With little fanfare, a Department of Commerce determination heralds a sea-change to the U.S. government’s approach to China trade and echoes growing sentiments in Washington that trade officials hold China fully accountable for granting subsidies to Chinese companies. If upheld, the Commerce ruling could encourage an avalanche of challenges to Chinese imports by U.S. manufacturers and, although unlikely, initiate a trade war between the United States and China.

In a preliminary decision announced March 30, Commerce overturned 23 years of trade policy and applied countervailing duties (“CVDs”) to products made in China and opening the door to other non-market economy countries (“NMEs”). The decision specifically addressed coated free sheet (high gloss) paper imported from China and affected a range of Chinese subsidies, including tax breaks, debt forgiveness, and low-cost loans. Accordingly, this departure could lead to the imposition of CVDs ranging from 10-20% for glossy paper imported from China in addition to antidumping duties designed to counter sales below “fair value” by Chinese producers/exporters.

Under U.S. trade law, Commerce is charged with conducting investigations into whether a particular product is manufactured using subsidies provided by a foreign government to the manufacturer of that product. If Commerce determines that subsidies have been provided, the Department instructs U.S. Customs and Border Protection to assess countervailing duties to offset the effect of the government subsidization provided abroad. Imposition of countervailing duties on a specific import increases the cost of the import. CVDs are imposed in addition to any regular import tariffs assessed at the time of importation and—most significantly—are borne by the U.S. importer of record.

Since 1984, Commerce has determined that it was unable to apply CVDs to NMEs because it was unable to accurately measure the impact of a subsidy in an economy where no market forces exist and where there was an absence of transparency and market data. In 1986, the Court of Appeals for the Federal Circuit case upheld the Department’s position in a case known as Georgetown Steel. Over the last 23 years, Commerce refused to apply CVDs against NMEs such as China, and the U.S. industry refrained from requesting that subsidies be investigated from those countries. Instead, U.S. domestic industries made antidumping the trade weapon of choice to counter predatory pricing by Chinese producers/exporters.

Set against a backdrop of growing concerns by U.S. domestic industries over a growing surge of Chinese imports, an Ohio-based U.S. producer, New Page Corporation, in late 2006 filed antidumping petitions against China, Indonesia and South Korea but also filed companion CVD petitions against coated free sheet paper and paperboard from China, Indonesia and South Korea. In effect, this trade action was the 21st century international trade equivalent of the “shot heard round the world” as Commerce’s 23-year-old position was challenged. Commerce was compelled to initiate a formal investigation on Nov. 21, 2006.

Commerce’s preliminary determination followed by one day a U.S. Court of International Trade (CIT) decision denying China’s request for a preliminary injunction against the U.S. in the Commerce case. China had argued that Commerce lacked the legal authority to levy CVDs against China, but the CIT ruled Commerce has the authority to impose anti-subsidy measures. As a result of Commerce’s initial investigation, preliminary countervailable subsidy rates ranging between 10.9 and 20.35 percent will be applied to Chinese producers of glossy paper products. As a result of Commerce’s preliminary determination, Customs will begin collecting from U.S. importers security on new imports of coated free sheet paper pending the outcome of the final Commerce investigation.

Under U.S. law, the Chinese government has seven days from the date of issuance of the preliminary determination to submit a proposed suspension agreement to U.S. officials. A suspension agreement would “suspend” the CVD investigation provided the Government of China agreed to modify its behavior so as to eliminate the subsidy programs at issue. If Commerce were to accept a suspension agreement, thereafter it would monitor compliance with the agreement.

During the final phase of its investigation, Commerce will have to address key issues regarding the appropriate methodology to use in calculating the level of subsidization received by Chinese manufacturers of glossy paper. The Commerce Department ruling reflects the Bush Administration’s understanding that the Chinese economy has changed since the early 1980’s and the amount of Chinese subsidies can be determined. In a statement issued March 30, Commerce Secretary Carlos M. Gutierrez noted the Administration’s aggressive enforcement of U.S. antidumping laws against “unfair Chinese trade,” adding that “China’s economy has developed to the point that we can add another trade remedy tool, such as the countervailing duty law.”

According to Commerce, Chinese dumping cases now represent 25 percent of all antidumping orders. Commerce’s preliminary determination in this current countervailing duty case comes at a time of growing sentiment on Capitol Hill towards increased use of U.S. trade laws against China. Bipartisan legislation has been introduced in both houses of Congress regarding the applicability of U.S. CVD law against NMEs, specifically aimed at China. The pending legislation would authorize Commerce to apply CVDs to China, or any other NMEs.

Moreover, a new Democratic trade policy released in March illustrates that U.S. trade with China is one of several key issues the current Democratic leadership aims to address in the coming months. Specifically, Democrats intend to take action regarding subsidies provided by the Chinese government; against China’s alleged currency manipulation (related legislation also pending before Congress); and seek solutions before the World Trade Organization (“WTO”) cases. This new policy vision also calls for the creation of a U.S. Trade Enforcer charged with preparing WTO cases, and a special U.S. Trade Prosecutor tasked with filing WTO cases.

The current sentiment on Capitol Hill certainly has been fueled, in part, by a growing U.S. trade deficit with China now estimated at a record $232.5 billion.

Commerce’s preliminary decision to apply U.S. anti-subsidy law against China will have several ramifications, including higher costs of glossy paper imports for consumers.

Of greatest concern, however, is the potential for an onslaught of anti-subsidy petitions should a suspension agreement not be worked out and final CVDs be assessed by Commerce. U.S. manufacturers in many other industries would be given a green light to file countervailing duty petitions against countless Chinese-origin products imported into the U.S.—including those already subject to antidumping orders. More such petitions and CVDs levied would ultimately mean that importers and U.S. consumers will be significantly impacted by this change in U.S. trade law.

How China will react also remains to be seen. Though the prospect of a trade war remains a distant possibility, China certainly could avail itself of WTO dispute procedures against the U.S., or, for that matter, use its own trade remedy laws to go after U.S. companies. To be sure, we live in interesting times.