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Addressing overcapacities: the shoe does not fit

03/04/2019

In this article, Laurent Ruessmann examines the use of the World Trade Organization’s existing trade defense instruments to address overcapacities and suggests a new tool is needed. The article was first published on 02 April 2019, by MLex, an independent media organization providing exclusive market insight, analysis and commentary on regulatory risk. The views expressed in this article are personal to the author and do not reflect the view of Fieldfisher or any of its clients.

 

In recent years, the buildup of substantial manufacturing overcapacities, particularly in China, has attracted increasing attention. These overcapacities have been undertaken strategically, with state support, on an unprecedented scale and cover an impressively wide range of products, from basic materials, such as steel and aluminum, to high-tech products, such as industrial robots, high-speed trains and solar photovoltaic cells and modules. This note examines the suitability of existing trade defense instruments to address these structural overcapacities, and concludes that a new trade defense tool is needed if they are to be addressed effectively.

The starting point for this note is the observation that each of the existing WTO trade defense instruments mentions or at least allows consideration of production (over)capacities, but only for limited purposes and with limited effect:

Antidumping Agreement

One of the reasons classically cited for dumping behaviour is that exporting producers are trying to offload excess production (capacities). However, in the face of major structural overcapacities of a sector or sectors, the antidumping instrument has significant weaknesses.

As a general matter, an antidumping investigation takes place only when the domestic industry has already suffered material injury, and only examines one product at a time. In the EU, the measures imposed are also limited to the extent of actual injury already incurred, unless the high requirements are met for the modulation of the lesser duty rule.

Although an investigation may be opened on the basis of an imminent threat of material injury, the requirements for such an investigation are extremely high, and essentially require that there are already indications of a price effect of the targeted imports.

Specifically concerning the available capacities of exporting producers, the WTO Anti-Dumping Agreement ("ADA") (Article 3.7) describes one of the factors the authorities should consider in relation to a determination of a "threat of material injury" as the existence of

sufficient freely disposable, or an imminent, substantial increase in, capacity of the exporter indicating the likelihood of substantially increased dumped exports to the importing Member’s market, taking into account the availability of other export markets to absorb any additional exports (1).

However, the degree of freely disposable capacity is simply one factor in the assessment and accorded no particular weight. This last point is highlighted by the final sentence of Article 3.7:

No one of these factors by itself can necessarily give decisive guidance but the totality of the factors considered must lead to the conclusion that further dumped exports are imminent and that, unless protective action is taken, material injury would occur.

Though spare capacities are not named expressly in Article 10.6 ADA, they are generally understood (at least in EU practice) to be among the "other circumstances" referred to in that provision which help to justify the retroactive application of provisional measures (for a period of not more than 90 days):

A definitive antidumping duty may be levied on products which were entered for consumption not more than 90 days prior to the date of application of provisional measures, when the authorities determine for the dumped product in question that:

(i) there is a history of dumping which caused injury or that the importer was, or should have been, aware that the exporter practises dumping and that such dumping would cause injury, and

(ii) the injury is caused by massive dumped imports of a product in a relatively short time which in light of the timing and the volume of the dumped imports and other circumstances (such as a rapid buildup of inventories of the imported product) is likely to seriously undermine the remedial effect of the definitive antidumping duty to be applied, provided that the importers concerned have been given an opportunity to comment. (emphasis added).

Again, the existence of substantial overcapacities is just one relevant circumstance and the impact of a decision to impose retroactive provisional measures is of limited impact (maximum of 90 days).

Overall, then, the weaknesses of the antidumping instrument in addressing structural overcapacities can be summarized as follows:

- the instrument is reactive (injury has already occurred or is imminent) and limited to one product at a time (as opposed to a sector), and

- it takes overcapacities into account in only a very limited manner (as one factor among others) and with no particular impact.

Agreement on Subsidies and Countervailing Measures

Often structural overcapacities are seen as the result of programs of systematic subsidies to a particular sector or group of sectors. Indeed, entire industries (let alone individual producers) cannot generally allow themselves to build up major overcapacities without significant government support. Unfortunately, the antisubsidy instrument suffers from the same limitations as the antidumping instrument (2). Thus, as a general matter, an antisubsidy investigation takes place only when the domestic industry has already suffered material injury, and only examines one product at a time.

Again, although an investigation may be opened on the basis of an imminent threat of material injury, the requirements for such an investigation are extremely high, and essentially require that there are already indications of a price effect of the targeted imports.

