1. Introduction
Technological innovation is a major driver of economic growthFootnote 1 and vital to addressing societal challenges such as climate change, health, and food security. Yet WTO subsidy rules are now being interpreted in a way that could restrain technological progress. The issue first arose in the long-running US large civil aircraft dispute,Footnote 2 which chiefly concerns the launch of a technologically superior aircraft (the Boeing 787 Dreamliner) for around the same price as the then-incumbent market leader (the Airbus A330).Footnote 3 Under the rules of the WTO Agreement on Subsidies and Countervailing Measures (SCM Agreement), this is regarded as a problem that needs a solution. The reason is that some of the research and development (R&D) that led to the technologies used on the 787 received government support. In 2012, the WTO actually granted a remedy to protect the manufacturer of the less fuel-efficient, superseded aircraft.Footnote 4 Subsequently, in the EU large civil aircraft dispute, the WTO found against launch aid to the rival manufacturer, partly because it had improved the technology on the A350XWB through lessons learnt in the development of earlier aircraft models.Footnote 5
The underlying rationale treats technological innovation itself – not just expenditure on R&D – as a mechanism that causes ‘adverse effects’ and ‘serious prejudice’.Footnote 6 The causal link between a subsidy and adverse effects is an essential element of an actionable subsidy claim. In US–Boeing, the WTO accepted that R&D subsidies could cause serious prejudice to the interests of a competitor not only by reducing a beneficiary's costs of production and giving it an edge in price competition but also by improving the beneficiary's product and giving it a head start in innovation competition.Footnote 7 This ‘technology effects’ analysis can challenge the introduction of new or improved products and processes that reach the market earlier than they could have done without subsidy, where this harms the trade interests of another WTO Member. By the same logic, had a smartphone operating system been developed with even modest government support, that could have been challenged on the ground that its improved functionality shrank the market for flip phones.
This paper begins by describing the technology effects analysis as it emerged in US–Boeing and the indirect learning effects analysis applied in EC–Airbus. It examines the presumed legal basis for this wide interpretation of the SCM Agreement and then explores whether a narrower interpretation of the rules and remedies is appropriate. The paper also considers whether the SCM disciplines offer effective relief in dynamic high technology markets. Finally, the paper looks ahead to consider how future cases could treat subsidies for R&D differently.
Technology is relevant to other aspects of the large civil aircraft cases that are not considered here. The panel in EC–Airbus found that a raft of government R&D grants and loans complemented and supplemented the serious prejudice caused to Boeing by launch aid for Airbus, although this conclusion was reversed on appeal for lack of detail.Footnote 8 The panel in US–Boeing found that government R&D contracts, which provided payments and access to facilities, equipment, and employees, constituted subsidies, and this conclusion was upheld on appeal.Footnote 9 The panel in US–Boeing also found that the waiver or transfer of patent and data rights in publicly funded research under the Bayh-Dole ActFootnote 10 was not specific, and therefore not actionable (if, indeed, it was a subsidy at all), but that finding was not sustained on appeal.Footnote 11 These aspects of the large civil aircraft cases all lie outside the scope of this paper.
2. Technology and Learning Effects in the Large Civil Aircraft Cases
This section describes the technological innovations at issue in the US–Boeing dispute and explains the ‘technology effects’ analysis that led to the crucial finding that the subsidized R&D caused serious prejudice to Airbus. It also examines a similar ‘learning effects’ analysis in the compliance proceeding of the EC–Airbus dispute. It then traces the limits of the technology effects analysis as exposed during the compliance proceeding in US–Boeing and recalls the concerns regarding these causation analyses expressed by third parties.
2.1 Technologies at Issue in US–Boeing
The technologies at issue in US–Boeing are features on jet aircraft and processes for their design and manufacture. They were first applied to the Boeing 787 Dreamliner and then to later models of aircraft, such as the 787/9-10, 777X, and 737 MAX.
The most important technologies at issue concern the composite structures used in the fuselage and wings on the 787.Footnote 12 Composite materials such as graphite can improve aircraft performance and lower operating costs for the customer because they weigh less than aluminium but their high manufacturing costs presented an enduring technical problem. Innovations such as the accelerated processes for production of composite materials, including mouldings, made the use of composites in large components, such as fuselages, cost-effective in large civil aircraft.
A range of other innovative technologies is also at issue, notably (a) the more-electric architecture of the 787 uses electrical power to drive secondary mechanical systems instead of a combination of hydraulic, pneumatic, and electrical power, thereby reducing maintenance and lowering overall fuel consumption; (b) the open systems architecture of the 787 allows for easier upgrading of aircraft functionality and alleviates some of the hardware; (c) enhanced aerodynamic and structural design technologies, including software, used in the design, production and assembly processes led to specific improvements in the 787's wings; (d) noise reduction technologies; and (e) health management systems to monitor the different parts of an aircraft and reduce maintenance costs.Footnote 13 None is a disruptive technology that would radically alter aircraft operational characteristics, such as size or speed.
