International Trade Subsidy Rules and Tax and Financial Export Incentives: From Limitations on Fiscal Sovereignty to Development-Inducing Mechanisms

Contents

FOREWORD

PREFACE¹

I. INTRODUCTION

II. INTERNATIONAL TRADE

GENERAL CONSIDERATIONS

III. DEVELOPMENT

GENERAL CONSIDERATIONS

IV. INDEPENDENT VARIABLES

EXPLICIT PREMISES OF THE RESEARCH

V. Dependent Variable

Development as a result of the interactions between International Trade and Taxation

VI. Analysis of the US-Foreign Sales Corporations (US-FSC) Case

VII. Conclusion

VIII. References

ENDNOTES

FOREWORD

Luís Eduardo Schoueri¹

The concerns regarding development and the inequality of conditions between developed and developing countries have been a part of the international agenda when it comes to trade liberalization since the Tokyo Round under the former General Agreement on Trade and Tariffs (GATT). On that occasion, developing countries, inspired by the works performed in the ambit of the United Nations Conference on Trade and Development (UNCTAD) and of the Economic Commission for Latin America and the Caribbean (ECLAC), claimed that the international trade liberalization could not be carried out without a special treatment assigned them, i.e., the promotion of free trade could not override development concerns. At that time, an outcome of such perspective was the adoption of the so-called enabling clause, which enabled developing countries to enter into regional agreements.

The development issue has remained a crucial subject within the debates surrounding the position of the underdeveloped countries vis-à-vis the World Trade Organization (WTO) legal framework. This is the concern of Paulo Penteado de Faria e Silva Neto, as he, based in a notion of redistributive justice, equity and fairness, urges for a regulation of the international trade which reveals itself less detrimental to developing countries. A reform in the WTO legal structure, which is allegedly based in the Washington Consensus and its neoliberal rationale, in the sense of increasing the freedom of developing countries when dealing with their development policy would then be needed due to a primary sense of justice and fairness: every country would have the right to seek its development without barring the others’ progress. To this effect, one may understand the presumption adopted for the author’s research, according to which the promotion of international trade is only advantageous to developing countries under certain conditions, which usually deviate from the archetype drawn by the WTO and by those who advocate a liberal concept of free trade.

The author identifies a tension between the current WTO regulations and the development which the developing countries seek based on their legitimate right to development (which does not comprise a narrow view of development as a mere quantitative and material progress, but is rather concerned with equality and distributional issues) in a sense that most of the effective trade-related incentive policies, as tax incentives programs, would almost invariably be deemed as a prohibited export subsidy under the current international trade law provisions, namely the Agreement on Subsidies and Countervailing Measures (ASCM). As argued by the author, the general and broad definition of subsidy provided by the ASCM would not be satisfactory to the developing countries’ interests, as it does not comprise the necessary exceptions for such countries’ needs - fact that would forbid the developing countries from making use of the several tax and financial incentive instruments, so necessary in the context of economic development, which are at their disposal. Paulo Penteado, nevertheless, does not naively suggest the legalization of subsidies, but rather indicates the benefits that could derive from a more focused and targeted system of permissible incentives and proposes an exception to the concept of subsidy which would allow developing countries more policy space in using export incentives.

The author, questioning the current WTO regime, which he points as having adopted solely the prevailing interests of developed countries without taking into account the needs of developing nations, considers the subsidies as valid instruments to achieve development, which lie within the policy space of the developing countries. To this effect, the author considers, for instance, an expansion of the concept of domestic incentives, which are outside the WTO jurisdiction, when it comes to development-related policies.

Paulo Penteado, when looking for a normative base for a lawful concession of export incentives by developing countries, addresses the so-called tax sovereignty, by which a country is supposed to design and control its tax system, and its limits in face of the WTO rules. However, the author does not criticize the current trade regulations by means of the usual claim concerning tax sovereignty losses, but rather makes an interesting argument whereby a development sovereignty comprising a complex of rights would ensure an enlarged policy space for the use of export incentives, through tax and financial tools, by developing countries, which would be justified as long as necessary to shorten the inequality between developed and developing countries.

The author not only addresses the relevance of the concession of export subsidies as a policy for national development, but also analyzes the conditions for its successful implementation, as the transparency and monitoring of the use of the resources, the application of the resources in productive activities, the prioritization of strategic areas and the discussion regarding the distribution of the gains and losses generated. It is not clear, however, how to distinguish between allowed and forbidden subsidies. The WTO’s experience with red, green and yellow subsidies should be considered.

Paulo Penteado puts to the test the liberal view towards the trade liberalization whereby the subsidies would be per se harmful, as they would allegedly distort the allocation of resources and give rise to a negative effect in the decisions of the market and its agents - the author points out that the redistributive effect of the adoption of export tax incentives by developing countries may improve the overall global welfare. Thus, in order to review this position regarding the State intervention in the process of economic development and to point the failures of the neoliberal agenda, the author makes good use from elements of the thoughts of members of the New Development Economics, namely the ones of Joseph Stiglitz. As addressed by the author, some heresies condemned by the market liberalism ideology which inspired the current international trade rules may reveal themselves, in an astonishing clash, as indispensable means for reaching development.

