Fair Exchange at the National and International Level
Kenneth P. Thomas
October 14, 2005
Introduction
Fair Exchange (Olson 2005) is an innovative approach to the problem of making government subsidies to business accountable. Instead of mere promises of more jobs, tax revenue, etc., a community trust becomes an actual owner of the company being subsidized and shares fully in the potential gains to the firm as a result of the subsidized project. This goes beyond clawbacks or even Community Benefit Agreements (CBAs) as a method of ensuring that the community indeed benefits from subsidizing an investment.
In fact, as shareholders of the investor, the community can even receive benefits if the subsidized project goes sour, as it will have a claim on the profits of the company as a whole, through its acquisition of stock in exchange for the subsidy.
This paper considers some of the international and national aspects of Fair Exchange. It concludes that international trade and investment rules provide no necessary hindrance to Fair Exchange agreements, and argues that a national version to level the playing field is likely to work better than a voluntary approach will.
International Aspects of the Fair Exchange Proposal
Fair Exchange, by definition, comes into play only in connection with government subsidies to business. State and local governments, not just the federal government, are subject to the Agreement on Subsidies and Countervailing Measures (SCM) that is part of the final package resulting from the Uruguay Round GATT (General Agreement on Tariffs and Trade), which went into effect in 1994. Note that these negotiations created the World Trade Organization (WTO), which now adjudicates disputes over subsidies as well as other trade disputes. There are several aspects of the SCM Agreement which are relevant here.
First, the Agreement bans export subsidies and domestic content requirements (USTR 1993, 3). This prohibition applies to subsidies that are contingent, in law or in fact, on export performance or upon domestic content criteria. At the 1999 Seattle WTO Ministerial meeting, developing countries demanded that export subsidies be allowed them under some circumstances, as a condition for the renewal of a “traffic light” system that allowed some subsidies to be non-actionable (“green light”) if they met the criteria of the SCM. The industrialized countries did not agree, so at present the “traffic light” system has expired and export subsidies are still illegal under the WTO (Thomas 2000, 262). While it can be anticipated that developing countries will renew this demand in the current Doha Round of negotiations, it is inconceivable that developed countries, including their sub-national governments, will be allowed to use export subsidies. The most relevant point here is that local content requirements will not be allowed.
Second, all other subsidies can be considered actionable, but the plaintiff country must show “adverse effects” to its interests to prevail in a dispute (USTR 1993, 5). In practice, this means that large subsidies for large projects are the most likely to bring scrutiny. Of course, the same would be true without Fair Exchange, so Fair Exchange will not be a consideration in whether a foreign government challenges a state or local subsidy or not.
Third, the idea of government purchasing a stake in a private company is a well-developed one in the European Union, which has already evolved considerable case law on when it is considered legitimate there. There are several aspects to the attitude of the EU which must be taken into consideration: a) Capital injections are considered to be a non-transparent form of subsidy, in the sense that it is difficult to measure the value of the subsidy when the government is receiving ownership rights in the firm. For this reason, in EU law and practice, the Directorate-General for Competition, which administers the EU’s “state aid” laws, discourages Member States from using this form of subsidy. Its efforts have met with some success (Thomas 2000). Because of this, it is possible that the European Union would find Fair Exchange transactions to be undesirable because of the transparency problem. This could be so even though the government transferred the stock to a community trust. Moreover, the potential transparency is unlike the usual cases in the EU, where government injects capital into what are already state-owned companies. This is not to say that contentious state aid cases only arise with capital injection into state-owned companies, but that is far more common than problems with injections into private firms. Overall, the possibility of EU action against Fair Exchange at the WTO would most likely be concentrated on large subsidies for large project. b) In European Union state aid law, the criterion for whether a capital injection is legitimate is whether the transaction would be taken by a private investor, the so-called “market investor” rule (Thomas 2000, 58-59). Obviously, Fair Exchange is meant to move governments in that direction, from simply making giveaways to corporations to acting like a normal market participant. From an EU standpoint, the more a government receives for its money, the more it is acting like a market investor. This factor could militate against EU objection to Fair Exchange. Finally, the fact that governments would only (briefly) own a small share of a private company may reduce or negate potential EU concerns over Fair Exchange. However, without interviewing officials in the Directorate-General for Trade, these considerations remain merely speculative.
Fourth, many trade agreements (for example, the North American Free Trade Agreement and the General Agreement on Trade in Services of the WTO) specify that foreign investors must be afforded “national treatment” by host governments (Cohn 2003, 295). This means that they cannot be discriminated against on a wide variety of dimensions, subsidies being one of them. Given that most state and local governments welcome any investments with open arms and pocketbooks, it is unlikely that Fair Exchange will violate national treatment.
In summary the World Trade Organization’s subsidy rules are unlikely to have any impact on Fair Exchange, unless another party, most likely the EU, objects to them on the basis that they are not transparent.
National Aspects of Fair Exchange
My
previous work on competition for investment (particularly Thomas 2000) suggests
that leveling the playing field requires intervention by the federal
government. Voluntary “no-raiding” agreements in the
In
contrast, the European Union has a centralized system for controlling all sorts
of subsidies, whether they are used to attract investment or not. The relevant
rules of the Treaty of Rome (Articles 87-89 EEC), can be thought of, in
The European Union’s system, very briefly, makes it mandatory to notify proposed subsidies in advance to the European Commission, and these incentives may not be implemented unless and until they are approved by the Commission (Thomas 2000, 51). This gives the Commission a centralized monitoring and control mechanism the effectiveness of which is particularly striking when one reflects that it coordinates the actions of sovereign states. The relative success of this centralized system (Thomas 2000, Chapter 6 passim.) suggests to me that, if Fair Exchange is to be successful, it must be enabled by federal laws that balance the playing field. To make this more palatable for poorer areas, it should phase in rules that allow larger subsidies to be given in areas of low income or high unemployment, as is the practice in EU regional policy.
Conclusion
This paper has analyzed several salient issues of the relationship between Fair Exchange and international and national law. From an examination of the World Trade Organization’s Agreement on Subsidies and Countervailing Measures, it appears that there is no necessary conflict between Fair Exchange and the SCM. In addition, it would be necessary for state and local governments to treat foreign and domestic investors on an equal footing in the potential granting of subsidies. Again, there is nothing in the proposal for Fair Exchange that would violate that principle, i.e. “national treatment.” In fact, state and local government competition for investment has shown no tendency to discriminate on the basis of a firm’s nationality. Rather, “Shoot Anything That Flies; Claim Anything That Falls” (Rubin 1998), seems to be the watchword of economic development officials.
At the national level, I argue that Fair Exchange should be enforced by the federal government in order to have a fair playing field. This is based on the failure of all prior voluntary “no raiding” agreements among states, and the relatively successful experience of the European Union in controlling subsidies through centralized enforcement now covering 25 sovereign nations.
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