WTO Rules on State-Owned Enterprises and Implications for Chinese SOE Reforms

Xuejun XIE

Perspectives, Vol. 3, No. 6


(Editor's Note: Due to space limitation, all footnotes have been omitted. References can be obtained from the author at xuejunx@yahoo-inc.com.)

In this article, I analyze the World Trade Organization ("WTO") rules concerning state trading, the Subsidy and Countervailing Agreements, several dispute settlement cases, and their implications for the operation of state-owned enterprises ("SOEs") in WTO member countries ("Members"). I will also discuss how the WTO rules may affect Chinese SOEs and efforts to reform them.

Before I go into the details of the WTO rules, two general observations may be made. First, historically speaking, the WTO was designed to be ownership-neutral and some authors suggest that it should maintain such neutrality. Second, the WTO is an intergovernmental body. Only member states and their governments have rights and obligations under various WTO agreements. There are very few WTO rules under which business enterprises might arguably have rights and obligations. Thus, it is usually understood that the WTO has no special rule for SOEs.

It would be too hasty, however, to conclude that the WTO is totally unconcerned with the creation and operation of SOEs. During the negotiations leading to China's admission as a Member of the WTO, the role of China's SOEs and their impact on free and fair trade were repeatedly questioned by the Members. The Members' concerns are reflected in the special rules for China's SOEs in the Working Party's Report for China's WTO accession. It is true that prior to the Chinese negotiations, ownership was a relatively minor issue at the WTO and did not draw much attention. However, an issue that is minor for the WTO as a whole could become critical for a very large member state like China, where SOEs dominate many of the most important industrial and trade sectors.

In Part I of this article, I will review WTO rules that are potentially relevant for SOEs. I will then evaluate such WTO rules in Part II. Finally, in Part III, I will try to draw some lessons for China's SOEs.

I. Is There a WTO Rule Governing SOEs?
A. The STE Rules
a. Article XVII of GATT--State Trading Enterprises
i. The Obligations for State Trading Enterprises

The original signatories to the General Agreement on Tariffs and Trade ("GATT") were aware of the danger that some Member governments might create certain public or state-owned enterprises to circumvent the governments' obligations under GATT. At the same time, those signatories were reluctant to impose greater restrictions on public enterprises than on private ones. As a result, Article XVII of GATT was enacted to regulate state trading, but the definition of "state trading enterprise" ("STE") was left ambiguous to allow a good deal of leeway.

Under Article XVII, STEs are required to abide by general principles of non-discriminatory treatment. More specifically, an STE shall make its purchases and sales "solely in accordance with commercial considerations" and shall "afford the enterprises of the other contracting parties adequate opportunity, in accordance with customary business practice, to compete for participation in such purchases or sales." This is often considered to be the substantive obligation contained in Article XVII. In addition, the Contracting Parties were required to notify GATT of their state trading practices; this is normally referred to as the transparency obligation.
The gist of the Article XVII is the principles of "non-discriminatory treatment obligation," "solely based on commercial consideration" and "adequate opportunity to compete." Clouds of disagreement surrounded the exact meanings of these concepts.

First, it is unclear from the WTO agreements whether the non-discrimination obligation in Article XVII is applicable to the national treatment principle in GATT Article III or only the most favored nation principle in GATT Article I. The ambiguity has been discussed both on a theoretical and a practical level,, but was somewhat cleared in the Korea - Measures Affecting the Import of Fresh, Chilled and Frozen Beef ("Korea - Beef") case. In the case, the Panel very clearly held that "this general principle of non-discrimination includes at least the provisions of Articles I and III of GATT". Furthermore, the Panel clarified the relationship between the "non-discrimination principle" of Article XVII: 1(a) and the "commercial consideration" obligation in 1(b). The Panel stated that:

"The lists of variables that can be used to assess whether a state trading action is based on commercial consideration (price, availability etc…) are to be used to facilitate the assessment whether the state trading enterprise has acted in respect of the general principles of non-discrimination. A conclusion that the principle of non-discrimination was violated would suffice to prove a violation of Article XVII; similarly, a conclusion that a decision to purchase or buy was not based on 'commercial considerations,' would also suffice to show a violation of Article XII."

