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Countervailing duty : the case of China's coated free-sheet paper exporting Liu, Kai 2008

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COUNTERVAILING DUTY THE CASE OF CHINA’S COATED FREE—SHEET PAPER EXPORTING by KAI LIU B.A., Sichuan University, 2004  A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF SCIENCE  in  THE FACULTY OF GRADUATE STUDIES  (Agricultural Economics)  THE UNIVERSITY OF BRITISH COLUMBIA (Vancouver)  NOVEMBER 2008 OKJJ LIU, 2008  Abstract In the last decade, as China engaged in market reforms, the U. S. Department of Commerce began to reassess the use of Countervailing duty Specifically,  (CVDs) laws against China.  in 2007, the Department of  Commerce started a countervailing duty investigation against a paper exporting company located in China, along with companies in Indonesia and Korea.  This thesis uses this case to ask whether there is evidence that  a company in a non—market economy responds differently to subsidize than those located in a market economy. First, I introduce what kinds of subsidies the government in China and Indonesia offer to companies in the paper industry and what kinds of subsidies  United  States  International  Trade  Commission  chose  to  investigate and what kinds of subsidies it did not choose, and explain why it did that. I use a simple theoretical model in this thesis based on the model of strategic trade used by Brander and Spencer (1985). Two exporting firms from two different countries are competing in a third country.  I modify  the model to capture the types of subsidies I have found in the paper industry and I separate domestic and export output. I show that the subsidy from a non—market economy country may induce more exports than if it comes from a market economy country.  Further, like Brander and Spencer, I find  11  that as one firm’ s exporting quantity goes up, another firm’ s exporting quantity will decrease. I then use an empirical model to test the results from the theoretical model.  I use quarterly firm—level data from one Chinese firm  (Chenming. Ltd) and one Indonesian firm (Asia Pulp&Paper Co. Ltd) named in the US CVD case. Chenming. Ltd (Chenming) is a big state—owned firm and it received lots of subsidies since 1950. Asia Pulp&Paper Co. Ltd (APP) is also a big paper producing firm but it is privately owned.  I find  evidence that both of the two firms increased their exports in response to subsidies,  although there is some evidence that exports from the  Chinese firm are more elastic with respect to subsidies, implying that subsidies from NMEs may well be of concern to importers.  111  Table of Contents Abstract  ii  Table of Contents  iv  List of Tables  vi  List of Figures  vii  Acknowledgments  viii  Chapter 1: Introduction  1  Chapter 2: Background of Countervailing Duty In The United States  5  2. 1 The History of Countervailing Duty Law 2. 2 Countervailing Duty Investigation 2. 3 The Application of CVD Laws to Non—Market Economies  5 7 9  Chapter 3: Coated Free—Sheet Paper From China and Indonesia 3. 3. 3. 3. 3.  1 2 3 4 5  Background 19 Coated Free—Sheet Paper and its U. S. Domestic Market. 20 A Brief Analysis of Supply 23 A Brief Analysis of Demand 24 A Comparison of U. S. Produced and Imported Coated Free— Sheet Paper 25  Chapter 4: Subsidies 4. 4. 4. 4. 4.  19  .  .  27  1 2 3 4 5  Definition 27 Subsidies From China and Indonesia 28 29 Government Loans Energy Subsidy 32 Plantation Subsidy 35 4. 5. 1 Subsidies in Paper and Tree Plantation Industry in China 35 4. 5. 2 Subsidy in Indonesia 37 39 4. 6 Subsidies Determined by Department of Comerce  Chapter 5: Theoretical Model 5. 1 Introduction 5. 2 Imported Paper in U. S 5. 3 The Model Chapter 6: Empirical Model  45 45 46 47 54 iv  54 6. 1 Importing of U. S Coated—Free Sheet Paper 6. 1. 1 Preliminary Department of Commerce Finding of Unfair Dumping of Coated Free—Sheet Paper From 54 China and Indonesia 6. 1. 2 Total Imports of Coated Free Sheet Paper From China 55 and Indonesia 56 6. 2 Empirical Model 56 6. 2. 1 Estat Durbinalt Test 57 6. 2. 2 Review of the Theoretical Model 58 6. 2. 3 The Data 60 6. 2. 4 The Model 64 6. 2. 5 3SLS Regression 67 6. 3 Result and Explanation 67 6. 3. 1 Basic Analysis 6. 3. 2 Subsidies 69 71 6. 3. 3 Exporting Quantity 72 6. 3. 4 Exports and US Domestic Price 6. 3. 5 The Relation Between Changing’ s and APP’ s Export 72 Behavior 73 6. 3. 6 Sensitivity Analysis Chapter 7: Summary and Conclusions 7. 1 Summary 7. 2 Limitations and Future Studies References  74 74 75 77  V  List of Tables Table 3. 1 U. S annual Capacity of Coated Free—Sheet Paper, 1970—2000.  ..  .  22  Table 4. 1 Summary of DR Reforestation Fund Allocations of Pulpwood Plantation Firms, 1998  38  Table 4.2 CFS Paper: Subsidy Programs in Shandong Chenming Ltd, China, Investigated by Commerce and Rates For Those Found to be Countervailable  40  Table 4. 3 Subsidy Programs in Indonesia Investigated by Commerce and Rates For Those Found to be Countervailable, For TK/PD  42  Table 6. 1 Coated Free—Sheet Paper in the U. S. Market  55  Table 6. 2 Estat Durbinalt I (Chenming Exporting Quantity)  57  Table 6. 3 Estat Durbinalt II (APP Exporting Quantity)  57  Table 6. 4 Data Used in My Empirical Model  60  Table 6.5(1) 3SLS Regression  65  Table 6.5(2) 3SLS Regression  66  Table 6. 6 R—Square  72  vi  [Original document missing page vii]  ACKNOWLEDGEMENTS  There are many people I would like to thank. First I want to thank my supervisor, Dr Kathy Baylis for her always support for this thesis, along with Dr Richard Barichello, who gives me good suggestions for my thesis. Thanks to Dr Gary Bull, for his attending the committee. Thanks to all the friends I have at UBC. I really appreciate the contribution of Lampros Lamprinakis and Lejiu Zhang in helping me to understand more of what I learned. Special thanks to Stephen Peplow in the correct writing of this thesis. Thanks to all the students and faculty members who ever helped me during the long run that I study at UBC, making me feel the beauty of this university and City of Vancouver. My deepest thank to my parents and relatives. Going abroad and studying is such an expensive and sometimes, hard period for me and my family. Without their support, nothing is possible.  VIII  List of Figures Fig 5.1 U.s Imported Coated Free-Sheet Paper From China  47  Fig 5.2 Basic Reaction Functions  49  Fig 5.3 New Reaction Functions  52  lx  CHAPTER ONE: INTRODUCTION  Countervailing duty laws (CVDs), as well as other trade laws such as antidumping laws (ADs), are now widely used.  A previous constraint  was that CVDs could not be used against non—market economies.  However,  a precedent was set in 2007 by a ruling involving NewPage Corporation, a U.S.  paper company that had petitioned for a countervailing duty  investigation of imports from companies in the People’ s Republic of China, Indonesia, and Korea.  The NewPage decision is the first CVD to be levied  against China, hitherto considered a non—market economy.  This thesis  uses the NewPage case to explore whether firms in non—market economies behave differently in response to subsidies than those in market economies. The development of globalization has allowed foreign companies that may have been aided by government subsidies to export their goods to the United States.  Over a century ago, the U. S. was the first country  to develop laws that limited the perceived subsidized imports.  Nominally,  “unfair”  competition of  such countervailing duty laws  (like  anti—dumping laws) try to equalize conditions which have been distorted by subsidized (or dumped) imports. Free—market principles have made it hard for the U. S. to have trade relations with non—market economy countries because in those countries,  market rules do not dictate company behavior.  Also, the U. S. has until  recently felt that since it is not possible to identify and quantify subsidies from non—market economy countries, countervailing duty laws cannot be used against these countries. On March 30, announced  its  countervailing  2007,  however,  affirmative duty  the U. S.  preliminary  investigation  into  the  Department of Commerce  importation  free—sheet paper from the People’ s Republic of China. of  Commerce  made  a  preliminary  producers/exporters had received net ranging from 10. 90 to 20. 35 percent.  in  determination  the  of coated  The Department  determination  that  Chinese  countervailing  subsidy rates  This preliminary determination, in  which a subsidy from a non—market economy country was quantified for the first time in history, thus marks the Department’ s first departure from its 23—year bipartisan practice of not applying CVDs to non—market economy countries such as China.  In this preliminary determination,  the  Department of Commerce explains that the Georgetown Steel judgment no longer applies to China because of how markedly different China’ s economy today is from the economies of the non—market economy countries of the 1980s Soviet bloc. This change in trade policy has occurred despite the fact that China is still seen as a non—market economy country. My thesis will use data from two companies involved in the 2007 case Coated Free-Sheet Paper from China, Indonesia, and Korea: Shandong  2  Chenming Ltd.  (a state—owned Chinese company), and Asia Pulp & Paper (a  privately owned Indonesian  company), to try to answer the following  question: Do subsidies in a non—market economy affect the quantity of its exports differently than subsidies in a market economy? This thesis analyzes the countervailing duty situation by using theoretical and empirical models.  Adapting the model of export subsidies  in an oligopoly developed by Brander and Spencer (1985), I model how a company in a non—market economy, such as China, and a company in a market economy, such as Indonesia, might alter their exports in response to the introduction of government subsidies, and what these responses would mean for a company in the importing country. I use my theoretical  The empirical model is more complicated.  model to construct an empirical model of the two exporting companies’ reaction functions.  Specifically, I estimate how exports are affected exports, GDP (for both  by the subsidy, domestic price, foreign companies’  China and the U. S.), and wages in the paper industry.  I use this model  to ask whether the subsidy to the Chinese company has the same effect on its exports as the subsidy to the Indonesian company. Below,  the  second  countervailing duty law.  chapter  describes  of subsidies  background  of  The third chapter describes countervailing  duty laws implemented in non—market countries. the kinds  the  Chapter four introduces  governments generally offer  to companies.  3  Chapters five and six present my theoretical and empirical models, while chapter seven discusses the results and limitations of the thesis.  4  CHAPTER TWO:  BACKGROUND OF COUNTERVAILING DUTY IN THE UNITED STATES  Nominally, the purpose of U.S. countervailing duty laws is to prevent the unfair competitive advantage that foreign governments offer to their exporting companies by giving them subsidies.  The principle  behind these laws is that U. S. producers should not have to compete with foreign companies that are not subject to the same competitive market constraints as U. S. producers. Under U. S. countervailing duty law, duties are imposed to offset whatever subsidy the foreign exporter has received, thereby ideally enforcing the goal of free—market efficiency. This chapter provides a brief introduction of the history of countervailing duty laws, describes how the U. S. Department of Commerce investigates CVDs, and discusses the implementation and policy problems associated with these laws.  2. 1 The History of Countervailing Duty Laws  The U.S. Congress enacted the first countervailing duty law in 1890.  That law empowered the government to tax importers of sugar  receiving financial support from the exporting countries.  The 1897 Act 2  1 See Tariff Act of 1890 (Mckinley Tariff). 2 See Tariff Act of 1897 (Dingley Tariff).  