opposite case.
• Due to the advantage, Boeing earns a positive profit, even when
Airbus enters the market.
• Equilibrium outcome is A=0 and B=125; Boeing produces and
Airbus does not.
• In real world, the country from which Airbus hails may decide to
help the local player on the ground of national welfare.
 What happens if EU decides to
subsidize Airbus operations ‘just’ to
provide it a foothold in the market?
 Effects of EU Subsidy to Airbus

Airbus Produce Don’t produce

Boeing

Produce 5 0
5 125
125 0
Don’t produce
0 0

• A subsidy of $ 25 billion is provided to Airbus by EU.

• The pay-off matrix is accordingly revised, with Airbus’s profit
being 5 billion and 125 billion under the two options.
• Airbus is now capable of producing.
• Boeing which is already present in the market continues to
produce.
• Equilibrium outcome is A=5, B=5.
• Both Boeing and Airbus operate in the Market after Subsidy is
provided.
• Why has subsidy failed to act as a deterrent in this situation?
• What if there is retaliation?
 Trade Game – Boeing-Airbus
Airbus
1 1970: Airbus formed as European consortium
of French and German companies
2 1970s: Spain companies joined the
consortium
3 1979: British Aerospace joined Airbus
Industries
4 1980s / 90s: Each of the four partners
operated as national companies and market
share of Airbus increased in line with its
reputation
5 2001: Airbus became a single fully integrated
company
6 2004: Airbus had overtaken its main rival
Boeing
7 2005: World’s largest and most advanced
passenger aircraft, the A380, appeared
8 Present: Position of Airbus further
strengthened
Boeing
1 1916: Construction of the first plane
2 1917: The Boeing Airplane Company arose
3 During World War I, the Navy needed
training airplanes and Boeing emerged as
leading designer of military aircraft
4 1927: Boeing created an airline, named
Boeing Air Transport (BAT)
5 1958:The US became a leader in
commercial jet manufacture
6 2001: Boeing’s focus on 787 Dreamliner
7 2003: Boeing loses ground to Airbus as
market leader
8 Present: attempts for recovery
Source: Neumann et al (undated)
Airbus vs. Boeing: Competition across Passenger
Aircraft Categories

Neumann et al
• Which models compete in regional and international markets?
• How important are subsidies for success?
• Is there an end to it?
https://www.ft.com/content/c08642f5-3aa3-447b-9028-c1c84b8e10fe
 Trade Game – Boeing-Airbus
• DS 316 – US complaint against EC to WTO in 2004.
• Measures: the provision of financing for design and development to Airbus
companies (“launch aid”); the provision of grants and government-provided
goods and services to develop, expand, and upgrade Airbus manufacturing
sites for the development and production of the Airbus A380; the
provision of loans on preferential terms; the assumption and forgiveness of
debt resulting from launch and other large civil aircraft production and
development financing; the provision of equity infusions and grants; the
provision of research and development loans and grants in support of large
civil aircraft development, directly for the benefit of Airbus, and any
other measures involving a financial contribution to the Airbus companies.
• The subsidies in question include those relating to the entire family of
Airbus products (A300 through the A380)
• The WTO dispute settlement panel found that EC measures lead to
displacement of exports of US LCA from the markets of Australia, Brazil,
China, Chinese Taipei, EC, Korea, Mexico, and Singapore and asked EC to
remove them.
• Appellate Body report was released in May 2011.

The verdict: The EC subsidies have caused serious prejudice to

the interests of the US and must be removed.
 Trade Game ..
• DS 317 – EC complained to WTO against prohibited and actionable
subsidies provided to US producers of large civil aircraft (LCA)
and in particular the Boeing company, as well as legislation,
regulations, statutory instruments and amendments thereto
providing such subsidies, grants, and any other assistance to the
US producers in 2004
• Parties request to set aside the original timetable for the dispute
until an unspecified date in the future in 2006.
• DS 347 – US complained that the launch aid provided by the EC
and the member States to Airbus for the development of large
civil aircraft and the loans appear to be subsidies that are
inconsistent with ASCM in 2006– withdrawal in 2006.
• DS 353 – EC complaint against US subsidies for LCA in 2005 – the
panel was supposed to submit report in 2008, but delivered in
March 2011.
The verdict: Some of the measures maintained by the States of
Washington, Kansas, Illinois and municipalities therein, the NASA
aeronautics R&D measures, some of the DOD aeronautics R&D
measures, and the FSC/ETI and successor act subsidies, constituted
specific subsidies.
 Trade Game ..
• DS 487 – EC complaint against US Conditional Tax Incentives for LCA
in September 2017.

• The Dispute Settlement Panel concluded that the tax rate, credit or
exemption at issue (the reduced business and occupation tax rate for
the manufacturing or sale of certain commercial airplanes) constituted
a financial contribution, because government revenue that is otherwise
due is foregone or not collected. So, US was asked to remove the
subsidy at issue.

• The Appellate Body reversed the Panel’s finding that one of the
challenged measures was made de facto contingent upon the use of
domestic over imported goods.

• The Appellate Body therefore reversed the Panel’s recommendation

that the United States withdraw this prohibited subsidy and hence
made no recommendation in this dispute.
 Comac C919

Breaking
the
Duopoly?

Comac, in partnership with Russia’s United Aircraft Corp

 Trade Game?
• DS 501 – US complaint against China’s Tax Measures Concerning
Certain Domestically Produced Aircraft in January 2016.

• “China exempts the sale of certain domestically produced aircraft,

including general aviation, regional, and agricultural aircraft, from
the value-added tax (VAT), while imported aircraft continue to be
subject to the VAT …. inconsistent with China's obligations
pursuant to Article III:4 of the GATT 1994 because they accord
products imported into China with treatment less favorable than
that accorded to like products of Chinese origin.”

• EU joined as Third Party.

• The panel was not formed – out of the Court settlement?

COMAC Market Forecast (2020-39)