Ensuring a Sound Basis for Global Competition: Competitive Neutrality

May 6, 2011
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Introduction Over the decade and a half after the fall of the Berlin Wall, and creation of the World Trade Organization, the world economy experienced one of the fastest periods of growth since World War II. Access to new markets, accelerating international investment, innovation, and entrepreneurship characterized the evolution of a "global" economy.

During this period, American, European, and Japanese global companies prospered. Their success inspired emulation in surprising and unexpected ways. A near-universal acceptance emerged that open markets and private investment were the key to economic growth and development.

How effective governments and business took advantage of opportunities provided by globalization was a central factor in determining success in sustaining economic growth and innovation during this period. Developing and emerging economies undertook privatization programs and the State's role in the economy correspondingly diminished.

State Capitalism and its Implications for U.S. Competitiveness We are now seeing a new challenge to the global consensus on open markets and private investment that helped fuel the tremendous growth of the global economy since the early 1990s.

The National Intelligence Estimate in November 2008 noted that "today wealth is moving not just from West to East but is concentrating more under state control. In the wake of the 2008-2010 global financial crisis, the State's role in the economy may be gaining more appeal throughout the world. These States are not following the Western liberal model for self-development but are using a different model -- "state capitalism.""

A significant state role in economies is not new. It has existed for many decades, even centuries. But for a time, due to privatizations and private sector entrepreneurialism in the 1980s and 1990s it actually receded.

Today, however, state-owned enterprises, and state-supported enterprises or "National Champions," are emerging to become serious global competitors. This trend has accelerated in the wake of the financial and economic crisis -- but it was manifesting itself even before then.

Several states that practice various versions of state-capitalism have ambitious plans to use this model to diversify their economies and climb the value-added ladder into high technology and advanced services sectors. The significant difference between today's efforts and those of earlier periods is that these states now possess significant financial resources to implement their plans, and need not rely heavily on foreign investment. And, importantly, there are few accepted international disciplines which effectively ensure a level, competitive playing field between state supported firms and the private sector.

It is not up to the United States to question the wisdom of other nations in establishing state enterprises. But it is very much a U.S. concern if the playing field is not level between them and their American competitors. And many in our industry have told U.S. government officials it is. SOEs and SSEs (State-Supported Enterprises) in several cases have gained domestic and international market share in large part because they are enjoying financial support, tax preferences, regulatory privileges, and immunities not generally available to their privately-owned competitors. These privileges are often reinforced with discriminatory government market access or purchasing policies. Together, they give SOEs and SSEs a competitive advantage over their private sector rivals -- advantages that are not necessarily based on better performance or innovation, but on government policies and practices that distort competition in the market.

Strategic sectors such as minerals, chemicals and telecommunications equipment -- along with other important sectors like insurance, have experienced significant structural and competitive changes and benefits as a result of SOE and SSE activity.

As I said earlier, State Capitalism isn't a new model. From the Middle Ages, European nobility practiced "Etatism" or dirigisme, particularly in France. Under this doctrine, the central government directs the economy through state-ownership of major industries and its planning of overall economic activity.

To quote the French classical liberal, Charles Dunoyer, from his book about the Ancien Regime and French Revolution, The Passage to Liberty:

"The State exercised over manufacturing industry the most unlimited and arbitrary jurisdiction. It disposed without scruple of the resources of manufacturers; it decided who should be allowed to work, what things it should be permitted to make, what materials should be employed, what processes followed, what forms should be given to productions. It was not enough to do well, to do better; it was necessary to do according to the [state's] rules."

In modern times, France and Japan in particular have been seen as practitioners of state-led economic development. In the post-World War II period, both countries experienced far-reaching economic and social transformation guided by state technocrats. Their apparent success was celebrated by some. Several countries emulated that practice, notably Korea, through its chaebol policies.

Over the past 20 years, however, a number of countries who practiced state-led economic development have reevaluated the benefits of this model. Privatizations of many state-owned companies occurred as a result. For example, Poland has divested over 7,000 SOEs since 1989, contributing to significant economic growth and stability. Many other countries, from Mexico, Singapore, and New Zealand did likewise.