5  was more general, covering any companies that had received a bounty or grant paid directly or indirectly on exportation. The Tariff Acts of 1913 and l922 expanded countervailing duty law to establish the lowest possible tariff and income tax rates for exporting. In the 1974 Tariff Act, Congress amended section 303 and expanded the law to include any subsidized companies. The Act also required a determination of injury to the domestic industry before imposing a countervailing duty on duty—free imports, but only if such a test was required by international obligations. In 1979, another countervailing duty provision, section 701, was 5 The purpose of this amendment was to make the laws consistent enacted. with the requirement of the Subsidies Code signed that year at the Tokyo Round  Multilateral  Trade  6 Negotiations.  This  GATT  Subsidies  Code  Stipulated that countervailing duty laws should be imposed only after a material injury to a domestic industry is shown.  It also seeks to  determine if a material injury has been inflicted or is threatened.  3 See Tariff Act of 1913 (Underwood Tariff Act) and Tariff Act of 1922 (Fordney—McCumber Tariff Act). 4 See Trade Act of 1974. 5 See Trade Agreement Act of 1979. 6 See Hoyt, Robert F.  “Implementation and Policy: Problems in the application of Countervailing Duty Laws  to non—market Economy countries.  “  University of Pennsylvania Law Review. Vol.  136. June 1988  6  Congress implemented these commitments in section 701 because the requirements of the Subsidies Code only apply to those countries which are signatories to the Subsidies Code or with whom the United States has negotiated substantially similar bilateral agreements.  As a result of  this implementation, the U.S. has two different countervailing duty laws: one for those countries which signed the Subsidies Code or similar agreements, and one for all other countries. The difference between the two laws is that the former, according to section 701, requires the administering authority to make a determination of material injury before imposing countervailing duties, whereas the latter, according to section 303,  Most non—market economy  requires no demonstration of injury.  countries are not signatories to the Subsidies Code and so do not receive 7 the benefit of an injury test.  2. 2 Countervailing Duty Investigations There  are  three  basic  elements  of  a  countervailing  duty  investigation: first, finding material injury to a domestic industry; second, identifying the existence of a subsidy; and third, quantifying the net benefit conveyed by the subsidy. Commitment  (ITC)  is  responsible  for  8  The U. S. International Trade the  first  element  of  this  7 See GAO REPORT TO THE CONGRESS, supra notes 1, at 29. 8 See GAO REPORT TO THE CONGRESS, supra notes 1, at 28  7  investigation.  The ITC identifies whether an industry has been  materially injured and whether the allegedly subsidized import is a cause of this injury.’  The ITC analyzes the volume of the imports, their effect If the ITC  on U.S. prices, and their effect on domestic producers.  determines that the imports in question are causing material injury to a domestic industry, the investigation is then turned over to the U.S. International Trade Administration (ITA).  °  The ITA is responsible for  the second and third elements of a countervailing duty investigation. However, its task of identifying and quantifying subsidies is difficult because neither the GATT, the Subsidies Code, nor the U. S. countervailing duty laws defines whatasubsidy is, per Se.  The countervailing duty laws  only provide that the term means the same as the terms “grant”  as used in section 303.  “  bounty”  and  Countervailing duty may be levied only  against subsidies granted by government. cover subsidies from institutions,  Although ostensibly the laws  they have never been imposed if  subsidies have been received from non—governmental organizations. After identifying a government subsidy, the ITA must quantify the net benefit the producer receives from the subsidy.  The ITA will have  to calculate the gross value of the subsidy, including any costs the  9 See OVERVIEW OF Ii. S. TRADE STATUTES, supra notes 45, at 52. 10 See 19 U.S.C 11 See 19 U.S.C.  1671(a) (2).  § 1677(5) 1982; OVERVIEW OF U.S TRADE STATUTES, supra note 45, at 51.  8  company has incurred in receiving the subsidy. The net benefit, the gross value less the cost, is the amount of countervailing duty imposed. This process however, might meet serious problems when applying CVD laws to non—market economy counriews.  2.3 The Application of CVD Laws to Non—Market Economies Unlike market economies, which use the price system to adjust demand—supply relations,  non—market  economies  rely on centralized  government planning to arrange the production, trade, and distribution of goods and services. Prior to the 1980s, the U.S. undertook no countervailing duty investigations of products from non—market economy countries.  12  In late  September, 1983, however, a group of U.S. textile manufacturers and unions filed a petition for the first such investigation against imports from the People’ s Republic of China.  The petition alleged that China’ s  policies granted a preferred monetary exchange rate and other benefits to the producers of exported goods, which constituted a countervailable subsidy.  ‘  However, the investigation was never completed: to protect its  domestic industry from the Chinese government, Commerce  convinced  the  petitioners  to  the U. S. Secretary of  withdraw  their  petition,  12 See GAO REPORT TO THE CONGRESS, supra note 1, at 27. 13 See Recent Development, 105.  9  guaranteeing to reinstate the investigation if the industry later requested the Department of Commerce to do so. The second countervailing duty petition was launched in November, 1983.  5 were The petitioners alleged that Poland and Czechoslovakia’  subsidizing exports of carbon steel wire rods.  During the investigation,  the Department of Commerce determined that countervailable subsidies granted in a non—market economy country could not be identified by the U. S. because the concept of subsidization had no meaning in a non—market economy country where costs, profits, and prices are determined by central This conclusion later led the  planning instead of by market forces. Department  of  Commerce  to  another  rescind  countervailing  duty  5 investigation into imports of potash from the German Democratic Republic’ and the Soviet Union.  ‘  It might be true that some of the non—market economy countries, such as German Democratic countries,  Soviet Union and China,  their  governments have some very strong subsidies to support their exporting companies. However, it is not easy to investigate this subsidies. The  14 See Textile, Apparel, and Relative Products From People’ a Republic of China, 48, Fed, Reg. 55,492 15 See Steel From Czechoslovakia. Supra note 114, at 19.371  16 See Potassium Chloride from the German Democratic Republic. 49 Fed Reg. 23,428  17 See Potassium Chloride from the Soviet Union. 49 Fed Reg. 23,428  10  reason the court determined that it is not possible to investigate countervailing duty in non—market economy countries is that the basic elements  of  a  countervailing  duty  investigation  such  as  the  identification and quantification of the alleged subsidy are thwarted by . 8 the structure of a non—market economy’  However, in Continental Steel  Corp. v. United States, the Court of International Trade overruled the Department of Commerce’ s conclusion.  In this case,  the Court of  International Trade concluded that subsidies in non—market economy countries can exist and, further, that the Department of Commerce should develop a method of identifying and quantifying them (Jones 2007). In this way, the Court of International Trade sought to solve the problems of investigating alleged subsidies  in non—market economy  countries by broadly defining subsidization as “a distortion of a pattern of regularity or even a pattern of reasonably expected fairness” and  Shuman  1984).  According  to  this  definition,  the  (Horlick Court  of  International Trade reasoned that the International Trade Administration (ITA) can  “detect patterns of regularity”  “beneficial deviations from those patterns”  and identify as subsidies any (Horlick and Shuman, 1984).  However, in Georgetown Steel Corp. v. United States (1986), the  18 See Potassium Chloride from the People’ s Republic of China, 49 Fed, Reg. 23,428 19 See Section 15, Trade Bill 1987  11  Court of Appeals for the Federal Circuit reversed the finding of the Court of International Trade.  ‘  The Court of Appeals adopted the arguments set  out by the Department of Commerce in its final determination that, by definition, subsidization is a market phenomenon that cannot exist in a non—market economy. Implementation and Policy Problems In 1987, several bills were introduced into the House and Senate  which invalidated Georgetown Steel Corp. v. United States and applied countervailing duty laws against non—market economy countries.  One of  the most successful efforts was section 157 of the 1987 Trade Bill, which suggested that Congress decrease discrimination between non—market economy countries and market economy countries when 20  countervailing duties.  investigating  This provision suggested that future legislative  attempts to overturn Georgetown Steel might be successful. Congress paid careful attention to how to apply section 157.  The  bill would require the Department of Commerce to apply the law to non—market economy countries when a subsidy could be identified and 21 The House Report on section measured. theoretical  and  administrative  157 only mentioned  difficulties  of  applying  “  the the  20 See 1987 Trade Bill 21 See H. Rep No. 40,  l000th cong,  .  1st sess. 138 (1987)  12  countervailing duty law”  22  and did not discuss whether the application  of laws would be consistent with U.S. trade policy. The problem of using CVDs is that the countervailing duty laws have not offered guidance about whether they could be applied against imports from non—market  economy  To  countries.  solve  this  problem,  the  investigators would have to be less concerned with accuracy when identifying and measuring a subsidy.  In debating changing the rules to  apply CVDs to non—market economies, Congress must decide whether it is willing to sacrifice accuracy in return for applicability (Hoyt 1988). The following sections provide detailed discussions of the problems with the policy and its implementation. The Policy Problem The policy problem for a countervailing duty investigation in a non—market economy country is whether the application of countervailing duty laws to this country is consistent with U.S. trade policy. In a non—market economy country, the government and the producer are  a  economic  single  entity,  which  makes  it  difficult  for  a  countervailing duty investigation to distinguish between dumping and subsidization.  23  Dumping occurs when a producer makes its exporting price  22 See VTO definition of dumping. 23 See Rawsori.  “An outline of United States regulation of Trade with Nonmarket Economy Countries”  13  lower than its costs and attempts to recoup this loss from a domestic price increase. If the government reimburses the producer for its loss, the process is called subsidization.  However, when the producer recovers its  losses from domestic price increases in a non—market economy country, it could also be called subsidization because the central or local government controls the price.  That is, the government thus helps the producer by  increasing the domestic price.  As a result, the U. S. International Trade  Administration would find it difficult to distinguish between dumping and subsidization practices in a non—market economy country (Diehlman 1988). The ability to apply both antidumping and countervailing duty laws to importers from non—market economy countries would afford domestic petitioners a choice of remedies for a single offense.  The result of this  choice would be the substitution of countervailing duty petitions for antidumping petitions against non—market economy countries.  