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Reining in distorting subsidies

The World Trade Report 2006 has as its principal focus government subsidies, which may have specific goals of correcting market distortions and meeting social objectives but can also distort trade. Coincidentally, the report of the WTO was released on July 20, a few days before the Doha round of talks was indefinitely suspended. The talks foundered because of the failure of the United States and the EU to agree on a reduced level of domestic support (subsidies) to agriculture. The U.S. negotiators linked this issue to a wider market access for its agricultural products by the EU and to a lowering of tariffs on industrial goods by India and other large developing countries. As the report says, one significant part of the Doha round negotiations involves reducing trade distorting subsidies and encouraging other forms of support that facilitate development and environmental protection. Though capable of delivering rich dividends, that approach calls for strong political will and commitment on the part of individual governments, traits that have been missing so far. The pernicious effects of subsidies on trade have been well documented. They can distort trade by conferring an artificial competitive advantage to exporters and those industries engaged in import substitution. These can aggravate tensions among trading partners and on occasion invite tit for tat responses that may nullify the intended gains of the subsidies.

The report estimates that 21 developed countries accounted for almost $250 billion of the $300 billion spent on subsidies last year globally. Even as a proportion of GDP, developing countries spent far less on subsidies. However, it is admitted that the incidence and impact of subsidies remain a seriously under-researched subject. Many governments cite several objectives to justify their extensive subsidies. Besides, few governments comply with the stipulation that trade distorting support measures should be notified to the WTO. Even more fundamentally there is no commonly accepted definition of subsidies, a glaring anomaly that the WTR 2006 has tried to correct. The report's observations on Export Processing Zones (EPZs) are of special relevance to India. Are the Special Economic Zones (SEZs), currently in fashion and analogous to the EPZs, compatible with the WTO rules? There are no clear-cut answers. Normally these zones reflect multiple policy initiatives such as provision of adequate infrastructure and minimum bureaucratic interventions, not all of which are trade distorting. Likewise, duty exemptions and tariff reductions for companies locating in the SEZ can be looked upon as incentives that, for a variety of reasons, cannot be extended to the entire country. However, certain other concessions, such as direct financial transfers can distort trade. The report cautions India and other countries against "destructive subsidisation," whether undertaken through the EPZ route or otherwise.

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