Under this approach, price, quality, availability, marketability and other elements are used to gauge the commerciality of a disputed STE business transaction, and furthermore, to decide whether the non-discrimination obligation has been violated. This decision can simplify the application of Article XVII. In a challenge to an STE business transaction, the complainant's evidence usually includes the market conditions and circumstances when and where the transaction happened, which can be determined by regular market surveys and a comparison with similar non-STE transactions. An STE transaction that is not commercially justified under normal market conditions is equated with discrimination and is thus a violation of the Article XVII obligation.

ii. Vagueness of the Definition

As a rule that has, during the existence of GATT, been rarely invoked by Members or applied by the Dispute Settlement Body ("DSB"), the definition of STEs and the relevance of that definition for SOEs have not always been clear. The 1994 Understanding on the Interpretation of Article XVII of the General Agreement on Tariffs and Trade (the "Understanding") gave a working definition (the "Working Definition") for an STE as follows:

"Governmental and non-governmental enterprises, including marketing boards, which have been granted exclusive or special rights or privileges, including statutory or constitutional powers, in the exercise of which they influence through their purchases or sales the level or direction of imports or exports."

This definition has three elements:

(i) the enterprise is a governmental or non-governmental entity, which includes marketing boards;
(ii) the granting to the enterprise of exclusive or special rights or privileges; and
(iii) a resulting influence, through the enterprise's purchase or sales, on the level or direction of imports or exports.

The Working Definition seems to indicate that Article XVII is concerned only with special or exclusive rights and privileges over a market rather than state ownership itself. In other words, if operating in fully competitive market, SOEs are not subject to the discipline of substantive and transparent obligations of Article XVII.

There are several reasons why this observation is not free from doubt. First, the Understanding explicitly provides that the Working Definition is "without prejudice to the substantive disciplines prescribed in Article XVII," by which it means that the definition is only applicable to the transparency section, not the whole clause. Second, the original text of Article XVII, Section 1(a) includes two disjunctive elements:

(i) "a State enterprise, wherever located;" or
(ii) "grants to any enterprise, formally or in effect, exclusive or special privileges…"

The scope of the Working Definition corresponds only to the second element of Article XVII: 1(a) - "any enterprise" with exclusive or special privileges. Interpreting this provision to replace the provisions of Article XVII: 1(a), would be tantamount to nullifying the first element of Article XVII: 1(a) - a "State enterprise, wherever located" - or render it redundant, an approach inconsistent with generally accepted rules for interpretation of WTO rules.

The drafters of Article XVII said "the term 'State enterprise' in the text did not require any special definition; it was the general understanding that the term includes, inter alia, any agency of government that engages in purchasing or selling." The 1960 Report states "[T] he Panel did not use the word 'enterprise' to mean any instrumentality of government. There would be nothing gained in extending the scope of the notification provisions of Article XVII to cover governmental measures that are covered by other articles of the General Agreement. The term was used to refer to an instrumentality of government which has the power to buy or sell …" Thus, government administrative organs should not be considered to be STEs, since their activities are regulated by other articles of the General Agreement. The history of the negotiations excludes governmental administrative organs from the scope of the definition of STEs, but gives no indication as to whether a government-owned enterprise should be considered to be a government agency engaging in purchasing and selling.

When discussing the Ad Note to Articles XI, XII, XIII, XIV and XIII, the Panel in the Korea - Beef case used the phrase "when an import restriction is imposed by a state trading enterprise, with or without exclusive rights…" (emphasis added). This statement suggests that an STE may be found "with or without exclusive rights" under Article XI. This observation may be applied to Article XVII to support the conclusion that exclusive rights are not necessarily a prerequisite to finding an STE. It takes a step back from the narrowing interpretation of STE in the Understanding, and leaves more uncertainty for the applicability of Article XVII.

Given the lack of clarity, neither denying nor admitting the applicability of Article XVII to SOEs is sufficiently justified. Short of further official clarification by the Members or an interpretation by the Dispute Settlement Body, it would seem that SOEs can benefit from the vagueness and claim that they are not bound by Article XVII.

b. No Benefit from Vagueness for Chinese SOEs

When the Article XVII was translated into Chinese, the Chinese Ministry of Foreign Trade and Economic Cooperation inadvertently or advertently interpreted the "state trading enterprise" as "Guo Ying Mao Yi Qi Ye," or "state-run trading enterprises." This subtle discrepancy might somewhat comfort the SOEs since over twenty years of economic reform they are now owned, but not operated, by the State. It might create the illusion that Article XVII is irrelevant to an SOE without special or exclusive trading rights. As we have seen, to understand the state trading enterprise as a state-run trading enterprise is not well justified in light of the WTO and GATT literature. Furthermore, it would be misleading to believe that SOEs have no special WTO obligations.