Specifically concerning the available capacities of exporting producers, the WTO Agreement on Subsidies and Countervailing Measures ("ASCM") (Article 15.7) describes one of the factors the authorities should consider in relation to a determination of a "threat of material injury" as the existence of

sufficient freely disposable, or an imminent, substantial increase in, capacity of the exporter indicating the likelihood of substantially increased subsidized exports to the importing Member’s market, taking into account the availability of other export markets to absorb any additional exports (3).

However, as in the antidumping context, the degree of freely disposable capacity is simply one factor in the assessment and accorded no particular weight. This last point is highlighted by the final sentence of Article 15.7:

No one of these factors by itself can necessarily give decisive guidance but the totality of the factors considered must lead to the conclusion that further subsidized exports are imminent and that, unless protective action is taken, material injury would occur.

Further, again as in the context of antidumping instruments, spare capacities are not named expressly in Article 20.6 ASCM, but they are generally understood (at least in EU practice) to be among the "critical circumstances" referred to in that provision which help to justify the retroactive application of provisional measures (for a period of not more than 90 days):

20.6 In critical circumstances where for the subsidized product in question the authorities find that injury which is difficult to repair is caused by massive imports in a relatively short period of a product benefiting from subsidies paid or bestowed inconsistently with the provisions of GATT 1994 and of this Agreement and where it is deemed necessary, in order to preclude the recurrence of such injury, to assess countervailing duties retroactively on those imports, the definitive countervailing duties may be assessed on imports which were entered for consumption not more than 90 days prior to the date of application of provisional measures.

Again, the existence of substantial overcapacities is just one relevant circumstance, and the impact of a decision to impose retroactive provisional measures is of limited impact (maximum of 90 days).

In the context of the antisubsidy instrument, there is an additional hurdle which is the difficulty of identifying all of the subsidies granted by the government to build up substantial overcapacities in a systematic fashion. This is a particular issue with regard to governments which do not respect their WTO transparency and notification obligations. Indeed, the fact that the focus is subsidies and not overcapacities, and the remedy is limited accordingly, is another fundamental weakness of the antisubsidy instrument in dealing with structural overcapacities.

Overall, then, the weaknesses of the antisubsidy instrument in addressing structural overcapacities can be summarized as follows:

- the instrument is reactive (injury has already occurred or is imminent) and limited to one product at a time (as opposed to a sector),

- it takes overcapacities into account in only a very limited manner (as one factor among others) and with no particular impact, and

- there is a major proof burden obstacle regarding the identification and documentation of manifold forms of government support for producers building up overcapacities, especially when the country in question is violating its WTO notification and transparency obligations.

Safeguards Agreement

To the extent a major structural overcapacity gives rise to a surge of imports, one could consider the use of safeguard measures to address them. However, a closer look at the requirements for the imposition of safeguard measures shows how weak that instrument is to address those overcapacities.

To impose safeguards under the WTO Agreement on Safeguards ("SG Agreement"), a WTO member must satisfy several conditions: there must be a surge of imports of a given product due to unforeseen developments which cause serious injury to a domestic industry. In particular, "the increase must be sufficiently recent, sudden and significant, both quantitatively and qualitatively, to cause or threaten to cause serious injury." (4)

In addition, safeguard measures must in principle be adopted erga omnes, must be temporary (adopted for not more than four years, with the possibility of one four-year extension), must be liberalized within that period, and give rise to a right to compensation for the affected WTO members.

While one could focus on the same elements as handicap the usefulness of other trade defense instruments for addressing structural overcapacities (i.e. the reactive nature of the instrument, the limitation to a single product, and the high burden of showing imminent injury), each of the conditions specific to safeguards is unsuited for addressing structural overcapacities, especially when there is one country in particular which has built up those structural overcapacities:

1) If a major structural overcapacity is established, it should not matter whether there has been a sudden or gradual increase of imports of any particular magnitude or recentness, or whether there have been unforeseen developments causing that increase. The mere existence of a major structural overcapacity, which may or may not have been foreseeable, may easily cause global market prices of the product in question to drop precipitously, regardless of the volume of local imports to date.

2) Similarly, it should not matter whether or not serious injury to domestic industry has already been caused or is imminent. Indeed, the existence of a structural overcapacity should itself be considered sufficient to show that serious injury is imminent.

3) The erga omnes requirement is an obstacle to dealing directly with one source of structural overcapacities.

4) If the safeguard measures must be temporary and liberalized during the time they are in effect, there is little incentive for a country having major structural overcapacities to negotiate their removal (especially to the extent that country acquires a right of compensation).

