State Ownership and State Investment

Pascal Lamy’s recent comments on the challenges facing the WTO

Pascal Lamy is a former Director-General of the WTO (2005-2013) and former European Commission Trade Commissioner (1999-2004). He is President emeritus of the Jacques Delors Institute. As one would expect, he is a frequent speaker on trade matters. Two events in the last several months presented some thoughts on the challenges for the WTO moving forward.

Mr. Lamy was interviewed by the Lowy Institute in Australia in early July on their COVIDcast addressing the future of globalisation. See The Interpreter, July 3, 2020, COVIDcast: The future of globalisation, https://www.lowyinstitute.org/the-interpreter/covidcast-future-globalisation. Similarly, on June 17, 2020, he and Robert Zoellick (former President of the World Bank and former U.S. Trade Representative) participated in a Peterson Institute for International Economics Trade Winds program, What future for the global trading system?, https://www.piie.com/events/what-future-global-trading-system.

Below are some of my notes on points made by Mr. Lamy I thought were of interest along with my commentary.

globalization vs. deglobalization

On the future of gobalization, Mr. Lamy is of the view that the next few years will be a period of more obstacles for trade and investment. These obstacles will change the speed of globalization but won’t lead to broad scale deglobalization. There will be some onshoring to address fragility of supply chains. However, the clamor for onshoring will be “more bark than bite”.

In the United States both the Administration and parts of the Congress have called for onshoring production of medical equipment. There has been some utilization of the Defense Production Act by the Trump Administration to get producers to use facilities to produce needed equipment. Many U.S. industries and unions have urged the government to take action to permanently reshore production of various medical equipment. See Joint Statement on Policy Objectives for Reshoring and Safeguarding Domestic PPE Manufacturing (embedded below).

joint-statement-of-reshoring-of-PPE-production

However, the U.S. has not entered into long-term contracts to support significant reshoring efforts, possibly supporting Mr. Lamy’s prediction of “more bark than bite”.

precautionism

Efforts by countries to recover from the economic damage caused by COVID-19 will be complicated by what Mr. Lamy called “precautionism” (governments protecting people from risk) and which he distinguished from protectionism (protecting producers from international competition). In Mr. Lamy’s view, protectionism can be addressed by eliminating restrictions or other obstacles. Precautionism involves risk profiles which will differ among Members and possibly may differ among issues being considered and hence will be much more difficult to address to achieve a level playing field. Mr. Lamy in the Trade Winds program used the example of the tourism sector which has been devastated by governments’ efforts to control the spread of COVID-19 and noted that there are a number of different initiatives by countries to get some reopening of tourism (e.g., nonessential air travel) between particular countries, but that there isn’t a common approach which in his view reflects differing risk profiles of countries.

I would note that precautionism is not limited to the response to the COVID-19 pandemic. The WTO’s Sanitary and Phytosanitary Agreement and the Technical Barriers to Trade Agreement both recognize the right of Members to take measures to protect their populations at such level as is deemed appropriate by the Member although encouraging use of international standards.

To the extent the aftermath of the COVID-19 pandemic is a more cautious risk profile for major trading nations, recovery will likely be slower and more fragmented.

Borrowings during the pandemic to lessen the economic collapse

Mr. Lamy made several points on the massive amounts of stimulus funds being provided by certain governments to limit the economic challenges being faced from efforts to slow the spread of COVID-19.

His first point is that the size of the government programs will necessarily distort trade and create a playing field that is not level. Rescue plans for companies or industries, subsidies provided, increased state ownership are all elements of the distortions that he sees occurring. He believes countries will have to come to grips with the emergency needs and see that markets return to their proper role with reduced government involvement.

The second point is that only a few countries are positioned to provide this type of financial assistance because of the inability for most countries to borrow huge amounts of money for such stimulus activities. Hence the north-south divide is growing according to Mr. Lamy. While this point is certainly true, multilateral organizations like the IMF and World Bank and regional development banks are working to provide debt forgiveness and other financial assistance to some developing and to least developed countries to provide some greater flexibilities.

WTO reform — U.S.-China tensions

Mr. Lamy views the WTO as weaker today than it was ten years ago. He attributes the main source of the weakened situation of the WTO to the growing divergence between the United States and China. In his view, the tension between the two has prevented convergence on a range of issues.

