Greening the road: China’s low-carbon energy transition and international trade regulation

Abstract

This article offers one of the first comprehensive analyses of China’s emerging practice in subsidizing the low carbon energy (LCE) transition by using the new energy vehicles (NEVs) industry as a case study. It puts forward a fresh framework for this analysis by dividing the NEV value chain into three segments: upstream, midstream, and downstream. Based on this framework, it expounds a strategic shift of China’s subsidization strategy across the NEV value chain, that is, from disproportionately subsidizing the midstream segment that produces NEVs and parts to increasingly subsidizing the upstream and downstream segments to promote research and development (R&D) and expansion of NEV infrastructure and consumption throughout the economy. It argues that this shift mainly comes out of the evolution of China’s industrial policies and economic priorities, which will continue to play a decisive role in the future restructuring and transformation of the NEVs sector. This shift may also reflect China’s intention to reduce potential trade conflicts and maximize WTO-compliance but only to the extent that doing so would not unduly constrain its capacity to pursue its economic goals and industrial policies. In addition, while the WTO rules and jurisprudence may accommodate some of these subsidies (e.g., NEV infrastructure subsidies), the relevant rules will need to be further developed to provide more policy space for other types of subsidies used worldwide (e.g., R&D subsidies). Until then, it remains debatable as to whether the WTO provides sufficient room for countries to facilitate a green recovery in the post-pandemic era.

1. Introduction

As the world struggles to contain greenhouse gas (GHG) emissions, there is a pressing need for a transition from a high-carbon to a cleaner and more sustainable low-carbon energy (LCE) system. ¹ This energy transition is essential not only for mitigating climate change and protecting the environment but also to improve social inclusiveness and facilitate technological progress. ² Further, it is closely aligned to a variety of sustainable development goals (SDGs), particularly SDG 7, which is about ‘affordable and clean energy’, and SDG 13, which calls for ‘climate action’. ³ Propelling this transition has, however, presented an existential challenge for all economies.

The COVID-19 pandemic has further intensified this challenge. For example, the resulting economic turmoil worldwide has disincentivized investment and innovation in the LCE sector and interrupted global supply chains crucial for the sector’s development. ⁴ The wide spectrum of exceptionally large recovery plans has far-reaching implications for the trajectory of GHG emissions, leading to an ongoing debate on the ways to reverse the pandemic-induced economic slowdown without relying on a wave of carbon-intensive stimulus spending.⁵ Seizing the opportunity to ‘build back greener’ to set the world on track for meeting the 2030 SDGs and carbon neutrality target by around mid-century is vital. ⁶ As confirmed in the global climate summit – Conference of Parties (COP)26 – recently held in Glasgow, countries will make further pledges to cut carbon emissions to keep temperature rises within 1.5 degrees.⁷ In addition, a wide range of national and sub-national governments, automotive manufacturers, and other stakeholders have committed to accelerating the transition to zero-emission vehicles to achieve the climate goals.⁸

Finding a low-carbon, high-growth recovery formula is anything but easy. Over 85 per cent of the world’s energy is still derived from fossil fuels, and LCE sources generally remain uncompetitive. ⁹ Hence, governments are increasingly resorting to a range of supportive measures to foster the development of LCE technologies and the growth of their market share. ¹⁰ Subsidies, as a major policy response, have attracted growing attention, especially as countries gradually shift financial support from fossil fuels towards renewable energy (RE). ¹¹ The rise of subsidies for the LCE sector has triggered more trade disputes and heated debates over the rulings of the World Trade Organization (WTO). ¹² Here, a fundamental issue is how to strike a balance between the use of subsidies for legitimate policy goals such as combating climate change and the need to constrain their abuse that adversely affects the interests of trading partners. ¹³

This article contributes to the existing scholarship by expounding China’s emerging practice in subsidizing the LCE transition. We will use new energy vehicles (NEVs)¹⁴ as a case study since it is beyond the scope of this article to cover all types of LCE technologies that are broad and rapidly developing. ¹⁵ NEVs are regarded as ‘the single most important technology for decarbonizing the transport sector’, accounting for 30 per cent of global emissions.¹⁶ Given the importance of this sector, China has maintained ambitious industrial policies and massive subsidies to foster the development of NEV technologies and innovation, manufacturing capability, enabling infrastructure, etc. Thanks to these policies and subsidies, China has surpassed the US and the EU to become the world’s largest NEV producer in just a decade.¹⁷ More recently, NEV manufacturing companies in China, including private companies, state entities, and wholly foreign-owned companies, have taken up a large portion of the domestic market.¹⁸

With an established NEV manufacturing industry, China has been shifting its subsidization across the NEV value chain and arguably in ways that seek to make these subsidies more adherent to WTO rules or less likely to trigger trade disputes. Our primary goal in this article is to explain this policy shift and the related emerging practice in China and the reasons behind it. We argue that this shift derives mainly from the evolution of China’s industrial policies and economic goals; and it may have also been influenced by recent trade disputes over RE-related measures.

Section 2 starts by classifying LCE subsidies into three categories based on the key segments of the value chain in this sector, namely, ‘upstream’ such as R&D, ‘midstream’ such as manufacturing of LCE products and components, and ‘downstream’ such as LCE infrastructure and consumption. This classification provides a framework for our discussion of China’s strategic shift in subsidizing the NEVs sector – i.e., from heavy subsidization in the midstream segment to increasing subsidization in the upstream and downstream segments – and the main explanations for this shift throughout the article. Section 2 then sets out briefly China’s overarching economic policies and goals that underpin this strategic shift. Against this backdrop, Section 3 delves into the major types of Chinese subsidies in the NEVs sector to advance our core argument about China’s reorientation of its subsidization strategy in light of developing its economic goals and priorities. Section 4 critically evaluates how the major WTO rules on subsidies and cases involving RE measures may have impacted China’s policy shift. In doing so, we also offer some observations on the flexibilities (or lack of flexibilities) that the WTO may have for China’s new approach to NEV subsidies. While focusing on China, our analysis has broader implications as governments restructure and expand LCE subsidies in the pursuit of a green recovery. Section 5 sets forth the conclusion.

