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US Industrial Policies, R&D, And The WTO’s Definition Of Non-Actionable Subsidies

23/12/2010 by Intellectual Property Watch 3 Comments

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The views expressed in this article are solely those of the authors and are not associated with Intellectual Property Watch. IP-Watch expressly disclaims and refuses any responsibility or liability for the content, style or form of any posts made to this forum, which remain solely the responsibility of their authors.

By Fred Block, Department of Sociology, UC Davis

The WTO framework, including the TRIPS agreement, has often been criticized for narrowing the permissible space for governments to pursue industrial policy. This is particularly true at the level of values; the current global trading system is based on free market ideas that celebrate the creativity of the private sector and denigrate the capacities of the public sector. However, commentators have also recognized that there is considerable “wiggle room” in the current trade regime that allows more scope for government policies than is often assumed.

But surprisingly, one of the most important areas of flexibility has received remarkably little attention. While the WTO rules are quite strict in treating most government subsidies to private firms as illegitimate and as justification for retaliatory action by trading partners, a very substantial exception is made for research and development subsidies. Trading partners have no grounds to object to these “non-actionable subsidies.”

The Uruguay Round Agreement on Subsidies and Countervailing Measures reads as follows:

8.2 Notwithstanding the provisions of Parts III and V, the following subsidies shall be non-actionable:
(a) assistance for research activities conducted by firms or by higher education or research establishments on a contract basis with firms if: the assistance covers not more than 75 per cent of the costs of industrial research or 50 per cent of the costs of pre-competitive development activity; and provided that such assistance is limited exclusively to:
(i) costs of personnel (researchers, technicians and other supporting staff employed exclusively in the research activity);
(ii) costs of instruments, equipment, land and buildings used exclusively and permanently (except when disposed of on a commercial basis) for the research activity;
(iii) costs of consultancy and equivalent services used exclusively for the research activity, including bought in research, technical knowledge, patents, etc.;
(iv) additional overhead costs incurred directly as a result of the research activity;
(v) other running costs (such as those of materials, supplies and the like), incurred directly as a result of the research activity.

This exception leaves considerable room for active government industrial policies designed to encourage private firms to innovate in both the development of new products and new production processes. By allowing subsidies to cover up to 75 percent of the cost of industrial research, governments can have a major influence on technology development by firms. Moreover, since “pre-competitive development research” is defined as everything that occurs before a firm produces a commercial prototype, states can play a major role in helping firms to transform new technologies into actual products.

Given the importance of US input into the Uruguay Round, it is hardly a coincidence that R&D subsidies to private firms have been a major element in the US government’s technology policies since the 1980s. In line with earlier successes with the computer industry and genetic engineering, funding agencies encourage scientists and engineers working in universities and government laboratories to create new firms to commercialize their breakthroughs. And it is generally seen as desirable that resources and ideas financed with federal research grants are then used by these startups. For example, the founders of Google began as graduate students – one of whom had funding from the National Science Foundation. The algorithm developed under that grant became the key piece of intellectual property for their newly created corporation.

Moreover, since the early 1980s, the US has had a program that focuses on supporting these startups. The Small Business Innovation Research Program (SBIR) gives out more than $2 billion per year to firms with fewer than 500 employees. It provides about three years of support – without strings – to firms that are making progress in commercializing a new technology. Private sector venture capital firms usually defer funding these small firms until they have gone through the SBIR process to move their idea closer to a commercial product.

It is not at all unusual that through SBIR and other federal programs, government might actually cover all of the initial costs for the startup firm for its first three or four years or even longer. Moreover, the Central Intelligence Agency and several other branches of government have their own venture capital firms that invest in promising startups. But once a firm does have a commercial prototype, it will usually be able to raise private sector capital in order to finance enhanced productive capacity. So the idea is that by the time the firm is ready to export, the government subsidy of development costs should be within the WTO rules.

But another feature of the US innovation landscape also makes it very difficult for potential competitors to prove that US R&D subsidies exceed the WTO threshold. It is part of the way the system is organized that government provides considerable in-kind support to private firms through publicly funded research facilities. The network of federal laboratories, mostly created during the Cold War, plays a central role here. Technologists on the federal payroll use the state of the art resources of these labs to help thousands of firms to overcome specific technological barriers. Sometimes private firms pay fees for research services provided by the federal laboratories, but it is unlikely that the charges are anywhere near what it would cost the firm to assemble comparable equipment and talent. Moreover, the details of these agreements between firms and federal laboratories – including the amount of money that changes hands – are not publicly disclosed.

The federal government also routinely funds the creation of research centres on university campuses that are intended to help a particular industry meet a specific technological challenge. Once established, some of these centres derive part of their funding from dues paid by industry, but here again, the benefits probably exceed the costs.

Two examples suggest the importance of this in-kind support. Starting in the 1980s, the Advanced Research Projects Agency of the US Department of Defense funded a laboratory in Southern California that would fabricate any chip design sent in by a legitimate researcher. This was a way of overcoming the bottleneck created by the high cost of fabricating chips; it opened up the industry to new ideas from graduate students and others outside of the dominant firms. More recently, the National Nanotechnology Initiative has built a series of expensive nano labs most of which are on university campuses. Private firms are encouraged to carry out their nano experiments in these facilities rather than building their own laboratories.

In addition to direct support for startups and in-kind subsidies, another tool that federal agencies use are R&D cost-sharing agreements with established firms. After lengthy consultation to identify a particular technological hurdle, the two parties agree to split the R&D costs over a specified time period to meet a certain technological objective.