Because the world has changed so much over the years, the WTO rulebook must be updated. China’s state capitalism economic system is creating significant problems for the world trading system. China’s trading partners are concerned about the high level of state ownership (30% for China) and the government support to the state-owned sectors. These facts lead to conflict with partners both in terms of market access in China and in terms of Chinese competition in other markets. Mr. Lamy notes that the WTO’s rules on state aid are weak. He doesn’t believe one can coexist with China in the WTO if rules on state aid are not toughened (what he describes as achieving “competitive neutrality”). Even with new rules, the geopolitical rivalry between the U.S. and China will remain.

Mr. Lamy agrees with the United States that the current WTO rules do not constrain China’s state capitalism practices which distort competition. He believes that China was making good progress on moving towards a market economy until the 2008-2009 financial crisis. China had lowered state ownership to 15% of the economy. With the financial crisis, China poured huge sums into the economy, including through state-owned enterprises. With the change in political leadership, the country shifted away from a convergence model and has continued to bolster its state capitalism model, now 30% of the economy. For the foreseeable future, the WTO will not be able to achieve convergence by China to a market-economy model, but will have to work on whether coexistence can be made to handle at least many of the distortions.

The Untied States has been pushing the WTO to come to grips with the fact that the WTO set of rules was created for market economies, and to recognize that such rules don’t work for large state capitalism economies. One of the WTO’s Deputy Directors-General, Alan Wolff, in a speech earlier this year, in reviewing principles that undergird the WTO identified convergence, not coexistence, as one of the core principles. See DDG Wolff: “There can be no permanent retreat from what has been created,” 10 June 2020, https://www.wto.org/english/news_e/news20_e/ddgaw_11jun20_e.htm (“Of necessity, the WTO is about convergence, not coexistence”)

In his comments during the Peterson Institute’s Trade Winds webinar, Mr. Lamy indicated that coexistence is possible if there are strong state-aid rules and reviewed the ability of Germany and France to work together in the EC despite France having had relatively high state ownership (around 15%) in the early years. The ability to work with a country with significant state-control was due to stringent state aide rules. The U.S., Japan and EU have been working to pull together improved disciplines on industrial subsidies, action that China has already indicated it will not accept. Mr. Lamy is of the view that China can be brought to the table by parties seeking “competitive neutrality” and by indicating to China that China will not gain additional market access without agreeing to new rules on state aid.

In a post last week, I reviewed an opinion piece by Peter Carl, a former EC Director General for Trade. His take on the same situation was that the EU, US and others should pursue improved disciplines on state aid but when such efforts are rejected by China, the EU and others should leave the WTO and start a new organization without China where convergence would be possible. See July 25, 2020, A new WTO without China?  The July 20, 2020 Les Echos opinion piece by Mogens Peter Carl, a former EC Director General for Trade and then Environment, https://currentthoughtsontrade.com/2020/07/25/a-new-wto-without-china-the-july-20-2020-les-echos-opinion-piece-by-mogens-peter-carl-a-former-ec-director-general-for-trade-and-then-environment/.

Mr. Lamy also reviewed how a functioning WTO is very important for developing and least developed countries. Trade and investment is a big lever for such countries in their development efforts. Thus, if the WTO continues to weaken, it is these countries that will be most hurt. Similarly, these same countries are likely most adversely affected by the trade and economic fallout from the COVID-19 pandemic.

WTO agenda

During the Peterson Institute’s Trade Winds program in June, Mr. Lamy indicated that proponents of open trade were in for a difficult time. He listed five issues of concern. Three were dealt with above (precautionism, government infusions to address COVID-19 pandemic, deglobalization/onshoring). He also reviewed the weaponization of trade, citing both the Trump Administration’s actions and the dispute between Japan and the Republic of Korea, and new forms of protectionism citing investment controls and new instruments.

Mr. Lamy believes that the WTO agenda needs to be looked at in two stages. The first or short term involves finding a new Director-General, and needs to include a cooling down period. My understanding of the cooling down period is to have governments who have poured trillions of dollars into their economies back out of such increased state involvement and permit reestablishment of a level playing field. This period will be a few years and will permit some increase in trust through small steps. He believes there will be a coalition for open trade and that the EU will be the leader depending on the outcome of the upcoming Presidential election in the U.S.