2. The LCE value chain and China’s policy priorities

2.1 The LCE value chain

The increasingly sophisticated LCE value chain calls for a segment-specific analysis to facilitate a discussion of the ongoing shift of priorities in subsidization, the impact of these subsidies on international trade, and their compatibility with WTO rules. The LCE value chain can be divided into three segments: upstream, midstream, and downstream. ¹⁹

The upstream segment mainly encompasses R&D activities, a market that is highly intensive in capital and technology and hence is difficult to enter. R&D subsidies are typically used to address market imperfections associated with the lack of financing and investment (e.g., due to low return on investment or long payback time) and to build technological capability and competitiveness. ²⁰ For immature LCE technologies, R&D subsidies can play an important role in reducing the entry and operation cost and bringing financing and investment to socially desirable levels. ²¹ The midstream segment mainly refers to the manufacturing of LCE and key components, such as NEVs and batteries. Compared to the upstream segment, the midstream segment has a relatively lower entry barrier and an increasingly expanding global market for imports and exports involving economies at different stages of development. ²² The high cross-border tradability makes the midstream market the main battlefield for NEV companies. The downstream segment covers the development of infrastructure to support the supply of LCE to end-users and after-sale services. This segment is highly value-added and has the potential to generate more employment. ²³ Nevertheless, compared to the midstream segment, the downstream segment remains less tradable mainly because many services (e.g., the sale of NEVs and the maintenance of charging facilities) require their providers and consumers to be in the same location.

Largely due to the different degrees of tradability of goods, services, and technologies in the different segments of the LCE value chain, the impact of the segment-specific subsidies on international trade varies significantly. Generally, the more a segment is exposed to international trade, the higher is the possibility of subsidies generating cross-border implications. A proof of this is the growing number of WTO disputes concerning midstream subsidies provided to RE producers, which are discussed in Section 4.

2.2 China’s new strategic goals

As the world’s largest carbon emitter and one of the first major economies steadily recovering from the pandemic, China is at the forefront of leading a sustainable recovery. The ambitious 2060 carbon neutrality pledge,²⁴ announced by President Xi Jinping at the 2020 UN General Assembly, calls for a ‘fundamental change in China’s energy supply systems’, which in turn requires structural and strategic adjustments of the relevant industrial policies and supportive measures. ²⁵ Such adjustments, as envisaged in the fourteenth Five-Year Plan (2021–2025), essentially encompass three broad areas and goals: technological advancement and innovation, infrastructure development, and internal market expansion. ²⁶ In the technology space, China carries on its firm commitment to advancing technological competitiveness, innovative capability, and independence in strategic industries, including the LCE sector. This commitment remains key to China’s economic development goals. It also reflects China’s concerns about the pandemic-induced uncertainties in the global supply chain and escalating tensions with major trading partners such as the US and the EU.

Furthermore, China’s emphasis on subsidizing the midstream segment in the past has led to a mismatch between strong manufacturing capacity and low deployment of certain LCE technologies.²⁷ Such disproportionate subsidization is likely to create industrial overcapacity and hinder the decarbonization process. Thus, China is ratcheting up its efforts to build new infrastructure essential for promoting the deployment of high technologies, including LCE technologies.²⁸ At the same time, the new strategy of ‘dual circulation’, which is also a policy response to the uncertainties in the external environment, seeks ‘greater economic independence’ by relying on ‘the domestic cycle of production, distribution and consumption’ as the main engine for economic growth while downplaying the role of international trade and investment (i.e., the external circulation).²⁹ This strategy necessarily hinges on and will lead to an expansion of the domestic market for LCE technologies. These overarching goals are not entirely new but have acquired prominence to become vital elements of China’s current policy priorities. As we argue below, they have been the key drivers of China’s reorientation of the subsidization strategy in the NEVs sector.

3. New trend of subsidization in China’s NEVs sector

Before its reorientation of subsidization strategy, China had disproportionately subsidized the midstream segment of the NEVs sector for over a decade. The reorientation has seen an ongoing shift to increasing subsidization in the upstream and downstream segments while gradually phasing out the midstream subsidies.

3.1 Phasing out midstream subsidies

The midstream segment of the NEV value chain mainly involves the manufacturing of NEVs and components such as batteries. This segment used to be the focus of China’s NEV industrial policy and support.³⁰ To boost manufacturing capacity, China has set various industrial targets, such as a minimum share of indigenous electric vehicles and plug-in hybrids in the domestic market³¹ and the creation of national champions specializing in the manufacture of key components, particularly power batteries.³² Between 2010 and 2020, China accounted for 44 per cent of global NEV production while the EU and the US shares were 25 and 18 per cent, respectively.³³

China’s subsidies in the midstream segment take a variety of forms, including direct transfer of funds, tax incentives, policy loans, cheap land, and electricity. The major subsidy has been the massive nationwide direct transfer of funds. In 2013, the central government selected 28 local areas as NEV promotion sites and has since provided direct payments to support the sale of eligible NEVs.³⁴ These subsidies were provided directly to producers in anticipation that the sale price was to be reduced proportionately to the level of subsidies. In practice, NEV producers have been the largest beneficiaries due to the lack of an effective monitoring system to ensure the benefits actually flow through to consumers.³⁵