As discussed earlier, there is no conclusive answer regarding whether and how the state trading rules apply to SOEs in the existing WTO literature. China's SOEs will not be able to benefit from this vagueness. During the negotiations for Chinese membership, some Members raised concerns about "[t]he continuing governmental influence and guidance of the decisions and activities of such [state-owned and state-invested enterprises] relating to the purchase and sale of goods and services," and they required that "such purchases and sales should be based solely on commercial considerations without any governmental influence or application of discriminatory measures." In response to the request of the Members, China's representative confirmed that:

"[a]ll state-owned and state-invested enterprises would make purchases and sales based solely on commercial considerations, e.g., price, quality, marketability and availability, and that the enterprises of other WTO Members would have an adequate opportunity to compete for sales to and purchases from these enterprises on non-discriminatory terms and conditions."

The "commercial considerations" obligations imposed upon SOEs are comprised of the commercial factors of price, quality, etc., "non-discriminatory terms and conditions" and "adequate opportunity to compete." This commitment was included in the Working Party Report for China's accession to the WTO (hereinafter the "Working Party Report"), which is not legally binding in and by itself. Nonetheless, China reaffirmed such commitments as binding obligations through Article 1.2 of the Accession Protocol by including them as an integral part of the WTO agreements.

These obligations have exactly the same keywords as that are prescribed in Article XVII, paragraphs 1(a) and (b). Essentially this commitment uses the same approach used in Article XVII to regulate China's SOEs. The vagueness of the definition of STEs thus becomes a side issue. It may be too hasty to equate Article XVII to China's SOE commitments in the Working Party's Report, but in interpreting this SOE commitment, the existing Understanding and application of Article XVII are valuable reference points.

c. A Harsher Obligation for China's SOEs

Under the analysis used in the Korea - Beef case, the "non-discrimination" provisions of the Working Party's Report will be applicable to both most-favored nation treatment and national treatment obligations. Also the Working Party's Report substantially enlarges the scope and content of STE obligations. A close reading of Paragraph 1 of Article XVII demonstrates that the non-discrimination obligation for STEs is limited to "purchases or sales involving either imports or exports", and that this obligation applies only to the trade of goods under the GATT framework, while the non-discrimination obligation for China's SOEs and state-invested enterprises ("SIEs") is plainly applied to the "purchase and sale of goods and services." It extends the obligations to purchases and sales that do not involve exports or imports, as well as to goods and services. The expansion of the scope of the non-discrimination obligation committed to in the Working Party Report is great and its impact has yet to be seen.

Moreover, the special rules governing SOEs and SIEs are not sector-specific. They have the potential to stir up large conflicts in those areas with regard to which China has not made WTO commitments. For example, China did not sign the Civil Aircraft Agreements, but that will make little difference to Chinese aircraft procurement practices, since all the airlines are either state-owned or state-controlled and are therefore subject to the non-discrimination obligations. Also the service areas where China has opted out for application under the General Agreement on Trade in Services will not be exempt from the non-discrimination obligation if the service providers or procurers are SOEs. To be sure, there has not as yet been any indication that China's SOE commitments will be interpreted and applied in such a way by the Member States; and China certainly would not agree with such an interpretation. However, the door to further argument was not definitively closed by the accession negotiations. Much more work will need to be done in the post-accession era.

B. Subsidies

SOEs may receive different kinds of subsidies just like those given to other kind of enterprises. Usually their ownership by the government may make it easier to get government benefits and government subsidies, but this does not represent a substantial difference from enterprises that are not affiliated with the government. In this sense, SOEs are treated equally under general WTO subsidy rules. However, government provision of equity capital can result in an enterprise owned or partly owned by government becoming an SOE. Equity infusion, as one form of subsidy, is thus inherently related to SOEs and directly relevant to the subject of this essay.

a. The Three Elements of Subsidy in the Form of Equity Infusion
The following three conditions must be satisfied to confirm that there is a "subsidy:"

(i) there is a financial contribution by a government or public body, that, among other things, includes the direct transfer of funds in the form of an equity infusion;
(ii) a benefit is thereby conferred; and
(iii) the subsidy must be specific, or is presumed to be specific (the prohibited subsidy is presumed to be specific).