These past global trends seem to be reversing. Some governments, particularly newly emerging economies have placed greater emphasis on managing their economies, utilizing a modern day version of industrial policy.

The issue the U.S. and other nations face is not whether SOEs or SSEs are inherently good or bad, but whether governments give SOEs preferable finance or regulatory treatment, or provide them discriminatory access to government procurement or domestic markets at the expense of their competitors. This is our concern -- and that of other nations as well.

The OECD has found that some governments give SOEs and SSEs highly preferential financial and regulatory treatment, compounded by discriminatory market access practices. This creates an unlevel playing field for non-state supported multinationals, and even for domestic companies in those countries engaged in such practices.

The OECD has produced considerable data demonstrating various examples of government support that favors state-owned or state-supported firms. That government support is provided through a range of subsidies, lower taxes, concessionary financing and guarantees, preferential regulatory policies, special treatment in awarding public procurement contracts, access to government information, monopoly rights, captive equity, and exemption from bankruptcy rules that are often available in various combinations.

Some practitioners of state capitalism reserve certain sectors exclusively to SOEs or national champions. Another common practice limits foreign investment in certain sectors dominated by SOEs or state-supported companies to joint ventures. This practice is often coupled with performance requirements to transfer technology to, or buy a certain amount of product from, the domestic SOE or national champion as a condition of investment.

Under these circumstances, market entry by foreign firms, or foreign goods and services, is either impossible or extremely costly. This is harmful to U.S. interests because it can give select foreign companies unearned competitive advantages in our own market and third country markets as well as in the market of the country applying the measures. So it is a major trade issue as well as a major investment issue -- and requires comprehensive trade and investment norms and disciplines.

We have seen a heavy statist approach in many parts of the Arab world. Recent events have forced a major international focus on this. Sadly, this state-directed approach to economic management has not served their interests well -- and has made it difficult for private SMEs, a potentially large job creator, to prosper or expand to create new jobs. In response, our assistance measures in the region are implementing programs to assist young Arab entrepreneurs to start new businesses -- and expand existing ones -- as well as providing support and encouragement to small and medium enterprises. There is enormous entrepreneurial potential in this region; open, competitive markets are the key to tap that.

While the state-led model of preferential treatment might appear attractive now for some emerging economies, as I mentioned earlier, history suggests that the costs of and distortions from such policies are likely to rise; and, non-favored companies could find access to resources and markets at home or abroad stifled by SOEs and SSEs.

Even China, which is perhaps the most successful current practitioner of "state capitalism," may find that in the long run, the model is unsustainable, despite its $2 trillion in reserves. For in the medium- to long-run, the inefficient allocation of capital, combined with preferential regulatory treatment and discriminatory market practices, will likely be unhealthy for China's overall economy. It could disadvantage smaller Chinese companies and work against the interests of an expanding number of vigorous private entrepreneurs, which could become an increasingly powerful force in driving innovation, economic growth, and job creation in the future.

The U.S. Government Response: Bilateral, Regional and Multilateral Engagement is Key President Obama has called on us to compete aggressively and effectively in the global economy. In his speech to the U.S. Chamber of Commerce he noted:
"With the march of technology over the last few decades, the competition for jobs and businesses has grown fierce. The globalization of our economy means that businesses can now open up a shop, employ workers and produce their goods wherever an Internet connection exists. Tasks that were once done by 1,000 workers can now be done by 100 or in some cases even 10. And the truth is, as countries like China and India and Brazil grow and develop larger middle classes, it's profitable for global companies to aggressively pursue these markets and, at times, to set up facilities in these countries."

Our strategy to meet the state capitalism challenge involves a re-examination and robust deployment of the policy tools available to level the playing field in the home markets of the practitioners of state capitalism, in third-country markets, and increasingly here in our own home market so that open competition is maintained for all players.