The reason  for this substitution is that only a few non—market economy countries receive the benefit of an injury test under the countervailing duty laws while under antidumping laws, all countries receive the benefit of the test.  When choosing between these two, the petitioners would absolutely  choose the first one because it makes the injury test meaningless in trade relations with non—market economy countries. Of even greater concern, when a petitioner files a CVD case against an importer from non—market economy country, the Department of Commerce  14  does not need to demonstrate injury.  Thus, allowing CVDs to be used  against non—market economies would increase the number of petitioners and the countervailing duty laws would offset trading practices that are not causing any material injury to the United States economy.  In effect,  instead of being an efficiency—maximizing standard in international trade relations, countervailing duty laws would become competitive weapons. This expansion of protection would harm relations between the United States and non—market economy countries and likely lead to retaliatory measures; furthermore, it would probably harm domestic producers as well (Rawson 1987). Currently, the United States enjoys a favorable balance of trade with non—market countries, and did so even before the end of the Cold War. These relations also give the U. S. significant political benefits.  To  allow the use of countervailing duty laws against non—market economy countries without requiring an injury test would therefore lead these countries to misunderstand international trade standards and the goals of the United States,  which would have both economic and political  ramifications. The Implementation Problem The implementation problem in applying countervailing duty laws to non—market economy countries is the difficulty in accurately identifying and quantifying subsidies in the absence of market—based  15  price, cost, and exchange rates. different from a market economy.  A non—market economy is completely In a market economy, price and cost are  determined by the market, involving such factors as demand, supply, and scarcity of goods.  The market can, theoretically, allocate goods with  maximum efficiency without government intervention.  As a result, a  company in a market economy purchases its inputs and sells its commodities at market—determined prices. The fundamental difference between a market and a non—market economy is that in a non—market economy, production is controlled by the Government’ s central planning: prices, costs and profits are controlled by the state and do not reflect market forces such as demand, supply, or scarcity of resources.  Instead, the price of a commodity is a tool used  by the government to promote  its social,  political,  and economic  objectives; that price does not reflect the cost of production.  Thus,  the goal of microeconomic efficiency does not exist in a non—market economy country.  Furthermore, there is no reliable exchange rate that  could convert a non—market currency into dollars (Downey and Graham 1985). In a non—market economy, the state and the producer are actually the same, making an alleged act of subsidization indistinguishable from the state’ s normal role of allocating resources.  Such distortions led  the Department of Commerce to conclude that attempts to identify and quantify subsidies in non—market economy countries cannot succeed.  In  16  place of an unobtainable accurate measure of subsidization in non—market economy countries, the Department of Commerce is therefore likely to substitute price and cost information from a comparable surrogate market economy.  This move is supported by Article 15 of the Subsidies Code,  which provides for the use of the surrogate country approach to calculate the value of a subsidy when conventional means are unfeasible.  Some  regulations previously proposed by the Department of Commerce also have advocated this use of surrogate country producers. Furthermore, just as there is no pure free—market economy country, there is no pure non—market economy country: the degrees to which central economic planning control the domestic prices of commodities in these countries  differs  significantly.  In North Korea,  the government  24 for instance, while in Cuba the controls almost all of the economy, control is less extensive.  In China and Viet Nam, recent reforms have The current trend  increased the numbers of privately owned companies.  is that many non—market economy countries are moving away from strict state control and toward a market economy system. continues,  prices and exchange rates  in  25  If this movement  these non—market  economy  countries will more accurately reflect the forces of demand and supply.  24 See People’ s Daily, 2006  25 See China Economy, 2007.  17  Such a change would greatly facilitate the application of countervailing duty laws. Thus, the implementation problem discussed here does not, in fact, render the attempt to apply countervailing duty laws to non—market economy Countries hopelessness. Congress connected market and non—market economies in 1974 when it applied antidumping laws to non—market economy countries by using surrogate countries to construct appropriate value pricing methods. That same process of using surrogate countries to derive calculations can be used to make countervailing duty laws applicable to non—market economy countries.  The real implementation problem has not  been that some barrier prevents the evaluation of disparate economies; it has been that evaluation attempts were always inaccurate.  Congress  must therefore now decide whether it can accept some necessary degree of inaccuracy arising from calculations of countervailing duty being based on forces in a surrogate country rather than in the non—market economy country itself (Soltysinski 1988).  18  CHAPTER THREE: COATED FREE—SHEET PAPER FROM CHINA AN]) INDONESIA  On March 30, 2007, the U. S. Department of Commerce announced its affirmative preliminary determination of the existence of a subsidy in its countervailing duty investigation into imports of coated free—sheet paper from China.  The Department’ s preliminary determination was that  Chinese producers/exporters had received net countervailing subsidies ranging from 10. 90% to 20. 35% ad valorem.  3. 1 Background On October 31, 2006, a petition was filed with both the Department of Commission and the Department of Commerce by NewPage Corp of Dayton, OFT, alleging that an industry in the United States was being materially injured or was threatened with material injury by subsidized imports of coated free—sheet paper from China, Indonesia, and Korea.  Accordingly,  on October 31, 2006, the Department of Commission instituted countervailing duty investigations 701—TA—444—446 (preliminary) and antidumping duty investigations 731—TA—1107—llO9 (preliminary) against China, Indonesia, and Korea.  26 See IJSITC:  “Coated Free Sheet Paper From China, Indonesia and Korea,  (Final) and 731—TA—1107—1109  “  Investigation Nos. 701—TA—444—446  (Final).  19  3.2 Coated Free—Sheet Paper and its U.S. Domestic Market Coated free—sheet paper contains no more than 10% by weight mechanical or combined chemical mechanical fibers.  It is coated with  kaolin (China clay) or other inorganic substances, with or without a binder, and has no other coating. Coated free—sheet paper has unique physical characteristics. First, the amount of mechanical pulp used to make the paper is limited to prevent the paper from discoloring.  Second, the coating on the paper,  which always contains kaolin clay but may also include some other substances, gives the paper a better printing surface than uncoated paper has.  For these reasons, coated free—sheet paper is used primarily in the  printing of corporate annual reports and high—end catalogues and magazines. Along with its other properties, including its heavier weight, these  key  Therefore,  characteristics  make  coated  free—sheet  paper  unique.  it is rarely used in traditional coated groundwood paper  applications where weight is important,  since it  is heavier than  groundwood paper, but is preferred in some applications over groundwood paper, which yellows relatively quickly. Coated free—sheet paper is also an alternative product.  Most  importers of coated free—sheet paper claim that coated groundwood paper and uncoated free sheet paper can be substituted for coated free—sheet  20  paper.  In fact, they offer a long list of products that could be used  in place of coated free—sheet paper,  including high—yield board,  super—calendared paper, plastic, coated bristol, electronic media, and However, not all importers agree with this claim.  fine—art paper.  Coated free—sheet paper, like other kinds of paper, is sold in the U. S. through two channels of distribution: to distributors and directly to end—users. channels.  However, different types of paper go through different  For example,  coated groundwood paper is more likely than  coated free sheet paper to be sold directly to end users.  Most U. S.  producers of coated freesheet paper are located to the east of the Rocky Mountains, although one producer is in Oregon.  Most of the importers  responding to the petition (six of nine importers from China, four of seven importers from Indonesia, and six of twelve importers from Korea) reported that  they  sold  their  imported  product  nationally.  While  these  respondents suggested that the domestic producers were reluctant to ship west of the Rocky Mountains, eight of the nine U. S producers responding to a USITC survey reported that they sold their product nationally.  27  Official Department of Comerce importation statistics, organized by subject source and customs district, indicate that imports of coated free sheet paper from China are most heavily concentrated on the west  27 All the data here come from USITC.  21  coast. These imports made up 66. 3% of total imports of coated free—sheet paper from China during 2005, while 22. 4% of total imports were shipped to the east coast.  American imports of coated free—sheet paper from  Indonesia are also concentrated on the west coast, accounting for 52.8% of total U.S. imports from Indonesia during 2005 (26. 9% went to the Great Lakes region, 17% to the east coast).  Most U. S. imports of Korean coated  free sheet paper (63. 3% during 2005) are also concentrated on the west coast (25. 5% went to the east coast) Table 3. 1  U. S. Annual Total Paper Output and Annual Coated Free—Sheet Paper Output, 1970—2000  Year 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990  Total paper (thousands of short tons) 26302 26309 26765 27601 28250 28849 29526 30191 30507 31825 33028 33929 35460 36492 36761 37439 38164 39147 39508 41068 42314  Coated Free Sheet Paper short of (thousands tons) 2258 2258 2335 2399 2480 2684 2672 2746 2908 3017 3166 3009 3523 3619 3578 3656 3861 3734 3915 3970 4376 22  Total Paper (thousands Coated Free Sheet Paper short of short tons) of (thousands tons) 4584 43878 5413 45537 46027 5384 5425 46237 47518 5052 47542 4763 48110 5079 49019 5768 48817 5856 49413 5847  Year  1991 1992 1993 1994 1995 1996 1997 1998 1999 2000  3. 3  A Brief Analysis of Supply The supply response of American producers of coated free—sheet  paper depends on changes in the prices of the level of excess output, the availability  of  alternate  markets  for  American—produced  coated  free—sheet paper, inventory levels, and their ability to shift to the manufacture of other products. The output utilization of American producers of coated free—sheet paper increased from 90. 1% in 2003 to 95. 1% in 2005.  This level of output  indicates that U. S. producers have almost no unused output with which they  28 See USITC:  “Coated Free Sheet Paper From China, Indonesia and Korea”  Nos. 701—TA—444—446(Final) and  731—TA—1107—1 109 (Final).  29 All the data here come from USITC.  23  could increase their production when prices change.  Similarly,  the  export by U. S. producers as a share of total shipments increased from 5. 5% in 2003 to 6. 