State Capitalism and Competitive Neutrality

Deborah A. McCarthy
Principal Deputy Assistant Secretary, Bureau of Economic and Business Affairs
APCAC 2012 U.S.-Asia Business Summit
Washington, DC
March 2, 2012

State capitalism has emerged and is a major new challenge. It features elements of markets liberalization and elements of state control. State capitalism takes advantage of open free markets while protecting key aspects of domestic production. It mobilizes resources of the state, forces joint ventures between foreign and local companies to transfer knowledge. It exerts control over key enterprises and subsidizes their expansion and growth overseas.

State-owned enterprises (SOEs), and state-supported enterprises (SSEs) or "National Champions," are emerging to become serious global competitors. UNCTAD highlighted this trend in its 2011 World Investment Report, in which it noted that investment from emerging and developing economies now accounts for a 29 percent of global foreign direct investment outflows. SOEs comprise 11 percent of this, and 19 of the world’s 100 largest multinational enterprises are SOEs.

Fortune magazine’s Global 500 list has reflected this as well. The 2005 Global 500 included 67 SOEs; by 2011 the number had risen to 106. State capitalism can also claim some of the world’s most powerful companies. The 13 biggest oil firms, which between them have a grip on more than three-quarters of the world’s oil reserves, are all state-backed. So is the world’s biggest natural-gas company, Russia’s Gazprom. But successful state firms can be found in almost any industry. China Mobile is a mobile-phone goliath with 600m customers. Saudi Basic Industries Corporation is one of the world’s most profitable chemical companies. Russia’s Sberbank is Europe’s third-largest bank by market capitalization. Dubai Ports is the world’s third-largest ports operator. The airline Emirates is growing at 20% a year.

SOEs and SSEs in several cases have gained domestic and international market share in large part because they are enjoying financial support, tax preferences, regulatory privileges, and immunities not generally available to their privately-owned competitors. These privileges are often reinforced with discriminatory government market access or purchasing policies. Together, they give SOEs and SSEs a competitive advantage over their private sector rivals -- advantages that are not necessarily based on better performance or innovation, but on government policies and practices that distort competition in the market.

The United States is committed to a global economic system that is open, free, transparent, and fair. And we’re working to institutionalize those norms in regional and global trade agreements and institutions.

Creating a level playing field for U.S. and other private companies competing against businesses owned, supported, or championed by foreign governments has been deemed competitive neutrality. The State Department has been working informally with like-minded states to develop a common understanding of what ‘rules of the road’ for these issues might look like, and has tabled a new proposal in the Trans-Pacific Partnership for disciplining SOEs in this regard. In the context of the Trans-Atlantic Economic Council we have expressed our mutual support for the work of the OECD in creating policy guidelines on competitive neutrality.

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

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

And in the area of bilateral investment treaties (BITs) and free trade agreements (FTAs) the aim is to strengthen the rules-based system on national treatment, dispute resolution, and market access for trade and investment. The United States presently is a party to BITs with 40 countries and FTAs with 17 partners. The goal of the protections afforded by these agreements is to promote a level playing field for all investors and traders, whether state-owned or privately owned.

We will build on the substantial progress made in 2009- 2010 in the review of the “Model Bilateral Investment Treaty.” Our objective is to produce an updated model that preserves core investor protections without compromising governments’ ability to regulate in the public interest, fosters competitive neutrality in foreign markets dominated by state-owned enterprises, and enhances transparency and labor and environmental protection. Completion of the Model BIT review will enable the intensification of negotiations with key emerging economies from China, India, and others, and the implementation of agreements that will expand American economic opportunity abroad.

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

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

A "competitive neutrality" framework must include mutually reinforcing policy recommendations from the disciplines of trade policy, investment policy, competition policy, and corporate governance to avoid:

  1. Individual governments implementing incentives to “tilt the playing field” in favor of their SOEs or SSEs;
  2. Reliance solely on domestic competition law which in itself is in most cases insufficient to deal with broad state-supported anti-competitive behavior;
  3. Reliance only on the OECD's SOE corporate governance guidelines: these address some, but not all, aspects of the issue; and they are also voluntary and are often unevenly implemented.

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

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

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

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

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

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

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

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

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