Trade and investment policy tools that address SOE and SSE behavior in their home markets have dominated our approach. Why was this so?

Domestically, Americans generally do not believe that SOEs allocate resources efficiently; our system is based on private enterprise and companies which are incentivized by the profit motive. This system has proved very efficient and highly dynamic in creating new business, new products, and new job opportunities. We have only moved to create SOEs, nearly always at the State or local level, to resolve market failure -- and usually only for short periods of time.

We generally have been able to provide relief to U.S. domestic producers from unfair trade practices from non-market economies via anti-dumping and countervailing actions. We have also crafted WTO accession obligations that embody the principle that SOEs should operate on a commercial basis.

However, today many SOEs and SSEs are using a multitude of advantages gained at home to become more competitive in global markets.

For example, the profit from lower taxes, less regulation, protected home markets, or select government procurement privileges artificially improves SOE/SSE economies of scale, lowers their operating costs, and increases their sales, enabling them to invest in new technology that increases their competitive advantage at home and abroad.

So not only are we competing against SOEs in their home markets but now also we must compete increasingly against SOEs from a number of countries in our own domestic market as well as in third countries.

The appearance of overseas SOEs and SSEs that may have an unfair competitive advantage in our country or in third countries by employing anti-competitive practices to gain market share requires a robust and effective policy response on several fronts.

Fair and open access to the markets of the countries that are following this state capitalist model is essential to the global competitiveness of America's companies. This is one important front.

Thus, we have been working to augment our bilateral trade and investment policy tools, such as free trade agreements, bilateral investment treaties, WTO accession commitments, and the Trans-Pacific Partnership, to counter measures abroad that distort markets and policies or practices that prevent, or limit, market access and competition.

Let's turn in more detail to the range of actions we are taking both on a bilateral and multilateral basis to respond to this new and increasingly important challenge to the U.S. economy and U.S. competitiveness.

Bilateral Response We are working to enhance our trade and investment agreement negotiating texts. The State Department works with USTR to lead joint efforts to conclude bilateral investment treaties that support two-way investment. And we support USTR's negotiation of Free Trade Agreements and the Trans-Pacific Partnership (TPP) that create binding trade and investment and competition commitments. The TPP is going to be a high standard, 21st century regional free trade agreement. It is currently being negotiated by nine parties. As it is intended to be a vehicle for Asia-Pacific-wide economic integration, the TPP is a major priority for us. It is also a way to set high standards for other negotiations to follow, and as such, we view it a significant opportunity to move the SOE issue forward. This is a particularly important priority.

And in the area of bilateral investment treaties (BITs) and free trade agreements (FTAs) the aim is to strengthen the rules-based system on national treatment, dispute resolution, and market access for trade and investment. The United States presently is a party to BITs with 40 countries and FTAs with 17 partners.

The goal of the protections afforded by these agreements is to promote a level playing field for all investors and traders, whether state-owned or privately owned.

These agreements apply not only to measures by the government itself, but also to measures of an SOE or other entities when exercising government authority. In other words, the government cannot avoid its international obligations under a trade or investment agreement with the United States simply by delegating such authority to a corporation.

Multilateral Engagement One aspect of a solution to these problems would be a political commitment to "competitive neutrality.""Competitive neutrality" implies that government-supported business activities not enjoy artificially-derived competitive advantages over their private sector competitors by virtue of their links to or benefits from governments.

The OECD has framed the issue by identifying essentially three reasons why SOEs may create an uneven playing field. These are: (1) receipt of support by their government owners; (2) incentives provided to SOE managers that afford them advantages not enjoyed by private companies, which are governed by cost constraints and profit goals; and (3) incentives that are not corrected by corporate governance arrangements.

To influence the overall objectives of governments, a new multilateral effort is called for. At the Organization of Economic Co-operation and Development, we are working with representatives of its Member States and the OECD Secretariat to develop a Competitive Neutrality Framework -- guidelines that would address the issues posed by "state capitalism."