3% in 2005, which means that Ii. S. producers have a limited ability to divert shipments to or from alternative markets in response to change in the price of coated free—sheet paper. that the U.S.  supply is relatively inelastic.  These indicators show However, the ratio of  end—of period inventories to U. S. shipments decreased from 17. 2% in 2003 to 15.4% in 2005, which indicates that American producers have some inventory they could use to increase shipments to the U. S. market.  Coated  free—sheet paper from foreign countries such as China might be responsible for this change.  3.4 A brief Analysis of Market Demand The overall demand for coated free sheet paper has increased since 2003 due to economic growth and its effect on advertising and on the publication of corporate financial reports. Coated free—sheet paper is also an alternative product.  As a lot  of other kinds of paper are. Most importers of coated free—sheet paper argue that it could be replaced by coated groundwood paper and uncoated free sheet paper. that  could  be  As a matter of fact, there is a long list of products used  as  substitutes,  including  high—yield  board,  super—calendared papers, plastic, coated bristol, electronic media, and  24  fine—art paper.  However, not all importers agree with this assessment.  Some importers have the opposite idea. One importer argues that coated groundwood paper is not a good substitute for coated free—sheet paper because it is not readily available in sheet form. One producer reported that the price of uncoated free—sheet paper has been increasing, thereby raising demand for coated free—sheet paper.  Most importers also reported  that the price of substitutes does not affect the price of coated free—sheet paper, although some felt that while the prices of substitutes did affect the price of coated free—sheet paper, this effect lasted for only between four and twelve weeks (USITC, 2007).  3.5 A Comparison of U.S. Produced and Imported Coated Free—Sheet Paper To determine if American produced coated free—sheet paper can be used in the same applications as imports from China, Indonesia, and Korea, the USITC asked producers and importers to report if the products can “always,  “  “frequently,  interchangeably. 30  “  “sometimes,  “  or  “never”  be used  Most U. S. producers reported that they can always use  either American or imported coated free—sheet paper interchangeably. At the same time, importers mentioned some important factors when comparing their products with domestically produced ones. 30  See USITC  Some reported  “Coated Free Sheet Paper From China, Indonesia and Korea (Final)  25  that American producers have shorter delivery times, which results in a higher cost to importers.  That is,  to maintain their inventories,  importers must make a greater investment if they are to remain competitive with American producers. On the other hand, some importers also argue that their coated free—sheet paper is superior to domestically produced paper in brightness, shading and gloss.  Although some importers mentioned that U. S. produced  coated free—sheet paper is stiffer, which is allows quicker production, it is still unclear whether U. S. or imported coated free—sheet paper seems to producers and importers to be superior.  26  CHAPTER FOUR:  SUBSIDIES  4. 1 Definition As noted in chapter two, the U. S. has no clearly defined definition of a subsidy for use in its CVD cases. different forms, which I discuss below.  Subsidies can come in many In my thesis, however, I use the  term “subsidy” to mean a form of financial assistance which is paid by a country’ s government to companies in a business sector and which could decrease the cost of their products or service, and/or increase their output.  According to the V,’orld Trade Organization (WTO) and Bull (2005),  subsidies may be separated into the following types: 1. Direct transfer of funds A direct subsidy is the simplest and arguably the least used form of subsidy.  It is a direct transfer of funds (grants,  loans and equity  infusion). 2. Potential direct transfer of liabilities (e.g. loan guarantees) 3. Government revenue that would be otherwise due but is foregone (e. g. tax exemptions) A tax subsidy is any form of subsidy from which the recipients receive benefits through the tax system, such as reductions in taxes on profits. 4. Government provision of goods or services other than general infrastructure  27  A government may offer a subsidy for the production of a given product or service.  A government gives this subsidy to encourage specific  development within an industry. 5. Government payments to a funding mechanism or government, or directions to a private body to carry out any of the foregoing functions. 4.2 Subsidies From China and Indonesia In this chapter, I will describe the subsidies I found from China and Indonesia. Exporting companies from these two countries received similar subsidies from their own government. During my research I found these companies received government loans, energy subsidies and plantation subsidies. When investigating subsidies from China and Indonesia, United States International Trade Coniinission(USITC) also found different subsidies from these two countries. As I will show them later, USITC found the Chinese company Chenming. Ltd received grants, government provided loans, and tax expenditure from Chinese government. USITC found the Indonesian company Asia Pulp & Paper(APP) is supported government provision of standing timber, debt forgiveness, government log export ban, government provided loans and subsidized funding for reforestation.  28  4. 3 Government Loans A government can use different types of subsidies to help its industries and companies(Bull,  One direct way to provide a  2005).  In non—market economy countries,  subsidy is to offer low—cost loans.  direct subsidies are much easier for a recipient to use because both the recipient (such as a paper company) and the lender (such as a bank, or state—owned banks in general) belong to the country. One of the most important characteristics of the Chinese paper industry is the extent to which it remains state—owned; some of the biggest enterprises in China’ s paper industry still belong to either the central or local government.  Although reforms beginning in 1978 and gaining  strength through the 1990s have transferred ownership of some of the big paper companies  from central  to  local  ’ private paper 3 government,  companies remain relatively insignificant to the country’ s paper industry.  One of the objectives of the reforms has been to create some  private paper companies—but no more than 50% of the total number. Although China consequently has more than 1000 state—owned paper mills and ten times more private ones, the privately owned paper companies are not as large as the state—owned ones.  Moreover, in recent years, the  Chinese government has been trying to close small companies: 1000 small  31 See China Central Government  “How to reform state—owned big firms”  (2005).  29  paper mills, most of them privately owned, have been closed, ostensibly for reasons of environmental protection.  32  China’ s industrial development has been directed and managed by According to the  the central government through its Five—Year Plans. government, the goal of the Five—Year Plans is to  “arrange national key  construction projects, manage the distribution of productive forces and contributions to the national economy, development, and set targets. The  10th  Five  map the direction of future  “  Year Plan for National  Economic  and Social  Development, covering the period 2001—2005, calls for the “establishment “  of a number of large companies and enterprise groups. achieve this goal,  ‘  In order to  big state—owned paper companies are eligible for  various tax exemptions and reductions such as income tax reductions to support  their  exporting  business.  The  U.S.  International  Trade  Commitment (USITC) has made a clear investigation of this tax exemption. I will discuss the tax rebates in more detail at the end of this chapter.  32 See China Paper Industry Annual Report, 33  See  1996—2006.  “China’ s Subsidization of its Forest Products Industry, Key Findings,  “  U. S. Forestry and Paper  “  U. S. Forestry and Paper  Association, 2004 (1—5). 34  See  “China’ s Subsidization of its Forest Products Industry, Key Findings,  Association, 2004 (1—5).  30  How many benefits do Chinese paper producers receive from the government?  The Chinese government offers several different types of  subsidies in the forms of loans and government grants to its paper industry. To expand its paper industry, the government invested more than $4 billion (USD) between 2001 and 2005.  Using this money, the Chinese paper industry  increased its paper and pulp production capacity by 15% in this period. Fourteen million tons of paper and 1. 5 million tons of pulp were produced. Furthermore, the central government has subsidized the interest of loans provided to paper companies to update their technology. 2002,  Between 1998 and  the Ministry of Finance offered $1.67 billion  (USD)  for 21  state—owned paper—processing projects, which the government believed would quickly raise China’ s ability to compete with foreign companies. By 2010, the Chinese government will have assisted 42 projects in this way. Subsidies in Indonesia In Indonesia,  the government has provided substantial capital  subsidies to the paper industry.  These subsidies have enabled producers  to sharply discount their investment and production costs. have  The subsidies  taken the forms of discounted loans from state—owned banks,  allocations from off—budget pools of finance, and generous tax deductions, according to clear findings in the U. S. International Trade Commission’ s  35  See People’ s Daily:  “The 10th Five ‘[ear Plan Report,  “  2006.  31  final report on the subsidies Indonesian firms received when exporting coated free—sheet paper to the United States.  36  Since the late 1980s, Indonesian pulp and paper producers have heavily benefited from the government’ s policy.  The government allows  pulp and paper producers to pay much less than market price to buy tropical hardwoods (under US$ 2. 50 per m3 compared to a market price of US$ 3. 7 per m3).  Moreover, being able to purchase large volumes of wood from  harvesters cutting down natural forests instead of plantations reduces Indonesian pulp and paper producers’  costs by 20% to 30% compared with  their North American and European competitors.  4.4 Energy Subsidies The cost of energy (such as electricity) is a large part of the paper industry’s production costs.  By definition, any measure that keeps  prices for energy consumers below market levels or prices for energy producers above market levels, or that reduces costs for consumers or producers, may be considered a subsidy.  Energy subsidies are most common  for electricity and natural gas costs. In recent years in China,  energy subsidies have increased as  domestic controls avoid passing on to final consumers international rises  36  See Indonesia Pulp and Paper Association.  37  See Indonesia Pulp and Paper Association.  32  in energy prices.  Such international increases have been significant:  in 2007 alone, electricity prices increased by RMB 2. 52 fen per kwh (0. 31 of a US cent) in China. In China, electricity subsidies are one of the important ways that the government supports its state—owned companies.  A “wise government  should have electricity subsidies (for its state—owned companies) to develop both state—owned companies and its electricity industry. Since China has frequent energy shortages, electricity consumption is an important cost for some big electricity consumers such as the paper industry.  In the first quarter of 2008, 459. 5 billion kwh were used by  the paper industry, up 11.8%. competitive  in  the  Thus, to make its paper products more  international  market,  the  Chinese  government  subsidizes both the paper—production companies and the electricity producers. In China, the electrical industry is a monopoly, which makes electricity very expensive (for industries, the 2005 wholesale price was RMB 0. 