Financial Contribution

The first element of financial contribution or direct transfer of funds by government is relatively straightforward since the definition explicitly includes equity infusion as one form of transfer of funds.

Benefit

The Appellate Body has given its guidance on how to identify the existence of a "benefit:"

"[t]he word 'benefit', as used in Article 1.1(b), implies some kind of comparison. This must be so, for there can be no 'benefit' to the recipient unless the 'financial contribution' makes the recipient 'better off' than it would otherwise have been, absent the contribution. In our view, the market place provides an 'appropriate basis for comparison in determining whether a 'benefit' has been 'conferred', because the trade-distorting potential of a 'financial contribution' can be identified by determining whether the recipient has received a 'financial contribution' on terms more favorable than those available to the recipient in the market."

This interpretation of "benefit" is congruent with Article 14 (a) of Agreement on Subsidies and Countervailing Measures ("SCM"), according to which a government equity infusion does not confer a benefit on the recipient unless the government investment decision is "inconsistent with the usual investment practice (including for the provision of risk capital) of private investors in the territory of that Member."

A Discussion Paper prepared during the drafting of the Subsidy and Countervailing Agreements (the "SCM Agreements") sheds some light on how this comparison should be conducted.

Government provision of equity is not a subsidy if the shares are purchased at prevailing market prices. If there is no comparable market price, the Discussion Paper required that the government "[s]how that a reasonable evaluation had concluded that the investment would yield an adequate return, or that the investment was consistent with the reasonable practice of private investors."

More recently, the Informal Group of Experts to the Committee on Subsidies and Countervailing Measures reached the same conclusion with respect to how the comparison should be conducted in a scenario where the recipient company's stock is publicly traded. If the government pays more than the market price of the public trading stock to obtain its shares, the overpayment is a cost to the government and should be treated as a subsidy. In cases where the stock in question is not publicly traded, the expert group did not endorse the Discussion Paper's comparison approach. It only suggested that other general factors, like the allocation period, government cost of funds, the time value of money, adjustments for inflation and interest etc., should be taken into account.

Perhaps the most comprehensive effort to elaborate the calculation of benefits was presented in the United States' regulations implementing the SCM Agreements. According to the final countervailing duties regulations promulgated by the United States Department of Commerce ("USDOC"), when a comparable market price is available, the government investment shall be compared to the market price to decide its legality under the subsidy rules. When there is no comparable private investor price, the government-provided equity is categorized as equity-worthy or unequity-worthy at the time of the equity infusion. It is equity-worthy if "the firm shows an ability to generate a reasonable rate of return within a reasonable period of time." If the government-provided investment is equity-worthy, the relevant United States authority will go further to check whether the terms and conditions of the government purchase of equity is consistent with the usual practice of private investors on a case-by-case basis. If the government-provided investment is decided to be unequity-worthy, the relevant United States authority will calculate the benefit as the amount of the equity infusion. The United States approach is different from that proposed by the Informal Group of Experts. It simply disregards any value the investment may have, and equates the entire investment as a grant that does not result in a return. Considering that the United States is the single largest user of countervailing measures, this difference between the United States approach and the widely accepted approach may become significant in future dispute settlement proceedings.

Specificity

With regard to the specificity test, the SCM Agreements do not say whether the SOEs, as a group characterized by their common ultimate ownership, can be categorized as "certain enterprises." There is a special rule in the Protocol on the Accession of the People's Republic of China (the "Protocol"). It provides that:

"For purposes of applying Article 1.2 and 2 of the SCM Agreement, subsidies provided to state-owned enterprises will be viewed as specific if, inter alia, state-owned enterprises are the predominant recipients of such subsidies or state-owned enterprises receive disproportionately large amount of such subsidies."