Longer term, Mr. Lamy believes that the WTO must go back to dealing with the big problems:

coexistence with China as long as China has 30% of its economy state-controlled; will require improved rules on state aid;

dealing with the trade and environment nexus; issue keeps rising on the global agenda; EU planned global carbon tax will be important issue;

around the challenge of precautionism, the world will need a new effort to level the playing field possibly similar to prudential rules in the finance system.

EU role in the WTO during the US-China tensions

The EU is serving as a stabilizing force in the WTO. Indeed, the more U.S.-China tensions increase, the more the EU will step in to provide stability. Mr. Lamy states that many WTO members want the EU to be a shield to protect them from having to pick sides with either the U.S. or China. This is a big role for the EU. If EU comes out of the COVID-19 pandemic stronger, it will bolster the role that the EU can play in the WTO to maintain stability.

Mr. Lamy cited the Appellate Body crisis as one where the EU by creating the multi-party interim arbitration agreement took the lead to maintain stability in the organization and got many countries to follow.

Conclusion

Mr. Lamy paints a picture of a challenging time for the world trading system in the coming years. He agrees that the WTO rules do not adequately address distortions that flow from China’s state capitalism economic system. His proposed solution is to coexist but work on obtaining stronger rules on state aid. While the U.S., Japan and the EU agree such improved rules are needed, there is a certain irony in his recognizing the need for stronger rules on state aid, as it was the EU, among others, who pushed for weaker subsidies disciplines during the Uruguay Round.

Mr. Lamy also paints a bleak picture of distortions created by countries’ efforts to stem off economic collapse as countries impose shutdowns to try to control the COVID-19 spread. His argument is from 30,000 feet and is conclusory – the introduction of such huge amounts of money necessarily distorts competition. My own view is that while the question of whether there are distortions is an important one, large parts of the funding don’t increase manufacturing or production but rather form a safety net under employers, employees and state and local governments dealing with an extraordinary situation that doesn’t reflect market forces. Of more use would be agreeing on identification of outcomes that are viewed as distortive versus those outcomes which simply offset the economic fallout from the pandemic. Many industries will end up much smaller after the pandemic than before and any rescue funds provided will reflect an effort to address the extraordinary event of governments mandating closure of markets. Presumably such funding should be agreed to be nonobjectionable. Whereas if an industry in a country expands with government assistance to take advantage of the closure of competitors because of restrictions flowing from efforts to address the pandemic, presumably such subsidies would be problematic.

The longer term issues Mr. Lamy raises will certainly take center stage at some point, but his list does not include any of the large number of pending issues before the WTO where progress will hopefully be made in the coming next year or so – fisheries subsidies, electronic commerce, etc.

What is clear is that the next Director-General will face a very challenging landscape with fundamental differences among many Members that will make forward movement by the WTO and its Members a challenging undertaking.

A new WTO without China? The July 20, 2020 Les Echos opinion piece by Mogens Peter Carl, a former EC Director General for Trade and then Environment

The WTO is an organization in crisis in part because of a system of rules created by market economy countries that doesn’t adequately deal with large economies with different economic systems. China is the largest and most obvious example but by no means the only WTO Member operating economic systems that are not consistent with market economy principles. While China engaged in significant changes to its system in its efforts to join the WTO and had undertaken commitments for further changes that would move China towards a market economy, changes in political leadership led to a reversal in direction, with emphasis on state planning, state-owned and state-invested enterprises to pursue the government’s objectives and massive government subsidies to take over global economic sectors. While China views opposition to its system as a means of trying to hold China back from achieving the economic growth it pursues, many trading partners view China’s approach to global trade and investment as highly disruptive and inconsistent with basic principles of reciprocity and the disciplines of the WTO on market economies.

The Trump Administration has changed the U.S. approach for trying to deal with China by its pursuit of a section 301 investigation and resulting tariffs when it could not get China to change its policies and actions. The U.S.-China Phase 1 Agreement was an effort to find a way to address at least some of the challenging practices and address resulting trade distortions through purchase objectives. Many trading partners have been concerned that the U.S. approach, at least as it involves purchasing objectives, constituted managed trade. A phase two U.S.-China negotiation to deal with remaining major concerns has not started and apparently won’t before the November 2020 U.S. elections.