The use of these technologies on the Boeing 787 Dreamliner prompted Airbus to design a more technologically advanced aircraft to compete with it. The A350XWB was built with advanced materials, including carbon composites, although it has a more conventional fuselage design and systems architecture than the 787. The A350XWB also has lower operating costs, fuel burn, and carbon dioxide emissions when compared with previous generation aircraft.Footnote 14
The innovations at issue in US–Boeing solved important technical problems in the aeronautical industry by, for instance, increasing fuel-efficiency. The European Union raised these innovations in a challenge under Part III of the SCM AgreementFootnote 15 because they were developed with support from the National Aeronautics and Space Administration (NASA) and the US Department of Defense (DoD).Footnote 16 The challenge was a counter-complaint to the United States’ complaint regarding launch aid and other subsidies in EC–Airbus.Footnote 17
2.2 Technology Effects in the Original US–Boeing Proceeding
A central claim in US–Boeing is that US government aeronautical R&D programs subsidized the development of the technologies at issue and that this aided Boeing and caused serious prejudice to Airbus.Footnote 18 An important aspect of the case is that the intermediate, positive effects of these subsidies on Boeing aircraft were framed in the claims not only in terms of the money saved on Boeing's product development costs, which might pass through to lower aircraft prices (price effects), but also on the basis of the value of the technological advancements obtained from the R&D itself (technology effects).Footnote 19 Viewed from the latter perspective, the subsidies gave Boeing a head start in developing the innovations that made the 787 a better aircraft, which reduced demand for competing products in the 200–300 seat market, resulting in lost sales, lower prices, and fewer exports of Airbus aircraft.
The panel found that Boeing's work on R&D contracts funded by eight NASA programsFootnote 20 and one DoD programFootnote 21 made a genuine and substantial contribution to Boeing's accelerated development of technologies used on the 787. On appeal, the R&D contracts were found to be subsidies due to a non-market-consistent allocation of intellectual property rights.Footnote 22 The work was early stage, high-risk aeronautical research that complemented Boeing's internal product development efforts.Footnote 23 Some of the work was directed to finding solutions to specific technological problems later used on the 787 while other work was part of a ‘single process of iterative learning and advancement in pursuit of a common technological goal’.Footnote 24 The panel did not evaluate the effect of each technology separately but concluded that, absent the aeronautical R&D subsidies, Boeing would not have been able to launch an aircraft incorporating all of the technologies on the 787 when it actually did in 2004, with promised deliveries commencing in 2008.Footnote 25
The characterization of the effects of the R&D subsidies by their impact on Boeing's technology could multiply the effects of these subsidies on Airbus for the purposes of the serious prejudice analysis. This was important because the amount of the subsidies, though large in absolute terms,Footnote 26 was dwarfed by the amounts involved in producing large aircraft.Footnote 27 It would have been difficult to show that the cash amount of R&D subsidies, viewed as reductions in Boeing's product development costs, translated into any kind of meaningful price advantage for Boeing aircraft when they were not directly related to prices or sales.Footnote 28 However, the complainant argued that the R&D subsidies had a ‘multiplier effect’ when assessed on the basis of the value of the R&D results to Boeing. This value took account of the knowledge and experience that Boeing engineers gained by undertaking R&D in cooperation with NASA and DoD engineers, including access to research and testing facilities, which gave Boeing a head start in its own related R&D activities.Footnote 29 The strategic importance of this argument for the complainant lay in the way that the multiplier increased the magnitude of the effects of subsidies for Boeing relative to those at issue in the complaint against Airbus.Footnote 30
The panel in US–Boeing accepted a causation analysis based on the ‘technology effects’ of the R&D contracts without extensive argument on the legal merits.Footnote 31 The panel's primary justification for this approach was that the nature of the R&D subsidies was intended to multiply the benefit from a given expenditure.Footnote 32 The panel also made the factual observation that competition in the large civil aircraft market was based on innovation.Footnote 33 The parties’ arguments focused on factual questions regarding the degree to which the commissioned R&D work had contributed to the development of the 787 technologies.Footnote 34 However, the respondent did not challenge the legal basis for this type of causation analysis.
The panel found that the ‘technology effects’ of the aeronautical R&D subsidies to Boeing caused serious prejudice to Airbus. The superior technology and lower operating costs of the 787, as well as its scheduled delivery dates from 2008, caused Airbus to lose a significant number of orders during the period from 2004 (when the 787 was launched) to 2006 (when the panel was established). This significantly suppressed the prices of the A330 and A350 during the same period because Airbus had to lower prices to secure other sales in the 200–300 seat aircraft market.Footnote 35 That threatened to displace and impede future Airbus exports to certain third country markets when the orders booked from 2004 to 2006 were eventually delivered from 2008.Footnote 36 Significant price suppression and lost sales, and threat of displacement of, and impediment to, exports constitute ‘serious prejudice’ under Article 6.3(b) and (c) of the SCM Agreement. The ‘price effects’ of certain federal, state, and local tax subsidies tied to aircraft sales were analysed separately.Footnote 37
The appeal did not alter the causation findings significantly. The United States argued that the causal link between NASA research and Boeing's launch of the 787 in 2004 was attenuated because the amount of the R&D subsidies was relatively low, rather than because their effects on the market were technological.Footnote 38 The Appellate Body saw no reason to find that the amount of the R&D subsidies diminished their important contribution to the development of the technologies on the 787.Footnote 39 The finding on threat of displacement and impediment was narrowed to one third country market.Footnote 40
The panel in US–Boeing found that US government R&D support to Boeing was subsidized and that these subsidies caused serious prejudice to the interests of Airbus, not because the 787 was less expensive to purchase than the A330 (it was not),Footnote 41 but rather because the 787 was a technologically superior aircraft. The Dispute Settlement Body (DSB) recommended that the United States withdraw these subsidies or remove their adverse effects within six months.Footnote 42 The implementation period ended in September 2012 and the dispute was promptly referred back to the panel to assess the United States’ compliance with the DSB recommendation.