By this definition, the subsidies provided to SOEs are predetermined to be specific and can be subject to further examination under the SCM Agreements. Apparently the subsidy rule will restrain many tools the Chinese government currently uses to foster and support the SOEs. For example, the debt-equity conversion scheme to relieve SOEs from burdensome bank loans is very susceptible to the challenge of forgiveness of due debt or equity infusion subsidies.

b. Consequences of Being Subsidized

A subsidy can be prohibited, actionable or non-actionable under the SCM Agreements. When a subsidy is going to be prohibited by the panel, the panel or the Appellate Body may recommend that the Member at issue withdraw the subsidy without delay. If an actionable subsidy is found to have had adverse effects on another Member, the subsidizing Member shall take appropriate steps to remove the adverse effects or shall withdraw the subsidy. The implications of this rule for SOE commercial transactions will be profound. It injects international trade law, a public law, into the private domain. For example, in the Australia - Subsidies to Automotive Leather case, the Panel required the Australian government to withdraw its subsidies in the grant contract within 90 days. The enforcement of such a decision is to require a material modification of the contract. According to conventional legal wisdom, the effectiveness and modification of private contracts are governed by private law alone, not by international law. When the party granting a subsidy is an enterprise other than government, e.g. a state-owned bank, the conflicts of public law and private law will be more salient than they were in the Australia case.

C. Case Law

Since the inception of WTO, the WTO dispute settlement system has been transformed by a change from its traditional diplomatic approach to a more legalistic approach. The precedents (especially those set by the Appellate Body) are, though not expressly binding, often deferred to in subsequent decisions. Case law is becoming more and more valuable to Members as a guide to interpreting and applying the enacted rules.

The issue of ownership has sporadically been raised in connection with other GATT/WTO issues and entered into the forum of dispute settlements. The methodology of the panels and the Appellate Body considering how ownership may affect international trade and how it shall be treated sheds light on our further exploration of the law of ownership under the new international trade regime.

a. Can an SOE Action Be Treated as a Government Policy?

In the case of Japan - Trade in Semi-conductor, the Panel interpreted the government measures flexibly. It stated "administrative guidance" is not a prerequisite to finding a governmental measure. If there are sufficient incentives or disincentives to complying with the non-mandatory measure and its effectiveness is essentially dependent on government action or intervention, there's no difference between mandatory and non-mandatory compliance for purpose of Article XI, paragraph 1.

This rationale was applied by the Panel of Canada-Periodicals to hold that the Canada Post rate policy was a governmental regulation and subject to the obligations in Article III, paragraph 4. Canada Post is a Crown corporation created and wholly owned by the government. It was alleged to have violated the national treatment obligation by charging domestic periodicals lower rates than imported periodicals. The complainant, the United States, claimed that the pricing practices of Canada Post were government regulations. The Canadian government argued that Canada Post "[o]perate[s] in a competitive environment; earn[s] a return on equity; [does] not depend on government appropriation; and finally, provide[s] a reasonable expectation that it would pay dividends." In the view of Canada government, its control over Canada Post was not more than the influence a shareholder might have exerted. The Panel ruled in favor of the complainant and decided that the challenged pricing practice was a government measure. The first reason cited by the Panel was that Canada Post had non-commercial business dependent on rates set by the Canadian government, so it has incentives to maintain its pro-domestic price policy on periodicals. The second reason cited was that because the Canadian government mandated the commercial nature of the delivery of publications and also had directive power to instruct Canada Post to change postal rates, it had control over the Post's pricing policy decisions.

The objective of China's SOE reform is to establish so-called modern enterprise systems similar to the management model of Canada Post- entities owned by the government but for all practical purposes independently operated in the marketplace. In this case, the Panel did not doubt the commercial nature of Canada Post and its independent operation. However, it viewed the challenged pricing practice as a government regulation based on the potential control right the government possessed due to its dual capacity as shareholder and government. The effect of this test may be magnified in the far more complicated and intractable government-enterprise and Party-enterprise relationships existing in China, and therefore makes the business decisions of Chinese SOEs very vulnerable to WTO challenge.

b. Privatization and Subsidy

In the case of United States - Imposition of Countervailing Duties on Certain Hot-Rolled Lead and Bismuth Carbon Steel products Originating in the United Kingdom ("US - UK Steel"), the Panel dealt with the trade impact of ownership transactions and the privatization of state ownership. For government subsidy to capital expenditures, the USDOC allocates the subsidy benefit over the average useful lifetime of the recipient's assets (the "allocable subsidy"). In its countervailing duties practice, the United States uses an irrefutable presumption that the allocable subsidy continues with the asset even after a change of ownership. Privatization does not trigger a re-assessment of the existence of a subsidy previously determined to exist. The Panel decided this case against US practice. In May 2000, the Appellate Body upheld the Panel's finding that the presumption that a "benefit" continues to flow from an untied, non-recurring "financial contribution" can never be irrefutable. However, today the United States still fails to observe the Panel's and the Appellate Body's ruling and persists in its original practice. The USDOC's continued use of the irrefutable presumption methodology has prompted a set of dispute settlement proceedings initiated by the European Union and Brazil. The DSB's ruling is currently under review.