Consequently, the subsidies led to a drastic increase in manufacturing capacity. To implement the national policy, local governments introduced similar financial support.³⁶ As NEV technologies became more mature, the central government reduced this subsidy six times between 2014 and 2020. Local governments were also asked to reduce their own subsidies. Moreover, the eligibility for this subsidy has been tied to increasingly stringent technology and performance requirements. The modified subsidy scheme favours NEV firms with higher levels of technical performance and is available to both domestic and foreign-invested NEV manufacturers. For example, in the first half of 2020, Shanghai-based Tesla secured the largest portion of this subsidy, approximately 20 per cent of the total amount granted. ³⁷ In 2018 and 2019, Shenzhen-based BYD received nearly RMB 8 billion, making it the home-grown champion of NEVs, followed by Beijing Automotive Group and Yutong Bus. ³⁸ Nevertheless, these direct payments are being phased out. Initially scheduled to be removed by 2020, the central scheme has been extended for two more years until 2022 due to the declining sales induced by COVID-19. ³⁹

Besides supporting NEV production, the NEV battery sector has also received sizeable subsidies.⁴⁰ In 2015, the central government introduced the so-called ‘white list’ of battery manufacturers without including any foreign firm, and only NEVs that use these batteries were eligible for government subsidies. ⁴¹ This local content requirement (LCR) was employed to boost the manufacturing capacity of power battery, the most expensive component of an electric vehicle. ⁴² It led to an astonishing growth in China’s battery installation capacity by nearly 57 per cent annually from 2015 to 2018. ⁴³ China has now surpassed Japan and South Korea to become the world’s largest battery manufacturer. ⁴⁴ After major domestic manufacturers such as CALT, BYD, and Guoxuan had acquired sufficient capabilities and global competitiveness, China abolished the LCR in 2019.

Overall, China has been scaling back and gradually removing the major subsidies granted to the midstream segment of the NEV value chain. This is a strategic move in light of China’s new priorities discussed in Section 2 and particularly after China’s manufacturing capacity had already been established. This move also reflects China’s growing concerns about overcapacity, budget constraint, and subsidy fraud.⁴⁵ In addition, as Chinese NEVs increasingly compete with foreign counterparts in overseas markets,⁴⁶ there might also be concerns about WTO-consistencies and potential trade disputes.⁴⁷ This point will be further explored in Section 4.

However, at least two outstanding issues are worth noting. First, while China has tightened the eligibility criteria for direct payments to NEV producers and removed the LCR in favour of domestic power battery makers, it arguably has maintained a de facto LCR. The modification of the direct payments in 2020 limited eligible NEVs to those priced at no more than RMB 300,000. ⁴⁸ While this criterion applies to all NEV manufacturers, it induces NEV manufacturers to source from local suppliers of key components, particularly batteries, to bring down the cost. For instance, Tesla managed to reduce the price for some vehicle models by using batteries provided by Chinese manufacturers. ⁴⁹ As reported, CALT supplied 20 per cent of Tesla’s battery demand in 2020.⁵⁰

Nevertheless, this de facto LCR will cease to exist once the direct payment scheme is phased out in 2022. Second, some other forms of subsidies remain, particularly at the local level, which has been provided to attract NEV firms to set up manufacturing plants or headquarters in local areas. For instance, in 2017, X-Peng received a low-rate loan of around RMB 1.5 billion from Zhaoqing City, Guangdong Province, and cheap land provided by Wuhan City, Hubei Province. ⁵¹ NIO signed a collaboration agreement with the Hefei government in Anhui Province and obtained an RMB 7 billion equity infusion from many state entities. ⁵² While these subsidies have created issues of WTO-consistency, China’s action to phase out them in an incremental manner is a positive development.

3.2 Shifting to upstream and downstream

3.2.1 Upstream R&D subsidies

China’s R&D capability in the LCE sector generally remains under-developed. ⁵³ In the NEVs sector, there is a significant technological gap that has constrained its quality development and competitiveness.⁵⁴ Therefore, this sector has been one of the strategic industries in which China is keen to enhance technological capability through R&D.

At the early stage, the R&D of Chinese NEVs was driven by small-scale government support. For instance, the ‘863 Electric Vehicle Program’ identified NEVs as a priority and allocated approximately RMB 738 million for R&D. ⁵⁵ The release of the Development Plan of Energy Conservation and New Energy Vehicles 2012–2020 further boosted central and local support for R&D. ⁵⁶ Under the NEV Innovation Program, 17 NEV projects and eight electric battery projects were selected for fiscal awards from the Energy Conservation and Emissions Reduction Fund based on their competitive performance in innovation and industrialization. ⁵⁷ Apart from NEV-specific R&D subsidies, general R&D incentives designed for emerging and strategic industries are also available. Most recently, the 2021–2035 Plan emphasizes the need to create a new industrial innovation ecosystem by promoting R&D collaboration between firms and research institutions, particularly to break major technological barriers and advance critical technologies and innovation.⁵⁸

To complement the national subsidies, local governments, particularly in the demonstration cities, have crafted R&D incentives to encourage NEVs innovation. For instance, the Guangxi provincial government provides a one-off fiscal award of RMB 500,000 to firms if their vehicles meet certain technical requirements or get listed in the national NEV Demonstration Catalogue.⁵⁹ The Yunnan provincial government offers R&D fiscal awards equivalent to 1 per cent of a NEV firm’s total annual revenue when the firm’s annual sale exceeds 100,000 vehicles for the first time. ⁶⁰ In Guangdong, the supportive scheme is more inclusive through an annual RMB 300 million grant for major R&D projects, including NEVs, power batteries and other key components, NEV innovation platforms, etc.⁶¹

Another major form of R&D subsidies is tax reductions and exemptions for NEV firms conducting innovation and research activities or technology transfer.⁶² In recent years, China has been seeking to prioritize the use of tax incentives for R&D, ⁶³ and since 2021, the ratio of additional pre-tax deductions for R&D expenses that NEV firms can apply for has been increased to 100 per cent.⁶⁴ Similarly, local governments have offered various tax incentives for NEV firms.⁶⁵ Another notable development has been China’s growing emphasis on the use of non-specific tax incentives, which will be further discussed in Section 4.