2.3 Learning Effects in the EC–Airbus Compliance Proceeding
Technology effects crossed over to the other large civil aircraft case. Rather than challenge the possibility that technology could have a ‘multiplier effect’ for the purposes of SCM disciplines in US–Boeing, the United States suggested that launch aid might have a multiplier effect in EC–Airbus. Footnote 43
As complainant in that other dispute, the United States claimed that launch aid and other subsidies caused serious prejudice to Boeing because they ‘facilitated and accelerated’ the introduction of whole models of aircraft (product effects)Footnote 44, and also led to lower prices (price effects).Footnote 45 In the original proceeding, ‘product effects’ were partly based on learning curve advantages gained from producing successive models of aircraft, insofar as they reduced costs.Footnote 46 The original panel found ‘product effects’ based on the economic effects of reducing costs and shifting risksFootnote 47 and it cited economic literature that explained the impact of learning curve effects on marginal costs of production.Footnote 48
However, during the compliance proceeding in EC–Airbus (which occurred after the original US–Boeing proceeding),Footnote 49 the complainant submitted that launch aid had ‘technology and learning effects’ where there was ‘a transfer of technology, knowledge, and production processes that benefit subsequent aircraft programs and that otherwise would not exist’.Footnote 50 It distinguished between the financial effects and the technological effects of launch aid on the A350XWBFootnote 51 and submitted that this was consistent with the original panel's findings.Footnote 52 The respondent disputed the technology connections between different aircraft as a factual matter,Footnote 53 but it did not challenge the legal basis of this causation analysis, presumably because of its position as complainant in the counter-complaint.
The compliance panel distinguished the subsidies’ indirect ‘learning effects’ from their ‘financial effects’Footnote 54 and identified various technological and managerial innovations that flowed from the subsidized production of the A380 and other aircraft to the A350XWB.Footnote 55 Some of these were product features, such as a wings high-lift system, hydraulic pressure levels, flight control architecture, and derivations of components and systems. The compliance panel treated these innovations as a means of transmission of serious prejudiceFootnote 56 and the Appellate Body agreed.Footnote 57 This formed part of the basis for the conclusion that launch aid continued to cause serious prejudice.Footnote 58
2.4 Technology Effects in the US–Boeing Compliance Proceeding
The limitations of the technology effects analysis were exposed during the compliance proceeding in US–Boeing. At the compliance stage of that dispute, the complainant raised more technologies used on Boeing aircraftFootnote 59 and presented more ‘technology effects’ arguments.Footnote 60 The compliance panel applied the same causation analysis as in the original proceedingFootnote 61 but it led to opposite results. These the compliance panel attributed to differences in timing: timing of the research, timing of the application of technology, or timing of the dispute itself.
Before the compliance panel, the complainant unsuccessfully argued that the technologies at issue in the original proceeding, such as the composite fuselage and wing design of the 787, were continuing to cause serious prejudice to the Airbus A350, since redesigned as the A350XWB. The compliance panel rejected this argument because the technology effects in the original proceeding only comprised the head start that subsidized R&D gave Boeing, not the technologies themselves. The compliance panel described this as the ‘acceleration effect’ of the subsidies. These technologies could have come into existence even without subsidized R&D, although they would have reached the market later than 2004, when the 787 was actually launched.Footnote 62 The compliance panel did not calculate the precise length of the head start because it decided that, in any case, the 787 could have been launched without subsidized R&D long before the end of the implementation period in 2012.Footnote 63 The Appellate Body considered that the head start might have continued until the first delivery date but, not knowing when that would have occurred without subsidy, it could not decide whether the technology effects had ceased by 2012 or not.Footnote 64 For the same reason, the complainant was unsuccessful in arguing that the adaptation of the 787 technologies to more recent Boeing aircraft caused serious prejudice to the A350XWB and A320neo.Footnote 65
Certain other findings were not appealed. The complainant had failed to persuade the compliance panel that so-called ‘sleeper’ technologies, based on earlier research but which had matured since the original proceeding, were also causing serious prejudice to the A350XWB.Footnote 66 The complainant also failed to demonstrate new technology effects based on later research funded by the same programs at issue in the original proceeding or later programs.Footnote 67
Although the technology effects analysis in US–Boeing had allowed the claims regarding R&D subsidies to prevail in the original proceeding, it did not lead to any remedy in the compliance proceeding more effective than the passage of time.
2.5 Concerns Expressed Regarding These Causation Analyses
Two third parties contested the legal basis for technology or learning effects under the disciplines of the SCM Agreement but their concerns were not addressed, partly for reasons of timing.
During the EC–Airbus and US–Boeing compliance proceedings, Japan argued that serious prejudice should stem primarily from the pricing policy of a subsidy recipient and not from its development of new technology. Japan submitted that it was more practical to limit the remedy of removal of adverse effects to price effects.Footnote 68 In the US–Boeing compliance proceeding, Korea argued that technology effects were difficult to reconcile with the structure of the SCM Agreement and its definition of a subsidy. Korea noted that the financial effects of a subsidy are quantifiable and remediable whereas the technological effects were not. Korea submitted that the assessment of serious prejudice on the basis of a technology causal mechanism should be carefully circumscribed, if not entirely rejected.Footnote 69
By the time that these third parties raised their concerns, the original panel in US–Boeing had already adopted an analysis based on technology effects and that had been upheld on appeal. A rejection of the technology effects causation analysis at the compliance stage of that dispute would have contradicted the original panel and required the compliance panel to deviate from adopted findings in the same dispute.