5 yuan per kwh, which is about seven cents U. S., compared with the 2005 price of 5.73 U.S. cents in the United States  ).  However,  state—owned companies with assets of more than RMB 100 million yuan (US$  38  See China Huaneng Electricity Co. Ltd.  39 See  “China Energy Report,  “  “Electricity Consuming Report 2007.  Jiangsu University.  33  14.4 million) 40 generally obtain subsidies.  Small private electricity  companies, in contrast, are less likely to be subsidized. The Chinese government rarely lets outsiders know the various amounts of subsidization electricity factories receive or how much it subsidizes  the  electrical  expenses  electricity—consuming companies. reformed several years ago,  of  big  state—owned  Although the electricity industry was  local governments continue to run these  enterprises the same way that the central government did before.  The  central government has therefore admitted that the reform is not as successful as the central government expected it to be; the reform has only transferred ownership of some electricity companies from the central government to local governments. Electricity Subsidies in Indonesia In Indonesia, the budget for subsidizing electricity has increased significantly since the 1998 economic crisis and increased the deficit of the national budget considerably.  “  The International Monetary Fund (IMF) believed that electricity subsidization since 1998 has caused significant pressures on the national budget.  As a result, the Indonesian government has raised a lot of its  40 See China Central Government 41 See  “How to Manage Big and Advantaged State—owned Companies.  “Government of Indonesia (GOT) Report”  ,  1997.  34  electricity prices.  For Indonesia’ s large industries, including the  paper industry, energy costs rose from 94Rp/kwh to a peak of 234. 5Rp/kwh. In the U. S., the average price that industries pay for electricity is U. 5. 6. 25 cents per kwh.  42  Electricity is subsidized differently in Indonesia than in China. Since Indonesia is a market economy country, it revised its Government Regulation No. 10/1989 pp No. 3, 2005, a regulation pricing electricity to favor small companies: small privately owned operations pay only 86. 5Rp/kwh for electricity, medium—sized private—owned companies pay on average 101. 5Rp/kwh and at most 250Rp/kwh, while the average cost for private owned companies  large,  is 94Rp/kwh and their peak price,  234. 5Rp/kwh 43 (Beca Worley International 1990).  4.5 Plantation Subsidies 4. 5. 1 Subsidies in China’ s Paper and Tree Plantation Industries The Chinese government has set ambitious expansion targets for its wood processing industry for the past five years.  In fiber resources,  China will develop 13. 33 million hectares of fast—growth, high—yield  42 See Beca Worley International,  43 See Sudja:  Century,  “  “Update Report on Captive Power in Indonesia.  “Electricity Power Supply in Indonesia: Developing Plan and Major Issues Toward the 21st  1989.  35  plantations in the next 10 years, which required $8.65 billion USD of investment. One of the most important policies that the central government has developed in order to meet these targets is its plan to devolve decision—making power  for  approval  of  new  investments  to  local  governments: that is, the central government plans to offer development aid such as tax, financial, and trade measures in local regions.  Local  government will use these means of support to develop their own tree plantation  industries.  The  details  of  governments  finance  and  investment policies in this matter are as follows: a) The Ministry of Finance has set aside $1.73 billion (USD) in interest—rate subsidies for the development of fast—growth, high—yield plantations by 2015. b) A further $1. 67 billion (USD) in interest rate subsidies has been provided by the Ministry of Finance for technological renovations of 21 state—owned paper—processing projects across China from 1998 to 2002. c) Policy banks’  low—interest loans and long repayment terms have  given fast—growth, high—yield plantation projects loans at 90 percent of the standard rate and with repayment terms of between 10 and 15 years, as opposed to China’ s conventional 3 to 5—year repayment periods.  36  4.5.2 Subsidies in Indonesia The main step that the Indonesian government has taken to support its paper and wood plantation industry is to provide substantial capital subsidies to paper producers, including the sale of pulpwood fiber at costs well below its stumpage value (Barr 2000).  However, since the early  l990s, the Ministry of Forestry has also provided companies establishing plantations with heavily discounted financing and equity capital through allocations from the government’s Reforestation Fund, Dana Reboisasi (DR). Plantation companies can obtain loans from the DR to finance up to 32. 5 percent  of  their  expenses.  This  arrangement  effectively  allows  plantation developers to commit only 21 percent of the overall investment from their own funds. The auditors Ernst & Young determined in 1999 that the government provided over Rp 1 trillion in DR monies to subsidize the development of 10 pulpwood plantation projects in 1998.  The Ernst &Young report also  found that many recipients of plantation subsidies have been able to manipulate the process through which the DR monies are allocated so as to further reduce the portion of their projects that they fund with their owncapital.  Most commonly, plantationcompanieshaveoverstatedthenet  area to be planted when applying for the DR funds.  Thus, for instance,  in the case of a plantation company that develops only 90 percent of the planted area for which it applied for DR support, without an adjustment  37  for the distribution of funds the portion of the project’ s total costs covered by DR monies rises from 46. 5 percent to 51. 7 percent.  The Ernst  & Young audit concluded that overestimation of HTI (Hutan Tanaman  Industri,  meaning  “fast-wood  plantation”) planted  areas  and  similar  irregularities resulted in the loss of US$ 223 million from the DR fund between 1993 and 1998. Table 4. 1 Summary of DR Reforestation Fund Allocations to Pulpwood Plantation Companies, 1998  Company  Affiliated Pulp Mill  Government Grant (Rp  ‘000bn)  Zero Interest Loan —  (Rp Musi Hutani Persada  (Rp  Total (Rp  ‘000bn)  ‘000bn)  ‘000 bn)  51.9  127.4  164.6  343.9  Surya Hutani Jaya  36. 6  90. 5  61. 7  188. 8  Menara Hutan Buana  43. 5  100. 9  0. 0  144. 4  ITCI Hutani  28.0  88.9  0.0  116.9  25. 0  58. 1  0. 0  83. 2  Acehnusa Indrapuri  13.0  30.2  0.0  43.2  Adindo Hutani Lestari  12. 4  28. 8  0. 0  41. 2  Pendi Hutani Lestari  20.1  11.9  0.0  31.9  Tusam Hutani LEstari  7. 5  17. 4  0. 0  24. 9  Tanjung Redeb Hutani  PT TEL  Commercial Loan  Kiani Kerts  38  Company  Affiliated Pulp Mill  Government Grant (Rp  ‘000bn)  Zero Interest Loan —  (Rp  Finantara Intiga  Kiani Kerts  Total  Commercial Loan (Rp  Total (Rp  ‘000bn)  ‘000bn)  ‘000 bn)  11. 6  11. 6  0. 0  23. 1  249. 6  565. 7  226. 3  1041. 6  Source: Ernst & Young, 1999  In addition, Indonesia’ s seven state—owned banks have subsidized the development of some pulp and paper mills through the provision of discounted financing.  Companies that have close relationships with the  government can obtain loans from these banks at much lower interest rates than at commercial banks.  4. 6 Subsidies Determined by the U. S. Department of Commerce in the CVD Case On October 25, 2007, the U.S. Department of Commerce published notices in the Federal Register of its final determinations that countervailable subsidies were being provided to certain producers and exporters of coated free—sheet paper in China, Indonesia, and Korea.  A  summary of the determined net countervailable subsidy rates in China follows:  39  Table 4.2  U.S. Department of Commerce Determinations of  Countervailable Coated Free—Sheet Paper Subsidy Programs Provided to Shandong Chenming Ltd, China  1 2  3 4 5 6 7  8 9  10  11  12  Subsidy Program  Type  “Other subsidies” for_Chenming State Key Technology Renovation Project Fund Clean Technology Production Fund Famous Brands Policy loans  Grants  “Two Free/Three Half”__program Income tax exemptions programs for FIEs based on location Local income tax exemption and reduction_program Income tax credits on purchases of domestically produced VAT rebates on purchases of domestically produced equipment VAT and tariff exemptions on imported_equipment Domestic VAT refunds  Net Subsidy Rate (percent ad val or em) 4. 11  Grants  4. 11  Grants  4. 11  Grants Government— provided loans Income tax  4. 11 4. 11  Income tax  0. 76  0. 76  0. 76 Income tax Income tax  0. 76  VAT  1. 51  VAT  1.51  VAT  1. 51  40  Subsidy Program  13 14  15  16  17  18  19  20  21 22 23  Direction adjustment tax on fixed assets Income tax exemption program for export—oriented_FIEs Corporate income tax refund program for reinvestment of FIEs Preferential tax policies for FIEs engaged_in_forestry Preferential tax policies for enterprises engaged in_forestry Special Fund for projects for the protection of natural forestry Compensation Fund for Forestry Ecological Benefits Discounted loans for export—oriented enterprises Subsidies for input suppliers Debt—to—equity swap for_APP_China Exemption from payment of staff and worker benefits for export—oriented enterprises  Type  Income tax  Net Subsidy Rate (percent ad valorem) 0. 76  Income tax  0. 76  Income tax  0. 76  Income tax  0. 76  Income tax  0. 76  Grants  4. 11  Grants  4. 11  Government—pr ovided loans  4. 11  (1)  (1)  (1)  (1)  (1)  (2)  41  Subsidy Program  Type  Total net subsidy rate  7. 41  Net Subsidy Rate (percent ad valorem) 44. 25  Not applicable/available. Program determined to be terminated  (1) (2) Source:  “Commerce CVD Issue and Decision Memorandum”  for China, October 17 2007  (3—16).  The following table shows the U. S. Department of Commerce’ s determination of the subsidies received by TK/PD in Indonesia:  Table 4. 3 TK/PD Subsidy Programs Investigated by the U. S. Department of Commerce, and Rates for Those Found to be Countervailable  .  Subsidy program  1 2 3 4  Government of Indonesia ( “GOT” ) provision of standing timber for remuneration GOT’ s log export ban (1) Subsidized funding for reforestation: “Zero interest” rate loans Debt forgiveness through the GOT’ s acceptance of instruments that had no market value  Net subsidy rate for TK/PD (Percent ad valorem) 14.21 3.11 01 0. 75  42  Net Subsidy Rate For TK/PD Percent ad valorem)  .  Subsidy program  /  forgiveness through SMG/APP’ 4 40 Debt buyback of its own debt from GOT Subsidized funding for reforestation: 6 government capital infusions into (2) joint venture forest plantations Subsidized funding for reforestation: 7 (3) commercial rate loans Total net subsidy rate 22. 48 Because enforcement of forestry laws has become difficult in (1) Indonesia, the GOT uses this ban on export to control over—harvesting and illegal logging. Program determined to be not countervailable. (2) Program determined to be not used. (3) Source:  “Commerce CVD Issue and Decision Memorandum”  for Indonesia, October 17,  2007, pp. 18—47.  According to the report mentioned above, the Department of Commerce primarily targeted direct subsidies.  Tables 4.3 and 4.4 indicate two  important facts: that the Department of Commerce was able to quantify many grants and government—provided loans; and that tax expenditures play a major role in both Indonesia and China.  Companies, especially  state—owned companies or those that have close political relationships with the government, can receive subsidies through the tax system.  As  the tables above show, tax deductions for employees (such as income tax deductions) or exemptions from consumption taxes (such as VAT deductions) allow enterprises to benefit from the tax system.  43  However, the USITC did not choose to target China’ s electricity subsidies in their report because it is difficult to accurately identify and quantify subsidies in the absence of market—based prices and costs: both paper producing companies and electricity companies belong to the country, so the real price the paper producers pay for electricity is not transparent.  