Accordingly, there is a clear trend of increased subsidization in the upstream segment of the NEVs sector, with a focus on R&D. Given the vital role of NEV technologies, continued growth is envisaged in China’s R&D subsidies in the coming years. The shift from midstream subsidies to the upstream serves China’s policy priorities and economic needs and is necessary to manage any potential budget constraint. One major issue, though, has been how to maximize the efficacy of the subsidies so that the R&D goals are achieved. As these subsidies are provided directly to the firms, there is a high probability that they may be (mis)used for other objectives (such as to increase production) instead of achieving breakthroughs in key NEV technologies.⁶⁶ This issue is being addressed partly through the introduction of the new industrial innovation ecosystem, as mentioned above, to encourage R&D collaboration between firms and research institutions.

3.2.2 Downstream infrastructure subsidies

Enabling infrastructure, which is critical for the delivery of LCE to end-users, remains underdeveloped in many countries. ⁶⁷ In the NEVs sector, the development of nationwide, reliable, and affordable charging infrastructure is essential for the penetration of NEVs. ⁶⁸ Although the absolute number of charging facilities installed has risen quickly in China, the density remains low and has become a major constraint for the growth of NEV adoption.⁶⁹

China did not place emphasis on developing charging infrastructure until 2015.⁷⁰ Consequently, the development of such infrastructure lagged far behind the rapidly-growing NEV production.⁷¹ To address this deficiency, the State Council issued a Guiding Opinion to set the overarching goals and specific targets for the development of charging infrastructure and direct increasing financial support in this sector.⁷² Over time, NEV infrastructure, including charging stations, has become one of China’s strategic priorities, particularly under the new infrastructure initiative mentioned in Section 2.

Following the national policy, an increasing number of local governments have introduced subsidy programs to support the expansion of charging infrastructure. These subsidies are of various types, such as compensation for the construction costs of charging infrastructure, fiscal support for installation and maintenance, and preferential utility rates, which reduce electricity costs for charging operators. ⁷³ More specifically, the Shenzhen government has set a target to build around 840,000 charging points by 2025 and provides fiscal incentives based on the installed capacity of charging points, ranging from RMB 100/kW to 400/kW. ⁷⁴ The Shanghai government offers a range of supportive programs, such as preferential electricity rates to firms and direct payments to NEV users to promote the installation and operation of public and private charging stations. ⁷⁵ Notably, in 2020, the Shanghai government removed the LCR, compelling the use of domestically made charging equipment.⁷⁶

As NEV infrastructure remains at the development stage in China, government support for the construction and operation of charging facilities will remain or even be stepped up in the near future. Nevertheless, as installation-based subsidies may lead to low-quality and low-efficiency investment, we may see a shift to operation-based subsidies based on the efficiency and performance of charging infrastructure operators. ⁷⁷ If one considers the NEVs sector as a whole, the strategic reorientation of subsidies can also be discerned in this downstream segment and is also well aligned with China’s overarching economic goals and needs. A shifting policy priority from NEV subsidies to charging infrastructure construction and maintenance subsidies is underway.⁷⁸

3.2.3 Downstream consumption subsidies

End-user subsidies can directly reduce consumption costs and enhance the affordability of and access to LCE by consumers. ⁷⁹ Over time, such subsidies may well induce a fundamental change of consumer behaviour towards environment-friendly consumption, thereby expanding and securing the market for LCE and eventually promoting an economywide adoption of low-carbon technologies. In this sense, stimulating domestic application and consumption of LCE constitutes an indispensable part of achieving decarbonization goals.

China’s policy shift from midstream to downstream subsidies in the NEVs sector has also involved a growing emphasis on consumer-oriented incentives that have contributed to a fast-growing adoption of NEVs. ⁸⁰ As of this writing, China has become the world’s second largest NEV market, accounting for half of the world’s NEVs and more than 90 per cent of electric buses and trucks.⁸¹

Since the launch of the ‘Ten Cities, Thousand Vehicles’ programme in 2009, government procurement became the mainstream policy instrument to expand the consumption of NEVs.⁸² In 2013, the central government released specific targets for the share of NEVs in government procurement and public purchases. ⁸³ This was followed by the introduction of a number of national measures mandating public procurement to promote the demand for NEVs. ⁸⁴ As estimated, around RMB 3 billion was spent on government procurement of NEVs for public transit in 2019. ⁸⁵ The enthusiasm for the private purchase of NEVs started to pick up when supportive policies for private consumers were gradually expanded and diversified, particularly after 2013. ⁸⁶ Unlike the direct payments to producers based on NEV sales (treated as midstream subsidies above), these subsidies are provided directly to consumers typically by way of tax incentives, including the exemption of vehicle and vessel tax, purchase tax, and registration tax.⁸⁷ While the purchase tax exemption is available only for NEVs listed on the catalogues published by competent authorities, ⁸⁸ the exemption from vehicle and vessel tax and registration tax applies to all NEVs. At the local level, consumer subsidies have been developed in a variety of forms. ⁸⁹ For example, the Shanghai government waives application fees and processes for NEV buyers while such application costs up to RMB 80,000 and often takes time. ⁹⁰ The Shenzhen government offers preferential parking fees for NEVs. ⁹¹ Reimbursement of charging-related electricity tariff has also been increasingly used by local governments. ⁹²

Currently, there is no sign that the above support for the consumption of NEVs is to be scaled back. Given China’s ‘dual circulation’ strategy and strong commitments to developing the NEVs sector, consumer subsidies may well continue to grow in the foreseeable future while midstream subsidies are gradually reduced or removed.