The question has been left hanging as to how the technology and learning effectsFootnote 70 causal mechanisms are permitted by the serious prejudice disciplines of the SCM Agreement. A wide interpretation may have been attractive in the large civil aircraft cases because the subsidies at issue in both proceedings had similar adverse effects. However, those cases concern the competitive subsidization of a duopoly. This type of interpretation should be carefully considered before it is applied to claims involving other products and industries.
3. How Subsidies Cause Serious Prejudice
Unlike previous disputes, the large civil aircraft cases partly analyse the cause of serious prejudice via technology or learning effects.Footnote 71 The principal parties, panels, and the Appellate Body all seem to have accepted a wide interpretation of the causal link required under WTO rules that covered non-financial effects of subsidies. They appear to have assumed that the type of subsidies at issue or the conditions of competition in the relevant markets, or both, permitted this approach. This section examines how the SCM Agreement could be construed in such a way, and then considers whether a narrower interpretation is called for.
3.1 Any Effects that Confer a Competitive Advantage
The text of Part III of the SCM Agreement focuses on the effects of actionable subsidies rather than on the way in which those effects are caused. The grounds for claim and one of the remedies are based on adverse effects rather than on the nature of the subsidy (unlike prohibited subsidies) or on numerical expenditure limits (unlike agricultural domestic support).Footnote 72 Even though the actionable subsidies disciplines do not exclusively concern effects,Footnote 73 this may permit a wide interpretation of the possible mechanisms that transmit effects from subsidies to markets.
Effects are what make a subsidy actionable, which means that causation is an important element of a claim,Footnote 74 but the SCM Agreement does not explain how to analyse the causal link. Article 5 provides an obligation not to ‘cause’ adverse effects to the interests of other Members through the use of any subsidy, and adverse effects include ‘serious prejudice’. Article 6.3 describes serious prejudice in terms of certain market phenomena, each of which must be the ‘effect’ of the subsidy.Footnote 75 Article 6.7 provides a non-exhaustive list of other factors to which serious prejudice must not be attributed in certain cases. The rest of Article 6 addresses the existence of serious prejudice and the development of a factual record, rather than the way in which serious prejudice is caused.Footnote 76
The parsimonious treatment of causation in Part III of the SCM Agreement, on actionable subsidies, means that even a requirement as basic as a ‘genuine and substantial’ relationship of cause and effect between a subsidy and serious prejudice, has to be inferred.Footnote 77 The lack of detail in the text contrasts with Part V of the same agreement, on countervailing measures, in which Article 15.5 imposes an express obligation on a national authority to demonstrate a causal relationship between the subsidized imports and injury and sets out a non-attribution requirement.Footnote 78
The lack of guidance in the treaty text has been interpreted as a grant of discretion to choose an appropriate method to analyse the causal link. The Appellate Body Report in US–Upland Cotton inferred ‘that a panel has a certain degree of discretion in selecting an appropriate methodology for determining whether the “effect” of a subsidy’ is a form of serious prejudice.Footnote 79 That comment was made in the context of an analysis of financial effects on production and prices. A ‘methodology’ refers to the factors and factual circumstances that a panel can take into consideration when analysing the subsidy and its effects. The factors typically include the nature and magnitude of the subsidy, the definition of the relevant market, the market power of the subsidizing Member, and evidence of temporal correlation between subsidization and serious prejudice.Footnote 80 The analysis can (in some cases, mustFootnote 81) include a counterfactual that compares the actual market situation with the situation that would have existed in the absence of the challenged subsidy.Footnote 82 Few limits to the panel's discretion to choose a methodology have been implied, and those that have been usually originate in trade remedy law. The main one is the requirement to conduct a non-attribution analysis to see whether other factors attenuate the causal link between the subsidy at issue and serious prejudice to the point where the causal relationship between them cannot be considered ‘substantial’.Footnote 83
This has led to a case-by-case approach to causation.Footnote 84 Causation can be absorbed in a unitary analysis of subsidies and their effects or it can be separated out in a two-stage analysis that first assesses whether serious prejudice exists and then determines what causes it.Footnote 85 The panel in US–Boeing broke down the analysis further by first determining the intermediate effects of the subsidy on the recipient's technology, then determining the effects of those intermediate effects on the recipient's competitor's sales and prices, and finally evaluating whether those indirect effects of the subsidy on the market constituted serious prejudice.Footnote 86
The ‘technology effects’ analysis in US–Boeing is unlike any analysis in a prior GATT/WTO Panel Report because it treats developments in technology, rather than reductions in production and development costs, as the mechanism that transmits adverse effects. The ‘learning effects’ analysis in the EC–Airbus compliance proceeding resembles it.
These causal analyses have the merit of recognizing that firms compete more through technological advancement than lower prices in high technology markets.Footnote 87 Market actors do not carry out R&D for the sheer wonder of innovation but rather in the hope of improving output. Technology effects capture the competitive advantage conferred by innovation. They recognize that subsidies used for R&D can lead to a competitive advantage for domestic industries, but with higher risk and higher return than production subsidies. Attributing a mere financial benefit to successful R&D may greatly understate the true value of having a public body bear those risks. Technology effects recognize that subsidies for R&D can be much more efficient than other subsidies.
