(See Appendix B)
Are there any other reasons why the US gives these Breaks
In 1981 GATT gave the US the backing of FSC’s which the US claims make the subsidy legal.
Exports have been a major contributor to the US’ exceptional economic growth since 1990. From 1992-1997 the US economy grew from $7200bn to $8100bn with exports accounting for a third of the growth. Dole (2000).
FSC’s encourage exports, which benefit the country in terms of reducing the trade
deficit by encouraging more exports than imports. Which, in a mercantilist view, will encourage wealth and stability.
Using FSC’s protects industries from higher quality lower priced goods penetrating the target market.
Washington believes that FSC’s do not create a distortion of competition merely a compensation for the VAT rebate the EU based companies bask in. De Jonquiries (2000)
And why the EU opposes them
The EU opposes the FSC as it provides the largest subsidy anywhere in the world and therefore distorts competition. De Jonquiries (1999)
The main reason is the substantial sum of money that is involved in FSC’s. The FSC let companies avoid tax bills worth $4bn per year. Thus, reducing costs which, in turn, reduce the price. It therefore has the same effect as a subsidy giving the US companies greater ability to obtain a competitive advantage.
“This is a clear subsidy of the US taxpayers to industry, granting an unfair advantage to US products in highly competitive markets” – Leon Brittan former EU commissioner. Walker (1998)
An example is General Electric, whom through FSC’s avoided over $150m million in tax in 1998. Piggott (2003)
Pascal Lamy, EU commissioner stated that the FSC system had a “major negative effect on international trade to the detriment of European companies” Williams (2000), as FSC’s tend to be in industries where the EU are also strong.
After EU losing the WTO disputes in beef and bananas it is widely argued that the FSC dispute is an immediate act of revenge from the EU. However although the authority to sanction has been awarded, the EU are reluctant to enforce them. Why? Robert Zoellick US trade Commissioner states, “it would be like letting off a nuclear bomb” as it would ruin trade relation between the two economic powers. Another reason for EU‘s reluctance to enforce the sanctions is the fact that EU have found these Location Specific Advantages within the US and are capitalising.
Companies such as BP, Unilever, ICI all benefit from the FSC’s. (Piggott 2003)
However Mr Lamy, suggests the reason for the delay in apportioning sanctions is to allow the US plenty of time to repeal FSC/ETI.
What has happened recently and what will be the outcome
On the 7th May 2003 the WTO Dispute Settlement Body authorised the EU to place countermeasures to increase customs duties to a total of $4bn as the US had not complied with the abolition of FSC/ETI’s. However, unlike the ‘knee-jerk’ reaction of Sir Leon Brittan, which started the FSC dispute, Mr Lamy, had awarded the US until 1st March 2004 to adopt the necessary legislation to repeal the FSC/ETI. ()
This deadline has been missed and the EU have decided to take action in the way of applying a 5% duty on selected US goods starting in march and rising 1% each month after the deadline with a maximum ceiling value of 17%. () Which will have the effect explained in the ‘Effect of EU sanctions’ diagram.
As it stands the US have no choice! FSC’s must be abolished or the sanctions will continue to harm their exporting trade. I believe the FSC/ETI will be dropped and US exporters will be forced to pay tax. It may come to the case where US reluctantly, will have no choice but to follow the EU and adopt a VAT style rebate system. However the US may still to opt to attempt to revise international trade rules as B, Dole suggests. Dole (2000) But that would be a lengthy process.
Another option would be for the US to drop out of the WTO in search of bilateral deals. With the WTO siding with EU over FSC’s brings a feeling of unpopularity within the US toward the WTO. The US has already been actively seeking bilateral deals rather than focus on the WTO ideologies. US is currently focusing on NAFTA and forming a strong bond with its members through bilateral trading - moving away from trade liberalisation. However this is an unlikely option as it is America who have benefited most from the WTO since its formation in 1995.
The current method of the WTO dispute settlement system is not to be proud of. The WTO’s main ideology is trade liberalisation. However as the FSC dispute highlights that under the current method, the accusing country is authorised to place retaliatory sanctions the violating country. This, clearly, is not the best method of freeing trade. Piggott(2003) argues that WTO should take a strong stance against such retaliatory action in order to preserve trade between the two countries.
Appendices
Appendix A
The FSC tax break has the same effect as an export subsidy. Therefore the cost of production is reduced by the subsidy amount.
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A tax break of AC will push the supply curve outward and to the right from S1 to SFSC
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Demand will increase from OD to OE due to the price being dropped.
These lower prices make US exports cheaper for the rest of the world. Giving the US a competitive advantage where there should not be one. This help US companies to export by making them more attractive in price, which in turn, increases the exports and reduces US trade deficit.
Appendix B
If the EU respond by sanctioning the US goods, it will have the effect of raising the price of the product for the consumer.
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The price for US imports will rise from Pw to Pwt.
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European producers can afford to expand production from OZ to OY as the tariff allows them to compete
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Consumers will be buying the product at a higher price therefore consumer demand will fall from OW to OX
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As a result the excess demand which was imported (OW-OZ) decreases to OX-OY
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Consumers lose aghd
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fgh is the decreased consumer surplus
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European producers would gain abcd
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The government would gain the duties paid befg
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bce is the net loss in welfare supporting inefficiency. However in this case the US are using a form subsidy to be ‘more efficient’ so bce is not supporting inefficiency.
The more the tariff is raised the more the diagram would be magnified. The sanction on US goods will raise the import price, decreasing demand, supply and imports from the US.
Bibliography
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The Economist (2000) ‘Tussle over Tax 4th March
- Piggott, J (2003) ‘How well is the WTO dispute settlement working?’ in Arestis, P et al “Globalisation, Regionalism and Economic activity”
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Walker, M (1998) ‘Trade war over tax dodge’ The Guardian 24th July
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accessed on 3/3/2004
- Dole, B (2000) ‘Upsetting the world’s trade balance’ Financial Times 22nd February
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De Jonquiries, G (1999) ‘ EU claims initial victory over US in trade dispute’ Financial Times 24th July
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De Jonquiries, G (2000) ‘Banana’s, Beef, and now export subsidies’ Financial Times 18th February
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William, F (2000) ‘Trade Ruling takes WTO into realm of domestic taxation’ Financial Times 25th Feb
WORD COUNT 998 (+ 285 APPENDICIES)
Padraig Clarke
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