The European Union and Japan have been working with the United States to put together proposed modifications to existing WTO agreements to deal with some of the aspects of the Chinese economic system (but also relevant to other Members) that cause massive distortions — industrial subsidies, excess capacity, state-owned and state-invested enterprises. China has repeatedly indicated that any efforts to address these issues at the WTO will be blocked by China as such efforts are viewed as aimed at restricting China’s rise.

Earlier this week (July 20), a former EC Director General for Trade, Peter Carl, penned an opinion piece in Les Echos with the provocative title, “A new WTO is needed without China” (literally A new WTO must see the day without China). https://www.lesechos.fr/idees-debats/cercle/opinion-une-nouvelle-omc-doit-voir-le-jour-sans-la-chine-1224748.

Mr. Carl indicates in the opinion piece that “Europe’s trade policy has stagnated for twenty years. It no longer meets the demands of today’s world and the European public attributes the loss of millions of jobs to China.” (all quotes from the opinion piece are informal translations by Google Translate ). The opinion is remarkable as it comes from a former senior EC trade official.

“Our policy is outdated and based on an outdated ideology that is identical to what it was before the arrival of China on the world state, after its accession to the WTO in 2001. Its centralized economy, its powerful industrial policy in all the key sectors, its enormous state subsidies, combined with a government apparatus and a political repression as powerful as those of the ex-USSR, swept large swathes of European and American industry. However, we act as if we were in the heyday of the 1990s, when our main competitors were other market economies, Japan, Korea, the United States. Our inaction resembles the ostrich policy and unilateral pacifism of the 1930s. We know the results. We must therefore protect our liberal economies and our open societies against adversaries. This requires a fundamental review of the trade policy of the European Union and the WTO.”

Mr. Carl calls for a complete reform of the WTO with the EU teaming up with the U.S. and other like-minded Members but recognizes that meaningful reform will be blocked by China. “The solution: withdraw from the WTO and create a new international trade organization without China. Most countries would follow our example. We would return to an open world economic order between market economy countries sharing the same ideas, on the basis of clear and reinforced principles in favor of the free market.” Mr. Carl advocates for the adoption of rules that would deal with “abuses” of the China model including improved subsidy disciplines and “rules against social, environmental dumping and inaction on climate change.” Such new rules are needed to permit the EU to green its economy.

Mr. Carl, addressing concerns that his proposal represents a turn to managed trade, says simply that “This is what we already have, although only China manages it, and we are suffering the consequences.”

That Mr. Carl felt the need to publish such a strongly worded opinion shows the underlying and growing tensions felt by major trading partners from a major economic power with a fundamentally different economic system than that pursued by the historic major players in world trade.

For WTO Members and their businesses and workers, the rising discontent by many with the functioning of the WTO and its ability to achieve meaningful reform should be a wake-up call. The WTO to be relevant must have rules that address the world in the 21st century. The WTO must also be able to have Members assume increased responsibilities as their stage of economic development evolves. Similarly, the WTO must confront whether existing rules can be modified to generate greater coverage of practices by different types of economic systems. If not, the WTO must consider whether it can survive where all Members don’t follow similar economic systems.

Unfortunately, there appears little likelihood that many of these critical reforms will be addressed in the coming years. China has objected to WTO Members trying to modify existing agreements to address distortions caused by China’s economic system. China has also objected to the U.S. effort to have Members consider whether WTO rules require Members to operate market-economy based systems. China and others have objected to U.S. efforts to define “developing country” and effectively have Members take on obligations commensurate to their stage of economic development. Stated differently, China is working hard to defend the status quo and prevent consideration of reforms that would achieve greater balance among all WTO Members.

While USTR Lighthizer and others have said that if the WTO didn’t exist, it would have to be created, Mr. Carl’s opinion suggests that one option that may take on greater appeal is the withdrawal from the WTO and the creation of a new international trade regime among countries with similar economic systems. Such a move away from the WTO would certainly involve enormous economic upheaval and political tensions. The more desirable course of action is to achieve timely reform of the WTO so that all Members feel the system achieves reasonable reciprocity.

Time will tell whether WTO Members find a path forward or whether the WTO becomes less and less relevant and even ceases to function. In a Member driven organization, the answer lies with the membership.

Continued Stress in U.S.-China relations — Reduced Cooperation in Multilateral Fora

The two largest economies in the world view each other as competitors and potential adversaries. With significantly different political and economic systems and ideologies, the United States and China have had different perspectives on commitments and obligations undertaken in the economic sphere.

