Financial Times, 18-Feb-2000
COMMENT & ANALYSIS: Bananas, beef - and now export subsidies: The US and European Union may be heading for a monumental trade dispute over the Foreign Sales Corporations
by Guy de Jonquieres
The US and the European Union have repeatedly clashed in recent years over trade in products such as bananas and beef. Now they face the threat of a new conflict that could make these disagreements look like casual skirmishes.
The source of contention is a 16-year-old US scheme that allows US-based exporters to avoid billions of dollars in taxes by channelling foreign income through offshore tax havens.
A World Trade Organisation disputes panel last year backed an EU complaint that the so-called Foreign Sales Corporations (FSC) scheme was an export subsidy that violated global trade rules.
The WTO's appellate body, the highest trade disputes tribunal, is reviewing that decision at the request of the US and is due to report by next Thursday. Washington says that if it loses the case and cannot settle the matter with the EU, there will be serious consequences.
"This would be the mother of all trade disputes if it ended up in a contentious position," says Stuart Eizenstat, US deputy Treasury secretary and a veteran troubleshooter in transatlantic trade conflicts.
The stakes are unusually high for several reasons. Until now, the US has managed to comply with WTO disputes rulings against it without changing core legislation. That may not be possible this time. The WTO panel has insisted the FSC law be amended or repealed by October 1.
Lawrence Summers, US Treasury secretary, has promised to support a WTO- compatible replacement if the FSC scheme is ruled illegal next week. But most observers think the October deadline - five weeks before the US elections - is impossible to meet. Some doubt whether Congress would ever agree to change FSC legislation. If Washington flouted the final WTO decision, Brussels could retaliate - just as the US slapped Dollars 308m (œ192m) of sanctions on the EU's exports last year for not complying with WTO rulings against its banana import regime and ban on hormone-treated beef. But the scale of EU retaliation over FSCs could be far bigger.
Just how big is unclear. The US Treasury says the FSC scheme costs Dollars 2.5bn annually in foregone tax revenues. But that is a back-of- the-envelope figure, which many observers think underestimates the benefits of FSCs to US exporters.
Some EU officials appear to relish the prospect of hitting the US hard, after being hounded by Washington over bananas and beef. Others fear that by backing the US into a corner they could set off a damaging spiral of transatlantic retaliation that would weaken the WTO. In any case, both sides have reasons to want to avoid a showdown.
Since Pascal Lamy became EU trade commissioner in September, he has set out to mend fences with the US and is working with Washington to try to rescue the global trade agenda from the wreckage of December's WTO meeting in Seattle. The EU's WTO challenge has also received little support from European companies, many of which benefit from FSCs through their US subsidiaries.
Meanwhile, Bill Clinton's administration has no interest in a bruising new trade battle while it is struggling to get Congress to back China's WTO entry. Losing the FSC case could also complicate a forthcoming vote in Congress, required by US law, on continuing the country's WTO membership.
So how have Brussels and Washington come close to a conflict neither side really wants? The US says it is mystified that the EU has chosen to challenge a 1984 law that, the US claims, was legitimised by an informal accord in the General Agreement on Tariffs and Trade, the predecessor to the WTO.
Washington also argues - and some independent tax experts agree - that the scheme does not seriously distort competition. They say it merely compensates US companies for the rebates on value added tax that EU-based exporters enjoy.
However, the EU's attack on FSCs appears to have much less to do with commercial advantage than with short-term tactical calculations by Sir Leon Brittan, Mr Lamy's combative predecessor. Fed up with US goading in the bananas and beef conflicts, Sir Leon was eager to to get even. The FSC scheme seemed a convenient target.
Starting the legal juggernaut rolling looks a lot easier than stopping it. As the final WTO ruling nears, US companies are anxiously reviewing their options. Many say that if the US loses the case, they want an amicable settlement with the EU - but only if it lets them keep their tax breaks.
Some have suggested a package deal covering US-EU trade disputes such as bananas, beef and civil aircraft subsidies, as well as FSCs, though trade experts say such an agreement would be hard to reach. If the EU refused to negotiate, some US business lobbyists say they would get tough by, for example, launching a salvo of trade complaints against the EU.
For the moment, US and EU trade policymakers are playing their cards close to their chest.
Both sides have said little publicly about the FSC dispute. They also insist they have not discussed the issue and do not expect it to feature prominently in talks Mr Lamy is holding in Washington this week.
The reason for this low-key approach is not clear. Perhaps Brussels and Washington have concluded that the angry megaphone diplomacy they engaged in over beef and bananas only makes solutions harder to achieve. Or perhaps it is because, as EU officials insist, there is little point in negotiating until the final WTO verdict is known.
The WTO appellate body has often used different legal reasoning from disputes panels and sometimes softened the impact of their decisions. However, the body has reversed the broad thrust of panels' findings in only one of the 25 cases it has reviewed to date.
Few people on either side of the Atlantic are betting that will happen this time, leaving observers puzzled by the outward calm in Brussels and Washington as next Thursday's deadline approaches.
"What worries me is that decision-makers seem to have done no contingency planning," says one business lobbyist with a keen interest in transatlantic trade policy. "There is a real risk that this could get out of control and a lot of people could get hurt."
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