Furthermore, that price is unrelated to both the cost of  the electricity and demand—supply relationships.  Therefore,  it is  virtually impossible for outside investigators to quantify the subsidies these industries receive, as the U. S. Department of Commerce eventually admitted. Nevertheless,  the Department’ s report was able to identify  differences between China and Indonesia in how subsidies are distributed. In China, subsidies are used to develop big state—owned companies and are given directly to those companies.  In Indonesia, however, the government  is trying to develop the entire industry rather than individual companies. Thus, the subsidies Indonesia’ s APP has received are mostly for the government’ s reforestation program, not for particular companies.  For  this reason, the Indonesian economy can be said to be run more like a market economy than the Chinese economy.  44  CHAPTER FIVE:  THEORETICAL MODEL  5. 1 Introduction  My analysis in this thesis is based on the linear Cournot model of strategic trade that was developed to try to explain whether subsidies from a non—market economy might affect trade differently than those from a market economy.  For a long time,  subsidies, especially effective  subsidies, have been commonly used as a tool of international rivalry in western economies.  More recently, however, some non—western, non—market  economy countries have started to use subsidization to support their exporting companies. Export subsidies are a very important form of policy in the paper industries of China and some other countries.  Big international traders  like China tend to subsidize their paper producers more heavily than smaller countries do.  Nevertheless, as considerable research has shown,  in some small countries subsidies function as efficient weapons of international trade if the domestic price for a product is set well above world levels and surplus production is dumped onto the world market. Basevi (1970) found that a domestic monopolist can benefit by exporting a product, a conclusion related to the later work by Spencer and Brander into how national governments can help domestic companies expand their market shares in profitable areas (1983) and to the Brander—Spencer Model  45  (1984), a basic tool for analyzing export subsidies.  Other analysis has  investigated how the market is distorted by subsidization (Bhagwati 1971) and how export subsidies may actually arise from a government’ s desire to distort the market so as to exploit market power in another good (Itoh and Kiyono 1987).  5. 2 Paper Importation into the U. S.  The market for coated free—sheet paper in this case is an oligopoly. As noted above, American imports of coated free sheet paper from China and Indonesia are most heavily concentrated on the west coast.  In 2005,  these imports into the U. S. made up 66. 3% of the country’ s total paper imports from China, and 52. 8% of its total paper imports from Indonesia. U. S. imports of coated free sheet paper from Korea were also concentrated on the west coast.  Meanwhile, the American domestic supply of coated  free—sheet paper was concentrated east of the Rocky Mountains; there was only one large producer on the west coast, in Oregon.  Because so much  of the coated free—sheet paper supply in the U. S. is imported, changes in the volume or price of imports from any of these three countries might affect the price that American importers and consumers pay.  46  Fig 5. 1  U. S. Imported Coated Free—Sheet Paper From China, Indonesia, and Korea (Volume: Short Tons)  600000 500000 400000I 300000  FI China • Indonesia D Korea  2000001000002004  2005  2006  Source: USITC 2004—2006  5. 3 The Model When I was building my theoretical model, I chose the simplest possible way to represent the situation. companies,  I supposed there to be two  one from a non—market economy,  China,  and one from a  market—economy, Indonesia, exporting coated free sheet paper to a third country, the United States.  Each of the exporters is trying to maximize  its profit. For this model,  I assumed that firm behavior is a simple Nash  quantity (Cournot) duopoly: the two exporting companies produce identical 47  products.  I also assumed that since the Chinese company is state owned,  the Chinese government will control its exports.  Furthermore, I assumed  that the Indonesian company sells its products in both Indonesia and the My final assumption was that the governments in both  United States.  exporting countries understand the structure of the industry and are able to set a credible subsidy on exports in advance of the quantity decision made by the companies. Let’ s start by reviewing the basic Brander—Spencer model on which my model is based.  Suppose there are two foreign companies, X and Y,  exporting a good to the third country, Home.  The profit function can be  written as follows:  H x (x ; y; Sx) = XP (X+Y) fly  (x ; y; Sy) = YP (x+Y)  —  —  XC + XSx  (5. 1. 1)  Ycy + YSy  (5. 1. 2)  Where H is the profit of the company. X and Y are the exporting quantities of companies X and Y. Cx and Cy are the constant marginal costs for companies X and Y.  Sx and Sy are the per unit subsidies that companies X and Y receive from their governments. P(X+Y) is the price of the good in the Home market.  Also, we can assume linear demand, so  P (X+Y) =  a  -  b (X+Y)  (5. 2)  48  I have  lix (x ; y; si)  =  X(a—b (X+Y))  fly (x; y; S2)  =  Y (a—b (X+Y))  -  -  XC  +  XSy  (5. 3. 1)  YCy  +  YSy  (5.3. 2)  In order to maximize the profit, I have the first order condition That is, marginal  over the quantity of function (5. 1. 1) and (5. 1.2). revenue equals marginal cost.  The first order condition can be  rearranged to give the reaction functions:  Y  QcSc  2b  2  2b  2b  2b  2  2b  2b  541 (.  (5.4.2)  Notice that the reaction function is downward sloping, as shown in the following figure:  Fig 5.2 Basic reaction functions  Y a  Cc  Sx  a  csy  2b  2b  2b  I  Y*  0  a 2b  S Cc 2b2b  a  q,,  b  b  b  x  49  In figure 5. 2 curves X’ and of companies X and Y.  *  represent the reaction functions  These two curves intersect at point 1.  Figure 5. 2  shows that for both companies, an increase in subsidy creates an increase in quantity exported. Both X and Y want to maximize their profit.  However, the reaction  functions indicate that an increase in one company’ s exports causes a decrease in the other company’ s exports.  Only at point 1 can these two  companies reach equilibrium (Nash Equilibrium): at this point alone, both companies can maximize their profits. Going back to the coated free—sheet paper case, the company I have chosen to discuss from China, Chenming Ltd, it is a state—owned company. The percentage of output being allocated to the Chinese domestic market is fixed by the government’ s political policy.  Also, as a non—market  economy country, the central government has fixed administrative prices for some of the important industries such as the paper industry.  That  is, the domestic price of coated free—sheet paper is also fixed.  From  the basic functions (5.3. 1) and (5.3.2),  the new profit function for  Chenming Ltd is the following:  Hx(x;y;sx)  =  PcXc+X(a—b(X+Y))  -  XCx-XcCx + XSx  (5.5.1)  Where Pc is the fixed administrative price in China’ s domestic market.  50  Xc is the fixed quantity of coated free—sheet paper Chenming Ltd offers in China’ s domestic market. X is the quantity of exporting coated free—sheet paper to the U. S. market. Suppose there are a fixed percentages of coated free—sheet paper made by Chenming Ltd selling in the Chinese domestic market.  From  function 5. 5. 1, I can have: a (X  +  Xc)  =  Xc  (5. 5. 2)  That is: (5.5.3)  1-a  Putting the equation 5. 5. 3 back into 5. 5. 1, I could have:  H x (x; y; Sx)  =  Pc a  1—a  X + X  (a—b (X+Y))  -  XCx  -  Cx  a 1—a  X +  XSx  (5.5.4) The other company I have chosen to discuss as competing in the U. S paper market against Chenming is the Indonesian company Asian Pulp & Paper Ltd (APP).  In order to simplify the model, I consider only its exporting  quantity:  Hy(x;y;sy)  Y(a—b(X+Y))  -  YCy+YSy  (5.5.5)  As I did before, in order to maximize the profit, I can obtain the following result from (5. 5. 1) and (5. 5. 2) by using the first order condition: a 1 -a 2b  a  2b  2  2b  2b I —a  2b  (5.6.1)  51  y* 2b  2  2b  (5.6.2)  2b  I will also show equations 5. 6. 1 and 5. 6. 2 in the figure following:  Fig 5. 3 New Reaction Functions  Y a B 1—ab  +  a b  —  a 2b  —  O’ b  —  2b  Oc b  2b  1*  0  1-aPca a 2b 2b  In figure 5. 2, curves X* and  *  of the two companies, Chenming and APP. 1*.  Cc  2b  Cc  a  2b  b  OjSy b b  x  represent the reaction functions Two curves intersect at point  Figure 5. 2 shows that for both companies, an increase in subsidy  causes an increase in exporting quantity,  and that an increase in  exporting quantity by one company decreases its competitor’ s exporting quantity.  Also, an increase in China’ s domestic price will increase its  exporting quantity. 52  The Chinese government could use either Pc or Xc as a subsidy instrument.  If it uses domestic price as the subsidy instrument, the  increase of the domestic price decreases the domestic consumer surplus. If the Chinese government uses Xc as the subsidy instrument, the increase of Xc increases the domestic consumer surplus.  Using either Pc or Xc  increases the profit of the company. At point 1* these two firms meet their equilibrium: neither company increases its exporting quantity.  At this time both companies can  maximize their profits.  53  EMPIRICAL MODEL  CHAPTER SIX:  In this chapter, the theoretical model in chapter 5 is estimated using empirical methods.  The chapter first discusses the data and then  presents the empirical model.  6. 1 Importing of U. S Coated Free—Sheet Paper 6. 1. 1 Preliminary Department of Commerce Finding of Unfair Dumping of Coated Free Sheet Paper From China and Indonesia In  March,  affirmative  2007,  preliminary  the  Department  determination  of Commerce in  the  announced  countervailing  its duty  investigation of imports of coated free—sheet paper from China, Indonesia, and Korea. that  The Department also announced the preliminary determination  Chinese producers/exporters  subsidies  ranging  from  10. 90  had received net to  20. 35  percent,  countervailable and  Indonesian  producers/exporters had received 10.85 percent subsidization. Harmonized Tariff Schedule of the United States  (HTSUS)  The  currently  classifies coated free—sheet paper under subheadings 4810. 13. 1900, 4810. 13. 2012, 4810. 13. 2090, 4810. 13. 5000, 4810. 13. 7040, 4810. 14. 1900,  44 USITC “Coated Free Sheet Paper From China, Indonesia and Korea” Investigation Nos. 701—TA—444—446(Final)  and 731—TA—1107—1109(Final).  54  4810. 14. 2010, 4810. 14. 2090, 4810. 14. 5000, 4810. 14. 7040, 4810. 19. 1900, 4810. 19. 2010, and 4810. 19. 2090. 6. 1. 2 Total Imports of Coated Free Sheet Paper From China and Indonesia In the U. S.  domestic market for coated paper, production has  increased over the past 30 years.  Coated groundwood paper capacity in  the United States grew at an average compound annual rate of 2. 7%, from 2. 01 million tons in 1970 to 4. 51 million tons in 2000.  Coated free—sheet  paper production grew as fast as that of coated paper in general.  From  1970 to 2000, U. S. coated free—sheet paper output more than doubled. Coated free—sheet paper is generally at the highest—value end of the printing— and writing—paper spectrum. At the same time as domestic production has been increasing, the United States has also been importing coated free sheet paper from abroad.  Exports to the  United States from 2004 to 2006 are presented in table 6.1.  Table 6. 1  Coated Free Sheet Paper Imports into the U. S. Market  Exporting  Volume(short tons)  Country  2004  2005  2006  China  146373  175869  334685  Indonesia  35876  48089  80116  (metric tons)  55  Exporting  Volume(short tons)  Country  2004  2005  2006  Korea  480727  452480  516632  Canada  303728  301898  159784  Finland  235536  168281  223942  Germany  209754  146822  186108  U. S.  4839651  4926891  4973370  Source: USITC:  Coated Free Sheet Paper From China,  Indonesia and Korea  (Final  Investigation)  6.2 Empirical Model To analyze the Chinese state—owned company and the Indonesian privately owned company, I use three stage least squares estimation (3sls) because 3sls is more efficient in dealing with endogenous variables; at the same time, 3sls can separately describe market demand and supply conditions. 