This interpretation of serious prejudice is influenced by the effects-oriented nature of the actionable subsidies disciplines.Footnote 88 Given that the effects of a given subsidy make that subsidy actionable, the choice of causal pathway may be wide open, insofar as the ordinary meanings of the terms used are broad enough to adapt to new factual situations as they arise. On this view, it does not matter how a recipient uses a subsidy, as long as that adversely affects the conditions of normal competition. Other countries will have a better chance to compete, including poorer countries that lack the resources to grant subsidies.
However, such an interpretation renders subsidies spent on R&D particularly vulnerable to challenge because relatively small subsidy amounts may cause relatively large adverse effects. For example, if a public agricultural research institute develops a new variety of seed that it sells at marginal production cost to farmers, the technology effect of the subsidy could be based on higher crop yield. If a government grants a tax deduction for R&D that ends up doubling the traveling range of an electric vehicle, the technology effect of the subsidy could be based on the vehicle's increased market share.
Such an interpretation also enables serious prejudice to be found even when a subsidized product is more expensive than a competitor product. Demand for a subsidized, innovative product can be driven by its superior features rather than its price.
This all exacerbates the problem that the SCM Agreement does not provide for any balancing of the possible positive and negative effects of subsidies.Footnote 89 The wide interpretation does take into account the positive externalities of technological innovation but, perversely, only as a measure of serious prejudice to a competitor. Moreover, it compounds the problem that the SCM Agreement, as it currently stands,Footnote 90 offers no way to take account of the fact that R&D subsidies can be an economically efficient response to market failure.Footnote 91
The legal basis of the ‘technology effects’ causation analysis in US–Boeing appears to have been inferred from the panel's discretion to choose a methodology. It was followed by the indirect ‘learning effects’ causation analysis in the EC–Airbus compliance proceeding. The panels’ respective findings reflect an interpretation of the actionable subsidies disciplines that can capture any type of competitive advantage in a given market. This makes R&D subsidies, or any subsidy used to fund innovation, more vulnerable to challenge.
3.2 Financial Effects on Production Costs and Prices Only
A narrower interpretation of the SCM Agreement may be appropriate, one that assumes that subsidies cause serious prejudice via their financial effects on costs of production and prices of the subsidized product. The definition of a subsidy, the nature of serious prejudice, the remedy to remove adverse effects, and the object of the SCM Agreement may all imply something regarding the causal link between a subsidy and its effects.
3.2.1 A Subsidy Must Be Financial
A subsidy is only covered by the SCM Agreement if it is financial in nature. Article 1.1(a)(1) provides that a subsidy usually involves a ‘financial contribution’ by government or a public body, which may take various forms. A financial contribution includes not only money, such as grants and loans (as in EC–Airbus) but also contributions worth money, such as goods or services or the purchase of goods, and even access to facilities, equipment, and employees (as in US–Boeing).Footnote 92 Article 1.1(a)(2) provides that a subsidy may also involve income or price support, which are also financial in nature. It makes no difference whether a measure is supply-side or demand-side but it must be financial.
The determination of whether a subsidy exists requires a benefit analysis, which is also financial. Article 1.1(b) provides that a subsidy only exists where a ‘benefit’ is thereby conferred, the assessment of which usually involves a comparison with a market benchmark.Footnote 93 For example, in US–Boeing, the benefit of the R&D contracts, including the contractor's access to government facilities, equipment, and employees, was assessed in financial terms through comparison with a market benchmark.Footnote 94
The definition of ‘subsidy’ does not mention the beneficiary or the subsidized product.Footnote 95 The definition uses the passive construction that ‘a benefit is thereby conferred’, which avoids any reference to the recipient or the way in which the recipient uses the financial contribution.Footnote 96 This definition also omits any reference to the product; hence, it is broad enough to cover a subsidy whether it operates directly or indirectly on the market. The definition does not address the way in which the effects of the subsidy reach the market, but it does require that the subsidy be financial.
3.2.2 Serious Prejudice Must Be the Effect of the Subsidy at Issue
Serious prejudice is one form of adverse effects to the interests of another WTO Member that can ground an actionable subsidy claim. The three forms of adverse effects set out in Article 5 are (a) injury to the complaining Member's domestic industry; (b) non-violation nullification or impairment, in particular of the benefits of tariff concessions made by the subsidizing Member; or (c) serious prejudice to the interests of the complaining Member. Most actionable subsidy claims allege (c), because serious prejudice can cover more than just the market of the complaining Member or the value of tariff concessions in the subsidizing Member.Footnote 97
Serious prejudice is defined in terms of market phenomena set out in Article 6.3, each of which is the effect of the subsidy at issue. These are (a) and (b) displacement of, or impediment to,Footnote 98 the complaining Member's exports (to the subsidizing Member or to a third country);Footnote 99 (c) significant price undercutting, price suppression, price depression, or lost sales (in any given market); and (d) increased world market share for a primary product or commodity. These phenomena are interrelated and can also be the effect of each other. Serious prejudice also includes a threat of any of these market phenomena that has not yet materialized.Footnote 100
3.2.3 There Must Be a Causal Link between Serious Prejudice and Finance
The SCM Agreement does not expressly address the nature of the causal link between a ‘subsidy’ in Article 1 and the ‘effect of the subsidy’ on a market and the interests of competitors in Article 6.3. It follows from the definition of a subsidy that the market phenomena must be the effect of a financial contribution (or income or price support). The financial contribution must affect output if it is to harm the interests of competitors.Footnote 101 However, the Agreement does not state how the recipient uses the subsidy.