4. Impact/flexibility or lack of impact/flexibility of WTO rules

While China’s reorientation of the subsidization in the NEVs sector has been driven primarily by its own policy priorities and economic needs, it may also have involved considerations of how to reduce trade conflicts and ensure WTO-compatibility. This section discusses the extent to which this reorientation has led to a gradual shift to subsidies that are less likely to trigger trade disputes and/or less controversial under WTO subsidy rules.

Industrial subsidies are one of the most controversial areas of international trade regulation. Given their widespread use by governments worldwide for economic recovery and other policy goals, subsidies pose growing challenges for the multilateral trading system largely due to their spill-over effects on trading partners and potential inconsistencies with WTO rules. ⁹³ Thus, as mentioned, the fundamental challenge lies in striking a balance between allowing sufficient policy space for the legitimate use of subsidies and preventing their abuse that harms the interests of trading partners. As subsidies often provide the first-best policy response to market failures, trade economists have cautioned against excessively intrusive disciplines, which may prompt governments to resort to second-best instruments and inefficient outcomes. ⁹⁴ As will be shown below, WTO tribunals are fully aware of the need for a balancing act in dealing with RE subsidies, although the current rules may be further developed to provide more policy space for their legitimate use.

Industrial subsidies are mainly governed under the Agreement on Subsidies and Countervailing Measures (ASCM), one of the most litigated WTO agreements. ⁹⁵ However, RE or LCE subsidies have been adjudicated in only three recent cases, ⁹⁶ including Canada – Renewable Energy ⁹⁷ (2010), India – Solar Cells ⁹⁸ (2013), and the US – Renewable Energy ⁹⁹ (2016). ¹⁰⁰ All three cases involved certain LCRs designed to incentivize the use of domestic goods over imported ones in the RE sector. All the LCRs were found to be WTO-inconsistent as they treated imported goods less favourably than domestic ones in breach of the national treatment (NT) rule under Article III of the General Agreement on Tariffs and Trade (GATT). In the first two disputes, the respondents – Canada and India – tried to justify their measures under existing WTO exceptions but were unsuccessful. Canada’s reference to GATT Article III(8)(a) was rejected by both the panel and the AB, although based on different reasoning. ¹⁰¹ India invoked not only GATT Article III(8)(a) but also GATT Article XX (d) and (j), which were also dismissed by the WTO tribunals. ¹⁰² Given the dim prospect of justifying LCRs under the WTO regime, it is not surprising that the US did not raise any defence under the dispute brought by India.

Only the Canada – Renewable Energy tribunal considered the ASCM in detail, which will be further discussed below. In India – Solar Cells, the US did not proceed with its claims under the ASCM while the US – Renewable Energy panel exercised judicial economy on ASCM-related issues after it found NT violations. Thus, the Appellate Body’s (AB) rulings under the ASCM in Canada – Renewable Energy have profound implications for future disputes over LCE subsidies. Our discussions below are focused on select legal elements under the ASCM and the GATT. Our goal is not to provide a comprehensive analysis ¹⁰³ but to examine the potential flexibilities these legal elements may provide for the Chinese subsidies in the NEVs sector.

4.1 Financial contributions

The ASCM applies to an exhaustive list of subsidies within the meaning of ‘financial contributions,’ including (i) direct transfer of funds, (ii) foregoing or non-collection of government revenue otherwise due, and (iii) provision of goods or services (other than general infrastructure) or purchase of goods (Article 1(1)(a)(1)). Despite the closed list, the different categories of covered subsidies have been interpreted broadly and applied to successfully discipline a wide range of government measures. China’s NEV subsidies, as contemplated in Section 3, are all in the standard forms that fall within the ambit of ‘financial contributions’. These include, inter alia, direct payment to NEVs and parts producers, ¹⁰⁴ policy loans, ¹⁰⁵ equity infusion, ¹⁰⁶ tax reductions and exemptions (such as for R&D), ¹⁰⁷ provision of goods or services to consumers (such as car plates), and government purchase of NEVs. ¹⁰⁸

China’s RE subsidies were challenged only once at the WTO in the China – Wind Power Equipment case. ¹⁰⁹ This case concerned subsidies in the form of grants, funds, or awards to manufacturers of wind power equipment contingent upon the purchase of domestic wind power components rather than imported ones. While these subsidies were designed to foster the domestic manufacturing of wind power equipment which contributed to the growth of China’s RE industry, the LCRs were prohibited under Article 3(1)(b) of the ASCM and impacted the interests of US competitors. China removed these subsidies after consultations with the US. There were several reasons behind China’s decision to settle the dispute rather than to proceed with the litigation.¹¹⁰ Since China was already the world’s leading producer of wind power equipment at the time of the dispute, the subsidies were dispensable and began to cause over-capacity and over-production.¹¹¹ Sustainable growth of the wind power industry, therefore, required a strategic shift to new priorities and approaches. ¹¹² A similar strategy is now seen in the NEV manufacturing sector. As shown in Section 3.1, having acquired world-class manufacturing capacity and capability, China is phasing out subsidies including LCRs used to foster the production of NEV batteries while prioritizing upstream R&D, which is key to enhancing the global competitiveness of Chinese NEVs and the downstream expansion of infrastructure and domestic consumption which is crucial for sustained growth of China’s NEVs sector.