6. 2. 1  Estat Durbinalt Test Estat Durbinalt test performs Durbin’ s alternative test for serial  correlation in the disturbance. residual serial correlation.  It tests the need for adjustment for  In this section, I try to test in two steps  by separating the Chinese and Indonesian companies’  exporting quantities.  For both steps I will first predict these companies’  exporting quantities,  56  run OLS regressions, and find their Estat Durbinalt quotients. The results are the following:  Table 6.2 Estat Durbinalt I (Chenming’s Exporting Quantity)  > chi2  [as  I 0. 11 1 Table 6.3 Estat Durbinalt II (APP’s Exporting Quantity)  Lags 1  Prob > chi2 0.894  The tables above show that the Probability > Chi2 is much greater than zero, which makes us feel comfortable about going into 3sls regression. 6.2.2 Review of the Theoretical Model In this chapter, I build my empirical model from the theoretical one described in the last chapter:  P=a  -  b(X+Y)  a 1—a2b  2b  2  2b 2b  (5.2)  2  2b  2b1—a  2b  2b  (561)  (5.6.2)  I use the following data in my empirical model.  57  6. 2. 3 The Data To compare how Chinese and Indonesian subsidies help exporters in those countries, I consider every related factor.  Chinese and Indonesian  exports are directly influenced by U. S. domestic prices in the coated free—sheet paper market, but they are also affected by GDP and workers’ salaries.  Since China is still a non—market economy country, many  state—owned companies’ exporting practices follow the country’ s overall economic trends.  In any country, regardless of whether it has a market  or non—market economy, the significant cost of workers’ how much a company exports. influenced by its GDP.  wages can affect  On the other hand, U. S. domestic prices are  All these factors will be shown in the model.  All the different types of data I collected are described quarterly from 2001 to 2007. model  Essentially, the subsidies data I use in my empirical  include how much the country supports the companies’  selling, and exporting activities.  production,  For Chenming Ltd, these subsidies  include production, technological development, brand support, government loans, tax decreases, and special funds for the development of plantations. For the Indonesian company, APP, the subsidies I factor into my empirical model include government loans, debt forgiveness, and special funds for plantation development. APP’ s quarterly reports.  These subsidy data come from Chenming’ s and American domestic prices, Chinese workers’  58  wages, and Indonesian workers’  wages come from the paper industry’ s  annual reports from the U. S., China, and Indonesia. Because paper export quantities are also affected by electricity The  costs, I include the price of electricity as a variable in my model. data for electricity prices come from China’ s and electricity industries’ Finally,  Indonesia  s  ‘  annual reports.  international  trade is always affected by foreign  exchange rates and interest rates.  Therefore, I also consider both as  important factors in my model.  I learned these two rates from China’ s  and Indonesia’ s central banks.  Table 6. 4 summarizes all of these data.  Table 6.4  Variables Chinese Exporting Subsidies Chenming’s Exporting Quantity China’ s GDP U.S. GDP U. S. Domestic Prices Chinese Workers’ Wages APP (Indonesia) Exporting Quantity Indonesian Workers’ Wages  Data Used in My Empirical Model  Observations 25  Mean 137667. 4  Std. Dev 72012. 94  Mm 34835  Max 256848. 4  25  13023.88  7160.89  3611  24701  25 25 25  35875. 12 11561.72 82364  12607. 9 1169. 661 6851. 27  19894 10022 71200  67767 13552 96300  25  3828. 651  750. 8656  2835. 2  5294. 4  25  8014. 92  4896. 023  1632  13539  25  2416.072  460.0488  1812.7  3299.4  59  Variables Indonesia’s GDP Indonesia’ s Exporting Subsidies  Observations Mean 567527.3 25 141388  25  Std. Dev 186351.9  Mm 347471  Max 915919  66261. 52  27200  221900  I have already mentioned the issues associated with applying countervailing duty laws to market and non—market economy countries.  In  my thesis, I try to find out whether there is a differential effect of subsidies on a non—market economy country (China) versus a market economy country (Indonesia). 6. 2. 4 The Model The semi—logarithmic function form is commonly used in econometrics because its coefficients represent useful concepts that are easily interpreted.  Generally, in a semi—logarithmic function, the  left—hand side (y value) is logged and the right—hand side (x value) maintains the original value.  In my model, that means I will choose as  log values Chenming’s Exporting Quantity, the U.S. Domestic Price, and APP’ s Exporting Quantity, while the rest of the data will retain their original values. After finding the log value, I can set up my 3sls empirical model. There are three endogenous variables in the model: the U.S. Domestic Price, Chenming’s Exporting Quantity,  and APP’ s Exporting Quantity (these  60  variables are derived from their log values).  The exogenous variables  are the following: theU.S. GDP, the Chinese exporting subsidies, China’ s GDP, Chinese workers’ Indonesian workers’  wages, the total Chinese exporting quantity,  wages, Indonesia’ s GDP, and Indonesia’ s exporting  subsidies (derived by using their original values). The empirical model will follow the theoretical model in the last chapter using Chenming Ltd from China and APP from Indonesia as data sources.  X and Y represent the exporting quantities from Chenming and  APP, respectively. The subsidies here are the subsidies that Chenming and APP received from their governments to support their producing and their selling, including their exporting.  According to Chenming’s quarterly report,  that company’ s subsidies include grants, government—provided loans, and income tax and VAT subsidies.  For APP, the costs of exporting, C(x) and  C(y), include the wages these two companies paid their workers and their electricity costs.  Since electricity is an important resource in the  paper industry, I consider it to be an important component in the cost. The price in my empirical model, P(x+y), is the U. S. domestic price of coated free—sheet paper.  Since the whole paper industry, like any  other industry, closely reflects overall American economic trends, I will use the U. S.  ‘  s GDP as a factor that influences the price of U. 5, domestic  61  coated free—sheet paper since it represents the market demand for coated free—sheet paper in the U. S. Because I am interested in the excess supply of paper from Indonesia and China, I need to control for fluctuations in domestic demand; therefore, I include GDP in my empirical model. From the theoretical model,  P  =  a  b(X+Y)  -  a 1—a 2b  2b  (5.2)  2  2b  a 2b I -a  2b  aXCY.SY 2b 2 2b 2b  (561)  (5.6.2)  I can build my theoretical model:  P= ao+ oX+ yoY+öoKo+eo  (6.1.1)  X= a.i+ iY+ yiC(x) + iS(x) + iTi +iKi+cj (6.1.2) Y  2X+  U2+  12C(y) +  2S(y) +c2’r2 +fl2K2+C2  (6.1.3)  Where P is the U. S. domestic price for coated free—sheet paper. X and Y are the exporting quantities from Chenming Ltd and APP to the U. S. K represents other factors that might affect the U. S domestic price such as the U. S.  ‘  s GDP and domestic output in the first function and GDP alone  in the second and third functions. C(x) and C(y) are the costs for Chenming Ltd and APP.  62  Cost  =  Workers’  wages  +  Electricity Price  +  Interest Rate  Foreign  +  Exchange Rate (against the U. S. Dollar)  (6. 2)  S(x) and S(y) are the exporting subsidies Chenming Ltd and APP receive from their governments. T represents the time trend, since it is a time—series. From the results of the theoretical model presented in chapter five, I know that as Chenming’ s exporting quantity increases, APP’ s decreases. Also, government subsidies from both China and Indonesia have a positive effect on their exporting quantities.  Therefore, in my regression I will  test to determine whether Chenming and APP’ s exporting quantities are negatively  related  and  if  government  relationships with exporting quantity.  subsidies  have  positive  I will use the empirical model  and the factors mentioned above to calculate the regression and prove the results. The process of running the 3sls model is the following: The first step is to regress the U. S. domestic price (logged) over the U. S. GDP, because the first stage of the 3sls is to remove endogenous variables (the U. S. domestic price) from the actual estimate (Chinese or Indonesian exporting quantity). Two actual estimates are included in the model, one of Chenming’ s exporting quantity (logged value) (logged value).  ;  the other of APP’ s exporting quantity  Table 6.5 shows all the coefficients of the three steps  63  of running the regression.  My explanation of the results appears after  the table. 6.2.5  3sls Regression Before obtaining a result, I try to forecast the result of the  regression. According to the theoretical model and the basic economic theory, I estimate the result to be as follows: According to the basic supply curve, quantity and price have positive effects on each other, so in the first step, the coefficients of China’ s exporting quantity, Indonesia’ s exporting quantity, and U.S. output will be positive. The second and third steps are about the demand curve.  Subsidy  should have a positive effect on exporting quantity, while price should have a negative effect on exporting quantity.  Costs, including workers’  wages, electricity prices, interest rates, and foreign exchange rates, should have negative effects.  Finally, the exporting quantity of each  competitor should have a negative effect on the other’ s exporting quantity. Tables 6.5(1) and (2) provide two more equations which consider the potential for Chinese and Indonesian subsidies being endogenous.  64  Table 6.5(1) 3SLS Regression  Coef  Std Err  U.S Domestic Price U. S GDP —0. 384 —0.918 U.S. OUTPUT 20033. 8* CHINA’S EXPORTING QUANT ITY INDONESIA’S EXPORTING —6861. 785 QUANTITY Chenming’s Exporting Quantity  2. 932 1. 862 14321.4  Chinese Exporting 8. 03 Subsidy China’s GDP 6. 55* U. S. Domestic Price 3. 53* —0.00033* Workers’ Wages —0.00611 APP(Indonesia)’s Exporting Quantity —0.061* Time Trend —0.00538* China’s Electricity Price China’ s Exchange Rate —0. 025 against the U.S. Dollar 0.0298* Chinese Interest Rate  9. 30  5587. 578  1.48 1. 75 0.000075 0.044 0.0085 0.0022 0. 159 0.01  APP(Indonesia)’ s Exporting Quantity Indonesia’s Exporting Subsidy Indonesia’s GDP Chenming’s Exporting Quantity Time Trend U.S. Domestic Price Workers’ Wages Indonesia’s Electricity Price Indonesia’s Exchange Rate against the U.S. Dollar  6.72*  2.18  1.29 —0.04  9.53 1.14  —0. 06* —8.77 9. 3* 0. 28  0. 04 10. 8 3. 2 0.29  —0. 0003*  0.00007  65  Coef APP(Indonesia)’ s Exporting Quantity  Std Err  —0. 03  Indonesia’ s Interest Rate  0. 02  Table 6.5(2) 3SLS Regression  Coef U. S Domestic Price —0. 257 U. S. GDP —1.86 U.S. CAPACITY 32764. 09* CHINA’ S EXPORTING QUANTITY INDONESIA’ S EXPORTING —14266. 38* QUANTITY Chenming’s Exporting Quantity Chinese Exporting Subsidy China’ s GDP U. S. Domestic Price Workers’ Wages APP(Indonesia)’ s Exporting Quantity Time Trend China’ s Electricity Price China’ s Exchange Rate against the U.S. Dollar Chinese Interest Rate  I Std  Err  2. 57 1. 27 12530.95 4552. 956  8. 48*  1.07  1. 96* —3. 44 —0.000357 —0.04  1. 77 2. 79 0.000086 0. 06  —0.07 —0.0014  0.01 0.0021  0. 104  0. 152  0. 024*  0. 009  APP(Indonesia)’ s Exporting Quantity Indonesia’ s Exporting Subsidy Indonesia’ s GDP Changing’ s Exporting Quantity Time Trend  8.43*  1.89  1. 81 —O, 04  8.59 0. 74  —0.08  0.04 66  Coef APP(Indonesia)’ s Exporting Quantity  Std Err  —0. 000028* Ii. S. Domestic Price —0.00005 Workers’ Wages Indonesia’ s Electricity 0. 156 Price —0.0004* Indonesia’ s Exchange Rate against the U. S. Dollar Indonesia’ s Interest —0. 