The implication of this case is that in the reform of Chinese SOEs, a viable equity share transaction system for SOE must be established. No matter in what form the transactions may occur, they will need to be in compliance with the WTO rule. A subsidy may be found in privatization, or other types of equity deal.

c. Commonality of Ownership

In another case, the US - Anti-dumping Measures On certain Hot-rolled Steel Products From Japan, the arbitrators dealt with the topic of transactions between related enterprises. The Appellate Body's observation in this case is noteworthy because it demonstrates how the WTO Dispute Settlement Body analyzes the trade impact of common ownership.

In this case, the arbitrators were invited to consider whether a transaction between parties under common ownership is in the ordinary course of trade. If it is not, the transaction price between the affiliates will be excluded from the calculation of "normal price" as provided by Article 2.1 of the anti-dumping agreement. The Appellate Body stated that, if the transaction parties have common ownership, despite their distinct legal personalities, the transaction has actually occurred within a single economic enterprise. The Appellate Body stated that: "[t]he lower the degree of common ownership, implying common control, between the parties to a sales transaction, the less likely it is that the transaction will not be 'in the ordinary course of trade.'" This observation is not a strange one. For example, in tax law, the terms of prices of transactions between related enterprises will be adjusted to reflect the actual costs or fair market value of the transactions in an effort to prevent tax evasion.

In China, state-owned or partly state-owned enterprises are very common. As SOEs, they have common ownership but dispersed control. They are literally part of a single economic entity - the government - but the different centers of control are often in conflict. To view the large number of SOEs all as related enterprises would be practically impossible in China. A revisiting of the "commonality of ownership" rule is needed to deal with state ownership in China.

D. An Over-Arching Theme?

The SOE-related WTO rules discussed above address possible distortion of the economy by direct government participation in the economy at different levels of participation. Despite the fact that there is apparently no coordinated WTO action with respect to STEs, subsidies and similar issues, an over arching theme underlying WTO SOE rule-making and interpretation may be discerned: A hypothetical private market participant is generally used as the benchmark against which the behavior of SOEs is measured. For market activities and norms to function as well as the WTO intends for them to, this ideal market participant has several important features. It must:

(i) be a profit or wealth maximizer;
(ii) use only commercial factors in making decisions about sales and purchase, and is not motivated by other non-commercial considerations. If competing products are identical or similar, it will not according to government involvement;
(iii) be a savvy and well-informed trader, never buying at higher price or selling at lower price than the market. It is so savvy that it has never been taken advantage of by its counter parties;
(iv) not be specially advantaged compared to others, e.g. it may not get financing on better than prevailing market terms and conditions.

This leitmotif permeates the entirety of WTO rules relating to state ownership and we can reasonably expect that in the future, rule making or interpretation will return to this standard again and again.

II. Good Law or Bad Law?
A. The STE Rules
a. STEs and Commercial Considerations

The WTO current rules for STE are not irreproachable. The "solely based on commercial consideration" principle is particularly precarious. The WTO Background Report indicates that the most important reasons for the Members to maintain STEs are not commercial ones, but rather social or economic concerns. According to the Background Report, the most-often-seen mandates for STEs are:

a. income support for domestic producers;
b. price stabilization;
c. expansion of domestic output;
d. continuity in domestic output;
e. increase in government revenue, or decrease in government spending;
f. rationalization and control of foreign trade operations, including achievement of economies of scale in trading operations, and improvement of the terms of trade;
g. protection of public health and strategic control;
h. management of important domestic resources; and
i. fulfillment of international commitments on quantity and/or price.