To our knowledge, China’s NEV subsidies have not attracted any trade disputes yet. While China is now the world’s largest NEV producer, its NEV exports remain marginal largely due to the lack of competitiveness in overseas markets.¹¹³ In the EU, for instance, Chinese NEV firms accounted for only 3.3 per cent of the market share in 2020, even after a 13-fold growth from 2019. ¹¹⁴ Most China-made NEVs are still consumed in the domestic market and a few developing countries, such as Bangladesh, India, and Brazil. ¹¹⁵ However, as China’s technological capability and global competitiveness continue to advance, its NEV exports are expected to grow, generating more trade conflicts. Therefore, China’s ongoing restructuring of NEV subsidies to focus more on the upstream and downstream segments can also be seen as a strategy to avoid such potential disputes. While upstream and downstream subsidies can also be problematic under WTO rules, they are less likely to be challenged due to the low tradability of NEV technologies, infrastructure, and related services to end consumers.¹¹⁶

Moreover, all major economies are committed to advancing LCE R&D and infrastructure, including in the NEV sector. ¹¹⁷ This presents a typical ‘glasshouse’ dilemma that would discourage WTO litigation.¹¹⁸ In addition, compared to the midstream subsidies provided specifically to producers of NEVs and parts, upstream and downstream subsidies may enjoy more flexibility under the current trade rules.

One such flexibility may arise from the exclusion of provision of goods or services in the form of ‘general infrastructure’ from the scope of ‘financial contributions’. In EC – Aircraft, the panel observed that ‘general infrastructure’ refers to ‘infrastructure that is not provided to or for the advantage of only a single entity or limited group of entities, but rather is available to all or nearly all entities’. ¹¹⁹ Therefore, a key criterion here concerns whether the infrastructure is made available to the general public or merely to a limited group of entities. The access to the infrastructure may be limited by law or in effect. ¹²⁰ In EC – Aircraft, the fact that the facilities involved were created for use by Airbus was found to be sufficient to disqualify these facilities from being ‘general infrastructure’ even though they were intended to serve public policy goals. ¹²¹ However, China’s subsidization of the NEVs infrastructure sector may be considered as the provision of goods or services in the form of ‘general infrastructure’ under the current case law. As noted in Section 3.2.2, faced with market imperfections such as insufficient investment in and hence a striking shortage of NEV infrastructure, China is rolling out various types of subsidies to incentivize investors and companies to enter this market so that the construction and operation of NEV charging stations can reach socially desirable levels. Since these stations are created for public use, they constitute ‘infrastructure of a general nature’. ¹²² There is no evidence to suggest that these stations or other major NEVs infrastructure has been or is being built for use by a limited group of actors or entities. One issue here, though, concerns the fact that currently, the Chinese subsidies are provided to entities that build and operate NEV charging stations as opposed to the government providing the infrastructure directly. However, as Lee has argued persuasively, it is possible to interpret the ‘general infrastructure’ exception as encompassing a government’s indirect provision of goods or services so as to leave policy space for bona fide green programs.¹²³ Since China’s subsidization of construction and operation companies constitutes an integral part of its provision of NEV charging stations countrywide, these subsidies fall within the ‘general infrastructure’ exception. Even if this argument fails, one may still find some flexibility under the element of ‘benefit conferred’.

4.2 Benefits

A financial contribution must confer a benefit to the recipient before it can be treated as a subsidy under the ASCM (Article 1(1)(b)). In essence, the test of ‘benefit conferred’ hinges on a determination of whether the financial contribution is provided ‘on terms more advantageous than those [that would have been] available to the recipient in the market’. ¹²⁴ Thus, the selection of a market benchmark is crucial. In Canada – Renewable Energy, the AB rejected the panel’s use of the wholesale electricity market, in which electricity was generated from all energy sources, as a benchmark in determining whether the Canadian feed-in-tariff (FIT) program conferred a benefit on wind power and solar photovoltaic (PV) generators. ¹²⁵ It ruled:

a distinction should be drawn between, on the one hand, government interventions that create markets that would otherwise not exist and, on the other hand, other types of government interventions in support of certain players in markets that already exist, or to correct market distortions therein. Where a government creates a market, it cannot be said that the government intervention distorts the market, as there would not be a market if the government had not created it. While the creation of markets by a government does not in and of itself give rise to subsidies within the meaning of the SCM Agreement, government interventions in existing markets may amount to subsidies when they take the form of a financial contribution, or income or price support, and confer a benefit to specific enterprises or industries. ¹²⁶

In drawing a distinction between ‘creation of a new market’ and ‘intervention in an existing market’, the AB endorsed the legitimacy of government actions that promote the use of RE sources which contribute to securing ‘the sustainability of electricity markets in the long term’. ¹²⁷ Given this distinction, the AB held that the appropriate benchmark should be ‘the terms and conditions that would be available under market-based conditions’ in the wind power and solar PV markets. ¹²⁸ Such a benchmark should be based on the relevant markets in Canada, and only if this is not available, an external or constructed benchmark may be used subject to adjustments in light of the factors contemplated under Article 14(d) of the ASCM. ¹²⁹ Due to the lack of relevant factual findings by the panel, the AB was unable to complete the benefit analysis, which effectively saved the FIT scheme.