These guidelines need to embrace very high standards -- and not watered down to attract more adherents. Instead, countries should be encouraged to meet the higher standards, which will help ensure their overall effectiveness.

If widely implemented, these efforts would help level the playing field in sectors in which private companies, state-owned enterprises, and state-supported enterprises compete. Our goal is to increase the profile and attention devoted to this subject and raise it to higher political levels -- including the Ministerial level at the upcoming OECD Ministerial meeting in May 2011.

A "competitive neutrality" framework must include mutually reinforcing policy recommendations from the disciplines of trade policy, investment policy, competition policy, and corporate governance to avoid:
(1) Individual governments implementing incentives to “tilt the playing field” in favor of their SOEs or SSEs;

(2) Reliance solely on domestic competition law which in itself is in most cases insufficient to deal with broad state-supported anti-competitive behavior;

(3) Reliance only on the OECD's SOE corporate governance guidelines: these address some, but not all, aspects of the issue; and they are also voluntary and are often unevenly implemented.

Other key elements of a competitive neutrality framework should include principles that would produce: taxation neutrality, debt neutrality, regulatory neutrality, practices that avoid distortions preventing comparable commercial rates of return between state-supported firms and private companies, and the setting of prices that reflect actual costs.

At the OECD, work on the corporate governance and competition policy aspects of a competitive neutrality framework is well underway. But a comprehensive set of guidelines will need consideration by the investment and trade committees as well as others with expertise relevant to these issues. A political-level commitment to this project from the OECD leadership and its Members will likely be necessary to bring it to a successful conclusion.

Once the OECD work on the competitive neutrality framework has been settled, we will need to begin the process of convincing emerging and developing economies that adoption of competitive neutrality is in their own long-term economic interests. The OECD's enhanced engagement policy is leading to discussions with the major emerging economies.

It is important that the UN Conference on Trade and Development (UNCTAD) also be involved. China and other governments who advocate alternative development models see UNCTAD as an important forum to reach other developing countries with evidence of how state-supported capitalism is succeeding. The revival of state-led industrial policy has become a common theme in these discussions. It is vital that the United States continue to highlight the benefits of markets-based policies that have led to prosperity in so many countries, and to emphasize the importance of a level playing field that provides new opportunities for people in all nations.

By engaging on this issue in UNCTAD, we hope to find additional allies who will support high multinational standards in this area. Many countries also should recognize that preferential policies or financial advantages for SOEs or SSEs in countries with deep pockets disadvantage them as well.

Countries without the resources to implement this model will realize that they can't compete with much stronger practitioners of State capitalism with massive amounts of funds at their disposal. And they will see evidence that such policies often are a disadvantage to those who want to start new companies -- that are key to job creation.

Ultimately, we will need both UNCTAD and OECD to work in tandem and in coordination with other multilateral institutions, as appropriate, on this activity in order to garner the broadest support among emerging and developing economies.

Conclusion In closing, I want to emphasize that we are engaging many economies in these discussions.

Now is the key moment to focus on competitive neutrality and attempt to re-level the playing field for U.S. and other global companies -- and indeed businesses and workers everywhere.

We welcome healthy competition. And indeed, we need to do more at home to be able to compete effectively in the face of the legitimate and well-earned competitive strengths of companies, workers, and countries around the world. A large portion of the competitive challenges we face in the United States do not come from state capitalism, but from private competitors and the rise of entrepreneurial cultures abroad. We must rise to meet these challenges.

But state capitalism, as practiced on its current scale and using current policy approaches, is, in numerous instances, distorting trade and investment patterns in global markets; to the extent that it distorts trade and confers artificial advantages it can significantly and adversely affect important segments of our own economy, and the impact could grow over time. Indeed, there are numerous examples. The issue is not so much the existence of SOEs or SSEs, it is the distortions that arise when there is an absence of competitive neutrality. This is the direct threat to U.S. jobs, profits, and competitiveness. It is essential for the health of our economy to make it a high priority for our trade and investment policies.

In view of the competitive challenge, this work has taken on new urgency for us all.

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