The recent imposition of steel safeguard measures by the EU, measures expressly adopted as a response to major overcapacities outside the EU, highlights to a large extent the limits of the existing safeguard instrument to address such overcapacities, as many of the above points are seriously disputed:

1) The grouping together of 28 (ultimately 26) steel product categories based on "strong interrelations" between all of those product categories is keenly disputed, particularly in relation to WTO Appellate Body case law concerned about the analysis of "unforeseen developments." (5)

2) Similarly, the existence of a sudden, sharp and significant increase in imports, when most of the buildup of overcapacity (cited as the primary "unforeseen development") and increase in imports took place before 2016, is not without major controversy (6).

3) In addition, the European Commission had not established injury during the investigation in relation to the increase of imports over the period considered, and many questions are raised about the determination of an imminent threat of serious injury (7).

Last but not least, there is no explanation why the measures should be imposed for only three years (starting not from the date of imposition of the definitive measures, but from the date of imposition of the provisional measures), and it is not at all clear how such measures (liberalized via an increase in the level of the free of duty quota by 5 percent after each year) will provide an adequate incentive for the negotiation and implementation of a reduction in the major structural overcapacities in certain third countries (particularly in China) which threaten the EU steel sector.

What shoe would fit?

In the light of the above observations, one can conclude that none of the existing trade defense instruments is adequate to address structural overcapacities, not least because they are focused on imports and not overcapacities in themselves. While unilateral measures may be applied only to imports, the question is whether a new tool could more adequately address major structural overcapacities by focusing in the first instance directly on them and by not being limited in the manner that existing trade defense tools are.

One question is whether the remedy provided by this new tool should be limited in application to imports of products for which there exists a structural overcapacity. To be most effective, and in light of modern commercial realities, the new tool should at the same time address structural overcapacities with regard to products that are not imported as such, such as means of transport. This would require a remedy or remedies beyond the application of additional import measures (as there would be no import of the products in question as such). In any event, an expansion of the possibilities for remedies to address structural overcapacities would be appropriate because there may be no substantial imports yet of products which are ordinarily imported. Additional remedies provided by the new tool could be import measures in relation to other products from the country where the structural overcapacity exists, or simply other measures affecting trade with that country.

Key to establishing this new tool would be the definition of a "major structural overcapacity" which would be actionable. While the exact contours of that definition would be the subject of negotiations, the basic elements would be relatively clear (freely disposable capacities, excess over domestic consumption, lack of additional export markets). Identifying a structural overcapacity as "major" could involve several factors, including the provision of state support for the buildup of the overcapacity and/or the magnitude of that overcapacity (in relation to global consumption or at least in relation to consumption in the country of importation).

In any event, there should be

1) no limitation to a single product (or "family of interrelated product categories") to the extent a major structural overcapacity is established for a given sector;

2) no requirement to show either unfair trade (dumping or subsidies) or a particular increase in imports (either actual or imminent, and regardless of whether there are unforeseen developments); and,

3) no requirement to show a particular degree of injury to the domestic industry (either actual or imminent).

In order to provide maximum incentive for the targeted country to reduce or at least to negotiate and implement a progressive reduction in its structural overcapacity, such a tool would need to be open-ended (or subject to review after not less than five years), and not necessarily liberalized over that period. Further, the country imposing the measures should have the option of limiting the measures to imports from the country which has the structural overcapacity.

Ultimately, the adoption of such a tool will depend on how serious and united WTO members are about addressing structural overcapacities in an effective manner.

Footnotes

(1) Article 3.7 ADA.

The ADA also (Article 3.4) mentions "utilization of capacity," but that is as one of the factors used to assess injury of the domestic industry in relation to the dumping of a given product.

(2) The ASCM provides an alternative remedy with regard to certain subsidies (a direct request for WTO dispute settlement) but the requirements are even higher (only concerns certain limited "prohibited subsidies" or – in the case of "actionable subsidies" – requires the existence of "serious prejudice"), making it even less apt as a tool to address structural overcapacities in a comprehensive and effective manner.

(3) ASCM, Article 15.7.

(4) See, e.g., Commission Implementing Regulation (EU) 2019/159 of 31 January 2019 imposing definitive safeguard measures against imports of certain steel products, OJ L 286, 1 February 2019, p 27, recital 38.

(5) Commission Implementing Regulation (EU) 2019/159, op cit., recitals 14 ff.

(6) Commission Implementing Regulation (EU) 2019/159, op cit., recitals 38 ff and 48 ff.

(7) Commission Implementing Regulation (EU) 2019/159, op cit., recitals 94 ff.

 

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