U.S. concerns

Specifically, the United States has viewed its bilateral trade negotiations with China and the later conclusion of China’s accession to the World Trade Organization (“WTO”) as having created a commitment by China to continue on market-based reforms with the eventual conversion of the Chinese economy into a market-economy consistent with the basic rules of the WTO. There have been high level dialogues between the two countries for years with a feeling in the U.S. that repeated commitments by China to fulfill commitments have not been honored and that the bilateral relationship had growing serious problems.

China concerns

China has had a different view of the world and its obligations to other countries through its joining the WTO. Reforms continued for a while but were replaced with a growing focus on state direction, state investment and heavy subsidization of a widespread number of sectors. China has viewed the United States as attempting to prevent its economic growth and global role and as not respecting its “right” to view itself as a developing country within the WTO and hence to have fewer obligations than a developed country.

Trump Administration changes approach

Under the Trump Administration, the United States has taken a more aggressive approach to dealing with what it perceives as distortions in economic competition and lack of meaningful reciprocity in the bilateral trade relationship. The U.S. has also looked at bilateral and multilateral approaches to address the problems it perceives China has created and is creating with the functioning of the global trading system.

Bilaterally, the U.S. has conducted its 301 investigation on a host of longstanding concerns of the U.S. business community on Chinese policies and practices. The adverse findings from the USTR investigation has led to the U.S. imposing additional tariffs on Chinese goods when resolution of the underlying issues was not achieved followed by retaliation by China and a series of additional rounds of more tariffs and more retaliation. The U.S. and China did engage in negotiations to see if they could resolve the underlying concerns of the United States. A phase 1 agreement was signed in January 2020, with a phase 2 process supposed to have commenced by May.

At the same time, the United States has pursued reform at the WTO (1) to address longstanding and bipartisan concerns with the WTO dispute settlement system, (2) to address rule changes to address some of the distortions that flow from China’s nonmarket economy, (3) to modify the self-selection nature of which Members are “developing” and (4) to improve transparency.

On transparency, many countries are not current on the various notification requirements, but major concerns have existed with China and India in terms of the number and dollar value of subsidy programs that are not being reported in their notifications to the WTO.

Some of the reforms of interest to the United States are being pursued as well by others, such as the EU and Japan on state-invested companies and industrial subsidies and various other countries on transparency.

But the WTO has been struggling to achieve forward movement on many issues of importance to different Members in part due to lack of consensus on issues and a lack of leadership/coordination among major players.

COVID-19 Complicates the Bilateral Relationship

The COVID-19 pandemic has complicated the situation for the WTO and for U.S.-China relations both because of the global reach of the health problem resulting in reduced functionality of the Missions in Geneva and the current inability to hold face-to-face meetings and the widespread use of export restraints on medical goods (including personal protection equipment like masks, gloves, shields, gowns, etc.) as demand in nations with significant number of infections has grossly exceeded existing inventories and production capabilities both in country and globally.

In terms of U.S.-China relations, the lack of complete transparency by the Chinese in the early months of the COVID-19 outbreak, some slowness of action by the World Health Organization, and both missteps on testing and slowness of initial action within the United States (and resulting massive unemployment, costs to the economy and multiple trillion dollar government response) has added finger pointing on the pandemic to the already tense bilateral relations. It has also resulted in the U.S. distrusting the WHO and temporarily suspending U.S. funding for the organization.

With the collapse in global trade, the pandemic has also made it far less likely that China will honor its increased import commitments from the U.S. in 2020 as contained in the Phase 1 Agreement. See U.S.-China Phase I Agreement – some progress on structural changes; far behind on trade in goods and services, https://currentthoughtsontrade.com/2020/05/12/u-s-china-phase-i-agreement-some-progress-on-structural-changes-far-behind-on-trade-in-goods-and-services/. That said, the U.S. continues to identify important advances being made at least in agriculture with China. See https://ustr.gov/about-us/policy-offices/press-office/press-releases/2020/may/usda-and-ustr-announce-continued-progress-implementation-us-china-phase-one-agreement.

On trade, the pandemic has crippled the economies of many countries with the resulting declines in imports and exports in the March-April time frame and likely going forward for some period, though China as the first country through the outbreak and a major producer of medical goods actually saw increased overall exports to the world in April.