The financial effects of a subsidy can have an impact on output by lowering the cost of production. If the subsidy depends directly on output, it will reduce short-run marginal costs of production, to which recipients will generally respond by lowering prices of the subsidized product, which will lead to increased demand for the subsidized product.Footnote 102 Alternatively, a subsidy may reduce long-run marginal costs of production, thereby maintaining or increasing productive capacity.Footnote 103 Either way, the financial effects of the subsidy under Article 1 can lead to increased sales or lower prices of the subsidized product, or both, and result in the market phenomena listed in Article 6.3.
Financial support is never a sufficient condition for innovation. R&D is risky and not simply a conduit between expenditure and results. Expenditure on R&D is only effective in assisting a recipient that is ready to pick up technological improvements, one who knows the next product that the market will need and buy.Footnote 104 The recipient's technical expertise may operate as the X factor that attenuates the causal link between the subsidy that financed the R&D activities and eventual increased market share or lower prices. The SCM Agreement does not provide redress for the unequal distribution of research capacity.
The context shows that the drafters of the SCM Agreement envisaged that a subsidy could affect the market through financial effects on production or prices. The quantitative threshold or types of subsidy formerly deemed to cause serious prejudice under Article 6.1 operated through financial effects on marginal costs of production.Footnote 105 The former ‘green light’ subsidy categories in Article 8.2 implied financial effects because they were based on the magnitude of the subsidy relative to costs, and the reimbursement of particular costs.Footnote 106 The other forms of adverse effects reach the market through the effects of subsidies on costs or price, or both: under Article 5(a) injury is determined on the basis of the volume of subsidized imports and their effect on prices and the consequent impact on domestic producersFootnote 107 while under Article 5(b) non-violation nullification or impairment customarily protects the value of a tariff concession, which is ‘to provide an assurance of better market access through improved price competition’.Footnote 108 The term ‘serious prejudice to the interests of another Member’ is used in the SCM Agreement in the same sense as in Article XVI:1 of GATT 1994,Footnote 109 which refers to the ‘effect of the subsidization on the quantity’ of the affected imports or exports (emphasis added).
Nothing in the context indicates that the drafters envisaged that a subsidy could affect the market through technology effects. In fact, the only reference in the Agreement to ‘developments in technology’ distinguishes them from the effects of subsidized imports.Footnote 110
3.2.4 Adverse Effects Are Removable
One of the remedies in Part III of the SCM Agreement appears to assume that adverse effects are caused by financial means. Article 7.8 provides that the respondent either ‘take appropriate steps to remove the adverse effects’ or ‘withdraw the subsidy’, at the election of the respondent.Footnote 111 Given that the first of these remedies is effects-oriented, like the cause of action itself, it can shed light on how the grounds for a claim were conceived.
Removal of adverse effects, on the most straightforward reading, can entail reduction of payments.Footnote 112 Given that this remedy is an alternative to withdrawal of the subsidy, it indicates that adverse effects can be removed without completely terminating a financial contribution or its benefit. This would occur when the amount of subsidy were reduced to a level where it did not cause increased sales or significant price effects within the terms of Article 6.3.Footnote 113 Similarly, Article XVI:1 of GATT 1994 refers to the possibility of ‘limiting’ the subsidization that causes serious prejudice.
The reduction of payments can remove adverse effects but that assumes that the amount of the subsidy is related to the magnitude of its effects, i.e. that less subsidy leads to less effects. The amount of a subsidy will be proportional to its financial effects on marginal costs of production and, hence, to changes in market share, insofar as competition is based on price.Footnote 114 In price-based competition, a competitor seeks to whittle away at an incumbent's market share at a given point in time through price reductions. However, the amount of a subsidy does not correlate to its effects on technology or to changes in market share where competition is based on innovation.Footnote 115 In high technology markets, a competitor may seek to supplant an incumbent entirely over time through innovations, until it is displaced in turn by the next wave of product advancements.Footnote 116 For example, Blackberry's once-dominant platform was entirely supplanted by Android and iOS because of functionality, not price.
The remedy of removal of adverse effects is also drafted in a way that assumes that the adverse effects can be removed or reversed through appropriate steps taken by the respondent government. That is a valid assumption where serious prejudice is caused by financial effects in a market insofar as competition is based on price, as in a commodity market. A limitation or withdrawal of the subsidy can reduce or eliminate its price effects, allowing prices to rebound, and market shares to revert to the status quo ante. That was the assumption underlying the grant of this remedy in US–Upland Cotton and one with which the drafters of the SCM Agreement were familiar, after the GATT complaints regarding subsidies for wheat, flour, and sugar.Footnote 117 However, when serious prejudice is caused by technology effects in a market in which competition is based on innovation, a limitation or withdrawal of an R&D subsidy will not lead to a change in market share. Changes ex post to an R&D subsidy do not reverse the technological inferiority of a competitor's product.Footnote 118 The price of that product will not rebound nor will the competitor recover market share until it, too, introduces an innovation. For example, Airbus’ eventual competitive response to the 787 was to design the A350XWB.