Accordingly, the liberal view pledges a tax neutrality which does not immediately imply efficiency, since neutralizing taxation would only make sense if all other factors were also neutralized. In other words, considering the enormous differences between developed and developing countries, tax (and subsidies) could be an instrument to allow competition which would otherwise be unfair. If one considers, for instance, that workforce in developed countries is usually better prepared, then one would also expect greater productivity in such environment, vis-à-vis developing countries. Of course one could claim that the latter should make all efforts for improving their educational systems (which would require a higher taxation, rather than tax incentives); a realistic approach however, shows that local manufacturers will have higher costs to reach a productivity comparable to their foreign competitors. Once again, tax (and subsidies) may be a tool to be considered.

Finally, the author analyzes the WTO concept of subsidy and its categories in light of the US-Foreign Sales Corporations (US-FSC) decision, a concrete case settled under the dispute settlement mechanism of the WTO in which the European Union challenged the United States’ special tax regime for such kind of corporations as a forbidden export subsidy. Paulo Penteado finds in the systematic refusal of the United States in complying with the WTO ruling in the case another reason for the adoption of a development-related exception to the general concept of subsidy, since, curiously, the country which is the very advocate of the free trade ideal seems not ready to adopt the measures proposed by the dispute settlement body of the WTO when the case deals with its own national welfare. The author also points the Brazil-Aircraft case as an example of how the fairness of the international trade rules, namely the subsidy concept’s benefit element, could be questioned when it comes to development issues, since, in this situation, the incentive would not be aimed at conferring an advantage, but rather to the removal of existing disadvantages.

From his whole research, one may fully understand the author’s assertion whereby development concerns should be taken seriously by the international trade regime in such a way that the WTO should change its role in the tax ambit from an empty limitation on fiscal sovereignty of countries in the name of ‘free trade’ to an arrangement where developing countries should be able to achieve their development goals by means of benefits granted by their tax systems. As suggested by the author, to link the legitimacy of a tax subsidy to the development degree of a country would be a step forward towards a fair international trade. Taxation would reveal itself, once again, as a tool for development. It is difficult not to agree with the author’s arguments, but one should note that this should not imply recognizing legitimacy of all sorts of subsidies. The latter should be avoided and justification based on developing arguments should not imply a free-pass against WTO rules. Proportionality seems to be the correct approach to apply the author’s proposition towards the so-called built-in exception, i.e., one should consider, on a case-by-case approach, the benefits of the subsidy vis-à-vis the risk of protectionism. Existing WTO panels do not seem to be prepared to such consideration. This seems to be the most important contribution of Paulo Penteado’s study.

PREFACE

¹

Flávio Campestrin Bettarello²

It has become somewhat of a cliché to start a preface by saying that the reviewed book deals with a very important and timely matter. However, I must say that this is exactly the case of the book written by Paulo Penteado de Faria e Silva Neto on International Trade Subsidy Rules and Tax and Financial Export Incentives. The issue of trade and development and, more specifically, that of trade as a development-inducing factor, should be at the center of any current discussion conducted by Trade Law scholars or by real world trade negotiators. Notwithstanding, I will take advantage of my long-time friendship with the Author (who I first met in Law School and Business School more than ten years ago and, by chance or destiny, moved from São Paulo to Brasília and then to the U.S. at about the same time I did) and diverge from this path of thought a little bit. I will come back to it by the end of this preface. At this moment, I would like to point out two other different and very important merits of this book: first, its successful attempt to provide both theoretical and practical perspectives to the object of study; and second, its correct methodological approach under an interdisciplinary and post-positivist framework.

A Most Needed Interface Between Theory and Practice

Ancient Greek thinkers already used the substantive "theoria" (θεωρία) as a derivative of the verb theorein. There are two possible origins for this latter word: as the conjunction of thea (vision) and horan (to see), it would mean to look at something; or as the derivative of theion (divine) or theia (divine things) and orao (I see), it would mean to contemplate the divine.

In the first acception, the word theory would have the same radical of the word theater (theatrum, θέατρον, seeing place). In this context, Robert Nisbet asserts that both Science and Art are dedicated to the comprehension of reality through orderly representations.³ To Nisbet, comedy and tragedy come close to hypotheses and theories in the sense that they consecutively constitute an investigation of reality and a distillation of perceptions and experiences. In the second acception, that of the contemplation of the divine, a theory should be the exercise of looking at the harmony and order (logos, λόγος) that permeates the real world around us.