United States Strategic Approach to The People’s Republic of China

Earlier this week, the White House forwarded to Congress a document required by the 2019 National Defense Authorization Act, United States Strategic Approach to The People’s Republic of China. On the trade/economic front, the paper repeats the concerns that the Administration has laid out in other documents most of which are summarized above (not including the COVID-19 issues). The U.S. views challenges from China to three broad areas — (1) economic challenges (largely failure to continue reforms to become a market economy, failure to honor commitments made to the US, use of predatory practices, insistence on being a developing country, etc.); (2) challenges to U.S. values; and (3) security challenges. The link to the document is here and the text is embedded below. https://www.whitehouse.gov/wp-content/uploads/2020/05/U.S.-Strategic-Approach-to-The-Peoples-Republic-of-China-Report-5.20.20.pdf.

U.S.-Strategic-Approach-to-The-Peoples-Republic-of-China-Report-5.20.20

Challenges for the WTO

The WTO remains able to move forward where issues are limited to a subset (the “willing”) as progress on e-commerce talks would support. But in a consensus based system, distrust between major players will paralyze large parts of any agenda. Indeed, with the large number of WTO Members (164) at various stages of economic development, there will almost always be a wide divergence of views on any issue. In such a situation, leadership and cooperation among major economies become important to develop a consensus. So it is hard to see how the WTO advances a reform agenda without improved relations between the organization’s two largest Members.

With the recently added challenge for the WTO of selecting a new Director-General, the sour relationship the U.S. and China will likely make finding a candidate who would be supported by a consensus of the Membership that much harder, suggesting at a minimum a process that takes the full six-month time for selection (versus any hoped for expeditious resolution in light of DG Azevedo’s departure at the end of August) and perhaps extended time lines. If the selection process breaks down into highly polarized camps (the existing procedures were developed to try to prevent such an outcome), the ability to move forward the WTO’s reform and existing negotiating agenda will be delayed by certainly months and perhaps longer.

Conclusion

At a time when the world is struggling with a global pandemic which continues to cause huge health challenges to many countries in the world and has devastated the global economy at least temporarily, costing tens of millions of workers jobs, and likely closing hundreds of thousand of businesses around the world while requiring government financial support that will likely exceed ten trillion dollars, there is an unfortunate lack of global cooperation between the major economic players and distrust at least from the U.S. of multilateral institutions viewed as either ineffective to deal with China’s economic system or not operating in an unbiased manner.

A major part of the challenge flows from the distrust that exists between the world’s two largest economies that precedes the pandemic but that has been worsened by the pandemic’s development and handling. The two countries have different economic systems which are essentially non-compatible, have different political systems and different ideologies and view each other as competitors and potential adversaries.

In a change of approach, the United States has decided to take a more aggressive approach to achieve reciprocity in fact with China and not merely on paper or from spoken promises. The change in approach has resulted in the U.S. acting unilaterally in certain situations. China has appeared unable to understand or agree with the concerns raised by the U.S. (and others) and harbors a belief that the real motive behind U.S. actions is “to keep China down”. This mutual distrust has resulted in both hard feelings and an inability to achieve cooperation on a large number of trade, economic and other issues.

The current U.S.-China relationship increases the problems for many multilateral organizations, but certainly for the WTO both in terms of selecting a new Director-General and in developing WTO reforms and moving ongoing negotiations forward.

Look for a challenging second half of 2020.

Oil and gas sector suffers declining demand, collapsing prices, expanded state involvement — skewed economic results damage much of the global economy

The United States and many other countries view the World Trade Organization as the forum for global trade rules that support market economies. One of the challenges for the WTO going forward is what to do with the important Members whose economic systems are not anchored in market economic principles. While China is the most frequently mentioned WTO Member whose economic system is causing massive disruptions for market economies, there are other countries with important sectors that are state-owned, controlled and directed. The United States, European Union and Japan have been working on proposals for modifications of WTO rules to address distortions flowing from massive industrial subsidies and state controlled sectors that do not operate on market principles.

While WTO reform is not likely to see serious engagement by WTO Members before the COVID-19 pandemic is brought under control, the sharp contraction of economic activity in many countries is highlighting the importance for WTO Members actually addressing the role of the state in industry and rule changes needed to avoid the massive distortions that state involvement too often created.