Further, the remedy cannot require the respondent government to reduce payments by more than the amount of the subsidy, no matter how extensive the adverse effects are. The effects of a subsidy can be magnified beyond their cash value by factors including the nature of the subsidy (such as whether it is tied to production or prices), the dynamics of competition (such as the elasticities of demand and supply), and how the subsidy is applied.Footnote 119 No provision formally limits adverse effects to the amount of the subsidyFootnote 120 but a respondent always has the option to withdraw the subsidy instead, which is inherently limited to the subsidy found to exist.Footnote 121
3.2.5 Improvement of GATT Disciplines
The main object of the SCM Agreement, taken as a whole, is to increase and improve GATT disciplines relating to the use of both subsidies and countervailing measures.Footnote 122 Subsidies claims under the GATT disciplines only ever alleged that the effects of subsidies were financial.Footnote 123 At the time of conclusion of the SCM Agreement, academic literature recognized that subsidies could confer ‘learning curve’ advantages but it analysed those effects on the basis of their impact on costs.Footnote 124 The 1992 bilateral agreement on aircraft between the US and EEC contained only a hint that the benefits resulting from technology obtained through government-funded R&D could be calculated in terms other than the reduction in particular costs.Footnote 125 Nothing indicates that a more expansive interpretation of the effects of government financial contributions on sales, prices, and market share was one of the intended improvements upon GATT disciplines.
In summary, the SCM Agreement provides that serious prejudice must be the effect of the subsidy at issue, which must be financial in nature. Although the Agreement does not explain how the subsidy causes serious prejudice, it may be a reasonable assumption that the subsidy operates through its financial effects on the cost of production and price of the subsidized product. This reading is supported by the remedy of removal of adverse effects, which impliedly assumes that those effects are proportional to the amount of the subsidy and expressly assumes that they can be removed by government intervention.
Subsidies for R&D do have financial effects but these can be distinguished from any technology and learning effects that they may also have. Subsidies for R&D reduce the recipient's costs, like any subsidy. A narrow interpretation would capture these effects. The results of subsidized R&D can also reduce the cost of production processes and create a price advantage, where competition is based on price,Footnote 126 but that may be considered the effect of the subsidy recipient's technical expertise. However, the technological effects of R&D do not necessarily lower the cost of production and, even when they do, that may not constitute their competitive advantage. New or significantly improved products can have the same or a higher cost of production but still increase sales for reasons of performance or quality, to which competitors (not the subsidy recipient) will generally respond by lowering prices of the superseded, competitive product (not the subsidized product).Footnote 127 When competition in a market is essentially based on innovation, serious prejudice can be caused by the better product itself. A narrow interpretation would exclude these effects.
Accordingly, on a narrow interpretation, actionable subsidies claims would still lie against subsidies used for R&D unless and until a new green light category is agreed. However, the causation analysis of serious prejudice would be limited to the financial effects of those subsidies and not take into consideration technology or learning effects.
4. Remedies in Dynamic Markets
High technology markets may be too dynamic for the WTO actionable subsidies disciplines to provide a positive solution, even on a wide interpretation of the way in which serious prejudice may be caused. WTO remedies are prospective. This is an important limitation in any case but particularly when the effects of a subsidy are framed in temporal terms, such as Boeing's and Airbus’ respective abilities to bring models of aircraft to market as and when they did. The problem is compounded by the duration of the dispute settlement procedures before a remedy is granted. Long product development cycles in high technology industries may mean that R&D subsidies have expired before any compliance obligation arises.
WTO dispute settlement proceedings take considerable time. Despite the many timeframes stipulated in the Dispute Settlement Understanding (DSU) (not all of them maximum periods), it is reasonable to expect even a typical dispute to take at least three years from consultations to compliance, and longer where compliance is disputed.Footnote 128 Serious prejudice cases take longer than average because they involve detailed economic evidence. Technology effects, if argued, require technical evidence and an assessment of the impact of innovative products or processes on competition.
The elements of the competitive environment on which a panel bases its assessment of serious prejudice in a high technology market are likely to be outdated before that assessment is complete.Footnote 129 For example, the 2004 complaint in EC–Airbus was largely motivated by Boeing's concerns about the amount of launch aid committed for the A380 but, by 2007, the United States was arguing that Airbus’ decision to focus resources on that aircraft was an ‘other factor’ that caused Airbus’ own problems.Footnote 130 Although market shares and prices in commodity markets also change during a WTO dispute according to supply and demand, the product being traded remains constant.Footnote 131
If and when WTO remedies are granted, they are generally understood to be prospective only.Footnote 132 The DSB lacks retrospective remedies, such as an account of profits for the period when a competitor did not have access to an innovation, and interim remedies, such as preliminary injunctions to restrain use of a product while a case is being heard.Footnote 133 It also lacks the powers of a competition authority to impose fines or order divestiture.
The speed of technological change is likely to render obsolete any remedy to remove adverse effects when those adverse effects derive from a time-to-market advantage. Such an advantage arises when the technologies at issue could have come into existence without subsidized R&D and it is eroded when the results become available to rivals. For example, in US–Boeing, the effect of the subsidized R&D was described as the 787's developmental head start over the Airbus A350. It was never definitively established whether the head start referred to the launch date or first delivery date, or when the latter would have occurred without subsidies.Footnote 134 Thus, it is possible that the effects of the technologies on Airbus were removed without any steps having been taken by the respondent government before the original panel even finished its report in 2011.Footnote 135 As there is no clear conclusion that those effects had not worn off by the end of the implementation period in 2012, the technology effects causation analysis rendered the compliance proceeding pointless as regards the R&D subsidies at issue in the original proceeding.