The substantive practice in its turn often gained the meaning of the application of a theory, in some sort of opposition to it. This common sense relationship between theory and practice fails to represent the thoroughness of the two concepts’ interaction. The wrong idea that theory and practice are opposites constitutes a misinterpretation of Aristotle’s triple categorization of disciplines. Aristotle identified three basic human activities: theoria (θεωρία), poiesis (ποιέω) and praxis (πράξη). To each of these three kinds of activities, a different type of knowledge would be related: theoretical (the pursuit of truth), productive (how to make and to fabricate) or practical (how to act among a plurality of actors). Practical knowledge would be further divided into ethics, economics and politics.⁴

This triple division does not mean that theory and practice must be dissociated. Theory and practice are, indeed, distinct but indissociable concepts. To Aristotle, the practice should be guided by a moral disposition (hexis, ἕξις) to act truly and rightly, taking into account the human being and the good life. This practical knowledge, also called prudence, moral thought or phronesis (φρόνησις), requires a comprehension about other individuals.⁵ In exercising the praxis, there is no previous knowledge of the right means to reach a determined outcome in a particular situation, because the outcomes are only specified on the deliberation about the adequate means to be applied to each situation.⁶ When one thinks about what one wants to obtain, the way by which it can be obtained is altered. When one thinks about the means to obtain something, the goal to be obtained also changes. There is a constant relationship between the means and the end, in the same way that there is a constant relationship between thought and action. This perennial movement involves interpretation, understanding and application in one unified process.⁷ This integrated process is exercised by individuals as human beings and is directed towards other human beings. The phronesis implies a movement between the particular and the general.

We may also say that there cannot be proper action without proper thought and that practice (political, economic or diplomatic) must be oriented by a unified process of interpretation, understanding and application. Besides that, this process must be guided by moral parameters and by robust theory in order to allow a more precise vision of the suitable means and goals. Praxis is not simply an action based in reflection. Praxis is a type of action with certain qualities: commitment to the well being of all humans; search for the truth; respect to the other. The exercise of the praxis requires that the individual "makes a wise and prudent practical judgment about how to act in this situation."⁸ In this sense, word and action, action and reflection, theory and practice are all facets of the same idea.⁹

Karl Marx asserted that theory and practice cannot be dissociated but, in doing so, Marx put praxis above the theory (that is why Labriola described Marxism as a philosophy of praxis¹⁰): All social life is essentially practical. All mysteries which lead theory to mystics, find their rational solution in human practice and in the comprehension of this practice (...). The philosophers have only interpreted the world, in various ways; the point is to change it.¹¹ Norberto Bobbio, however, indicates that theory should be put side-by-side with practice again. Bobbio asks: what does it mean to change the world?¹² And he answers: nothing, absolutely nothing until we may say with a maximum of clarity what are the objectives of this transformation and by each means we are able to reach it. Bobbio’s bottom line is that anything can be changed for better or for worse and by proper or improper means. That is why it is so critical to understand the world, a very hard task nowadays. According to Bobbio: till now, the politicians occupied themselves about changing the world, but now would be the moment to understand it.

By the time Bobbio resumes the idea of a phronesis-guided praxis, he gets closer to the epistemology of a critical theory that could be used to dictate a moral action. "As Horkheimer defined it in his programmatic writings as director of the Frankfurt School’s Institute for Social Research, a theory is critical if it fits three criteria: it must be descriptive (i.e., based on the best available empirical evidence concerning social conditions); it must be critical, in that its evaluations must be normatively justified; and it must also be practical, in that it can show how the transformation of the circumstances it criticizes is possible."¹³

Carr also states that a social science (in Carr’s specific case, the political science) must be based on the recognition of the interdependence of theory and practice, which could only be achievable through the combination of utopia and reality.¹⁴ The radical realist sees a theory as the codification of past and current practices. The utopianist considers that a theory is a norm to which the practice should inexorably adjust. In this context, both the realist and the utopianist views distort the relationship between theory and practice. Balance, here, is key.

This balance is exactly what Paulo Penteado de Faria e Silva Neto achieves when he envisages both practical and theoretical outcomes to his research, harmonizing what is desirable with what is doable. The Author’s insights conform a critical theory: they are based on empirical evidence (current WTO subsidy rules and the developing needs of developing countries); they are normatively justified (by recognition of the right to development as a universal human right and of the concept of development sovereignty); and they propose some possible (even if hard to achieve) transformations (the incorporation by WTO’s core regulatory framework of the valid claim of a right to development and fair/just trade).

Getting the Right Approach to the Complex Problems of Contemporary Law Studies

So, we already identified that the Author is successful in getting the proper balance between theory and practice. That is what he did. Nevertheless, a question as important as what he did is "how he did it." Many times, the discussion about method is completely forgotten. Not in this book: Paulo Penteado de Faria e Silva Neto explicitly annunciates that he will apply several methodological tools in order to reach an interdisciplinary approach to his object of study. In my view, this is the correct approach to be used to address the complex problems of contemporary law studies. But this is not the only relevant methodological aspect that we shall take into account. One should also address another important feature of contemporary law studies: very often, social sciences’ researches have both a descriptive and a normative dimension. Initially, the researchers look for elements and insights pertaining to the ontological realm of objects and facts. However, they seldom stop there: most contemporary scholars seek to propose (in an explicit or tacit way) a possible course of action suitable to a determined social reality. Under this framework, traditional positivist views get outdated.

Traditional positivism claims that scientific knowledge is unitary and that reality is independent from any human action. As a consequence, social phenomena would have a single causal explanation and all the