Apparently none of the foregoing factors except (e) may be related to profit making. It is not clear from the text of the Background Report and its context how an STE can consider only commercial factors in making purchases and sales even though its main mandates are not commercial. The WTO appears to be inconsistent in allowing the existence of state trading systems, while requiring STEs to be solely commercially oriented.

b. The Commerciality of An Enterprise

The underlying rationale for the GATT Article XVII is that the government-sponsored enterprises must act like private enterprises in the market. However, commercial considerations are not the only factors influencing private enterprises. Many private enterprises' restrictive business practices are meant to defeat the trade liberalization objectives of GATT. Professor Jackson has mentioned that, even in U.S. where competition law is most seriously enforced, "buy domestic" is not an unusual practice for American companies. Actually the for- and only-for-profit conception of corporate purpose, established in the famous Dodge v. Ford Motor Co. case at the beginning of last century, has been, if not abandoned, substantially modified over the last century. Companies are allowed and even encouraged to have some social responsibilities in addition to maximizing wealth for their shareholders.

Moreover, it may be questioned how commercial is "commercial" under this principle. A particular transaction may be commercially better than another but may not necessarily be better if measured against the long-term or firm-wide goals of the enterprise. Managers should have the freedom to consider transactions in light of the enterprise's operation as an ongoing concern rather than treating each deal as completely unrelated to any other. If the non-discrimination obligation is applied so as to require that STEs must not be taken advantage of in any transaction they enter into, it would tend to treat STEs as different from customary market operators, who of course make mistakes.

c. Corporate Law Approach

Actually, under general corporate law, short of self-dealing or fraud, courts will normally look into the substance of the directors' decision only when the negligence of the decision-makers is egregious. Otherwise, the management or directors' decisions are generally deferred to as business judgment. Needless to say, international trade law is different from corporate law, but the question may be asked as to why a court judge cannot decide whether a business decision is in the best interest of the company, but a trade arbitrator may decide the commerciality of an STE or SOE business decision?

d. The International Law Angle - When Does State Responsibility Arise?

Under customary international law, state responsibility arises when a wrongful act is committed by a governmental organ, no matter whether a legislative, executive, judicial or other organ. A state is also responsible for the acts of persons who are not state organs but have the power to exercise elements of governmental authority. In addition to situations involving the exercise of governmental authority, a state will be held liable for the conduct of a person if that person is "in fact acting on the instructions of, or under the direction or control of, that State in carrying out the conduct". SOEs generally do not carry out any governmental function that can be attributed to the delegation of authority by the State, and most corporate law regimes generally require a State shareholder to let the company make decision independently rather than commingling the shareholder's will with the company's. Therefore, to impute an SOE's misconduct in business activities to its state shareholder is, in the absence of government instruction, direction or control, not just unreasonable as a matter of fact, but also apparently unjustified in general international law practice.

B. Subsidy Rule-Compared with European Community State Aid Rules

The rigidity of the WTO subsidy rule can be seen if compared to the European Union's rule concerning state aid. Under EU treaties, a state government is free to invest in commercial enterprises or to provide other sorts of support, but it must not distort competition. The so-called market economy investor principle requires the state government to behave like a private investor if it wants to inject money into a company. Under this rule, there is no state aid if the government investment is under "terms which a private investor would find acceptable in providing funds to a comparable private undertaking when the private investor is operating under normal market economy conditions."

As shown by the case of Credit Lyonnais and Westdeutsche Landesbank, this rule is better at taking into account the particular circumstances under which the state makes its investment decision, especially when the recipient of government money is an enterprise making a loss or one threatened by insolvency. For example, the Commission will "take into account certain strategies of a holding or group interest of an investor and to distinguish between short and long term interest of an investor." Moreover, EU treaties provide for a wide range of exceptions to the state aid rule. The EU rule concerning state aid is more flexible and better defined, thus enabling-member states to support domestic and intra-EU economic and social objectives. In the much more heterogeneous and less integrated universe of the WTO, there is no good reason to have a more rigorous and restrictive rule for Members' direct participation in economy.