Oil and Gas as an Example

Few industrial sectors have as much state ownership and control as the oil and gas sector. While there are countries with privately owned producers, much of the world operates with producers that are state owned or state controlled. Since the 1960s, a number of countries have engaged in cartel-like activity to collectively address production levels to achieve desired price levels. While many of these countries are part of the Organization of Petroleum Exporting Countries (“OPEC”), OPEC meets with other countries as well in an effort to achieve production and pricing levels. Current OPEC members include Algeria, Angola, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, the United Arab Emirates, and Venezuela.

The activity has resulted in artificial pricing levels in export markets as compared to prices in home markets of OPEC members and periodic price shocks based on collective action. Large price increases in the 1970s led to high levels of inflation and rapid changes to manufacturing operations in some countries.

  1. Economic contraction as countries struggle to limit spread of the coronavirus

There has been a sharp contraction in demand for petroleum products in 2020 as countries have shut down movement of people in an effort to control the spread of COVID-19. Air travel has been decimated in many parts of the world and there are significant reductions in automobile travel. Manufacturing has also seen significant reductions. The contractions have resulted not only in national reductions in use of petroleum products but also international reductions both directly (reduced air traffic and ship traffic) and because of disruptions to supply chains which have reduced downstream production.

The U.S.-China Economic and Security Review Commission released a staff research report on April 21, 2020 entitled “Cascading Economic Impacts of the COVID-19 Outbreak in China” which reviews information on the wide range of economic impacts from the COVID-19 pandemic as felt in the U.S. https://www.uscc.gov/sites/default/files/2020-04/Cascading_Economic_Impacts_of_the_Novel_Coronavirus_April_21_2020.pdf. The report includes a section entitled “Turmoil in Energy Markets” which states,

“The standstill in Chinese production and halt in flows of goods and people has drastically depressed Chinese demand for energy products such as crude oil and liquified natural gas (LNG), adding pressure to an oil supply glut that had materialized at the end of 2019.99 In December of 2019, Institute of International Finance economist Garbis Iradian had forecasted a supply glut, pointing to high output from Brazil, Canada, and the United States.100 The COVID-19 outbreak exacerbated this challenging outlook. As the Organization of the Petroleum Exporting Countries (OPEC) reported in April 2020: ‘The largest ever monthly decline in petroleum demand in China occurred in February 2020.’101 Chinese oil demand ‘shrank by a massive 3.2 million barrels per day’ over the prior year.102 Research by OPEC forecasted China’s 2020 demand for oil will decrease by 0.83 million barrels per day over 2019.103 As the largest oil importer,104 Chinese oil consumption has a significant impact on global demand. In 2019, China accounted for 14 percent of global oil demand and more than 80 percent of growth in oil demand.105 Following the outbreak in China, the OPEC Joint Technical Committee held a meeting on February 8 to recommend new and continued oil production adjustments in light of “the negative impact on oil demand” due to depressed economic activity, “particularly in the transportation, tourism, and industry sectors, particularly in China.”106 In LNG markets, on February 10, Caixin reported Chinese state-owned oil giant China National Offshore Oil Corp. (CNOOC) requested a reduction of an unknown quantity in LNG shipments, invoking a “force majeure” clause due to COVID-19.107 S&P Global Platts, an energy and commodities analysis group, stated China’s LNG imports in January and February fell more than 6 percent over the same period in 2019.108

Prices have also dropped in this period. OPEC’s reference price index fell from $66.48 per barrel in December 2019 to $55.49 per barrel in February 2020, a drop of 19.8 percent.109 These price cuts are causing financially strapped* U.S. energy producers to cut back investment in oil and gas projects as profits erode. The U.S. Energy Information Administration forecasts that the current drop in oil prices will lead to lower U.S. crude oil production beginning in the third quarter of 2020.110″

The complete report is embedded below (footnotes 99-110 can be found on page 22 of the report).