The Department of Energy used this method in the early 1990s to get General Electric and Westinghouse to develop a new generation of high-efficiency, low-emission power plants that burn natural gas at extremely high temperatures. In kind support came as well through the funding of a university-based research centre dedicated to high temperature turbines. The project was successful and these power plants have been sold abroad. The Department of Commerce sponsored a similar initiative in the late 1990s with the Big Three automakers to upgrade the machining of parts for the industry.

As these examples illustrate, a robust strategy of industrial upgrading can be organized through these kinds of subsidies, In fact, a number of countries have very explicitly copied the SBIR program and China has been using all of these tools as part of its development strategy. Chile is another example of a country that has successfully used government-funded research to facilitate the successful upgrading of such industries as salmon farming and wine production.

But industrial policy through state R&D subsidies is a problematic development path for those less developed countries that have only a rudimentary science and technology infrastructure. When government budgets are extremely tight and basic human needs have not been met, it would be irresponsible for governments to devote resources to R&D subsidies that are inherently risky.

In short, use of this particular loophole in the global trading system is limited to countries that are already above a certain development threshold. Since countries below that threshold are also prohibited from using some of the strategies that helped rich countries develop in the past, such as export subsidies and reverse engineering of foreign products, the fairness of this regime is very much open to question.

But it is not just the fairness that needs to be questioned; the theoretical foundations of the current trading system are also problematic. The vision that animates the current trading system is the idea of the global economy as a level playing field where firms do not gain advantage by virtue of actions of their home governments. But how realistic is that vision if some of the world’s richest nations routinely use R&D subsidies to maintain their firms’ technological advantage in global trade?

The reality is that states and national economies are inevitably so intertwined that the level playing field vision for firms is neither feasible nor desirable. Just as they did in the past, nations will continue to use government as an instrument to improve the standard of living in a given territory. Trying to keep this from happening – in the name of some abstract free trade ideal – is like King Canute trying to hold back the tide.

The solution seems obvious. If richer nations are free to use R&D subsidies, then developing nations should be provided with compensatory concessions in the WTO framework such as more generous protections for infant industries, the opportunity to use export subsidies for limited time periods, and exemptions from some of the current TRIPS obligations. Moreover, as science and technology become ever more important to economic success, the richer nations have an obligation to help finance a science and technology infrastructure in developing nations that helps those countries meet their particular development challenges.

[Author’s Update: This language on non-actionable subsidies was agreed to provisionally for five years and its official renewal has been tied up in the Doha Round negotiations. However, in the ten years since the provision has lapsed, it does not appear that any research and development subsidies have been challenged in the WTO process except perhaps those involved in the longstanding US-EU dispute about government support for commercial airline production. In short, other nations continue to respect the strong US desire to maintain a “safe harbor” for R&D subsidies. The point remains that the least developed nations should be granted substantial concessions in exchange for tolerating subsidies that disproportionately benefit the most developed nations.]


Fred Block is co-editor with Matthew R. Keller of State of Innovation: The U.S. Government’s Role in Technology Development (Paradigm Publishers, 2011). He is a research professor of sociology at the University of California at Davis.

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Creative Commons License"US Industrial Policies, R&D, And The WTO’s Definition Of Non-Actionable Subsidies" by Intellectual Property Watch is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License.

Filed Under: Inside Views, Language, Themes, Venues, English, Innovation/ R&D, North America, Technical Cooperation/ Technology Transfer, WTO/TRIPS

Comments

  1. Zenobia says

    24/12/2010 at 5:45 pm

    Nice post but based on a failure to do basic homework about the WTO. If Prof. Block had bothered to read Article 31 of the SCM Agreement, he would see that Article 8 was only valid until 1999 unless renewed then. And if he had looked at textbooks of WTO law, or at the free explanatory material on the WTO’s website, it would show him that the 1999 renewal never took place. (1999 was not a good year for reaching agreement on anything.) Quote from the top of the page at http://www.wto.org/english/tratop_e/scm_e/subs_e.htm:

    “The Agreement as it originally entered into force contained a third category — non-actionable subsidies. This category (along with a provision establishing a presumption of serious prejudice in respect of certain specified types of actionable subsidies) applied provisionally for five years ending 31 December 1999, and pursuant to Article 31 of the Agreement, could be extended by consensus of the SCM Committee. As of 31 December 1999, no such consensus had been reached.”

    When these provisions were negotiated in the early 90s, having a non-actionable subsidies category was a must-have for Canada, which was using big subsidies to hold off mass unemployment in the Maritime Provinces. The Bush Administration pushed to limit non-actionability, but then the Clinton Administration rolled a lot of that back to make it possible to have Democratic industrial policy subsidies. Anyway this is all history now.

    Prof. Block also needs to think about whether these programs are really “subsidies” as defined by the SCM Agreement. If a program is not specific, as defined by SCM Article 2, it is not a subsidy at all. Specificity of R&D subsidies is a subject that has been well-examined in the context of countervailing duty proceedings. Generally if research is published, and anyone can use it, its benefit is assumed not to be capturable and therefore not a subsidy.

    Reply
  2. Fred Block says

    28/12/2010 at 5:15 am

    Zenobia’s comment makes a valid point that is now acknowledged in the update above. But whatever the legal standing of these paragraphs of the SCM Agreement, they continue to shape the practices of the WTO parties since challenges to R&D subsidies have not been happening. As to the second point, the U.S. government programs that I have described are designed to ensure that private firms control whatever intellectual property comes from government-financed research and development. Even in universities, researchers are now pressured to file patents for any discovery that might have commercial applications. Even government support for basic scientific research can easily evolve into a huge benefit for a particular private firm.

    Reply
  3. Tanya says

    26/09/2012 at 10:59 pm

    I’d suggest revisiting this issue in light of the recent Panel and Appellate Body decisions in the US-Boeing and EU-Airbus cases. Federally funded R&D was clearly found to be a subsidy by the WTO recently.

    Reply

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