The passage of time may render obsolete any remedy even when adverse effects derive from the very market presence of a product or a competitor. For example, in EC–Airbus, even if launch aid had enabled the creation and market presence of aircraft that would not otherwise exist, the Appellate Body decided that there is no obligation under Article 7.8 of the SCM Agreement to take any compliance measures where the subsidies at issue have expired, even if their adverse effects continue.Footnote 136 That decision, which unmoored the remedies from the ground of action, suggests that the Appellate Body baulked at the ramifications of a DSB recommendation to remove adverse effects in these circumstances.
Threat cases can be initiated earlier in time but WTO dispute settlement procedures are still slow and these claims also raise error–cost risks. It is very difficult for any tribunal, especially a WTO panel, to predict future market shares where the product itself is complex and the technology changes. Further, retrospective analytics such as net present value models can underrate innovation in the form of new products (as opposed to improved versions of existing products) because they make market projections based on past trends. If a panel were to find, wrongly, that R&D subsidies threatened adverse effects, it could delay the introduction of an innovation. The risk of missing out on welfare-enhancing innovation may outweigh the benefit of protecting the interests of a competitor. False positives are more costly than false negatives because, where there is no enforcement, there is at least the corrective of market forces.Footnote 137
Even if a panel finds that subsidies have caused serious prejudice through technology effects, this may merely postpone the day of reckoning to the remedy stage, when a compliance panel examines whether the respondent government needs to take any steps to remove adverse effects or withdraw the subsidy. Nonetheless, this does not shield subsidies used to fund R&D from challenge and any eventual ineffectiveness of SCM remedies would only become apparent at the end of costly litigation.
5. Looking Ahead
The importance of R&D subsidies is likely to increase. Technological innovation is needed to address societal challenges such as climate change, health, and food security.Footnote 138 R&D subsidies can correct market failureFootnote 139 and there is an increasing interest in a reinvigorated form of industrial policy.Footnote 140 Although actionable subsidies claims are not common, it is prudent to expect more.Footnote 141 There are several ways in which a technology or learning effects analysis could be avoided in future cases.
R&D subsidies are no longer exempt from actionable subsidies claims on any interpretation of the SCM Agreement, whether wide or narrow.Footnote 142 An incentive to argue technology effects arises in a market where subsidized technology itself creates a greater competitive advantage than the savings on R&D costs. That incentive can be diminished where a price effects analysis reflects the risk inherent in R&D funding by including, in the calculation of the financial contribution, subsidies for failed research efforts.Footnote 143 Knowledge spillovers may also diminish the product development head start gained from subsidized R&D.
The ineffectiveness of the remedies creates a disincentive to bring such claims in certain circumstances. Technology effects offer no effective remedy when R&D subsidies only give the beneficiary a time-to-market advantage that is shorter than WTO dispute settlement procedures. The DSU recommendation in US–Boeing provided no relief with respect to subsidies that Boeing received over the period 1989–2006 through US government R&D programs, even though they were worth at least $2.6 billion.Footnote 144 Further, EC–Airbus illustrates that the Appellate Body will refuse any remedy where the subsidies at issue have expired before the end of the implementation period, even where the adverse effects of those subsidies have not. A potential complainant may judge that action under these procedures would not be fruitful.
Where a complainant is not dissuaded from initiating a dispute, the facts of a future challenge to subsidies for R&D may be distinguishable from US–Boeing in one or more respects. The subsidies may not be specific. The innovative product may not be ‘like’ the competitor's product due to its additional functionality.Footnote 145 A subsidized innovation may not, in fact, confer a competitive advantage.Footnote 146 A product feature may be based on unsubsidized R&D.Footnote 147
In any event, a future panel may decide that the rules and remedies in Part III of the SCM Agreement assume that a subsidy would cause serious prejudice through its financial effects and not through developments in technology. The panel could distinguish the large civil aircraft cases on the basis that both principal parties argued technology and learning effects and neither contested the underlying legal rationale.
The technology effects causal mechanism could also be addressed in eventual negotiations to reform the SCM Agreement. Members might expressly agree that technology and learning effects are not envisaged as the effects of a subsidy for the purposes of Part III. This would reduce the degree of exposure to challenge of R&D subsidies, and other subsidies used for R&D. These subsidies would still be actionable on the basis of their financial effects, like any other subsidy, unless and until a new category of non-actionable subsidies is agreed.
6. Conclusion
A rationale has emerged in the WTO large civil aircraft cases making subsidies that fund technological innovation particularly vulnerable to challenge. In US–Boeing, the effects of most R&D subsidies were analysed not in financial terms but, rather, as R&D results that led to technologies used on the 787 Dreamliner. Meanwhile, in the EC–Airbus compliance proceeding, the effects of launch aid were analysed not only in financial terms but also as innovations developed on the A380 and later applied to the A350XWB. The legal basis for this development in WTO jurisprudence was not articulated.
There is a mismatch between the WTO actionable subsidy disciplines and innovation-based competition. A wide interpretation of the rules takes account of the fact that competition can be based on innovation but exacerbates the problem that the SCM Agreement does not provide for any balancing of the possible positive and negative effects of subsidies. Moreover, the large civil aircraft cases illustrate that serious prejudice stemming from a temporal advantage in product development can be eroded by the prospective nature of WTO remedies.
A narrower interpretation would find the rules and remedies in Part III of the SCM Agreement intended for an analysis of the financial effects of subsidies on production costs and prices. A panel in another dispute may reach a different conclusion from the large civil aircraft cases regarding the causal link between subsidies used for R&D and serious prejudice in a high technology market, either in its application to the facts or in the interpretation of the SCM Agreement. A potential complainant should in any case weigh up the likelihood of success on the merits against the prospects for effective relief.