USCC-staff-research-Cascading_Economic_Impacts_of_the_Novel_Coronavirus_April_21_2020

2. State-owned or controlled oil companies create further crisis

With a sharp contraction in oil demand, one would expect falling oil prices and reductions in global production over time. OPEC efforts to achieve reductions in production amongst themselves and Russia didn’t work out with Russia walking out of talks to reduce production to prevent further price declines. Russia and Saudi Arabia then engaged in a price war which resulted in further sharp price reductions in March and early April, large surpluses of oil in the market, with dwindling storage capacity for surplus production. See, e.g., https://en.wikipedia.org/wiki/2020_Russia%E2%80%93Saudi_Arabia_oil_price_war (and sources cited therein). Below is a graph of crude oil prices from 2015 through April 2020.

3. April Agreement to Reduce Production Beginning in May and June 2020

The United States, concerned with the collapse of oil prices and the effects on U.S. producers and oil/gas field companies, engaged in outreach to both Saudi Arabia and Russia to seek a solution. OPEC members, Russia and many others (including the United States) agreed to global production reductions of close to 10 million barrels/day beginning in May and carrying through June, with smaller reductions for later periods, in an effort to bring about balance between supply and demand. See, e.g., April 12, 2020, AP article, “OPEC, oil nations agree to nearly 10M barrel cut amid virus,” https://apnews.com/e9b73ec833e9a5ad304a69e3b9b86914. The U.S. Department of Energy has a webpage that reviews statements by members of Congress and others on the OPEC+ deal.

Because the agreement kicks in at the beginning of May, the continued production and reductions in available storage for oil resulted in further declines in oil prices, with prices on April 20 going negative for the first time in history. Prices have recovered somewhat in the last several days. https://www.cnbc.com/2020/04/24/oil-prices-could-remain-under-pressure-according-to-satellite-imagery-analysis.html; https://oilprice.com/Latest-Energy-News/World-News/OPECs-No3-Already-Started-Cutting-Oil-Supply.html.

WTO Challenges

Joint action during the global COVID-19 pandemic may be understandable and in keeping with the resort to extraordinary measures by governments during the crisis to preserve health and economies. Nonetheless, the extraordinary distortions that flow to global commerce from joint government activity limiting production of oil and gas products or establishing minimum prices for export have been ignored within the GATT and now the WTO for decades. This is unfortunate as the distortions affect both competing producers of the products in question in other countries and also downstream users and consumers more broadly. The overall distortions over time are certainly in the trillions of dollars.

GATT Art. XX(g) permits governments to enforce measures “relating to the conservation of exhaustible natural resources if such measures are made effective in conjunction with restrictions on domestic production or consumption.” While there have been some cases where Art. XX(g) has been examined, actions by OPEC or OPEC+ countries to limit production (and hence exports) have never been challenged.

While there are national antitrust laws in many countries, such laws (such as those in the United States) don’t make government interference in the economy or government restrictions on export actionable despite the harm to consumers and to downstream manufacturers.

In a consensus based system like the WTO, the likelihood of obtaining improved rules on state-owned or state-invested companies or to restrict governments’ ability to unilaterally or jointly restrict production and exports seems implausible. This is especially true on oil and gas with Saudi Arabia and Russia as WTO Members. The US-EU-Japan initiative hasn’t yet fleshed out possible rule changes for state entities, so one may see some efforts in the coming years that could be useful if accepted by the full membership. But if there is to be meaningful WTO reform, agreeing on rules for the actions of governments that affect production and trade in goods and services is clearly of great importance. Without such rules, the WTO will not actually support market economies in critical ways.

Modifying antitrust laws is the other option, but one which legislators have been unwilling to address over the last fifty years. It is not clear that there are current champions of such modifications in the United States or in other major countries.

Conclusion

There are many sectors of economies that are being seriously adversely affected by efforts to control the spread of COVID-19. Governments are taking extraordinary actions to try to prevent their economies from collapsing under the strains of social distancing.

The oil and gas sector is one where there has been significant negative volume and price effects. Unfortunately the extent of the negative volume and price effects is driven in large part by the actions of governments who are preventing the global market for these products from functioning correctly, just as government actions have interfered in the functioning of these markets for the last fifty-sixty years.

The recent agreement to slash global production by nearly 10 million barrels per day was needed in light of the extensive government interference that has characterized the market and the actions by Russia and Saudi Arabia in March and early April.

More importantly, the long-term government involvement and interference with the functioning of the sector should cause trade negotiators and legislators to be looking at how to reform the WTO and/or modify national laws to prevent government ownership, control or cartel-like actions from distorting trade flows and economies. The need is pressing, but don’t hold your breath for action in the coming years.