Drawing upon the AB’s approach in Canada – Renewable Energy, one may argue that Chinese subsidies for the development of NEVs infrastructure serve to create a market for NEVs charging facilities that would otherwise not exist without government intervention. Due to the high upfront cost and long-term payback, NEV infrastructure, such as charging stations, is considerably under-invested and under-supplied in China. Although China now has one of the world’s largest NEVs charging networks, there remains a significant shortage of reliable and affordable charging facilities.¹³⁰ This shortage calls for government intervention to ensure the sustainability of the NEV market, which is closely aligned with the overarching goal of mitigating climate change. This creation of a market for NEV infrastructure contrasts with the government intervention in the existing market where NEVs and parts are produced. Notably, the AB’s rulings quoted above have suggested that government intervention to create a market would not distort the market being created and hence should not be treated as subsidies under the ASCM.¹³¹

In addition, it is worth noting that while the AB treated the FIT programme as WTO-compatible, it ruled against the LCRs in the programme, which required certain minimum domestic content to be used in the development and construction of wind power and solar PV generation facilities. The different treatment of the FIT programme as a whole and the LCRs was a reasonable balancing exercise that accorded due respect to a bona fide green measure while condemning a trade-distortive industrial policy.¹³² This suggests that China must not introduce similarly trade-distortive and WTO-illegal LCRs by, for example, requiring the use of domestically made NEVs chargers over imported ones for its rollout of NEVs charging facilities nationwide.

4.3 Specificity

The ASCM applies only to subsidies that are ‘specific’ within the meaning of Article 2. Thus, subsidies ‘broadly available and widely used throughout an economy’ are not actionable under the ASCM. ¹³³ In essence, ‘specificity’ concerns whether only ‘certain enterprises’ or ‘geographical regions’ are eligible for a subsidy. It may arise from an explicit limitation on eligibility (i.e., de jure specificity) or where the eligibility appears to be automatic and based on objective criteria or conditions, such as limitation in effect (i.e., de facto specificity). ¹³⁴

The issue of specificity can be contentious in dealing with R&D and consumer-oriented subsidies. R&D activities that develop new technologies and products generate positive spill-overs economywide, and hence subsidies are widely used by governments to promote such activities. At the same time, R&D subsidies help reduce a firm’s costs and raise its productivity.¹³⁵ When the firm competes globally, the subsidies impact the interests of foreign competitors and may trigger competitive subsidization and trade conflicts. The 16-year-long US-EU disputes over the subsidization of their own national champions in the aviation sector (i.e., Boeing vs. Airbus) offer a perfect illustration of how the ASCM may restrain R&D subsidies. In EC – Aircraft and US – Aircraft, the two disputing parties cross-challenged a range of each other’s R&D subsidies mainly in the form of grants and loans (in the case of Airbus) and government procurement (in the case of Boeing).¹³⁶ In both cases, most of the R&D subsidies were found to be specific because they were targeted directly at the civil aeronautics sector.¹³⁷ Only a handful of programs were found to be non-specific because they were made available to R&D activities across a broad spectrum of economic sectors. In EC – Aircraft, for instance, the UK Technology Program funded seven key technology areas based on open competitions by all sectors without targeting aeronautics-related research.¹³⁸ Similarly, in US – Aircraft, the US’s Advanced Technology Program, which was designed to support R&D on high risk, high pay-off, emerging and enabling technologies, was found to be generally available to all economic sectors and not limited to any group of enterprises or industries.¹³⁹

China’s ambitious economic goals and industrial policies for technological development and innovation are widely documented. ¹⁴⁰ Currently, China’s R&D expenditure is the second largest in the world, including massive subsidies to firms. ¹⁴¹ However, since the thirteenth Five-Year period (2016–2020), China has emphasized using non-specific subsidies, particularly tax incentives, to ensure all eligible entities are involved in R&D activities. ¹⁴² The fourteenth Five-Year Plan (2021–2025) reiterated the principle of using non-specific R&D subsidies and upgraded the priority technology areas, which now include new generations of artificial intelligence, quantum computing, integrated circuits, neuroscience, gene and biotechnology, clinical medicine and health, aerospace, and deep land and deep-sea technology. ¹⁴³ This shift from subsidizing select firms and industries to nationwide subsidies in strategic areas is another demonstration of China’s intention to avoid WTO-incompatible subsidies in light of the existing jurisprudence. This shift, however, is not easy to implement and will take time since industry-specific R&D subsidies remain pervasive at both national and local levels, including in the NEVs sector, as shown in Section 3.2.1. More generally, given the importance of R&D subsidies to all economies, it is imperative for the WTO to leave sufficient policy space for governments. Such policy space should not be created mainly through treaty interpretation on a case-by-case basis, which is likely to generate inconsistencies and uncertainties. A better approach would be for WTO members to revive the category of non-actionable subsidies, which include those for R&D and environmental protection, through negotiations. ¹⁴⁴ As many have rightly recommended, such non-actionable subsidies should be reinstated and further developed to allow legitimate use of subsidies subject to pre-determined conditions (such as policy rationale, scope, and magnitude notification) that serve the shared goals and interests of all economies. ¹⁴⁵

The analysis of specificity above also applies to consumption subsidies. While such subsidies are granted to consumers rather than producers, they can still be found to be specific if they support the consumption of goods produced by a limited group of enterprises or industries. ¹⁴⁶ To avoid specificity, these subsidies need to be made generally available to all enterprises in the economy. ¹⁴⁷ However, it would be hard to create an economywide consumption subsidy, and such subsidies are typically targeted at select industries.¹⁴⁸ Despite this potential specificity, whether subsidies provided to consumers may be ‘actionable’ under the ASCM remains controversial. The WTO Secretariat holds the view that Article 1(1) of the agreement may not cover ‘transfers to consumers’, ¹⁴⁹ although that provision does not require the recipient of a financial contribution to be a producer. ¹⁵⁰ This means that the test of ‘benefit conferred’ may be satisfied by showing that some benefits have been conferred on consumers as opposed to producers. ¹⁵¹

Moreover, where consumer subsidies are granted on a non-discriminatory basis, i.e., without discriminating against imported NEVs, they would be less likely to cause adverse effects within the meaning of Article 5 of the ASCM.¹⁵² As shown in Section 3.2.3, China’s consumer subsidies in the NEV sector are generally applicable to all NEVs regardless of their origin and hence may not adversely affect the interest of foreign NEVs producers. In this sense, China’s shift from producer subsidies to consumer subsidies is another evidence of its attempt to reduce trade disputes and breaches of WTO rules.