III. Implications for Chinese SOE Reforms

Despite the disputable general applicability of WTO rules to STEs and SOEs, these rules have been accepted by China as part of its accession to the WTO. I cannot second-guess how and why China agreed to SOE terms that are critical to its state economy. However, it is clear that some sort of trade-off was made during the marathon negotiations. Furthermore, the "solely commercial consideration" principle seems compatible with the Chinese government's goals in reforming SOEs, namely to remold SOEs as profit-oriented enterprises. The consequences arising from the difference between commercial enterprises driven by the market and SOEs driven by the law was not fully appreciated by the negotiators. It must also be noted that the commitments made in the Protocol and the Working Party Report are specific to China only; this will make it very difficult to curtail any deleterious effects through future multilateral negotiations.

A. Sole Commercial Consideration and the Strategic Transition of Chinese SOEs

Considering the large scale of the state-owned economy in China and the government's strategy of adhering to public ownership in the future, the WTO's current rules for SOEs and their future development may have a profound impact on Chinese economic reforms. The most recent focus for SOE reform has been to concentrate state-owned resources on strategically important industries while retreating from other market sectors. The strategically important industries include those in which private investors are not active enough or for which the market is otherwise incapable of meeting capital needs. The main strategically important industries are those associated with national security, natural monopolies, suppliers of crucial products and services, and the high and new technology industries. The strategic importance of these industries implies that commerce cannot be their only consideration. How the SOEs will accommodate both the solely commercial consideration principle as well as other general social and economic causes associated with their strategic significance will be a vital challenge for the strategic transition of the SOEs and Chinese compliance with WTO rules.

B. Government as Shareholder-the Dilemma of Its Dual Role

As shown by the case of Canada - Periodicals, the government's dual role as shareholder and regulator puts the SOE in an awkward position, easily open to trade law claims. Under the holding of this case, an enterprise pricing policy can be deemed to be a governmental measure subject to WTO discipline. This case should set off alarm bells for deeply entangled government, Party and enterprises in China. In many circumstances, the line between government as shareholder and government as regulator has been blurred.

A theme of the twenty-odd years of SOE reform in China has been to separate the enterprises from government, even while the government remains the ultimate decision-maker with regard to important business decisions and the appointment and removal of the management of SOEs.. The separation of government and SOEs has always been the main objective of Chinese SOE reforms and has proved to be a difficult task. When the government closely controls the management of SOEs, business is suffocated by bureaucracy, but if the government relaxes its hands, the SOE suffers from all the problems associated with insider control. The current situation is complicated. Chinese accession to the WTO will open the door for others to allege that many SOE business decisions are government measures subject to WTO rules. The relationship between government and business in China will be regulated in accordance with a new norm.

Perhaps more fundamentally, by imposing direct obligations on thousands of Chinese state-owned enterprises, the WTO may change the current operating environment for SOEs. As enterprises, SOEs may not be brought directly before Dispute Settlement Bodies in Geneva, so the government will have to bear the result of any claim based on SOE misconduct. However, implementation of rules affecting SOEs and compliance with Panel or Appellate Body rulings related to SOEs will inevitably require the Chinese government to intrude into SOE transactions. For example, the Chinese government might be required to bring WTO-inconsistent SOE deals into compliance with WTO rules. Thus, the impact on SOEs will not be restricted to governmental policymaking or implementation only, but also to the day-to-day operations of SOEs. Should an SOE consider whether a proposed transaction is based solely on commercial considerations and is otherwise compatible with WTO law? Should a prospective business partner of an SOE consider whether the transaction will be challenged under WTO rules? This is no longer a hypothetical question.

IV. Conclusion

The issues surrounding the impact of the WTO on SOEs have not been well explored, and even only sporadically raised. Many of the observations I have made here are only my personal speculations. The future development of WTO rules affecting SOEs will depend on many factors. For example, whether rules affecting SOEs become a particular focus of the WTO will depend largely on how Chinese SOEs, taken as a whole, influence the level and direction of China's international and domestic trade. As long as the SOEs continue to suffer from the chronic illness of inefficiency and lack of competitiveness, it will be less of an issue, but if the Chinese government's goal of revitalizing the SOEs is reached and SOEs can effectively compete for the huge Chinese market with foreign traders and investors, its vulnerability under WTO rules will open a convenient door for previously unexpected WTO non-compliance challenges.

Perhaps it is still too early to have a full-fledged discussion on how the accession of China to the WTO will affect the already dire situation of Chinese SOEs, but many crucial issues are readily apparent and deserve an intensified and broader attention from the Chinese government, Chinese SOEs and those who care about them.
(The author is a legal counsel at Yahoo! China Inc.)