02 Rate Chinese Exporting Subsidy  8. 25e—06 0.0002 0. 189  0.97* Lag Chinese Exporting Subsidy China’ s GDP 0. 14 Indonesia’ s Exporting —0.01 Subsidy Indonesian Exporting Subsidy  0.098  Lag Indonesian Subsidy China’ s Exporting Subsidy Indonesia’ s GDP Note: The data with * is  0. 76* 0.23  0.00005  0. 12  0. 31 0.09  0. 12 0.28  0.09 0.009 its p—value less than 5% significance level.  From the two tables above I conclude that the results are fairly similar: that is, subsidy is not much affected by other factors.  I therefore  consider subsidy to be an exogenous variable.  6.3 Results and Explanation 6. 3. 1 Basic Analysis Table 6. 5(1) shows that some of the results have a different sign than I expected.  The first step shows that U. S. output and Indonesian  exporting quantity have negative effects on the U.S. domestic price: 67  perhaps the relatively low quantity of Indonesia’ s exports to the U. S. prevents Indonesia’ s exports from having a significant effect on the U.S. domestic market.  This step also shows that American output has a negative  effect on the U. S. domestic price, maybe because I have only 25 quarters of observations. In the second step, the Chinese interest rate has a positive effect on Chenming’ s exporting quantity, I believe because China’ s interest rate has changed little in recent years.  Also, as a big state—owned  company, Chenming might enjoy a lower interest rate than smaller companies in China.  The U. S. domestic price has a positive effect on Chenming’  s exporting quantity, which I think may also reveal a problem with the observations: over a short period, my calculation of the result might not accurately follow the demand curve. In the third step, the Indonesian workers’  wages have a positive  effect on the country’ s exporting quantity, which I think might be because APP changed its workers’  wages not in relation to its exporting  quantity but perhaps because of its total profit or other factors. The electricity price also has a positive effect on Indonesia’ s exporting quantity: I think APP might have received a different electricity price at some point because of the Indonesian government adjusting its policy on its paper industry.  This adjustment might not  be caused by an increasing in Indonesia’ s paper exporting quantity.  68  6.3.2 Subsidies The coefficient on subsidies from the empirical model follows that found in the theoretical model: that is, the exporting subsidies have a positive effect on exports from both countries, regardless of whether they have a market or non—market economy.  Meanwhile, as mentioned in previous  chapters, a non—market economy country such as China might have stronger government support for its exports than market economy countries.  The  reasons in this case are as follows: First of all, Chenming Ltd. has been a state—owned company since the 1950s.  Although its structure nowadays is stock—share holdings, its  largest share holder is China; therefore, the government naturally tries its best to support Chenniing, its own enterprise.  It is no surprise that  after the U. S. Department of Commerce declared that it had started to investigate the possibility of imposing CVDs against Chenming, almost all Chinese newspapers strongly opposed this investigation and tried to prove there had been no illegal subsidy in this case.  However, we must remember  that there are no privately owned newspapers in China. 3, 2007, the China Paper Industry Organization made  Further, on April “a strong protest,  asking the U. S. Department of Commerce to withdraw its policy.  “  The Department of Law in Beijing WTO Affair Centre said that,  according to the “unfair”  “discrimination  to  “rules from the WTO and U. S. domestic laws,  punish Chenming.  “  it was  These protests came out everywhere in  69  The opinions they voiced were virtually  China almost simultaneously.  as a matter of fact, I found no difference between the ideas  unanimous:  that appeared in published newspapers, documents, and declarations. There is no doubt that only a huge amount of subsidization for a state—owned company could have generated such uniform support. Another reason why the Chinese government gave so many subsidies to a state—owned company is that it wants such enterprises to make good profits abroad, not so as to give their workers better wages, but in order to support the Chinese  economy.  Because a Chinese state—owned company  can easily decrease its workers’ wages, it can reduce its production costs, allowing its exports to US will constitute a huge and inevitably damaging challenge to its U.S. rivals. But Indonesia is different.  APP is a private company, and so does  not have a strong influence on national development.  The Indonesian  government also subsidizes its companies less than the Chinese government. According to equations 6. 2 and 6. 3, =  S *13 Where  subsidy  =  S  *  dlnQ/dS  =  13  subsidy  (dQ/Q) / (dS/S)  =  dlnQ/dS, that is, (6. 3)  is the elasticity of the subsidy, S is the mean of the subsidy.  From tables 6. 2 and 6. 5, we can determine that Echina >  Indonesia  (6.4)  70  Because it is a non—market economy country, China offers more support to its big state—owned companies than market economy countries do, which in financial terms means offering more governmental subsidies. As  in  mentioned  market—economy  subsidy  the  country,  chapter,  Indonesia  however,  offers  because  subsidies  to  it an  is  a  entire  particular industry (such as the wood plantation industry) instead of particular companies.  As a result, big companies in Indonesia receive  less subsidization than their Chinese competitors.  6. 3. 3 Exporting Quantity According to table 6.5(1), we can form another equation: dQ(China)/dQ(Indoniesia) < dQ(Indonesia)/dQ(China).  That is, the effect  of APP on Chenming is not as great as that of Chenming on APP, which I think is a reasonable perspective: since Chenming is state—owned, its exporting activity depends more on government help than on market competition.  As a result, while APP cannot fully influence its exporting  quantity because it is not a state—owned company and so depends more on the market than Chenming, Chenming can determine its own exporting quantity. However, the effect here is not particularly significant, as even table 6.5(1) shows.  Table 6.5(2) shows that dQ(China)/dQ(Indomesia)  =  dQ(Indonesia)/dQ(China), which means in an unrestricted regression that the effect of either of the companies On the other is fairly similar.  71  6.3.4 Exports and U.S. Domestic Price From demand and supply curves, we know that when the market price goes up, the quantity supplied will go up as well.  The empirical model  shows this relationship strongly for Chenming’ s exports and for U.S. domestic capacity, but not for APP’ s exports.  My explanation for the  differing results is that I don’ t have enough data. Also, as it is a time—series equation and I have data for only 25 quarters, I may not have enough data for an accurate regression.  This is one of the limitations  of my thesis. 6.3.5 The Relation Between Chenming’ s and APP’ s Export Behavior The theoretical model shows that in a monopoly market, the exports of one company have a negative influence on those of another. We can see from the empirical model that  dQ/dQ < 0  and  that  dQ/dQ < 0  The R—Square results of 3sls in this chapter are the following: Table 6. 6 R—Square Equation U. S. Domestic Price Chenming’ s Exporting Quantity APP(Indonesia)’ s Exporting Quantity  Obs 25 25  R—Sq 0. 5337 0.6476  25  0.8513  72  6.3.6 Sensitivity Analysis According to tables 6. 5(1) and 6. 5(2), the coefficient sensitivity is comparable,  Kowever,  table 6.5(1) has a restriction: I consider  subsidies both from China and Indonesia as exogenous variables. contrast,  In  the regression of 6.5(2) is unrestricted because I consider  subsidies as an endogenous variable. different from table 6.5(2).  Yet table 6.5(1) seems not much  Therefore, we can accept the results of  table 6.5(1).  73  CHAPTER SEVEN:  SUMMARY AND CONCLUSIONS  7. 1 Suniinary Countervailing duty laws allow the U. S. government to investigate and offset subsidies received by foreign companies. However, the method that the U. S. uses to measure the amount of subsidization a foreign company has received makes it more practicable for the U. S. to  investigate a  foreign company from a market—economy country than its counterpart from a non—market economy country. That is the reason that until the case Coated Free Sheet Paper From China, Korea and Indonesia, the U. S. government did not take any countervailing duty actions against a company from a non—market economy country. Although China is still a non—market economy country, today China is far from what it was before the 1980s, and indeed the early 1990s. Because of how China has started to resemble a market economy country in some respects, the United States International Trade Administration therefore decided that it could investigate relevant subsidies in the case of coated free—sheet paper imports from China. The final affirmative determination was made on October 18, 2007, when the ITA found that Chinese exporters had received net countervailable subsidies from their government ranging from 7. 40 to 44. 25 percent. a result,  legislation seeking to apply countervailing actions  As to  th non—market economy countries was introduced in the 110 congress.  74  The results from my theoretical models confirm that subsidies can support a country’ s exports, even if it is a non—market economy country. The empirical models also allow the same conclusion.  Moreover, they  indicate that the subsidies a company receives in a non—market economy country affect competitors in a market economy country, which makes importing countries such as the U. S. anxious to find an effective means of protecting their own domestic industries. Using countervailing duty laws against non—market economy countries seems to be such an efficient action. In general, legislation should change when the situation changes. China,  like various other non—market economy countries,  changed its  economic system long before the collapse of the Soviet Bloc in the early l990s. It is still not a real market economy country, but the question of how the United States and other  “old market” economy countries should  deal with these so—called “semi—market—economy”  countries is a serious  challenge—or alternatively, a big opportunity.  7.2 Limitations and Further Studies The results determined from the empirical models confirm the conclusion provided by the theoretical models.  However, one of the  difficulties I met with when building the empirical models was that I could find only limited data. China’ s economic growth has outstripped its  75  statistics. That is why people sometimes do not believe the Chinese government’ s claims in regard to its economic development.  Another  limitation is that since these are time—series models and I was able to collect data from only 2001 to 2007, my models might not yield as accurate results as they may have if I could have collected data from a longer period. Further research within this  field should  focus  on other  non—market economy countries, since their economies are similar China’ s. Some of them have developed extremely rapidly, so their exporting quantity is much greater  than before.  Their subsidies, meanwhile, remain hard  to measure.  76  REFERENCES Asia Pulp & Paper Co. Ltd.  2001—2007.  Asian Pulp and Paper Monitor. 2007. Pulp and Paper Markets. January. Baylis, Kathy. Trade Policy.  2007.  Quarterly and Annual Reports.  Analysis and Forecasts of the Asian  Countervailing Duties. Handbook of International  Barr. Nicholas. 2000. Reforming pensions: Myths, truths, and policy choices. IMP Working Paper No. 00/139. Basevi, Georgio. 1970. Domestic Demand and Ability to Export. Journal of Political Economy 78, No. 2: 330—337.  The  Beca Worley International. 1990. Report on Private Power Generation in Indonesia: Indonesia Power Planning Project. Brander, J. and B. Spencer. 1985. 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