Global trade tensions fueled by rising government subsidies risk undermining efforts to fight poverty

We are witnessing important setbacks in the open, international trade system that has driven prosperity around the world and lifted billions of people out of poverty in developing countries. Geopolitical tensions, on the heels of earlier trade wars—and accentuated by shocks such as the pandemic, disruptions in supply chains, and climate events—are heightening the risk of economic fragmentation.

These setbacks could become a source of unwarranted economic inefficiency and a potential drag for the global economy. In particular, in a renewed drive toward self-reliance and interest in industrial policies to promote “strategic” sectors, the world’s major economies are increasingly turning to subsidies. And while subsidized exports of industrial goods from China were often blamed for hurting domestic industries in the West, these practices are increasingly being replicated elsewhere.

Developing countries are most vulnerable to the trade-distorting effects of subsidies. They rely on trade to drive economic growth, reduce poverty, diversify their economies, and respond to climate change. To attract investment, they need the certainty provided by a credible and coherent system of global trade rules. They also need to be able to compete on fair terms, a capacity that trade-distortive subsidies and protectionist policies will hurt.

Most subsidies are not directly related to trade but could have important effects on trade. Many have legitimate economic and social goals, such as promoting research and development or the production of environmentally friendly goods and technologies. Yet, even when deployed in pursuit of legitimate goals, subsidies can distort trade, fueling tensions and provoking countermeasures. And because the international trading system is ill-equipped to discipline their use, governments increasingly are responding with countervailing tariffs or subsidies of their own. 
 

Breaking this escalating cycle of subsidies and countermeasures calls for a multilateral solution.  But to reach such a solution, trade negotiators will need far more information than is currently available on subsidies and their economic impact. A recent World Bank study, “Unfair Advantage: Distortive Subsidies and Their Effects on Global Trade,” takes a step toward filling this knowledge gap and lays a foundation for further research. It builds and analyzes a database that categorizes over 2,000 subsidy programs in major trading partners (accounting for over 70 percent of global trade).

The report highlights that the use of subsidies is not limited to a single country or region. At the same time, they tend to be concentrated in big economies with the potential to influence global markets. China, the EU, and the United States account for about 75 percent of the documented measures.

Subsidies can be more distortive to trade than tariffs , the study finds. Ad valorem equivalents of their trade distortions are estimated to be double and quadruple the average tariffs for agricultural and manufactured goods, respectively. So, while not necessarily intended to influence trade, subsidies can have more pronounced effects than border measures applied directly to trade flows, such as tariffs.

Manufacturing is the sector in which the most measures are applied. They are prevalent in industries such as electronics, vehicles, machinery, ships, chemicals, food and beverages, and metals and metal products. To be sure, support in agriculture (e.g., meats, fruits and vegetables, pulse and legumes, nuts, and cotton) and services (e.g., activities related to innovation, information and communication, and construction) is also common.

Subsidies can displace trade and production in other trading partners, with negative repercussion for developing countries.  For low-income countries, such as in much of Sub-Saharan Africa, production and trade tend to be concentrated in agriculture, where distortions caused by subsidies are greatest. Meanwhile, distortive subsidies in manufacturing, including in parts and components, make developing countries involved in or aspiring to join manufacturing value chains particularly vulnerable.

Measures vary considerably by type and stated objective. Common types, with notable variations across countries, include grants, tax incentives, and loans and guarantees. A significant share of programs appears to be aimed at supporting the competitiveness of particular sectors. Another common objective is to generate or transfer technology. Subsidies with an environmental goal are less common, although most recently significant interventions are emerging with stated climate objective that remain to be assessed.

The study identifies principal limitations in the multilateral framework governing subsidies where improvements could be made. Among them:

• Significant gaps exist on subsidy rules related to cross-border services, foreign direct investment, type of economic transfer, and state-own enterprises;
• Notification requirements offer weak incentives for compliance;
• Subsidy-related disputes and trade-defense mechanisms are difficult, lengthy, and widely perceived as ineffective, providing little incentive for members to avoid causing harm through their subsidy measures.

The World Bank study aims to offer data and analysis needed to inform the debate on reforms. It contributes to a recently launched Subsidy Platform in cooperation with the International Monetary Fund, the Organization for Economic Cooperation and Development, and the World Trade Organization that aims to promote access to information on the nature, size, and economic impact of subsidies.

Dealing with subsidies in global trade will not be easy, but the costs of inaction in terms of lower integration, growth, and living standards could be substantial.  International cooperation, especially involving major trading partners, will be needed to preserve decades of trade integration and shared prosperity.