Towards this end, it is worth noting that given the importance of R&D and consumption subsidies to China’s pursuit of a nationwide adoption of NEVs or LCE technologies, it would be unlikely for China to remove these subsidies even if they are challenged under the WTO. This means that the impact of WTO rules and jurisprudence on China’s policymaking is limited, and WTO-compliance is subordinate to the need to pursue economic goals and industrial policies.

4.4 Government procurement

Government procurement has been a major policy tool in China’s pursuit of technological development and indigenous innovation. A range of national and local policies mandate government purchase of high-tech products supplied by qualified Chinese entities. ¹⁵³ While the overarching policy documents typically make government procurement available to all eligible firms and technologies, ¹⁵⁴ there are numerous industry-specific policies, including in the NEVs sector, as shown in Section 3.2.3.

Government procurement that favours domestic goods over imported ones constitutes NT-type discrimination under GATT Article III. However, Article III(8)(a) exempts such discriminatory measures from the NT rule as long as the procurement is made by governmental agencies and the products purchased for governmental purposes and not for commercial resale. In Canada – Renewable Energy, the AB ruled that this exemption applies only to products that fall within the product coverage of the NT rule, that is, ‘like’ or ‘directly competitive or substitutable’ products. ¹⁵⁵ Thus, it did not apply to the LCRs, which targeted RE generation equipment that was not like or competitive with electricity generated from such equipment and purchased by the Canadian government under the FIT program. ¹⁵⁶ With this ruling, the AB did not need to consider the other elements of Article III(8)(a). It merely observed that whether the products purchased are used for ‘commercial resale’ requires an assessment of the entire transaction concerned based on factors such as whether the sale is made at arm’s length and for profits. ¹⁵⁷ China’s government procurement policies on NEVs are generally targeted at domestic goods.¹⁵⁸ They are vulnerable to challenges under the NT rule (i.e., GATT Article III(4)). However, such policies are possibly exempted under Article III(8)(a) as they set purchase targets for government organs and agencies only and confine the purchased NEVs to public use. ¹⁵⁹ Here, it is worth noting that under paragraph 339 of the Working Party Report on the Accession of China, China committed to granting all foreign entities an MFN treatment in its government procurement. However, this commitment does not include NT. Thus, China will remain exempted under GATT Article III(8)(a) until it becomes a party to the WTO Agreement on Government Procurement. ¹⁶⁰ This current gap in China’s WTO obligations explains why China is strengthening and expanding government procurement of NEVs.

The relationship between GATT Article III(8)(a) and the ASCM, particularly subsidies provided by way of government purchase of goods (Article 1(1)(a)(1)(iii)), has never been considered by WTO tribunals. Thus, the issue of whether government procurement permitted under Article III(8)(a) is also exempted from the ASCM remains unsettled. A detailed discussion of this issue is beyond the scope of this article. Here, we merely note that government purchase of goods may constitute actionable subsidies and has frequently been subject to countervailing actions. ¹⁶¹ However, despite being specific, China’s government procurement of NEVs may well survive the scrutiny of ASCM because there is no evidence to suggest that the purchase is made on terms and conditions more favourable than those available in the market or at more than adequate remuneration. In other words, as long as China ensures that it is NEV procurement does not confer a ‘benefit’ to NEV producers or suppliers, ¹⁶² such procurement would be unlikely to be captured by the ASCM.

5. Conclusion

As many commentators have rightly pointed out, the pandemic provides a unique opportunity to leverage policy responses in pursuit of a broad and long-term transition from high carbon to LCE. ¹⁶³ Decarbonizing the transportation sector by promoting the development and deployment of NEVs contributes significantly to this transition. The NEVs sector has been an integral part of China’s economic policies for over a decade and remains a strategic priority that will attract increasing government support, particularly through subsidies.

While China’s industrial subsidies have been widely debated, this article has contributed to this debate by identifying and expounding a nuanced and sophisticated shift in China’s subsidization strategy across the NEVs value chain, that is, from the provision of disproportionate subsidies in the midstream segment that produces NEVs and parts to an increased focus on subsidizing the upstream and downstream segments to promote R&D, and the expansion of NEVs infrastructure and consumption throughout the economy. The key driver of this shift, as discussed in detail in this article, has been the evolution of China’s industrial policies and economic needs, which will continue to play a decisive role in the future restructure and transformation of the NEVs sector.

As China’s NEVs industry becomes more technologically advanced and globally competitive, the coming years and decades will likely witness increasing footprints of China-made NEVs in overseas markets. This increase will, in turn, lead to more trade disputes over China’s NEV subsidies. Thus, this article has also considered China’s reorientation of the subsidization in the NEVs sector in light of WTO law and jurisprudence on subsidies. It has been argued that this reorientation may also reflect China’s intention to reduce potential trade conflicts and maximize WTO-compliance, but only to the extent that doing so would not unduly constrain its capacity to pursue its economic goals and industrial policies. In this sense, WTO-compliance is merely a secondary consideration and will remain so in China’s policymaking.

In analysing the impact (or lack of it) of the WTO on China’s strategic restructuring of NEV subsidies, we have also shown that the current rules and jurisprudence may accommodate some of these subsidies (e.g., NEV infrastructure subsidies) but would need to be further developed to provide more policy space for other types of subsidies used by all governments (e.g., R&D subsidies). And such development should be pursued via negotiations as opposed to judicial interpretation. Until then, it is still highly debatable whether the existing WTO rules provide sufficient policy space for countries to facilitate a green recovery or build back greener.